RQ | India’s messed up agricultural markets

Indicat seems like a good website for data on Indian commodity prices. I came across this website when someone tweeted about tomato prices. What struck me was the wide variation in tomato prices both within markets and across markets.

Now, in terms of price variations within market, some of it can be explained by way of commodities of different grades – for example if I’ve brought bright firm and big tomatoes, I’ll expect a better price than what your small squishy tomatoes might fetch. Agricultural markets usually solve this problem by means of grading (unfortunately data of grading is not available, though the website gives data on different kinds of tomato).

The bigger reason why there is such wide price disparity within a market has to do with the auctioning process itself. For this I’ll dwell upon my limited experience of one data point in terms of a day that I spent in the potato market of the APMC yard in Yeshwantpur, Bangalore.

The issue is that the auction happens in lots, and quantities are not aggregated. Let’s say I bring in a couple of sacks of potatoes. The market makers inspect and grade them, and then proceed on an open outcry auction to auction my potatoes. The auction (increasing price English auction) quickly done, the market maker moves on to the next lot which someone else has brought. And so forth.

What this means is that potatoes that a trader can purchase is limited to the extent of the potatoes that were auctioned when he was present at the market. This process of continuous auctioning thus leads to large investments in time for the traders.

More importantly, having several small auctions rather than one big auction (where goods of similar grade are aggregated) leads to fewer buyers and sellers, and that leads to inferior price discovery. A significant portion of the bid-ask spread and uncertainty in the mandies can be eliminated by just aggregating demand and supply and having only one or two auctions for a particular commodity in a day.

In this mechanism, when I bring goods into the market, they will get graded and I will be given a receipt indicating quantity and grade. At the end of the day, there will be auctions for each “micro-commodity” (commodity of a very specific type) and based on the clearing price of the auction I an exchange my receipt for the appropriate amount. This receipt can be made negotiable – in that if I choose to not wait until the auction happens or want to lock in a price, I can simply sell the receipt outside of the market!

There is no rocket science to this mechanism. The reason it is not being implemented is because incumbent operators of the APMC (agricultural produce marketing committee) yards have a monopoly on trading commodities within their respective “areas” and thus have no incentive to improve their mechanisms. On the other hand, the current mechanisms are actually beneficial to increasing the returns to the market makers, with the producers and consumers bearing the price.

Then there is the issue of price variation across markets. While local markets might provide convenience to farmers and prevent them from traveling afar to sell their produce, it once again leads to fragmentation. For example, there is no reason that there need to be 15 tomato markets in Himachal Pradesh or 75 markets in Punjab! If we have a mandi receipt system, the problem of farmers traveling can be solved by aggregators, who can issue grade-quantity receipts to the farmers and collect and aggregate produce, and then take it to the mandi. While it is important that there is competition among mandis (so that the mandi with lowest bid-ask spread gets most of the business – which is how it happens in financial markets), we should not encourage fragmentation. And with increased competition, fragmentation will simply go away.

There has been some indication that the current union government is willing to reform the APMC Act (the first step towards it was taken by the previous NDA dispensation in 2003, but went into cold storage during 10 years of UPA rule). It is perhaps the one step that can have maximum impact on controlling inflation while at the same time giving good returns to farmers and horticulturists.

Figure 1 here shows the number of markets and quantity transacted in various states:

tomato1

Figure 2 shows that the more the quantity transacted per mandi (that is, better the aggregation), the lower is the variation in price:

tomato2

There is massive scope for beating down food inflation by simply increasing efficiencies and cutting down bid-ask spreads in agricultural markets. Unfortunately so far policy in this direction has been hostage to monopolists who dominate such markets. It is imperative that India opens up its agricultural markets in order to aid better price discovery of agricultural goods and consequently provide better prices for both producers and consumers.