INTRODUCTION #
Introduction of the High Yielding Varieties (HYV) seeds programme in the 1960s demanded a high priority to supplying irrigation water and fertil- isers to the farmers, the government tried to ensure that they were accessible and affordable. Subsidy on fertilisers is provided by the Central government whereas subsidy on water is provided by the State governments. Government gives different types of subsidies to farmers like, fertilizer, irrigation, equip- ment, credit subsidy, seed subsidy, export subsidy etc.
FOOD SUBSIDIES #
Food subsidies in India comprises subsidies to farmers through support prices and purchase operations of the Food Corporation of India (FCI), consumer subsidies through the public distribution system (PDS), and subsidies to FCI to cover all its costs. Food subsidies are mainly on account of paddy and wheat. The rapid increase in food sub- sidy in recent years is attributable to what is called the ‘economic costs’ of food grains, which include the minimum support prices paid to farmers in the Procurement process.
Government notifies the FCI about the pur- chase prices of the relevant food grains that it has to observe for the coming agricultural marketing season. These prices, known as minimum support prices (MSP) are based on the recommendations of the Commission on Agricultural Costs and Prices (CACP).
In practice, the notified purchase prices have been consistently higher than the MSP recom- mended by the CACP in recent years. Periodically,
an official committee is set up to recommend the volume of minimum buffer stocks to be maintained at the beginning of each quarter for the purpose of food security. This quantum, together with the amount needed to run the PDS, constitutes the minimum operational stocks of the FCI. However, the purchases of the FCI are open-ended in that it has to accept all the grains that are sold to it at the declared purchase price, and this sometimes results in mounting stocks well beyond the buffer stock norms.
Government from time to time fixes the cen- tral issue prices (CIP) of rice and wheat, which together with transportation and retailers’ margins, determines the prices at which consumers receive their entitlements at the fair-price outlet in the PDS system.
A common strategy to reduce the burden of food subsidy, without affecting the interests of the poor, is to build in specific features that target the poor. Since June 1997, the extant uniform CIP system has been replaced by a targeted PDS (or TPDS), to provide greater subsidies to the poor. Consumers below the poverty line (BPL) pay a lower price and receive a higher quantum of food grains than those above the poverty line (APL).
Despite this, there are indications that there are both inclusion and exclusion errors. Besides, there are wide disparities in PDS penetration in different States. India is not unique in providing either producer subsidies or consumer subsidies in the food grains sector. Several countries, including the developed ones, provide subsidies in the area of agriculture and allied operations at levels that are
fairly high compared to that in India. In some devel- oped countries, such subsidies which are mainly for the producers are several times higher than that in India.
Need for reform: The primary motivation for reform originates in the size of the food subsidy bill, even as a proportion of GDP. With escalating economic cost and poor targeting, the food subsidy bill has reached a level that is a significant propor- tion of the total government expenditure. Further, it also restrains the process of crop diversification. The main benefits of food subsidies are the resultant food security provided to the citizens, particularly the poor at affordable prices, and incentives to the farmers to keep food grains production at a comfortable level.
A key aspect of the system is the CIP and its relativity to the non-PDS price faced by those who either does not get the benefit of the PDS, or cannot meet their entire demand from the PDS. Although CIPs have remained unchanged for BPL families both for wheat and rice since 2000- 01, cumulatively between 1997-98 and 2003-04, they have risen faster than the consumer price index for agricultural labour. In recent times, there is the paradox of mounting stocks of food grains and reported starvation deaths. Food stocks reached a peak of 63 million tonnes. In July 2002, more than two-and-a-half times the norm of 24 million tonnes. By April 2004, the stocks were down to 20 million tonnes, still higher than the norm of 16 million tonnes for April.
The reduction of the stocks, however, was not brought about by increased PDS off take. PDS off-take at 20-22 million tonnes was less than the allocation in the last two years. To run the excessive stocks down, food grains were exported by providing exporters food grains at near BPL prices.
Large stocks of food grains raise the subsidy bill through increased handling and carrying costs along with the losses. Besides, withdrawing such large quantities from the market also results in rising open market prices of food grains, neutralizing much of the consumer benefits that the subsidy provides. There are severe regional imbalances in the oper- ation of the entire food subsidy scheme, as FCI’s purchase operations are mainly confined to five areas – Punjab, Haryana, Western Uttar Pradesh, Andhra Pradesh and now Chhattisgarh. The implication for
the present policy of purchase is that farmers of only a few States get the entire farmers’ subsidy. A large percentage of these farmers are not even poor.
The Major Problems #
A comprehensive analysis of food subsidies in India leads to the conclusion that a large part of the recent problems arise from the relatively high MSPs. In recent years, with the MSPs announced by the Government at levels higher than those recommended by the CACP, procurement has been high and off-take low, resulting in an inevitable build-up of stocks and a bloated food subsidy bill. The declared MSP has had several other negative fallouts. The first is the impact on food grain prices.
Since the issue price and the purchase price are linked, higher purchase prices result in higher issue prices. Further, with a large part of the marketed surplus in FCI warehouses, the lower supply exerts an upward pressure on prices in the open market. Everyone except those farmers with marketable surpluses of food grains are affected adversely.
Second, the high MSP combined with open- ended purchases by FCI has compounded the prob- lem for vibrant wholesale trade and storage with lower incidental and storage costs in food grains.
Third, the exclusive attention to wheat and rice has distorted the cropping pattern of farmers in favor of these two food grains alone. The higher water and fertilizer intensity of these two crops in turn has had adverse environmental impacts.
Fourth, the concentration of FCI purchases in just two food grains and a few States has facilitated tax exportation by some of these States. Although necessities like food grains are normally kept outside the tax net, Punjab and Haryana have imposed taxes such as mandi fees on the purchases of food grains.
With FCI paying such taxes, the tax gets exported to consumers in other States. Inefficiencies in the FCI are also responsible for the subsidy bill. Since all costs of FCI are automatically reimbursed in the extant system, there is little incentive to raise efficiency and reduce costs. Policy imperatives. It is of paramount importance to set more realistic MSPs, particularly with respect to wheat. To conform to its true nature, the MSP should correspond to the
CACP – determined C2 cost, which includes all cash costs and imputed cost of family labor.
Since these estimates may vary across regions, a simple average of these costs should be used as the uniform MSP. Further, the purchase operations should not be open-ended. Before every sowing season, procurement targets should be fixed on the basis of norms and a margin of error of about 10 per cent. FCI should suspend purchase operations once targets are achieved.
The FCI should have the flexibility of adding to these target quantities in specific markets only in case overall procurements fall short of the target in other markets. A system of price insurance, similar to the Farm Income Insurance Program introduced recently on a pilot basis, may be developed.
The scheme should be self-financing and with- out any subsidy obligation. This can operate in conjunction with the purchase operations to benefit those farmers who miss out on the opportunity of selling their surplus at the support price because of the close-ended purchase operations. In the short run, decentralization of procurement may not be a practical option. However, it should be pursued as a long-run objective to usher in greater efficiency in the purchase and distribution operations, and to distribute the benefits of the price support operations more evenly across the country.
A useful approach can be to work out the details of the scheme and announce it as soon as possible, allowing States to join in at the time of their choice. Once the farmers of non- participating States appreciate the benefits of their States joining in, the political process should ensure participation of a growing number of States.
Eventually, the FCI should act only as a coordinating agency in the matter of procurement with important parameters like procurement prices and aggregate stock requirements provided by the Government of India. In the meantime, the FCI should include a greater number of States in their price-support operations. Further, the tendency for tax exportation needs to be curbed, by appropriate legislation, if necessary. Since it is easy to identify the States that indulge in this practice, it should also be possible to work out differential purchase prices
for individual States based on the basic price and maximum allowed tax on the price.
In order to enforce efficiency, the reimburse- ment of costs to FCI should be based on normative unit costs and actual quantity involved, instead of reimbursement on actual basis. If some of the functions of the FCI can be carried out by others, it would help to trim the unwieldy size of the FCI. For example, actual delivery of grain may be postponed at the time of purchase, and a small mark-up on the purchase price may be allowed for this purpose. This will reduce the burden of storage on FCI. Active participation by private traders can also relieve the burden on FCI, but necessary institutional changes, including a revision of the concerned laws, are pre-requisites.
The responsibility for losses will have to be put squarely on the personnel above a given level, with general cuts in staff payments and perquisites. To balance this, costs reduced below norm- based ones may be retained and distributed among the staff as annual bonus or any other mechanism deemed fit. On the distribution side, the main challenges are to improve PDS penetration and reduce leakages. The former is the responsibility of the State governments, and barring moral suasion, the Centre can do little under the present system. One possibility is to intro- duce food coupons, which has been proposed as a possibility in Budget 2004-05. This method has been tried in several other countries, with mixed results.
There is need for caution in its introduction because of unforeseen difficulties in administering it at the massive scale that characterizes PDS. Only the additional subsidy given to the poor can be tried first, while continuing with the exclusive PDS outlets. At present, the additional subsidy for BPL families over and above that for APL is Rs. 195 per quintal on wheat and Rs. 265 per quintal on rice.
BPL cardholders can be given coupons worth Rs. 1.95 per kg. of entitlement of wheat and Rs.
2.65 per kg. of their entitlement of rice. The poor would then pay to the PDS outlet the same price as the APL families, but partly with coupons and partly with cash. For the PDS outlet, there will be only one price, but it will be entitled to exchange the coupons collected for cash. Gradually the system could be extended to any food grains seller even
outside the fair price shops.
The PDS in its present form has no self-targeting characteristics, except perhaps for the poor quality of the grains distributed driving away the non-poor. Self-targeting can be brought in by subsidizing coarse grains consumed generally by the poor alone.
Two other measures, which may encourage self targeting, are:
- Locating of PDS shops in areas where the poor live, and
- Allowing/restricting PDS grain purchases on a weekly basis rather than monthly basis. Often the very poor cannot afford purchase of monthly requirements in one go. On the other hand, restricting bulk purchases will discour- age the not-so-needy from PDS outlets.
FERTILIZER SUBSIDIES #
The fertilizer subsidy bill has escalated from Rs 500 crore in 1980-81 to more than Rs. 6,000 crore by the mid-nineties, and further to Rs. 12,662 crore (BE) in 2004-05. The Retention Price Scheme (RPS), which is at the root of the growing subsidy, and how much of the benefit of the subsidy is going to farmers rather than the producers of fertilizer have been matters of some debate in the country. Background
In order to control the fluctuations in fertilizer prices, the Government of India regulates the fer- tilizer market through the RPS. The RPS was first introduced for nitrogenous fertilizers in November 1977, and extended to complex fertilizers in February 1979. The RPS is essentially a cost-plus approach with some norms for capacity utilization and conver- sion coefficients. The plant specific retention prices (RP) are revised every quarter so that price increases in plant inputs can be taken into account. The retail price of fertilizers is fixed and is uniform throughout the country. The difference between the retention price (adjusted for freight and dealer’s margin) and the price at which the fertilizers are provided to the farmer is paid back to the manufacturer as subsidy.
Transportation costs are also compensated on the basis of equated freight computed on a normative basis. It was only in the aftermath of the economic crisis of 1991 that a serious attempt was made to
reform RPS to rationalize the fertilizer subsidies. Government decontrolled the import of complex fertilizers such as di-ammonium phosphate (DAP) and muriate of potash (MOP) in 1992, and extended a flat-rate concession on these fertilizers. But, urea imports continue to be restricted and canalized. Thus, flat-rate concessions are provided on imported and indigenous fertilizers, while urea is subsidized under the RPS. Government constituted a high- powered committee to review the existing RPS and suggest a new pricing policy for urea under the chairmanship of C. H. Hanumantha Rao in January 1997. The committee recommended a Normative Referral Price (NRP) system in place of the RPS. In 2000, the Expenditure Reforms Commission (ERC), in its report, suggested phasing out of the unit wise RPS in stages over a period of six years and its replacement with the group- concession scheme.
The new urea pricing policy for the industry suggested by the ERC came into effect from April 1, 2003. The new scheme is to be implemented in three stages: the first from April 1, 2003 to March 31, 2004; the second from April 1, 2004 to March 31, 2006. The modalities of the third stage were to be decided after a review of the first two stages. The Group Retention Pricing (GRP) recommended by the ERC, which had also been recommended by several other committees in the past, was implemented with some modification with effect from April 1, 2003.
The second stage with revised norms is currently under implementation. Magnitude of fertilizer sub- sidy: the beneficiaries. As a proportion of GDP, fertilizer subsidy, after expanding from 0.23 per cent in the early-1980s to a peak of 0.93 per cent in 1989-90, started to decline. It was 0.77 per cent in 1990-91, and 0.53 per cent in 1993-94. In a sub- sequent reversal of trend, it reached almost 0.68 per cent in 1999-2000, but has declined since and was estimated at 0.43 per cent in 2003-04.
The relative benefit-incidence of the substantial fertilizer subsidy on the farmers and the fertilizer industry has been a matter of some research. The difference between the hypothetical farm-gate price of imported fertilizers and the actual price paid by the farmers on fertilizer under the RPS, multiplied by the quantity consumed, may be taken as the fer- tilizer subsidy accruing to the farmers. The balance
of the total subsidy on fertilizer after deducting the portion of subsidy accruing to farmers may be taken as the share of subsidy to the fertilizer industry.
According to this methodology, the indus- try share in fertilizer subsidy decreased from an average of 75.46 per cent in the triennium ending (TE) 1983-84 to 24.38 per cent in TE 1992-93,
and further to –27.83% in TE 1995-96. A negative subsidy in this context indicates that the fertilizer industry was being implicitly taxed in TE 1995-96, with import parity prices so high that the fertilizer industry would have made higher profits if it had sold in the international market rather than in the domestic market under RPS. This implicit taxation of the fertilizer industry was short-lived, and by TE 1998-99, the farmers’ share had declined to 90 per cent, and further to 46 per cent by 1999-2000.
Overall, for the entire period of 1981-82 to 2002- 03, the average share of the farmers in the fertilizer subsidy was 62 per cent, with the residual 38 per cent accruing to industry. Estimates of the Nominal Protection Coefficients (NPCs) of fertilizers for the farmers, which is the ratio of the subsidized price paid by the farmers to the hypothetical farm gate price that they would have paid under free-trade.
Except in 1986-87, the weighted average of NPCs of N, P and K fertilizers always remained below unity, indicating that the farmers faced a lower (domestic) price than what they would have paid under free trade. The trend in NPCs reveals that the weighted average NPC for the 1980s was higher than that in the 1990s, corroborating that the farmers were indeed subsidized to a greater extent during the 1990s than they were in the 1980s.
RECENT DEVELOPMENT #
The Cabinet Committee on Economic Affairs (CCEA) Union Cabinet chaired by Prime Minister Shri Narendra Modi has approved the Fixation of Nutrient Based Subsidy (NBS) rates for Phosphatic and Potassic (P&K) fertilizers for the year 2017-18.
Government has been implementing Nutrient Based Subsidy (NBS) Policy for decontrolled P&K fertilizers. Under this policy, the subsidy on Phos- phatic and Potassic (P&K) fertilizers is announced by the Government on annual basis for each nutrient i.e., Nitrogen (N), Phosphorous (P), Potash (K) and
Sulphur (S) on per kg basis which is converted into subsidy per tonne depending upon the nutrient content in each grade of the fertilizers. These rates are determined taking into account the international and domestic prices of P&K fertilizers, exchange rate, inventory level in the country etc.
The CCEA in its meeting held on 31st March, 2017 decided to fix the NBS rates for 2017-18. As compared to 2016-17, the subsidy for the period 2017-18 has decreased from Rs. 13.241/kg to 11.997/kg (decrease of Rs. 1.244/kg) for P, from Rs. 15.470/kg to 12.395/kg (decrease of Rs. 3,075/ kg) for K whereas the subsidy of N has increased from Rs. 15.854/kg to 18.989/kg (an increase of Rs. 3.135/kg) and of S from Rs. 2.044/kg to 2.240/kg (an increase of Rs. 0.196/kg).
During 2016-17, the estimated consumption of P&K fertilizers is 279.8 LMT. Based on the assump- tion that the consumption of P&K fertilizers during 2017-18 would remain the same, the estimated subsidy requirement at proposed rates would be Rs. 19,848.99 Crores which is lower than 2016-17 (Rs. 20,688.43 Crores) by Rs. 839.44 crores.
This is in continuation with the reforms being undertaken in the fertilizers sector over the past two and a half years including DBT for subsidy payment, neem coating of Urea, reduction in MRP of P&K fertilizers to promote balanced use of nutrients, removal of minimum production criteria for manu- facturers of Single Super Phosphate (SSP).
Rationalization of fertilizer subsidy and its likely impact on urea industry #
How to rationalize fertilizer subsidy primarily revolves around rationalization of pricing of urea, the only fertilizer under the RPS. The impact of any rationalization will depend upon two important factors:
- Efficiency of domestic fertilizer industry and the domestic cost of production.
- The international price of urea.
The price of urea per tonne in the international market fluctuates between a low of US$70 and a high of US$240, and usually hovers around US$150. Given the cost structure of the 1990s, about 66,
57 and 41 per cent segment of the urea industry
become economically unviable at US$140, US$160 and US$180 per tonne, respectively.
The feedstock-wise comparison of retention prices with the import parity price suggests that in the event of opening up of the fertilizer sector to imports, the gas-based plants would survive, whereas the others, particularly the naphtha-based plants, would not. An important reason for the high cost of domestic production is the dominance of naphtha or fuel-oil/low-sulphur heavy stock as feedstock, which are more costly than natural gas.
With raw material, power and fuel constituting around 64 per cent of sales revenue of the domestic fertilizer industry, there is need to switch to cheaper options like liquefied natural gas (LNG) to enhance cost-efficiency. About one third of the existing urea production may become economically unviable at an import parity price of US$180 per tonne, if existing structure of capital costs is taken at its face value. If interest of the industry is to be kept in mind, for the sake of self-sufficiency, an appropriate flat-rate subsidy explicit to industry may have to be given. This will be tantamount to moving to a uniform retention price for the industry as a whole.
Phasing out of fertilizer subsidy and its likely impact on food grain production. With more than a third of the total fertilizer subsidy benefitting the fertilizer industry, an obvious question to ask is the impact of phasing out of the fertilizer subsidy on the output of food grains. The ERC estimated that an increase in the farm-gate price of urea to import-parity price without an increase in the pro- curement price of food grains would lead to a fall in food grains production of about 13.5 milliontonnes.
Any estimate of the adverse impact of phasing out fertilizer subsidy on food grains production is based on the condition that other things remain the same. However, they are unlikely to remain unchanged. First, fertilizer use and application is more dependent on technological and non-price factors than on price or agro-economic variables. These factors include irrigation facilities, cropping pattern, spread of high yielding varieties (HYVs), effective fertilizer distribution and availability of credit. Irrigation is a critical factor determining the use of fertilizers, and has a very significant impact on food grains production.
Enhancing irrigation would therefore help minimize loss of output from decontrol of fertilizer prices. A reduction in subsidy effected through an increase in urea prices may not translate into lower production through declines in fertilizer use, particu- larly if the non-price factors are made conducive to fertilizer use. Public investment in irrigation is an effective instrument to promote the use of fertilizers.
Second, rationalization of the urea price subsidy would have a significant salutary impact on balanced application of N (nitrogen), P (phosphate) and K (potash). The role of balanced nutrients cannot be overemphasized. It is possible that the increase in food grain production due to a favourable mix of fertilizer nutrients could well be in excess of any reduction in food grain production because of an increase in urea prices.
Third, since the procurement prices are cost- based, it is possible that an increase in procurement prices would also partially offset the negative impact of fertilizer price increase on food grains production. With high food grains stock with government pro- curement agencies in recent years, instead of further increases in procurement prices to offset any pos- sible urea price increase, an alternative could be to distribute fertilizers to targeted cultivator households alone (small and marginal) in the form of tradable coupons.
DBT IN FERTILIZER SUBSIDY #
Government announced to introduce direct ben- efit transfer of fertiliser subsidy to farmers on pilot basis in few districts of the country. Presently, annual subsidy on fertilizers is about Rs 73,000 crores.
Subsidies on food, fertiliser and petroleum have been pegged higher by over 3% to more than Rs2.4 lakh crore for 2017-18.
The subsidy bill on food, petroleum and fertil- isers is estimated at Rs2,40,338.6 crore for 2017-18 fiscal, according to the budget proposals presented by finance minister Arun Jaitley in Parliament.
The subsidy bill is seen at Rs2,32,704.68 crore for 2016-17 financial year, as per the revised budget estimates. The government has earmarked Rs1,45,338.60 crore for food subsidy in the next fiscal as against Rs1,35,172.96 crore in the revised estimate of this fiscal.
Food subsidy bill is expected to be higher next fiscal as the National Food Security Act, under which the government provides highly subsidised foodgrains to over 80 crore people, has been rolled out across the country from November 2016.
Fertiliser subsidy has been kept unchanged at Rs70,000 crore for 2017-18 fiscal, even as the domestic industry was demanding higher allocation to clear subsidy arrears of about Rs35,000 crore.
In fertiliser subsidy, the government has allo- cated Rs49,768 crore for urea and Rs20,232 crore for decontrolled phosphoric and potassic (P&K) fertilisers. Petroleum subsidy has been reduced to Rs25,000 crore for 2017-18 from estimated Rs27,531.71 crore in this fiscal. Of Rs25,000 crore for next fiscal, Rs16,076.13 crore has been ear- marked for LPG subsidy and the rest is for kerosene.
Issues #
- A significant part of cultivation is today done by tenant farmers or sharecroppers not owning the land and without any formal lease agreements.
- Selecting criteria for capping the number of bags on which the subsidy is payable, based on a reasonable assessment of requirement.
- Capping would depend on the specific ferti- lizer as well as the crop and location where it is grown – making it more complicated than the DBT for LPG.
Feasibility #
- In Uttar Pradesh, where the state government has created an online database of over 40 lakh farmers, each assigned a unique ‘Kisan ID’ identifying their village, land particulars, bank account and mobile numbers. Thus demonstrating feasibility of such transfers.
- This DBT portal was used to transfer Rs 140 crore of subsidy on seeds into the accounts of some nine lakh farmers during the recent rabi season.
- It is expected that DBT will result in reduc- tion in leakages, Improvement in quality of service delivery to the farmers and possible reduction in fiscal deficit.
SUBSIDY REFORMS AND CON- CLUDING OBSERVATIONS #
Three reasons account for the increase in the Central Government subsidies in recent years:
- Moving the petroleum sector to a transparent system of budgetary subsidies and delay in the announced phasing out of the subsidies on PDS kerosene and domestic LPG;
- Increase in explicit budgetary subsidies on food and fertilizer and
- Increase in input costs unaccompanied by any improvement in recovery rates resulting in escalation of implicit subsidies on a variety of economic and social services.
Operational inefficiency in the case of provision of any public good or service leads to higher cost of production and greater subsidies. There is a wedge between subsidies that are actually received by the users of the service and subsidies that are borne by the Government. Several types of inefficiencies may accompany the public provision of services. Apart from direct costs like overstaffing, poor maintenance of assets, procedural delays, and delays in taking critical decisions, there are systemic inefficiencies.
Subsidy reforms should aim at:
- Reducing their volume relative to revenue receipts.
- Limiting these to only Merit I and Merit II categories while eliminating the non-Merit subsidies.
- Administering subsidies more directly to the targeted beneficiaries, thereby eliminating input subsidies and focusing more on trans- fers rather than subsidies.
- Making these subsidies transparent by show- ing them explicitly in the budget and
- Avoiding multiple subsidies to serve the same policy objective.
Any subsidy restructuring has to address the issue of food subsidy. For food grains, support prices should be kept at the C2 level recommended by the CACP. To contain operational costs, reimbursement of expenses to the FCI should be based on norma- tive unit costs and actual quantities involved. With
respect to PDS, the system of dual prices encourages leakages.
A uniform price policy with a system of food coupons for the BPL families needs serious con- sideration. The system may be implemented in phases. In the case of fertilizer, both farmers and fertilizer industry have been subsidized. There is a need for policy measures to reduce subsidy to both the groups. Fertilizer subsidies should be done away with in their present form.
Urea imports should be de-canalized and a flat rate subsidy system may be introduced with two different rates of subsidy for domestic producers and importers in the short run, and a single rate in the medium term. Further, given the problem of domestic availability of natural gas, which is the cheapest feedstock, the option of setting up fertilizer plants in countries where natural gas is available in plenty may be considered. The fertilizer produced there can be shared between the host country and India as per the agreement reached. Another reason for the mounting burden of fertilizer subsidy is the lack of a mechanism to increase the farm-gate price of urea at regular intervals.
A system that provides for such a periodic increase is required. Social services being associated with strong externalities and scale economies qualify for large subsidies in comparison to economic services. While human development is legitimately a major concern of the welfare state, it may be necessary to reassess policies in this area at the micro level to temper this concern with the equally legitimate concern for the burgeoning public expenditures. This is particularly important if inadequate targeting and leakages are major problems with the subsidies.
The economic services can be priced in var- ying degrees. There is scope for augmenting cost recovery in these services. User charges should be linked to costs. Appropriate upward adjustment of these charges would directly reduce the subsidy bill. Services need to be divided into some broad groups, and broad norms for cost recovery need to be established for each of the groups. A concrete plan would require fixing recovery targets in three phases:
- Short-term (immediate increase)
- Medium term (in a period of five years) and
- Long term (ten or fifteen years).
The long term targets would need to be deter- mined on the basis of desired or optimum degree of subsidization worked out for broad groups of services. In the short term, the target should be to recover a specified portion of the variable costs.
High costs of service provision and low or negligible recoveries through user charges are the two critical factors leading to high subsidies. Costs need to be reduced, by eliminating producer ineffi- ciencies. Subsidy reforms need to follow a scheme of priorities by focusing on selected sectors, which yield maximum results. A scheme focusing on ser- vices in which there is considerable scope for higher recovery in the non-Merit category may constitute the first step.
NEGATIVE SIDES OF SUBSIDIES IN INDIA #
Energy-Groundwater Nexus #
Agriculture sector is perhaps having most justi- fiable claim on subsidized inputs given the dismal situation of the farmers in the country. On these lines, water and electricity for agricultural use are heavily subsidized by state governments. Again, politics seeped into this economic cause and most governments have failed to ensure rational and sustainable use of subsidized water and electricity. Owing to this, in large parts of India, groundwater is being extracted indiscriminately as electric pump consume electricity that is almost free of cost. This has led to dramatic fall in groundwater levels. Wells have gone dry at numerous places. Water extracted from deep earth often gets contaminated by arsenic mineral. This, together with erratic monsoon due to climate change, has pushed rural India in deep distress.
To remedy this problem, government has plans to separate agriculture feeder network from rest, under Deen Dayal Upadhayay Gram Jyoti Yojna. This separate agriculture feeder will supply electric- ity only for a few hours a day. This was first tried by Gujrat and results were encouraging as it had role in making Gujrat a power surplus state, along with arresting continuous decline in groundwater levels.
Subsidized fertilizers #
Nutrient Based Subsidy or NBS was introduced in 2010 with objective to promote balanced use of
fertilizers and to limit fertilizer subsidy of the gov- ernment. Idea was to fix subsidy as per nutrients (in per Kg ) in the fertilizer and leave the determination of price to suppliers. Presently Urea is not covered under the scheme due to political compulsions. Consequently subsidized price of Urea remained stagnant even when real costs of production have risen significantly. On the other hand Potassium and Phosphorous are covered under the scheme and a fixed subsidy as per content of nutrients is given to suppliers and they change Maximum Retail Price as per market signals. Secondary and Micronutrients are also covered under the scheme. (In short urea is still controlled and P, K, is decontrolled)
As a result, actual use of NPK is in ratio of around 8:3:1 while recommended use is 4:2:1. This additional use of urea doesn’t give any additional benefit to the farmer. Instead this can degrade soil and harm crop. Productivity and quality of a crop depends upon use of diversified mix of macro and micronutrients, which vary from soil to soil. While urea consumption has increased from 59 per cent to 66 per cent of total consumption in 2012-13 over 2010-11, per hectare consumption of fertilizer has declined from 140 kg to 128 kg over the same period.
Fertilizer subsidy was ‘67,971 crore in 2013-14, an increase of 11 per cent over 2009-10. Large part of this went to production and consumption of urea that was not needed at all.
Also, due to excessive use of fertilizers ground- water is also getting polluted and chemical bioac- cumulation problem is impacting health of people.
Apart from Urea, farmer is not even get- ting benefit due from NBS in case of subsidized potassium and phosphorus. Subsidy is provided to manufacturers, who in turn are responsible to pass this subsidy to farmers in form of reduced retail prices. Rather, manufacturers have increased their prices forming a cartel and have usurped subsidy meant for farmers. It’s only now that Ministry of Chemicals and Fertilizers has undertaken review of prices charged by registered manufacturers. It has plans to penalize and cancel registration wrongdoers.
Another mistargeting of fertilizer is that most of this is consumed by rich farmers of Punjab, Haryana and North West Uttar Pradesh. Uptake of fertilizers
depends a lot on sufficient supply of water to the crop. As about 60% of total cultivated area of India is rain fed, subsidy is cornered overwhelmingly by well irrigated states.
Cultivation of wheat, Rice and sugarcane at cost of pulses, horticulture crops and coarse but nutritious grains.
Consumption patterns in India are shifting rap- idly from calorie rich diet to protein and vitamin rich one. Despite this, protein based diet in India is abnormally expensive. Main source of protein for Indian masses is pulses. Last whole year there was clamour on the issue of skyrocketing prices of pulses. India’s subsidy regime had its hand behind this problem.
Pulses are most suitable to be grown in areas of Maharashtra and Madhya Pradesh, yet large parts of these areas are under cultivation of sugarcane. Sugar- cane due to high ‘fair and remunerative price’ is being sown in these areas. This create two problems – one, it deprives Indians of their source of protein; two, these areas are water deficit and sugarcane is water guzzling crop. This crop is sucking scarce water rapidly and when monsoon failed again this time, mainly in Marathwada; farmer had no way to escape.
Ironically, pulses are water efficient crops with capacity to rejuvenate soil by process of nitrogen fixing and farmer chooses crop like sugarcane which later proves to be a gross liability for him. Sugarcane is suitable to be grown in areas of Bihar and Bengal given abundant water, but it is not due to lack of electricity and irrigation.
Similar is the case for cultivation of Wheat and Rice. These two crops yield much larger quantity (about 5 times) per acre/hectare than crops like pulses. Higher MSP for pulses is not so high to make whole value of produce more remunerative for farmer. So he prefers conventional grains. This has led to huge stockpile of wheat and rice (40-50 million tons) ingovernment inventory which decays and is carried forward at cost of Rs 5/ year. On the other hand, India has to import more than 25% of its consumption of pulses.
Railways #
Subsidization and Cross- subsidization – Between 1993 and 2011, the wholesale price index rose by
295% and the fares of sleeper class and second class travel rose just by 144% and 106% respectively. Consequently, railway runs at heavy loss, which can be construed as subsidy to passengers of the railways. It’s only natural that railway has failed to expand capacity and improve quality to serve needs of booming Indian economy. When British left India had network of 52000 Kms, which now increased to measly 64000 Km.
Apart from this, freight carriers of railways are even more uncompetitive, because railway subsidizes passenger fare further by charging higher freight charges. Accordingly, in 1970’s freight used to contribute 65% of railway revenues and now it does only 33%. This is due to shifting of freight carriage from rail to road transport, which much costlier, more polluting and more time consuming. This has made our economy a lot more uncompetitive.
Agricultural Finance #
Farmers are entitled to pre- harvest loan at 7% interest rate. They are allowed further 3% subven- tion in case of timely payment. Farmers can also take loan for post-harvest time against negotiable warehouse receipt.
Economic survey notes three discrepancies in this subsidy. One, trend indicates that amount for a single loan is increasing for most of these subsidized loans. This means that more subsidies is going in favor of rich farmers. Two, extension of subsidized credit is concentrated in last three months of the financial year, which indicates that reluctant banks otherwise unable to meet priority sector lending targets, desperately disburse loans to reach target at the end only. It is unlikely that this way credit will reach to desirable party. Third, agriculture credit is getting concentrated on peripheries of urban areas, which means that money is being diverted to non- agricultural use.
Food inflation #
Fact that India produces surplus foodgrains doesn’t mean that these are available to consumers at cheaper prices. Rather, India till couple of years back witnessed spiraling double digit inflation driven by expensive food, even when world was reeling under deflation. This distortion is mainly due to increasing input costs to farmer coupled with per-
sistent increase in Minimum Selling Price declared by government. This forces government’s agency FCI to procure foodgrains in open ended manner. As a result, government ends up procuring 25-33% of total foodgrains production in the country. Apart from this, about 33% of foodgrains are captively consumed by farmers. All this leaves just 33%-45% of total foodgrains for open market. This. At times, culminates in an absurd situation, where there is shortage of grains in open market which push prices upward and millions of tons of grains stored in FCI godowns.
Few experts believe that entitlements under Food Security Act are sufficient only to fulfill 50% of requirement of foodgrains for a household. For this 50%, there is massive but inefficient storage and PDS system. This in many ways significantly increases price of remaining 50% food grain need of households. So, a well-intended system may be actually working counter to its stated goals.
Solutions #
A. Direct Benefit Transfers as solution #
Given above are only few examples of subsidy support gone wrong. In such scenario, direct bene- fit transfers comes to rescue government from this problem. It is likely to have multiple benefits –
Fiscal savings – Assuming explicit subsidies being extended by state in current form to remain between 3 to 4 lakh crores, DBT will curb this expenditure by around 15%, which is a conserv- ative estimate of current leakages. This can save government around 50,000 crore, which can be used more efficiently for developmental purposes. Given that government is capable of sailing through implementation of DBT in comparative smooth manner, as there is huge support from beneficiaries and opposition is weak (unlike other issues such as disinvestment, land acquisition), this will prove to be a low hanging fruit.
It hits at roots of corruption – It is common knowledge that subsidized fertilizer is diverted to industrial use from agricultural sector, kerosene is mixed in diesel and PDS food is leaked in black markets. In short, subsidy regime has nurtured a mammoth corrupt ecosystem and black economy in India. When DBT is implemented everything will
be sold on market prices by the government. For
E.g. Fair Price Shop owner will get PDS food in full central issue price plus margin kept by state government. Then question of giving away PDS commodities illegitimately doesn’t arise.
Further, Direct transfers will eliminate interme- diaries which will end system of rent seeking from beneficiaries. Otherwise there is rampant system of illegitimate commission which is collected by gov- ernment officials where they have power to stop, deny or delay the benefit to be passed.
It is likely to control inflation – Distortions created by subsidy regimes discourage investment in relevant sectors. This creates supply side constraints in economy. It is expected that recent deregulation of diesel will increase production and private firms will reopen their retail outlets. This will create competition which often results in cheaper prices.
Further, trading and purchase at market prices keeps demand in check. For e.g. subsidy on urea encourages farmers to use it more even when there is no due benefit. This created huge demand of urea and in turn high prices of unsubsidized urea. This scenario has increased government’s subsidy on urea manifold, which is not only waste but a disaster in itself. Similar case is with the food grains. DBT will leave more food grain in market and hence lower prices.
Better nutrition – When there is cash transfer poor will be able to diversify their diet by including more items like pulses, eggs etc. This will increase their protein intake.
However, there is risk that some households will misuse this cash in social evils like alcohol, tobacco or gambling. For this government has made eldest women in a household target beneficiary for cash transfers. This step is likely to empower women.
Government launched PAHAL scheme – pan India initiative for transfer of direct benefits for Liq- uefied Petroleum gas. Its huge success and about 3 crore fake beneficiaries have been eliminated, which will contribute to annual saving of Rs. 15000 crore.
Direct Cash Transfer is also being implemented for transfer of wages in MGNREGS scheme. It has resulted in reduction in delayed and fake payments in relevant areas.
Further, Direct Benefit Transfer for fertilizers and kerosene is on the cards. In case of fertilizers government is facing problems in determination of beneficiaries because there is lack of clear land titles.
B. JAM Trinity – Jan Dhan Yojna, Adhaar and Mobile base #
Direct benefits transfers intend to transfer subsi- dies directly to account of beneficiaries. For this to happen efficiently there are two separate but related issues which need to resolve as prerequisite. One is medium of transfer and second is identification of beneficiaries.
For first, government is banking upon Pradhan Mantri Jan Dhan Yojna, under which more than 20 crore accounts have been opened. This is perhaps most significant step toward financial inclusion till date as unbanked population has been halved to 233 million. Subsidies under PAHAL scheme, pensions under National Social Assistance Plan and wages under MGNREGS are being credit to newly opened Jan Dhan account of the people. It also provides for overdraft facility of Rs. 5000 after use of 6 months and Rs. 100000 accidental insurance. These incen- tives have created a massive demand for opening of accounts. One benefit is that overdraft by account holder will regularly get repaid by automatic transfer of various subsidies in the account. This reduces the risk of default to negligible levels.
However, lakhs of villages doesn’t have any brick and mortar bank branch. In these villages mobile penetration is steadily growing. India has more than 900 million subscribers and out of these about 370 million users are based in rural areas. Rural subscriber base is growing at 2.8 million a year. Currently internet penetration in India is about 40% and is expected to grow spectacularly once national optic fiber network is in place. This all will be developed into digital mobile or internet based cash transfer mechanism.
Further, RBI has opted for differentiated bank- ing by rolling out licences for Payment and Small banks. A bank licensed as a payments bank can only receive deposits and provide remittances. RBI last year issues 11 licences for payment banks to various corporate giants, telecoms and most impor- tantly, India Post. India post is having about 155000 branches mostly in rural areas.
Apart from this, in-principle licences for Small Finance Banks have been granted to 10 entities. Small finance banks are a type of niche banks in India. Banks with a small finance bank license can provide basic banking service of acceptance of deposits and lending. The aim behind these to provide financial inclusion sections of the economy not being served by other banks, such as small business units, small and marginal farmers, micro and small industries and unorganized sector entities. Accordingly, it is likely that within few years subsidies will find way to bank accounts of all beneficiaries.
Now, to be sure of identity of beneficiary, Adhaar card base is blessing in disguise. Atleast 93 crore Adhaar cards have already been issued and it will take some more time for universal coverage. Biometrics captured in this card ensures that there is no duplication and no wrong claim is made. Earlier Supreme Court banned use of Adhaar card on privacy concerns, but on government’s appeal it allowed its use provided it is not made mandatory.
Apart from these initiatives, behavioral and technical remedies may be of immense use to
control and target subsidies better. Under ‘Give it up’ campaigning, about 50 lakh LPG users have voluntarily given up there subsidy entitlements. On technological side, Urea is being neem coated, which while enhancing agricultural productivity, makes it unfit for industrial use.
Subsidies are meant for poor people and they shall ensure equitable redistribution of resource. Subsidies extended to rich are regressive. They help in keeping poverty intact and create inefficiencies in economy which culminates in inflation and cor- ruption. In such case economy is retarded as we have seen in India’s case. When India grew in first decade of millennium at average rate of 7.5% it was found that this growth was jobless and unsustaina- ble. India’s economy faced supply side constraints, which didn’t increase productivity as compared to GDP. RBI had to then control spiraling inflation by steep hikes in interest rates. Rationalization of subsidy regime will improve markets in India which will then attract more investment. This in short, can turn the wheel of a virtuous economy which creates more employment and attacks poverty at its roots.
