26th May 2009

Partho H. Chakraborty

Measuring the Challenges associated with Commodity Financing26th May 2009

Growth and Trade

• World GDP growth already projected by IMF to slowdown by 2% points (from 5 to 3 for 2008 and 2009)probably more. So with 2% world growth; global GDP percapita falls

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• Asia probably most resilient (though exports to US willfall); Latin America will slow down, Africa in recession

• Commodity prices declining already; volumes too. Naturalresource exporters will be hit; food and oil importers tobenefit

26th May 2009World Growth will slow reducing Trade Expansion

2006 Growth Figures RevisedSource: IMF

2009

An End to Commodity Boom? 26th May 2009

World Prices

• It is evident that all the price gains ofthe period January2007 to mid-2008have been wiped out by the later fallin prices.

• Oil prices in November 2008 wereback to the nominal level of January2007, which implies a decline in real

26th May 2009

2007, which implies a decline in realterms.

• And non-oil commodities, specificallyagricultural raw materials and metalswere actually lower even in nominalterms.

• It is worth noting that the latter groupdid not experience much of a pricerise even when the commodity priceboom of 2007-08 was supposedlyoperating in full force.

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

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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!

Cash Crops

• The other major cash cropsthat dominate cultivation areall oilseeds, and here too,very volatile and sharp swingsin prices are evident over therecent period.

• We can see the behaviour of

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• We can see the behaviour ofworld trade prices ofgroundnuts which are used tomake peanut oil, as well asthe other major cooking oils:palm oil, soybean oil andrapeseed oil.

• All of them show similartrends in prices, withcontinuous and substantialincreases from January 2007onwards, followed by sharpdeclines in the second half ofthe current year.

Food Grain

• The most extreme trendshave been evident in riceprices, which werebroadly stable,increasing only graduallythough most of 2007, but

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though most of 2007, butthen exploded toincrease by more thantwo and a half timesbetween January andMay 2008.

• Rice prices have fallenthereafter but are still 80per cent higher than theywere at the start of theperiod.

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

Business Confidence 26th May 2009

India highly prone to global credit crisis

WHO'S THE RISKIEST OF THEM ALL?Citigroup’s vulnerability indicators (%)

CountryMobile capital

to forex reservesExternal financingto forex reserves

Korea 208 95

Vietnam 34 64

• Mobile capital includes short-termdebt and foreign holdings of stocksand bonds. According toCititgroup, India’s short-term debtis $36.6 billion (Rs 17.53 lakhcrore)and foreign holdings of

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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 ofstocks and bonds are $140 (Rs6.70 lakh crore) and $5 billion (Rs23,955 crore) respectively. India’smobile capital accounts for 59 percent of its forex reserves.

• A sudden capital outflow can raisethe risk for the Indian economy,bringing the rupee too underpressure, says Citigroup

India highly prone to global credit crisis

• The country’s total external financing for 2008 is estimated at $63.7billion(Rs 3.05 lakh crore) (current account deficit and debt repayment),which accounts for 21 per cent of its forex reserves, making it highlyvulnerable to the crisis. However, Korea and Vietnam are the mostvulnerable in Asia, with their total external financing making up 95 per cent

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vulnerable in Asia, with their total external financing making up 95 per centand 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 Citigroupreport.

• 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

Ground Realities

• Exports and domestic sales have slowed down.

• For example Real Estate had almost ground to a halt so much so thatfreebies were the name of the game.

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• 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 forbusiness

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

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• This brings us to Factoring but as the insurance premiums stand to go upprofits 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?

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;

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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.

The "5i" framework

• Insight: Financial innovation appeared to increase the financial system's efficiency byspreading risks to a wide spectrum of market participants. However, the failure to cutthrough the opaqueness of many structured products and assess the multilayered leveragepyramid created systemic risk. Hence, forward-looking risk management must identifyinterlinkages and account for low probability/high severity events.

• Information: Financial markets must always cope with imperfect information and moral

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• Information: Financial markets must always cope with imperfect information and moralhazard. Transparency is the antidote to remedy deficiencies arising from the asymmetricdistribution of information. The growth of the credit bubble can be partly traced back to thefact that investors were in the dark about the magnitude of liabilities accumulated instructured investment vehicles due to their complexity and that they were not covered bythe consolidated reporting of banks and broker-dealer institutions.

• Incentives: Market participants respond to economic incentives. The separation of riskorigination and risk ownership within the originate-to-distribute (OTD) business modelintroduced by banks over the last 30 years led to a lack in due diligence and accountability.

The "5i" framework

• Investment: Financial markets depend on structures that support the flow of informationand the timely settlement of trades. Credit default swaps, for example, were and continueto be traded over the counter only and the settlement of contracts used to take weeks (nowdays). Hence, creating a central clearing facility for credit derivatives and enabling them tobe traded on regulated exchanges would help improve the market structure and reduceboth settlement and systemic risk.

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• Institutions: The global credit crisis demonstrated a major governance gap and the need toimprove prudential oversight and regulation. Financial market stability is a public good, andglobalized financial markets require a globally coordinated effort to create and maintain thispublic good. The financial architecture of the future must have an element that transcendsnational borders. To ensure success its institutions should include broad representation inrulemaking bodies, macro prudential surveillance and have agreed procedures forsystematic enforcement.

Impact of Basel II on Agriculture

• Implementation of Basel II does provide Indian banks the opportunity tosignificantly reduce their credit risk weights and reduce their required regulatorycapital, if they suitably adjust their portfolio by lending to rated but strongcorporates, increase their retail lending and provide mortgage under loans withhigher margins.

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• This would, of course, change the proportion of lending in their portfolio and thedirection 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 theirbottom-line as they make more provisions to write off these loans and it reflectswith reduced profit and the same could impact on it’s ratings and number.

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 tosolve it’s problem, India seeing to solve it on her own as if it is a domesticproblem.

• It has become debatable whether the measures adopted are working or

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• It has become debatable whether the measures adopted are working ornot but the moot point is that the future remains bleak with so much jobloss and despondency globally.

• We live in difficult times and there are even talks that this recession mightend up in the great depression of the 1920s

• 2008 was an extraordinary year and we are hoping that 2009 and beyondbrings us cheers

Thank You 26th May 2009

Partho H. ChakrabortyA - 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 22504email: parthohc@gmail.com; parthohc@rediffmail.comSkype: parthohc01