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

Abbreviations

Executive Summary: Warehouse Receipt System

Chapter 1 Commodity Futures Exchanges in India 11

Chapter 2 The Rationale:

Why Indian Agriculture Needs Warehouse Receipts

17

Chapter 3 Performance of Indian Warehousing Industry 32

Chapter 4 Commodity Analysis: Prospects and Hurdles 36

Chapter 5 Policy Issues Affecting Implementation of WarehouseReceipt System

52

Chapter 6 Institutional Framework: Expectations of Potential Users 56

Chapter 7 Legal and Regulatory Issues 63

Chapter 8 Feasibility of Developing a Warehouse Receipt System inIndia

67

Chapter 9 Co-operative Credit Institutions and Rural Banks 68

Chapter 10 Main Conclusions, Strategy and Action Plan 70

Appendix 1 Objectives and Outline of Tasks 83

Appendix 2 List of Persons Interviewed 85

Appendix 3 Commodity Analysis: Cotton 90

Appendix 4 Commodity Analysis: Soybean, Other Oilseeds andDerivatives

95

Appendix 5 Commodity Analysis: Gur 103

Acknowledgements

This report is based on field visits to East India Cotton Association (EICA), Mumbai; the Bombay Oilseeds andOils Exchange Limited (BOOE), Mumbai; the SOPA Board of Trade (SBOT), Indore; Coffee Futures ExchangeIndia Limited (COFEI), Bangalore; and The Chamber of Commerce, Hapur, Ghaziabad. These were augmentedby field visits to other centres pertinent to commodity trading and storage, and analysis and testing. We aremost grateful to the chief executives, directors, officials and members of these commodity exchanges and firmsin the businesses of trading, storing and testing commodities. The contribution of the Bureau of IndianStandards (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 aneconomic interest in warehouse receipts and commodity contracts. The policymakers and regulators include theGovernment of India's Ministry of Consumer Affairs and Public Distribution, Ministry of Agriculture andCo-operation, Ministry of Textiles, and the Department of Economic Affairs of the Ministry of Finance. Thesuggestions of the Ministries are gratefully acknowledged.

The Reserve Bank of India (RBI) and the National Bank for Agriculture and Rural Development (NABARD), likethe FMC, are policymaking and regulatory institutions. NABARD is also a stakeholder that has an active interestin 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 SuppliesCorporations (NAFCSC) and the National Co-operative Development Corporation (NCDC) are gratefullyacknowledged.

The Central Warehousing Corporation (CWC) and the State Warehousing Corporations (SWCs) are among theprincipal stakeholders and service providers that have a significant interest in the rapid expansion andsimultaneous 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 StateWarehousing Corporation and secretary of the National Association of Warehousing Corporations (NAWC) hasbeen most valuable and is acknowledged most gratefully. The NAWC represents the economic interests of theSWCs.

Mr. Choubey and Mr. Amaranarayan facilitated the discussion of the FMC's and the Government of India'sprogramme for modernising the warehouse receipt system with the chief executives of the warehousingcorporations. 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 Kumarof 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 theBombay 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

ATC Agricultural Trading Company

BIS Bureau of Indian Standards

BOOE Bombay Oilseeds & Oils Exchange Limited

CWC Central Warehousing Corporation

COFEI Coffee Futures Exchange India Limited

CM Collateral manager

CMA Collateral management agreement

CFS Container freight station

CCI Cotton Corporation of India

EICA East India Cotton Association

FCI Food Corporation of India

FMC Forward Markets Commission

IBA Indian Banks' Association

ICAR Indian Council for Agricultural Research

ICC Indian Cotton Contract

IP Identity-preserved (storage)

ISO International Standards Organisation

MSP Minimum support price

Mandi Regulated market where farmers must deliver theircommodities

NAP National Agriculture Policy

NAFCSC National Association of Food and Civil Supplies Corporations

NAWC National Association of Warehousing Corporations

NABARD National Bank for Agriculture and Rural Development

NDDB National Dairy Development Board

NSE National Stock Exchange of India

PCCCI Prime Commodities Clearing Corporation of India

PDS Public Distribution System

PSWC Punjab State Warehousing Corporation

RBI Reserve Bank of India

SBOT SOPA Board of Trade

SOPA Soybean Processors Association of India

SWCs State Warehousing Corporations

SWOT Strengths, weaknesses, opportunities and threats

TF Task Force

VAT Value added tax

WACC Weighted average cost of capital

EXECUTIVE SUMMARY

Warehouse Receipt System

Principal Objectives

This consultancy was carried out as part of the World Bank programme aimed at the improvement of thecommodity futures exchanges in India. This report deals with three principal objectives of the consultancyassignment:

Assess the feasibility of the warehouse receipt system in the commodities markets with specific emphasison 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 asystem of deliveries through warehouse receipts. The commodities included in the consultancy assignmentcollectively account for 20 percent of India's index of agricultural production. The consultants' principalconclusions 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, toreduce the cost of public support for agricultural marketing, to reduce transaction costs and to improveprice-risk management. Warehouse receipts can also play an important part in new policies which would makeIndian 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 StateGovernments dominate the warehousing industry, both as client and as service provider. Warehousing facilitiesowned by the central and the state Governments account for 65.9 million tons of warehousing capacity. About46 million tons of capacity is owned or leased by the Food Corporation of India and the State Food and CivilSupplies Corporations. The storage capacity that can be made available by state-owned warehousingcorporations is 19.7 million tons. Notably, banks and insurance companies are the "implicit stakeholders" ofmore that 36 percent of this capacity.

While Government warehouses have hitherto mainly served the public sector, they constitute a major asset thatcan be used to further the employment of warehouse receipts. Government warehouses are present across thecountry. They have developed homogeneous storage and quality practices, and their warehouse receipts areaccepted by most banks.

Their main weaknesses in the context of liberalisation and globalisation are that they are not well integratedwith private supply chains; they do not inspire confidence among some lenders, particularly, international banksand lenders; they lack certain forms of autonomy they need to improve services.

BOX 1: CONSULTANTS’ MAIN CONCLUSIONS

1. Warehouse receipts exist and are feasible

2. There is scope for massive expansion in their use, with correspondinglylarge benefits, deriving from:

increased liquidity in rural areas

lower costs of financing

shorter and more efficient supply chains

enhanced rewards for grading and quality

development of other productivity-enhancing agriculturalservices

better price-risk management

3. All this will result in higher returns to farmers, better service toconsumers (involving lower prices, better quality and greater variety) andmacro-economic benefits through a more healthy trade balance inagricultural commodities.

4. There are major obstacles to capturing benefits, including:

aspects of the policy and legal frameworks

lack of warehouse operators enjoying the fiduciary trust ofdepositors and banks. If banks wish to finance againstwarehouse receipts, they are either limited to sites operated bythe small number of existing operators whom they trust, orthey must incur high costs in screening out suitable operators

5. Overcoming these constraints requires action in the following areas: (a)policy and legal reform, with particular focus on sales taxation; (b)creation of a rigorous regulatory framework; (c) institution of electronicwarehouse receipt systems with central registry. Simultaneous action in

all these areas is a necessary condition for the "organised" warehousereceipt system to succeed. If one only eliminates part of them there is adanger that the efforts will fail, and that one will arrive at the erroneousconclusion that warehouse receipts are inappropriate for India.

6. Existing Government warehousing corporations should play a leading rolein the development of warehousing. However, they can only cover part ofthe field, which should be opened up to private operators, particularlythose who already provide storage services. Moreover, divestment shouldbe pursued with a view to increasing their private sector orientation andautonomy.

The Government of India and the State Governments intended co-operatives to provide rural warehousing, butco-operatives have not performed as vigorously as expected, leaving gaps in service provision. These gaps aremitigated by informal storage services which commission agents and rural merchants provide to farmers in theirlocality with credit sometimes being provided against the security of stocks involved. There are in additionprivate intermediaries who provide storage services to traders, processors and others. Unfortunately thesesystems hardly make use of formal bank credit, and expansion is constrained by their very informality and lackof legal underpinning.

Freight forwarders have traditionally provided storage in the ports, but inspection companies have recentlycome to the fore, encouraged by more open trade policies. The largest players are multinational operators thatarrived to service their international principals and banks. Local competitors have made headway in thisindustry, and it would assist them if they were allowed to insure offshore. Inspection companies appear to beperforming satisfactorily, but they have so far done little to develop upcountry services, even when this relatesto international traded commodities.

Despite the considerable liberalisation of recent years, various official policies discourage the use of warehousereceipts, particularly the very high level of public intervention in the market for food grains and sugar, and salestaxes 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 greatlyrestricts the number of companies which can act as warehousemen. These problems can be addressed byenhancing 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 andliens.

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 discussedthe important components of the action plan. The warehouse receipt system and the action plan were presentedand discussed at the NAWC conference on February 25, 2000 in Bangalore and at the conference of managingdirectors of warehousing corporations on March 21 and 22, 2000 in New Delhi. The implications of thewarehouse receipt system were further presented and discussed at the NAFCSC national conference on March24 and 25, 2000 in Bangalore.

BOX 2: PROPOSED STRATEGY FOR DEVELOPMENT OF WAREHOUSE RECEIPTS

The Government of India will foster the development of a national warehousing and warehouse receiptssystem for agricultural commodities, as a major part of its policy of ensuring that Indian agriculture is

1.

globally competitive on the international stage, while enhancing rural welfare and food security.

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.

2.

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 theknowledge 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.

3.

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 holdingswill be divested with a view to further enhancing managerial autonomy, but retain their fundamentalmandate of providing warehousing services as long, as there is demand for the service and is

commercially viable.

4.

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.

5.

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. Theregulatory authority will be structured in such a way as to ensure its complete autonomy and freedom

from political interference.

6.

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.

7.

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.

8.

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.

9.

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 frommaking 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 enshrinedin 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.

10.

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.

11.

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

BOX 3: PROPOSED PHASED ACTION PLAN

Component To be done by Target date

1. Promulgate the strategy Government ofIndia

November 2000

2. Institute Task Force (TF) Government ofIndia

December 2000

3. Commodity systems studies,comparing situation in Indiawith practice elsewhere

TF June 2001

4. Eliminate policy constraints Government ofIndia, based onTFrecommendations

December 2002

5. Draft and enact nationalwarehousing law

TF andGovernment ofIndia

June 2002

6. Develop and institute theregulatory framework

TF, Regulatoryauthority

December 2002

7. Develop and institute electronicwarehouse receipt system andcentral registry

TF, Softwarecompanies,Electronicregistry

March 2003

8. Develop and institutestandardised system of gradesand quality certification,enforcement and disputesettlement

TF, BIS, Ministryof Agriculture

March 2003

9. Formal start to implementation

TF, Regulatoryauthority,Electronicregistry,Warehouseoperators

June 2003

10. Progressive divestment ofGovernment holdings in CWCand SWCs

Government ofIndia

December 2006

11. Periodic monitoring andevaluation as implementationproceeds

Government ofIndia;consultants

December 2008

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 andmonitoring of stocks to be tendered for delivery. SOPA Board of Trade (SBOT), the soybeans and mustardexchange in Indore, instituted a similar network in February 2000 before commencing trading of futures. Asituation analysis pertinent to warehouse receipts and commodity exchanges and the prospects of promotingwarehouse receipts is given in Box 4.

In their report to the Forward Markets Commission, Burr and Anjaria (2000) have recommended thatexchanges institute their own networks of approved warehouses, and strict procedures for reporting andmonitoring of stocks to be tendered for delivery. The recommendation of Burr and Anjaria emphasises theimportance of commodity exchanges in the propagation of warehouse receipts.

BOX 4: COMMODITY EXCHANGES AND WAREHOUSE RECEIPTS

1. Three commodity exchanges - COFEI, SBOT and BOOE - in India haveeach established an institutional framework for warehouse receipts. Thecommodity exchanges have worked in close association with the FMC, andat its behest, in establishing their respective institutional frameworks forwarehouse receipts.

2. The business rules pertinent to warehouse receipts constituted by thethree commodity exchanges are independent of one another though thecommodity exchanges are all regulated by the same regulatory institution.

3. The FMC is the regulatory institution pertinent to commodity futuresexchanges in India. The FMC's knowledge of the principal requirements ofa warehouse receipt system is adequate to promote and regulate awarehouse receipt system in India.

4. Business rules of the commodity exchanges require delivery of theunderlying commodity through warehouse receipts. They also enablefulfilling margin requirements through warehouse receipts.

5. The attempts by the commodity exchanges towards establishing thebusiness rules for the usage of warehouse receipts are earnest. However,these attempts do not collectively point to the emergence of a warehousereceipt system in India since the commodity exchanges have very pooreconomic visibility at present.

6. The FMC has not authored a cohesive and consistent set of business rulesrelated to warehouse receipts. Therefore, the emergence of a warehousereceipt system in India requires external stimulus in order to have theinternal components of the commodity economy to work towardsestablishing a warehouse receipt system.

7. Though the principal warehousing corporations, the CWC and the SWCs,issue warehouse receipts, the warehouse receipts are not part of thewarehouse receipt systems specified or defined by the commodityexchanges. Moreover, the CWC and the SWCs have yet to be

acknowledged by the commodity exchanges as important economic allies.

8. The recent National Agriculture Policy (NAP) emphasises the importance ofcredit flows, the role of co-operatives and co-operative banks, and pricerisk management. The NAP is a catalyst that would enable the commodityexchanges, the FMC, the Government of India, and the other stakeholderssuch as growers' co-operatives, banks, the CWC and the SWCs to worktowards establishing a warehouse receipt system in India. Moreover, theestablishment of the national commodity exchange requires a warehousereceipt system.

The existing uses of warehouse receipts by commodity exchanges are extremely limited. However, theinstitutionalisation of the warehouse receipt system through the commodity exchanges is most likely to yieldthe best results in the context of promoting and propagating warehouse receipts, in particular electronicwarehouse receipts, and a national system of warehouse receipts. Box 5 includes the steps that may benecessary to promote and propagate warehouse receipts and the role of other economic institutions towardssuch a purpose.

BOX 5: COMMODITY EXCHANGES AND PROMOTION OF WAREHOUSE

RECEIPTS

1. The success of a warehouse receipt system in India is predicated on thefacilitation and promotion of warehouse receipts. Commodity exchangesare the only commercial institutions that have turned to warehousereceipts for enabling the pursuit of efficiency in transactions. A few otherinstitutions and market participants are aware of the utility of warehousereceipts. However, their institutional and commercial environment doesnot require them to exploit the efficiencies offered by warehouse receiptsand a warehouse receipt system. Therefore, the facilitation andpromotion of warehouse receipts and a warehouse receipt system is bestpursued by the commodity exchanges and the FMC.

2. Commodity exchanges in India enjoy very poor visibility. Therefore, thefirst step towards facilitation and promotion of warehouse receiptsnecessarily requires the promotion of commodity futures contracts andprice risk management. To be sure, the extant poor economic relevanceof commodity futures contracts and price risk management is probablyjust the early teething pains of the commodity futures industry that hasremained irrelevant to the Indian economy until recently. Farmers,businesses and banks in almost all the districts of India see the potentialof commodity futures contracts and price risk management and are mostlikely to internalise the benefits of a warehouse receipt system.

3. The NAP's focus on credit flows and price risk management should betransformed into a working plan that combines the efforts of the FMC, theMinistry of Consumer Affairs and Public Distribution, the Ministry ofAgriculture, and the commodity exchanges that have established awarehouse receipt system. These efforts should be unified with those ofthe CWC and the SWCs since a warehouse receipt system cannot exist in

a vacuum. Though autonomous in every economic sense, the CWC maybe deemed to be under the supervision of the Ministry of ConsumerAffairs and Public Distribution. Moreover, the CWC holds 50 percent of theequity of each of the SWCs.

4. With the establishment of a warehouse receipts system along withreliable clearing and settlement of futures contracts, banks would be ableto better manage the interests of their customers in both lending andhedging. Credit risk will be reduced considerably. This would be aconcomitant gain of a very large magnitude. Banks are less likely to faceliquidity risk and credit risk if hedging and lending against commoditiesare combined. Therefore, the efforts indicated above should beaugmented with those of banks, NABARD, the RBI.

5. Co-operative marketing and credit institutions are aware of the economicbenefits of futures contracts. Therefore, the above efforts should withoutambiguity involve the co-operative sector. Agriculture co-operatives andco-operative banks should be encouraged to associate themselves withthe facilitation and propagation of warehouse receipts since more than 45percent of credit to the agriculture sector is channelled by co-operativebanks.

6. The FMC should enable and encourage physical settlement of futurescontracts and comprehensively discourage cash settlement. Physicalsettlement through the use of warehouse receipts should be mademandatory where possible. The use of warehouse receipts to fulfil marginrequirements should be encouraged.

7. The propagation of grades, standards and storage is most critical to thepropagation and the viability of a warehouse receipt system. The Indianeconomy is characterised by an indifferent disposition towards grades andstandards though the storage practices of the CWC and the SWCs aresound. The emphasis on grades and standards is highest in the case ofcoffee. On a scale that awards 100 to the highest score, the score ofcotton, gur and the oilseeds complex are 78, 34 and 22 respectively. Theoilseeds complex scores the lowest on account of seeds, and thetechnological stagnation and fragmentation of the crushing industry.

8. The questionnaire survey pertinent to warehouse receipts and theirperceived economic utility shows that prospective users are aware of thepositive externalities of warehouse receipts a warehouse receipt systemon grades, standards and storage. The BIS, the NDDB, the NCDC, theMinistry of Consumer Affairs and Public Distribution, and the Ministry ofAgriculture should promote the accretion of the positive externalitiesvigorously. The orientation of futures markets towards rigorous contractspecifications would be most useful in this effort.

Legislative Effort and Action Plan

Warehouse receipts and a warehouse receipts system were the objects of legislative effort nearly three decadesago. A Warehouse Receipts Bill was drafted in 1978 with the principal, if not sole, objective of endowing uponwarehouse 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 ofthe draft. The principal legislative effort and the action plan that may lead to the viability and widespread use ofwarehouse receipts are discussed in Box 6.

BOX 6: PRINCIPAL LEGISLATIVE EFFORT AND ACTION PLAN

1. The draft Warehouse Receipts Bill of 1978 has numerous infirmities and itsfocus on fungibility and negotiability of paper-based warehouse receipts tothe exclusion of other issues reflects the commercial concerns that wereprevalent then. The questionnaire survey shows that participants hold aninstitutional framework that infuses the warehouse receipt systemincluding the warehouses with fiduciary responsibilities to be very critical.

2. The establishment of an institutional framework that comprehensivelyaddresses the fiduciary responsibilities is a prerequisite for the viability ofa warehouse receipt system. The warehouse receipt system shouldnecessarily support the issuance of electronic warehouse receipts.

3. The constitution of a task force comprising representatives of thecommodity exchanges, the FMC, the Ministry of Consumer Affairs andPublic Distribution, the Ministry of Agriculture, the Ministry of InformationTechnology, NABARD and the RBI is recommended.

4. Grades and standards should be propagated such that all commodities andcommodity baskets can achieve a score of 90 and above in two years.

5. Any monopoly powers of the Agricultural Produce Marketing Committees(APMC) should be revoked; the market for procurement and trading incommodities should be opened to competition.

6. The Essential Commodities Act should be revoked since it has the potentialto be invoked in a manner that restricts trade, transport and storage ofagricultural commodities. Several provisions of the Act have already beenmodified with the aim of facilitating trade, transport and storage.

7. The FMC should enunciate its policy pertinent to contract specifications.Contracts that envisage delivery through warehouse receipts should begiven fast track approval. Cash settlement may be disallowed untilwarehouse receipts become entrenched in the cash market. Exchangesthat trade the same underlying commodity, say, gur or one or morederivatives of rapeseed and mustard, may be co-opted by the FMC todesign a unified warehouse receipt system.

8. The CWC, the SWCs and private sector warehousing companies shouldhave a memorandum of understanding with the FMC and the commodityexchanges to support storage of commodities in a manner consistent withthe contract specifications.

9. Food and civil supplies corporations are likely to be dominant users ofcommodity futures contracts and warehouse receipts. The Government ofIndia should encourage joint investments by stakeholders as has beendone in the recent past. PSWC is a significant warehousing serviceprovider in India. It has entered into an agreement with a leading bank, alarge private sector company and the NSE - the world's leading electronicstock exchange - to establish an electronic exchange for tradingcommodity futures. The NAFCSC has resolved to invest in the electronicexchange for trading commodity futures.

10. The task force should accomplish its tasks in a manner that is consistentwith the basic objectives of the NAP.

11. The impact of the significant changes in the arrangements thatcharacterise global trade in agriculture commodities on India would beintense since India's globally weighted rank in agriculture produce is 2.23.Unlike many of the developing economies, the Indian economy possessesmost of the necessary institutional structures aimed at lowering the riskand cost of agricultural production. India's extant institutional structuresinclude the commodity exchanges, the FMC, the BIS, the CWC and theSWCs, a vast network of nationally active commercial banks and a verylarge number of co-operative rural credit institutions. Policy measures anda coherent action plan pertinent to the warehouse receipt system wouldfavourable alter the economic orientation of all the components of theinstitutional structure, including the large number of co-operative ruralcredit institutions.

12. Above all, India has three commodity futures exchanges that are earnestabout warehouse receipt systems. These systems involve oilseeds, cakesand meals, edible oils and coffee. Each of the systems should be treated asa pilot project while a national code for warehouse receipts is evolved.

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 commodityfutures exchanges in India has several objectives. One of the principal objectives of the joint programme is thestrengthening 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 inoperating and managing commodity futures markets. It, however, notes that restrictive policies have notprovided India's agriculture futures market a chance to contribute to price risk management and discouragedthem from upgrading their institutional capabilities.

In our field visits and in our discussions, policymakers and decision-makers in the central and stateGovernments reinforced such an evaluation. Their evaluation as well as that of potential users is that Indianagriculture 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 tosupport large scale hedging is a result of two deficiencies. First, futures open interests are vulnerable tosystemic risks. Second, the settlement of futures open interests through delivery at maturity is vulnerable torisk since data about stocks held by participants is either not available or is unreliable. Settlement risk isserious and militates against the efficiency of futures markets. The unavailability of public data on stocks, morethan 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 commodityexchanges in India to support large scale hedging is a significant deterrent to the economy's ability to cope withcommodity price risk. Systemic risks related to futures open interests and the settlement of maturing futurespositions are managed and minimised, and where possible eliminated, by clearing houses characterised byrobust policies and operating processes and by strong financial structures that rigorously discourage negativeexternalities. Guidelines pertinent clearing house ownership, operations and bye-laws are included in a reportto the FMC by Jeffery and Ramachandran (2000). The report on clearing house ownership, operations andbye-laws recommends the use of certified stocks and warehouse receipts to reduce settlement risk borne by aclearing 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 ofsettlement risk of maturing contracts, especially when commodity futures contracts are physically settled. Aphysically settled commodity futures contract requires a reliable system that addresses all aspects of compliancewith the grade, quality and quantity of commodity that underlies the contract. Cash settled commodity futurescontracts 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 andquantity of commodities that underlie commodity futures contracts. It makes available public data that isaccurate, reliable and timely, and such availability can be extended to a range of contracts. Thus, a system ofwarehouse receipts could enable India's agriculture futures markets to contribute to price risk management byequipping them with the capability to support large scale hedging. Such a capability has become necessary sinceIndia'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 continuallyeffect institutional improvements aimed at managing volatile commodity prices. Commodity-intensiveeconomies have used a variety of policies and instruments to manage volatile commodity prices. The use ofpolicies involving production and buffer stocks has dominated the use of market-based instruments indeveloping economies. Such policies have usually required budgetary outlays by the Governments of developingeconomies. In contrast, market-based instruments such as commodity futures, futures options and swaps havedominated the approach to price risk management in developed economies. Empirical evidence gathered overthe last three decades shows that market-based instruments are more flexible, effective and efficient comparedwith policies aimed at production and stocks in managing price risks.

The World Bank has initiated several programmes aimed at propagating information pertinent to themanagement of price risks using market-based instruments. The flexibility, effectiveness and efficiency of theseinstruments have motivated these efforts. The World Bank has continually evaluated the need for polices andprogrammes aimed at expanding the use of market-based instruments where such usage is expected to be morecost 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 1993from 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 theagriculture futures markets. The National Agriculture Policy announced in July 2000 articulates the policy of theGovernment 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 manycomponents identified by the World Bank and the Government of India as critical to the modernisationprogramme. The other components include commodity exchanges' rules and regulations, trading procedures,clearing house rules and regulations, trade supervision, regulation and monitoring, and promotional anddevelopment activities. The successful pursuit of these comprehensive components is expected to have afavourable impact on the confidence of users and potential users with a favourable impact on liquidity of futurescontracts.

Standardisation of Futures Contracts

Futures contracts are standardised contracts. In a futures contracts the contracting parties negotiate only theprice. Quantity, quality and the time of delivery are standardised by the exchange on which the futures arelisted for trading. The components of standardisation are made known to the participants of an exchange by theexchange through contract specifications. Standardisation is one of the principal distinctions between forwardand futures contracts.

Settlement of Contracts: Systems View

Trading, clearing and settlement constitute the three important components of the commodity markets. Tradinghas typically occupied the prime spot in the regulatory environment in India. Such a focus has been reflected inthe rules and regulations of commodity exchanges. However, the other two components - clearing andsettlement - have a very significant role to play. Unreliable clearing and settlement militate against the successof trading systems and trading institutions. The poor economic visibility of commodity futures exchanges inIndia is a result of the inadequate attention paid to clearing and settlement. The streamlining of clearing andsettlement 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 thesub-components. The principal functions classified under trading, clearing and settlement are given below (Table1). It may be observed that a large number of critical functions are performed by the clearing and settlementsystem. 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.

Table 1

Systems View of Trading, Clearing and Settlement

Trading Clearing Settlement

Order receiving

Execution

Matching

Reporting

Surveillance

Price limits

Position limits

Matching

Registering

Clearing

Clearing limits

Novation

Margining

Price limits

Position limits

Clearing house as

Marking-to-market

Receipts and

payments

Reporting

Delivery upon

expiration or

maturity

the common

counterparty

The success of exchange-traded contracts results from the efficiency, transparency, speed and security of threecomponents of the composite system - trading, clearing and settlement systems. Each component has its ownrole in determining the success of commodity contracts and in achieving the economic objectives of listing andtrading commodity futures contracts and futures options contracts. The objectives of warehouse receipts and awarehouse 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 thatdrive grades since, in a commodity futures contract, the specification of the underlying commodity involvesgrades 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 offutures markets in India. The FMC is under the administrative supervision of the Ministry of Consumer Affairsand Public Distribution of the Government of India. There are currently 19 exchanges in different parts of thecountry 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 totransparently effect deliveries against expiring contracts. Mr. D.C. Anjaria reconfirmed the case for such asystem during his presentation at the Commodity Futures Workshop between February 7 and 9, 2000. Hepointed out that settlement was normally in cash and was generally lacking in transparency; consequentlyfutures and physical prices did not converge towards expiration as one would normally expect, seriouslydetracting 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 providinggood collateral for bank lending, and thereby developing the rural financial system. Indeed there are stronghistorical precedents for this in other countries. Due to the hitherto dominant role of the State in agriculturalmarkets, this potential has hardly been exploited, but with gradual liberalisation and globalisation, thepossibility can now be more fully exploited.

The objectives of the assignment were as follows:

(1) To assess the economic feasibility of the warehouse receipt systemin commodities markets, with special reference to edible oilseeds,oils and oil cakes, cotton, gur

(2) To promotion a warehouse receipt system in the commoditiesmarkets

(3) To formulate a detailed and phased action plan for implementationof the warehouse receipt system

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 wereallowed six weeks and twelve weeks respectively for the task. They jointly or individually held discussions in thefollowing 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 andChandigarh. 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, ginningand 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 chiefexecutives 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 futurestrading already exists in them, or exchanges have been licensed to start trading. The consultants added coffeeto the list since the coffee exchange has pioneered deliveries through warehouse receipts, and might haveuseful lessons for other commodities.

Including coffee, the selected commodities constitute 19.52 percent of the Ministry of Agriculture’s index ofagriculture production. The discussion meetings and the field visits point to the nontrivial potential for theintroduction of warehouse receipt systems in the context of nearly a fifth of the agriculture produce output. Theweights of the commodities are given in Table 2.

The reader is referred to the section entitled "Commodity analysis; prospects and hurdles" and Appendices 3 to5, 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). Inaccordance with internationally accepted parlance, a warehousing company is considered public because it offersits services to the public in general, not to a specific customer. In India the term is used to connote publicownership, presumably because this is the only form of warehousing that is available.

Table 2

Commodity Weights In Index of India's

Agricultural Production

Principal

agriculture

produce

Weight

in index

(%)

Relevance to the

objectives

Barley 0.60

Castor seed 0.34 0.34

Chickpea 3.07

Coffee 0.44 0.44

Cotton 4.37 4.37

Groundnut 5.60 5.60

Jowar 6.16

Lentils 0.46

Linseed 0.13 0.13

Millet 4.04

Pigeon pea 1.31

Rapeseed/Mustard 2.41 2.41

Rice 29.74 1.59 (De-oiled rice bran andoil)

Rubber 0.39

Safflower 0.17 0.17

Sesame 0.24 0.24

Soybean 1.99 1.99

Sugarcane 8.11 1.70 (Gur)

Sunflower 0.54 0.54

Tea 1.46

Tobacco 1.12

Wheat 14.45

Total 87.13 19.52

Source: Ministry of Agriculture, Government of India

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 improvingprice-risk management. Of great long term consequence however is that warehouse receipts can play animportant part in making Indian agriculture more responsive to market opportunities and more competitive inrelation to World markets.

In the next subsections we discuss uses (1) to (3), after which we discuss the potential long-term impact ofwarehouse receipts in developing Indian agriculture.

Table 3

Commodity Warehouses and Warehouse Receipts: An Outline

Explanation

Warehouse receipt

(warehouse receipt) When backed by a suitable legal framework, it isan instrument that shows proof of ownership ofsome asset, say, agricultural commodities

It states the quality and quantity that is ownedby the receipt holder

It states the warehouse in which the commodityis stored

Issuing of

warehouse receipts The warehouse receipt is issued by warehousesapproved by an independent oversight body (orby a company enjoying a high level of credibilityand trust, and not requiring approval oraccreditation)

The warehouse receipt is issued after theproduce is certified for quality and quantity

The process involves rigorous but rapid testingand grading, often based on official standards

Types of warehouse

receipts A fully negotiable warehouse receipt is the mostliquid type. It can be successively negotiated byendorsement, without returning it to thewarehouse operator (collateral manager)

The warehouse receipt converts the inventoriesinto fully negotiable instruments (where buyer islegally protected from claims against previousholders)

However, negotiability is not a prerequisite for asuccessful system of warehouse receipts

A non-negotiable warehouse receipt issuedunder a Collateral Management Agreement(CMA) is the least liquid type

Other variants exist depending on local legalframework

Collateral

Management

Agreement (CMAs) -

how do they work?

Three parties sign the agreement: depositor,collateral manager (CM) and bank

When commodities are deposited against theagreement, the CM issues a non-negotiablewarehouse receipt direct to the bank

Bank then advances loan to depositor

Upon repayment, Bank sends warehouse receiptto CM with delivery order

In the event of default, Bank may seize andauction commodities

In the event of sale of commodities, CM cancelsold warehouse receipt and issues new one inname of new owner

Collateral in

commodity financing Warehouse receipts may be used as collateral forinventory financing by commercial banks

Lending may be effected on a "sight unseen"basis

Warehouse receipts reduce physical risk, andusually lead to lower lending rates

Warehouses and

commodity futures

markets

Warehouses and futures markets coexist forsound economic reasons

Warehouses internalise quality risk management

Futures markets enable hedging against pricerisk

Together, they are superior to simplewarehousing and the carrying of commoditystocks

Important trade

accessories Warehouse receipts extend sales beyond theharvesting season

Warehouse receipts build markets and marketconfidence

Warehouse receipts may be used in commodity-linked loans

Information, quality

preservation and

logistics

Very reliable stock information is made available

Warehouse keepers assume responsibility forpreserving and managing quality of warehousedcommodities

Quality reference improves transport and processlogistics

PrerequisitesSound legal system that appreciates propertyrights and transaction costs

Easy transferability, where buyer is protectedfrom claims against earlier holders (where fullnegotiability is required)

Independent approval or accreditation (veryprestigious players may dispense with this)

Insurance and performance guarantee (veryprestigious players may dispense with the latter)

Warehouse Receipt

Act A sound legal and commercial tax system shouldreckon with property rights and transaction costs

India has an act for securities depositories

An Act for warehouses and warehouse receiptsmay be necessary

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 feltthat the banking industry, if left in private hands, would lead to concentration of branches in urban pockets, andthat lending and deposit collection activities would not achieve desired levels of penetration in the rural regionsof the country. Food security was a serious issue, and India had to import substantial quantities of food grain tobridge 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 ruralareas. However, in the case of India's agriculture sector, the ratio of credit to output was merely 9.7 percent in1998-99 (see Table 4). Of the total flow of credit to the constituent sectors of the Indian economy, agriculturereceived 9.23 percent in 1998-99. If credit for public food procurement at 3.92 percent of total credit wereadded, the total credit allocated to agriculture would yet be only 13.15 percent. However, agriculture constitutesmore than 25 percent of gross domestic product.

Credit flows to the industrial sector have been of a larger magnitude. The industrial sector received 41.68percent 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 60percent) of the wholesale trade in India involves agricultural produce. Wholesalers buy the produce atharvest-time, often clean, dry and sort it, and sell it over varying periods - sometimes holding inventory untilthe succeeding harvest. Wholesale trade received 3.25 percent of total organised sector credit in 1998-99, butit constitutes more than 11 percent of net domestic product. Growth in credit to the wholesale sector was thelowest at 6.38 percent. The services sector is in general an unattractive destination for credit supplied by theorganised markets for credit.

Table 4

Analysis of Credit Flows and Credit Growth

Credit flow (Rs. billion)

Sectors 1998-99 1997-98 1996-97

Public food procurement 168.16 124.85 75.97

Agriculture 396.34 348.69 314.42

Other priority sectors 264.94 211.30 174.94

Manufacturing (small) 484.83 435.08 359.44

Manufacturing (medium and big) 1305.16 1175.30 1026.04

Wholesale trade 139.65 132.17 123.40

Other sectors 661.04 575.44 515.70

Services 516.10 459.60 415.00

Export credit 358.91 339.47 300.08

Total 4295.13 3801.90 3304.99

Credit flow (percentage)

Public food procurement 3.92 3.28 2.30

Agriculture 9.23 9.17 9.51

Other priority sectors 6.17 5.56 5.29

Manufacturing (small) 11.29 11.44 10.88

Manufacturing (medium and big) 30.39 30.91 31.05

Wholesale trade 3.25 3.48 3.73

Other sectors 15.39 15.14 15.60

Services 12.02 12.09 12.56

Export credit 8.36 8.93 9.08

Total 100.00 100.00 100.00

Annualised credit growth (percentage)

Public food procurement 48.78 Most growth

Agriculture 12.27 Less than average

Other priority sectors 23.06 More than average

Manufacturing (small) 16.14 More than average

Manufacturing (medium and big) 12.78 Less than average

Wholesale trade 6.38 Least growth

Other sectors 13.22 Less than average

Services 11.52 Less than average

Export credit 9.36 Less than average

Total 14.00

Credit to output (percentage)

Sector 1998-99 1997-98 1996-97

Net credit flow to GDP 28.19 27.87 28.76

Agriculture: Credit to output 9.70 9.67 9.05

Industry: Credit to output 32.28 31.90 30.92

Services: Credit to output 7.26 7.24 7.42

Source: Reserve Bank of India and Business Intelligence Unit

The relative allocation of credit by organised markets for credit to the constituent sectors of the Indian economyis 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 ofcredit than the other sectors when the sectors' size and relevance to the economy are reckoned with, and wouldhave received even smaller allocations if there had not been major and continuing programmes for prioritylending. Such lending is implicitly subsidised by a high level of default (see Table 5).

Table 5

Recovery Performance of Rural Financial Institutions

Agency Percentage of Recovery to Demand

1994-95 1995-96 1996-97

State Commercial Banks 90 90 84

District Central Co-operativeBanks

70 69 70

Primary Agricultural CreditSocieties

66 65 n/a

State Co-operative Agriculturaland Rural Development Banks 62 61 60

Regional Rural Banks 51 56 61

Commercial Banks 57 62 66

Source: Government of India, Economic Survey, 1999-2000

Most farmers and wholesale traders use their own equity and credit from informal suppliers of credit. Accordingto the RBI All India Debt and Investment Survey of 1991-92, around 39.6 percent of the rural population stilldepended on "non-institutional systems" for their credit requirements. The share of professional money lendersin rural debts had fallen from 13.8 percent in 1971 to 8.3 percent in 1981, but had increased 9.4 percent in1991. Even if we assume that farmers were fully frank in their survey responses, it is likely that the level ofdependency among traders is considerably higher than this.

The weighted-average cost of capital (WACC) in such circumstances is relatively high, and significantly higherthan in other sectors of the Indian economy. Borrowers bear a high WACC because the length of the operatingcycles 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 touse 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 explainswhy banks invested Rs. 362.61 billion in Government securities in 1998-99 alone while all credit outstanding toagriculture, 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 lowcompared with what small farmers pay in many other parts of the World. The rates of which we were informedwere in the range of 2 percent to 4 percent per month, compared with 10 percent or more commonly quoted inAfrica. Moreover credit is made available at short notice and with a minimum of paperwork. The formal bankingsector 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 wholesaletrade if it had better security and were easier to recover debts. This would be the case if there were a widerspread 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 wasalready about $2 billion in 1996-97; this includes food subsidy, implicit interest rate subsidy to the FoodCorporation of India (FCI), and the value of physical losses in the private marketing. By 1997/98, food grainsubsidies 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 forpoor targeting and leakage into the open market, less than one quarter of the grain distributed through thepublic distribution system (PDS) actually reaches the poor.

The existence of accredited warehouses would facilitate private stockholding in rural areas, and would make iteasier for the Government to reduce its buffer-stocking role with basic food commodities, allowing privateparties – farmers, traders, millers etc. - to store a much larger share of the total crop. The resultant savingswould significantly ease the pressure on public finances.

Another way in which the Government might reduce its buffer-stocking role is by making greater useinternational markets to stabilise domestic prices. While international commodity markets exhibit a degree ofprice volatility, variations are smoothed because nations at different latitudes harvest at different times in theyear, 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 supplyof credit for holding such inventories, would improve rural liquidity and lower borrowing cost, reduce storagelosses, lead to shorter supply chains, and generally enhance the competitiveness of domestic producers andprocessors, 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 warehousereceipt can be tendered to a buyer to execute delivery. This reduces counterparty risk and makes it easier to dobusiness with remote players. A special case of this is that of a commodity futures contract, where shortposition holders tender warehouse receipts for delivery against expiring contracts.

Warehouse receipts have a synergistic relationship with commodity futures exchanges, and the two tend tocoexist for sound economic reasons. Approved warehouses internalise risks regarding quality and quantity, andcan 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 thealternative of "cash settlement", since it ensures convergence of physical and futures prices, and providestraders with the option of giving and taking delivery. Disputes are minimised if stocks are handled by acompetent third party warehouseman.

At the same time, stocks held in warehouses are subject to risks that ensue from price volatility - the price ofthe commodity may have so declined that the realisation upon sale is less than the credit made available to theborrower. 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 futurescontracts to eliminate physical risk of the commodity while it is in inventory and hedge against the impact of aprice decline. For the same reason, banks lending against warehouse receipts often require borrowers to hedgethe 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 aresometimes exchanged in private warehouses, contracts reaching expiry are (as indicated above) normally cashsettled, at prices which are often at variance with the underlying physical market. Normally, however, tradersavoid delivery and offset their positions and or close them out by exchange of physical for futures. Theexistence of credible delivery mechanisms, and consequent improved linkage with the physical market, wouldsignificantly 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 thetask of raising production is greatly complicated by the small scale of farms (average 2.2ha) and extremelydiverse 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 infood production. Further increases are needed to keep pace with population growth and rising incomes, thelatter resulting in increasing consumption of animal proteins (principally milk, beef and chicken) for which thereis 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 Governmentseeks to increase this level by 4.5 percent over the next 20 years – at this rate production should double by2016. Similar objectives exist with other crops.

The main constraints affecting production are water and seed. Approaching 40 percent of agriculturalland 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 affecteddry-land farming. This will require the commercial supply of large quantities of plastic tubing, sprinkler systemsand other inputs.

Fertiliser is also vital for raising yields in irrigated areas, but its effective use depends on the availability of goodseed. 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 soybeanindustry of Madhya Pradesh.

Farmers’ current usage of seed leaves much to be desired. Due to conservatism, lack of financial resources andseed availability, they typically only renew 10 percent of their seed every year, so that yields are far belowpotential. Where major breakthroughs have been made, as in the case of irrigated wheat and paddy productionin the Punjab, the level is much higher, but with cotton and most oilseed crops produced in dry land areas theperformance 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 Haryanastarting 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 otherinputs required. For example soybean prices are formed by international price for oils and meals; the currentlylow 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 newagricultural technologies, but contemporary thinking increasingly stresses the importance of

commercial networks supplying new ideas and advice, inputs and credit, while also marketing theoutputs. A key player is the local merchant, which in some cases will be a co-operative, but given the limitedcoverage of the co-operative movement, will more often be the local commission agent or independent buyer atthe mandi. The latter's proximity to the farmer allows him to offer a range of services at low cost. His overheadscan be spread over the cost of input supply, credit, storage and marketing services, and he is well placed toscreen farmers for credit risks, thereby minimising defaults of the kind which have often plagued officialprogrammes.

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 thecountry and overseas. There is evidence of a shortage of such players in India and in the words of Mr Ohja, asenior official at the Ministry of Agriculture, there is a mismatch of supply and demand. For example, farmers inHaryana seeing a market opportunity in onions had to travel 1,500 km to the traditional supplying State. It issignificant that it was the farmers who seized this opportunity and not their local merchants. The pictureemerging from our short studies of the cotton, oilseed and gur industries are of industries dominated byundercapitalised intermediaries operating on low margins and unable to invest in improved services (see sectionof 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, andhave been remarkably successful in achieving this objective. However the requirement that all produce movethrough 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 thatmandis 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 localagricultural 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 hashappened in countries which have created strong warehouse receipts systems - for example in the first half ofthe century, they played a major part in the strengthening of rural elevators and the expansion of credit tofarmers 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 asignificant presence. However, if warehousing is described as an industry, the Government of India and theState 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 ifthey are lessees of facilities, or by suppliers to and customers of private sector owners. Warehouses are usuallyowned by companies for storing their own raw materials and finished goods. Such capacity is unlikely to becomeavailable for hire, except under certain circumstances that are discussed below. There are however two largeoilseed 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 asregards 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 suchproduce in warehouses that are either owned by Government or small private owners. Government is alsopresent in the warehousing industry as owner of warehouses earmarked for use by both private traders andparastatals.

Table 6

Government-owned Warehouses

Institution Capacity Owned ('000

tons)

Food Corporation of India 22,300

Central Warehousing Corporation 7,400

State Warehousing Corporations 12,300

Food and Civil Supplies Corporations of StateGovernments

8,200

Total 50,200

Source: Central Warehousing Corporation

The Government's presence in the warehousing industry has been guided by the All India Rural Credit SurveyCommittee 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 closeto the farms. Warehousing was seen as a necessary but relatively unprofitable activity which would not attractmuch private sector interest, and which therefore required public investment. Moreover, the presence of theprivate 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, whichcreated the Government of India-owned Central Warehousing Corporation (CWC) and provided for CWC to takean 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 ofabout 7.5 million tons, which it is expanding at a rate of about 200,000 tons per annum. The SWCs have morethan 2500 warehouse sites with an aggregate capacity of about 12.5 million tons. Together, the CWC and theSWCs dominate the warehousing industry and provide economically valuable services across the country (seeTable 7). Warehouses of the SWCs are usually smaller but well spread over more sites unlike the warehouses ofthe CWC that are usually big and located at fewer sites.

Table 7

Geographic Distribution of Warehouse Capacity Managed by FCI, CWC

and SWCs

State Owned Hired Total

('000 tons)

Andhra Pradesh 3868 838 4706

Arunachal Pradesh 23 0 23

Assam 526 176 702

Bihar 1315 431 1746

Goa 46 0 46

Gujarat 1231 316 1547

Haryana 2688 1862 4550

Himachal Pradesh 32 40 72

Jammu & Kashmir 199 58 257

Karnataka 1144 546 1690

Kerala 734 109 843

Madhya Pradesh 3174 1094 4268

Maharashtra 3868 753 4621

Manipur 41 1 42

Meghalaya 22 7 29

Nagaland 32 13 45

Orissa 1012 248 1260

Punjab 10233 12073 22306

Rajasthan 1665 325 1990

Sikkim 86 3 89

Tamil Nadu 3085 1398 4483

Tripura 72 17 89

Uttar Pradesh 5619 2317 7936

West Bengal 1367 570 1937

Andaman & Nicobar 28 0 28

Chandigarh 16 9 25

Dadra & Nagar Haveli 1 0 1

Daman & Diu 1 0 1

Delhi 433 30 463

Lakshadweep 1 0 1

Pondicherry 49 15 64

Total 42,611 23,249 65,860

Source: Central Warehousing Corporation

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 21percent, other scheduled banks with 16 percent, insurance companies with seven percent and the remainder byco-operatives and agricultural associations. This means that banks collectively own 37 percent of the equity ofthe CWC, while insurance companies and banks hold 44 percent. The CWC has a 50-percent stake in all theSWCs. The State Governments own the remaining 50 percent in their respective SWCs. By virtue of their largestake in the CWC (44 percent) and the CWC's stake of 50 percent in the SWCs, banks and insurance companieshave a stake of 22 percent in the 16 SWCs. Such a stake in the CWC and the SWCs makes theGovernment-owned banks and insurance companies the implicit stakeholders in over 7.2 million tons or morethan 36 percent of the total storage capacity of about 20 million tons, a very significant holding. Our discussionswith banks and insurance companies indicate that new opportunities that expand business incomes of the CWCand 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 (capacity800,000 tons), container freight stations (CFS) and some cold stores. Given the low profitability of its generalwarehousing activities, it is now considering a range of additional activities including:

a logistics operation linking custom-bonded port warehouses and its upcountry general warehouse (ICDS)

a cold chain with controlled atmosphere storage – a pilot project is expected in year 2000

the provision of infrastructure in the ports

provision of rail freight terminals

custom warehousing for private companies

bulk handling of food grain, in conjunction with an international company

liquid warehousing, involving edible oils and industrial chemicals

CWC and SWC warehouses are generally located in big cities and medium-size towns, though SWCs havewarehouses 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 ofservices. 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 ownindividual stores as warehouses, and hypothecate their stocks to banks – along the lines of similar projects inNepal and Thailand. The Ministry of Agriculture, Government of India, attributes non-implementation to lack ofbank 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. Thismay be attributed partly to "crowding out" by Government and partly to the relatively unprofitable nature ofupcountry warehousing, unlike port warehousing which can be more easily combined with freight-forwardingand other services.

Upcountry warehousing may be profitable when combined with trading, so that it becomes a means by which atrader can earn extra income by using space not immediately required for his trading business. The marginalcost of operating a store under such circumstances is quite low. Indeed a number of cases were cited wheretrading is combined with storage for clients, including that of soybean procurement by commission agents inmandis 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. Suchcases cannot truly be described as warehousing, but rather a marketing service involving delayed pricing of thecommodity. They do however demonstrate that Indian traders are quite sophisticated and are able to offer thefarmers 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 to5,000 ton capacity. Many of them issue warehouse receipts against which co-operative banks provide inventorycredit.

Another factor which may limit the activity of private warehouse operators is that under the Agriculture Act of1961, all warehouses storing agricultural produce have to be licensed by the district collectors who are part ofthe State bureaucracies. In some States, district collectors may be reluctant to license private warehouseoperators.

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 playershandling both bonded and non-bonded cargo. In Mumbai freight forwarders were until recently the main playersoperating warehouses, and were often nominated by the banks as collateral managers. They are still used inthis way by Government-owned and smaller private banks. The liberalisation of India’s oils imports has led to arapid growth in the volume of palm oil imported from Malaysia and other producing economies, with the volumereaching about 4.2 million tons in 1998-99, or 45 percent of domestic consumption. Handling such volumesrequires the services of specialised tank farms at the ports; such services are provided by the private sectorowners 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 andthey have access to offshore professional indemnity insurance.

The inspection companies have also entered the marketplace for warehousing in the context of structured tradefinancing for import or export. They seek to provide an integrated service to their principals, includinginspection, analysis, warehousing and collateral management. Notably, they do not own warehouses or tankfarms, 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 receiptsdenominated negotiable or non-negotiable. Negotiability should mean that warehouse receipts could betransferred between members of the trade by endorsement, or by attaching a delivery note, without fear thatownership by holders in due course can be successfully challenged, or subjected to unforeseen liens. There isconsiderable uncertainty in practice as to whether warehouse receipts are documents of title. So, with minorexceptions, they are not used to transfer title.

"Negotiable" warehouse receipts are however accepted as collateral by the banks, and this is authorised underRBI rules. The borrower must simply be known to the bank and have an account there. The bank advises thewarehouse of the lien, and goods are only released to the depositor when the bank returns the warehousereceipt suitably endorsed, signalling that the loan has been repaid. By attaching a delivery order to thewarehouse receipt, the depositor can also assign the stock to a buyer but no further transfers are possiblewithout issuing a new warehouse receipt.

CWC and SWCs issue non-negotiable warehouse receipts either when the depositor so requests or when thequality of the goods does not meet an established acceptance standard and is therefore unlikely to be goodcollateral.

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 grainsstored by CWC in 1998-99, is also a very significant customer. State agencies account for more than 75 percentof the usage of public warehouses. The private sector, farmers and co-operatives account for the remainder. Awarehouse at Indore was storing 7,000 tons for the Food Corporation of India (FCI) and 4,000 tons for privateparties, 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 ofprice rises, and their involvement in this activity was growing as they became increasingly educated and awareof 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 hadestablished a stacking plan that allowed it to build composite stacks out of relatively small identity-preservedlots. 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 themanager of one of the Indore stores reports that this had never happened – though they might on occasionshave to wait for three or four years for repayment. Only banks may lend against warehouse receipts; it is illegalfor 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 betweendepositors.

Table 8

CWC Storage Charges at Indore

Crop Standard

commercial rate

To farmers To FCI

Wheat Rs 3.00 Rs 2.10 Rs 1.82

Pulses andoilseeds*

Rs 3.45 Rs 2.415 Not applicable

* Insurance charged as extra depending on hazard rating (The charges pertainto 1999.)

Rates for FCI are established by an inter-ministerial committee and are about 60 percent of charges tocommercial 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 revenueofficer. 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 asub-lease on the warehouse, and the owner agrees not to operate it without authorisation. As goods aredeposited they issue a non-negotiable warehouse receipt directly to the bank, without passing through thehands of the depositor, an arrangement which eliminates the opportunity for forgery. Goods are released uponreceipt 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 warehousingcorporations is included in Box 7. The CWC has performed very creditably, having financed all its expansionthrough retained earnings. The 1998-99 Annual Report indicates that average capacity utilisation is over 78percent through the year. This high level is a direct result of the CWC’s presence across the country, whichallows it to take advantage of the varied seasons and commercial activities of different States. While onewarehouse site in Karnataka may be used to the extent of, say, 40 percent, in a particular month, another sitein 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 beencomputerised, 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 toGovernment. Nevertheless it seems to have a good reputation with most of its private clientele, though less sowith the international trading community (see below).

The staff we met at Indore appeared well trained and competent, and our brief visits to warehouse sitessuggested that handling procedures and grain hygiene were good. However the warehouses themselves were inneed of maintenance, particularly as regards damaged floors and broken windows (which gave access to birdsand 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 doesnot appear to be true of some larger private financiers, particularly the international banks. It is unclear howmuch of this is due to bankers’ practical experience of working with CWC, and how much to their apprehensionover 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: "Weknow the way publicly owned institutions work." Perceptions of the latter kind are likely to be a seriousimpediment to CWC as long as it remains part of the public sector.

BOX 7: SWOT ANALYSIS FOR PUBLIC SECTOR WAREHOUSES

Strengths Weaknesses

Presence across the country

Homogeneous storage practices

Established quality practices in

identity-preserved storage

Can store a range of products,

Not well integrated with privatesupply chains

Have yet to practice commingled

storage

Do not inspire confidence among

some domestic and many

and very large quantities

Satisfactory record-keeping and

financial accounting

Warehouse receipts are accepted

by most banks

international lenders

Biased towards consumption

centres

Public ownership diminishes

freedom to expand and improve

services

Opportunities Threats

New businesses aimed at shorterand cost-effective private supplychains

Partnerships and alliances with

the private sector

Alliances with banks and other

lenders to channel credit to

depositor

Alliances with commodity

exchanges to act as delivery

points

Alliances with transportproviders including multi-modaltransport providers fordoor-to-door credit

Certification and regulation of existingprivately-owned warehouses wouldlead to increased competition in thehinterland

While privileged access to Government clientele has allowed CWC to grow, public ownership appears to limit itsability to fully develop its activities in upcountry areas. The setting of storage rates for Government clients andfarmers is to a significant extent a political process, even though politicians may not be directly involved, andrates are set at levels that often compromise profitability. This may explain its low profitability while enjoying ahigh level of capacity utilisation. The low storage rates negotiated for farmers and co-operatives pose aparticular problem in expanding services to non-Governmental customers. Without being able to charge higherrates 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 itsunderlying financial viability, we suggest that it be considered for disinvestment by Government. The equity ofCWC would be an attractive inclusion in private portfolios. Government may wish to retain a shareholding so asto 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 theposition 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, giventhat CWC owns 50 percent of their stock and is represented on their Boards. Part of the answer may lie inpolitical appointments outside CWC’s direct control. State Governments own the other 50 percent of the stock oftheir respective SWCs and select the chief executives. The Warehousing Corporations Act had envisaged SWCsto be economic replicas of the CWC, while enabling them to act as agents for CWC in many activities relating tostorage and logistics. However, in practice few SWCs have had a close working relationship allowing them totake advantage of CWC’s innovative practices. The hiatus between the SWCs and the CWC is perhaps a result ofthe differences in their approach to business and profitability. Disinvestment of equity by the StateGovernments would probably have a beneficial impact. Moreover, SWCs have more warehouses located in thehinterland than the CWC. Disinvestment may be even more justified with these companies, as it will allow forbetter 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 traditionalsystem involving bank-appointed freight forwarders has certain shortcomings, notably that the warehouseoperator does not take responsibility for quantity and quality. This in turn limits the level at which banks willadvance inventory credit. In other ports, such as Kandla and Paradip, international and local inspectioncompanies have overcome such limitations, and the system is working much better, meeting the requirementsof international banks and trading companies.

In importing countries there is considerable apprehension about Indian exporters defaulting on contractualobligations, so the introduction of an internationally credible system of inspection and collateral management isa significant achievement. Notwithstanding, some trading parties still do not fully trust the inspectioncompanies, believing that they tend to find in favour of the party that has contracted them. This can becountered, it is said, by having each party contract an inspector, having a single inspector contracted by the twoparties, and having one’s "own man" shadow the inspector. All in all, however, the system seems to be operatingsatisfactorily.

The same cannot be said for export trade deals which involve pre-financing stocks in upcountry areas, or in thecase 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 areacceptable 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 extendgreen-clause pre-financing terms on letters of credit, unless there is some form of collateral management atorigin. Defaults have occurred due to the absence of such services. According to a major buyer, the oilseedsindustry particularly needs more warehousing facilities in up country areas of Gujarat, Madhya Pradesh andRajasthan. 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 atinternational rates for up to 180 days, but there are significant risks of default.

BOX 8: SWOT ANALYSIS FOR PRIVATE SECTOR WAREHOUSING

Strengths Weaknesses

Strong role in ports, related tointernational trade

Very limited upcountry presence

Limited professional development

Heterogeneous practices

Ad hoc adherence to quality protocols

(Warehouses mitigate these

weaknesses by working along with an

internationally credible collateral

manager.)

Opportunities Threats

Development of collateralmanagement along supplychains

A formal accreditation system

can make services more

marketable

Storage role of ruralentrepreneurs can be developedthrough training andaccreditation

Increased competition frompublicly-owned warehouses in the

ports

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 andcoffee. 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 to5. Taken together these commodities account for 19.52 percent of the India’s official index of agricultureproduction. The potential for the introduction of warehouse receipt systems in the context of nearly a fifth ofthe agriculture produce output is therefore far from trivial. However, there are significant hurdles to such anintroduction.

Grades and Standards

Industrial products, which are output of process engineering and manufacturing design, are produced tospecifications. Therefore, such products are relatively consistent in their physical properties and appearance,chemical properties and characteristics, and functional capabilities. However, agricultural products are by naturemuch more varied. Agricultural products can have a vast array of characteristics, even though the effortexpended 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. Acompact but comprehensive system for clear communication between buyer and seller is vital. Grades fulfil thatrequirement.

Grades are based on defined and accepted parameters that segregate similar products into categoriesconsistently in a manner that is easily understood by market participants. Standards are rules of measurementestablished either by regulation or by authority. Standards are used to arrive at grades based on measurableand quantifiable attributes. Grades and standards enable commodities and produce to be handled in greatervolumes. They enable produce to reach distant markets.

More importantly, they enable commodity exchanges to define the characteristics of the commodity that shouldbe 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 mostwidely 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 anorthodox 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 exportcommodity. The Coffee Board of the Ministry of Commerce has followed international standards for more thanfour decades. COFEI has adopted these international standards for its contracts. Similarly, cotton is a dominantpart of India's trade basket. Cotton is both exported and imported. The CCI along with the EICA enable theapplication of a rigorous system of grades and standards. In the case of oils, cakes and seeds, there arewell-established industry standards. The BOOE uses these standards.

In general, grades and standards convey valuable information about the products that determines prices andhelps 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 moretransparent.

Limited Impact

Though all four commodities or baskets, as the case may be, are amenable to grades and three are amenable tostandards, the penetration of grades and standards is not complete. A significant part of the markets pertinentto 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 historyof well-entrenched system of grades and standards. It is the least in the case of the oilseeds complex. Cottonand gur form the middle. In monetary terms, the penetration is highest in the case of the oilseeds complex andleast in the case of gur. The relative scores of the commodities have been derived based on a proprietarymethodology that assigns a score of 100 to coffee based on the penetration of grades and standards in thephysical market. The scores are given in Table 9. The scores can be adjusted to reflect the monetary value ofproduce.

Table 9

Penetration of Grades and Standards

Commodity Percentage of physicalmarket (normalised to

100)

Coffee 100

Cotton 78

Gur 34

Oilseeds complex 22

Oilseeds 6

Meal and cake 11

Oils 31

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 penetrationquite significantly.

The high score of oils, relative to seeds and cakes, points to the likelihood of the oil futures and the underlyingmarket being more active. It also points to a likely crisis in the underlying market for seeds and cakes ifimmediate steps are not initiated to propagate grades and standards in the seeds and cakes market. In ourdiscussion with policymakers, the importance of accelerating the process leading to a high score in the case ofedible oils was emphasised since the edible oilseeds complex constitutes a significant part of the agricultureproduce economy (see Table 2). Commodity exchanges that trade edible oils futures contracts are aware of thisemphasis.

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 andbranding of edible oils have helped in the handsome increase to 22. Futures contracts would accelerate theacceptance further. The penetration score is likely to rise to 75 if the BOOE, the SBOT and the other exchangesthat trade contracts belonging to the oilseeds complex evolve a common standard and apply it. The SBOT andthe BOOE commenced trading futures in February 2000 and August 2000 respectively but have established thenecessary processes to boost the penetration score in the edible oilseeds complex. Examples pertinent to basisquality follow.

The SBOT has specified the following in the case of yellow soybean futures contract:

Table 10

Basis Quality: Yellow Soybean

Moisture 10% max

Sand and silica 2% max

Damaged 2% max

The SBOT has specified the following in the case of soy meal futures contract:

Table 11

Basis Quality: Soy Meal

Moisture 11% max

Protein 48% min

Fat 1.5% max

Fibre 6.0% max

Sand and silica 2.0% max

Unrease (by EEC) 0.30 max

The SBOT has specified the following in the case of refined soy oil futures contract:

Table 12

Basis Quality: Soy Oil

Moisture insoluble impurities 0.1% max

Colour in Lovibond Scale Basic Unit

Maximum acceptable with Rebate Units 4 Max.

Expressed as Y+5R in 1/4" cell

Refractive Index @ 40oC 1.4650 to 1.4710

Specific gravity @ 30oC @ 25/25 0.917 to 0.921

Saponification value 189 to 195

Iodine value (Wij’s) 120 to 141

Unsaponifiabe matter % by wt. Max 1.5% max

FFA % by wt. Basic 0.25 max.

Flash point Pensky Marten method oC14

250 min

Refractometer Reading @ 40o C 58.5 to 68.0

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:

Table 13

Basis Quality: Groundnut Oil Expeller

Moisture & Insoluble Impurities 0.25% maximum

Colour in Lovibond Scale Basis units - 5 Maximum acceptablewith rebate units - 8.5(Rebate @Rs 10per MT per unit over basis) Expressedas Y+ 5R in ½ " cell

Refractive Index @ 40 degree C 1.4620 to 1.4640

Specific gravity @ 30 degree C/ 30degree C

0.909 to 0.913

Saponification value 188 to 196

Iodine value (Wij's) 88 to 98

Unsaponifiable matter % by weightmax

1 maximum

FFA % by weight 1% Maximum acceptable with rebate2%(Double rebate over basis)

Bellier- Turbidity Temperature 39 to 41

B.R. Reading @ 40 degree C 54 to 57

Bleachability minimum 40%below 40% to be rejected

Test for presence of other oils Negative

The BOOE has specified the following in the case of RBD palmolein futures contract:

Table 14

Basis Quality: RBD Palmolein

Butyro-refractometer reading at 40degree C

43.7 - 52.5

Or Refractive Index at 40 degree C 1.4550 - 1.4610

Iodine value ( wij's method ) 54 - 62

Saponification value 195 - 205

Cloud point Not more than 18 Degree

Unsaponifiable matter Not more than 1.2 percent

Acid value Not more than 0.3

FFA Not more than 0.15 percent (If it isabove 0.15 to 0.20 percent, the rebatewill be Re.0.25 per 10kg)

Moisture Not more than 0.1%

Flash Point Not less than 250 Degree C (PenskeMarten Closed Method)

Colour (5.25" Lovibond Cell) 3 R/30 Y.MAX.

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 ofthe same kind and grade.

PCCCI's business rule pertinent to commingling of commodities stocks: Members originating thedelivery order or their clients (Trading-cum-clearing Members/Registered Non-Members of the Exchange) givingdelivery shall be permitted to hold commingled stocks of tenderable grade of commodities covered by the saidDelivery Order which shall mean that such stocks may be mixed or kept together with other stocks of the samegrade 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 inedible oils since India is a very significant consumer, importer and producer of edible oils. Mr Ramasarma'srecommendations pertinent to the achievement of the high score and to the practice of commingled storagefollow.

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 applicationof 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 movementin 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; thewillingness of the industry to adhere to grades is significant. Since coffee's score is relatively placed at 100, anyimprovement has to be absolute. Such improvement is not likely because there is little absolute gap to becovered. Moreover, COFEI has listed raw coffee futures and such listing is most likely to complete the process oftotal adherence to grades and standards.

However, all absolute numbers would rise with the advent of warehouse receipts. The threat imposed by themarket by way of higher price for compliance with grades and standards and lower price for non-compliance andavoidance would have a favourable impact on the penetration of grades and standards. For example, cotton isan industrial input and therefore has both universal compliance and preferences built into it. Avoidance wouldimpose a very high cost by excluding a producer or processor that is not inclined to comply with grades andstandards.

FMC and Positive Externalities

Until the mid-1990s, the orientation of the FMC was towards maintaining status quo in the commodity futuresmarkets. In the recent past, the focus has shifted to an expansion of commodity contracts and commoditymarkets. This process has had a very favourable impact on the commodity environment. The expansion hasproduced several concomitant benefits.

Each contract market requires one or more commodity contracts that are unambiguously defined with referenceto grades and standards. Such a definition is necessitated by competition. Where there is no competition, thenecessity arises out of the need to achieve higher trading volumes and thus earn incomes that arecommensurate 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 createdpositive 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 toexploit the externalities.

The emergence of a warehouse receipt system may be viewed both as a positive externality and an intendedoutcome. 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 20percent of merchandise exports, and has experienced rapid expansion over the last decade. Notwithstandingthis industry remains seriously hampered by low yields, poor quality and under-investment in processing andobsolete equipment. Warehouse receipts can have a major impact in modernising this industry, because it willfree up funds for modernising ginning and pressing factories, and will tend to improve quality throughstandardisation.

At present these factories employ a significant part of net owned funds as working capital, but this precludesrapid modernisation of the factories, since long-term credit, based on balance sheet strengths, is not easilyaccessible. The limited net owned funds has necessarily to be employed in working capital to keep factoriesrunning regardless of the state of the machinery and equipment. The access to working capital credit based onwarehouse receipts would enable factories to shift a portion of net-owned funds to investments in machineryand equipment. Such a shift would not interrupt operations since credit through warehouse receipts would beavailable and would also be self-liquidating.

The modernisation of the ginning sector would moreover add to the competitiveness of India’s cotton spinningsector, given that this sector is increasingly dependent on imported ginned cotton. Such cotton is of moreuniform 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 thenear future be possible to develop a strong system of warehouse receipts with seed cotton (kapas) inMaharashtra. Presently, lenders may be deemed to be illegally procuring kapas in the event that they takepossession 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 EICAand other industry entities. When in the past India imported significant quantities of cotton, the CottonCorporation of India (CCI) and the EICA developed surveying, testing, grading and valuation systems which hada positive impact on the industry. At the same time, the presence of corporate organisations in spinning and thetextile research institutes has enabled investment in, and the entrenchment of, objective testing equipment andmethodologies. The cotton economy, with the exception of the market yards, is therefore well equipped tosupport a system of warehouse receipts.

EICA has recently introduced a contract for ginned cotton specifying the physical qualities of the fibre, and isalso likely to introduce a contract for kapas. Both kapas and ginned cotton are amenable to warehousing andthe issuance of warehouse receipts. The exchange has also begun work in earnest on warehouse receipts, andhas 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 fragmentedindustry structure whose inefficiencies (i.e. poor technical standards of oil extraction, inconsistent quality, lowcapacity 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 theother". It goes on to point out that in the case of the soybean industry, the best international processingfactories use only 12% of the solvent per ton of Indian factories, roughly half the steam, and three quarters theelectric power. To this should be added the poor development of the domestic market for high quality feed, andthe need to export much of the de-oiled cake, and the low quality of much of the cake, all of which depress theprice which can be paid to Indian farmers. As with cotton textile sector this is an industry where warehousereceipt 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 withGovernment-owned warehouses at Indore and elsewhere. However more services are needed in upcountryareas both to reduce risks of export trade in meal, and to facilitate delivery on futures contracts listed by theSBOT.

Compared with food grains, oilseeds are not subject to heavy Government regulation. However, the StorageControl 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 otherhand State sales tax of 4 percent has just been removed). Small-scale industry reservations still apply to someother oilseeds, though the Ministry of Agriculture has requested their removal.

Notwithstanding considerable cost inefficiencies in the crushing sector, the competitive environment in theoilseeds industry is fiercely competitive. In the case of soybeans, the margin between the farm gate and theprocessor was only about 7 percent of processor's buying-in price, prior to the increase in mandi tax. Thenarrowness of the margin provides a powerful incentive to evade taxes, and in States that have not removedsales taxes it will provide a disincentive to document sales between trading partners through warehousereceipts. Storage Control Orders have a similar effect. If such constraints can be overcome there will be goodprospects for warehouse receipts in the oilseeds industry.

It should be noted that much of the marketing margin covers services provided by commission agents who arelocated at the market yards (mandis). They fulfil vital roles within the marketing structure, notably:

primary quality control, while shouldering the risk that raw material does not meet specifications

a range of services for farmers, including storage, credit, providing inputs and information

This contradicts popular misconceptions about the role of middlemen. They have considerable skills and marketknowledge, and as suggested in the Rationale section of this report, they have a key role to play in enhancingagricultural productivity.

In the case of other oilseeds, rapid advances are noted in testing and grading methodologies. This will drive thetightening 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 emergenceof scientific testing processes is a prerequisite for their usage. Financing against warehouse receipts wouldmoreover 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 ofcommingling of gur, and common or public storage without any emphasis on identity preservation. Industrysources indicate they would welcome the resulting savings in storage costs.

Development of warehouse receipt systems for gur would facilitate its subsequent extension to the sugarindustry 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 arethemselves 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 forthree reasons:

The coffee industry has for long used reliable testing, grading and storing processes, set up by the CoffeeBoard when it enjoyed a monopoly of procurement. The private warehouses are certified by the exchangeand not by any regulatory authority constituted by Government. Notably it is the exchange and not theindividual warehouses which issues "certified warehouse receipts". The success of this innovation wouldhave important implications for the future of warehouse receipt systems in India.

The coffee industry has implemented an information technology solution that generates and issueswarehouse receipts in a manner that precludes endorsement or treatment as order warrants. The wideacceptance of the information technology solution may well make the issues of "negotiability",endorsement and transferability, important in an era characterised by paper, quite unimportant. ShouldIndia emphasise negotiability, endorsement and transferability of warehouse receipts, or should priority beaccorded to the regulation of warehouses that perform fiduciary functions? The latter is perhaps the rightchoice.

The imposition of sales tax on intermediate transactions has an unfavourable impact on transactions costand the cost of produce. While coffee meant for exports is exempt from state sales tax in Karnataka, it isquite impossible to show that the purchase and sale of coffee warehouse receipts is either related toexports or not related to exports. The state is most likely to regard them as transactions pertinent to thedomestic market and then levy sales tax. If the receipt is used by the final holder to acquire coffee forexport, sales tax would have been levied at least once. No rational exporter would, therefore, buy receiptsto possess coffee, and no grower or trader would hold stock in certified warehouses. Inappropriately leviedcommercial taxes militate against the economic benefits of warehouse receipts.

An unusual amount of effort has been devoted to creating a really rigorous delivery system. However the levelof trading on the exchange remains low and delivery is hardly practised. Probable explanations include thetaxation issue, lack of interest/understanding on the part of farmers and roasters, and dissatisfaction with thegrading 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, andthe geographical concentration of the coffee industry in south India, which makes most warehouses readilyaccessible from Bangalore. The decision to have all warehouse receipts issued from Bangalore (as opposed tosimply tracking them electronically), and not by the individual warehouses, may be attributed to concerns oversecurity, 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 coffeeeconomy. It may be difficult for the relevant exchanges to perform the two functions performed by COFEI. Whilethe warehouses owned by Government may well undertake the issuance of receipts, the issuance of receipts byprivate warehouses may not be easy.

In the cotton and oilseeds economies, there has been significant integration of the trading, storing andprocessing components of business. Stocks of farmers, processors, suppliers and customers are held inwarehouses operated by private parties (traders and processors) on an identity-preserved (IP) basis. Theseprivate parties will need to be involved in any attempt to develop warehouse receipt systems. WhileGovernment warehouses may assist in the stockholding process, they are not integrated within existingmarketing chains, and they are unlikely to take the lion's share of this business. However, if existing privatewarehouses can be properly regulated by a central authority, and depositors and lenders can be guaranteedagainst malpractice, it should be possible for them to issue warehouse receipts and for these to be used assecurity for financing. However, the task of regulating private warehouses owned by traders and processors isnot simple - there are significant risks arising from the warehouse operators' trading activities, and conflicts ofinterest arising therefrom. It needs to be well thought out in the local cultural context, and developedaccordingly.

The regulation of warehousing corporations owned by Government would be easier since such warehousingcorporations would not have operations that are integrated to trading. Banks and lenders are more likely tohave business alliances with such corporations. These alliances are on the drawing board; the alliances presentan important opportunity for the banking sector to play a significant role in the development of certification andregulatory standards.

A common finding with cotton, oilseeds and gur is that the implementation of a warehouse receipt system wouldhelp the industries concerned release equity capital for investment in new technologies, having a favourableimpact 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 inthe flow of credit from lender to borrower during the period of storage. A system of warehouse receipts has asignificant 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 collateralwhile 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 thisreport. The tables show that all the commodities chosen for the joint programme of the World Bank and theGovernment of India are characterised by seasonal output.

More importantly, the tables include the spatial dispersion of harvests of the same produce in the States wherethe produce is harvested. Information pertinent to the spatial dispersion would show that there is significantscope for the State Governments to act collectively in supporting a national system of warehouse receipts thatmay be engendered by the Government of India. In fact, the State Governments have the appropriate economicincentives 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 avery favourable impact on the underlying markets for the produce across the economy.

Table 15

Groundnut Harvest

State Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec

AndhraPradesh

Yes Yes Yes Yes

Assam

Bihar Yes Yes

Gujarat Yes Yes

Haryana Yes

HimachalPradesh

Yes

Jammu &Kashmir

Karnataka Yes Yes Yes

Kerala

MadhyaPradesh

Yes

Maharashtra Yes Yes Yes

Manipur Yes

Orissa Yes Yes

Punjab Yes

Rajasthan Yes

Tamil Nadu Yes Yes Yes Yes

Tripura

Uttar Pradesh Yes Yes Yes

West Bengal

Table 16

Rapeseed and Mustard Harvest

State Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec

AndhraPradesh

Assam Yes Yes

Bihar Yes Yes Yes

Gujarat Yes Yes

Haryana Yes Yes

HimachalPradesh

Yes Yes

Jammu &Kashmir

Yes Yes

Karnataka Yes Yes

Kerala

MadhyaPradesh

Yes Yes Yes

Maharashtra Yes Yes

Manipur Yes Yes

Orissa Yes Yes

Punjab Yes Yes

Rajasthan Yes Yes Yes

Tamil Nadu

Tripura Yes Yes Yes

Uttar Pradesh Yes Yes Yes Yes Yes Yes

West Bengal Yes Yes Yes

Table 17

Soybean Harvest

State Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec

AndhraPradesh

Yes Yes Yes

Assam

Bihar

Gujarat Yes Yes Yes

Haryana

HimachalPradesh

Jammu &Kashmir

Karnataka Yes Yes Yes

Kerala

MadhyaPradesh

Yes Yes Yes

Maharashtra Yes Yes Yes

Manipur

Orissa

Punjab

Rajasthan Yes Yes Yes

Tamil Nadu

Tripura

Uttar Pradesh Yes Yes Yes

West Bengal

Table 18

Sunflower Harvest

State Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec

AndhraPradesh

Yes Yes Yes Yes Yes

Assam

Bihar Yes Yes

Gujarat

Haryana Yes Yes

HimachalPradesh

Jammu &Kashmir

Karnataka Yes Yes Yes Yes Yes

Kerala

MadhyaPradesh

Yes Yes Yes Yes Yes

Maharashtra Yes Yes Yes Yes Yes

Manipur

Orissa

Punjab Yes Yes

Rajasthan Yes Yes

Tamil Nadu Yes Yes Yes Yes Yes

Tripura

Uttar Pradesh Yes Yes

West Bengal

Table 19

Sesame Harvest

State Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec

AndhraPradesh

Yes Yes

Assam Yes Yes

Bihar Yes

Gujarat Yes

Haryana

HimachalPradesh

Yes

Jammu &Kashmir

Yes Yes Yes

Karnataka Yes Yes

Kerala Yes Yes Yes

MadhyaPradesh

Yes

Maharashtra Yes Yes

Manipur Yes

Orissa Yes

Punjab

Rajasthan Yes

Tamil Nadu Yes Yes Yes Yes Yes

Tripura Yes

Uttar Pradesh Yes

West Bengal Yes Yes Yes Yes Yes Yes Yes

Table 20

Safflower Harvest

State Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec

AndhraPradesh

Yes Yes

Assam

Bihar

Gujarat

Haryana

HimachalPradesh

Jammu &Kashmir

Karnataka Yes Yes

Kerala

MadhyaPradesh

Yes Yes

Maharashtra Yes Yes

Manipur

Orissa

Punjab

Rajasthan

Tamil Nadu Yes Yes

Tripura

Uttar Pradesh

West Bengal

Table 21

Cotton Harvest

State Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Andhra Pradesh Yes Yes Yes Yes

Assam Yes Yes Yes

Bihar

Gujarat Yes Yes Yes Yes Yes Yes

Haryana Yes Yes Yes

Himachal Pradesh Yes Yes

Jammu & Kashmir

Karnataka Yes Yes Yes Yes Yes

Kerala Yes Yes

Madhya Pradesh Yes Yes Yes Yes

Maharashtra Yes Yes Yes Yes Yes Yes

Manipur

Orissa Yes Yes Yes

Punjab Yes Yes Yes

Rajasthan Yes Yes Yes

Tamil Nadu Yes Yes Yes Yes Yes Yes Yes Yes Yes

Tripura Yes

Uttar Pradesh Yes Yes Yes

West Bengal Yes

Table 22

Sugarcane Harvest

State Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec

AndhraPradesh

Yes Yes Yes Yes Yes

Assam Yes Yes

Bihar Yes Yes Yes

Gujarat Yes Yes Yes Yes

Haryana Yes Yes Yes Yes Yes Yes

HimachalPradesh

Jammu &Kashmir

Karnataka Yes Yes Yes Yes

Kerala Yes Yes Yes Yes

MadhyaPradesh

Yes Yes Yes Yes

Maharashtra Yes Yes Yes Yes

Manipur Yes

Orissa Yes Yes Yes

Punjab Yes Yes Yes Yes Yes Yes

Rajasthan Yes Yes Yes Yes

Tamil Nadu Yes Yes Yes Yes Yes Yes Yes

Tripura Yes Yes Yes Yes

Uttar Pradesh Yes Yes Yes Yes Yes Yes

West Bengal Yes Yes Yes Yes Yes

Table 23

Coffee Harvest

State Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec

Arabica

AndhraPradesh

Yes Yes Yes

Karnataka Yes Yes Yes Yes

Kerala Yes Yes

Tamil Nadu Yes Yes Yes Yes

Robusta

Karnataka Yes Yes Yes Yes

Kerala Yes Yes Yes Yes

Tamil Nadu Yes Yes

Chapter 5

Policy Issues Affecting Implementation of Warehouse Receipt System

Two factors make policy issues particularly important in the case of agricultural commodities: (a) theconsiderable political sensitivities attaching to agriculture and food and the consequent tendency forGovernments to intervene in both a strategic and ad hoc manner; (b) the fact that there are two levels ofintervention, 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 arereluctant to store or use warehouse receipts. For example, millers often find it easier to let Government do thestorage 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 publicfinances.

Examples from elsewhere show that prices can be managed within narrow bands with much lower levels ofpublic 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 domesticoutput, 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 theremaining storage of rice across seasons. They moreover noted that the cost of funds to traders was in excess ofthe gross return given by the seasonal margin, resulting in a negative real incentive to hold stocks for pricereasons. Traders were holding grain for operational purposes, such as continuity of paddy supply into mills, andregular supply of polished rice to customers, but seen from a speculative viewpoint their returns were evidentlynegative. 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 differencebetween official procurement and issue prices for wheat led to an immediate increase in direct procurement bymillers, who now found it profitable to finance around two months additional raw material stocks instead ofrelying 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 thePhilippines, 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 findwarehouse receipts to be a valuable tool that will facilitate the expansion of storage by other players. They willparticularly assist traders who do not have a very strong credit history and are therefore unable to borrowagainst 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 qualitycontrol and offload produce onto the State. When inferior grades are eligible for MSP, the expected price forsuperior grades falls. Testing, grading and sorting are pushed higher in the supply chain, almost to the point ofprocessing. Collateral value becomes uncertain at points that are lower in the supply chain, diminishing thescope for warehouse receipts.

Sales Taxation

With few exceptions, present taxation regimes provide for the payment of mandi taxes at 0.5 percent, and salestaxes levied either by the States (a regime of uniform rates is in place since January 2000) or, in the case ofinter-State movement, by the Government of India (4 percent). Sales taxes pose the strongest impediment tothe use of warehouse receipts, as was found in our visit to COFEI in Karnataka. Such taxes often representmore than the total gross margin earned by market intermediaries, so as long as they exist and are chargeableon goods changing hands in warehouses, no secondary market for warehouse receipts will develop; tax will bepayable on each sale.

In practice we believe that due to exemptions and evasion little sales tax is in fact being paid, but that theydiscourage marketing innovations in the formal sector.

European Community taxation regimes are generally more favourable to warehouse sales, and may provideclues for reform in India. VAT is not levied on the transfer of documents of title for goods in warehouse, theview being taken that the goods are not really in commerce. In UK, all "basic foods", ranging from bread toinstant coffee and drinking chocolate, are zero-rated. "Fancy items", like confectionery and cakes, arestandard-rated (17.5%), but VAT is not levied on the primary commodity (e.g. cocoa), but only from the level ofthe processor.

Dynamic Tariffs on Imports

The Government of India recently decided to dismantle quantitative restrictions on 1,429 items, including arange of agricultural produce, and tariffs are henceforth likely to be its main tools in protecting domesticproducers. While the move towards tariffs is welcome, experience with the sugar industry suggests that it maybe 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 evenhigher. The problem with this is that while international prices influence domestic prices, domestic processorsand 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 isallowed. Consequently they cannot plan investments and production in the expectation of given future levels ofprofits. 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 interpretationsof price signals. Dynamic tariffs militate against the effectiveness of the price-discovery process that is thecentrepiece 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 producethat 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 warehousesand 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 aremore likely to use warehouse receipts, so the measure is also detrimental to the emergence of warehousereceipt systems.

Small-scale Industry Reservation

In the case of processing of primary commodities, reservation is likely to have an adverse impact on the Indianeconomy. 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 StorageControl Orders, they make the country less competitive in terms of prices and quality, raise prices to consumersand increase India’s overall dependency on imported food. By restricting the scope of larger players, it moreoverprejudices their ability to store and make use of warehouse receipts.

Fortunately there is a movement towards de-reservation, with the Ministry of Agriculture recentlyrecommending 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 thedevelopment 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 assorting and grading downstream to assembly or processing stages. If traders had direct access to farmers, as inPunjab, it would enable farmers to perform more of these functions, thereby improving their price realisation. Itwould also put pressure on mandis to adopt such practices that enable buyers and farmers to transact on thebasis of known quality. Warehouse receipt systems might be developed to support the development of tradingconcerns 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 andglobalisation of agricultural marketing. Reduced intervention increases private parties’ incentives to engage ininter-seasonal storage, using warehousing services or otherwise. Specifically, the following are recommended.

Reduced and more carefully targeted public procurement, above all in the food grain market

Where possible, eliminating State and Central taxes on primary commodities. Where not, they should bemade applicable at a single point, i.e., ex-factory and upon import (against invoice value), these being thetwo places where volumes can be most easily monitored and evasion minimised

By the same token there should be no taxes on the trading of warehouse receipts

Reforming and rationalising such taxes is the primary pre-condition to expanding the use of

warehouse receipts for commodities other than food grains

It is also important to the development of delivery mechanisms through commodity exchanges. Indeedfailure to rationalise will tend to reinforce opaque and abstruse behaviour that has hitherto been acharacteristic of some exchanges, and may encourage others to remain in outright illegality

Ending mandatory marketing through the mandis, while fostering emergence of a strong breed of ruralmerchants providing a multiplicity of services to farmers, and highly responsive to new businessopportunities (see Chapter 2). The possibility of formalising the storage role already carried out by thesemerchants, through a system of warehouse receipt, should also be investigated

Ending minimum support pricing for crops that can be better stored and hedged by the private sector

Adopt a policy of static import tariffs on all agricultural produce, while avoiding unforeseeable changes

With regard to the above, it should be noted that the NAFCSC has made two important recommendations at themeeting 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. Ithas also urged the removal of all statutes that enable State Governments to limit the quantity of produce thatmay 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.

Section 1: How warehouse receipts are perceived

Percentage of

respondents

Comment and inference

Instruments backed bycommodities stored in awarehouse

11 Before explaining what awarehouse receipt is;warehouse receipt systemrequires intense propagation

Responses that follow are based on an oral description of warehouse receipts

and warehouse receipt system

Integral part of thecommodity marketingsystem

73 After explaining what awarehouse receipt is;warehouse receipt systemrequires simple propagationamong producers andprocessors

Integral part of thecommodity financingsystem

82 After explaining what awarehouse receipt is;warehouse receipt systemrequires simple propagationamong borrowers and lenders

Facilitator of a nationalcommodity market

54 Reflects producers' desire toaccess the national marketwithout hindrance and

uncertainty

Section 2: Principal effect of transferability or negotiability on

underlying commodity

Percentage of

respondents

Comment and inference

Can be sold 94 Tradability is understood

Can be traded 94 Tradability is understood

Swapped 45 Swapping is understood amongcotton industry participants

Used as collateral tosupport borrowing

80 Both borrowers and lenders areaware of the utility ofwarehouse receipts as collateral

Used as collateral tosupport lending

90

Used to support deliveriesin organised commoditymarkets

12 Most participants are unawareof this usage

Section 3: Principal benefits

Percentage of

respondents

Comment and inference

Efficiency of growersenhanced if inventory canbe converted into readilytradable receipts

57 Growers are aware of theinefficiency of storing physicalstock in their premises

Warehouse receiptsextend the sales ofmodestly perishableproduce beyond theharvest season

87 Reflects desire to hold stock forfuture sales

Grade can be known bybuyer and be madeknown by seller withoutambiguity

89 Grade-orientation of receipts isunderstood

Efficiency of processorsand producers enhanced ifinventory can beconverted into readilytradable receipts

68 Liquidity preference is reflected

Efficiency of trade 73 Liquidity preference is reflected

intermediaries enhancedif inventory can beconverted into readilytradable receipts

Efficiency of financialintermediaries andfinanciers enhanced ifcollateral can be readilytraded

65 Liquidity preference isreflected; warehouse receiptsare seen to ameliorate creditrisk (see below)

Credit risk of financialintermediaries andfinanciers enhanced ifcollateral can be readilytraded

92 Underscores expectation oftradable and liquid warehousereceipts, and the resultingimpact on the value ofcollateral

Section 4: Reasons for limited use of warehouse receipts

Percentage of

respondents

Comment and inference

Lack of an appropriateinstitutional system

90 Underscores absence of aninstitutional system

Lack of incentives forprivate storage industry

13 Success of warehouse receiptsystem not predicated onprivate storage industry

Government's policy ofminimum support prices

34 Government may have toreview support prices; supportprices are not a deterrent tothe use of warehouse receiptsin the case of gur, coffee, edibleoils and ginned cotton

Lack of an appropriatelegal system

68 Many respondents have viewedthe institutional system as onethat includes the legal system

Lack of an appropriateregulatory system

60 Many respondents have viewedthe institutional system as onethat includes the regulatorysystem

Limited familiarity ofbanking system withwarehouse receipts

45 Banks have limited knowledgeof warehouse receipts

Limited familiarity ofcommercial system withwarehouse receipts

68 Users and potential borrowersare quiet unfamiliar withreceipts

Section 5: Impact on credit flows

Percentage of

respondents

Comment and inference

Introduces a third creditdimension: produce loansor inventory credit

94 Reflects convenience andavailability of credit based onpossession of produce

Inventory credit wouldaugment crop loans andmedium-term andlong-term loans

98 Reflects convenience andavailability of credit based onpossession of produce

Increase in theavailability of credit

48 Borrowers expect lenders toalter asset composition;increase in total credit flow toagriculture may be around 30percent

Reduce cost of credit 51 Reflects effect of lowering ofcredit risk and costs related tomanaging loans to agriculture

Attract and mobilisenon-traditional financialresources

13 Few respondents are sanguineabout new sources of funds

Will bestow on theagriculture sector benefitssimilar to those obtainingin the manufacturingsector in the context ofcredit

89 Growers expect lenders toassign significant economicvalue to produce as collateral

Section 6: Collateral and borrowing

Percentage of

respondents

Comment and inference

Lenders regardwarehouse receipts assecure collateral

38 Many lenders expect significantimprovement in securing thecollateral value of receipts

Correctly structuredwarehouse receiptsprovide secure collateralfor lenders

83 Room for correct structuring isvery significant

Usage as collateral tosupport borrowing is thesole reason for warehousereceipts

11 Growers and intermediarieshave multiple uses forwarehouse receipts

Usage as collateral tosupport borrowing is theprincipal reason forwarehouse receipts

24 Usage as collateral is important

Usage as collateral tosupport borrowing is oneof the principal reasonsfor warehouse receipts

57 The design of the warehousereceipt system should reckonwith the expectations ofgrowers and intermediaries

Section 7: Impact on markets

Percentage of

respondents

Comment and inference

Warehouse receiptscontribute to the creationof cash markets and thusenhance competition

53 Usage in the context of cashmarkets is important; can beexpanded rapidly in thepresence of appropriate policies

Grade can be known andbe made known withoutambiguity

89 Reflects the value of grades tothe commodity market

Provide all the essentialinformation needed tocomplete a transaction

89 Reflects the value of grades,place stored and when stored tothe commodity market

Increased competitionamong sellers

77 Reflects the value ofinformation to competingsellers

Better-informed sellers 77 Reflects the value ofinformation to competingbuyers

Information effect willexpand marketssignificantly

76 Reflects the reduction ofinformation asymmetry

Cash market liquiditywould be enhanced

54 Positive externalities areexpected, but cautiously

Lower search costs forbuyers and sellers

43 Positive externalities areexpected, but cautiously

Lower transaction costsfor buyers and sellers

46 Positive externalities areexpected, but cautiously

Would create a liquid,competitive forwardmarket

54 Reflects possession of verifiablestock with secure prospectivevalue

Warehouse receipts canbe combined with price-hedging instruments

08 Poor awareness of commodityexchanges and hedging

Section 8: Impact of grades and standards

Percentage of

respondents

Comment and inference

Standards of gradingwould gain nationalimportance

91 Reflects the optimism of aprospective shift to grades andstandards; also reflects therelative unimportance of gradesand standards in the present

Grades provide anincentive to maximiseprice realisation

82 Link between price and outputquality is understood andawaited

Pricing related to gradewould provide neweconomic incentives to allproducers

63 Link between price and outputquality is understood andawaited

Grading would become agrassroots level activity

68 Link between price and outputquality is expected to have afavourable impact at all tiers ofproduction

Impact on small producersand growers would bevery positive since evensmall volume output ofdesired grades can bepriced efficiently

66 Link between price and outputquality is expected to have afavourable impact at all tiers ofproduction

Standards of storage willimprove in order topreserve specified quality

72 Reflects the concomitant impacton storage practices

Section 9: Impact of storage standards and practices

Percentage of

respondents

Comment and inference

Warehouse receiptsenable government tooffer support priceswithout invitinginefficiencies

61 Reflects the concomitant impacton storage practices

Small and big holderswould have equal accessto reliable storage

57 Some small growers are unsureabout access to storagefacilities; this points to theimportance of co-operatives

Sight unseen lendingbecomes possible

05 Few growers expect lenders todefy geography and lend 'long-distance'

Storage standards wouldrise

84 Reflects the concomitant impacton storage practices

Storage standards wouldhave a positive impact onexisting warehousecapabilities and facilities

79 Reflects the concomitant impacton storage practices

Section 10: Principal institutional requirements for expanded usage

Percentage of

respondents

Comment and inference

Warehouse receiptsshould be functionalequivalents to storedcommodities

98 Purpose of receiptscomprehensively understood

Rights, liabilities andduties of each party to awarehouse receipt to beclearly defined

97 Underscores the guidingprinciples of fiduciaryresponsibilities and ownershiprights

Warehouse receiptsshould be freelytransferable by deliveryand endorsement

65 Reflects importance of transferof rights

Warehouse receiptsshould be declared asnegotiable instruments

64 Reflects importance of transferof rights

Holders should be first inline to receive storedgoods on liquidation ordefault of a warehouse

96 Underscores the guidingprinciples of fiduciaryresponsibilities and ownershiprights

A recipient of or a lenderagainst a warehousereceipt should be able todetermine if there is acompeting claim

97 Reflects abhorrence ofinformation asymmetry

Section 11: Principal operational requirements for expanded usage

Percentage of

respondents

Comment and inference

Warehouse certificationshould be reliable

91 Regulation should focus first onthe issuer of receipts and then

on the issued receipt

Warehousing should bereliable and cost effective

92 Usage would be driven byreliability and cost

Basic physical andfinancial standards ofwarehouses should beguaranteed

81 Regulation should focus first onthe issuer of receipts and thenon the issued receipt

There should be anational inspectionsystem for warehouses

84 Standards of practice need totranscend local requirements

There should be anational rating system forwarehouses

46 Rating may be contemplatedsoon after initial systems areestablished

Independentdetermination andverification of quantityand quality of storedcommodities should bepossible

84 Emphasises focus on the abilityof issuers to preserve theunderlying commodities

Property and casualtyinsurance should beavailable

78 Reflects importance ofrecompense to depositors ofcommodities and produce

The integrity of thewarehouse receipt systemshould be assuredthrough performanceguarantees

88 Reflects importance ofwillingness of warehouses tocommit financial resources ex

ante and as a source ofrecompense

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 economicactivities 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 havelittle to do with the principal functions of commodity exchanges. Participants do not expect any commodityfutures exchange to play any significant role in meeting these expectations. In fact, they see a minimalrelationship between hedging and the raft of economic conveniences offered by warehouses and warehousereceipts.

Policymaking pertinent to the principal contributory factors to market hygiene should necessarily be the basisfor engendering a suitable institutional framework. It would be inadvisable to allow or expect commodityexchanges to develop and deploy their own policies related to warehouses and warehouse receipts in afragmented manner. The commodity exchanges in India have made a very impressive beginning. However, it isimportant that the necessary components related to nation-wide regulation are developed by the FMC in orderto capture the principal benefits offered by the commodity exchanges.

The expectations pertinent to the institutional framework go beyond negotiability of warehouse receipts. Thedraft 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 theevents such as fraud or mismanagement on behalf of the warehouse, or the insolvency of the depositor. Legalremedies 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 awarehouse. The status of a pledge is unclear under Indian law, and banks fear that in the event of a borrower'sinsolvency, they will enjoy no prior claim over other creditors.

Under India's present warehousing system, risks are minimised by the reputation of the warehousing companyitself and of the organisation that stands behind the company. In the case of CWC this is the Government ofIndia; in the case of the inspection company SGS India, it is the parent company in Geneva and the quality ofits professional indemnity cover. This greatly restricts the number of companies that can act as warehouseoperators, and the locations where such services are offered.

The situation contrasts with the case of transport receipts. These are issued by transport service providers thatare registered with the Indian Banks' Association, and are documents of title. Moreover when you endorserailway receipts no sales tax is paid.

Another complaint is that "negotiable" warehouses receipts such as those issued by CWC and SWCs are not infact negotiable. They may be endorsed by a depositor to a bank, but subsequent endorsements to secondarypurchasers or other banks never occur. Here it is important to note that different meanings can be attached tothe term "negotiability" (see Box 10). What is significant however is that further endorsements are preventedby 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 thewarehouse operator to the bank, without even having to be endorsed by the depositor. There is one less link inthe 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'scertificate (i.e., a warehouse receipt) is a document of title to goods. This makes it similar in content andsubstance to bills of lading, railway receipts, multi-modal transport documents such as those issued by theContainer Corporation of India, and dock warrants. Warehouse receipts are however accepted by banks as adocuments of title when presented by an owner in whose name the receipt was issued, and if the issuingwarehousing company is reputable and known. However while the endorsee whose name is affixed in awarehouse 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 warehousereceipts are non-negotiable in the first and narrower of the two definitions provided in Box 10. This provides aclear case for legal reform with a view to putting warehouse receipts on a par with readily acceptable negotiableinstruments. Moreover, if it is unambiguously specified in law that warehouse receipts are negotiableinstruments, 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 (pages25-27, 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 inthe underlying property, free of any outstanding claims". Warehousing laws should therefore be framed toempower 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 byendorsement. Law should make this practice possible, but as the warehouse receipts are paper documents itshould 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 theorder of a refinancing financial institution; (c) a purchaser can ask the warehouse to issue a new warehousereceipt while cancelling the old one, obviating the need for multiple endorsements. Notwithstanding, if India cancreate a system by which warehouse receipts are freely transferred between holders, it will reduce transactionscosts and increase usage.

The creation of a secure central electronic registry offers a way round this limitation. Warehouse receipts can besuccessively 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 warehousereceipts "negotiable". However, in our view these problems relate only partly to legal shortcomings, but deriveto a large extent from the fear of fraud and to the uncertain quality of the fiduciary contract between theparties involved.

It would therefore be naïve to expect a mere enabling provision in the law, say, through a warehouse receiptstatute, to solve all the above-mentioned problems. As indicated by Justice S.M. Jhunjhunwala (1999) whenreferring to the Negotiable Instruments Act of 1881, holding an instrument to be negotiable is not the same asthe 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 toaccept the document as such.

For this reason, a strong case can be made for a regulatory framework that sets standards for companiesissuing warehouse receipts, licences them and provides for their regular supervision. This would favour theirincreasing use by depositors and lenders, as well as the creation of new warehousing companies that couldinvest 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 warehousereceipt bill was written in 1978 at the initiative of the Banking Laws Committee, but does not meet all therequirements (see Box 11).

BOX 11: COMMENTS ON THE DRAFT WAREHOUSE RECEIPTS BILL OF 1978

The bill provides for a multiplicity of appropriate regulatory authorities within India though no warehousewould be regulated by more than one regulatory authority. However, there is a risk that it could lead tovariable standards, diminishing the acceptability of warehouse receipts of particular States at a nationallevel. Such problems are not unknown in the USA where States create their own agricultural warehousingadministration mirroring that of USDA. We are doubtful of the wisdom of creating multiple regulatoryauthorities, but if it is decided to do so we would strongly recommend doing it by commodity groups, e.g.,corresponding to the categories shown in Box 10 (below), but definitely not by State.

The bill does not provide for the certification of warehouses wherein the due process is both transparent

and strictly enforceable.

The bill does not attempt to create a suitable system for uniformity in the issuance of warehouse receipts,

again undermining acceptability on a national basis.

The bill does not impose a strict code for insurance; it makes it optional.

The bill does not support efforts aimed at supply management through national record keeping and

information dissemination.

Even though the draft bill was written by the Banking Laws Committee, the credit risk faced by lenders

and the due process for mitigating credit risk and providing recourse in the event of default by a borrower

have not been dealt with by the provisional sections.

The draft bill was written in an era when computers and information technology were not as developed as

they are now. The draft bill assumes the dominant use of paper and addresses several issues relating to

loss and mutilation of paper receipts.

Here it is worth noting that an international bank recently established in India indicated that there was a needfor a listing of "recognised players" in the warehousing industry, while another asked for a thorough vetting ofwarehouse operators. Meanwhile, the Indian Banks' Association stated that there was a need for clarity as towhich warehouses could be honoured by banks.

Experience in other countries such as USA, Canada, Philippines and Colombia suggests that the number ofcompanies and/or sites operated by these companies can be greatly increased if there are suitablearrangements for regulating and accrediting them, and for underwriting their performance. Largely as aconsequence of the passing of the Uniform Warehouse Receipts Act in 1916, the United States has about11,000 licensed grain handling companies authorised to issue warehouse receipts, and more in othercommodity sectors. Any farmer can take his grain to a local silo store and obtain a warehouse receipt. The morerigorous and thorough the system of oversight, the larger the number of operators who can be made credible todepositors and banks alike. Given local factors, India will probably require a more rigorous system than in thedeveloped country cases indicated.

Electronic Warehouse Receipts

The last point to be made is that warehouse receipt systems, if engineered in the present, could makesignificant 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 thesecurities market by using electronic record keeping and communication systems. We therefore recommend theusage of modern communications and record-keeping technologies in the context of warehousing andwarehouse receipts.

In this way it is possible to create a system whereby warehouse receipts are readily transferred betweensuccessive holders free of any outstanding claims (the broader definition of "negotiability" in Box 10), an aimwhich is unlikely to be achieved with paper-based systems. Such a system would enhance confidence inwarehouse receipts and make it easier much to borrow against them. Lenders could be registered with thecentral registry and be provided with online access to verify as well as report their lending information.

Electronic systems could bring various other advantages:

They would facilitate the development of spot markets in goods held in warehouses

They could be used to certify the existence and grade of stocks offered for sale and eliminate risks ofnon-performance by sellers

Electronic auction systems may be created by which stocks can be offered for spot sale in warehouse

They could be used for effecting deliveries upon expiry of futures contracts. Delivery procedures could besimplified, with netting across exchanges where the same commodity is traded.

They could be used to generate public information on aggregate stock holding of commodities, aidingdecision-making by Government and private parties

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 guaranteethe 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:

Government, including Ministries of Consumer Affairs, Finance, Agriculture and Commerce

Banks and financial institutions, including the RBI, state-owned, private, co-operative and internationalbanks

CWC and SWCs

Inspection companies

Commodity exchanges

One inspection company expressed reservation on the grounds that the use of warehouse receipts transferableby endorsement would invite forgery, and that the legal system did not lend itself to speedy prosecution ofoffenders. As indicated in the last section, such difficulties could be addressed by instituting a strong regulatoryregime 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 canaccomplish the following:

regulate warehouses without fear or favoura.

provide a foolproof means of tracking ownership and liens on stocks, without the disclosure of confidentialinformation

b.

Chapter 9

Co-operative Credit Institutions and Rural Banks

The availability of solvent, responsive and accessible credit institutions is a principal requirement for the successof a warehouse receipt system. Unlike some developing economies that are characterised by inadequacies in thesystem 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 (seeTable 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).

Table 24

Banking Network in India

Scheduled Commercial Banks 106

Metropolitan Branches 8144

Urban Branches 9645

Semi-Urban Branches 12283

Rural Branches 20571

Total Scheduled Commercial Bank Branches 50643

Regional Rural Banks 196

Metropolitan Branches 7

Urban Branches 326

Semi-Urban Branches 1857

Rural Branches 12285

Total RRB branches 14475

State Co-operative Banks 28

Branches 789

District Central Co-operative Banks 367

Branches 12128

Primary Agriculture Co-operative Societies 92,000

Urban Banks 1,811

State Co-operative Land Development Banks 19

Branches 1154

Primary Co-operative Land Development Banks 745

Branches 686

Source: Task Force on Supportive Policy and Regulatory Framework formicroFinance

The Indian co-operative system is the largest in the world. Co-operative and rural credit institutions deliver asignificant magnitude of credit to the agriculture produce sector. Co-operatives account for 45 percent share inthe rural credit for agriculture; they attract 31 percent of rural savings. The rural credit structure in Indiaserves around 120 million rural households in about 0.7 million villages through its 92,000 primary agriculturalcredit 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 ruralcredit institutions. This has indeed played a catalytic role in lubricating the process of farm productivity andproduction. 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 haveprogressively shifted to institutional or organised sources of credit.

Table 25

Credit Sources to Rural Households

Credit source Percentage

Government 6.1

Co-operative Societies 21.6

Commercial Banks & RRBs 33.7

Insurance 0.3

Provident Fund 0.7

Other Institutional Sources 1.6

All Institutional Agencies 64.0

Landlord 4.0

Agricultural Money-lenders 7.0

Professional Money-lenders 10.5

Relatives & Friends 5.5

Others 9.0

All Non-institutional Agencies 36.0

All Agencies 100.0

Source: Debt & Investment Survey, Government of India, 1992

Co-operative banks and regional rural banks have a greater geographic spread and are the most importantsource 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 theirrole to cater to households that fall in the lower asset classes requires an institutional framework that is capableof easy but reliable access to a very large population. Hence, any system of warehouse receipts should reckonwith this principal design requirement.

Table 26

Share of Debt by Different Asset Holding Classes

Household Assets Institutional Source (%)

(Rs. '000)

Less than 5 42

5-10 47

10-20 44

20-30 68

30-50 55

50-70 53

70-100 61

100-150 61

150-250 68

250 & above 81

All Classes 66

Source: Debt & Investment Survey, Government of India, 1992

Though co-operative credit institutions play a critical role in delivering credit, most of them are in poor financialhealth. 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 effectivefrom March 31, 1998. If the co-operative credit institutions are nursed back to health, they can be very usefulvehicles 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.

BOX 12: MAIN CONCLUSIONS

1. Warehouse receipts exist and are feasible

2. There is scope for massive expansion in their use, with correspondingly largebenefits, deriving from:

increased liquidity in rural areaslower costs of financingshorter and more efficient supply chains

enhanced rewards for grading and quality

development of other productivity-enhancing agricultural services,related to warehouse receiptsbetter price-risk management

3. All this will result in higher returns to farmers, better service to consumers(involving lower prices, better quality and greater variety), and macro-economic benefits through a more healthy trade balance in agriculturalcommodities.

4. There are major obstacles to capturing benefits, including:

aspects of the policy and legal frameworks

lack of warehouse operators enjoying the fiduciary trust ofdepositors and banks. If banks wish to finance against warehousereceipts, they are either limited to sites operated by the smallnumber of existing operators whom they trust, or they must incurhigh costs in screening out suitable operators

5. Overcoming these constraints requires action in the following areas: (a) policyand legal reform (notably re sales taxation); (b) creation of a regulatoryframework; (c) institution of electronic warehouse receipt systems with centralregistry. Simultaneous action in all these areas is a necessary condition forthe "organised" warehouse receipt system to succeed. If one only eliminatespart of them there is a danger that the efforts will fail, and that one will arriveat the erroneous conclusion that instrument is inappropriate for India.

6. Existing Government warehousing companies should play a leading role in thedevelopment of warehousing. However, they can only cover part of the field,which should be opened up to private operators, particularly those who alreadyprovide storage services. Moreover, divestment should be pursued with a viewto increasing their private sector orientation and autonomy.

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.

Government of India will foster the development of a national warehousing and warehouse receiptssystem for agricultural commodities, as a major part of its policy of ensuring that Indian agriculture isglobally competitive on the international stage, while enhancing rural welfare and food security.

1.

The aim is to greatly expand the physical availability of warehousing services, while making warehousereceipts a prime tool of trade and trade financing throughout the country. It will allow banks to improvethe quality of their lending portfolio, and enhance their interest in the agricultural sector.

2.

This will be accomplished by: (a) creating a really secure system, where warehouse operators areaccredited before the banks and the public in general, and where investors can build warehouses in theknowledge that they can gain accreditation providing they meet exacting official standards; (b)eliminating all policy and legal constraints to the use of warehouse receipts.

3.

Warehouse operators will belong to both the public and private sectors, and particular importance will beattached to the development of the private warehousing industry. Government of India and StateGovernment holdings will be divested with a view to further enhancing managerial autonomy, but retaintheir fundamental mandate of providing warehousing services as long, as there is demand for the serviceand it commercially viable.

4.

All licensed warehouses will be expected to perform to minimum professional standards in order toprovide confidence to depositors, lenders and the public in general. They will be encouraged to developtheir own code of conduct and self-regulate as far as possible.

5.

A warehousing law will be enacted, and a formal regulatory authority instituted to enforce standards andprotect the interest of those holding warehouse receipts against negligence, malpractice or fraud. Theregulatory authority will be structured in such a way as to ensure its complete autonomy and freedomfrom political interference.

6.

Up-to-date information technology will be used to develop a secure system of warehouse receipts wherebyownership and liens can be unambiguously defined, facilitating their rapid transfer between holders.

7.

As system of quality certification and grading of commodities will be established, with a view tominimising disputes and permitting cost savings through the commingling of stocks of different owners.

8.

Government will institute a Task Force responsible for designing and implementing the system. It will berepresentative of the different stakeholders, including those with practical experience of trading in thecommodities concerned and financing of trade.

9.

On the basis of the recommendations of the Task Force, Government will act promptly to remove anyconstraints in the form of restrictive legal codes, taxes or duties that seriously discourage firms frommaking use of warehouse receipts. Such prompt action will pertain to the designated priority commodities– including oilseeds, pulses, coffee, gur and cotton (see Box 13). The policy of non-intervention in thetrade in these commodities will be enshrined in law, except under emergency situations approved by votein Parliament, with a view to reducing the likelihood of ad hoc interventions which upset private tradecalculations and undermine collateral values.

10.

Once all the above conditions have been fulfilled, the system will be implemented stepwise, focusing onthe priority commodities, and the target date for formal commencement is June 2003. Varying approacheswill be adopted taking account of the specific circumstances of each commodity system (see discussion inthe next subsection).

11.

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 andStates Governments is relatively minor, including oilseeds, pulses, coffee, cotton and gur. However, the systemshould also target food grains, including wheat and rice, since in many areas they follow the same tradechannels as oilseeds and pulses, and it would not make sense to deny customers a storage service. This isalready the case in Madhya Pradesh where traders and farmers use warehousing services of CFC and the SWCfor wheat, along with pulses and oilseeds. On this basis the following commodities are suitable for warehousereceipt systems, with priority commodities being shown in bold.

Grains, oilseeds and pulses

Coffee

Gur

Cotton

Commodities in cold storage

Others, where stakeholders approve, and policy framework permits

Given the different handling and grading requirements, and problems of computability and taint, operatorscannot be expected to competently handle all types of product, or even all types of agricultural product. For thisreason, the licensing procedure needs to define which commodities an operator is entitled to handle under thelaw. The system should be built up stepwise, starting with licensing companies serving priority sub-sectors, butrequiring them to handle all other commodities to the same standard. Other agricultural sub-sectors should beprogressively added to the list, as well as cold stores facilities. This is very important in view of Government’splans 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 pursuedsimultaneously. Banks and insurance companies are significant shareholders of Government-ownedwarehousing 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 empowerthem to act as credit delivery channels. Banks would exercise due diligence while adopting such warehousingcompanies and sites. Alternative 2 may also be implemented by commodity exchanges, such as the cotton andcoffee exchanges, acting on behalf of their members.

Alternative 3 is more closely related to the extant structure Governing trade relationships than the first two. Tofully develop the system, it is vital to formalise these warehousing services, but the approach should becautious 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 inborrowers' 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 doesnot 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 alsoacts 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, theAgricultural Trading Company (ATC). This is a vehicle by which a rural trader or commission agent might expandto become an agricultural merchant of the kind described in Chapter 2. Along with other categories ofbusinesses 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 partof the country outside of the mandi structure. In return it will be publicly accountable as to the ethical nature ofdealings with farmers. It will have to collect normal levies on behalf of the State Agriculture Produce MarketingCommittees, and accept deposits of grain on a non-discriminatory first-come-first-served basis (similar to theelevator companies in the US and Canada). Such companies should be allowed to trade in their own right, butgiven the potential for conflict of interest between trading and service activities, will need to be strictlyregulated according to a standard code.

Action Plan

Box 15 shows the main components of the action plan, and an indicative timetable.

BOX 15: PROPOSED PHASED ACTION PLAN

Component To be done by Target date

1. Promulgate the strategy Government ofIndia

November 2000

2. Institute Task Force (TF) Government ofIndia

December 2000

3. Commodity systems studies,comparing situation in Indiawith practice elsewhere

TF June 2001

4. Eliminate policy constraints Government ofIndia, based onTFrecommendations

December 2002

5. Draft and enact nationalwarehousing law

TF andGovernment ofIndia

June 2002

6. Develop and institute theregulatory framework

TF, Regulatoryauthority

December 2002

7. Develop and institute electronicwarehouse receipt system andcentral registry

TF, Softwarecompanies,Electronicregistry

March 2003

8. Develop and institutestandardised system of gradesand quality certification,enforcement and disputesettlement

TF, BIS, Ministryof Agriculture

March 2003

9. Formal start to implementation

TF, Regulatoryauthority,Electronicregistry,Warehouseoperators

June 2003

10. Progressive divestment ofGovernment holdings in CWCand SWCs

Government ofIndia

December 2006

11. Periodic monitoring andevaluation as implementation

Government ofIndia;

December 2008

proceeds consultants

This list is not strictly chronological, and several components must be carried out simultaneously. Importantlinkages are as shown in Figure 1. Various components are discussed in more detail in the followingsub-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 leavingthe 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, unambiguouslycommitted to the development of a strong warehousing industry. Specialists in finance and crop storage, andresearchers 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 todeveloping momentum.

BOX 16: SUGGESTED APPROACH TO TASK FORCE

1. Form task force comprising:

Ministry of Law, and Ministry of Information TechnologyMinistry of Agriculture, and Ministry of Consumer Affairs and Public DistributionReserve Bank of India, and Ministry of FinanceNABARDCo-opted members from private producers and trade in commodities, insurance, warehouse operators

2. Secretariat answering to task force - staff on contract

3. Task force commissions studies, drafts legal texts, makes detailed recommendations and followsthrough 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 existingcommodity chains for the targeted commodities. A start has been made under this consultancy, but in such avast and complex country, there will be a need for exhaustive studies. As indicated by Mr Sivakumar of ITC, atthe FMC Conference on warehouse receipts in June 1999, it is only when the structure, strengths andweaknesses 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, andwho between them bring together agricultural economics training, and strong technical and marketingknowledge 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 madeuse of in India. This should start with desk-research, and be followed by visits to two or three key countries. TheUnited 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 withcommodity exchanges to offer various selling alternatives to the farmer, and the regulatory regime which hasbeen developed to oversee them. The Philippines experience is valuable because it has successfully developedan oversight system for rice, in a country where most production comes from small farmers. There should beinitial visits to these countries (say one week per country), and where appropriate this should be followed up byone 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 strongwarehousing systems of the non-trading General Warehousing type, and where these have gone further inservicing private sector clients. Argentina, Hungary and Kenya are suggested. The first two have formalregulatory 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 importantaspect to change and work on this should start immediately, via two routes: (a) legislation specifying that thesimple delivery of a warehouse receipt for stored goods does not constitute a sale, and; (b) reduction andsimplification 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:

Fully legitimise warehousing by private companies, on an equal basis to public sector providers.

Define products to be covered. We recommend it cover all storable agricultural and food commodities.

Define the services to be covered. Should it only cover public warehouses? Public warehouses are thosethat open for deposits by the public in general. Should it also extend to companies providing exclusivecollateral management services to specific customers? Should it include custom-bonded warehousing?

Define operators authorised to issue warehouse receipts (all those who wish to or only licensedoperators?) and the qualifications they require

Specify the regulatory authority, which licenses, accredits, inspects and/or closes down public warehouses– or alternatively specify how such authority will be selected

Define process for fixing fees, inspection and reporting arrangements

Ensure that warehouse receipts convey good title to goods, and provide for their transfer free fromoutstanding claims

Enhance the security interests of those lending against warehouse receipts

Provide for the creation of new categories of trading company entitled to issue warehouse receipts (e.g.,ATCs)

The facility to issue warehouse receipts might be granted to all companies and even individuals, or only tolicensed operators. In the former case the overseeing authority simply acts as an accreditation agency, and theseverest 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 thisregard, NRI has reviewed the experiences of several countries that have enacted warehousing laws over the lastcentury, and the evidence is incontrovertible – certain countries which have established strong authorities havereaped 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:

A department of a line Government ministry

An autonomous "regulator" along the lines recently chosen for the Indian electricity industry

RBI

FMCA company or association formed primarily by banks and financial institutions

A company formed by one of the existing stock exchanges or clearing house

Any combination of the above

The primary consideration in determining institutional location is the confidence it provides to lenders – after allit is their funds that will be at risk in the warehouses. This provides a strong rationale for putting the authorityunder the banks and financial institutions, or bodies such as stock exchanges and clearing houses where banksown most of the equity. The warm reaction of representatives of RBI, IBA and the NSE reinforces the view thatthis is probably the best route. The National Association of Warehousing Corporations might also contribute toestablishing the regulatory body.

The other important consideration is the need to ensure that the day to day operation of the authority isinsulated from political processes. This can affect working practice, and give rise to fears that in the event of acrisis Government may more easily requisition stocks – however far-fetched such fears may be, they can affectconfidence 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 incidenceof malpractice such as could undermine their credibility. A combination of measures can be considered:

A licensing procedure involving satisfaction of criteria as to technical competence, net worth, commercialand banking references, and performance guarantees

Developing a secure electronic system of warehouse receipts and central registry, backed up wherenecessary with paper documentation. In the latter case warehouse receipts should be central printed withserial numbering and other forms of identification

Unannounced inspections by examiners working for the authority, which in the event of non-performancewill have the authority to close or take control of a particular warehouse.

Mandatory insurance cover against: (a) "all risks" and; (b) non-performance by the warehouse operatorand staff.

With regard to the last item, companies may be required to purchase a bond a deposit it with the authority, orsubscribe to a contributory indemnity fund constituted for this purpose by the members of a given group ofwarehouses. The indemnity fund would seem eminently desirable in the case of the coffee industry, given thatthere is a relatively coherent group of warehouses belonging to the All India Association of Coffee Curers. Insome cases regulatory functions might also be delegated from the statutory authority to an industry body - inthe case of coffee, this might be COFEI or the Association of Coffee Curers. Once the Task Force has outlinedthe characteristics of the proposed system in its early stages, it will need to develop a business plan for theauthority, specifying the form of association, expected revenues and costs, and the initial investment to besubscribed 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 receiptsystem and central registry. This would enable ensure system efficiency and integrity. There is little doubt thatthe Indian software industry can develop the necessary technology, but it will first be first be necessary tothoroughly review of existing and related systems developed for warehousing by warehousing companies,regulatory authorities and commodity exchanges, electronic trade documentation (e.g., BOLERO) and stockexchanges. Suitable institutional investors with a stake in the success of the warehouse receipt system candoubtless be found among the financial community.

The company (or companies) operating the central registry (or registries) will need to be licensed by theregulatory authority, and assuming it is a monopoly (or near-monopoly) provider, its fee structures will also besubject 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 ofcommodities that are identity-preserved (IP), it will need at the very least to certify moisture content and thatthe goods are fit for storage. Depending on trade requirements certification may be needed for otherparameters such as dockage, grain size, foreign matter and gluten content. It should not be presumed thatgrades are needed for all commodities, since those with highly variable characteristics such as tea and cocoa aretypically stored on an IP basis.

Commodities with relatively homogeneous characteristics generally need to be commingled by grade, with aview to increasing efficiency in the use of storage space, and reducing transaction costs. Indeed a good systemof grading allows commodities to be traded by specification, without it being necessary to take samples. TheTask Force and sectoral interests involved will need to assess the feasibility and desirability of moving from IP tocommingling by grade, on a commodity by commodity basis. Account should be taken of official gradesdeveloped by the BIS. These may sometimes be suitable for the trade to adopt, but in other cases it willprobably need to develop new grades more closely aligned with commercial practice. Once these have beenpiloted and reviewed by BIS, they might then be officially adopted.

Who is to certify quality and grades? In the case of goods passing through the ports, inspection companies andspecialised laboratories are already carrying out this role. Futures exchanges have made similar arrangementsfor certification of lots offered for delivery. However such services would prove totally uneconomic where smalldeposits are made in public warehouses in up-country locations. In order to develop a low cost publicwarehousing system with a large number of storage points, warehouse companies need to do their own qualitycertification. They must employ graders who are professionally qualified and licensed to perform the task. Some

sort of performance guarantee will be required (see next sub-section), as well as arbitration arrangements toquickly settle quality disputes.

Component 11: Monitoring and Evaluation

We recommend periodic monitoring and evaluation of implementation by independent consultants with amixture of local knowledge and international experience.

Other Activities Required

In addition to the components listed, the commodity exchanges will need to institute their own networks ofapproved warehouses, and institute strict procedures for reporting and monitoring of stocks to be tendered fordelivery. This is discussed in the report to the FMC on monitoring and surveillance (Burr and Anjaria, 2000).

REFERENCES

Anon (1997) India, the Indian Oilseed Complex: Capturing Market Opportunities. World Bank reportNo.15677-IN

Anon (1999a) India, Foodgrain Marketing Policies: Reforming to Meet Food Security Needs. World Bank reportNo.18329-IN

Anon (1999b) India, Cotton and Textile Industries. World Bank report No.18857-IN

Burr, A.W. and Anjaria, D.C. (2000) Market Surveillance and Monitoring. Interim Report to the Forward MarketsCommission.

Coulter, J.P. and Shepherd, A.W. (1995) Inventory Credit; an Approach to Developing Agricultural Markets. FAOAgricultural Services Bulletin No 120. 105pp

Coulter, J.P., Leão de Sousa, E., Martines, J. (1998) Brazilian Experience with Grain Warehousing Services and

Associated Marketing Tools. Report commissioned by the DFID Crop Post-Harvest Research Programme.

Ellis, F., Trotter, B and McGrath, P. (1992) Report on the rice marketing system in Indonesia. NRI MarketingBulletin No. 4.

Jhunjhunwala, S.M. (1999) Warehouse Receipts – Negotiability and Tradability, in: Proceedings of workshop on

"Commodity Financing and Building a Warehouse Receipts System for India", jointly organised by FMC, UNCTADand Select Committee on Commodity Futures Exchanges.

Lacroix, R. and Varangis, P (1996) Using Warehouse Receipts in Developing and Transition Economies. Reportcommissioned by the World Bank.

Sivakumar, S. (1999) Financing Systems in the Indian Oilseeds Sector and Suggestions for Improvement, in:Proceedings of workshop on "Commodity Financing and Building a Warehouse Receipts System for India", jointlyorganised by FMC, UNCTAD and Select Committee on Commodity Futures Exchanges.

Appendix 1

Objectives and Outline of Tasks

The objectives of the assignment and an outline of the tasks are listed below.

1 (1) Economic feasibility of the warehouse receipt system in

commodities markets with special reference to edible oilseeds, oilsand oil cakes, cotton, gur

(2) Promotion of warehouse receipt system in the commodities markets

(3) Detailed and phased action plan for implementation of the

warehouse receipt system

2 (1) To study present system of storage, testing, quality certification,etc. in Indian commodity futures markets and critically comment onthe same

(2) To assess, for the selected commodities, the current performance of

the warehousing industry, differentiating between private andpublic warehouses, and identify the constraints that stand in theway of improved performance

(3) To make recommendations regarding warehouse receipt system for

Indian commodities markets keeping in view the present scenariowhere the warehousing facility available is being used for limitedcommercial purposes. The suggestion may, inter alia, should coverseveral areas such as:

(a) Based on lessons of international experience and best

international practices, and the in-depth review andassessment of the Indian situation, develop a set ofrecommendations on the most appropriate role of theGovernment to promote the efficient and sustainabledevelopment of the warehouse industry and warehousereceipt system, including the potential role and contributionof public warehouses. The set of recommendations wouldinvolve a detailed legal, regulatory and policy strategy,action plan and measures for promoting the warehouseindustry and warehouse receipt systems, for improving thequality and supply of competitive storage services, inspectionand certification, ensuring safety of goods stored, insuranceof goods, issue of warehouse receipts, and theirtransferability.

(b) Steps needed for promoting common warehousing facility

using the available public and private warehouses.

(c) The suggestions regarding testing and certification of goods

kept in public and private warehouses.

(4) Suggest guidelines for setting up of public warehouses, ownership,

storage, quality, inspection and certification, ensuring safety ofgoods stored, insurance of goods, issue of warehouse receipts,transferability of warehouse receipt.

(Public warehousing refers to the warehousing facilities created andmaintained by the government or government owned agencies -these are primarily for storage on government account but mayalso be made available to private parties on payment basis subject

to availability. Private warehousing refers to warehousing facilitiescreated and maintained by private entrepreneurs and available toany user on payment basis.)

(5) Framework for exchange level regulation for promoting and

supporting the warehouse receipt system in respect of performanceof commodity futures contracts

(6) Steps needed for improving acceptability of and for promoting

warehouse receipts for financing of the commodity trade by banks

(7) To conduct a one-day workshop to cover necessity and importance

of warehouse receipts and proposed action plan. Participants:officials of Government, Forward Markets Commission, selectedcommodity exchanges, public and private warehousing industry,traders, agriculture produce processors, commodity associations,and banks and financial institutions

Appendix 2

List of Persons Interviewed

Name Position Organisation

D Rajagopalan Chairman Agricultural and Processed Food ProductsExport Development Authority

K E S C Prasad GeneralManager

Andhra Pradesh State Civil SuppliesCorporation

Sabbir Hussain ManagingDirector

Assam State Warehousing Corporation

P D Patodia ManagingDirector

ATL Textiles

R Bhaskaran Joint Director Bankers Institute of Rural Development

Om Prakash Garg Chairman Bhatinda Om & Oil Exchange

A K Biswas ManagingDirector

Bihar State Food & Civil Supplies Corporation

S Govindan Senior Manager BNP Group (Trade Finance & Commodities)

S M Jhunjhunwala Former Judge Bombay High Court

NavinchandraShah

President Bombay Oilseeds & Oils Exchange

Kushal Thaker Director Bombay Oilseeds & Oils Exchange

G Sathyamoorthy Secretary Bombay Oilseeds & Oils Exchange

Anuj Kumar Director Bureau of Indian Standards

D Mukhopadhayay Director Bureau of Indian Standards

Hardeep Singh ManagingDirector

Cargill India

Sanjeev Asthana BusinessManager

Cargill India

Sunil Khairnar Merchant -Meal

Cargill India

Mohit Purbey ProcurementManager

Cargill India

N K Choubey ManagingDirector

Central Warehousing Corporation

Virendra Singh Director Central Warehousing Corporation

Subhash C Batra Secretary Central Warehousing Corporation

C T Thomas RegionalManager

Central Warehousing Corporation

Puran Singh WarehouseManager

Central Warehousing Corporation

Pankaj K Agarwal Director Chamber of Commerce, Hapur

Mahipal Singh Secretary Chamber of Commerce, Hapur

Ashwin Shah Chairman Coffee Futures Exchange India

P M Narayan Bhat BusinessManager

Coffee Futures Exchange India

Abhijit Sen Chairman Commission for Agricultural Costs and Prices,Ministry of Agriculture and Co-operation,Government of India

Rakesh Bhatnagar GeneralManager

Delhi State Civil Supplies Corporation

J N L Srivastava SpecialSecretary

Department of Agriculture, Ministry ofAgriculture, Government of India

Bhagat Singh AdditionalSecretary

Department of Agriculture, Ministry ofAgriculture, Government of India

C R Hazra AgriculturalCommissioner

Department of Agriculture, Ministry ofAgriculture, Government of India

M K Mandal AgriculturalMarketingAdviser

Department of Agriculture, Ministry ofAgriculture, Government of India

K Srinivasan Secretary Department of Consumer Affairs, Ministry ofConsumer Affairs and Public Distribution,Government of India

Kamal Kishore EconomicAdviser

Department of Consumer Affairs, Ministry ofConsumer Affairs and Public Distribution,Government of India

E A S Sarma Secretary Department of Economic Affairs, Ministry ofFinance, Government of India

J Bhagwati Joint Secretary Department of Economic Affairs, Ministry ofFinance, Government of India

R Parsuram Secretary Department of Food, Government of MadhyaPradesh

Suresh Kotak President East India Cotton Association

K F Jhunjhunwala Vice President East India Cotton Association

Hemant Mulky SecretaryGeneral

East India Cotton Association

P K C Sharma Secretary East India Cotton Association

Tulsidas R Ashar SwornSurveyor

East India Cotton Association

Dhruv Khaitan Chairman Equifax Venture Infotek

Prahlad Mahishi Secretary Department of Food, Civil Supplies andConsumer Affairs, Government of Karnataka

Rajesh Bahl Director GEO-CHEM Laboratories

Bipin V Karnik Manager GEO-CHEM Laboratories

Naveen Chaurasia Manager Glencore India

Adi Godrej Chairman Godrej Soaps

Victor Soares Vice President Godrej Soaps

Chaman Kumar ManagingDirector

Gujarat State Civil Supplies Corporation

R B Sharma Secretary Haryana Warehousing Corporation

Aditya Puri ManagingDirector

HDFC Bank

J H Mehta Vice President Hindustan Lever

Shvetal Vakil GeneralManager

Hindustan Lever

Zarin Daruwala Senior Manager ICICI

Sumon Bhaumik SeniorEconomist

ICRA

R Raghuttama Rao ExecutiveDirector

ICRA Advisory Services

Bandi Ram Prasad ChiefEconomist

Indian Banks' Association

R V Shastri Chairman Indian Overseas Bank

Yatin Wadhwana Chief Executive International Trading Company

S Sivakumar Chief Executive ITC (International Business Division)

B L Sridhar ManagingDirector

Karnataka Food & Civil Supplies Corporation

Ganesh G Hegde Senior DeputyGeneralManager

Karnataka Food & Civil Supplies Corporation

Gururaj Hunsigi Director Karnataka Institute of Applied AgriculturalResearch

K Amaranarayan ManagingDirector

Karnataka State Warehousing Corporation

J Krishna Raju Manager Karnataka State Warehousing Corporation

K G Ramachandran ManagingDirector

Kerala State Warehousing Corporation

C H Mirani Chairman KV Cotton Ginning and Pressing

Raghav Chandra ManagingDirector

Madhya Pradesh Civil Supplies Corporation

Arun Sabharwal Secretary Madhya Pradesh Civil Supplies Corporation

M S Shastri Secretary Madhya Pradesh State WarehousingCorporation

Vilasrao Patil Chairman Maharashtra State Warehousing Corporation

N K Arora Manager Maharashtra State Warehousing Corporation

Shyam Makharia Partner Mahaveer Prasad B. Makharia CottonMerchants

N Ramakrishnan Joint Secretary Ministry of Textiles, Government of India

Rakesh Agrawal ManagingDirector

MP State Co-operative Oilseed Growers'Federation

M V S ChalapathiRao

ExecutiveDirector

National Bank for Agriculture and RuralDevelopment

N Raghavan ExecutiveDirector

National Bank for Agriculture and RuralDevelopment

M V S SRamasarma

Manager National Dairy Development Board

G G Shah SeniorExecutive

National Dairy Development Board

R H Patil ManagingDirector

National Stock Exchange

R Mansingh Manager Nestle India

Niranjan Padhi ManagingDirector

Orissa State Warehousing Corporation

Davish Jain ManagingDirector

Prestige Group

Hans Hannaart ManagingDirector

Rabo India

Rajesh KSrivastava

AssociateDirector, Food& Agribusiness

Rabo India

Prashant Joshi Manager, Food& Agribusiness

Rabo India

Puneet S Kochar Manager, Food& Agribusiness

Rabo India

Jai Saxena Associate, Food& Agribusiness

Rabo India

Preeti Sinha Manager,StrategicAdvisory

Rabo India

Vineet Bhatnagar Chief Executive Refco India

Chirag Shah Manager Refco India

Khizer Ahmed ExecutiveDirector

Reserve Bank of India

Awesh Jain Manager Ruchi Soya Industries

Arun Deshpande Division Head SGS India (Agriculture Division)

Uday M Karnik DivisionManager

SGS India (Agriculture Division)

B R Gurumurthy MarketingConsultant

SGS India (Agriculture Division)

Sudhir Kumar ManagingDirector

Small Farmers' Agri-Business Consortium

Sandra Martyres ManagingDirector

Societe Generale

Sandeep Bhamrah SeniorExecutive

Societe Generale

A S Jeyakumar ExecutiveDirector

SOPA Board of Trade

P R Subramanian Secretary Southern India Mills' Association

D R Kalra ExecutiveDirector

Soybean Processors Association of India

G P Saxena Director Soybean Processors Association of India

B RamachandraRao

Chief GeneralManager

State Bank of India

M Ravindranath Credit Officer State Bank of India

R Raghavan AssistantGeneral

Tamil Nadu Warehousing Corporation

Manager

S K Sekhar AssistantGeneralManager

Tamil Nadu Warehousing Corporation

Prasanna Kumar Senior Manager Tamil Nadu Warehousing Corporation

Sandhya D'Mello CommoditiesCorrespondent

The Economic Times

G Chandrashekhar CommoditiesEditor

The Hindu Business Line

C M Singh ManagingDirector

UP State Warehousing Corporation

P S Tripathi Secretary UP State Warehousing Corporation

Manohar Lal R.Kalra

Chairman Vijai Beopar Chamber

Names of respondents to the questionnaire survey are not included in the list given above. However, the viewsexpressed by persons who were interviewed are consistent with the principal findings of the questionnairesurvey.

Appendix 3

Commodity Analysis: Cotton

Introduction

India has the world's largest acreage under cotton, but due to low yields is only the third largest producer,producing some eight million tons of ginned cotton (lint) per annum. India's share in global output is currently17 percent, but would rise to over 26 percent if it merely achieved the global average yield. Cotton researchersat EICA trace the low yields to (1) the unwieldy number of varieties (more than 80) including numerous hybridsand (2) the inadequate availability of credit at reasonable cost.

The textile industry is a major component of India's economy accounting for about one fifth of total industrialoutput in 1994-95 and about 7 percent of GDP. It has enjoyed impressive growth in recent years as controls onexternal and internal trade have been relaxed, there being an average 3.9 percent per annum rise in cottonoutput over the decade to 1996, and a 13 percent increase in cotton-textile exports over the five years to1995-96. In the latter year these were valued at nearly $6 billion and represented 20 percent of India'smerchandise exports (Anon, 1999b).

Aided by the phase-out of the Multi-Fibre Agreement, there are good prospects for continued growth, but theindustry remains hampered by low yields, poor quality and consistency and a slow pace of investment. There isa broad spectrum of production techniques, and a few internationally competitive firms coexist with a largenumber of inefficient ones. The World Bank report on the sector (Anon, 1999b) makes the point that "if thesector is to remain competitive now that cotton fibre imports have been completely liberalised, efforts to raiseproductivity, reduce costs and upgrade cotton quality are imperative".

This section shows how a system of warehouse receipts can contribute to that process.

Primary marketing arrangements including grading and testing

As of 1996, private traders including ginners and textile mills accounted for 77% of marketed Kapas (i.e. seedcotton), Maharashtra State Cotton Co-operative Growers' Federation, which enjoys monopoly procurementrights within Maharashtra, took 11% and the Cotton Corporation of India (CCI), whose market share wasdeclining, had 8%.

Farmers bring kapas to regulated market yards operated by Agriculture Produce Market Committees (APMCs).They make direct sales to other farmers or traders (adatiyas or commission agents), and testing and grading areeffected at the time of purchase or soon thereafter. Adatiyas often provide credit to farmers as well asperforming their trading function.

Adatiyas weigh and pay for the kapas, but the APMCs do not have the necessary testing facilities forascertaining grade and quality. Indeed determining the variety and principal physical properties is generallyregarded as a chore. Some buyers use small hand-ginning equipment to separate lint from seed to examine thephysical priorities of the fibre. Out-turn (ratio of lint to kapas by weight) is obtained through this process, whilestaple length of separated lint is determined by visual inspection. Quality parameters are assessed by buyers,who bear the associated risk, and there are no mechanisms for resolving disputes.

In Karnataka, Adatiyas use simple tests to segregate kapas on the basis of grade and quality. Upon segregation,kapas are presented for inspection and then offered to the highest bidders in sealed-bid auctions.

From the market yards, kapas are taken to the ginning and pressing factories for processing.

Segregation and storage

Buyers (in all states) store kapas in lots segregated on the basis of variety, grade and estimated staple length.The segregation usually involves some sample ginning. Most owners of ginning and pressing factories aretraders, but not all traders are owners of ginning and pressing factories.

Segregated lots of kapas are ginned while maintaining lot identity. The quality of the kapas determines thequality of lint obtained through ginning, so there is an emphasis on obtaining uniformity of staple length,strength, fineness of fibre, colour and cleanliness through proper segregation of the raw material.

Kapas is bought on the basis of variety, place of cultivation, and whether the farm from which the kapasoriginates is rain fed. It is less amenable to commingling than is ginned cotton.

Ginning and pressing factories use kapas from different sources and, if necessary, of different grades to produce'types' that conform to requirements of spinners. Types are adhered to with the objective of maintaining desiredquality and physical properties of fibre.

Ginned cotton is pressed into bales with press marking and serial numbers. Each bale may be further tested byspinning mills and traders using electronic testing machines. A few ginning and pressing factories, regionalcotton associations, East India Cotton Association (EICA) and several spinning mills own electronic testingfacilities.

Cotton yarn is spun from ginned cotton. Cotton yarn is tested using mechanical and electronic testing machinesthat produce reliable results.

The need for and feasibility of implementing a warehousing system for kapas and ginned cotton are discussednext.

Variety reduction and inventory credit

The development of a warehouse receipt system for cotton would have a favourable impact through: (1) varietyreduction, and; (2) the flow of credit from the organised banking sector, based on the marketability of preferredvarieties.

Variety reduction would emerge from the incentives that farmers face in growing cotton with testable physicalcharacteristics and properties of fibre. Physical characteristics and properties of fibre include staple length,micronaire and fibre strength. Descriptive details that focus on physical characteristics and properties of fibrewould obviate the need for usage of names of varieties.

A system of warehouse receipts and warehouse receipt financing would have a favourable impact on the flow ofcredit from the organised banking sector to growers and traders. Circumstances that enable better credit flowswould also have a favourable impact on storage, quality and uniformity.

Cotton is harvested once a year in most of the locales in which cotton is grown. Kapas is picked in three or morerounds in each season. The quality of kapas is not uniform across the rounds. The first two rounds and in somecases the second and the third rounds are associated with the best quality.

Farmers have an incentive to postpone sales of these earlier and better quality rounds of kapas to get betterprices. A system of warehousing and warehouse receipts for kapas would enable growers as well as traders topostpone sale in anticipation of better prices. Moreover, such storage would enable the flow of credit to farmersas well as traders.

Traders and big farmers operate private warehouses for storing kapas, storing on their own account as well forother farmers. Public or common warehouses owned by the Central Warehousing Corporation (CWC) and theState Warehousing Corporations (SWCs) store kapas for the CCI, the state cotton marketing federations andtraders, on an identity-preserved basis.

Storage of kapas is also a necessity for traders. It is a sophisticated activity that focuses on variety, grade, areaof cultivation and the round of picking. Since the picking rounds determine the quality of kapas, it is necessaryto blend kapas from different rounds in a predetermined proportion in order to obtain ginned cotton with thedesired characteristics. Results of ginning are predicated on the quality and uniformity of kapas that is ginned;the sophisticated storage activity needs reflect the relationship between kapas and ginned cotton.

Cotton is also custom-ginned from kapas in order to meet the requirements of spinning mills that producecotton yarn. Custom ginning requires storage of graded kapas. Such storage involves several varieties andgrades of kapas so as to meet requirements of customers.

Yarn derives its characteristics and price from the ginned cotton that is used for spinning. The demand forginned cotton with particular physical characteristics is driven by yarn requirements specified by weaving mills.Ginned cotton has necessarily to be stored in anticipation of orders from spinning mills for delivery of ginnedcotton with particular physical characteristics.

Most owners of ginning and pressing factories are traders, and they possess testing, grading and storagefacilities of high standards. Warehousing of kapas and ginned cotton at the ginning and pressing factoriesobviates the need for multiple handling of produce and eliminates the need to incur costs on unwarrantedtransport. A significant integration of trading, testing and grading, ginning and warehousing activities (for bothkapas and ginned cotton) by business units has been in progress since 1994 when imports of ginned cottonwere permitted under open general licence (OGL). The integration is a response to the new competitive globalenvironment. However, traders of kapas and ginned cotton who do not own ginning and pressing factoriesfrequently use government-owned warehouses.

As noted above, both kapas and ginned cotton are stored in private and Government warehouses, and aretherefore amenable to the issuance of warehouse receipts. Such issuance would have a favourable impact onthe flow of credit, trade in the primary and the processed produce, and downstream manufacturing by spinningmills.

EICA and apt contract specification

The EICA operated a futures contract for ginned cotton from the late 19th Century until 1968, when it wasbanned. Trading was however resumed in December 1998. Hitherto physical trading has been variety-based, butEICA’s new contract incorporates the Indian Cotton Contract (ICC) standard that is not oriented towards anyvariety of cotton. ICC specifies staple length (26mm), fineness (fine cotton), micronaire (3.6mm to 4.2mm) andstrength (not less than 18g per tex). Cotton meeting this standard must be roller ginned.

EICA's specifications enable the identification and description of ginned cotton without having to refer tovarieties and areas from which the produce is brought to market. While such identification and description havebeen in vogue in the cotton industry for more than a decade, the ICC has provided an opportunity for betteracceptance of testing and grading standards that may be applied to any variety of cotton. It does not precludedelivery of cotton with properties that deviate from the specifications, and a system of price premiums anddiscounts is used to enable deliveries.

EICA's delivery rules for ginned cotton do not require delivery through warehouse receipts. However, physicaldelivery may be effected by sellers in their warehouses or such other warehouses in which the seller's cotton isstored, including warehouses located in the cotton growing and ginning regions. Acceptance by buyers is by

sampling. EICA has in place a system of controllers and surveyors to assess quality.

EICA's delivery rules and its system of controllers and surveyors are apt strengths for the implementation ofdelivery rules based on warehouse receipts. Efforts towards implementing a system of warehouse receipts areapace; the EICA is likely to collaborate with the CWC, the SWCs, private warehouses, quality certificationagencies and banks in establishing the necessary protocol for the storage of cotton and the issuance ofwarehouse receipts. The establishment of the system would enable deliveries through warehouse receipts.

The EICA is also planning to list kapas futures contracts, and the delivery rules are likely to be in favour ofwarehouse receipts.

Prospects for warehouse receipts

Since the EICA is the only recognised exchange in India for the listing and trading of cotton futures contractsand since cotton is grown, ginned and pressed, and spun over a vast geography, it should be able to establish anation-wide system for trading and settlement. For this members and customers would welcome an amendmentof the byelaws of EICA which would require delivery through warehouse receipts.

Unlike the gur exchanges, the cotton industry already has well- established scientific testing and gradingprocesses. Both private and government warehouses have significant experience in storing cotton. Banks andother lenders have significant experience in lending against hypothecated stocks as well as against warehousereceipts issued by CWC and SWCs. Lenders, however, want a formal process of certification of warehouses,especially private warehouses, before they can expand this business.

Recommendations related to the cotton technology mission

The Government of India has established a technology mission for the rapid and significant transformation ofthe cotton economy, involving two ministries - agriculture and textiles - and the Indian Council of AgricultureResearch (ICAR). The mission is divided into four mini missions, the objectives of which are given below.

Table 27

Mini Missions Comprising the Cotton Technology Mission

Mini

mission

Scope of mini mission Responsibility

One Variety development

Quality enhancement

Yield improvement

Indian Council ofAgriculture Research

Two Technology transfer

Water management

Availability of seeds

Nutrients management

Seeds certification and distribution

Pest management

Awareness and extension

Ministry ofAgriculture -Department ofagriculture andco-operation

Three Problems related to market yards

Funding for upgrading yards

Ministry of Textiles

Renovation of market yards in states

Four Modernisation of ginning and pressingfactories

Ministry of Textiles

The mission can play a vital role in the implementation of a system for warehouse receipts. Mini mission 1 maybe instrumental in bringing greater uniformity in varieties grown, increasing the prospects for commingling,tradability and homogeneous storage practices. Mini mission 2 may increase the awareness of the warehousereceipt system, and help farmers plan for access of inventory credit. Mini mission 3 can introduce testingpractices in the market yards, reducing downstream costs. Mini mission 4 may help modern storage facilities atthe ginning and pressing factories, and encourage them to store for their suppliers and customers. This wouldlead to a tightening and shortening of the supply chain.

Appendix 4

Commodity Analysis: Soybean, Other Oilseeds and Derivatives

Introduction

For long, the oilseeds complex has been adversely affected by poor yields and inadequate credit flows, and morerecently the free import of edible oils, though not without tariffs, has exerted significant pressure. Warehousereceipts would lower the cost of credit, and have a favourable impact on the competitiveness of the sub-sectorboth as regards domestic and the export markets. The government's technology mission pertinent to oils, whichincludes pulses since oilseeds and pulses are dry land crops, is placed well to promote the usage of warehousereceipts.

As noted in the introduction to this report oilseeds have a weight of 13.8 percent in India's index of agriculturalproduction. The main components are groundnut, rapeseed/mustard, soybean and cottonseed. Soybeans arediscussed in detail since soy meal and soy oil are global commodities, creating considerable pressure formodernisation. Storage and logistics costs, and the availability and cost of credit have an important impact onthe industry's competitiveness. Soybeans have a weight of 2 percent in the index of agricultural production. Wealso discussed in detail other oilseed and derivatives with the BOOE.

The soybean marketing and processing sector

Brief industry background

Commercial cultivation of soybeans in India started in 1968, and has grown rapidly to the point where India isnow the world’s fifth largest producer, behind USA, Brazil, Argentina and China. The total volume of productionwas about 5 million tons in 1998, with 75 percent being produced in Madhya Pradesh. India's share in globalproduction is 3.6 percent.

Soybeans are produced by very small-scale farmers most of whom cultivate less than two hectares and with anaverage of one ton per hectare. Yields are low and have tended to stagnate in recent years. Most growth inproduction has come from area expansion. The main explanations advanced are as follows: only 10% of seedused by farmers is certified, and they have little access to crop insurance.

Soybeans are processed by solvent extraction in over 60 plants, most of them having capacity of between 300to 500 tons soybeans per day and the largest 1,500 tons. There is considerable excess capacity, with throughputof 5 million tons per annum being less than half of installed capacity at 11.5 million tons. Consequently someleading processors have opted not to build their own plants but for renting or leasing existing plants.

The yield in oil is around 18 percent or 0.94 million tons per annum based on current production. The yield inmeal is around 81 percent or 4.26 million tons per annum. The oil is sold in the domestic market for use inmargarine, vanaspati and other products, and is frequently blended with imported palmolein and other oils.Total Indian consumption of edible vegetable oil is now about 8 million tons of which 4 million tons is imported(mainly as palmolein from Malaysia).

Soybean meal goes for feed use. Due to India’s relatively low per capita consumption of animal protein, little

more than 1 million tons can be absorbed domestically, while around 3 million tons are exported, mainly toSoutheast Asia. Handling from the factory is in bags, but it is poured into the ship’s hold on export. The need toexport and thereby incur considerable transport and handling costs – over US$10 per ton between factory andimporting destination – places India at a disadvantage with what is an inherently low value commodity (inOctober 1999, its price was around US$167 per ton at destination). Costs are raised by about US$2.5 bylogistical inefficiencies, primarily higher ocean freight charges due to low turnaround time of ships at Indianports, where the average load rate is only 1,500 ton per day. Bulk handling has yet to be introduced. However,new private jetties in Kandla and Vishakapatnam are starting to overcome problems of slow port handling ofcommodities.

Low international commodity prices currently place the Indian soybeans industry in a situation of crisis. Yieldsare low, and are particularly hindered by slow replacement of seed, and not surprisingly farmers are consideringalternative crops. Imports on palmolein for direct bear a 40% import duty, while soft oils used by refiners andhydrogenation units bear a duty of 16.5%, but these are insufficient to stem the crisis.

Marketing system for unprocessed soybeans

Soybeans are purchased from farmers by commission agents and dealers operating through market yards ormandis under the supervision of Agriculture Produce Market Committees (APMCs), of which 160 in MadhyaPradesh alone deal in soybeans. Excepting where co-operatives are involved, or in other circumstances wherethe state government permits on a discretionary basis, all grains and oilseeds must be marketed through thisroute. Farmers deliver beans to the commission agents and dealers while the authorities do superviseweighment. Commission agents and dealers carry out primary quality control, pack the commodity and deliver itto processors. Commission agents normally work under contract to processors and normally earn 0.2 to 1percent commission depending on the services supplied - 1% being most common.

Logistically this system involves farmers or village traders with tractors and trucks delivering to mandis, in bagor bulk, prior to auction. After purchase, the buyer tips into a heap, conditions it as necessary to meet theprocessors specification (by sun-drying and/or blending it with other lots), and then re-bags it and transports itto the processor’s plant.

According to Ruchi Soya Limited, the largest processor, processors test-weigh the bags, and take a sample forvisual inspection, and then submit it for analysis to determine to see whether it meets the acceptancestandards. The acceptance standards: 2 percent foreign matter, 2 percent damaged seed and 10 percentmoisture. Notably the standard does not include oil content, which varies in the range of 17 percent to 19.5percent, but which tends to average out in the shipments of any particular commission agent. Each percentextra oil content is about Rs 225 extra per ton of soybeans purchased, or in other terms, each extra percent oilcontent is equivalent to almost 3% of bean value.

If the sample passes the visual test, the bags are immediately opened and contents poured into the plant’shopper. If it fails the analysis, the supplier is penalised in the payment, though by this time the beans havealready been accepted for processing. By exercising quality control on the incoming material, the commissionagent or independent buyer carries out an important function in the procurement chain. The commission agentalso bears the full financial risk of failing to meet the processor’s specifications.

Table 28 shows a processor’s estimate of the cost structure in October 1999. This shows typical processorsmaking significant losses - Rs 251 per ton of soybeans before financing charges. In practice some processorsmay have reduced costs – particularly those relating to transport and handling of meal – and thereby havesucceeded in breaking even.

Nevertheless the table illustrates the highly competitive nature of an industry where there is little opportunityfor profit at any level of the marketing chain. Notably the margin between the farm gate and the processor isabout 7% of the processor’s procurement price. Of course, this does not include the opportunity cost of the timethe farmer spends selling his beans.

Notably there are significant handling costs, from bulk to bag on the farm, from bag to bulk to bag by the timethe soybeans reach the plant, and back into bulk after it enters the processor’s plant. It may be argued that thisis wasteful and that costs could be reduced by bulk handling from the farm to the processor’s plant withoutpassing through the mandi. Moreover, transport costs could be reduced if trucks and tractors could be turnedround quickly. However, two important factors need to be considered before drawing any conclusions in thisregard:

The nature of the transport fleet, which is not equipped for bulk handling, and only opportunisticallyhandles soybeans. Its low cost of operation is dependent on its ability to switch quickly between cargoes.

a.

The commission agent’s role in quality control justifies some intermediate handling that necessarilyinvolves bags.

b.

Table 28: Approximate Soybean Crush Margin and Supply Costs (October

1999)

Revenue to processor US$/ton Rupees per ton

Soybean meal - fob port - $ perton

165

Equivalent price in Rupees 7,095

Transport and handling toFOB

800

Ex-factory price 6,295

Percentage yield fromsoybeans

81 percent

Revenue from one ton ofsoybeans

5,099

Refined oil - ex-factory 22,500

Percentage yield fromsoybeans

18 percent

Revenue from one ton ofsoybeans

4,050

Total revenue 9,149

Processing cost (excludingfinancing)

600

Break-even procurement price 8,549

Actual procurement price 8,800

Estimated profit (loss) (251)

Cost of procurement through commission

agent

Rupees per ton Percentage ofprocurementprice

Costs to farmer:

Bags* 55

Transport to Mandi 20

Offloading 30

Weighment charges 15

Sub-total 120 1.4

Cost to commission agent:

Loading/offloading 50

Bags* 55

Commission (1 percent ofprocessor's procurementprice)

1percent

88

Mandi tax - 0.5 percent ofauction value**

0.5percent

42

Freight to plant 250

Sub-total 485 5.5

Total procurement costs fromfarm gate

605 6.9

Notes: *bags cost Rs 21 each, are used three times and sold for Rs 7 each. Costper usage 14/3 =

Rs 4.7, say Rs 5 including twine. Eleven bags are used per ton, so cost of bagsis Rs 55

** Madhya Pradesh mandi tax increased to 2% in April 2000

It is also worth noting that significant quantities of soybeans are stored prior to delivery to the processor. Whilesmall farmers typically dispose of stocks within 90 days of harvest, larger producers store significant quantities,and release them gradually as prices rise in the post-harvest period. At times, commission agents and tradersalso store for farmers, fixing the price later at the moment the farmer wishes to sell. Delayed or to-be-fixedprices are common to soybeans, soy meal, and soy oil; other oilseeds, meals, and oils; gur; coffee; and cotton.

The second largest processor of soybeans, ITC, has recently launched a scheme which gives increased credibilityto this approach, whereby farmers may deposit soybeans with commission agents working on the company’sbehalf. The same agents also supply certified growing seed in exchange for commitments to sell, under atripartite agreement worked out with Monsanto. ITC intends to further develop their agency system by makinguse of the Internet to deliver farmers information on weather and prices and information on better growingpractices. By June 2001, the company plans to incorporate customised farm practices for different soil types,based on which farmer is logging in.

At the same time both traders and farmers deposit soybeans for storage with the CWC and the Madhya PradeshState Warehousing Corporation (MPSWC), and using the warehouse receipts to raise bank financing. At the timeof our visit (October 1999), both warehouses adjacent to the mandi at Indore were receiving small butsignificant quantities from the kharif crop, along with wheat and pulses. Most lots are 100 bags plus, but onestack of 40 bags was seen. Farmers get a 30 percent discount on storage charges and are reported to be

increasing their use of the warehousing facility where soybeans account for about 50 percent of the usage.Co-operatives also store on behalf of their members, issuing warehouse receipts in the same way.

Commission agents and traders make significant use of informal financing, as well as credit from mainlyco-operative banks. Commission agents advance such financing to farmers at around 2 percent per month,though the effective rate is higher where repayment occurs before the end of the month. They also giveprocessors seven days credit, offering discounts for prompt payment. Farmers also borrow from co-operativebanks. Traders and commission agents cannot depend on crushers for their capital, and have to rely on theirown savings, informal credit networks and bank borrowing. Co-operative banks are very active in suchfinancing.

Marketing of oil and meal

Oil is sold ex-factory to domestic processors. Meal is sold to importers through letters of credit, sometimesinvolving pre-financing by banks under red-clause terms. This is an area in which there have been significantdefaults in terms of delivery and quality, and where systems of collateral management are needed to look afterthe importer and lender’s interest from the moment the meal exits the factory. If, as presently occurs, qualityand availability can only be ascertained at the port, the importer faces the risk of meal not reaching the portwarehouse on time, particularly where shippers are themselves seeking to minimise port charges, or notmeeting specifications.

Credit

Processors are the main recipients of formal bank lending, and such lending is based on the strength of thebalance sheet. Lending rates vary between 15 and 18 percent per annum. Lending against the security of stockshas hardly developed with the soybean industry or with other parts of the oilseeds complex. Bankers attributethis to two factors: price volatility of oil and the potential for oil mixed with cheaper oils.

The introduction of futures contracts in seeds, meals and oils may have a favourable impact on lending againststock. Such introduction would perhaps be a necessary condition but not a sufficient condition for thedevelopment of lending against stocks, especially of agriculture produce.

Bankers are of the view that adequate warehousing laws are essential for securing their collateral, and also thatthe powers conferred by the Prevention of Food Adulteration Act need to be exercised more vigorously (indeedthey see more need for this than the powers conferred by the Essential Commodities Act). Such a view issupported by empirical evidence in the context of lending by banks - often branches of international banks -against imported stocks of oil. Such stocks are usually brought under a three-party collateral managementagreement.

Systems of delivery against futures contracts

The Soybean Processors Association of India (SOPA) has established a futures marketplace, SOPA Board ofTrade (SBOT), which lists soybean, soy meal and refined soy oil futures contracts. Unlike the common practiceof other global exchanges, delivery against contracts reaching expiry is compulsory. SBOT's delivery rulespermit delivery at delivery points within a 60km radius of Indore.

SBOT's delivery protocol involves delivery at and from warehouses owned by the CWC, MPSWC andco-operatives. The delivery protocol is amenable to the usage of warehouse receipts.

SBOT has developed a comprehensive set of bye-laws and regulations, but these mainly concentrate onconstitutional and financial aspects of the exchange. There is still a need for commodity-specific regulationsconcerning delivery for each of the three commodities handled. The possibility of commingling stocks by gradeshould also be considered, in line with international practice.

The main impediments to using warehouse receipts are sales taxation, possible enforcement of Storage ControlOrder and other sections of the Essential Commodities Act. Such enforcement would limit the quantity that canbe stored by stockowners and processors, defeating the purpose of the warehouse receipt system.

At the time of our visit, there was a four percent sales tax on soybeans to which farmers were exempted, andlikewise traders when they delivered to processors (who had to make a declaration that it was for processing).However this exemption not extended to sales between commercial parties of the kind envisaged by SBOT. The

removal of this tax on intermediate buyers of warehouse receipts was a prerequisite for organising deliveryagainst futures contracts and for further expansion in the use of warehouse receipts. Fortunately it has recentlybeen removed, unlike the tax which similarly affects the domestic coffee exchange in Bangalore.

Bombay Oilseeds & Oils Exchange

The BOOE has received the mandate from the FMC to list and trade futures contracts in some of the principalconstituents of the edible oilseeds complex: groundnut, sunflower, safflower, cotton seed, palmolein andsesame. Palmolein is imported principally from Malaysia. The introduction of the palmolein contract is asignificant signal of India's positive response to global trade and commitment to use market instruments such asfutures for managing price volatility.

The BOOE has completed the tasks pertinent to contract specifications for the above oilseeds, their derivatives(meal or cake and oil) and palmolein. BOOE has made an in-principle or provisional decision to adopt deliveryrules that are based on warehouse receipts. The BOOE has an active collaboration with the Solvent ExtractionAssociation (SEA). Among many objectives, the collaboration is aimed at enabling processors, extractors andrefiners to (1) manage price volatility and (2) make effective usage of existing testing and storage facilities. Thetwo objectives are expected to have a significant impact on the tightening and shortening of the supply chain.

Rapid advances in testing and grading methodologies would drive the tightening and the shortening of thesupply chain that support commingling. Testing and grading methodologies that support commingling, asadopted in the case of milk and oilseeds by the National Dairy Development Board (NDDB), would necessarilyhave to be quick and easy but have enough sophistication to spawn unqualified acceptance by farmers,processors and traders. The BOOE uses the services of inspection agencies and surveyors that have thecapability to use quick and easy processes for testing.

As in the case of gur, coffee, cotton and soy, the shorter supply chain would reflect the integration of tradingand processing. Any warehousing laws and warehouse receipt protocols should enable traders and processors towarehouse stocks of their suppliers and customers.

Prospects

This industry presents good prospects for the development of a warehouse receipts system. It is already beingpractised at the ports, and on a limited scale with government-owned warehouses at Indore and elsewhere. It isnow needed to facilitate delivery against futures contracts, and to reduce risks of export trade in meal. Stockscould be collaterally managed on the premises of some of the larger processors, and at strategically placedwarehouses along the line of rail.

Compared with food grains, oilseeds are not subject to heavy Government regulation, but there is still theStorage Control Order, the sales tax and the requirement that all oilseeds be marketed through mandis.Small-scale industry reservations still apply to some oilseeds, though the Ministry of Agriculture has requestedtheir removal.

The analysis also highlights the role of the commission agent as an intermediary directly in touch with farmers,who works on narrow margins, and who carries out valued financing and quality control functions. Thiscontradicts popular misconceptions about the role of middlemen. Given their considerable skills and knowledgeof the market place, commission agents and independent buyers could play an increased role in the supply ofinputs and technical advice, and might also develop systems of rural warehousing.

It is possible that costs can be reduced through the introduction of bulk handling, particularly of meal goingfrom the plants to the port, or to Indian feed mills, but this can only be substantiated through in-depth study.Our observations on procurement costs provide a caution against any precipitous move towards bulk handling,which would moreover result in large job losses.

On the face of it, SBOT's implementation of delivery rules based on warehouse receipts seems a little prematuregiven the lack of clear arrangements for delivery and lack of agreement to reduce sales tax. Indeed one mightsurmise that the latter problem would force hedging transactions and settlement back into informal channels.However, members seem to see things in another way; they feel that it is only by getting started that they willgenerate the momentum to overcome such constraints.

Appendix 5

Commodity Analysis: Gur

The following account is based on the field visit to the Chamber of Commerce, Hapur, and information gleanedfrom manufacturers elsewhere. The Chamber of Commerce, Hapur is registered with the Forward MarketsCommission for trading both potato and gur futures contracts.

Reasons why warehouse receipts are of interest with gur

Warehouse receipts are potentially of interest with gur for the following five reasons.

1. The seasonality of sugarcane

Sugarcane is the principal input for the manufacture of gur, khandsari and sugar. Small manufacturing unitsproduce both gur and khandsari by processing cane juice in open pans. Gur is an unrefined native sweetener.Khandsari is unrefined white sugar that is obtained through the simple centrifuging of the same concentratedsugarcane extract used to make gur.

Nearly a third of India's annual sugarcane output is processed by the khandsari and gur industry. Sugarcane isharvested and crushed seasonally, and the principal effects of seasonality of sugarcane output on the productionand storage of gur and sugar are quite similar.

2. Scope for extension to the sugar industry as a whole

The output mix of gur and khandsari is driven by market demand. The gur and khandsari industry, oftendescribed as a cottage industry, does not have to reckon with the restrictive policies that characterise the sugarindustry and its degrees of freedom.

The sugar industry is likely to be deregulated in stages in the near future and the principal components of thewarehouse receipt system pertinent to gur may well be extended to sugar. Both gur and sugar are amenable tocommingling and to the issuance of negotiable warehouse receipts. The extension would of course be on alarger scale. The output of the Indian sugar industry was worth about Rs.170 billion (US$ 4 billion) in 1999,about six times as big as the gur industry. .

Development of exchanges3.

Third, the following six commodity exchanges or associations that have been recognised by the Forward MarketsCommission (FMC) for trading gur futures contracts. .

Table 29

Exchanges Recognised for Trading Gur Futures Contracts

Number Exchange and location Traded commodity futures

1 Rajdhani Oils & OilseedsExchange Limited, Delhi

Gur

2 The Ludhiana Grain ExchangeLimited, Ludhiana

Gur

3 The Meerut Agro CommoditiesExchange Limited, Meerut

Gur

4 Vijai Beopar Chambers Limited,Muzzafarnagar

Gur

5 Bhatinda Om & Oil ExchangeLimited, Bathinda

Gur and potato

6 The Chamber of Commerce,Hapur

Gur and potato

By implementing a warehouse receipt system, the Indian sugar industry could make a significant economicresponse to reform and deregulation. Here, it is pertinent to draw attention to one of the principalrecommendations of the Mahajan Committee that was constituted to draw up a plan for the phased deregulationof the Indian sugar industry, i.e. the introduction of sugar futures contracts in order to manage price volatility.

The establishment of a warehouse receipt system for gur, with regulatory and operational inputs, would enablethe sugar industry to draw upon the experience of the six exchanges while establishing a system for sugarwarehouse receipts and sugar futures trading.

4. Lowering financing costs

Fourth, gur and khandsari manufacturers play a vital role in the local cane economies by complementing thesugar mills in the off take of sugarcane during the harvesting season. Though the production processes of thegur and khandsari industry are simple and less mechanically efficient than sugar refining, they are flexible andless capital intensive, and unaffected by the public policies which apply to the marketing of refined sugar.Statutory minimum price (SMP) and state advised price (SAP) do not apply. At the same time, they do notdepend on formal credit from India's vast banking system to support their investments in fixed and workingcapital.

Gur and khandsari producers generally pay for supplies and services in cash. However, the sale of gur andkhandsari in the spot market immediately after daily production is prone to the adverse effects of pricevolatility, which can destabilise their cash flow. Gur prices exhibit considerable volatility. Khandsari pricesrespond to Government’s releasing sugar for sale.

They therefore use a combination of own funds (equity) and credit from commission agents or adatiyas. Theseare usually financiers who provide credit from their own sources (equity), at a minimum annualised cost of 22percent. This is often associated with informal call options, which the manufacturers sell to the adatiyas atstrike prices set from time to time, based on likely future demand. Sometimes, the adatiya offers themanufacturer protection against price decline through put options, and in this case, the annualised cost of creditmay be 36 percent or more. The cost of credit would be higher by about 300 basis points (with all the optionsintact) if adatiyas had no access to gur futures. Adatiyas are therefore important constituents and customers ofthe gur futures exchanges.

Adatiyas perform an important economic function. The market in which the adatiyas operate is characterised bysignificant competition; the market does not support rents. However, the cost of funds available to adatiyas ishigh and this inevitably increases the cost of credit to manufacturers. Several adatiyas buy gur on price-to-be-fixed terms. Such transactions usually involve taking possession of gur on part payment, while furtherpayments are made on the basis of the spot price or on the basis of a floor price or both.

The establishment of a warehouse receipt system for the storage of gur would enhance the availability of creditto adatiyas and to the gur and khandsari manufacturers. The lower cost of credit would also have a favourableimpact on the implicit cost of the options that are built into transactions between the manufacturers and theadatiyas.

5. Facilitating process modernisation

Gur and khandsari manufacturers continue to use traditional processes, and have not invested in moderntechnologies compatible with their size and scale of operations, e.g. vacuum technology. Indeed, some of theoperators believe there are legal restrictions on their usage of vacuum technology. However, even if there areno restrictions, the industry lacks the financial means to invest in vacuum technology, since a significant part ofthe industry's modest equity capital is invested in finished goods.

The implementation of a warehouse receipt system for gur would enable the industry to release

equity capital for investment in new technologies. This would have a favourable impact on the

industry's cost of operations and profitability.

Quality standards and testing

Gur is classified into three grades, based on the residual molasses content, indicated by colour, while moisturecontent also plays a vital role in the market price. The grades in descending order of quality are gur dhara, gurmixture and gur raskat. Gur dhara has the least proportion of residual molasses, and may be further gradedinto top gur dhara and ordinary gur dhara. All three grades are amenable to commingling and the issuance ofnegotiable warehouse receipts providing there is an objective form of grading acceptable to the parties involved.Presently no such system is used. At Hapur, molasses content is assessed by visual examination of the truncatedcones of gur, while moisture is tested on the basis of the depth of the impression made by a thumb, but thereare no standards for the pressure to be exerted. Experience is said to play an important role in testing, gradingand sorting.

Delivery in futures markets

The basis quality of the gur futures contract listed by the Hapur exchange is gur dhara, but as noted abovethere is no scientific way of testing and grading (likewise it has no such process for potatoes). Poor acceptanceof these subjective testing procedures results in numerous disputes when gur is delivered upon expiration ofshort positions at Hapur and the other exchanges. The exchanges are therefore very keen that scientific andunambiguous testing and grading processes be developed. They are also in favour of uniform rules for deliveryand settlement of futures contracts using warehouse receipts.

Manufacturers and adatiyas are moreover in favour of industry-wide standards. The Bureau of Indian Standardsmay be the appropriate institution to develop a quality assessment and certification programme.

Private and common warehousing

The ambiguities about declared grades and leading to absorption of moisture have lead to the significant use ofprivately-owned or own-use warehouses by adatiyas and gur manufacturers. Some private warehouses storegur under conditions of low humidity and low temperature. Gur is stored while preserving identity. In any case,the question of commingling does not arise in most own-use warehouses.

Some gur (mainly gur raskat) is stored in public warehouses, on an identity-preserved basis. The charge inHapur, where refrigerated storage is available, is Rs.500 per ton per season. Other gur is generally stored byadatiyas and manufacturers in private or own-use warehouses, under conditions of low temperature andhumidity (13 to 16 degrees Celsius). Apprehension about poor storage conditions causes owners to avoid usingpublic warehouses with the higher grade material. The emergence of scientific testing and grading processeswould most likely lead to an acceptance of commingling of gur and common or public storage without anyemphasis on identity preservation. This would be welcomed by the industry for reasons of cost.

Public warehouses in the dominant gur-producing region are also eager to support the gur exchanges in theirpursuit of scientific testing and grading processes, and physical settlement of gur futures contracts throughcertified warehouse receipts. Most private warehouses are moreover eager to be registered by the gurexchanges for the issuance of warehouse receipts.

Prospects

Gur manufacturers and adatiyas are aware that futures exchanges list a few basis grades; they are likely to usea combination of warehouse receipts and futures positions to effect exchange of futures for physicals (EFP)

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where physicals may not necessarily conform to the basis grades. The emergence of scientific testing andgrading processes would most likely lead to higher delivery percentage on the exchanges and liquidity sincethey would prefer to deliver through the futures exchanges.

Gur manufacturers and adatiyas are aware of the warehouse receipt system implemented by the coffeeexchange in Bangalore, and are favourably disposed towards the amendment of the byelaws of their exchangesto require delivery through warehouse receipts. Any action by the FMC that leads to such an amendment of thebyelaws would be viewed favourably.

The emergence of scientific testing and grading processes would lead to the emergence and the acceptance ofuniform settlement and delivery rules across the exchanges. Such an acceptance may well lead to significantintegration among the gur exchanges in respect of contract specification, trading rules and trading platforms.

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