Amidst War, Inflation Marches On!

Amidst War, Inflation Marches On!

Inflation levels are gathering pace across the world and India is no exception to this raging phenomenon. Will the commodities sector, which is considered one of the best sectors to hedge against inflation, remain an investor favourite?Armaan Madhani elucidates how the inability to export essential commodities from Russia exhibits a golden opportunity for major Indian commodity players to fill the gap.

Inflation is inevitable. It is ubiquitous and can occur in almost any product or service. But inflation isn’t always a problem. A moderate amount of inflation is viewed as positive and considered to be a sign of a healthy economy. It helps boost consumer demand and foster economic growth. However, too much of anything is bad. Once inflation increases to become prevalent throughout an economy, the expectation of further inflation becomes an overriding concern in the consciousness of consumers and businesses alike.

As economies around the world continue to make strides towards a state of full recovery from the damaging effects of the pandemic, intensifying inflationary pressure is the common conundrum that looms over central banks at large. A few months ago, this increased inflation was being referred to as transitory, a temporary problem expected to fade away sooner or later. However, the ceaseless rise in prices continues to put a damper on growth prospects. The International Monetary Fund (IMF) in its recent published World Economic Outlook stated, “Elevated inflation is expected to persist for longer than envisioned earlier. Rising energy prices and supply disruptions have resulted in higher and more broad-based inflation than anticipated, notably in the United States and many emerging market and developing economies.”

The United States, United Kingdom and Euro Zone among many other economies are experiencing record levels of inflation stemming from a slew of factors, including the massive quantitative easing programmes being run since the outbreak of the pandemic. Not to forget the aggravating geopolitical crisis between Russia and Ukraine in recent weeks that has added fuel to the ongoing fire of inflation. Inflation levels are gathering pace across the world and India is no exception to this raging phenomenon.

Retail Inflation in India
As per the data released by the National Statistical Office (NSO), India’s retail inflation measured by the consumer price index (CPI) accelerated to 6.01 per cent in January 2022, the highest in seven months, from 5.66 per cent in December 2021. The CPI hit the upper limit of the Reserve Bank of India’s tolerance band, driven by rising prices of food and manufactured items. As companies struggle with rising input costs and pass on higher prices to consumers, India’s wholesale price inflation rate eased in January 2022, but continues to remain in double digits for the tenth consecutive month amid rising crude oil prices. Data released by the industry department shows that the wholesale price index (WPI)-based inflation rate decelerated to 12.96 per cent in January 2022 from 13.56 per cent in the preceding month.

To quote the Commerce and Industry Ministry, “The high rate of inflation in January 2022 is primarily due to rise in prices of mineral oils, crude petroleum and natural gas, basic metals, chemicals and chemical products, food articles, etc. as compared the corresponding month of the previous year.” The RBI in its recent Monetary Policy Committee (MPC) meeting kept the repo rate (i.e. the rate at which it lends short-term money to banks) unchanged at 4 per cent for the tenth time in a row to support growth and manage the inflationary pressures.

Empirical data suggests that emerging markets such as India typically run higher inflation rates than developed economies such as the US and countries of Western Europe. However, for the first time in the past 30 years, the US reported a higher consumer price inflation (CPI) rate than India in five consecutive months. The United States Department of Labour recently revealed that consumer prices have increased by 7.5 per cent over the past year, which happens to be the highest recorded in 40 years. This is higher relative to the 6.01 per cent CPI in India and analysts expect this trend to persist in the coming months. Apart from the heavy doses of federal aid, supply bottlenecks, shortage of workers, ultra-low interest rates and robust consumer spending have fuelled the rise in inflation.

Global Interest Factor
The continuous price rise has prompted the US Federal Reserve to consider raising rates earlier than it had previously planned. The heightened fears of a quicker increase in interest rates in the world’s biggest economy will mar capital inflows into India and other emerging markets. The Russia-Ukraine crisis will affect economies around the world either directly or indirectly, across a variety of channels from higher prices to dampened spending and investment, though it is unclear what the ultimate impact will be. To quote US Federal Reserve Chair Jerome Powell, “What we know so far is that commodity prices have moved up significantly, energy prices in particular. That is going to work its way through our US’ economy in the form of higher inflation at least in the short term.”

The global commodity prices began their ascent since from the first half of 2020. The key factor driving the price increase was the lower supply, demand recovery and liquidity flood in the second half of 2020 and the first quarter of 2021. As geopolitical tensions continue to exacerbate, global commodity prices are on track for the biggest weekly rally in more than 50 years. According to Refinitiv data, the S & P GSCI index, a broad barometer for the price of global raw materials, has jumped 16 per cent this week, on track for the sharpest rise on records dating back to 1970. It is now at its highest level since 2008.

Advantage Russia
Russia’s standing as a top supplier in oil, gas, coal, metals and grain signifies that the harsh sanctions applied to Russian entities following the invasion of Ukraine has derailed critical resource supply chains and led to dislocations all over. At present, Russia is the third-largest producer of crude oil in the world. Benchmark Brent crude oil prices recently surged to a 10-year high of USD 119.84 per barrel with Russian oil exports disrupted as traders try to avoid becoming entangled in sanctions. This extended rally also comes on account of fresh sanctions by the US that target Russia’s oil refining sector and data showing that crude stockpiles in the world’s top oil consumer, the US, have hit multi-year lows.

India is the world’s third-largest importer of oil. Hence, the current crisis will not only add to inflationary pressure but also impair consumer sentiment. The spike in oil prices is likely to have a material impact on inflation and the rupee, putting brakes on growth and widening the country’s current account deficit. According to minutes of the recent MPC meeting, global financial market volatility, elevated international commodity prices, especially crude oil, and continuing global supply-side disruptions pose downside risks to the outlook. The potential pick-up of input costs is a contingent risk, particularly if international crude oil prices remain elevated.

RBI Governor Shaktikanta Das has said, “High commodity prices and supply side shortages could weigh on corporate profitability amid weak pricing power and unfavourable base effects during 2022-23.” It’s not just crude oil market that will get disrupted. Russia also has the world’s largest reserves of natural gas. Russia’s natural gas production in 2021 is estimated to have been around 26.92 trillion cubic feet (TCF), second behind the US, which is estimated to have produced around 34 TCF. Any supply disruptions in the oil as well as natural gas shipments will lead to a massive shortage and further uptick in prices.

The Silver Lining
However, the earnings environment has turned favourable for upstream PSUs given the recent rally in crude oil, lower global supplies and the expectation of a hike in domestic gas prices in the coming month owing to rise in prices at international hubs. The current scenario is a boon for companies such as Oil India and Oil & Natural Gas Corporation (ONGC) which are likely to benefit from higher realisations. Q4FY22 could turn out to be a blockbuster quarter for these companies. Leading global investment bank Goldman Sachs in a note published in January stated that global crude oil prices could remain higher for longer due to demand-supply imbalances in the crude oil market.

They expect oil prices to be above USD 100 per barrel in 2023 suggesting that even if current prices cool off, they will eventually head higher. In the past six months, Oil India and ONGC have outperformed the market furnishing returns of 38 per cent and 36 per cent, respectively, as against a 7.7 per cent decline in the Nifty 50 benchmark index.

"High commodity prices and supply side shortages could weigh on corporate profitability amid weak pricing power and unfavourable base effects during 2022-23."

Shaktikanta Das, RBI Governor

Russia and Ukraine together contribute nearly 15-16 per cent of the global steel exports. Russia is among the top steel exporters and supplies around 10 per cent of global nickel, which is used to make stainless steel and batteries for electric vehicles.

Russia is also the world’s biggest aluminium producer outside China, accounting for around 6 per cent of global supplies. The inability to export metals from Russia has thrown in a golden opportunity for Indian metal producers to fill the gap. Hence, metal stocks have been thrust into the limelight. Of late, metal stocks have rallied on hopes that reduced Russian exports will help Indian companies to further capture the export market share. From February 24, 2022 to March 3, 2022, the Nifty Metal index has shot up ~16 per cent. 

At a time when global stockpiles have shrunk dramatically, aluminium prices recently soared to hit an all-time high of USD 3,741 per tonne on the London Metal Exchange, while the price of nickel surged to its highest in 11 years.

"What we know so far is that commodity prices have moved up significantly, energy prices in particular. That is going to work its way through our US’ economy in the form of higher inflation at least in the short term "

Jerome Powell, US Federal Reserve Chair

Conclusion
In addition, domestic steel makers have hiked the prices of hot-rolled coil (HRC) and TMT bars by up to Rs 5,000 per tonne as the supply chain is being impacted amid the ongoing conflict. Several analysts expect prices to further go up in the coming weeks with the crisis deepening. Steel players such as Tata Steel and JSW Steel are likely witness margin expansion on account of higher export volumes and rising prices. Hindalco, NALCO, SAIL, Vedanta and Hindustan Zinc stand to be key beneficiaries of lofty base metal prices. Conclusion In the latest quarterly a Reuters’ survey of more than 500 economists taken throughout January reported that although prices are expected to ease in 2023, the inflation outlook appears to be much stickier than it was in the previous survey taken three months earlier. Nearly 40 per cent of the respondents that were surveyed identified inflation as the biggest risk to the global economy this year, ahead of the 35 per cent who chose corona virus variants and 22 per cent who were concerned that central banks would act too quickly and restrict growth. Empirical data suggests that a geopolitical crisis always pushes the prices of all commodities higher.

In total 27 commodities ranging from the metals, energies to soft commodities have witnessed a solid rally with recordbreaking gains. This could be just the beginning. The fallout from the Russia-Ukraine conflict is obstructing a major global source of metals, energy as well as crops, bringing about prolonged supply-chain shortages and sharper global inflation. All things considered, there are bullish tailwinds distinctly visible that position commodities as one of the most lucrative bets in the medium term which also furnishes a decent inflation hedge. A sensible strategy for retail investors would be to allocate a small portion of their portfolio towards commodity stocks with pricing power, strong margins and low leverage.

 

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