What would a commodity crash mean for India? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

What would a commodity crash mean for India? 

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In this issue:
» Will India benefit from ample global gas supplies?
» Will India's Food Security Bill be a disaster?
» The noose around the sugar sector eased partially
» Is the Cyprus crisis a boon for Russia?
» ...and more!

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The world economy saw sky-high commodity prices as the commodity supercycle peaked out in the previous decade. Some believed that it would go on owing to reckless money printing by central banks across the globe, particularly the US. For a while, that was true. Each of the first two rounds of QE did send commodity prices soaring by more than 25%. But the time the third round was announced, commodity prices posted a decline. It started becoming clear that commodity prices cannot be driven by loose monetary policy alone.

Now, there is increasing evidence that the commodity supercycle has indeed come to an end. An article in the Economic Times points out some intriguing facts on major global commodities. Crude oil prices have touched a five-month low. Silver and copper prices are at their eight-month lows. Corn prices have witnessed a very steep plunge, the steepest in almost a quarter century! So is the case with several other commodities.

Supplies of major commodities have started matching or even exceeding demand. As a result, speculative money is losing interest in commodities as they don't expect substantial gains. The author highlights the fact that commodity assets under management are now 9% below the record levels of US$ 451 bn reached two years ago.

Is a major commodity crash in the making? It would be too premature to answer that. But it does seem that commodity prices are finally in an easing mode.

If this happens, this is going to be great news for the global economy. Consumers across the world could witness some relief in the form of lower prices.

Coming to India, this would definitely be a big positive. Given our huge reliance on imports of crude oil, palm oil and gold, any easing in prices would provide the much-needed relief on the current account deficit front. Moreover, expenditures that get locked out in fuel subsidies could be channelised towards productive investments.

Are the days of high inflation over for India? We are not too optimistic yet. One of the major drivers of high inflation has been increasing food prices. This is on account of excessive wastage, supply-side bottlenecks, and heavy dependence on monsoon rains. The Western region of India is currently witnessing the worst drought in several decades. Moreover, the ambitious Food Security Bill will also put significant pressure on government finances.

In conclusion, commodity prices going down are certainly a great relief to India. But will we get the full benefit of it? Much will depend on government's actions and policies.

Do you think Indian consumers will get some respite from declining commodity prices? Please share your comments or post them on our Facebook page / Google+ page

01:23  Chart of the day
The natural gas segment has witnessed a revolution with huge shale gas discoveries in the US. The supply glut has softened prices that now range around US$ 2 per million metric British thermal unit (mmbtu) to US$ 3 per mmbtu in the US. In contrast, even at subsidised rates domestic gas price in India is pegged at US$ 4.2 per mmbtu. The cost of imported gas is around three to four times of that. If the recommendations from Rangarajan-led committee are acted upon, the domestic gas price may even double. This may seem to be against the natural economic law that suggests that prices for a commodity should ease as supply goes up.

The chart of the day shows the countries with the highest remaining recoverable natural gas reserves (including conventional and unconventional sources). The total world recoverable reserves stood at about 752 trillion cubic metres at the end of 2011. With ongoing new discoveries, the supplies are increasing.

However, when it comes to India, there are further dimensions to look at. We are consistently witnessing a decline in the domestic gas supplies. At current prices, upstream energy companies have hardly any incentive to invest in further exploration of domestic gas. This has made the domestic supply scenario very bad. As such, it is through costlier imports that domestic gas demand is being met. Once gas is transferred across the nations through pipelines in the form of Liquefied natural gas (LNG), there are other cost components that get associated. These include investment in liquefaction plants, transportation costs etc to mention a few. Hence, it will be unfair to compare the gas prices in India with natural gas price in US.

While discovery of shale gas reserves is a positive for the sector, it requires significant investment with regards to time, technology and money before the gas can be consumed. Besides, there are some serious environmental concerns that need to be taken care of. To be self sufficient in the long term, we need to incentivise the energy sector to ensure domestic and foreign investments in gas projects. And for that, gas price hike may be required. Once the supply gets unlocked, prices will be rationalised in the long run.

Data source: DNA Money
*At the end of 2011

Just like the Right to Education Act, the Food Security Bill was expected to be the UPA government's trump card. In a country like India offering free food to the poor is not just considered generous but a divine act! Blinded by vote bank greed, the policy makers rushed into passing the bill without considering financial implications. Financial constraints in implementing the scheme are not the only flipside. There is wide consensus that Food Security Bill will hardly solve the problem of malnutrition in India. For it is not that India is lacking in grain produce. Instead there is surplus produce which the country is not even exporting. But lack of appropriate warehousing facilities have led to grains rotting in the open. Moreover, the public distribution system (PDS) has been a complete failure and rife with corruption. The Food Security Bill also negates the possibility of success of cash transfer scheme that may work better for some states. Steep rise in agri labour wages, fertiliser costs and tendency to cultivate cash crops are additional hurdles. But for the government, any populist legislation that wins votes is a winner!

After petrol, it is sugar now. It seems the government is in a decontrol mode. Though for sugar de-control is partial it is a step in the right direction. After the recent sugar de-control, the mills are free to sell their produce in the open market. Also, they are no longer obligated to sell their produce to the government at subsidized rates. The quota system has also been done away with meaning that the mills can sell as much sugar as they want in the market. Earlier government used to decide the amount of sugar that is to be sold in the open market.

We feel that decontrol will be beneficial to the industry as they will now be able to fetch a better price in the market. However, there is a lingering fear that this may lead to increase in sugar prices. But the government has assured that it would not happen. All states will continue to sell sugar at subsidised rates through ration shops. However, for that, they will procure the produce from open market at market determined prices. And the central government will subsidise the states for the difference in pricing. The said move is likely to double the government's sugar subsidy burden. But the industry will benefit as it will be able to freely price its produce. Nonetheless, it would be interesting to see how the government finances the subsidy considering that fiscal deficit is already above comfort zone at the moment.

When the bank crisis in Cyprus erupted, Russians were one of the largest hit as they held significant amount of bank deposits in the country. What made matters worse was the controversial decision where the bailout money was raised by levying a charge on depositor accounts. So prima facie it appears that Russia has received a raw deal.

But an article in New York Times states that this may not necessarily be the case. And that the Cyprus crisis may be a boon in disguise for Russia. How is that the case? For starters, some of Russia's overseas deposits which were hidden on account of dirty money from corrupt deals will be forced to come back into the country. In political terms, Russia can use this crisis as a platform to further its image, while the European Union struggles to not fall apart. One of the reasons why so much of Russian money has been out of the country has been because it has not really been a friendly investment destination. In such a scenario, will the Cyprus crisis compel Russians to bring money back into the country? Or will they have a look at other overseas destinations? One will have to wait and see.

Majority of the global stock markets fell over the week. After rallying on improving economic data and Fed's promise of continued monetary stimulus, the US stock markets ended lower this week on weak employment data. The US jobs report showed that employers hired at the slowest rate in the last nine months.

The European stock markets were also hit by poor US jobs data. This coupled with the warning of a deeper recession by the European Central Bank led to sharp downfall in all major European indices.

Only the stock market in Japan posted a 3.5% jump over the week. The strong revival was after the Bank of Japan (BoJ) announced a huge monetary stimulus to infuse US$ 1.4 trillion in to the economy in less than two years. However, the other Asian equity markets declined on weak economic signals from US and Europe. The Chinese market was marginally down by 0.5% as increase in the non-manufacturing Purchasing Managers' index in March aided in quelling the gloom to some extent.

Even the Indian stock markets ended the week in the red, down by 2% on slowdown concerns. India's manufacturing sector witnessed the slowest rate of expansion in 16 months in March as power outages hampered production and led to decline in new business orders.

Source: Yahoo Finance, Kitco

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    Equitymaster requests your view! Post a comment on "What would a commodity crash mean for India?". Click here!

    2 Responses to "What would a commodity crash mean for India?"


    Apr 7, 2013

    Though it may result in lesser import bill (max 15%), it may not mean anything to the man on the street, for the traders may not pass the benefits or he has to spend more other things food items or house-hold goods (including communication / computing devices), education or housing.



    Apr 6, 2013

    Dear Sir,The Banking Industry in Cyprus, a small country has failed and Russians who have black money are affected, is now a well known fact. Cyprus is a Tax Haven giving asylum to Black and Looted wealth. There are dozens of such Tax Havens around the world offering to keep Black Money. Those who deposit money to escape scrutiny from their Home Country do not know how well the banking Industry is regulated and governed in those countries. Given the levels of secrecy surrounding such transactions, it is high time the hoarders realize some day similar fate may befall the other Tax Havens also. Can I have the views of experts in your panel?

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