India’s government announced on Tuesday that it was raising the retail prices of gasoline and diesel.
Why is India’s government taking this step? According to the Financial Times the answer is simple. The cost of maintaining the subsidies was breaking the bank. India imports more than 70 percent of its oil — “Without the increase, the government oil companies are facing a deficit of $57.8bn from selling fuel at a subsidized price.”
“Due to the relentless increase in the international oil prices, it has become absolutely necessary for the consumer, who is also an important stakeholder, to also shoulder a small part of the increased burden,” said Murli Deora, minister of petroleum.
A quarter of the world’s gasoline consumption is subsidized, and, in terms of population, half of the world uses energy subsidies. This policy has created an important distortion, whereby rising oil prices have been effectively prevented from destroying oil demand. Subsidies have artificially raised inflation in the developed world (through artificially high oil prices) and suppressed inflation in the developing world (inflation would have been even higher in the absence of subsidies). As fiscal pressures mount, some countries will be forced to incrementally remove these subsidies. The net result will be an unwind of these distortions. For currencies, we believe that the net effect will be negative for emerging market countries, as this process will be stagflationary for them, and “Goldilocksy” for developed countries…