For Richer, Not Poorer: Energy Subsidies in India

IMF Blog, June 24, 2013

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Fuel subsidies in India are both fiscally costly and socially regressive.
At a global level, IMF research finds fuel subsidies:
- Crowd out high priority public spending like health, education and infrastructure.
- Put pressure on current account deficits.
- Distort productive investment toward energy-intensive sectors and technologies.
- Contribute to global warming (they are the opposite of carbon taxes).
In India, fuel subsidies were reaching the neighborhood of 2% of GDP before reform efforts.

Across many low- and middle-income countries, the top 20% of households capture six times more in benefits from fuel subsidies than the poorest 20%.
In India specifically:
- The top 10% of households spends more than 20 times as much on fuel as the poorest 10%, in per capita terms.
- If fuel products cost market prices, the top 20% of households would pay six times more for fuel, per person each month, than the poorest 20%.
- Low-income households consume mainly kerosene; kerosene is the least regressive product to subsidize.
- Upper income households predominantly use petrol (gasoline) and LPG; gasoline is the most regressive fuel product to subsidize.
The bottom 40% of families could be fully compensated for the move to market prices for less than a fifth of what government now spends on fuel subsidies.

Fuel subsidies:
- Crowd out spending on roads, schools, and hospitals.
- Add pressure to worsening current account deficits.
- Encourage distortions toward energy-intensive investment and technologies.
Reducing fuel subsidies would create fiscal space for high priority spending and help ease current account pressures.

Government measures over the past nine months include:
- Systematic increases in diesel prices.
- Plans to cap the number of subsidized Liquefied Petroleum Gas cylinders per household.
- Encouragement for state electricity boards to set more cost-reflective power tariffs.
These measures are described as welcome and pro-poor, because subsidy removal shifts costs toward higher-consuming richer households.
Targeting and leakage:
- The analysis assumes no leakage of benefits; leakage is a major challenge in India.
- Even if half of the efficiency gain were lost to leakage, fuel subsidy reform would still create significant fiscal space.
- The government’s plans to improve the targeting of fuel subsidies are viewed as particularly promising.

Source: David Coady, Thomas Richardson, June 24, 2013 — For Richer, Not Poorer: Energy Subsidies in India