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Project for NABARD :
"Contract
Farming as Means of Value-added Agriculture"
Final Report Approved by NABARD
Executive
Summary
Objectives, Concerns and Methods Used
Contract farming is seen as an effective means of generating supplies
for processing industries and exporters, with a substantial potential
of adding value to agriculture in India. In view of this potential
and its widespread practice abroad, Maharashtra Economic Development
Council decided to examine in depth issues connected with
contract farming, to facilitate contract farming arrangements to help
achieve objectives of agriculture and horticulture development. This
study was taken up with financial support from National Bank
of Agriculture and Rural Development and assigned to Management
Analytics, an independent research and consulting organisation. This
Report documents its findings.
The study was to help define the applicability, equitability and enforceability
of contract farming. It would attempt to identify crops and regions
suited for contract farming, components of contracts, credit requirements
and suitable institutional arrangements for disbursal and recovery,
safeguards to ensure contract performance, measures against non-performance
and arbitration procedures to resolve disputes
The study reviewed relevant experiences and remedies. It involved
four in-depth case studies of commodities grown under contracts [Poplars
under the Wimco programme in the North, mainly Punjab/Haryana; Tomatoes
and chillies under Pepsico/HLL/Nijjer programmes in Punjab and Sun-sip/Cleanfoods
(Ex Wimco) in Andhra Pradesh and Karnataka; Seed multiplication under
JK Agri-genetics, ProAgro and Nath Seeds in Andhra Pradesh, Maharashtra,
Gujarat; Sugarcane cultivation and processing under Prawaranagar and
Warnanagar co-operatives in Maharashtra, Modi Sugars in Uttar Pradesh
and Sakthi Sugars in Tamil Nadu]. Sample surveys of about 50 contract
and other growers for each commodity systems in the areas studied
were also conducted as a part of the study.
Brief History of Contract Farming in India and Forms of Contracts
The colonial period saw the introduction of cash crops such as tea,
coffee and rubber, poppy, and indigo in various parts of the country,
mostly through a central, expatriate-owned estate surrounded by small
outgrowers model. Most such arrangements exploited small peasantry
and resulted in indenture and alienation in some instances. ITC introduced
cultivation of Virginia tobacco in coastal Andhra Pradesh in the 1920s
incorporating most elements of a fair contract farming system and
met with good farmer response. This was replaced by auctions in 1984.
Organised public and private seed companies, which emerged in the
1960s, had to necessarily depend on multiplication of seeds on individual
farms under contract to them since they did not own lands. Faced with
an acute shortage of soft wood, Wimco, the country’s sole mechanized
match manufacturer, instituted an innovative farm-forestry scheme
for the cultivation of poplars in Punjab, Haryana and Uttar Pradesh.
It met with a good farm response and success despite the trees being
exotic to the regions.
Wimco also tried to procure tomatoes at the same time for its processing
factories in the South through a halting recourse to contract purchase.
Pepsico introduced tomato cultivation in Punjab in the 1990s under
contract farming to obtain inputs for its paste-manufacturing facility
established as a pre-condition to its entry into India. This was sold
to Hindustan Lever in 2000, which had earlier acquired the Kissan
tomato processing facility in Karnataka. Nijjer in Punjab and Bhilai
Engineering in Madhya Pradesh also took up tomato contract cultivation
programmes shortly after Pepsico. Contract farming was the strategy
of choice for almost all food processing projects contemplated in
the 1980s and 1990s, most of which never came up. Unreliable and uneconomic
raw material availability has been their major handicap. Smaller projects
involving specialised export crops, aromatics, medicinal plants and
herbs, etc still actively use contracts in their own restricted areas.
Contract farming is again in vogue, and even tried for bulk production
of subsistence crops, such as paddy-rice, maize and wheat. Punjab
government has actively encouraged it as a means of crop diversification.
Most such contracts now have specialised contract agencies as interfaces
between farmers and input suppliers/crop purchasers.
Commodity co-operatives (dairies in Gujarat, sugarcane in Maharashtra),
which emerged in the 1950s, provided most services envisaged under
ideal contract farming to their members and bought back the supplies
offered at contracted prices, although these were not strictly contract
arrangements. They succeeded enormously, leading to their replication
and compelling private companies also to adopt similar approaches.
Contract farming is now considered to be a corrective to market imperfections
and serving a useful purpose in India in its own limited sphere.
Contract farming covers loose buying arrangements, simple purchase
agreements, supervised production with input provision, with possibly
tied loans/advance and risk coverage, and managed production with
input provision and tied loans/advance. Introduction of new crops
and varieties as well as techniques of production also forms a part
of some contracts. Quality parameters may be integral parts of contracts,
but are not always understood properly. Defaults occur mainly through
availability of alternative channels of disposal to farmers and sources
of supply to buyers, which mere mention of exclusivity in contracts
cannot overcome. Effective reciprocity of terms and conditions is
not always assured. Contract agreements range from oral deals to formal,
registered written contracts. Sugar and milk co-operatives provide
significant social and community services as well.
Contract Farming Experiences
POPLARS
This programme, born of survival necessity of the sponsor, Wimco,
the largest match manufacturer, had several strong features: a thorough,
research-based approach, excellent extension approach, involvement
of NABARD to provide refinance for farmer loans from lead banks, risk
cover, clearly stated prices and purchase procedures, specially recruited
and trained extension staff and solid backing from not just the Indian
sponsor, but also its foreign parent. It was spread over three phases,
between 1984 and 1995. It succeeded in meeting or exceeding targets,
and creating great enthusiasm among farmers and demand among users,
leading to competitive markets replacing contract purchase from 1995
onward.
TOMATOES
Wimco’s efforts at about the same time of securing tomato supplies
through contracts in traditional growing areas of Andhra Pradesh and
Karnataka were lackluster and sporadic. Only a simple contract for
purchase was involved, without input supply, extension or credit components.
A decade later, Pepsico introduced tomatoes on a large scale in a
non-traditional area, Punjab, with purchase contracts backed by research
and extension support. It was closely followed by a similar programme
by Nijjer. These met with enthusiastic farmer response and Punjab
is now a major tomato-growing area. The companies also introduced
chilli cultivation with success among a subset of their contract growers.
Pepsico sold its operations to HLL in 2000. Only Nijjer still has
contracts.
SEEDS
Organised seed trade had to adopt contract growing from its start
in the 1960s, as it had no land of its own to multiply seeds. This
large business now survives only on contracts, which are formal and
explicit, covering all relevant factors. Seed contracts are now with
groups, not individuals, which helps not only in ensuring supplies,
but even more importantly, meeting quality standards and avoiding
disputes.
SUGARCANE
Enlightened farmer leaders integrated cane growing and processing
in the 1950s through the establishment of sugar co-operatives in Maharashtra.
They now provide inputs, extension, advances, and supervise/manage
harvesting as well as cane delivery to factory. Farmers believe their
prices to be remunerative and bonus and other social services offered
as added incentives for loyalty. The larger and more concerned private
companies elsewhere in the country, especially in Tamil Nadu and Uttar
Pradesh have taken the co-operatives as models and now offer similar,
though not all, services to their growers.
Impact of Contract Farming
NEW CROP ESTABLISHMENT
Poplar cultivation is now a stable, widely accepted
agro-forestry activity covering over 75,000 ha/year. There is a competitive
market, which meets most of farmers’ expectations.
Tomatoes are currently cultivated in Punjab on ca
25,000 ha, with a crop size of 5,00,000 t.
INDUSTRY RAW MATERIAL
Seeds are the business of over 150 companies, which
survive on contracts and have a combined annual turnover of over Rs
2,500 crore. Companies studied have reported healthy volumes and profits
and attribute them to contracts;
Sugarcane cultivation is based on long-standing relationships
between farmers and [processors; near contractual relations have led
to assured supply and prosperity for all.
HIGHER PRODUCTIVITY, INCOMES
Tomato contract farmers’ average yield is 25
- 50 per cent higher than the state average, while their per ha income
was 40 per cent higher than that for the control group;
Sugarcane growers reported higher than average yields,
recoveries in contract areas, and bonuses have meant higher incomes.
FARMER PERCEPTIONS
The sample surveys showed that contracts are not always well understood,
with prices, quality stipulations, and respective responsibilities
being the main areas of confusion. Overall, however, farmers were
distinctly satisfied with contracts and were ready to repeat them
in general and with the same parties in particular, if offered. This
was also reflected in the reported average length of association,
which was as high as 28 years for sugarcane growers. Farmers stated
higher incomes and prestige of association with a large organisation
to be the main benefits of contracts. Nevertheless, farmers firmly
believed that buyers were responsible for disputes, underlying the
antagonistic nature of contracts in general.
Contract Farming: Effectiveness, Pre-requisites and Problems
Contract farming is one among several possible interfaces between
crop cultivation and its processing and consumption. It is a powerful
means of introduction of new crops or farm technologies, especially
when both marketing and production uncertainties predominate.
Contract farming helps when markets do not exist or are underdeveloped;
conversely, contracts diminish in importance with development of competitive
markets. Contract farming works when specific quality requirements
must be met. Contracts are effective when there is no zero-sum game
(one party’s gain at the expense of the other). They are ideal
for a win-win situation, since they represent a natural mutual dependency.
Contracts succeed when they contain fair risk transfer or coverage
measures and trust relationships built over long periods. They are
most effective when they are critical to the continued operations
of the buyer organisation. They are deficient when their contribution
to the buyer is minor.
The effectiveness of contracts depends on the offer of a fair price
and adequate risk coverage. Other factors helping adherence to contracts
include exclusiveness, provision of proprietary planting materials
or inputs, and a strong, self-regulatory social systems among growers.
Contract farming is an exciting way of marrying small-farm efficiency
to scale economies of processing and marketing. It is an acceptable
via media for corporate ownership and could be a boon to processing
industry, if properly designed and implemented. It would help ensure
traceability and trackability for exports, which would be major consideration
in 2005.
Many factors also limit the utility of contract farming. Thousands
of contracts are needed for securing even modest quantities. The large,
quality-indifferent Indian market for fresh commodities acts as a
main roadblock, leading to a “Feast-or-Famine” syndrome;
shortages cause supply contracts to be flouted, and surpluses cause
gluts at the buyer’s doorstep.
This also causes problems in meeting stringent SPS requirements, which
will become an increasingly important consideration. Legal procedures
governing such contracts are seen to be one-sided, with defaults difficult
to pin. Little if any recourse to courts or other legal avenues is
seen as feasible. These reasons explain the relative absence of international
players in this segment of the Indian economy.
Contract Farming in Perspective
It is a step in evolution of competitive marketing and not permanent
substitute for it. Developed markets based on adequate infrastructure,
proper information flows, appropriate governance, organised futures
are clearly the desired set of institutions. Ideally, contract farming
is self-liquidating, as in case of poplars, as well as tomatoes in
Punjab. The continued presence of quasi-contractual arrangements in
sugarcane cultivation is clearly a result of the completely administered
nature of the commodity subsystem.
Application Areas for Contract Farming
The following are the prime candidates, each of which is marked by
an absence or an underdevelopment of competitive domestic markets:
• Seed multiplication;
• Organic foods, vegetables, fruits, and exotic produce/plants;
• Export crops;
• Aromatics, herbal and medicinal plants;
• Other cropping activities with specific requirements of
quality/cultivation practices.
The same consideration rules out commodities for established mass
markets, such as cereals, common fruits and vegetables, etc, as candidates
for contract cultivation
Interface
with Institutional Finance
Increased credit flow to agriculture is constrained by weakness and
ineffectiveness of institutions, poor credit absorption capacity of
the peasantry given the low resource base and limited risk bearing
ability, the relatively high cost of delivery of credit and eventual
recovery due to the diffused and dispersed distribution of the end-users.
Market and production uncertainties lead to defaults and add to farmers’
desperation.
Contract farming in general helps reduce market risk associated with
crop cultivation and is thus a possible instrument of credit deepening.
The presence of a third party could lead to outsourcing some preliminaries
of credit disbursal and help reduce the cost. The buyers’ commitment
to purchase substantially reduces the risk of default to the lender.
Therefore, credit institutions would be interested in using contract
farming as a means of improving credit disbursal and meeting the mandatory
targets for priority sector lending.
Yet their actual involvement in contract farming is limited because
there are not many well-planned contract farming schemes with adequate
safeguards for all concerned, backed by credible sponsors, and previous
experience has not been all positive. The cases studied suggest the
following desirable steps to expand institutional support to contract
farming:
NICHE APPROACH
The target crop activity should be well-defined, with manageable number
of growers who preferably share some other common traits to economise
the effort required to create awareness and interest among them.
SERIOUSNESS OF SPONSOR
Bankers need to be particularly careful in selecting the right sponsors.
The best candidates should possess persistence, superior knowledge
base and back-up, seriousness of intent as demonstrated by the criticalness
of the activity to their own survival and sufficient financial, organisational
and human resources to see the programme through the long haul. Size
and previous reputations of an organisation are no guarantee of their
commitment to the specific scheme.
WORKABLE, PARTICIPATIVE PROCEDURES AND PAPERWORK
Desirable sponsors need to participate as equals with bankers in the
preliminaries, helping perform some tasks without unduly taxing the
bankers’ constrained resources.
DEALING WITH GROUPS AS AGAINST INDIVIDUALS
Dealing with groups is the preferred, if not the only, way of obtaining
acceptable contract performance, through the positive use of the substantial
group synergy. This also highlights the need to work on niches, which
would help form groups.
RISK COVERAGE: CRITICAL!
A suitable risk coverage mechanism has to be an integral part of the
contract farming scheme. The entry of a large number of private insurance
companies in general and agriculture insurance areas opens up numerous
possibilities for innovation. Bankers should seek the involvement
of an insurance agency to evolve a tailor-made, innovative approach
to cover potential risk and create greater comfort for the farmer.
REPAYMENT: ALERTNESS TO CHANGES
Most contract farming schemes run on a tri-partite arrangement between
sponsors, farmers and bankers. Suitable strategies to ensure no leakages
out of the system (or devising methods to recover funds even in the
event of a leakage) are necessary. A continuing monitoring of the
market environment throughout the growing season and an arsenal of
actions to countervail the impact of such leakages are required.
AVOID LITIGATION
Litigation to recover money on default would be largely fruitless
and quite expensive. Bankers need to support measures such as those
suggested for conflict resolution to ensure higher and prompt repayment.
Bankers must certainly avoid the temptation to attach the borrowers
poor belongings.
Model Contract Farming Scheme
New
Measures and Regulated Markets
The Regulated Markets legislation sought to eliminate numerous marketing
malpractices by allowing transactions only in well-identified market
yards and under the supervision of a statutory market Committee. Over
time, procedures and paper work became focal points of market regulators,
rather than facilitation and enlarging of trade and regulated markets
became bottlenecks. Limited access to open trade adversely affects
production of new and diversified crops. Confining trade to the existing
yards and traders to recognised ones may not suit new crops with new
spatial patterns and trading entities. Freeing Indian agriculture
from such constraints through appropriate reform is an idea whose
time has come.
The draft legislation under circulation recommends recognition of
additional sub-market yards, including those managed by persons or
bodies other than market committees as markets under the act and the
establishment of special markets for specific commodities and special
committees to govern them. This does not quite meet the purpose. It
would still require the physical movement of a commodity between the
place it is produced and a market, instead of an unrestricted direct
movement between the points of origin and processing or consumption,
to help reduce cost, delays, wastage, and quality deterioration. The
thrust of the proposed measures, albeit unintended, is to increase
the extent of over-administration of the system, rather than to unshackle
it.
A desirable contract-farming approach requires several actions on
part of sponsors as well as administrators (financial institutions
roles and actions have been listed above):
Sponsor Issues for Action
Sponsors need to define unambiguously the type and nature of the contract,
as well as areas and periods covered at the outset. They have to list
the scope of their own activities as also those of the growers, and
their respective performance obligations.
Contracts must clearly specify:
•Quantities involved (on volume, area or entire crop basis),
delivery schedule, points of delivery and procedures to be followed
in the event of shortfalls or excesses;
• Modes and responsibilities of grading, packing and transport
and costs;
• Prices: fixed in advance of season, flexible prices, spot,
consignment, split;
• Payment modalities: time, form, hold-backs, if any;
• Incentives based on quality and/or time performance;
• Advances and their recoveries;
• Insurance, market fee and other related costs;
• Provisions in case of excess or short supply;
• Indicative net realisation by farmer.
Sponsors must focus on groups, and not individuals. The agreements
should be simple, short and devoid of legal jargon. They must not
involve property liens or attachments under any circumstances.
Development/Support Issues
• Processors or sponsors must equip themselves with suitable
R&D, efforts, especially concerning agronomy and the required
extension drive;
• All successful contract farming is based on appropriate
pricing. Given the often cyclical nature of agriculture production,
sponsors could consider establishing a price stabilisation fund
as a desirable step to overcome this problem;
• No contract farming scheme would succeed in the short run.
Persistence for a reasonable period extending over several years
is essential.
Administration
• State governments must recognise contract arrangements of
all types, and exempt them from the purview of the current or amended
APMC acts.
• There should be a simple registration of all contracts with
the concerned district agriculture office. This is to be performed
by the buyer, to avail of the exemption from the Act. There is no
need to ensure formalisation or government registration and supervision
of growers’ groups.
Conflict Resolution
The
best conflict resolution is avoidance of conflicts, as assumed in
the logic of the above recommendations. Nevertheless, some conflicts
might still arise, which need to be simply, effectively and quickly
resolved.
THREE-STAGE PROCESS
• Intra-group discussion and settlement
• Simple arbitration on the lok adalat model, with a local
First Class Judicial Magistrate assisted by farmer/sponsor representatives,
and one eminent person of area acting as the arbitration forum;
• One appeal to district judge/magistrate
The entire process must be completed in a maximum of three months,
and awards under it must have judicial sanction of a decree of a
civil court and must be enforceable. Legal practitioners must not
be allowed to participate in the process. It should not be subject
to Indian Contracts Act or further review.
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