Editorial: Commodities take a dip

Last week, global commodity prices recorded their biggest weekly fall in over 50 years. This is not a flash in the pan, as the decline has been accelerating since prices peaked in July; values are down by a third since then, and still falling. This mirrors the behaviour of international crude oil prices, which are also similarly down from their July peaks. The dramatic drop in the Baltic freight index for shipping rates, to about a third of what it used to be, tells the story very succinctly of the sudden shift in outlook. Indian commodity prices too have been falling, but rupee prices have been cushioned to some extent by the fall of the rupee against the US dollar, by 3 per cent in as many weeks and 16 per cent fall in the last six months.

 

While the commodity price dips are dramatic, they need to be put in a historical context. Until July this year, global commodity prices had enjoyed a six-and-a half-year bull run, rising over three-fold during the period. So, despite the fall over the last three months, global commodity prices are still more than twice as high as they were in early 2002. If this were all, then it would be easy to view the present downturn as a much-needed correction, setting right some of the earlier irrational exuberance. But prices are currently being set by both fundamental market forces and also fear about how the crisis in the financial sector will play out — deleveraging by financial intermediaries means that money will be sucked out of all markets, and that can also strengthen bear forces. As for demand trends, France is already into recession and other major European and North American economies may follow suit. For these economies, falling commodity prices will be accompanied by high and rising unemployment levels, and the distress that goes with them.

The major developing countries, like India and China, which have been enjoying very high growth even though both are net commodity importers (unlike Brazil and Russia), will find inflationary pressures easing as global demand for commodities tapers down and prices settle at more realistic levels. Commodity prices in India have fallen across the board over the past month — oil, ferrous and non-ferrous metals, and palmolein — but they are nearly all higher than a year ago. It goes without saying that they are still substantially higher than at the start of the bull run in 2002. Copper, tin, lead and nickel are higher by between 135 per cent and 253 per cent; steel, aluminium and palmolein are higher by around 40 per cent. Lower commodity prices will have a beneficial impact on raw material costs for manufacturing and help rein in the high inflation levels still plaguing the economy. But a slowdown in demand growth will likely lead to lower price realisation by manufacturing companies, and will also result in lower margins. The steel industry, for example, faces a sharper fall in selling price than raw material costs. All this will affect business sentiment as well as investment plans. A fall in the growth rate, which in the recent boom years was substantially investment-led, should be factored in.