Bank suggests hedge funds for developing country commodities

15 March 1999

The World Bank has predicted that global commodity prices are unlikely to rise following the impacts of the world financial crisis, and is considering how developing countries could reduce harmful price fluctuation in these markets.

Whilst developed countries have successfully used market mechanisms such as futures markets and hedge funds to control commodity trading risks, many of the poorest developing countries do not have access to these instruments. The Bank views the problem as one of market failure: developing countries lack the information or the capacity to access these instruments to manage the risks inherent in commodity production.

Generally commodity prices are falling. The Bank argues that it is fostering diversification out of primary commodity production through its privatisation policies. But to deal with short-term price fluctuations, the Bank is considering support for various types of financial instruments.

The Bank has established an “international task force” which will meet three times between February and June to draw up proposals for national level policies for commodity price risk management. Pilot studies of potential instruments may start in various developing countries by the end of this year.

During a UK consultation meeting with academics and NGOs in January, concern was expressed that market based solutions were unlikely to work for a number of reasons:

  1. developing country governments are likely to have to bear the costs. The private sector is unlikely to bear the risk, especially in countries where stabilisation is most important, ie. the poorest countries dependent on one or two commodities;
  2. currency risk is likely to be as important as commodity price risk in some countries;
  3. market based solutions will not help where there are only a few suppliers or in countries which are very dependent on only a few commodities. More interventionist solutions (eg. controlling supply) are needed in those cases;
  4. market based solutions cannot address underlying causes of commodity price decline and fluctuation, eg. subsidies paid to EU/US farmers;
  5. market based solutions do not always work well in developed countries either.

Alternatively, the Bank should look at how developing countries could manage the supply of some commodities, or develop hybrid solutions involving some market based instruments and some intervention. In a number of countries producers were insulated from the risks of commodity price fluctuation by marketing boards which the Bank had abolished in the name of efficiency.

Bank staff agreed that a purely market based solution was not likely to work, but argued that some market institutions such as hedge funds might increase the capacity of developing countries to participate in world markets. They did not see any contradiction between attempting to stabilise prices in the short term, and so make commodity exports more attractive, and the risk of decline in prices in the long term.

Notes from the UK meeting are available from Bretton Woods Project.