Futures and derivatives: How to make farming less of a gamble for farmers

By: and |
New Delhi | Updated: October 03, 2016 8:32 PM

Futures and derivatives-trading are frowned upon in India for being speculative. But these instruments can make farming less of a gamble for farmers than it is.

Farmers are not free to sell in many states because of laws that require them to dispose of their produce only in state-regulated mandis. (Source: Reuters)Farmers are not free to sell in many states because of laws that require them to dispose of their produce only in state-regulated mandis. (Source: Reuters)

There were no takers for tomatoes at the mandi in Mysuru at the beginning of August. Mohan Kumar, a young agronomist with Bigbasket.com, an online grocer that engages with organic farmers, said there was a glut. Farmers had stampeded into the crop because of the high prices that had followed the floods in Chennai last November. Almost every farmer in the district had grown tomatoes hoping to make a killing. They had miscalculated.

The boom-bust cycle is endemic to Indian agriculture. It is the fallout of rear-view farming. Farmers plant on the basis of prices that prevailed in the previous season, not those that are likely to obtain in the next. They often come to grief.

Contract-farming can take care of the price risk. Procurement of rice and wheat at support prices by the government in a few states is an example of this kind of transaction. Large food processors like those retailing branded potato wafers or supplying patties and fries made of the tuber to restaurant chains also lock in farmers in advance to fixed prices. But these arrangements do not cover most of the farmers.

Farmers are not free to sell in many states because of laws that require them to dispose of their produce only in state-regulated mandis. Even when this hurdle has been removed, they cannot have a choice of buyers because of being in hock to moneylenders. “If you want to free up the output market for farmers you must free up the credit market,” says Raghav Raghunathan, a young metallurgical engineer who headed operations for three years at Ram Rahim Pragati Producer Company in the tribal area of Bagli in Madhya Pradesh’s Dewas district.

In 2014, the procurement price for wheat was R1,450 a quintal. The Madhya Pradesh government announced a bonus of R100. Raghunathan found that even farmers within reach of the procurement centres were unable to sell to the government because their pavti or land-title deeds were with the trader-moneylenders. Those documents are required for procurement, as also to obtain subsidised inputs like seeds, fertilisers, bank loans and electricity.

The producer company was set up in 2012 by a federation of women’s self-help groups with the help of Samaj Pragati Sahayog, an NGO, after it was blocked from trading at the local mandi. These groups had displaced the trader-moneylenders. They were able to tap banks for loans, which normally shy away from lending to smallholder farmers because of information asymmetry—they are unsure who is creditworthy and who is not. SHGs can bridge these information gaps. Familiarity with each other enabled the Bagli SHGs to keep defaults low. The clusters then began to aggregate the produce of members and sell in the local market. The traders tolerated this for some time, but protested when they felt the threat. A helpful district administrator asked the SHGs to obtain a trading license, which is how they formed the producer company.

But the new entity found itself at a disadvantage. Traders in Madhya Pradesh style themselves as farmers to gain exemption from mandi tax (2% of commodity value), entry tax on oilseeds (1%) and cess. The producer company could not. It suffered losses to the extent of twice its share capital when prices fell, eroding the value of the stock of chana it had held for its members in anticipation of prices firming up.

That is when Ram Rahim decided to seek insurance in the futures market. After a long-drawn process and with the help of a supportive Forwards Market Commission, it obtained a license to trade on the National Commodity & Derivative Exchange (NCDEX) in 2014. That year, soybean prices fell from R4,800 a quintal to R3,300. If Ram Rahim had had a naked position, it would have suffered a loss of R60 lakh on stocks of 4,000 quintals. But it had locked in at R4,500 a quintal.

Currently, futures are available on the exchange for 12 commodities. Futures, for instance, are not allowed in groundnut, castor, pepper, tea, coffee, coconut, cotton, onions, potatoes, pulses or millets. Even if the range were broader, farmers will have to grow the varieties that are traded and produce them to specified grades. If not their produce would be unsaleable or fetch a lower price. Making that mindset change in Bagli farmers took a lot of effort. Even for traded commodities delivery points may not be available within reach. Ram Rahim was unable to trade in maize futures for this reason. Whimsical regulatory action is another risk. The government thinks futures stoke inflation. The threat of them being banned in a particular commodity is ever present.

Yet, Ram Rahim was able to sell the 2013 stock of soybean for R4,500 a quintal in May 2014 despite prices dropping. Soybean planted in June-July 2014 sold at R3,800 a quintal though prices went all the way down to R2,800 a quintal. These positions were taken ahead of the harvest.

But the innovation that producer companies really liked was forward contracts which were introduced in September 2014, when Ramesh Abhishek, at present, secretary, department of industry policy and promotion, was chairman of the Forward Markets Commission. Ram Rahim argued the case for producer companies to be allowed to do forward deals and negotiated waiver of minimum networth requirements.

Unlike futures, there are no lot sizes or grades in forward contracts. Commodities which are above fair average quality (FAQ) can get a premium. A farmer producer organisation could enrol on payment of R5,000. (To obtain a futures trading license, the minimum networth is R1crore and R50 lakh has to be deposited with the exchange). The exchange keeps a percentage of the commodity value as margin money. It enforces the contracts so the risk of a party defaulting on its commitments, known as counter-party risk, is taken care of.

Farmer organisations took a shine to the product, says an NCDEX executive. They had access to buyers from across the country. There were no standard specifications. They could for instance, offer to sell maize of 350 grains per 100 grams and a certain moisture content. Buyers could accept the deal after assaying the quality themselves or getting third-party inspectors to do it. It was like selling stuff on e-commerce platforms like eBay. The volumes had touched 50,000 tonnes in this segment, the NCDEX executive said, till Sebi (which has subsumed FMC) inexplicably disallowed them this January.

Futures are glacially catching on with farmers’ organisations. According to NCDEX, seven of them have participated in futures trading. But these are said to be mostly pilot or dummy trades.

Futures and derivatives trading (not allowed) are frowned upon in India for being speculative. But these instruments can make farming less of a gamble for farmers than it is.

The author is editor of www.smartindianagricuture.in, a website devoted to promoting modern practices in agriculture, including the use of genetically-engineered seeds

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