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Contract Farming: The Most Viable Avenue for Zarai Taraqiati Bank




  • The emerging trend of focusing more and more attention on improving the production and productivity of farming across the world has prompted the Developmental Financial Institutions to evolve better schemes to improve the income generation capacity of the farming community and help them repay the borrowed funds in time. Zarai Taraqiati Bank Limited is the major formal institution in Pakistan, which because being in public sector have in fact become the agent for rural development purveying the most important input i.e. credit. The main objective of the bank in lending should be to improve the recycling of funds capability borrowed from the public or raised from internal or external sources for the benefit of farming community. The recovery of loans portrays a dismal picture. Since agricultural lending expanded extensively, the recovery percentage has received a great setback due to which as per estimate more than half of the funds are not funneled back. In fact, financial distress has always been a feature of the financial scene but most of the time it has been associated with being a sectoral problem such as those affecting agriculture and industries.

    The second set of problems is much less widely recognised although probably more important. Serious loan repayment problems further reduce the viability of some loan portfolios. In many cases loan repayment problems emerge in all loan size groups.

     

    Contract farming

     

    Contract farming can be a good solution to address these problems. Contract farming is a system where agricultural production is carried out according to an agreement between a buyer and farmers, which is based on certain conditions for the production and marketing of farm products. Typically, the farmer agrees to provide the predetermined quantity of a specific agricultural product, meeting the quality standards and delivery schedule set by the purchaser. In turn, the buyer commits to purchase the product at a pre-determined price. The buyer also commits to support production through, for example, supplying farm inputs and land preparation facilities, providing technical advice and arranging transportation of produce to the buyer’s premises.

     

    2.        Plus Points

     

    2.1       Through contracts with farmers, the Kissan Support Services, a subsidiary of Zarai Taraqiati Bank can monitor input use and establish a degree of control over crop management decisions that might jeopardize repayment. KSSL can deduct repayments direct from crop payments, without having to rely on a third party to do this. It can also make future farming contracts depend on meeting repayment clauses of the current contract, a potentially strong repayment incentive in areas where no other source of input credit exists.

     

    2.2      Input credit provided by the Bank with interlocking arrangements to buy the smallholders’ crops under farming contracts can be beneficial for frequent recycling of Bank funds as in contract farming, a financier provides the inputs to farmers on credit in order to help secure produce of sufficient quantity and quality for onward marketing and instantly securing sufficient funds for reinvestment. The credit enables the farmer to acquire the required inputs to which he would not otherwise have access.

     

    2.3      Performance of Bank’s credit schemes under interlocked arrangements has to follow somewhat different principles than is the case in standard financial sector operations. Thus a scheme can be profitable for the Bank even with high transaction costs and a relatively high default rate, if it secures an adequate supply of quality produce and earns sufficient profit from its marketing.

     

    2.4      The Bank operations shall include a focus on supporting the intensification of smallholder production through improved technologies, the sustainable development of rural finance markets, and the establishment and expansion of agricultural produce markets. If well implemented, credit-based interlocking arrangements with KSSL can provide solutions to all of these three inter-linked areas, even in the often difficult operational environments in Pakistan. The Bank operations can serve as an important element in improving the chances of smallholders to participate in the production of high value crops.

     

    2.5       Towards farmer’s end, Firstly, it reduced the number if intermediaries in the disposal chain. Secondly, it will reduce the marketing and pricing risk as the purchaser is already there and the prices have been settled. Thirdly, it will provide a more reliable, regular and timely sources of income to the farmer. Fourthly, it will ensure timely supply of good quality raw material at reasonable price to the farmer. Finally, it will open new vistas to the farmer who gets the option of adopting new crops suitable to the local conditions of soil and climate and available irrigation facilities thereby enabling him to move away from non-profitable time old traditional farming practices. Farmers will be benefited by adopting improved technology and better quality seeds, credit and banking facilities also reach the door of the farmer as long KSSL is there to cover the risk of credit. Contract farming generally promotes export oriented and cash crops and as result the country is benefited by getting additional foreign exchange.


    2.5      Summarizing: the contract farming arrangements shall have the following comparative benefits in general: 

    • Contract farming as an arrangement shall have operational firstly in Rahim Yar Khan District as a pilot project on experimental basis – small and large have this arrangement in place.
    • The arrangement shall encompass a wide range of crops – wheat, rice, cotton, sugarcane, and other cash crops.
    • The arrangement shall be beneficial to both the farmer and the Bank.
    • The major benefits accruing to the farmer shall be – quality inputs, technical guidance, assured market and price. There shall be an enhanced farm productivity & income.
    • In many of the contract farming arrangements, the Bank shall enjoy twin advantages viz., assured availability of quality produce at pre-decided rates and assured market for Bank’s products reaching even the remote areas. This will also facilitates building the image of the Bank and its subsidiary KSSL and meets the social responsibility quotient.
    • The inference is that contract farming, if practiced by the Bank / KSSL, shall be serving the interest of both the parties.

     

     

    3.        Minus points

     

    3.1       The concept of contract farming is not free from demerits.Just like any other form of contractual relationship, if not operated properly there can be some problems with contract farming as well. The biggest problems to the proposed scheme sustainability shall emerge when the KSSL fails to procure the expected volumes and qualities of crops from the contracted smallholders in lieu of credit provided by the Bank. The first issue here concerns the quality of the produce. In a number of cases, despite the inputs provided, smallholder producers would have difficulties in meeting the quality standards required for marketing. The second and even more important issue is the case of side-selling and side-buying. In the present liberalized markets, the Bank can find it difficult to buy the crops from its own contracted farmers.

     

    3.2      Enforcement of contracts is very crucial. Contracted small-scale farmers may either divert inputs provided on credit by the Bank to other on-farm end-uses or sell them, or divert the contracted production to other purchasers without facing the types of penalties imposed on contract farmers who default. A major element in contract compliance in Pakistan is providing the smallholder with credible prospects, and desire, for contract renewal. In this regard, smallholders can be seen as collateralizing future income rather than assets to secure upfront transfers from contracts. The contract must be sufficiently attractive to the smallholder so that the costs of default (related to exclusion in future seasons) exceed the benefits from default (such as being able to pocket forward payments). If a contract is only marginally attractive in terms of profit then default risk shall be higher.

     

     

    4.        Points requiring extra consideration

     

    4.1       Opportunistic competitors can buy actively and systematically from farmers contracted by the Bank, and often find willing sellers within the smallholder community. Another related threat to the sustainability of proposed contract farming and input credit scheme is linked to the problems of law enforcement in contract farming in Pakistan and the obvious lack of an appropriate code of conduct among both the KSSL and farmers. Concerning the terms and impact of the Bank credit, the overall conclusion is that in general, there is little possibility that smallholder farming contracts and the related input credit operations shall be of an exploitative nature. Most of the operations shall have a potential to benefit both the KSSL and the farmer.

     

     

    4.2      However, unlike in standard banking operations, a relatively low recovery rate does not necessarily mean that the company input credit operation has failed. The target of the Bank is to buy produce through KSSL, not to make money of the input credit delivery. The credit amounts shall represent only a small share of the value of the crops produced with the inputs provided by the Bank. Therefore, if the produce buying targets of the KSSL can be reached, reasonable credit defaults can be acceptable.

     

    4.3      Time is the most important factor shaping the success of agro-based procurement system. Due to biological nature of the raw material, the understanding of overall ecosystem is important to make the correct decisions. If the Bank is short of funds, It can borrow from the other banks. But if you loose out on timings the Bank cannot rework with the clock and reset the timelines. This is one of the major reasons that why agro-business looks simple to an outsider but in fact it is are more knowledge intensive that makes business decisions extremely complicated when it comes to running it efficiently.

    4.4      It is, however, relevant to point out that in the increasingly liberalized markets in Pakistan, there is very little public sector field presence left in the agricultural input or output markets or in the rural sector in general. Thus, to intensify smallholder farming and to increase household incomes, new approaches and partnerships need to be considered and tested. KSSL should first launch the contract farming starting at any District as a pilot project on experimental basis and then extend to other areas after its proven success. It should however be kept in mind that Business Model for Contract Farming can work well where the Post Harvest Processing Technology is difficult, and Supply is Greater than Demand.

     

    Operating Contract Farming

     

    Zarai Taraqiati Bank Limited should finance farmers preferably who have contract farming arrangements with the KSSL. Under the Contract Farming arrangement, the farmers, and the KSSL shall enter into an agreement for the production and supply of agricultural products under forward agreements, frequently at predetermined prices.

    The KSSL, which will have a contract farming arrangement with farmers, could act as a “Management and Collection” agent in the lending arrangement, an interface between the Bank and the farmers. It should identify the borrowers, do the documentation, disburse the loan to the farmers on behalf of the Bank and after procurement from farmers, routes the proceeds payable to farmers, to the Bank towards repayment of their loans.

    Eligibility

    Farmers having cultivable fertile land of 3 acres and above.

    Tenor

    Duration of the crop plus 1 month.

    Disbursement 

    The disbursement of loans should be effected to the credit of current account to be opened by the KSSL with Zarai Taraqiati Bank exclusively for the said purpose. The KSSL should make the disbursement to the farmers and submit an acknowledgement receipt from the farmers to the Bank as a token of having received the loan.

    After the supply is over, KSSL should send to the Bank the entire proceeds payable to the farmers. The bank will make balance payment to the farmers after deducting their crop loan dues.

    Regulation :

     

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    Staffing

     

    The foremost issue is finding the right farmers and assessing them, which is beyond the scope of the bank’s regular work, and is also very time consuming. The operating cost of the bank will also increase if loans have to be realised by going to each individual farmer. For this extra temporary / part time staff like Village Assistants from the same village shall have to be hired.

    A Village Extension and procurement Manager has to take charge of a few village tracts depending upon the locality and state of communication, while a Village Tract Manager shall supervise the work of Village Assistants who will be in direct contact with farmers.

     

    In addition a separate division shall have to be established after completely diverting to contract farming. The main function of this Division within KSSL shall be procurement and distribution of farm inputs viz. chemical fertilizers, pesticides and other small farm implements. Close coordination with the local fertilizer factories, pesticide companies and also with transport agencies shall have to be undertaken for timely supply of these agricultural inputs down to farm level. In addition, it will be responsible for the import of chemical fertilizers, pesticides and agricultural inputs, according to its financial allocations. And on the other hand, it will also assist and support private entrepreneurs to meaningfully participate in this field.

    By.

    Shaukat Masood Zafar


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