International prices for soft commodities are known for their volatility, which is an important concern on both a macro and micro scale. Price fluctuations for soft commodities can destabilise real exchange rates and can cause difficulties for the governments of emerging market countries in facilitating the reduction of poverty and preserve a stable economic environment. On a micro scale, we are primarily concerned about the effect of price uncertainty on the operations of producers and traders in commodities. Volatility often leads to inefficiency and impairs the efficient allocation of resources for farmers. The higher and more unpredictable the price volatility of a commodity, the greater the possibility of incurring losses or realising gains on future sales or purchases of that commodity. Moreover, the uncertainty reduces the opportunities to access credit markets and can drive farmers and producers to utilise low risk production techniques and technologies, lowering incomes and not helping economic growth and poverty alleviation.

In the past, governments of emerging market countries have responded to such uncertainties by large scale market intervention, often initiated by state enterprises such as agricultural marketing boards, and usually insulating farmers from world price shocks. However, in recent years there has been an acknowledgment that such market interventions have adverse effects. Since the global trend is towards liberalisation, protectionism which favours inefficient operators is no longer encouraged. On the other hand, liberalisation policies tend to shift the risk of price uncertainty back from governments to producers. In the face of international market fluctuations, there is a clear need for risk management mechanisms to allow producers to manage risk in the transition to a market driven commodity sector.

With liberalisation, producers have become major players in the market place and more responsive to international market conditions. The desirable use of commodity linked financial risk management instruments by commodity producers reflects the need to obtain crucial protection from uncertain adverse price movements and often to gain access to short term finance. From the perspective of bankers, traders and the providers of instruments, it is important to answer key questions such as:

How can price shock protection in a country be obtained using commodity linked risk management instruments?
Which instruments are most widely used in the markets for the principal export commodities from developing countries, and why are these instruments chosen?
Are commodity linked risk management instruments able to benefit small-scale producers by provision of a greater degree of assurance about future prices for their produce?
What share of developing countries commodity output is covered by risk management today?
In which countries is the use of commodity linked financial risk management instruments most common?
What effect has the use of these instruments had upon the operations of producers of and traders in commodities?
What is the nature and severity of the legal restraints on the use of hedging instruments by potentially important players such as producer cooperatives?

Only when these questions are answered is it possible to identify strategies to protect developing country farmers from the price risk volatility. However, many strategies for price risk management for the world’s poorest producers – particularly in Africa – seem to depend on policies promoted by development agencies, NGOs, multilaterals using models derived in the developed/industrialised world.

Recently, Day Robinson International has developed a number of models to simulate the risk management needs for producers in developing countries. These models look closely at price risk management using hedging techniques, structured trade finance, collateral management and supply chain development. For more information, contact Day Robinson International (see below for details).

Daniel John, a postgraduate of London University in 1984, is the founder of Day Robinson International which is a global consulting, conference organizer and training provider. The company focuses on International banking with a bent on trade finance and structured trade finance used in the flow of international commodities.