Falling commodity prices and excess capacity in global markets remain significant influences on the relative performance of economies that have systematic biases to these forces.
The Ritesh Anand Column
In recent weeks, falling commodity prices in response to the events in China and Greece added to the pre-existing structural pressures. Commodity prices have fallen 10% in the last two months, and many commodities are back to post-crisis lows. While Zimbabwe benefits from falling oil prices, mineral exports generate over US$2 billion in export revenue and accounts for over 50% of export earnings. Falling commodity prices are likely to place further pressure on Zimbabwe’s ailing economy. Government needs to carefully consider the impact of the fall in commodity prices and consider increasing support to the mining sector.
The decline in commodity prices have divergent effects on economies by directly impacting trade and fiscal balances, inflation, as well as secondary effects on global investment and capital flows. They amplify divergences in financial markets, as countries that broadly benefit from falling commodity prices outperform those that are generally hurt by this fall.
Over the past year, as commodity prices in aggregate have sold off materially, asset markets and exchange rates for major commodity exporters have weakened, while those that have benefited most have been countries that are heavy net importers of oil (and other raw materials). Recent moves further exacerbated these divergences. Financial markets generally discount such changes in conditions before the changes actually occur, so the divergent effects of changes in commodity prices are already clearly apparent in asset prices.
As the graph highlights, equity markets in countries that suffer from falling commodity prices have significantly underperformed in comparison to equity markets in those that benefit from commodity weakness. In the most recent commodity sell-off, the gap between those that benefited and those that were hurt has returned to post-crisis lows, as renewed price declines have put sustained pressure on the divergence that was already unfolding.
Over the past couple of years, and more recently over the past month, commodity prices have fallen considerably reaching 10-year lows in many major commodity markets. In particular, the commodity markets that are more closely linked to incremental Chinese demand such as iron ore, copper and nickel have seen the most significant losses, especially in recent weeks as financial conditions in China have deteriorated, and the possibility of some forced selling having occurred for the need to raise cash after equity losses. Chinese equities have declined by more than 20% since the start of the year.
The outlook for commodity prices remains negative. The International Monetary Fund recently revised the global growth forecast from 3,5% to 3,3% due to weaker-than-expected economic activity in North America, rising bond yields and weaker inflation. Undoubtedly, events in Greece are likely to impact on Europe and there are growing signs of a slowdown in China.
Zimbabwe’s economy is vulnerable to declines in commodity prices. The mining sector accounts for over 15% of nominal GDP, 58% of the nation’s exports, 13% of fiscal revenue and over 50% of foreign direct investment. The mining sector provides employment for over 45 000 people. The sector continues to face systematic challenges that include:
Depressed mineral prices,
Lack of adequate funding,
Frequent power outages,
Escalating operating costs such as power, labour, and consumables, and
High regulatory taxes, fees, levies and royalties.
In light of the sharp decline in mineral prices, government should reconsider its position and outlook on the mineral sector. More needs to be done to encourage investment in the sector while building greater capacity in the energy sector.
The high cost of doing business in Zimbabwe also needs to be addressed. Zimbabwe is no longer competitive in the region in terms of labour costs and the levels of mining fees, taxes, levies and royalties need to be reconsidered.
Investors should be given tax incentives to stimulate growth in the mining sector. Growth forecasts for the mineral sector were revised downwards from 10,8% to -1,9% in 2014. It is likely that the mineral sector will decline further in 2015 unless growth in the sector is urgently encouraged.