Commodity price rise can bump up inflation by 1%, warns Nomura

A 10 per cent increase in crude oil prices, according to Nomura's estimates, may raise India's headline inflation by around 30 basis points (bps), add around 0.3 per cent of GDP to CAD

Global commodity prices, especially crude oil, natural gas and coal, have become a sore point for the markets and India Inc that is still grappling with the likely impact it will have on their bottom-line over the next few quarters. Consumers, on their part, are dealing rising fuel costs which is also fueling inflation concerns.

A recent note by Nomura suggests that if global prices of crude oil, natural gas, coal & electricity were to stay at current levels till December 2021 and rise by a modest 5 per cent till March 2022, the total potential impact on the consumer price inflation (CPI) back home will be around 1 percentage point (pp). (See table below)

“Domestic coal shortages will likely be resolved in a few months, but may lower industrial activity, while rising energy costs could accentuate inflationary pressures. The adverse terms of trade shock from higher energy prices are a headwind to medium-term growth,” wrote Sonal Varma, chief economist for India and Asia ex-Japan, Nomura in a recent co-authored note with Aurodeep Nandi.

Brent crude oil prices have been rising steadily from around $65 a barrel in August-end to over $85 a barrel now, while natural gas prices have jumped by around 26 per cent from August levels, data show.

As the base effect wears out and we see the cumulative impact of rising cost inflation, including fuel and power costs, improving pricing power and narrowing of the consumption demand gap, Dhananjay Sinha, managing director & chief strategist at JM Financial expects the inflation to rise in the next 12 months to 6.5 per cent and 6.5-7 per cent, for headline and core inflation, respectively.

“The risk of cooler winters in the US and Europe, along with negative elasticity with inventory levels and constrained supply from OPEC+ can push Brent crude up to over $100 a barrel. If the cooler winters in the northern hemisphere seen during 2020-21 extend beyond 2021-22, it could lead to a shift away from past trends and higher energy prices can sustain longer,” Sinha said.

While analysts at Goldman Sachs expect crude oil prices (Brent) to hit $90 a barrel over the next few months, those at BofA Securities also see Brent hitting $100 a barrel for the first time since 2014. “The boost to crude would be driven by three factors: gas-to-oil switching as a result of high gas prices, a jump in crude consumption over a cold winter and higher aviation demand as the U.S. reopens its borders,” a recent note by BofA said.

A 10 per cent increase in crude oil prices, according to Nomura's estimates, may raise India’s headline inflation by around 30 basis points (bps), add around 0.3 per cent of GDP to current account deficit, and reduce GDP growth by around 20 bps.

“We expect industrial production to contract sequentially in September / October, due to chip and coal shortages. GDP growth could be around 1pp lower in Q4, relative to our base case (5.3 per cent y-o-y). We retain our 2021 and 2022 forecasts of 7.7 per cent and 9.5 per cent, respectively, but see downside risks for next year,” Nomura said.

Impact on inflation