The Treasury’s Commodity Price Forecast is Doomed to Be Wrong

Shanghai has erected walls to separate closed neighborhoods from those that are still open.Credit:Bloomberg

China’s economy was already slowing before the outbreaks of the Omicron variant of COVID that were now sweeping through some of its biggest cities. Its modest, by historical standards, target of GDP growth this year of around 5.5% already looked hugely ambitious before it began locking down key industrial hubs.

For exporters of commodities – particularly iron ore – China’s response to its economic challenges is as important, if not more important, than whether its GDP growth is above or below 5%.
It is doing what it has historically done in response to economic threats and trying to put a floor on growth with fiscal and monetary stimulus.

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The stimulus in China has historically been directed towards investment in infrastructure and property markets. The implosion of its property sector after a crackdown on leverage in the property development sector last year has led to attempts this year to stabilize the sector through lower interest rates and incentives for potential buyers.

This should mean that iron prices will remain high for some time, although COVID, given China’s “zero-COVID” approach to the pandemic, remains a wild card.

Similarly, Russia’s invasion of Ukraine is both good news for Australian commodity producers, whether commodities or agricultural commodities, and a threat.

The prices of most commodities, especially energy, have soared since the West invaded and imposed the toughest financial sanctions ever imposed on a major economy. Russia is a force of global importance in the fields of energy, metal mining and agriculture.

Disruptions to commodity flows generated by the conflict in Ukraine and sanctions are likely to generate more benefits than harm for Australian miners, farmers and government revenues, but these impacts and their duration are uncertain, as are the longer-term implications of Europe’s efforts to shed its dependence on Russian energy or the impact of sanctions in bringing Russia and its resources closer to China.

In the short term, the combination of stimulus measures from China and the impact of sanctions against Russia on raw materials could have very significant effects on federal government revenues.

Treasurer Josh Frydenberg at the Press Club on Wednesday.

Treasurer Josh Frydenberg at the Press Club on Wednesday.Credit:James Brickwood

In the budget documents, the Treasury indicates that if iron ore and coal prices remain high until the end of the September quarters (rather than falling back over the next six months), then decline over the next six months. through the end of March next year to reach their long-benchmarks, the value of nominal GDP would be $135.2 billion higher between 2021-22 and 2024-25 and tax revenue would be $29.5 billion higher. billions of dollars.

The inherent volatility of commodity prices and the volatility of the geopolitical environment provide good reason for the Treasury to use very conservative commodity price forecasts. The broader uncertainties in the global economy – beyond China and Russia – make this caution all the more appropriate.

Prior to Omicron, the global economy was recovering from its pandemic lows, fueled by unprecedented fiscal and monetary stimulus. The supply chain bottlenecks the pandemic had generated were beginning to be resolved, consumers were spending their government largesse, and businesses were generating strong profit growth.

Inflation, however, was taking off – the rate is close to 8% in the United States – interest rates in developed economies look set to rise rapidly, financial markets have been quite fragile and volatile and There are growing fears that sharply rising global interest rates, a slowing China, the fallout from the war in Ukraine, Omicron and sanctions on Russia will undermine the recovery.

A global economic slowdown could pull the rug out from under demand and commodity prices and remove this prospect of windfall revenues for businesses and governments thanks to continued high commodity prices and a sharply lower fiscal outcome. better in 2022-23 than the Treasury expects.

The range of variables to consider and the scenarios that could develop, even in the short term, make the task of predicting commodity prices – or fiscal outcomes with any accuracy – nearly impossible.

Hoping for the best – which actually seems like the most likely scenario for commodities – but planning for the worst, as the Treasury does, is the only rational approach.

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