As global commodity prices head south, India's import bill will get a shot in the arm: gold and crude oil are the biggest items of India's import bill. Now, will fuel turn cheaper?
Why are gold prices falling?
The recent big crash in the bullion prices was precipitated by fears that Cyprus would sell a substantial portion of its official gold reserves to tide over a severe financial crisis. The resultant fright that it would set off a chain of indiscriminate dumping by other sputtering European economies have caused a fall in gold prices, which some analysts described, as unprecedented in modern history.
Why are oil prices falling?
The recent drop in crude oil price to below $100 a barrel has grabbed investors' and analysts' attention. Oil, gold and other commodity prices are primarily governed by the laws of demand and supply. A higher demand for a commodity, normally, pushes up its price and vice versa. Besides, there is also element of speculation. In the current context, according to credit rating and research firm Crisil, renewed concerns over recovery of economies in the euro zone, weak economic data from China and tepid retail sales data for the US, have triggered the sharp fall in crude oil prices.
What does falling crude oil, gold and other commodity prices mean for the Indian economy?
For a government caught in a pincer attack of rising prices, sliding economic growth and sagging political stock, the latest price trends gives an occasion to rejoice in strained times. India is a big importer of both gold and crude oil and any fall in the prices of these two principal commodities would bring down the current account deficit (CAD) by slowing down the outflow of foreign exchange.
What is the CAD and what is its importance?
India's current account deficit (CAD) - the gap between inflows of foreign currency and outflows - soared to a record of 6.7% of gross domestic product (GDP) during October-December, hit by high oil and gold imports and subdued exports. A widening CAD, which effectively means that India is buying more from the rest of the world than what it is selling, can turn out to be a big worry for policymakers in a slowing economy where fulfilling immediate dollar payment obligations may necessitate dipping into the pool of foreign exchange reserves. So far, India has been able to finance its CAD without drawing on the $300 billion foreign exchange reserves, even as the government hoped that CAD will moderate in the coming months as exports show signs of picking up. Higher dollar outflows can weaken the rupee that will make imported goods such as crude oil and gadgets costlier. The rupee is currently hovering around 55 to a dollar, down more than 15%, since the beginning of 2012. India's CAD during 1991 stood at 4.2% of GDP forcing the government to mortgage gold to tide over a balance of payments crisis as the country was left with foreign exchange reserves barely enough to meet three weeks' import payments.
Apart from helping rein the CAD, what are the other major implications of falling commodity prices on the Indian economy?
The immediate impact of falling crude oil prices is retail fuel costs. India imports about 75% of crude oil requirements and higher prices of the commodity usually reflects in higher retail fuel costs. Falling crude oil prices, therefore, normally has a cascading impact. Lower diesel and petrol prices would knock down the cost of ferrying goods across locations, which, in turn will help temper down overall prices.
Can we expect retail oil prices to come down in the near future?
After three consecutive cuts in the price of petrol, that benefitted consumers by over Rs. 4.50 a litre within a month, you can now expect another steep cut in the price of petrol by around Rs. 2 to Rs. 2.50 a litre by as early as end of this month. However, diesel prices will continue to be corrected by an average of 50 paise per month for the next 15 months in order to do away with the subsidy of close to Rs. 6.50 a litre on diesel.
Will falling commodity prices lead to faster interest rate cuts?
Wholesale price index (WPI)-based inflation, India's most commonly watched price index, grew 5.96% in March - its slowest pace in 40 months. The government's macroeconomic managers have, perhaps rightly, lost no time in pointing out that the inflation hump is decidedly behind us and the price line could settle below the Reserve Bank of India's (RBI's) comfort zone of 5%. Falling global commodity prices including crude oil, combined with a potentially bountiful summer harvest, are the principal reasons for this optimism. As the new crop enters the market in a month's time, food prices should stabilise. The cheer could travel to the average consumer, if the RBI slashes interest rates next month. Besides, the rupee that has taken a knocking on the back of widening CAD, which effectively means that India is buying more from the rest of the world than what it is selling, could get some respite if the price of crude oil, our biggest import, heads further down.