Soaring oil prices have forced Indian authorities to raise subsidized fuel prices and risk propelling inflation that is already running at a three-year high.

The Indian government subsidizes most fuel costs, meaning state oil firms are forced to sell fuel at hugely discounted rates to shield consumers from inflation. But with the price of oil soaring to a recent high of $135 a barrel, refineries have been unable to cover costs and pressed to the point of bankruptcy.

The inability to pass high prices onto consumers cost state-run refiners about $43 billion for the year ended March 31, Serangulam V. Narasimhan, finance director at Indian Oil Corp. Ltd., said last month. The companies lost roughly $18 billion the year prior.

The Indian government had tried to cope with the matter by scrapping a 5% import tax on crude oil and cutting the import tax on gasoline and diesel to 2.5% from 7.5%, but the measures proved ineffective. So, yesterday (Wednesday), the government attempted to ease the burden on the refiners by boosting its subsidized fuel prices for the first time since February.

The price of gasoline will rise 11% in the Indian capital of New Delhi to $1.17 (50.6 rupees) per liter. Indian drivers will pay 9% more for diesel, and families will be charged an additional 17% per cylinder of cooking gas, India’s Oil Minister Murli Deora told reporters.

Still, as Deora also pointed out, even with the price hike, India’s state-owned oil companies are projected to lose a total of $58.4 billion this fiscal year, which runs from April through March 2009.

“The prices should have been raised higher for a real impact,” Ballabh Modani an analyst with Mumbai-based Enam Securities Pvt. told Bloomberg News. “There’s no point in an ad hoc increase.”

While the companies still stand to lose a significant amount of money, the Indian government must tread carefully when raising prices, as wholesale prices are already at a three-and-a-half-year peak of 8.1%.

The hike in fuel prices was India’s biggest in 12 years, and is expected to add another between 0.5% and 0.6% to wholesale prices. If the government had pushed prices any higher, it would have been risking social unrest among the nation’s poor who are already coping with high food prices.

“Already milk, vegetables, wheat – the price of everything has gone up so much,” Balaram, an office driver earning a little over $100 a month, told Reuters. “And now gas and petrol. With my salary, after paying my rent and my expenses, what will I send home? How will I feed my family and what will I save?”

Together, food and fuel account for about 75% of household spending for poor families in Asia. And India, despite its growing reputation for economic success, currently has the largest number of people living in abject poverty: more than 350 million, or about a third of the population.

Source: India Fuels Inflation by Bailing Out Refineries