42 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS EXPERTS’ VIEWS | 43

Agricultural production, processing and trade are often considered low-margin, high-uncertainty operations, and are perceived as risky investments by financiers. Physical collateral, such as land and real estate or machinery and agriculture implements, is often of little use in mitigating financiers’ risks as such collateral tends to either be very difficult to enforce or of very little resale value. No wonder, to obtain finance for agriculture can be really difficult and often expensive, given the risk premium charged by financiers. In light of this, warehouse receipt finance has emerged as an attractive alternative for farmers and processors in the developed world.

Under a warehouse receipts financing scheme, goods stored in a warehouse are used as collateral against a loan. These goods could be agricultural or non-agricultural in nature. This has become a fairly mainstream method of financing in most industrialised countries, and there is evidence that the overall efficiency of markets, particularly in the agribusiness sector, is greatly enhanced when producers and commercial entities can convert inventories of agricultural raw materials or finished products into a readily tradable device. Producers deposit goods of a certain quality, quantity, and grade in accredited warehouses and receive a receipt for it. Being negotiable instruments, these receipts can be traded, sold, swapped, used as collateral to support borrowing, or accepted for delivery against a derivative instrument such as a futures contract.

According to a report by the Reserve Bank of India Working Group on Warehouse Receipts & Commodity Futures (2005), the overall efficiency of markets, particularly in the agribusiness sector, immensely improves when producers and commercial outfits are able to convert inventories of agricultural raw materials or finished products into a readily tradable instrument. Producers receive a receipt against goods of a given quality, quantity and grade deposited in accredited warehouses. It also says that being negotiable instruments, these receipts can be traded, sold, swapped, used as collateral to enable borrowing, or accepted for delivery against a derivative instrument such as a futures contract.

Despite growth projections, what remains the reality of the agriculture-related business is its high dependence upon seasonality. Broadly speaking, farmers face two major problems — lumpy cash flows and non-availability of intermediate finance. Warehouse receipts finance can play an important role in smoothening income for farmers by providing liquidity at times when cash flows dry out.

WR financing as a means of extending the sales period beyond the harvest season: As the harvest season approaches, small and marginal farmers find themselves in dire need of liquidity. The simple demand and supply equation results in prices falling to their lowest during harvest and gradually rising during

Warehouse Receipt Finance for Farmers

Warehouse Receipt Finance for Farmers – A Glimpse

While warehouse receipt (WR) finance has been in existence in India for a long time, and traders and large farmers do benefit by availing of the mechanism, small and marginal farmers have been virtually left out of it. This paper discusses the advantages and disadvantages of WR financing in India from small farmers’ point of view, while citing examples of how this mechanism has been used globally. It also lays stress on some key requirements for implementing a successful WR finance programme, concluding with a brief on IFMR Trust’s agricultural commodity pilot in Gujarat.

By Mr. Nachiket Mor and Dr. Kshama Fernandes

1the lean season . Although farmers are aware of this seasonal trend, they cannot take advantage of this and benefit from it as they are hard put to organise immediate cash. A typical small farmer sells his crop when its prices are at their lowest. This crop is often bought by traders or village-level aggregators who hold the stock through the harvest season till prices pick up and then sell it at a profit. To cite some numbers, the seasonal variation in castor seed prices during 2008 was almost Rs.200 per 20kg which translates into a profit of Rs.750 a bag of castor seed (which translates into an annualised return of 88.9 %). If farmers are enabled to hold on to their crop beyond harvest, a part of the price benefit could accrue to them. So, by providing farmers with a mechanism to store and hold on to their produce, warehouse receipts finance enables the extension of the sales period beyond the harvest season.

WRs as secure collateral for obtaining finance: Most banks are uncomfortable in extending pre-harvest loans to farmers. Warehouse receipts form sound collateral whose market value can be easily estimated and whose liquidity is much higher than conventional collateral such as land and machinery. In the event of default, the holder of the warehouse receipt has the first call on the underlying goods or its value. This provides banks and financiers with the comfort to lend to the farmer without lengthy documentation and long processing delays. Farmers, on their part, can avail of loans either to overcome immediate liquidity requirements or to finance future crop/investments on farm equipment or alternative businesses. According to the RBI Working Group report, on notion of reduced risk premia, collateralisation of agricultural inventories using warehouse receipts will lead to increased credit availability and reduced cost of credit. Besides, it will lead to mobilisation of mainstream financial resources into the agricultural sector.

In their study on the use and impact of warehouse receipts in developing and transition economics, Lacroix and Varangis (1996) concluded that warehouse receipts are an important addition to the store of negotiable instruments in a country’s financial sector. According to them, they not only provide important long-term economic benefits but also have immediate positive impact on the farmer’s life.

Is There a Downside for the Farmer?

While availing of finance against warehouse receipts appears to be an attractive option for the farmer, there are concerns about its inherent speculative nature. One must seriously look into a likely adverse outcome: this financing avenue may encourage farmers to take speculative positions having the potential of resulting in losses beyond their risk-taking ability. Warehouse receipt financing is profitable only when the expected rise in the value of the stored product is actually more than the cost of storage plus that of the borrowed funds (i.e., loan principal plus interest payments, bank fees, etc).

Many would argue that farmers ought to confine their activity to the area of their core competence — farming — and not indulge in speculation. However, in the absence of a readily accessible hedging mechanism, the Indian farmer is a speculator in any case. From the point of time he sows the seed till the point of time he sells the crop in the market the farmer is long on the commodity, unless he hedges his long spot exposure by selling his produce in a forwards, futures or options market, which he has no access to in India. Most farmers who sell their standing crop to traders and other local financiers before harvest do so at sub-optimal rates under tremendous liquidity pressure and not from the point of view of hedging their exposure. So, the contention that farmers should not engage in speculative activity because it is not their core competence is something that must be looked into in the light of alternatives available. Warehouse receipt financing is in essence a speculative activity. Availing of the facility simply extends farmers’ already existing price exposure beyond the harvest, providing him with a readily available cash flow and a potential upside. And, in general, even if the farmer wishes to sell in the spot market, it allows him to do price averaging (thus reducing his exposure to “impact” cost) by selling his harvest gradually instead of being forced to sell the entire quantity on a single day.

1 The persistence of this arbitrage is a conundrum. If indeed this pattern was risk-less and the large traders or buyers were not credit constrained then, at least for non-perishables, the return from this arbitrage should have been lower than the cost of financing and storage costs. In perishables, wherever possible, it should have led to more aggressive “calendaring” (more distributed production throughout the year). However, in almost all commodities this arbitrage persists. It is possible that the existence of the “peso problem” (the risk of a sudden, completely unexpected precipitous fall in value that is rationally anticipated by the market – first pointed out by Rogoff (1980)) makes this arbitrage both persistent and highly risky. If indeed that is the case, then one wonders if availability of warehouse receipt finance for the small farmer is a boon or a curse (discussed later in the note). Two alternate directions however look promising: commodity forward contracts to be offered to farmers at the time of sowing (so that they may “square off” the “long” position that they create as soon as they commit themselves to planting a particular crop and thereby lock in their profit margins) and an options contract or least a delta hedge (since options contracts on commodities are not legal in India) which allows the farmer to buy protection against a further drop in commodity prices but retain the right to benefit from a rise in prices.

42 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS EXPERTS’ VIEWS | 43

Agricultural production, processing and trade are often considered low-margin, high-uncertainty operations, and are perceived as risky investments by financiers. Physical collateral, such as land and real estate or machinery and agriculture implements, is often of little use in mitigating financiers’ risks as such collateral tends to either be very difficult to enforce or of very little resale value. No wonder, to obtain finance for agriculture can be really difficult and often expensive, given the risk premium charged by financiers. In light of this, warehouse receipt finance has emerged as an attractive alternative for farmers and processors in the developed world.

Under a warehouse receipts financing scheme, goods stored in a warehouse are used as collateral against a loan. These goods could be agricultural or non-agricultural in nature. This has become a fairly mainstream method of financing in most industrialised countries, and there is evidence that the overall efficiency of markets, particularly in the agribusiness sector, is greatly enhanced when producers and commercial entities can convert inventories of agricultural raw materials or finished products into a readily tradable device. Producers deposit goods of a certain quality, quantity, and grade in accredited warehouses and receive a receipt for it. Being negotiable instruments, these receipts can be traded, sold, swapped, used as collateral to support borrowing, or accepted for delivery against a derivative instrument such as a futures contract.

According to a report by the Reserve Bank of India Working Group on Warehouse Receipts & Commodity Futures (2005), the overall efficiency of markets, particularly in the agribusiness sector, immensely improves when producers and commercial outfits are able to convert inventories of agricultural raw materials or finished products into a readily tradable instrument. Producers receive a receipt against goods of a given quality, quantity and grade deposited in accredited warehouses. It also says that being negotiable instruments, these receipts can be traded, sold, swapped, used as collateral to enable borrowing, or accepted for delivery against a derivative instrument such as a futures contract.

Despite growth projections, what remains the reality of the agriculture-related business is its high dependence upon seasonality. Broadly speaking, farmers face two major problems — lumpy cash flows and non-availability of intermediate finance. Warehouse receipts finance can play an important role in smoothening income for farmers by providing liquidity at times when cash flows dry out.

WR financing as a means of extending the sales period beyond the harvest season: As the harvest season approaches, small and marginal farmers find themselves in dire need of liquidity. The simple demand and supply equation results in prices falling to their lowest during harvest and gradually rising during

Warehouse Receipt Finance for Farmers

Warehouse Receipt Finance for Farmers – A Glimpse

While warehouse receipt (WR) finance has been in existence in India for a long time, and traders and large farmers do benefit by availing of the mechanism, small and marginal farmers have been virtually left out of it. This paper discusses the advantages and disadvantages of WR financing in India from small farmers’ point of view, while citing examples of how this mechanism has been used globally. It also lays stress on some key requirements for implementing a successful WR finance programme, concluding with a brief on IFMR Trust’s agricultural commodity pilot in Gujarat.

By Mr. Nachiket Mor and Dr. Kshama Fernandes

1the lean season . Although farmers are aware of this seasonal trend, they cannot take advantage of this and benefit from it as they are hard put to organise immediate cash. A typical small farmer sells his crop when its prices are at their lowest. This crop is often bought by traders or village-level aggregators who hold the stock through the harvest season till prices pick up and then sell it at a profit. To cite some numbers, the seasonal variation in castor seed prices during 2008 was almost Rs.200 per 20kg which translates into a profit of Rs.750 a bag of castor seed (which translates into an annualised return of 88.9 %). If farmers are enabled to hold on to their crop beyond harvest, a part of the price benefit could accrue to them. So, by providing farmers with a mechanism to store and hold on to their produce, warehouse receipts finance enables the extension of the sales period beyond the harvest season.

WRs as secure collateral for obtaining finance: Most banks are uncomfortable in extending pre-harvest loans to farmers. Warehouse receipts form sound collateral whose market value can be easily estimated and whose liquidity is much higher than conventional collateral such as land and machinery. In the event of default, the holder of the warehouse receipt has the first call on the underlying goods or its value. This provides banks and financiers with the comfort to lend to the farmer without lengthy documentation and long processing delays. Farmers, on their part, can avail of loans either to overcome immediate liquidity requirements or to finance future crop/investments on farm equipment or alternative businesses. According to the RBI Working Group report, on notion of reduced risk premia, collateralisation of agricultural inventories using warehouse receipts will lead to increased credit availability and reduced cost of credit. Besides, it will lead to mobilisation of mainstream financial resources into the agricultural sector.

In their study on the use and impact of warehouse receipts in developing and transition economics, Lacroix and Varangis (1996) concluded that warehouse receipts are an important addition to the store of negotiable instruments in a country’s financial sector. According to them, they not only provide important long-term economic benefits but also have immediate positive impact on the farmer’s life.

Is There a Downside for the Farmer?

While availing of finance against warehouse receipts appears to be an attractive option for the farmer, there are concerns about its inherent speculative nature. One must seriously look into a likely adverse outcome: this financing avenue may encourage farmers to take speculative positions having the potential of resulting in losses beyond their risk-taking ability. Warehouse receipt financing is profitable only when the expected rise in the value of the stored product is actually more than the cost of storage plus that of the borrowed funds (i.e., loan principal plus interest payments, bank fees, etc).

Many would argue that farmers ought to confine their activity to the area of their core competence — farming — and not indulge in speculation. However, in the absence of a readily accessible hedging mechanism, the Indian farmer is a speculator in any case. From the point of time he sows the seed till the point of time he sells the crop in the market the farmer is long on the commodity, unless he hedges his long spot exposure by selling his produce in a forwards, futures or options market, which he has no access to in India. Most farmers who sell their standing crop to traders and other local financiers before harvest do so at sub-optimal rates under tremendous liquidity pressure and not from the point of view of hedging their exposure. So, the contention that farmers should not engage in speculative activity because it is not their core competence is something that must be looked into in the light of alternatives available. Warehouse receipt financing is in essence a speculative activity. Availing of the facility simply extends farmers’ already existing price exposure beyond the harvest, providing him with a readily available cash flow and a potential upside. And, in general, even if the farmer wishes to sell in the spot market, it allows him to do price averaging (thus reducing his exposure to “impact” cost) by selling his harvest gradually instead of being forced to sell the entire quantity on a single day.

1 The persistence of this arbitrage is a conundrum. If indeed this pattern was risk-less and the large traders or buyers were not credit constrained then, at least for non-perishables, the return from this arbitrage should have been lower than the cost of financing and storage costs. In perishables, wherever possible, it should have led to more aggressive “calendaring” (more distributed production throughout the year). However, in almost all commodities this arbitrage persists. It is possible that the existence of the “peso problem” (the risk of a sudden, completely unexpected precipitous fall in value that is rationally anticipated by the market – first pointed out by Rogoff (1980)) makes this arbitrage both persistent and highly risky. If indeed that is the case, then one wonders if availability of warehouse receipt finance for the small farmer is a boon or a curse (discussed later in the note). Two alternate directions however look promising: commodity forward contracts to be offered to farmers at the time of sowing (so that they may “square off” the “long” position that they create as soon as they commit themselves to planting a particular crop and thereby lock in their profit margins) and an options contract or least a delta hedge (since options contracts on commodities are not legal in India) which allows the farmer to buy protection against a further drop in commodity prices but retain the right to benefit from a rise in prices.

EXPERTS’ VIEWS | 4544 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

Warehouse Receipt Financing – International Experience

Experiences around the world suggest that warehouse receipt financing can be a profitable avenue for both the farmer and the financier. TechnoServe in Ghana has achieved considerable success in its inventory credit programme over the past two decades. According to TechnoServe’s Inventory Credit Programme in Ghana by Frank Hicks, the firm believes that only the confidence of being able to sell the produce at a reasonable profit to buyers can be the incentive for small and marginal producers, constituting 60% of Ghana’s farming population, to augment both production and productivity, and supply to local industries and exporters. As in most agricultural markets including India, small farmers remain the classic “price takers”, cut off from information flowing into and out of the market and profitable market opportunities. To improve their conditions, Hicks says, TechnoServe ushered in the concept of inventory credit in Ghana in 1989. The idea was to create an opportunity for these farmers to take advantage of seasonal price swings (used smartly by local traders) to mitigate risks for banks that were hesitant about lending in the rural belt and to increase food security for farmers who can buy back (or “redeem”) their produce rather than sell it.

Participating farmers usually form groups of 20-50 members to store their produce and carry it into the lean season when prices are at their peak — much higher than harvest time price levels. At the same time, they have the flexibility to exercise one of the following options:

• can decide to sell the produce through the group, using the proceeds to repay the bank for its credit and the group for the use of storage facilities, earning a net profit of 40 to 100%;

• They can take back the produce from the group to consume as food, repaying the bank loan and the group’s storage costs, and still saving a substantial amount by avoiding high lean season food prices.

TechnoServe has refined the model of inventory credit and expanded its application to other areas in Ghana. At preset, it is offering facilitating over 100 farmers’ groups access inventory credit. For nearly two decades now the participating farmers have maintained a cent per cent on-time loan repayment record, significantly improved their incomes and agricultural production, cut down post-harvest losses and accumulated capital to invest in other agricultural activities.

In a similar effort, the RBI Working Group report says, PTA Bank in Kenya finances coffee exporting farmers by accepting warehouse receipts as collateral. It also offers them a put option, purchased at the London Commodity Exchange, which guarantees sellers a minimum price for the coffee in storage. By assuring a floor price for the stored coffee, PTA Bank can provide finance for a higher percentage of the value of coffee than it could justify in the absence of the floor price.

According to Lamon Rutten (then Coordinator – commodity marketing, risk management and finance at United Nations Conference on Trade and Development), in Venezuela, under a system developed by private firm Induservices, provided capital enhancement to warehouse receipts on seasonal maize stocks. And this enabled the firm to attract huge investment to finance maize stocks.

Again in Colombia, Rutten said, a more complex structure, introduced in mid-2000, made it possible for cattlemen to receive strong financing support to feed their cattle – at rates determined through the competition among institutional investors on the country’s stock and commodity markets.

According to the RBI Working Group report, to work effectively, warehouse receipts require a recognised foundation in law ensuring that the ownership established by the receipts is not challenged. Warehouse receipts must be functionally equivalent to stored commodities with well-defined rights, liabilities, and duties of each party to a warehouse receipt (for example a farmer, a bank, or a warehouseman). They must be freely transferable by delivery and endorsement and the holder of a warehouse receipt must be first in line to receive the stored goods or their fungible equivalent on liquidation or default of the warehouse. A robust legal framework is a prerequisite to warehouse receipts being treated as secure collateral.

Also essential is a warehouse infrastructure, grading and collateral management system that provides guarantees on quality, quantity and storage of commodities, thus assuring that the quantities of goods stored match those specified by the warehouse receipt and also their quality is the same as stated on the receipt. This will give farmers the confidence to store their produce and banks the comfort to accept warehouse receipts as secure collateral for financing agricultural inventories.

Keys to Successful Implementation of a Warehouse Receipts Programme

And finally what is required is a combination of fair and transparent spot and futures markets that provide liquidity and price discovery, enabling both farmers and banks to value and sell warehouse receipts at short notice if need be.

In the Indian context, the proposed Warehousing (Development and Regulation) Act, 2007 incorporates almost all the aforesaid legal and warehouse infrastructure related requirements. Once approved and implemented, it should provide a sound basis for developing and promoting warehouse receipt-backed trade and finance activity in the country.

In pursuit of its mission for financial inclusion, IFMR Holdings has ventured into the agricultural space. Dealing exclusively with small and marginal farmers in the Kadi Taluka of Mehasana in Gujarat, three of its entities, Agricultural Terminal Markets Network Enterprise (ATMNE), IFMR Holdings, and IFMR Capital are working together on a pilot with the following objectives:

• To provide price discovery to farmers for their crops in a fair and transparent manner (ATMNE);

• To explore other services required but not available to small farmers currently such as transportation from the village to the market/buyer, village level warehousing capability, and agricultural extension services (ATMNE and IFMR Holdings);

• To provide commodity-backed finance to farmers who would like to avail of finance against the commodity as collateral (IFMR Holdings);

• To explore other financial products and services required but not available to small farmers currently such as commodity forward contracts and delta-hedging (IFMR Holdings and ATMNE);

• To develop tradable Asset-Backed Warehouse Finance Receipts (ABWFRs) so that they may be sold to mutual funds and other financial institutions (IFMR Capital).

As part of this pilot, the three IFMR Trust entities are working with the National Spot Exchange Ltd. (NSEL) to help farmers realise the best possible price for their agricultural commodities. ATMNE is an institutional trading and clearing member and provides trading access to small and marginal farmers. IFMR Holdings provides warehouse receipt finance, helping farmers wait out the low price realisation period during harvest.

IFMR Trust’s Pilot in Kadi Taluka (Gujarat)

This is in line with IFMR Trust's mission of ensuring complete access of financial services to every individual and every enterprise. Towards this, after extensive survey, Dharampur, a village 20 km from Kadi town, with 1,000 acres under castor production and a population of 3,000, has been identified as an ideal village to operate the pilot from.

Trading operations: The trading facility is located at Kadi in the exchange-managed warehouse premises. As part of the servicer agreement, the exchange provides guarantee on quality, quantity, and storage of commodities in the warehouses managed by it. The electronic exchange market provides nationwide access to buyers and sellers. The first crop to be traded was castor seed. While the market is still at its nascent stage, its volumes have been encouragingly large. The market caters to farmers from around 125 villages around Kadi. Farmers come to the warehouse with their commodities which are then put through a standard weighing and quality testing process. Depending upon the quality, weight adjustments are made and the commodity is packed in 75 kg bags and stacked away. The collateral manager issues a receipt of weight and quality, following which the farmer places a sell trade through the ATMNE agri-broker sitting at the trading terminal at the warehouse. Once the trade goes through, the farmer is handed over the cash and receipt for the same.

So far castor seed worth Rs. 2.5 crore has been traded by over 500 farmers based in 25 different villages surrounding Kadi, the smallest trade being one bag and the largest 70 bags. Over the last four months, price differentials between the mandi and the electronic exchange have dropped from Rs. 75 to Rs. 18 a bag possibly in response to a credible price discovery mechanism being provided to small farmers through the exchange.

Financing operations: Warehouse receipt finance in India is typically used by traders and affluent farmers. It is largely perceived to be non-applicable to or non-viable for the small and marginal farmer. Barriers to participation from the financiers’ side include reluctance on their part to deal with small-size transactions due to operational reasons. From the farmer’s end, there are issues concerning non-availability of reliable price information, lack of storage space, inefficient quality testing procedures, existence of multiple layers of intermediaries, hidden charges, documentation challenges, and high transportation costs.

EXPERTS’ VIEWS | 4544 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

Warehouse Receipt Financing – International Experience

Experiences around the world suggest that warehouse receipt financing can be a profitable avenue for both the farmer and the financier. TechnoServe in Ghana has achieved considerable success in its inventory credit programme over the past two decades. According to TechnoServe’s Inventory Credit Programme in Ghana by Frank Hicks, the firm believes that only the confidence of being able to sell the produce at a reasonable profit to buyers can be the incentive for small and marginal producers, constituting 60% of Ghana’s farming population, to augment both production and productivity, and supply to local industries and exporters. As in most agricultural markets including India, small farmers remain the classic “price takers”, cut off from information flowing into and out of the market and profitable market opportunities. To improve their conditions, Hicks says, TechnoServe ushered in the concept of inventory credit in Ghana in 1989. The idea was to create an opportunity for these farmers to take advantage of seasonal price swings (used smartly by local traders) to mitigate risks for banks that were hesitant about lending in the rural belt and to increase food security for farmers who can buy back (or “redeem”) their produce rather than sell it.

Participating farmers usually form groups of 20-50 members to store their produce and carry it into the lean season when prices are at their peak — much higher than harvest time price levels. At the same time, they have the flexibility to exercise one of the following options:

• can decide to sell the produce through the group, using the proceeds to repay the bank for its credit and the group for the use of storage facilities, earning a net profit of 40 to 100%;

• They can take back the produce from the group to consume as food, repaying the bank loan and the group’s storage costs, and still saving a substantial amount by avoiding high lean season food prices.

TechnoServe has refined the model of inventory credit and expanded its application to other areas in Ghana. At preset, it is offering facilitating over 100 farmers’ groups access inventory credit. For nearly two decades now the participating farmers have maintained a cent per cent on-time loan repayment record, significantly improved their incomes and agricultural production, cut down post-harvest losses and accumulated capital to invest in other agricultural activities.

In a similar effort, the RBI Working Group report says, PTA Bank in Kenya finances coffee exporting farmers by accepting warehouse receipts as collateral. It also offers them a put option, purchased at the London Commodity Exchange, which guarantees sellers a minimum price for the coffee in storage. By assuring a floor price for the stored coffee, PTA Bank can provide finance for a higher percentage of the value of coffee than it could justify in the absence of the floor price.

According to Lamon Rutten (then Coordinator – commodity marketing, risk management and finance at United Nations Conference on Trade and Development), in Venezuela, under a system developed by private firm Induservices, provided capital enhancement to warehouse receipts on seasonal maize stocks. And this enabled the firm to attract huge investment to finance maize stocks.

Again in Colombia, Rutten said, a more complex structure, introduced in mid-2000, made it possible for cattlemen to receive strong financing support to feed their cattle – at rates determined through the competition among institutional investors on the country’s stock and commodity markets.

According to the RBI Working Group report, to work effectively, warehouse receipts require a recognised foundation in law ensuring that the ownership established by the receipts is not challenged. Warehouse receipts must be functionally equivalent to stored commodities with well-defined rights, liabilities, and duties of each party to a warehouse receipt (for example a farmer, a bank, or a warehouseman). They must be freely transferable by delivery and endorsement and the holder of a warehouse receipt must be first in line to receive the stored goods or their fungible equivalent on liquidation or default of the warehouse. A robust legal framework is a prerequisite to warehouse receipts being treated as secure collateral.

Also essential is a warehouse infrastructure, grading and collateral management system that provides guarantees on quality, quantity and storage of commodities, thus assuring that the quantities of goods stored match those specified by the warehouse receipt and also their quality is the same as stated on the receipt. This will give farmers the confidence to store their produce and banks the comfort to accept warehouse receipts as secure collateral for financing agricultural inventories.

Keys to Successful Implementation of a Warehouse Receipts Programme

And finally what is required is a combination of fair and transparent spot and futures markets that provide liquidity and price discovery, enabling both farmers and banks to value and sell warehouse receipts at short notice if need be.

In the Indian context, the proposed Warehousing (Development and Regulation) Act, 2007 incorporates almost all the aforesaid legal and warehouse infrastructure related requirements. Once approved and implemented, it should provide a sound basis for developing and promoting warehouse receipt-backed trade and finance activity in the country.

In pursuit of its mission for financial inclusion, IFMR Holdings has ventured into the agricultural space. Dealing exclusively with small and marginal farmers in the Kadi Taluka of Mehasana in Gujarat, three of its entities, Agricultural Terminal Markets Network Enterprise (ATMNE), IFMR Holdings, and IFMR Capital are working together on a pilot with the following objectives:

• To provide price discovery to farmers for their crops in a fair and transparent manner (ATMNE);

• To explore other services required but not available to small farmers currently such as transportation from the village to the market/buyer, village level warehousing capability, and agricultural extension services (ATMNE and IFMR Holdings);

• To provide commodity-backed finance to farmers who would like to avail of finance against the commodity as collateral (IFMR Holdings);

• To explore other financial products and services required but not available to small farmers currently such as commodity forward contracts and delta-hedging (IFMR Holdings and ATMNE);

• To develop tradable Asset-Backed Warehouse Finance Receipts (ABWFRs) so that they may be sold to mutual funds and other financial institutions (IFMR Capital).

As part of this pilot, the three IFMR Trust entities are working with the National Spot Exchange Ltd. (NSEL) to help farmers realise the best possible price for their agricultural commodities. ATMNE is an institutional trading and clearing member and provides trading access to small and marginal farmers. IFMR Holdings provides warehouse receipt finance, helping farmers wait out the low price realisation period during harvest.

IFMR Trust’s Pilot in Kadi Taluka (Gujarat)

This is in line with IFMR Trust's mission of ensuring complete access of financial services to every individual and every enterprise. Towards this, after extensive survey, Dharampur, a village 20 km from Kadi town, with 1,000 acres under castor production and a population of 3,000, has been identified as an ideal village to operate the pilot from.

Trading operations: The trading facility is located at Kadi in the exchange-managed warehouse premises. As part of the servicer agreement, the exchange provides guarantee on quality, quantity, and storage of commodities in the warehouses managed by it. The electronic exchange market provides nationwide access to buyers and sellers. The first crop to be traded was castor seed. While the market is still at its nascent stage, its volumes have been encouragingly large. The market caters to farmers from around 125 villages around Kadi. Farmers come to the warehouse with their commodities which are then put through a standard weighing and quality testing process. Depending upon the quality, weight adjustments are made and the commodity is packed in 75 kg bags and stacked away. The collateral manager issues a receipt of weight and quality, following which the farmer places a sell trade through the ATMNE agri-broker sitting at the trading terminal at the warehouse. Once the trade goes through, the farmer is handed over the cash and receipt for the same.

So far castor seed worth Rs. 2.5 crore has been traded by over 500 farmers based in 25 different villages surrounding Kadi, the smallest trade being one bag and the largest 70 bags. Over the last four months, price differentials between the mandi and the electronic exchange have dropped from Rs. 75 to Rs. 18 a bag possibly in response to a credible price discovery mechanism being provided to small farmers through the exchange.

Financing operations: Warehouse receipt finance in India is typically used by traders and affluent farmers. It is largely perceived to be non-applicable to or non-viable for the small and marginal farmer. Barriers to participation from the financiers’ side include reluctance on their part to deal with small-size transactions due to operational reasons. From the farmer’s end, there are issues concerning non-availability of reliable price information, lack of storage space, inefficient quality testing procedures, existence of multiple layers of intermediaries, hidden charges, documentation challenges, and high transportation costs.

EXPERTS’ VIEWS | 4746 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

In our experience, the biggest challenge in terms of giving farmers access to warehouse receipt finance has been awareness creation. IFMR Trust has been putting in a lot of efforts at farmer education. By interacting with farmers in their local settings, it is explaining to them the concept of an electronic exchange that provides a transparent price discovery process, as well as the documentation, process, risks and returns from availing commodity-backed finance through IFMR Holdings.

IFMR Holdings provides loan against commodities as collateral. The purpose of the loan product is to provide short-term finance to farmers collateralised by commodities for which warehouse receipts are issued by a collateral management company. The exchanges arrange for collateral management services and act as a service provider.

The branch through which the IFMR Holdings finances farmers against commodities is located at Dharampur village such that it would serve a cluster of villages that cultivate in large quantities crop such as castor seed, mustard seed, and wheat, among others. Currently, loans are being given to farmers coming from five villages. Farmers can avail of finance against a single bag of castor seed placed in a warehouse. The maximum loan amount they can avail of against a particular commodity is Rs. 10 lakh (Rs.1 million). It goes like this: a farmer visits the branch and registers himself, which involves fulfilling the KYC (Know Your Client) process that includes biometric identification and physical verification of address proof. On completion of the process, the farmer is given a smart card which henceforth is used as a single source of identification and data capture for all transactions done by the farmer. After charging appropriate margins to cover price fluctuations, loan is given against the warehouse receipt for the commodity stored by the farmer in the NSEL-managed warehouse.

While farmers’ response to the warehouse receipt finance mechanism has so far been a cautious one, they are definitely gradually becoming aware of this facility and coming forward to avail of loans through this route. Reasons for their initial inhibitions could be:

Lack of awareness - For farmers used to centuries of trading through adhathiyas on the mandi and availing of loans from them, trading on an electronic exchange and availing of finance against the stored commodities has been a new experience.

Rigour of the quality testing process - The exchange follows a rigorous quality-testing procedure unlike regular mandis where quality is gauged simply by picking up a handful of commodity. A value reduction is applied if the commodity does not meet the set parameters. Farmers who initially took a while to understand the quality testing process now feel the process is more fair and transparent than the one they were used to.

Reluctance to store commodity in warehouse - Perishability of castor seed is almost negligible. Instead of storing it in a warehouse and incurring storage costs, farmers prefer to store it in their backyards.

Prior advances taken from traders - Almost 30-40% of farmers around Kadi have already taken loans from traders against commitments to sell their existing commodities to these traders.

The contribution of warehouse receipt systems in developing agricultural markets has been well recognised across the world. The Ghana experience shows that these schemes can dramatically reduce inter-seasonal price fluctuations, benefiting small and marginal farmers who otherwise have no choice but to resort to distress sales (sell immediately after harvest). Warehouse receipt finance can offer farmers a marketing and credit option that spurs productivity and thus increases their incomes. Farmers can also sell some of their stored products to finance future crop, thereby obviating or reducing the need for borrowing from moneylenders and traders. Financial institutions benefit from reduced risks and from liquidity due to ready collateral to guarantee or reimburse defaulted loans. Farmers, on their part, benefit from higher profitability being able to delay sales; from improved price transparency, and from increased bargaining capacity through working in farmers’ groups.

Conclusions

However, warehouse receipt finance is essentially a speculative activity and requires serious monitoring of grain quality as well as market price trends and fluctuations. When properly designed and managed, a warehouse receipt finance programme can allow small farmers to graduate from the status of “price takers” to that of “price negotiators” in the local market economy. The mechanism can also provide rural entrepreneurs with a route to capital accumulation that can be invested in more diversified and sustainable ventures capable of stimulating long-term rural economic growth and development, which in turn can contribute significantly to the overall economic growth in line with national aspirations.

References:

1. Bamako (Technical Note No. 5). 2000. “Warehouse receipts: financing agricultural producers”

2. Evans, Martin D.D., and Karen K. Lewis. 1992. NBER Working Paper Series, No.4003

3. Hicks, Frank. 1998. “TechnoServe inventory credit programme in Ghana”. United Nations Conference on Trade and Development

4. Lacroix, Richard, and Varangis, Panos. 1996. “Using warehouse receipts in developing and transition economies”, Finance & Development

5. “Report of the Working Group on Warehouse Receipts & Commodity Futures”. 2005. The Reserve Bank of India

6. Rutten, Lamon. 2001. “Local market opportunities with respect to warehouse receipt finance - tapping into the local capital market”, ESCAP-ADB Joint Workshop

7. Rutten, Lamon. 2001. “Financial engineering techniques for directly linking domestic capital markets and the agricultural sector – a short note”, ESCAP-ADB Joint Workshop

8. The World Bank (Agricultural Investment sourcebook series). 2004. “Ghana: Inventory Credit for Small-Scale Farmers”

Mr. Nachiket Mor is President, ICICI Foundation, and Dr. Kshama Fernandes is Vice-President, IFMR Trust. Views are personal.

EXPERTS’ VIEWS | 4746 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

In our experience, the biggest challenge in terms of giving farmers access to warehouse receipt finance has been awareness creation. IFMR Trust has been putting in a lot of efforts at farmer education. By interacting with farmers in their local settings, it is explaining to them the concept of an electronic exchange that provides a transparent price discovery process, as well as the documentation, process, risks and returns from availing commodity-backed finance through IFMR Holdings.

IFMR Holdings provides loan against commodities as collateral. The purpose of the loan product is to provide short-term finance to farmers collateralised by commodities for which warehouse receipts are issued by a collateral management company. The exchanges arrange for collateral management services and act as a service provider.

The branch through which the IFMR Holdings finances farmers against commodities is located at Dharampur village such that it would serve a cluster of villages that cultivate in large quantities crop such as castor seed, mustard seed, and wheat, among others. Currently, loans are being given to farmers coming from five villages. Farmers can avail of finance against a single bag of castor seed placed in a warehouse. The maximum loan amount they can avail of against a particular commodity is Rs. 10 lakh (Rs.1 million). It goes like this: a farmer visits the branch and registers himself, which involves fulfilling the KYC (Know Your Client) process that includes biometric identification and physical verification of address proof. On completion of the process, the farmer is given a smart card which henceforth is used as a single source of identification and data capture for all transactions done by the farmer. After charging appropriate margins to cover price fluctuations, loan is given against the warehouse receipt for the commodity stored by the farmer in the NSEL-managed warehouse.

While farmers’ response to the warehouse receipt finance mechanism has so far been a cautious one, they are definitely gradually becoming aware of this facility and coming forward to avail of loans through this route. Reasons for their initial inhibitions could be:

Lack of awareness - For farmers used to centuries of trading through adhathiyas on the mandi and availing of loans from them, trading on an electronic exchange and availing of finance against the stored commodities has been a new experience.

Rigour of the quality testing process - The exchange follows a rigorous quality-testing procedure unlike regular mandis where quality is gauged simply by picking up a handful of commodity. A value reduction is applied if the commodity does not meet the set parameters. Farmers who initially took a while to understand the quality testing process now feel the process is more fair and transparent than the one they were used to.

Reluctance to store commodity in warehouse - Perishability of castor seed is almost negligible. Instead of storing it in a warehouse and incurring storage costs, farmers prefer to store it in their backyards.

Prior advances taken from traders - Almost 30-40% of farmers around Kadi have already taken loans from traders against commitments to sell their existing commodities to these traders.

The contribution of warehouse receipt systems in developing agricultural markets has been well recognised across the world. The Ghana experience shows that these schemes can dramatically reduce inter-seasonal price fluctuations, benefiting small and marginal farmers who otherwise have no choice but to resort to distress sales (sell immediately after harvest). Warehouse receipt finance can offer farmers a marketing and credit option that spurs productivity and thus increases their incomes. Farmers can also sell some of their stored products to finance future crop, thereby obviating or reducing the need for borrowing from moneylenders and traders. Financial institutions benefit from reduced risks and from liquidity due to ready collateral to guarantee or reimburse defaulted loans. Farmers, on their part, benefit from higher profitability being able to delay sales; from improved price transparency, and from increased bargaining capacity through working in farmers’ groups.

Conclusions

However, warehouse receipt finance is essentially a speculative activity and requires serious monitoring of grain quality as well as market price trends and fluctuations. When properly designed and managed, a warehouse receipt finance programme can allow small farmers to graduate from the status of “price takers” to that of “price negotiators” in the local market economy. The mechanism can also provide rural entrepreneurs with a route to capital accumulation that can be invested in more diversified and sustainable ventures capable of stimulating long-term rural economic growth and development, which in turn can contribute significantly to the overall economic growth in line with national aspirations.

References:

1. Bamako (Technical Note No. 5). 2000. “Warehouse receipts: financing agricultural producers”

2. Evans, Martin D.D., and Karen K. Lewis. 1992. NBER Working Paper Series, No.4003

3. Hicks, Frank. 1998. “TechnoServe inventory credit programme in Ghana”. United Nations Conference on Trade and Development

4. Lacroix, Richard, and Varangis, Panos. 1996. “Using warehouse receipts in developing and transition economies”, Finance & Development

5. “Report of the Working Group on Warehouse Receipts & Commodity Futures”. 2005. The Reserve Bank of India

6. Rutten, Lamon. 2001. “Local market opportunities with respect to warehouse receipt finance - tapping into the local capital market”, ESCAP-ADB Joint Workshop

7. Rutten, Lamon. 2001. “Financial engineering techniques for directly linking domestic capital markets and the agricultural sector – a short note”, ESCAP-ADB Joint Workshop

8. The World Bank (Agricultural Investment sourcebook series). 2004. “Ghana: Inventory Credit for Small-Scale Farmers”

Mr. Nachiket Mor is President, ICICI Foundation, and Dr. Kshama Fernandes is Vice-President, IFMR Trust. Views are personal.