Fuel price rise: Inflation to go up, but effects uncertain

The government’s decision to free petrol prices and raise those of other fuels has given rise to inflationary expectations. Most analysts feel the headline inflation rate, as measured by the Wholesale Price Index (WPI), will see an immediate upward impact of around one percentage point on the June numbers.

“I expect an increase of 0.9 percentage point in the monthly WPI inflation… But it will result in lower fiscal and revenue deficits, cooling inflation in six-nine months,” said Kaushik Basu, chief economic adviser to the finance ministry. In May, when inflation was in double digits, Basu had said deregulation of petrol and petroleum products was an eventuality and timing was the only thing being deliberated.

“The inflation figure you are looking at may increase in the short term, but six months down the line, you would see lower inflation even as the index will reflect international prices,” Basu had said then. Adding that with the decontrol, underrecoveries of oil companies would go down and the fiscal situation would improve, curtailing inflationary expectations.
 

FUELLING PRICE RISE Impact on inflation due to price increases suggested by the Parikh committee
Product	WPI before price hike	Wpi after price hike	Increase in WPI
Petrol	246.50	246.70	0.10
Diesel	246.50	247.40	0.36
Kerosene	246.50	248.10	0.65
LPG	246.50	248.80	0.94
Total impact on inflation			2.05
Source: Antique Stock Broking

The inflation rate, as measured by the WPI, was 10.16 per cent in May, exceeding analyst expectations and fuelling inflationary ones. It had breached the double-digit mark at 10.3 per cent in February, while peaking at 11.04 per cent in May, primarily driven by a consistently high food inflation and rapidly picking up core inflation. Core inflation is a measure that excludes certain items that face volatile price movements, particularly food and energy.

“The immediate impact on headline WPI inflation would be 70-90 basis points, while the total impact would be around 120 basis points over the next seven-eight months, including the second-round impact of higher diesel prices, that would increase transportation costs and food prices,” said Indranil Pan, chief economist, Kotak Mahindra.

Most forecasters will raise their expectations for the current financial year by 100-130 basis points. However, they are divided on whether the Reserve Bank of India would go for a policy rate hike before the monetary policy review on July 27. Most see point-on-point inflation in the range of 7-7.5 per cent by the end of 2010-11.

“We believe RBI will raise policy rates by 25 basis points before the monetary policy review, though it would not be a reaction to the government’s decision to raise fuel prices,” said Subhada Rao, chief economist, YES Bank. Others like D K Joshi, chief economist with Crisil India, do not see an inter-policy rate hike by the central bank.

Even as the fuel index constitutes a low weight of 14.22 per cent, analysts are concerned about the ripple effect that today’s decisions would have in the entire index, as transportation and production costs will rise in the coming months, hitting consumers sharply.

“It would definitely be a shock for consumers, as consumer prices will go up significantly, but given that the move is directed towards more efficient consumption, it is definitely a step in the right direction,” said Sumita Kale, chief economist with research agency Indicus Analytics.