OVERVIEW OF RISKS
IN AGRICULTURE
Manas Ranjan Mohanty
MEMBER OF FACULTY
CAB, RBI, PUNE
Date:
College of Agricultural Banking, RBI, PUNE
1
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)
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..
Date:
College of Agricultural Banking, RBI, PUNE
3
Major Risks in agriculture
Production Risk

Quantity produced affected directly




Date:
Natural calamities
Weather conditions
Pests, diseases
Other localised events
College of Agricultural Banking, RBI, PUNE
4
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
Date:
College of Agricultural Banking, RBI, PUNE
5
How production risk is managed
Individual level
Date:
•
Diversification
• Crop diversification
• Subsidiary commercial activity (including
allied activities)
•
•
Sale of assets
Raising debts
College of Agricultural Banking, RBI, PUNE
6
How production risk is managed
System level
• Insurance
– Crop insurance
– Income insurance
– Weather/ rainfall insurance
Date:
College of Agricultural Banking, RBI, PUNE
7
How price risk is managed?
•Administered price mechanism
•Minimum Support Prices
•Contract farming
•Commodity futures market
Date:
College of Agricultural Banking, RBI, PUNE
8
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.
Date:
College of Agricultural Banking, RBI, PUNE
9
Crop Insurance - concepts
•
What is the basis of coverage ?
• Individual basis/ area basis
• Data availability
• Moral hazard issue
•
•
•
Date:
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
College of Agricultural Banking, RBI, PUNE
10
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
Date:
College of Agricultural Banking, RBI, PUNE
11
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)
Cereals, pulses,
oilseeds
Farmers: 7.6 crore
Premium: Rs 403.6 cr
Claim: Rs 2303.4 cr
Same as CCIS
Farmers: 4.5 lakh
Premium: Rs 2.84 cr
Claim: Rs 168 cr
Loanees compulsory
50% premium subsidy for SF/MF
Optional for States
Experimental Crop Area basis (5 states, 14 dists)
Insurance Scheme Only for SF/MF
(1997-98)
100% premium subsidy
Date:
College of Agricultural Banking, RBI, PUNE
12
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
•
Date:
Coverage on area basis (Target – Gram Panchayat level)
College of Agricultural Banking, RBI, PUNE
13
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
•
Date:
Crop cutting experiments to estimate crop yield
College of Agricultural Banking, RBI, PUNE
14
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
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.
Date:
College of Agricultural Banking, RBI, PUNE
16
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}.
Date:
College of Agricultural Banking, RBI, PUNE
17
National Agri Insurance Scheme
Rabi 1999-2000 to Rabi 2009 – 2010 (Data as o0n August 31, 2010):
Date:
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
College of Agricultural Banking, RBI, PUNE
18
Issues in crop insurance
• Product Design
–
–
–
–
Date:
Pricing – can it be actuarial?
Compulsory coverage – a disincentive?
Credit-based insurance at present
Claims settlement (often a lengthy and cumbersome process)
College of Agricultural Banking, RBI, PUNE
19
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?
Date:
College of Agricultural Banking, RBI, PUNE
20
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).
Date:
College of Agricultural Banking, RBI, PUNE
21
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
Date:
College of Agricultural Banking, RBI, PUNE
22
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.
Date:
College of Agricultural Banking, RBI, PUNE
23
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)
Date:
College of Agricultural Banking, RBI, PUNE
24
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
Date:
College of Agricultural Banking, RBI, PUNE
25
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.
Date:
College of Agricultural Banking, RBI, PUNE
26
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.
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
Date:
College of Agricultural Banking, RBI, PUNE
28
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)
Date:
College of Agricultural Banking, RBI, PUNE
29
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.
Date:
College of Agricultural Banking, RBI, PUNE
30
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.
Date:
College of Agricultural Banking, RBI, PUNE
31
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
Date:
College of Agricultural Banking, RBI, PUNE
32
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.
Date:
College of Agricultural Banking, RBI, PUNE
33
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.
Date:
College of Agricultural Banking, RBI, PUNE
34
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
Date:
College of Agricultural Banking, RBI, PUNE
35
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..
Date:
College of Agricultural Banking, RBI, PUNE
36
Functions of futures market
Price discovery
• An expression of the consensus of today’s expectations about the
price at some point in the future.
• The market disseminates in a transparent manner the likely future
price of a commodity.
Date:
College of Agricultural Banking, RBI, PUNE
37
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
Date:
College of Agricultural Banking, RBI, PUNE
38
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.
Date:
College of Agricultural Banking, RBI, PUNE
39
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).
Date:
College of Agricultural Banking, RBI, PUNE
40
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
Date:
College of Agricultural Banking, RBI, PUNE
41
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
Date:
College of Agricultural Banking, RBI, PUNE
42
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
Date:
College of Agricultural Banking, RBI, PUNE
43
The future scenario
• More involvement of farmers and consumers (hedging)
• Improving warehouse receipt-based financing
• Allowing “options” in agricultural commodities??
Date:
College of Agricultural Banking, RBI, PUNE
44
THANK YOU
For your thoughtful hearing and
insightful questioning
Date:
College of Agricultural Banking, RBI, PUNE
45