How Latin America copes with commodity price volatility

For Latin America, it is no longer certain that commodities are a short-term blessing and a long-term curse

  • By Thierry Ogier
  • 14 Mar 2013
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Natural resource-rich Latin America has been struggling to cope with commodity cycles and price volatility almost forever – but now, countries in the region seem better equipped to deal with volatility.

China’s voracious appetite has pushed prices up in recent years, although it has also highlighted the region’s dependency on commodities, especially in South America.

Some statistics are telling: commodities account for 74% of the sub region’s total exports, according to a recent report issued by HSBC; 74% of imports, meanwhile, are made up of manufactured goods.

Conventional wisdom has it that this represents something of a curse and an obstacle to development. True, Latin America has in the past lost many opportunities to capitalize on its natural resources wealth. But this could be a matter of policies, rather than a curse. High commodity prices over a long period of time may have left policymakers with a false sense of security. “The challenge for Latin countries is how to make the best of this good environment, rather than blowing it as a short-term transitory gain – in other words, how do you orient your economy so that you save as much as possible?” says Phil Suttle, chief economist of the Institute of International Finance (IIF).

In the meantime, succumbing to Dutch disease would be “an admission of incompetence”, according to Alberto Pfeifer, executive director of the Latin American Business Council (CEAL) in São Paulo. Regional policymakers, he argues, would be well inspired to try and deliver a collective response to the common threat of commodity price volatility.

The current commodity price cycle may not be “super” anymore, as it was during most of the past decade, but it is still supportive. “Terms of trade have improved more than 20% since the year 2000. After a sharp deterioration in 2009, as a result of the global financial crisis, it has already rebounded more than 10%,” says André Loes, chief Latin American economist at HSBC and author of the Latam trade flows –expanding, diversified and increasingly South-South report. The relative price of commodities has kept going up in recent years. “Increasing scarcity of raw materials will prove an enduring phenomenon. As a result, commodity prices should either sustain current favourable prices or even see further rises over the medium term,” says the report.

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But actually, there is no consensus on this view. Oil and gas supply may well increase as new reserves are being explored in the US and elsewhere. The level of global demand will also depend on the pace of the world economic recovery. Food and metal prices may still remain under pressure, which would favour exporters.

The natural resource curse is far from certain. “Historically, people have in mind that countries with a specialization in commodities could have more problems to develop. This would be an impediment to social development. This is part of the reason why in the past we in Latin America have pushed for policies of import substitution to try and depend less on commodities. I think this concern was overstated,” says Loes in an interview with Emerging Markets.


Otaviano Canuto, vice-president of the World Bank, says the region has experienced troubles in dealing with the issue of commodities in the past, but it is currently making progress. “There were ups and downs in the past. The appropriation of rent from nature in the region has never been done in a way that led to poverty reduction. There was no concern for the better distribution of those rents. This led to underinvestment in human capital, education and infrastructure,” says Canuto, a former Brazilian government official who is also head of the World Bank’s poverty reduction and economic management network.

“I believe that this has improved dramatically since the end of the 90s ... I am basically optimistic. Some of the major problems have been tackled. Now there is space for a focus on education in a substantial part of the region. There is clearly a revealed perception that this is the way to go,” says Canuto in an interview with Emerging Markets.

Perceptions that this is the region's curse have also changed.

“Saying that commodity per se is a bad thing is outdated,” says Loes. “The fear of underdevelopment related to the view of a systematic deterioration of the relative price of commodities seems less of a concern at this point in time than it has been in the past.”

But in the meantime, countries that are dependent on commodities should be flexible enough to adopt counter-cyclical policies and thus be able to compensate for a possible downturn. “It is not an important handicap, with the caveat that you have more volatility. You have to be prepared for that,” says Loes.

Commodities represent more than 50% of the exports of eight countries from Latin America and the Caribbean, according to the IADB. In South America, four countries have a great dependency on commodity exports. Except for Venezuela, the others (Chile, Peru and to a large extent Colombia) have the fundamentals to deal with the short-term impact of swings in commodity prices. “The danger is when you treat [high] commodity prices as a permanent thing and you spend it all today. And then when they go back down again, you find yourself locked into a high spending structure, and that’s when the problems occur,” says the IIF’s Suttle.

Some countries, such as Brazil, have adopted industrial policies to avoid Dutch disease. But according to Suttle, diversification strategies have to be taken with a pinch of salt. “One of the problems that I have seen, not just in Latin America but especially in Latin America, is that countries get themselves most into trouble when they think, ‘ah we’ve got this new-found wealth; we are going to use it to diversify our economy.’ And they start ploughing lots of money into new sectors – many of which don’t even have an economic rationale, and you end up with an amount of inappropriate investment spending: building manufacturing sectors that are not viable, or property ... I saw this in Latin America in the early 80s, mostly in Argentina. It was never viable,” says Suttle.

China dependency is another potential threat for commodity exporting countries from Latin America. But here again, the impact varies greatly in the region. Brazil and Argentina, for instance, are less dependent on China, because their economies are not as open as their Andean counterparts, and the Brazilian economy is more diversified. If China’s GDP expanded by 5% instead of 8%, Chile’s annual growth would be cut by one percentage point and Brazil’s by around half a point, says Loes in reference to a survey issued by the IMF last year.


In the meantime, Pfeifer argues that commodity price volatility remains a crucial issue for various countries in the region. In the case of Brazil, last year’s slump in iron ore prices was enough to cut the mining giant Vale’s export revenues by $9 billion. “But Brazilian exports are fairly diversified. Other countries are more dependent on commodities, such as Paraguay (essentially a soy bean exporter), Chile (copper) or Venezuela (oil),” he says.

South America is also much more exposed to commodity price volatility than Mexico and Central America. But the policy response in the region should be more proactive. “The region is still in a learning curve. At the moment, each country seems to be going its own way, instead of acting together,” Pfeifer says. “In Latin America, there are two blocs of countries, and they tend to get away from each other (instead of getting closer) in terms of macroeconomic management. As long as we do not have a common vision, we will be confined to measures of convenience.”

Some countries have adopted consistent long-term counter-cyclical economic policies. “Chile is the most eloquent example, but it is also the case of Peru and in a way Colombia. Even Bolivia, which adopted some populist policies in the past, is now rather orthodox. On the other hand, Brazil and Argentina have to a different extent adopted dubious measures lately that can jeopardize investor sentiment,” says Pfeifer.

Commodity price volatility can be very costly in the absence of responsible management.

“It would be interesting to have a common approach to this issue,” he adds. One tool would be to pool part of their international reserves to use as a buffer in crisis times. “Because when crisis comes, it affects all the countries at the same time. Such a fund does not exist at the moment. Maybe Unasur [Union of South American nations] could do this, or the Bank of the South. But somehow, I do not see this happening,” says Pfeifer.

Meanwhile, the World Bank has worked towards exporting some aspects of the successful Chilean policies to an exotic place such as Mongolia, which is another copper-rich country. “Lessons can fly overseas,” says Canuto. “I believe that Chile has pioneered in the region. It’s a good template to be adapted in other countries.” The Chilean experience was presented there and reforms were submitted to parliament. “Mongolia then approved the set up of a [savings] fund and the framework for making the extractive industry a tool for development,” Canuto says.

But if it is possible to do it in Mongolia, why not do it in other parts of Latin America? This depends mostly on the political culture, according to the senior World Bank official. “This is something that has to be owned by society as a whole, and then naturally the support from parliament, the media and society at large makes it possible anywhere, when people understand the perils associated with the volatility of earnings from commodity prices,” says Canuto. 

- Like every year, Emerging Markets daily newspaper covers the Inter-American Development Bank’s annual meeting, held in Panama in mid-March. Pick up your copy at the meeting, read the news on our website and follow us on twitter @emrgingmarkets 

- You can watch the IDB's live broadcast of events by clicking here.

  • By Thierry Ogier
  • 14 Mar 2013

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