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Commodities rally unlikely to hurt Indian economy

Not till energy prices remain contained

* Over the past few months, many commodities have seen a sharp increase in prices. However, the price surge is uneven across different commodities. There are broadly four baskets of commodities – base (or industrial) metals, precious metals, agricultural (food and non-food), and energy (or fuel). While base metals and agro commodity prices have seen a great surge in CY21, the same has been contained in precious metals and energy. In this note, we analyze the impact of the rapid surge in base metals and agro commodities on India’s macroeconomic fundamentals.

* In particular, we look at its effect on three different indicators – inflation, foreign trade, and domestic investments. There are two measures of inflation in India – retail inflation, as measured by the Consumer Price Index (CPI), and Wholesale Price Index (WPI), which captures prices at the first point-of-sale. Our calculations suggest that commodities – all four broad types – account for 32.5%/41% of the CPI/WPI basket. Given the almost absence of base metals in CPI and self-sufficiency in most food items in India, the impact of the recent surge in commodity prices is expected to influence WPI rather than CPI.

* While India is a large importer of precious metals and energy commodities, it runs a net surplus in agro commodities and a very small deficit in base metals. Within base metals, it ran an annual trade surplus of more than USD2b during the past three years in iron and steel, which has witnessed one of the sharpest price surges in CY21. India’s external trade is unlikely to be adversely affected.

* With the rise in iron, steel, aluminum, and copper prices, input cost in Construction is likely to go up. This is especially true because iron and steel hold a large weightage in the national accounting procedure. The question that arises is “whether companies will be able to pass-on higher input costs, which are directly dependent on the strength of housing demand in the country?” This is where India may get adversely affected due to higher commodity prices in CY21.

* While several commodity prices have surged dramatically in the past few months, with steel touching fresh highs of USD1,000/tonne and edible oil just 10% lower than its record high touched in CY08, the implications for the Indian economy are not as severe. This is true only till energy commodities (fuel, coal, natural gas, etc.) do not witness the same trend. The worry, however, is that base metals and energy items have moved hand-in-hand during the past decade. Will this time be different?

* Several commodities have surged rapidly in CY21: Global commodity prices have increased sharply in CY21, with CRB Core Commodity index rising 70% YoY in Apr’21. Although the CRB index is partly supported by a low base (fall of 35% YoY in Apr’20), agro commodities and base metals are showing a much faster and higher surge compared to fuel and precious metals.

* Steel, for instance, has crossed USD1,000/t for the first time earlier this month, and has doubled from levels seen in early CY20. This surge in commodities is led by supply constraints (as Chinese authorities have become more concerned about the environmental damage), better-than-expected global demand recovery, and the liquidity glut created by global central banks, led by the US Federal Reserve. Although other base metals have also surged in CY21, most of them remain (aluminum, zinc, nickel, and lead) much lower than their CY06-07-peak, except copper and tin, which have also risen to new highs in May’21.

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