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Business News/ Opinion / Weaker commodity prices is good news
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Weaker commodity prices is good news

Cheaper oil can help India tame inflation and lead to lower interest rates

Illustration: Jayachandran/MintPremium
Illustration: Jayachandran/Mint

The recent decline in global crude oil prices is the sort of good news that generates headlines. The stock market has also rallied. Oil has retreated from the recent highs it touched after Islamist extremists almost ran over Iraq. What is less talked about is the fact that global commodity prices in general have been softening in recent months.

This is a relief for a large commodity importer such as India.

How sustainable are these current downward trends? In its latest monthly report on commodities, the World Bank says it expects global crude oil prices to decline to $104 a barrel in 2015. Prices of farm produce will see more substantial declines despite the current risks to global production because of the El Nino; India may not benefit from this trend because of its closed agriculture markets which has meant that domestic food inflation has outpaced the rate at which global food prices have increased since the turn of the century. Metal prices will continue to go down further. So will fertilizer prices.

Several investment banks are now going a step beyond such modest forecasts to boldly predict an end to the global commodity supercycle that saw prices increase fourfold in the past decade. For example, Goldman Sachs has recently said that it expects global prices of metals, bulk commodities, farm produce and energy to see substantial declines over the next five years. There is some early talk of a structural bear market in commodities.

The investor Jim Rogers was one of the first to predict at the end of the previous commodity bear market that fundamental imbalances between the supply and demand for commodities will lead to a massive increase in prices. The economic boom in China was one important factor he pointed out.

Another was the supply constraints that followed decades of underinvestment in the primary sectors of the global economy. Much of his argument is captured in his 2004 book, Hot Commodities. Rogers has not yet lost faith. In his typically provocative way, he told an interviewer recently that stock brokers will be driving taxis in coming years while farmers will be driving Lamborghinis.

Ongoing risks such as geopolitical tensions in Ukraine and West Asia as well as the threat to farm production because of poor rainfall are obviously important concerns. But there are other factors that could dampen commodity prices in the coming years—the shale oil revolution in the US, the growth slowdown in China and rising global interest rates, for example. Some will help increase supplies, some will reduce demand and some will raise the costs of speculation.

The Indian economy has been highly sensitive to the global commodity cycle, and especially the changes in the oil market. In fact, some hedge funds have been known to go long on global commodities while shorting Indian equities (and vice versa) to take advantage of the negative correlation between the two. In that sense, the expected decline in global commodity prices could broadly be a positive for India.

What could this mean in practical terms? Cheaper oil will help ease inflation pressures. It will also be good news for the government budget to the extent that fuel subsidies reduce. Lower inflation will provide space for the Reserve Bank of India to cut interest rates once it is convinced that disinflation is not temporary. A rally in bond prices will provide banks with treasury profits that could be of use to help them repair their damaged balance sheets.

The Indian economy is right now perhaps on the verge of a tentative cyclical recovery. A lot needs to fall into place if it is to go back to a sustainable path of high growth. A broad decline in commodity prices could be a catalyst for a stronger recovery, as was the case during the growth acceleration after the previous economic downturn between 1998 and 2002.

Has the global commodity supercycle peaked? Tell us at views@livemint.com

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Published: 21 Aug 2014, 06:00 PM IST
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