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Business News/ Opinion / The maze of cross-subsidies

The maze of cross-subsidies

The discussion on how to pay for social obligations cannot start in earnest without accounting for them in the first place

Photo: MintPremium
Photo: Mint

The Indian Railways’ recent effort to recover a bit of its passenger subsidy stumbled almost as soon “flexi-pricing" for express trains was announced. In spite of the “GiveItUp"-style move of printing average passenger subsidies on tickets since June, media coverage quickly turned “flexi" into “surge". The Railways tweeted away about the tiny percentage of passengers affected (0.15%) and the amount of subsidy involved in passenger service (Rs30,000-34,000 crore loss per year), but has not yet brought the frame back to the message an unnamed official gave the press: “Those who can pay more, should pay more. Those who cannot, should be subsidized." “Loot and misuse", “price bomb", and “exploitative", the media responded. “Experimental", conceded the Railways.

While it is disappointing to see the rapid retreat of GiveItUp politics (and not just in railways, in education too as the ministry of human resource development reviews this spring’s Indian Institute of Technology fee hike), the furore in the headlines overshadowed the more interesting point that railways minister Suresh Prabhu made last week.

Prabhu called for passenger subsidies for particular groups—students, senior citizens, defence personnel, etc.—to be borne by respective ministries rather than left to the Railways to recover as best it could. This line of thinking and action could open new doors, real doors, for rearranging the subsidy tangles that stand in the way of some of the transformations India needs. The discussion on how to pay for social obligations cannot start in earnest without accounting for them in the first place. And the pretence of preserving ability to meet vague obligations continues to justify far too many distortions.

There is a certain clarity and simplicity to the argument that leakage to the elite prevents investment in the poor. But the reality is that money is fungible. The costs of extending liquefied petroleum gas (LPG) coverage to more households do not need to be recovered from middle-class households who give up their subsidies. The costs of investing in Indian Railways to upgrade freight service and capacity do not need to come specifically from passengers paying higher fares. There’s probably even an economic case for pulling public monies from some other source to invest in both causes (cleaner cooking gas and shifting freight from road to rail) once the health and environmental externalities from air pollution and local climate change are considered.

The subterranean structure of subsidies—the system of favours, fiefdoms, surcharges and soft budget constraints that have been granted to various public sector agencies to offset the burden of broadly defined “social sector obligations"—is a bigger problem. Defence of these revenue sources becomes an end unto itself, and an excuse for concessions of all sizes. Think about the Air India bailout in 2012 and the ministry’s dismissal of privatization in 2015—both were explicitly justified by the carrier’s “social obligations". It’s not a surprising outcome for a system in which social obligations are clearly large but not exactly counted or internalized in costing out the policy agendas promised. But such hazy bargains can create deep and distortionary third rails with far-reaching consequences.

Take the electricity sector, for instance. State-owned distribution companies are for the most part broke after years of bearing the cost of free agricultural power as well as theft from illegal connections. None of them, then, are eager for any changes that affect the areas where they do earn money: supply of power to industries. This counteracts other pressures for the sector to evolve toward lower-cost and lower-emission generation. Tamil Nadu has been promoting rooftop solar among other renewable energy sources, for example, and educational and commercial institutions in Tamil Nadu have excess capacity to spare. But they cannot feed this into the grid since there is no net-metering policy for these customers.

And the state is not alone: Maharashtra, Kerala and Rajasthan allow net metering (billing based on net consumption) only up to 1 MW. Similarly, the cross-subsidy surcharge imposed on industries to help fund low-cost or free supply to households and agriculture has counteracted the potential impact of open access rules on competition in electricity supply—alternative sources of power are too expensive after the surcharge is added. Companies are hammering away at the regime in various high courts, but the surcharges still counteract the effect of other regulatory developments since 2003.

Similar events have played out in other sectors as well, from telecoms to public sector banks to state transport companies. General, vague, social obligations to provide telecom services to “every nook and cranny", or meet the credit and banking needs of “the entire nation" have been used to justify regulatory favours, bailouts, soft enforcement, and preferential access to protected profit opportunities that distort markets and sometimes handicap efforts to meet the very public purpose that justifies them.

Cross-subsidies, more than subsidies, are the important arena for transformation. These will only become addressable after the terms of the bargains and the flows of the funding are made explicit and attached to particular purposes. Just as Prabhu recommended.

Jessica Seddon is managing director of Okapi Research & Advisory and writes fortnightly on patterns in public affairs.

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Published: 13 Sep 2016, 12:35 AM IST
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