Lower commodity prices: a tailwind for the Indian economy

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Like crude oil, certain commodity prices have fallen by up to 25% since the start of the year and some are down by as much as 60% from their 10-year highs. Prices of hard commodities, agricultural products and energy have all declined, with the economic slowdown in China and Europe denting demand. The recent cheapening of commodity prices could benefit India – a net commodity importer – as it offsets inflationary pressures and reduces its current account and fiscal deficits.

Sustained low commodity prices would be a significant boon for India, a country that imported a net USD 178 billion worth of commodities in the financial year ending in March 2014 (FY14). This amounts to 9.5% of GDP. While crude oil accounts for the largest part of the imports, India would also benefit from lower prices for industrial commodities, coal and precious metals.

Commodity prices: Iron ore, rubber, coal and crude oil have fallen by more than 20% (Dec 2013 = 100)

graph 1

India being a net commodity importer, lower prices in general, and cheaper oil in particular, should help to further improve its macroeconomic fundamentals as well as the earnings of companies in sectors with commodity -related costs. Lower prices could also ease inflationary pressures and help reduce the current account and fiscal deficits. In fact, the government has already taken advantage of lower oil prices to announce the full deregulation of the diesel price. This should render the fiscal deficit less dependent on oil price fluctuations.

India’s fundamentals have already been improving significantly in the past year. CPI inflation fell to 6.5% in September, while WPI inflation hit a five-year low at 2.4%, in line with the central bank’s target. The current account deficit fell to 1.7% of GDP in FY14. The fiscal deficit target for FY15 is 4.1%, down from a peak of 6.5% in FY10.

Potential impact of a sustained USD 10/bbl. fall in crude oil
graph 2Source: Noumra Global Economics estimates, October 2014

Lower oil prices affect 8.6% of the WPI basket (crude oil and fuels, excluding kerosene and LPG), with an additional 5% estimated to benefit from lower prices of crude derivatives. The impact on CPI inflation is less because this is based largely on a basket of food and non-tradable services. Indirectly though, lower oil prices could lower production and transportation costs, limiting food inflation.

Current account balance
India imports more than 70% of its oil consumption, worth 5.5% of GDP. It is estimated that the current account balance improves by USD 1 billion for every USD 1 decline in the price of a barrel of oil. Thus, lower crude oil prices should benefit the current account balance.

Fiscal balance
Historically, the government has subsidised petrol, diesel, LPG and kerosene. While subsidies should eventually apply only to LPG and kerosene, lower oil prices would still help lighten the subsidy burden.

GDP growth
The impact would be mostly indirect. Lower inflation should help to boost households’ real disposable income, fuelling demand for consumer discretionaries. Company profit margins could benefit from falling input costs, which would be an additional tailwind for business investment.

With the price/earnings ratio of the MSCI India index for next year close to the historical average at 14 times, equity market valuations appear to be fair in the context of mid-teens earnings growth. Further evidence of receding inflation, fiscal consolidation and structural reforms could encourage the central bank to reduce policy rates in the medium term. This would lead to a re-rating of the equity market. In the meantime, superior earnings growth should drive stock price performance.

Source for all data is Bloomberg, as of 16 October 2014.
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Anand Shah

Head of Investments and Deputy CEO, India

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