February 28, 2020: Karachi Business Recorder sat down with Mr. Arif Nadeem in his capacity as CEO of Pakistan Agricultural Coalition, a private-sector led not-for-profit, focused on improving agricultural productivity and farming incomes by bringing in tech-driven, entrepreneurial solutions. Following are the edited excerpts of the conversation:
BR Research: Distortions in produce markets is often noted to have played a crucial role in low productivity growth of agriculture sector. It is said that these distortions allow some players to earn abnormal profits consistently, whereas growers struggle to make ends meet. Where do these distortions originate from?
Arif Nadeem: Gallah mandis today are operating under the Agricultural Produce Markets Act of 1930s. The legislation was introduced with a noble principle to protect growers from money lender/middlemen exploitation, but over time has been used to do the opposite.
As a colonial power using Indian farming to produce surplus for European markets, the British could not tax the agricultural produce as it would have impacted the final price paid by the European consumer. Instead, they decided to create trading platform by establishing mandis.
Plot of lands for this purpose were sold to “commission agents” – a legally defined role – who paid a fee for the right to trade on the platform. Today, there are only 137 official mandis in Punjab, with total number of active commission agents between five hundred to less than a thousand.
Consider that since 1947, Punjab’s total wheat output has grown from under two million tons to over 18 million tons; growth in output has been virtually similar for almost every crop; and understandably so as the yields have increased dramatically.
However, the number of mandis and commission agents operating in them has remained stagnant. Because commission agent is a legally defined licensee, it essentially depicts a market with very high barriers to entry. This has allowed the commission agent, otherwise known as the middleman or the arthi, to corner the market by monopolizing supply.
Because of the regulatory bottleneck, middlemen exploit the market to the maximum; this is also why price of vegetables purchased at the retailer is often at 8 to 10 times multiple to cost of production at farmgate.
BRR: Can the distortions be addressed by simply removing the barriers to entry in the mandi? Does experience of other countries lends credence to this argument?
AN: The wholesale market operation in China offers great insight. No where in the world do the zamindars or growers have the time or resources to bring their produce to the market and sell it directly, even if it means bypassing the middlemen’s margin. This role is usually performed by aggregators.
The crucial difference between the Chinese and Pakistani mandis is that in China everyone is free to become an aggregator, transport the goods to the market to find buyers. That means many buyers and sellers exist both at the farmgate and mandigate.
BRR: PAC has been the lead advocate for modernization of agricultural produce markets to bring price stability. Yet incidences of market failure have become more frequent in recent times as witnessed in the price volatility of tomato, onions, garlic, wheat and sugar within last 6 months. Is PAC’s advocacy struggling to gain traction in the corridors of power?
AN: First, understand that perishables and non-perishables need to be dealt with separately. Rest of the world has developed a highly functional mechanism to deal with non-perishables in the form of commodity exchanges.
Since 2014, Pakistan Agricultural Coalition has been working on pilot projects for wheat, paddy, and maize to offer warehouse receipt financing services to growers through partner organizations such as NRSP, and various feed mills. Pilots conducted across the length of the country met with considerable success thanks to partnership and support extended by financial institutions and insurance companies.
Last year, after substantive consultations with the regulators and stakeholders, we were finally able to get the rules notified by SECP in the form of Collateral Management Companies (CMC) Regulations, 2019; SBP’s Prudential Regulations have also been amended to the effect.
BRR: The existing market structure stands on the foundation of middlemen (commission agent) who not only provide working capital financing to growers for farm inputs, but also extends liquidity support for personal needs such as education, health and marriage. Can CMCs really fill in that gap?
AN: The price volatility witnessed in agri- commodities results from chronic issues stemming from inadequate storage, lack of grading and standardization, and absence of future markets. The CMC model aims to resolve all three.
First, the CMC will help in establishment of accredited warehouses for storage of farm produce. Second, due to standardization and grading of produce that will be monitored by the CMC, commercial banks will be able to accept the commodity itself as the primary (and only) collateral against inventory financing. Third, the CMC-issued receipt will have a liquid secondary market, in that it will be tradable on the commodity exchange.
Growers’ dependence on the middlemen is an illusion of choice: the latter provides financing at the time of cultivation, and thus holds growers’ captive; he has no choice but to sell the produce to the middlemen in order to settle the loan along with exorbitant mark-up.
Come harvest season, the commodity price usually ebbs due to abundance of supply. The middlemen make the purchase at market price, leaving behind nominal profit for the grower net of financing. In bumper crop season, producers often reel under losses, struggling to even make loan payment to the middlemen because the market price is so low.
Warehouse receipt financing aims to address this by offering growers a choice to store their produce with the CMC post-harvest and take advantage of holding by timing the market – and sell when the price is right. Meanwhile, they may avail bank financing for farm inputs for next season cropping against the same produce held under collateral with the warehouse.
Our successful pilots show that once growers experience that the warehouse financing model offers a viable alternative to the existing structure and gives them a chance to make premium profits instead of selling instantly, as rational economic agents they will make the better choice in self-interest.
BRR: Will lending against warehouse receipts be extended at rates comparable to premium charged by middlemen? What is the role of transportation and storage in farmers’ current preference for selling output to the middlemen?
AN: Farmer’s biggest problem is that he has no seller other than the middleman traditionally relied upon to meet household liquidity needs. The middleman runs an integrated business operation where in addition to dealing in the commodity, he also sells inputs such as fertilizers and pesticides.
Moreover, inadequate availability of on-farm labour and transportation means that the cost of taking produce to the gallah mandi often exceeds the premium earned from selling it in an open market. In contrast, middlemen collect the produce from farmgate and transport the aggregate to the gallah mandi.
Academic research has documented that the farming middlemen charges mark up north of 40 to 50 percent on his services. The pilots run by PAC in partnership with financial institutions charged a ceiling rate of Kibor + 6 percent. Once the warehouse receipt financing market matures, we expect average banking spread to decline further.
BRR: The risk of fraud is met as the commodity will be under bank’s pledge at the warehouse. But how will the banks hedge the commodity price risk; that is, if the market price plummets so rapidly that the principal is no longer protected?
AN: To this end, we have asked the regulator to establish an indemnity fund. Note that the commodity under pledge will be insured (as is standard practice for security under bank collateral). Moreover, the warehouse may also be required to insure its price risk through blue-chip insurance companies. Thus, in case of a default, bank loan may be repaid through insurance proceeds.
BRR: Considering the positive spill overs of warehouse receipt financing for the agro-based industries, do you foresee players from the organized sector entering the business? What impact will it have on the middlemen and the existing market structure?
AN: Pakistan’s first CMC was incorporated by the name of Naymat Collateral Management Company Limited last month, with a paid-up capital of Rs300 million. Various partners of PAC have come on board as equity investors, including HBL, MCB, Arif Habib Commodities, National Foods, K&Ns, Jaffer Brothers, Transhold, and CDC.
Naymat will be in the business of accrediting warehousing service providers; we foresee several silos and storage providers taking interest in establishing near-farm storages. If the model gets going, my intuition is that progressive middlemen from existing gallah mandis will also co-opt it and become warehousing service providers.
BRR: Moving on from the subject of agricultural markets to cotton production. PAC was responsible for the incubation of a seed company in partnership with local textile players. Has the company met with success in development of new cottonseed varieties?
AN: The chronic deficit in domestic cotton output is finally being identified as a market gap by various players in the corporate sector. Some of the big names in local corporate are now seriously exploring feasibility of setting up shop in seed business.
This is a welcome sign. Most likely, these firms will be set up to produce/market cotton seeds by licensing germplasm from established biotech companies. This would lead to healthy competition between various local businesses based on seed quality; accredited seeds from these companies will hopefully help stem the tide of low-quality adulterated seeds that has currently flooded the market for cotton inputs.
BRR: Introduction of accredited germplasm is surely a welcome sign, but how does it fight against marketing of adulterated varieties that are sold under false labelling?
AN: Of the 753 registered seed companies, about 80 percent are fly-by-night operations. While it may sound counterintuitive but fighting poor quality seed variety does not require more regulatory oversight. Instead, PAC in its presentation to the regulators and various public officeholders has argued to provide an enabling environment to private sector companies operating in agricultural research & development business.
This means that the regulation in Pakistan needs to move from ‘checking-the-process’ to ‘checking-the-product’. This is known as ‘truth-in-labelling’ and has been successfully adopted around the globe.
BRR: How does ‘truth-in-labelling’ help with Pakistan’s cotton crisis on war footing. Would it not allow counterfeit seeds to flourish even more?
AN: On the contrary, the existing regulatory regime requires that new varieties be tested at several stages, finally culminating in nation-wide ‘National varietal trials’. This means that from day one when a biotech firm identifies and begins trials of new variety, it may take up to three to five years to seek also requisite approvals and release it for commercial production.
Instead, PAC has argued that a highly stringent standard be established for the top twenty R&D firms that have international breeders and spend millions of dollars on development of new varieties. The government should make on farm inspections of these private sector R&D firms and test their varieties for result.
These varieties should be tested for ‘DUS’ – distinctiveness, uniformity, and stability before commercial release. The ‘truth in labelling’ regulation will identify the plant crop characteristics such as staple length, boll ware size, etc.
Remember, ninety percent of the varieties currently selling in the market are unregistered. The only thing the existing regulatory regime based on ‘national varietal trials’ is doing is make it difficult for organized sector corporate players to compete by disincentivizing them from investing in development of new varieties as they follow the official guidelines, which takes several years before commercial release is allowed. Because of poor intellectual property protection, the payback is not nearly attractive enough.
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