Will the diesel price hike pave the way for more reforms?

After raising subsidised diesel prices despite heavy political opposition, the government may go further in reviving its stalled reform agenda on Friday when it weighs allowing foreign direct investment in its battered airlines.

India’s decision late on Thursday to raise diesel prices by 14 percent, the first such move in 15 months, is aimed at shoring up a weakening fiscal position, but has already come under intense fire from both the opposition and allies within the ruling Congress party-led coalition.

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While the move will add to inflation in the short term, it will ultimately make it easier for the RBI to loosen monetary policy and help revive investor confidence damaged by political gridlock in New Delhi

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“It is a bold move, and will send a strong signal to the Reserve Bank of India on the government’s efforts at fiscal consolidation,” said Anubhuti Sahay, an economist at Standard Chartered Bank in Mumbai.

While most other G20 central banks are trying to ease monetary conditions to counter a global slowdown, the RBI has consistently flagged high inflation as a key risk to an economy where growth is faltering.

Data on Friday is expected to show wholesale prices rose 6.95 percent year-on-year in August, slightly higher than July’s 6.87 percent, according to a Reuters poll of 32 economists.

INTEREST RATE MOVE?

The diesel decision was welcomed by investors.

“This is a positive signal because it shows the government is ready to move. But this is only the first step, and lot more needs to be done to bridge the fiscal gap,” said Indranil Pan, chief economist at Kotak Mahindra Bank in Mumbai.

On Monday, the RBI is expected to leave interest rates on hold, although several market players said the diesel move adds to the possibility of the first rate cut since April.

“All these days RBI was insisting the government should take steps to control the fiscal deficit. After this move there are all possibilities that the central bank may consider to reduce interest rates on Monday,” said R.K. Gupta, managing director of Taurus Mutual Fund in New Delhi.

India has set a target to cut its fiscal deficit to 5.1 percent of GDP in the financial year that ends in March, a goal many economists say it is unlikely to meet.

India’s inability to push through major reforms and ease its subsidy burden puts it in danger of becoming the first of the big “BRICS” emerging economies to see its credit rating downgraded to junk.

Later on Friday, the cabinet is expected to consider a proposal to allow foreign airlines to buy stakes in local carriers, a long-stalled move aimed at revitalising the country’s debt-ridden domestic carriers, although overseas airlines have shown little interest in investing.

Under current rules, foreign airlines are barred from buying stakes in domestic carriers, although foreign investors are allowed to hold a cumulative 49 percent. If the proposal is approved, foreign airlines would be allowed to buy similar-sized shareholdings.

Whether the diesel price hike sticks remains to be seen.

A leading partner in the ruling coalition announced a protest march at the weekend and the main opposition party called the move “financial terror”. Protests earlier this year over petrol price and railway fare hikes prompted Singh to partially roll them back.

Reuters