Cheaper oil and gold: a game changer for India?

April 16, 2013

Someone’s loss is someone’s gain and as Russian and South African markets reel from the recent oil and gold price rout, investors are getting ready to move more cash into commodity importer India.

Stubbornly high inflation and a big current account deficit are India’s twin headaches. Lower oil and gold prices will help with both. India’s headline inflation index is likely to head lower, potentially opening room for more interest rate cuts.  That in turn could reduce gold demand from Indians who have stepped up purchases of the yellow metal in recent years as a hedge against inflation.

If prices stay at current levels, India’s current account gap could narrow by almost one percent of GDP in this fiscal year, analysts at Barclays reckon.  They calculate that $100 oil and gold at $1,400 per ounce would cut India’s net import bill by around $20 billion, bringing the deficit to around 3.2 percent of GDP.

Markets are celebrating these developments, with Mumbai’s stock markets jumping 2 percent today, the biggest one-day rise in seven months. Indian oil companies, which must supply subsidised fuel to the population, gained 3-4 percent on the day. On bond markets, 10-year government bond yields fell to six-week lows. Analysts at JP Morgan are advising clients to stay long Indian debt, predicting two interest rate cuts and a 50 bps fall in the  5-year yield. They also suggest buying 5-year overnight index swaps or OIS  (A swap that exchanges a floating overnight rate for a fixed interest rate). Currently at 7.17 percent, this should fall below 7 percent in coming months, they say.

Steve Ellis, an emerging debt fund manager at Fidelity Worldwide Investment says:

We have been increasing exposure to India. We are more optimistic than the market on the reform process and India will benefit from the lower oil and gold prices.

Indian equities have suffered in recent weeks, however, on fears of a rollback in reform momentum and weakening growth. A monthly survey by Bank of America/Merrill Lynch on Tuesday showed investors swinging into a net 27 percent underweight position on India this month, from a 44 percent overweight last month.

Analysts at HSBC for instance are underweight India — they cite the  current account deficit and inflation as reasons. But the commodity price collapse, if sustained, could prove a game changer on both these fronts.

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