US move on Iran oil to see inflation rise, RBI holding rates in June

CAD and rupee may come under pressure

An increase in global crude oil prices following the US’ decision to end relief to India and others on purchase of the commodity from Iran would slightly raise the inflation rates in the country, besides increasing the government’s import bill and subsidy burden. However, the impact on prices would not be high since the inflation rate is currently moderate. But, it would make the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) cautious and it may refrain from cutting the repo rate in its June policy, contrary to what was expected.

Devendra Pant, chief economist at India Ratings, said every 1 percentage point hike in global crude prices would increase the consumer price index (CPI)-based inflation rate by 0.04 percentage point and the wholesale price index (WPI)-based inflation rate by 0.1 percentage point, if all increase is passed through in the domestic markets.

The CPI inflation rate stood at 2.86 per cent by the end of financial year 2018-19 (FY19), well below the average of the RBI’s mandate of 2-6 per cent. The WPI inflation rate, on the other hand, was 3.18 per cent. The impact of one percentage point increase in global crude prices would not have much impact on the inflation rate, keeping other things constant. 

Pant said had the inflation rate been in double digits, the impact would have been much graver. Brent crude, the international oil benchmark, rose 0.8 per cent to $74.64 a barrel early on Tuesday, adding to gains on Monday to reach its highest level since early November. It later fell back slightly to $74.43 by late morning in London.

It rose by up to 3 per cent in intra-day trade on Monday but later pared the gains.

Madan Sabnavis, chief economist at CARE Ratings, said the MPC would be more cautious during its June policy review. “If the crude oil price remains around $75/barrel for another month, the MPC may postpone a rate cut in the June bi-monthly committee meetings,” Sabnavis said.

The MPC has cut the policy rates twice after Shaktikanta Das assumed charge as the RBI governor.

Domestic fuel prices take into account the average of global prices of the past fortnight. So, the effect has not been seen so far.

D K Srivastava, chief policy advisor at EY, said the impact of the rise in global crude prices on the inflation rate would be limited. Global crude prices may rise to $80 a barrel in the first quarter of FY20, but may revert to normal after that, he said.Sabnavis said the benign oil prices of the previous four years may reverse now, which would impact India’s current account deficit (CAD) and in turn the rupee value. He said a permanent increase in crude oil prices by ten per cent under ceteris paribus conditions (which means nothing else changes) could translate into CAD incr­easing by 0.4-0.5 per cent of GDP.

Also, the rupee can go down by 3-4 per cent on an annual basis, assuming nothing else changes. 

The CAD increased to 2.6 per cent of GDP during April-December 2018 from 1.8 per cent in April-December 2017.

Trade deficit, which is excess of imports over exports and which forms the largest part of CAD, rose to $176.42 billion in 2018-19 from $162.05 billion a year ago. 

Sabnavis said higher domestic prices of crude would mean more revenue for the states as tax on fuel is ad valorem, which means it increases with an increase in prices. However, the Centre would have to bear the burden of subsidies for LPG and kerosene, and would not get higher taxes as these are flat rates, which remain intact irrespective of the fuel prices.

Petroleum subsidies at the Central level are pegged at Rs 37,478 crore in FY20 against Rs 24,833 crore in FY19.