Primary commodity prices and macroeconomic variables : a long run relationship

In recent years, fluctuations in such macroeconomic variables as interest rates and exchange rates appear to have significantly affected primary commodity prices. This paper studies the relationship between commodity prices and various macroeconomic variables. It focuses particularly on interest rates because of the important role they play in the portfolio adjustment model, in which investors move between commodities, bonds and money as interest rates change. The paper concludes that there is a long run quantifiable relationship between real interest rates and real commodity prices, but not between real commodity prices and either consumer prices or the money supply. Commodity prices in nominal terms strongly affect consumer prices but not the reverse - and some groups of commodity prices can be reliable indicators of movements in consumerprices. Changes in the money supply affect commodity prices, but not the reverse, and the relationship is not quantifiable.Insurance&Risk Mitigation,Economic Theory&Research,Markets and Market Access,Access to Markets,Environmental Economics&Policies

The structure of derivatives exchanges : lessons from developed and emerging markets

The authors examine the architecture, elements of market design, and the products traded in derivatives exchanges around the world. The core function of a derivatives exchange is to facilitate the transfer of risk among economic agents by providing mechanisms to enhance liquidity and facilitate price discovery. They test the proposition that organizational arrangements necessary to perform this function are not the same across markets. They also examine the sequencing of products introduced in derivatives exchanges. Using a survey instrument, they find that: a) Financial systems perform the same core functions across time and place but institutional arrangements differ. b) The ownership structure of derivatives exchanges assumes different forms across markets. c) The success of an exchange depends on the structure adopted and the products traded. d) Exchanges are regulated directly or indirectly through a government law. In addition, exchanges have their own regulatory structure. e) Typically (but not always) market-making systems are based on open outcry, with daily mark-to-market and gross margining -- but electronic systems are gaining popularity. f) Several (but not all) exchanges own clearing facilities and use netting settlement procedures. As for derivative products traded, they find that: i) Although most of the older exchanges started with (mainly agricultural) commodity derivatives, newer exchanges first introduce financial derivative products. ii) Derivatives based on a domestic stock index have greater potential for success followed by derivatives based on local interest rates and currencies. iii) The introduction of derivatives contracts appears to take more time in emerging markets compared with developed markets, with the exception of index products.Economic Theory&Research,Payment Systems&Infrastructure,International Terrorism&Counterterrorism,Non Bank Financial Institutions,Environmental Economics&Policies,International Terrorism&Counterterrorism,Payment Systems&Infrastructure,Economic Theory&Research,Non Bank Financial Institutions,Environmental Economics&Policies

Dealing with commodity price uncertainty

Liberalization in commodity markets has brought profound changes in the way price risks are allocated and managed in commodity subsectors. Price risks are increasingly allocated to private traders and farmers rather than absorbed by the government. The success of market reform depends on the ability of the emerging private sector to make full use of the available range of modern commodity marketing, price risk management and financing instruments. Because farmers do not generally have access to these instruments, intermediaries must be developed. Larger private traders and banks are in the best position to become these intermediaries. Preconditions needed for accessing modern commodity marketing, price risk management, and financing instruments are: a) creating an appropriate legal, regulatory, and institutional framework; b) reducing government intervention; c) providing training and raising awareness; and d) improving creditworthiness and reducing performance risk. The use of commodity derivative instruments to hedge commodity price risk is not new. The private sectors in many Asian and Latin American countries have been using commodity futures and options for some time. More recently, commodity derivative instruments are being used increasingly in several African countries and many economies in transition. And several developing and transition economies have sought to establish commodity derivative exchanges.Markets and Market Access,Payment Systems&Infrastructure,Environmental Economics&Policies,Commodities,International Terrorism&Counterterrorism,Access to Markets,Crops&Crop Management Systems,Commodities,Environmental Economics&Policies,Markets and Market Access

Price stabilization for raw jute in Bangladesh

Fluctuating prices for raw jute have been viewed as contributing to economic problems in the jute subsector. Price fluctuations were thought to reduce the jute farmers'welfare and there has been concern about the costs of parastatals'stocking operations in attempts to stabilize jute prices and incomes. The authors examine these fluctuations and analyze policies that might reduce them. They find that price fluctuations for raw jute reduce farmers'welfare only slightly because farmers'activities are typically diversified and jute's share in total income is small. Although stocking operations by the parastatals contribute to stability in prices and real income, they have been extremely costly and have crowded out private stocking. The authors contend that if the parastatals had refrained from ad hoc stocking and if the private sector had stocked efficiently, jute prices and incomes would have been just as stable - and at no cost. They argue that the Bangladeshi jute market should be free of government intervention and that a a market-based credit system that allows efficient stockholding behavior by the private sector should be established. They also found that improving the flow of market information to farmers and greater price responsiveness by jute mills to raw jute purchases would significantly improve the stability of raw jute prices and incomes. Having more information available would also make private stocking operations more efficient.Economic Theory&Research,Environmental Economics&Policies,Crops&Crop Management Systems,Access to Markets,Markets and Market Access

Impact of the International Coffee Agreement's export quota system on the World's coffee market

Ex-post simulations of the global coffee model over the recent period of operation of the International Coffee Agreement's export quota system, (1981-86) show the following. The quota system had a stabilizing effect on world coffee prices in the 1981-85 period. In 1986, when coffee prices increased sharply due to the drought in Brazil and the export quotas were suspended, prices would have been 24 percent higher in the absence of quotas over the 1981-85 period. However, the quotas have reduced export revenues (in real terms), except for such large producers as Brazil and Colombia. These countries gained form the scheme because they face very small or even zero marginal export revenues from increased exports, due to their large market shares. In projections of the coffee market, with and without the export quota system, prices would be substantially lower during the first half of the 1990s if the quota system were suspended in 1990. But prices would recover in the second half of the decade as production and exports declined in lagged response to the very low prices of the first half.Economic Theory&Research,Environmental Economics&Policies,Markets and Market Access,Access to Markets,Crops&Crop Management Systems

Hedging crude oil imports in developing countries

The objective of this paper is to explore the application of risk management techniques to a typical developing country state-owned oil company (SOC) involved in importing and refining crude oil and to make estimates of the potential gains from using such techniques. The paper is structured as follows. First, the authors describe the crude oil price data that they use in the study and estimate the volatility of oil prices. The next two sections discuss the nature of a typical SOC's exposure to oil prices and present risk management applications for each of the exposures identified. The following section discusses the internal and external constraints to the use of options and futures hedges typically encountered in a developing country and provides some possible remedies. The paper concludes that oil-importing developing countries could gain considerably from using financial risk management instruments if several constraints, particularly negative publicity and legal obstacles, are removed.Environmental Economics&Policies,Oil Refining&Gas Industry,Insurance&Risk Mitigation,Access to Markets,Markets and Market Access

Oil price instability, hedging, and an oil stabilization fund : the case of Venezuela

The Venezuelan government and PDVSA (Venezuela's state oil companies) are both exposed to oil price instability. Given the existing tax structure, PDVSA has a higher exposure than the government, especially when prices drop below $18-20 a barrel. The authors show that the volatility of prices for crude oil is higher (but not significant) than the volatility of prices for refined oil products. And both prices are highly correlated. So, there is not much strength to the argument that Venezuela, being now mainly an exporter of refined products, faces less volatility than when it was exporting mainly crude oil. The basis risk for hedging Venezuelan crude oil was founded to be higher than for other crudes of comparable quality in the region. One explanation could be the pricing policies Venezuela follows, which leads Venezuelan crude oil prices to deviate for long periods from international prices. The basis risk in Venezuelan refined products is much lower and at acceptable levels for risk management. The issue of liquidity is concentrated in contracts for periods of less than a year. For products, the liquidity is concentrated in the nearest 4-5 months. So, for short-term hedges (6-9 months ahead), there is sufficient liquidity for Venezuela to hedge a substantial part of its exports. For longer-term hedges, the over-the-counter market is the more appropriate vehicle. In either case, it will not usually be the case that all production or exports should be hedged. The authors also examined the issue of an oil stabilization fund. For an oil stabilization fund to be effective several preconditions must be met. Most notably: oil prices should not follow a random walk; financial markets are incomplete; and there are large adjustment costs. These conditions do likely apply in Venezuela. Venezuela's best strategy would be to remove as much short-term oil price risk as possible by using short-dated hedging instruments (such as futures, options, or short-dated swaps) and to also do some longer term hedging (using mainly over-the-counter options and long-dated swaps). They also find that an oil stabilization fund should be complemented by using market-based risk management tools. The oil stabilization fund could then be used to manage any remaining interperiod oil price risk to the extent considered necessary.Markets and Market Access,Environmental Economics&Policies,Oil Refining&Gas Industry,Energy and Environment,Energy Demand

OECD fiscal policies and the relative prices of primary commodities

Nonfuel primary commodity prices fell more than 30 percent in real terms between 1984 and 1990, even though global economic growth was reasonably strong. The collapse of international commodity agreements, rapid increases in supply for some crops, and agricultural policies in industrial countries have been responsible for some of the price decline. But all nonfuel primaries - agricultural and nonagricultural - experienced a sharp decline in real prices. That calls for a more general explanation. The authors investigatehow the relative price of (nonenergy) primary commodities and manufactures depend on fiscal policies in the OECD countries. It has been argued, for example, that expansionary policies in the OECD countries lead to increases in commodity prices. The authors show that it is not sufficient to establish whether policies are expansionary or contractionary; one must define the policy mix to know what impact it has. Previous studies have used partial equilibrium models to examine the link between maroeconomic policies and commodity prices. In those studies as in this one, the main channel of transmission of monetary and fiscal shocks is the interest rate. The authors use a general equilibrium model of the simultaneous determination of the relative price of commodities and the real world interest rate. The model's logic suggests that OECD fiscal expansion increases the real interest rate and reduces the relative price of commodities to equilibrate world labor product, and asset markets. Econometric estimates based on reduced form equations, using annual data since the 1950s, cannot reject the hypothesis that higher fiscal deficits are associated with a lower relative price of commodities. The estimates suggest that when the fiscal deficit of the G-5 rises one percentage point of GDP, the relative price of commodities drops about 2 percent. When the U.S. deficit rises by one percentage point of GNP, the relative price of primary commodities drops about 3 percent. This evidence provides good reason to believe that macroeconomic policies have been responsible for at least part of the little-understood decline in primary commodity prices over the past decade.Environmental Economics&Policies,Economic Theory&Research,Access to Markets,Markets and Market Access,Economic Stabilization

Does exchange rate volatility hinder export growth? Additional evidence

The authors examine the impact of exchange rate volatility on trade, using and ARCH-in-mean model. The advantages of this statistical approach over earlier approaches is that it provides more efficient coefficient estimates and it prevents the problem of spurious regressions. They applied the model to six countries, estimating both bilateral and aggregate exports. The results led to the hypothesis that the impact of exchange rate volatility may be influenced by the invoicing of exports. Also, one can argue that the effect of exchange rate volatility on trade is overstated, for the following reasons: exchange rate volatility does not measure the added riskiness of a firm's portfolio;exchange rates can provide a natural hedge in a firm's portfolio; exchange rates may be negatively correlated with each other or with the firm's other assets; and finally, the use of forward markets can provide a useful short-term hedge.Economic Stabilization,Environmental Economics&Policies,Macroeconomic Management,Fiscal&Monetary Policy,Economic Theory&Research