'Aam aadmi' and flip side of subsidies

Last Updated 28 October 2012, 15:44 IST

The Union government’s recent decision to reduce fuel subsidies sent panic ripples across the country as the general public feared increase in the price of commodities, transport costs and the cost of home cooked food.

There appears to be sufficient reason for panic. At the moment, the government expenditure has exceeded government revenue by a greater margin than what was budgeted. Revenue inflow has taken a hit on account of delays from disinvestment programmes and collection of taxes in the last few months among other reasons.

According to the Kelkar panel, the shortfall in revenues is to the tune of Rs 60,000 crore. The panel has indicated that substantial amount of deficit is constituted by subsidies such as fuel, food and fertiliser subsidies.

In 2011-12, food and fuel subsidy together accounted for 70 per cent of the outlay on major subsidies (on fertiliser, food, petroleum and interest). Given the prevailing inflationary conditions, the government cannot print more money or borrow more money from the market to fund the deficit.

Rating agency Standard & Poor’s has indicated that it might have to push India’s credit rating status to negative as we don’t seem to be in a good position to even repay current debt, let alone ask for more debt.

Thereby on immediate effect, reduction in subsidies appears to be the most feasible option if not the only option. In the aam aadmi’s perspective, it probably appears that the government could not manage its expenditures well and hence, he of all people, must come to the government’s rescue by taking a hit on his purse.

The impact of reform on something as essential as LPG and diesel is daunting, as we are afraid that the reform might burn a bigger hole in our pockets. Interestingly, there are countries that have adopted a liberalised system of pricing in the fuel sector by not deciding to subsidise fuel and let it move according to market forces.

Which means that with international price of oil steadily increasing, consumers will have to pay full market price without the subsidy cushion to soften the impact. It sounds scary. However looking at it from a detached perspective, it appears that the fuel subsidy does seem to pose a great problem as it accounts for a significant proportion of the GDP in many countries, leaving little for other essential social expenditures.

An IMF worldwide study revealed that in many cases, the size of subsidies was equivalent or more compared to the health and education budgets. For instance, in Indonesia and Yemen, the total subsidy bill was greater than the health and education budgets combined!

It was also found that most of the fuel subsidies go to higher income households and a very small proportion reaches the needy, suggesting leakages en route. For instance, a study by World Bank in 2006 found that  in Venezuela, during the 1990s, the richest 20 per cent of the population received six times more in fuel subsidy than the poorest third of the population, clearly defeating the very purpose of subsidy.

In the Indian context, the government has taken steps to reduce leakages in fuel subsidies by making arrangements for direct transfer of subsidy to the consumer’s bank account as in the case of LPG and fertiliser (in particular urea) subsidies. This would prevent unauthorised deliveries and eliminate black markets.

Further, it has attempted to ensure fairness and minimise wastages by estimating that on an average, a family would need six cylinders in a year at subsidised rates and seventh cylinder onwards, market price will have to be paid. This reform, if implemented correctly, would ensure efficient usage of LPG. Human psychology dictates that if you need to pay a lot for a commodity, make use of it wisely. But if someone is bearing your expense, feel free to use how much ever you want.

It is futile having fuel subsidies when the beneficiaries are not always the poor and subsidised resources are being wasted due to lack of awareness and an indifferent attitude. Instead we could derive lessons from the experiences of countries that have successfully channelled the excess funds released from reduction or elimination of fuel subsidies towards compensation programmes that included highly targeted programmes to benefit the poor. In particular, in most cases, the corpus of funds released was directed into providing better healthcare facilities and education.

Countries such as Ghana, Indonesia and Jordan have successfully reduced fuel subsidies. Governments in these countries compensated price rise in fuel by giving cash or in kind to the poorest sections of the society.

In the Indian context, this would be a positive step in the direction of ensuring access to quality health care, education (training of teachers, provide required infrastructure in terms of airy classrooms, blackboards, decent toilet facilities in schools and so on), cheaper transport networks, good roads and so on. For the government, this might help in harnessing more public support towards reduction in subsidies, at least in the long run.

Also, the move to cap the number of subsidised cylinders is likely to motivate the upper middle-class and the elite to combine the use of LPG cylinders along with other options such as induction stoves that are gaining popularity and microwave ovens for cooking. This might actually make more LPG cylinders available in the market, which might be eventually allocated to the needy, who can barely afford subsidised LPG cylinders. This would ensure fair distribution of the scarce resource.

Implementation is the key to success of any reform. Spreading awareness about the benefits of the reduced subsidy scheme would be a huge challenge, while social and political backlashes would definitely occur. Yet some countries have managed to successfully implement it. Are they being smart? Perhaps only time would tell.
In the Indian scenario, doing away with subsidies to ease the fiscal deficit is clearly not an option.

Considering that there are limited options available, reducing subsidies on a fair basis is one of the many things the government can do to reduce fiscal burden, keeping in mind that inflation needs to be curbed, private investment should not be crowded out on account of increased government borrowing to meet deficit, the country’s credit rating status needs to improve to attract the much-needed investment to pull the economy out of crisis.

The aam aadmi has little choice but to cross his fingers and follow suit. We must consider ourselves to be fortunate that we are not bearing the entire burden of fuel price rise and still have some leeway to enjoy fuel at subsidised rates. Whether the recently proposed reform to reduce subsidies would help in reducing fiscal deficit is something that we will have to wait and see.

But atleast the reform, if implemented correctly, would ensure that the aam aadmi would use the resources provided to him more efficiently in the fear that he would have to pay more out of his pocket. In the long run, the aam aadmi would stand to benefit, if reforms are well-implemented.

(The author is a freelance writer)

(Published 28 October 2012, 15:44 IST)

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