78236 March 2013 Number 184 www.worldbank.org/enbreve A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank‘s Latin America and Caribbean Region (LAC). Managing Agricultural Weather Risks in the State of Santa Catarina, Brazil by Diego Arias Carballo, Juan José Leiva, Abdoulaye Sy, Nouhoum Traore, and Federico Manfredi A griculture plays an important role in the state of Santa About 30 percent of cultivated land is mechanized and 2.4 Catarina, Brazil. Most of its production depends on percent is irrigated. small family-owned farms, which are greatly exposed to climatic and price shocks. In order to help small farmers to manage risks, the federal and state governments have been Weather Risks carrying out several programs and measures to reduce and Aside from the price fluctuations of inputs and outputs, the transfer agricultural risks. However, these initiatives are facing most important risks for the farmers of Santa Catarina are increasing fiscal constraints and could benefit from increased extreme weather. Weather risks include drought, flooding, use of some of the market-based risk management instruments. hail, and frost. In this note we focus on weather risks. Santa Catarina ranks seventh out of 26 Brazilian states in terms of agricultural production. One-half of the state’s agricultural Figure 1 output is livestock-based; the remainder includes perennial Map of Santa Catarina crops (41 percent) and forestry products (9 percent). The state’s most important perennial crops are corn, soybean, tobacco, rice, beans, onions, and wheat. Including agro-industry, the agricultural sector accounts for approximately 60 percent of exports and employs 40 percent of the labor force. Agricultural export growth is consistently above 15 percent annually. Exports consist mainly of meat (poultry and swine) and wood (furniture and cellulose). About 20 percent of the population lives in rural areas, of which some 90 percent are farmers. Of the state’s 193,000 land holdings, 90 percent consist of small family-farms of 50 hectares or less (34 percent are 10 hectares or less) which contribute 70 percent of the state’s agricultural GDP (AgGDP). The main family farm contribution to the state’s AgGDP includes maize (70 percent), beans (73 percent), rice (67 percent), swine and poultry (80 percent), milk (83 percent) and onion (91 percent). The average farm size is 34 acres, for a total of roughly 6 million acres (cultivated land is less than 1.5 million acres, 1.7 million acres are grazing grounds for animals and the rest is covered in forests). Source: EPAGRI 1 • The market insurance layer, where the risk would The most prominent climatic challenges are floods in the be transferred to an insurance company or financial coastal region and droughts in the western plateau (figure institution. 1). Of these extreme weather events, floods are the most visible, because they receive widespread media coverage and • The market failure layer, where the risk would often not sometimes cause deaths. However, drought poses a much be insured by individual farmers due to cognitive failure more significant challenge to agricultural productivity. The and ambiguity loading. Cognitive failure refers to the areas that are typically affected by drought are some of the fact that many decision makers tend to underestimate most agriculture-intensive (having triggered the irrigation their exposure to low-frequency, high-consequence investments in the past) and therefore this particular risk is losses and are unwilling to pay the full costs of an the most significant in terms of impact on both overall output insurance product. Ambiguity loading refers to the fact and farm income. that insurers will typically load premium rates heavily for low-frequency, high-consequence events, where considerable ambiguity surrounds the actual likelihood Figure 2 Total Annual Rainfall (mm) in Midwest Santa Catarina Figure 3 Risk Layering Goverment Market failure layer Size of loss: Reinsurers Market insurance layer Commercial Insurers Cooperatives/mutuals Risk retention layer Farmers/herders Event: Minor Small Medium Large Catastrophic Source: Mahul and Stutley (2010) of the event. Source: Cho et al. (2012) Although there are some important variations from year to The Role of the State year, the overall yearly rainfall is always abundant—with the As it is the case for any other market, the economic rationale driest years experiencing 1500 mm of rain (figure 2). While for public intervention relies on real or perceived market average rainfall levels appear to be consistently high when failures. Moreover, as governments often provide ex-post examined on a yearly basis, the distribution within the year is disaster relief, in Brazil the government also supports farmers quite irregular. through ex ante (insurance market) strategies. However, the state governments also play important roles at the other risk layers. Layering Weather Risks Given that most farms in Santa Catarina are small and that agricultural production is mainly rainfed, weather risks Layer 1 (High-frequency/Low-consequence events) play a key role in the production variability and farmer’s • Strengthen the agriculture sector infrastructure income. Agricultural risks have different sources, frequency, (roads, dams, irrigation systems) and facilitate the and potential to cause losses, all of which determine the implementation of innovative technologies (pest risk management strategies and instruments to be used. management systems) to small farmers. Classifying risk into different “layers� (figure 3) is a key risk • Provide agricultural extension regarding: risk exposure, management practice that gives valuable criteria to clarify crop diversification, intercropping, plot diversification, and further establish effective risk transfer strategies. The risk and/or adoption of advanced cropping techniques layers can be structured per level of potential losses, with (fertilization, irrigation, resistant varieties). different mechanisms and/or institutions addressing each layer: • Provide an institutional and legal framework for the development of risk polling vehicles, such as • The risk retention layer, where farmers would retain cooperatives or mutuals. the loss, either individually or with financial service providers. 2 • Promote the supply and demand of financial instruments • Implement rapid ex-post farmer support delivery needed to cope with production and market risks at the mechanisms to respond to catastrophic events. farm level, such as savings accounts and credit. • Create information systems capable of delivering timely and reliable data to farmers (early warning systems, Public Risk-Mitigation Measures agro meteorological forecasting). Because Brazil is a federal state, all agricultural policies come from the central government. In addition, the Ministry of Agriculture works with the state-owned Banco do Brazil, which Layer 2 (Moderate-frequency/Moderate-consequence is responsible for most agricultural credit and agricultural events) insurance. State institutions for agricultural policy are charged primarily with implementation and research. Santa Catarina • Provide a center of expertise able to support the State Agricultural Research and Rural Extension Agency development and scaling up of agricultural insurance, (EPAGRI) is the main institution responsible for the day-to-day derivatives, and other risk transfer instruments (several agricultural sector operations. Other important state agencies governments in the region have been establishing include the Center for Monitoring and Analyzing Agricultural agriculture risk management units with their Ministries Production and Public Policies (CEPA) and the Center for or Secretariats of Agriculture), bringing expertise in this area from the federal to the state level. Information on Natural Resources and Hydrometeorology (CIRAM). EPAGRI also works in direct coordination with • Create and manage a centralized database of agricultural farmers, farmers’ cooperatives, and all the municipalities of and weather statistics, and make the database available the state. EPAGRI has focused mainly on droughts and floods. to financial institutions. • Promote innovation among insurance companies and financial institutions, and access to international best Private Risk-Mitigation Measures practice through training courses, operations manuals, In addition to government-funded preventive measures, and other means. farmers take other actions to protect themselves from weather risks. One traditional method is the diversification • Provide a conducive regulatory framework for agriculture financing. of income. Farmers in Santa Catarina often cultivate several crops with different growth and harvest cycles. When drought does occur it may damage some crops but it is unlikely to last long enough to affect all crops. Moreover, many farmers Layer 3 (Low-frequency/High-consequence events) also farm animals, especially cows, pigs, chickens, and turkeys • Use risk financing/transfer instruments as appropriate as a savings mechanism against the whims of the weather. for large systemic negative shocks (weather derivatives, More modern initiatives include the purchase of genetically insurance, catastrophe bonds, contingency credit lines, modified drought-resistant seeds. The Brazilian Agricultural stabilization funds, etc.) to support vulnerable farmers Research Corporation (EMBRAPA) has long been working through public programs. on genetically modified seeds that can survive with lower • Implement social safety networks (conditional cash amounts of rainfall. However, despite the fact that many transfer programs) and effective reconstruction and farmers now use these drought resistant varieties, a severe rehabilitation programs. drought can still wipe out more than half of a harvest. Weather Risk Transfer Programs Weather risk transfer programs supported by the federal government usually come in the form subsidies to agriculture insurance policies. For instance, it is mandatory for any farmer who wishes to take out a loan from Banco do Brasil to purchase insurance covering the whole amount borrowed. This linkage between rural credit and insurance prevents weather shocks from having a spike in agriculture credit default rates, while maintaining the credit worthiness of farmers. The following programs have been implemented by the federal government in order to reduce the financial vulnerability of small farmers: 3 • The Agricultural Guarantee Program (PROAGRO): • Take advantage of the present structure of PROAGRO Created in 1973 and implemented in 1975, the purpose PLUS (farmers are already paying part of the premium) of PROAGRO was to guarantee that farmers will repay and structure additional state-level support. their entire financial debt, in the eventuality of losses • Conduct further studies and incentivize (if the studies’ caused by adverse climate conditions and diseases. results are conclusively positive) the implementation • PROAGRO PLUS: Created in 2004, PROAGRO PLUS of new weather risk management instruments with is similar to PROAGRO, but offers additional direct the potential for reaching small farmers, such as index- compensation to farmers for lost revenue. based insurance. Currently, the state government does not use financial risk Going Forward: Improving the Management transfer instruments or strategies to hedge fiscal exposure of Weather Risks to weather events. Farmers absorb the risk or rely on federal government support. State-level risk management Currently, Santa Catarina does not have explicit programs transfer instruments, such as contingent credit lines, weather to cope with weather risks. Response to floods have been derivatives, insurance will improve the management of fiscal ad-hoc and not designed ex-ante. The state government is exposure to weather events and allow for rapid and quick now considering moving towards a comprehensive water response in support of the most vulnerable farmers. management strategy and planning in order to address all dimensions of weather risk management in the state. To enhance weather risk management beyond the current programs in place, further recommendations include Given the small size of most farms in Santa Catarina and that developing a public sector agriculture risk strategy, with only one-third of family farms are covered through PROAGRO, a financing plan for hedging public expenditures against alternative approaches should be evaluated in order to ensure systemic shocks (commodity prices, droughts). This strategy that farmers do not undergo a process of de-capitalization and can include the need to hedge the state budget’s exposure loss of competitiveness as a result of adverse weather events. against extreme weather events by establishing an emergency Further investments in irrigation and the development of fund financed by a layered risk structure. Finally, the state a medium to long term strategy of water resources are could structure a disaster response program and promote the required. Current risk transfer policies and programs of the use of agricultural insurance by making farmers aware of the state of Santa Catarina rely heavily on federal programs such benefits of investing resources in ex ante risk management as PROAGRO. Some recommendations include: strategies. Bibliography About the Authors Cho, Hye-Kyung, Kenneth P. Bowman, and Gerald R. North, Equatorial Diego Arias Carballo is a Senior Agriculture Economist in the Agriculture waves including the Madden–Julian oscillation in TRMM rainfall and OLR and Rural Development Department (LCSAR); Juan José Leiva is pursuing a data. Journal of Climate, 17 (2012), 4387–4406. Master’s degree in Public Policy at Princeton University; Abdoulaye Sy is a Mahul, Olivier and Charles J. Stutley. Government Support to Agricultural Young Professional in the Poverty Reduction and Economic Management Insurance: Challenges and Options for Developing Countries. World Bank, Vice Presidency (MNSED); Nouhoum Traore and Federico Manfredi are 2010. pursuing Master’s degrees in Public Policy at Harvard University. Disclaimer: The findings, interpretations, and conclusions expressed herein are those of the author(s) and do not necessarily reflect the views of the Executive Directors of the International Bank for Reconstruction and Development / The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. About “en breve�... “en breve� is produced by the Knowledge and Learning Team of the Operations Services Department of the Latin America and the Caribbean Region of The World Bank – http://www.worldbank.org/lac. 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