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Diesel prices will now be market-linked. That means if global crude prices rise, customers will have to pay more for buying diesel and vice versa.
Diesel prices were cut by a sharp Rs 3.37 per litre today because global crude prices have fallen to a four-year low below $90 per dollar. Oil retailers have been making a profit on selling diesel since September 16.
The cut in diesel prices today will lead to a further cool off in inflation. That's because diesel is the most used fuel product in the agriculture sector and the transportation industry, both of which have a direct bearing on food prices. Lower inflation will improve purchasing capacity of common people.
A further fall in inflation will pressure the Reserve Bank to cut rates. That will further boost demand in the economy.
The government's subsidy bill will come down as it will no longer have to reimburse oil companies for selling diesel at below-market price. Last year (2013-14), the government had to pay Rs 85,000 crore for selling diesel, LPG and kerosene at below-market prices. This year the subsidy burden was estimated much lower at around Rs 63,000 crore.
The freeing up of diesel prices and the sharp fall in global crude prices is expected to further save the government over Rs 10,000 crore in subsidy payment this year, analysts say. Lower subsidy means the government may be able to meet its fiscal deficit target of 4.1 per cent of GDP. This will be a big positive for the Indian economy.
Lower fiscal deficit will reduce government borrowing and increase spending on asset creation, which will add to economic productivity.
India imports over 75 per cent of its domestic oil requirements. Oil is the biggest component of the import bill. Falling crude prices will lead to a reduction in import bill and will have a positive impact on rupee.
Diesel sales account for about 55 per cent of overall sales of oil marketing companies. Till now, these companies had to sell diesel at below-market price and were later compensated by the government for the loss in revenue. Upstream oil companies such as ONGC, Oil India and GAIL also had to contribute to subsidies. With diesel under-recovery gone, their subsidy burden will come down and profitability will go up. Expect these shares to do well.
Deregulation is also expected to bring private firms such as Reliance Industries and Essar Oil into retail sale. Such companies do not receive government support for selling diesel at discounted rates and currently sell via state refiners, despite having their own sales infrastructure.