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NEW DELHI (Reuters) - The government moved on Wednesday to mend its strained finances, which have hit capital investment and put its sovereign credit ratings in peril. Prime Minister Manmohan Singh's government hiked railway passenger fares after a gap of nine years and later in the day sources in his government said it had proposed an increase in heavily subsidised fuel prices to rein in a swollen fiscal deficit.
The move signals Singh's intent to push ahead with politically unpalatable but vital reforms to revive an economy that is on track to post its worst growth rate in a decade.
The economic slump is also making it tougher for Prime Minister Singh to fund flagship welfare programmes ahead of a national election due by mid-2014.
Railways Minister Pawan Kumar Bansal said the passenger fare increase will help generate 66 billion rupees for the cash-strapped rail system, whose creaky service has become a drag on the economy.
The government tried to raise the fares, unchanged since 2004, in March 2011 but protests from the Trinamool Congress forced Singh to abandon the plan. Dinesh Trivedi, the erstwhile railways minister, also resigned over the issue.
The refusal by successive ministers to raise passenger rail fares has strained the finances of the railways, sapping its capacity to lay new track, modernise services and improve safety.
A sleeper ticket from New Delhi to Mumbai, about 1,390 km (864 miles) away, can cost as little as about 400 rupees.
Bansal said the fare hike, which will be effective from January 21, was necessary. "Facilities and safety measures will improve with an increase in fares."
India's economic growth that once promised to hit double-digits is languishing below 6 percent for the past three quarters. One of Prime Minister Singh's key policy advisers, Montek Singh Ahluwalia last month said economic growth could get stuck at 5.0-5.5 percent if a policy logjam continues.
Singh has been pitching for a phased adjustment in domestic energy prices since last month to align them with global markets, warning that business-as-usual policies won't deliver higher growth.
India's policy to subsidise retail prices of fuels such as diesel, which account for about 40 percent of refined fuel consumption, to benefit the poor is a major drain on the exchequer.
These populist policies have swollen India's fiscal deficit, which funding through a heavy market borrowing has driven up borrowing costs for private investors and dimmed economic growth prospects.
Officials at the oil ministry said on Wednesday that the ministry has moved a proposal to the federal cabinet to increase diesel prices a rupee a litre every month. It has also suggested increasing the cap on subsidised cooking gas cylinders to nine from six and hiking prices by 100-110 rupees a cylinder.
The fuel prices were last raised in September when a beleaguered government, under pressure from the credit rating agencies, launched some of its most daring initiatives that also included opening the retail and other sectors to foreign players.
"There is also a possibility that the government may decide to raise diesel prices by 4-5 rupees a litre instead of going in for a phased increase," one of the oil ministry officials said.
"With general elections due in 2014, raising prices will be difficult in the second half of this year."
Ratings agencies Standard & Poor's and Fitch have warned that a widening fiscal deficit has put India on the brink of losing the investment grade status enjoyed by fellow "BRICS" Brazil, Russia, China and South Africa.
"It's positive news, as rise in fuel prices will help curtail subsidy bill, and hence the fiscal deficit," said Vivek Rajpal, fixed income strategist at Nomura in Mumbai.
New Delhi aims to trim the fiscal deficit to 5.3 percent of gross domestic product in the fiscal year that ends in March after overshooting the official target of 4.6 percent last year by 1.2 percentage points. But given the revenue and expenditure mismatch, many economists dub the target as optimistic.
Reporting by Rajesh Kumar Singh; Editing by Tony Munroe and Nick Macfie