Union Budget 2018: A Fair Contract For The Farmer
The Draft Model Act for contract farming presupposes that the farmer is the weaker party and is counterproductive.
Much grain has been sold through the mandis since the time I wrote on agricultural marketing for BloombergQuint, and many words have been spoken on the policy reforms. Let’s take a quick stock of the current status:
In the preface of the 2017 Model Agricultural Produce and Livestock Marketing Act, Ashok Dalwai, chairman of the committee that drafted the Model Act, hoped “…that all the States and Union Territories would embark upon the process of legislating their respective Acts based on the Model Act as early as possible. They would be free to adopt needed changes to suit the local variations, while all the time ensuring that the spirit of competition is encouraged and the principle of ‘Farmer First’ is kept in mind.” One hasn’t seen much enthusiasm on the part of states. Maybe, it’s high time NITI Aayog updated and marketed its Agricultural Marketing and Farmer Friendly Reforms Index (AMFFRI) with some high decibel campaign.
The other long-pending demand was for commodity options to manage the price risk inherent in agriculture. Things moved fast once commodity derivatives were brought under the Securities and Exchange Board of India. The Securities Contracts Regulation Act was amended to permit commodity options, and in the first instance, SEBI allowed one commodity option per exchange on a pilot basis. Earlier this month, NCDEX rolled out options in guar seed. Hopefully, the exchange and the regulator put in place sufficient checks and balances and manage this contract well, building confidence to add more mainstream commodities soon.
Simultaneously, efforts must be made to integrate spot and derivative markets in a manner that both of them serve their respective purposes while reinforcing each other.
Spot markets enable discovery of a relevant customer for every quality of a product, while managing value. On the other hand, derivative markets facilitate price discovery and risk management for standardised products. It’s important to educate spot market participants on the basis risk involved (when the value of the contract or hedge does not move in line with that of the underlying exposure), when derivative markets are used to hedge price risk. It’s also important for market participants to learn how futures and options can be embedded in bilateral spot market transactions so that price risk can be off-loaded to the larger marketplace. Otherwise, it remains a zero-sum game between a buyer and a seller. This is also the best way to make contract farming work, because both farmer and sponsor hedge, making use of futures or options, and neither of them gain by reneging on contracts when prices go up or down.
Talking of contract farming, the Draft Model Act for contract farming released recently for stakeholder consultation appears to be a counterproductive step, unless the draft is modified substantially.
Contract farming works best when a sponsoring company is seeking specialised produce of certain quality or specification, which is not easily available in sufficient quantity in the open market.
For these specialised products, the involvement of a sponsoring company in the farming activity is quite high, wherein they typically provide seed, inputs, agronomy support and have a team on the ground to help farmers. The farmer puts in a special effort to follow recommended practices, assume production risk, and make sure that the desired quality of output is produced. This is what gets the farmer a better price and the sponsoring company a value-added business opportunity. Unless the ownership is taken by both sides, a true win-win scenario will not flourish.
This is not a correct assumption, as no company can operate in an area where farmers are, as a group, not happy. Existing contract farming arrangements have been doing quite well without any external interference, with very few instances of companies and farmers being put to loss. The Model Act should be a promoting and facilitating Act as is intended, and should not end up as a regulating Act, scaring even existing players away.
Normally, contract farming does not work when either party is looking to fetch a better price without any product differentiation. This is where derivative market integration can help, with each party trying to get the best price from the market instead of from each other.
The farmer can sell on the futures market when he or she thinks the price is highest, while the sponsoring company can buy on the futures market when it thinks the price is lowest. Both get their best deals without taking it from the other. On the other hand, options work like a minimum support price for the farmer; the sponsoring company can offer the same without any risk, having bought it on the options market for a premium.
In fact, in the current context of Indian agriculture, it’s not just a farmer and a processor that should work together — through contracts or otherwise — but government should pitch in too, even at an operating level. The Government of Andhra Pradesh made a creative use of the Government of India’s PPPIAD scheme, by seeking ‘geography and product specific’ proposals from farmers groups, industry (food processors, retailers, agri businesses), new startups, NGOs and others. These proposals were to outline proposed interventions that would raise farmer incomes, as also enable commercially relevant backward integration for industry. The proposals spell out outcomes for farmers, investments committed by them (farmers and industry) as well as support expected from the government (e.g. reforms, enabling investments in building public infrastructure, community assets, farmer capacity building). An empowered committee set up by the state government evaluates the proposals and approves (duly modified, if required), and much like a venture capitalist, commits disbursement of funds as per the project implementation milestones. All other states could emulate this approach.
On the food processing front, another important way value can be added to agricultural produce and improve farmer incomes, I can only repeat the two points I had made in my last article. That is, working towards raising the consumer awareness about the hygienically processed and packaged food, and keeping the taxes low to raise consumption of processed food.
Meanwhile, we are all ears for the Finance Minister’s speech on Feb. 1.
S Sivakumar is Chief Executive – Agri Businesses, at ITC.
The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.