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Yesterday, this section highlighted that SBP’s wheat procurement financing framework perversely favours public sector procurement, which has a dual effect of not only crowding out direct buying by private sector, but also contributes to a debt build up that has increasingly become hardcore.

But first some context of how public sector commodity operations work. Each year in March, federal and provincial governments set wheat procurement targets after taking into account annual demand, carryover stocks from past year, average cost of production, and price movements in global and domestic markets. In nine out of past ten years, public sector agencies (such as PASSCO) and provincial food departments together procured at least 20 percent of national wheat output. Government procurement usually begins by April when harvest is at its peak and concludes by June end.

Because the wheat procurement policy is rooted in farmer welfare, public sector buying takes place at minimum guaranteed rate (also known as support price) that is usually set above market rate. Given the sheer scale of commodity operations – now closing in on Rs 200 billion annually (explained below) – PASSCO and food departments avail seasonal working capital financing lines from commercial banks at market-based pricing of Kibor + spread.

Once the public sector achieves its procurement target, private sector buyers enter to mop up the remaining tradable wheat, fulfilling demand from flour mills during July and August. By September, food departments announce their wheat release policy. Under the policy, government fixes a release price at which wheat is sold to registered flour mills (over 1,200 nationally). Based on domestic market price trend at the time – for example, if an upward price spiral is underway due to a shortfall - the release price may be set below cost to ensure that flour remains affordable for consumers.

And therein lies the contradiction. Because the twin objectives of ensuring better prices for farmers and maintaining affordability for consumers are at odds with each other, provision of subsidy becomes inevitable. In absence of full cost recovery, the provision for subsidy also funds government’s inventory carrying costs, transportation charges, cost of gunny bags, and debt servicing on outstanding debt stock. And that’s where this story really begins.

The outstanding debt stock of public sector borrowing against commodity operations peaks by June end, in line with conclusion of official procurement. Similarly, outstanding debt stock bottoms out by end of following March, once PASSCO and food departments have released wheat stocks into the secondary market as per pre-determined quotas. Payments from private flour mills (against wheat sold) is utilized for settlement of advances outstanding. Except, incremental debt availed each year is never really settled in full. Why?

One, the policy to maintain reserve stocks means that both PASSCO and provincial food departments carry inventory that is financed through incremental debt obtained each season. Moreover, because of limiting fiscal space, the subsidy amount allocated routinely falls short in plugging the gap between cost of procurement and release price. Worse still, delays in subsidy disbursement leads to accumulation of mark up, which in turn is also financed through incremental debt.

In fact, in its latest Financial Stability Review, the SBP itself acknowledges that although commodity financing should be self-liquidating in nature, banks’ payables are settled through periodic rollover of borrowings. This leads to the perverse situation where incremental debt availed each year is greater than previous year’s, yet leads to lower procurement (per unit) due to increase in nominal prices of wheat. Worse still, according to the same report, outstanding debt stock against commodity financing now constitutes more than one-third of total public sector borrowing (December 2019).

And that’s not all. While the debt stock of provincial food departments shows a degree of movement (but no annual clean up), the matters become worse at the federal level. Since at least FY12, outstanding debt for PSEs as of season close (March end) has remained stuck at Rs 200 billion, while it seasonally peaks between Rs 220 – 230 billion (June end). Meanwhile, average volume procured by PASSCO each year has fallen to half a million tons, much of which is financed not through bank borrowings, but instead from annual subsidy provision to the tune of Rs 10 – 20 billion in the federal budget!

What does that mean? In simple terms, that over much of the past decade, PASSCO has not only failed to reduce the outstanding debt stock against past commodity operations, but in fact avails incremental debt largely to service markup on outstanding loans, increasingly caught up in a vicious cycle.

But that only raises further questions, such as, why have subsequent governments not shut down PASSCO after one-time final settlement of its debt, especially as bulk of official procurement has shifted to provinces since 18th amendment?

Turns out, PASSCO may very well be a public sector enterprise, but it was setup nearly half a century ago with capital from GoP, and six commercial banks (four of which have been privatized since). A cursory review of documents available on the web shows that GoP only owns 25 percent of PASSCO’s equity, while the remainder is held with the commercial banks. Understandably then, that 6 out of 8 BoD members of PASSCO also belong to commercial banks.

Why does that matter? According to disclosures in annual accounts of one commercial bank, its investment in PASSCO has grown from Rs 5.5 million at inception to Rs 2.73 billion as of December 2020. This for a PSE, which according to SBP, could quickly turn into “an issue as 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 avail financing against the liquidation value of pledged wheat stock, public sector borrowing “is mainly backed by letter of guarantee issued by the GoP” (SBP, 2019). That’s because the value of stocks available (or procured) is simply not sufficient to justify outstanding commodity operations debt. So much for its self-liquidating nature.

Meanwhile, excessive regulatory scrutiny involved in extending credit to private sector wheat processors and traders means only those on government’s approved list are able to obtain financing from commercial banks. No surprises that these are same as those with assigned quotas by the Food departments!

This at a time when corruption is routinely alleged in quota allocation by food departments and procurement agencies. That ‘ghost mills’ obtain wheat against quota from the government, and sell it off in the aftermarket, is also an old story. Disappearance of wheat stocks from public sector godowns is also no news.

Yet, existing wheat financing policy effectively crowds out private sector buying by ensuring that wheat processors do not have access to bank credit lines during peak harvest period (April – May). This is of course done in the name of facilitating government targets, but in fact means that a monopsony market is created at the expense of competition.

The mounting public sector commodity operations debt is a story of wilfully ignored moral hazard. But even as all failures in wheat procurement operations point to leakages in the public sector, it is rich that private sector traders are blamed for speculation and hoarding.