Victims of exchanging currencies – who should take on this risk?Imagine that you are a small-scale coffee farmer. You would constantly have to deal with many factors that can affect your production, your price and, ultimately, your profitability. Part of your job would be to find ways to manage and if possible mitigate the risks that your business faces. However, as a small farmer, what tools would you have to manage your market and currency exposure?
2 Minutes Read
By Giancarlo Ghiretti
Co-founder and CFO
- We all know that growing coffee is a risky proposition. Imagine that you are a small-scale coffee farmer. You would constantly have to deal with many factors that can affect your production, your price and, ultimately, your profitability:
- - Unpredictable weather
- - Pests and diseases
- - Availability of labor
- - Currency changes
- - Access to market
- - Access to finance
- Part of your job would be to find ways to manage and if possible mitigate the risks that your business faces. To this end, you would plan for worst case scenario weather patterns, you would make sure that you eliminate weeds, and that you fertilize and spray your trees so they are healthy and productive. However, as a small farmer, what tools would you have to manage your market and currency exposure?
The US Dollar is the de-facto currency for buyers and sellers of green coffee. The large majority of coffee transactions are denominated in this currency. However, most coffee producing countries do not use the US dollar as their local currency. In Latin America (where we operate) we have the Mexican Peso, the Guatemalan Quetzal, the Nicaraguan Cordoba, the Colombian Peso and the Peruvian Sol. In each of these countries the internal market for coffee operates in the local currency, farmers sell and are paid for their coffee in their local currency, depending on the value of the USD at that moment in time. Ultimately, farmers need to sell their coffee in the local currency to then pay their workers, purchase inputs and spend locally.
This creates a daily risk for coffee farmers, as the amount of money that they will be paid for their coffee depends not only on the volatile C market, but also on the volatility of their local currency. How can a farmer be certain as to how much their coffee will be worth in local terms?
Let’s summarize some of the ideas to tackle this issue:
- 1. If coffee farmers were to price their coffee in USD and then be paid the converted USD amount at the time of sale, farmers would have certainty of their price in USD but no certainty of their local price. In this case, all the currency risk is taken on by the farmer.
- 2. Coffee farmers could sell their coffee in local currency, therefore transferring the risk of foreign exchange to coffee roasters. This could potentially work, BUT:
- It would leave the roaster with a large risk for which he or she probably has limited understanding with no hedging tools to manage it.
- There would also be issues as to how the roaster would pay the farmer in their local currency in a cost-efficient and timely manner.
- 3. Farmers could hedge their foreign currency exposure, either via a coffee exporter or directly with a bank or other FX operator. This is the ideal scenario, as the farmer would have control of how much FX exposure he or she is willing to take on.
- Typically, small coffee farmers have no other option but to opt for option 1, which carries the highest degree of risk and uncertainty. Option No. 3, while clearly the best, is generally not always available to small scale farmers, who often have little or no knowledge of this option, are unlikely to have the appropriate technology or would face very high transaction costs to carry it out.
Part of our work at Caravela is to help build bridges between roasters and farmers, while adding value in the supply chain. We help farmers minimize their currency risk by guaranteeing prices in local currencies in many of our origins, managing the FX exposure on behalf of farmers and roasters. This work creates stronger and more transparent partnerships between farmers, exporters, importers and roasters.
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