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Published byGwendolyn Waterworth Modified about 1 year ago

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

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

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

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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

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

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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, months of household income

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

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

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

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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

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

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

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THANK YOU

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