Bank Help Must for Warehouse Receipts’ Success

The overall efficiency of the commodity market, particularly agribusiness, will be greatly enhanced when producers and commercial entities are able to convert inventories of agricultural raw material, intermediate products or finished products into readily tradable products.

Some international collateral managers prefer to issue their own, non-negotiable receipts as part of “guaranteed total performance” packages, which they back with liability and indemnity insurance. It could be argued that the real value of such insurance will emerge only when a really huge claim arises as the insurance cover is only as good as what is stated in the policy document. In the United States, WHR (warehouse receipt) is a document of title supported by legislation, US Warehouse Receipts Act of 2000, which replaced a legislation enacted in 1916. By contrast, in the United Kingdom, a warehouse receipt is a non-negotiable instrument. In the UK, a negotiable form is represented by a warehouse warrant of the type issued by LME-nominated warehouses.

One of the important objectives of WHR in India is to make small farmers (cultivating less than two hectare and constituting about 80% of farmers) behave in a more commercial manner and move in the direction of producers/ entrepreneurs with larger holdings. This would also develop small and intermediate traders into larger and more versatile entrepreneurs expanding operations from localised trade to regional cross-border trading (and in some cases, international export markets).

A focus on establishing a supporting ecosystem like producer’s companies is needed in order to ensure consistent grades and adequate flow of product into licensed warehouses. A majority of higher-value commodities such as rice, wheat, maize, oilseeds and plantation crops come from small farmers. These small farmers tend to feature an unacceptably wide range of product quantity and quality, delivered to the warehouse. WHRs can also be used for government intervention in agricultural markets, which usually has two objectives: to support prices by buying directly from producers and to guarantee a measure of food security. In order to support prices, a government can accept warehouse receipts when prices drop below a support floor rather than taking delivery of physical inventories, a system similar to the loan rate system used in the United States till early 90s.

Since warehouse receipts guarantee the existence of stocks, governments can achieve their food security objectives by merely holding these receipts. The private sector can be made responsible for purchasing, storing, and disposing of the physical stocks. By this way, while the government can play a larger role in macro welfare of citizens, the private sector can focus on the efficiency of the operating system.

While there is confusion and insistence to mention quality specifications on the face of WHRs, those aware with documentary credit will appreciate the similarity of WHRs (issued by warehouseman) with a bill of lading (issued by a shipping company). The custodian of the goods may not necessarily possess the expertise to evaluate the quality of the stored commodities and in some quarters quality certification when issued by a custodian is considered as a conflict of interest. Therefore, by bringing in the element of quality of goods in a document of title would impede its commercial takeoff. A quality certificate from a reputed lab as enclosure will simplify the matter. On the other hand, WHRs need not be equated with a bill of exchange, which is a negotiable instrument in the strict legal sense that passes by mere delivery to a bona fide transferee for value consideration without regard to the title of the parties who make the transfer.

Last but not the least, trust shall be the major cornerstone for the success of a warehouse receipt in India. One of the most difficult keys to overcome is establishing 100% support from financial institutions. The WHR initiatives must develop a strong and viable support system among financial institutions (banks and non-banking institutions) to be successful. This can be accomplished by identifying the service providers which will attract widespread trust among financial institutions.

Published in The Economic Times

Wastage, Transport Cost Make Vegetable Farming Unviable

India is next only to China in terms of acreage and production of vegetables. India occupies prime position in the production of cauliflower, second in onion and third in cabbage worldwide. Farm land used for the production of major vegetables is estimated at 6.30 million hectare generating an output of around 93 million tonnes.

Interestingly, China is facing a serious social challenge at the moment due to the suicide of a vegetable farmer in Shandong Province. Last year, when vegetables prices surged, farmers cultivated large numbers of cabbages believing that the vegetable could fetch a good price in the coming year. However, it was discovered that no one would buy cabbages because too many people had already grown them and as a result of which the wholesale price had plunged to a low. The despair became too much for a farmer as he watched his cabbages rot and he ultimately committed suicide.

India’s daily turnover in vegetables and fruits is about Rs 275 crore. The typical “wastage” per day is around Rs 130 crore. Despite accounting for 15% of world’s vegetable production, India has a relatively low global share in exports (1.5%). Small holders dominate Indian vegetable production. The income from staple crops is inadequate and farmers are increasingly supplementing it with off-farm income by growing high-value produce such as vegetables.

In China, despite consistently high inflation particularly in food prices, vegetable prices are dropping bizarrely creating a panic-like situation. Like India, Chinese farmers tend to produce vegetables on a small scale and given the large domestic market, there has been a constant imbalance between supply and demand as a result of which vegetable prices have been subjected to sharp fluctuations since China abandoned planned economy. Farmers in China are getting a low price causing them to abandon the produce while for the city population there is no change in vegetable prices.

A logistic-induced cost accounts for two-thirds of the total cost of vegetables that are transported nationwide. Out of the transportation cost, payment of highway and bridge tolls (70% of worldwide toll roads are in China) make up as much as a third of the total transport costs incurred.

In recent years, across the various regions of India, planting and labour costs in vegetable farms have been on the rise. In city markets, vegetable and fruit prices remain high. The increasing costs in the intermediate links in the farm-to-market process have caused this price difference.

While talking about the wastages and the state-of-the-art cold chain solutions, it is often forgotten that the difference between the farm-gate price and shop price is being burnt in the high energy cost in transporting the fresh produce.

Published in The Economic Times

Volatility Reigns, Keeps Companies on Tenterhooks

Last week’s fall in price of commodities (crude, copper, cotton, lead, silver, soyabeans) has no fundamental reason and a sustained fall over a period of time may ease the strain on consumers’ wallets. Experts are trying to find out reasons, just the way price rise created “experts” who pretended to know the fundamental reasons (Chinese demand, weak dollar, lack of investable asset class).

Volatility can drive prices down as quickly as it can push them up. Making the situation more confounding is that commodities have become more volatile for reasons that no one fully understands. It is now quite widely accepted that the involvement of index investors was strongly associated with dramatic price movements.

Commodities emerged as an attractive alternative investment avenue for financial investors from around 2006 when the US housing market showed initial signs of its ultimate collapse. This was aided by financial deregulation that allowed purely financial agents to enter such markets without requirements of holding physical commodities.

India, in fact, imported these price movements. In an earlier round of extreme volatility in 2008, several big cotton companies were forced out of business when they were unable to make enormous margin calls caused by increases in margin requirement when futures prices moved. 

Price movements along with supply chains have been the focus of a voluminous debate. Movements in prices along the supply chain, drive the allocation of resources for companies and individuals to decide on the quantities of goods for production, purchase and productive capital.

In an efficiently functioning supply chain, prices are expected to react quickly to new information and adjust within a short span of time, thus resulting in no excess returns for any economic agent in the chain and in an optimal allocation of resources. However, this is not the case. The problem with commodity prices is not the price falls but the squeezing of the price margins, the difference between costs and prices. Individual supply conditions in commodity markets can deviate significantly from aggregate supply in an individual economy or the world economy due to specific factors such as changes in industrial climate (for industrial commodities) or weather (agricultural commodities). In addition, movements in non-commodity costs like wage, production and logistical costs can dominate the impact of past commodity prices on current prices, while market inefficiency or expectational aberrations can reduce the forward-looking value.

As an apt reference to the animal spirit of irrational exuberance, Keynes had written, “apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic.”

In the current scenario whether the receding commodity prices will hold or bounce back, remains to be seen. The latest fall only reinforces the volatility with which a large number of companies (airlines, electronic, construction, food etc.,) are struggling. The Bubbles always need a good story -- a story that gets people excited, that sounds good enough to convince most people they have to participate, and a story that’s usually rooted in facts. The strange thing is that these stories are often true.

Published in The Economic Times

Returns in Plantation Sector Skewed Towards Marketing

The term plantation is informal and not precisely defined. A plantation is a large artificially established forest farm where crops are grown for sale in distant markets rather than for local consumption. In Indian context, it includes tea and coffee (beverage), coconut, arecanut and cashew (nuts), pepper and rubber. Of all these plantations, the tea industry has steadily prospered all through the years and is making good profits even in the days of downturn.

When the holding belongs to a single individual, the person may be called a planter. The term “planter” has no universally accepted definition but it is identified globally with an elite class, “a landowning farmer of substantial means” but not so in India. The total coverage of plantations in India is comparatively less and mostly confined to small holdings. Plantation crops have been continuously facing the lack of investment and depressed yields and are in great need of modernisation. The conditions of labour in plantation economies have always been a matter of concern. Coercion and super-exploitation have sometimes been the characteristics of plantation economies.

If planters have not benefitted adequately from the rising prices of coffee, tea and spices, it is because most of the returns in this sector are skewed towards the latter stages of the value chain. A value chain has been defined as a full range of interrelated productive activities performed by firms to bring out a product from conception to complete production and delivery to final consumers.

Conversely, activities early in the value chain including production or extraction of commoditised plantation raw materials have declined in relative importance. The share of value in the final product has diminished and the bargaining power of those who carry them out has been reduced.

There are several ways to shift more of the profits to the people who actually grow these plantation crops. With the tendency of product differentiation, the share of overall returns has been shifting more and more towards the latter part of the chain and those business activities which underscore differentiation such as design and marketing.

Some Indian corporations realised the trend quite early, leading to the acquisition of a few global brands in tea markets. Corporations mean-while are growing in size and influence in the plantation sector, leading to significant concentrations of power. The result is value chain dominance by certain types of large plantation owners and corporations.

Published in The Economic Times