Taming Diesel Subsidy to Curtail Inflation and Foster Economic Growth
Government is reluctant to raise diesel price fully for fear that it might lead to inflation, even though administered price of petroleum products leads to large under-recoveries. Partial financing of under-recoveries by the government is done by direct budgetary support and indirectly by the Public sector oil marketing companies (OMCs) and upstream oil companies (ONGC and OIL). These high levels of under-recoveries raise the fiscal deficit, which in turn leads to higher money supply resulting in higher inflation prompting Reserve Bank to raise interest rate that lowers investment and economic growth rate over time. While steps have been taken by the government to decontrol prices of petrol, LPG and kerosene, diesel continues to be heavily subsidized, as a change in status quo may lead to inflation in the short term. To explore this trade-off between short term impact and medium term outcomes, IRADe has conducted a study titled ‘Taming Diesel Subsidy to Curtail Inflation and Foster Economic Growth’. The aim of the study is to assess the alternative road maps for diesel price reform in India.
Key findings are:
- Continuing with present policy of subsidizing diesel price is not tenable. This could have very large economic costs in the long term.
- Full increase, which is a one shot increase of 30%, in the diesel price leads to some immediate increase in inflation; however, continuing with present subsidy involves a much higher rate of inflation later and which persists over a longer time. The average inflation rate over 3 years will be 6.6 percent if diesel price is decontrolled but would be 9% if diesel subsidy continues. Such high overall inflation hurts the poor even more than the increase in diesel price.
- The trade-off between short term negative impacts and long term benefits is not just with inflation, but also for GDP. The growth rate would be 8% with price decontrol and only 6.5%, if we continue with the present policy. The loss in GDP will hurt poor whether they use diesel or not.
Sponsored by: Shakti Sustainable Energy Foundation and the Ministry of Finance.