Ashok K Lahiri.
When a new major region develops rapidly, prices of primary commodities experience a long super-cycle. They first increase and then decrease for 10 to 35 years each to complete 20- to 70-year-long super-cycles. That is conventional economic wisdom.
A super-cycle took place when Britain, with industrial revolution, developed rapidly from the late eighteenth century to the first half of the nineteenth century. It recurred during US industrialisation after the Civil War and European reconstruction after World War II.
The routine repeated itself with the spectacular Chinese transformation in recent times. With Deng Xiaoping’s reforms, China graduated to an “upper middle income” economy by 2010, according to the World Bank.
At the beginning of the reforms, for two decades until 2000, commodity prices were benign. The upswing thereafter was relentless until 2012.
Soon after 2000, China was purchasing 40 per cent or more of major base metals traded internationally. It became the world’s largest consumer of primary commodities.
For example, its steel consumption grew five-fold, and by 2015, exceeded the combined consumption of the US, Russia, India, Japan and South Korea. China could not beat the “super-cycle” upswing beyond 2000.
India is still a “low middle-income country” and at an early transformational stage. In 2015, with per capita gross domestic product (GDP) at current prices in US dollar terms only a fifth of China’s, India appears to be 10 years behind China. In 2015, it was where China had been in 2005.
So, the question is: Can India beat the super-cycle upswing for at least another decade?
Currently India’s share of world consumption of primary commodities is very small compared to its 17.5-per cent share of world population.
For example, in 2011-12, India accounted for only 3.5 per cent of world consumption of metals, compared to China’s 22.8 per cent with 19.2 per cent of world population. As it develops, India’s share is bound to increase. And as it does, will prices shoot up?
In primary commodities, it is useful to distinguish between petroleum and non-petroleum items. India, the fourth-largest importer of crude in the world, is dependent for over three-quarters of its crude petroleum needs.
It also depends on the rest of the world for non-ferrous metals such as copper and nickel, and critical minerals such as cobalt, germanium, molybdenum, and tungsten.
Over 202 million tonnes of its crude imports in 2015-16 accounted for more than a quarter of its import bill. A decrease of $1 per barrel in crude prices saves the economy at least $1 billion in imports.
Price of the Indian basket of crude – a derived basket of sour (Oman and Dubai) and sweet (Brent) processed by Indian refineries - increased more or less steadily from around an average of $22.5 per barrel in 2001-02 to a peak of $132.5 in July, 2008.
The Great Recession witnessed sharp adjustments of speculative positions. Within five months, it collapsed to $40.6 in December 2008, an overcorrection with hindsight. The price recovered rapidly to rule above $100 between February 2011 and August 2014.
Crude price has been benign for some time. From $111.89 in 2011-12, the annual average price has fallen every year until 2015-16, and helped save foreign exchange on imports, bolster public finance through lower oil subsidies and higher taxes on petroleum products, maintain prices of petroleum products - a universal intermediate – at reasonable levels, and hence, reduce inflation.
The declining trend reversed in February 2016, when the price of Indian crude started to increase every month from $28.1 in January to reach $47 in June 2016, before declining to $43.5 in July. Was this increase for five months a flash in the pan, or a portent of ill omen?
The rapid increase in shale gas production in North America and the influx of oil from Iraq and Iran, together with slowing demand from Europe and China, have created a situation of structural oversupply in the crude market.
Russia, a major oil producer and the OPEC countries led by Saudi Arabia, because of budgetary compulsions, cannot afford to correct the glut by output cuts.
Barring natural disasters, such as the recent fire near the oil sands in Alberta, Canada, or geopolitical risks such as a war in West Asia, the risks to India from a flare up in crude prices over the next few years appears limited.
For prices of non-petroleum primary commodities, on the other hand, global demand will play a fundamental role. Maintaining India’s overall self-sufficiency in foodgrains is fundamental in this context.
World prices tend to react strongly to India meeting a shortfall in its huge needs from international markets. In a way, however, India is well placed to take advantage of the current low growth in the rest of the world.
First, according to Schumpeter’s famous theory of creative destruction, the technological innovations that have created and are creating economic growth in emerging sectors will be accompanied by decay in older, obsolete sectors and methods of production and release resources.
The net draft may be far less than the additional demand that India creates with its industrialisation, infrastructure build-up and urbanisation.
Second, India’s growth has been much less resource intensive than China’s. During 2001-2014, China sustained an average annual growth rate of 9.8 per cent, a good 2.6 per cent higher than India’s 7.2 per cent.
But vis-à-vis India, this was with China investing almost a tenth more of its GDP for capital formation. There are indications that China is increasing its efficiency of capital use and reducing its incremental capital-output ratio.
If India maintains its “high bang for the buck” efficiency in use of capital, and China rebalances its economy by cutting down on investment, the net draft on primary commodities may be limited.
The critical issue is delinking the Indian economy from slow growth in the industrialised world and growth deceleration in China. India can beat the super-cycle if it can grow while the rest of the world slumbers, like when it won freedom in 1947.
Ashok K Lahiri is an economist.