The deregulation of petrol prices and the fuel price hikes effected on June 25, 2010 may lead to short run inflation upsurge of >1 ppt, but this poison heals the fiscal malaise and provides a multi-faceted strong positive delta for India’s macro-economy. Along with a 1% of GDP windfall extra non-tax revenue from the 3G and BWA auctions, it may help contain FY2011E GFD to 5.1% of GDP versus budgeted 5.5%.
We now expect RBI to act more decisively in July 2010 and raise policy rates 50-75 bps, including possibly a pre-policy rate hike in early July of 25 bps. The stiffer-than-before tightening may be prompted by (1) persisting double digit inflation since March 2010, (2) signs that inflation is becoming broad-based with manufacturing inflation rising at an annualized rate of 6.5% over last 3-months and (3) need to quell inflation expectations which may rise again on the back of fuel price hikes.
With a probability of a more aggressive rate tightening cycle, keeping interest rates soft may turn out to be more difficult in the current year.
