Report No. 35953-IN India Taking Agriculture to the Market October 17, 2008 Agriculture and Rural Development Unit South Asia Sustainable Development Department South Asia Region Document of the World Bank INDIA TakingAgriculture to the Market Contents Acronyms andAbbreviations.......................................................................................................... ii Acknowledgments........................................................................................................................... vii ExecutiveSummary......................................................................................................................... ix I Introduction............................................................................................................................ . 1 B. Challenges inthe Agricultural MarketingandProcessingSystems................................... A. Overview ........................................................................................................................... 1 3 I1. A. LiberalizingAgricultural Marketing.................................................................................. PolicyEnvironmentfor AgriculturalMarketingandProcessinginthe 1990s.................5 6 B Taxation ofthe Agricultural Marketing System .............................................................. . C. Investment Climate .......................................................................................................... 11 D. Ministries andAgencies InvolvedwithAgricultural MarketingandProcessing.............12 12 I11 LinkingFarmersto theMarket........................................................................................... . 19 A. CharacteristicsofFarmers GrowingHigh-Value Crops .................................................. 19 B. Farmers' Access to Markets............................................................................................. 21 D. Postharvest Activities PerformedbyFarmers to EnhanceQuality.................................. C. Farmers' Access to Market and Other Information.......................................................... 23 23 E. Contract Farming: Status and Challenges........................................................................ 25 F. Other MarketingArrangements ....................................................................................... 27 G Farmers' ParticipationinProducer Groups........................................................... . 28 I V . TradinginAgriculturalCommodities................................................................................ 31 31 B. Trading inWholesale Markets......................................................................................... A. Access to Wholesale Markets.......................................................................................... C. Investment Climate inWholesale Trading....................................................................... 37 40 D. FoodRetailing.................................................................................................................. 41 E. Domestic Grades and Standards....................................................................................... 45 V . Value-AdditionandExportofHigh-ValueAgriculturalProducts.................................. A. Recent Performance ofthe Ago-Food Processing Sector............................................... 47 47 B. MarketingOperations ofAgro-Processors andExporters ............................................... 49 D. SPS Standards andIndianHorticulturalExports............................................................. C. Recent Agricultural Export Performance......................................................................... 50 52 VI. FosteringanEfficientand CompetitiveAgriculturalMarketingSystem: PolicyOptions....................................................................................................................... 61 63 B. ExpandingMarket Infrastructure and Services................................................................ A. Creating the EnablingPolicy Environment ..................................................................... 65 ... 111 C. StrengtheningFarmer Linkagesto the Market................................................................. 71 D. StrengtheningCapacity to Manage SPS Standards.......................................................... 77 E. Conclusion ....................................................................................................................... 80 References....................................................................................................................................... 82 Annex A:India AgriculturalMarketingSurvey.......................................................................... 91 Annex B:Economic ConsiderationsinAgriculturalMarketing................................................ 97 Annex C:UsingNegotiableWarehouseReceipts......................................................................... 98 Annex D:India's EmergentHorticulturalExports:AddressingSPS and Other Challenges............................................................................................................ 99 Annex Tables................................................................................................................................. 104 Annex Figures................................................................................................................................. 93 Tables Table 1 Table 1.1 Agricultural growth rate inmajor states. 1985/8fL2002/03 ........................................... Fostering efficient and competitive agricultural marketing systems: Policy options ..xiv 1 Table 2.1 Major GO1agncultural marketing policy reforms. 1998/99-2005/06 ............................ Table 2.2 Implementationo f the Agricultural Produce MarketingAct inselected states ..............67 Table 2.3 Major domestic policy and trade regulations at the central and state levels. 1996 and 2006............................................................................................................... 10 Table 2.4 Tax reforms inthe agricultural and food processing sector .......................................... 11 Table 2.5 Selected investment climate indicators for India and China......................................... 12 Table 2.6: Government agencies involved inpromoting agncultural marketing and ago-industry development.................................................................................................................. 14 Table 2.7 Major agnculturalmarketing and ago-industry investment grant schemes for the private sector, 2005....................................................................................................... 16 Table 3.1 Selected characteristic o f households growing high-value crops infour states............21 Table 3.2 Major marketing channels for cereals and agnculturalproduce................................... 22 Table 3.3 Sales destination o f farmers' produce........................................................................... 22 Table 3.4 23 Farmer sources o f information...................................................................................... Wholesale market improvements requested by farmers............................................... Table 3.5 24 Table 3.6 D o traders reward farmers for quality-enhancing measures? ....................................... 25 Table 3.7 Examples o f successful contract farming initiatives..................................................... 26 Table 4.1 Type, location, and size o fmarkets............................................................................... 32 Table 4.2. Traders' access to shops/stalls inwholesale markets.................................................... 36 Table 4.3 Traders' credit sources.................................................................................................. 38 Table 4.4 Marketing margins from trading................................................................................... 40 Table 4.5 Supermarkets' share in food retail, selected countries.................................................. 42 Table 4.6 Examples o f organized, privately owned retail chains inIndia .................................... 43 Table 5.1 Characteristics o f processors and exporters.................................................................. 49 Table 5.2 Source o f capital by type o fenterprise.......................................................................... 49 Table 5.3 Major destinations o f Indian agriculturalexports, 2004 ............................................... 51 Table 5.4 Major impacts and emerging challenges o f SPS measures for Indian horticultural exports........................................................................................................................... 53 Table 5.5 Unitvalue variations betweenmarketsapplyinghigherand lower SPS standards ......53 Table 5.6 Estimated annual cost o f meeting SPS standards inthe EUin2005 ............................ 56 Table 6.1 Economic characteristics and performance mechanisms for agncultural marketing activities ........................................................................................................................ 63 Table 6.2 Developing rural/wholesale markets: Key planningprocesses..................................... 68 Table 6.3 Public activities to improve food safety........................................................................ 69 iv Table 6.4 Public andprivate options for strengthening farmers' linkages to the market..............72 Table 6.5 Actors instrategic response to standards ...................................................................... 79 Table 6.6 Public andprivate sector roles inenhancing trade-related SPS and quality management capacity.................................................................................................... 80 Figures Figure 1.2 Trends inagncultural exports. triennium Ending(TE) 1990/91 to TE 2003/04............. 2 Figure 1.1 Diversificationinfood consumption............................................................................... 3 Figure 1.3 Activities inthe agricultural marketing system .............................................................. 4 Figure 2.1 Facilities available inregulated markets handlinghigh-value products inMaharashtra. Orissa. Tamil Nadu. and Uttar Pradesh. 2005................................................................. 8 Figure 3.1 Percent share o f farmer households inrural households and share o f agricultural and 20 Figure 3.2 Farmers' membership inproducer groups by crop and state ........................................ wage income intotal farmer household income. 2002-03 ........................................... 29 Figure 4.1 Wholesale market density (2003) and distance to wholesale markets in focus states (2005) ........................................................................................................ 32 Figure 4.2 Distribution o f wholesale marketsby area.................................................................... 33 Figure 4.3 Limited infrastructure inwholesale markets................................................................. 33 Figure 4.4 Marketing services providedinwholesale markets ...................................................... 35 Figure 4.5 Facilities and equipment inmarket stalls ...................................................................... 35 Figure 4.6 Estimated produce losses inwholesale markets ........................................................... Figure 4.7 Estimated marketing costs infruit and vegetable supply chains. India and the U S A...37 39 Figure 4.8 Constraints inthe investment climate for agriculturaltrading inOnssa. Uttar Pradesh. 40 Figure 4.9 Sales inthe organized food retail sector. India. 2001/02-2007 .................................... Maharashtra. and Tamil Nadu....................................................................................... 41 48 Figure5.2 Mainconstraints to agricultural processors and exporters............................................ Figure 5.1 Foodprocessing levels inIndia..................................................................................... 50 Figure 5.3 Trends inagricultural exports. 1987/99-2003/04 ......................................................... Figure 6.1 Impact o frural roads improvement on the rural economy inAndhra Pradesh. 1997...51 70 Boxes Box 2.1 Salient features o f the model Agncultural Produce Marketing (Development and Regulation) Act 2003 ...................................................................................................... 9 Box 3.1 Direct marketing through the e-choupal ....................................................................... 28 Box 5.1 Framework for an ex ante assessment o f costs and benefits o f sanitary and phytosanitary (SPS) compliance................................................................................... 58 Box 6.1 Role o f government inagncultural marketing and agnbusiness development .............64 Box 6.2 Private contract enforcement and self-enforcing contracts........................................... 74 Box 6.3 75 Agricultural Technology Management Agency (ATMA) scheme ............................... Supermarkets: Sourcing produce from small-scale farmers ......................................... Box 6.4 77 Box 6.5 Market intelligence and women producers inBangladesh ........................................... 78 Annex Tables Table Al.l Number o f respondents by crop ............................................................................. 92 Table Al.2 Number o frespondents by state ............................................................................. 92 Annex table 2.1 State-level progress inadopting model APMC Act. as o f October 2005.............104 V Annex table 2.2 Incidence o fmarket cess and sales andother taxes levied in 105 different states. 2002 ............................................................................................ 105 Annex table 2.3 Agncultural marketingschemes for the private sector: Provisions for government support ...................................................................... 106 Annex table 3.1 Selected characteristics o fhouseholds growing high-value crops ....................... 110 Annex table 3.2 Farmers' sources o f credit .................................................................................... 110 Annex table 3.3 Constraints to increased high-value crop production .......................................... 110 Annex table 3.4 Postharvest operations performedby farmers ..................................................... 111 Annex table 3.5 Determinants o fpostharvestpractices to improve quality ................................... 112 Annex table 4.1Wholesale market revenues inTamil Nadu. Ollssa. Maharashtra. and UttarPradesh. 2005 .............................................................................................. 113 Annex table 4.2 Use o f auctions inwholesale markets ................................................................. 113 Annex table 4.3 Informationprovidedbefore the auction.............................................................. 114 Annex table 4.4 Market associations and dispute resolution.......................................................... 114 Annex table 4.5 Determinants o fcrop losses inwholesale markets .............................................. 114 Annex table 4.6 Socioeconomic characteristics o f traders ............................................................ 115 Annex table 4.7 Determinants o fmarketingmargins..................................................................... 115 Annex table 5.1Distribution o fprocessors and exporters surveyed .............................................. 116 Annex table 5.2 Role o f quality inprocessors' and exporters' transactions ................................... 116 Annex Figures Figure Al.l Location of sampled markets inOrissa .................................................................. 93 FigureA1.2 Location o f sampled markets inMaharashtra ........................................................ 94 Figure A1.3 Location o f sampled markets inUttar Pradesh....................................................... 95 Figure A1.4 Location o f sampled markets inTamil Nadu......................................................... 96 Figure C1.l Warehouse receipt financing: Process flow ........................................................... 98 Annex figure 2.1 Cold storages establishedunder NHB Cold Storage Scheme. 1999/2000 to January 2005 .................................................................................................. 117 Annex figure 3.1 h g a t i o n use for tomatoes. potatoes. mangoes. maize. and turmeric inTamil Nadu. Maharashtra. Uttar Pradesh. and Orissa............................................. 117 Annex figure 4.1 Distribution o f wholesale markets by age inTamil Nadu. Orissa. Maharashtra. and Uttar Pradesh........................................................................................... 118 Annex figure 4.2 Warehouse capacity inIndia. 2004................................................................ 118 Annex figure 4.3 Cold storage capacity inIndia. 2004.............................................................. 118 Annex figure 4.4 Main causes o f market disputes ..................................................................... 119 Annex figure 4.5 Trade credit by traders ................................................................................... 119 Annex figure 4.6 Sources o fprice and market information for traders ..................................... 120 Annex figure 4.7 Constraints to agncultural trading inOrissa. Uttar Pradesh. Maharashtra. and Tamil Nadu ............................................................................................. 121 Annex figure 5.1 Constraints to ago-processors and exporters inOrissa. Uttar Pradesh. Maharashtra. and Tamil Nadu....................................................................... 122 Acknowledgements This report was prepared by a team led by Dina Umali-Deininger, under the overall guidance o f Adolfo Brizzi, Sector Manager and Gajanand Pathmanathan, Operations Manager. Major contributors to the report are: Forhad Shilpi, Xiangping Liu, Marcel Fafchamps, RuthVargas- Hill, Bart Minten, J.B. Singh, Social and Rural Research Institute (India) (state agricultural marketing survey data collection and analysis); Mona Sur, Steven Jaffee, Kelly Jones (sanitary and phytosanitary issues), Niraj Venna (rural credit), and Gokul Patnaik (agricultural marketing policy review). This report also draws from a companion World Bank study, "India's Emergent Horticultural Exports: Addressing SPS and Other Challenges" (World Bank 2007). Administrative support was provided by Sarita Rana, Jai Mansukani and Lilac Thomas. The report was edited by Alicia Hetner. The team especially wishes to thank the peer reviewers, Sushma Ganguly, Richard Henry, and Gershon Feder, for their valuable guidance and advice during the preparation o f the report and Priya Basu, Robert Epworth, Rabih Karaky, Deepak Mishra, Martien van Nieuwkoop, and Fayez Omar for their helpful comments We gratefully acknowledge the valuable cooperation and generous assistance provided by officials from the Ministries o f Agriculture, Food Processing Industries, and Commerce; the Departments o f Agriculture and Marketing and Cooperation; the respective State Agricultural Produce Marketing Boards in Orissa, Uttar Pradesh, Maharashtra and Tamil Nadu. We thank all the fanners, traders, and other entrepreneurs in these states who gave their time to participate in the focus discussions and marketing surveys. W e also thank the UK Department for International Development (DfID) and the World Bank PSIA group for the financial support they provided in undertalung the state agricultural marketing surveys. This report has beendiscussed with the Government of India, but does not necessarily represent their views or bear their approval for all its contents. vii Executive Summary Overview Policy makers in India recognize the importance o f well-functioning markets to agricultural growth, food security, and broad-based rural development. Markets facilitate the commercialization and diversification o f farming, and they are essential for efficiently bringing food and agricultural products to domestic and international consumers. Well functioning domestic markets can reduce the cost o f food and assure stability o f supply, which as the recent global food crisis has highlighted, are key to assuring the food security o fpoor and non-poor households. They also open opportunities for greater value-addition and employment throughout the economy. In this regard, the Prime Minister o f India, Dr. Manmohan Singh, noted during the Agriculture Summit 2005 in New Delhi that "an important commitment o f the government i s to integrate the domestic market to all goods and services. The time has come for us to consider the entire country as a common or single market for agricultural products. We have to systematically remove all controls andrestrictions.. .." The rapid growth o f the Indian economy i s bringing new forces for change in agncultural marketing and processing systems. Changes in consumer demand are fueled by rising incomes, increasing urbanization, a growing middle class demanding more diversified and higher-quality food, more working women demanding access to prepared or processed foods and more convenient shopping under one roof, and increased exposure to products through wider media penetration (domestic and international television, cable, and internet). These forces inturn drive changes inthe structure o f marketing and encourage agricultural diversification. Critical weaknesses have been exposed in the agncultural marketing system as a result o f these rapidly evolving domestic and international developments. For most commodities, the agncultural marketing system-defined broadly to include physical assembly, handling, storage, transport, processing, wholesaling, retailing, and export o f agncultural commodities and associated infrastructure and support services-remains fragmented and uncoordinated, subject to multiple layers o f intermediaries, with markets that have inadequate infrastructure and facilities, and supply chains subject to high wastage and losses. In addition, the tighter international sanitary and phytosanitary (SPS) standards promulgated by governments and the private sector constitute an additional hurdle for India's agricultural exports to overcome. Experiences in many developed countries (in the USA and OECD, for example) and developing countries (such as Brazil, China, Indonesia, Malaysia, and Thailand) illustrate a natural evolution in how agricultural marketing systems are organized and managed. This evolution i s driven by changing socioeconomic conditions resulting from urban growth, rising consumer incomes, concerns about quality and food safety, increased agro-processing, and improved infrastructure and services. While the traditional marketing structure-in which fresh agncultural produce moves from farms to rural assembly/primary wholesale markets, secondary wholesale markets, retail markets, and finally to consumers-may persist, new forms o f coordinated supply chains may emerge, owing to the economic and competitive need to reduce logstical costs, meet consumers' rising demand for more value-added products, and at the same time address consumers' concerns about convenience, quality, and food safety. As noted, such forces for change are becoming evident inIndia. The development o f efficient and competitive marketing systems inIndia that can effectively respond to these domestic and global changes will require action on a number of fronts inthe short to medium term. Given the important roles o f the public and private sector in developing the agricultural marketing system, at this juncture the government needs to reorient its strategy to focus on: ix Continuing reforms in the policy and regulatory environment to eliminate the remaining obstacles to more effective market operations and the development o f more efficient supply chains. Rationalizing the roles and activities o fthe large number o f government agencies involved in agncultural marketing development to foster greater coordination, build synergies, eliminate duplication o f effort, and increase the focus on facilitation and regulation rather than direct intervention. 0 Reviewing and rationalizing public expenditures in the sector. Public expenditures should focus increasingly on financing public goods and services (such as markets, market information and extension, food safety, complementary rural infrastructure, and capacity building) that facilitate increased private sector participation. The numerous grant schemes designed to foster private sector investment should be reviewed and rationalizedto eliminate duplication and maximize impact. Policy and Regulatory Environment: Remaining Steps Complete the deregulation of the agricultural marketing system. Since the late 1990s, the Government o f India (GOI) has implemented a vast array o f policy reforms that have hastened the growth and development o f the agricultural marketing system. The next steps inmoving forward are to permanently remove storage and movement restrictions on all commodities and enforce them only during emergencies, eliminate the small-scale industryreservation on the remaining agro-industrial activities, and allow phased entry o f foreign direct investment (FDI) in food retailing (for example, through joint ventures with local companies) (table 1). Parliamentary approval o f the Forward Contracts (Regulation) Amendment Bill 2006, which will remove the ban on trading o f commodity options, will be critical milestones. Nationwide adoption o f the model Agricultural Produce Marketing (APM) Act i s an equally crucial milestone in the reform process. Broad-based adoption o f the model Act i s essential for building an integrated national market, which to date has been adopted by only 15 states and union territories. But institutional reforms within the Mandi complex are also necessary to improve the management and quality o f services provided by the regulated market network. Such reforms could include subcontracting market management to the private sector or privatizing markets. The Mandi Board could concentrate on planning and on regulating the wholesale marketing network, thus eliminating the conflict o f interest that currently arises when it acts as both operator and regulator. The removal o f storage and movement controls will also enable India's commodity futures markets to operate more effectively. These markets could play an important role inenabling farmers to hedge their pricerisks inthe context o famoreliberalizedmarket. Rationalize the tax structuregoverning wholesaling, retailing and agro-processing. Changes inthe tax structure will improve the incentives for private sector investments and participation. The adoption o f VAT by state governments helped considerably inreducingthe impact o f cascading state taxes across the agricultural supply chain, but the central excise tax on a large number o f processed agncultural and food products remains high.This tax increases the cost to consumers and reduces the competitiveness o f Indian products overseas. Complete the unfinished agenda for rationalizing the roles of government agencies. As mentioned, a multiplicity o f government agencies are involved in the agricultural marketing system. Functions and schemes overlap significantly. At least 39 central government agencies promote agncultural marketing development, either broadly or with respect to specific commodities. Most o f these agencies offer investment grants to the private sector, but weak coordination o f these efforts prevents greater synergies in development impact and in some instances leads to duplication. For example, three government ministries offer grants to invest in cold storage facilities; each grant scheme has different terms and conditions. Clearly these schemes should be rationalized. Greater X coordination should be fostered among the agencies that implement them to promote greater consistency, minimize duplication, more effectively track the level o f support, and document the impact o f these investments.. Rationalizing PublicInvestmentsinAgricultural Marketing: Towards a New Paradigm Improve market infrastructure and services. The limited accessibility and inadequate facilities o f existing markets are major constraints to efficient operation. In the medium term, it i s expected that a large share o f agricultural produce will continue to flow along traditional marketing channels. The continuing pressure on these traditional channels highlights the need to fill the significant gap in market infrastructure. Efforts over the longer term, however, have to be framed within a holistic agricultural market development strategy. In formulating a development plan to expand market infrastructure, two major issues are o f concern. First, in assessing infrastructure needs, a comprehensive assessment o f current and future marketing needs (that is, growth in production and demand, expected volumes o f marketed throughput, and product quality standards), nationally and at the state level, i s required. This assessment will necessarily involve carefbl consideration o f factors dnving the development o f alternative marketing arrangements to meet diverse and rapidly changing local needs, such as direct purchase, contract farming, and vertical integration trends. Market development, therefore, may call for a range o f options, from setting up village or district-level markets, rural hubs, to establishing general or specialized wholesale markets or terminal markets, to facilitating the development o f more direct marketing arrangements. Second, careful consideration i s required as to whether the government or private sector should take the lead inimplementingthe various marketdevelopment activities. Improving the operations and facilities o f regulated markets requires a closer review o f how the regulated market system i s managed, and particularly o f how it uses the significant revenues generated from the marketing cess and other fees. It will be critical to ensure that more o f these resources are used to improve market facilities (for example, to provide price information systems, adequate shops, parlung, drainage, improved roads, security within the market, public toilets, canteens, and hostels for farmers). Greater transparency regarding the actual revenues generated by the mandi system and the allocation o f expenditures i s critical. The annual audit o f accounts and their public disclosure should become mandatory for all Mandi Boards. Strengthen grades and standards and food safety. While grades governing the quality o f agncultural produce function best if adopted voluntarily, as they are set primarily to facilitate trade and are not a regulatory instrument, standards for food safety should be mandatory. The public sector has a critical role to play in ensuring food safety, not only interms o f policy malung and regulation, but also inproviding information and training (for example, information on international standards or risk assessment training), key infrastructure for prevention and control (such as laboratories for disease monitoring and surveillance or food testing), and research (for example, to develop hazard control strategies). Improve access to credit. Poor access to credit i s cited by farmers, traders, processors, and exporters as a major constraint to their production and marketing activities. Policy actions that could improve access to credit encompass a number o f areas, including: legal and regulatory reforms and restructuring o f rural banks, and broader adoption o f innovative products, such as group lending, lusan credit cards, and financial and operational leasing. Policy reforms are needed to improve the overall regulatory and legal framework for rural finance, inparticular for rural banks and rural credit cooperatives. Priority areas for action include: (1) enhancing the regulatory oversight and supervision based on internationally accepted prudentialnorms; (2) reducing government control and ownership (for regional rural banks this would require an amendment o f the existing law, and for rural cooperatives it would require state governments to adopt the model Cooperatives Law); (3) strengthening corporate governance and improving management and staff slulls, particularly incredit decisions and risk assessment and management; and (4) strengthening the legal framework to make it xi easier for regional rural banks and credit cooperatives to recover small loans and to facilitate the use o f land as collateral. Strengthen rural road connectivity. Public investment in rural roads, by increasing rural connectivity, can have a significant impact on farmers' access to markets, the development o f supply chains, and overall marketing efficiency, in addition to other beneficial impacts on rural households. In implementing the Bharat Nirman, it will be important for the Ministry of Rural Development (MoRD) to take the lead in implementing essential policy and institutional changes as well as in financing, technology transfer, human resource development, and monitoring o f rural road development in different states. Panchayat Raj bodies at the district, block, and village levels can play a pivotal role in the construction and management o f rural roads. Community participation offers significant potential for mobilizing the support o f local communities in generating resources, acquiring land, and tailoring rural roadprograms to local needs. StrengtheningFarmers'Linkagesto the Supply Chain Contract farming and supermarket procurement arrangements are two supply chain arrangements that are gaining ground amid active debate in India. While there i s growing appreciation, especially among entrepreneurs engaged in agricultural trade and agro-processing, of the potential benefits o f more coordinated supply chains, an important concern i s whether small- scale farmers can equally benefit from these arrangements. International experience provides useful lessons for fostering greater inclusion o f small-scale farmers. Notably, many o f the lessons emerging from this experience, such as successful approaches for strengthening farmers' bargaining`power or improving their technical capacity to meet consumers' product and quality requirements, are equally relevant for farmers who market produce through traditional channels. Recent experience in India indicates that contract farming and supermarket procurement approaches will have to involve small-scale farmers inthe medium term, because the farm structure obliges them to do so. Experience in several countries in East Asia and Latin America shows that land will not be the most important determinant o f participation; individual capitalflabor ratios and access to public infrastructure will be more important. The small-scale farmers who are "rich" in financial and human capital assets will be able to participate in the demanding new supply chains, which highlightsthe importance o f improving farmers' range o f assets to meet the new requirements o f more coordinated supply arrangements. Approaches to promote equitable participation by large- and small-scale farmers include: (1) facilitating entry and competition among buyers (for example, improving the rural infrastructure or establishing collection centers to reduce the transaction costs involved in sourcing from small- scale farmers); (2) organizing farmers into formal or informal groups to meet the volume requirements and strengthen farmers' bargaining power; (3) enhancing farmers' capacity to adopt improved production and postharvest techniques to meet the required higher quality standards; (4) assisting farmers to obtain the capital to make on-farm improvements and other required investments (for example, in irrigation, greenhouse, grading, or cooling facilities) and acquire essential national and international certifications; (5) training farmers and buyers about their rights and obligations under contract farming arrangement and in the design o f contracts; and (6) developing institutions that assist farmers to settle contract disputes (such as commodity or market associations). In some countries, public-private partnerships have been instrumental to the success o f new supply chain arrangements (for example, in providing extension and technical assistance to improve the quality and safety o fproduce and accreditation o f farmers). The Ministry o f Agriculture's AGMARKNET program, which collects selling prices at regulated markets and disseminates them through the Internet, i s improving access to real-time price information by market users. In the future, this program could be expanded to include information from nonregulated markets. Innovative ways o f connecting to these databases using advances in xii communications technology (dial-up services, mobile phones, or rural luosks) could be explored. Strengthening the public and private extension system can play an important role inhelping farmer access to production and market information. A number o f private firms in India offer extension services to farmers, although these generally are linkedto input supply or output purchasingkontract farming arrangements. The public extension system, on the other hand, i s falling behind. It must be reoriented away from traditional supply-driven, production-focused approaches and towards more market-oriented approaches. Delivery o f public extension services could be improved by introducing decentralized strategic planning, with the active participation o f farmers and other stakeholders. StrengtheningCapacityto Meet Sanitary andPhytosanitary(SPS) Standards There i s a need for the government to move towards a more cost-effective and strategc approach to SPS standards. Such an approach would involve placing somewhat less emphasis on mandatory controls, inspections, and testing and considerably more emphasis on promoting agro- food system stakeholder awareness about SPS management; developing and promoting adoption of good practices (such as good agricultural practices, good manufacturing practices, and hazard analysis and critical control point systems) throughout the supply chain; and facilitating effective individual and collective action by private firms, farmers, service providers, and others. It is often assumed that the management o f food safety and apcultural health i s predominantly the responsibility o f the public sector. Indeed, many critical regulatory, research, and management functions are normally carried out by governments, and in a variety o f circumstances importing countries require that certain functions, such as export certification, be performed by a designated "competent authority" in the public sector. However, the private sector can also play an important role in setting standards and in actual compliance with food safety and agricultural health requirements. Capacity building inthe private sector can complement (or even substitute for) public sector capacity, such as the investment inaccredited laboratory testing facilities. Conclusion India's rural development strategy faces the challenge o f meeting rapidly changing needs in rural areas, nationwide, and globally. Concurrent rapid growth in the apcultural and rural nonfarm sectors i s an integral and important part o f overall economic development, because these sectors jointly, directly, and indirectly help generate opportunities for greater employment and income growth. Removing policy and regulatory barriers so that those who choose to remain in agriculture can enhance their productivity and competitiveness and achieve the highest returns from their endeavors i s critical for maximizing the agricultural sector's contribution to overall economic growth. It i s particularly important because the majority o f India's workforce remains dependent on apculture. At the same time, growth in the rural nonfarm sector (industry and services) will not only offer alternative employment opportunities but will create a strong foundation for consumer demand in rural areas. An increase in rural-based demand can, in tum, stimulate growth in the agricultural and other sectors o f the economy. Achieving such broad-based growth, however, will require vigilant adjustment to rapidly changing market opportunities and challenges, internally and globally. A dynamic apbusiness sector and agricultural markets that integrate rural areas into the state and national economy will be important drivers for agricultural and rural growth, food security, and rural poverty reduction in India. As noted in the 10" Five Year Plan, fostering an efficient and competitive apcultural marketing system i s indispensable for the overall development o f the country's economy. International experience shows that modern and efficient agncultural marketing systems and the consequent improvements in competitiveness are crucial catalytic forces for directly and indirectly promoting growth and poverty reduction. Modern marketing systems reduce the cost o f food, reduce supply uncertainties, and improve the diets o f the poor and non-poor in urban and rural areas. Inopening greater opportunities for farmers and other entrepreneurs, they help generate ... XI11 employment and consequently raise and diversifL income potential inrural and urban areas. Finally, they enhance farmers' incentives to increase productivity and link more closely into local, national, and international markets. India has made great strides in the last five years in improving the environment for an efficient and competitive agricultural marketing system to grow and develop. The challenge now i s to sustain this momentum over the medium to longer term, so that the agncultural sector and society as a whole can truly capture the multiple benefits o fwell-functioning and efficient agricultural marketing systems. Table 1:Fosteringefficientand competitiveagriculturalmarketingsystems: Policyoptions Policy options Possible responses by private sector Main Strategic (farmers, cooperatives, constraints priorities Government of India State governments entrepreneurs) Weak Zeadjusting GO1incollaboration with state ' Explore option for formal coordination trategy for governments, private sector, and institutional mechanism to and igricultural other stakeholders to reviewprogress foster greater coordination overlapping narketing inimplementingagricultural across state departments functions ystem marketing strategy and explore involved inagricultural among large levelopment. options to: marketing development. number o f government 1. Rationalize roles and agencies. activities o f large number o f government agencies. Explore option for formal institutional Overlapping mechanismto foster greater government coordination. investment 2. Rationalize government schemes. expenditures on the large numbero f investment grant schemes. Consider options for targeting support and phasing out inthe medium term. 3. Prioritize types o f specific complementary investments inpublic goods and services to support market development (see part I1 below). Overregulation Leforming Remove remainingdomestic trade Adoption o f model AF'M Act. o f marketing iolicy and controls (storage and movement system. egulatory restrictions) and institute only in Improvemandi management: nvironment emergencies, eliminate small-scale increased transparency o f 3 foster industry reservation. revenue generation and market fficient operation through regular audits. narketing GO1Parliamentary approval of the Reorient revenues towards hain. Forward Contracts (Regulation) Amendment Bill 2006. market development; explore public-private partnerships, Rationalize taxation structure in the including such options as ago-processing and retailing sector. contracting market management Permit phased FDIthoughjoint to the private sector or ventures with local firms. privatizingmarkets. Separate regulatory and operational functions o f Mandi Board to remove conflict o f interest. xiv Table 1(cont'd.) Policyoptions Possibleresponsesby fain Strategic privatesector (farmers, onstraints priorities Government of India State governments cooperatives,entrepreneurs) Inadequate Improving hioritizemarket infrastructure development support, explore Provide complementary marketing accessto options for public-private partnerships. assistancefor private sector infrastructure, marketsand development of markets facilities, and services. m Support investments inruralroadsand state-levelpolicy and (access to land, application services. institutional changes to ensurelonger-term operation and maintenance. procedures). Conflicting Reforming D Support awareness campaign and capacity building throughout Develop in-house government regulatory private sector on good agricultural, hygiene, and manufacturing managementpractices to regulations framework for practices (for example, raise public awareness of food safety risks minimize food safety risks. governing food through various media, promote good agricultural practices on food processing. pesticide use through extension agents, and include such Develop industry-wide processing. information in the curricula ofpublic agriculturaVtechnica1 codes of good practice, institutes and universities). industry monitoring, and oversight. Weak Strengthendisease surveillance and control systems. domestic food Strengthening Accredit private laboratories and conduct reference/consistency safety food safety. testing. capacity. * Undertake coordinated market surveillance programs to gauge the incidence ofvarious food safety hazards inthe domestic ago-food system. Improve water supply and sanitation. Limited Improving Under contract farming access to access to rural government control and ownership arrangements, supply capital by credit. of regional rural banks; strengthen inputs, helpfarmers obtain farmers, regulatory oversight over, and loans and crop insurance. traders, support restructuringof, rural processors. banks. m Support innovative approaches(scaling up of microfinance models, group lending, kisan credit card, financiaVoperationa1leasing). Developing e Increase private entry and competition through improved 1Organize producer effective infrastructure (roads, electricity), assist in setting up collection organizations, collection linkages by centerdassembly markets. centers. farmers to supply chains mFacilitate organizationofproducer organizations. 1Supply inputs; helpfarmers m Train farmers and buyers in contract negotiatiodcontract design. obtain loans and crop insurance. 1Educate farmers about their rights and obligations under contract farming. Enhancing * Support strengthening ofmarket Improveextension service tProvide technical advice to farmers' informationsystems. delivery, foster greater farmers (possibly in capacity to market orientation-for partnership with government meet market * Strengthenagricultural research example, through the extension system). standards. on postharvestmanagement. Agricultural Technology ManagementAgency (ATMA) approach. Strengthenagricultural researchon postharvest management. xv Table 1(cont'd.) Policyoptions Possibleresponsesby private Main Strategic sector (farmers, constraints priorities Government of India Stategovernments cooperatives,entrepreneurs) - . ~ Weak nfluencing capacity to hiesoftl;e and multilateral dialogue and meet :ame." periodic negotiations to address tightening emerging constraints or international opportunities related to SPS SPS issues. standards. strengthening Support awareness campaign and capacity building o f private sector DImplement in-house good :apacity for on good agricultural, hygiene, and manufacturingpractices. management practices to :ompliance. Strengthen SPS and animal health monitoringand surveillance minimize food safety, systems. environment and other risks (for example, HACCP Accredit private laboratories and conduct referencekonsistency principles); develop systems testing. for traceability. Support research on food safety and agricultural health concerns (for Industry association example, field trials to determine alternative pest management D awareness buildingand self- approaches or to establish suitable minimumresidue levels for crops regulation. withmarketpotential; research to improve the quality ofplanting material). Support technical, administrative, and institutional change and innovation withinthe private sector to improve food safety (for example, through public-private partnerships for product innovation and establishingproduct traceability systems). Facilitateprivate sector collective action (creation o f active industry/exporter associations) and self-regulation. xvi I. Introduction A. Overview Improvements in farmers' productivity and competitiveness and greater diversification o f agncultural production are major pillars o f the Government o f India's (GOI's) poverty reduction strategy, because they offer the means to raise incomes across millions o f households that depend on agriculture. The welfare o f such households i s a major concern, given that more than three-quarters o f India's poor are in rural areas, and most o f the rural poor depend on agriculture for employment and livelihoods. According to the Census Table 1.1: Agricultural growth rate in major states, 1985/86- (2001), about 228 million people inrural 2004/05, constant 1993/94 rupees India, equivalent to 56 percent o f the Averape annualAGDP I Rural poverty 1 total labor force, are farmers and growth rate, % (headcount %) Regioidstate I 1995/9&2004/05 agncultural laborers. The National Northern Region 1985/8&1994/95 2004/05 Sample Survey Organization (NSSO) estimates that in2005 direct income from farming accounted for more than 50 percent o f farm household incomes. This share i s likely to be higher if income from agncultural wages i s included. As agncultural growth appears to be slowing, policy makers are concerned about agriculture's prospects for reducing rural poverty. Indeed, the average annual rate o f growth o f agricultural gross domestic product (AGDP) declined from 3.7 percent during 1985/86-1994/95 to 1.9 percent during 1995/96-2004/05 (table 1.1). The implications o f weakening agncultural performance-specially for Source:AGDP derived from World Bank database and author's calculation. Poverty rate-PlanningCommission. the large number o f poor, agriculture- dependent households, and especially in the traditional green revolution states and poorest states- have compelled the government to revitalize agnculture. The government's goal, as expressed inthe National Agricultural Policy 2000 and 1l* Five Year Plan (2007-2012), i s to avert the slow down and raise the agncultural growth rate from about 3 percent to 4 percent per year (Ministry o f Agriculture 2000; Planning Commission 2006). To achieve this goal, the GO1 puts emphasis on increasing agricultural productivity and promoting agricultural diversification. The impetus for diversification also increased in light o f India's comfortable foodgrain situation, awareness o f the growing and unsustainable fiscal burden o f foodgrain and other subsidies, and concerns over the environmental degradation associated with intensive rice-wheat systems (World Bank 20050.' Policy makers recognize the importance o f well-functioning markets to agricultural growth and broad-based rural development. Functioning markets are necessary to support the commercialization and diversification o f farming and to efficiently and competitively bring agncultural products to domestic and international consumers. . Well functioning domestic markets can reduce the cost o f food and assure stability o f supply, which as the recent global food crisis has highlighted, are key to assuring the food security o f poor and non-poor households. They are also essential to fostering more rapid growth in the nonfarm sector (that is, in manufacturing and services) by expanding opportunities for greater value-addition and employment in the economy overall. Greater appreciation o f markets' important role in overall economic development has 1These developmentsare discussedindetail inWorld Bank (20050. refocused government attention on improving the environment in which efficient agricultural marketing and agro-processing systems can grow and develop. Figure 1.1: Food consumption in India is shifting from cereals to higher value foods. Rapid growth in India's economy has raised incomes and i s opening a large domestic consumer base. Sustained economic growth since the 1990s contributed to increasing incomes and urbanization. GDP per capita rose by over 80 percent in real terms, from about 9,079 rupees (Rs) in l i 1 1 I I 1990/91 to Rs 16,586 in 2006/07 .-E Rural Urban Rural Urban Rural Urban Rural Urban (1993/94 rupees). The middle 5 Cereals & Sugar & edible Meat,eggs, fish Fruits,Veg & E class, about 30% o f India's 1.2 Pulses oils milk & milk Beverages v) products billion population, i s the fastest- 1 growing income group. Rural Source:NSSO 1996,2006b. poverty rates (headcount) declined from 39 percent in 1987/88 to 28 percent in2004/05 (Planning Commission). Income growth inrural areas, with about 75 percent o f India's population, has opened a large potential market for goods and services. Rapid economic growth i s also changing the composition o f consumer demand. Domestic consumers are diversifying their diets, moving away f?om cereals and towards higher-value products such as fruits and vegetables, dairy, meat, and fish (figure 1.1). This trend i s consistent with expectations, as the expenditure elasticity for these high-value agricultural products i s estimated to be three to four times that o f cereals (Dev & Rao 2004). Greater female participation in the workforce and higher disposable incomes are driving growth in demand for prepared and semi- prepared foods, which in turn drives the growth o f processed food industries (Pingali and Khwaja 2004). Growing consumer preference for shopping convenience under one roof, increased exposure to the media (television, cable, and the Internet), and increased ownership o f durable goods such as refhgerators and cars are fostering the growth o f modem retailing. Modem retail outlets such as supermarkets and hypermarkets, in tum, are demanding greater efficiency and quality standards in the supply chain (Mukherjee and Pate12001). Increased globalization o f markets i s opening new export markets for Indian agricultural products, both fi-esh and processed. Within India, the progressive elimination o f government export restrictions enabled local entrepreneurs to tap export markets increasingly. Rapid technological advances domestically and internationally inreal-time communication (cellular phones, Internet) and transportation (by air and sea) further facilitate these international linkages. Indian agricultural exports grew at an average annual rate o f 7.8 percent from 1990/91 to 2005/06 in real terms. India diversified out o f its traditional exports o f tea, spices, and coffee to export a wider array of horticultural, marine, and livestock products. Between the triennium ending (TE) 1990/91 and TE 2005/06, the value o f fresh and processed fruits and vegetables exported by India rose from 84 million U S dollar (US$) to US$550 million inreal terms (1993/94 dollars), while exports o f marine products rose from US$ 516 million to US$ 1.7 billion during the same period (figure 1.2). Globalization also contributes to "diet globalization" within India, where diets no longer conform to traditional local norms but are influencedby international tastes (Pingali and Khwaja 2004). 2 B. Challengesinthe AgriculturalMarketingandProcessingSystems These rapidly evolving domestic and international developments are exposing critical weaknesses in India's agncultural marketing system. For most commodities, the system remains fragmented and uncoordinated, subject to multiple layers o f intermediaries, with markets that have inadequate infrastructure and facilities, and a supply chain subject to high losses and wastage. It is common in India to have up to 6 or 7 intermediaries between the farmer and Figure 1.2: Agricultural exports are diversifying. consumer inthe marketing o f fruits and vegetables (McKinsey 1997). This long supply chain contributes to significant wastage-as much as 40 percent o f total fruit and vegetable production, 8oo equal to the consumption o f the United 600 Kingdom (UK), i s wasted (McKinsey 1997). A recent estimate puts postharvest losses in the food chain at about Rs 500 billion per year or about 11 percent o f agriculture GDP (Mukherjee and Pate12005). Thetighteningof international Source; Department of ConUlltXce* Note: TE -trienniumending. sanitary and phytosanitary (SPS) standards imposes new hurdles on Indian agricultural exports. Governments, as per the SPS Agreement o f the WTO, are free to set their own food safety standards and technical regulations, as long as they are based on scientific principles and are both transparent and nondiscriminatory. In addition to these public SPS standards, the private sector in many countries imposes more stringent SPS standards; one example, adopted by European retailers, i s the standards o f the Euro-Retailer Produce Worlung Group for Good Agncultural Practices (EurepGAP), which blend food safety and quality management standards. As a result, a large number o f Indian agricultural export shipments in recent years have been rejected in importing countries for failure to meet prescribed standards (for example, for levels o f contaminants, product labels, and the use o f additives). Objectivesof This Study To help the agricultural sector capitalize on emerging market opportunities and address the challenges described earlier, this study aims to: (1) examine the structure, operation, and performance o f India's agncultural marketing and processing sectors, with particular emphasis on high-value crops; (2) review the scope and impact o f government policies and programs to promote the growth and development o f efficient and competitive systems domestically; (3) identify the major bottlenecks and constraints (policy, technical, and institutional) to achieving this goal, and (4) explore options for improving the performance o f the agricultural marketing and processing sectors, drawing on national and international experience. For this study, "agncultural marketing" i s defined in the broadest terms-that is, the performance o f all activities involved in the flow o f products and services from the point o f initial agncultural production until they are in the hands o f consumers (figure 1.3). Agricultural marketing includes the physical assembly, handling, storage, transport, processing, wholesaling, retailing, and export o f agricultural commodities as well as accompanying support services, such as market information, establishment of grades and standards, commodity trade financing, and price risk management. H o w well the agncultural marketing systems works will depend on the policy and regulatory environment, the functioning o f market support institutions, and the availability and accessibility o f infrastructure, marketing and processing technologies, and finance. 3 This study primarily focuses on the marketing o f higher-value crops, in support o f the government's emphasis on agncultural diversification. Because the marketing system for higher- value agricultural products i s relatively "new" in the Indian agncultural perspective, little i s known about the system's status and performance, especially compared with the marketing o f traditional commodities such as rice, wheat, oilseeds, cotton, sugar, and livestock, which local and international researchers have studied extensively.* To overcome the lack o f detailed, field-level data on market operations and performance for higher-value crops, this study conducted an agncultural marketing survey in February-May 2005 in four states (Maharashtra, Orissa, Tamil Nadu, and Uttar Pradesh), focusing on five crops (maize, potatoes, tomatoes, mangoes and turmeric). The states were selected to illustrate different levels o f market development and regions inthe country. The five crops were selected in consultation with state agriculture officials to illustrate different marketing challenges. The India Agricultural Marketing Survey collected data through interviews with 1,579 farmers, 1,597 traders, 316 enterprises, market officials in 78 markets, and village leaders in 155 villages. Annex A provides details on the survey design. This report presents the survey findings and also draws from a companion World Bank report, "India's Emergent Horticultural Exports: Addressing SPS and Other Challenges" (World Bank 2007). The remainder o f this report i s organized as follows. Chapter 2 briefly recapitulates the main characteristics o f the policy environment for agricultural marketing and ago-processing in India, focusing largely on the reforms o f the 1990s and more recent efforts to further the development o f the marketing system. The special characteristics o f farmers who produce high-value crops and the challenges they face are the focus of chapter 3. Chapter 4 begins by reviewing data on the accessibility, infrastructure, and services o f wholesale markets as well as aspects o f wholesale trading, such as traders' sources o f information, their sources o f credit, and marketing costs and margins. Trends in food retailing and the use o f domestic grades and standards are also reviewed. Chapter 5 examines trends in value-addition and exports o f high-value agricultural products. Based on the findings inthese chapters, chapter 6 synthesizes and reviews policy options for fostering more efficient and competitive agricultural marketing systems in India. Figure 1.3 Activities in the agriculturalmarketingsystem Policyand regulations Institutions tructure andtechnology Finance Agri- cultural Processing input value- supply addition Agricultural marketingsystem Source: Authors. See, for example, Sharma 1997; Jha and Srinivasan 1999; World Bank 1999a, 1999b, 2000,2005f; Umali- Deininger and Deininger 2001;Ministryo f Consumer Affairs, Food and Public Distribution 2002; S h a m and Gulati 2003; Banerji and Meenakshi 2004; Acharya 2004. 4 11.Policy Environment for AgriculturalMarketingand Processinginthe 1990s Historically, agricultural marketing in India was subject to a large number o f regulations. These regulations, most o f which derive from the Essential Commodities Act 1955, include controls on private storage, transport, processing, exports, imports, credit access, and market infrastructure development. They also include the small-scale reservation o f selected enterprises. These regulations were put into place primarily to ensure a reasonable income for farmers and access to food commodities by consumers at affordable prices. The government and other stakeholders in the agricultural sector have increasingly recognized that pervasive regulation o f domestic marketing i s no longer ideal. Such regulation has increased transaction costs, risks, and uncertainty, thus unintentionally harming farmers and the agricultural sector. The resulting large marketing margins have placed downward pressure on farm prices, increasedthe costs for consumers, and undermined the competitiveness o f exports. Marketing restrictions and policies discouraged private investments in marketing infrastructure development, ago-processing, and agro-industry that could expand demand for primary apcultural products as well as generate additional employment inrural areas. To address these concerns, the GO1 over the last five years implemented wide-ranging policy reforms to promote greater efficiency and competitiveness in apcultural marketing. These measures focused on: (1) increasing deregulation, (2) reducing direct and indirect taxation o f agricultural marketing and processing, (3) strengthening government capacity to tackle food safety issues, and (4) launching several investment incentive schemes. The government followed a careful pace o freform to avert adverse effects on farmer welfare. Since the late 1990s, the GO1removed several marketingrestrictions. The government lifted storage and transport controls, removed several agricultural commodities from small-scale industry reservation, eliminated controls on cold storage and dairy processing, and formulated the model Agricultural Produce Marketing (APM) Act, which removes restrictions on direct sales by farmers and permits entities outside the government to establish and operate wholesale markets. A new Food Safety and Standards Act, which rationalize the multiple and sometimes conflicting regulations governing food processing and the Warehousing (Development and Regulation) Act, which will facilitate access to trade credit, have recently been approved by parliament. These policy and regulatory reforms are crucial to improving the investment climate in the apcultural marketing system. The GO1and state governments also took a number o f steps to rationalize the highrates o f taxation o f primary and processed agricultural commodities. All states have adopted the value-added tax (VAT) regime, which rationalizes the high and cascading state sales taxes. Over the last five years, the GO1reduced or eliminated the central excise tax (CET) on several processed agricultural products. Evenso, a large share o f apcultural and food products remains subject to highCET. The priority gwen to agricultural marketing i s illustrated by the growing number o f government agencies involved in its development. This study identified at least 38 central government agencies involved inmarket development, and the multiplicity o f agencies i s resulting in overlapping mandates, functions, and schemes. The growing emphasis on promoting efficient agricultural marketing and ago-processing systems i s very much warranted, but it highlights the need for a more coordinated strategy for the sector's development. These issues are elaborated below. 5 A. Liberalizing Agricultural Marketing The scope o f marketing reforms adoptedby the GO1widened and the pace o freform hastened duringthe last decade. The most critical actions were: (1) in 1998, repeal o fthe Cold Storage Order 1964, which eliminatedthe licensingrequirement and government control over cold storage fees; (2) in2002, lifting the licensingrequirements, stockmg limits, and movement restrictions for wheat, paddyhce, coarse grains, edible oilseeds, and edible oils, andremoving restrictions on access to credit under the Selective Credit Control Policy; (3) also in2002, amending the Milkand MilkProducts Order 1992to remove restrictions on investments by the private sector in dairy processing and to focus on food safety issues; (4) in2003, eliminating the ban on futures trading o f 54 commodities including wheat, rice, oilseeds, and p ~ l s e sand (5) since 1997, removing ; ~ several agricultural products from small-scale reservation (table 2.1).4 In2003, the GO1formulated the model act to reform the Agricultural Produce Marketing (Development and Regulation) Act 1951. The model act aims to foster a single market inthe country by removing the restrictionon selling agricultural commodities wholesale only instate-regulated markets and permitting the private sector to develop and operate wholesale markets. In2006, parliament approved the Food and Safety Standards Act, which rationalizes the complex and overlapping web o fregulations governing food processing and the Warehousing (Development and Regulation) Act, which will facilitate access to trade credit, The GO1also repealed the Cess Act, thus eliminating the 0.5 percent cess on agricultural and plantationexports. 'able2.1: ajor GO1agricultural marketing policy reforms, 1998/99-2005/06 Year Policv reform 1998199 Cold StorageOrder 1964repealed 2001102 Restrictionsondomestic and foreigninvestments(upto 100percent) inbulk handlingand storageremoved Inter-MinisterialTask Forceand Committeeof State MinistersonAgricultural Marketing Reformsestablished 2002103 Licensingrequirements, stocking limits, andmovementrestrictionson wheat, paddylrice, course grains, edible oilseeds, edible oils, and selectivecredit controlslifted MilkandMilkProductsControlOrder (MMPO) amendedto removerestrictionsonnewmilkprocessingcapacity, while continuingto regulatehealthand safetyconditions Leather and leatherandpaperproductsremovedfrom small-scalereservationlist 2003104 Banon futures tradingof 54 commodities, includingrice, wheat, oilseeds, andpulses, removed Levy on sugar reducedfrom 15percentto 10percent Modelact for StateAgriculture ProduceMarketing(Development and Regulation) formulated Processed food items exempted from licensingunderIndustries(Developmentand Regulations)Act 1951, except those reserved for small-scaleindustries (SSIs) and alcoholic beverages Foodprocessingincludedinlist ofpriorities for bank lending Automatic approvalfor foreigndirectinvestmentup to 100percentfor mostprocessed foods, exceptalcoholand beer and those reservedfor SSIs 2004105 - Grouo ofMinistersestablishedto formulate modeminteaated food law NationalHorticultureMissioninitiated 2006107 Food Safetyand StandardsAct approved Warehousing(Developmentand Regulation)Act approved Repealof Cess Act Forward Contracts(Regulation) Amendment Bill submitted to parliament Source: Mil try of Finance2002,2003a, 2004a, 2004b, 2005a, 2006; Ministry of Food ProcessingIndustries2002,2004,2005a; Departmentof Foodand Public Distribution 2005. A key legislationawaits parliamentary approval. The Forward Contracts (Regulation) Amendment Bill 2006, which removes the ban on trading commodity options has been submittedto parliament. Due to concerns about rising food prices in2007 and 2008, GO1re-imposed o f the ban on future trading of wheat, rice, potatoes, soybean oil and chickpeas. Processedproducts (or processing activities) removed from small-scale reservation included: ice cream; vinegar; rice and dal (milling); biscuits; sweetened cashew nut products; tapioca, sago, and flour; poultry feed; semifinished vegetable- and chrome-tanned hides and skins; harness leather; leather shoes; leather washers and laces; and sandalwood, pine, eucalyptus, lemon grass, and palmrosa oils. 6 Maharashtra Tamil Nadu Uttar Pradesh Orissa Maharashtra Agricultural Tamil Nadu Agricultural UttarPradesh OrissaAgricultural Produce Marketing Marketing(Regulations) Act Agricultural Marketing Produce MarketingAct APM Act (Regulation) Act 1963 1987 (Regulations) Act 1964 1956, amendedin 1996 Maharashtra State UttarPradeshState Orissa State Agricultural Marketing Tamil Nadu Agricultural Agricultural Produce Agricultural Marketing Apex agency Board MarketingBoard MarketingBoard Board Mandi revenue Source:Maharashtra State Agricultural Marketing Board, Tamil NaduAgricultural MarketingBoard, Orissa State Agricultural Marketing Board, Uttar PradeshState Agricultural Produce MarketingBoard. a There are also about 2,700 unregulated village markets in Maharashtra. b Thereare inaddition 397 unregulated wholesale and 1,150 unregulated primarymarkets inOrissa. Implementationo f the APM Act varies considerably by state. Maharashtra and Uttar Pradesh more strictly enforce the channeling o f produce through the regulated markets, and the development and operation of new markets are confined to the Mandi Board and the Market Committees. Inline with stricter enforcement, these states also have a large number o f "notified" commodities: 593 in Maharashtra and 347 inUttar Pradesh. By contrast, inTamil Nadu, except for 15 commodities, there i s no restriction on where and to whom farmers can sell. Some wholesale markets are developed and managed by local governments, municipal corporations, and the private sector (individuals and trader associations). In Olssa, farmer sales are restricted to regulated markets, but these regulations are only weakly enforced. Commission agents auction the goods in regulated markets in Maharashtra, Tamil Nadu, and Uttar Pradesh, while the Market Committee official does the same in Olssa. The respective Mandi Boards set similar market fees o f about 1-2 percent o f the gross value Kerala, Jammu and Kashmir, Manipur, Andaman andNicobar Islands, Dadraand NagarHaveli, and Lakshadweep do not havethe regulation. In2003, therewere 7,383 wholesale marketsinthe country, ofwhich 7,360 were regulatedmarkets.Inaddition, there were 27,294 ruralperiodic markets (Ministryof Agriculture, as cited inwww.indiastat.com). 7 of sales, which are paid by the buyer. Notably, the field survey found significant fee evasion in Maharashtra throughunder-reporting o f quantities sold or sales outside official market hours. Today, the APM Act adversely affects farmers and the agricultural sector. It restricts farmers' choices. They are required to sell their produce at regulated markets and cannot take advantage o f other channels that offer better returns. In some cases, by banning direct sales (to processors and other bulkbuyers, for example) the Act leads to hgher transaction costs. Although it is the buyer who pays the market and commission agent fee charged at the regulated markets, these costs eventually get passed on to farmers in the form o f lower purchase prices. The Act constrains market development and modernization by restricting private sector involvement in the operation and construction o f wholesale markets. While the regulated market system collects significant revenues from market and other fees, the infrastructure and facilities inmost markets are inadequate. The survey o f 78 wholesale markets in Maharashtra, Onssa, Tamil Nadu, and Uttar Pradesh found that a large proportion o f markets had limited paved roads, storage, drainage, and parking facilities. Nor did they have such basic amenities as public toilets and large weighing scales (figure 2.1). In some states, traditional retail markets have evolved into wholesale markets, many o f which have very poor facilities-no water, covered areas, drainage, or appropriate waste disposal. In 2001, the Ministry o f Agriculture (MOA)established an inter-ministerial task force to recommend measures for increasing the efficiency and competitiveness o f the marketing system, with the goal o ffostering a "single market" inthe country. The task force recommended a number o f reform measures, including amendment o f the state APM Acts. This effort culminated in the formulation o f a model act in 2003, which proposes to remove the restriction on direct marketing by farmers, open the development o f market infrastructure to other agencies, and establish a framework for contract farming (box 2.1). Figure 2.1: Facilities available in regulated markets handling high-value products in Maharashtra, Orissa, Tamil Nadu, and Uttar Pradesh, 2005 By 2008, 15 states had amended their APM Acts: Andhra 80 Arunachal I 4c* loo IS8 0 - Pradesh, 60 Pradesh, Chandigarh, U 40 Chhattisgarh, Goa, -4s Gujarat, Himachal p 20 Pradesh, Madhya 0 Pradesh, Karnataka, Maharashtra, Nagaland, Orissa, Rajasthan, and Sikkim. Bihar completely repealed the Act. Annex table 2.1 summarizes the status of Source: India Agricultural Marketing Survey 2005; author's calculations. Note: High-valueproducts include maize, tomatoes, potatoes, mangoes, and turmeric. APM reform in other states. Several states are amending their Act. Inthe interim, some states, including Uttar Pradesh and Karnataka, allow firm-specific waivers for direct procurement. Reform has been slowed by opposition from vested interests. For example, prior to the adoption o fproposed APM Act reforms in Rajasthan, traders protestedby closingregulated markets at the start o f the harvest for several days. 8 Box 2.1: Salient features of the modelAgriculturalProduceMarketing(Deve1opmentandRegulation) Act 2003 Legal persons, growers, and local authorities permitted to establish new markets inany area. No compulsion on growers to sell their produce through existing regulatedmarkets. Establishment o f direct purchase centers and o f consumer/famer markets for direct sale. Promotiono fpublic-private partnerships inthe management and development o f agricultural markets. Separateconstitution for special markets for commodities like onions, fruits, vegetables, and flowers. A separatechapter to regulate andpromote contract farming arrangements inthe country. Market Committee to promote alternative marketing system, contract farming, direct marketing, and farmer/consumer markets. StateMarketing Boards to promote standardization, grading, quality certification, market-led extension and training o f farmers, and market functionaries inmarketing-related areas. Constitution o f State Marketing Standards Bureau for promotion o fgrading, standardization, and quality certification o f agricultural produce. Source:Ministry of Finance 2004a. IntegratedFoodLaw Earlier, the food and food processing sectors were governed by a complex web o f laws, enforced by eight ministries.' In some cases, several o f these laws and associated regulations prescribed contradictory or differing standards, which increased transaction costs and discouraged private investment. For example, the Fruit Products Order (FPO) allowed artificial sweeteners in h i t products, and the Prevention o f Food Adulteration (PFA) Act banned them. Mandatory declaration labels required by the PFA differed from those o f the Packaged Commodity Regulation Rules (1977) under the StandardWeights and Measures Act. The emulsifier and stabilizers permitted for use injams and chutneys under the PFA differed from those allowed under the FPO. In 1998, the GO1beganto rationalize the legalandregulatory framework for food and food processing. The Prime Minister's Council on Trade and Industry established a Task Force on Food and Ago-Industries Management Policy to examine the issues and recommendmeasures to promote the growth o f the food and ago-industries. The task force completed its report in November 1998. Subsequently a Group o f Ministers was created and charged with formulating a new integrated food law. Parliament approved the Food Safety and Standards Act in 2006. The new Act consolidates the laws relatingto food. Itestablishes the Food Safety and Standards Authority o f India, which will lay down science-based standards for food items; regulate the manufacture, storage, distribution, sale, and importation o f food items; and ensure the availability o f safe and wholesome food for human consumption (Ministryo f Food ProcessingIndustries 2005b. Other key provisions o f the Act: (1) repeal of a number o f previous Acts and Orders;' (2) define standards for food additives, 'The most critical were the Preventionof FoodAdulteration Act 1954, implementedby the Ministry ofHealthandFamily Welfare); MilkandMilkProductsOrder 1992andAgriculturalProduceGradingandMarkingAct 1937, implementedby the Ministry of Agriculture; the EssentialCommoditiesAct 1955, Standards of Weights andMeasures Act 1976, Consumer ProtectionAct 1986, andBureauof IndianStandardsAct 1986, implementedby the Ministry ofFood, Consumer Affairs, andPublic Distribution;the Fruit ProductsOrder 1955, implementedby the Ministry of FoodProcessingIndustries; import and exportregulations, implementedby the Ministry of Commerce; Trade inEndangeredSpecies Act, implementedby the Ministry o fForestand Environment;Atomic EnergyAct 1962/Controlof Irradiationof FoodRule 1991, implementedby the Ministry of Science and Technology; andInfant Milk Substitutes,FeedBottles,and InfantFoods(Regulationof Production, Supply, and Distribution)Act 1992, implementedby the Ministry ofHumanResourceDevelopment) (Patnaik 2005). * The laws andorders repealedare the Preventionof FoodAdulterationAct 1954(37 of 1954), Fruit ProductsOrder 1955, Meat FoodProductsOrder 1973,Vegetable Oil Products(Control) Order 1947, the Edible Oils Packaging(Regulation 9 contaminants, genetically modified and organic foods, packaging, labeling, and food imports; (3) make provisions for accrediting laboratories, research institutions, and food safety auditors; (4)mandate licensing and registration of food business and set penalties for offenses; and (5) establish a Food Safety Adjudication Tribunal. This Act i s a cntical milestone inrationalizingthe legal and regulatory framework for the food processing sector and in improving the investment climate inthe food processing industry. RemainingRegulatory ReformAgenda The reforms listed earlier are crucial to improvingthe investment climate in the agricultural marketing system, but a number o f areas for domestic reformremain. While the GO1has temporarily lifted several key regulations such as storage and transport controls, the threat o f their reimposition discourages both local and foreign investment (table 2.3). Indeed, a storage ceiling for wheat o f 100,000 tonsgper establishment was reintroduced in2006. Such unpredictable changes inpolicy are cited as discouraging private investment in modem bulk foodgrain storage infrastructure in the country. A large number o f states still have to adopt the model APM Act. Some processed agncultural products remain subject to small-scale reservation: rapeseed, mustard, and groundnut oil;" pickles; bread; pastry; boiled sweets; cashew shell oil and natural essential oils; and wooden crates for packaging. Source World Bank2005f, author's assessment Note: Shadedcells = commodity controls exist; lifted = commodityregulation temporarily not enforced; # = wholesalemarketing controls removedinsome states. Order) 1998, Solvent Extracted Oil, De-oiled Meal, and Edible Flour (Control) Order 1967,Milk and MilkProductsOrder 1992,and other Orders under the EssentialCommodities Act 1955 (10 pf 1955)relating to food Note that all references to "tons" inthis report are inmetric tons. I OExceptions are rapeseed, mustard, and groundnut oil produced though solvent extraction, and oils processed by grower cooperatives and state agro-cooperatives. 10 B. Taxation ofthe AgriculturalMarketing System Highdomestic taxationraises the cost o f agricultural marketing andprocessing. Apcultural incomes are not directly taxed in India. Instead, the central and state governments impose various taxes on agricultural produce. At the regulated market level, in addition to handling and distribution charges, commission agent fees (1-8 percent), and the regulated market cess (0.5-2 percent), buyers also pay sales or purchase taxes ranging from 2 to 8 percent. States may also levy additional "special taxes." For example, Punjab and Uttar Pradesh levy additional state development taxes o f 0.5-3 percent.I Processed agncultural products are subject to high and multiple taxes. State sales taxes on processed agncultural products range from 8 to 23 percent. While primary agricultural commodities are mostly exempted, processed Processedfruits and vegetables reduced from 16% to 0% food commodities are subject to Specified cold chain equipment exempted an additional central sales tax Import duties (CST) o f 4 percent. As o f January 7nn?in? 2008, all states and Union 2003104 Central excise tax Territories, have adopted the Aerated drinks reducedfrom 32% to 24% value-added tax (VAT). The VAT Biscuits and boiled sweets reduced from 16% to 8% 2004/05 Introduction of VAT generally follow four categories: Central excise tax staple food products like rice, Dairy machinery, tractors, handtwls (spades, shovels, sickles) reducedfrom 16% to 0% wheat, whole wheat flour, and salt Meat, poultry, fish preparations reduced from 16% to 8% have 0 percent VAT; other Food grade hexane reduced from 32% to 16% products for daily consumption Tax waiver are taxed at 4 percent; most New agro-industries engagedinprocessing, preserving, and packagingfruits and vegetables:deduction of 100% profits for 5 processed food products are taxed years, and 25% for next 5 years at 12-13 percent; and "demerit" 2005/06 Central excisetax Aerated drinks reducedfrom 24% to 16% goods such as alcohol, tobacco, Condensed milk,ice cream, meat, poultry, and fishpreparations, and carbonated soft drinks are pectins, pasta, and yeast exempted taxed at a higher rate (Patnaik Ready-to-eatpackagedfoods, instantmixes (dosa,idli) reduced 2005). from 16% to 8% Vegetable tanning extracts (quebrachoand chestnut) exempted Processed agricultural Import duties Packaging machinesfor food processing reduce from 15% to 5% products are also subject to a w c e : Ministrvof Finance 2002.2003a. 2004a. 2004b 2005a.,2006:,Ministrvof central excise tax (CET). This tax Food ProcessingIndustries 2002,2004,2005a. ` i s levied on all manufactured goods in India but i s collected only from the "branded" or organized sector. The CET on agricultural products range from 8 to 18 percent, but most attract a CET o f 8 percent. Most other counties do not levy an excise duty on agricultural and processed food products. In Thailand, for example, excise duty is levied only on carbonated drinks and fruit juices (Prime Minster's Council on Trade and Industry 1998). To promote the development o f the food processing sector, the GO1reduced or exempted a number o f processed food products from the CET over the last five years. The CET was removed from processed fruits and vegetables, milk, ice cream, and meat, fish, and poultry preparations (table 2.4). The government cut the CET for packaged foods, instant mixes, and aerated drinks to 8 percent. Other apculturalproducts, however, remain subject to the CET. ~~ l1 Punjab, In this comprises a 2 percentrural development tax anda 1percent infrastructure tax. Uttar Pradesh levies a 0.5 percent rural development tax. 11 C. Investment Climate Recent assessments o f the investment climate studies (World Bunk 2004b, 200%) identify a number o f regulatory, governance, and infrastructural constraints to more rapid growth o f private enterprises (table 2.5). The two most critical problems are the highentry and exit barriers inindustry, which are exacerbated by insufficient labor market flexibility and an unreliable and expensive power supply (World Bank 2004b). For example, starting a business requires 11procedures talung about 71 days (for comparison, this i s about 4.5 times the number o f days required in China). Registering property, enforcing contracts, and export and import trading also require a large number o f procedures and days. Poor access to infrastructure remains an important limitation, especially with respect to power: the India Investment Climate (World Bank 2004b) finds that on average manufacturers face nearly 17 significant power outages per month in India, versus 5 in China. Approximately 9 percent o f the total value o f firm output is lost due to power outages. Table 2.5: Selectedinvestment climateindicatorsfor India and China Source: World Bank 2005b. a Indices are scoredbetween 0 to 100, representingthe highest level of regulation.The rigidity of employmentindex is the average of the difficulty of hiring, rigidity of hours and difficulty of firing indices. Cost of firing measures the cost of advance notice requirements, severancepayments, andpenaltiesinweekly salaries. To address infrastructural constraints in rural areas, the GO1 initiated the Bharat Nirman Program in 2005. The program, to which the government i s committing Rs 1,740 billion over 2005- 09, aims to improve access to infrastructure throughout rural India by investing in irrigation, drinkingwater, sanitation, roads, electrification, and telecommunications. More specifically, Bharat Nirman seeks to: (1) construct about 146,000 lulometers o f rural roads, which will provide road connections to 38,484 villages with more than 1,000 people and to all 20,867 habitations inhilly and tribal areas with more than 500 people; (2) provide telephone connections to 66,822 villages that previously lacked connections or had dysfunctional telephone systems; and (3) provide electricity to 125,000 villages through grid-based supplies or, inremote and inaccessible areas, through alternative technologies. These efforts, if successful, will contribute significantly to attracting private investment inrural areas. D.MinistriesandAgenciesInvolvedwithAgriculturalMarketingandProcessing Fostering the development o f the agncultural marketing and agro-processing sector falls under the purview of a large number o f government ministries and agencies, resultinginoverlapping mandates. This study identified at least 39 government agencies involved in apcultural marketing (table 2.6). The main ministries are the Ministries o f Apculture; Food Processing Industries; Consumer Affairs, Food, and Public Distribution; Health and Family Welfare, Small Scale Industries; Commerce and Industry; and Finance. Their respective departments are responsible for 12 policy formulation and regulation. They implement various programs to encourage private investment in domestic trading, postharvest management, exports, and quality management. They support initiatives to build capacity, improve food safety, and improve market information. Perhaps inevitably, this multiplicity o f ministries and departments results inoverlapping mandates. Various ministries implement investment incentive schemes to attract private investment in agncultural marketing and agro-processing. These schemes usually involve an investment grant to private entrepreneurs for a range o f projects, including: (1) contract farming; (2) setting up food processing, cold storage, packing, transport, irradiation, food fortification, and abattoir facilities; (3) investing in quality management, for example, to conform with certain standards or codes o f practice, such as those embodied inHazard Analysis and Critical Control Point (HACCP) programs, the CODEX Alimentarius, and the International Organization for Standardization (ISO) 9000/14000; (4) promoting exports (for example, through participation inexhibitions and international department store displays); and (5) establishing food parks and agro-export zones (table 2.7; see also more detailed list in Annex table 2.3). Grant amounts range from 10 to 50 percent o f total project costs, although most grants are inthe 25-30 percent range. The largest grants have ranged from Rs 100,000 to Rs 50 million. From 2000/01 to 2004/05, it i s estimated that the GO1 funded roughly Rs 7.7 billion on these programs. The MOA,inpromoting a holistic strategy for agncultural development, places highpriority on developingthe agricultural marketing system. As noted, the MOAspearheaded formulation o f the model APM Act and leads efforts to foster state adoption o f the amendments. The MOAplaces considerable emphasis on horticulture development to increase the productivity and profitability of agnculture, promote optimal use o f natural resources (land, water, and the environment), generate greater employment in rural areas, and improve the nutritional security o f the people (Ministry o f Finance 2003b, 2005/06b). To achieve these goals, the MOAset up the National Horticulture Mission in 2005, which seeks to promote the holistic development of the sector and double horticultural production by 2011. The National Horticulture Board (NHB), under the MOA,supports a number o f programs designed to foster growth o f the marketing and agro-processing system for horticultural products. These programs mainly consist of back-ended capital subsidy investment schemes supporting the construction, expansion, and modernization o f cold storage and warehouses for horticultural produce; the promotion o f commercial horticulture through improved production and postharvest management; and the development o f supply chains (table 2.). Between 1999/2000 and January 2005, NHBprovided financial support amounting to Rs 3.1 billion to establish 1,242 cold storage facilities in the country, covering 23 states (Patnaik 2005). This investment expanded India's cold storage capacity by 4.9 million tons. Uttar Pradesh was the largest beneficiary o f this support in terms o f additional capacity created (2.2 million tons), the number o f facilities constructed (464), and total subsidies granted (Rs 1.4 billion). Maharashtra was the second-largest beneficiary in terms o f additional storage capacity (216,000 tons) and Bihar was third(225,000 tons) (Annexfigure 2.2). Notably, the major impetusfor the private sector to enter the cold storage business was the repeal o f the Cold Storage Order 1964 in 1998. The MOAlaunched the Scheme on Market Infrastructure, Grading, and Standardization in 2004 to attract large-scale investment in market infrastructure and value chain projects. The scheme i s implemented in states that amend the APM Act to allow direct marketing, contract farming, and competitive markets in the private and cooperative sectors. State governments allocate land for the markets. The physical targets under the scheme are 561 markets (Rs 20 million each), 6,984 rural markets (Rs 4 million each), and 50 grading centers (Rs 2 million each) (Planning Commission 2005). These investments will significantly improve access to markets at the state level. 13 Source: Ministry o f FoodProcessing Industries 2005a; Ministry of Commerce 2005, Patnaik 2005. 14 The Ministry o f Food Processing Industries (MoFPI) was established in 1998 to formulate and implement policies and plans for the sector with the goal o f catalyzing investments in food processing. In line with this goal, the MoFPI supports programs to: (1) develop infrastructure, (2) upgrade technology and establish modem food processing industries, (3) foster backward and forward linkages in the value chain, (4) strengthen quality management, and (5) develop human resources and institutions. The first four programs provide investment grants to the private sector. Funding for these activities under the lo* Plan totaled Rs 6.5 billion(Ministry o f Food Processing Industries 2005). Between 2002/03 and December 2004, MoFPI investment subsidies for infrastructure development were estimated to total Rs 473.4 million; subsidies for the modernization o f the food processing industry and the promotion o f backward and forward linkages amounted to Rs798 million, while quality management subsidies amounted to Rs 166 million (Patnaik 2005). In2004/05, the GO1introducedmore incentives inthe food processingsector. Allnew agro- industries involved in processing, preserving, and packaging fruits and vegetables are eligible for a tax deduction o f 100percent o fprofits for five years, and 25 percent for the five years thereafter. The Agricultural and Processed Food Products Export Development Authority (APEDA), established in 1998, promotes agncultural exports. As an autonomous agency under the Ministry o f Commerce, APEDA aims to maximize foreign exchange earnings through increased agricultural exports, provide better income to the farmers through higher unit value realization, and create employment opportunities in rural areas by encouraging value-added exports o f farm produce. APEDA supports the private sector by identifying new markets, providing support systems to exporters and manufactures, and introducing new products to the international market. APEDA also has a number o f schemes to promote the development o f modem agncultural marketing and agro- processing arrangements to facilitate exports as well as export promotion. With the state governments, APEDA i s cofinancing the establishment 60 Agro-Export Zones (AEZs). APEDA also provides investment subsidies to the private sector for infrastructure development, quality management, and researchand development. The plethora o f schemes increases the attractiveness o f investing in agricultural marketing and agro-processing for private entrepreneurs, but now there i s some duplication. For example, at least three ministries promote cold storage investments through grant schemes offering different terms: The NHB (MOA):25 percent investment grant, up to Rs 5 million; 33.3 percent for the Northeast, up to Rs 6 million. MoFPI: 25 percent grant for plant, machinery, technical civil works in general areas; 33.33 percent indifficult areas, up to Rs 750,000. 0 APEDA:25 percent grant, upto Rs 1million. There i s an urgent need for greater coordination among government agencies to ensure greater consistency across development programs, minimize duplication, more effectively track the level o f support and impact o f complementary programs, and eliminate the possibility o f double-dipping. 15 e i 1 1 i I i i i I I i! , 18 111.LinkingFarmersto the Market About 228 million people inrural India, equivalent to 56 percent o f the total labor force, are farmers and agncultural laborers. Their output in 2007/08 contributed about 18 percent of national GDP. Because farmers and agricultural laborers constitute a large proportion o f the rural the government's poverty reduction strategy gives major priority to increasing agncultural productivity and fostering agncultural diversification as a means o f raising farm incomes and employment in rural areas. Consequently, as elaborated in chapter 1, the government i s promoting greater production o f higher-value crops, livestock, and other products. These products are not staples, so their demand i s more sensitive to price and income changes. Farmers must become highly attuned to the changing needs and preferences o f consumers, local or international, as signaled through the market. H o w well connected are farmers to the market? The first chapter o f this report described the India Agricultural Marketing Survey, undertaken to obtain a better understanding o f the marketing practices and challenges confronting farmers. Nearly 1,600 farmers in Maharashtra, Orissa, Tamil Nadu, and Uttar Pradesh were surveyed about their experiences in marketing higher-value crops, particularly tomatoes, potatoes, mangoes, maize, and turmeric. This chapter draws extensively on the survey results. The majority o f farmers surveyed report selling their high-value produce through wholesale markets, both regulated and unregulated. Farmers' most frequently cited concerns regarding the wholesale markets they patronize include inadequate market facilities, high marketing fees, long distances to the market, and the dishonesty o f traders. Farmers' efforts to market their produce are further hampered by limited access to market information. Often farmers have to rely on other farmers for information on prices, postharvest activities, and quality management. The limited reliance on agricultural officers for production and marketing information points to weaknesses in the agricultural extension and market information systems. Other than cleaning and grading for size, farmers undertake few postharvest activities, partly because they have limited access to technical advice about such activities and receive little monetaryreward for undertakmg them. Contract farming as an integrated marketing arrangement i s gaining ground for a number o f commodities in India. Inmany cases, contract farming has brought benefits in the form of greater access to improved inputsand technical advice, higher productivity and farm incomes, and increased demand for labor in rural areas. In other cases, contract farming has brought implementation problems associated with inadequate contract design, farmers' poor understanding o f the terms o f their contracts (such as pricing rules or quality standards), farmers' limited bargaining power, and the lack o f a legal framework governing contractual arrangements. Farmers' participation in producer associations remains limited, although the survey results indicate that farmers participating in associations receive prices that are 5 percent higher on average. These issues are explored in greater detail inthe sections that follow. A. Characteristics of Farmers Growing High-Value Crops Farmer household^'^ constitute the majority o f rural households in India. According to the latest NSSO estimates, farmer households accounted for 60 percent o f rural households in 2002-03. With the exception o fTamil Nadu, Andhra Pradesh, and Kerala, they accounted for 50-70 percent o f l4Farmer households comprise about 124.6 million farmers and 103.1million agricultural laborers inrural areas. An additional 2.9 millionfarmers and 4.3 million agricultural laborers are found inurban areas. 15According to the NSS, a "farmer household" has at least one farmer engaged inagricultural activities, including the cultivation o f crops, cultivation o f trees (rubber, coconut, or coffee, for example), animal husbandry, fisheries and aquaculture, beekeeping, vermiculture, or sericulture. 19 rural households in most states Figure 3.1: Percent share of farmer householdsin rura1householdsand share (figure 3.1). Among farmer of agricultural and wage income in total farmer household income, 2002-03. households, there continues to be limited diversification of sources o f income. In 11 o f the 18 states surveyed by the NSSO, direct income from farming accounts for over 50 percent of household income. This share is likely to be higher if incomes from agricultural wages are included. In view o f the +&+d0+5 ,+@ a*,&, + Y\ *,$ 9 p 1%+a Q $- `+ Q 3Q$990S 9 8SQOQ 3 I significant dependence o f a large majority o f rural households on source: NSSO 2005b. agnCUlhlTe, getting agriCUltllre Note: Raj=Rajastban;Ker=Kerala; Oris=Orissa, TN = Tamil Nadu, WB=West moving anemphasis will require not Bengal, Har = Havana, Jhar = Jharkand, Chh = Chhattisgarh, AF' =Andhra Pradesh, Only On raising farmers' Productivi~ J&K = Jammu and Kashmir, Kar = Karnataka, MP =MadhyaPradesh, UP = Uttar Pradesh, Mah=Maharashtra, Guj = Gujarat, Ass =Assam, Bih=Bihar, Pun= and diversifying their production, Punjab. but also on linkmg farmers more effectively to markets to meet growing and rapidly diversifying consumer demand. Diversification to higher-value crops poses new challenges for farmers. The greater perishability o f many higher-value crops demands more sophisticated systems for postharvest management and marketing. The higher price and income elasticities o f demand for these crops require farmers to be adept at responding to changing market trends. To understand these challenges, itis helpful to begin at the first point o fsale and gain a clear picture o fthe farmers who grow higher- value crops. Are farmers growing higher-value crops similar to other farmers in India? Studies o f crop choice and market participation have shown that farmers who grow nontraditional crops and who market their crops have different productive assets and access to credit and farmer networks than farmers who do not (Foster and Rosenmeig 1995; Conley and Udry 2001; Key, Sadoulet, and de Janvry 2000; Bandiera and Rasul 2004). The India Agncultural Marketing Survey finds that most producers o f the five focus crops are small-scale farmers, owning about 1-3 hectares on average. This finding dispels the common impression that only large-scale farmers are able to diversify into high-value agricultural production. Even so, on average the farmers in the survey owned twice as much land as the average farmer inthe state (table 3.1).16 Overall, the experience in India appears to be consistent with that o f other countries, where farmers growing higher-value crops tendto be more "asset rich" than the average farmer. The survey found that farmers growing higher-value crops have relatively larger farms, higher rates o f literacy, and greater amounts o f other assets, such as livestock or a house made o fbrick or cement (table 3.1). This information is not sufficient, however, to determine whether wealth attributes encourage farmers to grow high-value crops or if these attributes are an outcome o f producing and marketing such crops. Use o f irrigation i s fairly common inthe production o f higher-value crops. InUttar Pradesh, over 90 percent o f the area under potatoes, tomatoes, turmeric, and maize i s irrigated; 84 percent o f mango area i s irrigated (Annex figure 3.1). In states where access to irrigation i s more limited, significantly less irrigated area i s planted to the focus crops. Turmeric i s predominantly irrigated in Tamil Nadu. Irrigation i s widely used for tomatoes in Maharashtra, Onssa, and Tamil Nadu, 16 In1995196,about 62 percent oflandholdings inIndia were less than one hectare; 93 percent are less than two. 20 probably because o f the crop's greater sensitivity to water availability. The use o f irrigation in mango production i s limited. In focus group interviews, Table 3.1: Selected characteristicsof farmers in Tamil Nadu noted the increasing shift from householdsgrowinghigh-valuecrops in four producing paddy to mangoes, a less water-intensive crop, states to cope with growing water scarcity inthe state. Overall, farmers' access to formal credit arrangements i s very limited. Only 12 percent o f farmers in the marketing survey had access to formal credit through banks and other credit institutions (Annex table 3.2). Farmers had slightly better access to formal credit in Orissa (18 percent) and Maharashtra (24 percent) than in UttarPradesh (4 percent) and Tamil Nadu (9 percent). In focus group interviews, farmers frequently cited difficulties with meeting the documentation and other requirements o f banks as a major disincentive for applying for bank loans. Farmers depend more on informal sources o f credit; about 30 percent o fthe farmers interviewed obtained loans from moneylenders, ftlends, and relatives. As more organized marketing systems develop, farmers will increasingly require credit to invest inthe new and modern technologies essential for meeting the higher standards imposed by more sophisticated marketing systems, such as assurances o f food quality, safety, and traceability. Improving farmers' access to capital from the formal sector at a lower cost will be Orissa crucial. Tamil Nadu Farmers most frequently identify poor access to Maharashtra irrigation and credit as constraints to increased UttarPradesh 12** production. The marketing survey asked village leaders, Orissa 4 including farmers, to identify the main constraints to Source:Fafchamps, Vargas-Hill, and Minten 2006. Note: * denotes significantly different from the NSS agricultural production intheir villages. Limited access to state average at lo%, ** at 5%, and *** at 1%. Some irrigation i s the most frequently cited problem. In entries could not be tested due to zero variation in Maharashtra, all but 1 o f 41 villages surveyed list it as a castes/scheduledtribes. observations in data. SC/ST - scheduled major problem (Annex table 3.3). Poor access to credit i s a A person who can both read and write a simple the second most cited problem. Insufficient access to messagewith understanding in at least one language. bA katcha househas neither brick nor cement walls or extension and inputs are also identified as constraints. a metal roof. About one-fourth-ofthe villages surveyed inTamil Nadu and Orissa note poor roads as a constraint, while one-third o f the villages surveyed inMaharashtra report problems with labor shortages. B. Farmers'Access to Markets Agricultural produce i s generally marketed in India through four broad channels: (1) directly to consumers, (2) through wholesalers to retailers or exporters, (3) through cooperatives or public agencies, and (4) through processors to retailers or consumers (Acharya 2004). These channels may involve multiple intermediaries between farmers and the ultimate consumers (table 3.2). The India Agricultural Marketing Survey finds that most farmers sell their produce through wholesale markets (table 3.3). Sales to traders at the farmgate are an equally important channel for farmers inOrissa and Tamil Nadu, especially for maize, mangoes, and turmeric. Preharvest contracts with traders are most common for mangoes. Direct sales to processors are not significant, accounting 21 Cereals Fruitsand vegetables Farmer-consumer Farmer-consumer Farmer-village trader-onsumer Farmer-processor-consumedexporter Farmer-wholesaler-retailer-consumer Farmer-primary wholesaler-processor-onsumer Farmer-village trader-wholesaler-consumer/export Farmer-primary wholesaler-secondary wholesaler- Farmer-wholesaler-miller-processor-wholesaler-retailer- retailer/consumer consumer Farmer-preharvest contractor-primary wholesaler-secondary Farmer-government agency (FCIFfair price shop-consumer wholesaler-onsumer Source: Fafchamps et al. 2006. Note: TN = Tamil Nadu; OR = Orissa; MH= Maharashtra; and Up = UttarPradesh. Although most products are sold through wholesale markets, the proportion actually sold in regulated wholesale markets differs markedly by state. The APM Act requires farmers to sell produce through regulated wholesale markets, but the marketing survey finds that enforcement o f the APMAct varies significantlyby state. Only inMaharashtra are 85-100 percent ofcommodities sold through regulated markets. InUttar Pradesh, except for tomatoes, less than 42 percent o f sales occur through regulated markets (table 3.3). Despite the large "presence" o f regulated markets in Onssa, less than 20 percent o f crop sales are channeledthrough these markets. Farmers were asked which aspects o f the wholesale market should be improved. Their responses varied by state (table 3.4). InMaharashtra and Uttar Pradesh, where functioning regulated markets are more widespread, a reduction in market fees i s cited by about half o f the farmers. Improved market facilities and more honest traders are also frequently cited. By contrast, in Tamil Nadu and Orissa, where regulated markets are not as dominant, a reduction inmarket fees i s cited by less than 15 percent o f farmers. There i s greater demand for improved market infrastructure, as farmers more frequently mention the need for closer markets, improved transportation, and cold storage facilities. Farmers in Uttar Pradesh and Maharashtra highlight the need to reduce theft in markets. Market officials reported that most thefts occur after the market i s closed. Although 89 percent o f markets inUttar Pradesh post guards inmarkets after hours, only 40 percent o f markets in Tamil Nadu and Orissa and 45 percent inMaharashtra have after-hours security. 22 Less theft 11 10 37 31 0 0 3 5 18 16 Permission to sell and/or sell more Often 9 10 10 23 3 8 6 19 17 15 I . I .a Note: Satisfaction with wholesale market includes farmers who were indifferent, satisfied, and very satisfied. F&V = fruits and vegetables. These findings resemble results o f a recent survey in Kamataka. The Karnataka State Agricultural Prices Commission surveyed 3,408 farmers in the state and found that only 29 percent sold their produce inthe regulated wholesale markets. Farmers' main reasons for failing to sell inthe regulated markets included: distance to the market (31.2 percent), good price at the local market (18.4 percent), small quantity o f produce sold (12.7 percent), no knowledge o f the market (8 percent), cheating inweighing and harassment by hamalshoolies (3.1 percent); and the long wait for weighing (1.4 percent) (National Commission on Farmers 2006). C.Farmers' Access to Market andOther Information Market information i s an essential input to farmers' production and marketing decisions. It helps farmers decide what to produce and when, where and how to market their produce. It also guides their longer-term investments (Kohls and Uhl 1990). Market prices are one o f the most important types o f market information. The marketing survey finds that farmers primarily rely on other farmers for production and marketing information (table 3.5). Agncultural traders inimmediate markets are the second most common source o f both production and marketing information, ranging from information on how to use fertilizer and pesticide to information on prices as well as grading and other postharvest practices. Agncultural extension officers and the mass media play a limited role. These results suggest major weaknesses in the agricultural extension and market information systems. 3.1 These findings are consistent with farmers' ranking o f constraints to increased production o f high-value crops. They cite lack o f knowledge as a major constraint to increasing production (Annex table 3.1). Notably, among the four states, the contribution o f agricultural extension officers i s highest in Onssa for production-related information. Contract buyers, though to a very limited extent, are a source o f information for a small percentage o f farmers on sorting and grading and crop prices. D.PostharvestActivitiesPerformedbyFarmerstoEnhanceQuality Postharvest activities such as cleaning, sorting, grading, milling, and packaging can potentially enhance the sale price o f agricultural produce. Farmers growing high-value crops recognize that better quality can translate into a significant price premium. Farmers were asked the prices o f highversus average quality produce, and the price premium was estimated as the difference between the two prices. The quality features considered included size, shape, color, smell, taste, and moisture content. Based on farmers' estimates, the average quality premium between high and average quality produce i s 69 percent for mangoes, 59 percent for tomatoes, 53 percent for potatoes, 47 percent for turmeric, and 34 percent for maize. 23 Despite these perceived price premiums, not all farmers perform postharvest activities to improve quality. The marketing survey found large variation across commodities and states. Ollssa has the fewest farmers undertakmg postharvest operations (25 percent) (Annex table 3.4). About 80% o f farmers in Uttar Pradesh and 70% inTamil Nadu and Maharashtra report undertaking some postharvest activities. Only one-third or fewer farmers in Tamil Nadu and Ollssa grade their mangoes, compared to over 90 percent inUttar Pradesh and Maharashtra. Only 37 percent o f tomato farmers in Orissa report grading their harvest compared to 99 percent in Uttar Pradesh. About 70 percent o f maize farmers and 90 percent o f turmeric farmers dry their produce, but only a small percentage performs any milling and grinding(5 percent o f turmeric farmers and 45 percent o f maize farmers). The large discrepancy between farmers' perceived price premiums for quality and actual actions may be attributed to a number o f factors, including the small volume o f produce (which limitsgrading possibilities); price uncertainty (not knowing whether market prices will cover the cost o f additional postharvest activities); and the transaction cost o f searching for buyers who will reward quality. Few buyers o f agncultural produce signal quality requirements to farmers. Very few farmers participating in the marketing survey (6 percent) have actually received requests from buyers to change product specifications within the last five years (table 3.6). A large share o fbuyers who made such a request did not offer a price premium. With respect to food safety, only 3 percent o f farmers have been asked to change the type o f chemical or input they use. Among those farmers, the predominant change was related to pesticide use: a reduction in use (57 percent), changes in the timingo fpesticide application (62 percent), and changes inthe type o fpesticide used (26 percent). 24 Table 3.6: Do traders reward farmers for quality-enhancingmeasures? Source: IndiaAgriculturalMarketingSurvey 2005;authors' calculations. Even when buyers change their quality specifications, farmers do not always alter their practices. Very few farmers (only 8 percent) report that they actually complied with buyers' changed quality specifications. This low response rate i s explained partly by the fact that only 26 percent o f buyers who made such requests actually rewardedfarmers through higher prices. Farmers report that 40 percent o f mango and 45 percent of maize buyers did pay more when they complied with specifications. What factors drive farmers to undertake postharvest activities to improve quality? A regression analysis o f survey data found that farmers selling at wholesale markets and village markets (compared to those selling at the farmgate) are significantly more likely to alter their postharvest practices to improve quality (Annex table 3.5). A price premium for quality provides another incentive for farmers to change their practices. A household head with secondary education also increases the propensity to undertake postharvest practices, perhaps implying that the complexity o f these practices requires a higher level o f skill and literacy. Those who receive information on postharvest practices from other farmers and agricultural officers are more likely to adopt them, which may indicate farmers' higher level o f trust for these sources o finformation. E.ContractFarming:Statusand Challenges Contract farming i s being promoted by the GO1 to strengthen farmers' linkages to the market. The model APM Act suggests legal provisions for introducing contract farming at the state level. Contract farming i s an agreement between farmers and marketinglprocessing firms for the production and supply o f agricultural products under a forward agreement. This arrangement rests on a farmer's commitment to supply a specific quantity o f an agncultural commodity that meets certain quality standards at a specific time set by the buyer; it also rests on a buyer's commitment to purchase the commodity, usually at a previously agreed upon price. In most cases, the buyer also supplies or arranges for the farmer to receive inputs, production advice, and credit (Kohls and Uhl 1990; Eatonand Shepherd 2001; Singh 2005). In India, contract farming has been adopted to grow and market a wide variety o f commodities. These commodities include grains (rice, wheat, maize, barley); fruits (mangoes, apples); vegetables (tomatoes, potatoes, gherhns, chilies, mint, spinach); oilseeds; cotton; livestock products (broilers, milk); seeds; trees (eucalyptus, poplar); and other crops (tea, sugarcane, chicory, oil palm) (Spices 2003;Vaswani et al. 2003; Birthal, Joshi, and Gulati 2005; Deshpande 2005; Singh 25 Commodity State Agency I Farmers contracted I Servicesprovidedby buyer credit Maharashtra CottonCorporation of India Farmer association Extension Safflower (oilseed) Maharashtra Marico Industries Cooperative Credit, extension Tea Tamil Nadu Tea Board Women' self-help group Extension, transport Fruits,. Vegetables - North India Mother DairvMational Dairy Grower associations Inuuts, extension . - IDevelopment Board I ' Milk /Punjab /Nestle India Ltd. /Individualfarmers, \Inputs, extension, transport I lagents Earlier, contract farming arrangements were mainly two-party agreements between farmers and the buyer. More recently, trilateral and multilateral arrangements have deve10ped.l~In most cases these arrangements address farmers' constraints in accessing inputs, credit, and production advice. Overcoming these constraints i s especially critical when buyers introduce new technologies, such as improved crop varieties and livestock breeds, to farmers. To help farmers deal with the productionrisks, some buyers also help them obtain crop insurance. Recent studies o f contract farming in India have documented successful and unsuccessful experiences. The successful initiatives indicate that farmers engaged in contract farming benefited from substantial increases inyields and farm incomes; that contract farming contributedto increased employment, resulting from greater demand for family and hired labor; and that contract farming helpedreduce farmers' risks because o f the assured price and market (Bhalla and Singh 1996; Rangi and Sidhu 2003; Haque 1999; Dev and Rao 2004; Birthal, Joshi, and Gulati 2005; Deshpande 2005; Singh 2005). For example, Birthal et al. compared the performance o f contract and noncontract farmers producing vegetables (with the National Dairy Development Board), milk (Nest16 India), and broilers (Venkateshwara Hatcheries). They found that contract farmers' net profits surpassed those o f noncontract farmers by 78 percent (for vegetables), 100 percent (for milk), and 13 percent (for broilers). The higher returns mainly derived from higher yields and lower production and marketing costs. Costs were reduced in terms o f farmer's time, transport o f inputs and outputs, and access to information and new technology. The extent to which contract farming shows bias towards larger-scale farmers differs considerably across different contexts. Some studies pointed to a bias by some firms in Punjab l7 multilateral contract farming arrangements are: (1) farmeriproducer group +buyer + input supplier An example o fa trilateral arrangement is: farmeriproducer group +buyer +bank. Two examples o f +bank and (2) farmeriproducer group + facilitator +buyer + input supplier + bank. 26 towards medium- and large-scale farmers (Bhalla and Singh 1996; Singh 2000a and Satish 2003). Other studies found the opposite (Haque 1999; Dev and Rao 2004; Birthal et al. 2005). Birthal et al. found that contract farmers were about equally distributed among small-, medium-, and large-scale farmers for poultry and vegetables inAndhra Pradesh, Punjab, Haryana, and Delhi, while small-scale contract farmers accounted for the majority (56 percent) engaged in dairy production inPunjab. Dev and Rao (2004) found small-scale and marginal farmers dominating gherkm contract farming in Andhra Pradesh and Karnataka. Other studies documented that farmers pulled out o f contract growing arrangements because o f problems with lower prices, unjustified quality discounts or product rejections, delayed payments, and inadequate extension support (Bhalla and Singh 1996; Singh 2005). Breach o f contract by farmers and buyers has also occurred (Bhalla and Singh 1996; Singh 2000). Contract farming implementation problems can be traced to a number o f factors. These factors include inadequacies in contract design (for example, in pricing rules, delivery and payment rules, quality specifications and associated price implications, technical support requirements for farmers to adopt new technologies); a poor understanding between farmers and buyers o f their expectedroles; limited bargaining power o f smaller-scale farmers; and the lack o f a legal framework to govern contracting arrangements. Problems with inadequate contract design and program implementation contributed to the poor performance o f contract farming organized by the Punjab Agro Industries Corporation (PAIC) in 2002. PAIC committed to provide farmers seed and technical assistance and to purchase all o f the produce at a previously agreed price (Singh 2005). Bad weather duringthe harvest led to disease in farmers' crops (for example, peas became infected by fungus). Poor quality fungicides and inadequate technical support added to the problem. Large-scale rejections o f farmers' produce ensued because it did not meet PAIC quality standards. Farmers were instead advised to sell in the open market, which led to a crash in local prices (Singh 2003; Rangi and Sidhu 2003). As a result o f these production and marketing problems, about 60 percent o f the farmers subsequently dropped out o f the program (Dhaliwal, Kaur, and Singh 2003). The India Agricultural Marketing Survey finds limited participation by farmers in contract farming. Of the farmers surveyed, only 5.5 percent (87) are contract farmers. Most o f them are in Tamil Nadu (62 percent), followed by Maharashtra (17 percent), Orissa (14 percent), and Uttar Pradesh (6 percent). Contract farming arrangements are more prevalent for mangoes (85 percent). The most common assistance provided by the buyer, especially for mangoes and turmeric, i s labor for harvesting (49 percent o f contracts), followed by production advice (14 percent). Very few contractual arrangements provide inputs (4 percent). For mango farmers, the most frequently cited reason for entering into a contract farming arrangement i s the difficulty infindingworkers to harvest the hit. Contract buyers are mainly traders (57 percent), processors (19 percent), and exporters (14 percent). F.Other MarketingArrangements Other marketing arrangements designed to foster greater vertical coordination in the marketing chain have also been tried inIndia. The expanded access to the Internet, declining costs of computer technology, and affordable alternative sources o f electricity (such as solar energy) have made it easy to set up rural kiosks operated by private companies and nongovernmental organizations (NGOs). Kiosks offer a range o f services related to production and marketing, including, for example, farm and animal husbandry management and marketing advice, or input supply and price information. In some private initiatives, kiosks also serve as purchasing centers for farmers' products. The procurement operations require private companies to obtain a special waiver from the APM Act from the respective state governments. A well-hown example o f this initiative i s the e-choupal (e-luosk) operated by the ITC Limited Ltd. Each kiosk sells inputs and provides free 27 production and marketing information while serving as a procurement station for farmers' output (box 3.1). Despite a general perception that credit-marketing interlinked sales are widespread, the study finds only a limited number o f cases. The presence o f interlinked sales between farmers and traders at the regulated markets i s widely regarded as one reason that farmers do not sell directly to buyers. The survey, however, finds that only 9 percent (106 farmers) report selling their produce in advance. About 56 percent o f these 106 farmers are inTamil Nadu, 25 percent inUttar Pradesh, 10 percent in Maharashtra, and 8 percent in Orissa. Only for maize and tomatoes do farmers receive an advance in kmd, in the form o f farm inputs (fertilizer, seed, and pesticide). The fact that farmers growing the focus crops are relatively better o f f than the average farmer in the state may partly explain the limited use o f interlinked credit arrangements. Box 3.1: Direct marketing through the e-choupal Between 2000 and 2007, the agribusiness division o f ITC Limited set up 6,400 Internet kiosks called e-Choupals in nine Indian states, reaching about 38,000 villages and 4 million farmers. ITC establishes an Internet facility in a village and appoints and trains an operator (sanchalak) from among the farmers inthe village. The sanchalak operates the computer to enablefarmers to get free information on local and global market prices, weather, and farming practices. The e-Choupal also allows farmers to buy a range of consumer goods and agricultural inputs and services (sourced from other companies). The e-Choupal serves as a purchasecenter for ITC for 13 agricultural commodities including, with the sanchalak acting as the commission agent in purchasing the produce and organizing its delivery to ITC. In2006/07 ITC purchased about 2 million tons o f wheat, soybeans, coffee, shrimp, and pulses valued at $400 million through the e-Choupal network. This direct purchasing cuts marketing costs for both farmers and ITC. It improves price transparency and allows better grading o f produce. It also allows farmers to realize a bigger share of the final price. 1Source: Shivakumar, personal communication, 2007. G. Farmers'ParticipationinProducerGroups Producer groups, whether inthe form o f an association, cooperative, society, or other formal or informal organization, can benefit farmers in a number o f ways. With the large number o f small- scale and marginal farmers in India and often small marketable surpluses, producer groups through collective efforts can provide a mechanism to lower transaction costs in marketing and purchasing inputs, facilitate access to technical services and credit, and provide a unified voice to influence policy. Nationally, farmer participation inproducer organizations i s limited; the NSS survey o f farm households in 2002/03 found that only 2.2 percent had at least one member o f the household participatingina registered farmer organization. The India Agricultural Marketing Survey also finds limited participation o f farmers in producer groups. Only about one-third o f the farmers report being members o f any type o f producer group or association (figure 3.2). Participation i s highest in Maharashtra (52 percent) and Tamil Nadu (30 percent) and much more limited in Orissa (4.8 percent) and Uttar Pradesh (10 percent). Membership is most widespread among turmeric farmers (73 percent). The survey found that farmers' participation in an association benefits them by increasing the prices they receive in collectively selling produce by an average o f4.9 percent. 28 Figure3.2: Farmers' membershipinproducergroupsby crop and state Source: India Agricultural MarketingSurvey; author's calculations. 29 30 IV. TradinginAgricultural Commodities Farm produce generally flows to local wholesale markets, which is a pivotal stage in the marketing system in India. It i s where apcultural products are purchased by other wholesalers for sale in other wholesale markets inother states, by retailers for sale at local markets, by processors for greater value-addition; and by exporters for shipment to other countries in fresh or processed forms. At independence, when the country was plagued by food shortages and famines, "the immediate concern for government was to save farmers and consumers from malpractices o f traders and facilitate the growth and development o f an orderly marketing arrangement" (National Commission on Farmers 2006:396). The central and state governments' desire to develop and organize the marketing o f apcultural produce through regulated markets led to passage o f the APM Act and the launch o f a massive program to develop a national wholesale marketing network. This chapter reviews the operation of these markets and the performance o f the wholesale trade. It draws mainly on the findings o f the India Apcultural Marketing Survey in Maharashtra, Orissa, Tamil Nadu, and UttarPradesh. The marketing survey finds that the limited accessibility and poor facilities of wholesale markets impede them from operating more efficiently. In2006, India had more than 7,500 regulated wholesale markets, but their infrastructure and facilities remain inadequate despite the significant revenues they generate. They are a major source o f the significant losses and wastage in the marketing system. Withinthese markets, physical and informal barriers prevent entry into the trading business. Notably, marketing margins in the wholesale market decline with increased trader density. Analysis o f wholesale marketing in Tamil Nadu finds that the likelihood o f farmers selling at a wholesale market increases significantly with improvements inmarket facilities. Although wealthier farmers capture a larger share o f the benefits from the facilities incongested markets, investments in market facilities would be advantageous to the poor, because sales by poorer farmers would increase proportionally more than those by wealthy farmers. Traders cite governance issues and poor access to credit and rural infrastructure as some o f the most critical constraints to the growth o f their business. Poor road conditions and roadblocks (with the associated side payments) increase transport costs and cause delays. Traders rely mainly on personal funds to meet workmg capital needs. Among those who borrow, most depend on informal sources, such as moneylenders and fnends or relatives. Many cite problems with meeting the numerous bank documentation requirements as a major factor discouraging them from obtaining a bank loan. Organized food retailing, particularly by supermarkets and hypermarkets, i s expanding rapidly in India, even with the ban on foreign direct investment (FDI). Rising incomes, increased urbanization, a growing middle class, greater numbers o f working women, and increased exposure to products through wider media penetration have fueled the growth o f food retailing. Retailers in the organized sector identified several key constraints to their operations, including a number o f restrictive regulations, inadequate infrastructure, and multiple taxation. These issues are discussed in the following sections. A. Accessto Wholesale Markets Market DensityandDistance Market density and distance to the nearest market have an important influence on market accessibility, the associated cost o f transportation, and the returns to marketing. In2006, India had about 7,566 regulated wholesale markets and 21,780 rural primary/periodic retail markets-village haats, shanties, and the like (Ministryo fFinance 2007). Market density differs significantly by state. 31 Kerala, Punjab, and Goa have the highest density o f wholesale markets, with each market serving on average about 10,000 hectares o f gross cropped area (GCA). Haryana, Bihar, Uttarakhand, Andhra Pradesh, and Orissa follow, with wholesale markets serving between 13,000 and 15,000 hectares o f GCA. Madhya PradeshandRajasthanhave the lowest market density (figure 4.1). Figure 4.1: Wholesale market densityin India (2003) and distanceto wholesale markets infocus states (2005) '41 UP All ! Asam UP 12 1 1 /awholesaie/ retail Man Kar WB i I India TN 1161719 I MH 20 1i I AP Ori HP ' I15 Utchl A 1315 I OR 11 Har Bih ` I J 13 I i Goa 11013 Pm Ker 6 110 l6 I 0 15 30 45 0 5 10 15 20 2! GCA (000 ha)/wholesale market Median Distance to Market, km Source: Ministry of Agriculture; India Agricultural Marketing Survey 2005; authors' calculations State averages, however, can mask variations in market accessibility at the local level. The India Agricultural Marketing Survey asked farmers about the distance to the nearest wholesale and retail markets for grains and fruits. Distance to market is an important consideration, especially for perishable high-value commodities, because o f the potential losses during transport. The survey found that the median distance to a wholesale market i s about 11 hlometers in Orissa and 12 hlometers in Uttar Pradesh (figure 4.1). Wholesale markets in Tamil Nadu and Maharashtra are more distant, with median distances o f 16 and 20 kilometers, respectively. In addition to distance, farmers also list "bad roads" as an important constraint to marketing, as noted in the previous chapter. InfrastructureandServicesAvailableinWholesaleMarkets Wholesale markets may be specialized or dual-purpose. Seventy-eight wholesale markets were visited for the survey. Dual-purpose markets-which function as wholesale and retail markets -are more prevalent in Tamil Nadu and Orissa. In Maharashtra and Uttar Pradesh, most markets are exclusively wholesale markets (table 4.1). Most wholesale markets are in urban areas. The concentration o f regulated wholesale markets varies considerably by state. Regulated wholesale markets dominated in Maharashtra (95 percent) and Uttar Pradesh (94 percent). In Orissa, regulated markets dominated the sample Source India Agricultural MarketingSurvey 2005, authors' calculattons 32 (90 percent), but the AF'M Act i s only weakly enforced. Only 10percent o fthe wholesale markets in Tamil Nadu are regulated. Most wholesale markets are managed by local municipalities and not overseen by the Tamil Nadu MarketingBoard. At the state level, market density appears to be inverselyrelatedto market size. The density Of markets in Nadu and Orissais Figure 4.2: Distributionof wholesale markets by area butthese markets are also smaller: three-fourths occupy less than 5 acres (2 hectares) (figure Area of Market 80 4.2). By contrast, market density i s lower in 70 UttarPradeshand Maharashtra, but the markets 60 themselves tend to be larger: 67 percent o f $ 50 wholesale markets in Uttar Pradesh and 65 ,O 40 percent in Maharashtra occupy 21 acres (8.5 30 20 hectares) or more. 10 Market infrastructure and facilities in 0 Total TN OR MH UP the surveyed wholesale markets are limited and rudimentary. Good market facilities and a 5acres c 0 6-10acres infrastructure are critical to reducing rn 11-20acres 210r m r e acres transaction costs, improving price transmission, Source: India Agricultural Marketing Survey 2005; IMRB2006. and preserving the q u a l i t y f produce (Kohl and Uhl 1990; Acharya 2004). There currently i s no national or state database on the availability o f infrastructure and facilities in India's wholesale markets. The marketing survey found limited infrastructure in many markets (figure 4.3). Innfrastructure was slightly better inMaharashtra and Uttar Pradesh than inthe other two states. Most markets had covered shops, but less than 50 percent o fmarkets inMaharashtra and Ollssa had paved roads within the market yard. With the exception o f Maharashtra, only 44 percent o f wholesale markets in Uttar Pradesh and 10 percent in Orissa and Tamil Nadu had parlung for vehicles in the market. About 70-80 percent o f markets in Maharashtra, Tamil Nadu, and Uttar Pradesh had drainage systems, but only one-third had them in Orissa. Access to warehouses i s limited, except in Maharashtra (85 percent). Less than 40 percent o f markets had a drying area and less than 20 percent had cold storage facilities. Nationally, warehouse capacity i s low and confined to a few states. In 2004, six states accounted for 72 percent o f warehouse capacity in India: Figure4.3: Limitedinfrastructureinwholesalemarkets Punjab, Andhra Pradesh, Uttar Drying area Pradesh, Haryana, Maharashtra and Tamil Nadu. Punjab had the largest Warehouse capacity at 19 million tons (Annex ColdStorage figure 4.2). Warehouses in h d i a Drainage UP are used generally for foodgrains, QMH particularly rice and wheat. Three Parlong (Trucks) o f every four warehouses are Parking(allvehicles) operated by government )aved/pucca road in mkt yard agencies-Food Corporation o f Kutcha road in mkt yard India (FCI), Central Warehouse Corporation, and State Warehouse Market has covered shops Corporations (SWCs). They are Marketarea enclosed concentrated in the major foodgrain-producing states, such as 0 20 40 60 80 100 Punjab, Andhra Pradesh, Uttar Percent of Wholesale Markets Pradesh, and Haryana. Warehouses Source IndiaAgncultural Marketing Survey 2005, authors' calculahons 33 for other commodities remain limited. Mukherjee and Pate1 (2005), as part o f a survey o f the retail sector in India, found that warehouses and godowns (and the mandis that operate them) are often located inside cities, where truck transport i s restricted during certain hours. Transport i s delayed by city traffic congestion, and the timingo f market transactions i s restricted. Cold storage facilities are even more limited nationally. These facilities are concentrated in a few states. About 80 percent are in six states-Uttar Pradesh, Uttaranchal, West Bengal, Bihar, Gujarat, and Madhya Pradesh-and 95 percent o f the capacity in these facilities i s used to store potatoes (Annex figure 4.3). Uttar Pradesh and Uttarakhand18 jointly in 2004 had the largest capacity, at 8.3 million tons. To some extent, cold storage capacity inthe two states was enhanced by the NHB's cold storage investment grant scheme, which helped to add nearly half a million tons in capacity altogether in Uttar Pradesh and Uttarankhand between 1999/2000 and early 2005. Other states operate more multipurpose cold storage facilities. Himachal Pradesh and Maharashtra have a more significant share o f cold storage capacity dedicated to h i t s and vegetables. Kerala has the highest share (89 percent) used to store milk, meat, and other livestock products, followed by Maharashtra and Tamil Nadu. Most wholesale markets offer a very limited range o f services. They generally have a bank, post office, and police station, and nearby bus and railway stations (figure 4.4), but overall, only 29 percent o f the markets surveyed have a large weighing machine for traders to use. Other important amenities for market users, such as public toilets, a canteen, and a hostel for farmers are frequently laclung, They are more readily available inMaharashtra and Uttar Pradesh, but still in only about 70 percent o f the markets. Less than 40 percent o f the markets had public toilets or canteens in Onssa and Tamil Nadu. With the exception o f Maharashtra, less than 40 percent offered value-enhancing services, such as drying, grading, and fumigation. Stalls or shops inwholesale markets operate with limited equipment. About 90 percent o f the stalls had electricity inMaharashtra and Tamil Nadu, but only 63 percent inOrissa and 42 percent in UttarPradesh. Surprisingly, not all stalls had mechanical scales: 96 percent had them in Onssa, 90 percent inUttar Pradesh and Maharashtra, and 74 percent in Tamil Nadu (figure 4.5). Less than 10 percent o f the shops hadpaclung or fumigation equipment. Except for Maharashtra (76 percent), less than one-third o f shop owners inother states owned transport vehicles. Inadequate market infrastructure can have a significant impact on farmers. A recent study (Shilpi and Umali-Deininger 2007) examined the impact o f accessibility o f wholesale markets and availability o f market infrastructure within markets in Tamil Nadu. The study found that the likelihood o f farmers selling at the market increased significantly with an improvement in market facilities and a decrease in travel time to the market. Wealthy farmers are able to capture a disproportionate share o f the benefits o f market facilities in congested markets, but as noted earlier, investments to improve market facilities would benefit the poor, because sales by poorer farmers would increase proportionally more than sales by wealthy farmers. Regulated wholesale markets generate substantial revenues from market and other related fees, but only a limited amount appears to be reinvested in the marketing network. Among the markets inthe survey that were willing or able to report earnings, the average revenue per year i s Rs 9.1 million (Annex table 4.1)." Market earnings depend on the size o f the market, type o f commodities traded, and volume o f sales, and they vary significantly by state and across markets within the state. Uttar Pradesh markets have the highest average annual earnings, at Rs 21.9 million, 18Uttar Pradesh and Uttaranchal formerly were a single state. Only 70 percent o fthe wholesale markets surveyed were willing to supply revenue information, suggesting limited transparency inoperations. Orissa and Uttar Pradesh hadthe highest response rate. Reluctance to provide revenue information was greater inthe unregulated markets. Only 2 o f the 20 unregulated markets in the survey providedinformation. 34 but annual earnings withinthe state ranged from Rs 3.3 million to Rs 68.5 million. The amount kept bythe respectivemarketcommittees differedby state, from 30 percent inUttar Pradeshto 77 percent in Orissa. Of the total market revenues, however, only a small share is spent on operations and maintenance, equipment, facilities, and infrastructure. On average, Market Committees in Orissa, UttarPradesh, andMaharashtra spend Erom 19to 44 percent oftotal expenditures on operations and maintenance, 1 to 8 percent on equipment, and 6 to 19 percent on facilities. Notably, these are the areas that farmers would like improved (chapter 3) (for example, almost half o f the farmers in the survey cite the need to improve market facilities). The auction system i s not practiced in all markets. To promote greater transparency in the Figure4.4: Marketing servicesprovidedin wholesale markets Figure 4.5: Facilities and equipmentin market stalls Fulice Station Fust Office Electricity Comrcial Banks Motorized vehicle I PailStation Bus Station Non-mtorized transport 1~ UP Hostelfor Farmers UMH Rtbltc Toilets Canteen OR Telephone k Mechanizedcrop handling a m Fumgattonequipment Generator Dying machine Gradingservice Processing equipment Grading equipment Mechanicalscales Largeweighing machine 0 20 40 60 80 100 0 20 40 60 80 100 Percentof Wholesale Markets Percent of ShopslStalls in Market Source IndiaAgncultural MarketingSurvey2005, authors' Source: IndiaAgricultural Marketing Survey 2005; authors' calculations calculations, sales process and ensure a fair price to farmers, state governments mandated the adoption o f open auctions in the regulated markets. The marketing survey finds that the majority o f markets in Maharashtra (90 percent) and Uttar Pradesh (83 percent) follow the auction systemintheir wholesale markets, but only 45 percent have implementedit inTamil Nadu. InOllssa, only 1o f the 20 markets visited uses the auction system (Annex table 4.2). As expected, auctions are more common in regulated markets: 61 percent of regulated markets report using the auction system compared to 40 percent o f unregulated markets. In most cases, commission agents or employees o f the market authority conduct the auctions. Open outcry i s the most common method o f auctioning. Electronic biddingwas not available inany ofthe markets. Information givenprior to the auctioncanprovide important inputsto sellers' and buyers' decisions on the sale price. The survey finds that limitedinformation i s given about the quality of produce sold, such as the gradelsize, percentage o f broken grains, and moisture content (Annex table 4.3). This finding i s consistent with other reports that quality measures are not yet widely adopted in the marketing system. Only two-thirds o f commission agentdtraders report providing the quantity o f the lot for sale, less than half report the variety, and only about one-third report the grade. Informal Barriers to Trader Entry in Wholesale Markets The management o f shops in wholesale markets varies by state. Among the wholesale markets surveyed, 70-100 percent o f the markets in Tamil Nadu, Orissa, and Uttar Pradesh rented out shops or stalls to traders, while in Maharashtra shops were sold and rented out in about half o f the markets (table 4.2). If sold, the shops were auctioned, with the price influenced by the type o f product sold. The type o f product sold becomes a factor because many markets designate certain 35 locations for trading particular crops only. If a trader seeks to rent a shop inamarket, 93 percent ofthe traders report the need to apply to the market authority. But personal connections and family relationships also play an important role. Market officials contacted for the survey list several requirements for obtaining a shop or stall in the wholesale market. A number o f legal requirements, such as applying for a trading license, proof o f identity andresidence, sales tax registration, and security deposit, tend to be more strictly enforced in Uttar Pradesh and Maharashtra, perhaps because o f the higher prevalence o f regulated markets inthese states. Other factors taken into account for gaining a Note: TN=TamilNadu; OR=Onissa; MH=Maharashtra; and UP =Uttarhadesh. Source: IndiaAgricultural Marketing Survey 2005; authors' calculations. place inthe market include experience as a trader, creditworthiness, and presentation o f guarantees. The focus group interviews and field visits suggest that some o f these conditions serve as informal barriers to entry. In regulated markets in Maharashtra and Tamil Nadu, potential traders must present references from other traders currently operating in the market (five references inthe case o f one market in Maharashtra) to obtain a license to trade or set up a shop there. This requirement i s consistent with the finding that personal connections and family relationships are important for being able to rent a shop. Inaddition, many wholesale markets have reached their full capacity, and the physical infrastructure itself limits entry. The slow pace o f market development thusimposesa critical barrier to entry. LimitedInvolvementofMarketCommitteesinMarketDisputes 4.1 The presence o f different types o f market-related associations and systems for dispute resolution provides some information on the level o f development o f market institutions. One o f the expected advantages o f regulated markets i s their dispute resolution mechanisms (Acharya 2004). The marketing survey finds that trade associations are present in 80-89 percent o f markets in Maharashtra and Uttar Pradesh, but in only half o f the surveyed markets in Tamil Nadu and Orissa. Market workers' associations are found in all markets, with the highest percentage (56 percent) in Uttar Pradesh. Market disputes are generally handled informally. Market officials indicate that on average about two-thirds o f disputes are resolvedby buyers and sellers themselves (Annex table 4.4). Market committees take on a bigger role in dispute resolution only in Maharashtra. Traders' associations have very limited involvement in dispute resolution. Market officials were asked about the main causes o f market disputes. Inall four states surveyed, about half o f the market officials identify price as main cause (Annex figure 4.4). Problems with product quality are cited by 60-80 percent o f market officials inOrissa and Uttar Pradesh. Payment delays are a larger problem inMaharashtra (50 percent). 36 CropLosses intheWholesale Markets The perishability o f high-value agricultural products adds to the complexity o f handling and marketingthem. Based on information on traders' Figure 4.6: Estimatedproducelosses in wholesalemarkets last transaction at the wholesale market, it i s estimated that about 3 percent o f the value o f the two vegetable crops inthe survey-tomatoes and potatoes-is lost from spoilage at the trader's level. Spoilage losses in mangoes are higher, at $ 10 u) an average o f 10 percent o f the value o f sales : : a (figure 4.6). The average spoilage losses for the -I n 6 hardier products surveyed-maize and 0 e 4 turmeric-are the lowest, at 1.6 and 0.2 percent, 2 respectively. Actual crop losses are likely to be 0 higher, as traders tend to account only for losses TN OR MH UP All from physical wastage and do not factor in price potato tomato mango turmeric B. TradinginWholesaleMarkets Traders in wholesale markets perform a variety o f roles. They function as commission agents, wholesalers, retailers, or a combination o f these roles. Commission agents conduct auctions; organize the grading, sorting, weighing, bagging, storing, and transport o f produce for the buyer; collect marketing fees; and in some instances provide credit to farmers. They perform a facilitating role. They are supposed to act on behalf o f the farmer to obtain the best price and do not take ownership o f the produce. Wholesalers and retailers, on the other hand, take ownership o f the 37 produce. The survey found that on average, traders are male and in their 40s. The lack o f female traders i s notable. The majority o f traders have formal education; the level varies across states. The delineation o f functions between being a commission agent and wholesalerhetailer has blurred. About 65 percent o f traders in Maharashtra finction as both wholesalers and commission agents, and about 20-30 percent o f traders in the other states perform these dual roles (Annex table 4.6). While it could not be verified that they were acting in both capacities in handling the same transaction, the duality o froles can put farmers at some disadvantage inthe transaction. A significant proportion (20-40 percent) o f traders has close relatives who are commission agents or wholesalers. This connection can also work to the disadvantage o f farmers. Inone o f the focus group discussions undertaken as part o f the survey, farmers complained that commission agents lower the sale price when selling to their relatives. Traders pay attention to the variety and quality o f produce they procure. Based on information about their last purchase transaction, over 80 percent o f traders in all states reported paying attention to the variety and quality o f the produce. Traders put a price premium on good quality produce. Like the farmers, the traders were asked about the difference inprice between high- quality and average produce. The price premium i s estimated by the difference between the two. The quality features considered included size, shape, color, smell, taste, and moisture content. Based on traders' responses, the quality premiums between average and high-quality produce amounted to 54 percent for mangoes, 48 percent for tomatoes, 29 percent for potatoes, 37 percent for turmeric, and 28 percent for maize. As noted in the previous chapter, it appears, however, that the quality premiums are not fully passed on to farmers. Traders' Main Sourceof WorkingCapital Traders mainly use their own personal funds as a source o f working capital (table 4.3). Among those who borrow, a large proportiondepend on informal sources, such as moneylenders and fhends or relatives. InTamil Nadu, the proportion o f traders relying on moneylenders (3 1percent) i s three times those relying on banks (11percent). A greater proportion o f traders inMaharashtra have formal links to the- banking sector, about 87 percent have bank accounts, Table 4.3: Traders' creditsources and about 32 percent have an overdraft facility or had obtained a bank loan inthe past year. Duringthe focus group interviews, traders in Tamil Nadu noted that the numerous documentation requirements were a I Traderismemberofsaving I I I I I I major factor discouraging them fiom associationkhitfund 5.6 8.5 8.5 1.5 6.1 Trader has bank account 31 39 87 46 51 obtaining a bank loan. They reported Inaddition to bank account, preferringto use the bank's overdraft 1 traderhasoverdraft facility I 24.0 I 9.0I 32.4 I 10.8 I 21.8I facility, although the amount o f funds Source: India Agricultural Marketing Survey 2005; authors' calculations. Note; TN = Tamil Nadu; OR = Orissa; MH = Maharashtra; and UP = Uttar may be more limited. Pradesh. The majority o f sales and purchases involve payment on delivery. Based on sales or purchases over the past year, traders report that 60-65 percent o f these transactions occurred on a cash basis (Annex figure 4.5). Inone-third o f the cases, they obtained trade credit from the buyer. Advance payment i s very limited. Traders' Main Sources of Information Traders mainly rely on regular suppliers and buyers for price information. Price information i s critical for an efficient marketing system as it enables market participants to capitalize on arbitrage opportunities-that is, to move produce to markets where prices are higher. Traders in the survey 38 obtained price and market information from several sources. A large percentage o f traders reported collecting information themselves; few traders employed other people to collect information (Annex figure 4.6). The other most frequent sources o f information are other traders (33 percent) and regular suppliers or buyers (18 percent). It i s only in Maharashtra that traders have developed a reliance on the mass media, such as newspaper and electronic screens or boards displaying prices. Marketing Costs andMargins The large number o f intermediaries in the supply chain can raise the costs o f the final product for consumers. Inthe case o f h i t s and vegetables, the supply chain i s not integrated, and in some cases 6-8 intermediaries exist between the farmer and the consumer (Confederation o f India Industries and McKinsey and Company 2004). Figure 4.7 illustrates the impact o f a large number o f intermediaries on the marketing costs for fruits and vegetables in India. Costs are about 1.7 times those inthe USA. 'igure4.7: Estimatedmarketingcosts in fruit andvegetable supply chains, India and the USA NDlA i n I Farmer Farmer Agent Trader Agent Wholesaler Retailer TOTAL Consolidation Maket making Packing Marketmaking Breaking II ktivity transport Bulk Retailing USA Coop Wholesaler Retailer TOTAL Grading, Storage, Sorting, sorting, mkt transport, packing, \ctivity making quality control retailing ource:McKinseyand Company 1997. Note: Cost buildup for h i t s and vegetables. The gross margins for more perishable commodities tend to be higher. To assess the profitability o f trading activities, gross margins are estimated for the last sales transaction o f the trader and for the past year. The gross margin i s defined as the difference between the total sales and purchase value o f a commodity. The study could not conduct more disaggregated analyses o f operational expenses because traders were hesitant to provide detailed cost information. Median values are reported to address the effect of large outliers. The survey finds that on an annual basis, the median gross margins as a percentage o f total sales averaged 4 percent for maize, 7.8 percent for turmeric, 8.8 percent for potatoes, 10.3 percent for tomatoes, and 12.2 percent for mangoes (table 4.4). The higher percentage return for mangoes and tomatoes may reflect the higher risk premia due to their greater delicacy and perishability. 4.2 Analysis o f the survey data indicates that a 10percent increase inthe density o f traders in the wholesale market reduces the gross marketing margin (GMM) by 0.6 percent (Annex table 4.7). The impact o f trader density on reducing marketing margins has important implications for the conditions imposed for entry into the trading business inthe wholesale markets. As discussed earlier, being able 39 to buy or rent a stall or shop in a market is conditioned not only on legal requirements but on the physical limitations imposed by the market's size and by informal factors such as personal or family connections. C.Investment ClimateinWholesale Trading Traders in the survey identified access to credit and infrastructure and governance issues as the most critical constraints to the growth o f their business. Access to credit and cost o f financing are the most fi-equently citied constraints (figure 4.8). In addition to the collateral requirement, the significant documentation required and the large number o f government offices that traders must contact to procure that documentation, pose major hurdles to obtaining a bank loan. Poor road conditions and roadblocks (with the associated side payments) are the second most cited constraints. They delay transport and increase transport costs. Unavailability of electricity, lack of storage, corruption, and theft inmarkets are the third group o f frequently cited constraints. Figure4.8: Constraintsin the investmentclimatefor agriculturaltrading in Orissa, Uttar Pradesh,Maharashtra, and Tamil Nadu u z 40 F I? * 30 20 U O C Q) 2 10 0 Source:India Agricultural Marketing Survey 2005; authors' calculations. Note: Figures represent constraints rated by trader as moderate,major, andvery severe. The severity o f constraints varies by state. InOrissa, access to shops, access to finance, and the cost o f finance are the most important constraints identified by more than half o f the traders (Annex figure 4.7). The second most important set o f constraints i s related to governance (corruption and theft) and problems with rural infrastructure (roads, telecommunications, electricity); they are 40 noted by about one-fourth o f traders. In Uttar Pradesh, infrastructural problems (road conditions, electricity) and governance (roadblocks, corruption) rank highest. They are listed as major problems by about 60 percent of traders. These are followed by difficulties in accessing finance (47 percent) and the cost o f finance (47 percent). In Maharashtra, problems with electricity were the most important, mentionedby about 60 percent o f traders. This constraint i s followed by the high cost o f finance and poor access to shops/storage, noted by half o f the traders. Inrelative terms, Tamil Nadu appears to have a better investment climate compared to the other states surveyed; the severity of the constraints from the traders' perspective i s lower. About one-third o f traders surveyed inTamil Nadu report that poor infrastructure (road conditions, roadblocks) and poor access to finance i s the most important constraints. D.FoodRetailing With an estimated 15 million retail outlets in the country, the retail sector contributes about 10 percent o f GDP and employs 6-7 percent o f the labor force in India (Bajpai and Dasgupta 2004). Food retailing comprises a large segment o f the retail sector, accounting for about 63 percent o f total retail sales. The food retail sector consists o f two segments, the unorganizedtraditional and organized sectors. The unorganized retail sector comprises traditional low-cost formats, such as the local kirana shops, owner-operated general stores, convenience stores, hand cart vendors, and pavement vendors. They are generally family businesses utilizing household labor. The organized sector consists o f licensed food retailers operating in a number o f formats, from the traditional government cooperative and private retail outlets and chains to the newer hypermarkets, large and mini-supermarkets, grocery and convenience stores, discount stores, and specialty chains (Singh 2004; Chengappa et al. 2005b; Mukherjee and Patel 2005). In2001/02, the organized sector's food retail sales were estimated at Rs 18 billion. Rapid growth o f the food retail sector has been projected over the next couple o f years. One projection shows a quadrupling o f total food retail sales to about Rs 75 billionby 2007 (figure 4.9). Figure 4.9: Sales in the organized food retail sector, India, in the domestic food retail sector. ksing 2 80 350 incomes, increased urbanization, a growing 70 300 middle class demanding more diverse and c 60 250 higher-quality food products, more worlung - 50 200 women seelung the convenience o f shopping E., 2 40 150 for necessities under one roof, and increased 30 - 100 exposure to products through wider media `0 50 penetration (television, cable, Internet) are 10 fueling growth (Singh 2004; Chengappa 2005; .-2e 5 o 0 Mukherjee and Patel 2005). Indian families' a- 2001/02 2007 0FoodChainStores increased ownership o f durable goods such as Single Large Food Stores and others cars and refrigerators also facilitates the shift &Total Organized Retail 41 4.5). Despite the recent rapid expansion o f locally owned Table 4.5: Supermarkets' share infood hypermarkets, supermarkets, super centers, warehouse retail, selected countries clubs, and discount stores, there are no national chains. Percentage share of supermarkets in food Most retail companies tend to operate more regionally. Countr retail Notably, the modem food retail stores expanded more USA, UK, or France rapidly in the southern states and cities (Chennai, First wave: Bangalore, and Hyderabad). Their early start i s attributed Brazil to lower real estate prices, a large base o f high-income and Taiwan brand-conscious consumers, conducive to laws and Czech Re ublic Costa Rica About 50 regulations, and good infrastructure. In South India, 20 Chile About 50 percent o f households in cities such as Chennai and South Korea Bangalore purchase 40 percent o f their groceries through Phili ines About 50 these outlets (Singh 2004). In recent years, these modem Thailand About 50 South Africa retail formats have expanded to northem India cities such Second wave: as Mumbai, Delhi, Kolkata, Pune, Lucknow, Jaipur, and Mexico Ahmedabad (Mukherjee and Patel 2005) (table 4.6). Columbia Guatemala 4.3 Some lurana stores are upgrading themselves to Indonesia Bulgaria 25 become "super" kiranas or stand-alone supermarkets. This Third wave: trend i s apparent in Bangalore and Chennai, where China 13 organized food retailing i s gaining ground. The super luranas offer a wider range o f products than the typical grocery store. Corporate manufacturers such as Hindustan Lever Ltd., ITC, Godrej, Bharti,, Reliance, and D C M Sriram Consolidated are also setting up hypermarkets, supermarkets, and retail outlets in rural areas, recognizing their huge untapped potential. Gas-station stores are another growing retail outlet. Petroleum companies like Hindustan Petroleum Corporation Ltd., Indian Oil, and Bharat Petroleum have introduced branded outlets like Speedmart (around 60-65 in number), ConveniO's (around lSO), (around loo), which sell food items (Singh 2004). and In&Out Stores A recent survey o f retailers found that organized players value the importance o f setting up efficient supply chains, but many lack the financial resources to do so (Mukherjee and Patel 2005). These retailers mainly operate on a hub-and-spoke model" to cut down on transportation. To achieve economies o f scale and avoid multiple taxation and extra commissions from procuring from the regulated markets, some large retail players buy fresh produce directly from farmers. For example, FoodWorld has contract farming arrangements with large-scale farmers and farmer cooperatives and associations in Kamataka." For vegetables, it has established fruit and vegetable collection centers where farmers who are registered vendors can bring their produce. Food World sets strict quality standards and farmers are paid at wholesale market rates (Chengappa et al. 2005b). The more rapid growth o f the retail sector, especially the organized sector, i s constrained by a number o f policy, regulatory, and institutional factors. The main constraints cited by organized retailers include: (1) the APM Act, which hinders the development o f supply chains; (2) restrictions on shop opening times and days o f operation (shops can open only six days a week); (3) difficulties in acquiring land owing to restrictive zoning regulations, land ceiling and rent control laws, high stamp duties, and the high cost o f real estate; (4) multiple taxation and the complexity o f taxes, 2oFirms establish one hub, at a pivotal locationnear their stores, from which they assemble products from different suppliers. These hubs then supply the needs o f each store (Mukherjee and Patel 2005). 21Food World follows seasonal contracts with guaranteed purchase at predetermined prices (Chengappa et al. 2005b). 42 which hinder interstate trade and development o f interstate supply chains;22 (5) inadequate infrastructure-including poor approach roads and parlung and public transport facilities (which hinder customers' access), the poor quality o f electricity (which hampers efficient operations), and inadequate sewage and sanitation services; (6) multiple licenses and permits to start retail operation^;^^ and (7) the lack o f capital to develop supply chains. Unorganized retailers have some advantages over organized retailers in that they often do not pay taxes, and their establishment costs are low. For example, the operating cost of small-scale retailers i s estimated at 3-4 percent o f sales, compared to supermarkets at 13-15 percent o f sales (Mukherjee and Patel 2005). Nadu, Kamataka Source: Singh 2004; Mukherjee and Patel 2005. a Metro Cash & Carry has government permissionfor wholesale operations only. An issue that i s the subject o f considerable debate is whether FDIinretailing, including food retailing, should be allowed. The majority o f the organized retailers surveyed by Mukherjee and Patel (2005) favored the opening o f FDI through joint ventures, because such ventures could ease 22These include excise duty; octroi duty inmost cities; professional tax (which results indouble taxation of retailers who also pay the trade tax and business tax); refuse, water, and garbage tax; resale tax; trade, license, establishment, and business tax (Mukherjee and Patel 2005). 23According to a CII-KSA (2003) study, on average 15 licenses from 11government agencies (central, state, and local) are required to open a retail store, which takes up to six months and costs between Rs 5,000 and Rs 500,000, depending onthe kind and size o f store. 43 their capital constraints in developing supply chains. The organized players recognize that an efficient supply chain i s critical to successful operation. They can also benefit from the technical know-how and best management practices o f multinational retailers. Other proponents point to the benefits to consumers through lower prices, to the extent that organized retailers can take advantage o f economies o f scale and lower transactions costs with the development o f supply chains. Supply chain development can contribute to expanding markets for farmers' produce, especially higher- value products, reduce the high losses (estimated by McKinsey at Rs 500 billion per year), and generate additional employment along the supply chain. Industry experts in food processing believe that the growth o f the food processing sector hinges on the growth o f the retailing sector. The entry o f FDIwill expand the organized retail sector and therefore encourage growth o f the food processing industry, which is also critical for reducing losses in the marketing system (Mukherjee and Patel 2005). Proponents note that the threat to unorganized retailers will not be as severe, because the majority o f Indian consumers will still prefer to buy their fresh produce (such as fruits and vegetables) from local vendors on a daily basis rather than storing it for a week, while reaping other benefits such as greater personal attention, purchases on credit, and home delivery. 4.4 Opponents to FDI in retailing contend that the rapid growth o f the organized sector will bring a large potential displacement o fretailers inthe unorganized sector. Guruswamy et al. (2005) note that retailing i s the "primary form o f disguised unemployment and underemployment in India." Therefore, expansion o f the organized sector will result in significant net loss o f jobs. Trade associations oppose FDIbecause the development o f supply chains by organized retailers will make many trading activities redundant as the marketing chain gets simplified. Manufacturers (local and domestic) o f fast-moving consumer goods oppose FDIbecause it may reduce their leverage in the market. Indian manufacturers have built massive distribution networks that give them a stronger position in the market than retailers. With the growth o f organized retailing and vertical integration o f distribution, retailers will begin to play a larger role in designing and branding new (possibly in- house) products to meet consumers' preferences. Manufacturers will therefore have to gear their production to the specific demands o f retailers. Others note that procurement practices by organized retailers are biased towards large-scale farmers and therefore will bypass the vast majority o f small- scale farmers in India (Mukherjee and Patel 2005). The rapidly growing Indian economy and changing structure o f consumer demand are major forces driving the development o f modem organized retailing, however, and the ban on FDIinretailing has not been sufficient to stem the tide o f local entrepreneurs entering the sector. 4.5 International experience offer useful lessons for minimizing the adverse impact o f growth and expansion in organized retailing. As supermarkets became a dominant force inretailing inmany developed and developing countries, their emergence profoundly altered the organization o f the food retail trade. Incountries where they have acquired a sizeable share o f the retail market, supermarkets have fostered extensive changes in the structure o f production and wholesale marketing o f produce. Procurement by individual stores has been superseded by centralized procurement strategies, a network o f distribution centers, and "preferred supplier systems" (BerdeguC et al. 2003; Reardonand Timmer 2005a, 2005b). Perhaps more significant for producers, as supermarkets developed and the standardization and reputation o f their brands became important, they shifted from relying on traditional wholesale markets and brokers in spot markets to relying on long-term relationships with wholesalers and producers specialized in a specific product category and dedicated to the supermarket as their main client (Reardon and Timmer 2005a). Supermarkets have also tended to develop long-term relationships with specialized and dedicated food processors. These long-term contracts with suppliers are termed "vertical restrictions," and in many ways they imitate outcomes from a vertical merger even if they do not constitute full vertical integration. The contracts serve as incentives for suppliers to dedicate themselves to their supermarket clients by undertaking client- specific investments inlearningand equipment. 44 A major concern in India is the potential impact o f supermarkets on farmers, especially small-scale farmers. Supermarkets demand a wide variety and large volumes o f products, and the high transaction costs o f dealing with numerous suppliers frequently encourage supermarkets to source supplies from larger players wherever possible (Reardon and BerdeguC 2002; Reardon and Timmer 2005b). When a given product cannot be obtained from medium- or large-scale farmers alone (because there are no large-scale farmers, for example) or supplies are inadequate (there are not enough large-scale farmers to supply the product, for example), supermarkets contract small- scale farmers. For this reason, globally there i s a mixed picture with regard to small-scale farmers' involvement in supermarket supply chains. Insome countries in South America (Argentina, Brazil, Chile) and parts o f Eastem Europe (Russia, Slovakia, the Czech Republic), supermarkets do not contract with smaller-scale farmers, whereas supermarkets in other parts o f Eastern Europe (Croatia, Poland), East Asia (China, Indonesia, Thailand), Central America (Ecuador, Guatemala, Nicaragua), and A h c a (Kenya) contract with smaller-scale producers (BerdeguC et al. 2003; Boselie, Henson, and Weatherspoon 2003; Dries, Reardon, and Swinnen2004; Reardon and T i m e r 2005b). Supermarkets adopt a variety o f methods in procuring products from small-scale farmers. Some have direct contracts with small-scale farmers, as in China, Croatia, Kenya, Thailand, and Zimbabwe (Boselie, Henson, and Weatherspoon 2003; Dnes, Reardon, and Swinnen 2004; Huet al. 2004). Some act as wholesalers or enter into contracts with wholesalers, who subsequently purchase from or contract with small-scale farmers or producer organizations. This strategy i s found in the Philippines, South Ahca, Thailand, Indonesia, China, and Mexico (Boselie, Henson, and Weatherspoon 2003; Hu et al. 2004; Chowdhury, Gulati, and Gumbria-Said 2005; Chengappa et al. 2005b; Natawidjaya 2005). Other supermarkets ask large- and small-scale farmers to deliver produce to collection centers, where it i s graded, washed, packaged, labeled, and priced, as in Thailand, Vietnam, Costa Rica, Guatemala, Nicaragua, Kenya, and Zimbabwe (Boselie, Henson, and Weatherspoon 2003; BerdeguC et al. 2003; Chen, Shepherd, and da Silva 2005). Inthe Philippines, the U S Agency for International Development (USAID) supports a pilot project inwhich purchases are organized through large-scale farmers, who subcontract small-scale farmers (Chen, Shepherd, and da Silva 2005). Many supermarkets tend to use a combination o f these approaches. Producer organizations reduce the cost o f transacting with small-scale farmers, but studies also show that they are not sufficient to ensure contracting. Investments inphysical capital, management practices, and institutions that ensure collective compliance with supermarket standards are needed for farmers to maintain contracts with supermarkets in Chile (BerdeguC 2001) and in Central America (Jan0 et al. 2004). Notably, studies in various countries suggest that land size or land tenure often i s not the most important determinant o f farmers' participationinmodem supply chains. Assets other than land appear to play a much bigger role, particularly education; access to irrigation, transport, and roads; and other physical assets, such as wells, cold chains, greenhouses, good-quality irrigation water (because o f contaminants), vehicles, and paclung sheds. A very good farmer organization-another major asset-can help small-scale farmers sell directly to supermarkets (Reardon and Timmer 2005b; Reardon and BerdeguC 2006). Insome cases, supermarkets may provide critical inputs (seed, fertilizer, credit, technical assistance). For many small-scale farmers, these contracts are the only source o f such inputs, as seen inCentral and Eastern Europe, Central America, Thailand, and China). E.DomesticGradesand Standards Grades and standards are crucial both to pricing and operational efficiency inthe agncultural marketing system. Grading i s the sorting o f agricultural produces into uniform categories according to quality standards.By enabling the sale o fproducts by sample or description, it reduces the buyers' and sellers' search and transaction costs and fosters more efficient price discovery processes. Grading can help reduce spoilage by separating products o f poorer quality from those o f high 45 quality. High-quality products can command price premiums over lower-quality products ifthey are differentiated by grades (Kohl and Uhl 1990). 4.44 Standards and technical regulations stipulate what can or cannot be exchanged and define the procedures that must be followed for exchange to take place. By facilitating the flow o f information, standards reduce uncertainty and convey consumers' expectations and their quality and food safety requirements to producers. Without market standards, the rule o f "caveat emptor" ("let the buyer beware") prevails, along with confusion and unfairness. Standards can serve as an indirect mechanism for transferring technology to and within developing countries. They are crucial in allowing firms in developing countries to integrate into global agro-food supply chains by ensuring the compatibility and traceability o f products and/or raw materials from geographically dispersed places. Harmonized standards between countries and/or industries can reduce transaction costs by reducing duplicative conformity assessment functions, including inspection, testing, and certification. The Directorate o f Marketing and Inspection under the Department o f Apculture and Cooperation i s responsible for enforcing and implementing the Apcultural Produce (Grading and Marlung) Act. Its mandate includes promoting standardization and grading o f agricultural products. Grades and standards have been prescribed for 164 commodities at the producer level and for export. As o f January 2005, the list of commodities with AGMARK standards included 25 h i t s and vegetables. The AGMARK grades are primarily voluntary grades covering such characteristics as size, variety, weight, color, and moisture level. For certain items they also cover the acceptable levels o f organic and inorganic foreign matter (pulses) and chemical properties (such as specific gravity for essential oils). Different grades and standards are laid out under AGMARK for domestically consumed products versus exports. Inthe case o fmangoes, for example, the AGMARK grade specifies that for export "mangoes shall comply with the residue levels o f heavy metals, pesticides, and other food safety parameters as laid down by the Codex Alimentarius Commission." The Directorate provides third-party certification under the AGMARK quality certification scheme. The AGMARK seal i s supposed to ensure quality and safety. Any consumer, trader, or manufacturer can test products at one o f the 23 regional AGMARK laboratories for designated commodities. Typically, testing i s only carried out for commodities prone to adulteration, such as oils, ghee, whole and ground spices, honey, and whole and milled food grains. AGMARK certificationi s compulsory for blended edible vegetable oils and fat spreads. AGMARK standards, however, are not effectively enforced inthe domestic market. A recent survey in the Delhi region measured the presence o f heavy metals in a range o f vegetables sold in wholesale markets (Marshall et al. 2003). High levels o f heavy metals were found in many o f the samples: among several hundred samples o f palak (spinach beet) tested, 72 percent had lead concentrations exceeding the Indian permissible limit o f 2.5 milligrams per kilogram (mag), while 100 percent o f the samples exceeded the more stringent CODEX limit o f 0.3 m a g .Approximately half o f the lead concentration in palak was found in plant tissue, implying that diligent washing would not eliminate the risk to consumers. While 100 percent o f the samples had concentrations o f cadmium within the limits specified by India's Prevention o f Food Adulteration (PFA) Act (1.5 mgikg), 70 percent o f the samples exceeded the more stringent European Union (EU) standard (0.2 mgkg). For zinc, 21 percent o f samples exceeded both Indian and international standards. The current weak enforcement o f food safety standards poses serious public health concerns. 46 V. Value-Addition and Export ofHigh-ValueAgriculturalProducts Agro-industry i s an important segment o f the manufacturingsector inIndia. It includes firms involved in processing raw materials from the crop, livestock, forestry, and fisheries subsectors and intermediate products from other industries, such as hides and skins for manufacturing leather products and edible oils for manufacturinghydrogenated oils. In2000/0 1, agro-industrial enterprises accounted for 82 percent o f total unitsand 73 percent o f employment inthe manufacturing sector in India. They account for approximately 35 percent o f total manufacturingGDP or 5.5 percent o f total GDP (Chadha and Gulati 2007). Within agro-based industries, the food processing sector accounts for about 40 percent o f employment, number o funits, andvalue-added. Given India's growing domestic and export market opportunities, its diverse agro-climatic conditions, and its large, wide-ranging raw material base, the GO1 sees considerable untapped potential for growth inthe food processing sector. India processes only about 2 percent o f its primary agricultural production into value-added products. The government views the development o f the food processing sector as critical to increasing net returns to farmers, transforming more perishable products into more storable and appealing food products, reducing the significant postharvest losses in the marketing system, and opening new avenues for exports. A number of constraints must be overcome to attain more rapid growth in the food processing sector. Among the most critical constraints reported by agro-processors and exporters are the high cost o f credit, problems in accessing credit, problems inelectricity supply, and governance issues. India's agricultural exports climbed steadily during the 1990s and early 2000s, with nontraditional exports ( h i t s and vegetables, spices, meat, and marine products) mainly driving growth. Between 1990/91 and 2005/06, agncultural exports grew at an annual average rate o f 7.8 percent in real terms, reaching about US$6.4 billion in 2005/06. Despite its potential advantage o f low-cost production, India's weak capacity to meet stringent SPS requirements in importing countries i s hampering more rapid expansion o f agricultural exports. The main challenges to sustaining and expanding exports include: (1) absolute barriers or bindingconstraints for accessing particular markets; (2) temporary losses due to rejected (and sometimes destroyed) consignments o f fresh or processed products; (3) higher consignment-specific or recurrent transaction costs; and (4) patterns o f "defensive commercialization," whereby firms fail to pursue opportunities for remunerative trade with certain countries or types o f buyers because o f concerns about their inability to ensure compliance with regulatory or private standards inthose markets. A. Recent Performance of the Agro-Food Processing Sector Food Processing India i s one o f the top 10 producers o f many agricultural commodities but processes only a fraction o f its production. India i s the largest producer o f milk in the world (91 million tons), the second-largest producer o f fruits and vegetables (150 million tons), the third-largest producer o f foodgrains (210 million tons), and the seventh-largest producer o f fish (Ministry o f Food Processing Industries 2005~).However, most o f this production i s still consumed in fresh form. Recent estimates show processing levels o f only 2 percent for h i t and vegetables, 6 percent for poultry, 21 percent for meat, and 10 percent for marine products. The dairy sector has the highest level, at 37 percent (Govindan 2005a) (figure 5.1). These levels are low compared to overall averages o f 30 percent in Thailand, 70 percent in Brazil, 78 percent in the Philippines, and 80 percent in Malaysia (Mukherjee and Pate12005). The GO1views the food processing sector as a vital contributor to agricultural growth and the development o frural areas. The sector directly employed 13 millionpeople in2004/05, and it is 47 estimated to promote 2.4 times that number in Figure5.1: Foodprocessinglevelsin India indirect employment (Ministry o f Food Processing Industries 2005~). Agricultural production has increased over time, but seasonal production surpluses often create localized market price crashes and increase postharvest losses. For example, postharvest losses in the food chain are estimated to amount to about Rs 500 billion per year nationally (Mukherjee and Pate1 2005). Expanded food processing i s expected to increase net returns to farmers, transform more perishable products into more storable and appealing ones, 1 0 5 10 15 20 25 reduce the significant postharvest losses in the ProcessedlTotal Production,% marketing system, and open new avenues for i exports (Dev 2004; Ministry of Food Processing Source Rabobankanalysis, as cited inGovindan2005a Industries 2005~). Although the majority o f Indians still prefer to consume fresh produce and fieshly cooked food, a number o f factors are driving the recent expansion o f the food processing sector. As in the retailing sector, rising income levels, increased urbanization, a growing middle class demanding more diversified and higher-quality food products, an increasing number o f workmg women, and exposure to a wide variety o f processed products through the media and overseas travel are dnving growth o f the food processing sector (Dev 2004; Pingali and Khwaja 2004; Gomndan 2005a; IBEF 2006). All o f these trends help to increase demand for processed, ready-to-cook, and ready-to-eat products. In2004/05, the foodprocessingsector contnbutedabout 14percentofrnanufactunng GDP, producing about Rs 2.8 trillion worth o f products. The unorganized sector accounts for more than 70 percent o f the industry's output in volume and 50 percent in value terms. Prior to 1991, the government largely reserved the food processing sector for small-scale units. This policy restricted the entry o f large-scale domestic firms and FDI in the sector. Since 1991 the government increasingly removed regulatory restrictions, and over the last five years it introduced a number o f investment incentives (chapter 2). This policy shift increased the participation o f domestic and foreign multinational firms in the sector (Govindan 2005a). Between 1991 and 2006, foreign direct investment in the food processing sector totaled US$ 1.2 billion (Ministry o f Finance 2007). The MoFPI estimates that the food processing industrygrew by 7.1 percent per year over the last decade, albeit from a low base. It projects an average annual growth rate o f about 7.3 percent over the next five years (Ministryo fFoodProcessingIndustries 2005a). The fruit and vegetable processing sector inIndia is currently a Rs 36 billion (about US$800 million) industry (Govindan 2005a). Production i s split between the organized and unorganized sector, with the organized sector accounting for about 48 percent o f the industry's output. Product composition differs significantly across sectors, partly due to the fact that processing o f some items such as pickles/chutneys is reserved for the small-scale sector.24Pickles, mainly produced in the unorganized sector, are the single most important item, accounting for 30 percent o f the total processed output. Juices, pulp/concentrates, and potato chips make up about 70 percent o f the value o f production in the organized sector. The industry currently has an installed capacity o f around 2.3 million tons (IBEF 2006). This capacity doubled over the last 10years, although utilization i s around 24F i mthat donot meetthe requirements for small-scale industry status can still process reserveditems such as pickles and chutneys ifthey export at least 50 percent ofproduction. 48 46 percent. Currently, about 45 percent o f the production o f processed fruits and vegetables i s exported. The remainder primarily caters to the defense and institutional sectors. B.MarketingOperationsofAgro-Processors andExporters The processors and exporters interviewed for the survey were generally well educated, owned considerable assets, and had sales ranging from Rs 76,000 to Rs 2 million. A total o f 327 mango, turmeric, maize, potato, and tomato processors and exporters were interviewed (Annex table 5.1). They produced a wide variety o f products, ranging from mango juice and pulp to potato chips, turmeric powder, and maize starch.25 Median annual sales for those in the national list were Rs 2 million, compared to Rs 76,000 for those inthe state list (table 5.1). Enterprise owners in the national list are well educated (75 percent had at least an undergraduate Source:Fafchamps, Vargas-Hill and Minten 2006. degree) and employed more workers. The enterprises generally own the land, building, and basic equipment (scales, processing equipment, telephone) used. Notably, most firms do not own vehicles for transport. With the exception o f those involved in processing or exporting potatoes, a large share o f ago-processors and exporters interviewed (around 40 percent) report directly purchasing raw materials from farmers. In view o f the APMAct, this was a surprisingresult. For some crops such as mangoes, 90 percent o f exporters report sourcing products directly from farmers (table 5.1). Most o f these mango exporters also report that farmers deliver the product to their place o f business. While fairly large numberso f processors report buying directly from Source: India Agricultural Marketing Survey; authors' calculations. farmers, only a small fraction (8 percent) do so on a contractual basis. 25 The survey, however, encountered ahighnonresponserate among the sample drawnfromthe national list. Additional firms were drawn from a state list. Nonresponse bias thus likely affects the results. See Annex A for details. 49 The survey and focus group discussions highlighted processors' and exporters' limited dependence on banks, especially for working capital. About 40 percent o f the domestic processors have bank accounts, and o f those with accounts, 75 percent have an overdraft facility, mainly for meeting working capital needs (table 5.2). Only 22 percent indicated they hadborrowed from a bank during the previous years. Almost all exporters have bank accounts, although only about one-third have an overdraft facility. A slightly larger share, 36 percent, had borrowed from banks duringthe last year. Surprisingly, some processors and exporters still borrow from moneylenders, fhends, and relatives. Agro-processors and exporters in the survey cited the high cost o f credit, poor access to credit, poor electricity supply, and governance issues as the most critical constraints to expanding their business. High interest rates and collateral and documentation requirements are the most frequently citied constraints (figure 5.2). The second set o f constraints includes poor electricity supply (availability and quality), which disrupts processing activities. Roadblocks and associated payments, corruption, crime, theft, and unfair practices form the third group o f problems, which increase operating costs. Difficulties in obtaining land, uncertainty over economic policy, and high rates o f taxation are cited as constraints by more than one-quarter o f the respondents. Figure 5.2: Main constraintsto agricultural processorsand exporters Source: India Agricultural Marketing Survey 2005; authors' calculations. Note: Figures representconstraints rated by entrepreneursas moderate, major, and severe. The ranking o f constraints and their severity vary significantly by state. The cost o f finance (59 percent) and difficulties in accessing finance (48 percent) and land (34 percent) are the three most critical constraints cited by entrepreneurs in Orissa (Annex table 5.1). In Uttar Pradesh and Maharashtra, poor electricity supply and roadblocks are the two most cited problems (over 50 percent o f entrepreneurs). These are followed by corruption (45 percent) and crimehheft (39 percent) in Uttar Pradesh and by macro-instability (46 percent) and high rate o f taxation (45 percent) in Maharashtra. By contrast, entrepreneurs inTamil Nadu appear to face the most favorable investment climate for processors and exporters. With the exception o f unfair practices (cited by 38 percent of entrepreneurs), less than 15 percent o f entrepreneurs cited other factors as constraints. C.RecentAgriculturalExport Performance The increased globalization and liberalization o f international markets, facilitated by both bilateral trade agreements and the WTO, are opening new export markets for Indian agricultural products, both fresh and processed. Rapid technological advances in real time communication (cellular phones, Internet) and transport (by air and sea), within India and internationally, and the progressive removal o f government export restrictions have further strengthened these international 50 linkages. Indian agncultural exportsz6 Figure 5.3: Trends in agricultural exports, 1987/99- not only grew rapidly, but they have 8000 ___-_ also diversified from traditional exports o f tea, spices, and coffee to exports o f horticultural, fisheries, and livestock products. In the last 15 years, the m 5000 highest export growth rates per year in .-C real terms were recorded by meat and 4000 * meat products (13.8 percent), h i t and 3000 vegetable exports (12.9 percent), and 5ui 4 2000 cashews and spices (11.2 percent), although starting from a low base. 1000 Marine exports grew at 6.9 percent per 0 year. By 2005/06, marine exports amounted to US$ 1.9 billion (current prices), cashew and spice exports totaled US$ 1.4billion, and fruit and vegetable exports reached US$ 770 million (figure 5.3). By the early 2000s, the main destination o f Indian agncultural exports was high-income countries, particularly but not exclusively those within the Organisation for Economic Co-operation and Development (OECD). High-income countries account for about 58 percent o f total agncultural export value (table 5.3). Major markets for processedfruits and processed vegetables are the EU and USA. Exports o f fresh fruits and fresh and dned vegetables are concentrated in countries within the South Asian Association for Regional Cooperation (SAARC). Other 15% 6% 52% 24% 3% 3,891 Total exports (agriculture and allied products) 898 383 4,014 1,506 154 6,955 Share of total exports 13% 6% 58% 22% 2% 100% Despite being one of the major horticulture producers inthe world, India i s a small player in the global horticulture export trade. India's share o f global exports is only 0.3 percent for fresh and processed fruits, 1 percent for fresh and processed vegetables, 0.2 percent for fresh cut flowers, and 2.6 percent for dried flowers and fresh and dried plants. Among fruits and vegetables, the fastest- growing segments are processed vegetables and processed fruits, which grew at an average rate o f 10 percent and 11percent per annum, respectively, inreal terms. Major exports o f processed fruits and vegetables include mango pulp, which accounted for almost 50 percent o f the value o f processed fruit exports in2004. Other processed fruit exports include pickles and chutneys from vanous fruit, 26These include tea, coffee, rice, spices, cashews and cashew products, oil meals, fruits, vegetables, and marine products. 51 including mangoes. Seventy-five percent o f India's export earnings from fruit and vegetable exports are from IO co~ntries.~' As Indian agricultural exports increase and diversify indestination and composition, a major challenge i s meeting the SPS standards in export markets. As per the SPS Agreement o f the WTO, each country i s allowed to set its own standards and technical regulations as long as these are based on scientific principles and are both transparent and nondiscriminatory. Members o f WTO are encouraged although not required to adopt the internationally recognized standards, guidelines, and proposals o f the Codex Alimentarius (for food safety), the InternationalPlant Protection Convention (for plant health), and the World Organization for Animal Health (OIE) (for animal health). SPS measures are traditionally established and enforced by government authorities. This pattern still prevails with regards to plant and animal health measures, but with regards to food safety, often more stringent private sector standards are being introduced. Private standards or supplier protocols have grown inprominence over the past decade or so as a means o f further ensuring compliance with official regulations, filling perceived gaps in such regulations, andor facilitating the differentiation o f company or industryproducts from those o f competitors. Increasingly, private standards tend to blend food safety and quality management concerns (for example, I S 0 22000) or to have protocols that combine food safety, environmental, and social (child labor, labor conditions, animal welfare) parameters. As an example, of the latter, major European retailers have adopted the Euro-Retailer Produce Workmg Group for Good Agricultural Practices (EurepGAP) fruit and vegetable protocol (Willems, Roth, and van Roekel2005). D. SPS StandardsandIndianHorticulturalExports2* Challenges posed by SPS standards have manifested themselves in different ways for Indian horticulture. They include: Absolute barriers or binding constraintsfor accessing particular markets. The most prominent case involves fresh mangoes and the plant health concerns o f authorities in the U S A and Australia (and untilrecentlyJapan). Temporary losses due to rejected (and sometimes destroyed) consignments of fresh or processed product. The most high-profile incident occurred in 2003, when 28 containers o f grapes consigned to the Netherlands were rejected owing to violative pesticide residues. Less visible yet more common instances include the rejection o f numerous small consignments o f processed horticultural products by the U S A because o f improper labelling, poor packaging, illegal additives, and other problems. Other markets have experienced a few other episodes in which fresh produce was rejected. Higher consignment-specific or recurrent transaction costs due to duplicativetesting, highlevels o f entry-point inspection, or the further treatment o f goods upon arrival in the overseas market. These costs have affected the profitability o f India's cut-flower exports to Japan and the Netherlands and addedto the costs o f exporters o f other products. Patterns of "defensive commercialization," whereby firms fail to pursue opportunities for remunerative trade with certain countries or types o f buyers because o f concerns about their inability to ensure compliance with regulatory or private standards inthose markets. This pattern i s common in Indian horticulture, although additional factors have also weighed on these commercial strategies. 21These includeBangladesh,USA, UnitedArab Emirates(UAE), GreatBritain, Germany, SaudiArabia, Sri Lanka, the Netherlands, andFrance. 28See WorldBank (2007). 52 Table 5.4 summarizes various ways that SPS measures and challenges have affected Indian horticultural exports and presents some emerging SPS challenges. The defensive commercialization impact i s perhaps least noticed but most pronounced in Indian horticulture. The other issues are being dealt with in response to specific events or through bilateral negotiations. There are large differentials in the unit values o f Indian exports to different markets and distribution channels (table 5.5). For many products, a majority o f sales are directed at lower-value markets. This trend partially reflects comparative advantage-for example, India's location permits access to South Asian and Persian Gulf markets at relatively l o w freight costs, and the resident and immigrant populations in these markets prefer h i t and vegetable varieties commonly grown in India. For some o f these markets, transactions are readily managed by Indian suppliers, and commercial behavior strongly resembles the patterns found in the Indian domestic market. 1 challenges of SPS n asures for Indian hoi icultural exports Bindingconstraint Temporary losses High compliancecosts Defensive Emergingchallenges commercialization Agreement on SPS Grapeconsignment Pesticidemonitoring Processedfruit and Heavymetals infresh requirements for rejections inEurope programfor grapes vegetablesales by small andprocessed export of fresh and mediumenterprises vegetables mangoes to USA Borderrejections of Fumigationof cut and Australia many small flowers inJapan Grapeexport strategies Pesticidesin consignmentsof pomegranates processedfruits and Stalledupgrading of Onionexport strategies vegetab1es mangopulp operations Requirementsfor Avoidance of certaincut- traceabilityin Onionconsignment EurepGAPand flower markets processed fruits and rejectioninEurope smallholdervegetable vegetables growers Periodicpricediscounts Environmentaland byprivatebuyers socialrequirementsin cut flowers ~~~ Source: World Bank 2007. Table 5.5: Unitvalue variations between markets amlvine higher and lower SPS standards (average FOB unit values on Indian exports, 2002-03,- i&"USi/q I Source: World Bank 2007. Yet at least some o f these commercial patterns reflect either an inability or a lack o f confidence among processors and exporters to comply with the quality, food safety, and/or plant health requirements o f the higher-value markets. These patterns may also reflect an implicit calculation on their part that they would not be commercially compensated for the investments and recurrent costs necessary to attain higher quality and/or comply with food safety or plant health standards. Nothing i s wrong with serving less-demanding customers, especially if they provide consistent business and margins are adequate to sustain the supply chain. Insome o f these markets, India may face relatively less competition and thus command a large or even dominant market share. Being a cheap, reliable supplier may not be a sustainable commercial strategy in the long term, 53 however. Dynamic horticultural markets may see new entrants. Lax food safety and plant health standards may not prevail inthe future inthe targeted middle- and low-income markets. AddressingPesticideResidueProblemsinGrapeExports Problems related to pesticide residues and heavy metals in fresh and processed exports are a major challenge for Indian horticulture exports Grape exports furnish one prominent example. Grapes are a highly seasonal crop, and India has the advantage o f being able to capitalize on a critical window in the European market between March and April, when grape production ends in South Afnca and Chile, and before grapes from Egypt and Turkey enter the market. India i s one o f the few countries that can produce good-quality fresh grapes at this time o f the year. In2003/04 India exported about 27,000 tons o f grapes with an export value o f about US$ 25 milli~n.'~ Grape exports to Europe accounted for about US$ 15 million, indicating that any loss in market share in Europe will be very costly for India. Moreover, although grape exports account for only a small share (about 0.5 percent) o f total agricultural exports, it was an important milestone for India to penetrate the EUmarket. In May 2003, Indian grape exporters catering to the European market received a pivotal wake-up call concerning the costs o f failing to meet food safety standards. In the midst o f a commercial dispute with an Indian grape exporter, a Dutch importer had samples o f Indian grapes tested by a private laboratory. The tested samples contained residues o f the insecticide methomyl in excess o f the EU maximum residue limit (0.05 microgram per hlogram). Dutch authorities alerted about the findingtested samples from the 28 containers o f Indian grapes inRotterdamport and found that about 75 percent o f them exceeded the maximum residue limits (MRLs) for methomyl and/or acephate. This triggered the EU Rapid Alert system, resulting in significant short-term economic losses and affecting India's reputation as an exporter. The price o f Indian grapes dropped sharply. The Indian grape shippers incurred losses, either in Dutch sales or by diverting the shipments to other markets. This incident came as a shock to the industryand to the Indian government. 5.19 Inthe months following the endofthe 2002/03 grape export season, India's Agricultural and Processed Food Products Export Development Authority (APEDA) took the lead in addressing the pesticide problem. It consulted widely within the industryand with external experts and devised an integrated scheme o f grape supply chain oversight to restore the industry's reputation and minimize future noncompliance with EUstandards. Implementedin2003/04, the scheme included: Registration with the Department o f Agriculture o f all farms growing grapes destined for Europe. Some 6,200 growers registered for the 2003/04 season. Formation o f a cadre o f horticultural field inspectors who would visit each registered grape grower at least three times during the crop cycle. Some 244 inspectors were initially appointed and trained (there are now 291). Inspection and registration o f all grape export pachnghouses by APEDA. Approximately 100packinghouses were inspected, o fwhich 20 failed to meet certain basic requirements. Mandatory testing prior to harvest for pesticide residues in samples from each registered field o f export grapes. Authorization for exporting grapes was given only to fields that passed the test. Grapes from fields with failed results would need to be sold inother markets or retested. Chechng o f every consignment by AGMARK to ensure conformity with EU quality specifications for grapes. AGMARK would issue certificates. Issuance o f a phytosanitary certificate by the Plant Protection, Quarantine, and Storage Department for every consignment o f grapes for export. 29 In2004, Indiaproducedabout 1.2million tons of grapes. Grape production increased by 70 percent over the last decade. Maharashtra produces about 75 percent ofnational grape output. 54 0 In2005, another procedure was added, whereby the National Research Centre (NRC) for Grapes took a 5 percent sample from grape consignments exiting the packinghouse to retest for pesticide residues. 5.20 Ultimately the grape crisis gave rise to a stringent system o f checks and controls to ensure that h i t shipped to Europe met prevailing standards. This system required considerable resources. Laboratory testing capacity had to be enhanced quickly, so considerable supplementary resources were provided to public laboratories, and partial subsidies were gwen to upgrade private sector laboratories. A 25 percent government subsidy was also gwen to private and cooperative pachnghouses to upgrade their systems. Budgetary support facilitated the training and placement o f the grape field inspectors and the expanded work o f AGMARK. Ongoing support to NRC-Grapes was enhanced, both for overseeing the pesticide monitoringprogram and for conducting an expanded program o f researchon pest management. Recognizing this considerable burden, AF'EDA committed to subsidizing 50 percent o fthe costs o f the mandatory pesticide residue testing. The experience inresponding to the grape crisis generated several benefits. The new control system reducedthe failure rate among samples o f grapes intended for export to the EUfrom about 12 percent in 2003/04 to 6 percent in 2006 (World Bank 2007).30To date, no consignment o f Indian grapes has been officially rejected or put on the EU Rapid Alert System. Local laboratory testing contributed to some foreign exchange savings. Instead o f exporters paying EU laboratories the equivalent o f Rs 25,000 per sample for testing the grapes, the tests could be performed locally for Rs 7,000 per sample. Finally, the crisis also raised greater awareness among domestic consumers about food safety issues more generally and pesticide residues in food specifically, leading to increased vigilance by local consumer groups andNGOs. The grape crisis provided strong impetus for exporters and the industry at large to promote better agnculturalpractices and improved oversight and control over the entire supply chain. Several companies are working with their outgrowers to become certified under EurepGAP as groups or so- called Produce Marketing Organizations. An estimated 30 percent o f currently registered export grape growers (3,5004,000) are either EurepGAF' certified or will be so shortly. Increased attention i s being given to pest scouting and reducing the overall level o f chemical spraying. Questions have been raised about the accuracy o f preharvest intervals recommended on pesticide labels, and recommendations are being revised. Both private companies and cooperatives are closing export channels to growers who do not consistently follow good agricultural practices. Record-keeping i s being improved, as are overall systems o f tra~eability.~~The GO1 i s also developing a national program for good agncultural practices (IndiaGAP). The grape crisis directed greater attention to the cost o f compliance. The cost o f pesticide residue testing (to government and the private sector) for grapes i s estimated to be about 7.9 percent o f the FOB value o f India's grape trade to Europe (table 5.6). This cost i s quite high compared to costs internationally, where the recurrent compliance cost i s about 1-3 percent o f export revenues. In the Indian spice industry, the estimated cost for testing dry chilies for pesticide residues and aflatoxin i s 2.8 percent o f FOB value. Inthe Bangladeshi and Nicaraguan shmp industries, the total recurrent costs o f compliance with export food safety requirements are 1.1 percent and 1.3 percent o f export revenues. Some o f the compliance costs for grapes, such as laboratory testing and operational costs o f packinghouses, could decline if other commodities (such as other h i t and vegetable exports) are subject to similar standards and compliance testing. But at the same time, the highcosts also point to the need for greater collective action (such as the formation o f a grape exporters association) within 30 There i s still room for improvement, as the failure rate inSouth Africa i s less than 4 percent o f samples. 31 One fmis developing a sophisticateddatabase combining information on farmers' pesticide spraying, weather, and residue tests to provide more exact recommendationsto growers. 55 the grape industry. Collective action could foster the adoption o f sustainable "codes o f good practice" throughout the supply chain as a means o f reducing some high-cost activities, such as repeatedfield inspections and multiple mandatory tests. Table 5.6: Estimatedannual cost of meetingSPS standards inthe EUin 2005 Source: World Bank 2007. Note: Assumingexports of 15,000 t, the cost of SPS compliance is US$98/t. Assuming the average FOBprice i s US$lkg, the cost of SPS complianceis 10%.The cost of residuetestingalone, not including any capitalexpenditures,is US$45/t or 4.5% of FOBvalue. EmergingPlantHealthChallenges Plant health issues pose another barrier to the entry o f agricultural exports into some markets. An example i s mango exports to the USA, Japan, and Australia. Some 564 pests are considered to be associated with mango production inIndia (Australian Government 2004). Many o f these pests are not present in potential mango-importing countries, and some could survive long- distance transport and storage, thus posing a potential threat to fruit and other agncultural production in the importing countries. Some o f these pests are difficult or impossible to detect through visual inspection or cannot be contained simply by cleaning the fruit's surface. More elaborate phytosanitary measures are neededto manage the potential risks posedby these pests. As a result, Indian fresh mangoes have been barred from the Japanese and Australian markets for extended periods. Protracted negotiations between these trading partners and India have been tahng place to resolve the phytosanitary constraints. For these countries, the primary concern was the risks posed by various fruit fly species. India has been conducting a long-standing dialogue with the USA (lasting more than a decade) to agree on suitable phytosanitary measures for the entry o f India mangoes into the U S market. InMarch 2006, a Framework Equivalency Plan was outlined, which would enable Indian fresh mangoes to be exported to the U S market. The central part o f this agreement i s that the Indian mangoes would be irradiated, at a low dose, at specially approved facilities. The system o f compliance would also involve procedures for produce inspection (including preclearance), irradiation facility certificationand auditing, and other measures. India has also been having a long-standing dialogue with Japan on measures to resolve its plant health concerns.32The proposed solution i s to use vapor heat treatment (VHT) to manage the risk posed by fruit flies. APEDA imported the equipment for this technology and a testing and demonstration chamber was created at Vashi. InJune 2006, Japan formally lifted the ban on Indian mangoes, and the first trial shipments to Japan took place in July 2006. Several exporters have expressed interest in tapping this market and are willing to invest in their own VHT facilities. The 32 The Japanese have negotiated market access arrangements for fresh fruits with many countries, based on agreed methods o f phytosanitary treatment. For example, agreements were reached for using VHT on Australian, Philippine, and Thai mangoes, on Israelipapayas, and Taiwanese litchis. Methyl bromide treatment i s the agreed treatment for cherries from Canada, Colombia, New Zealand, and the USA. See Gupta and Khetarpal(2005) for elaboration on Japaneseplant health requirements. 56 Japanese mango market i s well supplied from Southeast Asia and elsewhere, but there could well be commercial opportunities for Indian exports. These should be examined hrther before investments inspecializedtreatment facilities aremade. With Australia, more elaborate measures have been defined and agreed upon to reinstate Indian mango exports to the country. Prior to 1996, Indian mangoes were regularly exported to Australia and treated with ethylene dibromide (EDB).This trade was suspended following the global phase-out o f EDB because o f concerns about worker health and safety. Recently, Australian authorities carried out a detailed pest risk assessment to determine the required remedies, which include: vapor heat or hot water treatment prior to export; establishment o f pest-free production areas; inspection and remedial action for other identified pests; and government support for operational systems to maintain and verify the phytosanitary status (for example, registration of orchards and packinghouses and government inspection prior to export). To follow up, the GO1has designated several locations as free o f the mango pulp weevil and mango nut weevil. The terms o f reference and institutional responsibilities for establishing and maintaining such pest-free areas have been outlined. One pilot scheme reportedly has begun in Maharashtra. Pursuing this approach will be an enormous challenge, given the extensive coordination required between federal and state agricultural agencies and research institutions, and the current weak internal quarantine control mechanisms to prevent the movement o f mangoes from one production site or state to another.33 To further capitalize on export opportunities, costs and returns inmeeting SPS requirements mustbe carefully assessedand balanced. All things considered, it is not obvious that the likely costs and administrative attention needed to fulfill all the requirements for accessing the Australian market would match the benefits o fparticipatinginthat market. Costs and benefits must be more thoroughly assessed before making major investments or public resource commitments. Achieving compliance at a potentially high cost would not make sense if the actual commercial potential o f this trade i s limited. However, instituting several o f the required supply chain oversight and product inspection measures would likely have spillovers for enhancing India's fresh mango trade in other countries. A detailed assessment could better inform government policies and resource allocations (box 5.1). Part o f that assessment should include a closer examination o f the actual market potential for Indian mangoes inthose countries that would especially value the improved Indianphytosanitary controls. Food Safety for Processed Products India's trade in a range o fprocessed fruit and vegetable products appears to have a stronger basis for international market access and competitiveness, relative to its trade in fresh horticultural produce. With processed products, Indian suppliers do not encounter the plant health issues inhibitingthe fresh produce trade. Indian exports also have somewhat less difficulty in managing risks related to pesticide residues and other contaminants, greater flexibility with regard to domestic and international logistics, and greater potential for product differentiation and company branding. The industryalready draws upon large numbers o f farmers for raw materials and employs significant numbers o fpeople relativeto the capital invested. Mango pulp exports illustrate the opportunities and challenges in processed food exports. India i s among the world's leading suppliers o f mango concentrate and puree. India's export trade in mango pulp features clusters o f firms inparts o f Tamil Nadu, Maharashtra, and Andhra Pradesh. In 2003/04 India exported close to 90,000 tons o f pulp, with an export value o f around US$ 55 million. India produces puree from a number o f mango varieties, including Alfonso, Kesar, and Totapuri. Worldwide, Alfonso puree i s recognized as a superior product and holds a significant premiumover 33India's Plant Protection, Quarantine, and Storage Department issued guidelines for establishing pest-free areas for h i t flies and mango nut (seed) and pulp weevils inM a y 2005. 57 similar products fiom major exporting countries. However, the bulk of India's exports are directed to very price-conscious juice and preparation manufacturers in the Middle East and Southeast Asia, with comparatively small quantities going to industrial consumers inhigher-priced European, North American, or NorthAsian markets. Box 5.1: Framework for an ex ante assessment o f costs and benefits of sanitary and phytosanitary compliance Cost-benefit analysis can and should be used to determine the advisability o f new or potential investments in standards compliance. Expected costs will need to be compared with expected benefits. This is easier to do at the enterprise level (in financial terms) than at the broader sectoral or even national level, given that certain costs and (especially) benefits are likely to spill over onto other stakeholders, including participants in domestic market supply chains. Nevertheless, such likely impacts can be noted and at least partly estimated. Such forward-looking cost-benefit analysis related to the adoption o f new standards is important to undertake. Although an inexact science, this exercise can normally shed ample light on the magnitude o f likely costs and benefits and thus effectively contribute to policy makingand public investment decisions. In the context of trade, compliance costs are defined as the additional costs necessarily incurred by the government andor private enterprises inmeeting the requirements to comply with a given standard in a given external market. This definition has two key elements. First, it covers the costs that are additional to those incurred by the government andor the private sector inthe absence o f the standard. Second, it refers to those costs that are necessarily incurredincomplying with the standard. A distinction needs to be made according to the level o f recurrence o f compliance costs. Nonrecurring costs are the one-off or time-limited investments made to achieve compliance. Recurring costs are borne over time (for example, the costs o f maintaining regular surveillance and laboratory testing programs). For an ex ante analysis, nonrecurring costs need to be amortized appropriately. In estimating the costs o f compliance, it i s necessary to consider costs incurred by both the public and private sectors. Examples o f typical costs that may be incurred include: Investment inpackinghouses or upgrading packinghouses. 0 Investment intesting infrastructure (laboratories). 0 Cost o fpesticide residue surveillance programs. Third-party certification costs. Costs o f training farmers, processors, and exporters ingood agricultural practices, good hygiene practices, and good management practices (GAP,GHP, and GMP). Costs o f measures required for phytosanitary treatments (such as fumigation, establishing pest-free areas, setting up hot water treatment facilities). Costs o f field trials to c o n f d m o d i f y preharvest intervals for pesticide use. Cost o f upgrading procurement systems. Cost o f hygiene controls in food processing, such as upgrading factories to meet hazard analysis and critical control point (HACCP) standards. Inaddition to the costs of compliance, the associatedbenefits must also be identified and quantified. Benefits could include maintaining market share, enhancing market access, or reducing costs through unimpeded access. As with compliance costs, the benefits associated with compliance can be recurring or nonrecurring. Potential tangible benefits relate most directly to the impact that better food safety control systems have on production costs, including reduced wastage andor reworking, enhanced productivity, and so forth. Further tangible benefits may include broader access to markets andor particular market segments. Although the focus here is on export-oriented supply chains, spillover benefits can also occur in the domestic market through reduced wastage and enhanced safety o f products. These benefits act to offset recurring compliance costs such that the longer-term impacts might result in lower supply costs. These benefits can be augmented if the government and fminnovate inthe face of new standards and thus minimize compliance costs. Source: World Bank 2005a. Mango pulp importers complain, however, that India suffers vis-A-vis its Latin American competitors because it cannot establish prices early in the season or maintain them at stable levels 58 throughout the season. Current reliance on spot purchases, compounded by mistrust and antagonism between growers and processors, and between processors and merchant exporters, makes it very difficult to set and sustain stable prices. This failure places Indian exporters at a disadvantage. Government and industry should work to develop new models o f cooperation among growers, processors, and exporters to comply with prevailing commercial requirements. Poor crop intelligence i s another factor cited as a major impediment to stable and predictable product pricing, which indicates that the system for generating and monitoring crop estimates also needs to be improved. 59 60 VI. FosteringanEfficient and CompetitiveAgricultural MarketingSystem: PolicyOptions Experiences in many developed and developing countries (for example, in the USA, OECD countries, China, Brazil, Indonesia, Thailand, and Malaysia) illustrate a natural evolution in the organization and management o f apcultural marketing systems. This evolution i s driven by changing socioeconomic conditions resulting from urban growth, rising consumer incomes, and concerns about quality and food safety, increased ago-processing, and improved infrastructure and services. While the traditional marketing structure-in which apcultural produce moves from farms to rural assembly/primary wholesale markets, to secondary wholesale markets, and on to retail markets-may persist, new marketing arrangements may arise, driven by the competitive need to reduce logistical costs, the need to meet rising consumer demand for more value-added products, and concerns about convenience, quality, and food safety. For example, some general wholesale markets may come to specialize in trading only a limited range o f products, or they may even deal exclusively in samples o f graded produce that are auctioned electronically to achieve greater efficiency. Other markets may expand to become terminal markets (serving major cities in the U S A and Japan, for example) or market complexes (such as the Thalad Market in Bangkok or the Unidades Alimentarias inSpain), which include facilities for grading, processing, and packaging. Some processors, exporters, and supermarket chains, seeking to reduce costs, maintain greater coordination throughout the value chain, and ensure traceability o f produce, may bypass the wholesale market system altogether and create direct links with producers. These links may take the form o f contract growing arrangements (as inChina, Brazil, and Eastern Europe), corporate farming, or vertical integration (FA0 1999; Hu et al. 2004; Reardon et al. 2005; World Bank 2005e). Inthe UJS, about 75 percent o f all traded fruits and vegetables bypass wholesale markets, although some o f the transactions are actually arranged by wholesalers based in wholesale markets. Produce i s often delivered directly from farmers or field-based collection centers or pack houses to supermarkets, which have developed their own merchandising/distributioncomplexes (FA0 1999). Similar forces for change are emerging inIndia. These forces are unleashedby sustained and rapid economic growth, which changes the structure o f domestic demand, and by opportunities created when export markets are opened for a diverse range o f agricultural products. Now, however, the agricultural sector in general and the apcultural marketing system in particular face the immense challenge o f catching up to meet the changing needs o f farmers, traders, and the broadening range o f consumers that apculture must cater to-not only Indian households, but also processors, institutional buyers, specialty and general retailers, supermarkets, restaurants, hotels, food chains, and exporters. As illustrated in the previous chapters, the agricultural marketing system in India remains uncoordinated and fragmented, characterizedby an inadequate and poorly equipped network o f markets in most states, with limited market support services. More efficient operations are further impeded by a number o f regulations, including the APM Act and the small-scale industry reservation. India's private sector has stepped forward, despite these impediments, to pioneer new marketing arrangements in some states to reduce transaction costs and improve food safety and hygiene. These new approaches include modem electronic wholesale market trading ( S A F A L in Bangalore, electronic spot exchanges in Mumbai) or close collaboration with farmers to set up farm inputsupply/output collection centers invarious states (e.g. ITC's e-choupal, Bharti rural hubs, Tata Kisan Sansar), supermarket retailing, and contract farming for various crops across the country. The successes among these private initiatives illustrate the gains in marketing efficiency that could be achieved and offer lessons for ensuring that benefits are shared broadly among farmers, traders, and consumers. 61 Inthe shorttomediumterm, fosteringthe development ofefficient andcompetitive marketing systems that can effectively respond to the dynamic changes occurring domestically and internationally would require action on a number o f fronts. Recognizing the important roles o f the public and private sector in the development o f the agncultural marketing system, a reorientation of the government's current strategy i s needed, focusing on: i.Continuingreform ofthe policy andregulatory environment to eliminate the remaining obstacles to more effective market operations and the development of more efficient supply chains. ii.Rationalizingtherolesandactivitiesofthelargenumberofgovernmentagenciesinvolvedin agricultural market development to foster greater coordination, build synergies, eliminate duplication o f effort, and increase their focus on facilitation and regulation rather than direct intervention. ... 111. Reviewing and rationalizing public expenditures in the sector. Public expenditures would focus more closely on financing public goods and services-such as markets, market information and extension, food safety, rural infrastructure, and local capacity building-that facilitate private sector participation. The very large number o f grant schemes to foster private sector investment would be reviewed and rationalized to eliminate duplication and maximize impact. Over the medium term, as the investment climate and inflow o f private investments improve, support would become more targeted, and "sunset" provisions would be formulated for some o f the investment grant schemes. Inreorientingthegovernment's agnculturalmarketingstrategy, itwouldbeimportanttoconsiderthe broad diversityo f agro-ecological, socioeconomic, institutional, and infrastructuralconditions across the states, along with the wide-ranging and changing needs of farmers, traders, processors, and consumers today. Thus the development strategy would need to be tailored to specific states or regions. Given the competing needs inthe economy, it will be essential to focus public expenditures on areas or marketing activities that, because o f their economic characteristics, the private sector i s less likely to finance or provide adequately. Table 6.1 classifies the major types o f marketing activities according to their economic characteristics and, based on these classifications, suggests the roles the public and private sector should play. Marketing activities generally exhibit private good characteristics. Under competitive market conditions, the private sector can supply agncultural products and marketing services at socially optimal levels (see Annex B for a discussion o f the economic classification o fdifferent types o f goods and services). Many activities, however, come with positive or negative externalities, or spillover effects, necessitating public involvement or intervention. Examples o f positive externalities are the information spillovers associated with market information and extension and the large social benefits from access to roads, water, and electricity, which justify government involvement to ensure that they are provided at adequate levels. Some activities have negative externalities (for example, the pollution associated with input use, agricultural processing, and transport), and government intervention(for example, regulation or the imposition o f a pollution tax) i s needed to internalize the negative externalities. Market support services are a mix o f toll and public goods, while market infrastructures are generally private goods with significant externalities. These services often will need to be provided through a combined public and private effort. Owing to their public good nature or externalities associated with some goods and services, market support services may be undersupplied by the private sector and require public financing. However, their execution can be subcontracted to the private sector (for example, market management). Lessons from other counties illustrate priority areas for the public sector in fostering the development o f agnbusiness and agricultural marketing systems (box 6.1). 62 Source: Author's assessment. a H= high; M= medium; L= low. b P =pollution; I= informationspillover; Ph=public health; S =public safety; G=groundwater depletion; N=network externalities. c Includes farmer organizations, cooperatives, and Nos. Some activities exhibit economies o f scale, such as storage, processing, and port and rail facilities. They require "lumpy" investments, and in the absence o f well-functioning financial markets, can serve as a barrier to entry. Modern processing, storage, transport, and trading facilities may face higher operating costs initially due to low capacity utilization. These large unit costs inthe initial years, together with uncertainty about the future, may inhibit private firms from investing in these activities. A. Creatingthe EnablingPolicyEnvironment Since the late 1990s, the government took many bold steps in deregulating agncultural marketing, reducing taxation o f the system, and directing substantial public resources to foster the development o f efficient and competitive agncultural marketing systems in the country. These interventions contributed to improving market performance and attracting greater private investment. At this juncture it is opportune to review and adjust the government's strategy for agricultural marketing development to address the emerging "second-generation'' challenges. There i s a need to rationalize the roles and activities o f the large number o f government agencies involved in agncultural marketing development to foster greater coordination, build synergies, and eliminate duplication o f effort. As noted in chapter 2, at least 39 GO1agencies are involved in promoting agricultural marketing development. Several GO1Departments and agencies offer grants to attract private investment in agncultural marketing, processing, and exports, many targeted at high-value horticulture. These programs encourage greater inflow o f private capital, but 63 weak overall coordination has engendered a multiplicity o f overlapping schemes subject to different terms and conditions. There i s an urgentneed to review and monitor progress inimplementing these schemes, assess their impact, and, where appropriate, rationalize them to minimize duplication. In some cases, it may be time to consider adopting sunset provisions. These actions will be critical to maximize the returns and impact from government development expenditures in the system. At the same time, public expenditures need to focus increasingly on financing public goods and services that facilitate private sector participation. Examples include markets, market information and extension, food safety, rural infrastructure, and local capacity-building. Box 6.1: Roleof governmentin agricultural marketingand agribusiness development Settingandensuringenforcement of transparent and consistent "rules of the game" 0 Establishand enforce rules that define and allocate property rights (that is, property andbankruptcy laws, intellectualproperty rights, zoning regulations). 0 Establish and enforce rules that define permissible and nonpermissible forms o f cooperation and competition (that is, licensing laws, laws o f contract and liability, company and cooperative laws; antitrust laws). 0 Establish and ensure compliance with biosafety, food safety, worker safety, and sanitation regulations. 0 Negotiate favorable t e r n for access to international markets, and ensure fair practices on the part o f international trading partners. Addressingmarket failures 0 Ensure that the country is protected from the h a d l introductiodspreado fplant pests and animal diseases. 0 Ensure the availability o f (production, price, industry) information and statistics to facilitate market activity and to monitor market progress. 0 Invest inor facilitate risk management instruments for agribusiness system participants (futures contracts, options, negotiable warehouse receipts, crop insurance). 0 Compensate for unbalancedpower relationships within the agribusiness systemby monitoring potential abuses o f market power, providing training and information, andor supporting organizational development among weak participants. 0 Compensate losers instructural reform processes through safety nets and other transitional, targeted programs. Buildphysicaland knowledgecapital 0 Facilitate development o f agricultural marketing facilities (that is, marketplaces, wholesale markets). 0 Invest ininfrastructure, especially infrastructure related to transport and energy. 0 Invest inknowledge-building to accelerate the agribusiness learning process and better enable the emergent private sector to participate/compete (that is, research and development, academic/technical training, agricultural extension). Source: World Bank 2003c. Continuedprogress in deregulating the agricultural marketing system will be crucial. During the Agnculture Summit 2005 in New Delhi, the Prime Minister of India, Dr. Manmohan Singh, emphasizedthat "an important commitment o f the Government i s to integrate the domestic market to all goods and services. The time has come for us to consider the entire country as common or single market for agncultural products. We have to systematically remove all controls and restrictions.. .." To achieve this goal, it will be necessary to take the next step and permanentlyremove storage and movement restrictions on all commodities, limit their enforcement to emergencies only, eliminate the small-scale industryreservationon the remaining agro-industrial activities, and allow phased entry o f FDIinfoodretailing (for example, throughjoint ventures with local companies). 64 Nationwide adoption o f the model APM Act will be critical for building an integrated national market, but institutional reforms within the regulated market complex will be necessary to accompany these regulatory reforms to improve the management and quality o f services provided by the regulated market network. Reforms could include subcontracting market management to the private sector or privatizing markets, while the Directorate o f Marketing or the Mandi Board concentrates on planning and regulation throughout the wholesale marketing network. An exclusive focus on planning and regulation will remove the conflict o f interest occurring when the Board functions as both market regulator and operator. The removal o f internal trade restrictions is essential ifIndia's commodity futures exchanges are to operate effectively and enable farmers to hedge their price risks inthe context o f more liberalizedmarkets. Storage, movement, and credit controls are not compatible with the operations o fthis riskmanagement instrument. Approval o f the Forward Contracts Bill in allowing the trading o f options will be critical for expanding the set o f risk management instruments available to the private sector. Rationalization o f the tax structure governing wholesaling, retailing, and ago-processing will improve incentives for private sector investment and participation. The adoption o f VAT by state governments has helped considerably inreducingthe impact o f cascading state taxes across the agricultural supply chain. But the central excise tax on processed food items remains high for a large number o f processed agncultural and food products. It increases the cost to consumers and reduces the competitiveness o f India's products overseas. Promotingagribusiness, ago-industry, and overall growth inthe rural nonfarm sector requires an increased focus on improving the rural investment climate. In addition to agncultural market deregulation, measures that will improve the investment climate include: 0 Implementing labor market reform by removing legislation that blocks layoffs in medium and large firms, easing constraints to hiring contract labor, and allowing more flexible working days inretailing. 0 Facilitating access to creditfor small and medium enterprises (SMEs) by introducing new technologies for SMEs, facilitating the establishment o f credit information bureaus for small borrowers, and promoting collateral substitutes. Investing in key infrastructure. Efficient transport services are critical to India's manufacturing competitiveness; investments are needed to improve roads and port infrastructure and promotemore efficient functioning o frailways (World Bank 2004b). B.ExpandingMarket Infrastructure and Services Improving Market Infrastructure There i s a great need to improve the marketing infrastructure network and the facilities in markets, but this expansion will need to be framed within a holistic infrastructure development strategy. The expectation that a large share o f agricultural produce will continue to flow along traditional marketing channels inthe medium to longer term highlights the need to fill the significant gap inmarket infrastructure. Informulating a market infrastructure development plan, two issues o f concern must be addressed. First, an assessment o f infrastructure needs will require a comprehensive assessment o f current and future marketing needs, nationally and at the state level, taking into account projections o f production and demand growth, expected volumes o f marketed throughput, and product quality standards. The assessment will necessarily involve careful consideration o f factors driving the development o f alternative marketing arrangements to meet diverse and rapidly changing local needs (that is, direct purchase, contract farming, and vertical integration trends). Market development, therefore, may call for a range o f options, from setting up village markets or 65 establishing district-level ap-marts, rural hubs, general or specialized wholesale markets, or terminal markets, to facilitating the development o f more direct marketing arrangements. Second, careful consideration i s required in determining who can take the lead in implementing various activities-the government or the private sector. Efforts to strengthen the marketing network and improve the management of existing markets are contingent on reform o f the APM Act. The GO1 therefore should encourage states to amend their APM Acts in line with the recently formulated model act. Two critical areas for action are to (1) enable other (non-public sector) agencies to develop and operate apcultural markets and (2) enable farmers to market their produce outside state-regulated markets. The second action will give farmers the freedom to choose the best option for marketing their output to obtain the best price. Enabling other entrants to develop and operate markets will complement government efforts to improve farmers' access to key market infrastructure and services. In view o f the government's programs to promote increased apcultural productivity and output o f various commodities, permittingprivate investments inwholesale markets will help ensure that the necessary facilities are available when these initiatives come to fruition. Having the correct infrastructure in place will enhance competition; reduce marketing losses from spoilage and spillage, transportation, and other marketing costs; and improve hygiene in the marketplace, thus strengthening the competitiveness o f Indian agricultural products. As the India Agricultural Marketing Survey found, limits to the number o f shops available in a market obstruct further entry by private traders, which could enhance competition. The private sector i s interested in investing in wholesale markets where permitted by the APM Act. In Tamil Nadu, for example, a turmeric traders' association with 156 members, recognizing the impediments to trade o f not having a wholesale market (for example, the lack o f transparency in pricing and the increased logistical costs o f assembling an appropriate volume o f produce) are taking it upon themselves to build andmanage a wholesale market. The Spices Board i s providing assistance amounting to Rs 1 million. To finance the remainder o f the development costs, the traders have formed groups o f five to obtain group loans from banks. Improving the operations and facilities o f existing regulated markets will require a closer review o f how the regulated market system i s managed, especially o f how market revenues are used. The regulated Market Committees and the state Mandi Boards collect a significant amount o f revenue from the marketing cess and other fees (license, shop rental, market entry fees). It will be critical to ensure that more o f these resources are investedback into the markets to improve market facilities, including very basic facilities that are often laclung, such as price information systems; adequate shops, parking, drainage, and improvedroads; security; public toilets; canteens; and hostels for farmers. Greater transparency i s needed regarding the actual revenues generated by the mandi system and the allocation o f expenditures. Annual audits o f accounts and their public disclosure should become mandatory. The GO1i s proposing a new national program for developing terminal markets to help fill the marketing infrastructure gap. A terminal market will have a hub-and-spoke format to link with collection centers in major production areas, and it will provide electronic auctioning o f goods, cold storage and warehouse facilities, grading and packaging facilities, transport (including cool chains), and banking services. The government's program i s designed as a public-private joint venture, with a minimumo f 51 percent private equity. The GO1will provide the balance through venture capital funds from the Small Farmers Agri-Business Consortium (SFAC). The private sector partner is expected to build the infrastructure and provide the services, establish the collection centers, organize farmer associations, and manage the market. The state government will facilitate land acquisition, provide basic support infrastructure (electricity, water, communications, etc), and provide regulatory clearances. 66 International experience shows the importance o f formulating a market infrastructure plan based on pluralistic marketing arrangements to meet diverse local needs, rather than committing exclusivelyto one business model. Indeciding the direction for market infrastructure development, it i s important to begin with a holistic, long-term plan for developing market infrastructure at the state level. Such a plan would encompass a variety o f possible approaches, which will provide the overarching framework for individual projects. This strategy will help to ensure that new initiatives build on and catalyze synergies with existing systems. Each new initiative will require a clear definition o f goals, careful assessments o f market requirements (for example, the current and future volume o f throughput) and physical infrastructure needs, and, most important, an assessment o f the initiative's economic viability. Thus the ex ante prescription o f a 1percent ceiling on marketing fees for the terminal market already may circumscribe the economic viability o f some potential investments. Insome states, the terminal marketmodelmay suit localneeds, butinstates withdiffering circumstances, other approaches may generate greater benefits. For example, business growth in Assam has been spurred by primary wholesale markets (Graham Dixie, World Bank personal communication). InUttar Pradesh, the development o f complementary rural assembly markets (haat painths) benefited farmers and contributed to development o f the rural economy. The Uttar Pradesh Diversified Apcultural Support Project supported the upgrading o f 114 haat painths and cattle markets.34These markets serve as points for direct consumer sales as well as assembly points for bulk purchases for transport to more distant wholesale markets or buyers. The constructiodmarket upgrading investments resulted in a 15-20 percent increase inthe number o f buyers and sellers and a 39 percent increase in daily traded volumes. Because o f improvements in basic facilities like toilets and drinkmg water, the participation o f women traders in the market increased by 18 percent (IIM 2003; World Bank 2004a). Table 6.2 provides a useful checklist to guide decision-making in developing new markets. Strengthening Standards for Food Safety While grades governing the quality o f agricultural produce function best if they are voluntary and they are set primarily to facilitate trade and are not a regulatory instrument, standards for food safety, on the other hand, should be mandatory. The adoption o f food safety standards addresses concerns over the potential acute health risks posed by pesticide residues, heavy metals, other forms o f environmental contamination, and especially microbiological contamination from such pathogens as E. coli and Salmonella. The public sector has a critical role to play in ensuring food safety, not only in terms o f policy making but also in the provision o f information and key infrastructure, prevention, control, and research. Table 6.3 lists some o f the main activities involved in promoting food safety, how this effort may evolve as the economy develops, and key areas of public intervention. Improving Access to Credit Inadequate access to credit and its high cost are cited by farmers, traders, processors, and exporters as an important constraint to expanding or improving production and marketing. Most farmers do not have access to formal institutional finance and rely on informal sources o f credit. Traders and entrepreneurs note the cumbersome procedures for and cost o f obtaining loans from banks for workmg capital and investment needs, which push them to depend on moneylenders, fnends, and relatives. 34 These markets had an estimated annual turnover o f 1,000 tons intrade commodities. After the markets were builtandupgraded, management was transferredto the village panchayat. 61 Table 6.2: Develop g ruraVwholesale markets: Key plai ng processes STAGE 1 STAGE 5 STAGE 8 IDENTIFYINGTHENEED FORRURAL CHOOSINGTHE RIGHT SITE CHECKING THE MARKET'S MARKETS 5.1 Review suitability of site locations VLABILITY 1.1 Establisha clear set of goals for the market 5.2 Review site features 8.1 Estimatedevelopment costs 1.2 Identify market channelsinrural areas 5.3 Determineifan environmental 8.2 Estimaterecurrentcosts 1.3 Defineresponsibilityfor decision-making assessmentis needed 8.3 Estimatebenefits for the market (government,private sector, 5.4 Prepare an impact statement 8.4 Test financial viability community) 5.5 Review site options and 8.5 Assess the proposals 1.4 Reviewplanningconsiderations availability 8.6 Amend the marketdesign to 1.5 Identify market improvementoptions (new ensure viability or existingmarkets) STAGE 6 PREPARINGTHE SITE PLAN STAGE 9 STAGE2 6.1 Gather designdata CONSTRUCTINGTHEMARKET ASSESSINGMARKET TRADING 6.2 Organizelanduses 9.1 Obtain consents and agree on REQUIREMENTS 6.3 Planvehicular access and the financing 2.1 Decideon design informationneeded circulation 9.2 Preparetender documents and 2.2 Assess supply and demand 6.4 Plan for supplementary uses tender the works 2.3 Estimatethe market's throughput 6.5 Finalizethe site plan 9.3 Completeconstruction and equipmentcontracts, supervise STAGE 3 STAGE 7 construction, and monitor WORKING WITH FARMERSAND DECIDING ON THEBUILDINGS implementation TRADERS AND EQUIPMENTNEEDED 9.4 Confirmpractical completion 3.1 Consultwith the users 7.1 Designbuildings and evaluate the work 3.2 Providesupport to the market committee 7.2 Designinfrastructure 3.3 Assess user needs 7.3 Identify environmental impact STAGE 10 mitigationmeasures OPERATINGAND MAINTAINING STAGE4 7.4 Decideon market equipment THE MARKET IDENTIFYING THE SPACEREQUIRED 10.1 Commission the market 1.1Estimatesales spacerequirements 10.2 Agree on space allocation and 1.3 Identify trading spaces leases 1.4 Decideon the market's facilities 10.3 Agree on the market fee 4.5 Determinethe area needed for the site. schedule 10.4 Agree on the marketregulations w c e : Tracey-White 2003. Rural banking in India typically i s associated with directed lending, interest rate caps on small loans, and debt waivers announced by governments from time to time as relief measures for indebted farmers. All o f these policies have led to credit rationing and are likely to have a counterproductive impact on credit flows to rural areas. Alun to the case o f private ago-processing enterprises surveyed in this study, rural banks are also subject to the "inspection and vigilance raj" (from the Central Vigilance Commission, CAG, and other agencies), which has meant that the appetite for risk taking and the desire to innovate are considerably reduced. Instead the emphasis i s on collateralized lending, standard products that may or may not fit agricultural needs, and "procedure"-based approaches to banlung, which are cumbersome and heavily document-based. All o f these limitations point to the need for rural banks to transition to easier and more efficient operatingprocedures. Policy actions that could improve access to rural credit encompass a number o f areas, including: parliamentary approval o f the legal framework for the use o f negotiable warehouse receipts, legal and regulatory reforms and restructuring o frural banks, 35 and promotion o f innovative products, such as group lending, lusan credit card, and financial and operational leasing.36 35See World Bank (2004~)for a more detailed discussion. 36Inafinancial lease, lease payments amortize the price o fthe asset. At the end ofthe lease period, the lessee can purchase the asset for a token price. The lessee i s responsible for maintenance and risk o f obsolescence o f 68 Type of public How activitiesevolve as a countrydevelops Key areas for public sector activity owi income 1 Middle income High income support Stakeholderinvolvement inpolicy making Legal and regulatory Disease or hazard surveillance framework Participationin Codex, OIE, InternationalPlant Infrastructureto support Policy decision- Proteciionconvention or major importer for niche markets riskconditions andpreferences interventions for Targeted Consumerand industry Labelingand certification to * Provision of education for better informconsumersabout information childhood illness reducing food handling and production processes, product and malnutrition preparation safety, and potential hazards Control of external Controlprograms for or single source single-source hazards Mandatedstandards Phasedimposition of Measuresfor Hygiene, training hazards Widespread application of regulation for formal food prevention and at key points in Phasedimposition HACCP sector control food chain of standards Monitoring of key Monitoring of food Provide generic HACCP hazards in food supply models for small-scale processorsand food supply vendors Water supply Sanitation and water Infrastructureand Sanitation Basic and applied researchon supply research Marketingfacilities many hazards Marketing infrastructure Applied research to reducekeyhazard Researchto develop hazard control Priority areas for improving the performance o f rural banks and credit cooperatives include: (1) enhancing the regulatory oversight and supervision based on internationally accepted prudential norms; (2) reducing government control and ownership (for regional rural banks, this effort requires amending the current law; for rural cooperatives, it requires state governments to adopt the model Cooperatives Law); (3) strengthening corporate governance and improving management and staff skills, particularly incredit decisions and risk assessment and management; and (4) strengthening the legal framework to make it easier for regional rural banks and credit cooperatives to recover small loans and to facilitate the use o f land as collateral (World Bank 2003b, 2004~). The government's program to legalize the use o f negotiable warehouse receipts can significantly improve access to worhng capital across the supply chain. Warehouse receipts are used widely in many countries, including Brazil, Japan, Poland, the USA, and Vietnam, as secure collateral to obtain financing for commodities (World Bank 2005g). As a negotiable instrument, a receipt can be traded, sold, swapped, or used as collateral by farmers and entrepreneurs for obtaining loans from formal institution^^^ (World Bank 2003~).In moving forward, the development o f an efficient warehousing system and indemnity fund or bonding will be critical. Reliable and efficient warehousing will be essential from the lender's perspective, because improper storage or inaccuracies inthe warehoused quantity/quality will reduce the security cover. An efficient licensing the asset, and the leasing contract usually cannot be canceled. An operating lease does not include the option to purchase the asset. Maintenance costs and risk o f obsolescence are borne by the lesser, and leases can be canceled. The lessor recoups the investment through multiple leases and final sale of the asset. Because of the option to purchase the asset, a financial lease i s a close substitute for a loan. 37 Annex C describes how negotiable warehouse receipts operate. 69 procedure that guarantees minimumstandards will need to be put inplace and could be managed by the government or subcontracted to the private sector. An indemnity fund or bonding will also be required in case a warehouse i s not able to deliver a commodity. Most often, the indemnity fund i s financed from a fee levied on customers (World Bank 2005g). Promoting innovative approaches can be instrumental to expanding access to credit. Contract farming in which the buyer provides inputs and technical advice can ease farmers' working capital needs. Facilitating the scal-up and sustainability o f low-cost microfinance models, such as a model that links a self-help group with a bank, could make finance more accessible, especially for small- scale farmers. Promoting new risk mitigation instruments (for example, weather-based insurance) and greater savings mobilization, perhaps through banks' use o f "agents or banlung correspondents" such as post offices and NGOs (recently enabled by a Reserve Bank o f India circular on banking correspondents), could increasing savings mobilization and help reduce farmers' vulnerability to risk,while reducingtransaction costs for banks. EnhancingRuralRoadConnectivity Public investments in rural roads, by increasing rural connectivity, can have a significant impact on farmers' access to markets, the development o f supply chains, and overall marketing efficiency, in addition to other beneficial impacts on rural households. A recent study o f rural road investments in Bangladesh found that they reduced poverty by 5-7 percent through lower transportation and input costs, higher wages, and higher agricultural production and output prices (Khandker et al. 2006).38 Specifically, transport expenses declined by 36-68 percent, agricultural wages rose by 27 percent, fertilizer costs fell by 5 percent, and output prices rose by 4 percent. Rural road improvements in Andhra Pradesh also illustrate cost savings and other benefits to the community (figure 6.1). The GO1recognizes the need to strengthen rural connectivity. Under the Bharat Nirman program, the Ministry o f Rural Development aims to build by 2009 about 146,187 lulometers o f rural roads to link 66,802 unconnected habitations o f over 1,000 people3' and ensure fullmarket connectivity byupgrading 194,132 lulometers ofexistingassociated routes. Figure6.1: Impact of rural roadimprovementon the rural economy inAndhra Pradesh, 1997 Average FreightCharges Impactof Improvementof Rural Roads (Opinion Survey of the Rural Population) Higher intensity Bringingoutside of cultivation teachers Bringingoutside 25% Moreseasonal opportunities Expansionof 24% cultivatedland 21% Source: Rural Transport Surveys 1997; Andhra PradeshEconomic RestructuringProject. Ensuringthe sustainability o f these investments requires drawing lessons from past experiences. Most government programs in the past suffered from the lack o f a carefully designed policy and institutional framework to ensure sustainability. Maintenance i s often neglected. Road assets 38They also contributed to increased girls' and boys' schooling. 39This includes 500 inhilly and tribal areas. 70 deteriorate prematurely, and a huge backlogo f maintenance accumulates. The quality o f construction and maintenance i s generally poor, resulting inoverall low service life o f the roads. Inimplementing the Bharat Nirman it will be important for MoRD to take the lead in implementing essential policy and institutional changes as well as in financing, technology transfer, human resources development, and monitoring o f rural road development in different states. Panchayat Raj bodies at the district, block, and village levels can play a pivotal role in the construction and management o f rural roads. Community participation offers significant potential for mobilizing the support o f local communities inresource generation, land acquisition, and tailoring the rural roadprograms to local needs (World Bank 2003~). C. StrengtheningFarmerLinkagesto theMarket Uncoordinatedand highly fragmented agricultural supply chains are hamperingthe ability o f farmers and enterprises to capitalize on more remunerative market opportunities. Agncultural products often have to go through several layers o f intermediaries before reaching the consumer, contributing to higher costs and losses across the marketing chain. Fostering well-coordinated supply chains can provide many advantages, such as the reduction in costs and losses intransportation and storage; access to technologies, capital, and technical and market information; traclung and tracing o f sources o f produce; and better control o f product safety and quality. Insome cases well-coordinated supply chains can also provide opportunities for risk-sharing across chain partners. Partners can optimize results when they collaborate to fine-tune their activities to minimize transaction costs along the supply chain from "farm to fork" (van Roekel, Willems, and Boselie 2002). Given that agncultural products are bulky, perishable, with varylng quality, and produced in dispersed areas, more coordinated supply chain management can be critical to reducing costs and losses and expanding markets. A number o f policy impediments, particularly the APM Act and various trade controls (transport, storage), have impeded the development o f more efficient supply chains inIndia. Thus progress in reforming these regulations is critical to capturing the benefits o f more efficient supply chains. While the major share o f agricultural production i s expected to flow through traditional marketing channels in the medium term, two supply chain arrangements that have been actively debated in India are contract farming and supermarket procurement arrangements. There is growing appreciation, especially among entrepreneurs engaged in agricultural trade and processing, o f the potential benefits o f more coordinated supply chain arrangements, but an important concern i s whether small-scale farmers can equally benefit from these arrangements. The following section draws lessons from international experience in implementing these arrangements and explores options for fostering greater inclusion o f small-scale farmers. Notably, many o f the lessons derived, such as the approaches to strengthen farmers' bargaining power or improve their technical capacity to meet consumers' product and quality requirements, are also relevant to farmers who market produce throughtraditional channels. LinkingSmall-scale Farmersthrough ContractFarming Contract farming, while expanding inmany states, still presents a number o f implementation challenges. As described in chapter 3, these include limited farmer bargaining power, poor enforcement o f contract terms and conditions, small-scale farmers' lack o f technical expertise, high incidence o f quality discounts and product rejections, and exposure o f farmers with contracts to risk. Table 6.4 summarizes some approaches to overcome these problem^.^' A number o f mechanisms can help improve farmers' bargainingpower. Farmersby virtue o f their relatively small operations and large numbers often have little bargaining power relative to 40This section draws extensively from Swinnen(2004) and Eatonand Shephard(2001). 71 contracting firms. Their bargaining position can be enhanced by fostering collective organizations (producer groups, associations, cooperatives, and the like); educating farmers about contracting operations; training farmers in contract negotiation; and enabling more rapid entry by greater numbers o f contracting firms to expand competition. Experience in markets where contract farming has been in existence for a number o f years shows that where farmers have been able to organize collectively to deal with contracts, they have managed the contracts well (Japan and the USA, for example) (Wilson 1986; Asano-Tamanoi 1988; Singh 2005). Farmers' leverage can be improved by programs that encourage the establishment of producer organizations and by strengthening existing organizations through training in leadership and management. It i s particularly crucial to educate the members and leaders o f such organizations about contract negotiation. In India there i s broad experience in organizing producer organizations, including many successful experiences. It i s important to draw lessons from them. rable 6.4: Public an private options for strengthenii ;farmers' linkagesto the n irket Issue PublicSItor Private sector Public investments Policy environment Limited farmer Improverural infrastructure Liberalizetradeto attract Educatefarmers abouttheir rights bargainingpower (roads, markets, electricity) to investmentsincontract and obligations as contractees foster competition farming Provide supportfor organizing Develop guidelinesto producerorganizationsor new encourage companies to institutionalarrangements(such invest as collectioncenters) Train farmers incontract negotiation Train firms incontractdesignand management Lack of technical Train extensionstafffor market- Provide extension support to expertise orientedagriculture farmers Supplykeyinputs Highincidenceof Supporttrainingfor farmersin Establishinstitutionsfor Educatefarmers abouttheir rights qualitydiscountsand appropriatecultivation and disputeresolution and obligations as contractees productrejections quality-enhancementpractices Enforceexplanationof Provide extension support to 0 Train firms incontractdesignand gradingdecisionsto farmers farmers management Enforceexplanationof Supply inputsto farmers Educatefarmers abouttheir rights rejections to farmers Monitor quality beforeharvest and obligations as contractees Poor enforcementof 0 Invest instatistical dataneeded Establishinstitutionsfor Developtrust :ontract terms and for yield forecasting disputeresolution Develop contractsthat are self- :onditions Educate farmers about their rights Develop institutionsthat enforcing and obligations as contractees allow for independent 0Develop interlinkedcredit and Train firms in contract designand verification of contract output arrangements management specifications Conductregularmonitoring visits 0 Establishknowledgebase of Strengthenproducer to farms contracts organizations Conductyield forecasting (by firms) Exposureof farmers Fosterthe developmentof Enablean insurancemarket Designcontractsthat sharerisk with contractsto risk commodity futures exchanges equally amongparties and Train firms inhow to usemarket provide some insurance instrumentsto hedgetheir risk ource: Swinnen 2004; i itonand Shephard 2001. Competition prevents contracting firms from exercising monopoly power over farmers with respect to contract terms. While imitation i s a powerful motivator o f competition, governments can encourage competition by removing constraints to firm entry, such as by improving rural infrastructure, which helps to reduce the transaction costs involved in undertaking contracting, and allowing contracting firms to increase the number o f farmers they contract with (Minten 2006). Developing collection centers in some countries has also been a cost-effective way for firms to contract with a large number o f small-scale farmers at once (as in Bulgaria, Poland, Romania, and Latin America). Investing in other aspects o f the rural infrastructure, such as electricity, has also beencitedas important (Baker and da Silva 2006). 72 Contract enforcement i s crucial to make contract farming sustainable. Ultimately, the best way o f solving contract enforcement problems i s to build trust. This may take time. Innovative contract specifications and self-enforcing contracts could mitigate the problem (Bogetof and Olsen 2002; World Bank 2005h). Creating the right conditions for successful self-enforcing contracts requires extensive knowledge o f the sector and local conditions (box 6.2). There can be a public sector role for capacity building incontract design and development o f a knowledge base that draws public lessons from the individual experiences o f firms incontract design. Monitoring and evaluation are essential to enforce contracts. For the contractor, the combination of yield forecasting and regular farm visits allows the firm to check for shirking or side-selling o f produce, as well as to monitor climatic conditions and the incidence o fpests and disease that mightreduce the quantity or quality o f the final product. Dependable statistical information on current and past production i s needed for appropriate yield forecasting (Minten 2006). Other interventions that can help ensure better enforcement o f contracts. Strengthening producer organizations may help enforce contracts on the farmers' side. Other options include: (1) educating farmers about their rights and obligations as parties to a contract; (2) investing in institutions that assist farmers with dispute settlements (it i s generally impossible or too costly to settle disputes in court, so alternative institutions, such as commodity or market associations, can play an important role in settling disputes); and (3) developing institutions that allow for independent verification o f contract specifications. Interventions that strengthen public sector quality testing and certification schemes can help in this regard, as can interventions that set up systems for accreditation and certification, promote better farm and postharvest practices, and encourage better record keeping and traceability systems. Capacity building for farmers and buyers helps improve contract success. Contract farming i s often a new venture for both the contracting firm and the contracted farmer. For farmers it often involves taking on new production and farm management practices. On the firm side it often involves monitoring contracts in an environment o f imperfect information and a high degree o f risk. There i s a need to build capacity on both sides to ensure that contracts are well implemented, monitored, and managed. Fostering the use o f risk management mechanisms can help farmers cope with risks associated with contract farming. Agricultural production i s always risky: farmers face both yield and price risk, which can lead to substantial income and welfare volatility. When farmers enter contracts in which they agree to deliver a specified quantity and quality o f produce at a given date, they increase their exposure to the risk o f defaulting on the contract if their yield i s worse than expected for some reason. They further increase their exposure to risk if they agree to undertake specific investments to fulfill the contract. Contracts can help farmers deal with these risks if they offer provisions for yield and/or price insurance to farmers as applicable. For example, contracting firms can offer farmers a fixed price and insure the price risk they take on by using commodity options, which are more easily available to them than to farmers. For this kmd o f risk management strategy to work, the Forward Contracts (Regulation) Amendment Bill must be approved. The Bill provides for the use o f commodity options, public support to develop commodity exchanges, and training for contracting firms inusingoptions to hedge their risk. LinkingSmall-scaleFarmersto OrganizedSupply Chains Recent experience in India suggests that in the medium term, supermarkets and their agents must largely source produce from small farmers, because the farm structure obliges them to do so. This experience is shared by several countries in East Asia and Latin America where small-scale farmers predominate. Given existing farm structures, Reardon and Timmer (2005b) note that land will therefore not be the most important determinant of participation. The individual capitalllabor ratios and access to public infrastructure will be more important drivers o fparticipation. It will be the 73 "asset-rich" small farmers, in financial and human capital terms, who will be able to participate in the new, demanding supply chains. These experiences highlightthe importance o f upgrading farmers' range o f assets to meet the new requirements of supermarkets or other coordinated supply arrangements. Such assistance could take the form of: (1) organizing farmers into formal or informal groups to meet volume requirements; (2) building capacity in production and postharvest techniques to meet the higher quality standards required; (3) helping farmers obtain the capital to make on-farm improvements and other required investments (irrigation, grading, and cooling facilities); and (4) assisting farmers in obtaining required national and international certifications (Boselie, Henson, and Weatherspoon 2003; Reardon and Timmer 2005b). Some supermarkets or their agents inChina (Xincheng, SanLu), Kenya (Homegrown), Croatia (Konzum), and Central America (Hortifi-uti) assist farmers to overcome these asset constraints by supplying inputs, providing technical training to farmers, or helping farmers to obtain bank loans (box 6.3). In some countries, public-private partnerships were instrumental to the success o f supply chain arrangements. Some examples include joint extension delivery by supermarket field staff and government extension officers (Hortico in Zimbabwe and Homegrown in Kenya), technical assistance to improve quality and safety o f produce and accreditation of farmers (Dutch assistance to farmers for Tops inThailand), and technical assistance to assess the supply potential o f small producers (USAID-supported partnerships between universities and Alice inKenya). Finally, the public sector will have an important role to play in the development of rural infrastructure and services such as rural roads, electricity, agricultural extension, and rural credit institutions. Box 6.2:Private contract enforcement and self-enforcing contracts Enforcing contracts through courts i s sometimes not viable owing to a combination of litigation costs, ineffective contract law, poor third-party verifiability, and the potential loss o f the only suitable trading partner for that commodity. This i s especially true intransition economies. Inthis situation, contracts may be enforced without legal institutions by including flexible conditions to anticipate market changes and by including sufficiently large private sanctions. Private sanctions include both the losses that result from termination or nonrenewal o f the business relationship and from reputation losses, including increased costs o f doing business inthe future. To understand how this approach can be effective, it is important to understand that typically, when there are no changes in factors that affect the contract conditions, there will be no contract breach-othenvise rational partners would not have agreed to the contract in the first place. If important changes occur in the market environment, however, it may become attractive for some partner to breach the contract. Consider the case when a farm and a processing company agree up front on a price to be paid by delivery o f a commodity. The contract price i s set at the expected market price, but the actual market price may deviate from the contract price. Ifthe market price is higher than the contracted price, the contract provides unanticipatedbenefits to the processing company but it provides unanticipated losses to the farmers, who could sell the product at a higher price on the market. The farmers will compare the costs o f staying with the contract (that is, the losses it incurs by obligating them to sell at a lower contract price than the market price) with the costs they would incur by breaching the contract. As long as the costs o f contract breach are larger, the farm will continue to supply. I f market prices increase sufficiently, it may become beneficial for the farm to breach the contract and sell its product to another company that pays the marketprice. Inversely, ifthe market price falls below the contracted price, the farm gets unexpected benefits from the contract, and the processing company has to pay more than it would pay to buy the commodity inthe market. Now the processing company considers whether it will honor the contract. Hence, as long as the market price varies within a certain range around the contracted price, the contract will be honored by bothparties. This range is called the "self-enforcing range" o f the contract. More generally, the self-enforcing range measures the extent to which market conditions can change without precipitating a hold- upby either party. As long as the relationshipremains within the self-enforcing range, inwhich the benefits of a hold-up are less than the costs for each transacting party, contract breach will not occur. Source: World Bank 2005h. 74 Box 6.3: Supermarkets:Sourcingproducefrom small-scale farmers Fruits and vegetables in India: FoodWorld operates 93 supermarkets inmajor cities inIndia. Each city follows a hub-and-spoke policy with centralized purchases. It buys one step away from farmers, usually from m i l l s for rice, cereals, and gram and from wholesale markets for other commodities. It also has direct contracts with farmers, farmer associations, and farmer cooperatives, usually annual seasonal contracts with guaranteed purchase at a previously agreed price. Food World negotiates with seed and fertilizer companies on behalf o f farmers for loans and ensures that correct varieties are supplied. Farmers deliver their fruits and vegetables to collection centers. Payments, however, are made about 11-45 days after sale. Vegetablesin China: Xincheng is a vegetable wholesale fmdedicated to supplying 500 supermarkets inChina. It sources half o f its vegetables from 4,200 small-scale farmers in the rural area near Shanghai with which it has contracts. Xincheng supplies the farmers with seed, fertilizer, and pesticides on credit at the beginning o f the production season. It also provides technical assistance to train farmers in producing vegetables that meet the quality and safety standards that Xincheng requires. The contract specifies that all produce has to be grown according to these standards and sold to Xincheng at harvest. Input costs are deducted from the output price paid. The fm applies high quality standards (in terms o f appearance and freshness o f the produce) and monitors the produce to ensure that it meets the food safety requirements o f the Shanghai municipal government. SanLu, a similar supplier o f vegetables to supermarkets, sources vegetables from small-scale farmers through verbal agreements with village group leaders. SanLu provides farmers with seed, technical assistance, and information about market needs for various vegetables and producer prices. It guarantees to purchase the produce if it meets its quality standards. Produce is delivered by farmers to collection centers which are located inthe main production centers. SanLu packs and washes the vegetables for the Beijing supermarkets and export markets. Strawberries in Croatia: In Croatia, the supermarket chain Konzum established a preferred supplier program to procure strawberries. The program's main feature i s to encourage suppliers to use irrigation and greenhouses to reduce the seasonality o f strawberry production and increase quality. Both irrigation and greenhouse production required significant capital investments by farmers, who lacked either capital to make such investments or the collateral to secure bank loans. To enable farmers to obtain bank loans, Konzum intervened with local banks, stating that its contracts with farmers could serve as a "collateral substitute." Leafv greens in Costa Rica and Nicaragua: Hortifruti, the wholesale buyer o f fresh fruits and vegetables for the largest supermarket in Costa Rica (CSU), has established a network o f farmer suppliers. Seventy percent o f these suppliers are small-scale farmers who predominantly produce leafy greens. These farmers have an implicit contract (rather than an explicit written contract) with Hortifruti, which gives them stable access to an attractive and growing market where they can sell at prices slightly above the wholesale market. Each supplier must clean, crate, or pack the product in final usable trays and deliver it to one o f Hortifruti's distribution centers. Extensionworkers visit suppliers to check crop calendars and productionpractices. Inaddition to receiving technical assistance some farmers receive input credit. Produce i s rejected if it does not meet the color, shape, and ripeness characteristics that consumers seek. Hortifruti tests the produce for pesticide residues and E. coli infection to better inform extension staff on how to direct their technical assistance to farmers. The costs o f the tests are borne by the farmer, but farmers do not receive penalties for produce that does not pass the test, nor is substandard produce discarded (there are no quality standards that supermarkets must adhere to). Hortifruti believes that either o f these punishments would damage their ability to build sustainable relationships with farmers schooled in producing high-quality produce. The advantage to Hortifruti o f contracting farmers is that they have a group o f farmers they can work with to increase quality standards. Alvarado et al. (2003) also note (translation in BerdeguC 2003): "The strategies o f monitoring and control o f growers and harmonization o f growers' planting periods resulted in company growth o f 15-20 percent per year between 1997 and 2001, and cost savings of 40 percent, as a result o f reduction inproduct losses and waste due to quality increase." Source: BerdeguC et al.. 2003; Hu et al. 2004; Dries, Reardon, and Swinnen 2004; Chengappaet al. 2005a; Chen, Shepherd, and da Silva 2005. 75 Small-scale farmers therefore need support inupgrading their skdls to meet the requirements o f coordinated supply chains. Such support involves investment in farmers' human and physical capital, assisting in the development o f producer organizations to facilitate market connections for small-scale farmers, and strengthening the managerial capacity o f these organizations to ensure these links are maintained. The impact o f supermarkets on farmers, however, is only part of the picture. Some studies have shown that supermarkets also reduce the costs o f the food basket for lower- and middle-incomeconsumers (for example, inChile). Improving Market Information and Market Intelligence Market information i s extremely critical in enabling farmers to stay attuned to the demands and changing preferences o f consumers. Market information i s essential to guiding farming, marketing, and investment decisions. It encompasses more than timely and accurate prices; it also encompasses buyer contacts, distribution channels, buyer and producer trends, import regulations where appropriate, competitor profiles, grade and standards specifications, variety specifications, seed sources, production guidance, postharvest handling advice, and storage and transportation recommendations. As highlighted by farmers, lack o f access to production and marketing informationi s a major constraint. The MOA'SAGMARKNET program to collect sales prices at the regulated markets and make these prices accessible through the Internet can contribute significantly to improving access to real-time price information. Inthe future, these could be expanded to nonregulated markets as well. Innovative ways o f connecting to these databases using advances in communication technologies should be explored and enabled (for example, dial-up services, mobile phones, or ruralkiosks). Strengthening the extension system (public and private) can play an important role in helping farmers obtain critical market information. A number o f private firms in India offer extension services to farmers, but generally they have been linked with input supply or output purchasing/contract farming arrangements. Some examples include the A M U L ' s Dairy Cooperative federation, Mahindra's Krishi Vihar, ITC's e-choupal, and Food World supermarket's contracting arrangements. Yet the public extension system i s falling behind. It must shift away from its traditional, supply-driven and production-focused approach and towards a more market-oriented approach. Improved delivery o f public extension services could be promoted by introducing decentralized strategic planning in which farmers and other stakeholders participate actively. One approach that has displayed some success in transitioning to a more market-oriented approach in India i s the Agricultural Technology Management Agency (ATMA). ATMA i s essentially a management concept, in which existing extension and other support service staff are used more effectively in the district by fostering coordination among line departments and fostering partnerships with producer groups, women's groups, NGOs, and the private sector (box 6.4). Informulating extension strategies, there can be a large payofffor incorporatingtraining on market intelligence for farmers or farmer groups. Market intelligence involves building capacity to undertake market research-that is, to seek out and analyze relevant market information-to guide decision making. Box 6.5 presents an example o f how training by extension officers on market intelligence helped a women's group inBangladesh successfully refine their enterprise development plans to better respond to market needs. Similar experiences have been documented for ATMA groups inBihar (Singh, Swanson, and Singh 2005). 76 Box 6A:Agricultural Technology Management Agency (ATMA) scheme The ATMA approach i s one mechanism being piloted by India's Ministry o f Agriculture to promote decentralized, farmer-driven extension. The ATMA approach involves the creation o f new management mechanisms, including an ATMA society and ATMA governing board at the district level, farmer advisory committees and block technology teams at the block level, and producedself-help groups at the village level. ATMAs are quasi-governmental registered societies. They have more flexibility than government line departments, because they can receive funds from both government and nongovernmental sources, enter into contracts, maintain revolving accounts, charge for services, and recover costs from farmers or other service recipients. The ATMAs are controlled by governing boards o f stakeholders and receive guidance from Farmer Advisory Committees established at the block level. The block technology teams are responsible for implementing and integrating the extension activities across each block, thus ensuring coordination among the different line departments. They work closely with the farmer interesthelf-help groups. Bottom-up planning and prioritization o f extension needs are institutionalized under tlus new approach through the preparation o f strategic research and extension plans (SREPs) approved by the governing board. Block action plans are prepared by block technology teams within the framework o f the SREP and approved by Farmer Advisory Committees. The block plans are aggregated to produce the district's annual work plan. The program also promotes increased partnerships between the ATMAs and the private sector and NGOs. A T M A s support private extension initiatives by contracting NGOs to take on extension responsibilities in selected blockdareas, using farmer-to-farmer extension services through individuals or through farmer organizations, andby developing partnerships with input providers for demonstrations and farmer training. Source:Seth and Sidhu2003; WorldBank2005f. D.StrengtheningCapacityto ManageSPS Standards Strengthening SPS management capacity in India can contribute to growth and poverty reduction by increasing the competitiveness o f Indian exports, improving domestic food safety, and promoting the adoption o f safer and more sustainable agricultural practices. 41But the approach o f government so far in SPS management concerning ago-food exports has mainly been defensive- reacting to events in a "fire-fighting" mode to limit damage from apparent noncompliance with trading partners' requirements. In response to various crises on the SPS front, the strategy o f the public sector has combined (1) aggressive enforcement o f existing or modified regulations, (2) heightened requirements for mandatory testing o f raw materials and finished products, and (3) considerable investment in new "hardware," either through investment in public sector laboratories or subsidies for private investment inlaboratories, factory upgrades, and the like. This approach has generally proven "successful," at least in terms o f relatively quickly restoring India's access to the affected market. Yet such crisis management measures have generally been quite expensive, both financially for the government and in terms o f lost income or livelihood for the many farmers, SMEs, and factory workers adversely affected by regulatory crackdowns. In some cases (grape exports, for example), the cost o f compliance has been quite high. The considerable attention given to product testing has enabled the GO1 and various sectors to gain a more detailed look at the symptoms o f noncompliance (that is, in the form o f test results showing violative levels o f microbiological parameters or pesticide residues). Developing counties such as India and individual suppliers commonly perceive little room for maneuvering in the face o f emerging standards. Inother words, they believe that they must "comply or perish." Inreality, countries and suppliers face a wide range o f choices, even when they seek to comply with a particular standard. Developing countries and individual suppliers can pursue one or a combination o fthe following strategies inthe context o f evolving standards: 4'See World Bank (2007) for a more detailed discussion. I1 Box 6.5: Market intelligence and women producers inBangladesh A group o f women producers wanted to diversify into new, profitable products, especially those suited to the landless among them. At a preliminary meeting to discuss resources, a short list o f four products was developed: (1) bamboo baskets, (2) potato crisps/chips, (3) rice cakes, and (4) embroidered blouses. The women believed that embroidered blouses offered the best opportunity. After learning about market intelligence, four o f the women, with assistance from agricultural extension officers, decided to research the local town market and report back to the group. Two marketing specialists and two extension officers accompanied the women to the market, gave them some training in market research, and provided a checklist o f questions. The specialists led the first two market interviews, and then the women farmers led the process. The women were worried about going into the market, but they were supportedby one another and helped by the local extension officers and government marketing specialists. Through their research, the women discovered that there was a small and slow market for bamboo baskets, the potato crisp market was dominated by large-scale processors, and the market for embroidered blouses was seasonal and difficult. However, there was an excellent opportunity to supply rice cakes. These were supplied from a town two hours away, and the women already had the skills and resources to produce high-quality rice cakes. Retailers were enthusiastic about being able to source rice cakes locally. At the next farmers' meeting, the women presented their findings. The group agreed to produced samples o f rice cakes and take them to the retailers duringthe following week. Source: Dixie 2006, personal communication. 0 Compliance: adopting measures to meet international standards or the requirements o f one's trade partners. This strategy might involve some combination o f legallregulatory change, the application o f certain technical or other risk management approaches, the implementation o f testing, certification, andor other conformity assessment measures, and other actions. Voice: seelung to influence the "rules o f the game" andor how they are implemented via participation in international standard-setting fora, communications with the WTO, negotiations with bilateral or regional trading partners, andor business planning with downstream clients. 0 Redirection: altering commercial strategies to encompass sales to different countries or market segments, changes in the mix or form o f products, and other maneuvers, taking into account the costs andbenefits o f complying with different standards. The timing and mode o f strategic response may also vary. Actions may be taken on a proactive or reactive basis. A proactive response involves anticipating future requirements and taking measures ahead o f time in a manner that minimizes costs or maximizes benefits. A reactive response involves a player waiting until the requirements are put in place and only then adopting responsive actions, perhaps hoping to limit action or at least to learn from the mistakes o f the "first movers." The strategy can be either defensive or offensive; a defensive strategy involves measures designed to minimize the changes required, whereas an offensive strategy involves trying to exploit an opportunity created by standards, such as a price premium for organic products. The locus o f strategic response may also vary. Some responses may be taken by individual firms, farms, or government agencies. Other responses involve collective action, perhaps through producer or industryorganizations or interministerialtask forces. There is scope also for strategic responses that involve public-private collaboration or collaboration between developing country stakeholders in multiplecountries (table 6.5). 78 Table 6.5: Actors in strategic responseto standards Institution/approach Individual Collective SubsidieslCotmancmg Joint ventures Jointpublic-private sector task-forces Source: World Bank2007. While there are certainly diverse views, the mainstream official and private perspective in Indian horticulture i s that many, if not most, o f the emerging SPS and other international standards are not scientifically based and therefore represent an unfair "barrier to trade." This situation i s considered to result either from deliberate efforts to protect farmers or processors from competition or to be fueled by unreasonable consumer fears inhigh-income countries and improved technologies for detecting hazards. Whatever the driving forces, the presumed primary solution is seen to lie in effective negotiations with India's (official and private) trading partners and, failing that, in addressing the various measures ininternational fora for setting standards or resolving disputes. Inthe future, it would beimportantfor the GO1to movetowards a more cost-effective and strategic approach. Considerably more emphasis i s needed to promote awareness about SPS management among agro-food system stakeholders. Taking a more proactive stance requires moving towards a more cost-effective, strategic approach. Such an approach would place somewhat less emphasis on mandatory controls, inspections, and testing. It would place considerably more emphasis on promoting ago-food system stakeholder awareness about SPS management and facilitating effective individual and collective action by private firms, farmers, and service providers. It is often assumed that the management o f food safety and agricultural health is predominantly the responsibility o f the public sector. Indeed, many crucial regulatory, research, and management functions are normally carried out by governments, and in a variety o f circumstances importing countries require that certain functions be performed by a designated "competent authority" in the public sector (table 6.6). However, the private sector can also play a critical role in setting standards and inthe actual compliance with food safety and agricultural healthrequirements. Capacity building in the private sector can complement (or even substitute for) public sector capacity, as with the investment inaccredited laboratory testing facilities. By narrowing the gap between domestic and international standards, India could create a better platform for expanding exports. Extension service providers have a large role in promoting agricultural good practices to ensure that farmers follow recommended dosages and appropriate pre- harvest intervals inusingagricultural chemicals and inassisting with soil and water testing. There i s also a need for promoting good hygiene and manufacturing practices and quality management to minimize food safety, environmental, and other risks. India and its private sector are in a position to anticipate standards and take early action to gain competitive advantage through compliance and differentiation. Unlike many other developing countries, India has enormous scientific and technical capacities. It can effectively undertake research and field trials to stay ahead o f the game. For example, Indian stakeholders anticipate problems in complying with existing EU pesticide residue tolerances for pomegranates. Indian complaints about "unfair" approaches used to test for residues in pomegranates are getting limited attention, given that this crop i s o f minimal commercial importance to India's trading partners. India needs to manage this challenge-through its own actions-by performing its own field trials to establish proper regulatory tolerances and by promoting better pest management practices among its 79 pomegranate growers. Similarly, future challenges are expected inrelation to compliance with heavy metal tolerance levels in vegetables. Proactive steps can be taken to reduce the incidence o f such heavy metals, thus lowering the risks o f hture trade disruptions and the risks to Indianconsumers. There i s growing evidence to indicate that for well-prepared countries and suppliers, rising standards represent an opportunity for modernization o f export supply and regulatory systems and adoption o f safer and more sustainable practices (World Bank 2005d). Countries that have taken a proactive stance, including staying abreast of technical and commercial requirements and anticipating future changes, have been able to reposition themselves in more remunerative market segments. Table 6.6: Publicand privatesector roles in enhancingtrade-relate1 3PS and quality managementcapacity Publicsector role Private sectorrole Diplomacy: "Good" managementpractices: (Responsibility of central government) Implement appropriate managementpractices to minimize Undertake continuous dialogue and periodic negotiations to address food safety, environmental, and other risks. Examples emerging constraints or opportunities. include "good" agricultural, hygiene, and manufacturing Emphasize commitments, confidence building, and opportunities for practices and HACCP principles. mutual recognition andjoint problem-solving (rather than conflicts per Where commercially valuable, gain formal certification se). for such adopted systems. Develop incentives, advisory services, and oversight Buildingawarenessand promotinggoodpractices: systems to induce similar adoption o f the above "good (Responsibilities lie with central and state governments) practices" by supply chain partners. Raise stakeholder awareness about and promote good agricultural, hygiene, and manufacturingpractices and quality management. Traceability: Incorporate these areas into cumcula o fpublic agricultural/technical Develop systems and procedures to enable the traceability institutes and universities as well as consumer awareness campaigns. o f raw materials and intermediate and final products in Accredit private laboratories and conduct reference/consistency testing. order (for example) to identify sources o f hazards or Facilitate technical, administrative, and institutional change and manage productrecalls or other emergencies. innovation within the private sector (for example, through public-private partnerships for product innovation or product traceability systems). Developtraining, advisory,and conformityassessment services: Riskassessment and management: On a commercialbasis, provide support services to Adopt suitable food safety and agricultural health legislation modeled on agriculture, industry, and government related to quality international good practices and consistent with India's WTO and other and food safety management. Invest inthe needed human treaty obligations. (Responsibility o f central government) capital, physical infrastructure, and management systems Manage national or state systems o f pest and animal disease surveillance. to competitively supply such services. (Responsibilities lie with central and state governments) Undertake coordinated market surveillance programs to gauge the Collectiveaction and self-regulation: incidence o f various food safety hazards in the domestic ago-food Work through industry, farmer, and other organizations to system. (Responsibilities lie with central and stategovernments) share the costs o f awareness-raising and systems Find solutions to phytosanitary constraints that limit domestic (for improvement, alert government to emerging issues, imports) and foreign (for exports) market access. This effort might entail advocate for effective government services, and provide a pest risk assessment, product inspection, or agreed development o f pest- measure o f self-regulation through the adoption and or disease-free areas. (Primary responsibilities lie withthe central oversight o f industry "codes o f practice." government, but state governments have an important role in implementation) Support research to address food safety and agricultural health concerns (for example, field trials to determine alternative pest management approaches or to establish suitable MRLs for crops withmarket potential; improve the quality o f planting material). (Responsibilities lie with central and state governments; rolefor national and state-level agricultural research organizations) Source:World Bank 2007. 80 E. Conclusion The Government o f India's rural development strategy faces the challenge o f meeting rapidly changing needs in rural areas, the country, and the global environment. A recent added challenge is global rise in food prices. Economic development and increasing industrialization normally lead to a changed and smaller role for the agncultural sector. This structural evolution has begun in India. A concurrent rapid pace o f growth in the agricultural and rural nonfarm sectors i s thus important and integral to India's overall development, because these sectors jointly, directly, and indirectly help generate opportunities for greater employment and income growth. To maximize agnculture's contribution to the overall economic growth, it i s critical to remove policy and regulatory barriers, so that those who choose to remain in agnculture can enhance their productivity and competitiveness and achieve the highest returns from their endeavors. Removing these barriers i s particularly important because the majority o f India's workforce remains dependent on the agricultural sector for its livelihood. At the same time, growth in the rural nonfarm sector (industry and services) not only offers greater alternative employment opportunities but can create a strong foundation for consumer demand in rural areas. An increase in rural-based demand in turn can stimulate growth in the agricultural and other sectors o f the economy. Achieving such broad-based growth, however, will require vigilant adjustments to rapidly changing market opportunities and challenges, internally and globally. Integrating rural areas into the state and national economy through a dynamic agnbusiness sector and agricultural markets will be important drivers for agncultural and rural growth, ensuring the country's food security, and rural poverty reduction inIndia. As noted inthe lO* Five Year Plan, fostering efficient and competitive agricultural marketing is indispensable for the overall development o f the country's economy (Planning Commission 2003). International experience shows that modern and efficient agriculturalmarketing systems and the consequent improvements in competitiveness can be a crucial catalytic force for directly and indirectly promoting growth and poverty reduction. Modem marketing systems can help to reduce food costs, resolve supply uncertainties, and improve the diets o f the poor and non-poor in urban and rural areas. 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Finance and PrivateSectorDevelopmentUnit, SouthAsia Region, World Bank, Washington, DC. 88 .2005h, TheDynamics of Vertical Coordination in Agrifood Chains in Eastern Europe and Central Asia, Implicationsfor Policy and WorldBank Operations, Washington, D.C.: Environmentally SociallySustainableDevelopmentUnit, EasternandCentralAsia Region, World Bank. .2007, India's Emergent Horticultural Exports: Addressing Sanitary and Phyto-Sanitary Standards and Other Challenges, ReportNo. 36178 - IN ,SouthAsia Agriculture andRural DevelopmentDepartment, World Bank, Washington, D.C. 89 90 Annex A: India Agricultural MarketingSurvey A survey o fthe agricultural marketing chain was undertaken infour states inIndia as part o f the study described in this report. The four states-Maharashtra, Onssa, Tamil Nadu, and Uttar Pradesh-were selected to cover the broad spectrum o f development inagncultural marketing chains for higher-value agncultural produce. Maharashtra in the west and Tamil Nadu in the south rank highamong Indianstates interms o fper capita income. They are more advancedindiversifying into high-value crops and in developing marketing and processing facilities to penetrate export markets. The more populous northern and eastern states o f Uttar Pradesh and Onssa, on the other hand, rank low inper capita income. Although some agncultural diversification has taken place in these states, they have yet to develop the marketing and processing sectors that could catapult them into outside markets. The respective state governments raised their own specific concerns about the need for improving agricultural marketingwithin their states and were happy to provide support to the study. Crop Selection To compare agnculturalmarketing across the four states, it was necessary to select crops that were produced in all four states and could ensure adequate statistical coverage and comparison across individual farmers and traders. Given the study's focus on the operational efficiency o f agncultural marketing systems for high-value crops, five crops were selected to illustrate different marketing challenges. Ideally cereals, vegetables, fruits, spices, highly perishable crops, and storable commodities would be represented among the five crops. To fit these criteria, maize, potatoes, tomatoes, mangoes, and turmeric were chosen. Maize i s an annual grain crop used increasingly for producing starch as well as livestock and poultry feed. Potatoes and tomatoes are common vegetable crops, but tomatoes are more perishable and suffer greater handling losses than potatoes. Mangoes are tree crops grown and consumed widely in India and partly exported. Quality control, handling, and sanitary issues are most serious for tomatoes and mangoes. Turmeric i s a ginger-like spice essential to Indian cuisine. One-fifth o f India's output i s exported. Sampling Design Detailed surveys o f traders, agricultural marketing enterprises, and farmers involved in trading, processing, exporting or producing one o f the five study crops were conducted in Maharashtra, Orissa, Tamil Nadu, and Uttar Pradesh. In each state, 20 wholesale markets and 40 villages were selected to construct a sample o f 400 traders and 400 farmers. Community surveys were conducted at the market and village level. A sample o f 600 processors and exporters o f the five crops (inprinciple, 150 in each state) was also drawn. Inline with the study's objectives, the survey focused on wholesale markets, wholesale traders or brokers, and farmers who sold the five crops to traders for resale. The sampling strategy was designed around the market. First, a market was sampled for a given crop. The enumerators listed the traders found in the sampled market (those who could regularly be found in the market, regardless o f whether they owned a permanent structure for trading), recording which crop they traded and whether they traded as a wholesaler, commission agent or retailer for that crop. Those traders found to be trading as wholesalers or commission agents for the crop for which the market was selected comprised the sampling frame from which traders were sampled and interviewed. Duringthe listing process, traders o f the crop for which the market had been selected were asked to list five villages from which they sourced most o f their crop, or which were known to produce a lot o f the crop in question. Based on their responses, a list o f villages that supplied the selected market was drawn up and became the sampling frame from which the team supervisor sampled two villages. Two villages were visited to develop a list o f households that produced the crop for sale, that bought one o f the five crops for resale, or that processed one o f the five crops. This became the sampling frame from which farmers, village traders, and village 91 processors were selected. For each market, 20 traders were interviewed (both in the market and in the village), 2 villages were selected, and 20 farmers surveyed across the 2 villages. Ideally 10 o f the 20 traders were to be found in the villages listed. Inreality few traders resided in the villages; they were more likely to reside inurban areas and travel to the villages to buy and sell. When the required number o f small-scale traders was not found inthe village, village retail markets were visited to find small-scale traders ina givencrop. Retail traders as well as wholesale traders and commission agents were foundinthe village markets. A two-pronged approach was taken to sample processors and exporters. Small-scale, informal processors were listed as part o f the village listing exercise, and they were all interviewed, given that few processors were expected to be found. In addition, a list o f medium- and large-scale enterprises was drawn up for each state, using a combination o f national and state-level lists o f agricultural enterprises. Markets were selected for a given crop with a probability inproportionto the quantity o f that crop traded in their district. Each state comprises about 30 districts, and each district contains on average six or seven markets. This selection process required data on the quantities o f maize, potatoes, tomatoes, mangoes, and turmeric traded ineach district. Inonly one o f the states selected- Uttar Pradesh-were records o f annual quantities traded available. Inthe absence o f similar data for the other states, estimated market surplus data were used as the basis for sampling the markets. Markets were selected randomly for each crop with a probability proportional to the districts' share o f the state's total market surplus in a given crop. Markets in districts with a negative market surplus for a given crop were given a zero probability o fbeing selected for that crop. The final breakdown o f the sample by crop, state, and market participant i s presented in tables Al.l and A1.2. The locations o f markets and villages sampled for each crop are shown in figures A1.1to Al.4. Respondent Maharashtra Orissa Tamil Nadu Uttar Pradesh Total Markets 20 20 20 18 78 Trader 411 400 386 400 1,597 Village 41 40 35 39 155 Farmer 401 400 378 400 1,579 Enterprise 70 167 35 44 316 92 FigureAl.1: Location of sampled markets in Orissa 93 FigureA1.2: Location of sampled markets in Maharastra 94 FigureA1.3: Location of Sampled markets in UP U 95 FigureA1.4: Tamil Nadu: Location of Surveyed Markets 96 Annex B: Economic ConsiderationsinAgriculturalMarketing Apcultural producers, traders, and processors encounter a number o f market failures, which require public sector interventionto resolve. These market failures include: 0 Excludability of users: If anyone can freely obtain and use new knowledge, such as market information or extension advice, there i s little incentive for the private sector to provide it. 0 Rivalry of consumption: If one's use o f a product or service does not reduce its availability to others (for example, the use o f extension advice), the private sector will be reluctant to provide it. 0 Externalities: Frequently described as the spillovers or side effects o f an economic activity, externalities can be positive (integrated pest management) or negative (water and air pollution). Economics of scale: Processing costs may increase as the volume o f output decreases. Economies o f scale can make it more difficult for small firms to compete or undertake investments to comply with regulations or standards, such as food safety standards. For large firms, economies o f scale can generate market power. 0 Asymmetric information: Participants in a marketing transaction may not have the same knowledge o f the market situation. Farmers may lack the information that traders possess about consumers' quality preferences. These market failures can be overcome through regulation and investments inpublic goods- that is, goods that are nonexcludable (potential users cannot be excluded from use by owners) and nonrival (consumption o f the good does not reduce its supply to others). Purely public goods and purely private goods occupy opposite ends o f the economic spectrum. Toll goods are those with high excludability and low rivalry. Common pool goods are those with low excludability but high rivalry. Many marketing-related goods and services lie in the intermediate area, which means that there i s considerable potential for the public and private sectors to share responsibility for funding and delivering them. Those with significant externalities may alsojustify public intervention o f some kind, such as subsidizing the activities that result in positive externalities or taxing or regulating those that result innegative externalities. 97 Annex C: UsingNegotiable Warehouse Receipts Figure C.l.l: Warehouse receiptfinancing: Processf 'W WR Farmer management Buyer L\ ameement 1 I Warehouse I Source: World Bank (2005d) Note: WR= WarehouseReceipt; C = Cash; G = Goods The process ofusingnegotiablewarehouse receipts maybe dividedinto seven steps (annex figure C1.I) (World Bank2005d): 0 Step 1: The farmer, company, or trader deposits the commodity in a warehouse operated by a designated warehouse keeper. The stored commodity i s certified for quality and graded by a government-approved valuer(s). The certificate issued accompanies the commodity to be deposited, which i s then inspectedby an agency authorized to certify the quantity deposited. The warehouse issues a warehousing receipt that specifies the quantity (as certified by the warehouse) and the quality (as certified by the accompanying quality certificate) o f the commodity. 0 Step 2: The farmer, company, or trader can request financing from a bank, which then takes possession o f the warehouse receipt pending its decision on financing. The bank does this to ensure that the commodity stored i s not subsequently tampered with. 0 Step 3: The bank deputes an approved controller/assayer to draw samples form the stored commodity and bringit to a certified laboratory for testing. 0 Step 4: The financing amount i s fixed at a percentage lower than the market value o f the commodity stored, after keeping an adequate margin based on the price volatility o f the commodity. In the event that the quality tests do not confirm the quality stated on the warehouse receipt, financing i s rejected. 0 Step 5: The bank appoints a collateral manager who monitors the commodity stored, conducts periodic stock audits, and provides an indemnity cover and fidelity insurance for the transaction. The bank monitors the market value o f the stored commodity based on the daily price from the most liquid spot market. If the market value i s lower than the stipulated bank cover, a margin call is issued. The companyhader acquires an insurance cover for the commodity stored and the warehouse keeper purchases an insurance cover for the warehouse against theft, fire, and natural calamity. 0 Step 6: The farmer, company, and trader can respond to the margin call within the stipulated time period by either depositing additional quantities of the commodity or prepaying part o f the outstanding amount. If the company/trader does not respond to the margin call, the bank exercises the right to sell the commodity at the end o fthe stipulated period andrecover the outstanding amount. 0 Step 7: At the end o f the financing period, the companyhrader repays the outstanding amount (principal plus interest) and the bank hands over the warehouse receipt, thereby releasing the commodity and completingthe transaction. 98 Annex D: India's EmergentHorticultureExports:AddressingSPS andOther Challenges ExecutiveSummary4' How HaveSanitary andPhytosanitaryIssuesAffectedIndia's HorticulturalTrade? In recent years, both the private and public sectors in India have developed aspirations for expanding India's participation in international horticultural trade. Despite being one o f the world's largest producers of horticultural crops, India trades very little o f its massive production internationally. India's share in global horticultural trade was a mere 0.5 percent in 2004 (US$ 575 million, compared with a global trade o f US$ 108 billi~n).~' Given the increased attention to food safety and/or plant health concerns in many segments o f international horticultural trade, questions have been raised as to whether sanitary and phytosanitary (SPS) measures have been or could be a "barrier" to India's present and future horticultural trade, and what the appropriate responses from Indian stakeholders should be. SPS standards are but part o f a wider set of competitiveness challenges facing Indian horticultural producers, processors, and exporters. Most subsectors face on-going challenges related to varietal development, postharvest loss, local and/or international logistics, and market organization. In many subsectors, the very fragmented system o f production and trade is not especially suited for international trade, especially in cases where there are growing demands for the traceability and/or certification o f products or raw materials. There is a widespread perception among stakeholders that India's huge domestic production o f various fruits should inevitably translate into large-scale exports (for example, o f mangoes, bananas, or even citrus). This perception i s inconsistent with the experience o f most leading developing country exporters, which fostered large, export-oriented supply chains backed up by smaller domestic markets. The challenges that India faces have arisen at least in part because o f the huge rift between standards in India's domestic market, on the one hand, and international standards, on the other. The challenges posed by standards have manifested themselves in different ways for Indianhorticulture,including: Absolute barriers or binding constraintsfor accessingparticular markets. The most prominent case involves fresh mangoes and the plant healthconcerns o fU S and Australian authorities. Temporary lossesfrom rejected (and sometimes destroyed) consignments of fresh or processed product. The most high-profile incident occurred when some 28 containers o f grapes consigned to Holland in 2003 were rejected due to violative pesticide residues. Less visibly, yet more commonly, numerous small consignments o f processed horticultural products entering the U S A have been rejected for improper labelling, poor packaging, inclusion o f illegal additives, and other reasons. Inother markets, there have been a few other rejections o f fresh produce. Higher consignment-specific or recurrent transaction costs due to duplicative testing, high levels o f entry-point inspection, or the hrther treatment o f goods upon arrival in overseas 40This annex summarizes the findingsreported inWorld Bank (2007). 41 Inthis study, "horticultural products" are defined as including fresh and processed fruits and vegetables, cut flowers, and ornamental plants. Nuts or driedprocessed legumes and pulses are not included, although the Agricultural and Processed Food Products Export Development Authority (APEDA) generally includes them in its data on horticultural exports. 99 markets. The profitability o f India's cut-flower trade into Japan and the Netherlands has been affected, and exporters o f other products have also had to bear added costs. Patterns of "defensive commercialization, "whereby firms fail to pursue opportunities for remunerative trade with certain countries or types o f buyers because o f concerns about their inability to ensure compliance with regulatory or private standards in those markets. This pattern i s common in Indian horticulture, although additional factors have also weighed on these commercial strategies. The OfficialResponseto Trade-relatedSPS Management There i s a common assumption that developing countries such as India (and individual suppliers therein) have no room for maneuvering in the face o f emerging standards. That is, they face situations o f "comply or perish." Inreality, countries and suppliers face a wide range o f choices, even when they seek to comply with a particular standard, although the increased emphasis in recent years on proscriptive process/procedural requirements (rather than product or outcome standards) does somewhat curtail this room for maneuvering. Developing countries (and individual suppliers) can pursue one or a combination o f the following types o f strategies inthe context o f evolving standards: Compliance: adopting measures to meet international standards or the requirements o f one's trade partners. This strategy might involve some combination o f legalh-egulatory change, the application o f certain technical or other risk management approaches, the implementation o f testing, certification, and/or other conformity assessment measures, and other actions. Voice: seeking to influence the "rules o f the game" and/or how they are implemented via participation in international standard-setting fora, communications with the World Trade Organization (WTO), negotiations with bilateral or regional trading partners, andor business planningwith downstream clients. Redirection: altering commercial strategies to encompass sales to different countries or market segments, changes inthe mix or form o f products, and other maneuvers, taking into account the costs and benefits o f complying with different standards. The timing and mode o f strategic response may also vary. Actions may be taken on a proactive or reactive basis. A proactive response involves anticipating future requirements and taking measures ahead o f time in a manner that minimizes costs or maximizes benefits. A reactive response involves a player waiting until the requirements are put in place and only then adopting responsive actions, perhaps hoping to limit action or at least to learn from the mistakes o f the "first movers." The strategy can be either defensive or offensive; a defensive strategy involves measures designed to minimize the changes required, whereas an offensive strategy involves trying to exploit an opportunity created by standards, such as a price premium for organic products. The locus o f strategic response may also vary. Some responses may be taken by individual firms, farms, or government agencies. Other responses involve collective action, perhaps through producer or industry organizations or interministerial task forces. There i s scope also for strategic responses that involve public-private collaboration or collaboration between developing country stakeholders inmultiple countries. While there are certainly diverse views, the mainstream official and private perspective in Indian horticulture i s that many, if not most, o f the emerging SPS and other international standards are not scientifically based and therefore represent an unfair "barrier to trade." This situation i s considered to result either from deliberate efforts to protect fanners or processors from competition or to be fueled by unreasonable consumer fears in high-income countries and improved technologies for detecting hazards. Whatever the driving forces, the presumed primary solution i s seen to lie in effective negotiations with India's (official and private) trading partners and, failing that, in addressing the various measures ininternational fora for setting standards or resolving disputes. 100 With such a perspective, arguably insufficient attention has been devoted to monitoring the requirements o f official and private standards, interpreting their implications for Indian horticulture, and using current and anticipated requirements as catalysts to upgrade existing operations and strengthen supply chain management. This response i s not altogether surprising, given the limited imprint of export horticulture on Indian agriculture thus far. Yet the absence o f a proactive or preventive approach to managing SPS standards for trade has left Indian horticulture either to adopt "defensive" strategies o f commercialization-that is, to avoid markets that apply more stringent standards-or to adopt reactive, "fire-fighting" methods when trading partners' concerns about India's noncompliance with standards lead to actual or threatened trade interruptions. These approaches contrast sharply with those taken in leading (and competing) developing countries in the horticultural export trade, such as Brazil, Chile, Mexico, Thailand, Kenya, and South Afnca. The mainstream Indian approach seems to call for negotiation first and belated (and begrudging) compliance second. In contrast, many other countries are investing in compliance as a means to both improve their competitive position and enhance the effectiveness o f their negotiations on particular technical and commercial matters. With regard to trade performance patterns and the prevailing international reputation for horticultural industries, this latter approach seems to have been relatively more effective. When faced with crises related to noncompliance with SPS measures, as inthe case o f grapes, the public sector has focused on end-of-the line solutions. This strategy has included a combination of: (1) aggressive enforcement o f existing or modified regulations, (2) heightened requirements for mandatory testing o f raw materials and finished products, and (3) considerable investments in new "hardware," either through investment inpublic sector laboratories or subsidies for private investment inlaboratories, factory upgrades, andother improvements. This approach has generally proven "successful," in the sense that access to the affected market was restored relatively quickly. Yet such crisis management measures have generally been quite expensive, both financially for the government andinterms o f lost incomes or livelihoods for the many farmers, small and medium enterprises (SMEs), and factory workers adversely affected by regulatory crackdowns. Insome cases (for example, grapes), the sustainability o f the adopted measures i s uncertain, given the higher overhead cost o f compliance. The considerable attention given to product testing has enabled the Indian government and various sectors to gain a more detailed look at the symptoms o f noncompliance (including results of tests indicating violative levels o f microbiological parameters or pesticide residues), although insufficient attention and resources have been directed to address the underlying causes o f these problems. Recent moves to improve agtlcultural practices through initiatives such as the IndiaGAP program suggest a shift inthe right direction, however. Taking a More Proactive Stance Towards SPS Management Standards present an opportunity for modernizing export supply and regulatory systems and adopting safer and more sustainable practices. Countries that have taken a proactive stance, including staying abreast o f technical and commercial requirements and anticipating changes, have been able to reposition themselves in more remunerative market segments. Consignments from such countries are subjected to comparatively less inspection by trading partners. "Good" reputations, gained through demonstrated compliance, yield lower transaction costs for farmers and exporters. Considerably more emphasis i s needed to promote awareness about SPS management among agro-food system stakeholders. Takmg a more proactive stance requires a move towards a more cost- effective and strategic approach. Such an approach would place somewhat less emphasis on mandatory controls, inspections, and testing. It would place considerably more emphasis on promoting agro-food system stakeholder awareness about SPS management and facilitating effective individual and collective action by private firms, farmers, and service providers. By narrowing the gap between domestic and international standards, India could create a better platform for expanding exports. 101 Extension service providers have a large role in promoting agncultural good practices to ensure that farmers follow recommendeddosages and appropriate preharvest intervals inusingagro-chemicals and in assisting with soil and water testing. There is also a need for promoting good hygiene and manufacturing practices and quality management to minimize food safety, environmental, and other risks. India and its private sector are ina positionto anticipate standards and take early action to gain competitive advantage through compliance and differentiation. Unlike many other developing countries, India has enormous scientific and technical capacities. It can effectively undertake research and field trials to stay ahead o f the game. For example, Indian stakeholders anticipate problems in complying with existing European Union (EU) pesticide residue tolerances for pomegranates. Indian complaints about "unfair" approaches used to test for residues in pomegranates are getting limited attention, given that this crop is o f minimal commercial importance to India's trading partners. India needs to manage this challenge-through its own actions-by performing its own field trials to establish proper regulatory tolerances and by promoting better pest management practices among its pomegranate growers. Similarly, future challenges are expected in relation to compliance with heavy metal tolerance levels invegetables. Proactive steps can be taken to reduce the incidence o f such heavy metals, thus lowering the risks o f future trade disruptions and the risks to Indian consumers. By anticipating shifting standards in existing markets, India is likely to identify opportunities for expanding into more remunerative segments in these markets. India does not currently face very stringent standards for horticultural commodities inregionalmarkets or inthe Middle East. The bulk o f Indian produce entering these markets is targeted at the migrant worker community. This low-priced, bulkmarket should remainan attractive outlet for Indian exporters, who benefit from inexpensive and frequent freight links and similarities in diet and culture with the targeted importers and consumers. Yet there should also be potential to more firmly tap into the expanding high-end market segment in the Middle East, especially supermarkets. The required standards do not match those applicable at the higher end in Europe, although buyers for these supply chains will increasingly want evidence o f "good agnculturalpractices" and produce traceability. There i s a need to institute stronger monitoring and evaluation components to gauge the effectiveness o f various investment and incentive schemes andor instruments made available by the central and state governments to promote horticultural exports and facilitate the upgrading o f postharvest practices, infrastructure, and quality assurance systems. For instance, there are plans for more than 48 Agricultural Export Zones (AEZs) for horticultural crops. Carefully evaluating the performance o f some o f these schemes will have large payoffs in terms o f future strategic decision making and resource allocation. There i s also a need to rationalize various subsidy schemes and make some o f them easier for the private sector to access. There i s a need to carefully assess the costs and benefits o f standards compliance and evaluate the trade-offs. Investments in phytosanitary and food safety risk assessment and mitigation should be guided by the market potential of the export commodity. For example, all things considered, it i s not obvious that the likely costs and administrative attention required for Indian mangoes to gain access to the Australian market would match the benefits of participating inthat market, given its probable size. Achieving compliance at a potentially high cost would not make sense if the actual commercial potential o f this trade i s limited. The experience to date has been that the government has taken disproportionate responsibility for managing SPS-related "crises." It i s often assumed that the management o f food safety and agricultural health i s predominantly the responsibility o f the public sector. Indeed, many crucial regulatory, research, and management functions are normally canied out by governments. In a variety o f circumstances, importing countries require certain functions to be performed by a designated "competent authority" inthe public sector. The private sector also has fundamentally important roles to 102 play, however, in the process o f setting standards and in the actual compliance with food safety and agricultural health requirements. Experience elsewhere demonstrates that capacity building in the private sector can complement (or even substitute for) public sector capacity, including inresearch and development and conformity assessment (inspection, certification, and testing). This report contains both general and very specific recommendations pertaining to the redefinition o f public and private sector roles and responsibilities inmanaging SPS-related challenges inIndianhorticulture. There i s a much greater need for collective action by the private sector. International experience highlights the importance o f collective action within the private sector to promote awareness o f SPS matters, to find technical and institutional solutions to emerging challenges, to implement programs to promote "good" agricultural or manufacturingpractices, and otherwise provide a degree o f self-regulation, which then reduces the need for government agencies to play enforcement roles. Indian horticulture presents many instances in which limited cooperation among private sector actors has either created a vacuum that the government has had to fill or has forced individual firms to tackle problems on their own. For example, the absence o f an organized forum among Indian grape exporters has prevented any self-regulation, with APEDA filling the void with a mandated system of multistage government oversight. For crops with limited potential for short-term export development, it would be important to carefully weigh the benefits o f reorientingproduction to the specifications o f the export market versus strengthening the industry's practices and quality consciousness to increase productivity and provide India's own consumers with a better-quality and safer product. Given the size and anticipated growth of the domestic market, there could well be far greater financial and social benefits from a program centered on improving the domestic supply chain rather than on prospective exports. Doing so may also serve as a means o f deflecting import competition from exporters such as the Philippines, assuming that on-going trade reforms will lead to a similar degree o f import liberalization as has occurred for other fruit. The emerging dynamics in the domestic market, especially the modernization o f retail, will likely have a far more significant impact on Indian farmers and traders than the export market. As the food retail sector modernizes, the focus will initially be on convenience and quality, but over time more emphasis will be gwen to food safety parameters in the modernized sector. The growth o f the modem food retailing sector will likely induce extensive changes in the structure o f production and product aggregation. Greater supply chain coordination will occur in parallel with more traditional supply chains involving multiple intermediaries and sales through wholesale markets. The more coordinated supply chains for the domestic market could also provide an improved platform for exports o f certain fresh h i t s and vegetables, although the value-addition that will occur in the domestic market will likely dwarfthat which couldbe obtained through exports. Prospects for exports o f fresh horticultural produce to developing countries and processed products to high-income markets are the strongest. India exports a diverse range o f horticultural products. Among its various fresh horticultural exports, India has had the greatest success with supplying onions and mangoes to other developing countries. Exports o f fresh produce to high-income countries are small and have not exhibited much dynamism. India has had considerably more success in exporting processed horticultural products-including mango pulp, processed gherkins, dehydrated onions, and various traditional foods-to high-income markets. Although greater public sector attention has been devoted to promoting fresh horticultural exports to high-income countries, India's competitive prospects are likely to remainbetter in (1) fresh produce sales to rapidly growing developing countries and (2) processed food sales to higher-income countries. Such export supply chains also involve comparatively larger numbers o f farmers and firms, providing scope for the benefits from trade to spread more broadly. 103 Annex Tables Source: Ministryo f Agriculture. Note: DM= direct marketing; CF= contract farming; PM =private sector market development. 104 Source: Ministry of Agriculture 2002. Note: NA =not available; F&V = fruits and vegetables. a Kamataka charges an additional 1% sales tax and charges a resale tax o f 1.73% (1.5% basic and 15% surcharge). 105 I c c b c C c b C ? I L i 1 e r .1c I I Source:Fafchamps et a%2006. Note: *denotes significantly different from the NSS state average at lo%,** at 5%, *** at 1%. Some entries could not be tested due to zero variation inobservationsindata. [what is SUST?] a A person who canbothread and write a simple messagewith understanding in at lease one language. bA "katcha" househasneitherbrick or cementwalls or metalroof. Annex table 3.2: Farmers' sourcesof credit Source: Fafchamps et al. 2006. Nore: TN = Tamil Nadu; OR = Orissa; MH+ Maharashtra; Up = Uttar Pradesh. Annex table 3.3: Constraints to increasedhigh-value crop production I Proportion of villages facing contraints by state I Source; Fafchamps et a12006. Note: TN = Tamil Nadu; OR = Orissa; MH+ Maharashtra; UP = Uttar Pradesh. 110 Annex table 3.4: Postharvestoperationsperformedby farmers Percentageof farmersperformingpostharvestactivity Crophtate Milling/ Source: IndiaAgricultural Marketing Survey 2005, authors' calculation Note: TN = Tamil Nadu; OR= Orissa; MH+ Maharashtra; UP = Uttar Pradesh 111 Source: India Agn'cultural MarketingSurvey 2005, authors' calculations. Note:Probit analysis. Significant at the 1% level (***), 5% level (**), 10%level (***). 112 Note: TN= Tamil Nadu; OR = Orissa; MH+ Maharashtra; UP = Uttar Pradesh. Source: IndiaAgricultural Marketing Survey 2005; authors' calculation. Annex table4.2: Use of auctions inwholesale markets Ifauction, auctionsystemused(%): Openoutcry 77 100 100 100 95 Bids written on chivpaper 11 100 0 0 2 Electronic bidding 0 0 0 0 0 113 Source:Fafachampset al. 2006. Note: TN= Tamil Nadu; OR= Orissa; MH Maharashti-a; UP = Uttar Pradesh. + Source:Fafachamps et a]. 2006. Note: TN = Tamil Nadu; OR= Orissa; MH Maharashtra; Up = UttarPradesh. + Source: India Agricultural Marketing Survey 2005; authors' calculations. 114 Annex table 4.6: Socioeconomic characteristics of traders Source: Fafchamps et al. 2006. Note: TN = Tamil Nadu; OR = Orissa; MH Maharashtra; Up= Uttar Pradesh. + Note: Medianregression i s used in the analysis;* denotes significant at 5%; ** significant at 1% Source: IndiaAgricultural Marketing Survey 2005; authors' calculations. 115 Source: IndiaAgricultural MarketingSurvey 2005. they buy from Firms reportingthat suppliers basedon buyerspurchasebased sanitaryconditions on sanitaryconditions 63 I 3 86 86 Source: Authors' calculations. Annex Figures Annex figure 2.1: Cold storages established under NHBCold Storage Scheme, 1999/2000to January 2005 2500 500 4464 '3 &450 E 2000 400 0 350 0 0 1500 300 E E 182 250 b m 0 1000 -- 137 + 200 tj P 150 0m 500 100 50 0 0 2 Capacity 000 mt + No of Cold Storages Source: National HorticultureBoard. [need to add to refs?] Note: Values infigure denotenumber of cold storage facilities established. 116 Annex figure 3.1: Irrigation use for tomatoes, potatoes, mangoes, maize, and turmeric in Tamil Nadu, Maharashtra, Uttar Pradesh, and Orissa 100 90 80 70 60 50 40 30 20 10 0 Tail Nadu Maharashtra Uttar Radesh Orissa (55%) (18%) (69%) (29%) maize 19 potato FJtomato mango rn turmeric Source:India Agricultural Marketing Survey 2005; authors' calculations. Annex figure 4.1: Distribution ofwholesale marketsby age it Tamil Nadu, Orissa, Maharashtra, andUttar Pradesh. 1;: 35 If 2o 15 10 5 I 0 All TN OR MH I10vrs c 11-20vrs rn 21-40 vrs 0 =-41vrs up I Source: India Agncultural Marketing Survey 2005; IMRB 2006. Annex fiEure 4.2: Warehouse capacity in India, 2004 v $ 1000 8g 500 7 19 26 29 0 Source Department of Food and Public Distnbution [2005?J Note FCI, CWC, and CWC statistics are only up to 2003 117 Annex figure 4.3: Cold storage capacity in India, 2004 100% 5 f Q) 80% 60% c s I- c 40% f 20% 0% Multi-purpose Fruits & Veg o Milk, Meat & Products Others Source Directorate of Marketing and Inspection, MOA[missing reference/ Note. denotes statistics up to 2003 Numbers inparenthesis refer to cold storage capacity in tons in the state * Annex figure 4.4: Main causesof market disputes I Product Weight Grading Price Payment Payment Other quality terms delays 0Tamil Nadu Orissa Maharashtra E3 Uttar Pradesh Source: IndiaAgricultural Marketing Survey; authors' calculations Annex figure 4.5: Trade credit for traders 60 50 40 30 20 I O 0 Sales Furchases fm Advance paymnt Paid after delivery Source: Fachamps et al. 2006 118 Annex figure4.6: Sourcesof price and market informationby traders Regular customers/ suppliers Wrsonal observation Frequencyof responses,% Source Fafchamps et a1 2006 119 Annex figure: 4.7: Constraintsto agriculturaltrading in Orissa, Uttar Pradesh, Maharashtra, and Tamil Nadu 70 4 '' 60 50 z2 40 30 20 2 10 0 70 13 60 50 E 50 -0 40 I- E 2 30 b 20 C 82 0 10 0 Source: IndiaAgricultural MarketingSurvey 2005; authors' calculations. Note:Figuresrepresentconstraintsratedby trader as moderate,major,and very severe 120 Annex figure5.1: Constraintsto agro-processorsand exportersin Orissa, Uttar Pradesh,Maharashtra, and Tamil Nadu e E 6o 40 50 5- 30 20 0 10 2E 6o 50 40 5 30 20 3 10 cE O 50 Tamil Nadu Source: India Agricultural Marketing Survey 2005; authors' calculations. Note: Figures representconstraints rated byprocessorsand exporters as moderate, major, and very severe 121 dumali-deininger C:Documentsand Settings\wb50891\MyDocumentsL Drivehdia Ag MktgReportFinal GreyWinal Ag reportdoc 10/16/2008 10:55:00Ah4 122