Rising crude prices to hamper economic recovery

Rising crude oil prices are set to jeopardise the recovery of India's economy, which has been jolted by the demonetisation drive.

As per global wealth advisory, UBS, consumer price index (CPI) is expected to hover around 5%, contrary to the Reserve Bank's estimates. The RBI has projected inflation of 4.7-5.1% year-on-year (YoY) in H1 and 4.4% YoY in H2.

However, global oil prices are now 16% higher than the RBI’s FY19 $68/bbl forecast. Petrol and diesel have a 2.3% weighting in the CPI basket.

"So a 10% rise in crude prices could raise CPI inflation by about 25bps if the government does not cut the excise duty and passes on the cost to users. We expect refined core inflation (headline, minus food and fuel (petrol & diesel) groups) to stay around 5.5-6% in FY19, indicating demand-push inflation and rising input price pressure," UBS said in a note.

As a result of rising crude oil prices, the petrol prices have gone up constantly for 16 days since Karnataka went to polls on May 12. As of Tuesday, the petrol prices in Bengaluru stand at Rs 79.71 per litre, and are set to breach the Rs 80 mark in a couple of days.

Due to the inflationary pressure arising out of fuel price hike, there is an increased talk of interest rates being hiked in the country. "We assign a 40% probability that the MPC will pre-emptively hike rates by 25 basis points (bps) in the June policy meeting. We expect the tone of the policy statement to remain hawkish," UBS said.

The minutes of the April meeting suggest that two of the six MPC members have already decided to vote in favour of a 25 bps rate hike.

However, the advisory is certain that the there would be 50 bps rate hike in the current financial year.

"We expect the MPC to hike rates by 50 bps in the rest of FY19 starting from its August meeting," it said.

However, it is expeted that a crude oil shock (towards $100 per barrel) and subsequent depreciation of Indian rupee to higher than 70 to the US dollar may cause the rate hike cycle to start sooner (June) and be more aggressive (at least another 75bps from now).

"Possibly – in this pre-election year – the government could try to lower taxes on petrol and diesel to mitigate the impact on prices," the note said.

In 2017, when government slashed the excise duty on petrol and diesel by Rs 2 per litre, it caused a fiscal slippages worth almost Rs 13,000 crore. 

The country, in 2017-18, could not adhere to the fiscal deficit target of 3.2%, owing to the lesser dividend contribution to government by the RBI, as a result of increased costs arising out of demonetisation drive.