2011

Role of Agri-Finance Institutions in Financing Agri Projects

Final Project Report
In partial fulfillment of the requirement for the award of the two year full time Post Graduate Program-Agri Business Management Project Guide-Prof. Nishant Singh

Mithlesh Shukla, PGP-ABM, Unitedworld School of Business, Ahmedabad 3/28/2011

Acknowledgement
I would like to convey my heartiest gratitude to several people, for their support and guidance, which helped me to complete this project. I wish to take this opportunity to thank Mr. B S Bhatia, Dean, Unitedworld School of Business, Ahmedabad for permitting me to undertake this project. I also acknowledge our thankfulness to Prof. Nishant Singh, Project Guide for his valuable suggestions and support in completion of this project. Last but not least, my endless appreciation goes to my family, who has stood by my side and given me moral support whenever I was low and boosted my will power. Thank You.

Declaration
I Mithlesh Shukla, student of Unitedworld School of Business, Ahmedabad, hereby declare that the project report titled Role of Agri-Finance Institutions in Financing Agri Projects has been done by me in partial fulfillment for the award of the two year full time Post Graduate Program-Agri Business Management. I also declare that this project report submitted to Unitedworld School of Business is the result of my own effort and has not been submitted to any other institution for the award of the degree or diploma.

Place: Ahmedabad Date: 28th March, 2011 Mithlesh Shukla, PGP-ABM, Unitedworld School of Business, Ahmedabad

Table of Contents
Acknowledgement................................................................................................................................... 2 Declaration.............................................................................................................................................. 3 Executive Summary ................................................................................................................................. 6 Introduction ............................................................................................................................................ 7 Background of Agriculture Growth Rate in India ...................................................................................... 8 Structure of Agricultural Credit System in India ..................................................................................... 10 Types of Agricultural Credit ................................................................................................................... 11 On the basis of Time .......................................................................................................................... 11 Short Term .................................................................................................................................... 11 Medium Term ................................................................................................................................ 11 Long Term ..................................................................................................................................... 11 On the basis of Purpose ..................................................................................................................... 11 Productive ..................................................................................................................................... 11 Consumption ................................................................................................................................. 11 Unproductive................................................................................................................................. 11 Sources of Agricultural Credit ................................................................................................................ 12 Non-institutional Credit Agencies ...................................................................................................... 12 Traders and Commission Agents .................................................................................................... 12 Landlords ....................................................................................................................................... 12 Money Lenders .............................................................................................................................. 12 Institutional Credit Agencies .............................................................................................................. 12 Government .................................................................................................................................. 12 Cooperative Credit Societies .......................................................................................................... 13 Commercial Banks ......................................................................................................................... 13 Regional Rural Banks...................................................................................................................... 13 Agency Wise share of Credit Flow to Agriculture ............................................................................ 14 Micro financing .............................................................................................................................. 15 Trends in Agricultural Credit .................................................................................................................. 15 State-wise Distribution of Institutional Credit ........................................................................................ 20 Problems in Agricultural Credit System .................................................................................................. 22 Transaction Costs of Agricultural Credit ............................................................................................. 22

Loan Overdue .................................................................................................................................... 22 Economic Viability of Rural Credit Institutions.................................................................................... 23 Access to Institutional Credit of Small Farmers .................................................................................. 23 Indebtedness among the Farmers...................................................................................................... 24 Conclusion............................................................................................................................................. 25 Bibliography .......................................................................................................................................... 26

Executive Summary
This report attempts to analyse the role of Agri-Finance Institutions in Financing Agri Projects and other agricultural activities and issues in agricultural credit in India. The analysis reveals that the credit delivery to the agriculture sector continues to be inadequate. It appears that the banking system is still hesitant on various grounds to purvey credit to small and marginal farmers. The situation calls for concerted efforts to augment the flow of credit to agriculture, alongside exploring new innovations in product design and methods of delivery, through better use of technology and related processes. Facilitating credit through processors, input dealers, NGOs, etc., that are vertically integrated with the farmers, including through contract farming, for providing them critical inputs or processing their produce, could increase the credit flow to agriculture significantly.

Introduction
Finance in agriculture is as important as development of technologies. Technical inputs can be purchased and used by farmer only if he has money (funds). But his own money is always inadequate and he needs outside finance or credit.

Professional money lenders were the only source of credit to agriculture till 1935. They use to charge unduly high rates of interest and follow serious practices while giving loans and recovering them. As a result, farmers were heavily burdened with debts and many of them perpetuated debts. There were widespread discontents among farmers against these practices and there were instances of riots also.

With the passing of Reserve Bank of India Act 1934, District Central Co-op. Banks Act and Land Development Banks Act, agricultural credit received impetus and there were improvements in agricultural credit. A powerful alternative agency came into being. Large-scale credit became available with reasonable rates of interest at easy terms, both in terms of granting loans and recovery of them. Although the co-operative banks started financing agriculture with their establishments in 1930s real impetus was received only after Independence when suitable legislation were passed and policies were formulated. Thereafter, bank credit to agriculture made phenomenal progress by opening branches in rural areas and attracting deposits.

Till 14 major commercial banks were nationalized in 1969, co-operative banks were the main institutional agencies providing finance to agriculture. After nationalization, it was made mandatory for these banks to provide finance to agriculture as a priority sector. These banks undertook special programs of branch expansion and created a network of banking services throughout the country and started financing agriculture on large scale. Thus agriculture credit acquired multi-agency dimension. Development and adoption of new technologies and availability of finance go hand in hand. In bringing "Green Revolution", "White Revolution" and now "Yellow Revolution" finance has played a crucial role. Now the agriculture credit, through multi agency approach has come to stay.

The procedures and amount of loans for various purposes have been standardized. Among the various purposes "Crop loans" (Short-term loan) has the major share. In addition, farmers get loans for purchase of electric motor with pump, tractor and other machinery, digging wells or boring wells, installation of

pipe lines, drip irrigation, planting fruit orchards, purchase of dairy animals and feeds/fodder for them, poultry, sheep/goat keeping and for many other allied enterprises.

Background of Agriculture Growth Rate in India

Agriculture Growth Rate in India GDP had been growing earlier but in the last few years it is constantly declining. Still, the Growth Rate of Agriculture in India GDP in the share of the country's GDP remains the biggest economic sector in the country. India GDP means the total value of all the services and goods that are produced within the territory of the nation within the specified time period. The country has the GDP of around US$ 1.09 trillion in 2007 and this makes the Indian economy the twelfth biggest in the whole world.

The growth rate of India GDP is 9.4% in 2006- 2007. The agricultural sector has always been an important contributor to the India GDP. This is due to the fact that the country is mainly based on the agriculture sector and employs around 60% of the total workforce in India. The agricultural sector contributed around 18.6% to India GDP in 2005.

Agriculture Growth Rate in India GDP in spite of its decline in the share of the country's GDP plays a very important role in the all round economic and social development of the country. The Growth Rate of the Agriculture Sector in India GDP grew after independence for the government of India placed special emphasis on the sector in its five-year plans. Further the Green revolution took place in India and this gave a major boost to the agricultural sector for irrigation facilities, provision of agriculture subsidies and credits, and improved technology. This in turn helped to increase the Agriculture Growth Rate in India GDP.

The agricultural yield increased in India after independence but in the last few years it has decreased. This in its turn has declined the Growth Rate of the Agricultural Sector in India GDP. The total production of food grain was 212 million tonnes in 2001- 2002 and the next year it declined to 174.2 million tonnes. Agriculture Growth Rate in India GDP declined by 5.2% in 2002- 2003. The Growth Rate of the Agriculture Sector in India GDP grew at the rate of 1.7% each year between 2001- 2002 and 2003- 2004. This shows that Agriculture Growth Rate in India GDP has grown very slowly in the last few years.

Agriculture Growth Rate in India GDP has slowed down for the production in this sector has reduced over the years. The agricultural sector has had low production due to a number of factors such as illiteracy, insufficient finance, and inadequate marketing of agricultural products. Further the reasons for the decline in Agriculture Growth Rate in India GDP are that in the sector the average size of the farms is very small which in turn has resulted in low productivity. Also the Growth Rate of the Agricultural Sector in India GDP has declined due to the fact that the sector has not adopted modern technology and agricultural practices. Agriculture Growth Rate in India GDP has also decreased due to the fact that the sector has insufficient irrigation facilities. As a result of this the farmers are dependent on rainfall, which is however very unpredictable.

Agriculture Growth Rate in India GDP has declined over the years. The Indian government must take steps to boost the agricultural sector for this in its turn will lead to the growth of Agriculture Growth Rate in India GDP.

Structure of Agricultural Credit System in India

(Source: Reserve Bank of India Bulletin November 2004 Issue)

Types of Agricultural Credit

On the basis of Time
Short Term Short term credit is generally provided for periods up to 15 months. This type of credit is given for purchase of seeds, fertilizers, pesticides, feeds, marketing of agricultural produce, payment of wages of hired labour. Medium Term Medium term credit is provided for periods from 15 months to 5 years. This type of credit is given for purchase of cattle, small agri implements, repair and construction of wells. Long Term Long term credit is provided for periods above 5 years. This type of credit is given for purchase of land, permanent improvements of land, digging of tube wells, purchase of larger agri implements, machinery like tractors and repayments of old debts.

On the basis of Purpose

Productive This type of credit is given for purchase of seeds, fertilizers, pesticides, feeds, marketing of agricultural produce, payment of wages of hired labour. Consumption Between the moment of marketing of agricultural produce and harvesting of next crop, there is long interval of time and most of the farmers dont have much income to sustain in this period. Also times of flood, drought and damages to crop etc. Unproductive This type of credit is provided for the purposes such as litigation, performance of marriages, birth or death, religious functions, festivals, etc.

Sources of Agricultural Credit

Non-institutional Credit Agencies
Traders and Commission Agents Traders and commission agents advance loans to agriculturists for productive purposes against their crop without completing legal formalities. It often becomes obligatory for farmers to buy inputs and sell output through them. They charge a very heavy rate of interest on the loan and a commission on all the sales and purchases, making it exploitative in nature. It an important source of finance in case of cash crops like cotton, tobacco and groundnut. Landlords Mostly small farmers and tenants depend on landlords for meeting their production and day to day financial requirements. Money Lenders Despite rapid development in rural branches of different institutional credit agencies, village money lenders still dominate the scene. Money lenders are of two types- agriculturist money lenders who combine their money lending job with farming and professional money lenders whose sole job is money lending. A number of reasons have been attributed for the popularity of moneylenders such as: (a) they meet demand for productive as well as unproductive requirement; (b) they are easily approachable at odd hours; and (c) they require very low paper work and advances are given against promissory notes or land. Money lenders charge a very high rate of interest as they take advantage of the urgency of the situation. Over the years a need for regulation of money lending has been felt. But lack of institutional credit access to certain sections and areas had facilitated unhindered operation of money lending. Cooperative credit and self-help groups can play a major role in control of money lending.

Institutional Credit Agencies

Government These are both short term as well as long-term loans. These loans are popularly known as Taccavi loans which are generally advanced in times of natural calamities. The rate of interest is low. But it is not a major source of agricultural finance.

Cooperative Credit Societies The history of cooperative movement in India dates back to 1904 when first Cooperative Credit Societies Act was passed by the Government. The scope of the Act was restricted to establishment of primary credit societies and non-credit societies were left out of its purview. The shortcomings of the Act were rectified through passing another Act called Cooperative Societies Act 1912. The Act gave provision for registration of all types of Cooperative Societies. This made the emergence of rural cooperatives both in the credit and noncredit areas, though with uneven spatial growth. In subsequent years a number of Committees were appointed and recommendations implemented to improve the functioning of the cooperatives.

Soon after the independence, the Government of India following the recommendations of All India Rural Credit Survey Committee (1951) felt that cooperatives were the only alternative to promote agricultural credit and development of rural areas. Accordingly, cooperatives received substantial help in the provision of credit from Reserve Bank of India as a part of loan policy and large scale assistance from Central and State Governments for their development and strengthening. Many schemes involving subsidies and concessions for the weaker sections were routed through cooperatives. As a result cooperative institutions registered a remarkable growth in the post-independence India. Commercial Banks Previously commercial banks (CBs) were confined only to urban areas serving mainly to trade, commerce and industry. Their role in rural credit was meager i.e., 0.9 per cent in 1951- 52 and 0.7 per cent in 1961-61. The insignificant participation of CBs in rural lending was explained by the risky nature of agriculture due to its heavy dependence on monsoon, unorganized nature and subsistence approach. A major change took place in the form of nationalization of CBs in 1969 and CBs were made to play an active role in agricultural credit. At present, they are the largest source of institutional credit to agriculture. Regional Rural Banks RRBs were set up in those regions where availability of institutional credit was found to be inadequate but potential for agricultural development was very high. However, the main thrust of the RRBs is to provide loans to small and marginal farmers, landless labourers and village artisans. These loans are advanced for productive purposes. At present 196 RRBs are functioning in the country lending around Rs 9,000 crore to rural people, particularly to weaker sections.

Agency Wise share of Credit Flow to Agriculture

(in percentages)

(Source: NABARD)

Micro financing Micro financing through Self Help Groups (SHG) has assumed prominence in recent years. SHG is group of rural poor who volunteer to organize themselves into a group for eradication of poverty of the members. They agree to save regularly and convert their savings into a common fund known as the Group corpus. The members of the group agree to use this common fund and such other funds that they may receive as a group through a common management.

Generally, a self-help group consists of 10 to 20 persons. However, in difficult areas like deserts, hills and areas with scattered and sparse population and in case of minor irrigation and disabled persons, this number may range from 5-20. As soon as the SHG is formed and a couple of group meetings are held, an SHG can open a Savings Bank account with the nearest Commercial or Regional Rural Bank or a Cooperative Bank. This is essential to keep the thrift and other earnings of the SHG safely and also to improve the transparency levels of SHG's transactions. Opening of SB account, in fact, is the beginning of a relationship between the bank and the SHG. The Reserve Bank of India has issued instructions to all banks permitting them to open SB accounts in the name of registered or unregistered SHGs.

Trends in Agricultural Credit

In India a multi-agency approach comprising co-operative banks, scheduled commercial banks and RRBs has been followed for purveying credit to agricultural sector. The policy of agricultural credit is guided mainly by the considerations of ensuring adequate and timely availability of credit at reasonable rates through the expansion of institutional framework, its outreach and scale as also by way of directed lending. Over time, spectacular progress has been achieved in terms of the scale and outreach of institutional framework for agricultural credit.

Over time the public sector banks have made commendable progress in terms of putting in place a wide banking network, particularly in the aftermath of nationalization of banks. The number of offices of public sector banks increased rapidly from 8,262 in June 1969 to 68,355 by March 2005.

One of the major achievements in the post-independent India has been widening the spread of institutional machinery for credit and decline in the role of non-institutional sources, notwithstanding some reversal in the trend observed particularly in the 1990s.

The share of institutional credit, which was little over 7 per cent in 1951, increased manifold to over 66 per cent in 1991, reflecting concomitantly a remarkable decline in the share of non-institutional credit from around 93 per cent to about 31 per cent during the same period. However, the latest NSSO Survey reveals that the share of non-institutional credit has taken a reverse swing which is a cause of concern (Table 1).

Table 1: Relative share of borrowings of cultivator households from different sources (In percent)

(Source: All India Debt and Investment Survey and NSSO)

Notwithstanding their wide network, co-operative banks, particularly since the 1990s have lost their dominant position to commercial banks. The share of co-operative banks (22 per cent) during 2005-06 was less than half of what it was in 1992-93 (62 per cent), while the share of commercial banks (33 to 68 per cent) including RRBs (5 to 10 per cent) almost doubled during the above period (Chart 1).

Chart 1

The efforts to increase the flow of credit to agriculture seems to have yielded better results in the recent period as the total institutional credit to agriculture recorded a growth of around 21 per cent during 1995-96 to 2004-05 from little over 12 per cent during 1986-87 to 1994-95. In terms of total credit to agriculture, the commercial banks recorded a considerable growth (from around 13 per cent to about 21 per cent), while cooperative banks registered a fall (over 14 per cent to over 10 per cent) during the above period (Table 2).

Table 2: Institutional Credit to Agriculture (Rs. crore)

(Source: Economic Survey and NABARD various issues)

However, the growth of direct finance to agriculture and allied activities witnessed a decline in the 1990s1 (12 per cent) as compared to the 1980s (14 per cent) and 1970s (around 16 per cent). Furthermore, a comparative analysis of direct credit to agriculture and allied activities during 1980s and since 1990s reveals the fact that the average share of long-term credit in the total direct finance has not only been much lower but has also decelerated (from over 38 per cent to around 36 per cent), which could have dampening effect on the agricultural investment for future growth process (Chart 2).

Chart 2

The disaggregated picture as per size-wise distribution of credit reveals that the growth of direct finance to small and marginal farmers witnessed a marked deceleration from about 24 per cent in the 1980s to little over 13 per cent during the 1990s.

Sectoral deployment of gross bank credit reveals that the share of agriculture since the second half of 1990s has ranged between 11-12 per cent. As at end March 2006, the share stood at around 11.9 per cent (Table 3).

Table 3: Sectoral deployment of gross bank credit (Rs. crore)

(Source: Report on Trend and Progress of Banking in India, various issues)

State-wise Distribution of Institutional Credit

There are wide variations in the availability of institutional credit per hectare of gross cropped area in different States. It was as high as Rs.9,403 in Tamil Nadu, Rs.7,666 in Kerala, Rs.5,352 in Punjab and Rs.4,604 in Andhra Pradesh, while it was as low as Rs.311 in Assam, Rs.667 in Rajasthan and Rs.698 in Madhya Pradesh during 2001-02 (Table 4).

Table 4: Distribution of flow of institutional agricultural credit in different states of India

(Source: Report of the Advisory Committee on Flow of Credit to Agriculture and Related Activities from the Banking System, RBI)

The accessibility to institutional credit is higher in the Southern region where the level of agricultural development is also higher. Similar results were reported in the studies conducted earlier during the 1980s (Rao, 1994). It is kind of vicious cycle operating in less developed States. Less availability of credit influences adversely the adoption of modern technology and private capital investments, which in turn lowers the productive capacity of the agricultural sector and results in lower productivity and production, and also pushes the farmers to borrow from non-institutional sources. Consequently, the demand for agricultural credit for short and long-term purposes is dampened.

Problems in Agricultural Credit System

Transaction Costs of Agricultural Credit
Two issues are involved in agricultural lending in India. The banking sector has to cater a very large number of small borrowers spread over a very large area. Secondly, size of the loan is very small. The small and marginal farmers constitute more than 80 per cent of the farmers and some of the areas are remotely located. Catering to their requirements of farmers of such areas becomes very difficult and costly. From borrowers point of view, access to intuitional credit especially for small, resource poor and illiterate farmers gets inhibited as the procedural and documentation requirements are cumbersome, time consuming and increase the cost of borrowing for the farmers. On the other hand, access to noninstitutional credit is regarded to be very simple where transaction cost is negligible and involve no procedural complications. Empirical studies show that transaction cost in case of non-institutional loans was negligible whereas it ranged from 3 to 5 per cent in case of CBs, 1.4 to 3 per cent in case of cooperatives and more than 8 per cent in case of RRBs.

Loan Overdue
Recovery of loans is an important aspect in the economic viability of rural financial institutions as the range of services provided by them is limited and focused on advancing of loans only. Some empirical studies have suggested poor recovery performance of agricultural loans. Major reasons for high level of loan default are - low level of income generation, particularly on small farms, diversion of loans for unproductive purposes, inadequacy of loans leading to their diversion and willful default under the hope that they will be waived in future. Though the average rate of loan default in agriculture is 37 per cent, the recovery performance varies greatly across states/regions and financial institutions. The recovery

performance has been more than 80 per cent in relatively developed states like Punjab, Kerala, Haryana and Tamil Nadu. It has been 60-80 per cent in case of Andhra Pradesh, Gujarat, Karnataka, Maharashtra, Rajasthan, Madhya Pradesh and Uttar Pradesh. The recovery performance is poor in eastern and northeastern states except West Bengal. There is one good feature that where the use of institutional credit was higher, the recovery performance was also better.

Economic Viability of Rural Credit Institutions

Agricultural loans were considered to be unviable by rural financial institutions due to low rates of interest and high risk and transaction cost in the pre-reform period. The interest rate structure started undergoing changes after the financial sector reforms of 1991 in order to improve the economic viability of rural credit and provide more flexibility to banking institutions to decide the interest rate structure for agriculture and other sectors. The interest rates were further rationalized after the exchange rate mechanism was made more flexible and foreign capital was allowed in the Indian economy. Recently, agricultural loans up to Rs. 50,000 have been made available at a rate of 9 per cent. However, sharp rise in interest rates for different sectors of economy has put a pressure for upward revision in the interest rates of agricultural loans as well. Still the economic viability of rural financial institutions is not good due to high transaction and risk cost. It was noted that the net margins (as per cent of working capital) in the case of DCCBs was negative at All-India level while the economic position of RRBs has improved. The cooperative loans have become more costly due to some margins getting added at every level of its three-tier structure.

Access to Institutional Credit of Small Farmers

The small and marginal farmers constitute 80 per cent of operational holdings and cultivate around 36 per cent of area in India. Their number is expected to grow in future due to subdivision of holdings and lack of employment opportunities in the non-farm sector. Due to their small holding they are disadvantageously placed with respect to access to technology, credit and other institutional supports. The information on distribution of institutional agricultural credit shows that their access to credit to meet their short term and long term capital requirements has not improved over the years.

There are some disquieting features of lending to small borrowers. The number of small borrower accounts in case of commercial banks has come down over time indicating shifting of their focus to large borrowers. The rate of growth in agricultural advances to small and marginal farmers (less than 2 ha) by scheduled commercial banks in the 1990s has come down as compared to other farm size

categories due to which their share declined from 54 per cent in TE 1993 to 51 per cent in total agricultural credit in TE 2002. The All India Debt and Investment Survey (AIDIS) showed that rural households with assets less than Rs 20,000 had access to institutional loans for their credit needs only up to 35 to 37 per cent while the share of non-institutional agencies in the outstanding debt was as high as 52 to 62 per cent. In case of higher asset households, 70 per cent of the outstanding debt came from institutional sources. Therefore, in spite of strong network of rural branches and strong emphasis on target lending under poverty alleviation programmes, creating self-employment opportunities, etc, a large number of rural poor remain outside the fold of formal banking system for their credit needs. The important factors impeding the access of disadvantaged sections to institutional credit are higher transaction costs due to large numbers and small borrowings, higher risk cost, complicated procedures and large documentation required, inability of small borrowers to provide tangible collaterals, nonavailability of tenancy agreements, loan waivers affecting recovery performance, poor risk mitigation mechanism for farmers in the wake of natural calamities and crop failure and mind set of bankers against small loans viewing them as unprofitable.

Indebtedness among the Farmers

Indebtedness of Indian farmers has a long history. The Deccan Riots Commission of 1875 reported that one third of the occupants of government land were under debt. The Famine Commission of 1880 reported that one third of the land holders of the country were under deep debt and another one third were also under debt but in position to redeem it. The Famine Commission of 1901 estimated that more than 80 per cent of farmers were under debt. The Great Depression of 1929-30 also worsened the debt situation. The problem of indebtedness of Indian farmers in the post-independent India continues with varying degrees. After 1981, indebtedness has shown an increasing trend over the years with 57.2 per cent of cultivators indebted in 2003. According to the 50th round of the National Sample Survey Organization (NSSO) in 2005, if farmers engaged in allied agricultural activities (going by principal source of income) are added to the cultivators then the proportion of indebted farmers at all India level is 48.6 per cent. Deceleration in agricultural growth in the 1990s is regarded as one of the most important factors responsible for increasing indebtedness.

Conclusion
To conclude, an assessment of agriculture credit situation brings out the fact that the credit delivery to the agriculture sector continues to be inadequate. It appears that the banking system is still hesitant on various grounds to purvey credit to small and marginal farmers. The situation calls for concerted efforts to augment the flow of credit to agriculture, alongside exploring new innovations in product design and methods of delivery, through better use of technology and related processes.

Bibliography
Primary data collection from NABARD District Office, Surat www.rbi.org.in www.nabard.org Government of India, Economic Survey, various issues Report of the Advisory Committee on Flow of Credit to Agriculture and Related Activities from the Banking System www.afcindia.com Reserve Bank of India Bulletin November 2004 Issue NABARD Annual Report, various issues