Measuring the challenges associated with commodity financing


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Challenges with Commodity Financing

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Measuring the challenges associated with commodity financing

  1. 1. 26th May 2009 Partho H. Chakraborty Measuring the Challenges associated with Commodity Financing 26th May 2009
  2. 2. Growth and Trade • World GDP growth already projected by IMF to slow down by 2% points (from 5 to 3 for 2008 and 2009) probably more. So with 2% world growth; global GDP per capita falls 26th May 2009 • Asia probably most resilient (though exports to US will fall); Latin America will slow down, Africa in recession • Commodity prices declining already; volumes too. Natural resource exporters will be hit; food and oil importers to benefit
  3. 3. 26th May 2009World Growth will slow reducing Trade Expansion 2006 Growth Figures Revised Source: IMF 2009
  4. 4. An End to Commodity Boom? 26th May 2009
  5. 5. World Prices • It is evident that all the price gains of the period January2007 to mid-2008 have been wiped out by the later fall in prices. • Oil prices in November 2008 were back to the nominal level of January 2007, which implies a decline in real 26th May 2009 2007, which implies a decline in real terms. • And non-oil commodities, specifically agricultural raw materials and metals were actually lower even in nominal terms. • It is worth noting that the latter group did not experience much of a price rise even when the commodity price boom of 2007-08 was supposedly operating in full force.
  6. 6. Cotton • Cotton is , the most widely planted non-food cash crop that directly affects the livelihood of millions of farmers • This price had fallen significantly in the past few years, so that in January 2007 it was less than 60 per cent of 26th May 2009 it was less than 60 per cent of the level reached in 2005. • The price started to increase around the middle of 2007, and by March 2008 had increased by 44 per cent compared to May 2007. But after that peak there has been quite a sharp crash in prices in just a few months, such that in November 2008 the price was actually lower than it had been in January 2007!
  7. 7. Cash Crops • The other major cash crops that dominate cultivation are all oilseeds, and here too, very volatile and sharp swings in prices are evident over the recent period. • We can see the behaviour of 26th May 2009 • We can see the behaviour of world trade prices of groundnuts which are used to make peanut oil, as well as the other major cooking oils: palm oil, soybean oil and rapeseed oil. • All of them show similar trends in prices, with continuous and substantial increases from January 2007 onwards, followed by sharp declines in the second half of the current year.
  8. 8. Food Grain • The most extreme trends have been evident in rice prices, which were broadly stable, increasing only gradually though most of 2007, but 26th May 2009 though most of 2007, but then exploded to increase by more than two and a half times between January and May 2008. • Rice prices have fallen thereafter but are still 80 per cent higher than they were at the start of the period.
  9. 9. Food and Fuel Subsidies as % of GDP 26th May 2009
  10. 10. Business Confidence 26th May 2009
  11. 11. India highly prone to global credit crisis WHO'S THE RISKIEST OF THEM ALL? Citigroup’s vulnerability indicators (%) Country Mobile capital to forex reserves External financing to forex reserves Korea 208 95 Vietnam 34 64 • Mobile capital includes short-term debt and foreign holdings of stocks and bonds. According to Cititgroup, India’s short-term debt is $36.6 billion (Rs 17.53 lakh crore)and foreign holdings of 26th May 2009 Vietnam 34 64 India 59 21 Indonesia 237 13 Philippines 97 12 Thailand 54 0 Taiwan 88 -6 Singapore NA -9 Hong Kong NA -15 China 16 -19 Malaysia 71 -24 Note: Higher the figure, more vulnerable the country Source: Citigroup crore)and foreign holdings of stocks and bonds are $140 (Rs 6.70 lakh crore) and $5 billion (Rs 23,955 crore) respectively. India’s mobile capital accounts for 59 per cent of its forex reserves. • A sudden capital outflow can raise the risk for the Indian economy, bringing the rupee too under pressure, says Citigroup
  12. 12. India highly prone to global credit crisis • The country’s total external financing for 2008 is estimated at $63.7 billion(Rs 3.05 lakh crore) (current account deficit and debt repayment), which accounts for 21 per cent of its forex reserves, making it highly vulnerable to the crisis. However, Korea and Vietnam are the most vulnerable in Asia, with their total external financing making up 95 per cent 26th May 2009 vulnerable in Asia, with their total external financing making up 95 per cent and 64 per cent of their respective forex reserves. • Singapore (9 per cent), Hong Kong (15 per cent) and China (19 per cent) are among the most resilient of the Asian economies, cites the Citigroup report. • Since our reserves have been built on capital flows and not with savings, we remain vulnerable when the tide reverses,” said K N Dey, CEO, Basixfx, a forex advisory firm
  13. 13. Ground Realities • Exports and domestic sales have slowed down. • For example Real Estate had almost ground to a halt so much so that freebies were the name of the game. 26th May 2009 • The cascading effect was the industries related to it such as cement, stones, etc. • The Risk of Defaults much more than before • Credits drying up • External factors such as Swine Flu puts a further halt albeit temporarily for business
  14. 14. Commodities Financing • Time to look at Barter Trade? • In a buyer’s market Letter of Credit hardly seems to have a role to play • This brings us to Factoring but as the insurance premiums stand to go up 26th May 2009 • This brings us to Factoring but as the insurance premiums stand to go up profits get reduced substantially • Can banks give credit with Exim Bank re-financing it? • Any other form of innovative financing: Lender gets paid in kind • How can technology help?
  15. 15. Challenges in hedging commodity exposure to local exchanges and overseas markets • Heavy commodity users are now facing a new paradigm where reduced prices but higher volatility is not necessarily giving the expected economic benefit. • A new phenomenon has emerged whereby reduced price levels should support increased industrial activity; 26th May 2009 support increased industrial activity; however, the higher price volatility adds more uncertainty and, therefore, potentially reduces economic activity. • Producers are now suffering from both a drop in commodity prices and reduced demand. • The prospect for 2009 means that heavy commodity users are seeking to adapt to a new context and to reflect the lower price/ higher volatility situation in their commodity risk management approach.
  16. 16. The "5i" framework • Insight: Financial innovation appeared to increase the financial system's efficiency by spreading risks to a wide spectrum of market participants. However, the failure to cut through the opaqueness of many structured products and assess the multilayered leverage pyramid created systemic risk. Hence, forward-looking risk management must identify interlinkages and account for low probability/high severity events. • Information: Financial markets must always cope with imperfect information and moral 26th May 2009 • Information: Financial markets must always cope with imperfect information and moral hazard. Transparency is the antidote to remedy deficiencies arising from the asymmetric distribution of information. The growth of the credit bubble can be partly traced back to the fact that investors were in the dark about the magnitude of liabilities accumulated in structured investment vehicles due to their complexity and that they were not covered by the consolidated reporting of banks and broker-dealer institutions. • Incentives: Market participants respond to economic incentives. The separation of risk origination and risk ownership within the originate-to-distribute (OTD) business model introduced by banks over the last 30 years led to a lack in due diligence and accountability.
  17. 17. The "5i" framework • Investment: Financial markets depend on structures that support the flow of information and the timely settlement of trades. Credit default swaps, for example, were and continue to be traded over the counter only and the settlement of contracts used to take weeks (now days). Hence, creating a central clearing facility for credit derivatives and enabling them to be traded on regulated exchanges would help improve the market structure and reduce both settlement and systemic risk. 26th May 2009 • Institutions: The global credit crisis demonstrated a major governance gap and the need to improve prudential oversight and regulation. Financial market stability is a public good, and globalized financial markets require a globally coordinated effort to create and maintain this public good. The financial architecture of the future must have an element that transcends national borders. To ensure success its institutions should include broad representation in rulemaking bodies, macro prudential surveillance and have agreed procedures for systematic enforcement.
  18. 18. Impact of Basel II on Agriculture • Implementation of Basel II does provide Indian banks the opportunity to significantly reduce their credit risk weights and reduce their required regulatory capital, if they suitably adjust their portfolio by lending to rated but strong corporates, increase their retail lending and provide mortgage under loans with higher margins. 26th May 2009 • This would, of course, change the proportion of lending in their portfolio and the direction of their lending, implications of which we examine below. • Agriculture has been a sector where the govt has been hitting the banks to lend. • Is it Welfare economics to waive of Rs. 60,000 crores of loans? • A heavy price for the banks to pay as banks would have to take a very hit on their bottom-line as they make more provisions to write off these loans and it reflects with reduced profit and the same could impact on it’s ratings and number.
  19. 19. Summing Up • We talk of a global crisis but yet we have not seen it being tackled in co- ordination with all the affected players – rather it looks like USA is trying to solve it’s problem, India seeing to solve it on her own as if it is a domestic problem. • It has become debatable whether the measures adopted are working or 26th May 2009 • It has become debatable whether the measures adopted are working or not but the moot point is that the future remains bleak with so much job loss and despondency globally. • We live in difficult times and there are even talks that this recession might end up in the great depression of the 1920s • 2008 was an extraordinary year and we are hoping that 2009 and beyond brings us cheers
  20. 20. Thank You 26th May 2009 Partho H. Chakraborty A - 305, DSR Spring Beauty Apts., 124/1, ITPL Main Road,A - 305, DSR Spring Beauty Apts., 124/1, ITPL Main Road, Brookefields, Kundalahalli, Bangalore - 560 037, India Tel: +91 80 420 50293, Cell: +91 99863 22504 email:; Skype: parthohc01