Friday, May 25, 2012

>PETROL PRICE HIKE: Heralding Stagflation? (May 24, 2012)

State-owned oil companies increased petrol prices by Rs7.50/litre with effect from Wednesday midnight. They hiked petrol prices by Rs6.28/litre excluding local sales tax or VAT. The price hike came just a day after Prime Minister Mr. Manmohan Singh called for implementation of strict measures to help the economy. The government had decontrolled petrol prices in June 2010 and since then they were hiked just once in November 2011. While the hike was on the cards and expected, the quantum of the hike has surprised all. While the move may bring some short-term reprieve for oil marketing companies (OMCs) grappling with higher under-recoveries, it would lead to inflationary pressure as other administered prices would also increase even as Wholesale Price Index (WPI) in April 2012 stood at 7.2% YoY and food inflation at 10.5%. We have factored in such price hikes for our FY13 WPI inflation estimate of
8.5%. The immediate inflationary impact may be limited on account of petrol having a lower weight in WPI.

The hike in petrol prices by state-owned oil companies should not merely be viewed in isolation but as part of a broader strategy of increasing administered prices and reducing subsidies. The petrol hike will have no impact on fiscal deficit and hence we can expect diesel, public distribution scheme kerosene, domestic liquefied petroleum gas (LPG), urea, and electricity prices also to be hiked in future as the government wants to align domestic prices with global prices. Such a strategy, policy makers believe, will result in short-term spike in inflation but will thereafter result in higher GDP growth. We believe the rise in administered prices will result in higher inflation, higher interest rates, and decelerating demand with no assurance of laying a foundation for future economic growth. Indeed, stagflation may be the likely fallout of such a policy. We reiterate our negative stance on the banking sector and view this development as a major setback for sustained efforts by the Reserve Bank of India (RBI), which has been struggling to contain inflationary pressures.

Oil & Gas: The steep petrol price hike could bring some respite to the financials of OMCs, but what is important is the intention behind the price hike – is it meant to ease the financial stress on OMCs or is an indicator of forthcoming bold decisions for other regulated petroleum products. India is currently facing a double whammy of elevated crude oil prices and a sliding rupee and in such a state, without a hike in the prices of regulated petroleum products, the overall under-recoveries may touch Rs2,000bn(US$36.36bn) in FY13E compared to Rs1,385bn(US$28.76bn) in FY12. The government, in the 2012-13 budget, mandated only Rs430bn of oil subsidy for FY13E and showed its intention to rein in subsidy to 2% of GDP and so keeping in mind the strain on government finances, we believe the hike in the prices of regulated petroleum products is imminent. We have already factored in Rs5/litre hike in the price of diesel, Rs50 hike per LPG cylinder and Rs3/litre hike in kerosene in our FY13E under-recoveries estimate. We believe the petrol price hike and restricting upstream companies’ subsidy burden at ~40% in FY12 could bring some semblance of positive undertone for companies in our coverage universe, but we will review our ratings and target prices only after the likely revision in the prices of regulated petroleum products.

To read report in detail: PETROL PRICE HIKE