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Reaching the Benefits of Commodity Derivatives

to Indian Farmers

S Sivakumar, ITC Limited May 2006


Risk: Farmers’ Perspective

 Need: It will be good if I can be assured of my post-


harvest price when I am making my planting decision

 Solution: Sell Futures

 Need: God forbid, my crop production suffers because


there is too little rain, or too much rain, or rain at wrong
time, or some pest / insect attack. Market price goes up,
but I get stuck with smaller crop and lower price

 Solution: Buy Put Option

 Recommendation: Permit Options

S Sivakumar, ITC Limited May 2006


Execution: Farmers’ Perspective
 Need: My objective is price protection for what I am
producing, I can’t manage Exchange margins etc., I
would simply want to deliver my goods & settle
 But: My lot size is too small to take it all the way to one of
the Exchange delivery centre. Cost is too high for that
long distance
 Also: The variety / quality that I produce is not the
Exchange “grade”. In fact my grade fetches me better
price
 Solution: I want to sell & deliver to my regular buyer, if he
can give me an option embedded forward price
 Recommendation: Permit Cash Market Contracts where
pricing could be in the nature of OTC Options
S Sivakumar, ITC Limited May 2006
Option Pricing: Farmers’ Perspective

 Need: While I understand the logic of Option premium,


very often the premium is so high, the option doesn’t look
worthwhile

 Solution: I don’t mind giving up some upside to reduce


the premium

 Possibility: Write options in coupled transactions to


reduce the cost by getting some premium

 Structures: Caps, Barriers, Averages etc

 Recommendation: Do not restrict writing options, in case


of coupled transactions
S Sivakumar, ITC Limited May 2006
Selling: Farmers’ Perspective

 Need: I end up selling immediately after harvest, as I do


not have storage capacity, or because I need cash,
although I know that the price will be higher a few weeks
later

 Solution: Delink Product Delivery, Cash Payment,


Pricing transactions

 Possibility: I can then deliver soon after harvest, take


cash when I want, price when I think it is highest

 Recommendation: Reform APMC Act to facilitate


flexibility to delink. Warehouse Receipt negotiability is a
precondition too.
S Sivakumar, ITC Limited May 2006
Downside of ignoring these needs
 Uncertain Cash flows to farmers shall result in people
moving away from farming business resulting in:
– lower domestic production leading to higher inflation
– higher dependence on imports, leading to trade
imbalances for the Country (larger deficits in BoP)
 Not paying attention to these needs of farmers shall
increase disparity between rich and poor in the country
resulting in:
– Social unrest
– Political tensions
 As 57% of Indian workforce is in agriculture, uncertain
cash flows to farmers shall result in lower growth rates
for the sector slowing down the economy
S Sivakumar, ITC Limited May 2006
Conclusion

 Fragmented Size, Geographic Dispersion, and


Heterogeneity in Circumstances are the fundamental
characteristics of Indian farmer

 Market institutions (futures, options, insurance etc) and


Regulatory Framework (APMC, WHR etc) need to be in
place to make the Indian farmers globally competitive

 Need Institutional Intermediaries who can bundle (i) cash


market transactions, (ii) gateway to exchange
transactions, (iii) OTC options (iv) physical reach into
the villages

S Sivakumar, ITC Limited May 2006


ITC eChoupal is one such potential Intermediary

S Sivakumar, ITC Limited May 2006


What is eChoupal?

 A two-tier infrastructure, specifically designed…


– to deliver multiple services for both farming and farm
produce marketing in an integrated manner
– to suit the unique character of rural India,and
– to cater to the evolving needs of demand driven food
& agriculture value chain
 More importantly…
– Farmers can access information and knowledge free
of cost,
– and have a freedom of choice when it comes to
transactions
– ITC recovers the costs by unlocking value from
streamlining the supply chain
S Sivakumar, ITC Limited May 2006
Characteristics of Rural India

 Farmers are small


– impacting their bargaining power
 Villages are geographically dispersed
– impacting real-time access to information
 Variation in circumstances (agro-ecology, resources)
– impacting costs & scope of customisation

 The infrastructure is also weak, and still evolving


– Physical, Social, Institutional

S Sivakumar, ITC Limited May 2006


And historically, the markets evolved
in this context
 The traditional middlemen…
– made up for the lack of infrastructure
– lent money, sold inputs and bought output
– but, created an exploitative cycle of dependency
 The subsequent institutions set up by the Govt…
– were more appropriate for the supply driven value
chains in an economy of shortages
• e.g. mandi (a fair price discovery mechanism, but
the sunk cost of transport limits choices)
• e.g. agri extension system (delivered great results
during Green Revolution days, where the
communication needs were more generic)
S Sivakumar, ITC Limited May 2006
Demands of the globalising trade
1. Transition from supply-driven to demand-driven value
chains
– Quality as per customer needs (& changing diets)
– Traceability to farms & farm practices (SPS, TBT)
2. Competitiveness in Price / Value equation
– Increased farm yields
– Lower transaction costs along the chain
 Further accentuating the need for…
– Customised knowledge
– Real-time & relevant information
– Access to quality inputs at competitive prices
– Effective vertical coordination of the value chain
– Efficient Price discovery & risk management
S Sivakumar, ITC Limited May 2006
ITC eChoupal, by leveraging Information
Technology, takes on these challenges
 By virtually aggregating the small farmers and linking
them to various entities in the supply chain
• Improving transaction efficiency

 Delivering real time information to many farmers


directly across geographies
• Facilitating informed choices

 Provide customized solutions for a farmer’s specific


need with the help of experts
• Increasing farm yields

S Sivakumar, ITC Limited May 2006


Reaching IT to the Farmer – Tier 1
 eChoupal @ Village Level (Within 5 KM reach of all
target farmers)
– Sanchalak, a farmer selected from within the
village & trained, interfaces between Computer
and the Community
– Computer with Multimedia & Internet Access
– Additional investments in Solar Power & VSATs to
overcome weak infrastructure

S Sivakumar, ITC Limited May 2006


Reaching IT to the Farmer – Tier 2
 Choupal Saagar @ Cluster level (within 30 KM from all
Choupals)
– Samyojak, a trader appointed by ITC, provides
various services under ITC supervision e.g. Quality
Testing, Electronic Weighment, Storage, Payments
– New made-to-design hubs being built, to overcome
the shortage of space in the traditional warehouses
for parking (tractors / trollies) and farmer utilities,
besides many operational problems

S Sivakumar, ITC Limited May 2006


ITC eChoupal Services - 1

 Direct Marketing
– Price discovery in Village Video
• Quality assessment by the Sanchalak Video

– Produce delivery at Choupal Sagar


• Transparent weighment & instant payment
• Sanchalak aggregates and organises transport for
very small farmers

– Links Commodity Futures Exchanges


• Currently price dissemination
• Gateway for transactions at appropriate time
S Sivakumar, ITC Limited May 2006
ITC eChoupal Services – 2
 Training the Sanchalaks in appropriate production
technologies
– who in turn disseminate to other farmers
 Custom built local language web portals contain
– weather conditions forecasts together with
recommended actions & contingent plans
– frequently asked questions on farming
 Web casting of specially prepared video films on best
farming practices Video
 Testing facilities (new as well as access to existing)
– Soil, germination, virus etc
 Supply chain for quality farm inputs Video
– Innovative schemes like self reliance in soy seed
S Sivakumar, ITC Limited May 2006
The Financial Products Portfolio

 Insurance
– Life
– General
• Weather
• Crop
• Motor
• Health
 Credit
 Credit Rating Services

S Sivakumar, ITC Limited May 2006


All these services are delivered through
Collaborative effort

 18 Agri Input Companies (from both


Public & Private sector)

 State Departments of Agriculture


 State Agricultural Universities
 Some Krishi Vigyan Kendras
 National Research Centers of ICAR

 Indian Meteorological Department

S Sivakumar, ITC Limited May 2006


Thank You

S Sivakumar, ITC Limited May 2006