Subsidies – The Blood-Sugar of Indian Economy


subsidyEvery year, as budget is presented on Feb 28, media tries to educate us about the budget and its provisions for direct and indirect taxes. They inform us as to how the budget would impact our pocket etc. Here, we are bringing on table, the issue of subsidies, which impacts economy as well as our pockets directly. It is important for people to know how the various types of subsidies affect them and economy. We taxpayers want Finance Minister to reduce Tax. Do we ever expect the government to pay higher taxes to us? Actually we do. How? By expecting government to increase subsidies which is inverse of taxes. Opposite to taxes which increase the government income, subsidies reduce government’s income.

Subsidies play a very important role in any economy; country has various resources which are to be gainfully deployed for the benefit of the people of the country. Subsidies are provided to ensure equitable utilization of the resources for the people and they play an important role in developing and underdeveloped nations. Developing nation provides subsidies for improving the living standard the vast majority of population and to ensure they are not derived of basic amenities of life which is the rationale for providing subsidies by governments of underdeveloped nations also. Subsidies represent a sizeable item of the center’s non- plan revenue expenditure. In India, Food and fertilizers are the two main items subsidized by the government through budgetary support.

Diesel-pieThe question arises why India needs subsidies? Is it fulfilling the purpose? Is it implemented without leakages? No doubt a developing country like India needs subsidies due to various reasons. Providing minimum consumption entitlement to the poor
by subsidizing the items consumed by them is extremely important for the welfare of the largest section of population. However, the benefits can be maximized only when the subsidies are transparent, well targeted, and are designed for effective implementation without any leakages. These days, one can hardly see the benefits of the subsidies and often the government is criticized for granting subsidies which do not reach their target or are manipulated by the rich. The whole issue of granting subsidies or not has given rise to many questions which need to be answered by our government, economists and politicians as well. The subsidies on oil, especially on diesel is the biggest example. The breakup of the consumption of diesel shows that 16% in total used by the private vehicle. There is an old suggestion according to which the diesel used in private vehicles will have no subsidies. This would make a difference.

Recognizing the need to reform subsidies, the Indian government, at different times, has appointed several committees to assess how best to address the issues related to fuel subsidies:

Rangarajan Committee Report, 2006. This report recommended that international (or “trade parity”) prices be used as a  reference for a more market-based approach to pricing of petrol and diesel. It also recommended that subsidized kerosene should be restricted to below poverty line (BPL) families and the retail price of LPG be raised, with any remaining subsidies
financed directly from the budget.

Parikh Committee Report, 2010. This report recommended that the prices of petrol and diesel be fully liberalized, both at refinery gate and at the pump. It also recommended that:
(a) subsidized kerosene sold through the public distribution system be targeted to BPL families, and its price raised each year according to the growth in nominal agricultural GDP per capita;
(b) the price of kerosene sold outside of the PDS system be set close to that of diesel to eliminate incentives for diversion; and (c) subsidized LPG should be quantity rationed, or replaced by direct cash transfers to BPL households with LPG prices fully liberalized.

Nilekani Task Force Interim Report, 2011. This task force was set up to work out modalities for the replacement of in-kind fuel and fertilizer subsidies by direct cash transfers to households using the Unique identification (UID) system currently being rolled out nationwide. The report argued that this would substantially reduce the fiscal cost of subsidies by eliminating the
leakage that exists under the current system.

Kelkar Committee Report, 2012. This report set out a “roadmap for fiscal consolidation”, including a timeline for the reduction of fuel subsidies. It recommended the elimination of diesel subsidies over a two-year period followed by full price deregulation in 2014. It also recommended the elimination of LPG subsidies over a period of three years, and the reduction of more politically sensitive kerosene subsidies by one-third over the same.

As for food sub sidies, despite continuously rising food subsidies, hunger and malnutrition prevails in the entire county. Due to faulty practices, people who are in the real need of subsidies- even for their sheer survival are being forced out of the system. A panel set up by Prime Minister Narendra Modi last month urged the government to lower the number of beneficiaries to 40 per cent from 67 per cent as part of efforts to trim the $18.64 billion food subsidy bill that is stretching state finances. The budget itself shows that in last 5 year the food budget has doubled and is increasing at an alarming rate, without making any significant impact on ground, thanks to poor governance in this sector.

Food-BudgetFertilizer subsidy, another big burden on the country’s finances reveals the same picture. It is a very well known fact that the hardly half of the subsidy benefits go to farmers, rest is cornered by fertilizer industry. If we take a look at the fertilizer subsidy and its origin, then we will come to know that the original purpose was to encourage spread of green revolution technology to new areas and farmers but this reason and motive has lost its credibility in the recent years. The fertilizer subsidies for the financial year 2014-15 has been increased by Rs. 2,000 cr (from Rs. 68,000 cr to Rs. 70,000 cr).

The Evolution Of Fertilizer Subsidy

The Green Revolution is built around high-yielding crop varieties supported with the use of fertilizer. So the government woos the private sector, with the result of nine urea plants to come up.

As oil prices increase, companies say they can’t sell at the government-set price in 1977, the Retention Pricing Scheme (RPS) is introduced: companies are reimbursed for their additional costs and a fixed profit margin.

The Retention Pricing Scheme begins to miss its objectives. Companies exploit its cost-plus formula. They prefer urea to other fertilizers. So do farmers, weakening the soil. Government gropes for an alternative to the RPS.

Prices of all fertilizers except urea freed. Nutrient-based subsidy replaces RPS: companies are paid a fixed amount per nutrient irrespective of their cost of production. Next move: cash transfers to farmers.

The subsidies to reach farmers directly as cash transfer through Jan Dhan Yojana.

The blanket application of fertilizer subsidy is another crucial area which needs deliberation. The subsidy for rich farmers do not serve any purpose. It has been suggested by various experts that the availability of subsidized fertilizer should be restricted to farmers who grow staple food and cereals as they need it the most and those farmers, who produce cash crops, do extensive horticulture or produce farm goods for direct exports should be kept outside the purview of subsidy regime.

The most alarming aspect of the surging subsidies is not the size, but the manner and purpose of spending on them. Subsidies provided in India suffer from both inclusion error (wrong kind of people benefiting) and exclusion error (deserving people left out of subsidies). Efficient subsidies must be transparent, targeted and-in many cases-temporary. These are missing from most subsidies in India. There are some changes done time to time by the government to make subsidy transparent. The message goes to the policymakers, politicians and economists. The question is not whether to subsidies or not, but how subsidies effectively reach the person actually needing it. Traditional methods to ensure effective targeting has failed. The hope is that the new initiatives such as direct cash transfer, Jan Dhan Yojana, creative designing of subsidy products and better monitoring technologies would ensure that the money reaches the needy, makes the maximum impact and is not frittered away, as has been the case till now.