The value of fossil-fuel subsidies worldwide totalled $548 billion in 2013, $47 billion of which were provided in India (amounting to about 2.5% of India’s GDP). The Government of India (GoI) has provided fuel subsidies to meet a variety of economic and social objectives, including increasing rural energy access, supporting the purchasing power of the poor, stimulating economic activity and managing energy price volatility. However, fuel subsidies – mostly universal in nature – are poorly targeted, and therefore largely wasteful as social spending, with benefits mostly flowing to large users of energy, who tend to be wealthy households and businesses. For every six rupees the GoI spends on kerosene subsidies (the least regressive of India’s fuel subsidies) only one rupee reaches the poorest 20% of consumers. The Global Subsidies Initiative’ recent research on the spatial distribution of subsidies in India demonstrates that the benefits of fuel subsidies are overwhelming enjoyed in richer and more urban states. The ineffectiveness of fuel spending is magnified by the sheer size of these fiscal outlays, which puts pressure on public finances and crowds out more effective development spending. In the last financial year, for example, the Indian government spent US$7.8bn subsidizing Liquefied Petroleum Gas (LPG) - $1.4bn more than the equivalent central budget allocation for primary education, and $2.5bn more than the allocation to the flagship National Rural Employment Generation Scheme (NREGS) public employment programme.
Recognizing the clear limitations of the status quo, building on the progress made by the previous Congress-led government in gradually reforming fuel prices and reacting to the opportunity presented by low international oil prices, in late-2014 the newly elected Modi Government announced a series of sweeping policy reforms to energy pricing, significantly (if not entirely) decontrolling diesel pricing, revising natural gas prices based on a market-linked formula, changing domestic LPG subsidy entitlements and delivery mechanisms, increasing coal cess (wholesale tax) from Rs 100 per tonne to Rs 200 per tonne, increasing taxes and duties on petroleum products, and auctioning de-allocated coal production blocks through competitive bidding processes. This package of measures, presented as a reflection of the newly elected government’s reformist intent, in fact represents a complex mix of continuity and change in relation to the previous government’s energy pricing policies with important implications for Indian energy policy, consumption and use. The diesel and LPG components of the reform package are discussed below.
Diesel price decontrol
The decision to fully decontrol diesel pricing, allowing public sector Oil Marketing Companies (OMC) to price diesel on a cost-recovery basis, is an important symbolic development and the culmination of the process of moving away from a commitment to universal, expensive and highly regressive subsidization of transport fuels which began with the liberalization of petrol prices in 2010. Much of the credit for the progress made between 2010 and 2014 should be given to the previous Congress-led government, which instated and implemented gradual diesel price appreciation between early-2013 and mid-2014, however the Modi Administration should be commended for seizing the opportunity for complete decontrol provided by low international oil prices.
In the intervening months since the decision to decontrol diesel prices was made, in October 2014, the GoI has shown itself to be willing to periodically intervene in diesel price-setting at the margins by OMCs. The willingness of the GoI to keep a ‘hand on the tiller’ of diesel pricing is a slightly worrying development as it demonstrates a continued readiness to actively intercede in price-setting in response to changing market conditions. The concern, therefore, is that if and/or when international oil prices rise, the GoI will be inclined to curb price rises and revert back to fuel subsidization. Recognizing that international crude price are likely to increase over time, the GoI should be in the process of developing concrete plans to manage these prices rises without resorting to the reintroduction of subsidies (through variable taxation mechanisms, social protection measures for vulnerable groups and public communications about the ills of reintroducing subsidies that refer to the wastefulness and ineffectiveness of fuel subsidies as social policy).
Re-adoption of DBTL
In relation to LPG subsidies, two policy announcements were made: the proposed reintroduction of the Direct Benefit Transfer for LPG (DBTL), and a statement of the government’s intention to fix the per unit subsidy for LPG. Reforms to LPG policy are the most problematic of the recent policy changes as there is no case for the introduction of DBTL on the grounds of equity, administrative efficiency or fiscal responsibility. DBTL does not decouple receipt of subsidy from fuel consumption (subsidy receipt is contingent on purchase of LPG), nor does it apply any form of targeting in selecting beneficiaries (retaining the highly regressive distribution of the existing subsidy). DBTL reduces the net value of the subsidy to the consumer, increases the administrative cost of delivering the subsidy, exacerbates the regressive distribution of subsidy expenditure, and will not significantly decrease total fiscal outlay (potentially even increasing it).
The announcement of the government’s intention to fix the total unit subsidy for LPG, although not as directly antithetical to genuine subsidy reform as the reintroduction of DBTL, has the potential to reduces the value of the subsidy to all users, including poor consumers deserving support for LPG consumption. A far better idea for LPG subsidy dispersal reform than either fixed caps or DBTL would be to simply reduce the annual per-household allocation of subsidized LPG cylinders, which, despite the advice of both ministries of finance and petroleum, has been kept at twelve cylinders per year. Since it is general only wealthy households that consume more than 8-10 cylinders per year, an effective and administratively simple way of enhancing the targeting and reducing the cost of LPG subsidies would to be decrease the cylinder allocation to 6-8 per annum.
Future prospects
The late-2014 decontrol of diesel prices is a step forward in Indian energy pricing policy that is to be commended. There are many policy initiatives, however, that can and should be added to the Modi Administration’s subsidy reform program that will allow the Indian government to achieve the ‘golden triangle’ of subsidy reform – to contain total subsidy expenditure, to ensure a more progressive distribution of subsidy benefits and to enhance clean energy access and use in India, particularly among the poor.
- In diesel markets it is important that the government moves to complete deregulation, meaning the implementation of robust independent pricing mechanisms, and the introduction of structural reforms that enhance the role of liquid fuel market regulators and that deepen competition in downstream fuel markets. The government should also devise plans now in anticipation of higher international oil prices that set out mechanisms that tackle the socio-economic effects of higher prices without a reintroduction of universal subsidies, including through non-subsidy social protection programs for vulnerable groups.
- In LPG markets, the government should look to immediately reduce the annual household cap on annual subsidized cylinders, which in a stroke will enhance the progressiveness of the subsidy regime and reduce the wastefulness of spending. At the same time, it should introduce targeting mechanisms that link DBTL to economic status while investigating business model options and investing in pilots and supply chains for non-LPG provision of clean cooking access in rural areas, for example through biogas etc.
- In kerosene markets, the government should increasingly look to replace the affordable provision of kerosene to the rural poor with the affordable provision of increasingly mature and cost-effective clean off-grid lighting technologies – in the absence of rural electrification – such as solar LED lanterns, again, initially, by investigating business model options and investing in pilots and supply chains for non-kerosene provision of clean lighting.
- In electricity markets, the government should assist states in reforming electricity tariff structures, various cross subsidies and agriculture-electricity subsidies without impacting poorer households, agricultural production and livelihoods, especially in relation to recent successful electricity sector reforms in states such as Punjab.