TWN Info Service on WTO and Trade Issues (Aug21/08)
13 August 2021
Third World Network

UN: LAC economies need to boost their resilience amid commodity price hike
Published in SUNS #9407 dated 13 August 2021

Geneva, 12 Aug (Kanaga Raja) – The recent commodity price hikes and the high level of uncertainty regarding future commodity market developments underscore the need to boost the resilience of economies in Latin America and the Caribbean (LAC) to the impacts of future shocks, such as commodity price fluctuations and capital flow volatility.

This is one of the main conclusions highlighted by the UN Conference on Trade and Development (UNCTAD) in a new study titled “The Recent Commodity Price Surge: A Boon for Latin America and the Caribbean?”

According to the study, commodity prices as a group have increased from the start of the Covid-19 pandemic in December 2019, and especially with respect to the floors attained by several individual commodities in the first half of 2020.

However, there has been a wide heterogeneity across groups and especially individual products, it said.

It said while many different supply and demand factors are behind the recent commodity price increases, the roles of two key drivers are worth highlighting.

First, the recovery in world economic activity as countries advanced in their vaccination efforts and subsequently removed a number of movement restrictions.

Second, the improvement in investor and consumer expectations also contributed to commodity price increases, in particular for energy, and mineral and metal commodities.

The different degrees of commodity dependence across the LAC region indicate that the impacts of commodity price increases on trade and GDP growth in the Commodity-Dependent Developing Countries (CDDCs) of the LAC region will also be heterogeneous, said the study.

This is compounded by differences in terms of public indebtedness, domestic policy environments and other socio- political-economic factors impacting on macroeconomic variables, it added.

“Also, for countries in the LAC region that import substantial amounts of basic commodities such as food and fuels, persistently high commodity price levels could cause additional issues such as cost pressures on prices and a rise in poverty and food insecurity.”

The study said that volatility is likely to remain a challenge for CDDCs in the LAC region.

It noted that commodity price swings are accompanied by movements of key macroeconomic indicators such as GDP growth, trade balances, debt positions and exchange rates.

Also, LAC countries that import key commodities such as food and energy are prone to shocks and volatility transmitted via global commodity markets.

“Unquestionably, the near-term priority for LAC countries is to rebuild their economies after the shock of the Covid-19 pandemic,” said UNCTAD.

In this context, it said high commodity prices, if they are persistent, may provide a welcome boost for commodity exporters in the region.

However, the study pointed out, the recent commodity price hikes and the high level of uncertainty regarding future commodity market developments are a reminder that, over the medium and longer term, it is also important to strengthen domestic institutions and policy frameworks (including fiscal, monetary, macro-prudential and social policies and their associated institutions) with a view to increasing the resilience of LAC economies to the impacts of future exogenous shocks, such as commodity price fluctuations, capital flow volatility and others.

EXPORT COMMODITY DEPENDENCE IN LAC

The UNCTAD study noted that in recent months, commodity prices across the board have increased significantly.

This is an important development for the countries in Latin America and the Caribbean (LAC) since commodity sectors play a vital role for many economies in the region, it said.

According to UNCTAD, a country is export commodity-dependent when commodities account for 60 per cent or more of its total merchandise export revenue.

According to this criterion, all countries in South America as well as Jamaica and Belize can be classified as commodity-dependent developing countries (CDDCs), it said.

This means that 14 out of 33 countries (42 per cent) in the LAC region are commodity-dependent. Additionally, 7 countries in the region do not meet the 60 per cent threshold but have a commodity share of 50-60 per cent so that the commodity sectors play a major role in their economies.

For the 14 CDDCs in the LAC region, said UNCTAD, the average (median) share of the leading commodity group in total merchandise exports was 27.0 per cent (24.2 per cent) in the period 2015-2019.

The 14 LAC CDDCs cited by the study are Argentina, Belize, Bolivia, Brazil, Chile, Colombia, Ecuador, Guyana, Jamaica, Paraguay, Peru, Suriname, Uruguay and Venezuela.

Highlighting the impact of the pandemic on the different commodity prices, the study said firstly, Energy was the only commodity group that suffered a severe decline in early 2020 following the onset of the Covid-19 pandemic, with a price decline of 61.5 per cent in real terms in the four months from January-April 2020.

Minerals and Metals experienced a much smaller decline (14.7 per cent) during the same period and prices of the Food and Beverage groups were little affected.

The prices of commodities like soybeans and arabica coffee were not affected except for an increase in short-term volatility.

These developments reflect the impact of the restrictions to movement that were imposed around the world in 2020 to slow the spread of Covid-19, which affected in particular energy prices, and the increase in uncertainty that brought about a slowdown in investment, which affected the prices of minerals and metals, said the study.

“Second, what is extraordinary about the drop in energy prices was not only its size but also its speed: the 61.5 per cent real price decline in four months was identical in terms of percentage and speed (but smaller in terms of price declines, due to base differences) to the hitherto largest and fastest fall in energy prices, which occurred between August and December 2008 as a result of the global financial crisis,” said UNCTAD.

Third, recent price increases for the Mining and Metals, Food and Energy groups resulted in real price levels in June 2021 previously not seen since September 2011, June 2014 and October 2018, respectively.

As for the Minerals and Metals, commodity group prices in June 2021 were 22.5 per cent below the peak levels attained in March 2008 before the global financial crisis.

Similarly, for the Food commodity group, prices in June 2021 were 25 per cent below the peak prices reached in June 2008.

However, Energy prices are at present far below the levels registered pre-financial crisis, in part due to expanding supply of gas and petroleum during the last decade, including due to fracking.

While prices of all commodity groups increased with respect to the beginning of the Covid-19 emergency, there was significant heterogeneity in terms of the magnitude of price increases across different commodity groups.

On the one hand, prices of Minerals and Metals increased by 53.3 per cent since the start of the Covid-19 pandemic and prices of Food increased 27 per cent. On the other hand, prices of Beverages and Raw Materials only increased 4.7 per cent and 4.5 per cent, respectively.

Energy prices have increased by 15.6 per cent since the start of the pandemic and doubled with respect to the minimum levels registered in April 2020.

UNCTAD said prices of commodities in the Precious Metals group increased continuously during the pandemic, buoyed by investor demand as a safe asset in the face of expansive monetary policies around the world and the increase in uncertainty due to the Covid-19 pandemic.

Within the Minerals and Metals group, three key commodities like copper, iron ore and aluminum experienced significant price increases, with iron ore showing the largest price increases.

Among food commodities, there were large price increases for maize, soybeans and products of the latter (soybean oil and soybean meal), which drove the price increase of the Food commodities group.

UNCTAD said in the Beverages group, coffee experienced moderate price increases (from a relatively low base) caused by supply issues during the period and increasing demand.

For cocoa, the combination of supply side developments like bumper crops in West Africa with reduced grindings in key markets during the Covid-19 pandemic, resulted in prices in June 2021 that were 7.8 per cent below in real terms than prices at the start of the Covid-19 pandemic in December 2019, it added.

FACTORS AFFECTING COMMODITY PRICE HIKE

According to the study, a number of broad-based factors played a role in the recent increase in commodity prices.

It said the acceleration of world economic activity has boosted the demand for energy and metal commodities.

The spread of the pandemic was accompanied by severe restrictions of contacts and movements around the globe leading to a decline of economic activity.

Pointing to the beginning of a recovery in world economic activity starting in the second quarter of 2020 and accelerating in the first quarter of 2021 as vaccination campaigns took off around the world, the study noted that the growth in world economic activity has been backstopped by expansive monetary and fiscal policies across the board and the progressive lifting of restrictions of movement and activities.

For steel production, the recovery of the Chinese economy played a key role as the country accounted for 56.7 per cent of the global production of crude steel and 56.2 per cent of the global consumption of steel products in 2020.

In parallel to the increase in world economic activity, there has been an improvement of investor expectations as indicated by the reduction in the volatility in international financial markets.

The study said that reduced volatility and improved investor expectations have also led to increased attractiveness of commodities as an asset class, pushing up the number of transactions and prices in some commodity futures markets.

More recently, it noted, policy announcements such as the United States and European Union Covid-19 stimulus packages worth US$1.9 trillion and EUR 750 billion, respectively, may have also supported a favourable outlook by investors and consumers on near-term recovery and growth.

UNCTAD said in light of recovering world economic activity, positive expectations, and expansive macroeconomic policies, including fiscal stimulus, packages relaxing monetary policy and a number of supply-side factors, it is no surprise that commodities linked to construction and infrastructure, like iron ore, coal and copper, have been among the most dynamic commodities in terms of price increases.

It noted that longer term trends such as the rapid growth of the market for low-carbon energy technologies and electric vehicles are starting to impact the demand for minerals.

For instance, battery production is already the largest end use for cobalt and lithium and is absorbing increasing shares of the market for class-I nickel.

The global electric car stock has increased by 43 per cent in 2020 and is expected to increase more than ten-fold through 2030.

Furthermore, the share of renewables in the global energy mix has increased from 27 per cent in 2019 to 29 per cent in 2020.

UNCTAD also observed that the recent increases in food prices are due to a number of factors affecting market fundamentals, as well as production costs around the world.

First, rising energy prices contribute to higher agricultural production costs both directly, through fuel price increases, and indirectly, through the rise in fertilizer prices, it said.

In the same vein, higher energy prices have driven up transportation costs, which have added to the upwards pressure on food commodity prices.

Second, supply uncertainties have contributed to increasing prices of certain agricultural commodities, it said.

For example, drought conditions have led to downward revisions of the maize production forecast for the 2020/21 growing season in Brazil, one of the world’s largest maize exporters.

Third, rising global demand has caused the supply-demand balance to tighten for a number of food commodities.

For instance, global utilization of soybeans and maize is expected to outweigh global production in the 2020/21 marketing season, leading to a reduction of global stocks.

The study noted that the increase in commodity prices took place despite the appreciation of the US dollar against other currencies like the Euro or Renminbi, starting in the second quarter of 2020.

However, further appreciation of the US dollar, for example, as a result of tightening of interest rates to contain inflationary pressures, may dampen further commodity price increases, it said.

Overall, given the persisting uncertainty regarding the evolution of the pandemic at the time of writing (July 2021), in particular regarding the impact of the new virus variants, it can be expected that commodity prices will remain volatile in the near future, the study underlined.

POSSIBLE IMPACT ON LAC ECONOMIES

According to the UNCTAD study, most if not all countries in the LAC region rely on the production and export of commodities as a source of economic growth through different channels.

One channel operates through investment in commodity sectors. In particular, mining and energy are very capital- intensive sectors where foreign direct investment plays a key role.

Another channel operates via capital inflows, which are often positively correlated with the commodity price cycle.

Also public and private income and expenditure tend to follow commodity cycles. As a result, the evolution of GDP growth in LAC is correlated with the observed evolution of commodity prices, said the study.

For example, the (Pearson) correlation coefficient between changes in the UNCTAD commodity prices index and the weighted average GDP growth of CDDCs in LAC in the period 2000-2020 indicates a linear correlation of 70 per cent between both variables and is statistically significant with a 99 per cent confidence interval.

The recent increase in commodity prices can be expected to strengthen the post-pandemic recovery of CDDCs in the LAC region, said UNCTAD.

It said that a key risk factor to this positive outlook is the emergence of new variants of SARS-CoV-2 and their potential to disrupt economic activity in the LAC region and across the globe, either directly or via an increase in uncertainty.

The study observed that commodity price movements impact the fiscal balance not only through their effects on the economic cycle but also through their link with fiscal revenue both directly (when exports are taxed or public firms engage in commodity export) and indirectly (e.g. via income taxes on exporting firms).

It noted that several studies have found evidence of pro-cyclicality of fiscal policy at different periods in different countries in the LAC region.

For instance, several CDDCs in the LAC region experienced falling debt-to-GDP ratios during the last commodity price boom and rising debt-to-GDP ratios thereafter.

UNCTAD said that there exist large differences in debt-to-GDP ratio levels between different countries of the region.

It said the recent commodity price increases can be expected to have a positive impact on GDP growth and public revenue in CDDCs in the LAC region, which could contribute to manage public expenditure needs in the wake of the Covid-19 pandemic.

Another key impact of the recent commodity price increases on CDDCs in the LAC region will be through the trade balance, said the study.

For many commodity exporters in LAC, price increases have led to significant increases in commodity export revenues in the first half of 2021, relative to the same period of 2020 and in spite of stagnant or (in some cases) even falling export volumes, it added.

For instance, Brazil’s Free On Board export revenue from oilseeds in the first 6 months of 2021 was 24.3 per cent higher than in the same period of 2020 although exported volumes were slightly lower in the first half of 2021 with respect to the same period in 2020.

Similarly, Chile’s export revenue from copper ores and concentrates was 48.8 per cent higher in the first half of 2021 than in the first half of 2020, while exported volumes had only increased by 4.4 per cent.

On the other hand, said the study, commodity price increases have a negative effect on the trade balances of net commodity importers in the LAC region, such as those importing energy and food commodities.

For example, Costa Rica’s Cost Insurance and Freight cereal import bill during the first five months of 2021 was 34.8 per cent higher than during the same period of 2020, while import volumes only increased by 5 per cent.

Other countries in the LAC region such as El Salvador and Honduras also saw their import bills for basic food commodities increase disproportionately with respect to imported volumes in the first half of 2021.

Finally, commodity price movements also result in changes in the nominal and real effective exchange rates of CDDCs in the region, in particular for those countries that are most closely integrated with international capital markets and which follow more flexible exchange rate regimes, said UNCTAD.

In the past, there has been a close correlation between the evolution of nominal exchange rates of the domestic currencies of those countries vis-a-vis the US dollar and the evolution of the commodity prices of key export commodities in each country, it added.

For example, the (Pearson) correlation between the nominal monthly exchange rates of Chile, Peru and Colombia and the monthly real price index of Minerals and Metals (for Chile and Peru) and of Energy (for Colombia) for the period January 2000-June 2021 was 63.7 per cent, 64.4 per cent and 68.9 per cent, respectively, and in all three cases, significant with a 99 per cent confidence interval.

This indicates that a commodity price increase (decrease) of the relevant commodities for each country is closely associated with an appreciation (depreciation) of the nominal exchange rate, the study concluded.