LAST year, the government dismantled the administered price mechanism for petroleum products. It deregulated the price of petrol, but stopped short of doing the same in the case of diesel and cooking gas, saying higher prices of these fuels could hit the poorer sections of the society. The government continues to pay huge amounts as subsidies to fuel retailers to sell petroleum products below cost. ET takes a look at the practice of subsidising fuels and its impact on the economy.
How are prices set in India?
While prices of most goods and services in India are market determined, administered pricing exists in certain sensitive sectors. The government offers subsidies on some goods and services, changing the price at which they are sold. It works in the opposite direction of a tax, by decreasing the final price rather than increasing it. For example, diesel is sold at a lower price than petrol, as it is used by the railways and trucks. An increase in transportation costs would directly lead to an increase in the prices of most food items, which would, in turn, hurt the vulnerable sections of the population.
Is this the ideal way?
Economic theory says prices should be left to the forces of demand and supply and should not be tampered with as they reflect relative scarcities. But even in advanced market economies, governments offer subsidies to protect weaker sectors of the economy.
How does the government finance subsidies?
The government funds these subsidies using part of its revenues from taxes on goods and services.
What are problems with the current system?
Whenever the government offers subsidies it alters the final consumer prices, affecting the consumption patterns in the economy. For example, people buy diesel vehicles because they can obtain the fuel at a lower price.
Are there other ways of supporting those in need?
There are other solutions where prices would be left untouched and people would be given direct support through cash transfers. But this raises other issues such as setting criteria for selection of people who deserve support. There could also be problems in identifying people for cash payouts.
