In a cabinet meeting presided over by the Prime Minister Manmohan Singh, it was decided to partially decontrol pricing of diesel, giving the state-run oil marketing companies to "make small corrections in pricing from time-to-time".
In a related decision on India's petroleum sector, it was also decided to raise the annual allocation of subsidised cooking gas from six to nine cylinders per household.
The government had earlier limited the number of subsidised cylinders to six per annum.
The decisions on diesel and cooking gas take immediate effect, officials said.
"Oil marketing companies have been given the freedom to make small corrections from time-to-time," Finance Minister P.Chidambaram said, even as officials said the oil marketing companies could revise prices by an amount less than Rs.1 per litre at one go.
The move comes nearly three years after petrol prices were similarly freed in June 2010 and ahead of the Congress Party's introspection meeting (Chintan Shivir) and the annual session in Jaipur, Jan 17-19, 2012.
But other political parties notably the main opposition Bharatiya Janata Party (BJP), Trinamool Congress and the Left parties, did not take kindly to the move saying, that the diesel prices had a bearing on the overall inflation of most commodities.
Reacting on the government's decision BJP spokesman Prakash Javadekar termed it "atrocious" saying it would have a "cascading" effect on the prices of other commodities.
"First they raised rail fares and now diesel. This is atrocious," Javadekar said.
"Diesel goes into the prices of all essential commodities. Whether it is food grains, vegetables, fruits, diesel becomes a component when price escalation takes place," West Bengal Finance Minister Amit Mitra said.
Petroleum ministry officials said the move was necessitated by the fact that oil marketing companies had accumulated losses worth Rs.52,711 crore from April-September, 2012 (Rs.9.60 per litre in the present scenario by selling diesel at below cost).
The OMCs had incurred under recoveries of about Rs.81,192 crore for the 2011-12 and Rs.34,706 crore in 2010-11.
The last time diesel prices were hiked was in September 2012, when it was increased by Rs.5.63 a litre, the sharpest ever rise.
