EGYPTIAN CRISIS
Egypt’s political crisis may drive oil and commodity prices higher, Indian central bank Deputy Governor Subir Gokarn said, flagging a “new risk” to inflation that may spur policy makers to boost interest rates.
“There’s obviously a risk that the situation will transmit into higher commodity prices,” Gokarn told reporters in New Delhi today. “So, that intensifies the risk.”
Indian government bond yields climbed to a three-week high as Asia’s third-largest economy, which meets about three quarters of its annual energy needs from imports, braces for the impact of higher fuel costs. Oil prices could more than double if the unrest in Egypt forces the closure of the Suez Canal, Venezuelan Oil Minister Rafael Ramirez said Feb. 4.
“Everybody is bearish on bonds due to the gains in prices,” said Debendra Kumar Dash, a fixed-income trader at Development Credit Bank in Mumbai. “The Egypt issue has also added to the uncertainty on the oil front.”
The yield on the benchmark nine-year government bond climbed for a third day, rising one basis point to close at 8.21 percent in Mumbai. The rupee advanced 0.2 percent to 45.48 against the dollar.
Reserve Bank of India Governor Duvvuri Subbarao on Jan. 25 raised the key repurchase rate for a seventh time in a year and pledged “persistence with the anti-inflationary monetary stance” as he boosted the nation’s inflation forecast.
Subbarao said India’s benchmark wholesale-price inflation rate may be at 7 percent by March 31, compared with the earlier estimate of 5.5 percent. The gauge rose 8.4 percent in December.
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Egypt’s Crisis
“A whole set of events unfolded in the Middle East which are starting to have an impact on oil prices and that is something which we didn’t anticipate at the time of making the policy announcement on Jan. 25,” Gokarn said yesterday in Dabolim, in the western Indian state of Goa. “It is going to have an impact on our thinking, on our actions going forward.”
Protests demanding an end to President Hosni Mubarak’s 30- year rule erupted Jan. 25 in Cairo and have left as many as 300 people dead, according to the United Nations. Concern that turmoil in Egypt could force the closure of the Suez Canal, halting crude shipments through the waterway, sent North Sea Brent oil prices above $100 a barrel for the first time since October 2008 last week.
Brent crude for March settlement climbed as much as $1.07, or 1.1 percent, to $100.90 a barrel on the London-based ICE Futures Europe exchange today. Prices have climbed 44 percent in the past 12 months.
Suez Canal
About 2.5 percent of world oil output moves through Egypt via the Suez Canal and the Suez-Mediterranean Pipeline, according to Goldman Sachs Group Inc.
Egyptian Vice President Omar Suleiman and some members of the opposition yesterday agreed on limited steps to resolve the crisis, even as the government stood firm against the demand from protesters that Mubarak resign.
India’s Prime Minister Manmohan Singh said Feb. 4 the nation needs to urgently contain prices, that are rising at the fastest pace among major economies in Asia, as inflation poses a “serious threat to the growth momentum.”
Asian economies including India and China led a global recovery last year that’s been restrained by Europe’s sovereign- debt crisis and a U.S. job market where unemployment has stayed above or at 9 percent since May 2009.
“Uncertainty in the Middle East will impose risks on oil and higher prices of oil could lead to inflation,” Joseph Stiglitz, a Nobel Prize-winning economist, said in New Delhi on Feb. 5. “In the short-run, it may make the recovery more difficult.”
KINGFISHER’S BANKRUPTCY
Kingfisher Airlines, the second biggest carrier in India, was denied a public bailout today by Civil Aviation Minister Vayalar Ravi. It may finally spell doom for the struggling airline, barring a major intervention by investors, reports Reuters.
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Kingfisher has been stumbling along for years now, and Veritas Invest went so far as to deem Kingfisher “a bankrupt organisation.” Its inability to keep up with fuel costs forced the airline to cancel more than 200 flights in the past week, and its pilots are running for the hills.
Vijay Mallya, the beer tycoon that runs it, blames its problems on the “high-tax” and “hostile” environment, and that the “entire industry is in serious trouble,” according to Vikas Bajaj at the New York Times.
These are absolutely valid points, but it’s impossible to ignore how the company has been mismanaged, too.
Its acquisition of Air Deccan — Kingfisher tried to get into the low-budget game when it bought the airline, and rebranded it Kingfisher Red, in 2008. It bombed, and Kingfisher decided a couple months ago to discontinue the discount service.
It dug itself into a huge pit of debt — The airline’s interest costs are through the roof, and it’s gutting the company. Bajaj reports that 20% of its revenue is spent on interest, compared to the 6.5% that Jet Airways, the largest airline in India, spends.
Operational inefficiencies keep piling up — The Kingfisher fleet is made up of lots of different planes, and earlier this year it had to ground some planes because it didn’t have the cash to maintain them. A stark contrast is India’s most profitable airline, Indigo, which uses a Southwest Airlines-esque operational model to keep maintenance costs as low as it can.
RISING YUAN
A rising yuan may not massively boostChina’s commodity imports as demand from the developed world crumbles, leaving raw materials from oil to copper vulnerable to more shocks.
While a stronger yuan increases the buying power of the world’s top commodity importer, China’s domestic demand will not be enough to compel Beijing to aggressively snap up commodities when key markets like the United States and Europe are facing economic uncertainty.
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China last week allowed the yuan to rise at its fastest weekly pace since the global financial crisis in 2008, signalling that it is moving away from a single-minded focus on protecting exporters as it worries about inflation and the weakening dollar.
“China’s growth is not in a vacuum. At the end of the day, China too is reliant on demand from the European Union and the United States,” said Vishnu Varathan, economist for Asia at Capital Economics.
“China’s domestic demand alone won’t be strong enough to more than offset what’s happening on the global stage.”
The two troubled areas are also China’s biggest export markets — the EU takes a fifth of its shipments and the U.S. around 17 percent, based on Chinese government data for July.
Spot yuan, which hit an all-time high of 6.3820 per dollar this week, has risen 6.87 percent since it was depegged from the dollar in June 2010 and 3.17 percent so far this year.
“It helps but we do not expect an appreciation beyond 5 percent is on the cards,” said Dominic Schnider, executive director for wealth management research at UBS.
The recent wild swings in commodity prices, including oil’s 8.6 percent slide in a day in May’s market rout, suggests even a 5 percent appreciation in the yuan will have little impact.
The current prices of commodities are also well above levels seen during the previous crisis, giving China less incentive to buy aggressively.
Copper at around $8,940 a tonne is three times more expensive than its lowest level during the 2008-09 global financial crisis.
U.S. crude, despite falling 24 percent from this year’s high to around $87 a barrel, is still more than double its 2008 trough.
BUYING SPREE NO MORE
China’s buying spree supported prices of key inputs from oil to grains and base metals during the last global financial crisis as Beijing, backed by a massive 4 trillion yuan (380 billion pounds) stimulus budget, restocked at low prices.
But times have changed, with Beijing’s hands now tied by tighter credit and without stimulus cash to spare.
Fighting three-year high inflation, China has raised interest rates three times and upped banks’ required reserves ratio six times this year, making it more expensive for buyers to boost stockpiles.
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“That stimulus was the saviour for cyclical commodities especially base metals,” said Schnider at UBS.
“I don’t think China would be eager to give it another big shot especially in an environment where you have price pressure creeping up from all sides.”
China’s tight credit policy could restrict the country’s spot purchases of refined copper in the fourth quarter, traders said, in contrast to the past two years when Beijing’s loose monetary policy helped lift imports to record highs.
“End-users are more sensitive to price hikes given the fact that it is not easy to obtain credit,” said Chen Dixi, copper analyst at Jinrui Futures.
China may also reduce investment and slow the construction of new high-speed rails for the rest of the year after a fatal accident last month, which could cut orders for copper-contained parts and copper-based power cables, said Antaike analyst Yang Changhua.
But China’s latest move to allow the yuan to appreciate faster than before suggests that the country has scope to selectively ease monetary policy.
“We believe that China, from a policy point of view, will engineer a soft landing and I think they will go out of their way to avert a hard landing,” said Capital Economics’ Varathan.
“So it will have some scope to loosen credit though this will be more targeted. They will still have restrictions on the property market but they will cushion other sectors especially the SMEs (small and medium enterprises) to ensure that the job market doesn’t spiral downwards,” he said.
That flexibility could help some Chinese buyers secure bank financing and look for bargains to stock up when commodity prices fall, although not all can benefit.
WIN SOME, LOSE SOME
“How much weight China can pull will depend on the commodity in question,” said Xinyi Chen, analyst at Barclays Capital.
“We are still optimistic on copper and think that there will still be a pickup in imports towards the end of the year because the end consumption that is tied to copper will be public housing, which is not tied to the current climate,” she said.
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China is ploughing money into massive development projects, including an ambitious plan to build 20 million affordable housing units this year and next.
Other potential winners from the construction frenzy include iron ore and coking coal, as mills churn out more steel while the rush by cement companies to ramp up production would also boost demand for thermal coal, a key source of energy for these plants.
China’s strength, however, may not have that big an impact on oil prices.
“Crude oil is still largely dependent on the developed world and if we see significant weakness in demand there, then oil prices are definitely at risk,” said UBS’ Schnider.
The United States is the world’s biggest oil user, with 21 percent of global demand of 88 million barrels per day at the end of the second quarter, double that of No. 2 consumer China, according to data from the International Energy Agency.
China’s oil consumption has been losing steam since May, with implied oil demand up a paltry 0.4 percent in July, the second lowest this year, on climbing crude costs that cut refining margins.
“Can China hold everything up by itself? No it can’t, but it can hold prices well above levels during the global crisis,” said Citigroup analyst David Thurtell.
“It’s in China’s long-term interest to not let prices get too low because they want to see more mines being developed and more smelters being brought on stream.”
