The agricultural sector still accounts for almost one quarter of Nepal’s Gross Domestic Product (GDP), with 57.3% of the economically active Nepali population engaged in the sector. Yet, the sector is largely driven by smallholder farmers, with 57.5% of agricultural households owning less than 0.1 hectares of land. Smallholder farmers, defined as those farming less than 2 hectares of land, face persistent challenges, the most pressing being limited access to markets, due to which most farmers are not getting fair prices for their produce. This NEFtake explores how contract farming could help bridge the gap by improving market access and ensuring fairer returns for smallholder farmers.
The Core Underlying Problem
The agriculture industry in Nepal has a market structure which is almost perfectly competitive. There are many farmers who produce similar goods, and a single farmer cannot influence the market price. Thus, farmers must accept whatever price is set by the market. Unfortunately, this price often does not even cover the cost of production of agricultural goods. As a result, recently, farmers in Kapilvastu district left their tomatoes and cabbages to rot in the field as they could not find buyers to purchase their produce. Similarly, despite the provision of a government-set floor price for agricultural products, paddy farmers in Nawalpur and dairy farmers in Chitwan have not been getting a fair price for their produce. While this is a problem plaguing all farmers in the country, smallholder farmers are at greater risk due to not having strong bargaining power. Hence, they are more likely to receive an even lower price for their goods. In other words, due to smallholder farmers’ limited ability to influence the market price of their goods, it makes them more vulnerable to exploitation by middlemen. By improving access to markets, smallholder farmers can gain more options on where and how to sell their products. This would increase competition among middlemen and helps farmers secure fairer prices. A possible avenue for this is contract farming.
What is Contract Farming?
Under contract farming, buyers agree in advance to buy the agricultural goods from farmers at a certain price and time. Sometimes buyers even provide inputs, technical support, and financing to farmers. Perishable goods like milk, tomatoes and cabbage or expensive crops or crops with high degree of quality variation are more likely to be produced under contract farming. This arrangement, often driven by the private sector and large corporations, guarantees a continuous supply of goods at pre-determined prices to buyers. On the other hand, it protects farmers from price fluctuation and provides them with stable prices. It also encourages smallholder farmers to invest more in their farms as they become more certain of their income level. Thus, contract farming is often a win-win situation for both buyers and farmers.
Contract farming has been practiced in many developed, emerging, and even in developing countries. In the USA, 99.5% of broiler chicken production happens through contracts with farmers. Similarly, contract farming governs 30% of soybean production in Brazil and more than 50% of tea and sugar production in Kenya.
Empirical Evidence on the Benefits of Contract Farming
There is considerable empirical evidence on contract farming improving the welfare of smallholder farmers in terms of their income, productivity, and profitability. For instance, in Bangladesh, contract farming increased the productivity and profitability of smallholder poultry farmers. Contract farmers produced 5020 kg more chicken per year and earned BDT 7.2 more net return per bird than non-contract farmers. Meanwhile, in Punjab, India, as part of an agreement between PepsiCo, a multinational corporation, and smallholder farmers producing basmati rice, the corporation provides farmers with seeds, technical knowledge, and training, along with buying their rice at a preannounced market price. There has been an increase in productivity for these farmers as well, along with guaranteed higher prices for their produce. Additionally, five Randomized Controlled Trials (RCTs) and three quasi-experimental studies found that a secure contract leads to an increase in investment in agricultural inputs and higher agricultural yields, as well as an increase in income. For example, in Benin, rice farmers who had contracts with buyers increased their plantation area by 23%, received 29% higher yield, sold 140% more rice, and witnessed their income rise by 52%.
Existing Legal Provisions of Contract Farming in Nepal
In Nepal, contract farming is often understood as lease farming. In 2017, the Government of Nepal issued a model of Agribusiness Promotion Act. The rural municipalities and municipalities used this model to draft their own agribusiness promotion act and program which has provision for contract farming. The act and the program define contract farming same as lease farming. Under lease farming, tenants rent agricultural land or farm from the landowner for a certain time at specified monthly payment. There is no agreement on purchasing agricultural output or providing agricultural input, which is a major feature of contract farming.
However, based on recommendations from the High Level Economic Reforms Commission, the Government of Nepal has recently formed an action plan to make necessary legal and institutional arrangements for contract farming within two years. The Ministry of Law, Justice and Parliamentary Affairs will help the Ministry of Agriculture and Livestock Development in this regard.
Examples of Contract Farming in Nepal
Although formal contract farming is not well-practiced in Nepal, there is an informal system of oral agreements in the production of broiler chicken. Intermediaries in the poultry industry, known as “poultry suppliers,” act as a central link in the value chain, providing inputs such as chicks, feed, and medicines to farmers, often with the assurance of buying back the chickens once they are ready for sale. For this, suppliers have connections with hatcheries, the feed industry, veterinary shops, and wholesalers. Depending on the credibility of the farmers, some poultry suppliers even provide the input materials on credit.
Unfortunately, farmers often express concern that suppliers charge them higher prices for the inputs and pay lower prices for their chickens. They also complain that suppliers sometimes provide them with low quality inputs. However, since the agreement between farmers and poultry suppliers happens orally, it is not possible to take any action against suppliers. In such a scenario, written contracts between farmers and poultry suppliers could solve these issues.
Limitations
There are 35 successful cases of contract farming with only 9 failed cases around the world. While contract farming can increase the market access of smallholder farmers and their income, they can sometimes be detrimental to smallholder farmers. First, smallholder farmers might be exploited by large private firms. The firms might charge higher prices for inputs, higher interest on credit, provide lower quality inputs and offer them lower prices for their goods. Second, smallholder farmers might fall into a debt trap. Under contract farming, farmers can have access to credit without collateral which increases their credit appetite. If the quantity and quality of agricultural goods is not as per contract, contractors might not purchase their goods which can push them towards debt trap.
Conclusion
Contract farming has a huge potential to uplight Nepali smallholder farmers. It improves their market access and guarantees them fair prices. A substantial number of research shows contract farming increases farmers’ productivity and profitability. Even though informal contract farming exists in Nepal, there is a need for proper legal provision to realize its full potential. Hopefully, the government of Nepal will create necessary laws for contract farming on time. However, there are different models of contract farming and Nepal should adopt a specific model that suits its socio-economic conditions and unique cultural context.
Pawan Raj Dallakoti holds a BA in Liberal Arts with a concentration in Japanese Business and the Global Economy from Doshisha University, Japan. He also studied for a year at the School of Political Science and Economics, Waseda University as an exchange student. He is currently a Research Fellow at the Nepal Economic Forum (NEF). Prior to joining NEF, he interned at the National Policy Forum (NPF) and the SAARC Secretariat. His research interests lie in evidence-based policymaking in agriculture, energy, and environment.
