Saturday, May 19, 2012

Greece paranoia – a blessing in disguise for India

The fears and paranoia surrounding Greece exit is likely to prove to be a blessing in disguise for India, via its impact on commodity prices and inflation.

The sharp fall in commodities over the past few weeks is primarily driven by speculators making hay while the sun shines, or Greece related fear persists, so to say. Not to say that Greece related fear is the only reason. Of course there are a few others as we’ll see in the analysis below, but had there been no Greece factor, commodity prices might not have been making new intermediate lows.

With Greece’s blessings

All key global commodity prices are falling and making new intermediate lows. So, what’s causing it and what is likely to be the impact on the Indian economy and corporate results?

The fall is caused by growth moderation in China, slower than expected recovery in the US, large stockpiles of commodities with suppliers and last but not least, a speculative selling driven by fears surrounding Greece’s exit.

And what could be the possible impact for India? Given that India’s industrial recovery is progressing at a healthy pace, what it implies is that going forward inflation is likely to come down and corporate profitability will continue to increase. All because of blessings from Greece !

Let’s take a more detailed look at the points made above.

Commodity Prices Making New Intermediate Lows

The S&P GSCI Spot Index is on a sharp intermediate downtrend (chart from Bloomberg). The UBS Bloomberg CMCI composite price index also shows a similar trend.

commodity prices

Oil (European Brent Spot) is on a sharp intermediate downtrend. It is currently at around $107 after touching highs of nearly $130 a few months back. (Chart from Bloomberg).

coal prices

Coal has been in decline for a while (chart from and is on a major downtrend.

coal prices

A similar pattern prevails across all other key commodities like copper, zinc, aluminium etc.

What’s Causing the Fall in Commodity Prices?

There is a very nice story in by Eben Esterhuizen, Kapitall, The Motley Fool, which lists three key reasons:-

1. China is cooling down. Commodities are the inputs of all manufacturing processes. As economic activity slows down, so will demand for manufacturing inputs. As demand falls, so will the price.

2. The U.S. economy is struggling to heat up. Yes, the U.S. economy is recovering, but it has been a sluggish recovery. And as explained by reason No. 1, any slower-than-expected economic recovery will lead to lower demand for manufacturing inputs.

3. Suppliers of raw materials have overestimated demand for raw materials. As just explained, the economic sluggishness has come as a surprise to most suppliers of raw materials. Since they were overly optimistic, they increased their stock piles too rapidly. Now the sizes of their inventories are bigger than the demand for their raw materials, which further drags down prices.

The authors have hit the causes of commodity falls right on the spot. However I believe that there is a fourth reason too:-

4. Speculation driven by fear of Greece’s Exit. A large part of the fall is likely to be caused by speculators driving down prices to cash in on the fear and paranoia around Greece’s exit. The reason for this is that except for the Eurozone, global economies are in various stages of bottoming out and recovery. What about the future outlook for commodity prices? The prevailing view amongst commodity experts is that the fall is likely to continue, though some believe that the selling is overdone. I too tend to believe that the downtrend in commodity prices would continue, primarily driven by paranoid fear rather than any ‘real’ factors.

What Would be the Impact on the Indian Economy and Corporate Results?

The commodity fall couldn’t have come at a better time for the Indian economy. India is in a slow and steady recovery mode. Many folks seem to have been spooked by the negative 3.5% IIP numbers reported this week. But those concerns are largely due to their being driven by an incorrect interpretation. IIP numbers are tracking a very normal pattern of recovery, not one of contraction.

Here’s what I expect the impact to be over the next few quarters:-

- Inflation is likely to fall (vegetable price inflation remains a concern, but that’s another story.

- Falling inflation is likely to drive up real demand in the economy.

- A combination of rising demand and falling prices will result in Indian corporations posting strong quarterly sales and profitability growth. Quarterly corporate results are already on a rising trend. Year on Year quarterly results for Sept. 2011 showed a massive 21% decline in corporate profits, but then posted a sharp recovery with a 13% growth in the Dec. 2011 quarter; the trend continues for the March 2012 quarter with 12% profit growth (for companies that have declared their results to date).

- What about the impact of the falling Rupee? The fall in the Rupee is not driven by any flight in capital but by speculative selling. The fall might continue a bit longer, however I don’t expect it to have any significant impact on corporate profitability. The reason for this is that, at some point, the RBI and the government will crack down hard on speculators and that would be the end of the Rupee fall. The RBI has already issued a veiled warning to speculative interests. The next set of measures would be far harsher. Those who seem to underestimate the power of a state, do so at their own peril.

All in all, it almost seems that all this paranoid fear around Greece’s exit is likely to prove a blessing in disguise for India.