Commodities rout threatens commodity-dependent countries

The collapse of commodity prices has hit commodity-dependent developing countries particularly hard. Reviewing this adversedevelopment, UNCTAD hasstressed the need for policies, including economic and fiscal diversification, to reduce countries' exposure to the cyclicality of commodity markets.

Kanaga Raja

THE prices of commodities on the whole have continued on a downward trend since 2011 and this rout in the global commodities market poses a serious threat to commodity-dependent developing countries in terms of export earnings, employment and public service provision, the United Nations Conference on Trade and Development (UNCTAD) has said.

This warning is highlighted in a Note prepared by the UNCTAD Secretariat for the Multi-Year Expert Meeting on Commodities and Development that took place in Geneva on 21-22 April.

The UNCTAD paper said that the adverse impacts of declining global commodity markets on the world economy, particularly on the economies of commodity-dependent developing countries, could be addressed if pragmatic policies such as economic diversification were adequately implemented.

The paper reviews recent developments in key commodity markets and examines the factors that contributed to fluctuations in commodity prices in 2015.

'Broadly speaking, commodity markets suffered a continuing price slump throughout most of 2015 caused primarily by the following factors: oversupply; slowing demand, especially for minerals and metals, in China and other emerging economies; faltering economic recovery in advanced economies such as Japan and the European Union; and a strong United States dollar.'

The UNCTAD non-oil nominal commodity price index averaged 194 points in October 2015 from nearly 219 points in January 2015, a decline of 25 points in only 10 months.

According to the paper, since the peak observed in February 2011, there has been a general decline in non-oil commodity prices. Price indices for food; agricultural raw materials; and minerals, ores and metals that make up the index have followed the same pattern since 2011.

During 2015, the prices of most commodities fell, UNCTAD said, citing, for example, the price of wheat (hard red winter No. 2) which fell from $261 in January 2015 to $218 in October 2015.

A similar trend could be observed for maize and rice. Prices for beverages such as robusta coffee followed the same pattern. Raw materials, especially tropical timber, also experienced declining prices.

By contrast, cotton experienced a moderate price recovery from January-October 2015, while the prices of cocoa and tea remained elevated over the same period, compared with those of the previous year.

The UNCTAD all-food price index also declined from 222 points in January 2015 to 198 points in October 2015, with the prices for individual food and agricultural products experiencing a downturn as a result of high supply and large stocks accumulating over the years.

'A possible upward price risk in 2016 is El Nino, which could cause abrupt changes in the weather, bearing negative consequences on global agricultural production. However, in the short term, the most likely price scenario for food and agricultural commodities remains a downward trend or stability amid comfortable levels of stocks,' said the UNCTAD paper.

It noted that the markets for minerals, ores and metals also exhibited a trend of declining prices, extending into 2015.

'This was based on a number of factors such as growth deceleration in China and emerging economies; the fragile economic recovery in developed economies such as Japan and the European Union; high production capacity resulting from large investments made during the last decade-long commodity boom; a strong United States dollar and low-cost mining, partly supported by low energy prices.'

The UNCTAD paper noted that structural economic changes occurring in China, as it moved from investment-led growth to a consumption-driven economy, combined with the country's objective to achieve a less polluting economic model, have put products such as iron ores and steel under downward pressure.

Fossil fuel markets, including crude oil, coal and natural gas, continued to record low prices in 2015 because of excess supplies, which helped build large inventories amid weakening demand growth.

The slump in crude oil prices that ran from mid-2014 to early 2015 continued. Between June 2014 and January 2015, the price per barrel for Brent and West Texas Intermediate crude fell respectively from $112 and $105 to $48 and $47.

The price slumps were driven primarily by excess supply resulting from strong production from members and non-members of the Organisation of Petroleum Exporting Countries (OPEC), as well as a considerable increase in shale oil output, especially in the United States, in a context of slow demand growth.

'Moreover, the accumulation of record short positions by financial speculators is likely to have exacerbated the downward trend and substantially added to volatility of oil prices.'

Thereafter, the downward trend in crude oil prices reversed from February until mid-2015. However, continuing strong supply and high levels of stocks amid lacklustre demand growth contributed to reversing the price trends from their peaks in mid-2015. In October 2015, Brent and West Texas Intermediate averaged $48 and $46 per barrel, respectively.

'Strong oil supply is being underpinned by high production from OPEC and non-OPEC member countries, even at low prices, as oil exporters primarily seek ways to preserve market shares,' said the paper.

'In the short to medium term, oil prices are not expected to record any significant rebounds if current market conditions persist - that is to say, if excess supply is boosted by the market share strategy from top oil-producing countries and is coupled with weak demand growth. For example, the World Energy Outlook 2015 forecasts oil prices to remain at about $50-$60 per barrel until 2020.'

Policy issues

The UNCTAD paper said food and agricultural commodity prices have been experiencing a downward trend for several years now, and that these developments are detrimental to producers, especially small-scale farmers, who are the backbone of agricultural food and non-food production in developing countries.

'The small scale of their activities makes them vulnerable to depressed prices, which erode their economic viability.'

To mitigate the negative effects of low prices on these farmers, the paper recommends that commodity-dependent developing countries implement measures that would enable them to reduce production costs so that they remain competitive in agricultural commodity markets.

In particular, they need access to low-cost productive assets, such as land; agricultural inputs, such as fertilisers and seeds; and affordable credit. Moreover, assistance should be extended to small farmers to ensure that they have the necessary skills and ability to benefit from market participation.

In extractive industries, low prices of almost all commodities, from minerals and metals to fossil fuels, have divergent implications for commodity-dependent developing countries, depending on whether they are net importers or net exporters of these commodities.

For example, the dramatic drop in crude oil prices since mid-2014 has benefited net oil importers, such as Ethiopia, India, Kenya and South Africa, by lowering their import bills.

Conversely, commodity-dependent developing countries have been seriously affected by the sharp decline in other commodity prices. This effect has manifested itself in the form of macroeconomic impacts, including worsening fiscal deficits, currency depreciations and increasing sovereign risk.

'The pressure of declining commodity markets on commodity-dependent developing countries calls for strong and effective policy actions. The current situation should provide an opportunity for deeper reflection on policy orientation in which these countries could reduce their dependence on a limited number of commodities.'

In the short and medium terms, improvement in resource allocation, privileging investment in productive sectors rather than consumption, could be a relevant response to the current drop in commodity revenues. Furthermore, being more cautious or less optimistic with respect to the outlook of commodity prices when preparing budgets would help prevent situations where countries need to deal with deep budget deficits when commodity prices suddenly decline.

'The need to adopt long-term strategies that would help commodity-dependent developing countries build and strengthen their resilience to commodities price swings cannot be over-emphasised,' said the paper.

For example, investing in the development of their productive capacities and/or saving in good times to be able to ride out the bad times when the prices decline, would make sense.

'In the long term, the need for policies, including economic and fiscal diversification to reduce countries' exposure to the cyclicality of commodity markets, cannot be overstated.'

Diversification strategies, such as vertical diversification and non-commodity-led growth, could strengthen the resilience of commodity-dependent developing countries to shocks by enabling them to derive their revenues from various sources.                      

A longer version of this article was first published in the South-North Development Monitor (SUNS, No. 8230, 27 April 2016).

*Third World Resurgence No. 307/308, March/April 2016, pp 30-31