Burning Petrol

I am not a economist by profession but have a fair knowledge of economics and its policies as far as Indian economy is concerned. Last Sunday was a burning Sunday for Indians. Its not because of temperature but its because of petrol price hike. Indian oil companies increased petrol prices by Rs 5/Liter. The increase comes only a day after the assembly poll results in five states, and was greeted by anger and derision from ordinary citizens and opposition parties. Which shows a good move as far as good politics is concerned but not a good move if you look at the inflation pattern. The last price hike was in January, when oil companies had raised the price by four to two percent. Thus, in the last nine months, the price of petrol has increased from Rs.47.93 per litre to Rs.63.37 (prices are in Delhi) – through nine revisions.

Last week RBI increased key rates to control inflation. Inflation is a great concern for RBI while Fiscal deficit for government. On one hand RBI is tightening monetary policy to capture inflation but on another side govt. is more worried about it’s fiscal deficit. Just to narrow down the gap of fiscal deficit government increased petrol prices so that it has to pay less subsidy on other petroleum products. Now the question is will RBI be able to tab inflation without government cooperation?      

The RBI’s policy, from being highly accommodative till the beginning of 2010, has turned around completely. Monetary policy is much tighter now with rate hikes of 250 basis points in the last one year. Its all because of high inflation.

Now the government, too, has reversed its borrow-and-spend policy. Fiscal deficit is projected at 4.6% of the gross domestic product (GDP) for 2011-12 against a high of 6.8% of GDP seen in 2009-10. Fiscal deficit came off to 5.1% of GDP for the year 2010-11.

The government is still subsidising fuel, but with the latest round of fuel price hikes, the fuel subsidy bill is likely to reduce from high projections of Rs 200,000 crore for this fiscal. The consumer will now have to pay more for fuel as well as incurring higher borrowing costs and this will lead to a fall in aggregate demand. In recent past govt. talked about diesel subsidy. The whole matter was to give the benefit of subsidy to only those who are actual receiver not to diesel luxury car owners. 

My personal take on this price rise is that fuel price inflation will trend higher in the coming months due to fuel price hikes.

The RBI is looking at inflation numbers printing at around 9% levels in the next few months. Manufacturing inflation, which has been trending at around 6.2% levels, will ease off as liquidity-driven demand shows signs of a slowdown. The noises made by infrastructure companies on slowdown in projects are a good indication of demand pressures coming off.

The external factor of high commodity prices including oil will always be a threat to inflation. However, with central banks across the world from Europe to China tightening policy, demand may come off, leading to commodity prices stabilising, albeit at higher levels.

Let’s see how these policies work for indian economy.

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