Proposed Contract Farming Act in India: Possible Risks, Challenges and the Way Forward

Proposed Contract Farming Act in India: Possible Risks, Challenges and the Way Forward

 By:

Vijay Sardana

International Agribusiness and Trade Laws Expert

Production and marketing contracts cover a growing share of agricultural production in many countries.

These formal written contracts are increasingly used in place of spot markets, where commodities are bought and sold for immediate delivery, to set prices for agricultural commodities and market them, as well as to govern product quality, quantity, and production techniques.

It is important to note that the expansion of contracting is closely tied to other developments in agriculture, such as:

· increasing farm size,

· greater demand for customized products, and

· tighter product monitoring from production through marketing.

Contracts can provide farmers with important benefits, such as:

·   reduced income risks,

·   easier access to credit, or

· higher prices for products with special attributes.

In Contract Farming, risk management, cost of operation and dispute resolution will decide the success.

For buyers, contracts can deliver products with desired qualities that reduce processing costs or fulfill consumer demands. But the use of agricultural contracts may also carry costs. They limit farmers' decision-making freedom, and they may lead farmers to exchange price risks in the market for unexpected contract risks.

By reducing spot market volumes, contracts can increase the risks of trading in spot markets, raising costs and undermining the value of traditional price discovery methods (which are useful only to the extent that they provide information about products moving through the entire trading system).

Finally, it is also observed that contracts allow buyers, with a better understanding and better bargaining powers in agricultural commodities exploit market power and reduce prices paid to farmers.

It is important to understand, analyze and evaluate contracting's effects on:

·      existing risk,

·      existing productivity,

·      existing market power, and

·      existing price discovery.

We must anticipate all possible scenarios before we finalize the Contract Farming Act across all cropping systems and allied sectors.

Let us keep the following points in mind while developing a framework for Contract Farming Act if we want to make this act meaningful and relevant to the stakeholders.

· Contracts are more likely to be used by larger producers and for products with special attributes like perish-ability, mandatory processing before consumption or usage or specific parameters to deliver special quality.

· Contract farming dominates in poultry, sugar, paper, tobacco markets, tea, coffee, cocoa, cotton, soybean, milk, seeds, flowers and similar products world over.

· It is not found suitable for general purpose crops like wheat, pulses, fruits, and vegetables, etc.

· Producers may contract mainly to secure higher prices for delivering products with desired (and often higher cost) attributes. This needs better regulatory and tax regime which encourages farm extension services.

· A major benefit of contracts is that they often offer higher prices than farmers could receive in spot markets. In an inflationary economy like in India, this assumption may go wrong.

· Contracts can be designed to greatly reduce growers' risks from price fluctuations, this can be used as hedging tool in the absence of hedging options

· Well-designed contracts also often lead to increased productivity, either by cutting production or processing costs or by enhancing product value, with only secondary attention to risks.

· Contract terms may allow buyers to impose lower prices on producers under some market and quality conditions example lower price if oil content is low or fiber length is less or moisture is high.

· The exercise of market power is of real concern in contract markets, which are often concentrated markets with few buyers and cartelization can push prices down

· Contracts can enhance productivity and response to consumer demand.

· More than required regulatory oversight and interference will limit their use and may raise the cost of doing business and reduce demand for the contracting arrangements with farmers.

· It is important to identify contract terms that extend bargaining power to farmers without reducing efficiency.

· Contracting may complicate market price reporting. The growth of contracting will affect voluntary price discovery system to identify reference price for the contracts and may result in a drop in the number of transactions whose prices are reported.

· Future markets price discovery and their relevance in spot market should be studied to understand price discovery mechanism.

· Contracting creates an ongoing challenge for government policy. To meet their own food safety, product attribute, and environmental goals throughout their supply chains, processors and retailers can use agricultural contracts to control many farm-level production processes. This may increase the cost of production but who will capture this while negotiating on behalf of farmers.

· The expanded use of contracts raises several issues for government regulatory agencies with responsibility for ensuring food safety, food attributes, and environmental control. For example, should contractors bear financial liability for food safety or environmental failures at contractee farms?

· When should a contract be taken as evidence of compliance with public regulations, allowing regulatory agencies to shift inspection resources to facilities or activities that pose higher risks to health and the environment?

·  It is important that before we pass the law, we must undertake few pilots to understand the operational level challenges in understating contract farming.

· Bargaining power of farmers will decide how much risk they are able to negotiate while negotiating prices with the buyer, who will do negotiations on behalf of the farmers to ensure fair deals.

· Are contingency plans acceptable in contract farming in case of natural calamity? Who will bear the cost of insurance?

· Will cost of doing business be less than existing method of doing business?

. Who will be accountable in case issues like Animal welfare and Good Agriculture Practices are not practiced by the farmers?

. If Contract arrangement is for a specific grade, who will ensure the valuation of mixed grade crop and with which formula?

· What is the dispute resolution mechanism to address the conflict between buyer and seller in time bound manner so that disputed crop is not wasted? If the dispute mechanism is tilted towards either side, this will discourage the signing of contracts?

· What if farmers are not in a position to deliver the contracted material due to any reason and all the overheads are already borne by the buyers?

· In case of dispute will reach the courts, who will stand witness with or against whom? Can contracting authorities or assessors will act as a witness? 

Mediation system must be reliable and timely to make contract farming a success.

Political Risk is the biggest threat to Contract farming in India - like stock limit, changes in customs duty, restriction on stock movement by state governments, changes in mandi-taxes, etc will change the whole market structure and price discovery factors. If this happens, either of the contract is bound to loose because of no default of his or her. This will lead to unfair business environment. 

Can anyone in the country ensure that politics, either by union government or by state governments, will not interfere in economic activities? If not, then where is the comfort in entering into legally binding contracts.

Force-majeure clause will be extensively abused because as of today the whole agriculture production system depends upon natures' vagaries in terms of quality and quantity.

The way forward:

The proposed Contract Farming Act must be considered with an open mind. Farmers will only benefit if buyers find that the Contract Farming Act is useful for them. Contract Farming Act must give comfort to the buyers so that they are encouraged to come forward contract farming arrangement, but in the current form, it will not only increase the cost of doing business but will also discourage buyers from coming forward to enter into the contract due to one-sided nature. The proposed law is not balanced in approach.

In place of making entirely new Contract Farming Act, we can make suitable insertions in existing Contract Act to address the need of agriculture and allied sectors mainly with respect to risk management, production uncertainty, and dispute resolution.