Commodity Headwinds To Have Varying Fiscal Impacts

BMI View: Falling commodity prices will have varying impacts on the fiscal accounts of major Latin American countries, due to the wide range of export concentration, as well as differing levels of dependence on the export sector for public financing. We see the downsides risks most prevalent in Peru and Venezuela.

Shifting global dynamics will have a negative impact on a range of commodity prices over the coming years, resulting in increased headwinds for some Latin American economies. Indeed, with the normalisation of US monetary policy set to see gold price fall as demand for developed market assets picks up, our Asia team predicting a slowdown and reorientation of Chinese growth away from the investment-led model of recent years which will weigh on demand for copper, and our Oil & Gas team expecting global energy demand to be relatively well-supplied, leading to slipping prices for crude. Below we assess the susceptibility of the major economies in the region to declining commodity prices.

  • The fiscal impact for agriculture-focused exporters like Brazil and Argentina will be relatively minimal, thanks to well-diversified export baskets, low reliance on export revenues to fund fiscal accounts, and the fact that our Commodities team expects prices to average only slightly lower over the coming years.

  • Oil producers Colombia and Mexico, and copper exporter Chile, are moderately exposed, due to either low export diversification, or high dependence on the export sector for revenues.

  • Peru and Venezuela are the most exposed. In Peru's case, exports are highly concentrated in gold and copper, the prices of which we expect to head significantly lower in the coming years. While we expect only moderate declines in the price of oil, Venezuela's export basket is extremely concentrated in the sector, and the government depends on the sector for more than half of its total revenues.

Agricultural Producers Relatively Diversified

More Diversified Export Sectors Better Positioned
Latin America - Export Concentration Indices

Commodity Headwinds To Have Varying Fiscal Impacts

BMI View: Falling commodity prices will have varying impacts on the fiscal accounts of major Latin American countries, due to the wide range of export concentration, as well as differing levels of dependence on the export sector for public financing. We see the downsides risks most prevalent in Peru and Venezuela.

Shifting global dynamics will have a negative impact on a range of commodity prices over the coming years, resulting in increased headwinds for some Latin American economies. Indeed, with the normalisation of US monetary policy set to see gold price fall as demand for developed market assets picks up, our Asia team predicting a slowdown and reorientation of Chinese growth away from the investment-led model of recent years which will weigh on demand for copper, and our Oil & Gas team expecting global energy demand to be relatively well-supplied, leading to slipping prices for crude. Below we assess the susceptibility of the major economies in the region to declining commodity prices.

  • The fiscal impact for agriculture-focused exporters like Brazil and Argentina will be relatively minimal, thanks to well-diversified export baskets, low reliance on export revenues to fund fiscal accounts, and the fact that our Commodities team expects prices to average only slightly lower over the coming years.

  • Oil producers Colombia and Mexico, and copper exporter Chile, are moderately exposed, due to either low export diversification, or high dependence on the export sector for revenues.

  • Peru and Venezuela are the most exposed. In Peru's case, exports are highly concentrated in gold and copper, the prices of which we expect to head significantly lower in the coming years. While we expect only moderate declines in the price of oil, Venezuela's export basket is extremely concentrated in the sector, and the government depends on the sector for more than half of its total revenues.

Fiscal Impacts Of Commodity Price Changes
Main commodity export Export concentration* Fiscal dependence on export sector (% of total revenues) Outlook for main exports Downside risk to fiscal revenues from exports
Argentina Soybeans, Oil Low (0.16) Low (6.5%) Prices to fall modestly Low
Brazil Iron Ore, Oil, Crops Low (0.15) Low Prices to fall modestly Low
Chile Copper High (0.36) Low (3.6%**) Prices to fall significantly Moderate
Colombia Oil, coal High (0.43) Moderate (16.6%) Prices to fall modestly Moderate
Mexico Oil Low (0.15) High (33.0%**) Prices to fall modestly Moderate
Peru Copper, gold High (0.24) High (26.6%**) Prices to fall significantly High
Venezuela Oil Very High (0.64) Very High (>50.0%) Prices to fall modestly High
*Measured with UNCTAD 2012 Export Concentration Index, from 0 to 1. **Figure refers only to public revenues generated by commodities listed, not total exports. Source: National Sources, UNCTAD, BMI

Agricultural Producers Relatively Diversified

Our Commodities team sees foresees the prices of some crops (cocoa, coffee, and palm oil) to average higher in 2014 than in 2013, while others (sugar, corn, and soy) are likely to average lower. Given the composition of the export baskets of Argentina and Brazil, we expect that on balance the prices for these countries' exports will be lower in the coming years. However, an unexpectedly large drop in the price of a single crop is unlikely to be devastating, since both countries export a relatively diverse basket of goods. In the case of Brazil, the basket includes a wide variety of crops, iron ore, and oil. In Argentina, while soybeans are the most important crop, the country also exports large amounts of corn, oil, and manufactured goods. Indeed, the two countries score among the lowest in the region using the UN Conference on Trade and Development (UNCTAD) index of export concentration (which applies a Herfindahl-Hirschmann index of market concentration).

More Diversified Export Sectors Better Positioned
Latin America - Export Concentration Indices

Furthermore, the vast majority of both countries' total government revenues are generated through other means, such as VAT and other domestic taxation, meaning that even if the prices of agricultural goods decline by more than we forecast in the coming years, fiscal accounts will remain resilient.

Oil Producers More Exposed

Turning next to oil producers, we believe that risks to the fiscal accounts of Mexico and Colombia are moderate, while Venezuela is the most vulnerable to falling prices. As illustrated in the chart above, Mexico also has a relatively diversified export basket, with a large manufacturing sector which helps to feed consumer demand in the United States. However, while oil accounted for only 13.0% of total exports in 2013, crude exports generate a comparatively large share of total government revenues, at 33.0% over the past 12 months.

Crude Plays An Outsized Role In Mexican Government's Revenues
Mexico - Oil Revenues As % Of Total Government Revenues, 12mma

We expect crude oil prices to edge lower in the coming years as political risk subsides and the production of shale oil surges in the US, although downside will be limited by rising energy demand in emerging markets. Due to Mexico's heavy reliance on oil revenues, combined with our broadly neutral view on the price of oil, we believe the downside risks to the country's fiscal accounts are moderate. We hold a similar view towards Colombia. Although fiscal accounts are less dependent on the export sector in Colombia than in Mexico, the export basket is much less diversified, with oil accounting for more than half of total exports, dwarfing the other main exports of coal and coffee.

Oil Dependence Rising In Colombia
Colombia - Exports

We believe that the most fiscally vulnerable major oil producer in Latin America is Venezuela. Despite our view that oil prices will remain relatively stable, domestic crude production has stagnated, while the productive capacity of other sectors has languished under the extremely poor business environment of the administration of President Nicolás Maduro and his predecessor Hugo Chávez. As a result, oil accounts for nearly 90.0% of total exports and over half of government revenues, and a significant drop in crude prices would be potentially devastating, leading to even greater fiscal deficits, a pullback in social spending, and even political upheaval as patronage structures are undermined.

Miners To See Stiffest Price Headwinds

Our Commodities team forecasts that some of the largest price declines over the coming years will be for both precious and industrial metals, creating fiscal headwinds for major Latin American miners Chile and Peru. We forecast the average price of gold will fall 14.8% in 2014, to USD1,200/oz, as the gradual unwinding of exceptionally loose monetary policy in developed markets (particularly the US) causes investors to reduce their holdings of perceived safe-haven assets. Meanwhile, as Chinese growth slows and becomes more oriented toward domestic consumption (rather than investment), demand for industrial metals will also fall. We are forecasting the average price of copper to fall 7.5% in 2014, to USD6,800/tonne, while iron ore will fall by 14.9%, to USD115.0/tonne.

We expect this dynamic will pose the highest risk to Peru, which generates 26.6% of its total government revenues from the mining sector, which is dominated by copper and gold. Following a series of reforms aimed at raising greater revenue from the extractive industries, including major legislation passed in 2011, this is a significant increase compared to historical levels - mining revenues accounted for less than 5.0% of total government revenues as recently as early 2008. In the case of Chile, the other major copper producer in the region, while the metal represents over a third of total exports, the country has been successful in recent years in its efforts to diversify its fiscal revenues, meaning the country is only moderately exposed to the expected decline in the prices of industrial metals.

Fiscal Exposure To Metals Prices On The Rise In Peru
Peru And Chile - Mining Revenues As % of Total Revenues

Risks To Outlook

Given the myriad factors affecting the prices of commodities, there are significant upside and downside risks to our outlook. We believe among the most significant of these is the potential crackdown on the use of copper as collateral for financing in China, which if imposed would see the price of copper head significantly below our current forecasts ( see 'Turning Bearish LME Copper', April 30). In terms of oil prices, a significant escalation in the crisis in Ukraine could see the price of oil remain higher than we currently anticipate. Finally, our outlook depends on the continued recovery of the United States, which will allow the Federal Reserve to pare back its asset purchase programme. If growth continues to disappoint, as it did in Q114, when real GDP expanded by only 0.1% quarter-on-quarter, monetary policy may remain looser for longer than we anticipate, with positive implications for the price of gold.

Selected Commodity Price Forecasts
2010 2011 2012 2013 2014f 2015f
Gold Price, USD/oz, ave 1221.0 1572.0 1669.0 1408.7 1200.0 1150.0
% chg y-o-y 25.4 28.7 6.2 -15.6 -14.8 -4.2
Copper Price, Three-month, USD/tonne, ave 7512.8 8826.0 7955.0 7349.5 6800.0 6750.0
% chg y-o-y 44.5 17.5 -9.9 -7.6 -7.5 -0.7
Iron Ore Price, USD/tonne, ave 153.4 175.5 128.6 135.2 115.0 105.0
% chg y-o-y 81.5 14.4 -26.7 5.1 -14.9 -8.7
Coffee Price (Arabica), Usc/lb, ave 161.8 253.1 174.3 125.9 150.0 135.0
% chg y-o-y 22.6 56.4 -31.1 -27.8 19.1 -10
Soybean Price, Usc/bushel, ave 1039 1317 1465 1407 1350 1300
% chg y-o-y 7.3 26.8 11.2 -4 -4.1 -3.7
Brent Crude Oil Price, USD/bbl, ave 80.26 111.05 111.70 108.70 104.93 102.0
% chg y-o-y 28.7 38.4 0.6 -2.7 -3.5 -2.8
Thermal coal, USD/tonne, ave 99.0 120.5 96.8 83.9 87.0 90.0
% chg y-o-y 38.1 21.7 -19.7 -13.3 3.7 3.4
Source: Bloomberg, BMI
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