BackImpact of lower commodity prices likely to be neutral
View that low commodity prices being a boon is directionally appropriate, but overstates advantages
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The fall in prices will prove a strong positive for global growth, said Credit Suisse in its report, The End of Expensive Oil. Here’s what it means for India.
Fixed income
Indian fixed income markets may be one of the biggest beneficiary of the ongoing weakness in commodities. Lower oil prices have allowed India’s central bank to take a dovish stance, as inflation trajectory has become more credible. Long-bonds are the most efficient expression of a bullish view given expectations of a rate cut in the first quarter and favourable demand-supply dynamics in the same quarter.
Equity
At nearly 5% of gross domestic product (GDP), India is one of the most significant net energy importers. A lower oil price has a doubly positive effect: first round impact on GDP, and second round impact on monetary policy. It is likely that Reserve Bank of India (RBI) will begin to cut interest rates in early 2015, with inflation set to undershoot its 6% target. Lower oil price will also enable India to close its current account deficit (already 1.5% of GDP from peak of 4.7%).
These only serve to further underpin the positive stance on Indian equities, which benefit from a cheap currency; strong demographics and limited exposure to a growth slowdown in China. The market is not especially cheap, but historically, an acceleration in GDP growth tends to correlate with a re-rating of the equity market.
Economy
The consensus view of lower commodity prices being a boon for India is perhaps directionally appropriate, but overstates the advantages. The absolute impact on the economy is likely to be only neutral to slightly positive.
Marginal impact on balance of payments: While lower oil prices definitely reduces import bill, given that weaker global demand is a driver of cheaper oil, India’s exports are likely to get hurt as well (and they are). Further, as surpluses in capital exporting economies (like oil producers) get eroded, capital flows could get constrained. The overall balance of payments surplus should be $40-45 billion.
Low impact on inflation: Imported commodities are a small part of Consumer Price Index inflation—petrol and diesel together have 2% weight. Second-round effect of diesel’s decline may be limited; freight operators had not raised rates in the past three years despite a nearly 50% rise in diesel costs.
Impact on fiscal deficit: The FY15 budgeted amount for fuel and fertilizer subsidies may not change much for FY15, as 35,000 crore of the oil subsidy is already spent (a carry-over from last year). But it should help with fiscal deficit assumptions for FY16.
Sectors
Consumer staples, consumer discretionary, cement and telecom companies will benefit. Home and personal care companies have 40-50% of input costs linked to crude oil, and paints, 25%. But some of the benefit would be offset by the higher advertising and promotion spends by fast-moving consumer goods companies and a likely price cut in the case of paints. It is estimated a 10% drop in crude prices could increase earnings per share (EPS) by 1-7%.
For tyre companies, a 10% change in crude is estimated to increase EPS by 20%. For telecom companies, a 10% fall in diesel prices leads to a 1.2-1.4% increase in earnings before interest, tax, depreciation and amortization for larger mobile operators. For cement companies, a 10% drop drives 12-15% EPS increase, as they have moved their fuel to petcoke.
Edited excerpts from Credit Suisse report, The End of Expensive Oil.
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