India's decision to allow fuel prices to rise may spur the inflation rate by almost a percentage point, the finance ministry said, adding pressure on the central bank to raise interest rates.
Prime Minister Manmohan Singh's government permitted state refiners to set prices of gasoline higher by about 3.5 rupees (7.5 cents) a liter and that of diesel by 2 rupees yesterday, as it sought to cut subsidies and trim the budget deficit from a 16-year high. Gasoline has been freed fully while diesel prices will eventually be market-determined, the government said.
India's move to pare its $5.5 billion oil subsidy, accounting for about 2.5 percent of its budget, comes as global investors heighten scrutiny of government finances in the aftermath of the European sovereign-debt crisis. The action threatens to stoke inflation from 10.16 percent touched in May.
"India will move toward a better fiscal situation over a period of time -- people will view it positively," said Jitendra Sriram, who helps manage $800 million as head of equities at HSBC Asset Management (India) Pvt. in Mumbai. "There will be some rate action by the Reserve Bank of India, but it will come in the July policy announcement."
Reserve Bank Governor Duvvuri Subbarao, who has raised rates twice since mid-March, said June 18 he would tighten monetary policy in a "calibrated" manner, given the cash squeeze in the economy and risks to growth posed by Europe's debt woes.
Cash Shortage
Indian lenders are short of cash after telecommunication companies including Bharti Airtel Ltd. paid $14.6 billion of license fees for wireless phone services and businesses withdrew money for paying taxes.
Even so, investors including Manish Sonthalia, who helps manage the equivalent of $200 million in equities at Motilal Oswal Securities Ltd. in Mumbai, said it's a "no-brainer" that Subbarao will boost borrowing costs before the next monetary policy decision scheduled for July 27.
"Though the immediate impact of this policy will be to increase inflation, in six to nine months we will have lower prices than would have happened in the absence of this much- needed reform," Kaushik Basu, chief economic adviser at the finance ministry, said in a statement in New Delhi yesterday.
For the moment, the fuel-price rise may push the inflation rate up by 0.9 percentage point, Basu said.
"A rise in interest rates will happen before the scheduled monetary policy date," Motilal's Sonthalia said. The bond market yesterday "also suggested that."
Yields Rise
India's 10-year government bonds fell the most in a month after the fuel price decision, pushing yields to 7.65 percent in Mumbai, the highest in two weeks. The Sensitive index declined 0.9 percent to 17,574.53 on the Bombay Stock Exchange, while the rupee advanced 0.5 percent to 46.28 against the U.S. dollar.
Inflation is a political issue in India where the World Bank estimates almost three-quarters of the nation's 1.2 billion people live on less than $2 a day. Singh's move to trim subsidies will improve the country's credit profile, said economists including Rahul Bajoria, a Singapore-based economist at Barclays Plc.
Moody's Investors Service has a Ba2 rating, two levels below investment grade, for India's local currency debt. Standard & Poor's places the nation's rating at BBB-, its lowest investment level.
Singh is aiming to narrow the budget deficit to 5.5 percent of gross domestic product in the year ending March 31, from 6.9 percent in the previous year.
"The fiscal situation could look far more sanguine and the rating outlook could become positive after the fuel price decision," Barclays' Bajoria said.
Companies including Tata Motors Ltd. and Hero Honda Motors Ltd., the country's biggest truck and motorcycle makers respectively, backed the government's decision on fuel.
Prakash M. Telang, Tata Motors' managing director of India operations, said freeing prices of gasoline and diesel is a "good concept" that the country needs to reduce government borrowings, while Ravi Sud, chief financial officer at Hero Honda, said the move won't hurt sales of two-wheelers.
To contact the reporter on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net
