More uncertainties ahead for global economy

G Chandrashekhar | Updated on April 25, 2019 Published on April 25, 2019

With growth engines China and the US beginning to slow simultaneously, the effect on commodity markets can be disastrous

The year 2018 was characterised by geopolitical risks, protectionism and sanctions. In the current year all the uncertainties and risks are spilling over, with greater vigour, creating headwinds for the markets. Commodities including energy, metals and agriculture cannot remain insulated.

The ongoing trade tension between two of the world’s largest economies — the US ($18 trillion) and China ($12 trillion) — are clearly distorting the global markets. Tariffs and counter-tariffs are the order of the day. Whether the ongoing discussions between the two countries to resolve the dispute will produce satisfactory results is anybody’s guess.

Following trade friction, global value chains and commodity flows are undergoing changes. For instance, US sanctions on Russian aluminium producer Rusal turned into an opportunity for China which exported large quantities to buyers of aluminium products from Rusal. Similarly, tariffs on steel are causing changes in the trade pattern. Both soyabean and cotton are other fine examples. After imposing retaliatory tariffs on US goods, China bought the two critical agri-commodities from Brazil. But a less known fact is that a part of US-origin cotton and soybean went to Brazil to fill the void. Whether these signify structural changes in trade flows, time alone will tell.

The newest US tariff threat is on EU automobiles. The European aviation industry is also on the radar. If these threats materialise, the world faces the risk of trade friction escalating into an all out trade war in which more countries will be sucked in. At the moment, the fight is by and large restricted to two countries — the US and China.

Effects of trade war

While resource nationalism and economic nationalism are already evident in some measure, a full-fledged trade war will exert adverse effects on the global economy. Economies that are more open and well integrated with the global economy are sure to suffer more.

Trade war has the potential to inflict lasting damage to global growth, causing loss of output, loss of jobs, loss of incomes and distortion of established global value chains. Clearly, there will be no winners in the event of a trade war.

A more serious challenge to global commodity markets is the growing concern over economic growth. The positive correlation between growth and commodity consumption is of course well recognised. It is known that growth prospects in the EU and Japan are tepid. There is evidence China is slowing; and there is increasing consensus that the US will begin to slowdown in the second half of this year as the positive effects of stimulus (tax cuts, etc) are fading.

Message from the US Federal Reserve is clear too — a pause in the rate hike cycle. This will prevent the dollar from rising further but will actually weaken it. There is also a chance that there could be a rate cut later this year or next year depending on data flow.

When two engines of growth — China and the US — begin to slow simultaneously, the effect on global financial markets including commodity markets can be disastrous.

Decline of global growth to below 3 per cent is sure to impact commodity demand and commodity prices. There will be demand compression. Financial investors will exit the market which will exaggerate the price impact. With fall in prices across the commodity spectrum — perhaps with the exception of gold, the safe haven — there will be reluctance to invest in exploration and mining.

Such a scenario is more likely to play out in the second half of the year. The commodities most affected would be energy products (mainly crude) and industrial metals.

Brent crude is currently trading around $75 a barrel following the US decision not to extend the exemption granted to eight countries (including India) from buying crude from Iran. Admittedly, on current reckoning, oil looks bullish because of tightening supplies. However, weakening global growth is sure to result in demand compression in the months ahead.

It is now increasingly recognised that crude risks a fall to $60-65 levels sometime in the third quarter of this year as financial investors pull out because of demand concerns while the US continues to pump out larger quantities of shale oil. Production cut agreement of OPEC+ may also come apart.

Closer home, another uncertainty is the weather. South Asia faces the risk of El Nino which typically brings dry conditions.

It is critical that Indian policymakers take these global and domestic uncertainties and risks on board and come up with contingency plans. The new government has its tasks cut out.

The author is a policy commentator and commodities market specialist. Views are personal

Published on April 25, 2019
This article is closed for comments.
Please Email the Editor