World Bank clients are looking to the development bank to help them cope with likely falls or volatile moves in commodity prices as demand and production shrink thanks to trade wars between the US and China.
Jingdong Hua, treasurer of the World Bank, said the bank was seeing increased interest from client countries on how to use commodity hedges to protect their budgets from commodity volatility. “It’s positive for our clients to have predictable budgets, so they can progress with expenditures to achieve development goals,” he said.
This trend is likely to disproportionately affect emerging market countries, since commodity exports form a large part of many developing economies. The IMF forecasts that global economic growth will recover to 3.4% in 2020, but Neil Mackinnon, global macro strategist at VTB Capital, believed this might be optimistic, saying: “Global economic headwinds, which seem to be getting stronger, could easily derail the IMF’s forecasts. Slower growth implies a reduced demand for commodities and a decline in their price, but much depends on the Chinese economy.””
Offering comfort
The bank offers technical assistance and advice on such transactions but, more importantly, enables its clients to obtain better terms than they could obtain on their own through a form of blended finance. “If an insurance company or hedging solutions provider is writing a policy directly to a country with a lower credit rating, the premium will be higher and there are other potential issues to price in,” said Hua. “With our triple A rating, we can step in between and offer the provider better comfort.”
One potential beneficiary is Rwanda, which imports 100% of its oil so when global oil price spikes, it has a huge effect on the budget and can prevent infrastructure spending. “With a commodity hedge, we can use the capital markets to protect infrastructure development projects and preserve budget discipline,” said Hua.
Since the hedge can work in both directions, the product can also be used to protect countries from price collapses in the commodities they export. Mongolia, for example, is reliant on exports of copper and coal. During the last copper price collapse, Mongolia was forced to enter an IMF programme.
The tool can be used to protect clients against eventualities other than commodity price fluctuations, including weather. For countries with hydroelectric power generation, a lack of rainfall can cause budget pressures because the country will have to buy diesel to make up the shortfall in power generation.
The World Bank first participated in such a transaction in 2018, acting as an intermediary for Uruguay, which purchased an insurance hedge against a lack of rainfall.