India Cross-Asset Strategy The Commodity Sell-off: Implications on India :Morgan Stanley Research,

Commodity Prices Fall
Since mid-Feb, commodity prices have declined sharply. Global oil and gold prices are down nearly 15%, CRB metals index is down 8.5% and vegetable oil prices (crude palm oil) are down nearly 7%.
Economics: Sustained Fall in Commodities = Lower Rates
If this price fall sustains, it will create room for a bigger fall in interest rates and accelerate improvement in macro stability indicators. Oil, gold and coal are India’s three biggest imports.
Currency: Losses Could Reverse
The INR is currently two sigma cheap relative to the long-term average of its trade-weighted index. We think the INR could benefit disproportionately from higher equity prices and could reverse its trailing losses.

Credit: Upside Risks but Currently Fair Value
While credit is fairly valued currently, it bears upside from a narrowing external deficit. Banks, the biggest sector, benefit but credit quality improvement is slow and loss cushions remain a drag.
Equities: Absolute Upside
The absolute case for equities is strong. Short term positioning is weak, valuations are in the buy zone, earnings expectations are low and sentiment is still fragile. Indeed, global liquidity is firmly perched in India’s favor. If the fall in commodity prices is sustained the it creates the specter of a shift in local savings and a fall in short rates much to the benefit of equities.
Equities Relative to EM: Fair Value
India’s moderately above average relative valuations may keep its performance in line with EM. The key upside risk is a sustained drop in India’s inflation, which tends to drive relative P/E re-rating.

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India Economics: Fall in Commodity Prices if Sustained Will Provide Room for a Larger- Than-Expected Decline in Interest Rates
Summary
 Total net commodities trade deficit excluding gold is US$114.5 billion (6.2% of GDP). Net gold imports are 2.7% of GDP.
 Key commodity imports are (a) oil, (b) gold, (c) coal, (d) fertilizers, and (e) vegetable oil (primarily crude palm oil).
 Recent fall in prices of commodities (excluding gold) will accelerate the pace of improvement in macro stability indicators such as fiscal deficit, trade deficit and inflation.

Oil is the most important commodity that India imports. Oil imports were 6.3% of GDP in F2013.
 While gold imports are high, we believe gold price movements have little correlation with gold imports. We expect gold imports to decline due to moderation in inflation. The fall in commodity prices will help the pace of correction in inflation and therefore gold imports.
 If the recent fall in commodity prices is sustained, we believe that the improvement in macro stability indicators will mean a larger than expected decline in interest rates over the next 12 months.