Moving Forward: Enhancing access to coffee price risk
Coffee farmers are exposed to major price risks. They are well-aware of this, and by and large, they try to manage these risks through a series of traditional risk management methods such as diversification and reduction of use of inputs. This is not irrational behaviour; they know that such behaviour reduces their expected earnings, but they are even more aware of the large risks that they would run if they were to put all their efforts in coffee production. Not surprisingly, then, there is a real appetite among developing country farmers for modern risk management tools, and a willingness to pay for them—and to pay a realistic price. A study in Uganda finds, for example, that even though farmers tend to underestimate the degree of price variability, “the majority of farmers would demand insurance [options] at actuarially fair premiums.”24 The World Bank’s work in Nicaragua similarly found (in 2001, when coffee prices were at a very low level) that more than half of farmers were willing to pay realistic option prices.25 Once farmers learn about tools such as futures and options, they are generally keen to find ways to use them. In practice, though, the problem lies not in farmers’ interest or their willingness to pay, but rather, in the practicalities of linking farmers to risk management markets (among other difficulties, the quantity produced by most coffee farmers is much below that of the standard contract size on futures markets), and their ability to pay (a cash flow problem).
Willingness to pay is somewhat opportunistic and depends on the overall market conditions, but generally, many farmers are willing (but not necessarily able) to pay 5–15 per cent of the price that they receive (or 2–8 per cent of the world market price) if this strongly reduces their price risk exposure. This is normally enough to buy out-of-the-money “price insurance” for the period from when decisions on inputs and labour are made to the harvest period. But who will offer them such “price insurance”?
The experiences discussed in Section 2.2 show that there are a number of possible risk intermediaries. But despite efforts from a number of organizations, the large majority of farmers are not yet reached through such intermediaries. How can one move forward?
The first way to move forward is simple enough: learn from the lessons of experience, and intensify efforts to replicate “best practices”. This implies that development agencies and national governments should do much more to educate local banks and help them to build up sustainable relationships with viable cooperatives and other farmers’ associations (a strategy that would not necessarily limit itself to coffee—a bank’s efforts will be much more sustainable if it can provide a broad range of risk management services). As the experience of Tanzania shows, a local bank not only has the field presence necessary for the continuing interaction with an ever-changing pool of cooperative managers, but can also reduce the costs of risk management by passing on part of its own benefits in terms of reduced default risk. An additional benefit of having a local bank as the provider of risk management instruments is that such a bank already has commercial relationships with international banks (in other words, it has already met these banks’ KYC requirements) and it can build on these relationships to provide a gateway to international risk management markets.
24 Ruth Vargas Hill, Coffee price risk in the market: exporter, trader and producer—data from Uganda, Global Poverty Research Group, January 2006. ITF, Nicaragua: Coffee Price Risk Management – Phase II Report, The World Bank, February 2002. 25