On Energy Subsidy Reforms in India

by Siddharth Singh

The new Indian government—now seven months old—led by Prime Minister Modi has maintained a fair degree of continuity of the economic policies initiated by the previous government. This is especially true in the case of energy pricing and subsidies: the government has continued the gradual removal of energy subsidies that had begun during Manmohan Singh’s regime in 2010. This policy continuity is not surprising, as in spite of the sharply rising prices of petroleum products such as petrol and diesel in 2013 and early 2014, the Modi-led Bharatiya Janata Party did not make it into a major electoral issue.

The previous government had decontrolled the prices of petrol in 2010, which brought under-recoveries by the oil marketing companies from $1.1 billion in 2007-08 to zero in 2011-12. Petrol prices now move in a manner such that under-recoveries by companies are never positive (in other words, there is no subsidy burden from petrol on the government). However, overall energy subsidies continued to rise even after 2010. At their peak, oil and gas subsidies were $15.5 billion (Rs. 96,800 crores) in 2012-13. In fact, the rising subsidy payments were the trigger of the fuel price reforms in the first place, as oil and gas subsidies were below $456 million (Rs. 2852 crore) for several years prior to 2008-09.

The previous government had also begun gradually decontrolling the prices of diesel by increasing their prices by $0.01 (Rs. 0.5) per liter every month in 2013. The idea was to bring the under-recoveries by companies down to zero, as they had for petrol. In 2013-14, diesel under-recoveries by oil marketing companies were $10 billion (Rs. 62,300 crore). The Modi government continued this policy of gradual decontrol of diesel after assuming power, and assisted by falling global crude prices, brought down under-recoveries to zero in October 2014. This implies the government will no longer have to pay cash subsidies to companies for selling diesel below cost price.

Note that the under-recoveries by companies—most of which are owned by the government—are not exactly equal to subsides by the government, as parts of the under-recoveries are borne by upstream (or crude oil extraction) companies, many of which are also government owned in India.

In November 2014, the new government launched a scheme under which subsidies for LPG (which is a key cooking fuel) will be directly transferred to consumers to their bank accounts. This measure, if successful, will significantly curb leakages as it will ensure better targeting of these subsidies. The pilot projects for such transfers started in 2011 and have had mixed success.

The government has also put in place a new natural gas pricing formula, although this will not have a direct impact on subsidies as the consumption of natural gas is not subsidised in India. The government is also internally contemplating reforms of kerosene subsidy, although there is no clarity at the moment on the direction that would take.

This flurry of energy price and subsidy reforms will impact stakeholders differently. Firstly, India’s finances will be positively impacted as the falling energy subsidies will reduce the fiscal deficit, which was 4.5 percent of GDP in 2013-14. The government is now all set to comfortably meet its 2014-15 fiscal deficit target of 4.1 percent of GDP. Due to falling oil prices, the quantum of current account deficit too will reduce, as India imports close to 80 percent of its oil demand.

Secondly, the fact that both petrol and diesel now have zero under-recoveries will prod private entities to enter India’s fuel marketing sector. They have so far maintained marginal presence as they are not entitled to subsidies. However, even though both petrol and diesel have now been decontrolled, private companies have so far chosen to wait and watch to see if the price reforms will stay, as over a decade ago, price reforms had once been revoked after a few months of implementation.

Thirdly, there has not been any political opposition to the decontrol of petroleum product prices so far. Indeed, the government has been fortunate enough to experience falling crude prices, which led to petroleum product prices falling during the last legs of the price decontrol. However, the real test of policy continuity would be when crude oil prices rise and petroleum product prices also rise as a result. Will the government cave in to political pressure to reduce fuel prices (by implementing a subsidy), especially if elections are around the corner? Political viability, after all, is a key pillar of sustainable energy subsidy reforms. So far, the government has played it safe by choosing to increase excise duties on petrol and diesel instead of letting their prices fall along with crude oil prices. This not only is increasing state revenues and leading to windfall gains by public companies in the short run, it will eventually leave room for the reduction of these taxes when international crude prices rise, thereby ensuring petrol and diesel prices do not increase significantly—or at all.

Indeed, 2015 promises to be an interesting year for observers of India’s energy economy as various stakeholders will begin to feel the impact of these fuel price reforms.

Note: all data on the Indian oil and gas sector cited above have been taken from the Petroleum Planning and Analysis Cell.

About the Author

Siddharth Singh is a researcher at the Centre for Research on Energy Security (CeRES) at The Energy and Resources Institute (TERI) in New Delhi, India. He is available on Twitter @siddharth3

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