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Will either inflation or deficit ease?
Tue, 28 Dec Pre-Open

There are two things that the Indian government would heartily wish for in 2011. One is bringing inflation down to acceptable levels. The other is to get its finances in order. While one of the two objectives could be achieved, meeting both targets seems like a tall order, indeed.

One factor that could create considerable havoc is a spike in crude oil prices. The Indian government already has its hands full trying to bring the current inflation down. Rising food prices and spikes in certain non food items have meant that inflation continues to persist at high levels. Throw in higher fuel prices and you have a scenario where the government's aim to bring inflation down will go awry. The government has lifter control over petrol prices with the rise in oil prices. But it still decides the price of diesel, kerosene and LPG.

Now, if oil prices continue to rise, and the government decides that it has to keep inflation within check at any cost, it will then have to continue doing what it has been doing for the past several decades. Subsidize fuel prices. This means that it will have to compensate oil marketing companies for the losses that they incur on lower market prices for fuel. The higher oil prices go, the larger the subsidy will have to be. And higher subsidies mean that the government will find it difficult to bring down its deficit. Readers would do well to recall that the government had laid a roadmap for bringing down fiscal deficit to 4.8% by FY12.

Crude prices, in the meanwhile, have been rising. Severe winter in Europe and North America means that the demand for this black gold has picked up. With two more winter months to go this demand is not likely to ease in the near term. Meanwhile, India along with China continues to guzzle oil as their economies grow at a brisk pace.

The government, along with the RBI, has been working towards bringing down inflation without hurting economic growth. This can still be done as the central bank has steadily raised interest rates for taming inflation; the impact of which has not hurt India's GDP growth. However, we believe that bringing the fiscal deficit down still seems like a tough nut to crack.

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