Deregulation of Fuel prices might not work with the middle class driven Indian Economy

Fuel subsidies form a major component of India’s much debated public spending overheads and have been heavily criticised by free marketers and economists. The government, currently facing flak for the lacklustre GDP numbers and scuttled reforms coupled with growing domestic inflation and fiscal deficit, is for the first time seriously contemplating a move towards deregulating prices of both petrol and diesel. While petrol prices have already been partially deregulated, deregulating diesel would have a serious impact on commodity prices and amplify inflation.

While most of the debate is concentrated on this indirect effect on the pockets of the Indian middle class, we forget the more direct impact on middle class spending, which is the driver for growth in India. A car is not a luxury to many middle class households living in India’s growing cities. Many of these cities have very scanty public transport systems if any.

It is incomplete to argue whether the middle class can pay Rs 100 for a litre of petrol, rather we should ask if it is worth for the middle class to pay Rs 100 for a litre of petrol (which is essentially for transport) and still remain profitable in their domestic accounts. If the middle class can pay this price and still retain enough so as to not affect their spending patterns, then the government would have effectively passed on the costs from the Oil companies to the common man and the deregulation move would be justified.

However if the increased fuel cost is such that it does affect their savings considerably (which looks plausible given current inflation numbers) then this would also affect their spending on non essential commodities. Once the middle class goes into a self imposed austerity drive it would largely trim the profits of the consumption driven consumer industry and be detrimental to the economic recovery we are all hoping for. In other words the government would have only passed on the losses faced by the public sector oil companies to the common man and finally to the industry with no gains for the economy as a whole.

The subsidies on fuel in my opinion still remain a contentious issue which cannot be considered with merely the government’s expenditure in mind. A fully deregulated fuel market will have a much higher impact on the industry and this ultimately would have to be mitigated through reforms and by ending the policy paralysis – steps that require greater public backing which the government might just loose by removing the subsidies on fuel.