Subsidies have been a bane for the Indian economy for several years. They are supposed to be meant for the poor. However, it is a well known fact that most of the subsidies end up distorting the economy. A large part of the subsidy outlay for fuel, food, fertiliser, education, etc. do not benefit the common man. While it may not be possible to do away with subsidies entirely, it is certainly possible to bring them under control. In this aspect the new government has reasons to smile.
The fuel subsidy is easily the biggest. For FY15, it has been budgeted at Rs 1,000 bn. A large part of this amount is the subsidy given to diesel. However, things are looking up on this front. The government has been increasing the regulated price of diesel in baby steps, by Rs 0.5 per month, since Jan 2013. Over 18 hikes in succession, the price of diesel has been increased by Rs 11.24. Thus the revenue loss (known as under recoveries) on diesel, for oil marketing companies, has fallen to just Rs 1.78 per litre as per an article in the Business Standard. The fall in Brent crude prices over the last two months has also helped. Due to this, the government's overall subsidy burden could reduce by about 12% this year.
This has led to calls for a complete deregulation of diesel prices. We believe the time has come for the government to bite the bullet on this one. Petrol prices have been deregulated since 2009. This had led to a distortion in the market as many consumers started shifting to diesel powered vehicles like SUVs over the petrol options. This is just one example of the distortion that subsidies can cause in the economy. After all, the people who can afford to buy SUVs are by no means poor! Thus, the sooner we see a complete deregulation of diesel prices the better. This will also lead to better control over the fiscal deficit in the long term. If the government can demonstrate good control over its finances, the RBI would find it easier to cut interest rates as well. This will be a huge positive for the markets we believe.
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