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Wheat: reduce the procurement

Last week the sub-committee on wheat of Economic Coordination Committee (ECC) of Cabinet recommended an increase in wheat minimum support price (MSP) to Rs1,600 per 40 Kg for the upcoming season from existing Rs1,400. Over the next week, this will require approval from ECC, and subsequently by the cabinet. Ministry of Food Security and Research wanted to increase support price to Rs1,780 as, according to it, Rs1,600 would be barely covering the cost. The government may compensate farmers’ higher cost in the form of subsidies to fertilizer and other inputs.

Ideally, the government should not be in the procurement business and should rather incentivize farmers to harvest wheat through input subsidies. That used to be partially the case prior to 2008. But with squeezing fiscal space, government subsidy on fertilizer, diesel, and other inputs fell significantly. In 2009, the then PPP government increased the wheat support price by over 50 percent in one go to Rs950/40kg. One reason for such an increase was sudden rise in international prices and currency depreciation at home. The international prices fell (normalized) in subsequent years; but domestic support price never did. For a long time, the MSP in Pakistan was 20-30 percent premium to that in India.

The 50 percent increase in wheat price in one go resulted in extremely high food inflation in a very short time. Food inflation was over 33 percent in a quarter and over 23 percent in FY09. The international wheat prices came back from their high of $344 per ton in FY08 to $185 in FY10 and remained range bound at $200-250 most of the time since then. But MSP in Pakistan kept on increasing.

The spiral impact of wheat on all other food commodities (especially milk) and in turn on wages kept Pakistan’s headline inflation in double digits for several years. The argument for MSP was to ensure enough production of wheat as it is imperative for country’s food security. But the side-effect is that for non-farm poor, the essential food becomes dearer.

Empirical evidence suggests that even the poor farmer has become vulnerable. It is a known fact that government largely buys wheat from big farmers, and the smaller is forced to sell in open market. During the last decade, MSP in Pakistan remained at premium to international prices, the poor farmer had no choice but to sell at discount to MSP. Marginalized farmers faced the brunt of inflation but did not receive the benefit of high wheat prices. Meanwhile, in that time the nutrition indicators worsened in the country. For better nutrition intake, prices must come down or income levels must move up.

The MSP kept on increasing since 2008 and was at Rs1,300 when this government came into power. With (artificially) stable currency, prices in Pakistan were at good premium to international prices. There was no incentive for exports or to smuggle out. But there was enough incentive to smuggle in.

The government carryover stocks of wheat were growing. Interestingly, stocks were growing during FY16-18 when international prices were at decade’s low (below $200 for three years). Is this rise in stocks due to a bumper crop or wheat being smuggled into the country? Nobody knows this. Meanwhile, the case of exporting wheat was building up.

In FY18, the government stocks reached a historic 9.8 million tons due to a high level of opening balance with the food departments. The high levels of official stocks coincided with Pak Rupee depreciation. This led the government to announce wheat export quota; however, for a short while, sudden depreciation also made domestic wheat competitive enough to even create incentive for smuggling. This was the time when piles of stocks mysteriously disappeared from the warehouses of Sindh’s Food Department. By FY20, the legal and probably illegal exports reduced opening stocks in FY20 to the lowest levels in 10 years. And the crop also fell short of target.

The government took poorly informed measures in response. It announced highest-ever procurement target of 8 million tons – and most of it has been achieved. Since both opening stock and crop production were low, while government achieved very high procurement, the private wheat market became dry. The government was planning to release stocks in the market by Oct 2020, except flour mills were unable to procure wheat from open market. The result was simple, prices started skyrocketing. Wholesale market prices in Faisalabad last week stood at Rs2200/40kg.

Had the government procured less, the shortage and the price increase would have been lower. Since the opening stocks were low and crop wasn’t bumper, the imports could have been done earlier to stabilize the market. The other problem is that demand and production estimates in Pakistan are questionable. Strengthening of PBS could not be stressed more.

Similarly, based on a 10-year-old USDA study, it is assumed that up to 50 – 60 percent of country’s consumption is on farm. Furthermore, a constant consumption of 125kg per capita has been assumed by Ministry of Food Security for more than two decades. Should growing income levels have no effect on wheat consumption trends?

The gaps in data extend to the government departments, whose extent of information is limited to position of official stocks and retail price in various regions. To make matters worse, the administration assumed that higher official procurement would stabilize prices. To reach that goal, the Punjab government even imposed a ban on private storage of wheat over 25 maunds when in May its procurement fell short of target. The damage could still have been controlled if mitigating measures had been taken, except the federal government remained indecisive on the decision to import for over 4 months!

This is the story of the wheat fiasco with historic background. The lessons to learn are to strengthen Pakistan Bureau of Statistics (PBS) to properly gauge demand and supply, taking timely decisions of import, curbing smuggling and most importantly for the government to gradually move away from this business of procurement.

Interestingly, the government has decided to move away from wheat procurement by 2025; but this year procurement was the highest ever – actions and plans are divergent. The government is increasing MSP to ensure that farmers sow enough wheat this year. History suggests that MSP in Pakistan has always been unidirectional – only move up. This decision of MSP proposed is seeing the increase in international prices and higher input prices. However, there is no significant spiral in international prices– rather these are normalizing after the exceptional fall in early days of Covid-19.

The domestic production cost last year was estimated at Rs1,100/40kg. The MSP was maintained at 25 percent above cost of production. The cost has moved up to around Rs1,350-1,400 this season. Seeing this, Rs1,600 is a right price. But this would mean that retail price of government procured wheat would be Rs1,900. As there is cost of government procurement – packaging, storage and debt servicing, and then there are wholesaler and retailer margins. The domestic prices are likely to normalize around Rs1,900 from existing Rs2,200.

Now to avoid repeat of this year’s mistakes, the government should significantly reduce its procurement target. The subtle point is that it is not the price but higher procurement of government that had created this crisis. Some say that the government should not give procurement price at all. Well for that, the country should be ready to significantly import wheat in coming years. As the substitution to other crops – sugarcane, canola, and maize— is already viable.

The problem is the policymakers are looking from the lens of wheat production cost, but not from the opportunity cost of the farmer. The return on other crops is better. Farmer ought to move to those. The yields on other crops are improving, while for wheat the story is other way round. Economic literature suggests that high wheat procurement price since 2008 has reduced the incentive for big farmers to enhance the wheat yields. It is important to note that improvement took place in the market-based crops. The key lesson is that the government should move towards making wheat market-based crop too, and look to attain food security from other angles.

Ali Khizar, "Wheat: reduce the procurement," Business Recorder. 2020-10-25.
Keywords: Economics , Economic growth , Food security , Food inflation , Food department , Federal government , Economic literature , Pakistan , MSP , PBS

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