Amid rising crude, fuel excise cut more viable to cool pump prices: DBS Bank’s Rao

According to Rao, CPI inflation will likely return to the RBI’s 2-6 percent tolerance range by September.

Cutting the excise duty on auto fuels may now be a more viable option than price cuts by oil marketing companies (OMCs) to cool domestic petrol and diesel prices, Radhika Rao, senior economist at DBS Bank, said. According to Rao, rising global crude oil prices are closing the window for OMCs to lower pump prices, expectations of which have been fuelled by the government's decision to cut prices of cooking gas cylinders.

"While a jump in global international oil prices lowers the window for a price cut, excise duty reductions might allow for a move lower in retail pump prices, ahead of a busy election calendar. The timing might also coincide with the approaching festive period," Rao told Moneycontrol in an interview.

Also Read: MPC's Ashima Goyal calls on states to cut fuel tax, oil firms to lower prices

Pump prices of petrol and diesel have not moved for more than a year in most parts of the country. Meanwhile, the average price of India's crude oil basket fell below $75 per barrel in June from $116 per barrel in the same month last year—although it has firmed up to $92 per barrel so far in September—allowing OMCs to generate huge profits.

Meanwhile, November Brent crude futures on the ICE crossed the $94-per-barrel mark on September 15.

Rao pointed out that despite the rise in crude oil prices, the average for the year so far remains below the $85 per barrel assumed by the Reserve Bank of India (RBI) as the price of India's crude oil basket for its inflation forecasts. However, "if oil prices continue to climb or remain at elevated levels due to supply cuts, the anticipated terms of trade relief to various macro variables will not play out," she said.

Edited excerpts:

At 6.83 percent, the August Consumer Price Index (CPI) inflation print was slightly lower than the consensus estimate of 7 percent. However, even as vegetable prices are on the decline, cereals and pulses saw a sequential increase in August. Are the risks of higher food inflation becoming more generalised due to these steady increases in cereals and pulses inflation greater compared to the temporary spikes in vegetable prices?

Vegetable inflation witnessed significant relief in August, with few of the previous pain points correcting sharply due to better arrivals and administrative measures. Beyond the correction in the 'temporary' segment, 'persistent' components like cereals, pulses, spices and sugar increased during the month, causing food prices (ex-vegetables) to rise from July to August. While there are limited signs that these risks have become generalised, historically, food inflation tends to influence inflationary expectations, requiring the authorities to monitor developments closely. Pre-emptive steps have been taken to prevent a broad-based rise in price pressures, at a time when global oil prices have also returned to above $90 per barrel and weather remains a wild card as the winter crop approaches.

What do the early trends in September prices suggest? Could CPI inflation for September fall below 6 percent?

Multipronged corrective steps have been taken, including higher imports, export restrictions, improved interstate supplies, changes in stockholding norms, release from buffers and a short crop cycle (for vegetables). Non-food items should also find relief from a cut in cooking gas prices as well as a moderating core. These factors are likely to bring inflation back into the target range by September.

Core inflation has edged down to around 4.8 percent. Do you expect this steady decline to continue, or could demand-side pressures during the festival and election seasons push it higher?

Non-food, non-fuel price pressures have continued to soften, with our forecasts pegging core at below 4.5 percent in October 2023-March 2024, reflecting benign demand-led forces. Our trimmed mean measures—10 percent and 20 percent—also point towards inflation at sub-5.5 percent and sub-5 percent, respectively.

Below the surface, however, core captures only part of the inflation basket, with two aspects to note. Firstly, the housing component faces few computational issues, as inflation here is benign despite real data for the property sector, which points to a consistent rise in rentals. Secondly, market participants await the next edition of the consumer expenditure survey to relook the existing weights in the inflation basket, especially the volatile segments which make 60 percent of the total.

Also Read: Oil Minister comfortable with crude oil prices in range of $75-$80 per barrel

Even as food prices and core inflation are easing, crude oil is becoming an issue. The average price of India's crude oil basket in September is now above $90 per barrel. How much of a risk are rising oil prices to Indian inflation, considering that the RBI's forecasts assume a price of $85 per barrel?

Average crude prices for the year are still below the RBI's forecasts, but if oil prices continue to climb or remain at elevated levels due to supply cuts, the anticipated terms of trade relief to various macro variables will not play out. The spillover will be more apparent in the tradable-sensitive WPI (Wholesale Price Index) inflation, while a pass-through to consumer retail fuel is less probable in a pre-election year.

It's been more than a year since pump prices of fuel were changed. The government has so far resisted reducing the excise duty on petrol and diesel. However, with a number of states set to go to polls at the end of 2023 and the general election in the first half of 2024, do you think the government is perhaps just waiting for the right time to lower fuel prices?

After cooking gas, expectations have risen that lower petrol/diesel prices might follow, via excise duty cuts. The last such move was undertaken in May 2022 to curb inflation. While a jump in global international oil prices lowers the window for a price cut, excise duty reductions might allow for a move lower in retail pump prices, ahead of a busy election calendar. The timing might also coincide with the approaching festive period. Prorated for October 2023-March 2024, the total fiscal cost might be to the tune of 0.1-0.2 percent of GDP.

You noted in your comments immediately after the release of August CPI data that the monetary policy committee (MPC) is on course to maintain a hawkish pause in October. When do you see the rate cycle turning, and the MPC first cutting the repo rate?

Notwithstanding the deceleration in August inflation, it is too early for the RBI policy committee to let its guard down as inflation remains above the 4 percent target. Authorities are expected to monitor weather-related risks, sticky food inflation, lower reservoir levels, and a developing El Nino weather pattern (as the winter crop approaches), besides a rise in global oil prices. With inflation still above the target, the MPC is on course to maintain a hawkish pause in October, besides keeping liquidity relatively tight. The RBI's constructive view on growth and uncertainty over the level of US terminal rates are likely to keep the policy committee from exploring rate cuts this fiscal year.