Complementing Regional Rice Reserves with Novel Domestic Reserve Mechanisms

Roehlano M. Briones
The author is a senior research fellow at the Philippine Institute for Development Studies.

Contents
Abbreviations ............................................................................................................................... iii Executive Summary ...................................................................................................................... 1 1. Overview of Self-Sufficiency Policies ........................................................................................ 2 1.1 Flexible Self-Sufficiency ...................................................................................................... 2 1.2 The Prospect of Extreme Shocks........................................................................................ 2 2. Storage and Food Security: Background and Conceptual Framework ...................................... 3 2.1 Supply Shocks and Market Volatility ................................................................................... 3 2.2 Rice Utilization and Storage in ASEAN ............................................................................... 5 2.3 Economic Model of Storage ................................................................................................ 5 2.4 Welfare and Stabilization Policy .......................................................................................... 6 3. Options for Food Security Reserves ......................................................................................... 7 3.1 Matrix of Options for Domestic Reserves ............................................................................ 7 3.2 Options for Publicly-Owned Stocks ..................................................................................... 8 3.3 Food Security with Privately-Owned Stocks........................................................................ 9 3.3.1 Regulatory Arrangements for Option 4 ........................................................................ 9 3.3.2 Issues in Market Development and Regulation ......................................................... 10 4. Conclusion ............................................................................................................................. 11 References ................................................................................................................................. 13

Tables
Table 1: Indicators of Domestic Utilization, ASEAN Member Countries, 20102011 ...................... 5 Table 2: Options for Intervention in Food Storage ......................................................................... 7

Figures
Figure 1: Projected Price of Thai White Rice 5% Freight on Board, Mean and 95th Percentile .... 4 Figure 2: Percentage Difference between Projected Mean and 95th Percentile for Annual Paddy Production of Rice-Exporting Countries ....................................................... 4 Figure 3: Percentage Difference between Projected Mean and 95th Percentile for Annual Consumption of Milled Rice of Rice-Importing Countries ......................................... 4

Boxes
Box 1: Example of a Nutritional Norm for Per Capita Intake of Rice .............................................. 2 Box 2: Warehouse Receipt System ............................................................................................... 9 Box 3: The Rice Stockpile Scheme in Singapore ........................................................................ 10

Abbreviations
ADB AGRM ASEAN APTERR BERNAS Asian Development Bank Arkansas Global Rice Model Association of Southeast Asian Nations ASEAN Plus Three Emergency Rice Reserve Padiberas Nasional Berhad

Unless otherwise noted, $ refers to US dollars.

Executive Summary
The combination of domestic production, storage, and openness to trade are common instruments to achieve food security.1 When supported by interventions to increase food stocks and enhance production, these instruments offer resiliency against a typical range of environmental shocks. However, in a world beset by climate change, extreme production shocks are a tangible reality rather than a hypothetical prospect. Moreover, collateral export restrictions to contain domestic price instability are also a common response in rice-exporting countries. Regional rice reserves offer some protection from both extreme shocks and export restrictions to the extent that the forward contract scheme is a precommitment exempted in principle from changes in the supplying country's government policy. Beyond regional reserves, increased domestic rice reserves offer the best protection against extreme climate or policy shocks. Given the high costs of sourcing and stockpiling rice reserves, a careful assessment must be made of the effectiveness of various options. The two activities of sourcing and storage entail the following combinations of public and private provisions: Option 1: Publicly owned stocks in public storage Option 2: Publicly-owned stocks in private storage Option 3: Privately-owned stocks in public storage Option 4: Privately-owned stocks in private storage

Option 1 is the traditional scheme. It entails the largest fiscal outlay up front to build warehouses and to purchase rice stocks from farmers, millers, and traders. Option 2 is an emerging scheme as the rice procurement of state trading agencies begins to exceed the capacities of government warehouses. One interesting variation is engaging the private sector in rice distribution as in the Emergency Food Assistance Project of the Asian Development Bank (ADB) in Cambodia. Option 3 is rarely observed in practice. Option 4 is also not as common as either Options 1 or 2, although there are some practical examples in Southeast Asia, the most ideal of which is found in Singapore. The advantage of Option 4 is that it realizes efficiencies from private sector storage and avoids the fiscal burden of government procurement as well as the management burden of releasing and replenishing stocks. The disadvantage is that it requires a strong regulatory arm and a private sector that is well developed in terms of logistics and marketing. Nevertheless, with the increasing emphasis on private sector development and privatepublic partnership, Option 4 appears to be the most suitable way forward to address the problem of extreme shocks to food supplies and trade.

This report was prepared for the Second ASEAN Rice Trade Forum on 4 5 June 2013 in Yogyakarta, Indonesia. The Asian Development Bank (ADB) provided technical assistance under TA-REG 7495: Support for the Association of Southeast Asian Nations Plus Three Integrated Food Security Framework, with financing from the Japan Fund for Poverty Reduction. The author is a senior research fellow at the Philippine Institute for Development Studies. This report does not necessarily reflect the views of ADB or the Government concerned, or the institutions at which the consultant works, and ADB and the Government and these institutions cannot be held liable for its contents.

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1. Overview of Self-Sufficiency Policies

1.1 Flexible Self-Sufficiency With few exceptions such as city states or countries with small populations, the bulk of a country's food consumption is sourced from domestic supply, evincing a natural tendency toward selfsufficiency. However, total self-sufficiency need not be rigidly imposed. Flexible self-sufficiency, which combines domestic production with trade to meet domestic consumption, can realize both food availability and affordability. One practical formulation of flexible self-sufficiency involves determining a domestic production target that is achievable through productivity-enhancing investments. These investments aim to increase the average yield and area harvested to the point where the marginal cost approximates the world price. As additional protection for food security, this production target will ensure a level of domestic production equal to per capita intake compliant with nutritional norms (Box 1). This contrasts with the usual self-sufficiency policies that target observed per capita consumption.

Box 1: Example of a Nutritional Norm for Per Capita Intake of Rice

Suppose the target for average daily calorie intake is 1,200 kilocalories (kcal). If 60% of calories should come from carbohydrates, of which 80% is from rice, then the target kilocalories from rice is 1,200 per capita. Assuming 3.5 kcal/gram (raw rice), this translates to 274.2 grams of rice daily. On an annual basis, this is about 100 kilograms (kg) per capita. This is lower than the estimated per capita consumption of 127.4 kg in Indonesia, 123.3 kg in the Philippines, and 141.2 kg in Viet Nam.
Source: International Rice Research Institute (2013).

In practice, countries combine domestic production with trade. Only the Philippines explicitly targets 100% self-sufficiency in rice production while Brunei Darussalam targets 60%; Indonesia, 90%; Malaysia, 70%; and Singapore, 0% (all consumption utilizes imports). 1.2 The Prospect of Extreme Shocks Domestic production plus trade appear to be adequate to meet "normal" types of shocks. However, a real threat to food availability is the prospect of extreme shocks, which can occur in three ways: (i) Extreme negative shocks. These include widespread and severe plant diseases, pest infestations, droughts, and floods. The latter two are weather-related events expected to increase in likelihood over the coming decades because of climate change. Export restrictions or outright bans. These may have broader or more severe effects than climate change, depending on the stringency of the restriction and the policies of the country implementing it. Interaction between extreme negative shocks and export restrictions. Export restrictions are often imposed in the aftermath or in anticipation of a calamity affecting domestic harvests. For instance, Russia implemented a ban on exports of wheat in 2010 as it was then suffering from a drought, which had destroyed up to 17% of the wheat crop (Welton 2011).

(ii)

(iii)

Complementing Regional Rice Reserves with Novel Domestic Reserve Mechanisms | 3

The first-best solution to such export restrictions and bans is to obtain a commitment from exporting countries to refrain from such policies. In practice, these commitments need to be negotiated and enforced; in the short term, such commitments may not materialize except perhaps on a piecemeal basis such as a moratorium on export bans or country-specific exemptions. Another more practical response to the prospect of extreme shocks is to supplement production and trade with storage. In practice, both the private and public sectors undertake storage for their own reasonsfor commercial gain, in the case of the private sector, and for public welfare, in the case of the public sector. However, in the aftermath of the 2008 crisis, domestic storage based on status quo assumptions may not be sufficient preparation for future food crises. There is a need therefore to expand reserves for added protection in case of extreme shocks. Augmentation of reserves can done at the regional level. In 2011, the Association of Southeast Asian Nations (ASEAN) Plus Three2 established the ASEAN Plus Three Emergency Rice Reserve (APTERR). This regional mechanism seeks to address threats to food security due to natural calamities by creating a pool of food security reserves out of pledges from member countries. A supplying country can pre-arrange a transfer of its pledged reserves to a recipient country by way of a forward contract. The forward contract requires the delivery of rice in the event of an emergency in the recipient country. In principle, this works faster than an ad hoc purchase order. Although APTERR is a powerful instrument for regional food security, a main limitation is its total size of rice reserves of 787,000 tons. While much larger than its predecessors such as the ASEAN Emergency Rice Reserve, the level is still too small to address extreme calamity risks (Briones 2012). The other policy option is to increase domestic reserves. Such policy option must compare the added costs against the presumed benefits. The costs, however, depend on the type of arrangement actually pursued since different food security reserve schemes incur different costs. This paper presents a description of practical options for increasing domestic food reserves, focusing on rice, with an evaluation of the cost effectiveness of various options.

2. Storage and Food Security: Background and Conceptual Framework

2.1 Supply Shocks and Market Volatility Food consumption on a regular basis is needed to maintain health. If food production was stable and highly predictable, there would be little need for food stocks. However, food production is erratic and prone to shocks, which requires securing supplies from other sources even outside the country. However, as shown by simulations using the Arkansas Global Rice Model (AGRM), 3 the presence of trade will not eliminate price volatilities. In fact, trade is compatible with a high

The ASEAN Plus Three is composed of the 10 member nations of ASEAN Brunei Darussalam, Cambodia, Indonesia, the Lao People's Democratic Republic, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Viet Namplus the three East Asian nations of the People's Republic of China, Japan, and the Republic of Korea. Developed and maintained by the University of Arkansas Global Rice Economics Program, the Arkansas Global Rice Model is based on a multicountry statistical simulation and econometric framework. The model is disaggregated by five world regions (Africa, the Americas, Asia, Europe, and Oceania), which each includes country models that have a supply sector, demand sector, trade, stocks, and price linkage equations.

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degree of price volatility when supply shocks are sufficiently large.4 Figure 1 presents a simulation using the AGRM for the price of Thai white rice 5% over the period 20122022, based on average rates and assuming the occurrence of severe shocks. Whereas the price per ton on average varies from $403 to $454, the price per ton in case of severe shocks varies from $504 to $556, a difference of 21.3%. A similar comparison for paddy production shows a much wider range of variation in rice-exporting countries. On average, the domestic paddy production in Thailand is 6% lower under extreme shock conditions compared to the mean; for Viet Nam, paddy production is 3% lower (Figure 2). For rice-importing countries, the range in rice consumption outcomes is likewise quite narrow. The consumption rate in Indonesia is 2.5% lower in the extreme case compared to the mean while it is 2.8% lower in Malaysia and 6.2% lower in the Philippines (Figure 3).
Figure 1: Projected Price of Thai White Rice 5% Freight on Board, Mean and 95th Percentile ($/ton)
600.00 550.00 500.00 450.00 400.00 350.00 300.00 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Mean

95th Percentile

Source: Wailes and Chavez (2013).

Figure 2: Percentage Difference between Projected Mean and 95th Percentile for Annual Paddy Production of Rice-Exporting Countries
0.0 -1.0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Figure 3: Percentage Difference between Projected Mean and 95th Percentile for Annual Consumption of Milled Rice of Rice-Importing Countries
0.0 -1.0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

-2.0 -3.0 -4.0

-5.0 -6.0 -7.0 -8.0 -9.0

-2.0 -3.0 -4.0

-5.0 -6.0 -7.0 -8.0 -9.0

Thailand

Vietnam

Indonesia

Malaysia

Philippines

Source: Wailes and Chavez (2013).

4

In the following example, the impact is based on a market outcome (price or quantity) obtained in the context of repeated simulations creating a distribution of runs, based on random draws. A quantile price corresponds to a "sufficiently large" shock if that price exceeds 95% of prices in the distribution of runs. A quantile quantity (production or consumption) corresponds to a "sufficiently large" shock if it is higher than only 5% of the quantities in the distribution of runs.

Complementing Regional Rice Reserves with Novel Domestic Reserve Mechanisms | 5

Hence, large price variations can be triggered by relatively moderate gyrations in yield; as consumption variations are small, then consumption spending for rice will be subject to large swings. This means, households are placing high priority on food spending, with corollary contraction in other consumption items (e.g., health and education) in the event of large price spikes. 2.2 Rice Utilization and Storage in ASEAN Table 1 presents utilization indicators for ASEAN countries. Domestic utilization has grown moderately, except for Thailand (where it fell slightly) and Singapore (registering a high growth, which may be a statistical artifact). The largest import-to-use ratios are observed for Singapore (well above 100%, owing to re-exports) and Brunei Darussalam, in that order. In 2011, the large rice-consuming countries of Indonesia and the Philippines had low import-to-use ratios as a result of self-sufficiency policies in rice production. Meanwhile, the major rice-exporting countries of Cambodia, Thailand, and Viet Nam are able to generate a surplus of 27% 47% of utilization and to sell this abroad.
Table 1: Indicators of Domestic Utilization, ASEAN Member Countries, 2010 2011 Country 2010 Brunei Darussalam Cambodia Indonesia Lao PDR Malaysia Myanmar Philippines Singapore Thailand Viet Nam 32 2,961 39,034 1,748 2,470 19,593 11,898 209 12,120 19,270 Utilization ('000 tons) 2011 34 3,036 39,682 1,828 2,511 19,753 12,414 275 12,084 19,468 Growth (%) 3.9 2.5 1.7 4.6 1.6 0.8 4.3 31.9 -0.3 1.0 Stocks-to-Use Ratio (%) 2010 57.6 10.9 6.1 8.0 29.4 21.9 22.1 19.2 63.6 29.9 2011 47.2 17.0 4.1 14.2 30.9 20.3 27.6 18.2 65.5 22.3 Imports-to-Use Ratio (%) 2010 88.2 0.0 0.6 1.3 31.6 0.0 20.0 118.9 0.0 0.0 2011 92.4 0.0 4.1 3.2 41.1 0.0 5.7 128.7 0.0 0.0 Exports-toOutput Ratio (%) 2010 0.0 35.0 0.0 2.2 0.0 4.9 0.0 42.2 27.8 2011 0.0 35.0 0.0 1.3 0.0 4.9 0.0 45.6 27.0

Lao PDR = Lao Peoples Democratic Republic. Source: ASEAN Food Security Information System (2012).

Table 1 also provides data on beginning stocks, which represent both private and public stocks. The stocks-to-use ratio is highest for Thailand (the worlds largest rice-exporting country) and Brunei Darussalam (a small rice-importing country). Also with sizeable stocks-to-use ratios are Malaysia and the Philippines. The recommendation of the Food and Agriculture Organization of the United Nations is to maintain the stocks-to-use ratio at around 17%. However, the ratios for Indonesia and Lao PDR are below this indicator, with Indonesia, the largest rice-producing and rice-consuming country in the region, having the lowest stocks-to-use ratio (under 5%). 2.3 Economic Model of Storage Suppose harvest is a random variable subject to independent and identically distributed shocks.

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In the absence of storage services and under reasonable assumptions, it can be shown that (i) prices should likewise be independent and identically distributed, and (ii) positive and negative price spikes should be symmetric, such that accounting for inelastic demand, extreme price declines should be as likely as extreme price increases. When storage is introduced, a new instrument is available to stabilize food availability and prices. Traders perform intertemporal arbitrage through storage if the future price is anticipated to be higher than the current price. Against this benefit, traders must weigh the costs of maintaining stocks, specifically the storage service plus the opportunity cost of deferred sale. Given these trade-offs, an economic model of storage has been developed to describe the behavior of traders and to compare it with the optimal level of stocks. The workhorse for this type of problem is the competitive storage model, pioneered by Gustafson (1958) and elaborated by Wright and Williams (1982). In the competitive storage model, speculators hold stocks in anticipation of a future increase in prices under conditions of expected profit maximization and rational expectations. In contrast to the no-storage scenario, Deaton and Laroque (1992) showed that the market with speculative storage would exhibit three properties: (i) autocorrelated time series; (ii) spells of relatively stable prices punctuated by extreme price increases; and (iii) a skewed price distribution, as price increases tend to be larger compared to price declines. The first property is a direct consequence of storage behavior. The second and third properties arise from the fact that inventory is bounded from below; during stock-outs, following an extreme negative shock (or series of shocks), the market reverts to the no-storage scenario. However, during extreme positive shocks, storage continues to maintain its stabilizing function. Deaton and Laroque (1992) showed that these three properties are empirically present in commodity time series. However, the competitive storage model is inconsistent with the high degree of serial correlation in actual time series. Cafiero et al. (2011) showed that under plausible numerical specification, competitive storage models do generate high degrees of serially correlated price series. Hence, competitive storage models are empirically relevant. 2.4 Welfare and Stabilization Policy The competitive storage model describes the behavior of private traders but it can also be used to derive welfare implications. Gouel (2012) showed that traders will not be able to provide the optimal level of storage. The reason is that traders are risk-neutral and set storage to maximize intertemporal expected profit, and they do not account for the risk aversion of consumers. Ideally, consumers are able to purchase state-contingent securities (insurance) to offset price risk, but such markets do not exist. As private storage is not enough, an alternative is public storage. However, Gouel (2012) found that under plausible parametrization and simplifying assumptions, the benefit from shifting to optimal storage using public stocks is minimalless than 1% of commodity expenditure. Convexity of the utility function (giving rise to risk aversion) generates only a weak rationale for intervention. A more compelling argument invokes food security: in the event of an extreme negative shock combined with a stockout or the exhaustion of supplies, the poorest consumers face elevated malnutrition and mortality. Formally, this can be modeled as a threshold effect (Myers 2006) where sufficiently high prices terminate the enjoyment of health or even life. This suggests the need for precautionary reserves with a humanitarian purpose, which is clearly outside the

Complementing Regional Rice Reserves with Novel Domestic Reserve Mechanisms | 7

commercial motivations of traders. Larson et al. (2011) applied a competitive storage model to analyze a "strategic reserve" that is deployed in case of extreme price spikes. An "extreme" spike is one that belongs to the upper 10th percentile of price variation. The reserve would then have to release stocks to bring the price back to the limit price; the reserve "fails" when reserves are depleted and the price remains above the limit. The time path to accumulate stocks up to a target level is specified by a stocking rate. Larson et al. examined the effectiveness and cost of a strategic reserve based on a model simulation for the Middle East and North Africa countries at a 2011 baseline. They found that the likelihood of staving off a price spike rises when the size of the reserve increases, but this comes at higher cost. Targeting releases of the strategic reserve to a needy group (at pre-crisis prices) dramatically reduces costs. Based on plausible parametrization they suggested a reasonable approach involving a reserve target at 50% of annual consumption with a restocking rate of 10%, resulting in the reduction of domestic price volatility from 16.4% to 14.5%, a failure rate of 0.55% of the time, and at a cost of $827 million per year.

3. Options for Food Security Reserves

3.1 Matrix of Options for Domestic Reserves The foregoing studies assume that public and private storage incur similar costs. Given the plausibility of market failures, some manner of intervention with regard to storage appears warranted. However, the manner of intervention as well as the cost of the intervention have to be incorporated in the analysis. Options for intervention are summarized in Table 2. The columns divide the actors in the production of storage services, while the rows divide the types of ownership of food stocks. Production can be produced by either the public or private sector; likewise, stocks can be owned by either the public or private sector. The combination of public storage of public stocks leads to Option 1, which is the most conventional form of market stabilization. Private storage of public stocks leads to Option 2, in which storage function is outsourced to the private sector. Mandatory storage of private stocks in public warehouse for food security purposes is Option 3, which is rarely observed in practice. Lastly, Option 4 denotes privately-owned stocks in private storage; such stocks must be controlled by government regulation if they are to be mobilized for food security.
Table 2: Options for Intervention in Food Storage Stock Sourcing Storage Public Option 1 Traditional scheme Procurement of stocks from farmers/traders/millers, stored in public warehouse Option 3 Compulsory storage in public warehouse Rarely observed Private Option 2 Outsourcing of storage and even distribution to private warehouses Complemented by storage incentives (concessional loans, tax exemptions, etc.) Option 4 Emergency food reserves by regulation

Public

Private

Source: Author.

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3.2 Options for Publicly-Owned Stocks Option 1 is a traditional scheme for food security in many developing countries, particularly in Asia, which allows the government to exercise the greatest control over the quantity and deployment of food stocks. It is also the most expensive option, entailing upfront investments (for warehouses) and maintenance costs. Parastatals combine marketing, storage, and food security mandates in countries such as Bangladesh, India, Indonesia, Pakistan, the Philippines, and Viet Nam. A review by Rashid et al. (2006) noted that the rationale for the initial establishment of these parastatals could be found in the poor condition of markets, the low adoption of modern technologies, and the fragility of international trade at the start of the postcolonial era. However, in the intervening decades, markets have developed, modern technologies have proliferated (witness the Green Revolution), and international trade has deepened remarkably. The relevance of these parastatals is becoming increasingly questioned especially in light of evidence suggesting the following: parastatals operate at higher cost than their private sector counterparts, and have inflicted a large fiscal burden on governments; there is no demonstrable impact of parastatals on price instability, at least in the recent period; the reduction of market intervention reduces price distortion, public sector costs, and strengthens private sector trading, which in turn contribute to the deepening of markets and price stabilization.

These points are echoed in a recent study on public foodgrain stocks (World Bank 2012). A review of the evidence found that (i) the multiplicity and lack of clarity of objectives of public stocks lead to failures, (ii) fiscal costs frequently escalate to unsustainable levels, (iii) the economic costs of maintaining high food prices are very large, (iv) countries fail to achieve price stability despite having buffer stocks, and (v) buffer stocks often crowd out the private sector. Option 2 removes the need for the public sector to make upfront investments and helps lower operating costs by relying on more efficient private sector storage. Some parastatals, such as the National Food Authority in the Philippines and the Public Warehouse Organization in Thailand, are already doing this to avoid expanding their overhead costs. Option 2 can be extended to various forms of publicprivate partnership in food security. For instance, rice importation and storage for Brunei Darussalam is handled by BruSiam Foods, a joint venture between the Government of Brunei Darussalam and a private company in Thailand. In Cambodia, the ADB-funded Emergency Food Assistance Project (EFAP) procured 12,000 tons of rice stocks from the Federation of Cambodian Rice Millers Associations (FCRMA). At the same time, the FCRMA was engaged to undertake the distribution of free rice to target communities (EFAP 2009). While the storage duration of EFAP was only about 2 weeks, the contract with the rice millers could have been written ahead of an emergency and the stocks kept in storage. Such an arrangement would be a significant departure from Option I. Nevertheless, Option 2 still entails public financing for the purchase of stocks. Such fiscal burden is avoided in Options 3 and 4. This paper omits discussion of Option 3, which is rarely seen, and elaborates on Option 4 in the following discussion.

Complementing Regional Rice Reserves with Novel Domestic Reserve Mechanisms | 9

3.3 Food Security with Privately-Owned Stocks 3.3.1 Regulatory Arrangements for Option 4 Option 4 entails the government regulation of rice stocks owned and stored by the private sector. From the viewpoint of public administration, a major advantage of Option 4 over Option 2 is the low financial outlay from the government. Costs incurred in the arrangement are shouldered by market agents (traders, producers, and consumers), which requires regulation by government to ensure compliance with food security measures on storage and release. One way of enforcing regulation is through warehouse receipts (Box 2). The regulator may apportion quantities under receipt for mandatory storage. The advantage of this system is that the warehouse receipt holder may keep their stock in any accredited warehouse. During times of abundant harvest, the amount for mandatory storage may be raised, reducing the disposable supply in the market and supporting the market price. Alternatively, when prices rise, the regulator may relax the mandatory storage requirement in an attempt to raise disposable supply and reduce the price. In the Philippines, warehouse receipts for sugar are called quedan, which are issued by the sugar regulatory agency and mandatory for all raw sugar milled in the Philippines. Warehouses, however, are privately owned. The quedan is classified by destination: A-sugar is for the United States (US) export quota; B-sugar is for the domestic market; C-sugar is for reserve; and D-sugar is for export (outside the US). C-sugar may not be released from the warehouse unless reclassified by the Sugar Regulatory Administration. By adjusting the level of C-sugar, the regulator can raise or lower the amount of sugar in storage.

Box 2: Warehouse Receipt System

A warehouse receipt is a document that certifies the availability of and the rights to withdraw a quantity of stock, of specific characteristics, to a designated recipient, within the facilities of a storage provider. Modern warehouse receipt systems can be traced to the United States. The opening of vast farmlands in the Midwest, together with the development of transport infrastructure, led to a massive inflow of grains to trading centers, most notably in the city of Chicago. In the 19th century, storage providers, called elevators, issued tradable receipts against the stock. Elevators fell under tight regulation from the state of Illinois from the 1960s onward. The Chicago Board of Trade (CBOT) emerged as the dominant commodity trading floor. The market for tradable receipts expanded considerably with the opening of futures trading, which was initially intended to ensure East Coast buyers a price ahead of the delivery of physical grain. Futures trading became the dominant activity in the CBOT. As the scope of the market expanded beyond Illinois, the exchange fell under federal regulation by the 1920s. Other well-known warehouse receipt systems are in Colombia and Venezuela. Since the 1990s, the system has been introduced (with donor support) in Sub-Saharan Africa.
Source: UNCTAD (2009).

A warehouse receipt system works well for raw sugar that is a homogenous product. Rice is a different matter altogether. It has been difficult to establish a widely accepted warehouse receipt system for rice because of difficulties with standardizing rice grades. The example of Singapore,

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however, shows that a licensing system is a sufficient regulatory scheme for implementing Option 4 (Box 3).

Box 3: The Rice Stockpile Scheme in Singapore

Singapore has no domestic production of rice so any storage for food security purposes requires imported stocks. Rice is a controlled item under the countrys Price Control Act, and importers and wholesalers must be licensed by the government. The regulatory agency is the International Enterprise Singapore Board (IE Singapore). Within the framework of the Price Control Act, IE Singapore implements a rice stockpile scheme to maintain an adequate supply of rice in the market. Under the scheme, the varieties of white, basmati, ponni, and parboiled rice are classified as stockpile grade. Importers of stockpile grade rice are automatically enrolled in the rice stockpile scheme. Participants must precommit the monthly import quantity for the domestic market, as well as a stockpile quantity. Importers are free to designate their monthly import quantity although white rice is subject to a minimum of 50 tons. The monthly import quantity is allowed to adjust under certain conditions, depending on the state of the market. The stockpile quantity is twice the monthly import quantity, and must be kept in a governmentdesignated warehouse, owned and run by a private company. The importer maintains ownership of the stockpile quantity. However, the government may acquire the stock during emergency with compensation. In normal periods, the stockpile quantity shall be rotated by the importer; no batch of stocks can be kept in the warehouse for more than a year. Currently, there are 41 licensed importers participating in the rice stockpile scheme.
Source: International Enterprise Singapore (2013).

Once a reserve is set aside, the regulation may specify a trigger price, above which the government can make releases from the reserves to bring prices down to the limit (the same strategy analyzed by Larsen et al. 2011). To ensure the release, the government may prescribe the mandatory acquisition of the reserve (with compensation). The trigger price may be set at some extreme level, such as in the 90th95th percentile of the price distribution based on past time series. Another strategy is exemplified by Malaysia where a private entity, the Padiberas Nasional Berhad (BERNAS), is conferred an exclusive right to import rice as part of its contract with the Government of Malaysia. While this right, which runs until 2012, can be assigned to the private sector, BERNAS effectively possesses an import monopoly. The contract in turn obligates it to implement the National Rice Stockpile scheme, which is now set at a level of 292,000 tons of rice. BERNAS views this role both as a food security function as well as a mechanism to stabilize rice supplies and rice prices in the country (BERNAS 2013). However, the import monopoly is controversial because of its highly distortionary market effects and its removal would likely increase social welfare gains (Vengedasalam et al. 2011). 3.3.2 Issues in Market Development and Regulation Option 4 entails the implementation of food security measures by the private sector, which require a high degree of private sector development in marketing and storage. To assure such development, government intervention should be designed to ensure that three conditions will prevail in food markets: i) an adequate degree of price volatility, ii) an adequate collection and

Complementing Regional Rice Reserves with Novel Domestic Reserve Mechanisms | 11

dissemination of information, and iii) regulatory effectiveness. These conditions are discussed in some detail by Giovanucci et al. (2000). Adequate degree of price volatility. The incentive for private storage is the expectation of a future price increase. However, if government intervention to stabilize prices becomes too strong, price volatility will be inadequate. Government must allow some play for market prices to adjust and to encourage intertemporal arbitrage. Within some range of price variation, private agents should be given flexibility in their decisions on production, storage, trading, and importation, within a regulatory framework. The trigger price should, therefore, be set at a high level (a quantile close to 100%). Adequate infrastructure and enabling investment climate. Aside from getting price variation right, government must provide an enabling environment for investments in logistics facilities (including storage) and transport equipment. Government needs to invest in complementary infrastructure such as roads, bridges, and utilities, by itself or in partnership with the private sector. Government may also offer incentive schemes for logistics investments. Regulatory effectiveness. Government must also provide a strong and credible framework to guide private sector activity. This involves specified and enforced grades and standards for rice varieties, regulations for warehouse facilities, and a legal system for enforcing contracts. Dispute settlement mechanisms must be put in place to address non-compliance. A functional monitoring system must be established to track inventories, and preferably the flow of transactions on a regular basis. As also discussed, the commercial level of inventory must be augmented by a food security reserve enforced by regulation. Collection and dissemination of information. The monitoring system can be combined within an information system that will track and report current and future conditions of supply and demand. This includes crop forecasting and stocks analysis, to enable the formation of more accurate price expectations. A similar point has been made by Mackenzie (2012) in the context of the development of a futures market in rice.

4. Conclusion
This paper has reviewed the potential benefit of mobilizing food reserves as an emergency preparation for extreme supply shocks. While private traders have an incentive to provide storage services, economic theory implies that their storage levels may be insufficient compared to what are needed for food security and for protection against risks. However, the traditional method of supplanting private stocks with public stocks in public storage is inadvisable because it is costly and ineffective based on recent experiences. The ideal strategy emphasizes the role of the private sector, which relies on both private storage and private stocks, albeit under government regulation. There are precedents for this approach to food security, although these remain less popular compared to the traditional method. The private sector approach requires an enabling environment for the private sector to function as the primary provider of storage and logistics services. From the existing statist regimes, the evolution to market-oriented food systems will not happen in the short term or even in the medium term. During the interim, governments may pursue publicprivate sector partnerships such as through outsourcing storage and food distribution to the private sector. The participation of the

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private sector can gradually increase toward building the resilience of commercial food production and the distribution system to severe supply shocks.

Complementing Regional Rice Reserves with Novel Domestic Reserve Mechanisms | 13

References
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