Making Sense of Onion Economics in India: Can Islamic Finance Help? – by Mohammed Obaidullah

I was motivated to write this piece by the story of a poor farmer in India. The story of this 48-year old farmer Devidas Parvane from the Rasai village of Pune in Maharashtra state in India as reported in the mainstream media captures a classic unresolved problem of agricultural finance in India. The farmer brought 952 kg or about 1 ton of his onion produce to the wholesale market in Pune city. According to his estimates, this required a financial investment of Rs4000 (less than USD60) plus of course, his hard labor. What was the return after deducting all relevant expenses?[1] The farmer ended up receiving just Rs1..(Rupees one) from the entire lot. Disappointed and in tears, he asked the media to carry his message forward – if the government fails to remedy the situation, the only recourse for him would be to commit suicide.[2]

onionOnions are considered an indispensable ingredient of most Indian cooking and a major cash-crop for the Indian farmer.[3] The onion market is characterized by extreme fluctuations in supply due to dependence of onion production on uncertain weather conditions, leading to extreme volatilities in the onion prices. The value chain of the onion farming business constitutes the farmer who sells its produce at the whole-sale market. The whole-sale intermediary, in turn, sells to the retail sellers who then sells to the final customer. Among all the parties, the farmer and the final customer are believed to have the least bargaining power, and consequently, suffer the most due to price volatility.

The final consumer suffers during extreme price increases, but seeks to minimize the impact by adjusting the quantity consumed. However, it is hard to cut the consumption of an essential ingredient of cooking and therefore, demand for onions is relatively inelastic.

The farmer in contrast, faces a bleaker scenario. Theoretically speaking, the fortunes of the farmer, the wholesaler and the retailer are tied together. During price increases due to poor supply conditions all should gain, since demand is relatively inelastic. However, it appears that gains to the wholesaler and the retailer are disproportionately higher as compared to the farmer, since the former engage in hoarding and speculation, further pushing up the prices. Hoarding at the farmer’s end is generally ruled out without access to warehousing and storing facilities. Similarly, during price declines accompanying excess supply the farmer is unable to stock the produce due to lack of cold-storage facilities and is forced to offload the same to the wholesaler at abnormally low prices. While excess supply is not easily absorbed by inelastic demand, the fall in prices is entirely absorbed in the prices paid to the farmers pushing down their margins to below normal or even negative levels. The whole-saler and the retailer, in contrast, are able to maintain their margins and their respective sale prices. In brief, the farmer bears the down-side risk during price decline without benefiting from the upside return potential during a price increase. In contrast, the intermediaries – wholesale and retail – benefit from the upside, often contributing to the northward movement of prices through hoarding. At the same time they are able to shift the down-side risk to the farmer and hold on to their margins.

The above contention is evidenced by some investigative exercises undertaken by Indian journalists at the ground level. In recent times, the most pronounced decline in supply of onions leading to a sharp increase in their prices occurred in November 2010 when an unseasonal and excessive rainfall in onion-producing regions delayed the arrival of onions in markets, raising the price of onion from Rs35 (USD0.52) to Rs88 (USD1.30) per kg in just one week. The government as a response, took several measures, including banning of onion exports, lowering import taxes and getting in shipments of onions from neighboring countries, leading to prices retreating to Rs50 (USD0.85) levels. The sharp spike in the prices was attributed to errant rainfall, hoarding, official incompetence and price-ramping by traders. It was revealed that wholesalers, retailers and speculative traders in New Delhi charged a markup of over 135 percent, taking in profits of over Rs 1 million (US$15,000) a day.[4]

The situation in 2016 seems to be exactly opposite. A recent media report that traces the movement of onion prices along the entire value-chain of onion business – from the fields of farmers to the plates of consumers, has some interesting findings. In India three states, Maharashtra, Rajasthan and Madhya Pradesh top the list for production of onions. In Maharashtra the Nasik District is known for its onion production that is sold through 40 wholesale markets. Even when the price is perceived to be not-remunerative-enough, the farmers are forced to offload their produce in the markets as they are unable to stock the same due to absence of cold-storage facilities.

Who benefits from the economics of onion prices? The pricing of 1 kg of onion across the distribution channel as it moves from the fields of Maharashtra to plates of consumers in Delhi makes interesting analysis.[5]

  • Farmer sells at wholesale market in Nasik @ Rs 2.00
  • Nasik wholesale sells @ Rs 7.00 (margin of 250 percent)
  • Transportation cost from Nasik to Delhi: Rs 2.00 per kg
  • Landed cost of 1 kg onion at wholesale market in Delhi: Rs 9.00
  • Sale Price of 1 kg onion at wholesale market in Delhi to Retailers: Rs 16.00 (margin of 75-80 percent)
  • Sale Price of 1 kg onion at Retail to final customers in Delhi: Rs 20.00 (margin of 25 percent includes transportation plus profits)

It is clear from the above analysis that the farmer may indeed receive as low as ten percent of the price that the final consumer pays. The bulk of the price goes to intermediaries in various forms. Such irrational pricing that makes farming a losing proposition poses grave danger for food security in India as farmers are driven out of this profession. What has been the policy response so far to curb this menace?

Policy Response in India[6]

The policy response in India so far, has been the establishment of the Agricultural Produce Market Committees (APMC). The stated objective of APMCs is to ensure that farmers are not exploited by intermediaries (e.g. traditional money lenders in the villages) who compel farmers to sell their produce directly for an extremely low price. APMCs will ensure that all food produce should first be brought to a market yard and then sold through auction.

APMCs involve dividing the region/ state geographically and setting up of markets (mandis) at different locations. Governments in states, Maharashtra, Karnataka, Tamilnadu, Andhra Pradesh etc. have enacted legislation for formation of APMCs or Marketing Boards and for provision of operational rules. Most APMCs have a market place where traders and other marketing agents are provided stalls and shops to purchase agriculture produce from farmers. Farmers can sell their produce to agents or traders under the supervision of the APMC. The key features of APMCs are as follows:

  1. Farmers are required to sell their produce via auction at the mandi in their region as auctions are the best available methods for price discovery.
  2. Traders require a license to operate within a mandi as a measure of due diligence and transparency.
  3. Wholesale and retail traders (e.g. shopping mall owners) and food processing companies cannot buy produce directly from a farmer. This is to ensure that vulnerable farmers are not exploited by the traders.

In practice however, many ills remain in the system.

The auction system has been found to be vulnerable to manipulation by the traders and their agents. The licensee traders and commission agents have formed informal cartels at the mandis. There is either no auction, or even if auction is held, the cartel deliberately bids too low.

It is also believed that the exclusion of direct buyers (e.g. super markets) has made the system only less competitive. There seems to be a case in favor of permitting the direct buyers as competition among buyers should lead to better price realization by the farmers. This is the recommendation of the new model APMC Act provided by the government of India.

Due their strong bargaining position at the APMC, some traders and middlemen engage in many unhealthy practices:

  • Traders and middlemen engage in hoarding by making major investments in warehouses and storage facilities and artificially manipulate the prices.
  • Traders also need to make huge investment while seeking license to operate in the mandis; the licensing system brings all the accompanying evils.
  • Often traders delay payment to farmers for weeks or months even after receiving the produce.
  • If payment is made at the time of sale, then the trader at times, arbitrarily deducts some amount, on the excuse that he has not received payments from the other parties.
  • To avoid taxes, some traders do not give sale slips to farmers. As a result, it is difficult for the farmer to prove his income to get loans from banks.
  • Middlemen receive double commission (both from seller and buyer), thus making consumers pay for this spread.
  • Price discovery is more efficient for cereal, pulses and oilseeds, where the government announces Minimum support prices (MSP) in advance. This is not the case with most perishables fruits and vegetables including onions making farmers completely dependent on intermediaries for price discovery.
  • During peak production of seasonal crops, prices drop so drastically, the farmers can’t even cover the cash expenses of transportation to markets, leave alone the cost of production, as the example cited earlier highlights.

The New Model Act

The new model APMC Act has many strengths as it seeks to address the major problems of the old Act. The key provisions are as under:

  • Permission to farmer to directly sell produce to whomever he wants, e.g. processors, exporters, graders, packers, without bringing the same to the mandi
  • Permission to private market yards, Direct Purchase Centers, farmers’ market for doing trade in agriculture produce thus, destroying the monopoly of mandis.
  • Public Private Partnership in the management and development of agricultural markets in the country for post-harvest handling, cold storage, pre-cooling facilities, pack houses etc.
  • Regulation and promotion of contract-farming arrangements in the country; creation of dispute resolution mechanism for contract farming.
  • Prohibition of commission agents in any transaction
  • Setting up of State Agricultural Produce Marketing Standards Bureau for grading, standardization and quality certification of agricultural produce
  • Increased responsibilities of APMC committee that include: ensuring complete transparency in pricing system and transactions taking place in market area; and payment for agricultural produce sold by farmers on the same day
  • Publication of data on arrivals and rates of agricultural produce brought into the market area for sale.
  • Promotion of public private partnership in management of mandis

Some other suggestions to improve matters include introduction of electronic auction platform; open membership and abolition of license system, and of taxes etc.

Case for Commodity Futures, Forwards

The concern for price discovery and insulating the poor farmers against sharp price falls have led to the search for alternatives including the establishment of futures exchanges. Though the key benefit of an organized futures exchange is believed to price discovery, available evidence for India is to the contrary. In an investigation into the futures markets in agricultural commodities in India, the statistical analysis of data on price discovery in a sample of four agricultural commodities traded in futures exchanges have indicated that price discovery does not occur in agricultural commodity futures market. The results showed that the futures and spot markets are not integrated. The exchange-specific problems like thin volume and low market depth, infrequent trading, lack of effective participation of trading members, non-awareness of futures market among farmers, no well-developed spot market in the vicinity of futures market, poor physical delivery, absence of a well-developed grading and standardization system and market imperfections have been found as the major deficiencies retarding the growth of an organized Futures Exchange.[7]

Another alternative is contract farming which is a forward agreement between farmers and buyers under which the buyer agrees to buy produce from farmer at a predetermined price; usually provides inputs (seeds, fertilizers, and pesticides), technology and production practices so that final produce meets his desired quality. The farmer agrees to grow and supply the produce to the buyer at predetermined quality, quantity and prices. Contract farming is prevalent in a few states including Andhra Pradesh, Himachal Pradesh, Madhya Pradesh, and Maharashtra while states like West Bengal have opposed it on the ground that the same may be exploitative.

Does Islamic Finance Provide a Solution?

Similar to contract farming, but more demanding in terms of transparency and definitiveness is the Islamic forward called Salam sale. In contrast to a conventional forward or contract farming, the entire sale price of the produce sold in advance is paid to the farmer by the buyer. The price per unit, quality specifications and all terms of sale are clearly determined in advance. The farmer gets the price in advance (and uses the same to finance pre-cultivation activities) and delivers the sold commodity after the harvest, and is thus insulated from price manipulations that may result in a free-fall subsequent to a bumper harvest.

Further in the true spirit of an Islamic economy, which is a sharing-based economy, Islamic economists recommend sharing and cooperation-based institutional structure for farmers, such as Farmers’ Cooperatives. This is in line with recommendations of various policy experts in agri-business field who have sought to curb the exploitation of the farmer and enhancing its bargaining power. This involves the setting up of producers’ cooperatives comprising the individual farmers as members. The member-farmers off-load their producer with the cooperative, which then enters the market with much stronger bargaining power and obtain better prices. The improved bargaining power may be further enhanced with access to warehousing and storage facilities. The producers’ cooperative may also provide other useful services, such as, financial services, value-addition services in the form of processing and packaging for better price-realization. The profits made by the cooperative – high or low – for the services rendered is ultimately shared among the member-farmers, thus, eliminating any possibility of exploitation by one party or another.

While conventional commercial banks are generally reluctant to deal with cooperatives, there have been good examples of Islamic banks playing proactive role in creating a network of local cooperative organizations and then placing funds with them under multiple arrangements, creating a win-win situation for all parties.[8]

Notes

[1] This is calculated as follows: Sale price of 952kg @ Rs1.60 or Rs1523.20 minus expenses (commission to intermediary: Rs 91.35 plus wage for putting the onions in sacks: Rs18.55 plus wage for handling the sacks of onions: Rs 59.00 plus duties for weighing onions: Rs.33.30 plus transportation by truck to APMC: Rs.1320) amounting to Rs.1522.20. This example is sourced from http://abpnews.abplive.in/business/onion-farmer-got-one-rupee-only-on-selling-1-ton-onion-381557/

[2] Farmer suicides are fast becoming a major societal problem rooted in the stark economic realities related to farming. For an economic analysis of farmer suicides in India, see this blog by Mohammed Alim at  https://agric.in/2012/07/15/has-the-government-of-india-done-enough-to-tackle-the-incidence-of-poverty-induced-farmer-suicides/

[3] India is the second largest onion producer in the world, after China. Forty-five percent of the onion produce in India comes from the states of Maharashtra and Karnataka.

[4] Varma, Subodh (23 December 2010). “The great onion robbery: 135% mark-up from mandi to retail”The Times of India. Retrieved 3 January 2011.

[5] Source: http://abpnews.abplive.in/india-news/ground-investigation-on-onion-rates-362524/

[6] This section draws heavily on http://mrunal.org/2013/08/food-processing-nuisance-of-apmc-acts-commission-agents-marketing-of-agricultural-produce-issues-and-constrains-for-gs-mains.html

[7] R. Salvadi Easwarana and P. Ramasundaramb “Whether Commodity Futures Market in Agriculture is Efficient in Price Discovery ? — An Econometric Analysis”, Agricultural Economics Research Review Vol. 21 (Conference Number) 2008 pp 337-344

[8] A good example is the Bank Muamalat Indonesia that created a network of Islamic financial cooperatives called Baitul Maal wa Tamweels (BMTs) and then placed funds with them for onward financing to members under alternative Shariah-compliant arrangements.

Sharia market goes mainstream; Monad University begins courses in Islamic finance

By TwoCircles.net Staff Reporter,

Hyderabad: The subject of Islamic finance has surfaced at copious controversies in India, travelling through court cases, to political podiums, after all of it; finally this vast lucrative finance market is getting a mainstream acceptance, at least academically.

Monad University Uttar Pradesh is introducing Islamic finance as higher educational courses. The university, in collaboration with Institute of Islamic Banking Finance & Insurance (IIBFI), Chennai is providing three passages for Islamic finance education. MU is introducing Post Graduate Diploma in Islamic Banking & Finance (PGDIBF), MBA in Islamic finance and PhD in Islamic finance.

Read more at :

http://twocircles.net/2013apr28/sharia_market_goes_mainstream_monad_university_begins_courses_islamic_finance.html

India rules out Islamic banking for the moment

India Friday ruled out introducing Islamic banking in the country for the moment, making the wait longer for interest-free access to finance under the principles of Sharia.

The introduction of Islamic banking was recommended by a committee on financial sector reforms, set up by the Planning Commission, for delivery of interest-free finance on a larger scale, even through the banking system.

However, the government decided not to go ahead with the recommendations, and said it was not feasible to introduce the new system in the current scheme of things.

‘In the current statutory and regulatory framework, it is not feasible for banks in India to undertake Islamic banking activities,’ Minister of State for Finance Namo Narain Meena told the Lok Sabha Friday.

He said the rules will apply to domestic banks and their international operations and any foreign bank operating in India.

A large number of around 150 million Muslims in India – the third largest Muslim population in the world after Indonesia and Pakistan – prefer to stay away from commercial banks due to religious proscriptions against interest-driven banking.

The values of interest-free Islamic banking are finding greater recognition. China, which has around 80 million Muslims, recently gave its first licence for Islamic banking to the Bank of Ningxia.

source : newdelhinews

Scope of Islamic Investment in Indian Equities

A relatively new concept a decade ago, Islamic banking and finance has seen explosive growth in recent years. This can be attributed to the fact that many predominantly Islamic nations have seen an increase in financial wealth mainly due to a surge in exports and high oil prices. This increasing income is fuelling an increasing demand for Shariah compliant offerings along ethically-aware Islamic principles as an alternative to western banking and investment products.

While Islamic compliant investment avenues are now becoming available in most countries, India has not seen large scale development. Other than a handful of Shariah compliant funds, currently India offers limited options for investors looking at Shariah compliant investing. However, this should not go to undermine the scope for Shariah compliant investment opportunities in India.

Post the 1991 liberalization reforms, India’s GDP has consistently grown at over 5% and has now crossed the 8% mark. This figure as compared to the US figure of less than 3% and European growth rate of 2% on a 10 year average is remarkable. [1] Infact, with its population qualifying as a huge yet untapped consumer market and relatively cheap labour, India is expected to be one of the world’s two largest economies by 2050. [2] The huge capital inflows in the country mirror the confidence of foreign investors in the Indian economy’s ability to match this expectation. Foreign Institutional Investor flows have shown a consistent upward trend with the total for current financial year (ending March 2007) being USD 7.99 billion as on 29th December 2006. [3]

India’s institutional framework is well suited for the world economy. Corporate India has been performing well. This, coupled with strong macroeconomic fundamentals, growing industrial and service sectors provides great potential for investment in the Indian economy. Infact India ranks higher vis-à-vis other BRIC nations (Refers to the countries Brazil, Russia, India and China which are rapidly developing and are expected to eclipse most of the current richest countries of the world by the year 2050). in the World Economic Forum’s Global Competitiveness report. India has scored well in innovation, sophistication of firm operations and adoption of technologies. [4]

India has amongst the most developed and organized markets in the world. Two of India exchanges are amongst the five largest in the world. India has almost 10000 listed companies, a number second to none. Asia’s oldest stock exchange, the Bombay Stock Exchange (BSE) is India’s biggest in terms of listed companies (4853) and market capitalization (USD 797 bn) [30th November 2006]. [5]

By number of transactions, the National Stock Exchange (NSE) and BSE are the third and fifth largest in the world respectively. [6]

The India benchmarks – the BSE Sensex and the Nifty have given annualized returns of 57.30% and 67.05% respectively for December 2005 – November 2006. Between March 2001 and December 2006 BSE market capitalization has recorded a jump of over 600 percent, whereas the same for NSE has been over 589 percent. [7]

Such strong numbers only go to confirm that it is the ‘ideal’ time to take a call on the India-story.

To gauge the scope of Islamic investment opportunities in the Indian stock market, it is imperative to examine stocks which conform to the norms stipulated by the Islamic Shariah principles. A thorough study was conducted by Dr. Shariq Nisar, an eminent personality of Islamic Finance in India. [8]

Below are a few facts from the study that go to prove that there is huge potential for Islamic investing in India.

‘Out of the 1000 NSE listed companies, 335 are Shariah compliant. The market capitalization of these stocks accounts for approximately 61% of the total market capitalization of companies listed on NSE. This figure is higher even when compared with a number of predominantly Islamic countries such as Malaysia, Pakistan and Bahrain where share of Shariah compliant market capitalization is 57%, 51%, and 6% respectively of the total market capitalization. [9] In fact, the growth in the market capitalization of these stocks was more impressive than that of the non- Shariah compliant stocks.’

‘The software, drugs & pharmaceuticals and automobile ancillaries sector were the largest sectors among the Shariah compliant stocks. They constitute about 36% of the total Shariah compliant stocks on NSE.’

On examining the BSE 500 (Mostly India’s Fortune 500), the market capitalization of the 237 Shariah-compliant companies hovered between 48% – 50% of the total BSE 500 market capitalization during the period of Dr. Shariq Nisar’s study.

The table below indicates the number of Shariah compliant companies in India during the period of study.

  Mar-02 Mar-03 Mar-04 Mar-05 Dec-05
NSE
Total number of companies listed 988 988 988 988 1000
Shariah compliant companies 115 137 185 237 335
           
BSE
Total number of companies listed 500 500 500 500 500
Shariah compliant companies 95 112 164 196 237

Author Source: Centre for Monitoring Indian Economy (CMIE)

There are a few Shariah compliant investment vehicles available in India for foreign investors. The Kotak Indian Shariah fund is one such fund which endeavours to achieve capital appreciation by being invested in the shares and equity-linked instruments of companies which the Investment Manager believes are Shariah compliant as per the Shariah supervisory board.

Conclusion
India is expected to see stellar macroeconomic performance in the coming years. The Indian Equity indices have risen around 49% (Sensex) [10] in the past one year on the back of a strong domestic growth story, improving global competitiveness of Indian companies and robust Foreign Institutional inflows into India. The huge spread of listed Shariah compliant companies gives the fund managers a wider spectrum and flexibility to identify and invest in future growth sectors and companies. Investors from across the world, who are looking at Shariah compliant investment opportunities, could find India as an attractive destination. In fact Indian markets may throw wider options vis-à-vis many Islamic countries. This is what differentiates the Indian markets. Also as an investor, one would be investing into a billion people country with a GDP growth rate in excess of 8% and corporate earnings growing in excess of 15% predominantly out of domestic consumption rather than export dependence.

There is a strong likelihood of a substantial increase in the funds available for Shariah investment as a result of growing wealth in Islamic countries and communities. Complementing this is the fact that India is becoming extremely important for investors’ portfolios and long-term Shariah investors will find this story a difficult one to ignore.

[1] Bloomberg
[2] BRIC report – 2003
[3] bseindia.com
[4] http://weforum.org/pdf/Global_Competitiveness_Reports/Reports/gcr_2006/top50.pdf
[5] bseindia.com
[6] Economic survey 2004-05 ministry of finance, GOI 2005
[7] Bloomberg
[8] Dr. Shariq Nisar holds a PhD in Economics with a specialization in Islamic Finance. He is investment advisor to Idafa Investments Pvt. Ltd, a Shariah compliant investment management firm in India.
[9] Islamic Capital market products: Developments and Challenges, Islamic Research and Training Institute, Islamic Development Bank, 2005.
[10] Bloomberg

Thanks investindia