Identifier
Created
Classification
Origin
08NEWDELHI314
2008-01-31 05:55:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy New Delhi
Cable title:  

CONTRACT FARMING HAS LIMITED USE THUS FAR FOR ORGANIZED

Tags:  BTIO EAGR ECON EINV IN ETRD EFIN PREL 
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VZCZCXRO5634
RR RUEHAST RUEHBI RUEHCI RUEHLH RUEHPW
DE RUEHNE #0314/01 0310555
ZNR UUUUU ZZH
R 310555Z JAN 08
FM AMEMBASSY NEW DELHI
TO RUEHC/SECSTATE WASHDC 0228
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHCG/AMCONSUL CHENNAI 2354
RUEHKP/AMCONSUL KARACHI 8462
RUEHCI/AMCONSUL KOLKATA 1667
RUEHLH/AMCONSUL LAHORE 4287
RUEHBI/AMCONSUL MUMBAI 1463
RUEHPW/AMCONSUL PESHAWAR 4753
UNCLAS SECTION 01 OF 05 NEW DELHI 000314 

SIPDIS

SENSITIVE
SIPDIS

USDA PASS FAS/OCRA/HIGGISTON
STATE FOR SCA/INS JASHWORTH AND SCA/RA MURENA
DEPT PASS TO USTR - CLILIENFELD/AADLER
DEPT PASS TO TREASURY FOR OFFICE OF SOUTH ASIA - ABAUKOL
USDOC FOR 4530/ITA/MAC/OSA/LDROKER/ASTERN
TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN

E.O. 12958: N/A
TAGS: BTIO EAGR ECON EINV IN ETRD EFIN PREL
SUBJECT: CONTRACT FARMING HAS LIMITED USE THUS FAR FOR ORGANIZED
RETAIL, BUT APPEALS TO FARMERS

REF: A) 08 NEW DELHI 95
B) 08 MUMBAI 19

NEW DELHI 00000314 001.2 OF 005


UNCLAS SECTION 01 OF 05 NEW DELHI 000314

SIPDIS

SENSITIVE
SIPDIS

USDA PASS FAS/OCRA/HIGGISTON
STATE FOR SCA/INS JASHWORTH AND SCA/RA MURENA
DEPT PASS TO USTR - CLILIENFELD/AADLER
DEPT PASS TO TREASURY FOR OFFICE OF SOUTH ASIA - ABAUKOL
USDOC FOR 4530/ITA/MAC/OSA/LDROKER/ASTERN
TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN

E.O. 12958: N/A
TAGS: BTIO EAGR ECON EINV IN ETRD EFIN PREL
SUBJECT: CONTRACT FARMING HAS LIMITED USE THUS FAR FOR ORGANIZED
RETAIL, BUT APPEALS TO FARMERS

REF: A) 08 NEW DELHI 95
B) 08 MUMBAI 19

NEW DELHI 00000314 001.2 OF 005



1. (SBU) SUMMARY: Contract farming offers farmers a stable and
profitable way to sell to agro-businesses, and is gaining popularity
as a means of cutting out middlemen in the agricultural supply
chain. A number of companies are successfully sourcing agricultural
products directly from farmers for their needs and are looking to
expand the goods procured through this process. Contract farming
relies fundamentally on a long-term relationship with farmers, an
established presence in the agri-business, and large investments by
the company at the start of the venture with little help from the
agricultural community. Although it forces companies to initially
undertake a large amount of risk, this type of arrangement can also
offer stable quantities and eventually create a mutually beneficial
relationship between companies and farmers, which can then
ultimately benefit the Indian consumer. Still, its applicability to
organized retail and to smaller farmers is limited, and expanding
the scope of this model may require more state involvement, at a
time when agricultural is politically controversial.


2. (SBU) This cable is part of a series that will address the
potential impact of organized retail on the agricultural sector.
Although the front end of the "retail revolution" has attracted
considerable attention through new stores and shopping formats,
these cables will focus on the back end of the supply chain and
examine a few of the business models being used by the private
sector to engage India's farmers. END SUMMARY.

BACKGROUND
--------------



3. (SBU) Contract farming is a system of sourcing that links
suppliers to buyers through forward contracts. At the core of such
an arrangement is the commitment of the seller to provide a certain
quantity and type of commodity to the buyer at a specified time.
The buyer in turn guarantees the supplier a fixed price for the
produce. Contract farming has been used in India for hundreds of
years, largely for commodities such as cotton and tobacco. The
Agricultural Produce and Marketing Committee (APMC) Acts, state laws
passed in the 1960s and 1970s, prohibited companies from contracting
directly with farmers for farm produce, but since 2003, several
states have amended these acts to allow companies to directly
procure goods from farmers through either spot purchases or contract
farming. The advantage of this model is that companies can easily
procure goods and farmers have an alternative to selling at the
mandis (market yards),at which they are charged large commissions
by traders and earn a fraction of the ultimate retail price of their
produce.


4. (SBU) The legislative changes - along with the increased use of
branded products and the rise in organized retail driven by growing
consumer demand - has prompted some companies such as Indian Tobacco
Corporation (ITC) to attempt contracts in fresh fruits and
vegetables. However, the proposition is risky because these
contracts are still not legally enforceable in India; therefore,
either side can choose not to honor the contract (which is usually
verbal or informal). If the market price of the contracted
commodity falls, the company could choose to procure the goods at
the local mandi instead of paying the farmer a higher, pre-agreed
price. If the price of the commodity rises, the farmer has an
incentive to break the contract and sell at a higher price at the
mandis.


5. (SBU) In order to mitigate the risks of contract default,
successful companies have been using local partnerships and a
long-term presence to assure needed quantities. PepsiCo started
contract farming in 1989 with tomatoes - originally as part of a
corporate social responsibility project - and McDonald's began
entering into informal contracts in 1996 to supply its Indian
stores. Recent studies point to contract farming as a means to
improve farmer income.

MCDONALD'S EXPANDING
CONTRACTING OPPORTUNITIES

NEW DELHI 00000314 002.2 OF 005


--------------


6. (SBU) Congenoffs met on January 15 with Mr. Abhijit Upadhyaye,
McDonald's Mumbai-based director of supply chain and menu
management. McDonald's first store opened in 1996, he stated, and
the company has since expanded to 140 total stores across India.
However, he highlighted that the company arrived in India as early
as 1990 to identify suppliers, create joint ventures, and contract
with companies for logistics and cold chain help to establish an
efficient and dedicated supply system. Upadhyaye explained that
McDonald's uses "handshake" contracts with its suppliers, which
means that no written guarantees are provided, but a supplier that
breaks a contract loses McDonald's business completely - a large
enough threat to any local supplier because of McDonald's sheer
size, which keeps contracts largely intact. The supplier, he
stated, has to work with the farmers to get needed produce, and
until recently, had to procure these goods from the mandis. (Note:
McDonald's works through a Canadian company, McCain, to procure its
produce. McCain is ultimately responsible for filling the contract,
either locally or through imports. End note.)


7. (SBU) Upadhyaye noted that McDonald's was now contracting with
farmers, largely in Gujarat and Madhya Pradesh, for two products -
iceberg lettuce and potatoes. He explained that McDonald's gives
specifications on quality and size to the farmers, while an expert
agricultural team provides them with extension services such as
technology and training in good farming techniques. According to
Upadhyaye, the company is also working to provide its farmers with
access to credit through McDonald's or partner banking institutions.
Through these services, he stated that farmers were improving their
yields by up to 40 percent and developing higher quality products
that fetch higher contracted prices from the company. However, he
said that McDonald's uses primarily large landholders - farmers with
100 to 200 acres - for its contracts. Upadhyaye mentioned that the
company still uses the mandis for crops such as tomatoes and onions,
although it is planning to develop direct contracts for tomatoes in
the near future. He further noted that other fresh produce used in
McDonald's India offerings, such as peas and carrots, are too low in
volume to be worth contract farming. McDonald's does not own cold
chain infrastructure and does not plan to develop it, he added.


8. (SBU) Upadhyaye emphasized that the contracts were based largely
on mutual trust between the producers and buyers, and took a long
time to develop. He noted McDonald's commitment to on-time
payments, technology transfers, and ability to reward reliable
suppliers with new business. In return, he stated that McDonald's
expects all suppliers to deliver assured quantities, quality
produce, and competitive prices. He believes that this fair
exchange makes both sides equally dependent and forms a lasting and
stable business relationship.


PEPSICO LEVERAGING GOVERNMENT,
LOCAL INVOLVEMENT
--------------


9. (SBU) ECONOFFS also met with PepsiCo officials in New Delhi, who
discussed the company's foray into contract farming in tomatoes as
early as 1989. Sunil Duggal and Pawan Sharma, the director and
general manager of corporate affairs, respectively, explained
PepsiCo's early entry into such farming was part of a deal with the
Indian government for the opportunity to sell their soft drinks in
the country. The company opened a tomato-processing plant in
Punjab, which sourced local produce for the manufacture and export
of tomato paste and purees. Duggal relayed that the Punjab
government was looking to diversify its farmers' output because
paddy crops were badly stripping the soil and water levels in the
state, and therefore partnered with PepsiCo on this venture. Local
bodies such as the Punjab Agricultural University and Punjab
Agro-Industries Corporation advised and provided extension services
to Punjab's farmers for PepsiCo's needs, including inputs such as
seeds, delivery of agricultural best practices, and regular crop
inspections. Duggal praised their local knowledge, which he said
helped the company's farmers vastly improve yields and quality.


NEW DELHI 00000314 003.2 OF 005



10. (SBU) Duggal noted that the company contracts with several
hundred farmers, both large and small. He admitted that contract
default is a risk in certain crops when mandi prices are higher, but
the company can offer to match the market price of some contracted
goods, which can be a high cost but assures quantity. He explained
that Pepsi does not renege on its contracts, offers the farmer
stability, provides regular advice and feedback on the produce, and
can offer financial help when needed - all of which help sustain the
long-term relationship and avoid default. He said the company
rejects less than 10 percent of produce because of failure to meet
PepsiCo's specifications, and in those cases will turn to the mandis
to make up the quantity needed.


11. (SBU) Duggal and Sharma on January 23 took ECONOFFs on a tour
of a PepsiCo-operated farm in Jalandhar, Punjab for citrus fruit,
one of the company's newer contracting ventures that was started in
2004, using citrus trees imported from Florida and California. The
25-acre nursery is owned by two farmers, but leased to the Punjab
government through the Council for Citrus and Agri-Juicing in
Punjab. Its representative, senior manager Baldeep Bajwa, explained
that the area was operated by PepsiCo through a USD 5 million
investment. Including nearby facilities, Duggal stated that PepsiCo
contracts about 65 total acres of land for citrus, another 20 to 25
acres for direct growing of vegetables, and 10 additional acres to
explore experimental practices for growing basmati rice.


12. (SBU) Dr. Susheel Sankhyan, Pepsi's general manager at the
nursery, showed EMBOFFS the greenhouse plants, buds, and trees that
PepsiCo is nurturing at the farm, using modern agricultural
practices. The nursery's five greenhouses can produce a total of 4
million viable citrus trees per year. Sankhyan explained that
because the orange is relatively new to India and a full orange tree
takes six years to develop, the company grows the trees for 18 to 24
months and then turns them over to farmers to plant, nurture, and
harvest the fruits. Sankhyan explained that farmers sign 12-year
contracts (allowed by the Punjab government),in which they collect
rent for the first six years, and receive both rent and 50 percent
of the revenues of the citrus sales for the second six years.
(Note: Duggal stated that the orange juice business is growing at
about 30 percent per annum. End note.)


13. (SBU) Bajwa noted that while farmers seem happy with the
arrangement now, it was difficult to initially persuade them to
plant the citrus trees. He said that they generally intercrop
(plant complimentary crops on the same land) for the first six years
while the land is undeB lease so as to have supplemental income, but
also to hedge against the risk of the company reneging on a
contract. Bajwa also spoke of new employment opportunities for
farmers in the area because of these new crops - farmers in Punjab
were routinely leaving the area and leasing their land to other
farmers, which reduced the overall number of employed landless
laborers. Now, he stated, nurseries like this employed at least 75
people and could offer new opportunities if demand grows. In
addition, the citrus crops use only a tenth of the water required
for intensive and damaging crops such as rice, which will help stem
the water depletion in Punjab's soil and sustain agriculture in the
long-term. New techniques offered by PepsiCo and the government on
farming are also applied to other crops to improve yield, Bajwa
added.


14. (SBU) EMBOFFS then visited PepsiCo's nearby juicing plant, not
far from the nursery. (Note: The short supply chain means that
PepsiCo does not require cold chain infrastructure from the farm to
the plant, though it does have cold storage at the plant for its
concentrate. End note.) The multi-product plant opened in May 2007
but only operates when certain fruits are in season. Ashok Kumar,
vice president of manufacturing for a food processing firm working
with PepsiCo as a consultant, highlighted that PepsiCo used to
import its oranges from Brazil and Mexico, but is now able to meet
its demand locally because of its new contracting arrangements.

SMALLER NICHE PLAYERS ALSO BENEFIT
FROM CONTRACT FARMING
--------------


NEW DELHI 00000314 004.2 OF 005



15. (SBU) Congenoffs in Mumbai also met on January 10 with members
of the Maharashtra Export Development Commission (MEDC),a small
think tank that advises the Maharashtra government on a variety of
economic policies, including agriculture. Mr. Kagliwal, the
chairman of the MEDC and president of Nath Seeds, a
Maharashtra-based oilseed company, asserted that organized retail,
and especially contract farming, were "the best thing to happen to
the Indian farmer." He said that farmers have four primary needs at
the moment - credit, technology, an assured buyer, and a
remunerative price. Contract farming, he stated, meets all of these
needs; moreover, farmers can increase their quantity without
deflating the price received at the mandi. Although the business
model has higher risks and higher investment needs, it promises
higher rewards to both sides, he noted.


16. (SBU) In a separate meeting on January 16, Mr. Kapadia, the
managing director of Jayant Oilseeds, a Mumbai-based member of the
MEDC, further praised contract farming's abilities to help both the
company and farmer. Kapadia explained that the company, which began
operating in 1952 and now is a large producer of castor oil seeds,
uses contract farming to work with small and marginal farmers, 80
percent of whom own less than an acre of land. Kapadia claimed that
the company now works with over 7,000 farmers. The company
currently cultivates 20,000 acres but plans to quintuple this figure
by next year, and reach over 500,000 acres in three years.


17. (SBU) Kapadia highlighted the ease of contract farming for
oilseed, which is a technically advanced niche product. Although as
a hybrid seed it requires much research and development on the
company's part, farmers can use it as a profitable intercrop that
requires almost no maintenance. The company, he added, gives the
farmers technical knowledge, equipment, and the seeds and verbally
guarantees to buy the produce. Because the crop is specialized and
no other buyers exist in their market at the moment, the company's
default risk is low; similarly, the farmer has no alternate buyer
and so is likely to sell as promised.


18. (SBU) According to Kapadia, the company has seen the positive
impact on farmers first hand. He cited farmers' incomes as having
improved 25 to 30 percent from working with the company, and relayed
stories of farmers who want to abandon the intercrop method and
convert fully to oilseeds. He noted that the state of Maharashtra,
which was looking for an alternate crop for its poor and debt-ridden
sugarcane and cotton farmers, approached the company to develop new
opportunities. Kapadia also highlighted expansion plans in Gujarat
and Rajasthan, and praised the latter as being run by a
forward-leaning and progressive state government. He related that
initially farmers still need to be convinced of the profitability
and ease of the crop, but the company's partnerships with state
governments and local NGOs make market entry more efficient and
logistically easier.

COMMENT
--------------


19. (SBU) Contract farming is a clear success for agri-businesses
and farmers in distinct and specific cases. The common themes for
success of the three companies that we approached which have
utilized contract farming appear to be a close link with state
governments and local institutions, a long-term presence and
reputation in local markets, and a willingness to take larger risks
and make larger investments in the nascent stages - which in turn
offer farmers stability, better incomes, and, ultimately, greater
choice and employment opportunities. Contract farming offers
farmers a chance to move beyond subsistence farming and break the
debt cycle, though it appears that most of the beneficiaries remain
large and wealthier farmers.


20. (SBU) However, contract farming is not being employed much by
organized retailers and likely will not be in the near-term.
Although ITC has begun using contracts for "exotic" crops such as
celery, most of the retail players we spoke with do not believe they
can either procure the volumes needed in a cost effective way -
having to rely on too many transactions and individual farmers - or
that farmers will actually honor their contracts, in which case the

NEW DELHI 00000314 005.2 OF 005


company will have to take a hit. The trust deficit between farmers
and companies appears to run both ways, as farmers also seem
reluctant to trust a single buyer and convert their farmland into a
commodity that may not sell.


21. (SBU) The political environment in different states influence
the development of contract farming. Should state governments get
more involved, however, the potential for contract farming in
agricultural produce - as an alternative to selling at mandis -
could become more viable and expand beyond its narrow scope.
Amending APMC acts so that direct contracts between farmers and
companies is possible is a good first step, but stronger state
government-led extension services and links to agri-businesses may
help reduce the trust deficit that is sidelining the emergence of
the direct farmer-corporate relationships. Legal enforcement of
contracts will remain difficult in agriculture given its political
sensitivity, so local institutions may need to help foster these
relationships. If the situation in Punjab before and after contract
farming arrived is any indication, contract farming offers farmers
substantial opportunities for cashing in on the agricultural retail
boom.

MULFORD