OVERVIEW OF RISKS IN AGRICULTURE

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OVERVIEW OF RISKS IN AGRICULTURE

• Manas Ranjan Mohanty
• MEMBER OF FACULTY
• CAB, RBI, PUNE

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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)

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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..

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Date
College of Agricultural Banking, RBI, PUNE
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Major Risks in agriculture

• Production Risk
• Quantity produced affected directly
• Natural calamities
• Weather conditions
• Pests, diseases
• Other localised events

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Date
College of Agricultural Banking, RBI, PUNE
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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

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Date
College of Agricultural Banking, RBI, PUNE
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How production risk is managed

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

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Date
College of Agricultural Banking, RBI, PUNE
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How production risk is managed

• System level
• Insurance
• Crop insurance
• Income insurance
• Weather/ rainfall insurance

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Date
College of Agricultural Banking, RBI, PUNE
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How price risk is managed?

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

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Date
College of Agricultural Banking, RBI, PUNE
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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.

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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

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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

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Crop Insurance Earlier schemes
Crop insurance by GIC (1972-1979) 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 Cereals, pulses, oilseeds Farmers 7.6 crore Premium Rs 403.6 cr Claim Rs 2303.4 cr
Experimental Crop Insurance Scheme (1997-98) Area basis (5 states, 14 dists) Only for SF/MF 100 premium subsidy Same as CCIS 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)

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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

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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

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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.

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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.

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National Agri Insurance Scheme

• Rabi 1999-2000 to Rabi 2009 2010 (Data as o0n
  August 31, 2010)

No of farmers covered 15.86 crore
Sum insured Rs 1,86,934 cr
Premium collected Rs 5,266 cr
Claims paid Rs 18,420 cr
Premium subsidy Rs 485 cr
Farmers benefited 4.48 crore
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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)

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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?

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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).

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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

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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.

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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)

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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

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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.

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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.

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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

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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)

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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.

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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.

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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

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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.

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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.

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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

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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..

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Functions of futures market

• Price discovery
• An expression of the consensus of todays
  expectations about the price at some point in the
  future.
• The market disseminates in a transparent manner
  the likely future price of a commodity.

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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

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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.

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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).

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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

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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

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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

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The future scenario

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

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THANK YOU

• For your thoughtful hearing and insightful
  questioning