Does India Need Fossil Fuel Subsidy?
At a time when there is growing global pressure to phase out Fossil Fuel subsidies (FFS) to address sustainability questions in energy consumption, India has made a budgetary outlay of Rs 11,925 crore for FFS in the Union Budget for the fiscal year 2024-25. India ranks 4th among the top five nations in fossil fuel subsidies, per International Monetary Fund (IMF) data of 2023. Although efforts to phase out fossil fuel subsidies are gradually progressing, India’s political economy has been holding on to FFS due to the claimed welfare impact of these subsidies on poor households. The growing international consensus that FFS harms economic, social and environmental sustainability forces the discourse back into the mainstream: How can India gradually eliminate the FFS and provide a market-based solution to India’s sustainable energy concerns via well-assessed FFS reforms?
The discourse of FFS has continuously remained at the forefront of the discussion of developing economies for a while, as many countries allocate substantial shares of their public budgets to subsidies. Increasing energy prices can exacerbate this situation. The IMF calculated global fossil fuel subsidies topped over US $7 trillion in 2022. While one-quarter of the total global FFS is explicit subsidies or undercharging for the cost of supplying a fossil fuel, the majority is implicit subsidies, including undercharging for environmental costs and forgone consumption tax revenues. The IMF offers a long list of negative externalities of energy subsidies, such as environmental damage, aggregated air pollution and premature deaths, and traffic congestion, along with fiscal challenges such as higher public debt, higher tax burdens, crowding out of potentially productive public spending, lower investments and innovation in energy efficiency and renewables, and increase in vulnerability of countries to volatile international energy prices.
India has been gradually reforming its FFS by slowly reducing fossil fuel subsidies. India's fossil fuel subsidies have declined by 59% in the last decade. However, the 2022 energy crisis, due to the disruptions in the global energy supply chain and India's growing energy demand, has increased its energy subsidies to Rs 3.2 lakh crore (US$ 39.3 billion) in 2023. India responded by peaking fossil fuel prices in 2022–23 by capping retail prices of petrol, diesel, and domestic liquefied petroleum gas (LPG), cutting taxes, providing direct budgetary transfers to businesses and consumers, and supporting existing energy supplies. As a result, oil and gas subsidies rose by 63% in FY 2023 compared to FY 2022. Coal, oil and gas subsidies account for around 40% of total energy subsidies, while clean energy subsidies account for less than 10%. The total FFS in India is US$ 346 billion, over 10 per cent of the Gross Domestic Product (GDP). Significant oil and gas subsidies include the lower per cent GST rate of 5% for domestic LPG, against the benchmark rate of 18% for other minerals, and LPG connection subsidies to Pradhan Mantri Ujjwala Yojna (PMUY) beneficiaries.
The international consensus has been increasing to eliminate FFS for an effective market-based solution to a broader climate change question. There has been a more comprehensive global effort to remove explicit fuel subsidies and impose carbon taxes to disincentivise the overconsumption of carbon-intensive energy along with improved net welfare due to local environmental benefits and removing price distortions. Governments pass on price volatility by deregulating energy prices to firms and households, who will then incorporate price signals into their decisions. While this will disincentivise carbon-intensive energy forms by forcing firms and households to look for alternate forms of energy and promote innovation in the energy efficiency sector, the challenge remains that it could lead to initial price shocks on consumers.
FFS policy reform needs a thorough study of existing subsidies (quantity of subsidies and their beneficiaries) to avoid the adverse impacts of sudden price shocks. The assessment will give a clearer understanding of the subsidies that can be eliminated on a priority basis. A suitable timeline can be chosen to assess the likely impacts of eliminating subsidies. Since energy affordability is critical to energy policymaking in India, given that energy consumption per person is lower than the world average per person energy consumption, an ideal FFS reform should include a detailed assessment of the effect of price shocks on small businesses and low-income households. Mobilising political support for FFS removal will remain a key challenge in India’s political economy. FFS reforms can be implemented when the global oil prices are lower and remove the scenarios where reforms are forced due to fiscal emergencies to reduce political obstacles.
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