Developments in Agricultural Marketing in India

Indian agriculture had undergone phenomenal transformation in the last five or six decades. The metamorphosis was not only brought about by technological changes such as the green revolution but also by institutional innovation in delivering the farm inputs and marketing of output. The agricultural marketing system is a link between the farm and non-farm sectors. The marketing of agricultural commodities is different from the marketing of manufactured goods. Agricultural output is characterized by seasonality, perishability, and variability (of quality). Further they are bulky and hence costly and difficult to handle especially while storing and transporting. Weather and biological nature of the crop play a crucial role in determining the quantity and quality of the output. The output comes from many small farmers operating independently. Therefore, farmers are price takers and cannot influence the market price. This disadvantage resulted in unfair trade practices and exploitation of the farmers by trade.

In order to ensure a fair deal to the farmers government stepped in several ways. Announcing minimum support price for several commodities, monitoring and controlling movement of agricultural products, setting up of regulated markets etc are some of the interventions to streamline agricultural marketing. Regulation of primary markets was an important institutional innovation. Construction of well-laid out market yards and sub yards was considered essential for effective implementation of the regulation programme. The markets were administered by a committee consisting of representatives of all stake holders such as farmers, traders, local elected members, government officials etc. It was made mandatory that all the agricultural produce must be traded in the regulated markets. There are 7161 (2364 main yards and 4807 subyards) Agricultural Produce Marketing Committees known as APMC or simply mandies functioning in the country.

Despite enormous progress in improving the infrastructure for marketing agricultural produce there were several problems persisting in the system. Regulated markets provided only physical and regulatory facilities, real benefits would accrue only when the price determination process is strengthened.  The licensed traders in the market colluded in determining the price. Instead of fair price and transparency a kind of oligopsony emerged. Further, the emergence of value added processors who emerged in the 90s felt the system increased the cost of the supply chain due to various intermediaries as processors under the law could not directly procure from the farmers. Global Trade requirement such as the SPS measure and Agreement on TBT have necessitated a review of existing standards for different commodities in order to harmonize them with International Standards.

Considering the emerging needs it was felt that agricultural marketing reforms were necessary so an inter ministerial task force was formed for the purpose. In June 2002, the inter-ministerial task force on Agricultural Marketing Reforms made major recommendations related to the amendment to the State APMC Act for promotion of direct marketing and contract farming, development of agricultural markets in private and cooperative sectors, provide central assistance for the development of marketing infrastructure subject to such deregulation and reforms, progressive dismantling of controls and regulations under the Essentials Commodities Act to remove all restrictions on production, supply storage and movement of commodities and trade and commerce in all farm commodities, stepping up of pledge financing, expansion of future trading to cover all agricultural markets, introduction of negotiable warehouse receipt system and use of information technology to provide market led extension services to the farmers. The Central Government drafted a Model Act on Agricultural Marketing to guide the States in the implementation of the suggested norms which provided for the establishment of direct  purchase centers and farmers markets for direct sales to the consumers, complete transparency in the pricing system and payment to the farmers, public- private partnership for professional management of existing markets and setting up a Market Standards Bureau for promotion of standardization, grading and quality certification of produce. On January 2004, in the National Conference of State Ministers on Agricultural Marketing and Land reforms all State Governments agreed to adopt the Model Act on Agricultural Marketing in their respective States. Almost all states have amended their APMC act more or less in line with the model act. However, some states have not adopted some of the provisions.

Farmers Market

In order to bring the farmer producer and the urban consumers together farmers’ market in various parts of the country was started especially for fruits and vegetables. They were known by various names in different parts of the country. It was called apni mandi in Punjab, ryotu bazaar in Andhra Pradesh, uzhavar sandhai in Tamilnadu.

Contract Farming

There are several intermediaries between the processing firm and the farmer. They contribute to the overall inefficiency in the system. It is estimated that there are six to seven intermediaries in fruits and vegetable marketing in India. On the other hand, the emergence of niche markets for agricultural commodities due to increased income forced many agribusiness firms to find new ways of procuring the commodities for their requirement. Contract farming is one such method wherein the company directly procures from the farmers the required quantity with specified quality at a pre-negotiated price. Though the production risk remains with farmer market risk is transferred to the purchaser. Several companies are procuring their raw materials such as gherkin, potato, safflower, marigold, basmati rice etc through contract farming.

Producers' Company

The Company Act 1956 (The Act) recognised only three types of companies namely companies limited by shares (subdivided into public limited and private limited companies), companies limited by guarantees and unlimited companies. With the coming into force on February 6 of the Companies (Amendment) Act 2002 (1 of 2003), a fourth category producers companies, finds a place in the Act. The legislation enables (a) incorporation of cooperatives as companies and conversion of existing cooperatives into companies (b) to ensure that the proposed legislation accommodated the unique elements of cooperative business with a regulatory framework similar to that of companies. The members have necessarily to be primary producer that is persons engaged in an activity connected with, or related to primary produce. This enables the farmers to reap the economies scale as well as increase the bargaining power vis a vis the market. Since the amendment scores of producers companies have been established in different parts of the country covering a host of commodities ranging from agriculture and plantation crops to handicrafts. However, the efforts were largely handheld by the NGOs and there are only a few which emerged on their own.

Futures Market

The future market which was banned in India in the 1960s as it was feared that they lead to speculation and unwarranted price rise in agricultural commodities. Future markets in many countries have helped to smoothen price volatility and thus led to price discovery. In India, in the past decade future markets on several commodities were revived.

Futures market is a marketplace in which futures contract are traded. In simple terms, a future contract is an agreement to either buy or sell a given commodity at some specified time in the future. Future contracts exist for various agricultural commodities. There are 5 National Exchanges –NCDEX, MCX (both in Mumbai), NMCE and Ahmedabad Commodity Exchange (ACE) (Ahmedabad) Indian Commodity Exchange Gurgaon besides 21 Regional Exchanges in different parts of the country.

Electronic Spot

An electronic spot exchange called SNX was promoted by Mother Dairy Foods Processing Limited (MDFPL)—(a subsidiary of National Dairy Development Board of India), Multi Commodity Exchange (MCX) and Financial Technologies Limited. SNX was an electronic spot market for fruits and vegetables in an exchange format. It is a seamless spot market with national reach (buyers and sellers from any part of the country can participate) to enable transparent price discovery and delivery of fruits and vegetables in the country. The SNX attempts to make the market for agriculture produce perfectly competitive where large number of traders from various parts of the country can participate in the bidding through electronic trading platform and no single individual or group can influence the price thus resulting in better price discovery. However, after initial round of trading in mangoes and bananas in 2007 and 2008 the attempt was given up.

On the other hand, NCDEX started a spot exchange called NSPOT. NCDEX e Markets Limited (formerly known as NCDEX Spot Exchange Ltd) is the leading National Spot Exchange in India. It offers trading platforms for agricultural commodities to various market participants, primary producers including farmers, traders, processors etc. These trading platforms combine technological efficiency and market friendly trading features in a transparent atmosphere. Currently it provides trading facilities for chana and sugar and imported pulses.

Terminal Markets

In order to bring the producer and consumer closer and bypass the middlemen as far as possible the terminal market concept was conceived. It is being implemented under the National Horticultural Mission.

The main objective of the terminal market is to link the farmers to markets by shortening the supply chain of perishables and enhance their efficiency and thus increase farmers’ income. It also aims to bring transparency in the market transactions and price fixation for agricultural produce. The terminal market with ultra modern facilities would be located near major urban centres in the country. These markets would be serviced by a number of collection centres (spokes) established in key production areas. The collection centres would get the supply from individual farmers or farmers association at the village or block level. Eight terminal market complexes for perishables at Nagpur, Nashik, Bhopal, Kolkata, Patna, Rai, Chandigarh and Mumbai were to be established by 2006-07. Although the detailed project report has been prepared for several terminal markets such as Chandigarh, Mumbai, Sambalpur, Ahmedabad, Surat the response for the bid was lukewarm. Even the terminal market SAFAL in Bangalore promoted by NDDB is not getting the necessary produce to be traded.

Use of ICT (E-Choupal)

There are ways of by passing the middlemen and deal directly with the farmers using technology. One such exercise is undertaken by the Indian Tobacco Company (ITC) for procurement of agricultural commodities through e-choupal using information technology. Central to the e-choupal procurement is a computer with Internet facility at the village level giving the farmers the needed information about the market. This enables the farmer to make an informed decision about when to sell, where and at what price giving him a sense of empowerment rather than be at the mercy of the traders in the mandi.

Private Sector Initiatives

Apart ITC other private agribusiness firms developed their own model for procuring agricultural commodities.

Mahindra Shubhlabh 

Mahindra Shubhlabh Services Limited (MSSL) was established in the year 2000 for selling inputs as well as purchasing output.  MSSL’s operations are now restricted to the fruits and vegetables (F&V) segment. The operations of this segment were initiated in 2005 with the export of grapes to Europe and UK, and domestic business was initiated in 2009. Currently, the product basket of the company includes exports of grapes and pomegranates, and sale of apples, oranges and pears in the domestic market. In November 2013, MSSL launched its fresh fruit brand, Saboro, for the health conscious Indian consumer offering a wide range of fresh fruit.

In April 2014, Mahindra ShubhLabh Services Ltd. signed a joint venture agreement with UNIVEG, a Belgium based Euro 3.2 billion Fresh Produce Company. The JV will also focus on the modernisation of the domestic fruit supply chain in order to respond to the demand for high quality produce. It will focus on improving ripening, packaging, & storage processes to offer better fresh produce.

Hariyali Kisaan Bazaar

Hariyali Kisaan Bazaar was started by DCM Shriram Group in 2002. The idea which began in providing quality input to the farmers developed into purchasing output from the farmers as well as selling consumer durables and FMCG.  Hariyali Kisaan Bazaar was one-stop solution for farmers and nearly 300 outlets were operating. However, it had come down to 37 outlets and these outlets are only selling diesel and petrol.  The concept of rural organized retail seems to be ahead of its times. As HKB was cash only outlets they were unable to sell enough of agri inputs as well as other goods. The procurement of wheat, potatoes to supply processors was not enough to run the outlets profitably.

Organised retail

With the emergence of organized retail in the country, procurement of fruits and vegetables by them directly from the farmers also emerged. Many retailers such as Reliance Fresh, Namdhari Fresh, Spencers etc as well as wholesalers such as Metro Cash and Carry started their own collection centres. The price at which the fruits and vegetables are to be procured in a particular day is communicated to their contact farmers mostly through SMS. If the price is right the farmers bring the produce to these centres where it is weighed and payment given as per quality specifications. From these collection centres the commodities are sent to different outlets of the retailers in the cities.

Collaboration between Processors and NGOs/CBOs,

There are instances where the processors engaged the NGOs or community based organsiations (CBOs) in organizing production and procurement of the required raw materials. The NGOs/CBOs acted as a conduit between the farmers and processors supplying seeds and other inputs and aggregating the output and supplying it to the processors. Although the arrangement between Pepsico and BASIX for procuring potatoes in Jharkahnd initiated in 2005 did not sustain after two rounds there are other processors looking at such opportunities.

NGOs and SHGs

There are several SHGs in different parts of the country involved in procuring agricultural commodities, process and market them. These are again overly relying on NGOs. For examples, Self Employed Women’s Association (SEWA) in Gujarat is promoting RUDI a Multi Trading Company. It is engaged in marketing spices and staples procured directly from the farmers, processed, packed and marketed by rural women. It engages the women Self Help Groups in all these activities. It not only created employment opportunities to rural women but also provided better price to the farmers. The company distributes its products in 14 districts of Gujarat.

Warehouse Receipt Finance

 Farmers have to resort to immediate post harvest sales as they have no holding capacity. They cannot hold on to the harvested crop as they need immediate cash to pay back the loans raised to cultivate the crop and as well as to meet their household expenses. Further, most of the farmers lack storage space with them. This twin handicaps prevent them from taking advantage of a better price that may prevail few months down the line. Warehouse receipts provide farmers with an instrument that allows them to manage their liquidity requirement by extending the selling well beyond the harvesting period. This helps in preventing the farmers from resorting to distress sales.

In order to ensure an efficient warehouse financing system the government of India had enacted the Warehouse Regulation and Development Act 2007. Under this act the warehousing development and regulatory authority would be established. (It has been established in 2010).  Many private players such as Adani Agri Logistics, Star Agri Warehouse and Collateral Management Ltd, Shubham Logistics, Ruchi Industries besides National Bulk Handling Corporation, National Collateral and Management Services. 

Warehouse Receipts Financing of Commodity Markets

Right from nationalization of banks and the emphasis on priority sector lending to financing self help groups through micro finance many innovations had taken place in agriculture and rural finance in India. However, the efforts mainly concentrated on production financing and neglected to a large extent the equally important marketing finance. A good marketing system facilitates easier financing and a good financing system improves efficiency in marketing. Warehouse receipt financing can help a great deal in bringing liquidity to marketing of agricultural goods.

Warehouse receipts are documents issued against the deposit of the commodities in the warehouses. When these receipts are backed by legal provisions to ensure quality and safety of the stocks stored they can be used as collateral. These receipts can be pledged to raise money, sold or transferred. Generally, farmers face two problems bulky cash flows at the time of harvest and non availability of intermediate finance. Lack of adequate post production financing impedes the ability of farmers to realize optimal prices for their crops. Warehouse receipt finance can play an important role in smoothening income for farmers by providing liquidity at times when cash flows dry out.

Agricultural Marketing and Finance

Farmers in India generally dispose of the crops immediately after harvest. Prices are normally low when the supply is high. Farmers have to resort to immediate post harvest sales as they have no holding capacity. They cannot hold on to the harvested crop as they need immediate cash to pay back the loans raised to cultivate the crop and as well as to meet their household expenses. Further, most of the farmers lack storage space with them. This twin handicaps prevent them from taking advantage of a better price that may prevail few months down the line. Warehouse receipts provide farmers with an instrument that allows them to manage their liquidity requirement by extending the selling well beyond the harvesting period. This helps in preventing the farmers from resorting to distress sales.

How does the warehouse receipt financing system operate? The warehouse receipt financing operate with some variations in different countries. However, it essentially has the following mechanics. After harvest the farmer deposits his crop in an accredited warehouse and receives a receipt of the stock stored. The warehouse promises secure and safe storage.  The warehouse will release the stock only on production of the receipt. The farmer then can approach a bank to raise a loan by pledging the warehouse receipt. The bank gives the loan based on the current market valuation of the crop. Usually it will lend upto a certain percentage of the value of the crop deposited, for example, may be upto 70 percent. The period of the loan is related to the annual price pattern the borrower is required to repay before the time when prices normally pass their seasonal peak. The bank places a lien on the commodity so that it cannot be sold without the proceeds first going to repay the loan outstanding.

Farmer can in consultation with the bank sell the stocks when the prices are favourable and payback the loan with interest. The farmer instead of taking out the physical stock to sell simply hands over the receipt to the trader or processor who made the purchase. The buyer can take delivery of the commodity by paying storage fees loan principal and interest are deducted before delivery is made. The lender/ bank can dispose of the commodity/pledged goods only if the borrower defaults on the loan. Otherwise, the title and any changes in the value of the deposited commodity belong to the depositor/borrower.

 As it is clear from the above description there are three parties involved in the process. a) the borrower i.e. the farmer who uses the produce as a security for a loan. b) the bank which treats the produce as collateral. The bank has several advantages in lending this way. Warehouse receipts’ liquidity is much higher than conventional collateral such as land and machinery which are difficult to enforce hence, provides banks and financiers with the comfort to lend to the farmer without lengthy documentation and long processing delays.  c) the warehouse operator who maintains the produce in good condition and assures the bank that the collateral is secure. Apart from collecting the rent for storage the warehouse owner collects insurance fee to guard against fire or unusual weather conditions to offset any loses in terms of quality and quantity of stored commodities. So, empowering farmers to hold on to the produce would need three enablers i) accredited warehouses in the vicinity ii) commercially acceptable grading and assaying standards and iii) ease of raising liquidity against commodities stored in the warehouses.

The farmers can also use future trading for the purpose. Here, the farmers can book a short (sell) contract in the commodity exchange for a future price. The collateral management companies such as National Collateral Management Limited have accredited warehouses which are electronically connected to the central hub which enables the stock position to be updated on real time. The collateral management company issues a dematerialized (demat) warehouse receipt to the farmer through the warehouse where he has deposited his crop. The farmer then approaches a bank for loan against the electronic warehouse receipt. The collateral management company will electronically update all information of the warehouses to the bank, this will also decrease the  risk attached to the loan issued against the pledged warehouse receipt

As it is clear from above description the warehouse receipt is the instrument which is pledged /traded in lieu of the fundamental assets. Warehouse receipts are functionally equivalent to stored commodities. As the whole transaction takes place without the physical verification of the stocks by the bank or the processor the assurance about the quality and quantity of the goods mentioned in the warehouse receipt is of at most importance to the entire process of making the warehouse receipt negotiable. The integrity of the warehouses needs to be ensured by licensing or accreditation to carry out the activity. The rights, liabilities and duties for each party to a warehouse receipt (producer, bank warehouse etc) must be clearly defined. Ideally, the receipt should be freely transferable by delivery and endorsement. Holders of receipts must have the right to receive stored goods or their fungible equivalent if the warehouse defaults or its business is liquidated and the lender should be able to determine before granting the loan if there is a competing claim.

Warehouse Receipts in India

In India, Agricultural Produce (Development & Warehousing) Act, 1956 was enacted, later   repealed and replaced by Warehousing Corporations Act, 1962. Central & State Warehousing Corporations were established under this act. Private sector initiative on warehousing was limited.  Warehouse receipts were issued by a warehouseman to any person depositing goods in the warehouse. The licensed warehouseman was authorized to issue a negotiable or a non negotiable warehouse receipt. Banks did have a facility for lending against commodities. However, this potential has never been realized in the Indian context as lending against commodities was considered to be risky. Further, the banks were not internally equipped to evaluate the goods stored in the warehouse and was uncertain of the quantity and quality of the goods lodged therein.

The Warehousing receipts in vogue did not enjoy the fiduciary trust of depositors and banks. There was fear of not being able to recover the loans in events, such as fraud, or mis-management on behalf of the warehouse or insolvency. The available legal remedies were also time consuming and inadequate. Further, the format of warehouse receipts used in the country was not uniform. Hence, there were impediments in the negotiability of warehouse receipts creating difficulties to the farmers and other depositors of goods.

In order to ensure an efficient warehouse financing system the government of India had enacted the Warehouse Regulation and Development Act 2007. Under this act the warehousing development and regulatory authority would be established. (It has been established in 2010).  The authority is in charge of certifying or registration of warehouses, renews, modify, withdraw, suspend or cancel such registrations. The authority will regulate the registration and functioning of accreditation agencies who grant accreditation to warehouses. It will regulate the process of pledge, creation of charges and enforcement in respect of goods deposited with the warehouse. Specify the duties and responsibilities of the warehouse. WDRA can regulate the rates, terms and conditions that are offered by the warehousemen. It ensures a fair dispute settlement between warehouses and warehouse receipt holders. Ensure minimum percentage of space for storage of agricultural commodities in a registered warehouse. Further, the grades and standards to be followed for different crops that are to be stored are specified in the act. In short, the act has put in place proper measures to ensure the negotiability of the warehouse receipts.

Can Farmers Really Participate in Futures Market?

Can Farmers Really Participate in Futures Market?

Risk and uncertainty are integral to the production environment of agriculture because the quality and the quantity of output that results from a given set of inputs are generally not known. Since agriculture is prone to events beyond the control of the farmers such as weather, insects and diseases the production or yield risk is high. Price uncertainty is also a normal feature of farming. Agricultural operations are biological in nature hence, there is a considerable time lag between sowing and harvest. However, production decisions have to be made well in advance of realizing the final product. Market prices are not known at the time these decisions have to be made. The consequence of incorrect anticipation can be potentially ruinous to the farmer.

Some risk management strategies such as crop diversification reduce the risk with in the farm’s operation. Crop insurance scheme is one way to protect against production loses. Contract farming offers the opportunity for the farmers to transfer the market risk or price risk to the buyer. Risk management is not a matter of minimizing risk but of determining how much risk a farmer can take given the alternatives and preferable tradeoffs. Mnimum Support Price (MSP) programme by the government is one of the ways by which Indian farmers are protected against market volatility. However, price support programme is only available for major crops not all crops are covered

Future trading is another way through which farmers can have insulation against price volatility. It is an institutional mechanism to trade risk. A primary use of futures contract involves shifting risk say, from a farmer who desires less risk (the hedger) to a party who is willing to accept the risk in exchange for an expected profit. However, it is not easy for the farmer leave alone the Indian farmer to participate in the future trading given the knowledge, infrastructure and the size specifications in the contract.

Future Contract

A future contract is an agreement priced and entered on an exchange to trade at a specified future time a commodity or other asset with specified attributes. To make trading possible the exchange specifies certain standardized features they include the quantity to be delivered, delivery month, delivery location, acceptable quality or grades of the commodity. It is important that future contracts are standardized because it enables the traders to focus on one variable namely price.  Standardization makes it possible for traders anywhere to trade in these markets and know exactly what they are trading.

There are a number of ways future contracts can be used in marketing agricultural commodities. Future contracts can be a temporary substitute for an intended transaction in the cash market that will occur at a later date. This is called hedging. Hedging is buying and selling futures contracts as a protection against unfavourable price changes. A short or selling hedge is used when the farmer plans to sell a commodity at some future date that is the farmer is concerned that the price may fall at that time in the spot market.  A long or buying hedge is used when the farmer plan to buy a commodity at a future date as he expects the price might increase at that date in the spot market.

Future trading

We will try to understand the mechanics of hedging by an example of a hypothetical farmer in Punjab growing potato and trading it on the Multi Commodity Exchange of India (MCX) platform. The farmer can sell a potato future contract on the MCX platform for delivery of a standard quality and quantity of potatoes in the month they would be sent to the market, if the crop is sown in October the farmer can sell them for a price that would be prevailing at the time of harvest i.e. in the month of February. If after having sold a futures contract potato prices fall on the physical market below the level at which he sold on the futures he can either deliver the potato against his contract or because the contract is standardized close out his position by buying out an equal number of futures contracts. The prices of futures contract might have fallen as the physical prices decline to reflect the value of potatoes delivered to the market. The difference between the price at which he sold and the price at which he purchased is the benefit the farmer got by trading in the futures.

Suppose our farmer in Punjab plants 5 acres of potatoes in October with an expected production of 30 metric tonnes. At the time the February price of potato the farmer guesses would be say Rs 350 per quintal. The farmer feels that he can earn a reasonable profit at that price. Since farmers have no control over price, by sowing potato the farmer is essentially betting that the price of potato will not decrease between the planting and harvest time. He can hedge this bet by selling in the futures at the current futures price quoted which is Rs 350 per quintal. Since the contract specification at MCX is for 30 MT and the farmer expected a production of 30 MT from his 5 acres he would sell one future contract.

The initial margin for a hedger and the maintenance margin on the contract are 6 percent as per the contract. The farmer would need to deposit at least Rs 6300 with a clearing organization to cover the margin for the contract sold. Everyday the contact would be marked to the market that is if the market moves in farmer’s favour (future prices declines) on a particular day the farmer’s margin account would be credited with the accrued profit of that day. On the other hand, if the future price rises the margin would be debited with the accrued losses. In case at any time the margin account falls below Rs 6300 the farmer would be required to deposit additional amount to bring back the account to Rs 6300. This process goes on let us say till the crop is harvested. The farmer got 30 MT he expected and the crop in general had been good as it is a normal year (that is other potato farmers also got good yield) hence the price had declined to say Rs 300 per quintal. The farmer has 30 MT of potatoes with him and he has sold 30 MT at the futures market. Now the farmer can unwind his position in two ways. One is to make delivery as per the terms of contract. In this case delivery location is the cold storages in Agra. This means the farmer has to incur transportation cost from his village in Punjab to Agra. This would be prohibitively costly.

However, most of the futures contracts are liquidated by squaring off the position rather than delivery as the mechanism to deliver may be inconvenient to the farmer. The farmer in our example can take an equal and opposite position in the futures market by buying one contract at the current price of Rs 300 per quintal. The farmer’s margin account increased by Rs 15,000 (Rs 50 per quintal x 300quital or 30 MT). The future trade has given the farmer a profit of Rs 50 per quintal. The farmer can sell the potato he has harvested at the nearby mandi at the spot price of Rs 300 per quintal. Considering that the farmer had received Rs 350 per quintal in the futures market even though he sold the potato for Rs 300 per quintal in the spot market he had effectively received Rs 350 per quintal for his crop.  

On the other hand, if the price of potato rises to Rs 400 per quintal the farmer will lose Rs 50 per quintal on the future but will be able to sell the potato at Rs 400 per quintal in the spot market. Thus the effective price he receives would be Rs 350 per quintal. This does not mean the hedge was not successful. Sometime the price goes up and sometimes down with hedging, however, farmer will be at least aware of his returns despite the volatility in price.

    

Farmers and Future Trading

Theoretically it is possible as described above for the farmer to hedge against price risk using futures contract. However, farmers’ participation in futures market even in advanced economies is low. This is mainly because of “lack of know how, lack of collateral for margins, small scale of operations and too cumbersome to execute, monitor and administer hedging transactions by small producers” Let us examine the factors that hinder the farmers in participating in the future trading.

Membership Fee

To participate in future trading it is necessary that one become the member of the commodity exchanges or trade through members. The cost to become a member is very very high (Table 1).  The admission fee alone in MCX is Rs 5 lakhs and 10 lakhs for the two categories of members whereas it is Rs 15 and 25 lakhs in NCDEX. Besides, there are annual fee, maintenance charges, VSAT cost etc, Therefore, farmer had to go through the firms or individuals who are already members to take part in the trade. This involves commission to be paid to the firm. The larger the traded volume the commission would be proportionately lower but in case of the farmer who is not a speculator the trading volume would be low dictated by his land size and expected yield. Therefore, the cost would be high for him.

Marked to Market Margin

Commodity exchanges require its members to deposit and maintain in their accounts a certain minimum amount of funds for each open position held. These funds are known as margin and represent a good faith deposit that strives to provide protection against losses in the market. The clearing house collects margins directly from the members of the exchange who in turn are responsible for the collection of funds from their clients. Therefore, the farmer had to maintain a deposit of the amount as specified in the contract with his firm for each of his position. As the margin is marked to the market that is daily fluctuation in the price is calculated and adjusted to the account the farmer had to deposit additional money whenever such situation arises.

Technology

The commodity is traded on line so there are a large number of buyers and sellers (sort of perfect competition) and no individual influences the price. This helps in correct price discovery -- one of the major roles of the commodity exchanges. For the farmer to track the prices and take part in trading he must not only have some preliminary understanding of the computers and internet but also have access to them nearby his village. No need to emphasis the point on computer literacy and rural connectivity to highlight the handicap farmers faces to really participate in trading in futures market.

Lot Size and Delivery

The exchange specifies the lot size for each contract for different commodities (Table 2).  If the farmer is not delivering the commodity at the end of the contract period but decides to square off the position as the potato farmer in our example lot size may not be an issue for the farmer. However, in case the farmer decides to deliver, say a potato farmer near Agra takes a futures contract to hedge against the risk and at the end of the contract period he may wish to deliver at the designated cold storage then lot size is going to be a deterrent for the farmer to participate in the trade. In case, crop production is affected due the vagaries of the weather, pest or disease and is lost the farmer had to buy the crop and deliver it to the designated cold storage. The contract also specifies the quality of the commodity to be delivered therefore it is the responsibility of the farmer to ensure the quality of his crop to meet the specification mentioned in the contract. There are costs involved for assaying the quality which has to be borne by the farmer.

 Role for an Aggregator

In order for future trading to be really used as a risk management tool for the benefit of the farmers it is often suggested to have an aggregator. These aggregators can pool the requirement of the farmers and canalize them in exchange platform. For this the aggregator has to be a neutral player who does not have any trading interest but earns a fee from such transactions. It could be a producer’s cooperative, an NGO or farmers’ association. The key issue in making available hedging instrument to farmers especially small farmers would necessarily mean building institutions that will allow retailing of risk management instruments to them. In other words, there needs to be institutional arrangements so a large entity can pool risk from many small farmers and hedge them. The Task Force on Plantations in its submitted report to the Government of India recommended forming of cooperatives by small growers to trade in futures. The proposed system would allow the aggregation of price risks of these producers.

Constraints for an Aggregator

Though there is role for an aggregator there may be several constraints that might confront it to effectively pool the requirements of the farmers and manage the risk at the exchange platform. Let us take a scenario where 25 farmers with an average holding of 6 acres coming together to form a cooperative or association to act as an aggregator for the purpose of hedging against price risk  Let us assume the farmers are taking two crops in a year- basmati rice and potato. The production is say 105 tonnes of basmati rice with the yield of 7 quintals per acre and 900 tonnes of potato with a yield of 6 quintals per acre from the 150 acres owned by the farmer members. The cooperative must first open a trading account with a firm (brokerage) having a membership in the exchange, as is evident from Table 1 it would be very costly even for a cooperative.  The lot size of the futures in rice is 10 MT per contract. The cooperative can enter into future for 10 contracts of rice and assuming that the price is Rs 1200 per quintal the value for 100 tonnes is Rs 12,00,000 at 8 percent initial margin (as per the contract specification of the exchange)  the cooperative need to deposit Rs 96,000 with the firm. The expected production of potato from the 150 acres of the members is 900 tonnes. The cooperative can trade in 30 contracts at the rate of 30 MT per contract. Assuming a price of Rs 350 per quintal the 30 contracts value would be Rs 31, 50,000 and the cooperative at 6 percent initial margin needs to deposit Rs 1, 89,000 with the firm. For the two crops the initial margin worked out to be Rs 2, 85,000 and for each farmer it is Rs 11,400. This seems to be a reasonable amount. As the cooperative also need to maintain the marked to market margin farmers must be in a position to pay the additional sum required as and when required.

The co-operative need to invest in infrastructure facilities such as computer with VSAT connection with UPS power back up to operate in the village. This is technically feasible as demonstrated by the ITC’s e choupal initiative. However, considering the size of the farm and the volume traded it may not be financially viable for the members to invest on the facility.

Before trading at the beginning of each crop season the members should work out the cost of cultivation and arrive at a consensus on the expected returns to enable the cooperative to lock in on an agreed price in the future. In case the price falls in the spot market member farmers would be happy. The cooperative would buy equal number of contracts to close or square off the position. The accrued differential that is between the spot price and the futures is credited to the cooperatives trading account. The cooperative then distributes the amount in proportion to the land holding and yield. The farmers sell their harvest in the spot market at the declined price but as they got the accrued amount from the cooperative due to the hedging operation they would be getting effectively the original price at which they agreed to lock in. In case the price rises in the spot market and the society by buying squares off the position, now the resultant loss should be paid by the cooperative and the farmers are expected to pay in proportion to their land holding and yield. Let us take the example of potato we used for the single farmer. If the locked in price is Rs 350 per quintal and the current price is Rs 400. The society by squaring off incurs a loss of Rs 50 per quintal and had to pay the exchange Rs 4,50,000. The member farmers sell their potato at Rs 400 per quintal and are expected to pay the society Rs 50 per quintal to pay off the exchange. This is difficult to achieve as members may not pay the society. They may under state the yield to pay less to the society and over state the yield if they had to get the accrued benefits of hedging. With the kind of cooperative spirit and few success stories it would not be pragmatic to think cooperatives or farmer’s association can successfully play the role of an aggregator for a long period on a sustainable basis.  “Hedgers must have a mindset that says I got what I expected therefore I am satisfied even when they could have done better without hedging or a fellow farmer gets a better price.” It would be hard to expect an individual farmer in a cooperative setting to have such a mind set.

In case the cooperative follows the delivery model the quality specification as defined in the contract would be difficult to maintain across the 25 farmers. Further, apportioning the cost of assaying that is quality test among the members in proportion to their land holding or yield would not be easy. Objectively maintaining quality and rewarding the member had been a major weakness of the producers’ cooperatives in India. If the lot is rejected on quality grounds the member may accuse the cooperative of bias. Further, it would be difficult for the cooperative to ensure the lot size if the farmer is not replacing his rejected lot by purchasing from outside or paying the cooperative to make good the shortfall from other sources. Similar situation might arise when there is a crop failure as the member farmer had to arrange for the crop with the quality specification mentioned in the contract to enable the society to fulfill its obligation with the exchange.

To sum up, it is theoretically possible for the farmer to manage price risk through future trading. However, in practice farmers even in advanced countries are not using futures to hedge against risk. In India apart from lack of technical knowhow, small size of holdings resulting in high transaction cost dissuade the farmers to trade in futures. The suggestion to have an aggregator who can pool the requirements of the farmers and trade in the exchange platform though seems an attractive proposition has its own set of constraints.  At best futures market may be helpful to farmers indirectly by way of better price discovery rather than for risk management.

Table 1 Membership Fee in the Two Major Commodity Exchanges (Amount in Rupees)

Deatails	MCX*		NCDEX
	Trading cum clearing member (deposit based)	Institution Clearing Member	Trading  cum clearing member	Professional Clearing Membership
Admission Fee	5,00,000	10,00,000	15,00,000	25,00,000
Interest Free Security Deposit	50,00,000	50,00,000	15,00,000	25,00,000
Processing Fee	10,000	10,000	5,00,000
Annual Subscription	50,000	50,000	--	1,00,000
Annual insurance fee	5,600	5,600	--	--
VSAT cost	1,65,000	1,65,000	--	--
Advance maintenance charges	--	--	50,000	1,00,000
Net worth requirement	--	--	5,00,00,000	5,00,00,000

* MCX has another category called trading cum clearing member (non deposit based) where the admission fee is 10 lakhs and the security deposit is 15lakhs

Source: www.mcxindia.com and www.ncdex.com

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A Critical Look at the Terminal Market Concept for Perishables

A Critical Look at the Terminal Market Concept for Perishables

The agricultural marketing system is a link between the farm and nonfarm sectors. The biological nature of the agricultural commodities and small farm nature of agriculture in the country had made the farmers price takers with little influence over the market price. APMC act in almost states were amended to include provision of direct marketing and contract farming, development of agricultural markets in private and cooperative sector.

With the increasing income there has been a considerable shift in favour of fresh fruits, vegetables, animal protein, milk etc in the Indian consumer basket. On the other hand, the organized retail is growing with the emphasis on cost reduction through supply chain efficiency. The existing supply chain for agricultural commodities is long and fragmented resulting in considerable wastages especially for fruits and vegetables. Hence the system was neither able to pass a fair share of consumer rupee to the producer nor was able to benefit the consumer with lower prices. With the launch of the National Horticultural Mission in 2005-06 it was expected that there would be a manifold increase in production of fruits and vegetables. The expected increase in production could be sustained only when there is adequate infrastructure to handle post harvest management and marketing of these crops. With this background, the scheme of terminal market complex was conceptualized and being implemented.

The terminal market would operate in a hub and spoke model. The terminal market would be the hub linked to a number of collection centres called spokes. With the amendment of the APMC act greater private sector involvement was expected in setting up the terminal market complex.  

Terminal Market

The terminal market with ultra modern facilities would be located near major urban centres in the country. These markets would be serviced by a number of collection centres (spokes) established in key production areas. The collection centres would get the supply from individual farmers or farmers association at the village or block level. The farmers or their association can bypass the collection centres and supply directly to the terminal markets.

The market complex would contain all the necessary infrastructure. The electronic auctioning platform would help in quick, efficient and transparent process of the transactions. The processor, exporter, wholesaler, trader, retail chain can all be members of the exchange and participate in the auctioning. There are provisions for cold storage, warehouse facilities, ripening chambers at the complex. Necessary infrastructure for cleaning, grading, packing, pellatisation, quality testing etc would be part of the complex. The participants can avail these services on payment of user charges.  Besides, facilities for banking and transport etc would be provided. In short, all facilities for smooth transactions and better price realization would be created under one roof.

Collection Centres

The collection centres would be located at key production areas. The major function of the centre would be to aggregate the produce received from the registered farmers or their association and sent them to the terminal markets. These commodities would be washed, graded and sorted before sent to the terminal markets. These centres would receive the payment from the terminal market and settle it with the suppliers. The centres would collect and disseminate information on prices, quality requirement etc to the growers. There would be advisory services on agronomic practices such as inputs, their dosages etc.

Thus, the collection centres in production areas will integrate producers and retailers, processing units and exporters etc. into market system. The number of collection centres shall be determined in each case depending on the size of the market, distance from growing areas and other factors.

Functioning of the Terminal Markets

The commodities to be marketed by the TMC will include all perishables, inter-alia, fruits, vegetables, flowers, spices, aromatics, herbs, medicinal plants, meat products, poultry products, dairy products and fish and marine products etc. Non-perishables can also be handled in the TMC. However, the annual throughput for perishable horticultural produce such as fruits, vegetables, flowers, medicinal plants, aromatics, herbs etc handled by each TMC should not be less than 70% of the throughput capacity of the TMC.

The individual farmer or producer association brings the produce from the farms and villages. At the collection centres the commodities are washed, cleaned and graded. Poor quality is rejected and those which meet the quality specifications are made into a lot and sent to the terminal markets. The supplies coming from the collection centres are auctioned through the electronic trading platform. Since, the farmers are expected to get a fair return a floor price is fixed for the commodity below which the goods will not be sold. The unsold stock may be taken to the cold storages to be auctioned on a subsequent day. The payment from the successful bidder is collected on the same day and the stocks transferred to him. The purchaser may transfer the goods to some place outside the market complex or use the facilities at the market to store or further process the commodities. Only registered buyers are allowed to participate in the auction.  

In case the purchaser bids for smaller quantity in the lot, the lot will be broken and the remaining quantity would be auctioned again. In case of unsold stocks the terminal market through its forward linkages with institutional buyers or through its retail outlets would dispose off the commodity. For example the project report for the Chandigarh complex envisages apart from linkages with institutions like Army, Paramilitary, eating establishments it was expected that ten retail outlets would be opened in different parts of the country by the market operator to dispatch the produce.

Eight terminal market complexes for perishables at Nagpur, Nashik, Bhopal, Kolkata, Patna, Rai, Chandigarh and Mumbai were to be established. Although the detailed project report has been prepared for several terminal markets such as Chandigarh, Mumbai, Sambalpur, Ahmedabad, Surat etc by National Institute of Agricultural Marketing and other consultants the response for the bid was lukewarm. The government is considering increasing the subsidy component[1] to make the idea more attractive to the private players. There could be several reasons for low response to the concept. Some of the reasons could be flaws in the very design some of which we try to highlight below.

 

Issues in the Conception of TM

A market can be defined as a place where buyers and sellers meet in order to exchange products and values with others.  It is a place where the needs and wants of the consumer is expected to be met. However, the terminal market apart from providing a place and facilities for buyers and sellers to interact is also obliged to create forward linkages with the institutional buyers as well as set up own retail outlets. That is it is expected that the market operators also would indulge in buying and selling the commodities. There is no reason why a market operator would involve himself in trading activity. His primary aim would be to look for a fair return on his investment by providing the services or facilities in the complex rather than take additional risk of buying and onward marketing of the commodities.

For example, the project report on Chandigarh terminal market envisages setting up “Forward Link Team” which will find the daily prevailing rate in all important markets of India and find out the possibility of dispatching the produce. Further, the report expected the TMC to open retail outlets at Chandigarh and other parts of the country to sell the commodities coming to terminal markets. Further, an ambitious idea was proposed that is, to brand the commodities passing though the Chandigarh terminal.

So, it is clear that terminal markets are expected not merely to provide a platform but indulge in buying and selling of the commodities. This is unlikely because the buyers take part in market transaction to fulfill their particular need or want in exchange for some value terminal market operators are not in a position to do unless some promoters also have interest in organized retail, processing or export. Even then, it is unfair to expect that they will be able to clear whatever arrives in the market.

At the time of auctioning a floor price is fixed for the commodity. If the auction price is below the floor price the commodity will not be sold. The floor price is fixed in order to ensure a fair return to the farmers. In case, if the commodity is not sold what happens? If it is kept in cold storage for some time for the price to rise who will bear the cost?  If there is bumper harvest depressing the prices will the floor price be revised to the level which may not be remunerative to the farmer? Ideally market forces must be allowed to operate and the goods need to be cleared unless the specific producer or association request that the commodity should not be sold below a certain price and willing to hold in the cold storage at its own cost. The terminal markets operators should be kept away from such responsibilities.

At the collection centre the supply comes from different individual farmers from many villages either brought by the farmer himself or by the producer association. The commodities are graded and sorted since much of the quality parameters for fruits and vegetables are subjective it would not be possible to convince a farmer that his produce is second grade. The problem would be compounded if the price difference between the two grades is high or when the produce just marginally fails to make the higher grade. There will be accusation of bias, nepotism etc against the centres’ office bearers. Such situation had lead to collapse of many collective efforts in the country. This may well prove an Achilles heel in the terminal market in forming groups or association of farmers to ensure supply.

In the normal traditional market the farmer’s lot receive an average price irrespective of the percentage of different grades in the lot. Nothing is returned to him. In case of terminal market concept, at the collection centres after grading the residual is expected to be taken back by the farmer. Apart from the cost of transport the farmer has to find alternative ways to dispose of these residuals. Because of such hassles, farmers would prefer the traditional market to terminal markets.

Farmers in most part of the country sell the perishables especially fruits through forward contracts. That is just a month before harvest contractors take the orchards or plantation for a fixed amount. The farmer is not only saved from price volatility but also in having to arrange for labour to harvest small quantities and arrange for transport. As the harvesting season extends to a month or couple of months it makes eminent sense for the farmer to have such arrangements. It is therefore, not reasonable to expect them to form groups or associations and bring the produce to the market.

Further, the lots coming from the collection centres would be bigger. In case a bidder bids for a part of the lot it needs to be broken and the rest would be auctioned again. In case there are three different price realizations for the same lot how that would be distributed to the farmers. Will the realization would be pooled and divided proportionately according to the supply of a farmer or would they be treated separately. What would be the reaction of the farmers?

The farmers are expected to be paid immediately upon selling of his produce. The bidder is to deposit the amount immediately on purchase of the commodity. What would be the arrangement to transfer and how long that would take is not clear. However, it was mentioned in the guidelines to create a revolving fund to expedite the payment process. The question is who will contribute to this and why the operator of the market should take this additional responsibility.

The terminal market operator is responsible for establishing the collection centres that is identifying the location and getting the necessary clearances. They are to offer 26 percent stake in the terminal market to these collection centres. This is with the intention that the collection centre would continue to supply on a sustained basis if their interest is involved. Each terminal market would require substantial investment may be ranging from rupees 50 crore to 100 crores. Twenty six percent of this would be a huge amount to be raised from the farmer members at the collection centres. With no direct return at least in the initial years it would be a herculean task to mobilize the amount from the farmers.

These markets are to be located near major urban centres and a large area of prime land is to be allotted to the project. It would be tantalizing for the promoters to use major portion of the land for commercial establishment and less to marketing agricultural products. If proper mechanism is not put in place such a misuse cannot be prevented.

Therefore, more clarity is needed in various aspects of the proposed terminal market idea. The role of the promoter has to be made realistic in order to make the proposition attractive to the private investors.

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Agrarian Crisis in India: Is Corporate Farming a Solution?

The continuing crisis in Indian agriculture and the resulting distress driving some farmers to the extreme step of taking their own lives tugs the conscious of many. In their anguish they proffer many solutions. One such solution to consolidate the holdings and allow the corporate to own or lease in the land to take advantage of the scale by using better technology and linkages to market.

However, the corporate in India may join the “bleeding heart” politician and shed copious tears about the plight of the farmers but would not venture into corporate farming to alleviate their misery. Corporate entities would like to deal with the farmers either through current market mechanism or by way of contract farming as it confers them several advantages. The objective of any firm while procuring the raw materials is to get them in right quality and quantity and on time with least cost. So long as this objective is met through existing market mechanism there is no reason for the firm to look for alternative means of sourcing the raw materials. If the requirement of the firm is idiosyncratic in nature and there is market failure, that is the market is not able to supply the required material in time with least cost on a sustainable basis then the firm may try to have better control over supply. Still the firm would prefer contract farming over integrating backward into production to ensure adequate supply.

Independent family farms offer enormous advantage to the firms compared to corporate farming. Failure of crop due to vagaries of the monsoon, pest and diseases etc are inherent to agricultural operation. Under family farming these production risks remain with the farmers. Under corporate farming these risks would have to be borne by the firm. Variation in quality of output is normal in agriculture and could be minimized to some extent but cannot be eliminated. Under the family farming the firm pays only for the quantity of quality products supplied. That is, it pays for the products which meet quality parameters and rejects the rest whereas in corporate farming the cost has to be incurred for the entire produce by the firm.

Agriculture production is seasonal in nature. Farmers in many parts of the country produce two or more crops in a year in the given piece of land. By following crop rotation they try to optimize their land and other resources. However, under corporate farming especially for short term crops the land and other resources may be idle for better part of the year after a crop cycle adding to overheads thus adversely impacting the cost of production of the crop.

In the family farm, the farmer and his family are residual claimants to the income from the crops, that is, they get whatever is left after paying for the factors of production. However, in corporate farming they become part of factors of production and are entitled for wages and other benefits adding to the cost of production.

The crisis of the agrarian sector warrants much more serious analysis. A detailed mapping of the resources of each block in the country would give more insights into the problem and throw up probable solutions.  In some blocks farmers might be encouraged to take off farm activities and make farming part time in other places the potential for animal husbandry may have to be exploited and in yet another producers companies or cooperatives must be encouraged not to only to have better bargaining power but also to reap scale economics in procuring inputs and marketing outputs. Unless such an attempt is made the Procrustean idea of corporate farming for the agrarian crisis may make interesting reading nothing else.