Countering distress sales: the potential of negotiable warehouse receipts

1. Countering distress sales: the potential of negotiable warehouse receipts By: Lamon Rutten Coordinator, commodity marketing, risk management and finance United Nations Conference on Trade and Development Government of India/World Bank Workshop on Foodgrain Marketing Policies to Meet Food Security Needs in the 21st Century Dehradun, Uttar Pradesh, 14-15 June 1999

2. Overview • Specific policies are just tools to reach a goal. • Reducing the likelihood of distress sales: what are we really talking about? • Possibilities to enable farmers to obtain credit against goods in storage. • Possibilities to empower farmers to have a larger marketing reach. • Conclusions

3. Is food policy functional and effective? • Reasons for government intervention in food marketing: • ensure farmers get a “fair” price • ensure farmers get a certain “minimum” price • ensure consumers pay a “fair” price • ensure consumers pay a certain “maximum” price • ensure more efficient storage • ensure more efficient marketing/transport • create a stable, predictable environment for the private sector

4. Is food policy functional and effective? • ensure more efficient storage • Yes, but only if compared to farmers’ own storage. Professional private sector storage is likely to be more efficient. • ensure more efficient marketing/transport • Does a large government entity have benefits of scale - better logistics? In principle, yes - but so do large private entities. And note that government entities can put their benefits of scale at the service of the private sector (e.g. Philippines maize policy) • create a stable, predictable environment for the private sector • Perhaps, but this is coupled to a lack of incentives for the private sector to invest in post harvest treatment, quality improvement, grading systems, trade infrastructure, etc. One result: rather high post-harvest losses (7-10 % from farm to market level, 4-5 % from marketing to distribution). However, the government cannot just “disappear”.

5. FAIR: No monopolistic/oligopolistic profits Presupposes a good functioning of markets In other words: improving the functioning of markets can replace direct government intervention MINIMUM/MAXIMUM PRICES Income/expenditure objectives Difficult to target through price policies Direct subsidies (income transfer, or even infrastructure investments) are more efficient. “Fair” vs. minimum/maximum price

6. Distress sales:the bottomline is that farmers need cash The farmers’ need for cash has a number of implications for their behaviour: • Early sale of products • Short-term cash-earning activities (even if not optimal) • Risk-averting behaviour (e.g. off-farm income) Thus, providing an alternative source of cash has implications beyond that of reducing distress sales.

7. On the other hand,what look like “distress sales” could represent rational behaviour Selling produce directly after harvest could the logical: • Subsidized government storage • Unpredictable future marketing environment (e.g. subsidized government imports and sales) • Lack of accessible and appropriate storage facilities • Social pressures Thus, providing credits for goods in stock may not in itself be a solution.

8. How to avoid distress sales?What are distress sales? Defined here as sales immediately after harvest for “unfair” prices. Therefore, there are two ways to reduce the problem: • Give farmers the alternative of getting credit on their production; that is, enable farmers to store for later sale; naturally, this supposes that the storage environment is favourable. • Ensure a fair price directly after harvest.

9. A simple warehouse receipt finance scheme - Pepper Marketing Board, Malaysia 6. Provides credit 5.Lodges receipts with bank Farmers Banks 3. Deposits products 2.Guarantees receipts 7.Signs sales contract Warehouse 4.Issues receipts 1. Approves warehouse 9. Delivers receipt; warehouse makes delivery Traders Government (PMB) 8. Reimburses credit; in return, bank transfers receipts

10. Another simple warehouse receipt finance scheme - A plan for reforming BULOG, Indonesia Note: traders can also use the scheme 6. Provides credit 5.Lodges receipts with bank/gov Farmers Banks/ government facility 3. Deposits products 2.Guarantees receipts 7.Signs sales contract Warehouse company 4.Issues receipts 1. Private cy. leases warehouse 9. Delivers receipt; warehouse makes delivery Traders BULOG 8. Reimburses credit; in return, bank transfers receipts

11. A private-sector based warehouse receipt finance scheme - A role for commodity exchanges Note: farmers can also use the scheme 6. Provides credit 5.Lodges receipts with bank Small traders Banks 3. Deposits products 2.Guarantees warehouse Warehouse company 7a.Sign sales contract 4.Issues receipts Clearing house 1. Approves warehouse 9. Delivers receipt; warehouse makes delivery Large traders Commodity exchange 7b. Delivery through exchange 8a. Reimburses credit; in return, bank transfers receipts

12. Do banks have the wherewithal for this type of operations? Counter: due to inefficient lending practices in the past, most banks consider agricultural lending as very risky. Linked to this, appropriate skills are missing. In favour: 1. This is a safe type of agricultural lending. Instead of taking a risk on the farmer/trader, the bank takes a risk on a warehouse company/Government body/exchange. 2. This type of lending can be a spearpoint for other highly attractive forms of agricultural lending - e.g. for fertilizers. 3. Refinancing is easy. The Federal Reserve (USA) as well as the Bank of England discount loans provided against “trade paper” (which includes warehouse receipts) on very attractive conditions, irrespective of the country involved. IT IS POSSIBLE TO HAVE INDIA’S AGRICULTURAL STOCKS FINANCED BY WESTERN BANKS/INVESTORS, AT VERY LOW RATES.

13. Using warehouse receipts to improve marketing - the National Food Authority of the Philippines The NFA has two schemes in place, and one under planning for maize and rice marketing: • Storage/support payment • Marketing from countryside into towns • In preparation: preparing the two

14. The Philippines: the system that doesn’t work Department of Agriculture Loan guarantee, for when loan is overdue, and the commodities covered by the “quedans” do not exist Bank Supervision Loan - maximum term 180 days, up to 85 % of value of commodities Assignment of “quedans”, and presentation of several other documents Quedan and Rural Credit Guarantee Corporation Owner of the products Issues warehouse receipts (“quedan”) Approval of warehouses for inventory financing Warehouses Deposits rice, maize or sugar Application for obtaining a franchise for inventory finance; supported by a bond.

15. Storage/ support payment Farmer deposits products Farmers NFA warehouse NFA gives advance payment • Farmers have the choice between • Forfaiting the products (thus getting the “minimum price) • reimbursing the advance payment plus storage charges to NFA, which then returns the product • sell to a trader or processor, who will reimburse the NFA and take delivery.

16. Enhancing farmers’ marketing reach Farmer deposits products Farmers NFA warehouse NFA does not make an advance payment Farmers give the order to the NFA to sell their products once a certain price is reached. NFA puts this provisional sales order on its (Internet) computer system (at a price in which transport costs from the rural warehouse to Metro Manilla have been added to the farmers’ ask price). Processors and traders are directly connected to the system, and can continuously make bids for delivery ex-NFA warehouse in Manilla. If a farmer’s ask price and a buyer’s bid price match, the NFA informs the farmer, and prepares delivery ex-Manilla. At an opportune time, it then transfers the goods from the rural warehouse to its Manilla warehouse. If after 6 months, the products have not been sold, farmers need to take them back, paying storage charges.

17. Using commodity exchanges to enhance marketing Farmers Exchange warehouse Deposits products Commodity exchange The highest bidder gets the products The warehouse receipt is (electronically) transferred to the exchange and auctioned off. By standardizing the quality descriptions into specific grades, and standardizing the documentation used, an exchange can evolve into a forum for trade of warehouse receipts, with the receipts issued by any of a list of approved warehouses (which may be part of an exchange). The interest in this is likely to be large - international traders would be interested, as would new groups of exchange users. In effect, by creating trade in standardized financial products, the exchange will be providing a new investment tool for banks, pension funds, even small speculators. Forward trade in the receipts could also be developed. The result will be much greater flexibility for those active in the commodity, and much easier access to finance.

18. Even more flexibility: the Brazilian model Deposits products Exchange- approved warehouse Farmers Issues receipts The warehouse receipt is transferred to the bank, which gives a credit. The bank gives its “aval”, which makes trade of the receipts on the secondary market possible. Bank Commodity exchange Secondary market Farmers observe commodity exchange prices, and can sell whenever they want, through an electronic network linking the countries’ exchanges.

19. For discussion only Conclusion: the way forward • General principles for change: • The current system of government food market intervention is not efficient, and not sufficiently functional. The Government of India can use its money better. Why continue copying bad examples from abroad? • Any change from the current system requires a gradual approach, with a continuing strong role of the Government. • The process of change has to be pragmatic - the second-best solution may be the best one. • The process of change needs to be widely accepted, and not go against the objective or subjective interests of key parties.

20. Review government policies which hinder the development of a private-sector based warehouse receipt system Restrictions on marketing Restrictions on transport (e.g. on interstate transport) Restrictions on storage (state storage controls; selective credit controls of RBI) Restrictions on tradability of warehouse receipts (negotiable instruments act) For discussion only Elements of the way forward: Explore roles for government marketing, financing and storage entities which can support the development of a warehouse receipt system • Leasing out warehouses • Issuing tradable warehouse receipts • Creating an electronic network to trade warehouse receipts • Promote the emergence of “approved warehouses” at each regulated wholesale market • Make special credit lines available.

21. UNCTAD’s work in the area of commodity risk management and finance: - reports, advice, training materials, training seminars and conferences on structured commodity finance, including warehouse receipt finance - reports, advice, training materials, and training seminars on commodity price risk management - advice to emerging commodity exchanges - advice to Governments on price risk management practices; use of modern financial instruments to support policy liberalization; and legal and regulatory structures affecting the use of risk management and structured finance markets. For further information please contact: Lamon Rutten Coordinator, commodity marketing, risk management and finance United Nations Conference on Trade and Development 1211 Geneva 10, Switzerland Tel. (41 22) 9075770 / 5755 / 5014 Fax (41 22) 917 0509 email Lamon.Rutten@UNCTAD.org