Hedging cotton price risk in Francophone African countries

Cotton exports account for a significant share of total commodity exports in francophone African countries, suggesting that these countries have a large exposure to volatility in cotton prices. An analysis of the cotton marketing systems in these countries revealed that most of the price risk is borne by the parastatals and ultimately by the government. This has led to problems in years of low cotton prices when the government maintained high producer prices. In recent years, these countries introduced some flexibility in their pricing policies to deal with that problem. As a means of managing their cotton price risk, francophone African countries have been using forward sales. Between a quarter and a third of exported cotton has been sold forward before harvesting. Forward sales have provided only limited coverage against price risks. The use of cotton futures and options could increase this risk coverage. Futures and options contracts can also give these countries flexibility in their sales strategies. Countries planning to privatize their cotton marketing sectors should consider the use of futures and options because forward sales are likely to decline significantly in a privatized system. The authors examined the feasibility of using New York cotton futures and options contracts as hedging instruments and found that there were benefits of reduced price volatility. Simulations for 1989, 1990, and 1991 show in every case that hedging was effective in reducing price risk from 30 percent to 60 percent. For every 1 percent reduction in risk, the reduction in income ranged from 0.66 percent to 1.12 percent.