REVIEW OF AGRICULTURAL WAREHOUSE RECEIPTING INITIATIVES IN ETHIOPIA

by J. Coulter Consulting Ltd., Bromley, UK jcoulter01@yahoo.com

working under contract to University of Greenwich, UK and funded by the Common Fund for Commodities

June 2012

Contents
Contents ........................................................................................................................................................ ii Glossary ........................................................................................................................................................ iv Exchange rate used ...................................................................................................................................... iv Acknowledgement........................................................................................................................................ iv Summary........................................................................................................................................................ 1 1. Introduction ............................................................................................................................................ 5 2. Ethiopia background ............................................................................................................................... 6 2.1 Agriculture and food security ............................................................................................................. 6 2.2 Monetary and financial sector developments ................................................................................... 8 3. Agricultural marketing systems prior to warehouse receipting initiatives ............................................ 10 3.1 Introduction ...................................................................................................................................... 10 3.2 Grains and pulses.............................................................................................................................. 10 3.3 Coffee ............................................................................................................................................... 12 3.4 Sesame.............................................................................................................................................. 14 3.5 Trade financing mechanisms ............................................................................................................ 15 4. Main features of WRS development in Ethiopia .................................................................................... 15 5. The Ethiopian Commodity Exchange (ECX) and related post-2008 marketing innovations .................. 17 5.1 About ECX ......................................................................................................................................... 17 5.2 Chronology of ECXs development .................................................................................................... 18 5.3 Membership and financial support .................................................................................................. 19 5.4 Primary level markets ....................................................................................................................... 20 5.5 Warehousing..................................................................................................................................... 21 5.6 WR financing at ECX ......................................................................................................................... 23 5.7 Observations on storage sites .......................................................................................................... 25 5.8 Observations on the performance of ECX and related marketing innovations ............................... 26 5.9 Plans for other commodities ............................................................................................................ 30 6. Conclusions and recommendations ....................................................................................................... 32 6.1 Re the enabling environment ........................................................................................................... 32 6.2 Re strategic coherence ..................................................................................................................... 33 6.3 Re operational effectiveness ............................................................................................................ 33 6.4 An overriding need for more independent review and open discussion ......................................... 34 References ................................................................................................................................................... 35 ii

Annex 1: List of organisations and individuals contacted .......................................................................... 36 Annex 2: The coffee system ....................................................................................................................... 37 Ethiopias coffee industry and its position vis--vis the world market ................................................... 37 The market structure before ECX ............................................................................................................ 40 Market structure with ECX ...................................................................................................................... 40 Direct exports without trading through ECX ........................................................................................... 41 Impact of the current marketing system on Ethiopias coffee industry ................................................. 42 Impact on exporters and public finance .................................................................................................. 43 How to develop the system in the future?.............................................................................................. 44 Annex 3: Comments on the situation with sesame in Humera ................................................................... 45

iii

Glossary
Acrabi AMC CBE CFC DERG DVP ECX EGTE EFSRA e-WR GIN GOE GRN GTP IFC MoARD MoFED MOTI NBE Open-access warehousing Rural trader Agricultural Marketing Corporation Commercial Bank of Ethiopia Common Fund for Commodities Former communist regime of Ethiopia Delivery-versus-payment Ethiopian Commodity Exchange Ethiopian Grain Trade Enterprise Ethiopian Strategic Food Reserve Agency Electronic warehouse receipt Goods issued note Government of Ethiopia Goods received note Growth and Transformation Plan International Finance Corporation Ministry of Agriculture and Rural Development Ministry of Finance and Ministry of Trade and Industry National Bank of Ethiopia (central bank) Warehousing services that are provided to the public at large, rather than to selected customers. I have avoided using the trade term public warehousing so as to prevent readers misunderstanding it to connote public ownership. Most openaccess warehouses are privately owned and controlled. Productive Safety Nets Programme Rural trader, known locally as Acrabi Warehouse receipt system

PSNP Supplier WRS

Exchange rate used

Ethiopian Birr 17.5 = US$1 in Feb-March 2012

Acknowledgement
The author wishes to express gratitude to the management of the Ethiopian Commodity Exchange for meeting him and facilitating visits to banks and three warehousing sites, and to the many other informants who provided valuable information for this study.

iv

Summary
Ethiopias agricultural sector has grown rapidly over the last decade, but the country still has major pockets of chronic and transitory food insecurity. The Government of Ethiopia (GoE) has embarked on an ambitious Growth and Transformation Plan (GTP) 2011-15, with a view to doubling production of key crops and reducing the number of safety net beneficiaries from 7.8 to 1.8 million households. Ethiopia has for long been Africas leading coffee producer with approximately half of the crop going for domestic consumption and the remainder for export. Over the last decade, the country has experienced rapid growth in its agricultural exports, with sesame seed and pulses approaching coffee as the leading items in volume terms. GoE is also engaged in a massive programme of infrastructure investment, and is financing much of this and the GTP by requiring the banks to purchase low-interest bonds. Government banks, notably the Commercial Bank of Ethiopia (CBE), dominate the banking sector and take a leading role in this, and stringent requirements have now been placed on private banks. Lending against the security of warehoused commodities is not new in Ethiopia, since have for long provided traders and Government enterprises with merchandise loans. The banks carry out their own surveillance and do not employ independent collateral managers as do banks elsewhere in Africa. There have been few problems with these loans and repayment levels are reported at around 99%. From 2001, GoE attempted to develop a formal warehouse receipt system (WRS) by establishing a system of open access (or public) warehousing to help farmers gain from seasonal arbitrage, with support of CFC. In 2003, it passed a Warehouse Receipts System Law (Proclamation) and went on to establish a regulatory unit at the Ministry of Agriculture and Rural Development (MoARD). This subsequently licensed eight warehouses belonging to the parastatal Ethiopian Grain Trade Enterprise (EGTE), and attempted to persuade cooperatives, commercial farmers and others to deposit wheat and maize, but the response was negligible. This MoARD-regulated initiative ended in 2007 with the establishment of the Ethiopian Commodity Exchange (ECX) which then became GoEs preferred instrument for implementing the WRS. Little information is available on the earlier initiative, so the most meaningful way to appraise the added value of the warehouse receipts systems in Ethiopia is to make a before-and-after-ECX comparison. The author has proceeded on this basis. ECX is an unusual exchange in that it is fully Government-owned, while at the same time having a mainly private membership, including trading members who can trade on their own account, and intermediary members who can also trade on account of others (as brokers). It has also enjoyed very substantial donor funding (estimates range to more than US$ 40 million), including the payment of salaries for staff with extensive international experience in the financial sector. ECX started as a cash (i.e. spot) exchange with a number of delivery locations (i.e. warehousing sites with weighbridges, testing laboratories and offices) located around the country where sellers would deposit all goods, and have them graded, prior to sale across the exchange floor. It was entitled both to operate its own warehouses and to certify third party warehouse operators, though so far it has only done the former. All stocks are stored on a commingled basis, by grade, which is a departure from international practice which typically allows the lots of high value commodities (like Arabica coffee) to be segregated or identity preserved by depositor. Title is transferred to buyers 1

using electronic warehouse receipts (e-WRs) that ECX itself issues and holds in its central depository, and ECX has established a system of performance guarantees including a settlement guarantee fund of over Birr 100 million (about US$ 5.8 million), made with member contributions. After an unsuccessful attempt to attract cereals trade, ECX switched its attention to coffee, assisted by GoE which mandated the entire coffee crop (for export and domestic consumption) to be traded through the ECX trading floor, in place of auctions in Addis Ababa and Dire Dawa. However, cooperative unions and large commercial farms have a special derogation that entitles them to export direct. The volume of trade grew vertiginously, and in September 2010 two other export commodities (sesame and pea beans) were similarly mandated. There are now 17 delivery locations and about 55 warehouses. By the third year of operations (FY 2010/11), the volumes of commodities traded had reached 509 thousand tons, of which 51% was coffee, 41% sesame, 7% pea beans and 1% maize, the latter being the only non-mandated commodity. Net earnings were reported at Birr 50 million (about $3 million), and the return on capital employed at 55%. During 2011/12, there was a fall in the world coffee market and a crisis in the Ethiopian industry, resulting in the retention of stocks and a very large drop of sales through ECX. More or less coincidentally with the establishment of ECX, GoE has required that farmers sell these mandated crops through primary transaction centres in each Kabele (lowest administrative unit), so that they can be purchased by rural traders (suppliers, colloquially known as acrabis) and cooperatives for delivery to ECX warehouses. In September 2010 ECX started a warehouse receipt financing pilot with sesame and pea beans, with technical support and capacity building from the International Finance Corporation (IFC). However this has been strictly an adjunct to ECXs trading floor and due to the short expiry date on the warehouse receipts (30-90 days depending on the crop) does not allow for intra-seasonal or longterm storage. Since February 2011, the Government-owned Commercial Bank of Ethiopia (CBE) has advanced about $1.50 million to 42 borrowers against stocks of sesame and pea beans in three separate storage locations. Over 90% of borrowers have so far been suppliers, though ECX believes there is also major potential with the cooperative unions. This start has been made despite the NBE Bills Directive requiring the private banks to buy Government bonds, and which means that only GoE-owned banks can afford to give WR loans. Notwithstanding, the WRS pilot is well regarded by private banks that see the warehouses as highly secure and because the scheme allows them to access a clientele they cannot reach with conventional merchandise loans. One potential snag with the WRS for cash crops is the lack of a clear seasonal carry structure (increasing price trend), which increases the risk that borrowers will experience financial losses. In view of this, they need better market intelligence to manage the speculative risks involved. ECX has had difficulty in gaining traction with food commodities, and this is attributed to lower than expected production, lack of on-site cleaning facilities, a high percentage of reject, a Government export ban and traders fear that a formal system like ECX will bring them under the purview of the tax authorities. Despite this, Government plans to mandate the trading of maize and wheat through the primary transaction centres and ECX, in 2012/13, and intends to progressively extend the system to other crops. In examining ECX, and the WRS which it has ushered in, the author identified a range of pluses and minuses. However, on a short study of this kind and given the availability of information, it was not 2

feasible to attempt an overall quantification benefits to farmers, of economic gains or the costeffectiveness of the system. For this reason, he limited himself to a more modest assessment, against the criteria of enabling environment, strategic coherence and operational arrangements, and a few recommendations which flow from this analysis 1. Re the enabling environment, there is mixed picture. GoE has provided very determined support for the development of ECX and its warehousing system, backed up by the willingness to enforce compliance with applicable law and regulations. GoE has moreover been quick to pass enabling legislation for warehouse receipts, giving banks full confidence in the instrument. However, in some respects GoEs approach appears to have been too determined, taking insufficient account of strategic issues (see below), and with current plans to mandate more than 1 million tons of maize and wheat, an action likely to prove problematic in view of; (a) the difficulty of policing flows of basic foods, and; (b) the expected overload on ECXs already overstretched delivery system. The development of reliable power supplies and internet connectivity lags behind the expansion of ECXs delivery structure, resulting in major delays in unloading and loading commodities in certain locations, while some aspects of the enabling environment (notably the discouragement of differential trading) increase the price risk that exporters face and make it more difficult for them to access bank financing. At the same time, the GoE requirement that higher grades of coffee be exported is the source of a large-scale black-market, whereby exportable grades are diverted for domestic consumption, by-passing ECX. 2. Re strategic coherence, there is widespread consensus that the new system has made the internal market more transparent and improved enforcement of contracts between suppliers and exporters. However the new market structure is adding further logistical steps (at the level of primary transaction centres and exchange warehouses) creating new costs in the value-chain. At the same time, coffee exporters are finding it difficult to cover their short positions, and this is contributing to problems of contractual default at the export level. ECX is at odds with the current trend in the international coffee market, as the mandatory market structure diminishes traceability and thereby reduces the premiums that Ethiopia can earn for its coffee, at a cost which may be upwards of US$26 million per annum. A fresh approach focusing on increased agricultural productivity, adoption of the most efficient pulping technology and maximizing quality premiums in the international market could potentially earn Ethiopia much larger sums, in the hundreds of millions of dollars per annum. As regards warehouse receipting, the Tanzanian experience with coffee offers some useful pointers to Ethiopia. It is a voluntary system whereby Government or its nominee licenses privately owned dry mills to act as one-stop-shops, and carry out a range of activities (storage, financing, dry milling, classification and grading) in single locations. The system is logistically efficient and allows for traceability, with origin coffee being handled on an identity-preserved basis. The plan to mandate the trading of maize and wheat through primary transaction centres and ECX is highly questionable given the capacity limitations and congestion that already exists at ECX delivery points, and the difficult in policing the system. The easiest way to develop exchange trading and warehouse receipting for cereals is by using demand-side stimulation, as described above, but without mandating the system on private players. As is suggested in the 3

case of coffee, ECX would not need to run the warehouses, but simply accredit suitable companies to carry out this function and ensure their compliance with the relevant regulations. Unlike the present arrangements, warehouses should be one-stop-shops with primary processing facilities (notably cleaning), and with sufficient capacity for seasonal storage (i.e. upwards of six months). Indeed it probably makes logistical sense for ECX to move towards onestop-shop warehouses for all commodities, whereby the commodities are cleaned, dried or otherwise processed to standards required by end-users and export markets. Government could also develop the grain trading side of ECX through supply-side stimulation, in this case using ECX to auction off stocks of imported wheat (such as it imported in 2010/11) and other commodities. 3. Re operational effectiveness, ECXs greatest strength lies in the operational arrangements of its trading system and delivery locations. Moreover, its warehouse receipts inspire confidence among the banks, avoiding the distrust which has held back warehousing initiatives in some other countries. Running warehouses has provided ECX with a wealth of experience it could put to good use by establishing an accreditation and inspection service for private warehouses. At the same time, it has significant logistical problems resulting from a mixture of internet and power failures, and shortage of physical capacity (warehouses and weighbridges). This makes it difficult to handle large volumes of mandated crops, and results in large tailbacks at certain sites; in the worst cases lorries queue for over 10 days. The planned mandating of grain crops can only exacerbate these problems. There is moreover widespread distrust of ECX among the trade, regarding grading and underweight, and a perception that the authorised channels of complaint and redress are not fully effective. This study did not provide either a brief or the scope to investigate this, but it is suggested that confidence might be enhanced if those supporting ECX periodically contract an international company to carry out a thorough operational audit. The establishment of ECX is a very significant achievement; it involves by far the largest formal commodity trading mechanism in Sub-Saharan Africa outside of the Republic of South Africa, and provides a credible basis for developing a strong WRS. However, its approach is largely experimental, involving a much higher level of State involvement than is normally in the case with such entities. For this reason, there is a need to stand back, study its performance and draw lessons for the future development of this or similar initiatives. There also needs to be much more open discussion and debate, in Ethiopia, about ECX and related policies.

1. Introduction
Towards the end of 2011, the Common Fund for Commodities (CFC) contracted the University of Greenwich Natural Resources Institute (NRI) to carry out a cross-country review of agricultural warehouse receipt systems in Eastern African countries, and of their role in facilitating the development of commodity exchanges. NRI in turn contracted my own company (J. Coulter Consulting Co. Ltd.), to carry out a case study in Ethiopia, while three other authors were to do case studies in Kenya, Tanzania, Uganda and Malawi. I completed the Ethiopia review in June 2012, but for reasons beyond my control, it has not so far been possible to complete the cross-country review. Notwithstanding, CFC was keen that the Ethiopia information be published and, as of October 2013, authorised me to issue it as a free-standing report albeit that the findings are dated to June 2012 which is when I finished my work on the assignment. I came to this assignment with considerable international experience in the subject area, and significant experience in Ethiopia which I had gained on three assignments since 1994, including a CFC-funded warehouse receipts initiative with the Ministry of Trade and Industry from 2001 to 2003. In the latter, my main contribution had been to commission the drafting of a Warehouse Receipt System Proclamation that subsequently became law. My work on the present assignment involved extensive UK-based deskwork and telephone interviewing, and two visits to Ethiopia, the first between February 26 and March 13, 2012, and second around a Warehouse Receipts Systems Symposium in June of the same year1. I held meetings with a range of stakeholders and institutions, including the Ethiopian Commodity Exchange (ECX), the Ministry of Trade and Industry, the European Union, the International Finance Corporation (IFC), various exporters and international traders, two banks, NGOs and consultants, some of these having extensive contacts with producers. Annex 1 shows a list of institutions and individuals contacted. Much of my work focused on ECX because this is currently the only provider of open-access warehousing services2, and because it could help inform other African countries interested in the ECX exchange and warehousing model which is currently being promoted there. I started my FebMarch visit by making a presentation to ECX executives about warehouse receipting experience in Eastern and Southern Africa, after which ECX helped me with visits to its warehouses (delivery locations) in Addis Ababa, Hawassa and Nazret, and two banks. I also interviewed ECX HQ staff, though some questions went unanswered due to the institutions concerns over confidentiality3. Notwithstanding, it was important to get as accurate as possible a view of the situation, and this prompted me to seek additional information from other sources as well as to undertake my second visit at my own expense in June 2012. Based on my findings, I was able to make an assessment of the ECX/WRS experience, as regards the enabling environment, strategic coherence and operational arrangements, and to make certain
1

Organised by the International Finance Corporation (IFC) and the Ethiopia Commodity Exchange (ECX), Addis Ababa, June 4-5, 2012 2 See glossary for definition of open-access warehousing, also known as public warehousing.
3

Confidentiality extended to the release of annual reports, though I was able to obtain from another source a highly informative ECX Review of Ethiopia Financial Year 2003 (i.e. 2010/11). My experience in seeking information echoes comments by a previous researcher (Robbins, 2010). 5

recommendations. Due to the short duration of the assignment and limited availability of information, some important questions remain to be answered. Nevertheless I believe that it throws some light on a subject about which there has so far been little in the way of independent research.

2. Ethiopia background
2.1 Agriculture and food security
According to official statistics, Ethiopia had a population of 84 million people in 20114, growing at 3.2% per annum. About 83% of the population live in rural areas and are primarily dependent on agriculture for their livelihoods, there being 12.6 million smallholder farmers operating on farms averaging 1.2 hectares each, and several hundred commercial farms. Their combined annual crop production is 31 million tons, of which 71% is comprised of field crops like cereals, pulses, and oil crops (see Table 1 below), and the remainder consisting of vegetables, fruits, and cash crops (mainly coffee, sugarcane, chat, and enset). Sector growth is reported to have averaged 6.8% pa in real terms for the ten years to 2010/11, or 10.2% if one excludes the first two of these years when growth was negative; the combined output of the agricultural sector is now an estimated Birr 221 billion (US$13 billion), about 41% of national GDP5. TABLE 1: ETHIOPIAN PRODUCTION OF CEREALS AND PULSES (in millions of tons) Item 2001 2002 2003 2004 2005 2006 2007 2008 2009 Cereals (total) 9.6 9.0 9.5 10.7 13.4 13.4 11.8 13.0 15.5 of which: Maize 3.3 2.8 2.7 2.9 3.9 4.0 3.3 3.8 3.9 Wheat 1.6 1.4 1.6 2.2 2.3 2.8 2.2 2.5 3.1 Sorghum 1.5 1.5 1.8 1.7 2.2 2.3 2.2 2.3 3.0 Barley 1.0 1.2 1.1 1.4 1.4 1.4 1.3 1.4 1.8 Cereals, nes (includes Teff) 1.7 1.6 1.9 2.1 3.1 2.3 2.4 2.6 3.2 Pulses & oilseeds 1.5 1.4 1.4 1.9 1.9 2.0 2.2 2.5 2.6 2010 15.6 4.4 3.0 3.0 1.4 3.2 2.7

Source: FAOSTAT Notes: 1. some figures are estimated, imputed or from unofficial sources; 2. nes = not elsewhere specified

While agriculture is smallholder-dominated, large-scale land allocations by government to both domestic and foreign investors have greatly boosted the opportunity for commercial farming in recent years. The main food crops are maize, sorghum, teff, wheat and barley. Parts of southern and western Ethiopia regularly produce food that is marketed in urban centres and shipped to deficit areas of the north-east, the east and elsewhere. Notwithstanding the existence of this trade, there is considerable food insecurity of a chronic and transitory nature in these areas and this has led Government and the donor community to set up safety nets and distribute large quantities of food
4

This is according to the Central Statistical Agency of Ethiopia. The CIA World Factbook gives a higher figure of 91 million. 5 Official statistics quoted by Access Capital, 2011a and 2012a

relief. Needs have varied widely depending on the harvest; between 1995 and 2004, the number of people requiring food aid varied between 2.8 million in 1996, a bumper harvest year, and 13.2 million in 2003, when the country experienced acute food shortages following one of the worst droughts in living memory (Walker and Wandschneider, 2005). The GoE is now embarking on a Growth and Transformation Plan (GTP) 2011-2015 whereby it aims to triple the number of farmers receiving relevant extension services, to reduce the number of safety net beneficiaries from 7.8 to 1.8 million households, and more than double the production of key crops, from 18.1 million tons to 39.5 million tons. It has an overall target of at least 8.1% annual agricultural growth over the five-year period. The planned expenditure is very large: for the fiveyear GTP period as a whole, the sum of budgetary government spending and off-budget spending by public enterprises is programmed to reach Birr 1.26 trillion ($72 billion at current rates of exchange), or an average of 41 % of GDP per year over five years6. Most parties, including the President of Ethiopia, view this plan as an ambitious one, and some think it is over-ambitious7. Agriculture accounts for about 30.4% of merchandise exports, and the main export crops by value are coffee, sesame, fresh vegetables and pulses. All of these, except fresh vegetables, are nonperishable and therefore relevant to this review.

Figure 1: Ethiopias top agricultural exports in 2009 (source FAOSTAT)

6 7

Access Capital, 2011a See http://blogs.reuters.com/africanews/2010/08/13/is-ethiopias-development-plan-too-ambitious/

Table 2 shows annual exports of these three items since 2000, according to FAO. TABLE 2: ETHIOPIAN EXPORTS OF COFFEE, SESAME SEED & PULSES ('000 tons) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Coffee, 119 83 123 134 149 146 176 156 171 111 199 161 green Sesame 27 15 64 69 70 219 190 140 131 256 n/a n/a seed Pulses 25 20 100 42 102 108 126 174 179 181 n/a n/a Source: International Coffee Organization and FAOSTAT Note: n/a = not available on FAOSTAT Coffee exports consist of about 70% unwashed and 30% washed Arabica, high altitude, coffee. The commodity completely dominated exports at the beginning of the decade, but since then there has been an explosive growth in the exports of sesame seed and pulses. Total pulses exports were 181,000 tons in 2009, including white pea beans (used in making canned baked beans and sold in dried packaged form), red kidney beans, pinto beans, chick peas, lentils and others.

2.2 Monetary and financial sector developments

The public sector accounts for most of Ethiopias banking sector, notably the Government-owned Commercial Bank of Ethiopia (CBE), with has over 500 branches, and claims to account for over 70% of total deposits, loans and advances. CBEs total portfolio of loans and advances, including holdings in bonds, was Birr 77 billion in June 2011. While also financing the private sector, CBEs resources are overwhelmingly committed to the public sector, i.e. Central and Regional Governments and publicly-owned enterprises, for investment in power generation, telecoms, airlines, agricultural input supply, roads, railways etc.. Ethiopia also has 14 private banks, and at the end of June 2011, these had total deposits of nearly Birr 50 billion and outstanding loans of Birr 26 million8. All these banks are Ethiopian-owned, as GoE does not admit foreign banks. A very large part of their resources are also being used to meet the large Government investment plans; we explain how this happens below. Ethiopia experienced major inflation during the last decade, with consumer prices rising by over 10% in five out of the eight years from 2003 to 2010, with 2008 registering the largest increase (55.3%). The phenomenon is generally attributed to a combination of: (a) heavy Government expenditure on public infrastructure, notably large hydro-electric projects like the Ethiopia Renaissance Dam (on the Blue Nile), and; (b) increases in food prices in the second half of the decade. The Ethiopian currency has also undergone devaluation, but to a lesser extent than the underlying inflation. Currency reserves are very tight, for which reason GoE is particularly concerned to maximise exports and ensure that foreign exchange is promptly brought into the country. One informant went as far as to say that: all policy decisions are driven by foreign exchange.

Ethiopia also has a substantial microfinance sector, including 30 institutions with assets of nearly Birr 10 billion and outstanding loans of Birr 6.7 billion on September 30, 2011.

TABLE 3: ETHIOPIA, ANNUAL PERCENTAGE PRICE INFLATION AT CONSUMER LEVEL, AND INTEREST RATES, 2000 to 2010 Year Rate of inflation Lending rates 2000 0.3 2001 -11.4 2002 -1.0 2003 23.5 2004 1.7 2005 13.0 2006 11.6 2007 15.1 2008 55.3 2009 2.7 2010 7.3

10.9

10.9

8.7

7.0

7.0

7.0

7.0

7.5

8.0

12.2

12.2

Source: IMF International Financial Statistics and (for interest rates) in 2009 & 2010 Central Bank of Ethiopia

Government sought to control inflation by imposing credit caps on private banks, but at the same time remained committed to its policy of heavy public investment in infrastructure and other activities, notably the five-year Growth and Transformation Plan. In April 2011 it substituted the credit cap with another instrument, 5-year National Bank of Ethiopia (NBE) Bills, the primary purpose of which is to generate resources it needed for its investment plans. Private banks were thereafter required to spend 27% of the gross value of any loan disbursements or advances on NBE bills, which pay an interest rate of just 3% pa, considerably below current rates of inflation and below the cost of bank funds (around 5% pa). The new directive applies retroactively to all private bank loans given since July 1, 2010, but excludes the two large Government banks, i.e. Commercial Bank of Ethiopia (CBE) and the Development Bank of Ethiopia (DBE). The NBE Bills Directive is causing a major diversion of funds from the private sector to the Government, which Access Capital (2012) estimates will amount to Birr 11 billion within a year, enough to cover 90% of the Governments budget deficit. The same sources states that credit to the private sector, which is already low to begin with in Ethiopia, will be held back in the coming years as banks allocate funds towards NBE bills. Given that the NBE bills will not have repayments for five years, while upcoming repayments from private loans are shared with government when they are lent out again, the share of loans going to government will rise steadily over time. A simulation of this effect suggests that the government share of new loans could rise from 27% to 41% of total loans within just the next year. It appears that the NBE Bills Directive will not be performing a sterilization function of withdrawing funds from the banking system to control the growth in money supply; rather, the Central Bank is simply reallocating private sector funds for government spending. Ethiopia already has a low level of private sector credit, just 10% of GDP in June 2010, compared to an African average of 36%9, and this measure will tend to reduce it. Local private banks are moreover heavily regulated as regards their lending, collateralization requirements and access to foreign currency. Like all businesses they must obtain many licenses and authorisations, while importation is time-consuming and requires numerous permits.

Access Capital (2011b)

Interest rates in Ethiopia are currently in the range of 9% to 13% and are in principle marketdetermined. In practice however, GoE has a strong influence on rates through the competitive actions of Government-owned banks, and seeks to keep them at moderate levels. Indeed if one allows for inflation (see Table 3 above), real interest rates have often been overwhelmingly negative in recent years, such that savers have been subsidizing borrowers, which are largely in the public sector. Apart from this, Government policy does not allow banks to charge widely different interest rates according to the borrowers risk profiles. The situation is very different in other African countries, for example in Uganda where the rate of interest applicable to SMEs was typically 22% on top of which there was a 2% arrangement fee, while the rates applicable for blue chips were of the order of 12-13%10.

3. Agricultural marketing systems prior to warehouse receipting initiatives

3.1 Introduction
In this section we describe how markets have been working up to the establishment of the Ethiopian Commodity Exchange (ECX) which has since 2008 been the main agency in establishing the warehouse receipts system. In the case of cereal crops the situation remains virtually unchanged as negligible quantities have so far passed through ECX.

3.2 Grains and pulses

Much of the information here comes from a study by IFPRI (Rashid and Negassa, 2011); they found that cereal production averaged 10.7 million tons in the 2000s, of which 28.1%, equivalent to 2.95 million tons, was marketed. Traders and processors of various types and scale operate in cereal markets, with small-scale traders dominating both ends of the marketing chain. IFPRI survey data suggests there were about 300,000 small traders, each dealing in around 10 tonnes pa. Traders and processors can be grouped according to the four major market functions they perform: aggregation (known as collectors), wholesaling (known as suppliers), processing, and retailing. The bottom end of the marketing chain is dominated by smallholder farmers and various buyers (petty traders, farmer-cum-traders, and, more recently, primary cooperatives) that aggregate the small volumes typically sold by individual farmers. The other key actors at the bottom of the marketing chain are state and commercial farmers, owning more than 100 hectares of land, who account for roughly 5% of maize and wheat production. Some of these farmers also have cereal trading businesses that supply flour millers, aid agencies, the parastatal Ethiopian Grain Trade Enterprise (EGTE) and wholesale suppliers. By 2008, 36% of farmers in Oromiya, SNPP, Amhara and Tigray were members of cooperatives and 28% of these sold grain through their cooperatives; 10% of non-members also sold grain through cooperatives. However, cooperatives are much stronger in the coffee sub-sector, and much of their grains activity is tied up with their being a channel for subsidised input packages.
10

Source: J. Coulter, interviews in Uganda, March 2011

10

Wholesale suppliers, including EGTE, mainly perform the tasks of temporal and spatial arbitrage, and supply raw materials to flour millers and other processors. There are also many brokers (traders who arrange cereal trades but do not buy or sell grain themselves), and these play a key role in coordinating grain buying, selling, and transportation, by matching buyers and sellers, inspecting and witnessing transactions, and providing guarantees to enforce contracts. In general, brokers operate at both the production and consumption end of the marketing chain. However, the major activities of brokers are concentrated in Addis Ababa, where they receive grain from the regional wholesalers, inspect its quality, determine its price, and sell it on behalf of their clients. The original idea of ECX was to bring these cereal brokers into a formal trading floor (see section 5 of this report). In the case of pulses, a substantial proportion of the marketed surplus was sold to specialist exporters who belong to a trade body called the Ethiopian Pulses, Oilseeds and Spices Processors Exporters Association (ESPOSPEA). These bought from specialist suppliers who would procure from farmers and collectors further upstream with a view to meeting the requirements of international buyers, in terms of type, colour, shape and other characteristics (for example baked bean manufacturers in the UK require pea beans of a characteristically round shape; flat beans are essentially a by-product that is sold for food aid). Starting in the early 90s, food aid agencies have become major cereal buyers. Their share of supplies increased quite significantly in the early 2000s, and during the period 20032004 to 20062007, WFP procured an average of 394,443 tons of maize and wheat pa, mainly from large cereal traders, the Ethiopian Grain Trade Enterprise (EGTE) which supplied 20.1% and some nongovernmental organisations (Rashid and Negassa, 2011). There was a major hiatus starting in 2007, as Government barred procurement on account of price hikes, but WFP resumed purchases in 2009, procuring 73,591 tons, followed by 252,076 tons and 85,293 tons respectively in 2010 and 201111. In extremely remote rural areas of Ethiopia, cereals are still processed manually using mortar and pestle or grinding stones. In relatively accessible rural areas, households bring their grain to be processed at small-scale hammer and flour mills, and most cereals consumed in urban areas are likewise processed in such small-scale establishments. There has however been considerable expansion in commercial milling. Until the early 1990s, the government owned all commercial flour mills, but since then the situation has changed rapidly such that by 2008, there were 65 large commercial flour mills with annual processing capacity of 968,000 tons, roughly equivalent to 30% of the marketed surplus. However the growth is geographically concentrated, and 80% of capacity is located in Oromiya and Addis Ababa. Two parastatal companies are engaged in the food trade, including the above mentioned EGTE, and the Ethiopian Food Security Reserve Agency (EFSRA). GoE formed EGTE in 1992, by changing the name of the Agricultural Marketing Corporation (AMC) and giving it new mandates in line with changed policies of the post-DERG period. Since then, GoE has gradually limited EGTEs roles, such that during the 2000s it only handled 1.87% of the marketed grain surplus, according to Rashid and Negassa (2011). Notwithstanding, Government continues to use EGTE for a variety of purposes, including procurement of domestically produce grains (notably in 2003), and international procurement and distribution of wheat to meet deficits (in various years since 2007). Since the establishment of ECX in 2008, EGTE has also emerged as an important coffee exporter.
11

Source: WFP Procurement Annual Reports.

11

ESFRA was established in the 1970s with the support of FAO and DFID as a sort of food aid pipeline, so as to ensure that in the case of emergencies grain could be quickly obtained for food relief purposes, against donor commitments to resupply. Since EFSRA was established, the target stock level has been gradually expanded reaching 407,000 tons of cereals from 2004. However, in practice it has only seven warehousing sites with an effective capacity of 285,000 tons, and during the period 20042009 held an average stock of 179,000 tons, which is about 44% of the target level. Since 2004, there has been a major switch away from using the food for emergency programmes to safety nets and price stabilisation (in urban areas), and from 2005 to 2009, the Productive Safety Nets Programme (PSNP) accounted for 57% of withdrawals. There is a widespread consensus that EFSRA has performed well in terms of addressing emergencies and managing grain stocks efficiently12. According to Rashid and Lemma (2011) EFSRA has been successful because it has maintained a reasonably smaller stock with very little impact on the market prices. However, they went on to say that the situation was likely to change if the stock level was significantly increased for price stabilisation purposes, depressing domestic prices, increasing the costs, and adversely affecting the evolving private sector in the cereal value chain, where millions of people make their living. Apart from these comments, it is worth noting that EFSRA is relevant to this study, as a very large warehousing operation and the repository of much of Ethiopias warehousing skills, evident in the fact that ECX has recruited a number of EFSRA staff for its own warehousing operations.

3.3 Coffee
Readers should refer to Annex 2, which describes the situation before and after ECX. Figure 2 illustrates the pre-ECX structure. The principal chain consisted of farmers, collectors, suppliers, exporters and international buyers, as well as wholesale and retail traders serving the domestic market, which absorbs about half the Ethiopian crop. Initially, all Ethiopian coffee was required to pass through auction centres in Addis Ababa or Dire Dawa, but starting in 2001, cooperatives and to a lesser extent private investors were granted permission to by-pass them, opening the way for direct export sales. Moreover the requirement to sell coffee for domestic consumption through the auctions was not very rigorously enforced. The main participants were required to have licenses for their respective functions; for example collectors had to sell to suppliers, suppliers were allowed to deliver their coffee to the auction but were not allowed to export it, and exporters could only buy coffee from the auction.

12

Information here quoted from Rashid and Lemma (2011) and from my prior contacts with EFSRA.

12

Figure 2: Ethiopian domestic coffee marketing chain in 2006

Source: Petit (2007), adapted and updated from earlier reports

In the case of dried cherries, either the collector or supplier took care of the dry milling, while suppliers took care of wet milling, using their own or third-party mills. Cooperatives were also significant players, carrying out these same functions. Suppliers had to ship export-grade coffee either to Addis Ababa or Dire Dawa so they could be traded on the mandatory auctions where exporters were required to buy. Unwashed Arabicas were auctioned as green coffee, while washed Arabicas were traded as parchment.

13

With the Addis auction, suppliers had to bring trucks bearing coffee to the Coffee Processing and Warehousing facility13. The Coffee Liquoring Unit (CLU) took samples, then cupped and graded the coffee, and the auction was conducted on a truck-by-truck basis. After the auction, the suppliers immediately took their truckloads to the premises of the exporter who could inspect, sample and test. If the exporter found the coffee did not meet the sample specifications from the Coffee Liquoring Unit (CLU), he could make an appeal and have the commodity resampled and graded. If the claim was upheld, the buyer could reject the truckload and send it back to the auction. When, as was normally the case, the exporter accepted the load, he would then process it for export using his own or hired facilities. Only native Ethiopians were (and still are) allowed to be exporters. There were two main complaints about this system, that of buyers occasionally issuing bouncing checks and defaulting on payments, and congestion at the Coffee Processing and Warehousing Enterprise, with trucks sometimes having to queue for as long as 15 days.

3.4 Sesame
Ethiopia is the worlds fifth largest producer of this crop, and production is concentrated in the north-west of the country, bordering Sudan. Harvesting takes place over a short period, and marketing is concentrated between late November and early February. The major actors in the market were exporters, suppliers, brokers/agents, local collectors, primary cooperatives and their unions. A study conducted in Metema area revealed that farmers sold about 22% of their production to collectors, 34% to wholesalers and 18% to cooperatives14. The two most important cooperative units were the Setit-Humera and the Metema Agricultural Marketing Unions. There was no mandatory auction such as existed with coffee, and this allowed exporters to establish their operations within the producing regions. In the case of Humera, there was a market place around a central square, involving farmers, suppliers (rural traders), brokers, truckers and exporters. There was a lot of speculation, and a lack of transparent linkages to the international market. However producers had close relationships with suppliers, could sell to them for cash, or put their product into the suppliers store and fix the price at the time of the farmers choosing (price-to-fix arrangement). Exporters were able to deal directly with local suppliers, and inspect the product before purchase. This was important because it allowed them to ensure that whitish sesame of the lowland kind was not mixed with red sesame from higher altitudes. Annex 3 provides further information on the situation in Humera, pre and post-ECX. Both in the case of sesame and pea beans, there were numerous and costly performance failures on the part of suppliers, and payment failure on the part of exporters. Indeed, both buyers and sellers would frequently default on contracts if prices moved against them.

13

This large facility also provided dry milling, storage and collateral management services (for banks providing merchandise loans); it has three processing lines and storage capacity of 90,000 tonnes of coffee. 14 Alemu and Meijerink, 2010

14

3.5 Trade financing mechanisms

The main sources of pre-export financing are exporters equity and bank financing, which is usually made available to companies against presentation of export contracts or physical collateral. Physical collateral is of particular importance in a country that lacks any system of independent credit rating, so much of the lending is secured by property and some by the commodities themselves in the form of merchandise loans. However, some long-standing customers are able to access funding simply on the basis of trust and the banks knowledge of their business. Merchandise loans are an important pre-cursor to the warehouse receipt system (WRS), as they involve lending against the security of commodity collateral. Banks normally provide loans against stock held in customers stores under dual-key arrangements where both the bank and the borrower hold keys; the borrower can only access the stock when a representative of the bank is present with the banks key. The procedure is used for all sorts of products, except those that are barred on grounds of shelf-life or safety; in practice it is mainly used with fertiliser, grains (imported and domestically produced), coffee, imported edible oil, industrial raw materials and merchandise such as furniture. New borrowers may be required to put up additional collateral apart from the merchandise, but there is likely to be no such call with customers who have a good track record. The stock must be insured against fire and allied perils (flood, lightening etc.), but cover for theft and fraud is often considered unnecessary (unlike the situation in some other African countries which have experienced large frauds). Repayment is more or less assured, and the rate of default is not more than 1%. This largely explains why Ethiopian banks do not have recourse to specialist collateral managers as they do in most other African countries. Another possible explanation is that GoE has not allowed in the international banks to get established in Ethiopia; elsewhere in Africa these are normally the first to insist on employing these specialists. Notwithstanding these advantages, bankers see various advantages in an open-access warehousing system of the kind ECX is now introducing, including even greater security, an implicit Government guarantee, the ability to dispense with surveillance visits, the ability to lend to new borrowers (particularly those up-country) who do not qualify for merchandise loans, and greater convenience to the borrower. We discuss these in section 5.7 below. Due to the NBE Bills Directive, only CBE is at present providing merchandise loans. The value of these averaged Birr 424 million per annum between 2007 and 2011, about 2% of the banks total average loan portfolio over these years. However even this figure dwarfs the value of CBEs loans to date against warehouse receipts issued by ECX against stock in its exchange warehouses (Birr 20 million).

4. Main features of WRS development in Ethiopia

In the run up to the year 2000, GoE was in conversation with CFC about the establishment of a formally regulated warehouse receipts system, as a means of helping farmers and their cooperatives increase their returns from the market. An agreement was then signed under which CFC provided technical assistance to the Ministry of Trade and Industry (MOTI), starting in 2001 and lasting to 15

2004. This led to the drafting and passage through Parliament of a WRS Act, Proclamation no. 372 of 14 October 2003. In common with other laws of this kind, the Proclamation provides for rights and obligations of the parties, for warehouse receipts to be negotiable instruments, for the commingling of goods, for the maintenance of records, for the use of electronic documentation, for bonding and insurance of warehouse operators, for MOTI or its delegate to license warehouse operators and regulate the activity, and other matters. After the Proclamation, Government passed regulatory authority to the Ministry of Agriculture and Rural Development (MoARD), which set up a special regulatory unit to license and inspect warehouses. Warehouse receipts were printed, operational manuals were produced and there was an awareness-creation programme with banks, cooperatives and other Government departments. The regulatory unit licensed some eight (8) Government warehouses belonging to EGTE, and during the period 2005/07 an attempt was made to persuade cooperatives, commercial farmers and others to deposit maize and wheat. We have tried to obtain a written report on this operation, and the lessons learned, but none was available. However, according to verbal accounts the system inspired little interest on the part of stakeholders, and only a small volume of grains (between 300 and 400 tons) were deposited, and in a single location15. There were moreover problems with the quality of grain delivered to the warehouses. MOTI indicates that the regulatory unit also tried to license private warehouse operators, but there was no interest. There is a major business in renting out warehouses and building warehouses for rent, but owners were not interested in going through the expense of becoming compliant with Governments regulatory arm and running open-access warehouses. There is also reported to have been some disagreement between Government departments about the feasibility of the WRS, and insufficient organisation with regard to inspection and laboratories. The warehouse receipting pilot continued for about one year, but ECX then became Governments preferred instrument for establishing the WRS, and the earlier initiative was discontinued. GoE has formally passed the regulatory function back to MOTI, but there has been no attempt to re-establish the regulatory unit. Government established ECX under Proclamation no 550 of 2007, clause 24 of which provides that ECX may operate warehouses and certify third party warehouse operators, to carry out weighing and inventory management of agricultural commodities and issue Exchange warehouse receipts for the purposes of Exchange trading. As this quotation suggests, the prime purpose of warehouse receipts as far as ECX is concerned is to serve as an instrument for delivering produce against exchange contracts. It is part of a delivery-versus-payment (DVP) system whereby the seller delivers goods in return for immediate and assured payment, there being virtually no risk of contractual default on either side. The role of warehouse receipts is more important in ECX than it is with most active commodity exchanges around the world. These are usually futures and options exchanges where sellers must only tender warehouse receipts against expiring contracts, i.e. the small percentage of contracts where long and short positions have not been previously offset and go through to delivery. By contrast, ECX is currently a spot market exchange which requires all contracts to go through to delivery, and where suppliers must deposit the goods they are selling in
15

This figure is far smaller than that communicated to CFC in March 2008, i.e. that in this year warehouse receipts for some 4,700 tons of grain have been issued within the national warehouse and inventory credit system (CFC, pers. comm.).

16

the warehouse and have them classified and graded before offering them for sale. So far ECX has run all the exchange warehouses itself, though it has been considering the possibility of certifying third party warehouse operators. At the end of FY 2010/11, there were 55 warehouses in 16 locations, with a combined capacity of 2.8 million bags of coffee, sesame and pea beans16. It is not clear from the Proclamation that ECX is formally authorised to certify warehouses for the purpose of securing warehouse receipt financing; indeed until 2010, warehouse receipts were only used as a delivery instrument. However, starting in September 2010 ECX started a programme of warehouse receipt financing with sesame and pea beans, with Government blessing and with the technical support of the International Finance Corporation (IFC). As far as we can ascertain, ECXs activities are the only form of open-access warehousing currently practiced in Ethiopia. Hence the viability of the activity is crucially dependent on the direction and progress of ECX, subjects that I discuss in section 5 which deals with the enterprise. Government now sees ECX as its main vehicle for establishing the WRS in Ethiopia. As a result of the NBE Directive, only the Government-owned CBE is presently providing working capital loans against merchandise inventory. As we noted above Government banks are exempted from the Directive, and private banks are in effect being crowded out of short-term lending. Ironically, and in contrast to the situation in most African countries, term loans only viable form of lending open to private banks, as this limits the funds they need to tie up in low-interest bonds. At the same time, the current policy framework causes private banks to ration credit among existing customers and avoid taking on new customers.

5. The Ethiopian Commodity Exchange (ECX) and related post-2008 marketing innovations
5.1 About ECX
ECX was originally conceived as a trading hub in commodities produced for the local market, mainly grains and and pulses. Eleni Gabreh-Mahdin (2001), the future Chief Executive Officer of ECX, led some intensive studies of Ethiopian grain markets, concluding that there was a need for an institutional framework that would reduce the costs of searching for trade counterparties, to reduce the dominance of personalised exchange and increase the share of grain handled by brokers. At that time, export value chains were considered to be relatively well organised, less informal and in less need of an organised market place. It was also envisaged that the exchange would be a private sector institution, owned by its members. ECX was established under Proclamation No. 557 of 4 September 2007, as wholly state owned marketing institution, but with a mainly private membership who would be exchange actors engaged in trading on their own account or for the account of others. Members may be trading members who can trade on their own account, and intermediary members who can also trade on account of others, i.e. perform a brokerage role. Membership is also classified as to whether it is full

16

Bag weights traded on ECX are 100 kg for sesame and pea beans, 80 kg for parchment coffee and 60 kg for green coffee. 2.8 million bags of sesame and pea beans weigh 280,000 tons, while 2.8 million bags of green coffee weighs 168,000 tons

17

or imited, with the latter being restricted to either the buying or selling of a single specified commodity. The Board of Directors consists of 11 members of whom six including the chairperson, would be appointed by the responsible Ministry, and five elected by the members. ECX was set up to run an open-outcry trading floor for spot and (in the future) futures contracts in agricultural commodities, Those selling across the exchange floor are collectively known as suppliers; they are mainly rural traders (acrabis) who buy from farmers and often carry out some primary processing, and may also be producer organisations or larger individual farmers. Those buying across the exchange floor are normally exporters or companies processing for the domestic market. Suppliers and buyers often trade on the exchange in their own right, or use the brokerage service of an intermediary member. Significantly in the case of exportable commodities, the exchange does not provide a trading floor in export-ready commodities, but in semi-processed commodities that require some cleaning and grading prior to export. As Ethiopia does not permit international buyers to trade in raw commodities within Ethiopia, the exporters are all local companies. The Exchange provides market information (mainly current exchange prices) to the public at large using electronic and other media, and takes responsibility for:
commodity grading warehousing the maintenance of an automated central depository of Exchange warehouse receipts, and the clearing and settlement of trades.

In all these cases, ECX is authorised either to provide the service itself or approve third parties to do so. So far it has opted for a do-it-yourself approach. ECX has also established systems of market surveillance, risk management, dispute resolution (through arbitration) and security. ECX is regulated by the Ethiopian Commodity Exchange Authority (ECEA), established under another Proclamation and funded by the Ministry of Finance. It has approximately 100 staff solely concerned with ECX, carrying out a range of promotional, training and oversight activities, notably recognition of clearing institutions, exchange actors and their

associations, and the provision of trading rules and ensuring the establishment of a settlement guarantee fund.

5.2 Chronology of ECXs development

ECX started operations in FY2008/09, focusing on food grains, notably maize, but was able to gain little traction with this crop at a time when Ethiopian and world cereal prices were very high. According to available data (Rashid and Negassa, 2011) ECX only traded 950 tons of maize and 90 tons of wheat from its inception in April 2008 until February 2009. However, the exchanges fortunes changed radically when Government (in agreement with ECX management) mandated the countrys entire coffee crop to be traded across the exchange floor. The decision came as something of a surprise to an industry which already had certain Government-approved structures, notably two coffee auctions, in Addis Ababa and Dire Dawa respectively. As Ethiopias number one export earner, the industry already had a complex regulatory framework. One of GoEs key concerns was the generation of foreign exchange, in view of which regulations prescribe that all coffee of above a certain grade must be exported, and not sold to the local market. The new structure was not welcomed by all stakeholders, particularly when Government seized the stocks of six exporters on the grounds of hoarding and selling to the local market, rather than selling through ECX. 18

In September 2010, Government mandated that two further export commodities, sesame and pea beans, be traded across the exchange floor. In the third year of operations (2010/11), the volume of trade reached 509 thousand tons, of which 51% was coffee, 41% sesame, 7% pea beans and 1% maize, the latter being the only non-mandated commodity. Governments decision resulted in a massive growth in ECXs volume of trade, and (aided by very high coffee prices) it had net earnings of Birr 50 million (about US$ 3 million) in 2010/11, ten times up on the figure in 2009/10, and giving a handsome return on capital employed of 55%. Net earnings are likely to fall in 2011/12, due to a collapse in both World coffee prices17. This is not only depressing the value of commissions earned by ECX, but has resulted in lower trading volumes, as suppliers who have bought from farmers at high prices and have been holding back their stocks in the hope that the market will rebound - as of early June 2012 it was reported that 40,000 tons of coffee was being held in this way18. As a consequence of this many exporters have had difficulty obtaining supplies to fulfil their contracts with foreign buyers, some have defaulted and many are reported to be making losses. The lack of foreign exchange receipts is precipitating a crisis with Government which has been applying pressure on the parties concerned, including (reportedly) threats of seizure and withdrawal of licenses. ECX has had difficulty gaining traction with non-mandated food commodities. Maize is the main commodity concerned and the main buyer is the World Food Programme (WFP), which in 2010/11 bought 5,000 tonnes, a small part of its total purchases (256,000 tons and 86,000 tons in 2010 and 2011 respectively). The relationship between ECX and WFP has been anything but trouble-free. There has been a mismatch of grading requirements, with WFP rejecting about 71% of the stock delivered to ECX warehouses in 2010/11 on grounds of an excessively high content of broken kernels. There have allegedly been payment delays on the WFP side, and (at least in the early stages) WFP found ECX daily limits on price variation problematic. ECX additionally attributes low cereals trading to lower than expected production, a Government export ban in 2010/11 and on suppliers fears that if they sold through ECX they would be brought within the tax net. Indeed ECX staff and Government officials often assert that GoE must mandate the trading of crops through ECX, since without this the traders would always remain in the informal sector and eschew a transparent trading platform of this kind, for tax reasons. Despite it being mandatory to trade these three export crops through ECX, cooperative unions and large commercial farms have a special derogation that entitles them to export crops direct, without passing through this system. However, they must register the commodities with ECX and have ECX grade them and certify they are fit for export in this way.

5.3 Membership and financial support

Not surprisingly in view of its mandatory nature, ECXs membership has continued to grow. By the end of 2010/11 it had 245 full members and 283 limited members. It has since 2005 benefited from
17

The New York C contract is a good indicator of the international price of washed Arabicas. It was high nd st during 2011, peaking at US 305 cents/lb on May 2 and 289 cents/lb on Sept 1 , but has since fallen back, reaching around 200 cents/lb in early March and 157 cents/lb in early June 2012. A large harvest in Brazil has contributed to the fall.
18

Source: Ethiopian Coffee Growers, Producers and Exporters Association 19

substantial donor funding, far more than other exchange initiatives in Africa. It is difficult to ascertain exactly how much funding has been provided, though estimates range to over $40 million. CFC reports that it already had $21 million of pledged commitments by March 2008, including $8 million from the World Bank, $5 million from UNDP, $3 million from the Government of Ethiopia, $ 1 million from the Canadian International Development Agency (CIDA), $1 million from USAID, $1 million from IFAD and $ 0.5 million from WFP. ECX staff informed me of commitments of US$ 30.3 million up to 2010 including sales of membership seats19. ECX has recruited experienced staff from the Ethiopian diaspora as well as two non-Ethiopian staff whose salaries are covered by UNDP and GoE. Four remained at the time of my visits, but they are to be substituted with locally-hired staff on normal Ethiopian terms.

5.4 Primary level markets

An important aspect of ECX, as conceived by Government, is its linkage to the Kabele (village) level. The Kabele is the lowest administrative level within the district (Woreda). Each Kabele is supposed to have a primary transaction centre, a fenced location with certified scales, where farmers are required to negotiate with and sell to suppliers, as opposed to selling to local collectors at the farm gate. The latter practice is now banned. A local inspector must certify that the goods are deposited in the market centre. A supplier wishing to buy from farmers must have a certificate of competence showing that s/he has his/her own warehouses within the Woreda, a weighing scale and a certain level of capital. However, the certificate does not authorise purchases in any neighbouring Woreda. When the supplier purchases from farmers, an inspector from the Woreda verifies the stock and provides a certificate (effectively a certificate of origin) allowing him/her to ship it out of the Woreda. The supplier presents the same document to the ECX warehouse at which s/he must deliver the commodity. It is intended that there be so many of these depots that no farmer will have to travel more than 7 kilometres from his/herfarm with loaded donkeys to find one. The plan is to eliminate an entire tier of smallscale traders (collectors) and by so doing offer the farmer an opportunity to earn higher prices, with assurance of quality and quantity. According to CFC, the EU intends to support this network of depots through a EUR 10 million programme. However, the new arrangements are reportedly a bone of contention between the cooperatives and the civil administration. The cooperatives wish to market the product directly on behalf of their members, but the same members are required to sell their crops through the market centres, while the coops must compete with private traders for the same supplies. This system started with coffee and is progressively being applied to all mandated crops. Origin is very important in the classification and pricing of coffee, so providing certificates of origin seems to make sense in the case of coffee, as prices can vary considerably between neighbouring Woredas, and ECXs classification system reflects this. However, sesame and pea beans have minimal or no

19

This includes $7 m from the World Bank, $7 m from the EU, $5.5 m from UNDP, $2.5 m from GoE, $2 m from USAID, $1 m from CIDA, $0.4 m from WFP, $0.4 m from IFC and $4.5 m through the sale of membership seats.

20

Woreda-specific characteristics to justify this form of certification, which looks like an unnecessary control, one which that may encourage rent-seeking without any offsetting advantage20. Suppliers feel constrained by the new system, and are consequently tending to focus on crops that have so far not been mandated, e.g. chick peas and red kidney beans. However, Government wishes to progressively bring most, if not all, field crops within the mandatory system, and particularly those destined for export.

5.5 Warehousing
ECX has so far established 55 warehouses at 17 locations throughout Ethiopia, where suppliers must deposit commodities prior to trading them over the exchange floor. All the warehouses and most of the weighbridges are rented, primarily from the Ethiopian Grain Trading Enterprise (EGTE), Ethiopias grain trading parastatal which has a lot of storage capacity around the country, as well as a range of private owners. Warehouse locations are shown in Figure 3. ECX directly manages the warehouses, using a system of electronic warehouse receipts (e-WRs). It is important to understand that the e-WRS is not a web-based community of the kind established in South Africa. In South Africa, silo operators issue silo certificates electronically to individual depositors, who may then transfer them to lenders (in encumbrance of the underlying goods) or to buyers (as title to the goods), or back to the warehouse operator for cancellation. All these parties are signed up participants in the system of silo certificates. In ECX, the e-WR is an electronic document issued within the Central Depository, to facilitate transfer of title on the exchange floor (not for transactions agreed outside the exchange) and for pledging the commodity as loan collateral. The Central Depository issues the depositor with a paper copy that he cannot pledge or sell, though he can present it to the bank to start the lending process. ECX has also established a system of performance guarantees, including a settlement guarantee fund of over Birr 100 million formed from member contributions21, insurance against fire and allied perils (0.09% pa of the value of the stock), and fidelity guarantee covering each Lead Inventory Controller (i.e. the person in charge of each warehouse) for first loss of 100 tons of commodity. Insurance is charged for on a declaration basis. Fidelity insurance is normally the most costly aspect of warehouse insurance, but by insuring all 60 warehouses under a single policy ECX has been able to obtain bulk rates, which works out at about Birr 8,200 or US$480 per warehouse per annum. Ethiopia does not have a history of warehousing fraud, and bankers we spoke to consider this to be a very secure system backed up by an implicit Government guarantee. ECX has a complex contract classification, above all the system for coffee which takes account of the following variables: whether washed or unwashed whether export speciality, commercial or local coffee the origin of the coffee, e.g. Sidama, Limu

20

In this regard, I interviewed an Ethiopian researcher who cited a case where the inspector failed to arrive for two days; he surmised that he was seeking a bribe in exchange for the requested certification. 21 Each intermediary member must contribute B300,000 and each ordinary member B200,000.

21

a grading structure taking account of raw value (defects, shape and make, colour and odour) and cup quality value

Figure 3: ECX warehouse locations as of June

The combination of all these factors results in large number of different contracts traded over the exchange floor. By contrast, the classification system for pea beans is much less complex, and takes account of: origin; the percentage of round beans (preferred to flat beans); size (in practice there is

22

little variation), and; grade, determined by percentages of foreign matter, overall defects, insectbored grains and contrasting class. All deposits are stored on a commingled basis, i.e. stock is not held identity preserved in the name of an individual depositor, but is located in a stack of the relevant grade. On loading out, stocks are issued to buyers on a first-in-first-out basis according to grade. Warehousing accounts for the majority of the staff working for ECX. The overall payroll peaked at 1,314, but the management of this staff has now been outsourced, so that by mid-2011, this number had fallen to 551. However the number of outsourced labour dependent on ECX remains very large, about 190 at a single location in Addis Ababa, from which one may deduce that the total number of outsourced labour depending on ECX is probably well in excess of 2,000. For some time, ECX management has been expressing the wish to focus on its core trading functions, and to move out of warehousing in favour of third-party warehouses that it would license and inspect. This would bring it closer to the normal practice of commodity exchanges around the world, i.e. of using a number of privately-owned exchange-registered warehouses. By divesting itself of its own warehousing activities, ECX would moreover be well placed to become Ethiopias warehouse regulatory agency, under delegation from the supervising Ministry (MOTI), since there would be no conflict of interest with its regulatory role. ECX has yet to take practical steps to license third-party warehouses and Government is not prioritising it for the moment.

5.6 WR financing at ECX

Warehouse receipting is limited by the very short expiry dates on the e-WRs, in the case of coffee one month from issue and in the case of sesame and pea beans, two months from issue, and for maize three months from issue. This reflects two factors: a) the limited storage space that ECX has available in its warehouse, and its over-riding need to trade stocks quickly and make space available for incoming deposits. This greatly limits their utility in financing storage of commodities, particularly seasonal storage of domestically consumed commodities. b) Governments wish to gain export revenue as quickly as possible, for which reason it discourages exporters from holding on to stock and speculating for better prices. In the case of coffee and sesame seed, farmers and traders may not be able to gain much by speculating on price rises, as there is reportedly not a clear seasonal price trend that would favour such activity. Indeed sesame exporters believe that suppliers need to sell quickly so as to take advantage of high world (notably Chinese) demand in the winter months. The same exporters often short-sell crops to overseas buyers and are concerned that if suppliers speculate this will make it more difficult for them to find available stock with which to fulfil their contracts. With pea beans the case appears to be slightly different. A leading exporter reported that there is some carry structure in international prices, rising from the beginning of the year (Ethiopian harvest time) to a peak around August-September. In the case of coffee, the 30 day expiry date practically rules out warehouse receipt financing, but it is still possible for sesame and pea beans, for which loans can be made up to about 50 days (allowing 10 days for processing of the loan and repayment formalities). A modest start was made 23

between Feb and May 2011, and the operation was continued into FY 2011/12. Between Feb 2011 and Jan 2012, CBE advanced US$ 1.14 million to 36 players who deposited a total of 292 tons of sesame in Gonder and Humera, and 170 tons of pea beans in Nazret. By the end of May 2012, CBE had advanced 42 depositors a total of about $1.5 million. Depositors were mainly suppliers (acrabis) who invest much of their borrowings in further purchases, and fewer than 10% were farmers. However ECX believes there is major potential with the cooperative unions, and that their deposits will grow once they have changed a constitutional provision which requires them to call a General Assembly every time they wish to borrow more than US$ 5,000. CBE has complete confidence in the security of the stock held by ECX, and advances depositors 60% of the value of the crop in store; this provides more than enough margin to absorb any likely short term fluctuation in world prices, making this a virtually risk free operation from the banks point of view. Only CBE is lending, as the NBE Bills Directive deters the other banks that are enthusiastic about the product, notably Wegagen Bank. ECX and IFC, which is supporting this operation technically, are confident that if this constraint is overcome there can be a large expansion of credit, added to which there is potential for lending against stocks at other sites such as Metema, Kombolcha and Addis. Notwithstanding the positive features of merchandise loans, banks recognise the added value in lending against ECX warehouse receipts, and ECX affirms some of the private banks (including one I vistied) are keen to come on board, if and when GoE changes the NBE Bills Directive in a way that allows them to lend. Banks point out the following advantages: ECXs DVP system provides the means of practically eliminating all defaults, except those resulting from a catastrophic decline in the market value of the commodity, a risk which equally exists with merchandise loans. This is an important advantage since, as one banker put it: while the average rate of default on merchandise loans is no more than 1%, a default by a single large customer could jeopardise the banks entire financial standing. ECX takes custody of the goods, taking charge of store management, grading, pest control and insurance, such that the bank does not have to concern itself with these aspects. Bank staff do not need to carry out frequent surveillance visits. Moreover, ECX provides current price information so it is unnecessary to independently verify the value commodities. ECX guarantees are Government-backed. Greater convenience to the borrower, who can access his commodities at any time during the warehouses working hours, and the bank, which can avoid surveillance activities.

The WRS is accessible to many rural traders who would not have adequate warehouses of their own or access to merchandise loans, that is to say it enables banks to widen their customer base and deepen their market penetration. While depositors have hitherto found warehouse receipt financing to be a profitable operation, it is quite likely that they will lose money in the future, due to adverse price movements, given the lack of a strong seasonal carry structure (increasing price trend) with export crops they sell through ECX. While such losses are unlikely to jeopardise their ability to repay the banks, which are using a loanto-value ratio of only 60%, it would be helpful if ECX could provide them with more market intelligence than at present, to help them manage the speculative risks involved. Presently most of the market information ECX presently provides members and the public is in the form of current 24

price information, but this provides little guidance about possible future price movements. They will need historic price series and more market commentary to help them understand domestic and international seasonal price movements.

5.7 Observations on storage sites

This and the next section may be read in conjunction with Annexes 2 and 3 which provide more detailed information on coffee and sesame respectively. The rented warehousing facilities are often far from ideal from ECXs point of view. At many locations capacity is limited, and this makes it important to turn stock over quickly. The number of entrances, weighbridges and parking space for trucks is limited such that any delay, notably those due to telecommunications or power failure22, can lead to the development of long tail-backs. The incidence of such problems varies between different delivery locations, and problems have been most acute at Humera, Metema, Gimbi and Nekempt delivery locations. We received reports of unloading of coffee having taken over two weeks in certain locations in southern and western parts of the country, and over ten days for sesame in Humera and Wollega. An independent observer found serious problems with sesame in Humera in December 2011, describing the situation as quite disturbing, with huge queues, nobody listening to depositors and the emergence of rent seeking activities as suppliers seek to jump the queue. The short season marketing season for sesame (November-January) puts a tremendous strain on the delivery infrastructure and handling process, unlike coffee that is traded for most of the year. Such events are very costly to the suppliers, in terms of demurrage and cash flow, and this has serious knock-on effects on farmers. ECX acknowledges that long queues can develop and that some centres handle 150 trucks per day. However, ECX says that it has a Service Level Agreement of 3 days, and says that in the case of sesame 85-86% of trucks are received within this time limit. Delivery locations with good power supply and telecommunications connections, like Adama which mainly handles pea beans, appear to suffer few problems; the warehouse supervisor claims that he can always get trucks trucks unloaded in less than two days, and get them loaded in one day. ECXs Chief Information Officer says that steps are being taken to improve electronic communications, e.g. by developing the capability to generate documents in off-line mode and transmit when connectivity returns, and equipping delivery locations with high powered laptops with extra batteries and car adapters for charging, making use of generators used for powering coffee roasting machines (in Gimbi). The layout of warehousing sites poses another problem to ECX. Often the offices and sampling areas, weighbridges and warehouses are spread out, complicating management and control of stocks going through the system. ECX seems to have gone to great efforts in following up, and seeking to explain, weight losses between deposit and issue of commodities. In the case of coffee, much of the problem can be attributed to moisture losses, and this has led to the introduction of a daily moisture loss adjustment of 0.0065% of the commodity weight during storage, to be borne by either the depositor or the buyer, according to the time the commodity is in the name of each. According to ECX (2011), the volume of warehouse delivery shortfalls that could not be explained by
22

These problems lead to delays in the transmission of GRNs, GINs, pick-up tickets and other documents between the delivery locations and Central Depository, making it difficult for the warehouse staff to handle commodities in and out in timely fashion.

25

moisture-related shrinkage and had to be compensated for in cash or kind were of very limited magnitude, i.e. some 261 tons, or 0.052% of the total volume of commodities traded through ECX. However, there remain nagging doubts as to reasons for why these losses occur. Possible explanations include loss of weight in diesel used driving between weighbridges and warehouse sites, spillage and theft by, or in collusion, with ECX staff23. Moreover, as I discuss in section 5.8 below, exporters frequently complain about short delivery, and feel that the problem is more serious than ECX will acknowledge. Given the strength of these perceptions, some form of independent verification might be justified. Office space at the delivery locations is often inadequate, notably for grading staff that must often work under very cramped conditions, sometimes with no proper place to store reference samples, and exposed to a lot of dust. An investment in uniforms and masks would not come amiss. In terms of operations, ECX has a well-structured system of controls from the moment of arrival to dispatch of commodities. Staff is divided into two groups, under the management of a Warehouse Operations Supervisor and a Laboratory Supervisor respectively. Operational staff include weighers, runners (to carry samples), inventory controllers (in the warehouses), data entry clerks, security marshals (to accompany trucks to and from weighbridges etc.) and guards. Laboratory staff includes a sampling inspector, samplers, and quality coordinators (i.e. grading staff). The sampling system is designed to ensure that graders do not know whose samples they are testing, with all samples and test results being channelled through a coder who has unique knowledge of the code. Data entry clerks generate Goods Received Notes (GRNs) and Goods Issued Notes (GINs) and transmit them to the Central Depository which uses them as a basis for issuing warehouse receipts and recording delivery to buyers. Spillage presents a problem in warehouses for sesame and pea beans, resulting from the use of low cost polypropylene bags of 100 kg capacity (coffee continues to be held in jute sacks which do not pose a problem). The 100 kg bags are also more difficult to handle, and produce stacks of rather irregular shape. Consequently, ECX is planning to switch to heavier duty 50 kg bags of the kind currently used by the World Food programme.

5.8 Observations on the performance of ECX and related marketing innovations

Given the considerable funds and effort invested in the new marketing structure, one would hope that GoE, ECX and/or one of the international agencies supporting ECX would have commissioned independent performance reviews. There is a particular need for such reviews in a situation where the new market structure has been mandated, and stakeholders do not have the option of voting with their feet, i.e. using alternative marketing structures. In saying this, I do not imply any adverse judgement on GoEs policy of mandating crops to be traded through primary transaction centres and ECX; it may be possible to justify such measures (at least for a limited duration) on various grounds, e.g. economic efficiency, infant industry/economy of scale considerations, or the need to overcome
23

With warehouse employees earning B3,900 per month, there are powerful temptations to pilfer or embezzle. Assuming a coffee price of B105 per kg, an ECX warehouse employee earning B3,900 per month could double his salary by selling when a 37 kilos of coffee/month.

26

tax disincentives alluded to in section 5.2. I am simply saying that in a situation where players are not free to use an alternative market structure, Ethiopia needs to institute alternative reality checks in the form of independent and objective reviews and evaluations. Despite making a number of enquiries, we were unable to obtain any such documentary evidence on the impact and cost-effectiveness of the new marketing structure. A Government institution had commissioned a review, but had not authorised its release. Moreover, information on the operations of ECX was very limited due to managements policy of confidentiality, which extended to the most basic information one would normally expect to find in the public domain including volumes of commodities traded and earnings per annum. For this reason, we were very reliant on other parties for the provision of information of this and other kinds. Any radical new system will be butt of criticism, however well it is implemented; it disturbs established practice, creates winners and losers and encounters vested interests. Not surprising there is no shortage of adverse comments about ECX from the supply and buying side. The work of the consultant is therefore to try to distinguish between transitory and teething problems and more deep seated challenges. There are two points on which most interviewees seemed to agree, that ECX has eliminated contractual defaults within the supply chain, and has increased market transparency. Prior to mandatory sale through ECX, there were numerous and costly performance failures on the part of suppliers (notably for sesame seeds and pea beans), and payment failure on the part of exporters (for all three crops). In the case of coffee, some buyers were issuing dud cheques against stocks delivered through the auction. However according to coffee industry representatives, the problem was cleared up two years before GoE mandated coffee to be traded through ECX: the Ethiopian Exporters Association, Government and other stakeholders agreed a settlement arrangement whereby the buyer had to produce a bank certificate showing that sufficient funds were held in a blocked account. Regardless of the success of this latter measure, it is not clear that the establishment of ECX was a precondition to improving contract enforcement in Ethiopian agricultural trade. Apart from establishing a settlement arrangement around the coffee auction, other measures might have been taken. In the case of sesame, it may have been possible to establish a system of mandatory auctions at key trading centres along the lines of practice in Sudan. It may also have been possible to strengthen the legal framework and dispute-resolution procedures for all commercial transactions. As regards market transparency, there is little doubt that thanks to ECX, farmers and other players are more aware of market prices which they can obtain by simply dialling up a number; indeed ECX reports 60,000 SMS price requests per day. A long-term observer of the sesame trade in Humera claims that prior to ECX there was a lot of collusion and lack of transparency. The main areas of concern are as follows: That the new system is adversely impacting on Ethiopias ability to take advantage of the growing international market for washed Arabicas, and niche markets. The overwhelming view of the exporters and international buyers we consulted during this study is that the new structure was tending to commoditise the coffee trade, damage traceability and depress the premiums that it could earn from better quality coffee, mainly but not exclusively washed Arabicas. It is difficult to quantify the resulting loss, but it is clearly of material importance. It depends on ones assumptions 27

as to how much could potentially be sold as washed coffee, and the premiums that Ethiopia can earn for niche products. One informant estimated the loss at US$0.20-$0.30 per lb of washed coffee exported24. If one applies this figure to the 59,604 tonnes of washed coffee traded through ECX in 2010/11, one gets an overall loss of $26.2 to $ $39.3 million. Another commentator (TechnoServe 2011) estimated that Ethiopia can earn an additional $90 million per annum if it fully focused on producing good quality washed Arabica. It could moreover earn much more if it devoted more effort to raising agricultural productivity from the currently very low levels. Immediate logistical problems As discussed in section 5.7, there are serious logistical problems at some of the ECX delivery locations, and this diminishes confidence in the system. These problems may be gradually addressed over the coming years depending on the availability of funds for improving and expanding delivery locations and determined Government action re problems with power and telecommunications. Longer term logistical and transaction cost issues Even if these current problems are resolved, there is also a question as to whether the new system is inherently efficient or otherwise. Notably in the case of sesame and pea beans, for which there was no mandatory auction prior to ECX, the new market structure involves more links than the one it has replaced. According to sesame exporters we interviewed, they used to transact much of their business directly with farmers, whereas everybody is now required to sell at the primary markets, a situation which they claim favours suppliers (acrabis) who buy up the crop and deliver to the ECX warehouse, with a large profit25, but without providing a commensurate service, and rendering Ethiopia a less competitive source of supply. They claim that the grading carried out at the delivery location is not relevant because there is no value addition prior to delivery; the product has to be cleaned and processed before export (see Annex 3 dealing with sesame). They also claim difficulty in fulfilling customer requirements in terms of quality. Formerly exporters of sesame could chose to obtain all their requirements in a certain part of the country, but find this difficult with the new system. They find they have to shop around for lots from different regions, and are unable to supply products with uniform characteristics. Even in the case of coffee it is not clear that the new system is logistically advantageous. Previously coffee could be shipped directly from the Kabele to the exporter in Addis or Dire Dawa, passing through the auction, but there are now two shipments, the first from the Kabele to the ECX delivery point and the second from there to the exporters premises. Some parties allege that the consequent double handling increases overall transport cost from farm gate to export. A more in-depth study would be justified to determine whether and to what degree the new system has been beneficial, or otherwise, in terms of overall system costs.

24

This figure is based on the normal differential between prices for Yirgacheffe and Sidamo when purchased directly from cooperative unions and when purchased from exporters who had procured through ECX. 25 At the time of the interview, they were buying at B1,500-B1,600 per quintal (1 quintal = 100 kg) and selling at B1,900-B1,950.

28

Widespread default on export contracts for coffee This problem has been very serious in the coffee trade of 2011/12, with suppliers holding back stocks at prices they cannot hope to recover in the international market, and with many export defaults and problems of short shipment ensuing. Part of this can be attributed to a pre-existing situation whereby exporters engage in extensive short selling and are unable to hedge in the international market. However, the new marketing structure with its strict demarcation of roles of suppliers and exporters seems to have exacerbated the problem. Suppliers can hold their stocks for up to a month at ECX delivery locations, and this makes it more difficult than before for the exporters to get their hands on coffee with which to cover their short positions. Alleged shortages and erroneous grading at ECX delivery points Exporters frequently complain of shortages upon pick-up and errors in the grade of commodity they are allocated to pick up. The level of complaints over shortages contrasts with ECXs finding that actual shortfalls in 2010/11 were only 0.052% of the total quantity of commodities transacted (ECX, 2011). As regards grading, particularly strong complaints were voiced re both sesame and coffee, while a pea bean exporter believed that the standards themselves did not accurately reflect international requirements. Exporters attribute these problems to errors in scales, ECX coffee liquoring and grading staff having insufficient experience, and corruption. ECX has attempted to prevent the latter through the above-mentioned system whereby samples are assigned confidential codes; notwithstanding this, we heard claims that exporters can overcome this anonymity and identify the origin of lots offered for across the exchange floor. Under ECX rules, buyers can request sampling at dispatch but they claim this is usually impractical in view of the congestion and the speed of turnover of stocks at exchange warehouse. They need to run around to secure supplies to satisfy their short positions, so they lack time for sampling and testing. Some also express scepticism about the scope for successful challenges to ECX, dealing with an all-powerful Government institution that you cannot sue. They acknowledge the existence of private board members but believe they lack real power. Different views are expressed by ECX staff. ECX is conscious of concerns about the accuracy of scales and is now paying the Quality and Standards Authority to calibrate weighbridges on a quarterly basis instead of annually. Suppliers and buyers frequently make claims about grading. As regards grading, buyers can register a disagreement within 5 days of pick-up, though they will need to have the samples taken at the time of pick-up; they cannot go into the store and take samples from stacked commodities. Significantly however, ECX staff I interviewed tended to confirm the exporters contention that exporters procurement staff was too busy to have their product re-graded upon dispatch. ECX says it gets many claims from suppliers and buyers, and first tries to deal with them through discussion, seeking to assess whether the claim is legitimate or has some other explanation. In the latter case ECX will seek to convince them that arbitration is not worthwhile. However, 18 cases have so far gone to arbitration (16 with coffee, two with pea beans), with claimants winning in four of them (all with coffee) and five staff consequently being fined. Arbitration is carried out by a five person panel including three graders from the relevant Government body, i.e. Coffee Liquoring Unit (CLU) or the Ethiopian Conformity Assessment Authority (for sesame and pea beans), one from ECX

29

and one representing the claimant (supplier or buyer). The claimant must pay Birr 3,000 in order to bring a case, reimbursable if he/she wins. Disconnect between supply and demand side activities. Some stakeholders raised concerns about the disconnect that the current market structure has introduced between supply and demand side activities. Except where dealing with cooperative unions, there is little scope for exporting companies to get involved in promoting new crops, varieties and cultural practices at smallholder level. One of the pulse exporters had previously been active at this level, but in the future the onus for such activities would fall fairly and squarely on the relevant GoE bodies, MoARD and the Ethiopian Institute of Agricultural Research (EIAR). Summary statement. There are clearly some costly logistical problems with the new systems, and uncertainty as to whether the system will prove economically efficient (vis--vis the previous system) even if these problems are resolved. Getting to the bottom of the latter would require more indepth investigation that has been possible in this review, as well as a high level of official support. There is little doubt however that the current policy framework and marketing structure is preventing Ethiopia from taking full advantage of the growing international market for washed Arabicas including niche markets. Moreover, the new system seems to be making it more difficult for many exporters to correctly fulfil their international sales contracts. The aspect of the above discussion that causes most concern is the lack of independent reviews of the performance of the new marketing structure, something that is badly needed as a reality check and in the interest of public accountability.

5.9 Plans for other commodities

Government is planning to steadily increase the number of commodities mandated to flow through primary transaction centres and ECX, starting in the 2012/13 harvest with wheat and maize. In December 2011,

MOTI submitted the scheme to a high-level inter-ministerial team chaired by the Ministry of Finance (MoFED); approval is expected subject to adjustments, and there will then be a programme to raise public awareness about the new system. It is also widely believed that Government will require other pulses, including chick peas, red kidney beans and niger seeds to pass through the new structure (primary transaction centres + ECX), though no dates have been set for this. There is in principle much more scope for warehouse receipt financing with grains than for export crops, given that in most of the country there is only one harvest, and some of the stock needs to be stored for upwards of six months. However, ECX rules provide for warehouse receipts with a 3month expiry date, which is a great limitation in this regard. Besides this, it is hard to believe that GoE is serious about mandating sale of all marketed maize and wheat through the ECX trading floor, for the following reasons: ECX will face overwhelming capacity constraints in the area of physical infrastructure (weighbridges, warehouses) and staffing. ECX is already overstretched in trying to handle three export crops whose combined production is around half a million tons; trying to handle the marketed surplus of maize and wheat, of the order of 1.2 million tons, risks causing a logistical and administrative break-down and discredit the system. The relative informality of the grain trade, the multiple channels by which produce flows from producers to consumers, and the virtual absence of exports make the mandating of grains a 30

much greater challenge than with crops destined for export. Export transactions are highly visible and have provided Government with a means of verifying the flow of products and funds. By contrast policing flows of grains requires Government to have intimate knowledge of the operations of tens of thousands of small traders and hammer millers operating round the country. GoE already has a major problem enforcing the prohibition on sale of export grade coffee in the local market, and is likely to have a much greater problem with grains. The attempt to control the situation risks a proliferation of rent-seeking by lower level officials. ECX officials were non-committal about GoE plans for maize and wheat, and clearly had more pressing concerns on their minds. They mentioned that they had been trying to attract cooperative suppliers and major buyers including WFP, Ministry of Defence and Universities, within a voluntary (i.e. non-mandated) framework. Judging by the low level of grain sales across trading floor, ECX has not so far had much success in this endeavour. If GoE really wants to bring grains into the ECX and the WRS, it needs to carry out demand-side stimulation, i.e. it needs to get buyers on the Governmental side (food aid agencies, schools, prisons etc.), and intergovernmental institutions like WFP, to purchase most of their supplies through ECX, taking delivery in the form of warehouse receipts. If these demand-side players comply, it will not be difficult to get interested suppliers to deposit their commodities at ECX delivery points. Solvent demand for these commodities will also overcome any concern these suppliers have about being brought within the tax net a problem highlighted in ECXs annual review for 2010/1126. However to facilitate this change, ECX will need to establish a different kind of delivery location than those it has at present, which are facilities designed for trading commodities, and for storage up to between one and three months depending on the commodity. Capacity constraints hardly permit longer-term storage. Moreover, the experience of WFP we described in section 5.2 above shows that it is vital to have products processed according to end-user requirements. Most farmers and suppliers lack grain cleaners of their own, so warehouses ought to provide the service on site, as part of a one-stop-shop service. In this way they can condition their grains according to grading standards that meet buyer requirements and avoid the rejections which have hitherto plagued relations with WFP. Depositors and buyers will also need the option of relatively long-term storage (upwards of six months) so that they can engage in seasonal arbitrage. Hence, if ECX is to develop the grains sector it will need a much larger handling and warehousing capacity than ECX can itself provide; indeed it will need to start certifying independent warehouse operators. The greatest scope for demand-side stimulation lies with the hundreds of thousands of tons of commodities per annum of domestic and imported origin procured and handled annually by the World Food Programme, the Disaster Risk Management and Food Security agency (DRMFS), EFSRA and EGTE, for food aid purpose or for stabilising the domestic food market. With regard to the latter, it is worth noting that GoE imported 1.9 million tons of wheat for this purpose in 2010/11, and sold them to the public and processors through EGTE, based on a quota allocated to each processor. These volumes could alternatively have been auctioned off through the ECX trading floor. Indeed GoE could use ECX for a range of public procurement and trading activities, following the
26

The situation regarding taxes is not entirely clear. On the one hand I learned that food commodities were tax-exempt. At the same time, it was reported that a factor deterring wheat and maize traders from bringing their non-mandated commodities to ECX in 2010/11 is that it prevents them from evading taxes, notably 2% TOT withholding tax and 15% VAT (if the company happens to be VAT registered).

31

example of some South American countries, which have even found it useful for procuring items like school lunches. If GoE can establish a major trade in public sector grains across the ECX floor, it is likely that private buyers, notably the larger scale millers will also find it attractive to bid for them and gradually come on board. However, it has to be recognised that moving over to the ECX system would require a major upheaval in the rules and operations of the Governmental institutions involved, which is no easy matter. Food aid buyers like WFP would need to progressively move from their present tenderbased procurement systems, to one of buying through the exchange floor and using ECXs rapid clearing and settlement system. So far there appears to have been no discussion between ECX and the relevant Government Ministries and agencies (DRMFS, ESFRA and EGTE) on the subject of using ECX for procurement and sales of public sector grain stocks. To implement such a system, EFSRA and EGTE would need to turn their stores into ECX-certified warehousing facilities that could hold stocks for either private sector or public sector operators. For its own part ECX would also need to start licensing other third party warehouse operators to handle the surge in demand. In short, bringing food aid commodities into the ECX system poses a major change to existing operations and habits. In conclusion, I believe that if GoE really wishes to establish the WRS and exchange-trading with grains, it will need a new long-term strategy, involving demand-side stimulation by public sector buyers, completely voluntary participation of private players, and warehouses that are equipped for cleaning and standardisation of grains.

6. Conclusions and recommendations

In examining ECX, and the WRS which it has ushered in, I have identified a range of pluses and minuses. However, on a short study of this kind and given the availability of information, I cannot go as far as to attempt an overall quantification benefits to farmers, of economic gains or costeffectiveness of the system. For this reason, I have limited myself to a more modest assessment, against the criteria of enabling environment, strategic coherence and operational arrangements, and a few recommendations which flow from this analysis

6.1 Re the enabling environment

There is a mixed picture here. GoE has provided very determined support for the development of ECX and its warehousing system, backed up by the willingness to enforce compliance with applicable law and regulations. It has moreover been quick to pass enabling legislation for warehouse receipts, giving banks full confidence in the instrument. However, in some respects GoEs approach appears to have been too determined, taking insufficient account of strategic issues (see below), and with current plans to mandate more than 1 million tons of maize and wheat, an action likely to prove problematic in view of; (a) the difficulty of policing flows of basic foods, and; (b) the expected overload on ECXs already over-stretched delivery system. We also note that the development of reliable power supplies and internet connectivity lags behind the expansion of ECXs delivery structure, resulting in major delays in unloading and loading commodities in certain locations. At the same time certain aspects of the enabling environment (notably discouragement of differential trading) increase the price risk that exporters face and make it more difficult for them to access bank 32

financing. The GoE requirement that higher grades of coffee be exported is the source of a largescale black-market, whereby exportable grades are diverted for domestic consumption, by-passing ECX.

6.2 Re strategic coherence

There is a widespread consensus that the new system has made the internal market more transparent and improved enforcement of contracts between suppliers and exporters. However the new market structure is adding further logistical steps (at the level of primary transaction centres and exchange warehouses) creating new costs in the value-chain. At the same time, coffee exporters are finding it difficult to cover their short positions, and this is contributing to problems of contractual default at the export level. ECX is at odds with the current trend in the international coffee market, as the mandatory market structure diminishes traceability and thereby reduces the premiums that Ethiopia can earn for its coffee, at a cost which may be upwards of US$26 million per annum. A fresh approach focusing on increased agricultural productivity, adoption of the most efficient pulping technology and maximizing quality premiums in the international market could potentially earn Ethiopia much larger sums, in the hundreds of millions of dollars per annum. As regards warehouse receipting, the Tanzanian experience with coffee offers some useful pointers to Ethiopia. It is a voluntary system whereby Government or its nominee licenses privately owned dry mills to act as one-stop-shops, and carry out a range of activities (storage, financing, dry milling, classification and grading) in single locations. The system is logistically efficient and allows for traceability, with origin coffee being handled on an identity-preserved basis. The plan to mandate the trading of maize and wheat through primary transaction centres and ECX is highly questionable given the capacity limitations and congestion that already exists at ECX delivery points, and the difficult in policing the system. The easiest way to develop exchange trading and warehouse receipting for cereals is by using demand-side stimulation, as described above, but without mandating the system on private players. As I suggest in the case of coffee, ECX would not need to run the warehouses, but simply accredit suitable companies to carry out this function and ensure their compliance with the relevant regulations. Unlike the present arrangements, warehouses should be one-stop-shops with primary processing facilities (notably cleaning), and with sufficient capacity for seasonal storage (i.e. upwards of six months). Indeed it probably makes logistical sense for ECX to move towards one-stop-shop warehouses for all commodities, whereby the commodities are cleaned, dried or otherwise processed to standards required by end-users and export markets. Government could also develop the grain trading side of ECX through supply-side stimulation, in this case using ECX to auction off stocks of imported wheat (such as it imported in 2010/11) and other commodities.

6.3 Re operational effectiveness

ECXs greatest strength lies in the operational arrangements of its trading system and delivery locations. Moreover, its warehouse receipts inspire confidence among the banks, avoiding the distrust which has held back warehousing initiatives in some other countries. Running warehouses 33

has provided ECX with a wealth of experience it could put to good use by establishing an accreditation and inspection service for private warehouses. At the same time, it has significant logistical problems resulting from a mixture of internet and power failures, and shortage of physical capacity (warehouses and weighbridges). This makes it difficult to handle large volumes of mandated crops, and results in large tailbacks at certain sites; in the worst cases lorries queue for over 10 days. The planned mandating of grain crops can only exacerbate these problems. There is moreover widespread distrust of ECX among the trade, regarding grading and underweight, and a perception that the authorised channels of complaint and redress are not fully effective. Our study did not provide either a brief or the scope to investigate this, but we suggest that confidence might be enhanced if those supporting ECX periodically contract an international company to carry out a thorough operational audit.

6.4 An overriding need for more independent review and open discussion
The establishment of ECX and is a very significant achievement; it involves by far the largest formal commodity trading mechanism in Sub-Saharan Africa outside of the Republic of South Africa, and provides a credible basis for developing a strong WRS. However, its approach is largely experimental, involving a much higher level of State involvement than is normally in the case with such entities. For this reason, there is a need to stand back, study its performance and draw lessons for the future development of this or similar initiatives. There also needs to be much more open discussion and debate, in Ethiopia, about ECX and related policies.

34

References
Access Capital (2012a) Sector Review, Agriculture, Jan 13 2012 Access Capital (2012b) Banking sector review, Jan 11 2012 Access Capital (2011a) Macroeconomic Handbook, Dec 31, 2011 Access Capital (2011b) Monetary policy review, April 2011 Agrisystems Ltd, 2001. Coffee Support Project, Ethiopia. Revised Draft Formulation Report for the European Commission. April 2001. Alemu, D. and Meijerink, G. (2010) The Ethiopian Commodity Exchange (ECX), an Overview. A joint publication by the Ethiopian Pulses, Oilseeds & Spices Association (EPOSPEA) and Wageningen University and Research Centre. ECX (2011) Review of Ethiopia Financial Year 2003, i.e. FY 2010/11 on western calendar. Gabre-Madhin, E. (2011) Of Markets and Middlemen: Transforming Agricultural Markets in Ethiopia. Washington: IFPRI LMC, 2000. International Coffee Organization/Common Fund for Commodities Study of Marketing and Trading Policies and Systems in Selected Coffee Producing Countries: Ethiopia Country Profile. Study prepared by LMC International Ltd. Oxford, England. NRI, 2006. The Potential for Diversification in Coffee Exporting Countries. Project ICO/CFC/10FT. Report prepared for the International Coffee Organization and the Common Fund for Commodities. London: Natural Resources Institute. Petit, N. (2007) Ethiopias Coffee Sector: A Bitter or Better Future? In Journal of Agrarian Change, Vol. 7 No. 2, April 2007, pp. 225263. Rashid, S. and Lemma, S. (2011) Strategic Grain Reserves in Ethiopia; Institutional Design and Operational Performance. IFPRI Discussion Paper 01054. Markets, Trade and Institutions Division. Rashid, S. and Negassa, A. (2011) Policies and Performance of Ethiopian Cereal Markets. Development Strategy and Governance Division, IFPRI, and Ethiopia Strategy Support Program II, IFPRI-Addis Ababa. ESSP II Working Paper No. 21 Robbins, P. (2010) Review of the role of commodity exchanges in supporting smallholder farmer market linkages and income benefits. Consultancy report to Catholic Relief Services. TechnoServe (2010) Growing Ethiopias Coffee Export Sector: Challenges and Opportunity. Discussion Document TechnoServe (2011) Financing rural coffee cooperatives in Ethiopia. Presentation by Carl Cervone, Operations Manager, TechnoServe Ethiopia, January 20, 2011 Walker, D. J. and Wandschneider, T. (2005) Local Food Aid Procurement in Ethiopia. Case Study Report by Natural Resources Institute for EC-PREP (UK Department for International Development). http://www.ec-prep.org 35

Annex 1: List of organisations and individuals contacted

ACDIVOCA ACOS Ethiopia Amaro Gayo Coffee (Organic) Ato Amaha, pulse, oilseed and spice exporter Armajaro Trading Ato Aman Adenew Ato Aschenaki Gebrehiwot Association of Ethopian Microfinance Institutions S.A. Bagersh PLC Caf Africa, Nyon, Switzerland Channel Coffee, Ethiopia Coffee Liquoring and Inspection Center Coffee Processing & Warehouse Enterprise Commercial Bank of Ethiopia Dormans Coffee Ethio Agri SEFT Ethiopian Coffee Growers, Producers and Exporters Association European Union Delegation of the European Commission to Ethiopia EPOSPEA, Ethiopian Pulses, Oilseeds and Spices Processors and Exporters Association Ethiopia Commodity Exchange, Headquarters and warehouses in Addis Ababa, Adama and Hawassa Himatsing International Pte Ltd International Coffee Organisation, London John Kennedy, Technical Assistant working for ECX Meset Consult Ltd. Metad Agricultural Development PLC Ministry of Trade, Agricultural Marketing Directorate Olam Ethiopia Soreti International Trading Co. The Synergos Institute TechnoServe Inc., Ethiopia and East Africa Ato Tilahun Teshome Wegagen Bank Ato Wondwossen Mezlekia, Seattle, USA World Food Programme, Adama 36

Annex 2: The coffee system

Ethiopias coffee industry and its position vis--vis the world market
Ethiopia is the largest coffee producer in Africa, and the sixth largest in the world, with an industry which at the beginning of the millennium employed an estimated 1.3 million farmers while helping sustain the livelihoods of about 15 million people27. Coffee is overwhelmingly a smallholder crop, though commercial estates are significant, accounting for about 10% of exports28. According to figures from the International Coffee Organisation (ICO), production of green coffee was 450,000 tons in crop year 2010/11 and almost 500,000 tonnes in 2011/12. Notwithstanding, the productivity of Ethiopias coffee industry is very low (about 700 kg per ha according to FAO), and could be increased by 50% without irrigation or fertiliser29. Some critics attribute this situation to the lack of a national coffee strategy and of a specialised sub-sector agency, such as exists in most coffeeproducing countries. Ethiopia only produces Arabica coffee, and supplies some renowned varieties, such as Sidama, Yirgacheffe and Limu, which command a premium in international markets. Coffee originated in Ethiopia, and unlike other African countries, it has a very strong coffee drinking culture. ICO figures show slightly more than half of production being domestically consumed. A very large part is consumed in rural areas and never enters commercial channels, making consumption difficult to assess. The volume of coffee traded by ECX in its third year (2010/11) was 238,270 tons, of which 85% was export grade and 15% local coffee; 71% was unwashed and 29% washed coffee. With high world prices, the market was very buoyant, but the recent price fall has caused suppliers to hold on to stocks and by the end of February 2012 it was reported that volumes were down by 30% on the previous year. From an international trade perspective, Ethiopia is in a very favourable position. The demand for washed Arabicas has been growing rapidly (see Figure 1) at a time when supplies from traditional Central and South American sources have been stagnating. While Ethiopia mainly exports unwashed Arabicas it is well-placed to switch most of its production to wet milling using efficient equipment using eco-pulpers of a kind pioneered in Brazil and Colombia, and promoted with cooperatives under TechnoServes Ethiopia Coffee Initiative.

27 28

Agrisystems, 2001 and LMC, 2000, quoted by Petit 2007 according to the Ethiopian Coffee Growers, Producers and Exporters Association 29 Source: for Brazil, TechnoServe, 2011; for Vietnam Ethiopian Coffee Growers, Producers and Exporters Association

37

Figure 4: World market growth for high quality (i.e. washed) Arabica, versus unwashed Arabica and Robusta (source: TechnoServe, 2010)

Calculations by TechnoServe suggest that this could add $90 million to the value of Ethiopias annual coffee exports. The greatest potential for doing this is in Western Ethiopia, in areas such as Jimma, Illubabor, Wollega and parts of the Southern Nations, Nationalities and Peoples Region (SNNPR).

Figure 5: Scope for increasing the value of Ethiopias coffee exports (according to TechnoServe, 2010)

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Ethiopia stands to gain much more than this by raising its very low agricultural productivity, and taking advantage of the global move towards traceability and niche marketing, focusing on gourmet, organic, fair trade or eco-friendly (such as shade-grown and bird-friendly) attributes. These are coffees typically trading at around US$ 100 cents above the New York contract price, a price which reflects prices for standard Latin America washed Arabicas. As noted by NRI (2006) international coffee buyers have been focusing on higher quality and consistency, traceability of origin, economic, social and environmental transparency and capacity for direct long-term partnerships between producer and roaster. Given its wealth of genetic resources and large areas with exceptionally good growing conditions, Ethiopia has the potential to produce large amounts of such differentiated products. Ethiopia moreover appeals to the subjective side of marketing, having a story, notably about Ethiopia as the birthplace of coffee. While there is a limited and growing market for gourmet coffees which one international trader estimates at 5% of the total international trade, a much larger market is emerging among the major roasters such as Nestl, Kraft Foods Inc. etc. which are seeking the moral high ground with sustainable sourcing, traceability and improving farmers living conditions.

Box 1: Kraft Foods commitment to sustainable sourcing

Kraft Foods, the second largest global coffee buyer, has committed itself to sustainably sourcing 100% of its coffee beans for its European brands by 2015. It is already the largest buyer of coffee from Rainforest Alliance Certified farms, having increased its volume by 47% in the last year. Kraft says it will proactively look for ways to help support and secure the coffee supply chain from crop to cup, doing things like improving living conditions for coffee farmers, enriching their growing methods and protecting the precious ecosystems surrounding their farms - - - protecting wildlife and the environment and it will improve their incomes and quality of life, and promote the long-term survival of their crops. Source: http://www.kraftfoodscompany.com/eu/en/responsibility/sustainability/coffee.aspx While these features of the international market all favour Ethiopia, buyers find it a difficult source with which to deal, due to frequent defaulting and short shipments on the part of exporters. Ethiopian banks finance exporters against physical sales contracts, at a loan-to-value ratio of 70-80%. As they must have a physical sales contract and a letter of credit in hand, they typically engage in short selling, and this in turn results in frequent defaults at times of increasing prices, as occurred in 2011. They could better manage their price risk if they could obtain financing against a hedge on the New York futures market, but Ethiopian exporters are unable to do this, due to official policies and the unavailability of foreign exchange for margin payments. There is also a widespread view that some of the measures taken by GoE towards the international trade are counterproductive, notably insisting on containerisation in an industry that does not have machines for blowing coffee into containers.

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The market structure before ECX30

The structure is described in Figure 2, in section 3.3 of this report. The principal chain consisted of farmers, primary collectors (sebsabies), suppliers (akrabies), exporters and international buyers, as well as wholesale and retail traders serving the domestic market, which absorbed about half the Ethiopian crop. In the case of dried cherries, either the collector or supplier took care of the dry milling, while suppliers took care of wet milling, using their own or third-party mills. Initially, all traded coffee was required to pass through auction centres in Addis Ababa or Dire Dawa, but starting in 2001, cooperatives and to a lesser extent private investors were granted permission to by-pass them, opening the way for direct export sales. Moreover the requirement to sell coffee for domestic consumption through the auctions was not very rigorously enforced. The main participants required licenses to exercise their respective functions, i.e. collectors had to sell to suppliers, suppliers were allowed to deliver their coffee to the auction but were not allowed to export it, and exporters could only buy coffee from the auction. Only Ethiopian-owned companies were (and still are) allowed to be exporters. Unwashed Arabicas were auctioned as green coffee, while washed Arabicas were traded as parchment, both semi-processed products requiring the exporter to engage in further processing to meet international buyers specifications. On arrival in the Addis Ababa or Dire Dawa, all beans were taken to the auction compound where their provenance and quality were sampled and tested by the Coffee Liquoring Unit (CLU) on a truck-by-truck basis. Grading standards were set according to the number of defects and the type of processing. Washed coffee supplies were usually denominated as Sidamo 2, Limu 2 or Yirgacheffe 2, while the most common unwashed coffees were Jima 5, Sidamo 4 or Harar 5. Efforts were made to keep consignments from different regions separate in order to maintain their distinctive flavour. Deliveries which do not meet export standards were rejected and redirected for the domestic market. The Addis auction was held in the compound of the Coffee Processing and Warehousing Enterprise, a large facility which provided dry milling, storage and collateral management services (for banks providing merchandise loans); it has three processing lines and storage capacity of 90,000 tonnes of coffee. After the auction, the suppliers immediately took their truckloads to the premises of the exporter who could inspect, sample and test. If the exporter found the coffee did not meet the CLUs sample specifications, he could make an appeal and have it resampled and graded. If the claim was upheld, the buyer could reject the truckload and send it back to the auction. When, as was normally the case, the exporter accepted the load, he would then process it for export using his own or hired facilities.

Market structure with ECX

ECX trades the same semi-processed commodities as were previously traded over the auction floor. However, suppliers no longer sell their coffee on truck, but must deposit it at one of eight ECX delivery points located closer to the producing areas. There they are graded by ECX staff, and stored in commingled form by classification and grade, there being some 600 grades overall. Suppliers
30

Much of the information here comes from Petit, 2007, pages 16-20, who drew part of his information from various earlier reports by LMC, NRI, Agrisystems and others.

40

have up to 30 days to sell the stock over the exchange floor, while buyers have up to 10 days to pick up the goods, with heavy daily penalties applicable to those exceeding these limits. The Central Depository in Addis Ababa issues the buyer with a delivery note entitling him to receive coffee at the delivery locations, and trucks are required to be loaded out on a first-in-first-out basis. The exporter or his representative may not go inside the warehouse and select the commodity, but is entitled to get the product sampled and graded upon dispatch, and this may form the basis of a claim. After exporters have processed their coffee for export, they must separate out grades described as local and reject coffee and sell the local coffee back into the national market through the ECX trading floor. The establishment of trading at ECX has been accompanied by the establishment of primary transaction centres, as set out in the Coffee Quality Control and Transactions Council of Ministers Regulation, No. 161/2009; producers are required to sell their red-cherry or sun-dried coffee to certified suppliers at these centres. In each region, an appropriate organ (i.e. department of the regional Government) must determine the number and distribution of primary transaction centres. In practice the policy is to establish one in every Kabele, the lowest administrative level in Ethiopia. The primary transaction centre is supposed to be a fenced enclosure of at least 50 x 50 meters, have common services (including market data board, loading and unloading platform and dry waste burning and pit latrine), have officially-certified weighing scales owned by each supplier, and be clean and convenient for information technology services. Coffee suppliers are required to have an official certificate of competence, as are other players involved in the commodity chain (wholesalers, roasters, processors and exporters). In order to obtain the certificate, the supplier must possess a warehouse, coffee pulping and drying machines, weighing scale, moisture meter, bags and other necessary materials, and fulfil various other processing, environmental and employment requirements. Coffee Quality and Transaction Inspectors are the front line staff required to enforce the regulation. Foreign nationals and companies cannot get a license for trading and exporting raw products, unless they are involved in farming or processing coffee for export.

Direct exports without trading through ECX

As was the case with the previous system, cooperative unions and commercial farmers may export direct. According to the Ethiopian Coffee Growers, Producers and Exporters Association, this accounts for about 20% of total exports, with the coops taking about 12% and commercial farmers 8%31. A growing proportion of this is now processed on the new wet mills (eco-pulpers) introduced under TechnoServes Ethiopia Coffee Initiative, which reached an estimated 45,000 famers in 2011 and resulted in the production of around 1,755 tons of green coffee. To carry out this direct trade, exporters must register their exports with ECX which cups and grades shipments, and they may only export if their prices are above the ECX floor price. Unlike the situation in Tanzania, individual primary societies are not allowed to deal directly with international buyers but must sell through their cooperative unions an arrangement where the benefits are critically dependent on the performance of the cooperative union. At the same time, many coops are suffering from bad debts and accruing interest, making it difficult for them to access new credit
31

Other sources reported direct trade to only account for 10-12% of the total.

41

and reform their business, and play their proper role in productivity enhancement and quality improvement. While official policy is supportive of direct exports, there are many challenges in completing them, for example bottlenecks at inspection centres, shortage of jute banks and facilitating bank transactions.

Impact of the current marketing system on Ethiopias coffee industry

The advent of ECX has brought about improvements in the payments system (guaranteed by ECX) and in market transparency (farmers can now dial a number to find prices). The system moreover allows suppliers (including cooperatives) to deliver products to regionally-based warehouses instead of shipping them all the way to Addis Ababa. However the new system involves an element of double handling which according to some parties increases overall transport cost from farm gate to export. With the previous system the coffee could be shipped directly from the Kabele to the exporter, passing through the auction, but there are now two shipments, from the Kabele to the ECX delivery point and from there to the exporters premises. One of the main problems with the old system was traffic congestion at the Coffee Processing and Warehousing Enterprise where samples were taken for auction and, reportedly, trucks sometimes had to queue for as long as 15 days. There have also been some serious logistical problems at ECX delivery points, though ECX claims these have had less damaging that those under the previous system, and that improvements in ICT and power supply offer a way of gradually addressing them. However some parties allege that the queuing problem could have been effectively addressed without instituting ECX. The bottleneck was not caused by sampling and grading activities, but by suppliers having the right to keep their trucks at the delivery warehouse for 3 days while they speculated on price rises. The logical solution to the problem was to limit the presence of trucks to one day and to increase the number of locations where stocks could be transacted. Further research would be needed to establish beyond doubt the logistical impact of the new market structure, whether net beneficial or otherwise. However, there seems to be little doubt that the current system is adversely impacting on Ethiopias ability to take advantage of the growing international market for washed and particularly premium Arabicas. Petit (2007) discussed trends in the world coffee market and concluded that Ethiopias primary need was to raise the quality (of both differentiated and non-differentiated coffees) rather than quantity, as higher quality levels fetch significant premiums. By contrast, the overwhelming view of the trade participants consulted during this study (both exporters and international buyers) is that the present system is having the opposite effect. At a time when the international coffee trade is seeking to add value, Ethiopia has been commoditising its trade, damaging traceability and depressing the premiums that it earns from differentiated coffee one international trader estimated the loss at US$ 0.20-0.30 per lb. The causal factors are said to lie both at the level of the primary transaction centres and in the trade in washed parchment. With regard to the former, an exporter described the case of a typical Kabele where there are several wet mills and a Government-backed transaction centre, where farmers living within an approximately 7 km radius are now required to sell the coffee to certified suppliers. Previously farmers could take their cherries directly to wet mills whose owners would 42

inspect the goods and where necessary request removal of immature, fermented, black beans or otherwise sub-standard product, and thereby get the best possible quality. For their part, farmers could get a competitive price closely related to the quality of the product delivered. While suppliers are sometimes wet millers agents, they are often independent players. The exporter alleges that as buyers compete for the cherries, traditional procurement rules are breached, individual farmers cherries get mixed up and good coffee gets adulterated with cheaper coffees from the neighbourhood. Coffee that needs to be pulped immediately sits in the sun and ferments. By the time wet millers receive the cherries their agents have procured, they have already paid for them and are not in a position to reject them or the cherries require sorting prior to acceptance. At the level of the wholesale trade, the new system has further diminished traceability, as the stock traded is not identity-preserved. While ECX allows exporters to request grading of coffee upon dispatch from the warehouse, few take advantage of this facility, and it is claimed that there is a lack of effective recourse. Having stocks re-sampled and tested at remote ECX delivery points takes time and ties up staff and trucks in situations where they are struggling to fulfil orders and cover short positions. It does not make sense in terms of time and logistics. Exporters widely believe that the grading staff are insufficiently experienced (three month training is insufficient) and are suspicious of the integrity of the sampling/grading process, pointing to cases where ECX has had to take action against its own staff. Some exporters also fear that bringing complaints they will incur official disapproval for which reason the best policy is to keep heads down. The combined impacts of the changes at primary and wholesale market level on exporters are that: (a) they incur high costs of reprocessing the coffee prior to export, and; (b) they tend to opt for the bulk market and lose premiums formerly earned for quality coffee.

Impact on exporters and public finance

The new system is reported to have impacted adversely on the margins and profits of exporters, as they have found themselves squeezed between suppliers and international clients. Indeed, at the time of my mission Ethiopian prices were reported to be above those of New York after allowing for the cost of shipping. The immediate causes were: (a) a fall in international prices which had left suppliers unable to recover the cost of coffee they had purchased from producers, causing many to hold back supplies in the hope that prices would rebound, and; (b) strong demand on the domestic market, to which much export grade coffee is sold without passing through ECX, despite the official prohibition. For their part, exporters were struggling to meet the demand of their international customers, and often had to accept losses on their transactions. At the same time, the new ECX-based structure seems to strengthen suppliers position in the marketing chain vis--vis the exporters; suppliers who deposit coffee at delivery points have 30 days to sell their produce, and are reported to be selling slowly or delaying sales in the expectation of higher prices. By contrast, exporters have 10 days to remove the stock following change of title, and must pay a heavy daily penalty for overstaying this limit. It is also claimed that suppliers have an 43

informational advantage: exporters must officially register their sales and prices, such that the broker members representing the supplier side have foreknowledge of their positions. There have been some delivery failures leading ECX to settle in cash and kind, which exporters claim is a lengthy process. However, according to ECX data, delivery shortfalls of all commodities were only 261 tons in 2010/11, or 0.052% of the amount deposited and traded, a major improvement on the previous year32. However, the handling of complaints took an average of 44 days (compared to the SLA of 11 days) when compensation was in cash and somewhat longer when in kind. As we noted in section 2.2, GoE is extremely sensitive to any delay in generating foreign exchange receipts, and any diversion of export grade coffee to domestic markets. In 2009, it impounded the stocks of six coffee exporters whom it deemed to be hoarding stocks; it instructed EGTE to export the stocks and deposit the net proceeds in the exporters accounts. At the time of the my visit, GoE was pressing suppliers to sell and exporters to fulfil their export contracts, allegedly with the threat of impounding and removal of trading licenses.

How to develop the system in the future?

Given the time and information at our disposal, we cannot make a full set of proposals for the improving ECXs existing system. However, it is evident that Ethiopia is far from taking full advantage of its opportunities in the world coffee market. One of the problems seems to be that official pressure to maximise FX earnings in the short run is compromising the development of a quality-oriented export industry that would maximise Ethiopias earnings in the medium and long term. The strong domestic market remains constantly undersupplied giving rise to a flourishing high priced black market, which encourages speculative activity and detracts attention from meeting the requirements of the international market. We believe that in this and other aspects, the situation could be greatly improved if Government could establish a much more open and inclusive dialogue with the main stakeholder groups involved, including international buyers. Ethiopia may also find it useful to exchange experiences with other countries in the Region. On the subject of warehouse receipts, the Tanzanian system may provide some useful pointers, as follows: 1. Tanzania makes extensive use of dry mills, sometimes called coffee curing companies. These are one-stop shops providing cleaning, processing, storage and collateral management services, and delivering a product that is ready for export through the auction (or directly in the case of quality coffee). By contrast, the current Ethiopian system separates the functions of warehousing (at ECX delivery points) from the dry milling and classification for export. This carried out by service providers or at exporters premises in Addis Ababa. 2. The Tanzanian dry mills are licensed warehouses operated by a variety of cooperative and private enterprises, unlike ECX warehouses which are currently 100% ECX-run. 3. The dry mills do not suffer capacity constraints in providing these functions, unlike ECX warehouses that require quick turnover and provide no scope for depositors to hold their stock for more than 30 days and to collateralise it with lenders. Stocks may be deposited on an identity-preserved basis and do not need to be commingled by grade as with the ECX system.

32

Some exporters comments suggest that shortfalls are greater than the level indicated by ECX, but I was unable to confirm this.

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Not all stocks deposited with the coffee curing companies are traded on the Moshi Auction; farmer business groups or primary cooperative societies producing premium coffee make much use of these facilities and are free to deal directly with export buyers. 4. The Tanzanian system involves few logistical steps and allows for a shorter supply chain: farmer > supplier/rural coop/farmer association > domestic exporter/international buyer, i.e. 3 steps instead of farmer > supplier > exporter > international buyer (4 steps) 5. Whereas the Ethiopian system reserves all coffee exports for indigenous companies, Tanzania allows international buyers to procure through the Moshi auction. Some may object to this on grounds that it would lose Ethiopia added value through exports. However recent experience suggests that when Government organises a competitive market place (through an exchange or auction), exporters have little scope to earn supernormal profits and can sometimes incur major losses. A system along Tanzanian lines would also have the virtue of shifting much of the difficult work of price risk management onto international buyers who are better versed in these activities. ECX could move towards a system of this kind while keeping its price discovery function. The main difference is that the contracts would be in export grade coffee rather than intermediate semiprocessed products as at present. Exchange prices would continue to provide a yardstick for local producers and traders to use in fixing their own prices, taking account of the relevant basis (i.e. a standard adjustment for transport, handling & processing costs, and market mediation between the local market and the exchange). In fact Ethiopia already has some dry mills of the Tanzanian kind, including the massive Coffee Processing and Warehouse Enterprise and the Kaffa Plant, both located in Addis Ababa. These have large storage facilities and collaterally manage exporters stocks for the banks. They could become ECX delivery points and further dry mills could be established and licensed elsewhere in Ethiopia closer to the producing areas. ECX would move from its present contracts based on standard grades to an auction of identity-preserved ready-for-export lots of which the origin can be more easily traced.

Annex 3: Comments on the situation with sesame in Humera

There are two groups of producers dedicated to sesame, including small-scale farms typically with 311 ha under production, and large-scale farms with 50-150 ha and 4-5 very large farms with 2-3,000 ha. Even small-scale producers use machinery, albeit inefficiently, and most get 4-500 kg/ha. Work is under way to raise yields to 1-1.5 ton/ha, through row planting, application of fertiliser and mechanisation of all phases of production, including harvesting, and a contract-farming/direct export arrangement. This is being done under the auspices of Setit Cooperative Union, an organisation that brings together 12,000 members organised into 19 member cooperatives. The scheme is designed to provide timely input finance and wean producers off local money lenders who charge annualised rates of 200-400%. Contract farming has generally worked poorly with smallholder producers of grains and oilseeds in Sub-Saharan Africa, but promoters think the prospects are good in Tigray region, as Government support can be relied on in enforcing contracts.

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With sesame, harvesting takes place over a short period and most of the crop is sold in the November-January period. In the pre-ECX marketing system there was a market place around a square, involving farmers, suppliers (rural traders), brokers, truckers and exporters. There was a lot of speculation, and a lack of transparent linkages to the international market. However producers had close relationships with suppliers, could sell to them for cash, or put their product into the suppliers store and fix the price at the time of the farmers choosing (price-to-fix arrangement). Exporters were able to deal directly local suppliers, and inspect the product before purchase. This was important because it allowed them to ensure that whitish sesame of the lowland kind was not mixed with red sesame from higher altitudes. The establishment of ECX has allegedly created three immediate problems: Trucks are being tied up for a week or two at unloading; various parties coincide in this observation and one observer noted that queues over 1 km long in December 2011, and that there was considerable queue jumping suggesting that ECX staff were being bribed. There was a lack of space for immediate storage, and sesame bags were sometimes being stacked against the walls of warehouses. With ECXs first-in-first-out allocation, the former traceability has disappeared, and buyers frequently complain of short weight, trash and incorrectly graded produce. They cannot pay on delivery, after checking quality, as they could before, and consequently they get sesame of mixed colours and a lot of trash, requiring a lot of downstream expenditure on separation and cleaning to meet their international buyers specifications. Exporters claim that recourse is more theoretical than real, for reasons explained in section 5.8 of this report. Farmers, particularly small-scale farmers, are finding it difficult to find storage space in traders warehouses which are no longer available.

Outside observers give various explanations for the slow unloading and consequent tail-backs, attributing it to: inadequate infrastructure; slow weighing, sampling and grading, and; ICT and power problems. As regards infrastructure, warehouses are spread throughout the town, capacity is limited and the two privately-owned weighbridges are reported to be a bottleneck. ICT and power failure are probably the most serious problems in Humera, leading to delays in vital documentary processes involving the suppliers, warehouses, buyers and the Central Depositary in Addis Ababa. The cause of the alleged shortages and grade discrepancies is unclear, whether due to human error or corruption (i.e. shifting stocks within warehouses, or manipulation of the grading process for profit). Buyers suspect rent-seeking, with suppliers bribing to get better grades. Exporters also allege that the system is empowering suppliers (acrabis) to speculate at their expense, and in a way which may endanger Ethiopias ability to compete in the world sesame trade. Once the product is placed in safe storage they have up to 60 days to sell it, allowing the suppliers to sit on their produce and speculate on rising prices; it was claimed that ECX prices were Birr 350 Birr 400 per ton above farmer prices in late February, reflecting this speculative activity. The availability of warehouse receipt financing increases the incentive to speculate in this way. Exporters criticise this situation, saying that if suppliers speculate excessively, they stand to lose the opportunity to sell during the time of peak demand in the principal market, i.e. China, which is during the winter months.

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While it is evident that small-scale producers are being allowed to export directly, and by-pass ECX, it is not clear that this opportunity is being extended to the large-scale producers in line with normal Government policies on this issue. According to one report, Government is insisting that all their production be channelled through ECX. If large-scale producers form their own share company for the marketing of their production, it will be required to procure through ECX. The Wollega area of Ethiopia is another important sesame producing area, supplying a distinctive type of seed to that coming from Humera, Metema and Gonder. According to one source, there have been large delivery backlogs there, taking up to ten days or more.

47