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Smallholders participation in contract farming and comparison with global experiences

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Contract farming has the potential to improve the welfare of smallholders however it is not a sufficient condition for such improvement. Smaller farmers can be excluded from contracts because of selection bias by agribusiness firms awarding contracts to larger farms, be adversely affected by the second-round effects of contracts on incomes and prices and suffer from narrowing of markets that lie outside of contracts.

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Smallholders participation in contract farming and comparison with global experiences

  1. 1. 1 Indian Institute of Plantation Management, Bangalore CERTIFICATE This is to certify that the Synthesis Paper titled “Smallholders participation in contract farming and comparison with global experiences” by Devesh Shukla submitted for the partial fulfillment of PGDMABPM 2016-18 is an original work and no part has been submitted or published for the award of any degree or diploma. Comments by the Examiner : Name of the faculty/guide Mr. K. NARENDRAN ___________________________ Signature of the Examiner Date: ______________
  2. 2. 2 INDEX Sr. No. Particulars Page no 1. List of tables 02 2. Executive summary 05 3. Introduction 06 4. Advantages of contract farming 07 5. Problems of contract farming 09 6. Suggestion for contract farming model of agriculture in india 11 7. Reasons why smallholders participate in contracts 13 8. Comparison with global experiences 18 9. Conclusion 25 10. Reference 27 SUB INDEX 1. Introduction 06 2. Advantages and problems of contract farming 07 2.1 Advantages of contract farming 07 2.1.1 Advantages for farmers 07 i. Provision for better inputs and production services 07 ii. Easy access to credit 07 iii. Application of better technology 07 iv. Improvement in skills of the farmers 07 v. Guaranteed pricing system 08 vi. Easy access to reliable market 08
  3. 3. 3 2.1.2. Advantages for the sponsors 08 i. Political acceptability 08 ii. Overcoming barriers on land restrictions 08 iii. Production consistency and shared risk 08 iv. Quality assurance 09 2.2 Problems of contract farming 09 2.2.1. Problems faced by the farmers 09 i. Possibility of greater risk 09 ii. Outdated technology and crop incongruity 09 iii. Manoeuvring in quotas and quality specifications 09 iv. Corruption 10 2.2.2. Problems faced by the sponsors 10 i. Limitation on land availability 10 ii. Social and Cultural constraints 10 iii. Farmers disgruntlement 10 iv. Below quality agro-inputs 11 v. Sale of crops by the farmers beyond contractual agreement 11 3. Suggestion for contract farming model of agriculture in India 11 4. Reasons why smallholders participate in contract farming 13 4.1 Adoption of new enterprises 13 4.2 Reasons smallholders enter contracts 15 4.2.1 Access to markets 15 4.2.2 Access to credit 16 4.2.3 Managing risk 17
  4. 4. 4 4.2.4 Provision of information 18 5. Comparison with global experiences 18 5.1 National policies 19 5.2 Kenyan tea development authority (KTDA) 19 5.3 Ghana and Ivory Coast 20 5.4 Thailand 21 5.5 Malaysia 22 5.6 India 23 5.7 Mozambique 24 6. Conclusion 25 7. Reference 27
  5. 5. 5 EXECUTIVE SUMMARY An agribusiness firm‟s choice to expand activities through contract farming rather than plantations, buying directly from open markets or other means reflects differences in transaction costs found in different types of procurement systems. Smallholders may enter contracts to reduce transaction costs of accessing new markets, borrowing, managing risk, acquiring information or increasing employment opportunities. The success of contracts reflects both the contracting environment and management practices. The contracting environment includes the strength of markets for contracted output, government macro policies, technical sophistication in production and attenuation of land ownership while important management elements are farm groups, selection of participants for contracts, managing contract default and conflict resolution. Direct benefits from contracting accrue to smallholders from improved access to markets, improved technology, better management of risk and opportunities for employment of family members. Indirect benefits occur from empowerment of women and increased commercial acumen on the part of smallholders. Contract farming has the potential to improve the welfare of smallholders however it is not a sufficient condition for such improvement. Smaller farmers can be excluded from contracts because of selection bias by agribusiness firms awarding contracts to larger farms, be adversely affected by the second-round effects of contracts on incomes and prices and suffer from narrowing of markets that lie outside of contracts. Institutional developments that might ameliorate this type of exclusion are anti-trust legislation, policies to directly improve the contracting environment, policies to address specific problems smallholders face in entering contracts and participation by NGOs in contract facilitation.
  6. 6. 6 1-INTRODUCTION “Contract farming is defined as an agreement between farmers and processing and/or marketing firms for the production and supply of agricultural products under forward agreements, frequently at predetermined prices”. The arrangement often involves the purchaser in providing a degree of production support through, for example, the supply of inputs and the provision of technical advice. For this arrangement to work the farmer commits himself to provide a specific commodity in quantities and at quality standards determined by the purchaser. The company on the other hand agrees to support the farmer‟s production and to purchase the commodity. A fundamental feature of contract farming is the shifting of risk from producers to processors since it is a form of futures market. Production and price risks are important features of poultry farming. Risk sharing is one of the widely cited reasons for contracting. Numerous studies of contract farming emphasize risk reduction as a principal incentive for producers to enter in to contracts. Much of the price risk is reduced, in contract farming, by the use of a predetermined price rather than the market price. The modernization of agricultural value chains – the systems of agreements, arrangements, and contracts that link farmers to consumers of food, typically through one or more intermediaries – is both a consequence and cause of economic development. Commercial demand increases due to income and population growth, urbanization, and trade liberalization. Marketed supply rises simultaneously as a result of productivity improvements in production, post-harvest processing, and distribution systems. The combination of increased commercial demand and supply has led to the emergence of modern marketing channels employing sophisticated management methods, such as costly grades and standards or vertical coordination or integration of activities that profitably add value to raw commodities through transport, storage and/or processing. Participant farmers – whose comparative advantage allows them to tap the latent demand of better-off or more distant markets made accessible by emergent agricultural value chains - typically improve their productivity and profitability, thereby further stimulating commercial demand and supply. The emergence and modernization of agricultural value chains (AVCs) thus result from and contribute to economic development.
  7. 7. 7 2-ADVANTAGES AND PROBLEMS OF CONTRACT FARMING 2.1ADVANTAGES OF CONTRACT FARMING 2.1.1. ADVANTAGES FOR FARMERS The main benefit of a contractual agreement for farmers is that the sponsor will normally undertake to purchase all produce grown, within specified quality and quantity parameters. Contracts can also provide farmers an opportunity to access a wide range of managerial, technical and extension services that otherwise may be unattainable. Farmers can use the contract agreement as collateral to arrange credit with a commercial bank in order to fund inputs. Thus, possible advantages of Contract Farming for farmers are given below – i. Provision for better inputs and production services: For ensuring a proper crop husbandry practices in order to achieve projected yields in required qualities many contractual arrangements involve considerable production support in addition to the supply of basic inputs such as seed and fertilizer. Sponsors may also provide land preparation, field cultivation and harvesting as well as free training and extension. ii. Easy access to Credit: With the collapse or restructuring of many agricultural development banks, the majority of small holder producers experience difficulties in obtaining credit for production inputs. Contract farming usually allows farmers access to some form of credit to finance production inputs. Arrangements can also be made with commercial banks or government agencies through crop liens that are guaranteed by the sponsor, i.e. where the contract serves as collateral. iii. Application of better technology: New production techniques are often necessary to increase productivity as well as to ensure that the commodity meets market demands. However, small scale farmers are frequently reluctant to adopt new technologies because of the possible risks and costs involved. Private agribusiness will usually offer technology more diligently than government agricultural extension services because it has a direct economic interest in improving farmers production. iv. Improvement in skills of the farmers: The skills the farmer learns through contract farming may include record keeping, the efficient use of farm resources, improved methods of applying chemicals and fertilizers, knowledge of the importance of quality and the characteristics and demands of export markets. Farmers can gain experience in carrying out field activities following a strict timetable imposed by the extension service. In addition, spill over effects from contract farming activities could lead to investment in market infrastructure and human capital, thus improving the productivity of other farm activities. Farmers often apply techniques introduced by management (ridging, fertilizing, transplanting, pest control, etc.) to other cash and subsistence crops.
  8. 8. 8 v. Guaranteed Pricing System: The returns farmers receive for their crops on the open market depend on the prevailing market prices as well as on their ability to negotiate with buyers. This can create considerable uncertainty which, to a certain extent, contract farming can overcome. Frequently, sponsors indicate in advance the prices to be paid and these are specified in the agreement. Thus Contract Farming ensures guaranteed and fixed pricing structures. vi. Easy access to reliable market: Farmers will not cultivate unless they know they can sell their crop, and traders or processors will not invest in ventures unless they are assured that the required commodities can be consistently produced. Contract farming offers a potential solution to this situation by providing market guarantees to the farmers and assuring supply to the purchasers. Even where there are existing outlets for the same crops, contract farming can offer significant advantages to farmers. They do not have to search for and negotiate with local and international buyers, and project sponsors usually organize transport for their crops, normally from the farm gate. 2.1.2. ADVANTAGES FOR THE SPONSORS The possible advantages for the sponsors are as follows – i. Political Acceptability: Contract farming, particularly when the farmer is not a tenant of the sponsor, is less likely to be subject to political criticism. It can be more politically expedient for a sponsor to involve smallholder farmers in production rather than to operate plantations. In recent years, many African governments have promoted contract farming as an alternative to private, corporate and state owned plantations. ii. Overcoming barriers on land restrictions: The majority of the world plantations were established in the colonial era when land was relatively abundant and the colonial powers had little conscience about either simply annexing it or paying landowners least compensation. However, in present days most large tracts of suitable land are either traditionally owned, costly to purchase or unavailable for commercial development. Contract farming, therefore, offers access to crop production farm land that would not otherwise be available to a company, with the additional advantage that it does not have to purchase it. iii. Production consistency and shared risk: Working with contracted farmers facilitates sponsors to share the risk of production failure due to poor weather, disease, etc. The farmer takes the risk of loss of production while the company absorbs losses associated with reduced or throughput non existent for the processing facility. Where production problems are widespread and no fault of the farmers, sponsors will often defer repayment of production advances to the following season. Both estate and contract
  9. 9. 9 farming methods of obtaining raw materials are considerably more reliable than making purchases on the open market. iv. Quality assurance: A steady markets for fresh and processed agricultural produce require reliable quality standards. Moreover, these markets are moving increasingly to a situation where the supplier must also conform to regulatory controls regarding production techniques, particularly the use of pesticides. Both estate and contracted crop production require close supervision to control and maintain product quality, especially when farmers are new with innovative harvesting and grading methods. 2.2 PROBLEMS OF CONTRACT FARMING 2.2.1. PROBLEMS FACED BY THE FARMERS The potential problems as confronted by the farmers due to Contract Farming are given below- i. Possibility of greater risk: Farmers who were entering into a new contract farming venture should be prepare themselves to assess the prospect of higher returns against the possibility of greater risk. Such risk is more expected when the agribusiness venture is introducing a new crop to the area. There may be production risks, particularly where prior field tests are inadequate, resulting in lower-than-expected yields for the farmers. Market risks may occur when the company forecasts of market size or price levels are not accurate. ii. Outdated technology and crop incongruity: The introduction of a new crop to be grown under conditions meticulously controlled by the sponsor can cause disruption to the existing farming system. Again, the introduction of sophisticated machines (e.g. for transplanting) may result in a loss of local employment and overcapitalization of the contracted farmer. Furthermore, in field activities such as transplanting and weed control, mechanical methods may produce less effective results than do traditional cultivation methods. Therefore, Field extension services must always ensure that the contracted crop fits in with the farmers total cropping regime, particularly in the areas of pest control and field rotation practices. iii. Manoeuvring in quotas and quality specifications: Incompetent management can lead towards production exceeding original targets. For example, failures of field staff to determine fields following transplanting can result in gross over planting. Sponsors may also have unrealistic expectations of the market for their product or the market may crumple unexpectedly owing to transport problems, civil unrest, change in government policy or the arrival of competitors. In some situations management may be tempted to manipulate quality standards in order to reduce purchases for honouring the contract. Such practices may cause sponsor-farmer confrontation, especially if farmers have no method to
  10. 10. 10 dispute grading irregularities. Therefore, all contract farming ventures should have forums where farmers can raise concerns and grievances relating to such issues. iv. Corruption: Problems occurs when staff responsible for issuing contracts and buying crops taking undue advantages of their position. Such practices result in a collapse of trust and communication between the contracted parties and soon undermine any contract. In a large contract, the sponsors can themselves be dishonest or corrupt. Governments have sometimes fallen victim to dubious or “fly-by-night” companies who have seen the opportunity for a quick profit. Therefore, in every case farmers who make investments in production and primary processing facilities run the risk of losing everything. 2.2.2. PROBLEMS FACED BY THE SPONSORS The possible problems as confronted by the Contract Farming Developers are outlined below – i. Limitation on land availability: Farmers should have a suitable cultivable land on which they are to cultivate contracted crops. But problems can arise when farmers have minimal or no security of tenure as there is a possibility of drainage in sponsorship investment as a result of farmer - landlord disputes. Difficulties may also arise when sponsors lease land to farmers. Some contract farming ventures are dominated by customary land usage arrangements negotiated by landless farmers with traditional landowners. While such a situation allows the poorest cultivator to take part in contract farming ventures, discrete management measures need to be applied to ensure that landless farmers are not exploited by their landlords. Before signing a contract, the sponsor must ensure that access to land is secured, at least for the term of the agreement. ii. Social and Cultural constraints: Promoting Contract Farming is a cultural, customary beliefs and religious issues. In communities where custom and tradition play an important role, difficulties may arise when innovative farming is introduced. Therefore, before introducing new cropping practices, sponsors must consider the social attitudes and the traditional farming procedures of the community and decide how a new crop can be introduced. iii. Farmers disgruntlement: Sometimes, situations may crop up which may leads towards farmer discontent; e.g. biased buying, late payments, incompetent extension services, poor agronomic counsel, undependable transportation for crops, a mid-season change in pricing or managements impoliteness to farmers will all normally aggravate the relationship between sponsors and the farmers. If not readily addressed, such circumstances will cause antagonism towards the sponsors that may result in farmers withdrawing from projects.
  11. 11. 11 iv. Below quality agro-inputs: Sometimes farmers are forced to use inputs supplied under contract for the purposes other than those they were intended for. They may choose to utilise the inputs on their other cash and subsistence crops or even to sell them. As a result contracted crops yields were reduced and the quality are affected. Improved monitoring by extension staff, farmer training and the issuing of realistic quantities of inputs can resolve the matter successfully. Majority of farmers conform to the agreement when they have information that the contract has the advantages of technical inputs, cash advances and a guaranteed market. However, until a project is very poorly managed, input diversion is usually an infuriation rather a serious problem. v. Sale of crops by the farmers beyond contractual agreement: The sale of produce by farmers to a third party, outside the terms of a contract, can cause major problem to the sponsors. However, extra-contractual sales are always possible when there is an alternative market. The outside buyers offered cash to farmers as opposed to the prolonged and difficult collection of payments negotiated through the cooperative. Sometimes the Sponsors may encourage extra-contractual practices as there are several companies working with the same crop (e.g. cotton in some southern African countries) and they could collaborate by establishing a register of contracted farmers. Managers must be aware of the situation when produce were sold outside the project and also when produce from outside being forced into the buying system. This happens when non-contracted farmers take advantage of higher prices paid by a well-known sponsor. Non-contracted crops are filtered into the buying system by outside farmers through friends and family who have crop contracts. Such practices make it difficult for the sponsor to regulate production targets, chemical residues and other quality aspects. 3-SUGGESTION FOR CONTRACT FARMING MODEL OF AGRICULTURE IN INDIA Based on the above study, the following recommendations are made for an improved Contract Farming Model of agriculture in India – i. Present provisions of institutional arrangement to record all contractual arrangements should be made effective. The Panchayat or Gram sabha, particularly in PESA areas or in case of Forest Right Holder communities, may be connected with this process. This will promote and strengthen confidence building between the parties and also help to solve any dispute arising out of violation of contract. ii. There should be a contract farmers association or cooperatives at the plant level which will improve bargaining power of the farmers and the sponsors and promote equality of partnership. It will also minimise the role of middlemen or commission agents who are involved in marketing of the contract commodities on behalf of the company.
  12. 12. 12 iii. The selection of appropriate plant genotype is one of the crucial factors for Contract Farming. Unless the plant material is of good quality and high yielding and also less prone to pests and diseases, the contract farmers may lose their confidence and discontinue the cultivation of contracted crop. iv. Every contract farming agreement should have a provision for both forward and backward linkages. Unless both input supply and market for the produce are assured, small farmers are not encouraged to participate in contract farming. v. Bank finance to small and marginal farmers should be on easy terms. vi. A sustainable contract farming requires adequate infrastructure facilities e.g. roads, public transport, telephones, postal services, stable power and water supplies, cold storage facilities, etc. Therefore, it is the responsibility of the governments to provide the minimum necessary infrastructure facilities like roads, electricity, cold storage, and market yards. vii. The contracts should be managed in clear and participatory manner so that there is greater social consensus in handling contract violation from either side without getting involved in costly and lengthy process of litigation. Also the terms of contract need to be more comprehensive and flexible. viii. In many parts of the country, agricultural tenancy is legally banned, although concealed tenancy exists. Tenants who do not enjoy security of tenure are unable to participate in contract farming. Hence, legalisation of tenancy is a prerequisite for the tenant farmers who will enter into contract farming. Although different forms of land tenants including share-croppers can be adopted to maintain the contract farming but security of tenure is a must. ix. As assured market of the farm motivates a farmer to enter into contract with a company, similarly market prospect for the processed products of the company should exist. Ultimately, it is the success of the company's product in national or international market, which decides whether contract farming for any particular crop or commodity would sustain. x. The government must ensure that contract farming, which is generally a commodity specific and tends to promote monoculture, does not grow beyond certain limit which will destroy biodiversity and agricultural ecology. xi. The Central Warehousing Corporation and the State Warehousing Corporations should develop commercially acceptable quality standards in respect of various commodities in order to ensure quality maintenance of the stored goods over a sufficiently longer period of time.
  13. 13. 13 xii. Updated database of contract farmers along with other relevant details such as the area & crops under contract, contracting agency, etc. should be maintained at various state levels and should be available to the public through an website. xiii. Agreements written in vernacular language should be given priority so that the local farmers can understand the terms of contract. To suite the other party, it can be made bilingual. Standard formats for farmer-friendly agreement should be designed and mandated by the governments. xiv. Contract Farming in lands recognized under Forest Rights Act is a virtual control of a person or agency other than the right-holder himself/herself and this lead towards violation of the spirit & mandate of the Act; therefore governments should take protective measures in this context. xv. Liability of the contractor for any environmental losses should be fixed by the government, and in case such losses occur, the penalty realized in a proportionately appropriate amount should be spent for restoring the concerned area, preferably through the local Palli sabha/Gram sabha. 4-REASONS WHY SMALLHOLDERS PARTICIPATE IN CONTRACT FARMING Contracts are initiated by those who write them and, as discussed above, agribusiness firms write contracts to either increase profits by expanding operations or reduce profit variability by diversifying supplies. However, if contracts are to work, they must be attractive to potential contractors. Hence, contracts struck with smallholders need to increase farm profits or reduce risk exposure. 4.1 ADOPTION OF NEW ENTERPRISES A farmer considers three factors prior to undertaking a new enterprise or substantially changing the way an existing enterprise is pursued. These are revenue implications, cost implications and any additional exposure to risk that might arise from the new activity. In principle, a contract does not need to improve revenues to be attractive if revenue losses are more than fully offset by cost savings. However, researchers have yet to report examples of contract farming involving expected reductions in revenue and increasing revenue is likely to be important. Two types of farm costs are relevant to adoption opportunity costs and input costs. Opportunity costs occur with a new activity because other on-farm or off-farm activities may need to be curtailed. In essence, new enterprises „crowd out‟ existing activities resulting in lost income (or its equivalent in utility) from these sources. Hence opportunity costs reflect how resources such as labour, land, buildings and machinery are used in existing on-farm and off-farm enterprise or in leisure or community activities. Labour may be used to generate income or diverted to leisure or community activities. Land
  14. 14. 14 is likely to be used for other cropping or livestock purposes or rented out, sheds may be used for on-farm activities such as grading, processing and storage or for industrial piece-work and machinery can be used either on the farm or rented out. Two considerations are relevant to evaluating opportunity costs. First, it is important whether the input is constrained in the sense that more of it cannot be purchased or obtained through negotiation with third parties. For example, if land can be rented in then the opportunity cost of land used in a new contractual enterprise equals its rental value. In contrast, if extra land is not available and the smallholder is „land constrained‟, then the opportunity cost of land in a new contract equals the gross margin of the existing on-farm activity that is curtailed to accommodate the contract. Smallholders may be constrained with other inputs. Hiring in of additional labour may be impossible because it is unavailable and credit may be unavailable because the smallholder has no collateral. The second consideration in evaluating opportunity costs concerns farm inputs that have zero or very low value for the smallholder. De Janvry , Fafchamps and Sadoulet (1991) extend the theory of „shadow pricing‟ to farm input markets where inputs such as land and labour cannot be used because of high transaction costs. An example is where a farm family has surplus labour because it cannot rent in more land to provide employment for family members and things like travel costs, availability of work, social factors or cultural beliefs prevent off-farm work. In this situation, even though the village day rate for labour may be Rs.100,000 the shadow price for the family‟s labour is zero or very low reflecting only subjective valuation of leisure time or participation in village activities. In this sense, the family has a reservation price for its labour, say Rs.50,000 per day, that is never met by the market after transaction costs are The second type of cost is expenses incurred in purchasing farm inputs. Such expenses include hired labour, machinery, seed, chemicals, storage, marketing and rented land. A new enterprise must increase total farm income if it is to be a candidate for adoption by the smallholder .subtracted and hence family labour is under- utilised. Relatively low shadow prices can occur in more subtle ways with land where social factors prevent certain types of activities. An example of social transaction costs in land use is wealthy land owners in Pakistan producing livestock, never crops. Clearly, if a farm contract can provide employment for resources that have very low shadow prices then it will be attractive to the smallholder. Increasing total farm income requires expected revenues to be greater than purchased input costs plus opportunity costs. Adoption also requires farm risk remain at acceptable levels hence the effect of the new enterprise on stability of income is important. How farmers respond to uncertainty is contentious however elements of the problem are captured in safety-first theory, where smallholders will not expose themselves to the risk of their income falling below some minimum threshold level. Farm bankruptcy is relatively common in developed countries where its consequences are
  15. 15. 15 serious though not necessarily dire. In developing countries losing land can be dire and empirical evidence shows developing country farmers generally take more conservative account of uncertainty than developed country farmers. 4.2 REASONS SMALLHOLDERS ENTER CONTRACT FARMING Agribusiness firms are likely to have four areas of strategic advantage that allow cost savings to be conferred on smallholders through contracting :  They may provide services for managing on-farm risk.  They may have access to product markets where high transactions costs effectively prevent smallholder access.  They may have access to relatively inexpensive credit where, for a range of reasons, smallholders face high interest rates or have no access.  They may provide information on extension, logistics and marketing at relatively low cost. 4.2.1 Access to Markets Recent expansion of contract farming is often viewed as part of the broader globalisation phenomenon whereby removal of trade restrictions has led to increased flows of agricultural products, especially from developing to developed countries . Runsten (1992) documents a range of contracts since 1989 for HVF crops including strawberries, melons and frozen vegetables processed in Mexico then exported to the United States by both domestic and multi-national agribusiness firms. Goodman and Watts (1997) document the development of contracts, alongside other multi-national activity, for pineapples and bananas from Central American countries for export to the United States and Europe. Glover and Kusterer (1990) document similar activity in Central American countries and Porter and Phillips-Howard (1997) examine a range of new types of contractual arrangements involving international trade from Africa. Agribusiness firms are instrumental in „opening‟ markets for smallholders in all of these studies. These firms have advantages over smallholders in market knowledge and experience, information links, legal expertise, economies to size in processing and transport and have the financial muscle necessary for sustaining international trade relationships. From a smallholder perspective, in the absence of contracts these markets are „missing‟ in the sense that transaction costs of accessing them on a small scale are effectively infinity.
  16. 16. 16 4.2.2 Access to Credit Non-traditional crops are more costly to produce than traditional crops and cash requirements for farm inputs are usually relatively high. This is because HVF crops often require specialty inputs and have more exacting quality requirements requiring sophisticated technology and flexible use of labour and chemicals. Hence, smallholders need access to credit to undertake production. Many smallholders are credit constrained in the sense they have no access to credit at all. Alternatively, if access is available they face high interest rates, often three to four times the bank rate, from local moneylenders or excessive transaction costs if they use bank credit. High interest rates reflect relatively high costs faced by local moneylenders in sourcing funds and servicing borrowers who do not have collateral. Titles to land may be traditional rather than legal and court processes slow, expensive or ineffective so that small loans are not worth pursuing legally. In this situation, a moneylender is limited to collateralising the smallholder‟s desire for future loans and, since they are often part of the same community, may face social pressure to be benevolent when repayments are delayed by bad seasons or exigencies such weddings and funerals. These high costs are passed on to borrowers by moneylenders in the form of high interest rates. When smallholders seek credit from agricultural banks or micro-lenders, transaction costs are high. On even small loans they may face forced purchases, loan delay costs, travel costs, application fees, legal service costs and collateral titling costs .There are several areas of potential savings for agribusiness firms in providing credit. If the firm is large and well established it is likely to obtain funds at normal business rates. A large firm may also have advantages over moneylenders in management of risk because of the size and diversity of its loan portfolio. That is, investing in a large number of small cash advances allows diversification of lending risk either across participants in a particular contract or across participants in a number of different commodity contracts or activities. The agribusiness firm also has lending advantages by virtue of its contract. A contract allows monitoring of input use, a degree of control over crop management decisions that might jeopardise repayment and can specify how cash advances are to be repaid. Also, contracts require delivery to the firm hence cash advances can be deducted from post-harvest cash settlements. Other loan protection devices include making future contracts depend on meeting repayment clauses in current contracts and making loans in the form of specialised agricultural inputs rather than cash. Finally, there may be no other local market for the contracted commodity than the agribusiness firm thus ensuring diversion of collateralised farm output cannot occur. These factors reduce the need for collateral and mean that agribusiness firms are likely to incur lower costs than moneylenders which can be passed on to smallholders through contracting.
  17. 17. 17 4.2.3 Managing Risk Farmers in developed countries have three basic approaches to the management of risk. First, they can diversify over both on-farm and off-farm enterprises offsetting losses in one activity against gains from other activities. Second, they can smooth income over time by adjusting savings and borrowings to offset low and high income years. Third, they can use futures or forward markets or crop insurance policies covering price and yield variability to reduce risk. In contrast, developing country smallholders have limited strategies for managing risk. Diversification on the farm offers prospects for income smoothing however yield risk may be correlated across enterprises if seasonal conditions are the major determinant of crop yield. There may be scope for scattering plots across a district to diversify yield risk or finding off-farm work or entrepreneurial activity when farm returns are down. Restrictions facing smallholders in credit markets associated with high interest rates and lack of access, discussed above, limit the scope for using borrowings to supplement income in bad years and smoothing income over time. Finally, sophisticated markets for insurance, such as crop insurance and forward and futures markets, usually do not exist in developing countries and remain the province of wealthy farmers who can access international hedge markets. Hence, given the difficulties smallholders face in shifting risk, it is not surprising risk aversion is central in smallholder decision making and particularly so in adoption of new crops and technologies. Entering a contract may mitigate or exacerbate smallholder risk. If upfront investment is required then failure of either the crop or the contract results in loss. Alternatively, if the contract works and becomes integral in the farm plan then it constitutes a form of diversification and may reduce risk providing it does not dominate the farm plan. Agribusiness firms could hedge some price risk for HVF products in options and futures markets to protect their own forward commitments and provide upstream protection to smallholders. However, there is not convincing evidence firms actually do this by putting price guarantees in contracts. We found from interviews with Indonesian smallholders that contracts for seed corn, Mangosteens and ginger stipulated prices based on market prices at time of delivery. Thus, opportunities for reducing smallholder risk through contracting include diversification into a new crop with price movements largely independent of those for traditional products, reduced risk associated with start-up costs and seasonal operating costs met be the firm through subsidies at start-up and forward payments and reduced yield risk from the firm‟s extension activities.
  18. 18. 18 4.2.4 Provision of Information Information can be expensive to gather and is not depleted by use. Hence an agribusiness firm spreading information over many contracts has advantages in providing crop specific information over smallholders gathering their own information. Most contracts described in Glover and Kusterer (1990) included visits by firm extension officers to either individual farmers or farm groups several times during the first year of the contract but often less in later years. These visits combined dissemination of information with suggestions about management as well as providing firms with feedback on issues between themselves and growers. Most developing countries have government extension services to disseminate information about traditional crops however, given the limited nature of developing country government resources, these agencies are unlikely to provide specialised information about new crops. Such specialised information may concern chemical restrictions related to food safety requirements in specific markets, timing of planting and harvest to meet markets, management of product quality and other market and technical information. 5-COMPARISION WITH GLOBAL EXPERIENCE This section will examine some national policies on outgrower schemes (their possible contradictions) and some case study evidence on successful schemes. Most contract farming and outgrower schemes have both private and public sector involvement, although the public sector tends to be more involved in the latter. It is likely that public sector involvement, whether in direct management or in supportive policy, will be necessary if outgrower and/or contract farming schemes are extended to tree farming. For example, transnationals, as well as „development‟ organisations like CDC are reluctant to invest in projects that have a slow maturation period or to finance contract growers themselves. State development banks have taken on part of this role but for this they need to formulate means of enforcing loan repayments; appropriate interest rates and compensation for assuming financial risk. The role the government will play is of course dependent on the specific configuration of power within the country. Insofar as most contracts in African agriculture are mediated by state sponsorship – through actual state investment in processing plants, expropriation of land for use by transnational corporations, setting of prices, enforcement of contracts, and recruitment of labour and smallholders or simply by the state‟s agreeing to provide such basic needs as roads, schools, clinics, and housing in order to make contracting more attractive – the state becomes enmeshed in the social relations of production. In so doing, the state becomes more than an impartial mediator: „it becomes an important battleground for competing interests in the contracting arrangements‟. It is probable that agribusiness companies will have greater political influence than growers, and that governments may not even have much choice in how they deal with the problem of smallholder welfare. However, there is evidence that some governments have intervened on behalf of smallholders through for example,
  19. 19. 19 price stabilisation, guaranteeing debts or trying to obtain better contract conditions and services for smallholders. 5.1 NATIONAL POLICIES Smallholder schemes are attractive to many governments because it appears to provide an avenue whereby small farmers can enter commodity production on favourable financial terms. It also provides a useful mechanism for a variety of explicit and implicit political objectives such as earning foreign exchange, moving populations to new settlements, redistributing land and gaining the political support of the middle peasantry. Most national governments became involved in smallholder schemes and/or in taking over plantations after Independence. In almost all countries where there had been plantations, governments are using tax incentives and credit facilities to influence the plantation sector in line with development objectives. The most common form of public sector support for contract farming manifests itself in a „nucleus estate‟ which encourages the expansion of smallholders around it. In some cases, the plantation itself provides finance training and technology. For example, the United Planters Association of India has a joint program with the Tea Board of India to assist smallholders. In Indonesia, the Nucleus Estates Smallholders Program has made the market for palm oil and tea accessible to smallholders. In the Ivory Coast, smallholdings – called „Plantations Villageoises‟ – are expanding around the large industrial complexes created by government for the exploitation of rubber and palm oil. National policies have also tried to diversify, at a national level, in order to break monocrop dependence and to make contract crops less risk intensive for smallholders. The Philippines, for example, introduced more crops such as coffee, banana, and pineapple to break dependence on sugar. In Malaysia during the 1960–70s there was a shift from rubber towards palm-oil, although rubber recovered its leading role in the 1980s when it was decided the competitive position of synthetic rubber would not decline. Most smallholder programs have government support the case studies below will examine different policy approaches and the reasons for their success and failure. 5.2 THE KENYAN TEA DEVELOPMENT AUTHORITY (KTDA) Kenya has a large plantation sector co-existing with the largest and most effective smallholder sector in Africa. The Kenyan example is interesting to consider for this reason. It has an extremely high rate of population growth (over 4% a year) and is fast approaching a land frontier with alarming levels of poverty, underemployment and malnutrition. Labour is in surplus and will continue to increase with population growth in the absence of alternative sources of non-agricultural employment. By the mid-1980s more than 230,000 households were involved in the contract production of tea, sugar, oilseeds, tobacco and horticulture. About 15.5% of all Kenyan smallholders produce under contract accounting for 40% of tea, 50% of sugarcane, and 80% of tobacco production. The centre of the contract system, and the most renowned part of it is the sugar and tea sectors, both
  20. 20. 20 dominated by large parastatals. Tea was first planted in the 1920s on plantations. Since then the tea output has increased by 700% with a large part of it smallholder contribution. For the last three decades this growth has been steered by KTDA which was established in 1964. The development of contract farming, and the implications for the replication of this development have to be understood in the political history of Kenya. The white settler class which ruled the Kenyan colony, had secured the legislative right to ban peasant production of export crops and to confine Kenyan peasants to crown reserves. The imposition of regulations on production and the expulsion of tenants led to the Mau rebellion in the early 1950s. This was in effect a political emergency and the colonial state targeted tea and pineapple as peasant crops, and after Independence in 1963, the expansion of peasant commodity production. The expansion of tea, coffee, sugar and tobacco was overseen by the state, and later CDC and the World Bank. Watts (1990) argues that the expansion of smallholder tea production is best understood by examining the political motives that underscored it. „In this sense, it is no surprise that in the case of tea, the contract crop par excellence, more than half of smallholder production was located in the Central Province, the overcrowded reserve that both spawned the nationalist revolt against the British and provided the political bedrock of the Kenyatta regime in the postcolonial era‟. More serious than the above is the claim that KTDA has concentrated resources in one area and concentrated on relatively prosperous smallholders. The income effects for the Kenyan tea smallholder are positive with above average standards of living in a normal year. The KTDA has drawn heavily on government resources and imposes direct costs on the government for salaries, which are not recovered from the tea growers. They are also able to draw on the best extension staff. Further, smallholder cash crop production may not be the best option for the rural poor. First, they cannot join if they do not have enough resources of land and secondly, the wages paid by smallholders are amongst the lowest in Kenya. Some commentators have pointed out that plantations are actually better for the rural poor because they are more productive and therefore more labour intensive. 5.3 GHANA AND IVORY COAST Contract farming of oil palm in the Ivory Coast and Ghana provides an interesting comparative study. Both the Ivory Coast and Ghana had a tradition of oil palm production and a growing gap between internal demand and supply at the time of Independence. The two countries both had an interest in the potential contribution of the projects to their post- Independence import-substitution. Both states have a political agenda with smallholders and both brokered the relationship between agribusiness and smallholders. In both states, the organisational model chosen was the nucleus-estate smallholder combination. However, the comparison reveals
  21. 21. 21 the extent to which the terms of the contract and smallholder collective action are dependent on the political space given by the state. The development of the modern oil palm industry in the Ivory Coast started in 1963. The Plan Palmier outlined a program for the establishment of state owned nucleus estates (plantations agroindustrielles) and land belonging to contracted smallholders (plantations villageoises). Funds provided by the World Bank and the European Development Fund played an important role in enabling the implementation of the plan. The state released forest reserves established by the colonial estate for the new plantations and created a land tenure system whereby anyone working the land could have title to it. This land tenure system was enforced by traditional elites and government institutions. By 1984 the estates, operated by the parastatal Palm industrie, constituted 60.3% of the area devoted to oil palm production and 39.7% was constituted by contracted smallholders. Intercropping was prohibited. Peasant producers were offered government subsidies, cash advances and good prices, which reflected the high prices for palm oil in the world market during the 1960s and 1970s. Contracted smallholders were also given a six-year grace period before they had to begin repayment of their debts so participation in the scheme did not require a cash outlay. The average size of smallholding is 4.41 hectares and smallholders must be able to show that the land is commensurate with their labour power and management skills. Security against smallholder default and continuity in oil palm production, are secured through a provision which ties heirs to the loan obligations of the contracted farmer. This was made possible for many by the government policy on immigration that ensured a flow of cheap labour from the Sahel in particular. The development of the contract and the reaction of the contracted smallholders in both countries to deteriorating terms of trade. In the Ivory Coast, peasant resistance took highly individual forms, the diversion of palm nuts to the open market, neglecting trees and not replanting which has led to the under utilisation of plant capacity. These individual responses have not been effective in changing the producer price structure. In Ghana, the smallholders have formed an association known as SHAK which has emerged as a voice for the smallholders dealing with a number of issues including production related matters such as the need for seedlings, timely collection and proper weighing. The issue of food availability and services such as methods of transporting food has also been successfully taken up by SHAK. 5.4 THAILAND Thailand has extensive experience of contract farming with the highest degree of private sector involvement and foreign direct investment. Contract farming has been a central component of the government development plan and its strategy of integrated agricultural development generated through the private sector. The contract farming model used, is one in which private firms supply farmers with inputs, credit and technical assistance and
  22. 22. 22 purchase the farmers outputs. The major role played by private firms in contract farming, is largely due to a credit extension policy that requires commercial banks to extend 20% of their total deposits in rural credits. Commercial banks have preferred to do this through contract farming as opposed to direct loans to smallholders as this reduces the credit risk. The proliferation of contract farming is part of a larger national agrarian restructuring which has shifted Thai agriculture from its traditional dependence upon primary commodities to an integrated agro-food system. However, contract farming has not done very well in Thailand. Public outgrower schemes have never been attempted which reflects Thai agricultural policy of introducing policies that affect the agricultural sector (such as the rule on credit) without intervening directly. Most private contract farming schemes have failed. In some cases early successes in contract forestry were not sustained as firms switched from artificially supported terms designed to attract growers to more realistic terms. But the failure of contract farming in Thailand is better explained by the competitive market. The growers and contractors both have multiple potential business partners, products and non agricultural income sources. These do not meet the condition of quasi-monopsony which appears crucial for contract farming. Contractors fear that growers will apply inputs supplied for contract crops to non-contract crops and contract defaults are the rule rather than the exception. Growers can survive in fluctuating markets by shifting to new buyers or products and capitalising on short term export opportunities. Farmers invest revenue from boom periods in new crops or non-agricultural activities, including real estate, and are able to survive in this way. The preferred mechanism for both Thai contractors and growers to cope in this fast market is the quotaman. This is an intermediary who is able, through personal contacts, to provide access to small producers when necessary without the formality of a contract. Companies can diversify their sources of supply and rely on several quotamen to spread their risks. Quotamen are also better able to judge a growers creditworthiness and their margins are not cut by tax. Contract farming in Thailand has failed because the success of the agricultural sector in Thailand. 5.5 MALAYSIA The Malaysian experience of contract farming is characterised by heavy public sector involvement in land settlement-outgrower schemes and reliance on traditional tree crop exports like rubber and palm oil. The responsible public sector body is the Malaysian Federal Land Development Authority (FELDA), established in 1956. The Malaysian case is interesting because it has had a long experience with outgrower schemes; many schemes are now in the second crop cycle and second generation of farmers. FELDA has set up 442 schemes, covering 714,945 hectares and involving more than 100,000 families. The schemes were designed to settle new lands and to produce a prosperous export-oriented Malay peasantry. Ghee and Dorral (1992) have evaluated the schemes as successful, with a notable success in increasing farmer incomes, long waiting lists of applicants, and
  23. 23. 23 an annual economic return of 20%. The yields which have been achieved on FELDA schemes are impressive, they match those of plantations for rubber and in the case of oil palm exceed those of outgrowers by 30–300% . The contract system itself is very complex and still in a state of development. The settlers are allocated 4 hectares of land to manage which are situated in a larger management block. The system in the 1960s was that settlers were given title to land but a minimum of institutional support and inputs. This system led to poor husbandry and was changed a decade later to a system whereby settlers were assigned to blocks for cooperative work. The settlers arrive 18 months after planting and are allocated 4 hectares each, arranged in blocks of 100 for cooperative work. These plots are managed under the supervision of a field assistant and are worked in a regimented way under his control. On maturity, the holdings become the responsibility of individuals and the field assistant becomes an extension worker. The growers receive title to the land once they have repaid their debt. It was thought that peer pressure would induce the settlers to work, but absenteeism and subcontracting to illegal Indonesian workers became a problem. The latest system under consideration is one of share ownership instead of land ownership. 5.6 INDIA The Indian data come from a survey of 825 farmers covering five commodity sectors: cotton, gherkins, marigold, papaya, and broiler chickens. The study area – nine administrative districts in the southern state of Tamil Nadu – is heterogeneous in its agro-ecological conditions, physical features, and levels of socioeconomic development, spanning districts that are among the richest as well as the poorest in India. The survey was conducted in two phases between 2007 and 2010. The list of contracting farmers for the year of the survey was obtained from one contracting firm in each of the commodities studied. Based on this list, all the villages in the sample area were divided into contracting villages or non-contracting villages. A similar exercise was carried out for the larger administrative units, blocks and districts. Starting from the largest administrative unit for the study area, contracting districts were sampled, within which contract and non-contract blocks were randomly sampled and then further on, within sampled blocks, contract and non-contract villages were sampled. In the villages sampled, a census house listing identified four key types of farmers: those currently contracting; those who grew the contract crop but for the open market or for other firms; those who had given up contracting and those who had never contracted. The sample respondents were randomly selected from each type. Gherkins are a nontraditional export crop with no domestic markets. The crop is procured from farmers and processed at small-scale plants by washing, rinsing, and preserving in brine, acetic acid, or vinegar. Gherkins are then either bottled and labeled for international clients or shipped in barrels for bottling. Cotton is a traditional cash crop in parts of the study area, with established local markets and networks. Recent years have seen mills integrating along the garment chain and extending backward to contract with farmers for good quality, long staple cotton for milling. Papaya was introduced in the region
  24. 24. 24 in the 1990s for extracting papain, an enzyme whose industrial uses range from making meat tenderizer to treating insect bites and other wounds. The variety is not ideal for table consumption, and the fruit is used to make candied fruit or puree. Marigold contracting was initiated by firms for oleoresin extraction for export, mainly as colouring agent for poultry feed. Marigold, however, has a thriving local market as a flower used for a number of ceremonial occasions, religious and otherwise. The broiler chicken industry is almost completely vertically integrated in the study region, a process that began in the mid-1990s. In this case, day-old chicks are provided by the firm and bought back. The firm acts as an aggregator but also has its own brand of chicken in various processed forms. 5.7 MOZAMBIQUE The Mozambican data come from the official agricultural household survey produced by the Mozambican Ministry of Agriculture with the assistance of Michigan State University . The balanced panel for 2002 and 2005 consists of 3480 households. The sample is based on the Agricultural and Livestock Census from 2000, using the standards of the National Statistics Institute. The sampling design aimed at evaluating rural production and incomes representative of rural small- and medium-holders at the provincial and national level. The survey collected detailed information on household characteristics welfare indicators landholdings, employment types, and remittances as well as detailed information regarding farming practices, crops grown, harvested and sold, and livestock, assets, and incomes. In addition, a community level survey for both years collected information on marketing, prices, and infrastructure. The focus of on which this paper draws, is on the impact of farmer groups on smallholder marketing behaviour and welfare, although only a limited share of agricultural marketing in Mozambique during this period was through CFAs. Because of the perceived importance of farmer groups for connecting smallholders to CFAs, the insights of this study contribute directly to the broader meta- narrative.
  25. 25. 25 6-CONCLUSION The rapid transformation of agricultural value chains and spread of CFAs with the rapid rise of Super markets, fast-food chains, and other retailers with downstream market power, along with a more prominent role for global agro-exporters, is one of the more important and fascinating agricultural development phenomena of the past few decades. The relatively high upfront investment required to participate in modern markets is a challenge to participation of smallholders, however. In the same way that much of the early Green Revolution literature focused on limited small farmer uptake of improved seeds, fertilizer and other components of “modern” production systems, a large share of the emerging literature on modern value chains has been concerned with smallholder participation in CFAs and with whether these same value chains might be leaving many poorer farmers behind. This is perhaps unsurprising given that, historically, market sales of food have been heavily concentrated in the hands of a small number of producers, even in regions and countries with broad-based market participation. Although most of the evidence comes from staple grain markets, a relatively small group (i.e. less than 10 percent) of relatively well- capitalized farmers located in more favorable agroecological zones accounts for a significant majority of market sales throughout the world (Barrett 2008). This suggests that gains from agrifood value chain transformation accruing to net sellers in the form of higher profits will likely concentrate in the hands of a relatively modest share of the farm population in the developing world, although there is presently scant hard evidence on this important point. Most empirical studies of the welfare effects of CFA transformation and participation have struggled to establish causality, i.e. to ensure that the estimated impacts on welfare can truly be ascribed to CFAs rather than to unobserved factors. To be sure, most such studies suggest that participating farm households enjoy higher levels of welfare. Few studies, however, have credible controls for the nonrandom pattern of geographic placement of firm contracting and of firm selection of individual suppliers into specific commodity value chains, raising serious questions as to whether the observed associations between farmer income and participation, for example, reflect the welfare effects actually caused by the value chain transformation or merely placement and selection effects. The good news is that some progress is being made in this area as researchers have begun exploiting panel data designs, credible instrumental variables for participation in CFAs, and randomization of interventions to properly control for exogenous drivers of both welfare changes and CFA participation.
  26. 26. 26 Yet much more remains to be explored. In particular, we know little about the effects of participation on potentially more durable and transformative gains associated with improved nutritional status and educational attainment by smallholders children and smallholder households accumulation of productive assets. Likewise, more needs to be done to determine whether the emergence of modern value chains shifts power within the household, for example whether men take over crops traditionally cultivated by women once they become profitable, or grab wives land as it becomes more valuable for cash cropping, although Raynolds (2002) shows that in the Dominican Republic, CFAs for tomatoes increase the demand for women‟s paid labor. This paper has synthesized the findings from some countries – Ghana, India, Malaysia, Thailand and Mozambique – to inform a conceptual work of the determinants and dynamics of smallholder participation in CFAs and to begin to tease out a meta-narrative describing and explaining patterns of participation and effects that are too often elusive in a literature heavily dependent on smallscale, one-off case study evidence. I hope that this synthesis paper helps spur further integrative modeling and analysis of the distributional implications of accelerating structural transformation in the agricultural marketing channels of the low-income world.
  27. 27. 27 7-REFERENCE 1.Narayanan, S. (2010a). “Relationship Farming: The Problem of Enforcement in Contract Farming Arrangements in India.” Working Paper, Cornell University. 2.Asokan, S. R. (2005), “A perspective of contract farming with special reference to India”, Indian Journal of Agricultural Marketing. 3.Kumar J. and Kumar P.K. (2008), “Contract Farming: Problems, Prospects and its Effect on Income and Employment”, Agricultural Economics Research Review. 4. Nakhat,A.N. (2004), “Contract faming: Towards low risk and high gain agriculture”, Agriculture Today. 5. Swain P.K., Kumar C. and Raj Kumar C.P. (2012), “ Corporate Farming vis-a-vis Contract farming in India: A critical perspective”, International Journal of Management and Social Science Research, 6. Fold, N. and K. V. Gough (2008). From Smallholders to Transnationals: The Impact of Changing Consumer Preferences in the EU on Ghana‟s Pineapple Sector. 7. Bijman, J. (2008). “Contract Farming in Developing Countries: An Overview.” Working Paper, Wageningen University. 8. Kirk, C. (1987), Contracting out: plantations, smallholders and transnational enterprise, IDS Bulletin . 9. Shojarani B.N. (2007 ), “Globalization and Contract Farming in India- Advantages and Problems” at dspace . iimk . ac . in bitstream /2259/520/1/637-647+.pdf accessed on 14th December, 2014 10. Dr. Manas Chakrabarti “ An empirical study of contract farming” international Journal of Informative & Futuristic Research (IJIFR)On Contract Farming In India 11. http://www.icar.org.in 12. https://en.wikipedia.org/wiki/contract farming Prospects of Contract Farming in India
  28. 28. 28 5.2. Problems of Contract Farming5.2. Problems of Contract Farming 5.2. Problems of Contract Farming 5.2. Problems of Contract