Agrarian markets often see interlinked market transactions – the arhatiya deals with the farmer in both the crop market as a commission agent, and in the credit market as a moneylender. In this post, Kumar et al. examine the trade-off between the welfare of farmers and arhatiyas, and how schemes and institutions can work to increase access to formal credit in agriculture.

A significant proportion of agricultural households still depend on non-institutional sources for their credit requirements. Only 61% of total agricultural households (National Bank for Agriculture and Rural Development, 2018) and around 34% of total operational agricultural holdings (Ministry of Agriculture, 2019) are estimated to have taken credit from institutional sources. 

A more peculiar feature of agricultural markets is the phenomenon of interlinked markets – in Agricultural Produce Market Committee (APMC) mandis of Punjab and Haryana, the arhatiyas (commission agents) – whose primary role is to facilitate the transaction between farmers and buyers – also play the role of moneylenders¹. This is a classic case of an interlinked market transaction, where the arhatiya deals with the farmer in the crop market as a facilitator of trade, as well as in the credit market by advancing working capital. 

This interlinkage has been explored in economic theory (Basu 1986) as well as empirical work. Research investigating agro-economy interlinkages in Andhra Pradesh, Bihar, and Punjab in the early 1980s (Bell and Srinivasan 1989), and Punjab in the late 1990s (Gill 2004) reached the conclusion that the party that was relatively more influential in an interlinked transaction reaped greater economic benefits at the expense of the other. The notion that interlinked transactions are a relic of the semi-feudal agrarian structure was debunked by Bell and Srinivasan (1989), who found that compared to Andhra Pradesh and Bihar, the number of households in Punjab involved in an interlinked transaction was higher. Similarly, compared to Andhra Pradesh and Bihar – where less than a fifth of agri-loans were interlinked – Punjab reported up to three-fifths of its agri-loans being interlinked – with tied loans² being typically larger in size than untied loans. Moreover, other works on the subject have shown that interlinkage occurs more prominently in “advanced” areas vis-à-vis “backward” areas – the former being more commercialised than the latter (Bhaumik and Rahim 1999). Thus, the prevalence of interlinking of credit transactions does not diminish with commercialisation. A parallel finding documented in literature is that interlinked transactions are often found to involve small and marginal farmers (Bhaumik and Rahim 1999). 

In this post, we argue that interlinkages are at the core of the shortcomings of an APMC-dominated agricultural marketing ecosystem and comment on how recent policy initiatives have made sizeable improvements in this ecosystem. We then discuss potential policy interventions to ease the constraints faced by farmers in interlinked agricultural markets. 

Informal credit and interlinked transactions

Often, small and marginal farmers, who make up 86.2% of the total operated agricultural landholdings (Ministry of Agriculture, 2018), find it difficult to access unsecured loans due to the absence of a collateral considered to be valuable by formal sources of credit. On the other hand, arhatiyas lend money to farmers against collateral such as agricultural produce, which in turn is to be marketed by them. In such intertwined market transactions, the collateral (here, the crop that would be harvested) is usually undervalued, and a high enough interest rate is charged on the credit. Hence, the farmers’ financial situation suffers in face of the profits arhatiyas make from these transactions. The arhatiyas often exploit farmers by charging interest rates ranging from 15 to 24% (or more), as against the institutional rate of 8 to 10%. Recent reports have indicated that there have been cases of arhatiyas asking farmers to deposit blank cheques to facilitate mandi transactions. 

Less than adequate access to formal credit forces farmers to rely on these arhatiyas for their financing needs.³ The Reserve Bank of India’s Internal Working Group to Review Agricultural Credit in their 2019 report, have pointed out that in some states like Kerala and Tamil Nadu, agricultural credit from formal sources is more than the agricultural gross domestic product (GDP) of these states, signalling that there is indeed a demand for credit, and credit is being used for non-agricultural purposes as well– mainly consumption (Reserve Bank of India (RBI), 2019). 

Solving interlinked transactions

One way to break free from this interlinkage is to end the dominance of the influential party (here, the arhatiyas) in at least one of the markets (here, the credit market or the grain market). This ensures that they cannot extract more than their due from the worse-off party (here, the farmers) in related transactions. The Farming Produce Trade and Commerce (Promotion and Facilitation) Act, 2020 was a good step forward in this regard, as it would have augmented the price discovery process⁴ by increasing choices for farmers to sell their produce. 

Despite its rollback, several states like Gujarat, Himachal Pradesh, Tamil Nadu, Karnataka, and Madhya Pradesh have amended their APMC acts along the lines of the impugned farm laws. This should promote wider participation of private corporate firms like ITC, Ruchi Soya, Cargill etc. in these states, which are already active in some geographies in the agricultural produce marketing process. Participation of firms that already have a presence in the food processing sector would open up vistas for farmers to sell perishable commodities and crops with short periods of maturity at competitive prices and with greater frequency, partly alleviating the need for short-term credit. It will also help incentivise and attract new private entrepreneurs in food processing as it should become easier to purchase agricultural commodities from farmers without the usual fetters imposed by APMC acts, such as the requirement of a region-specific APMC trade licence (akin to an entry barrier), high fees, and levies on APMC trade etc. 

Access to formal credit

In addition to direct loans from the banking sector to the agricultural sector, the Kisan Credit Card (KCC) has proved to be a successful policy intervention in the institutional agricultural credit ecosystem. Since its introduction in 1988, the KCC has brought much-needed improvement in the access to short-term institutional credit to the agricultural sector, accounting for over 60% of outstanding loans under priority sector credit by March 2018 (RBI, 2019). 

Although the KCC aims at providing easy short- and medium-term credit to farmers, as of 2019 only 10.5% of agricultural households and 45% of farmers possess an operative KCC in 2019 (RBI, 2019). The actual coverage is likely to be even lower, as NABARD’s All India Rural Financial Inclusion Survey revealed that only 4.6% of the agricultural households held more than one card (NABARD, 2018). This underwhelming penetration of the KCC – despite the ease of access and flexibilities in availing credit through it – hints at the scope for improvement in the policy, even though the scale of credit extended on account of the KCC scheme has been impressive⁵. 

The central bank allows commercial banks, cooperative banks, regional rural banks (RRBs), and small finance banks (SFBs) to operationalise the KCC scheme under broad guidelines. However, the Scale of Finance (SoF)⁶ under KCC is decided by the District Level Technical Committee (DLTC) and this crop-wise SoF forms the basis for determining the credit limit for each farmer. This SoF is decided after taking into account various aspects such as the cropping pattern in the district, agro-climatic conditions, methods of farming, irrigation, etc. Thus, the short-term credit limit for any farmer is the SoF pertaining to the crop grown and area owned, plus 30% – 10 and 20% for post-harvest expenses/consumption and maintenance of farm assets, respectively⁷.

In a study conducted in 14 states⁸ it was found that credit under KCC is insufficient to cover the costs of cultivation. Moreover, owing to the differing geographical and agro-climatic conditions, the SoF for the same crop was found to vary across districts of a state. The shortfall in the credit available vis-à-vis the costs is the principal reason why informal credit is more attractive. Additionally, a 10% (of SoF) limit on the credit available for post-harvest expenses and consumption purposes may not be sufficient. These could be the potential explanations behind the less-than-satisfactory performance of the KCC scheme (RBI, 2019). 

This can be mitigated by bringing uniformity in the methods by which different district-specific DLTCs decide the SoF. This will reduce the disparities in the credit limit for farmers who follow similar cropping patterns. Moreover, considering the minimum support price is decided at the national level, and is based on average cost of production across the country, it may be beneficial to decide the SoF at the state level. This will ensure that state-wide differences in costs of production owing to differences in geographical and agro-climatic factors are taken into consideration, while also taking care of within-state disparities. 

Additionally, the merits of the 10% limit on credit meant for post-harvest expenses as well as consumption, needs rethinking. While an RBI report has put forth suggestions to encourage banks to give credit to agricultural households for consumption purposes based on collateral security and repayment capacity (RBI, 2019), the transaction history of KCC could instead be used to determine the eligibility of farmers for collateral-free advances. This would leave scope for the farmer to set aside the existing 10% for post-harvest expenses. 

The arhatiyas issue a J-form to farmers once their produce is sold in the mandi. It records the value and volume of the farmer’s output sold, which – given normal conditions – is unlikely to vary drastically every year. Therefore, data from J-forms from five to seven years’ prior can be used as a basis of credit. KCC transaction history and J-forms, coupled with negotiable warehouse receipts⁹, can help formal lenders undertake credible credit appraisal of informal lenders – in this case, farmers.

The KCC scheme limit can be augmented based on J-forms. It will allow farmers to get loans at a 4% annual interest rate, if combined with existing interest subvention schemes. A reasonable upper limit can be put in place as a check against misuse by beneficiaries. This has a built-in system of incentives for credit discipline – households would know that if they default on the payment, they would not be able to get easy and timely formal credit in the future. Such changes in the scheme would address the concern of inadequate credit limits on the KCCs held by farmers, and reduce their dependence on the arhatiyas for credit. 

Conclusion and way forward

In this context, the role of Small Finance Banks (SFBs) assumes critical importance. Licensed to primarily cater to the those at the bottom of the economic pyramid; many of them have evolved robust systems to assess cash flow of customers who are part of the informal economy: including field-based cash flow, credit appraisal capabilities, in addition to collection teams that effectively leverage social-sanction-based enforcement. 

SFBs have shown stellar performance in terms of achieving (and exceeding) their priority sector lending targets as well as their agriculture and small and marginal farmer sub-targets (RBI, 2019). The current ecosystem of SFBs is organised in such a manner that one SFB caters to a geographically localised clientele. This positions them perfectly to tackle the problem of the spatially non-uniform distribution of agricultural credit. 

A mechanism for providing a dedicated line of credit to SFBs dedicated to agriculture – through Special Long-Term Repo Operations for SFBs (RBI, 2021b) – maybe worked out¹⁰. The method of allocation can be a reverse-auction, where the bid is based on the rate of interest that SFBs would charge small and marginal farmers. The quantum of funds can be demarcated into separate geographical area-based tranches to ensure equitable spatial distribution of this credit. 

As a first step, the interest subvention scheme¹¹ may be extended to cover SFBs as well, in view of their overwhelming achievement in purveying credit to the small and marginal farmers. 

The authors are grateful to Prof. Arup Mitra of Institute of Economic Growth for his comments on an earlier version of this post. Views expressed are personal.

Notes:

1. The Model APMC Act 2003 restricts the wholesale marketing of notified agricultural produce in an area under the jurisdiction of APMC to only licensed arhatiyas. The whole spectrum of services from finding a buyer for the produce, price discovery, packaging and transportation is taken care of by these agents making them a lynchpin in agricultural markets. But owing to the difficulties associated with accessing formal credit, the presence of arhatiyas becomes unavoidable in the credit market as well.
2. Here, tied loans are those that are made between agents that are interacting in more than one market. 
3. Generally, these loans are taken for the purchase of agricultural inputs, for day-to-day needs, weddings, vehicles, or when facing a cash crunch.
4. The Farming Produce Trade and Commerce (Promotion and Facilitation) Act 2020 aimed at providing an eco-system to facilitate intra- and inter-state trade of farmers' produce through electronic mediums, and expanded their ambit beyond the physical boundaries established by the APMC markets. As a result, it created the possibility of more competition leading to better pricing for farmers.
5. From 2007-08 till 2018-19, the KCC scheme has exceeded the annual targets of credit extension by an average of 11%, with amount of outstanding credit as on end March 2021 at over Rs. 12 billion (RBI, 2021c).
6. The Scale of Finance is the finance required for raising a crop per unit of cultivated area (that is, per acre or hectare).
7. The SoF is revised by 10% in the next four years, based on changes in the crop pattern adopted by the farmer (RBI, 2017).
8. The study was conducted by the Internal Working Group to Review Agricultural Credit in the states of Punjab, Haryana, Uttar Pradesh, Madhya Pradesh, Maharashtra, Gujarat, Karnataka, Tamil Nadu, Andhra Pradesh, Telangana, Kerala, Bihar, West Bengal, and Assam (RBI, 2019).
9. Negotiable Warehouse Receipts are issued to farmers upon storing their produce in warehouses accredited with Warehousing Development Regulatory Authority (WDRA).
10. Akin to the unconventional monetary measures that the RBI has taken in recent times for EXIM Bank, NABARD, Small Industries Development Bank of India, National Housing Bank, etc. (see RBI (2021a) for a list), as well as for Micro, Small and Medium Enterprises.
11. The interest subvention scheme was instituted with the aim to provide short term credit to farmers at subsidised interest rate. 

Further Reading

• Basu, Kaushik (1986), “One kind of power”, Oxford Economic Papers New Series, 38(2): 259-282.
• Bell, Clive and TN Srinivasan (1989), “Interlinked Transactions in Rural Markets: An empirical study of Andhra Pradesh, Bihar and Punjab”, Oxford Bulletin of Economics and Statistics, 51(1): 73-83.
• Bhaumik, Sankar and Abdur Rahim (1999), “Interlinked Credit Transactions in Rural West Bengal”, Indian Journal of Agricultural Economics, (54)2. Available here.
• Gill, Anita (2004), “Interlinked Agrarian Credit Markets: Case Study of Punjab”, Economic and Political Weekly, 39(33): 3741-3751.
• Ministry of Agriculture (2018), ‘All India Report on Agricultural Census 2015-16’, Report.
• Ministry of Agriculture (2019), ‘Agricultural Statistics at a Glance 2018’, Report.
• Ministry of Agriculture and Farmers Welfare (2022), ‘Factsheet on Kisan Credit Card (KCC)’.
• NABARD (2018), ‘NABARD All India Rural Financial Inclusion Survey’, Report.
• RBI (2017), ‘Master Circular on Kisan Credit Card (KCC) Scheme 2017’.
• RBI (2019), ‘Report of the Internal Working Group to Review Agricultural Credit’, Report.
• RBI (2021a), ‘Annual Report for the Year 2019-20 (Annex II)’, Report.
• RBI (2021b), ‘Governor’s Statement on 5 May 2021’.
• RBI (2021c), ‘Report on Trend and Progress of Banking in India 2020-21’, Report.
• Wydick, Bruce (2001), “Group Lending under Dynamic Incentives as a Borrower Discipline Device”, Review of Development Economics, 5(3): 406-420. Available here.