Fuel Subsidy Reform in Developing Countries: Direct Benefit


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Fuel Subsidy Reform in Developing Countries: Direct Benefit Transfer of LPG Cooking Gas Subsidy in India
Neeraj Mittal, Anit Mukherjee, and Alan Gelb*
Abstract
As shown by international experience, efforts to reform energy subsidies have a mixed record of success. This paper provides a detailed picture of the India’s reform of household subsidies for the purchase of LPG cooking gas—the largest cash transfer program in the world. From all available evidence the reform has been a success, both in reducing leakage and diversion of LPG to the commercial market and in improving the quality of service for legitimate beneficiaries. The paper documents the process of implementation, especially de-duplication of beneficiary lists, elimination of price subsidies by direct transfers to bank accounts, and the use of Aadhaar, India’s biometric ID program, to improve access to poor and rural beneficiaries, especially women. Lessons for other countries include: (i) clearly articulating reform objectives helps to build strong political support; (ii) capping consumption of subsidized cylinders together with removal of market price distortion reduces black marketing and improves quality of service delivery; (iii) information campaigns and social media can encourage self-targeting and “nudge” the wealthy to opt out of the subsidy; and (iv) using information technology and digital ID, or Aadhaar, eliminates duplicates and provides fiscal space to target subsidies and expand access to clean cooking fuel for poor rural households, especially women.
* Neeraj Mittal, World Bank; Anit Mukherjee, Center for Global Development; Alan Gelb, Center for Global Development
Neeraj Mittal, Anit Mukherjee, and Alan Gelb. “Fuel Subsidy Reform in Developing Countries: Direct Benefit Transfer of LPG Cooking Gas Subsidy in India.” CGD Policy Paper. Washington, DC: Center for Global Development. https://www.cgdev.org/publication/fuel-subsidy-reform-developingcountries-india
CGD is grateful for contributions from the Bill & Melinda Gates Foundation in support of CGD staff and resources for this work.
CGD Policy Paper 114 December 2017

Table of Contents
Glossary .............................................................................................................................................2 1. Introduction and Overview ........................................................................................................3 2. The Previous System and Motivation for the Reform ...........................................................5
2.1. How the Previous System Worked....................................................................................5 2.2. The Need for Better Fiscal Management of Fuel Subsidies ..........................................5 2.3. The Need for Better Effective Targeting of Fuel Subsidies ..........................................7 3. Implementation of LPG Subsidy reform .................................................................................8 3.1. Preparatory Stages ................................................................................................................8 3.2. Harmonizing and De-duplicating Beneficiary Lists ......................................................10 3.3. Capping LPG Consumption.............................................................................................13 3.4. DBTL: Shifting from In-Kind to Cash Subsidy Payment............................................16 3.5. Targeting Subsidies: From Self-selection to Exclusion Criteria..................................20 3.6. Expanding Access to LPG—the Prime Minister’s Ujjwala Program (PMUY) .........23 4. Savings from Reform and Effects on Consumers ................................................................25 5. Perspectives and Lessons from LPG Subsidy Reform ........................................................28 5.1. Process .................................................................................................................................29 5.2. People...................................................................................................................................31 5.3. Technology ..........................................................................................................................31 6. Concluding Remarks..................................................................................................................33 References ........................................................................................................................................ 34 Appendix 1 ......................................................................................................................................36

The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.
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Glossary

AEPS

Aadhaar Enabled Payment System

APB

Aadhaar Payment Bridge

CTC

Cash Transfer Compliant

DBT

Direct Benefit Transfer

DBTL

Direct Benefit Transfer of LPG

KYC

Know Your Customer

LPG

Liquified Petroleum Gas

MoPNG

Ministry of Petroleum and Natural Gas

NCPI

National Payments Corporation of India

OMC

Oil Marketing Company

PaHaL

Pratyaksh Hastantarit Laabh (Direct Benefit Transfer of LPG)

PDS

Public Distribution System

PMUY

Pradhan Mantri Ujjwala Program

UIDAI

Unique ID Authority of India

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1. Introduction and Overview
India’s cooking gas subsidy is the largest direct benefit transfer program in the world. Also known by its acronym PaHaL,1 it enables transfers of cash subsidy on LPG cylinders directly to the bank accounts of 177 million subscribers enrolled with the three state-owned petroleum product marketing companies in India.2 The direct benefit transfer for LPG (DBTL) scheme was initiated in 2013, but the current form of scheme called PaHaL was rolled out on 15 November 2014 and progressively rolled out to cover the entire country by early 2015. Within four years, the program has transferred a total of nearly $10 billion in public subsidy to LPG consumers and currently involves approximately 40 million subsidy transfer transactions every day.3
India’s LPG reform is a rare case of success in achieving reform in the difficult area of energy subsidy reform. PaHaL has increased efficiency and reduced leakages compared to the previous in-kind subsidy regime, resulting in significant fiscal savings for the government at fraction of the cost of the program. By providing additional fiscal space, it has also facilitated a rapid expansion of clean cooking fuel especially to poor rural households who were previously left out of the LPG network. In the process, it is reducing exposure to household air pollution with positive long term health benefits, in particular for rural women and girls.
Energy subsidies are particularly difficult to reform. Over the past two decades, several countries have tried to rationalize fuel subsidies to maintain fiscal stability and improve market efficiency (IMF, 2013). In almost all cases, the policy has been to increase administered prices, leaving the underlying iniquitous distribution of benefits unchanged. India has moved to market price for LPG and targeted the subsidy towards lower income groups. Few countries have tried to impose consumption caps through vouchers that are particularly hard to administer and are quickly undermined by black marketing and corruption. India’s experiment with subsidized LPG consumption cap is therefore an interesting case, especially since it seems to have coincided with improved service delivery (Gelb et.al., 2017). With the exception of Iran, none of these reform cases have used cash transfers as a compensatory mechanism while this is one of the most important innovations in India. Finally, there are few cases where the reform process has leveraged technology in the way India’s program has to manage change and deliver benefits. This has important implications for future design of energy subsidy reforms in other countries with comparable architecture, including digital ID, access to financial services and mobile enabled information and communication.
All reform efforts face political opposition and popular backlash. Resistance stems from several factors, including misinformation about the impact of the reform, lack of trust in leadership, poor perceptions of government effectiveness and inadequate compensation for
1 Pratyaksh (Direct) Hastantarit (Transfer) Labh(Benefit) in Hindi 2 http://mylpg.in/ 3 https://dbtbharat.gov.in/scheme/schemedetail?id=MQ==
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poor households that are most severely impacted by price increases (Atansah et.al., 2017). India’s LPG reforms provide lessons on how to mitigate these political economy risks that could derail energy subsidy reform programs.
The success or failure of energy subsidy reforms depend on the ability of governments to institute permanent and stable reform that gain public support and mitigate opposition by coalition of vested interests. The design, sequencing, coordination and implementation of various components of the reform agenda is crucial to its success. India’s LPG reform program provides an opportunity to understand how these have been brought together to achieve the objectives of public policy, providing lessons for other countries facing similar challenges in restructuring their own energy subsidies.
The reform program in India adopted a two-pronged approach. On the one hand, it has cleaned up and pruned the subsidy beneficiary lists. This involved the one-time removal of duplicate and ghost connections through a Know Your Customer (KYC), which reduced diversion of subsidized LPG cylinders from domestic to commercial use using these ghost connections. The KYC process also prevents duplicate enrollments in the 10-12 million new customers who apply for LPG connections each year. The program also allowed the move to target subsidies that were previously universal. Over 10.5 million people have been motivated to voluntarily give up their subsidy through the GiveItUp initiative, a rare example of a reform that has successfully incorporated self-targeting of a subsidy regime by nudging those who did not need it to opt out. By putting in place a system of standardized, deduplicated list of consumers, the program will improve the targeting and distribution of public resources on fuel subsidies for the foreseeable future.
On the other hand, the reform has removed market distortions and the incentive to divert LPG due to a dual pricing mechanism. LPG cylinders are now sold at the market price through the supply chain right up to the consumer, and the subsidy is only transferred after delivery, directly to consumers’ bank accounts. The number of subsidized cylinders is capped at 12 per connection per year. While the new subsidy mechanism has shielded the beneficiaries from the volatility of international fuel prices it has simultaneously enabled the central government to manage its expenditure on fuel subsidies by cutting down on leakages.
India’s cooking gas subsidy has demonstrated that it is possible to implement a complex reform that leverages technology—including digital ID, electronic banking in conjunction with sound policy measures, in a harmonized way in spite of political sensitivity. It has also supported a broader social goal—expanding access to clean cooking fuel for all, including the poor thereby increasing buy-in of those consumers who are adversely impacted by the reform. This makes it particularly interesting as a model for programs to reform other inkind subsidies in India, such as food and fertilizer, and for other countries striving to improve the efficiency and equity of their own subsidy mechanisms.
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2. The Previous System and Motivation for the Reform
2.1. How the Previous System Worked Before the reforms, all registered domestic users received unlimited domestic LPG cooking gas delivered to their place of residence in 14.2 kg cylinders in response to bookings made by them with their LPG distributor for one of the Oil Marketing Companies (OMCs) at subsidized prices fixed by the Government. The subsidized price of the domestic LPG cylinders was set by the Ministry of Petroleum and Natural Gas (MoPNG) based on federal Cabinet decisions, and the consumers paid that price irrespective of the international market price of LPG. The subsidy could be as high as 100 percent of the payments in certain months or even more when LPG prices were high in global markets.
The difference between actual market price and subsidized retail price—the LPG subsidy— was absorbed on the balance sheets (called “under-recoveries”) of the oil marketing companies and partly covered by the federal government’s budget. Consumers were unaware of the subsidy burden, paying only the subsidized price set by the federal government.
The difference in price between subsidized domestic LPG and commercial LPG (that was sold at market price and faced higher taxes) created an incentive for intermediaries to divert the subsidized LPG for commercial purposes (Barnwal, 2016). The supply chain of LPG was opaque and in the absence of access to the booking/ supply details, the end consumer was not even aware of the diversion. While this was universally recognized and widely reported in the media, there was little systematic data on the quantum of produce diverted but anecdotal evidence pointed to a black-market cylinder price that was double that of the subsidized price.
To tackle the issue, governments have tried various initiatives—including color coding LPG cylinders (red for domestic, blue for commercial use), raids on warehouses by criminal investigating agencies and radio frequency (RFID) tagging with smartcards that could track consumers. However, none of these efforts addressed the core problems effectively— duplicate/ghost LPG connections, the inability of consumers to track delivery of domestic LPG cylinders and the dual pricing in the supply chain leading to wide gap between prices of domestic and commercial LPG rates. These initiatives could also not address the problem of unreliable supply arising exacerbated by diversion to the commercial sector and the lack of accountability of domestic deliveries.
2.2. The Need for Better Fiscal Management of Fuel Subsidies Budgetary subsidies in India have been the subject of intense policy debate since the early 1990s. In 1991, India started a process of economic liberalization under an IMF structural adjustment program. Government’s control over the economy, known as the “license-permit raj” was progressively dismantled to encourage private investment in manufacturing and services. Tariffs on imports were significantly reduced, exposing domestic producers to external competition. Reforms included rationalizing the existing subsidy regime to reduce fiscal and revenue deficits, with energy subsidies being at the center of the debate.
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Nevertheless, the subsidy reform effort over the last quarter of a century has been erratic at best and ineffective at worst. During the structural adjustment period from 1992 to 1996, subsidies as a percentage of GDP declined from 4.92 percent to 3.61 percent. The fiscal deficit fell from 7.6 percent of GDP before the reforms to 5.6 percent in 1995-96, demonstrating the government’s commitment to better fiscal management (Kumar et.al., 2004).
However, popular backlash against hardline structural adjustment policies resulted in a period of political instability in the second half of the 1990s. Successive changes of government led to a reversal of fiscal performance especially in food, fertilizer, and fuel subsidies. At the aggregate level, subsidies rose to 4.59 percent of GDP by early 2000, with both food and fertilizer subsidies increasing by nearly 20 percent between 1995-2000. By 2003-04, the subsidy bill contributed nearly 80 percent of the fiscal deficit, putting macroeconomic stability of the economy in jeopardy (Kumar et.al., 2004).
Management of fuel subsidies has been particularly problematic. Compared to food and fertilizer, fuel subsidies are more sensitive to fluctuation in the international energy prices as India’s import dependency is over 80 percent (Rangarajan, 2006). The basket of commodities is diverse. It includes motor spirits (petrol and high speed diesel) distributed through a retail network controlled by state oil marketing companies. Kerosene for cooking and lighting is sold exclusively through the public distribution system (PDS). Cooking LPG bottled in cylinders is sold by a network of distributors selected by, and on contract with, the oil marketing companies. In addition to these final products, crude oil derivatives are also used in the manufacture of fertilizer with its own elaborate system of producer subsidies. The logistics of crude production, distribution and end use in various sectors involves millions of intermediaries and at least three different ministries of the government of India.
Until 2002, the central government fixed the final price of petroleum products below its full cost to shield consumers from the adverse impact of volatility in international prices. In 2002, the government took the first step towards decontrol of the administered price regime by allowing the oil marketing companies to fix petrol and diesel prices based on the fortnightly average of the prevailing international price of crude. While fiscally responsible, it was understandably a deeply unpopular measure, and was discontinued under the next government that came into power after the elections in 2004. The rollback was ill-timed— estimated fuel subsidies increased from 0.6 percent of GDP in 2004-05 to 1.9 percent in 2007-08, due to the sharp increase in crude oil prices from $40 per barrel to $140 in the international market during that period. (Anand et.al. 2013)
In 2005, the Parliament enacted the Fiscal Responsibility and Budget Management (FRBM) Act that capped the fiscal deficit at 3 percent of GDP, reducing the headroom for absorbing significantly higher subsidies on imports and consumption of petroleum products. The burgeoning fiscal cost due to the increase in international crude oil prices necessitated a radical rethink of the administered price regime and a holistic look at the structure of the prevailing fuel subsidies in India.
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In June 2010, the government announced full decontrol of petrol prices giving the oil marketing companies the task of setting pump prices of petrol aligned to the global price of crude oil. It also announced a phased decontrol of diesel prices but kept kerosene and LPG out of the ambit. While there is still considerable ambiguity about the fate of kerosene subsidies, major reforms have been carried out in LPG supply chain and subsidy management. These started in mid-2013 with Project Lakshya and continued by the PaHaL program that was rolled out nationwide from January 2015 onwards (Mittal 2014). These reforms also set the stage for the Ujjwala program, that provides subsidized LPG to poor rural households.
2.3. The Need for Better Effective Targeting of Fuel Subsidies Apart from the fiscal management imperative, inequities in the distribution of public subsidies was also evident. Relatively richer and administratively more efficient states were able to garner a larger share of consumer subsidies, especially on food and fuel (Chakraborty, Mukherjee and Amarnath 2010). While most of the poor resided in rural areas, mis-targeting and diversion resulted in an urban bias in the incidence of food and fuel subsidies (Howes and Jha 1992; Anand et. al. 2013). Finally, using data from the National Sample Survey, various studies documented the wide disparity in the distribution of subsidy across income deciles. In 2004-05, ten years after the so-called “targeted” PDS (TPDS) was launched to give higher food grain entitlement to below poverty line families, the offtake of poorer households was actually 10 percent less than that of richer households both in rural and urban areas. Reducing targeting errors, along with the elimination of diversion was estimated to improve the incidence of subsidy on poorer households by nearly 25 percent (Jha and Ramaswami 2010).
Except for kerosene which is distributed through the PDS system, fuel subsidies in India were universal in nature and included in the subsidized price of the product, with adverse distributional impact. This is not very different from the experiences of most other countries, where fuel subsidies are often captured by the relatively richer segments of the population (IMF 2013). Per IMF estimates, the top 20 percent of households in India captured six times more in benefits from fuel subsidies than the poorest 20 percent of the population (Anand et.al., 2013).
The product mix in fuel consumption varies considerably across income classes (Figure 1). While almost all the subsidy to the bottom 20 percent was from use of PDS kerosene, more than half of the total fuel subsidy going to the top 20 percent was from the use of LPG. (Anand et.al. 2013). This reflects the differences in composition of cooking fuel between urban and rural areas—65 percent of urban households reported LPG as their primary cooking fuel in 2011, compared to 11.4 percent of rural households who depended overwhelmingly on firewood and other biomass (Registrar General of India, 2011). It is also an indication of the difficulty faced by poor households to pay for initial setup costs and recurring expenses for LPG. Weak LPG distribution network in rural areas was an additional barrier. The LPG subsidy was thus inequitable and did not much benefit the poor, providing the rationale for a radical overhaul of the system (Lahoti et.al., 2012).
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Figure 1: Distribution of Subsidies—By income group and type of product, 2009-10
3. Implementation of LPG Subsidy Reform
3.1. Preparatory Stages The LPG reforms were the culmination of nearly a decade of policy recommendations by various committees set up by the government of India to provide guidance on fuel subsidy reform. While the detailed terms of reference of the committees varied, they had a similar mandate: to recommend strategies for the government to rationalize fuel subsidies including LPG and improve its targeting. Recommendations relevant to the case study are summarized in Box 1.
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Fuel Subsidy Reform in Developing Countries: Direct Benefit