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
0,2
0,4
0,6
0,8
1
1,2
-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…
15
• ..Shocks to commodity prices may be large, difficult to predict and with
variable persistence over time...
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
160
0
10
20
30
40
50
60
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).
16
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...
0,00
20,00
40,00
60,00
80,00
100,00
120,00
140,00
-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
gyan
d
min
eral
exp
ort
ers
(wit
hla
rge
SWF)
Ener
gyan
d
min
eral
ex
po
rter
s(w
ith
ou
tla
rge
SWF)
Ener
gyan
d
min
eral
imp
ort
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
0,00
50,00
100,00
150,00
200,00
250,00
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.
27
• 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