Studies chart path to reduce India's fossil-fuel subsidies with minimal economic impact

New Delhi - Three new studies have unveiled a method to reduce India's fossil-fuel subsidies while managing the economic and social impacts of higher fuel prices.

The Government of India has committed to reducing subsidies (including for fertilizer and food) to 2 percent of GDP. High levels of subsidies to fossil-fuels(INR 43,904 crore in 2010-2011) are placing a heavy burden on public finances, compromising investment in much-needed social and physical infrastructure.

Yetreform has been hampered by legitimate concerns over how higher fuel prices will affect the broader economy, potentially disrupting key sectors like transport, industry and agriculture, and the ability of poor citizens to cope with higher prices.

The International Institute for Sustainable Development's Global Subsidies Initiative (GSI), in collaboration with the National Institute for Public Finance and Policy (NIPFP) and The Energy and Resources Institute (TERI), have released studies that evaluate the impacts of phasing out diesel, LPG and PDS kerosene subsidies.

The research also examines cash-transfer schemes as a means to protect poor citizens as fuel prices rise.

According to the research, diesel prices include a relatively minor fiscal subsidy; however, under-recoveries see a combination of the government, national upstream oil companies and oil marketing companies covering 25 per cent of the price.

Eliminating this 25 per cent under-recovery in diesel prices would lead to around a 1 percent rise in general price levels.

Nonetheless, given India's low average salaries and large number of jobs in the informal sector, even small spikes in inflation can put poor consumers at risk. Certain sectors of the economy are also vulnerable to higher fuel prices, the research said.

According to the research, most commonly used large public road transport would be one of the most affected sectors, seeing an eight per cent increase in costs, and goods/freight transport costs
would rise by ten per cent.

Rail transport costs would rise by 2.5 to 3.5 percent, and industry an average of 0.25 percent. In the agriculture sector, the costs of cultivating wheat would rise by 2.75 percent and sugarcane 0.75 percent, the research said.

Vulnerable consumers will be better able to adjust if the under-recoveries are gradually eliminated perhaps allowing prices to increase by an average of INR 1 per litre over one or two steps per month, over a year or more, the research added.

The research pointed out that the government may wish to retain flexibility to increase prices more when inflation is seasonally low and ensure that key consumer goods and staples are available at these times.

According to the research, the government should consider direct compensation to businesses that will struggle with higher diesel prices in the short-term.

The research also supports reform of subsidies to LPG. These subsidies are of greatest benefit to upper-income urban households, which use the most gas.

According to the research, the government should move quickly to introduce small price increases in LPG, and introduce a cap on consumption of subsidized LPG cylinders by households.

In the longer run, the government should abolish the LPG subsidy, the research added.

The research also examines the role of direct cash transfers for kerosene, such as those being piloted in Mysore and Alwar, as part of the fuel-subsidy reform strategy.

This analysis underlines the urgency of stepping-up efforts to pilot cash-transfer programmes in
states in which highlevels of diversion of PDS kerosene occurs.Over the longer term, priority should be given to increasing financial inclusion and developing a more detailed direct transfer scheme to support low-income groups' transition to higher energy prices.