Can't say crude prices have peaked: UBS

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The global cues in the past two-three weeks have changed rather dramatically. We have seen a huge fall in commodity prices not just crude but other commodities, base metals as well and we have seen a dramatic rise in the dollar versus most other currencies. What does this mean in terms of global economic use? What does this mean for global inflation cues and what is the impact on India of all these. Bhanu Baweja the expert from UBS spoke to CNBC-TV18 on currencies, commodities and fixed income in the emerging markets. He spoke on where the crude prices and inflation are headed and how does India fit in.

 

An exclusive interview with Bhanu Baweja, the Global Head of Emerging Markets at UBS:

 

Q: First the fall in commodity prices that we have seen especially in crude. Would you say that it is definitely peaked off for 2008 and what would you say is the trajectory from hereon?

 

Baweja: I think crude can come a bit lower from here; very difficult to say that it's definitely peaked. We have to remember that this is a commodity where inventory levels are still extremely low. There is no doubt about the fact that global demand has taken a turn for the worse not just in the US but also from Europe. But demand is one side of the equation; supply still remains tight which is why I would be hesitant to say that crude has definitely peaked because if we get one event that needs to supply which leads to lower balance in the short-term, it will basically mean that oil prices will have to go much farther.

 

I think that crude can come towards USD 100/bbl but I also believe that they are not going to go too much lower than that also because the marginal cost of production of crude is not too much lower than that. Over the next three-four years we expect energy prices to stay high; we think crude can go back towards USD 140-150/bbl. So we are not looking at a major decline in crude prices.

 

Q: How are you looking at the US economy? Are you expecting a recession at all or do you think that US will get away with perhaps a lesser of a slowdown because commodities are probably cooling?

 

Baweja: To be absolutely clear; I think demand is slowing down, the supply side is what keeps commodity prices elevated and not all commodity prices, as one would know base metals prices have already been coming lower. Now energy prices are coming off as well. In the US our view is that we are already in a recession and although this is not going to be a sharp recession; this is certainly going to be a prolonged slowdown as this is not an income statement problem but a balance sheet problem. The US consumer and also the US government need to adjust their balance sheet and that doesn't happen in one-two quarters. So this is very different from the slowdown in 2001. It's different from the US slowdown in 1991, I think this can take much longer.

 

The only part of the US economy whose balance sheet is in a pretty rude health is the corporate sector. But the corporate sector is not going to invest, not in the US anyways.

 

Q: You are speaking about a prolonged US slowdown and perhaps even a euro zone slowdown in addition. What does all this mean for countries in Asia and in particular India? Will India look more decoupled since it is not so depended on trade? How does this impact the Indian economy?

 

Baweja: The Indian economy is going to be more shielded as it always has been. One can consider that Indian domestic demand is very strong or one can say that India is much more isolated. In this case, I think the former is correct.  Indian domestic demand is much stronger now but there is no way to award a cyclical slowdown.

 

So does that mean India is going to go into recession? Absolutely not but India is going to go down from 9% growth towards possibly 7.5% growth; which is a fair slowdown? What it means for Asia as a whole depends on how export oriented an economy is? Places like Taiwan, Singapore, and Malaysia are already seeing their export orders declining much more significantly. So growth is coming lower in India; I am not sure inflation is quite ready to come lower yet.

 

Q: What would your guess be on Central Bank? You think they are done?

 

Baweja: I think they are not done because I do believe that there will be more quantitative tightening. We focus on interest rates in most economies but most economies work differently from each other. In the US it's fair to focus on the Fed fund rates but in India, I think there should be more focus on the CRR because this is an economy where the quantity of money still matters more. If commodity prices do not play ball and we cannot make policy on hope - I think there is a problem out there. I think there is enough inflation momentum in this economy for things to go wrong again.

 

Q: Since you are optimistic on Indian growth, what is your view on flows perhaps after 12 months. Liquidity has dried up; in fact we have seen an outflow of money from India. Do you think with this kind of a prolonged slowdown in the US, global liquidity could refocus on a country like India pretty soon by the end of 2008- early 2009 do you see liquidity returning?

 

Baweja: Not in a hurry. Liquidity is a concept that's not very easily understood. I think liquidity is a state of mind and when confidence declines liquidity evaporates without the money evaporating. So risk appetite is going to stay reasonably low. There are still quite a few question marks on how India is going to do if oil prices surge or goes much higher from here. That will be a problem that India cannot handle - not on the currency side and neither on the fiscal side.  So there are quite a few risks. I do not think people have the appetite to pre-empt. So they will wait for evidence that (a) policy makers are not making any mistakes (b) their job is not made much more difficult by the external circumstances and (c) domestic demand does hold up. There is a cyclical slowdown where valuations are expensive and there is a lot in price and that's where we are right now.