In the wake of the recent increase in petrol prices and India's looming fiscal deficit situation, it is important to understand why diesel prices should also be revised upwards.
For several decades, India has been subsidising the price of diesel. But in recent years, both the global environment and the Indian economic scene have undergone substantial changes.
Despite this, many economic policies, such as the heavy subsidy on diesel prices, have remained unaltered over the period; this needs serious reconsideration.
For instance, in the last six years, the average growth rate of crude oil prices (based on the Indian basket) has been at 13.5 per cent.
During the same period, however, the average value of diesel under-recoveries, as a percentage of fiscal deficit, stood at 14.6 per cent!
Similarly, between 2009 and 2010, when global oil prices fell by more than 21 percentage points, diesel under-recoveries as a percentage of fiscal deficit fell only by 13 percentage points.
What is wrong in subsidising diesel?
It is vital to understand that subsidies are associated with two important (negative) economic fallouts, besides many others.
Why it is wrong
First, a subsidy of any kind involves a disincentive to use the subsidised good or service efficiently as they have been obtained cheap.
Second, the government can finance a subsidy only by expanding its fiscal deficits. In the process, scarce resources are transferred from a private party (tax-payers) to the government.
It is well documented that owing to the absence of a profit motive in government spending, such resource transfers leads to decreased productivity.
Acknowledging the reality
Revision in diesel prices, no doubt, would entail temporary displeasure, and resistance from the pubic and political parties. But it would only help the country's cause to keep political interest aside, and focus on the economic benefits.
In the name of shielding the economy from fuel price volatility, the government is exposing future generations to tougher times. It is time people realise this fact.
The Government may also want to look back at the heavily resisted policy shifts in the 1990s that has created a slew of positive changes in the Indian economy.