News in Charts: Assessing China’s dominance in global commodity markets

The high rates of economic growth that China experienced between the beginning of the 21st century and the start of the pandemic have underpinned a substantial increase in its demand for commodities. Opening up trade, rapid urbanisation and industrialisation have benefited China greatly. Expansion of its manufacturing sector has imposed heavy requirements on China’s power generation network, while rural-urban migration has meant greater investment in transport and utilities infrastructure, not to mention residential construction. Demand continued to increase during and after the global financial crisis (GFC), on the back of strong government stimulus in housing and manufacturing, with this process continuing on.

However, the impact of Chinese demand on commodities differs. The main categories in which Chinese influence has been disruptive is metals and energy — with its share of merchandise imports rising from 6% and 7.4% respectively in 2001, and from 13.5% to 20.6% in 2022. In contrast, China’s share of food and agricultural raw materials imports is much lower, for two main reasons. First, food commodities are not highly traded in international markets (only 15% of world production is). Second, for many years now, China has been implementing a strategic policy of self-sufficiency in key cereals such as rice and wheat, leading world production currently in those two commodities.

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In tandem with China’s high GDP growth rate and the subsequent rise in commodities demand, global commodity prices saw a period of sustained increases. From the turn of the century up to the GFC, energy prices tripled, metal prices doubled, and food and agricultural prices increased by 94% and 57% respectively. This period, known as the ’commodity supercycle‘ of the 2000’s, can be defined as an extended period during which commodity prices were well above their long-run trend. Prices fell as a consequence of the GFC, but then made a strong recovery that peaked around 2014, after which the price of crude oil collapsed. The past few years have seen a notable rise in commodity prices, but the nature of this event is associated with negative supply shocks related to the COVID-19 pandemic and geopolitical events, such as the war in Ukraine, rather than an increase in commodities demand.

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Fathom has estimated the sensitivity of commodity prices to a shock in Chinese demand, often defined as elasticities, that can be used to gauge the magnitude of price changes expected for a particular commodity were China to experience a demand shock (defined as a significant deviation of growth from its long-term trend). Fathom derived these elasticities from a study by the IMF, scaling them by China’s share of global demand. Fathom’s analysis shows that commodities related to the construction sector, and for the manufacture of key industrial and consumer products, have higher price elasticity. In other words, they are more sensitive to changes in Chinese demand. On the other hand, energy, agricultural raw materials and food are notably less sensitive to shocks in Chinese demand. An important caveat of this exercise is that elasticities were calculated at a global level by the IMF, and thus do not take into account China-specific characteristics. Furthermore, the study makes use of official GDP statistics, which may have altered the true picture. All of this may have affected the elasticities for certain commodities — notably energy.

The Chinese economy is likely to slow further over the coming years, and some countries will be more affected than others by this. The ones likely to be more affected are those that produce and export some of the commodities that China demands more of. These countries have traditionally been emerging and developing economies, which have benefitted from China’s rising growth over the past two decades, but given China’s weak growth prospects they could be seen as more exposed to negative shocks going forward. The high sensitivity of these countries to the Chinese economy can be exacerbated if they have pre-existing macroeconomic or financial vulnerabilities, which can be captured using Fathom’s Financial Vulnerability Indicator (FVI) — a world leading country risk model that provides financial, currency and sovereign crisis probabilities for 175 economies.

The FVI currently flags Chile as one of the key commodity exporters with the highest sovereign score. Chile is the world’s largest producer of copper and second largest of lithium, accounting for almost 10% when expressed as a share of Chile’s GDP. Therefore, it is to be expected that price developments in these commodities greatly impact the country’s fiscal position. This has been the trigger for Chile’s high sovereign FVI score — both copper and lithium prices fell sharply in international markets during 2022, which has resulted in Chile’s current account balance worsening. Going forward, as China’s growth slows further, its demand for lithium and copper could also be negatively affected, and so Chile will be observed more closely in terms of financial vulnerability going forward.

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Finally, another interesting country to observe is Zimbabwe, which exports nickel, lithium and chromium — three key China-sensitive commodities. The FVI flags this country as vulnerable to a currency crisis, notably due to a deteriorating budget balance and a very sharp fall in the level of reserves held by the central bank. These reserves increased massively during 2021, as a result of the Special Drawing Rights (SDR) issued by the IMF to developing economies in response to the COVID-19 pandemic. However, these were drawn down quickly to pay for health and social protection investments, and for infrastructure developments, with the latest IMF assessment indicating that the country no longer has adequate levels of reserves.

Notably, the government has recently launched a new gold-backed currency, the ‘Zimbabwe gold (ZIG)’, after the ’Zimbabwe new dollar (ZWL)’ depreciated by a whopping 4600%, amidst higher volatility and soaring USD demand. Only time will tell whether the ZIG will solve, once and for all, the currency issues of Zimbabwe.

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The views expressed in this article are the views of the author, not necessarily those of LSEG.

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