Two symptoms and one cause: Capital flows, commodity prices and global determinants

Working papers | 2012 | N 57

Abstract

This paper presents and evaluates the hypothesis that emerging countries specialized in commodity production are prone to experience non orthogonal commercial and financial shocks. Specifically, we investigate a set of global macroeconomic variables that, in principle, could simultaneously determine in opposite direction commodity prices and bonds spreads in commodity-exporting emerging economies. Employing common factors techniques and pairwise correlation analysis we find a strong negative correlation between commodity prices and emerging market spreads. Moreover, the empirical FAVAR (Factor Augmented VAR) model developed to test our main hypothesis confirms that this negative association pattern is not only explained by the fact that commodity prices are one of the most relevant fundamentals for commodity exporters bond spreads. In particular, we find that reductions in international interest rates and global risk appetite; rises in quantitative global liquidity measures and equity returns; and US dollar depreciations, tend to diminish spreads of emerging economies and strengthen commodity prices simultaneously. These results are relevant in order to improve our knowledge regarding the reasons behind some typical characteristics of emerging commodity producers, such as their tendency to experience high levels of macroeconomic volatility and procyclicality, or their propensity to be affected from exchange rate overshooting, external crisis and sudden stops. Concerning policy lessons, a key conclusion is the difficulty in disentangle challenges coming from financial openness and structural considerations in emerging economies, such as the lack of diversification of the productive structure or the difficulties of a growth strategy solely based on natural resources. It would be profitable to internalize the connection between these two key variables in formulating and conducting economic policy.

JEL classification: F32, F42, O13