By Uday Krishna & Rajendra Kumar, Agricultural Terminal Markets Network Enterprise, IFMR Trust

Agriculture incomes in India are volatile because of a number of unforeseen factors, such as weather, disease/pest infestations and/or market conditions. With 65 per cent of the population dependent on agriculture, it is essential to manage both production and price risks. The government has responded by encouraging the setting up of modern exchanges, with daily mark-to-market margins, a trade guarantee fund, back-end computerisation, on-line trading and demutualising of new exchanges.

However, to realise the benefits from such initiatives, the bulk of farmers, who are small and marginal, require access to finance immediately after harvest, though they possess limited collateral to obtain bank funding. Physical collateral such as land and agricultural implements are of little value in mitigating a financier’s risks as the collateral is difficult to enforce and has a low resale value.

Liquidity problems

Agriculture is a seasonal business with high price uncertainty. During harvest, prices drop due to excess supply. But, if the harvest is lower than expected, the prices rise. Hedging against price fluctuation is possible through derivative contracts such as commodity futures, fixed price forward sales or purchase of put options.

With commodity futures, the farmer agrees to sell the commodity at a pre-determined price and date. While a fixed price forward sale agreement is possibly the simplest price hedging strategy, it is difficult to find the right counter-party unless the size of the expected crop is reasonably well known, prices are satisfactory and buyers have enough confidence in the seller to commit on a forward basis.

Since there are several variables, such contracts are better implemented with a put option for the farmer or a call option for the buyer. In India, proposals to allow options in commodities and provide for registration of brokers by suitably amending the Forward Contracts (Regulation) Act have been pending in Parliament for over five years.

Warehouse receipt financing

Small farmers need liquidity urgently and the crop is inevitably sold to traders/village-level aggregators immediately after harvest. The buyers hold the stock through the harvest season till prices rise. If farmers are enabled to hold their crop beyond harvest, this price benefit could accrue to them. Farmers face two major problems — lumpy cash flows and non-availability of intermediate finance.

Warehouse receipt finance, which can be used to extend the sales period beyond harvest season and secure collateral for obtaining finance, can play an important role in smoothening farmers’ incomes by providing liquidity at times when cash-flows dry out.

The concept of warehouse receipt financing is not new in India. Banks have been extending these facilities to large aggregators, traders and bulk farmers, ignoring small and marginal farmers. Extending cheaper credit to small/marginal farmers is easily done through warehouse receipt financing if banks purchase suitable hedges on the price of commodities, assuming only a minimal credit risk.

In warehouse receipts financing, producers deposit goods of a certain quality, quantity and grade in accredited warehouses and receive a receipt for it. Since these receipts are now accepted as negotiable instruments (under the Warehouse Development and Regulation Act 2007), they can be traded, sold, swapped and used as collateral to support borrowing or accepted for delivery against a derivative instrument such as futures contract. This facilitates access to finance.

For the receipts to work effectively, it is essential to ensure infrastructure, and grading and collateral management systems which guarantee the quality and quantity of stored commodities. This will provide comfort to farmers — to store their produce, as well as to banks — to accept warehouse receipts as secure collateral to finance farmers.

Trading units on national-level commodity exchanges are large, preventing small and marginal farmers from participating individually; they depend on local mandis/middlemen. Also, the rather small number of delivery centres and the price difference across physical markets limit farmers from participating in trading.

There is a need to increase the reach, provide the services of an assayer and reduce transportation costs. Setting up local access to commodity exchanges and end-buyers, allowing them the kind of price discovery offered by national exchanges, and convenience of access, is a possible solution.

An example of a local exchange is the Agricultural Terminal Markets Network Enterprise, which works with castor farmers, allowing them to trade at local branches across Kadi Taluka, 65 km from Ahmedabad.

Price discovery

Small and marginal farmers are also inconvenienced by the inter-bank settlement time, preventing exchanges from making instantaneous payments to traders. Price discovery between international and domestic commodity markets can improve by allowing banks to offer commodity solutions as an intermediary between international counterparties and smaller Indian companies.

While domestic exchanges currently offer over 50 commodities across various segments, the number of contracts listed on the exchange for agricultural commodities continues to be low. As the number of listed contracts increases, price discovery will improve.

This article first appeared in The Hindu Business Line.

What does it mean to be a farmer in Kurnool (a district in Andhra Pradesh)? One part of the district grows commercial crops such as sunflower and tobacco while another supports nothing but paddy (the Telugu-Ganga Canal influences the soil in way that only paddy can be grown here). Against this backdrop, we wanted to understand the lives of the farmers in the district, what they do for sustenance and how they manage their finances. We travelled across Kurnool and met a diverse cross- section of respondents covering small and large farmers, housewives, small businessmen, Sarpanch and SHG presidents. As a part of our conversations with these respondents, we enquired with them about formal and informal sources of finance available to them, especially through microfinance institutions (MFIs) and their experiences with them. These were in-depth interviews with individuals as well as with groups as other villagers often gathered around us to share their views as well. We also met an officer from a government owned bank to understand his view of the financial options available to his clients.

Following qualitative research methods, we aimed to maximise diversity in our respondent set. The purpose of this post is neither to generalise our findings nor to draw conclusions merely based on our observations from this trip, but to place on record the multiplicity of voices heard from the field on issues at the heart of the microfinance debate. We feel that many of these perspectives and personalised narratives have been missing from recent coverage on the Andhra Pradesh microfinance situation.

[The names of the respondents have been changed at their request to protect their privacy.]

Weather shocks

The farmers of Kurnool district are reeling under the damaging impact of fungal attacks on their crops. Vast expanses of black paddy fields greeted us as the two of us travelled to Nandyal in the Kurnool district of Andhra Pradesh. 

An excess of rainfall  and prolonged wet weather has led to fungal attacks on almost all the paddy fields in the region. (By November 24, 2010, 496,000 hectares have been submerged or otherwise damaged due to the excess rains and yields are expected to be much lower than usual.) These are difficult times for farmers who had toiled hard all through the sowing season, often borrowing to meet their daily expenses in the hope of a good harvest. But their crops are being attacked by a disease that would reduce their yields to less than 50% of normal yields. The question in our minds, as we observed this was, how does a farmer here manage her financial requirements?

Fungal attacks on the paddy fields in the region

“[This year] I planted sunflower and turmeric along with paddy. These commercial crops require high levels of investment. [To make these investments] I rely upon my savings, bank loans against the collateral of my land and on the rental that the small farmers pay for leasing parts of my land”, says Abilash, a farmer with 10 acres of land in Atmakur village.

We ask him what role a microfinance institution (MFI) plays here.

“Only about 10 percent of my investment cost is met by the MFI loan” he replies. “But you should talk to my labourers or the small farmers from the lower caste / tribal colony. They are the ones that keep taking MFI loans”, he adds.

While talking to them we learnt that the “colony” people are the ones who are hired as labourers by the big farmers or lease a piece of land from them. If they choose to lease the land, they have to pay their lease rental upfront because the landlords do not want to bear the risk of crop failure (the big farmers also confirmed the existence of this practice). Since they are from a “lower caste” they do not even consider requesting permission to pay at the end of the harvesting season. They also know that if they take loans from these rich farmers and default, they run the risk of being boycotted by the entire village.

No land documents meant that the lessees had no access to a source of financing such as a commercial bank. Moneylenders or MFIs were the only options left for them to approach. (Self-Help Groups interestingly, had not yet caught their attention, though they are aware of it).   “The moneylender does not give us the amount of loan we want. Not because we are not capable of repaying, but because he wants to have us hooked to him. He gives about half of what we need tells us that only if we repay this promptly will he give us more. God knows how much interest I have paid him!” says Ahmed, a “colony” resident who has taken one acre of land on lease.

This means there is still some more money that needs to be borrowed. “We have BASIX, SHARE and Swayam Krishi [SKS] operating here and they have been good to us. My wife took the loan and I was able to take the land on lease, buy some pesticides and fertilisers. Last year, we had a bountiful harvest so I decided to lease more land and cultivate more cash crops. But this year the crops have failed and I have spent all the money I took as loans.”

So what would he do to repay the moneylender and the MFI? “For the microfinance loan, my wife works as a daily-wage labourer and she earns enough to repay the Rs. 250 weekly repayment. But I don’t know what to do with the moneylender. I will have to borrow more from him or someone else to repay his loan” he says.

By now, we are surrounded by some 20 people, all from the “colony” and all of them (excepting 2) had taken loans from MFIs. We asked them if they had ever faced any difficulties in repaying the MFI loans. “Sometimes we do face difficulty”, one of them said. “I have a small piece of land and my wife works as a daily wage labourer. Sometimes, when my wife falls sick, we lose income for a few days. Then weekly repayment becomes difficult. If it was a monthly repayment, we could easily compensate for it by working extra. The recent system of paying monthly has helped us.”

Multiple borrowings

We raise the issue of adequate borrowings and we ask if they have multiple borrowings and why. An elderly farmer in the crowd says, “We told you before that our requirements are never met completely from one source. Why would we borrow from different people if there was no need to do so?”

A labourer who had never taken an MFI loan interjected, “Do they explain why they take your signature while giving the loan? They have the capability to auction all your property if you don’t repay them on time”. When we ask him if he had read any such document from an MFI, he said he had only heard people say it. We ask them if the MFI had explained the documents and procedure. The others said, “They did, but we did not understand and we were all eager to take the loan.”

When we meet a group of women in a different mandal (Allagadda) the next day, we get some more perspective on the phenomenon of multiple borrowings. The women said they do have multiple borrowings, often up to four MFI loans. A woman who sells sarees for a living says, “I know my neighbour goes for Monday, Tuesday, Wednesday and Thursday groups. I too have taken loans from three MFIs”, says one woman. But why did they take these loans? “Why should we say no when someone gives it to us? We get good income and we know we can pay off the weekly dues easily. Then what is wrong in taking the loans?” she replies.

One of the women says, “When a new MFI enters our village, they first enrol the women who already have an MFI loan. They call us and explain that they are a similar company and that they would offer higher loans. Next, they ask us to bring our friends and they continue to offer loans. We keep taking loans from them because we have a need. Besides, who are they to decide how much I can afford? I know my limitations and I will take as long as I have a need. If I don’t tell them, how will they know if I have already taken a loan [from elsewhere]?” another woman asks. “Even if the MFIs checks on who is borrowing [from multiple sources], we will produce five new faces and as soon as MFI gives them the loan, we take the money from them” said another woman, while others laughed and agreed with her.

Collection practices

The previous day, when we were in the “colony”, we had asked the small farmers and labourers what the loan officer would do if they failed to repay. “They would insist that we repay. They would sit here and ask us to clear our dues. Normally, if my friend has a genuine problem such as illness of a child, we would pool in money and cover her. Didn’t we agree to do it when we took the loan?” they said.

The women in Allagadda also give us a similar answer. “They come here exactly on the same day and collect the amounts from the centres. We believe them because they are very professional. They do not even drink water or even talk to us anywhere else other than at the centres”, says one of the women.

We ask them what would be the officer’s response if they did not pay. “Why would I not pay? Had I not agreed to pay every week when I took the loan? If I do not pay, my group members lend me money for the week. I put in extra work and repay it to them” is the reply. There was strong sense of conviction in their voices.  In case of a second default, the woman can still depend on the group to help her again, but not the third time. “The third time is when things become bad”, they say. “Why would I help someone who is not interested in repaying her own loan?”

“How would the loan officer behave then?” we ask.

“He would say that the group can leave the centre only after paying the instalment and I would not blame him for that. But why would I have to sit unnecessarily if it is not my fault? I would shout at the woman [defaulter] for being careless. Anybody, who has borrowed has to pay up.  Am I not paying my dues?” replies one of the women.

Interest rates

In all the conversations that we had, the most striking aspect was the absence any mention of high interest rates. In fact, the Sarpanch of a village acknowledged that because of the presence of MFIs, the money lenders had brought down their interest rates.”If the MFIs were not there, the money lenders would create an artificial scarcity and would say that loans were available only at 5 percent per month. Now it is available to us at 2-3% per month”.

When we met the branch manager of a government owned bank in the village and asked him about other sources of finance for the villagers, he said there were about 300 SHGs in his branch and he was all praise for them. “We insist that all the team members to come to the bank when they want to withdraw money”. On the Joint Liability Group (JLG) model used by the MFIs, he said would really be interested in testing out the JLG model. “But unfortunately, I am short-staffed and am not able to spend as much time on forming these groups and managing weekly payments”, he said.

Farmer suicides

Almost all the respondents we met had heard of farmer suicides. When we asked them how they felt about deaths of their fellow farmers who were pushed to commit suicides, the common response we received was “His family would suffer and he did not think about them. It was his bad luck. Poor guy.”  We asked if the MFIs could have pushed them to suicide by their aggressive collection practices, they replied “We know that only some of the stories [of suicides] are real and others are not. For example, a story of suicide reported in a village close-by was an accidental death, while TV showed it as a suicide”. But the others were quick to point out “How do you know? We only know in our village nobody committed suicide”. On MFI staff harassing the borrowers, they said, “Nobody can enter our village and harass us or use foul language against our women and get away with it. We would have not allowed such things to have happened in our village”.

Beyond the MFI

Finally we were curious to know if they were still repaying the MFI loans.   They replied, “No, when the MFI person came, we said, we can’t pay this week and he went away silently and came back next week.”  However in Allagadda, the women said they paid up their dues.

We asked them what they would do, if the MFIs were gone or if they stopped giving loans, but they don’t seem to have imagined such a scenario. One common response we got was “Where would the MFIs go?” When we insisted that they imagine such a scenario, they replied that they would somehow borrow from somewhere or someone and manage to continue, but they did not have a clear alternative.

We had to cut our visit short because of the ensuing political situation, but we believe this visit offered a perspective that was worth sharing.

At the early stages of economic development, agriculture and related activities employ almost all the resources and provide work and livelihood for the entire population.  Even today the dominance of agriculture in India and South Asia is evident. The dominant asset and non-labour factor of production, historically for millennia until the emergence of large scale manufacturing and industry, was land.  Agriculture, broadly defined to include animal husbandry, with land and labour as primary inputs was the production activity around which all other services, trade, arts and petty manufacturing were organized at early stages of development, if not always. Economy was the idealized self-sufficient village community or small areas reachable with the relatively primitive transport and communications technologies.

Two features of agriculture illustrate the significance of finance, credit and management in development. First, the inputs and their allocation—of land across various crops and of labour across land preparation, irrigation and application of fertilizers prior to sowing—must be committed at the beginning of the crop cycle.  Farmer has very limited flexibility to adjust the allocations during the crop cycle in response to weather and demand shocks. Other inputs such as fertilizer, labour for irrigation and weeding, etc., can be adjusted to realised shocks. Second, while most inputs are committed during the crop cycle, the output being subject to additional weather shocks is not known until the harvest is processed and securely stored. Further, the value of the output depends on post-harvest spot prices. Since at best only the joint probability distribution of shocks, prices, etc., and not their actual realisations can be known, the environment of agricultural production is highly uncertain.

The uncertainty and risk of committing land and other inputs in advance of realization of value generates demand for credit to finance the inputs and to sustain the farmer’s consumption during the crop cycle. The length of this cycle varies from a few months for seasonal crops to a year or more for annual and tree crops. Moreover in areas where there is ample rainfall or assured irrigation more than one crop can be raised on the same plot of land. This allows the possibility that the loss of crop in one season could be offset by a bountiful crop in the next. Indeed, in parts of India where Kharif crops could be lost because of floods, the retained moisture and silt from floods could enable more extensive cultivation and higher yields of crops in the following Rabi season. Thus the agricultural risk—ex ante and realized—could could change from year to year due to natural disasters of floods and droughts.

Historically, in addition to credit, risk taking, and risk sharing arrangements have evolved, first in agriculture and then elsewhere as development proceeded, eventually to a specialized and complex financial sector. On the supply side, only those who had enough accumulated resources, social and legal instruments for collecting the principal and interest, and a capacity and taste to bear the default risk, could extend credit.  It is no surprise that only landlords with large landholdings and traders in agricultural inputs and outputs had the capacity, desire and ability in adequate combinations to become large players in providing credit. And the demand for credit arose not only for financing the crop cycle but also for covering households in general for variations in cash flows subject to health shocks, demographic events (e.g. births and deaths), social and religious expenditures (marriages, funerals) whose timing and costs are uncertain. Credit is necessary for household consumption smoothing, i.e., to shield their consumption stream from large variations in their income stream.  The virtual absence of means of insurance against various risks across families or communities meant that credit was a joint mechanism for inter-temporal resource allocation through borrowing and lending as well as means of insurance against risks. Serving two related but different objectives through the single instrument of credit forced inevitable compromises in the service of each. In other words, a single instrument will almost never achieve two objectives as well as two instruments—one for each objective—could.

Various forms of tenancy developed early on such as share-cropping, fixed produce rent, fixed cash rent to provide a range of arrangements for risk-sharing, each with its own risk and expected return patterns for the landlord and tenant.  The attractiveness of each arrangement to individual landlords and potential tenants depended in large part on the sources of risk and covariations (in physical yields per hectare, in spot price per unit of output at harvest, cost and capacity to store harvested output to gain flexibility in the time of its sale, and so on) and the capacity to bear risk and risk preferences.  The fact that a landlord (or trader) is often a provider of credit to his/her tenant meant that the landlord and tenant have a bilateral relation with respect to land and credit (whose supplier is the landlord and the tenant is the demander), and labour (whose supplier is the tenant and demander is the landlord). Such simultaneity of bilateral relations across three markets (land, labour and credit) might confer more market power on one of the two parties (usually the landlord or trader) relative to independent pairing in the three markets.

In the case of a trader (who is the supplier of credit, agricultural inputs and marketing service for output) and his agriculturist (who is demander of credit and inputs and supplier of outputs) the situation is analogous. In addition to making a portfolio choice of allocating her land among crops, the cultivator also decides on inputs (e.g., when and how much fertilizer to use), allocates her and her family’s labour between self-employment on her land and supplying it to others, and chooses when and how much to sell her harvests of different crops net of her family consumption, etc. Responsibility for making these decisions makes her a manager of resources. Thus finance and management have been core functions in agriculture at all stages of development, increasing in complexity and specialization as development proceeded.

The post Second World War literature on development was devoted to the analysis of the efficiency and distributional implications of alternative credit, insurance, marketing and other arrangements. While these arrangements may have originated in the historical past in what were then called “underdeveloped” countries, they remain present, if not endemic, in contemporary developing countries.  The sophistication of the tools of analysis increased in step with their development in economic theory and econometrics.

It is no accident that historically the interest rate on finance or credit has been the target of attention of religious, literary and secular analysts. Apart from the Islamic prohibition of the charging of interest on loans, fulminations against “usurious” interest rates and characterization of money lenders as heartless “usurers” with no compassion for adverse shocks experienced by borrowers are ubiquitous in almost all religions.

A very early attempt to regulate interest rates is seen in Kautilya’s Arthasastra (commonly dated as a work of 4th century BCE). Kautilya’s sophisticated understanding of the link between interest rate and risk (regulated interest rate steeply rising from a ‘risk free’ 1.5% per month as the transactions financed become riskier and riskier and of legal aspects of liabilities for repayment) in loan transactions in Arthasastra is nothing short of remarkable, leaving aside the privileges to Brahmins and higher castes in rewards and punishments. Appendix I contains an extract from Arthasastra on interest rate regulations. In fact the sophisticated understanding of Kautilya of many aspects of economics and finance including the role of the state (i.e., the King) for provision of irrigation through construction of dams, standardization, weights and measures, preparation of budgets and audits with a clear understanding of income and expenditures, the possibility of corruption by public servants and incentive aspects of payment of adequate salaries for them, import and export taxes, etc., is truly amazing. Appendix II contains brief excerpts from R.P. Kangle’s (1972) translation that include, (i) Pages 90-98 on accounts, audit and definitions of revenues and expenditures, (ii) Pages 98-103 on administrative corruption, (iii) Pages 145-148 on Trade, (iv) pages 162-165 on Customs duties and tolls and (v) finally pages 350-351 on salaries of civil servants.

It is widely believed that the state described by Kautilya is a police state or at least a high centralized state. While there is some evidence in support of such a view, Kangle provides a much more nuanced view that it was a bureaucratic welfare state. Kautilya lists at least twenty departments! Indeed, one can claim that India has been a bureaucratic state for millennia, whether under Mauryas whom Kautilya helped to gain power, Mughals, the British or since independence, though the efficiency of the bureaucracy is another matter altogether. Appendix III contains Kangle’s analysis of Kautilya’s conception of the state.

More than a year ago, I was requested to chair a sub-committee of the Academic Affairs Committee for reviewing the MBA programme of the IFMR Business School and coming up with a vision for its future.  The Committee presented the Board with its future vision of the IFMR Business School and a proposal to offer a single integrated, rather than three, Post Graduate Diplomas in management which would be, if not unique, at least have few parallels in the world in its integration of development, finance and management.  The Committee’s vision had its academic rationale in the overlap among the disciplines of Finance, Management and Development. This note explains this rationale and illustrates this with the example of a major sector, Agriculture, in which risk taking, credit, finance and management are central.  The note also explains the comparative advantage of IFMR Business School in offering an integrated MBA with its proven record of excellent research on finance and development and location in a currently very dynamic developing and emerging market country, India.

–

Professor T.N. Srinivasan is Samuel C. Park Jr. Professor of Economics, Yale University and Member, IFMR Business School Board.

Agriculture finance, especially to small and medium farmers, is riddled with risks and challenges. Some of the broad categories of risk include -

• Climate change risk – exposure to variations in weather patterns
• Production/yield risks due to natural hazards
• Market and price risk
• Collateral limitation in the form of weaker and riskier security
• Government interventions weakening local rural credit culture

Many programs take the safe way out and end up lending to large farmers. A more robust way to lend to small and medium farmers is to explore existing delivery channels that focus on small and medium farmers and promote products that mitigate these risks. This is an appropriate time for the lending institutions to take a step back and re- visit the lending strategy.

While it is not necessary to abandon the traditional method of lending, it makes good sense to adopt an integrated approach of judiciously combining the old and the new methods of lending.

It is also important to learn from the existing projects to identify success factors, replicate and scale up. Many a time all it takes is designing a sub-component in an existing project than having to start something totally new. Existing channels that connect the small farmers should be identified to build financial capabilities. Lending institutions can leverage these existing linkages in the agriculture supply chain by connecting with participants such as input suppliers, commodity procurement agencies, and farmer groups.

Agri-lending is a challenging task and identifying risks and devising mitigants requires a lot of work with ears close to the ground. There has to be collaborative participation in the system and existing linkages have to be leveraged to the fullest possible extent. A comprehensive solution can be worked out only by bringing together different stakeholders and participants.

How to expand and reach scale?

1. Map opportunities – Identify opportunities in the commodity supply chain/breadbaskets and design projects around them.
2. Implement projects – Identify key components of success from existing projects, scale up and replicate, map further opportunities for the sector/region
3. Capacity building and knowledge sharing – Integrate small farmers into the financial system, including working with producer organizations and leverage farmer capacity building in productivity & standards (e.g. finance investments for new technologies)
4. Leverage and replicate – Complement existing initiatives, apply lessons learned/best practices from projects and consider providing incentives (e.g. financing and/or risk sharing at initial stages to demonstrate sustainable new financing approaches/products)

Some important levers for Financial Institutions to increase agriculture lending are

• Loan product design
• Tools to identify and manage risks
• Delivery channels to reach small farmers
• Financial literacy – awareness and training

A recently held regional forum on agriculture finance in Zambia had participants from local banks, producer organizations, input suppliers, NGOs, international organizations, donors, and consulting firms. The participants were asked to point out one change each that, according to them, would bring about effective agri-lending. The 5 winning ideas that emerged were –

• Develop a system of private sector mechanized service providers in rural areas: lead farmer/entrepreneur leases equipment to provide services to surrounding small farmers
• Invest in irrigation systems—community-based , owned and managed
• Develop a franchise model of community based storage facilities, provide real time market information, potential input demand aggregation
• Create private sector led agri-lending training centers for bank staff and farmers
• System of profiling of producer groups on their governance, financial management and performance—profiles that can be used by banks for lending to them

 Like these ideas or have an idea to take agriculture finance to small farmers? Voice your thoughts, we want to hear it.