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

The rate of inflation for the week ended May 15 is expected to be 8.02%, the highest level since September 2004, according to Bloomberg News.

“The current high level of inflation is totally unacceptable, especially in terms of impact on inflationary expectations,” Reserve Bank of India (RBI) Governor Yaga Venugopal Reddy told reporters last week.

Authorities have tried their best to rein inflation in without compromising economic growth. The central bank has left its key interest unchanged but has tightened cash conditions by raising its cash reserve ratio – the amount of cash banks must keep on hand – by 25 basis points to 8.25% as recently as April 29.

The government has stepped in over the past two months to reduce import duties, ban futures trading, halt the export of cement, rice, wheat, and edible oil, and implored steelmakers and cement companies to cut prices.

However, such measures have proved largely ineffective as commodity prices continue to soar. Oil, which climbed to a new record over $135 a barrel last week, is particularly problematic, as state oil firms currently sell fuel at hugely discounted rates.

Selling fuel at such steep discounts cost state-run refiners about $43 billion for the year ended March 31, Serangulam V. Narasimhan, finance director at Indian Oil Corp. Ltd., said May 9. The companies lost roughly $18 billion the year before.

The government in February raised gasoline and diesel prices for the first time in nearly two years in an effort to reduce refiners’ losses, but the increase has achieved little. Another “price hike is inevitable,” although the “specific quantity of the price increase” was still being worked out, Petroleum Secretary M.S. Srinivasan told the AFP.

“We expect a decision in three-to-four days time,” Srinivasan said.

The Press Trust of India reported, without naming sources, that the petroleum ministry was seeking a 10-rupee-a-liter increase in petrol prices and a five-rupee-a-liter hike in diesel prices.

Based on current pump prices in New Delhi, this would represent a 22% increase for petrol and 16% on diesel, according to AFP.

India isn’t the only developing nation fending off inflation. Consumer prices in China jumped 10.3% in April from a year earlier. Inflation has soared throughout Eastern Europe, rising 17.5% in Latvia, 11.4% in Estonia and a staggering 30.2% in the Ukraine, according to Bloomberg News data.

“Inflation, now in double digits in many countries, is the region’s most pressing current problem,” the European Bank for Reconstruction and Development said in a recent economic outlook report. “If left unaddressed, inflation could risk price-wage spirals, exchange rate re-alignments, or could force a belated and sharp response by monetary policy.”

Source: India and Other Emerging Economies Continue to Struggle With Inflation