Markets are not fully pricing in fuel-led inflation yet, say analysts

Markets are not fully factoring in the impact of fuel price-led inflation at the current levels, believe analysts, who see up to 8 – 10 per cent correction in frontline indices once the inflationary pressures kick in.

After a hike of Rs 25 per litre in diesel prices for bulk buyers over the weekend, the government has raised petrol and diesel prices by 80 paise a litre each, while domestic cooking gas (LPG) prices were increased by Rs 50 per cylinder, ending over four-and-half month election-related hiatus in rate revision amid rising crude oil prices.

“The market is already prepared for a hike in fuel prices and that’s why they corrected sharply recently. Despite getting cheaper crude oil from Russia, one must also keep in mind that only two refineries in India – that of Reliance Industries Limited (RIL) and Essar Oil – have the ability to process this crude variety. Processing cost for public sector refiners – HPCL, BPCL and IOC – will be higher; hence the discount for the Russian crude will get neutralized to some extent. The market can correct another 8 – 10 per cent from here as they’re not fully pricing in the fuel price–led inflationary impact yet,” said A K Prabhakar, head of research at IDBI Capital.

 

Retail prices of petrol and diesel had been on a freeze since October 2021 when crude oil prices were hovering around $80 a barrel. On their part, oil prices have been volatile in the past one month – rising to over $140 a barrel as the geopolitical issues between Russia and Ukraine escalated, and dropping to around $95 a barrel as the issues showed signs of thawing.

“The move to hike diesel prices for bulk users is less inflationary and will increase the time lag for inflationary impact. The market was expecting a much steeper hike across the board, especially after the state poll outcome was known; and in the backdrop of Russia – Ukraine war and its impact on crude oil prices,” said G Chokkalingam, founder and chief investment officer at Equinomics Research.

Economic shock

Since India is a net oil importer with inelastic demand (imports 84 per cent of its oil requirements), any sustained rise in global oil prices, analysts at UBS Securities said, is a negative shock to the economy and could lead to higher inflation.

“A 10 per cent rise in crude oil prices relative to our baseline increases CPI inflation by 30 basis points (bps) if the government were to pass the full increase on to consumers. There would be a cascading impact too (of similar magnitude), which would be felt over a period of time,” said Tanvee Gupta Jain, economist, UBS Securities.

Consumer price index (CPI) inflation, meanwhile, surged to 6.1 per cent y-o-y in February from 6 per cent in January, which contrasts with the Reserve Bank of India's (RBI’s) view that inflation had already peaked in January, and despite unchanged fuel prices.

“Rising global fertilizer and food prices, the pass-through of higher input costs to consumers and services sector reopening pressures will continue to push inflation higher. We expect CPI inflation to average 6.3 per cent y-o-y in 2022, with core inflation likely to trend above 6.5 per cent throughout most of the year,” wrote Sonal Varma, chief economist for India and Asia ex-Japan at Nomura, in a recent co-authored note with Aurodeep Nandi.

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