Diesel, a heavily subsidised fuel used mainly by farmers and in trucks and buses, has become increasingly popular as many middle class families look to cut their fuel bills, and diesel-powered vehicles are the industry's sole major growth area.

The hike of 5 rupees or 12 percent, announced by the government late on Thursday, comes after months of fierce lobbying by carmakers which argued a proposed tax on diesel-powered vehicles was unfair as it would leave other diesel consumers unscathed.

Even with the hike, petrol remains around 45 percent more expensive than diesel and shares in automakers rose in relief that the government had chosen not to slap a tax on diesel vehicles.

Maruti Suzuki India Ltd, the country's biggest carmaker, climbed 2.4 percent while Tata Motors Ltd rose 3.3 percent and Mahindra & Mahindra Ltd was up 1.1 percent.

The way the price difference between petrol and diesel had grown was not desirable. There was a need for an increase, Sugato Sen, senior director of the Society of Indian Automobile Manufacturers, told Reuters after the announcement.

It would have been better to have a smaller increase, but it is still definitely much better than a tax on diesel cars.

Diesel vehicles accounted for 40 percent of car sales last fiscal year, twice their share in the previous year. India's car sales look set to fall below industry estimates of 10 percent growth this year, as high interest rates and sluggish GDP growth dampen demand.

Over 80 percent of new orders for market leader Maruti Suzuki's Swift hatchback are for the diesel version, while passenger vehicle sales at Mahindra & Mahindra, which almost exclusively builds diesel-powered utility vehicles, are up an annual 30 percent in the first five months of the fiscal year that began in April.

Raising the price of state-subsidised diesel is seen easing New Delhi's subsidy burden and a widening fiscal deficit.

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