VZCZCXRO5634
RR RUEHAST RUEHBI RUEHCI RUEHLH RUEHPW
DE RUEHNE #0314/01 0310555
ZNR UUUUU ZZH
R 310555Z JAN 08
FM AMEMBASSY NEW DELHI
TO RUEHC/SECSTATE WASHDC 0228
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHCG/AMCONSUL CHENNAI 2354
RUEHKP/AMCONSUL KARACHI 8462
RUEHCI/AMCONSUL KOLKATA 1667
RUEHLH/AMCONSUL LAHORE 4287
RUEHBI/AMCONSUL MUMBAI 1463
RUEHPW/AMCONSUL PESHAWAR 4753

UNCLAS SECTION 01 OF 05 NEW DELHI 000314 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
USDA PASS FAS/OCRA/HIGGISTON 
STATE FOR SCA/INS JASHWORTH AND SCA/RA MURENA 
DEPT PASS TO USTR - CLILIENFELD/AADLER 
DEPT PASS TO TREASURY FOR OFFICE OF SOUTH ASIA - ABAUKOL 
USDOC FOR 4530/ITA/MAC/OSA/LDROKER/ASTERN 
TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN 
 
E.O. 12958: N/A 
TAGS: BTIO EAGR ECON EINV IN ETRD EFIN PREL
SUBJECT: CONTRACT FARMING HAS LIMITED USE THUS FAR FOR ORGANIZED 
RETAIL, BUT APPEALS TO FARMERS 
 
REF: A) 08 NEW DELHI 95 
 B) 08 MUMBAI 19 
 
NEW DELHI 00000314  001.2 OF 005 
 
 
¶1.  (SBU) SUMMARY:  Contract farming offers farmers a stable and 
profitable way to sell to agro-businesses, and is gaining popularity 
as a means of cutting out middlemen in the agricultural supply 
chain.  A number of companies are successfully sourcing agricultural 
products directly from farmers for their needs and are looking to 
expand the goods procured through this process.  Contract farming 
relies fundamentally on a long-term relationship with farmers, an 
established presence in the agri-business, and large investments by 
the company at the start of the venture with little help from the 
agricultural community.  Although it forces companies to initially 
undertake a large amount of risk, this type of arrangement can also 
offer stable quantities and eventually create a mutually beneficial 
relationship between companies and farmers, which can then 
ultimately benefit the Indian consumer.  Still, its applicability to 
organized retail and to smaller farmers is limited, and expanding 
the scope of this model may require more state involvement, at a 
time when agricultural is politically controversial. 
 
¶2.  (SBU) This cable is part of a series that will address the 
potential impact of organized retail on the agricultural sector. 
Although the front end of the "retail revolution" has attracted 
considerable attention through new stores and shopping formats, 
these cables will focus on the back end of the supply chain and 
examine a few of the business models being used by the private 
sector to engage India's farmers.  END SUMMARY. 
 
BACKGROUND 
---------- 
 
¶3.  (SBU) Contract farming is a system of sourcing that links 
suppliers to buyers through forward contracts.  At the core of such 
an arrangement is the commitment of the seller to provide a certain 
quantity and type of commodity to the buyer at a specified time. 
The buyer in turn guarantees the supplier a fixed price for the 
produce.  Contract farming has been used in India for hundreds of 
years, largely for commodities such as cotton and tobacco.  The 
Agricultural Produce and Marketing Committee (APMC) Acts, state laws 
passed in the 1960s and 1970s, prohibited companies from contracting 
directly with farmers for farm produce, but since 2003, several 
states have amended these acts to allow companies to directly 
procure goods from farmers through either spot purchases or contract 
farming.  The advantage of this model is that companies can easily 
procure goods and farmers have an alternative to selling at the 
mandis (market yards), at which they are charged large commissions 
by traders and earn a fraction of the ultimate retail price of their 
produce. 
 
¶4.  (SBU) The legislative changes - along with the increased use of 
branded products and the rise in organized retail driven by growing 
consumer demand - has prompted some companies such as Indian Tobacco 
Corporation (ITC) to attempt contracts in fresh fruits and 
vegetables.  However, the proposition is risky because these 
contracts are still not legally enforceable in India; therefore, 
either side can choose not to honor the contract (which is usually 
verbal or informal).  If the market price of the contracted 
commodity falls, the company could choose to procure the goods at 
the local mandi instead of paying the farmer a higher, pre-agreed 
price.  If the price of the commodity rises, the farmer has an 
incentive to break the contract and sell at a higher price at the 
mandis. 
 
¶5.  (SBU) In order to mitigate the risks of contract default, 
successful companies have been using local partnerships and a 
long-term presence to assure needed quantities.  PepsiCo started 
contract farming in 1989 with tomatoes - originally as part of a 
corporate social responsibility project - and McDonald's began 
entering into informal contracts in 1996 to supply its Indian 
stores. Recent studies point to contract farming as a means to 
improve farmer income. 
 
MCDONALD'S EXPANDING 
CONTRACTING OPPORTUNITIES 
 
NEW DELHI 00000314  002.2 OF 005 
 
 
-------------------------- 
 
¶6.  (SBU) Congenoffs met on January 15 with Mr. Abhijit Upadhyaye, 
McDonald's Mumbai-based director of supply chain and menu 
management.  McDonald's first store opened in 1996, he stated, and 
the company has since expanded to 140 total stores across India. 
However, he highlighted that the company arrived in India as early 
as 1990 to identify suppliers, create joint ventures, and contract 
with companies for logistics and cold chain help to establish an 
efficient and dedicated supply system.  Upadhyaye explained that 
McDonald's uses "handshake" contracts with its suppliers, which 
means that no written guarantees are provided, but a supplier that 
breaks a contract loses McDonald's business completely - a large 
enough threat to any local supplier because of McDonald's sheer 
size, which keeps contracts largely intact.  The supplier, he 
stated, has to work with the farmers to get needed produce, and 
until recently, had to procure these goods from the mandis.  (Note: 
McDonald's works through a Canadian company, McCain, to procure its 
produce. McCain is ultimately responsible for filling the contract, 
either locally or through imports. End note.) 
 
¶7.  (SBU) Upadhyaye noted that McDonald's was now contracting with 
farmers, largely in Gujarat and Madhya Pradesh, for two products - 
iceberg lettuce and potatoes.  He explained that McDonald's gives 
specifications on quality and size to the farmers, while an expert 
agricultural team provides them with extension services such as 
technology and training in good farming techniques.  According to 
Upadhyaye, the company is also working to provide its farmers with 
access to credit through McDonald's or partner banking institutions. 
 Through these services, he stated that farmers were improving their 
yields by up to 40 percent and developing higher quality products 
that fetch higher contracted prices from the company.  However, he 
said that McDonald's uses primarily large landholders - farmers with 
100 to 200 acres - for its contracts. Upadhyaye mentioned that the 
company still uses the mandis for crops such as tomatoes and onions, 
although it is planning to develop direct contracts for tomatoes in 
the near future.  He further noted that other fresh produce used in 
McDonald's India offerings, such as peas and carrots, are too low in 
volume to be worth contract farming.  McDonald's does not own cold 
chain infrastructure and does not plan to develop it, he added. 
 
¶8.  (SBU) Upadhyaye emphasized that the contracts were based largely 
on mutual trust between the producers and buyers, and took a long 
time to develop.  He noted McDonald's commitment to on-time 
payments, technology transfers, and ability to reward reliable 
suppliers with new business.  In return, he stated that McDonald's 
expects all suppliers to deliver assured quantities, quality 
produce, and competitive prices.  He believes that this fair 
exchange makes both sides equally dependent and forms a lasting and 
stable business relationship. 
 
 
PEPSICO LEVERAGING GOVERNMENT, 
LOCAL INVOLVEMENT 
-------------------- 
 
¶9.  (SBU) ECONOFFS also met with PepsiCo officials in New Delhi, who 
discussed the company's foray into contract farming in tomatoes as 
early as 1989.  Sunil Duggal and Pawan Sharma, the director and 
general manager of corporate affairs, respectively, explained 
PepsiCo's early entry into such farming was part of a deal with the 
Indian government for the opportunity to sell their soft drinks in 
the country.  The company opened a tomato-processing plant in 
Punjab, which sourced local produce for the manufacture and export 
of tomato paste and purees.   Duggal relayed that the Punjab 
government was looking to diversify its farmers' output because 
paddy crops were badly stripping the soil and water levels in the 
state, and therefore partnered with PepsiCo on this venture.  Local 
bodies such as the Punjab Agricultural University and Punjab 
Agro-Industries Corporation advised and provided extension services 
to Punjab's farmers for PepsiCo's needs, including inputs such as 
seeds, delivery of agricultural best practices, and regular crop 
inspections.  Duggal praised their local knowledge, which he said 
helped the company's farmers vastly improve yields and quality. 
 
 
NEW DELHI 00000314  003.2 OF 005 
 
 
¶10.  (SBU) Duggal noted that the company contracts with several 
hundred farmers, both large and small.  He admitted that contract 
default is a risk in certain crops when mandi prices are higher, but 
the company can offer to match the market price of some contracted 
goods, which can be a high cost but assures quantity.  He explained 
that Pepsi does not renege on its contracts, offers the farmer 
stability, provides regular advice and feedback on the produce, and 
can offer financial help when needed - all of which help sustain the 
long-term relationship and avoid default.  He said the company 
rejects less than 10 percent of produce because of failure to meet 
PepsiCo's specifications, and in those cases will turn to the mandis 
to make up the quantity needed. 
 
¶11.  (SBU) Duggal and Sharma on January 23 took ECONOFFs on a tour 
of a PepsiCo-operated farm in Jalandhar, Punjab for citrus fruit, 
one of the company's newer contracting ventures that was started in 
2004, using citrus trees imported from Florida and California.  The 
25-acre nursery is owned by two farmers, but leased to the Punjab 
government through the Council for Citrus and Agri-Juicing in 
Punjab.  Its representative, senior manager Baldeep Bajwa, explained 
that the area was operated by PepsiCo through a USD 5 million 
investment.  Including nearby facilities, Duggal stated that PepsiCo 
contracts about 65 total acres of land for citrus, another 20 to 25 
acres for direct growing of vegetables, and 10 additional acres to 
explore experimental practices for growing basmati rice. 
 
¶12.  (SBU) Dr. Susheel Sankhyan, Pepsi's general manager at the 
nursery, showed EMBOFFS the greenhouse plants, buds, and trees that 
PepsiCo is nurturing at the farm, using modern agricultural 
practices.  The nursery's five greenhouses can produce a total of 4 
million viable citrus trees per year.  Sankhyan explained that 
because the orange is relatively new to India and a full orange tree 
takes six years to develop, the company grows the trees for 18 to 24 
months and then turns them over to farmers to plant, nurture, and 
harvest the fruits.  Sankhyan explained that farmers sign 12-year 
contracts (allowed by the Punjab government), in which they collect 
rent for the first six years, and receive both rent and 50 percent 
of the revenues of the citrus sales for the second six years. 
(Note: Duggal stated that the orange juice business is growing at 
about 30 percent per annum. End note.) 
 
¶13.  (SBU) Bajwa noted that while farmers seem happy with the 
arrangement now, it was difficult to initially persuade them to 
plant the citrus trees.  He said that they generally intercrop 
(plant complimentary crops on the same land) for the first six years 
while the land is undeB lease so as to have supplemental income, but 
also to hedge against the risk of the company reneging on a 
contract.  Bajwa also spoke of new employment opportunities for 
farmers in the area because of these new crops - farmers in Punjab 
were routinely leaving the area and leasing their land to other 
farmers, which reduced the overall number of employed landless 
laborers.  Now, he stated, nurseries like this employed at least 75 
people and could offer new opportunities if demand grows.  In 
addition, the citrus crops use only a tenth of the water required 
for intensive and damaging crops such as rice, which will help stem 
the water depletion in Punjab's soil and sustain agriculture in the 
long-term.  New techniques offered by PepsiCo and the government on 
farming are also applied to other crops to improve yield, Bajwa 
added. 
 
¶14.  (SBU) EMBOFFS then visited PepsiCo's nearby juicing plant, not 
far from the nursery.  (Note: The short supply chain means that 
PepsiCo does not require cold chain infrastructure from the farm to 
the plant, though it does have cold storage at the plant for its 
concentrate. End note.) The multi-product plant opened in May 2007 
but only operates when certain fruits are in season.  Ashok Kumar, 
vice president of manufacturing for a food processing firm working 
with PepsiCo as a consultant, highlighted that PepsiCo used to 
import its oranges from Brazil and Mexico, but is now able to meet 
its demand locally because of its new contracting arrangements. 
 
SMALLER NICHE PLAYERS ALSO BENEFIT 
FROM CONTRACT FARMING 
---------------------- 
 
 
NEW DELHI 00000314  004.2 OF 005 
 
 
¶15.  (SBU) Congenoffs in Mumbai also met on January 10 with members 
of the Maharashtra Export Development Commission (MEDC), a small 
think tank that advises the Maharashtra government on a variety of 
economic policies, including agriculture.  Mr. Kagliwal, the 
chairman of the MEDC and president of Nath Seeds, a 
Maharashtra-based oilseed company, asserted that organized retail, 
and especially contract farming, were "the best thing to happen to 
the Indian farmer."  He said that farmers have four primary needs at 
the moment - credit, technology, an assured buyer, and a 
remunerative price.  Contract farming, he stated, meets all of these 
needs; moreover, farmers can increase their quantity without 
deflating the price received at the mandi.  Although the business 
model has higher risks and higher investment needs, it promises 
higher rewards to both sides, he noted. 
 
¶16.  (SBU) In a separate meeting on January 16, Mr. Kapadia, the 
managing director of Jayant Oilseeds, a Mumbai-based member of the 
MEDC, further praised contract farming's abilities to help both the 
company and farmer.  Kapadia explained that the company, which began 
operating in 1952 and now is a large producer of castor oil seeds, 
uses contract farming to work with small and marginal farmers, 80 
percent of whom own less than an acre of land.  Kapadia claimed that 
the company now works with over 7,000 farmers.  The company 
currently cultivates 20,000 acres but plans to quintuple this figure 
by next year, and reach over 500,000 acres in three years. 
 
¶17.  (SBU) Kapadia highlighted the ease of contract farming for 
oilseed, which is a technically advanced niche product.  Although as 
a hybrid seed it requires much research and development on the 
company's part, farmers can use it as a profitable intercrop that 
requires almost no maintenance.  The company, he added, gives the 
farmers technical knowledge, equipment, and the seeds and verbally 
guarantees to buy the produce.  Because the crop is specialized and 
no other buyers exist in their market at the moment, the company's 
default risk is low; similarly, the farmer has no alternate buyer 
and so is likely to sell as promised. 
 
¶18.  (SBU) According to Kapadia, the company has seen the positive 
impact on farmers first hand.  He cited farmers' incomes as having 
improved 25 to 30 percent from working with the company, and relayed 
stories of farmers who want to abandon the intercrop method and 
convert fully to oilseeds.  He noted that the state of Maharashtra, 
which was looking for an alternate crop for its poor and debt-ridden 
sugarcane and cotton farmers, approached the company to develop new 
opportunities.  Kapadia also highlighted expansion plans in Gujarat 
and Rajasthan, and praised the latter as being run by a 
forward-leaning and progressive state government.  He related that 
initially farmers still need to be convinced of the profitability 
and ease of the crop, but the company's partnerships with state 
governments and local NGOs make market entry more efficient and 
logistically easier. 
 
COMMENT 
------- 
 
¶19.  (SBU) Contract farming is a clear success for agri-businesses 
and farmers in distinct and specific cases.  The common themes for 
success of the three companies that we approached which have 
utilized contract farming appear to be a close link with state 
governments and local institutions, a long-term presence and 
reputation in local markets, and a willingness to take larger risks 
and make larger investments in the nascent stages - which in turn 
offer farmers stability, better incomes, and, ultimately, greater 
choice and employment opportunities.  Contract farming offers 
farmers a chance to move beyond subsistence farming and break the 
debt cycle, though it appears that most of the beneficiaries remain 
large and wealthier farmers. 
 
¶20.  (SBU) However, contract farming is not being employed much by 
organized retailers and likely will not be in the near-term. 
Although ITC has begun using contracts for "exotic" crops such as 
celery, most of the retail players we spoke with do not believe they 
can either procure the volumes needed in a cost effective way - 
having to rely on too many transactions and individual farmers - or 
that farmers will actually honor their contracts, in which case the 
 
NEW DELHI 00000314  005.2 OF 005 
 
 
company will have to take a hit.  The trust deficit between farmers 
and companies appears to run both ways, as farmers also seem 
reluctant to trust a single buyer and convert their farmland into a 
commodity that may not sell. 
 
¶21.  (SBU) The political environment in different states influence 
the development of contract farming.  Should state governments get 
more involved, however, the potential for contract farming in 
agricultural produce - as an alternative to selling at mandis - 
could become more viable and expand beyond its narrow scope. 
Amending APMC acts so that direct contracts between farmers and 
companies is possible is a good first step, but stronger state 
government-led extension services and links to agri-businesses may 
help reduce the trust deficit that is sidelining the emergence of 
the direct farmer-corporate relationships.  Legal enforcement of 
contracts will remain difficult in agriculture given its political 
sensitivity, so local institutions may need to help foster these 
relationships.  If the situation in Punjab before and after contract 
farming arrived is any indication, contract farming offers farmers 
substantial opportunities for cashing in on the agricultural retail 
boom. 
 
MULFORD