Thread: Inflation and stagflation, is it new.

Globalization is shaping peoples lives.

Financial Market Instruments

If used responsibly, commodity hedges and other risk management building blocks can help enormously in managing balance sheet risk. Hence, it’s pleasing to see that financial market instruments and strategies are being examined.

Governments are keen to manage their balance sheet risks. They do so through a range of mechanisms, e.g. by being conscious of the currency exposure of their assets and liabilities, by building up foreign exchange reserves, privatizing assets, and adopting sound principles of fiscal management – including managing contingent liabilities. In the energy field, risk management may involve liberalizing energy markets, diversifying energy and fuel sources, restraining demand, managing inventories and creating incentives for energy efficiency.
In 2000, the World Bank introduced several hedging products to help developing countries manage their balance sheet risks. With these products, countries have the opportunity to manage exchange rate, interest rate, and commodity price risk in their

IBRD loan portfolios. We can also use these instruments to transform their non-IBRD portfolios.
In using derivative products, it’s essential that users understand their pricing characteristics. We have recently seen how competitive pressures drove investors to take on greater risks in their search for high yield. We saw dominant institutional investors investing in complex structured products with risk and return characteristic that they did not fully understand – even more so when market liquidity began to dry up with corresponding uncertainty on how to value underlying cash flows.

The Effects on Developing Countries

But even with efficient financial markets, there remains a critical challenge for many developing countries. One of the cruel ironies today is the connection between rising energy and food prices. This coupling can have devastating implications for global poverty and food security. Higher energy prices have increased fertilizer and transport costs and stimulated bio-fuel production. In the US, for example, a quarter of the maize crop – representing over ten percent of global output – went into bio-fuel production this year. Together, higher energy prices, drought, and rising demand have led to a 75 percent increase in the price of staples since 2005. Just last week, rice prices soared to a 20 year high.

Just as the poorest on this planet are the most exposed to the effects of climate change, they are also highly vulnerable to the effects of rising fuel and food prices. Food and energy prices usually represent over 70 percent of the consumption basket of the poor. The long term consequences are considerable. Poor households will cut back on food consumption and education – and girls will invariably be the first withdrawn from schooling. Reliance on traditional fuels will increase with obvious environmental consequences.

This leads to an important point. The catalyst of globalization will only be sustainable if it can create opportunities and benefits for all.

Today, given the recent revisions to purchasing power parities, well in excess of over a billion people live on less than $1 a day. The benefits of globalization are by-passing many of the poorest who are in danger of becoming politically and socially disenfranchised and disconnected from global society. We have seen how their exposure to higher food prices recently led to riots in West Africa and South Asia.

A world where a large proportion of the population remains trapped in extreme poverty and unable to share the benefits and opportunities of globalization, carries unacceptable costs in terms of human suffering, economic losses and political tensions, and has important potential implications for security within countries and across borders.

This makes one think about the demand and balance, about the forces of economies and greater efficency on how to rise new supply and investment. These supply contrains will be difficult to rectify, but should be seen as a challenge for governments in Macro Economic Policies.