The government on Thursday allowed the public sector oil companies to raise diesel prices by 40-50 paise per litre and simultaneously sought to offset the negative political fallout by hiking the cap on subsidised LPG cylinders from six to nine.
A marginal reduction of 25 paise per litre in the price of petrol was also announced.
Petrol prices had been increased by 35 paise per litre earlier this week.
The revised diesel and petrol prices will be effective from Friday. At present, diesel costs Rs. 47.15 per litre in Delhi.
Higher diesel prices are likely to raise food prices, among many others, and fuel inflation.
Top government sources, however, refused to call the diesel price increase a move towards deregulation.
"We have given some liberty to oil marketing companies to raise diesel prices in small doses from time to time," oil minister M Veerappa Moily said.
The cabinet committee on political affairs, chaired by Prime Minister Manmohan Singh, which took the decisions, considered the Vijay Kelkar panel report, which had recommended a Rs. 1-per-month hike in diesel prices for 10 months to wipe out the diesel subsidy.
The CCPA also decided to increase diesel prices by Rs. 11 a litre for bulk consumers (defence, railways and state transport corporations).
The monthly increase in retail diesel prices by around 50 paise per litre will fetch the government about Rs. 13,800 crore a year and will compensate the exchequer for the outgo of Rs. 9,300 crore on account of increasing the cap on subsidised LPG cylinders to nine a year.
Then, charging market rates from bulk consumers will bring down the government's subsidy outgo on diesel by Rs. 12,907 crore.
"I am not factoring in (the price rise) at this moment. I am proceeding on the basis that the subsidy bill remains the same (as earlier)," finance minister P Chidambaram said.
While economists and the stock markets welcomed the decision, political parties like the BJP, the Left parties, Akali Dal and Trinamool Congress, among others, criticised the move.