Even as American consumers are reeling from $4 plus a gallon prices, Indian consumers are still enjoying low fuel prices for petrol (about Rs 50 a litre for regular), diesel (about Rs 35 a litre for regular), kerosene and LPG, thanks to their government's populist measure of fixing prices at low levels. However, recent events have shown that we too may get burnt at home.

State-run oil marketing and refining companies must sell fuel below cost to the public. Their sizeable revenue losses resulting from this move are partly (less than 50% of the margin) absorbed by upstream players like ONGC and Gail India, the refining companies themselves, and the central government in the form of bonds.

These "oil bonds" are not accounted for in the fiscal budget. Such subsidies cost the government as much as an estimated Rs 60,000 crore in 2008, or about 2% of the national GDP. Similarly, ONGC expects to carry a burden of Rs 20,000 crore. This does not include the burden by discounting kerosene for ration-card holders. The oil and marketing companies themselves lose over Rs 550 crore a day by selling subsidised fuel, and have had to increase their borrowings to the hundreds of crores to finance production, expansion and other capital expenditure.

The problem with artificially lowering domestic fuel prices is that it prevents natural adjustment or correction of demand in the face of ever-increasing oil prices as it would happen in the free market. Thus, demand is artificially sustained and will further rise as long as the Indian consumer is able to afford the energy bill of his cooking and transportation needs.

What may well happen is a vicious spiral of higher demand feeding escalating oil prices, and creating a cascading inflationary effect on other goods in the market basket. Moreover, the government will feel the strain as it diverts more fiscal funds into subsidies to keep the oil refining and marketing companies above water. As of May 16, public sector oil companies have put a stay on new LPG connections, because the loss margins (of Rs 306 per cylinder) became too massive to stomach.

Ironically, the government, spurred on by the Left Front's urging to keep fuel prices within reach of the masses, assumes that to raise fuel prices, as most Western industrialised nations would do, may cause a price shock and consequently, an inflationary spiral. The move in February this year to increase petrol and diesel prices by a mere Rs 2 and Rs 1 per litre, respectively, had already met with opposition in some quarters, but has done little to stem the blow of unprecedentedly high global crude oil prices. Because India does not have enough reserves or natural sources of crude oil, and the fiscal budget is not bottomless, it cannot keep purchasing crude oil at current levels of demand while selling them at fixed low prices, and expect PSUs to stay afloat.

The government is now pondering correction measures, from waiving the customs duty on petrol and diesel, to evaluating its policies on subsidising and pricing petroleum fuel products.