NEW DELHI (Reuters) – The government freed up state-subsidised petrol prices and raised the prices of other fuels as pressure to trim a budget deficit outweighed concerns about the political impact.
A panel of ministers increased prices of state-subsidised diesel, kerosene and cooking gas, which could help reduce the fiscal deficit from the projected 5.5 percent of 2010/11 GDP, but also accelerate inflation and chances of a rate increase.
The extent of the rises beat expectations. Prime Minister Manmohan Singh pushed them through despite grumbling within his own alliance and fears of a voter backlash, signalling a willingness to push other long-pending economic reforms.
The price rises risk stoking headline inflation, which is already in double-digits, and could hasten monetary tightening by the Reserve Bank of India (RBI) before a policy review on July 27.
"The decision suggests that reformers in the Congress have gained an upper hand over populists for now," said political analyst Mahesh Rangarajan, referring to the Congress Party, the main component in the ruling coalition.
"It may indicate that the government is in a mood for further faster reforms. The rise in fuel prices, particularly of diesel, will concern Congress allies which are soon going to face elections."
For a graphic on India's fuel price history, click here
Friday's price rises would shrink the losses of state-run oil marketing firms by about $13 billion in fiscal 2010-11 to $11.4 billion, according to Oil Ministry projections,
Finance Secretary Ashok Chawla told Reuters this month he expected the fiscal deficit to shrink to 4.5 percent of GDP in fiscal 2011 if fuel prices were deregulated and on the back of other revenues, including the 3G spectrum auction.
Shares of state run oil marketing companies closed up more than 10 percent on the news.
INFLATION VS REFORM
But the price increases came just as concerns were growing that inflation was running out of control.
"The decision does suggest that the government is focused on the reform agenda and is ready to reduce subsidy and cut the fiscal deficit irrespective of a short-term rise in inflation," said Kevin Grice, senior economist at Capital Economics.
The Finance Ministry's chief economic adviser, Kaushik Basusaid, said the price rises would impact headline inflation by 0.9 percentage points.
The move also heightened bond market expectations that the RBI will raise interest rates by 50 basis points, not 25, at its July 27 policy review.
"It was a difficult decision for the government, more so as inflation is in double digits," said Anubhuti Sahay, an economist at Standard Chartered bank in Mumbai.
"Our estimation indicates that it can push headline inflation up in the first round by 138 basis points. Second-round effects will follow soon.
"This would increase a probability of an inter-meeting (rate) hike and if that does not materialise, we can see a 50-basis points increase in both policy rates."
The panel said petrol prices would be market driven, rising 3.50 rupees per litre, while kerosene prices would rise by 3 rupees a litre. While petrol is mainly used by the middle class for cars, kerosene is used by the poor for power.
Diesel prices will rise 2 rupees per litre and will be freed up later. Cooking gas prices were raised by 35 rupees a cylinder.
India's bond yields jumped after the news. The yield on the 10-year benchmark bond ended 8 basis points higher at 7.65 percent, after rising to 7.68 in the day.
Overnight indexed swap (OIS) rates also rose following the decision, closing 8 basis points higher, while the 1-year swap rate ended 13 basis points higher at 5.56 percent.
In early June, the Congress-led government held off the price rise decision after two powerful ministers from coalition parties stayed away from a ministerial panel meeting, signalling opposition on fears of voter backlash.
Congress was handed a second term in office last year on the back of the ruling party's pledge to share the spoils of years of economic boom and protect hundreds of millions living below the poverty line. The government backed out a few months ago on freeing up farm prices after street protests.
"Prices of everything will go up because of the fuel price hike," said Nitin Singh, a contractor in Delhi. "It will shoot up the household budget by 2-5 percent."
Rival Asian giant China by contrast abandoned similar fuel price subsidies from January 2009 to great effect for then-struggling refiners grappling with losses, as Indian state-owned refiners do now.
Any move to remove price controls will help Reliance Industries(RELI.BO), which operates the world's biggest refining complex but exports most products as the local market is dominated by state firms that sell cheap fuel.
Finance Minister Pranab Mukherjee has said a strong harvest following a normal monsoon would tame food prices.
Farm ministry officials on Friday gave their most optimistic forecast yet for the annual rains -- which irrigate 60 percent of the country's farms -- saying the June-September rainfall would likely be 102 percent of the long-term average.
(Additional reporting by Rajesh Kumar Singh and Abhijit Neogy)
Writing by Alistair Scrutton; Editing by Matthias Williams)
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