The air is thick with symbolism. In February, Brazil called
on Germany to boost a European financial firewall to combat the
storm ravaging the eurozone. That same month, Mexico commanded
its former European colonizers to adopt its own economic
blueprint from the aftermath of the debilitating currency
crisis in its own backyard, known as the 1994 Tequila
Latin American bulls have a spring in their step, with the
IMF forecasting a 3.6% expansion this year compared with a
recession in the eurozone. The regions projected economic
outperformance would seem to confirm that Latin Americas
bull run over the past decade barring the post-Lehman
tumult is not about to end.
And yet, despite accolades for the regions stronger
fundamentals, Latin America remains chronically vulnerable to
global shocks even as economic structures and global
trading ties have experienced profound shifts in recent
decades. Economic structures have changed over the
centuries, but Latin Americas dependence on commodities
its major source of wealth since the discovery of the
Americas in the 15th century has remained and, on some
metrics, has increased, says Alberto Pfeifer, executive
director of the Business Council of Latin America (CEAl).
Indeed, the share of commodity exports as a proportion of
Latin America and the Caribbean regions total exports has
risen from 27% to 39% over the past decade. Prices for primary
commodities have soared in recent years, with real energy and
metal prices tripling since 2003, while food prices have
increased by 50% since then, buoyed by Chinese demand.
As a result, the regions economic fortunes are synched
to Chinas business cycle like never before.
But Latin Americas commodity picture and thus
its susceptibility to price volatility varies widely.
South America, for example, is the most commodity-dependent
sub-region, with net exports representing 10% of GDP in 2010,
compared with 6% in 1970. Meanwhile, central America, led by
Mexico, typically posts a flat balance of trade in commodities,
as increased energy imports and lower agricultural exports over
the years have offset oil production.
Within South America, although Argentina, Brazil and Uruguay
have taken steps to diversify their economies in recent years,
commodities still represent 60% of their total exports of goods
and services, according to the IMF.
Countries such as Chile, Colombia, Ecuador, Peru and
Venezuela which specialize in heavy metal and hard
energy exports (products that are more sensitive to the global
economic cycle than oil) are piling on fiscal risks. A
decline in gold and copper prices to 2005 levels would reduce
Perus exports by a third, for example.
South America is more dependent on commodities, as a share
of its GDP, than in the 1970s, a fact overlooked amid the
euphoria over the regions structural transformation.
A backdrop of commodity dependence and volatile global
growth prospects has unnerved some observers. Many
commodity-producing Latin American economies are vulnerable
right now, says Jeffrey Frankel, economics professor at
Harvards Kennedy School of Government.
The fear is the commodity boom has lulled policymakers and
market players into a false sense of security, seduced by the
regions healthier investment, consumption and debt
metrics relative to advanced economies.
A dip in commodity prices typically triggers
balance-of-payment instability and fiscal stress in large net
commodity exporters. Meanwhile, high commodity prices can put
upward pressure on currencies triggered by the commodity
windfall and large capital flows and create fiscal
dependence on commodities while entrenching a decline in the
domestic manufacturing industry.
This phenomenon, known as Dutch disease, has
infected economies as diverse as those of Norway and
South Americas resource dependence raises fears over
deindustrialization during boom periods, and during price dips,
that the regions over-reliance on commodity exports will
It is not hard to conjure up regional and global
developments that could derail the bull run for a clutch of
valuable commodities. These scenarios range from a Chinese hard
landing to the introduction of new technologies to extract
cheaper energy sources. Moreover, commodity consumption trends
come and go, heaping on the risks of a positive supply shock in
the coming years.
Examples could include: US soybeans outcompeting Brazilian
produce, emerging African oil producers snapping on the heels
of Venezuelan producers, or new Brazilian output in the coming
years crowding out oil from its regional counterparts.
The decade-long commodity price boom with the glaring
exception of the post-Lehman collapse is unique in
recent history by virtue of its magnitude and broad-based
nature, with both soft and hard commodities enjoying blistering
The pace and duration of this rally inevitably raises
questions as to its sustainability. Under the shadow of this
risk, emerging exporting economies vulnerability to
commodity price shocks over the past 40 years provides many a
cautionary tale. In a landmark December 2011 report, IMF
researchers calculated that a commodity-related terms of trade
shock of 1% of GDP in a given emerging market exporter would
reduce growth by 0.13% in the same year and by 0.08% in the
subsequent post-shock year.
The study based on statistical analysis of the
relationship of macroeconomic variables to commodity-related
trade shocks since the 1970s confirmed two conventional
schools of thought.
First, countries with a stronger fiscal position outperform
their deficit-challenged peers because of their flexibility to
pursue counter-cyclical policies. Second, exchange rate
flexibility provides a shock absorber in economies with
relatively low financial dollarization.
These are now mainstream policy recommendations, from the
IMF and others, for South American exporters to avoid boom and
bust cycles. With the exception of Chile, in recent Latin
American history, we have remained inebriated by the commodity
bonanza, says Pfeifer of the Business Council of Latin
America. We have not been wise enough to nurture our
extraordinary wealth boom. That has to change.
However, there is less consensus on the likely success of
policies to tackle the other consequence of high commodity
prices: appreciating currencies, investment bias and addiction
to commodity revenues.
In recent years, Brazil, Chile, Colombia and Peru have
endured the relative stagnation of their domestic manufacturing
industries, caused by commodity-driven exchange rate
For Brazil one of the worlds largest exporters
of iron ore, soybeans, ethanol and beef, among others
the stakes are high.
Some 70 years after its first discovery of oil, Latin
Americas largest economy is poised to become a major
global oil exporter after the discovery of the massive Tupi oil
field in November 2007, the largest such find in the West for
According to Opec (Organization of the Petroleum Exporting
Countries), Brazil had the sixth largest recoverable oil
reserves in the world at 123 billion barrels, at the end of
Former president Luiz Inácio Lula da Silva has
described these new resources as the opening of a direct
bridge between natural wealth and the eradication of
poverty and the Tupi discovery as the second
independence for Brazil.
But the commodity windfall has already come with its own
costs, despite the associated fiscal cushion: Brazils
currency, the real, is up around 40% against the dollar since
its 2008 crisis low.
The strength of the currency principally driven by
large capital inflows has undermined the price
competitiveness of Brazilian exports in global markets and,
conversely, imports have grown at a faster pace. Brazil
recorded its widest monthly current account gap on record in
January at $7.1 billion, bringing the 12-month deficit to the
equivalent of 2.17% of GDP, driven by soaring demand for
foreign products and services.
Many economic indicators from high imports of
foreign goods, weak export orders for manufactured goods and
lacklustre job creation in the industrial sectors
highlight that Brazilian deindustrialization concerns require
urgent policy action, says Graciana del Castillo,
managing partner of Macroeconomics Advisory Group.
Despite some signs of life in January, manufacturing has
failed to expand since 2007 despite growth in the
broader economy. In the past 16 years, manufacturing has lost
three percentage points as a component of total production of
goods and services.
Symptoms of the resource curse abound in Brazil,
says Alfredo Coutino, Latin America director at Moodys
Analytics, citing a stagnant industrial sector; retail sales
outpacing industrial production; and employment growth in
manufacturing underperforming the services sector by 10%
between 2006 and 2011.
The Brazilian government is likely to attempt to distribute
the fruits of its growing commodity wealth to the larger
population by ramping up social spending. But the risk of
long-term output volatility will be exacerbated if production
is concentrated in the primary sector, holding the country to
ransom to controlled commodity prices externally.
Evidence for the so-called Dutch disease is all over
the place in Latin America. The question is whether anything
should be done about it and if so, what, says Frankel of
Harvards Kennedy School.
In Brazil, for example, the government in September slapped
taxes on imported cars to shore up its domestic manufacturing
industry, a move that highlighted the global impact of
commodity exporters grappling for export competitiveness.
But aside from active currency intervention and capital
controls policies seen as ultimately impotent in
stemming structural appreciation pressures there are few
weapons in the policy arsenal. Government efforts to provide
exporters with currency hedging tools and subsidized capital,
for example, ultimately cannot solve long-term currency
strength pressures, experts say, while large subsidies or
import sanctions will fly in the face of international trade
Put simply, Brazil and other countries in a similar position
have to grin and bear it. Besides what is already being
done in Brazil exchange rate intervention and capital
controls there is little it can do in the near
term, says Eduardo Levy Yeyati, professor of economics at
the Universidad Torcuato Di Tella, Buenos Aires, and a former
chief economist of the central bank of Argentina.
Others agree. Brazil is going to be rising up the
ranks of global commodity players, so it has to get used to the
strength of its currency, says Marcelo Salomon, an
economist at Barclays Capital. Counter-cyclical fiscal policies
and a largely flexible exchange rate with intervention
only justified to smooth excessive volatility or correct overt
misalignments are needed, he says.
The flipside of South Americas reduced dependence on
foreign capital over the past decade has been its increased
dependence on primary exports, says Yeyati. This windfall comes
with opportunity costs, while its fruits have been unevenly
distributed. A bursting of the commodity price bubble or the
prolonged ill-effects, economic and political, of excessive
exchange rate appreciation should force policymakers to re-tool
the regions growth model away from cheap credit and a
Countries need to snap out of this commodity-dependent
nirvana and face the need to enhance high-quality investment
and education, says Yeyati. Opportunity costs abound.
Coutino of Moodys, for example, argues that commodities
have created the illusion of fiscal strength in Latin America
when, in the absence of reforms, non-commodity related tax
revenues represent less than a fifth of the regions GDP
compared with a third in OECD countries.
To reduce commodity dependence in the coming years, South
America needs a reformist push aggressive in its scope, from
overhauling the tax and labour market system to regional trade
integration efforts, to jump-start the industrial sector, says
Ultimately, it might only be a prolonged commodities slump
that wakes policymakers up to the seriousness of the