A ministerial panel had been due to come to a decision on Monday but two powerful ministers from coalition parties stayed away, signaling their reluctance to be associated with a move that could stoke inflation and spark a voter backlash.
On Tuesday one of those parties, the regional Trinamool Congress which provides the government with vital parliamentary support, said a rise in fuel prices at a time when the government was struggling to rein in inflation would only hurt the poor.
But Finance Minister Pranab Mukherjee said the Cabinet will decide on Thursday on a date for a new ministerial meeting and that a decision on fuel subsidies would be taken shortly — putting his Congress party which heads the coalition on a potential collision path with some of its smaller allies.
"Fuel prices affect the people directly and the government must work out some other solution," Saugata Roy, a senior leader of Trinamool and federal minister, told Reuters.
The party's powerful leader, Railway Minister Mamata Banerjee faces elections in her stronghold state of West Bengal next year and is wary of alienating voters. She skipped Monday's meeting.
Given the political sensitivity of raising fuel prices for hundreds of millions of India's poor who form the bedrock of the government's support, reform is likely to be gradual.
Price controls on gasoline, seen as rich man's fuel, are likely to be relaxed the most, with smaller hikes in diesel and cooking gas prices.
The government is also hoping for a good monsoon and lower international crude prices, so that inflation currently hovering around 10 percent would ease and help soften the blow.
Monday's deferral of a decision on raising fuel prices was the second time in a year the government had faltered on biting the bullet on politically sensitive reform measures needed to cut the fiscal deficit from the projected 5.5 percent of 2010/11 GDP.
"While this will likely come as an immediate disappointment to the street, we would prefer some sustainable policy action with further discussion rather than just an ad-hoc price hike at this time," Goldman Sachs said in a research note.
"We continue to believe that the process of fuel pricing reforms is moving forward and recent government actions indicate there is an appetite for some tough decisions on energy pricing."
The delay underscores the difficulties for the government in pushing through financial reforms that entail tough adjustments, such as streamlining food and welfare schemes and opening up the retail, pension and insurances sectors to foreign investors.
But while allies such as Trinamool may make it harder for subsidy reforms to be passed, there is little threat to the stability of the federal coalition — these parties hold powerful ministries they will not want to give up.
The most likely outcome is more gradual reform.
"The government might not rush on this issue now," said N. Bhaskara Rao of the Centre for Media Studies think tank. "They will ... examine the implications on railway economics, effect on the public distribution system and will ensure that the cost of inflation is kept at a minimum before making any further move."
Even a minor rise in fuel prices would disrupt carefully planned household budgets in India, where 40 percent of the 1.2 billion population lives under $1.25 a day.
"If cooking gas prices go up any further, we will have to use firewood instead. Many poor people like us will start cutting down trees," said Ranjana Kumar Singh, 35, a housewife in Patna.
"I'm sure the price of food will also go up significantly, which would be a disaster for poor people like us."
Such sentiments could lead to voters like her to punish Congress and its allies in state polls scheduled this year and next. But key ministers appear determined to push ahead.
Oil Minister Murli Deora said on Tuesday that lifting fuel price controls would not hurt ordinary people, and would help state-run oil firms to cut their losses.
In a sign that private oil retailers, who will benefit from market-linked pricing policies, were eagerly awaiting a decision, Essar Oil said on Tuesday it will speed up planned expansion of its retail network if the government decides to deregulate fuel prices.
Any move to remove price controls will also help Reliance Industries, which operates the world's biggest refining complex but exports most products as the local market is dominated by state firms that sell cheap subsidized.