Introduction:

Periods of commodity price shocks sharply coincide with moments of intense economic stress, which in turn have sometimes led to political upheavals. Rising commodity prices create stress. Inflation goes up. The trade gap widens. The rupee comes under pressure. Falling commodity prices bring relief on all three fronts.

Body:

Commodities, raw or partially processed, are often the most significant exports of developing countries, and revenues obtained from them have an important effect on the economies and living standards in these countries.

The causes of the rise in commodity prices:

• India is a net importer of commodities, so the trends in global commodity prices are especially important. Eg: Oil imports
• Since 1960, India has faced three major commodity import price shocks.
• Severe droughts in last 6 years and continuing agrarian distress have reduced crop yields.
• Prospects for continued deterioration in the supply mean prices are likely to stay high in the near term.
• Oil prices, too, have picked up, driven by geopolitical risks.
• Populism could push up inflation and slow down government-led capital expenditure.

Implications for economic growth:

• Commodity price fluctuations, along with the globalisation of the world economy and increased liberalisation of commodity markets have led to profound changes that seriously affect the weaker economies of the developing world.
• Commodity price instability has a negative impact on economic growth, countries’ financial resources, and income distribution, and may lead to increased poverty instead of poverty alleviation.
• High commodity prices cut domestic purchasing power while low commodity prices add to it.
• The most significant commodity in this context is oil.
• Indian economic stability is often hostage to what happens under the hot Arabian sands or in the air-conditioned rooms where the global oil cartel meets.
• The international terms of trade—or the ratio of the price at which a country sells to the world to the price at which it buys from the world—are thus a key concern for Indian policymakers.
• India’s import basket is dominated by commodities while Indian exports have significant manufactured items such as engineering goods, textiles and pharmaceuticals.
• Commodity price shocks have stronger effects on domestic inflation in developing than in advanced economies.
• Food shocks are more likely to have sustained inflationary after-effects in countries with food as a sizable portion of the basket of goods and services measured by the consumer price index
• The India’s balance of payments is also supported by software exports as well as NRI deposits.
• Periods of global commodity price shocks are associated with fall in net export earnings for India and a deterioration of terms of trade
• China has been less prone to topple over when terms of trade deteriorate because its exports are robust.

Way forward:

• Policymakers must strive to keep the surge in commodity prices from triggering a sustained overall increase in inflation—that is, to prevent the commodity price shock from passing through to so-called core inflation (inflation stripped of volatile fuel and food prices).
• Better overall governance, greater central bank autonomy, and, to a lesser extent, the adoption of inflation-targeting frameworks seem to help anchor inflation expectations and reduce second-round effects of international commodity price shocks.
• There is a need to find alternative sources of energy in the form of renewable energy which can tide away the oil price shocks. Strategic oil reserves can be a short-term measure.
• Reduced gold imports and lucrative financial options for people should be devised.
• Strengthening the manufacturing and MSME sector to push for more export-oriented growth.
• Better agrarian policies with inclusion of technology in agriculture to curb the food price shocks.