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Inventory credit is unlikely to be successful in countries where the macroeconomic and policy environment is unsupportive of private trade. Traders will not undertake storage, even for a few months, if they sense a danger that Government will impose price controls, seize stocks (on the ground that traders are "hoarding"), ban exports, permit unscheduled food aid imports and/or suddenly reIease food security reserve stocks in response to only modest price rises.
The Indian case study (Case Study 2) provides an example of potentially viable inventory credit arrangements, through the use of warehouse deposits, which work imperfectly because both the rice and wheat market and the financial system are heavily regulated by Federal and State Governments. Funds made available to the trading sector are controlled, the percentage of the value of the stored crop against which loans can be obtained is dictated by the Central Bank, and the level of stock which can be held by private traders and millers is also controlled.
In Africa and Eastern Europe, the temptation for governments to adopt a similar approach and try to control the grain market, even after liberalization has supposedly taken place, will remain strong. Policy changes will not remove the residual mistrust of the private sector. Moreover, the provision of inventory credit may actually assist the private trade to "speculate" and this, despite its obvious advantages, may be difficult, politically, for governments to accept.
To introduce inventory credit successfully into a country, the following conditions will need to be satisfied:
With regard to government leading, some governments use Food Security Reserves to prevent famine conditions or extreme price fluctuations. It is recommended that government interventions be kept as small as possible consistent with this objective. Where possible, prices should be stabilized by opening up the market to international or intra-regional trade. The problem with large reserves is that government operations are invariably subsidized in one way or another and, if reserves are operated at high levels, they tend to crowd out private operators who have to pay the full costs of storage. Similar considerations apply to food aid, particularly when the food concerned competes directly with national production. The frequently disruptive effect of food aid on production and marketing incentives is widely documented. Such food aid should be incorporated into Food Security Reserves or, in their absence, be released onto the market in a way which avoids disruption and is based on clear guidelines established in advance of each harvest. In Africa, only a minority of countries appear to be ready for inventory credit, due to policy frameworks which remain either interventionist or ambiguous. However, with the implementation of structural adjustment, the situation is constantly changing, and the number of eligible countries is tending to increase slowly.
Free-market reform is a necessary but not a sufficient condition for introducing inventory credit. This is illustrated by the case of Zambia, which has liberalized grain trading, but where the implementation of structural adjustment resulted in erratic and often extremely high real interest rates (reaching well in excess of 100 percent in 1993). Under these circumstances traders were unlikely to borrow for grain storage, fearing that price rises would not compensate for high and unpredictable financing costs.
A further factor which will make it easier to implement inventory credit schemes is the liberalization of trade between adjacent countries. Notwithstanding the arbitrary nature of borders inherited from colonial regimes, African governments have generally adopted highly restrictive policies towards private grain exports. Concerns over domestic food security are normally used to justify restrictions, but this takes little account of the role of intra-regional trade in stabilizing food prices. Moreover, such policies discourage exports at times of grain surplus and reduce the incentive to hold stocks for sale in neighbouring countries.
There is probably no country where at some time market intermediaries have not been held up as unscrupulous exploiters of the people. Terms like coyote in Central America or walangusi in Tanzania sum up perennial public suspicion about their role. Hard-pressed governments often use traders as scapegoats for hardships experienced by farmers and consumers. Small- or medium-scale traders usually lack powerful political connections, and are an easy target, allowing governments to ignore what are often more fundamental causes, such as lack of employment opportunities in urban areas, thin markets characterized by weak demand and poor policies.
NRI chose Ghana as the most suitable country in Africa in which to promote inventory credit financing on a pilot scale. There were no restrictions on internal trade, and the country had a deregulated banking system and moderate real rates of interest. However, even there, some elements of the policy and institutional framework were unfavourable. For example, a large public sector deficit makes it easy for banks to make money by investing in treasury bills, rather than by searching for new borrowers. Moreover, a lack of definition of the role of the grain marketing parastatal left some ambiguity about the "rules of the game" in which the private sector was expected to operate.
In conclusion, the development of efficient trade financing will be a slow process in many areas of the world. However, facilitation measures as described elsewhere in this paper will undoubtedly assist. Inventory credit should be introduced only in countries where the policy and institutional frameworks are relatively favourable, such that imitation is encouraged through the "demonstration effect".
SHOULD MILLERS BE FAVOURED?
The pattern of grain marketing varies from country to country and according to the grain concerned. In many developing countries farmers have a leading role in the storage of grain, which they release at intervals during the months following the harvest. Those experiencing storage problems and severe cash constraints will tend to release their crop earlier, giving rise to pronounced seasonal gluts.
The role of millers varies greatly, however, according to whether the mills are of the large commercial kind or small custom-mills. Large commercial mills are typical in many Asian countries, e.g. India, Pakistan, Philippines and Indonesia, where millers tend to move quickly into the business of interseasonal storage - providing that government policies are conducive - in order to ensure the availability of operational stocks on a year-round basis. Millers seem to be highly suitable targets for inventory credit in countries where most grain reaches the consumer after commercial milling. One of the largest inventory credit programmes in the developing world is targeted at rice millers in the Philippines (see Case Study 1).
By way of contrast, in most countries in sub-Saharan Africa, grain is normally milled either by pounding in the home or by small custom-mills. Most interseasonal storage is carried out on the farm, while traders seek a rapid turnover of stock. In these countries, there appears to be the greatest need for new sources of credit for grain storage by traders although, in time, some custom-mill owners are likely to progress to stockholding.
Some African countries have large commercial milling sectors but these have generally grown up as part of state-controlled marketing systems which took care of all their procurement. With market liberalization, these mills have quickly lost market share to small custom-mills which have lower overheads and are more favourably located vis-à-vis producers and consumers. This pattern has been repeated with maize in Kenya, Tanzania, Zimbabwe and Zambia, and in Mali with rice, among other countries. In Africa, therefore, it is unlikely that the large-scale commercial milling sector will quickly move into the storage role along Asian lines.
FARMERS OR TRADERS?
A concern often raised about inventory credit is that it should be directed at the farmer, and not the trader or the middleman, whose role is seen as potentially exploitative.
Several Asian countries, including Thailand and India, operate marketing credit schemes where individual farmers are funded to store grain on their own farms; the schemes are usually tied in with production credit programmes. However, unless there is a subsidy, the cost of lending to individual small farmers tends to be prohibitive, and these schemes have involved heavily subsidizing both supervision costs and interest rates. On account of this, it is difficult to make any general recommendation in favour of marketing credit schemes for farmers. They are particularly difficult to implement in countries with weak rural credit systems, characterized by a dearth of financial institutions and low repayment rates.
Costs of storage by farmers can be reduced to economic levels if they form co-operatives and store collectively. However, the problem with cooperatives is that they tend to develop slowly and to be unsustainable without continued outside support and supervision. In the worst cases, cooperatives are promoted for political reasons and are seen simply as a way of obtaining credit which does not have to be repaid. This was the case with Village Associations in certain parts of Mali (Case Study 3).
Even where co-operatives and similar organizations have been promoted in a more professional manner, questions may be raised about their long-term sustainability. In other parts of Mali, the repayment performance of Village Associations has been good but this is largely attributable to high levels of outside supervision.
Co-operatives engaged in inventory credit under the auspices of the NGO TechnoServe in Ghana (Case Study 5) have experienced considerable financial success. However, despite the organization's continued emphasis on self-reliance, the co-operatives are, as in the Malian case above, highly dependent upon outside supervision. TechnoServe's experience also suggests that success is more likely in high-potential areas or with high-value produce.
The main conclusion which emerges is that, as a general rule, marketing credit should not be targeted exclusively at particular users but should be promoted without subsidy to allcomers, as a business activity which is profitable to both the lender and the borrower, and where lending decisions are made by banks without any kind of external pressure. In most African countries, grain traders are likely to be leading users of such credit because of their skills in judging grain price movements and marketing opportunities. There may also be scope for well-organized farmer co-operatives, for millers, poultry farmers and industrial users of grain to adopt inventory credit. It is important to avoid viewing marketing credit in the same light as production credit has come to be seen in many parts of Africa, i.e. as a form of entitlement which does not have to be repaid.
This conclusion may initially be unwelcome to those who wish to ensure that maximum benefits accrue directly to farmers. However, two observations are relevant.
Lending is about managing risk, and it is important to identify the main risks involved with inventory credit. These seem to be inconsistent government policies, excessive funding on soft terms, the physical security of the produce, certain "legal risks", and speculative loss. Ways of minimizing these risks are discussed below.
Risks arising from government policies were mentioned in Section 4. If policies are not supportive of inventory financing and they are not applied in a fairly consistent manner, promotion of the concept should be avoided. The Ghana case suggests that in some countries it may be possible to "manage" these risks by raising public and government awareness about the benefits of inventory credit. This may involve research followed by a conference, involving all parties interested in the subject of trade financing, where the pros and cons of inventory credit are thoroughly explored. If the conference produces a consensus in favour of inventory credit, Government can take several steps which will enhance public confidence that consistent support will be forthcoming:
(a) produce a policy statement in favour of this form of financing, reaffirming its resolve to leave normal trade and trade financing to the private sector, to refrain from internal controls on prices and grain movements, and only to intervene in specified circumstances involving grave threats to food security, in ways which do not create disincentives to private production and trade;
(b) support commercial warehouse development by promptly making available to the private sector redundant state-owned warehouses (see Section 8);
(c) make inventory credit a specific part of the terms of reference of a ministry (or set up an informal task force of ministries, banks and traders), and commission research to assist in its effective implementation;
(d) promote and finance an effective market information system.
The Malian case (Case Study 4) shows that the success of inventory credit can be compromised by the enthusiasm of donors seeking quick results through the provision of credit.
As a general rule, inventory credit is likely to be successful and sustainable when banks lend at their own risk, making use of funds mobilized through local branch networks. However, the Philippines case (Case Study 1) indicates that there are exceptions to this rule in countries with more mature banking systems. In the Philippines, lending risks are underwritten by a Government agency, Quedan and Rural Credit Guarantee Corporation (Quedancor), which guarantees the stock at an official guarantee price. This has not led to irresponsible lending, however, and Quedancor's resources (2 percent of amounts loaned) have easily covered pay-outs.
In many countries, however, such arrangements risk creating an environment where banks can lend irresponsibly. Political pressures may also cause guarantee prices to be set at unrealistically high levels, leading to the bankruptcy of the organization providing the guarantee. Generally speaking, therefore, it is suggested that governments do not offer official guarantees. Banks have much to gain through the successful operation of inventory credit and, preferably, they, rather than governments or donors, should be the prime movers in establishing inventory credit
Most risks involving physical security can be eliminated by making sure the produce is insured against fire and extreme weather conditions (hurricanes, etc.), and by banks working only with competent and highly reputable warehouse operators. However, even where highly reputable companies are involved, there is always scope for human error and the safe-keeping of produce cannot always be taken for granted.
The availability of insurance cover will vary according to the state of the local insurance business, and the general security situation in the country concerned. In Ghana, cover can be obtained for fire at low premiums, 0.2 percent of the value of the produce insured, while a small additional charge will cover whirlwinds and tornadoes.
Guidelines for the selection of warehouse operators were provided in Section 3.
The legal risks involved with inventory credit schemes, discussed in greater detail in Annex 2, will differ depending on the legal framework that exists in a particular country. These risks can be divided into two types. The first might be called "substantive" risks, i.e. risks that arise because a country's laws are ambiguous or inconsistent, or because they fail to provide sufficient protection to the interests of the various parties. One risk that is likely to arise in the case of an inventory credit scheme is that the borrower may sell the produce without the lender's authorization. Of course, the lender will still have a right to sue the borrower for breaching the loan agreement, but that right may not be worth much now that the underlying security, i.e. the grain, has gone out of the control of the borrower. Unless the law provides for a procedure for a bank to register its security interest, and also provides that such an interest exists, then the lender may have a hard time taking action to get the grain back from a third party who purchased it in good faith.
Other substantive risks that may be encountered arise in the case of the death or bankruptcy of a borrower or warehouse operator. The question a lender must keep in mind is whether its claim against the asset will survive either event. Ideally, a lender's security interest should provide it "priority" against the claims of other creditors - in other words, even in the case of death or bankruptcy, a secured lender should have first access to the collateral, before the deceased's estate, the bankruptcy court or the trustee gets such access. Unfortunately, laws regarding inheritance and bankruptcy tend to be complex and are often ambiguous, and may at times override the interest of the secured lender. It is important, therefore, to determine the extent of these risks under the laws of a given country, and investigate ways of minimizing them.
In lending to traders, some lenders may wish to expand the range of collateral options by requiring insurance on the life of the trader. Such "key-man" insurance may be justified because grain traders are often "one-man-bands" and their death may seriously jeopardise loan repayment.
The second type of legal risks may be characterized as "procedural" risks. However strong a lender's legal rights may seem on paper, the procedures laid out for realizing those rights may be extremely time-consuming, expensive and full of pitfalls for the unwary. Such factors can be very important, particularly where security for a loan is provided by a perishable commodity like grain. These risks are exacerbated in situations where a country's judicial system is overburdened, weak or corrupt.
In Section 1 it was mentioned how returns to storage can vary from one year to the next (this is illustrated graphically in Figures A1-A6 in Annex 1). Even in cases where price fluctuations are extreme, such as maize in Ghana, there are years when price rises are relatively modest. Risks are generally greatest in years of bumper crops. The extensive provision of inventory credit will increase these risks. As banks increasingly make funds available for storage, the inter-seasonal price pattern should become smoother and there will be fewer opportunities for profitable trading. The level of speculative risk, and the possibility of banks being forced to realize assets in the form of stock, will increase.
With internationally traded commodities, speculative risks can be avoided by hedging on futures markets. However, this is difficult in the case of the many commodities for which futures markets do not exist or which are produced mainly for local consumption. Prices are often out of line with those in the world at large, so that speculative risks cannot be hedged on futures markets. While the borrower cannot avoid speculative risks, there is much that the bank can do to minimize its exposure to speculative losses. The following measures are important.
In most countries market liberalization calls for a reduced role for parastatals or state-controlled co-operatives that formerly were the sole official marketing channels. These agencies have large storage capacity, as well as grain dryers and cleaners which are of excellent quality. To date, only a few countries have successfully identified alternative uses for these facilities and seldom have they been sold to the public.
Some grain marketing parastatals may have a future as warehouse operators. Indeed they could be the basis for a network of stores, such as that existing in India, which offers secure storage for a wide range of products. Many parastatals have considerable expertise in storage techniques and pest control. Unfortunately, there can be several problems in using parastatals in this way.
The Ghana Food Distribution Corporation (GFDC) is a parastatal which has moved speedily into the storekeeper role and has satisfactorily performed the technical functions involved. Notwithstanding this, GFDC still exhibits some of the typical problems associated with parastatals and this gives legitimate cause for concern (see Case Study 4).
In view of the above problems, serious consideration should be given to the possibility of selling off or leasing stores and grain handling equipment to the private sector. This should be done quickly through a tendering process or other mechanism which ensures that the disposal prices are not inflated but are in line with going market prices.
Another possibility is to put stores in the hands of a specialist public warehousing organization which has no trading role' such as the Central Warehousing Corporation in India (see Case Study 2). However, this option involves some of the same institutional problems of parastatal trading enterprises, and can make it difficult to engender bank confidence. One way in which confidence might be enhanced is for the warehousing corporation simply to maintain the stores and lease them to professional warehouse operators in the private sector.
This brief discussion on aspects of quality control relates to Africa, although it may be relevant in other parts of the world.
Private sector grain marketing systems rarely employ formal quality control standards, and levels of moisture, foreign matter, broken grains, etc. are often high. However, due to their rapid stock turnover, traders are able to operate in this manner without it adversely affecting their business.
Parastatats usually have formal buying standards for grains and are often well equipped with moisture meters, grain drying and cleaning equipment, but in many countries this equipment is under-used and standards are only vaguely applied.
When grain has to be stored for several months, stricter controls are needed to avoid spoilage, especially regarding moisture content. Moreover, in the event of a dispute between the depositor and the warehouse operator regarding the quality of stock at the time of redemption, there must be an agreement over quality at the time of deposit, so that any deterioration can be measured. Standards are also required if warehouse receipts are to become negotiable, and grain is to be traded by specification, as suggested in Section 4.
For these reasons warehouse operators should establish their own set of quality standards. At first these are likely to be simple standards establishing a Fair Average Quality (FAQ) for food or feed use. Standards can be less exacting when the identity of produce is preserved than when it is confused. As noted previously (see page 16), uniform standards are needed when identity is confused to avoid the situation whereby depositors delivering high-quality produce subsidize those who deliver poor grain.
Warehouse operators need to be fully familiar with scientific storage measures and pest control techniques. Governments, possibly through former parastatals, can provide support in the form of appropriate training. However, the temptation to license warehouse operators should usually be resisted because it often creates opportunities for corruption. Control of warehouse standards will come through the banks, whose funds are tied up in the stock, and the insurance companies, who will not provide insurance if they think that a storekeeper is incompetent.
Fumigation can be a contentious issue, particularly when private storekeepers are involved. Parastatal pest control staff have usually learnt to practice preventative pest control, but a less enlightened commercial attitude is to fumigate only when infestation is rife, as a last resort, to prevent the commodity from dropping a grade or becoming unsaleable. Problems will be reduced if there are clear contracts for fumigation, followed up by regular monitoring of fumigation practice and infestation levels.
DEVELOPMENT OF A FUTURES MARKET
In the larger countries of Eastern Europe and the developing world, trading in warehouse warrants may eventually lead to commodity exchanges, with trading on a futures basis. Futures trading is fundamentally different from the physical trading as discussed here. All contracts are for a conventionally standardized grade of commodity, in a standard lot size, and for delivery at a standard day of a month in a standard location. However, a futures trade can only develop where there is an underlying physical trade in the commodity concerned. A trade in warrants helps establish standards for quality and other parameters, upon which the futures trade can be established.
Few futures contracts go through to physical delivery as the volume of transactions is such that sales are normally cancelled out by purchases. However, when delivery does occur, the warehouse warrant is a convenient document by which physical exchange can be registered.
Futures transactions are normally separate from physical transactions, and should not be confused with "forward" sales, which are simply physical transactions specifying delivery of the goods at some date in the future. However, the development of futures markets is advantageous to producers, traders and processors, as it allows them all to manage price risks through hedging. Futures markets also allow people outside the physical trade to speculate in the commodity concerned. Futures prices influence physical prices and vice versa, and provide a vital link between the commodity trade and financial markets, and help smooth price fluctuations.
The developing world's experience with such exchanges is rudimentary and not encouraging, particularly with domestically traded commodities. Markets tend to suffer from lack of liquidity, there being a limited number of buyers and sellers interested in the commodity concerned. Consequently, they are more vulnerable to manipulation than are established exchanges. In Brazil, development of futures markets for grain has been hampered by the lack of standardized grades, hindrance to the movement of merchandise and the trade's inability to deliver on contracts. Futures markets should not have been developed:
COMMODITY FUNDS AND COMMODITY CERTIFICATES WITH GUARANTEED DELIVERY
Further innovations in the financial and trading sector in Brazil suggest the sort of developments which are possible in the long term, particularly in the more developed middle-income countries. In July 1992, the Federal Government authorized the establishment of Commodity Investment Funds. These funds raise resources on the market, which must be invested in a range of financial products, of which a minimum of 25 percent and a maximum of 80 percent should be invested in papers backed by agricultural commodities, including warrants, Commodity Certificates with Guaranteed Delivery (CM-Gs - see below) and futures contracts. Any commercial bank can set up a Commodity Fund and Federal and State Governments can buy and sell positions in them.
In their first year of operations, Commodity Funds raised substantial amounts of funds and in September 1993 their capitalization was equivalent to US$4.8 billion. The Funds were on their way to becoming the main vehicle for gathering financial resources for agricultural production and marketing. However, they were running into a problem which had dogged previous attempts to modernize the financing of agricultural trade - the lack of credibility of warehouse warrants.
The Brazilian experience may seem remote to countries whose level of development and/or scale of the internal market does not permit such sophistication in the financial sphere. However, it brings home the fundamental importance of starting the process of improving trade finance with sound storekeepers, whose warrants inspire business confidence.
Brazil is developing another instrument which may partially substitute for the warehouse warrant, the Commodity Certificate with Guaranteed Delivery (CM-G). It is a sales contract on a given commodity and comes in two versions: guaranteed immediate delivery, which refers to existing stocks; and guaranteed future delivery, which refers to crops not yet harvested, or even crops not yet established. CM-Gs are intended to mobilize resources from the market to finance commodity storage and production costs. They would be issued by the owner of the commodity, registered in the cIearing-houses of commodity exchanges, and guaranteed by a commercial bank.
The GM-G contracts will be traded on spot markets, and are expected to be the main stock-based paper to be purchased by Commodity Funds, instead of warrants. In countries which are much less developed than Brazil, however, it is difficult to see such financial instruments taking off; there are simply not sufficient creditworthy parties to issue the certificates. A well organized system of warehouse warrants can, by contrast, provide physical security upon which the financial system can base its confidence. By establishing the credentials of borrowers in the eyes of the banks, inventory credit can be a first step towards creating more sophisticated systems.