India raised diesel prices about 9 percent on Friday after months of delay, a politically unpopular move that will add to inflationary pressure, but also eases the government’s subsidy burden and could bolster its image among wary investors.
“This is the only window they have for any cutting of subsidies. By the end of the year they will be in [state] election mode,” political analyst Mahesh Rangarajan said.
Since it was first elected in 2004, Indian Prime Minister Manmohan Singh’s government has often refrained from pushing through tough reforms in favor of pleasing its predominantly rural voter base.
Persistently high inflation as well as the government’s handling of a spate of corruption scandals has led to what many critics describe as policy paralysis in New Delhi.
With galloping spending and slowing growth, New Delhi must reassure investors fretting over political and bureaucratic delays over major projects that it can run the economy and retain voter support.
Diesel will now cost just over 41 rupees per liter in the capital after the government panel raised prices by a record 3.4 rupees per liter including local taxes. It also raised kerosene and cooking gas prices.
“The inflationary implications of the diesel price hike are unavoidable. Broadly, with inflation currently at around 9 percent, the hike in prices should take the WPI [wholesale price index] into double digits again and keep it there for a while,” said Rupa Rege Nitsure, chief economist at Bank of Baroda.
The increases, announced by Indian Oil Minister S. Jaipal Reddy, were roughly in line with expectations.
Taken together, they will -directly add about 55 basis points to headline inflation, said Yes Bank economist Shubhada Rao in Mumbai, who expects another 25 basis points to 50 basis points of interest rate increases by India’s central bank, which has already raised rates 10 times since March last year despite the risk to growth.
Diesel accounts for 40 percent of petroleum product demand in India and is the most widely used transport fuel. It powers tractors and irrigation pumps for farmers in one of the world’s biggest producers and consumers of grains and sugar.
Lifting prices is politically fraught.
“I am sandwiched between economists on the one hand and populists on the other hand,” said Reddy, an advocate of price rises, following the meeting. “Political problems will always be there and economic problems do not wait for solution of so-called political crises.”
Since the government agreed in principle to lift fuel costs a year ago, international crude prices have soared 33 percent, swelling the money it has to spend on subsidizing fuel prices for a country with 500 million people living in poverty.
However, world oil prices fell 6 percent on Thursday after major consuming countries announced an emergency release of stocks, only the third time ever, and dropped further on Friday.
With inflation in India above 9 percent and domestic fuel costs up nearly 13 percent this year, raising fuel prices will immediately hit the fractious coalition’s core voters among the poor who live on less than the cost of 2 liters of diesel a day.
Petrol prices, which largely affect more affluent Indians, have gone up about 23 percent since they were liberalized a year ago.