Power and Irrigation Subsidies An example for: Andhra Pradesh & Punjab

1. Power and Irrigation Subsidies An example for: Andhra Pradesh & Punjab Maximo Torero m.torero@cgiar.org International Food Policy Research Institute Based on paper by: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington. IGC-ISI India Development Policy Conference

2. Major stylized facts of the current pricing mechanism and subsidy scheme • Jump in electric pump use • Jump in the share of electricity consumption in agriculture • Huge deficit with respect to revenue • Growing imbalances: reduction of cross-subsidy and Subsidy substantially increased • Deterioration of supply • Environmental damage • Subsidy is regressive Page 2

3. Jump in electric pump use • Bet. 1960 and 2000, irrigated area more than doubled. • This came mostly from tube well (TW) irrigation. Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 3

4. Jump in electric pump use • In AP, the real changes take place in irrigation through TW. Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 4

5. Jump in electric pump use • The role of TW in irrigation is even more prominent in PJ. • While the role of TW has been increasing, the canal irrigation • has been declining in PJ. Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 5

6. Jump in electric pump useEnergizationof TW (in million) • With the increased role of TW in irrigation, the energization of • TW took place in a rapid pace. Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 6

7. Jump in the share of electricity consumption in agriculture • Effects of two – first, an increase in the number of pumps, and second, an increase in electricity consumption per pump set – has increased the demand for electricity in irrigation by many folds. • By 1998, agriculture emerged as a the largest consumer of electricity in India. Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 7

8. Share of Agriculture in Consumption and Revenue 35 30 25 20 (as a % of Total) 15 10 5 0 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 1994-95 consumption revenue Huge deficit with respect to revenue • However, the consumption share did not match with the revenue share, and created a financing gap as a result. Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 8

9. Growing imbalances • Partial reforms have not been helpful since the cost of supply has been going up while the agricultural tariff has not been reformed • A reduction in cross-subsidy has added to the odd further Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 9

10. Environmental damageProduction Pattern and Ground Water Level Fall between 1981 and 2000 in Andhra Pradesh and Punjab (a) Andhra Pradesh (b) Punjab Page 10

11. Who are the beneficiaries? Source: Data from 54th round • There is a very strong link between land possession and electric pump ownership in AI, and in AP and PJ. Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 11

12. Distribution of subsidy Source: Data from 55th round • Not surprisingly, the distribution of irrigated land is extremely skewed in the case of all India. Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 12

13. In AP? Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 13

14. And in Punjab? • And it is worse in Punjab! Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington Page 14

15. Objective of this paper • Examine the general setting of subsidy in power for irrigation and canal irrigation • Identify alternative institutional mechanisms to rationalize the subsidies Page 15

16. From a Vicious Circle Page 16

17. To a Virtuous Circle Page 17

18. Methodology We follow a four step methodology: • Step 1: Estimate rural households demand for electricity • Step 2: Measure consumer welfare • Step 3: Explore alternative price schemes based on price discrimination theory • to better assign the current subsidy, • to identify ways through which it can be funded through the market. Page 18

19. The Data • Secondary sources: • Data aggregated at the level of the state and district • Household data • NSS 54th round (CPR) • NSS 55th round (Consumption) Page 19

20. Step 1: Estimate rural households demand for electricity • Estimate rural households demand for electricity using the almost ideal demand system (AIDS) developed in Deaton and Muellbauer (1980) N good demand system: are constant parameters and X is the representative expenditure on the system of goods given by: where qi is the quantity demanded for ith good P is the overall price index derived from: Page 20

21. AIDS Elasticity's The own price elasticity for Andhra Pradesh and Punjab together is -0.5192, and the price elasticity for each of the consumer groups based on the size of their land possession can be summarized in: Page 21

22. Step 2: Measure consumer welfare • Our welfare measure for a given socioeconomic level j, we define Pmax as the maximum price the consumers will observe, which is instrumentalized by assuming different subsidy regimes • then including the flat installation charge as an annual installment, the total net surplus for all services is: Page 22

23. Step 3: Explore alternative price schemes based on price discrimination theory Non-linear tariffs based on second degree price discrimination Assumptions: • Asymetric information: the firm and the regulator don’t know the value assign by individuals (farmers) • The firm and the regulator know the distribution of probabilities qÎ [ q , q* ] q ~ f(q ) ===> Disign of mechanisms Page 23

24. Step 3: Explore alternative price schemes based on price discrimination theory (Cont 1) 1. Discount for quantity: 2. Optional Plans: (t,T) Page 24

25. Step 3: Explore alternative price schemes based on price discrimination theory (cont 2) • The unit cost (Cj) will depend on the quantity demanded by each farmer (y), the monthly rental (R), the rate (t) and the number of free Kwh (L), and is defined for household j as: • When consumer plans are introduced, the j-th farmer will choose plan k that minimizes its expenditure given yj*: • However, consumption plans may change the amount demanded at the equilibrium point and then farmer will re-adjust Page 25

26. Simulation of three progressive pricing schemes • The first price scheme is a simple two part payment schedule that established an initial quantity (q1) priced at p1 (q1 is what smallholders consume so they will keep same level of subsidy); while demand exceeding q1 units is priced with marginal cost, i.e. p2. • This second mechanism considers a fixed rate (F), under which the household receives q1 units of electricity. Consumption exceeding q1 is charged with a marginal cost v1 for households demanding less than q2 units, and households with consumption exceeding q2 will pay v2 for additional units. • The third consumption plan has a variable first part and two marginal rates. This scenario will eliminate the burden of the subsidy to the government given small-holders will also pay the first part of the tariff based on their consumption. Page 26

27. Simulation 1: Results of a simple two part tariffAndhra Pradesh Page 27

28. Simulation 1: Results of a simple two part tariffPunjab Page 28

29. Simulation 1:Concentration curves for electricity consumption (Kw), actual and two-part tariff simulation Andhra Pradesh Punjab Page 29

30. Simulation 2: Impact of an optimal consumption plan with a fix rate and two marginal rates • This second mechanism considers: • A fixed rate (F), under which the household receives q1 units of electricity. • Consumption exceeding q1 is charged with a marginal cost v1 for households demanding less than q2 units. • Households with consumption exceeding q2 pay v2 for additional units. In this sense, household’s expenditure can be represented by Page 30

31. Profits of electricity industry under different combinations of v1 and v2 (v1<v2) Andhra Pradesh Punjab Page 31

32. Summary of Simulation 2, selected values of v1 and v2Andhra Pradesh Page 32

33. Summary of Simulation 2, selected values of v1 and v2Punjab Page 33

34. Summary of Simulation 2, Distribution of electricity subsidy, selected values of v1 and v2 (% of total subsidy): Andhra Pradesh Page 34

35. Summary of Simulation 2, Distribution of electricity subsidy, selected values of v1 and v2 (% of total subsidy): Punjab Page 35

36. Summary of Simulation 3: Impacts of an optimal consumption plan with a variable first part and two marginal rates – Andhra Pradesh Page 36

37. Summary of Simulation 3: Impacts of an optimal consumption plan with a variable first part and two marginal rates – Punjab Page 37

38. Conclusions • The use of electricity in agriculture for irrigation following the green revolution has significantly contributed to agricultural productivity growth in India. • However, there is an inbuilt inefficiency in the current pricing mechanism and measuring system of power for irrigation in India and specifically in Andhra Pradesh and Punjab. • One of the mechanisms used to cover the subsidy for agricultural (and domestic) power consumption was cross-subsidy from industrial and commercial consumers. In fact, the tariff charged to industrial and commercial consumers in India has been one of the highest in the world. • Both of this problems have generated what we called along this report a vicious cycle which results in poor supply outcome in form of low quality of power, unreliable supply, unavailable to many potential users and high transmission and distribution (T&D) losses. • In addition, and most seriously, it had exacerbated the fall of the ground water level. • A price discrimination strategy is proposed based on the size of the farmers plot and on the implementation of a two part tariff mechanism. • In summary, in all these three price schemes, the major result is that the subsidy will be more progressive and resources will be used more efficiently. If low-demand consumers or high-demand consumers want to consume more electricity, they will need to pay a charge over the marginal costs for each unit above their fixed charge. Page 38

39. Future research • Implement proposed tariff schemes implemented based on the simulated electricity consumption by the farmers according to their plot size and what they produce • Open the option for self selecting into pre-paid meters if they belief price schemes are not capturing real consumption and use it as a way to manage the price discrimination mechanism • Measure the difference between two schemes in terms of: • progressiveness of the distribution of the subsidy with respect to the first two part tariff mechanism; • reduction or elimination of the burden of the subsidy to the government by cross subsidizing small holders with the revenues from large holders; • changes in the quality of the service Page 39