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Unleashing the Sleeping Giant - Contract farming

The agricultural value chain

Let’s assume you are a farmer who owns less than 2 hectares of land (among 85% farmers in India). Based on last year’s prices, you decide to sow potatoes. However, when your crop is ready after 3 months, you cannot sell to anyone you like. So, if you are among the lucky 40% who have access, you make your way to the nearest government-regulated mandi (Agricultural Produce Market Committee or APMC), the only one place you are legally allowed to sell your crop. You give your cleaned, sorted, and weighed product to the auctioneer who puts it on display on the market platform. APMC registered traders, interested in your product, gather around, and start bidding. The highest bidder eventually takes home your crop after you settle the transaction with the buyer. This buyer can then transport and sell it to food processors, retailers, or at APMCs in larger cities.

While the above narrative looks good on paper, APMCs are rent-seeking and monopsonistic in nature, prohibiting transparent price discovery, leading to the traders walking away with the lion's share and the farmers getting 25% of the price paid by the end consumer, at best. While the “front end” activities – including wholesaling, processing, logistics, and retailing – are rapidly evolving through the intervention of private enterprise, the “back end” activities of production have been continuously fragmenting. The government is trying to improve this linkage issue through 3 ordinances passed in June which we have covered earlier.

In today’s post, we will deep dive into ‘The Farmers' (Empowerment and Protection) Agreement on Price Assurance and Farm Services Ordinance, 2020’ which provides a legal basis to the practice of contract farming in India’s agriculture and allied sectors.

What used to happen until now?

It is not that contract farming is new to India or it did not have any legal backing. Under the Model APMC Act, 2003, contract farming was permitted and the APMCs were given the responsibility to record the contracts and mandated to resolve the disputes in such contracts. For this APMCs’ charged market fee and other levies, which varied from state to state. However, only 14 states have issued rules to govern contract farming. Only 15 companies have entered into contract farming for cotton and barley in Punjab, Haryana, MP, Gujarat, Maharashtra, Karnataka and Chhattisgarh. Reliance, Spencer’s, Subhiksha, More, Food Bazaar, Field Fresh, Pepsico, and Nijjer currently use this procurement model. Contract manufacturing has also seen limited success in seed and poultry farming. Informal contracts between industry and farmers are also quite common. A case in point is West Bengal, where many small and marginal farmers grow chips grade potatoes under contractual arrangements without written contracts.

Roadblocks to the adoption of the existing model are two-fold:

● There are apprehensions on the part of farmers to enter into contracts as they are not organized and are ill-equipped for any legal battle with corporates - Pepsi sued individual potato farmers in Gujarat for Rs 1.06 crores for patent infringement.

● Corporates are reluctant to enter into formal contracts with hundreds of farmers due to the huge transaction cost and contract uncertainty for crops with government-mandated minimum support price.

So, what’s new?

This is the first time in Indian history when national legislation for agricultural marketing has been created to streamline the first transaction between the farmer and the first buyer. This defies established policy understanding, going back to the Royal Commission of Agriculture in 1928, where these transactions were classified as state subjects because of the sheer diversity and complexity of local stakeholder controlled physical markets across India - in terms of land arrangements, crops planted, first trading relationships, tenurial arrangements, ecology and infrastructure.

The new ordinance has the following features:

● A farmer may enter into a written agreement that can specify terms and conditions of quality, grade, time of supply price and the extension services etc.

● The agreement could be for a period of one crop cycle to 5 years.

● The price or any variation of the same has to be part of the agreement. For any additional amount over the agreed price, the prevailing price in APMC/electronic portal etc. will be the benchmark.

● No state law will be applicable to agricultural produce under this arrangement

● The penalty of non-payment by the buyer will be 1.5 times the value of produce. Encumbrances on the farmer’s land cannot be part of the contract

Will this improve things on-ground?

The ordinance clearly lays out a framework for contract design and penalties to mitigate breach of contract. Let's look at its impact on the decisions to be taken by farmers -- what to sow, how much to invest.

● What to sow? The legal environment for contract farming, with the assurance of a price (based on projected future market prices by corporates) to the farmers at the time of sowing, will help them take cropping decisions based on forward prices. This will increase household income and mitigate market risk, protecting the farmer from cyclical prices of agricultural products.

● How much to invest? Long-term contracts with farmers will justify higher investments on farms through increased farm mechanization* and faster shift to high-value products such as horticulture and fisheries. This move can be further accelerated through agricultural advisory services, provision of inputs, and credit support by corporates.

Companies which enter into contracts with farmers can reap the following benefits:

● What to store? Coupled with the removal of warehousing caps under the Essential Commodities Act, companies can adopt a market-based warehousing system to stock up on goods based on forecasts of future shortages and trading prices.

● How much to charge? Better control of the quality and traceability of products can help firms tap into the trend of greater consumer awareness about food safety and hygiene in the domestic market. This also opens up the scope for international trade with ITC* planning to create export-oriented fruit and vegetable clusters.

Beware of the pitfalls

While the ordinance is a positive move towards freedom of contracting, it still perpetuates the threat of government interference and fails to address larger structural conditions:

● Lack of bargaining power: Big buyers going to individual farmers is not an efficient proposition. Farmer producer organizations (FPOs), based on local interests, need to be created to lower transaction costs, ensure uniform quality, and improve the bargaining power of farmers vis-à-vis these large buyers.

● Executive adjudication: The ordinance delegates dispute resolution to the executive (sub-divisional magistrate), who will not be bound by rules of procedure, instead of the judiciary. This gives the government more powers than the parties in cases of conflict.

● Suo Motu litigation: The government may intervene in cases where neither of the parties to a farming contract has raised a dispute, thus violating the ‘privity of contract’.

Avoiding the tyranny of good intentions

Can this nationally driven reform work? India is vast and heterogeneous and bears similarities with the EU. Hence the government needs to step up if it wants to create a national market. Economic enterprise can only go so far, common markets require significant political and financial investments with a strong focus on implementation - the creation of regulatory institutions to coordinate trade between states, creation of physical infrastructure - roads, utilities and market places for private players, making access to global markets easier and rethinking India’s agricultural insurance and farm credit strategy. The plight of farmers in Bihar, after the abolition of the APMC Act in 2006, should serve as a cautionary tale for us.

In spite of short term hiccups, a sustained move towards a market-based food system can play an outsized role in reducing mass poverty in India.

*GSN Invest++: We've analyzed ITC as well as VST Tillers under the GSN Invest++ program. You could join now to get access to an in-depth analysis of these and many other interesting companies!


About the Author: The post is written by our EZPP Partner Abhirup Roy with relevant edits from our editorial team. Abhirup is a graduate from IIM Ahmedabad and works with Zolo Stays.


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