IS IT TIME FOR INDIA TO GET RID OF FUEL SUBSIDIES?

Lately, there has been a lot of talk going on about the price of petrol going up and the plight of ‘aam aadmi’ using fuel in everyday life. The recent price hike in petrol created a lot of restlessness among the general public. There were strikes and passive dissatisfaction with the government’s action. For middle-income people, such a rise is not a severe problem because they can afford it. Yet, ending subsidies has an alarming effect on the poorest in developing countries like India– affecting every facet of life. Society today is so dependent on fuel that even the poor cannot simply abstain from use. They need it for heating, cooking, generators, crop transport and motorbikes. Fuel is an absolute necessity for economic survival of the poorest. But there is another side to this story. The subsidy on fuel is a huge drain on the finances of the government of India. If we combine diesel, kerosene and LPG, Rs 1,90,000 crore is the amount of subsidy in our country. This has led to a huge fiscal deficit. So, to answer whether it is time for India to get rid of fuel subsidies, we need to understand certain things.

Starting with the basics, a subsidy is an assistance paid to a business or economic sector. Most subsidies are made by the government to producers or distributed as subventions in an industry to prevent the decline of that industry or an increase in the prices of its products or simply to encourage it to hire more labor. In India, subsidies are provided to consumers of sensitive petroleum products and electricity. The government has been subsidizing fuels to protect consumers from international price volatility and to make energy affordable in the economy. Three sensitive petroleum products-kerosene, LPG and diesel-are sold below international market prices, with the government providing a fiscal subsidy on LPG and kerosene. The subsidy, however, covers only a part of the difference between the cost and the regulated price. This results in under-recoveries for the oil marketing companies (OMCs). A large part of these under-recoveries is compensated through additional cash assistance from the government while another portion is covered by financial assistance from oil companies. The remaining portion remains uncompensated to the OMCs.

When the government gives a subsidy to the sellers, it has some microeconomic effects.

As we can see in the diagram, giving a subsidy increases supply and the supply curve shifts to the right to S2. This is because the sellers have a higher incentive to sell. As the supply curve shifts, the price of fuel reduces to P(B). This is the price paid by the buyers. But the sellers receive a higher price P(S). Hence the difference between the price received by the sellers and that paid by the buyers is the subsidy which is paid to the sellers by the government.

Now, considering this microeconomic effect, if there were no subsidies, the prices prevailing in the economy would have been P(E). This is lower than what the sellers receive with subsidies and higher than what the buyers pay and so, the quantity of fuel sold in the economy would be lower at Q1 instead of Q2. Hence, retracting subsidies is a disincentive for both the buyers and the sellers which would lead to a fall in consumption.

Despite that, there are many reasons why there is a sudden discussion about retracting subsidies.

First of all, Subsidy on fuel was mainly supposed to target the poor and those in the villages, who need to use diesel, kerosene, etc for their basic subsistence but cannot afford to pay a high price for it. But in recent times, we have seen that it is actually helping the rich and the well-off. With petrol costing on average 42% more than diesel, there has been a jump in the share of cars powered by the subsidized fuel, while in the countryside only wealthy farmers who can afford a tractor or water pump benefit. Data suggests that 23% of subsidized diesel went into SUVs and captive power generators. When the north of the country was hit by massive power blackouts on two consecutive days some days back, the lights stayed on in offices, five-star hotels and swanky residential areas across New Delhi as thousands of diesel generators purred into action. Rural development minister Jairam Ramesh said, “There are many lower and middle-income families which use LPG, but there are many rich, including myself, who get subsidy on LPG cylinders despite not needing it. There is a subsidy of Rs 503 on every LPG cylinder.”

Second, these fiscal payments are increasingly eating into the revenues earned by the government. Every year, the government experiences a fiscal deficit which is worsened by the huge amount of subsidies that it gives out. In the last fiscal, the government had overshot the fiscal deficit target by a whopping 5.7%, as subsidy burden grew and revenue fell short of expectations. This reduces the opportunity for investment by the government in other welfare projects that would directly help the poor.

Third, the need for a judicious use of fuel has been realised. When it is available at a low price, there is overexploitation of the limited and scarce resources. It has been noted that there is an unsustainable increase in demand of petroleum products. Also, subsidies on fuel like diesel, etc give no incentive to people to invest in the production of other renewable and environment-friendly resources.

But there are a few apprehensions about retracting fuel subsidies. Politically, it will lead to a lot of instability as it would create uproar among the public. Economically, Reserve Bank of India Governor D. Subbarao has said that the proposal to remove fuel subsidy can lead to a 2.6% hike in inflation, which has remained a major cause of worry for the central bank and has forced it to maintain an anti-inflationary stance despite sharp slowdown in economic growth. However, the central bank has consistently noted that the government urgently needs to cut its subsidy bill to maintain a manageable fiscal deficit. Further, the RBI has also maintained that India must sacrifice some growth in the short-term to contain stubbornly high inflation in order to achieve sustainable growth in the medium to long-run.

So, even though people argue that taking away fuel subsidies would heighten prices on fuel and consumption will go down, a vital economic argument against fuel subsidies is that they inflict a heavy burden on government budgets, add to global warming, pollution and wasteful consumption in general. This, in turn, diverts much-needed resources from more pressing needs, such as health and education.

To conclude, I would come back to the question of the hour: Is it time for India to get rid of fuel subsidies? I think that no economic action should be too sudden as it can have major adverse effects in the immediate short-run. But as I have argued throughout, the fuel subsidies definitely need to be retracted if we want a sustainable growth in future. Some sacrifices have to be made today in order to have a better future. But this should be done gradually over a period of time and with a proper explanation to the public, not overnight.

Stuti Oberoi

B.A.(Hons) Economics, II Year