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Implications of Fuel Price Hike

July 2, 2009

Late last evening, the government raised retail prices of petrol by 9% (Rs4/ltr) and diesel by 6% (Rs2/ltr). Although this is still less than current international prices (petrol and diesel would need to be raised by an additional Rs2.5/ltr as margins are negative, the hike is positive, bodes well for the reform process and is a step towards fiscal consolidation.

Given that petrol and diesel have a weight of 2.9% in the WPI, the fuel price hike would have a ~30bps impact on inflation. We expect inflation to cross 4% levels by year end. On rates, we expect bond yields are likely to stay in the 6%-7% range due to the RBI’s continued participation in the borrowing program. We maintain our view that
RBI will reverse its easy money policy next year.

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