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economic outlook

Inflation to cross 5% in 2018-19

by Mahesh Vyas

Consumer price inflation was 4.6 per cent in April 2018. It has remained higher than RBI’s 4 per cent target since November 2017 but, has been well within its upper band of 6 per cent. Inflation is also well within RBI’s expectations. Its Monetary Policy Report last April had expected inflation to pencil 5.1 per cent in the first quarter of 2018-19.

Till its rise last November, inflation was consistently below 4 per cent and had averaged at just above 3 per cent. Compared to this consistently low inflation level, the recent rise to a band of 4-5 per cent has become noticeable.

Inflation has also become a source of some concern because of the recent rise in the price of crude oil. On May 22, the Indian basket of crude oil had touched USD 78.1 per barrel. This was 10 per cent higher than it was a month ago.

The biggest driver of inflation in 2018-19 hitherto, was the impact of HRA as it gets implemented in states during the year. However, the recent rise in crude oil prices has brought a new factor into inflation computations for 2018-19.

RBI’s baseline scenario assumes crude oil prices to average around USD 68 a barrel. It now looks like the average could be between USD 75 and 77 per barrel assuming that there is no new crisis.

We expect crude oil prices to continue to rise for a few months and decline thereafter. Prices have risen essentially because international oil producers decided to cut output in collusion. We expect average monthly prices to peak at USD 79 per barrel in June and stay there till August. Or, in a worst-case scenario, they may continue to rise to peak at USD 85 per barrel in July and decline thereafter.

Prices are expected to fall by September and more so after the November 2018 meeting of OPEC and other oil producing nations. We expect Saudi Arabia to offset the adverse impact of the sanctions against Iran. Russia is expected to not agree to support a further extension to curtail production beyond November 2018.

The persistent increase in crude oil prices has led to a steady increase in the price of petroleum products in India. These prices were kept unchanged between April 24 and May 13, apparently because of elections in Karnataka. But, after the elections, prices have been hiked steadily and consistently on each day between May 14 and May 25.

The average increase in petrol and diesel prices across cities post Karnataka elections has been 0.34 per cent per day. This is much higher than the 0.11 per cent per day average increases seen before the Karnataka elections-driven freeze in prices.

Changes in the price of crude oil during the year is expected to impact consumer price indices variously.

Products that get impacted directly by crude oil price changes account for only 4.3 per cent of the consumer price index. Petrol for vehicles has a weight of 2.2 per cent, LPG has a weight of 1.3 per cent, kerosene has 0.6 per cent, diesel for vehicles, 0.2 per cent and air fare, 0.1 per cent.

It is assumed that the government will allow the current and expected increases in crude oil prices to be passed on to consumers and, it may not have to pass on increases in the second half of the year as crude oil prices decline. This may even suit the political interests of the government.

RBI had expected CPI inflation to touch 5.1 per cent in the quarter ended June 2018. We had projected 5.2 per cent. The direct impact of the recent increase in petroleum products implies that inflation may touch 5.8 per cent in this quarter. May and June could see inflation of about 6 per cent or possibly even a shade above 6 per cent.

As crude oil prices decline, this direct impact of their elevated levels would decline correspondingly but the secondary impact of high oil prices compared to a year ago would play out in the remaining quarters.

Inflation during 2018-19 also faces challenges from a depreciating rupee. As of May 25, the rupee was at 68.3 to a US dollar. This marked a 5.4 per cent depreciation compared to the level a year ago. As crude oil prices rise and the current account deficit worsens, there are fears that the rupee could breach 70. This could feed into inflation.

Inflation in 2018-19 is therefore likely to remain a little more elevated than we believed earlier. Our projections of March 2018 indicated an inflation rate of 4.7 per cent in 2018-19. We now believe that it may turnout to be 5 per cent or even a shade higher, as compared to 3.6 per cent in 2017-18.