How the devil is in the details of an agricultural warehouse receipt system

How the devil is in the details of an agricultural warehouse receipt system

Attempts to unlock the potential of  agriculture in Zimbabwe and other African countries have seen concepts like ‘agricultural commodity exchange’ and ‘warehouse receipt system’ coming into discussions by policy makers, financial institutions and development partners.  However, these concepts have proved easier said than done.  A commodity exchange may be easy to understand since it basically entails commodities of equal value being exchanged. More than a decade ago, Zimbabwe used to have the Zimbabwe Agricultural Commodity Exchange (ZIMACE) which focused on trading three crops only (maize, wheat and soya bean) from a few commercial farmers. Efforts to revive the commodity exchange have been on the drawing board for the past two years.  Given the new agricultural dynamics where more than 40 different agricultural commodities are produced by hundreds of farmers across the country, the new ZIMACE should have a new complexion.  This is a story for another day.  For now, let us move to the warehouse receipt system.

26 October 1

Unpacking the notion of a warehouse receipt system

A simple description of how a warehouse receipt system functions is this: A farmer delivers commodities (say, maize) to a central warehouse and s/he is given a collateral certificate (receipt) that s/he can present to a bank.  Since commodities (maize) delivered in the warehouse work as a bond, the bank is comfortable extending  a loan to the farmer so that the farmer can buy inputs as well as meet other needs. Once commodities are sold, the farmer’s loan is repaid directly to the bank by the warehouse receipt system management, with the farmer receiving some change.

Where things start getting complicated

Generally the notion of warehousing has to do with a fall-back position or a back- up food system.   After estimating the amount of food a household requires for a season, each farmer decides to store and warehouse surplus as a way of sustaining food availability over a long period of time.  In the case of businesses, warehousing is meant to sustain a certain level of stocks (commodities) so that the business is able to consistently meet customer needs. That is why each business takes re-order levels seriously.

In a properly organised marketing system backed by accurate production projections and assured availability of commodities when required, businesses and farmers or consumers have the luxury of keeping stocks in their warehouses very low. It takes resources to keep commodities in a warehouse.  If a farmer can easily access some food items all year round after selling three quarters of his/her maize just after harvesting, the farmer can rely on the market for future household consumption. Selling commodities soon after harvest allows a farmer to re-invest in other income-generating projects like poultry or piggery, resulting in more income.

However, because farmers are not certain whether they are going to get the same food items in the market and realize income, they tend to try and keep enough food to last six months.  This uncertainty, of getting commodities at the same price, leads to farmers remaining anxious about matching production and the market.  As long as the opportunity cost of selling is greater than warehousing, farmers will prefer warehousing at household level up to the next season instead of selling and later buying from the market.  For example a farmer who sells two tons of maize after harvest, can earn $400 plus an extra $200 earned from investing in an income generating project. If the same farmer later tries to repurchase the same two tons of maize from market at $700, it means the farmer has incurred an extra $100 cost to repossess the same two tons.

On the other hand, if a farmer presents his or her commodities as collateral to the warehouse receipt system at $250 a ton and goes on to get a loan of $500 from a bank at an interest of 10%, the farmer will repay a total of $600. If it happens that during the time his/her maize is in the central warehouse receipt system the price goes up by 10%, the farmer will realize $550, meaning s/he will need to top up another $50 to settle the loan.  This means a challenges for the warehouse receipt system is anticipating charges that may eat into expected price increases, worsening a farmer’s position upon repayment.

Another scenario relates to lost opportunity cost that comes with warehousing, where a farmer is locking expected income streams in warehoused commodity.  For example a farmer can sell two tons of maize on the open market upon harvest and earn $500, allowing him/her to engage in income generating projects that will earn him/her an extra $200 in six months.  If the farmer gets a loan from the warehouse receipt system at an interest of 10%, s/he repays $600.  This means during that period the farmer will have lost $100 that he would have earned by selling commodities on his own just after harvest and re-invested in other income-generating projects.

It is possible that if a farmer is allowed to sell two tons and re-invest in other income generating projects, s/he should be given an extra loan of $500 using other forms of collateral such as cattle. The income from the sale of maize and investing in other income generating projects will be used to repay the loan.  In six months the farmer’s income will be $700 and that of the loan to be repaid will be $600.  The farmer can repay the loan and remain with an extra $100 as well as commodities in the field still secured by the already repaid loan.

In the warehouse receipt system, who makes critical decisions?

Once s/he delivers to the warehouse, the farmer might continue speculating and anticipating favourable prices while the bank will be expecting its loan repayment.  The farmer will be forced to sell commodities when s/he is still expecting prices to rise. Since the warehouse receipt system has no control over the external market, will it make enough profit to be able to meet costs related to fumigation, storage, security, transport and others?  One commodity can be transported to a central warehouse only to be re-transported back to the same community as people buy back the same commodity.  Who will bear these costs?  Who will make decisions to sell and manage the system?  Who ensures quality remains the same in a warehouse?  The whole logistical and management system has costs that have to be fully understood.

There is a loss of ownership of commodities by the farmer once s/he delivers to the warehouse. In the event of a drought, farmers who will have used commodities as collateral will not be able to afford the same amount of commodities they will have put in the warehouse.  This means the burden of warehousing is shifted to the farmer.

Dealing with relationships between commodities

In most markets, agricultural commodities have unique relationships which have to be understood before introducing a warehouse receipt system or a commodity exchange. Some commodities move in pairs while others act as substitutes.  If you lock soya bean in a warehouse receipt system and influence its presence in the market, sunflowers and other oil seeds can take the place of soya bean as consumers adjust to what is available in the market.  If you lock sweet potatoes, some consumers can substitute sweet potatoes with pumpkins and butternuts.  The warehouse receipt system may not have sufficient control on consumer tastes and behaviour.

26 October 2

As complementarity commodities, leafy vegetables and tomatoes tend to go together.  In addition, most field crops move with vegetables as relish.  If you lock field crops like maize, farmers are left with horticulture (relish) and meat (beef, chicken), etc.  Since most commodities targeted for warehousing may be basic necessities and staples, locking these commodities in a warehouse may deprive communities of their staple and disrupt local food baskets. As an experiment, the warehouse receipt system may be introduced in cash crops like cotton and tobacco where farmers can be availed inputs while prices of these commodities firm up.  A lot of work still remains to be done on practical aspects of the warehouse receipt system. The system has failed in a number of African countries due to lack of thorough analysis and understanding of agricultural commodity dynamics.

Here is an alternative model

Since buyers and processors may not have enough cash all the time, it would be better to introduce a tripartite arrangement involving the farmer, the buyer and the bank.  Farmers can supply commodities to the processor or buyer at an agreed price.  The bank pays the farmer so that the farmer goes back to the farm while the processor gets busy processing while the buyer gets busy selling. The buyer and processor pays the bank as commodities and processed products are sold. This arrangement takes care of the usual problem where smallholder farmers do not want to wait 21 to 30 days for payment.  Banks and processors or buyers don’t mind waiting that long for payment.

Where we have 21 – 30 day repayment periods the farmer will be idle, waiting for payment while the buyer and processor will be the only ones active.  The tripartite arrangement enables bot the farmer and processor/buyer to be active simultaneously.  Once the system is fully functional, all the three actors will be active.  The processor/buyer will be busy repaying the bank, the bank will be busy disbursing to farmers while the farmers will be busy producing and supplying to the processor/buyer.  Besides locking money in the system, this arrangement has an in-built collateral mechanism tied with flowing commodities.  The arrangement can be extended to 3 – 6 months so that as the farmer produces according to a production calendar, the processor has time to process and be ready for commodities.  The facility can also vary with commodities depending on production calendar.

This model rides on margins in each business model not on the principal loan.  The process will be able to pay the loan and allow every actor to remain with some margin after value addition.  The bank should be able to pay farmers with a small mark up. If commodities are worth $1000, the bank pays the farmer $1100 so that the farmer makes a mark-up of $100. The processor/buyer sales at $1400 and goes on to repay $1200 to the bank. This means the buyer/processor gets $200 profit while the bank and farmer gets $100 each.  The processor/buyer gets slightly more to cushion against handling and uncertainties in the market.  This is a win-win situation.

Most of the maize in Zimbabwe’s informal market is wanted by processors but because the processors do not  have ready capital, the commodities are in the informal market where the price may be beyond what the processor can afford in order to stay in business. We have to re-discover our collective relationships if agriculture is to drive the economy. / /

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