The steepest hike in diesel prices in recent memory is the Congress's way of telling the nation it has not lost the stomach for tough economic decisions. It must not yield to the chorus of protests that has erupted from allies and opposition parties. The economics of the move is not in doubt. Unless the government cuts down on subsidies, they will keep on crowding out productive investment, leaving little scope for interest rate cuts by the Reserve Bank of India (RBI). By squeezing credit to industry, the government has been forcing the country down the path of slower economic growth along with fairly stubborn inflation. The timing of the hikes sits in conformity with the RBI's view that it is less painful to increase oil prices when overall demand is low than when the economy is operating near its potential rate of growth. The inflationary impact now, it is reasonable to expect, will be lower than, say, six months down the line if the economy pulls out of the trough it is in.
International developments, too, support a hike in local diesel prices at this juncture. Monetary expansion by central banks in the US and European Union will have a lagged impact on crude oil — the previous rounds of the Federal Reserve's quantitative easing have led to spikes in Brent prices a year down the line. Over the last fortnight the Fed and the European Central Bank have independently announced open-ended bond purchases to revive their respective economies. The oil subsidy would have become even more unwieldy after the flood of newly minted dollars and euros pushed up commodity prices across the globe. Bold as it is, the decision still falls short of deregulating diesel prices two years after petrol was taken off bureaucratic control. The market distortion created by the relatively free price of petrol and the administered one for diesel is showing up in the lopsided sales of fuel hungry diesel utility vehicles. Officially administered hikes, even if they are not prompted by the country's electoral calendar, do nothing to restrict the mass of affluent Indians riding free on the diesel subsidy.
The fuel price hike could herald a new spirit in the Congress that seeks to straighten kinks in the economy holding both growth and social welfare back. Finance minister P Chidambaram is out to revive investor interest in the India story and there are expectations the government could serve up stalled reforms in retail, pensions and insurance. Mr Chidambaram does not have time on his side and he could give the Congress image the makeover it needs after an extended period of policy stasis.