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An exploration of commodity income stabilization options for coffee farmers - page 24 / 47





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indirect benefits, rather than better price realizations, are what allows those who use price risk management to improve their revenues.

The instruments offered on these exchanges are futures and options (except in India, where options are not yet allowed by law). Futures contracts offer producers the opportunity to lock in prices, while producers who buy options either get protection from downside risk (in the case of put options) or the opportunity to benefit from price increases even if they have already sold their crop (in the case of call options). Note that in quite a few countries (including the United States) certain government entities, cooperatives and/or institutional investors have restrictions in their statutes or regulations on the use of their resources for “speculation.” If then these countries consider futures and/or options as speculative instruments (as some for unclear reasons do), the entities concerned cannot use these markets. For example, when in the early years of this decade Vietnam’s major coffee exporter, a state-owned entity, started looking at possibilities to hedge its price risk, with the explicit purpose of passing on the benefits to the country’s cooperatives in the form of a minimum price scheme, it found that it could not do so as the country’s law defined use of options as “speculative.”

Use of organized futures and options markets can be cumbersome for a developing country producer. Consider the steps involved:

  • 1.

    First, the producer has to make the decision to manage price risks—which in the case of a cooperative body may not be an easy process.

  • 2.

    Second, the producer has to identify a reputable broker who is willing to provide him access to a relevant futures market; and open a trading account with him. Each of the elements of this step have their own problems (“reputable”—there have been quite a few cases of brokers abusing their clients; “willing”—will a broker find it worthwhile to service a small client?; “relevant”—what makes a market relevant?; “open an account”—is subject to often heavy regulatory requirements).

  • 3.

    Third, the producer has to ensure that he has access to the funds necessary to enter into a futures or options transaction. When the broker is abroad and hard currency is required, this may necessitate permissions from a central bank and/or other government entities.

  • 4.

    Fourth, the producer then has to use his new-found access to make appropriate trading decisions. In the case of the more traditional markets, he will trade through his brokers; in the more modern exchanges such as those in India, the broker will provide him with a password and a trading limit, and he can directly buy or sell on the exchange platform. But given the fast movements of futures markets, what constitutes “appropriate”? And given production uncertainties, what quantities should one hedge? In practice, these cannot be committee decisions: an individual will have to be given the authority to decide what constitutes an appropriate transaction, and to execute it—and presumably, he will need to undergo rigorous training and will need to be given access to up-to-date market information in order to make the right decisions. But how can such individuals be controlled? How can a cooperative ensure that the staff authorized to hedge does not abuse their position to speculate? One would require strong administrative systems for registering, monitoring and auditing trading decisions. Even large banks have had difficulty putting into place a proper system of checks and balances.


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