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

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

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

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

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. Jump in electric pump use Page 5 Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington

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

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. Page 7 Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington

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. Page 8 Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington

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 Page 9 Source: Chowdhury, S and Torero, M; (2009). Power and Irrigation Subsidies in Andhra Pradesh & Punjab. IFPRI, Washington

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

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

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

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

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

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

From a Vicious Circle Page 16

To a Virtuous Circle Page 17

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

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

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) Page 20 N good demand system: P is the overall price index derived from: are constant parameters and X is the representative expenditure on the system of goods given by: where q i is the quantity demanded for ith good

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

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

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   [ ,  ]  ~ f(  ) ===> Disign of mechanisms Page 23

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

Step 3: Explore alternative price schemes based on price discrimination theory (cont 2) The unit cost (C j ) 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 y j * : However, consumption plans may change the amount demanded at the equilibrium point and then farmer will re-adjust Page 25

Simulation of three progressive pricing schemes The first price scheme is a simple two part payment schedule that established an initial quantity (q 1 ) priced at p 1 (q 1 is what smallholders consume so they will keep same level of subsidy); while demand exceeding q 1 units is priced with marginal cost, i.e. p 2. This second mechanism considers a fixed rate (F), under which the household receives q 1 units of electricity. Consumption exceeding q 1 is charged with a marginal cost v 1 for households demanding less than q 2 units, and households with consumption exceeding q 2 will pay v 2 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

Simulation 1: Results of a simple two part tariff Andhra Pradesh Page 27

Simulation 1: Results of a simple two part tariff Punjab Page 28

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

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 q 1 units of electricity. Consumption exceeding q 1 is charged with a marginal cost v 1 for households demanding less than q 2 units. Households with consumption exceeding q 2 pay v 2 for additional units. In this sense, household’s expenditure can be represented by Page 30

Profits of electricity industry under different combinations of v 1 and v 2 (v 1 <v 2 ) Punjab Andhra Pradesh Page 31

Summary of Simulation 2, selected values of v1 and v2 Andhra Pradesh Page 32

Summary of Simulation 2, selected values of v1 and v2 Punjab Page 33

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

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

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

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

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

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