WAREHOUSE FINANCING
Short on Logic and Long on Imagination
The attempt by the RBI to promote warehouse financingfor agricultural commodities is undoubtedly a welcome move.The major problem, however, is that the country lacks modernwarehouses. It would have been much better if the RBI-constituted Working Group on Warehouse Receipts and Commodity Futureshad drawn up a road map to develop the warehouse receiptsystem for bank financing against agricultural commodities.
MADHOO PAVASKAR
S
Meanwhile, neither the government of India nor the RBI took any steps to develop warehousing finance. On the other hand, the mid-1960s saw the introduction of the absurd selective credit controls by RBI, which tended to restrict agricultural commodity financing to trade and industry by raising interest rates and margins to prohibitive levels, and prescribing unreasonably low aggregate ceilings on such advances, in the fond hope of curbing the prevailing inflation in the economy. Contrary to expectations, these credit controls proved counterproductive, and prices then rose more rapidly, as the commodity trade and industry was constrained to borrow at usurious interest rates from the non-banking financial channels, enhancing in the process their cost of holding commodities for storage. It was only after the World Bank and UNCTAD backed the trade demand for the abolition of selective credit controls that the RBI realised the futility of such controls, and eventually abandoned them altogether towards the end of 1996.
Warehousing Woes
Be that as it may, the present attempt by the RBI to promote warehouse financing for agricultural commodities is undoubtedly a welcome move. Disappointingly, however, the major problem is that the country lacks modern warehouses. A few good warehouses, such as those of the Central and State Warehousing Corporations, do not provide any facilities for either grading or quality testing of goods stored therein, nor do they seek any quality certification of such goods from independent quality testing agencies. Without such quality certification, it will be difficult for the banks to advance loans against such warehouse receipts. In fact, the storage of agricultural commodities in central and state warehouses is far from significant at present. To be sure, farmers scarcely use them. Probably, most farmers cannot afford the storage charges of such warehouses. As a result, these warehouses, by and large, store properly packed non-agricultural commodities and manufactured products.
As for the private warehouses, less said the better. Most of these are ill-ventilated and in dilapidated conditions, attracting moisture, rodents, flies and insects. As it is, aggregate storage in the country is grossly inadequate in terms of both quality and capacity. Most farm produce, either raw or pre-processed, is not infrequently stored in the open, resulting in admixture of impurities, deterioration in quality and losses due to pilferage and thefts. It is estimated that almost 20 per cent of the annual farm and plantation produce is presently lost in storage.
Need for a Road Map
Against this dismal backdrop, it would have been much better, had the RBIconstituted Working Group on Warehouse Receipts and Commodity Futures drawn up a proper road map for developing the warehouse receipt system for bank financing against agricultural commodities, as also for the crafting of new and innovative risk management products by banks to suit the diverse needs of farmers through the different stages of farm production and marketing. Such a road map should have clearly demarcated the various milestones to be crossed by the authorities and agencies concerned, before banks can actually induce farmers to seek advances against the duly certified warehouse receipts, and offer them appropriate price risk management products. Instead, the working group has merely presented the final goals to be achieved by the commercial banks. That is like putting the cart before the horse.
Actually, banks have many miles to go as yet. The milestones that they and their potential commodity market beneficiaries, as well as the government agencies engaged in agricultural research and extension services, need to traverse along the road, are far too many. These include, among others, reduction in crop varieties and improvement in seed varieties; increase in production and distribution of certified seeds; widespread adoption of better cultivation and harvesting practices; development of hi-tech agriculture; construction of state-of -the-art warehouses at assembling and terminal markets and upgrading the storage practices in them; provision of grading facilities at the agricultural produce markets and quality testing services at warehouses; establishment of quality testing laboratories by independent authorised agencies; prescription of baling and packaging practices; development of agricultural commodity standards; spread of crop and general insurance; collection and dissemination of economic and market intelligence influencing prices of agricultural commodities and their products; generating new, economical and easily marketable agricultural insurance
Economic and Political Weekly May 6, 2006
products; devising commodity futures contracts covering most, if not all, grades of all major agricultural commodities and their products produced and deliverable at all the assembling and terminal markets in the country; and designing and arranging courses for training farmers and other commodity market functionaries for dealing in dematerialised warehouse receipts and price risk management products.
True, these and many more milestones need to be placed on the road not by banks alone, but also by various government, semi-government and non-government (private sector) authorities and agencies. Surprisingly, but sorrowfully, not only has the working group failed to recommend the appropriate measures for laying the much required diverse milestones to reach the goals it has set before the banks, but, worse still, it seems to have even failed to realise their need. The working group has only recognised the need for some of the legislative changes required to make the warehouse receipts negotiable and transferable by endorsement, and to permit banks to trade selectively in agricultural commodities and have independent proprietary positions in commodity futures. It is rather too simplistic to believe that mere legislative changes, as suggested by the working group, can enable banks to offer solutions to the varied problems faced by farmers in marketing their agricultural produce.
Even amongst the different legislations, the working group has overlooked the fact that even the Forward Contracts (Regulation) Act (FCR Act) does not permit the transfer of warehouse receipts or other documents of title to goods received in delivery against the ready and non-transferable specific delivery contracts. Any such transfer attracts the penal provisions of that act.
To be sure, much groundwork needs to be done to improve the entire marketing infrastructure in agriculture, which is currently pitiable and riddled with numerous evils and impediments. At best, banks can take care of agricultural finance, and that too when the rest of the marketing infrastructure is in place. Unfortunately, banks cannot ensure the latter. It is just not in their hands. The working group has simply failed to recognise this distressing ground reality, and seems to assume unpretentiously that all will be well with the Indian agricultural marketing infrastructure (as if by a magic wand), to allow the banks to lend to the farmers against their electronic (dematerialised) warehouse receipts, as also to enter the commodity futures business to cover their price risks.
Incidentally, the model of dematerialisation of warehouse receipts, borrowed from the prevailing stock exchange practices, is far from ideal for the commodity markets in the country, especially in their present state. Apart from the absence of scientific grading and quality standards for most farm commodities and their products, the high storage and demat account costs, the need for frequent retesting and quality certification of goods in storage, and, above all, the fear of loss of privacy and secrecy of one’s stock holding, will dissuade most commodity market functionaries from dematerialising their stocks. The high storage and quality certification costs will discourage even farmers from dematerialising their agricultural produce brought to the market yards for sale.
If the commodity market functionaries shy away from dematerialising their commodity stocks, the demat delivery system proposed by the working group may pose a real threat to not only the economic utility of the commodity futures contracts, but also their continued existence for long. This is because with negligible deliverable supplies available from the limited demat stocks, the commodity futures contracts dependent on them are sure to turn out to be too narrow to perform either the price discovery or the price risk management function effectively. For fear of manipulations and squeezes, neither hedgers nor speculators will be attracted to such narrow contracts. In such circumstances, commodity futures are certain to die a natural death. Paradoxical though it may seem, what is good for the stock exchange, is not necessarily so for a commodity exchange. In fact, as it appears, it may actually prove disastrous for the latter. Surprisingly, the working group, appointed to develop the commodity futures, failed to perceive this danger of the demat delivery system.
Unlike in India, the warehouse receipts and shipping bills (for road, rail, sea and air transport) are freely negotiable and transferable in the US and other developed countries on both sides of the Atlantic and thePacific. Laws have been framed in those countries, prescribing the manner of drawing the legally enforceable warehouse receipts,warrants or other documents of title to goods, determining the warehousing standards, as also for ensuring the quality of the underlying goods through proper certification. Yet, these countries have not rushed in to adopt the demat delivery system. In the US, UK, Japan and other developed countries with active commodity futures markets, actual deliveries against commodity futures contracts are still being made through the issue of paper warehouse receipts and shipping bills, though, of late, at the Chicago Board of Trade (CBOT), for very few commodities, namely, corn, soyabean and soyabean products, such receipts and bills are being electronically transmitted. But CBOT has not introduced a similar electronic transmission system for other commodities like wheat, oats and rice.
Actually, farmers do not so much need advances against their storage as for their input supplies for the growing of crops. But with the initiation of the warehouse receipt (demat or otherwise) system for bank advances, “the present input-based financing pattern of agricultural credit would give way to output-based finance”, which is more aligned to the market, as the working group observes in its report. True, the warehouse receipt based bank lending mitigates the bank’s risks, but does not meet the needs of the farmers at a time when they require bank loans badly. In the absence of production loans, farmers will be left to fend for themselves, and will once again be in the clutches of the local moneylenders and commission agents in the assembling markets. The working group (dominated as it is by bankers) is obviously more interested in safeguarding the banks than serving the interests of the farmers.
Cash Settlement: A Strange Suggestion
Yet another poor proposal made by the working group is for the cash settlement of the transferable specific delivery (TSD) contracts, where one of the parties to such a contract is a bank. The group suggests exemption of such contracts by the government from the purview of the FCR Act so as to “enable banks to provide bilateral contracts to suit the needs of their customers, without running the risk of taking or making delivery”. The suggestion of the group is not only unsound, but also impractical and surreal in nature.
For one thing, by definition, a specific delivery contract, whether transferable or not, “means a forward contract which provides for the actual delivery of specific qualities or types of goods during a specified future period at a price fixed thereby or to be fixed in the manner thereby agreed and in which the names of both the buyer and the seller are mentioned ”. If any such
Economic and Political Weekly May 6, 2006 contract were to be allowed to be cash settled, it will become void under Section 20 of the Indian Contract Act. The granting of exemption by the central government under Section 27 of the FCR Act to the TSD contracts, where one of the parties to such contracts is a bank, cannot provide legal validity to such contracts under the Indian Contract Act.
Moreover, the power under Section 27 of the FCR Act has been conferred on the government to exempt certain contracts, mainly non-transferable specific delivery (NTSD) contracts, entered into by the government procurement agencies and farmers in specified commodities brought under the regulation of the said act. And even when such contracts are so exempted, these are not allowed to be cash settled. Such exemption does not validate contracts that are void ab initio under the Indian Contract Act.
Anyway, it seems rather ridiculous to extend such exemption to a TSD contract, in which more than one party is involved, and where the first seller, by definition, is certainly desirous of giving actual delivery. Why on earth should a bank buy such a contract in the first place, if it did not intend to take delivery later? The cash settlement of such contracts by banks will necessarily impair their normal relationship with the physical markets, and affect adversely their utility to other commodity market functionaries. In fact, such cash settlement may simply lead to the proliferation of bucket shops, or virtual casinos, throughout the length and breadth of the country, which will be organised, disappointingly, by the rural branches of commercial banks. Worse still, far from assisting the poor farmers in the country in the production and marketing of agricultural produce, farmers will be merely lured to gamble in these casinos.
CUG Bug
The most quixotic element in the report of the working group is the presence of the close user group (CUG) bug in it. The group proposes to create a CUG, an umbrella structure for everyone engaged in the commodities business. The membership of the CUG is sought to cover the commodity exchanges, APMCs, commission agents registered with APMCs, warehouses, quality assurance and grading agencies, exporters, importers, other domestic users of commodities, insurance companies, producers (meaning perhaps agro-processors), and, of course, the banks. Farmers will be admitted as associate members. “The CUG is envisaged as an electronic platform that would offer straight through processing for every one connected with the commodities”.
And then the working group dreams that a farmer drives into a CUG member’s warehouse with his agricultural produce, gets it graded through a member grading agency, insures it with a member insurance company, obtains an electronic warehouse receipt of the CUG for it, seeks a loan from a member bank by transmitting the requisite application and the electronic receipt online, receives the loan sanction online and finds his bank account duly credited with the loan amount. In due course, he sells the commodity, either spot or forward, on the electronic platform of the CUG through one of the member intermediaries, preferably the same bank, which had advanced him the loan. One, however, wonders whether the Indian farmer is as
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Economic and Political Weekly May 6, 2006
yet ready to turn this working group’s dream into reality.
The CUG will frame its own rules, which will be abided by all the members, irrespective of the prevailing laws to the contrary. To put it differently, members can voluntarily violate the laws of the land through their mutual consent. The CUG will have its own arbitration and adjudicating procedures for redressing the grievances of members. The rules of the CUG may provide graded penalties for various offences, including expulsion. There can be more than one CUG in the country. All of them will be subject to the supervision and regulation of the FMC.
It is very difficult to understand the rationale for the CUGs. Does the working group really think that the diverse commodity market players will ever come together to form CUGs on their own, or voluntarily become members of those established by the government or institutions like banks? If many CUGs are established, how can they become perfect marketplaces for farmers, since a farmer of one CUG will not be able to deal with the members of other CUGs? Incidentally, can a member of a CUG deal with those who are not members of any CUG? In fact, for agricultural commodities, we need national, and not fragmented, markets. The proliferation of CUGs will lead to the same club culture that prevailed in the commodity futures field before the advent of the national commodity exchanges. It seems that the CUG bug will tear apart the agricultural marketing fabric, which the national exchanges are weaving carefully through the last few years. The concept is novel, but naïve, and, worse still, pernicious.
Long and Short
In conclusion, it appears that the report of the working group is short on logic and long on imagination. Actually, the imagination of the working group runs quite wild, and really flies in the face of the hard ground reality. Not only did the group fail to elicit the views of the farmers or their representatives, but also never sought any consultation with the commodity trade and industry bodies. Not surprisingly, most of its recommendations are unrealistic. The RBI and the union ministry of agriculture should therefore think twice before accepting such an errant report. The working group, in turn, should reconsider its report in entirety.
EPW[The views expressed in this article are personal.]
Email: madhoopavaskar@yahoo.com
Economic and Political Weekly May 6, 2006
