The Politics of Diesel in India are Complicated

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Written by Ammar Master, manager, LMC Automotive and contributor to India Automotive Monthly—Market Trends for J.D. Power Asia Pacific

It is never easy to run a government in a socially and economically sensitive society, especially when that government is dependent upon a number of allied partners with diverse and often different viewpoints on almost every issue.

This is the precarious position of India’s government, which is led by Manmohan Singh, United Progressive Alliance (UPA), after his administration decided to implement a number of long overdue reforms including a 14% hike in diesel fuel prices in mid-September.

A multi-party coalition has broken apart after a major partner, the Mamata Banerjee-led Trinamool Congress, decided to withdraw its support for the current government. Ms. Banerjee is the same leader who protested against the construction of Tata Motors’ Nano car plant in her home state of West Bengal, which forced the automaker to abandon its production plans in the state.

Admittedly, Ms. Banerjee is not alone in this latest disagreement. Several other opposition parties have also criticized the government for its decision to not only increase the price of diesel, but also to allow foreign direct investment in the retail sector. On the streets, opposition parties and trade unions have protested across India against the government. Schools were shut, while road and rail transport were disrupted in several areas.

Diesel Price Increase Creates Party Dissension

The lack of support from the Trinamool Congress means that the UPA administration will have to appease other minor political parties, many of which are not pleased with several economic reforms that are being tabled by the current administration.

Therefore, it is possible that, although the government acted in a rare moment of strength, the diesel price hike may be forced to at least partially be rolled back. However, the UPA might be able to save face in reversing its decision by citing an easing of crude prices.

The government’s current decision reduces the price gap between petrol and diesel to 48%, compared with the previous gap of 66%. In Delhi, the price of diesel at the pump now stands at INR 46 per liter (equivalent to about US $3.24 per gallon) vs. a petrol price of INR 68 per liter (equivalent to about US $4.78 per gallon).

Diesel Price Increase Probably Will Not Curb Auto Sales

Yet, the hike in diesel prices is not expected to have a major impact on the new-vehicle industry. We do not believe that sales this year will be hurt by the decision to increase diesel prices. We also do not think that buyers will switch over in any big way to lower-priced petrol-powered models.

There is still a significant price gap between the two fuels. At the same time, diesel vehicles offer lower running costs compared to petrol vehicles over the vehicle’s lifetime.

Furthermore, automakers with a strong lineup of diesel models—such as Maruti Suzuki and Mahindra—are likely to increase incentives for their models.

The industry also welcomes the increase in diesel prices as it reduces price distortion between the two fuels. At the same time, the government’s decision also puts to rest the possibility of an additional tax on diesel-powered vehicles (at least in the immediate future).

Automakers Continue to Offer Both Petrol and Diesel Engine Options

Most industry players know that a complete deregulation of diesel will not happen soon. For that reason, the industry offers new models with both petrol and diesel engine options.

Where it makes economic sense, older models that did not traditionally have diesel versions are being developed with an option for a diesel engine. An automaker that does not have petrol models, such as Honda, is also considering diesel engines for its upgraded vehicles.

Given the continued demand for diesel models, we also think that vehicle makers are likely to increase investments in diesel engine manufacturing units in India. This is because the localization of engine manufacturing will help cut costs and allow more competitive pricing of their models.

In conclusion, it appears that the government made the right decision to raise diesel prices. It makes economic sense. India cannot continue with its fuel subsidies over the long term in an environment of high crude prices and with the burden it places on the country’s fiscal budget. The magic evidently lies in the timing and the amount of the price hike.