Financial Daily from THE HINDU group of publications
Wednesday, Jan 04, 2006
Agri-Biz & Commodities - WTO
Should India demand farm subsidy cuts by developed nations?
Since the Doha meeting in November 2001, India has been playing an active role in harnessing opinion to shape agricultural policies that reduce distortions and create a level playing field for all nations, especially the developing economies, some of which overly rely on farm goods exports on which depend the livelihood of millions of farmers.
India's position at various Ministerial and other meetings has been to press for:
Key elements of the subject of negotiation include overall reduction in trade-distorting domestic support based on a tiered formula such that developed nations with higher levels of such support make deeper cuts (three largest distorters: The US, the EC and Japan to undertake 70-80 per cent reduction), and for each sub-component of overall domestic support, separate disciplines have been agreed to be negotiated which will lead to numerical limitations on support levels and/or tightening of their criteria to ensure that the trade-distorting aspects are minimised.
Also, all forms of export subsidies will be eliminated by a credible end-date, which after the Hong Kong Ministerial is 2013.
OECD agricultural policies
There is general agreement that OECD agricultural policies continue to affect international agricultural markets. Policies providing support prices, implemented through trade barriers, and/or other export support or deficiency payments that raise producer revenues to target levels, shield producer returns from world market signals.
Together with technology (especially, agricultural biotechnology) subsidies tend to increase production in the short-to-medium term. This is one of the reasons for weakening supply response to prices. Other supports such as payment linked to land or other inputs also tend to raise supplies. Any support invariably leads to greater investment in agriculture and raises the production potential.
It is the admitted position that total support to agriculture in the OECD area remains in excess of $350 billion a year (1.3 per cent of the OECD GDP) out of which market price support and output payments remain dominant (as high as 70-80 per cent). In other words, of the total support of $378 billion in 2004 (up from $349 billion in 2003 and $310 billion in 2002), close to $280 billion is on account of support to producers.
Across OECD countries, there is a wide range of support levels; also there is a wide variation in support level across commodities. The categories of measures that potentially have the most production-distorting effects are market price support, and payments based on output and input subsidies (such as interest, water, fertilisers, and energy subsidies).
An important component of agricultural support in OECD is the expenditure on `General Services' which is sector-wide and covers institutional services such as research, education, inspection, marketing and rural infrastructure. The monetary value of General Services has been rising in recent years and was $65.8 billion in 2004 (up from $62 billion in 2003 and $56 billion in 2002).
World agricultural trade
Primary foods are the largest component of trade in agriculture, followed by processed foods and agricultural raw materials. About 80 per cent of the agricultural trade is in food products. In a general sense, while the developing countries are net exporters of primary foods and net importers of processed foods, the reverse is the case in major developed countries.
It is known that growth in farm goods trade has been less than in manufactured goods primarily because of diversification of economies away from agriculture, in addition to perishability of farm products, slower growth in demand for food resulting from rising affluence, and natural calamities such a droughts and floods as also outbreak of food-borne or animal diseases.
But a major impediment to growth in agricultural trade remains the high level of agricultural support and protection. Many impediments to trade that had been largely removed for manufactured goods were permitted for agriculture in particular, domestic and export subsidies as also import restrictions ranging from bans to variable levies.
Support payments invariably affect current production decisions insofar as they lower production risks. Agricultural trade protection while depressing world commodity prices inhibits investment in the farm sector and, as a result, prevents developing economies to explore their farm potential.
Within the OECD, the spread in support levels among commodities is significant. There is a wide difference in the level of support and protection among commodities. For 2002-2004, while the overall commodity support averaged 30 per cent, it was lower for oilseeds (20 per cent) and maize (25 per cent) and above average for wheat (35 per cent) and significantly higher for sugar (54 per cent) and rice (80 per cent).
In addition to domestic support that has the effect of enhancing output, OECD countries are known to extend subsidy for promoting exports. Export subsidies take several forms such as credit and credit guarantee schemes, export enhancement programmes, export refunds, involvement of State enterprise, export taxes and restrictions and so on. Beyond containing global commodity price rise and restricting free-market price discovery, aggressive export marketing campaigns depress prices.
Four countries the European Union, the United States, Japan and Korea account for over 90 per cent of total support (producer support, general services, etc) extended by the OECD countries. In 2004, the total support by the EU was $150.5 billion, followed by the US with $108.7 billion and Japan with $60.8billion. Korea accounted for $ 22.5 billion.
Indian agriculture and world farm goods trade
India provides product-specific domestic support in the form of Minimum Support Price. There is also non-product specific support provided in the form of either free or subsidised fertilisers, seeds, water, power and credit. The Aggregate Measure of Support is considerably less than the de minimis level.
At about 600 million tonnes, India is world's third largest producer of food after China and the US. In recent years, the output growth has been tardy with shortages becoming more visible, while income and population growth continues to generate robust demand for food across the country. Post-liberalisation, the annual average farm growth rate that was 4.5 per cent during 1991-1996 (Eighth Plan) declined by over half to 2.2 per cent during 1997-2002 (Ninth Plan). In the first three years of the current (Tenth) Plan period, farm growth further dipped to a woeful 1.1 per cent. No wonder, shortages are becoming endemic and can only get worse if the current growth trends continue.
Agricultural items from which India earns notable amounts of foreign exchange and in which there is large global trade include rice; meat and preparations; oilmeals/extractions; groundnut and sesame seed; and spices. In addition, India is a large exporter of marine products, plantation crops such as tea and coffee; cashew kernels; castor oil; poultry and dairy products; horticulture products; tobacco and so on.
Overall, India is a marginal player in the global agri-commodity trade. Our dominance in the export market is restricted to commodities such as Basmati rice and castor oil. Even in these we are not exactly price-setters. With the exception of rice, the country is not a significant exporter of any of the major commodities traded globally in large volumes. Going by recent output growth trends, cotton has the potential to become an important export item. However, quality and competitive prices are key determinants of export volume.
On the other hand, India is a notable importer of a number of sensitive agricultural commodities. Not only are we among world's top five oilseeds producers, we are the second largest importers of vegetable oil (5.0 million tonnes), after China. We are world's largest producers, consumers and importers (over 2 million tonnes) of a variety of pulses. Rising domestic production of cotton has helped reduce import dependence in the last three years; yet, we import about 5-8 lakh bales of cotton a year. India has been a net importer of sugar since last two years. Signs that we may continue to remain an importer are ominous. Same is the case with foodgrains, especially wheat and maize (corn). Unsteady output and rising demand are leading to tightening of supplies and raise the possibility of import in the years ahead.
Given the growing domestic food and feed requirements and output growth trends, India is most unlikely to be a notable exporter of any of the major agricultural commodities anytime soon. On the other hand, the possibility of the country turning an importer of more commodities than at present is real. Many believe that India would go the China way in becoming a large importer of a wide range of farm goods in the near future.
It is in this global and national context that one must examine whether New Delhi's stand at the WTO negotiations for reduction of subsidies by developed economies makes commercial sense for the country.
For the purpose of this analysis, four major commodity groups oilseeds, foodgrains, cotton and sugar are selected. India is a major producer of these commodities. We are second largest in wheat and rice (after China); second largest in sugar (after Brazil); third largest in cotton (after China, and the US); and the fifth largest in oilseeds. These commodities represent significant economic value for the country because of their huge income and employment potential. However, on current reckoning, in none of these commodities is India in a position to significantly influence global prices, unlike, say, the US or the EU.
What will be the effect of OECD subsidy reduction on India? This paper does not seek to quantity the price effect of a possible reduction or elimination of farm support in developed economies but to visualise the direction of price change and the effect such a move can potentially have on the world market and the implication for India.
In recent years, global oilseeds output has been rising consistently. Output growth has occurred mainly in soyabean and is contributed by major origins the US, Brazil and Argentina. Latest estimates suggest that the global oilseeds output in 2005-06 would be about 385 million.tonnes (mt), up from 380 mt of the previous year and higher than the average of 326 mt of the previous four years.
Soyabean dominates global oilseeds output currently, accounting for 220 mt (previous five-year average: 191 mt). Over 80 per cent of the world trade in oilseeds (75-80 mt) is accounted for by soyabean (65-68 mt). The US is the largest producer (over 80 mt) and exporter of soyabean (27-30 mt).
It is common knowledge that technology (genetically-modified soyabean) adoption and subsidy payments (especially in the US) have combined to drive output up. Interestingly, not only the area under cultivation but also the yields per hectare have increased during the last 10 years, in major origins such as the US, Brazil and Argentina. In addition to support, higher yields and farm scale economies have helped augment supplies and rein-in global oilseeds prices, despite rising demand.
On oilseeds, the OECD producer subsidy is estimated at $9 billion. Of this, the US accounts for approximately $4.5 billion (mainly, soyabean) and the EU $2 billion (mainly, rapeseed). Assuming that the US oilseeds subsidy is almost entirely for soyabean, the $4.5 billion subsidy for production of 80 mt works out to a subsidy of $56 per tonne of soyabean produced in the US. At current soyabean price of around $220 a tonne at the origin, the element of subsidy is 25 per cent of the market price. As the US exports about 40 per cent of its soyabean production (either as bean or meal), it can face adverse market reaction to higher prices, should the subsidy be cut.
Assuming that the EU oilseeds subsidy is almost entirely for rapeseed, the $2 billion subsidy for 15 mt output works out to a subsidy of $133 per tonne. At the current rapeseed price of around $ 230 a tonne at the origin, the subsidy element in the EU is well over 50 per cent of the market price. The EU is not a big exporter of rapeseed and the price impact on the world market would be limited.
Given the large size of global production, rising yield, production volumes of major origins, and seasonality of crop and trade pattern, any reduction or elimination of producer subsidy for oilseeds (mainly soyabean, and especially in the US) is unlikely to affect significantly the international oilseed prices, and much less the vegetable oil market in the medium-to-long run, if one assumes a phased reduction in subsidy. However, the output in the US may be affected in the short-run and the soyabean market may tend to firm up as a consequence, especially in the US, and affect that country's soyabean export volumes.
On the flip side, it would improve the marketability of other oilseed crops and encourage other origins to produce and export more not only soyabean but also other oilseeds. Sooner, rather than later, there would be increased supply as a response to higher world prices. In developed economies and in those that are export-dependent, the supply response to price is prompt and robust.
One must also bear in mind the emergence of biodiesel demand that is helping vegoils prices stay firm. Even a small hiccup in the global output can have a disproportionately large impact on vegoil prices something that is not in the interest of large consumers and importers such as China, India, Pakistan and Bangladesh.
For India, higher world oilseed prices (and, in turn, vegetable oil prices) as a result of reduction/elimination of subsidies in developed countries may not be desirable. We are a leading importer of edible oils (5 mt valued at over $2 billion a year, accounting for over 40 per cent of domestic consumption) because of chronic domestic shortage. Five mt of vegetable oil would be equivalent to approximately 15 mt of oilseeds.
Given the level of integration of India's domestic market with the world vegetable oil market, higher world prices would push the landed cost of imports up. Higher costs/prices of imported goods would hurt consumer interest. Oilseed growers here would stand to benefit with a strong vegoil market under normal circumstances. However, the tariff structure (Customs duty) for imported oils and how well the government deploys it would determine whether the benefit of higher prices would flow to oilseed growers. The current tariff structure is skewed in favour of soyabean oil (WTO-bound peak rate of 45 per cent), while other oils bear a considerably higher duty burden (for crude palm oil it is 80 per cent, for example).
In addition, under Indian conditions, high open market prices do not automatically translate to augmented output the following season. The supply response to prices is rather limited here because oilseed farmers face severe challenges in cultivation and marketing.
Given the country's rising import dependence, higher world oilseed prices (and, in turn, vegetable oil prices) are unlikely to benefit India and are not in our interest. Higher world prices would hurt consumer interest but not exactly promote producers' interest domestically. A rise in world soyabean prices, to some extent, may improve the competitiveness of India's soyabean extraction export. However, again, looking at robust growth in the domestic livestock industry, the internal demand for all kinds of animal and poultry feed is expected to expand in the coming years, making surplus oilmeals a thing of the past.
Indeed, low international prices (for whatever reason, including subsidies) are beneficial for India because of its growing import dependence. In order to protect domestic producers from the onslaught of low priced subsidised imports, the government uses the tariff mechanism.
Among foodgrains (comprising wheat, rice, coarse grains and pulses), wheat is the most important in terms of world production, consumption and trade. The World wheat output is in excess of 600 mt while the world trade is about 110 mt. Wheat production and export figures respectively of major origins are as under: Australia: 22-24 mt and 16.5 mt; Canada: 25-26 mt and 16.5 mt; EU-25: 125-135 mt and 14.5 mt and the US: 53-60 mt and 27.5 mt.
The OECD producer subsidy for wheat is estimated at $18.5 billion. Of this, the EU-25 accounts for about $10 billion and the US a little over $4 billion. The US and the EU have already publicly locked horns over reduction of subsidy. Nearly 50 per cent of the US wheat output is exported, while for the EU exports constitute a little over 10 per cent.
At the origin, wheat price is about $120 a tonne. A subsidy of $10 billion for 125 mt wheat output in the EU works out to a massive $80 per tonne or two-third the current market price. The US wheat enjoys subsidy of about $65 a tonne, close to 50 per cent of the current market price.
No doubt, a phase-out of the wheat subsidy would lead to a sharp output cutback in the short-run, especially in the US from where nearly half of the output is exported. When the world wheat market is in a state of balance, any reduction in output in a major origin would have a disproportionately large impact on world prices. As a result of a wheat subsidy cut, world wheat prices would rise inexorably. It would benefit other major exporters such as Australia and Canada (whose export as a percentage of domestic output is significantly large) to increase their share of the export market, while hurting large importers.
The wheat output in India has been rising steadily. But in recent years not often was the production target reached. The demand, on the other hand, has been rising relentlessly, driven by rising incomes and changing food habits (enhanced wheat consumption in South India, for example). The potential for a sustained increase in output so as to lead to genuine export surplus does not exist, on current reckoning. The government's policy of not supporting large increases in procurement price for wheat in the last two-three season (unlike in the late 1990s to early this decade) and the need for crop diversification could well restrict wheat output growth.
India is unlikely to benefit from world wheat price increase because of the low level of domestic market integration with the world market. Indeed, given the sluggish growth output rate and uncertainties visiting wheat production, there is a possibility of a mismatch between supply and demand emerging sooner, rather than later. India could well turnout to be an importer of wheat. High international wheat prices are, therefore, not desirable from a short-to-medium term perspective.
Cotton is one of the most volatile agricultural commodities in the world market. It is cultivated worldwide Asia, Africa, Australia, North and South America. Driven by Asian economies, the world cotton consumption has been growing steadily, despite competition from synthetics. China is world's largest producer, consumer and importer. The US has significant economic interest in cotton. It is the world's second largest producer, but the largest exporter, shipping out as much as 60 per cent of output and accounting for 40 per cent of world exports. India is ranked third largest in terms of output and second in terms of consumption. In addition to China, major importers include Turkey, Indonesia, Pakistan, Thailand, Bangladesh and Russia.
Both technology (GM seeds) and subsidy drive American cotton production and exports. Growers enjoy scale economies; technology helps reduce insect-induced crop losses; and subsidy (estimated at $3 billion) helps raise output and release large surplus for export. In the last five years, the US cotton output has been 4-5 million tonnes. Payment of $3 billion as subsidy for 5 mt output means a subsidy of $600 a tonne of cotton produced. Given the current market price of $1,100 a tonne, the subsidy element is more than 50 per cent in the US.
The dominant position of the US in subsidised production for export in the global cotton market has upset several small African producers such as Benin, Burkina Faso and Chad which are unable to compete because of depressed international prices caused by huge subsidies granted by the US. The WTO has ruled against US cotton subsidies; yet they are continuing. There is little doubt that the removal of the US cotton subsidy would push world prices up, surely in the short-to-medium run, until production in other origins catches up. Higher world cotton prices would invariably lead to a slowdown in consumption growth, while improving the marketability of cotton from Africa and other origins.
At this point of time, insofar as cotton is concerned, India is peculiarly placed. Since 2003-04, the domestic cotton output has risen markedly and signs are that the trend will continue. Although growing, the domestic consumption trails production, leading to huge inventory overhang and depressed domestic market prices. Cotton exports from India are a possibility if international prices remain high over 50 cents a pound. However, there are limits to India benefiting from a global price rally given infrastructure, quality and other limitations that would constrict export volumes. No doubt, a strong world market and firm domestic prices would be friendly to cotton growers here; but can potentially hurt India's textile and garment producers' interests.
Around the world, sugar is a highly politicised and state-supported sector. Protection covers direct payments, export subsidies, high import tariffs and non-tariff barriers. The sugar market too is highly volatile. Production variability is caused by weather condition in principal cane producing countries such as Brazil and India. Europe produces sugar from sugar beet.
While the total world output has been fluctuating the last five years, export and import data show a rising trend; global stocks have steadily declined. Because of high crude oil prices, a part of the cane grown is diverted for ethanol to be blended with gasoline and used as biofuel. Brazil, world's largest producer of cane sugar, is also the largest producer of ethanol. Quite apart from basic sugar demand and supply fundamentals, the rising bio-ethanol demand has pushed global sugar market to highs not seen in recent years.
The OECD sugar subsidy is estimated at $7.8 billion of which the US and the EU together account for over $4 billion. The US is not an exporter of sugar, while the EU is a net exporter of about 3 mt a year. The EU subsidy of $3 billion for 20 mt of sugar translates to $150 per tonne, representing 50 per cent of the current market price.
The WTO recently ruled against the EU granting export subsidies to promote sugar export. The world sugar market is distorted because of subsidies and protection in the form of high import tariffs. A phase-out of the sugar subsidy would invariably lead to a further increase in the already strong prices. It would surely hurt the interest of importing countries such as Russia, China, Indonesia and those in West Asia. For sugar exporting developing countries to benefit, the developed nations must reduce sugar import tariffs.
As far as India is concerned, from being a sugar exporter till 2003, the country turned into a net importer from 2004 onwards as indigenous output plunged. Production growth is unlikely to meet demand growth in a sustained manner in the near future. There is nothing to suggest that the domestic production situation would dramatically improve to create genuine large export surplus anytime soon. If anything, raw sugar imports may continue even in 2006.
Sugar is a highly water intensive crop. Given the forecast of serious water shortage in the country over the next 10 years, a serious rethink on sugarcane cultivation may become necessary.
India's attempt should be to remain a large sugar producer with volumes sufficient to meet the growing internal demand. Exporting sugar would only mean exporting precious water out of the country. For the future, the possibility of India importing sugar is far greater than India remaining a consistent exporter. Therefore, abolition of sugar subsidy by the OECD countries may not be in India's interest.
Subsidies given by OECD countries, especially the US and the EU, are huge. Every tonne of commodity produced is subsidised to the extent of between 25 per cent and 50 per cent of the market price. These subsidies encourage more production, augment global supplies, depress world prices and distort the discovery of free-market prices. There is, therefore, a strong move to pressure the developed economies to phase out farm support.
The foregoing simple analysis shows that in none of the four major commodities would India stand to benefit substantially if the subsidies were eliminated. It may be politically correct and perhaps expedient for India to make appropriate noises against farm subsidies at global forums such as the WTO. While reduction or elimination of subsidies would impact world commodity prices, consuming and importing nations would be the worst hit. Unlike several countries that are dependent on farm goods export, India is a large consuming country. Subsidy-induced low prices would be in Indian consumers' interest.
India's own emerging situation tardy output growth, rising internal demand, supply tightness, firm prices warrants that we prepare to remain open to imports. A lot of attention is now being showered on the farm sector; but given the benign neglect of this sector for decades, entrenched problems and serious challenges in raising production and productivity, self-sufficiency itself would be a distant dream, leave alone generating export surplus of major commodities.
Importantly, the global policy context is becoming increasingly complex. Most countries, including India, face the dilemma of how to reconcile the conflict between protecting domestic interests and fulfilling international obligations. If experience is any guide, the developed economies would continue to 'somehow' subsidise agriculture so long as their internal compulsions operate.
Developed economies can afford huge payments as subsidy. India cannot. At a time when quantitative restrictions on imports have been removed and the domestic market is slowly integrating with the global market, the only way for the policymakers to regulate / monitor low priced subsidized imports is to use the fiscal instrument (customs tariff) effectively. So far, the government has acquitted itself reasonably well in using import tariffs to protect domestic interest.
At the same time, such protection should not degenerate into protection of inefficiencies. Concerted efforts are required to strengthen agriculture, improve agri-produce marketing and enhance quality. Huge investments are necessary for this national effort. Government will have to find adequate financial resources for strengthening input delivery system, expanding irrigation, building rural infrastructure and delivering price/market information to farmers.
Also, there has to be accountability on the part of administration for completion of developmental projects and schemes. Under the Constitution, 'agriculture' is a State subject. Without the active support and participation of State governments, agricultural growth and progress is almost impossible. There is nothing to suggest that New Delhi is even remotely engaged in making agricultural growth a national priority.
The objective should be to make Indian agriculture globally competitive. Global competitiveness may defined as the "ability to produce globally acceptable quality at globally comparable cost". Whatever be the country's stand at the WTO and other international forums, there is no alternative to focussing on domestic issues.
Let us begin to set our house in order.
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