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The World Bank outlook...

Mar 14, 2005

In the recently released World Bank's economic outlook, there are interesting insights into the current trend in the global economy, commodity prices, the relevance of the same on developing economies (including India) and key risks. Here are the key excerpts.World GDP - From recovery to expansion...
As per the World Bank, "World economic growth is expected to slow in 2005 and 2006, expanding by 3.2% in each year. Several factors are likely to contribute to this more moderate pace of activity.

  1. First, the investment cycle in the United States has likely peaked, implying a slowdown in growth. The investment to GDP ratio in the United States is currently 21%, close to its peak of 21.5% during the Internet bubble, and well above historical peaks of less than 18%.

  2. Second, world demand has outstripped supply, resulting in substantial increases in oil and other commodity prices that have cut into incomes, moderating demand in many countries.

  3. Third, higher interest rates will slow investment growth as central banks continue shifting monetary policy from a loose to a more neutral stance.

  4. Fourth, the large fiscal impulse that has helped propel the U.S. economy in recent years will weaken in 2004-although the deficit will remain high; and in Europe, budgetary policy is expected to tighten as countries seek to regain control over deficits, which in many cases exceed Maastricht limits.

  5. Finally, efforts in China to bring growth down to a more sustainable pace should also contribute to weaker, but still strong, demand over the medium term"

Commodity markets - High oil price prospects
As per the World Bank "Although a substantial rise in oil prices is not the most likely scenario, given new sources of supply and reduced oil intensities in the world economy, there remains considerable scope for higher oil prices, particularly given the current sensitivity of oil markets to localized disruptions in production. Indeed, OPEC excess capacity is estimated to have fallen from 4.6 million barrels per day in 2001 to only 1.4 million barrels per day in 2004"

The chart above highlights the change in key commodity prices on a cumulative basis (2004 upon 2001). Understandably, prices of petroleum products have risen by almost 40% in nominal terms in the last four years while the rise in metal prices is even higher at 60%.

Overall estimates suggest that the hike in oil prices already observed can be expected to dampen world economic output in 2005 by about 0.5% of GDP. In the calendar year 2004 for instance, the rise in oil prices has impacted GDP growth of oil importers like India by 0.3%.

Interest rates - A risk...
While much has been debated about the impact of a faster rise in interest rate in the US economy and its consequent impact on developing economies like India, here is the simulated study by the World Bank. "Simulations suggest that a 200 basis point (2%) increase in long-term interest rates could reduce world GDP over the short- to medium-term by about 0.5 percent per annum. The impact would be somewhat stronger for developing countries, because higher rates will raise debt servicing burdens, which require additional cuts to spending and demand"

Our view...
After softening, crude prices have once again escalated very sharply and are likely to have inflationary effect on the Indian economy. While Indian oil companies have 'absorbed' the rise and the end consumers have been 'protected' for now, it may not be the case for long. With other commodities like steel, aluminium and copper still holding ground, both manufacturers and consumers are faced with higher price scenario. Investors should not overlook this risk factor.

Who will pay for it?
Crude (US$/Barrel)29 45 52.6%
Coal (US$/MT)32 52 60.3%
Aluminium (US$/MT)1,513 1,883 24.5%
Copper (US$/MT)2,059 3,254 58.0%
Steel (US$/MT)330 588 78.0%
Source: World Bank

Secondly, the prospects of interest rates rising faster in developed economies cannot be ruled out. Given the Indian stock markets high dependence of foreign investors, it is time get out of 'the magic 7,000 level syndrome' and focus the downside.

While we do recommend stocks to our subscribers even at the current level with a two to three year perspective, the fact that investors should opt for systematic investments and play a more defensive role as far as selection of stocks is concerned at the current juncture cannot be understated.

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