Different possibilities of outcome, If India does reform its refined fuel policy

The government on Friday will once again grapple with the political hot potato of deregulating fuel prices, seeking a way to improve its financial health as it tries to shield its 1.2 billion citizens from high prices.

A panel of ministers, empowered by the cabinet to decide the country's fuel policy, will review the policy at 1 pm (0730 GMT).

Earlier this month, the panel deferred the decision due to political concerns that the move would hurt voters already hit by high food prices.

Asia's third-largest economy has been looking for new ways to reduce subsidies and set prices of motor and cooking fuel since the failure of its 2002 bid to get state-owned refiners to fix prices every two weeks in step with global rates.

But this is a political minefield in a country where 410 million people live on less than $1.25 a day and any decision by the panel of ministers who debate the issue must have the approval of Sonia Gandhi, the left-leaning powerful chief of the Congress party that has led coalition governments since 2004.

Analysts worry that maintaining the status quo could discourage private sector investment in India's under-developed energy sector and send a signal that the government would rather please its mostly poor and rural political base than push through pro-market reforms.

BM Bansal, chairman of state-run Indian Oil Corp on Wednesday said the current petrol price, 47.93 rupees ($1.03) per litre, was 3.20 rupees, or nearly 7% lower than market rates, while diesel rates were 9% lower.

Shares of IOC and other state refiners Bharat Petroleum Corp Ltd and Hindustan Petroleum Corp Ltd  were up 1.1% to 1.2%, outperforming the benchmark index, which was down 0.5% at 0355 GMT on Friday.

Raising fuel prices would stoke inflationary pressures, already at levels uncomfortable enough for voters to slam Congress in municipal elections this week in the swing state of West Bengal.

An economically sound decision may help India narrow its fiscal deficit, but could yield electoral losses for the Congress in the half-dozen state elections scheduled this year and next.

Many coalition allies would be unhappy with the unpopular measure, which is sure to be pounced upon by opposition parties including the communists who tried to unseat the government over a February hike in motor fuel prices.

Rival Asian giant China, with its own billion-plus population, abandoned similar fuel price subsidies from January 2009 to great effect for then-struggling refiners grappling with losses, as Indian state-owned refiners do now.

If India does reform its refined fuel policy during a window stretching from the end of the lawmakers' budget session in May until parliament gathers next for its monsoon session in August, here are the possibilities that could play out.

Lifting subsidies would trigger spikes of up to 15% in retail prices of diesel and gasoline -- adding to the political pressure on a government already facing protests over rising prices of food and consumer goods.

This option looks even more difficult in the wake of two fuel price hikes since the end of February.

It could stoke inflation, forcing a tightening of monetary policy. The government's fiscal deficit, now projected at 5.5 percent of the budget for the year ending March 2011, would probably shrink, freeing up capital for other programmes.  

In the fiscal year that ended March 31, India spent 149.5 billion rupees ($3.35 billion), or nearly 1.5 percent of all government expenditure, on oil subsidies, compared with initial estimates of 31.1 billion rupees.

Market rates would allow private firms Reliance Industries and Essar Oil, that now mainly export fuel, to consider domestic retail sales.

Revenue would spike dramatically at retailer Indian Oil Corp, as well as Hindustan Petroleum and Bharat Petroleum, and upstream firms ONGC, Oil India and GAIL (India).

Higher retail prices could briefly dampen demand for fuel and vehicles.

Scrapping government intervention would hit poor consumers, who have no access to electricity and use kerosene for lighting and cooking. 

India may end pricing controls on petrol, viewed as the rich man's fuel, and gradually remove controls on diesel, which could spur higher inflation but ease its fiscal burden.

It would help cut losses at state oil firms, but fuel demand may be hit briefly and could draw some opposition from the automobile sector.

It may spur a change in fuel use. A large gap between diesel and kerosene prices may see the cheaper fuel being used to adulterate diesel.

Introduction of a Unique IdentitySmartcards framework may follow to ensure a transparent public distribution system of kerosene and domestic LPG.

The government may decide to continue with the populist mechanism of subsidising fuel prices but would then face the risk of a ballooning fiscal deficit, and jettison its plan to trim the deficit to 4.1% of GDP by the end of March 2013.

The finances of the public sector oil marketing companies would be hammered. Projected losses for the firms are estimated at $24.4 billion this year, based on an average crude price of $85 a barrel.