APPENDIX V.

INCOME-INSURANCE LINKED SCHEMES FOR FARM SUPPORT

A. Comprehensive Income-Insurance Linked Scheme for Farm Support

The following is the text of a proposal by the Department of Food and Public Distribution, entitled “Comprehensive Income-Insurance Linked Scheme for Farm Support”.  The Committee’s comments are at the end of the text:

1.0   Need for alternative

1.1   Due to the adverse economic and fiscal impact, as well as because the price support policies under the MSP Scheme are inadequately covering the farmers in all States and are adversely impacting on market and private trade, it is essential to find a viable alternative to the existing agricultural produce marketing policies.  The alternative policies, while protecting the interest of the farmers, should encourage private trade and is both financially and environmentally sustainable. 

2.0  Should Government give up procurement?

2.1  It has been suggested in some quarters that due to the adverse effects of the open ended procurement system, Government should give up procurement of foodgrains altogether, and leave the entire foodgrains management system to private trade.  This would allow the free interplay of market forces of demand supply to determine market prices.  This paper does not suggest such a radical step for five basic reasons:-

(i) The present procurement system has had several beneficial effects.  The FCI has built a huge infrastructure, unparalleled in most countries.

(ii) It is not entirely necessary to dismantle the entire system.  It is possible to effect reforms and contain procurement to manageable levels and effect efficiencies that will at the same time reduce the adverse consequences of the existing MSP – open ended procurement regime.

(iii) Alternatives to the MSP regime, viz., income support or insurance for protecting the interests of farmers are complex to manage in the Indian scenario; they are systems that are not tried and tested and may throw up several problems, if they are introduced in lieu of procurement.

(iv) Sizeable procurement of foodgrains, will continue to be required for the PDS and other welfare schemes such as the SGRY and the Mid-day Meal programme.

(v) Allowing the market to determine market prices, will in the short run, lead to a sharp fall in open market prices.  In the case of wheat, the prices may ‘crash’ to Rs. 350 per quintal, which may in the following years lead to farmers shifting away from wheat, leading to a sharp decrease in output and a possible sharp increase in prices in the subsequent years.  In other words, if the reform is not managed well, there could be wide fluctuations in prices of foodgrains prices.

3.0  The Proposed Reform Package

3.1   In the emerging scenario, there is no single policy which can help in achieving these multiple objectives.  The four most critical components of the proposed comprehensive reform package are spelt out below which will have to be implemented concurrently;

(i) Crop diversification and sustainability,

(ii) Reform in fixing MSPs/procurement prices for foodgrains,

(iii) Income insurance scheme to farmers, and

(iv) Compensation to State Governments for loss in revenue.

4.0   Crop Diversification and sustainability

4.1 In order to meet the challenge of surpluses emerging in certain crops like rice and wheat it is essential to encourage changing the cropping pattern in favour of pulses, oilseeds, horticulture crops etc. 

4.2  In this context a case study of the State of Punjab was undertaken by the Department of Agriculture and Cooperation, which showed that the area under rice in the State had increased from 20 lakh Ha. to 26 lakh Ha. between 1990-91 and 1999-2000.  The acreage under other crops like maize, cotton and oilseeds had consequently declined in the State. Increase in acreage under paddy cultivation has led to over exploitation of ground water resources and the ground water table has declined by 20 to 30 ft in the districts studied. In certain districts the average annual rate of depletion of ground water has been 1.3 to 1.6 ft.  This means that the demand of ground water is in excess of the supply. 

4.3  Immediate steps towards crop diversification and ending the rice-wheat rotation are required in Punjab.  Accordingly, the MSPs needs to be fixed in favour of pulses, oilseeds, etc., compared to wheat and paddy.  Marketing arrangements also need to be improved for these crops. 

4.4  It also needs to be ensured that areas, having certain inherent advantages in respect of certain crops, grow these crops so as to have a favourable impact on the cost of cultivation.  This will help to tackle not only the problem of excessive surpluses in respect of crops like rice and wheat but help in diversification and balanced and sustainable development of agriculture, which is in the long-term interest of both the farmers and the nation.

4.5  It is, therefore, proposed that a Centrally Sponsored Scheme on crop diversification with built in sustainability concerns may be formulated and implemented by the Department of Agriculture  and Cooperation in the IX Five Year Plan with special focus on Punjab and Haryana. The efforts will have to be on a much larger scale with vastly enhanced outlays, in comparison to the outlay provided in the Ninth Five Year Plan.  The scheme should, inter alia, provide incentives to farmers for shifting to non-food crops as well as for a ‘crop-holiday’.

5.0    Reform in fixing MSPs/procurement prices for foodgrains

5.1  The MSP Scheme, as being implemented at present will have to be modified. The MSP is finalized based on recommendations of the CACP as also by taking into consideration other factors as considered important by the Government.  The price recommended by the CACP for a particular commodity, covers C2 cost which is the comprehensive cost of production and takes into account all the cost components other than management cost.

5.2  After the recommendations of the CACP are received there is a tendency on the part of the Government to enhance the recommended price by some percentage in respect of certain commodities on extraneous considerations.  Consequently, the MSPs, particularly of certain crops like rice and wheat have increased substantially over a period of time not only in absolute terms as compared to the cost of cultivation but also relatively compared to costs of certain other agricultural commodities, covered under MSPs.  For instance, the C2 cost of paddy in Punjab is a little under Rs.430 per quintal against the MSP of Rs. 610 per quintal in 2000-01.  Such instances can be multiplied.   In the case of certain other commodities, particularly pulses and coarse cereals the MSPs have tended to remain low.  Thus over a period of time, the MSPs have grown favourably in respect of certain crops and gone against certain other crops. 

5.3  Perhaps, this policy was justified in the context of shortages and the problem of food security being faced by the country when there was need to encourage the production of cereals like wheat and rice on account of their higher productivity levels.  There is need to correct this imbalance in the MSPs.  This in turn will become an important instrument in helping to change the existing cropping pattern.

5.4  The HLC has recommended that there is need to rationalize the MSPs and bring them in line with the C2 costs. This would mean that the MSPs for wheat and paddy would each get reduced by about Rs. 100 per quintal. Moreover, it has also been recommended by the HLC that statutory levies imposed by several State Governments on procurement are excessive. These levies need to be rationalized across States and reduced to at most 4% of the value of purchases.

5.5 It is, therefore, proposed that the Department of Agriculture & Cooperation should not announce any MSP.  Instead a gross procurement price for wheat and paddy would be announced, computed on the basis of C2 cost + 4% levies in lieu of the present MSP system.  The FCI, the State Governments and their agencies will take up market intervention operations at this procurement price.  It is estimated that if the gross procurement price is fixed in this manner, the annual procurement of foodgrains would come down from the present level of about 40 million tonnes for wheat and rice to between 20 to 25 million tonnes, which would more or less be in line with the present requirement for the PDS, welfare schemes and buffer stock operations.

5.6  The CACP and the Department of Agriculture & Cooperation would continue to have responsibility to determine the C2 cost.  However, this would not automatically become the MSP.  In States where the levies are in excess of 4%, the gross procurement price at C2 + 4% levies would imply that the actual amount payable to farmers would get reduced to the actual levies in excess of 4%.  However, in view of the fact that the State Governments would also be interested in ensuring a remunerative price to farmers, it is felt that over a period of time the State levies would be brought down to 4%, so that in effect the C2 cost and the actual amount payable to farmers would get equated.

5.7  Replacement of the MSP regime with the fixation of a gross procurement price, as suggested above, would not only bring down the stock levels of foodgrains in the Central Pool but would also result in lower acquisition cost for the FCI and consequently a lower economic cost of foodgrains.

6.0   Loss in farm income

6.1 If the proposed reform as above in the fixation of the procurement price is implemented, there will be a loss in farm incomes, as the farmers have hitherto have been getting assured income based on attractive MSPs which have been higher than the C2 cost.  There is need to compensate farmers for this loss in income.  Two alternative schemes have been suggested:-

(i) Direct payment system, and

(ii) Income support linked to insurance

7.0 Direct Payment System

7.1 Under the direct payment system, this loss of income could be compensated by directly reimbursing the farmers the positive difference between the present MSP and the proposed gross procurement price.  However, the modalities for implementing such a scheme are far too complex.  The following difficulties are anticipated,

(i)  As per information available, there are about 100 million farmers in the country.  The records relating to ownership holdings are not well recorded.

(ii) Land tenurial systems are varied across the country.  Tenancies, share cropping, etc. would add to the complexity in determining the actual beneficiary of the compensation.

(iii) This system would not take into account the differences in yields and would not be able to compensate farmers in situations where the yields are low in particular areas on account of drought and other seasonal factors.

(iv) Even farmers who do not have marketable surplus, will be required to be compensated because the scheme it would not be able to make a distinction between one set of farmers and others.

(v) At present, there are some regions in the country where market prices are on par with MSP.  Income compensation would have to be made in all areas of the country.

(vi) There may be a tendency on the part of farmers in connivance with the officials to manipulate documents to show they have grown paddy and wheat, if the direct payment system is confined to these two crops.

(vii) Farmers will have to be given compensation only on recorded market transactions.  The market infrastructure is poor in several parts of the country.   

(viii) It is estimated that if the Government has to compensate each of the farmers growing paddy and wheat in the country, it may end up paying more than what is already being incurred in the existing system of procurement.

8.0 Income Support linked to insurance

8.1 In view of the drawbacks of the direct payment system, it is suggested that the Government may introduce the agricultural insurance scheme.  This directly addresses the issue of producing subsidy.  Farmers would be required to take up a comprehensive insurance cover

(i) to protect them in the event of failure of crops as a result of natural calamities, pests and disease; and,

(ii) to protect their income from yield and price loss.

8.2 At present the Ministry of Agriculture and Cooperation is already implementing the National Agricultural Insurance Scheme (NAIS) under which fluctuations in the yield or output of the farmers are protected.  The scope of the Scheme could be broadened to include the total income of the farmers. This would imply that insurance would cover fluctuations in output as also fluctuations in price.

8.3 In Rabi 1999-2000, the National Agricultural Insurance Scheme (NAIS) was introduced.  It covers (a) loanee farmers on compulsory basis and non-loanee on voluntary basis; (b) almost all crops including annual commercial/horticultural crops and (c) risk up to the value of thresh h old yield. The risk, over and above the liabilities of Implementing Agency are shared between the Central and State Government in the ratio of 1:1.

8.4  The position of coverage of NAIS during Rabi 1999-2000 and Kharif 2000 seasons is  given below:

                                                            Rabi 1999-2000           Kharif 2000

(i)         Farmers covered          5.74 lakh                      85.61 lakh

(ii)        Area covered               7.80 lakh hectares        132.31 lakh hectares

(iii)       Sum Insured                 Rs.339.12 crore           Rs.6918.00 crore

(iv)       Insurance charges         Rs. 5.25 crore              Rs. 204.35 crore

8.5 The implementation of NAIS during Rabi 1999-2000, did not cause any financial difficulty -  payable claims were well within the premium generated.  But due to drought and widespread crop loss, Kharif 2000 incurred claims of nearly Rs. 1200 crores.

8.6  The Insurance Scheme has not been very popular.  The number of farmers covered and the area covered has been quite a small fraction of the total cultivated area or total number of farmers in the country.  This is despite the fact that the Insurance Scheme has been in existence, in some form since 1979.  The main reasons for the scheme being not popular are:-

(a) The Scheme is designed in such a manner that compensation for risk is calculated at Block levels and all farmers in a Block received the same level of compensation, irrespective of the level of individual’s loss of the crops.  Likewise if a crop is damaged substantially in a village, the farmers may not get any compensation, if the total yield in the block  does not fall below the threshold level.

(b) The Scheme requires that the farmers should insure all notified crops for which loan is availed, including less risky crops, at premium rates which at least initially have been fixed uniformly in all States. Accordingly, some States which have higher production stability, do not expect benefit from the Scheme.

(c) States are apprehensive of the large financial burden that such a scheme will put on the State exchequer.

8.7 If an insurance scheme has to be implemented successfully, the above deficiencies need to be tackled.  Unfortunately, solution to the problem at (a) above cannot be found because yield data at village level is not available.  But efforts towards finding a solution to this problem need to be continuously made. Till then, the area approach would have to be adopted.  However, the difficulties at (b) & (c) above do not seem to be insurmountable.  There is no reason for the premium rate to be same for all States or areas.  Likewise the burden of the States can be reduced by apportioning major part of it to the Centre, in view of the significant savings that will accrue by fixing a gross procurement price based on C2 cost. 

9.0 Salient features of the Income Insurance Programme

9.1 This Scheme will have the following objectives:

I. To provide insurance coverage to farmers in the event of failure of crops as a result of natural calamities, pests and disease.

II.  To protect farmers’ income from yield, and price loss.

Crops covered:  The scheme shall cover Paddy and Wheat only.

States covered:   This scheme will be implemented in the entire area covered under wheat and rice in the country.

Farmers to be covered:  All farmers growing wheat and paddy.

9.2 Guaranteed Income (G.I.) : Under the scheme all the farmers participating in the insurance scheme will be guaranteed an income calculated by multiplying the product of the average yield of the preceding 3 years multiplied by the average market price for the last 3 years (calculated on ‘moving average’ basis).

9.3 If the Actual Income(A.I.) per hectare, which is a product of the yield recorded during the season multiplied by the prevailing market price, falls short of the G.I. per hectare, all insured farmers will be deemed to have suffered losses in income and will be eligible for compensation depending upon the level of indemnity.  For calculation purposes, the level of indemnity may be taken as 80% on average.

10.0 Typical Illustration

10.1     Wheat

For one hectare plot

            (i)         Size of farm                  =          1 hectare

            (ii)        Average yield   =          4 tonnes per hectare of wheat

            (iii)       Level of indemnity         =          80%

Base Price(average

market price of

preceding 3 years         =          Rs. 6000 per tonne

                        G.I.                              =          4 X 80% X 6000         =          Rs. 19200

At a premium rate of 4%, the total premium payable by the farmer would be Rs. 768.

Compensation payable :

Actual Income              1. Actual yield  =          3.5 tonnes per hectare

                        2. Actual market price=            Rs. 4800 per tonne

                        3. Actual income per hectare= 3.5 X 4800 =Rs. 16800.

Shortfall in income per hectare =Rs. 19200 – Rs. 16800 = Rs. 2400

The net liability after deducting the premium received is Rs. 2400–768=Rs. 1632 per hectare.

10.2     Paddy

            (i)         Size of farm                  =          1 hectare

            (ii)        Average yield               =          3 tonnes per hectare of paddy

            (iii)       Level of indemnity         =          80%

(i)                  Base Price(average

market price of

preceding 3 years         =          Rs. 5100 per tonne

                        G.I.                              =          3 X 80% X 5100         =          Rs. 12240

At a premium rate of 3%, the total premium payable by the farmer would be Rs. 367.

Compensation payable :

Actual Income  :           1. Actual yield (say)      =          2.5 tonnes per hectare

                        2. Actual market price=            Rs. 4720 per tonne

                        3. Actual income per hectare = 2.5 X 4720 =   Rs. 11800.

Shortfall in income per hectare  =Rs. 12240 – 11800 = 440

The net liability after deducting the premium received is Rs. 440 – 367 = Rs. 73 per hectare.

10.3     In actual practice, the losses may be even lower.  This is for the following reasons:-

(i)  The entire cultivated area will not be covered under the Scheme, though the Scheme is made compulsory for States.  In fact, quite a few farmers & areas will be either inaccessible or may not exercise the option;

(ii)  The average yield levels do not decline steeply, that too across the entire area insured.  In any case, decline in yields are likely to be offsetby gains elsewhere;

(iii) Normally decline in output is followed by increase in prices.  In these typical illustrations, it has been assumed that both parameters decline together.

11.0 Liability of the Government

11.1   The liability of the Government will be confined to the subsidy component of the premium to the farmers.   It is proposed that a premium rate of 4% for wheat and 3% for paddy would be a reasonable rate for the farmer to bear.  In respect of marginal farmers, the farmers may be asked to bear a premium rate of 2% and 1.5% for wheat and paddy respectively.  In the initial years, it is estimated that insurance companies may calculate the acturial rate at 18% in respect of wheat and 4% in respect of paddy, based on the likely decline in the farm incomes.

11.2  Taking the above typical illustrations in respect of wheat and paddy as at paras 10.1 to 10.3 and premium rates of 4% and 3% payable by farmer on wheat and paddy respectively (and 50% of this for marginal farmers), with the balance subsidy payable by the Government, the total liability of the Government has been estimated in the succeeding paragraphs.

11.3  The number and area of operational holdings is given at Table-I and the average size of holdings is given at Table-II of Annex-V. There are 45 million hectares under paddy cultivation  and 25 million hectares under wheat cultivation in the country carried out by about 40 million farmers.  It is estimated that about 14 million farmers in respect of paddy and 8 million farmers in respect of wheat  would opt for this scheme in the initial year.  Of these, it is estimated that 3 million marginal farmers in respect of wheat, and 5 million marginal farmers in respect of paddy would opt for this scheme.  With an average holding of 1.57 hectares the total estimated liability under the Insurance scheme is calculated as below:

Calculation of liability on farmers and Government

11.4   In other words, out of the total liability of Rs. 4337 crores in respect of wheat, it is estimated that about Rs. 918 crores will be payable by farmers and the net liability of Government will be Rs. 3420 crores.  In respect of paddy, the total liability is likely to be Rs. 1098 crores, of which the premium payable by farmers is estimated to be Rs. 787 crores and the net liability of Government is likely to be Rs. 311 crores.  Totally, the net liability of Government for both paddy and wheat is estimated to be Rs. 3731 crores, assuming about 22 million farmers opt for this scheme.

11.5     It is clear from the above that the cost on the exchequer even at such a high subsidized premium rate will be far less than the cost involved in maintaining huge surplus stocks of foodgrains by FCI and other procuring agencies.  Further as the system stabilizes, the base price (average for the preceding 3 years) will also gradually move towards the C2 cost.  In other words, the difference between the C2 cost and the market prices will tend to get narrowed down.  This will automatically reduce the liability of the Government, though it may be several years before the insurance system can become a self-financing one.

12.0     Merits of the alternative approach:

12.1     This approach to agriculture marketing will be a major step towards building the confidence of the private trade in agriculture marketing in the country.  As seen in the earlier part of the note, FCI has accumulated huge stocks of foodgrains – locking up over Rs. 50,000 crore of bank funds. At the present stage of its development, the country can ill afford continuation of such a situation in its food economy.  Private trade must play its legitimate role in agriculture marketing. Implementation of this model will help significantly in the development of agriculture markets in the country.

12.2     Secondly, under this model, the prices of agriculture produce will be, over a period of time, be determined by the forces of demand and supply.  The country may not have to face a situation where there are huge public stocks of foodgrains. Excess production or supply will cause the prices to decline. The decline in prices will help in increased demand, particularly from the poorer sections or BPL segment of population.  Besides, if prices fall the exporters will also be encouraged to export. There would thus be a possibility of sustained exports of foodgrains from the country. On the other hand, in case of decline in production, the prices will increase reducing liability under the Insurance programme.  The requirement of the weaker sections of the society through the PDS and other schemes would continue to be met from the procurement operations at procurement prices indexed at C2 cost (+4% levies).

12.3     Thirdly, the existing system under which procurement is effected at MSP is essential operating only in four States, Punjab, Haryana, Uttar Pradesh and Andhra Pradesh. Even here only a small segment of population of farmers is covered.  Thus the benefit of the present policy, which is being implemented at such a huge cost is available  only to a very small number of farmers in a few States in the country.  The alternative scheme will have a much wider  reach and potentially a larger number of farmers in all the States will be benefited.

12.4  Fourthly, the alternative model will provide comprehensive risk management tool in the realm of crop production and marketing by protecting yield variations as well as price fluctuations, a promise made in the National Agricultural Policy – 2000.

12.5   Fifthly, the alternative scheme would be WTO compatible as it seeks to protect the income of the farmers and should form part of the non-trade distorting ‘Green Box’ support.

12.6   Sixthly, and perhaps the most importantly, this alternative model does not dismantle the entire procurement system, but only adopts in such a way as to move it on more rational lines, without compromising on the interests of farmers.

13.0 Loss in State revenues

13.1  Reduction in the MSPs and taxes by fixing a gross procurement price based on C2 + 4% will lead to a significant loss in revenues.  In particular, States like Punjab, Haryana and Andhra Pradesh, who are currently levying taxes @10.5% on the MSP, will lose a considerable amount of their revenue.  To compensate the State Governments for this loss of revenue, it is proposed that we may transfer about Rs. 1500 crore to the procuring States, in proportion to the revenue loss.

14.0  Gist of proposals

14.1  In the light of the above discussion, it is proposed that the current MSP regime and the open ended procurement of foodgrains may be modified as under:-

(i) A gross procurement price equivalent to C2 cost plus 4% of State levies may be fixed.

(ii)  A Centrally Sponsored Scheme for crop diversification may be formulated and implemented by the Department of Agriculture & Cooperation with special focus on Punjab and Haryana. The scheme will also have an in-built mechanism for compensating the loss to farm incomes on account of crop diversification, including for ‘crop-holiday’ and for shift to non-food crops.

(iii)  An income insurance scheme for farmers to be introduced, in respect of wheat and paddy, that will ensure that farmers are compensated by loss of income indexed on the basis of the preceding 3 years moving average market prices for the crops.

(iv)  To compensate the State Governments for the loss of revenue a sum of about Rs. 1500 crore will be transferred to the procuring States annually.  This could be for a period of 3 to 5 years.

B.  COMMITTEE’S  COMMENTS ON THE PROPOSAL

1.  This proposal of the Department of Food and Public Distribution is on the lines of an earlier proposal entitled “An Alternate Approach to Agricultural Marketing” of the Department of Agriculture and Co-operation (DAC). The DAC proposal envisaged that MSPs will continue to be declared but there would be no physical procurement at MSP, but the MSP would be the basis for calculations of the indemnity on insurance, i.e. farmers would receive compensation through insurance whenever actual market prices fell below MSP. In contrast, the proposal above envisages continued procurement by FCI at MSP, but with MSP set strictly at C2 cost. Also, the indemnity will not be calculated on MSP but on the basis of average market prices in the past three years. The Committee is in full agreement with these modifications. MSP operations are needed both to ensure actual price stabilisation, which is necessary to encourage technology adoption. This is distinct from insurance against income losses arising from price instability. MSP operations will also be required to feed the Public Distribution System.  Also, if indemnity is based on MSP, this will make insurance subject directly to government decisions on this, reducing the chances of this being a purely commercial operation or of it being accepted as a WTO “Green Box” measure. It is preferable on both these grounds to make actual average past prices the basis of indemnity calculations.

2.  If this scheme is introduced immediately, it can be a viable method of compensation in the transition to a lower MSP. In regions where MSP has been effective in the past, average past prices are roughly the MSP and anyone taking insurance will thus be immediately guaranteed the difference between past MSP and the lower prices after the MSP reduction. However, in about three years, the effect of past high MSPs would be removed from the indemnity calculations which will be then be based on market prices. In regions where MSPs have not been effective in the past, the indemnity will from the beginning reflect the market prices rather than past MSPs. Most of the subsidy on premium required for this scheme can be paid from the compensation provided to States for farmers in our recommendations. Our preference would be for any Central subsidy on premium to be limited only to small and marginal farmers and allowing State governments to provide any extra subsidy. The Central subsidy would then be very small but the scheme would provide a vehicle by which subsidies given to States can actually be distributed to farmers as compensation.

3. For the scheme to be useful immediately, as envisaged above, it may be necessary to delink this from insurance against yield fluctuations. The existing NAIS suffers because of inadequate provision for crop-cutting experiments. An insurance purely against prices falling below past averages can be started on the basis of  records at Regulated Markets immediately without waiting for the system of yield estimation to develop.

4.  Both this proposal and the proposal of DAC limit the scheme to rice and wheat only. This is unacceptable since it would continue preferential treatment for these crops and may affect crop diversification adversely. Any insurance scheme should aim at simultaneously providing insurance both for cereals and major competing crops in the region.

Table V.3 Increasing Trend of  Procurement of Wheat and Rice

                                                                                    (Figures in Lakh MT)

*   Rice including Paddy in terms of Rice
** Figures as on 12.4.2002,

TABLE –V.5 TABLE I :      Number and Area of operational holdings in India

Note : Figures in brackets are percentages of total in the respective column.

SOURCE:  Department of Agriculture & Cooperation, Government of India, Annual Report, 1994-95.

TABLE II : Average size of holdings in different categories in India

SOURCE:  Complied from All India Report on Agricultural Census (1976-77) and Annual Report 1994-95, Department of Agriculture & Cooperation, Government of India.     

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