A Hedge Against Uncertainty In Agribusiness

Corona robs joy of poultry farmer,
Eggs are sold far below market can offer.
Time has come to introduce big buyer,
Way of hedging against loss & not letting him suffer.

Coronavirus stretched its shadow over poultry farming, dairy farming and other agribusinesses. News reports say gloomy dairy farmers are selling their milk much below the market price. Mobile egg sellers are selling eggs at Tk 75/dozen. In normal times, a dozen would cost Tk 120. Evidently, poultry farmers and dairy farmers bear the full brunt of the falling demand, compounded by indefinite lockdown.

Poultry and dairy farming are 100% value adding economic activities. Money was often drawn from local cooperatives, relatives, microfinance institutions and even public banks. Any bad spell to farming activities will augur ill for informal and institutional investors. So in a broader sense, many investors’ money may be lost if poultry and dairy projects fail because of Coronavirus.

If poultry farmers and dairy farmers are not duly compensated for the loss, then we may see a production slump in the subsequent years, adding further woes to the consumers by raising the prices of eggs and milk. Egg is the cheapest source of protein. Any supply shock or price hike in fish or meat leads to consume more eggs. As it appears, this Coronavirus may also make a dent in our protein consumption.

I did a little analysis on the impact of disaster years on egg price for the period 2012-2018. For the given period I gathered data for fish(Rui) and egg prices. Data gleaned from BBS Statistical Pocket Book 2016 and 2018.

At 5% level of significance and for 7 observations and 1 explanatory variable, the Durbin-Watson statistic reported no autocorrelation(d = 2.345).

It was assumed that for ordinary citizens fish and egg secured the bottom places in the protein ladder in terms of price. So, apart from supply and demand side factors egg price to some extent depends on fish price. It was also assumed that eggs were sold at Tk 95 per dozen in 2017 as the data for that year was not available.

Following regression function was constructed:

lnEgg_t = a + b Fish_t + c D_t
where lnEgg_t = log natural of Egg price at t,
Fish_t = Fish price at t,
D = 1 for disaster years ( any kind) ,
= 0 form calm/ normal years.

After running the regression got the following result:

lnEgg_t = 4.97 -0.0012 Fish_t + 0.00616 D_t (F= 1.153, p = 0.402)
(t=18.64, p= 0.000048) (t= -1.48, p= 0.211) (t= 0.117, p=0.91)

Except the intercept, neither the model nor the slope coefficients turned out to be significant. If the coefficient of the dummy variable were significant, we would say that egg prices during disaster years were 0.62% higher than those during calm years.

For the current year, we are witnessing that egg price hits all time low in the last 10 years. Unfortunately, our market conspicuously lacks mechanism of hedging against volatility. Moreover, in a corrupt country like ours compensation for disasters may often fall in wrong hands, mocking the steps to aid victims. As it is noticed, borrowers of microcredit often receive compensation during bad times due to their attachment to institutional lenders. By the same token, if we develop some kind of institution in farming and agribusiness model, then we will ensure just prices for our farmers and will insulate them from any volatility from man-made or natural disruption.

Game theory helps us better to grasp this point. Here I present a sequential game. Pairs of numbers in the game tree represent payoffs to poultry farmer(P) and wholesaler(W). Poultry farmer has two choices to make: to make a contract with an institutional distributor to sell his eggs at negotiated price in the future(C); or not to make the contract with big distributor and rely on the usual middlemen(NC). Meanwhile, for wholesaler, the choice is to offer the prices of normal market(N) or the volatile market (V)reading the market demand.

The first number in the pair represents the price received by the poultry farmer by selling a dozen of egg. The second number represents the payoff to wholesaler by selling a dozen of egg.

Two important criteria for determining the outcome of the game are:

⚫ Provided that what the others have chosen, a player’s decisions must be optimal.
⚫ At the time decisions are taken, they are optimal for the decision-maker.

Looking at game tree, we realize that for two subgames there are two Nash equilibria. If poultry farmer chooses no contract with big distributor, then wholesaler’s optimal decision will be to offer the normal market price. (96,120) is the equilibrium here. Because Tk 120 is greater than Tk 75 for the wholesaler. If the poultry farmer goes for contract with big distributor then wholesaler’s response will be to go for normal market price offer. Here the Nash equilibrium is (108,140).

For poultry farmer, a decision at the present time depends on his returns in the future. He will compare his returns under two states. He will notice that a contract will fetch him Tk 108 and no-contract will get him Tk96. Moreover, volatile prices (Tk 48 > Tk 36) are higher under contract. Since Tk 108 under contract-normal market price is higher than Tk 96 under no-contract –normal market price, his optimal decision will be Tk 108. So poultry farmer looks forward but reasons backward. When poultry farmer chooses the contract, wholesaler will go for the normal-market price, Tk 140 here. So (108,140) is the subgame perfect equilibrium here.

Underlying assumptions here in this discussion are---- there are many big distributors (including the govt backed-one) apart from middlemen; returns under contract with distributors are higher than those under no-contract. Moreover, in any kind of disaster like situation if the govt wants to send compensation then it can do so through the distributors.

Anyone could become this big distributor. Egg cooperatives, TCB, a public listed company or a big local group could easily vie for a big distributor. Govt has to ensure that there are many of these distributors and they operate under certain laws.

Key take-away of this discussion is : big distributors are needed in agribusiness to protect the farmers from volatility and uncertainty. Their presence will ensure just prices for the farmers as well as help flawless distribution of compensation in a disaster like situation.

The idea of big distributors should be preceded by new laws or fine-tuning of existing ones. Laws demarcate do’s and don’ts for the parties in crisis like situation and dispel any ambiguity. Value-adding nature of agribusiness and involvement of informal investors calls for greater govt protection. Laws should be attuned to these ground realities.