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Rural Pulse Issue - XIII, Jan. - Feb. 2016NABARD

Why are inter-sectoral terms of trade important?Changes in ToT or the relative changes in the prices of agricultural and non-agricultural goods have huge ramifications on income distribution, consumption decisions, savings, investment, welfare, agricultural production, technology adoption, rural poverty, trade balance, growth, etc.

It is believed that ToT along with increase in productivity is important for raising incomes of farmers and the agricultural sector. It is obvious that if factors such as productivity and output growth are stagnant, an improvement in the commodity terms of trade for agriculture reflects improvement in the welfare of farmers. Conversely, a decline in the commodity ToT can be offset by improvement in productivity and increased output volume in the farming sector. The importance of ToT in the Indian context, lies in the fact that although India has been undergoing a transformation from being an agriculture-based economy to one where non-agricultural sectors have become the drivers of growth, close to 50% of the workforce continues to depend on agriculture for livelihood. The consumption patterns of the Indian public and especially so of the rural population has been undergoing significant changes, whereby changes in inter-sectoral ToT would prove crucial in determining the well-being of farmers and the Indian consumer public in general. Maintaining a steady balance in ToT is crucial from a food security perspective as also the trade balance. The beneficial impact of favourable ToT is further influenced by several factors such as the size-

Terms of Trade (ToT), in economic parlance, is defined as the ratio of the value of a country’s exports relative to its imports. The ToT index in agriculture, however, is defined as the ratio of prices received to the prices paid for goods purchased by the sector. This, in turn, refers to the number of units of non-agricultural commodities that can be purchased by one unit of agricultural commodity. If the price of agricultural output rises relative to prices paid for inputs, a positive shift is said to have taken place in terms of trade in agriculture as it implies that the agriculture sector has fared better in comparison to other sectors in the economy. This article is an attempt to explain the concept of ToT in agriculture, its determinants, the trend in the Indian context and provide a few pointers for policy directions.

Terms of Trade in Indian AgricultureGopakumaran Nair*, Kavitha Ram**

class of farm holdings, the proportion of marketed surplus etc., therefore influencing the existing inequalities in the distribution of income among farmers.

Historical trendStudies on ToT in agriculture received limited attention, in the past. Classical economists believed that the limited land and resources to produce food would constrain the production of food and agricultural products whereby they would retain a high scarcity price. But the notion continued to hold good till first half of the 20th century only when 11 out of 15 studies on the subject showed an increasing trend of terms of trade in agriculture1. The trend during the period after 1950s (till 1985) highlighted that only 9 of 93 studies concluded rising ToT in agriculture while 38 showed declining ToT in agriculture and the remaining did not show any convincing trend2.

The classical hypothesis was fully overturned in 1950s by Raul Prebisch and Hans Singer with their research. Their work postulated that the barter terms of trade between primary goods and manufactured goods, resulted in the transfer of income from developing to developed countries. This was explained in terms of the tendencies for economic growth to increase the demand for manufactured goods more than for primary products, and for productivity to increase more rapidly for primary products, thus driving the prices of primary products lower relative to those of manufactured goods3.

*Deputy General Manager, **Manager, Deprtment of Economic Analysis & Research (DEAR), National Bank for Agriculture & Rural Development (NABARD), Mumbai

1 Scandizzo, P.L. and D. Diakosavvas (1987), Instability in the terms of trade of primary commodities, 1900-1982. FAO, Econ. and Soc.Devt. Paper 64, pp.1-31, 159-167.2 Colman, David(2009), “Agriculture’s Terms of Trade: Issues and Implications”, Presidential Address at the27th Conference of the International Association of Agricultural Economists, Beijing, China, August 17, 2009.3FAO Corporate Documentary Depository, “The State of Agricultural Commodity Markets-2004 sourced from http://www.fao.org/docrep/007/y5419e/y5419e02.htm)

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It has been argued that in times of inflation, terms of trade and distribution of income turn in favour of agriculture5. This, therefore, has an adverse effect on savings rate in the economy as increased inflation in agriculture leads to increased spending. Studies by Chakravarti (1974) show that beginning from 1964-65, a favorable agricultural Net Barter Terms of Trade was instrumental in squeezing the profit margins of the industrial sector through an increase in the product wage rate6.

In a developing country like India, expenditure on food constitutes a major proportion of the total consumption expenditure. In the pre-liberalisation period, the fluctuation (implying the change) in Wholesale Price Index (WPI) was very uneven and sharp (Chart 1). There were even times when food inflation dipped to negative levels in the 1970s. However, this trend has changed and inflation in food articles has remained high, particularly in the past ten years, in comparison to manufactured products and all commodities in general. To a certain extent, this can be deemed responsible for the favorable ToT that has prevailed in the post liberalization period. The movement in ToT has been more or less in sync with the changes that have happened in inflation as is observed by a comparison of Chart 1 and 2.

The estimation of ToT index for agriculture by different agencies/ researchers shows variations depending on the variable used in constructing and the issues/ shortcomings associated with them. The general consensus among economists is that ToT in

World over, at the aggregate level, terms of trade within the agriculture sector was constant during the latter part of 20th

century. A closer look on countries in different income groups discloses that the developing countries experienced large and persistent fluctuations. Since deteriorating terms of trade in agriculture affect the balance of payments and debt burden of many developing countries, the fall in terms of trade between agricultural commodities and manufactured imports has been more devastating.

Indian Scenario

In Indian context, earlier attempts to estimate the TOT in agriculture was credited to Thamarajakshi [1969], Kahlon and Tyagi [1980], Tyagi [1987], Mungekar [1992] and Palanivel [1999] by using alternate prices data, different trading baskets and by identifying commodity basket and appropriate weights to define the composite index of prices received and prices paid by agriculture. In all the estimations, price movements hold the key and also play a major role in agricultural price policy formulation. Farmers respond to relative prices, rather than absolute prices and since ToT represents relative prices, it was added in 1980 as one of the factors for fixing Minimum Support Prices (MSP) in India4. The ToT index was estimated by both Commission on Agricultural Costs and Prices CACP and the Directorate of Economics and Statistics (DES) and the indices have shown divergences owing to differences in the methodology adopted.

4 Dev, S. M. and Rao, N. C. (2015), “Improved Terms of Trade from Agriculture-Results from Revised Methodology”, Economic and Political Weekly, April 11, 20155Khusro, A.M. (1961), “Inter-Sectoral Terms of Trade and Price Policy”, Economic and Political Weekly, 28 January 19616 Deb, Surajit (2002), “The Debate on Agriculture- Industry Terms of Trade in India”, Working Paper No. 109, Centre for Development Economics, Delhi School of Economics

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agriculture was unfavourable in the period prior to liberalisation while it has been more or less favourable during the past 10 years. The estimation done by Thamarajakshi revealed that ToT in agri remained favourable throughout the pre-liberalisation period i.e., from 1970-71 to 1991-92. However, the CACP series showed that the TOT in agri showed mixed trends, with only two years (1975-76 and 1978-79) during the 1970s and the entire decade of 1980s showing unfavourable ToT in agri, with the trend turning favourable in the early 90s. Although the value of ToT index has varied in the calculations done by Thamarajakshi and CACP, the trends are broadly similar, as the swings are similar.

Since 1993-94, the ToT index has remained favourable as per the estimation of Directorate of Economic and Statistics (base: TE 1991-92), and Economic and Political Weekly (base: 2004-05) till about 2008-09. It is widely agreed that the MSP has played a crucial role in maintaining a favourable TOT in agriculture during the period. The Working Group constituted by the Ministry of

Agriculture under the chairmanship of Prof. S. Mahendra Dev for estimating the ToT used TE 2011-12 as the base and worked out indices for farmers (WG-Farmer)and agriculture sector (WG-Agri sector), separately .

Table 1 : Index of ToT in Agriculture (TE 2011-12 = 100)Year MoA -WG – Farmer MoA-WG - Agri sector2004-05 87.8 81.62005-06 84.8 79.82006-07 87.1 82.82007-08 92.2 86.72008-09 99.9 93.92009-10 100.2 98.42010-11 102.9 102.92011-12 97.3 98.82011-12 97.3 100.92013-14 95.6 99.1Source : GoI 2015 as quoted in S.M. Dev, N.C. Rao, improved ToT for Agriculture, EPW Vol.I No.15, April 2015

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Publisher :- Shri M. V. Ashok, CGM, Department of Economic Analysis and Research (DEAR), NABARD, Head Office: Plot No. C-24, ‘G’ Block, Bandra-Kurla Complex, Bandra (E), Mumbai- 400051

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Findings of the Working Group

The Working Group has estimated that the index of ToT for farmers showed an increasing trend during the period from 2004-05 to 2013-14. It increased from 87.8 in 2004-05 to 102.9 in 2010-11. If 2004-06 is used as the base, the ToT has increased by 19 per cent. With TE 2011-12 as the base, the ToT index was less than 100 in 8 out of 10 years. If triennial average of the index 2004-05 to 2006-07 is taken as 100, the index is above 100 for all years since then, primarily on account of better global agricultural prices, MSP intervention, food inflation etc.

The ToT index during 2012-13 and 2013-14 for farmers was low compared to base TE 2011-12. The Working Group has stated moderation in global prices as being responsible for the fall in index during this period. Although MSPs increased, there was a moderation in wheat and rice prices around that time. There were steep increases in wages, diesel price etc. leading to increase in cost of farm inputs etc. The increase in input prices were faster than that of output prices during this period.

Regarding ToT for agriculture and non-agriculture, the Working Group observed that the ToT index for agriculture sector rose much faster than for farmers during the period from 2004-05 to 2013-14. It rose from 81.6 in 2004-05 to 102.89 in 2010-11. The index increased by 26 per cent for agriculture sector as compared to 17 per cent for farm sector during the same period. It also shows that agriculture sector benefited much more than non-agriculture sector.

If average of ToT index for TE 2006-07 is taken as the base, the index has risen from 100 in 2004-07 to 126 in 2010-11. The reasons responsible for rise in ToT for farmers and agriculture sector as a whole remain the same. Rise in wages for agricultural laborers for non-agricultural activities has also contributed to higher increase in ToT for agriculture, when compared to farmers.

In short, the reasons for favorable ToT for farmers during the past decade as summarized by the Working Group include significant increase in minimum support prices, rise in global

agricultural prices and rise in wages for agricultural labourers for non-agricultural activities.

Looking forward• Considering that almost half of India’s total workforce

continues to depend on agriculture as a source of livelihood and taking into account, the influence of MSP in maintaining a favourable ToT in agriculture, it is necessary to ensure that adequate price support mechanisms are in place, without distorting the general price scenario. Given that agricultural growth and production are highly contingent on weather fluctuations among other factors, the importance of price support mechanisms cannot be underestimated; hence the need to maintain a parity between agricultural input and output prices is essential in so far as maintaining favourable ToT in agriculture is concerned.

• In India, about 85% of the total operational holdings belongs to the SF/MF category, which is a pointer to the extent of subsistence farming in the country. Given the smaller share of marketable surplus of SF/MF category, it is obvious that the benefits of increased MSP and favourable agricultural prices are not accruing to SF/MF in comparison to large farmers. Does this situation warrant corrective measures such as differentiated pricing of inputs to SF/MF?

• Despite favourable ToT, the agriculture sector is not doing well and is plagued by productivity concerns. The main concern from the food security perspective or foreign exchange from agriculture is not about increasing acreage under agriculture; instead it is about increasing productivity. This warrants not just price interventions from a welfare perspective; it implies the necessity of non-price interventions as well. In the long-term, maintaining a favourable ToT entails increase in productivity by enhanced investments in agriculture, irrigation, power, farm mechanisation and the like. Due emphasis on research interventions is likely to yield a solution in the long term, if not in the near future.