Tuesday, November 4, 2008

Ethiopia Launches Commodity Exchange to Develop Agriculture

By Phillip Kurata - Addis Ababa, Ethiopia

Ethiopia, a country of chronic food shortages and malnutrition, has launched an agriculture commodity exchange in a daring experiment to raise food production by creating a safe, transparent agriculture market.

The idea to create a commodity exchange was hatched by a former senior economist at the World Bank, Eleni Gabre-Madhin, who was born in Ethiopia and educated in the United States. Gabre-Madhin did her doctoral research on the role of markets in developing countries and refined her ideas while at the International Food Policy Research Institute. She now is the chief executive of the exchange.

Gabre-Madhin said the Ethiopian government began to consider a commodity exchange after the food crisis in 2002-2003; a bumper crop and price collapse in 2002 were followed by drought that threatened 14 million people with starvation the next year.

"In the bumper harvest, prices fell so low that farmers could not repay their loans, despite abundant production. The next year, not enough food was produced to feed the population. This led the government to think about the market: 'Why don't people store grain from year to year? Why can't the market deliver in bad times and save in good times?'" she said.

Although Ethiopia is the biggest grain producer in Africa, its traditional markets are small because of narrow networks of trust among buyers and sellers. "Most farmers trade within 12 kilometers of their farms and only with people they know," Gabre-Madhin said. She said more than two-thirds of farmers have faced contract defaults, and only 4 percent have received legal enforcement of contracts.

In the traditional trading system, grain changes hands four to five times between producer and consumer. With each change, the grain is put into new sacks. This system enables buyers to know what they are getting in terms of quality and quantity, as the contents are inspected and weighed, but it is vulnerable to price shocks.

The Ethiopia Commodity Exchange began operating in April, creating transparency and predictability in the national market and connecting Ethiopian commodities to international markets.

The U.S. Agency for International Development provided $1 million to launch the exchange.

The exchange provides warehousing, a reliable payment system, real-time market information, and quality control. Producers sell directly to the exchange, which assures payment within 24 hours.

"In the past, truck drivers took payment in envelopes filled with cash. It was never certain if or how much of the money would make it back into the hands of the seller," Gabre-Madhin said. Buyers in the traditional system do not know the quality of what they get unless they open up the sacks and inspect the contents. The exchange has assumed the grading task and guarantees the quality, so a distant buyer can be confident of what he is purchasing.

The Ethiopian exchange is linked to commodity markets around the world, making it possible for a trader in India, for instance, to buy futures of the prized Ethiopian lentils.

As for Ethiopia's major export, coffee, 461 coffee suppliers have obtained one-year memberships on the new commodity exchange.

"We're going to disseminate New York prices on our trading floor, and we'll feed our prices to the New York market. That means if you are looking at Ethiopian, Colombian or Rwandan coffee, you will have a basis for comparison," Gabre-Madhin said.

Agricultural traders have deluged the exchange with applications for membership, which, in Gabre-Madhin's view, is a sign that market confidence is building. "Worries about getting paid and getting the expected quality are being eliminated," she said.

Gabre-Madhin said she expects the exchange will create incentives for farmers to bring more of their produce to market. In the traditional trading system, about one-fourth of Ethiopia's grain is brought to market. She said the goal of the exchange is to handle 50 percent of Ethiopia's grain production in five years.

She said that nearly half of Ethiopia's rural households are net buyers of food. "Poor people buy food as well as sell food, which means that markets matter a lot, even at this low level of income," she said.

The exchange is not without its critics. Some say it will not work as a market institution because government officials occupy six of the 11 seats of the board. Gabre-Madhin believes that the government's involvement with the exchange will help it learn quickly how markets function.

Another concern has been that the exchange will further increase food prices, which have doubled in the past year. If Ethiopia's food-deficient neighbors can buy Ethiopia's commodities, then there will be less food for the country's already malnourished people, critics say.

Gabre-Madhin counters that the exchange is not the panacea for all of Ethiopia's food problems, but it is an important element for a functioning agriculture-based economy.