Speech

Speech by Rodrigo de Rato,
Managing Director of the International Monetary Fund
At the Energy and Minerals Business Council Meeting
Melbourne, Australia
November 18, 2006

As Prepared for Delivery

1. I'd like to begin by thanking you for your invitation to speak, and congratulating you on organizing this meeting to coincide with the G-20 meetings. Energy and resources issues are critical for the international community, and it is very useful to hear the industry perspective.

2. The International Monetary Fund also has an important and distinct perspective on these issues, as an institution with a global membership and a mandate to promote economic and financial stability. With that in mind, I would like to focus today on four questions, which I think are important for the Fund, for our members, and also for you.

3. The first question is how developments in the global economy are likely to affect demand for energy and for commodities over the next few years. This is an area where the Fund has some expertise. For example, one of the analytical chapters of our most recent World Economic Outlook focused on trends in non-fuel commodity prices.

4. The second question is how developments in energy and commodities markets will affect the global economy, and the economies of individual countries. This is of fundamental concern to the Fund. Well-functioning energy markets are a key element in promoting global economic and financial stability. And volatility in energy and commodities markets can cause balance of payments problems for our members. This is true not only for importing countries, but for oil producing countries and for the many countries that are heavily dependent on non-fuel commodity exports. Such exports account for more than 10 percent of GDP in some 36 countries, and more than 5 percent of GDP in 92 countries. The Fund needs to know where problems are likely to arise, so that we can advise on how to deal with them.

5. The third question follows logically from the second: what energy policies are necessary to promote stability and growth in the global economy? A related question is what macroeconomic policies are necessary to prevent problems arising in the energy and minerals sectors from doing damage to national economies, or to the global economy? I believe it is particularly important that both macroeconomic and energy policies should promote a sustainable balance in the supply and demand for energy.

6. This insight gives rise to the final question: what is a sustainable balance in the long term? How concerned should we be about the risks of dangerous climate change? And what can policy makers do in the face of these risks?

7. Let me begin with the first question, and also give you our view on how the Fund sees the prospects for the global economy. In short, prospects are very good. The world is enjoying a period of rapid growth and low inflation that has not been seen since the 1960s. Global growth has been fueled by continuing worldwide productivity improvements, and we expect 2007 to be another year of solid and broad-based growth. There would be some slowing in the United States, but this would be offset by more rapid growth in the euro area and continued strength in emerging markets, particularly China and India. The implications of this strong growth for demand for energy and minerals are fairly clear. It will not have escaped your notice, I am sure, that some of the countries that are growing fastest are also countries where demand for energy and minerals is also rising most steeply. For example, energy intensity has grown rapidly in China in recent years, and increased demand for base metals in China has accounted for much of the increase in global demand in these commodities.

8. Still, after four years of strong expansion, there are some risks to continued strong global growth. The risk that is on most people's minds at the moment is a slowdown in the United States. The housing market correction now in progress is quite deep, and the situation is likely to get worse before it gets better. So far the effects have been limited to a decline in residential investment, with consumption growth holding up and business investment solid. But the correction in the housing market will undoubtedly have some effect on household consumption. A major cause of consumption growth in recent years has been the increased ease with which homeowners in the United States have been able to use asset price gains to finance higher consumption. Moderation in U.S. consumption growth is not in itself a bad thing: if the United States were to continue to run current account deficits at the present level, it would mean ever-growing external indebtedness. This would raise the risks of a disorderly unwinding of global current account imbalances by a sharp depreciation of the U.S. dollar and, in response, an increase in dollar interest rates. But an abrupt slowing of U.S. consumption growth--if not offset by stronger demand growth elsewhere--would have spillover effects elsewhere that would be a cause for concern.

9. To reduce risks related to sustained global imbalances, as I announced during my last visit to Australia, in June, the Fund has begun a "Multilateral Consultation"--a discussion with several members and groups of members at once--to share analysis of the nature and consequences of global imbalances and to help build a common understanding on policies designed to make needed changes. It will take time to complete the consultation, and for agreed actions taken to produce effects on global imbalances. But if we can make progress on this issue, we can remove a significant risk to global economic prospects.

10. Let me now move on to the second question, the impact of high and volatile energy and commodity prices on the global economy. I will talk first about oil. Over the last few years, the world has lived with high oil prices without serious macroeconomic repercussions. In part, this is because the current episode, unlike in the 1970s, was initiated by demand pressures against the background of strong global activity. Compared with earlier rounds of price increases, the world also has lower energy intensity, which has lessened the impact on growth. More competitive global labor markets and more credible monetary policy frameworks have reduced the impact on inflation. And governments around the world are now, in most cases, passing on oil prices increases to consumers, thus letting the price mechanism work on demand, and easing pressure on budgets. For example, countries such as Egypt and Indonesia have reduced subsidies on oil products and replaced them with targeted social spending.

11. Meanwhile on the supply side, oil-producing countries have also acted to stimulate production and infrastructure investment. For example, the Gulf Cooperation Council countries' investments in upstream and downstream oil and gas sectors are projected to reach nearly a quarter of a trillion dollars over the next five years. This is expected to increase their oil production by around 20 percent and gas production by over 70 percent by 2011.

12. However, we have also seen some responses to high prices which are more questionable. Some oil-producing countries have reacted to higher prices by allowing large increases in their non-oil fiscal deficits, increases which are unlikely to be sustainable in the long term. An increased focus on energy security has also led some countries to be suspicious of investment by foreign companies. But changing the rules of the game too often can have long-term costs. These countries--and producer-country governments which have sought to make short-run gains by taking a larger share of oil and gas revenues--should bear this in mind. There are tradeoffs between immediate revenue gains and maintaining a business environment that encourages competition and investment, and governments should consider these carefully.

13. Meanwhile, prices in non-oil commodities have continued to be high. This has so far worked to the advantage of a number of oil-importing developing countries which also export minerals. But if high prices of minerals prove to be temporary, being driven by past shortfalls in investment that are beginning to be corrected, the same countries may find themselves in a more difficult position in just a few years.

14. This leads then to the third question I posed earlier. What are the energy and macroeconomic policies that are needed to produce a secure and stable energy market, and to avoid price volatility in commodities being carried over into macroeconomic instability? My answer is in two parts, the first relating to energy policies, the second to macroeconomic policies.

15. Governments can help in two respects. First, removing barriers to investment in both extraction and refining capacity can help ensure that there is an adequate supply response. This would help to meet demand pressures that are likely to be felt over the next few years. Second, enhancing transparency in oil markets would help to reduce price volatility. The creation of the Joint Oil Data Initiative is a particularly important step. We at the IMF are assisting in this exercise by including energy statistical practices in our country-level Data Dissemination Standards initiatives and working with member countries to improve reporting of oil-related statistics. Transparency in another sense is also important: the Fund strongly supports the Extractive Industries Transparency Initiative, which is designed to ensure that resource revenues are used well. We urge more countries to participate in it.

16. Macroeconomic policies-budget and monetary policies-are important primarily on the demand side. First, budget policy. Many countries still maintain subsidies on energy products. They are an expensive and badly targeted way of protecting the poor from rising energy prices-much of the benefit goes to the better off. Moreover, by distorting price signals, subsidies can lead to severe misallocation of resources. They blunt incentives to conserve energy and lead to inefficient investment choices. Reducing energy subsidies not only facilitates fiscal consolidation but also encourages conservation and diversification. Only when the price of oil properly reflects its scarcity will consumers and investors respond to price signals in an appropriate and timely way. With regard to monetary policy, central banks should avoid repeating the mistakes of the 1970s, when increases in oil prices were allowed to feed through into higher inflationary expectations.

17. Governments of countries which are currently benefiting from high prices in commodity exports have an opportunity to use the increased revenues to benefit their economies in ways which will outlast the commodities boom. Specifically, some can use the windfall gains to strengthen productive capacity by investing in infrastructure and in human capital. Others can repay debt or accumulate financial assets to give themselves more room for maneuver in the future.

18. Let me now turn to my final question, on the potential long-term risks from climate change, and the appropriate policy response. The link between greenhouse gas emissions and changes in global temperature is now well-established. It is a matter of fact rather than of faith. The consequences of global warming are less certain, but they are expected to be serious. The recently published Stern Report, commissioned by the UK Government, suggests that GDP losses from dangerous climate change could range from 5 to 20 percent of GDP in many countries. If these numbers are borne out by further analysis, they are alarming indeed. In terms of the effect on people's quality of life, including here in Australia, the effects could also be devastating. A book setting out the conclusions of the International Symposium on Stabilization of Dangerous Greenhouse Concentrations, called "Avoiding Dangerous Climate Change," contains many examples. Scientists project that with a 2 degree Celsius rise in global temperatures, 97 percent of coral would be bleached. With a 4 degree rise in temperatures, most Australian agriculture would no longer be viable. And along the way would come the extinction of species and of many varieties of plants, and the loss of Australia's alpine zone. The effects on people's livelihoods and way of life in other countries could be equally profound.

19. I believe governments should adopt a risk management approach to climate change, preparing policies to head off the most extreme changes, and to adapt to changes that are no longer preventable. Indeed, some governments are already doing this under the Kyoto framework. The Australian government also recently announced funding for an effort to encourage investment in new technologies for cleaner fossil energy and renewable energy. This is a promising approach because it could increase overall investment, thus promoting global growth in the short term and mitigating the economic costs of emissions reduction. But encouraging new investments is not likely to be sufficient. The international community has to come together to find ways to limit emissions of greenhouse gases that are both fair and economically efficient. Specifically, I believe that a successor to the Kyoto agreement, making use of either an emissions trading scheme or a tax scheme for greenhouse gases, will be necessary.

20. The Fund's involvement in these issues has been limited up to now, but this may need to change. Most of the policy instruments to address climate change are microeconomic in nature and in the domain of our colleagues in the World Bank and the UN Environment Program. Nevertheless, the Fund could play a role in highlighting the policies that countries are pursuing-or should be-to deal with the collective risk from climate change. Moreover, in the Fund's multilateral surveillance, there may be scope for some assessment of the potential global impact of climate change. These issues are of great concern to some our members, and to us. We are currently working on the question of what is the most constructive role the Fund can play in addressing them.

21. What impact might all of this have on energy markets, and energy producers? I would expect that a successful effort to avoid dangerous climate change would involve measures to reduce demand, measures to create new sources of supply of energy not based on fossil fuels, and perhaps measures to capture carbon produced from existing energy sources. Obviously the existing suppliers of energy could play a big role if they chose to. The solution to this problem must ultimately be a multilateral one, involving many countries, international organizations, and the private sector. The Fund will play its part. I hope that business will also play a constructive role. I know that a number of companies already have begun major initiatives on this issue. I also see meetings like this as a potentially very useful source of advice to governments, and to international institutions.

22. With that, I thank you again for your attention, and I invite your questions.