Challenges with Commodity Financing

1. 26th May 2009
Partho H. Chakraborty
Measuring the Challenges associated with Commodity Financing
26th May 2009

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. 26th May 2009World Growth will slow reducing Trade Expansion
2006 Growth Figures Revised
Source: IMF
2009

4. An End to Commodity Boom? 26th May 2009

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. 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. 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. 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. Food and Fuel Subsidies as % of GDP 26th May 2009

10. Business Confidence 26th May 2009

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. 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. 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. 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. 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. 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. 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. 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. 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. 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: parthohc@gmail.com; parthohc@rediffmail.com
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