Impact of India's Diesel Subsidy Reforms and Pricing Policy on Growth and Inflation

Diesel has the strongest linkages with the economy amongst all petroleum products consumed and a major contributor to inflation and fiscal deficit in India. Therefore, the diesel subsidy reforms implemented since 2012 and the diesel pricing policy implemented since 2014 by the government of India would have significant economic implications. It was expected that the diesel subsidy reforms would reduce fiscal deficit and provide for a market-based pricing which would enhance the efficiency of diesel use in the economy and therefore reducing inflation and increasing growth. However, the diesel pricing policy followed by GOI deviated from being 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 provides us with an opportunity to assess if diesel subsidy reforms has been beneficial to India’s economy and if the pricing policy adopted was the most optimal for the economy? This will have important policy lessons on reforming petroleum pricing for other developing countries who are also large importers of petroleum products. A VAR based macroeconomic model is estimated using 78 quarterly data from 1997-98 Q1 to 2016-17 Q2 covering the period of diesel subsidy reforms and pricing policy on India’s economy. The impact and contribution of the reforms and pricing policy to growth and inflation in the post reforms period is assessed and the role of other macroeconomic factors in limiting the economy from benefitting from the reforms is shown. Results show that diesel subsidy reforms improved growth and helped cushion India’s economy against the negative impact of slow exports growth. The analysis also shows that a market linked diesel pricing policy would have provided more growth than the pricing policy pursued