Moody's expects the new government to increase the retail selling prices of controlled fuel products – kerosene and liquefied petroleum gas (LPG) -- to help control its subsidy burden.
The the government, in it view, is most likely to go for staggered increases, similar to the ongoing 50 paisa per litre hike in diesel prices every month.
This is because, while a one-time price increase will have a more immediate impact on reducing the burden, it would also be more challenging to push through, given the need to control inflation.
Moody's Investors Service said it expects the new government to reduce fuel subsidies through a gradual process, which would lead in turn to higher product prices and therefore prove credit positive for oil marketing companies (OMC).
"We also expect the government to be in a position to completely deregulate diesel prices over the next 12 months, as retail prices move closer to international market rates," said Vikas Halan, Moody's Vice President and Senior Credit Officer.
Moody's expected the loss, or under-recovery, at which diesel, kerosene and LPG are sold to total Rs 1,10,000 crore for the fiscal year ending March 2015, if the price of crude oil remains elevated for the rest of the year and the government does not increase the retail selling prices of LPG or kerosene.
Currently, the government keeps the prices of these three products at below international market prices and compensates retailers for the losses some three to six months later.
"Accordingly, a reduction in under-recoveries, as a consequence of increase in retail selling prices, will be credit positive for the three state-owned oil marketing companies because it will reduce the debt required to fund these losses until the government reimburses them," it said.
A lower subsidy bill will have a limited positive impact on upstream companies' cash flows.
While Moody's expects the government to reduce the burden on the two state-owned upstream companies ONGC and OIL, Moody's also expects them – in a scenario where under-recoveries decline -- to bear a proportionately higher share of the subsidies, as the government significantly reduces its own burden.