Special Focus: How important are China and India in the global demand for commodities?

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1 For more information, visit Overview As in the first quarter, global growth of about 2.3 percent (saar) disappointed in the second quarter of 215. In August, equity markets corrected sharply (4 percent from mid-june) in and fell across developing countries. The currencies of emerging and frontier markets depreciated by an average of 7 percent. Prospects of tighter financing conditions, combined with further weakening of commodity prices and slower growth, may continue to test the resilience and policy resolve of developing countries. Chart of the Month Volatility in currency and stock markets climbed sharply in July and August, while bond market movements have been less pronounced. For example, the Chicago Board Options Exchanges Volatility Index, which tracks equity price swings and is known as the VIX, briefly jumped in August to a level not seen since the 28 financial crisis. Volatility has moderated since then, but there are continuing concerns about the slowdown in major emerging markets and speculation about the timing of a U.S. Federal Reserve interest-rate hike. Table of Contents Monthly Highlights.2 Special Focus...6 Major data releases...8 Other reports from Prospects Group...8 Recent WB country reports...8 Annex table: economic developments 9 Annex table: financial markets..1 Indices of volatility Source: Bloomberg. Special Focus: How important are and in the global demand for commodities? Demand from and, to a lesser extent, has accounted for virtually all of global demand growth in metals and coal (and, to a lesser extent, energy) since 2, but considerably less in food commodities. With growth in and expected to exceed high income country growth, combined with much scope for catch-up in metals and energy consumption, their demand for metals and oil may continue to grow robustly. Consumption of agricultural commodities in and should grow broadly in line with global averages. Metals and energy demand tends to be highly income elastic whereas food demand tends to grow more closely in line with population growth. Prepared by a team led by Christian Eigen-Zucchi (3496), comprising John Baffes, Mai Anh Bui, Xinghao Gong, Eung Ju Kim, and Trang Nguyen. DECPG - September 215

2 Monthly Highlights September 215 Global growth: another disappointing year is likely. Global growth struggled to gather momentum in the second quarter of 215, with activity in the Euro Area and Japan slowing, growth in continuing to decelerate, the economies of Russia and Brazil contracting, and those of other major commodity exporters weakening (Figure 1.A). Looking forward, PMI surveys are still firmly in expansionary territory in high-income countries, but point to contraction in developing countries (Figure 1.B). In its June Global Economic Prospects report, the World Bank predicted global growth of 2.8 percent this year, up from 2.6 percent in 214, and 4.4 percent in developing countries, down from 4.6 percent in 214. Against the backdrop of disappointing data outcomes and bouts of turbulence in global financial markets, there is now a likelihood that even the modest pick-up in global growth forecasted earlier for 215 will not materialize, and projections are being revised downwards. Global inflation: still low. Global inflation remains low, reflecting the continued dampening effect of low commodity prices, sluggish wage growth in advanced economies, and overcapacity in. Despite weaker activity, inflation increased or remained elevated in a number of large emerging markets so far this year (Brazil, Russia, Indonesia, Malaysia, Colombia, Chile, Turkey, South Africa, Egypt). This reflected significant currency depreciations, and, to a lesser extent, increases in administrative prices and indirect taxes. The renewed drop in crude oil prices in July/August will help maintain downward pressure on global inflation in coming months (Figure 1.C). United States: recovery on track. Although slowing for the first half of 215 as a whole, growth rebounded from a temporary setback in Q1 to a robust 3.7 percent in Q2 (saar) and has shown further signs of improvements since then. Labor market conditions continue to tighten, with the unemployment rate falling to 5.1 percent in August the lowest since April 28 and monthly employment gains averaging 247, over the past year (Figure 1.D). The U.S. Federal Reserve left the federal funds rate unchanged at the current -.25 percent target range in September, citing dampening effects on the U.S. economy from recent global economic and financial developments. While the expected increase in U.S. policy interest rates is likely to proceed smoothly, there is a risk of market volatility through the tightening cycle. Euro Area: gradually healing. Growth in the Euro Area slowed to 1.4 percent (saar) in Q2, down from 2.1 percent in Q1. Both domestic demand and trade have picked-up in 215, while inflation decelerated unexpectedly to.1 percent in August (y/y), far below the ECB s 2 percent target. The ECB s quantitative easing program is aimed at supporting growth, helping improve credit conditions, weaken the euro, and shelter peripheral economies from contagion risks from Greece (elections in Greece on September 2 returned the Syriza Party to power, without dissidents within the party who had opposed the bailout). Germany, Spain, and Ireland are on track for above-trend growth in 215, while growth remains fragile in France and Italy. Inflows of 4, asylum seekers during the first half of 215 (.2 percent of the European Union labor force) and more in July-September present both political and fiscal challenges but, if absorbed into productive employment, could help lift long-term growth prospects. : financial market turmoil amidst slowdown. Growth in was reported to be 7 percent year-on-year in Q2, supported by stimulus measures. High-frequency indicators for Q3 are mixed, pointing to a continued slowdown in manufacturing activity, including contractions in exports and imports and slowing industrial production growth. Domestic demand-related indicators show greater resilience, with rising services PMI and retail sales growth. In August, a change in the calculation of the RMB reference rate resulted in a 4.5 percent depreciation of the renminbi against the U.S. dollar, the largest two-day drop since the mid-199s. A 4 percent correction of Chinese stock markets since mid-june, after a strong rally during November 214 to mid-june 215, has dented investor confidence. Concerns about the outlook prompted the authorities to ease monetary policy further in the third quarter, lowering the benchmark interest rate by 25 bps to 4.6 percent and injecting more liquidity into the financial system, as well as announce further fiscal stimulus measures. Brazil: deepening recession. Brazil entered into recession in the first half of 215, with a 7.2 percent (q/q saar) contraction in Q2 (Figure 1E). Investment has been falling since Q3 213, with the Petrobras scandal hurting investor confidence and contributing to delays in much needed infrastructure investment. Due to the roll back of subsidies on key commodities and the pass-through from exchange rate depreciation, inflation remains high and is rising. To anchor inflation expectations, the policy interest rate has been raised repeatedly, now set at percent (the highest in nine years). Fiscal consolidation has also weighed on growth, but presents opportunities for structural reforms. A challenging external environment, including falling commodities prices and more difficult financing conditions (especially with the loss of Brazil s investment grade credit rating by S&P) are contributing to the economic weakness. 2

3 September 215 Emerging and frontier markets: more signs of slowing growth. High-frequency indicators suggest that weak growth in Q1 among major emerging markets (Brazil, Nigeria, Russia, and South Africa) has extended into Q2, and is likely to disappoint yet again in 215. With the exception of and Eastern Europe, among others, a majority of developing countries, could see weaker growth in 215 compared with 214, as subdued external demand weighs on exports. A number of oil exporters (Russia, Colombia, Nigeria, Venezuela, Malaysia) are under acute pressure from deteriorating terms-of-trade, while countries reliant on export revenues from metals and other non-energy commodities (Argentina, Indonesia, Chile, Peru, South Africa, Zambia) also face significant headwinds. Q2 growth releases show steep contractions in Brazil and Russia, and a further slowdown in Indonesia, Malaysia, Nigeria, and South Africa. In contrast, the recovery in appears to remain robust. For now, growth prospects in 215 for low-income countries remain above 6 percent. Trade: sharp slowdown. The first half of 215 saw a 4 percent contraction in global trade compared with the second half of 214. The fall was the first since 29 and was driven by a significant contraction in import demand from emerging markets, including from Asia and Central and Eastern Europe (Figure 1.F). Global financial markets: high volatility. Volatility in currencies and stocks increased significantly in July and August, after the 4 percent equity price correction in June and the adjustment to the exchange rate setting mechanism in August in. Global currency volatility continued to rise at the beginning of September, extending steady increases since January (Chart of the Month above). The Chicago Board Options Exchanges Volatility Index (VIX) briefly jumped in August to levels not seen since the 28 financial crisis. A gauge of price swings in U.S. treasuries has risen but movements were far less pronounced. Volatility has moderated since then, but it remains elevated amid concerns about the slowdown in and worries about U.S. policy interest rates. s foreign exchange reserves: falling sharply. With the People s Bank of intervening to steady the renminbi and valuation changes associated with the appreciation of the U.S. dollar, s foreign-exchange reserves fell by $93.9 billion in August to $3.56 trillion, the lowest level since July 213 (Figure 2.A). Almost 4 percent of s reserves are held in U.S. Treasury securities, making the world s biggest investor in U.S. Treasuries. Exchange rates and emerging market equities: mounting pressures. The sharp correction in Chinese stock prices, unexpected depreciation of the renminbi, lingering weakness of commodity prices, and uncertainty about the timing of a U.S. Federal Reserve rate hike sparked a sharp sell-off in emerging market currencies and equities. Half of the 2 largest stock-markets among emerging and frontier economies have fallen 2 percent or more from their peaks, with Peru and leading the decline with falls of more than 4 percent (Figure 2B). The currencies of key commodity exporters (including the Russian ruble, the Indonesian rupiah, the South African rand, the Brazilian real, and the Malaysian ringgit) fell to multi-year lows against the U.S. dollar. Growing investor concerns about political risk contributed to sharp depreciations of the Turkish lira and Brazilian real. Emerging market bonds: modest increases in borrowing costs. Although market turbulence in August was mostly concentrated in equity and currency markets, emerging market borrowing costs also rose in line with heightened riskaversion, with the EMBI spread increasing by 23 basis points since end-july (Figure 2C). Outflows from emergingmarket bond and equity funds have been significant in August, but the pace of outflows has eased and preliminary data suggests that international debt issuance by emerging markets remains steady. Commodity prices: continued downward pressures. Indices of agriculture, energy and metals prices continue to decline (Figure 2D). Oil prices fell below $46/bbl in August, to their lowest level since the 28 crisis. The decline has been driven by an oversupplied global market, partly reflecting the resilience of U.S. shale oil production to date. OPEC production continues to climb, with Saudi Arabia and Iraq reaching record levels recently. The agreement with Iran over its nuclear program could, if ratified, increase Iranian oil exports by.5-.7 million barrels per day by 216. Increasing concerns about slowing growth in the world s second largest oil consumer also contributed to the recent drop in crude oil prices. Similar factors underpin a further slump in metal prices, to their lowest in more than six years. The strengthening U.S. dollar has played a role, as depreciating currencies of commodity producers tend to delay closure of higher-cost capacity. Grain and oilseed prices declined as well in August, down 8 percent and 7 percent, respectively, in response to well-supplied markets and despite El Nino concerns. As noted in the Commodity Markets Outlook, the broad weakness in commodity prices is expected to persist for the rest of 215, before a modest recovery in

4 September 215 Figure 1: Selected Activity Indicators A. Global GDP growth B. Manufacturing PMI Percent Index, +5: Expansion Q Q Indonesia United States United Kingdom Mexico Euro Area Japan South Africa Brazil Russia C. G2 inflation and oil price change D. U.S. job creation (non-farm payroll employment) Year-on-year, percent 12-month cumulative change, millions Percent 5 Inflation (LHS) Projection (LHS) 6 4 Oil price changes (RHS) Sources: World Bank, Bloomberg, Haver Analytics, CPB World Trade Monitor. A: The latest available observation is Q1 for, Brazil and South Africa, Q2 for all others. Data are average annualized growth rates, seasonally adjusted. B: The dotted lines show the trend. The last observation is July 215. C: Consumption weighted average of inflation rates of 16 members of the G2 (ex. Russia and Argentina). Data for Japan excludes the April 214 sales tax effect. Projections are from individual country Vector Autoregressive models. D: Last observation is August 215. E: Last observation is Q F: Merchandise world trade, fixed base 25=1; 6 month-on-month annualized rate of change Developing countries High-income countries Job creation (LHS) Civilian unemployment rate (RHS) E. Brazil GDP growth F. Global import growth Percent Q1-13 Q3-13 Q1-14 Y/Y Q/Q annualized Q3-14 Q

5 September 215 Figure 2: Selected Financial and Commodity Indicators A. s foreign exchange reserves B. Emerging market stock-market indices (in local currency) US$, billions Percent 4,1 1 Change from peaks YTD change 3,9 3,7-1 3,5-2 3,3-3 3,1-4 2,9-5 2,7 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14 Mar-15 Aug-15 Peru Egypt Colombia Brazil Indonesia Turkey MSCI EM Thailand Malaysia South Africa Russia Mexico C. Emerging-market sovereign bond spreads D. Commodity price indices, monthly Basis points US$ nominal, 21=1 5 Taper tantrum Collapse of oil price 18 Energy Metals Agriculture Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Sources: World Bank, Bloomberg, Haver Analytics. A. The latest available observation is August 215. B. YTD is year-to-date change. Last observation is September 1, 215. C. JPMorgan s EMBIG spreads are defined as weighted average of bond spreads of external debt instruments issued by sovereign and quasi-sovereign entities in emerging markets over U.S. government securities. The taper tantrum period covers early May through August 213. D. Commodity Price Indices, 21=1. Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 5

6 September 215 Special Focus: How important are and in the global demand for commodities? Demand from and, to a lesser extent, significantly increased global demand for metals and energy especially coal but less so for food commodities. With growth in and expected to continue outpacing high income country growth, and significant scope for catch-up in metals and energy consumption, their demand is likely to continue growing strongly. In contrast, their consumption of agricultural commodities is projected to grow more slowly, in line with global averages. Differences in s and s demand for commodities are largely explained by different income elasticities and different growth engines in and. s metal consumption soared during 2-14, while s grew at a measured pace. s metal consumption growth alone accounted for nearly all of the net increase in global consumption in 2-14, whereas accounted only for 5 percent of the global increase. As a result, s share of world metals consumption more than tripled from 13 percent in 2 to 47 percent in 214 (Figure 3A). During 2-14, s primary energy consumption tripled, and s doubled (Figure 3B). Together, and accounted for 28 percent of global energy consumption in 214. s and s energy consumption growth has been driven mainly by coal (Figure 3C). Together, the two countries accounted for nearly all of the increase in global coal consumption over the period. Today, consumes half of the world s coal, up from less than onethird in 2, and consumes almost one-tenth, more than double its 2 share. Since 21, growth in Chinese coal consumption has decelerated significantly as a result of slower economic activity, efforts to improve air quality, and increased use of other fuels such as oil, natural gas, nuclear, renewables, and hydropower. Although s share in global oil consumption has more than doubled since 2 (from 4.8 to 11.1 mb/d), it remains a modest 12 percent while s share amounts to 4 percent. In contrast to coal and metals, s and s consumption of most agricultural commodities grew broadly in line with global consumption over the past two decades. As a result, their share of world consumption is virtually unchanged at about 22 percent and 1 percent, respectively (Figure 3D). The exception among agricultural commodities is edible oils, where s share of global consumption rose almost one-and-a-half fold (to one-fifth of the global total in 214), while s share remained around one-tenth. The diverging impact of s and s expansion during the 2s on individual commodity markets reflects different income elasticities between commodities. Consumption of industrial commodities, including metals and coal, tends to respond strongly to economic activity whereas rising consumption of food commodities (especially grains) is mainly associated with population growth. While s and s share of the global population has remained broadly stable at 37 percent, their share of global economic activity has tripled from 5 percent in 2 to 16 percent in 214. With income elasticity of metals consumption exceeding unity, and that of energy estimated at around unity, their demand for primary energy and metals has grown even faster than GDP. In contrast, the income elasticity of most agricultural commodity consumption is typically less than unity. Thus, the response of real food commodity prices to income could be negative depending on the changes in inflation. Edible oils are an exception, since growing incomes are associated with increased food consumption in restaurants and in processed form both with higher edible oil content compared to home-cooked meals. Divergent trajectories of demand between and stem from their predominant growth models, their pace of growth, and relative economic size (Figures 3E and F). Consumption of primary energy and, especially, metals is strongly correlated with industrial production. The industry-led nature of s growth between 2-14, compared with s, partly accounts for s stronger surge in metals consumption. Industry (energy, manufacturing, and construction) accounted for almost half of s growth but only about one quarter of s growth during As a result, s share of global industrial production increased five-fold during the past two decades and is now eight times higher than that of. 6

7 September 215 Figure 3. How important are and in the global demand for commodities? and have played an important role in boosting global demand for metals and primary energy, especially coal. Their demand for food commodities has been more stable, broadly following global averages. These trends are more pronounced for, which has grown faster since 2 than, and pursued a growth model more reliant on industry. The divergence in the demand for commodities is associated with differing income elasticities. A. Metal consumption B. Primary energy consumption Million metric tons Million tons of oil equivalent 6 1, Rest of world 8, 6, 4, 2, Rest of world C. Coal consumption D. Grain consumption Million tons of oil equivalent Million metric tons 2, 1,5 1,2 1,5 Rest of world , Rest of world E. s consumption of key commodities F. s consumption of key commodities Primary energy Oil Metals Grains Edible oils Population GDP IP Percent of world total Primary energy Oil Metals Grains Edible oils Population GDP IP Percent of world total 7

8 September 215 Major data releases Major Data Releases 24 August September215 Upcoming releases: 21 September, October 215 Country Date Indicator Period Actual Forecast Previous Country Date Indicator Period Previous Mexico 8/2/215 GDP (Q/Q) Q2.5%.5%.4% 9/22/215 PMI Manufacturing SEP 47.3 Eurozone 8/21/215 PMI Composite AUG France 9/23/215 GDP (Q/Q) Q2.6% Canada 8/21/215 CPI (Y/Y) JUL 1.3% 1.4% 1.% South Africa 9/23/215 CPI (Y/Y) AUG 5.% South Africa 8/25/215 GDP (Q/Q) Q2-1.3%.4% 1.3% United States 9/25/215 GDP (Q/Q) Q2 -.2% United States 8/27/215 GDP (Q/Q) Q2 3.7% 3.12%.6% Mexico 9/28/215 Unemployment Rate AUG 4.3% UK 8/28/215 GDP (Q/Q) Q2.7%.7%.4% 9/29/215 PMI Manufacturing SEP 47.3 Brazil 8/28/215 GDP (Q/Q) Q2-1.9% -2.% -.2% UK 9/3/215 GDP (Q/Q) Q2.4% Mexico 8/28/215 Unemployment Rate JUL 4.3% - 4.4% Eurozone 9/3/215 Unemployment Rate SEP 1.9% 8/31/215 PMI Composite AUG Indonesia 1/1/215 CPI (Y/Y) SEP 7.2% Indonesia 9/1/215 CPI (Y/Y) AUG 7.2% 7.1% 7.3% 1/1/215 PMI Manufacturing SEP 52.3 Eurozone 9/1/215 Unemployment Rate AUG 1.9% 11.1% 11.1% Turkey 1/1/215 PMI Manufacturing SEP 49.3 Canada 9/1/215 GDP (Q/Q) Q2 -.1% - -.2% Eurozone 1/1/215 PMI Manufacturing SEP 52.3 Australia 9/1/215 GDP (Q/Q) Q2.2%.5%.9% United States 1/1/215 PMI Manufacturing SEP 53. Brazil Industrial Production (Y/Y) JUL -8.9% % United States 1/2/215 Unemployment Rate SEP 5.1% 9/3/215 PMI Composite AUG Turkey 1/5/215 CPI (Y/Y) SEP 7.1% Turkey 9/3/215 CPI (Y/Y) AUG 7.1% - 6.8% South Africa 1/5/215 PMI Manufacturing SEP 49.3 Canada 9/4/215 Unemployment Rate AUG 7.% 6.87% 6.8% Eurozone 1/8/215 GDP (Q/Q) Q2.4% United States 9/4/215 Unemployment Rate AUG 5.1% 5.2% 5.3% Turkey 1/8/215 Industrial Production (Y/Y) AUG.3% Eurozone 9/8/215 GDP (Q/Q) Q2.4%.3%.4% Mexico 1/8/215 CPI (Y/Y) SEP 2.6% Mexico 9/9/215 CPI (Y/Y) AUG 2.6% - 2.7% Canada 1/9/215 Unemployment Rate SEP 7.% Other reports from the Prospects Group Global Economic Prospects June 215: The Global Economy in Transition Commodity Market Outlook July 215 Policy Research Note March 215: The Great Plunge in Oil Prices Policy Research Note September 215: The Coming U.S. Interest Rate Tightening Cycle: Smooth Sailing or Stormy Waters Recent World Bank Country Updates Indonesia: Slower than Expected Growth Russia: Contracted 4.6 percent in Q2 after 2.2 contraction in Q1. Serbia Public Finance Review: Toward a Sustainable and Efficient Fiscal Policy Recent World Bank Research The cost of road infrastructure in low and middle income countries. The impact of Syrian refugees on the Turkish labor market. The middle-income trap turns ten. Impact of property rights reform to support s rural-urban integration : village-level evidence from the Chengdu national experiment. Depreciations without exports? global value chains and the exchange rate elasticity of exports. 8

9 September 215 Economic Developments indicators expressed as %ch y/y, except Industrial Production quarterly figures are %ch q/q, annualized Q1 Q2 Q3 Q4 Q1 Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Industrial Production, S.A. World High Income Countries Developing Countries East Asia and Pacific East Asia x Europe and Central Asia Latin America and Caribbean Middle East and N. Africa South Asia Sub-Saharan Africa Inflation, S.A. 1 High Income Countries Developing Countries East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and N. Africa South Asia Sub-Saharan Africa Inflation is calculated as the GDP-weighted average for all groups. Trade and Finance indicators expressed as %ch y/y, except International Reserves are %ch p/p and trade quarterly figures are %ch q/q, annualized Q1 Q2 Q3 Q4 Q1 Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Exports, Nominal, US$, S.A. World High Income Countries Developing Countries East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and N. Africa South Asia Sub-Saharan Africa Imports, Nominal, US$, S.A. World High Income Countries Developing Countries East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and N. Africa South Asia Sub-Saharan Africa International Reserves, US$ High Income Countries Developing Countries East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and N. Africa South Asia

10 September 215 Financial Markets MRV Q3 Q4 Q1 Q2 Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Interest rates and LIBOR (%) U.S. Fed Funds Effective ECB repo US$ LIBOR 3-months EURIBOR 3-months US 1-yr Treasury yield German Bund, 1 yr Spreads (basis points) JP Morgan Emerging Markets Asia Europe Latin America & Caribbean Middle East Africa Stock Indices (end of period) 2 Global (MSCI) High-Income ($ Index) United States (S&P-5) Euro Area (S&P-35$) Japan (Nikkei-225) Developing Markets (MSCI) EM Asia EM Europe EM Europe & Middle East EM Latin America & Caribbean Exchange Rates (LCU / USD) High Income Euro Area Japan Developing Brazil Egypt Russia South Africa Memo: USA nominal effective rate MRV = Most Recent Value. 2 MSCI Indices for Asia, Africa, and Europe and C. Asia, for 28 are calculated from February-December, due to data availability. 3 Change expressed in levels for interest rates and spreads; percent change for stock market and exchange rates. Commodity Prices MRV Q3 Q4 Q1 Q2 Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Oil price, $/b, nominal Non - Oil Index Metals and Minerals Index Baltic Dry Index Simple average of Brent, Dubai and WTI. 2 Base Date = Jan 3, 211 due to data availability. The Index component combination in the Weekly tables differs from that of the Pink Sheet. 3 Base Date = Jan 4, 21 due to data availability. The Index component combination in the Weekly tables differs from that of the Pink Sheet. 4 Base Date = May 1,