grain trading and marketing in russia

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					Russian grain trading and marketing:
evolution and struggles
Dr. Alexander Belozertsev
                                During the last ten years the Russian grain marketing system is going through a
                                remarkably traumatic evolutionary change, the dimensions of which potentially
                                influence much the world grain industry. For many years a highly centralized
                                command system, devoid of any concept of market approaches, has been the
 Alexander A. Belozertsev       mechanism for allocating resources within the grain sector. Functions were
 received his Ph.D. in          performed exclusively through state-owned facilities, and product distribution
 Agricultural Economics         was also on a command basis.
 from the Moscow
 Agricultural Academy
                                Concurrent with many other developments over the past ten years have been
 named by K.Timirjazev in
 1986, worked for the State     numerous institutional changes in the Russian grain industry. Of particular
 Commission on Food and         importance is the simultaneous decrease of the role of the state-owned
 Procurement (The               organizations and the development of numerous joint stock (private)
 Government of the USSR)        companies within the national grain system. Most notable, however, is that the
 from 1989 till 1991, and the   market functions (handling, processing) that the Ministry of Grain Procurement
 Chicago Board of Trade,        and, later, state-owned corporation ‘RosKhleboProdukt’ traditionally provided
 Economic Analysis              on the Russian grain market were replaced by the mid of 1990s by a certain
 Department in 1991-1992.       number of privatized grain companies, started from scratch or on the basis of
 He also worked as a
                                the former regional ‘KhleboProdukt’ organizations.
 Representative of Cargill
 Investor Services, Inc. in
 Russia for 1992-1996. He       Russian export-import operations with grains were also decentralized in 1990s,
 currently works as a           moving from a state monopoly to a large number of Russian participants in the
 Representative of the USA      world grain market. ExportKhleb, the mogul of the former Soviet Union grain
 Rice Federation in Moscow      import system, was transformed into a joint stock company at the beginning of
 (Russia).                      1990s; since, its role in Russian grain imports has diminished dramatically.
                                Besides being the agent for ‘RosKhleboProduct’ on certain imports,
                                             R
                                ExportKhleb has pursued other trading opportunities, primarily in the former
                                             u
                                Commonwealth of Independent States (CIS) countries, acting fundamentally as
                                             s
                                a private trading company.
                                             s
                                             i
                                An important new feature of the grain marketing system in Russia is the
                                             a
                                increased role of regional and city governments, which operate through certain
                                grain marketing companies and semi-governmental organizations.

                                Commodity exchanges, which flourished in Russia in the beginning of the
                                1990s, do not play a key role in the national grain distribution system.
                                Moreover, the few exchanges which are still actively involved in grain trade do
                                not provide reliable price information, as the grain flow through these
                                marketplaces is rather low. Futures and options on grains (as known in the
                                West) are not traded yet in Russia.

                                The purpose of this paper is to describe changes occurring in the Russian grain
                                market system with a particular focus on factors impacting the evolution of
                                private grain trade. Specific sections describe 1) economic conditions
                                confronting the industry; 2) traditional organization of grain marketing; 3) the
                                current and evolving marketing system; 4) grain exchanges in Russia, their
                                current function, and obstacles inhibiting their evolution; and 5) a discussion of
                                the future of this market and likely progression toward a more competitive
                                system, which would be integrated with the rest of the world.

                                Economic conditions confronting the grain marketing sector
                                Agribusiness accounts for 30 percent of Russia’s GNP and comprises about 70
                                percent of the consumer market. Russia is still the largest grain-producing
                                country among the CIS countries and one of the largest grain-producing
                                countries in the world. Tremendous challenges would confront any grain
                                marketing system of this geographical size and volume.



                                                    - 105 -
                                                      from 65.6 million hectares average per a year in 1986-90 to 59.2 million
                                                      hectares in 1991-1996 and 56.0 million hectares in 1997. The average grain
                                                      production in Russia in 1986-90 was 104.3 million tons, in 1991-96 88.0
                                                      million tons, and 87.0 million tons in 1997; for 1998, a mere 45-46.0 million
                                                      tons is forecasted. The main grain producers in the country are still big farms,
                                                      which were transformed in 1990s from state and collective farms to joint-stock
                                                      enterprises. Private farming is still not important in Russian grain production,
                                                      comprising less than 10 percent of the total grain output.
               120                    Russian grain
                     1986-1990                        During the last 20 years the percentage of Russia in world grain production has
million tons




                                       production
               100                                    decreased from 5.2% in 1985 to 4.6% in 1995; per capita grain production also
                                        1997
               80           1991-96                   decreased from 688 kg of grain in 1985 to 448 kg in 1995.
               60                              1998
                                                      Three sets of macro-economic conditions have a large impact on this evolving
               40
                                                      market structure. First, the financial stabilization policy has decreased the
                                                      volume of cash flowing into the agrarian sector. Second, the rouble has been
                                                      severely devalued recently, from 6.20 per U.S. dollar before 17 August 1998 to
                                                      about 15 by the end of October 1998. Third, the banking system still suffers a
                                                      severe crisis, which does not allowed to use funds allocated for the domestic
                                                      agriculture in an efficient way. These funds are important because grain
                                                      marketing activity in most countries involves stockholding and typically
                                                      requires relatively easy access to capital.

                                                      Price liberalization in Russia in early 1992 and tight government monetary
                                                      measures worsened the financial position of the agribusiness sector, especially
                                                      the grain sector. Prices for manufactured goods increased considerably
                                                      compared to those for agricultural products. In addition, the flow of finance to
                                                      Russia’s big grain-producing farms decreased considerably, making it
                                                      practically impossible to maintain soil fertility and to adapt new technologies.
                                                      Distribution problems and a decrease in raw material imports from other CIS
                                                      republics have created additional problems in the Russian grain sector. Finally,
                                                      many suppliers to grain-producing farms are still monopolists; their monopoly
                                                      powers add to price hikes for machinery, supplies, and services.

                                                      Grain marketing organization
                                                      Grain distribution in the former Soviet Union was highly regulated.
                                                      Specifically, the Grain Procurement Agency (‘KhleboProduct’ Ministry, which
                                                      has changed its name many times) was responsible for grain distribution.
                                                      ‘Khleboproduct operated under strict supervision of the Central government
                                                      and ‘GosPlan’, the State Committee on Planning, based on rigid orders and
                                                      fixed procurement prices. Today, this organization still exists, - under the name
                                                      of ‘RosKhleboProduct', - but it has already lost its monopoly on the Russian
                                                      grain market, and since 1993, almost all of its regional subsidiaries (regional
                                                      ‘KhleboProduct’) have been privatized. These regional ‘KhleboProduct’
                                                      organizations (and some in the bigger cities such as Moscow and St.
                                                      Petersburg) and private commercial companies such as OGO and RosContract
                                                      began playing an active role in the domestic grain market.

                                                      Investment in the grain sector in the former Soviet Union was also
                                                      monopolized. Central credits were invested to build large elevators and storage
                                                      facilities, as well as for harvesting and transportation equipment plants and
                                                      factories. Despite these investments, Russia continued to have an inefficient
                                                      grain distribution system. At present, most of these facilities use from 50 to
                                                      60% of their capacity (but note that is has remained difficult to obtain accurate
                                                      figures on storage capacities and means of transportation).


                     The area planted with
                     cereals in Russia decreased


                                                                          - 106 -
Evolutionary change in Russian grain marketing.
Numerous changes have been occurring in the Russian grain marketing system.

RosKhleboProduct The Russian grain marketing system has always been
controlled through centralized organizations. One of the principal organizations
in the Russian grain marketing system is RosKhleboProduct with its network
all over the country. RosKhleboProduct performs functions that the Ministries
of Procurement and Agriculture formerly assumed including procurement and
distribution. (although of course not identical, similar organizations exist in the
United States -the Commodity Credit Corporation-, Canada and Australia the
Canadian and Australian Wheat Boards-, and France -ONIC).

RosKhleboProduct was formed in 1992 and has a number of crucial functions,
including 1) procure grains from domestic production; 2) allocate inputs in
conjuction with ministries; 3) distribute grains to mills and bakeries; 4) own
and manage the vast majority of handling and strorage facilities; 5)control
imports; and 6) act as one of the principle shareholders of ExportKhleb.

In 1993, the privatization process of the state-owned grain handling and storage
facilities was initiated and since then, ‘RosKhleboproduct’ has lost its
monopoly on the Russian grain market and has become just one among the big
players in the national grain marketing system.

ExportKhleb was founded in the former Soviet Union in 1923. It was
originally a state shareholding company which evolved later into a permanent
division of the All-Union Ministry of Foreign Trade (in the 1930s). Exporting
was its exclusive function until 1963, when the Soviet Union imported large
amounts (about 7 million tons) of grain for the first time. Since then it has been
responsible for state grain sales and procurement abroad, on behalf of the
Council of Ministers of the USSR. During the ‘Perestrojka’ in the late 1980s,
several pressures emerged:
1) there were criticisms about the functioning of the grain import agency;
2) an effort was made to demonopolize trade in the internal market; and
3) some republics were beginning to become decentralized.
For these reasons, from 1988 onwards, the agency was formally restructured as
a joint-stock shareholding company, with both corporate and private
individuals holding shares; and a number of subsidiaries were created to
provide services on the domestic and world markets for what was anticipated to
be a broader customer base (firms and organizations that were trying to
promote their own grain operations outside the state distribution system).
ExportKhleb started working with profit objectives, typically on a commission
basis, and competing with newly emerging private companies and
organizations.

Market organization. Until the beginning of the 1990s obligatory sales (or
state purchases) referred to as sales to the Federal or Regional Reserves, had
been an important component of Russian grain marketing. These obligated
sales were made at somewhat rigid procurement prices established through a
political process and administered by RosKhleboProduct . These purchases
have been decreasing for a number of years. State procurements were 33% of
production in 1986-90 and 19.6% in 1991-1995; in 1997, federal and regional
government procurement was about 10 million tons (11.5%).

Traditionally, for many years, alternatives for distribution outside the state
organizations have been limited in the grain sector. Surplus of grains could be
used on farm level in various ways or potentially bartered.




                    - 107 -
Some groups of Russian entrepreneurs have started their own grain trade In
1993 many grain elevators and regional KhleboProduct units were privatized
by groups of local and federal private business groups. In other cases, private
traders started independently. This process has already led to the creation of
regional private grain companies which are competing with current federal and
regional state agencies. Many newly-formed private grain companies after
some years of trading activities already started to be interested in the grain
processing and feedstuff businesses, building and equipping their new mills,
spaghetti factories and feedstuff enterprises. In addition, newly formed private
firms and companies tried to enter the grain trade, not by handling physical
grain, but by providing only brokerage services between sellers and buyers of
grain. Regional agencies are also trying to adjust to the current situation
through creation of state-owned commercial subsidiaries.

Grain Policies and Pricing. Traditionally, the central government established
state purchase prices for a period of one up to five years. Prices did not reflect
supply-demand balances at the regional/federal levels but generally covered
production costs and some profits for most grain producing units. Differentials
were included for location and quality and, to some extent, for individual, state
or collective farms. Of particular importance was that these were the only
alternatives for producers and, in fact, provided the maximum prices that
producers would be paid for obligatory sales. In 1990, a pricing system was
initiated to stimulate production and state purchases of grains. This essentially
involved premiums for sales above a pre-established goal, with a part to be
paid in hard currency (by ExportKhleb as a credit against its import program).
However, this program was largely unsuccessful.

The Russian grain market currently has three sets of related prices.

State procurement prices - These are fixed and could be changed from year to
year according to price trends on the commodity markets. Nowadays, these
prices are no longer used widely as the volume of procured grain through the
state channels is not very high, and mainly includes the purchases of grains for
the Regional Food Funds. In some regions these prices are being formed at the
regional grain auctions, which are usually organized by the regional
administrations (governments).

“Free market” (or local) prices - these prices are formed outside the state
distribution system and are negotiable in practice; usually these prices depend
on regional supply and demand conditions. In the 1997/98 trading year they
fluctuated from 1,200 Roubles per tone (exchange rate at that time was about
$=RR6.00) down to 700 Roubles ($=RR13-15.00). As federal or competitive
agencies have to be able to compete with the "free market", they have to follow
free market prices.

Commodity exchange prices - These are discovered at commodity exchanges
and vary through time. For the last couple of years commodity exchanges were
not as active as they were at the beginning of the 1990s, so these prices do not
play an important role in the domestic grain market.

Three important changes in the economical environment of the Russian grain
industry were introduced in !990s. These are largely in response to the
financial difficulties and the need for longer term reform in the agrarian sector.

First, prepayments are being made to producers to cover a portion of
production costs and crop insurance on volumes that would be delivered at
harvest. Credit is usually provided at favorable interest rates compared to
commercial rates, but this practice has not been spread all over the country due
to banking difficulties. Also, not many of the grain producers who received



                    - 108 -
such credits have managed to reimburse in time, so, the aggregated debt of the
agrarian sector increased dramatically in recent years.

Second, in a revolutionary move in transforming the current grain sector to
market conditions, mandatory sales of grain to government reserves have been
reduced considerably. Right now, the federal (central) and regional grain
reserves are being created on a voluntary basis under contracts with producers.
In particular, 50% of the grain purchased for the Federal Fund are being paid in
advance, not in cash, but usually with inputs (fuel, seeds, fertilizers, and
technical equipment and parts. After completion of the harvest campaign, those
producers who fulfill the contracts receive a 50% subsidy on equipment, parts,
and fuel purchased at the beginning of the year. The Federal Grain Reserve is
being used only to supply deficit regions. The size of the regional grain
reserves are being determined in each specific region; under the responsibility
of the head of the local governments. That is why in the bad harvest of 1998
several regional administrations ahave decided not to "export" grains produced
in their region to the other parts of the country.

Third, bread prices almost all over the country are being controlled by the local
governments. Specifically, the bread prices are tied to the commodity prices
with a fixed differential; the difference between fixed and actual prices is
compensated from the state (regional) budget.

Russian grain exchanges
At the beginning of 1990s, the emergence of commodity exchanges in Russian
grain markets provided an alternative mechanism for price discovery and
transactions. As in other countries, Russian grain exchanges served two critical
roles and functions: helped to develop price discovery, both spot and forward,
and dissemination of price information. Russian commodity exchanges for a
short period of time also served the important role of allocating commodities
among buyers and sellers, a point normally omitted in discussing roles of
commodity exchanges in the West.

One of the first exchange auctions for grain occurred in February 1991. At that
time the State Commission on Food and Procurement organized 3 auctions in
Moscow, attended by managers of state and collective farms. These managers
participated partly because they realized they could no longer rely exclusively
upon the governmental procurement agency to purchase their products at
guaranteed prices for deferred delivery. These auctions were in terms of the
rights to purchase automobiles at the official state price. Of greater importance
to farm managers was access to inputs that were proposed to be included in
subsequent auctions.

At the beginning of 1990s the number of commodity exchanges that existed in
Russia was estimated from 300 to 700. Exchanges flourished rapidly between
late 1990 through mid-1992. At that time, up to 270 exchanges were registered
with the State Committee on Anti-Monopoly Policy, the authority looking over
these enterprises. Since then, the number of exchanges has fallen dramatically.
In 1997 the total registered number was no more than 80, not all of which were
involved in grain trade. Currently, there are relatively active, functioning grain
exchanges in Moscow (the Moscow Grain Exchange), in Saratov (The Saratov
Grain Exchange), and in Krasnodar (the South Food Exchange).

There were so many exchanges in Russia in the early years for a number of
reasons. The vastness of the country and the primitive communication
technology created the demand for local price discovery. Many organizations
rushed to establish exchange mechanisms to take advantage of the early growth
in this industry. Only a few of the exchanges have managed to become more
efficient (at handling orders, matching buyers and sellers, disseminating


                    - 109 -
information, and centralizing activities). Still others have linked up as
networks (a system permitting trading, margin calculating, clearing, and
settling) of trading houses.

For instance, The Moscow Grain Exchange has already developed the
mechanism of auction trading providing a wholesale marketing service for
grains to the Moscow City government. The grain processing enterprises in
Moscow (big flour mills, cereals and fast food factories) usually use the
Exchange for the grain and grain products purchases as the Moscow City
government provides certain funds and guarantees for the sellers and buyers in
the clearing process.

In the case of grain and other agricultural commodities, these exchanges are
fundamentally spot and forward cash markets as opposed to futures and options
markets in the western countries.

Trading occurs usually weekly. Trading procedures differ from those in
western exchanges. First, offers to sell, including price, quantity, quality, and
shipment period (a process which is not standardized) are published and
circulated among brokers. At the trading session, the offers made are declared,
and the buyer is identified through the action when the higher price is
established. This exchange mechanism is fundamentally a “matching’ process,
as distinguished from a “double auction” in western exchanges.

Exchanges usually earn profits by charging a margin, typically 0.5 - 2.0% of
the value of product traded. Some transactions are consummated outside of the
exchange due, in part, to this “middleman” tax. This is a key problem
inhibiting commodity exchange development.

Recent estimates are that not more than 1% of the grain produced in Russia is
traded on exchanges. The principal implication of this is that observed prices
on the exchanges display abnormally wide spreads between bids and offers.

In the early stages, prices were thought to be proprietary and were not
disseminated. However, prices are now disseminated broadly and related
commodity marketing functions (e.g., price reporting services, price
forecasting and analysis, sales of pricing information) have already emerged;
this information has become in a high demand in the domestic grain market.

The future of Russian grain trading.
The Russian grain marketing system is already passing from a command
system to the emergence of commercial mechanisms which could supplant
previous regimes. Given the size of the Russian market, and the potential for
grain production, changes occurring in the market system are not so rapid and
have important implications for the world grain trading system.

While there many subtle changes, there are, at least, three of particular
importance. First, the former governmental monopolies on the Russian grain
market (‘RosKhleboProduct’       and    ExportKhleb) have become semi-
governmental and more commercial entities, which need to survive in a more
competitive market environment. The privatization process in the case of
grains, in some sense, essentially involves transforming a government
bureaucratic organization to a private monopoly under auspices of ‘a joint-
stock’ company, including the big number of the former state and collective
farms.

Second, trade restrictions (i.e., the need for export licenses) and exploitation of
market power by former Soviet Union republics in transport functions preclude
full integration of Russian markets with other world markets. Until and unless


                    - 110 -
these are removed, signals throughout the market system will continue to be
distorted.

Third, there is the emergence of private grain trading as alternative to the state
distribution system. At this point, a dual marketing system is operating in
Russia with a growing private activities on the commodity market.

Also, the necessity and growing demand for the development of grain futures
contracts are tremendous. However, it must be emphasized that viable and
properly functioning cash markets (encompassing the items listed above) are a
prerequisite to any futures and options (or standardized contracts). In addition,
there are four additional requirements for grain futures in Russia.

First, a banking system with an efficient mechanism for funds deposits and
transfer must be developed. Currently, it sometimes takes weeks to transfer
funds even for a cash transaction. Efficient funds transfer is required for a
properly functioning clearing system which is the hallmark of any futures
exchange.

Second, a regulatory structure compatible with facilitating futures trading is
needed.

Third, speculative traders capable of absorbing risk that hedgers seek to reduce
have to be potentially interested.

Fourth, Russia needs a competitive marketing system.             Delivery and
convergence of cash and futures prices can be achieved only with unrestrained
access to a competitive marketing system. No organization (or state monopoly)
should dominate the market and influence prices through its procurement
process, and control of the handling and transport sectors.

These proposals are costly, but they will be more efficient than a relief effort
that contains no stimulus for conversion to a market economy. Right now,
Russia is already asking for billions of dollars and food donations to feed its
population. Simply supplying grain for immediate consumption, however, will
only prolong the misery of the conversion process. The program suggested
above would provide incentives needed for the creation of a reliable and
efficient grain marketing system in the country that will hopefully eliminate the
current shortages in Russia.




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