Global Economic Prospects Commodities at the crossroads Uri Dadush Andrew Burns World Bank Brussels, Dec. 9, 2009

Macro Outlook : Main Points  The financial crisis is massive and global  US sub-prime was the crisis trigger, but vulnerabilities run much deeper and wider  Despite improved fundamentals, developing countries are being engulfed by the crisis  Very severe downside scenarios possible, but most likely is an extended global recession  Continued vigorous policy response required to mitigate effects and prevent recurrence

Shipping costs are plunging Baltic Exchange Dry Index

A massive, global, crisis  World output growth down from +3.5% in to -2.5% estimated in the current quarter  Stock markets around the world fall about 50% from their peak in Summer 2007  In the U.S., unemployment (a lagging indicator) set to rise from 4.5% in 2007 to 8% or higher in 2009  Oil prices fall from $150 at the peak in Spring 2008, to less than $50; prices of metals also collapse.

Equity markets plummet... weakening exchange rates MSCI Equity market index ($), Jan =100 Exchange rates, LCU/USD index Jan =100* * increase implies weaker local currency Brazilian real

…while emerging markets bond spreads widened substantially Basis points Emerging-market bond spreads Jan 2007 – Nov 18, 2008 Source: JPMorgan

..and corporate bond spreads have surged Basis points Emerging-market corporate bond (CEMBI) spreads Source: JPMorgan

Examples of countries most affected by financial turmoil High-Income: Iceland, Australia, Hungary, Korea Middle-Income: Jamaica, Ukraine, Mauritius, Kazakhstan, Lesotho Low-Income: Pakistan, Zambia, Ghana, Madagascar

Financial crisis may have culminated in early October Spread between 3-month US$ Libor and policy interest rate, basis points

What caused the crisis?  US vulnerabilities  1. Monetary and Fiscal policies too loose too long  2. Innovation and Regulatory Failure  3. Excessive household debt and bank leverage  Global vulnerabilities  1. Demand Boom and Inflationary Pressures  2. Large and widening external imbalances  Triggers  1. Subprime securities collapse  2. Lehman failure

A major sustained world boom preceded Metal Prices Global IP Percent change, year-on-year Source: World Bank.

Inflation surged High-income OECD Developing countries Median inflation rates: Jan 2000 to Sep 2008 Source: World Bank.

percent U.S. policy rates left too low for too long Real Fed Funds Target Rate (Deflated by CPI) Jan – Sep Source: Federal Reserve, U.S. Department of Commerce and World Bank.

U.S. fiscal surplus turned to deficit in 2001 General Government Financial Balance share of GDP, 1990 to 2007 Percent of GDP Source: U.S. Department of Commerce and World Bank.

U.S. Households ran up record debt as home prices surged House price index Right axis Household Debt to GDP(%) Left axis Household debt to GDP (%) and House price index 1980 to 2008 Percent of GDP Source: Federal Reserve Board, RBS:Case-Schiller, World Bank. Index, 2000=100

External Vulnerability Source: World Bank. Current account balance (Developing oil importers x China) (% of GDP), Overall budget balance (% of GDP)

High-income countries in recession Source: World Bank and National Agencies. Growth of real GDP, Q to Q3-2008, percent change annualized Q1 Q2 Q3

Decline in import growth affecting exports from developing countries... U.S. imports Latin American exports Annual growth of import volumes Percentage change (12m/12m) Source: World Bank

World trade to contract in 2009 for the first since the early 1980s Source: World Bank. annual percent change in trade volumes World trade volume Developing country exports

Oil Price Forecast $/barrel Source: DEC Prospects Group.

Food price forecast Index (2000 = 100) Source: DEC Prospects Group.

$ billions Net private debt and equity flows , projected Percent Percent of GDP (right axis) Private capital flows set to decline more sharply still in 2009 Source: World Bank.

Investment in MICs to reduce sharply Annual fixed investment growth 1992 to 2007, projected Percent Source: World Bank.

Declining Investment Source: Haver Analytics. Indonesia Thailand Russia Venezuela Growth of real fixed investment, Q to Q3-2008, percent yr on yr

Sharp decline in GDP growth expected High-income Developing Source: World Bank. Growth of real GDP, percent

Great depression: Sui Generis US GDP, annual growth Source: BEA volume Price

The (hoped for) drivers of recovery  Turn in the housing cycle  Debt work-outs  Greed  Realignment of exchange rates  Falling commodity prices, declining inflation and space for fiscal and monetary stimulus  The credibility of the state

How the world will change: some (incomplete) longer term implications  Fiscal burden  Monetary overhang  Moral Hazard  Nationalized Banks (and other firms?)  Large reserve accumulation encouraged  Opposition to the free market paradigm and to global integration will increase

Annual GDP growth; Percent Slowing growth across all regions Source: World Bank

Source: World Bank Slowing growth across all regions Annual GDP growth; Percent

Policy Directions as illustrated by G-20 Fighting this Crisis 1. Global Fiscal Stimulus 2. Restraining Protectionism 3. Enhanced IMF Resources Preventing the Next One 1. College of supervisors 2. Managing systemic risk of CDS 3. Oversight of Credit Rating Agencies 4. Enhanced disclosure/common accounting Reflecting New Realities/Enhancing Legitimacy 1. G-20 or G-8? 2. Developing countries in Global Stability Forum, IMF and WB

Commodity markets: prospects and policy challenges  Recent commodity boom was more durable and larger than earlier ones but otherwise classic  While lower than in the recent past, prices are expected to remain much higher than in the 1990s – which should ensure sufficient supply to meet demand  In the right policy environment, commodity wealth can be pro-growth  Policy improvements could reduce both the likelihood of future sharp price hikes and their negative consequences

The recent boom was one of the largest, longest lasting and involved more commodities MUV-deflated US$ (2000=100) Source: World Bank Agriculture Metals Oil

Food Metals and minerals Energy Real prices of internationally traded commodity prices in developing countries, CPI-deflated Indices, Jan. 2000=100 As with earlier booms, the slowdown in global growth has brought the boom to an end

Causes of the boom  Sustained rapid developing country growth  Sharp increase in Chinese demand for metals  Decades of weak prices, during which as much as ½ of global demand was being met from idle capacity  Surge in demand for some food crops for biofuel production

US oil company investment expenditures, Billions of 2006 dollars Real price per barrel, USD 2000 Low prices in the 1980s and 1990s translated into limited investment in the oil sector Source: World Bank

Half of the increase in global grain and oilseed consumption went to biofuels Share (%) of annual increase

Commodity markets: prospects and policy challenges  Recent commodity boom was more durable and larger than earlier ones but otherwise classic  While lower than in the recent past, prices are expected to remain much higher than in the 1990s – which should ensure sufficient supply to meet demand  In the right policy environment, commodity wealth can be pro-growth  Policy improvements could reduce both the likelihood of future sharp price hikes and their negative consequences

Slower population growth and lower investment rates will ease commodity demand Source: World Bank, Linkages Model. Growth of GDP, annual average (percent) High-income countries Developing countries

Average annual growth rate, Demand for most commodities expands less quickly than income but faster than population Source: World Bank

Commodity intensity of GDP, index 1971 = 1 Technological progress increases the efficiency of resource use Source: World Bank.

Reserves of commodities reflect incentives and remain ample Source: World Bank.

Higher prices should provide the incentives to continue ensuring additional supply from non-traditional sources Global oil production, millions of barrels per day Source: Sandrea and Sandrea (2007).

Globally, agricultural productivity growth exceeds demand growth Source: Productivity (Coelli and Rao, 2005); Food demand, FAO (2006) Projected annual average growth rates , per cent

Future policy on biofuels may affect food prices Source: DEC Prospects Group. Oil < $50 Oil > $50

Source: Global Warming and Agriculture: Impact Estimates by Country William R. Cline CGD, 2007 Not Available Losses Gains 25+ % 15-25% 5-15% 0-5% 25+ % 15-25% 5-15% 0-5% Climate Impact : Agriculture Without Carbon Fertilization

Commodity markets: prospects and policy challenges  Recent commodity boom was more durable and larger than earlier ones but otherwise classic  While lower than in the recent past, prices are expected to remain much higher than in the 1990s – which should ensure sufficient supply to meet demand  In the right policy environment, commodity wealth can be pro-growth  Policy improvements could reduce both the likelihood of future sharp price hikes and their negative consequences

Average GDP growth rate, (percent) Commodity dependent countries tend to grow less quickly than more diversified exporters Source: World Bank

Value of per capita primary commodities in exports (US$ thousands) / Share of primary commodities in total merchandise exports (%) Commodity dependent countries tend to be poor, but commodity rich countries tend to be rich Source: World Bank

Average volatility of export revenues, Standard deviation of percentage change Impact of severe shocks on economic progress Source: World Bank

Commodity markets: prospects and policy challenges  Recent commodity boom was more durable and larger than earlier ones but otherwise classic  While lower than in the recent past, prices are expected to remain much higher than in the 1990s – which should ensure sufficient supply to meet demand  In the right policy environment, commodity wealth can be pro-growth  Policy improvements could reduce both the likelihood of future sharp price hikes and their negative consequences

Poverty impacts depend on actual food price increases, which varied widely across countries Percent increase in real food prices, Dec – Dec. 2007

Overall global poverty increased by million Increase in poverty rate, percent of population

Policy responses helped alleviate poverty impacts but may have exacerbated price increase Policies aimed at limiting price hikes –Reducing taxes on food –Increasing domestic food stocks –Imposing export bans –Expanding food subsidies Policies aimed at offsetting the costs to the poor –Expanding cash-transfers –Expanding school feeding programs

Improving our capacity to respond to commodity cycles Domestic policy agenda –Improve targeting of social welfare schemes –Invest in rural infrastructure and agricultural R&D –Be prepared to react rapidly because of long-term costs of even a relatively short bout of high food prices Global policy agenda –Proceed with trade liberalization, including improved disciplines governing export bans –Increase the financial independence of World Food Program –Improve information flows and coordination of food stocks

Global Economic Prospects Commodities at the crossroads Multilingual (English, French, Spanish, Chinese) Interactive forecast website (live Dec. 9)