Commodity Slump intensifies Risks to emerging markets
Posted in Finance Articles, Total Reads: 462
, Published on 16 November 2015
Looks like world markets have got the habit of behaving weirdly. Just when people thought that Eurozone and Greece woes are settling down, it is the commodity exporters who are standing on thread now. Going by basics, IMF defines a country as commodity exporter when commodities form at least 35% of economy’s total exports and the net commodity exports account for a minimum 5% of country’s gross trade. Calculations reveal that there are around 52 emerging and developing economies which can be classified as commodity exporters among which 20 are low income countries. The high no. of exporters under this category is a reason to worry since this means loss in export earnings, less jobs and currency crises.
If estimates of World economic outlook are to be believed, then recent decline in commodity prices could wipe out 1 percentage point from the growth rate of commodity exporters and the no. goes to 2.5 if energy related exporters are considered. Therefore it is important to understand if these risks may intensify further, because once these nations fall, it will not happen in isolation.
Overheated Past Growth
An Economist once said- "Exporting commodities by themselves doesn't seem to be a very sustainable way of growing, it doesn't employ very many people, and it doesn't allow workers to be skilled up, trained, brought on to use more technology and machinery which increases productivity."
A very valid question here is whether the spectacular growth seen by various commodity rich nations was actual or overheated and has this growth indirectly lowered the productivity in these economies. Kazakhstan is one of the example as it has lucratively enjoyed growth for a decade by basing its economy primarily on commodity exports. No wonder its currency recently fell down by 25% as soon as it was freely floated.
Why commodities crashed?
Understanding commodity slump is a complicated task. Prices of almost all essential commodities like crude oil, gold, silver, platinum, sugar, cotton and soybean are down. Basic explanations revolve around macroeconomic factors such as excess supply and low global demand, over production of oil by U.S. and slowdown in China.
But the growth rate of United States is on upward trend and if the largest economy is growing (which means demand should go up), then there are definitely other factors at play rather than basics of demand-supply. Historically, the importance of commodities as a determinant of monetary policy has gone down. In case the real rate (inflation adjusted) of interest start rising, real commodity prices usually follow inverse path and there are justifications for this. When the interest rates are high, the incentive for doing extraction today increases rather than doing it later. This reduces the price of storable commodities and thus increases the pace of oil pumping, metals mining and forests logging, all leading to fall in commodity prices. It also becomes profitable to invest in bond markets if interest rates are forecasted to go up and hence investors pull money from commodity contracts, which again tank the prices down. A point to consider further during increasing rate regime is the strengthening of domestic currency. Currency appreciation reduces the price of globally traded commodities for the domestic population. Since principal commodities are traded in U.S. dollar and Fed is going to increase rates, the above reasoning becomes significant.
The curious case of China
As per World Bank, China consumed around half of the metals produced globally in 2012. Statistics from British Petroleum reveal that China’s share in global consumption is around 50.5% and in crude oil, only U.S.
is ahead. Large Poultry Industry has made Chinese global leader of Soybean imports, accounting for 60% of total. In terms of metal consumption, 53.5% of refined copper produced worldwide goes to China. For Zinc and Aluminium, the figures are 45% and 59.7% respectively. This all becomes important because the Industrial production of Chinese economy which was once growing at 12% three years back is now hovering around 6.5%. There are excess inventories lying with exporters but the dragon is falling. So, China has undoubtedly become the curious case which is set to intensify risks of commodity exporters in the near future.
Should Emerging Nations worry?
Five years ago, emerging markets were expected to be next big thing, but since many of them are commodity sellers, the big thing may have to wait for some more years. The future holds good for the users of industrial materials like India, but for commodity rich nations such as Brazil and Russia, they have already started reporting negative GDP growth rates. Capital outflow from markets of emerging economies, fluctuating exchange rates, lacklustre industrial production in Asian region and declining asset prices are some of the factors which might negate any kind of optimistic view. Also, there is no surety on when China would resume stability and the weaker corporate profits add up against any signs of early recovery. Other major factor influencing capital inflow is rate hike risk from Fed. The interest rates in all probability would be increased and that will test the stability of emerging markets. In these turbulent times, investors generally flow to safe havens of developed economies. So, in context of emerging markets, it is better to stay cautious than normal.
Golden opportunity for India
Being a net commodity importer and high forecasted growth of Industrial activity, India stands to benefit from falling prices. Lower cost of raw materials and decreasing inflation will definitely improve the bargaining power of Indian manufacturers. There is a high possibility that capital outflow from China will effectively become India’s inflow as India is one of those few developing economies which is growing upwards. But, all of this would become true only if the Prime Minister’s massive talk of reforms can do the walk. If Issues such as Land acquisition and GST are not resolved quickly, then India can sit back happily and remain as market follower.
The article has been authored by Gaurav Maheshwari, K.J. Somaiya Institute of Management Studies and Research (SIMSR)