Monday, February 18, 2008

Economic Implications of the Indian Fuel Price Hike

by Phillip Horton

The long awaited hike in fuel prices of India was finally announced by the government on February 14 despite protests by the CPM of India an important supporter of the UPA government. Since the prices of fuel in the global market were already high the Indian oil companies had to suffer huge looses which could not be recovered by the subsidies that the government provided. The fuel hikes as announced by Oil Minister Murli Deora were quite moderate and they also came after 20 months. The government raised the price of petrol by 2 rupees which is $0.05 for a liter, and the price of diesel has been increased by one rupee. The 4.6% and 3.3% hike respectively in the fuel prices will also have its effect on inflation. For the common Indian even this moderate hike is enough to topple their monthly budget but the other economic implications of this hike are more important. The moderate hike in the prices was enough for the share of the oil retailers to surge in the market however the most important effect of the fuel hike will be on the interest rates. With this fuel hike expectations for any cut in the interest rates by the Reserve Bank of India have been dashed.

Many experts are now of the opinion that any rate cut in the interest rate is far very unlikely due to the hike. Analysts also say that the moderate hike will not lead to any significant pressure on the inflation rate. Oil minister Murli Deora stated that the government tried all it can so that the prices do not increase but crude oil price in the international market stood at more than $100 a barrel by the 2nd of January this year and it came to just $90 at present, the burden for the government oil companies was too much to bear and hence the price increase.

Expectations for an early rate cut were ripe when the forecast by the government indicated that the economic growth will settle at 8.7 percent for the period 2007/08, the rate for the same earlier was 9.6%. In the last year that is 2007 the government did not increase the fuel prices at all despite the crude oil prices in the international market climbed to over half which forced the oil companies to bear huge losses. Chief economist at Reliance Industries Ltd. T.K. Bhaumik said that the hike had long been awaited and it will only partially relive the government oil companies to cover their losses, but the impact of the hike on the inflation will be just subsidiary.

Kotak Mahindra Bank’s Chief economist Indranil Pan opines that the direct implication of the hike will be that there will be 15 basis points on headline inflation and its indirect effect would be 30-35 basis points on inflation. Standard Chartered Bank’s economist Shuchita Mehta was of the opinion that inflation would rise by about 4.5% till March and 5.5% till the month of September. She also said that the Reserve Bank of India’s policy not to change the rates is right for the moment.

 

 

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