When it comes to increasing the prices of regulated fuels like diesel, LPG and kerosene, it's a case of getting stuck between the devil and the deep blue sea. If you go ahead and hike prices before key state elections, you become hugely unpopular - if you don't, you have a fiscal mess, which can cause economic chaos and a sovereign rating downgrade.
Of course, with no political muscle (dependence on allies), the ability to hike prices gets all the more difficult.
Here's why regulated fuel prices need to be hiked?
India's crude oil basket in rupee terms has moved up to Rs 5891, an almost 10% rise since the June levels. In rupee terms, the crude oil basket was Rs 5,280.62 per barrel on June 19.
The government will have to bite the bullet and raise prices of diesel, kerosene and LPG or face a deteriorating fiscal deficit, which is now threatening to go way above the targeted levels of 5.1% of GDP for FY 2013. Diesel, Kerosene and LPG are regulated, with the government bearing a substantial chunk of the burden.
Under recoveries on regulated fuels have already reached dangerously high levels. Oil marketing companies have reported under recoveries to the tune of Rs 47,811 crore, until June 30, 2012.
Diesel under recovery as on August 1, 2012 has already reached Rs 12.03 a litre, while domestic LPG under recovery is Rs 231 per cylinder and PDS Kerosene at 28.54 a litre.
The government faces a challenge though. On the one hand if it increases the price of regulated fuels like diesel, it is likely there would be a huge spike in inflation. Also, the government would dash its own hopes, by being hugely unpopular. It can't afford to so so, especially with select states going to elections in the next few months.
The mercurial Mamata Banerjee would also oppose a hike. It's also likely there would be dissent from the SP, another crucial ally offering support to the government from outside, if prices were to be increased.
If there is no hike, the fiscal deficit may become unmanageable and foreign rating agencies could downgrade India's sovereign rating on account of fiscal profligacy. Not to mention the fact that the RBI would not cut rates, when fiscal deficit is so high, hitting economic growth rates further.
Fuel subsidies along with fertilizer subsidies contribute the largest chunk to the fiscal deficit. In fact, subsidies contribute more than 2% to GDP. Rating agencies have warned that the fiscal deficit would cross 6% of GDP for 2013, if the government does not increase regulated fuel prices.
Clearly, it's a fine balance that the government needs to strike between maintaining fiscal consolidation and choosing not to be hugely unpopular. Which way it tilts, only time will tell.