An impending problem with wheat inventories of the government

by Ajay Shah.

Wheat stocks with the FCI had risen to 24 million tonnes in 2012-13. This was an imprudent level of inventory, either when compared with the requirement of buffer stock in the country, or when compared with the ability to store wheat in the public system. There was a concerted effort to bring down this inventory, and it was brought all the way down to 8 million MT in 2016-17.

We may now face a bit of a problem on this score. Under certain assumptions, there is a possibility that at the end of 2021-22, wheat stocks could be about 35 million MT.

	Govt. opening stock	Produc-tion	Procure-ment	PDS, Schemes outgo	Open Market Sales Scheme (OMSS)	Closing stock
2017-18	8.1	92.5	31	24	1.4	13.7
2018-19	13.7	92	36	24	8.1	17.5
2019-20	17.5	97.5	34	24	3.0	24.3
2020-21	24.7	98.5	39	34	1.5	27.3
2021-22 (Estimated)	27.3	98	39	24	7.0	35.3

The table above shows data for recent years, and an estimate for 2021-22. At the end of 2016-17, i.e. at the start of 2017-18, wheat stocks were at 8.1 million MT. From this point, inventories have come back up.

Procurement rose to 39 million MT in 2020-21. We assume that it will stay at the same level in 2021-22.

The use of wheat in the public system has been stable at about 23 or 24 million MT. The exception to this is 2020-21 where an additional 10 million MT were given out into the country through "PM Garib Kalyan Yojana", on account of the Covid-19 crisis.

Assuming that 7 million MT is sold through the OMSS, this yields a projection of closing stock, on 31/March/2022, of 35 million MT.

It is worth reiterating the assumptions under which we posit this scenario, for wheat inventory of 35 million MT on 31/March/2022: (a) Public procurement in 2021-22 will be the same as the previous year, i.e. 39 million MT, (b) 24 million MT will be used by PDS and other schemes and (c) Government will sell 7 million MT to the private sector through OMSS.

Holding 35 million MT of inventory presents certain difficulties. It represents an unreasonable scale of holding a buffer stock, when compared with the requirements associated with fluctuations of wheat production. As the data in the column shows, the fluctuations of wheat production are about a few million MT; e.g. a buffer stock of 5 million MT to 8 million MT would suffice. In addition, 35 million MT is likely to exceed the mechanisms available in the public system to safely store wheat. When low quality storage mechanisms are employed, the exchequer loses money owing to depreciation.

This problem was incipient in 2020-21 also, and was averted because an additional 10 million MT was pushed out into schemes, on account of Covid-19.

What can the government do in order to fare better? There are four useful pathways:

1. If wheat procurement is reduced, then the problem will be diminished. As an example, if the government goes back to the 2019-20 level of buying 34 million MT, this would get the projected closing stock down from 35 million MT to 30 million MT.

2. Selling more wheat through OMSS would help. At its peak, 8.2 million MT was sold thorugh OMSS in 2018-19.

3. The macroeconomic distress associated with Covid-19 has not entirely subsided. Hence, there is a case for repeating something like the PMGKY grain subsidy, to help improve access to food for poor people.

4. Improvements in storage, such as going beyond CWC to private warehouses, will reduce the extent to which stored wheat depreciates.

There is a need for policy makers on food to recognise these impending problems and initiate steps through some linear combination of these four actions. On a similar subject, also see an article by Siraj Hussain and Jugal Mohapatra.

Closing the gap between farmers and warehouses

by Smriti Sharma.

Warehouses have long been considered important for holding and preserving crops. But warehouses can also potentially solve liquidity issues for farmers. Prices for commodities are depressed immediately after harvest because most farmers bring their crops to the market and this excessive supply pushes the prices down. This means that farmers have to settle for prices that may not be remunerative. If farmers could store their crops in warehouses till the time they got a better price for their produce, it could help avoid the distress sales, but farmers don't use warehouses. The reasons for that can be broadly divided into a) Lack of finance and b) lack of access to storage:

Lack of finance

Small farmers don't have the financial wherewithal to hold their crops. According to the NSSO, in the year 2013, almost 86 per cent of the Indian farmers held less than 2 hectares of land. Of these 86 per cent farmers holding less that 2 hectares of land, 80 per cent farmers held only 1 hectare of land. The same report points out that every month farmers holding upto 1 hectare of land spent Rs. 1213 more than they earned. In case of farmers with upto 2 hectares of land, the dissaving was of Rs. 469 per month. Small farmers depend on the earnings of one harvest to finance sowing the next and therefore cannot store their crops and wait.

Another reason farmers don't store their crops is because farmers need money to repay their loans. In absence of access to formal sources of finance, small and marginal farmers borrow money from arhatiyas and other middlemen at very high interest rates. Farming is a resource intensive business. Cultivating a crop requires seeds, fertilizers, pesticides, water and fuel. Farmers usually procure these inputs on credit. The arhatiyas lend money to farmers at a exorbitant interest rates ranging from 24 per cent to 45 per cent per annum. This creates a pressure on the farmers to sell their harvest as soon as possible and repay the money to the arhatiyas.

Lack of access to storage options

Warehouses are usually far from the production centres and closer to mandis. Farmers don't find it viable to transport small quantities to warehouses. This is because the transportation costs, storage charges, loading and unloading charges end up exceeding the remuneration. This is why farmers prefer to sell their produce to a local village-level middleman who can aggregate crops of various farmers and take the entire stock to the mandi.

There do exist some godowns in rural areas but such warehouses are not equipped to scientifically store and preserve the crop. The Government started Grameen Bhandaran Yojna in 2001 to encourage scientific warehousing in rural areas but this study reveals that most godowns built under the scheme did not conform to the quality parameters for scientific warehousing. When a farmer stores his crop in a warehouse, he's in effect leaving his entire wealth in the hands of people managing the warehouse. Leaving his wealth in either an unsecured place or unreliable hands is a risk that a small farmer cannot bear. Which is why, farmers are reluctant to store their produce.




How would we address these problems?

Improve quality of warehouses

Warehouses are not simply storage points. Warehousing is a combination of the product (the warehousing facility) and the service (warehouse management). Until now, the warehousing regulations in India focused only on the physical attributes of the warehouses, things such as the plinth height, ceiling and flooring. However, the warehouse service providers need to be assessed on the basis of their ability to preserve quality and make good for any losses (if incurred) to depositors. Warehousing Development and Regulatory Authority (WDRA) is currently in the process of re-writing its warehouse registration rules wherein the focus would be on the systems and processes for warehouse management, heightened disclosures and making more information available to market participants. These requirements will ensure that the warehousing space is occupied only by those who have the financial, managerial and technical strength to do the business of warehousing.

In addition, WDRA intends to bring in a system of grading warehouses which will help in differentiating warehouses as well as bridge the information gaps in the warehousing sector. The system of grading will generate and encourage a system of information creation that will be useful for farmers to identify the warehouses in their proximity that they can use to store their crops.

Bring the mandi to the warehouse

Farmers avoid going to mandi because the transportation charges, loading and unloading charges make the entire deal unviable. If WDRA registered warehouses could be recognised as sub-market yards as suggested in this article, then the distance between farmers and buyers could be reduced. Farmers could use warehouses as a point of storage until the time the market turns favourable. In the meantime, the stock could be pledged to avail loans from banks. Currently, the warehousing market largely offers a physical storage receipt against which farmers can get their stock financed. Banks lien the stock, place an external collateral management company to secure the quantity and quality of stock. With negotiable warehouse receipts issued by WDRA-registered warehouses, farmers would be able to transfer the ownership of their commodity without having to make physical deliveries. This will save costs for farmers and encourage them to store their crops in warehouses.

Achieving scale through aggregation

Small and marginal farmers with their small yields are unable to interest the buyers to procure crops from them directly. This re-inforces the dependence of farmers on aggregators. Some states in India have done away with the APMC Act to enable farmers to market their produce directly. However, farmers continue to depend on middlemen to buy their harvest and sell it further. This issue of dependence cannot be solved unless small farmers achieve scale which is also their Achilles' heel. Farmers need to aggregate their produce so that they can collectively rent warehouse, market their produce and negotiate better terms for procuring farming inputs and loans. This form of aggregations is already being tried out with farmer producer organisations (FPOs) and primary agricultural cooperatives (PACs).

Some success stories have been shared here. To encourage aggregation among farmers, NABARD has set up a Producer Organisation Development Fund (PODF) to provide credit support to any registered producer organisation by way of grants or loans or both. More steps in the same direction need to be taken.

Conclusion

Warehousing is both a need and the solution to farmers' post harvest crop management. WDRA is hoping to reform the warehousing space with better registration requirements, inspection and supervision mechanisms. This will instill a lot of confidence among the users of warehouses including the farmers and the banks. This in turn will help bridge the distance between the farmers and the warehouses.

Acknowledgement

I am grateful to Amey Sapre for insights.

New moves in regulating warehouses

by Anirudh Burman and Iravati Damle.

Warehousing is an important aspect of supply chains. Good warehousing has direct advantages in terms of storage of value, facilitating pledge financing, reduction in wastage, and reducing price shocks by allowing market participants to anticipate future demand and plan for the same. Warehousing has to be trustworthy for these benefits to accrue. Market participants have to be confident that the information provided in warehouse receipts (proof of deposit of a commodity) is accurate at all times. The warehousing sector in India does not reflect these attributes at present. Government regulation can correct some of these inefficiencies.

The warehousing sector in India is unorganised and fragmented (link). The organised segment is dominated by the public sector undertakings such as the Central Warehousing Corporation (CWC) and State Warehousing Corporations (SWC). Over the past decade, private firms have ventured into the business of warehouse services (warehouse service providers or "WSPs"). A large number of small and state level entities dominate the private warehousing segment (link). Under the current constitutional framework, state governments make legislation to regulate licensing of warehouses(For example, West Bengal Warehousing Act, Punjab Warehousing Act, Karnataka Warehousing Act). States across the country have different licensing norms; with different standards (See page 16 of a note on the proposed framework for registration of warehouses for comparison of State warehousing laws of Punjab, West Bengal and Karnataka)


This has resulted in the following problems in the warehousing sector:

• Lack of national standards and uneven levels of enforcement action on offences committed by Warehouse Service Providers (WSP).
• The absence of an integrated information system prevents high quality warehouse service providers from sharing information with potential customers. Therefore, they are unable to differentiate their services from the other players in the market and charge higher rents. As a result, the sector is currently in a low level equilibrium. This will ultimately hamper the growth of the warehousing market, with high-quality warehousing services withdrawing.

The market has started creating its own systems for dealing with inefficiencies. For instance: Banks undertake lending activities against warehouse receipts through Collateral Management Companies (CMC). These banks pay a premium to the collateral managers to insure themselves against the risks of bad warehousing. The collateral managers provide a range of services, including:

• Locating good warehousing facilities;
• Taking delivery of pledged commodities and/ or verifying their quantity and quality;
• Ensure the physical security and quality of the stock for the bank;

Establishment of WDRA

In 2006, the government passed the Warehousing Development Regulation Act, to make provisions for the development and regulation of warehouses, negotiability of warehouse receipts, establishment of a Warehousing Development and Regulatory Authority and for matters connected therewith or incidental thereto. The Act allows warehouses registered with the WDRA to issue Negotiable warehouse receipts (NWR), which are backed by a legal sanction. The WDR Act and accompanying rules and regulations stated registration requirements with the objective of keeping a check on the warehouse service provider. However, it has failed to receive the expected response from the market and bridge the information gap, with the use of NWRs being low.

How do we solve the problem?

WDRA was established to be a national regulator that would build trust and credibility in the instrument of warehouse receipts by ensuring warehouse operators are competent, follow the required processes correctly, and adhere to minimum standards set by WDRA. This is intended to add comfort to those trading in NWRs. As an agent of the State, WDRA has to do so by following the rule of law. Regulations drafted by it must follow a procedure where all stakeholders are informed of the rationale of the proposed regulatory system, the problems that the regulation proposes to solve, and the proposed method of solving these problems.

Lessons from FSLRC for WDRA

The recommendations of the Financial Sector Legislative Reforms Commission (FSLRC) are important in this regard (link).  The Financial Sector Legislative Reforms Commission drafted the Indian Financial Code (IFC) which makes substantial recommendations regarding the procedure that financial regulators must follow while making regulations (Report of FSLRC, Vol 2). By Section 52 of the IFC, if a financial regulator proposes to make any regulations:

• it must publish a draft of the proposed regulations
• this must be accompanied by a statement listing the objectives of the regulations, the problem that the regulations seek to address, the underlying principles, expected outcome, cost benefit analysis, process of making representations.
• it must list the reasons for preference of one principle over another.
• it must publish the representations received, take them into consideration and also state its response to the representations received.
• if the final regulations differ from the proposed regulations, it must list the details and reasons for the difference and also undertake a cost benefit analysis of the differing provisions.

NIPFP has supported WDRA in drafting two concept notes for making draft regulations pertaining to the registration and grading of warehouses. WDRA has solicited public comments on these notes:

• Cover Note: (link)
• Note 1, pertaining to the proposed regulatory framework for registering warehouses by WDRA: (link)
• Note 2, pertaining to the creation of a grading system for warehouses and the regulation of entities who may be allowed to grade warehouses: (link)

Feedback on the two notes may be sent latest by 20th July, 2015 to the Director (Tech.), WDRA at dirtech.wdra@nic.in or may also be sent to the Director (Tech.), WDRA, 4/1, Siri Institutional Area, August Kranti Marg, Hauz Khas, New Delhi 110016.

This style of rational, consultative and transparent regulation-making is, as yet, unusual in India.

Conclusion

The field of warehousing suffers from uneven regulation and the absence of national standards. Stakeholders argue that registration requirements with WDRA do not provide market relevant information about the credibility of the WSP/warehouses. The costs of registration outweigh the benefits. This is hampering the growth of the warehousing market in the country. The first note envisions a redesign of the registration process to establish minimum standards and provide quality assurance to market participants. The second note makes the case for WDRA to facilitate the process of generating credible information about registered entities through a system of grading warehouses and WSPs, after registration. While better registration norms will establish minimum standards, grading will ensure that the market gets information about the performance of the warehouse/WSP post registration. These interventions can enable WDRA to efficiently solve the market failures.

Solving market failures through information interventions

by Ajay Shah. 

The standard approach in public economics

The standard approach of conventional public economics is to emphasise that the market economy generally works well, barring a group of market failures. The job of government is to try to address these market failures. The standard checklist of market failures is:

1. Externalities -- e.g. a factory that pollutes.
2. Asymmetric information -- e.g. safety in food or medicines.
3. Market power -- e.g. firms that earn super-normal profit owing to weak competition, and
4. Public goods -- e.g. law and order.

In the standard approach we weigh market failures against the problems of obtaining effective State intervention. The barrier is `public choice theory': the State is not benevolent. The citizen is the principal, the State is the agent, and there is a principal-agent problem. It is not easy to obtain performance when setting up real world arrangements that will sally forth, intervene in the working of the economy, and address market failures. This limits the class of situations where intervention may be appropriate. In a world with a perfect and benevolent State, we'd do a lot more in terms of going after market failures. In India, where State capacity is low, we are very selective and only do a few things.

The end of asymmetric information?

Alex Tabarrok and Tyler Cowen look at the proliferation of methods to create, store and transmit information, and say that there is an increased class of situations where asymmetric information has been conquered, thus reducing the extent of market failures.

Improved access to information also reduces the public choice problem. More information about the activities of politicians and bureaucrats is available to the citizen, which reduces the principal-agent problem.

It's a good article. I felt the case was a bit overstated. E.g. reputation measures on the Internet help people see more about you, and that's good in some settings (e.g. you know something about the Uber driver), but it's a small change in a vast gulf of lack of information. E.g. the authors say : Many public choice problems are really problems of asymmetric information. I don't agree. Yes, more information will help, but the principal-agent problem between citizen and State is vast and complicated. Merely monitoring some of the activities of civil servants better does not solve the public choice problem.

There is vast asymmetric information in the relationship between an employer and an employee in most complex work places, and nothing has changed which will make a dent to this. We can think of numerous other situations where the asymmetric information has not changed.

More or less government intervention?

The flavour of the article is that with less asymmetric information, you'd need less State. Yes, that is true, but it's also the case that with less of a public choice problem, you could use more State. In thinking about public policy, we are constantly watching the market failure that's worth addressing versus our ability to construct a State apparatus that would actually deliver the goods in trying to address this market failure. The new age of improved information cuts both ways: it reduces the places where we might want a State intervention, and it increases the class of places where we could pull off a successful State intervention.

A new kind of State intervention

In this new age of easy capture, storage and transmission of information, I have felt that there is a new kind of State intervention: one which rearranges the information set. The State can use its coercive power to force certain kind of information to be captured or released or transmitted. This is a beautiful intervention that directly addresses the root cause of the market failure, the lack of information.

As an example, in the old analysis of insurance, there were some good drivers and some bad drivers, but the insurance company did not know who fell into what category. There was adverse selection (bad drivers were more likely to sign up for insurance) which led to high prices of insurance and many good drivers got insurance which was not actuarially fair.

This is the standard description of the market failure, in the textbooks. We can now think of a new kind of State intervention: The government forces cars to be equipped with devices that measure how the person drives. This is an intervention that directly stabs at the asymmetric information.

Here is another example which nicely illustrates an information intervention. We have been working in the field of regulation of warehouses. There is an asymmetric information problem: I submit my goods for storage at the warehouse, but I don't know how much care will be exercised by the warehouseman. There are old style interventions which reduce this information asymmetry.

In some situations, we can directly attack the information asymmetry. As an example, consider frozen food. When you deposit 1000 kilograms of cheese into a cold storage, you worry that the warehouseman will not maintain the temperature at precisely 4 degrees. But now there are low cost devices that will measure the temperature every minute and thus tell you what your cheese experienced.

Now the customer and the warehouseman can enter into a private contract where the temperature of the cheese is monitored, and a set of payoffs calculated based on the extent to which the temperature of the cheese strays above 4 degrees. Good warehousemen would think: Why don't I release this information, so that prospective customers would trust me? The trouble is: this data could be tampered with, or data could be selectively released.

This suggests the design of a government intervention: The government could establish an inspection mechanism which ensures truthful release of comprehensive data about all transactions by the warehouse. This is a combination of the new age of devices (the data logger) plus a dose of State intervention (to ensure truthful and complete data release). We could also envision a valuable State intervention that standardises the XML files which are put out by all warehousemen, which would reduce the cost of processing this data for customers.

This is an example of what I call an `information intervention', which rearranges the structure of information, and thus combats the market failure that's rooted in asymmetric information.

Improving warehousing in India through a grading mechanism

by Smriti Sharma.

A key sub-industry in modern agriculture is warehousing. Storage reduces price fluctuations. Trusted storage permits `dematerialisation', where warehouse receipts are traded or delivered, and is the key link between physical goods and finance. At present, the quantity and quality of warehouses in India are inadequate. This is a key bridge that has to be crossed for the modernisation of agriculture. Trusted mechanisms for warehousing of non-agricultural goods are also an important enabler of the market economy.

Warehouses claim to take in goods and keep them safe. The customer of a warehouse does not know the probability with which the promise will be violated. There are a diverse array of warehouses in India, but customers do not know the failure rate of alternative warehouses. Currently, consumers do not have information to differentiate between one warehouse and the other. Most people make a choice with regard to a warehouse on the basis of word of mouth and local reputation. Sellers of warehousing service withhold privileged information about their warehousing service from the buyers. This leads to a situation of information asymmetry.

Information asymmetry is one of the classic market failures. Market economies seek to establish State capacity that efficiently addresses market failures. As an example, customers of a restaurant do not know whether the kitchen is clean, and this calls for the State to undertake certain interventions which address this problem.

Absent government involvement, users of warehousing services have devised their own solutions to address this problem. National Commodities Derivatives Exchange (NCDEX) operates a remarkable closed-user-group (CUG) that attempts to solve the problem of information asymmetry by creating its own inspection, audit and monitoring mechanism to ensure sanctity of the physical settlement of commodities traded on its exchange. Alongside this, many collateral management companies have come up which offer turn-key services of protection to users.

As is well known in public economics, when faced with market failures, such private solutions are not as nice as having a well structured and efficiently implemented government-based solution.

Grading of warehouses

Warehousing Development Regulatory Authority (WDRA) is mandated by the Warehousing (Development and Regulation) Act, 2007 to regulate warehouses that issue negotiable warehousing receipts (NWRs). Currently, WDRA registered warehouses go through a process of accreditation. This process verifies whether entities who apply to register with WDRA comply with certain registration requirements. This intervention is inadequate in that it does not create a mechanism for watching the performance of a warehouse on an ongoing basis. In and of itself, the WDRA registration has generated limited trust on the part of market participants.

A better intervention, which can be introduced by WDRA, is a mechanism for grading of warehouses, WDRA can provide more granular and complex information pertaining to warehouses and WSPs. This would require establishment of processes through which grades are awarded.

Experiences with grading in related fields

Is grading the right intervention for this market failure? Some analogies may be instructive:

• Credit rating agencies assign grades to bonds.
  
• In the real estate sector, grading helps by providing the real estate developers with the incentives to conform to fair trade practices and legal requirements.
  
• The New York Health Department made it mandatory for the restaurants in its five boroughs to get themselves graded for their sanitary scores. The grades summarising the sanitary scores are then made public. Within 18 months of starting the grading programme, the share of restaurants without a trained food protection supervisor decreased from 13% to 7%. Prior to grading, 11% of the restaurants had inadequate hand washing facilities, which reduced to 5%. Also, a 10% drop was registered in restaurants that had signs of mice infestation.

These areas -- bonds, real estate, restaurants -- have the same market failure as that found in warehouses, i.e. information asymmetry.

Grading warehouses and warehouse service providers

Warehousing is an amalgam of warehousing infrastructure including warehousing premises, equipment and manpower which is used to deliver a service. For purposes of grading warehouses, warehouses need to be compared to each other, and against some benchmarks that the market may find useful.

A variety of public and private agencies internationally have formulated broad parameters, on the basis of which warehouses are classified and graded. For example, in Tanzania, warehouses are scored on parameters specified by Warehouse Receipts Regulations, 2006 and then graded accordingly. In UK, United Kingdom Warehousing Association issues an advisory for its members that lists broad headings like these, against which standards are set for warehouses.
Real estate consultants like Knight Frank also have their own list of parameters for warehouses. The parameters devised by each of these agencies are customised for the needs of their clientele. There is no single check-list against which WDRA can require warehouses to be graded.

A grade can capture information on the physical attributes of the warehouse (e.g. warehouse building and warehouse site), management of the warehouse (e.g. ownership, technical and managerial staff) and the warehousing processes and activities (e.g. storage and handling of goods, fire security, pest control, use of technology and book-keeping).

There is no fixed recipe for grading. WDRA must allow expertise present in the market to innovate in designing better grading mechanisms, and for grading agencies to discover what information is relevant for the warehousing market. For an analogy, financial regulators have pushed the bond market towards the use of credit rating agencies, while not micro-managing how credit rating agencies analyse a bond.

Re-imagining the role of accreditation agencies of WDRA

Provisions in the WDR Act allow WDRA to facilitate grading of warehouses by specialised agencies. It would be useful for WDRA to develop such an environment for the warehousing industry.
Rolling this out also presents complexities, which will need to be addressed:

1. Financial regulation in India has encouraged a mindless notion on the part of investors, where the credit rating agency is the only determining factor about whether a bond can be the target for investment or not. A more subtle environment needs to be created, without black-and-white notions. As an example, a steady stream of information emanating from a warehouse, about failures in settlement, is valuable for users without being a black-and-white grade.
   
2. The business of grading is frought with conflicts of interest. The "issuer-pays" model disincentivises grading agencies to be critical of their clients and award unfavourable ratings. The global experience with rating of bonds has exhibited such problems.
   
3. The tools of coercion by the State can be applied at various levels, such as forcing warehouses to get graded, or forcing warehouses to always disclose what grade they got, etc. Careful analysis is required to use the minimal coercive power while maximally addressing the market failure.

Conclusion

There is a market failure -- asymmetric information -- in the field of warehousing, which justifies government intervention. The intervention presently used at WDRA -- requirements applied at registration -- are not addressing the problem. The WDRA Act contains provisions which could be used to bring about a mechanism for grading warehouses. Done right, this could reduce the information asymmetry.