Primary commodities have recently moved back towards the centre of the debate on development, and in particular, the attainment of the Millennium Development Goals (MDGs). This renewed focus arises out of the realization that the majority of the poor live outside cities and that the reduction of poverty foreseen by the MDGs must therefore, in large measure, depend on rural development.

The declining prices and high price volatility associated with “traditional” tropical export crops have tended to exacerbate problems of rural poverty over the past two decades. President Chirac, in the speech quoted at the head of this paper, records that seventeen sub-Saharan African countries depend on non-oil primary products for over 75% of their exports. The commodity dependence problem interacts with problems deriving from indebtedness.

According to the IMF (2003a, p.9), the most typical cause of indebtedness “is that the financing provided … did not generate the economic growth envisaged, or, in other words, … borrowing decisions were predicated on growth projections that never materialized”. In more technical parlance, an adverse selection problem implies that the group of severely indebted countries will contain a disproportionate number of poor countries which have failed to achieve planned or projected growth rates. Failure to diversify away from traditional primary exports is one cause of such growth shortfalls.

This has particular relevance to the Heavily Indebted Poor Countries (HIPC) Debt Initiative agreed by the IMF and World Bank in 1996 and extended in 1999. The Enhanced HIPC Initiative attempts to reduce a country’s indebtedness to ensure that the remainder of its debt is sustainable in relation to likely future growth – see Kraay and Nehru (2003). That judgment is based on a number of indicators, of which the principal are the flow ratio of debt service to either export revenues or GDP and the ratio of the debt stock, evaluated as the NPV of future flows, to GDP.

A number of HIPCs which have reached the HIPC “completion point” ³ have found that, despite the agreed debt reductions, their debt levels remain unsustainable, either because of falls in the prices of their commodity exports or because of higher oil import prices.

A 2002 IMF-World Bank review reportedly concluded that one of the two main causes of deterioration of debt indicators for HIPC countries in 2001 was “lower export earnings owing mainly to declining commodity prices”⁴ .Lower average exports accounted for over 50% of the deterioration of the HIPC debt service indicators and export prices declined by an average of 4.8% for HIPC countries which experienced a deterioration in debt indicators against only 1.1% for those which did not (IMF and IDA, 2002, pp.24-7).

Two commodities – coffee and cotton – stand out as responsible for a large part of the deterioration of HIPC debt sustainability. Coffee is the most important tropical export crop both in terms of value and in terms of the number of exporting countries. Coffee prices declined sharply from 1999 and in 2001-02 the (nominal U.S. dollar) International Coffee Organization (ICO) Indicator Price averaged only 40% of its average over 1996-98⁵.

In cotton, the (nominal U.S. dollar) Cotton A Index, normally taken as the representative price for the world market, averaged 63% of its 1996-98 value over 2001-02.Of the fifteen HIPCs listed in IMF and IDA (2002) as having experienced deterioration in debt service indicators, four (Guinea, Honduras, Nicaragua and Uganda) are heavily dependent on coffee exports and four (Benin, Burkina Faso, Chad, and Uganda) are heavily dependent on cotton exports. The deterioration of the debt sustainability indicators in Uganda, which is dependent on both coffee and cotton exports, was poignant since the Ugandan policy environment was generally regarded as particularly strong.

These developments have focused renewed attention on how international commodity policy might assist the poorest commodity-dependent countries, and in particular on whether either the HIPC Initiative or IDA lending procedures might be modified to ensure that future commodity price shocks do not imperil debt sustainability. While a number of initiatives are under consideration, we confine attention in this paper to detailed examination of a single proposal.

The specific proposal we consider is that repayments of concessional debt should be conditioned on the prices of the commodities that the country exports. The objective is to more closely match the debt service obligations facing indebted governments with their ability to meet these obligations, as measured by their export revenues.

The hope is that, in periods in which low world prices result in a decline in export revenues, countries will face reduced debt service obligations. However, the schemes are structured to be broadly neutral from the creditor standpoint so that reduced payments in certain years are offset by increased payments at other times. The schemes may therefore be caricatured as Paretian adjustments to debt service schedules to circumvent a credit market constraint faced by HIPC governments. The structure of the paper is as follows.

In section 2, we outline the objectives and scope of the schemes we subsequently investigate, and discuss the relative advantages and disadvantages of basing interventions on export revenues on the one hand or the world prices which underlie these revenues on the other.

In section 3, we show that price-based interventions may be structured as an overlay of floating for fixed commodity swaps or swaptions which allow indebted countries to offset export revenue movements through variations in their concessional debt service. The section also discusses hedging and offsetting issues.

In section 4, we describe the simulation sample and methodology and propose a money-metric measure for evaluating the resulting welfare improvements in a consistent manner across countries. Using a sample of ten moderately or severely indebted African HIPCs, we find modest benefits from the proposed interventions.

In section 5, we argue that basis risk and quantity variation are largely responsible for the limited extent of these benefits and suggest that these factors qualify the applicability of all price-based commodity market interventions. Section 6 concludes.

 

3 The HIPC initiative envisages countries progressing from a “decision point” to a “completion point”. At the decision point, creditors commit on sufficient debt relief to leave the remaining debt sustainable, relative to the information available at that time. Movement from the decision point to the completion point, when the agreed debt reduction takes place, is conditional on the country establishing a track record by implementing poverty reduction and other policies to which they committed at the decision point. See http://www.worldbank.org/hipc/about/flowchrt4.pdf

4 The other major cause was the slow recovery of the world economy.

5 Source: ICO (http://www.ico.org/frameset/traset.htm ). The precise comparison is sensitive to the choice of years. However, the coffee price was even higher in 1994-95. The ICO Indicator price is based on an average of exchange prices which relate most directly to cif prices in consuming countries. Because the cif-fob margin is relatively insensitive to the level of the export price, the fob prices obtained by exporters declined by an even larger percentage. The coffee crisis is discussed in Oxfam (2002).

By Prof. Christopher L. Gilbert, Prof. Alexandra Tabova

Next: Objectives, Instruments and Scope

Summary: Index