The invisible hand of self-interest: Corruption and politics of fuel subsidies

Presentation byDr. Bhamy V. Shenoy at A seminar organized by

Global Subsidy Initiative on The Hidden Costs of Fuel Subsidies in India

At Mumbai YMCA, March 8, 2011

Political Economy of Subsidy Reform in IndiaHistory of Petro-product subsidies

• 1939-1945: Subsidized kerosene included in Public Distribution System(PDS) for residential Consumers.

• Late 1960s: subsidies for liquified petroleum gas(LPG) introduced for res. consumers.

• 1976: Petroleum prices fixed under administrative price mechanism (APM)

• 1980s: First attempt at marking subsidized kerosene with dye.

Political Economy of Subsidy Reform in IndiaHistory of Petro-product subsidies

• 1989: Coupon system introduced to control access to subsidized kerosene in Mysore (program closed after two years).

• 2002: APM dismantled: Petroleum prices liberalized. But not kerosene and res. LPG.

• 2003: Government starts to control prices again.

• 2005: GPS fitted to kerosene distribution trucks to prevent diversion (closed in 2008)

• 2006: Adding a specialized dye to kerosene (program closed in 2008)

Political Economy of Subsidy Reform in IndiaHistory of Petro-product subsidies

• 2007: Planning commission recommends introduction of “high tech” smart cards to distribute residential kerosene. No state governments showed interest.

• Three high level committees to look at petro pricing

• 2006: Rangarajan committee recommends liberalization of petro product prices.

• 2008: Chutervedi committee also recommends liberalization of petro product prices.

• 2010: Parikh Committee recommends market oriented pricing. None of the committee reports were implemented till in July when gasoline was liberalized.

Political Economy of Subsidy Reform in IndiaHistory of Petro-product subsidies

• My research goes into the factors preventing any government to implement subsidy reforms despite the huge burden it imposes on the economy.

• India has been trying to reform subsidy regime through many innovative schemes, but the political system is preventing it.

• Three high level committees, several strategies like adding dyes, GPS to monitor trucks, coupon system, Smart card idea, Bio-metric Unique Identification Number etc.

• Every scheme has failed or not implemented. Why? It is Adam Smith’s invisible hand of self interest

The invisible hand of self-interest: Corruption and politics of fuel subsidies

0

18

35

53

70

0

18

35

53

70

0

18

35

53

70

Drivers behind adulteration and Diversion : Price differentials (Rs/litre)

0

18

35

53

70

PDS Kero Mar Kero Petrol Diesel Mar LPG Res LPG Comm LPG Auto LPG

39.4236.92

13.47

25.57

34.50

61.83

33.70

12.18

The invisible hand of self-interest: Corruption and politics of fuel subsidies

0

15000

30000

45000

60000

Petrol Diesel Kerosene LPG

2839324639

51027

297

Petroleum Sector subsidies at $100/b ( Rs crores)

The invisible hand of self-interest: Corruption and politics of fuel subsidies

0

3750

7500

11250

15000

LPG Sub Kero-sub Div to petrol Div to diesel Div of LPG

14326

1595

14522

98568518

Collection of rents from adulteration and diversion of subsidized products (in Rs. Crores per year)

The invisible hand of self-interest: Corruption and politics of fuel subsidies

Under recoveries by oil companies (Rs crores)Under recoveries by oil companies (Rs crores)Under recoveries by oil companies (Rs crores)Under recoveries by oil companies (Rs crores)Under recoveries by oil companies (Rs crores)Under recoveries by oil companies (Rs crores)

2005-06 2006-07 2007-08 2008-09 2009-10

PDS Kerosene 14384 17883 19102 28225 17364

Residential LPG 10246 10701 15523 17600 14257

Gasoline 2723 2027 7322 5181 5151

Diesel 12647 18776 35166 52286 9279Total Under-recoveries 40000 49387 77123 103292 46051

When crude oil price was $147/b, under recoveries of oil companies were Rs. 250,000 crores. This was 38% of

total government revenues. Private companies were forced to close their 3000 service stations.

When crude oil price was $147/b, under recoveries of oil companies were Rs. 250,000 crores. This was 38% of

total government revenues. Private companies were forced to close their 3000 service stations.

When crude oil price was $147/b, under recoveries of oil companies were Rs. 250,000 crores. This was 38% of

total government revenues. Private companies were forced to close their 3000 service stations.

When crude oil price was $147/b, under recoveries of oil companies were Rs. 250,000 crores. This was 38% of

total government revenues. Private companies were forced to close their 3000 service stations.

When crude oil price was $147/b, under recoveries of oil companies were Rs. 250,000 crores. This was 38% of

total government revenues. Private companies were forced to close their 3000 service stations.

When crude oil price was $147/b, under recoveries of oil companies were Rs. 250,000 crores. This was 38% of

total government revenues. Private companies were forced to close their 3000 service stations.

The invisible hand of self-interest: Corruption and politics of fuel subsidies

How were subsidies financed? (Rs. Crores)How were subsidies financed? (Rs. Crores)How were subsidies financed? (Rs. Crores)How were subsidies financed? (Rs. Crores)How were subsidies financed? (Rs. Crores)

Type of Assistance 2004-05 2005-06 2006-07 2007-08

Transfer from Upstream 5947 14000 20507 25708

Central budget 2957 2930 3080 2822

Oil bonds 0 11500 24121 35290

total 8904 28430 47708 63820Losses absorbed

by marketing companies

NA 11570 1679 13303

The invisible hand of self-interest: Corruption and politics of fuel subsidies

• Many questions the estimates of under recoveries by OMCs. They feel it overstates the losses. Some also feel that the gov. can reduce prices by reducing taxes. If we go by international standards of taxing the downstream and also overall profitability of downstream, such arguments are not valid.

Petrol price build up Rs/litre

Crude oil cost 28.31Customs duty 1.46Refining cost 0.77Premium for petrol 3.80Transportation cost 1.2Marketing cost 1.1customs duty (exc) 2.41Excise taxes 14.35

Education cess 0.43

Sales taxes 12.37

total cost 63.79Sales price 61.83Profit/loss -1.96

0 20 40 60 80 100 120 140 160 180 200

GreenBenchmark Line:

Retail Price ofGasoline in theUnited States

= 56 US Cents/Litre

RedBenchmark Line:Price of Crude Oilon World Market

= 30 US Cents/Litre(= US$48/Barrel)

GreyBenchmark Line:

Retail Price ofGasoline in Spain

= 123 US Cents/Litre

Gas

oline

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1235630

Cat

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at. 2

Cat

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Country Category 1Very High Gasoline Subsidies

(1–29 US Cents)

The retail price of Gasoline is below the price for crude oil on the world market.

Country Category 2Gasoline Subsidies (30–55 US Cents)

The retail price of Gasoline is above the price for crude oil on the world market and below the price level of the United States.Note: The fuel prices of the United States are average cost-covering retail prices incl. industry margin, VAT and incl. approx. 10 US cents for the 2 road funds (federal and state). This fuel price may be considered as the international minimum benchmark for a non-subsidised road transport policy.

Country Category 4Very High Gasoline Taxation

(123–253 US Cents)

The retail price of Gasoline is above the price level of Spain.

Country Category 3Gasoline Taxation (56–122 US Cents)

The retail price of Gasoline is above the price level of the United States and below the price level of Spain.Note: In November 2008, fuel prices in Spain were the lowest in EU-15. Prices in EU countries are subject to VAT, fuel taxes as well as other country-speci!c duties and taxes.

Iran* 10S. Arabia 16Turkmenistan 22

Kuwait 24Oman 31

Trinidad and Tobago 36Myanmar (Burma) 43

Egypt 49Ecuador 51

Malaysia 53Nigeria 59

Taiwan (China) 64Panama 67

Belize 70Azerbaijan 74

Australia 74Canada 76

Liberia 77El Salvador 78

Gambia 79Vietnam 80

Kyrgyzstan 80Kazakhstan 83

Guyana 84Guatemala 86

!ailand 87South Africa 87

Botswana 88Togo 89

Philippines 91Bhutan 91Lao PDR 92Cambodia 94

Chile 95Niger 99

Barbados 100Tajikistan 103Colombia 104

Afghanistan 105Armenia 108

New Zealand 109Kosovo 110

Tanzania 111Somalia 112

Nepal 113Lithuania 113Cameroon 114Macedonia 115

Haiti 116Paraguay 117

Slovenia 118Moldova 120

Timor-Leste (East Timor) 122Spain 123

Andorra 124Brazil 126

Croatia 127Cyprus, South 128

Bulgaria 128Serbia 129

Mali 130Chad 130

Switzerland 130Côte d'Ivoire 133

Uzbekistan 135Albania 136

Austria 137Israel 137

Mongolia 138Burundi 139

Peru 142Sri Lanka 143

Central African Republic 144Mauritania 149

Korea, South (R.) 151Denmark 154

Germany 156Finland 157

Slovakia 157Sudan, South 159

Norway 163Malta 166

Netherlands 168Mozambique 171

Guadeloupe 181Turkey 187

Eritrea 253

* Ira

n: 5

3 U

S-¢/

litre

for s

ales

abo

ve 1

20 li

tres

/mon

th 2 Venezuela

14 Libya21 Bahrain22 Qatar

30 Yemen34 Algeria

38 Brunei45 United Arab Emirates

50 Indonesia53 Angola

56 United States61 Jordan

65 Sudan68 Bolivia

74 Mexico74 Jamaica

76 Lebanon76 Korea, North (D.R.)

78 Argentina78 Namibia79 Lesotho80 Honduras81 Congo, R. (Brazzaville)

84 Pakistan85 Syria86 Swaziland87 Nicaragua88 Ukraine89 Russian Federation90 Ghana91 Sierra Leone91 Suriname92 Ethiopia

94 Papua New Guinea96 Tunisia

99 China102 Guinea103 Benin104 Dominican Republic

107 Singapore109 India109 Georgia

111 Romania111 Antigua and Barbuda112 Latvia113 Bosnia and Herzegovina114 Gabon115 Fiji115 Iceland117 Bangladesh

118 Uruguay118 Estonia

120 Kenya123 Congo, D.R. (Kinshasa)123 Greece124 Costa Rica

127 Montenegro127 Hungary128 Grenada129 Morocco130 Zimbabwe130 Uganda130 Liechtenstein

133 Belarus134 Palestine (W. Bank and Gaza)135 Senegal

137 Rwanda137 Czech Republic138 Burkina Faso138 Sweden

140 Luxembourg142 Japan

143 Poland144 United Kingdom

150 Belgium152 France

155 Madagascar156 Ireland157 Italy158 Tahiti (French Polynesia)

161 Portugal164 Monaco

167 Cuba170 Zambia

178 Malawi184 Cape Verde

195 China, Hong Kong

Retail price of petrol in 174 countries as of Sep 2008

The invisible hand of self-interest: Corruption and politics of fuel subsidies

• All political parties clamour for subsidies to help the poor. In reality most of the subsidies go into their pockets. The owner of this bullock cart is unable to earn subsistence living.

The invisible hand of self-interest: Corruption and politics of fuel subsidies

• This is a regular sight seen in the morning in many urban areas where people wait for hours to get their kerosene quota. These are the people for whom political leaders pretend to shed crocodile tears.

The invisible hand of self-interest: Corruption and politics of fuel subsidies

• Subsidies influence not only supply/demand for fossil fuels. It has impact on GHGs. We have been mostly concerning ourselves with economic impact of subsidy reform.

• In India and most likely in other developing countries, misused subsidies affect governance because of generation of black money on a large scale. It is this aspect of subsidy reform which has not got the attention which it deserves.

The invisible hand of self-interest: Corruption and politics of fuel subsidies

• Manjunath, an IIM graduate was murdered by kerosene mafia in 2005. PM gave assurance that he would take steps to diversion of PDS kerosene. In 2010, an additional collector was mudered by kerosene mafia. Drowned in scams, his murder has been already gone off the national agenda.

The invisible hand of self-interest: Corruption and politics of fuel subsidies

• In recent months when 2G scam, CWG scam, Adarsh scam have caught the imagination of the media and political class, why has petroleum scam involving PDS kerosene and residential LPG which is far larger been ignored? Is it because the latter is systemic while in the former high visible leaders are involved?

The invisible hand of self-interest: Corruption and politics of fuel subsidies

RECOMMENDATIONS

• In India we need greater publicity to the generation of black money through the misuse of fossil subsidies and the real beneficiaries of such subsidies. Beneficiaries are not the poor as often claimed by politicians.

• In comparison to many countries including some of the developing countries, India’s tax rates are low.

• While assisting the poor is justified, we need to improve delivery system to improve governance.