The additional duty is being planned to compensate the heavily subsidised diesel prices, which powers much of the economy, especially in rural areas and in transportation.
Demand for diesel-powered vehicles has surged, accounting for more than 40 per cent of new car sales in India in the year to March 2012 or double their share in the previous year.
Almost all of the large, expensive SUVs and jeeps bought by the newly wealthy are powered by diesel, as are many of the luxury saloons sold by Audi or BMW.
Growing diesel consumption is a major headache for a country grappling with ballooning budget and current account deficits and which imports more than 80 per cent of its fuel needs.
Shares in Mahindra and Mahindra traded 1.5 per cent lower at Rs 685. The company is completely dependent on diesel cars, which contribute 99 per cent to its sales. M&M’s profitability could get impacted if it partially absorbs the proposed hike.
Diesel cars comprise 48 per cent sales of Maruti Suzuki and the proposed hike could hit margins, which are already under pressure. The move will also increase the long waiting period on the company's popular diesel models. 70 per cent sales of Tata Motors' come from diesel cars and the proposed hike could create a slowdown in its utility vehicles segment.
Shares in Maruti Suzuki, India's biggest car maker, were down 2.8 per cent at Rs 1,114, while Tata Motors shares traded 1.1 per cent lower at Rs 240.20 on the BSE.
All these stocks underperformed the BSE auto index, which traded 0.94 per cent lower.
Last week, executives from Tata Motors, Maruti Suzuki, Mahindra & Mahindra and Ford had argued against increasing the excise duty on diesel vehicles at a meeting with finance ministry officials.
The Society of Indian Automobile Manufacturers (SIAM), an industry lobby group, estimates that diesel vehicles consume less than 7 per cent of the fuel's sales in India, but the government puts the figure closer to 15 per cent.
The government has increased the price of petrol while diesel has remained frozen since July 2011. At 40.91 rupees per litre in New Delhi, diesel is 43 per cent cheaper than petrol.
(With inputs from Reuters)