Why electricity subsidies need an urgent rethink
With several assembly elections scheduled this year, political parties are promising free power. But, we are oversubsidising in most states, and doing it inefficiently. A dialogue of effective and efficient subsidy provision is urgent, and the first step on this road is transparency
Several assembly elections are scheduled over the next 12 months, with a range of electoral promises being offered by all political parties. Some of these pledges have moved beyond subsidised electricity to free power for India’s poorer households. This is worrying because providing higher subsidies appears to be an unwinnable battle. Subsidies are not inherently bad. Even electricity prices before subsidies are meant to be progressive. For instance, much like our income tax brackets, consumers who use less power have lower prices per unit. The more units you consume, the higher the prices go, benefiting the poor.
Further, subsidies for agricultural power supply, despite their problems, are meant to keep food affordable and secure. Therefore, these agricultural subsidies serve the purpose of ensuring food security. However, it is household electricity subsidies that need examination along several dimensions: One, targeting; two, saving energy; and three, financial impacts. Unfortunately, subsidies are currently failing on most of these counts. Therefore, instead of free power, the system of electricity subsidies needs a structural rethink.
Who is deserving of a subsidy is difficult to answer, for this is a policy choice. However, we can benchmark policies by examining who gets how much subsidy. Electricity follows a principle of social welfare redistribution to keep it affordable. First, via cross-subsidies (differential pricing across consumers, set by regulators), and then, through subsequent subsidies that the state government may choose to offer. The choices for state governments start with the thresholds or limits for eligibility and how much subsidy should be offered.
Our analysis reveals that we are oversubsidising in most states. The national monthly average of household consumption in Financial Year (FY) 2019 was 105 units (kilowatt-hours or kWh) of electricity, varying from 60 to 260 kWh across states. But the limits for eligibility can be several hundred kWh. For example, Delhi’s 400 kWh/month limit means almost 90% of homes are eligible for a subsidy in a given year.
Further, how we offer subsidies also matters. Giving a set number of units free doesn’t incentivise consumers to save energy when they are well behind the threshold. And larger consumers, who are ostensibly richer, take home more subsidies since they use up subsidised units.
The aggregate fiscal impact of subsidies is also problematic. The average electricity subsidy has tripled from fiscal year FY 15 to FY 21, currently standing at ₹1.37 per unit sold. This translates into subsidies now comprising 21% of the revenue generated from the sale of power, up from 11% in FY15. Not only are subsidies high, but they’re also often not paid on time. This hurts the cash flows and viability of distribution companies (discoms). Even for state budgets, subsidies (including subsidised power for agriculture) can be a large outlay, as high as tens of thousands of crores, and step-changes in promised subsidies can double the subsidy burden.
Since most parties focus on pledging free (or subsidised) consumption, the only way to do better in this model is to give more. If we truly want to protect the poor, as subsidies set out to do, we should also give them relief from fixed-cost charges, which place a disproportionate burden on low-volume consumers. The Centre for Social and Economic Progress (CSEP) studies identified this as an issue in Delhi’s first round of subsidies, where the rich got more subsidy than the poor, even in relative terms. This aspect has since been addressed in Delhi with revised subsidy norms that covered the total bill.
Other details also matter. For example, two states can have different models for the same — say, a subsidy of 300 kWh/month. In one, crossing this threshold ends all subsidies, while in another, crossing the threshold only stops consumers from receiving further subsidies for higher consumption. So, while this is meant to be a pro-poor endeavour, a reasonable cap on subsidies may be advised. This may increase costs for some (richer) segments of consumers, but it is likely to not only encourage greater energy efficiency but also accelerate the shift to green energy through the installation of rooftop solar power systems. Phasing out subsidies as consumption reaches the eligibility threshold is progressive and may reinforce greater percentage savings from consuming less. Making subsidies progressive is just one dimension, for all subsidy schemes should be explicit in their target share of coverage, which, ideally, should be limited to the most deserving.
Furthermore, in our goal to make consumption cheaper, we can nudge citizens to buy more efficient appliances. A key example is the government’s major success in promoting energy-efficient LED bulbs. Repurposing some of the state electricity subsidies for, say, efficient fans, which consume less energy, can also be successful policy pushes that occur simultaneously.
There are several possibilities, such as pilot projects to use direct benefit transfers to consumers instead of paying the discoms directly, which, despite larger issues of threshold and eligibility, can address some woes. Another focus area should be providing quality power supply, since unreliable power supply hurts the poor the most due to the lack of affordable back-up power.
A dialogue of effective, efficient subsidy provision is urgent, and the first step in this pursuit is transparency. This means the need for mandatory detailed compilations of subsidies, which today are not formally captured in regulatory accounts.
All end-users want cheaper power, but this should be done through improved discom operations, including lower system losses. The main hurdle in rethinking the existing framework is changing our mindsets and understanding of power subsidies. We need to stop thinking of them as an unlimited river, and instead as a limited and precious resource, one that needs to be used efficiently, and most importantly, fairly.
Nikhil Tyagi is research associate and Rahul Tongia is senior fellow at the Centre for Social and Economic Progress (CSEP), a New Delhi-based not-for-profit think tank
The views expressed are personal