Misdirected subsidies

Confirmation, if any was needed, that India’s staggering spend on fossil fuel subsidy is largely misdirected, has come from the marketplace itself. As reported in these columns (‘Diesel car sales lose momentum as steady rise in fuel price hits demand’, March 10), the sales of diesel-powered cars have declined sharply once the government’s belated attempt to reduce the subsidy outgo on diesel began to bite. Since January last year, the government has raised the retail price of diesel by 50 paise per litre every month. Cumulatively, this has resulted in an over 17 per cent increase since the regular price hikes began. This has already resulted in an around 20 per cent or higher drop in the sales of diesel cars of popular carmakers such as Maruti Suzuki and Honda, which offer consumers the choice of identical vehicles with petrol and diesel engine options. Clearly, once they saw the subsidy benefit on diesel disappearing, consumers shifted their choice to petrol cars, demonstrating both their readiness and ability to pay the unsubsidised, market price for petrol in the process.

This raises a huge question mark over the government’s fuel subsidy spends, which have thus far been justified in the name of the poor, since diesel was an essential input for the transportation sector. Any increase in diesel prices, it was argued, would thus prove inflationary, and hurt the poor the most. As the automobile industry’s experience shows, subsidised diesel has resulted in benefit for carmakers and car buyers, while having no perceptible impact on inflation, which has maintained its relentless rise both before and after diesel price increases. Worldwide, it has been demonstrated time and again that fuel consumption tends to be price inelastic. For the poor, it is a necessary expense which has to be borne; the rich have enough options to alter their consumption basket without cutting back on fuel spends. Also, fuel subsidies are a very inefficient way to provide affordable transportation.

According to an IMF study, 61 per cent of diesel subsidy in middle income countries like India actually flows to the top quintile — 20 per cent — of the population. The bottom 20 per cent — in whose name the subsidy is given — gets only 3 per cent! Such subsidies also place a tremendous burden on government budgets, diverting spending from avenues which are actually more pro poor. India spends over ₹2 lakh crore a year on subsidies. This is money which could have been spent on creating actual physical infrastructure, providing healthcare and improving education, all of which have much higher impact on poverty alleviation. Subsidising fuel in an energy importing country like India has the added impact of eroding the trade balance and weakening the currency — as we have learnt to our cost.

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