MSP as a futures contract!

One of the largest sources of food subsidy in India is the Minimum Support Price (MSP) assured to famers for various crops. The government periodically revises the MSP, especially for paddy and wheat, most often in response to political pressures, as a pork-barrel.



Stripped of all the welfare and political jargon, the MSP is a simple futures contract where the government contracts to buy the crop at a pre-determined price. However, unlike the conventional futures contract traded in commodities exchanges, MSP does not have any specified time duration and the buyers can exercise this contract free of cost. The MSP offered for paddy and wheat procurement by the Government of India, through the Food Corporation of India (FCI), can claim to being possibly the largest single futures contract in each of these commodities anywhere in the world.

So how about replacing the MSP with a specifically tailored futures contracts, in which individual farmers or their groups (co-operatives or farmers groups) enter into contract with market makers and traders (government through its canalizing agencies like FCI can also participate as a market maker) to sell their produce at pre-determined prices within a specified time? The market prices of many of these contracts may offer greater net benefits to the farmers than the fixed MSP support of the government.

If the number of participants in these exchange traded contracts increases, it adds to the depth and breadth of the commodities exchanges, thereby making prices more reflective signals of the market expectations and reality. If the government wants to assist the farmers by giving them an assured minimum price, it can subsidize the prices of the futures contracts by way of contract vouchers and through the provision of contract guarantees. An appropriately structured voucher pricing, can prevent market distortions, while providing assistance to the farmers.

The government should incentivize the setting up of trading terminals of the national commodities exchanges in each district head quarters. Agriculture co-operative societies (MACS, PACS etc) can enter into contracts on behalf of the individual farmers. Banks can leverage the business opportunities to act as clearing houses that stand guarantees to the futures contracts enterned into by the farmers. The State Warehousing Corporations can act as facilitators and initially as even market makers. Further, such initiatives will also enable greater access for farmers to formal credit mechanisms.