China to weather fuel hike, India inflation soars
Tuesday, 24 June 2008

REUTERS, NEW DELHI- The twin engines of emerging Asian economic growth are grappling with the effects of soaring oil costs as India's inflation hits 13-year peaks and investors weighs the impact of higher fuel prices in China.

India has now joined Indonesia, Vietnam, Sri Lanka and Pakistan in suffering double digit inflation, with data showing its headline price index rose above 11 percent in early June as a result of an increase in state-set fuel prices.

The news sent the benchmark Indian stock market to its lowest this year and government bond yields to their highest in nearly seven years as investors anticipated tighter monetary policy to bring prices under control.

In China, analysts said Thursday's surprise decision to increase retail gasoline and diesel prices by up to 18 percent would not undermine its fight against inflation, although some motorists were less than thrilled at the prospect of spending more at the pump.

"The gasoline price hike is unlikely to change the declining trend of CPI," Goldman Sachs economists Hong Liang and Yu Song said in a client note.

China's annual consumer price rate dipped to 7.7 percent in May from a near 12-year high of 8.5 percent in April.

Economists expected the price rise would add an extra percentage point, or less, to consumer inflation over the rest of the year in a nation where people spend little on fuel products.

After resisting the mounting pressure of soaring oil prices for weeks, China has fallen into line with Asian neighbours in scaling back fuel subsidies and raising prices, a move few expected until after the Olympics in August.

Far from dampening demand, however, some said the move may actually support near term demand growth for diesel and gasoline as it would alleviate shortages by lifting refiners' margins.

A senior official in China's powerful planning agency also said the hike would ease pressure on refiners and should see them provide more fuel to the retail market. Oil recouped most of Thursday's losses stemming from Beijing's price hike, rising $4 as the market judged Chinese demand would get a boost from the move.

The Shanghai Composite Index closed more than 3 percent up, with oil companies and power firms in the lead, suggesting a months-long slide in the index may finally be ending.

BUT NOT IN INDIA

It was a different story in neighbouring India, which imports more than 70 percent of its oil and where all financial markets took a knock from the sudden surge in headline inflation.

The jump above 11 percent was largely driven by the higher fuel costs and was far beyond market expectations of 9.82 percent annually, as well as the previous week's 8.75 percent.

After nearly two weeks of debate, the Indian government bit the bullet and raised retail fuel prices by about 10 percent in early June, unable to sustain its large-scale support for state-run oil firms in the face of fiscal pressure and mounting oil costs.

The ruling coalition faces state and national elections in coming months and rising prices are likely to be a hot topic. The finance minister warned of more measures to dampen prices, after duty cuts to keep prices down and supplies adequate.

"This is indeed a very difficult time and we will have to take stronger measures both on the demand side and monetary side," Finance Minister Palaniappan Chidambaram said.

After a pause of more than a year, the Reserve Bank of India (RBI) raised its key lending rate, the repo rate, unexpectedly last week, taking it to 8.0 percent, its highest in 5-1/2 years.

The central bank, like China's authorities, has largely focused in the past year on draining cash from the money market to keep inflation in check, rather than raising rates outright.

But economists expected after Friday's data the headline price index had not yet peaked and higher rates would be needed.

"I wouldn't be surprised if there is another monetary measure on its way in the next fortnight or so, and this is likely to be a repo rate hike of about 25 basis points," said Abheek Barua, chief economist at HDFC Bank in New Delhi.

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