A farmer is drying coffee beans in Minas Gerais state, Brazil (photo: iStock/alffoto)

The Challenge of Moderate Commodity Prices in Latin America

By Christian Bogmans and Jorge Restrepo

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In Latin America and the Caribbean, high prices for commodities—like coffee and copper—were once a key driver of growth, helping countries to raise incomes and lower poverty. But stable and moderate levels of commodity prices mean that in the future countries will need to rely on alternative sources of inclusive growth.

Commodity dependence

Latin America and the Caribbean region is rich in fertile lands, mineral ores, oil, natural gas, and coal deposits. Its economies are leaders in the export of coffee (Brazil, Colombia, Central America), copper (Chile, Peru), iron ore (Brazil), oil and gas (Bolivia, Colombia, Ecuador, Mexico, Trinidad and Tobago, Venezuela), and soybeans (Argentina, Brazil, Uruguay).

Because the region’s economies rely heavily on exporting commodities—economic activity, government revenue, and current account balances are susceptible to commodity price shocks.

More notably, previous IMF research has found that growth in Latin America is highly correlated with commodity price changes. Therefore, the outlook for commodity prices is key in forecasting the region’s economic prospects.

A short-lived rebound in commodity prices

After increasing by 55 percent between January 2016 and June 2018, the IMF’s primary commodity price index declined by 9.7 percent in the following eight months. Energy prices led the decline, falling by 17 percent between June 2018 and February 2019, while food and metal prices dropped by 4.5 percent and 0.6 percent, respectively.

Metal prices started to falter in March 2018 when tariffs were imposed on steel and aluminum. Lower metal prices were also a reflection of industrial production in China starting to lose steam.

Agricultural prices peaked in June and started a slow decline, following the imposition of tariffs on imports of soybeans, corn and wheat. Oil prices fell in October and November, stabilizing at a lower level thereafter. This was partly due to weaker global growth and transitory short-run factors driving excess supply conditions in the oil market.

Outlook and risks

As our analysis suggests, commodity prices are volatile and subject to global risk factors and uncertainty. International interest rates, the strength of the US dollar, global growth, and supply factors all weigh heavily on the movement of most commodity prices, making it hard to forecast.

Futures markets, where participants buy and sell commodities for delivery on a specified future date, indicate that oil prices are expected to hover around current levels over the next few years. Although risks to the outlook are balanced, there is substantial uncertainty, especially considering the political situation in Venezuela and global trade tensions. Higher U.S. oil production and a slower global economy have the potential to reduce prices, while supply disruptions and stronger global growth could increase prices.

Prices of base metals, such as copper, are also expected to remain stable at current levels with a high degree of uncertainty. The evolution of metal prices will depend to a large extent on the economic outlook of China—the world’s largest consumer of metals.

Food and beverage prices are expected to rise somewhat. Farmers in Latin America and the Caribbean may benefit from higher prices of corn, wheat, soybeans, and coffee.

Given China’s large weight in commodity markets, a US-China trade deal could lead to a rebound in commodity prices.

The rebound would benefit Latin America and the Caribbean’s energy and metal exporters, but not necessarily the region’s agricultural exporters, which have benefited from recent trade tensions through a premium on the price of their soybeans. The ongoing El Niño phenomenon—the climate pattern of ocean water warming—could hurt agricultural exporters, but higher food prices could partly offset this effect.

Regional impact

The impact of commodity price shocks differs across countries depending on the composition of their commodity exports and imports. A concise way to analyze this impact is by looking at the commodity terms-of-trade indices, which provide the ratio of average commodity export prices to average of commodity import prices.

This terms-of-trade index captures which countries would benefit and which would suffer from a specific change in commodity prices. For example, when oil prices fall as in late 2018, net oil importers such as Chile and Uruguay benefit, while net oil exporters such as Colombia and Venezuela suffer.

 

Previous studies have found that a rise in the commodity terms-of-trade boosts economic growth temporarily. Particularly, this occurred in economies with large commodity exports as a percentage of GDP, with growth returning to its pre-shock level once investment and consumption have adjusted to the higher terms-of-trade level.

The way forward

These results suggest that the short-lived rise in commodity prices from early-2016 to mid-2018 helped boost growth in Latin America and the Caribbean, particularly in the Andean countries. However, the outlook of stable prices indicates that commodity prices are unlikely to be a significant growth engine for the region in the coming years.

This outlook reinforces the need for the economies of Latin America and the Caribbean to accelerate the implementation of structural reforms to boost growth and improve social outcomes.

Key priorities include further opening to trade and foreign direct investment, streamlining regulations in the goods and labor markets, promoting competition, investing in infrastructure and education, and preserving or expanding well targeted social programs.