Africa is one of the richest regions in terms of the wealth of the commodities it has. But Africa’s commodity dependence is often spoken of as a resource curse rather than a boon.

The argument put forth is that commodity-dependent, low-income countries are caught in poverty traps that involve low productivity and high exposure to external shocks, which are fostered by the volatility of their export earnings and often create irreversibly retarded growth.

To the extent that commodity-dependent countries have an export structure that is not diversified and therefore vulnerable to any shock whether internal or external, this argument is true. It is also true that attempts to gain from Africa’s commodity resources through traditional models of export-oriented growth have not really helped the continent.

The UN Conference on Trade and Development (Unctad) report on Development and Globalisation of 2008 calculates a country’s commodity dependency rate as the value of each country’s four main commodity exports as a share of the value of its total exports. They calculate this for the period 2003 to 2005. A dependency rate above 50 percent implies that more than 50 percent of national earnings from exports come from four commodities.

The economies of such countries are highly vulnerable to commodity market fluctuations. On the basis of their calculation they find that in Africa, 34 of the 52 countries are more than 50 percent dependent, while some countries such as Benin and Burkina Faso are more than 65 percent dependent. The four main commodities vary across countries. For instance in Ethiopia it is coffee, crude oil, oilseeds and vegetables, in Rwanda it is coffee, tea, base metals and petroleum other than crude, in Burundi it is gold, coffee, sugar and alcoholic beverages while for countries such as Algeria, Angola, Nigeria, Libya and Sudan it is chiefly crude oil.

The report also finds that the boom of commodity prices increased the extent of dependency since the higher prices meant commodities represented a higher value of total export of developing countries. On the basis of this, many argue that the way out of this vulnerability should be diversification of these economies into more commodities, other industries and services.

But diversification is not an easy process and involves adjustment costs in terms of livelihoods being lost. No other sector is as employment-intensive as the primary commodity sector. A development model on the basis of industrial and services sectors means competing with economies with well established comparative advantages. The development of such sectors also requires strong infrastructure and development of soft skills, which Africa does not have at the moment.

Given these facts, the best option for Africa seems to be to find a way to make use of the comparative advantage it already has over the rest of the world – commodities. This is why Africa needs a different approach from the existing export dependency to take advantage of its wealth of commodities. Developing multiple commodity spot exchanges with appropriate delivery and logistic mechanisms along with a single robust derivatives exchange which will complement these spot exchanges can be a good way forward.

A major flaw with export structures is that they have limited mechanisms to mitigate the risk that arises from price volatility. This is where commodity exchanges have an edge over purely traditional export markets. Reduced transaction costs, price discovery, price transparency and risk transfer are some of the key functions of a commodity exchange.

By bringing together buyers and sellers of a commodity at a common centralised location, be it physical or electronic, commodity exchanges reduce the transaction costs that suppliers and buyers have to bear. Further, these exchanges, by providing a central location for demand and supply information to converge, help in price discovery and price transparency. The opportunities provided to hedge help in risk management. Even an increase in speculation, which is often criticised by those who criticise markets, actually helps in risk management and lowering the spread between the buy and sell quote.

An increased number of speculators increases the liquidity in the market and thereby reduces the risk of any large trade resulting in large price movements. Further studies carried out on certain commodities do reveal that price volatility leads to increased speculation and not the other way around.

Again, exchanges operate through an anonymous order book and every buyer and seller is on even land. The role of a clearing house and the requirements for margins and daily mark-to-market settlement of losses mitigate risk as well. The financial crisis revealed that exchanges are one of the most robust institutions, not a single market intermediary was deprived of the mark-to-market price settlement on a daily basis, despite a huge rise and fall in prices of commodities. Again not a single exchange went bust during this crisis.

Thus developing commodity exchanges could be extremely beneficial in Africa. It helps producers to lock in prices, hedge price risk, mitigate the risk due to price volatility and it also ensures that there shall not be systemic failures due to the rigorous risk management mechanisms that are practiced by international exchanges.

There have been numerous and repeated attempts to develop commodity exchanges in Africa. But to take advantage of the opportunities provided by the exchange-traded instruments it has to be ensured that commodity exchanges in Africa go beyond being purely auction houses.

Markets need to be well regulated to succeed. This is where the role of governments in Africa come in.

A more important aspect is that fragmented exchanges do not work well and do not benefit anyone. Globally, the current trend is consolidation of exchanges. For exchanges to perform well there needs to be volume, liquidity and depth. Further, setting up an exchange involves huge costs. The ideal situation would be a pan-African exchange with accredited warehouses.

In fact, it is with such an objective that the regulators under the East African Securities Regulatory Authority met in Kampala and invited Joseph Bosco, the managing director and chief executive of the Global Board of Trade, the international multi-asset exchange situated in Mauritius, to highlight the role of a commodity and currency exchange in the development of regional capital markets. During the meeting, Bosco emphasised the need to create a single pan-African derivatives exchange that would be connected to a network of spot exchanges in Africa.

This market ecosystem will not only be an ideal channel for risk mitigation to tide over high and varied volatility, but at the same time will bring to the whole of Africa new markets, new mechanisms and new opportunities.

Developing commodity exchanges is definitely not a solution to all of the problems Africa faces. But it will complement and enhance the efforts by the governments to develop the region. And most importantly it will provide a way to take advantage of the key resource Africa has, its commodities, the treasure within.

Swapna Nair is the manager for research and product development at the Global Board of Trade in Mauritius.