1. Indian Agriculture and FPOs

 1.1 Economic Gain from Agri Value Addition and Food Processing

The Gross Value Addition from agriculture, forestry and fishing is estimated at ₹ 1.85 Lac Crore (FY18)4. Currently, agri value chains are highly fragmented and inefficient, especially at the production stage. So, Indian agriculture has the potential for huge growth, particularly through post-harvest value addition / food-processing. However, the majority of Indian farmers have small and fragmented land holdings, a significant challenge to growth.

Small and marginal farmers account for 50% of all land holdings

About 67% of India’s, 1.3 billion population, is rural, and~70% of rural households depend primarily on agriculture for livelihoods5. Over 83% of farmers (9-10 Crore farmers) are small or marginal land holders, covering ~50% of operational land holdings6.

Poverty combined with low productivity leads to deep food security challenges

The average land holding has declined from 2.3 hectares in 1970-71 to the current 1.37 hectares.7 Close to 70% of the holdings are less than 2 hectares, making it difficult to improve productivity through mechanization in irrigation and implements.

At the same time, small and marginal farmers face a poverty penalty8, and are unable to afford or access resources like irrigation mechanization, extension services9, quality seeds, fertilizers, soil nutrients, pesticides, post-harvest storage, transport and value addition /processing abilities, which would enable them to graduate out of poverty.

Input dealers often remain the one-point source for farmers to obtain inputs, knowledge and market linkages. Farmers typically have small purchase sizes and also find it difficult to access formal credit. They remain chronically indebted to input dealers, reducing and limiting profit margins.

1.2 Increase in Yield and Profits Through Collectivization

Small and marginal farmers face decreasing land assets, and difficulty in accessing credit and timely agri-inputs like quality seeds, power, critically timed technical advice & assistance, or the benefits of mechanization. In this situation, Farmer Producer Organization (FPO)10 is a form of aggregation which offers farmers the strength of collective action. In FPOs, farmers retain individual land rights, while leveraging economies of scale for advisory, production, procurement and most importantly, market access and value addition to members’ produce. This is established through pooled resources of land and labour, shared storage space, transportation and marketing facilities. In addition, FPOs also improve bargaining power of small farmers and reduce transaction costs of banks and buyers to deal with them11.

Agricultural GDP growth is twice as effective in reducing poverty, as compared to growth in other sectors of the economy12. Thus, collectivization in agriculture can reduce poverty for a large proportion of low-income population (small and marginal farmers), and also improve unit profitability and aggregate commercial outcomes for the country as a whole.

Based on the local commodity production, the level of focus on the commodity / region / demography of farmers by resource institutions, the density of FPOs and intensity of FPO operations differs across regions in India. The following heat map is indicative of the same.

Figure 1: Definition of an FPO13

Analysts may want to further explore lending conditions based on the type of commodity grown, the region where it is grown, and the season when it is grown. The following table, sourced from IFFCO Kisan, gives a snapshot of the same.

Table 1: Agri Commodity Seasonality

1.2.1 Collectivization of FPOs for Commercial Gain – a Priority of the Government

The Government of India has recognized the role of agriculture collectivization for effective intervention from the dawn of Planned Development (1950), (although agricultural credit cooperatives trace their origin to colonial times (1905). Until 2002, collectivization was conducted through farmer cooperative structures, registered with the Registrar of Cooperative Societies. Cooperatives are largely state promoted and focus on accessing state programs rather than empowerment of farmer collectives to become independent business entities.

In 2002, the Producer Companies Act was added as an amendment to the Indian Companies Act of 1956.

Producer Companies are incorporated with the Registrar of Companies (RoC).

Figure 3: Transition from Cooperative to Company Structure for FPOs

1.2.2 Government Agencies Working to Promote FPOs

The Government of India has put in place a number of policies, schemes and funds aimed at benefiting the agriculture sector, with particular focus on FPOs through Small Farmers’ Agri-Business Consortium (SFAC)14, and National Bank for Agriculture and Rural Development (NABARD).

Small Farmers Agri-Business Consortium (SFAC)

Set up in January 1994, SFAC operates as a Development Institution under the aegis of Department of Agriculture, Cooperation & Farmers Welfare, Ministry of Agriculture & Farmers Welfare. SFAC’s mandate is to develop agriculture in India. Its vision is to empower farmers by promoting agri-business through private sector investments and market linkages. Its mission is to link farmers to technology and markets, in association with private and cooperative sectors.

SFAC aims to provide backward and forward linkages, where necessary.

In addition to its core objectives, SFAC also helps implement various schemes and programs of the Indian government, financial institutions and banks.

SFAC also offers the following financial assistance:

1. Venture Capital Assistance Scheme (VCAs)

2. Farmers Producers Organizations (FPOs)

3. Equity Grant and Credit Guarantee Fund Scheme (EGCGFs)
   (Further details in Annexure)

(Further details in Annexure)

There are also a number of central and state specific schemes (including one-time support grants and subsidies for capital infrastructure) which are routed through SFAC. They include; Rashtriya Krishi Vikas Yojana (RKVY), Remunerative Approaches for Agriculture and Allied Sector Rejuvenation (RAFTAAR)15, re-vamped National Food Security Mission (NFSM)16, and deployment of e-NAM17.

National Bank for Agriculture & Rural Development (NABARD) & NABKISAN

NABARD

NABARD is a Development Bank set up in 1982 by GoI to provide and regulate credit and other facilities for the promotion and development of agriculture, small scale industries, and other rural crafts and allied economic activities. Within this scope, NABARD acts as a coordinator for rural credit institutions, training and research partner for lending and capacity building organizations in rural areas, regulator for Regional Rural Banks (RRBs) and District Cooperative Central Banks (DCCBs). NABARD also provides refinance to rural lending institutions, enables institutional development, and evaluates and monitors client banks.

National Bank for Agriculture &

Rural Development (NABARD) & NABKISAN

NABARD

NABARD is a Development Bank set up in 1982 by GoI to provide and regulate credit and other facilities for the promotion and development of agriculture, small scale industries, and other rural crafts and allied economic

activities. Within this scope, NABARD acts as a coordinator for rural credit institutions, training and research partner for lending and capacity building organizations in rural areas, regulator for Regional Rural Banks (RRBs) and District Cooperative Central Banks (DCCBs). NABARD also provides refinance to rural lending institutions, enables institutional development, and evaluates and monitors client banks.

It sanctions credit for rural activities through rural cooperative banks and RRBs, and also invests in rural infrastructure development through its Rural Infrastructure Development Fund (RIDF) and the more recent NABARD Infrastructure Development Assistance (NIDA) scheme.

Particularly for producer organizations,

• NABARD’s Producers Organizations Development Fund (PODF) was established in 2011, with an initial corpus of ₹ 50 Crore. Support under PODF was provided for as grant for promotion and capacity building of FPOs, and loans for market linkage.

• A follow-on NABARD PRODUCE Fund was set up in 2014, with an initial corpus of ₹ 200 Crores to create a network of more than 2,000 FPOs in the country

NABARD also has dedicated funds for tribal development (the Tribal Development Fund or TDF), and resource management funds (Umbrella Program on Natural Resource Management (UPNRM). For more details, please refer to the annexure.

NABKISAN

NABKISAN Finance Limited (NKFL), registered as an NBFC, is a subsidiary of NABARD. The main objective of NABKISAN is to provide credit for promotion, expansion and commercialization of enterprises engaged in agriculture, allied and rural non-farm activities. One focus area of NABKISAN is extending term loans and working capital loans to FPOs.

1.2.3 Key Institutions Involved in Supporting Setting Up and Operations of an FPO

The majority of FPOs in existence have used external support (typically from SFAC, NABARD) to set up.

This segment explains the working of key agencies and bodies under the two national-level agriculture development organizations (NABARD, SFAC) of the Indian government18. It is important to note that the sub structures under each have been designed to enable

1. Resource support

2. Implementation support

Promoting Organization Support Via SFAC

SFAC is currently more active in carrying out macroeconomic policies related to facilitating grants, subsidies and other resource availability under the aegis of plans like RKVY, NFSM, and others. SFAC has empaneled a network of Resource Institutions (RIs) which provide resource support (including business development) to FPOs through a network of selected local agencies, typically NGOs. Tasks related to implementation are delegated to the local institutions. Typically, there are 5 NGOs and 10 FPOs under each RI.19

Promoting Organization Support Via NABARD

NABARD operates through a network of regional offices, which percolate down to the district level. It provides FPOs with both capacity building support through Resource Support Agencies (RSAs), and implementation support through producer organization promoting institution (POPIs).

Figure 4: Structure of support by support by Promoting Organizations under NABARD

The POPIs are implementation organizations, typically NGOs in the FPO formation and capacity building stages. These POPIs are identified and trained by NABARD, thereby enabling them to support FPOs through their formation, capacity building, evolution and growth. The RSAs are technical expert organizations which train POPIs, and help the POPIs in implement the program.

1.2.4 Key Central Policies for FPOs

Apart from the policies and funds detailed above, there are a number of policies of the state and the central government which can be leveraged. These include20:

1. Operation Greens: A Centrally Sponsored Scheme (CSS) started by the Government of India. Its total budgetary allocation is ₹ 500 Crores, and is implemented by the Ministry of Food Processing Industries (MoFPI). The scheme is aimed at capacity building of FPOs through their professional development, reduction of post- harvest losses, creation of preservation & processing infrastructure, provision of agri-logistics for supply chain, price stabilisation for consumers and producers and preventing distress sale

2. PMKSY Scheme: The MoFPI, under the Pradhan Mantri Kisan Sampada Yojana (PMKSY), has sub- components, enabling setting up of storage and processing infrastructure.

3. Tax Exemption: As of FY 17-18, Farmer Producer Companies, registered under the Companies Act, having an annual turnover up to ₹ 100 Crore are exempt from tax on profits derived from farm-related activities for a period of 5 years21.

There are similar policies at the state level, including:

1. Odisha Farmer Producer Organisations (FPOs) Policy, 2018

2. Centre of Excellence for FPOs, 2017, by the Government of Karnataka22

3. Rythu Kosam, Andhra Pradesh Farmer Producer Organisations Promotion Policy 201623

4. The Punjab FPO policy

5. Agriculture – Promotion of Collective Farming by organising small/marginal farmers into Farmers Interest Group (FIG)/Farmers Producer Group (FPG) of Tamil Nadu24 among others25.

For a detailed list of central and state level schemes associated with Minimum Support Price, PM-AASHA ‘Pradhan Mantri Annadata Aay SanraksHan Abhiyan’ (PM- AASHA) schemes like PSS (Price Support Scheme), the newly designed Price Deficiency Payment Scheme (PDPS) and Pilot of Private Procurement Stockist Scheme (PPSS), refer to point 3 in Annexure.

1.2.5 Convergence as a Mechanism to Reduce Risk and Improve Farmer Incomes

Aside from the resources available to FPOs for capacity building, and utilizing SFAC’s Equity Grant Scheme for increasing FPO’s equity, convergence with other schemes offers a way to reduce risks in lending.

Convergence refers to combining complementary, intersectional schemes available through the government in an effective way to hedge risks, improve lendability while enhancing developmental outcomes. These may includev commodity specific schemes26, or those which leverage affirmative-action based support27, and improved market access through the National Commodity and Derivatives Exchange (NCDEX), where commodities can be hedged, and sold at day-to-day market prices.

Case Study: How an FPO Leveraged Government’s Catalytic Infrastructure Support Schemes

An FPO promoted by POPI Sabala, in Vijayanagaram district of Andhra Pradesh leveraged available SFAC, NABARD, and state government schemes to get a better risk profile and acquire improved farmer incomes. The FPO leveraged a state government scheme developed in conjunction with NABARD, which offers grant support for the purchase of catalytic physical infrastructure likestorage godowns, marketing sheds, value addition processing units and custom hiring centers etc. The CooperativeBank (DCCB) that extended the loan was able to reduce its exposure, as a significant portion of the funding for the infrastructure was provided by the government as subsidy.

Similarly, an FPO in Chittoor District, Andhra Pradesh, availed loan for a primary processing centre, wherein the outlay of ₹ 15 lacs was funded as a loan of ₹ 5 lacs, with the balance funded through existing schemes.

With the repayment risk significantly reduced, and the FPO being able to value-add utilizing the catalytic infrastructure, it could sell processed produce at a multiple of the price it would otherwise have got by sale at minimum support price, by gaining access to high value markets, and helped increase farmer incomes.

1.3 Classification of FPOs by Origin and Their Ability to Raise Debt

FPOs take on certain characteristics tied closely to their mode of origin. The following table provides information on FPOs by way of origin. FPOs are typically set up in the following formats

Out of the estimated 5,000 – 6,000 FPOs in India, the majority have been set up to help empower farmers (column 1 of Table 1). So, they are in the very early stages of commercial development. Thus, FPOs are perceived as significantly high-risk clients by banks, who typically lack a thorough understanding of the FPO ecosystem.

The financing needs for FPOs, including the largest segment of FPOs – those promoted by SFAC and NABARD, largely differ by their stages in crop / commodity production cycle.

Typically, early stage / nascent FPOs start with dealing in bulk purchasing inputs and selling to members. Progressively, the FPOs build their resources, find high value market linkages, and evolve.

Figure 5: Crop Production Cycle

Thus, the majority of FPOs (due to being early stage) face challenges of not only accessing finance, but being able to build catalytic infrastructure and key capital assets.

In accordance with the type of legal entity, resources needed, the degree of self-governance differ. While there may be higher compliances with the structure of a producer company, there are comparable autonomy and self-governance benefits as listed above.

2. FPO Credit Market

2.1 Estimated Size of the FPO Credit Market

While the number of FPOs is estimated at between 5000 - 6000, FPOs transacting business as on date may be in the range of 2500 - 3500. On a conservative estimate of

average credit absorption capacity of ₹ 10 lacs per FPO, the potential market size is ₹ 350 crore.

This apart, based on the information gleaned from the major institutions lending to FPOs, reasonable estimate can be made that there are about 200 FPOs that have credit need of the order of ₹ 50 lacs, and around 50 FPOs whose credit requirements would be over ₹ one crore each.

This estimate excludes large sized corporate FPOs such as Sahyadri, whose credit needs are larger, and should be assessed like a corporate loan rather than as a loan to an FPO.

This estimate also excludes the on-lending to farmer market, where the FPO acts as Business Correspondent (BC) to a lending institution or themselves borrow and on-lend to the members, usually in kind. The on-lending business, in our view, is fraught with risks that an FPO Balance Sheet cannot absorb. However, depending on the comfort & risk appetite of the lending institution this can be a big market in itself.

In summary, the credit absorption potential of FPOs as on date is as follows:

Table 3: Credit Absorption Capacity of FPOs 2019-20

The size of the market is expected to grow exponentially in the years ahead, considering the thrust being given by

Government & other promoting institutions and the ground work done over the last 5 years bearing fruit.In the next 3 years, the FPO Credit Market (excluding on-lending) will be about ₹ 2000 crore, and could be larger, if warehousing and commodity management with market linkages can get better organized, and gains wider adoption.

2.2 Existing Players in the FPO Credit Market

Currently, FPO lending is majorly led by three Non-Banking Finance Companies (NBFCs) viz, NABKISAN, Samunnati and Ananya. Other NBFC lenders are Nabard Financial Services Limited (NABFINS), Maanaveeya and Caspian. In the following section, some key features of the business models of NABKISAN, Samunnati and Ananya are discussed.

Table 4: Key Lenders to FPOs

2.3 Caspian’s Experience in Lending to Agri-Enterprises and FPOs

Caspian is a 15-year-old pioneer organization in impact investing in India, for equity and debt. It invests in multiple sectors including food and agriculture, microfinance,small business finance, education, healthcare, water & sanitation. In addition, Caspian runs market and ecosystem development initiatives in critical sectors, primarily in the food and agriculture ecosystem.

Caspian has cumulatively disbursed ₹ 320 crores in debt to Agri enterprises, with a current portfolio outstanding of ₹ 46 crores, representing 12% of Caspian’s debt portfolio. Caspian has recently launched of “Rabo- Caspian Agtech Financing Fund” in partnership with Rabobank with a corpus of ₹ 15 crore, to empower viable enterprises in early and growth stage that show promising outcomes with respect to application of technology to leverage efficiencies in the agriculture sector.

The current FPO portfolio of Caspian include:

1. Chetna Organic Agriculture Producer Compan

2. Samalpatti Mango Growers Association

3. Indur Intideepam Societies Federation Limited

4. Bangalore GreenKraft Producer Co Limited

In all these cases, the facility is in the nature of a Working Capital financing.

2.4  Bank Lending to FPOs    

Despite incentives and policies including priority sector lending (PSL) norms 29 instated by RBI in 2015, only a few banks have ventured into lending to FPOs. Close to 90% of the lending to FPOs is by NBFCs.

Reasons for this include:

1. Small and scattered market
2. NBFCs with Agri focus and mandate taking the lead
3. Lack of a clear policy directive from RBI
4. No specific bank level corporate guidelines to guide the branches and field staff
5. Field staff lacking adequate awareness and exposure to FPOs

2.4.1 Banks Currently Lending to FPOs

Banks that have lent to FPOs include, ICICI Bank, SBI, UCO Bank, Union Bank of India, Canara Bank, Vijaya Bank, Ratnakar Bank30, Andhra Bank, Syndicate Bank31, Yes Bank, Indian Bank, and District Cooperative Central Banks (DCCBs) in AP, and some Regional Rural Banks (RRBs).

Majority of them have extended working capital facilities.

In addition, in 2019, SBI rolled out a co-lending model with select NBFCs, particularly for PSL, where SBI would hold 70-80% of the exposure. This model is based on the RBI framework for co-origination of loans by banks and NBFCs in PSL.

SBI is also involved in JLG financing32 for landless, lessee farmers in collaboration with NABARD in the state of Tamil Nadu.

2.4.2 Challenges Faced by FPOs in Accessing Bank Credit

Even in cases where the banks have lent, FPOs typically face the following problems:

Inability to Provide Timely Funds :To provide timely funds, bankers need to understand the crops / commodities centric to client FPOs. The processes and staff limitations and the lack of an internal process are barriers.

Restricted Quantum of Loan:Limited understanding about FPOs increases bankers’ risk perception, so, banks limit lending to the amount that can be completely covered through collateral, or external guarantees, like the SFAC credit guarantee for FPCs33.

For an FPO which may require a working capital higher than what is contributed as equity (₹ 5-10 lacs)34, banks often refuse lending the full amount. Larger entities like FPO Federations find it difficult to raise more than ₹ 1 crore, as the SFAC credit guarantee scheme cover is capped at that level. 35.

Geographical Location-Based Limitations for Warehouse Finance:In cases of warehouse financing, bank guidelines typically state that the warehouse used by the FPO must be near the bank branch. This limits the options available to FPOs operating in relatively remote locations.

Strict Intake Restrictions:Very often, banks mandate strict legal compliances, including audited balance sheets for 3 or more years.

3. Credit Evaluation of an FPO

Credit evaluation of an FPO is similar to that for a typical company, while making adjustments for the special, stagewise needs of an FPO, concomitant stage wise risks, and risk mitigating circumstances.

4. Some Successfully Employed FPO Funding Models

In this section, some lending models adopted by NBFCs and FPOs to tailor-make lending arrangements as per the specific context are presented. These models use operational innovation to increase the quantum of credit, reduce risk and exposure, of a dealing where there is limited security available with the flipside of a higher risk, and may be adapted and replicated on a larger scale.

5. Catalytic Role Played by Promoting Institutions (POPIs) in Building Robust & Bankable FPOs of Smallholder Farmers

Promoting Institutions play a pivotal role in incubating, nurturing, and building FPOs into bankable institutions. Two such case studies are described below. Banks who are looking to fund FPOs can benefit from reaching-out to FPOs through their promoting Institutions, to get access to a screened & sorted list of FPOs as well as be able to lend in clusters and build a viable portfolio size

6. Partnership with Warehousing Companies & Collateral Managers

Another way of lending to FPOs without taking direct exposure on FPOs is through warehouse receipt loans.

6.1 Arya Collateral Warehousing  Services Private Limited

Background: Arya is one of the first companies in India to introduce Collateral Management with primary focus on agricultural produce in 2002. It works with farmers, FPOs, financial institutions, corporates, development organizations, commodity exchanges and international players in its attempt to integrate the entire agriculture value chain.

Methodology: Usually at the time of harvest, farmers obtain lower prices due to higher supply as the entire crop is brought to the market. To overcome this, farmers hold their goods in a warehouse and obtain a receipt against which they can get a loan from banks for the next season’s crop. If a farmer wants to take his goods out of the warehouse, he pays the equivalent amount to the bank and then sell the goods. The risk here stems from:

• Post-disbursement monitoring is weak

•  Farmers approach money lenders to pay the bank as the stock in the warehouse is not sufficient to pay the loan amount.

•  In case of a price dip, storage cost increases and there is no reason for farmer to sell the stock

Close to ₹ 2-2.5 billion has been disbursed through this model with low default rates and high success outcomes for aligned FPOs and farmers.

Innovations from Arya: Unlike other warehouse & collateral management service providers, Arya has consciously decided to focus on FPOs across the country. Arya has mapped & geo-tagged the locations of ~1,850 FPOs across the country in association with Tata Trust. Arya sees the larger opportunity and greater economies of scale by focusing on FPOs as compared to individual farmers / traders. The location of the warehouses is usually near the farms in Tier 2, 3 and 4 cities. Arya provides two options to the FPOs:

• Sell on an efficient platform to an agri business corporate or a partner spot exchange. or

• Hold the commodity in a warehouse managed by Arya until a better price is realized.

If the FPO chooses to hold the commodity in a warehouse, Arya helps arrange finance for the FPO through banks against the security of its aggregated produce. When the FPO decides to sell its produce, its loan is liquidated and the upside is available to the farmer as his gain after adjusting the costs. Arya also provides avenues for better price discovery to the FPO through its market linkages platform. This usually results in better profits to the FPO.

Product Highlights:

Tenor: Typical tenor of each Warehouse Receipt Finance loan is 6-7 months.

Leverage: Up to 3 times of networth

Loan to Produce Value (LTV): Upto 70% based on the crop and its associated price risks. (The larger the price fluctuations, the lower the LTV offered).

Arya is currently working with 70 FPOs and intends to increase this number multifold in next 2 years. Arya makes business on warehouse charges (from FPOs), commission on enabling trade from the buyer, charges for quality testing and logistics.

Benefit to the FPOs:

• Access to loans: Arya has the resources to securitize commodities. Credit quality is ensured when Arya aligned FPOs follow best practices50 disseminated by Arya over the course of 3 months through continuous engagement. This saves the costs for both banks and FPOs

• High value, lower risk market linkages: Arya has strong market connections with suppliers, buyers, large corporations and credit providers. Arya connects FPOs to these players, so that FPOs need undertake only limited marketing. It also enables better price discovery to the farmer.

• Access to market insights: FPOs partnering with Arya have access to trends analysis done by Arya. ranging back ~4-5 years. Most importantly, Arya has access to actions being taken by large corporations (Cargill, others) for the same commodities. Arya passes this information on to FPOs, to help them take a decision on whether to sell the produce immediately, or to securitize it in an Arya warehouse.

Benefits to Lenders:

• Offloading of risk: Lenders can derive comfort from Arya being a storage and market linkage partner.

• Securitization and quality check: It also certifies the quality, quantity and oversees the execution of the loan.

• Delegated Monitoring: There is a better loan monitoring process as Arya suggests the commodity, documentation and process.

Management of lender risks:

• Repayment risk / Monitoring:  Continuous engagement in the initial phases, and continued engagement with the FPO’s management and board through the presence of 1 Arya executive in the region ensures that repayment targets are adhered.

Warehouse receipt loans however are for post-harvest period and do not fulfil the entire credit requirements of the FPOs, especially for inputs and during aggregation of the crops.

Banks can start relationship by initially lending to FPOs as warehouse receipt finance, and once the track record is established with the bank, it can extend working capital loan facilities like cash credit or overdraft.

7. Key Product Features to be Considered for Loan to an FPO

7.1 Working Capital

How Much to Lend for Working Capital?

In the case of seasonal agricultural produce, the output only passes through the hands of the FPO. The FPO typically does not hold the output by itself. If it does, the retention period is very short. Therefore, working capital funds can be rotated51 several times over, and therefore, the working capital requirement will be a fraction of the turnover. For organizations which have experience in lending to FPOs, this is an important consideration. According to feedback from Ananya, Samunnati and NABKISAN, working capital cycles corresponding to commodities can be used to decide the lending period for working capital loans for output from FPOs. Working capital cycles of 2-4 months if commodity is sold without processing / value addition, or 8-9 months in the case of seed production (Source: discussion with Ananya); 20-60 days for short duration crops like vegetables, 90 days for tomatoes, 11 months for banana cultivation (Source: discussion with Samunnati) all require corresponding flexible working capital loan access models.

A good tool to use to get an understanding of the cycle of operations and the working capital gap is the Cash Flow method.

Cashflow Analysis for FPOs:

Cash flow statements provides a straightforward report of the cash available. A company can appear profitable “on paper” but may still not have enough cash to replenish its inventory or pay its immediate operating expenses. This can be avoided through proper cash flow analysis.

In a majority of the FPOs, credit requirement is for working capital. The performance of the FPO depends on various factors like weather, type of crops, crop yield, participation of the members, market linkage, credit linkage etc. Historical financial statements inform a lender about the past performance of the FPO, but it does not guarantee the same performance in the upcoming year. Importantly, past annual financial statements do not give a true picture of seasonality within the year, or more particularly, it does not give true picture of what happens in between the year.

During the year, there may be some months when there is no economic activity and therefore no cash inflows. Lenders need to design the loan product in a way that there is no loan repayment during such period. The loan should be repaid during the months of high cash inflows. The timing, amount and structure of repayment can be effectively analyzed through a simple monthly projected cash flow statement.

It’s important to give “responsible debt”—debt that has manageable interest rates and repayment terms. This is a hallmark of good cash-flow management and ultimately helps both the lender and the FPOs grow. Conversely, loans with unrealistic repayment terms erode cash flow and hinder early-stage survival and later growth. The Cash Flow method is explained below though an illustrative Case Exercise.

Illustration

 Own Resources: The FPO has net worth (Equity + Retained Earnings + Grant) of ₹ 600,000. The FPO has a member base of 1000 farmers each of whom has contributed ₹ 300 towards equity share capital. The FPO had previously received a grant of ₹ 200,000 and has ₹ 100,000 of accumulated profits from operations in previous years.

Activity: The members of the FPO harvest two crops during the year – Paddy in Kharif season and Wheat in Rabi season. The FPO supplies inputs like fertilizer, seeds, nutrients, pesticides etc. to its member farmers as well as aggregates their produce. The aggregated produce is then sold to local traders and institutional buyers. The FPO enjoys margins of 5% on inputs and 15% on aggregated produce. Some inputs are sold to the members on cash basis, whereas some are sold on credit. In the same way, farmer members sell part of the produce to the FPO on cash basis, and part on one-month credit.

Cashflow Analysis:

As can be seen from the cashflows, the FPO has periodical requirement of working capital – once in the month of June and again in January. Some of the sourcing of inputs during both the season can be done from available cash, whereas the larger requirement of working capital can be fulfilled through timely availability of cash credit facility. Once the FPO realizes the sales value, it is important to appropriately structure the repayment of the cash credit facility, and if required, tranche them. This ensures that the loan facility is utilized for the intended purpose, and interest burden on the FPO is minimized.

As can be seen from the cash flow statement, the FPO has high cash inflows from July to September in Kharif season and from February to March in Rabi season. Both these months are ideal for partial repayment of the cash credit facility. An average cash balance at the FPO of ₹ 1 Lac is also desirable to meet any unforeseen expenses.

Conclusion:

By rotation of the cash credit facility of ₹ 11 Lacs, the FPO can achieve turnover of ₹ ~75 Lacs. While limiting the leverage to 2x of equity, the FPO can generate 3.75% Net Profit Margins (cash basis). Throughout the year, the interest coverage ratio is >3x indicating a healthy loan servicing capacity.

The Five Immutable Principles of Credit:

Any lender to an FPO (or even otherwise), should check whether their loan meets the following standards while extending credit:

1. Credit should be Timely: Especially in the agriculture sector where there is seasonal requirement, unless provided in time, credit may not serve its intended purpose.

2. Credit should be Adequate: If the credit provided is not adequate, the gap may be bridged by high cost borrowings to the detriment of the lender & the borrower.

3.  Credit should be Appropriate: This involves product structuring as per the business needs.

4. .Credit should be Affordable: Credit should be reasonably and affordably priced52

5.  Finally, Credit should be Hassle-free: In terms of systems & processes, it must be operationally convenient for the borrower & the lender

Case Study – Chetna Organic

Chetna Organic Agriculture Producer Company Ltd is an FPO working on finance, market linkages and commodity[1]trading. Set up in 2009 with support from its parent NGO Forum for Integrated Development (FFID), Chetna works with over 25,000 farmers spread across Andhra Pradesh, Maharashtra and Orissa. It works on developing sustainable market linkages for farmers’ organic produce in national and international markets. The FPO pays its member farmers organic premium as well as Fair Trade Premium.

Chetna was established with the aim of addressing the poverty related distress of small and marginal cotton farmers. Today, it runs a multi-faceted program with 360-degree support intervention for empowering farmers and promoting community entrepreneurship. For this purpose, the farmers have been federated into 13 district level co-operatives (with more than 836 Self Help Groups working under the co[1]operatives). These co-operatives lead all local level initiatives of their member farmers such as local government linkages, establishment of community owned infrastructure, capacity building through Chetna Organic support, etc.

Chetna starts procuring cotton from the months of December to February, does primary processing by converting cotton into lint & separating cotton seeds and supplies it to cotton mills between February to September. Thus, Chetna requires working capital facility for a period of 9-10 months a year, with periodic repayments in between.

Below is an example of how increase in the working capital loan has helped Chetna increase its turnover by 5 times in last 5 years.

Table 8: Cashflow Analysis Outcome & Corresponding Debt Requirements

Total Debt Availed during the season                       2.50                     5.0                      5.0                     12.0                    12.0

Due to efficient use of capital, Chetna has been able to achieve turnover of 2.5 – 3.5 times the debt facilities availed by it during the year. The lenders of Chetna (NABKISAN and Caspian) increased the limit from ₹ 2.5 Cr in 2014- 15 to ₹ 12 Cr in 2017-18. Chetna had faced problems in procuring cotton from the farmers in 2018-19 since the Government had increased the Minimum Support Price (MSP) by 25%. Hence, the debt limit was maintained at ₹ 12 Cr in 2018-19 by the lenders. Chetna has also availed warehouse financing facility of ₹ 2 Cr from Yes Bank (with guarantee from Rabo Foundation) post harvesting season in March for last couple of years.

However, it is important to note that the debt limits to Chetna are finalized only after the procurement plans are finalized, and after analyzing projected monthly cashflows during each season. The strong and experienced leadership team at Chetna has also been one of the comfort factors to the lenders.

7.2 Term Loans

Growth / mature stage FPOs have need for term loans to ascend to the next level, by improving backward / forward integration. Term loans help create catalytic infrastructure like processing units (dal mills, dairy chilling plants, packaging units, etc.), custom hiring centres, storage units, purchasing vehicles or extending road infrastructure for transporting produce.

Term loans are typically available with a tenure of 2-5 years, depending on the risk appetite of the lending institution.

FPOs are unique in that they can grow fast and create wealth for farmers by leveraging policies and schemes of the Government to avail term loans for catalytic output marketing and infrastructure. Numerous FPOs have leveraged infrastructure schemes (one-time grants, guarantee for loans, subsidies) to subsidize costs of accessing term loans. For example, an FPO consisting of tribal farmers looking to set up a custom hiring centre (CHC) could leverage grants not only under RKVY and NFSM, but also other specific tribal-based grants. In this manner, the FPO only had to contribute 10% of the total cost of setting up the CHC, with 60% covered by government subsidies and grants (via SFAC), and 30% through NABKISAN grants.

To read more about banks which have lent to FPOs, and various challenges related to acquiring term loans for an FPO, refer to sections

• 1.2.4 “How to use Convergence to reduce risk and improve farmer income”, and z

•  2.4 “Bank lending to FPOs”

7.3 Interest Rates: How Price Sensitive are FPOs to Interest Rate? Does Interest Rate Matter?

From a lender’s perspective, FPO loans are generally of smaller ticket size, require case to case structuring, need detailed due diligence visits (in the first two rounds at least), and intensive monitoring. Shouldn’t the loan pricing be higher, factoring in these costs?

On the other hand, from an FPO’s perspective, their activity is more than just a business. Considering the government’s thrust for FPOs, banks should extend concessional finance at affordable rates.

Both these positions carry merit as a starting point for negotiation. Lenders today may also approach the loan pricing more scientifically. This is because we now have data about the performance of a pool of reasonably-sized FPO loan assets over a significant time period, and across various lending institutions. The pricing negotiation therefore gets more nuanced, and loan price discovery is relatively easier than in the past, when this segment was nascent.

The benchmark for any new lender entering this space will be the rates presently charged by current lenders to FPOs (10 to 19% pa interest, plus other charges like processing fee).

Banks, having the advantage of CASA deposits (that NBFCs do not), can offer FPOs more competitive rates than NBFC, particularly for larger sized FPOs with a good track record and credit history. The ability of banks to extend Allfinanz (Loan, Current/Overdraft account to route transaction, remittances and insurance through its own or as corporate agent), will give it an edge over an NBFC.

FPOs are farmer-member-centric organizations. Any saving in interest rate through availing of loan from a bank instead of an NBFC will strengthen the balance sheet of the FPO through reduction in interest cost, and corresponding increase in profit, helping the FPO to pay higher price/patronage bonus to its members, as well as increase its borrowing capacity (leverage) in subsequent years.

However, the attractiveness or decision by an FPO of where and from whom to borrow is determined not only by pricing, but also factors like cumbersomeness in procedures, timeliness and more importantly, the confidence of whether the loan will actually materialise.

Over time, FPOs have matured in their understanding of the difference between card rates and the actual cost of borrowing. There are many cases of FPOs going back & forth between NBFCs. Also, they now have an understanding of how to simultaneously utilise a low-cost facility (for core working capital) and a high cost facility (for shorter cycles).

The key to negotiating rate could be the benchmark of a PSB loan rate, but FPOs are beginning to recognise that comparisons will have to be between possible options rather than a hypothetical benchmark.

FPOs are realising that refusing to avail loan merely on the basis of price is not good business. They operate in a seasonal market and business opportunities may be lost for a full year, till the next season.

Thus, a short-term working capital loan of 3 to 6 months at 15% per annum (for illustration) would still be beneficial, even if a bank loan could have been obtained at 10 or 12% pa (if available).

Illustratively, in a transaction where the FPO has a margin of 12% and the transaction can be completed in 2 months, the effective cost of interest on a loan taken at 15% pa will be 2.5%, giving a net margin of 9.5% to the FPO. If the FPO can rotate the money twice over, the returns would double.

8. Where to Find FPOs

Figure 14: How to find FPOs for lending

9. Risks & Risk Mitigation

Lending to FPOs by its very nature, will continue to be an activity with relatively higher risk. Although in absolute size the portfolio may be small, it would in the initial stages, if taken as priority by the bank, require investment of time and effort disproportionate to its expected returns.

However, the selection process through detailed due diligence and proper credit underwriting has the ability to offset the high risks of ‘Adverse Selection’.

As a matter of further care & caution, banks could consider FPOs that have been through loan cycles with NBFCs and have a good track record. CIBIL score could be one standard metric. The option of looking at FPOs that need loans beyond what the NBFCs are providing is another way. If the business is sound & well managed, has a strong leadership team and has a borrowing history, there is opportunity to take an exposure.

Lenders often obtain some kind of guarantee or quasi- guarantee from the FPO Promoting Institutions. While this may be seen as a moral pressure, it is rather difficult to enforce, as most of the promoting institutions are not-for- profit. Even for-profit promoting institutions have limited tangible assets to acquire in case of default. Further, grants and other monetary support that the promoting institutions receive, even if unspent and in the bank account, will be beyond the scope of attachment for recovery of dues.

One of the most effective ways of oversight and risk mitigation, is through periodic monitoring of the FPO, off-site & on-site, during the business season. For effective monitoring, it is best to assign the portfolio to the nearest bank branch and when the individual loans are small, to use a cluster approach. Another method of credit assessment and risk monitoring could be setting up specialized central teams who only looks at FPOs with the help of local branch officers. The NBFCs who have been successful in lending to FPOs have taken this approach.

During the monitoring field visit, it is essential to look at crop yield, weather as well as participation from themember farmers in the economic activities of the FPO. Post harvesting, storage risk is at the peak and the banker should insist on taking insurance cover for the same.

On-lending per se is not what an FPO is designed for, and therefore is preferably avoidable. It can be considered in case the Promoting Institution is strong and has good community connect. Hoping that the FPO can do a better job than a bank is a myth and expecting them to absorb the downsides like in the MFI first loss structure may not work as their own net worth would generally be small.

The guarantee provided by SFAC would be a good way to secure the loan. The eligibility criteria are available here:

To mitigate price risk, RABO has formulated a scheme- Commodity Value Bank Guarantee. The key feature of which are as follows:

Stage 1: Commodity Value Bank Guarantee

1. Rabo Bank provides portfolio guarantee to banks, to provide credit enhancement against loss in commodity value.

2. This guarantee would be used to cover FPOs from price risk, and is akin to an insurance cover against price risk.

3. The guarantee gets triggered if:

4. The price of the commodity falls below an agreed threshold (that of the margin call) during the tenor of the loan facility and the FPO is unable to top-up the collateral required under the margin call.

5. The price of the commodity is below the threshold price at the end of the tenor of the facility and the Bank issues notice for liquidation of the collateral, and the borrower is unable to repay the loan from other cash flows.

6. The maximum cover under this would be capped at 15-20% of the commodity value. This would ensure That FPOs do not lose value due to price risk and would comprehensively address the risk perception of FPOs.

7. The product ensures that any loss to the bank due to fall in commodity value would be honored through guarantee claim (up to the pre-agreed amount), if not paid by the FPO.

8. After the Commodity Value Guarantee is claimed by the bank, the Warehouse Finance Facility for the relevant FPO will continue as per existing terms and conditions. It will achieve two of the main objectives- (a) The loan continuation in spite of calling the guarantee, allows the FPO not to become a defaulter (b) the loan continuation also enables options of enjoying the commodity upside (if any happens during the facility tenor).

Stage 2: Credit Bank Guarantee

1. A portfolio guarantee to banks to cover repayment and default risk originating from FPOs.

2. It’s a 50% pari-passu guarantee for loan losses to the bank;

3. The guarantee amount would be up to 10% of the loan amount, pari-passu with the Bank. The pay-out would be the lower of (i) the guarantee amount and (ii) 50% of the actual loss suffered by the Bank.

4. This would operate more like a credit guarantee for Banks should there be any loss to the Bank on account of the WRF loan extended to FPOs.

5. For the purpose of Credit Guarantee, only outstanding Principal and Interest amounts are admissible to calculate the shortfall amount.

End-use: The funds will be deployed exclusively for the purpose of issuance of credit guarantees in favor of bank credit to FPOs and other similar farm aggregation models (as may be approved by RF). The product will be valid for use for financing designated commodities.

Other conditions:

1. This guarantee is available only to FPOs and Farmer collectives

2. It would cover FPOs up to a maximum commodity value of ₹ 50 lacs

3. This is a financial inclusion tool and shall be available only in case there exists a bundled credit linkage on Warehouse Receipt Finance through a Bank / FI.

10. Through the Looking Glass - Future Outlook

Though India is urbanizing and moving towards a knowledge economy, a significant part of the population will continue to depend on agriculture as a livelihood in the near future. Further fragmentation of the already small holdings is a reality around which any future policy interventions &programs will have to be devised. FPOs will thus play an important role in the days ahead.

One constraining factor limiting FPOs’ ability to raise debt is the low equity base, and the restriction placed on raising equity outside of their members.In the view of this, we have spoken to a few lenders to FPOs about new work-in-progress initiatives, that could increase the access to finance for FPOs.

1. Providing Subordinate Debt: FPO’s are asset-light organizations and cannot provide substantial security or collateral. However, it has been observed that equity of the FPO is being provided as a collateral to procure loans. If FPO’s can succeed in raising subordinate debt,it can be counted as net-worth, thus raising the ability of the FPO to garner a higher quantum of loan.

2. Offering Structured Products: Procedures like securitization can be adopted to convert the loans to eachFPO into tradeable and standardized securities which can be sold to investors. For this to succeed, the FPO portfolios needs to have regular repayments, good asset quality, low prepayment risk and be diversified with other asset classes.

3. Co-lending: Financial institutions in tandem with public finance institutions can explore opportunities in co-lending, for priority sector lending. This can help to share the risk and enhance the credit flow to the agricultural sector.

Conclusion

With the increasing importance & thrust being given to FPOs in terms of policy & support, there is going to be an upsurge in the number of FPOs, and demand for credit.It is therefore the opportune time for banks to capitalize on the emerging opportunity and be in readiness to benefit from it.

It goes without saying that, if FPOs are going to be the engines for transformation of the status of smallholder farmers, Capital will have to be the fuel required to drive this vehicle, and Bank credit is best suited to make it happen.

Annexures

1. Available resources
2. FPO Guidelines, SFAC
3. SFAC List of FPOs Statewise
4. NABARD Portal on Farmer Producers Organizations
5. SFAC - Particulars of Organization and its dutie
6. NABARD - Particulars of Organization and its dutie
7. Equity Grant and Credit Guarantee Fund Scheme for Farmer Producer Companies - Operational Guideline
8. NABKISAN, FPO products
9. RKVY RAFTAAR
10. Re-vamped National Food Security Mission (NFSM)

- Operational Guidelines

1. NABARD and SBI sign MoU for JLG financing
2. Tribal Development Fund Outline
3. Organizations with tools for assessing FPONABARD
4. NABKISAN (primary assessment tool)
5. RaboBank
6. Ananya
7. SFAC
8.  M-Cril Tool53
9. Vrutti’s Self-Assessment Tool- PICAT (Producer Institution Capacity Assessment Tool)
10. Applicable schemes under MSP, PM-AASHA, from Vrutti’s Business Acceleration Unit (BAU) Manual

MSP (Minimum Support Price) Operations: MSP procurement of commodities is the central govt. mandate to purchase the farmers produces when the prices of commodities fall below the MSP level. Under the MSP policy, the government fixes the rates for 23 notified crops grown in kharif and rabi seasonsUnder the new umbrella policy PM-AASHA ‘Pradhan Mantri Annadata Aay SanraksHan Abhiyan’ (PM-AASHA), states would be allowed to choose from three schemes -- existing Price Support Scheme (PSS), newly designed Price Deficiency Payment Scheme (PDPS) and Pilot of Private Procurement Stockist Scheme (PPSS)

• Price Support Scheme (PSS): In Price Support Scheme (PSS), physical procurement of pulses, oilseeds and Copra will be done by Central Nodal Agencies with proactive role of State governments. It is also decided that in addition to NAFED, Food Corporation of India (FCI) will take up PSS operations in states /districts. The procurement expenditure and losses due to procurement will be borne by Central Government as per norms.

The central and state govt. also recognised FPOs registered under producer companies act for PSS operations and many of FPCs and federations of state FPCs are part of this operations. The following are the opportunities and advantages:

1. Generates good amount of revenues and profits
2. Builds the working capital of the FPOs business operations in short span of time
3. Coverage and benefits large number of BAU / FPO farmers
4. Position and recognition of FPO at local and districts
5. Built competencies and confidence of BAU/FPO team to operate larger procurement operations

Whom to approach: The NAFED, FCI and SFAC are the nodal agencies of central govt. to take up PSS operations. The NAFED and FCI does the procurement process through state MARKFED departments. BAU should approach the district level units of MARKFED i.e., Dist. Marketing Department and get approve the procurement centre operations. The SFAC is exclusively procures through the FPCs and BAU should regularly contact and avail the procurement centre whenever they are part of PSS.

• Price Deficiency Payment Scheme (PDPS): Under Price Deficiency Payment Scheme (PDPS), it is proposed to cover all oilseeds for which MSP is notified. In this direct payment of the difference between the MSP and the selling/model price will

be made to pre-registered farmers selling his produce in the notified market yard through a transparent auction process. All payment will be done directly into registered bank account of the farmer. This scheme does not involve any physical procurement of crops as farmers are paid the difference between the MSP price and Sale/model price on disposal in notified market. The support of central government for PDPS will be given as per norms.

The PDPS is on the lines of Madhya Pradesh government’s Bhavantar Bhugtan Yojana (BBY), but will protect oilseeds farmers only. In similar line the Karnataka govt. announced PDPS for onion, under this farmer will be compensated difference between market rate and MSP, up to. 200/- per quintal.

 Pilot of Private Procurement Stockist Scheme (PPSS): In this participation of private sector in procurement operation needs to piloted so that on the basis of learnings the ambit of private participation in procurement operations may be increased.

“The selected private agency shall procure the commodity at MSP in the notified markets during the notified period from the registered farmers, in consonance with the PPSS guidelines, whenever the prices in the market fall below the notified MSP and whenever authorised by the state/UT government to enter the market, and maximum service charges up to 15 percent of the notified MSP will be payable”.

This will mark the first time private players are going to be involved in the government procurement pr Definition of and institutional mandates related to Small and Marginal Farmers Definition

Marginal farmer: A farmer cultivating (as owner or tenant or share cropper) agricultural land up to 1 hectare (2.5 acres)

1. Small farmer: A farmer cultivating (as owner or tenant or share cropper) agricultural land of more than 1 hectare and up to 2 hectares (5 acres)
2. Institutional Mandates54

Small Finance Banks will have a target of 75 per cent for priority sector lending of their Adjusted Net Bank Credit (ANBC). While 40 per cent of ANBC should be allocated to different sub-sectors under PSL as mentioned below, the balance 35 per cent can be allocated to any one or more sub-sectors under the PSL, where the banks have competitive advantage

Acknowledgement

We express our gratitude to the following for imparting critical information which was used to strengthen the report.

Table 10: Primary Interviewees

We would also like to acknowledge the kind contribution of Mr. Narasimham Srinivasan, Dr. Venkatesh Tagat, and Madhav Wadavi in quality and fact checking this report, to ensure necessary nuances, examples and sub-topics are included.