The obscure origins of commodity trading debt – BR research

Yesterday, this section pointed out that SBP’s wheat purchase financing framework perversely favors public procurement, which not only crowds out direct purchases by the private sector, but also contributes to a build-up of debt that more and more became hardcore.

But first, some background on how public sector product operations work. Each year in March, the federal and provincial governments set wheat supply targets after taking into account annual demand, last year’s carry-over stocks, average cost of production, and price fluctuations in the markets. global and domestic. In nine of the past ten years, public sector agencies (such as PASSCO) and provincial food departments have jointly purchased at least 20 percent of the national wheat production. Public markets usually begin in April, when the harvest is at its peak, and end at the end of June.

Because the wheat supply policy is anchored in the welfare of farmers, public sector purchases take place at a guaranteed minimum rate (also called a support price) which is usually set above the market rate. Given the scale of commodity operations – now approaching Rs 200 billion per year (explained below) – PASSCO and food departments have seasonal working capital funding lines of up to commercial banks at market-based prices of Kibor + spread.

Once the public sector has reached its purchasing target, private sector buyers come in to mop up the remaining salable wheat, meeting demand from flour mills in July and August. By September, the food departments announce their wheat liberation policy. Under this policy, the government sets an introductory price at which wheat is sold to registered flour mills (over 1,200 nationwide). Based on the price trend of the domestic market at the time – for example, if an upward spiral in prices is taking place due to a shortfall – the exit price can be set below cost to ensure that flour remains affordable for consumers.

And this is where the contradiction lies. Since the dual objective of ensuring better prices for farmers and maintaining an affordable price for consumers conflicts with each other, the granting of subsidies becomes inevitable. In the absence of full cost recovery, the grant provision also finances the cost of maintaining government stocks, transport costs, the cost of jute bags and debt service on outstanding debt. And that’s where this story really begins.

The outstanding debt of public sector loans to commodity operations peaks at the end of June, in line with the conclusion of government contracts. Likewise, outstanding debt peaks at the end of the following March, after PASSCO and the food departments release stocks of wheat into the secondary market according to predetermined quotas. Payments from private mills (against wheat sold) are used to settle overdue advances. Except that the additional debt used each year is never really paid in full. Why?

First, the policy of maintaining reserve stocks means that PASSCO and the provincial food departments carry out stocks financed by the additional debt obtained each season. Moreover, due to the limitation of budgetary space, the amount of the allocated subsidy generally fails to close the gap between the purchase cost and the introductory price. Worse yet, delays in disbursing grants lead to a build-up of margin, which in turn is also financed by additional debt.

In fact, in its latest financial stability review, the SBP itself recognizes that although commodity financing should be self-liquidating in nature, bank debts are settled by periodic loan rollovers. This leads to a perverse situation where the additional debt used each year is higher than the previous year, but leads to lower purchases (per unit) due to the increase in nominal wheat prices. Worse, according to the same report, the outstanding debt relative to the financing of raw materials now constitutes more than a third of total public sector borrowing (December 2019).

And that’s not all. While the outstanding debt of provincial food ministries shows some movement (but no annual cleanup), things are getting worse at the federal level. Since at least FY12, the outstanding debt of post-secondary institutions at the end of the season (end of March) has remained stuck at 200 billion rupees, while it peaks seasonally between 220 and 230 billion rupees (end of June) . Meanwhile, the average volume purchased by PASSCO each year has fallen to half a million tonnes, much of which is funded not by bank loans, but rather by annual grants to the tune of Rs 10-20 billion. in the federal budget!

What does it mean? Simply put, for most of the past decade, PASSCO has not only failed to reduce the stock of debt compared to past commodity transactions, but in fact uses up additional debt to a large extent. party to serve the margin on outstanding loans, more and more caught in a vicious circle.

But that only raises other questions, such as: why did subsequent governments not shut down PASSCO after a one-time final debt settlement, especially since the bulk of government procurement was transferred to provinces since the 18th Amendment?

As it turns out, PASSCO may be a public sector company, but it was formed almost half a century ago with capital from GoP and six commercial banks (four of which have since been privatized). A quick review of the documents available on the web shows that the GoP owns only 25% of PASSCO’s equity, while the rest is held by commercial banks. It is therefore understandable that 6 of the 8 board members of PASSCO also belong to commercial banks.

Why is this important? According to information published in the annual accounts of a commercial bank, its investment in PASSCO increased from 5.5 million rupees at the start to 2.73 billion rupees in December 2020. This for a PES, which SBP says could quickly turn into “a problem because complicated as the circular debt”. So much for moral hazard. But is the central bank fighting back to seek resolution?

Unlike private sector borrowers who resort to financing against the liquidation value of the pledged wheat stock, public sector borrowing “is primarily secured by a letter of guarantee issued by the GoP” (SBP, 2019). This is because the value of stocks on hand (or purchased) is simply not sufficient to justify the outstanding debt of commodity transactions. So much for its self-liquidating nature.

Meanwhile, excessive regulatory scrutiny involved in providing credit to private sector wheat processors and traders means that only those on the government-approved list are able to obtain financing from commercial banks. No surprise that they are the same as those with quotas allocated by the Food Departments!

This at a time when corruption is regularly alleged in the allocation of quotas by food departments and supply agencies. The fact that “ghost mills” obtain wheat against government quota and sell it on the secondary market is also an old story. The disappearance of wheat stocks from public sector margins is not news either.

Yet the current wheat finance policy effectively crowds out private sector purchases by ensuring that wheat processors do not have access to bank lines of credit during the peak harvest period (April-May). This is of course done in the name of facilitating government objectives, but it actually means that a monopsony market is created at the expense of competition.

The growing indebtedness of public sector commodity operations is a story of deliberately ignored moral hazard. But even though all failures in wheat supply operations point to leaks into the public sector, it is rich that private sector traders are accused of speculation and hoarding.

About Vicki Davis

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