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A STRATEGY FOR THE DEVELOPMENT OF WAREHOUSE RECEIPT SYSTEM FOR AGRICULTURE IN INDIA CONSULTANCY ASSIGNMENT FOR THE Forward Markets Commission, Government of India and The World Bank
Consultants: Jonathan Coulter, Natural Resources Institute, UK G. Ramachandran, India
Final Report October 2000
Contents
Acknowledgements This report is based on field visits to East India Cotton Association (EICA), Mumbai; the Bombay Oilseeds and Oils Exchange Limited (BOOE), Mumbai; the SOPA Board of Trade (SBOT), Indore; Coffee Futures Exchange India Limited (COFEI), Bangalore; and The Chamber of Commerce, Hapur, Ghaziabad. These were augmented by field visits to other centres pertinent to commodity trading and storage, and analysis and testing. We are most grateful to the chief executives, directors, officials and members of these commodity exchanges and firms in the businesses of trading, storing and testing commodities. The contribution of the Bureau of Indian Standards (BIS) and the National Dairy Development Board (NDDB) to this report is gratefully acknowledged. This report is based on discussions with other policymakers and regulators, and stakeholders that have an economic interest in warehouse receipts and commodity contracts. The policymakers and regulators include the Government of India's Ministry of Consumer Affairs and Public Distribution, Ministry of Agriculture and Co-operation, Ministry of Textiles, and the Department of Economic Affairs of the Ministry of Finance. The suggestions of the Ministries are gratefully acknowledged. The Reserve Bank of India (RBI) and the National Bank for Agriculture and Rural Development (NABARD), like the FMC, are policymaking and regulatory institutions. NABARD is also a stakeholder that has an active interest in the agriculture produce economy. Their suggestions as well as those of the Indian Banks Association (IBA), the Bankers Institute of Rural Development (BIRD), the National Association of Food and Civil Supplies Corporations (NAFCSC) and the National Co-operative Development Corporation (NCDC) are gratefully acknowledged. The Central Warehousing Corporation (CWC) and the State Warehousing Corporations (SWCs) are among the principal stakeholders and service providers that have a significant interest in the rapid expansion and simultaneous modernisation of the warehouse receipt system in India. The generous encouragement of Mr. N.K. Choubey, managing director of the CWC, and Mr K. Amaranarayan, managing director of Karnataka State Warehousing Corporation and secretary of the National Association of Warehousing Corporations (NAWC) has been most valuable and is acknowledged most gratefully. The NAWC represents the economic interests of the SWCs. Mr. Choubey and Mr. Amaranarayan facilitated the discussion of the FMC's and the Government of India's programme for modernising the warehouse receipt system with the chief executives of the warehousing corporations. The contribution of Mr. Narendrasinh Jhala, chairman of the NAWC and Mr. Subhash C. Batra, secretary of the CWC, to these discussions is gratefully acknowledged. Mr. R. Raghavan and Mr. Prasanna Kumar of the Tamil Nadu Warehousing Corporation have enabled the evaluation of the draft Warehouse Receipts Bill, 1978. The rigorous analysis, comments and suggestions of Justice S.M. Jhunjhunwala, former judge of the Bombay High Court, are gratefully acknowledged. We are particularly grateful to Mr S. Sivakumar and staff of ITC for time devoted to discussing the issues and commenting on an earlier draft.
Abbreviations and Glossary
EXECUTIVE SUMMARY Warehouse Receipt System Principal Objectives This consultancy was carried out as part of the World Bank programme aimed at the improvement of the commodity futures exchanges in India. This report deals with three principal objectives of the consultancy assignment:
The consultants added coffee to the list of commodities since the domestic coffee exchange has implemented a system of deliveries through warehouse receipts. The commodities included in the consultancy assignment collectively account for 20 percent of India's index of agricultural production. The consultants' principal conclusions are given in Box 1. Principal Conclusions India can use warehouse receipts to make it more attractive for banks to lend to the agricultural sector, to reduce the cost of public support for agricultural marketing, to reduce transaction costs and to improve price-risk management. Warehouse receipts can also play an important part in new policies which would make Indian agriculture more responsive to market opportunities and more competitive in relation to world markets. The potential net benefits to the economy are very large. The current state of the warehousing industry is reviewed. Outside of the ports, the Central and the State Governments dominate the warehousing industry, both as client and as service provider. Warehousing facilities owned by the central and the state Governments account for 65.9 million tons of warehousing capacity. About 46 million tons of capacity is owned or leased by the Food Corporation of India and the State Food and Civil Supplies Corporations. The storage capacity that can be made available by state-owned warehousing corporations is 19.7 million tons. Notably, banks and insurance companies are the "implicit stakeholders" of more that 36 percent of this capacity. While Government warehouses have hitherto mainly served the public sector, they constitute a major asset that can be used to further the employment of warehouse receipts. Government warehouses are present across the country. They have developed homogeneous storage and quality practices, and their warehouse receipts are accepted by most banks. Their main weaknesses in the context of liberalisation and globalisation are that they are not well integrated with private supply chains; they do not inspire confidence among some lenders, particularly, international banks and lenders; they lack certain forms of autonomy they need to improve services.
The Government of India and the State Governments intended co-operatives to provide rural warehousing, but co-operatives have not performed as vigorously as expected, leaving gaps in service provision. These gaps are mitigated by informal storage services which commission agents and rural merchants provide to farmers in their locality with credit sometimes being provided against the security of stocks involved. There are in addition private intermediaries who provide storage services to traders, processors and others. Unfortunately these systems hardly make use of formal bank credit, and expansion is constrained by their very informality and lack of legal underpinning. Freight forwarders have traditionally provided storage in the ports, but inspection companies have recently come to the fore, encouraged by more open trade policies. The largest players are multinational operators that arrived to service their international principals and banks. Local competitors have made headway in this industry, and it would assist them if they were allowed to insure offshore. Inspection companies appear to be performing satisfactorily, but they have so far done little to develop upcountry services, even when this relates to international traded commodities. Despite the considerable liberalisation of recent years, various official policies discourage the use of warehouse receipts, particularly the very high level of public intervention in the market for food grains and sugar, and sales taxes which tend to drive trade into informal channels. Dynamic tariffs on imports, storage control orders, small-scale industry reservations and mandatory use of market yards (mandis) also constrain their use. The other main problem is the lack of fiduciary trust on the part of banks and depositors, and this greatly restricts the number of companies which can act as warehousemen. These problems can be addressed by enhancing the status of warehouse receipts in law, creating a really effective system of regulatory oversight, and by instituting a secure central electronic registry allowing for the tracking of all changes in ownership and liens. In accordance with the above conclusions, the Government of India may adopt the strategy given in Box 2.
Discussion of Warehouse Receipts and the Action Plan A workshop conducted in New Delhi between February 7 and 9, 2000 by the FMC and the World Bank discussed the important components of the action plan. The warehouse receipt system and the action plan were presented and discussed at the NAWC conference on February 25, 2000 in Bangalore and at the conference of managing directors of warehousing corporations on March 21 and 22, 2000 in New Delhi. The implications of the warehouse receipt system were further presented and discussed at the NAFCSC national conference on March 24 and 25, 2000 in Bangalore.
BOX 2: PROPOSED STRATEGY FOR DEVELOPMENT OF WAREHOUSE RECEIPTS
The proposed action plan, and indicative timetable are given in Box 3.
Role of Commodity Exchanges Commodity exchanges can play a vital role in the promotion of the warehouse receipt system and the usage of warehouse receipts. Coffee Futures Exchange India Limited (COFEI), the coffee futures exchange in Bangalore, has since 1998 used its own network of approved warehouses, and strict procedures for reporting and monitoring of stocks to be tendered for delivery. SOPA Board of Trade (SBOT), the soybeans and mustard exchange in Indore, instituted a similar network in February 2000 before commencing trading of futures. A situation analysis pertinent to warehouse receipts and commodity exchanges and the prospects of promoting warehouse receipts is given in Box 4. In their report to the Forward Markets Commission, Burr and Anjaria (2000) have recommended that exchanges institute their own networks of approved warehouses, and strict procedures for reporting and monitoring of stocks to be tendered for delivery. The recommendation of Burr and Anjaria emphasises the importance of commodity exchanges in the propagation of warehouse receipts.
The existing uses of warehouse receipts by commodity exchanges are extremely limited. However, the institutionalisation of the warehouse receipt system through the commodity exchanges is most likely to yield the best results in the context of promoting and propagating warehouse receipts, in particular electronic warehouse receipts, and a national system of warehouse receipts. Box 5 includes the steps that may be necessary to promote and propagate warehouse receipts and the role of other economic institutions towards such a purpose.
Legislative Effort and Action Plan Warehouse receipts and a warehouse receipts system were the objects of legislative effort nearly three decades ago. A Warehouse Receipts Bill was drafted in 1978 with the principal, if not sole, objective of endowing upon warehouse receipts the status of negotiability under the Negotiable Instruments Act, 1881. The Warehouse Receipts Bill was initiated by the Banking Laws Committee and did not proceed beyond the stage of discussion of the draft. The principal legislative effort and the action plan that may lead to the viability and widespread use of warehouse receipts are discussed in Box 6.
Chapter 1 Commodity Futures Exchanges in India Strong in Trading, Weak in Settlement The joint programme of the World Bank and the Government of India for improving the functions of commodity futures exchanges in India has several objectives. One of the principal objectives of the joint programme is the strengthening of the delivery practices in the commodity exchanges in India. The 1996 World Bank report, Managing Price Risks in India's Liberalised Agriculture: Can Futures Markets Help?, evaluated Indian agriculture futures markets. The World Bank report acknowledges India's long experience in operating and managing commodity futures markets. It, however, notes that restrictive policies have not provided India's agriculture futures market a chance to contribute to price risk management and discouraged them from upgrading their institutional capabilities. In our field visits and in our discussions, policymakers and decision-makers in the central and state Governments reinforced such an evaluation. Their evaluation as well as that of potential users is that Indian agriculture futures markets lack the necessary capability to support large scale hedging. In the evaluation of market participants, the inadequate capability of the commodity exchanges in India to support large scale hedging is a result of two deficiencies. First, futures open interests are vulnerable to systemic risks. Second, the settlement of futures open interests through delivery at maturity is vulnerable to risk since data about stocks held by participants is either not available or is unreliable. Settlement risk is serious and militates against the efficiency of futures markets. The unavailability of public data on stocks, more than the reliability, is viewed as one of the principal sources of settlement risk. The World Bank and policymakers in India have recognised that the inadequate capability of commodity exchanges in India to support large scale hedging is a significant deterrent to the economy's ability to cope with commodity price risk. Systemic risks related to futures open interests and the settlement of maturing futures positions are managed and minimised, and where possible eliminated, by clearing houses characterised by robust policies and operating processes and by strong financial structures that rigorously discourage negative externalities. Guidelines pertinent clearing house ownership, operations and bye-laws are included in a report to the FMC by Jeffery and Ramachandran (2000). The report on clearing house ownership, operations and bye-laws recommends the use of certified stocks and warehouse receipts to reduce settlement risk borne by a clearing house on behalf of its clearing members. Reduction of Settlement Risk While an apposite clearing structure is necessary to support large scale hedging, it does not address the issue of settlement risk of maturing contracts, especially when commodity futures contracts are physically settled. A physically settled commodity futures contract requires a reliable system that addresses all aspects of compliance with the grade, quality and quantity of commodity that underlies the contract. Cash settled commodity futures contracts do not impose such a requirement at the time of settlement. A system of warehouse receipts addresses these aspects pertinent to compliance with the grade, quality and quantity of commodities that underlie commodity futures contracts. It makes available public data that is accurate, reliable and timely, and such availability can be extended to a range of contracts. Thus, a system of warehouse receipts could enable India's agriculture futures markets to contribute to price risk management by equipping them with the capability to support large scale hedging. Such a capability has become necessary since India's agriculture markets have become more open to the global supply and demand functions. Market-based Instruments for Hedging The World Bank has played a vital role in enabling commodity-intensive developing economies to continually effect institutional improvements aimed at managing volatile commodity prices. Commodity-intensive economies have used a variety of policies and instruments to manage volatile commodity prices. The use of policies involving production and buffer stocks has dominated the use of market-based instruments in developing economies. Such policies have usually required budgetary outlays by the Governments of developing economies. In contrast, market-based instruments such as commodity futures, futures options and swaps have dominated the approach to price risk management in developed economies. Empirical evidence gathered over the last three decades shows that market-based instruments are more flexible, effective and efficient compared with policies aimed at production and stocks in managing price risks. The World Bank has initiated several programmes aimed at propagating information pertinent to the management of price risks using market-based instruments. The flexibility, effectiveness and efficiency of these instruments have motivated these efforts. The World Bank has continually evaluated the need for polices and programmes aimed at expanding the use of market-based instruments where such usage is expected to be more cost effective than other budget-based instruments.
India's Agriculture Futures Market The institutional improvement of India's agriculture futures market has received focussed attention since 1993 from both policymakers and regulators in India. The Kabra Committee Report (1994) and the World Bank Report (1996) are widely regarded as the principal sources for policies aimed at the rapid modernisation of the agriculture futures markets. The National Agriculture Policy announced in July 2000 articulates the policy of the Government of India pertinent to price risk management and an expansion of India's agriculture futures market. The NAP provides the necessary impetus for market-based price risk management. A system of reliable deliveries, especially through the use of warehouse receipts, constitutes one of the many components identified by the World Bank and the Government of India as critical to the modernisation programme. The other components include commodity exchanges' rules and regulations, trading procedures, clearing house rules and regulations, trade supervision, regulation and monitoring, and promotional and development activities. The successful pursuit of these comprehensive components is expected to have a favourable impact on the confidence of users and potential users with a favourable impact on liquidity of futures contracts. Standardisation of Futures Contracts Futures contracts are standardised contracts. In a futures contracts the contracting parties negotiate only the price. Quantity, quality and the time of delivery are standardised by the exchange on which the futures are listed for trading. The components of standardisation are made known to the participants of an exchange by the exchange through contract specifications. Standardisation is one of the principal distinctions between forward and futures contracts. Settlement of Contracts: Systems View Trading, clearing and settlement constitute the three important components of the commodity markets. Trading has typically occupied the prime spot in the regulatory environment in India. Such a focus has been reflected in the rules and regulations of commodity exchanges. However, the other two components - clearing and settlement - have a very significant role to play. Unreliable clearing and settlement militate against the success of trading systems and trading institutions. The poor economic visibility of commodity futures exchanges in India is a result of the inadequate attention paid to clearing and settlement. The streamlining of clearing and settlement system is necessary in order to increase the reliability and success of trading institutions. A systems view is essential to appreciate the importance of the three principal components and the sub-components. The principal functions classified under trading, clearing and settlement are given below (Table 1). It may be observed that a large number of critical functions are performed by the clearing and settlement system. Delivery upon expiration is a key function that requires the support of institutions such as warehouses, instruments such as warehouse receipts and systems such as a warehouse receipt system.
The success of exchange-traded contracts results from the efficiency, transparency, speed and security of three components of the composite system - trading, clearing and settlement systems. Each component has its own role in determining the success of commodity contracts and in achieving the economic objectives of listing and trading commodity futures contracts and futures options contracts. The objectives of warehouse receipts and a warehouse receipt system are pertinent to the commodity futures markets as well as to the banking sector. Commodity futures markets have in turn a very powerful influence on the grading and applicable standards that drive grades since, in a commodity futures contract, the specification of the underlying commodity involves grades and standards used to determine compliance with grades. Commodity Exchanges and Warehouse Receipts The FMC is the Government of India's agency in the endeavour directed at the improvement of the working of futures markets in India. The FMC is under the administrative supervision of the Ministry of Consumer Affairs and Public Distribution of the Government of India. There are currently 19 exchanges in different parts of the country that trade a range of commodities. Most exchanges are single-commodity exchanges. An important component of this programme is the establishment of a system of warehouse receipts in order to transparently effect deliveries against expiring contracts. Mr. D.C. Anjaria reconfirmed the case for such a system during his presentation at the Commodity Futures Workshop between February 7 and 9, 2000. He pointed out that settlement was normally in cash and was generally lacking in transparency; consequently futures and physical prices did not converge towards expiration as one would normally expect, seriously detracting from the credibility of the contracts traded. Warehouse Receipts and Economy-wide Impact However in a developing economy such as India's, warehouse receipts can play a much larger role by providing good collateral for bank lending, and thereby developing the rural financial system. Indeed there are strong historical precedents for this in other countries. Due to the hitherto dominant role of the State in agricultural markets, this potential has hardly been exploited, but with gradual liberalisation and globalisation, the possibility can now be more fully exploited. The objectives of the assignment were as follows:
Appendix 1 shows an outline of tasks to be fulfilled, as specified in the terms of reference. A two-person team, including an international and a local consultant carried out the assignment. They were allowed six weeks and twelve weeks respectively for the task. They jointly or individually held discussions in the following places between October 1999 and January 2000: Mumbai, New Delhi, Bangalore, Indore, Ahmedabad, Kandla, Rajkot, Coimbatore, Guntur, Vijayawada, Calcutta, Chennai, Hapur, Nagpur, Hassan, Jaipur, Hissar and Chandigarh. Interviews were held with the following:
Appendix 2 shows a list of persons met. Cotton, oilseeds and their derivatives, and gur were highlighted in the terms of reference because futures trading already exists in them, or exchanges have been licensed to start trading. The consultants added coffee to the list since the coffee exchange has pioneered deliveries through warehouse receipts, and might have useful lessons for other commodities. Including coffee, the selected commodities constitute 19.52 percent of the Ministry of Agriculture’s index of agriculture production. The discussion meetings and the field visits point to the nontrivial potential for the introduction of warehouse receipt systems in the context of nearly a fifth of the agriculture produce output. The weights of the commodities are given in Table 2. The reader is referred to the section entitled "Commodity analysis; prospects and hurdles" and Appendices 3 to 5, which contain more detailed information on the four commodities mentioned. It is important to note that the definition of "public warehouse" used in this report is not the one normally used in India – and indeed the one mentioned in the terms of reference (see Appendix 1). In accordance with internationally accepted parlance, a warehousing company is considered public because it offers its services to the public in general, not to a specific customer. In India the term is used to connote public ownership, presumably because this is the only form of warehousing that is available.
Chapter 2 The Rationale: Why Indian Agriculture Needs Warehouse Receipts Warehouse Receipts and Uses The principal uses and benefits associated with warehouses and warehouse receipts are included in Table 3. Their principal uses lie in: (1) increasing the willingness of banks to lend for agriculture and wholesale trade; (2) reducing the cost of public support for agricultural marketing; (3) reducing transaction costs and improving price-risk management. Of great long term consequence however is that warehouse receipts can play an important part in making Indian agriculture more responsive to market opportunities and more competitive in relation to World markets. In the next subsections we discuss uses (1) to (3), after which we discuss the potential long-term impact of warehouse receipts in developing Indian agriculture.
Increasing the Willingness of Banks to lend for Agriculture and Wholesale Trade One of the objectives for nationalising banks in India was to improve rural and agricultural credit. It was felt that the banking industry, if left in private hands, would lead to concentration of branches in urban pockets, and that lending and deposit collection activities would not achieve desired levels of penetration in the rural regions of the country. Food security was a serious issue, and India had to import substantial quantities of food grain to bridge the severe shortfalls year after year. There is a bank branch for every 15,000 people in India. Of the 65,118 bank branches, 32,856 are in rural areas. However, in the case of India's agriculture sector, the ratio of credit to output was merely 9.7 percent in 1998-99 (see Table 4). Of the total flow of credit to the constituent sectors of the Indian economy, agriculture received 9.23 percent in 1998-99. If credit for public food procurement at 3.92 percent of total credit were added, the total credit allocated to agriculture would yet be only 13.15 percent. However, agriculture constitutes more than 25 percent of gross domestic product. Credit flows to the industrial sector have been of a larger magnitude. The industrial sector received 41.68 percent of total credit in 1998-99. Industry constitutes less than 20 percent of net domestic product. Moreover, the ratio of credit to output was 32.28 in the case of the industrial sector in 1998-99. Credit flows to wholesale trade have also been of a small magnitude. A very significant portion (at least 60 percent) of the wholesale trade in India involves agricultural produce. Wholesalers buy the produce at harvest-time, often clean, dry and sort it, and sell it over varying periods - sometimes holding inventory until the succeeding harvest. Wholesale trade received 3.25 percent of total organised sector credit in 1998-99, but it constitutes more than 11 percent of net domestic product. Growth in credit to the wholesale sector was the lowest at 6.38 percent. The services sector is in general an unattractive destination for credit supplied by the organised markets for credit.
The relative allocation of credit by organised markets for credit to the constituent sectors of the Indian economy is driven by business risk, price volatility, perceived credit risk, quality of the collateral provided by borrowers, and the size and strength of balance sheets. Agriculture and wholesale trade receive smaller allocations of credit than the other sectors when the sectors' size and relevance to the economy are reckoned with, and would have received even smaller allocations if there had not been major and continuing programmes for priority lending. Such lending is implicitly subsidised by a high level of default (see Table 5).
Most farmers and wholesale traders use their own equity and credit from informal suppliers of credit. According to the RBI All India Debt and Investment Survey of 1991-92, around 39.6 percent of the rural population still depended on "non-institutional systems" for their credit requirements. The share of professional money lenders in rural debts had fallen from 13.8 percent in 1971 to 8.3 percent in 1981, but had increased 9.4 percent in 1991. Even if we assume that farmers were fully frank in their survey responses, it is likely that the level of dependency among traders is considerably higher than this. The weighted-average cost of capital (WACC) in such circumstances is relatively high, and significantly higher than in other sectors of the Indian economy. Borrowers bear a high WACC because the length of the operating cycles of their businesses is often small. Yet, the banking sector regards agriculture activities and wholesale trade as poor credit risks. Most farmers and traders either do not have such balance sheets or are unwilling to use their balance sheets to access credit from the banking sector. Banks are currently handicapped by a poor legal system that makes loan recovery quite difficult. This explains why banks invested Rs. 362.61 billion in Government securities in 1998-99 alone while all credit outstanding to agriculture, including amounts lent in the past, was less than Rs. 400 billion at the end of 1998-99. One must be careful not to overstate the cost of informal credit, because in reality Indian rates are low compared with what small farmers pay in many other parts of the World. The rates of which we were informed were in the range of 2 percent to 4 percent per month, compared with 10 percent or more commonly quoted in Africa. Moreover credit is made available at short notice and with a minimum of paperwork. The formal banking sector can never hope to entirely replace other service providers in this market for credit. However, one would expect the wider availability of inventory credit, both to farmers and the wholesale trade, to swell liquidity in rural areas and exert a downward pressure on informal lending rates, and bring greater stability to the prices of commodities for which there is pronounced seasonal price variability. The banking sector might be more willing to extend post-harvest credit to the agriculture sector and wholesale trade if it had better security and were easier to recover debts. This would be the case if there were a wider spread of reliable warehouses issuing warehouse receipts, which are readily acceptable as documents of title. Reducing Cost of Public Support for Agricultural Marketing According to a World Bank report (Anon, 1999a), the cost of the Government of India’s food grain policies was already about $2 billion in 1996-97; this includes food subsidy, implicit interest rate subsidy to the Food Corporation of India (FCI), and the value of physical losses in the private marketing. By 1997/98, food grain subsidies alone had reached Rs 90 billion ($2.2 billion). The efficiency and effectiveness of this system has often been questioned. By one estimate, after accounting for poor targeting and leakage into the open market, less than one quarter of the grain distributed through the public distribution system (PDS) actually reaches the poor.
The existence of accredited warehouses would facilitate private stockholding in rural areas, and would make it easier for the Government to reduce its buffer-stocking role with basic food commodities, allowing private parties – farmers, traders, millers etc. - to store a much larger share of the total crop. The resultant savings would significantly ease the pressure on public finances. Another way in which the Government might reduce its buffer-stocking role is by making greater use international markets to stabilise domestic prices. While international commodity markets exhibit a degree of price volatility, variations are smoothed because nations at different latitudes harvest at different times in the year, and because there are major stockholdings and mechanisms available for managing price risks. Government of India's recent decision to lift quantitative restrictions (QRs) on the import of 1,429 items, including basic agriculture produce such as wheat, rice, maize, other cereals, edible oils and dairy products, suggest that it will increasingly rely on this mechanism of price stabilisation in the future. In a globalised system, the management of domestic crop inventories in approved warehouses, and the supply of credit for holding such inventories, would improve rural liquidity and lower borrowing cost, reduce storage losses, lead to shorter supply chains, and generally enhance the competitiveness of domestic producers and processors, at relatively little cost to the State.
Reducing Cost of Sales Transactions and Improving Price-Risk Management Independent warehousemen can independently certify the existence of goods offered for sale, and a warehouse receipt can be tendered to a buyer to execute delivery. This reduces counterparty risk and makes it easier to do business with remote players. A special case of this is that of a commodity futures contract, where short position holders tender warehouse receipts for delivery against expiring contracts. Warehouse receipts have a synergistic relationship with commodity futures exchanges, and the two tend to coexist for sound economic reasons. Approved warehouses internalise risks regarding quality and quantity, and can guarantee the quality or grade of goods tendered for delivery. Most of the world's leading futures contracts for agricultural commodities involve mandatory physical delivery upon contract expiry, rather than the alternative of "cash settlement", since it ensures convergence of physical and futures prices, and provides traders with the option of giving and taking delivery. Disputes are minimised if stocks are handled by a competent third party warehouseman. At the same time, stocks held in warehouses are subject to risks that ensue from price volatility - the price of the commodity may have so declined that the realisation upon sale is less than the credit made available to the borrower. Managing these risks is the raison d'être of futures markets, making it more viable to carry stocks. For this reason, producers, processors and traders may use a combination of warehouse receipts and futures contracts to eliminate physical risk of the commodity while it is in inventory and hedge against the impact of a price decline. For the same reason, banks lending against warehouse receipts often require borrowers to hedge the value of the underlying collateral in a futures market. Futures contracts and warehouse receipts can thus be used jointly to manage price risk and physical risk. In most of India's commodity exchanges little use is currently made of warehouse receipts, and while goods are sometimes exchanged in private warehouses, contracts reaching expiry are (as indicated above) normally cash settled, at prices which are often at variance with the underlying physical market. Normally, however, traders avoid delivery and offset their positions and or close them out by exchange of physical for futures. The existence of credible delivery mechanisms, and consequent improved linkage with the physical market, would significantly reinforce the exchanges' ability to attract business. Readying Indian Agriculture for the Challenges of the 21st Century With 142 million hectares of cultivated land, India is the world's third biggest agricultural producer. However the task of raising production is greatly complicated by the small scale of farms (average 2.2ha) and extremely diverse climatic conditions. Since 1947, Government's priority has been to assist farmers increase yields. It has been successful in this aim, with yields rising to around four times the level in the late 1940s, making the country largely self-sufficient in food production. Further increases are needed to keep pace with population growth and rising incomes, the latter resulting in increasing consumption of animal proteins (principally milk, beef and chicken) for which there is a high income elasticity, and a consequent increase in demand for feed ingredients. India’s food grain production is currently around 200 million tons, and in view of rising demand Government seeks to increase this level by 4.5 percent over the next 20 years – at this rate production should double by 2016. Similar objectives exist with other crops. The main constraints affecting production are water and seed. Approaching 40 percent of agricultural land is irrigated, but Government seeks to raise this to 85 percent making extensive use of rain catchment, sprinkler systems, and bore wells, there being serious concern that the green revolution has hardly affected dry-land farming. This will require the commercial supply of large quantities of plastic tubing, sprinkler systems and other inputs. Fertiliser is also vital for raising yields in irrigated areas, but its effective use depends on the availability of good seed. In most dry-land areas, crop yields do not justify the use of fertiliser, so that seed alone can, by and large, be considered the key input required to increase production - an example of this is the rain-fed soybean industry of Madhya Pradesh. Farmers’ current usage of seed leaves much to be desired. Due to conservatism, lack of financial resources and seed availability, they typically only renew 10 percent of their seed every year, so that yields are far below potential. Where major breakthroughs have been made, as in the case of irrigated wheat and paddy production in the Punjab, the level is much higher, but with cotton and most oilseed crops produced in dry land areas the performance has been much poorer. Seed supplies are also important to assist farmers in diversifying their production or in responding to new market opportunities as they arise – for example farmers in Haryana starting produce onions for the Delhi market, or farmers in Punjab seeking to produce forage legumes. With the greater importance now accorded to market forces, farmers must be ever more ready to move in and out of crops as market conditions dictate, and obtain the necessary seeds, technical advice and other inputs required. For example soybean prices are formed by international price for oils and meals; the currently low level of these prices is likely to cause some farmers to diversify to other crops. Hitherto public policy has stressed the role of extension services and co-operatives in leading the uptake of new agricultural technologies, but contemporary thinking increasingly stresses the importance of commercial networks supplying new ideas and advice, inputs and credit, while also marketing the outputs. A key player is the local merchant, which in some cases will be a co-operative, but given the limited coverage of the co-operative movement, will more often be the local commission agent or independent buyer at the mandi. The latter's proximity to the farmer allows him to offer a range of services at low cost. His overheads can be spread over the cost of input supply, credit, storage and marketing services, and he is well placed to screen farmers for credit risks, thereby minimising defaults of the kind which have often plagued official programmes. The task of persuading farmers to adopt improved inputs and/or diversify into new crops calls for highly progressive commercial service providers, including both local merchants and others at one remove (e.g. larger wholesale dealers, cotton ginners, millers), knowledgeable about market opportunities around the country and overseas. There is evidence of a shortage of such players in India and in the words of Mr Ohja, a senior official at the Ministry of Agriculture, there is a mismatch of supply and demand. For example, farmers in Haryana seeing a market opportunity in onions had to travel 1,500 km to the traditional supplying State. It is significant that it was the farmers who seized this opportunity and not their local merchants. The picture emerging from our short studies of the cotton, oilseed and gur industries are of industries dominated by undercapitalised intermediaries operating on low margins and unable to invest in improved services (see section of this report on "Commodity analysis; prospects and hurdles" and Appendices 3 to 5). There is also reason to ask whether market yards (mandis) are universally appropriate for 21st century India. They were originally instituted in the 1920s as a means of ensuring market transparency, and have been remarkably successful in achieving this objective. However the requirement that all produce move through these centres may constrain the development of shorter supply chains involving lower handling costs, and allowing the merchant class to work more directly with producers to raise yields. Some reports indicate that mandis are congested and failing to reward producers for improved quality (Anon, 1999).
What does this mean for public policy? The main implication is that policies should engender the emergence of progressive and efficient marketers and suppliers of agricultural support services, both local agricultural merchants and other downstream players. A system of warehouse receipts can play an important part in this by helping to capitalise these players, by giving them access to the finance they need, to enhance their competitive position in the market place and offer better services to farmers. Indeed this has happened in countries which have created strong warehouse receipts systems - for example in the first half of the century, they played a major part in the strengthening of rural elevators and the expansion of credit to farmers in the American mid-West.
Chapter 2 India's Warehousing Industry Industry Structure Warehousing is a well-established activity in India. Both the public sector and the private sector have a significant presence. However, if warehousing is described as an industry, the Government of India and the State Governments are the dominant players (see Table 6). The private sector has significant warehousing capacity, but such capacity is aimed at use by the owners, even if they are lessees of facilities, or by suppliers to and customers of private sector owners. Warehouses are usually owned by companies for storing their own raw materials and finished goods. Such capacity is unlikely to become available for hire, except under certain circumstances that are discussed below. There are however two large oilseed companies that specialise in renting or hiring storage, with aggregate capacity less than 0.6 million tons. Most warehouse owners are sole proprietors and partnerships, usually having small and dispersed capacity. Private warehousing has yet to come to the fore as an integral part of India’s warehousing industry, except as regards port warehousing. Government has hitherto been the largest player in the warehousing industry. It has a massive role in the procurement of food grains and other agriculture produce, and as a depositor of such produce in warehouses that are either owned by Government or small private owners. Government is also present in the warehousing industry as owner of warehouses earmarked for use by both private traders and parastatals.
The Government's presence in the warehousing industry has been guided by the All India Rural Credit Survey Committee of 1949. The Committee recommended a three-level structure, including the Government of India, the State Governments and co-operatives. Co-operatives were expected to provide storage in rural areas close to the farms. Warehousing was seen as a necessary but relatively unprofitable activity which would not attract much private sector interest, and which therefore required public investment. Moreover, the presence of the private sector was seen as a threat to the continued and smooth availability of produce for consumption. A major step in implementing the three-tier policy was the Warehousing Corporations Act of 1962, which created the Government of India-owned Central Warehousing Corporation (CWC) and provided for CWC to take an active role in creating 16 State Warehousing Corporations (SWCs). CWC started with 7,000 tons of storage capacity, but now has 450 warehousing sites with a total capacity of about 7.5 million tons, which it is expanding at a rate of about 200,000 tons per annum. The SWCs have more than 2500 warehouse sites with an aggregate capacity of about 12.5 million tons. Together, the CWC and the SWCs dominate the warehousing industry and provide economically valuable services across the country (see Table 7). Warehouses of the SWCs are usually smaller but well spread over more sites unlike the warehouses of the CWC that are usually big and located at fewer sites.
Equity Ownership by Banks and Insurance Companies The Government of India has a 53-percent equity stake in CWC, followed by the State Bank of India with 21 percent, other scheduled banks with 16 percent, insurance companies with seven percent and the remainder by co-operatives and agricultural associations. This means that banks collectively own 37 percent of the equity of the CWC, while insurance companies and banks hold 44 percent. The CWC has a 50-percent stake in all the SWCs. The State Governments own the remaining 50 percent in their respective SWCs. By virtue of their large stake in the CWC (44 percent) and the CWC's stake of 50 percent in the SWCs, banks and insurance companies have a stake of 22 percent in the 16 SWCs. Such a stake in the CWC and the SWCs makes the Government-owned banks and insurance companies the implicit stakeholders in over 7.2 million tons or more than 36 percent of the total storage capacity of about 20 million tons, a very significant holding. Our discussions with banks and insurance companies indicate that new opportunities that expand business incomes of the CWC and the SWCs would be of interest to banks and insurance companies. New Activities of CWC The CWC started diversifying its services in the 1980s, establishing custom-bonded warehouses (capacity 800,000 tons), container freight stations (CFS) and some cold stores. Given the low profitability of its general warehousing activities, it is now considering a range of additional activities including:
CWC and SWC warehouses are generally located in big cities and medium-size towns, though SWCs have warehouses in small towns. As indicated above co-operatives were to fulfil the rural warehousing role, but co-operatives have not performed as vigorously as envisaged, leaving a significant gap in the provision of services. Small private warehouses fill the gap in some villages. In the early 1990s, Government of India tried to initiate a scheme whereby farmers would use their own individual stores as warehouses, and hypothecate their stocks to banks – along the lines of similar projects in Nepal and Thailand. The Ministry of Agriculture, Government of India, attributes non-implementation to lack of bank confidence and crop failure in the year planned.
Warehousing Outside the Ports Government dominates warehousing outside the ports, and activities of private operators are very limited. This may be attributed partly to "crowding out" by Government and partly to the relatively unprofitable nature of upcountry warehousing, unlike port warehousing which can be more easily combined with freight-forwarding and other services. Upcountry warehousing may be profitable when combined with trading, so that it becomes a means by which a trader can earn extra income by using space not immediately required for his trading business. The marginal cost of operating a store under such circumstances is quite low. Indeed a number of cases were cited where trading is combined with storage for clients, including that of soybean procurement by commission agents in mandis in Madhya Pradesh (Appendix 3), coffee curers in Karnataka, and jute adatiyas in West Bengal. Often, however, the depositor does not have the freedom to withdraw the commodity and sell to another client. Such cases cannot truly be described as warehousing, but rather a marketing service involving delayed pricing of the commodity. They do however demonstrate that Indian traders are quite sophisticated and are able to offer the farmers contractual alternatives – a point to which we shall return later. Where co-operatives exist they usually offer warehousing services to local farmers, using stores of 2,000 to 5,000 ton capacity. Many of them issue warehouse receipts against which co-operative banks provide inventory credit. Another factor which may limit the activity of private warehouse operators is that under the Agriculture Act of 1961, all warehouses storing agricultural produce have to be licensed by the district collectors who are part of the State bureaucracies. In some States, district collectors may be reluctant to license private warehouse operators. Warehousing In and Around Ports The CWC and some of the SWCs are also represented in ports, but there is a much larger variety of players handling both bonded and non-bonded cargo. In Mumbai freight forwarders were until recently the main players operating warehouses, and were often nominated by the banks as collateral managers. They are still used in this way by Government-owned and smaller private banks. The liberalisation of India’s oils imports has led to a rapid growth in the volume of palm oil imported from Malaysia and other producing economies, with the volume reaching about 4.2 million tons in 1998-99, or 45 percent of domestic consumption. Handling such volumes requires the services of specialised tank farms at the ports; such services are provided by the private sector owners along with superintendence and inspection companies, Companies of the latter type include SGS, ITS-Seascan, Inspectorate Griffith, Geochem and J.S. Boda. The largest players are international companies and they have access to offshore professional indemnity insurance. The inspection companies have also entered the marketplace for warehousing in the context of structured trade financing for import or export. They seek to provide an integrated service to their principals, including inspection, analysis, warehousing and collateral management. Notably, they do not own warehouses or tank farms, but take full legal possession of them by leasing them from the owners. Industry Conduct CWC and SWCs receive deposits from farmers, companies and Government, issuing warehouse receipts denominated negotiable or non-negotiable. Negotiability should mean that warehouse receipts could be transferred between members of the trade by endorsement, or by attaching a delivery note, without fear that ownership by holders in due course can be successfully challenged, or subjected to unforeseen liens. There is considerable uncertainty in practice as to whether warehouse receipts are documents of title. So, with minor exceptions, they are not used to transfer title. "Negotiable" warehouse receipts are however accepted as collateral by the banks, and this is authorised under RBI rules. The borrower must simply be known to the bank and have an account there. The bank advises the warehouse of the lien, and goods are only released to the depositor when the bank returns the warehouse receipt suitably endorsed, signalling that the loan has been repaid. By attaching a delivery order to the warehouse receipt, the depositor can also assign the stock to a buyer but no further transfers are possible without issuing a new warehouse receipt. CWC and SWCs issue non-negotiable warehouse receipts either when the depositor so requests or when the quality of the goods does not meet an established acceptance standard and is therefore unlikely to be good collateral. The Government of India and State Government institutions are the main customers for CWC’s and the SWCs’ storage services. The Food Corporation of India (FCI), which accounted for nearly 80 percent of all food grains stored by CWC in 1998-99, is also a very significant customer. State agencies account for more than 75 percent of the usage of public warehouses. The private sector, farmers and co-operatives account for the remainder. A warehouse at Indore was storing 7,000 tons for the Food Corporation of India (FCI) and 4,000 tons for private parties, including farmers, traders and certain processors, with farmers accounting for about half of the total. Commodities stored included wheat, soybeans and pulses. Farmers were said to be storing in anticipation of price rises, and their involvement in this activity was growing as they became increasingly educated and aware of speculative opportunities, and increasingly able to save. Most deposits were for 100 bags or more, though deposits of only one bag would be accepted. CWC had established a stacking plan that allowed it to build composite stacks out of relatively small identity-preserved lots. There is no commingling of lots belonging to different depositors. The warehouse receipt gives banks the right to seize and auction the goods of a defaulting depositor, but the manager of one of the Indore stores reports that this had never happened – though they might on occasions have to wait for three or four years for repayment. Only banks may lend against warehouse receipts; it is illegal for trade counter-parties to use them as collateral for credit. Storage is charged on a monthly basis or portion thereof. Table 8 shows that charges vary widely between depositors.
Rates for FCI are established by an inter-ministerial committee and are about 60 percent of charges to commercial depositors. Farmers and farmers co-operatives get a discount of 30 percent on the standard rates. To prove the depositor is a farmer, he must present an attestation to this effect signed by the village revenue officer. Many farmers are probably fronting for traders at their local mandis or are village traders who also farm. Inspection companies have a simple and uniform approach to the provision of collateral management services. Prior to receiving deposits, they draw up a standard tripartite collateral management agreement, involving the depositor, the financier and the inspection company (collateral manager). At the same time the latter takes a sub-lease on the warehouse, and the owner agrees not to operate it without authorisation. As goods are deposited they issue a non-negotiable warehouse receipt directly to the bank, without passing through the hands of the depositor, an arrangement which eliminates the opportunity for forgery. Goods are released upon receipt of a delivery note from the bank.
Chapter 3 Performance of Indian Warehousing Industry Central Warehousing Corporation (CWC) An analysis of the strengths, weaknesses, opportunities and threats (SWOT) of the public sector warehousing corporations is included in Box 7. The CWC has performed very creditably, having financed all its expansion through retained earnings. The 1998-99 Annual Report indicates that average capacity utilisation is over 78 percent through the year. This high level is a direct result of the CWC’s presence across the country, which allows it to take advantage of the varied seasons and commercial activities of different States. While one warehouse site in Karnataka may be used to the extent of, say, 40 percent, in a particular month, another site in Uttar Pradesh may be used to the extent of, say, 90 percent. The central office, the sixteen regional offices and major international container depots have already been computerised, and ISO certification is planned for the entire organisation. This performance can be largely attributed to CWC’s privileged position as a provider of warehousing services to Government. Nevertheless it seems to have a good reputation with most of its private clientele, though less so with the international trading community (see below).
The staff we met at Indore appeared well trained and competent, and our brief visits to warehouse sites suggested that handling procedures and grain hygiene were good. However the warehouses themselves were in need of maintenance, particularly as regards damaged floors and broken windows (which gave access to birds and insects). Much of the office furniture needed replacing, and storage of records needed improvement. CWC’s warehouse receipts appear to be fully acceptable to public sector and co-operative banks. The same does not appear to be true of some larger private financiers, particularly the international banks. It is unclear how much of this is due to bankers’ practical experience of working with CWC, and how much to their apprehension over their being State-owned. One banker complained about poor stacking of cargo and excessive bureaucracy, and said that he would only use CWC if he put his own staff to oversee operations. Another simply said: "We know the way publicly owned institutions work." Perceptions of the latter kind are likely to be a serious impediment to CWC as long as it remains part of the public sector.
While privileged access to Government clientele has allowed CWC to grow, public ownership appears to limit its ability to fully develop its activities in upcountry areas. The setting of storage rates for Government clients and farmers is to a significant extent a political process, even though politicians may not be directly involved, and rates are set at levels that often compromise profitability. This may explain its low profitability while enjoying a high level of capacity utilisation. The low storage rates negotiated for farmers and co-operatives pose a particular problem in expanding services to non-Governmental customers. Without being able to charge higher rates there is little incentive to invest in additional warehouses in more remote locations closer to the farms. Given private sector perceptions of CWC, its need for more freedom in negotiating storage rates, and its underlying financial viability, we suggest that it be considered for disinvestment by Government. The equity of CWC would be an attractive inclusion in private portfolios. Government may wish to retain a shareholding so as to ensure continued commitment to service provision in the warehousing sector.
State Warehousing Corporations SWC warehouses are reported to inspire less confidence among depositors than those of CWC, though the position varies considerable from State to State. Users of SWCs more often store non-agricultural produce. It is difficult to explain why there should be a difference in performance between CWC and its affiliates, given that CWC owns 50 percent of their stock and is represented on their Boards. Part of the answer may lie in political appointments outside CWC’s direct control. State Governments own the other 50 percent of the stock of their respective SWCs and select the chief executives. The Warehousing Corporations Act had envisaged SWCs to be economic replicas of the CWC, while enabling them to act as agents for CWC in many activities relating to storage and logistics. However, in practice few SWCs have had a close working relationship allowing them to take advantage of CWC’s innovative practices. The hiatus between the SWCs and the CWC is perhaps a result of the differences in their approach to business and profitability. Disinvestment of equity by the State Governments would probably have a beneficial impact. Moreover, SWCs have more warehouses located in the hinterland than the CWC. Disinvestment may be even more justified with these companies, as it will allow for better use of their assets. Private Sector Warehouse Operators A SWOT analysis of the private sector warehouse operators is included in Box 8. In Mumbai, the traditional system involving bank-appointed freight forwarders has certain shortcomings, notably that the warehouse operator does not take responsibility for quantity and quality. This in turn limits the level at which banks will advance inventory credit. In other ports, such as Kandla and Paradip, international and local inspection companies have overcome such limitations, and the system is working much better, meeting the requirements of international banks and trading companies. In importing countries there is considerable apprehension about Indian exporters defaulting on contractual obligations, so the introduction of an internationally credible system of inspection and collateral management is a significant achievement. Notwithstanding, some trading parties still do not fully trust the inspection companies, believing that they tend to find in favour of the party that has contracted them. This can be countered, it is said, by having each party contract an inspector, having a single inspector contracted by the two parties, and having one’s "own man" shadow the inspector. All in all, however, the system seems to be operating satisfactorily. The same cannot be said for export trade deals which involve pre-financing stocks in upcountry areas, or in the case of imports, involve supplier credit. The problem is illustrated in the case of soy meal exports in Appendix 3. Far Eastern importers do not wish to risk chartering a vessel unless they are sure that quality and quantity are acceptable at origin. If they wait for information from a port warehouse, it will be too late to cancel the charter. They therefore need the stocks to be collaterally managed at origin. Likewise they will be reluctant to extend green-clause pre-financing terms on letters of credit, unless there is some form of collateral management at origin. Defaults have occurred due to the absence of such services. According to a major buyer, the oilseeds industry particularly needs more warehousing facilities in up country areas of Gujarat, Madhya Pradesh and Rajasthan. The SWCs of the three States and the CWC may pursue this opportunity. Similar problems occur with the importation of edible oils and pulses. Supplier credit is sometimes extended at international rates for up to 180 days, but there are significant risks of default.
Chapter 4 Commodity Analysis: Prospects and Hurdles Commodities Analysed The commodities chosen for closer analysis in this study are cotton, oilseeds and derived products, gur and coffee. More detailed information on the first three of these, including analysis of testing and grading systems, storage practices, and the disposition of exchanges towards warehouse receipts, is provided in Appendices 3 to 5. Taken together these commodities account for 19.52 percent of the India’s official index of agriculture production. The potential for the introduction of warehouse receipt systems in the context of nearly a fifth of the agriculture produce output is therefore far from trivial. However, there are significant hurdles to such an introduction. Grades and Standards Industrial products, which are output of process engineering and manufacturing design, are produced to specifications. Therefore, such products are relatively consistent in their physical properties and appearance, chemical properties and characteristics, and functional capabilities. However, agricultural products are by nature much more varied. Agricultural products can have a vast array of characteristics, even though the effort expended in producing then may be identical. Agriculture products are described in markets on the basis of their weight, size, shape, density, firmness, resistance to insect damage, cleanliness, colour, taste, odour, maturity, blemishes, and moisture content. A compact but comprehensive system for clear communication between buyer and seller is vital. Grades fulfil that requirement. Grades are based on defined and accepted parameters that segregate similar products into categories consistently in a manner that is easily understood by market participants. Standards are rules of measurement established either by regulation or by authority. Standards are used to arrive at grades based on measurable and quantifiable attributes. Grades and standards enable commodities and produce to be handled in greater volumes. They enable produce to reach distant markets. More importantly, they enable commodity exchanges to define the characteristics of the commodity that should be delivered to fulfil obligations. Since commodity futures contracts are standardised and are traded by a very heterogeneous set of participants, the standardisation is best accomplished by using grades that are most widely understood and determined on the basis of standards that are accepted widely. All commodities - coffee, gur, and the oilseeds complex - meet the principal requirement associated with grades. Coffee, cotton and the oilseeds complex have standards. However, gur does not have standards as defined in an orthodox manner. This is surprising since gur is a manufactured product like sugar or khandsari sugar. The entrenchment of grades and standards pertinent to coffee can be traced to its status as an export commodity. The Coffee Board of the Ministry of Commerce has followed international standards for more than four decades. COFEI has adopted these international standards for its contracts. Similarly, cotton is a dominant part of India's trade basket. Cotton is both exported and imported. The CCI along with the EICA enable the application of a rigorous system of grades and standards. In the case of oils, cakes and seeds, there are well-established industry standards. The BOOE uses these standards. In general, grades and standards convey valuable information about the products that determines prices and helps define contracts for delivery. For example, cotton associations dealing in non-transferable specific delivery (NTSD) contracts follow this. These have resulted in the efficiency of markets and helped in make them more transparent. Limited Impact Though all four commodities or baskets, as the case may be, are amenable to grades and three are amenable to standards, the penetration of grades and standards is not complete. A significant part of the markets pertinent to the commodities has remained impervious to the penetration of grades and standards. The penetration of grades and standards is highest in the case of coffee. The plantations industry has a history of well-entrenched system of grades and standards. It is the least in the case of the oilseeds complex. Cotton and gur form the middle. In monetary terms, the penetration is highest in the case of the oilseeds complex and least in the case of gur. The relative scores of the commodities have been derived based on a proprietary methodology that assigns a score of 100 to coffee based on the penetration of grades and standards in the physical market. The scores are given in Table 9. The scores can be adjusted to reflect the monetary value of produce.
The oilseeds complex has a weighted score of 22. Oils have a score of 31. This score is significantly lower than expected. The low score precludes large scale and cost effective commingling of oils based on free fatty acid (FFA) content. Seeds, cakes and meals have been relatively impervious to grades and trail gur in penetration quite significantly. The high score of oils, relative to seeds and cakes, points to the likelihood of the oil futures and the underlying market being more active. It also points to a likely crisis in the underlying market for seeds and cakes if immediate steps are not initiated to propagate grades and standards in the seeds and cakes market. In our discussion with policymakers, the importance of accelerating the process leading to a high score in the case of edible oils was emphasised since the edible oilseeds complex constitutes a significant part of the agriculture produce economy (see Table 2). Commodity exchanges that trade edible oils futures contracts are aware of this emphasis. Prospects of Proliferation of Grades and Standards The penetration score of the edible oilseeds complex was about 5.6 15 years ago. Imports of edible oils and branding of edible oils have helped in the handsome increase to 22. Futures contracts would accelerate the acceptance further. The penetration score is likely to rise to 75 if the BOOE, the SBOT and the other exchanges that trade contracts belonging to the oilseeds complex evolve a common standard and apply it. The SBOT and the BOOE commenced trading futures in February 2000 and August 2000 respectively but have established the necessary processes to boost the penetration score in the edible oilseeds complex. Examples pertinent to basis quality follow. The SBOT has specified the following in the case of yellow soybean futures contract:
The SBOT has specified the following in the case of soy meal futures contract:
The SBOT has specified the following in the case of refined soy oil futures contract:
Moreover, the SBOT has a business rule that requires delivery thorough certified warehouses: In respect of contracts confirmed by the Exchange, commodities shall be taken delivery of by the buyers from the Certified Warehouses situated within the Municipal Corporation limits of Indore and within its radius not exceeding 60km or such other places as may be decided by the Trading, Clearing and Settlement Committee before the commencement of trading in a delivery month. The BOOE has specified the following in the case of groundnut oil expeller futures contract:
The BOOE has specified the following in the case of RBD palmolein futures contract:
Similar quality standards have been specified in the case of other edible oils. More importantly, the bye-laws of the PCCCI - BOOE's designated clearing house - enables the commingling of oils, seeds, and cakes and meals of the same kind and grade. PCCCI's business rule pertinent to commingling of commodities stocks: Members originating the delivery order or their clients (Trading-cum-clearing Members/Registered Non-Members of the Exchange) giving delivery shall be permitted to hold commingled stocks of tenderable grade of commodities covered by the said Delivery Order which shall mean that such stocks may be mixed or kept together with other stocks of the same grade of commodities duly certified by approved Surveyors. Mr M.V.S.S. Ramasarma of the NDDB attaches significant importance to the rise in the penetration score in edible oils since India is a very significant consumer, importer and producer of edible oils. Mr Ramasarma's recommendations pertinent to the achievement of the high score and to the practice of commingled storage follow. Free fatty acid, colour, MIV (other parameters being within Prevention of Food Adulteration Act) are important quality markers that need to be reckoned with while moving towards grading and commingled storage of a particular edible oil under warehouse receipt system because the oils are not stored party-wise. In fact, the individual depositor's oil loses its identity once it is commingled in the tank. It is therefore desired that the quality parameters of bulk oil should be standardised, say, two or three grades, such that the parties who deposit better quality oil get reasonable premium. In case of only one standard grade, the premium goes to the party supplying inferior oil when it is commingled with other good quality oil, which acts as a disincentive for the party depositing better quality oil. By having two to three grades of specifications, the oils can be stored separately which, in turn, enables both the buyer and the seller to know about the quality that is bought and sold. The concept can be similar to different grades that are being followed for grains and oilseeds. As the quality of edible oils deteriorates with passage of time, due care should be taken to list the oils based on either quality at the time of deposit or the age of the oil stored, with specifications at the time of deposit. The warehousing authorities should be certified based on the reputation for transparency, reliability and quality services so that the buying parties shall have confidence on the system itself. Regarding testing procedures, the same are prescribed by "Directorate General of Health Services (DGHS)". Alternatively, any standard, published, well-accepted test procedures recognised by the Government of India, which shall also be acceptable under PFA Act, can be evolved. We expect a significant metamorphosis in India's edible oilseeds complex as a result of the rigorous application of grades and standards. Such an application is a prerequisite for a warehouse receipt system in edible oils.
The penetration in the case of cotton will rise to 95 if all restrictions pertinent to physical trade and movement in cotton are revoked; it would also rise as a result of futures trading on a national scale. The improvement of the penetration in the case of gur is predicated on the emergence of standards; the willingness of the industry to adhere to grades is significant. Since coffee's score is relatively placed at 100, any improvement has to be absolute. Such improvement is not likely because there is little absolute gap to be covered. Moreover, COFEI has listed raw coffee futures and such listing is most likely to complete the process of total adherence to grades and standards. However, all absolute numbers would rise with the advent of warehouse receipts. The threat imposed by the market by way of higher price for compliance with grades and standards and lower price for non-compliance and avoidance would have a favourable impact on the penetration of grades and standards. For example, cotton is an industrial input and therefore has both universal compliance and preferences built into it. Avoidance would impose a very high cost by excluding a producer or processor that is not inclined to comply with grades and standards. FMC and Positive Externalities Until the mid-1990s, the orientation of the FMC was towards maintaining status quo in the commodity futures markets. In the recent past, the focus has shifted to an expansion of commodity contracts and commodity markets. This process has had a very favourable impact on the commodity environment. The expansion has produced several concomitant benefits. Each contract market requires one or more commodity contracts that are unambiguously defined with reference to grades and standards. Such a definition is necessitated by competition. Where there is no competition, the necessity arises out of the need to achieve higher trading volumes and thus earn incomes that are commensurate with investments made in trading, clearing and settlement systems. It would not be incorrect to suggest that the FMC and its policies towards the commodity markets have created positive externalities that can be exploited by the cash market comprising growers, processors and traders. Other service providers and intermediaries such as banks and warehousing corporations are also in a position to exploit the externalities. The emergence of a warehouse receipt system may be viewed both as a positive externality and an intended outcome. However, regardless of whether it is an externality or an intended outcome, the impact of grades, standards, futures contracts, and warehouse receipts would be favourable. The commodities are discussed next.
Cotton The textile industry accounting for about one fifth of India's industrial output, 6.85 percent of GDP, and 20 percent of merchandise exports, and has experienced rapid expansion over the last decade. Notwithstanding this industry remains seriously hampered by low yields, poor quality and under-investment in processing and obsolete equipment. Warehouse receipts can have a major impact in modernising this industry, because it will free up funds for modernising ginning and pressing factories, and will tend to improve quality through standardisation. At present these factories employ a significant part of net owned funds as working capital, but this precludes rapid modernisation of the factories, since long-term credit, based on balance sheet strengths, is not easily accessible. The limited net owned funds has necessarily to be employed in working capital to keep factories running regardless of the state of the machinery and equipment. The access to working capital credit based on warehouse receipts would enable factories to shift a portion of net-owned funds to investments in machinery and equipment. Such a shift would not interrupt operations since credit through warehouse receipts would be available and would also be self-liquidating.
The modernisation of the ginning sector would moreover add to the competitiveness of India’s cotton spinning sector, given that this sector is increasingly dependent on imported ginned cotton. Such cotton is of more uniform quality, and is usually imported at a lower landed cost. It should be noted that due to constraints arising from the system of monopoly procurement, it will not in the near future be possible to develop a strong system of warehouse receipts with seed cotton (kapas) in Maharashtra. Presently, lenders may be deemed to be illegally procuring kapas in the event that they take possession of the cotton of defaulting borrowers. However, some leading banks have appraised the potential, and they expect significant credit flows once the policy framework has been reformed. The prospects for warehouse receipts in the cotton industry are much enhanced by the past work of the EICA and other industry entities. When in the past India imported significant quantities of cotton, the Cotton Corporation of India (CCI) and the EICA developed surveying, testing, grading and valuation systems which had a positive impact on the industry. At the same time, the presence of corporate organisations in spinning and the textile research institutes has enabled investment in, and the entrenchment of, objective testing equipment and methodologies. The cotton economy, with the exception of the market yards, is therefore well equipped to support a system of warehouse receipts. EICA has recently introduced a contract for ginned cotton specifying the physical qualities of the fibre, and is also likely to introduce a contract for kapas. Both kapas and ginned cotton are amenable to warehousing and the issuance of warehouse receipts. The exchange has also begun work in earnest on warehouse receipts, and has identified a very large and reputed financial institution interested in providing inventory credit.
Soybeans and Other Oilseeds A World Bank report (Anon, 1999) makes a similar diagnosis of the oilseeds industry, describing "a fragmented industry structure whose inefficiencies (i.e. poor technical standards of oil extraction, inconsistent quality, low capacity utilisation and high operating costs) are largely borne by growers who receive lower than international prices at one end of the production chain and consumers who pay higher than international prices on the other". It goes on to point out that in the case of the soybean industry, the best international processing factories use only 12% of the solvent per ton of Indian factories, roughly half the steam, and three quarters the electric power. To this should be added the poor development of the domestic market for high quality feed, and the need to export much of the de-oiled cake, and the low quality of much of the cake, all of which depress the price which can be paid to Indian farmers. As with cotton textile sector this is an industry where warehouse receipt can play a role in freeing up funds for investment in necessary modernisation and rationalisation. In the soybean industry, warehousing is already practised at the ports, and on a limited scale with Government-owned warehouses at Indore and elsewhere. However more services are needed in upcountry areas both to reduce risks of export trade in meal, and to facilitate delivery on futures contracts listed by the SBOT. Compared with food grains, oilseeds are not subject to heavy Government regulation. However, the Storage Control Order applies to oilseeds. There is also the requirement that all oilseeds be marketed through mandis, which in Madhya Pradesh now levy a charge of 2 percent, up from 0.5 percent in the last season (on the other hand State sales tax of 4 percent has just been removed). Small-scale industry reservations still apply to some other oilseeds, though the Ministry of Agriculture has requested their removal. Notwithstanding considerable cost inefficiencies in the crushing sector, the competitive environment in the oilseeds industry is fiercely competitive. In the case of soybeans, the margin between the farm gate and the processor was only about 7 percent of processor's buying-in price, prior to the increase in mandi tax. The narrowness of the margin provides a powerful incentive to evade taxes, and in States that have not removed sales taxes it will provide a disincentive to document sales between trading partners through warehouse receipts. Storage Control Orders have a similar effect. If such constraints can be overcome there will be good prospects for warehouse receipts in the oilseeds industry.
It should be noted that much of the marketing margin covers services provided by commission agents who are located at the market yards (mandis). They fulfil vital roles within the marketing structure, notably:
This contradicts popular misconceptions about the role of middlemen. They have considerable skills and market knowledge, and as suggested in the Rationale section of this report, they have a key role to play in enhancing agricultural productivity. In the case of other oilseeds, rapid advances are noted in testing and grading methodologies. This will drive the tightening and the shortening of the supply chain that supports commingling and the use of warehouse receipts. Moreover, the BOOE has already made a provisional decision in favour of a warehouse receipt system. Gur The gur exchanges are in favour of using warehouse receipts for delivery purposes, but the speedy emergence of scientific testing processes is a prerequisite for their usage. Financing against warehouse receipts would moreover allow gur manufacturers to devote some of their equity to modernising their low-tech businesses, particularly through the use of vacuum technology. The emergence of scientific testing and grading processes would most likely lead to an acceptance of commingling of gur, and common or public storage without any emphasis on identity preservation. Industry sources indicate they would welcome the resulting savings in storage costs. Development of warehouse receipt systems for gur would facilitate its subsequent extension to the sugar industry as a whole, and assist in the deregulation of the same. Coffee COFEI has implemented a system of warehouse receipts involving a network of private warehouses which are themselves members of COFEI, and which meet the exchange’s certification criteria. Delivery and margining rules favour the use of warehouse receipts. The coffee exchange's warehouse receipt system is a test case for three reasons:
An unusual amount of effort has been devoted to creating a really rigorous delivery system. However the level of trading on the exchange remains low and delivery is hardly practised. Probable explanations include the taxation issue, lack of interest/understanding on the part of farmers and roasters, and dissatisfaction with the grading system established by COFEI. Implications for the Development and Regulation of Warehousing Services COFEI’s decision to certify warehouses seems very logical in view of the lack of any other certification body, and the geographical concentration of the coffee industry in south India, which makes most warehouses readily accessible from Bangalore. The decision to have all warehouse receipts issued from Bangalore (as opposed to simply tracking them electronically), and not by the individual warehouses, may be attributed to concerns over security, and uncertainty over the legal status of warehouse receipts issued by private companies. The cotton economy and oilseeds economies are significantly bigger and more complex than the coffee economy. It may be difficult for the relevant exchanges to perform the two functions performed by COFEI. While the warehouses owned by Government may well undertake the issuance of receipts, the issuance of receipts by private warehouses may not be easy. In the cotton and oilseeds economies, there has been significant integration of the trading, storing and processing components of business. Stocks of farmers, processors, suppliers and customers are held in warehouses operated by private parties (traders and processors) on an identity-preserved (IP) basis. These private parties will need to be involved in any attempt to develop warehouse receipt systems. While Government warehouses may assist in the stockholding process, they are not integrated within existing marketing chains, and they are unlikely to take the lion's share of this business. However, if existing private warehouses can be properly regulated by a central authority, and depositors and lenders can be guaranteed against malpractice, it should be possible for them to issue warehouse receipts and for these to be used as security for financing. However, the task of regulating private warehouses owned by traders and processors is not simple - there are significant risks arising from the warehouse operators' trading activities, and conflicts of interest arising therefrom. It needs to be well thought out in the local cultural context, and developed accordingly. The regulation of warehousing corporations owned by Government would be easier since such warehousing corporations would not have operations that are integrated to trading. Banks and lenders are more likely to have business alliances with such corporations. These alliances are on the drawing board; the alliances present an important opportunity for the banking sector to play a significant role in the development of certification and regulatory standards. A common finding with cotton, oilseeds and gur is that the implementation of a warehouse receipt system would help the industries concerned release equity capital for investment in new technologies, having a favourable impact on the industry's cost of operations and profitability. National System of Warehouse Receipts Warehouse receipts enable produce to be stored between harvest, while the receipts are used as collateral in the flow of credit from lender to borrower during the period of storage. A system of warehouse receipts has a significant impact on growers on producers when they face the right incentives to (1) store produce, (2) postpone sales until the time and price of sale are favourable, and (3) use warehouse receipts as collateral while borrowing. Discontinuous production and seasonal harvests provide the right incentives. Tables 15 through 23 include details of the temporal distribution of harvests of the commodities analysed in this report. The tables show that all the commodities chosen for the joint programme of the World Bank and the Government of India are characterised by seasonal output. More importantly, the tables include the spatial dispersion of harvests of the same produce in the States where the produce is harvested. Information pertinent to the spatial dispersion would show that there is significant scope for the State Governments to act collectively in supporting a national system of warehouse receipts that may be engendered by the Government of India. In fact, the State Governments have the appropriate economic incentives to collaborate with the Government of India in designing a national system of warehouse receipts, and contributing to its supervision and regulation. Such a process of collaboration and joint effort would have a very favourable impact on the underlying markets for the produce across the economy.
Chapter 5 Policy Issues Affecting Implementation of Warehouse Receipt System Two factors make policy issues particularly important in the case of agricultural commodities: (a) the considerable political sensitivities attaching to agriculture and food and the consequent tendency for Governments to intervene in both a strategic and ad hoc manner; (b) the fact that there are two levels of intervention, at both the Central and State levels. The main issues are discussed below. High levels of procurement and storage by Government The high levels of Government intervention reduce seasonal price variability to a level where private parties are reluctant to store or use warehouse receipts. For example, millers often find it easier to let Government do the storage and procure their raw materials on a hand to mouth basis. However, the cost of financing this storage, and the associated PDS, is very high, and it poses a serious problem to those seeking to manage public finances. Examples from elsewhere show that prices can be managed within narrow bands with much lower levels of public procurement, and at much lower cost than those indicated earlier in this report (see Box 9).
BOX 9: PRICE STABILISATION IN INDONESIA AND PAKISTAN In the latter 1980s, public procurement in Indonesia was equivalent to an average of only 6% of domestic output, or 20% of total inter-seasonal carryover (Ellis et al., 1992), while the average seasonal price variability (i.e. highest month over lowest month) was only 11%. Farmers (32%) and traders (48%) accounted for the remaining storage of rice across seasons. They moreover noted that the cost of funds to traders was in excess of the gross return given by the seasonal margin, resulting in a negative real incentive to hold stocks for price reasons. Traders were holding grain for operational purposes, such as continuity of paddy supply into mills, and regular supply of polished rice to customers, but seen from a speculative viewpoint their returns were evidently negative. The same authors went on to conclude that, by more targeted operations with respect to season and location, Government of Indonesia could achieve its price stabilisation role at considerably lower cost. The author (Coulter) can cite his own experience of Pakistan in 1990. A simple increase in the difference between official procurement and issue prices for wheat led to an immediate increase in direct procurement by millers, who now found it profitable to finance around two months additional raw material stocks instead of relying on Government supplies. An elastic supply of storage is what one would expect from economic theory; and a good warehouse receipt systems will increase the elasticity. Such a system has for long existed in the Philippines, and has worked well (see Coulter and Shepherd, 1995).
When the State Governments and the Government of India decide to deal with this problem, they will find warehouse receipts to be a valuable tool that will facilitate the expansion of storage by other players. They will particularly assist traders who do not have a very strong credit history and are therefore unable to borrow against the strength of their balance sheets. Minimum Support Prices and Monopoly Procurement Minimum guaranteed or support prices (MSP) and monopoly procurement encourage farmers to neglect quality control and offload produce onto the State. When inferior grades are eligible for MSP, the expected price for superior grades falls. Testing, grading and sorting are pushed higher in the supply chain, almost to the point of processing. Collateral value becomes uncertain at points that are lower in the supply chain, diminishing the scope for warehouse receipts. Sales Taxation With few exceptions, present taxation regimes provide for the payment of mandi taxes at 0.5 percent, and sales taxes levied either by the States (a regime of uniform rates is in place since January 2000) or, in the case of inter-State movement, by the Government of India (4 percent). Sales taxes pose the strongest impediment to the use of warehouse receipts, as was found in our visit to COFEI in Karnataka. Such taxes often represent more than the total gross margin earned by market intermediaries, so as long as they exist and are chargeable on goods changing hands in warehouses, no secondary market for warehouse receipts will develop; tax will be payable on each sale. In practice we believe that due to exemptions and evasion little sales tax is in fact being paid, but that they discourage marketing innovations in the formal sector. European Community taxation regimes are generally more favourable to warehouse sales, and may provide clues for reform in India. VAT is not levied on the transfer of documents of title for goods in warehouse, the view being taken that the goods are not really in commerce. In UK, all "basic foods", ranging from bread to instant coffee and drinking chocolate, are zero-rated. "Fancy items", like confectionery and cakes, are standard-rated (17.5%), but VAT is not levied on the primary commodity (e.g. cocoa), but only from the level of the processor. Dynamic Tariffs on Imports The Government of India recently decided to dismantle quantitative restrictions on 1,429 items, including a range of agricultural produce, and tariffs are henceforth likely to be its main tools in protecting domestic producers. While the move towards tariffs is welcome, experience with the sugar industry suggests that it may be applied in a manner that undermines one of their main purposes: assisting in domestic price formation. Since January 1999 sugar tariffs have been raised successively to 60 percent ad valorem and may go even higher. The problem with this is that while international prices influence domestic prices, domestic processors and other parties cannot estimate what that impact will be, because they do not know the level of tariff in, say, three months time. Under such circumstances, it is useless to hedge on international markets, even if this is allowed. Consequently they cannot plan investments and production in the expectation of given future levels of profits. An excerpt from a newspaper article: "Dynamic tariffs exacerbate price volatility by creating noise. Noise frustrates farmers, traders and processors in their attempts to plan activities based on the interpretations of price signals. Dynamic tariffs militate against the effectiveness of the price-discovery process that is the centrepiece of the market" (Ramachandran, The Hindu Business Line, February 22, 2000). Dynamic tariffs are also likely to increase uncertainty over the value of collateral, diminishing the potential usefulness of warehouse receipts. Storage Control Orders State Governments possess the authority to promulgate orders that limit the quantities of agriculture produce that producers and traders may store. While these powers may have provided a sense of security in the past, their continuation at a time when India has liberalised imports is detrimental to the emergence of warehouses and warehouse receipts. These powers prevent more efficient players from expanding their market share and, one may surmise, renders Indian producers less competitive. Players seeking to expand their operations are more likely to use warehouse receipts, so the measure is also detrimental to the emergence of warehouse receipt systems. Small-scale Industry Reservation In the case of processing of primary commodities, reservation is likely to have an adverse impact on the Indian economy. It is designed to protect the interests of India’s many hundreds of thousands of small-scale processors, but this is ultimately at the expense of much larger numbers of farmers and consumers. Like the Storage Control Orders, they make the country less competitive in terms of prices and quality, raise prices to consumers and increase India’s overall dependency on imported food. By restricting the scope of larger players, it moreover prejudices their ability to store and make use of warehouse receipts. Fortunately there is a movement towards de-reservation, with the Ministry of Agriculture recently recommending the de-reservation of rapeseed, mustard and groundnut. Mandatory Use of Mandis in Primary Marketing As noted earlier the current primary marketing structure involves mandis, and has generally favoured the development of transparent market practices. However, the structure is in some cases logistically inefficient, preventing direct movement of produce from farm to processor, and tends to force quality functions such as sorting and grading downstream to assembly or processing stages. If traders had direct access to farmers, as in Punjab, it would enable farmers to perform more of these functions, thereby improving their price realisation. It would also put pressure on mandis to adopt such practices that enable buyers and farmers to transact on the basis of known quality. Warehouse receipt systems might be developed to support the development of trading concerns outside of the mandi structure. Conclusions Regarding Policy Measures Policy reform in the above areas needs to be an integral part of India’s overall policy towards liberalisation and globalisation of agricultural marketing. Reduced intervention increases private parties’ incentives to engage in inter-seasonal storage, using warehousing services or otherwise. Specifically, the following are recommended.
With regard to the above, it should be noted that the NAFCSC has made two important recommendations at the meeting of the managing directors of the food and civil supplies corporations held on March 24 and 25, 2000. The NAFCSC has called for the removal of statutes that limit inter-State movement of agricultural produce. It has also urged the removal of all statutes that enable State Governments to limit the quantity of produce that may be stored by the private sector.
Chapter 6 Institutional Framework: Expectations of Potential Users
This chapter discusses the responses to a questionnaire survey. The questionnaire was based on "Using Warehouse Receipts in Developing and Transition Economies", a seminal work authored by two economists of the World Bank, Richard Lacroix and Panos Varangis. The questionnaire was administered between May and July 2000.The responses of 1360 potential users of warehouse receipts to each of the 11 sections of the questionnaire are summarised in this chapter. The comments and inferences are self-explanatory. The emphasis of the respondents is on the establishment of an institutional framework for warehouses and warehouse receipts rather than on the negotiability of warehouse receipts.
Analysis of Expectations and Major Factors Pertinent to Design A system of warehouse receipts is perceived to be very important to the efficiency of the underlying economic activities of a cross section of the economy's participants. The emphasis is unambiguously on reliability, costs, credit flows and the marked improvement of economic efficiency. Quite unsurprisingly, these expectations have little to do with the principal functions of commodity exchanges. Participants do not expect any commodity futures exchange to play any significant role in meeting these expectations. In fact, they see a minimal relationship between hedging and the raft of economic conveniences offered by warehouses and warehouse receipts. Policymaking pertinent to the principal contributory factors to market hygiene should necessarily be the basis for engendering a suitable institutional framework. It would be inadvisable to allow or expect commodity exchanges to develop and deploy their own policies related to warehouses and warehouse receipts in a fragmented manner. The commodity exchanges in India have made a very impressive beginning. However, it is important that the necessary components related to nation-wide regulation are developed by the FMC in order to capture the principal benefits offered by the commodity exchanges. The expectations pertinent to the institutional framework go beyond negotiability of warehouse receipts. The draft Warehouse Receipts Bill, 1978 is discussed in the following chapter.
Chapter 7 Legal and Regulatory Issues The main problem is one of lack of fiduciary trust on the part of banks and depositors. In addition the above-mentioned concerns over the performance of warehousemen, banks fear not being able to recover debts in the events such as fraud or mismanagement on behalf of the warehouse, or the insolvency of the depositor. Legal remedies are totally inadequate, and can take between 7 and 15 years if you take somebody to court. Warehouse receipts are not unambiguous documents of title, but simply a statement that goods are kept in a warehouse. The status of a pledge is unclear under Indian law, and banks fear that in the event of a borrower's insolvency, they will enjoy no prior claim over other creditors. Under India's present warehousing system, risks are minimised by the reputation of the warehousing company itself and of the organisation that stands behind the company. In the case of CWC this is the Government of India; in the case of the inspection company SGS India, it is the parent company in Geneva and the quality of its professional indemnity cover. This greatly restricts the number of companies that can act as warehouse operators, and the locations where such services are offered. The situation contrasts with the case of transport receipts. These are issued by transport service providers that are registered with the Indian Banks' Association, and are documents of title. Moreover when you endorse railway receipts no sales tax is paid. Another complaint is that "negotiable" warehouses receipts such as those issued by CWC and SWCs are not in fact negotiable. They may be endorsed by a depositor to a bank, but subsequent endorsements to secondary purchasers or other banks never occur. Here it is important to note that different meanings can be attached to the term "negotiability" (see Box 10). What is significant however is that further endorsements are prevented by the fear of fraud and the absence of timely remedies. Such fears also explain the increasing use of CMAs, where the warehouse receipt goes directly from the warehouse operator to the bank, without even having to be endorsed by the depositor. There is one less link in the chain, and therefore one less opportunity for fraud. We have examined the Sales of Goods Act, 1930, and it states unambiguously that a warehouse-keeper's certificate (i.e., a warehouse receipt) is a document of title to goods. This makes it similar in content and substance to bills of lading, railway receipts, multi-modal transport documents such as those issued by the Container Corporation of India, and dock warrants. Warehouse receipts are however accepted by banks as a documents of title when presented by an owner in whose name the receipt was issued, and if the issuing warehousing company is reputable and known. However while the endorsee whose name is affixed in a warehouse receipt can be deemed to be legal owner, when the warehouse receipt is endorsed to another person, and is then used as collateral security, ownership may not be enforceable. In this sense Indian warehouse receipts are non-negotiable in the first and narrower of the two definitions provided in Box 10. This provides a clear case for legal reform with a view to putting warehouse receipts on a par with readily acceptable negotiable instruments. Moreover, if it is unambiguously specified in law that warehouse receipts are negotiable instruments, lawbreakers will be exposed to the full penalty prescribed by the Negotiable Instruments Act, 1881.
BOX 10: DIFFERENT MEANINGS ATTACHED TO THE TERM "NEGOTIABILITY" General information on legal aspects of warehouse receipts can be found in Coulter and Shepherd, 1995 (pages 25-27, 39-40 and Annex 2). This document raises an important issue concerning the much-used term "negotiability". In some legal systems, a negotiable warehouse receipt is one which confers on a transferee "a direct interest in the underlying property, free of any outstanding claims". Warehousing laws should therefore be framed to empower warehouses to create negotiable instruments (in this sense). On the other hand the term "negotiable" is often understood as meaning that the warehouse receipt is freely transferable between successive holders by endorsement. Law should make this practice possible, but as the warehouse receipts are paper documents it should not necessarily be expected to become the norm. Elsewhere there is often a reluctance to "negotiate" warehouse receipts beyond the initial bank and borrower, or the purchaser and seller. The reasons for this are as follows: (a) warehouses see such "negotiable" documents as a security headache; (b) banks do not need to "negotiate" them in order to refinance their loans – it is enough to certify that they are holding them to the order of a refinancing financial institution; (c) a purchaser can ask the warehouse to issue a new warehouse receipt while cancelling the old one, obviating the need for multiple endorsements. Notwithstanding, if India can create a system by which warehouse receipts are freely transferred between holders, it will reduce transactions costs and increase usage. The creation of a secure central electronic registry offers a way round this limitation. Warehouse receipts can be successively transferred within a secure system which continually tracks changes in ownership.
In some of our discussions, some parties have highlighted the need to reform the law so as to render warehouse receipts "negotiable". However, in our view these problems relate only partly to legal shortcomings, but derive to a large extent from the fear of fraud and to the uncertain quality of the fiduciary contract between the parties involved. It would therefore be naïve to expect a mere enabling provision in the law, say, through a warehouse receipt statute, to solve all the above-mentioned problems. As indicated by Justice S.M. Jhunjhunwala (1999) when referring to the Negotiable Instruments Act of 1881, holding an instrument to be negotiable is not the same as the practice that makes such instrument negotiable, this quality being "the creature of custom of merchants". Hence a stronger legal definition of warehouse receipt may be of little avail where there is a lack of volition to accept the document as such. For this reason, a strong case can be made for a regulatory framework that sets standards for companies issuing warehouse receipts, licences them and provides for their regular supervision. This would favour their increasing use by depositors and lenders, as well as the creation of new warehousing companies that could invest in storage facilities in the knowledge that their services could be accredited before the banks. Such legislation is needed because there are no existing statutes that address these issues. A draft warehouse receipt bill was written in 1978 at the initiative of the Banking Laws Committee, but does not meet all the requirements (see Box 11). BOX 11: COMMENTS ON THE DRAFT WAREHOUSE RECEIPTS BILL OF 1978
Here it is worth noting that an international bank recently established in India indicated that there was a need for a listing of "recognised players" in the warehousing industry, while another asked for a thorough vetting of warehouse operators. Meanwhile, the Indian Banks' Association stated that there was a need for clarity as to which warehouses could be honoured by banks. Experience in other countries such as USA, Canada, Philippines and Colombia suggests that the number of companies and/or sites operated by these companies can be greatly increased if there are suitable arrangements for regulating and accrediting them, and for underwriting their performance. Largely as a consequence of the passing of the Uniform Warehouse Receipts Act in 1916, the United States has about 11,000 licensed grain handling companies authorised to issue warehouse receipts, and more in other commodity sectors. Any farmer can take his grain to a local silo store and obtain a warehouse receipt. The more rigorous and thorough the system of oversight, the larger the number of operators who can be made credible to depositors and banks alike. Given local factors, India will probably require a more rigorous system than in the developed country cases indicated. Electronic Warehouse Receipts The last point to be made is that warehouse receipt systems, if engineered in the present, could make significant use of information technology solutions that make it unnecessary to transfer paper by endorsement. Central securities depositories such as the National Securities Depository Limited (NSDL) have transformed the securities market by using electronic record keeping and communication systems. We therefore recommend the usage of modern communications and record-keeping technologies in the context of warehousing and warehouse receipts. In this way it is possible to create a system whereby warehouse receipts are readily transferred between successive holders free of any outstanding claims (the broader definition of "negotiability" in Box 10), an aim which is unlikely to be achieved with paper-based systems. Such a system would enhance confidence in warehouse receipts and make it easier much to borrow against them. Lenders could be registered with the central registry and be provided with online access to verify as well as report their lending information. Electronic systems could bring various other advantages:
Chapter 8 Feasibility of Developing a Warehouse Receipt System in India Financial Feasibility The fact that warehouse receipts are already being used all over India suggests that the activity is feasible. Feasibility will grow if India continues liberalising its agricultural marketing system, reduces public procurement, and institutes a more favourable sales tax regime. Feasibility will also be enhanced if the strategy proposed in this report is implemented. In particular, the creation of an oversight mechanism to accredit and/or guarantee the performance of warehouses will reduce risks to depositors and lenders. Institutional feasibility The following sectors we talked to supported the development of the system of "negotiable" warehouse receipts:
One inspection company expressed reservation on the grounds that the use of warehouse receipts transferable by endorsement would invite forgery, and that the legal system did not lend itself to speedy prosecution of offenders. As indicated in the last section, such difficulties could be addressed by instituting a strong regulatory regime and electronic system with a secure central registry. The main question to be answered is how India can create an institutional framework of high integrity that can accomplish the following:
Chapter 9 Co-operative Credit Institutions and Rural Banks The availability of solvent, responsive and accessible credit institutions is a principal requirement for the success of a warehouse receipt system. Unlike some developing economies that are characterised by inadequacies in the system of credit delivery to growers and processors, India has a well-developed system of credit delivery. However, concerns regarding repayment of loans by borrowers have led to a compression of credit flows (see Table 4). The poor magnitude of credit flows conceals the strengths of the Indian economy to deliver credit. Banking and credit institutions are spread across a wide geography and in large numbers (see Table 24).
The Indian co-operative system is the largest in the world. Co-operative and rural credit institutions deliver a significant magnitude of credit to the agriculture produce sector. Co-operatives account for 45 percent share in the rural credit for agriculture; they attract 31 percent of rural savings. The rural credit structure in India serves around 120 million rural households in about 0.7 million villages through its 92,000 primary agricultural credit societies (PACS). Small farmers constitute 42 percent of the co-operative membership of PACS. It is estimated that in 1999-2000, credit to the extent of Rs. 418 billion was disbursed by co-operative and rural credit institutions. This has indeed played a catalytic role in lubricating the process of farm productivity and production. Table 25 provides empirical evidence of the growing importance of co-operative societies, commercial banks and regional rural banks (RRBs). Moreover, a large number of rural households have progressively shifted to institutional or organised sources of credit.
Co-operative banks and regional rural banks have a greater geographic spread and are the most important source of credit for many households. Table 26 shows the growing importance of institutional sources of credit. However, the need to deepen institutionalisation is critical at the lower asset classes. The deepening of their role to cater to households that fall in the lower asset classes requires an institutional framework that is capable of easy but reliable access to a very large population. Hence, any system of warehouse receipts should reckon with this principal design requirement.
Though co-operative credit institutions play a critical role in delivering credit, most of them are in poor financial health. Bringing back to health the rural credit delivery system is a priority of the Ministry of Finance. Prudential norms were established for the co-operative credit institutions by NABARD and became fully effective from March 31, 1998. If the co-operative credit institutions are nursed back to health, they can be very useful vehicles for the propagation of the warehouse receipt system.
Chapter 10 Main Conclusions, Strategy and Action Plan Based on the preceding chapters, we have reached six main conclusions. These are given in Box 12.
Strategy and Action Plan for Development of the Warehouse Receipt System In accordance with the above conclusions, we propose that Government of India adopt the following strategy.
BOX 13: PROPOSED COMMODITIES FOR THE WAREHOUSE RECEIPT SYSTEM IN INDIA The scheme will at first focus on important commodities where intervention into marketing by the Central and States Governments is relatively minor, including oilseeds, pulses, coffee, cotton and gur. However, the system should also target food grains, including wheat and rice, since in many areas they follow the same trade channels as oilseeds and pulses, and it would not make sense to deny customers a storage service. This is already the case in Madhya Pradesh where traders and farmers use warehousing services of CFC and the SWC for wheat, along with pulses and oilseeds. On this basis the following commodities are suitable for warehouse receipt systems, with priority commodities being shown in bold.
Given the different handling and grading requirements, and problems of computability and taint, operators cannot be expected to competently handle all types of product, or even all types of agricultural product. For this reason, the licensing procedure needs to define which commodities an operator is entitled to handle under the law. The system should be built up stepwise, starting with licensing companies serving priority sub-sectors, but requiring them to handle all other commodities to the same standard. Other agricultural sub-sectors should be progressively added to the list, as well as cold stores facilities. This is very important in view of Government’s plans to create a chain of privately-owned cold-storage units with 1.2 million tons capacity.
Alternative Approaches to the Development of Warehousing Box 14 shows five alternative approaches to warehouse operation. Alternatives 1 and 2 may be pursued simultaneously. Banks and insurance companies are significant shareholders of Government-owned warehousing companies, and their support to the two alternatives was expressed in the meetings. Moreover, banks are already equipping themselves to implement Alternative 2, by ‘adopting’ warehouses so as to empower them to act as credit delivery channels. Banks would exercise due diligence while adopting such warehousing companies and sites. Alternative 2 may also be implemented by commodity exchanges, such as the cotton and coffee exchanges, acting on behalf of their members. Alternative 3 is more closely related to the extant structure Governing trade relationships than the first two. To fully develop the system, it is vital to formalise these warehousing services, but the approach should be cautious in view of potential conflicts of interests between trading and service functions. Alternative 4 is an approach which warehouse operators use to facilitate lending against stocks held in borrowers' premises. BOX 14: ALTERNATIVE APPROACHES TO IMPLEMENTATION Coulter and Shepherd (1995) listed several alternative approaches to implementation:
1. Centralised warehouse or silo managed by a specialised warehouse operator; the operator does not trade in the items stored, but simply holds the stock as security for bank lending. 2. Centralised warehouses or silos operated by a specialised warehouse operator; the operator also acts as a channel for bank lending to a number of individual borrowers. 3. Centralised warehouses managed by a storekeeper, who is also a trader. 4. Warehouses operated by individual borrowers, under the supervision of a surveillance company (alternatively the surveillance company/warehouse operator may take full control of the borrower's store, sometimes known as "field warehousing"). 5. Warehouses operated jointly by the borrower(s) and a bank under a dual key arrangement. It is with a view to implementing alternative 3 that we suggest legislating for a new category of company, the Agricultural Trading Company (ATC). This is a vehicle by which a rural trader or commission agent might expand to become an agricultural merchant of the kind described in Chapter 2. Along with other categories of businesses ATCs would be authorised to issue warehouse receipts, subject to licensing and regular inspection, and compliance with grading requirements. Where this company would differ from other local traders is that it would be free to set up business in any part of the country outside of the mandi structure. In return it will be publicly accountable as to the ethical nature of dealings with farmers. It will have to collect normal levies on behalf of the State Agriculture Produce Marketing Committees, and accept deposits of grain on a non-discriminatory first-come-first-served basis (similar to the elevator companies in the US and Canada). Such companies should be allowed to trade in their own right, but given the potential for conflict of interest between trading and service activities, will need to be strictly regulated according to a standard code. Action Plan Box 15 shows the main components of the action plan, and an indicative timetable.
This list is not strictly chronological, and several components must be carried out simultaneously. Important linkages are as shown in Figure 1. Various components are discussed in more detail in the following sub-sections. FIGURE 1: SCHEMATIC OUTLINE OF ACTION PLAN
Component 1: Promulgation of Strategy Government should present its strategy to the public to show broadly how it intends to proceed, while leaving the Task Force to work out details, in full consultation with the relevant stakeholders. Component 2: Institute the Task Force (TF) This should include suitably experienced individuals from the trade and banking sectors, unambiguously committed to the development of a strong warehousing industry. Specialists in finance and crop storage, and researchers in agricultural marketing systems oriented towards practice might also be involved. Sub-groups should be formed to work on specific commodities. A small-staffed secretariat should be formed with a view to developing momentum.
BOX 16: SUGGESTED APPROACH TO TASK FORCE 1. Form task force comprising :
2. Secretariat answering to task force - staff on contract 3. Task force commissions studies, drafts legal texts, makes detailed recommendations and follows through to implementation
Component 3: Commodity Systems Studies, Comparing Situation in India with Practice Elsewhere Any attempt to develop warehouse receipts systems should be preceded by a thorough review of existing commodity chains for the targeted commodities. A start has been made under this consultancy, but in such a vast and complex country, there will be a need for exhaustive studies. As indicated by Mr Sivakumar of ITC, at the FMC Conference on warehouse receipts in June 1999, it is only when the structure, strengths and weaknesses of commodity systems are thoroughly understood, that one can propose practical improvements. It is suggested that reviews are carried out by three-person teams appointed from within the task force, and who between them bring together agricultural economics training, and strong technical and marketing knowledge of the commodity concerned. The same individuals should then systematically study other countries’ warehousing and related commodity-trading experience, with a view to identifying aspects that might be made use of in India. This should start with desk-research, and be followed by visits to two or three key countries. The United States and the Philippines are particularly worthy of study. Despite the large scale of American farming, the USA is interesting because of its experience with regulated "elevator companies" which interact with commodity exchanges to offer various selling alternatives to the farmer, and the regulatory regime which has been developed to oversee them. The Philippines experience is valuable because it has successfully developed an oversight system for rice, in a country where most production comes from small farmers. There should be initial visits to these countries (say one week per country), and where appropriate this should be followed up by one or more longer visits by individual task force members to follow up in greater depth. Members of the National Association of Warehousing Corporations should visit countries that have strong warehousing systems of the non-trading General Warehousing type, and where these have gone further in servicing private sector clients. Argentina, Hungary and Kenya are suggested. The first two have formal regulatory arrangements and a large presence in rural areas. In Kenya, warehouses in Nairobi and Mombasa (mainly Asian-owned) have formed their own association, and taken steps to raise industry standards. Components 4 and 5: Eliminate Policy Constraints, Draft and Enact National Warehousing Law Areas suggested for policy reform were listed in the Policy Issues section. Sales taxes are the most important aspect to change and work on this should start immediately, via two routes: (a) legislation specifying that the simple delivery of a warehouse receipt for stored goods does not constitute a sale, and; (b) reduction and simplification of tax structures at the level of the Government of India and the State Governments. A warehousing law should be drafted and submitted for legislation. The main objectives will be to:
The facility to issue warehouse receipts might be granted to all companies and even individuals, or only to licensed operators. In the former case the overseeing authority simply acts as an accreditation agency, and the severest penalty it can impose is to remove its accreditation. In the latter case – our recommended approach – all companies issuing warehousing receipts, including those already issuing doing so, will need to be licensed. The institutional location of the overseeing authority is probably the most crucial decision to be taken. In this regard, NRI has reviewed the experiences of several countries that have enacted warehousing laws over the last century, and the evidence is incontrovertible – certain countries which have established strong authorities have reaped substantial benefits, while others with weak authorities and licensing procedures have paid a high price (see Coulter, 1998). Our discussions suggest the following alternative locations:
The primary consideration in determining institutional location is the confidence it provides to lenders – after all it is their funds that will be at risk in the warehouses. This provides a strong rationale for putting the authority under the banks and financial institutions, or bodies such as stock exchanges and clearing houses where banks own most of the equity. The warm reaction of representatives of RBI, IBA and the NSE reinforces the view that this is probably the best route. The National Association of Warehousing Corporations might also contribute to establishing the regulatory body. The other important consideration is the need to ensure that the day to day operation of the authority is insulated from political processes. This can affect working practice, and give rise to fears that in the event of a crisis Government may more easily requisition stocks – however far-fetched such fears may be, they can affect confidence and collateral value. Here the banking route and the autonomous regulator both appear desirable. Component 6: Develop and Institute Regulatory Framework The authority will be responsible for enhancing the reputation of warehouse receipts and minimising incidence of malpractice such as could undermine their credibility. A combination of measures can be considered:
With regard to the last item, companies may be required to purchase a bond a deposit it with the authority, or subscribe to a contributory indemnity fund constituted for this purpose by the members of a given group of warehouses. The indemnity fund would seem eminently desirable in the case of the coffee industry, given that there is a relatively coherent group of warehouses belonging to the All India Association of Coffee Curers. In some cases regulatory functions might also be delegated from the statutory authority to an industry body - in the case of coffee, this might be COFEI or the Association of Coffee Curers. Once the Task Force has outlined the characteristics of the proposed system in its early stages, it will need to develop a business plan for the authority, specifying the form of association, expected revenues and costs, and the initial investment to be subscribed by shareholders. Component 7: Develop and Institute Electronic Warehouse Receipt System and Central Registry As indicated above, it is quite necessary for India to develop and institute an electronic warehouse receipt system and central registry. This would enable ensure system efficiency and integrity. There is little doubt that the Indian software industry can develop the necessary technology, but it will first be first be necessary to thoroughly review of existing and related systems developed for warehousing by warehousing companies, regulatory authorities and commodity exchanges, electronic trade documentation (e.g., BOLERO) and stock exchanges. Suitable institutional investors with a stake in the success of the warehouse receipt system can doubtless be found among the financial community. The company (or companies) operating the central registry (or registries) will need to be licensed by the regulatory authority, and assuming it is a monopoly (or near-monopoly) provider, its fee structures will also be subject to regulation.
Component 8: Develop and Institute Standardised System of Grades and Quality Certification, Enforcement and Dispute Settlement Warehouse receipts should certify the quality of the goods represented by the receipt. In the case of commodities that are identity-preserved (IP), it will need at the very least to certify moisture content and that the goods are fit for storage. Depending on trade requirements certification may be needed for other parameters such as dockage, grain size, foreign matter and gluten content. It should not be presumed that grades are needed for all commodities, since those with highly variable characteristics such as tea and cocoa are typically stored on an IP basis. Commodities with relatively homogeneous characteristics generally need to be commingled by grade, with a view to increasing efficiency in the use of storage space, and reducing transaction costs. Indeed a good system of grading allows commodities to be traded by specification, without it being necessary to take samples. The Task Force and sectoral interests involved will need to assess the feasibility and desirability of moving from IP to comminglin | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||