Diesel price rise: Easier said than done

Higher inflation and lower growth rate outweigh the fiscal deficit argument

Armed with the Kirit Parikh committee recommendation, the ministry of petroleum & natural gas is contemplating a Rs 5 a litre rise in diesel prices – 10 times higher than the Rs 0.50 a litre increase every month it has been implementing for almost a year and almost equivalent to the Rs 5.5 a litre increase since January.

When the government started increasing these prices, the under-recovery was Rs 9 a litre. A weakening rupee and higher oil prices internationally have increased this to Rs 10.5 a litre, even after taking into account the Rs 5.5 rise since January.

But raising diesel prices is easier said than done. The government has lost four key elections recently where inflation was a major issue. The ground reality is that the contemplated rise has the potential of creating an economic shock. For an economy, struggling to grow at above the five per cent mark, a sharp diesel price rise would hurt further.

India’s oil demand growth is already at a decadal low, with diesel showing a fall of 0.7 per cent. Diesel accounts for 43 per cent of all-oil product demand. According to Antique Research, diesel demand was hit by lower consumption from commercial vehicles, an improved power scenario and a shift by industrial customers to alternative fuels due to price rise. Consumers from the cement and mining industries switched to petcoke. Further, automobile companies have vociferously complained rising prices have severely dented sales of diesel cars – the fastest growing segment in the sector before the price rises ensued. The sector is witnessing one of the worst phases in a decade. Higher diesel prices will immediately affect freight operators and discourage heavy vehicle sales.

But diesel prices are rising over the world. According to a Bank of America Merill Lynch report, gross refining margins (GRM) in Singapore are at an 18-week high on account of a sharp improvement in diesel and petrol prices. The scrips of public sector oil marketing companies have shot up on expectation of a rise in diesel prices. Private sector entities which export diesel will benefit from the move. There is little doubt the sharp rise in diesel prices will help improve the government’s fiscal deficit, as well as the financials of oil marketing companies. But the country still runs largely on diesel. The adverse impact of higher inflation and lower growth will override the deficit impact. Is the government willing to risk it?