NEW DELHI (Reuters) - The government said it may eliminate diesel and gasoline subsidies as soon as July, quicker than expected, ending a policy that had crushed state refiners' profits, strained government finances and inflated oil demand.
Emboldened by an unexpectedly strong election victory this month, the Congress-led cabinet will consider a proposal to free state controls on transport fuel prices in July, Oil Minister Murli Deora told reporters, news that sent shares of oil companies surging as investors bet on more stable earnings.
"It will go to the cabinet. It will be discussed soon, within six weeks," said Deora, who on Thursday was reconfirmed in the role he has held since early 2006, when world crude oil prices were first pushing beyond $70 a barrel.
The move, which one state oil executive said would trigger a 5 percent rise in prices if made today to match $65 crude oil, is one of many important reforms expected from the government, and suggests it is ready to take difficult but important steps in order to balance growth with fiscal prudence.
Pricing freedom would increase tax revenue and remove massive subsidies bills, helping offset the cost of economic stimulus measures that have stretched public finances and widened the fiscal deficit to 6.1 percent of GDP in 2008/09 (April/March).
But it could hurt industry accustomed to below-market prices, raising input costs at a tough time. India's economy grew 6.7 percent in 2008/09, a six-year low, and economists say it is set for a recovery from the second half of this fiscal year.
While few had expected it to move so quickly on such a sensitive issue, analysts said it was likely to win government approval since the Congress party no longer relies on its former communist allies for support, and noted that the proposal would not affect subsidies on kerosene, used for home cooking.
"They will be able to pass it in the cabinet," said D.H. Pai Panandikar, President RPG Foundation, a private economic think tank. "It's not necessarily going to hit the people now because oil prices are low at the moment."
Like many developing countries including China, India has sought to protect its poor against rallying world prices and curb broader inflation pressures by controlling domestic prices centrally, partly subsidising state oil firms for their losses.
Some are working now to take advantage of the fall in crude prices from a $147 a barrel peak last year to dismantle those controls, although China's partial liberalisation at the start of 2009 is already under strain as Beijing resists another rise.
Oil prices rose above $65 a barrel on Friday, taking gains to 27 percent in May, the biggest one-month gain in a decade, and analysts say the market seemed focused on the bullish sentiment and brighter macroeconomic outlook.
But because India barely cut prices during crude's long decline, current petrol prices would only rise by about 5 percent if the government ended controls on pricing, a senior Indian Oil Corp official told Reuters.
India imports about 70 percent of the oil it consumes and accumulated a huge burden of subsidies as it kept prices artificially low when crude soared to its peak last year.
"You have to bite the bullet. The subsidies seem to be so out of control .. How can you run the government on a wide fiscal deficit?" asked Mridul Saggar, chief economist at Kotak Securities. "You run the risk of faster price adjustment, larger price adjustment, but then if you don't do that, the cost is in terms of growth as well as interest rates."
But some analysts say getting approval could be tough.
"I have my own reservations. In a country like India where you have a large population of poor and where raising fuel prices is always a politically sensitive issue, it may not be possible," said R.K. Gupta, managing director at Taurus Asset Management.
Eliminating subsidies would also open a domestic opportunity for private sector firms Reliance Industries and Essar Oil to shut down their petrol stations, struggling as customers bought cheaper fuel from subsidised state rivals.
The news helped drive up the oil and gas sector index, which includes Reliance and state-run explorer ONGC, was 4.2 percent by 0930 GMT, outperforming a rise of 2.9 percent in the benchmark index.
Market-driven prices would help curb fuel use in India, one of the only major consumers expected to see positive demand growth this year.
India's oil product consumption, a proxy for demand, has risen about 47 percent in last decade to 133.44 million tonnes in 2008-09. India's largest oil retailer, Indian Oil Corp, sees diesel demand rising 4-5 pct, petrol demand up 8-9 pct and overall demand rising 3-4 pct this fiscal year.
Additional reporting by C.J. Kuncheria