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SPECIAL REPORT

Inflation

Trade Balance
(% of GDP)

Asia-0.81.4-1 China-0.80.8-0.6 India-12.6-1.2 Malaysia-0.420 Philippines-1.61.6-2 Thailand-1.80.8-3 Latin America*-0.21.20 Argentina-0.40.20.2 Brazil-0.42-0.4 Chile-0.42-1.4

Source: IEA based on IMF analysis

 Global economic growth: Stephen Roach, chief economist, Morgan Stanley, predicts that the US economy could go into a recession if oil prices do not correct within the next three months. Consequently, other global economies closely linked to the US through trade will also be dragged into a recession, according to Roach.  As per the IMF, every $5 per barrel increase in oil prices shaves off 0.4 per cent from global economic growth. Despite the phenomenal rise in oil prices this year till date, global economic growth has been strong because of an exceptionally strong growth in the first quarter this year. However, some of these stimulants may not hold up going forward, according to the IMF.  Obviously, macro economic indicators of oil importing developing countries will suffer the most, particularly because their oil intensity is relatively high.  According to International Energy Agency (IEA), Asia would experience the largest increase in inflation on the assumption that the increase in international oil prices would be quickly passed through to domestic prices. Rising consumer prices may necessitate hikes in interest rates.  Financial markets and stock valuations: The sharp fall in bond markets has prevented a retreat in stocks in US and emerging markets in the past few months. As per BCA Research, a global investment research firm, there could be problems with US profit growth as oil prices have spiked to new highs, yet the Fed remains steadfast in its determination to lift interest rates.  BCA Research's latest weekly report said: "Our profit model, based on the dollar, interest rates and oil prices, warns of a sharp profit deceleration next year. An outright profit contraction is likely by late 2005 if oil prices do not correct and/or interest rates continue to rise steadily. Such an outcome would first be heralded by a sizable setback in stock prices."  Others derive solace from the fact that oil prices are still not as high in real terms as they were in the late seventies. "Oil prices will have to be around $80 for prices to equal what they were during the last peak in real terms. And I do not see any threat of recession on account of oil prices as the US, for instance, is far more energy efficient today than 30 years ago," says Hazel McNeilage, managing director (Asia), Principal Global Investors.  Indian economy and stock markets: In terms of output, the Indian growth story is robust but deteriorating compared to previous quarters. In the April-June 2004 quarter, GDP grew by 7.4 per cent, lower than the 8.2 per cent growth registered in the January-March 2004 quarter and 10.5 per cent in the October-December 2003 quarter.  Inflation has also been inching higher, driven by increases in fuel and commodity prices. In the year to September 25, the Wholesale Price Index (WPI) eased to 7.38 per cent after hitting a three-and-a-half-year high in late August.  Traders on bond street are expecting a hike in interest rates even as Finance Minister P Chidambaram recently warned central banks to be cautious about rate hikes as it is largely supply driven.  For the Indian economy and the corporate sector, inflationary pressure looms large due to the rise in the prices of commodities and oil, additional taxes, including the 2 per cent cess introduced in the Budget, and the introduction of value added tax (VAT).  Corporate profitability (non-oil companies): Non-oil companies in India will be relatively insulated from oil prices to the extent that the domestic prices of transport fuel are not rising as fast as international prices would dictate.  However, industries which rely on petroleum-based inputs will suffer a serious setback. "Corporate profitability could be hit 1-5 per cent, depending on how much companies are able to pass on costs to end-users," says Rajesh Jain, director, Pranav Securities.  Companies in the FMCG, automobiles, cement, steel, power and capital goods sectors will bear the brunt of high freight and input costs. Paint companies will see some serious dent in profitability as 50 per cent of their raw materials are from oil-based derivatives.  Soaps and detergent manufacturers, which absorb significant oil-based inputs, will see an escalation in costs, but this may not result in an earnings squeeze as there are counter-balances at play.  Auto companies will see demand slow down, apart from cost push on account of plastics/Acrylonitrile-Butadiene-Styrene (ABS) components. Cement and steel will see increases in freight costs.  The stock markets seem to be discounting some of these concerns already. Amongst the top five losers last month (ended October 7) were the S&P Paints index (-5.62 per cent), Solvent Extraction Index (-4.38 per cent), Photographic Products (-3.77 per cent), Abrasives (-3.69 per cent) and Packaging (-3.47 per cent).  Another spill-over effect of high oil prices will be on the currency. Currently, about 31 per cent of India's total imports is on account of oil. So far during this fiscal, out of total imports of $37,138 million, $11,375 million was on account of oil. And oil imports have seen a 54.85 per cent increase compared to the same period last year.  Higher demand for dollars means a depreciating currency. The perverse beneficiaries will be the exporters. That may be one reason why tech stocks are partying on the bourses.