Friday, December 26, 2014

Crude Shocks keep India in Smiles

B. Yerram Raju  & Nitin Gupta*

“The economics of oil have changed. Some businesses will go bust, but the market will be healthier,” says the Economist (December 6, ’14). Is this the beginning of cheap oil regime or just an interlude between two big bumps?

2013, in retrospect,  had turned out to be the strongest year of recovery, with growing US Economy and stabilizing Chinese economy. Commodity prices were projected to remain flat with an up-side risk due to unexpected supply-side shocks.

Enter December 2014 and all the projections seem little more than wishful thinking. IMF went on record recently: “the global economic growth may never return to pre-crisis levels” ! All the Quantitative Easing (QE) from the US (3 till now – totaling over $ 4 trillion or, twice that of the entire Indian economy) which was supposed to push cash to banks ended up just in increased valuations and stock indices accompanied by higher prices of gold and other commodities. Emerging economies like India had to contend with high inflation. Some even said: it is ‘US Fed exported inflation’!

Now we’re in a scenario where the interest rates of most major markets globally are still at rock-bottom levels (which was the reason to adopt QE in the first place), and despite additional liquidity with banks and their “better health” the economy still isn’t improving. Initial fears of QE stoking global inflation have reversed now since the desired impact is clearly missing, and instead we’re facing fresh fears of deflation.

Today, 2 of the world’s 3 biggest economies – US and Japan are reeling with increasing debt-to-GDP ratio, with US hovering over 100% and Japan, at a massive 225%. This means that if US and Japan were to devote even a massive 10% of their GDP for debt repayment, it would take them 10 and 22 years respectively to clear their debts. Another major economy, China is witnessing falling growth, higher inventories and housing bubbles, along with many other large economies like Australia and Euro Zone. Several companies in the Euro-zone have taken a substantial hit on their revenues due to sanctions imposed on Russia, adversely affecting economies of the few relatively better-off countries in Euro-zone like Germany.

India on the other hand, looks relatively promising despite its close to 66% debt-to-GDP ratio. The new government has been successful in changing perception of “doing business in India” in a relatively short time. India, a net importer of commodities, has also benefitted significantly by falling commodity prices – most major one being Crude Oil, since it is the biggest by import value. Crude oil has fallen below $60 per barrel, nearly 45% since its peak in the middle of 2014, and with OPEC openly stating against cutting production, it might even fall to $45 per barrel. While OPEC’s decision not to reduce output despite such a fall in prices is being attributed to stifling recent massive US investments in Shale Oil and to corner Russia, the fact is, it is a silver-lining in a dark cloud for India.
However, there are significant head-winds ahead for India and rest of the world. With Euro-zone unable to move away from the edge of crisis, and growth in most major economies faltering, India cannot easily export its way to growth. Most countries are struggling with low domestic demand due to poor demographics leading them into a currency race to the bottom, since depreciated currency will give them better export value. India, with its demographic dividend (65% of the population under 35 years of age), must look inwards for growth. No wonder Raghuram Rajan called for a manufacturing growth led by domestic markets.

Are the shocks of declining crude prices going to hit the rest of the commodity markets - Copper, Wheat, Soybeans and Rice? The cost of production of these commodities could be well on the rise but will be staring the prices in the eye. When that level comes, many producers of such commodities might temporarily halt production that could impact GDP growth adversely and stoke inflation.
Global economy could be in a mess. Indian economy would for sometime be in smiles as it triggers a lower inflexion point in inflation and the consequent abatement in interest rates. Year 2015 would begin on a happy note.

*Dr Yerram Raju, Risk Management Consultant and Nitin Gupta, Managing Director, Risk Edge Solutions (P) Ltd. (

Published in Business Advisor, December 25, 2014.