Annals of the Sri Lanka Department of Agriculture. 2008.10:45-54.
ADOPTION OF FORWARD SALE CONTRACTS IN ANURADHAPURA AND MATALE DISTRICTS K.S. KARUNAGODA1, H.P. GUNARWARDHANE2, Y.M. WICKRAMASINGHE2, S.P.R.P. SENANAYAKE3, N.S. KARUNAGODA4 1 Socio-Economics and Planning Centre, Department of Agriculture, Peradeniya 2 Faculty of Agriculture, University of Rajarata, Pulliyankulama 3 Faculty of Agriculture, University of Peradeniya, Peradeniya 4 Regional Development Department, Central Bank of Sri Lanka, Colombo
ABSTRACT Although Forward Sale Contract System (FSCS) offers a mechanism to reduce price risk, few percentages of farmers have joined the programme. The factors affecting the adoption of FSCs are evaluated using a sample of rice, maize and onion growers in Anuradhapura and Matale districts. The analyses indicate that scale of operation, contacts with village extension agents and participation in social activities positively influence adoption decision while farmers with off-farm income and higher household income are most unlikely to participate in the FSCs. The results indicate that the FSCS has provided a reasonable hedging mechanism to farm households which depend more on agricultural income and those who have invested more on selected crops. The promotional programmes of the FSCS would effectively be carried out through the agricultural extension system. The higher capital requirement per contract and price instability of products may act as main barriers for the promotion of the FSCS system. KEYWORDS: Adoption, Maize, Onion, Rice, Socio-economic factors.
INTRODUCTION Development policies of the agricultural sector mainly focus on the alteration of biological, institutional and technological progress that helps to bring about a sustainable increase in agricultural production and farmers’ living standards in Sri Lanka. Although, research and development efforts are geared to increase the output of agriculture, less emphasis has been placed on the improvement of marketing and distribution system. In this context, the development of marketing of agricultural products has become a bottle neck to the growth efforts of agriculture in Sri Lanka. Supply response of rice, field crops and vegetables is significantly influenced by weather and the expected prices. The fluctuation of the production and the price of agricultural commodities go in a vicious circle where the seasonality adds a high degree of uncertainty. Thus, the development of a mechanism to minimize uncertainty of future prices would help overcome the undesirable effects of fluctuation in agricultural production and prices. In 1999, Central Bank of Sri Lanka (CBSL) introduced a Forward Sale Contract System (FSCS) to overcome the price and marketing
46 KARUNAGODA et al.
uncertainties faced by the farmers and uncertainty of input availability faced by the processors. The FSCS operates through the coordination of different stakeholders including participation of financial institutions, buyers, farmers, farmer organizations, government and non-government organizations etc. A Forward Sale Contract (FSC) is a legally binding agreement between the buyer and the seller. The seller agrees to sell a specified quantity of an agricultural produce of a specified quality on a given future date at a predetermined price. Such contracts amount to marketing agreements in advance, which would secure a confirmed order to the seller and on the other hand, an assured supply to the buyer. In this system, provision has been made for a bank to participate as a facilitator of the contract. The bank brings the buyer and the seller together to determine the contract price. The FSCS helps in strengthening the agricultural supply and management of the supply chain with the reduction of marketing cost and price stabilization. The contract price is determined on the cost of production (50% margin to cost of cultivation), and the retail price (for commodities with high seasonal price variation), or the border price of the commodity (import competing products). The choice of the most appropriate method depends on the commodity itself and various other factors such as the variation of farm gate price and retail price etc. (Govi Sahanaya, 2000). Even though the FSCS promises benefits to all stakeholders, the level of adoption is very low (CBSL, 2006). Hence, this study was carried out to investigate the level of adoption of the FSCS, examine the socio-economic factors that contribute to farmers’ participation in the FSCS and identify the difficulties encountered by the farmers in adopting the system. MATERIALS AND MEHODS Model Dorfman (1996), Goodwin and Schroeder (1994) noted that agricultural producers face uncertain outcomes when adopting innovations and the decision on adoption of some marketing techniques. Lowell and Kau (1973) indicated that decision on adoption of an innovation can be explained using a threshold theory of decision in which a reaction occurs only after the strength of the stimuli increases beyond farmers’ reaction threshold 1. Rahm and Huffman (1984) concluded that the rate of adoption of an innovation increases with increased education level. Byerlee and Polanco (1986) have used a step wise approach to the adoption of a package that reflects the characteristics of each component and the interactions between them and profitability, risk, divisibility, initial capital requirements, complexity and availability of the technologies are identified as significant factors. 1
It was hypothesized that there exists a “breaking point” or threshold in the dimension of the explanatory variable bellow which a stimuli elicits no observable response. Only when the strength of the stimuli reaches the threshold level does a reaction occur.
ADOPTION OF FORWARD SALE CONTRACTS 47
The participation in the FSCS adoption decision is dichotomous in nature and therefore, a binary choice model was selected for the evaluation. The factors those affect the adoption of FSCS were related to the socioeconomic characteristics of the farmers. Logistic curves of cumulative adoption levels were fitted to describe the adoption path considering the following representation; Y *i = β 0 +
k
∑
j= 1
β j χ ij + u i ………………………………………………....1)
The observable dummy variable Yi defined by; Yi = 1 if Y* > 0, Yi = 0 otherwise, ui is the error term and k Pi = Prob(Yi = 1) = prob ui > − ( β 0 + ∑ β j χ ij j= 1 k = 1 − F β 0 + ∑ β j χ ij …………………………..…..2) j= 1 Where F is the cumulative distribution function of error term U. If the distribution of error term is symmetric, observed Yi were realization of a binomial process with probabilities (Pi) given by equation 3. Pi = F β 0 +
β j χ ij …………………………………………….……...3) j= 1 k
∑
The likelihood function can be written as; L=
∏
yi = 1
Pi ∏ (1 − P ) yi = 0
If the cumulative distribution of Ui is logistic2; F (Z ) =
exp( Z i ) 1 + exp( Z i )
Where Z i = β 0 +
k
∑
j= 1
β j χ ij
F (Z i ) = Zi 1 + exp( Z i ) 1 Pi = E (Y = 1 / X i ) =
Hence, log
1+ e
2
− (β 0 +
k
∑
β j X ij )
…………………………………..…4)
j= 1
The functional form for F will depend on the assumption made about the error term u.
48 KARUNAGODA et al.
Where Xi is explanatory variables and Y=1 means the farmer desires to adopt an innovation. The equation (4) could be written as: 1 Pi = ……………………………………………………………5) 1 + e − Zi Where Z i = β 0 +
k
∑
j= 1
β j χ ij
Equation (5) represents the Cumulative Logistic Distribution Function. The value of Z ranges from – ∞ to + ∞ , Pi ranges between 0 and 1 and that Pi is nonlinearly related to Zi. If Pi the probability of Y=1, is given by (4), then (1-Pi) the probability of Y= 0 is; 1 1 − Pi = …………………………………………………....…..6) 1 + e Zi Therefore; Pi 1 + e Zi = = e Z i ………………………………………….…….7) − Zi 1 − Pi 1 + e k P log i = β 0 + ∑ β j χ ij …………………………………………..…8) 1 − Pi j= 1 The left hand side of the equation (7) indicates the odds-ratio. The log odds-ratio is a linear function of the explanatory variables (equation 8) (Gujarati, 2007). The logit model was used to determine the factors that influence farmer participation in the FSCS (1= farmer joined, 0=farmer did not join). The independent variables were farmer’s age (age), land holding area (land extent), level of farmer education (above secondary =1, below secondary =0), access to extension services and social participation (0 for farmers with score less than 2 and 1 for farmers with score more than 2) and income level and source of income. Access to extension service was measured using a score developed and based on the farmer’s interactions with the extension agencies. Social participation has been defined as the degree to which an individual participated voluntarily in different organizations in the community and whether he held executive positions. The extent of participation was measured by summing up involvement in community organizations as an executive member, committee member, ordinary member, or none, with a weight of 4,3,2 and 1 respectively. These variables were measured as a categorical variable with two categories. Number 2 was assigned if farmers scored more than 4 marks and, 1 was assigned if farmers scored less than 4 marks. Off farm employment was a binary variable. If a farmer receives more than 75% of his annual income from sources other than farming, he was assigned one and zero was assigned otherwise.
ADOPTION OF FORWARD SALE CONTRACTS 49
Data The preliminary information collected from the Central Bank of Sri Lanka (CBSL) indicated that the FSCS is popular among growers of rice, big onion, maize, soy bean and the rate of diffusion of FSCS is high in Polonnaruwa, Anuradapura, Monaragala, Ampara, Matale and Hambanthota districts. Anuradhapura and Matale districts were selected for the study because of the proportion of adoption of FSCs in these districts was relatively high. Two villages were purposely selected from Matale (Wewala) and Anuradhapura (Kudapattiya) districts using the information provided by the Central Bank’s Regional Office at Anuradhapura and Kandurata Development Bank at Dambulla. A random sample of 50 farmers was selected for each crop (onion, paddy and maize) from Wewala (onion) and Kudapattiya (maize and paddy). The data collected included information of the farmer (age, education, occupation, farming experience), income, particulars of land ownership, information on social participation (participation in common village activities) and contacts with extension agents, storage facilities, knowledge of farmer on FSCs and problems encountered by the farmer. Data collection was carried out in 2006. RESULTS AND DISCUSSION The progress of the FSCS during the period of 2004 - 2006 is presented in the Tables 1, 2 and 3. Accordingly, FSCS was in operation for maize, paddy, soybean, green gram, finger millet, ginger, sesame, papaya, sunflower and vegetables. When compared with the total number of contracts signed in 2004, the number of contracts signed in 2005 has increased by 111%. The number of farmers benefited by FSCs during the same period has increased by 132%. Maize showed the highest growth (383%) while paddy showed a marginal growth of 9% during the period of 2004 to 2005. The contract grower system was popular in maize and soybean. The development of maize and soy-based food industry, increase in world market prices and the concern on genetically modified organisms may have encouraged the local food processors to rely more on local suppliers. In these crops, the firms provide inputs and extension services to farmers and the presence of FSCs may have encouraged processors to initiate FSCs. In 2006, positive development in number of contracts is seen only in paddy but in all other crops it showed a decline (Table 1). The increase in area under maize in 2005 and 2006 may have induced the processors not to enter in FSCs due to lower (higher) risk of availability (price instability) of products. When compared with the number of farmers who cultivate these crops, the level of adoption of FSCS was very low. Contract prices in a given year showed a variation and it was mainly attributed to the geographical location and variety (Table 2).
50 KARUNAGODA et al. Table 1. Forward sale contracts: 2004-2006. Crop
2004 No. of contracts
Maize Paddy Soybean Green Gram Finger millet Other crops* Total
7,048 13,130 5,442 5,335 1,813 9,075 32,768
No. of farmers benefited 7,102 13,470 5,520 5,443 1,890 9,940 33,425
2005 No. of contracts 34,071 14,270 6,700 1,200 520 12,410 69,171
2006 No. of contracts
No. of farmers benefited 40,500 16,200 6,700 1,200 540 12,410 77,550
6,,667 23,033 4,325 988 101 553 35,667
No. of farmers benefited 7,194 23,585 4,325 1,038 832 847 42,821
* Includes ginger, sesame, papaya, sunflower and vegetables.
Source: Central Bank of Sri Lanka Table 2. Forward sale price (Rs/kg): 2004-2006. Crop Maize Paddy Soybean Green Gram Finger millet Other crops*
2004 14-18 13-16 20-25 27-30 45-50 25-375
2005 16-18 14-17 30-38 47-52 20-25 20-370
2006 14-18 11-18.5 25-30 50-65 35-45 20-65
* Includes ginger, sesame, papaya, sunflower and vegetables. Source: Central Bank of Sri Lanka
The buyers are entitled to low interest bank loans (7% per annum in 2006) and the maximum limit of the loan was revised from Rs. 25 million in 2004 to Rs. 50 million in 2005 (CBSL, 2005 and CBSL, 2006). The amounts of loan granted were Rs. 2,412 and 2,637 millions in 2005 and 2006 respectively (CBSL, 2005 and CBSL, 2007) (Table 3). The credit per contract was quite large and it indicated that the credit component also played a significant role in the FSCs. Table 3. Loans granted for forward sale contracts: 2005 and 2006. Crop
Maize Paddy Soybean Green Gram Finger millet Other crops* Total
2005 Amount (Rs. Million) 687 745 375 51 14 540 2,412
per contract (Rs.) 16,963 45,987 55,970 42,500 25,926 43,513 31,102
* Includes ginger, sesame, papaya, sunflower and vegetables. Source: Central Bank of Sri Lanka
2006 Amount (Rs. Million) 132.5 2,243.0 178.1 59.2 11.0 23.7 2,637.5
per contract (Rs.) 18,348 78,467 41,179 57,032 13,221 16,175 61,594
ADOPTION OF FORWARD SALE CONTRACTS 51
A summary of the characteristics of the farmers surveyed in the selected villages are provided in the Table 4. Education up to primary level was prominent in all three cases while a small percentage of farmers had tertiary level education. The land holding sizes varied with the crops investigated and it was less than 3 ac (1.2 ha) for majority of onion and maize samples while the sample of paddy included a prominent group of farmers with more than 3 ac (1.2 ha) of land holding. The results of the three logistic models are summarized in the Table 5. For paddy and maize farmers, off-farm employment, land holding size, participation in social activities and access to extension service activities were the determining factors of participation in the FSCS. In case of maize farmers, other than the above factors, indebtedness and farming experience showed a significant relationship. Farming experience, land holding sizes (low land and high land) and household income were the determinants of participation for onion growers. Table 4. Characteristics of the Study Samples. Farmer attributes Age (Average yrs) Family size (members) (mode) Education Primary Secondary Tertiary Land holding size <1ac 1-3ac >3ac Farming experience >10 yrs < 10 yrs Involved in Off-farm employment Yes No Access to extension High Low
Anuradhapura Paddy Maize 40 41 3-5 3-5
Matale Onion 43 3-5
54% 36% 10 %
50% 38% 12%
34% 54% 12%
20% 34% 46%
22% 64% 14%
64% 36%
62% 38%
58% 42%
90% 10%
44% 56%
54 % 43%
42% 58%
48% 52%
54% 46%
34% 63%
It was also found that farmers (paddy and maize) whose livelihood was mainly dependent on off-farm employment or with higher household income (onion), were reluctant to adopt the FSCs. This indicates that the tendency to join the programme decreases with the farmers` nonagricultural income opportunities. Higher social participation was positively co-related with the adoption of FSCS (paddy: odds in favor increase by 11)
52 KARUNAGODA et al.
and maize farmers (odds in favor increase by 7.4). This may be due to the fact that higher social participation makes farmers aware and it persuades farmers to join the FSCs. Access to extension service significantly influenced the paddy and maize farmers` decision. Land holding size increased the odds in favour of adopting FSCs in all crops. In case of onion farmers, the separation of land holding size into lowlands and highlands showed a different result and higher low land extent reduced the odds in favour of joining the FSCS while higher onion and maize extent favoured adopting decisions. The larger extent was associated with more output and higher risk in returns. Thus, the farmers may like to hedge against the price risk by adopting the FSCs. Though education plays a significant role in the adoption decision, it was not significant. Farming experience showed positive and significant relationship for maize and onion growers. Table 5. Determinants of Participation of FSCS. Crop Paddy
Model P (Y = 1) log = − 10.25 * * − 2.7 * * X 1 + 2.06 * * * X 2 + 2.43 * * X 3 + 2.82 * * X 4 P (Y = 0) (4.08) (1.06) (0.65) (1.18) (1.34) Where X1= Off-farm employment, X2=Land extent (total), X3= Social participation, X4=Access to extension service,
Maize
P(Y = 1) = − 13.73 * * − 4.22 * * * X 1 + 1.99 * * * X 2 + 1.99 * X 3 + 1.99 X 4 + 2.42 * X 5 + 1. P(Y = 0) (5.79) (1.66) (0.71) (1.36) (1.36) (1.13) (0.93) (0.21) Where X1= Off-farm employment, X2=Land extent (Total), X3= Social participation, X4=Access to extension service, X5=Farming experience, X6=Indebtedness, X7=Education
Onion
P (Y = 1) = 5.55 − 0.16 X 1 + 0.76 X 2 − 0.21X 3 + 0.23 * * X 4 + 0.77 * * X 5 − 1.15 * * X 6 − 0 P (Y = 0) (3.46) (0.80) (0.48) (0.14) (0.11) (0.36) (0.50) (0.16) Where X1= Age , X2=Family size, X3= Level of education, X4= Farming Experience, X5= Land Holding-High land, X6=Land Holding-low land, X7= Household Income level
log
log
Note: Figures in the parenthesis are standard errors. *, ** and *** indicate statistical significant at 10, 5, 1% level respectively.
About 22% farmers in Wewala village have joined FSCS since its inception in 1999. The percentage of farmers joined the program in Kudapattiya village was about 26%. The majority of farmers were aware of the FSCS and only 26% of the non-adopters had no idea about the system. The suspicion about the agreement (36% of non- adopters) was one of the main reasons for non-adoption and it had arisen mainly due to less acquaintance with the buyers and the suspicion on the strength of the
ADOPTION OF FORWARD SALE CONTRACTS 53
agreement on fulfilling stipulated conditions by buyers under more favourable (unfavourable) market prices. The majority of farmers depended more on the conventional marketing channels and a very small percentage of farmers had thought of possible alternatives for the reduction of risk through the marketing strategies. Majority (75%) of farmers did not have sufficient storage facilities and they were unable to keep the harvest for sometime until the buyers come to fulfill the contractual agreement. The FSCS envisages the determination of contract prices by various methods but the price determination of products seems highly influenced by the prices which prevailed in the past season 3. The violation of the agreement was observed in both parties (buyers and sellers) and the main reason for the violation was unfavourable price change at the market. These observations indicated that the price stability, forecasting system, improvement of information, etc. would improve the benefits of the FSCS. CONCLUSIONS Although FSCS offers a mechanism to reduce producerâ&#x20AC;&#x2122;s price risk, the proportion of farmers who joined the program was low. The analyses indicated that land extent, participation in social activities, contacts with village extension agent positively influenced the adoption decision. Higher off-farm income or higher household income reduced the chances of participation in the FSCs. The average loan per contract was fairly high and the availability of loans may have acted as a barrier for FSCs and it needs further investigations. The determinants of participation indicated that FSCs provides a reasonable hedging mechanism to farm households who depend more on agricultural income and those who have invested more on agricultural activities. Therefore, farmers have identified the FSCs as a mechanism to reduce the price (income) and marketing risks. Promotional campaign of FSCs may effectively be carried out through the agricultural extension system. The uncertainty of future prices could further be reduced through the consistent trade policies and development of intuitional structure for better information. Thus, the programme requires additional institutional support to the three parties involved. Marketing of agricultural products is still a major concern of the majority of farmers in the villages surveyed. The marketing strategies adopted by farmers in the selected villages were not diversified due to various constraints. Diversification of marketing strategies such as focusing on specific market windows, aiming at specific markets, selling of value added products etc. together with forward contacting would provide better solution to the price and marketing problems faced by the farmers. 3
Observation of the survey, 2006
54 KARUNAGODA et al.
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