The Hindu Business Line : Seeing the glass as three-fourths full

Sooner or later, oil and other commodity prices will soften in line with the fundamentals of the global economy and stock markets will bounce back. Till then, and until inflation softens, the painful transition has to be endured.

Yogesh Suri

Inflation has gone well past the 11 per cent mark and is expected to touch 17 per cent. Crude oil prices may shortly cross $200 per barrel.

Stock markets will continue to crash globally, and the BSE Sensex could plumb the 10,000 mark.

The RBI is set to further tighten its monetary policy and interest rates may go back to the mid-1990s level of 18-20 per cent.

The US will soon move into recession and growth rates in developing countries, including India, are expected to dip sharply. Doomsday is coming closer. Right? No, wrong!

Everyday we are bombarded with such stories that are creating havoc with the markets, making individuals / institutions lose hard-earned money.

Crude issue

And it is common knowledge that the single biggest factor causing this gloom is the international price of crude oil.

Barely a few months back (early January 2008), similar issues were being faced with regard to equities.

When the Sensex crossed 21000, people were predicting it would cross 25,000 in a year’s time. Stocks not even worth pennies were being sold for pounds, and rising by the day.

Clearly, the market was overheated and what happened subsequently is well-known. The same thing is happening to crude now.

No doubt there is some demand supply mismatch, but how much?

Against global demand of about 87 million barrels per day for 2008, supply is short by barely 1 million barrels, too insignificant to cause a near 50 per cent price rise since early 2008.

Clearly, there are factors beyond normal demand-supply mismatch and market forces.

The culprits

Coming to inflation, it continues to rise at fresh 13-year highs, with the latest figure at 11.91 per cent.

Inflation may cross the 12 per cent mark and stay there for a few weeks but, by and large, it appears that inflation has almost peaked out.

It is also comforting that prices of essential food articles are now stabilising and indicate a spurt of just 5 per cent, year on year.

The biggest culprits are mineral oils and products (petrol, diesel, LPG, etc.) (year on year growth in prices 26.7 per cent), minerals (YoY growth 49.1 per cent), edible oils (18.1 per cent) and basic metals/ alloys/ metal products (22.4 per cent).

As global growth slows (in part because of measures to control excessive speculation and monetary tightening), one can expect a sharp retreat in the global prices of crude oil and metals, which can reverse high inflation numbers.

Even if these prices stay at present levels and do not spike significantly, inflation may still retreat sharply from January 2009.

Milder outlook

Inflation is basically the percentage change in the Wholesale Price Index (WPI) during a particular week, over corresponding week of the previous year. Between end-December 2007 and end-June 2008, the WPI went up by 21.4 per cent, whereas in normal course, the rise in the WPI during the corresponding six months of the previous few years is 4.1-9.3 per cent (see Table).

Assuming that growth during the corresponding period of calendar 2009 is about 7 per cent, inflation can be expected to drop to 4-4.5 per cent, or even lower, by June 2009.

In other words if the rise in inflation is steeper this year, next year it would fall in the same fashion (base-effect). Besides, 2009 may be even better since a host of monetary measures put in place by the RBI in recent times would impact commodity prices with a lag of three-six months.

This, together with projections of “normal” south-west monsoons should ensure 2008 fares well in keeping agricultural prices low.

However, till December 2008, the country may have to bear the burden of double-digit inflation.

Once inflation softens next year, there is every possibility of a milder monetary policy stance to refuel the economic engine, which would have suffered some slow-down due to higher interest rates and other demand control measures.

Coming to state of the economy, so far there has been no sharp slowdown in economic growth.

The Centre’s direct tax collections for the first quarter of this financial year have recorded a growth of 38.6 per cent, which indicates the continued soundness of the corporate sector.

Deposits and advances growth of banks remain buoyant and so far there are no indications of any major slowdown in investments.

Painful transition

The relief on personal taxation announced in the Budget 2008-09 and implementation of Sixth Pay Commission recommendations would also result in putting more money in the hands of people which will help improve aggregate demand.

Therefore, even in the worst-case scenario, India’s real GDP growth should be at least 7.5 per cent during 2008-09, which still remains among the best in the world.

The prospects for the global economy are expected to improve in the second half of 2008. By December 2008, most of the losses on account of the US sub-prime crisis would have been written off and the financial sector will be ready to start afresh, on a clean slate.

Sooner or later, oil and other commodity prices will soften in line with the fundamentals of the global economy and stock markets will bounce back. Till then, the painful transition period has to be endured. Let’s look at the glass as three-fourths full.

(The author is Chief Economist, State Bank of Bikaner and Jaipur. The views expressed in the article are personal)