Bill & Melinda Gates Foundation

Risk management is the way forward for farming

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September 18, 2018

Large numbers of low-income families the world-over depend on agriculture as their primary source of income.  Agriculture is however a challenging sector and several issues prevent farmers, in particular small-holders, from realizing greater incomes. These include, low yields, weak market linkages, high price volatility, limited risk management, and poor price realization.  Given the very large numbers of people involved, addressing these concerns of farmers is an important goal of public policy.  For farmers’ incomes the keys to transformative growth are, among other things, the two areas of price and yield risk management.

Price risk management: Like other commodities market prices of agricultural products are highly volatile.  Spot, futures, forwards, and options are essential tools which accurately transmit market signals to farmers and simultaneously allow them to choose the risk management approach that is best suited for them without relying on ex-post subsidies should markets turn adverse.   A number of countries have focused on making these tools easily available to farmers.

In Australia for example, both farmers and buyers are able to purchase the necessary forward contracts and put and call options on agricultural products directly from their banks. Here cotton growers are the most prominent users of these tools to manage price risk and around 20% of wheat growers use market price risk management techniques such as futures contracts, options, and over the counter products like swaps.  Easy access to these products and services has transformed the incomes and risk exposure of these farmers allowing them to respond to market signals by purchasing the level of protection that they need at market prices and altering their cropping patterns where necessary.   

In Brazil, in response to a fall in bank finance for agriculture, the Bank of Brazil introduced an instrument called Сedula de Produto Rural (CPR), a tradeable product note, which represents a promise to supply a fixed quantity of agricultural produce in the future (tradable CPR, introduced in 1994) or its future financial value (financial CPR, introduced in 2001).  Farmers are able to sell CPRs to raise financing.  These instruments allow them to both raise financing at a competitive price, as well as transfer the commodity price risk to the buyer. CPRs in Brazil are deemed to be to be securities and are actively traded on the commodity exchange.  Commercial banks are permitted to participate in these contracts as well. The quantum of finance being raised by farmers in Brazil through this route is to the extent of 40% of total financing whereas traditional bank financing amounts only to 30%. 

Yield risk management: While effective management of price risk is essential, it is also equally important for the farmer to be able to effectively manage the risks to the yield that she is able to get from her farm. Crop insurance incentivizes farm investment and increases farmers’ ability to absorb shocks. However, to be effective at scale, technological tools like remote sensing and machine learning for better standardization and quality assurance of underlying crop data are needed to streamline decision making processes between insurance providers and farmers. 

In the United States, where 90 percent of farmland is covered by insurance, companies have started to use drone technology to gather data on insurance claims following adverse weather events that affect production. Drone footage can be assessed using machine learning and computer vision software to increase the speed, reliability and targeting of claims processing and make payouts faster. In Europe, new agricultural technology companies are offering solutions in areas such as data intelligence and processing, farm mechanization, and robotics. By combining satellite data with artificial intelligence, weather information, and drone-based soil mapping, technology can, for example, be used to optimize planting periods, forecast crop yields, detect pests and diseases, and even help pin-point for the government where new irrigation projects need to be located for maximum impact.  For example, a recent agreement between PartnerRe, a US based, diversified reinsurer, and Farmers Edge, an American decision-agriculture company, will allow farmers to access customized insurance products with integrated precision-farming capabilities.  Insurers will also benefit from a more efficient loss adjustment process.

If farmers, the world-over, including in emerging economies such as India, are able to benefit from such approaches towards price and yield risk management, they will be able to build a great deal of resilience in their approaches towards agriculture while responding accurately to the signals from the wider agricultural market.

This article was originally published in Hindustan Times on Sep 13, 2018

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