Subsidies on petroleum products have been a contentious issue not only in India but in many countries. The rise in international oil prices in 2007 and early 2008 led to a huge increase in these subsidies. After falling in tandem with the plunging oil prices last year, petroleum subsidies are now rising again. The authors of an IMF (International Monetary Fund) Staff Position Note estimate that global consumer subsidies on petroleum products, which amounted to $60 billion (Rs2.75 trillion) in 2003, will rise to $250 billion this year. It was as high as $520 billion in 2007, or 0.7% of global gross domestic product, or GDP.
Given the fact that many countries have already seen a steep rise in their fiscal costs because of stimulus programmes started as a response to the financial crisis, the question of how best to curtail petroleum subsidies becomes all the more important. The need to curtail fossil fuel consumption as a result of global warming is another reason for worrying about these subsidies.
What if the entire subsidy on petroleum products is lifted and any increases and decreases in prices are passed on in full to the consumer? The authors say that, in that event, the median oil importing company would reap an efficiency gain of 2% of GDP.
The paper also points out that the petroleum subsidy is inequitable. The note points out: “The benefits of gasoline subsidies are the most regressively distributed, with over 80% of total benefits accruing to the richest 40% of households. For diesel and liquefied petroleum gas (LPG), respectively, over 65% and 70% of benefits go to these income groups.” The consumption of kerosene, though, may benefit the poor more. That is why the authors say that a subsidy on kerosene could continue, but there are clearly limits and it has to be properly targeted as kerosene can be diverted for mixing with diesel.
The other alternative to protect the more vulnerable sections is to provide schemes that benefit the poor in other ways, such as increasing expenditure on education, health and infrastructure. For instance, when Indonesia more than doubled petroleum prices in 2005, a temporary cash transfer programme was initiated to mitigate the impact on poor families. The note also says that the government must be transparent about oil subsidies. For example, the Indian government’s recent decision to give cash transfers to oil marketing companies rather than oil bonds is a step in the right direction.
How can the government overcome vested interests and sell the removal of subsidies to the public? The note points out that in 2005 “the government of Ghana used the finding of a Poverty and Social Impact Analysis that petroleum subsidies go predominantly to high-income groups to convince the public of the need to raise petroleum prices. To prepare the public for the price increase, parliamentary discussions on the subject were broadcast on television and radio”. It also linked subsidy reform to higher social spending.
So what’s the solution? The authors say the best solution is to completely free petroleum prices. That will de-politicize petroleum product pricing—currently, because the government controls the price, it is at the receiving end whenever the price goes up. In case full decontrol is not politically feasible, the next-best solution is an automatic pricing mechanism that adjusts prices regularly in light of the changes in international prices. These smoothing mechanisms could include moving averages, price adjustment caps and/or triggers, and price bands, and many countries have opted for this partial deregulation.
India is not alone in having a problem of how to dismantle its petroleum product subsidies. We can learn from how other nations have been able to cope with the issue.
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