The NITI Aayog is currently preparing a new model contract farming law—the earlier one was recommended 14 years ago—to revamp the system of firm farm linkages in the Indian agriculture sector.
The NITI Aayog is currently preparing a new model contract farming law—the earlier one was recommended 14 years ago—to revamp the system of firm farm linkages in the Indian agriculture sector. The main objective is to assure procurement from farmers at remunerative prices, while mitigating risks arising due to price fluctuations, especially of perishable commodities.
Global experience shows that contract farming has been able to meet these objectives as it reduces costs of accessing information, services and marketing. Through interlinked arrangements, contract farming reduces production- and marketing-risks. The increase in farmer’s income because is brought about through marketing efficiency gains, mainly due to supply-chain compression owing to reduced number of marketing functionaries, and control over retail prices. Therefore, contract farming also generally benefits consumers.
The model marketing Act in 2003 had clear provisions for contract farming, which allow buyers and sellers to transact without routing through mandis—an obvious choice for states trying to augment farmers’ share in value distribution. Yet, contract farming has not been promoted or has become popular to the extent expected. Even in states that adopted the model marketing Act and allowed direct transactions between organised private sector and producers, contract farming has been minimal.
Contract farming in India does have major success stories. Although in poultry, for example, it has been widely successful, in numerous other commodities contract farming has not taken off or has failed.
One factor that seems to have been instrumental in limiting success in contract farming has been that arrangements have often not fully accounted for the heterogeneity based on socio-economic characteristics of farmers. These include differences based on size of holding as well as capacity or skill to participate in agribusiness. Most reforms, therefore, though well-intentioned, have turned out to be largely ineffective and generally neither inclusive nor business-friendly.
The roadblocks for contract farming relate to both demand as well as supply side of the market. On the supply side, the most important constraint has been the scale of farm produce. Most Indian farmers are marginal and small (86% holdings are less than two hectares). All states, except Punjab, have less than one hectare average size. Bihar has an average size of holding of only 0.3 hectare—here 97% holdings are small. With such small holdings, the marketable surplus of individual farmer has turned out to be extremely small. Buyers have no incentive for contract farming with a large number of small and marginal farmers due to high transactions (e.g., costs related to negotiations) and marketing costs (e.g., cost of collecting produce). Further, the problem is heterogeneity in quality of produce with a large number of small farmers who can’t be monitored for quality and safety. If contract farming is to succeed, we have to consolidate farmers through farmer producer organisations (FPOs) and self-help groups as a precursor to firm-farm coordination.
Another problem is related to the regularity in supply of farm produce. A successful business model hinges on secured and consistent supply of raw materials or produce. This also requires buyers to contract with numerous suppliers, increasing transactions costs and creating viability issues. The solution might lie in the following: Upon the formation of FPOs, they could be federated to maintain supply of farm produce on a larger scale and with regularity.
To promote FPOs, the government has constituted the Small Farmers’ Agribusiness Consortia (SFAC) under the ministry of agriculture & farmers welfare. It has the status of a society that aims to increase incomes of marginal and small framers through aggregation and development of agribusiness. It also supports FPOs through schemes such as Equity Grant and Credit Guarantee Fund Scheme. The government had declared 2014 as the international year of FPOs. Yet, by January 31, 2017, there were only 580 registered FPOs, and only about 120 FPOs are under process of registration.
Clearly, the number of registered FPOs is extremely low. More than 40% FPOs are concentrated in three states: Madhya Pradesh, Maharashtra and West Bengal. To expedite the registration of FPOs, we propose that the SFAC may be made an independent body like, say, the National Dairy Development Board or National Horticulture Development Board. The independent body needs to sensitise farmers, facilitate formation of FPOs, evolve mechanisms to federate them, and improve capacity on marketing and financial matters.
On the demand side also, there are several conditions for success of contract farming. The question is: Why would an agribusiness entrepreneur choose a contract over spot markets? Earlier studies by the International Food Policy Research Institute and National Institute of Agricultural Economics and Policy Research show that an agribusiness entrepreneur must be engaged in one or more of the following businesses: (1) organised retailing; (2) agro-processing; (3) branding products; (4) exporting farm or processed commodities; and (5) marketing niche commodities. In such cases, spot transactions are not able to deliver because of safety and quality issues. To make contract farming successful, constraints faced at front-end need to be corrected. Failing to do so and the benefits of contract farming would not be fully realised.
Hence, for the model contract farming law to benefit farmers and improve marketing efficiency, it has to be made business-friendly by consolidating farmers for production and marketing. This is possible only through FPOs and their federations. The model law must consider the aggregation issues. Else, the promise of firm-farm coordination might end up with a fate like that of the model Act of the 2003 vintage.