Fight Against Inflation To Benefit From Lower Oil Prices

The RBI has recently had much to cheer about as far as its policy effectiveness is concerned. The bank achieved its target of bringing inflation to sub-6% by January 2016. More recently, the latest reading on consumer price inflation was at sub-5% levels, which is even better.

The 4.8 per cent level inflation for March 2016, augurs well for RBI's target of 5 per cent inflation rate by January 2017. In its recent monetary policy statement the bank notes that "Going forward, CPI is expected to decelerate modestly and remain around 5 per cent during 2016-17 with small inter-quarter variations". This is expected on account of a balancing of risks, where upside risks include uncertainties around monsoons, increased spending and firming in commodity prices - particularly oil, and downside risks are the muted global growth conditions.

The IMF's latest World Economic Outlook, though, has struck off at least one upside risk to inflation: commodity price increases. Soft oil prices, specifically, are a boon for India, where a third of imports are oil imports. Therefore, increases in oil prices can have an inflationary impact from a direct price increase, indirect impact from a potential increase in government borrowing as well as result in imported inflation on account of the exchange rate effect.

The fund states that "Baseline assumptions for the IMF's average petroleum spot prices…suggest average annual prices of $34.75 a barrel in 2016-a decline of 32 per cent from 2015". While the outlook does mention that geo-political tensions in the Middle East could disrupt oil supplies and put upward pressure on prices, but the existence of inventories and response from US shale producers could keep them under control.

More generally, the overall commodity price softness is a positive to the extent that they represent a raw material cost for much of industry. The exceptions being commodity producers like steel companies. Global metal prices are expected to decline further by 14 per cent in 2016 and even agricultural commodity prices are expected to fall by 6 per cent over the course of this year.

Going by these latest forecasts, and the expectations for a normal monsoon in India, managing inflation may turn out to be a cakewalk for the rest of 2016. The real test, though, will be in 2017, when oil prices are expected to pick up, as is global demand and the domestic economy will be firm too.