Poverty reduction for small farmers through agroforestry Overcoming by broverya77


									Poverty reduction for small farmers through agro-
forestry: Overcoming risk aversion
A paper by

HOODA, A.K.*, and HOODA, N

Group Coordinator Research, Forest Research Institute (ICFRE)
New Forest P.O., Dehradun-248006, India.
Email: hoodaak@icfre.org; anilkhooda@yahoo.co.in
Ph: #91 135 2752670
Fax: #91 135 2756865


The study carries out financial and cash flow analyses to determine the viability
and additional income generation on small farms by adopting Poplar based
agroforestry systems. These results show that such agroforestry practices can
produce substantial additional income to the small farmers and reduce poverty.
However, the rate of interest, at which credit is available, is the key factor in
determining the wealth generation for small farmers. At higher interest rates the
benefits get transferred to lenders and therefore the small farmers are deprived
of the benefits. To reap the benefits of agroforestry systems in income
generation and reducing poverty especially in rural areas, there is need to
develop suitable financial packages to provide credit facility to farmers at
comparable rates.

Keywords: financial analysis, interest rate, small farmer, wealth, poplar


Agroforestry (AF) has been suggested as one mean of ameliorating negative
land use impacts while addressing the basic needs of agrarian societies
(Douchart 1989). The basic premise of an AF system is that total net benefit is
greater where joint rather than singular production exists (Betters 1989).
Agroforestry efforts have been undertaken as main component of social forestry
projects started in 1980’s onwards for rural development in India as it was
perceived to have great potential in reducing poverty in rural poor. The
supplemental income from trees on farms is important to the livelihood of poorer
farmers. In India, studies on social forestry programmes have shown that such
tree raising on farmlands in the fertile plains of northern India have been largely
taken up by the large farmers having big land holdings or by the absentee
landowners (Saxena 1991, Kumar et al. 2004).

The results from the economic evaluation of several AF models on these farms
using Poplars (Populus deltoides) as tree crop in combination with different
agricultural crops have proved the potential of these AF practices to provide
greater financial returns than that from other cropping patterns. Kumar et al.
(2004) have recently analysed and presented the economic analyses of these
AF systems. Based on the farmer surveys, all financial measures such as IRR,
NPV, and B/C ratio show that the AF systems provide good returns. These AF
systems have been adopted by large number of big farmers in Haryana, Punjab,
U.P, and Uttaranchal states in northern India and have resulted in generating
Raising trees on farms provide an opportunity to develop portfolios of short and
long-term investments and therefore require the process of discounting to
determine ‘net present value’ (NPV), benefit cost (B:C) ratio, for comparison
with other land use systems. However these analyses do not take in to account
the financial losses (constraints) that the farmers have to face till the maturity of
the tree crops. These economic measures thus do not explain why the small
farmers have not adopted the AF practices. While refining a previous analysis
of the economics of an AF system, Maille (1991) pointed out that all benefits
and costs need to be included and revenue streams over time should be
compared using the NPV of an infinite set of rotations. While these concepts
are valid for policy framing and economic analysis from Government’s view,
farmers, however, do not have that long horizon and their decision making to
adopt a land production system is constrained by several factors. A simple
financial analysis, which provides information about the financial returns at
various time periods, is better suited from farmers’ point of view and also for its
simplicity. It aids the farmer in decision making by providing them the
information on net returns that they are likely to get after the maturity of the
trees compared to the generally used economic measure such as NPV, B/C
ratio and IRR. The question is what interest rate to use for the small and
marginal farmers and why?

The rate to use for discounting is crucial for such evaluation and it may be
based on such factors as the rate of return for the investors’ best alternative
investment (equity), the rate paid for the borrowed capital (debt). In the case of
subsistence farmer, however, these approaches to determining rates for
investment are not applicable to AF (Betters 1989). Hoekstra (1985) suggested
using time preference rate based on several factors regarding the farmers’
current status, his outlook, and the risk of AF practice being unsuccessful and
the length of time to wait before consumption. For small and marginal farmers,
the rate would be higher and therefore the NPV, B:C would be lower. However
the time preference rate does not quantify the rate to be used and needs to be
coupled with the use of some other technique e.g., best alternative rate (Betters
1988). Thus a range of rates is used to analyse the AF production to determine
rate sensitivity. Ahmed (1989) evaluated the impact of increase in interest rate
from 10% to 20% on NPV reduction in AF system with Eucalyptus on field
boundaries and compared the IRR of these boundary plantations with that of
block plantations models. However such comparison does not give any
information about the quantum of benefits for which NPV and B:C is needed to
aid in decision-making. For practical purposes, the rate at which credit is
available to the small farmer easily and readily should be adopted for such
economic or financial evaluation. IRR cannot be used solely as it ignores the
relative magnitudes of returns and costs.

Achieving the full promise of agroforestry requires a fundamental understanding
of how and why farmers make long-term land use decisions and applying this
knowledge to the design, development, and marketing of agroforestry
innovations (Mercer 2004). An AF system can take upto six to eight years
before benefits are realised compared to the few months required for
agricultural crops. The present paper reanalyses the financial viability of the
Poplar based agroforestry systems by incorporating the effects of financial loss
that small and marginal farmers have to bear while adopting the agroforestry
system till the maturity of trees. This reanalysis is based on the study by Kumar
et al. (2004) and also examines the effect of actual interest rates on financial
viability of these agroforestry systems.


Kumar et al. (2004) have evaluated NPV, B/C ratios at 6%, 9%, and 12%
interest rates of agroforestry models wherein Poplar is harvested at 6 years of
age. A summary of their results at 9% interest rate is presented in Table 1, as
this rate will be used in the discussions in this paper. The analyses at other two
discount rates are immaterial in the present interest rate scenarios especially for
the farmers in decision-making. The B/C ratios vary around 3 and the IRR’s for
all the block models are above 90%. These results suggest that these
agroforestry models with Poplar as the tree component are highly profitable and
the adoption of these systems has benefited farmers by increasing their income
manifolds and also created a wood based industry around Yamunanagar

Therefore all farmers should have adopted these AF systems for wealth
generation. However the study did not compare the results with that from
agriculture alone practices with which farmers are quite conversant and that
generate incomes at short regular intervals nor the reason for very poor
adoption of these agroforestry practices by small farmers. The data from the
Yamunanagar district is reanalysed by including the loss in income from
agriculture during the six years till the trees are harvested in the AF systems.
The net income compared to the income from predominant agriculture system
(Wheat-Rice cycle) is presented in Figure 1. This figure shows that there is net
loss in yearly income to the farmer in the first five years if he adopts the AF
system. A big farmer with large land holding can optimalise his income during
the first five years by allotting different proportions of land to agriculture to meet
his current year income needs and the rest to AF to wealth generation.

However, in the case of small and marginal farmers whose land holding is less
than 2 ha, all the land has to be devoted to the agriculture to meet his current
year cash needs. He cannot have portfolios where different parcels of land can
be allotted for his sustenance and for wealth generation. Some of these small
farmers divert a small portion of their land to AF by adopting the Boundary
model, however their NPV and B/C ratios are lower, although IRR is higher
(Table 1). Thus these small farmers are unable to generate wealth compared to
big farmers not only on total land holding basis but also per ha basis. The
distribution of operational holdings in Haryana by different size groups are
40.6%, 19.9%, 11.3%, 4.3% and 0.7% for the marginal (>1 ha), small (1-2 ha),
semi-medium (2-4), medium (4-10 ha), and large (> 10 ha) respectively (E. & S.
O. 2002). Thus over 60% farmers, who are small and marginal, are deprived of
generating wealth from agroforestry. While a small category of medium and
large farmers (17.8%) have the capacity to add income to their wealth by
adopting agroforestry. Thus in present circumstances, the agroforestry is
creating further gap in the wealth generation for large and small farmers and is
not helping in reducing poverty for the rural poor.

If the small farmer has to adopt the AF system for higher wealth generation as
evaluated by Kumar et al. (2004), he needs to have credit facility to compensate
for loss in income during the first five years and to meet his subsistence needs.

The sources for this credit are the banks and the moneylenders in the villages
or towns. The interest rate charged by banks is taken as 9% (actual rates
discussed later) and that by the local moneylenders as 24%, the rate at which
the money is lent in villages. The net benefit stream from the agroforestry after
compensating for the loss in income from the agriculture system is presented in
Figure 2a. It shows the net wealth generated for the farmer at the end of six
years (rotation period) over and above the agriculture system. The values
presented are for the three agro-climatic zones of Haryana, where the
productivity of Poplar is considered to be 80% in zone II, and 50% in zone III to
that in Yamunanagar that lies in zone I.

The results in terms of present prices indicate that at 9% interest rate, the
adoption of Poplar based AF system results in net wealth generation in all the
three zones, though the income generated is highest in Zone 1 and least in
zone 3. At 24% interest rate, the AF system is a loss-making proposition for the
farmers in Zone 3. This partly explains the different rates of adoption of Poplar
based AF systems in the three zones, which are low in zone II and are very low
in zone III.

However, the Poplar prices are not stable in the market and have shown a
downward trend in last 10 years (FRI 2004). The price has decreased from the
peak of Rs. 4500-4700 per tonne in 1998 to Rs.1700 per tonne in 2004. In
comparison agriculture produce prices have steadily gone up (Fig. 3). Still, the
AF systems are wealth-generating proposition at present rates. Not only that
the agricultural crop prices have gone up, but also wheat, rice and sugarcane
are supported by guaranteed prices by the Government. Thus while raising
agriculture crops farmers do not face risk as far as marketing and prices are
concerned, but for Poplar and other tree prices are at the mercy of traders
(Saxena 1991) and the declining trend in last 10 years show that farmers are
looking at lower incomes from trees compared to present rates.

The results are evaluated assuming a 25% decline in Poplar wood rates and are
presented in Figure 2b. These results indicate that at 9% interest rate, the AF
system is still profitable in Zones 1 and II, however, at 24% interest rate it is loss
making proposition in Zones II and III. And the profitability in zone I go down to
around Rs.50000, which is 1/6th to that at present rates at 9% interest rate.
These results show why the planting of Poplar is going down as the farmer is
facing uncertainty of future Poplar prices. If we include the rising price trend of
agricultural crops as evident from figure 3, it can be concluded that the
profitability of Poplar based AF practices would be even less in future.

For the small farmer, the boundary plantation model is suggested as it results in
small loss in agriculture income compared to the block model and is more
common among the small farmers (Kumar et al. 2004). However, the viability of
this system needs to be examined thoroughly as growing rice in summer will
result in reduction in crop due to tree-crop interactions and shade. It may also
result in wind throw in trees due to wet soil conditions over a prolonged period.
Even ignoring these likely losses, a financial cash flow analysis of such system
is presented in Figure 4. The results indicate that those farmers who do not
have to borrow (0% interest rate); the boundary model of AF is wealth
generating compared to agriculture. However, for those small and marginal
farmers who need cash to compensate for loss in agriculture income, and for
planting and tending costs of Poplar raising, the profits go down at 9% interest
rate. At 24% interest rate, the AF proposition is loss making in all scenarios
including in zone I, except when the prices of Poplar go up by 25%.

The same conclusions can also be arrived at by using the NPV, B/C analyses
incorporating these financial constraints for small and marginal farmers.
However the simple financial cash flow analysis presented above is more
appealing to the farmers who are more informed of the likely benefits or loss
accruing to him at the maturity of trees and helping them in decision making.


Wojtkowski et al. (1991) have demonstrated the possibilities and advantages of
a simulation approach to AF modelling. Involvement of a large number of
variables such as species, agricultural crops, planting density, rotation, soil,
rainfall, irrigation, fertilizers etc., a large number of scenarios can be simulated
to find the best management strategies for optimising the profits. However
there is need to incorporate economic constraints also for such modelling.
Betters (1998) concluded that most of the research on AF systems development
focuses on (i) determining the land’s suitability for various types of AF practices;
(ii) determining management options that should meet the objectives and serve
the needs and wants of the people as well as suitable for land base; and (iii) to
determine the best or optimal strategy to use which relies heavily on the use of
economic tools and concepts using analyses tools such as production
economics, capital theory, valuation techniques, B:C analysis, and linear
programming. A review of the papers presented at the recently held national
workshop on agroforestry that 95% of the literature focussed on the first two
aspects while economic analyses was rarely presented (FD 2004).

From the above financial analysis it is obvious that the interest rate, at which the
credit is available to the small and marginal farmer to compensate for his loss in
income during the maturity period of the Poplar trees, is one of the main factor
in determining the adoption of the Poplar based AF system. Earlier the farmers
could get small credit from the banks and that too on annual basis unless they
had to mortgage their assets (mainly land). However to adopt the AF system
under discussion, they need credit on a regular annual or six monthly basis for a
long period (6-8 years) without any repayments in the intervening period. These
facilities did not exist earlier. The alternative is to approach the local
moneylenders who loan credit at very high interest rates at which the AF system
becomes a loss-making proposition to farmer. Also interest on such loan is
required to be paid on monthly or yearly installments and mortgage of assets is

Recently credit to farmers from banks is available at 12% simple interest rate
under ‘Farmer Credit Card Scheme’. This simple interest rate of 12% is
comparable to 9% compound interest rate used in financial analyses in this

paper for a 6 years maturity period, though the net profit would be slightly lesser
at 12% simple interest rate. However the amount being lent is limited to the
land holding and is Rs 50000 per acre and the duration for repayment is 3
years. Hence for the AF system with a rotation of 6 years this scheme is
inadequate for the small farmer to enable him to adopt the AF system. Hence
there is a need to modify this scheme by extending the period so as to enable
the small and marginal farmers to practise the AF system on their lands. This
will allow the wealth generation for the small farmers as well from growing of
trees. At present the rich big farmers are taking benefits of these AF production
systems and the income gap in rich and poor farmers is increasing in the rural

Agriculturists in developing countries also face great uncertainties and are
strongly risk averse (Binswanger 1980). Lilieholm and Reeves (1991)
demonstrated the use of the expected value-income variance criterion using the
quadratic programming to determine the decision making of a risk-averse
farmer who will only consider those AF plans that have lowest risk. For a big
farmer with large holding, where the constraints are less, the decision making is
easily demonstrated by minimising the risk where crops having highest
expected net returns are negatively correlated. However, for a small farmer the
choice is limited due to land constraint and also due to the cash flow, which
further limits the adoption of trees with uncertain prices in a downward trend of
tree crop prices compared to rising trend of alternative agricultural crop prices.
In such a scenario the E-V criterion will completely eliminate trees for a risk-
averse small and marginal farmer. Shively (1997) used safety-first constraint to
the expected utility model that showed that when the constraint is binding, AF
adoption decision depends on farm size and non-farm income.

Menz and Grist (1997) used LP modeling in SE Asia for Acacia mangium as
tree crop in AF systems, which demonstrated the interplay of land area
availability, labour productivity, and interest rates leading to relatively complex
picture. This study showed a clear indication of the potential role of trees on
farms, but this potential role decreased with increased interest rates. The
analyses suggested that small farmers would be less inclined towards tree
growing. Risk aversion objectives of small landholders and their limited
opportunities to borrow for investment in tree planting prevent them from AF
alternative although on pure economic grounds AF is attractive over a wide
range of interest rates.

It is this lack of credit that forces farmers to cut the Poplar trees at 6 years
without obtaining full benefits of the still increasing growth rates of Poplar. Lal
(1991) has recommended a rotation of 8 years for obtaining 90cm girth at breast
height as it provides good veneer quality logs suitable for the match and wood
panel industries. However farmers are resorting to felling trees without trees
attaining the right size that could fetch higher prices. Facilitating the credit for
longer duration thus can even increase the wealth generation for small farmers.
State and the federal Governments are faced with the huge carrying cost of
storage and distribution of food grains and optimum levels of diversification can
be achieved if farmers are offered practical and viable land-use options such as
agroforestry (Lal 2004). The results from the present analysis are in agreement
with the conclusion by Shively (1997) that when adoption is costly, the
probability of falling below subsistence level for low-income households is
crucial to decision making. Acharjee et al. (2004) reported significant
correlation between the perceived benefits (therefore the adoptability of the AF
system) to farmers’ operational holding and his income.

The second factor that affects adoption of the Poplar based AF systems is price
uncertainty. The farmers are well conversant with risk factors that affect the
productivity the crops and tree crops are safer compared to variation in produce
of agriculture crops. However it is the uncertainty involved with the prices of the
crops where tree produce prices are highly variable while the agricultural crop
prices are stable and guaranteed by the Governments. Saxena (1991) while
analysing the fall of Eucalyptus prices in northern India, concluded that because
of legal restriction on the transport and sale of wood, and other institutional
factors, the gap in the farm-gate price and the consumer price remained very
wide. One reason is that compared to agricultural crop marketing, the state
governments have set up vast infrastructure; remunerative procurement prices
are announced in advance of the crop; market yards have been set up to
reduce exploitation; and the middle man’s (commission agents) commission has
been fixed. None of these interventions have been made with tree marketing.
Agricultural markets have generally been described as competitive and efficient.
The downward trend in Poplar prices in last 10year show that farmers face huge
risk by adopting AF systems, as these are long duration crops. While
subsidising these AF systems with guaranteed prices is not advocated, there is
need to analyse the reasons for the decrease in prices of Poplar. FRI (2004)
and Lal (2004) have discussed these issues. Impacts of risks and uncertainties
on agroforestry in India have been rarely studied.

In present scenario, the benefits of additional income generation that are reaped
by the big farmers would lead to further income inequalities in rural areas. Rao
(2003) compared the trends in income inequalities on SE Asian countries. Low
degree of income equality in Taiwan was due to explicit pursuit of an egalitarian
policy framework that includes direct incentives through taxes and credit. In
comparison, in Indonesia and Thailand have any significant land reforms and
other policies at promoting equality.

Lal (2004) suggest that NABARD could play very constructive role of facilitator
to help farmers groups benefit from various schemes for taking full advantages
of fast growing clonal plantations. Even from clonal Eucalyptus plantations at
10 year rotation on irrigated fields, farmers can expect a gross return of Rs.
12,50,000 and it can emerge as an attractive alternative land use option offering
tremendous opportunities for diversification of agriculture where surplus wheat
and rice has to be stored out in open and the Government is incurring
staggering losses on storage and purchase at guaranteed prices (Lal 2004).
However these schemes need long term bank finance for small and marginal
farmers. Need for policy framework for integrated development of farm forestry
and agroforestry is required.


The results demonstrate that the availability of credit and its duration could be a
major factor in the adoptability of the Poplar based AF system for small and
marginal farmers. The rate of interest at which the credit is made available
determines the economic viability of the AF system. Government need to
interfere and make policy changes for making available sufficient credit for long
duration needed till maturity of trees at competitive rates for small farmers to
take benefit of AF system for wealth creation and poverty reduction. Otherwise
agroforestry would further aggravate income inequalities between big and small
farmers in rural areas.


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Table 1. Net Present Values (NPV), Benefit Cost ratios (B:C), and Internal Rate
of Returns (IRR) of different agroforestry models in Yamunanagar district at 9%
discount rate with Poplar as tree crop (Kumar et al. 2004).

Agricultural crops grown with Poplar                Model       NPV (Rs) B:C ratio
Sugarcane (S) + Turmeric (T)          Block          374096      3.06       97
S + Wheat (W) + Fodder (F)            Block          322400      3.47       94
S +W + F + T + Maize                  Block          343902      2.58       96
S + Potato + Berseem + Fodder         Block          401409      3.01       97
Rice + Wheat                          Boundary       178429      2.42       389
Sugarcane + Wheat + Rice              Boundary       209677      2.73       216

Fig. 1 Yearly net income from agriculture (Wheat - Rice cycle), from agroforestry
and loss in income during first five years during the rotation period of Poplar.

Fig. 2 Net income surplus income from block model agroforestry over and above to
that from agriculture alone (Total income from Agroforestry - income from Agriculture)
at 9% and 24% rate of interest in the three agroclimatic zones of Haryana.

Fig. 3 Changes in minimum support prices of wheat and rice (paddy) and
prices of Poplar wood in Yamunanagar

Fig. 4 Net income surplus income from boundary model agroforestry over and
above to that from agriculture alone (Total income from Agroforestry - income from


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