India Gold and oil prices – Major silver linings? :: Barclays Capital

India
Gold and oil prices – Major silver linings?
The drop in commodity prices, particularly in gold and crude oil, if sustained, could be
a major positive driver for India. The immediate and most visible impact would be on
the current account balance, which could improve by nearly 1% of GDP in FY 13-14, on
our estimates. A reduction in oil under-recoveries would also reduce the necessity for
domestic fuel price hikes, which contribute over 25% to current inflation.
Crude oil and gold are the two major commodity imports for India, and both have increased
significantly in recent years. India’s oil imports are typically sticky and not very sensitive to
price. The surge in gold import demand in recent years, on the other hand, has remained
mostly speculative in nature. This means that in the case of a downward trending price, not
only would the gold import bill likely decline, volumes could also decrease.
We examined the potential change in India’s net import bill in light of the recent drop in
prices of these two commodities, under the assumption that there will be no change in
oil/gold import volumes due to price change. Given the observed price-demand
relationship in recent years, we believe this is a conservative assumption.
We estimate that if gold prices remain flat at USD1400/oz, and Brent crude remains at
USD100/bl, India’s net import bill for these commodities could fall by nearly USD7bn and
over USD13bn, respectively, given our flat volume assumptions. This would result in net
savings of around USD20bn on the current account deficit, lowering it to USD66bn
(around 3.2% of GDP) and bringing it below our baseline estimate of over USD85bn
(4.1% of GDP). We have also not factored in any drop in other metal prices, such as
copper/palladium/silver, which could increase the benefits to the current account.

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Inflation would also benefit from lower commodity prices
The impact of lower commodity prices is meaningfully favourable for India’s inflation
dynamics as well. A sizeable part of current inflation emanates from the rise in administered
prices, which alone contribute around 1.7 percentage points to India’s current headline
inflation of c.6.0%. If oil prices remain low, the need to hike administered prices comes off
at the margin. For instance, under-recoveries on diesel would decline to less than INR3/litre
if Brent crude averages USD100/bl, meaningfully lower than around INR6.5/litre at the
beginning of the financial year, when oil was hovering around USD112/bl. Moreover, an
average Brent crude price of USD100/bl, will push inflation for non-administered items of
the fuel group negative on a y/y basis in the coming months, given a high base. This also
means that pass-through into demand-led price pressures could be weaker, posing
downside risks to inflation.