Insuring a risky venture called agriculture

Indian farmers face yield risks as much as they face price risk


A new crop insurance scheme was approved by the Union cabinet on Wednesday. If implemented well, it could help delink agriculture from the associated uncertainties. The scheme, covering all crops, includes small and marginal farmers in its initial phase. It will merge all farm-related insurance schemes and provide cover for production-related risks and price volatility.

India derives about 17% of the gross domestic product from agriculture. If over half the Indian population wasn’t reliant on it for livelihood and agriculture wasn’t the risky venture it is, this figure wouldn’t have been as worrying.

The last financial year recorded the agriculture sector growing at a meagre rate of 2%. The two successive droughts haven’t helped ease matters. Against this backdrop, chief economic adviser Arvind Subramanian has stated that the 2016 annual budget needs to focus on agriculture in the detail it deserves.

The fundamental problem with Indian agriculture is that farmers face yield risks as much as they face price risks. No other sector can claim this level of uncertainty at almost every level of operation—the risk of monsoon failure and infestations during crop growth, the risk of lower prices after harvest, compromise in quantity and quality during storage and distribution, the list goes on. These risks assume higher proportions given productivity and technology lacunae and affects the economy as a whole through the agriculture sector’s extensive linkages.

In this context, the new crop insurance scheme is a well-timed policy. But here is a word of caution: attempts were made in the past to insure the Indian crop market, and almost all of them have failed. Glaring gaps remained in the insurance market years after implementation of schemes like Comprehensive Crop Insurance and National Agricultural Insurance. The extremely poor stayed out of the insurance brackets because of their inability to pay premiums; insurance was made compulsory for farmers who had borrowed money from banks with defaulters not being entitled to claim the insurance; insurers defining areas for each notified crop for calamities excluded many isolated cases of crop failure; adverse selection of crops by farmers continued on account of information asymmetries.

If these implementation shortfalls are not addressed, the entire endeavour risks being written off as yet another sunk cost.

But de-risking agriculture does not begin or end with insurance. The assessment of risk should begin much before sowing and proceed beyond harvest. The decision of what to sow and reap is currently not a well informed choice based on a sound assessment of soil, yield and prices. If insured, small and marginal farmers show an increasing tendency to sow cash crops reliant on the monsoon—a classic case of moral hazard. It is here that better risk assessment, contract design and cooperatives prove handy. Mixed farming and inter-cropping also helps in diversifying the risks generally associated with monocropping.

Commodity futures are yet another solution to achieve price risk management and price discovery. Unfortunately in India, no significant price discovery has occurred in agricultural commodity markets which started their operation a decade ago. This is primarily because of the lack of integration between the futures and spot markets.

An Agricultural Economics Research Association paper cites a number of exchange-specific problems to explain the inefficiencies in futures markets—thin volume, infrequent trading, lack of effective participation of trading members, non-awareness of futures market among farmers, absence of well-developed grading and standardization system and market imperfections.

Resolving these issues would enable the futures markets to finally achieve the objective for which it was established—discovering and managing price. If the newly proposed unified agricultural market is successful in unifying the agricultural prices across mandis in the country, spot markets too will emerge as a winner.

‘No risk, no gain’ may be a favourite adage but true wisdom involves diversifying, insuring and managing risk. The country will do well if it educates its farmers of the same and farmers will do well to heed this advice.

What other measures can help in de-risking agriculture in India?