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India’s Climate Dilemma

To reduce its greenhouse-gas emissions, India must cut or eliminate subsidies for electricity generated from fossil fuels. Despite the country's stated commitment to combating climate change, however, any attempt to reform the Indian electricity market is bound to face significant political obstacles.

PROVIDENCE/NEW DELHI – The 2023 United Nations Climate Change Conference (COP28) in Dubai concluded with a carefully worded statement calling for the phase-out of fossil fuels, raising hopes that the international community might finally meet the targets set by the 2015 Paris climate agreement. But achieving these carbon-reduction goals will be difficult without immediate and decisive action by India, the world’s third-largest greenhouse-gas (GHG) emitter.

India – which accounted for 7.6% of global GHG emissions in 2022, compared to China’s 30.7% and the United States’ 13.6% – has set ambitious renewable-energy targets and taken a leading role in international climate talks. But while these efforts suggest that India is genuinely committed to moving away from fossil fuels, the country also faces political obstacles that could severely impede its ability to achieve crucial climate goals.

India has adopted a countercyclical approach to taxing petroleum-related products, reducing taxes when global prices increase and raising them when prices drop. European governments followed a more extreme strategy after gas prices spiked in the aftermath of Russia’s invasion of Ukraine, providing subsidies of more than €650 billion ($712 billion) between September 2021 and January 2023 to protect consumers from soaring energy costs.

In India, however, the effective carbon price was just €14 per ton in 2021. Moreover, electricity in India is heavily subsidized, with many households and farmers benefiting from free power or paying only a fraction of the actual cost. To offset this, industrial and commercial users are charged higher rates. Nevertheless, even with this arrangement, the government subsidizes about 20% of the cost of electricity production.

Given that electricity accounts for 34% of India’s total GHG emissions, reforming electricity pricing is crucial to meeting its emissions-reduction goals. But this will not be easy, as electricity prices are set not by one central authority, but by the country’s 28 states and eight quasi-sovereign union territories. These 36 jurisdictions, each with its own policies and interests, represent the proverbial elephant in the room, complicating any effort to eliminate carbon subsidies.

Throughout India’s post-independence history, almost every state has subsidized electricity prices. Consequently, the expectation of free or cheap power has become deeply ingrained in the country’s democratic politics. While heavy subsidization has significantly expanded energy access, it also strains state governments’ finances, impeding clean-energy investments. In agricultural regions, free electricity has contributed to the degradation and depletion of water resources. Moreover, reliance on coal for power generation causes severe pollution-related health problems and results in increased carbon emissions.

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In Indian politics, which is increasingly prone to competitive populism between state governments, giving away free or cheaper power (along with cash transfers) is a stock currency of elected officials. The popularity of this approach has been evident in several recent elections, with parties promising electricity subsidies and following through after coming to power. Consequently, the price of power has steadily headed in the wrong direction: greater carbon subsidization instead of greater taxation.

India’s central government has tried to nudge state governments to rationalize electricity pricing, but with limited success. Likewise, measures, such as the European Union’s Carbon Border Adjustment Mechanism (CBAM) or emission reporting requirements, are unlikely to have a significant impact. Such measures, protectionist in effect, are primarily aimed at tradable goods and services, sectors that are not heavily subsidized in India and for which the government is trying to establish a cap-and-trade system. Crucially, mechanisms like the CBAM will have minimal effect on the pricing of non-industrial electricity consumption.

But the deeply rooted popularity of India’s electricity subsidies and resistance to reform do not necessarily mean that efforts to reduce emissions, both within India and worldwide, must fail. While India has little chance of changing how electricity is priced, it can change how it is produced. Demand may be beyond influence, but by shifting the power grid from fossil fuels to renewables, the country can supply cheap power while still reducing carbon emissions.

For this transition to be economically feasible, renewable energy and storage must be cheaper. Despite their protectionist nature, industrial policies like US President Joe Biden’s Inflation Reduction Act could benefit developing countries like India. By lowering the costs of green-energy production and storage, such policies could make subsidized electricity less problematic from an emissions standpoint.

India’s experience offers some important lessons for policymakers and economists. Unanimous and vigorous advocacy for carbon taxation can be misguided because it ignores country realities. Barring an unforeseen shock, India’s 36 jurisdictions are unlikely to eliminate indirect carbon subsidies in electricity generation. It is crucial, therefore, to focus on identifying feasible solutions that could be developed and implemented within these political constraints. International financial support, for example, could significantly reduce the risks associated with renewable energy and storage projects in developing countries and make them more attractive for private investment.

What is clear is that simply invoking textbook solutions will get us nowhere. If the definition of insanity is repeatedly doing – or in this case evangelizing for – the same thing and expecting a different result, this particular madness will endanger us all.