Lenders must act to avoid another round of commodity defaults

“Give them bullets. I want to be back in soon,” said the Venezuelan president Carlos Andrés Pérez, who had shortly earlier been hiding under an overcoat as rebel soldiers tried to storm the Miraflores Palace.

The attempted coup of February 1992 was the dramatic culmination of a sequence of collapsing oil prices, financial turmoil and the “Caracazo” anti-austerity riots of 1989 that left hundreds dead.

Venezuela defaulted on its debts in 1990, 1995 and 1998, following a well-established pattern. “Spikes in commodity prices are almost invariably followed by waves of new sovereign defaults,” note Carmen Reinhart and Kenneth Rogoff in their authoritative survey of global financial crises.

Countries dependent on commodity revenues run up their budgets during the good times. Their currencies are buoyed by exports, and they surf domestic housing and credit booms.

When – as now – resource prices fall, investment in new projects dries up, a falling currency raises the burden of foreign currency debts, local banks may collapse and need rescue, and the government may be forced to default on domestic or external debts. Even the prudent borrowers suffer from a general withdrawal of confidence and credit, spreading the contagion.

The 1980s were a “lost decade” for exporters of oil, minerals and agricultural products across Latin America and Africa, exacerbated by high interest rates.

In 1997-98, the Asian crisis drove oil prices to $10 per barrel, spreading the default pain to Russia. And in March this year, Ghana, a new oil exporter which spent its windfall before earning it, agreed to a $1 billion IMF rescue package.

Who are the vulnerable commodity exporters these days? Venezuela has so far avoided default by mortgaging oil earnings, but it seems doubtful this can continue. Its Latin America neighbours, Colombia, Mexico and Brazil, are oil exporters with sizeable current account deficits. Brazil faces not only falling prices for its petroleum, farming and iron ore, but the huge debt burden, corruption and mismanagement of the state oil firm Petrobras.

Elsewhere, Russia is hampered not only by lower prices for oil, gas and metals, but also by sanctions, although a weaker rouble improves competitiveness and it has sizeable financial reserves. Malaysia is suffering from lower petroleum earnings, high foreign debt and a corruption scandal. Even the well-run diamond producer Botswana is under pressure.

Four ministers wrote a letter in early October to Iran’s president Hassan Rouhani, warning him of a “condition of crisis in the economy”. Its banks, reported in March to have $32 billion in bad loans, may need bailing out. Next door, Iraq’s desperate fiscal situation is worsened by the costs of the ISIL conflict.

Among developed countries, Australia and Canada, which avoided recession in 2008-09 and have been through epic housing booms and run-ups in wages, confront lower prices for oil, gas, coal, iron ore, gold and uranium.

What effect would such crises have on commodities markets? Initially, further financial turmoil would hit growth in the affected countries, reducing their own commodity demand.

They might cut back on spending on new projects, as Brazil is doing. But once in operation, mines and oilfields will continue, even increasing production in a desperate attempt to stay afloat. More likely, bailouts encourage the opening of the natural resource sector to foreign investment and so increasing output and efficiency, as Venezuela did in the mid-1990s, and Mexico and Iran are pursuing now. This further squeezes competitors.

The one hope for rival producers is if a major oil exporter or miner slips into political turmoil that disrupts output. Venezuela’s output of almost 3 million barrels per day was halted during 2002-03 by a general strike aimed at unseating the president Hugo Chávez – leader of the 1992 coup attempt.

But gambling on the misfortunes of others is not a strategy. Sensible action by lenders and governments now can ease the risk of another wave of commodity defaults.

Robin Mills is the head of consulting at Manaar Energy, and author of The Myth of the Oil Crisis.

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