Subsidised fuel weighs on India's budget

By Karishma Vaswani India business correspondent, BBC News, Mumbai

Thakoo Bai Arwar relies on cheap fuel

Thakoo Bai Arwar is one of millions of poor Indians who waits for this time of the month, every single month.

It is when she can head to the government ration shop and buy her monthly supply of subsidised kerosene. She and her family depend on the low price of kerosene - a fuel that many low income Indians use for cooking.

Their lives depend on support from the state.

"I have a fixed budget for my monthly expenditures," she says as she stands in line waiting for her turn to buy the precious fuel.

"I can't afford to spend more than this amount for kerosene. We use it for everything, so if the price goes up we would really suffer.

"The government needs to look after poor people like us."

Rising oil prices

At the ration shop, that sentiment is echoed by many others waiting for their turn to buy kerosene. There is a sense here out on the streets that these subsidies are here to stay for good.

It is very, very challenging and we are being really badly affected Sarthak Behuria, chairman of Indian Oil

This is India's problem. People out on the streets depend on the lower price of essential fuels like kerosene and petrol to survive. But India buys 70% of its oil from international markets - and pays global prices for it.

Selling fuel to its citizens at an artificially low cost is taking its toll on the country's economy. India sells gasoline, diesel and other consumer fuels at below cost - and is now starting to feel the heat as oil prices head towards $100 a barrel.

Global markets

While global oil prices hit record highs, prices at India's petrol pumps stay low.

Poor Indians use kerosene as a fuel for cooking

By comparison, the other big energy guzzling emerging market in the world, China, raised its oil prices by 10% in October. China, like India, makes its state oil firms shoulder the cost of selling oil at a subsidised rate.

India's state-run oil firms are worst affected.

Indian Oil, the country's largest state run oil firm, is not allowed to pass on higher oil charges to customers because of government subsidies.

The company estimates it is losing some $50m a day because of this.

"We are being doubly hit," the chairman of Indian Oil, Sarthak Behuria, says.

"We are unable to sell oil at the international prices to our customers. We have to buy this oil from overseas markets because we import seventy percent of our oil. It is very, very challenging and we are being really badly affected."

Electoral concerns

The government compensates state run Indian oil firms for their losses from selling below the international market rate for fuel by issuing oil bonds to them. The bonds only partially offsets those losses.

Eventually the burden of subsidising fuel for its citizen will catch up with the government, and when it does it will be a very expensive burden for the state to bear Lakshmi Narayan, an independent analyst

Despite the difficulties of India's oil companies, the decision from political leaders in Delhi is that we will see no fuel hike in petrol or kerosene anytime soon.

India's government has been terribly worried about the impact of rising prices on its population.

Although the economy here has seen strong growth, it's estimated that almost 300 million people live below the poverty line.

Millions more survive on less than $2 a day, and that is the group of people that the government is worried about most.

They make up the bulk of the country's population, and the bulk of voters here.

India is also facing crucial elections this December, so raising fuel prices would be politically unpopular.

"Basically, you're seeing sensible economics play second fiddle to political realities," says Indranil Pan, economist at Kotak Mahindra Bank.

"Inflation... has been a major concern for this government and although the central bank has been doing a good job by trying to control the general rate of inflation, which does seem stable for now, food inflation is still quite high.

"The government is under pressure to keep food prices low, so it will be a political decision whether to raise fuel prices or not.

"I don't see it happening till the middle of next year, after all the elections are out of the way, even if international oil prices keep soaring."

Economic gamble

But how long can the Indian economy afford to wait?

Subsidising fuel costs the Indian economy dear

Oil firms are losing billions of dollars from subsidising poorer Indians with their fuel.

The government's coffers are also being affected because it has to issue oil bonds to these firms, draining their financial resources.

There is an argument, however, that with the US dollar depreciating against the Indian rupee, that India can still withstand the burden of sky high oil prices for now.

"The Indian rupee has strengthened by some 15% against the US dollar this year," says Lakshmi Narayan, an independent analyst.

"That has made it much easier for the Indian government to buy oil from the overseas markets. But yes, this can't continue forever.

"Eventually the burden of subsidising fuel for its citizen will catch up with the government, and when it does it will be a very expensive burden for the state to bear."

But the political imperative is proving to be more of a priority than running the economy in a sensible and efficient manner.

Staying in power means ensuring low prices for the masses who make up the majority of India's voters - even if that means risking the health of India's economic future.

India Business Report is broadcast repeatedly every Sunday on BBC World.