But lower commodity prices are also possible, with potentially serious consequences for commodity exporting countries
The recent decline in commodity prices (oil and metals are down 8.4 and 4.7 percent in the last month) attests to the possibility that commodity prices come down sharply in the projection period. The price rises of the past decade reflect the influence of a wide range of factors (see the 2009 edition of Global Economic Prospects http://go.worldbank.org/G8LVQDRH70 for a detailed discussion), but may have reached unsustainable levels.
Figure 19. Falling natural gas prices have created large arbitrage opportunities
Source: World Bank.
Notwithstanding the sharp declines in May, since 2000, oil prices have increased by 268 percent, metals and minerals prices by 245 percent and agricultural prices by 165 percent. While demand for these products can be inelastic in the short run, such large price swings unleash very powerful economic forces, in the form of substitution on the demand side, increased supply (via increased exploration and investment), and technological change.
All of these forces are at work currently (see box Comm.1 in the commodity annex), most obviously in the energy sector where OECD oil demand has declined 8 percent over the past 5 years, and where new technologies (such as shale gas and liquids extraction techniques) have brought large new supplies to market. These new supplies have opened up large and potentially destabilizing price differentials between natural gas and crude oil (figure 19) that could contribute to a longer-term fall in oil and other commodity prices.
If commodity prices were to come off their current highs there could be potentially serious consequences for the external and internal imbalances of commodity exporting economies, who depend upon commodity revenues to finance a large share of their imports and government expenditures.
Table 5. Impact of lower commodity prices on developing country GDP, current and government accounts
Impact of a 20% fall in various indicators
Source: World Bank
Table 5 reports the simulated impact on developing country commodity exporters of a 20 percent decline in commodity prices. The first three columns of the first set of simulations show the impact on: the level of GDP (after two years); the government balance as a percent of GDP; and the current account balance as a percent of GDP, under the assumption that oil prices fall by 20 percent and that other commodity prices fall according to their own sensitivities to the fall in oil prices (oil prices are an important determinant of other commodity prices). The fourth through sixth columns report the impacts from a simulation that assumes oil prices do not change, but that other commodity prices decline by 20 percent.
In the first set of simulations, alternative financing is assumed to be found so that the government revenue shortfalls caused by the crisis are made up for via borrowing (external or domestic). In the second set of results, revenue shortfalls are assumed to be binding such that government expenditure must be cut by the decline in government revenues from the earlier simulation.
In the first scenario government deficits rise by close to 1 percent of GDP in the Middle-East and North Africa because of lower oil prices. However, GDP effects are relatively small —in part because the government is assumed to continue to maintain spending at earlier levels via increased borrowing. Impacts in the non-oil commodity price simulation are smaller because these commodities tend to be much less important sources of revenue for governments at the aggregate level.
In the second set of results, all of the lost government revenues from the first are assumed to be deducted from government spending. Here GDP effects are much larger, but because of demand compression current account effects are more muted. Impacts for individual countries are of course larger, with GDP in Paraguay, Uruguay, Argentina, Kyrgyz Republic, Belize, Chile, and Uzbekistan (all important extractive commodity exporters or countries with close links to commodity exporters) projected to decline relative to baseline by more than 2 percent in the non-oil with government budget constraint scenario.