India's government decided to deregulate petrol prices Friday in a bold economic reform that risks a popular backlash as the country struggles with double-digit inflation.

The step, which will mean an increase in fuel prices, is part of efforts by the left-leaning Congress-led government to reduce a gaping budget deficit by reducing the massive subsidies it pays to state-run fuel companies.

"The price of petrol will be market determined," Oil Secretary S. Sundareshan announced, adding that petrol prices would rise by 3.5 rupees (seven cents) a litre and diesel prices by two rupees at midnight Friday.

Diesel prices will also be deregulated but no time frame has been set, he said, adding that the government would keep its right to intervene if global crude prices soared.

The prices of cooking gas and kerosene -- known as the "poor man's fuel" -- will remain state-subsidised but also rise, a panel led by Finance Minister Pranab Mukherjee decreed.

Kerosene will rise by three rupees a litre and cooking gas by 35 rupees a cylinder.

The step drew praise from industry, which noted that state-run oil companies had been obliged to sell fuel at hefty discounts to market rates, but was condemned by opposition politicians.

"Oil companies that have been bearing this subsidy can now free up cash for investment," said the Confederation of Indian Industry.

"Most importantly, the move has shown the government has the ability to implement policy changes even if they are politically difficult," the group said.

Economists said the announcement marked the first "big bang" reform by the Congress-led government, which was re-elected last year with a strong mandate that fuelled hopes it would push ahead with economic liberalisation.

Oil and gas stocks spurted higher after the announcement -- state-run Oil and Natural Gas Corp jumped 6.35 percent to 1,264 rupees.

The announcement shows "the government is in a serious mood as far as expenditure reforms," Shubhada Rao, chief economist at Yes Bank, told AFP.

At the same time, both industry and economists warned the move would fan inflation, which is running at 10.16 percent, with food price inflation even higher.

Communist leaders threatened public protests.

"This move shows how utterly insensitive and callous the government is to the terrible impact of price rises on the people of this country," senior communist leader Brinda Karat told reporters.

Petroleum Minister Murli Deora insisted that Congress had the backing of its allies for the move. But one regional ally, Trinamool Congress chief Mamata Banerjee, voiced strong opposition.

"It is not fair to burden the common man," she said.

The government's chief economic adviser, Kaushik Basu, conceded the fuel price hikes would push up inflation by nearly a percentage point but added that they would reduce the deficit.

The government is aiming to lower its fiscal deficit to 5.5 percent of gross domestic product in the current financial year to March from a record 6.6 percent last year.

Rao forecast that the central bank would move before its July 27 policy meeting to hike interest rates to contain inflation, which she described as "accelerating rather uncomfortably."

© ANP/AFP