Commodity rally likely to put a spanner in India‘s growth story

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The has entered in the third year of its super cycle. While crude oil, metals, coal and steel have seen some of the sharpest rallies, what has also disturbed markets, companies and emerging market economies is the fear of trade wars that can have a major destabilising effect.

The rally has impeded a revival in which has been dwindling the past four years of Modi government rule, despite the initial euphoria, with inflation and higher interest rates haunting companies and Post FY16, international base metals and are up almost 50 per cent, steel 40 per cent and thermal coal 70 per cent. Only iron ore has stabilised at lower levels.

Madan Sabnavis – Chief Economist, Ratings explains, “Any recovery in an economy would mean an upward movement in prices as demand increases. This holds particularly for metals, and hence a global economic recovery starting from the US and spreading to Europe would mean higher prices. Being a price taker, such prices automatically enter the Indian inflation indices which would exert upward pressure.”

Rising prices are more worrisome, having been on an upward scale for quite some time and marching towards $80 a barrel. Brent averaged $49 in FY17 and $58 in FY18 but on April 10 this year, it hit $71, showing a rise of 40 per cent in little over a year. According to Sabnavis of Ratings, “Oil prices tend to settle at a higher level given the dynamics. This is another cause for concern.”

The problem doesn’t stop here. In India, with the rupee depreciating against US dollar, metals, industrial fuel furnace oil and even diesel have seen sharper increases. This is certainly an inflationary. Furnace oil, which averaged Rs 22,983 a tonne in FY17, rose to Rs 29,332 in April 2018. Similar is the case for all base metals.

T Gnanasekar, Director, CommTrendz Research & Fund Management says, “Rising oil prices are going to be a huge challenge not only in managing current account deficit, but also reigning in inflation with the election year ahead. Project cost overruns could dent the prospects of expansions and make loans costlier. With the latest developments in banking regulations related to NPA (non-performing assets), it will be all the more difficult to source cheaper funds.” He said that with rising dollar interest rates, rupee exchange rate hedging cost is also rising and, “clearly rising prices could put spokes in the wheel for many capacity expansion initiatives.”

Sabnavis of agrees. He says, “Higher inflation driven by commodities poses a headwind from the point of view of purchasing power as well as monetary policy response, where the RBI would perforce increase interest rates which can come in the way of fresh investment.”

Gnanasekar also feels with oil prices rising it will not be surprising if government brings back administered price mechanism for petrol and diesel. On the positive side, he sees resistance to demand with prices rising. At higher level if demand is not followed, metals prices will moderate.