May 11, 1998

COMMODITIES: THE PLUS AND MINUS OF RISK-MANAGEMENT TOOLS

 

Geneva, 7 May (Chakravarthi Raghavan) -- Liberalization of the commodity sector (in developing countries) has overall been a positive experience, but the withdrawal of the government from the sector has led to some lacunae in services provided to producers and others active in the commodity sector, an experts meeting on commodity risk management and collateralized finance agreed here. 

The experts meeting, convened by UNCTAD's Commission on Trade in Goods and Services and Commodities concluded a three-day meeting, after adopting an agreed set of recommendations which support the view that commodity risk management and collateralized finance could help commodity exporters and countries but that it is not without risks nor a panacea for commodity sector problems.  

An UNCTAD secretariat document before the group that the liberalization of commodity sector, withdrawal of many governments from the marketing and pricing of commodities, use of market-based risk management instruments and collateral financing techniques has grown increasingly useful, "perhaps even crucial."  

This has made it possible for governments to reduce costs of international borrowing and secure their budgets. Enterprises have been able to improve their efficiency, reduce costs and got better access to finances, thus improving profitability. And farmers have been able to enlarge their marketing operations and facilitate their access to the credit required to buy inputs. 

The use of such instruments are also effective, "as long as goals are set realistically - reflecting the realities of the market."  

But use of these instruments have been constrained by a number of factors. These include need to raise awareness of these instruments, and training in using them. Price risk management instruments and warehouse receipt finance have been restricted by a poor institutional environment - weak local banking structures and under-developed farmers associations. 

And while there is also need for a legal and regulatory policy framework within countries, the international community also imposed some obstacles, "particularly through negative pledge covenants imposed by multilateral development banks." 

However, UNCTAD report warns, "it should be clear that modern, market-based financial tools are not a panacea and, if improperly applied, can dangerous."  

"Especially for complex deals, there is often an information imbalance: the fair costs of structuring the financing, or of risk management instruments, are only known to the provider."  

In the wake of the financial crisis in Asia, other financial experts have noted that current trend of banks and financial institutions, not undertaking any risk assessment of their own, but merely trying to earn fees and commissions, and using a variety of derivatives, at both ends of the deal, often mislead the customers.  

When things are going well, it is merely a case of who makes more bucks in what, but when things go badly (as happened with some of the complicated swap deals and derivatives, as in South Korea) developing country producers and enterprises could be hurt badly, the experts say.  

For modern market-based price risk management and financing tools is to the benefit of private-sector actors, governments need to ensure that the policy, legal and regulatory framework in place stimulate proper use of tools - by a systematic revision of policies in a range of areas including taxation, accountancy rules, foreign exchange regulations, bankruptcy rules and proceedings and export licensing. 

The UNCTAD report has not dwelt with the issues of equitable sharing of benefits of liberalization of commodity sector and how these could be achieved.  

Other UNCTAD reports issued last year, including one on sub-Saharan African experience, as well as several NGO studies, have shown that some of the liberalization and commodity sector reforms pushed by the IMF and World Bank, for a variety of reasons, has resulted in the benefits have been garnered by intermediaries and traders, rather than producers.

The expert group said, in its conclusions and recommendations, that there was a clear link between experience to price risks on the one hand, and lower investment and growth, and more income inequality, on the other. Savings on interest costs, when using commodities as collateral can be considerable.  

The withdrawal of the government from the commodities sector, the experts agreed, had led to some lacunae in services provided to producers and others active in the commodity sector.  

There was need for a comprehensive approach to enhance the understanding and use of commodity price risk management and collateralized finance, the experts agreed.  

The best way to achieve this would be through coordination and cooperation not only among international organizations, but also with the private sector, including NGOs, associations of farmers and other local stake-holders, the experts recommended. 

Besides addressing a series of recommendations for actions at national level, the experts said the World Bank and UNCTAD could play an important role in providing policy analysis, advice and technical assistance. Other organizations like the Common Fund for commodities, international commodity bodies and regional development banks could also play important roles, in close collaboration with each other.  

The actions by these bodies at international level could include: 

A pilot programme for country-level risk analysis, as part of a country trade review mechanism, could be undertaken the experts said.  

UNCTAD was asked in particular to continue, among other things, its analytical work in 

The World Bank group and regional development banks, should consider undertaking actions for facilitation of commodity-risk management transactions; facilitating provision of commodity risk management transactions through local banks; and examining possibilities for increased guarantees on risk management and structured finance transactions between developing country entities and providers of these financial instruments.