Unexpected rebound

Even as the spike in crude oil has hogged all the limelight, a mini bull market seems to be on across the entire commodities complex. After a renewed surge in November, global iron ore prices are now up by 115 per cent on a one-year basis. Natural gas prices have soared 91 per cent, zinc prices are higher by 81 per cent, nickel is up 28 per cent and copper is up 22 per cent. Industrial metal prices have been supported by dwindling inventories at the London Metal Exchange and stockpiling by China, which has seen double-digit jumps in its imports of coal, iron ore, oil and copper in October and November, after lying low for many months. Indications from the Trump camp that the new US government will embark on a multi-billion dollar infrastructure build-out has also fed this rally. Some of this price rise is speculative and further gains could be capped if there is a production response (shale oil), or if the optimism around China or Trump proves overdone.

Nevertheless, the recent rebound, coming on a low base, does flag new risks both to India’s macros and to corporate profits. At the macro level, a commodity revival taken with recent rupee weakness can bloat the import bill and expand India’s current account deficit at a time of lacklustre export growth. Higher landed costs for fuel will also mean that the Centre will have to work doubly hard at reining in its fiscal deficit. The falling oil prices of the last two years had allowed the Centre to pad up its indirect tax revenues through the easy expedient of repeatedly hiking excise duties on fuel. But if fuel prices edge up, this windfall can no longer be taken for granted. Signs of a revival in oil and commodity prices are also not good news for foreign portfolio flows into India. For the last couple of years, India has been perceived as a great ‘macro trade’, as one of the few large economies that is a net user (and not exporter) of natural resources. But reviving prices can turn the tables on this argument. Nor are rising material and fuel prices good news for India Inc. Yes, energy and metal firms which chip in about a fourth of the earnings for the Nifty 50 may see profit upgrades. But for the rest of India Inc, made up mainly of users of industrial metals and fuel, this about-turn can take away the cost savings that added 200 basis points to aggregate operating profit margins in the last two years.

Of course, there is a silver lining too, to the prospect of a commodity revival. A return to moderate inflation will aid both nominal GDP growth and corporate toplines. Commodity price increases have usually endowed India Inc with greater pricing power in the past. But with the wild card factor — demonetisation — denting consumer confidence and demand, taking selling price increases may not prove as easy this time around.