THE BLOG
06/23/2010 05:12 am ET Updated May 25, 2011

How the World Food Program Can Feed More People More Quickly With Better Risk Management Tools

The World Food Programme feeds almost 100 million people around the world. It has a world class logistical capability but its financial risk management capacity is extremely limited. In a new paper coauthored with Benjamin Leo and Owen McCarthy, I argue that the World Food Programme must be empowered to actively manage price risk, using financial markets to feed more people in a timely manner. The United States and other significant funders can also play a significant role.

Currently, 100 percent of WFP food procurement is executed through spot markets. This exposes it to substantial commodity and transport price risk as well as significant food delivery delays. In 2008, the WFP experienced a 40-50 percent budget gap due to sharp commodity and transport price increases. The net impact was dramatically higher per capita food assistance costs and sustained levels of hunger and malnutrition in some parts of the developing world. The WFP has limited flexibility to actively manage price risks. This is due to its reactive and unpredictable revenue mobilization model (relying on emergency appeals); lack of multi-year donor contribution commitments; and restricted donor contributions (in-kind transfers or program earmarks). Unrestricted cash contributions typically account for less than 10 percent of the WFP's total budget. Our paper offers three complementary policy recommendations:
  1. The WFP and its Board should implement a targeted hedging pilot focused on chronically food-vulnerable countries, using a conservative decision making methodology. There are several risk management instruments available for WFP operations, such as physical call options, forward contracts, and futures contracts. All instruments are utilized widely for risk management purposes. Several commodity exchanges offer sufficient commodity coverage and market depth to prevent market distortion effects. Key benefits include greater financial predictability, the potential for improved delivery times; and increased local and regional trade, building upon the WFP's Purchase for Progress initiative.
  2. The United States and other rich countries should commit untied cash donations to increase WFP operational flexibility. The United States and other rich countries could instruct WFP management to utilize these cash resources specifically for the proposed hedging pilot. Also, donor contributions to the proposed World Bank Food Security Trust Fund could support WFP hedging operations. Specifically, the World Bank Trust Fund could provide a financial guarantee or modest credit line to the WFP, which would enable it to enter into commodity derivative contracts up to one year in the future. With appropriate policies in place, the practical Trust Fund impact would be very modest.
  3. The United States should utilize forward purchases for its own in-kind contributions to the WFP, increasing certainty for the WFP and for American farmers. Currently, U.S. in-kind contributions are appropriated based on monetary values instead of metric tonnage. This shifts commodity price risks to the WFP and food beneficiaries. The United States could procure part of its in-kind contributions to the WFP through forward purchases. As this would provide increased price certainty for American farmers, it may be politically palatable to Congress. Other countries which make in-kind purchases might also consider this approach.
In the wake of the 2009 financial crisis, I am well aware that the appetite for financial innovation may not be large. But the very conservative proposals described here are a far cry from the risky derivatives that fueled the crisis. Simple call options and futures instruments are well proven in large-scale commodity exchanges. The WFP can use these instruments to counter the effects of high and volatile food prices and in turn, feed many more hungry people around the world.