Fuel rise to up inflation 70 bps

Revenue loss due to duty cuts will push up fiscal deficit target for FY12 to 5.3%.

You win some and you lose some, they say. The government’s decision to simultaneously increase prices of diesel, kerosene and LPG cylinders and slash duties (withdrawal of five per cent customs duty on crude oil imports and lowering the excise duty on diesel) will impact oil companies and inflation in different ways. While the stock market has given the thumbs-up to the move, the price hikes and duty readjustment will have multiple macro implications, especially for inflation and fiscal deficit.

It goes without saying the increase in fuel prices would help oil marketing companies cut under-recoveries by 29.4 per cent from Rs 170,000 crore to Rs 120,000 crore in FY12 (assuming the Indian crude oil basket is at $112/bbl). On the upside, price increases (for diesel, kerosene and LPG cylinders) will lower the subsidy burden of the government by Rs 26,800 crore for FY12 from Rs 89,700 crore (assuming the subsidy sharing mechanism of last year). These are positives for oil marketing companies and most brokerages have a buy call on state-owned OMCs.

On the downside, “the price hikes will add 70 basis points to headline inflation,” says Barclays Capital. Given the increase in diesel prices will have a cascading effect on freight rates, the indirect effect on the headline inflation rate could be another 110 basis points over the next three-four months. According to the government’s own assessment, the duty readjustments will result in a revenue loss of Rs 49,000 crore for the Centre. Consequently, the overall revenue collection target for FY12 will fall 6.2 per cent to Rs 740,900 crore. This revenue loss is expected to stretch the fiscal deficit target for FY12 to 5.3 per cent, from 4.6 per cent initially projected in the Union Budget.

So what can one expect from the Reserve Bank of India? Given the central bank will have to factor in several “known unknowns” such as global commodity prices and progress of the monsoon, most economists are anticipating another 25 basis-point increase in the repo rate, as headline inflation is expected to remain elevated for a few months. So, don’t expect a pause in rate hikes just yet.