A sharp fall in commodity prices across segments in the past couple of months is expected to rescue India Inc from shrinking profitability in 2013-14.
The fall is 15-20 per cent. Metal prices in India have fallen by seven to 10 per cent during the period.
Since mid-February, the commodities market has seen a reversal following the European debt crisis and fear of an early phasing out of the US Fed's quantitative easing programme. Last week's news on China's lower-than-expected economic growth has added to the trend. Base metals are down 15 per cent on an average, while Brent crude oil lost 17 per cent. Rubber is down 23 per cent.
"Lower commodity prices, including crude oil, will help companies improve their operating margins, which has been under stress, and if recent rate cuts by RBI will slowly be transmitted," said D K Joshi, chief economist, CRISIL. He also said demand is expected to pick up gradually and this year being election year consumption will increase. Normalcy of monsoon will play an important role in rural demand.
"A fall in commodities' prices, along with sharp fall in crude oil prices, can dramatically improve Indian companies' net profit margin. Manufacturing companies will be major beneficiaries, as two-thirds of their cost of production is raw material cost," said Mahesh Vyas, managing director of Centre for Monitoring Indian Economy, an independent think tank.
"Assuming the recent fall in commodity prices sustains, India will figure among the biggest winners in terms of higher growth, lower inflation and/or better economic fundamentals," said Rob Subbaraman, Nomura's chief economist for Asia ex-Japan, in a recent report on the impact of falling commodity prices.
He said, "A fall in commodity prices reduces the cost of energy and other factor inputs, thereby lowering the cost of Asia's manufacturing production. This boosts profit margins, a clear positive for business investment." Commodity prices globally have fallen due to demand contraction and fear of withdrawal of liquidity. China's lower economic growth will result in lower demand for commodities; it has been a big demand driver of commodities in recent years.
India Inc will also benefit from the fall in raw material costs; also, lower prices would mean more demand. Nomura's Subbaraman says, "A negative demand shock seems a more plausible explanation for the current drop in commodity prices." He believes demand will recover in the second half of the calendar year. Adding: "Even with global demand recovering in H2 (the year's second half), we find it conceivable that global commodity prices remain at these lower levels because of positive supply-side developments - better weather affecting food prices and anticipation of the big pipeline production bulges of shale gas in the US and LPG in Australia, to name a few."
The impact on companies and sectors will differ but raw material cost will come down substantially. A fall in fuel prices will result in a fall in energy cost, as well as cost of several other raw materials that are derivatives of crude oil. The fall in gold prices will, of course, hurt companies in the jewellery space, while metal refiners will get hurt as their margin incomes come down.