Establishment of the reserve requires either the provision of finance or the direct provision of grain e.g. from existing government owned stocks, or from donations of grain by donors. In the case of Zambia the reserve was initially established by the sequestration of stocks held by agents who were held to be in default of loan repayments to the government, while the Tanzanian government made resources and funds available to the Food Security Unit to reconstitute the reserve from domestic purchases. It is to be expected that whichever method, or combination of methods, is used, the reserve will not be fully resourced, either in terms of cash or stocks, from the outset but rather be built-up progressively, as additional resources are made available by government or, perhaps, donors. Additional resources may be generated periodically from profitable sales of the reserve. However, these should be considered as windfalls rather than as a regular feature of a reserve which is normally considered to be a cost centre, requiring periodic injections of cash, rather than a profit centre. Thus, for the first few years of operation, the purchases are likely to be limited not by the size of the reserve required but rather by the finance available to purchase grain.
A prime concern for the management and operation of a strategic grain reserve should be ensuring that transactions undertaken in connection with the reserve have as little effect on the orderly functioning of the grain market as possible. In addition, transactions should be undertaken in such a manner that private traders recognise that, rather than serving as a threat, the reserve can complement their activities by providing additional resources in times of shortages. Thus, procedures for purchasing grain which allow for private sector participation are likely to be more successful in averting its concerns with respect to the reserve and engendering a spirit of cooperation than those in which the reserve and traders are in direct competition.
In deciding which would be the most appropriate method for purchasing grain for the reserve it should be recognised that, under free market conditions, neither a parastatal nor an institutional agency has the flexibility which individual traders have, to react instantaneously to movements in commodity markets. Thus, in a competitive trading situation, it is the trader who will normally be able to out-perform an institution.
Options which could be considered for the purchase of grain include: direct purchase, either at the prevailing market or at a support price; using appointed agents and through public open tendering. As parastatals are normally also grain traders in their own right, it would be normal to expect that they would choose to use their own resources for purchasing grain for the reserve, either through their established buying points and/or at their depot locations. However, consideration could be given to requiring the parastatal to formerly involve private sector traders to supply a proportion of grain required for the reserve either acting as agents or through open public tender.
Specialist reserve agencies are not regular purchasers in the market, as are normal traders, but only enter the market occasionally, normally immediately after harvest, to make purchases to replenish the reserve. Under these circumstances it is unlikely to be economic for an agency to set up the structures necessary to purchase its requirements directly in the market in parallel, or competition, with established traders. It would normally be preferable for the agency to either appoint agents to purchase grain on its behalf or use a tendering system. Both systems avoid the need of an agency having to establish and staff its own purchasing structure, which would only be required infrequently, while they both try to harness the skills and energy of the private sector to supply the quantities required. By using existing market participants in their normal marketing roles they do not distort the normal functioning of the market, except for increasing demand.
Using agents to purchase grain for the reserve, who are also traders in their own right, is vulnerable to malpractice. Quite naturally agents will tend to reserve the best qualities of grain for their own transactions with the poorer qualities of grain, which may well still be within the specification, being offered to the reserve. With no means of proving the actual purchase price paid, it is probable that the reserve will be overcharged for the grain supplied. A tendering system offers the likelihood of increased competition between traders for the supply of specific quantities of grain of a specified quality to nominated locations. As such the prices quoted are more likely to reflect the prevailing market price. There is a likelihood, however, that traders, not used to the discipline of contracts, may tend to default when they find they are unable to fulfil their obligations, or when they find an alternative customer willing to pay a higher price. To minimise such risks consideration could be given to requiring a performance bond redeemable only on satisfactory completion of the contract. The tendering system has already been adopted as the standard procedure for the purchase of grain for the reserve in Malawi, Tanzania and Zambia. The reserve needs to recognise that, initially at least, many of the traders operating in the grain market and wanting to supply the reserve are relatively small businessmen, with limited working capital. As such they may not be in a position to extend credit to the reserve agency for the full value of their contract. The possibility of making stage payments, say after the delivery of a specified quantity, is recommended.
In addition to the purchase of grain on the domestic market for the reserve, there may be a need to consider purchases of grain on the international market. This would be particularly the case when the severity of a crop failure puts pressure on grain prices early in the marketing year. Under such circumstances trying to make significant purchases in the domestic market may well cause prices to rise even faster. The extent to which the reserve agency would need to enter the international market would, in turn, depend on the extent to which the market has been liberalised and the private sector encouraged to import directly on its own account to make good any market shortfall. However, as the private sector will not want to over-import, because of the lowering effect it would have on market prices, the agency responsible for the reserve will need to take a cautious position and ensure that it has sufficient stocks to meet any perceived shortfall in private sector grain imports. To assist in the determination of this "import gap", i.e. the difference between the perceived import requirements and the provision made by the private sector, it may be desirable to require importers to register the quantities they have arranged to import to enable the total import provision to be calculated. The total confirmed import quantity could also be made available to the private sector to help them in their decision making processes.
Apart from concerns over not wanting to over-import other constraints may limit the private sector's ability, or willingness to import. These include: difficulties in gaining access to foreign exchange for the purchase, lack of experience in importing substantial quantities, small scale of operation of many private sector traders and concerns over possible government interventions. Under such circumstances, the government may wish to provide some support to the private sector to their mutual advantage. This could be undertaken for example by the government acting as an intermediate importer, i.e. arranging for the import of grain and then selling it off to traders in smaller, more manageable, lots1 The price charged for the grain should carry a premium so that traders who import directly have some commercial advantage and the government does not import at a loss. Alternatively, the government may enter into arrangements with the commercial banks to underwrite part of the loans made to finance grain imports.
1 For example the government could make arrangements for the import of 20,000 tonnes of grain and then sell it off in 1,000 tonne lots to millers/traders
In the event that there still remains an "import gap" the reserve, if it does not hold sufficient stocks to cover the gap, may need to enter the international market to buy the required quantities for crediting to the reserve, where it would be used in the same manner as other grains held. This is a less desirable option than encouraging private sector imports, or selling imported grain to traders in lots on arrival, as the government would have to finance the cost of the grain until it was finally marketed, which could be several months later. It is therefore in the government's direct financial interest to set the climate for encouraging private sector imports.
A more advanced option which could also be considered by reserve agency/government is the use of other financial instruments for covering all, or part, of the import needs. These are the use of futures and options for either hedging positions or providing a form of insurance, Appendix 2. However, a word of caution is required if the use of such instruments is being considered. While they can be of considerable assistance in lowering costs in a commodity market, they can also lead to substantial financial losses if not used properly. To take advantage of such systems a detailed knowledge and experience of the international market is essential. As in most countries this expertise is not readily available, agencies considering using these, or similar, instruments should seek the advice of a reputable trading house or broker1
1 Impartial advice can be obtained from organisations such as FAO and UNCTAD.
Options for the Purchase of Grain for Establishing the Reserve
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Options |
Advantages |
Disadvantages |
Comments |
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Direct purchase by agency at market price |
a) Agency able to control the quantities purchased by selecting when, where and for how long to enter the market. |
a) Agency unlikely to be able to compete effectively with private traders who are able to respond more rapidly to changes in market conditions. |
a) Purchases should be made over a prolonged period and in several locations to minimise pressure on prices |
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b) Agency has to maintain procurement points whether purchases made or not |
b) Emphasis could be given to concentrating purchases in disadvantaged areas. However, because of higher distribution costs it is likely to be more expensive. |
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c) Likelihood of a large number of small individual transactions. |
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at support price
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a) Provides a floor price for producers. |
a) In surplus years agency likely to buy large quantities when amount required for reserve is at a minimum. |
a) Floor price should only be supported at a limited number of locations, otherwise would be tantamount to re-introducing pan-territorial prices |
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b) Agency does not have to adjust prices as market conditions change. |
b) In deficit years when market price above the floor the agency will only buy marginal quantities. |
b) To avoid an open ended commitment to purchases the agency could restrict purchases to an publicised maximum.
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c) Opportunities for falsify recording purchase prices reduced.
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c) Agency has to maintain procurement points whether purchases made or not. |
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d) Largest amounts likely to be bought in the more remote areas where producer prices are lowest. |
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e) Likelihood of a large number of small individual transactions. |
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Using appointed agents |
a) Agency does not have to establish or maintain procurement facilities |
a) Opportunities exist for malpractices as difficult to supervise agent |
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b) Uncertainty how much will be offered. |
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Purchase through tenders
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a) Agency not required to establish buying points. |
a) During the initial years of market liberalisation traders may not be of sufficient size or have the experience or discipline to meet contract requirements. There is a danger that traders could default on delivering contracted amounts.
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a) To discourage default on contracts an effective and enforceable law of contract needs to be in place. |
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b) Private traders responsible for the purchase and delivery of the contracted amounts to the agreed storage locations. |
b) Consideration could be given to requiring performance bonds from the larger tenderers to discourage default.
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c) Quality standards can be easily enforced. |
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d) By using traders to supply the grain the agency is not directly involved in the market and can therefore not be accused of distorting the market. |
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e) Control over the quantities purchased and price paid. |
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Commercial Imports
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a) Enables reserve stocks to be built-up when domestic availabilities are low |
a) Foreign exchange required |
a) Should be made only when insufficient domestic supplies are available to |
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without having an impact on the domestic market |
b) Purchase price is likely to be high
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replenish existing reserve stocks to levels needed to meet perceived requirement |
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b) Possible to use advanced instruments, such as futures and options, to hedge price fluctuations |
b) Could also be made to compensate for perceived under-provision by private traders |
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Food Aid |
a) Free of charge or at a concessional price |
a) Often not the type of grain required, e g yellow instead of white maize, or wheat instead of white maize or sorghum |
a) Gram supplied as food aid may need to be monetised by sale into the market to provide finance for the purchase of required grain type |
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b) Prolonged delays often experienced in receipt of food aid |
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c) Grain provided is often of a poor quality and likely to attract a lower price on the market |
In the years when regulated markets were the norm food aid destined for market operations was usually channelled through parastatal grain agencies The grain was normally sold into the market at the prevailing official price, usually heavily subsidised, with the revenues so generated often being absorbed by the parastatals to help cover their losses In addition to handling the marketed food aid, the parastatals were also often used as conduits for channelling food aid in support of relief operations to NGOs or government agencies
With the transition to liberalised markets far more care is required with respect to the manner in which food aid is released into the market to ensure that it does not distort normal market operations or undermine the confidence of private sector traders There are essentially two options open to government for minimising these risks The first is to absorb the food aid which is to be monetised into the strategic grain reserve, where it would be treated as a normal part of the reserve stocks, and the second is to treat it as a commercial import undertaken by government with the grain being sold progressively into the market Sales into the market, are particularly useful when the grain is either not of the type usually held in the reserve, e g yellow maize or wheat rather than white maize, or if its storage life is limited By generating cash from the sale the required type of grain for the reserve can be purchased.
Due consideration should be given to the method of sale and the price at which the grain is sold To avoid depressing the market at a time when prices are already low, i.e. just after harvest, sales should preferably be made, at market prices, towards the end of the marketing year when prices start to rise This would also serve to maximise the revenue generated Because the grain was either a donation or supplied on concessionary terms, the temptation to sell it at prices below the prevailing market price should be avoided This would either serve to disrupt the market and undermine trader confidence or provide traders with an ideal opportunity for making excessive profit at the expense of the government Care should also be taken when releasing such grain into the market that existing import positions of traders are not compromised. Ideally food aid sales should be made at prices which are in excess of the prevailing import parity price for the particular location. To avoid misunderstandings government should also keep private traders fully advised of any planned arrival of food aid shipments and of the manner in which they are to be used. This will help the private sector adjust its market position to take account of the likely impact that the additional quantities of grain will have on the market.
