Fuel price hike likely to prop up gilt prices

Government bond prices are likely to rise by about 20 paise when the government announces a hike in retail rates of petroleum products, with the hike expected to be way below of what gilt dealers have already priced in. Dealers have factored in a hike of Rs 5-8 per litre in the prices of diesel and petrol.

The government is likely to raise automobile fuel prices this week, but Petroleum and Natural Gas Minister Murli Deora said on Saturday that the hike will be modest.

A rise in petrol and diesel prices could push up inflation, and, consequently, force Reserve Bank of India to raise interest rates.

"Everyone knows that the hike will be small because the government have to please the Left. With global oil prices so high, they could keep hiking it in stages," a dealer said.

The 7.59 per cent 2016 gilt, the 10-year benchmark, is likely to rise to Rs 100.01, or 7.59 per cent yield, this week from Rs 99.82, or 7.61 per cent now, once the hike in retail prices of petroleum products is announced.

According to dealers, despite the clamour from oil refining companies as well as RBI, the government is likely to announce only a modest Rs 2-3 hike per litre of diesel and Rs 5-8 rupee per litre of petrol.

"It could be around Rs 3-4 per litre. But if they want to pacify the Left, then it would be around Rs 2, or less than that," said Laxmi Iyer, fund manager, Kotak Mahindra Mutual Fund.

"In my view, it should be around Rs 4 per litre. Any hike over that will result in selling in the market," Iyer said.

"Oil marketing companies are asking for higher share. But the market is expecting lower hike owing to political pressure," said a dealer with a private bank.

Oil companies have been losing about Rs 9.33 per litre on sale of petrol and Rs 10.43 per litre on diesel.

At current retail prices, oil companies may suffer a revenue loss of Rs 735 billion in 2006-07, a petroleum ministry projection showed. The Communist Party of India (Marxist) is opposing the government's plans to raise prices of petroleum products.

"Without reduction of the tax burden on petroleum products, any attempt to impose added burden on the people will have no justification and has to be strongly resisted," CPI(M) politburo said in a statement on Sunday.

"A powerful countrywide movement must be launched against any proposed petroleum price hike," the statement said.

The government has not allowed state-run oil marketing companies to raise retail prices of petroleum products since September, despite the steep rise in international crude oil prices.

On Friday, near-term crude oil futures, which are the most tracked, closed at $71.37 per barrel, just off their record highs of $75.35 per barrel.

Lack of adequate pass-through of the rise in international oil prices to retail prices made the outlook on inflation hazy, dealers said.

"Inflation may rise due to the oil price hike, but since the increase of diesel and cooking gas is expected to be small, the overall inflationary impact is expected to be muted," said Manoj Rane, country treasurer, BNP Paribas.

"Prices may fall if oil prices are hiked more than expected and with the rupee weakening, inflation looks inevitable," said Tarini Vaidya, country treasurer, Centurion Bank of Punjab.

The rupee weakened to a 24-week low of 46.09 per $1 because of strong demand from oil companies.

RBI, which controls inflation through its monetary measures, has been recommending a full pass-through of oil prices.

"The outlook on inflation as well as the choice of appropriate manner of dealing with the pass-through of oil prices remains clouded at the current juncture," RBI said its annual monetary and credit policy for 2006-07 (April-March).

"It is increasingly becoming clear that there has to be a fuller pass-through of increases in international crude prices," RBI said, noting the capacity of absorbing impact of high oil prices was declining.

Gilt prices are seen moving in a 20-25 paise band in June.

Big investments could be avoided ahead of gilt auctions, U.S. Federal Reserve's meeting, and quarterly advance corporate tax payment.

RBI is scheduled to raise Rs 150 billion via auction of government bonds in June.

The US Federal Reserve, at its rate setting meet June-end, is expected to raise interest rates by 25 basis points to 5.25 per cent.

Quarterly advance corporate tax payment could tighten liquidity.

Companies are due to pay the second instalment of their advance tax on June 15, which could drain about Rs 150-180 billion from banks.