Fuel tax cut: Inflation may drop to 6.5-7.3% in May

Fuel tax cut: Inflation may drop to 6.5-7.3% in May

23 May    Finance News

The government’s cut in the fuel tax and measures to cool prices of iron, steel, coal, plastics and cement may drive down retail inflation in the short term, analysts said. They, however, added that given the stickiness of price pressure, it has to do more to ease supply constraints and curb inflation substantially during the course of the current fiscal.

Retail inflation in May will likely drop to 6.5-7.3%, they forecast. In the near term (after June), inflation may drop by up to 40 basis points. The consumer price index-based inflation hit a 95-month high of 7.79% in April.

Over the next 9-12 months, however, food inflation may remain relatively elevated unless prices of the mostly-imported edible oils and vegetable ease substantially. Moreover, any rise in fiscal deficit from the budgeted level of 6.4% of GDP (some analysts now expect it to be as high as 6.8%) due to elevated subsidy bill, and potential pass-through of entire under-recoveries by oil-marketing companies in the coming months could potentially exert upward pressure on inflation, some of the analysts said. Of course, the outlook will improve dramatically if the Russia-Ukraine crisis abates within the first quarter.

Analysts at Nomura retained their FY23 inflation projection for India at 7.2%, against 5.5% in the last fiscal, stating that the risks still remain. The steep under-recoveries for oil marketing companies persist (as of May 16, under-recoveries of diesel and petrol were Rs 12 and Rs 11 per litre, respectively). Therefore, while OMCs have fully passed on the benefit of lower excise duties to consumers now, they will likely hike prices in the coming months as well to retain their margins.

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“Beyond fuel prices, we still see significant upside inflation risks from other drivers. Higher food inflation, a pending rise in electricity tariffs, the continued passage of higher input costs from firms to consumers and other second-round effects (house rents, wages) are likely to drive inflation,” the Nomura analysts said.

Of course, in the near term, the direct and indirect impact of the fuel tax cut on inflation in the near term will likely be 30-40 basis points, they added.

Some other economists are more cautiously optimistic. ICRA chief economist Aditi Nayar said the reduction in the excise duty will help to cool the inflation trajectory going ahead, and complement monetary policy. “We project the May 2022 CPI inflation at between 6.5-7.0%,” Nayar said. ICRA has, however, retained its FY23 retail inflation forecast of 6.5%.

India Ratings chief economist DK Pant said the direct impact of the excise cut is likely to be about 20-25bps and the indirect impact, likely with a lag of at least a month, could be about 15-20 bps. Retail inflation in May is likely to be in the range of 7% to 7.3%. “Cut in excise duty of petrol and diesel is unlikely to bring down high inflation quickly. We have seen the last round of excise/VAT cut did not translate into sharp reduction in inflation. Unless commodity prices cools off and domestic supply-related bottlenecks are eased, it will be very difficult to observe sustained decline in inflation,” Pant said.

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