Four months after the Congress took a big political gamble by raising diesel prices, it is embarking on a creeping deregulation of the fuel's price by allowing oil companies to spread out future adjustments over a year. Bulk buyers can't stagger the proposed hike, though. These, by themselves, are courageous decisions in the run-up to a general election. They could also pave the way for continuous changes in diesel prices to skirt the political backlash against bunched-up increases. The economy gets a chance to adjust to incremental fuel price changes and should benefit from the thrift enforced by the harsher discipline of market forces. India's oil imports climb due to spikes in crude prices and also because its energy consumption remains oblivious to how international prices move. Our oil demand does not decline as prices rise and this adds to the downward pressure on the rupee. It's a vicious cycle that can be broken by freeing up all fuel prices and reimbursing only those who cannot afford market rates. A sizeable chunk of the economy is getting a free ride on the government's fuel subsidy.
There is a pretty compelling case for freeing diesel prices. Trucks burn around 40% of the diesel used in the country, and they are free to charge higher freight if fuel prices rise. Power generators and industry use another 18% and they anyway charge market rates for their output. No subsidy is needed for these three categories of consumers. Likewise, car owners, who account for 15% of diesel use, can afford to pay more for the fuel and, in fact, can even cough up more for an additional excise duty on the cars they buy. The only vulnerable segment is agriculture, which consumes 12% of the country's diesel, and it, too, can be shielded from volatility by higher minimum support prices for farm output. The resultant inflation from all this may not be vicious. A study commissioned by the finance ministry suggests a one-shot 30% increase in diesel prices could lower average inflation in 2011-15 from 7.13% to 5.68%.
Thursday's decision on diesel pricing by the Cabinet Committee on Political Affairs - the move was sugar-coated by a larger subsidy on cooking gas - runs the risk of politics intervening. The Centre has spent 82% of the budgeted major subsidies for 2012-13 in seven months and finance minister P Chidambaram does not see much of an impact of incremental diesel price changes over the next two months. The effects should, however, show up in the next fiscal year when Mr Chidambaram is committed to lowering the deficit from 5.3% to 4.8%, partly by keeping the subsidy bill in check.