APPENDIX III

FCI: ECONOMIC COST AND SCOPE FOR REDUCTION

A detailed study by the Administrative Staff College of India on “The Costs of Acquisition and Distribution of Foodgrains by the Food Corporation” (May 2001) is already before the  Ministry of Consumer Affairs, Food and Public Distribution. The ASCI study, in turn, took as its benchmark, a report on “The Cost Audit of the Operations of the Food Corporation of India” (1989) conducted by the Bureau of Industrial Costs and Prices. These two studies have covered  the gamut of issues involved. It is not necessary in this Appendix to traverse the same ground. Instead, attention is focussed here on key aspects of structure, organisation, procurement, storage, distribution and quality which are crucial for  cost control. 

2.1 Under 13(1) of the Food Corporation of India Act, ‘it shall be the primary duty of the Corporation to undertake the purchase, storage, movement, transport, distribution and sale of foodgrains and other foodstuffs’. S.6 says that ‘ The Board of Directors in discharging its functions shall act on business principles having regard to the interests of the producer and consumer and shall be guided by such instructions on questions of policy as may be given to it by the Central government”. As to what constitutes ‘policy’, S.6 says, “ If any doubt arises as to whether a question is or is not a question of policy the decision of the Central Government thereon shall be final”.

2.2 During the thirty-five years since its inception, FCI has become  the principal executive arm of the Food Ministry for implementing the policies of the Union Government relating to national food security. The Central government takes decisions on  minimum support prices, specifications of FAQ, relaxation of specifications, central issue prices for PDS , foodgrains allotments for PDS and other schemes, export prices and export quantities. The FCI is no doubt consulted, but decisions on these key issues are taken outside the board-room of the FCI.

2.3 When it comes to field operations, however, the FCI enjoys a significant degree of autonomy. In procurement, for instance, the FCI decides the agencies, the agency-wise percentage of procurement and the mandis to be attached to each of the agencies. To finance procurement , it  estimates its credit requirement and conducts negotiations with the RBI. It decides how much of the procured quantity is to be stored in godowns and how much should be under plinth and cover. It decides on the steps for preservation of foodgrains. It draws up its own movement program from the procurement centres to the different storage points and from the storage points to the destinations in the consuming areas. It decides how much should be transported by rail and how much by road.  If the dimensions and the nation-wide character of the FCI’s operations are taken into account, the independent powers enjoyed by the management of the FCI are indeed impressive.

2.4  The costs of FCI’s operations, therefore, fall into two groups:  

(a) Costs which are determined by Government decisions on minimum support price, central issue price, quantities procured and issued, specifications of grain,  norms of buffer and operational stock, specifications of packing material, railway freight, procurement incidentals and interest rates. These costs which are usually referred to as “policy induced costs” account for 69 % of the economic cost.

(b) Costs which are affected by  FCI’s operational efficiency in procurement, distribution and storage and by the efficacy of its internal controls , for instance, in checking transit and storage losses and in maintaining quality control.

2.5 Consequently, for arriving at the true economic costs of FCI’s operations it would be necessary, for instance, to deduct all taxes paid, since these are statutorily fixed; to deduct the cost of storing excess stock because of the policy of open-ended procurement and to make allowance for  government policy decisions taken on extra commercial considerations (such as those on minimum support price, jute specifications, 50 kg bags and departmentalisation of depot labour). As decisions taken at Government level determine 69 % of the FCI’s costs, neither the profit and loss account of the FCI nor the per unit level of government subsidy nor the ratio of government subsidy to FCI’s economic cost provides an index of the cost effectiveness of the FCI.

3.1 There are no private sector firms in the grain trade in our country which operate on a comparable scale or with comparable responsibilities or under comparable constraints as the FCI. There are, of course, grain traders who operate on a smaller scale but reliable data on the economics of their operations is not available. Using private sector unit costs as a benchmark for assessing FCI’s performance is therefore not a feasible option.

3.2  The alternative exercise of comparing trends in the wholesale price index with trends in FCI’s  costs was conducted by the Bureau of Industrial Costs and Prices (1989) which found that between the period 1981-82 to 1987-88, operational costs grew by of 217 %, whereas WPI went up  only 44 % during this period.  The Administrative Staff College of India (2001) has, however, pointed out that it would be unwise to base any overall conclusions on this data because in the subsequent period there was “a reversal of the trend with FCI costs growing at a smaller rate”. 

3.3   On the other hand, the normating of costs done  by the Bureau of Industrial Costs and Prices in its 1989 report provides a useful method. A straight projection of these norms on the basis of current prices would, however, yield questionable results, as has been shown in the ASCI report of 2001 in which the FCI easily passed the test of the updated norms. Obviously, the norms will have to be recalculated taking into account the fluctuating levels of procurement, distribution and stocks with the FCI. For instance, it will not be sufficient to merely update the norm of Rs. 14.10 per quintal for buffer storage on the basis of current interest rates or pest treatment costs. It would be necessary to recalculate the base itself, taking into the fact that the 1989 norm assumed 75% storage space, whereas the current utilization level would be well over 100%. Contract labour has given way to departmental labour in the depots with a clear perceived loss of efficiency; costs of storage have declined on the one hand because of higher capacity utilisation but on the other hand have gone up because of  the higher costs of prophylactic treatment of old stock and stock under CAP. All these factors will have to be built into the revised norms through an in-house exercise in the FCI. The updating of norms should be an annual feature and the updated norms should be used as the benchmarks for assessing FCI’s  performance in the annual performance budgets.

4.1 Certain alternative structures to make the FCI more cost effective have been suggested by ASCI (2001) and others. The suggestions cover the following gamut :

4.2 The Committee  considered these suggestions and came to the conclusion that the FCI which is the centralised agency should concentrate upon and develop its area of core competence, to maintain the Central Pool, carry out long-distance movement, and make direct market intervention when either producer prices fall below MSP or when there are particular shortages. However, while the Committee does not envisage any basic change in structure, and this must continue to reflect FCI’s role as the Central agency responsible for price stabilisation, there is clear need for the FCI to change the way in which it does business. Changes are called for to enable faster, commercially oriented decision making. 

4.3 Over the years there has, undoubtedly, been a progressive erosion of FCI’s autonomy. In many ways the FCI  has ceased to function like a corporation and  more and more like a government department. Obviously where government fiats are issued for other than economic reasons, it would be unreasonable to expect FCI to function on economic lines.  It would, therefore, greatly help the FCI to operate autonomously, accountably and cost-effectively, in areas within its ambit if a Memorandum of Understanding becomes a standing feature of the FCI-Government nexus. The MOU should cover the operations of the FCI in procurement, storage, buffer stocking, distribution, open market sales and exports. In this, the principles outlined in the Main Report should be incorporated, but the MOU should serve as the basis for autonomous day to day operations in these areas. It should also lay the ground for greater operational flexibility in matters like open market sales and disposal of sub-standard stock. The MOU arrangement would help to commercialise FCI’s operations wherever there is scope. The financial provisions in the MOU would cover the subsidies arising from each of the activities entrusted to the FCI. The financial figures would reflect the activity-wise norms agreed to between the Government and the FCI. The convention should be established that once the MOU is signed, there should, ordinarily, be no directions from Government, formal or informal on matters covered in the MOU. Benchmarking FCI’s operations,on the lines indicated in para 3.3 is necessary for meaningful MOU monitoring.

4.4  A single line of command has been accepted as the proper form of organization for public sector undertakings. The FCI is the exception - it has both a full time Managing Director and a full-time Chairman. This system, clearly, dilutes and divides responsibility at the top. It affects the speed and quality of decision making and  weakens the whole management structure. The BICP had, therefore, suggested a decade ago that the posts of Chairman and Managing Director may be merged.  The Food Corporations Act which provides for separate posts of Chairman and Managing Director will need amendment to bring about the change in the top management structure.

5.1 The FCI cannot have control over the two major items of procurement cost – the procurement price, if this is the MSP, and statutory charges. There are, however, other areas which are within FCI’s competence where a commercial approach can be taken.

5.2 The responsibility for procurement is currently shared between the FCI and State government agencies. FCI’s share in procurement has declined over the years. The average procurement in FCI centres is markedly lower than State run centres because the FCI has been loaded, year after year, with a large number of centres which are opened not so much for procurement as for preventing distress sales. The unit costs in such centres are unduly high. State governments are much better acquainted than the FCI with the locational needs of farmers. There is strong justification, therefore, for divesting FCI of the task of opening uneconomic procurement centres and for entrusting the entire procurement to State government agencies, especially in Punjab and Haryana.

 5.3   During the 1990’s FCI has been involved in price support operations for jowar, maize and bajra. The quantities are becoming larger year after year and storage losses have been heavy because of limited shelf life. It has proved to be difficult to sell these coarse grains through the PDS and the bulk of the procurement has been sold, at heavy loss, as cattle feed. It is desirable that that the FCI’s role is confined to procurement of the major cereals for the PDS and that price support operations in coarse cereals are handled by State  agencies.

5.4 FCI should make all efforts at preserving the identity of grain, i.e. ensure that the place, date of purchase and quality specification, if any, is preserved from procurement to sale. 

6.1  FCI has been given the responsibility for maintaining the Central Pool, comprising of operational stocks and buffer stocks. The desirable levels of minimum stock in the Central Pool and the actual levels during the past three years have been discussed elsewhere in this Report.

6.2  It has been explained in the Report that  government policies of high support prices and targeted public distribution have led to increased procurement on the one hand and fall in offtake on the other. As a result, stocks of wheat and rice with the Centre during the past three years have been grossly above the norms. They presently stand at 65 million tonnes - about 31 million tonnes in excess of the buffer requirement.  This has led to acute storage problems and an inordinately large quantity is at present in the open in cover and plinth storage. FCI’s standard storage practices are aimed at timely preventive and prophylactic action. In the current situation where abnormally large stocks have been stored in the open, for long periods of time, under cover and plinth, it is difficult to enforce proper quality control or follow proper storage practices. The heavy stock accumulation has resulted in  higher carrying costs by way of freight, handling expenses, storage charges, interest charges, transit and storage shortages and administrative overheads.

6.3 The Buffer Stock Committee had fixed 85 % as the optimum level of storage utilization. Later, the BICP (1989) suggested a norm of 75 % average capacity utilisation. The actual storage utilization, presently, is far in excess of the norms because the holdings in the Central Pool are two and a half times the recommended level of buffer and operational stock. A disproportionate quantity of grain has been stored in CAP (cover and plinth) in conditions which are highly susceptible to theft, pests and deterioration.  The task of the FCI in the present situation is to tackle the serious diseconomies which have set in because of bnormal stock levels.

 6.4  Action on the following lines is indicated:

(a) Existing silo capacity should be fully utilised; further silo capacity if required should be in the private sector.

(b) The present height limits of stacks have been fixed keeping convenience in destacking as the consideration. However, in the current situation, in godowns where the offtake is slow, it would be feasible to increase stack heights. This will enable maximisation of utilisation of covered capacity.

(c) CAP techniques are at present meant to cater for short period storage.  Designs of plinths and specifications for LDPE sheets will have to be revised taking into account the current situation in which stocks under CAP will have to maintained for several years before issue.

(d)  The FCI has been regularising losses up to 1% loss for wheat, 1.5% for rice and 2.5% for paddy on quantities issued.  However, storage losses are only calculated at the time of destacking. The storage loss figures indicated in the annual reports of the FCI do not, therefore, give an indication of actual losses. In the current situation when accumulation of stocks outstrips issues by a wide margin, the number of stacks “killed” forms a relatively small percentage of the total stacks held. Better methods of calculating storage losses are required. More realistic estimates of storage losses, for instance, could be arrived at through (i)100 % weighing of stocks in one compartment each from a representative selection of godowns selected by random sample (ii) 100% weighing of a random sample of CAP stacks (iii) wholesale “killing” of all the stacks in selected godowns, even if this involves extra expenditure on transport of stocks to issue points.

(e)  Currently, abnormally heavy stocks are being held for unduly long periods and a disproportionately large quantity is being held in CAP.    Deterioration of stock will therefore be at a much faster rate than in the past. The principle of ‘first-in, first-out’ (i.e. stock procured earlier is distributed before stock procured later) and priority for disposal of stock under CAP, therefore, becomes particularly important. The laxity which seems to have crept into the application of this principle will have particularly adverse consequences when, as at present,  large volumes of stocks are held. The introduction of a modern system of inventory control is, therefore necessary, inter alia to ensure that the FIFO principle is adhered to. .

(f)  The godowns in the East and the North-east have a history of high storage losses and of excessive deterioration. Godowns in these Zones are currently holding much higher stocks than they used to in the past. Physical verification in these Zones, should be intensified and more rigorous sampling methods should be adopted in these Zones. 

(g)   The FCI was given full powers in August 1992 to dispose of substandard stocks of foodgrains. The FCI has prescribed the drill that in cases where poor quality foodgrains are despatched, a joint inspection should be done by the consignor and the consignee within 21 days of the assessment by the QC division of the consignee. The sub-standard grain is required to be disposed of and the final loss assessment statement is required to be completed within 10 weeks of the receipt of stock. The procedure is cumbersome and needs to be simplified.

(h)   Abnormally heavy stocks are currently being held. A significant percentage of this stock was procured under relaxed specifications and disproportionately large quantities are being held in CAP. The drill for prophylactic treatment will have to be revised taking the current situation into account.

(i)  Losses occur at a succession of stages – at the mandis, during transport, during storage, during loading, unloading, stacking and destacking and at the time of issue to the public distribution system. Loss of stock in storage and transit is a major element in economic cost. The C & AG and the BICP have pointed out that the FCI has a poor record of fixing responsibility for storage losses and effecting recovery. There is need for corrective action

(j) During the last 35 years the FCI has introduced systems for physical verification of stocks, squad checking at transit points, joint inspection of stocks by consignors and consignees  and prophylactic treatment of stocks. Many of these systems seem to have become rusty with disuse.

(k)   The depot manager is the first line manager of the FCI at the ground level. The selection of depot managers is haphazard, they receive no special training and there are no incentives for good work. These points need urgent action failing which there is loss of control at the cutting edge of the FCI.

(l)   The systems at present in force for detecting shortages are patently inadequate. A time-bound programme for  computerised inventory control along with  modern systems of inventory management is called for. With proper integration of identity of individual sack numbers, this can also be a method of quality control and identity preservation.

7.1   The FCI uses 50 kg capacity jute bags for packing the procured grain. The FCI spends about Rs. 650 crore a year on buying jute bags and it was estimated in the year 2000 that more than Rs. 120 crore were lost in terms of grain because of the poor texture of the gunnies. Suggestions have, therefore, been made that jute should be replaced by HDPE. On the other hand, arguments for retention of jute bags are that jute is environment-friendly unlike HDPE; that the fair-price shop owners sell the used gunny bags and that shift to synthetics with low resale value will affect the viability of fair price shops and most importantly that the withdrawal of FCI’s bulk demand will seriously affect the Indian jute industry. While on the one hand, wholesale replacement of jute by FCI would not be feasible on the other hand, a tightening of specifications and more rigorous inspection procedures by the jute industry is clearly called for.

7.2   FCI has suggested revised specifications which will  reduce grain loss from the seams and from loose texture of the jute fabric. FCI has also suggested supply of standard bags with the branded net weight. An increase in the number of bales per lot which are drawn and opened for inspection has also been suggested. These suggestions need to be acted upon. Even though there may be a case for subsidising jute as an environmentally friendly material, the present situation in which the FCI subsidises the jute industry is clearly anomalous.

8.1  Timely preventive action is necessary, otherwise grain in storage becomes insect bored or weevilled. Moisture is another major enemy especially for paddy which is procured with moisture levels above 18 %. Rice which is procured with moisture levels above 16 % tends to become deep brown or black and gives off an unpleasant smell. Current PFA standards permit organic or inorganic foreign matter up to 3 %. In the case of wheat, the FCI follows the rule that stocks beyond four years which conform to PFA standards are treated as stocks to be disposed of by tender. Where they are beyond PFA they should be treated as non-issuable stocks and disposed of as feed.

8.2   The FCI has laid down procedures for prophylactic treatment for preventing deterioration of stock in storage. The stock currently held has dwarfed even the huge capacity of the FCI. The prescribed drills have , therefore,  lost much of their efficacy. The drills themselves call for revision taking into account the much longer duration of stock-holding and the inordinately large volumes stored in the open.  Much greater vigilance is called for at the supervisory level for ensuring observance of storage procedures and for safeguarding against storage losses. Entrusting prophylactic measures to private agencies on contract basis could also be considered.

8.3   FCI operates in a captive market provided by the PDS network. As a result, over the years the objective of maximising the satisfaction of the consumer has tended to recede. It is important, therefore, to create an awareness that every task in the FCI is part of a customer-supplier relationship. There has to be a work culture of total quality management.

8.4   In the case of wheat, for instance, where harvesting is done using combine-harvesters,  inorganic and organic foreign matter in the bulk wheat is a major problem for the procuring agencies because such foreign matter is not removed by the combines . Most mandis do not have the paved floor space for receiving the huge volumes of wheat flowing into the markets and the grain is dumped on the ground where it picks up stones and soil. Only surface cleaning of the grain heaps is done  and  only stems and  straw are removed. Mechanical brooms with aspirators and stationary sieves are used in some mandis but this process is inadequate for meeting even domestic let alone international standards               

8.5    The Committee suggests that an  overall quality control exercise be taken up, targeting the main wheat areas of Punjab, Haryana and western Uttar Pradesh. The programme should cover the following

(a) a drive at the farm level for  installing mini-cleaners with attached aspirators.

(b) enforcement of the  responsibility of the arthias (commission agents) to get the grain cleaned for which in Punjab and Haryana, a commission of  2½% is paid .

(c) installation of  mechanical vibrating size separators with stoners for cleaning wheat in the mandis of Punjab, Haryana and western UP.

(d) an embargo on  relaxation of quality standards for grain meant for human consumption.

(e) tightening of FCI’s inspection procedures and rejection of any grain for the Central Pool which does not meet the specifications.

(f) superior quality stock should be brought up to CODEX ALIMENTARIUS standards and segregated  in the mandis  and in the FCI godowns.

9.1   Transit losses occur at various stages – within the mandis, between the mandis and the FCI godowns, in transit by rail and road, between zones and within zones and at the time of issue to the PDS. These losses are determined at the destination points. The transit losses displayed in the FCI’s annual accounts are invariably much higher than storage losses. The C&AG and the BICP have pointed out that the break-up of grain losses as transit and storage losses is open to question. It has been pointed out that the depots are in the habit of adopting the issue weights as the receipt weight and showing the entire difference between the issue weights and the despatch weights as transit loss. To conceal storage losses, depots were found to be recording less weight at the time of receipt and showing abnormal transit losses. Losses occur because of underloading by the FCI at the despatching point, losses during transit and losses at the destination. Under the present system, the losses at the despatch point and the losses at the destination can be easily camouflaged and shown as transit losses.

9.2.  This anomalous position arises because there are no systems of weighment at the majority of railheads. The Railways, therefore, issue rail receipts not for actual quantities despatched but for unverified quantities shown in the FCI’s manifest. This system of “said to contain RRs” makes it difficult to distinguish between shortages on account of underloading at the despatch point, shortages during transit or shortages at the destination. The system clearly calls for a thorough review.The FCI had prepared a 15-point Action Plan in 1987 and the BICP in 1990 had given 25 recommendations for controlling storage and transit losses. These cover adherence to quality specifications at the time of procurement, packing in standardized bags, machine stitching of bags, proper weighment, installation of in-motion weigh-bridges, reduction of spillage, regular prophylactic treatment, priority liquidation of stocks in CAP storage, special vigilance over depots which been registering heavy losses, sending escorts with wagons on routes where transit losses have been heavy, frequent squad checking at loading and unloading points, intensive depot inspections and induction of the Central Industrial Security Force. These plans should be fully operationalised, and targets for implementation of these measures should be incorporated in the FCI’s MOU with Government.

9.3  The immediate steps needed to reduce transit losses are: a programme of installation of electronic in-motion weighbridges, machine-stitching of bags and frequent squad checking at loading and unloading points. None of the 34 weigh bridges introduced by the FCI is operational. These electronic in-motion weigh bridges should be made functional immediately.

10.1 The FCI has a full-fledged Internal Audit and Physical Verification Division which has an important role to play in cost control in the FCI. The IA&PV division is headed by an Executive Director and has a staff of 600 in its headquarters, zonal and regional  formations. The staff strength of the IA&PV Division has remained the same though the volumes handled by the FCI have increased several fold. The efficacy of the IA&PV division, however, does not lie so much in the strength of its staff as in the quality of its reports. It is pertinent that an in-house review was done in 1995 and FCI management came to the conclusion that the IA&PV division needed “quality upgradation”. 

10.2  The IA & PV Division is expected to conduct transaction audit, accounts audit, systems audit, efficiency audit and physical verification of stock. In practice it has been placing more emphasis on establishment audit and,  systems audit has been hardly attended to. To be useful as instruments of cost control, the IA&PV reports should cover core issues like manpower, subsidy, budgetary control, construction management, port operations, import and export, open market sales, procurement incidentals and gunny accounts.

11.1  The FCI needs up-to-date market intelligence for the following type of activities:

(a) OMS sales which are conducted for disposal of stock in times of surplus or for stabilisation in times of deficit

(b) Release of stocks to agencies which undertake exports

(c) Purchases at above MSP, which might be required as envisaged in the Main Report if MSP purchases are inadequate.

11.3 In its 1989 Report on the Cost Audit of the Operations of the FCI, the BICP had recommended the setting up of a national computerised information network in the FCI, which inter alia could be used for transmission of market data from all over the country. Very little headway has been made on this even after a decade.

11.4 Given the vast improvements in Information Technology over the last decade, and Indian capability in this respect, it should be possible for FCI to develop a real-time system to input and track prices in every market in which it is present, and develop models to assess market conditions and prices.

12.1     Food credit is provided for FCI’s procurement operations by a consortium of 50 commercial banks led by  the State Bank of India. The current rate of interest of 11.65 % is based on the average of the Prime Lending rates of the five major banks in the consortium. Food credit  is in the nature of an extended running account and there is no deadline for repayment. The stocks financed by food credit are huge, slow moving stocks and banks do not have any system for quantity or quality verification. During the Committee’s discussions at the RBI, participating banks acknowledged that food credit was not based on commercial principles. On the other side, the bulk of the outstanding food credit is on stock which the FCI does not require for operational purposes. There is clear need for both the banks and the FCI to take corrective action.

12.2 Open ended procurement requires open-ended bank credit but this makes it all the more necessary to have a clear discipline regarding the relationship between banks, the FCI and the Government of India. In our view this discipline should be guided by the following.

(a) The current system envisages that stocks be valued at their acquisition cost up to a period of three months, after which they be valued at the lower average sales prices. This requires government to make prompt settlement of the subsidies implied by its decision on MSP and CIP. However, this discipline is not strictly followed and FCI is required to borrow because of late refund of subsidies by the GOI. This increases FCI’s economic cost which finally has an adverse effect on the government budget. 

(b) As grain below FAQ should not be procured by FCI for the central pool, credit for such purposes should not be treated as part of food credit.

(c)  There should be clear credit limits related to some multiple of the highest quarterly buffer norm. Stocks above this limit should be financed directly by the GOI and accounted for separately.

(d) Bank credit should be based on the procurement price recommended by CACP. Any credit requirement over and above this should be met through the Budget.

12.3 Banks should develop procedures for third party verification of stock.

12.4 Food credit is single-entry line of credit and is, for all practical purposes, risk free. In a situation of sluggish expansion of bank credit due to subdued industrial growth and depressed investment demand, food credit is an attractive line of credit for the banks. The RBI itself has pointed out in its report on “Fiscal and Monetary Implications of Buffer Stock Operations in Food grains” (31.3.2001) that ‘administrative cost and default risk associated with normal credit operations are all virtually absent in the case of food credit operations”. There are strong grounds for negotiating with the RBI for a lower rate of interest, not more than one per cent above the average cost of credit, at least for credit up to minimum buffer norms.

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