OVERVIEW OF RISKS IN AGRICULTURE

1. OVERVIEW OF RISKS IN AGRICULTURE Manas Ranjan Mohanty MEMBER OF FACULTY CAB, RBI, PUNE College of Agricultural Banking, RBI, PUNE

2. Where risk arises in agriculture Small land holdings Poor soil quality Inadequacy / improper quality of inputs (seed/ water/ fertilisers/ pesticides/ credit) Lack of extension (knowledge/ technology)

3. Where risk arises in agriculture 3 • 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.. Date: College of Agricultural Banking, RBI, PUNE

4. Major Risks in agriculture Production Risk Quantity produced affected directly Natural calamities Weather conditions Pests, diseases Other localised events 4 Date: College of Agricultural Banking, RBI, PUNE

5. 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 5 Date: College of Agricultural Banking, RBI, PUNE

6. How production risk is managed • Individual level • Diversification • Crop diversification • Subsidiary commercial activity (including allied activities) • Sale of assets • Raising debts 6 Date: College of Agricultural Banking, RBI, PUNE

7. How production risk is managed System level Insurance Crop insurance Income insurance Weather/ rainfall insurance 7 Date: College of Agricultural Banking, RBI, PUNE

8. How price risk is managed? • Administered price mechanism • Minimum Support Prices • Contract farming • Commodity futures market 8 Date: College of Agricultural Banking, RBI, PUNE

9. 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. College of Agricultural Banking, RBI, PUNE

10. 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 College of Agricultural Banking, RBI, PUNE

11. 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 College of Agricultural Banking, RBI, PUNE

12. Crop Insurance – Earlier schemes College of Agricultural Banking, RBI, PUNE

13. 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) College of Agricultural Banking, RBI, PUNE

14. 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 College of Agricultural Banking, RBI, PUNE

15. 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

16. 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. College of Agricultural Banking, RBI, PUNE

17. 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}. College of Agricultural Banking, RBI, PUNE

18. National Agri Insurance Scheme Rabi 1999-2000 to Rabi 2009 – 2010 (Data as o0n August 31, 2010): College of Agricultural Banking, RBI, PUNE

19. Issues in crop insurance • Product Design • Pricing – can it be actuarial? • Compulsory coverage – a disincentive? • Credit-based insurance at present • Claims settlement (often a lengthy and cumbersome process) College of Agricultural Banking, RBI, PUNE

20. 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? College of Agricultural Banking, RBI, PUNE

21. 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). College of Agricultural Banking, RBI, PUNE

22. 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 College of Agricultural Banking, RBI, PUNE

23. VarshaBima • 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. College of Agricultural Banking, RBI, PUNE

24. 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) College of Agricultural Banking, RBI, PUNE

25. 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 College of Agricultural Banking, RBI, PUNE

26. 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. College of Agricultural Banking, RBI, PUNE

27. 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. Commodity-specific insurance products

28. 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 College of Agricultural Banking, RBI, PUNE

29. 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) College of Agricultural Banking, RBI, PUNE

30. 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. College of Agricultural Banking, RBI, PUNE

31. Futures contracts For the buyer of commodities: • The holder of the contract has acquired the obligation to buy the underlying commodityat the current price. • He will profit if the market price of the commodity goes up. College of Agricultural Banking, RBI, PUNE

32. 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 College of Agricultural Banking, RBI, PUNE

33. 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. College of Agricultural Banking, RBI, PUNE

34. Market participants Speculators • 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. College of Agricultural Banking, RBI, PUNE

35. 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 College of Agricultural Banking, RBI, PUNE

36. 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.. College of Agricultural Banking, RBI, PUNE

37. 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. College of Agricultural Banking, RBI, PUNE

38. 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 College of Agricultural Banking, RBI, PUNE

39. 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. College of Agricultural Banking, RBI, PUNE

40. 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). College of Agricultural Banking, RBI, PUNE

41. 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 College of Agricultural Banking, RBI, PUNE

42. 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 College of Agricultural Banking, RBI, PUNE

43. 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 College of Agricultural Banking, RBI, PUNE

44. The future scenario • More involvement of farmers and consumers (hedging) • Improving warehouse receipt-based financing • Allowing “options” in agricultural commodities?? College of Agricultural Banking, RBI, PUNE

45. THANK YOU For your thoughtful hearing and insightful questioning College of Agricultural Banking, RBI, PUNE