Lower demand hits commodity prices in emerging economies

See-sawing commodity prices, the recent declines and the current downturn leaves two Bric economies in an unenviable position. Brazil and Russia, both of which depend heavily on the production and export of commodities, are quite unlike India and China?which import them to fuel growth.

Matters might have not been this bad had growth been maintained in the OECD. UNCTAD, for example, reports that the index of non-fuel, dollar-denominated commodity prices increased by 41.9% between May 2007 and May 2008.

But that was not to be. Not only has the post-sub prime crisis slowdown of US activity levels pulled down commodity prices, it has also suddenly made nonsense of capital intensive programmes to diversify out of hydrocarbons, into new energy sectors.

Hence, the current reality differs greatly from what would have occurred had there been production shortages to driven up prices. Then, at least growth would not have been leashed in by prices in international commodity markets. Higher than trend prices would, in fact, have simply spilled back as additional demand for OECD exports. And that is how it would have been until 2050.

Recently, Rio Tinto and BHP Billiton even named China as the economy to watch in that regard. Being a double-digit growth economy, high Chinese activity levels would not only mean that there will continue to be a ramping up of energy demand; it would also hold for many ?base metals?. It would have also vindicated an exceptionally strong trend. After all, China and India have been the world?s two fastest growing economies. The latter?s imports include aluminium, copper, iron ore, numerous base metals, and oil. And those imports had been holding up despite a slight slow-down consequent on attempts to decelerate inflation.

Indeed, that is what explains why Bric?s commodity exporters were seen to be going from strength to strength while the other two were wobbling along. Indeed, the data of three months back shows the Morgan Stanley Capital Index (MSCI) for India losing 6%, and that for China 5.4%. On the other hand, Brazil?s index, and Russia?s, gained 7.3 and 15.7% respectively.

We see a similar contrarian trend in Bric stock-markets. So, while Sensex fell Bovespa (the Brazilian index) reached unprecedented highs. Indeed, July 2008 saw the market capitalisation of Brazil?s stock market actually overtaking India?s?for the first time in six years. But, much of that traces back to year 2000?after which the demand for industrial metals really took off, led by China.

That was also the year from which China?s share of iron ore demand started rising internationally: it went from 12% of the global total (1996), to 45% (2006). Even copper demand swelled from 11% to 23% over that interval. Thereafter, there was even a gradual tailing-off of this growth-driven boom?s ability to surprise.

But the markets have turned out to be inscrutable. That is seen from the manner in which the price estimates of base metals have been falling systematically short of actual market quotes?something that holds right up to recent times.

Worse, ?politics? intervened. That is why capital investment on the supply side remains flaccid. So, given the investment risks, all the new (greenfield) investments have remained well below par because of the ?location risks? that typically attend (mainly developing economy) locations.

As for the current double-whammy?the fall-out of the US? sub-prime crisis?interest hikes have attended it. Not only has that tended to decelerate demand growth in China, it has also left commodity exporters with the sudden problem of softening demand. That can be very unsettling for the Bric economies that lack other growth drivers. Accordingly, we end by pointing out just how well-placed are Bric?s pair of commodity exporters?and what steps they have been taking to meet this latest challenge.

Taking Brazil first, that used to be an economy that was hugely, and internationally, indebted and growing at barely 2% in 2002. But that was to change from 2003, the year that kicked-off the international commodity boom.

Year 2003 also saw the installing of President Luis Inacio ?Lula? da Silva who?despite apprehensions?has been a better reformer than many others within the developing economies.

Given that 40% of Brazil?s exports is in the nature of commodities, it was ideally placed to reap the fruits of the post-2003 boom. Its economy and resource base are such as to attract immense hard currency inflows on the capital account. That money entered into mining, manufacturing and agri-businesses. And, that those businesses are thriving is a major reason behind Standard & Poors? recent investment quality upgrade of Brazil. Besides, Brazil is in the ?5%-plus? growth league, virtually debt-free and host to 30 NYSE (ADR-listed) companies. More than 40 others are traded in the over-the-counter market.

Finally, Russia, the other Bric economy that depends on natural resources (and accounts for 12% of international crude sales) follows a mix of market and political signals?with many of the latter emanating from areas of ex-Soviet influence.

The current fall in commodity prices would affect Russia the most since the economic growth of that country is almost entirely driven by high oil prices.

Finally, the outlook for great many developing countries depends on the future price trends of the commodities they export. They would be the first ones to succumb to adverse price cycles or investment-led leads and lags in supply responses. Clearly, the Bric must find internal sources of growth until a fresh international correction and upturn.