Govt raises diesel prices nearly 8% to ease subsidy burden

India raised diesel prices nearly 8% on Friday after months of delay, a politically unpopular move that will add to inflationary pressure but also eases the government's subsidy burden and could bolster its image among wary investors.

After a meeting that was delayed by about six hours, a government panel raised the price of diesel by Rs 3 per litre to around Rs 41 per litre. It also raised kerosene by Rs 2 per litre and LPG prices by Rs 50 per cylinder.

The increases, announced by Oil Minister S. Jaipal Reddy, were roughly in line with expectations.

"This is the only window they have for any cutting of subsidies. By the end of the year they will be in (state) election mode," political analyst Mahesh Rangarajan said.

Since it was first elected in 2004, the government of Prime Minister Manmohan Singh has more often than not refrained from pushing through tough reforms in favour of pleasing its predominantly rural voter base.

Persistently high inflation as well as its handling of a spate of corruption scandals has led to what many critics say is a state of policy paralysis in New Delhi.

With galloping spending and slowing growth, New Delhi faces the task of reassuring investors fretting over political and bureaucratic delays for major projects that it can run the economy and keep voter support.

Diesel is the most widely-used transport fuel in India and powers tractors and irrigation pumps for farmers in one of the world's biggest producers and consumers of grains and sugar.

"The inflationary implications of the diesel price hike are unavoidable. Broadly, with inflation currently at around 9%, the hike in prices should take the WPI (wholesale price index) into double digits again and keep it there for a while," said Rupa Rege Nitsure, chief economist at Bank of Baroda.

Since the government agreed in principle to lift fuel costs a year ago, international crude prices have soared 39%, swelling the money spent on subsidising fuel prices to a country with 500 million people living in poverty.

Petrol prices, which largely affect more affluent Indians, have gone up about 23% since they were freed a year ago.

Reddy, an advocate of price rises, told Reuters earlier on Friday the International Energy Agency's (IEA's) planned release of strategic stockpiles would give only temporary respite.

"We don't know whether this (softening in global prices) is a stable trend," he added.

J.P. Morgan has already cut its forecast for benchmark Brent oil for the third quarter to USD 100 a barrel from USD 130 but on Friday global crude prices paused from losses.

Adding to inflationary pressures

With inflation above 9% and domestic fuel costs up nearly 13% on the year, raising prices would immediately hit the fractious coalition's core voters among India's poor, who live on less than the cost of 2 litres of diesel a day.

The longer-term benefit to the country's finances would come from reducing massive spending on subsidies and cutting the USD 101 million a day in losses for state-run fuel retailers Indian Oil Corp , Bharat Petroleum Corp and Hindustan Petroleum Corp on sales of diesel, kerosene and cooking gas at state-set cheaper prices.

A three-rupee increase in the price of diesel would add 40-45 basis points to wholesale price inflation, according to Yes Bank .

Shares in Bharat Petroleum and Hindustan Petroleum rose 2.8% and 6.1 percent respectively in a market that ended 2.9% higher.

(USD 1 = Rs 44.955)