What are the consequences of commodities price slump?

When prices of commodity rise they transfer riches from consumers to producers but when they fall consumers benefit. With so much at stake, the turning points are important. Currently we are standing at the cusp of such a turning point.

Commodity prices have fallen nearly 15 per cent since June-end, according to Bloomberg index. The Economist price index for Commodities has fallen by 16.5 per cent in terms of the dollar. Last week, the price of crude oil on NYMEX dropped to a four-year low of $74 a barrel from some $107 in June.

Prices of metals such as copper, platinum, silver and gold have also fallen sharply. Sustained low commodity prices are expected to help India in a big way, considering that it imported $178 billion worth of commodities in the last financial year. This amounts to 9.5 per cent of GDP.

Crude oil made up the largest part of imports. India will also benefit from lower prices for industrial commodities such as coal, metals, etc.

During the last quarter (June-September), the raw material cost, as a percentage of sales in corporate India, has come down, which is likely to drop further in the current quarter.

However, questions of end-users’ demand remains uncertain.

For agricultural commodities in the country, market yard prices will only start showing real downtrend when retail energy prices drop at the same pace.

The decline in the price of non-agricultural commodities can partly be explained by economic changes taking place in China. In the last two decades, China had been consuming coal, iron ore, copper, oil and other commodities with insatiable appetite.

While China’s economic transition was expected, stagnation in Japan and conditions pointing towards impending European deflation were unanticipated.

The big losers in all these are nations that depend on commodity exports such as Russia, Brazil and Iran. Russia and Iran have substantial economic problems because of Western sanctions and government mismanagement.

Brazil’s economy was slowing before the decline in commodity prices. Russia and Brazil are standing at the brink of their sovereign rating being relegated to a junk grade.

Demand in the days to come remains a primary concern. Since marginal cost of large producers are comparatively much less than the small producers in some sectors (iron ore, copper and coal), they continue to produce even after admitting to a global downturn.

Consumption has failed to keep pace with the rush by investors and producers to boost output across the entire commodity and resources spectrum over the last few years, creating a dangerous situation for markets where large stockpiles begin to build.

In the past, tough times have helped commodity producers become lean and mean through consolidation, mergers and cost-cutting. It is unlikely to be different this time too.

The writer is a commodity commentator. Views are personal.

COMMENT NOW