Impact of India's diesel subsidy reforms and pricing policy on growth and inflation

Abstract

India's consumption of petroleum products depends 85% on imported crude. Diesel constituted 40–45% of consumption. The government till 2014 controlled the retail price of diesel and the burden of subsidies was borne by the public sector oil companies and the government. While low retail diesel price lowered the cost of distribution of goods, it increased the government fiscal deficit. Therefore, the diesel subsidy reforms initiated in 2012 and the diesel pricing policy followed since 2014 by the government of India was expected to reduce the fiscal deficit and provide for market-based pricing which would enhance the efficiency of diesel use in the economy and therefore reduce inflation and increase growth. However, the diesel pricing policy followed by GOI deviated from market-based pricing. It improved the fiscal position of the government and the resources of the OMCs but economic growth during the post reforms period did not improve as was expected. India's experience of the post-reform years is assessed with a VAR based macroeconomic model, estimated using 78 quarterly data from 1997-98 Q1 to 2016–17 Q2 covering the period of diesel subsidy reforms and pricing policy. The results show that diesel subsidy reforms improved growth and helped cushion India's economy against the negative impact of slow export growth and low rainfall. The analysis also shows that a market-linked diesel pricing policy would have provided more growth than the pricing policy pursued. This has lessons for other developing countries.