Weak rupee to wipe gains from easing crude oil prices, says report
Moneylife Digital Team 17 October 2011

A depreciating rupee is pushing import costs further, raising inflation in domestic fuel prices which are linked to international prices. Inflation, now at 9.7%, remains higher than RBI’s comfort zone for the past 18 months

Inflation remained stubborn at 9.7% in September 2011, compared to 9.8% in August. There are little signs of a decline in core (non-food manufacturing) inflation, which at 7.6% in September has now remained above the RBI’s (Reserve Bank of India) comfort zone of 4.5%-5%, for the past 18 months. As a result, there might be another 25 basis points (bps) hike in the RBI’s mid-year monetary policy review on 25th October, says a recent CRISIL report. For any gains from the recent decline in international crude oil prices to reflect in lower inflation, the rupee will have to appreciate to 47 per $1 by December 2011. These are the observations the CRISIL report.

Inflation in the fiscal year so far (April to September 2011) stands at 9.6% compared to 9.9% during the same period of 2010—indicating few signs of moderation. Inflation for July 2011 has also been revised upwards to 9.4% from 9.2% reported earlier.

Food inflation stood at 8.8% in September 2011 compared to 9.1% in August. Despite good rains, there might not be much downside to food inflation due to substantial rise (in the range of 7% to 14%) in minimum support prices of principal food-grain commodities in 2011-12, which set the floor for market prices.

Primary articles’ inflation declined to 11.8% in September, compared to 12.6% in August. This was enabled by a sharper decline in non-food articles, namely fibres and oil seeds. Fuel inflation rose to 14.1% in September, from 12.8% in August, reflecting the impact of petrol price hike during the month as well as higher prices of aviation turbine fuel, bitumen, furnace oil and other lubricants.

Despite some softening of global crude oil prices in recent months, crude oil prices in September 2011 continued to be higher than a year ago. In addition, a depreciating rupee is pushing import costs further, raising inflation in domestic fuel prices which are linked to international prices. If the international oil price remains at the current level of around $85 per barrel till December, which represents around 5% annual decline in price, then the rupee will have to appreciate to 47.0 per $1 in order to reflect gains from lower oil prices into inflation.

Core (non-food manufacturing) inflation remained worrisome at 7.6% in September 2011 compared to 7.7% in the previous month. Given that core inflation remains much higher than RBI’s comfort zone of 4.5 to 5%, CRISIL expects a 25bps hike in the mid-year monetary policy review on 25 October 2011.

Despite a fall in crude oil prices since April 2011, they continue to remain higher than a year ago. In addition, the rupee has sharply fallen against the dollar, by 16%, compared to a year ago. Although this is currently adding upward pressure on the imported component of inflation, it is expected to be a transient phenomenon—the impact of which is unlikely to sustain until March 2012.

The second-round pass-through of exchange rate depreciation into retail prices would be limited as firms would find it difficult to raise prices because of slowing private consumption growth.

For 2011-12, minimum support price (MSP) for paddy has been hiked by 8%, for jowar by 11.4% and for arhar, moong and urad by 6.7%, 10.4% and 13.8% respectively. This, in conjunction with relatively low growth in production, especially of pulses, will put upward pressure on market prices, going forward. First advance estimates of food-grain production for 2011-12 have placed production growth for paddy at 7%, for jowar at 0.9% and arhar and urad at 0.3% and 0.6% respectively. Production of moong is expected to decline by 30.2% in 2011-12.

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