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Inflation likely to hit 9% mark
June, 05th 2008

Count the government out from those who cheer up on Fridays. It is the day when inflation data is released and inflation, after the present hike in fuel prices, is inching closer to 9% - a 13 year high. On a day when the government bit the bullet and raised retail fuel prices but not steeply enough to align them with global prices, inflationary expectations firmed up and interest rate outlook changed.

Wholesale price inflation is now set to shoot up by 50-65 basis points (0.5% to 0.65%) immediately because of the hike in the prices of petrol and diesel. Rising transportation and power costs is expected to push up the most closely watched price index to about 9% in the medium term, economists said. The direct impact on account of the price hike the fuel groups appreciation in the wholesale price index (WPI) will be felt in the inflation data to be released in a fortnight.

The fuel group that also includes other oil derivatives like bitumen, furnace oil and naptha, accounts for 14.23% in the WPI. Annual inflation, as measured by wholesale prices, hit 8.1% in mid-May, its highest level in more than three and a half years. Bankers say that if inflation moves up significantly, interest rates need to be reviewed for an upward revision.

To the extent passing on a part of higher global oil prices to the consumer obviates some of burden from government borrowing (oil bonds are part of state borrowings but are not accounted for in the official fiscal deficit), hiking retail petro prices would have fed macroeconomic stability.

However, the limited rise proposed makes this virtue too small to matter. By keeping fuel prices artificially low, the government encourages consumption of fuels rather than conservation, and only ends up subsidising Opec, said leading economist Saumitra Chaudhuri. The immediate effect would be 50-60 basis points which would be felt in a fortnight, while the second round effect in sectors where oil usage and transportation are major cost factors, would be visible in about two months. This would be another 40 basis points, said Crisil director and principal economist D K Joshi. He added that the farm loan waiver, soaring fertiliser subsidies and the cost of implementing pay rise for government employees would severely affect the governments efforts to meet the fiscal deficit targets.

According to HDFC Bank chief economist Abheek Baruah, the immediate impact of fuel price hike on wholesale price inflation could be as high as 65 basis points. WPI is likely to go up to roughly 8.8-8.9% in about three weeks. In the longer term, that is in about three months, the figure may rise to 9%. Around this time last year, inflation was low. This low base effect will also push up inflation this year, said Mr Baruah. Inflation was over 9% nearly 13 years ago in September, 1995. Costlier diesel is expected to push up cost of power generation and could affect even small time traders, who use diesel generators. The price hike is therefore, expected to have a cascading effect.

Bankers said that interest rates would need to be reviewed if inflation moves up beyond 50-100 basis points. Punjab National Bank executive director K Raghuraman said: If inflation cannot be controlled, interest rates may go up as a result of the cascading impact of the fuel price hike. Depositors will need to be protected in the wake of higher inflation. Therefore, deposit rates may need to be looked at and subsequently lending rates will also be examined. But no changes are expected in the short term. Due to a crash in bond prices, bank portfolios will book substantial depreciation, since 25% of their total resources is parked in government securities.

The increase in inflation because of raising the administered price is estimated to be 0.05-0.06%. But this is only a part of the overall under recoveries. If the total under recoveries of more than Rs 2,45,000 crore were to be wiped out, inflation would jump up by 4.7%, M S Srinivasan, secretary, petroleum ministry said on Wednesday. The last change in retail fuel prices was on February 14 this year, when the government raised petrol by Rs 2 a litre or 4.6%, and diesel by Re 1 a litre, or 3.3%.

In the meanwhile, OECD predicted on Wednesday that India and China are set for slower but robust economic growth this year although sharply higher inflation looms as a key threat amid soaring global food and oil prices. Indias expansion will fall to 7.8% in 2008, partly due to higher interest rates, the report said. The governments forcast, however is 8.5%, for which, finance minister P Chidambaram had promised to take corrective measures in sectors where growth is slowing, particularly in manufacturing. The OECD expects Indian growth to speed up in 2009 but said the principal risk to its forecasts was inflation not moderating.

Rising inflation is also expected to affect sales in sectors like automobiles. There will be a multiplier effect of the fuel price increase, that could spike up inflation temporarily and moderate growth on the back of inflationary pressure. There may be a little bit of postponement of purchases of vehicles, said S Ramanathan, head of equity, Sundaram BNP Paribas, Chennai.

Asian countries have been taking a slew of measures to check rising prices. Indonesian and Taiwanese governments have pledged payments to low income families to help them cop with fuel price increases. Pakistan has increased fuel prices twice since March 30, 2008 and inflation rate is near 20% in the neighbouring country. India raised petrol price on Wednesday by Rs 5 per litre, diesel by Rs 3 a litre and cooking gas by Rs 50 a cylinder.

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