Time to set price distortions right

India should focus on reducing cost of doing business

April 20, 2022 12:25 am | Updated 11:44 am IST

One of the key objectives of reforms has been to reduce the distortions generated by the earlier excessive micromanagement of the economy. With internal economic liberalisation, openness to international trade and investment, an open free market economy has emerged. Improving the ease of doing business continues to be a major priority. But even more important is the cost of doing business. For this, action is needed to reduce government policy-induced pricing distortions which add to the cost of doing business. In our open economy, these pricing distortions have become a source of competitive disadvantage to domestic value addition and job creation. India’s relative lack of success in manufacturing and employment generation is the outcome.

As with all reforms, it would need leadership and investment of political capital in generating a consensus and steering change. Reformers, who advocate that a crisis is the best time for difficult reforms, take an irresponsible undemocratic view and serve the political leadership poorly as the nation has discovered with the three farm laws which came through ordinances. The origin of government policy induced pricing distortions lie in the political need to find a way out for a cash-strapped government to raise resources. Or, to provide affordable goods and services to those in need through a cross subsidy within the sector without having to find money for direct subsidy payments. It is time for an informed discussion on these distortions.

Pricing distortion in petrol, diesel

Energy is the basic requirement of the modern industrial economy and the key to competitiveness. Its pricing distortions are onerous. In the early days, cars were considered luxury goods and high excise duty was levied on petrol, but it was lower on diesel to make it cheaper for the essential needs of transport. The price difference between petrol and diesel led to a surge in the supply and use of diesel cars and SUVs. This distortion led the government to increase the price of diesel gradually. The price difference has since been marginal. But the exceptionally large revenues that came to the government from the high taxes on petrol and diesel created such a dependency that these have been kept out of GST. More recently, the central government has been raising taxes on these to raise additional revenues to moderate the fiscal impact from COVID. This has given an inflationary impetus. But the real adverse impact is on the cost of road transport of goods which makes the cost of logistics about twice that of our competitors. Petrol and diesel, therefore, need to come under GST. Even at the highest rate of 28%, the price of petrol would be around ₹60 per litre. The discussion needs to be on how to manage government finances thereafter.

Electricity pricing is also highly distorted. A cess of ₹400 per tonne on coal was levied to generate resources for promotion of renewable energy and decarbonisation of the economy. When GST was introduced, the receipts from this cess were suddenly diverted for making good the shortfall in tax receipts of the States. The present consumption of about a billion tonnes of coal generates revenue of around ₹40,000 crore. About two thirds of this additional cost is borne by the electricity sector. As the Railways have been unable to raise passenger fares to cover their costs, they need to cross subsidise passenger traffic from goods freight. They, therefore, charge about twice the actual cost for carrying coal to thermal power plants. This distortion adds to the cost of coal for thermal power plants and further increases the price of electricity for the distribution companies. They, in turn, cross subsidise most domestic household consumption by having higher tariffs for industrial users. This increases the cost of industrial production vis-a-vis competitors in other countries. The consequential loss of competitiveness results in lower manufacturing growth and the creation of fewer jobs.

User friendly processes

Not only is it difficult to get land for business enterprises, but prices are also higher than they need to be. India has had a real estate asset price bubble with return on land assets by way of rents or returns on farming being around 2%, far lower than the cost of capital. Land use conversion and redevelopment processes need to be made user friendly. Combined with public provision and upgradation of quality infrastructure this would reduce supply side constraints and lower prices in real terms. Unless this happens, India would continue to generate far fewer jobs than it can.

Only private investments can create jobs for our young generation. Government jobs are a mirage. The sooner we realise this and start grappling with feasible pathways for reducing the cost of doing business and getting a surge in private investment which creates jobs, the better. Our demographic dividend is fast becoming a nightmare.

(Ajay Shankar is a former Secretary, DIPP, Government of India)

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