Postcards of the Future- Farmers and Futures Market

The second in the series of ‘Postcards of the Future’ is how the current farmers’ ecosystem requires a systemic overhaul. The ideas in this post are borrowed from the podcast episodes from ‘The Seen and the Unseen’ and some readings on the aforementioned topic.(Links at the end of the post)

The recurrent problem with respect to agriculture has been not getting fair prices for the produce sold or not getting a fair buying price when the prices are too high. The shortage of warehousing space initiates this boom-bust cycle where in years where the production is high prices crash and then the next production cycle experiences a decline in output which leads to an increase in prices. In the paper by Anirudh Burman, Ila Patnaik, Shubho Roy and Ajay Shah on ‘Diagnosing and overcoming sustained food price volatility: Enabling a National Market for Food’, they called this to be the Samuelson Cobweb Model at play.

Fig 1: Historical Costs of Cotton, Soyabean and Wheat

The graph above indicates the boom bust cycle which approximately happens over a span of 3-4 years. It clearly exhibits the price volatility that exists and provides a strong reasoning to why the farm laws were passed. This boom-bust cycle is the primary reason why government interventions need to be reduced as we go ahead and why the market needs to correct itself so as to not only benefit the farmer but the nation as whole as well. The solutions that were mentioned in the various sources(links of which will be mentioned at the end of the post) are basically four fold,but the post will dive deeper into Futures Market.

The first solution proposed is an expansion in the warehousing capacity( the recently passed farm laws address the expansion of warehouses, as the primary reason private players refrain from building large warehouses is the limit w.r.t. the stock stored, and once the upper limit is no longer capped it solves the problem), which without private intervention is nearly impossible. A market based warehousing system is required which prevents price volatility, and entails an informed decision making with respect to which crops to sow, how much to invest in increasing the yield and what to store. Currently the farming landscape looks to the past and not towards the future while planning the production, and hence it becomes a market that reacts rather than strategizes. An economy that enables Futures Markets becomes quintessential for growth, which was the second proposed solution. They have existed in India for quite sometime but there have been hurdles with respect to how famers and private investors can participate in it.

One of the primary reasons for low involvement of farmers in the Futures Market is the lack of funds on the part of Farmer Producer Organization(FPO). Since FPO’s do not have enough funds to acquire the produce from the farmers and Banks do not consider their business model to be viable, farmers eventually move to middlemen or the Mandis. An additional financial burden which is faced by the farmers pushes them to take loans from money lenders who charge exorbitant rate of interest on the money borrowed. This then forces farmers who have borrowed money to sell their produce to these money lenders in order to payoff debt and hence it creates a vicious cycle. This also creates a extensive need for micro-financing so as to prevent financial exploitation of such forms.

Currently farmers cannot directly enter the Futures Market, it has to be done via FPO. Other than lack of funds creating a problem, it so often happens that the produce that is procured by FPO , does not always meet the quality specified by the commodities exchanges and it often leads to high rejection rates. This further makes FPO averse to procurement of such produce and trading often ends up entailing inputs such seeds, fertilizers, pesticides , etc. which can be carried forward as inventory if it doesn’t get sold entirely.

FPOs are also reluctant when it comes to pre-harvest hedging and believe that holding stock gives them a higher bargaining power. But since the crops have higher prices pre-harvest and their reluctance to lock in those prices ends up creating minimum profits for them as crop prices fall dramatically post harvest. As mentioned above farmers have to rely on FPOs but FPOs have to rely on brokers to access the exchange , which without the right incentives doesn’t end up to be rural areas.

There have been few examples of where Futures Market was successfully used by FPOs in price realization for the farmers. One of those being the Ram Rahim Producer Company in Madhya Pradesh. This was started in 2012 to cater to the Bagli Village of Dewas district and was done with the support of Samaj Pragati Sahayog, a water and livelihoods based organization. The objective was to undertake aggregation and marketing of their farm produce which included soyabean, chana, maize and wheat. They simultaneously wanted to break down the involvement of money lenders and other middlemen which exploit the farmers.

Though initially when they acquired the Bengal gram and were waiting to sell till the markets turned favorable, markets crashed. This highlighted that simply accumulation itself doesn’t result in higher bargaining power. The next season when they procured soyabean, obtained a hedging/trading account at NCDEX by becoming a client of a member. This time around the the enterprise was able to closely follow market developments and when prices reached an all-time peak May 2014, they were
able to hedge on the exchange and save themselves from the price fall post harvest. This essentially teaches the farmers to peer into the future for better prices and not look towards the past which will govern the current production cycle for price realizations. Over the years, the crop portfolio has diversified and they have moved towards pulses and maize , though maize didn’t see a variation in prices and hence didn’t prove to be as profitable. This happened because the price discovery of maize took place in a delivery center in Bihar, and hence it created a need to have delivery centers that were closer to them where price discovery of various crops could happen. The trade in soyabean turned to be profitable because of the delivery center being located in Indore. Increasing delivery centres regionally could make it possible to scale Futures market which would also help in breaking the middlemen system.

We are an economy where ~60% of the population is involved in farming but sees a mere ~16% contribution to the GDP. This gap creates room for opportunities and efficiencies and from the readings and the podcasts that I have listened to, they all point to farmers looking into the future along with crop diversification and an increase in exports.

References:

Readings:

1.https://www.livemint.com/opinion/online-views/opinion-how-can-india-become-an-agricultural-powerhouse-post-coronavirus-11591508334787.html

2.https://www.yourarticlelibrary.com/agriculture/how-future-trading-helps-in-improving-agriculture-production-in-india-explained/40240

3.https://www.mayin.org/ajayshah/MEDIA/2020/food_economic_freedom.html

Working Paper 383, Linking farmers to the future by Tirtha Chatterjee, Raghave Raghunathan, Ashok Gulati.

Podcast:

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