"The bottomline is that inflation will follow an inverted U in FY14, after last week's diesel price hikes that will add 120 bps to FY14 inflation.
"Inflation should persist around 7 per cent in the March quarter, which will then likely go back up to 7.5-8 per cent in H2 of 2013. But it should abate to 6.5-7 per cent by March 2014," BofA-ML Indai chief economist Indranil Sen Gupta said in a note.
However, the American brokerage said it continues to expect the Reserve Bank to cut policy rates by 25 bps on January 29. It is likely to be cut by 75 bps by June, then pause in the second half as inflation picks up and cut another 50 bps again in the March 2014 quarter as inflation subsides.
The government allowed oil marketing companies to increase the retail price of the fuel by 50 paise per every month and ended subsidy on bulk and institutional diesel consumers like railways, state road transport corporations and to power plants. The current subsidy on diesel stands at Rs 9.50 to a litre.
Gupta said, "we expect inflation to persist at 7-7.5 per cent in the March quarter after the diesel price hike. And accordingly we hike our March 2013 inflation forecast to 7.3 per cent from 7.1 per cent."
On the impact of the staggered diesel price hike, it said the move will add about 120 bps to FY14 inflation if crude remains at USD110 per barrel.
However, on the positive side, Gupta said, the price hike will help the government trim its oil subsidy by Rs 20,000 crore to Rs 67,300 crore (assuming a rupee value of 54 to the dollar).
Stating that the long tightening by the RBI has begun to turn counter-productive, he said "we cannot deny that RBI tightening is increasingly turning counter-productive in hurting growth rather than denting an inflation that is largely 'imported'."
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