Where is the diesel price hike that India needs?

Where is the diesel price hike that India needs?

The cheer of the New Year was darkened by news that India's public finances continue to be in dire straits. The deficit of government spending over revenue has already reached over 80 per cent of budgeted levels.

The clear indication is that the Budget target of a fiscal deficit at 5.1 per cent of gross domestic product, or the finance minister's "revised" target presented in the fiscal consolidation road map a few months ago, of 5.3 per cent of GDP, is out of reach.

Even missing those targets by a small amount will be impossible unless action is taken to control subsidies immediately. In particular, long-promised action on diesel subsidies is yet to materialise.

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It is important to remember that ballooning fuel subsidies – which the prime minister said in October would overtake the Rs 1.4 lakh crore spent last fiscal year unless corrected – dwarf most other government spending, even on its flagship social schemes.

Their continued existence endangers the spending increases that the United Progressive Alliance (UPA) has built into the new Five-Year Plan document for social sector spending, of over 140 per cent.

The longer they last, the less credible is the UPA's claim to be an "aam admi" government, or that it is committed to the sustainability of its welfare spending.

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Thus, a rationalisation of diesel prices is overdue. The prime minister has several times hinted that it is around the corner. But hints are just not enough - either for the government's bottom line or to satisfy analysts looking with ever-increasing anxiety at India's poor macroeconomic numbers.

It has now been reported that raising diesel prices by a rupee a month for some months, perhaps 10, is under consideration. This sort of approach would be best.

It minimises the political opposition to the changes, making them easier to push through. It accustoms people to the idea of variable fuel prices, and gives them time to change their habits in response to different expectations about future prices.
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It should also be accompanied by credible moves towards the depoliticisation of price setting, so as to ensure that future movements in world oil prices do not backfire on whichever government is in power.

Lessons should be learnt from the supposed freeing up of petrol prices, which in effect did nothing of the kind since government approval is still tacitly sought for major changes - ensuring that it was still held responsible by consumers for any increases.

Critics will point out that India's consumer price inflation continues to be high, squeezing household budgets and preventing interest rate cuts from the Reserve Bank of India that might get Indian manufacturing going again.

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But the truth is that, if the fiscal deficit were to reach even higher than the already high targets for 2012-13 – perhaps close to six per cent, as the Kelkar Committee report argued late in 2012 – then it would have a more broad-based and long-term effect on inflation than raising fuel prices.

The fiscal deficit is financed through more money entering circulation, which inevitably raises prices. "Suppressed inflation", through fuel subsidies, is not suppressed forever - it has to emerge eventually.

Good economic management requires it to be brought into the open as soon as possible. The government cannot delay much further.