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RSTV- The Big Picture : LPG Subsidy Cut: Do Subsidies Make Economic Sense?
Published on Aug. 21, 2017, 10:42 a.m.

LPG Subsidy Cut: Do Subsidies Make Economic Sense?

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TOPIC:

General Studies 2

  • Government policies and interventions for development in various sectors and issues arising out of their design and implementation
  • Welfare schemes for vulnerable sections of the population by the Centre and States and the performance of these schemes

General Studies 3

  • Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Background

Subsidised LPG now costs Rs 477.46 per 14.2-kg cylinder in Delhi. It was priced at Rs 419.18 in June 2016. The rate of non-subsidised LPG, which consumers pay after exhausting their quota of below-market priced bottles, costs Rs 564. Recently, the government decided to hike the LPG price by Rs. 4, implicitly stating that LPG subsidy cannot be continued for perpetuity. If Rs. 4 hike is made every month from 2017 and global crude prices remain constant, the subsidy would be Rs. 10 or down per cylinder. In three years, subsidies have fallen down from Rs. 54000 crore in FY 2014 to Rs. 15000 crore in FY 2017.

Efficiency of subsidy

Subsidy is an important component in any civilised society. Because citizens are at different levels of well being. Logical case on subsidies can be made on two grounds

  1. Private benefit is less than social benefit. The things are subsidised to encourage people to use it. Using LPG has a social benefit as people are moving away from firewood.
  2. A case on redistributive grounds. There is a system which is allows certain people to reach a minimum level of dignified living. Using subsidies in such case will promote social growth.

Some examples

  • In India, much money is wasted in name of subsidy. It was decided to give food subsidy to those who cannot afford it at market price. But instead it subsidised large scale inefficiency into Food Corporation of India. Pilferage, spoiling of food, excessive labour cost in handling of food was subsidised.
  • Subsidy on irrigation, fertiliser, power for farmers is not showing desired results. All the money is being wasted. If the same amount is being invested in the farm economy, then the farm and economy would gain far more and there would be much better productivity.
  • National Rural Employment Guarantee Scheme though portrayed as employment scheme is actually a subsidy scheme. When there is no work in certain seasons of the year, the people who deserve to have subsidy are asked to turn up for manual work. This kind of subsidy is required as it allows people to lead a dignified life.
  • There has been increase in number of households using LPG to 23 crores. This proves that LPG subsidy has indeed helped the people rise the social status as well as getting better health.

Hence, there are two kinds of subsidies-merited and unmerited. Good quality education subsidy is merited subsidy as it meets requirements of large section of population. Subsidies in health care, especially primary healthcare is towards building healthy society. These subsidies cater to long term benefits of society.

There are many which can come under unmerited subsidies-

Though there has been increased number of LPG users, the LPG gas subsidy has 85% users in urban areas. Of this, majority are middle class and higher class users. Thus, the idea of bringing subsidies in LPG might not be effective in long term.

Some of the subsidy is paid to the fertilisers company to enable the small and marginal farmers purchase fertilisers at subsidised rate. However, these are majorly consumed by large farmers having average 5-10 acres of irrigated land. The dry lands of India which accounts for 60% of total land don’t use fertilisers and subsidy. 90% of procurement of such subsidy is from Punjab, Haryana and coastal Andhra and only 10% by rest of India. Electricity to farms is also subsidised. Now, mostly prosperous farmers possess such pumps in their farms who then avail such benefit. And also in most cases, the electricity is not regular, thereby diluting the purpose of providing subsidy for boosting farm economy.

This shows the huge cascade of unmerited, unwanted, unknown, unwritten subsidies adding to the burden.  As a reason of this, there is not enough resources to build anything new or invest in new infrastructure or schemes.

The problem with demerit subsidies is that not much thought is put to who actually is going to benefit from it. Today, the demerited subsidies are little more than 5% of GDP, which is a huge number.

The LPG subsidy

Oil subsidies have been target of respective governments for years. Especially the gas subsidy as it forms a part of domestic cooking option.

In domestic cooking option between LPG and firewood, LPG is the most desirable option. Firewood is harmful for the health for the family using it. However, with regards to fossil fuels, India has to import 80% of the hydrocarbon demand. Hence, it is not good idea to use an imported item at a subsidised rate for domestic cooking. Instead, there can be a possible cycle such as using domestic coal to generate power, supply the power effectively to all rural areas and urban household, encourage cooking using electricity. Though it is a long term solution, it is possible and beneficial in future.  This will also mean that domestic coal will be optimally utilised without depending absolutely on imported energy.

Also, the gas subsidy amounts are matter of friction. Unless there is open competition in the marketing of LPG gas with private players also competing with PSUs, there is not real knowledge of gas prices available. How the depreciation on cylinders is calculated will change the prices of cylinders is not known.

Additionally, there is an element of cross subsidy which is charged to commercial LPG consumers. Thus, too many levels of subsidies make it more complicated and inefficient.

The real question is should LPG be used as a fuel for this purpose? In cities and town, piped natural gas makes more sense. It doesn’t have subsidy and still the price is low.

Also, there should be complete elimination of kerosene for cooking as its primary purpose was only for lighting. Using it for cooking is thorough misallocation of resources and thus shouldn’t be subsidised.

For lighting, there should be solar lanterns if unsure that rural areas will not get electric connection soon. Thus there is scope to rationalise subsidies without doing much damage to consumers.

Conclusion

The way forward lies in efficiently using the government resources, expenditure and effort on purposeful ends. The present problem lies in inefficiency and ineffectiveness of public expenditure. The subsidies given, the tax collected, the way in which public delivery mechanism works as part of it requires thorough analysis.

Along with it, there is a need to have a coherence in tasks taken. One year government says in parliament that NREGA is biggest monument to failure in India’s history. Next year, after drought, the government takes credit for increasing outlay in NREGA. Thus, there is no coherence in government’s approach on how and what to spend money on or how and where expenditure can be saved. Thus there requires a holistic assessment of government finances, tax collections. Subsidies can be tackled as part of an overall consolidation and nationalisation of total public finances.

Not only subsidies, but also there are exemptions worth rs. 7000 crore which need to be rationalised. This issue shouldn’t be perceived as investment vs. subsidy tussle. That reduction in subsidy will increase investments. Instead, a vision is required to make efficient use of resources with determination of goals and where the money will come from to fulfil them.

Connecting the dots:

  • Is a subsidised economy sustainable? Critically analyse
  • Subsidies form a critical part of developing nation. However, they may also strangle growth in long term. Evaluate
  • The habit of subsidies is not beneficial for society as well as economy in long term. Do you agree? substantiate.