Fuel price increase may force RBI to hike rates.

The Centre biting the bullet on petroleum product prices a couple of days back is expected to have a positive impact on government finances. But it has also raised fears of the Reserve Bank of India (RBI) raising interest rates in the wake of rising inflation due to the fuel price hike.

"We expect the RBI to raise rates in the coming weeks," said Rohini Malkani, economist at Citigroup India, citing the petroleum price hike as one of the main reasons for the view.

RBI is scheduled to meet on July 27 to take a call on policy rates - repo (at which it lends to banks) and reverse repo (at which it pays banks on their overnight deposits) rates. Waiting till the D-day for hiking policy rates is very difficult, is what several analysts feel now.

"Given that the impacted fuels have a weight of 5.44 per cent in the WPI (wholesale price index, an inflation measure) these measures would impact inflation by 100 basis points (one per cent). This could result in inflation averaging eight per cent levels in 2010-11, from 7.4 per cent estimated earlier," Malkani said.

"With the economy on the road to recovery, as reflected in industrial production gathering steam, non- oil imports and bank credit posting recovery, coupled with inflation remaining sticky, we maintain our view of 75 basis points (BPS one-hundredth of a per cent) of tightening in 2010," Malkani added in a report.

The Empowered Group of Ministers (EGoM) at its meeting on Friday made petrol prices market-driven and in the process hiked its price by Rs 3.5 per litre. The panel also hiked diesel price by Rs 2 per litre, liquefied petroleum gas (LPG) prices by Rs 35 per cylinder and kerosene by Rs 3 per litre, in line with the Kirit Parikh Committee recommendations that were aimed at fiscal consolidation.

The move is expected to slash the subsidy burden of the government by a quarter. Alok Deshpande, oil and gas sector analyst of Elara Capital, said, "Subsidy for 2010-11 is expected to be about Rs 53,000 crore post-Friday's decision, roughly a 24 per cent decline from the expected Rs 70,000 crore earlier."

With lesser burden of underrecoveries for the oil marketing companies (OMCs), the government may see its deficit falling, obviating the need for the government to raise Rs 4.57 lakh crore to meet its expenditure for 2010-11 through borrowings in the next few months.

Saurabh Handa, oil and gas analyst at Citigroup said while under-recovery on petrol, which comprises 10 per cent of total losses of OMCs, would now be wiped out, OMCs would continue to make losses on the sales of diesel, LPG and kerosene.

Deepak Pareek, oil and gas analyst at Angel Broking is of the view that the upstream companies were keeping their fingers crossed as the government had not yet finalised the subsidy sharing mechanism with them.

The impact on public finances would thus depend on how the under- recoveries would be financed. "Moreover, while the Kirit Parikh Committee report has sought to address the subsidy formula, as of now there is no clarity on subsidy sharing," Malkani of Citi said.

The Centre raised about Rs 1.61 lakh crore by last weekend, out of the Rs 4.57 lakh crore of borrowing planned for the current fiscal, constituting about 33 per cent. It has raised about Rs 1.51 lakh crore through 37 bond issues and Rs 10,000 crore through six treasury bill issues.


Source : India Today