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Recently, the Ministry of Agriculture released a draft Model Contract Farming Act, 2018. The draft Model Act seeks to create a regulatory and policy framework for contract farming. Based on this draft Model Act, legislatures of states can enact a law on contract farming as contracts fall under the Concurrent List of the Constitution. In this context, we discuss contract farming, issues related to it, and progress so far.
What is contract farming?
Under contract farming, agricultural production (including livestock and poultry) can be carried out based on a pre-harvest agreement between buyers (such as food processing units and exporters), and producers (farmers or farmer organisations). The producer can sell the agricultural produce at a specific price in the future to the buyer as per the agreement. Under contract farming, the producer can reduce the risk of fluctuating market price and demand. The buyer can reduce the risk of non-availability of quality produce.
Under the draft Model Act, the producer can get support from the buyer for improving production through inputs (such as technology, pre-harvest and post-harvest infrastructure) as per the agreement. However, the buyer cannot raise a permanent structure on the producer’s land. Rights or title ownership of the producer’s land cannot be transferred to the buyer.
What is the existing regulatory structure?
Currently, contract farming requires registration with the Agricultural Produce Marketing Committee (APMC) in few states. This means that contractual agreements are recorded with the APMCs which can also resolve disputes arising out of these contracts. Further, market fees and levies are paid to the APMC to undertake contract farming. The Model APMC Act, 2003 provided for contract farming and was released to the states for them to use this as reference while enacting their respective laws. Consequently, 20 states have amended their APMC Acts to provide for contract farming, while Punjab has a separate law on contract farming. However, only 14 states notified rules related to contract farming, as of October 2016.
What are the issues with the current structure, and how does the draft Model Act seek to address them?
Over the years, expert bodies have identified issues related to the implementation of contract farming. These include: (i) role of APMCs which are designated as an authority for registration and dispute settlement in most states, (ii) provisions of stockholding limits on produce under contract farming, and (iii) poor publicity of contract farming among the farmers about its benefits.
Role of Agricultural Produce Marketing Committees/Marketing Boards
The NITI Aayog observed that market fees and other levies are paid to the APMC for contract framing when no services such as market facilities and infrastructure are rendered by them. In this context, the Committee of State Ministers on Agricultural Reforms recommended that contract farming should be out of the ambit of APMCs. Instead, an independent regulatory authority must be brought in to disengage contract farming stakeholders from the existing APMCs.
In this regard, as per the draft Model Act, contract farming will be outside the ambit of the state APMCs. This implies that buyers need not pay market fee and commission charges to these APMCs to undertake contract farming. Further, the draft Model Act provides for establishing a state-level Contract Farming (Promotion and Facilitation) Authority to ensure implementation of the draft Model Act. Functions of the Authority include (i) levying and collecting facilitation fees, (ii) disposing appeals related to disputes under the draft Model Act, and (iii) publicising contract farming. Further, the sale and purchase of contracted produce is out of the ambit of regulation of the respective state/UT Agricultural Marketing Act.
Registration and agreement recording
The Model APMC Act, 2003 released to the states provides for the registration of contract farming agreements by an APMC. This was done to safeguard the interests of the producer and the buyerthrough legal support, including dispute resolution. The procedures for registration and recording of agreements vary across states. Currently, registration for contract farming has been provided with the APMC in few states, and with a state-level nodal agency in others. Further, market fee on purchases under contract agreements is completely exempted in few states and partially exempted in others. The Committee of State Ministers on Agricultural Reforms recommended that a instead of a APMC, district-level authorities can be set-up for registration of contract farming agreements. Further, any registering authority should verify the details such as the financial status of the buyer.
Under the draft Model Act, every agreement should be registered with a Registering and Agreement Recording Committee, which will be set up consisting of officials from departments such as agriculture, animal husbandry, marketing, and rural development. Such a Committee can be set up at the district, taluka or block levels.
Disputes between the producer and the buyer
The Ministry of Agriculture and Farmers Welfare observed certain risks related to upholding the contract farming agreement. For example, producers may sell their produce to a buyer other than the one with whom they hold a contract. On the other side, a buyer may fail to buy products at the agreed prices or in the agreed quantities, or arbitrarily downgrade produce quality. The Committee of State Ministers on Agricultural Reforms recommended that dispute redressal mechanism should be at block, district or regional-level state authorities and not with an APMC.
Under the draft Model Act, in case of disputes between a producer and a buyer, they can: (i) reach a mutually acceptable solution through negotiation or conciliation, (ii) refer the dispute to a dispute settlement officer designated by the state government, and (iii) appeal to the Contract Farming (Promotion and Facilitation) Authority (to be established in each state) in case they are not satisfied by the decision of the dispute settlement officer.
Stockholdings limits on contracted produce
Stockholding limits are imposed through control orders as per the Essential Commodities Act, 1955. Such provisions of stockholding limits can be restrictive and discourage buyers to enter into contracts. It was recommended that the buyers can be exempted from stock limits up to six months of their requirement in the interest of trade. Under the draft Model Act, limits of stockholding of agricultural produce will not be applicable on produce purchased under contract farming.
Other recommendations
While contract farming seeks to provide alternative marketing channels and better price realisation to farmers, several other marketing reforms have been suggested by experts in this regard. These include: (i) allowing direct sale of produce by farmers, (ii) removing fruits and vegetables out of the ambit of APMCs, and (iii) setting-up of farmer-consumer markets, (iv) electronic trading, and (v) joining electronic National Agricultural Market for the sale of produce.
Later this week, the GST Council will meet to discuss the issue of GST compensation to states. The central government is required to compensate states for any loss of revenue they incur due to GST. The Centre must pay this compensation on a bi-monthly basis, but over the past one year these payments have been delayed by several months due to lack of funds. The COVID-19 pandemic and the consequent lockdown have amplified the issue manifold, with both centre and states facing a revenue shortfall, limiting the ability of the Centre to meet states’ compensation needs.
Why is the Centre required to compensate states for GST?
With GST implementation in 2017, the principle of indirect taxation for many goods and services changed from origin-based to destination-based. This means that the ability to tax goods and services and raise revenue shifted from origin states (where the good or service is produced) to destination states (where it is consumed). This change posed a risk of revenue uncertainty for some states. This concern of states was addressed through constitutional amendments, requiring Parliament to make a law to provide for compensation to states for five years to avoid any revenue loss due to GST.
For this purpose, the GST (Compensation to States) Act was enacted in 2017 on the recommendation of the GST Council. The Act guarantees all states an annual growth rate of 14% in their GST revenue during the period July 2017-June 2022. If a state’s GST revenue grows slower than 14%, such ‘loss of revenue’ will be taken care of by the Centre by providing GST compensation grants to the state. To provide these grants, the Centre levies a GST compensation cess on certain luxury and sin goods such as cigarettes and tobacco products, pan masala, caffeinated beverages, coal, and certain passenger vehicles. The Act requires the Centre to credit this cess revenue into a separate Compensation Fund and all compensation grants to states are required to be paid out of the money available in this Fund.
How much compensation is provided to states?
For 2018-19, Centre gave Rs 81,141 crore to states as GST compensation. However, for the year 2019-20, the compensation requirement of states nearly doubled to Rs 1.65 lakh crore. A huge increase in requirement implies that states’ GST revenue grew at a slower rate during 2019-20. This can be attributed to the economic slowdown seen last year, which resulted in a nominal GDP growth of 7.2%. This was significantly lower than the 12% GDP growth forecast in the 2019-20 union budget (Figure 1).
Figure 1: GDP growth rate (2017-21)
Sources: Union Budget Documents; MOSPI; PRS.
In 2019-20, the gross GST revenue (Centre+states) increased by just 4% over the previous year. Despite this, due to the compensation guarantee, all states could achieve the growth rate of 14% in their GST revenue – much higher than the overall growth in GST revenue. However, there was a delay in payment of compensation from Centre. More than Rs 64,000 crore of the compensation requirement of states for 2019-20 was met in the financial year 2020-21.
What led to a delay in payment of compensation to states?
In 2019-20, the delay in payment was observed due to insufficient funds with Centre for providing compensation to states. These funds are raised by levying a compensation cess on the sale of certain goods, some of which were affected by the economic slowdown. For instance, in 2019-20, sales of passenger vehicles declined by almost 18% and coal offtake from domestic coal companies reduced by nearly 5%, over the previous year. As a result, cess collections registered a growth of just 0.4% in 2019-20 (Figure 2), against the 104% increase seen in the compensation requirement of states. This resulted in a shortfall of funds of nearly Rs 70,000 crore.
Figure 2: Cess collections insufficient for providing compensation
Note: In 2017-18, GST was implemented for only nine months. Compensation amount shown may not match with the amount released in that financial year because of delay in releases.
Sources: Union Budget Documents; Ministry of Finance; GST Council; Lok Sabha Questions; PRS.
How can compensation be paid to states if cess collections are insufficient?
The shortfall in collections for 2019-20 was met through: (i) surplus cess collections from previous years, (ii) partial cess collections of 2020-21, and (iii) a transfer of Rs 33,412 crore of unsettled GST funds from the Centre to the Compensation Fund. These unsettled funds are GST collections, generated in 2017-18 from inter-state and foreign trade, that have not yet been settled between centre and states.
In the 2020-21 budget, the Centre has estimated a 10% growth in nominal GDP. However, due to the impact of COVID-19 and the lockdown, the actual growth in 2020-21 is likely to be much lower. In such a scenario, states’ GST revenue would also be much lower than expected, thus leading to a higher compensation requirement. However, the ability of Centre to pay compensation depends on the cess collections, which are also getting impacted this year. For instance, cess collections during the period Apr-Jun 2020 have been 41% lower in comparison to the same period last year. Moreover, of the Rs 14,482 crore collections made during this period, Rs 8,680 crore has been likely used up for paying compensation for 2019-20.
Note that under the GST (Compensation to States) Act, 2017, Centre can provide compensation to states only through the money available in the Compensation Fund. The Union Finance Minister, in her budget speech in February 2020, clarified that transfers to the Fund would be limited only to collections of the GST compensation cess. Despite a shortfall of money in the Compensation Fund, the Centre is constitutionally obligated to meet states’ compensation requirement for a period of five years.
Various measures have been suggested to address the issue of shortfall in the Fund, either by reducing the compensation payable to states (which would require Parliament to amend the Act following GST Council’s recommendation) or by supplementing the funds available with Centre for providing compensation to states. The Act allows the GST Council to recommend other funding mechanisms/ amounts for credit into the Compensation Fund. For example, one of the measures proposed for meeting the shortfall involves Centre using market borrowings to pay compensation to states, with the idea that these borrowings will be repaid with the help of future cess collections. To enable this, the GST Council may recommend to Centre that the compensation cess be levied for a period beyond five years, i.e. post June 2022.
Impact on states post 2022
In 2019-20, except for a few north-eastern states, most states saw their compensation requirements increase multifold by 2-3 times, over the previous year’s figures. Table 1 shows the compensation requirement of states for the years 2018-19 and 2019-20. Six states (Delhi, Gujarat, Karnataka, Maharashtra, Punjab, and Tamil Nadu) accounted for 52% of the total requirement of compensation for 2019-20. Further, in some states such as Punjab and Delhi, compensation grants form a significant share of the overall revenue receipts (20% and 16% resepctively).
Note that states have been guaranteed compensation only for a period of five years. After June 2022, states dependent on compensation will observe a revenue gap due to a cut in these grants coming from Centre. States have roughly two years to bridge this gap with other tax and non-tax sources to avoid a potential loss of revenue, and a consequent fall in the size of their state budget, which could adversely affect the economy. To what extent will such concerns be alleviated remains to be seen based on the course of action decided by the GST Council.
Table 1: GST compensation requirement of states for 2018-19 and 2019-20 (in Rs crore)
|
State |
2018-19 |
2019-20 |
% increase in compensation requirement |
||
|
Amount |
As a % of revenue |
Amount |
As a % of revenue* |
||
|
Andhra Pradesh |
0 |
- |
3,028 |
3% |
- |
|
Assam |
455 |
1% |
1,284 |
1% |
182% |
|
Bihar |
2,798 |
2% |
5,464 |
4% |
95% |
|
Chhattisgarh |
2,592 |
4% |
4,521 |
7% |
74% |
|
Delhi |
5,185 |
12% |
8,424 |
16% |
62% |
|
Goa |
502 |
5% |
1,093 |
9% |
118% |
|
Gujarat |
7,227 |
5% |
14,801 |
10% |
105% |
|
Haryana |
3,916 |
6% |
6,617 |
10% |
69% |
|
Himachal Pradesh |
1,935 |
6% |
2,477 |
8% |
28% |
|
Jammu and Kashmir |
1,667 |
3% |
3,281 |
5% |
97% |
|
Jharkhand |
1,098 |
2% |
2,219 |
4% |
102% |
|
Karnataka |
12,465 |
8% |
18,628 |
11% |
49% |
|
Kerala |
3,532 |
4% |
8,111 |
9% |
130% |
|
Madhya Pradesh |
3,302 |
3% |
6,538 |
4% |
98% |
|
Maharashtra |
9,363 |
3% |
19,233 |
7% |
105% |
|
Meghalaya |
66 |
1% |
157 |
2% |
138% |
|
Odisha |
3,785 |
4% |
5,122 |
5% |
35% |
|
Punjab |
8,239 |
13% |
12,187 |
20% |
48% |
|
Rajasthan |
2,280 |
2% |
6,710 |
5% |
194% |
|
Tamil Nadu |
4,824 |
3% |
12,305 |
7% |
155% |
|
Telangana |
0 |
- |
3,054 |
3% |
- |
|
Tripura |
172 |
1% |
293 |
3% |
70% |
|
Uttar Pradesh |
0 |
- |
9,123 |
3% |
- |
|
Uttarakhand |
2,442 |
8% |
3,375 |
11% |
38% |
|
West Bengal |
2,615 |
2% |
6,200 |
4% |
137% |
Note: Arunachal Pradesh, Manipur, Mizoram, Nagaland, and Sikkim did not require any compensation in 2018-19 and 2019-20.
*Revenue for the year 2019-20 does not takes into account those GST compensation grants which were payable to states in 2019-20 but were released by Centre in the year 2020-21. The percentage figures would be slightly lower if such grants are included in 2019-20 revenue.
Sources: State Budget Documents; Ministry of Finance; Lok Sabha Questions; CAG; PRS.
