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An exploration of commodity income stabilization options for coffee farmers - page 6 / 47

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requirements of the marketplace often falls foul of government controls on currency movements. To some extent, over-the-counter risk management instruments have provided a way around these obstacles: in particular, option-based tools (which require only the payment of an upfront premium) have been used by farmers’ groups in Africa and Latin America.

The easier way to get access for farmers would be if risk management elements were part of the conditions of their physical sales or their financing, or other transactions. Coffee buyers—often large international firms—have the ability to incorporate a wide range of risk management tools, including “safety net” prices for future delivery, in their purchasing contracts. They can then lay off the resultant risks on the organized futures and options markets. However, they are not yet doing much beyond “Price-To-Be-Fixed” (PTBF) contracts for producers, in which prices for future delivery are expressed in terms of futures market reference prices. PTBF contracts can be used as a tool for risk management—e.g., to achieve the season’s average price, or to lock in the profitability of certain investment decisions—but they can equally be used for speculation. Producers selling PTBF without any form of price protection must accept that, given the unpredictability of future price developments, they are losing all control over the final sale price.

Bank credits could also be made to incorporate risk management elements, but in practice, price risk management is hardly ever built in to farmers’ credit, largely because most developing country banks have a very low level of understanding of price risk management markets. But there is a start—with international assistance, a bank in Tanzania has started making options a part of its financing package.

There are many obstacles hindering the use of market-based price risk management tools by coffee farmers. Lack of understanding by the farmers of the relevance of these tools is the least of these: once farmers become aware of the possibilities that these markets offer to manage their risks more efficiently, they are generally keen to use them and willing to pay realistic amounts for such use. While technical assistance and training would be necessary to make them fully familiar with the ins and outs of these markets, the ground for receiving such assistance is fertile. The larger problems are in the intermediation process: the risk management markets are far away, and have access criteria (including financial requirements) that small growers will have difficulties meeting.

Solutions involve bringing growers closer to the market (in particular, by encouraging farmers’ association to take up price risk management), and bringing the market closer to farmers (by stimulating local commodity exchanges that can offer smaller contracts denominated in local currency and accessible through local brokers, and by incorporating price risk management into the routine transactions that farmers are engaged in). There is much scope for profitable action in this regard, and much room for innovation.

The various parties involved in the coffee ecosystem can all play a role. Farmers’ associations/cooperatives and their apex organizations at the national and international level can educate their members, and put their political influence behind initiatives to enhance use of risk management markets. They can build risk management elements into the goods and services that they provide (inputs, credit, crop marketing). They can also play the role of broker/intermediary to advise and hedge for and on behalf of farmers. Processors (millers, roasters) can consider ways to use, in particular, options to become more competitive buyers in their markets. Traders, both local and international, generally already have access to risk management markets, and rather than just using these markets to manage their own risks,

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