Contract Farming in India
Indian agriculture is progressing in all spheres to keep up with the ever-increasing population. In the Tenth Five-Year Plan (2002–07), the government envisaged at least 4% growth rate per annum, so that food security is assured and employment opportunities in agriculture are created. The National Agricultural Policy also aimed to strengthen the national economic growth through efficient marketing to accelerate foreign exports by establishing Agri-Export Zones for various crops in major crop-growing areas, where technical know-how and facilities for export will be provided. Therefore, there is a shift from sustainable to commercial agriculture. Farmers can increase their income from crop production. Recent trends in consumerism have opened a new vista for agricultural production on large scale by adopting contract farming, which can transform small farmers into viable commercial producers by monitoring quality, quantity and cost of crop production, and can link production with consumption. This change can help develop markets and bring about changes in the present conventional agriculture which is expected in India in near future.
Contract farming is basically an agreement between farmers and processors and/or marketing firms for the scientific production and supply of a specified agricultural product at a frequently and mutually predetermined price. Technical guidance on cultivation practices, harvesting, storage etc. and quality inputs at wholesale rate are assured by the tripartite contract. The main objective is to increase crop production, improve quality farm produce and possibly minimize cultivation cost. The farmer is therefore compelled to provide the produce in a specific quantity and quality determined by the processor. Although legal protection is possible to both parties, the success depends upon physical, social and cultural conditions because all terms and conditions prescribed in the agreement are to be fully respected by concerned parties, so that the project gives an impetus to scientific planning and implementation of integrated crop cultivation.
Primarily, contract farming can be of three types.
· Procurement contracts under which only sale and purchase conditions are specified
· Partial contracts wherein only some of the inputs are supplied by the contracting firm and produce is bought at pre-agreed prices
· Total contracts under which the contracting firm supplies and manages all the inputs on the farm and the farmer becomes just a supplier of land and labour.
The relevance and importance of each type varies from product to product and over time and these types are not mutually exclusive. Whereas the first type is generally referred to as marketing contract, the other two are types of production contract. But, there is a systematic link between product and factor markets under the contract arrangement as contracts require definite quality of produce and, therefore, specific inputs. Also, different types of production contracts allocate production and market risks between the producer and the processor in different ways. The price of the contracted produce can be growers’ fixed price, residual (profit/loss) sharing by sponsor and grower, open market based price, spot market price, consignment based, two part split price, tournament price (fixed plus variable based on relative performance), base price plus quality based incentive price, or administered price.
At a more macro-economic level, contracting can help to remove market imperfections in produce, capital (credit), land, labor, information and insurance markets; facilitate better co-ordination of local production activities which often involve initial investment in processing, extension etc.; and can help in reducing transaction costs. It has also been used in many situations as a policy step by the state to bring about crop diversification for improving
farm incomes and employment. Contract farming is also seen as a way to reduce costs of cultivation as it can provide access to better inputs and more efficient production methods. The increasing cost of cultivation was the reason for the emergence of contract farming in Japan and Spain in the 1950s and in Punjab in the early 1990s.
Need for contract farming
Considering the present socio-economic status of Indian farmers, contract farming seems to be an ideal option because this system would have certain advantages over the present crop production and marketing systems, such as:
· Profit in produce sale is possible by capitalizing the scientific research in post-harvest technologies.
· Indian agriculture per se is becoming commercial due to global demand for a variety of foods and fibre, and food products.
· Any crop can be cultivated on a large area to obtain produce of uniform quality by adopting appropriate technology. Crop production is also possible on small land-holdings through cooperative/ corporate farming to enhance productivity and avoid admixture or inferior quality produce.
· Technology transfer becomes easier due to large-scale adoption.
· Risk involved due to fluctuation in market price is minimized. This point is relevant to the present strategy of farm economics as the Minimum Support Price is generally declared at the end of crop season and it often remains ambiguous.
· Commercial and nationalized banks are coming forward to finance contract farming through soft loans and are revising prime lending rates.
· Additional income from intercrops is certain due to crop diversification. Consolidation of small and marginal lands can make farming economically viable, resulting in higher (>30%) net returns than traditional/conventional farming systems.
Experiences from contract farming in India
In India, food supermarket chain growth including FDI in retail, international trade and quality issues like SPS, organic trade, fair trade, and ethical trade, promotion by the central and the state agencies, banking and input industry push for contract farming, farming crisis and reverse tenancy, and failure of traditional cooperatives, are likely help spread of contract farming across crops and regions as they provide new space to this arrangement in the context of withdrawal of state from agricultural space.
Contract farming has various models/variants being practiced in India at present. Some of the studies conducted of the contract farming system in India more recently focus mostly at the economics of the contract farming system in specific crops, compared with that of the non-contract situation and/or competing traditional crops of a given region, e.g. in gherkins (hybrid cucumber) in Andhra Pradesh, tomato in Punjab and Haryana and cotton in Tamil Nadu. It has been found that contract farming has given much higher (almost three times) gross returns compared with that from the traditional crops of wheat, paddy and potato in case of tomato and in cotton due to higher yield and assured price under contract farming.
Many CF projects fail due to either poor design of the project or default by any of the contracting parties. In contract farming, both companies and growers try to improve their own positions, as a negotiation, which change over time. Further, contract design is a complex task given that there is always a problem of incomplete contracts due to bounded rationality of the contracting parties. It is the adverse selection and moral hazard problems in contracting which pose challenges and need to be managed in order to make the farmer deliver the contracted terms and conditions. The experiences of contract farming suggest that it is not the contract per se which is harmful as a system but how it is practised in a given context. If contracts are well designed and implemented, they can certainly lead to a betterment of all the parties involved, especially farmers. But, there can not be a single blue print or contract farming model for all situations. Even for individual farmers, it is not contract per se but the relationship it represents which is crucial as the divergence between the two may prove crucial in determining the development of contract farming as an institution. Further, it is the context of the contract which can make a whole lot of difference as there are many actors and factors in the environment which influence the working and outcome of contracts and lead to a culture of contracting which is location and community specific. The way farmers perceive contract farming, i.e. define their relationship with the companies, and differ in each cultural context.
Co-ordination, Motivation, and Transaction costs are three pillars of a contract arrangement. Therefore, it is important to consider contract design as a multi-criterion decision problem. Some basic rules of contract design include:
· Coordinating to minimize production costs which means using price signals or instructions or both
· Balancing decentralization and centralisation in farm decisions which impacts problems like moral hazard and hold up
· Minimizing or sharing risk and uncertainty
· Reducing the costs of pre- and post contractual opportunism (adverse selection and moral hazard) by various mechanism of allocating contracts and monitoring them
· Encouraging group or co-operative action among producers to lower costs and ensure better compliance
· Motivating long term contracts to reduce hold up problem
· Balancing pros and cons of renegotiation of contracts over time
· Reducing direct costs of contracting
· Using transparent contracts
Finally, there is no need to look for permanence in contract farming arrangements though short or medium term sustainability is desirable for availing of its effects on the growers and the local economy. But, as market conditions for a crop/commodity change, contract farming can wither away as market becomes efficient. Contract farming as a vertical co-ordination mechanism is only a response to a situation of market failure and depends on commodity/crop/sector dynamics which are liable to change anytime, especially in globalised and liberalised world. But, there are many indications that contract farming can continue even in the presence of competitive markets as has been the case in the developed countries or even Thailand. Finally, it must be realized that contract farming is only an instrument/means to agricultural and rural development, not an end in itself.
