India’s Gasoline Price Increase May Stoke Inflation.

June 28 (Bloomberg) -- India’s decision to allow fuel prices to rise may spur the inflation rate by almost a percentage point, the finance ministry said, adding pressure on the central bank to increase borrowing costs.

The government on June 25 permitted gasoline prices to be market-determined for the first time since December 2003. Political parties had previously avoided loosening controls to win support from India’s 828 million people who live on less than $2 a day. Diesel costs are regulated and will eventually be freed, the government said.

India’s move to pare its $5.5 billion oil subsidy, accounting for about 2.5 percent of its budget, comes as global investors heighten scrutiny of government finances in the aftermath of the European sovereign-debt crisis. The action threatens to stoke inflation from 10.16 percent in May.

“India will move toward a better fiscal situation over a period of time, people will view it positively,” said Jitendra Sriram, who helps manage $800 million as head of equities at HSBC Asset Management (India) Pvt. in Mumbai. “There will be some rate action by the Reserve Bank of India, but it will come in the July policy announcement.”

Prime Minister Manmohan Singh’s government allowed state refiners to set prices of gasoline higher by about 3.5 rupees (7.5 cents) a liter and that of diesel by 2 rupees, as it sought to cut subsidies and trim the budget deficit from a 16-year high.

‘Much-Needed Reform’

“Though the immediate impact of this policy will be to increase inflation, in six to nine months we will have lower prices than would have happened in the absence of this much- needed reform,” Kaushik Basu, chief economic adviser at the finance ministry, said in a statement in New Delhi.

For the moment, the fuel-price rise may push the inflation rate up by 0.9 percentage point, Basu said.

Reserve Bank Governor Duvvuri Subbarao, who has raised interest rates twice since mid-March, said June 18 he would tighten monetary policy in a “calibrated” manner, given the cash squeeze in the economy and risks to growth posed by Europe’s debt woes.

Indian lenders are short of cash after telecommunication companies including Bharti Airtel Ltd. paid $14.6 billion of license fees for wireless phone services and businesses withdrew money to pay taxes.

‘No-Brainer’

Even so, investors including Manish Sonthalia, who helps manage the equivalent of $200 million in equities at Motilal Oswal Securities Ltd. in Mumbai, said it’s a “no-brainer” that Subbarao will boost borrowing costs before the next rate decision scheduled for July 27 as price pressures mount.

India’s 10-year government bonds rose today in Mumbai after falling the most in a month on June 25 following the fuel-price announcement. The yield on the securities fell 1 basis point to 7.64 percent.

The Sensitive Index gained 0.5 percent to 17,665.01 on the Bombay Stock Exchange at 9:05 a.m., while the rupee climbed 0.4 percent to 46.1 against the U.S. dollar.

Singh’s move to cut subsidies will improve the country’s credit profile, said economists including Singapore-based Rahul Bajoria at Barclays Plc.

Moody’s Investors Service has a Ba2 rating, two levels below investment grade, for India’s local currency debt. Standard & Poor’s places the nation’s rating at BBB-, its lowest investment level.

Singh is aiming to narrow the budget deficit to 5.5 percent of gross domestic product in the year ending March 31, from 6.9 percent in the previous year.

“The fiscal situation could look far more sanguine and the rating outlook could become positive after the fuel price decision,” Barclays’ Bajoria said.

Companies including Tata Motors Ltd. and Hero Honda Motors Ltd., the country’s biggest truck and motorcycle makers respectively, backed the decision on fuel.

Prakash M. Telang, Tata Motors’ managing director of India operations, said freeing prices of gasoline and diesel is a “good concept” the country needs to lower government borrowings, while Ravi Sud, chief financial officer at Hero Honda, said the move won’t hurt sales of two-wheelers.

Source : Business Week