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.

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:

• Assess the feasibility of the warehouse receipt system in the commodities markets with specific emphasis on edible oilseeds, oils and oil cakes, cotton and gur

• Promote the warehouse receipt system

• Formulate a detailed and phased action plan for implementation

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.

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.

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.

1. The Government of India will foster the development of a national warehousing and warehouse receipts system for agricultural commodities, as a major part of its policy of ensuring that Indian agriculture is globally competitive on the international stage, while enhancing rural welfare and food security.
2. The aim is to greatly expand the physical availability of warehousing services, while making warehouse receipts a prime tool of trade and trade financing throughout the country. It will allow banks to improve the quality of their lending portfolio, and enhance their interest in the agricultural sector.
3. This will be accomplished by (a) creating a really secure system, where warehouse operators are accredited before the banks and the public in general, and where investors can build warehouses in the knowledge that they can gain accreditation providing they meet exacting official standards; and (b) eliminating all policy and legal constraints to the use of warehouse receipts.
4. Warehouse operators will belong to both the public and private sectors, and particular importance will be attached to the development of the private warehousing industry. Central and State Government holdings will be divested with a view to further enhancing managerial autonomy, but retain their fundamental mandate of providing warehousing services as long, as there is demand for the service and is commercially viable.
5. All licensed warehouses will be expected to perform to minimum professional standards in order to provide confidence to depositors, lenders and the public in general. They will be encouraged to develop their own code of conduct and self-regulate as far as possible.
6. A warehousing law will be enacted, and a formal regulatory authority instituted to enforce standards and protect the interest of those holding warehouse receipts against negligence, malpractice or fraud. The regulatory authority will be structured in such a way as to ensure its complete autonomy and freedom from political interference.
7. Up-to-date information technology will be used to develop a secure system of warehouse receipts whereby ownership and liens can be unambiguously defined, facilitating their rapid transfer between holders.
8. A system of quality certification and grading of commodities will be established, with a view to minimising disputes and permitting cost savings through the commingling of stocks of different owners.
9. Government will institute a Task Force responsible for designing and implementing the system. It will be representative of the different stakeholders, including those with practical experience of trading in the commodities concerned and financing of trade.
10. On the basis of the recommendations of the Task Force, Government will act promptly to remove any constraints in the form of restrictive legal codes, taxes or duties which seriously discourage firms from making use of warehouse receipts with designated priority commodities – including oilseeds, pulses, coffee, gur and cotton. The policy of non-intervention in the trade in these commodities will be enshrined in law, except under emergency situations approved by vote in Parliament, with a view to reducing the likelihood of ad hoc interventions which upset private trade calculations and undermine collateral values.
11. Once all the above conditions have been fulfilled, the system will be implemented in steps, focusing on the priority commodities, and the target date for formal commencement is June 2003. Varying approaches will be adopted taking account of the specific circumstances of each commodity system.

The proposed action plan, and indicative timetable are given in Box 3.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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:

• Six commodity exchanges (commodity exchanges are also known as commodity associations), their directors, administrative staff, members and customers
• Executives and staff of companies that process agriculture produce: gur and khandsari factory, ginning and pressing factory, spinning mill, solvent extraction plant, fat separation plant, and coffee curing plant
• Wholesale traders and trading companies, commodity commission agents, and commodity financiers
• Public warehousing corporations, private warehouses and certified private warehouses; their chief executives and senior officials
• Testing and research laboratories
• Inspection and superintendence companies, and the Bureau of Indian Standards
• Banks (public sector banks, private sector banks and multinational banks) and financial institutions; senior executives in banks and financial institutions
• Senior directors and executives of the Reserve Bank of India (RBI)
• Senior executives of the Indian Banks Association (IBA)
• Senior executives of state-owned insurance companies
• Senior officials of the central Government

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.

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.

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.

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.

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.

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 21^st 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.

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. To