Commodity Prices More Likely to Fall: IMF

Commodity exporting nations should prepare for a future in which commodity prices are far less likely to increase at the pace of the last decade and could in fact decrease, an International Monetary Fund (IMF) report warned on Tuesday, in an update to its World Economic Outlook.

West Virginia Patriot mining operations at the Guston strip mine just outside of Starcity West Virginia.
Douglas Graham | Roll Call | Getty Images
West Virginia Patriot mining operations at the Guston strip mine just outside of Starcity West Virginia.

The IMF report warned the weak global economic outlook suggested that commodity prices were in fact more likely to decline during the latter half of 2012 and into 2013.

Sizable downside risks to global growth also posed risks of further downward adjustment in commodity prices, said the report. Global oil prices were a considerable factor in determining the future direction of commodity prices. If oil prices were to rise sharply as a result of greater supply-side concerns, this could unexpectedly depress global demand and eventually lower the prices of all other commodities, warned the IMF.

If prices were to enter such a cyclical downswing, commodity exporters would likely suffer, given historical patterns. A number of commodity exporters were ready to handle such a downswing, having strengthened their policy frameworks over time or having already adopted operating principles to guide fiscal policy, the IMF said.

But other countries should use the opportunity presented by strong prices now to lower debt levels, strengthen institutions, and build fiscal room to support a timely countercyclical policy response in the event of a commodity price downswing.

While it was still possible that commodity prices were experiencing a long upswing meaning prices might stay close to current historic highs, they may also retreat in response to increasing user efficiency and the unwinding of earlier supply constraints, according to the report.

“Given the unusual uncertainty and the difficulty of projecting commodity market prospects in real time, the best approach is a cautious one that builds buffers to address cyclical volatilities and gradually incorporates new information to allow a smooth adjustment to potentially permanently higher commodity prices,” the IMF said.

The IMF also said countries with higher levels of household debt leveraged against property values faced a longer path to economic recovery than others.

In a second update to the World Economic Outlook, focused on the role household debt played in the financial collapse of 2007 and the subsequent role it has played in stifling economic recovery, the IMF argued countries like the United Kingdom, United States, Spain and Ireland which saw housing market collapses alongside high levels of household indebtedness would take longer to restore economic growth.

“Housing busts preceded by larger run-ups in gross household debt are associated with significantly larger contractions in economic activity. The declines in household consumption and real GDP are substantially larger, unemployment rises more, and the reduction in economic activity persists for at least five years. A similar pattern holds for recessions more generally: recessions preceded by larger increases in household debt are more severe,” the report said.

The report drew a distinction between a simple collapse in house prices and an associated drop in household wealth, arguing that it was the combination of house price declines and pre-financial crisis levels of debt which help to explain the severity of the economic contraction seen immediately after 2007.

According to the findings of the IMF, household consumption fell by as much as four times more in countries where high levels of personal debt were leveraged against the price of property than in countries without the link between high levels of debt and property values.

Moreover, these larger contractions were not simply driven by financial crises. The relationship between household debt and the contraction in consumption also holds for economies that did not experience a banking crisis around the time of the housing bust, according to the report.

Macroeconomic policies were a crucial element in dealing with excessive contractions in economic activity during periods of household deleveraging, according to the IMF.

Monetary easing in economies where mortgages typically have variable interest rates was one policy lever on which central banks could pull to reduce mortgage payments and avert household defaults.

But economic stimulus had its limits, the IMF admitted. Once nominal interest rates get close to zero it becomes impossible to implement further rate cuts, and high government debt may constrain the scope for deficit-financed transfers of debt.

That said, government policies targeted at reducing the level of household debt relative to household assets and debt servicing relative to household repayment capacity could mitigate the negative effects of household deleveraging on economic activity, suggested the report.

In particular, household debt restructuring programs, such as those implemented in the United States in the 1930s and in Iceland today, could significantly reduce the number of household defaults and foreclosures, it said.

The IMF report comes on the same day that the one of the UK’s biggest mortgage lenders reported an increase in property values in March. Halifax - part of the state owned Lloyds TSB Banking Group - reported a 2.2percent rise in house prices in March. It also comes a week before the IMF holds the first of its Spring meetings on April 20-21.