Jeffrey Frankel, a professor at Harvard University, recently presented a proposal for commodity exporting countries that would also benefit importing countries. Over the past five years, the price volatility of these commodities has been very high, almost unprecedented. It is true that in the phase of price increases the countries exporting oil, copper, iron, wheat and coffee, to name but a few, benefited from it, but now they find themselves in a vulnerable condition, because prices in dollars have fallen and threaten these economies, especially those with high external debt. From here the proposal: to issue commodity bonds, i.e. securities in raw materials.
Exporters should issue debt denominated in the price of commodities, rather than in dollars or other currencies. Jamaica would issue "aluminum bonds", Nigeria "oil bonds", Mongolia "copper bonds" and so on. Investors could compare “coffee stocks” from Guatemala, “cocoa stocks” from Ivory Coast, “rubber stocks” from Liberia, to continue with the examples. The advantage lies in offering a new way to hedge against the risk of volatility in the prices of the underlying, while maintaining the debt service unchanged. The market for these securities is potentially large, given that commodity consumers have every interest in hedging themselves against price uncertainties. There is a demand for commodity-backed debt, just as there is a market for credit-default swaps (CDSs).
The problem to solve, especially in times like these, is the liquidity of this type of market. Perhaps, Frankel admits, there aren't that many investors today who want to buy oil and simultaneously bet on Nigeria's credit. But here, and this is the new idea, the World Bank could have a role, which could take charge of the creation of a market for securities in commodities, especially in those countries where it already operates as a lender. It could work like this. Instead of dollars, a loan to Nigeria would be denominated in terms of the price of oil and the Bank would simultaneously issue an equivalent amount of "oil bonds". If the Bank lends to many oil-exporting countries, the market for these securities would quickly become large and liquid.
Of course, the usual way to hedge against the risk of price changes is to operate on the futures market, but the disadvantage is that these are derivatives with a short-term maturity, which does not meet the needs of, for example, metal producers or oil for which the investment necessary to extract the raw material can be 10 or more years and not a few months. Not to mention the volatility of futures prices which do not always offer sufficient coverage. If the financial engineers got to work soon and the World Bank picked up on the idea, the disastrous consequences of the looming commodity price fall could be contained and perhaps even neutralised. Word of Jeffrey Frankel.
