Fuel price hike | Can the government postpone the pain any longer?

The double blockade of the Strait of Hormuz has upended the oil and gas market, with crude even crossing $125 a barrel before recovering. The United States’ blockade is hitting Iran hard. Iran, however, is in no mood to surrender its nuclear ambitions. The stalemate is not resolving anytime soon.

India, with total dependence (85 per cent of consumption) on petroleum imports and on the Gulf for gas (with no alternatives), is neck-deep in trouble on both supply and price fronts.

The government has, for the last two months, taken the hit (reduced excise duties by nearly half on petrol and diesel) and postponed the consumer pain (by mandating oil marketing companies (OMCs) to keep prices unchanged). That no longer seems workable.

What now, after the Assembly polls and with prospects of a short war evaporating? Can the government postpone the pain any longer? When it bites the bullet, will it unleash the inflation gorilla across the entire consumption basket? What happens to the government’s fiscal deficit? Is the Indian economy in trouble?

No option but to hike fuel prices

The Narendra Modi government has dismantled the system of market pricing of petroleum products, which channels all diesel and petrol supplies through the OMCs when pump prices no longer cover the cost of production (import cost plus refining/bottling margins). Private companies (Reliance, Nayara, etc.) shut off retail supplies in such situations and export (unless the government puts high export duties, as it has done currently) or sell to the OMCs. As all supplies go through the OMCs, their losses (under-recoveries) pile up depending on how high import prices go. At $100 per barrel, the OMCs were reportedly losing Rs 20 on petrol and Rs 100 on diesel per litre (even after excise duties were reduced by Rs 10 per litre). Currently, their under-recoveries have gone up to Rs 30,000-40,000 crore a month.

On May 1, the price of a commercial LPG cylinder (19 kg) was raised by a hefty Rs 993, taking its price from Rs 1,581 (in December) to Rs 3,072 — which is an increase of 94 per cent. In contrast, a 14.2 kg domestic LPG cylinder is priced at Rs 913 in Delhi (after a Rs 60 increase in March). On a per kg basis, the difference in prices of a commercial LPG cylinder (Rs 161.66) and a domestic cylinder (Rs 64.30) is inexplicable and unsustainable. Historically, the commercial LPG cylinder has been priced at best at a 20-25 per cent premium to the domestic cylinder; that parity would require the domestic cylinder price to be raised to Rs 1,775.

Despite the Modi government’s paranoia about increasing consumer prices, it cannot postpone the inevitable any longer.

Likewise, pump prices of diesel (diesel consumption is about four times that of petrol) would have to be raised by about Rs 25 to Rs 40 per litre and petrol prices by Rs 15-20. Ethanol substitution in petrol is a small palliative; it has damaging consequences for India’s water economy as well.

Energy makes the base of inflation spiral

Energy is fundamental to agriculture, industry, and services production.

Urea is produced from natural gas, and water is pumped up by electricity. No industrial production takes place without the use of energy. Most professional services are overwhelmingly power-driven. Agricultural produce is taken to consumers by transport running on diesel and gas; and, no computers operate without power.

Raising energy prices, therefore, pushes up the cost of production of most agricultural products, industrial products, and services. This second-order inflation impact of energy prices plays out gradually and indirectly but surely and quite materially.

India’s system of computing economy-wide inflation is fragmented and unrepresentative. The new consumer price index (CPI) (base 2024) also does not have a good correspondence with private final consumption expenditure (PFCE) in GDP. There is no producer price index (PPI) for determining inflation in investment goods; India’s wholesale price index (WPI) does not have services in it, despite services making up more than 50 per cent of GDP. Consequently, GDP deflator (underlying inflation) undershoots economy-wide inflation, and ends up showing a larger GDP and suppressing actual inflation.

There is no doubt that the increase in gas, petrol, diesel, and aviation fuel will make most agricultural, industrial, and services costlier and unleash inflation gorilla. The fact that both CPI and WPI had ultra-low inflation in 2025-2026 will compound the problem on account of the adverse base effect. The forecast of deficient rainfall will increase energy use, and make inflation quite miserable.

It would not be surprising if both retail and wholesale inflation cross 6 per cent by September-October.

Biting the bullet less damaging

It is a tough situation for the Modi government; the first real challenge it has faced in the last 12 years.

Shoving fuel under-recoveries under the carpet will have adverse consequences on government finances, raising its fiscal deficit. More borrowings will, in turn, impact interest cost and manifest in other forms, generalising the inflation. This will also lead to massive shortages, supply disruptions and black-marketing.

Passing the fuel price increase to consumers and industries will help realign production, consumption, and the economic system, and protect it from greater damage.

Bite the bullet and save the bigger catastrophe.

Subhash Chandra Garg is former Finance & Economic Affairs Secretary, and author of ‘The Ten Trillion Dream Dented’, ‘Commentary on Budget 2026-2027’, and ‘We Also Make Policy’.

(Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.)