Institutional reforms for agricultural growth: T. C. A. Anant

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Institutional reforms for agricultural growth: T. C. A.

Anant

Gaurav Bhattacharya

Gargi College University of Delhi

April 28, 2020

Gaurav Bhattacharya (Gargi College, DU) BA(P) EDPI II April 28, 2020 1 / 18

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Overview

1 Major challenges in agriculture

2 Institutional Reforms

3 Markets

4 Finance

5 Organisation

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Major challenges in agriculture

Share of agriculture in GDP

The contribution of agriculture and allied activities to the GDP has declined from 35 per cent in 1980s to 25 per cent in 1999-2000.

In 2019-2020, the figure stood at 16.5 per cent.

This is a cause of concern given that majority of the population continues to depend on agriculture as the main source of support.

Fiscal burden

Agricultural subsidies put enormous pressure on the fiscal health.

This includes both direct subsidies for foodgrains and fertilisers and indirect subsidies through pricing of power, water.

Increase in subsidies, combined with the inability of the state to raise additional resources, imply lower public investment in agriculture and rural areas.

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Poverty and social development

In terms of social indicators like poverty, literacy, healthcare, housing, drinking water, roads and other basic necessities of decent living, the rural communities have extremely poor performance in both absolute and relative terms.

This has contributed to the decline in productivity and hence, income.

Farmer suicides

The aspect of farmer suicides has received much media attention over the past years.

A major reason cited is the direct relation between size and profitability (Reddy, 1993).

Mohanty (2001), in a detailed study on suicides amongst cotton farmers in Maharashtra, paints a complex relationship between the size of the operation, the caste of the cultivator and the reason for suicide.

The study shows that newer cultivators have poor links to information channels and use inputs less efficiently in times of crisis, which

inflates the cost of production.

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Institutional reforms

As a consequence of lopsided economic reforms, agricultural distress is more prominent.

In dealing with several constraints faced by the sector, institutional reforms seem to be worthwhile.

Institutions have been defined as the rules of the game of a society which are humanly devised constraints that structure human interactions.

Institutions form a multidimensional phenomena which comprises both formal rules (statute law, common law, regulations) and informal constraints (conventions, norms of behaviour, self-imposed codes of conduct), and the enforcement characteristics of both.

Each of these components needs to function in tandem, ensuring complementarities.

While formal rules can be changed overnight through direct control of public policy, informal norms change gradually through education, social action and the development of civil society.

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Markets

The State regulates the markets for agricultural commodities.

Trade in agricultural goods is restricted through the Essential Commodities Act, complex interstate tax rules, absence of private storage, non-existent forward markets, illegality of risk sharing through use of contracts.

The agricultural sector’s dependence on the vagaries of nature escalates risk and uncertainty.

Policies like closed external trade regime, pervasive government controls on private sector activities, extensive markets interventions, and crop insurance have been sought to minimise risk and price volatility.

However, these impose an enormous informational and financial burden on the government.

Consequently, phased reduction of some of these instruments has been in place.

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Markets: Risk sharing

The market system deals with risks through the following mechanisms:

long-term contracts, trade, and alternative forms of finance.

Forward contracts could minimise risks since prices of commodities for future delivery are agreed upon on the date of the contract, thereby, hedging against fluctuations in prices.

Further, these contracts must be tradable in forward markets with provision for adequate storage and quality control.

However, existing laws make it difficult for the agriculturist to share risks.

Long-term contracts rely on informal solutions in case of disputes since formal recourse is ruled out.

Possibilities of collusion amongst participants in these markets gives rise to monopoly power.

In case of commodities where forward markets exist, the narrow set of contracting parties and limited possibilities of trading these contracts mean that risk is not adequately shared.

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Markets: Increased dependence on MSPs

MSPs are designed to incentivise farmers to increase production.

The problem with MSPs is that they were not offered on all crops.

This has led to distortions in incentives across crops.

MSPs come into direct conflict with issue prices, leading to an increase in the subsidy burden.

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Markets: Profitability

The first concern relates to shifting focus from productivity to profitability.

Increased profitability reduces risk of loss.

Unlike farm-size and productivity, scale and profitability have a positive relation (Reddy, 1993).

Hence, small household cultivation may not be profitable.

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Finance: Demand for finance

Finance is primarily needed for creating capital and infrastructure in the rural areas, and meeting the operational requirements of the agriculturist.

Cultivation is a time-bound process, and hence, there is a need to incur costs before a saleable output is generated.

These costs can be financed through long-term contracts, which help in risk sharing.

In the absence of long-term contracts, the farmer has to depend on his own resources or debt.

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Finance: A moral hazard problem

Agricultural credit reeks of the moral hazard problem; the lender and the borrower have asymmetric information.

In this case, the borrower’s actions are unobservable.

As a result, the lender can restrict the borrower’s future access to credit through the following actions:

Refuse to sell on credit in the future, including crucial inputs such as fertilisers, seeds, equipments;

Refuse to market the output of a producer who defaults on a working capital loan;

Reduce access to other lenders through publicity about credit history;

Build social pressure on the borrower by depriving other members of the group of access to future credit when a member defaults;

Alternative security options through collaterals such as land, cattle or crops can be explored.

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Finance

Concerns over collaterals: Land

Using land as collateral involves archaic paper based registries with high search costs.

Local laws limit the sale of land to designated groups or communities.

There are land-use laws in place which restrict the scope further.

These factors create a thin localised market for land, reduce its resale value and limit its value as a collateral security.

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Finance

Concerns over collaterals: Movable assets

No effective system to register claims over movable assets.

Lien against tangible assets like cattle can hardly control movement and sale of such goods.

Registration being non-mandatory, it is impossible to determine if an asset has a prior claim against it or not.

This reduces the effectiveness of institutional lending.

Concerns over collaterals: Crops

There is no legal sanction on sale of crops used as security.

Formal credit markets are unable to prevent such sales.

Only cooperative societies have the statutory right to register claims on standing crops.

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Finance: Policy prescriptions for an efficient credit market

The Asian Development Bank (2000) study suggests the following legal reforms with respect to security transactions:

A system of creation of a cheap, simple and comprehensive credit security law which would lead to inexpensive creation of a security interest against all property by any person for any transaction;

Publicity that is public, inexpensive to file and easy to search through creation of accessible public registries where securities can be easily created and registered (registration being mandatory in certain cases);

Priority based on simple and unambiguous rules such as a law fixing priority based on afirst-to-file rule, thereby, saving cost and time in settling legal disputes through a system of mandatory registration with priority from the date of registration;

Fast and cheap enforcement.

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Finance: Alternative dispute settlement mechanisms

Locally viable mechanisms likeLok Adalats and community institutions.

In the absence of accessible dispute settlement mechanisms, transactions will be conducted in personalised settings, thereby, discouraging new entrants and non-traditional participants.

Community institutions develop a variety of laws and practices which include:

Re-examining the laws governing relating to the use of agricultural crops and inputs as securities;

Building a system of registries to register security interests in movables;

Improving the system of land registration;

Reduction of stamp duties on land transfer and mortgage;

Creation of simple rules for priority of claims;

Provision for safety net to the borrower in case of extreme failure;

Developing an effective personal bankruptcy code to provide protection to small borrowers who are subject to a variety of legal and social disabilities.

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Organisations: Gradual movement from the

state-guaranteed system to a self-regulating system

When an agriculturist takes recourse to borrowing in the credit market, the burden of debt is imminent.

The debt-equity ratio (defined as the ratio of total debts to total assets net of liabilities) rises.

Unlike cooperatives and Hindu Undivided Families (HUF), farmers can neither raise equity finance nor distribute risks.

Hence, the scope of raising funds by expanding membership seems implausible.

In this view, expanding corporate forms in agriculture through plantations can raise equity finance.

Plantation agriculture implies commercial farming where crops are grown for profits. Eg. sugarcane, coconuts, etc.

Furthermore, pre-crop contracts can be used as risk-sharing devices provided they are given some explicit legal sanction.

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Infrastructure: Need for financial decentralisation

Agricultural and rural development would need investments in social overhead capital, viz. roads, irrigation facilities, education, health, etc.

Private participation in building social infrastructure is highly unlikely due to the long gestation period and low returns on such projects.

Hence, public investment is essential.

Improved mechanisms in public good provisioning at the local level assumes special significance.

Need for financial decentralisation in this regard, since the 73rd and 74th amendments to the Constitution do not provide any framework.

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Infrastructure: Need for financial decentralisation

Provision for devolution of resources down to the local level needs to be ensured.

There must be a separate fiscal domain forPanchayats and Municipalities.

Success of projects also depends on people’s participation (Balwant Rai Mehta Committee on Community Development), and

complementary processes ensuring freedom of institutions, public feedback and accountability.

Lastly, strengthening local institutions in the management of common property resources could act as a useful supplement.