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An exploration of commodity income stabilization options for coffee farmers - page 33 / 47





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A second way to move forward is continuing financial innovation. There is much scope in developing countries for new financial instruments that can directly address farmers’ risk management needs. For example, input providers can sell inputs to coffee farmers with a “risk management voucher” attached—such a voucher could be, for example, the OTC equivalent of an European option, which gives the holder a pay-out if, at expiry, the reference coffee price is below a certain level. No one needs to take a price risk. Such vouchers can be packaged by a local bank which provides them to the input providers— something similar has been done with weather derivatives in India. Farmers could hold on to these vouchers (giving them insurance against price risk), or they could sell them in a secondary market (there is enough market savvy in most developing countries to enable the development of such markets even without any development agency support). Also, independent warehouse operators could offer those who deposit their coffee with them “price insurance” on the value of their stocks, given them more flexibility in deciding when to sell and enhancing the value of the stocks as collateral for loans. New futures markets can be created in developing countries, offering smaller contracts in local currency.

While not the main subject of this paper, this latter possibility of new developing country futures exchanges merits some more discussion. Until very recently, such localized exchanges were only impractical ideals—calls have been made for them as far back as the mid-1970s, but the costs of setting up such exchanges and the difficulties in envisaging ways to create enough liquidity to make them viable proved too much of an obstacle. But with the onset of electronic trading (rather than the traditional open outcry system) in the late 1990s, this has changed. An evident impact of this development is that it has become cheaper to set up a localized exchange—although the need remains for an exchange to build up a sound support system comprising grading services and warehousing capacity, and it would be a mistake to set up an exchange “on the cheap” on the assumption that one just needs to build a platform and then users will come. But at least equally important is the capacity of electronic trade to provide a “liquidity gateway” which can seamlessly blend local liquidity and the much larger depth of an international marketplace.

An increasing number of financial players are willing to provide arbitrage between local markets, with tailored contracts which may be in local currency, and international ones. At the same time, there is a process of international realignment among the world’s major commodity exchanges (the globalization process is now even coming to the Chinese exchanges), and the quest for territorial footprints is likely to lead to new initiatives that will bring futures markets much closer to many farmers. Local futures exchanges, when structured properly, not only bring risk management tools much closer to the farmers (and others in the local economy), but they also create a transparent marketplace, and act as a catalyst for the improvement of physical market infrastructure and practices. The development of such local futures exchanges (which of course may just be the local representation of a regional or international exchange, offering products tailored to the local market) thus deserves support from governments and the international community. Organizations such as the African Union have recognized the importance of this issue, but development agencies have yet to move from their current phase of supporting pure donor- driven initiatives towards the promotion of commercially viable commodity exchange projects. 26

26 So far, the major organization involved in promoting viable exchange initiatives has been UNCTAD, which has been involved in country-level work in this domain since 1992 (and from 1975 onwards, had regularly included the development of developing country commodity exchanges among its policy recommendations). Some of the exchanges promoted by UNCTAD now count among the world’s largest, but UNCTAD has never been successful in obtaining donor support—over the years, total official development assistance


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