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

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

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

4. 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

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

6. 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 4,920 2.4 months of household income

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

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

9. An Alternative (contd.) Farmer sells 100 of these tickets Gets 0.8*100 = 80 In good weather has100+80-100 = 80 In bad weather has 0+80 = 80 Exactly the same payoff as insurance

10. 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

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

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

13. www.idfresearch.org THANK YOU