Commodity slump intensifies risks to emerging markets: Kemp

Oil, gas and mining accounted for nearly nine percent of all new greenfield foreign direct investment (FDI) projects announced over the last decade. Oil, gas and mining FDI has played a large role fuelling growth over the last decade, especially in developing countries. The current and prospective slowdown in investment is likely contributing to sluggish performance in 2015 and 2016.

Between 2005 and 2014, the petroleum and mining industries announced new FDI projects totalling almost $745 billion, according to the United Nations Conference on Trade and Development (UNCTAD). The only industries where foreign investors announced more greenfield projects were utilities ($850 billion), business services ($785 billion) and motor manufacturing ($760 billion) (see footnote).

These four industries accounted for nearly 40 percent of all greenfield FDI recorded by UNCTAD and the Financial Times (“World Investment Report” 2015). The value of petroleum and mining projects announced peaked in 2008-2009, when they accounted for 10-12 percent of all FDI, and helped push the announced total to a record $1 trillion per year.

The number and value of new petroleum and mining projects announced since 2008-2009 has been declining and had fallen by more than two-thirds in 2013-2014. But because of the long delays between announcing a project and it coming onstream, many projects announced in 2008-2009 are only now entering production, contributing to the wave of oversupply in commodity markets in 2013-2014. Glencore’s chief executive Ivan Glasenberg has blamed commodity producers for crashing commodity prices by exercising poor capital discipline and over-investing.

But the roots of the current slump can be traced back to investment decisions made in the heady days of 2005-2008, when there was widespread panic about shortages and prices were hitting record highs. The pipeline of new projects has been getting thinner as those announced in 2008-2009 are delivered and there are fewer new ones to replace them. Moreover, some projects announced in 2013 and 2014 are being postponed or cancelled altogether as producers respond to falling revenues by trying to conserve cash.

Metals and mining investment is set to slow sharply over the next 5 years as the boom which began in 2005-2008 unwinds. The effect on major commodity exporters such as Australia and Canada is obvious, but the biggest impact will be felt in commodity dependent developing countries across Latin America, Africa, the Middle East and Asia. Commodity dependent developing countries are about to hit by a triple blow from falling commodity prices, rising interest rates in the United States and the slowdown in South-South trade flows.

Rising rates in the United States and other countries at the “core” of the global economy usually cause a slowdown, even reversal, in capital flows to developing economies on the “periphery”. Making matters worse, one of the fastest growing components of global trade has been merchandise trade between developing countries themselves. In the next couple of years, developing countries must struggle with lower revenues from commodities, at the same time that revenues from other exports are set to fall, and capital flows could dry up.

The scale of the challenge is the central theme of the latest “Global Financial Stability Report” published by the International Monetary Fund on Wednesday. “Despite an improvement in financial stability in advanced economies, risks continue to rotate toward emerging markets,” the authors note. “With more vulnerable balance sheets in emerging market companies and banks, firms in those countries are more susceptible to financial stress, economic downturn and capital outflows.”

“Slumping commodity prices, China’s bursting equity bubble and pressure on exchange rates underscore these challenges,” the Fund warned. The slowdown in emerging markets has implications for commodity demand, because developing countries have provided more than half of all the growth in demand for fuels and metals. The virtuous cycle of cheap capital, plentiful investment and rapidly growing demand which supported commodity producers and commodity dependent countries could be about to go into reverse.

Instead, it is possible to see a vicious cycle of more expensive capital, scarce investment and stagnating demand for the next 3-5 years. Slumping oil and gas investment acted as a significant headwind on growth in the United States in late 2014 and early 2015. The same phenomenon is likely to play out globally as the petroleum and mining industries, and commodity dependent developing countries, adjust to the end of the boom.

Ultimately, falling commodity prices will boost the spending power of consumers even as they cut the budgets of producers, so the eventual impact should be close to zero. But while consumers may take some time to increase their spending, producers are forced to adjust almost immediately. Sharp falls in commodity prices therefore tend to have a contractionary effect on the global economy in the short term until the positive effects filter through later (which is exactly what happened in the United States as the shale drilling boom unwound). With developing economies set to grow more slowly over the next couple of years, commodity producers will increasingly depend on the advanced industrial economies to sustain demand.



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