After nearly nine months of vacillating, the government has finally increased retail prices of petroleum yesterday. While prices of petrol has gone up by Rs4 per litre and diesel is costlier by Rs2 per litre, prices of kerosene and LPG remains unchanged.

The last price hike was in September 2005, when crude oil prices were below $60 per barrel. Crude prices touched record highs of above $75 per barrel in April before retreating modestly in May. NYMEX near month futures closed at $72.40 per barrel yesterday. The Indian crude basket, a mix of Brent and Middle-East crude, is currently priced at around $66 per barrel.

The latest price hike would only partly offset the retailing losses being incurred by oil marketing companies, as the average under-recovery during the month of May was nearly Rs9 per litre in the case of petrol and almost Rs10 for diesel. At retail prices which prevailed till yesterday, total under-recoveries of oil marketing companies for the current financial year would have been over Rs73,000 crore at average NYMEX grade crude oil prices of $70 per barrel.

To bridge the gap, the government has brought down the import duty on refined products to 7.5 per cent from 10 per cent earlier. This would only reduce the tariff protection currently enjoyed by domestic refiners. As the country does not import any refined products, this measure would not have any direct impact on government revenues.

The proposal of Rangarajan Committee, set up to study oil pricing, to move to trade parity from import parity for fixing refinery-gate prices of refined products has been accepted. This would further reduce the tariff protection on domestic refining and erode the margins being enjoyed by refiners.

Even after the price hike and indirect tax adjustments, upstream oil companies like ONGC, Gail India and Oil India would have to fork out Rs24,000 crore during the current financial year as subsidy sharing. Standalone refiners like Reliance Industries would share up to Rs3,000 crore in subsidies.

The finance ministry has also agreed to issue oil bonds worth over Rs28,000 crore to oil marketing companies during the current financial year. These bonds would be issued in 4 instalments of Rs7,000 crore each.

Oil marketing companies would continue to incur losses, even after the price hike, reduction in indirect taxes and oil bonds, though the extent of losses would come down. Companies like Indian Oil, HPCL and BPCL would see a further decline in their refining margins, which would keep their overall financial position still precarious.

The fuel price hike would most certainly force the RBI to raise short-term interest rates by at least 25 basis points, or even 50 basis points, in July. Even before the price hike, inflation had been rising for the past three weeks and stood at 4.74 per cent in the third week of May. Inflation for the month of June would move beyond 5 or 5.5 per cent, the stated comfort zone of RBI, leaving very little elbowroom for the central bank.