Boiling oil prices will crank up inflation by 1 per cent

Oil refiners want Rs 5.6 more per litre of petrol and Rs 7.6 for diesel.

NEW DELHI: Maybe it's time you started bracing yourself for heftier fuel bills. Oil marketing companies, staggering under the impact of gravity-defying global oil prices, are seeking an increase of Rs 5.6 a litre in the price of petrol and Rs 7.6 a litre in the case of diesel.

That's a good 12% hike over current prices of petrol and 24% in the case of diesel.

Don't panic just yet. Politics will ensure that consumers are shielded from the full impact of the price hikes, but with state assembly elections getting over soon, the government will have to deal with this long-deferred issue.

Passing on the increase will mean an immediate rise in transport costs.

Diesel, largely a transport fuel, is the biggest chunk of petroleum products consumption. Road transport and agriculture account for around 75% of diesel consumption and the railways 5%.

Close to a quarter of diesel sales, according to a Ficci study, are to industry.

The dependence of Indian industry on diesel-based captive power plants was as high as 13.9% in 2003-04. So expect a huge trickle down effect across sectors.

Back-of-the-envelope calculations show the net impact could be an increase in inflation of 1% over the whole year, says Ajit Ranade, chief economist of the Aditya Birla group.

That's broadly on the lines of what the Reserve Bank of India seems to be targeting, since it talks about targeting an inflation of 5-5.5% in 2006-07. A 1% increase in the Wholesale Prices Index (WPI) is also what can be  expected  with  a

Rs 5,000 crore annual impact of price  increases (direct as well as cascading effect), says Jibon Mukhopadhyay of the SP Jain Institute of Management, quoting a broad thumb rule. The Ficci study itself notes that every $10 per barrel increase in global oil prices will lead to a 2.1% rise in the WPI.

Ranade is not sure if the cascading effect will be huge. Given the highly competitive scenario, manufacturers may just decide to absorb the costs and not pass it on to consumers, he feels.  In any case, since the WPI-based inflation at the end of 2005-06, at 3.5%, was lower than what the RBI had forecast, Ranade feels there is some elbow room for a 1% increase in inflation.

Will that dampen demand? Not really, says Ranade. "Inflation won't touch 5% immediately. And we have lived with higher inflation."

Higher inflation will put an upward pressure on interest rates, which could, notes DK Pant of the National Council of Applied Economic Research (NCAER), affect the current investment boom in the economy, though Ranade doesn't feel the impact will be significant.

Not raising the prices may not be the answer. Don't think only the oil companies will take a hit in that case. If they go into losses, government finances will suffer, because of a dip in non-tax revenue (in the form of dividend receipts), Pant notes. Bonds to help them tide over the crisis only postpones the inevitable payout that the taxpayer will have to bear.

And if the government bears the subsidy burden, that will push up the deficit, forcing it to step up borrowings, leading to further pressure on interest rates. "The government is caught in a bind. It will face problems if it passes on the burden or even if it doesn't," notes Pant, "and it's difficult to say which impact will be more adverse."

The macro impact of deferring a hike, says Ranade, will be diffused over time, while the impact of a hike is immediate and will be felt more by the lower income groups. The government may just bet on not disturbing the growth impulses (which an increase will entail) and letting strong growth tide over the problems that a postponement will bring in its wake.