Economics-of-Agricultural-Production-and-Rural-Markets-English-Version-munotes

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1 Module I
1
ECONOMICS OF AGRICULTURAL
PRODUCTION RESOURCE USE AND
INSTABILITY IN AGRICULTURE - I
Unit Structure:
1.0 Objectives
1.1 Introduction
1.2 Resource and Input Use
1.3 Theory of Production
1.4 Important Production Relationship
1.5 Economics of input and product substitution
1.6 Questions
1.7 References
1.0 OBJECTIVES
 To understand the theory of production
 To explain optimum utilisation of resources and input use
 To analyse factor – factor and product - product relationship
 To know the availability of substitute
 To understand the operational function of input and output
1.1 INTRODUCTION
Primary Sector production which is Agricultural production is the
production of inputs like grass or crop attached to the surface of the land,
whether or not the grass or crop is to be sold commercially, and the
production of any farm animals, including farmed elk, whether or not the
animals are to be sold commercially. Agriculture is the practice of
cultivating plants and livestock. Agriculture was the key development in
the rise of sedentary human civilization, whereby farming of domesticated
species created food surpluses that enabled people to live in cities. The
histo ry of agriculture began thousands of years ago. munotes.in

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2 Developing country like India is highly dependent on agriculture with
respect to job and it is also very significant player in providing raw
material for industrial sector as well . so we can analyse the cont ribution
of agriculture in our GDP. Agricultural production economics is
concerned with the productivity of farm inputs. As such it deals with
resource allocation, resource combinations, resource use efficiency,
resource management and resource administrat ion. Agricultural
production economics involves analysis of production relationships and
principles of rational decision making to optimize the use of farm
resources on individual farms as well as to rationalize the use of farm
inputs from the point of vie w of the entire economy. Depending on
variety, crops grow over a period of 120 to 180 days before maturity. The
growth cycle and phenological stages include: germination, leaf
development, tillering, inflorescence emergence, flowering, fruiting,
maturity, senescence and harvesting. The main factors of production
are natural resources (land, water, soil, rainfall), labour and capital. These
are different products produced by farmers, each of which uses inputs to
produce outputs.
1.2 RESOURCE AND INPUT USE
Economics: Economics is defined as optimum utilisation of resources.
Which occurs due to scarce resources available to us. As wants are
unlimited and means are limited thus to fulfil the need and requirement of
people we use the resources economically.
Agricultural economics , is the study of the allocation, distribution, and
utilization of the resources used, along with the commodities produced, by
farming. Agricultural economics plays a role in the universal objective of
economics of development, for a con tinuous level of farm surplus is one
of the wellsprings of technological and commercial growth. Agricultural
inputs are defined as products which is permitted for optimum use in
organic farming. These include feedstuffs, fertilizers and permitted plant
protection products as well as cleaning agents and additives used in food
production.
Agricultural production means the production of an agricultural operation.
It shall also mean th e agricultural product storage, service facilities and
farmsteads which relate to the individual farm unit; In this chapter we will
be learning about theory of production and various concept about
Production function. These terms are usuallypresented as pa rt of an
introductory economics or agricultural economics course and provide a
starting point for the further study of agricultural production economics.
The significant objective of agricultural production are
 To create employment opportunity in order to solve the problems of
unemployment.
 To increase the per capita income to remove the gap between rural and
urban. munotes.in

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3  To improve intake of nutritional foods item and upgrade the standards
for betterment of health.
" THE PRIMARY GOAL OF ORGANIC AGRICULTURE IS T O
OPTIMIZE THE HEALTH AND PRODUCTIVITY OF
INTERDEPENDENT COMMUNITIES OF SOIL LIFE, PLANTS,
ANIMALS AND PEOPLE.”
1.3 THEORY OF PRODUCTION
Production as per the study with respect to manufacturing and agriculture
is that technique which transforms certain inputs into a consumable form.
The most important factors of farm product production are Land, Labour,
capital and equipment’s utilised for production of resources. Land is used
to produce desired crop. Labour and capital are utilised for the cultivation
and harvesting of crop.
Agricultural production is the study of quantitative relationship which are
important in production process in agriculture. “These relationship is in
the form of input – output patters, anddifferent type of interactions among
the i ndividual inputs themselves and among the product prices and with
nature of production pattern which brings out the attainment of certain
desired optima, like profit maximisation or cost minimisation.Agricultural
production economics as a scope and covera ge area of resource use and
various other elements related to it are efficient utilisation of resources,
resource combination, resource allocation , resource management and
resource administration. Which covers the subject matter like factor -
product rel ationship, factor – factor relationship, product – production
relationship etc. The study of which is taken in to consideration through
some Law’s such as laws of returns to scale, law of diminishing returns
and various important concepts such as Iso qua nts, Production Possibility
Curves(PPC) and ISO - Cost Curve Etc.
Production decision faced by individual farmers is of three different
forms:
1. Farmers are expected to use certain amount of given product having
certain amount of resource to use. Farmer s always try to maximise
profitability by optimising the resources that is by using resources
which yield most profitable amount of resources. This feature can best
way explain with the help of factor – product relationship.
2. To produce specific amount o f given output, producer need to take
decision regarding the combination of maximum profitable resource
use. It can systematically explained with the help of factor – factor
relationship.
3. Sometime farmers find it difficult to take decision regarding the
profitable combination of resources mix of products to produce. This is
referred to as product – product relationship which is concerned with
the determination of what crop to grow and which livestock to breed
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4 1.3.1 Production Function:
The entrepreneur or manager of the farm has to Take right decision
regarding quantity to be produced and also combination of inputs do be
used. The production function is the relationship between physical
outputs and physical inputs farm firms use. It can be express Algebraically
as well. in the following form:
Y = f (x ₁, x₂, x3…….. xn)
where Y is Quantity of output X 1, X2, X3 stands for quantities of factor X ₁,
X2 , X3…….X n.
The Above equation shows relationshi p between output y and input X,
X₂, X3 etc.
Y= a + bx
The above equation shows that there is a constant relationship between
inputs used and the output generated. This is also called as linear
production function.
AccordingAc to A. Koutsoyian “Production f unction is a Purely technical
relation which connects factor inputs and outputs. It describes - the laws of
proportion that is the transformation of factor inputs into products at any
particular time period. Production function represents technology of afi lm
of an industry. or of the economy as whole, it includes all the technically
efficient method of production”.
The production function is the conventional procedure in a production
function study is to predict the total output curve as a regression equat ion.
The Marginalproducts for factor inputs can then be predicted singly by
computing the derivative of the product Y, with respect to the resource
inputs X 1 and X ₂ under consideration.
1.3.2 Types of Production function :
There are various algebraic equa tion forms derived for production
function by economist. As it is known agriculture productivity is affected
by multiple factors of example soil, Climate, type and variety of crop or
livestock etc. so using one common method of production function will be
giving misleading or wrong data. Hence in world economy country like
U.S.A and Europe have Undertakenseveral different form of production
function for agriculture.
The production function can also be classified on the basis of time period.
Those are sho rt term production function and longterm production. In
short Jun because of lack of availability of timesome inputs are kept
constant andsome inputs are variable.
For short term production function we usedLaw of variable proportion
and for long term pro duction function Law of returns to scale is the
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5 1. Homogeneous Production Function
A homogeneous production function is a function such that if each of the
inputs is multiplied by k then k can be completely factored out of the
function. The po wer v of k is called the degree of homogeneity of the
function and is a measure of the returns of scale.
Suppose, we have a function.
X0 = f(L, K)
and we increase both factors of this function by the same proportion in
such a way that the resulting new le vel of output X* is given by
X* = f (aL, aK)
If a can be factored out, the new level of out X* can be expressed as a
function of a (to any power w).
X* = awf(L K)
X* = aw X0 ……… Since X 0 = f (L, K)
This kind of production function is known as homogeneous a nd in case
where ‘a’ cannot be factored out, the production function is known as
non-homogeneous. In a more general form, a homogeneous production in
case function can be expressed as:
Ymk= (mx, my)
Where m is any real number and K is constant. This funct ion is
homogenous of Kth degree. If K is equal to one, then the function
becomes homogeneous of the first degree. If K is equal to 2, thenfunction
becomes homogeneous of the second degree and yields increasing returns
to scale. If on the other hand, K is l ess than one, the function yields
diminishing returns to scale.
It become essential to understand that if the production function is linear
and homogeneous, all the isoquants in this case would be exactly similar
in shape as shown in Figure No. 1.1 and ex pansion path of the farm -firm
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Figure No. 1.1
In fig 1.1 given above IQ 2 , is simply a greater than IQ ₁ showing double
the output. If a straight line OM is drawn from the origin which intersects
the isoquants IQ 1 and IQ ₂ at points A ₁ and A ₂ respectively, then in a linear
homogeneous production function, the slope of the curve IQ, at A, must be
equal to the slope of the curve of the IQ, at point A ₂. In this sense, the
curves must be parallel when seen from of the origin.
Properties of Linear Homogeneous production Function :
(1) If we are using two inputs, capital and labour, then product of either
input dep ends upon the proportion in which inputs are combined.
(2) The Partial derivative
and
(Marginal Product of either input)
are the function of the ratio to labour (K/L)
(3) If production function is homogeneous of degree one, the marginal
productivities of labour and capital are homogeneous of degree Zero i.e.,
they remain unchanged for proportionate change of both the inputs.
(4) The linear homogeneous production function satisfies the Euler's
Theorem which states that the total product is completely exhausted by the
sum of factor payments, that is
L+
K = Q
2. Cobb - Douglas Production function:
It is applicable also in agriculture production. Agricultural productivity
may be defined as the ratio of index of local agricultural output to the
index of total input used in farm production.
The Cobb -Douglas production function is an empirical production
function developed by Charles W. Cobb (American Mathematician) and
Paul H. Douglas (American Economist) base d on empirical studies of
various manufacturing industries of the USA. This production function
was published in American Economic Review in 1928 in the form of an munotes.in

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7 article A Theory of Production. By the name of mathematician C.W. Cobb
and economist P.H. Do uglas, this production function is termed Cobb -
Douglas production function. Here we explain the major properties of the
Cobb -Douglas production function.
The mathematical form of this production function can be expressed as
Q=A.KαLβ
Where ,
Q=The level of output produced in a year,
K = Capital (machine, equipment, and buildings),
L = Labour,
A = It is an index of technology or efficiency parameter also called total
factor productivity and is positive, a and B are positive parameter s of the
production function which measures output elasticities of capital and
labor, respectively. These values are constants and are determined by the
available state of technology.
It is confirmed by the C -D production function that it is a multiplicati ve
production function which implies that both the factors of production are
essential to produce goods and services. It means, if the amount of one of
the factors of production is zero, no output can be produced. (i.e. if K=0,
Q=0 and if L = 0, Q = 0).
Another important thing to note is that originally it was found that the sum
of exponents of the C -D production function was equal to one. That is α+β
is one.
From further research and analysis, it was generalized and found that the
sum of exponents α+β coul d be equal.to one, more than one, and less than
one.
Properties of Cobb – Douglas :
1. The C -D Production Function Can be Used to Measure the
Returns to Scale :
The C -D production function can be used in the calculation of the nature
of returns to scale. The sum of the powers/exponents of factors in Cobb -
Douglas production function, that is a+ß measures the returns to scale.
Therefore,
1. If α+β =1, it exhibits constant returns to scale (CRS)
2. If α+β >1, it exhibits increasing returns to scale (IRS)
3. If α+β <1, it exhibits decreasing returns to scale (DRS)
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8 2. The Factor Intensity (A Relative Importance of Factor in
Production Process) :
In the C -D production function, the factor intensity is computed by taking
the between ratio a and B (ratio between exponent of cap ital and exponent
of labor) as
If α/β >1, there is the use of the capital -intensive technique of production
(capital is more vital in the manufacturing process), and
If α/β <1, there is the use of the fabor -intensive technique of production
(labor is more vital in the manufacturing proc ess)
3. Average Physical Productivity of Inputs :
capital and labor (APK and APL) can be computed below.
APL = Q/L = AKαLβ/L = AKαLβ.L -1 = AKαLβ -1
APK = Q/K = AKαLβ/K = AKαLβ.K -1 = AKα -1L
4. The Marginal Product of an Input Can be Expressed in terms of its
Average Product :
Marginal physical productivity/marginal products/marginal productivities
of the inputs in the case of Cobb -Douglas production function can be
expressed in terms of their average physical productivity/average
productivities. It can be jus tified below.
A marginal product is a change in total output due to a one -unit change in
the use of a particular input. The partial derivative of the C -D production
function measures the marginal product of its factor inputs. Therefore,
Marginal Product of Labour (MPL)=
or

MPL =
= ∂(AK αLβ)/∂L = AK α∂(Lβ)/∂L= βAKαLβ-1= βAKαLβ/L
=βQ/L = β.APL
Marginal Product of Capital (MPK) =
or

MPK =
= ∂(AK αLβ)/∂K = A L β ∂( K α)/∂K = αAKα-1Lβ
=αAKαLβ/K =αQ/K = α .APK
5. Output Elasticities :
The powers of labor and capital (that areβ and α ) in the C -D production
function measure output elasticities of labor (L) and capital (K)
respectively. The output elasticity of a factor shows the perc entage change
in output due to a given percentage change in the number of factor inputs.
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9 As we know that,
Q=A.KαLβ
Output elasticity of Labour - Exponents of labor in the C -D production
function= β
The output elasticity of labor is given by
XL/Q
X L/Q = βQ/L X L/Q = β
The output elasticity of Capital -Exponents of capital in the C -D
production
Function = α
The output elasticity of capital is given by
X K/Q
And
X K/Q = αQ/K XK/Q = α
Therefore, the output e lasticity of labor is β and the output elasticity of
capital is α.
6. Marginal Rate of Technical Substitution (MRTS) :
The marginal rate of technical substitution (MRTS) in the theory of
production that measures the degree of substitutability/ interchange ability
/exchangeability between factors inputs. The MRTS in the case of the C -D
production function can be expressed in terms of the ratio between labor
and capital. It is given below.
MRTS L,K= dk/dL= MPL/MPK = (β.Q/L)/( α.Q/K) = β / α (K/L)
And
MRTS K,L= dL/dk= MPK/MPL= (α.Q/K)/( β.Q/L) = α / β (L/K)
7. Elasticity of Factor Substitution is Equal to Unity :
The elasticity of substitution (o) of the C -D production function is defined
as the percentage change in the capital -labor ratio divided by the
percen tage change in the marginal rate of technical substitution and is
equal to unity. It is given as
α = (Percentage change in K/L)/ (Percentage change in MRTSL,K)
= {d(K/L)/(K/L)}/{d (MRTSL,K)/ (MRTSL,K)}
={d(K/L)/(K/L)}/{d (β / α. K/L)/ (β / α. K/L)} = 1
The value of elasticity of substitution (α) can lie between zero and infinity.
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10 between factor inputs. In the limiting case if α =0, two inputs must be used
in a fixed proportion and they are complementing to each other; in this
case, the production isoquants are right angles or L -shaped. In another
limiting case, if α tends to infinity, two inputs are perfectly substituted,
and the isoquants are straight lines (linear) touching bothaxes. T his
indicates that a given amount of product can be produced by using only
capital or only labor or by an infinite combination of K and L.
8. The Efficiency of Production :
In the C -D production function, the efficiency of production can be
measured by coe fficient A.
• If the value of A is higher, there is a higher degree of efficiency of
production
• If the value of A is lower, there is a lower degree of efficiency of
production
9. Linear Form of Cobb -Douglas Production Function :
C-D Production function c an be made linear using logarithm and the level
of output can be estimated based on regression analysis.
As we know
Q=A.KαLβ …………………….. (1)
Applying log on both sides of equation (i) we get
Log Q = Log (A.KαLβ) )
1.4 IMPORTANT PRODUCTION RELATIONSHIP
There are three different form of product relationship which covers the
subject matter of production through significan t way of analysis. They are
as follows
1.4.1 Factor – Product Relationship
1.4.2 Factor – Factor Relationship
1.4.3 Product -Product Relationship
1.4.4 Factor – Product Relationship
This explains significant relationship between input and output and its
production function is ve ry much connected with the law of variable -
proportions. The principle of production i.e., the amount of a resource that
should be used and consequently the amount of the product that should be
produced is directly related to the operation of Law of Diminis hing
Returns. This law explains how the amount of the output changes as the
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11 The law of variable proportions which is a new name given to old classical
concept of "Law of Diminishing Retu rns" has played a vital role in the
history of economic thought and occupies an equally important place in
the modern economic theory. Assume that a firm's production function
consists of fixed quantities of all inputs (land, equipment etc.) except
labour, which is variable input. When the farmer expands output by
employing more and more labour, it alters the proportion between fixed
and the variable inputs. The law of variable proportions also known as law
of diminishing returns can be stated as follows:
To explain the law more clearly, let us take an example of a farmer who
has got many acres of land, building, equipment etc. He has now to make
the decision regarding the number of workers he is going to hire for the
coming crop season. In reaching this dec ision, the farmer will keep an eye
on the physical productivity of labour on the farm. Table 17.1 contains a
hypothetical example of a production function with labour as a variable
input.
Table 1.1
Output at Wheat in physical Units from Five – Acre Land
No. of
Workers Total
Product Average
Product Marginal
Product
1 100 100 100 Stage I
2 220 110 120 Stage I
3 270 90 50 Stage I
4 300 75 30 Stage I
5 320 64 20 Stage II
6 330 55 10 Stage II
7 330 47 0 Stage II
8 320 40 -10 Stage III

In Table 1.1 if the farmer hires only 4 labourers during the season, his total
product from the farm would be 300 units. If instead of 4, he lines 5, the
product will increase to 320 and so on. The data contained in the first two
columns of this table predict the producti on function. The 3rd and 4th
columns have been derived from the first two columns.
The 3rd column shows av erage product per worker on the farm and is
obtained by dividing column 2nd by column 1st. The 4th column contains
marginal product and is obtained by substracting the total product
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12 employing X, workers, i.e., marginal product of 3rd worker would be 270
- 220 50 units.
A close look at Table 1.1 reveals that both average product and marg inal
product increase in the beginning and then decline. Of the two, marginal
product drops off faster than the average product. Total product is
maximum when the farmer employs the 6th worker, nothing is produced
by the 7th worker and its marginal product ivity is zero, whereas marginal
product of 8th worker is -10; by just creating a crowd, the 8th worker not
only fails to make a positive contribution but leads to fall in the total
output.
Production function with one variable input and the remaining fixed inputs
is illustrated in Figure No. 1.2.

Figure No. 1.2
In Figure No. 1.2 total production rises from zero at an increasing rate
point. A (the total product curve TPP is concave upward up to up to point
A). Beyond A, output continues to rise but at a de creasing rate until it
reaches a maximum, at point C. Point A on the production function, where
the total product stops increasing at an increasing rate, is called the point
of inflection. B indicates the point of maximum output. Beyond point B,
the total product curve slopes downwards.
From the foregoing discussions, we conclude that there can be types of
input -output relationships in the production of a commodity when only
one input is varied and the quantities of all other inputs are kept constant.
These are:
(1) Constant marginal rate of returns (constant productivity)
(2) Decreasing marginal rate of returns (decreasing productivity)
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13 A brief discussion of these three types follows:
1. CONS TANT MARGINAL RETURN FUNCTION
Constant productivity or constant returns the true if all the variable factor
which are applied to the fixed factor result in equal additions to the total
output of the product. The relationship between factor input and produc t
output is then termed as linear. For example if fertilizer applied at the rate
of 0, 5, 10, 15 and 20 kgs. per acre, results in yields of 0, 10, 30 and 40
quintals of rice respectively, constant productivity is realised for the
fertilizer input. Producti on function denoting constant or linear returns is
shown in Figure No. 17.2.

Figure No . 1.3
Constant Returns
In Figure No. 1.3 the output (rice) has been depicted on the Y -axis while
the variable input fertilizer is depicted by X -axis. The resulting cur ve Y is
a straight line and the production function is said to be linear Constant
returns are shown by the triangles, the horizontal side of each triangle
corresponds to an input of 5 kgs. of fertilizer the vertical side shows
corresponding addition to out put of rice of 10 units. This relationship can
also be expressed as:

In terms of algebraic equation, this production function can be as Y = a +
bx. expressed
This kind of relationship does not generally exist when inputs per acre or
per animal are intens ified. Constant productivity is seldom found when
only one factor is varied with respect to all other factors in agriculture. munotes.in

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14 2. DIMINISHING MARGINAL RETURNS FUNCTION :
Diminishing marginal returns function or diminishing productivity (the
variable factor exists when each additional unit of input adds less to total
output compared to the previous unit. Diminishing returns realised, for
example, if the first input adds 25 units to total output, while the second
adds 20 units, the third adds, 15 units, the fourth adds are 10 units, and the
fifth adds 5 units and so on.

Figure No. 1.4
Decreasing Returns
As seen in Figure No. 1.4, the curve Yp is concave to the X -axis. This
relationship can also be expressed as:
>
> ………………..

Since ∆X1 = ∆X2 , ………………∆Xn. Hence the ratio
goes on
decreasing as we apply more units of input.This law is applicable in
almost all practical situations of agriculture production. To land, it applies
both in its intensive as well as extensive fo rms. The application of
additional unit of labour and capital to a piece of land or raising the
proportion of land to doses of labour and capital causes diminishing
returns. It is due to the diminishing returns in agriculture that world food
production cou ld not be expanded in proportion to the increase in
population.
The phenomenon of diminishing marginal returns has played a crucial role
in shaping the classical theory of production. In fact, writers like Malthus,
Ricardo and their contemporaries based a number of their ideas on the
phenomenon of diminishing returns. The situation of diminishing returns,
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15 applicability in all production processes and hence exerts a significant
impact on theoris ing several laws in economics.
3. INCREASING MARGINAL RETURNS FUNCTION :
Increasing returns to a single factor exist when each successive input of
the variable resource adds more to the total product than the previous
input. Increasing factor returns are i llustrated in Figure No. 1.5, by the
curve Yp.

Figure No. 1.5
Physical Production Function Indicating Increasing Returns to a
single Factor
The curve Y in Figure No. 1.5, is convex to the X -axis. The triangles in
this figure illustrate returns; while the return from the first unit of input is,
say 2Y ₁, the return from the second unit of inputs is 4Y,, the return from
their is 6Y, and so forth. Each additional of the variable factor adds more
to output than the previous unit which can be expressed in algebraic form
in following way
<
< ………………..

Since ∆X₁ = ∆X₂= = ∆X3, the ratio ∆Y/∆X will go on increasing as more
and more units of input are added.
Measuring Factor Productivity
We express the factor productivity in two ways:
1. Average physical product =
=
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16 2. Marginal Physical Product =
=


In Fig 1.6 we express input along the X -axis and output along the -axis.
Therefore, AB is the output corresponding to input level of OB.

Figure No. 1.6
At this level, APP is measured by the ratio AB/OB. But we know AB/OB
is also the tangent of the angle α which is derived by drawing a line from
the origin through point A on the production function. Therefore, APP =
tan α. In Figure No. 1.7 point C has chosen because it is at p oint that tan a
is maximum.
Marginal productivity (MPP) has been measured in Figure No. 1.7.

Figure No. 1.7
If the distance AB represents one unit of input, MPP can be measured by
measuring HE. Here MPP =HE/CE = tan Ɵ, which indicates the slope
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17 small, such that CH coincides with the curve itself, MPP value the slope of
the curve at that point.
Fig 1.8 has been drawn with derived MPP and APP curves

Figure No. 1.8
Relationship be tween Total, Average and Marginal Products :
In Fig 1.8, it is noted that so long as TPP rises at an increasing rate, MPP
is also rising and production function curve is concave upwards. Beyond
point A, TPP is increasing but at a diminishing rate. Correspo nding to
TPP, MPP starts declining. TPP achieves its highest level at B, at further
which point MPP falls to zero. Beyond this point, if variable input is
further increased, TPP will fall absolutely in which case MPP becomes
negative.
MPP starts declining from the inflexion point A and it intersects the APP
curve at D, the point of maximum value of APP. This intersection
indicates the equality of MPP and APP at maximum APP.
THREE STAGESOF PRODUCTION FUNCTION
The relationship between average product and mar ginal product, thus, can
be reduced to three propositions as follows:
1. In the beginning, total physical product (TPP) rises at an increasing rate,
average and marginal products also increase but MP rises at a faster
rate than AP. Production function in t his part is concave upwards.
2. When average product attains maximum value and is constant, marginal
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18 3. Beyond the point of maximum value, average product starts falling but
marginal product falls more than average product.
We can s um the above relationship thus:
 When AP is maximum and constant, MP becomes equal to AP;
 when AP starts falling, MP falls faster than AP.
In the same manner in Figure No. 1.8 the relation between input and
output can be divided into three stages.
 Stage 1 is Characterised by an increasing product per worker. Two
workers produce more than twice as much as one worker. Increasing
returns to scale are reaped due to indivisibility of factors of production. By
indivisibility, we mean that the fixed inputs like m achinery, management,
finance, etc. are not available in very small sizes. When the supply of
variable factor is increased in the initial stages, we get increasing returns
because fixed factors are made to work to their full capacity. Since the
concept of indivisibility is considered vague, modern economists have
attributed increasing return to the economies of scale and specialisation. In
stage 1 the production function continues to rise up to the level of input at
which the average productivity is at a ma ximum. In this stage the marginal
productivity remains always higher than average productivity. To
maximise his profit, the farmer can continue to increase variable factor as
long as the average productivity is increasing.
 Stage 2 the total product curve c ontinues to increase but at a
diminishing rate. Stage is extended upto a point where total product
reaches maximum but marginal productivity equals zero. This stage is
known as the stage of diminishing returns as both average and marginal
products of varia ble input continue to fall during this stage.
 Stage 3 the total product is declining. In this stage, the farmer is
incurring greater costs, as he is utilizing more of the variable input, but is
simultaneously receiving less output.
Our farmer who is concer ned with profit maximisation would find two of
the above stages 1st and 3rd as irrational. In stage 1, though the farmer is
faced with increasing returns, yet the farmer can increase his profit only
by switching to stage 2 in which the total product is sti ll rising. For profit
maximising farmer to produce in stage 1 is thus irrational.
Stage 3 similarly is irrational. In this stage, the farmer will be incurring
greater costs as he is utilising more of the variable factor, but is
simultaneously receiving les s returns because each additional unit of
variable input results in a decline in total output.
We, thus, conclude that for a profit maximising farmer, the level of
resource use occurs in stage 2. Regardless of factor cost and product price,
the chosen leve l of input application should be somewhere in the range
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19 The small farmer, who has limited funds and as a consequence, may
operate in a range of increasing returns to capital, is, however, not an
irrational producer. The ce ntral problem here is one of capital limitations
rather than ignorance. The small -scale farmer often can only maintain
production in stage 1 if he is to produce at all since he does not have
enough resources to extend production into stage 2.
1.4.2 FACROR – FACTOR RELATIONSHIP :
In production process, factors of production generally substitute for each
other. In case of cattle feed, barley can well be substituted for maize.
Similarly, substitution can take place between hired labour and family
labour. This substitution not only takes place within similar factors but
even within dissimilar factors as well. We very well know that a machine
is a substitute for labour, and in many countries suffering from labour
shortage, this kind of substitution has taken pla ce.
 ISOQUANTS OR ISO -PRODUCT CURVE
A production function with two variables which are substitutable for one
another within limits can be represented by a family of iso product curves
or isoquants, sometimes also known as production indifference curves. It
is the locus of all combinations of X1 and X2 which yield a specified
output level. For a given output level, farmer's production becomes
Q0 = f(X ₁X₂)
Where Q° is a parameter. The locus of all the combinations of X ₁ and X ₂
which satisfy the above equation forms an isoquant.
Let us suppose, the farmer can produce a given output of wheat, say 50
quintals by employing any one of the following alternati ve combinations
of two factors, labour and capital.
Table No. 1.2
Labour Capital Output (wheat)
1 +10 50 quintals
2 +7 50 quintals
3 +5 50 quintals
4 +4 50 quintals

If this iso -product schedule is plotted on a paper we get an iso product or
equal pro duct curve as shown in Figure No. 1.9. The amount of labour has
been depicted on the X -axis and the amount of capital along the Y -axis.
AB is the iso -cost curve which shows all the alternative combinations
which can produce 50 quintals of wheat. munotes.in

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20

Figure N o. 1.9
Point a on the curve shows that 50 quintals of wheat can be produced by
C, of capital and L, units of labour. Point b shows that the same output can
be produced with C ₂ amount of capital and L, units of labour. In Figure
No. 1.10 an iso -product map has been depicted which shows a set of four
equal product curves which represent 50 units, 100 its, 150 units, and 200
units of wheat output respectively.

Figure No . 1.10
The shape of the isoquant will depend upon the extent of substitutability of
the tw o inputs. In case the two inputs are perfect substitutes, the shape of
the isoquant would be a straight line: in case they are good substitutes, the
isoquant would be slightly curved and convex to the origin; in case the
factors are poor substitutes, the i soquant will have a steep curvature. If the
two input factors are to be used in a fixed proportion i.e., they are
absolutely non -substitutable, isoquants are right angles as shown in Figure
No. 1.11 (a), (b), (c), and (d) respectively. munotes.in

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21

Figure No . 1.11

There are, thus, three broad categories of such combinations inputs:
1. Fixed proportion combination of inputs,
2. Constant rate of substitution, and
3. Varying rates of substitution.
1. Fixed Proportion Combinations :
Certain products can be produced only if inputs are mixed in a fixed
proportion at all levels of production. The product contour under fixed
coefficients is of the type as shown in Figure No. 1.12
There is only one combination of resources for producing the quantity of
product represented by t he contour LS. A product output of 100 units
requires an input OK of resource X 2 and OM of resource X ₁. If input of
X₂ is increased to OL while X, is held constant at OM, the output remains
at 100. Hence both X 1 and X ₂ are limitational factors since output is
limited by the input of either. munotes.in

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22

Figure No . 1.12
Input which combine in Fixed Proportions
2. Co nstant Rate of Substitution :
Perfectly substitutable factors replace each other at a constant rate,
regardless of the level of output or of the proportion in which the factors
are combined. Examples of this are family and hired labour, home grown
and purc hased grain and two different brands of some seed or fertilizer
which are basically identical. Two inputs which substitute at con stant rate
are shown in Figure No. 1. 3.
In Figure No. 1.13, the factor substitution rates are constant because when
product is held constant at one level, one unit increase in X 1 always results
in one unit decrease in X ₂. Constant substitution rates can further be
illustrated in the example given in Table.3.

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23 Inputs which substitute at Constant Rate
Table 1.3
Iso – Product Relationship indicating constant rate of substitution
with output fixed
X1 X2 ∆X 1 ∆X 2
(MRS)
1 0 50
2 5 40 5 10 2
3 10 30 5 10 2
4 15 20 5 10 2
5 20 10 5 10 2
6 25 0 5 10 2

In Table 1.3, the substitution ratio is constan t throughout all combinations
of the two factors. Substitution at a constant rate is, however, one of the
extremes in factor - factor relationships.
3. Varying Rate of Substitution :
In most cases of input combinations, factors substitute for each other at
diminishing rates because the factors of production are incomplete
substitutes for each other. For example, the marginal rate substitution of
hay for grain becomes smaller and smaller as hay continuously replaces
grain, with milk output remaining consta nt. In other words, increasingly
greater quantities of hay are required to offset or replace each successive
decrement in grain input. The shape of iso product curves in such cases is
the convexity towards the origin as shown in Figure No. 1.14

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24 An Illustration of Decreasing Rate of Substitution
PROPERTIES OF ISOQUANT :
Isoquants or equal product curves normally possess properties
which are similar to those generally assumed for indifference curves.
The following are the important propertie s of isoquants:
1. An isoquant curve is negatively inclined. This property signifies that
when the quantity of factor X is increased, the quantity of factor Y must
be reduced, in order to maintain the same level of output.
2. An isoquant curve does not cr oss or cut the higher or lower isoquants. If
the two equal product curves, say, one corresponding to 30 units of output
and the other to 40 units of output cross each other, they will then have a
common factor combination corresponding to the point of inte rsection.
This would mean that some factor combination which can produce 30
units of output according to one isoquant can also produce 40 units of
output according to the other equal product curve. This seems quite
absurd. How can the same factor combinati on produce two different levels
of output, while techniques of production remain the same.
3. Isoquants are convex to the origin. The degree of convexity of the
isoquant indicates the relative ease or otherwise with which one factor can
be substituted for the other while the total output remains same. This is
because of the diminishing marginal technical rate of substitution of one
input for another along an isoquant when we move from left down to the
right.
Product – Product Relationship :
The third produc tion decision involves product -product relationships, that
is, decisions as to which crops and/or livestock should be produced from
the available stock of inputs. Taking into account the conditions of soil
and weather and also the number of resources at th e disposal of the farmer,
a list of all the products which can be raised on his holding can be drawn
up.
BASIC RELATIONSHIPS
Farm products having various relationships to each other. These basic
product -relationships can be: joint products, complementary,
supplementary and competitive products.
A. Joint products are produced through a single production process. One
of the products cannot be produced alone but must be accompa ed by one
or more products. All agricultural products are mostly joint docts. Fo r
example, wheat and straw, mutton and wool, corn and acks, hogs and
manure are produced jointly. The case of joint products depicted
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25

Figure No 1.15
Production Possibilities for Joint Products
For short period analys is, joint products may be treated as a single
Product. But in the long -run, adjustment can be made in the combination if
the price of one product is higher than that of the other.
B) Complementary Enterprises :
Two products are technically complements to e ach other when an increase
in output of the one, with resources held constant in amount, also results in
an increase in output of the other.


Figure No . 1.16

Production Possibility Curve Showing Complementary Relationship
In Figure No. 1.16 the range of c omplementarity is from point P to H and
from point K to L. Thus, we find that two enterprises are never
complementary over all possible combinations of the two. The
complementary relationship always gives way to competition.


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26 C) Supplementary Relationship :
This relationship exists when, with resources constant, output of one
product can be increased without gain or sacrifice in another product. For
example, a small poultry enterprise is supplementary to the other
enterprises on many farms. Dairying is als o a semi supplementary
enterprise in many farming regions. Figure No. 1.17shows supplementary
enterprise relationship.



Figure No . 1.17

Production Possibilities and Range of Supplementary Enterprises

D) Competitive Relationship
Competing products are thos e which compete for use of the farmer's
resources. With limited resources at the disposal of farmer, all crop and
livestock enterprises become competitive at some point. With two
competing products, the use of resources to produce more of one
necessitates a sacrifice in the amount of the other product. When the two
products are competitive, they may substitute at a constant rate or
increasing rate.
1.5 ECONOMICS OF INPUT AND PRODUCT
SUBSTITUTION
1.5.1 Marginal Rate of Technical Substitution :
As noted above, an equal -product curve represents all those input
combinations which are capable of producing the same level of output We
have also noted that the substitutability among the factors is limited and in
order to produce a given output, when the less of one fa ctor is used, a
greater amount of the other factor will have to be associated with it so as
to keep the output level same. Accordingly, isoquants in Figure No. 1.18
have been drawn with a downward slope through part of them to indicate
the fact that when l ess of one factor is used, a greater amount of the other
factor will have to be associated with it. In fact, the substitution of one munotes.in

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27 factor for another will not only become more difficult as it is pushed
further and further; there usually is an absolute li mit to it, beyond which
further substitution becomes impossible. At this point the isoquant
becomes parallel to one of the axes, represen ting the fact that beyond this
point an increased use of one factor will not increase output at all even
when the quantity of the other factor is not varied further but kept
constant. Hence, the points where the isoquants become parallel to the axis
show t he limits within which substitution is possible If all those points
beyond which the isoquants become

Figure No. 1.18
parallel to the axes are joined together, we get ridge lines which show that
in between them, economically feasible units of capital and labour can be
employed to 50, 100, 200 units of wheat as shown in the Figure No. 1.18
In between the ridge lines, the isoquant curves show the different
combinations of capital and labour which can produce a given level of
output. The slope of isoquants w ithin the ridge lines shows the rate at
which one factor can be substituted for another without altering the
amount of output. The rate at which labour can be substituted for capital in
the production of wheat, without changing the quantity of output is kn own
as marginal rate of technical substitution. The marginal rate of technical
substitution between factor L and C, MTS L,K, expresses the rate at which
K can be substituted for L in the production of A without changing the
quantity of output. Let there be a small movement on the isoquant PP,
from G to H as shown in Figure No. 1.19 munotes.in

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28

Figure No. 1.19
In this movement a small amount of factor Y, say, ∆Y has been replaced
by a small amount of factor X say ∆X, without any change in output. The
slope of isoquant PP, at point G is, therefore, equal to ∆Y/ ∆X. The slope
of isoquant at a point can also be known from the slope of the tangent
drawn on the isoq uant from that point. In the Figure No. 1.20 TT 1 is the
tangent drawn at point G on the isoquant curve PP ₁
The slope of the tangent to a point on an isoquant is the rate at which X ₁
must be substituted for X ₂ (or X ₂ for X ₁) in order to maintain a
correspon ding output level. The negative slope defines the rate of
technical substitution, so that:

Figure No. 1.20 Least Cost Combination of Inputs
The slope of the tangent TT 1 is given by OT/OT ₁. We can, therefore, say
that the marginal rate of technical substi tution at point G is equal to
OT/QT ₁.
Since by changing the factor composition, the output remains the same
along the isoquant, the loss in physical output from a small reduction in
factor Y will just be equal to the gain in physical output from a small
increment in factor X.
Accordingly, loss of output gain in output = gain in input
∆Y.MPY = ∆X. MPx munotes.in

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29 where MPy and MPx are marginal physical products of factor Y and X
respectively.
=

= Marginal rate of technical subst itution.
MRTS xy=

This suggests that the marginal rate of technical substitution is also equal
to ratio of the marginal physical products to two factors.
1.5.2 Iso Cost Line :
In order to achieve the least cost combination of factors of production, the
farmer must know the prices of these factors. The prices of factors are
represented by the iso -cost lines. The Iso -cost line shows various
combinations of labour and capital that the firm could buy for a given
amount of money at the given factor prices . An iso -cost line shows the
quantity of either factor and combina ion of both factors which can be
purchased for a given cost. This has been illustrated in Figure No. 1.21

Figure No. 1.21

In Figure No. 6.11 the line AB is the iso -cost line. It shows tha t the firm
can hire OA amount of capital or OB amount of labour or some
combinations of labour and capital along the AB line. Thus, iso -cost line is
the locus of all those combinations of labour and capital which, given the
prices of labour and capital, co uld be bought for a given amount of money.
The slope of the iso -cost line is equal to the ratioof the factor prices, that
is, the slope of iso -cost line =LKPP
where P L is the price of labour and P K is the price of capital.
Similar iso -cost lines can be drawn for different sums of money. If the
money to be spent on the factors increases the iso -cost line will shift to the munotes.in

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30 right and it denotes that, with the given factor prices, the firm could buy
more o f the factors. Thus, we can have a family of iso -cost lines AB, A 1
B₁, and A ₂B2 as in Fig 1.21 They are all parallel to one another because
the factor prices are assumed to be the same in all Cases The iso -cost
lines closer to the origin show a lower tota l cost outlay.

1. Optimal Input Combination for Minimising Cost :
In this case, the firm has to produce the given output with the minimum
cost. This is explained in Figure No. 1.22

.
Figure No. 1.22

The single isoquant Q denotes the desired level of output t o be produced.
There is a family of iso -cost lines AB, A 1 B1 and A ₂B₂. The so -cost lines
are parallel because the factor prices are assumed to be constant and,
therefore, all the iso -cost lines have the same slope.

The firm minimizes its cost at the point 'e' where the isoquant Q is
Tangent to the iso -cost line A 1 B₁. The optimal combination of factors OK
and OL. The optimal combination takes place at the point 'e' where the
given output can be produced at the least cost. Points below e are desirable
(in terms of cost) but are not attainable for output Q. Points above e a re on
higher iso -cost lines and they show higher costs. Hence, the point e is the
least cost point and it is the west cost combination of factors for producing
the maximum tput, Q. It is produced by OK amount of capital and OL
amount of Labour.

At the poin t of tangency, that is, at point e, the slope of iso -cost line is
equal to the slope of the isoquant. This is the first condition for the
equilibrium. The second condition is that the isoquant should be convex to
the origin at the point of equilibrium. Thu s at the point e the ratio of
marginal product of two factors is equal to theratio of their factor prices,
that is,
At point e =
= Slope of Isoquant munotes.in

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31 Where =
= Slope of Iso – Cost Line

2. Optimal Input Combination For Max imisation of Output :
The equilibrium conditions of the firm are the same as above, that is, the
iso-cost line should be tangent to the highest possible isoquant and the
isoquant must be convex. However, the present problem is conceptually
different. In th is case the firm has to maximise its output for a given cost.
This is explained in Figure No. 1.23.



Figure No. 1.23

The firm's cost constraint is given by the iso -cost line AB. The maximum
level of output that the firm can produce is Q ₂ because the point 'e' lies on
the isoquant Q ₂. The point 'e' is the equilibrium point because at this point
the iso -cost line AB is tangent to the isoquant Q ₂. Other points on the iso -
cost line, that is, S and T, lie on a lower isoquant Q ₁. Points above 'e' that
is on isoquant Q, indicate higher levels of output which are desirable, but
are not attainable due to the cost constraint. Hence, Q ₂ is the maximum
output possible for the given cost. The optimal combination of factors is
OK 1 and OL 1 . At tangency of Isoquant Curve and Iso -Cost Line.

1.5.3 Expansion Path (Scale Line):
In this section we try to study how the firm, given the factor prices, will
change its factor combinations as it expands its output in the long run.
This is explained in Figure No. 6.15. munotes.in

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32


Figure No. 6.15.

The iso -cost lines A 1 B₁, A₂B₂ and A 3B3, are drawn parallel to each ther
because the relative factor prices are assumed constant. If the im wishes to
produce the level of output denoted by isoquant Q ₁ will choose the least
cost factor combination e, at which isoquant Q 1is tangen t to iso -cost line
A1B₁. Similarly, if the firm wants to produce higher levels of output
denoted by isoquants Q ₂ and Q 3 it will choose the factor combinations e,
and e, which are the least cost factor combinations for the outputs Q ₂ and
Q, respectively. It should be noted that at the points e 1, e2, and e 3, the
marginal rate of technical substitution of labour for capital is equal to the
ratio of factor prices, that is, each isoquant is tangent to the relevant is cost
line.If we join the minimum cost factor c ombinations e 1, e2 and e 3 we geta
line OE. It is called the expansion path or the scale line. The expansion
path is defined as the locus of the points of tangency between the
isoquants and the iso -cost lines. It shows how the firm, given the factor
prices, will change the amount of two factors when it increases the scale of
production. Since the expansion path represents least cost combination of
factors for different levels of output, it shows the cheapest way of
producing each level of output given the re lative factor prices. The rational
entrepreneur will choose to produce at some point on the scale line when
both factors are variable in the long run.

The scale line can have different shapes and slopes depending ap the
relative prices of the factors used and the shape of the isoquam Thus, on
every isoquant map there will be different scale lines in every different
relative prices of the factors.





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33 1.6 QUESTIONS

Q1. Explain theory of Production with respect to agriculture.
Q2. What to you understand by fact or -factor relationship, explain with
suitable diagram?
Q3. What are the properties of Cobb – Douglas Production Function?
Q4. Describe Expansion Path.
Q5. Explain the concept of Marginal Rate of Technical Substitution.
1.7 REFERENCES
1. Singh, A. S. (2010 ). Fundamentals of Agricultural Economics. Jammu:
Himalaya Publishing House.
2. Sundharam, R. D. (2010). India Economy. Delhi: S. CHAND &
COMPANY LTD.





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34 2
ECONOMI CS OF AGRICULTURAL
PRODUCTION RESOURCE USE AND
INSTABILITY IN AGRICULTURE -II
Unit Structure:
2.0 Objectives
2.1 Introduction
2.2 Imperfections in product and input markets in developing agriculture
2.3 sources of price variability and income instability
2.4 Rationale for and types of government intervention for price
supportand reduction in instability
2.5 Alternative concepts of cost of cultivation and determination of
minimum support price
2.6 Role and optimum size of buffer stock
2.7 Questions
2.8 References
2.0 OBJECTIVES
 To know imperfection in product and input market
 To understand different aspect of sources of variability in price
 To make students aware of role of government intervention in
stabilising price
 To understand the concept of Minimum Support price
 To understand the term Buffer Stock
2.1 INTRODUCTION
On the basis of the experience of the agricultural sector during
independence period, the government of India reali sed the need to re form
the agricultural sector to meet the challenges at home as well as in the
changing global scenario in the 21st century.
The post Agriculture period is the base for the development of other
sectors like Industry manufacturing etc . Its importance lies in the fact that
it provides the most essential consumption goods for the people. It is
however depressing to note that since independence agricultural growth on
an average was less than 4 percent. Not only this but in certain years the
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35 The Government plays significant role in eradicating or reducing the
constraints faced by the agriculturists. With an objectives of establishing
an appropriate and conducive environment to achieve a higher growth rate
the Government of India announced a National Agricultural Policy on
28th July 2000.
 The most important Objectives of National agricultural Policy are as
follows:
1. To achieve a growth rate of more than 4 percent per annum in
agriculture.
2. To introduce the r equired structural changes.
3. To bring in necessary reforms.
4. To make efficient use of resources.
5. To sustain higher growth rate with necessary supporting services -
Technological, environmental and economic.
6. To make agriculture more market oriented.
7. To achieve equity, that is, all the farmers should benefit from the
positive changes in agriculture.
2.2 IMPERFECTIONS IN PRODUCT AND INPUT
MARKETS IN DEVELOPING AGRICULTURE
The imperfections can be viewed in terms of factors such as land, labour
and credit; and output markets.
a) Labour market imperfections - To carry out farming activity, while
small farms mainly rely on family labour, large farms have to depend on
hired labour either on a permanent or a seasonal basis. Family labour
being the residual claimant as well as bearer of residual risks is considered
to be well -motivated. Hired labour, on the other hand, is considered to
require continuous supervision as they do not put in much effort and
judgement as family labour.
b) Land market imperfections - Land market imperfections are associated
with the assumption of sticky operational holding due to imperfect land
rental markets and inflexible owned holding due to sales market
imperfections. The imperfections in land rental markets arise due to the
uncertainty created by ambiguous and inexpedient land reform legislation,
by Marshallian inefficiency and by transaction costs.
c) Credit market imperfections - Since risks and asymmetric information is
inherent in agriculture, the amount of cre dit supplied to the farm sector is
rationed by the formal financial institutions. For the purpose of getting
loans, farmers need to submit collateral in the form of land or other fixed
assets to the financial institutions. Thus the farm households face liq uidity
or credit constraint. The lack of access to credit can limit the ability of munotes.in

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36 farmers to rent or purchase the required inputs such as land, labour,
fertilisers and so on.
d) Product market imperfections - It can be understood that market
imperfections include missing markets (an extreme case of market
imperfection), partly missing markets (rationing, seasonality), thin markets
(imperfect competition) and interlinked markets. The causes of pervasive
market imperfections are covariate risk, asymmetric in formation, moral
hazard and transaction costs.
2.3 SOURCES OF PRICE VARIABILITY AND INCOME
INSTABILITY
2.3.1 PRICE VARIABILITY: The instability of farm prices results from
several factors.
1. The relative sluggishness with which farmers are able to respond to
changes in the demand for their product.
2. Farmers generally must produce on the basis of expectations, and if
their expectations turn out to be wrong, the resulting surplus or
shortage cannot be corrected until the beginning of the next production
cycle.
3. Once a crop is planted, very little can be done to increase or decrease
production in response to market prices.
4. As long as prices cover current operating costs, such as the cost of
harvesting, it pays fa rmers to carry through their production plans even
if prices fall to a very low level.
5. It is not unusual for the prices of particular farm products to vary by a
third or a half from year to year.
6. That extreme variability results from the relatively low responsiveness
of demand to changes in price —i.e., from the fact that in order to
increase sales by 5 percent it may be necessary to reduce the price by
15 percent.
2.3.2 INCOME INSTABILITY: The instability of farm prices is
accompanied by instability of farm income.
1. Gross income from agriculture generally does not vary as much as do
individual farm prices, net income may vary more than prices.
2. In modern agriculture, costs tend to be relatively stable; the farmer is
unable to compensate for a drop in prices by reducing his payments for
machinery, fertilizer, or labour.
3. The incomes of farm workers are generally below those of other
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37 4. There are two major reasons for that inequity. One is that in most
economies the need for farm labour is declining, and each year large
numbers of farm people, especially young ones, must leave their homes
to seek jobs elsewhere.
5. The difference in ret urns to labour is required to bring about that
transfer of workers out of farming; if the transfer did not occur, farm
incomes would be even more depressed.
6. The farm people generally have less education than do nonfarm people
and are able to earn less at nonfarm jobs.
7. The difference in education is of long standing and is found in all
countries, developed and undeveloped; it also exists whether the
national education system is highly decentralized, as in the United
States, or highly centralized, as in France.
Thus the high levels of price and income volatility for farmers are related
to the market fundamentals of supply and demand. However, they can be
intensified by other macro -economic variables, the broad political and
legislative environment for farmers, and speculation on agricultural
products. Large price fluctuations and the resulting variations in income,
which are caused by the endogenous and exogenous factors described
above, represent risks that are specific to farmers. However, the
agricu ltural sector also faces multiple risks that affect other sectors as
well, including business/entrepreneurial risks, legal risks, social risks,
financial risks etc.
2.4 RATIONALE FOR AND TYPES OF GOVERNMENT
INTERVENTION FOR PRICE SUPPORT AND
REDUCTION I N INSTABILITY
The Government of India, felt the need for a price policy set up a
committee under the chairmanship of Prof. Jha in 1964 -65. The Jha
Committee recommended the prices for agricultural commodities for the
year 1964 -65. The committee further recommended setting up
Agricultural Price Comm ission. A s per the Agricultural Price Commission
was set up in 1965. Currently the commission is called - Commission For
Agricultural Costs and Prices (CACP). Th us accordingly commission is
expected to determine and announce administered prices on a yearly basis.
(A) DETERMINATION OF APPROPRIATE LEVEL OF PRICE
The CACP while determining an appropriate level of price is expected to
consider the following factors:
(i) the cost of production
(ii) changes in input prices
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38 (iv) demand and supply
(v) risk factors
(vi) effect on industrial cost
(vii) effect on cost of living
(viii) effect on general price level
(ix) international price situation
(x) parity between price of different crops, parity between input and
outpu t prices and also parity between price received by the farmers
and paid by the consumers and
(xi) trend of price level in the past.
(B) ANNOUNCEMENT OF ADMINISTERED PRICES
Government of India introduces three different types of administered
prices, namely, minimum support prices, procurement prices and statutory
minimum support prices.
(i) Minimum Support Prices (MSP): The minimum support prices
announced each year by the CACP takes into account the abovementioned
facto rs. Special consideration is given to the cost factor. The cost concept
covers all items of expenses of cultivation including the imputed value of
inputs owned by farmers.
(ii) Statutory Minimum Support Price: Earlier in the case of two
commodities namely jute and sugarcane the minimum support prices had
been assigned a statutory status. This made it illegal for anybody to
purchase the commodity at less than its minimum support price. In the
case of sugarcane, no factory can pay a price lower than the stat utory
minimum. In case of jute, the market infrastructure continues to remain
weak, hence the enforcement of minimum support price has become a
difficult task. Inspite of its statutory basis, the implementation of statutory
minimum price remains unsatisfac tory. Thus limitations of the law to deal
with the economic spectacles are to be recognised and dealt with.
(iii) Procurement Price: Procurement price is the price at which the
government procures grain from producers. Normally, the procurement
price is lo wer than the open market price but higher than the minimum
price.
(iv) Issue Prices: They are prices at which the government supplies food
grains at ration shops. They are lower than the procurement prices to
protect consumer's (BPL) interest. The differen ce between the MSP and
issue price is met by the government through subsidy. For Antyodaya
Anna Yojana (AAY) scheme the issue price was 300 per quintal. Since
2002 -03 the issue price for AAY categories have remained unchanged.
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39 (C) IMPLEMENTATION OF ADMINISTERED PRICES
Government need to consider following measures for the implementation
of administered price :
(i) Entrusting the Task to Different Agencies: The Food Corporation of
India (FCI) undertake s prices support operations for most foodgrains. The
National Agricultural Cooperative Marketing Federation (NAFED)
undertakes such operations for coarse cereals, pulses and oilseeds. The
Cotton and Jute Corporations of India are entrusted with the price s upport
operations for cotton and jute respectively. In the case of sugarcane, sugar
mills are required to pay the minimum prices to the producers.
For tobacco, the responsibility for implementing the price policy decisions
rests on Tobacco Board. Similar specialised Commodity Boards exist for
rubber, coffee, tea, spices, coconut, oil -seeds and vegetable oils,
horticulture etc.
(ii) Establishment of National Crop Forecasting Centre (NCFC): It
was established by the Government in January 1999 to keep a caref ul
watch on the prices of primary products which include wage goods and
other items of common man's consumption and recommend vigorous
intervention if necessary by the government in the market. NCFC will put
an advanced warning system that signals likely s upply shortfalls. This was
found necessary till now in the case of onions, pulses, and edible oil.
(iii) Setting up of Hig h Powered Price Monitoring Board: It was set up
in 1999 for monitoring the essential commodity prices and anticipating the
need for go vernment's intervention in the market.
(iv) Buffer Stocks: Buffer stocks are stocks build up by the government to
stabilize prices. Food corporation of India and NAFED build -up buffer
stocks of essential grains which are utilized when there is shortage of
output. Since 1992 onwards buffer stocks have gone up continuously.
Currently we have enough buffer stocks of essential grains.
(v) Warehousing: Government has made arrangements to set up
warehouses including warehouses of FCI. Such warehouses help farmers
store the farm products till they are demanded in the market.
MSP is the minimum price is nothing but the government pays for the
farmers’ produce at the time of procurement. It is aimed at saving the
crops from price fluctuations in the market. The MSP fixed by the
government is considered as being remunerative for farmers. But MSPs do
not have legal backing.
MSPs were first introduced in 19 66-67 when the country adopted Green
Revolution technologies. To boost the domestic production and encourage
farmers to plant the high yielding varieties, the government resorted to
MSP. A minimum support price was guaranteed to them.
It is fixed by the ce ntre based on the recommendations of the Commission
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40 CACP submits two separate reports for Kharif and rabi seasons and based
on these, centre fixes MSPs twice a year.
The important cost con cepts used by CACP are the 2Cand 2Ccosts. 2C cost includes all actual expenses in cash and kind incurred in
production by actual owner plus rent paid for leased land plus imputed
value of family labour plus interest on value of owned capital assets plus
rental va lue of owned land net of land revenue.
C, cost is equal to 2C+ 10 percent of cost to account for managerial
remuneration to the farmer.
Hence the formula for Minimum Support Price (MSP) can also be
expressed in the following way
MSP = C = (2C2+ C3)
Swaminathan Formula: The M.S. Swaminathan Committee titled as 'The
National Commission on Farmers' recommended to fix MSP at level 50
percent more than the weighted average cost of production2C, in its report
submitted in 2006. It is called 2C+ 50%. Farmers during their recent
agitation in Maharashtra demanded the implementation of Swaminathan
formula.
 Crops getting Minimum Support Price
As of now, 23 crops are being supported by the centre by fixing of MSP.
They belong to the family of cereals (7), pulses (5), oilseeds ( 7) and
commercial crops (4).
 The crops are:
1. Paddy
2. Jowar
3. Bajra
4. Maize
5. Ragi
6. Tur (Arhar)
7. Moong
8. Urad
9. Cotton
10. Groundnut
11. Sunflower seed
12. Soya bean
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41 14. Niger seed
15. Wheat
16. Barley
17. Gram
18. Masur (Lentil)
19. Rapeseed and Mustard
20. Safflower
21. Toria
22. Jute
23. Coconut – Copra and De-Husked Coconut

Need for MSP:
 To safeguard farmers from the market price fluctuations.
 The prices of farm commodities are dependent on various factors such
as good harvest season which leads to fall in prices.
 In such cases, farmers might not prefer to sow the aforesaid crop next
season. MSPs would encourage farmers to sow these crops and
thereby maintain a healthy supply.
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42 2.6 ROLE AND OPTIMUM SIZE OF BUFFER STOCK
Buffer stock is reserv ing some quantity of a commodity that is used to
offset price fluctuations and unforeseen emergencies. Buffer stock is
generally kept for essential commodities and necessities like food grains,
pulses etc. Due to market inefficiency i.e shortage of Onion in market
NAFED is maintaining buffer stock of it and released some proportion of
stock of Onion . In India, buffer stocking of food grains is conceptually
seen as a vehicle to deliver strategic food and agricultural domestic
support policies through which the government cat ers multiple objectives
such as providing famine relief, ensuring food security to consumers and
providing production incentives to farmers.

Figure No. 2.1
If there is a very good harvest and supply increases to S2, the market price
would fall to P2.
This price is below the target price (TP)
To maintain the price at TP, the government will need to buy the surplus
stocks (Q2 -Q1) and store the goods. This reduces supply on the market
and effectively keeps prices at the target price.
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43

Figure No. 2.2
Buffer Stock with a shortage
In this case, there is a fall in supply. In a free market, the price would rise
to P2 (above the target price)
To reduce prices back down to target price, the government need to sell
goods from the buffer stock and effectively increase supply back to S1.
 The Government of India has given the task of procuring buffer stock
to National Agricultural Cooperative Marketing Federation of India
Limited (NAFED), Food Corporation of India (FCI) and Small
Farmers Agri -business Consortium (SFAC)
Objective Of Practicing Buffer Stock
Buffer stock of food grains in the Central Pool is maintained by the
Government of India (GOI) / Central Government for
 Food Security: Meeting the prescribed minimum buffer stock norms
for food security,
 Welfare Schemes: Monthly release of food grains for supply through
Targeted Public Distribution System (TPDS) and Other Welfare
Schemes (OWS),
 Emergency use: Meeting emergency situations arising out of
unexpected crop failure, nat ural disasters, etc., and
 Price Stability: Price stabilisation or market intervention to augment
supply so as to help moderate the open market prices.

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44 Basic Norms and Principles of Buffer Stock:
 The Cabinet Committee on Economic Affairs fixes the minimum
buffer norms on quarterly basis: i.e as on 1st April, 1st July, 1st
October and 1st January of every financial year.
 In addition to buffer norms, Government of India has prescribed a
strategic reserve of 30 lakh tonnes of wheat w.e.f. 01.07.2008 and 20
lakh tonnes of rice w.e.f. 01.01.2009.
 At present, G overnment of India prefers to use the term – Foodgrain
stocking norms – which refers to the level of stock in the Central Pool
that is sufficient to meet the operational requirement of foodgrains
and exigencies at any point of time. Earlier this concept was termed
as Buffer Norms and Strategic Reserve.
 Presently, stocking norms fixed by Government of India on
22.01.2015 comprise of:
1. Operational stocks: for meeting monthly distributional requirement
under TPDS and OWS.
2. Food security stocks/reserves: for meeting shortfall in p rocurement.
 While four months requirement of food grains for issue under TPDS
and OWS are earmarked as operational stocks, the surplus over that is
treated as buffer stock and physically both buffer and operational
stocks are merged into one and are not di stinguishable.
 According to the present practice, the GOI treats the food stock over
and above the minimum norms as excess stock and liquidates them
from time to time through exports, open market sales or additional
allocations to states. The buffer stock figures are normally reviewed
after every five years
Food Stock available in the central governments’ pool is the stock held by:
1. State Government Agencies (SGAs)
2. States which are taking part in the Decentralised Procurement Scheme
3. Food Corporation of India(FCI)
As of now, the stocking norms for buffer stock decided by the GoI
comprises of:
1. Operational Stocks
The stock required to meet the monthly requirements for welfare schemes.
2. Food Security Stocks
The reserves to meet the procurement shortfall. The food grains for issue
under welfare schemes are considered as operational stock, whereas the
surplus is considered as buffer stock and operational stock both. The stock munotes.in

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45 which is over the minimum stockpiling norms is treated as excess stock
and it is export ed from time to time, extra allocations for some states or
through open market sales.
Importance/Need of Buffer Stock :
A. TO Stabilizing Prices:
The Stability in prices help maintain farmers incomes. A rapid drop in
prices can make farmers go out of business, which leads to structural
unemployment.
B. For the Enhanc ement of Investment:
Better Price stability condition will encourage more investment in
agriculture.
C. It Reducing Inflation:
The determined and Target prices help prevent excess prices for consumers
and help reduce food inflation. Which might be important for households
living in poverty, who may struggle to pay high prices during years of
shortage.
D. IT brings out the Consistent Supply:
It helps t o maintain food supplies and avoid shortages.
E. Helps to Promote welfare schemes : Helps welfare state to run
welfare schemes through Public Distribution schemes in an effective
manner.
Challeges / Problem Faced in implementation of Buffer Stock:
A. High Cost of Logistics and administration: Due to majorfunds
allocated for buying the buffer stocks, it becomes troublesome for the
Agricultural ministry and FCI to frame and adjust the budget to make
funds available for the efficient establishment and working of the storage
units. This can be seen in the following ways:
1. Dual Wastage: Huge quantities of food stocks get spoiled due to
unscientific storage methods and at the same time a large percentage
of the population is dying of hunger in India.
2. Warehousing Issue s: Lack of sufficient storage space and other
storage infrastructure after the procurement.
3. Wastage: Open, outdoor storage, the food grains are often spoiled
by rodents, frost, and rain, causing a huge financial loss for the
government.
4. Transportation iss ues: The cost of transportation of the grains to
and from the FCI godowns is huge. Spilling and spoilage at the time
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46 5. Diversion and pilferage: The Buffer stocks are sometimes diverted
to black markets, liquor man ufacturing units, Ghost beneficiaries.
This way instead of the targetted population, others benefit from the
buffer stocks of food grains, starving a great percentage of the
population.
B. The Trade Distortion practice: IN Many developed countries of
the West consider the government procurement of food grains and
maintenance of the buffer stocks as a trade distortion practice. They drag
India to the WTO regarding the same.
C. The Skewed Cropping pattern: Integration of the buffer stocks
with MSP for food grains like rice and wheat leads to excessive
production of these food grains. These are water -intensive crops and need
the greater application of fertilizers for greater productivity. This not only
affects the environment but also affects crop diversity, comprom ising the
nutritional security of India. Farmers belonging to regions not favourable
for the production of rice and wheat will also have an inclination for
goring rice and wheat.
D. Open -Ended Procurement: in the absence of proper estimation
of the overall b uffer stock estimation for running the PDS and
emergencies, the open -ended procurement of the food stocks further poses
a challenge to proper storage and outtake of the buffer stocks.
2.7 QUESTION S
Q1. What are the factors responsible for unstable price and income in
agriculture sector?
Q2. Describe Minimum support price.
Q3. what do you understand by buffer stock?
Q4. Explain how government intervention bring out stability in price in
agricultur e market.
Q5. What are the factors responsible in failure of Minimum Support Price?
2.8 REFERENCE S
1. Heady Earl O., Economics of Agricultural Production and Resource
Use, Prentice Hall, New York, 1961 (Module 1)
2. Kahlon A.S. and D.S. Tyagi, Agricultural Price Policy in India, Allied
Publishers Pvt. Ltd., New Delhi 1983 (Module 1)


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47
Module II
3
RURAL CREDIT MARKETS - I
Unit Structure
3.0 Objective
3.1 Introduction
3.2 Characteristics of rural credit markets
3.3 Credit fragmentation
3.4 Organised and unorganized sector
3.5 Theories of informal credit markets
3.6 Lenders Risk Hypothesis
3.7 Default and Collateral
3.8 Default and Credit Rationing
3.9 Informational Asymmetries and Credit Rationing
3.10 Questions
3.11 References
3.0 OBJECTIVE S
 To make the students aware about the concept of Rural Credit Market.
 To understand features of rural credit market
 To know the difference between organised and unorganised sectors.
 To understand various theories of rural credit market
 To get the knowledge of lenders Risk Hypothesis.
3.1 INTRODUCTION
A rural area is an open band of land that has few homes or other buildings,
and with very few people. A rural areas population density is very low.
Many people live in a city, or urban area. Their homes and businesses are
situated very close to one another. Though rural society is characteris ed by
the implication of agricultural activities, rural development is broader than
agricultural development. First, various non -agricultural economic
activities take place in rural areas. Agricultural sector is vital player and at
important position in the Indian economy. Agriculture till date is the major munotes.in

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48 occupation of the people living in the rural areas. Approximately 70% of
India's population live in rural areas and their major activity is agriculture,
and major productive asse t land. For the rural population, it is the
regulator and proprietorship of land that governs their wellbeing . It gives
employment opportunities to about 65 percent of the working population
of India.
The major challenges faced by the farmers are addresse d with a sense of
urgency. Agriculture as per the federal governing system of central state
relation become the part of State subject, the majority of public investment
in agriculture takes place at Agriculture Economy is the major concern
area of state go vernment .
Major Agricultural and allied products are cereals (mainly rice), tea,
coffee, cashew, spices, tobacco and leather are important items of India's
exports and hence foreign exchange earnings. Agriculture is also directly
and indirectly influencin g the performance of other sector in the
economy.It is major source of raw material for agro -based industries
including textiles, cigarettes, jute, sugar, paper, processed foodstuffs and
vanaspati. Not only this but agricultural sector also provides market for
capital goods (tractors, pump sets and other agricultural machinery),
inputs (fertilisers, insecticides), and light consumer goods.
The advancement of the agricultural sector rest on, to a large extent, on
such core industries as power, petroleum, fe rtilisers and machine tools.
Thus, there is inter -dependence between agriculture and industry.
Two major workings of agricultural development strategy have been:
(a) subsidies on inputs and
(b) minimum support price for output.
But the problems of “rur al indebtedness and the exploitative practices of
the village moneylenders continue to create problem to the farmers. Loan
which are taken for agricultural purposes or small home businesses across
the rural areas in India is known as a Rural Credit. the objective of rural
credit delivery was directed by the considerations of confirmingacceptable
and timely availability of credit at reasonable rates of interest through the
expansion of institutional framework .
3.1.1 Kinds of Rural Credit
There are T hree different kinds of Rural Credit –
1. SHORT TERM CREDIT – These loans have a limited repayment
tenure that can range up to one year at the most. Therefore, such credits
can act as a brief business or private capital requirement for farmers and
others in a rural setting.
2. MEDIUM TERM LOAN – Any loan that has a tenure ranging from
two years to less than 10 years is classified as a medium -term loan. The
credit amount available varies from one firm or individual to the next,
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49
3. LONG TERM LOAN – These are considerable sums that farmers can
avail for a tenure ranging between 5 years and 20 years. In agriculture,
such a line of credit is useful in creating permanent assets. For example,
with the help of such a loan, farmers can purchase tract ors and other
farming properties.

 Agriculture is the main source of income of individuals be located in
in the rural regions across India. Every year, farmers and peasants need to
invest a large amount of funds to ensure a healthy harvest. Thus, they
often resort to borrowing money from moneylenders and financial
institutions to fulfil their basic needs before harvest season arrives, and
they can earn money by selling their crops. Hence any loan taken for
agricultural purposes or small home businesses acro ss the rural areas in
India is known as a Rural Credit.

3.1.2 SOURCES OF RURAL CREDIT
Credit facility to farmers is provided in two different way i.e formally and
informally depending upon the amount size urgency requirement and
frequency of funding.
1. Land Development Banks :
These banks provide a substantial sum of money as a credit to farmers by
using their land as collateral. This low -interest loan has a repayment
tenure ranging between 15 and 20 years. Farmers are free to avail this loan
to bear the cost of land development work, including the creation of wells
or other irrigation related facilities.
Still, land development credits are underutilized since most farmers
remain unaware of this source of funding.
2. Co-operative Credit Societies :
One of the most cost-effective sources of funding for farmers, co -
operative credit enables credit to small - and medium -scale farmers. These
short -term credits are extended by Primary Agricultural Credit societies or
PACs. Nonetheless, these societies have not been able to minimize the
influence of moneylenders on the Rural Credit market.
3. Regional Rural Banks :
Is Setby the government, regional rural banks or RRBs extend monetary
assistance to marginal farmers, landless laborers and artisans.
4. Commercial Banks :
 Originally, commercial banks were hesitant to provide credit for
agriculture due to the risks involved with such a move. However, today,
these banks extend monetary help both directly and indirectly, to farmers.
Direct investment in agr iculture refers to short and medium term loans to
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50 to the advances to farmers made through intermediary agencies or
institutions.
5. Government :
 Also known as Taccavi loans, these are short -term credits extended by
the Indian government to assist struggling farmers, especially in the
aftermath of natural calamities, such as floods and droughts.


3.2 CHARACTERISTICS OF RURAL CREDIT
MARKETS
1. Formation : Rural credit market evolution has taken place since 1952.

 Indian Rural credit market is divided in two segments i.e Informal and
formal credit market.

 Informal credit market is the system of moneylenders, traders, and
input suppliers .

 The formal credit market is organized segment c onstituted by
cooperative banks, regional rural banks, commercial banks, and
nonbanking financial companies.

2. Structure : Rural credit market in India need elaborate structure of
rural financial institutions (RFIs).

 The apex institution in rural credit market is National Bank for
Agriculture and Rural Development (NABARD) .

 Key player in developmental functions for rural upliftment by
introducing NABARD is the Reserve Bank of India, is the monetary
authority.

 The Cooperative banks, scheduled commercial banks, and regional
rural banks are the three major principal of rural financial agencies.
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51 3. Pattern of funding :

In rural credit market Cooperative banks provide both short -term as
well as long -term funding to the rural people .

 The short -term credit is offered in three different tier i.e through (i)
State -level cooperative banks, or SCBs (numbering 30), at the apex (ii)
District -level credit cooperative banks, or DCCBs (numbering 368)
constituting the middle tier, (iii) Primary societies over 98,000 village -
level.

 Each higher tier largely relies on the lower tier for credit dispersal and,
to an extent, on deposit mobilization.

 State level and District -level cooperative institution s operate, to a
limited extent, through their branches.

 Number of SCBs branches are 847 and over 12,000 branches of the
DCCBs.

4. Informational constraints :

Fundamental feature that creates imperfections in credit market .
Informational gaps occur at two basic levels:

1. There is lack of information regarding the use to which a loan will be
put.

2. There is lack of information regarding the repayment decision.

 Limited knowledge of:
 Innate characteristics of the borrower that may be relevant in such
a decision
 The defaulter’s subsequent needs and activities, which place limits
on his incentive to default.
• All the important features of credit markets can be understood as
responses to one or the other of these informational problems.

5. Segmentation :
Many credit relationships are personalized and take time to build up.
 Usually, a rural moneylender serves a fixed clientele, to whom he
lends to on a repeated basis
 He is extremely reluctant to lend outside this circle.
Most often, a moneylender’s clients are from within his village or
from close by, so that the moneylender has close contact with
them and is well informed about their activities and whereabouts.
 Repeat lending —a phenomenon in which a moneylender lends
funds to individuals to whom he has lent before (or has otherwise
close interactions with) —is very common.
 Hence rural credit markets exhibit a tendency towards
segmentation
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52 6. Interlinkage :
 An extension of segmentation: int erlinked credit transactions.
A majority of village moneylenders do not pursue us ury as their sole
occupation.
 Most of them are also wealthy landlords, shopkeepers, or traders
dealing in the marketing of crops.
 Given market segmentation, landlords tend to give credit mostly to
their tenants or farm workers
 traders favor lending to clients from whom they also purchase gr ain
 Thus segmentation often takes p lace along occupational lines
The complementarity of some production relationship facilitates the
credit relationship.
 Interlocking of markets — people conduct their busine ss in different
markets (land, labor, credit, etc.) with the same trading partners, and
make the terms of transaction in one market depend on the terms and
conditions in the other.

7. Interest Rate Variations :
 Segmentation has a natural corollary: informal interest rates on
loans exhibit great variation, and the rates vary by geographical
location, the source of funds, and the characteristics of the borrower.
 High interest rates are not necessarily the norm in informal credit
transactions
 .Low or even zero -interest loans from traders are not uncommon.
 The absence of interest is deceptive: given the interlinked nature of
many of these transactions, interest may be hidden in other features
of the overall deal (su ch as the price at which a trader buys output
from the farmer or the implicit wage at which a laborer is required to
work off an ostensibly interest -free loan).
 The disparities in interest rates pose a puzzle: why don’t clever and
enterprising agents borro w from lenders who charge comparatively
lower rates and lend that money to borrowers who are paying and are
prepared to pay much more?
 Answer: segmentation and the informational variations that cause it.
 The personal characteristics of people matter and so does the nature
or length of interaction between a borrower and a lender.
 The lender, before lending to a client, asks himself such questions
as: Do I know him well? Is he from my village? Is he a good farmer?
How much land does he possess? Does hehave a pump set to irrigate
his land if rainfall is scarce?
 The lender’s decision whether or not to advance a loan and, if he
does, what the terms and conditions will be, crucially depend on the
answers to these questions.
 Thus, arbitrage opportunities may be onl y a mirage: the rate at which
a landlord lends to client A from village X may not be the same at
which he is willing to lend to client B from village Y.


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53 8. Rationing :
 Rationing: upper limits on how much a borrower receives from a
lender.
 By rationing, we mean that at the going rate of interest, the borrower
would like to borrow more but cannot.
 In this sense credit rationing is a puzzle: if the borrower would like
to borrow strictly more than what he gets, there is some surplus here
that the moneylender ca n grab by simply raising the rate of interest.
 This process should continue until the price (interest rate) is such
that the borrower is borrowing just what he wants at that rate of
interest.
 So why does rationing in this sense persist?
 Rationing includes the complete exclusion of some potential
borrowers from credit transactions with some lenders.
 That is, at the going terms offered by the lenders, some borrowers
would like to borrow, but the lender does not lend to them.
 In this sense rationing is intimately connected to the notion of
segmentation.

9. Exclusivity :
 Exclusive dealings.
 Moneylenders typically dislike situations in which their borrowers
are borrowing from more than a single source.
 They insist that the borrower deal with them exclusively; that is,
approach no other lender for supplementary loans.
 Particular dealings are often (though not always) bilateral, and
 Informational, locational, and historical advantages often tend to
confer on lenders the blessings of a “local monopoly”, which they
exploit
3.3 CREDIT FRAGMENTATION
Credit fragmentation in corelated with land fragmentation .Land
fragmentation is a major problem in rural credit absorption which
unfavourably affects agriculture and rural development . The average land
holding in India is 1.15 hectare per farmer, which was 2.1 hectare per
farmer at the time of independence as per the statistics of RBI.
When rural credit absorption gets affected farmers do not show interest
modern farming, use of advanced equipment etc, added Mudra.
Rural credit distribution imbalance is another problem which affects the
rural development, said Mudra.
“In India, farmers who own more than 10-hectare land use 85%
institutional credit. Landless farmers use only 15% of the institutional
credit. So, despite strong rural credit figures there is lot of imbalances ,” he
said. munotes.in

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54 “In India, farmers who own more than 10-hectare land use 85%
institutional credit. Landless farmers use only 15% of the institutional
credit. So, despite strong rural cre dit figures there is lot of imbalance
On important steps taken in the direction of rural and agriculture credit,
Mundra said: “For the first time, in the priority sector guideline revision,
small and marginal farmer have a separate 7% allocation for rural credit.
This along with effective insurance scheme launched by the government
will address the rural credit distribution imbalance.”
Credit needs of the farmers can be fragmented in two different angles - (i)
on the basis of time, and (ii) on the basis of purpose.
A. On the basis of time :
Agricultural credit needs of the farmers can be classified into three
categories on the basis of time - (i) short -term, (ii) medium -term, and
(iii) l ong-term.
Short -term loans are crucial for the purchase of seeds, fertilisers,
pesticides, feeds and fodder of livestock, marketing of agricultural
produce, payment of wages of hired labour, litigation, and a variety of
consumption and idle purposes. The duration of such loans is less than 15
months. Main agencies for granting of short -term loans are the
moneylenders and cooperative societies. Medium -term loans are generally
gained for the purchase of cattle, small agricultural implements, repair and
const ruction of wells, etc. The period of such loans extends from 15
months to 5 years. These loans are provided by moneylenders, relatives of
farmers, cooperative societies and commercial banks. Long -term loans are
required for effecting permanent improvements on land, digging tube
wells , purchase of larger agricultural implements and machinery like
tractors, harvesters, etc., and repayment of old debts. The period of such
loans extends beyond 5 years. Such loans are normally taken from Primary
Cooperative Agri cultural and Rural Development Banks (PCARDBS).
B. On the basis of purpose :
Agricultural credit needs of the farmers can be classified on the basis of
purpose the following categories - (i) productive, (ii) consumption needs,
and (iii) unproductive.
In case of productive needs, we can include all credit requirements which
directly affect agricultural productivity. Farmers need loans for the
purchase of seeds, fertilisers, manures, agricultural implements, livestock,
digging and repair of wells and tube wells , payment of wages, effecting
permanent improvements on land, marketing of agricultural produce, etc.
Repayment of these loans is generally not difficult because the very
procedure of production generally creates the ability for repayment. Very
Obvi ous th at Farmers often require loans for consumption as well.
Between the moment of marketing of agricultural produce and harvesting
of the next crop there is a long interval of time and most of the farmers do
not have enough of income to sustain them through this period. Therefore, munotes.in

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55 they have to take loans for meeting their consumption needs. In the period
of droughts or floods, the crop is considerably damaged and farmers who
otherwise avoid taking loans for consumption, have als o to incur such
loans. Institutional credit agencies do not provide loans for consumption
purposes. Accordingly, farmers are involuntary to depend upon
moneylenders and Mahajans to meet such requirements.
In addition to consumption, farmers also require lo ans for a diversity of
other unproductive purposes such as litigation, performance of marriages,
social ceremonies on the birth or death of a family member, religious
functions, festivals, etc.
Since institutional agencies do not grant credit for such unp roductive
purposes, farmers have to seek assistance from moneylenders and
Mahajans . It is often very difficult to repay such loans because they do not
contribute to the productivity of farmer.
3.4 ORGANISED AND UNORGANIZED SECTOR
Rural credit market is comprised of two different sources these are firstly
Organised or institutional source and secondly Unorganised or Non
institutional source availability for rural credit.
 Unorganized/ Non-institutional Sector :
The non -institutional sources are -(i) moneylenders, (ii) relatives, (iii)
traders, (iv) commission agents, and (v) landlords. This sector does not
belong to the body which come under the control of RBI. The rate of
interest charge by them are very high a nd thus exploitation prevails in
such market. The practice of unorganised source of rural credit due to
backwardness or existence of rural remote areas and also due to lack of
development of Organised credit source.
 Organised / Institutional Sector :
The organised sectors come under purview of RBI i.e Monetary authority.
The institutional sources comprise the cooperatives, Scheduled
Commercial Banks and Regional Rural Banks (RRBs). As far as
cooperatives are concerned, the Primary Agricultural Credit S ocieties
(PACSs) provide mainly short and medium -term loans and PCARDBS
long-term loans to agriculture. The commercial banks, including RRBs,
provide both short and medium -term loans for agriculture and allied
activities. The National Bank for Agriculture and Rural Development
(NABARD) is the apex institution at the national level for agricultural
credit and provides refinance assistance to the agencies mentioned above.
The Reserve Bank of India as the central bank of the country plays a vital
role in this domain by giving overall way to rural credit and financial
support to NABARD for its operations.
During the period of Independence , vital source of agricultural credit was
the moneylenders. In 1951 (the year when planning was initiated in the
country) mone ylenders accounted for as much as 71.6 per cent of rural munotes.in

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56 credit. The major position of the moneylenders was due to the reason that
there was no other source worth the name and the farmers were forced to
borrow from them. This almost total requirement of th e farmers on the
moneylenders enabled the latter to dictate terms and exploit the former in
a number of ways. For example , moneylenders charged exorbitant rates of
interest ranging from 18 per cent to 50 per cent or even more. They often
operated accounts to their advantage by not entering the money returned
and interest paid into the account. They also forced farmers to sell the
agricultural produce to them at low prices. Long -term loans were often
advanced against the security of land and moneyl enders often manipulated
things in such a way as to grab the land. On account of this reason, they
can be termed 'anti -social' elements.
The government thus undertaken various steps to regulate the activities of
the moneylenders. For this purpose, various legislations were enacted. The
basic objectives of these legislations were as follows:
1. To bring about an improvement in the terms on which private credit
was made available to the agriculturists and place legal restrictions on
the unreasonable exactions of the moneylenders
2. To enable the civil courts to do greater justice to both the lenders and
the borrowers than was possible, under the ordinary Code of Civi l
Procedure.
3. To the first category belong such provisions as: (a) licensing and/or
registration of moneylenders, (b) fixation of maximum rates of
interest, and (c) maintenance of accounts by moneylenders, grant of
regular receipts, etc.
4. To the second cate gory belong such provisions as: (a) the empowering
of the court to 'reopen' the closed transactions and go behind the
written contract, (b) protection of certain forms of assets from
attachment in execution of decrees, and (c) the empowering of the
court t o direct payment of decretal amount by instalments.
Trend and growth of institutional or organised Sector:
1. The first institution established and promoted was the institution of
cooperative credit societies .
2. The Cooperative movement in this country was started as far back as
1904. However, its development was very slow.
3. Even in 1951, cooperatives provided only 3.1 per cent of total rural
credit. Hence, the dominance of moneylenders in agricultural credit
continued.
4. It was only with the nationalisation of 14 major banks in 1969
(followed by nationalisation of 6 more banks in 1980) that the hold
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57 5. In 1975, the government set up the third institution the in stitution of
RRBs (Regional Rural Banks).
6. Thus, by the end of 1976, there emerged three separate institutions
for providing rural credit, which is often described as the multi -
agency approach.
7. In 1982, NABARD was set up.
8. India now has a wide network of rural finance institutions (RFIS).
9. There are more than 30,000 commercial bank branches, 14,000
regional rural banks, and about 1,00,000 rural credit Cooperatives.
10. This translates to about 4,700 people served by each RFI outlet.
11. As a result of the efforts u ndertaken by the government to develop
the institutional sources of credit, the role of non -institutional
sources like moneylenders in agricultural credit declined
considerably.
12. The share of non -institutional sources in rural credit which was as
high as 9 2.7 per cent in 1951 fell consistently to 68.3 per cent in
1971 and further to 30.6 per cent in 1991 (in 2002, it rose to 38.9 per
cent).
13. More significantly, the share of moneylenders fell from 71.6 per cent
in 1951 to merely 17.5 per cent in 1991 (though it rose to 26.8 per
cent in 2002). The share of institutional sources in rural credit rose
correspondingly from only 7.3 per cent in 1951 to 31.7 per cent in
1971 and further to 66.3 per cent in 1991 (in 2002, it fell to 61.1 per
cent).
14. In year 1969 , 14 major commercial banks were nationalised .
15. The share of institutional credit to agriculture through commercial
bank increased from 38.4% in 1980 – 81 to 74.3% in 2010 – 11. The
RRB contribution is about 8% to 10% of agricultural credit over the
year as per the source collected by Rakesh Mohan, “Agricultural
credit in India”, Economic and Political weekly, March 18, 2006.
Government of India – Economic Survey.
3.5 THEORIES OF INFORMAL CREDIT MARKET
Lender’s Monopoly The lender in the rural area has exclusive monopoly
power over his clients or we can say farmers and rural peasants and can
therefore charge a considerable higher price for loans than his
opportunity cost. There are two problems with this line of explanation.
1. Empirical - It is certainly true t hat the credit market is segmented, but
this is not necessarily a justification for an assumption of complete
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58 but in today’s rural civilizations , we can at best assume that lenders have
“local monopoly” with limits.
2. Theoretical -The Monopoly power is not necessarily an explanation of
high interest rates, at least of high explicit interest rates. From the point of
view of efficient surplus generation, it is often better to pick up money
lending profits in forms other than interest (interlinkages)
3.6 LENDER’S RISK HYPOTHESIS
This hypothesis sustains that lender earn no (ex ante) return on their
money over and above their opportunity cost. However, there is
considerable risk of default in rural credit markets: the borrower might
default on interest payments and even part or all of the principal.
• This risk comes from many sources:
1. There is the risk of involuntary default: owing to sheer misfortune (crop
failure, unemployment, disease, death, etc.), the borrower simply may
not have enough money when the loan matures.
2. There is the possibility of voluntary or strategic default: the borrower
may simply take the money and run, or stubbornly refuse to pay up.
3. In the simplest ve rsion of the theory, there is an exogenous probability
of default on every dollar lent out. Competition between
moneylenders drive the rural interest rate down to a point where each
lender on the average earns zero expected profit (over and
above the oppor tunity cost of funds to the lenders).Consider a typical
village moneylender in a competitive market.
• Let L be the tot al amount of funds he lends out
 Let r be the opportunity cost o f funds for every moneylender
 Let i be the interest rate charged in competitive equ ilibrium in the
informal sector
 Because only a fraction p of loans will be repaid, the moneylender’s
expected profit is:
P(1 + i) L – (1+ r)L.
• The zeroprofit condition implies that this value must be zero in
equilibrium, that is:
P(1 + i)L – (1+ r)L = 0
i =
- 1
Note : when p = 1, which means, when there is no default risk, the entire
loan is paid back, we have i = r:informal interest rates are the same as
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59 • However, for p < 1, we have i> r: the informal rate is higher to cover
the risk of default.
• For e.g. let the formal -sector rate to be 10% per annum and suppose
that p = ½: i turns out to be a steep120% per annum!
• Clearly, even under competition, informal -sector rates are very
sensitive to the default risk.
• The preceding simple story lays a finger on a very important aspect of
the reality of rural credit markets - the risk of default.
• However, if we look at the data, the fact remains that actual rates of
default in rural credit marke ts are very low indeed.
• Suggests that although potential default may be important, lenders
manage to devise contracts and create incentives to circumvent the
problem.

Default and Fixed Capital Loans :
It is assumed that the default probability is independent of the amount to
be repaid. Larger amounts to be refunded may lead to a larger risk of
default.
• Certain loans will not be given at all under any conditions , regardless
of the interest rate premium, because the premium itself affects the
chances of repayment.
• Large loans themselves advance the chances of default and will,
therefore, not be made.
• The line of reasoning can be extended , not just to the size of the loan,
but also to the kind of use to which the loa n will be put.
• If the loan can be used by the borrower to permanently put himself in
a situation in which he never has to borrow again, then such loans may
not be forthcoming.
• In the presence of strategic default, the devastating provision of
informal loans will be for working capital or consumption purposes ,
rather than for fixed investments that may permanently reduce the
borrower’s future need for credit.
3.7 DEFAULT AND COLLATERAL
The fear of default also generates a tendency to ask for collateral,
whenever this is possible. Collateral may take many forms.
Fundamentally, collateral is of two types: both lender and borrower value
the collateral highly . The borrower values the collateral highly, but the
lender does no t. From the point of view of strategic default, it is irrelevant
whether the first or the second form of collateral is employed.
Collateral that is valuable to both parties have the added advantage that it
shelters a lender against involuntary default as well. For these forms of
collateral, credit may merely be a veil for acquiring collateral: alternative
view of extortionate interest rates.
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60 Say, VS (S for “small”) be the (monetary) value that the borrower places
on the collateral.
Let VB (B for “big”) be the value that the moneylender attaches to the
very same collateral. Hence the collateral is of value to both parties. Let
the monetary value on the loss to the borrower f rom default, over and
above the loss of his collateral be F.Such losses may comprise the fear of
not receiving future loans etc.
When the time comes to return the loan, we can conceive of two
possibilities:
(1) The borrower may be in a state of involuntar y default: he simply does
not hold the wherewithal to repay the money. In that case, he certainly
loses the collateral, which passes into the hands of the moneylender .
(2) The borrower may anticipate default and take his chances with the
landless labor ma rket or even with migration to the city. The total loss to
the borrower in this case is VS + F, whereas the gain is that he gets to
keep the principal plus interest that he owed.
Thus the borrower will prefer to return the loan if
L (1+i) < V s + F
The Lender will prefer his money back if: L (1+i) > V B
loan repayment is in the interest of both parties only if VB< V s + F
the lender’s valuation must not exceed the borrower’s valuation by too
much. In the special case where F = 0, so that collateral is the only way to
force loan repayment, the lender’s valuation of the collateral
must be less than that of the borrower.
Suppose that VB > VS + F. In this case, it follows that whenever the
borrower prefers to repay the loan, the lender actuall y wants
him not to do so! The lender would actually like the credit transaction to
be an excuse to acquire the collateral (cheap).Thus collateral that is of
high value to both lender and borrower may (paradoxically) result in credit
transactions with exces sive rates of default. This sort of analysis works
much better for consumption loans than production loans. With
consumption loans (taken, say, for an illness in the family), the amount is
often fixed and cannot vary with the rate of interest. With production
loans, a high interest rate may be self -defeating because the borrower can
scale back the amount of the loan by reducing the extent of his productive
activity. This hints at a possible explanation of why interest rates may be
high for some types of credit transactions but not for others.
3.8 DEFAULT AND CREDIT RATIONING
Credit rationing refers to a situation in which at the going rate of interest
in the credit transaction, the would like to borrow more money, but is not
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61

Figure No. 3.1
Maximising rate of interest i on a loan
So far there is no credit rationing. Now we show that the likelihood of
default is closely associated with credit rationing. To do so we introduce
the possibility of strategic default. Supposing that the farmer can keenly
default on the loan. In the event of a strategic default, the moneylender
will never lend to him again. However, the farmer can constantly go for
his next best alternative and guarantee himself a profit of A from the ne xt
date onward.
To study the default problem, then, we have to justify for the importance
that the debtor confers to future gains and losses. We consider the
borrower’s mental time horizon: the extent to which the future concerns
him when he makes current decisions. Suppose that at each date, the
farmer thinks N dates into the future and factors in the consequences of his
current decisions on gains and losses in the coming N periods. Let f(L) be
the value of the output for every loan size L. Thus f(L) is s imply an
expression that describes the production function: as L increases, so does
the value f(L).
The Participation Constraint: the requirement that the farmer should want
to participate at some interest rate i and some loan size L is just the
statement that:
f(L) – L(1+i)
A
In the presence of potential default, a fresh constraint appears called the
No Default Constraint. We look at what the farmer gets over his entire
mental horizon of N dates. It is the amount per da te, multiplied by N:
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62 What does he get if he decides to default? Well, today he will get all of
f(L).

From tomorrow onward, he is excluded by our moneylender and so can
get only A per period. Thus the total profit over the N period menta l
horizon is
f(L) + (N − 1)A
For default not to occur N is f(L) – L (1+i)
f(L) + (N-1) A
f (L) -
L (1+i)
A
This condition looks a bit like the participation constraint except for the
term N/(N − 1) that multiplies the cost line.
Because this term always exceeds 1, the new restriction is tighter than, and
therefore effectively subsumes, the participation constraint.
The shorter the mental horizon, the more difficult it is to meet the no -
default constraint. For instance, if N = 1, so that the farmer never
contemplates the future consequences of his current actions, NDC can
never be satisfied. The farmer will always default on the loan, so no loans
will be advanced. On the other hand, if the farmer is very farsighted, then
N is very large and t he fraction
N/(N − 1) has a value close to1: we are then effectively back to the old
problem in which only the PC matters.
Thus we are interested in situations in which N is neither too large nor too
small. When NDC holds, the original cost line gets mult iplied by the
factor N/(N -1).The rest of the analysis remains the same. We maximize
vertical difference between the production function and the modified cost
line such that it is no less than A.
To find this maximum, we set the marginal product of the prod uction
function equal to the slope of the modified cost line, which is N/(N − 1)(1
+ i).At interest rate i**, the maximized difference just equals A. If it is
chosen any higher, then the NDC will fail. Thus the interest rate i** and
the associated loan siz e L** represent the moneylender’s optimal solution
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63

Figure No. 3.2
Loan Contracts when default is possible
At the optimum credit transaction, the moneylender will advance a loan of
L**. The marginal product of the loan equals N/(N − 1)(1 + i**) and not
the true marginal cost of the loan as faced by the borrower , which is
1 + i**.
It follows t hat we have credit rationing: if the borrower were asked in an
interview if he would like to borrow more at the going interest rate i**, he
would answer in the affirmative. The moneylender would not react to such
a situation by simply raising the interest rate or advancing a larger loan at
the going interest rate (or some combination of the two). The fear of
sparking off a default prevents such actions by the moneylender. A higher
loan increases the return to a defaulter by allowing him to pocket more
money . A higher interest rate increases the return as well, by allowing the
defaulter to save on the repayment of more interest . The moneylender’s
preferred contract therefore involves credit rationing. Credit rationing may
stem from considerations other than d efault. In the next section, we take
up this theme.
3.9 INFORMATIONAL ASYMMETRIES AND CREDIT
RATIONING
Not all borrowers bear the identical amount of risk. Some are high -risk
borrowers and some are low risk borrowers. Risk may be correlated with
characteristics of the borrower that are observable to the lender (such as
landholdings or access to irrigation) . It may significantly be contingent on
other qualitie s that are not observable (farming skills or mental insight in
the face of a crisis, thrift , the quality of his land etc)
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64 When the factors that make for risk are observable, the lender can select
his clients or charge appropriately higher rates for the hi gh-risk
clients.

However, to the extent that clients bear different risks that cannot be
discerned by the lender, an additional dimension is added to credit
market transactions —the interest rate now affects the mix of clients that
are attracted (and hence , the average probability of default)

This new dimension might give rise to a situation in which at prevailing
rates, some people who want to obtain loans are unable to do so . Lenders
are unwilling to capitalize on the excess demand and raise interest rat es for
fear that they will end up attracting too many high - risk customers .
Consider ing a moneylender who faces two types of potential customers:
call them the safe type and the risky type. Each type of borrower needs a
loan of (the same) size L to invest in some project or activity. The
borrower can repay only if the investment produces sufficient returns to
cover the repayment. Suppose that the safe type is always able to obtain a
secure return of R (R > L) from his investment. On the other hand, the
risky type is an uncertain prospect; he can obtain a higher return R ′ (where
R′ > R), but only with probability p. With probability 1 − p, his investment
backfires and he get a return of 0 . The lender can freely set the interest rate
without fear of losing his clients to competing lenders.

Let us suppose that the lender has enough funds to lend to just one
applicant, and that there are two of them (one risky, one safe).

The highest interest rate i for which the safe borrower wants the loan .
Because his net r eturn is given by R − (1 + i)L, the highest acceptable rate
for him is i1 = R/L – 1

For the second borrower, the expected return is p[R ′ − (1 + i)L]; hence, the
maximum rate he is willing to pay is i2 = R ′/L − 1.

Clearly, because R ′ > R, we have i2 > i1. The risky borrower is willing to
pay a higher rate of interest than the safe borrower, and this interest rate is
independent of his probability of success, p.

The reason is that bankruptcy yields zero, and in such a situation he
defaults on the loan anyway, so his expected profits depends only on the
success state. In this sense the risky borrower acts as if he does not care
about failure. If the lender charges i1 or below, both borrowers will apply
for the loan. If the lender cannot tell them apart, he has to give the loan
randomly to one of them. On the other hand, if a rate slightly higher than
i1 is charged, the first borrower drops out and excess demand for the loan
disappears. The lender may then go all the way up to i2 without fear of
losing the second customer. The lender’s choice is then really between the
two interest rates ii and i2.Suppose the lender charges i2. His expected
profits are then given by
2 = p(1+i2)L – L munotes.in

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65
If the lender charges i1, he attracts each type of customer with probabil ity
1/2. His expected profits are then given by
1 =
i1 L +
[p (1+i1) L – L]

Under what condition will the lender be reluctant to charge the higher
interest rate? This will happen when Π1> Π2.
P <

if the high -risk type is “sufficiently” risky (remember, a lower p means a
higher chance of default), then the lender will not raise his interest rate to
i2, thereby attracting the risky type. Instead, he will stick to the lower level
i1 and take the 50 –50 chance of getting a safe customer. This will lead to
credit rationing in equilibrium: out of two customers demanding a single
available loan, only one will get it; the other will be disappointed. The
price is not raised even in the face of excess demand, but the reason is
different. Raising the price would drive away the good borrower instead of
the bad one, and the higher possible return cannot compensate for he
lowered chance of repayment.
3.10 QUESTIONS
Q1. What do you understand by the term Rural credi t Market?
Q2. Explain lenders risk hypothesis.
Q3. what is the term default collateral.
Q4. what are the features of rural credit market?
Q5. Distinguish between organised and unorganised sector.
3.11 REFERENCE S
1. Puri, M. (n.d.). Indian Economy. Himalaya Publishing House.
2. Sundaram, D. a. (2010). Indian Economy. Delhi: S.Chand & Co. .
Reference Link:
u/sites/default/files/B.%20A.(Hon)Eco_3_DevEcoII_23 -
28thMarch_Anushruti.pdf (Puri)


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66 4
RURAL CREDIT MARKETS - II
Unit Structure
4.0 Objective
4.1 Introduction
4.2 Evolution of Credit System in India
4.3 Role and Performance of Commercial Banks
4.4 Co-operative credit institutions
4.5 Regional Rural Banks
4.6 Nabard
4.7 Micro Credit through SHG in India
4.8 Imperfection in Rural Credit Market in India
4.9 Questions
4.10 References
4.0 OBJECTIVE S
1. To know the evolution of credit system in India
2. To understand various role and criticism of commercial banks
3. To know problems of Regional Rural Bank
4. to know functions of Nabard
5. To understand imperfections in Rural Credit Market
6. To understand rural co -operatives and credit institutions
4.1 INTRODUCTION
Being the backbone of the Indian economy, agriculture has all along been
treated as a significance sector for the allocation of institutional credit. The
insignificant growth rate of agriculture in the past few years has further
strengthened the channels o f credit flow to this sector.
Agricultural production in India rest on upon millions of small farmers. It
is the concentration of their exertion and the efficiency of their technique
that will help in raising yields per acre. Because of insufficient financ ial
resources and non-appearance of timely credit facilities at reasonable
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67 go in for improved seeds and manures or to introduce better methods or
techniques. It is, therefore, of the utmost importance that the finan cial
necessities of the farmers are adequately met.
Provision of adequate and timely credit at fair rates of interest has,
therefore, to be measured as an integral part of agricultural development.
Aid rendered by way of credit has, however, to be related to specific items
of productive work or of essential costs of cultivation. Following
guidelines from the RBI, commercial banks are increasingly devoting
attention to agricultural sector to meet its credit needs.
Agricultural growth is vital for alleviating rural poverty. Access to
institutional credit to more farmers and suitable quantity and quality of
agricultural credit are crucial for realising the full potential of agriculture
as a profitable activity.
The Government has taken many policy initiatives f or strengthening farm
credit delivery system for providing credit at affordable rates of interest to
support the resource requirements of the agricultural sector. The emphasis
of these initiatives has been on providing timely and adequate credit
support to farmers with particular focus on small and marginal farmers
and weaker sections of society to enable them to adopt modern technology
and better -quality agricultural performs for increasing agricultural
production and productivity. The policy essentially lays emphasis on
enlarging credit flow at the ground level through credit planning,
implementation of region explicit strategies and justification of lending
policies and procedures and carrying down the rate of interest on farm
loan.
Need for agricultural credit arises because modern farm technology is
expensive and the individual possessions of the farmers are insufficient .
Establishment of agricultural credit, as an input, is essential for prevalent
use of improved agricultural methods.
Sources of agricul tural credit are grouped into two categories:
(a) institutional sources and
(b) non -institutional sources.
Institutional sources include co -operative societies, commercial banks and
other government agencies. Non institutional sources comprise
moneylend ers, landlords, relatives etc. Emergence of Micro Finance
4.2 EVOLUTION OF CREDIT SYSTEM IN INDIA
Rural financial market expansion is a complex procedure. The formation
of the formal credit structure for financial agriculture and other rural
activities began in India in the initial part of this century with the
introduction of co -operatives. It receive d a big push during the plan
period. The All India Rural Credit Survey Committee (AIRCS) 1954,
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68 Institutional credit structures. The committee emphasized the terrible
insufficiency in the su pply of institutional credit to the rural sector and
proposed an integrated scheme of restructuring many more committees
and recommendations. Priority sector lending, lead bank scheme, services
area approach, setting up of NABARD, are some of the outcomes of the
repeated scrutiny of the system.
The Agriculture Credit Review Committee (ACRC) 1989, examined the
existing rural credit system in detail. It highlighted the wide gap between
income generated and costs incurred by rural credit institutions,
necessit ating external assistance. The committee suggested greater self -
sufficiency for commercial banks; the weakness of RRBs were seen as
endemic to the system with non -viability built into them. Co -operatives
were sought to be reinforced through thrust on depos it deployment and
lessening of political interference. The Narsimham Committee on
Financial Sector Reforms 1991, among other things, recommended a
redefinition of priority sector, gradual phasing out of directed credit
programmes to 10% of aggregate bank c redit and deregulation of interest
rates.
The outcome of "an imposing superstructure of credit institutions has been
built which one committee after another has kept reshuffling or adding to"
(Dandekar, 1993). Commenting broadly on the exercise in developi ng
countries (to which the India experience seems to be no exception),
Braveman and Guasch, 1986, see most of the changes in institutional
design as largely superficial, window dressing type rather than substantial.
"the institutions have been perceived mo re like a welfare agency than a
commercial undertaking. There seems to be little effort to integrate deposit
taking activities or to generate saving mobilization -a vital activity for the
long run success of a credit institution. No provisions were made to deal
with non -compliance, or to implement a reasonable system of incentives
to both lenders and borrowers to induce the desired objectives."
4.3 ROLE AND PERFORMANCE OF COMMERCIAL
BANKS
In the history for long period of time the segment of commercial banks in
rural credit was inadequate . For instance, it was only 0.9 per cent in 1951 -
52 and 0.7 per cent in 1961 -62. The inappropriate contribution of
commercial banks in rural credit in India is partly explained by the
existence nature of agriculture and i ts unorganised, individualistic
working . Moreover, the heavy requirement of agriculture on rains makes it
an indeterminate and risky project . As in contradiction of this, the
manufacturing sector is moderately more organised and less reliant on
natural fac tors. Thus , the commercial banks tended to essence on the
industrial sector and even abstracted the funds mobilised from rural areas
to see the demand for credit of the industrial sector.
The Solution in the form of state of dealings that 14 major commerci al
banks were nationalised in 1969. This was followed by the nationalisation
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69 number of branches in rural areas and have increased their advances to
these areas significantly . In June 1969, out of the total of 8,262 branches
of commercial banks in India, 1,832 (i.e., 22.2 per cent) were in rural
areas. As at end June 2016, the number of total branches had report up to
1,39,406. Of this, 47,621 (i.e., 34.2 per cent) were in ruralareas. T his
shows that while the total number of branches increased by about
seventeen times, the total number of rural branches increased by about
twenty six times. The advances from banks to agriculture have also grown
by leaps and bounds. In 2016 -17, banks acco unted for 75.0 per cent of
institutional credit provided to agriculture (7,99,800 crore out of 10,65,800
crore).
Positive changes took place after nationalisation, the commercial banks
have played significant role in prov ision of rural credit. This has
empowered farmers to purchase agricultural inputs and adopt new
agricultural technology on an increasing scale, expand activities in the
non-farm sector in rural areas, and also accelerate the pace of private
agricultural investment. Hence increase in numb er of banks has played a
essential role in India's agricultural growth and modernisation in addition
to liberating large number of rural people from the controls of the
moneylenders. Under the Reserve Bank's Service Area Approach to rural
lending in opera tion since April 1989, individual bank branches are
expected to serve the credit needs of 15 to 25 villages each. After carrying
out surveys and preparing village -wise economic profiles, bank branches
have been preparing credit plans for the villages in th eir service areas.
Block level bankers' committees or we can say groups have been
established for coordination among credit institutions and developmental
agencies and for monitoring the application of the credit plans. Each bank
has also been preparing Sp ecial Agricultural Credit Plan (SACP),
segregated into quarterly targets, which is monitored by the Reserve Bank
of India.
An important disagreement in support of bank nationalisation was that
commercial banks had kept themselves aloof from the problems of
agriculture and had remained largely uninterested to the credit needs of
farmers for agrarian processes and land improvement. When social control
of banks was introduced in 1967, a rapid expansion in bank branches in
rural areas was started. By July 1969, all commercial banks had over
1,860 branches in rural and semi -urban areas; this number had increased to
over 30,585 by June 2006. There are now over 16 million agricultural
borrowing accounts with commercial banks amounting to Rs. 63,080
crores, as compa red to only (2 million accounts with total outstanding
advances to the extent of about Rs. 160 crores in June 1969. A large
number of village co -operatives are among the borrowers, some of them
borrowing from other financial agencies as well.
4.3.1 Direct Finance by Commercial Banks :
At the time of bank nationalisation, it was clearly conceded that the
commercial banks did not have the necessary experience or the personnel
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70 specialising in rural credit since the beginning of the century. Even then,
the nationalised banks were ex pected to go vigorously in support of the
farmers in general and the small cultivators in particular. In the initial
stages, for obvious reasons, the nationalised b anks concentrated their
attention on large cultivators and other special category farmers such as
those en gaged in raising high -yielding varieties of food grains . At present
short term crop loans account for nearly 42 to 45 per cent of the total loans
disbursed by the
commercial banks to farmers. Term loans for varying periods for
purchasing pump sets, tractors and other agricultural machinery, for
construction of wells and tube -wells, for development of fruit and garden
crops, or levelling and development of land for the purchase of plough
animal, etc. are provided. These term loans account for about 35 to 37 per
cent of the total loans disbursed by commercial banks.
Finally, commercial banks extend loans for such activities as dairying,
poultry farming, p iggery, bee keeping, fisheries and others -these loans
account for 15 to 16 per cent. Region wise , Southern region accounts for
the bulk of the credit disbursed by com mercial banks viz., 52 per cent of
the total credit ex tended.
4.3.2 Commercial Banks and IRDP :
Since October 1980, the Government has prolonged the combined rural
development programme (IRDP) to all development blocks in the country
and has asked the commercial banks to finance IRDP. The leading banks
have to prepare banking plans, and allot the concern of financing the
recognized recipients among the participating banks. It has been found
that commercial banks have not realized IRDP willingly. But commercial
banks have valid reasons for their tepid attitude.
In the first place, commercial ba nks have been asked to finance all
economically and backward people identified by government agencies.
Commercial banks have found that most of the rich farmers have managed
to get their names implanted in the recipients list through paying the
Government officials or through using political pressure. In other words,
all the prospective borrowers are not really economically backward and
banks have the responsibility to find out the eligible beneficiaries.
Secondly, commercial banks have found that all the b eneficiaries do not
utilise the loans for which they are arranged . In many cases, the farmers
may use the bank loans for fruitless purposes but may yield receipts of
purchase of buffaloes through bogus seller (who may oblige for a
commission). Commercial b ank has to determine the reliability of sale -
purchase tran sactions before disbursing loans.
Finally, small and marginal farmers are cheated petty government
officials, veterinaries , local poli ticians and panchayat samiti members
before they convert recipi ents of bank loans. Ultimately it is t banks
which suffer due to heavy overdue . Acco rdingly, banks are reluctant to
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71 4.3.3. Credit to Priority Sectors :
The commercial banks are instructed to attain certain targets and sub -
targets under priority sector lending. Forty per (40%) cent of the adjusted
net bank credit (ANBC) is therefore essential to be channelled to
recognized as priority sectors such as agriculture, small -scale industry,
small business, etc. Direct finance to agriculture and allied activities is to
reach a level of 18 per cent of net bank credit. Credit to priority sector by
public sector banks, private banks and foreign banks in 2016 -17 was 39.5
per cent, 42.5 per cent and 36.9 per cent respectively of ANBC.
In April 2016, priority sector lending certificates (PSLCs) scheme was
implemented . The PSLC scheme is a mechanism to incentivise banks
having surplus in lending to different types of the priority sector and
thereby for the improvemen t of overall priority sector lending. PSLCs
allow the market mechanism to drive priority sector lending by leveraging
the comparative strength of different banks. This scheme allows a bank to
assistance by selling over -achievement of its target in a partic ular sector
through PSLCs to another bank, which can purchase it to meet its target in
that sector, while selling its own over -achievement of the target in another
sector to another bank and so on. A platform to enable trading in the
certificates has been provided by the Reserve Bank through its core
banking solution (CBS) portal (e -Kuber).
4.3.4 Financial Inclusion Plans (FIPS) :
The Commercial banks ha s been considered as the main vehicles of the
efforts at financial inclusion. For this purpose, a phase -wise approach has
been adopted for the expansion of banking facilities. The first phase
covered the period 2010 -13, the second phase covered the period 2013 -16
and curre ntly the third phase covering the period 2016 -19 is in operation.
Financial Inclusion Plans (FIPS) equipped by the domestic commercial
banks offer a structured and planned approach to financial inclusion. The
Plans capture self -set targets of the banks on limits such as the number of
outlets (branches and Business Correspondents or BCs), Basic Savings
Bank Deposit Accounts (BSBDAs) opened by bank branches and BCs,
overdraft facilities availed in those accounts, transactions in Kisan Credit
Card (KCC), Gener al Credit Card (GCC) accounts and transactions
through the BC -ICT channel (progress on these parameters is presented in
the section on 'Financial Inclusion').
4.3.5 Operations of Commercial Banks: A Critical Review :
Despite the achievements of the comme rcial banks in the field of rural
credit mentioned above, their performance and operations have invited a
lot of criticisms. The main points of criticism are the following:
1. The fast rise in bank credit to rural areas after nationalisation has
formed str esses in the system due to rapid expansion and diversification.
One of the problems of such rapid expansion has been the weakening in
the quality of scheme preparation, particularly under the antipoverty
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72 workload of day -to-day housekeeping, without commensurate increase in
the supporting staff.
2. The commercial banks have found approving and monitoring of a great
number of small advances in their rural branches, time -consuming and
manpower intensive and consequently a high cost proposition. Partly
because of this, the banks have been found hesitant in posting sufficient
supervisory and other staff in rural branche s. Consequently, supervision of
rural advances has come to be neglected. Also, the staff in rural branches
of commercial banks lacks sufficient enthusiasm to work in rural areas for
various reasons. Not only this, as pointed out by ACRC, there is a lack of
adequate staff in rural branches of commercial banks.
3. Foundation of a large number of branches in rural areas which do not
have suitable business potential, rise in establishment expenses, and
increase in non -performing advances affected the profitabi lity of the banks
adversely. While the yield on advances has been declining, the average
cost of credits and borrowings has increased, reducing the margins
presented to the banks.
4. The recovery situation of the commercial banks is bad. In certain years,
the level of overdues has been 30 per cent or even more. This is an
upsetting situation and calls for corrective action. As warned by the
Seventh Plan, "If this trend is not reversed and banks are reduced to
institutions providing grants rather than recycl ing scarce resources to get
the maximum benefits for the country as a whole, the banking system will
be unable to provide more credit to meet the growing needs of the farmers.
5. For a extensive period of preparation , the commercial banks failed to
fill th e geographical gap in the availability of credit not covered by the
cooperatives. The areas which is already developed with various banking
facility more focus has been given in such aras whereas less developed
rural backward areas are deprived of these se rvices. Besides this in the
absence of proper geographical spread of bank branches, it was found that
more than one bank operated in the same area resulting in unhealthy
competition between one commercial bank and another. The real need was
to make availab le only one alternative source of institutional credit,
whereas in reality, the multi -agency system tended to become multi -
alternative credit system. However, according to Reserve Bank's Report
on Trend and Progress of Banking in India 2016 -17, in recent times, gaps
across various geographical regions have declined on account of the
efforts made towards expanding access to the formal financial system.
Under -banked geographical regions such as the North -East as well as the
Eastern and Central Regions have re corded noteworthy improvement in
population per bank branch.
6. The credit -deposit ratio is an important indicator of the degree of
involvement of banks in lending. The rural credit -deposit ratio declined
from 1.58 per cent in 1991 to 0.73 per cent in 2001 which shows that
deposits mobilised from rural India were being utilised elsewhere. In other
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73 According to Tenth Five Year Plan, this decline in the rural credit -deposit
ratio has a direct bearing on the decline of public sector capital formation
in the rural sector.
7. Loan disbursal to small and marginal farmers decelerated sharply in the
1990s. The option provided to the commercial banks to meet priority
sector lending targets by investin g in RIDF (Rural Infrastructure
Development Fund) and placing deposits with SIDBI (Small Industries
Development Bank of India) reduced the rate of growth of direct finance
to small and marginal farmers. As a result, the annual compound growth
rate of direc t finance (disbursement) to farmers with less than 2.5 acres
(marginal farmers) declined from 18.1 per cent in 1980s to 13.0 per cent in
1990s. The annual compound growth rate of direct finance (disbursement)
to small farmers (holdings between 2.5 acres to 5.0 acres) declined from
15.1 per cent to 11.0 per cent over the same period.¹0
8. The problem of coordination not only between one commercial bank
and another but also between commercial banks and the cooperative credit
structure, on the one hand, and be tween banks and the Government
departments, on the other, has assumed serious dimensions. Though under
the Lead Bank Scheme, there is a Lead Bank for each district, yet in many
cases the number of branches belonging to the Lead Bank is less than the
number of branches belonging to other commercial banks put together. If
50 or more branches owned by 10 to 15 banks are to be brought together
to implement a common programme, it can well be imagined how difficult
the task of coordination and implementation is u nder such a situation.
9. A study of the impact of banking sector reforms on agricultural credit
by Gagan Bihari Sahu and D. Rajasekhar reveals certain disturbing facts
as far as bank operations in the post -reform period (the period since 1991)
are concer ned:
(i) Because of increasing overdue and growing losses to rural bank
branches, the banks were directed to shut down their loss making branches
or merge them with other banks. As a result of this policy decision, there
was a marginal deterioration in the number of rural branches during the
era of 1990s;
(ii) The segment of those farmers, borrowing less than 25,000 deteriorated
in both the total number of loan accounts and total loan amount during the
transformation period;
(iii) Banks providing b igger quantum of funds to activities earning higher
interest incomes. This trend was more projecting after the deregulating the
lending rate to eventual borrowers;
(iv) The better off farmers amended their access to official credit as
compared to marginal farmers; and
(v) Despite the increasing consensus to extend credit facility to agriculture
in general, and small and marginal farmers in specific , banks were
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74 of creditworthy bo rrowers who had be en traditionally marginalised in the
credit market.
4.4 CO -OPERATIVE CREDIT INSTITUTIONS
The rural cooperative credit institutions in India have been organised into
short -term and long -term structures. The short -term cooperative credit
structure is based on a three -tier structure, except the States in the north -
east region. At the lowest tier are the Primary Agricultural Credit Societies
(PACSS). These are organised at the village level. At the second tier are
the District Central Cooperat ive Banks (DCCBS) organised at the district
level. At the third and uppermost tier are the State Cooperative Banks
(StCBs) organised at the State level. As far as the village level PACSs are
concerned, they can be formed by any ten or more than ten persons . These
societies generally advance loans only for productive purposes. The
repaying capacity of the individual is taken into account while advancing
such loans. The DCCBS are of two types cooperative banking union and
mixed central cooperative banks. Memb ership of the former is open only
to cooperative societies, while membership of the latter is open to both,
individuals and Cooperative societies. The chief task of the District
Central Cooperative Banks is to advance loans to the PACSs in times of
need so that they in turn, advances loans to the DCCBs in order to
augment can fulfil the requirements of farmers. The StCB_ capacity to
provide loans to the village level PACSs. It also coordinates and regulates
the working of DCCBs. I also provides the link bet ween the Reserve Bank
of India and the money market on the one hand and lower levels of
cooperative structure on the other. In addition to their short -term credit
requirements, farmers also require long -term credit for: (1) effecting
permanent improvements in land (for example, making wasteland fit for
cultivation, digging of wells or tubewells etc.); (ii) purchasing agricultural
implements; and (ii) repaying old debts. To cater to these requirements,
long-term credit cooperatives have been set up. These ar e organised at two
levels. These differ from State to State and may be categorised into four
types as: (i) the unitary structure in which State Cooperative Agricultural
and Rural Development Banks (SCARDBs) operate at the State level
through their branches and have direct membership of individuals; (ii) the
federal structure in which Primary Cooperative Agricultural and Rural
Development Banks (PCARDBS) operate as independent units at the
primary level and federate themselves into SCARDBs at the State level:
(i) the mixed structure wherein both the unitary and federal types operate
in one form or another; and (iv) the integrated structure wherein no
separate Agricultural and Rural Development Banks exis t and the long -
term credit business is undertaken by the long -term section of the StCBs
concerned. The rural credit cooperative structure in India is a huge
institutional structure comprising 33 StCBs, 370 DCCBs and 93,367
PACSS at the grass root level in the short -term credit structure and 13
SCARDB and 601 PCARDBs in the long -term credit structure as at end -
March 2017
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75 4.4.1 Structure of cooperative credit Institutions

Source: RBI Publication
The Above Chart represent the structure of co operative credit institution
for the era of 2006.
4.4.2 Growing Trend in Cooperatives and Rural Credit :
Although the cooperative movement was initiated in India as far back as in
1904, the role of cooperative credit societies in providing credit was
almost negligible in the pre -Independence period. Even after half a
century of operations, cooperatives provid ed only 3.1 per cent of total
rural credit in 1951 -52. However, progress after Independence has been
quite rapid. For instance, the Cooperatives provided 15.5 per cent and 22.7
per cent of total rural credit in 1961 -62 and 1970 -71 respectively. The
amount of short -term and medium -term credit advanced by these societies
increased from 23 crore in 1951 -52 to 203 crore in 1961 -62 and further to
1,425 crore in 1979 -80. This shows that over a period of nineteen years
(1960 -61 to 1979 -80) the short and medium ter m loans increased by more
than seven times. There was an impressive expansion in rural credit
provided through cooperatives in the Sixth and Seventh Plans. By the time
the Eighth Plan started (in 1992 -93), the rural credit provided through
cooperatives had touched the level of 6,484 crore (which was 53.4 per cent
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76 However, thereafter, while absolute amount of rural credit provided by
cooperatives increased, their percentage share in tot al institutional credit
declined.
In 2016 -17, cooperatives accounted for 13.4 per cent of institutional credit
provided to agriculture ( 1,42,800 crore out of 10,65,800 crore).
Each and every Committee/Working Group which has reported on the
rural credit s ystem in India since the Royal Commission on Agriculture
(1928) has reaffirmed that from the point of view of structural
appropriateness, there is no alternative to cooperatives at the village level
for provision of rural credit. The Rural Credit Survey Co mmittee (1954)
eloquently expressed this view in the oft -quoted statement, "cooperation
has failed, but cooperation must succeed". Even the All India Rural Credit
Review Committee (1969) which recommended the entry of commercial
banks into the rural credit system stated clearly that this was being done to
'supplement' and not 'supplant the cooperative credit structure. In fact,
there has been an extensive expansion, both in the coverage and
operations, of cooperative credit societies in the post -Independence period.
The performance in the issue of loans is also commendable. However, the
rural cooperative institutions are beset with many problems ranging from
low resource base, high dependence on refinancing agencies, lack of
diversification, huge accumulated losses, persistent NPAs (non -
performing assets), low recovery levels and various other types of
organisational weaknesses. Many institutions have continued to make
losses over the years.
4.4.3 Deficiencies in the working of the cooperative societies are a s
follows:
1. The essence or basic features of cooperative banking system must be a
larger reliance on resources mobilised locally and a lesser and lesser
dependence on higher credit institutions. However, many PACSS are at
present dependent on DCCBs and h ave failed miserably in mobilising
rural savings. Heavy dependence on outside funds has, on the one hand,
made the members less vigilant, not treating these funds as their own and
on the other led to greater outside interference and control. Overall, this
has made the cooperatives a "mediocre, inefficient and static system"
.2. The cooperative credit institutions are plagued by the problem of high
level of overdues. These overdues have blocked the process of credit
reprocessing since they have substantially reduced the capacity of
cooperatives to grant loans. Overdues have also impaired the eligibility of
the cooperatives for availing of refinance facilities from NABARD. Not
only this, mounting overdues result in increasing the transaction cost for
effecting recovery.
3. The rural cooperative institutions have a high level of NPAs (non -
performing assets). For instance, as at end -March 2016, the aggregate
NPAs of StCBs were estimated at 56 billion which was 4.5 per cent of the
total outstanding loans and adva nces. For DCCBs, on the same date, gross
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77 outstanding loans and advances. Gross NPAs of SCARDBS and
PCARDBS (as percentage of loans outstanding) were 16.6 per cent and
37.0 per cent res pectively as on March 31, 2016.5 This high level of NPAs
have seriously impacted the overall 'health' of the cooperative institutions
and adversely affected their viability.
4. A large number of rural cooperative credit institutions have incurred
substanti al losses. As on March 31, 2016, 5 out of 33 StCBs, 51 out of 370
DCCBs, 36,695 out of 93,367 PACSS, 4 out of 13 reporting SCARDBS
and 295 out of 601 reporting PCARDBS incurred losses,
5. PACS is the most important link in the short -term cooperative credit
structure. However, most of them are too small in size to be economical
and viable. Besides, several of them are also dormant while some are
defunct
6. PACSS extend credit only to their members. Therefore, a useful
indicator for both access to and demand for credit from PACSS is the
borrower -to-member ratio. This ratio has generally remained below 50 per
cent suggesting that less than half the PACS members access credit from
the institutions themselves.
7. Because of their strong socio -economic position an d grip over the rural
economy, large landowners have cornered greater benefits from
cooperatives. This is the opposite of what the planners intended. Farmers
having holdings less than 2 hectares in size have received about one -third
of total loans advanced by the PACSS while the share of tenants, share -
croppers and landless labourers (who are the poorest and, therefore, the
most needy) has hovered around only 7 per cent. The restricted access of
small farmers to cooperative credit is further highlighted by the fact that
only 30 per cent of the farmers holding less than 1 hectare are members of
PACSs, whereas almost all the farmers holding above 4 hectares are
members of PACSs.
8. There are considerable regional disparities in the distribution of credit
by co operative societies with the six States (Gujarat, Maharashtra,
Karnataka, Kerala, Haryana and Tamil Nadu) accounting for more than 60
per cent of the short -term loans to agriculture for a considerable period of
planning.
In addition to the above problems, many cooperatives suffer from poor
management and lack of enthusiasm and dedication among members
resulting in a great deal of inefficiency and poor service to the members.
Moreover, affairs of most of the cooperative soc ieties are managed by the
large farmers to their advantage in connivance and collusion with
government officials while the small and marginal farmers and other poor
members generally have no say. This dampens the spirit of the latter and
their faith in 'co operation' is badly shaken. This is a serious threat to the
long-run sustainability of the cooperative movement.
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78 4.5 REGIONAL RURAL BANKS (RRB)
The important points of the 20 -point economic programme of Mrs Indira
Gandhi during Emergency was the liquidation of rural indebtedness by
stages and provide institutional credit to farmers and artisans in rural
areas. It was in pursuance of this aspect of the New Economic Programme
that the Government of India setup regional rural banks (RRB)
The main obj ective of the RRBs is to provide credit and other facilities
particularly to the small and marginal farmers, agricultural labourers,
artisans and small entrepreneurs so as to develop agriculture. trade,
commerce, industry and other productive activist ties in the rural areas.
"Regional rural banks (RRBs) were considered as institutions that
combine the local feel and understanding of cooperatives and the business
organisation ability of the commercial banks. In a multi -agency approach
for Agricultural and rural credit in India, RRBs have a special place"
Initially, five regional rural banks were set up on October 2, 1975 at
Moradabad and Gorakhpur in Uttar Pradesh, Bhiwani in Haryana, Jaipur
in Rajasthan and Malda in West Bengal. Each regional rural bank ha d an
authorised capital of Rs. 1 crore, and issued and paid -up capital of Rs. 25
lakhs. The share capital was subscribed by the Central Government (50%),
the State Government concerned (15%), and the sponsoring commercial
bank (35%). The RRBs though basica lly scheduled commercial banks,
differ from the latter in certain respects:
(a) The area of RRBs is limited to a specified region containing one or
more districts of a State
(b) The RRBs grant direct loans and advance mainly to small and marginal
farmers, rural artisans, agricultural labourers and others of small means
productive purposes.
(c) The lending rates of RRBs should not higher than the prevailing
lending rates of co -operative societies in any particular State. The
sponsoring and the Reserve Bank o f India provide many subsidies and
concessions to RRBs to enable the function effectively.
4.5.1 RRBs and NABARD
National Bank has the responsibility to lay policies for RRBs, to oversee
their operations, look refinance services and attend to difficulties led by
them. The National Bank undertakes all work relating to the establishment
of RRBs, administration of refinance scheme, preparation of suitable
working policies, monitor their performance, and keep liaison with the
Reserve Bank in regard to branch ex pansion and the statutory inspection
of RRBs.
4.5.2 Progress of RRBs: An Evaluation
RRBs have a significant role to play in our rural economy as they have to
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79 course of time, the y are proposed to eradicate money -lenders altogether.
However, they were not set up to replace co -operative credit societies but
to complement them. In the last 30 years, RRBs have been active
participants in programmes designed to provide credit assistanc e to
identified beneficiaries under the new 20 -point programme, IRDP and
other special programmes for scheduled castes and tribes. They are also
applying discrepancy rate of interest (DRI) schemes for the weaker
sections, physically handicapped persons who are usefully employed, can
secure finance from RRBS for purchase of artificial limbs, hearing aids.
Wheel chairs etc. subject to a maximum of Rs.2,500 per borrower. The
RBI conducted a field study in April 1981 on all qualitative features of
advancing by RRBs. This study established clearly that, by and large,
(a) RRBs had followed instructions given by RBI and the Government of
India regarding loan policies, procedures, etc.
(b) The basic aim of setting up RRBs viz, developing the rural economy
by providi ng credit for the development of agriculture, trade, commerce
industry and other productive activities in rural areas was being fulfilled;
(c) RRBs had successfully maintained their image as a small man's bank
by confining their credit facilities to the ta rget groups viz., small, marginal
farmers, agricultural labourers, artisans and small enterprises for
productive activities; and
(d) the recovery position was not satisfactory.
4.5.3 Evaluation of RRBs
According to Reserve Bank of India, "The RRBs have far ed well in
achieving the objective of providing access to the weaker sections of the
civilization to institutional credit but the retrieval position on the whole is
not satisfactory"?
At the time they were set up, RRBs were expected to revolutionise rural
banking by bringing in all the advantages of commercial banks to the door
steps of the small and marginal farmer and the rural artisan They were
expected to be concerned with the credit needs of the rural poor. RBI has
officially lauded the work of RRBs.
The Narasimham Committee on the Financial System (1991) evaluated the
working of RRBs. They were established to provide a low cost alternative
to the operation of commercial bank branches but the function ing of the
RRBs has given much cause for concem. Acc ording to the Committee,
there were three basic problems:
(a) On account of the many restrictions placed on the business they could
undertake, RRBs had low earning capacity:
(b) the wage and salary scales of RRBs have been rising and, in fact, with
the rec ent award of a tribunal, their scales would approximate those of
commercial banks; with the increase in salary scales, an important
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80 (c) the sponsoring banks were also running their own rural br anches in the
very area of operations of the RRBs; this had given rise to certain
irregularities and to avoidable expenditure on controls and administration.
In the opinion of the Narasimham Committee, the problem was one of
improving the viability of RRBs without sacrificing the basic objectives
for which they were originally set up. The Government should help in
evolving a rural banking structure which could combine effectively the
advantages of the local character of RRBS with the financial strength and
organisational and managerial skills of the commercial banks.
The Narasimham Committee recommended that commercial banks should
segregate the operations of their rural branches through the formation of
one or more subsidiaries. Each rural subsidiary should have a compact
area of operations so as to facilitate recruitment and deployment of
manpower apart from providing the needed thrust in business operations
and effective improvements in the control and supervision and information
systems.
The Narasimham Co mmittee also recommended that banks should have
the freedom to swap rural branches -banks with fewer rural branches in
certain areas should be in favour of those banks which have a greater
presence.
The rural subsidiaries should be treated at par with RRBs in regard to cash
reserves and statutory liquidity requirements (SLR) and refinance facilities
from NABARD. All concessions in lending to agriculture and small
industry should be phased out, and the would be saving in costs of
administration bog through th e process of rationalisation. According the
rural subsidiaries would become more viable and eventually profitable.
The Narasimham Committee left the option to RRBS and their sponsoring
banks as to whether the former should retain their identity or whether they
should be merged on a voluntary basis with the sponsor banks rural
subsidiaries. Such mergers should be considered mainly on commercial
and development consideration
In case RRBs retain their identity and continue to function, they should be
permitte d to engage in a types of banking business. Their focus should be t
continue to lend to the target groups but they should not be forced to
restrict lending operations to the targe groups alone.
Finally, NABARD should help RRBs to earn higher level of inter est
income for their surplus cash balances and for their funds presently
invested in government securities or in government guaranteed securities
for SLR compliance. These measures would help to improve the viability
of RRBs.
4.5.4 Khusro Committee on RRBs
The Agricultural Credit Review Committee under the chairmanship of Dr.
A.M. Khusroobservat that the weaknesses of RRBs were endemic and non
viability was built into their structure. The RRBs d accumulated huge munotes.in

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81 losses; and in a few cases, the losses had er oded even a part of their
deposits. There was thus a strong case for winding up such an insolvent
institution. Besides, the RRBs were able to serve the interests of the
largest groups in the manner expected of them According to the Khusro
Committee, theref ore, there was no place for RRBs in the country's rural
credit system in the near future and that they should be merged with
sponsor banks.
The Government of India considered the recommendations of Narasimhan
and Khurso committees The Government was of the view that RRBs,
together with Commercial banks and cooperatives have a critical role to
play in multi -agency approach to delivery of agriculture and rural credit.
In 2004, the Finance Minister announced the Government's intention to
double the flow of cre dit by banks to the agricultural sector in three years.
Under this policy the Government took series of steps to improve the
strength and functioning of RRBs and thereby enable them to meet their
primary objectives.
4.5.5 Restructuring of RRBs
The Reserve Bank of India appointed the M. C. Bhandari Committee to
suggest measures for restructuring RRBs. Most of the sanctions of the
Bhandari Committee are being applied. The issued share capital of RRBs
has been enhanced - - from Rs. 75 lakh to Rs. 1 crore. NABAR D monitors
the working of RRBs as regards productivity, cash management, advances
portfolio and recovery performance. NABARD has planned a package of
short -term measures for RRBs:
(a) RRBs are freed from their service area obligations.
(b) They are allowed to increase their non -target group financing from 40
per cent to 60 per cent.
(c) They are e permitted to relocate some of their loss -making branches at
agricultural produce centres, yards, mandis, etc.
(d) They are given freedom to open extension counter s.
(e) They are allowed to give loans for non -priority sector purposes like
loans for consumer durables etc. and
(f) They are allowed to upgrade and deepen the range of their activities to
cover non -fund activities.
To implement its 2004 policy, the Gove rnment entrusted the task of
restructuring the RRBs to RBI and NABARD. The recommendations Prof.
V.S. Vyas "Ad vising committee on Flow of credit to Agriculture and
Related Activities to restructure RRBs in order to improve their
operational vitality and t o take advantage of the economies of scale was
accepted. After consultation with all concerned parties, state Governments
and commercial banks, the Government of India amalgamated 147 RRBs
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82 19 banks in 17 states. The total number of RRBs have now declined from
196 to 95 (as on September 2007).
The role and financial performance of RRBs have been evolving in
response to policy initiatives and changing business environment. Their
net loan adv ances to the agricultural and rural sector have amounted to
March 31, 2006 Rs. 38,520 crores March 31, 2007 Rs. 47,330 crores This
was a smart increase of 2.3 percent a year
4.6 NABARD
4.6.1 Meaning and Introduction of NABARD :
NABARD is a Development Bank with a directive for providing and
adaptable credit and other facilities for the promotion and development of
agriculture, small -scale industries, cottage and village industries,
handicrafts and other rural crafts and other allied economic activities in
rural areas with a view to promoting
The full form of NABARD is the National Bank for Agriculture and Rural
Development. NABARD accomplishes any credit -related concerns for
agricultural and rural activities such as their policy, planning, and
operations. In general, NABARD handles the funding of any agricultural
activities with respect to rural development in India as the institution's
primary goal is the nationwide growth of India's rural community. There
are three areas NABARD works around: development, su pervision, and
finance . Since its beginning, RBI had shown keen interest agricultural
credit and maintained a separate department for this purpose. RBI
extended short -term seasonal credit as well as medium -term and long -term
credit to agriculture through S tate level co -operative banks and land
development banks.
At the same time, RBI had also set up the Agri cultural Refinance
Development Corporation (ARDC) to provide refinance support to the
banks to promote programmes of agricultural development, particul arly
those requiring term credit. The wider role of bank credit from
"agricultural development" to "rural development" the Government
proposed to have a more broad -based organisation at the apex level to
extend support and give guidance to credit instituti ons in matters relating
to the formulation and implementation of rural development programmes.
A National Bank for Agriculture and Rural Development (NA BARD) or
the National Bank, for short, was, therefore, set up in July 1982 by an Act
of Parliament to t ake over the functions of ARDC and the refinancing
functions of RBI in relation to co -operative banks an RRBS.
4.6.2 Resources of NABARD
The authorised share capital of NABARD was Rs. 500 crores and its paid -
up capital was Rs.100 crores, contributed equall y by the Central
Government and the Reserve Bank. The paid -up capital of NABARD was
raised from Rs. 100 crores to Rs.500 crores and thtn to Rs. 2,000 crores by munotes.in

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83 the year 1999. The resources of the National Agricultural (long term
operations and stabilisatio n) funds were transferred to NABARD. World
Bank and IDA have also been providing funds to NABARD for
implementation of the projects financed by them. The most important
source of NABARD's funds are now RIDF deposits, closely followed by
market borrowings.
In recent years, there has been considerable improvement in the resource
position of NABARD mainly due to:
(a) Significant rise in the deposits under the Rural Infrastructure
Development Fund (RIDF) by commercial banks,
(b) use of tax -free bonds through th e issue of capital gains bonds and
priority sector bonds.
(c) acceptance of priority sector deposits from private banks.
NABARD cannot accept short -term public deposits and, therefore, it has
depended on the general line of credit (GLC) from RBI from its i nception
in 1982 NABARD's dependence on GLC from RBI is quite large and
NABARD uses this source to meet short -term credit and working capital
requirements. When it comes to aiding rural communities financially,
NABARD plays a few distinct roles. They are a s follows:
 The NABARD scheme aims to provide funds for India’s rural
infrastructure to enable long term irrigation practices.
 Generally offering financial services and aid for the development
and improvement of rural India.
 Planning, implementing and manag ing any funding programs for
farming and agricultural activities.
 Providing all kinds of funding services for developing and growing
food processing units and food parks in designated areas.
 Offers both long term refinance and short -term refinance servicin g to
its customers. Simultaneously, it provides any direct refinance
services to Indian cooperative banks.
 Offering lending services, cold chain, and storage infrastructure to
rural warehouses.
 Marketing federations can receive credit facilities from the
NABARD scheme.
 Creating new policies for India’s rural financial institutions
4.6.3 Features of NABARD Scheme
 It offers support for funding or refinancing.
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84  It Creating credit plans available at a district level for these
communities.
 It also Offers guidance and support to the banking sector so the
latter can achieve their own credit targets for the year.
 This also play vital role in Carrying out the supervision of
cooperative banks and Regional Rur al Banks (RRBs) in India.
 Devising new projects that aid in rural development of the country.
 Putting into place any of the government’s developmental schemes
aimed at helping the growth of rural areas.
 Offering training services for handicraft artisans.
 The following loans are available under the NABARD scheme
4.6.4 Types of NABARD Loans
1. Short Term Loans
These are crop -oriented NABARD loans offered by several financial
institutions to farmers to refinance crop production. This loan offers
farmers and t heir neighbouring rural communities the assurance of food
security. When agro -operations are seasonal, as of FY17 –18, the
NABARD scheme has sanctioned 55,000 Crores to a host of financial
institutions as the short -term credit loan amount.
2. Long Term Loa ns
These loans are offered by multiple financial institutions for either farm
or non -farm activities. Their tenure is much longer than short term
loans and ranges from 18 months to a maximum of 5 years. As of
FY17 –18, NABARD refinanced close to `65,240 Cro res to financial
institutions, covering any concessional refinancing of `15,000 Crores to
Indian Regional Rural Banks (RRBs) and Cooperative Banks.
3. RIDF or ‘Rural Infrastructure Development Fund.’
RBI introduced the RIDF as part of the NABARD scheme as they
noticed a shortfall in lending to priority sectors that need support for
their rural development. With the main focus being rural infrastructure
development, a total loan amount of ` 24,993 Crores was disbursed in
FY17 –18.
4. LTIF or ‘Long -Term Irriga tion Fund.’
This was introduced as part of the NABARD loans to provide funding
for a total of 99 irrigation projects with the disbursal of a loan amount
of ` 20,000 Crores.

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85 5. PMAY -G or ‘Pradhan Mantri Awaas Yojana -Gramin’
Under this financial scheme, NRIDA or the ‘National Rural
Infrastructure Development Agency’ was given a loan amount of
`9000 Crores to carry out its project of building pukka houses with all
essential amenities to needy households 2022.
6. NIDA or ‘NABARD Infrastructure Development Assistance.’
NIDA is a sub -program under the NABARD scheme, and it specializes
in providing credit to any financially well -to-do institutions or
corporations that are state -owned. Hence, NABARD also refinances
non-private scheme s with the help of this program.
7. Warehouse Infrastructure Fund
Warehouse Infrastructure Fund provides scientific warehousing
infrastructure for agricultural commodities. Initial loan of the amount
Rs. 5000 was provided by NABARD in the FY 2013 –14. As of 31st
March 2018, the amount disbursed is Rs. 4778 cr.
8. Food Processing Fund
Under the food processing fund of NABARD, the Indian government
has a loan commitment of `541 Crores to be disbursed to 11 large scale
food park projects, 1 integrated food park project, and 3 rural food
processing units in India.
9. Direct Lending
The NABARD scheme has specially sanctioned a loan amount of
`4849 Crores for cooperative banks, which will assist four state -owned
cooperative banks and 58 Co -operative Commercial Bank s (CCBs)
spread across the country.
10. CFF or ‘Credit Facility to Marketing Federations’
This category of NABARD loans promotes the marketing of farm
activities by financially strengthening marketing federations. The
amount disbursed to such federations a s of 2018 was `25,436 Crores
in total.
11. PACS or ‘Primary Agriculture Credit Societies’
NABARD has also launched a unique ‘Producer Organizations
Development Fund’ or PODF for short. The goal is to provide
financial support to PACS that mainly operate as ‘Multi Service’.
4.6.5 Functions of NABARD
NABARD has a dual role to play: (a) as an apex institution and (b) as a
refinance institution. NABARD has inbred its apex role from RBI i.e. it is
performance all the functions formerly performed by RBI with re spect to
agricultural credit. At the same time, NABARD has taken over the munotes.in

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86 functions of ARDC and thus provides refinance facilities to all banks and
financial institutions lending to agriculture and rural development.
(1) NABARD services as a refinancing in stitution for all kinds of
production and investment credit to agriculture, small -scale
industries, cottage and village industries, handicrafts and rural crafts
and real artisans and other allied economic activities with a view to
encouraging integrated ru ral development;
(ii) it provides short -term, medium -term and long -term credits to State Co -
operative Banks (SCR) RRBS, LDBS and other financial institution
approved by RBI;
(iii) NABARD gives long -term loans (up to 20 years) to State
Governments to enable them to subscribe to the share capital of co -
operative credit societies;
(iv) NABARD gives long -term loans to any organization permitted by the
Central Government or contribute to the share capital or invests in
securities of any institution concern ed with agriculture and rural
development:
(v) NABARD has the responsibility of co ordinating the activities of
Central and State Governments, the Planning Commission and other
all India and State level institutions entrusted with the development of
smalls cale industries, village and cottage industries, rural crafts,
industries in the tiny and decentralised sectors, etc.
(vi) It has the responsibility to inspect RRBs and co -operative banks, other
than primary co -operative societies; and
(vii) It maintains a Research and Development Fund to promote research
in agriculture and rural development, to formulate and design projects
and programmes to suit the requirements of different areas and to
cover special activities.
4.6.6 NABARD and Rural Credit
1. Credit extended by NABARD : NABARD providesshort -term credit
facilities to StCBs for financing Seasonal Agricultural Operations (SAO);
marketing of crops; pisciculture activities; production/procurement and
marketing activities of cooperative weavers' societies; purchase and sale of
yarn by apex/regional societies; production and marketing activities of
industrial cooperatives; financing of individual rural artisans through
PACS; purchase and distribution of fertilisers and allied activities; and
marketing activities. Med ium-term facilities are provided to StCBs and
RRBs for converting short -term loans for financing SAO to medium -term
(conversion) loans and for approved agricultural purposes. Long -term
loans are provided to the State Governments for contributing to share
capital of cooperative credit institutions. NABARD's refinance policy on
short -term SAO (Seasonal Agricultural Operations) for cooperative banks
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87 through adoption of region -specific strategies and rationalisation of
lending policies and procedures.
2. Rural Infrastructure Development Fund : RIDF -I was established in
1995 -96 with the major objective of providing funds to State governments
and State -owned corporations to enable them to complete various types of
tural infrastructure projects. RIDF has been continued on an annual basis.
The annual allocation of funds under the RIDF has gradually increased
from 2,000 crore in 1995 -96 (RIDF -1) to 20,000 crore in 2012 -13 (RIDF -
XVIII). Aggrega te allocations over the period reached 1,72,500crore. In
addition, a separate window was introduced in 2006 -07 for funding the
rural roads component of the Bharat Nirman Programme. Budget
allocation for RIDF for the year 2015 -16 was kept at 25,000 crore. Loans
under RIDF are given for various purposes like irrigation projects,
watershed management, construction of rural roads and bridges, etc. The
projects, however, have shown considerable time overruns. According to
NABARD, the reasons for this are: (1) mi smatch between physical and
financial disbursements; (ii) the implementing departments (of
governments) were not adequately funded by the State governments; (iii)
the projects faced problems of land acquisition, forest and environmental
clearance; (iv) ina dequate monitoring and inability to take corrective
action by government officers; and (v) lack of transparency among the key
functionaries.
3. Microfinance Innovations : The access to credit for the poor from
conventional banking is often constrained by l ack of collaterals,
information asymmetry and high transaction costs associated with small
borrowal accounts. Microfinance has emerged as a viable alternative to
reach the hitherto unreached for their social and economic empowerment
through social and fina ncial intermediation. It involves provision of thrift,
credit and other financial services and products of very small amounts to
the poor for enabling them to raise their income levels and thereby
improve living standards. In operational terms, micro credi t involves small
loans, up to 25,000, extended to the poor without any collateral for
undertaking self -employment projects. Such loans are provided through
microfinance institutions (MFIs). One of the most popular models of MFI
has been the Grameen Bank mo del, developed originally in Bangladesh
and replicated in various parts of the world. Under this model, non -
government organisations (NGOs) form and develop self -help groups
(SHGs) and provide credit to them. Microfinance schemes in India have
emerged as m ajor avenues for bringing the poor within the purview of the
organised financial sector. In this context, NABARD has played a key role
in the development and promotion of SHGS and other microfinance
institutions and in providing refinance at special rates. SHG -bank linkage
programme has now emerged as a major microfinance initiative.
Alongside SBLP (SHG -bank linkage programme), microfinance
institutions (MFIs) formed by non -government institutions (NGOs) and
non-banking finance companies (NBFCs) are also pl aying an important
role in providing microfinance. Joint liability groups (JLGs) too have
emerged as successful non -collateralised credit instruments for financing
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88 particular. Dur ing 2016 -17, there were about 1.9 million SHGS credit
linked with bank financing of 38,800 crore. The number of MFIs in this
year was 2,314 and loans disbursed by them amounted to 19,300 crore. As
far as JLGS are concerned, they number 0.7 million in 2016 -17 and loans
disbursed by them stood at 9,500 crore.
4. Kisan Credit Card Scheme : The Kisan Credit Cards (KCCs) scheme
was introduced in 1998 -99 to facilitate short -term credit to farmers.
Commercial banks, cooperative banks and RRBs are implementing this
scheme. Each farmer is provided with a Kisan Credit Card and a passbook
for providing revolving cash credit facilities. NABARD has accelerated
the pace of issue of KCCs. However, the progress of the scheme is not
uniform across States, and is dismal in th e north -east. This is attributed to
low level of loans issued to farmers availing of crop loans from banks;
poor financial position of the cooperatives and RRBs in the region; lack of
infrastructure facilities which are a hurdle in he way of augmenting cre dit
facilities, etc.
5. Credit Monitoring Arrangement : With a view to providing
cooperative banks with more freedom and discretion to operate in an
increasingly liberalised and competitive banking environment, NABARD,
in consultation with the Reserve Ban k, decided to replace the Credit
Authorisation Scheme (CAS) with the Credit Monitoring Arrangement
(CMA) with effect from the year 2000 -01. The banks will, however, have
to follow prudence and exposure norms and have to satisfy themselves
about the technic al feasibility and financial viability of the proposals,
creditworthiness of borrowers, risk management, margin, security
requirements, etc.
6. Refinance under SGSY : NABARD has issued operational instructions
to RRBs and cooperative banks with regard to i mplementation of
Swarnajayanti Gram Swarozgar Yojana (SGSY) on similar lines as was
issued by the Reserve Bank for commercial banks. Policy guidelines for
refinance support under SGSY were also issued to all financing banks.
Banks have been, inter alia, ad vised to evolve suitable norms for grading
of SGSY groups at different stages of financing on the illustrative
parameters indicated by NABARD.
7. Cooperative Development Fund : NABARD set up the Cooperative
Development Fund (CDF) in 1993 with the objective of strengthening the
cooperative credit institutions in the areas of organisational structure,
human resource development, resource mobilisation, recovery position,
etc. The assistance is provided to StCBs/SCARDBS/ CCBS/PCARDBS
by way of a grant or a soft loan or both.
8. Supervision : NABARD is the supervisory authority for StCBs, CCBs
and certain other State level co -operative institutions such as SCARDBs.
Accordingly, NABARD undertakes periodic on -site inspection of these
organisations and since 1998 -99 this has been supplemented by a system
of off -site investigation. The three main functions of NABARD are e
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89 4.7 MICRO CREDIT THROUGH SHG IN INDIA
4.7.1 Introduction :
Micro credit has emerged as a noticeable credit channel to the poor as
their access to conventional credit channels is constrained by the
prerequisite of collateral and high contract cost. Micro finance is routed
through self -help groups (SHGs). Over the years, SHG -Bank Association
Programme which contains commercial banks, regional rural banks and
co-operative banks -has emerged as the major micro finance programme in
the country. The focus under SHG -Bank Linkage Programme is largely on
those rural poor who have no supp ortable access to the formal banking
system. The target groups, therefore, largely comprise small and marginal
farmers, agricultural and non -agricultural labourers, artisans and craftsmen
and other poor engaged in small businesses like vending, and hawking .
The programme has been providing the rural poor access to the formal
banking system and has attained several indicators in terms of gender
sensitisation, empowerment and poverty alleviation. The programme
provides thrift linked credit support to the memb ers of SHGs. While the
programme directly benefits the members, it also helps banks in reducing
their transaction costs as well as risk in delivering small loans. The
programme has now presumed the form of a micro finance movement in
many parts of the coun try and has started making inroads in the resource
poor regions of the country as well.
4.7.2 Growth of SHG :
SHG -BLP and MFIs. The most important initiatives for financial inclusion
are the SHG -BLP (Self -Help Group Rank Linkage Programme) and MFIs
(microfinance jestitutions). The SHG -BLP of NABARD started as a pilot
project in 1992. There are now more than 70 lak h SHOs under this
programme, comprising a large number of poor households, who are
accessing credit through commercial and cooperative banks. NABARD
has recently initiated the process of repositioning the SHG -BLP as SHG2.
This approach is basically aimed a t encouraging the poor to save. It
includes SHGS introducing voluntary savings in groups or banks
encouraging SHG members to open individual bank accounts for
depositing their surpluses. This approach s also aimed at preparing the low
literacy and low -income clients to progressively move from community
banking endeavours to individual banking. Following the RBI guidelines
in 2000, commercial banks including RRBs have been providing funds to
MFIs for online lending to poor clients. Though initially only a ha ndful of
NGOs were into financial intermediation using a variety of delivery
methods, their numbers have increased considerably. MFIs have been
playing an important role in substituting moneylenders and reducing the
burden of formal financial institutions. However, in 2010 -11, this sector
ran into difficulty with reports of unfair practices by MFIs to recover loans
and a number of farmer suicides attributed to these practices. Accordingly,
the Reserve Bank of India set up a committee headed by Y.H. Malegam to
study and advise on the microfinance sector. Based on the
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90 India announced the creation of a separate category of Non -Banking
Financial Company - Micro Finance Institution (NBFC -MFI) in a circular
issued on December 2, 2011.
4.7.3 Operational Function of SHG :
SHG -Bank Linkage Programme was officially launched in the year 1992
as a flagship programme by National Bank for Agriculture and Rural
Development (NABARD) and aptly supported by the RBI through its
policy support. The objective is to encounter the financial needs of the
poor by linking SHGs with the formal credit agencies. The programme
envisions organisation of the rural poor into SHGS for building their
dimensions to manage their own finances and then transfer bank credit on
commercial terms. The poor are stimulated to voluntarily come together to
save small amounts regularly and extend micro loans between themselves.
Once the group accomplishes required maturity of management larger
resources, the bank credit follows. A self -help group is a group of about
15 to 20 people from a homogenous class who join together to address
mutual issues. They include voluntary carefulness activities on a regular
basis, and use of the collective resource to make interest -bearing loans to
the members of the group. In the progression of this process, they imbibe
the fundamentals of financial intermediate -n and also the basics of account
keeping. The members also learn to grip resources of size, much beyond
their distinct capacities. They begin to appreciate the fact that the
resources are limited and have a cost.
Once the group is stabilised, and shows established financial behaviour,
which generally takes up to six months, it is considered for linking to
banks. Banks are encouraged to provide loans to SHGS in certain
multiples of the accumulated savings of the SHGs. Loans are given
without any collateral and at interest rates as decided by banks. Banks find
it easy to lend money to the groups as the members have already attained
some financial correction through their carefulness and internal lending
activities. The groups choose the terms and conditions of loan to their own
members. The peer pressure in the group ensures timely repayment and
becomes social collateral for the bank loans.
The SHG -Bank linkage programme, conceptualised and launched by
NABARD in 1992, at tempts to link the poor in large numbers to the
formal banking sector in a sustainable and cost-effective manner. The
programme rekindled the basic human trait of self-worth of every member
in a group. By handling savings and internal lending, the groups m ature to
acquire credit worthiness for themselves and earn self-assurance of banks
for loans by providing trust as collateral. This has emerged as the prime
micro finance model in the country and is now a proven method of
financial inclusion, providing unbanked rural clientele access to formal
financial services from the existing banking system. This SHG - Bank
linkage model has emerged as the largest and fast est micro finance
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91 The social intermediation in forming and nurturing the self-help groups is
handled by a large number of non-governmental organisations, voluntary
agencies, community based organi sations like farmers' club, local bodies,
field level functionaries of government agencies, socially committed
individuals and bodies and banks themselves. Commercial banks followed
by RRBs and co -operative banks also play an important role in credit
linking the SHGS. NABARD provides grant assistance to various partner
agencies in promoting and nurturing of SHGs and extends refinance
support to banks against their loans to SHGS. NABARD also takes lead in
providing financial and other support for capacity bu ilding, sensitising and
aiming the personnel of all the partner agencies including banks.
With the success of the SHG -Bank linkage programme, linkage of Micro
Finance Institutions (MFls) with the banking sector was promoted by
NABARD to enable on -lending b y MFIs to SHGS and individuals.
4.8 IMPERFECTION IN RURAL CREDIT MARKET IN
INDIA
1. It has not produced desired results in terms of the direction, quantum
and quality of the flow of credit.
2. It is distressed by disturbing high overdue , bad debts, loan defaults,
unviability, low profitability, overburdening of staff, declining control and
deteriorating customer services. It is projected that the over dues of credit
institutions have increased from Rs. 2,818 crores to Rs. 9,661 crores
during 1983 -93.
3.The complex tiering of funds through RBI -NABARD -Commercial
Banks -State Cooperative Banks (SCBs) -District Co -operative Banks
(DCBs) -Primary Agricultural Credit Societies (PACS), has tended to
unduly increase the cost of banking.
4. Structure s of rural credit markets in developing countries may be
understood as responses to the problems of adverse selection, moral
hazard and enforcement. Imperfect information in this sense creates
problems from the viewpoint of controlled Pareto efficiency. In Indian
case too, information inadequacies have contributed to inefficiencies like
high transaction costs and low recycling of credit.
5. From the institutional viewpoint , role of an appropriate institution as an
enforcer and source of incentives and promo ter and persuader of saving is
essential for development. The institutional design should serve to
promote and facilitate functioning at the levels of both the leaders and
borrowers. This factor seems to have been largely overlooked in the Indian
case. Mot ivating to perform has not been given due importance.
6.Directed credit programmes and subsidized lending have badly affected
viable operative of credit troubling units. The entire workout has largely
come to be considered by tier up of funds from above to borrowers who
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92 4.9 QUESTIONS
Q1. Explain the restructuring of RRB.
Q2. What are various functions performed by NABARD?
Q3. What are the criticism of Commercial banking with respect to Rural
Credit?
Q4. How does Micro credit operate?
Q5. Explain in detail about rural cooperative credit system.
4.10 REFERENCES
 AHMAD, R. (JULY, 2012). AGRICULTURE,RURAL BANKING AND
MICRO FINANCE IN INDIA. NEW DELHI: NEW CENTURY
PUBLICATIONS NEW DELHI, INDIA.
 MISHRA, V. P. (2018). INDIAN ECONOMY. DELHI: HIMALAYA
PUBLISHING HOUSE.
 SUNDHARAM, R. D. (2010). INDIAN ECONOMY. NEW DELHI: S.
CHAND & COMPANY LTD.



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93 Module III
5
LABOUR MARKETS – I
Unit Structure:
5.0 Objectives
5.1 Conce pt of Work, Skill and Productivity
5.2 Methods of Measurement of Employment and Unemployment
5.3 Free and Unfree Labour
5.4 Questions
5.0 OBJECTIVES
 To study the Concept of work, s kill & productivity.
 To understand the Methods of measurement of employment and
unemployment.
 To study the meaning of FREE & UNFREE labour.
5.1 CONCE PT OF WORK, SKILL AND PRODUCTIVITY
‘Work’ is defined as engagement in economic activity i.e. any acti vity
resulting in production of goods and services that add value to the
National Product. As per United Nations System of National Accounts
(UNSNA) 1993, all production of goods irrespective of whether it is used
entirely for self consumption, by the prod ucer, household or it is partly or
fully sold in the market and irrespective of its production and distribution
is legal or illegal fall within the production boundary.
However, in case of services, only those services that are at least partly
marketed; fa ll within production boundary. Consistent with the India
system of National Accounts (INSNA), engagement in production of
goods entirely for market by the producer / household is considered in
primary sector. Further, processing of primary products entirel y for self
consumption is also not covered in the ambit of economic activity.
However, own account construction (building of house for one’s own use)
is included in economic activity for employment and unemployment
surveys. Thus, we understand that by now, definition of work in NSS
(National Sample Survey Employment & Unemployment surveys) is not
fully synchronized with the 1993 UNSNA.
It may be noted that speed of work controls the quantity of labour. One
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94 This speed depends upon various factors such as education, health, climate
and skill having impact on tendency of work.
Skill of work is related to the proficiency of the labourer. Skill is related
with the kind of work that how much wastage is done, how many
accidents are committed and many other factors are considered to know
the efficiency of work. Augmenting the skill endowments of labour force
is essential for improving productivity and output. Traditionally, the skills
are obtain ed or skills come from, ‘Learning by doing’ or practice makes
man perfect. However, recent trend prices that focused training improve
the capabilities of labour. Much of workforce is illiterate, which fails to
understand the processes, system and standards and therefore basic
education upto secondary schooling is at least must in improving skills.
The skilled labour force improves the quality of employment and the
productivity of labour.
Productivity may be defined as the ratio of the output of goods and
services to the in parts human as well as others used in production process.
i) Labour productivity, the best known measure of factor productivity
reflects the influence of various factors (such as capital quality of
labour technological change and organisatio n of production) that
affect the productivity.
Based on inputs to production, labour productivity can be decomposed
into two components:
a) Productivity due to capital deepening (i.e. improvements in physical
capital available per labour unit, and ;
b) Mu lti factor productivity (TFP) or Total Factor Productivity (TFP) : It
is the contribution other than that emanating from the increased use of
inputs (capital and labour). TFP than measures the increase in efficiency
with which resources are being used thro ugh innovations and improved
management techniques to increase the output from a given contribution
of capital and labour.
Following are seven determinants of productivity growth:
1) The rate of technological progress.
2) Investment in physical capital s uch as machinery, equipment and
structures.
3) The Quality of the workforce.
4) Size and quality of the natural resource base.
5) Industrial structure and intersectoral shifts.
6) The macro economic environment or aggregate demand conditions.
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95 Harris had identified three proximate drivers (The Big Three) of
productivity growth.
1) Investment in machinery and equipment
2) Education, training and human capital
3) Openness to trade and investment.
While the prox imate drivers may not be exhaustive, they do point to the
critical elements of an enabling public policy for enhancing productivity
and employment.
The ICT can have a positive impact on growth not only through a surge in
ICT investment, strong productivity effects from the ICT -producing
industries but also through a more productive use of the ICT in the rest of
the economy. The ICT equipments enable new organizational models and
other innovations in the production process as well as the production of
new go ods andervices. Thus, even if the ICT investment goods are
standard products, they enable firms to innovate and accumulate
firmspecific capital with positive spillovers on production.
Most of the empirical studies on productivity in India have focused on t he
growth in the TFP in the manufacturing sector. These studies suggest a
decline in the total factor productivity growth (TFPG) till 1970s, with a
turnaround taking place in mid – 1980s persuent to the reoriented trade
and industrial policies and improved infrastructure performance.
The transition to high -growth phase occurred ground 1980 a full decade
before economic liberalization due to pro -business policies that started
being adopted during the 1980s. Various incremental reforms in the
industrial secto r during the 1980s appear to have had a positive impact on
the productivity during the 1980s. The trends in productivity in past
reform period show significant increases in productivity. At the sectoral
level, there is evidence of improved TFPG for the exp orting sectors vis -à-
vis the non exporting ones. (Dholakia and Kapur, 2001; Unel, 2003). More
recently, Kato (2005) finds that the smaller the market share of a firm, the
higher is its productivity growth.
Recently Virmani has attempted to measure the TFPG for the Indian
economy as a whole. His estimates suggest that the TFPG has followed a
V-shaped pattern since independence, with near flattening from the late
1980s. Growth in the TFP decelerated since early 1950s, when it was
about 2.5 percent till mid -1970s when it fell to less than 0.5 percent.
Subsequently the TFPG recovered and peaked at about 2.6 percent in
1988 -89 and has broadly remained around these levels since then.
5.2 METHODS OF MEASUREMENT OF
EMPLOYMENT AND UNEMPLOYMENT
Accelerating growth and expanding employment opportunities are the
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96 continuing increase in the labour force is an integral part of our objective
of inclusive growth. Higher growth leads to enhanced employment.
How ever, the question that arises is at what rate? Employment elasticity
with respect to output measures the percentage increase in employment
due to the percentage increase in output. The overall employment
elasticity of an economy is the combined effect of the sectoral
employment elasticities and the composition of output. It is also true that
as an economy grows, employment elasticity may fall which is in part a
reflection of the improved productivity of labour. Improved productivity
of labour is necessary in order to sustain high G.D.P.
A development programme aimed at expanding opportunities must focus
on three factors; growth productivity of labour and relative price of labour
and capital. The structural changes that occur in the process of growth
have al so an impact on employment trends. In India, we find two
important features of these trends.
1) Structural transformation in India followed the typical pattern of
agriculture yielding to industry and industry to services. However, the
share of services sector exceeding 60% of GDP shows that, economic
development has shown ‘jump’ to the third stage of development.
2) The structural change in India shows another significant change. In the
pattern of sectoral shares of employment. While the share of
agriculture in G DP has declined significantly from 52% in 1951 to
21% in 2001, the share of employment has declined only marginally
from 65% in 1951 to 57% in 2001.
Conversely, even though services sector account for nearly 51% of output
in 2001, its share in employment w as only 22%. The pace of employment
shift has lagged behind the pace of sectoral shift in output. This is
particularly striking because services sector employment elasticity is
higher than employment elasticity in agriculture. V.K.R.V. Rao called this
as ‘Structural Retrogression’ of economy.
5.3 FREE AND UNFREE LABOUR
‘Free labour’ implies voluntary entry of a labourer into employer
employee relationship as per his choices at the selected and accepted terms
and conditions of payment and work. On the other hand, unfree labour
denotes the conditions of involuntary entry by compulsion; may be f
economic or social condition learning no choice to the labour for term and
conditions of work and place. Unfree labour is also called as ‘Forced
labour’. The conditions of unfree labour are precisian and the living is
quite vulnerable. Often the unforced labour results into situation like
‘Bonded’ system or ‘Slavery’ system and it is a bane on humanity.
Unfree labour has received an unusual amount of official attention d uring
the last few years. the continued existence of slavery and slavery -like
practices has also received renewed official attention, including that of the
UN Commission for Human Rights and its Working Group on
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97 is, however, the International Labour Organisation (ILO), which has
launched a campaign against ‘Forced labour’, and , as part of this, has
ventured an estimate of the extent of forced labour world -wide.
The recent ILO report ‘A glob al alliance against forced labour’ (ILO
2005a) represents the most coherent and most empirically informative
international report on forced labour.
The International Labour Organisation is the UN agency responsible for
international labour standards, and i s the only international organisation
pursuing labour rights issues at the international level. Its approach to
labour issues is, by definition, consensual. Not only is it a UN
organisation, it also has a tripartite set up, encompassing governments,
employ ees and labourers; a set up which is unique within the UN system.
The ILO fight back took place through a reformulation and refocusing of
its efforts, centered on the 1998 ILO ‘Declaration on Fundamental
Principles and Rights at work’, following which the main ILO objective
become ‘decent work for all’. This has been pursued through a campaign
for a ‘fair globalisation’, internationally, regionally, sector specifically.
Central to this were four ‘core labour standards’, namely : freedom of
association and t he right to collective bargaining; elimination of all forms
of forced or compulsory labour; effective abolition of child labour and the
elimination of discrimination in respect to employment and occupation.
An ILO special Action Programme to combat Force L abour exists, and has
published several survey -based reports within the field of forced labour.
The ILO defines forced labour as work or service extracted from any
person under the menace of any penalty and for which the said person has
not offered himself Voluntarily.
In other words, forced labour involves involuntary entry to the labour
relation, and coercion to remain within it, this is the internationally, legally
accepted definition of forced labour types of forced labour, including
slavery, serfdom an d debt bondage. 2005 report ‘A Global Alliance
Against Forced Labour (ILO 2005a) seeks to create public awareness
about the phenomenon of forced labour, through quantifying it.
The 2005 report calculated that a minimum of 12.3 million people in the
world w ork as forced labour. This is the first official estimate of the
magnitude of forced labour world wide, and it is emphasized that this is a
minimum estimate. The main region for forced labour by far is Asia and
the Pacific, with more than three quarters of all forced labourers and with
the highest incidence of forced.
Following are the different forms of forced labour.
1) Private Economic Exploitation : It is most commonly found and nearly
⅔ rd of all forced labour belongs to this type. This includes unfr ee
labour of bonded labour type, forced domestic work or forced labour in
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98 2) Forced Labour Imposed by the state : This includes compulsory
recruitment of citimen in defense or any other government led activities
learnin g little freedom of choice of acceptance to them.
3) Forced labour for Commercial, sexual exploitation : Regional patterns
are observed all over the world about these types of unfree labour.
It is very difficult to quantify the unfree labour. According to Bales (1999)
the estimate of forced labour globally is more than twice the size of that of
ILO minimum estimate (27.9 million against 12.3 million). Within the
unfree labour category debt bonded labour dominates in many regions of
South Asia and Latin Amer ica. In Sub -Saharan Africa, previous Master -
slave relations have been modernized but not been replaced with free
labour relations in some regions, whilst in – conflict and post. Conflict
areas, abductions followed by slave -like relations or enrolment as ch ild
soldiers are the main forms of forced labour.
The ILO analysis of forced labour is however restricted. Trafficking of
unfree labour is labelled as, ‘the underside of globalization’. Commodity
chain links between global retailers, suppliers and labour c ontractors,
leading to employment of forced labour at the end of global chains so as to
compete on cheap and stable production are noted. It is stated that, in
order to compete on the world market, employees in transition countries
may make use of unfree l abour : and it is pointed out that deregulation of
labour markets, downsizing of labour inspection.
In the main ILO report on unfree labour, little is done to link unfree labour
to present day capitalist development and to the general ILO strategy for
decent work in this context. The strategy of the ILO is to isolate the ‘worst
forms of “un -decent labour”’, so that these incidents can be dealt with in
isolation, without challenging the overall system that created the
conditions for their occurrence in the f irst place. The focus is on dealing
with what is seen as ‘exploitation’, namely unfree labour, child labour etc.
standard ‘free’ labour relations on the other hand, are not seen as
exploitative. This means that the ILO Report depoliticizes unfree labour
issues, isolates them as an ‘unnatural’ element of capitalism.
THEORETICAL DEBATE ABOUT UNFREE / FORCED LABOUR
The discussion regarding forced labour and capitalism is observed around
existing debates between Tom and Jairus Banaji. There are important
simil arities between Brass, Rao and Banaji. They all locate their work in
relation to that of Marx, and distance themselves from liberal views that
argue that labour relations such as bonded labour are free and equal, since
they are freely entered, contractual relations. They all share the basic
Marxist understanding that the sheen of equality provided by contracts
covers the fact that all labourers are exploited through their production of
surplus value. Exploitation is not something reserved for forced labour,
and free labour does not exchange equal values through the exchange of
their surplus value producing labour power for wages as liberal
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99 Regarding the relationship between forced labour and capitalism, for
Marx, commodification of labour power and thus, free labour were
essential to capitalism. The commodification is based on labour being
doubly free: freed, or dispossessed, from the means of production, and free
to sell his / her labour power to any capital ist who wishes to buy it. It is
axiomatic for Marx that labour will be commodified and hence doubly
free, in the above sense under capitalism.
In the debate on Free/ unfree labour, Brass proposes that unfree labour and
capitalism are compatible. He argues that the creation of unfree labour is
an essential part of modern capitalism. It represents class struggle from
above, as labour is displined through being robbed of / losing the control
of the sale of its own labour power, and labour power is thus cheapen ed.
Brass theory provides a general and seemingly progressive framework for
understanding present – day unfree labour relations. Empirically, he
focuses mainly on debt bondage relations, where the labourer mortgages
his / her future labour power against a loan from a creditor employer. It
enables him to argue that debt based labour relations are unfree,
irrespective of duration and ideological dressing. This enables him to
conceptualize new forms of seasonal labour relations in capitalist
agriculture in Ind ia as being unfree, as the relations involve the
mortgaging of future labour power against loans. This is discussed in
detail in the next section ‘employer – employee relationship’.
5.4 QUESTIONS
Q1. Define and explain the concepts of work, skill and productivity.
Q2. Explain how employment and unemployment can be measured.
Q3. Differentiate between Free and Unfree Labour.

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100 6
LABOUR MARKETS – II

Unit Structure:
6.0 Objectives
6.1 Types of Employer -Employee Relationship
6.2 Determinants of Wage Rates
6.3 Labour Market Segmentation and Gender -Based Discrimination
6.4 Wage Differentials
6.5 Contract Labourers
6.6 Questions
6.0 OBJECTIVES
 To study the types of Employer – employee relationship
 To study the Determinants of wage rates
 To study the Labour market segmentation
 To study Gender -Based Discrimination and Wage Differentials
 To study the contract labourers in India
6.1 TYPES OF EMPLOYER -EMPLOYEE
RELATIONSHIP
The employer -employee relationships have undergone changes over a
period of time. Many factors determine this relationship. Production
methods, land reforms, alternate oc cupation increased political power of
lower castes are some other factors.
1) During colonial times, bonded labour shed the vestiges of patron –
client relations which used to include certain modest benefits for the
labouers.
2) In the later part of colon ial period it was replaced by hand nosed
modern economic relations more exploitative than those previously
existed.
3) After independence most classical bonded labour relations ceased to
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101 involving migrant labour instead of employing the ex -bonded laboure as
free labour.
4) In many parts of rural India, more or less free labour relations have
been developed within agricultural. As methods of production have moved
away from labour in tensive economic activities bondage have been
modernized into a relation called as, ‘neobondage’.
1) Neobondage involves the tying in of prospective labourers through
loans / advances given during the lean season before the start of seasonal
employment relation. Labour here is seasonal migrant. The migrant labour
force tends to be more effectively exploited through longer working hours,
lower wages and less labour unrest. During employment period, he may
only be paid a minimum allowance while the overall payment is settled at
the end of the seasonal employment. This compels the labourers to stay in
employment after advance has been paid off. This kind of relationship is
identified in agriculture especially in sugarcane, rice mills, construction,
family bondage is also common, caste relations are also an issue. The vast
majority of bonded labourers continue to belong to the lowest, ex -
touchables caste groups and tribes. Due to economic compulsions, men
enter into neobondage female bonded labourers and children may or may
not enter the relationship voluntarily.
However, it needs to be understood that advances are common place even
if free employment relations, due to poor economic position and also
because such advances provide an incentive for employer to keep the
labourers in employment. In the recent research it is found that labourers
viewed an advance from an employ er as the preferred option, compared to
other types of loans as such, relation offered a chance to pay off the debt.
2) Jobber / Contractor labour relation: Many a times, a bonded labour
relation is organised through jobbers/contractors, who will provide t he
advance, organize the migration and be the manager at the work place.
The jobbers would be working for one ore more employers or for a main
jobber, who would provide the advances and rely on them to deliver the
labour. The labourers are in the long term debt relationship with the
jobbler& not with the end destination employer. As the poor labourers
have debt bondage.
3) Contract labour: The official classification of work under taken
through jobbers or labour contractors is contract labour. Contract labo ur is
wide spread. An estimated 10.7 million labourers in construction alone are
contract workers, comprising 83% of all construction workers. Contract
work is widespread in unorganized sector activities such as stone
quarrying, beedi rolling, rice shellin g and construction.
4) Long term debts and Casual labour relations: The poorer the
labourer is less alternative opportunities of employment, he will have. This
condition makes him enter into long term debt bondge. Recently, if has
been found that labourers manage to avoid the long term debt bondge with
more alternative job opportunities. The long term debts and casual labour
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102 even in Andhra Pradesh. Here, the jobbers tend to be from t he area of the
origin of the migrant labour and form part of power relations built into the
local social order. This enables them to enforce loan or advance based
labour relations over several years. Long term debt bonded labourers
compare themselves to th e traditional bonded farm servants and they are
free to change the jobber fairly and regularly.
5) Debt bondage without jobber: There are causes of debt bondage
which do not involve debt jobbers. This is particularly the case where no
migration is involved , i.e. where employers are in a position to enforce
debt related employment pledges through local power relations. The old
style debt bonded yearly relationship in agriculture is of this kind.
6) Other forms : Milder forms of unfree relations are also foun d, such as
share cropper conditioned on the acceptance by the share cropper of
labour service duties, performance of some unpaid labour throughout year
in order to be given work during the harvest season, free labour service in
exchange of grazing land etc . Some involve the actual confinement of the
labourers in the work location or sometimes under the armed guard.
The above description about the various types of relationship between
labour and employer points towards the degree of freedom or unfreedom
and inequality over and above what normally 102 called as standard free
labour relation. The distinction between milder and harsher forms of
bonded labour points towards a continuum from more or less free relations
to fully unfree relations i.e. the degrees of un freedom and / or inequality
unlying the labour relation. The catagorisation of such type reflects the
character of labour relations.
It is difficult to say if the ‘low route’ of development in India has involved
an increase or decrease in bonded labour rel ations. What is certain is that
while the old style, year – round, intergenerational bondage relations have
lost their overall importance, the development of new bonded labour
relations, and other labour relations involving degree of unfreedom,
compatible with capitalism has been facilitated.
6.2 DETERMINANTS OF WAGE RATES
Determination of wage rate is a basic problem of an organisation. The
central point of all the labour problems in an organisation is the wages and
salaries. This question determines the c apacity of the production, the rate
of productivity, efficiency of labour cost of production, sale price of
commodity, profits of the organisation, and industrial peace in the country.
Wages can broadly be divided into three categories – Living Wages,
Mini mum Wages and fair wages.
1) Living Wages : Living wages means the wages that may be sufficient to
provide for the bare necessities as well as certain amenities for the
employees. It means the level of wages that may be sufficient to provide
for the bare necessities and such amenities that are considered necessary
for the well -being of the employee and his family members in accordance
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103 Article 43 of the constitution of India states that. The state shall endevour
to secure by suitable legislation or economic organisation or in any other
way to all workers, agricultural, industrial or otherwise work, a living
wage, conditions of work ensuring decent standard of life and full
enjoyment of leisure and social and cultural opportunities.
The term Living Wages has been defined as under : The Fair Wage
Committee Report, “The living wage should enable the male earner to
provide himself and his family not merely the base essentials of food,
clothing and shelter but a measure of frugal comfort in cluding education
for the children, protection against ill health, requirements of essential
social needs and measures of insurance against the more important
misfortunes against old age”.
Thus, Living Wage must provide not only for the bare necessities, s uch as
food, clothes and shelter, but also for some conforts and amenities by
current human standards such as – traveling, health, education of children,
social needs, old age and recreation etc.
2) Minimum wages: According to Fair Wages Committee, “Minimu m
Wages should provide not only for the bare necessities of a worker. It
should also provide for the maintenance of efficiency of the worker. From
this point of view, minimum wages must be sufficient to provide for all
requirements of education, health and other essential amenities”.
Minimum Wages means the minimum payment to worker so that he may
be able in providing for basic needs for himself and his family members
and to maintain his working efficiency only some other scholars are of the
new that minimu m wages should also provide for minimum education,
medical facilities and other amenities. According to them, minimum
wages should ensure a minimum standard of living considering the health,
efficiency and well being of the worker.
Objectives of Minimum Wa ges:
1) To maintain the efficiency of workers, particularly in the industries
where the workers do not get fair wages.
2) To discourage the strikes, lock -outs and industrial disturbances so
that industrial peace maybe maintained.
3) To check the unhea lthy competition among entrepreneurs.
4) To protect the interests of workers, particularly when the workers
are not organised.
5) To strengthen the labour unions.
6) To check the exploitation of workers by the entrepreneurs.
7) To increase the effi ciency of workers.
8) To help the workers in maintaining and increasing their standard of
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104 9) To provide economic and social justice to the workers.
10) To check the unhealthy competition among the workers.
11) To improve the management system.
12) To improve the productivity of workers.
Methods of minimum wages:
There are two methods to determine the Minimum Wages. These methods
are as under :
1) Indirect Method : The Government determines minimum wages
keeping in view the following provisions of Minimum Wages Act.
a) Government determines minimum wages for the workers working in
government departments. Following the wages so determined by the
government, the minimum wages in the private sector industries is al so
determined.
b) While working on contract, the government imposes a condition of
minimum wages in contract deed.
2) Direct Method : For the determination of Minimum Wags, the
Government may take following steps :
a) To Appoint Wages Boards : State government may also appoint wage
boards for the determination of minimum wages. These boards may be of
two types
i) Wages boards appointed for the purpose of advising government on the
issue of minimum wages. It is important to know that these boar ds are
responsible to give their advice only.
ii) Wages boards that are appointed to determine the minimum wages after
considering the circumstances of the industry. Representatives of both the
workers and employers take part in these boards.
b) To Deter mine Minimum Wages : Under this method of wages
determination, the state Government may determine minimum wages for
the workers working in different industries.
After determining such wages the Government issues orders to the
enterprise to pay these wages to the workers working in their industries.
This method is widely adopted in India.
Principles of Determination of Minimum Wages :
Following are the principles that should be followed while determining
minimum wages.
1) Principle of Paying Capacity of the Industry : While determining the
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105 also be considered because the wages to be paid should not prove a burden
upon the industry.
2) Principle of Equality : According to this principle, al l the workers doing
same work and having equal ability and experience, must be paid equal
wages. This principle does not man equal wags for all. It only means that
all the workers in the same industry having equal efficiency and
experience should get equal wages.
3) Principle of Standard of Living : While determining minimum wages,
the principle of standard of living, should also be followed. The wages
should be enough to provide for the bare necessities and essential
amenities to the workers. From this po int of view, different wages may be
determined for different places and different industries. In addition to this,
rates of wages should be modified from time to time.
3) Fair Wages : It is very difficult to give a precise definition of Fair
Wages because it varies from country to country and from time to time.
Therefore, it is possible that an amount of wages that is fair for one
country at one time may not be fair for another country or for next time.
Therefore, fair wages can be determined only after con sidering the
specific circumstances of the industry for which the wages are to be
determined. The term ‘Fair Wages’ has been defined as under.
Prof. Marshall, “Rate of wages in a particular industry can be regarded as
fair wages only when it is almost equa l to the wages which is paid in other
industries for the works which are of the same caliber and equally difficult
and require almost equal efficiency and training”.
Prof. Pigou, “Fair wages is the wages which is paid at the rate which is
being paid to the workers of same status in the enterprises of the same type
and of near -by areas”.
On the basis of analytical study of above definitions, it can be concluded
that Fair Wages is the amount of wages that may provide the basic needs
and amenities to the worke rs according to their social status.
Fair Wage is more than minimum wages. Fair Wage is determined after
considering several factors such as the wages paid for similar work in
other trades and industries requiring same amount of ability and
adjustment, pro ductivity of the labour and paying capacity of the industry.
Fair Wage is determined between the lower and upper limits. The lower
limit of wage is the minimum wage and the upper limit is the capacity of
the industry to pay.
Determination of Fair Wages:
The rules and the problems in the process of determination of Fair Wages
are as follows :
1) Determination on the Basis of Paying Capacity of the industry :
According to this technique, fair wages should depend upon the paying
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106 estimated on the basis of net profits of the enterprise but following are the
difficulties in adopting this method as the base of determination of fair
wages.
i) The amount of profits may be substantially reduced by in creasing
the provision for depreciation and other provisions and reserves.
ii) Similarly, the amount of profits may be increased or decreased by
increasing or decreasing the expenses.
Considering these difficulties, Fair Wages Committee has suggested that
the paying capacity of an enterprise must be related with the current rate
of wages which depends upon,i) Purchase Price ii) Quantity of Production
iii) Profit of the Enterprise iv) Unemployment.
2) Difficulty in the Execution of Fair Wages:
i) As all the emp loyees work with the same efficiency and ability
ii) It is necessary that the working conditions of all the workers getting
equal rate of wages must be similar.
3) Determination on the Basis of Productivity of the industry :
Rate of Wages is closely rela ted with the productivity of the labour.
Productivity of the labour does not depend upon the efficiency of labour
only. It depends upon many other factors also, such as – managerial
capacity, financial management and technical facilities etc.
Therefore, these factors must also be considered while determining the
rate of wage on the basis of productivity and labour.
6.3 LABOUR MARKET SEGMENTATION&GENDER -
BASED DISCRIMINATION
Labor market in India is heterogeneous and fragmented. Entry in some of
the segments is restricted. The important causes of segmentation are
discrimination, supply side factors and modernization of productive
activities. Indian economy is a dualistic econo my with the modern and
traditional sectors operating side by side. The modern formal sector is
concentrated in the cities whereas the traditional informal sector is
concentrated in ruralareas. While the formal labor market is protected by
social security l egislation and is largely unionized, the traditional labor
market is not unionized and also lacks legal protection. Wage rates and
incomes vary widely between the formal and informal labor markets.
6.3.1 Urban Labor Market
According to LK Deshpande, based on his study of labor market in
Mumbai (Segmentation of Labor Market: A Case Study of Bombay,
1985), there are basically three segments. These are the factory sector,
small establishments sector and the casual labor sector. Labor market
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107 urban labor force in India is largely a migrant labor force whose roots are
found in the rural areas. The labor force can be distinguished on the basis
of ownership of their assets. Those who do no t own or own less physical
and human capital find employment in the peripheral market as marginal
workers. Others who are better off in terms of ownership of assets enter
into the better sections of the urban labor market. Lack of occupational
and inter -sectoral mobility keeps the majority of the poor in the peripheral
labor market. The real earnings of the factor labor are the highest followed
by the earnings of the labor in the small establishment sector. The real
earnings of the casual labor are very low . Garry Rodgers in his work
“Creation of Employment in Segmented Labor Markets; A General
Problem and Implications in India”, 1993 has classified the urban labor
market in seven categories:
1. Protected regular wage work
2. Unprotected long term wage work
3. Unprotected regular short term wage work
4. Unprotected irregular wage work
5. Independent wage work
6. Small capital owning self employed
7. Marginal self employed without capital
According to Rodgers, the more there are dividing lines within soci ety, the
easier it is for the labor market to fragment and scarcer income earning
opportunities the greater the intensity of segmentation. John Harris
(Character of an Urban Economy, Small Scale Production and Labor
Markets in Coimbatore, WPW, June 12, 198 2) has classified workers into
five categories: permanent wage workers, short term wage workers,
disguised wage workers, dependent workers and self employed workers.
Permanent wage workers have the job security and are employed in larger
factories. Wages o f these workers are higher. Permanent workers have
land owning background. They belong to upper castes, are better educated
and usually come from more distant places. Short termwage workers work
in smaller factories or other establishments. They do not enj oy job
security. Their wages are low. Short term wage workers belong to low
castes and do not have land owning background. Disguised wage workers,
dependent workers and self employed workers are all casual workers.
They usually belong to lower castes and t heir earnings are low.
6.3.2 Rural Labor Markets
The rural labor market is the largest segment with 56.6% of the labor force
working in the agricultural sector. Asset distribution in the form of land
ownership and caste hierarchy are important considerati ons in the rural
labor market. The control of the employer in the rural labor market on the
workers continues to be strong. The welfare of labor in rural areas depends
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108 public entit lements. Seasonally migrant labor move from place to place for
work and perform unskilled work. They are known as outsiders in the
rural labor market and do not have stable relations with their employers.
The bulk of the rural labor force is not unionized.
6.3.3 Primary and Secondary Labor Markets in India
The segmented labor market approach makes distinction between primary
and secondary labor markets. The primary sector is sub -divided into
primary independent and primary subordinate. Workers in the primar y
sector enjoy the benefits of formal labor market whereas workers in the
secondary sector do not enjoy any kind of social security. In India,
primary labor market workers working in both the public and private
sectors enjoy high wages, employment security , good working conditions,
career advancement and legal protection. In the secondary labor market,
wages are low, working conditions are poor and there is no scope for
career advancement. Labor is exploited in the secondary market. Workers
in the secondary labor market have a higher turnover rate, higher
incidence of absenteeism and higher rate of insubordination. The
secondary labor market is not homogenous. Labor market for small scale
industrial units is a part of the secondary market. Despite lack of ca reer
advancement opportunities, poor wages and low job security, workers
consider employment in small industrial units better to casual work in the
informal sector.
6.3.4 Urban Informal Labor Market in India
The urban informal labor market is a part of the secondary labor market.
The participants in urban informal labor market have the following
characteristics:
1. Participants are unprotected and insecure.
2. Participations are unregulated and labor is free to respond to market
forces.
3. Most workers have low skill and poor asset ownership and therefore
their freedom to respond to market forces is limited.
The urban informal labor market is used by the rural migrant labor as a
transitory employment option that provides meager and uncertain income.
6.3.5 Caste Based Discrimination
Segmentation within the labor market takes place due to differences in
caste, race and gender. In India, racial discrimination is not an issue.
However, caste and gender are the big issues in terms of discrimination. In
India, scheduled castes and tribes have been historically discriminated and
hence workers belonging to scheduled castes and tribes have to seek
employment in the secondary market. The employers in the primary
market are prejudiced against the members of scheduled castes and tribes
and do not hire their services. Caste based discrimination leads to wage
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109 The members of the scheduled castes and tribes are also discriminated in
the field of edu cation, health and access to market. They are employed in
low paid jobs. This type of occupational discrimination is called
occupational segregation. In informal sector, it is found that employers
hire SC/ST labor on the condition that they accept lower wa ges in
comparison to wages of non SC/ST labor.
6.3.6 Gender Based Discrimination
Gender based discrimination means that women are paid less and their
service conditions are poor in spite of good skills, qualifications and
productivity. According to Sociolo gists, the subordination of women in
the patriarchal system leads to their subordination in the labor market.
There is a clear segmentation in industrial labor market in cities like
Mumbai and Coimbatore. Women are prevented from having access to all
kinds of jobs. Women workers in handloom, power looms and other small
scale industries sector suffer far greater discrimination than in the large
factory sector. Being illiterate and having not trade union support they are
involved in low paid jobs with no care er advancement prospects. A
segmented labor market does not allow entry into the primary labor
market by those who are socially, economically discriminated against.
6.4 WAGE DIFFERENTIALS
One of the important characteristics of labour market is that the wages
between different occupations are not equal or wages in the market differ
across the demographic groups. (For example, men may be paid more
wages than the women for similar kinds of jobs). It is also found that
many jobs are done exclusively by men o r by women. Some textile jobs,
nursing may be done exclusivelyby the women whereas some jobs in
dock -yards, shipping, etc may be exclusively done by men. Such labour
market discrimination is said to exist if individual workers, who have
identical productiv e characteristics are treated differently because of
demographic groups they belong or occupations to which they belong.
6.4.1 Inter - sectoral or occupational wage differentials
Since J.S. Mill, economic theorists have tended to explain occupational
wage differentials by differences in costs of training or other obstacles to
supply of labour. This however accounts for a long -run wage differentials.
In the short run, the number of persons in an occupation is fixed and
earnings are affected by the changes i n demand and wage rigidities. The
wages basically vary between one occupation and other because there is
no single labour market. There are many labour markets depending upon
different types of labour. For example, there may be deficiency of supply
of labo ur in the market for doctors but there may be surplus in the market
for engineers. Hence the wage rate in both these markets will differ. In the
short -run, supply of labour of a particular kind (say doctors) cannot be
raised as special, rigourous training may be required, special aptitude is
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110 the first and foremost reason for wage differential is lack of occupational
mobility.
6.4.2 Male – female wage Differentials
There are two promine nt forms of male -female or gender discrimination in
labour market. Firstly, the employers may pay less to women than men
with the same experience and to work under same conditions in the same
occupations. Secondly, women with same education and productive
characteristics may be placed in lower paying occupations or with lower
responsibility jobs as compared to men. Thus, the labour market
differential is said to be present when wages paid by the employers to men
and women with equal productive characteristi cs are not equal, even in the
same occupations. This trend may be due to many reasons. To mention a
few of them: -
1. Many of the women are married and hence they are not entirely
dependent on their own earnings. This may make them accept lower
wages.
2. The average wages of men are higher because the proportion of skill is
greater among men than women.
3. Much larger proportion of men tend to work harder than women
because they have dependents to maintain.
4. The absentee rate out of sickness is less amo ng the men as compared to
women.
5. Turnover or job -changing is more among the women than the men due
to many reasons like marriage, children, etc.
Royal Commission on Equal Pay (1946) published a Majority and
Minority Reports. Majority Report favoured wa ge differentials between
men and women on the ground that men possess greater physical strength
and are generally more efficient than women, that the sickness rate was
higher among women, that they are more likely than men t absent
themselves from work for trivial reasons, and that were generally less
ambitious than men and in crises showed less initiative. The Minority
Report admitted that where physical strength was concerned, men were
more capable than women, but it was claimed that with this exception
women were equally as efficient as men, the fact that in the past women
had been promoted to few posts of responsibility being ascribed to the
prejudice of employers and the jealousy of employees. (A Textbook of
Economics – J. L .Hanson page 322).
6.4.3 Wag e differentials in India
According to D.R. Gadgil, wage differentials in India are the characteristic
of unorganised labour market and personal differentials are because of
job-selling, individual bargaining and wage discrimination. Wage
differentials by sex have also been very common in India. But the
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111 through the fixation of minimum wages, appointments of wage boards and
pressures from the unions. Inter -industry and inter – state diffe rentials are
also on a continuous decline over years.
One of the Directive Principles of Indian Constitution is “Equal Pay for
Equal Work”. The Fair Wages Committee and other wage fixing
authorities in India have always recommended equal pay to equal work for
men and women workers. But the things are difficult to implement
because even though conditions, processes and products are standardised
for the purpose of wage calculations, workpeople cannot be standardised.
That is, the workers may differ on the bas is of their experience, efficiency
and hence the wages also may differ.
6.5 CONTRACT LABOURERS IN INDIA
Contract labor is not recorded on the payroll. It is not directly paid by the
employer. The principal employer is not directly responsible for the
payme nt of wages or any other matter arising out of employment of
contract labor. The benefit of contract labor to the principal employer is in
terms of cheap labor and avoidance of other attendant costs that may arise
out of regular employment such as provisio n of welfare facilities, paid
leave, social security, bonus, administrative costs, installation of plant and
machinery which otherwise is provided by the contractor etc. Contract
labor can be divided into two categories, namely; persons employed in job
contracts and labor contracts. Big firms offer job contracts or certain
operations, for example, loading and unloading of material to contractors.
In this case, the contractor employs his own labor and also pays them.
In case of labor contracts, the contracto r supplies only labor to the
principal employer for employment in various categories of work. The
contractor is responsible for payment of wages as determined by him to
the workers. Contract labor is employed as unskilled and skilled labor.
Unskilled labor include categories such as loaders, cleaners, sweepers,
helpers etc and skilled labor include categories such as turners, fitters,
electricians, gas cutters, carpenters, blacksmiths etc. Contract labor is
generally found in industries such as engineering, textile, carpet weaving,
building constructions, irrigation projects, road construction etc. Out of
these, mining and building industries are found to be the major employers
of contract labor.
Contract labor was one of the most exploited forms of labor. Bo th the
contractor as well as the principal employer did not bother about contract
labor. The Government of India therefore passed the Contract Labor Act
to prevent the exploitation of contract labor. The Contract Labor
(Regulation and Abolition) Act, 1970 provides for the regulation of the
conditions of work, health and safety, wages and other amenities for the
welfare of contract labor. A contractor is required to provide canteens, rest
rooms, latrines, urinals, drinking water, washing facilities and first aid
boxes for the use of contract labor. If a contractor fails to provide the
amenities or to make payment of wages, the principal employer will be
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112 contract labor and the principal employe r can recover such expenses from
the contractor.
The objective of the Act is to prohibit the employment of contract labor
and wherever it is not possible to prohibit, conditions of work of contract
labor is sought to be improved. The Act is applicable to e very
establishment employing twenty or more workmen as contract labor and to
every contractor employing twenty or more workmen. The Act further
empowers the Central and State governments to apply the provisions of
the Act to any establishment or contractor employing less than twenty
workmen. The Central Government has prohibited employment of
contract labor in categories of work in coal, iron ore, limestone, dolomite,
manganese, chromite, magnesite, gypsum, mica and fire clay mines,
building industry, and r ailways. Contract labor is prohibited in the Central
Food Corporation of India godowns and Port Trust.
6.6 QUESTIONS
Q1. Write a note contract labor.
Q2. Describe various types of employer -employee relationships.
Q3. What are the various categories of wages and discuss how they can be
determined.
Q4. Discuss in detail the concept of Labour Market Segmentation.
Q5. Explain the essence of Labour Market Dualism.
Q6. Differentiate between the Formal Sector Labour Mar ket and Informal
Sector Labour Market.
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113 Module IV
7
LAND AND LEASE MARKET S - I
Unit Structure
7.0 Objective
7.1 Introduction
7.2 Definition of Land
7.3 Features of Land
7.4 Land Market
7.5 Types of Farming
7.6 Mechanism of Land Transfer
7.7 Lease Market
7.8 Model Agriculture Land Le asing Act 2016
7.9 Formal vs. Informal Lease Extensions
7.10 Questions
7.0 OBJECTIVE S
In this module students will study the case of land and lease market. The
objective is to know and understand the typical features of land market in
a less developed c ountry like India and the types of farming in India , along
with the crop sharing practices in India. Along with this we will also throw
some light on the concepts of lend holdings, interlocking and inter
linkages, contract farming etc.
7.1 INTRODUCTION
India is still an agrarian country of the world, though there is a fast growth
of industry and more of service sector, as a large number of people even
today depend on agriculture and live in rural areas . Agriculture in our
country still faces many problems which needs proper institutional
solutions. Land is the most important and the basic factor of production in
agriculture. So it is very much essential to throw light on the issues related
to the land market and tenancy and cropping patterns.
7.2 DEFINI TION OF LAND
Theterm ‘land’ generally refers to the surface of the earth. But in
economics, it includes all that, which is available free of cost from ‘nature’
as a gift to human beings. Land stands for all nature, living and non -living
which are used by m an in production. All the natural resources found on,
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114 Land has been defined by various scholars, as:
To Marshall, “By land is meant not merely land in the strict sense of the
word, but whole of the materials and fo rces which nature gives freely for
man’s aid in land, water, in air and light and heat.”
Thus, we can say, land includes:
i. Surface of the earth like plains, plateaus, mountains, etc.
ii. Sea, rivers, ponds, etc.
iii. Air, light, etc.
iv. Oil, coal, natur al gas, etc.
v. Silver, gold and other metals and minerals.
Even though land is passive factor and it does not possess any ability to
produce on its own, it is an important agent of production. Modern
economists consider land as a specific factor of produc tion, which can be
put, not only to a specific purpose but to several other uses.
7.3 FEATURES OF LAND
1. Free Gift of Nature:
Basically, land is available free of cost from the nature. In the initial
stages, man paid no price for the land acquired by him. H owever, to
improve the usefulness or fertility of land or to make some improvements
over land, some expenditure is to be incurred, but as such, it is available at
no cost from nature. Man has to make efforts in order to acquire other
factors of production.
But to acquire land no human efforts are needed. Land is not the outcome
of human labor. Rather, it existed even long before the evolution of man.
2. Supply of Land is Fixed (Perfectly Inelastic ):
Supply of land is fixed in quantity. It means supply of land cannot be
increased or decreased like other factors of production. Although for an
individual, supply of land may be flexible, but at macro level, the overall
supply of land is fixed. However, only effective supply of land can be
increased by making an in tensive use of land.
3. Difference in Fertility:
All lands are not equally fertile. Different patches of land have different
degrees of fertility. Some locations are very fertile and have very good
agricultural productivity, whereas some patches are totally b arren and
nothing can be grown there. Similarly, the degree of richness of mineral
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115 4. Indestructibility of Land (Permanent Factor) :
Land is an indestruct ible factor of production. Man can change only the
shape of a particular location and composition of its elements, but as such
land cannot be destroyed. It can either be converted into a garden or to a
forest or to an artificial lake. However, some parts o f land get eroded due
to natural factors, but that is immaterial because overall availability of
land does not change.
5. Immobility:
Unlike other factors, land is not physically mobile. It is an immobile factor
of production, as it cannot be shifted from on e place to another. It lacks
geographical mobility. Some economists, however, describe land as a
mobile factor on the argument that it can be put to several uses.
6. Land is a Primary Factor of Production:
In any kind of production process, we have to start with land. For
example, in industries it helps to provide raw materials, and in agriculture,
crops are produced on land.
7. Passive Factor of Production:
Land is a passive factor of production, because it cannot produce anything
on its own. It is not an activ e factor of production. Human element and
capital inputs are required to be combined in an appropriate manner with
land in order to obtain yields from it.
8. Effect of Laws of Returns:
Since land is a fixed factor of production, the laws of returns are more
effectively applicable on it. Increased use of capital and labo ur on a
particular plot of land leads to an increase in crop production at a
diminishing rate. Thus, land is subject to Law of Diminishing Returns.
9. Alternative Uses of Land:
Land can be put to several uses. Land is used for alternative purposes like
cultivation, dairy or poultry farms, sheep rearing, building, etc. The use of
land for any particular purpose depends not only on the return from that
particular use, but also the returns from alter native uses.
10. Land is Heterogeneous:
Land like other factors of production differs from another in respect of
location, fertility, nature and productivity. Two pieces of land are not
exactly the same. Some plots of land are more fertile, some are less fert ile,
some plots are even unproductive.

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116 7.4 LAND MARKET
Land is one of the important factors of production along with labour,
capital and entrepreneur. It is the basic factors of production though it is
passive in nature (as land cannot produce anything o n its own).
We come across different markets like product market, money market etc.
Similarly, we come across market for the factors of production like land
market, labour market etc. Here we will discuss some issues related to
Land Market.
Land markets ar e mechanisms that, provided there are appropriate
institutional checks and. balances, allocate ownership and use rights in a
manner that allows land and its associated. assets to be used in the most
economic way. The efficiency of the land market varies ac ross the world
together with its openness to public scrutiny and support for the concepts
of sustainable development. In less economically developed societies, and
in particular where informal settlements exist, it has not always been
possible to develop a n effective land market and this leads to under -
capitalisation. Land markets are generally regulated through land tenure
and land administration systems. Key elements in any land tenure system
include the extent to which land can be bought or sold; whether it can be
used as collateral and if so who then takes over a property if any loans on
the land cannot be repaid; who has rights of access to or passage through
the land; the rules governing inheritance; and the extent of additional use
rights and obligati ons.
There are certain inherent problems with land because of its peculiar
characteristics, which impede the natural emergence of a well -functioning
market. The legal and regulatory framework can potentially overcome
these problems.
1. In India, despite some reform efforts, the land market continues to be
highly distorted and inefficient.

2. Land records are inaccurate, outdated, and incomprehensive.

3. There are widespread uncertainties relating to land titles, which have
hurt the market.

4. Transaction costs ar e significantly high by international standards,
which have discouraged formal land transactions.

5. Initiatives which could have made the market function better have not
been taken; while some regulations have been introduced which have
introduced or magni fied the distortions in the market.

6. A major negative consequence of this underdeveloped and distorted
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117 eschewed market negotiations for land acquisition and have favored
the use of em inent domain powers.

7. While reforms have begun in many areas, an area that has been left
untouched relates to regulatory restraints on land use.

8. The most notable has been the requirement of NAC. Because the
clearance is typically given after land is tra nsferred from one party to
another, there is a significant transfer of wealth from farmers to project
proponents, which has been the source of a great deal of social
discontent. The elimination of this restriction on land use would go a
long way towards ma king the land market a great deal more efficient
than it is now.

9. Morris and Pandey (2009) have already highlighted the major
distorting factors regarding the land market scenario of India among
which multiple layered land administration system is a seriou s
impediment to the smooth functioning of the land markets.

10. The land market in LDCs is typically thin. This thinness can be traced
among other reasons to poor land records, and a slow moving legal -
justice system.

11. The high land acquisition costs and the l engthy process make it a
critical barrier for designing land use transport policies. A significant
part of the infrastructure development is delayed due to this reason
The land markets are heavily distorted due to zoning and development.

Well -functioning land market can in principle contribute to broad based
rural development in several ways.

First, where the ownership distribution of land differs from the optimal
operational structure, land markets can transfer land from less to more
productive produce rs and thus increase productivity.

Second, transferable land rights make it less costly to rural residents to
take jobs in the nonfarm economy, something that is likely to boost the
off-farm sector.

Third, transferability of land increases investment inc entives because
those who make such an investment can enjoy the benefits even if they are
no longer able to personally use the land.

Finally, the ability to transfer land at low cost will reduce the transactions
cost of accessing credit and can, if there is effective demand for credit,
increase credit supply.

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118 7.5 TYPES OF FARMI NG
Farming Systems in India are strategically utilized, according to the
locations where they are most suitable. The farming systems that
significantly contribute to the agricultur e of India are subsistence
farming , organic farming , industrial farming . Regions throughout India
differ in types of farming they use; some are based on horticulture , ley
farming , agro forestry , and many more. Due to India's geographical
location, certain parts experience different climates, thus affecting each
region's agricultural productivity differently. In dia is very dependent on its
monsoon cycle for large crop yields.
Each region in India has a specific soil and climate that is only suitable for
certain types of farming. Many regions on the western side of India
experience less than 50 cm of rain annually, so the farming systems are
restricted to cultivate crops that can withstand drought conditions and
farmers are usually restricted to single cropping. The farming systems that
significantly contribute to the agriculture of India are subsistence farming,
organic farming and commercial farming. Regions throughout India differ
in types of farming they use, some are based on horticulture, ley farming,
agro forestry , and many more. Due to India’s geographical location,
certain parts experience different climates, thus affecting each region’s
agricultural productivity differently. India is very dependent on its
monsoon cycle for large crop yields. Based primarily on nature of land,
climatic charact eristics and available irrigational facilities, the farmers in
India practise different types of farming.
From Subsistence to Commercial, from mixed to terrace. Understand
everything about types of farming in India. . Farming is an important
activity for an y country. It includes growing crops, vegetables, fruits,
flowers. The economy of any country only depends on farming. Farming
depends upon the geographical condition, the demand for a product, labor,
and level of technology.
Based primarily on nature of land, climatic characteristics and available
irrigational facilities, the farmers in India practise different types of
farming.

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119

A. SUBSISTENCE FARMING
Subsistence farming is described as family farming because it meets the
needs of the farmer’s family. Most of the yield is consumed by the family
with very little surplus for the family
This type of farming is practiced to meet the needs of the farmer’s family.
The whole family works on the farm
Traditionally, low levels of technology and household labour were used to
produce on small output. It is characterised by small and scattered land
holdings and use of primitive tools. It required a low level of technology
and household labour.
Majority of farmers in the country practise subsistence farming.
As the farmers are poor, they do not use fertilisers and high yielding
variety of seeds in their fields to the extent they should do.
Facilities like electricity and irrigation are generally not available to them.
These types of farming produce small output. The y do not use high
yielding varieties of old seeds and fertilizer. Yield is not very high
Facilities like electricity and irrigation are not available for them. Most
subsistence farming is done manually.
Subsistence farming can be further classified as int ensive subsistence and
primitive subsistence farming.
1.Intensive Subsistence Agriculture
In intensive subsistence agriculture the farmer cultivates a small plot of
land using simple tools and more labour. Thus ,it includes a small plot of
land and for gro wing crops, simple and low -cost tools, and more labour.
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120 Climate with a large number of days with sunshine and fertile soils permit
growing of more than one crop annually on the same plot of land .
Rice is the main crop. Other crops include wheat, maize, pulses and
oilseeds.
Intensive subsistence agriculture /farming is practiced in the thickly
populated areas of the monsoon regions . These regions are of south,
southeast and east Asia.
2. Primitive Subsistence Agriculture
i) Shifting Cultivation:
Shifting cultivation is practiced in the thickly forested areas of Amazon
basin, tropical Africa, parts of Southeast Asia and Northeast India. These
are the areas of heavy rainfall and quick regene ration of vegetation.
A plot of land is cleared by felling the trees and burning them. The ashes
are then mixed with the soil and crops like maize, yam, potatoes and
cassava are grown. When soil loses its fertility, the land is abandoned and
the cultivator moves to a new plot.
It is a quick regeneration of vegetation
The farmers move to the other land to repeat this process. Shifting
cultivation is also known as ‘slash and burn’ agriculture.
The process of shifting cultivation is that first of all the land is cleared by
falling trees and burning them. Then the ash of the trees is mixed with the
land soil.
This cultivation farming is grown on crops like maize, yam, potatoes, and
cassava. Crops are grown in this land for 2 or 3 years. Then the land left
out b ecause fertilizer of the soil decreases.
Shifting cultivation is known by different names in different parts of the
world –
 Jhumming North East India
 Milpa Mexico
 Roca brazil
 Ladang Malaysia
 Ray in Vietnam.
 Nomadic Herding:
Nomadic herding is practiced in the semi -arid and arid regions of Sahara,
Central Asia and some parts of India, like Rajasthan and Jammu and
Kashmir.
In this type of farming, Herder does not grow any fodder but move from
one place to another with their animals for fodder and water, a long defined
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121 Sheep, Camel, Yak and Goats are most commonly reared. They provide
milk, meat, wool and other products to the herders and their families
ii) Nomadic Herding:
This type of farming is done on the semi -dry area and dry area. Like
central Asia, some parts of India like Rajasthan and Jammu and Kashmir.
The process of this farming is that the herdsmen move one place to
another place for feed and water, along defined routes.
The most used animals in this farming are sheep, camel, yak, and goat s.
The product of this farming is milk, meat, and other to the herdsman and
their families.
B) Commercial Farming
In this farming, crops are growing for sale in the market. The main
purpose of this farming is to do business.
It required large areas and a high level of technology.
It’s done with the high cost of tools.
Commercial farming is 3 types.
i) Commercial grain farming: -
This farming is done for grains.
This fa rming is done in the winter season.
In this farming, only a single crop can be grown at one time.
This farming spread in North America, Europe, and Asia.
These areas are populated with large farmers.
ii) Commercial mixed farming: -
This type of farming is d one for growing foods, fodders crops.
In this farming, one or more crops are grown together.
It has good rainfall and irrigation.
The crops are cared for carefully.
The crops are done almost at the same duration.
This farming is most used in Europe, easter n USA Argentina, southeast
Australia, New Zealand and South Africa.

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122 iii) Commercial plantation farming: -
This farming required a large amount of labour and large areas.
It used simple crops like tea, coffee, cotton, rubber, banana, and
sugarcane.
The pro ducts are processed in the farm itself of nearby factories.
These products do not directly go to the sale. After growing these
products, the leaves are roasted in the factories or farms. These are all tree
crops.
This farming required large transportation because the products of this
farming are transported to one area to another area.
7.6 MECHANISM OF LAND TRANSFER
7.6.1 Transfer of Property Act,1882 :
A transfer refers to a conversion of a thing from one person to another
person. Property may be defined a s anything physical or a virtual entity
owned by an individual or a group of people. A property can be
transferred from one person to another person by transferring rights, or
interest, or ownership, or possession the party can satisfy either or all the
ingredients.
The transfer of property can be made in the two following ways:
First: act of the parties;
Second: by law.
Transfer of property is defined under Section 5 of the Transfer of Property
Act, 1882 . It refers to an act done by a living person conveying property to
one or more person or by himself or by one or more living persons in the
present or the future. Living people include a company, an association, or
body of individuals whether incorporated or not.
7.6.2 Important concepts highlighted in the Act :
 Immovable property: According to the General Clauses Act,
1897 immovable property includes land, benefits arising out of the
land, things that are attached to the land. Under transfer of property,
the immovable property can be defined as all prope rty are immovable
property other than standing timber, growing crops, or grass.
 Mortgage debt: After the amendment of 1900 mortgage debt was
excluded from actionable claims.
 Instrument: According to the transfer of property Act, 1882
instrument refers to a non -testamentary instrument. It acts as evidence
of the transfer of property between living parties. According to
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123  Attested: It refers to a formal document signed by a witness. The
transferors of the property are known as the executant. The
amendment act was introduced in 1926 which mentioned that there
must be two or more witnesses who must sign the document in
presence of the exe cutant not necessarily at the same time but they
shouldn’t be the party to the transfer.
 Registered: According to the transfer of property Act, 1882 registered
refers to any property registered where the act is operative. One must
comply with various proc edures of registration.
The description of the property should be mentioned.
Avoid fraud.
Deeds should be presented by a competent person.
The property must be registered in the same territory where the registered
office is situated.
 Actionable claims: A claim to any debt, other than the debt secured
by mortgage of immovable property or by hypothecation or pledge of
movable property or to any beneficial interest in a movable property or
to any beneficial interest in movable property not in the possessi on,
either actual, or constructive possession of the claimant which the civil
courts recognize as affording grounded of relief, whether such debt or
beneficial interest be existent, accusing, conditional or contingent.
 Notice: Notice refers to knowledge of the fact. The person has
knowledge of facts about various circumstances. According to the
Transfer of Property Act, 1882 it prescribed two kinds of notices
Actual or implied notice: The person having actual knowledge about a
particular fact.
Constructiv e notice: The knowledge of the fact is obtained through
circumstances.
7.6.3 Essential elements of the Transfer of Property Act, 1882 :
 To be a living or juristic person: For a transfer of property, there
must be a transfer between living or a juristic person. .
 Transfer through Conveyance: Conveyance of property can be either
done in the present or in the future. It is necessary to ensure nothing is
transferred before the title.
 The Property must be transferable: According to Section 6 of
transfer of property Act, 1882 there are properties which cannot be
transferred:
The chance of an heir -apparent succeeding to an estate, the chance of a
relation obtaining a legacy on the death of a kinsman, or a ny other mere
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124 The mere right to re -entry for breach of a condition subsequent cannot be
transferred to anyone except the owner.
The easement right cannot be transferred.
The interest of the property res tricted in its enjoyment to the owner cannot
be transferred.
Political pensions, public office, the salary of the public officer cannot be
transferred.
The right to sue cannot be transferred.
Stipends to military, navy or the airforce, political pension ers, and civil
pensioners cannot be transferred.
No transfer cannot be made as opposed to the natural interest or if the
object or the consideration is unlawful then the transfer cannot be held
valid.
The right to future maintenance cannot be transferred .
Tenants having an untransferable right to occupancy, the farmer of an
estate in respect of which default has been made in paying revenue or
lessee of an estate under the management of the court of wards, to assign
his interest as the tenant, farmer, or l essee.
 Transfer of property must be done by a competent person: For a
valid transfer, it is necessary that the property transferred should be of
a sound mind, should not be intoxicated, must be a major or he is not a
person disqualified by law cannot en ter into a contract of transfer of
property with another person.
 The transfer should be made in a prescribed form: The transfer of
property need not be made in writing however certain property to
transfer then it must be in writing:
Sale of movable proper ty value more than a hundred rupees.
Sale of intangible must be in a written format.
All mortgages which are more than a hundred rupees should be transferred
in a written form.
The transfer of actionable claims must be in a written form.
A gift in a f orm of immovable property.
Lease of immovable property exceeding more than one year.
 The rule against perpetually: It is necessary that the property must
be transferred during the lifetime of an individual perpetuity rule
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125  Property cannot be transferred to an unborn child: A property
cannot be transferred to an unborn child necessary to consider that
while transferring the interest of the property person should be above
the age of 18 years.
 Conditional transfer of property: Under Section 25 of the transfer of
property Act, 1882, the property can be transferred complying to the
condition mentioned. If the condition becomes impossi ble, forbidden
by law, opposed to public policy, or is immoral the transfer would be
held void.
7.6.4 Kinds of transfer under the Transfer of Property Act, 1882 :
1. Sale of immovable property: There is a transfer of ownership from
the buyer to the seller in exchange for the price. Delivery of tangible
property from the seller to the buyer.
2. Mortgage of immovable property: The property gets transferred
from the buyer to the seller in the form of a mortgage where the
immovable property is mortgaged to secure a loan. The mortgagor has
to pay the principal loan along with the interest to release the
immovable property from the mortgage.
3. Leases of immovable property: The possession of the property is
being transferred from one person to another person for a fixed price in
this scenario there is no transfer of ownership.
4. Exchange of immovable property: When two persons mutually
decide to transfer immovable property it would be referred to as an
exchange of property.
5. Gift of immovable property: According to the t ransfer of property
Act, 1882, gift refers to a transfer of movable or immovable property
violently or without the consideration, by one person that is donee, to
donor transfer is accepted by and on
7.7 LEASE MARKET
Historically, ownership rights over la nd resources in India had been
severely limited. Different regions followed different proprietorship and
revenue collection models. On the whole, a few people flourished at the
cost of many, characterizing the unjust nature of these systems.India
inherited such a flawed framework of land rights upon its independence.
The monopolistic control of a few over land resources seemed untenable
in an independent India. Consequently, in the decades following
independence in 1947, most provinces and states adopted la nd reforms to
reduce the gross inequity in the distribution and management of land
resources.
Among the many land reform measures initiated, tenancy reforms had the
potential for the greatest positive impact on the living conditions of the
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126 the process of land leasing (tenancy) can be understood as an agreement
between the lessor and the lessee of the land where the lessee acquires the
right to use the land from the lessor in return for a payment of a pre -agreed
rent. After independence, most states either streamlined their existing laws
or enacted new laws to regulate different aspects of land leasing.
Nevertheless, there remained significant variations in the regulatory
framework of lan d leasing among states.
Tenancy reforms aimed to provide security of tenure and safeguard the
vulnerable communities (Scheduled Tribes and Scheduled Castes) from
being unfairly treated by the landholding community. To achieve this goal,
tenancy laws impose d strong to severe restrictions on various aspects of
land leasing. Restrictions varied regarding the class of people who were
permitted to lease out their land, the procedure, and limitations on the
resumption of the leased -out land; the incidence of the burden of
acquisition of ownership rights; and the rate and mode of interest
permissible, among others. However, the restrictive nature of land leasing
regulations proved counterproductive. Ironically, the land leasing
regulation created such skewed incent ives that it led to further
informalization of the rural economy.
The tenants faced strict scrutiny over formal leasing as landlords feared
the loss of ownership rights through the application of the principle of
adverse possession. The concept of deemed o wnership is common in most
of the agricultural land leasing laws. Under the provisions of deemed
ownership, near -ownership rights are conferred on persons who are
agricultural tenants as of a particular date. This provision, coupled with
provisions that re stricted leasing out agricultural land, created extremely
adverse incentives against leasing out land and the formalization of
tenancies. In fact, a 2016 survey by the National Bank for Agricultural and
Rural Development found that only 2 percent of the su rveyed households
reported to have leased out land, while about 12 percent of the households
reported to have leased in land.
An ideal land leasing framework should incentivize formal land leasing
while protecting the interests of both the landowners and t he tenants.
Speedy contract enforcement at the least cost with respect to finance and
time is a must for the efficient functioning of land leasing markets. Given
the wide prevalence of absentee landlordism in India, vesting of
ownership rights through the principle of adverse possession is a grave
concern for landowners, and the law must have relevant checks and
balances to ensure its minimal misuse by the tenant class.
Land leasing remained an idle subject for a long time, but with a push for
a capital -intensive model of agriculture, increasing economic growth,
changes in the rural economy, and urbanization, land leasing has gained
renewed prominence in the land governance activity.
A lease by definition is the transfer of possession and use of a physical
asset for a time less than its expected useful life in return for economic
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127 have many similar features, including having a duration less than the
useful life of the asset and transferring the residual rights associated with
the asset to the renter. However, technically they are quite different; rental
refers to the short -term rights to use assets and is not regarded as
transferring possession of the asset to the renter, but instead conveys only
a temporary license. Leasing is an instrument of investment finance
through which the legal ownership of the good is dissociated from its
economic ownership.
Lease performs an essential economic function of allowing a person or
legal entity to acquir e an asset at lower cost than what they would have to
pay to own the asset .A rural lease according to de Almeida and Buainain
is “an agrarian contract by which a person (lessor) is bound to allow
another (lessee), for a fixed or undetermined period of tim e, the use of
land or rural property, part or parts thereof, including or excluding other
goods, improvements made and/or facilities, in order to exercise farming,
cattle raising, agro -industrial, extractive or a combination of activities, via
compensation or rent. The lessor takes back possession of the land or rural
property after the lease expires while the lessee is entitled to use the land
or rural property free of interference from the lessor during the lease
provided the lessee pays the rent and perf orms the other obligations of the
lease .Specifically, in the case of land, the lease agreement, which may be
written or oral, transfers parts of the bundle of property rights from the
landowner to the tenant in exchange for either a fixed rental payment
every period (a fixed rent contract) or a predetermined share of the output
(share -cropping contract) .
Land leasing contracts are regulated by a lease agreement which sets out
the obligations of the parties involved during the period of the lease and so
provides useful legal protection to everyone concerned .The legally
required elements are usually minimal which allows the parties greater
flexibility in structuring the other aspects of their relationship using
specific lease provisions tailored to their in dividual needs and
circumstances .
The leasing is undertaken under a different set of conditions and level of
protection for the lessee with different combinations of three groups of
rights —user rights, occupancy rights, and owner rights .
Land leasing is an important tool for economic development and its
growing use can be explained by its effects on generating liquidity,
releasing equity capital and improving accounting ratios .
From a rural development point of view, land leasing performs social
functi ons by enabling people who do not own land or possess only limited
capital and income to access it, thereby providing conditions for
entrepreneurship in the field of agriculture. For the lessee, the leasing of
land serves as a medium to obtain income from farming without having to
commit a lot of money to the purchase of land. Whereas, for the lessor,
land lease serves as a great opportunity to obtain incomes without
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128 Land leasing also functions to minimise the risk of owning land, by
transferring the residual rights from the owner to the lessee for the
duration of the lease, allowing the lessee to try out the use of the land
without having to purchase the land with debt financing . With this, both
the lessor and the lessee bear less r isk than if they held the land alone.
Reducing risk is a benefit, for which the party who achieves the greatest
reduction in risk will have to compensate the other. Leases provide a ready
mechanism to do this through adjustments in rent.
Leasing land also comes with greater managerial flexibility, while meeting
environmental restrictions, off -farm work obligations and can
accommodate different forms of contracts. The flexibility allows it to
serve as an important means of developing the required economies o f
scale for modern agriculture. For example, Some studies among dairy
farmers in Ireland showed that those farmers who rent land have higher
outputs and are more profitable compared to those farmers who do not rent
land. Some studies also showed that farm ers with a higher proportion of
rented land are more productive, are more prone to invest in machinery
and use more variable inputs than farmers who only farmed their owned
land. Similarly also found that farms in Sweden with more leased land
produced food more intensively compared to farms with a greater portion
of owned land. In these studies, it is argued that the direct costs incurred in
the form of land rentals creates stronger incentives for the farmers who
rent land to work on the land more intensive ly, relative to the opportunity
costs borne by owned fields. Similar conclusions were also reached by .
The choice of contract duration is an important component of contract
design in agricultural land leases. According to some studies long-term
land leas es are chosen when the costs of transferring tenant assets attached
to the land are high, or if the depreciation of assets beyond the contract
period are difficult to assess and therefore difficult to price for transfer to
the landowner. On the other hand, short -term contracts reduce the costs of
enforcing contract stipulations and the costs of renegotiation or tenant
dismissal in the face of market uncertainties, poor tenant performance, or
disputes over poorly defined rights to assets. When the tenant’s l and-
specific assets are exhausted within the contract period or if the landowner
provides the land -specific permanent assets, then short -term contracts
become Land more viable]. However, it is often not the case that land -
specific assets are exhausted with in the contract period in modern
agricultural production systems, particularly in developed countries where
agricultural production requires the use of cutting -edge capital equipment
and land management techniques to ensure increased productivity and the
sustainable management of land. Fixed inputs used in agricultural
production are provided directly by either the landowner or tenant and are
often not readily shared. The extent to which the tenant or landowner
becomes the residual claimant of the input pro ductivity depends on the
length of the lease term ,in particular, if the productive life of the inputs
extends beyond the contract period and if the post -contract transfer of
asset rights is difficult .The incentives of tenants to provide durable site -
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129 of being able to appropriate future . For instance, maintaining soil fertility
to increase production requir es investment in land management in the
form of applying appropriate levels of fertilizer, but the effect of such an
investment goes beyond the period in which the investment is undertaken.
Tenants will choose the optimal level of investment if they antici pate that
they will benefit from increased productivity in the future. Incentives to
invest in land improvement can be provided by establishing contracts that
are long enough to allow tenants to benefit from future potential
productivity gains .
Land leasi ng is a commercial agreement in which the user or lesse
acquires the right to use the land in lieu of certain amount of payment.
Agriculture land leasing at present in India can be classified into following
categories:
• Kerala and J&K have complete ban ov er leasing.
• In Uttar Pradsh, Himachal Pradesh, Bihar etc. land leasing is allowed in
certain cases like where owner is widowed women, children, defence
personnel etc.
• Punjab, Haryana, Gujarat, Maharasthra and Assam the tenant gets the
right to purchase leased land after a certain period.
• In Tamilnadu, Rajasthan and West Bengal liberlised land lease exist.
As a result of this the land leasing activity is very less in India or if exists
it is underground or unregulated. Therefore there is a need for ref orm in
land leasing.
Why there is need for reform in land leasing in India ?
India's march on the path of inclusive, sustainable and faster growth needs
disentangling from some legacy issues. Land leasing is one such area
which needs reforms. There are var ious factors which favor this and some
of them are:
• Fragmented landholdings: The average landholding size in India is 2.8
acres. The miniscule returns farmers get from this small landholding
prevents mechanization and investments in agriculture and its
profitability.
• Low investment in agriculture: In the fear of losing land and in the
absence of long term tenancy laws the agriculture land lease are limited
to one year. The tenant is not sure of regaining tenancy next year.
Therefore there is no incentiv e for capital investment in agriculture.
• Changes in the occupational structure in rural areas and increasing
cases of fallow land: Occupational structure in India has gone
significant changes and there has been migration from rural areas to
urban areas. This has resulted into the emergence of informal and
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130 • Providing benefits to tenants: The presence of informal tenancy puts
tenants at the risk of exploitation because of no legal security and high
rents. Along with these risks the tenants didn't get benefits of various
government initiatives related to credit, insurance and subsidies like
Kisan Credit Card, fertilizer subsidy.
• Problems of land acquisition: With the passage of new land acq uisition
law in 2013, the process has been more comprehensive and lengthy. The
cost of acquisition has also increased. This creates an opportunity and
necessity for exploring long term lease as the option for
industrialization. This will reduce farmer's un rest and may solve the
associated problems of loss of means of livelihood etc.
What will be the benefits?
• Benefits in the form of enhanced investments, economies of scale in use
of capital, machines and other inputs.
• Enhanced social mobility as non far mland owning groups or castes can
benefit by taking land on lease can generate more income. Those with
small landholding can lease out their lands and migrate to other
occupations and therefore will reduce the burden on agriculture land.
• Will help corpor ate farming under which corporates can take large
chunks of land on lease and do cultivation. This will completely
professionalize the agriculture activity.
• Benefits to industries in the form of reduced costs of land acquisition.
They can take land on le ase and after certain period of time lease
agreement can again be negotiated. This will also reduce farmer's unrest
who agitate against loss of land titles.
What are the concerns?
• Future government led redistribution in the favour of tenants as was done
after independence.
• Will prevent redistribution of land through transfer ownership as people
living outside the area will prefer leasing instead of selling. Otherwise
land distribution through selling was an important means of
redistribution and consoli dation of land. Land leasing will promote
absentee landlords.
• It may led to situation where individuals with big pockets will control
agriculture by taking large chunks of land on lease.
What else is needed?
Land leasing alone is not the solution to the problems faced by agriculture.
This has to be complemented by a number of other steps which are:
• Modernization and digitization of land records so that each and every
owner has proper titles of his land. This will also reduce litigation
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131 • Established of independent regulator for the sector to resolve the disputes
legalization and operationalisation of land leasing will bring in people
who will take lease at large scales. The standardization of lease
agreements and dispute reso lution mechanisms should be developed.
Otherwise litigations will clog the already burdened courts.
• Modernization of the agriculture marketing so that informed decisions
regarding leasing can be made so that informed lease agreement are
concluded with pr oper knowledge of future market rates.
• Enhancing credit and insurance facilities for agriculture
• Providing improved technical inputs in the form of soil health card,
laboratory facilities etc.
• Transformation of agriculture as a business - cum - livelihood activity so
that investments are planned based on long term strategies and hedged
from market and environmental risks.
• Proper awareness and education among the rural folk about the benefits
that land leasing can bring to their household income and life. They must
be taught about the benefits of land leasing.
Overall land leasing will be of great help to Indian agriculture which is
reeling under stress because of continuous droughts and neglect by
governments.
Recently government has formed the ‘Haqu e committee’ to frame model
land leasing act and many states have requested government for
prospective implementation of tenancy laws so that existing tenants are
not affected.
7.8 MODEL AGRICULTURE LAND LEASING ACT 2016
7.8.1 Background :
The fear of losi ng right, title and ownership over one’s own land by
leasing out, discourages the land owners even when they are themselves
unable to cultivate to lease out their parcels of land. This is the cause
behind substantive extent of land remaining fallow. The St ate Revenue
laws provide for right to ownership by proving adverse possession for a
certain period as prescribed by the actual tiller. The census 2011 reveals,
that the extent of lease in the country is around 6 per cent. In the absence
of a legal provisio n back -stopping such leasing, most of it is oral and
therefore does not entitle the lessee to claim the status of a farmer and
access various benefits available from the government and credit
institutions.
It is further known, that a lot of land remains fa llow for many do not opt to
offer their piece of land on oral lease. It is, therefore, necessary that lease
is legally recognised by enacting a suitable law. However, it should
explicitly and emphatically protect the interests of the land owner, in
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132 The Model Land Lease Act, 2016 prepared and approved by the NITI
Aayog offers an appropriate template for the states and UTs to draft their
own piece of legislations, in consonance with the local re quirements and
adopt an enabling Act.
7.8.2 Statement of Objects and Reasons :
An Act to permit and facilitate leasing of agricultural land, to improve
agricultural efficiency and equity, access to land by the landless and semi -
landless poor, marginal fa rmers, occupational diversity and for accelerated
rural growth and transformation; provide recognition to farmers
cultivating agricultural land on lease for enabling them to access loans
through credit institutions, insurance, disaster relief and other sup port
services provided by Government, while protecting fully the land rights of
the owners; and matters connected therewith or incidental thereto. It also
provides for recognition of farmers cultivating on leased land to enable
them to access loans through institutional credit.
Whereas, the prohibitions and restrictions under existing state laws
governing agricultural land leasing forced the landowners and lessee
cultivators to have informal agreements only for cultivating the land and
thereby depriving the lessee cultivators of the benefits which are normally
due to them, the existing laws also create insecurity among landowners to
lease - out agricultural land which reduces the access to land by the
landless poor, small and marginal farmers and others by w ay of leasing.
7.8.3 Main Features of Act :
1. Legalise land leasing to promote agricultural efficiency, equity and
power reduction. This will also help in much needed productivity
improvement in agriculture as well as occupational mobility of the
people and rapid rural change.
2. This is very important step for land reforms through which needs of
landlord as well as lease holder have been taken care.
3. Through this act, the landlord can legally lease the land with mutual
consent for agriculture and allied activiti es. In this act, it has been
taken care that in any circumstances the leased holders' claim on land
will not be valid.
4. Lease holder may receive institutional loan, insurance and disaster
relief so that he may invest more and more in agriculture.
5. Allow auto matic resumption of land after the agreed lease period
without requiring any minimum area of land to be left with the tenant
even after termination of tenancy, as laws of some states require.
6. Incentivise tenants to make investment in land improvement and a lso
entitle them to get back the unused value of investment at the time of
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133 7. In order to resolve the dispute between the landlord and lease holder,
the provision of “Special Land Tribunal” has been made in the Civil
Court.
7.8.4 Chall enges Associated with the Model land Leasing Act, 2016 :
1. Absence of tamper -proof land records: The biggest challenge to the
Model Land Leasing Act is the lack of tamper -proof land records with
the revenue department. This is one of the reasons why landowne rs
fear leasing out their farms.

2. Diversion of land from crop cultivation to commercial use: Model
Land Leasing agreement Act (2016) may encourage the diversion of
agricultural land from crop cultivation to commercial use because it
allows leasing of agric ultural land for activities like animal husbandry,
plantation crops etc.in addition to crop cultivation.

3. Absentee Landlordism: Model land leasing act will prevent
redistribution of land through transfer ownership as people living
outside the area will pre fer leasing instead of selling.Otherwise, land
distribution through selling was an important means of redistribution
and consolidation of land. Land leasing will promote absentee
landlords.

4. Lack of Uniformity: Since agriculture is a state subject, the dis parity
and abundance of laws create confusion, and lack of uniformity, which
may prevent the formation of a healthy leasing ecosystem.

5. The act is also silent on whether a land already under lease agreement
can be mortgaged or not, keeping in view that the lessee might be
interested in availing crop loans or term loans in case of allied
activities.

6. Exploitation of small and marginal farmers: The model Land
Leasing Act doesn’t specify the rent on leased land and the period of
lease and has rightly left it to the concerned parties in the land lease
market which could lead to exploitation of small and marginal farmers.

7. Food security: Leasing out land to activities other than agriculture
might endanger the food security of the country in the long run.
7.8.5 Measures to be taken to protect the interest of small and
marginal farmers
It has been noted that an estimated 36% of India’s tenant farmers were
completely landless, around 86% owned less than two hectare and 56%
owned less than one hectare of land. Theref ore, the small and marginal
farmers deserve special attention.
 The strict restrictions must be removed from the Act so that small and
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134  Proper awareness and education among the farmers about the benefits
that land leasing can bring to their household income and life.

o They must be taught about the benefits of land leasing and also about
the rules and regulations so that they are not fooled by industrialists
and large landowners.

 Since most of the small and marginal farmers are dependent on cattle,
the grazing lands must not be leased out in the name of fallow land.
 Farmer activists have strongly advocated that agricultural land must
not be used for industrial purposes.
o Moreover, agricultural la nd should not be given to corporate houses in
the name of poor farmers. There should be a viable ceiling on land to
be given on lease and it should also be given to landless, agriculture
labourers or unemployed youths at the household level.
7.8.6 Conclusi on
Overall, the Model land leasing Act if implemented properly in the right
spirit will be of great help to Indian agriculture which is reeling under
stress because of lack of agricultural efficiency and productivity.
7.9 FORMAL VS. INFORMAL LEASE EXTENSIO NS
There are two routes a leaseholder can take to extend their residential
lease. Each route has it's own advantages and disadvantages, but the
general consensus is that the formal (statutory route) is the preferred
option. However this is not always the c ase, as the best route for each
scenario is very subjective.

7.9.1 Differences Between Formal and Informal Lease Extensions
With formal lease extensions , the leaseholder serves a notice on the
landlord putting forward an offer to extend their lease by th e statutory 90
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135 tenant reach an agreement on the premium (amount payable to the
landlord).
With informal lease extensions , the leaseholder normally approaches the
landlord on an infor mal basis and agrees a premium without serving a
statutory notice. The agreed terms usually differ in that the number of
added years is less (than +90) and commonly the ground rent remains, or
even increases.
7.9.2 Formal Lease Extension Advantages
 You are guaranteed +90 years and no further ground rent.
 The agreed premium is usually better value for money
 The term remaining on the lease is 'frozen' immediately upon
commencing the formal route, meaning that the premium no longer
increases as the term decrea ses. Each day counts.
 A landlord may insist only on proceeding with a formal statutory
notice.
7.9.3 Informal Lease Extension Advantages
 You are not required to own the property for at least two years.
 Legal fees will be slightly cheaper (albeit only the c ost of serving a
section 42 notice - £220 on average)
 If a formal lease extension is unaffordable then accepting a lower
additional term (for example +40 years rather than +90) and keeping
the ground rent in place, will result in a lower premium. However
there's a catch - the lease will need to be extended again sooner - the
lower premium won't usually make up for this, nor continued ground
rent payments.
 When approaching a landlord on an informal basis - the most likely
scenario is that the landlord will r equest a payment to cover
admintistration and valuation costs to enable the landlord to instruct a
professional to calculate the premiumm. It is highly likely that the
landlord's offered premium will be substantially inflated, resulting in
the leaseholder having no alternative but to commence the formal
route from scratch.
7.9.4 Which Route Is Best?
If you have owned the property for a period of at least two years, we
strongly recommend that you commence matters through the formal
route . Always instruct a p rofessional to carry out a valuation and serve the
notice. Once you have commenced the formal route, it is still possible to
reach an informal agreement (deviating from the standard +90 years and
nil ground rent) at any stage of the process. By serving the notice, munotes.in

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136 If you have not owned the property for at least two years AND the
remaining term is less than 82 years - the informal approach would be
preferable.
7.10 QUESTIONS
Q1. What the meaning of Land? What are the features of Land?
Q2. Explain the variou s types of farming.
Q3. Explain the ‘Transfer of Property Act, 2016’.
Q4. Explain the ‘Model Agriculture Land Leasing Act, 2016’.
Q5.What is the meaning and advantages of formal lease extension?
Q6. What is the meaning and advantages of informal lease ex tension?




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137 8
LAND AND LEASE MARKETS - II
Unit Structure
8.0 Objectives
8.1 Share Tenancy
8.2 Sharecropping/Crop sharing in Indian Economy
8.3 Inequity in distribution of holding .
8.4 Inter-Locking of Indian Agricultural Market
8.5 Interlocked/Interlinked Factor Market in Agrarian Sector
8.6 Analysis of Rural Classes
8.7 Contract Farming
8.8 Questions
8.9 References
8.0 OBJECTIVES
After studying this units you will be able to –
 Understand the meaning of Share tenancy.
 Understand inequity in distribution of h olding.
 Understand the concept of crop sharing in Indian Economy.
 Understand the interlocking of Indian Agriculture Market.
 Know the concept of contract farming.
8.1 SHARE TENANCY
Share ten ancy as used in this Code means the relationship which exists
whenever two persons agree on a joint undertaking for agricultural
production wherein one party furnishes the land and the other his labor,
with either or both contributing any one or several o f the items of
production, the tenant cultivating the land personally with the aid of labor
available from members of his immediate farm household, and the
produce thereof to be divided between the landholder and the tenant.There
are mainly two types of te nant system which are commonly used by the
landowner and the farmersin south and south -east Asian countries. They
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138 Lease Tenancy:
A contract where farmers pay a fixed rent to the own er of the land for a
particular peri od of time. The output is not shared by the land owner and
neither the inputs.Example: 250 USD per hectare of rice field for one year
period of time.
Share Tenancy:
A contract where output is shared with no corresponding sharing of all
inputs,i.e., the sh are in appropriation is different from the share in
provision of some of the inputs(purchased inputs are usually shared
through profit sharing). Example: 35% of rice will be taken by the
landowner whereas farmer will get 65% of the total rice production.
Share Tenancy has more advantage in terms of agricultural
development over the Lease Tenancy . In share tenancy, the output
or the profit is shared by both the landowner and the tenant in a certain
proportion. Thus if there is any uncertainty or natural cal amities (like
flood, cyclone, typhoon etc.) hampers the production, the total loss is
covered by both the parties. Which release the pressure on the farmers
shoulder to some extent. On the other hand, under the lease tenancy the
landowner does not share an y loss of the production. So, the total losses
are born by the farmers if some uncertainties happen in production. Small
and resource poor farmers are always risk averse. Thus, they try to
avoid the risk and uncertainty. Under share tenancy system small an d poor
farmer can share the risk of crop failure and so, this system is better over
the lease tenant system for the poor and marginal farmers.
There are some arguments that “Share Tenancy is inefficient.” But Keijiro
Otsuka And Hayamishowed in his “Theori es of Share Tenancy: A critical
Survey” that Share Tenancy is efficient if the landowner bear the
transaction cost. By transaction cost he mentioned about the monitoring
and supervision.
Share tenancy improves the overall efficiency of the farm and thus th e
productivity. Tenants are better supervisors; landowners are better
managers. Thus, under the share tenancy both the landowner and the
farmers give equal attention (supervision and management) where asunder
the lease tenancy only the tenant gives his sup ervision to the production.
But due to lack of adequate management, farm reduces the efficiency.
Imperfect Labour Markets also support the Share Tenancy over the lease
tenancy.
Landowners can’t always find sufficient labour at bottleneck periods
whereas Te nants can’t always find work when they want it.
Share cropping resolves both of these issues by providing sufficient labour
to the landowner and by managing work for the farmers when they want
it.A recent study in Bangladesh (Mahmuda Nasrin and M Taj Uddi n,
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139 Tenant farmers but this picture is true only forthe high value crops (e.g.
hybrid rice, Banana, Pineapple etc.). For the other crops (non -highvalue
crops) farmers still prefer the share tenancy system. From the above
arguments we can say that Share Tenancy is better than the Lease Tenancy
for the overall agricultural development.
The Theory of Share Tenancy by Steven Cheung, first published as a PhD
thesis 50 years ago, was an impor tant watershed study on the economics
of contracts. It contained the first formal demonstration of the Coase
Theorem, linked the concepts of property rights and transaction costs, laid
early foundations for the future economics of contracts, and can even l ay
claim to originating the idea of a risk/incentive trade off in contract
design. This essay examines Cheung’s key contributions in Share
Tenancy, and considers reasons for its somewhat limited legacy outside of
China.
In 1967, Ng -Sheong Cheung defended h is thesis at UCLA entitled The
Theory of Share Tenancy — with Special Application to the First Phase of
Taiwan Land Reform. The thesis’ one chapter was also called “The
Theory of Share Tenancy,” and contained all of the key theoretical
insights of the thes is. Cheung said that his interest in share tenancy started
from reading the literature on Taiwanese land reforms, and that he did not
originally think of working on something so broadly applicable.
Major Insights in “The Theory of Share Tenancy”
Although S hare Tenancy was a study of agricultural contracting, its key
theoretical and methodological insights are much broader. Cheung
carefully modelled a share contract under the assumption of “zero
contracting costs,” “private property,” and “free markets.” He considered
the problem from the landowner’s point of view, rather than the tenant (as
was traditionally done). He also — and this was critical — considered the
share tenancy arrangement as a contract subject to constraints; share
tenancy in Cheung’s eyes w as not an exogenous cultural tradition.
Cheung recognized that a share tenancy contract had several key terms:
the share percent, the size of the land plot, and the amount of non -land
inputs; and these terms were also constrained by the alternative earning s
of the tenant and the market rental value of the land. Given the assumption
of wealth maximization, the terms were simultaneously chosen and
mutually agreed upon to maximize the joint wealth of the parties. Under
these conditions, Cheung showed that in e quilibrium the use of resources
was identical to all forms of private ownership: owner -operator farming,
cash renting, or wage farming. Competition among landowners and
farmers meant that each asset owner must receive their competitive rent in
all contract forms, and this forced the optimal contract choice — otherwise
losses would accrue to some party in the share tenancy arrangement.
Cheung showed that when contracts are modelled correctly and when
there were no transaction costs, the allocation of resourc es was driven by
the assumption of wealth maximization, and the contract terms adjust to
make certain that this outcome was achieved. As a result, the inputs used, munotes.in

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140 the crop output, and the distribution of asset earnings were identical across
different type s of contracts. The crop share contract provides exactly the
same outcome as a cash rent or wage contract.
Cheung’s survey of the share cropping literature prior to 1960 stands alone
for its thoroughness, and quite understandably no one has ever produced a
second survey of this early literature on crop sharing. Cheung notes that
since Adam Smith the general treatment was to consider the share as
equivalent to an ad valorem tax. Such a “tax equivalence” approach,
however, ignored the contractual reality of t he tenancy arrangement. It
constrained the economist to not consider that land or other inputs could
be adjusted in response to changes in the rental share; that the share was
determined endogenously by contracting parties; and that there were
competitive pressures to maximize the wealth of the parties involved in
the lease. Such an approach could only lead to a false conclusion: namely,
that sharing was inefficient because tenant effort was suboptimal.
The tax equivalence approach had a number of implicati ons. First, it
implied that share tenants earned rents — returns above their opportunity
costs — and therefore they should have competed to work on such farms.
Second, land operated under share tenancy should have used smaller labor
to land ratios compared to owner -operated or cash -rented land. Third, if
the land was constrained under sharing, the land rents and land values
should be lower for shared land. Finally, over time, inefficient sharing
should die out as a practice/custom.
Cheung took care to point out the implications of the traditional tax
approach. Furthermore, he highlighted a number of findings from China
and Taiwan that suggested the traditional approach was wrong. He also
wisely noted that sharing had not gone anywhere, and in fact, it existe d in
“retail stores, beauty salons, gasoline stations, amusement park rentals,
and even the much -regulated oil and fishery industries”. He gave the idea
that share tenancy was a type of contract.
From beginning to end there was a powerful methodological po int made
throughout The Theory of Share Tenancy. If wealth maximizing
landowners got together with wealth maximizing tenant farmers, and
contracted over various terms in order that the tenant farmer might use the
owner’s land, then the contractual outcome and subsequent resource
allocation must be wealth maximizing — as a matter of logic.
Cheung argued that any constrained equilibrium must be efficient, and
therefore, efficiency was a redundant term lacking any sort of normative
or welfare content. To say t hat an outcome was efficient, was only to say
that the individuals maximized. The most important idea found in The
Theory of Share Tenancy was also the most subtle: the relationship
between property rights and transaction costs. Although it would take
another twenty years before all of the details would be worked out,
Cheung pioneered bringing the concepts of transaction costs and property
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141 In the 1967 thesis, the term “transaction cost” appears eight time s. The
term was never explicitly defined, and in only three instances can a
meaning be implied. Consider the following two examples: Eg.1[share
contracting] obviously involves a higher transaction (contracting) cost for
the landowner to enforce a share con tract than a ground rent contract:
stipulations are in greater detail, and efforts must be made to investigate
agricultural output so as to guard against fraud by the tenant ... Eg.2it
seems that in general the transaction cost of a wage contract is also h igher
than a ground rent contract due to the cost of labor management. In both
of these cases Cheung clearly understood that transaction costs result from
enforcing and maintaining property rights. In the first case the landowner
must enforce rights over t he rent, and must monitor the incentive of the
tenant to underreport the crop. In the second case, a landowner has to
manage workers to prevent shirking, a type of theft.
Cheung’s Theory of Share Tenancy —different explanation
• The agricultural landown er can organise production in a number
of ways:
• For small plots they depend on family labour especially where
the Joint Family system exists and where the labour market cost
is high.
• Alternatively they could function by hiring workers at fixed
wage rates and function as capitalist farmers or owner cultivators
• In both these cases landowners also act as entrepreneurs
• If they do not wish to take this responsibility they could go in
for diff erent tenurial arrangements - the best known ones being
fixed rent tenancy and share tenancy.
• Under Fixed rent tenancy the tenants take charge of cultivating
the land and pay the landlord a fixed amount in each period
• In ca se of share tenancy the tenant pays the landlord a fixed
proportion of the output.
• Many economists have criticised share tenancy however it
continues to exist.
Y

P
PRODUCTS
WAGE B
W C
A
O L 1 L2 X
LABOUR
Figure No. 8.1 munotes.in

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142 • In the diagra m we assume that a landlord gives a plot of land to the
tenant on the agreement that the tenant gives the landlord a fraction of the
total output in each year as rent. Labour is the only Factor of Production.
MP shows the Marginal Product of Labour and EM shows the Marginal
Earnings Curve. The tenant cannot lease in any more land. The Wage
Rate is represented by OW. The tenant uses OL/ units of Labour. The
Total Income of the Tenant will be OEAL/.The Landlord gets a Rent of
PEAB. Now, if the te nant had sold OL/ units of Labour in the Labour
market he would have earned OWAL/. Hence the Tenant’s net income is
EAW. As long as net incomeis positive it is worthwhile for the tenant to
be a share tenant. If the Landlord had acted as an owner operator and
directly hired labour in the labour market and if he had employed OL*
units of labour he would make a profit of PWC which is higher than the
rent he earned earlier. The Total Production of the economy would be
more and there would be better utilisatio n of inputs. Therefore, Marshall
and Adam Smith have criticised Cheung’s Theory of Share Tenancy
stating that it results in sub -optimal use of inputs.
Y
P
E
WAGE
PROD UCT W A C
B
O X
L M
LABOUR
Figure No. 8.2
Equilibrium is reached where (1 -r) x L = wLi.e. OE*DL*= OWCL*This
implies that E*WA = ACD. The landlord’s income under share tenancy is
PE*DCand if he was an ownercultivator using hired labour it woul d be
PWC.Thus, income is the same whether he goes in for share tenancyor
using hired labour. In the case of Labour and Tenant also it is the
same whether he goes in for share tenancy or hires out his labour.
Share Cropping is poss ible when the tenant earns more through
share tenancy than by hiring out his labour. Moreover, it is attractive
if production risk exists. In case of share tenancy there is limited
liability compared to fixed rent where th e liability is totally on the
tenant. Moreover, if the landlord uses hired labour he has to bear the
total liability while in the case of share tenancy he would have
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143 8.2. SHARECROPPING/CROP SHARING IN INDIAN
ECONOMY
Sharecropping is a form of land tenancy, in which the landowner permits
the tenant to use his land in return for a stipulated fraction of the output
(the ‘share’). It is an institutional arrangement which has prevailed in both
developing countries and less -developed countries [LD(s)]. No doubt,
sharecropping is most commonly found in LDCs.
Sharecropping is a legal arrangement with regard to agricultural land in
which a landowner allows a tenant to use the land in return for a shar e of
the crops produced on that land.
Sharecropping has a long history and there are a wide range of different
situations and types of agreements that have used a form of the system.
Some are governed by tradition, and others by law.
Sharecropping has bene fits and costs for both the owners and the tenant.
Under a sharecropping system, the landowner provided a share of land to
be worked by the sharecropper, and usually provided other necessities
such as housing, tools, seed, or working animals . Local merchants usually
provided food and other supplies to the sharecropper on credit. In
exchange for the land and supplies, the cropper would pay the owner a
share of the crop at the end of the season, typically one -half to two -thirds.
The cropper used his share to pay off his debt to the merchant. If there was
any cash left over, the cropper kept it —but if his share came to less than
what he owed, he remained in debt.
Farmers who farmed l and belonging to others but owned their own mule
and plow were called tenant farmers ; they owed the landowner a smaller
share of their crops, as the landowner did not have to prov ide them with as
much in the way of supplies.
In this system, the landowner encourages the cropper to remain on the
land, solving the harvest rush problem. Since the cropper pays in shares or
portions of his harvest, owners and croppers both share the risk s and
benefits of harvests being large or small and of prices being high or low.
Because both parties benefit from larger harvests, tenants have an
incentive to work harder and invest in better methods than, for example, in
a slave plantation system.
8.2.1 A Progmatic Compromise:
It may apparently seem that, since, under sharecropping, a certain portion
of output has to be surrendered to the landowner; there is loss of
incent ives to invest. However, a close look reveals that it has certain
advantages which have not been offered by tenant farming. Sharecropping
seeks to achieve a compromise between peasant proprietorship and tenant
farming.
Sharecropping is an institutional arr angement designed both to share risks
and to provide incentives, in a situation when monitoring effort (labour munotes.in

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144 supply) is costly. Sharecropping represents a compromise. While rental
contracts provide (in the absence of bankruptcy) perfect incentives (since
the sharecropper is able to retain all of his VMP L), it provides no risk -
sharing. On the other hand, wage contracts shift all of the risk on to
landlords, who are in the best position to bear.
In truth, the sharecropping contract has certain optimality pr operties: the
contract seeks to maximise the welfare of the worker, subject to the
landlord obtaining a particular value of expected rents from his land. Even
the inefficiency associated with the worker receiving less than the value of
his marginal product may be mitigated with long -term contracts; workers
who fail to produce a sufficiently high level of output over an extended
period of time run the risk of termination of their contract.
8.2.2 Mainly for this reason we find the persistence of sharecropping ,
mainly in LDCs. Some of its important features are:
1. Cost Sharing:
The landowner has an incentive to encourage the tenant to use inputs such
as fertilizer) which raise the workers’ marginal product, and which,
therefore, result in the workers putting e xtra effort (i.e., working hard).
This explains why the landlord might bear a fraction of the costs of inputs
that exceed the fraction of the output that he receives. This is he principal -
agent view of sharecropping.
2. Positive Externalities:
Important ex ternalities might arise between land markets and credit
markets. These externalities can explain the interlinking between credit
and land markets that is frequently observed in LDCs (i.e., the landowner
is also a money -lender).
An increase in the amount of outstanding debt affect both workers’ efforts
and their choice of technique (risk). These, in truth affect the return to the
landowner. Conversely, a change in the terms of the sharecropping
contract will in general, affect the probability of default, and the return to
the lender.
8.2.3 Current View of Sharecropping:
The current view is that sharecropping may not have the optimality
properties associated with the ‘principal -agent’ view. Firstly, though the
contracts are ‘locally efficient’ (that is they ma ximise the expected utility
of the worker, given the expected rents to be received by the landlords),
they are not ‘general equilibrium efficient’, that is, there exist, in general
taxes and subsidies which could lead to Pareto improvements.
Secondly, shar ecropping is likely to have a deleterious effect on the level
of production A sharecropping contract with a 50% share has the same
effects as that of a 50% tax on output Such a tax is likely to reduce output
significantly unless the labour supply curve is backward bending (in which
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145 tax-induced income fall). In such a situation, land reform in which
workers receive the land which they formally cultivated as sharecroppers,
may incre ase agricultural productivity significantly.
The sharecropping relationship may take a variety of forms. Some
contractual forms may affect the adoption of innovations. In truth,
innovations which increase output (at any level of input of labour), but
which decrease the marginal product of labour (and, hence, reduce
workers’ incentives to work), will be resisted by landlords who may
impose restrictions on the use of such technologies. But these innovations
will, at the same time, reduce agricultural producti vity.
8.2.4 Hanumantha Rao provides the following rational of share
cropping in India:
“Owing to the continued pressure of population on limited land resources,
tenancy has persisted through in formal contracts. Because of the ceiling
on-land holdings, sub -division and persisting pressure on land as a source
of livelihood, there has been an increase in the operated area -owned as
well as leased in -held by the small and marginal family. Moreover, with
the widespread adop tion of non -technology and rise in inp ut intensity, the
incentives for investment and for captur ing the returns on investment seem
to be predominating over the need for sharing yield risks leading to natural
replacement of share -cropping tenancy by the fixed crop and cash rents.”
8.2.5 Effici ency of Share -Cropping (Under Land Reforms):
According to T. Schultz, farm lease contracts are essentially institutional
devices for allocating risk among landowners and tenants. In the opinion
of Hanumantha Rao, cash rents guaranteed in advance of product ion that
the risks of production are shared entirely by the tents, while crop -sharing
rentals indicate the distribution of such risks among the tenants and the
landlords in proportion to their respective shares in output. In contrast,
fixed -kind rents sett led in advance of production imply the sharing of
price and allocate the yield risks entirely to the tenants.
Fixed cost rents are preferred by landowners where there exists a
significant scope for entrepreneurship. The reason is that such rents offer a
foretold advantage: they permit the tenants also to capture the returns
expected from their own decision -making. Such rent also protects those
who lease out their land against the possible risks arising from the
production decisions of the tenants.
Under unc ertain situations, there is limited scope for entrepreneurial
functions. In such situations there may be a requirement for the tenants to
reduce fluctuations in their in come by shifting part of their risk to the
landowners through share cropping arrangeme nts.
Thus it logically follows that in situations where the element of
uncertainty is smaller and there is hardly any role of the entrepreneur, the
landowners find it profitable to lease out a portion of land on a share -rent
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146 While referring to the inefficiency of share -cropping, Alfred Marshall
brought into focus a very important point: the rent under this system
would be lower than the fixed rent or net income from own cultivation if
the tenants were free to restrict their household income.
8.2.6 In Marshall’s view:
” When the cultivator has to give his landlord half of the returns to each
dose of capital and labour that he applied to the land, it will not be to his
interest to apply an y doses the total return to which is less than twice
enough to reward him. If, then, he is free to cultivate as he chooses … he
will apply only so much capital and labour as will give him returns more
than twice enough to repay himself; so that his landlor d will get a smaller
share even of those re turns than he would have on the plan of a fixed
payment.”
Fig. 2 illustrates this proposition with labour as a variable resource applied
to a unit of land. Under own cultivation, ∂Y/∂x = w, output from a unit of
land, say one acre, is equal to the area OXW’Y, and net income is equal to
WW’Y, which would also be t he amount under a fixed -rent contract.
Under share -cropping, where rent constitutes 50% of output, it will not be
to the advantage of the tenant to extend input beyond X’ where ∂Y/∂x =
2W, output per acre will not exceed the area OX’ YY’, and rent will no t
exceed one -half of this area or P mYY which is less than WW’Y. The share -
tenant can get addi tional income to the extent of the area W mP as
compared with what he would otherwise get as a wage -earner.

Figure No. 8.3
In Marshall’s view, share -cropping (tenancy) may be advantageous when
the holdings are very small and is not suitable for holdings large enough to
give scope to the enterprise of an able and res ponsible tenant. In 1969,
Cheung presented an interesting theory of the choice of contracts on the
basis of the ‘gains from risk dispersion.’
However, his theory suggests that share contracts can be ex pected to be
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147 than in areas of relative certainty, if transaction costs are equal. However,
in the Indian context, Hanumantha Rao has reached a different conclusion.
As he puts it - “Relative economic cer tainty in the sense of limited scope
for decision -making seems to be necessary for the prevalence of share -
cropping. Otherwise, individual anticipations regarding input -output rates
and prices may differ, making it difficult for the parties concerned to
arrive at an agreed choice as to the p roduct mix and the amount of inputs
to be committed.” In contrast, situations of high uncer tainty call for fixed -
cash rents.
Cheung notes: ‘the tenant’s incentive to use an amount of input less
than that stipulated in a share contract’ and suggests the ro le of
transaction costs in determining the lease arrangements In making
this suggestion Cheung implicitly assumes that the proposition
between land and labour inputs can be varied over a significant range
for share -rented crops.
However; if produc tion fun ctions are characterised by relatively inflexible
input combinations, then the costs of enforcing tenants’ input would be
lower and the incentives for share -contract would be in areas where share -
cropping is widely practiced and where landowners prefer to leave out
land, ow ing to managerial discounts of crop cultivation with hired labours.
8.3 INEQUITY IN DISTRIBUTION OF HOLDING
8.3.1 Meaning of Agricultural Holding :
The term “Agricultural Holding ” implies the total area of land which is
held for cultiv ation as a single unit by an individual , joint family or more
than one farmer on a joint basis. Such land may either entirely be owned,
taken on lease ,or may be partly owned and partly rented,
An “Operational Holding ” is one which includes all lands(i.e ., cultivated ,
fallow and even the land which is not under cultivation ) used wholly or
partially for agricultural production
operated as a single technical unit by a single household or anumber of
households operating jointly. An individual may have asin gle or a number
of operational holdings if each of them constitutes a separate unit of
management
On the other hand “Ownership Holding ” includes all the area owned by a
cultivator or a number of cultivators jointly whether under own cultivation
or subject to others. The concept of this type of holding is useful under
feudal systems, as it gives an idea whether land ownership is concentrated
in a few hands or is evenly distributed .It may also be known if the
tendency is towards dispersal among a number of persons.
It also helps in finding out the level of income and living of the farmer,
employment, requirements of hired labour, and utilisation of farming
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148 on which agrarian relations in a socialistic society could be based .If there
is a heavy concentration of land in a few hands, it may be distributed
among those without land through legislative measures
8.3.2 SIZE OF HOLDINGS
The size of an agricultural holding in any country depends on
geographical and climate conditions ,partly upon the laws and social
institutions ,partly upon the methods and technique of cultivation .The
ideal size of the holdings will vary likewise with the nature of the crop,
and the objective behind agricultural pro duction .Thus ,where grain and
food are in demand ,the larger holdings alone can be regarded as economic
.Small farm on the other hand ,are best suited for dairy produce ,vegetable
and fruit growing or for vine orchards .According to Crver to be most
profi table a farm devoted to the cultivation of wheat must be at least 160
acres ,but this is obviously an impossible ideal in the Punjab or in
Tamilnadu .The question where a holding is economic or uneconomic can
not be settled in a rigid manner. Various autho rities have attempted to
define an economic holding for Indian conditions .
According to Keatinge , “ A holding which allows a man a chance of
producing sufficient to support himself and his family in reasonable
comfort after paying his necessary expenses may be termed an “economic
holding”. On the other hand Dr. Mann has defination economic holding as
“one which will provide for an average family at the minimum standard of
life considered satisfactory. ”
The summary of the limit of economic holdings ,as prescribed by
different authorities may be given below Prof. East has adopted 2 ½ acres
per capita as the minimum needed to produce an adequate diet for one
person. Keeping in mind the fact that in many part of the country two
crops are raised during the y ear and the food requirements may be less in
the East than in the colder countries of the West ,we may safely assume
that 5 acres in the minimum size of agricultural holding necessary for the
maintenance of a family of the 5 souls or 1 acre per capita, alt hough
differences in soil ,productivity, water supply ,crop rotation and
agricultural practice may alter the size of the holding to some extent.
Dr.D.Stamp assumed that one acres of well -cultivated land in the mid -
latitude is sufficient to produce an adequ ate diet for one person .
It may be said that an economic holding should be such as may offer
reasonable opportunities to the peasant and his family to employ the factor
units(i.e. a pair of bullocks) in the most efficient manner .The return from
such a h olding will depend upon fertility of soil ;intensity of cultivation
;crops raised ;method of cultivation ,and the organisation of agriculture;
cost and returns and living cost
The agrarian reforms committee evolved an idea of three norms of size of
holding s
a) Economic holding : According to the Committee, an Economic
holding is that : (i) which must afford a reasonable standard of living to munotes.in

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149 the cultivators (ii) Provide full employment to a family of normal size and
at least two pair of bullocks . (iii) Hav e a bearing on other relevant factors
peculiar to the agrarian economy of the region
(b) Basic holding : A basic holding is a holding smaller than the economic
holding which may be able to provide a reasonable standard of living to
the cultivator but not efficient for the purpose of the agricultural
operations .
(c) Optimum holding : An optimum holding is the holding ,which
keeping in view the ceiling to the size, the managerial capacity and
financial resources of an average cultivator, refers to the size not
exceeding three times the size of an economic holding.
8.3.3. FACTORS DETERMINING SIZE OF ECONOMIC HODING
If the term an “Economic Holding ” is understood in the above sense ,it
should be at once obvious that an economic holding can not be a fixed
quantity of land at all places and under all circumstances. It is obvious that
size of an economic holding will be different in the fertile land of Punjab
compared to dry land in Deccan and an economic holding in the case of
plantation crops like tea, coffee , and spices will be different from one in
the case where only jowar, maize and such other minor cereals can be
produced. The size of an economic holding in the case of horticulture
would be different from that of land producing tobacco, or groundnut or
one which can grow rice.
It is also obvious that size of an economic holding in the case where
primitive technique of production is yet employed would be different from
the one where mechanisation of agriculture has taken place .
What then are the factors t hat determine the size of economic holding in a
country ? Broadly following factors may be said to determine the size of
an economic holding in a country at any particular time :
(i) The quality of land ,degree of fertility, etc.; (ii) Availability of adeq uate
and steady supply of water , say ,from an irrigational project in the area
making double or even treble cropping possible . (iii) Method of
cultivation, namely whether the land is cultivated extensively with
conventional tools and implements or whethe r modern methods of
cultivation such as mechanisation, use of chemical fertilisers, improved
seeds and pesticides, etc., are used. (iv) Nature of crops grown on land –
whether it is tobacco, or wheat ,or rice or tea or coffee or jowar and maize,
will determ ine the size of an economic holding in the country ; and
(v) Organisational capability of a farmer is also an important determinant .
It is thus clear that various factors such as quality of soil ,rainfall
,possibility of adequate a nd regular supply of water ,whether single or
multiple cropping is adopted ,mode of cultivation , distance from city
markets , organisational capability of the cultivator ,etc., determine the
size of an economic holding. It should be obvious that size of a n economic munotes.in

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150 holding will differ from region to region and from one time to another
depending upon the above factors.
The concept of an “Economic Holding” comes to be quantified in terms of
“Standard Acres” which enable an average family of a farmer to earn an
income sufficient for at a minimum level of civilized consumption or in
simple terms a reasonable standard of living prevailing at any particular
time in the country.
8.3.4 CAUSES FOR SMALL SIZE OF LAND HOLDINGS :
Indian agriculture is characterised b y the dominance of very small size of
holdings. As already seen ,more than half of the operational holdings in
India are either sub -marginal (below 0.5 hect.) or marginal (0.5 to 1.0
hect. ) .
The following are the main causes o smallness of holdings.
1) G rowing population in the country : Fast growing population in our
country has placed heavy pressure on the fixed supply of land .With every
increase in population, the land gets divided and sub -divided, leading to a
smaller size of holding .
2) The Law of Inheritance : Another important factor giving rise to the
small size of holding is the operation of the law of inheritance. At the
death of the farmer ,his land gets divided among all his sons.
3) Decline Of Joint Family System : Under the joint family s ystem ,the
land of the whole family was held and cultivated jointly. With the
breakdown of this system ,the number of small holdings has increased.
4) Decline Of Handicrafts And Village Industries : It is a known fact
that India was on world map of the fi nest handicrafts in the past. The
village economy was marked by a close co -operation between industry
and agriculture. Villagers were selfcontented economic units exchanging
surpluses between industry and agriculture. With the advent of Britishers
on the I ndian scene, the situation progressively deteriorated and Indian
handicraft faced stiff competition from British manufactured goods.
The British occupation slowly changed the professional system ,ruining
the overtaxed peasant, developing exchange and mone tary economy,
reducing millions of craftsmen to poverty through competition from
modern industrial goods. The decline in village industries and handicrafts
displaced the village artisans and compelled them to take refuge in
agriculture. This increased the pressure on land and resulted in its sub -
division into smaller holdings on a large -scale.
5) Rural Indebtedness : Indebtedness of the rural peasant has been a
serious problem .With too much of belief in superstitions ,rituals and
social ceremonies an too much of an authority of the priest ,the poor
peasant always cut their coat beyond the cloth and have to resort to
borrowing .With the absence of the organised credit institutions, they have
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151 to fall in to his trap. With high rates of interest , the amount of loan keep
on compounding and renders it difficult for the borrower to repay it in full.
At one or the other stage ,therefore, the money lender would annex part of
the land holding of t he borrower leaving only a small holding for him
.Since millions living in the village fall into this trap ,small holdings also
multiply by millions and in a large number of cases peasants become
landless.
6) Attachment Of Landed Property : The social str ucture in the country
is such that people remain greatly attached to landed property and this
results in the family holding being divided over and over again. There has
been rigidity in the occupational structure. Sufficient or not ,a family will
remain at tached even to a small piece of land rather than look out for an
alternative employment.
8.3.5 AGRARIAN STRUCTURE
The significance of land reforms anywhere arises from the defects in the
prevalent agrarian structure .In the context of India ,it will be pr oper to
have a look at the agrarian structure that obtained on the eve of the overall
strategy of agrarian reconstruction and growth. Agrarian Structure on the
Eve of Independence : Various interests in land on the eve of
independence fell into four classe s:
 Cultivating Holders : These may be classified into two categories, (a)
owners, (b) tenants. If the owner cultivates the land himself, there is no
other person holding an interest in his land above or below him and
between him and the state. As agains t this, tenant -holders do not have any
ownership rights on land. They may more appropriately be described as ‘
occupancy tenants’ to distinguish them from the ‘tenants -at-will’. They
have no direct relation with the state, but there is a chain of intermedi aries.
 Intermediaries : These are either non -cultivating owners of land or
noncultivating occupancy tenants.
 Tenant -at-will : He cultivates the land and bears its cost of cultivation.
He may or may not have any security of tenure. Invariably his inter est is
not permanent and heritable.
 Agricultural Labourers : These constitute the mass of unemployed
landless population in village; very few of them are at the bottom of the
socio -economic ladder of the rural community.
The agrarian structure in pre -Independence period was woven around
these varied interest. It presented decadent semifeudal order with wide
inequalities and multifarious exploitation of the mass of cultivators. There
was a high degree of concentration of land ownership at the top.
This type of agrarian structure, acts as a powerful 0bstacle to economics
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152  The tenant has little incentive to increase his output since a large share
accrues to the landowner who incurs no cot.  A very small margin is left
with act ual cultivator; and this may be quite insufficient to provide for
capital in vestment on the land.  Tenants secure no benefits of working
with better equipment or with better seeds. In short, under this type of
agrarian structure landlords and intermediar ies grow rich and continue to
flourish, the state is revenue and the cultivator -tenants live a hand -tomouth
existence.  It is in this backdrop that we have to examine the major
objectives of land reforms policy in India, the progress achieved structure.
This type of analysis will help us make suggestions for an improved land
relations system in future.
8.3.6 BROAD FEATURES OF THE EMERGING AGRARIAN
STRUCTURE
The emerging agrarian structure reveals the existence of three distinct
sectors of Indian agricultu re, coexisting but also contending with one
another.
 The first sector is the developed sector of modern entrepreneur farming
by rich peasants.
 The second sector comprises the area under self -cultivation by medium,
small and marginal farmers.
 The thi rd sector is composed of the vast area of land under cultivation by
share -croppers and various kinds of tenants and sub -tenants having no
proprietary rights in land, no security of tenure, no share in the various
aids, no security of tenure, no share in th e various aids and inputs
distributed by the State or institutional agencies.
It is this third sector which is the worst placed in the agrarian economy
and is still subject to various forms of semi -feudal exploitation such as
rack-renting, usury, economic bondage and caste.
This makes it necessary for us to suggest as to what the agrarian structure
in future should be. Before we should know the causes that have been
responsible for the relatively poor performance of land reforms in India.
8.3.7 Cause for poor performance :
 Lack of political will : Enactment of progressive measures of land
reforms and their efficient implementation call for hard political decisions
and an effective political support, direction and control. considering the
character of t he political power structure obtaining in the country it was
only natural that the required political will was not forthcoming the
political bosses and the powers –that-be resorted to what can be called
‘land grabbing’. The political will assured that land reforms failed.
 Absence of pressure from Below : The beneficiaries of land reforms,
particularly share -croppers and agricultural labourers, are weighed down
by crippling social and economic disabilities. Except in a few scattered munotes.in

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153 and localized pockets, practically all over the country the poor peasants
and agricultural workers are passive, unorganized and inarticulate. In the
circumstances, it issmall wonder the there has been no insistent pressure
from below, a prerequisite for the effective implementa tion of land reform
laws.
 Administrative Organisation -Inadequate : Policy Instrument In all the
States, the responsibility for the implementation of measures of land
freeform rests with the revenue administration. The implementation of
land reforms is on ly one among its many function. Traditionally, high
priority is given to the maintenance of land reforms is only one among its
many function. Traditionally, high priority is given to the maintenance of
public order, collection of land revenue and other reg ulatory functions.
Land reforms do not, therefore, get the required attention.
 Legal Hurdles : The land reform laws were defective in many ways.
Legislations relating to the land reform were so full of loopholes that a
commentator was led to say that an elephant could easily walk through
them. Some loopholes were deliberately built in, while others were the
result of poor drafting. Practically, in every State protracted litigation has
delayed and often frustrated the implementation of land reform laws.
 Absence of Correct Updated Land Records : A programme that aims at
the redistribution of income and wealth in the rural areas cannot succeed
unless the beneficiaries can produce evidence of their rights. The position
regarding records of tenancies, partic ularly in the matter of entries relating
to the rights of share -croppers, is not satisfactory anywhere in the country,
and no records exist in some areas.
 The main reasons for this unsatisfactory state of affairs are the
following.  In some areas, where cadastral surveys have been out -
ofdate for a long time, resurveys have not taken place;
 Some areas have never been cadastrally surveyed ;  In some cases no
machinery of any kind has existed for maintaining village records;
 In some areas(such as the zami ndari areas,) The machinery which
keeps records is private;
 Even where records are kept by Government revenue officials there is
no uniform system;  Even official records may not be correct.
The errors would be of two kinds with reference to their origi n;(a) Bona
fide errors arising out of law on the part of the recorder; (b) Deliberate
wrong recording from mala fide motives. The problem is largely
administrative.
 Some Weak Spots in the Programme : The programme of land reforms
has been viewed so fat i n isolation form the mainstream of economic
development. The main ingredients of the programme like the abolition of
intermediary tenures, tenancy reform and ceilings on agricultural holdings
were treated as disjointed programmes and sought to be implement ed as munotes.in

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154 such . The lack of financial support has been the weakness of land reforms
right from the beginning. No separate allocation of funds was made in the
Five-Years Plant for financing land reforms.
8.3.8 SUGGESTIONS FOR IMPROVEMENT
Review of Tenancy Leg islation:
The existing legislation was enacted in background of the traditional
agricultural technology. With the new agricultural technology coming in,
things have changed radically. Owner cultivation of a minimum size of
land has become viable and it no longer needs legislative support.
Moreover, in some areas the ground -level picture has changed as small
farmers are facing difficulties in coping with the new expensive
agricultural technologies. Under the compelling to give their land to a
bigger farmer who has enough resources including tractors and other
implements of cultivate more land. This rich tenant in some cases has used
the protective, well -intentioned legislation to cheat the poor owner.
No social purpose is served in giving the big tenant sec urity at the expense
of the small landlord. There is, therefore, need to liberalise tenancy laws.
Effective Implementation of Ceiling legislation : Firm measure are
required against fictitious and benami transfers deliberately effected by
big landowners t o circumvent ceiling laws. The State Government should
hold a proper enquiry into such transfers. If on enquiry it is found that the
transfers wee made to evade the provisions of ceiling laws, the land so
transferred should be vested in the State after the imposition of a suitable
penalty on the transferor. Ceiling may be relaxed in case of uncultivated
waste land where large and long gestating investment may be needed,
provided it can be ensured that the land will be used for agricultural
purposes and that it will not be used as a tax shelter.
Surplus Land and Its Distribution : The surplus land should be allotted to
the beneficiaries on the specific condition that they would not be permitted
to sell or mortgage these lands to private individuals. If at an y time a
beneficiary wants to leave the profession of cultivation the land held by
him would revert to the State
Simplifying Legal Procedures and Administrative Machinery : The
establishment of special courts to dispose of cases in villages of their
origi n or in the close - by township would expedite work as they would be
in the know of relationship and happenings in the field and thereby serve
the ends of justice better.
Land reform cannot be properly enforced without popular cooperation and
support at al l levels. Popular co -operation and support at all levels.
Popular supervisory committees should, therefore, be constituted at all
levels, consisting of people’s representatives, including the beneficiaries,
officials and experts to exercise vigilance on im plementation. These
committees should be vested with certain statutory powers like the
inspection of records and sites, collection of evidence, etc., weight age. munotes.in

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155 Generation of Awareness among Potential Beneficiaries : The requires the
support of education al campaigns and political mobilization on the
principles of land reform, Further, the existing socio -economic order in
which the power base lies with the rural rich should be radically
reconstructed to form a new order in which the power balance will favo ur
the rural poor.
There are three developments in recent times that may have favourable
impact on this type of change:  Emergence of ‘biological, technology’ in
agriculture which has made the small -peasant agriculture potentially
viable;  Political dep endence of the power elite of all types of ideological
and political persuasions on peasant support; and  Emergence outside the
agricultural system of State -sponsored institutional framework of State -
sponsored institutional framework of scientific researc h, technological
innovation and diffusion, water control, input and credit supply and price
support for agricultural development.
8.4 INTER -LOCKING OF INDIAN AGRICULTURAL
MARKET
Interlocking often acts as a security (hedge) against risk . For example,
when a landowner makes loan to a tenant, (or a sharecropper), he faces
very little risk of default. The reason is that, he can recover his loan from
the tenants' share of the crop.
8.4.1 Causes of Interlocking of Agricultural Markets:
1. Risk Reduction:
Interlo cking often acts as a security (hedge) against risk. For example,
when a landowner makes loan to a tenant, (or a sharecropper), he faces
very little risk of default.
The reason is that, he can recover his loan from the tenants’ share of the
crop. Thus, the risk of default is reduced through the interlocking of the
land (lease) and the credit market.
Similarly, if there is crop failure due to adverse weather or some natu ral
calamity, the landowner can recover his rent by forcing the tenant to
supply his lab our service free in the next agricultural season. This is
possible due to interlocking of land (lease) market and labour market. This
interlocking of different mar kets in agriculture leads to risk reduction to
some extent.
2. Economies:
Another reason for such in terlocking is to derive some economies or
advan tages. For example, suppose the landowner gives loan to tied labour
on the condition that the latter will supply labour service at a fixed wage
for a specified time period. munotes.in

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156 During the peak season, th e wage rate goes up due to high demand for
labour. But due to inter -market contractual relations (in this case between
the credit market and labour market) the landowner can get labour services
from, the tied labourers at lower wage rates. In this way, the wage cost of
the landowner becomes much less than it would be in the absence of
interrela tion between these two markets.
Borrowers also enjoy economies. For exam ple, when a tenant owner
borrows money from com mercial banks or co -operative societies he h as to
incur some cost. He has to complete some rigid formalities and, in the
process, spend time and money in order to get the loan. But if he borrows
from the landowner he is not required to spend anything. Such cost saving
is possible through such, inter locking.
3. Money -Substitute:
Finally, interlocking of different markets acts as a money -substitute. In
most parts of rural India, the barter system still exists. Commodities are
directly exchanged for commodities and money is not widely used as a
medium o f exchange. But the success of the barter system requires double
coincidence of wants which is created through the interlocking of different
markets in agriculture (Double coincidence of wants necessitates that the
set of goods or com modities each individ ual is willing to exchange must
be exactly what is required by the other party.).
An example will make the concept clear. Let us suppose, the landlord
engages agricultural workers and agrees, as per contract, to pay them
wages in terms of crop. In this cas e, the landowner needs labour services
which can be supplied by the labourer. On the other hand, the labourers re -
quire food -grains for consumption which can be supplied by the
landowner. Fig. 2.3 illustrates a barter transaction between two individuals
due to double coincidence of wants which again is due to the interlocking
of the labour market and the product market. In this way, the interlocking
system is used to facilitate barter (i.e., non -money using) transactions in a
subsistence economy.

Figure No. 8.4
A Double Coincidence of wants munotes.in

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157 8.4.2 Effects of Market Interlocking:
(a) Distress Sale and Purchase:
Due to such interlocking farmers have to make dis tress sale of their crops
immediately after harvest at low price to be able to pay kind rent. Again,
they may re quire to take loan from the moneylenders in cash to be able to
buy food from the market at a higher price in the lean season to be able to
keep body and soul together.
(b) Involuntary Exchange:
Because of such interlocking, exchange is not always voluntary. When the
tenant borrows for consumption from the landowners —either in cash or in
kind—he is required to pay interest in kind. For that he may be forced to
sell his output to the landowner at less than the market price (because the
landowner may also be trader in commodities) or to agricultural supply,
his labour power in the peak season at less than the market wage. In most
cases, the exchange relations are not voluntary. Due to loan contract, the
tenant or sharecropper can neither sell his por tion of output (left after rent
payment), at the mar ket price, nor sell his labour in the peak season at the
market wage.
(c) Monopolistic Control:
Thirdly, as a re sult of interlocking, the control of the agricultural sectors
gets into the hands of a few individuals who control all the markets. No
such thing as free competition or voluntary exchange is found in any of
the markets. Through the exercise of monopolistic control of all the four
markets, it is pos sible to extract more surplus which is, ultimately,
converted into property income.
(d) Greater Dependence on a Few Individu als:
Due to such interlocking the majority of peo ple in rural areas have to
depend for more and more on few such powerful and influential indi -
viduals.
For example, the tenants will have to depend on the landowner for leasing
in land. The labour ers will have to depend on the landowner for em -
ployment and wages, the debtors wi ll have to de pend on the landowners
for the supply of credit. Similarly, the buyers of agricultural products will
have to depend on the landowner for food and industrial raw materials.
For these reasons, the land owner becomes a strong force in the rural areas. munotes.in

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158

Figure No. 8.5
Dependence on the landowner by the other sections of society.
The landowner, in his turn, gets rent, labour serv ice, interest and pr ofit
(from sales of marketed sur plus).
(e) Greater Surplus Extraction:
Fifthly, as a result of such interlocking the landowner, who is usually most
powerful in the rural sector, extracts surplus from different markets. If the
same person extracts surplus from all the four markets, the amount of
surplus extracted becomes very large. If, for example, the tenant refuses to
pay higher rents (as demanded by the landowners), the land owner will
refuse to lend him money in times of necessity.
At the same time, th e tenant may be asked to pay higher interests. If he
refuses to pay it, he may be given the threat of eviction. These examples
are just enough to prove that interlock ing of product and factor market in
agriculture leads to greater surplus extraction.
(f) Obstacle to Technological Progress:
Some economists like Prof. Amit Bhaduri have opined that interlocking of
different markets in agriculture acts as an obstacle to technological
progress. If the landowner gives loans to the ten ants at high rates of
interest and if the former can make profits by selling agricultural products
or if he can raise the level of rent, then he does not have any desire or
inclination to apply modern (sophis ticated) techniques in agriculture. He
may live a quiet life without being bothered about the in crease in land
productivity.
The landowner gives only consumption loans to the tenants. So pro duction
loan is not given because it is feared that the tenant can use the loan to
adopt modern tech nology and produce more output with t he same amount
of inputs. If output increases, he may not be required to borrow from the
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159 Thus, the landowner can prevent the adoption of modern techniques. This
is how the interlocking of different markets in ag riculture —in this case
land (lease) market and credit market —stands in the way of productivity -
raising improvements (such as use of modern tech niques).
However, in reality, we often find that land lords not only provide
production loans to culti vators, b ut encourage them to adopt improved
technique as well. Moreover, after the initial success of new agricultural
strategy (which brought about the green revolution) new technique has
become less costly and more attractive than before.
As things stand today, the landowner will induce the tenant to adopt new
technique so that output of agricultural products and, consequently, his in -
come, increases. Thus, the view that interlocking of different markets in
agriculture is a major obsta cle to technological progr ess does not stand to
reason.
8.4.3 Conclusion:
Various studies and surveys have found interlocking among various
markets in agriculture. However, much like the law of di minishing returns,
interlocking is not something peculiar to -agriculture. Instead, in terlocking
is observable in the industrial sector as well. In case of the corporate form
of business (or joint stock companies, as they are called) the same
individual is found to be on the Board of Directors of several unrelated
companies.
This is known a s the interlink directorate —a situation in which one or
more person(s) sit on the board of two or more compa nies, where these
firms have similar products, such as oil and electricity or gas. Such
conditions can lead to collusion or formation of cartels. A gain, the director
of an industrial company may be on the board of a financial organisation
such as the Industrial Development Bank of India. This is how industrial
and financial sectors of the economy get interlocked.
In the final analysis, it appears tha t the most notable and common feature
of interlocking is that the same two persons confront each other in differ -
ent (product and factor) markets. Such interlock ing initially develops due
to formal relations. But, over time, these formal relations gradual ly
become social relations which get reflected in different markets (which are
essentially social institutions).
Such interlocking existed in pre -market econo mies and continues to exist
in today’s market -based economies. So the truth is that interlocking of dif -
ferent markets in agriculture is not anything new or unique to agriculture.
It is universal in its appli cation. Such interlocking relation was and is
found in almost all sectors of the economy.

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160 8.5 INTERLOCKED/INTERLINKED FACTOR MARKET
IN AGRARIA N SECTOR
Abstract Informal credit sector plays a vital role in the rural sector in
developing countries since formal credit institutions failed to provide
access to rural credit to poor farmers. Let us analyze various theoretical
aspects of interlinked cre dit transactions in the rural credit market in
developing countries. positive and negative theoretical concepts in regard
to interlinked credit transactions in agrarian sector. It shows that the poor
farmers in rural sector are exploited by lenders in the form of cash or kind
or labour. However, it further indicates interlinked credit transactions may
cause positive impacts in the rural credit markets. Hence, policy makers
should give more focus on it to eradicate the above problem and should
have a vibran t plan to give several subsidies to the poor, to make
investment in rural areas, to strengthen easy marketing facilities etc.
The concept of interlinkage has probably been borrowed from
anthropology, where the multi -standard nature of relationships in smal l
face-to-face communities has often been emphasized. Such societies have
been called multiplex, and multiplex relationships between the same
economic agents in a poor agrarian community are often described as
interlinked contracts encompassing several mar kets.). Interlinked credit
transactions can broadly be classified into four categories, namely those
involving linkage of land, labour, inputs and output of farm households
(Sarap, 1991). An interlinked transaction is one in which the parties trade
in at l east two markets on the condition that the terms of all trade between
them are jointly determined (Bell and Srinivasan, 1989). According to
their definition two parties and more than one market are involved in the
interlocked factor market. Prices of goods and services in the classical
competitive markets are determined by the market forces (demand and
supply) but, prices of factors of production in agrarian economy are
interlinked, thus reward of land, labour and credit are determined by the
interlockers.
Many theoretical and empirical studies have explained different types of
linkages in the rural sector such as *land and labour markets, *land and
input markets,* land and output markets,* labour and output markets,*
input and output markets.
The credit l inkages between poor borrowers and lenders may be in several
forms, namely, *cash -to-cash (Cash receipt of the loan by the borrower
and cash repayment of loan and interest to the creditors),* cash -to-kind
(Cash receipt of the loan and kind repayment), *cas h-tolabour (Cash
receipt of the loan and repayment in the form of labour services), *kind -
to-cash (kind receipt of the loan and cash repayment),* input -to-cash
(input receipt of the loan and cash repayment), and *cash -to-output (Cash
receipt of the loan an d repayment in the form of output). However, all
repayments also include interest with loan amount It could be proved that
interlinked credit transactions between lenders and poor peasant lead to
negative impacts to the borrowers while it incurs some advan tages among
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161 The impacts of interlocked factor markets may be explained by two ways.
One argument says that borrowers are exploited and affected by creditors
in many ways. On the other hand, it is to be stated that interlinke d
transaction is efficient and effectiveness at the market. The word
“interlinkage” was first used by Bardhan and Rudhra (1978) that caused to
much of the development of recent theoretical work. Their survey
examined the interrelationship of the factors in the rural market.
According to them, the landlord quite often gave production loan to the
tenants and the tenants very often took consumption loan from the
landlords. They also suggests that overwhelming majority of tenancy and
attached labourers contract s do not display feudalist features. Further,
workers are employed in the peak season after being offered consumption
loan in the lean season at subsidized rate of interest. In general, it is stated
that two parties involving in the interlocked factor mark et are identified as
weaker party and stronger or dominant party. Interlinking of transaction in
different markets is also very effective way for the dominant party to
avoid social or legal controls on charging higher prices in some markets
and to select c riteria for rationing scarce resources (like credit and land)
when prices are inflexible or sluggish in adjustment (Bardhan, 1980).
Interlinked transactions bring this type of market under the control of
dominant party. Bardhan (1973), Basu (1983), have ex plained about the
various kinds of control exercised by the money -lenders over landless
borrowers which strengthen the segmented and personalized character of
these markets.
Loans are given by money lenders under certain conditions. Duration of
the loan, underpricing collateral system, deduction of the interest
payments at the beginning of the loan and control over the borrowers are
common practice at this market. Weaker party is always identified as
peasant and poorer than stronger party. The dominant par ty would have a
sufficient power at this market. Hence, this situation leads to exploit the
weaker party. It has been argued that because of the imperfection in the
land and credit markets where the landlord/ money -lender poses localized
monopoly, interlin king of credit with tenancy transactions increases the
power of the landlord which leads a greater exploitation of the tenant
(Bardhan, 1983). These factor markets involving different parties do not
operate under competitive conditions. This imperfection i s that access to
factors of production is far more difficult for the weaker parties than other
parties (Baradwaj, 1974, 1980). In the rural sector quite often credit is paid
or repaid in kind, quite often interest is not explicit but implicit in the
terms of the transaction (Bardhan, 1983). Since the interest payments are
implicit at the market, the rate of interests is higher than the normal market
interest rate. Hence, poor borrowers happen to pay more than actual
payments.
The main manifestation of this imperfection is that access to factors of
production is far more difficult for the weaker parties than for others.
Besides, inadequate information which is caused by short supply of these
factors, which in turn, lead to a rationing of them, can result in the
stronger party exploiting the weaker party in the process of exchanging
goods and services. Thus, it has been generally recognized that agrarian munotes.in

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162 markets are highly fragmented and different parties in a given sub -market
may have unequal access to the ot her markets (Sarap, 1991). Basu (1984)
explained the concept of interlinkage in the light of lender’s risk
hypothesis while Bardhan (1984) described employer’s risk hypothesis.
Under the model of Basu (1984) the under pricing of collateral, the
existence o f high interest rate, and the multiplicity of interest rates are
clearly indicated. All these features are widely prevalent in backward
agriculture. Basu (1984) further says that interlinkage is a form of
insurance against risk and moral hazard.
On the ot her hand, Bardhan (1984), in his theory, explained that the
landlord presumes that there may be excess demand for labour at the
agricultural peak season (sowing and harvesting) and hence he provides
consumption loan to the workers on the basis of their pre -commitment to
work in his field in the next peak season. It is to be noted that pre
agreements are done by both groups. Hence, Poor peasants are controlled
by landlords or other lenders. Interlinked transactions bring this type of
market under the control of dominant party. Bardhan (1973), Basu (1983),
have explained about the various kinds of control exercised by the money -
lenders over landless borrowers which strengthen the segmented and
personalized character of these markets.
Interlinking of transacti ons in different markets is also an effective way
for the dominant party to avoid social or legal controls on charging high
prices in some markets and to select criteria for rationing scarce resources
when prices are inflexible or sluggish in adjustment (B ardhan 1980).
Further, Baduri (1986) argues that a trader or money lender having a
monopoly on one market of the interlinked transaction can gradually
extend his control to the other market implied in the transaction. Lenders
exercise monopoly power over t hese borrowers (Hoff and Stiglitz, 1990).
Studies of informal credit market suggest that it is extremely important to
understand the nature of dependence of poor households and the social
character of the control mechanism exercised by the lenders (Subbara o,
1989). Stiglits (1992) also explains the general theory of interlinkage of
agriculture in LDCs. According to him the landlord may also supply credit
to workers to induce them to work hard. Interlinked transaction is a major
barrier for poor farmers and labourers to take collective action.
Another type of interlocking relates to credit and product markets where
the landlord serve as a trader in buying that part of his share of output in
case the borrower is a tenant, or, in case the borrower is a small fa rmer,
the output equivalent in value to the loan plus interest. It is possible that
both small farmers and tenants sell their output immediately after the
harvest to the landlord -cum-trader when prices are low (Subbarao, 1989).
The medium and large farm ho useholds are relatively free in the product
market due to their superior bargaining status compare to small farmers
and agricultural labourers (Narayana Reddy, 1992). Interlinkage of the
produce and credit markets and under -pricing of collateral may occur
because of interest rate ceilings and also under -pricing of collateral and
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163 should be observed together (Gangopadhyay and Sengupta, 1987). This
indicates indicate the exploitation of bo rrowers in the rural credit market.
But, the study of Braverman and Stiglits (1982) explains the relation
between the landlord and tenants with another perspective. According to
them, the activities of landlord may be in certain circumstances lower
agraria n output and make tenants worse off. In other circumstances, total
agriculture output might increase and tenants could be better off and only
the landlord suffers.
However, a number of studies indicate the benefit of interlinked credit
transactions is an efficient way to reduce the excessive cost of acquiring
information between transistors in imperfect market. Economists have not
failed to show the advantages of interlinked credit transaction among
markets. Brawerman and Stiglitz (1982) pointed out that i t is an efficient
response to information asymmetry and uncertainty. Brawerman and
Guasch (1984) stated that this transaction plays as a screening device in
the selection of consumers. On the other hand, Bell and Sirnivasan (1989)
said that interlinked tra nsaction is a flexible market response in the
growing commercialization. They further pointed out that this transaction
can increase economic efficiency in certain context.An interlinked
transaction is an incentive mechanism to guarantee loan refunding.
Conclusion: The analysis has demonstrated the actual meaning of
interlinked credit transactions and many theoretical explanations of several
economist or authors. Imperfection is common features of backward
agrarian sector.At least two parties, identified as weaker and dominant
party, are involving in interlinked credit transactions at this market. Since
the dominant party has a monopoly power, the landless labourers, tenancy
farmers and other poor farmers (weaker party) are exploited by the lenders
at this m arket. Higher implicit rate of interest, under pricing of collaterals
and working more time in the field are the ways of exploitation. However,
the interlinked credit transactions lead to economic efficiency and an
effective way to reduce the cost of trans actions among transactors in the
rural credit market. In general, weaker parties are severely exploited by
dominant parties through interlinked credit transection. In particular, inter -
locking factor market still exists in under developed countries, especi ally
in rural areas. The elimination of above situation would be helpful to
reduce exploitation of dominant parties and it would also be a constructive
way to assist weaker parties in terms of inter -locking factor market.
Hence, policy makers should give m ore focus on it to eradicate the above
problem and should have a vibrant plan to give several subsidies (Eg: -
fertilizer subsidy) to the poor, to make investment in rural areas, to
strengthen easy marketing facilities etc.
8.6 ANALYSIS OF RURAL CLASSES
The land holding is the principle determinant of the class structure in rural
society. This is owing to the fact that agriculture is the principle economic
activity in the rural areas. The land tenure system that evolved during the
British period gave rise to the class of Zamindars, along with the class of munotes.in

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164 Watandars and the Jagirdars in the Indian states. The bulk of land in the
rural areas was owned by this upper stratum of the society.
The merchants and traders who were also the moneylenders, gradually
acqu ired the land of many small and marginal farmers, leading to the
proliferation of the class of the landless labourers.
If we analyse class structure in rural India in the post -independence
period, we come across four classes. The three classes in the agr icultural
field are of land owners, tenants and labourers and the fourth class was the
class of non -agriculturists.
With this background of agrarian structure, let us now analyse agrar ian
relations. The relations may be classified as (a) those which ar e defined
and enforced by law, (b) which are customary, and (c) which are of fluctu -
ating character. Daniel Thorner rejected the often -described classification
of cultivators in rural areas in three categories: landlords, tenants, and
labourers.
If we anal yze class structure in rural India in post -independence period,
we find four classes: the three classes in the agricultural field are of land
owners, tenants, and labourers, while the fourth class is of non -agricultur -
ists According to A.R. Desai (1959), landowners constitute about 22 per
cent, tenants about 27 per cent, agricultural labourers about 31 per cent
and non -agriculturalists about 20 per cent.
A large majority of the cultivators (60%) are marginal cultivators with less
than 2 hectares land, foll owed by small cultivators (16%) with 2 to 5
hectares land, medium cultivators (6%) with 5 to 10 hectares land, and big
cultivators (18%) with more than 10 hectares land.
The available land per family in vil lages is less than one acre (or 0.4 ha).
About 75 per cent of the total sown area is under food crops. About 35 per
cent of the total produce is sold by cultivators. In about 65 per cent of
these sale transactions, commodities are sold to the trader in the village
itself.
The marketing of agricultural pr oduce in the mandis (markets) is largely in
the hands of intermediaries who represent private interests and who
control both credit as well as dis posal of the produce. Thus, a large
number of agrarian proletariat, a large number of uneconomic holders of
land, and a small number of artisans and self -employed people in villages
reveal a miserable economic life lived by these people.
With this background of agrarian structure, let us now analyse agrar ian
relations. The relations may be classified as (a) thos e which are defined
and enforced by law, (b) which are customary, and (c) which are of fluctu -
ating character. Daniel Thorner rejected the often -described classification
of cultivators in rural areas in three categories: landlords, tenants, and
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165 This was on the ground that one and the same man can belong
simultaneously to all three of these categories. A person can himself
cultivate a few acres of land he owns, give some land on rent, and in
emergency may work on other’s field as labourer. He has analysed
agrarian relations by using three specific terms: Malik for agricultural
landlords, Kisan for working peas ants (including tenants), and Mazdoor
for agricultural labourers.
The Malik derives his agricultural income primarily (although not
necessar ily solely) from property rights in the soil, i.e., from a share of the
produce of lands possessed by him. The share is realised in cash as well as
in kind (percentage of produce). He may give his land either to tenant(s) or
may cultivate it by hiring labo urers. He may manage the hired labourers
himself or through a manager.
The Malik may also have subsidiary income from business, profession,
etc. The Maliks are of two types: those who are absentee landlords and
those who reside in the village in which the y own land Kisans are the
working peasants, who may be small landowners or tenants the difference
between the Malik and the small Kisan is the size of the land held. The
Kisan himself and one or more members of his family actually perform the
field labour. Sometimes the income of the Kisan is so low that he himself
or his family members(s) work as agricultural la bourers.
Mazdoors are those landless villagers who earn their livelihood primarily
from working on other people’s land. They receive wages in cash and
sometimes in kind also. When they are not able to find work in villages,
they migrate to other states either for working as agricultural la bourers (as
Biharis migrating to Punjab) or as construction or industrial labourers.
While Daniel Thorner has a nalysed agrarian social structure in terms
of three classes on the basis of three criteria, viz.,:
(a) Income obtained from the soil (i.e., rent, own cultivation, or wages),
(b) The nature of rights (i.e., ownership, tenancy, sharecropping and no
rights at all), and
(c) The extent of fieldwork actually performed (i.e., doing no work, doing
partial work, doing total work, and doing work for others).
D.N. Dhanagre (in Desai, 1983) has suggested a different model of
agrarian classes. He has proposed five class es: landlords, who derive
income primarily from land - ownership by collecting rent from tenants,
sub-tenants and share croppers; rich peasants, i.e., small landowners with
sufficient land to support the family and who cultivate land themselves,
and rich te nants who have substantial holdings and have to pay a nominal
rent to their land lords; middle peasants, i.e., landowners of medium size
holdings and tenants with substantial holdings and paying higher rent;
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166 (a) Land -owners with holdin gs insufficient to maintain a family, and
therefore forced to rent others’ land,
(b) Tenants with small holdings,
(c) Sharecroppers, and
(d) Landless labourers.
The rich peasants and the trader moneylenders exploit the poor tenants and
the landless laboure rs so much that relations amongst them are al ways
sour. The former two classes wield considerable economic, social, and
political power. The emergence of cooperative and credit societies in the
villages have no doubt affected the power of the Maliks, yet they con tinue
to be strong.
Two things are to be noted here: one, cooperative societies have not been
much successful in villages, and two, private trader continues to op erate
successfully. People with vested interests want to maintain the status quo.
Even land reforms have not reduced the power of Maliks and money -
lenders. Unless economic, social and political progress takes place in the
countryside, unless a movement is born which leads to more even distri -
bution of productive resources, greater economi c strength on the part of
the smaller units leading to ability to withstand pressures from either the
top cultivators’ strata or the moneylender trader classes, no great success
can be achieved in improving class relations.
The problems of landless agricul tural labourers are more economic than
social. We do not deny that their place in the social structure is of great
importance but we hold that the problem of employment opportu nity to
them, and the problem of their wages are more crucial.
Employment oppor tunity is related to the growth of agricultural econ omy
and incentives to artisans in the villages. In the Agricultural Labour
Enquiry, an agricultural labourer was described as a person who worked as
an agricultural labourer for more than one -half of the total number of days
on which he actually worked during the year. On the basis of this
definition, about 30 per cent workers were identified as agricultural la -
bourers, one -half of them being without land and the rest being in
possession of a little land (say one bigha or so).
As many as 85 per cent of agricultural labourers get only casual work
during times of harvesting, weeding, preparation of soil, and ploughing.
Today, the average wage of an agricultural labourer varies from Rs. 30 to
Rs. 60 per day. The extent of employment varies under different
conditions in various parts of the country, the average being about 200
days.
Thus, there is work for wages for about six months in a year, total
unemployment for rather more than three months, and some kind of self -
employment for less than three months. In this way, their (agricultural munotes.in

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167 labourers) average income is hardly about Rs. 10,000 a year. They, thus,
live below the poverty line.
The Agricultural Labour Enquiry was concerned primarily with cer tain
econ omic aspects but the social disabilities and low social position of the
bulk of agricultural labourers are in themselves no small part of the
problem. The vast majority belong to SCs, STs, and OBCs.
Some of their social handicaps might have diminished beca use of the
government’s dis criminatory and reservation policies, yet their economic
and social status has not much improved. They are not considered a part of
social life in a village.
8.7 CONTRACT FARMING
Contract farming can be defined as agricultural p roduction carried out
according to an agreement between a buyer and farmers, which establishes
conditions for the production and marketing of a farm product or products.
Typically, the farmer agrees to provide agreed quantities of a specific
agricultural p roduct. These should meet the quality standards of the
purchaser and be supplied at the time determined by the purchaser. In turn,
the buyer commits to purchase the product and, in some cases, to support
production through, for example, the supply of farm inputs, land
preparation and the provision of technical advice.
Contract farming involves agricultural production being carried out on the
basis of an agreement between the buyer an d farm producers. Sometimes
it involves the buyer specifying the quality required and the price, with the
farmer agreeing to deliver at a future date. More commonly,
however, contracts outline conditions for the production of farm products
and for their delivery to the buyer's premises.[1] The farmer undertakes to
supply agreed quantities of a crop or livestoc k product, based on the
quality standards and delivery requirements of the purchaser. In return, the
buyer, usually a company, agrees to buy the product, often at a price that
is established in advance. The company often also agrees to support the
farmer t hrough, e.g., supplying inputs, assisting with land preparation,
providing production advice and transporting produce to its premises.
Contract farming is the contractual arrangement between farmer and the
firm, whether oral or written, specifying one or m ore conditions of
production and/or marketing of an agricultural product.
Contract farming minimally demands a crop agreement made in advance,
the firms, in varying degrees, shares the decision making power with the
farmer. The farmer lends to the producti on process labour and land in his
possession. Conversely the firm provides some of the production,
knowledge inputs, marketing facility and participates in production
decision and supervision.

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168 8.7.1 Objectives
1. Supplying planting material
2. Guiding producti on of crops
3. Facilitate bank loan
4. Assured buy back agreement
8.7.2 Types
Several types of contracts are distinguished according to the sharing of
risks and specification of contract terms. From the management view
point, two types of contracts are determine d.
1. Limited Management Contract where a farmer gets production input
and sells the produce to the firm. There is no real guarantee for the
price for the produce.
2. Full Management Contract where the farmer and the firm have entered
into contract for certain a mount of production. In this kind of contract
the price is announced before the season thus the price risk is
minimised. The firm provides market for the produce provided the
quality specifications are met.
8.7.3 Khols and Uhl (1985) classified contra cts i nto three broad
categories :
1. Market specification contract where contract is a pre -harvest
arrangement that binds the firm and grower to a particular set of
conditions governing the sale of the crop. These conditions often
specify price, quality and timing of delivery of the produce.
2. Resource providing contract where the contract oblige the contracting
firms to supply production inputs, extension or credit in exchange for a
marketing arrangement.
3. Management and income guaranteeing contract where contract
includes the production and marketing stipulations of the former two
types. In addition, market and price risks were transferred from
farmers to firm and the farmer is assured of a certain level of revenue.
But the contracting firms take a substantial part o f the managerial
responsibility of the farmer.
8.7.4 Models :
1) Tri-partite Model :
This model incorporates industry, growers and financial institutions.
Under this system, the industry supplies quality planting material at
subsidized rate and assures min imum support price.The financial
institutions viz., Indian Bank, State Bank of India and Syndicate Bank
provide credit facilities to the growers. munotes.in

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169

2. Quad -partite Model
This system is similar to tri -partite model barring the involvement of
research instit ute. In this system, research institute play a significant role
for technological advancements through varietal development and also to
advice site specific precision technology to the growers. A pre and post -
plantation scientific advice helps to develop h uman resources through on
and off institute mode to farmers and plantation staff of the industries.

Contract farming business models
3. Informal model - As the name suggests, it is an informal model. This
model is followed by single entrepreneurs or smal l companies who enter
informal contracts with the farmers for a particular season. This is majorly
done for fresh vegetables and fruits. Unlike the rest of contracts which are
long term, the informal model is not for long. It could be for a single munotes.in

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170 season o r two. Generally the duration of such a contract depends upon the
need and resource arrangement by the entrepreneurs or small companies.
 Generally, in this type of informal model, the buyer has to take help
from the government regarding the supporting serv ices like extension
service, technology transfer, technical know -how as well as credit
arrangement. The buyer can also form contracts with farmers without
giving services to them while ensuring their produce will be bought by
the buyer.
 This model is the most transient and speculative of all contract
farming models, with a risk of default by both the promoter and the
farmer. However, this depends on the situation: interdependence of
contract parties or long -term trustful relationships may reduce the risk
of opportunistic behaviour. Special features of this CF model are:
o Small firms conclude simple, informal seasonal production contracts
with smallholders.
o The success often depends on the availability and quality of external
extension services.
o Embedded serv ices, if at all provided, are limited to the delivery of
basic inputs, occasionally on credit; advice is usually limited to
grading and quality control.
o Typical products: requiring minimal processing/ packaging, vertical
coordination; e.g. fresh fruit/ veg etables for local markets, sometimes
also staple crops.

4. Intermediary model - In this model, the buyer subcontracts an
intermediary (collector, aggregator or farmer organisation) who formally
or informally contracts farmers (combination of the central ised/ informal
models). Special characteristics of this CF model are:
o The intermediary provides embedded services (usu - ally passing
through services provided by buyers against service charges) and
purchases the crop.
o This model can work, if well -designed and if incentive -structures are
adequate and control mechanisms are in place. munotes.in

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171 o This model can bear disadvantages for vertical coordination and for
providing incentives to farmers (buyers may lose control of production
processes, quality assurance and regula rity of supplies; farmers may
not benefit from technology transfer; there is also a risk of price
distortion and reduced incomes for farmers).

5. Multipartite model - This model can develop from the centralised or
nucleus estate models, e.g. following th e privatisation of para - statals. It
involves various organisations such as govern - mental statutory bodies
alongside private companies and sometimes financial institutions. The
services provided by the farmer will come from different organizations
accordi ng to their expertise. For example, farmers will be provided
financial services from the financial institutes who are part of the contract,
they will be getting agri -inputs from the agri -inputs company, while
specific technology needed at farm level will b e provided by the tech
company. And at the end, the harvested produce is taken by the main
buyer company.
 This model makes a large ecosystem where different stakeholders are
involved under one project. Typically such projects are relatively big
and a large quantity of produce is exchanged between the grower and
buyer.
 This type of contract farming system brings a win -win situation for all
the bodies coming under the project. Farmers are benefited as they
have access to all kinds of services
 Special features :
o This model may feature as joint ventures of parastatals/ community
companies with domestic/ foreign investors for processing.
o The vertical coordination depends on the discretion of the firm. Due
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172 o This model may also feature as farm -firm arrangement complemented
by agreements with 3rd party service providers (e.g. extension,
training, credits, inputs, logistics).
o Separate organisations (e.g. cooperatives) may organise farmers and
provide embedded services (e.g. credits, extension, marketing,
sometimes also processing).
o This model may involve equity share schemes for producers.
6. Centralized model - In this model, the buyers’ involvement may vary
from minimal input provision (e.g. specific variet ies) to control of most
production aspects (e.g. from land preparation to harvesting). In this type
of contract farming, there is one centralized processor or buyer who is the
only entity involved in the contract with farmers. It is centrally monitored
and managed by the buyer. All the services whether it is technical
guidance or advisory is provided by them and no other stakeholder or
entity is involved. The services by the buyer company may range from
providing just good quality seeds or the extreme oppos ite by providing all
the required services like land preparation, seedlings, Agro -chemicals and
even harvesting services. Moreover, in this type of contract farming, the
buyer procures from many small farmers rather than buying from a few
large farmers. T his is the most common CF model, which can be
characterised as follows:
o The buyer sources products from and provides services to large
numbers of small, medium or large farmers.
o The relation/ coordination between farmers and contractor is strictly
vertical ly organised.
o The quantities (quota), qualities and delivery conditions are
determined at the beginning of the season.
o The production and harvesting processes and qualities are tightly
controlled, sometimes directly implemented by the buyer’s staff.
o Typica l products: large volumes of uniform quality usually for
processing; e.g. sugar cane, tobacco, tea, coffee, cotton, tree crops,
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7. Nucleus estate model - In this model, the buyer sources both from own
estates/ plantations and from contracted farmers. The estate system
involves significant investments by the buyer into land, machines, staff
and management. This CF model can be characterised as follows:
o The nucleus estate usually guarantees supplies to assure cost -efficient
utilisation of installed processing capacities and to satisfy firm sales
obligations respectively.
o In some cases, the nucleus estate is used for research, breeding or
piloting and demonstration purposes and/ or as collection point.
o The farmers are at times cal led ‘satellite farmers’ illustrating their link
to the nucleus farm. This model was in the past often used for state
owned farms that re -allocated land to former workers. It is nowadays
also used by the private sector as one type of CF. This model is often
referred to as “outgrower model”.
o Typical products: perennials
o The nucleus estate model
o In the nucleus estate model the buyer company owns and manages the
farm. The land which they own may be their own or taken on lease
from the farmers. This type of cont ract farming model forms a closed
ecosystem where the buyer has much control on the farm as well as all
the activities done throughout the season. Hence, they can expect the
exact quality of farm produce after the harvest. Such a model is
followed by the c ompanies who have their own land and the quantity
produced from that land fulfills their need.
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8.7.5 Advantages/ Benefits of Contract Farming :
Contract farming comes with various benefits not only to farmers but also
to the buyer companies. Contract fa rming is looking towards the benefits
both for the farm -producers as well as to the agro -processing firms. Let us
see some of the benefits of contract farming:
1. Benefits to farmers:
 Guaranteed and fixed pricing structure: Generally farmers are
unaware o f the price they will get from the market after harvesting.
Due to supply demand fluctuations the agricultural products are priced
beyond the affordability of the farmers. Contracts enable the price
fixation before the season starts and give an assured pri ce to the
farmer.
 Guaranteed buy back: The private companies guarantee buying of
the farm products after the harvesting. Hence, farmers do not have to
find a market to sell their produce. This also decreases the
transportation cost which other wise farmers have to bear taking the
products to market.
 Introduction to the technology: Involvement of technology firms
helps the farmers to adopt the latest technology. Eventually the best
quality of produce can be grown and incomes for farmers increase.
 Access to c redit and financial services: India`s rural financing sector
is still unexplored. Farmers are not aware of various financial services.
Even if they are aware, there is poor accessibility. Contracts enable
them to take the benefit of taking credit and crop insurance.
 Skill and knowledge transfer: Through technical knowledge and
advanced cropping schedule given by the buyer company farmers have
an opportunity to learn something new and adopt in their daily farming
activities.
 Provision to inputs and productio n services: Not only the input
provided but also the knowledge transfer of judicious use of those
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175  Makes small scale farming competitive - small farmers can access
technology, credit, marketing channel s and information while lowering
transaction costs
Assured market for their produce at their doorsteps, reducing marketing
and transaction costs
It reduces the risk of production, price and marketing costs.
Contract farming can open up new markets which wo uld otherwise be
unavailable to small farmers.
It also ensures higher production of better quality, financial support in
cash and /or kind and technical guidance to the farmers.
In case of agri -processing level, it ensures consistent supply of agricultural
produce with quality, at right time and lesser cost.
2. Benefits to buyer:
Desired quality and quantity of produce: The firms can get the specific and
timely delivery of products directly from the field.
Traceability: As the produce is grown under the con stant monitoring and
observation, the company is well aware of the ingredients used in the form
of inputs to produce them which helps to get advantage of backward
traceability.
Avoiding market supply -demand fluctuation: The market is never constant
for the raw material produced at farm. However, the demand for processed
food is increasing day by day. In such a case, it is very much important to
have a constant supply of raw material. The contract based farming
enables the constant supply.
Cost-efficient: Th e cost of procuring the farm produce decreases while
procuring it directly from the farm gate as there is minimal involvement of
middlemen like agents who charge the commission.
3. Agri -based firms
 Optimally utilize their installed capacity, infrastructure and manpower,
and respond to food safety and quality concerns of the consumers.
 Make direct private investment in agricultural activities.
 The price fixation is done by the negotiation between the producers
and firms.
 The farmers enter into contract produ ction with an assured price under
term and conditions.

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176 8.7.7 Challenges :
• Contract farming arrangements are often criticized for being biased in
favor of firms or large farmers, while exploiting the poor bargaining
power of small farmers.
• Problems fa ced by growers like undue quality cut on produce by firms,
delayed deliveries at the factory, delayed payments, low price and
pest attack on the contract crop which raised the cost of production.
• Contracting agreements are often verbal or informal in nat ure, and
even written contracts often do not provide the legal protection in
India that may be observed in other countries . Lack of enforceability
of contractual provisions can result in breach of contracts by either
party.
• Single Buyer – Multiple Selle rs (Monopsony).
• Adverse gender effects - Women have less access to contract farming
than men.
• while growing new crops,farmers face the risks of both market failure
and production problems Farmers may become indebted because of
production problem a nd excessive advances.
Some other issues are
 Soil fertility concern.
 Environmental issues.
 Food security concerns.
 Seed problems.
 Labour problems.
 Contract disputes.
 Middle man’s influence.
8.7.8 Policy support :
Agricultural marketing is regulated by the States’ Agricultural Produce
Marketing Regulation (APMR) Acts. In order to regulate and develop
practice of contract farming, Government has been actively advocating to
the States/ Union Territories (UTs) to reform their agri marketing laws to
provide a system of registration of contract farming sponsors, recording of
their agreements and proper dispute settlement mechanism for orderly
promotion of contract farming in the country.
8.7.9 NABARD’s Initiatives in contact farming :
NABARD developed a sp ecial refinance package for contract farming
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177 production of commercial crops and creation of marketing avenues for the
farmers. The various initiatives undertaken by NABARD in this directio n
are:
 Financial Interventions
 Special Refinance package for financing farmers for contract farming
in AEZs
 100% refinance to disbursements made by CBs, SCBs, RRBs and
select SCARDBs (having net NPA less than 5%)
 Term facility for repayments (3 years)
 Fixation of higher scale of finance for crops under contract farming.
 Extension of refinance scheme for financing farmers for contract
farming in AEZs to contract farming outside AEZs besides coverage
of medicinal and aromatic plants.
 Extension of Refinance sc heme for contract farming under Automatic
Refinance Facility.
8.7.10 Agricultural produce suitable for Contract Farming :
The various agricultural produce are suitable for practices under contract
farming like tomato pulp, organic dyes, poultry, pulpwood, mushrooms,
dairy processing, edible oils, exotic vegetables, baby corn cultivation,
basmati rice, medicinal plants, potato for making chips and wafers, onions,
mandarin oranges, durum wheat, flowers and orchids, etc.
Key minimum requirements for appropriat e contract schemes
Broadly, the project must:
 not result in farmers’ overspecialisation in certain crops to the
detriment of building resilience and contributing to local food security;
 promote sustainable farming practices and not promote reliance on
chem icals or expensive seeds, or lead to excessive debts;
 lead to higher incomes for farmers than they would otherwise earn,
and compared to alternative models
 substantially include women farmers and promote their rights;
 promote the land rights of farmers;
 apply free, prior and informed consent of those affected in terms of
project design and implementation.


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178 In relation to contractual terms, the project should:
 be negotiated transparently and fairly among the parties, providing
adequate information at all t imes on the financial aspects of the project
and the risks and likely impacts;
 consider alternative contract farming models;
 be regulated by a written contract spelling out the details and
obligations of both the company and the out -growers, and which mus t
be written in a clear and understandable way with out -growers given
sufficient time to review it;
 be transparent about how the price is determined, the duration of the
project and how production inputs and other services are to be
supplied and used by fa rmers;
 build in a clause for the renegotiation of the contract at agreed
intervals, and specify the sharing of production and market risks
among the parties;
 track and communicate performance to affected stakeholders to build
accountability at the operatio nal level;
 prevent unfair practices in buyer -farmer relations, and not prohibit or
discourage farmers from associating with other farmers to compare
contractual clauses or to address concerns or problems;
 have clear mechanisms for settling disputes.
The go vernment should:
 act as a third party, or mediator, between the parties and not be a
mouthpiece for the company sponsor;
 have appropriate legislation to ensure that farmers’ rights can be
enforced
8.7.11 Conclusion :
Companes like HUL • ITC • SUGUNA POULTR Y •
VENKATESHWARA HATCHERIES • PEPSICO • RALLIS • NESTLE
have entered in contract farming.
India, given the diverse agro climatic zones, can be a competitive producer
of a large number of crops. There is a Need to convert our factor price
advantage into su stainable competitive advantage. India has most small
and marginal farmers. They are not able to avail some basic services
required in Agriculture. The reason can be either they are not aware of
such services or they are not able to access them. Contract f arming in
India can solve this issue. Moreover, there is constant price fluctuation in
the market, due to which not only farmers but also exporters, agri
processing firms are facing challenges. This system of getting under
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179 produce. India has to evolve from its conventional way of farming. The
first step is to adopt the contract farming system and scaling the model
throughout the geography. Government can also support by actively
makin g public private partnerships and working with farmers making
many such joint ventures and achieving the target of doubling farmers’
income.
8.8. QUESTIONS
Q.1. Explain the economics of share tenancy.
Q.2 Write an explanatory note on share tenancy.
Q.3 Explain crop sharing practices in India.
Q.4 Write a note on inequality in distribution of holdings.
Q.5 Write a note on market interlocking and interlinkages.
Q.6 Write a note on analysis of rural classes.
Q.7 Write an explanatory note on contract farm ing.
8.9. REFERENCES
1. Heady Earl O. Economics of Agricultural Production and Resource
Use.
2. Kahlon A. S.and D.S.Tyagi, Agricultural Price Policy in India
3. Basu Kaushik, Agrarian Structure and Economic Underdevelopment.
4. Dantwala M L, Indian Agricul tural Development since Independence.


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