Commodities rout threatens commodity-dependent countries

Low commodity prices are clouding the outlook for commodity-dependent developing countries, says a UN development body, pointing to the need for policy measures to promote diversification of these economies.

by Kanaga Raja

GENEVA: 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 UN Conference on Trade and Development (UNCTAD) has said.

This warning was highlighted in a Note prepared by the UNCTAD secretariat for the Multi-Year Expert Meeting on Commodities and Development that took place here 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.

“Addressing these issues is critical for the sustainability of the global economy, especially in view of the recently adopted Sustainable Development Goals, whose purpose is to ‘leave no one behind’.”

Commodities challenge

In his opening statement at the expert meeting on 21 April, Joakim Reiter, Deputy Secretary-General of UNCTAD, said commodity markets are anything but predictable, and on top of this, the main challenge for many countries is the downward trend in commodity prices since 2011.

“These downward trends can have important implications on the development efforts of many countries. And it is therefore important to find answers to one question: how can our policy responses address these challenges and foster inclusive growth?” he said.

He went on to highlight three messages. First, commodity prices are low, and there should be no assumption that this will change anytime soon. This poses challenges for developing countries that are dependent on commodities, he said, adding that macroeconomic imbalances are symptoms of this: widening fiscal deficits, eroding currencies and looming sovereign risk.

He said where governments inadequately anticipated the reversal of economic fortunes after a decade-long boom and did not build the necessary firewalls, these symptoms are increasingly acute.

The second message is that developing countries “must not let a serious crisis go to waste”. For years, many commodity-dependent developing countries lost out on the opportunity to harness the commodity boom. Most of them did not succeed in accelerating structural transformation and building productive capacities. “But the current market conditions should be seen as an opportunity to make decisions that have been avoided for too long.”

The third message is that there is a broad consensus, or at least convergence, on the reforms needed in commodity-dependent developing countries, but a consensus in theory is not the same as a consensus in practice.

With shrinking revenues from commodities, governments will have to make hard choices about budget priorities, said Reiter.

The list of requirements is long: They need to diversify away from commodities, promote productivity growth and private sector development and cut trade cost. They need to become leaner and more efficient in their administration while protecting social spending. They need to borrow more responsibly and better manage the volatility of markets.

And they need to adopt the right accompanying policies to realize trade’s potential for sustainable development, he said.

Market developments

The UNCTAD secretariat Note 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 Organization 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.

“It is expected that oil prices will remain sensitive to market developments. At the time of writing, IEA [International Energy Agency] had projected that global demand growth would slow down in 2016 to 1.2 million barrels per day from 1.8 million barrels per day in 2015. According to its supply projections, 2015 was expected to be the second consecutive year of declining investments in oil production capacity, a trend that is expected to continue in 2016.”

According to UNCTAD, this situation could force higher-cost oil producers in countries such as Brazil, Canada and the Russian Federation to leave the market. The resulting potential decline in global oil output should be offset by supply growth in some OPEC countries such as the Islamic Republic of Iran and Iraq.

“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.”

Renewable energy has continued its growth but its share in the global energy mix remains low, said the paper.

It noted that China’s energy needs, coupled with its objective to achieve a less polluting economic model, have been driving the country’s renewable energy production and consumption, while in India, energy demand, led by expectations of strong economic growth, has sustained the development of renewables such as solar and wind energy systems.

UNCTAD said that if cheap fossil fuel prices persist, the situation could be a challenge for the development of renewables due to their competitiveness as sources of energy.

This issue persists at a time when world leaders have reached an ambitious agreement for environmentally sustainable growth during the twenty-first session of the Conference of the Parties to the United Nations Framework Convention on Climate Change held in Paris from 30 November to 11 December 2015.

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 fertilizers 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.

Commodity-dependent developing countries are advised to devote more policy attention and resources to the agricultural sector, said UNCTAD. Achieving such objectives will also require particular attention this year, considering the threats linked to El Nino. According to the UN Food and Agriculture Organization (FAO), 25% of all damage caused during natural disasters such as El Nino is in the agricultural sector. El Nino will exacerbate the frequency and impact of floods, heavy rains and droughts from the end of 2015 to early 2016 and is expected to cause more damage to agricultural production than in 1997-98.

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.

In Algeria and Saudi Arabia, high fiscal break-even oil prices of $129.8 per barrel and $111.3 per barrel, respectively, in 2014, relative to low oil prices, have forced these countries to cut spending or draw down their reserves to cover shortfalls in government revenues.

“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.”

UNCTAD said lessons could be learnt from examples of countries that have successfully diversified their economies.

“For example, Malaysia has successfully diversified its economy both vertically and into non-primary-commodity-driven sectors. The country has effectively moved away from its historical dependence on agriculture and mining products to processing of crops such as palm oil and rubber and to manufacturing of electrical and electronic products.”

Malaysia has also prioritized the implementation of its industrial policy focused on an export-led manufacturing sector. As a result, since the early 2000s, manufactured goods have represented on average about 80% of the country’s exports.

“This is even more crucial at a time when the international community is debating on how to attain the Sustainable Development Goals, which underscore the imperative of achieving inclusive and sustainable economic growth and development.”

Short- and long-term strategies

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-emphasized,” 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.

Furthermore, vulnerable commodity-dependent developing countries may need access to international safety-net programmes provided by international financial institutions and donors through various instruments such as emergency grant funding and loans.

“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.

The paper said that these strategies can also help reduce their exposure to the negative effects of unfavourable secular terms of trade (Prebisch-Singer hypothesis).

The paper cautioned that if prices of fossil fuels continue to fall or remain depressed for a long period, the situation could threaten the development of renewable energy; this might in turn compromise the achievement of the Sustainable Development Goals.

For example, in late 2015, IEA suggested that crude oil prices hovering around $50 a barrel until the end of the current decade would hold back the development of electric cars and biofuels production that are contributing to efforts aiming to curb carbon emissions. It estimated that about $800 billion of efficiency improvements in cars, trucks and airplanes would be lost under these circumstances.

“These alarming prospects for renewables mean that supportive policies, including access to finance, improved technologies, a stronger legal environment and subsidies, would need to continue supporting the development of the renewable energy sector,” said UNCTAD. (SUNS8230)                         

Third World Economics, Issue No. 615, 16-30 April 2016, pp11-13, 15