mcx

ENABLING FARMERS TO LEVERAGE COMMODITY EXCHANGES

Final Report

Submitted to

MULTI COMMODITY EXCHANGE OF INDIA LTD

401, Boston House, Chakala, Andheri (E), Mumbai – 400 093

12th August, 2008

Submitted by

CARDINAL EDGE MANAGEMENT SERVICES (P) LTD 76-A, Jaipuria Enclave,

Kaushambi, Ghaziabad – 201 010

Enabling Farmers to Leverage Commodity Exchanges

Cardinal Edge Management Services (P) Ltd. 1

EXECUTIVE SUMMARY

Project Rationale: Fluctuations in prices of agricultural commodities adversely impact the incomes and livelihoods of farmers, particularly the small and marginal farmers. To understand the efficacy of commodity futures for price hedging by farmers, a pilot project was undertaken in Surendranagar involving 67 cotton-growers. The larger goal of this pilot project was to arrive at a working model for farmer participation in commodity derivatives trading.

Project Participants: This multi-stakeholder pilot project was enabled by associations among a number of institutional entities namely Sajjata Sangh, Aga Khan Rural Support Programme India [AKRSP(I)], Multi Commodity Exchange (MCX), National Bank for Agriculture and Rural Development (NABARD), Cardinal Edge Management Services and a Farmer’s Federation from Chotila taluka of Surendranagar . The focus group for this pilot project comprised 67 farmers out of which 76% were small & marginal farmers (less than 5 acres landholding) and the remaining 24% were semi-medium farmers (5 acres to 12.5 acres landholding). Among the focus group farmers, 87% of the farmers sow only cotton in the Kharif season. Around 45% of the focus group farmers keep their land fallow during the Rabi season whereas 49% of them grow wheat as the sole Rabi crop. The high dependence of the focus group farmers on cotton crop necessitated the hedging of cotton prices as the primary aim of this project.

Key Activities: The main activities planned under this initiative were access to market information, awareness creation & training; institutional development, formation of linkages with professional service providers and institutions; adoption and trial of price hedging through commodity derivatives, validation and reconfiguration of existing commodity derivative contracts.

Project Approach and Operational Design: The Kapas futures contract on MCX was identified as the most suitable contract for hedging prices of cotton. The project necessitated development of such information structures on the ground which would help keep track of the physical operations of each farmer participant in order to manage the corresponding futures positions on the exchange and subsequently redistributing the benefits of price hedging proportionately among the project participants. However, due to the constraints of time and limitations in the understanding of participating farmers, a homogeneous-group based approach was adopted for farmers’ participation in price hedging. The initiative was carried out in five villages and one representative was chosen from each village to take decisions regarding the position on the exchange on behalf of his associated farmer members. The farmers were divided into sub-groups of 3-4 for meeting the minimum lot criteria of 4 MT per contract. In all the five villages, arrangements for public display of market information were made. AKRSP (I) field office collected the price and market scenario information from broker, web sources, and Cardinal Edge, and subsequently passed it on to the Farmers’ Federation for further dissemination. Subsequently, this information was passed on to the member farmers. The member farmers conveyed opinions and decisions about their positions to their representatives, which was finally aggregated at the level of Farmers’ Federation. The Farmers’ Federation subsequently communicated the necessary actions to the broker or the AKRSP representative dealing with the broker. The schematic diagram for market information and futures trading decision flow has been provided in the following figure (Figure 1)



Figure 1: Schematic Diagram for Market Information and Futures Trading Decision Flow

Project Implementation and Outcomes: In November 2007, market outlook predicted cotton prices to fall considerably on expectations of glut due to high domestic production. In the wake of these predictions, Farmers’ Federation decided to take positions on the exchange during Mid-December deeming the existing price levels to be attractive and representative of market demand-supply equilibrium. However from 20th December 2007 onwards, prices started making a sharp rise upwards. The uptrend in prices was explained by the fundamentals of good export demand from China, US, and other countries, coupled with shortfall in world production. This opposing trend from earlier predictions encouraged the farmers to lock in their futures contract positions at higher prices and correspondingly hold their cotton stocks for a longer duration in anticipation of price rise in spot (physical) markets. Farmers’ Federation took position for 26 contracts of Kapas futures on MCX. The average price for short positions was Rs 471.35, whereas, the average price for long positions was Rs 495.08. The deficit in mark-to-market margin was Rs 123,480.

Project Evaluation: To evaluate the outcomes of the initiative, structured questionnaire survey and focus group discussions were conducted. The survey included necessary items to clearly bring out the Pre-Post and With-Without scenarios related to the intervention. The control group constituted to examine the With-Without scenario comprised 60 farmers from Amreli and Surendranagar district which were comparable with the focus group farmers participating in the pilot project.

The key findings of the project evaluation survey can be summarized as:

☼ The average price realization of focus group farmers was Rs 2541/quintal which is around 3.1% more than the average price realization of Rs 2460/quintal of control group farmers

☼ The average price realization of focus group farmers this year was Rs 2531/quintal which is around 5.9% more than their average price realization of Rs 2399/quintal last year

AKRSP/Broker/ Cardinal Edge

Farmers’ Federation

Village Representative 1

Village Representative N


Downward Arrow: Flow of Market Information

Upward Arrow: Flow of Futures Trading Decision



☼ Around 38% of the overall cotton produce of focus group farmers was sold after the month of November as compared to 27% of the overall cotton produce of control group farmers

☼ Around 38% of the overall cotton produce of focus group farmers this year was sold after the month of November as compared to 29% of their overall cotton produce last year

☼ One of the other major benefits expressed by the focus group farmers was their better bargaining power with traders due to higher awareness of futures prices and cotton market developments.

Key Constraints: The key constraints that came to light during the implementation of this project are being highlighted below for consideration by relevant stakeholders.

☼ Regulatory Constraints

o The foremost regulatory constraint with respect to participation of farmers (particularly small and marginal farmers) on commodity exchange are the procedural hurdles (PAN card requirement, KYC norms compliance, burdensome paperwork etc) for opening a demat/trading/bank account.

o Restriction on participation of financial institutions (Banks, Mutual Funds, FIIs) also undermines the liquidity on commodity exchanges and allows trading on many contracts to be exposed to price manipulation and market cornering.

o The bans/suspensions on futures trading in commodities of strategic importance have shaken the confidence of common citizens and physical market players in the price risk management effectiveness of commodity derivatives.

o Lack of useful risk management instrument like options which have proved to be of immense value in managing risks of farmers and physical market players in other countries restrains potential hedgers in India by making them vulnerable to the unlimited downside risk inherent in futures trading.

☼ Policy Constraints

o Policy interventions by the Government have a momentous impact on the direction and magnitude of price movements in commodities. Abrupt policy changes by the Government generally result in upsetting the market equilibrium leading to the shift of balance in favor of one or the other counterparty. Uncertainty of Government interventions acts as a dissuading influence on genuine market participants (including hedgers) and weakens the free-market behavior of commodity markets.

☼ Institutional Constraints

o The procedural requirements and the technical complexities involved in commodity derivatives trading necessitate the presence of institutional entities which can act as technical support providers for farmer participation on commodity exchanges. Grassroots organisations like NGOs, cooperatives, agribusiness companies, farmer organisations have the ability to serve as technical support providers but given their existing under-preparedness and limited capacities for managing price risk management initiatives, the fruits of promising initiatives for improving commodity markets in India may not reach the intended beneficiaries especially the disadvantaged farmers.

o Hedging the prices of the forthcoming harvest through futures trading requires the farmer to pay in the initial margin and Mark-to-Market (MTM) margin upfront. Such requirement is extremely constraining for farmers keen to hedge their price risks and calls for funding through institutional financing mechanisms.



Key Recommendations: The key recommendations for future initiatives are summarized below.

☼ The first step towards such farmer-participation initiatives needs to be linkage development with NGOs and Voluntary organization for regular price and market information dissemination. The information dissemination has to be complemented by intensive efforts in building the capacities of aggregator organisations [like AKRSP (I)] and their associated farmer representatives. To ensure the proper understanding of theoretical concepts, it would be useful to conduct simulation and coaching exercises.

☼ For future initiatives of similar nature, the creation of an apex level management team consisting of representatives from all key project stakeholder-entities is essential. This apex-level team would regularly assess the direction and progress of initiative and undertake necessary course correction measures.

☼ A rigorous baseline survey of focus group and control group farmers needs to precede the development of the institutional framework on the ground. In addition, the specifications of the futures contract needs to be in conformity with the physical commodity and farmer for which price hedging is desired.

☼ The training & capacity building activities are under the purview of developmental activities to be undertaken under the project and necessitate the arrangement of associated funding alternatives. Other financial support sources for such projects can include farmers’ contribution, loans from financial institution, and development funding for envisaged developmental activities under the initiative. The loan part should include long term funding support from funding agencies and other institutions (like CCI, NABARD etc) for mark-to-market margin. This fund can be utilized for streamlining the cost & benefits over the duration of the initiative.

☼ To ensure proper compliance and improving the quality orientation of farmers, it is necessary to provide linkages to farmers for assessment of their quality specifications. This would enable the aggregating-organization to link project benefits with the quality and avoid cross subsidization among participating farmers arising from proper distribution of costs and benefits. In addition, the linkages with cotton industry and ginning mills can ensure spot market interface, and standardization of production and market operations.

Suggestive Institutional Structures for Future Interventions: Based on the insights from this project, the following institutional structure design emerges for future projects.

The lot size as per the futures contract may be a key determinant of whether to undertake positions on a futures contract on an individual basis or on a group basis. If the ratio of the quantity to be hedged by each individual farmer to the lot size of the preferred futures contract (named as significance ratio) is less than 1 for most of the farmers, a group-based approach will be more expedient. The smaller the significance ratio, the more sub-optimal will be the hedging in terms of its effectiveness as well as participant’s control. Even though the transaction costs for hedging are significantly reduced in the group-based approach, the autonomy of decision and objectivity in terms of sharing gains or losses from hedging are reasonably compromised on the other hand.

One of the key prerequisites of a good institutional structure is the independence it provides to each participant/actor for taking decisions related to its commensurate stake in any transaction. Therefore the decision-making related to trading decisions especially the entry and exit prices in futures contracts has to be vested with the individual participant or with the representative designated by the joint participants in a futures contract. Therefore the first-tier of collective organization will be at an individual futures contract level where either an individual participant or his representative will act on his behalf for communicating trading decision information upwards.

At the second-tier, the participants in a collective hedging program must organize themselves ideally at a village level to ensure smooth flow of market information downwards from the more informed stakeholders and trading decision information upwards from the individual participant or the



representative designated by the joint participants under a common futures contract. The village-level representatives may be federated at a higher-tier (third-tier/apex-level) for coordination, monitoring, course correction, and evaluation. The nodal body (in addition to hedging participants) can also be represented by all the key stakeholders of the project who can contribute with the various specialized inputs required for undertaking such hedging programs. The nodal body may also be vested with the responsibility of guiding the establishment of operational and informational structures in the project location. The nodal body can execute suitable linkages with relevant service providers like brokers, commodity market analysts and financial institutions willing to extend quality support to the project participants.

The institutional structure must ensure that each participant receives timely and reliable information on the market developments pertaining to the commodity being hedged. The information structure for market-based information is more likely to pyramidal in shape with the nodal body occupying the vertex of the pyramid. The nodal body can then pass the information down to the next lower-level tier (the second-tier) existing at the village level which can ensure arrangements for further dissemination of market information to hedging participants (first-tier or futures contract participants).

For equitable distribution of gains and losses from hedging, the corresponding quality of physical produce of each participant needs to be ascertained. Loss and gain distribution criteria based on the quality of physical produce need to be jointly established and clearly communicated to each participant in a group-based futures contract trading. Furthermore, there needs to be a well-defined contractual relationship between the nodal body (acting as a technical support provider) and each participant in a collective hedging program.

The program is collective only in the sense of aggregating the technical support and other service requirements associated with hedging. The decision-making may however be completely decentralized and individual-futures-contract-based in order to delegate responsibility to participant(s) in an individual futures contract for its/their own gains or losses. The margin requirements and corresponding futures trading operations have to be likewise managed by participant(s) in any individual futures contract. The schematic diagram of the suggestive institutional structure has been provided in the following figure (Figure 2).

Figure 2: Schematic Diagram of Suggestive Institutional Structure for Future Interventions

Futures Contract-Level (Tier 1)

Village-Level (Tier 2)

Apex-Level (Tier 3)Nodal Body

(Village Representatives + Other Key Stakeholders)

Village 1 Representative

Futures Contract 1

Participant(s)

Futures Contract 2

Participant(s)

Village N Representative

Futures Contract N

Participant(s)



TABLE OF CONTENTS

1. BACKGROUND ..................................................................................................................................... 8

2. SITUATION ANALYSIS ........................................................................................................................ 9

3. KEY OBJECTIVES ................................................................................................................................ 10

4. METHODOLOGY ................................................................................................................................. 11

5. LITERATURE REVIEW ....................................................................................................................... 11

6. PILOT PROJECT OPERATIONALIZATION .................................................................................... 19

7. LINKAGES ............................................................................................................................................ 21

8. INSTITUTIONAL DESIGN .................................................................................................................. 23

9. EXCHANGE PARTICIPATION APPROACH ................................................................................... 24

9.1 APPROACH FOR PARTICIPATION ON COMMODITY EXCHANGE ...................................................................... 24

10. 2007-08 FORECAST & TRADE SCENARIO ................................................................................... 24

10.1 COTTON FORECAST ..................................................................................................................................... 24 10.2 TRADE SCENARIO ........................................................................................................................................ 25 10.3 FUTURES MARKET SCENARIO ..................................................................................................................... 26

11. OUTCOMES ...................................................................................................................................... 26

12. FINANCIALS .................................................................................................................................... 26

13. IMPACT ASSESSMENT SURVEY .................................................................................................. 27

14. FARMERS’ VIEWPOINT ................................................................................................................. 30

15. CONCLUSIONS ................................................................................................................................ 33

16. WAY FORWARD ............................................................................................................................. 33

17. SUGGESTIVE INSTITUTIONAL STRUCTURES FOR FUTURE INTERVENTIONS .............. 34



TABLE OF ANNEXURES

1. TRADE STATEMENT……………………………………………………………………………… 36 2. MARKET SCENARIO FOR THE MONTHS OF NOVEMBER-DECEMBER……………….. 37 3. QUESTIONNAIRE FOR PROJECT EVALUATION SURVEY………………………………… 39



1. BACKGROUND Even after 55 years of independence, agriculture is still the principal sector in India providing employment to nearly two-thirds of its population and contributing around 24 per cent of GDP. Risk is an indispensable but manageable element in agriculture. Revenues and incomes from agriculture can vary widely from year to year due to unforeseen weather, disease/pest infestations, and/or market conditions. When the unfavorable deviations in agriculture significantly reduce income in the short-term, there can be serious repercussions in the absence of effective risk management tools. Especially in case of developing countries that have remained commodity-dependent with a large proportion of dependent population it becomes crucial to manage backend and price risk.

In the present scenario, it is expedient to focus on organizations and collectives involved with farmers to explore their possible roles as aggregators for price risk management and collateralized finance. These aggregators can assume the role of facilitating agents or a risk-bearing layer between the farmers and the commodity exchanges. Moreover, downside risks and transaction costs can be distributed among several farmers by these aggregators so that the possibility of default arising out of disproportionate exposures is mitigated.

In addition to the above, aggregators can play a vital role in information dissemination and knowledge/capacity-building of farmers. Undeniably, keeping track of the market developments and taking suitable positions on the commodity exchanges is a lot easier for aggregators than it is for farmers. Alternatively these aggregators can rely on an intermediary to fulfill their information, financial and infrastructural needs. These intermediaries can be a broker, financial institution, a government institution, technical consultancies etc.

At the moment many of these organizations capable of aggregating farmers’ risk exposure are presently supporting farmers by providing technical inputs, assuring good quality production inputs and capacity building. In some cases attempts have been made to link the producers to the markets assuring more stable and remunerative prices. However these actions are diffused and have not yet been carried out on a large scale. Also, there is a growing realization to provide risk management services to farmers in wake of their high exposure. To manage price risks, options such as contract farming, forward linkages, and futures trading are being evaluated and explored. This proposal stems from the intent of some of the organizations willing to play the role of aggregator. To realize the intent, integration of all the principal stakeholders on a common platform will be mutually beneficial.

In view of the above mentioned problems, the intervention was conceptualized by Sajjata Sangh (A Network of leading NGOs in Gujarat) in Jul, 05 in its annual general meeting. The meeting was attended by member NGOs & leading farmers. To introduce the concept Multi Commodity Exchange (MCX) was invited in the forum. Subsequently much deliberation took place on the ideal design of the intervention. The intervention was conceptualized as two-pronged strategy for linking up farmers with relevant organizations for spot marketing & simultaneously accessing futures market to hedge the price risk. Given the relevance & suitability of Kapas contract traded on MCX, it was expedient to approach MCX for the proposed initiative. To develop an interface for facilitating linkages between Sajjata Sangh, aggregator NGO, farmers, and MCX, Cardinal Edge Management Service (P) Ltd was hired as consultant by MCX.



2. SITUATION ANALYSIS Cardinal Edge had undertaken primary research in Rajasthan & Uttar Pradesh during March-April 2007 during which viewpoints of farmers & traders pertaining to commodity derivatives trading were collected. Thereafter various constraints related to Kapas V-797 futures contract for cotton crop were discussed and analyzed through several meetings with NGOs & farmers of Gujarat. 4 Variety Differences Present cotton contracts for trading are limited to very few varieties only. Hence it limits the participation of farmers sowing different varieties. For example in Surendranagar district of Gujarat, predominantly BT cotton is cultivated; however if a farmer wants to hedge himself on the exchange then the only option for him is to trade on the Kapas V-797 contract available on exchange. In absence of relevant contracts, the various issues that can arise are price differences between contract variety & actual variety being produced, disparate market trends for contract variety & actual variety produce, discounting or rejection of delivery by exchange. 4 Procedural Problems Voluntary Organizations registered with not-for-profit mandate are not allowed to open DEMAT account for trading purposes or involve into any activity that has only a profit-generation motive. Consequently these organizations are not suitably equipped to act as aggregator on behalf of their farmers. On the other hand, farmers also cannot open DEMAT accounts because of non-availability of PAN Cards with them. 4 Brokerage Operations In the wake of low trade volumes, brokers do not have an incentive to serve the rural clientele. The small positions from a rural clientele could raise a problem of high transaction costs which undermine the viability of operations in rural areas with thin client coverage and small transactions. In addition, the brokers do not have clear guidelines or understanding about the rules pertaining to trading by voluntary organizations. Such lack of clarity results in delays and procedural hassles for the farmers.

Issues Related to Kapas V-797 Contract 4 Duration of the Contract The kapas contract expires in the month of April and theoretically prices of spot & futures market will converge during that time only. However the farmers predominantly tend to sell their harvest during the period of October to February. Taking into account the physical market transactions by farmers, the positions need to be squared off during the time of selling of the produce in the spot market. In case of higher prices (than the one at which farmers have entered) in futures market at that time, there are chances that farmers may have to book losses in the futures market despite taking due precautionary measures, like stop loss. Though there are possibilities that such losses could have been offset from selling in the spot market, the non-availability of kapas contracts that terminate during the time of selling in the spot market precludes such possibilities. 4 Trading Unit The present trading unit is 4 MT. That is much higher for an individual farmer to enter into futures trading. For instance in Surendranagar district of Gujarat the average land holding is 3 acres with an average yield of 1100 Kg/Acre, which totals 3.3 MT in a season.



4 Margin Money In absence of access to formal credit system for margin payment to commodity exchanges, arrangement of initial margin money amount of 4% deters farmers’ entry into trading. 4 MTM Requirements Similarly arranging money for MTM requirements can be more cumbersome or difficult for the small & marginal farmers. Moreover there are other issues in case of intra-day high volatility such as providing timely notice to farmers on margin calls, arranging for money at a short notice and timely transfer of margin call amount to their trading account. In absence of prompt actions during these conditions farmers may face the risk of liquidation or squaring off of their positions. 4 Physical Market Price Difference In the existing scenario the prices in the physical market differs across the mandis present within a state. i.e Prices for Shankar 6 (B) 30MM variety during Mar-Jun, 06 for Rajkot & Chotila markets differs in the range of Rs 150-180/Quintal. During 80% of time prices were higher in Rajkot market; however distances between two markets is 60 Kms only. In this situation the spot prices polled from Surendranagar market doesn’t bear close resemblance with other major mandis in the state or major producing regions. The underlying difference between polled prices & actual mandi specific prices finally results in deterrence for farmers of other major producing regions to participate into commodity trading. To bridge this difference, it is necessary to poll the prices from other prominent mandies of the same area instead of just one major mandi. 4 Delivery Centers Presently availability of few delivery centers and price difference across physical markets limits the farmers across the country to participate in trading. The need is to increase the reach and provide services of assayer and means for reduction of transportation cost.

3. KEY OBJECTIVES 4 To provide a status report on pilot project “Enabling Farmers to Leverage Commodity

Exchanges” highlighting a clear analysis of the outcomes, learning and way ahead for scaling-up linkages between farmers and exchange.

4 To suggest possible areas of intervention in for facilitating scaling-up of intervention between MCX, aggregators/facilitators, farmers, and other relevant stakeholders.

4 To capture and document the constraints and limitations faced by stakeholders involved in the initiative for hedging the price risk of farmers’ through MCX.

4 To identify the nature and level of support required from various stakeholders like MCX, farmers organizations, government, facilitating agencies, funding organizations, other voluntary agencies and key players to provide boost to participation of farmers in commodity trading.



4. METHODOLOGY The assignment entails that data has been collected from both primary and secondary sources. Secondary Research Secondary information has been collected from: 4 Journal articles, case studies and reports available on agricultural price risks, commodity

exchanges and commodity derivative trading 4 Web resources of World Bank, UNCTAD, International Task Force on Commodity Risk

Management, USDA-ERS, Forward Markets Commission, Domestic and International Commodity Exchanges The secondary research assisted in building a broad-based understanding of agriculture price risk issues for the design of primary research instruments.

Primary Research The primary level information has been collected mainly through: 4 Structured questionnaire survey of 67 member farmers who were involved in the commodity

trading. 4 In-depth interviews of 23 physical market traders who had prior experience of commodity

trading. The rationale behind was to understand the limitations and constraints associated with commodity futures trading by farmers and physical market traders.

4 Focus group discussions with farmer representatives from the pilot project. 4 Structured questionnaire survey of 60 non-member farmers to evaluate and distinguish their

outcomes vis-à-vis the pilot project farmer members.

5. LITERATURE REVIEW 4 Insurance vs. Price Hedge1

To understand the proper mechanism to hedge price risks, it is imperative to know the advantages and disadvantages of existing mechanism. The insurance mechanism relies on collecting premium regularly from a large number of clients and pooling. These premiums are used to compensate for losses when they occur, up to a level set in advance, and to cover for administrative costs and profit. Therefore, risk is spread over a large number of exposure units to be insurable. In addition, risks should not be too highly positively correlated or so high as to make premiums unaffordable. The resulting losses in case of occurrence of event should be accidental and measurable. In the wake of these reasons, price risk is better managed using futures markets than insurance markets because it affects all producers of one commodity at the same time. Catastrophic risks are also difficult to insure privately because loss events are not independent, can affect large areas and be extremely costly.

1 Farmer Risk Management and Futures Markets, Jean Cordier, École Nationale Supérieure Agronomique Renne, France



4 Futures & Options as Risk Hedging Instrument2 The outcome from a study in USA states that when a producer combines a forward sale with the purchase of crop insurance, the probability of low revenue is reduced dramatically for each of the locations, compared with the no-strategy case. The cost-effectiveness of futures contract and options to protect farmers against price risks is contingent on yield variability, on the correlation between yield and price variability (natural hedge) and on the distance from markets. In case of high yield variability, production becomes less predictable, consequently a farmer may only hedge a small volume in order to avoid having to buy additional products to fulfill his futures contract in case of low yields. In this scenario, the hedge ratio, i.e. the optimal share of actual production to be hedged, and the risk reduction efficiency is low.

The need and acceptance of risk-hedging instruments depends on the strength of negative relationship between yield and price, called the “natural hedge”, for a particular commodity in a particular region. For instance, widespread low corn yields can cause prices to increase significantly. Conversely, low prices are often associated with bumper-crop years. This partially “offsetting” relationship between prices and yields tends to stabilize farm revenues over time. Yield and price variations are less likely to offset each other where the natural hedge is weak. In states such as North Carolina, low corn prices and low yields (or high prices and high yields) are more likely to occur at the same time than in the Corn Belt, making corn revenues inherently more variable. This is because these areas have less impact than the Corn Belt on national output and prices. Forward selling reduces revenue risk substantially in areas where the natural hedge is relatively weak.

4 Risk Management Techniques3 Traditionally risk pooling and risk spreading techniques are utilized by farmers for risk management. Risk pooling techniques include all price smoothing mechanisms organized by groups of producers. For example, average pricing for a crop year as offered by co-operatives is a very efficient risk management instrument. The farmer delivers his crop at harvest time and receives an advanced payment. He will receive a bonus in June in order to obtain the average market price of the past crop year. Some co-operatives offer a price averaged according to specific periods of time. For example, a farmer who decides to store his grain on the farm can contract at harvest a February delivery. He will receive the average price of a three-month period based on the date of delivery. For livestock production, some co-operatives offer moving average prices; for example, a twelve-week average price. These price smoothing techniques reduce the impact of price volatility and the related risk premium for the farmer. However, the use of reference markets – centralized and organized markets, spot markets and/or futures markets – is necessary.

4 Futures Markets-Diversification Tool

Futures markets are centralized and organized markets where futures contracts and options are traded. All economic agents, both professionals and speculators, can buy and sell such contracts at low transaction costs and on a competitive basis. Market liquidity guarantees the quality of the futures prices as well as the premium values of the put and call options. This means that the futures price incorporates all available information. In other words, at any time and for a set of current information, the futures price is the best predictor of the future spot price.

2 Income Risk Management in Agriculture, OECD, 2000 3 Farmer Risk Management and Futures Markets, Jean Cordier, École Nationale Supérieure Agronomique Renne, France



At the time of sowing the farmer has three basic potential strategies: Strategy 1: Do nothing with the hope of a spot price increase. This position is usually called

speculative. Strategy 2: Hedge future production by selling futures contract at for a volume equivalent to

the expected crop. The farmer is covering the market price risk and fixing his financial margin.

Strategy 3: Buy a put option at-the-money, meaning the right to sell for a premium.

Two possibilities may occur after the farmer’s decision during sowing: the market price can increase or decrease during the production cycle. As expected, the speculative strategy (Strategy 1) has the highest result variability, with very high and very low results with respect to market behaviour. With no basis risk, the hedging with futures contract (Strategy 2) offers as final payment the value of the target price in both cases. Finally, the purchase of a put option (Strategy 3) is a good “second best” strategy, bringing financial results very close to the best results of any of the above cases. This example presents the basic interest of futures contract as well as options. Combinations of strategies are required. Risk diversification comes from the positive correlation between futures and spot prices as well as asymmetric risk outcomes of options.

This hedging activity should be managed as a dynamic position. The question is when to sell futures contract. Should the farmer sell the entire expected crop quantity when planting seeds? Should he choose a time between sowing and harvest? In fact, the farmer must diversify the hedging times in order to really diversify price risk and manage yield risk. A satisfactory hedging programme could be utilizing futures market at various stages of crop production and spreading the risk over the duration of the crop.

Optimal hedging has been studied extensively by academics, first in the seventies/early eighties using purely futures contracts and then in the late eighties/nineties using option contracts. The models are increasingly complex but are all based on price correlation between the futures and the local spot prices. They give important information on the quantity to be hedged with respect to both the cash position and the correlation coefficient between the futures and the spot prices. Practical analysis also gives useful information on the diversification potential of futures markets. This is called hedging effectiveness computed as the reduction in variance that results from maintaining a hedged position rather than an unhedged position. All these types of practical computations are bridging the gap between theoretical analysis of risk management and practical use of futures markets.

4 Mix of Pooling and Spreading Contracts4

A few years ago, farmers were using either pooling or spreading techniques. There were two types of intermediary, clearly separated: some offered average pricing as a pooling technique and others offered an instant market price for immediate or delayed delivery. This dichotomy is disappearing. First, co-operatives with a pooling approach are now offering more instant market prices with greater access to futures markets. They provide services for selling and buying on the futures market in order to facilitate market access and decrease transaction costs. On the other hand, private traders offer a range of marketing contracts from classical forward contracts to averaged price contracts, with a great number of customized options contracts. For example, farmers can

4 From Risk-pooling to Safety Nets: Crop and Revenue Insurance in the United States, Joy Harwood, Robert Dismukes, Monte Vandeveer and Richard Heifner; United States Department of Agriculture



weigh differently weekly prices for computing a weighted averaged price over a long period of time. In doing so, farmers mix a price smoothing technique with some personal market ideas on price seasonality. Another type of contract by private traders offers an initial payment for harvest delivery very close to the spot market price, with a bonus in the case of a price increase during the storage season. The date for fixing the bonus will depend on the farmer. This contract is a mix of a co-operative initial payment for product delivery and an option contract, with the option premium included in the initial payment. Its value is minimised by a back-to-back management with final users and/or international traders. Competition between all types of intermediaries brings many innovative contracts for marketing agricultural products as well as the necessity for each intermediary to offer a complete set of contracts in order to satisfy the diversity of farmers’ needs. Farmers have access to more complete, accurate and up-to-date information. Therefore, some farmers want to manage the market relationship and use their intermediary as a pure service activity (assembling, storage, transportation). Others do not want to deal directly with the market, but do want to promote a modern image by using the techniques that intermediaries are offering. A co-operative which offers only an averaged annual price is out of date. Even though few of its members may use sophisticated tools, the co-operative must be in a position to offer such tools in order to maintain a positive image.

Another example, Central Soya, a grain processing company in Poland, has introduced a risk management instrument for local producers. Central Soya agrees to purchase grains, but producers can opt to fix (call in) their price and receive payment at some future date. Central Soya guarantees that they will receive a price no lower than the price on the day of delivery. In that sense, the Central Soya contract works as a put option. By delivering and not fixing their price, producers can take advantage of the increase in price later in the season (they can spread their sales), and also have price protection: prices cannot drop below those on the day of delivery. Without this system producers would need either to sell at harvest, when prices are usually at a seasonal low, or store and sell later, thus incurring storage costs. For Central Soya, the delay in payment means savings in the cost of financing its purchases. Producers, for their part, can use the Central Soya contract to obtain financing from banks. Governments can also intermediate for small farmers. For example, in Mexico, the government is offering a guaranteed minimum price to cotton farmers and hedges its exposure by purchasing put options on the New York cotton exchange.

4 Mode of Access to Hedging5

Farmer group is a heterogeneous entity with significantly varying level of scale. Mode of access to hedging may be different for the large & financially strong farmers from small & marginal farmers. For large farmers, one important question is when to sell futures contract. The optimum strategy is diversification, the farmer must diversify the hedging times in order to really diversify price risk and manage yield risk. A satisfactory hedging programme is distributed in stages, according to crop cycle. The stage-wise planning provides the surety about production and ensures full hedge. In addition, the risk is spread over the time and the futures market is used as a part of the marketing programme.

However, small & marginal farmers can use derivative markets only indirectly through aggregators, without negating any of the benefits of these markets. The key issue regarding aggregators is whether a third party can perform the function more efficiently; that is, at the lower cost. The use of commodity derivative markets requires adequate lines of credit, know-how, infrastructure, and market information and hence the answer to this question may be given

5 Role of farmers’ associations in commodity price risk management and collateralized commodity finance, UNCTAD



in affirmative. Farmer associations or cooperatives can act as aggregators to manage price risk for their members.

Alternatively, farmers may utilize the forward contracts negotiated with local intermediaries, private traders and co-operatives. For example, the farmer checks the futures market in October for the reference price (October of the following year) and begins to negotiate the basis for delivery at harvest time (or later, after a period of storage on the farm). When the farmer and the buyer agree, the forward contract is signed for a defined quantity, with quality premium/discount conditions, one or several periods of delivery and a fixed price. The intermediary trader who is long on his cash position will then sell on the futures market as a temporary substitute for a cash buyer.

The farmer is indirectly using the futures market, which presents several advantages. First, he is able to negotiate the exact volume he wants to sell and not a multiple of the futures contract quantity. He can sell the expected quality, choose the period of delivery and, more generally, fix the basis. He is not taking any basis risk on the transportation, storage or quality markets. Another advantage is the absence of margin deposits, margin calls and all the mechanisms designed to maintain the financial integrity of the futures market. This benefits the farmer who, as a small market participant, usually has high intermediary costs for trading on the futures market.



4 The Role of Government6 Most strategies that farmers can use to reduce income risk are likely to increase their production cost or might not be sufficient in the case of natural catastrophes. Such market failures have been used to justify government intervention in risk management in agriculture.

Risk in agriculture is often considered as having specific characteristics that explain the more frequent government intervention in risk management than in other sectors. Specifically, the relationship with nature, in particular the dependence on climate and biological processes, makes risk more difficult to control than with mechanical processes. Inelasticity of both demand and supply also contribute to fluctuations in agricultural commodity prices. In consequence, variability in agricultural prices is often higher than that in other products and annual income from agricultural activities can vary to a large extent in the absence of offsetting policy interventions. However, futures markets help to reduce price volatility but do not prevent longer-term price downturns.

When government intervention in risk management involves elements of support, as has often been the case in OECD countries, farm families have no incentive to adopt risk strategies at the production and consumption level, or to use market-based approaches. This in turn hampers the development of market, risk-shifting solutions. In addition, reducing risk faced by farmers may encourage them to take production decisions that are not sustainable. Hence, it is argued that some degree of instability can be good as it encourages technical progress and innovation in marketing. Various underlying elements contribute to increasing the costs of intervention and lower its efficiency. Appreciating these concerns, some governments have tried to encourage farmers to use futures markets. It is established widely that futures markets, where they exist, help to reduce price fluctuations within a given year. Recognizing this, government’s first contribution could be to provide information on prices and contracts, and training programmes to farmers on how to use futures markets. In some cases, governments have acted as intermediaries between farmers and futures exchanges, with or without subsidy.

4 Case Studies The following case studies explain the efficacy of hedging instruments in managing price risks. These case studies cover the details of the institutional structure adopted by aggregators to facilitate the farmers to hedge. The contracts on various exchanges are largely utilized by farmer bodies and representatives to hedge their risks. In some areas the coverage is more than 60% of production area. For instance, on Paris Bourse SA in France, contracts on rapeseed, introduced in 1994 have been increasingly used by co-operatives and processors and now cover 60% of European production. Guatemala – Price Risk Management to Facilitate Access to Finance7 The experience of Guatemala’s coffee sector demonstrates the feasibility of reaching small farmers with modern financial instruments. In 1994, the country’s National Coffee Growers’ Federation (ANACAFE), a private non-profit organization, introduced a coffee credit system aiming to improve the access of coffee producers to commercial bank financing. The use of risk management instruments is a prerequisite for participation in the credit programme. It considerably reduces the risk to the banks, allowing them to provide credit to coffee farmers at lower interest rates (according to ANACAFE’s estimates, this led to interest rate savings for farmers of over 10% of the loan value). ANACAFE is merely a facilitator, neither it provides the

6 Income Risk Management in Agriculture, OECD 7 Role of farmers’ associations in commodity price risk management and collateralized commodity finance, UNCTAD



credit, nor does it act as a broker. Small farmers generally depend on the ANACAFE programme to obtain credit. The system has the following components: Training & Capacity Building: ANACAFE provides training to farmers in different areas

helping farmers to understand and calculate their production costs; explaining to them the mechanisms of agricultural credit; and explaining the way that world markets determine the price of their coffee, and how the inherent risks can be managed. ANACAFE also provides market intelligence to farmers on a continuing basis–it distributes beepers which continuously signal the futures market price.

Facilitation: ANACAFE extension staff then evaluates the production potential of a farmer, and assist him or her with the necessary paper work for a loan. ANACAFE provides the farmer with a list of banks with which it has an agreement, and the farmer chooses the bank. The loan application, with supporting documents, is then transmitted by ANACAFE to the bank. Normally, the bank would then approve the loan, but with disbursement only after the farmer has obtained a hedge (he or she can choose which instrument to use: a fixed-price forward sale, sale of futures, purchase of put options, a collar strategy, or other).

All farmers in the country are, by law, associated with ANACAFE and can participate in the programme. The proportion of coffee farmers who hedged increased from zero to around 20% in the late 1990s as a result of ANACAFE’s activities.

Government Intervention to Facilitate Access to Futures Market8 In Canada, the Cattle Option Pilot Programme offered a customized option contract to cattle producers. The contract was available for smaller volumes than is usual in option. The Farm Credit Corporation implemented the programme while Cargill Investors Services Ltd. wrote the actual options. The programme covered the price risk and the exchange rate risk simultaneously.

8 Role of farmers’ associations in commodity price risk management and collateralized commodity finance, UNCTAD



However, the programme was discontinued because of low participation rates and lack of interest from producers.

In Mexico, an Agricultural Products Option Programme (APOP) was introduced in 1994 for cotton. It was extended to corn, wheat, sorghum and soybeans in 1995. The programme allows producers to hedge their production using commodity options at the Chicago Board of Trade and the New York Cotton Exchange. The implementation organization, ASERCA, acts as an intermediary between the producers and the US brokers, and subsidizes part of the option premium. Under the simple coverage, ASERCA pays 50% of the premium cost. Under the funded coverage, ASERCA may provide a larger contribution but the farmer must deposit the same amount in a fund (FINCA) and any profits from holding the option go into that fund. APOP functions as price insurance. The typical cost to the farmer is 5 to 8% of the strike price of the option. APOP contracts accounted for up to 11% of total production for wheat, but only 1% for corn as most corn farmers are very small.

Under the FAIR Act of 1996, a Dairy Option Pilot Programme was introduced in the United States. It gives milk producers in specific counties the opportunity to buy option contracts on a maximum of 6, 00,000 pounds of milk. Costs are shared between producers and the government: USDA pays 80% of the premium of each option as well as broker fees up to USD 30 per option. Situation in India In the present scenario limited involvement by farmers in hedging on futures markets may be attributed to government intervention through minimum support price (that already provide a



significant degree of protection against income losses), unequal availability depending on products and regions, and lack of understanding of the complex mechanisms involved. The importance of education and training for farmers and local intermediaries especially has to be emphasized. For instance, inadequate training and education of smaller farmers, extension officers and local bank managers explains why the Canadian Cattle Option Pilot Programme was not successful. In addition, the small landholding coupled with inadequate quantity for the purpose of hedging on the exchange delimits the farmers’ capacity. These issues require a multi stakeholder approach towards enabling the farmers to hedge their price risk through various instruments. The concept of aggregation can be utilized to overcome the shortcomings of quantity adequacy related to the financial instruments. In addition, the aggregation initiative can involve exchanges, brokers, voluntary organizations (VOs) and financial institution for training and capacity building, financial arrangements, knowledge support and hand holding to ensure effective hedging.

Recognizing the absence of developed risk management markets in developing countries, the International Task Force (ITF) on Commodity Risk Management of the World Bank recommends the creation of an international intermediary that would facilitate transactions between private providers of price insurance instruments (banks, brokers or traders) and potential users of such price insurance in developing countries (producer organizations, traders, processors, local banks or public sector entities). It would need to perform three types of functions in the risk management markets:

a) Facilitation by providing partial guarantees to mitigate risks involved in the transaction; b) Intermediation, by acting as a pass-through between the provider and user of the price

insurance instruments, in selected and limited cases; and c) Provision of core services and technical assistance – in particular, market information and

support to local transmission mechanisms. 6. PILOT PROJECT OPERATIONALIZATION

4 Initial Introduction

A workshop on cotton futures was held with member of Sajjata Sangh, to apprise them about the concept. The workshop was attended by 10 member NGOs of Sajjata Sangh. The concept of futures trading was introduced by MCX among the member NGOs. The initial queries and concerns were primarily related to non-availability of BT Cotton contract on the exchange. The farmer representatives demanded introduction of BT cotton contract, to introduce the commodity futures among their farmers. To this effect, Cardinal Edge along with MCX alleviated their fears regarding the quality constraints. The correlation in spot prices of BT cotton and futures prices of Kapas contract was shown to the farmer representative. Though, in the meeting it was decided to conduct a pilot while utilizing Kapas contract for understanding the efficacy of commodity futures for price risk management. Sajjata Sangh conceptualized a pilot with one its member NGOs to participate in the initiative. Aga Khan Rural Support Programme (India) (AKRSP (I)) working with Surendranagar based cotton farmers assumed the role of aggregator to implement the pilot.

4 Follow-Up Meeting To introduce the initiative among its farmer member, AKRSP (I) along with MCX introduced the concept to 900 farmers in one of its general meeting. Subsequently, a pilot was discussed with AKRSP (I) promoted farmers federation in Chotila.



4 Concerns In addition to contract constraints, AKRSP (I) raised the concern about complexity of the initiative. To address their concern, the necessary provisions were made in the proposal. As it was a pilot initiative aimed at identifying the constraints and limitations associated with farmer participation on the commodity exchanges, a clear provision in terms of MTM margins had been made to underwrite/bear the losses made by farmers in case the price movements are not favorable to them. Considering the possibilities of trading losses, the proposal to NABARD attempted to plug the conditions that could have inflicted losses on the participating farmers. The farmers however could gain from the upside which was also an equally probable outcome. In addition, the news articles on farmers incurring losses on exchanges perturbed AKRSP (I).



The subsequent analysis of the same articles only corroborated the speculative tendencies of farmers that were devoid of a careful consideration of the realities of physical markets.

4 Financial Arrangements These initiatives are of specific and unconventional nature and don’t fall in regular purview of development activities of NGO. To promote its widespread adoption financial support can be harnessed only from those financial institutions that promote innovation in cutting edge technology in development. The intervention required funding from a core development finance institution that can clearly play a critical role with NGOs & national level commodity exchanges to work synergistically to realize the objective of establishing an efficient and transparent price discovery mechanism for agricultural produce in India, in the larger interest of farming community for better price realization & hedging of price risk of farm produce. With this proposition, AKRSP (I) jointly with Cardinal Edge developed a proposal for NABARD to provide funding for the initiative.

7. LINKAGES

4 Funding Support To access the funding support, Cardinal Edge developed the proposal in consultation with AKRSP (I). Subsequently, Cardinal Edge and MCX discussed the initiative with NABARD on 10th July, 07. Pursuant to the meeting, the proposal for “Enabling Farmers to Leverage Commodity Exchanges” was discussed with farmers’ federation and submitted to NABARD head office on 7th Aug, 07. The amount was released in the last week of November, 07 and consequently the funds were transferred to the federation in the first week of December, 07.

4 Technical Knowledge Provider A provision for recruiting a technical service provider for providing regular market research feeds was mentioned in the proposal. Though, the delayed sanction and consequent delay in implementation process did not provide the enough leeway to AKRSP (I) to recruit a technical knowledge provider. MCX had agreed to fill the gap with its Product Knowledge Management Group (PKMG). Though, considering the technical complexities involved and AKRSP (I)’s inability to undertake the necessary activities by itself even after linkage with MCX, Cardinal Edge agreed to offer technical and administrative assistance to the project. The technical knowledge was accessed from MCX and conveyed to AKRSP (I).

4 Training & Capacity Building To create awareness among the member farmers, MCX agreed to support AKRSP (I). A provision for four training workshops was made in the proposal to provide awareness on functioning of the market and commodity futures. These workshops were held in Chotila.



4 Suitable Agency/Broker In consultation with MCX, Cardinal Edge approached Religare and Kotak Securities to open the trading account for the initiative. The initial approach was to open the trading account in the name of AKRSP (I), though, the legal status of AKRSP (I) does not allow them to engage in any kind of profit-oriented activity. In wake of this situation, farmers’ federation opened the trading account on behalf of his farmers. The major issue in opening the account was lack of PAN card and address proof with the farmers. In addition, the brokers also had limited understanding in opening the account for voluntary organizations. On account of lack of clarity among brokers, the procedural issues took one month to complete. Though, the process for opening the account with Religare was discontinued because of their lack of understanding on relevant documents and consequent delay. Finally, the trading account was opened with Kotak and it became functional in the beginning of December, 07.

4 Training & Capacity Building Pursuant to the introduction of the initiative, a workshop was held in Chotila to apprise farmer representatives about the functioning of the market. The objective of the workshop was to train the farmer representatives to discuss the concept in their village. The member farmers of federation from the five villages were invited in the second workshop, the objective of the second workshop was to inform the farmers on Kapas contract and its functioning. Subsequent to the second workshop, AKRSP (I) started enrolling the farmers from the five project villages for the initiative. 67 farmers from the five villages of Chotila were enrolled for the initiative. The third workshop was focused on the member farmers to apprise them of the functioning of the market



and the related intricacies. Prior to taking the position on the exchange, fourth workshop was held with member farmers and a simulation was arranged to provide them an idea of actual working of the Kapas futures. In addition following points were covered to ensure compliance with the institutional norms: Educating farmers to do trade (including on how to avoid being cheated), and provide them

information concerning markets, traders, prices, etc. Highlighting importance of quality, and the ways to evaluate quality; Stressing the importance of clauses of the contract & reliability in contract performance, and

imposing social sanctions against those who willfully break contract obligations;

8. INSTITUTIONAL DESIGN The schematic diagram for market information and futures trading decision flow has been provided in the following figure

Schematic Diagram for Market Information and Futures Trading Decision Flow

The Kapas futures contract on MCX was identified as the most suitable contract for hedging prices of cotton. The project necessitated development of such information structures on the ground which would help keep track of the physical operations of each farmer participant in order to manage the corresponding futures positions on the exchange and subsequently redistributing the benefits of price hedging proportionately among the project participants. However, due to the constraints of time and limitations in the understanding of participating farmers, a homogeneous-group based approach was adopted for farmers’ participation in price hedging. The initiative was carried out in five villages and one representative was chosen from each village to take decisions regarding the position on the exchange on behalf of his associated farmer members. The farmers were divided into sub-groups of

AKRSP/Broker/ Cardinal Edge

Farmers’ Federation


Village Representative N


Downward Arrow: Flow of Market Information

Upward Arrow: Flow of Futures Trading Decision



3-4 for meeting the minimum lot criteria of 4 MT per contract. In all the five villages, arrangements for public display of market information were made. AKRSP (I) field office collected the price and market scenario information from broker, web sources, and Cardinal Edge, and subsequently passed it on to the Farmers’ Federation for further dissemination. Subsequently, this information was passed on to the member farmers. The member farmers conveyed opinions and decisions about their positions to their representatives, which was finally aggregated at the level of Farmers’ Federation. The Farmers’ Federation subsequently communicated the necessary actions to the broker or the AKRSP representative dealing with the broker.

9. EXCHANGE PARTICIPATION APPROACH

9.1 Approach for Participation on Commodity Exchange 4 Considering the volumes, open interest & specifications of the contract, farmers federation had

taken short positions for 26 lots in the Kapas V-797 contract of MCX. However, in order to account for the differences in quality and prices between the Shankar-6/10 cotton variety (which is the typical cotton variety grown in the selected project area) and the V-797 Kalyan cotton variety, a hedge ratio of 1.20 was determined. This ratio was calculated on the basis of MSP Prices declared by the Government of India for the 2006-07 season (Rs. 1665 for Kapas V-797 & Rs. 2005 for Shankar 6/10).

4 The market entry timing, quantity and price were determined using the market outlook/analysis and inputs collected from the Product Knowledge Management Team of MCX, Kotak Commodities and web sources like commoditiescontrol.com.

4 The initiative was carried out in five villages of Surendranagar district. Each village had a farmer representative to disseminate the information among farmers and convey their decision to AKRSP (I). The market and price information were constantly disseminated to farmers. Farmers were organized in sub-groups of 3-4 members for the purpose of taking position on the exchange. The available contract size on the exchange is for 4 MT.

10. 2007-08 FORECAST & TRADE SCENARIO

10.1 Cotton Forecast

The trade outlook was formed on the basis of production, demand & supply scenario during the period of December 2007 to February 2008. The market outlook for the various period and sources is mentioned below.

4 USDA, 12th December 2007: World Trade Forecasts, In 2007/08, world trade is forecast to rise due to increased imports by China. China’s imports are expected to rise by 4 million bales, to 14.5 million. China’s imports are expected to account for 35 percent of world trade, above the 28-percent average of the previous 5 years, but substantially below the 43-percent share reached in 2005/06. India was a minor cotton exporter in 2004/05, but surpassed Uzbekistan to become the largest U.S. competitor in 2006/07. India exported 5 million bales in 2006/07, and is expected to export 5.3 million bales in 2007/08.

4 CommoditiesControl.com, 28th December 2007: India Raised Cotton Export Estimate to 7 Million Bales in 2007-08, The cotton exports by India's are expected to total around cotton 7 million bales in 2007-08, which is exceeding an earlier government estimate of around 6 million bales. Federal textiles commissioner said, earlier, the cotton exports was estimated at 6 million bales but due to strong demand from the U.S., Pakistan and to a lesser extent from China, it have now revised the estimate to around 7 million bales. In 2006-07, India exported around 5.5 million bales of cotton.



4 AgriWatch.com 2nd January 2008: India: Cotton Export Booming in 2007-08, The cotton exports from the country are soaring like never before and give remunerative incomes to many cotton growers across the country. In the international market, Indian cotton is in great demand due to its better quality and lower prices as compared to other country. In spite of firming rupee, shipments are moving at a fast pace to markets such as China, Pakistan, Bangladesh and South East Asia. Already close to 30-lakh bales have been shipped out. It is estimated that this season, India will export above 70-lakh bales of cotton. Indian cotton farmers have not get output and prices so good for several years. They are expected to produce a record crop of around 300-lakh bales (170 kilograms each) in 2007-08 as compared to 270 lakh bales of 2006-07. Consequently, India ranks second in world cotton production in 2007-08, having overtaken the US and standing next to China. Out of the total production, domestic consumption is around 225-230 lakh bales maximum, therefore there is a genuine export surplus of a large quantity of Indian cotton. Currently, domestic cotton market has continued to stay firm in spite of a large crop, because of ongoing export demand. However at present, attempts, both overt and covert, have initiated from certain sections of the cotton sector to put a brake on cotton exports, according to sources. Lobbying to stop cotton exports has started. Because, the cotton mills are facing a problem due to higher rate of cotton and rupee appreciation. Therefore, they are postponing their buying at that price level. Only some mills are buying cotton for their daily requirement.

10.2 Trade Scenario According to The Cotton Corporation of India, the total world production for the year 2007-08 is 25.99 million metric tons (MMT) compared to 26.74 MMT of previous season. The domestic production scenario for the year 2007-08 is 31 million bales compared to 28 million bales of previous year. The demand figures states 31 million bales for the year 2007-08 with increased exports of 0.7 million bales vis-à-vis last year. According to the World Prices Cotlook index, the percentage increase in prices compared to previous season is in the range of 12-30%. The reason for the recent price increase is attributed to the emerging demand from US, China and other South East Asian countries, complemented by lower world production.

Monthly average Cotlook A Index (FE) 2004-05 2005-06 2006-07 2007-08

FE Index FE Index FE Index FE Index

In US Cents per lb

August 51.91 53.23 59.88 66.62

September 55.03 53.94 58.82 68.12

October 50.89 57.74 57.03 68.93

November 47.71 55.87 57.39 69.68

December 47.51 56.09 59.43 69.52

January 50.23 58.36 59.06 73.21

February 48.69 59.66 57.86 75.05

March 55.34 57.59 58.42

April 55.99 56.23 57.13

May 54.9 54.35 55.57

June 52.66 55.14 60.61

July 53.17 55.42 67.84



10.3 Futures Market Scenario Futures trading in ongoing Kapas contract started from 16th August 2007. The minimum trade price was Rs 403.9 and the maximum reached to Rs 501.3 for 20 kg lot. The contract price touched the upper limit of Bandhani set by the exchange. The overall price change was 25%. The volatility in prices was explained by the fundamentals of major demand from US, China and other countries, coupled with shortfall in world production. Farmers’ federation had taken position for 26 lots on MCX platform. The average price for short positions was Rs 471.35, whereas, the average price for the long position was Rs 495.08. The trade statement for the positions is attached as annexure 1. The deficit in mark-to-market margin is Rs 123,480. The deficit is primarily due to the continuous rise in prices since December 2007. In the wake of these conditions, though the farmers had been able to lock in their desired price on the MCX platform, however, the rising prices have resulted in the net deficit.

11. OUTCOMES The intervention was planned to understand the efficacy of futures instrument in hedging the price risk of farmers. In addition, the intervention sought to evolve an approach towards aggregator model to enable farmers in leveraging commodity exchanges. 4 Price Discovery: The primary benefit of the intervention is the awareness among farmers about

price discovery mechanism through futures market. The regular access to information on supply and demand of domestic and international markets has resulted into understanding the price pattern, and making an informed decision for selling their produce.

4 Efficient Storage: The regular access to demand and supply situation of domestic and international market enabled farmers to take informed decisions on storage options of their produce. Member farmers took advantage of positive market outlook and upward price trend, and retained their produce till the end of February to realize better prices.

4 Better Negotiation Power: Regular dissemination of price information has resulted into better

negotiation power in the spot markets/local traders. These prices were displayed on the regular basis in the intervention villages. In addition to member farmers, other farmers from the village also had access to these prices. This has resulted in better negotiation with the local traders who came for procurement in the villages. These traders also realized that farmers have access to futures market prices and have active positions on MCX platform, this resulted in adjusting their offerings to the prices displaying on exchange.

4 Design of Aggregator Model: During the implementation of the initiative, learning related to

institutional design, costs and benefits sharing, training & capacity building and other incidental aspects have been assimilated. This would assist us in enabling the creative thinking on various issues emerged during the initiative and utilize the learning in scale-up the initiatives.

12. FINANCIALS The pilot was conceptualized to investigate the efficacy of price risk management market in hedging the price risks of small holders. This year the adverse price movement in Kapas contract has resulted in net deficit on farmers short positions. In the month of November, market outlook and the domestic production scenario predicted prices to fall down (See annexure 2). In the wake of these predictions, farmers’ federation decided to take positions of exchange platform and increase the



average price. Though, by the mid of December 2007, prices took a sharp move towards north. This contradictory trend resulted in decision of maintaining the stock of the produce. The contradictory price trend resulted from shortage in supply and high demand from various countries. In the wake of continuous rise in price since the month of December 2007, farmers decided to store their produce for realizing the better prices in the following months. Based on the stock situation on 12th Feb 2008, around 50% of the overall produce was still lying unsold with the farmers. To match their exposure on the exchange, farmers had open positions in the month of February 2008, when the maximum price rise took place. The price volatility resulted in touching the upper price limit of Bandhani. This resulted in the net-deficit on the open futures position on MCX platform.

Source: Cotton Corporation of India

13. IMPACT ASSESSMENT SURVEY

In addition to the focused group discussion, a survey was conducted to quantify the benefits and assess the impact. The methodology adopted for the impact assessment was to compare the state of beneficiaries i.e. member farmers before and after the intervention, which in this case, is utilizing commodity derivatives for hedging price risks. Quantitative and qualitative data was collected from member farmers. The before-after study has been complemented by with-without study where member farmers of Surendranagar district utilizing commodity futures were compared with other farmers in Amreli district who do not have exposure to commodity derivatives. Simultaneously, interactions with key resource persons from AKRSP (I) and Sajjata Sangh were undertaken to substantiate the findings emerging from primary research on member farmers. 4 Sampling Plan In quantitative surveys, a sample design should provide a rationale for what groups of clients and non-clients to include in the sample, how many to include, how to select them, and the location of program study sites (and non-program study sites, if included). It should consider the best ways to include respondents with and without the benefits of the intervention and in measuring changes over time. Therefore, the sample design of the project has been categorized into the following components:

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aining nts.



4 Information Access The primary mode for accessing the information is newspaper and local traders. All the farmers rely on these sources for fulfilling their information needs. The other sources of government agriculture staff, NGO staff, television and cooperative society are hardly utilized for the purpose of information access.

Neither focus group nor control group had any information about the minimum support price (MSP) declared by the government. In addition, none of the surveyed villages had storage facilities. The focus group farmers clearly mentioned the availability of commodity exchanges (Vayda Bazaar), though the control group had no awareness of such mechanism. However, both groups were not aware of warehouse receipt finance schemes by various financial institutions.

The focus group was aware of mechanisms to lock-in the desired prices to safeguard their risk; the control group had no awareness about such mechanisms. The focus group cited the name of the NGO to assist them in knowing the market outlook, though the control group clearly cited the absence of such facilitator.

4 Planning for Next Season The member farmers were aware of the Kapas contract and its conditions. Though, the farmers were not aware of Bandhani condition applicable to Kapas contract. Among the member farmers, 86% resorted to sell their produce from their doorstep. However, all the member farmers referred and utilized the futures prices for the purpose of bargaining with traders.

Two reasons were cited by the farmers for the purpose of price increase of Cotton, 56% of the farmers feel export demand is the primary reason though the remaining perceives the weather conditions as a responsible factor for price increase.

72% of the farmers have expected the price range of Rs 580-620/20 Kg for the next season, the rest of the farmers have predicted Rs 650-680/20 Kg. Within the focus group, only 66% of the farmers have expressed their willingness to utilize futures market along with planned spot market operations to realize their target price. However, the remaining farmers have clearly mentioned the efficacy of futures prices in determining the spot market operations. The member farmers have indicated their need for the continuous dissemination of price information for the purpose of effective planning of spot market operations. In addition, 70% of the farmers have indicated the option of availing the storage facilities for the better price realization.

14. FARMERS’ VIEWPOINT Focus Group Discussion: To know the viewpoint of the farmers on their participation on commodity exchanges, Cardinal Edge conducted a focused group discussion with 15 selected member farmers. The findings of the same are given below:

Benefits from Futures Market 4 Market Information Access: The price information displayed by exchange provided a good

reference point to assess the spot prices and negotiate with traders/agents. In addition, it created awareness among the farmers to track the market and form an outlook on prices based on the available information. Price discovery process provided them an idea about price movements. The price movement signals assisted them in planning their spot operations effectively.

4 Positions on Exchange: This introduced awareness about new market system among farmers along with a mechanism for locking-in their desired prices. In addition, it provided an essential



feature of price signal that assisted them in taking decisions about operations in spot market. During the pilot farmers benefited from price signals from futures market and decided to store their produce for the longer period in the expectation of better realization from spot market.

4 Spot Market Operations: Information access and positions on exchange has assisted farmers in deciding about their physical market operations and store their produce for longer period in the expectation of better price realization. In absence of futures market, farmers try to manage their risk by collecting the information from local mandis and accordingly planning their process. Though, the need of cash, lack of storage options and vagaries of weather may force them to sell their produce without utilizing the benefit of price signals.

Key Constraints

4 Regulatory Constraints The foremost regulatory constraint with respect to participation of farmers (particularly small

and marginal farmers) on commodity exchange are the procedural hurdles (PAN card requirement, KYC norms compliance, burdensome paperwork etc) for opening a demat/trading/bank account.

Restriction on participation of financial institutions (Banks, Mutual Funds, FIIs) also undermines the liquidity on commodity exchanges and allows trading on many contracts to be exposed to price manipulation and market cornering.

The bans/suspensions on futures trading in commodities of strategic importance have shaken the confidence of common citizens and physical market players in the price risk management effectiveness of commodity derivatives.

Lack of useful risk management instrument like options which have proved to be of immense value in managing risks of farmers and physical market players in other countries restrains potential hedgers in India by making them vulnerable to the unlimited downside risk inherent in futures trading.

4 Policy Constraints Policy interventions by the Government have a momentous impact on the direction and

magnitude of price movements in commodities. Abrupt policy changes by the Government generally result in upsetting the market equilibrium leading to the shift of balance in favor of one or the other counterparty. Uncertainty of Government interventions acts as a dissuading influence on genuine market participants (including hedgers) and weakens the free-market behavior of commodity markets.

4 Institutional Constraints The procedural requirements and the technical complexities involved in commodity

derivatives trading necessitate the presence of institutional entities which can act as technical support providers for farmer participation on commodity exchanges. Grassroots organisations like NGOs, cooperatives, agribusiness companies, farmer organisations have the ability to serve as technical support providers but given their existing under-preparedness and limited capacities for managing price risk management initiatives, the fruits of promising initiatives for improving commodity markets in India may not reach the intended beneficiaries especially the disadvantaged farmers.

Hedging the prices of the forthcoming harvest through futures trading requires the farmer to pay in the initial margin and Mark-to-Market (MTM) margin upfront. Such requirement is extremely constraining for farmers keen to hedge their price risks and calls for funding through institutional financing mechanisms.

4 Variety Difference: According to farmers the major constraint is incongruence in existing Kapas contract and physical market operations of the BT Cotton. Though, the correlation in prices may work, however, the prices displayed by exchange should be of BT Cotton for effective spot



operations. In addition, the delivery conditions needs to match the variety and timing for the BT Cotton.

Suggestions for Contract Reconfiguration & Enabling Conditions 4 Introduction of BT Cotton contract: The entire Gujarat state is predominantly BT Cotton belt,

around 80% of the net sown area is covered with BT variety. In tune with the physical conditions the available contract should be of BT Cotton. In addition, the delivery conditions needs to match the duration of the crop and should be at the end of the harvest.

4 Small size of contract lot: The contract lot needs to be adequate enough for a small & marginal farmer. The farmers can form a small group and pool their produce for taking positions on exchange. However, the complexities related to individual choices and requirement results in varied operations at the physical level by each farmer, consequently the management of groups becomes complex.

4 Delivery Centres: The proximity of delivery centres to the physical locations is of the prime importance for the farmers utilizing delivery option.

4 Financial Arrangement: The margin money and mark-to-market margin requirement needs to be arranged from formal financial sources. The mark-to-market margin should be arranged with a long term perspective to take care of year-to-year fluctuations.

4 Information Access: Market and price information needs to be disseminated on regular basis to assist farmers in managing and planning spot market operations.

Spot Market Operations 4 Reason for Early Selling: The primary reason is the cash requirement to repay loans, manage

household expenses, preparation for the next season and social obligations. The second reason of lack and access to formal credit facilities restricts investment in processing, storage and marketing avenues. The informal credit sources dictate inhibitive terms with respect to quantum, duration and interest rates (ranges between 36-60% per annum). Finally proper storage conditions require investment in terms of insecticides and packaging, in absence of these there is high risk of loss. In these conditions more preference is given to present and tangible outcomes rather than mere possibilities. In the last season, the rainfall in the month of November, coupled with lack of storage options had resulted in early sell of produce in the market.

4 Price Expectations: The market outlook was based on the last year scenario. During the last year, the prices touched the Rs 500 mark, though stayed there for two days only. Subsequently, prices started falling down. Farmers perceive that subsequent to harvest the additional domestic or international demand is primarily met by traders from their own stock, hence the price changes are not reflected at the ground level. Based on the last year experience, farmers had a perceived price of Rs 550/20 Kg as reference point. In addition, there was a perception of fall in prices after touching the mark of Rs 550. In the wake of these perceptions majority of farmers resorted to sell their produce on the median range of Rs 550- Rs 580. Though, the realized price range was Rs 450 (In November) to Rs 580 (In February).

4 Mode of Selling: The majority of the farmers resorted to sell their produce at their doorstep. The primary reason was better negotiation for price realization. The transportation to Mandi incurs extra cost and lessens their bargaining; however, in case of sell at doorstep they can negotiate better prices with the traders/agents. The reference point for the transaction was futures prices displayed in their village. This had resulted in better negotiation for the prices. According to farmers, they have realized their expected price based on their perception of last year scenario.



15. CONCLUSIONS The interactions with farmers on their participation in futures trading have revealed ‘optimistic though pragmatic’ views about scaling-up of initiative. The scaling-up is expected to augur well for all the relevant stakeholders, if the viewpoints of the farmers can be incorporated in a reasonable way for facilitating them to leverage commodity exchanges for hedging their price risks. The various facilitating agencies like the Commodity Exchanges, Forward Market Commission, Development Funding Agencies, NGOs/VOs, Cotton Industry and Agri-input Companies have to play an instrumental role for ensuring the following: 4 Convergence between the available instruments and the farmers requirement with due

safeguards for protecting the interests of both the stakeholders 4 Ensuring long term linkages with Cotton Industry for standardization of production and market

operations 4 Provision of long term financial, technical and capacity-building support to the farmers for

meeting the deliverables and benchmarks agreed to (mutually by exchanges, mills and farmers) 16. WAY FORWARD 4 Initial Groundwork To promote similar pilots it is imperative to create an Apex-level Steering Team involving various stakeholders for implementing and managing these initiatives. The beginning step needs to be linkage development with NGOs and Voluntary organization for regular price and market information dissemination. The effective implementation of the initiative necessitates developing an information system to track the agricultural operations of farmers. The information system needs to incorporate the information on previous years’ price realization and market operations by the farmers. The initiative involves identification of lead farmers and facilitators for providing support and guidance to other farmers on both technical inputs and administrative requirements. The enrollment of member farmers needs to be based on their willingness to ensure financial contribution and share inherent risks under this initiative. To ensure the compliances it would be imperative to formalize the agreements among farmers, industry representatives, commodity exchanges and all other stakeholders involved. The mobilization and monitoring process would be conducted by hiring local extension workers for quality, quantity and process control. 4 Reconfiguration of Contract In line with the physical conditions and operations it is imperative to reconfigure the existing contracts of the exchange. The contract needs to be in tune with the physical conditions on the ground level. The contract should match the BT Cotton variety and the delivery conditions needs to in synchronization with the duration of the crop. 4 Training & Capacity Building To ensure the proper understanding of theoretical concepts it would be necessary to conduct simulation and coaching exercises. The training & capacity building activities are under the purview of developmental activities to be undertaken under the project and necessitate the arrangement of associated funding alternatives. The capacity-building activities need to be conducted on relevant areas in association with industry experts/specialists.



4 Spot Market Linkages To ensure proper compliance and judge the quality of produce at regular intervals it is necessary to monitor the quantity and quality of cotton production both periodically and at producer’s solicitation. This would enable the institution to link benefits with the quality and proper distribution of costs and benefits. In addition, the linkages with cotton industry and ginning mills can ensure spot market interface, and standardization of production and market operations. The aggregation process would also require conducting post harvest review and undertaking activities for dispatch and delivery of cotton. 4 Financial Support Arrangement for financial support necessitates development of a detailed project plan for linking up and streamlining the various activities for the proposed initiative. The sources include farmers’ contribution, loan from financial institution and development funding for envisaged development activities under the initiative. The loan part should include long term funding support from funding agencies and other institutions (like CCI, NABARD etc) for mark-to-market margin. This fund can be utilized for streamlining the cost & benefits over the duration of the initiative. In addition, the working capital requirements/operational expenses would be required to fulfill the cash requirement at the time of harvest and beginning of the new season. 4 Supportive Linkages To ensure standardization of produce, exploration of tie-ups with suitable agri-input providers (seed, fertilizer, crop insurance and pesticide companies) for bulk procurement and for quality and quantity assured technical support would be undertaken. In addition, it would be necessary to identify agencies for providing logistics and post-harvest support. 17. SUGGESTIVE INSTITUTIONAL STRUCTURES FOR FUTURE INTERVENTIONS Based on the insights from this project, the following institutional structure design emerges for future projects.

The lot size as per the futures contract may be a key determinant of whether to undertake positions on a futures contract on an individual basis or on a group basis. If the ratio of the quantity to be hedged by each individual farmer to the lot size of the preferred futures contract (named as significance ratio) is less than 1 for most of the farmers, a group-based approach will be more expedient. The smaller the significance ratio, the more sub-optimal will be the hedging in terms of its effectiveness as well as participant’s control. Even though the transaction costs for hedging are significantly reduced in the group-based approach, the autonomy of decision and objectivity in terms of sharing gains or losses from hedging are reasonably compromised on the other hand.

One of the key prerequisites of a good institutional structure is the independence it provides to each participant/actor for taking decisions related to its commensurate stake in any transaction. Therefore the decision-making related to trading decisions especially the entry and exit prices in futures contracts has to be vested with the individual participant or with the representative designated by the joint participants in a futures contract. Therefore the first-tier of collective organization will be at an individual futures contract level where either an individual participant or his representative will act on his behalf for communicating trading decision information upwards.

At the second-tier, the participants in a collective hedging program must organize themselves ideally at a village level to ensure smooth flow of market information downwards from the more informed stakeholders and trading decision information upwards from the individual participant or the representative designated by the joint participants under a common futures contract. The village-level representatives may be federated at a higher-tier (third-tier/apex-level) for coordination,



monitoring, course correction, and evaluation. The nodal body (in addition to hedging participants) can also be represented by all the key stakeholders of the project who can contribute with the various specialized inputs required for undertaking such hedging programs. The nodal body may also be vested with the responsibility of guiding the establishment of operational and informational structures in the project location. The nodal body can execute suitable linkages with relevant service providers like brokers, commodity market analysts and financial institutions willing to extend quality support to the project participants.

The institutional structure must ensure that each participant receives timely and reliable information on the market developments pertaining to the commodity being hedged. The information structure for market-based information is more likely to pyramidal in shape with the nodal body occupying the vertex of the pyramid. The nodal body can then pass the information down to the next lower-level tier (the second-tier) existing at the village level which can ensure arrangements for further dissemination of market information to hedging participants (first-tier or futures contract participants).

For equitable distribution of gains and losses from hedging, the corresponding quality of physical produce of each participant needs to be ascertained. Loss and gain distribution criteria based on the quality of physical produce need to be jointly established and clearly communicated to each participant in a group-based futures contract trading. Furthermore, there needs to be a well-defined contractual relationship between the nodal body (acting as a technical support provider) and each participant in a collective hedging program.

The program is collective only in the sense of aggregating the technical support and other service requirements associated with hedging. The decision-making may however be completely decentralized and individual-futures-contract-based in order to delegate responsibility to participant(s) in an individual futures contract for its/their own gains or losses. The margin requirements and corresponding futures trading operations have to be likewise managed by participant(s) in any individual futures contract. The schematic diagram of the suggestive institutional structure has been provided in the following figure (Figure 2).

Figure 2: Schematic Diagram of Suggestive Institutional Structure for Future Interventions

Futures Contract-Level (Tier 1)

Village-Level (Tier 2)

Apex-Level (Tier 3)Nodal Body

(Village Representatives + Other Key Stakeholders)

Village 1 Representative

Futures Contract 1

Participant(s)

Futures Contract 2

Participant(s)

Village N Representative

Futures Contract N

Participant(s)



Annexure 1: Trade Statement

Trade Date Tr. Type

Rate Trading Lots

Trade Date Tr. Type

Rate Trading Lots

17-Dec-07 Sell 453.0 2 28-Feb-08 Buy 488.9 1

17-Dec-07 Sell 452.6 2 28-Feb-08 Buy 489 2

19-Dec-07 Sell 453.6 1 28-Feb-08 Buy 489 1

19-Dec-07 Sell 453.6 1 5-March-08 Buy 498 1




5-Jan-08 Sell 475.0 1 5-March-08 Buy 498 1





25-Jan-08 Sell 479.8 1 7-March-08 Buy 493.6 1

30-Jan-08 Sell 481.2 1 7-March-08 Buy 492.5 1

5-Feb-08 Sell 482.6 1 12-March-08 Buy 494.6 1





Buy

Total 26 26



Annexure 2: Market Scenario for the Month of November-December Cotton Falls on Forecast for Larger U.S. Crop, Lower Exports Bloomberg, November 9, 2007 Cotton fell for a third straight day, the longest slide since September, after the U.S. cut its export forecast and said the domestic crop will be larger than expected a month ago. Farmers will harvest 18.86 million bales in the year that began Aug. 1, up from 18.15 million projected last month, as yields gained in Texas, the Department of Agriculture said today. Exports will total 16.2 million bales, down from 16.7 million forecast last month, the USDA said. The U.S. is the largest exporter of the fiber. “The production figure is a lot larger than the market was expecting,'' said Rohit Savant, a commodity analyst with CPM Group in New York, in an interview today. ``This is a substantial increase. That's going to be bearish.” Cotton futures for December delivery fell 0.05 cent, or 0.1 percent, to 64.64 cents a pound on ICE Futures U.S., formerly known as the New York Board of Trade. Futures still are up 30 percent in the past year on expectations for a smaller U.S. crop. “Yield is expected to average 859 pounds per harvested acre, up 33 pounds from last month and up 45 pounds from 2006,'' the USDA said in its report today. “If realized, the yield will be the largest on record, surpassing the previous record of 855 pounds per acre set in 2004.” Rising Production Production is expected to be higher in the Southwest and lower Mississippi Delta regions, with growers expecting record yields in Louisiana, New Mexico, Oklahoma and Texas, which is the largest U.S. producer of the fiber, USDA said. Eight analysts, economists and traders surveyed by Bloomberg News before the release of the report expected USDA to boost its crop forecast to 18.26 million bales on average. A bale weighs 480 pounds. “The U.S. numbers were a bit of a shock,'' Sharon Johnson, an analyst for First Capitol Group in Roswell, Georgia, said today in an e-mail message. The USDA lowered its estimate for imports by China, the largest producer and consumer of the fiber, to 14.5 million bales, compared with 15 million forecast a month ago. China's crop estimate was left unchanged at 35.5 million bales. “Adding insult to injury is an increase in exports by India,'' Johnson said. The South Asian country is the second- largest producer of cotton. Indian Exports India, which competes with the U.S. to sell fiber to importers such as China, will export 5 million tons, more than the 3.6 million predicted last month, the USDA said. The department left its production estimate for India unchanged at 23.5 million tons. The revisions to Pakistan's production and import figures were the “only bullish news,” Johnson said. Pakistan's output forecast was reduced to 9.75 million bales from 11 million bales and imports were increased to 3 million from 1.7 million.



Still, higher import demand from Pakistan may benefit India rather than the U.S., Johnson said. In the year ended July 31, the U.S. harvested 21.59 million bales and shipped 13 million overseas. The country's inventories stood at 9.5 million bales as the year started on Aug. 1. Cotton Prices are Likely to Head South Business Standard, November 14, 2007 Cotton prices are likely to head south in the coming days as arrivals pick up momentum across the country. Currently, major markets in Gujarat, the largest cotton producer, remained closed on festival season. Sandeep Shah, an Ahmedabad-based trader, said, “As the markets are closed for 5-7 days, there are no fresh arrivals. But once the markets open and arrivals begin, there could be a decline in cotton prices.” Before the market closed last week, the Shankar-6 variety of cotton was ruling at around Rs 20,000-20,200 a candy. “There is a possibility of a 3 per cent fall in rates in the week ahead,” added Shah. This would mean a fall of around Rs 600 a candy. Meanwhile, reports suggest the cotton prices have fallen by Rs 100 a candy (1 candy= 356 kg) in the central zone (Gujarat and Madhya Pradesh). “This is a very insignificant price movement in cotton,” said sources at the Cotton Corporation of India. Gujarat, which has the highest yield pattern in the country, is expected to contribute around 110-115 lakh bales (each of 170 kg). According to O P Agarwal, executive director of the Cotton Association of India, markets were ruling steady and arrivals have not yet picked up. “By the end of this month, cotton arrivals will zoom and prices may soften,” he said. The country is expecting a crop of 310 lakh bales in 2007-08, up by around 15 per cent from the last year’s crop size of 270 lakh bales. Market experts said that Bt cotton had contributed to the robust production. Currently, Bt cotton covers almost more than half the area under cotton cultivation in the country. The total acreage is expected to touch around 95 lakh hectares this year.



Annexure 3: Questionnaire for Project Evaluation Survey

1. BASIC INFORMATION Name: …………………………………………Address: ………………………………………………… Village: …….……………………… ……..Taluka: ……………………………..District: …………… Contact Number: Landline ………………………………Mobile ……………………………………… Landholding: .........................acre Crops Grown: Kharif ……………….Rabi………………......... 2. COTTON PRODUCTION DETAILS

2007-08 2006-07 2005-06 Area (Acre) Quantity (Quintal) Cost/Acre (in Rs) 3. PRICE & MARKET INFORMATION Market & Price Information Sources (Please tick all the information sources availed by you for getting price information on cotton)

Sources 2006-07 2007-08 Newspaper Local Traders Television Govt. Agri-Extension Staff Coop. Society Local NGO Others (specify)

Price Expectations at various Crop Stages [In terms of Price per 20 kg (maund)]

2007-08 2006-07 Stage Month Price Month Price Sowing Flowering 1st Picking / Harvest 2nd Picking 3rd Picking



4. SALES & PHYSICAL OPERATIONS Sales in Physical Market (Qty in Quintals; Price per Quintal; *Location - Mandi Name / Own Village / Home)

Stage 1st Lot 2nd Lot 3rd Lot 4th Lot 2007-08 2006-07 2007-08 2006-07 2007-08 2006-07 2007-08 2006-07 Quantity Month Price Location* Motivation for Sale (Please tick one or more relevant reasons for sale of your produce)

2006-07 2007-08 Stage Urgent

Cash Needs

Target Price

Attained

Lack of Storage Options

Commitment of Produce

Cash Needs

Target Price

Attained

Lack of Storage Options

Commitment of Produce

1st Lot 2nd 3rd 4th

Any Other Reasons Specified: (i)………………………………………………………………………………………… (ii) ……………………………………………………………………………………….. 5. PRICE RISK MANAGEMENT Awareness of Physical Market Measures Yes No Respondent Comments

Are you aware of MSP for different cotton varieties declared by the government?

If yes, were you able to realize the price greater than the declared MSP?

Is there any facility in your village for collective storage of your produce?

If yes, have you used it to store cotton during any of the last three years?



Awareness of Upcoming Risk Management Tools Yes No Respondent Comments

Are you aware of the possibility of getting loan against your produce stored in warehouse?

Are you aware of the Vaayda Bazaars / Commodity Exchanges in India?

If yes, please name any two of them. Are you aware of mechanisms to lock your target price for cotton?

Are there any institutions/ organizations which help you to know the market outlook for cotton?

Awareness of Futures Trading on Commodity Exchanges (Only for Farmer Participants in Pilot Project for Price Hedging)

Respondent Comments

What is the lot size of cotton futures contract on MCX?

The futures contract used during the pilot project was based on which variety of cotton?

What is the initial margin money requirement for cotton futures contract?

Do you know about the Bandhani limits in the cotton futures contract? What do they signify?

Were the futures prices for cotton contracts useful to you? If yes, then in what ways?

Why did cotton prices rise this year by so much?

What prices are you expecting for cotton in the coming season? How will you ensure that you are able to get your target price?



BIBLIOGRAPHY

4 “Income Risk Management in Agriculture”, OECD, 2000 4 “Transfer of Risk along the Food Chain”, Leland Swenson, National Farmers Union, United

States 4 “Farmer Risk Management and Futures Markets”, Professor Jean Cordier*, École Nationale

Supérieure Agronomique de Renne, France 4 “From Risk-pooling to Safety Nets: Crop and Revenue Insurance in the United States”, Joy

Harwood, Robert Dismukes, Monte Vandeveer and Richard Heifner, United States Department of Agriculture

4 “Commodity Price Movements and How to Manage Them at the Micro-Level: the Role of Farmers' Associations”, Olivier Combe and Werner Deenen

4 “The role of farmers’ associations in commodity price risk management and collateralized commodity finance”, UNCTAD, 10 January 2002

4 “Dealing with Commodity Price Uncertainty”, Policy Research Working Paper 1667, Panos Varangis & Don Larson, World Bank

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