Commodities Boost Economic Recoveries, Mirroring Aftermath of Financial Crisis
Higher commodity prices are delivering economic windfalls to countries that supply metals vital to the global recovery from the pandemic, though the boom could still mask problems like high infection rates and slow vaccine rollouts.
Prices of iron ore and copper both hit record highs this week as the trillions of dollars of stimulus deployed world-wide push up demand for metals. It is a case of history repeating itself for exporters such as Australia and Chile, which benefited from heavy infrastructure spending by China and other countries striving to recover from the financial crisis more than a decade ago.
Rising prices help commodity-producing countries by delivering more tax revenue, which can be used to pay for healthcare and other economic-support measures that were made necessary by the pandemic. By borrowing less, countries can be better insulated against future economic shocks. Higher commodity prices can be an engine for local stock markets and drive up profits for mining companies such as BHP Group Ltd. and Rio Tinto PLC, which then pay out large dividends to shareholders.
Oil producers, from the U.S. to Russia to countries in the Middle East, could benefit from a similar trend. Although oil prices aren’t nearing record levels, they have risen recently amid upbeat forecasts for global demand as vaccine rollouts progress and travel restrictions ease. One key oil market benchmark, Brent crude, is up more than 30% this year.
Still, governments that bet on sustained revenue windfalls from high commodity prices to increase short-term spending are vulnerable if prices fall. A boom in commodity prices also risks stoking inflation around the world. Policy makers may need to intervene to prevent bubbles from forming, including by raising interest rates, even when economic recoveries are fragile.
High commodity prices can also be a challenge for countries that have to import oil, gas or metals. And even for producing countries, higher prices aren’t always a quick fix that can supercharge economic growth. Brazil’s economy, for example, has struggled during its recent coronavirus outbreak despite being a major exporter of iron ore.
But Australia, which accounts for more than 50% of global iron-ore exports, is an example of how fortunes can turn for the better when commodity prices run hot. On Tuesday, it unveiled a forecast budget deficit for the 12 months through June of 161 billion Australian dollars, equivalent to $126 billion. Six months earlier, it had expected the deficit would balloon to nearly 200 billion Australian dollars.
Australia’s improved finances owe much to the crushing of coronavirus within its borders—the country has recorded fewer than 30,000 cases since the pandemic began—and the impact of stimulus measures including a wage subsidy for workers. But the run-up in iron-ore, to a record $233.10 a metric ton on Wednesday as China’s steel mills bought more of the commodity, has also played a significant part.
“The iron-ore price has been a lot higher than what we had initially forecast,” said Josh Frydenberg, Australia’s treasurer.
Australia’s spending plans for the coming 12 months are based on iron ore falling back to $55 a ton. If it stays at $230 a ton, Australia will get $15.5 billion more in annual revenue, estimates George Tharenou, an economist at UBS Group AG. That would cushion the economic impact of Australia’s borders remaining closed for longer, including on sectors such as tourism and education for foreigners, and a slow start to its vaccination program.
Last week, Australia’s central bank upgraded its forecast for gross domestic product growth in the 2021 calendar year to 4.75% from an estimate in February of 3.5%.
“Higher mining profits also boost stock prices, helping bolster household balance sheets at a time when traditional investments in term deposits are yielding near zero,” said Kieran Davies, chief macro strategist at Coolabah Capital.
There is another benefit for Australia as iron ore’s rally blunts Chinese trade pressure. China imposed a series of import restrictions and tariffs on Australian products including barley and beef last year, after being angered by Prime Minister Scott Morrison’s call for an international investigation into the initial outbreak of Covid-19 in China. But its reliance on iron ore from Australia meant the commodity wasn’t targeted by Beijing.
“The biggest buyer on the planet is buying it from the biggest seller on the planet,” said Stephen Halmarick, Commonwealth Bank of Australia’s chief economist. “There’s nobody else that can sell the quality and quantity that China demands.”
The World Bank expects metal prices to rise nearly 30% this year before falling in 2022, as stimulus-driven growth eases and supply constraints are resolved. Still, it says much depends on major stimulus programs, with the proposed $2.3 trillion infrastructure spending bill in the U.S. potentially adding new support for metal prices, including aluminum, copper, and iron ore.
Other commodity exporters are experiencing growth comebacks. Chile’s economy is forecast by the International Monetary Fund to expand by 6.2% this year—better than the average for South America—as its exports benefit from higher copper prices and the strong recovery in developed countries and China. The price of copper has doubled over the past 12 months, notching an all-time high of $4.7785 per pound on Comex on Tuesday.
The run-up in commodity prices has coincided with Chile’s rapid progress in its vaccination campaign, though the country has recently experienced a surge in coronavirus cases—some public-health experts have said the country reopened too quickly. The IMF said both the path of copper prices and the course of the pandemic pose a risk to its forecast, though Chile’s fast pace of vaccinations is expected to contain pandemic-related risks.
For many countries, though, higher prices of commodity exports are more of a silver lining as they tackle major economic and health challenges brought on by the pandemic. In much of Africa and South America, coronavirus infections remain high and vaccination rates are low.
Economic activity in Brazil, the world’s second-largest exporter of iron ore by volume, has taken a hit in recent months as state and local governments have needed to reimpose stricter social-distancing measures in the face of record-high numbers for new Covid-19 infections and deaths. Brazil’s statistics agency said industrial production fell 2.4% in March from February, after a smaller decline in February.
Last week, Brazil’s central bank raised its benchmark lending rate as policy makers work to counteract inflation. It also signaled another rate increase at its next meeting in June, even as the economy remains fragile.
By David Winning and James Glynn