The government on Friday introduced a market-determined pricing mechanism for petrol and diesel along with a hike in prices of cooking gas and kerosene. This is an attempt to narrow the fiscal gap by cutting the fuel subsidies provided to the state-run oil companies. The move, which is likely cap the fiscal deficit below the projected 5.5% target for the current year and free up the revenues for other productive programmes, will push up the headline inflation by more than one percentage point, forcing the central bank to hike key policy rates immediately.
The inflation figures will move up by another 130-150 basis points in the next two months adding to the pressure on RBI to hike the policy rates, Jehangir Aziz, chief economist at JP Morgan Chase, pointed out. The fuel items that have become costlier have a weight of 5.44% in wholesale price index. ?While the fiscal deficit figures for the current year may not see any sharp dip on account of this decision in the medium term, the fiscal prospects look much better,? he added. The yields on government debt moved up by three to five basis points across all maturities as markets factored in an imminent hike in the policy rates.
The fiscal deficit is not expected to come down sharply even after the reform. The government may have to shell out more than Rs 50,000 crore, against the earlier expectation of Rs 77,000 crore, as subsidy to the government-owned fuel companies. Saurabh Handa, oil & gas analyst at Citigroup, pointed out that while under recoveries on petrol, which comprises only 10% of total losses, would be wiped out, oil marketing companies will continue to make losses on deisel, LPG and kerosene. Prices of the four state-run companies in oil sector surged in a falling markets after the decision on fuel price hike was announced. In the current system, the losses made by the OMCs is borne by upstream oil companies, the Centre and the OMCs themselves.
RBI, which has already hiked the key policy rates twice by 25 basis points each time since mid-March, may be forced to accelerate the move towards normalisation of monetary regime as inflation moves up further. But adviser at the finance ministry Kaushik Basu was quick to defend the government’s decision saying, ?On account of lower fiscal and revenue deficit in six to nine months, we will have lower prices than what would have happened in the absence of this much needed reform.? Sameeran Chakraborthy, head of research at Standard Chartered Bank, said the move towards deregulation may trigger an upgrade in India’s ratings by the credit rating agencies there by allowing Indian companies to assess cheaper overseas credit.?In the medium term, this is a great boost for the fiscal scenario as there will not be worries about how much we have to shell out in terms of fuel subsidies,? he added.