ET BureauThe fall in global prices effectively represents a kind of ‘income transfer’ from oil exporters to oil importers. To the extent that this fall will boost consumption and investment in oil-importing countries such as India, which will offset economic turmoil in the oil exporting countries, that will boost global growth. But will it?
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Says Madan Sabnavis, chief economist of CARE Ratings: “This is a fairly unique situation. There has been a longer-term structural shift in the market.” The structural shift he is referring to is the dramatic shale gas boom in the United States which has effectively turned what was one of the world’s biggest importers of oil into a large potential exporter.
And while this change has been recognised for some time, what has also happened in the last few months is that the Organisation of Petroleum Exporting Countries (OPEC) has decided not to cut production in the face of falling prices. This has merely exacerbated the sharp drop in crude prices.
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But here’s why the fall in oil prices may not be so important for the Indian economy at the current juncture:
At a bit over 5%, India’s growth is still weak. The index of industrial production (IIP) growth for October showed its sharpest fall in three years. A decline in crude oil prices is certainly a plus in this scenario, as it lowers costs not just for consumers but for companies as well.
But if industry faces uncertain consumer sentiment not just in India, but globally, the fall in costs may simply improve their bottomline while adding little to the top line. There will be little incentive for companies to invest in expanding capacity.
Global growth is weak as well. The Chinese economy has slowed down by as much as two percentage points from its peak, while the European economies are staring at the prospect of deflation, with inflation in the region of 0.3%. The only major economy seeing good growth at the moment is the United States.
The uncertainty in the rest of the global economy, including the Euro area and China, coupled with a strong US economy, is one of the factors driving a strong dollar. Another index of global growth — metal prices, which are vital inputs into industry — is also showing weakness, indicating slack demand from companies faced with possibly slow markets (see chart).
India’s trade deficit continues to expand. The trade deficit has expanded to an 18-month high, with exports being weak in the face of slow global demand, even as imports of key commodities such as gold have shot up. While imports of electronics goods have also risen, signalling a possible increase in investment, it remains to be seen whether this increase in imports will be sustained.
Inflation expectations remain high. Even as wholesale inflation has fallen to zero, there are two key problems. One is that recent declines in inflation have been driven in part by a technical ‘base effect’ because of high inflation rates at the same time last year. But this base effect will go away early next year.
“This reflects, to some extent, transitory factors such as favourable base effects and the usual softening of fruits and vegetable prices that occurs at this time of the year. On the other hand, protein-rich items such as milk and pulses continue to experience upside pressures,” he said. “Survey-based inflationary expectations have been coming down with the fall in prices of commonly bought items such as vegetables, but are still in the low double digits,” he added.
Rural growth may be sharply hit. Weak and lacklustre agricultural prices in the global markets for commodities such as cotton, rice and soyabean mean that rural incomes are likely to be lower, or at the very least, flat this year. This bodes ill for the rural economy, and for the demand for goods from a key range of industries from fast-moving consumer goods to vehicles. Agricultural workers still account for almost half the workforce in the country.
Professor NR Bhanumurthy, professor at the National Institute of Public Finance and Policy (NIPFP), says: “The fall in the forward price of oil tends to be a leading indicator as far as the health of the global economy is concerned,” he says. “It can reflect expectations of the health of the global economy going forward.” In an environment of such uncertainty, expectations among investors or firms will be crucial for the health of the global — and by extension — the Indian economy.
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