Rhetoric aside, can Modi Sarkar ever afford to deregulate LPG, kerosene prices?

With just four days to go for the budget, Finance Minister Arun Jaitley has already warned that the government might have to take some tough calls to ensure a healthier economy. And many expect this to mean a better management of the government finances by reducing fiscal deficit to bring back a certain notion of economic growth back on track.

In Indian debates on subsidies there is a over powering focus on food, fuel and fertiliser subsidies that are seen as free for all packages that must be cut down for the economy to grow. While subsidised kerosene is opposed by many, other government subsidies like tax waivers on corporates, gold, jewellery, etc., are hardly spoken about. It is less an ideological issue, as much as an economic and political issue (though the three are almost always inseparable).

First, we need to understand how the fuel scene in India works. India produces only a small portion of its crude oil (by companies like the ONGC, IOC etc) needs, and must import from other countries at international market prices. It must then refine the crude oil to form products like petrol, diesel, aviation fuel, kerosene, and LPG. Petrol prices are already deregulated to the extent that the refineries can fix the price for themselves. Diesel has also been freed so that its price goes up 50 paise per month till it reaches market parity price. 

The major concern remains with LPG and kerosene, which are still untouched. The oil marketing companies (OMCs) sell the LPG and kerosene at low prices to the public and the rest of the money is compensated by the government. Now that the government treasury is also not quite strong, the OMCs and refineries have been seeing very delayed payments and their own health is being questioned. The Kirit Parekh expert panel recently recommended that the government must "immediately" hike prices of diesel by Rs 5 a litre, kerosene by Rs 4 per litre and cooking gas by Rs 250 per cylinder. It also asked the government to bring down the annual entitlement of nine subsidised LPG cylinders to six; and do away with diesel subsidy completely in one year.

So why can't the government just cut the subsidies and move on? The biggest concern could be political: a vote bank that the new government cannot take for granted. But the issues go deeper. Diesel is used in various other purposes like transport, agriculture etc. With the inflation already above 6% and a food price inflation that refuses to come down, India must tread softly on its deregulation policy paths. When diesel price goes up, any producer who uses it as a raw material will pass on the hike by raising price of his services. So the cost of food, transport (bus, auto fares) etc., are likely to go up even more.

Iraq is the second largest exporter of oil to India. With the political scene in Iraq being vulnerable, the international oil prices will also remain volatile in the near term, which means the government will find it more difficult to pass the cost to the customer completely. In India, the monsoons have not been supportive of the new government and food shortage is a situation the government cannot rule out. So complete deregulation of diesel seems out of question now.

Talking of LPG, it might be a right area to bring some deregulation and cutting of subsidies. On various recent occasions, Amartya Sen has argued that the poorest in India do not have gas stoves to use cylinders with, and the this subsidy is majorly for the middle class and not the poorest of the country. LPG is a final product in itself and is hardly used in a more refined form, which means the cascading effect on inflation due to rising LPG prices will be lower than, say, diesel. The government is also asking those who can afford higher prices to give up on LPG subsidy so that it can provide more of it to the poor. However, given the difference between a subsidised cylinder and an unsubsidied one – almost Rs 450-500 – this is unlikely to have huge support from the middle class.

Kerosene, on the other hand, is a fuel that is genuinely used by the poor who have few options for domestic and cooking fuel. Kotkasim in Rajasthan ran a pilot scheme of direct cash transfer for kerosene subsidies. The entitlement is three litres for all card holders except those who use gas cylinder. Single gas cylinder holders are entitled for two litres and those who have double gas connection do not get any kerosene. The government transfers money for three months' of kerosene supply initially to one's bank account, and one has to use the money to buy kerosene from ration shops. A case study carried out on the pilot has revealed a drastic fall in the consumption of kerosene for mandatory bank accounts, the reluctance of banks to do so, delayed transfer from government to banks etc. So this scheme will be difficult to be scaled up to the national level unless the loopholes are fixed. Cutting kerosene subsidies absurdly might hurt the poorest in India.

Most investment and brokerage firms understandably want as much freeing of the markets and lowering of government subsidies as possible, and therefore, government control over crucial sectors in the economy. Barclays, in its budget expectation report, writes, "As subsidies on diesel have been almost phased out, the focus will shift to reducing subsidies for LPG/kerosene, which accounted for 55% of total under-recoveries of the oil companies in FY13-14. While the government has ruled out immediate price hikes, we think it may choose to adopt a similar gradual mechanism to raise LPG/kerosene prices. However, it is far from certain what action it will take in this area in the short term."

However, the rationalisation of subsidies is essential not just for the fiscal deficit issues, but also for more spending on pressing issues like healthcare and education. India has one of the lowest spending on healthcare compared to its GDP in the world, and with very low human development indicators it will need to build both physical and social infrastructure in a better way. For that it needs to reduce subsidising the middle class and the rich, and focus on those who need it the most. Now that is a political call the Modi Sarkar have to take.