The government has allowed oil companies to raise diesel prices after strangulating them for eight years. Oil companies can raise diesel prices by a small amount every month (Rs 0.45/litre to Rs 1/litre are estimates of raise every month) to bring down the under recoveries in the selling price of diesel. Oil companies have already raised prices for bulk users by Rs 9.25/litre taking full advantage of being allowed to price diesel at market rates to this category of buyers.
The media is alive and kicking on the diesel price hike with expert comments such as "it is not deregulation" or " half hearted attempts at deregulation" etc. The markets on the other hand have cheered the decontrol move by taking up oil stocks such as BPCL and ONGC by over 10% post decontrol.
In current times of government bashing being the norm for media, the fact that the government has taken a step towards reducing subsidies in order to reduce fiscal deficit by allowing oil companies to start making profits again should be appreciated. The markets on the other hand will look at the positives of the diesel price decontrol and is likely to give improved valuations to PSU (Public Sector Unit) stocks.
The BSE PSU index has underperformed the BSE Sensex by 17% over the last two years.
The reason for markets giving thumbs down to PSU stocks was due to issues such as "Policy Paralysis" leading to rising inflation, rising subsidies and rising fiscal deficit. The market saw the government as a poor manager and drove down PSU stocks as they were deemed shareholder unfriendly due to poor governance.
It is true that a move such as decontrol (if it may be called so) of diesel prices by the government will not in anyway improve the functioning of PSU's, as the government will have a large say in what PSU's should do. However a government that is being forced to acknowledge its past inaction and is taking the right steps such as lowering subsidies is highly positive for economy, PSU stocks and the broad market.
The government has taken a calculated step in allowing oil companies to raise fuel prices. The government is aware of the fact that the rising force of US in the world oil market is expected to keep oil prices down over the next many years. US shale gas revolution is expected to reduce US oil imports by 20% by 2014. Stable global oil prices will help the government reduce subsidies by 20% once fuel is priced to market.
The diesel price decontrol is positive for the Rupee. The lower subsidy bill of the government will improve the fiscal deficit math leading to less pressure on the bond markets to absorb government bond supply. The government is raising a record Rs 479,000 crore through market borrowing in fiscal 2012-13 and if it can lower the borrowing amount in 2014-15 bond yields can fall leading to lower levels of interest rate in the economy. Lower interest rates in the economy is positive for equities leading to strong capital flows and hence a stronger currency.
The market pricing of fuel will also discourage excess consumption due to subsidies and that will lead to more rational use of fuel. Oil import bill will not burgeon on the back of rational fuel use and on the back of a stronger currency.
The follow up to the diesel price decontrol will be a good budget that shows lower deficits and has its eye on inflation. A good budget will see markets taking up PSU stocks along with the broad market and since PSU stocks have underperformed over the last two years the catch up could fetch handsome returns to investors.
Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.