The government on Thursday increased the prices of diesel by Rs 5, showing fiscal prudence and reducing the impact of increasing "dieselisation" of the economy. Here are few reasons why it was necessary and almost inevitable to hike diesel prices.
1) India crude basket up almost 20% since June
Brent crude which was trading at $89 on June 21, 2012 has moved to $116 per barrel on September 14. A 25% hike in crude prices internationally. The Indian crude basket generally tracks Brent crude and is just a couple of dollars lower than Brent. The India crude basket has shot up almost 25% since June, tracking Brent Crude.
2) Increasing dieselisation of the economy
Diesel has been subsidised keeping the poor in mind, but the rich with their diesel guzzling vehicles have been enjoying subsidised rates. In fact, the difference of almost Rs 25-35 between petrol and diesel had led even the rich to buy diesel vehicles and use subsidised diesel, in which the government was bearing almost Rs 15-20 of the cost. Ditto for LPG where commercial establishments have been getting cylinders at subsidised rates.
3) Rs 551 crore loss daily for Oil Marketing Companies
Oil Marketing Companies until a few days ago were incurring a daily loss of Rs 551 crores on under recoveries. These companies have made huge borrowings, which are to the tune of Rs 1,57,617 crore at the end of the quarter ended June. These set of companies faced a ratings threat due to the deteriorating state of their finances and this could increase their cost of borrowings. The diesel hike and the LPG limitation would help their finances.
4) Fiscal deficit would go out of control
If there was no diesel hike the fiscal deficit was likely to spiral out of control. The government had projected deficit of 5.1% of GDP in its budget for 2012-2013. However, since international prices of crude remain at elevated levels and if domestic fuel prices were not raised the budget deficit could have span.out of control.
5) Rating agencies would have downgraded India
If there was no fuel price hike, in all probability international rating agencies would downgrade India's sovereign rating to junk, citing lack of fiscal consolidation. S&P has already changed India's rating outlook to negative and is likely to review India's rating in the next few months.
6) Will give room for RBI to cut rates
The RBI is not likely to cut repo rates if there is no fiscal consolidation on the part of the government. With the government now showing signs of fiscal prudence through a diesel hike, the RBI could look at cutting repo rates which could encourage economic growth through investments.