Sunoor Kaul is the Co-Founder and Director of Origo Commodities, India’s fastest growing agri-technology company. It provides end-to-end supply chain and financing solutions to the agricultural sector, thereby, streamlining commodity procurement, storage and facilitation of trade. In his capacity as the Director of Origo, Sunoor manages the Trade Finance vertical of the business, while also overseeing the technology aspects related to Trade Finance as well.
The Agri market contributes significantly to India’s GDP, making it a critical component of the country’s economy. Also, a large portion of the country’s population — which is 20% of the world’s population — depends on the sector for its livelihood directly or indirectly. India is one of the largest agriculture producers globally and stands third after the US and China.
The Indian Agri sector offers tremendous growth opportunities, particularly with the population increasing rapidly and driving the demand for commodities. Farmers and traders are now turning to high-tech solutions to meet the country’s diverse food requirements. There have also been various changes in the commodities sector, growth in contract farming, financing, increased warehousing, etc., over the years.
On the other hand, commodities as an underlying asset can bring in high return on investment both as a fixed income product as well as a margin trading product. An advantage of commodities as an investment is that they can be used as a hedge against inflation or deflation risk. Such purchases can also be made in the form of futures contracts, ETFs (Exchange-Traded Funds), or stock options. This makes commodities an interesting investment option for financial institutions.
Given the growth and demand in the Agri sector, it only makes sense that financial institutions step in and contribute while growing along with it. So let’s delve deeper and understand how exactly financial institutions can benefit and why they should take the plunge.
For starters, the Indian Agri market is worth about $300 billion, of which about 33% ($100 billion) comes from private trade. Traders, commission agents, and processors, who deal in commodities, usually rely on debt financing to procure it. For Banks/FIs a large number of partners in the ecosystem are acquired by selling traditional banking instruments like cash credit, term loans, bank guarantees, etc. Most of these instruments either need high net worth or have to be backed up by sizable collateral.
Now, imagine how restrictive that is for trade? An entity has just two options to increase its trade volumes. It can either wait for years for its profits to accumulate and contribute to its net worth before seeking additional loans. The other option, which can be chosen only by the rich few, is to mortgage family wealth or financial holdings.
This begs the question, “Why don’t we have more innovative instruments available to study the cash flows of a business and identify potential businesses that are planned to grow? And, why can’t debt financing be made available against cash flow? A simple solution in this area would allow any business to grow without legacy or family wealth.
Trade finance in most developed nations allows for cash flows from trade to determine the limits. This means the capability that the entrepreneur brings to a bank becomes the ability to structure the trade, and execution is compared to land bank or trust fund. For banks, too, this is an opportunity to participate in the $100 billion trade market by financing it.
Security for such trade finance structures is better than what’s available in conventional lending. For instance, it can be physical cargo that’s backing the trade or the invoice that supports the goods in transit. Liquid securities can be lien-marked and liquidated whenever such requirements come up. Banks specializing in Trade Finance can do a quick turnaround and have a robust risk assessment on security, backing the trade, and financing. Also, most of these liquidity securities can be insurance-backed, allowing the banks to share the risk.
Additionally, trade financing contracts are usually short-term, ranging from 2 to 6 months, allowing banks to see the cashback sooner than the 3- to 10-year loans that are generally offered to companies. Thus, while it’s important to maintain traditional banking facilities that have brought India’s trade and economy to the current level, it’s just as essential to grow from here, especially when the economy is facing severe turbulence due to the outbreak of the COVID-19 pandemic.