By Megha Bahree
In India subsidies of any kind are the sacred cow, the untouchable, the hot button political issue which could swing votes. That attitude has ensured that in 2009 India had the largest subsidy bill amongst net oil importers, as per the Organization of Economic Cooperation and Development’s report card on the country’s economy. And for a country that is often compared to China, for once it has left that neighbor behind—India’s per capita oil subsidies were almost three times higher than China’s, and its gas subsidies six times higher.
India’s addiction to fossil fuels subsidies is well known. The OECD report doesn’t offer any surprises there. But, as the report highlights, it’s clearly a key concern for the country’s overall growth. “Energy subsidies encourage wasteful consumption, fuel adulteration and smuggling and create a system that is overwhelmed by corruption,” the report states. “Globally, by blurring market signals, they push up the level and volatility of energy prices, since when world prices rise India’s consumption does not fall commensurately. Last but not least, they are environmentally damaging.”
While releasing the report this morning, Montek Singh Ahluwalia, the deputy chairperson of the country’s Planning Commission, said, “I do believe reduction of energy subsidies is not a compulsion only for fiscal purposes…. We need to ask ourselves, what sort of a world is India moving into over the next five years? There’s going to be a humongous technological improvement in solar technology” and that could be one area that would help reduce the country’s dependence on fossil fuels.
The bulk of India’s energy subsidies aim to provide cheap fuel for lighting to poor households; replace fuels like firewood and dung with cleaner cooking fuels; insulate the domestic economy from the volatility of the international prices of petroleum products. But, up to 50% of subsidized kerosene ends being “diverted” from the public distribution system and sold elsewhere at higher prices.
With rising oil prices globally, the cost of maintaining these subsidies is going up as well. For instance, the central government in its budget for 2011 had set aside 200 billion rupees ($4.47 billion) to compensate oil companies for the losses they would incur by selling at less than market prices. But by May itself, the revenue shortfall for oil companies had risen to 2 trillion rupees or 2% of gross domestic product, the report says.
In addition to putting pressure on government finances, distorting relative prices and creating corruption opportunities, India’s current system of pricing sensitive petroleum products creates severe financial pressures on the public-sector oil marketing companies, which collectively account for around 98% of retail outlets in the country. Cash flows across this sector have generally been unsustainably weak and interest payments have risen. As a result, their share prices in the period between late 2008 and early 2011 fell 25% relative to the Indian market index, with shares in the largest company falling even more, the report says.
Another problem with subsidies is that they fail to be concentrated on their target audience—the poor. Nationally, the richest 30% of households consume 72% of all liquefied petroleum gas, or cooking gas, while the poorest 30% consume just 2%. And these come at a cost. Subsidies for electricity, LPG and kerosene accounted for 87% of total subsidies in India in 2009, or 1.9% of the GDP.
Subsidies have also discouraged private sector companies from investing in certain sectors like electricity markets, or caused them to withdraw. For instance, both Reliance Industries and Essar Oil mothballed their retail gas stations when the government reversed its decision to move away from controlled oil pricing.
The OECD’s answer to India’s way out of this black hole is a broad policy reform that should include a move to market based pricing, standardizing tax rates, a direct cash transfer to the poor so they can directly pay for their fuel needs.
Ambitious, and the jury is still out if the government will succeed in attempting any of this.