The algebra of subsidies

India’s power subsidy structures perpetuate distorted prices for dirty fuels and limit the resources available to target the households needing support

The algebra of subsidies
Without factoring in these additional variables, the algebra of subsidies will be limited to the constants of past policies rather than the profitable promises of the future.

By Arunabha Ghosh

The budget is an exercise in arithmetic and algebra. Planned expenditures must square with estimated revenues. Otherwise, expenditure must reduce or the fiscal deficit must increase, with the threat of high inflation rearing its head. But, these arithmetic identities are not as straightforward. There are variables that could be adjusted to find additional resources or to deflect spending towards alternative (more progressive and sustainable) purposes. At the heart of shifting from the constants of arithmetic to the variables of algebra lies the reform of subsidies.

India spends about Rs 2.89 lakh crore (~$39.5 billion) annually to subsidise energy production and consumption, according to a recent CEEW and IISD study. This covers electricity, gas, LPG, kerosene and fertiliser. Subsidies are needed either to promote goods and services that have greater social/environmental welfare or to underwrite access to basic levels of consumption for those who cannot afford them. If the latter are not assessed properly, subsidies end up being wasted, thereby distorting the very social welfare they were meant to fix.

Consider this: Poorly targeted electricity subsidies (at Rs 63,778 crore) constituted more than a fifth of all energy subsidies. Yet, India has one of the highest electricity tariffs on a purchasing power parity basis. India’s policies and programmes indicate that it is, rightly, going through two energy transitions, towards universal energy access and a shift toward cleaner energy. But its subsidy structures militate against both objectives, perpetuating distorted prices for dirty fuels and limiting the resources available to target the households needing support.

The algebra of subsidies can change if we adopted principles consistent with social justice, environmental sustainability and new economic opportunity. First, we need better information. Only 13 states and Union territories report power subsidy data; just seven give data by category. Improved subsidy distribution data would help identify the groups that benefit, and create the political space to revise electricity tariffs upwards for richer consumers. The Give-It-Up campaign for LPG subsidies followed this principle.

Second, the population needs to be better categorised based on wealth/income. The forthcoming census can go beyond the way the Socio-Economic Caste Census has been used so far to create merely inclusion/exclusion criteria. In order to overcome the limitations of self-reporting of incomes, wealth and social indicators would also be needed to categorise households properly.

Third, conditional cash transfers should ensure that the consumption of demerit goods (such as dirty solid fuels for cooking) does not displace cleaner cooking gas. But the subsidy amount must vary by wealth/income levels. Otherwise, poorer and deserving households might slip back into using solid fuels rather than refilling a cylinder, despite vast sums spent on giving them an LPG connection.

Fourth, unconditional and direct income transfers may be used to support a basic minimum level of consumption of electricity, commensurate with climatic conditions, type of housing and household wealth. Similarly, subsidies for agricultural use of electricity and fertiliser should be linked to farm size. In fact, a targeted direct benefit transfer scheme for power could be designed in collaboration with departments responsible for providing non-energy social welfare schemes as well.

Fifth, incentives that wean households or farmers or industries away from dirty fuels could have wider benefits. In agriculture, for instance, natural farming could save subsidies on fertiliser, and instead cover the costs (within a decade) of shifting farmers to more sustainable farming practices. Subsidies for renewables are needed to invest in grid balancing and energy storage so that the wider electrification of many other sectors (transport, cooking, small industries) becomes feasible.

Who would benefit if these principles were followed? For one, millions of poor households could have continued access to safe, affordable and cleaner cooking fuels or electricity. Lower crude prices give an opportunity to increase the number of free LPG refills to beneficiaries of the Pradhan Mantri Ujjwala Yojana. This would, in turn, increase household disposable income, thereby driving rural demand.

In urban areas, CEEW estimates that rapid rollout of piped natural gas by 2025 could result in LPG subsidy savings of overRs 1 lakh crore, even if the government fully subsidised the Rs 6,000 cost of a PNG connection at an outlay of Rs 25,000 crore. Likewise, a well-targeted direct income transfer could cover all or a portion of nominal electricity consumption. Such an electricity access safety net, during stressed economic conditions, would cost Rs 3,000 crore for three months, less than 5% of annual power subsidies across all states.

Moreover, substituting subsidy reforms (such as a direct benefit transfer to poor consumers) for poorly designed cross-subsidies could substantially improve industrial competitiveness. In 2017-18, electricity cross-subsidies from commercial and industrial consumers amounted to Rs 75,000 crore. Fixing the distortions could allow for industrial power tariffs to drop by 20-35% and 30-50% for commercial establishments.

Low power tariffs offered to distribution companies also ensure that older and inefficient coal power plants stay in business. Shutting down inefficient thermal power plants, many which happen to be older than 25 years, would increase the financial solvency of newer, more efficient generators. Targeted decommissioning would save the power system up to Rs 23,000 crore, benefits that could be shared with participating discoms or pay for the transition of the coal-dependent workforce.

Furthermore, savings in the power system could be redirected for the clean energy transition. India’s goal of 450 gigawatts of renewables capacity by 2030 would need $200 billion for generation capacity alone. There is very limited capacity in banks and NBFCs to meet such debt requirements, and project developers struggle with the high costs of tapping bond markets. Instead, a subsidised and timebound credit enhancement of Rs 4,543 crore, spread over five years, could mobilise bond market flows of Rs 76,000 crore and almost double India’s installed ground-mounted solar capacity.

The biggest beneficiaries could be discoms. Despite massive cross-subsidies, between FY 2016 and FY 2019, the revenue deficit on account of domestic and agriculture consumers grew 48%, from Rs 1,17,824 crore to Rs 1,74,391 crore. The widening revenue gap makes it impossible to make capital investments to upgrade distribution infrastructure or increase clean energy procurement.

The difference between good and bad subsidies lies in the balance between social welfare and political patronage. The pandemic-induced economic crisis gives one more chance to fix the distortions, increase energy security nets for those who need them, free up resources to invest in clean infrastructure, create more jobs and attract billions more in new investment. Without factoring in these additional variables, the algebra of subsidies will be limited to the constants of past policies rather than the profitable promises of the future.


CEO, Council on Energy, Environment and Water
Twitter: @GhoshArunabha @CEEWIndia

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