Weather derivatives for Indian agriculture

Abstract

Around 57% of India’s population and 73% of total employment still, relies on agriculture for their livelihood.Consequently, their weather risk exposure is very substantial.Even a 2° C to 3.5° C rise in temperature, could result in average loss in at the farm level net revenue in the range of 9% and 25% Traditional risk hedging techniques and crop insurance have so far been unable to cope with the vagaries of nature and hence the need arises for a new instrument to hedge weather risk. However, with the advent of weather derivatives, farmers may use no longer be worried about suffering losses due to erratic weather.A weather derivative is financial instruments including weather swaps, options, and option collars, which may be used by farmers to hedge their weather risks.The payoffs of these instruments may be linked to various underlying weather variables like temperature, rain, wind, etc. The weather risks associated with few selected crops have been identified and based on their risk profile; an optimal hedging strategy has been recommended for each of these crops.The crops studied were cotton, tea (commercial crops), wheat, rice (Food crops), cardamom (spices), rapeseed and mustard (Oilseeds). Further policy measures have been recommended as follows: Institutional infrastructure: An institutional body comprising of derivative exchanges, brokers, consumer cooperatives and weather observatories, should be established by the government to implement trading in weather derivatives. Regulatory mechanism: The government should set up an independent regulator with adequate resources and empowerment to regulate the market for weather derivatives. Education and awareness among market participants: The various market participants need to be educated and trained to understand the benefits and risks associated with weather derivatives, and the Government has to play a pivotal role in this regard.