Sweetening A Bitter Pill

In another bold step, the Indian government has allowed Oil Marketing Companies (OMCs) to effect small hikes in the price of diesel. At the same time, the government has also raised the cap on subsided LPG cylinders from 6 cylinders to 9. Leaving the diesel price hike decision in the hands of the companies, therefore, would be seen by many as the proverbial spoonful of sugar that helps the medicine – in this case, the rise in subsidised cylinders – go down.

The Ministry of Oil & Natural Gas has considered the Vijay Kelkar Committee report, which proposed to move away from the current subsidy of Rs 9.60 per litre on diesel by increasing the prices of the fuel by Re 1 per month. The quantum and period of the hike is as yet unknown. The government had last hiked the price of diesel in Sept 2012 by Rs 5.63 per litre.Earlier, in June 2010, OMCs were directed to consult with the government before bringing about any hike in diesel prices. The prices have been raised twice since then, and the government has now laid the onus of deciding the prices on OMCs. However, it has refused to term this move as a full or partial decontrol.

The government would also be looking to reduce the Current Account Deficit (CAD), which has touched 5.4% of the country’s GDP in the Sept quarter of this fiscal. Credit rating agencies, which keenly watch the CAD, may consider this as a positive step with regard to India’s sovereign credit rating.

However, it appears that the moves may not bring down the CAD immediately in this fiscal, but will have a bearing on the next one. It must also be remembered here, that the government has increased the cap on LPG cylinders without any hike in the prices – hence, the rise in the price of diesel may be somewhat offset by the hike in the number of subsidised cylinders. It remains to be seen which amount turns out to be the larger one.

In India, a large amount of fuel goes towards public transport utilities and freight carriers. A diesel price hike, therefore, is a sensitive issue with deep moorings. The headline inflation came down to 7.18% in Dec 2012 from 7.24% in Nov 2012. Fuel and power inflation declined to 9.38% in Dec 2012 from 10.02% a month earlier. If OMCs hike the diesel prices, that will translate into slightly higher inflation. Even though the RBI has now changed the mood from inflation to growth, it will keenly watch the inflation numbers in next two months before taking a decision. Even if the RBI goes ahead with a rate cut in the Mar quarter, the higher fuel prices will add to inflationary pressures in the next fiscal.

We maintain that this is a definite step towards easing in a price decontrol regime with respect to energy resources, and much as it is an indication that the government is trying to bridge the twin deficits.