Government is likely to raise diesel prices after a presidential election on July 19, a highly-placed oil ministry source said on Thursday, as Asia's third largest economy battles to avoid a sovereign downgrade to "junk" by two ratings agencies.

Prime Minister Manmohan Singh has long vowed to curb a worrying fiscal deficit by raising the price of heavily subsidised and widely used fuels such as diesel, but has not followed through because of worries about a political backlash.

"This has been the thinking for quite some time," that a price rise could come after presidential polls, the source said, requesting anonymity. The last diesel price increase was in June 2011.

"It is inevitable. By how much I can't say," he added. Widespread street protests followed an increase ingasoline prices earlier this year and the government was forced to partially roll back the measure.

A veteran economist, Singh is temporarily serving as finance minister.

He has a short window between the vote for the largely ceremonial presidential post, taken by an electoral college of parliament and state legislatures, and the start of the monsoon session of parliament. Opposition parties can be expected at that session to oppose vocally any increase in fuel costs.

Shares in India's oil exploration and refining companies gained on Thursday after newspaper reports that a price increase was on the cards.

The Business Standard newspaper said Singh had explained to the Congress Party leadership that without a price hike India was likely to be downgraded by Standard and Poor's. The paper said he recommended a hike of at least 5 rupees per litre.

Both Fitch and S&P have cut their credit outlook for India to negative from stable, citing a slowing economy, policy inaction and worsening fiscal, and current account deficits.

Both agencies currently rate India as the lowest investment grade and a downgrade to junk would force major pensions funds to pull out of India for at least a year.

Diesel is widely used by farmers, trains and trucking companies. At 40.91 rupees (73 U.S. cents) per litre it is about 40 percent cheaper than gasoline. Any attempt to raise the price will be unpopular even within Singh's Congress party, especially in farming states such as Punjab. The move could also put upward pressure on food prices at a time of public anger at stubbornly high inflation. 

"As far as diesel is concerned, an increase in its price will affect farmers. This is not an item for transportation alone but it is a crucial component of growth in the agrarian economies of Punjab and Haryana," Birender Singh, a general secretary of the Congress Party told reporters on Thursday. 

The oil ministry source added that gasoline prices -- ostensibly already freed from government controls - were currently not causing any losses for India. 

"It is under control, there is volatility both on the rupee front and oil prices (global) at the moment we are not incurring any loss," the source said. (REUTERS)