Moody's Investors Service expects India's new government to reduce its payment of fuel subsidies through a gradual process, which would lead in turn to higher product prices and therefore prove credit positive for the country's oil marketing companies (OMC) - Indian Oil Corporation (IOC, Baa3 stable), Bharat Petroleum Corporation (Baa3 stable) and Hindustan Petroleum Corporation.

''We expect the recently elected government to increase the retail selling prices of controlled fuel products, kerosene and liquefied petroleum gas (LPG), to help control its subsidy burden,'' says Vikas Halan, a Moody's vice president and senior credit officer.

''In our view, the government's most likely approach will involve staggered increases, similar to the ongoing Rs 0.5 a liter 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,'' says Halan.

''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,'' adds Halan.

The Moody's report says that it expects the loss, or under-recovery, at which diesel, kerosene and LPG are sold in India will total Rs 1.1 trillion (USD 18.3 billion) for the fiscal year ending March 2015 (FYE3/2015), 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.

On the other hand, a lower subsidy bill will have a limited positive impact on upstream companies' cash flows.

''While we expect the government to reduce the burden on the two state-owned upstream companies, we also expect the latter-in a scenario where under-recoveries decline - to bear a proportionately higher share of the subsidies, as the government significantly reduces its own burden,'' says Halan.

The two upstream companies are Oil and Natural Gas Corporation (LC: Baa1 stable, FC: Baa2 stable) and Oil India (Baa2 stable).