The total fiscal losses on account of kerosene subsidisation are in excess of Rs. 24,000 crore; far above the conventional estimates which do not recognise the fiscal cost of diversion and adulteration. These distortions are very severe. Worse still are the “third order” effects of entrenched rent seeking and corruption of distribution networks and the conversion of retailing to patronage. In such situation, reform and deregulation become problematic. At the core of all these failures in the “price arbitrage” that arises when price based subsidies are resorted to. This paper studies the current design of the public distribution system and price based subsidisation to bring out the perversities, and argues that a complete replacement is called for. The Public Distribution System (PDS) which had value in an era of shortage and rationing has no role today. Market based distribution can bring down the direct costs. The rents being earned by those associated with the distribution channel for kerosene, however, are very large. The subsidy through uniform low pricing of kerosene, though intended for the poor, is in fact not reaching them as they are in no position to buy much of the kerosene allotted to them even at the low issue prices. It is imperative to bring into play information and communication technologies so as to break the stranglehold of the distribution channel. The direct subsidy scheme, which is based on free market pricing of kerosene, and therefore a radical departure from the current method of uniform low pricing, is the answer for achieving effectiveness of subsidization. The subsidy is to be disbursed to the poor through smart cards and the accounting of disbursal is to be done using systems similar to those used by credit card companies. The proposed system would almost completely eliminate the indirect losses arising from distorted choices. A task force (TF) must be set-up for implementation, with wide-ranging powers and full financial backing of the government of India so as to be able to function autonomously. The disbursement of subsidy should be such that it is recorded at the point of transaction and get immediately captured in a large centralized database, thereby creating a permanent audit trail. The operations of the system should be monitored by an SPV to be specially created for the purpose and working under the broad supervision and direction of the task force. The gain to the economy and society at large from elimination of indirect losses due to sub-optimal choices of fuel-mix, product-mix, and asset mix would be immense as they would be completely eliminated in the new system. The most important gain, however, is that the beneficiaries would be in a position to fully utilize their entitlements and spend the same on products and services of their choice, significantly enhancing, thereby, the utility of their consumption. This should also make direct subsidies politically rewarding.   

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