Commodity price volatility and policy challenges: an emerging … · 2019-05-02 · o Strong oil demand growth (e.g. China, Middle East and other newly industrialized economies) ...

Commodity price volatility and policy challenges: an emerging market perspectiveJuan José EchavarríaGovernor

CVII Meeting of Central Bank Governors of CEMLA29 April, 2019

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Policy implications of commodity price volatility

Global financial conditions and commodity prices

Monetary policy implications of commodity pricevolatility

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• Different theories have tried to explain commodity price behavior. For the case

of oil…

‒ Super Cycles of Commodity Prices (Erten and Ocampo, 2013):

There is a gradual change in prices long-term trends rather than a stochastic trend.

During the period 1865-2010, four past super cycles are identified, ranging between 30

to 40 years and with large amplitudes varying between 20% and 40% higher or lower

than the long run trend.

‒ Random Walk and Regime Shifts (Hamilton, 2008)

Oil prices have been historically unpredictable an follow a random walk. However, they

might be explained by different regimes at different points in time.

o Strong oil demand growth (e.g. China, Middle East and other newly industrialized

economies)

o Limits to expanding oil production (e.g. Drop in Saudi Arabia production since

2005)

o Cartelization of commodity markets

Sources: Erten, Bilge. Ocampo, José Antonio. Super Cycles of Commodity Prices Since the Mid-Nineteenth Century (April 2014). Elsevier, Vol. 44. Available at ScienceDirect: https://doi.org/10.1016/j.worlddev.2012.11.013

Hamilton, James D. Understanding Crude Oil Prices (November 2008). NBER Working Paper No. 14492. Available at NBER: https://www.nber.org/papers/w14492

• After a period of high market tightness and volatility, international financial

conditions have improved and the expectations of further tightening have

decreased...

Source: Bloomberg. Updated: April 24, 2019.

0

50

100

150

200

250

300

350

Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Apr-19

5-Year CDS

Peru Colombia

Mexico Chile

0

10

20

30

40

50

60

70

80

90

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18

VIX Index

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• …such changes in financial conditions might have effects on commodity price

behavior. Historically, high real interest rates have lead low real commodity

prices (Frankel 2006)*.

Source: World Bank, Bloomberg*Frankel, Jeffrey A., Commodity Prices, Monetary Policy, and Currency Regimes (May 2006). NBER Working Paper No. C0011. Available at SSRN: https://ssrn.com/abstract=913304

y = -0,0342x + 0,7653

0

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0,8

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-2 0 2 4 6 8 10

Log

Rea

l Co

mm

od

ity

Pri

ce In

dex

FED Real Interest Rate (%)

Goldman Sachs Commodity Price Index vs. FED Real Interest RateAnnual, 1970-2017

The sector with the strongest correlation is .

Other sectors with a strong correlation ar

cattle

copper,

corn, hogs and soyb

e

eans.

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• …The negative correlation between an increase in real interest rates and a

decrease in real prices of commodities occurs through a variety of

mechanisms (Frankel, 2006):

‒ By increasing the incentive for extraction/selling today rather than tomorrow, in

order to earn interest on the proceeds from the sale

‒ By decreasing firms’ desire to carry inventories (higher opportunity costs)

‒ By encouraging speculators to shift out of commodity contracts (especially spot

contract), and into treasury bills.

• In its empirical study, Frankel finds that when the FED real interest rate goes

up by 1 percentage point, it lowers the real commodity price index by 6

percent…

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• Nevertheless, many other factors beyond real interest rates influence

commodity prices (e.g. weather, political conditions in producing countries,

sector specific microeconomic factors, etc.).

• Identifying the relationship between financial conditions and commodity

prices is extremely difficult and is a debatable issue that has been widely

discussed by academics.

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• External financial conditions remain volatile…

o Central bank monetary policy responses in developed economies are still uncertain and volatile

o Global trade, investment and output remain under threat from ongoing trade tensions

o Some downside risks in systemic economies such as the euro area, China and the United States persist

o Political uncertainty and geopolitical conflict in some countries also add downside risk to global

investment

Source: Bloomberg. Updated: April 25, 2019

38%

77%

39%

62%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Apr-19

Market-Implied Probabilities for the FED's December/2019 Meeting

Probability of Hike Probability of No Change (2.25-2.5) Probability of Cut

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• Hence, if there is a relationship between financial conditions and commodity

prices, external volatility could generate terms of trade shocks.

• Therefore, it is important to analyze the challenges that commodity price volatility

poses for policymakers in commodity dependent countries.

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Policy implications of commodity price volatility

Global financial conditions and commodity prices

Monetary policy implications of commodity pricevolatility

Source: IMF. UNCOMTRADE1 Commodities groups: Food and live animals; Beverages and tobacco; Crude materials, inedible, except fuels; Mineral fuels, lubricants and related materials; Animal and vegetable oils, fats and waxes; Manufactured goods classified chiefly by material.2 The latest available data for Venezuela are as of 2013 and for Saudi Arabia are as of 2016.

• In a vast number of countries, commodities are a key part of the nationaleconomy...

Commodity exports (% Total exports) 2018

12

13

• …Commodity price behavior affects terms of trade in commodity exportingcountries…

0

20

40

60

80

100

120

140

160

Mar

-10

Jun

-10

Sep

-10

Dec

-10

Mar

-11

Jun

-11

Sep

-11

Dec

-11

Mar

-12

Jun

-12

Sep

-12

Dec

-12

Mar

-13

Jun

-13

Sep

-13

Dec

-13

Mar

-14

Jun

-14

Sep

-14

Dec

-14

Mar

-15

Jun

-15

Sep

-15

Dec

-15

Mar

-16

Jun

-16

Sep

-16

Dec

-16

Mar

-17

Jun

-17

Sep

-17

Dec

-17

Mar

-18

Jun

-18

Sep

-18

Dec

-18

Mar

-19

Terms of Trade (2010=100)

Chile Colombia Peru Mexico Argentina

Fuente: Bloomberg

• …Commodity prices are highly volatile; in particular non-renewablecommodities (e.g. oil, energy and metal prices)…

Source: World BankDeflected by MUV Index - A proxy for the price of developing country imports of manufactures in U.S. dollar terms, used to assess cost escalation for imported goods. Updated twice a year, the index is a trade-weighted average of export prices of manufactured goods for 15 major developed and emerging countries, with local-currency based prices converted into current U.S. dollars using market exchange rates. 14

0,00

50,00

100,00

150,00

200,00

250,00

300,00

350,00

400,00

450,00

19

601

961

19

621

963

19

641

965

19

661

967

19

681

969

19

701

971

19

721

973

19

741

975

19

761

977

19

781

979

19

801

981

19

821

983

19

841

985

19

861

987

19

881

989

19

901

991

19

921

993

19

941

995

19

961

997

19

981

999

20

002

001

20

022

003

20

042

005

20

062

007

20

082

009

20

102

011

20

122

013

20

142

015

20

162

017

20

18

Real commodity price index (1992=2010)

Energy Agriculture Metals & Minerals

0,00

20,00

40,00

60,00

80,00

100,00

120,00

140,00

1879

1882

1885

1888

1891

1894

1897

1900

1903

1906

1909

1912

1915

1918

1921

1924

1927

1930

1933

1936

1939

1942

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017

Real crude oil prices 1879 – 2017 (2017=100)

Source: BP Statistical Review of World Energy June 2018

1861-1944 US Average; 1945-1983 Arabian Light posted at Ras Tanura; 1984-2017 Brent

USD / Barrel

• …In the last decades, oil prices have experienced a phase of high volatility,which implies significant challenges to oil exporting countries…

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• ..Shocks to commodity prices may be large, difficult to predict and with

variable persistence over time...

0

10

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90

100

110

120

130

140

150

160

0

10

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70

80

90

100

110

120

130

140

150

160

Oil in the 1990's, 2000's and 2010's

The solid line represents actual WTI crude oil daily prices for the period. The dashed lines are based on market projections for prices of WTI Futures Contracts from 1 month to the last data available of 2023 for some selected transaction dates when WTI prices reached a peak or a trough (the futures curve generally starts two months after this).

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Source: IMFOil exporters: Bolivia, Canada, Colombia, Ecuador, Iraq, Mexico, Nigeria, Oman, Peru, Sudan, United Arab Emirates, Norway, Kuwait, Qatar, Australia, Saudi Arabia. Oil Importers: Austria, Belgium, Germany, Spain, France, United Kingdom, Japan, United States, Switzerland, Argentina, Brazil, Hungary, India, Poland, Turkey, Thailand,

• …Oil price shocks imply highly volatile government revenues. Oil dependent

countries are more sensitive to oil price volatility than oil importers...

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120,00

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-20,00%

-15,00%

-10,00%

-5,00%

0,00%

5,00%

10,00%

15,00%

20,00%

25,00%

30,00%

General government revenues growth and Oil Prices

Oil Exporters Oil Importers Oil price (right axis)

USD / BarrelUSD / Barrel

17

Source: Sovereign Wealth Fund Institute. IMF.

• …Because of difficulties in fully hedging against commodity price

fluctuations, commodity dependent countries take precautionary measures,

such as establishing sovereign wealth funds. Currently these funds hold more

than USD 4.1 trillion...

180,00% 100,00% 200,00% 300,00% 400,00% 500,00%

Nigeria

Iraq

Mexico

Canada

Colombia

Peru

Russia

Argelia

Australia

Oman

Kazakhstan

Azerbaijan

Saudi Arabia

Libia

Qatar

United Arab Emirates

Norway

Kuwait

Brunei

Sovereign Wealth Funds 2019(% GDP)

0% 1000% 2000% 3000% 4000% 5000%

Argelia

Iraq

Nigeria

Peru

Canada

Mexico

Colombia

Russia

Australia

Oman

Kazakhstan

Azerbaijan

Libia

Qatar

Kuwait

United Arab Emirates

Saudi Arabia

Brunei

Norway

Sovereign Wealth Funds 2019(% Principal energy and mineral exports)

Energy and mieral exporters(with large SWF)

Energy and mineral exporters(without large SWF)

Source: IMF. SWF: Sovereign Wealth Fund. Gross national saving (gross operating balance (revenue – expense, excluding consumption of fixed capital) excluding net capital transfers receivable)

• …The existence of a sovereign wealth fund to cope with energy and mineral

price volatility has important macroeconomic implications. Energy and

mineral exporters with large sovereign wealth funds tend to have, on

average, higher gross national saving rates...

19

0

10

20

30

40

50

60

70

Australia Kuwait Norway Oman Qatar SaudiArabia

UnitedArab

Emirates

Bolivia Canada Colombia Ecuador Mexico Peru Sudan

Gross national saving (%GDP)

2013 2015 Av. 2013 Av. 2014

Source: IMF. SWF: Sovereign Wealth Fund. Fiscal deficit: General government net lending/borrowing (revenue – expense – net gross investment in non financial assets)

Energy and mineral exporters(with large SWF)

Energy and mineral exporters(without large SWF)

• …Accordingly, energy and mineral exporters with large sovereign wealth funds

tend to have precautionary fiscal policies…

20

-20

-10

0

10

20

30

40

Australia Kuwait Norway Oman Qatar SaudiArabia

UnitedArab

Emirates

Bolivia Canada Colombia Ecuador Mexico Peru Sudan

General government fiscal balance (%GDP)

2013 2015

Source: Bloomberg. SWF: Sovereign Wealth Fund.*7-year CDS

• …A downswing in energy and mineral prices causes exporters of these

commodities to be perceived as riskier. However, exporters without sufficient

hedging mechanisms are more sensitive.

21

Ener

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d

min

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exp

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ers

(wit

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SWF)

Ener

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d

min

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s(w

ith

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SWF)

Ener

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min

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imp

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ers

Change in 5-year CDS (pbs 2014-2015)

(20,00) - 20,00 40,00 60,00 80,00 100,00

Brazil

Poland

Turkey

Thailand

Hungary

Saudi Arabia*

Qatar

Norway

Australia

Colombia

Mexico

Peru

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Policy implications of commodity price volatility

Global financial conditions and commodity prices

Monetary policy implications of commodity pricevolatility

• As a first policy implication, depending on country circumstances, a flexible

exchange rate might help to cope with commodity price volatility. In Colombia,

the floating exchange rate regime has worked well as a shock absorber. However

certain preconditions should be fulfilled…

23Source: Banco de la República

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0

500

1.000

1.500

2.000

2.500

3.000

3.500

Jan-00 Jan-04 Jan-08 Jan-12 Jan-16

Exchange Rate (left axis) vs Terms of Trade (right axis)COP/USD 2000=100

1. Limited currency mismatches. Currency mismatches remain low and contained

in both the real and financial sector.

24*FX Market intermediaries: Includes credit establishments and brokerage firms.

Source: Banco de la República.

32,4%

4,7%

2,4%

3,1%

1,5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2010 2011 2012 2013 2014 2015 2016 2017

Debt of the Corporate Private Sector by currency and

hedge(% of GDP)

Non-exporters Debt (unhedged) Non-exporters Debt with FDI (unhedged)

Non-exporters Debt (hedged) Exporters Debt

Local Currency Debt

-700

0

700

1.400

2.100

2.800

-5%

-2%

1%

4%

7%

10%

13%

16%

19%

22%

Jun-16 Dec-16 Jun-17 Dec-17 Jun-18

FX Net Open Position of the Financial Sector(Assets minus liabilities in foreign currency)

FX Net Open Position (% TechnicalCapital)

FX Net Open Position (RHS)

% o

f Te

chn

ical

Cap

ital U

SD M

illion

Upper regulatory limit

Lower regulatory limit

2. A low pass-through, which is supported by a credible inflation targeting regime.

Despite the exchange rate depreciation in 2014, inflation expectations

remained close to the 3% target…

25Source: Banco de la República – Monthly Survey of Economic Expectations

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Sep-18 Mar-19

Inflation and Inflation Expectations

Average of 1-Year Ahead Expectations

Average of 2-Years AheadExpectations

Headline Inflation

3. Sufficient external buffers. A sufficient level of external buffers provides another

safeguard against external shocks. The Flexible Credit Line (FCL) by the IMF has

complemented the accumulation of international reserves…

26

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 Mar-19

International Reserves - Percentage of IMF's ARA Metric

Adequate level suggested by the IMF

Source: IMF and Banco de la República. The ARA Metric is updated yearly, the reserves quarterly.

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• A second policy implication is related to changes in natural interest rates

stemming from persistent shocks to terms of trade with strong effects on the

macroeconomy.

• Risk premia may shift persistently after a protracted terms of trade shock.

165%

66%

0,0%

20,0%

40,0%

60,0%

80,0%

100,0%

120,0%

140,0%

160,0%

180,0%

200,0%

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Jan

-15

Ap

r-1

5

Jul-

15

Oct

-15

Jan

-16

Ap

r-1

6

Jul-

16

Oct

-16

Jan

-17

Ap

r-1

7

Jul-

17

Oct

-17

Jan

-18

Ap

r-1

8

Jul-

18

Oct

-18

Jan

-19

Ap

r-1

9

CDS and Terms of Trade

Colombian CDS (% of Peruvian CDS)

Colombian ToT (% of Peruvian ToT)

21

%4

8%

0%

10%

20%

30%

40%

50%

60%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Debt of the Central Government(% of GDP)

Peru Colombia