Subsidies subsidizing India's growth

Mon, 27 Jun Pre-Open

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The latest increase in diesel and LPG prices has come at a time when the country is already reeling under high inflation rates. This increase is bound to send inflation rates to new highs. This is because diesel and LPG form a significant part of the inflation basket. But one might ask as to why rates have been raised especially when crude oil prices have been on a decline trend over the past few days. Such an increase definitely appears to be a paradox.

Well the reason behind this is a word called 'subsidy'. The Indian government has typically subsidized the fuel for the weaker sections of the economy. This has artificially kept prices of things like diesel, LPG and kerosene below the prevailing global market rates. The idea is that the oil marketing companies (OMCs) sell these products at the lower or the subsidized rates. In turn, the government would compensate the OMCs for the loss in prices through a subsidy.

The process appears to be excellent in theory. The weaker sections of the economy keep getting fuel at lower prices. The oil marketing companies continue to make a profit. And the government earns the trust and most importantly the vote from its citizens. But in reality this is not the case. The subsidy is actually a huge burden on the country's fiscal deficit. Particularly in the event of rising crude oil prices, the subsidy burden increases. It eventually reaches a point where the government cannot increase the subsidy payout. This leads to an under-recovery in oil prices for the OMCs and forces them into losses.

One might think that well all this is ok as long as the weaker sections of the economy continue to benefit. Well the truth is that in reality they don't benefit either. This is due to the skewed consumption pattern. It is actually the 30% of the richest members of the society who consume nearly 72% of the country's total LPG. The poorest 30% only consume 2%. As a result, the subsidized rates are actually enjoyed more by the economically better off sections of the society. So the premise that lower rates help the economy completely falls flat on its face.

Subsidies tend to skew the domestic prices. So much so that they no longer reflect the reality of the markets. In reality, if prices go up, consumption is supposed to decline. This is how markets remain in balance. But subsidies skew this balance. The result is that there comes a time when this skewed nature starts reflecting on the country's growth. In addition to this, subsidies fuel chances of corruption as seen in the infamous kerosene scam. This further hampers the country's growth. And the worst impact of subsidies is that it deters private sector participation. It is a known fact that private sector only participates in those industries that have an open pricing. They prefer to shun those sectors that are highly regulated.

The choice that the government has today is to end the 'subsidy' structure. It may lose some votes. It may not be able to fill the pockets of the politicians with the huge wads of cash that they are accustomed to seeing. But it is the right step towards driving the country to its next level of growth.