Rajan Calls on Modi to Seize the Moment and Cut Fuel Subsidies

India must take advantage of the lowest oil prices in a year to free up fuel costs and reduce subsidies that contribute to one of Asia’s widest budget deficits, central bank Governor Raghuram Rajan said.

Brent crude, a benchmark for more than half the world’s oil, has fallen 14 percent since June to $96.38 per barrel, helping cut losses on sales of subsidized diesel. Refiners are also required to sell cooking gas and kerosene below production costs in a nation where 827 million live on less than $2 a day.

“We need to seize this moment to eliminate diesel subsidies completely,” Rajan said at a conference in Mumbai today. “We can of course wait but the moment will leave us and we may be back to subsidizing.”

Getting end users to pay for the products will help Prime Minister Narendra Modi improve public finances and rein in Asia’s fastest inflation. Funds to ease the burden for food, fuel and fertilizers rose fivefold under his predecessor, prompting a rating downgrade warning from Standard & Poor’s.

“The under-recoveries on diesel are almost wiped out, oil has fallen through the crucial $100 mark and the demand-supply outlook doesn’t look threatening,” said Radhika Rao, an economist at DBS Bank Ltd. in Singapore. “Elimination of fuel subsidies is doable.”

Diesel subsidies, which accounted for 57 percent of the nation’s total fuel subsidies in the year through March 2013, will probably be extinguished by March 2015, according to Deutsche Bank AG. This will help reduce the handouts by as much as $17 billion from the previous year and help Modi progress toward his goal of cutting the budget deficit to 3 percent of gross domestic product by March 2017, analysts including Taimur Baig in Singapore wrote in a Sept. 1 research report.

Budget Deficit

India plans to narrow the gap to 4.1 percent of GDP this year from 4.5 percent in the preceding period. Modi is counting on a boost in tax revenues to achieve this and had kept subsidies largely unchanged in the annual budget.

There are concerns about the quality of fiscal consolidation, according to an RBI report last month. Rajan has repeatedly called on the government to rein in spending, saying better finances will help curb price pressures and higher fuel costs for consumers can reduce consumption.

Consumer inflation eased to 7.8 percent in August from a year earlier and a report showed today that wholesale inflation slowed to a five-year low of 3.74 percent.

“Inflation is coming down and this is consistent with our forecast and I am glad,” Rajan said today. “Macro indicators are improving but still have some way to go before we can declare we are out of the woods and claim victory on inflation, and that is only a matter time.”

Fed Taper

The loss on sales of diesel has fallen to 0.08 rupees (less than 1 U.S. cent) a liter from 13.4 rupees in September last year after the previous government began gradually increasing prices from January 2013, Oil Ministry data show.

Oil prices are lower than the median forecast in a Bloomberg survey as the Federal Reserve pares its monetary stimulus, reducing the amount of money in the global system.

The authority will raise interest rates in June, Bank of America Merrill Lynch predicts, faster than a previous September 2015 estimate. The Reserve Bank of India will hold rates at a review this month and will probably lower borrowing costs in February, Bank of America economists led by Mumbai-based Indranil Sen Gupta forecast.

“’Imported’ inflation is abating with Fed tapering holding commodity prices in check,” they wrote in a research report today. “Indian diesel prices will get benchmarked to global prices by June.”

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