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Inflation Vs crude prices - Views on News from Equitymaster
 
 
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  • Jul 8, 2003

    Inflation Vs crude prices

    Inflation (read Wholesale Price index (WPI) in India) has gone down by 16% since its highs of 6.2% (Average during April). Currently, it stands at around 5.2% levels. Lets understand one of the key factors that have a major influence on inflation in the Indian context in this current article.

    Inflation, in economic and simple terms, means rising prices. Consider the current weightage first in WPI. While manufacturing products has about 64% weightage in WPI, primary articles (food and non food articles) contribute to 22% weightage and fuel, power and lubricants contribute the remaining 14%. Any increase in prices of products across any segment has a bearing on inflation. However, crude prices seem to have a bigger say. The following analysis strengthens this argument.

    Crude oil prices increased during FY03. It reached at its peek during February 2003. The primary reason for the rise in crude prices during FY03 was tension arising out prior to the US led attack on Iraq. This apart, disruption in Nigeria also led to the northward movement of crude prices. Why then, any international increase in crude prices affects India?

    India imports about 70% of its crude oil requirements (mainly for manufacturing petroleum products). Thus, any increase in crude prices internationally forces domestic refineries to raise prices of petrol and diesel. To put things into perspective, prices of petrol and diesel saw an increase in FY03 at much higher rate in the last 10 years. Since prices of diesel and petrol rose, cost of transportation also moved north resulting in an upward movement in WPI. Moreover, apart from transportation, petroleum products are one of the key sources of energy for the manufacturing sector. Manufacturers are then forced to pass on the rise to consumers. Since the manufacturing sector and fuel has a bigger weightage in WPI (78% together), inflation tends to go up. The WPI reaching a high of 6.2% during the period March-April 2003 therefore, has to be viewed in this context.

    The graph above clearly strengthens our view. Though there is a marginal lag effect of a rise in crude prices on inflation, the co-relation seems to be strong.

    In the last quarter, crude prices have stabilized at US$ 27 per barrel, which is significantly lower than US$ 32 per barrel witnessed in February 2003. The oil PSUs passed this benefit to the customers by reducing the prices of petrol and diesel. This reduction was one of the key reasons of the fall in the inflation witnessed in the last few weeks. However one should note that fuel prices alone are not responsible to determine movements in inflation. As pointed earlier, other things like primary articles and manufacturing goods also play a major role in the movements in inflation.

     

     

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