Sudip Bandyopadhyay’s Blog

Once upon a time – six months ago, another age – anyone who could say “crack spread” without laughing was assured a lucrative job as an oil trader. Back then, when crude oil trading at $140 a barrel, the world looked Malthusian. The globe was threatened by a violent scramble for scarce resources, and peak oil theorists – or “Pot” heads – held the stage. Now the oil price has collapsed to just below $ 40 and everyone is swimming in the stuff. Curiously, for those who seek patterns in numbers, the crash comes exactly 10 years after the Asian financial crisis, when crude prices plumbed $10. Few believe crude will fall that low again – although in theory it could. Demand has contracted so rapidly that it has depressed the spot price relative to future prices, creating what oil traders call a contango. The quickest exit from the situation would be for producers to start storing oil too – by keeping it in the ground. Pressure is rising for Opec members to do more and more of just that. Yet even when the world economy eventually recovers, extra capacity drilled during the boom will keep a lid on prices. Slowing population growth in the developing world and increased energy efficiency will curb demand, keeping prices at about $ 75 a barrel, the World Bank forecast last week. Rather than being different, the recent commodity boom of “permanently higher and rising prices” looks much the same as history’s many other commodity booms. All these also boosted inflation and took place during periods of strong economic growth and geopolitical uncertainty. Then they too passed and were forgotten.

In general, experts agree that although the sharp price declines of recent months could be a buying opportunity for longer-term investors who missed the boat earlier this decade, the desire to increase exposure to risky assets such as commodities is unlikely to re-emerge until the global financial crisis abates. That would mark a significant change since investors started to pour serious money into commodities about five year ago. For some it was the lure of strong returns, for others a hedge against inflation. For all, it was the appeal of diversification, amid a notion that commodities prices usually do not move in the same direction as equities or bonds. By the end of June, investors’ commodities assets under management had risen to $ 270 bn, up from about $ 10 bn in 2000. Not all the increase had come from fresh inflows; a significant portion of the rise derived from the appreciation of the assets themselves. However, assets under management fell in the thjrd quarter for the first time since 2003 to about $ 211 bn, according to Barclays Capital. Price markdowns rather than outflows accounted for the bulk of the fall, however. Whether investors start pouring money into the asset class again will depend on which view prevails; that the current drop in prices is just a blip or that the boom has ended. But for investors, executives and bankers alike the commodities boom and bust cycles teach that extrapolating today’s event into the future may prove the wrong bet. Ten years ago today, when oil prices bottomed at $ 9.64 a barrel, the common wisdom was that commodities prices were heading down. Today’s forecasts could prove equally fallible.

The Union government has been the sole focus of attention in the context of a fiscal stimulus package for the Indian economy. To a certain extent, that is inevitable – the central government is responsible for the Indian economy. That said, the role of state governments in aiding fiscal stimulus should not be underestimated. Obviously, state government action cannot be a substitute for central government action, but it would be perilous to assume away its significance. Interestingly enough, the fiscal health of India’s states as a whole has been steadily improving over the last ten years. Gross fiscal deficits of state governments as a percentage of GDP was as high as 4.6% in 1993-2000, but has declined since – the Budget estimate for 2008-09 is 2.1% . The fiscal health of the Centre on the other hand, is not as encouraging. Although the official Budget estimate has declined from over 4% in 2003 - 04 to 2.5% now, official figures underestimate the problems by not including off-Budget subsidies like oil bonds. In effect, this means that state governments have more room for fiscal manoeuvre than the central government. Thus apart from Central Government fiscal stimulus and monetary measures by RBI, we all need to also start looking at State Governments for fiscal relief and stimulus.

The markets displayed strong buoyancy during the week driven largely by important global events like the US Fed cut rate and OPEC meeting but more specifically due to strong FII buying in Indian markets which kept sentiments positive and the undertone mildly bullish. On the domestic front, Inflation further declined sharply, and slipped below 7% to 6.84% for the week ending Dec 6th 2008. This is definitely an encouraging sign as in most likelyhood Inflation could end up between 4~5% by March 09, much below the RBI’s comfort level of 7% and could trigger further interest rate cuts by RBI & banks, which the markets are awaiting and could provide boost to market sentiment. Also Global crude prices witnessed a sharp fall, post the OPEC meeting on Dec 17th 2008, where in it was decided to cut oil supplies by 2.2mn bpd from Jan1 2009 onwards in a bid to stop the fall in oil prices. However the markets were disappointed with the quantum of oil cuts looking at the bleak energy demand scenario ahead globally and consequently crude prices touched a low of $36 a barrel – which is the lowest ever level seen in the last 4 years.

Sentiment for this week is still upbeat after consistent rally for last few days. FIIs buying now appears to have slowed down, with their ‘Net figure’ for the last week slipping from Rs. 1833 crs to just Rs.52 crs till 18th dec.08 in cash segment. Holiday season for FIIs will start this week, in view of which no big inflows are expected. Also this week is an ‘Expiry’ week’ for F&O and . Choppiness is therefore anticipated. On the positive side, announcement of another fiscal package by government and further measures by RBI in terms of rate cuts is likely to boost the sentiments.
( ** this is the transcript of the weekly column I write for Economic Times )