After years of volatility, commodities have rallied globally in the last two weeks, as economic sentiments recover across the world, particularly in the US and China. This trend is expected to continue in 2018 and that could spell bad news for India, a net importer of metals and oil.
Rising commodity prices will stretch India’s government finances, squeeze corporate profits, and lead to imported inflation that may stunt economic recovery.
Oil prices, in particular, are expected to hurt airlines, paint manufacturers, and automobile companies. The rude crude will make finance minister Arun Jaitley’s budget-making exercise tougher, as crude oil accounts for nearly 35% of the country’s import bill.
Global factors that kept a lid on commodity prices – particularly oil – in recent years led to a windfall for the Narendra Modi government. As of January 4, Brent crude was trading near $68 a barrel, tearing out of the government’s comfort level below $60.
India’s crude basket cost $52.55 a barrel between April and November 2017, compared to $47.56 in the financial year ended March 2017.
Every $10 per barrel rise in the price will worsen India’s fiscal balance by 0.1% and current account balance by 0.4% of the GDP, according to Nomura.
Meanwhile, natural gas, copper, zinc, and lead are on multi-year highs.
Despite the recovery in late 2017, commodities are still less valued than equities and there is still huge headroom for a further strengthening of prices. In the past, commodity prices have shot through the roof every time they have been at such deep discount to equities, according to experts. “If you ever thought about buying commodities...maybe you should buy them now,” Jeffrey Gundlach, CEO of global investment firm DoubleLine Capital, which manages financial assets worth $109 billion, said in December.
And India imports a whole lot of these commodities. The margin from cheaper commodities was a big cushion for corporate profits, which led to a 35% rally in Indian blue-chip stocks in dollar terms in 2017. But the party is likely to scale down in 2018.
In particular, India’s state-owned banks could suffer from a hangover. These lenders typically keep an eye on the Brent crude as any rise in its price can lead to the government missing its fiscal targets. Of late, that fear has weakened government-issued bonds, a big chunk of which is owned by these banks. As crude prices rise, bonds lose their worth, sparking a bear run on bank stocks.
Besides, the rise in commodity prices could also fuel inflation, which is the last thing the Modi government will want as it prepares for a string of elections this year and the next.
This article first appeared on Quartz.
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