Railway fare hike may add up to 50 bps to inflation

El-Nino risks fading; but any further shortfall in rains could hit growth, fuel inflation says Bank of America Merrill Lynch

The government"s decision to hike passenger rail fares and freight rates may end up pushing up inflation by up to 50 basis points. Poor rains may have a further adverse impact on inflation, according to a Bank of America Merrill Lynch India Economic Watch report dated June 23rd.

"Friday's railway price hike " 14.2% for passenger fares and 6.5% for freight rates "should add 25-50bp to CPI inflation under reasonable assumptions in the absence of firm CPI data.

At the same time, a more precise calculation is not possible because the government does not publish the break-up of transportation head in CPI inflation," said the report authored by India Economists Indranil Sen Gupta and Abhishek Gupta.

The report noted that while rains so far have been 45% below normal, the risk of El-Nino (the weather phenomenon responsible for the reduced rainfall) seems to be fading. While normal rains will result in consumer inflation coming down to 7-7.5% by March 2015; poor rainfall could push up inflation to 8-10%.

This could affect growth as well, possibly cutting growth to below five% for the financial year ending in March 2015. Drought-like conditions would impact the autumn harvest, pulling down growth. The increase in agriculture-led inflation could cause the central bank to avoid cutting interest rates too soon, for fear of further stoking inflation. This in turn could impact industrial recovery, noted the report.

"We continue to estimate that an El Nino-induced drought poses a 50-75bp risk to our 5.4% FY15 growth forecast (Table 4)".There are typically three impacts. First, drought directly impacts the autumn kharif harvest (~8% of GDP). A 3% swing, for example, would pull down growth by about 25bp. Second, there are second-round effects of the slowdown in agriculture that could be as large as the first. Finally, industrial recovery would be pushed back further if the RBI delays rate cuts due to rising agflation and inflation," it said.