As the Centre Weans India Off Kerosene Subsidies, How Should States Respond?

Can a share of the money saved from kerosene subsidies be provided to states to reinvest in cheaper, cleaner and more efficiently-run subsidies for clean energy?

How can states negotiate with the Centre to protect their rural populace as well as reinvest the kerosene subsidy savings? Credit: Reuters

How can states negotiate with the Centre to protect their rural populace as well as reinvest the kerosene subsidy savings? Credit: Reuters

The health hazards of household kerosene consumption are well recorded. Yet, India is one of the largest consumers of kerosene on an absolute and per capita basis. Because there are no accessible, affordable and established sustainable alternatives, poor rural households, especially in remote areas, continue to use kerosene as their primary lighting fuel. This may soon change following announcements by the central government to reduce the volume of subsidised kerosene allocated to states and gradually increase  the price of subsidised kerosene.

What are the implications of this policy for India’s states? And, crucially, how can states negotiate with the Centre to protect their rural populace as well as reinvest the kerosene subsidy savings?

There are three factors at play here. Firstly, it is not clear, to date, whether the central government’s fiscal saving on kerosene subsidies have been shared with states. Secondly, states are now bearing the burden of lighting expenditure so they should ask for compensation from the Centre. Lastly, kerosene pricing reform presents an opportunity for transitioning rural households to solar lighting.

Transferring savings

Nearly a decade ago, in 2008, the Chaturvedi committee reported that rural households used PDS kerosene primarily for lighting and not for cooking (while the reverse was true for urban poor households). Due to challenges in access to grid based electricity, the unelectrified and under-electrified rural households continued using kerosene for lighting, driving up consumption. However, between 2011 and 2017, household electrification rose significantly and kerosene consumption fell (see Figure 1).

                                        Figure 1: Kerosene consumption falls as household electrification rises

Source: Household electrification data from here. Kerosene consumption and reduced under recovery from here.

However, this fall in kerosene consumption has also been driven by two central government policies to reduce kerosene subsidy expenditure.

First, since the previous UPA regime, the Centre has been decreasing quotas of subsidised PDS kerosene that it allocates for states to distribute. The volume of reductions became larger in 2015 when the BJP government came to power and the global oil price fell (see Figure 2). The sharpest reduction was seen in 2016-17 when allocation nationally was reduced by over 20% from the previous year. The primary motivation for reducing allocation is controlling the subsidy expenditure borne by the central government. Other motivations include the large losses of PDS kerosene to the black market, which prevents intended poor beneficiaries from accessing subsidised kerosene, decreasing the efficiency of targeting of this subsidy.

        Figure 2: Kerosene Allocation to All States is Reducing

Source: Kerosene Allocation data from here

Second, since August 2016, it has progressively hiked the price of kerosene every fortnight by 25 paise per litre. Together, and in combination with the oil price crashed after 2013, these measures have created significant savings on the subsidy bill. In 2016-17, kerosene under recoveries (initially borne by the oil marketing companies but later compensated by the government) were reduced to Rs 7,606 crores, compared to Rs 29,409 crores in 2012-13 (see Figure 3).

Figure 3: Reduced kerosene allocations is reducing under-recovery

Source: PPAC, Ministry of Petroleum and Natural Gas

All these reductions in kerosene allocations have generated savings for the central government, but there is no clear mechanism by which we can tell whether or not they have been passed on to states. Some policies do exist. To further incentivise reductions in kerosene subsidy expenditure, for example, the Centre awards cash compensation to states that undertake voluntary reductions in the distribution of subsidised kerosene. Only a few states like Karnataka, Haryana and Telangana undertook voluntary cut for which about Rs 112.4 crore was transferred to them in 2016-17.

Given the central government’s plans to continue reduction in kerosene allocation, a significant amount of fiscal savings may accrue, but with no formal plan as to how they will be shared between the Centre and the states. Some states, therefore, run the risk of increasing costs for rural households’ lighting needs, with hardship most likely to increase in states where household electrification rates are low or poor quality, and a larger percentage of households are rural and poor such as Odisha, Bihar, Jharkhand and Uttar Pradesh.

Odisha, for example, in 2012, was home to 42 million people, of which 14 million are poor and as per Socio-Economic Caste Census (SECC 2011), 87% of the population resides in rural areas where electricity supply is poor.

Kerosene and other petroleum products are currently under the 5% tax bracket of the Goods and Services Tax. Credit: Reuters

How should savings be distributed if the funds spent on kerosene subsidies have, in the past, effectively functioned as a form of transfer between the states and the Centre?

State tax revenue

Kerosene and other petroleum products are currently under the 5% tax bracket of GST (goods and service tax) (formerly some states charged VAT between nil to Rs 5 per litre of PDS kerosene). When people consume less subsidised PDS kerosene, the states collect fewer taxes. Though this argument will not hold steady if households transition from PDS kerosene to other lighting fuels (grid electricity, solar etc.) on which the state may collect more GST. And hence any losses in revenue from kerosene tax revenue may be offset by higher tax revenue on other lighting products.

What remains clear is that because of reduced allocation, the Centre’s burden on lighting expenditure for the poor is being passed on to state governments. This is a strong rationale for states to negotiate with the Centre for higher compensation allowances—at least by states with a higher rural population.

Solar lighting opportunity

One welcome impact of the increase in kerosene price is that clean lighting solutions like solar lanterns become more cost-competitive: as prices have increased, a new set of policy briefs from the International Institute for Sustainable Development (IISD) has found that switching to a branded company’s entry-level solar lighting system will slightly reduce the annual cost of lighting for the household (see Figure 4).

Figure 4: PDS kerosene prices are rising, making solar lanterns competitive

Source: PPAC, Ministry of Petroleum and Natural Gas

Despite these favourable cost comparisons, solar lighting still faces a barrier that kerosene lighting does not: a high up-front house for using a system, which most poor households cannot overcome.

Given the net cost savings, states should consider negotiating for a share of kerosene subsidy savings in order to promote solar lighting solutions as a first-best response to meet the energy lighting needs of households.

Sum of their parts

Government efforts to reform kerosene subsidies make sense, as kerosene is expensive, dirty and the distribution system is prone to leakage and diversion. But for households without good access to electricity, there are significant energy access challenges to address.

The answer to this should lie in the savings that come from kerosene subsidy reforms themselves: Can a share of the money saved be provided to states to reinvest in cheaper, cleaner and more efficiently run subsidies for clean energy?

Shruti Sharma is policy advisor, International Institute for Sustainable Development. This article is based on three IISD policy papers, which examine the impacts of kerosene subsidy reform in India.