Commodity Prices in Argentina: What Moves the Wind?

There is a widespread feeling that favorable winds have been blowing in the direction of many emerging economies. This “tail wind” has essentially two components: low international interest rates and high prices of several commodities. But in contrast to the 90s, nowadays the emphasis is put on the second component at least in South America and, particularly, in Argentina. In the latter case, much of the recent growth performance is usually attributed to the current situation of soaring primary products prices and terms of trade. From the Argentinean perspective, commodity prices influence the economy through several channels. In general, a significant commodity dependence shapes almost every policy stance in a small and open economy. Price volatility imposes not only macroeconomic restrictions over fiscal, monetary, and exchange rate policies; but also affects consumers purchasing power, private and public savings, commercial openness strategies, agricultural policies and investment allocation among economic sectors. This paper investigates which are the drivers of a price index that includes the eight main commodities exported by Argentina (expressed in real terms) employing a VECM. This allows us to establish a long run relationship between commodities and its fundamentals and to study the short run dynamics after different shocks. The drivers we consider are the role of the real exchange rate of the United States, the global income, the real interest rate and a global liquidity measure. Theoretically, commodity prices should rise with global income, and fall with real exchange rate appreciation of the dollar and with real interest rate. However, these theoretical predictions have not fully mirrored in the empirical studies. Regarding the evolution of the main commodities exported by Argentina, we observe in 2007 that our nominal index was 43% higher than the respective mean of the whole period (1986-2007). This figure decreases to 12% when real prices are considered. Indeed, the data showed a peak in 2007 which is not too different to those observed in 1995-1997, and they are clearly lower than the prevailing ones during 1988-1991. In a nutshell, commodity prices were undoubtedly passing through a positive cycle up to 2007, although the belief of a historical unique boom does not seem supported by the data. The empirical model shows that the real effective exchange rate of the US shows a negative and significant coefficient in the cointegration equation. This is consistent with previous empirical results which suggests that dollar depreciations have been associated with rises in real commodities prices. As theory predicts, the elasticity lies between zero and minus one. Regarding short run analysis, we observe an overall negative but small response. In the long run equation, the real interest rate coefficient appears to be negative indicating that rising financial costs of inventories increase current supply and reduce spot prices. In the same way, interest rate could work as a predictor of an economical slowdown which results in future supply excess that depresses current prices. Besides, short run dynamics of commodities to one standard shock in this variable exhibits an accumulated drop of approximately 1.7% after eighth quarters. Real international liquidity seems to be a significant determinant of prices in the long run as well as in the short run. A positive shock in liquidity generates a cumulative change in commodity prices of about 6.6% after two years. The impact of demand for raw materials which is approximated by the industrial production index of OECD countries plus China and main emerging Asian economies presents a non statistically significant coefficient in the long run relationship. However, the short run impulse results positive and significant during the first five quarters, but then this effect tends to vanish. Since our index is dominated by agricultural commodities, it is possible that this short run result is consequence of an immediate reaction to an unexpected demand increase. Supply would only be fixed in the short run, but quite flexible in the medium and long run. As a general conclusion of this paper, it seems that most of the macroeconomic variables that determine commodity prices are the same influencing capital flows from the center to the periphery. The US real exchange rate, the international real interest rate and the global liquidity coordinate exogenous cycle in countries like Argentina via two channels: the commercial and the financial channel. These variables induce a positive correlation between channels which increases exogenous volatility coming from the center. Since international factors dictating commercial and financial cycles in an small open economy are the same, it is troublesome to cushion real commercial shocks using international financial markets. If declining prices were caused by monetary tightening and dollar appreciation it would be more difficult to finance the shortfall in domestic income with external finance. This suggests that a good domestic strategy should develop domestic measures to smooth external cycles when prices are in high levels. We point out there are policy recommendations that belong to the macroeconomic field and other that are structural. The objective of the first ones would be to reduce volatility, smoothing transitory elements. Measures oriented to this end are, for instance: keep a relatively flexible exchange rate; accumulate international reserves; avoid real exchange rate appreciation with respect to its long run equilibrium; implement a taxes-subsidies system for exports accordingly the phase of external price cycle; establish fiscal funds to stabilize expenditure; and adopt countercyclical regulations of short term capital flows. Structural policy measures should try to deal with the declining trend in commodity prices. Thus, increasing diversification in commodity exports as well as enhancing production chains for each raw material through an industrialization process would help to reduce price volatility. Other areas of policy would focus on building infrastructure and encouraging the development of local financial instruments to diminish future uncertainty. Finally, coordination between producer countries could collaborate to stabilize markets.