Govt’s difficult decision on diesel prices

New Delhi, January 3 (Reuters): The government has deferred a decision on raising diesel and cooking oil prices to compensate state-owned oil marketing firms for revenue losses on selling these products below market prices. The government may have got cold feet on the sensitive political decision after a spurt in food inflation. But crude prices touched a 26-month high of almost $92 per barrel last week, raising the possibility of increasing the government’s subsidy burden this fiscal year.
In June, India freed up petrol pricing and raised the prices of other fuels and followed it up with another hike in petrol prices in early December. Here are the possible scenarios for diesel pricing:
PRICES HELD STEADY
This is the most politically safe step at a time when inflation is high and the government heads for major state elections in Tamil Nadu, Kerala and West Bengal this year. The government may also opt to do nothing ahead of the February budget parliamentary session, as it fears that increasing prices of petroleum products could open it up to more attacks from a belligerent opposition. Government allies like the Trinamool Congress, which is a major political force in the election-bound West Bengal, may also oppose a rise in fuel prices.
IMPACT
* India’s subsidy burden for the fiscal year ending in March may rise even though Finance Secretary Ashok Chawla said New Delhi would cap subsidies at a third of fuel-sale losses. For this fiscal year, India has offered a subsidy of $3.79 billion, about 1.5 percent of total expenditure, but over five times the budgeted amount and 15 percent more than a year ago. Oil Secretary S. Sundareshan has said the finance ministry will bear more than a third of the total revenue losses of state oil marketers.
* The move would not immediately imperil the 2010/11 target of a fiscal deficit of 5.5 percent of gross domestic product, as the government has a large cash balance at the central bank.
* Keeping the current opaque subsidy regime may hurt valuations of explorer ONGC and India’s largest retailer IOC, and their share sales could be pushed back to the next fiscal year, which could mean the government misses its state-run firms’ stake-sale target of $8.86 billion.
* Share prices in IOC, Hindustan Petroleum, Bharat Petroleum, ONGC and Oil India could suffer as they continue to sell products below market levels.
RAISING PRICES
This is an option that the government may be forced to exercise if crude prices shoot up further or remain at these high levels for some time. Sundareshan said last month that revenue losses at oil marketers — Indian Oil Corp, Hindustan Petroleum and Bharat Petroleum — on fuel sales in the current fiscal year were estimated at 660 billion rupees ($14.6 billion). He has also said any increase of more than 2 rupees a litre — about 5 percent — must be approved by the panel of ministers.
IMPACT
* Any rise in fuel prices would stoke inflation, possibly heading to 8 percent in December from 7.48 percent in November and well above the central bank’s target of 5.5 percent by March. High food inflation of more than 14 percent may lead to headline inflation staying at elevated levels for some time.
* A 5-percent rise in petrol and diesel prices could add about 1 percentage point to inflation, according to finance ministry officials.
* Raising diesel prices would help New Delhi reach its goal of reducing its subsidy expenditure to 1.7 percent of GDP in the current fiscal year from 2.1 percent last year and further to 1.6 percent and 1.4 percent, respectively, in 2011/12 and 2012/13.
* It would put added pressure on the Reserve Bank of India to raise rates at its policy review on Jan. 25.
* An increase in rates would encourage private firms Reliance Industries and Essar Oil (ESRO.BO) to beef up local retail sales from their current negligible market shares.
* Revenue could increase at IOC, HPCL, BPCL and upstream firms ONGC, Oil India and GAIL (India), which now must offer discounts on crude sales and products to marketing firms.
* Share prices of all the oil firms could rise.