Agriculture commodity financing: prospects and limitations

By M. S. Qazi

The agriculture sector contributes 21.0 per cent to annual GDP growth, employs 44 per cent of the total workforce and supports the living of about two-thirds of the population living in rural areas. Textile industry, the largest manufacturing and export earning sector, heavily depends upon it for the supply of raw cotton. Essential cash crops such as wheat, rice, sugarcane and cotton are the lifeline of the country’s exports and economy. The government intervenes to finance the purchase of agriculture commodities, particularly wheat, and fixes their prices prior to sowing for providing good returns to cultivators and keeping the commodity markets intact. It is also responsible to stock millions of tons of agriculture commodities by financing commodity operations through borrowed money from commercial banks to prevent supply shocks and price escalation. Hence, it is critical to work out whether the government achieves these objectives at the risk of derailing the financial management affairs, subsequently having an adverse impact on economic stability and development.

The measures adopted by the federal and provincial governments are contrary to the functioning of the free market system; however, they are pivotal to keep under check supplies and prices of food commodities. Past experience reveals that financing and pricing of agriculture commodities creates more supply shocks for lack of timely and effective decisions taken pertaining to pricing and marketing. These government initiatives fuel inflation and enlarge the fiscal deficit by creating high levels of public debt. The latest figures indicate that the commodity (wheat, sugar and urea) trade finance reached Rs382 billion, with a share of Rs300 billion for wheat. It further stoked the double-digit inflation.

With respect to government intervention in fixing the support prices of agriculture commodities, wheat and sugarcane are at the forefront. It has been increasing the support price of wheat over the years, thus influencing its market price. In 2008, it enhanced the procurement price of wheat from Rs625 per 40 kg to Rs950 per 40 kg. This measure proved to trigger inflationary pressures that have persisted since then. According to State Bank of Pakistan (SBP) analysis, cumulative price of wheat surged by 40 per cent between 2003 and 2007 whereas between 2008 and 2010, there was a swell of 120 per cent. In the international market the price enhanced by 22 per cent only.

Similarly, sugar prices amplified by 46 per cent during 2003-07 and by 184 per cent from 2008-2010. These figures clearly indicate that the upward revision in the support prices of wheat and sugar is one of the main factors that gave a rise to the inflation level.

Food is a provincial matter and grain stocks are procured and maintained by the provinces. Pakistan Agriculture Storage and Supply Corporation (Pasco) is in charge on behalf of the federal government. Loanable funds are used for financing commodity operations that is essentially a short-term, self-liquidating business, with bank advances utilised to procure, hold and maintain stocks of selected food and non-food items. The advances are subsequently retired as the stocks are sold or exported but, “there has been an exponential growth of bank credit for commodity operations during the decade: from Rs107.4 billion at end-FY00 to Rs414.2 billion at end-FY10. Almost 20 banks are engaged in commodity financing, with the top 5 banks holding a sizable average share of 92 per cent, according to the SBP report. The reason for the accumulation of such an enormous commodity circular debt is that the provincial governments and Pasco have been holding huge stocks, much more than the stocks required for market stabilisation at high interest costs, ranging between 1.1- 2.8 per cent, over and above the 3-month Kibor, on commodity loans. Such extensive food stocks could not counter price escalation and shortages of wheat and sugar recently experienced by the common consumers.

Seasonal liquidity pressure as well as the delays in the retirement of commodity financing create liquidity crunch and expand the fiscal deficit. Retirement of commodity loans in line with the commodity financing cycle is essential to free up liquidity to be utilised for other purposes. But delayed retirements and rollovers are leading to both price distortions (loans to government priced higher than loans to the private sector), as well as the building up of circular debt in commodity operations.

The government had a total stock of 4.2 million tons of wheat but preferred to procure yet another 6.7 million tons during 2009-10 that increased the circular debt by 288 per cent, as compared to 33 per cent in the preceding years from 2005-08. The carryover stocks of the provincial governments at present are problematic owing to inadequate storage capacity available with them and high cost of debt servicing they have to pay. According to the latest data, the Punjab government holds sufficient stock of wheat recorded at 5.5 million tons. It carried over 2.39 million tons from the previous year with a debt of Rs104 billion that presently is around Rs150 billion.

A wise decision albeit too late has been taken by the centre to allow Punjab to export surplus wheat stock. It plans to export 150,000 tons of wheat in the international market by Jan 10th, 2011 that would earn FX reserves, pay off the colossal debt and release liquidity for purchasing seasonal commodities in March/April, 11.

Prudent management of commodity operations can reduce the debt figures and also fiscal pressures faced by the federal and provincial governments.

Price intervention by the government is desirable through reasonable support prices, but if motivated by other than purely economic reasons, the result is that distortions in prices and market stability are created. Wheat price crashed to Rs750 per 40 kg last year, Rs200 less than the price fixed by the government in 2008. Sugarcane price has been fixed at a minimum of Rs125 per 40 kg for current harvesting season. It hardly matches the market price trend of Rs200 per 40 kg with the result that growers and millers are at odds with each other.

High agriculture support prices, such as that of wheat, fixed in 2008 have international implications too. Higher price paid off the dividend and the country reaped a bumper crop of 23.8 million tons. The reduction in price differential between domestic and international stocks of wheat also curtailed smuggling but wheat exporting countries sent a consultation reference under the World Trade Organisation provision blaming the country “for providing extra subsidy to wheat producers in the form of higher wheat support price”. Pakistan is the 8th largest wheat producer in terms of area and 6th in production but 49th in terms of yield per acre that has a lot of scope for improvement.

In order to tackle the negative effects arising out of storing excessive agriculture commodities, particularly wheat and sugar, and not to let the consumers suffer as they have since the last two years, the best strategy is to off-load the carryover stocks, pay off the principal amounts and account for the subsidies paid by the government. This would have little impact on accumulating commodity circular debt and increasing fiscal deficit.