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Matter of miscued LPG subsidy - Outside View by S.S. TARAPORE
Matter of miscued LPG subsidy

The Indian Union fisc has a history of massive subsidies for the petroleum sector. Over the years, the subsidy swelled to alarming levels and was clearly identified as one of the major reasons for an unsustainable fiscal deficit. Political imperatives prevailed over hardnosed fiscal correction of the large non-merit subsidy. Over time, the subsidies for petrol and diesel were eliminated and the kerosene subsidy reduced.

A quirk has been that governments of different political hues have recognised the aberration of indiscriminate subsidies on Liquefied Petroleum Gas (LPG) for domestic cooking purposes, but as yet, hard action has not been forthcoming. For the past three years, governments have considered corrective action only to develop cold feet when it comes to final decisions. It is a case of unfounded political fears prevailing over common sense. In the upshot, the bulk of the LPG subsidy is miscued to income groups which clearly do not deserve it.

Size of LPG subsidy

There are an estimated 165 million LPG consumers of domestic cooking gas and about 40 per cent of supplies are met through imports. As part of the attempt to cover 75 per cent of rural households with LPG connections, an additional 50 million consumers would be added in 2015, making a total of 215 million LPG consumers. If no action is taken to prune the LPG subsidy, the subsidy bill could reach a staggering Rs 75,000 crore per annum, especially if international crude prices bounce back.

Steps by recent governments

The UPA Government took the wrong tack by capping the number of cylinders per annum, which would be subsidised. First, there was a limit of six cylinders, which was raised to nine and finally, to twelve cylinders.

This implied that virtually all consumers of domestic cooking gas were covered by the subsidy at the low price of Rs 450 a cylinder. Since the commercial price is around Rs 900 per cylinder, the subsidy was of the order of 50 per cent of the commercial price, across the board, for all consumers. Needless to say such largesse provided no political mileage to the UPA government.

What was worse was that there was a major strategic flaw in the system. It was felt by the authorities that a dual price structure would create a thriving black market in cylinders. Hence, the system of a uniform commercial price for all consumers, together with a Direct Benefit Transfer to all consumers, equivalent to the difference between the commercial price and the subsidised price was evolved. This meant large swirling of funds between the oil marketing companies and the consumers. The upshot of all this was total chaos and very quickly, the authorities went back to providing up to twelve cylinders per consumer at the subsidised price.

The BJP government resorted to moral suasion, asking consumers to voluntarily give up the subsidy. Needless to say, this totally failed.

Pragmatic approach

If the kerosene subsidy could be gradually reduced, there is no reason to believe that the LPG subsidy cannot be pared down without the political fallout being unmanageable.

On tentative calculation, in the absence of any adjustment measures, the LPG subsidy could swell to a peak of Rs 75,000 crore per annum if international crude prices experience an upswing. Assuming an average annual consumption of eight cylinders per consumer, a total of 1720 million cylinders would be consumed per annum, with an approximate subsidy of Rs 450 per cylinder.

Under the present government, the Ministry of Petroleum had mooted a proposal for a one-shot increase in the subsidised price by Rs 250 per cylinder, but fearing a political fallout, little has been heard about this proposal.

A pragmatic approach could be to raise the price by Rs 50 per cylinder in quarterly phases, which would reduce the subsidy by about Rs 8,600 crore per annum. The elimination of the non-merit subsidy could take nine quarters. Assuming that 20 per cent of consumers get back the subsidy by way of the Direct Benefit Transfer (DBT), the net reduction in the subsidy would be Rs 6,880 crore per annum per each quarterly increase in the LPG price, by Rs 50 per cylinder.

The calculations set out above are merely illustrative of how the LPG subsidy could be reduced in phases. The government would need to take a judgment call on the phased reduction and the actual increase in the LPG cylinder price each quarter could be conceivably lower than the amount set out in the above illustration. Accordingly, the time frame for eliminating the LPG subsidy for the non-merit consumers could be more than the nine quarters indicated in the illustrative calculation.

Concluding observation

The central theme of this column is that a gradual phased reduction of the LPG subsidy is doable, without affecting the genuinely disadvantaged segment of the population. Such a scheme would render the LPG subsidy properly targeted and keep the burden on the fisc within manageable limits. Not tackling the LPG subsidy could, over time, result in the fiscal deficit spinning totally out of control. The choices before the government are clear.

Please Note: This article was first published in The Freepress Journal on October 20, 2014. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.


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1 Responses to "Matter of miscued LPG subsidy"


Oct 21, 2014

Mr.Tarapore has outlined a very much doable blueprint of gradual reduction of subsidy @ Rs.50 per cylinder every quarter such that the subsidy is wiped out in 9 quarters completely.At the same time return 20% subsidy by way of Direct Benifit Transfer to identified BPL or other such need based customers.The sooner the Government bites the bullet the better as majority of the Subsidy woes of the Central Govt. will be wiped out paving way for a much regulated fiscal deficits.

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