India's Policy Coup In Advance of G-20 Summit

June 25, 2010 12:00 PM

India has just implemented a policy coup. In arguably its most important policy reform over its two stints in office, the Congress-led Indian government announced a major package of deregulation of its petroleum pricing regime, which would reduce substantially consumer subsidies in this area. The reform covers four products: petrol, diesel, liquefied petroleum gas (LPG), and kerosene.  Petrol has been deregulated with immediate effect; prices for diesel will be deregulated in the near future; and in the case of the other two products, prices have been raised to reduce, but not eliminate, the subsidy.

Domestic Implications

This policy reform has major significance domestically and internationally.

Eliminating these subsides has been a kind of holy grail of reform because—to mix Christian and Hindu metaphors—consumer subsidies are a sacred cow: Cheap prices for petroleum products, especially kerosene and LPG, are seen as one of the most important policies to help the poor (despite the fact that much of these subsidies do not go to the poorest).

This government has been in power for over six years now, and its weakness was not so much that it failed to roll back dirigisme but that it was always flirting with fiscal populism. Although this populism has been attributed to the need for political support from the more left-oriented parties, the dirty secret was that fiscal populism was etched in the instincts of many within the Congress Party itself. With this policy reform, this government goes a long way in signaling that it is serious about long-run fiscal consolidation.

This reform will have three major benefits. First, it will place government finances on a better long-run trajectory because these subsidies have ranged from 1 to 2.5 percent of GDP, depending on world prices. India is one of those emerging markets whose public finances are still shaky, reflected in the fact that public debt to GDP remains high (about 80 percent of GDP) despite many years of rapid economic growth.

Second, it will reduce the inefficiencies—economic and environmental—from subsidized energy prices. The reforms announced today will increase petroleum prices by about 10 percent, reducing wasteful consumption and greenhouse gas emissions.

A third, more long-term (and subtle) benefit of this reform is that it signals that the government is willing and able to move from unfocused subsidies to better-targeted measures to meet its social objectives of helping the poorest.

Of course, one important caveat remains. Past efforts at petroleum deregulation have floundered when world oil prices have risen. The test for this government will be whether it can sustain deregulation when crude prices rise above $100 per barrel, and there are indications that the government might lapse into price controls under these circumstances.

International Consequences

It is not a coincidence—like with the announcement by China to move toward a more flexible currency—that the Indian reform was announced just ahead of the G-20 Summit in Toronto. Elimination of consumer subsidies in the energy area was one of the important policy reforms sought by the G-20. And in undertaking this reform India has signaled that it takes these international responsibilities seriously. India is not reforming because of international pressure but it is acknowledging that there are international dimensions to domestic and domestically motivated actions.

This reform also has implications for climate change negotiations and India's role in them. India has been portrayed as recalcitrant because of a perceived unwillingness to contribute to the international effort. But this reform will lead to substantial emissions reductions. The Organization for Economic Cooperation and Development has estimated that the elimination of consumer subsidies by India would reduce emissions by close to 25 percent.

While the United States and Europe bicker over stimulus and financial regulation this weekend with very little prospects for movement on either side, India, and China, may well steal the thunder with actual policy change.

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Arvind Subramanian Senior Research Staff

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