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Contract Farming through Agribusiness Firms and State Corporation

Contract Farming through Agribusiness Firms and State Corporation

In order to overcome declining productivity and falling farm incomes in Punjab, the Johl Committee recommended that contract farming be undertaken to reduce costs and provide farmers with better inputs and technical know-how, thereby increasing agricultural yield. This paper compares direct contracts with agribusiness firms and indirect contracts with these firms through the state. Direct contract farming is observed to operate effectively, with positive outcomes for the farmers irrespective of the farm size. Indirect contracts seem to favour only those farmers with larger farms, who do not benefit as much as direct contract farmers.

Contract Farming through Agribusiness Firms and State Corporation A Case Study in Punjab

In order to overcome declining productivity and falling farm incomes in Punjab, the Johl Committee recommended that contract farming be undertaken to reduce costs and provide farmers with better inputs and technical know-how, thereby increasing agricultural yield. This paper compares direct contracts with agribusiness firms and indirect contracts with these firms through the state. Direct contract farming is observed to operate effectively, with positive outcomes for the farmers irrespective of the farm size. Indirect contracts seem to favour only those farmers with larger farms, who do not benefit as much as direct contract farmers.

PARMOD KUMAR

T
he production augmenting technology that heralded the process of the green revolution during the late 1960s and 1970s has started showing signs of deceleration since the late 1980s. It is becoming increasingly difficult to maintain a monoculture of wheat-rice rotation, which has subsequently led to growth-related economic, social and environmental problems in Punjab. There is growing realisation that the current cropping pattern and the strategy of increasing production is progressively becoming costlier in terms of rising costs of production, overexploitation and degradation of land and water resources and in general, the strain on the environment of the state. It is being argued that growth in productivity of important crops has either declined or stagnated, whereas input intensity has been increasing over the years leading to declining total factor productivity [Sidhu and Johl 2002]. Much has already been written on these issues and concern has been expressed by researchers about disquieting aspects of Punjab agriculture [Nadkarni 1988; Johl 1996; Sidhu 1998; Chand 1999; Johl and Ray 2002]. The rising discontent among the farm community due to increasing costs, falling farm income and other problems such as a declining water table, water logging, soil degradation and environment pollution have reached such proportions they are now mounting pressure on the state government to make some serious efforts to address these problems.

To look for solutions to these problems, the state government constituted an expert committee on diversification of agriculture in Punjab under the chairmanship of S S Johl (popularly known as the Johl Committee) in 1986. The committee recommended that at least 20 per cent of the area presently under wheat and paddy must be replaced by other competitive and profitable alternative crops like fruits and vegetables, which accounted for less than 2 per cent of the gross cropped area at that time. Sixteen years after its initial recommendations, the Johl Committee again recommended in 2002 that one million hectares of area under wheat and paddy rotation should be replaced by other crops, which consume less water, are compatible ecologically and are in demand in the country.

Given the Johl Committee recommendations, the state government envisaged contract farming as a step towards achieving cost reduction and value addition on farms by providing the farmers with better seeds and other inputs, improved marketing channels and technical know-how. To give a boost to the diversification of agriculture in the state, the Punjab government launched a multi-crop, multi-year contract farming scheme in 2002.1,2 The Punjab Agro Foodgrains Corporation (PAFC) has been designated as a nodal agency for promoting and coordinating the activities of diversification under contract farming in the state. This public sector agency was set up to provide farmers high yielding variety (HYV) seeds from reputed companies, technical supervision and follow-up on agronomic practices and to buy back the entire produce of the farmers through its tie-ups with buyers/processors/exporters. The PAFC has a very ambitious plan of bringing 2.5 million acres of rice-wheat area under alternative crops through contract farming by 2007 (Table 1).

Besides the PAFC, there are many indigenous and multinational companies (agribusiness firms) which are doing contract farming directly with the farmers in the state. For example, Pepsi is procuring chilly and ‘basmati’ paddy from the farmers under contract farming. Pepsi also plans to enter the business of ginger and garlic paste and processing of several fruits like mango, guava, orange and other citrus fruits. Frito-Lay, a subsidiary of Pepsi in the business of potato chips, procures potato from the farmers under contract farming. Hindustan Lever (HLL), a subsidiary of Uniliver, is contracting farmers to procure basmati paddy for processing and exporting basmati rice. Similarly A M Todd (previously Indo-mint) is doing contract farming in medicinal plants and Chambal Agritech is in the business of potato seeds.

I Review of Studies on Contract Farming

Since the contract farming system in India is a recent phenomenon, research in this field is still at the early stages. In a study on contract farming in tomato in Haryana, Dileep et al (2002) observed that contract farming system for tomato considerably reduced the yield uncertainty and completely removed the price uncertainty among its farmers. The study observed that the processing firms were biased towards large farmers while selecting farmers for the contract. Their major suggestion was that the contracting system be made legally obligatory on the part of the contract farmers and the processing firms to strictly adhere to the contract by bringing suitable legislative measures by the government.

Singh and Asokan (2003) studied four different cases of contract farming, namely gherkins, basmati paddy, broiler chicken and safflower. They observed that gherkin farmers were satisfied with contract farming as the returns were higher than competing crops. Basmati paddy growers, however, were not satisfied as their yield and income were lower compared to normal paddy. In the case of broilers, the growing charges paid to the farmers were low compared to their investment, making the investment non-viable. Regarding the case of safflower, the authors were not able to meet any of the growers due to time constraint.

Dev and Rao (2005) examined contract farming in oil palm and gherkin in Andhra Pradesh. The authors observed that despite various shortcomings, on the whole contracts were working well in both the crops. While contract farming had solved the problem of supply of quality raw material for the processors, the latter were unable or even in some instances unwilling to meet the needs of the cultivators. The authors also observed that contracting firms preferred large farmers and in some cases neglected the smaller ones. Authors therefore suggested for some form of government intervention to ensure proper enforcement of contracts especially in the case of small and marginal farmers.

A few observations made by some other studies [Rangi and Sidhu 2000, 2003; Singh 2000, 2002, 2004 and 2005] are that results of contracting are very promising in the early years. Farmers benefit from improved technology and higher productivity, quality and production. However, once farmers deploy themselves into the new technology, problems start cropping up. If the market price is more advantageous than the contract price, farmers renege on the contract. Generally the contracts are not written and the legal enforcement system is too tedious for both growers and firms. Other criticisms levelled against contract farming in these cases are that it generally prefers labour saving farm practices; the level of commitment of rural development is lower than that of corporate development; lack of transparency and too few institutions and NGOs for proper dissemination of information for the success of contract farming.

II Objectives of the Study

In light of the above facts, it is worthwhile to evaluate contract farming in a wider framework and make an objective assessment of the system. The paper makes an attempt to systematically analyse the two models of contract farming (PAFC and direct contract by agri-business firms) followed in Punjab in the framework of small versus large farmers. In a number of cases it has been reported that contract farming is more viable for large farmers and it exploits the small ones. This study evaluates these aspects on the basis of the empirical findings of operations of contract farming in Punjab.

The paper is organised in the following order. After presenting the database and methodology used in the paper, the major findings of the primary survey are discussed in Section III. The section presents the functioning and performance of PAFC and agri-business firms engaged in contract farming, discusses the household characteristics of contract and non-contract farmers and presents the cropping pattern. It also puts forward economics of production and resource use efficiency of the selected contract and non-contract farmers and evaluates the productivity of contract versus non-contract farmers by estimating a production function using the ordinary least squares method. The last section summarises the major findings and offers policy suggestions.

This paper is based on a primary survey of 200 households, comprising 100 each of contract and non-contract farmers in Punjab. The selection of the sample broadly involves the following stages. At the first stage, all the firms involved in contract farming in Punjab were contacted and a list of farmers who were active participants in contract farming during the preceding year was obtained. The list included the names and addresses of the farmers and their contracted area crop-wise. Based on this list, farmers were chosen by the stratified random sampling method. However, as the firms could not provide information regarding the operational size of the holdings, it was not possible to give a proportionate representation to different size classes of farmers. For the selection of non-contract farmers, no such list was available. Therefore, keeping in mind the objective of the study to prepare a baseline to make a comparison between contract and non-contract farmers, non-contract farmers were selected in the peripheral areas with a similar cropping pattern as that of contract farmers. Further, the company’s perspective was construed directly by guided interviews and informal discussions with the management, officials and other field employees. Table 2 in the Annex gives a description of contract and non-contract households selected from each district and by farm size categories.

III Empirical Results

Functioning of the Contracting Firms

Before starting a discussion on the major findings of the study, it would be imperative to give a brief description about the firms engaged in contract farming and specify their modes of operation in the field. Two types of firms were operating in contract farming. The first type belonged to those agribusiness firms, which had a direct contract with the farmers and were responsible for providing inputs/extension services to the farmers and were procuring the end product directly from the farmers. The firms operating under this category were (i) Pepsi/Fritolay, (ii) HLL,

(iii) Chambal Agritech, and (iv) A M Todd. The second type belonged to those companies, which were operating through the PAFC. There was a set of three types of companies with which the PAFC tied up to provide inputs and extension services to the farmers and to buy back their contracted crops. The first set belonged to the seed companies namely, Pro Agro; Advanta India; Sygenta India; Pioneer India; and Monsanto. The second set belonged to the consultant companies engaged by the PAFC for consultancy on agronomic practices to the contract growers. These companies were: Escorts, DCM Sriram, Mahindra Shubh Labh, and Tata Chemicals. The third set belonged to the buyers/ processors/exporter companies who tied up to provide a buy-back guarantee to contracted farmers and to provide forward linkages for their produce. The major companies in this category were: LT Overseas, KRBL, United Breweries and Cargil. It was a tripartite agreement between the farmer, the PAFC and the companies providing seeds, extension services and buy-back guarantee to the farmers on behalf of the PAFC.

The contract in most of the cases was written but without any legal obligations both on the part of firms as well as farmers. Most of the firms provided seeds to the farmers at a market price

Economic and Political Weekly December 30, 2006

and in some cases firms provided necessary machinery and implements either at nominal charges or free of cost. The major criterion followed by firms while selecting farmers for contract were: the geographic location of the farm; farm size;3 the socioeconomic strength of the farmer possession of mechanical implements, irrigation sources and willingness of the farmer to acclimatise to the new eventualities. None of the firms provided any direct credit to the farmers although a few of them had a plan to introduce the same in future. Similarly, no firm was providing any crop or other insurance to the contracted farmers.

Out of the two models of direct contract and indirect contract (through the PAFC), it was observed that only the former was operating effectively. In the case of direct contracts, companies provided farmers a good variety of seeds and extension services and procured their end product at the pre-agreed price. In most of the cases, these companies had their own qualified consultants/ technocrats who guided the farmers about sowing and harvesting operations. To encourage farmers to produce quality products, these companies generally did not charge farmers for consultancy services. While Chambal Agritech and A M Todd lifted the produce from the farm gate at the company’s cost, Pepsi/Fritolay and HLL asked farmers to deliver their product at the pre-agreed procurement point. In the case of indirect contracts, however, farmers were not happy with the services of the companies. Although, there was a written contract between the farmers, PAFC and service providers, there was a complete lack of knowledge on the part of farmers and a lack of commitment on the part of service providing companies. The farmers did not have any information about the service providers and in some cases they even had to pay a lump sum amount in lieu of the services, which were never provided to these farmers. For some crops like maize, sunflower and durum wheat, farmers were provided with seeds in the beginning, but after planting the crop no extension services were provided to the farmers and neither was any provision made to collect the contracted produce. As a result, farmers were forced to sell their product in the open market. In the case of direct contracts, firms purchased the contracted quantity only if the produce could pass quality norms set in the agreement. The produce which could not qualify under the norms was rejected by the firms without compensating the farmers for the rejected lot.

In the household analysis, for the sake of generalisation and to draw some useful conclusions, contract farmers under different firms have been clubbed together in two categories. The first category belongs to those farmers who were engaged in direct contracts led by agribusiness firms. The second category belongs to the farmers engaged in indirect contracts through PAFC led companies. The results are discussed in the following sections.

Distribution of Households and Their Size of Holdings

The last three decades of commercialisation have heavily burdened the state/farmers with the use of certain inputs such as tractors, pump-sets and chemical fertilisers. As a result, per hectare return on land has started either stagnating or declining [Ghuman 2002]. In the given circumstances, small and marginal farmers have started leasing out land in favour of medium and large farmers, a phenomenon widely quoted in the literature as “reverse tenancy” [Singh 2000]. Reverse tenancy is also evident from the fact that the number of operational holdings are increasing all over India while they are declining in Punjab.

The total number of operational holdings in Punjab declined from 13,75,000 in 1970-71 to 10,88,000 in 1985-86 and further to 10,38,000 in 1995-96.4 It is mentioned at the outset that the new system of contract farming is even more inclined towards medium and large farmers. The companies prefer large growers for contracts, perhaps to avoid problems of dealing with too many small growers [Glover and Kusterer 1990]. The earlier studies on contract farming in Punjab also supplement the above argument.5

In the present case, no marginal farmer in the size group of below one hectare was found operating under contract farming. A handful of small farmers in the size group of one to two hectares were operating and a few of them were selected. The majority of farmers operating under contract farming belonged to the medium and large farmers and that was also represented by our selected sample. In the present analysis, we have categorised farmers above 10 acres into large and very large farmers. Thus, the analysis consists of five categories: (i) marginal farmers operating 0.01 to 2.50 acres, (ii) small farmers with operational holdings from 2.51 to 5 acres, (iii) medium farmers with operational holdings between 5.01 and 10 acres, (iv) large farmers with operational holdings between 10.01 and 25 acres, and (v) very large farmers with operational holdings above 25 acres.

Table 1 presents the main characteristics of the selected households. The table shows that the average household size was not different across the two categories of contract versus non-contract farmers. Across farm size, the total number of family members varied between 5 and 10 and as expected the family size of large farmers was higher compared to small farmers because of the prevalence of the joint family in the former case and nuclear family in the latter case. It is interesting to note that the net operated area among all size classes was higher than their operated area on account of their higher leasing compared to leasing out of land. However, the noteworthy point is that out of their operated area, contract farmers leased in around 43 per cent whereas non-contract farmers leased in only 29 per cent. Further, in the case of contract farmers, small cultivators leased in 7 per cent of their operated area whereas very large cultivators leased in 46 per cent of their operated area. In the case of non-contract farmers, the difference between small and large farmers was much less, 14 and 36 per cent, respectively. It is apparent that a larger size of operational holdings seems to be more economical under contract farming and as a result, even large farmers tried to increase their operational land to gain economies of scale by leasing in more land. It also verifies our earlier assertion that contract farming has a tilt towards higher size of operational holdings. This trend in the long run might cause a restructuring of holdings towards a more viable operational size appropriate for the use of modern implements.

The average size of operational holdings was 37.3 and 22.6 acres respectively, in the case of contract and non-contract farmers. Last but not least, out of the total cropped area by contract farmers, only 15 per cent was placed under contract crops and 85 per cent was kept under non-contract crops. The figure for contract crops varied between 12 and 24 per cent across various farm sizes. Thus, contract farmers of all categories perceived contract farming as a risk of losing returns in case of rejection of their produce by the companies on quality grounds, as was mentioned in the previous section. Therefore, they tried to maintain immunity against risk by planting at least two-thirds of their operated area under non-contract crops.6 However, it is worth mentioning that contracting firms did not exert any pressure on the farmers and the judgment of keeping a certain amount of operated area under

contract or non-contract crops remained with the farmers rather over from paddy to alternate kharif crops does not seem to be than with the operating firms. working so far among the farmers covered in our field study.

Cropping Pattern

The cropping pattern of contract and non-contract households is presented in Table 2. No perceptible differences in terms of types of crops grown by these two categories of farmers are evident from the table. In both the cases, paddy and wheat were the predominant crops despite introduction of some new crops like paddy basmati, potato seed, mint, durum wheat and hyola by the contracting firms. Around 64 per cent of gross cropped area was under wheat and paddy in both these cases. An identical cropping pattern of contract and non-contract farmers was the outcome of our selection procedure because while selecting the households, a close peripheral area was chosen for both the sets of farmers to fulfil the basic objectives of the study.

However, a close scrutiny of the cropping pattern of selected households and its comparison with that of the state average reveals that in fact, contract farming in the selected areas has, to some extent, brought in diversification in the sowing pattern of ‘rabi’ crops. Particularly, some area of the wheat crop has been successfully replaced by other rabi crops. This is clear from the table as area under wheat by the selected households was only 31 per cent against the state average of 43 per cent. The crops, which replaced the wheat area were potato, sunflower, potatoseed, mint, and hyola in that order. In fact, the combination of potato and sunflower constituted a very magnificent alternative to the wheat crop as growers could take advantage of double crop in lieu of wheat in the rabi season.7 In addition, some farmers found the combination of potato and mint and potato and hyola as better alternatives to the wheat crop. In the ‘khariff’ season, however, no such lucrative alternatives were available to the farmers. Some farmers opted for basmati paddy, which was a better option in terms of delayed sowing with the arrival of monsoon as well as in terms of less water requirement. Unfortunately, the other alternative crops like maize, khariff pulses and khariff oilseeds like groundnut could not compete with paddy in terms of net profitability.

Nonetheless, the problem of sustainability of the cropping pattern in the state remains. The main objective of state-induced contract farming was to achieve diversification of paddy area because of acute water problem in the latter case, while wheat has no major sustenance problem. The PAFC model of switching

Economics of Production, Cost and Resource Use Efficiency

Gross farm output is a function of area sown and yield rate per unit area, which in turn depend on land availability, technology used and composition of farm inputs applied by farmers. Table 3 presents the value of gross output per household and per acre for contract and non-contract farmers. A positive association between the value of output per household and farm size is clearly visible for all the three categories of direct, indirect and non-contract farmers. It is interesting to note that the average value of output per household was almost double in the case of direct contract farmers (Rs 1,387,000) as compared to non-contract farmers (Rs 6,93,000) while indirect contract farmers had a lower output than contract farmers (Rs 11,22,000).

Table 2: Cropping Pattern of Selected Farmers

(Percentage of gross cropped area)

Contract Farmers Non- Gross
Direct Indirect Non- Contract Total
Contract Contract Contract Farmers
Crops Crops Crops
P addy 0.0 0.0 38.7 31.3 32.2 (32.5)
Wheat 0.0 0.0 36.1 32.3 31.2 (43.1)
Basmati 25.8 31.3 0.0 2.3 3.5 (-)
Potato 31.3 0.9 9.8 13.5 12.4 (-)
Potato-seed 26.8 0.0 0.0 0.0 1.8 (-)
Mint 15.2 0.0 0.3 0.0 1.2 (-)
Maize 0.0 34.5 1.2 3.5 2.9 (2.1)
Sunflower 0.0 20.8 5.6 6.0 5.8 (-)
Durum wheat 0.0 9.6 0.0 0.0 0.3 (-)
Hyola 0.0 2.9 0.0 0.1 0.1 (-)
Groundnut 0.8 0.0 0.0 0.1 0.1 (0.1)
Other coarse grains 0.0 0.0 0.0 0.1 0.0 (0.4)
Other pulses 0.0 0.0 0.8 0.4 0.6 (0.7)
Other oilseeds 0.0 0.0 0.1 0.3 0.1 (1.0)
Sugar cane 0.0 0.0 1.6 0.7 1.1 (1.6)
Cotton 0.0 0.0 0.1 0.3 0.2 (6.6)
Other vegetables 0.0 0.0 1.3 0.4 0.8 (-)
Fruits and plantations 0.0 0.0 0.3 3.7 1.6 (-)
Green fodder 0.0 0.0 4.2 5.2 4.2 (-)
Other crops 0.0 0.0 0.0 0.0 0.0 (12.0)
Total 100.0 100.0 100.0 100.0 100.0

Note: The figures in parentheses are percentage of GCA in Punjab during the TE 1999-01.

Source: Calculated based on data obtained from Economic Survey Punjab, various years.

Table 1: Main Characteristics of Selected Farmers

Household Size Main Earners Owned Area Net Area Net Operated Cropping Intensity Area under (No) in Agriculture (Acres) Leased in Area (Acres) Contract (No) (Acres) Farming (Acres)

Contract farmers

Marginal ––– –– – – Small 5.00 1.50 4.00 0.00 4.00 2.06 2.00 (24.2) Medium 5.42 1.25 8.79 0.63 9.42 2.05 2.31 (12.0) Large 7.46 2.17 12.40 5.15 17.54 2.11 7.56 (20.4) Very large 7.35 2.11 27.89 23.47 51.35 2.07 15.74 (14.8) Aggregate 7.10 2.01 21.40 15.86 37.26 2.08 11.89 (15.4)

Non-contract farmers

Marginal 3.00 1.50 1.50 0.25 1.75 2.00 0.00 Small 5.25 1.25 3.91 0.16 4.06 2.06 0.00 Medium 6.74 1.89 6.66 1.76 8.42 2.03 0.00 Large 6.72 2.00 13.38 3.22 16.60 2.05 0.00 Very large 9.71 2.50 37.08 20.44 57.52 2.20 0.00 Aggregate 7.13 1.97 16.04 6.53 22.57 2.14 0.00

Note: The figures in parentheses are contract area as a percentage of gross cropped area.

Economic and Political Weekly December 30, 2006

Nonetheless, the household analysis does not reveal the whole picture as it ignores the differences that crop up due to differences in area operated by the households. Therefore, a comparison based on value of output per acre also known as productivity in value terms seems to be more logical. The productivity statistics in Table 3 clearly show a visible edge of direct contract farmers over their counterpart indirect and non-contract farmers in all size classes. On the other hand, productivity of non-contract farmers compared very well with that of indirect contract farmers. The difference in productivity of direct and indirect contract farmers was Rs 2,000 in the case of small farmers, which increased to above Rs 10,000 in the case of very large farmers. Thus, productivity per acre in the case of direct contract farmers clearly indicated a rising trend across farm size. A similar trend was also observed in the case of non-contract farmers whose productivity increased from Rs 21,000 in the case of marginal farmers to Rs 31,500 in the case of very large farmers. The productivity of indirect contract farmers was almost same across various farm size classes. On an average, direct contract farmers’ per acre productivity was Rs 38,500 compared to Rs 28,500 of indirect contract farmers and Rs 30,700 of non-contract farmers.

The above presented a comparative analysis of value of output per acre for contract and non-contract farmers. However, it is worth mentioning that the gross value of output of contract farmers comprises value of contract crops and the value of non-contract crops grown by these farmers. If we want to compare productivity of contract crops with that of non-contract crops, in that case, it is implicit that we should compare the value of output per crop instead of value of output per acre, the analysis is done in the next section. Table 4 presents the value of output per cropped area.

Comparing productivity per acre of cropped area, it is seen from the table that there were no significant differences between the crop productivity of contract and non-contract farmers for the non-contracted crops. On the other hand, crop productivity on contracted area presented a contrasting picture for the direct and indirect contracts. Productivity per acre of cropped area was almost twice (Rs 27,900) for direct contract crops but far below (Rs 11,400) for the indirect contract crops. Thus productivity of indirect contract crops was even less than that of non-contracted crops as well as that of non-contract farmers. Across different size classes no uniform trend was found between crop productivity and farm size for all contract as well as non-contract farmers.

Thus, the productivity trends observed above indicate that agribusiness firms led (direct) contract farming helped farmers raise their productivity level to much more than their counterpart indirect contract farmers. It was partially because of the extension services by the highly educated technocrats of the firms and better variety of seeds and other inputs provided by these firms along with a better price package for the contracting farmers and partially because of high value crops grown under such contracts, for example potato for chips; potato seed; basmati paddy and medicinal plants (Table 5). State enterprise-led firms on the other hand not being very precise in their strategy towards extension services and buy-back provisions to the farmers and also because of the traditional nature of crops like cereals, pulses and few oilseeds supported by these firms (Annex Table 1) did not prove to be very helpful to the contracting farmers and as a result, value of their productivity remained equal or even less than that of non-contract farmers.

It is evident from Table 5 that those farmers who contracted with agribusiness firms were able to sell more than 85 per cent of their output to the firms. Around 15 per cent output in basmati was not picked up by the firms due to moisture content and around 23 per cent of potato crops were rejected due to size and sugar norms. In the case of indirect contracts led by the PAFC on the other hand, no procurement at all was made by the designated firms like Escorts, Mahindra Shubh Labh and Tata Chemicals. Only in the case of basmati, a small amount was purchased by DCM Sriram and Tata Chemicals. Further, the price received by farmers in the case of direct contracts was much higher compared to market price with the exception of basmati paddy. In the case of indirect contract farmers, the latter had no option but to sell in the open market as neither the PAFC nor its designated firms came forward to purchase their product despite having a written contract.

Table 3: Value of Output of Selected Households

(Rs)

(Criterion I)

Contract Farmers Non-contract Direct Contract Indirect Contract Farmers Led by Agri-Led by PAFC business Firms

Per household
Marginal 36995
Small 143080 79360 104084
Medium 340024 276773 211667
Large 641525 513039 513005
Very large 1955076 1510431 1815051
Aggregate Per acre of operated area 1387628 1122733 693294
Marginal - - 21140
Small 28616 26453 25621
Medium 35792 29921 25135
Large 37056 28502 30899
Very large Aggregate 38856 38511 28499 28531 31555 30724
Table 4: Value of Output of Selected Households

(Rs)

(Criterion II)

Contract Farmers Non-contract Contracted Crops Non-Farmers Direct Indirect contracted Contract Contract Crops

Per cropped area

Marginal ---10570 Small 11767 14000 13851 12428 Medium 29918 13360 14876 12393 Large 27580 10528 14720 15071 Very large 28001 11563 15621 14318 Aggregate 27940 11399 15497 14338

Table 5: The Performance Indicators of Two Types of Contracts

Percentage Percentage Average Average of Output of Output Price Paid Price Sold by the Procured by the Firm Received

Farmers by the Firm from the Market

Direct contract led by agribusiness firms

Basmati paddy 99.5 86.6 1112 1271 Groundnut 100.0 100.0 1300 – Mint (medicinal plants) 100.0 100.0 408 – Potato 97.6 75.9 467 195 Potato-seed 100.0 91.7 345 167

Indirect contract led by PAFC

Basmati paddy 98.3 1.8 1150 1255 Durum wheat 100.0 0.0 – 641 Hyola 100.0 0.0 – 1623 Maize 99.6 0.0 – 510 Potato 100.0 0.0 350 Sunflower 100.0 0.0 – 1458

Note: The average price is in Rs per liter for mint and Rs per quintal for all other crops.

The productivity trends seen above present only the revenue aspect and trends in farm income might be completely different from that of land and crop productivity as presented above. It needs to be mentioned that higher crop productivity for direct contract crops may partly be because of the predominance of potato and potato seed crops, which had much higher value of output compared to wheat and rice. On the other hand, expenses on seed and other operational costs incurred by farmers in the former case were much higher compared to the latter. Therefore, the farm business income or net return from contract crops might not be as lucrative as they look from their crop productivity.

The trends in cost incurred and total returns realised by the contract and non-contract farmers are presented in Table 6.8 The cost of cultivation includes all elements of input cost involved in the production of crops right from the stage of preparatory tillage to the final stage of collecting produce in the form of grains and their by-products. A glance at the statistics reveals that out of total cost of cultivation, fixed cost constituted around half of the amount in the case of non-contract farmers and a little more than half in the case of direct and indirect contract farmers.

As was pointed out earlier, the cost of production was generally higher in the case of direct contract farmers because of their higher intensity of vegetable crops as compared to their counterpart indirect and non-contract farmers. In majority of the cases, this was also true across all size categories. For example, on an average, the material cost per acre was Rs 10,583 for direct contract holders and Rs 7,954 for indirect contract holders while it was Rs 9,079 for the non-contract holders. The similar comparison for total fixed cost was Rs 14,252, Rs 12,399 and Rs 11,567 respectively, for direct, indirect and non-contract farmers. The total cost of cultivation was observed as Rs 27,641 and Rs 22,343 for the direct and indirect contract farmers, and Rs 22,964 in the case of non-contract farmers. Similar comparison also holds for small, medium and large farmer categories.

Accordingly, the difference in net returns among the direct, indirect and non-contract farmers was not as high as it was observed in the case of total value of output in the previous section. The gross value added defined as total value of output minus total material cost was observed to be Rs 28,000 per acre for direct contract farmers, while the figure was slightly less than Rs 21,000 per acre for indirect contract farmers and slightly above that amount for the non-contract farmers. The difference in gross output per acre of direct and indirect contract farmers was Rs 9,980, which came down to Rs 7,351 for the gross value added by these two categories of farmers. The difference between direct contract and non-contract farmers came down from Rs 7,787 for the gross value of output to Rs 6,283 for the gross value added per acre.

Table 6 shows two estimates of farm business income (FBI). In the first case, FBI1 is calculated by subtracting value of total cost (excluding the rental value of own land) from gross value of output. In the second case (FBI2), while subtracting total cost from total output, the rental value is also included in the total cost. The FBI2 is the estimate of net returns to the farmer after subtracting all paid out and imputed costs including the cost of operated land. FBI1 on the other hand, is the carryout income of the farmer from farming business after bearing all paid out expenses and depreciation on her capital assets. A glance at farm income data reveals that while FBI2 indicates higher net returns to the large holders in the farming business for both the categories of contract farmers as well as that of non-contract ones, FBI1

Table 6: Input Use, Output and Returns Per Acre Realised by Contract and Non-contract Farmers

(Rs per acre)

Farm Size Total Material Total Fixed Cost Total Cost Gross Value Farm Business Farm Business
Cost Added Income1 Income2
Direct contract led by Small 6439 17193 26352 22177 17464 2264
agribusiness firms (24.4) (65.2) (100.0) (84.2) (66.3) (8.6)
Medium 9373 16578 29260 26419 19172 6532
(32.0) (56.7) (100.0) (90.3) (65.5) (22.3)
Large 10803 14887 28797 26253 18261 8258
(37.5) (51.7) (100.0) (91.2) (63.4) (28.7)
Very large 10610 14119 27472 28246 17048 11384
(38.6) (51.4) (100.0) (102.8) (62.1) (41.4)
Aggregate 10583 14252 27641 27928 17268 10870
(38.3) (51.6) (100.0) (101.0) (62.5) (39.3)
Indirect contract led by PAFC Small 6309 15200 23942 20144 17711 2511
(26.4) (63.5) (100.0) (84.1) (74.0) (10.5)
Medium 9197 18502 29702 20724 13192 219
(31.0) (62.3) (100.0) (69.8) (44.4) (0.7)
Large 8507 12263 23064 19995 12383 5438
(36.9) (53.2) (100.0) (86.7) (53.7) (23.6)
Very large 7859 12300 22113 20640 14488 6386
(35.5) (55.6) (100.0) (93.3) (65.5) (28.9)
Aggregate 7954 12399 22343 20577 14254 6188
(35.6) (55.5) (100.0) (92.1) (63.8) (27.7)
Non-contract farmers Marginal 6190 8066 17170 14950 10827 3970
(36.1) (47.0) (100.0) (87.1) (63.1) (23.1)
Small 8015 13534 24080 17605 10341 1541
(33.3) (56.2) (100.0) (73.1) (42.9) (6.4)
Medium 7497 10380 20320 17639 12320 4815
(36.9) (51.1) (100.0) (86.8) (60.6) (23.7)
Large 8629 13957 24733 22270 16379 6166
(34.9) (56.4) (100.0) (90.0) (66.2) (24.9)
Very large 9531 10869 22771 22023 15290 8783
(41.9) (47.7) (100.0) (96.7) (67.1) (38.6)
Aggregate 9079 11567 22964 21645 15243 7760
(39.5) (50.4) (100.0) (94.3) (66.4) (33.8)
Note: Figures in parentheses indicate percentage to the total cost.
5372 Economic and Political Weekly December 30, 2006

indicates no major differences in the carryout returns to the small and large farmers in all these cases.

Functional Analysis of Farm Productivity

The tabular analysis presented above suffers from the limitation of not being able to segregate the quantum effect of multiple variables present in any relationship. The multiple regression is a tool which gives us both the direction as well as the quantum effect of each variable present in the relationship. The ordinary least squares (OLS) estimates of farm productivity are presented in Table 7. The relationship was preferred in proportionate form as in absolute terms most of the regressors were highly collinear.

First explaining the aggregate production function (all farmers), all the variables were highly significant with a positive sign. The coefficient of operated area indicates that the farm productivity was increasing with the increases in farm size. The positive relationship seems to be an outcome of higher use of mechanical operations in sowing and harvesting activities in the state, as the latter implicates a clear advantage of economies of scale to the large holders. The higher use of machines in the production process is also pointed out by the high elasticity of mechanisation and tractor. Fertiliser and plant protection and human labour were the other variables, which had high elasticity. The high elasticity of human labour points the fact that despite high mechanisation, certain activities in the sowing and harvesting operations especially in fruits and vegetable crops are still reserved for human labour.

Comparing the production functions of direct, indirect and noncontract farmers, it is observed from the results that the operated area was significant in the case of direct contract and non-contract farmers while it was insignificant in the case of indirect contract farmers. The implication is that large farmers having higher level of investment in mechanical instruments drew the benefits of economies of scale and observed higher productivity per acre only in the case of direct contract and non-contract farmers. In the case of indirect contracts, productivity of large farmers was not significantly different from the smaller ones as was also seen in the tabular analysis in the previous section. In the case of seeds and mechanical operations, the coefficients of direct contract farmers had higher value indicating availability of better seeds to direct contract farmers from contracting companies and better use of mechanical tools by the these farmers because of the scientific advice given to them by the research and extension staff of the companies. The coefficient of labour use was also higher on direct contract farms possibly because of having more area under vegetable crops, especially that of potato and potato seeds as compared to that of indirect and non-contract farmers (Table 2). On the other hand, elasticity was higher on fertiliser and plant protection in the case of non-contract farmers. The non-contract farmers were using large doses of chemical fertiliser probably much more than required as was also observed by the author during the fieldwork.9 The coefficient of irrigation was insignificant in the case of direct contract indicating comparatively less importance of irrigation in direct contract crops. It was positive and significant in the case of indirect and non-contract farmers possibly because of more weightage of water prone crops like paddy.

In order to find out whether the production function was significantly different between the direct and indirect contract farmers, the Chow test of equality of coefficients [Chow 1960] was used. The observed values of the Chow test were found to be 4.66. The null hypothesis that the coefficients of two production functions were not significantly different was rejected at the 1 per cent significance level. Hence, we accept the hypothesis that the two samples belonged to different populations and productivity of direct contract farmers was higher than that of indirect contract farmers. The results were further verified by the coefficient of the dummy variable for direct contract farmers in the aggregate production function.10 It is evident from the footnote that the dummy variable was significant with a positive sign in the case of direct contract farmers. The coefficient implies that per acre productivity of direct contract farmers was 6 per cent higher than that of counterpart indirect and non-contract farmers. The dummy variables of indirect and non-contract farmers were insignificant but negative, indicating lower productivity in their case (not reported here).

However, the comparison of value of output per acre of direct, indirect and non-contract farmers from the above function is not implicit for the productivity of contracted and non-contracted crops. The reason being, the ratio of contract and non-contract crops grown by the contract growers stands 15 and 85 per cent, respectively. Therefore, it will be more sensible if we make a comparison of productivity between the contracted crops and non-contracted crops rather than comparing contract farmers and non-contract farmers.

For the sake of comparison of contract versus non-contract crops, the operated area of contract farmers was segmented into contract crops and non-contract crops. Segregation of contract and noncontract crops gave us 300 observations, 100 each for contract household for the contracted and non-contracted crops and 100 observations in the case of non-contract farmers. The results of production function of these 300 observations are given below: Log (gvo_gca) = 4.8 + 0.0002* Log (gca) + 0.14* Log (seed_gca)

(10.7) (0.01) (8.0)

+ 0.23* Log (fert_gca) + 0.16*Log (tractr_gca) + 0.03*Log (Irrg_gca)

(5.6) (4.6) (1.0)

+ 0.12*Log (lab_gca) + 0.24*dum_dir + 0.06 * dum_indirect

(2.4) (5.1) (1.2)

R-2 = 0.67 F = 73.9 N = 292

All the coefficients had a positive sign and they were significant, except that of gross cropped area (gca). The coefficient of the dummy variable for direct contract crops was highly

Table 7: The Estimated Production Function for Selected Households

Dependent Variable: Log Value of Output

(Rs per acre)

Independent Variables Contract Farmers Non- All Farmers
Direct Indirect Contract
Contract Contract Farmers
Constant 4.44 7.52 5.47 5.22
(6.7) (8.0) (9.4) (13.7)
Log net operated area 0.06 0.01 0.04 0.04
(acres) Log seed (1.9) 0.12 (0.4) 0.06 (1.7) 0.06 (2.7) 0.11
(Rs per acre) (4.1) (1.1) (1.9) (5.7)
Log (fertiliser + plant 0.24 protection) (Rs per acre) (3.0) -0.06 (-0.5) 0.27 (3.2) 0.19 (3.6)
Log mechanisation and 0.26 0.15 0.15 0.18
tractor (Rs per acre) Log irrigation (no of hours (3.1) -0.04 (2.1) 0.19 (2.3) 0.08 (4.3) 0.10
of tubewell per acre) (-0.6) (2.3) (2.1) (3.5)
Log labour use (no of days per acre) 0.34 (3.6) 0.21 (1.9) 0.17 (2.4) 0.23 (4.5)
Adjusted R-squared F-statistic 0.75 32.2 0.23 2.75 0.66 33.5 0.64 57.8
No of observations 6 3 3 7 9 2 192
Chow test* 4.66
(Equality of coefficients) (7, 86)

Notes: (i) The figures in parentheses are respective ‘t’ values.

(ii) The table value of Chow test at (7, 86) degree of freedom was 2.79 at 1 per cent significance level.

significant with a positive sign. The implication is that the value output per cropped area was on an average 24 per cent higher on direct contracted crops as compared to other indirect and noncontracted crops. The dummy variable of indirect contract crops was positive but insignificant indicating that there was no difference in crop productivity of indirect contract farmers and noncontract farmers.

Thus, these results confirm that the experiment of contract farming through agribusiness firms in Punjab was certainly beneficial for the farming community in general. Our results further confirm the findings of earlier studies on contract farming led by agribusiness firms including the examples of multinational firms as well as that of indigenous firms in the case of tomato in Punjab and Haryana [Dileep et al 2002; Gabrani 1996; Rangi and Sidhu 2000]. On the other hand, the experiment of contract farming led the public sector undertaking has failed miserably as indicated by the findings of our survey results.

IV Concluding Remarks

The PAFC, on behalf of the Punjab government is promoting contract farming on a large scale to bring necessary diversification in the state. The PAFC is following a tripartite agreement between the farmer, the PAFC and the companies providing seeds, extension services and buy back guarantees to the farmers. A few other multinational and indigenous companies are also directly procuring their raw material from the farmers under the gambit of contract farming. The present paper analyses these two models of contract farming in the framework of large versus small farmers.

Out of the two models of contract farming, it was observed that only the direct model of agribusiness firms was operating effectively. The extension services provided by the agribusiness firms were quite effective and farmers had the benefits of scientific advise from the technical staff of the firms without paying any charges for the same. Similarly, the buy back guarantee was honoured whole-heartedly and at the pre-fixed procurement price by the agribusiness firms. In the case of the PAFC model, despite written contracts there was a complete lack of commitment on the part of service providing companies. In most of the cases, no extension services were provided to the farmers and neither was any provision made to lift the contracted produce.

The empirical results indicated that the system of contract farming in the state was skewed towards medium and large farmers. Contract farmers of all the categories kept three-fourths of their area under non-contract to avoid the risk of crop rejection in contracting. Cropping patterns revealed that contract farming in the selected areas has to some extent, brought in diversification in the sowing pattern of rabi crops. In the khariff season, however, no lucrative alternatives were available to the farmers. By that means, the basic purpose of state induced contract farming to diversify a large acreage under paddy to other alternate crops in order to contain the falling water table remained unattended.

The productivity data clearly showed a visible superiority of direct contract farmers over their counterpart indirect and noncontract farmers in all size classes. The superiority of direct contract holders over other classes was more dominant in the case of crop productivity. High material expenditure on fertiliser and plant protection highlighted the over use of chemicals in the state’s agriculture. As cost of cultivation was generally higher on direct contract farms in comparison to indirect and noncontract farms, the gross value added as well as farm business income had less dispersion between these three sets of farmers as compared to farm productivity.

The regression analysis revealed a direct relationship between farm size and productivity (except the case of indirect contract farmers) possibly because of higher use of mechanical operations in the farming activities. The high elasticity of human labour pointed out the importance of manpower in the management of agriculture despite high mechanisation. The results of the Chow test clearly point out that productivity of indirect contracting farmers was way behind that of direct contract farmers. This was further confirmed by the coefficients of dummy variables which indicated that direct contracting farmers had 6 per cent higher farm productivity while they had 24 per cent higher crop productivity per acre compared to their counterpart farmers including those of indirect contract farmers.

Regarding the question of viability of small farmers under contract farming, our field data indicated that although the contracting companies had a preference for medium and large farmers, however, a few small farmers below five acres, who were selected by the companies fared very well. The productivity of these small farmers was almost comparable with that of their counterpart large farmers. In our productivity regressions, we used dummy variables for small and large farmers and observed that dummies were insignificant for all size classes indicating no significant differences in the productivity among small, medium and large farmers for the contract as well as non-contract farmers.

Annex Table 1: Contract Farming Plan of PAFC

(000’ acres)

2003 2004 2005 2006 2007

Hyola 50 200 300 400 450 Barley 5 15 25 40 70 Winter maize 3 5 11 13 15 Durum wheat 50 200 300 400 450 Sunflower 9 40 100 150 225 Spring corn 5 15 15 40 80 Basmati paddy 85 100 150 150 150 Kharif corn 50 300 400 500 600 Guargum 5 6 8 10 15 Castor 3 10 20 40 50 Groundnut 1 2 15 20 25 Organic basmati 5 3 5 7 1 5 Vegetables 2 4 6 10 20 Cotton 15 51 120 150 200 Other crops 12 50 26 71 136 Total 300 1000 1500 2000 2500

Source: Punjab Agro Foodgrains Corporation, Chandigarh.

Annex Table 2: Distribution of Selected Households by Districtsand by Farm Size (No of Farmers)

Name of District/ Contract Farmers Non-Contract All Farmers Category of Direct Indirect Farmers Farmers Contract Contract

(Agribusiness (State Firms) Enterprise)

Ferozpur 0 18 24 42 Hoshiarpur 11 8 18 37 Jalander 7 0 1 8 Ludhiana 21 0 8 29 Moga 90110 Patiala 15 1 22 38 Sangrur 0 10 26 36 Gross Total 63 37 100 200

Marginal farmers 0 0 2 2 Small farmers 1 1 16 18 Medium farmers 8 4 19 31 Large farmers 16 8 39 63 Very large farmers 38 24 24 86 Gross Total 63 37 100 200

Economic and Political Weekly December 30, 2006

Moreover, no discrimination was observed across farm size in terms of procurement by the agribusiness firms as well as price obtained by the small and large farmers.

To check the imbalance in state agriculture and to disembark farmers from the paddy-wheat rotation, there is a serious need to restructure policies pertaining to the present way of input subsidisation and assured marketing through state procurement. Farmers have to be trained to produce market-based products if they have to raise their profitability from the farming. Corporate led contract farming can play a big role in evolving such a system and can help farmers diversify in new crops especially in the high value cash crops like fruits, vegetables, mushrooms, fisheries, etc. The state government needs to promote this system at a larger scale by adopting certain policy actions such as framing rules to provide a proper legal framework for the smooth functioning of the entrant firms as well as farmers in the contracting system. Certain tax concessions need to be given to attract a large number of firms especially in the area of fruits and vegetable processing. The government can impose certain conditions along with the provision of incentives to agribusiness firms so that these firms should have bindings to involve the small and marginal farmers in their net. At the same time, the state government should avoid any direct involvement in the contracting system. In no part of the world is contract farming being practised by the state. The role of the (state) government should be that of a facilitator rather than being self-indulgent.

The process of restructuring might be faster than expected, given the fact that agriculture is becoming more attractive to Indian corporate giants who were till now operating only in the industrial sector. Corporate India is now entering every area of agribusiness from contract farming to rural malls, from seed research to medicinal plants and from food processing to exports. Most of these corporate organisations are opening their centres in the rural areas to form a network of one stop shops for farmers providing everything from farm inputs to loans and technical know-how to the farmers. A few examples are: ITCs ‘e-choupals’, Tata’s Tata Kisan Sansar, Godrej acquired and merged HLL’s agribusiness, Mahindra’s Shubh Labh, Bharti, Pepsi, Sriram and Reliance. Reliance and Bharti are now planning to enter in agribusiness in Punjab.

In addition to diversification towards high value cash crops, attempts should be made to diversify enterprises as well. A network of small-scale rural enterprises for processing agricultural produce could provide employment and income to farmers. The huge extension machinery in the state, research and development and agricultural university should look beyond wheat and paddy. New and emerging crops and enterprises should be the main focus of research for the longer period sustainability of the state agriculture.

EPW

Email: pkumar@ncaer.org

Notes

[This paper is drawn from an ongoing research study titled ‘Contract Farmingin India; Options and Implications for Small and Large Farmers’, sponsoredby the Sir Ratan Tata Trust. A previous version of this paper was presentedat a FAO Conference on ‘Commercialisation of Agriculture and SmallFarmers’ held in Rome, on May 4-5, 2005. The author wishes to expresssincere thanks to Kanchan Chopra for her comments on the paper and toan anonymous referee of the EPW.]

1 Contract farming refers to a system under which farmer sells her produce

under a forward contract to a known buyer. The buyer could be an

agribusiness firm, a local processing unit or a multinational company.

2 Contract farming at a commercial scale was introduced in Punjab by Pepsi

for the tomato crop in the early 1990s.

3 The firms most preferred choice was medium and large farmers but not very

large farmers. The ideal size was within the range of 4 to 20 hectares. Withinthis size, farmers generally had all the necessary implements to carry outthe requisite cropping adjustments. Below this size, farmers generallylacked the necessary implements as well as the will power to do so. Abovethis size, it becomes difficult for the firms to get necessary adjustmentson the part of the farmer; rather farmer starts dictating terms to the firms.4 Statistical Abstract of Punjab (various years), Economic Advisor, ESO,

Chandigarh.5 See Singh (2002), Rangi and Sidhu (2000), Singh and Ashokan (2003).6 Besides risk aversion, the other reasons for lesser area devoted to contact

crops could be the subsistence requirements of food crops like wheat andrice, requirement of fodder crops for livestock, shortage of input availabilityto fulfil the conditions of contract or non-suitability of conditions ofcontract on a large scale and so on.

7 The growers overcame the risk in returns from potato because of itsfluctuating price and yield to some extent by undergoing contract in thiscrop with Fritolay and Chambal Agritech.

8 The reader may contact the author for the details of material costs, fixedcosts and total operational costs item-wise.

9 During the fieldwork, the author observed that by and large, non-contractfarmers and a small percentage of contract farmers also were usingfertiliser and pesticides in much higher quantity than what was advisedby the contracting firms.

10 Log (gvo_noa) = 3.7 + 0.06 * Log (noa) + 0.08* Log (seed_noa)

(8.0) (3.7) (4.6)

+ 0.23*Log (fert_noa) + 0.21*Log (tractr_noa) + 0.10*Log (Irrg_noa)

(4.3) (5.2) (3.0)

+ 0.21*Log (lab_noa) +0.06*dum_dir

(4.0) (2.1)

R–2

= 0.64 F = 49 N = 192

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