Commodity Price Risk

The developing countries largely depend on commodity revenues. As these countries heavily rely on the earnings generated by the export of commodities, they are very much exposed to the risk of generating loss due to price volatility of the commodities.
For this reason, in these developing countries, Financial Instruments for Hedging Commodity Price Risk get so much importance.Financial Instruments for Hedging Commodity Price Risk play an important role in the economies of the Developing Countries.

This is because; these developing economies depend largely on commodity trading and are exposed to the risk of receiving trade shocks because of price volatility.The developing countries like the Republic of Congo, Venezuela and Nigeria depend hugely on commodity trading, as these countries earn substantial amount of money by exporting Crude Oil.
The economies of Zambia and Chile largely depend on earnings generated by export of copper. Similarly, the Malawi economy depends on export of agricultural commodities like tobacco.
As these economies heavily rely on these export earnings, they are very much exposed to the risk of receiving low earnings due to price volatility of the respective commodities. For this reason, in these developing countries, Financial Instruments for Hedging Commodity Price Risk get so much importance.

The main concerns that rise from the price volatility of commodities are the following:
The major concern of the developing countries is that, the price volatility of the commodities can substantially reduce the fiscal balance of their economies. These economies generate earnings from royalties and commodity related taxes. The commodity sectors, which are state-owned hugely, depend on dividend income. Now, if the commodity prices experience a fall, the revenue level of the developing countries naturally drops. With low level of revenue, the countries are compelled to reduce the level of expenditure. If the earnings from commodity export falls drastically, then in many cases, the developing economies incur debt.
Another concern arises from the fact that the governments of the developing countries cannot predict the level of future revenue, as they cannot anticipate the future price fluctuation of commodities. So, the governments are not able to predict whether they will be able to generate that level of future revenue, which is required to meet the future financial needs. They are also not able to estimate the external borrowing need. As a result, at the times of crisis, these developing countries, which largely depend on commodity revenue, take new external debt by paying high rate of interest.

 

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Last Updated on : 1st August 2013

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