The world is struggling with low demand. With consumers in the western world still in the doldrums and the Chinese investment boom fast ebbing, the world seriously lacks a demand engine that can spur growth activity.
Not surprisingly, the global inflation rate — if one excludes the 2009 crisis period — is close to a ten-year low and is likely to dip lower given the precipitous fall in commodity prices. Few expect a quick revival because when the market starts winding down after a commodities super cycle, it tends to develop its own momentum. Even unviable suppliers continue operations for much longer than desirable owing to access to cheap funding, particularly if the price weakness follows years of big profits. Sometimes, local government support also helps, like the recent royalty cuts for some iron ore mines in China. Costs also decline faster, not just because the currencies of commodity-exporting countries start to fall due to deteriorating trade balances, but also because prices of inputs start to come down and companies start to focus more on costs after years of focusing only on revenues. This is playing out with textbook precision in commodities such as iron ore. And while there may be factors that are unrelated to underlying demand or supply that have accentuated the precipitous fall in crude oil prices, the trigger for it does seem to be demand weakness.
There are three important ways in which weak demand, weak commodity prices and fear of global deflation affects the Indian economy and markets.
The first is the effect of global monetary policy on asset prices. Deflation can be debilitating to economies that have a lot of debt: of this set, peripheral Europe is the most well-known. Fear of deflation is provoking central banks across the world to further ease monetary conditions. The weighted average policy rate in countries adding up to nearly three-fifths of world GDP is already near zero, and the rest are mulling cuts as well. Further, the quantitative easing (QE) in 2015 is expected to be nearly twice that in 2014, with the Bank of Japan and the European Central Bank offsetting the end of QE by the US Fed