Benefits of Warehouse Receipt System: Evidence from Africa

Dr Gift Mugano
As a follow up to enquiries from readers on the importance of the warehouse receipt system (WRS), this instalment unpacks the benefits.

In rapping up discussion on this matter, next week’s issue will deal with implementation challenges of the WRS.

The WRS addresses inefficiencies in agricultural markets, reduce post-harvest losses, opens up access to remunerative markets and reduces cheating

Inefficiency in agricultural markets and underlying factors

About three decades after liberalisation, agricultural markets in Africa remain largely inefficient. These markets are typically characterised by high distribution margins and seasonal price variability.

Poor rural transport infrastructure is one of the contributory factors as, quite often, food-surplus areas lack good road and rail networks, leading to underinvestment in haulage transport facilities in rural communities and consequent high transit losses, the cost of which is passed onto consumers.

Lack of efficient storage infrastructure is another factor. It is a major reason for the very high levels of postharvest losses found in Africa — often estimated at 30 percent. World Bank study in Eastern and Southern Africa on the cost of post-harvest losses in the grain sector showed that it is in the region 13.5 percent of total output which is quite significant.

Transaction costs in Africa’s agricultural markets are also very high as noted by World Bank. This is attributable in part to the cost of assembling produce from atomistic and widely-dispersed production units as well as uncertainty about the quality and quantity attributes of goods being exchanged, the result of the absence of effective systems of standard grades and measures.

Contract enforcement is poor and as a consequence the rural trade is predominantly cash-based, thus accentuating the problem of illiquidity in the trade which is the result of limited access to commodity finance.

The markets lack transparent systems of price discovery as well as institutions and instruments to manage price risks. The marketing uncertainty created dampens production incentives and stymies growth in agricultural output and productivity. High food price variability makes poor consumers in urban and deficit-producing rural areas prone to food insecurity.

WRS opens up access to remunerative markets

Producer groups as well as small and medium-scale traders are usually unable to enjoy improved margins by trading with players further down the marketing chain. This is largely because, in an environment where formal contract enforcement mechanisms, lacking the ability to develop trust based on repeat transactions or informal relationships or access to market institutions which facilitate trade-by-description constitutes a significant barrier to entry such markets.

The WRS offers a means to overcome this barrier. First, it enables smallholder farmers to bulk their crop for deposit, ensuring compliance with quality standards and minimum quantity requirements.

The quality and quantity of the stored commodity which can be traded is assured, thus making ‘sight-unseen’ trade possible, implying sellers can sell to buyers in a wider geographical area than their immediate location.

Furthermore, the guarantee of delivery by warehouse operators reduces counter-party risk, that is, the risk of non-performance of trade contracts.

A farmer group, the Oridoyi Rural Cooperative Society (ORCS) in Tanzania, which has used the WRS in marketing its cotton since 2002 was able to raise cotton output by its members from just over 130 000 kg of seed cotton to the peak of over 1,100 000 kg of seed cotton over a period of four years. Seed cotton delivered by the members to the ORCS is warehoused and ginned for a fee by the KNCU Cotton Ginnery at Moshi.

Financing is usually provided by the CRDB Bank Ltd, a major local commercial bank. In the 2005 /06, the ORCS was able after ginning to market their lint directly to a UK-based cotton merchant, with the assistance of locally resident broker.

The quality of their lint was certified using modern equipment owned by the Tanzania Cotton Board. Hence, quality uncertainty, which can undermine impersonal trade, was mitigated.

Usually, the ORCS initially pays the floor price announced by the TCB to its members when they deliver seed cotton. This is followed by subsequent payments from profits made. However, it was from retained profits that the cooperative financed cultivation of additional four hectares for each member, thus increasing output by the group.

It is apparent that the producer groups in Tanzania were able to access more remunerative markets and obtain better prices because the WRS made it possible to reduce imperfect information problems that often undermine transactions between parties in agricultural markets in Africa. For instance, information asymmetry between smallholder producers and traders often skews bargaining power in favour of the latter (traders).

It is for this reason that donors and governments invested in agricultural market information systems (MIS) in many African countries. However, provision of price information alone, as tends to occur under most MIS in Africa, is insufficient in strengthening the bargaining position of producers. Institutional infrastructure such as the WRS, which improves the collection and dissemination of broader market information (including stock levels, overall supply and demand) to players, makes it possible for transparent and competitive transactions involving a large number of buyers to occur. Producers’ bargaining position is, thus, strengthened because information dissemination is not de-linked from access to market opportunities.

WRS reduces scope for cheating in agricultural trade

Lack of or ineffective enforcement commodity standards (on quality as well as weights and measures) is quite common in the rural/informal trade in agricultural commodities in Africa even though such standards may exist in the formal segments of the market.

For larger-scale buyers, including millers and other processors, the quality and quantity uncertainty this situation creates raises the cost of, and therefore, limits transactions with smallholder producers and other rural-based traders.

On the other hand, producers and small-scale rural traders often lose out due to considerable cheating on quality and weight.

For instance, in Zambia it is common for maize supplied from smallholder farmers to suffer a price discount of between 10 percent to 15 percent because of quality uncertainty.

The Kulya Nkona AgriCooperative Society which used the WRS to market their maize avoided this problem as the receipt system ensured that buyers paid for the independently determined quality described on the warehouse receipt.

In post-liberalisation Uganda, while prices paid for coffee beans in the urban markets differ on the basis of quality, there is no such quality discrimination in the rural trade where producers are paid for volume delivered without enjoying any quality premium.

In Tanzania, the Common Fund for Commodities (CFC) funded a network of coffee curing factories (previously owned by cooperative unions) were certified as warehouse operators, and allowed to receipt deposits of parchment coffee (Arabica) that conforms to adopted grading standards.

Depositors included primary cooperative societies (PCS), other farmer associations and private traders. Participating PCS — numbering 32 with membership of over 3 500 — procure parchment coffee from their members, making an initial payment representing about 60 percent of the market price.

Finance of up to 80 percent of the value of the parchment is then provided by a bank, with the stocks being used as the collateral. This financing allows the PCS to buy volumes of more than 10-times its working capital as the credit provided depends on the volume deposited. The certified operator processes the parchment into green coffee, which is marketed through a competitive bidding process at the Moshi Coffee Auction.

Proceeds from the sale are channelled through the financing bank, allowing it to recover credit advanced. Since the 2002/ 03 season, financing to the tune of about US$10 million has been provided to the range of depositors by two commercial and one cooperative bank in Tanzania.

Members of the participating primary cooperative societies on the average obtain US$1.10 per kg of parchment coffee sold using this system — usually paid out in three instalments. Comparative figures for farmers selling to their cooperative unions and to private traders are US$0,75 (usually through two-to-three instalments) and one-off payment of about US$0,65 per kg of parchment, respectively. As a result of this the PCS now account for over 65 percent of coffee sold through the Moshi Coffee Auction.

In South Africa, where a well-developed silo receipt system underpins the operation of the most mature commodity exchange in Africa, lenders tend to interlock agricultural production credit with crop marketing through the receipt system. This minimises the risk of loan default by ensuring that producers can obtain better prices which enables them to service the loans but also lenders have greater control over the main security, which is the deposited crop.

The current work by the Reserve Bank of Zimbabwe and Ministry of Agriculture which is aimed at operationalising the Zimbabwe Commodity Exchange which comes with WRS will provide massive benefits to the economy.

Together we make Zimbabwe great.

  • Dr Mugano is an Author and Expert in Trade and Development. He is a Research Associate at Nelson Mandela Metropolitan University and a Senior Lecturer at the Zimbabwe Ezekiel Guti University. Feedback: Email: [email protected], Cell: +263 772 541 209.

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