The Macro Management of Asian Driver Related Commodity Induced Booms R. Avendaño, H. Reisen & J. Santiso OECD Development Centre All China Economics Conference Honk Kong, December 2007

I The Macroeconomic Links II The Macroeconomic Policy Challenge III Some Recent Policy Evidence IV Towards Export Diversification

Integration of the Asian Drivers into the world economy has shaped primary commodity markets Four key contributing factors until very recently : Global output growth   Commodity prices procyclical with growth (Beta ≈ 1.5% for each %point of growth) ‏ Barter terms of trade  Industrial world growth > 4% Lower US interest rates  Higher output prospects / low storage costs Weakening of US dollar  Denomination of raw material prices

The combined contribution of China and India to global growth is substantial Source: Own calculation based on the IMF World Economic Outlook Database, 2007.

Africa and Latin America have benefited from this “super-cycle” in both soft and hard commodities Source: OECD Development Centre, based on Datastream and African Development Bank (2007), African Economic Outlook 2007, Paris, OECD Non-agricultural (exhaustible) vs. agricultural (renewable) resources.

I The Macroeconomic Links II The Macroeconomic Policy Challenge III Some Recent Policy Evidence IV Towards Export Diversification

The Asian Drivers pose a number of challenges for commodity-dependent countries Various challenges: 1.Choice of currency regime 2.Inter-temporal budget spending (reserve and asset management) ‏ 3.Counter-cyclical stance of fiscal policy 1. Currency regime –ER movement dependent on commodity prices (≈ 80%) ‏ –Preference for managed floats for their currency: With commodity boom, a pure float  nominal appreciation  Overshooting / substitution / recession A currency peg  Short-run spike in inflation: Bond sterilization can increase interest rates and further capital inflows.

Accounting for Balance Sheet fragilities, and guaranteeing fiscal control 2. Reserves –Greenspan-Guidotti rule: reserves should cover short term debt –Optimal level of reserves after commodity windfall –Financial so as social costs of holding reserves (Rodrik 2006) ‏ 3. Fiscal Control –Several tools for open capital accounts: Mundell assignment  Unstable Fiscal policy  Internal balance Monetary policy  External imbalances –The challenge for fiscally weak governments Prevent ex. rate appreciation reducing demand of non-tradables Stabilizing demand by smoothing expenditure

Managing Public Sector Commodity Booms Source: based on discussion in Collier (2007), “Managing commodity booms: lessons of international experience”, Oxford University, Centre for the Study of African economies, Department of Economics. How much to save? How much to invest at home? How much to invest abroad vs. retire public debt? Long run saving rule Commodity price smoothing rule Excess return of home investment Construction price smoothing rule Excess cost of public debt over global return

Three factors that might generate the adverse long-run effect: 1. Dutch disease 2. Leamer triangle 3. Volatility Spending effect Resource movement effect

I The Macroeconomic Links II The Macroeconomic Policy Challenge III Some Recent Policy Evidence IV Towards Export Diversification

Sampling: Assessing the impact of Asian Drivers on commodity prices and demand A. Price Effect Main commodity price Import share of AD on main commodity Initial share in t=0 Note: Price equation based on a similar methodology as the one proposed in Kamin, B., Marazzi, M, Schindlerm J. “The impact of Chinese Exports on Global Import Prices, Review of International Economics, 14 (2), Highest to lowest values taken. B. Demand Effect Exports to AD / Total Exports (average )‏ Exports to AD / GDP (average )‏

Sampling: Assessing the impact of Asian Drivers on demand and prices Selection and Control Groups

Defining the analytical framework: The Fiscal Response 4.1. Government Budget Response Function Indicator of fiscal policy (in this case government expenditure, expressed as a percentage of GDP). Measure of the business cycle (log deviation of real GDP From Hodrik-Prescott trend)‏ Terms of trade (HP filtered)‏ Set of variable controls Sources: World Development Indicators, International Financial Statistics, procyclicality Two periods:

Part I: Government Expenditure Table 4a. Government Expenditure Response - All countries - Procyclicality Fiscal control

Part I: Government Expenditure

Note: P=procyclality, C=counter-cyclicality, N=fiscal neutrality

Part II: Budget balance (% of GDP)‏ Note: Data on fiscal policy obtained from the Economist Intelligence Unit, the OECD African Economic Outlook and Jimenez and Tromben (2006).

Part II: Budget balance (as a pourcentage of GDP)‏

Note: Data on fiscal policy obtained from the Economist Intelligence Unit, the OECD African Economic Outlook and Jimenez and Tromben (2006). Part II: Budget balance (as a pourcentage of GDP)‏

Respecting the Guidotti-Greenspan Rule: Higher Reserves, Lower Debt Source: Computed on the basis of World Bank Global Development Finance Database.

The AD boom has reduced vulnerability to speculative attacks on emerging markets Source: Computed on the basis of World Bank Global Development Finance Database.

A different risk debt management compared to the 1970s: debt composition and maturities Source: Blommestein and Santiso, 2007, based on IMF Global Stability Report, 2006.

Inflation and Real Effective Exchange rates : No clear boom-effect in selection countries Source: Authors, 2007; based on Economist Intelligence Unit and IMF Statistical Yearbook, Sterilized foreign exchange intervention to accommodate ER appreciation.

Real appreciation has been observed in Africa during the studied period: Zambia Source: Authors, 2007; based on Economist Intelligence Unit and IMF Statistical Yearbook, 2007.

Estimating the impact of Asian Drivers’ demand on inflation Export share of country i to Asian drivers Government expenditure growth Diff. between inflation in year i and average inflation Sources: International financial statistics, Datastream and World Integrated Trade System (WITS) database. Hausman tested fixed-effect estimator for both samples.

In Africa, fiscal policy has played an important role in explaining inflation deviations Inflation Deviation and Exports to Asian Drivers - Selection Group - Inflation Deviation and Exports to Asian Drivers - Control Group -

I The Macroeconomic Links II The Macroeconomic Policy Challenge III Some Recent Policy Evidence IV Export Diversification

The rise of China and India is a challenge for export diversification Note: Herfindahl-Hirschmann index calculated as, where represents the market share of country j on the exports of country i in its total exports. Source: Latin American Economic Outlook 2008, OECD Development Centre. Based on data from Comtrade, World Integrated Trade Database, 2007.

The shadow side of the commodity boom: Towards export concentration Source: African Economic Outlook 2007, OECD Development Centre. Based on data from Comtrade, PC-TAS and World Integrated Trade Database, 2007.

Conclusions 1.The macro challenge faced by Latin America and Africa: commodity booms are longer term, not just cyclical. 1.An overall assessment about the macro response is positive: targeting both inflation and REER, and fiscal control in Africa. 1.Short term benefits (prices, proceeds) both also debt reduction, broader client base, reduced vulnerability 1.Evidence of specialisation revisited. Dutch disease and Leamer effects

Conclusions (II)‏ Prospective demand of AD driver  from mineral to agricultural  A positive effect on vertical diversification? 1.The AD driven commodity boom shows higher resilience on some African countries than expected 1.A permanent concern: capitalise windfall revenues on infrastructure 2.The imperatives of product diversification

The Macro Management of Asian Driver Related Commodity Induced Booms R. Avendaño, H. Reisen & J.Santiso OECD Development Centre All China Economics Conference Honk Kong, December 2007