Rebooting India: Realizing a Billion Aspirations (12 page)

Subsidized kerosene is provided as an affordable cooking fuel to the poor. Unfortunately, this has also given rise to the ‘kerosene mafia’, who illegally obtain subsidized kerosene and sell it for far higher prices on the black market. The system is so powerful and well entrenched that when Yashwant Sonawane, the additional collector of Malegaon in Maharashtra, allegedly tried to stop a local hoodlum stealing kerosene from a tanker, he was doused in the very same kerosene and burnt to death.
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Earlier, in 2005, an Indian Oil Corporation manager named Shanmugam Manjunath had ordered a petrol pump near Lucknow to be sealed for selling fuel adulterated with subsidized kerosene; the petrol pump owner murdered him in retaliation.
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These stories helped catapult the kerosene mafia into the public eye. Manjunath’s death inspired a biopic, and Sonawane’s murder was mentioned by Pranab Mukherjee, then the finance minister, in the Budget speech of 2011–12.

While the fuel subsidy burdened the Indian exchequer to the tune of $15 billion at its peak, far greater and much more worrisome is the insidious impact of such heavy fossil fuel usage on the environment. Recognizing the financial and environmental repercussions of subsidizing fossil fuels, governments across the world, from Jordan to Iran, are slashing subsidies and raising fuel prices. Research from the International Monetary Fund (IMF) shows that most fuel subsidies are misdirected; only 7 per cent of the subsidies in poor countries go to the poorest 20 per cent of households, while the richest 20 per cent of society claim a disproportionate 43 per cent.
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Cutting these subsidies altogether would result in a worldwide savings of over $500 billion, accompanied by a 6 per cent drop in global carbon emissions by 2020.
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A further impetus to the scrapping of fuel subsidies came from the G20 Pittsburgh Summit.
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A declaration released by the G20 nations, a group which includes India, pledged to phase out ‘inefficient fossil fuel subsidies’, which ‘encourage wasteful consumption, reduce our energy security, impede investment in clean energy sources and undermine efforts to deal with the threat of climate change’.

The central government currently offers subsidies on over a dozen commodities, including everything from coal to car parts, to oil, jute and cattle fodder; state governments can and do add to that list. This bouquet of subsidies doesn’t come cheap; as per the 2014 Budget, the central government was projected to spend nearly Rs 4 trillion on subsidies, over 4 per cent of India’s GDP; in comparison, the country’s defence budget is around 2.5 per cent.
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That is a very heavy burden for an economy to bear.

Different goods are subsidized in different ways. In the case of fuel, for example, subsidies operate right down the production chain, starting with the purchase of raw materials and ending with the consumer. The subsidy burden eventually becomes the responsibility of state-run enterprises, leaving them grappling with heavy losses year after year. Fertilizer manufacturers, on the other hand, pay market price for raw material and production, and their expenses are later reimbursed by the government, showing up as excess expenditure on the government’s balance sheet. As the prices of raw materials soared over the last decade, budget deficits and government debt grew likewise.

Subsidies are applied early in the production process of most commodities so that, as goods move through the supply chain, their prices are already low. In practice, this means that consumers can buy products at two prices, either the standard market rate or the cheaper subsidized rate. This price gap is ripe for exploitation by large, well-organized gangs like the kerosene mafia. Ordinary individuals exploit these loopholes as well; one enterprising maid buys subsidized rice from her home state of Tamil Nadu and sells it at market rates in Bengaluru, using her profits to fund her children’s education. These are just a few of the countless examples in which the subsidy regime has turned out to be completely counterproductive, causing economic harm and actually working as a disincentive towards growth and development.

How does the government pay off its enormous subsidy spends? Its ability to do so is dependent on three factors: the international
market price of commodities; how much money it can generate through revenue and borrowing; and the efficiency of its subsidy administration. The first factor is largely out of the government’s control—it has no choice but to pay the going market rate for raw materials. The second factor, the state of the nation’s treasure chest, is dependent upon the economy. We could raise taxes to generate more revenue for spending, but this approach runs the danger of stifling economic activity if taxes get too high. The only lever of control we realistically have as a society is to pay for subsidies by cleaning up our subsidy regime.

The first step in the clean-up is to recognize that our subsidies work at the wrong level in the system. Instead of being applied to manufacturers or other intermediaries, subsidies need to operate at the level of the consumer. As soon as we do this, the dual-pricing system for goods will vanish, removing all incentive for diversion and fraud. The advantages of such a direct benefits transfer system are detailed in the accompanying diagram.

Developing a direct transfer system for subsidies on LPG, kerosene and fertilizers was the mandate of a task force instituted by the then finance minister Pranab Mukherjee and chaired by Nandan. The task force released its recommendations as a report in 2011,
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outlining a mechanism to ensure that subsidies were correctly targeted only to the truly deserving. What were some of the challenges that such a mechanism would need to overcome? Apart from the multiple opportunities for pilferage and fraud, the current model also robs consumers of their freedom to choose. The government specifies which goods are to be subsidized, and where you can buy them—subsidized wheat, for example, is available to you only at the ration shop in your locality and nowhere else—due to which unintended monopolies and distorted production patterns emerge. An ideal system would allow for people to choose when and where they wish to avail of subsidized goods, whether it’s a physical product or a cash transfer. Today, the Aadhaar Payments Bridge that we discussed in a previous chapter, is being actively used to administer the LPG subsidy as well as other schemes across the country.

The time to carry out subsidy reform is right now. The domino effect of low global oil prices has reduced the government’s subsidy bill and brought in a period of relative stability. More than two-thirds of the country already has an Aadhaar number, and the LPG subsidy system is proof that direct benefits transfers really do work. With low opposition to change and a smaller likelihood of increasing the consumer’s economic burden, what better time can there be to initiate a sweeping overhaul of this millstone around the Indian economy’s neck?

Much of middle-class India relies on liquefied petroleum gas to cook its meals and, increasingly, to power its vehicles. Subsidized LPG is available through government-run Oil Marketing Companies (OMCs) via their national distribution networks, at an annual cost to the country of around Rs 240 billion. This fuel comes packaged in cylinders of different colours and sizes depending on whether they are meant for domestic or commercial use. Current usage statistics indicate that 120 million consumers (measured as families, not individuals) use an average of eight cylinders annually. Assuming that an average family consists of four people, that works out to a per capita consumption of two cylinders per person per year. As of 2011, 89 per cent of all LPG consumption was domestic, out of which the poorest 50 per cent consumed only 25 per cent of the available subsidized LPG.
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Until recently, an individual could buy an unlimited number of subsidized domestic LPG cylinders. As a result, people would buy these in large numbers and then sell them on the black market at the open market price, netting a handsome profit for themselves while bleeding the exchequer. Dealers created ghost consumers and delivery boys themselves false-booked cylinders under a consumer’s name so that they could sell domestic cylinders for commercial use. The diagram in this section explains how the original LPG subsidy worked and outlines the many ways in which this system could be subverted.

In order to shore up the tottering LPG subsidy system, the task force recommended a multi-phase solution. The first step was the creation of a ‘transparency portal’ where every consumer’s LPG consumption details were made available online, operating under the umbrella of the Right to Information Act.
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The oil companies were initially hesitant to comply, but some pressure from the government ensured that such online portals were eventually created. Prominent politicians and industrialists were found to be consuming cylinders at improbably high rates—one politician was found to have claimed 240 cylinders in a year, or one cylinder every one and a half days, costing the central government almost Rs 100,000 in subsidies alone.
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The media highlighted these stories and the resulting public outrage further fanned the flames for LPG subsidy reform.

The task force’s second recommendation was to place a cap on the annual number of cylinders a customer could order. Initially set at six, the limit was later revised to nine. Customers were also requested to submit their Aadhaar details so that their identity could be verified. By linking the customer’s Aadhaar number to their LPG connection, ghosts and fakes in the system could be eliminated; the cap on cylinders meant that customers would monitor their usage with a closer eye, further weeding out fraud. A study carried out by the International Institute for Sustainable Development reported that a cap of eight cylinders per year per household works out to an estimated savings of more than Rs 40 billion, or a sixth of the entire subsidy spend.
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The third recommendation of the Task Force was to set a single market price for LPG and transfer the subsidy amount directly into the beneficiary’s bank account. In 2011–12, although India’s three OMCs reported a combined turnover of Rs 8 trillion, their profits were only Rs 6.17 billion, or 0.7 per cent of their turnover—an unsustainable business model. Direct transfer of subsidy benefits can turn these loss-making OMCs into profitable institutions, since they no longer have to bear subsidy costs as losses in their balance sheets. Eventually, moving the subsidy out of the supply chain and directly to the consumer will pave the way for new firms to enter
this huge market. Consumers will benefit from higher service quality, competitive pricing, and innovation; for example, new players might offer cheaper cylinders made of light composite materials rather than the iron cylinders currently in use.

The last recommendation the task force made was to convert LPG to a targeted subsidy. Currently, everyone is eligible for subsidized LPG, whether they need it or not. By limiting the subsidy only to those who cannot afford to pay the market price for LPG, the government can potentially save considerable funds that can be deployed for other purposes—witness the ‘Give It Up’ campaign launched by the current government, exhorting those who don’t need the LPG subsidy to give it up for the welfare of the country. This type of fine-tuning is possible only in a direct transfer system.

The implementation of an Aadhaar-based direct transfer model for LPG subsidies is already underway; the initial rollout began in June 2013, covering eighteen districts in ten different states of India.
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It was rolled out nationwide on 1 January 2015 and now covers 120 million customers. An estimated 33 million LPG connections were estimated to be fake or disconnected, and an additional 1 million customers voluntarily gave up the subsidy. The country’s chief economic advisor Arvind Subramanian said that the savings in 2014–15 could be as much as Rs 127 billion, while in 2015–16, they were expected to be Rs 65 billion,
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being lower largely due to lower oil prices.

Under this system, the customer pays the full market price for an LPG cylinder. As soon as the cylinder is delivered, the subsidy is transferred to the customer’s bank account using the APB. The accompanying diagram explains the new LPG subsidy architecture in greater detail.

Those who do not require the subsidy simply do not enrol in the scheme. In the six-month period between September 2013 and February 2014, an estimated Rs 4 billion was saved thanks to consumers who chose not to enrol. Consumption of domestic LPG, which traditionally grew by 6–8 per cent annually, showed a first-ever decrease of 18 per cent. Over 600,000 duplicate connections were detected; removing these duplicates would result in a projected
annual savings of Rs 1.93 billion. In total, the direct transfer system, in conjunction with the cylinder cap, was set to save the exchequer Rs 65 billion a year.