Fuel tax cut: Inflation could fall to 6.5-7.3% in May

Analysts say the government’s reduction in fuel taxes and measures to reduce the prices of iron, steel, coal, plastics and cement could reduce retail inflation in the short term. They added, however, that due to the stickiness of price pressures, more needs to be done to ease supply constraints and significantly control inflation during the current fiscal year.

Retail inflation is likely to fall to 6.5-7.3% in May, they predicted. In the near term (after June), inflation could fall to 40 basis points. Consumer price index-based inflation reached a 95-month high of 7.79% in April.

Over the next 9-12 months, however, food inflation could rise comparatively unless the prices of most imported edible oils and vegetables are significantly eased. Furthermore, higher subsidy bills have led to an increase in the fiscal deficit from the budget level of 6.4% of GDP (some analysts now expect it to be as high as 6.8%) and the potential pass-through for a complete low-recovery through oil-marketing. Some analysts say companies could put upward pressure on inflation next month. If the Russia-Ukraine crisis subsides in the first quarter, the outlook will certainly improve dramatically.

Nomura analysts have maintained their FY23 inflation forecast for India at 7.2%, as against 5.5% in the previous fiscal, the risk still remains. The steep low recovery for oil marketing companies continues (as of May 16, the under-recovery of diesel and petrol was Rs 12 and Rs 11 per liter, respectively). So, as OMCs now fully pass on the benefits of lower excise duties to consumers, they are likely to raise prices to maintain their margins in the coming months.

“Beyond fuel prices, we still see significant reverse inflationary risks from other drivers. High food inflation, pending electricity tariff hikes, continued passage of higher input costs from companies to consumers and other second-tier effects (house rent, wages) are likely to drive inflation, ”Nomura analysts said.

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

Some other economists are more cautiously optimistic. Aditi Nair, chief economist at ICRA, said the reduction in excise duty would help soften the pace of inflation and complement monetary policy. “We project CPI inflation in May 2022 to be between 6.5-7.0%,” Nair said. ICRA, however, maintained its FY23 retail inflation forecast at 6.5%.

DK Pant, chief economist at India Ratings, said the direct impact of the excise deficit could be around 20-25bps and the indirect effect, possibly at least a month later, could be around 15-20 bps. Retail inflation in May could be between 7% and 7.3%. “Reducing excise duty on petrol and diesel is unlikely to bring down inflation quickly,” he said. We have seen that the last round of excise / VAT cut did not translate into sharp decline in inflation. Unless commodity prices cool and internal supply-related constraints ease, it will be very difficult to observe a sustained fall in inflation, “Pant said.

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