Risk to Small Farmers Shubhashis Gangopadhyay India Development Foundation (June 5, 2004) Prepared for the conference on Integrating the Rural Poor into.

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Presentation transcript:

Risk to Small Farmers Shubhashis Gangopadhyay India Development Foundation (June 5, 2004) Prepared for the conference on Integrating the Rural Poor into Markets

Risk Subsistence versus commercial farming Why is risk critical? Inability to absorb losses

Role of Financial Markets Reducing the cost of finance Reducing the risk of farming Insurance model Low probability, high losses High probability, crisis

Insuring Against Risk Insurance 100with probability pW 0 with probability 1-pL Coverage bought will be 100W - L Independent of the probability Premium rate = 1-p If p = 0.8, premium = 100*0.2 = 20 If p = 0.7, premium = 100*0.3 = 30

Insuring Against Risk (contd.) Payoff Good crop: 100 – 20 = 80 Bad crop:0 – = 80 Perfect consumption smoothing 20 to be paid upfront

Feasibility? The subsistence farmer Income of INR 24,600 Probability of loss (INR 0) 0.2 Poverty lineINR 328 Annual subsistence needINR 19,680 Premium per yearINR 4, months of household income

Some Other Problems Incentive issues Adverse selection Moral hazard Limited liability (5 for 1) Correlated risk

An Alternative 100 with probability with probability 0.2 Sell a ticket that pays 1 if good weather at a price of 0.8 Buyer gets 0.8* *0 = 0.8 so buys the ticket

An Alternative (contd.) Farmer sells 100 of these tickets Gets 0.8*100 = 80 In good weather has = 80 In bad weather has 0+80 = 80 Exactly the same payoff as insurance

Alternative is Better……. Collecting money upfront Solves the liquidity problem Borrowing rate greater than lending rate Alternative makes money Correlated risk Credibility and unlimited liability

Market Solution Not rainfall insurance Who cross-subsidizes whom? Who are the players? Could be anybody!

Getting the Systems NGOs Credibility of NGOs Clearing house Technology Speculators!

THANK YOU

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