Is Commodity Disinflation a boon for India?

A giant wave of disinflation is hitting the world. Two factors seem to be playing a major role:

  1. The US Shale oil boom, and
  2. Slowdown in China

commodity prices

The combination of hydraulic fracturing and horizontal drilling has unleashed a natural-gas bonanza that has made the U.S. the world’s largest natural-gas producer. Five years ago, many companies built natural-gas import terminals, anticipating greater U.S. demand for imported fuel. Now, those terminals are being re-purposed to export gas to Japan and other parts of Asia.

The glut of cheap natural gas has had a knock-on effect on coal. American coal mined in the eastern U.S. is begin shipped overseas to Europe, especially the U.K., the Netherlands and Italy. And rising US supply of cheap energy is meeting falling demand of raw materials in China and Europe.

Spot iron ore prices fell to match their lowest level on May 15 on the back of a soft Chinese steel market. Iron ore is also under pressure from additional supply, with top miners on track to boost output. Rio Tinto, the world’s second-biggest iron ore producer, is slated to increase its annual production capacity to 290 million tonnes this year from 237 million tonnes currently.

The Chinese have been exceptionally slow in reducing supply in the wake of falling demand. Aluminum Corp. of China, or Chinalco, says that more than 90% of the aluminum produced in China is produced at a loss. Huaxin Cement Co’s President was on record saying that cement makers need to shut down old plants to avoid “catastrophe” for the whole industry. In 2012, the majority of Chinese steel companies operated at a loss. Some reports peg Chinese steel overcapacity at 20%-30% – putting China’s excess capacity at the same size as the total output of India, the world’s fourth largest steel producing country, last year.

So what does this mean for India? If the fall in commodity prices sustain, then India will figure among the biggest winners in terms of higher growth, lower inflation and better economic fundamentals. Lower commodity prices will likely lower WPI inflation, help moderate the current account deficit and help reduce the government’s fuel and fertilizer subsidy bill. This might embolden the RBI to cut interest rates and pave the way for a cyclical recovery.

Hang tight, we are just getting started!

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