OVERVIEW OF RISKS IN AGRICULTURE Department of Economics Bapatla College of Arts & Science

Where risk arises in agriculture

• • • • Small land holdings Poor soil quality Inadequacy / improper quality of inputs (seed/ water/ fertilizers/ pesticides/ credit) Lack of extension (knowledge/ technology)

Where risk arises in agriculture

• • Due to seasonality and the gestation period • • Variation in output Variation in market price Post-harvest issues (storage/ transport/ processing/ marketing)

The policy environment is also a source of risk..

Major Risks in agriculture

Production Risk

 Quantity produced affected directly     Natural calamities Weather conditions Pests, diseases Other localised events

Major Risks in agriculture

Price (Market) Risk

• Fluctuations in price of agri produce – Markets – local & global – Agri-business/ agri-export and market risk – Market risk in post-WTO scenario

How production risk is managed

Individual level • Diversification • Crop diversification • Subsidiary commercial activity (including allied activities) • Sale of assets • Raising debts

How production risk is managed

System level

• Insurance – Crop insurance – Income insurance – Weather/ rainfall insurance

How price risk is managed?

•Administered price mechanism •Minimum Support Prices •Contract farming •Commodity futures market

Crop Insurance

• A means of protecting the farmers against uncertainties of crop yields arising out of natural factors beyond their control.

• Compensation is paid to the farmers when the actual average yield of an area of a particular crop is less than the guaranteed yield.

Crop Insurance - concepts

• What is the basis of coverage ? • Individual basis/ area basis • • Data availability Moral hazard issue • • • Which crops are covered ?

• All crops or some crops Who is eligible for coverage ?

• Loanee/ non-loanee farmers What type of risk is covered ?

• Natural calamity and other risks

Crop Insurance – concepts

• • • • How is the threshold yield determined ?

• Based on past performance How is the premium determined?

• Actuarial method? Or arbitrary determination?

Whether premium subsidy is available?

• For small and marginal farmers Who is the implementing agency

Crop insurance by GIC (1972-1979)

Crop Insurance – Earlier schemes

Individual basis (6 states) Cotton, groundnut, wheat, potato Farmers: 3110 Premium: Rs 4.5 lakh Claim: Rs 37.9 lakh Pilot Crop Insurance Scheme (1979-1985) Area basis (13 states) Loanee only Voluntary 50% premium subsidy for SF/MF Optional for States Cereals, Millets, Oilseeds, Cotton, Potato and Gram Farmers: 6.27 lakh Premium: Rs 1.97 lakh Claim: Rs 1.57 lakh Comprehensive Crop Insurance Scheme (1985-1999) Area basis (17 states) Loanees compulsory 50% premium subsidy for SF/MF Optional for States Experimental Crop Insurance Scheme (1997-98) Area basis (5 states, 14 dists) Only for SF/MF 100% premium subsidy Cereals, pulses, oilseeds Same as CCIS Farmers: 7.6 crore Premium: Rs 403.6 cr Claim: Rs 2303.4 cr Farmers: 4.5 lakh Premium: Rs 2.84 cr Claim: Rs 168 cr

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National Agricultural Insurance Scheme (NAIS or RKBY)

Implemented since Rabi 1999-2000 • Implemented by Agriculture Insurance Company of India Ltd (since 2003) • Cereals, Millets, Pulses, Oilseeds, Sugarcane, Cotton & Potato.

– Other annual Commercial / annual Horticultural crops subject to availability of past Yield data • States to adopt the scheme – – Compulsory for loanee farmers voluntary for non-loanee farmers • Coverage on area basis (Target – Gram Panchayat level)

National Agri Insurance Scheme

• Comprehensive risk insurance – – Area basis for widespread calamities Individual basis for localised calamities • Premium dependent on crops – Flat rates for cereals, pulses – – High for commercial/ horticultural crops (actuarial basis) Premium subsidy for small & marginal farmers • Crop cutting experiments to estimate crop yield

National Agri Insurance Scheme

• • • Average yield : – Moving average of yield for past three years (rice, wheat) or five years (other crops ) Levels of indemnity: – 90% - low risk – – 80% - medium risk 60% - high risk Threshold yield: – Average yield X level of indemnity

National Agri Insurance Scheme

• • • Sum insured: Minimum coverage is the loan disbursed by the bank as per the Scale of Finance.

Farmers can opt for higher coverage up to the value of Threshold Yield at flat rate. Value of threshold yield calculated by multiplying with MSP or market price (where MSP is not there) during last year.

Coverage up to value of 150% Average Yield is also available. Premium is charged on actuarial rates for sum insured exceeding value of Threshold Yield.

National Agri Insurance Scheme

• 'Indemnity' to the farmer is calculated as per the following formula : • Shortfall in Yield X Sum Insured Threshold yield {Shortfall in Yield = 'Threshold Yield - Actual Yield' for the Defined Area}.

National Agri Insurance Scheme

Rabi 1999-2000 to Rabi 2009 – 2010 (Data as on August 31, 2010): No of farmers covered 15.86 crore Sum insured Premium collected Claims paid Rs 1,86,934 cr Rs 5,266 cr Rs 18,420 cr Premium subsidy Farmers benefited Rs 485 cr 4.48 crore

• Product Design

Issues in crop insurance

– Pricing – can it be actuarial?

– Compulsory coverage – a disincentive?

– Credit-based insurance at present – Claims settlement (often a lengthy and cumbersome process)

Issues in crop insurance

• High basis risk [difference between the yield of the Area (Block / Tehsil) and yield of the individual farmers].

• Delivery channels – Banks at present – Can there be other channels?

Weather/ Rainfall Insurance

• Indian agriculture is extremely sensitive to rainfall.

• Above sixty percent of cultivated area is heavily dependent on rainfall.

• Rainfall variations accounts for more than 50% of variability in crop yields.

• Rainfall problems accounted for 90% of claims under the Crop Insurance program (CCIS and NAIS).

Weather/ Rainfall Insurance

• • • • Index-based insurance products (Based on historical data, the yield and rainfall are correlated to arrive at a rainfall index) Payout not linked to loss verification – speedy settlement of claims Use of RFIs/ NGOs/ SHGs for delivery Not linked to crop loan • Implemented on a pilot basis by ICICI-Lombard & also by AICI (Varsha Bima) in a few states

Varsha Bima

• • • • • • • Covers anticipated shortfall in crop yield on account of deficit rainfall Introduced in 2005; administered by AIC Aimed at cultivators for whom NAIS is voluntary Coverage through RFIs Various coverage options available Pre-specified sum insured (between cost of production and value of production) Payout based on rainfall data within a month of indemnity period.

Weather Based Crop Insurance Scheme (WBCIS)

• • • Provides payout against adverse rainfall incidence (both deficit & excess) during Kharif and adverse incidence in weather parameters like frost, heat, relative humidity, un-seasonal rainfall etc. during Rabi.

Technical challenges in designing weather indices and also correlating weather indices with yield losses. Needs upto 25 years’ historical weather data.

Weather data as observed at Reference Weather Stations (RWS)

Modified NAIS

• • • • • Notified in September 2010 by GOI To be implemented on pilot basis during Rabi 2010-11 in 50 identified districts Actuarial premiums to be paid for insuring crops and hence claims liability on insurer Unit area of insurance for major crops to be village/ village panchayat Indemnity amount to become payable for prevented sowing/ planting risks and for post harvest losses, due to cyclones

Modified NAIS

• • • • Payment up to 25% of likely claim under MNAIS as advance for providing immediate relief to farmers Uniform seasonality norms to be applicable for both loanee and nonloanee farmers More proficient basis for calculation of threshold yield (average yield of last seven years excluding upto two years of declared natural calamity) Minimum indemnity level in case of MNAIS of 70% will be, instead of 60% as in NAIS.

Commodity-specific insurance products

• • • • • • • Wheat insurance Mango insurance Potato insurance Grapes insurance Coconut insurance Rubber insurance Coffee insurance • • Mostly rainfall index based schemes Several schemes implemented by AICI Ltd.

Managing Market Risk – Futures Market Futures contract is a derivative contract.

It is an agreement between two parties to buy or sell a commodity of a specified quantity and quality at a specific time in future at a specific price through the Exchange.

It differs from a simple “forward” contract Existence of an Exchange Standardisation of contract terms

Futures Exchange

Platform for buying & selling of standardized futures contracts of various commodities.

Clearing house - Guarantees trade No credit risk No delivery risk Governed and regulated by Own Rules, Regulations, Bye-laws Regulatory Body (Forward Markets Commission)

Futures contracts

For the seller of commodities:

• The holder of the contract has acquired the obligation to sell the underlying commodity at the current price.

• He will profit if the market price of the commodity declines before the future date.

Futures contracts

For the buyer of commodities:

• The holder of the contract has acquired the obligation to buy the underlying commodity at the current price. • He will profit if the market price of the commodity goes up.

Futures Market

• Margin requirement – Initial margin – Margin call • • Marking to market daily Margin call if margin balance falls below the initial margin required • Scope for high leverage in the futures market

Market participants

Hedgers

• • • • Those who are already exposed to (spot) market risk Hedgers trade futures for the purpose of keeping price risk in check. Loss in spot hedged through gain in futures.

– It could be the reverse!

Profit making is not the motive.

Speculators

Market participants

• Speculators seek out risk in the hope of turning a profit when prices fluctuate. • They trade purely for the purpose of making a profit and never intend to take/ make delivery of the underlying commodities.

•

Settling Futures Contracts

Futures contracts can be closed by taking/ making delivery of the goods described in the contract.

• All contracts carry a compulsory delivery clause in case contract remains open till expiration.

• Less than 2% of futures contracts are settled with actual physical delivery.

– Hedgers : Delivery on futures inconvenient/ more costly – Speculators : Not owning/ intending to own the actual commodity

Settling Futures Contracts

• Futures contracts can also be closed • By making an offsetting trade • The purchase or sale of an equal and opposite position can be used to settle an existing position.

•

This makes the futures market a place for “hedging” price risk or “speculating” or

“investing”, rather than making physical delivery..

Functions of futures market

Price discovery

• An expression of the consensus of today’s expectations about the price at some point in the future.

• The market disseminates in a transparent manner the likely future price of a commodity.

Functions of futures market

Mitigating price risk

• Purchase in the futures market by those hedging against upward price risk • Sell in the futures market by those hedging against downward price risk

Commodities Futures Trading in India • Futures Markets In India – – – – Bombay Cotton Trade Association - Cotton Futures (1875) Oilseed Futures, Gujarati Vyapari Mandali (Groundnut, Castorseed, Cotton)– 1900 Jute Futures, Calcutta Hessian Exchange Ltd. – 1919 Bullion Futures, Mumbai – 1920 • Forward Contracts Regulation Act (FCRA) came into effect in 1952. Forward Markets Commission (FMC) set up in 1953 to regulate forward markets.

• For several reasons, futures trading was prohibited by Government in the 1970s.

Commodities Futures Trading in India • The post-liberalisation era • Committee on Forward Markets (1993) • • National Agriculture Policy (2000) Inter-Ministry Task Force on Agri-Marketing Reforms (2002) • Notification issued in 2003 allowing futures trading in commodities • Futures trading prohibited in some commodities in 2007 and again in 2008. (The ban has since been lifted).

Multi Commodity Exchanges

• Multi-Commodity Exchange of India (MCX), Mumbai • www.mcxindia.com

• National Commodities and Derivatives Exchange (NCDEX), Mumbai • www.ncdex.com

• National Multi-Commodity Exchange of India (NMCL), Ahmedabad • www.nmce.com

• Indian Commodity Exchange (ICEX), Gurgaon • www.icexindia.com

• Ace Derivatives & Commodity Exchange (ACE), Ahmedabad • www.aceindia.com

Commodities Futures Trading in India- Issues • Need for increase in volumes • Vulnerability of farmers/ trade – – Large no. of small/ marginal farmers Need for aggregation • Demand-Supply issues – Impacts even the spot markets • Lack of standardised storage facilities – Role of commodity exchenges • • Accredited warehouses Collateral management companies

Role of banks

• • •

Immediate/ short term

Financing for warehouses/ cold storages Financing farmers against warehouse receipts – The Warehouse (Development and Regulation) Act, 2007 Financing related to futures contracts (e.g. margin finance) • •

In the medium/ long term

Offering standard futures contracts to the farmers to suit their needs Trading in agricultural commodity futures

The future scenario

• More involvement of farmers and consumers (hedging) • Improving warehouse receipt-based financing • Allowing “options” in agricultural commodities??

THANK YOU

For your thoughtful hearing and insightful questioning