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Symposium 2009

Implementation - IOU option as an alternative to crop insurance

The Challenge

Poverty reduction has become the central objective of development policy, as reflected in the United Nations’ Millennium Development Goals (MDGs). While economic growth is seen as an important ing ...

Poverty reduction has become the central objective of development policy, as reflected in the United Nations’ Millennium Development Goals (MDGs). While economic growth is seen as an important ingredient in achieving sustainable poverty reduction, the emerging consensus is that growth has to be pro-poor to reach such ambitious targets as the MDGs.

The India Development Foundation (IDF) in collaboration with the Price Stabilization Fund Trust (PSFT) set up by the Government of India is going to launch a pilot project over five years to test the IOU option.

The plantation sector in India is one of the oldest in the organized sector. The important characteristic of this sector is that its output is always for the market and, hence, exposed to all the risks of commercial farming. While large plantation owners can absorb some of the risks, the small growers of plantation crops are especially vulnerable to these risks. The problem is exacerbated by the fact that they have very little ability to absorb the risk of loss. Such risks are high as market volatility is an integral part of the world agricultural produce market. This problem is particularly high for plantation farmers as a large portion of their produce is exported. Owing to high volatility and the high probability of losses in the agricultural sector, the premium rates are high and, thus, insurance becomes unaffordable for the farmer. Insurance is a good tool for covering low probability events but fails when the risk of loss is significantly higher.

IOU option as an alternative to crop insurance The IOU option was developed to provide financial relief to the farmers as an alternative to crop insurance. The scheme is targeted at the plantation farmer who is vulnerable to price shocks in addition to other factors affecting his output. This would act as a tool to stabilize the income of the farmer by absorbing some of the effect of the price shocks. Essentially, it would ensure that the farmer has some income in a bad year and sets aside some of his gains in a good year.

IDF is about to launch a pilot project to test the IOU option. The project will be conducted for the Price Stabilization Fund Trust (PSFT), set up by the Government of India. The pilot will run for a total of 5 years. The target districts will be Wyanad and Idukki in Kerala, Coorg and Mysore in Karnataka, Coimbatore and the Nilgiris in Tamil Nadu, Sonitpur in Assam and some districts in Tripura. The crops covered under this pilot will be tea, coffee, tobacco, rubber, spices and fruits and vegetables (each of these crops has increasing demand in the export market).

This concept can be made more sophisticated and, hence, more attractive to the buyers (and the farmers). The IOUs put up by farmers of different products can be aggregated and sold as an instrument to the buyers, which is essentially an index of all plantation crops. This will reduce the aggregate risk of the buyer, who will be willing to pay a higher price, which means a greater value to the plantation growers. In principle, if such a market is set up, one can increase the domain of these IOUs to cover the entire agricultural sector to come up with an agriculture index derivative in exactly the same way as we have the stock index for companies.

Source:

India Development Foundation, http://www.idfresearch.org/current_project.asp

Copyright @ 2005 India Development Foundation

    Related Solutions

    Solution
    Symposium 2009

    Replace crop insurance with IOUs that require farmers to pay only when the harvest is good.

    Replace crop insurance with IOUs that require farmers to pay only when the harvest is good.

    Replace crop insurance with IOUs that require farmers to pay only when the harvest is good.

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