10/13/2014

The Economic Times

Title : SWAMI SPEAK - Fire Burn, Cauldron Bubble?
Author : Swaminathan S Anklesaria Aiyar
Location :
Article Date : 10/01/2014
Falling commodity prices are good. Unless they signal a global recession
The stock markets have soared this year, with blue chips up 30% and some midcaps up 100% or more.
Many analysts believe that, even without radical reform, Prime Minister Narendra Modi's
administrative dynamism will help raise GDP growth from last year's 4.7% to 5.5% this year, 6.5%
next year, and 7% later.Some stock market analysts predict a multi-year bull run.
This could indeed happen. Yet, India is now more globalised than most people realise, with
international trade of over 45% of GDP , a current account deficit that needs to be plugged by global
investment, and a stock market in which over half the floating stock of Sensex companies is owned by
foreigners. So, India's fate will be decided by global trends as much as Modi's efforts.
It's a Bird! It's a Pterosaur!
Two worrying trends have emerged on the global scene. One is a crash in commodity prices. The
other is an imminent rise in global interest rat es. Historically , crashing commodity prices and rising
interest rates have often combined to create a global recession. Commodity prices have plunged 20%
in the last six months. If this reflects a surge in global produc tion after years of insufficient out put,
that can be a good trend that sat isfies demand, lowers input prices for manufacturers, raises profits
and tames inflation.
However, falling commodity prices can also signal a coming recession. They may indicate an
economic slowdown for reasons poorly understood by policymakers, and so not countered. The
current commodity crash is definitely linked to an unexpected slowing of global growth. China, Japan
and Europe are growing more slowly than expected at the start of the year. Chinese growth might
actually dip below 7%, half its peak rate in the 2000s.
Recess(ion) Bell
Hence, the IMF is revising its global growth projections (in PPP terms) for 2014 down from 3.6% to
3.1%.Note that a fall below 3% is widely accepted as a sign of recession.
Latin America, Russia and Africa grew fast between 2003 and 2010. As commodity producers, they
benefited from the huge surge in Chinese demand. Today , they are all feeling the heat of China's
slowdown. Brazil, Russia and South Africa all face the danger of zero or negative growth.
World food prices used to be depressed by the dumping of surpluses by Western nations. But after
2005, food prices skyrocketed. Bad harvests coincided with the huge diversion of agricultural land to
producing biofuels: ethanol from maize and synthetic diesel from vegetable oils. Back in 2005, the
Chicago market price of maize was $2 a bushel and of wheat was $3 a bushel. After 2008, wheat
prices briefly went into double digits and maize reached $8 a bushel.
However, prices have since downtrended, and after ups and downs, they have suddenly fallen steeply
since May 2014. Maize is now down to just $3.25 a bushel and wheat to $4.75 a bushel. World cereal
production this year is estimated to be 20% more than demand, so the surplus will keep prices down
for some time to come. Soybeans and cotton are down one-third from their rates a couple of years ago.
Edible oil prices have crashed. Rice prices have fallen only a little, which is lucky for India, a ma jor
rice exporter.
Oil was just $25 a barrel in 2003 but soared to almost $148 in 2008. In re cent times, the price of
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Brent crude has been around $110 a barrel. But this has now fallen to $96 a barrel, de spite troubles in
Ukraine and West Asia that would normally have sent prices spiralling. Iron ore has halved from a
peak of $180 a tonne. Coal and metals are down to their lowest lev els for five years.
Homeward Ho!
The second source of worry is the co ming rise of interest rates in rich co untries. The US has for
years indulg ed in quantitative easing, unleashi ng trillions of dollars on the world ec onomy . This has
created froth, if not actual bubbles, in all asset markets.
The eurozone looks like getting into quantitative easing, and Japan is neck-deep in it too. The tidal
wave of cheap currency from rich countries has boosted property and stock pric es globally , including
in emerging markets like India.
But the US is about to end quanti tative easing next month, and will start raising interest rates next
year.
Even if this does not happen in Eu rope or Japan -and it could -this may induce billions to flow out of
em erging markets back to rich countri es in search of higher yields. This is what happened in the
summer of 2013, sending the rupee crashing from ` . 68 to the dollar, before re . 55 to ` covering to ` .
62 per dollar. Markets then recovered, but RBI governor Raghuram Rajan has warned that this could
happen again. Combined with falling global demand and cra shing commodity prices, it would be a
recipe for global recession.
Maybe the rich countries will sen se the danger, and ease money again to stave off a recession. Yet, as
form er adviser to Ronald Reagan, David Stockman, puts it, the trillions pum ped by central banks of
rich countri es into the global economy have cre ated asset bubbles that have to burst some time. We
stand warned.

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