Just A Sneeze--Or Dutch Disease?

Includes: ENZL, EWA, EWC, NORW
by: AllianceBernstein (AB)

By Guy Bruten

The changing dynamics of the commodity boom imply leaner times ahead for producer countries. Investors, however, should be wary of tarring them all with the same brush, as we believe such countries will offer different risks and opportunities as the cycle unwinds.

China is moving to a slower structural growth rate, commodity suppliers are bringing more capacity on stream and prices for some commodities are in decline.

As we discuss in The Commodity Supercycle and the Risks of “Dutch Disease,” these trends suggest that the 15-year-old commodity boom is entering a phase in which price growth tends to fall short of its long-run trend, and the risks of sharp price declines are likely growing.

Given the different ways in which they responded to the supercycle’s upswing, we think it likely that producer countries will respond differently to the downswing, too. This is an important point for investors to consider as they assess how these countries are likely to perform after the boom peaks.

The classic risk for commodity-exporting countries caught up in a boom is that they will succumb to “Dutch disease”—that is, the structural damage caused to an economy by the crowding-out effect of the boom on non-resource sectors (this can happen, for example, if the boom forces a country’s real effective exchange rate, or REER, to rise, disadvantaging its manufacturing-export sector).

By looking at the potential for Dutch disease in five producer countries—Australia, Canada, Chile, New Zealand and Norway—we can assess their relative vulnerability to a commodity downturn. A logical place to start is to look at the effect of the current boom on their respective economies.

The display below illustrates this through each country’s terms of trade, which capture the size of the commodity sector as well as the extent of the price shock. The results differ quite widely. Australia is the most affected, while Chile and Norway are close behind and all three outstrip New Zealand and Canada by a wide margin.

These rankings change significantly when we look at how the shock affected each country’s REER, as shown in the display below. While Australia again comes out on top, Canada and New Zealand come second and third respectively. By contrast, the REERs of Norway and Chile have changed little, reflecting these countries’ use of stabilization funds to absorb the shocks that translate elsewhere to pressure on monetary policy and REERs.

Similar observations apply to capital spending and external accounts. Capital spending rose sharply in Australia, Canada and New Zealand. Some of the spending went into resource projects, but much of the income boom spilled over into housing, implying more pressure on monetary policy to contain emerging inflation pressures, and hence more upward pressure on the countries’ REERs.

Norway and Chile have generally run current account surpluses, leading to a major improvement in their net external positions; in Australia and New Zealand, however, income gains have spilled over into sharply higher imports, and the net external positions have shown little improvement.

With such big differences among commodity exporters during the upswing of the boom, it seems sensible to expect differences among them on the downswing, too. For this reason, it may be simplistic to belabour the point, suggested by the evidence, that Australia is the country likely to be affected most by a commodity downturn.

What we can say, however, is that it would be unwise, in light of these differences, to lump all commodity exporters into one bucket.

- Guy Bruten is Senior Economist—Asia Pacific at AllianceBernstein Australia.

Disclaimer: The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.