10
Jan

Agricultural Markets: Five Opportunities for Innovation After Demonetisation

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Guest post by Samir Shah, MD & CEO, NCDEX

Due to the demonetisation of currency and recall of the currency notes of Rs. 500 and Rs. 1000 denominations announced by the government there was some panic in the initial days and the mandis were closed for some days. However, things are becoming better with the passage of time.

Recent visits to the mandis and fresh feedback received from the market participants indicates that arrivals have started improving in the mandis. The Rabi sowing status, which was feared to be disrupted due to cash crunch, has not seen any major impact as most of the essential inputs were available on credit or in old currency notes.

In the weeks after demonetisation, it was observed that commercial small farmers in “tight” value chains (such as sugarcane delivered to a specific neighbouring sugar mill, fruits, vegetables, milk, tea, specialty coffee and spices, fertilisers, seeds) benefitted from the strong relations between buyers/traders and producers and quickly adopted digital payment. These tight value chains generally involve greater control of the flow of goods and funds to ensure repayment (via delivery of the crop) and limit the opportunities of side selling (when the farmer delivers somewhere else to avoid repayment of loans extended under value chain financing models).

Government policies that support and encourage such value chains will speed up the shift to formal bank financing, financing from buyers (e.g., sugar mills, cotton ginners, milk companies), increase financial literacy and understanding about banking requirements among small farmers.

In looser supply chains where crops can be sold on the side and where repayment is difficult to capture through delivery, local lenders who are near farmers have an advantage, as proximity closes the asymmetric information gap, facilitates credit assessment, and makes repayment enforcement easier. Government policies should use input suppliers in the area, local credit unions, credit cooperatives, and microfinance institutions (MFIs) in that location for reaching out to such farmers.

The current situation, therefore, warrants exploring and providing more user-friendly and easily accessible scale-neutral technology, which can serve the economic needs of India’s 138 million farms. Fortunately India has already developed and successfully tested some of the best farm market-based ecosystem in the form of online agricultural markets.

Digitisation is opening up new opportunities for cost-saving automation, accuracy, speed and vastly-improved efficiency in agricultural trade documentation, storage, finance, and risk management. Supported by the right policies and market infrastructure institutions, it can transform Indian agriculture’s financing models, risk mitigation models, and distribution models.

1) Re-launch Exchange-traded Forwards and Launch Options

Exchange-traded commodities have already demonstrated the advantages from digitisation through greater speed, transparency, global reach, accuracy and reduced cost. Exchange traded Forward contracts (permitted by the erstwhile FMC, since suspended by SEBI), futures, and options allow crop prices to be locked in prior to the actual delivery of the product.

Exchange traded forwards can bring to cash-less and traceable (in addition to reducing defaults and better quality based sales) systems the entire Rs 7 – 9 lakh crore agri produce in India every year and enable the entire value chain to adopt newer and more compliant ways of doing business, including government procurement.

Except in wheat and rice that have partial protection through government procurement, Indian farmers are buffeted by price volatility. The availability of options can be the ideal instrument for insuring their margins. Farmer producer companies and cooperatives can be encouraged to use options to manage commercial risk in the production, processing and marketing of agricultural products. Banks can extend credit to purchase price insurance.

In other words, under the new agricultural market structure, farmers will be able to sell through transparent, digital markets such as the exchange-traded forwards or the National Agricultural Market/State Agricultural Market. They will also be able to sell to government agencies at the minimum support price through exchange-traded forwards. And they will be able to protect themselves from price volatility by using options.

Similarly, call options – that give the government the right – but not the obligation – to buy pulses when prices rise, for example, will reduce the need for accumulating physical stocks and add transparency by setting clear rules for government intervention. The food subsidy budget for FY17 is Rs 1.34 lakh crore, of which Rs 1.03 lakh crore is to be routed through FCI to the intended beneficiaries.

Exchanges can thus become the fulcrum of the new cashless agricultural economy if they move upfront on the developmental agenda of policymakers, regulator and political agencies.

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2) Create more capacity in commodity exchanges in order to encourage more agricultural value-chain participants to use regulated markets for risk management and financing.

Agricultural sector companies not involved in primary production (i.e., traders, processors, food companies, input suppliers) have their own financing, and production and price risk management needs. Working capital, funding for acquisition of assets (movable and real estate), cash flow management services, hedging and insurance are often needed by these agricultural companies.

Increasing position limits, adding many more commodities for trade (such as pulses, rice and dairy), and reducing taxes (such as CTT) will encourage them to increasingly use the exchange platform for low-cost risk management, marketing, and inventory financing.

3) Expand the digital mandi network by connecting National Agricultural Market and State Agricultural Markets (SAM)

Early indications are that although NAM has been implemented in 250 mandis across India, it is still currently restricted to post-trade data entry and not functioning as real price discovery, clearing and settlement driven markets.

On the other hand, SAM initiatives in Karnataka have implemented e-trading virtually end to end. Rashtriya e-Market Services Limited (ReMS), a joint venture of Karnataka Government and NCDEX Spot Exchange Limited (NSPOT) was formed to setup a Unified Marketing Platform (UMP) for modernising more than 300 APMC regulated market yards into a single online marketplace for the state, and enhancing the efficiency of regulated markets in the state. The Karnataka Government provided unified licenses for all APMCs within Karnataka. It also allowed for warehouse-based sales, warehouse receipt-linked loans and single point levy of market fees across the state, making Karnataka one of the first few states to adopt all recommendations of model APMC Act. More than 66 lakh farmers have successfully completed transactions worth Rs 32,000 crore till date through the Unified Market Platform in Karnataka. A simple trading platform for “Tur” pulses trading in Gulbarga Mandi was provided and eventually government provided an e-trading UMP across the state. Through the e-platform, the state Government and NCDEX have played a key role in linking smallholders to a wider market and helping them realize better prices for their produce.

A study covering impact assessment of e-tendering of agricultural commodities in Karnataka conducted by National Institute of Agricultural Marketing, Government of India, reveals that about 83% of stakeholders felt that the operations have become more transparent and time-efficient. Farmers have reported an 18% increase in income realization and traders have reported at least 25% of their time being saved through the online process. Overall, all the mandis have experienced an increase in trading volume and revenue because of increased sale at the higher side of price range and stable prices.

Creating interoperability between NAM and SAM will help accelerate digitisation of mandis. Digitalisation is an important step for reducing inefficiencies in agricultural markets, developing rural financial services, transparent pricing and promoting better organised agricultural value chains. By connecting the two networks through interoperability to establish a comprehensive market architecture, farmers in almost 500 market yards can seamlessly experience the benefits of digitisation.

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4) New WDRA-regulated repository will boost warehouse-based sales and commodity finance

Agricultural warehousing accounts for 15% of the warehousing market in India and is estimated to be worth Rs 8,500 crore.

Beginning can be made by exempting the 450 exchange-accredited warehouses, with a combined capacity of 2 million tonnes, from Stock Control Order under the Essential Commodities Act to encourage inflow of crops in this transparent and regulated warehousing network.

Simultaneously, the WDRA can encourage a pan-India digital network through the new Repository of all licensed warehouses for real-time data collection on food stocks. The benefits of switching to electronic accounting are almost immediate and lie in speed, ease of use, accuracy and cost. Automation reduces overheads and man-hours, with document transmission constrained only by the speed of the Internet.

The commodity repository will provide the legal and regulatory environment for inventory financing and warehouse receipt lending to encourage the use of these financing mechanisms. While currently the size of the market is estimated at about Rs 30,000 crore, as per a recent study by NABCONS, the potential for finance against collateral of major agri commodities and fertilisers is Rs 1,66,234 crore.

The combination of repository, digital warehouses, digital mandis, and warehouse receipts will create a legal environment that ensures easy enforceability of the security, and makes warehouse receipts a title document. It will create a network of reliable and high-quality warehouses that are publicly available. It will introduce a system of licensing, inspection, and monitoring of warehouses. It will lead to the creation of a performance bond and banks that trust and use the system. It will encourage agricultural market prices that reflect carrying costs. It will reduce the threat of hoarding of essential commodities and ease raw material procurement. And it will promote well-trained market participants.

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5) Strengthen producer organisations as important aggregators for delivering digitised financial and non-financial services to smallholder farmers.

More than 18,500 small and marginal farmers have successfully hedged their crops on NCDEX in the last 10 months through nine Farmer Producer Companies. By creating the right mechanisms, more such companies can be encouraged to connect to formal, regulated, cash-less markets. There is also the need to invest resources in capacity building for financial and managerial skills as well as improved corporate governance.

For small farmers, the advantages of joining a collective are direct access to a viable market (local, regional, global) for the end product; a clear, transparent pricing mechanism, a price that is attractive; shift away from mono-cropping low-value high-volume crops; avoiding overreliance on credit to purchase inputs; leveraging a competitive advantage in production, quality certifications, proximity to the end market; and, credibility of the buyer and trust among farmers via regular direct interaction between the buyer and the farmers.

There are already a number of NGOs and initiatives that work to strengthen farmer producer organisations, but a more conscientious effort and a bigger scale is needed.

Post-demonetisation innovation can improve the following constraints in the agricultural sector:

  1. Enable transparent, efficient market structure (e.g., through greater adoption of exchanges)
  2. Reduce administrative and distribution costs of food procurement (e.g., through options and exchange-traded forwards)
  3. Improve security of the collateral and cash flows (e.g., warehouse receipt financing, price hedging, insurance).
  4. Improve competitiveness of small and marginal farmers (eg. Farmer producer companies)
  5. Increase the share of formal finance in agricultural commodity markets.
9
Oct

Improving Competitiveness in Agri-commodity Markets – Part 3: Recommendations for Policy and Market Framework

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By Sreya Ray and Bama Balakrishnan, IFMR Capital, with inputs from Kshama Fernandes.

This post is the concluding part of the three-part series on the competitiveness of agri-commodity markets in India.

How can policy enable competitive agri-commodity markets thereby also improving the conditions and incentives for farmers and others? Once again, we use the three key fundamentals as a guideline:

  1. Access to Credit: As compared to a target of INR 575,000 crore credit for the agriculture sector, only INR 308,025 crore was disbursed to the farming sector (as on 31st October 2012)1. Not only is the quantum insufficient to meet the needs of the farmers, but also the credit arrives too late in the cycle (whether at the pre-harvest, harvest, or post-harvest stage), and the repayment schedules can be inflexible or too short and not accommodating of the length of the cycle. Policy reforms should be put in place to encourage and expand lending at each of the three stages of the cycle.
  2. Hedging of risks: The government at both the state and national level should incentivize the usage of hedging measures by both the farmer and others in the value chain, whether it be by promoting the use of micro-insurance products, giving farmers access to commodity derivatives or keeping transaction costs low for risk hedgers in commodity markets (OTC, spot, futures, and derivatives). As an illustration, the proposed CTT would increase transaction costs for traders and key risk hedgers that purchase commodity futures. This could constrain trading volumes, which in turn would hamper liquidity and price discovery and result in inefficient risk hedging, all of which would affect parties exposed to the commodity – farmers, traders, and wholesalers. A lot of commodities underlying traded futures contracts that are classified as industrial commodities are often used by farmers for price discovery (price of sugar as a proxy for sugarcane price). A drop in the underlying volumes of these contracts could harm hedgers as well as farmers who use these contracts to price their produce.
  3. Price discovery: Having in place established and widespread commodity exchanges that deal in not only spot but also futures and derivatives will, as explained earlier in the post, enhance fair and transparent pricing of agricultural produce. Towards that, the government should encourage the setting up of exchanges whether physical or virtual, and allot a public sector body to regulate such markets. Apart from exchanges, direct markets can also be encouraged on a smaller scale, such as Rythu bazaar cooperative model, the ITC e-choupal model. This will require a dedicated awareness campaign that will reach out into the rural hinterland and educate the farmers about the options available to them. Suitable amendment of the Food Safety Standards Act and/or the promulgation of laws to standardize quality at a wholesale level may be required to protect the players in the agri-commodity market at a wholesale level. Besides this, policies that promote the linkages between spot and futures market and thereby aid price discovery in a fair, transparent and reliable manner will go a long way.

Some more steps towards Competitive and Sustainable Commodity Markets: Addressing Current Challenges in Regulation and Governance

The main goals of a commodity exchange are to provide a platform for risk hedging and price discovery. Both these are important aspects of the agricultural cycle affecting all stakeholders. We review the existing landscape of commodity exchanges (NCDEX, MCX, NSEL, NSPOT) to identify the issues that hamstring the agri-commodities market.

Strong linkages between the exchange and warehouse regulators: If the commodity exchange is to honour contracts based on physical delivery of commodities, it must ensure that the warehouse meets minimum standards of quality, security, climate control, staffing, waterproofing, et cetera. This is particularly important as warehouse receipts can be used to raise financing for the warehouse itself to expand or invest in facilities such as pest control, fumigation, fireproofing, and standardized weighing equipment. The Warehouse Development and Regulatory Authority can act as a third party verifier of scientific warehousing standards and issue receipts that are treated as negotiable instruments and accepted by the Indian government and banks. In order to register with the WDRA, the warehouse must comply with strict rules on the terms of storage and construction and make penal provisions for stock shortfalls from the amount on the receipts. The 350 warehouses across the country that are registered with WDRA are subject to regular inspections by empanelled agencies. Although WDRA has been in existence since 2010, most of the warehouses in employ under the current exchanges –NSEL, NCDEX, MCX, NSPOT- are not registered with WDRA. In light of the NSEL debacle, it has been reported that the FMC is considering a proposal for compulsory registration of all warehouses used by spot and futures exchanges with the WDRA. Such a move would be a positive step for the market. Registration would also incentivize warehouse operators to improve the quality of their construction and facilities and therefore reduce wastage in the long run.

Price linkage to external markets: Since commodities are traded globally, it would make sense to start thinking about linkages of the Indian commodity exchanges with global markets. If there is a bumper corn harvest in West Africa that drives global corn prices down, the Indian farmer should be aware of these global movements. Removing the barriers to market information will ensure more transparency and information symmetry and lead to a more efficient exchange particularly in commodities where linkages with the global markets are increasing.

Price distortion caused by the government being a large player in markets for those commodities under MSP: Since the government is a key high-volume buyer of the commodities under the MSP umbrella at pre-fixed prices, it will invariably cause price distortion. More efficiency in procurement, storage and stock management by the Government may in turn minimize the degree of distortion in the market.

Need to differentiate between industry crops and food crops: Policy makers should understand the distinction in the impact measurement of movements in prices for industry crops and food crops. A supply shock in rice will directly affect the consumer who will have to pay much higher prices for his daily staple. However, a similar magnitude of supply shock in guar, which is an input into many different processed food and non-food products and for which there exist alternatives, will not affect the end-customer to the same extent in the same window of time. This distinction has implications for product design and policymaking (for example, applying the Essential Commodities Act differently to industry vs. food crops). In the context of commodity exchanges, the distinction could come into play in the pricing of derivatives, in hedging measures, as well as transaction costs.

FCRA Act: It has been nearly a year since the Cabinet approved the Forwards Contracts Regulation Amendment Bill and it awaits passage by the Parliament. Passing this bill will ensure a boost to the commodity exchange industry through introduction of new products like options and new generation commodity derivatives to expand risk management opportunities beyond the usual futures and forward instruments, and will provide more autonomy and accountability in the operations of the FMC (the regulator of forwards markets). An analysis of the NSEL crisis currently unfolding may reiterate the urgent need to pass this bill for empowered supervision of this important component of agri-commodity markets.

Even if the FCRA Act is passed, still needs a few more tweaks for FMC: FMC currently reports to Ministry of Consumer Affairs while all other financial market regulators are under the Ministry of Finance. In order to serve as an effective regulator of commodity markets, it should be independent and supervised by the more relevant Ministry of Finance and held accountable for its critical supervisory activities.

A better business model for exchanges in line with the top global commodity exchanges: Across the world, commodity exchanges use turnover fee based on volume rather than value. This encourages exchanges to push for higher volumes of contracts which in turn enables better price discovery – the primary aim of such an exchange. Further such a revenue model would avoid any conflict of interest as the exchange would be indifferent to the direction of price movements.

Correction: FMC has now come under the purview of Ministry of Finance since early September. Thanks to Mr. Ramesh for pointing it out in the comments section.


1 – Farmer’s Access To Agricultural Credit – Department of Agriculture And Cooperation, GoI

30
Sep

Improving Competitiveness in Agri-Commodity Markets – Part 2: The Policy Environment

By Sreya Ray and Bama Balakrishnan, IFMR Capital , with inputs from Kshama Fernandes.

This post is part 2 of a three-part series, and depicts the legislative and policy backdrop to agri-commodity markets in India

Legislation and Policy

The agri-commodity sector is today regulated in a broad sense by a few relevant Acts and legislation, including:

The State Agricultural Produce Marketing Regulations Act (APMC Act):

Agriculture markets are regulated in India through the APMC Acts for each state. By the provisions of a state APMC Act, every APMC is authorized to collect market fees from the buyers/traders in the prescribed manner on the sale of the notified agricultural produce.

According to MoA data, out of 35 states and Union Territories (UTs), only 17 states have amended their APMC Act to allow direct marketing, contract farming and markets in private and cooperative sectors. Key grain producing states, such as Haryana, Punjab and Madhya Pradesh, have initiated only partial reforms. Seven states and UTs have no APMC Act to govern agricultural trade.

In July 2013, the Committee of State Ministers In-charge of Agriculture Marketing to Promote Marketing Reforms submitted a final report to the Agriculture Minister calling for an effective implementation of Model APMC Act in all the states.

The mandate of the committee was to (i) persuade various State Governments/Administration of Union Territories to implement the reforms in agriculture marketing through adoption of Model APMC Act and Rules; (ii) suggest further reforms necessary to provide a barrier free national market; (iii) suggest measures to effectively disseminate market information and to promote grading, standardization, packaging and quality certification of agricultural produce.

The committee has also recommended the setting up of multiple and competitive marketing channels; independent regulatory authority to encourage private investors; need for viability gap funding to attract private sector investment; higher investment in marketing infrastructure under Rashtria Krishi Vikas Yojana; waiver of market fee on fruit and vegetables; setting up of independent district level authority for registration and dispute settlement; and setting up grading units with trained manpower in the market.

Timely follow-up and implementation of the recommendations of the Act may facilitate more efficient and competitive market access for agri-commodities at a producer level.

Essential Commodities Act 1955

This act was passed to protect the public interest for certain commodities regarding control of production, supply & distribution, commerce & trade. The objective was to ensure delivery of certain commodities and products to the general public. It gives powers to control production, supply, distribution etc. of commodities for maintaining or increasing supplies and for securing their equitable distribution and availability at fair prices. It allows state governments to set specific limits on the level of food grains stock a trader can have at any given point in time.

Essential Commodities (Amendment) Act, 2006 was enacted in December 2006 and came into effect from February 2007. It prescribes Stock Limits as just a ‘temporary measure’ during periods of price rise due to a shortfall in the domestic availability of the relevant commodities. Stock limit has been presently imposed only on a few commodities like rice, paddy, pulses, edible oils/oilseeds and sugar.

This Act has been limiting the effective operation of commodity exchanges, an issue elaborated subsequently.

Food Safety and Standards Act, 2006

This Act subsumes various central food quality Acts like Prevention of Food Adulteration Act of 1954, Fruit Products Order of 1955, etc., and also any order issued under the Essential Commodities Act, 1955 relating to food. It is intended to ensure prevention of fraudulent, deceptive or unfair trade practices which may mislead or harm the consumer, and prevent sale of unsafe, contaminated or sub-standard food.

The Food Safety and Standards Authority of India (FSSAI), established under the overarching legislation, will lay down science based standards for food items and regulate their manufacture, storage, distribution, sale and import to ensure availability of safe and wholesome food for human consumption. As many as 22 States and Union Territories now have Food Commissioners in place as required under the Act, while seven are expected to do so by the time it is enforced.

The Act as it stands now covers a wide range of commodities including those commodities underlying standardised commodity futures contracts which are often unprocessed in nature and not meant for consumption or usage in the form as described by the commodity contract. This can translate into delivery risk for the buyer/seller on the exchange on grounds of quality, as well as for the exchange itself on grounds of questionable quality of commodity stored/delivered under a pre-defined contract.

Forward Contracts (Regulation) Amendment Bill, 2010

The Forward Contracts Regulation Act, 1952 (“FCRA”) is the principal legislation providing regulation of commodities markets, commodity forward contracts, prohibition of options in goods and matters related to them. The Forward Markets Commission (“FMC”) set up in 1953, implements the provisions of the FCRA and regulates the functioning of the commodity markets in India. The FMC used to function under the aegis of the Ministry of Consumer Affairs, Food & Public Distribution (“Ministry”), until the NSEL crisis of August 2013, the fallout of which resulted in the move of FMC to the purview of the Ministry of Finance in September 2013.

While the commodity futures market was liberalised with effect from April, 2003 and modern institutional structures evolved, the FMC continued to function in its traditional manner. The GOI decided to restructure and strengthen the FMC broadly on the lines of the Securities and Exchange Board of India (“SEBI”) as well as confer upon it more statutory powers and greater autonomy and make necessary amendments to the FCRA for the said purpose. There is also a growing demand for allowing trading in options and new generation of commodity derivatives so as to provide wider opportunities for risk management.

In 2010, the Ministry introduced the Forward Contracts (Regulation) Amendment Bill, 2010 (“Amendment Bill”), covering the amendments mentioned above, i.e. more autonomy and power to FMC to regulate the markets; introduction of new products like options etc. In October 2012, the Union Cabinet approved the bill. As on date, the Amendment Bill has not yet been passed by the Parliament.

26
Sep

Improving Competitiveness in Agri-Commodity Markets – Part 1: Understanding the Markets

AgriCommodity_1
This post is Part 1 of a three part series.

By Sreya Ray and Bama Balakrishnan, IFMR Capital , with inputs from Kshama Fernandes.

The Indian farmer might earn only INR 30 a day, but there are many of him. According to the 2001 census, the Indian agriculture sector employs about 60 percent of the population, of which farmers comprise 119 million (the rest are agricultural non-owner labourers). Yet agriculture contributes only 14 percent to total GDP (2011-12, as per Ministry of Agriculture statistics), and has seen stagnating growth at around 3-3.5 percent over the last five years (compared with 7-8 percent national GDP over the same period, according to Ministry of Agriculture statistics). This is a big community that continues to remain entrenched in economic immobility. There has been a lot of informed discussion at the academic and policymaker level on how to revive the agricultural sector via policy and external stimuli such as subsidies. This series explores issues core to improving competitiveness in agri-commodity markets and presents them from the perspective of the needs of the Indian farmer.

Part 1 of the series outlines a few factors that would enhance competitiveness in these markets
Part 2 sets down a background of legislation and policy framework in the sector
Part 3 lists out our recommendations to improve the policy and market framework and will follow in a subsequent blog post.

The Need for Competitive Markets

The agricultural cycle can be divided for the purpose of our analysis into pre-harvest activities, harvesting, and post-harvest activities.

  • The pre-harvest activity entails seeding/planting, pruning, irrigation, disease/pest control.
  • Harvesting will entail the use of seasonal/temporary labour and or/machines to reap the harvest
  • Post-harvesting will require the use of transportation, warehousing and storage, and getting a good price for the produce.

Pre-harvest needs:

The farmer’s requirements include access to credit so that the farmer may finance the seed and fertilizer purchase, the labour required, the irrigation needs and insurance or other hedging measures to protect against adverse weather or rainfall patterns or plant disease etc.

A specific challenge at the pre-harvest stage is the lack of access to suitable financial products both in terms of credit as well as insurance. This may force farmers to obtain pre-harvest financing from ‘middleman’ to whom they are forced to sell their produce – leaving them in a weak bargaining position. Further the lack of access to insurance and hedging products such as micro-insurance, weather insurance or crop yield products may weaken their overall financial position, leaving them exposed to risks they are not best equipped to deal with (weather, price-volatility, crop demand-supply dynamics at harvest time).

Harvest needs:

The lack of access to financial services could equally manifest at the harvest stage if the farmer needs to finance the hiring of labour and machinery.

Post-harvest needs:

Significant linkages with agri-commodity markets truly begin at the post-harvest stage when the farmer may have a range of requirements including: credit, adequate and well-located infrastructure for transportation, warehousing, direct low cost access to wholesale markets without depending upon middlemen, ability to source price information in a timely manner.

At this stage there are many challenges faced by the farmer:

  • Insufficient access to finance at the post-harvest stage, forcing farmers to resort to middlemen to finance transportation/warehousing as well as to find buyers and determine wholesale prices.
  • Inadequate infrastructure for warehouse and storage of crops can result in high crop wastage.
  • Most warehouse and storage facilities are distantly located from the rural farmlands, resulting in a high price and opportunity cost for the farmer in terms of time taken for transporting his crop. Poor roads may complicate this further.
  • Inability of farmers to access updated commodity price information due to poor awareness and understanding or information asymmetry.
  • Inability of farmers to directly access markets, due to limited reach of private wholesale markets or MSP mandis has increased dependence upon middlemen to handle the agricultural commodities and fix a wholesale buyer and the price themselves, leaving the farmer with little say in the price he gets after paying commission fees.

To summarize, there are three fundamental issues:

1) Access to credit: at all stages of the cycle to enable the farmer to move away from dependency on middlemen and towards self-reliant price discovery.

2) Hedging of risks: need to hedge against not only adverse weather and sub-optimal crop yield (via insurance and weather derivatives), but also against price shocks. A farmer who grows a crop is long that commodity the day he sows the seed. Not having access to hedging mechanisms forces the farmer into a speculative position on the commodity. His returns now depend upon how the prices of the commodity behave at harvest time. An increase in the underlying commodity price will leave him richer. A drop in the commodity prices may leave him with barely enough to cover the costs of input and labour. Access to commodity futures and options will give the farmer a choice to hedge and move away from his current position of “speculator by default”. While futures contracts exist on some commodities, the size of the contract is too prohibitive for the small farmer. Mechanisms would need to be put in place to provide farmers access to futures hedging by way of aggregation by an intermediary.

While today farmers can theoretically sell futures on various agricultural products to “lock in” a price, there are two drawbacks. Firstly, it means depositing margins for farmers as sellers of futures, and secondly giving up on rise in the price of their produce. While futures based hedging would benefit farmers, having commodity options would enable farmers to hedge their long positions while retaining the price upside, an upside thus far only available to traders and aggregators. Buyers of “put” options have the right but not the obligation to sell, or make a delivery, at a pre-determined price and date. Basic, standardized commodity options are increasingly traded on exchanges globally and often have liquid secondary markets. Since buying a put option is being bearish on the underlying commodity, even though it is similar to selling a future, it involves no margin to be posted, and the only loss that accrues if the underlying commodity’s price increases, is the original premium posted. The benefit of the upside is preserved for the put buyer. In short, a well-designed agricultural commodity options market could completely replace the MSP system.

3) Price discovery: To ensure fairness and transparency of prices of agri-commodities, it is necessary to have an organized, competitive, liquid, and efficient market wherein market forces, and not the influence of middlemen, result in price discovery and full awareness of both buying and selling prices by the farmer and the consumer. Deep and wide futures markets are an effective means of enabling such price discovery – which goes beyond the local geography that serves as a reference for the farmer and could lead to better quality decision making by the farmer. The price of raw farm products such as sugarcane and natural rubber are derived from the futures price of processed end-commodities such as sugar and rubber. Availability of warehousing and storage with guaranteed standards will enable the farmer to hold stock for a potential upside. This is also a requirement for exchanges that operate on delivery based contracts. As we said earlier, the ability to hedge his long commodity position will better enable him to manage price risk.

At present, there is no uniform system of standards for measuring and certifying food quality and safety at the wholesale point of trade. It is observed in different studies that due to the lack in information integrity, the farmers are often paid less for their high quality agriculture produce and at the same time, retailers feel that they have paid more for lower quality food1. Additionally, the Food Safety Standards Act does not currently exempt the value chain up to the wholesale point from food quality and safety checks, thereby putting the exchange or transacting parties at risk if the underlying commodity of the contract or transaction is found to contravene the stringent quality standards as per the Act, leading to a possible repudiation of the contract.

The next post (Part 2) will explain more about the Food Safety Standards Act and other pieces of legislation and policy that are relevant for the study on competitive agri-commodity markets.


1 – Economic Inefficiencies in Farm-Market Linkages in Agriculture Value Chain in India: Problems and Solutions – Anshul Pachouri

4
Apr

The March Phenomenon in Agricultural Lending

By Deepti George, IFMR Finance Foundation

The Task Force on Credit Related Issues of Farmers, chaired by Umesh Chandra Sarangi, in its report submitted to the Ministry of Agriculture, Government of India, in 2010, observes that while month-wise credit disbursement patterns should have been in line with ground level requirements of kharif (June, July, September) and rabi (December, January), one-fourth of the disbursements instead happen in March, a month that is not critical to agriculture production.

Below table and the interactive chart throws light on this:

March_PSL_Table

Many of the reasons cited by the report for this phenomenon are likely to be direct consequences of having year-end priority sector lending targets for banks.