It has been said that doing small things in a great way makes one great. By letting oil-marketing companies raise diesel prices very gradually, the government may be doing great things in small ways. If the government sticks to its decision, it would show considerable bravery in acting on an issue that is political hot potato: dismantling the administered pricing mechanism for fuel products that lies at the core of the fiscal deficit mountain it has yet to conquer. Diesel subsidies amount to about 2 per cent of India’s GDP. A sudden increase by about Rs 4 or 5 (about 10 per cent of current prices) per litre — which is what most analysts expected — would have increased consumer-price inflation by about 1 per cent. This would have derailed other reform measures to tackle the fiscal deficit that the government might be contemplating. With the complete deregulation of retail prices, ‘under-recoveries’ would come down by roughly Rs 70,000 crore (the Rs 0.45 increase already announced will reduce the shortfall by Rs 3,300 crore). Assuming that the Central government’s share is 50 per cent, that will shave off about 0.35 per cent (35 basis points, or bps) from the deficit. Bulk buyers will have to pay full price, and that reduces the under-recoveries by another Rs 13,000 crore.
Immediately, the increase in retail diesel prices will have a positive effect on the exchange rate of the rupee, which has taken a beating in the last few months. Since most of our oil is imported, the value of the rupee will rise across all foreign-exchange markets. But what the government taketh, it also giveth away on another fuel product: liquefied petroleum gas, which households use for cooking. The government has increased the allocation of subsidized LPG cylinders from six to nine per year, and that adds Rs 10,000 crore to the deficit. And the allocation could go up further, to 12 a year, if not more. It should not be forgotten that elections in nine states are due this year, and general elections are just 15 months away. The other big worry is about the inflationary effects of the diesel-price increase, and particularly the so-called second-order effects on commodities and transport costs. Most hope that it will be moderate since the periodic increases will be small. But perhaps the biggest worry is about the ability of this government to stick to its guns on the price increase.