Regulatory Impediments to Market Based Policy Reforms in Agriculture: The Case of NWRs International Workshop On Indian Agriculture: Improving Competition, Markets and the Efficiency of Supply Chains Jyoti Gujral Piyush Joshi Infrastructure Development Finance Clarus Law Associates Company Limited 1
Contents n Current Scenario in Indian Agriculture n Regulated Markets: Showing signs of market failure n Need for market based policy reforms in Agriculture n Negotiable warehouse receipt (“NWR”) – Potential holistic solution n Benefits & impediments to NWR use n Promoting use of NWRs – an alternate approach for FCI n Broader Legal & regulatory framework to facilitate NWR based markets 2
Current Scenario in Indian Agriculture: Farmer in a debt trap n Agricultural activities in India are largely carried out by small and marginal farmers 121 million operational holdings, over 80 percent of which comprise marginal and small holdings of less than 2 hectares (ha). (Census 2001 figures). n R&D, Extension, Market intelligence services by govt. but inadequate n The farmer needs timely credit – his credit needs include personal loans. Credit is often provided by the trader (informal money lending system) either by: holding the farmer produce as collateral; or in kind i. e. in form of inputs (seeds, fertilizers, supplements etc. ) n Storage is either not available or owned by the trader/moneylender who does not encourage the farmer to get credit from other sources. n As a result, Either the trader sells the farmers produce and deducts the principal and the interest, (the price received by farmers is therefore discovered under limited circumstances - not competitively discovered – forcing farmer to sell through trader only) or Farmer is pressurized into distress sales to square off debts soon after harvesting – barely recovering capital and does not foster emergence of agriculture support service providers – extension, market intelligence, credit, inputs, storage etc. n The multiple roles performed by the trader allow him to exploit the farmer, who finds himself in a debt trap 3
Regulated Markets: Showing signs of market failure n The current regulatory framework provided by the State APMC Laws has resulted in market failure by: facilitating a supply chain with a large number of intermediaries, thereby reducing the profitability of agriculture reducing scope for competition due to the licensing regime adopted high taxation - reducing scope for innovation, diverting trade into informal channels n APM Laws are inadvertently promoting use of intermediaries by not permitting trade outside the market yards. Currently, there is a long (non-value) supply chain with 3 -5 intermediaries between the farmer and the consumer. Two major costs (intermediaries’ margins and the handling costs) get added and the farmer gets only 25% -60% of the price that the consumer pays finally. n Further, the APM Laws have resulted in strong incentives for the intermediaries to act in an anti-competitive manner by restricting licensees and permitting few traders to be money lenders, input suppliers, storage owners and processors. The focus of government is in fact on guaranteeing marketing margins enjoyed by intermediaries and using their regulatory powers to ensure collection of market fees, cess etc. , with farmers at the end of the chain receiving what might be referred to as a 'residual price'. Also there further scope for 'unconscionable conduct' in relation to the final residual price offered to the farmer by the next intermediary High taxes make it difficult for the organised sector to compete with the existing players. 4
Need for Market Based Policy Reforms in Agriculture n India has been unsuccessfully trying to implement reforms in its agricultural marketing sector since the late nineties. Some early initiatives at providing alternative markets were: National Dairy Development Board’s auction market in Karnataka; Commodity exchanges Direct markets in AP, Punjab for horticulture produce n Even after a decade, the reforms have resulted in A handful of attempts to give/seek private market licenses. Only a couple of states have attempted contract farming over a few hundred thousand acres. Some retail initiatives that appeared promising have yet to integrate farmers fully through backward integration. The commodity exchanges have failed to provide accessibility to the small and medium farmer to the national market, who even today remains dependent for marketing his goods to the middleman. The middlemen either buy the goods from his doorstep (mostly at peak harvest period i. e. distress conditions), or in the nearest mandi which the farmer visits in a highly non-transparent manner or again in distress sale conditions. n There is an urgent need to introduce a new market mechanism that is efficient and has the power to link the farmer in a remote area with national and international markets – profitably. 5
Negotiable Warehouse Receipt (“NWR”) – Model with potential to offer a Holistic Solution n The Negotiable Warehouse Receipt (the “NWR”), is an instrument introduced recently under the Warehousing Development & Regulation Act (“WDRA or Act”) which has the potential to provide an alternate market channel that can link the farm gate to the national markets. n Warehouse receipts (WR) are documents issued by warehouses to depositors against the commodities deposited in the warehouses, for which the warehouse is the bailee. These documents are transferred by endorsement and delivery. n Negotiable warehouse receipt is a negotiable instrument. It is in the nature of an actionable claim representing a right to a commodity. n With the warehouse receipt based trading: Farmers can store their produce in the nearest registered warehouse Farmers can take the NWR to the nearest physical market (the “spot market”) or virtual market (the “spot exchange”). The farmer can sell the NWR to a trader. The trader can sell the NWR to another trader in a distant market. Thus, even though the receipts are handled by several intermediaries, the ‘physical goods’ need not move until the final delivery and this would greatly reduce the costs / wastages associated with multiple handling. The grading of commodities and scientific storage by an accredited warehouse (i. e. a third party) provide credibility to the receipts and facilitates paper based trading. n Thus, WRs can help the farmer to improve profitability addressing his need for credit, by allowing him to sell at the right time at the right place. . 6
Negotiable Warehouse Receipt (“NWR”) – Benefits -Farmers • Better prices for their goods • Loans at low interest rates • More and easy credit on the same produce • Reduced storage losses -Lenders • Reduced cost of lending • Reduced risk -Traders • Increase in trade • Reduced costs of transaction -Government -Warehousemen -Insurance companies • Assured quantity and quality of buffer stock • Cost saving • Rural Development • Higher capacity utilization • Higher charges • Increased business • Lower reinsurance premiums • Boost for new types of products 7
Negotiable Warehouse Receipt (“NWR”) – Key Impediments. . . 1 Indian agriculture scenario remains riddled with a plethora of laws that are outdated and continue to provide incentives to promote a system that has clearly failed. Current policy & regulatory framework is impeding growth… n Minimum Support Price (MSP) Regime: The high levels of Government intervention reduce seasonal price variability to a level where private parties are reluctant to store or use warehouse receipts. For example, millers often find it easier to let Government do the storage and procure their raw materials on a hand to mouth basis. The current FCI procurement is through the traditional mandis with the commission agent/traders strongly entrenched in it and there is no role at all currently for the warehouse receipt based systems. MSP and monopoly procurement encourage farmers to neglect quality control and offload produce onto the State. Thus, the continued procurement mechanism associated with FCI would propagate the existence of old incentive system and may result in no/low usage of WRs and reduce prospects of private sector investment in storage. n Sales Taxation: Present taxation regimes provide for the payment of mandi fee, cess and sales taxes levied either by the States or, in the case of inter-State movement, by the Government of India. As long as they exist and are chargeable on goods changing hands in warehouses, no secondary market for warehouse receipts will develop. This results in diverting sales to informal channels, discourage marketing innovations in the formal sector and makes it difficult for organized sector to compete with the existing traders. 8
Negotiable Warehouse Receipt (“NWR”) – Key Impediments… 2 n Agriculture Produce Marketing Act: Warehousing is a regulated activity under APM Laws and for commencement of warehousing activity in any location within a notified area, it is essential to obtain licenses from the APMC having jurisdiction over the respective market area. Since these licenses are for a period of one year and need to be renewed thereafter, this causes uncertainty and hinders investments in storage especially by organized players. The APMC Laws mandate trading of agricultural produce in the designated market yards in its jurisdiction, only by licensed traders of the respective APMC. The Act would apply in case of warehouse receipts based trading. If a person buys from a WR based market system and transports such goods they may be confiscated by APMC officials unless backed by valid licenses and papers to prove that mandi fees, cess etc has been paid. n State Warehousing Acts: Regulate warehouses in some states that intend to store certain identified commodities as per the prevalent legislation and generally cover agricultural goods. In fact the multitude of agencies that grant licenses make it even more difficult for any player to scale up operations for a pan India warehousing business. n Dynamic Tariffs in Imports: The Government of India is likely to use tariffs as a tool in protecting domestic producers which is likely to increase uncertainty over the value of collateral, diminishing the potential usefulness of warehouse receipts. 9
Negotiable Warehouse Receipt (“NWR”) – Key Impediments… 3 n Essential Commodities Act: Large scale private investment in storage and marketing has been absent due to certain restrictive provisions of the EC Act and control orders issued thereunder Storage of goods is sometimes construed as hoarding and any order issued by the Government against hoarding of stock directly affects the warehouses that have to comply with all Government orders issued in respect of storage of goods and stock limits. In respect of various essential commodities, the State Governments have issued Dealers Licensing Orders, which require a person to obtain license before buying or storing specific commodities. In such license, the Government also specifies stock limits. These powers prevent more efficient players from expanding their market share and could render producers less competitive. n Forward Markets (Regulation) Act, 1952 (FMR Act): The government uses futures trading as one of the instruments to contain rise in prices of agricultural commodities. The participation of traders and farmers in the futures trading is limited due to uncertainty in policies. In February 2007, Go. I banned futures trading in rice and wheat. Further, in May 2008, four more commodities such as potato, gram (Chana), soya oil, and rubber have been added to the list of banned commodities. Uncertain regulatory environment affects the commodity exchange business and though the physical / spot markets continue trading, the key potential drivers of the warehouse receipt business are affected. Trading in options is banned in India under the FCRA whereas it is an important and safe tool of hedging for farmers. 10
Negotiable Warehouse Receipts (“NWRs”) – Facilitating growth of warehouses n Promoting growth of warehouses: Warehouses are critical to any system of agricultural financing based on negotiable warehouse receipts or non negotiable warehouse receipts as the agricultural commodities have to be stored in a safe and certain location in order to enable development of a warehouse receipt system. Promoting the spot exchanges and NWR would provide the required boost to the warehousing sector once the farmers and traders see the additional advantages. n Promoting use of NWRs as a procurement tool for FCI: It may be possible to reduce the cost of the public food programme if FCI were to accept warehouse receipts in lieu of physical stocks and store food grains in rural godowns till they are required to be moved for distribution. A functioning warehouse receipt system obviates the need for government to build physical inventories to support prices as they could just purchase warehouse receipts when the prices fall below a certain minimum. 11
NWR based markets address market failure n Growth of national spot exchanges: The spot exchanges create an avenue for a direct market linkage among farmers, processors, exporters and end users with a view to reducing the cost of intermediation and enhancing price realization by farmers. They also provide the most efficient spot price inputs to the futures exchanges. They bring home the advantages of an electronic spot trading platform to all market participants in the agricultural and nonagricultural segments. The spot exchanges can most effectively use negotiable warehouse receipts to develop national markets. A pan India electronic market removes the inherent inefficiencies in the APMCs market and has proved that farmers realisation has increased by 4 -6% despite paying the market fees/cess etc. to the APMCs. n National spot exchanges address market failure in three ways: First, it improves the overall efficiency of the supply chain as it reduces handling costs; second, it offers advantages relating to information, price formation and standardization; and finally it provide access to finance and remote markets to the small farmers. 12
Negotiable Warehouse Receipts (“NWRs”) – Need for broader legal & regulatory framework Given the web of regulations governing the agriculture sector there is a need for broader regulatory reform and for facilitating the emergence of more market based government and private sector initiatives. n Enacting a comprehensive Warehousing Law: Though warehousing activity is not defined under any Schedule of the Constitution of India, still commencement of warehousing activity needs licenses from various authorities. Regulation of warehouses by APMCs results in requirements of separate approvals for establishing warehouses in different locations even within the same state. Additionally, many states have State Warehousing Acts that further regulate the establishment of warehouses that intend to store agricultural commodities that are notified or specified under the State Warehousing Act. This translates into a staggering licensing and regulatory compliance requirement for the development of any national network of warehouses that are of a uniform minimum standard. Consequently, in order that the benefits intended from introducing NWRs are actually realised and made available to the farmers, it is necessary that a comprehensive national level legislation regulating warehouses be formulated. For this it is recommended that WDRA be suitably amended and be made into a comprehensive warehousing law. 13
Negotiable Warehouse Receipts (“NWRs”) – Need for broader legal & regulatory framework n Integrating National Spot Exchanges under WDRA: National Spot Exchanges have the potential to help NWRs’ achieve its full potential. At present the growth of the National Spot Exchanges is adversely affected as they have to register with the relevant APMC’s to be permitted to trade. WDRA must free them from the ‘undue intervention by the APMCs’. Under the WDRA when they integrate the accredited warehouses, they would simply be the platform for EWRs and not ‘traders’ or ‘markets’ who need a license from the APMC’s. WDRA can frame rules authorizing and registering spot exchanges as being one of the authorized platforms for issuing and trading of electronic warehouse receipts and thereby take them out of the ambit of the APM Laws. n Integrating Commodity Exchanges under WDRA: FMC should encourage physical settlement through the use of warehouse receipts and should be made mandatory where possible. The use of warehouse receipts to fulfill margin requirements should be encouraged. Contracts that envisage delivery through warehouse receipts should be given fast track approval. Cash settlement may be disallowed until warehouse receipts become entrenched in the cash market. The Authority must recognise the standards adopted by the Commodity exchanges and permit their warehouse to issue NWRs. 14
Negotiable Warehouse Receipts (“NWRs”) – Clarifications required n Need to Clarify Impact of “Negotiability” of a Warehouse Receipt Confusion exists whether each transfer of a NWR by virtue of its endorsement as a negotiable instrument would attract APMC market fee, sales tax, etc. , as there is a change in title to the underlying goods or whether APMC market fee, sales tax etc. would arise only at the point the ultimate holder of the NWR seeks to take physical delivery of the goods at the warehouse based on the NWR. n Need to Clarify Position of WRs under Sales Tax: There is no clarity under the WDRA on the issue of: whethere would be a charge imposed on each stage of a transaction of a negotiable warehouse receipt; what shall be the situs of such charge; and what steps need to be taken in order to bring some clarity in the relevant legislations in relation to the above mentioned issues. n Need to resolve implication of Storage Orders and Essential Commodities Act: The ECA mandates that commodities that have been identified as being “essential commodities” can only be traded and stored by licensed holders. n Need to resolve confusion w. r. t position of NWR under Forward Contract Regulation Act: Confusion exists since FCRA states that any transaction involving transfer of document of title and not of actual physical delivery becomes a forward contract, and therefore transfer of NWRs without physical possession of goods would become a forward contract. 15
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