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Latin America’s Commodity Dependence: What If The Boom Turns To Bust?
By: iMFdirect   Wednesday, November 2, 2011 8:32 PM
But not all countries have followed this trend: heavy energy (Colombia, Ecuador, and Venezuela) and metal exporters (Chile and Peru) have witnessed both increasing dependence on and little (or no) diversification away from commodities, making them especially vulnerable to a commodity price slump.

Metal and energy prices are highly sensitive to global growth 

Prices of many commodities have moved closely during the last cycle, but the magnitude of their booms and their sensitivity to global output have varied across categories (see Figure 2):

  • Energy and metal prices have tripled since 2003, and current prices are not far from the historic peaks of the 1970s. However, these prices are highly sensitive to global output, as seen during the 2008–09 crisis and all previous recessions (the only exception being the oil shocks of the 1970s).

  • The surge in food prices since 2003 has been less spectacular. Prices are up about 50 percent, and they have only partly reversed the pronounced downward trend seen for several decades. At the same time, food prices are much less sensitive to world growth.

Policies matter

The history of sharp terms-of-trade drops during the past 40 years tells us that these price shocks can have a sizeable impact on the region, and can be even more important than other external shocks (see Figure 3). But their magnitude cannot fully explain how countries fare during episodes of price busts.

Instead, policies during the boom years play a critical role in determining a country's subsequent economic performance. Our study finds that:

  • Countries that behave more prudently during the boom phase of commodity price cycles—preventing a deterioration of their underlying fiscal and external positions—perform better during the bust.
  • Exchange rate flexibility is a powerful shock absorber, although less so in the context of highly dollarized economies.
  • In countries with strong fundamentals, the extent of financial integration with the rest of the world can also play an important role in buffering the shock, by helping to keep external funding available.

Latin America has reaped the benefits of the commodity boom of the last decade. But preserving those gains requires undertaking the right set of policies to be prepared for a possible bust, while favorable conditions last. This is especially important in the case of metal and energy exporters, which are particularly vulnerable to a global slowdown. 

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