The central problem that various policies in the agriculture sector strive to solve is the risk associated with the enterprise of farming. The risks are umpteen — monsoon cycles, price uncertainty, supply-chain inconsistencies, perishable output, etc.

To protect farmers from these risks, the focus has traditionally been on crop insurance, primarily through the Pradhan Mantri Fasal Bima Yojana. This scheme covers the yield risk, but farmers are still left unprotected against the price risk. This gap can be filled by leveraging the derivatives market for agricultural commodities.

Futures and options are derivative instruments that derive their value from an underlying asset, and derivative contracts involve an agreement to buy or sell the asset at an agreed price on a future date.

Specifically, put options can be of great use to lock onto a minimum price for farmers at the time of sowing itself while also allowing them to gain from the open market in case prices rise.

This means if the price of the commodity falls in the future, the farmer can sell at the pre-decided price to the seller, but if the price rises, the farmer can sell in the open market. To buy the put option, the buyer has to pay a fixed premium to option writers who act as insurers.

Transfer of risk

Through this mechanism, the risk is transferred from the farmer to the market participants who are willing and capable of taking risks for a premium. The government must consider creating an AgriPut Fund to pay fully or partly the initial premium. CSR activities can also be utilised for the same. A well-functioning derivatives market can also send strong price signals for agricultural commodities that can abridge the major information asymmetry on future prices faced by farmers.

This asymmetry in agricultural markets is captured succinctly by an economic model called the Cobweb Model. This model argues that the farmer decides which crop to sow based on the prices prevailing in the market in the previous period. If the price of a crop was high in the previous period, farmers increase its production.

At the time of harvesting, this supply glut suppresses its price. In the next season, farmers decrease its production considering the low prices in the previous period. Consequently, the price in the harvesting season rises.

Thus, the market keeps fluctuating between high and low prices and consequent surpluses and shortages. In the Indian scenario, this translates to a cycle of scarcity and plenty.

In the case of perishable items like tomatoes, there have been instances of farmers dumping their produce on roads due to the low prices. Such was the case with red chillies in Andhra Pradesh and Telangana and tur and grapes in Maharashtra. While in the time of scarcity-induced high prices, farmers hardly get their due, they take a huge hit in income in times of glut and resultant price crash.

Market imperfections

A healthy derivatives market can disseminate reliable price signals to help both farmers and other stakeholders take more informed decisions. The underlying problem that has kept India away from a well-functioning agricultural derivatives market is the multiple market imperfections.

There is overarching participation of the government in every stage. Skewed incentives through MSP declaration and open-ended procurement for a few crops has dictated the cropping pattern. However, with the paradigm shift envisaged in the role of the government as a catalyst, more space shall be given to the private sector in the times to come.

Once conducive market conditions are created, the derivatives market will attain enough depth and liquidity in terms of number of transactions and participants.

Till then, efforts must be made to disseminate financial literacy and fintech training to farmers and FPOs. A strategic rethink to view farmers not as mere scheme beneficiaries but as empowered stakeholders is imperative.

The market has the potential to turn the farmers’ fortunes and enable them to become entrepreneurs, Atmanirbhar in the true sense.

The writer is an IAS officer working as Assistant Secretary to the Ministry of Agriculture and Farmers Welfare. Views are personal