• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

R. L. Chawla

NEXT to interest payment /debt servicing and Defence expenditure, subsidies are the largest item of the Central Government's non-Plan expenditure. Totalling Rs 11,854 crore in 1994-95, subsidies increased to Rs 23,593 in 1998-1999; Rs 24,487 crore in 1999-2000 and Rs 31,207 crore in 2001-02.

The revised figure for 2002-03 is Rs 44,618 crore, and the Budget estimate for 2003-04 is placed at Rs 50,607 crore. The subsidies budgeted in 2002-03 absorbed nearly 16 per cent of the net revenue of the Centre and is likely to constitute 11.4 per cent of total revenue expenditure.

Subsidies for such major items as food and fertiliser have shown rising trends over the recent years. For instance, of the total subsidy bill, food and fertiliser subsidies together constituted 91.7 per cent in 1994-95, fell to 87.7 per cent in 1998-99, recovered to 92.6 per cent in1999-2000 and touched a hefty 96.4 per cent in 2001-02.

The following year, this proportion dropped to 78.9 per cent and is likely to increase to 81.5 per cent (BE) in 2003-04. The sharp fall in the share of food and fertiliser subsidies in 2002-03 and 2003-04 is mainly on account of the petroleum subsidy and grant to NAFED. Further, the share of other items, such as edible oils, interest subsidies and miscellaneous subsidies, was very low during the 1990s but showed some recovery from 2002-03 onwards.

Alongside with Defence and interest payments, subsidies are considered a holy cow. In the post- reform period, subsidies have been under constant scrutiny by policy-makers, industry and academia.

While expenditure on major subsidies is explicitly shown as a part of non-Plan expenditure, the highly subsidised user charges for postal services, power consumption and irrigation facilities are implicitly a draw-down on the budget of public enterprises.

Rationale and justification

The literature on subsidies distinguishes between merit and non-merit goods/services and areas, consumption and production subsidies and, quite often, between explicit and implicit subsidies. In merit goods such as elementary education and healthcare, whose consumption gives rise to substantial externalities, these qualify for state subsidies.

In the case of non-merit goods/services — agriculture, irrigation, industry, power and transport — subsidies are justified on account of long-term growth, redistribution or simply promotion of particular activities in particular region(s). An in-depth study by NIPFP (1997) shows that subsidies on non-merit items accounted for 11 per cent of GDP (both at Central and State government level).

These services hardly managed an average recovery rate of 9 per cent and a residue, that is, subsidy element of 91 per cent .The same study identified various components of subsidies that need to be slashed. Similarly, the Expenditure Commission also emphasised that select subsidies should be rationalised and scaled back.

Distinguishing between consumption and production subsidies, it may be stated that while the subsidy incurred on the supply of foodgrains through PDS at below FCI's economic cost constitute the consumer subsidy, the producer subsidy is the direct offshoot of the price-support-based procurement operations of the government.

The justification for buffer stock is that it helps provide income support to the poor. Among scholars of the political economy of policy reforms, a preceding crisis is frequently cited as the explanation for revolutionary change — the so-called `benefit of crisis' hypothesis.

In India, for example, it is becoming financially unsustainable for the government to support the existing pension system for its employees. Thus it has launched the defined contribution pension scheme for its new employees, avoiding the massive fiscal subsidy borne by itself over a period of time.

There is again a raging debate on the merits and demerits of input subsidy/support prices and income supplements in line with WHO consistent policies. While the feasibility of providing income supplements in an advanced country such as the US, with a farming population of 2 per cent, may be tenable, in India, with two-thirds of its population in the agriculture sector, it might create severe administrative bottlenecks.

Effect of subsidies

Let us now examine the effects of subsidy on specific sectors and their implications for the economy, in general.

Food subsidy has grown from Rs 12,060 crore in 2000-01 to Rs 24,200 crore (RE) in 2002-03. This means doubling of the subsidy bill in a matter of just three years. Right from the Green Revolution days, guaranteed procurement by the government has, over a period of time, turned out to be a liability and should have been reduced or done away with. However, political compulsions have allowed this subsidy to increase in an uncontrolled manner.

The calculations of the Commission on Agriculture Costs and Prices (CACP) show that weighted average of C3 cost of eight wheat-growing States is just Rs 532 per quintal while the weighted average of C2 is Rs 483, as against which the CACP minimum support price (MSP) is Rs 620 per quintal. The difference between the MSP and the C2 or C3 price constitutes the producer subsidy, which has been mounting over the years.

The high carrying cost of buffer stock is a subsidy benefiting neither the consumer nor the producer. At present, the buffer subsidies alone account for over 20 per cent of the food subsidy bill. While the difference between the economic cost of foodgrains and their issue price remains high, not much effort has been made to reduce operational efficiency and prune the subsidy level.

The government's rationale for fertiliser subsidy is that it will encourage the balanced use of fertiliser and, therefore, it offers subsidies on decontrolled fertilisers, such as DAP and MOP. Official data show that subsidy on domestic urea production has been the major component of total fertiliser subsidy.

Despite this justification, there is growing evidence that high levels of urea subsidy, over the years, have distorted the use pattern of nitrogen-phosphate-potassium in a way detrimental to soil fertility.

In the present Budget proposal, the announcement of the marginal rise in fertiliser price aimed to correct the distortions in fertiliser use that has been causing nutrient imbalance in the soil. However, the government's efforts to cut subsidy and marginally increase user charges met with stiff resistance, not only from opposition parties but also by NDA constituents, and subsequently it has had to withdraw the price increase.

As for the fertiliser subsidy, it is argued that it only benefits inefficient producers, rather than farmers.

Back in 1998, the Hanumantha Rao Committee had estimated the long-run marginal cost of domestic urea at Rs 6,500 per tonne. Unmindful of this cost coverage, the government subsidy per tonne adds up to around Rs 4,100 per tonne now. There is a strong opinion which suggests withdrawal of urea subsidy altogether.

Both input subsidy and support prices are deemed inefficient, and high support prices result in reduced consumption and accumulation of huge food-stocks.

On the contrary, advocates of the income supplement school argue that these are trade non-distorting incentives as such subsidy leaves product prices undisturbed so that they reflect the actual cost of production. Taken together, the subsidy bills of both the Central and the State governments runs close to 13-14 per cent of GDP — more than their total fiscal deficit.

As far as LPG/ kerosene/diesel are concerned, a fixed subsidy on these items was announced in last year's Budget. Since then, the prices of these products moved sharply but oil companies could not change retail prices.

More so as subsidies announced on these products also remained unchanged, with the result that there is a huge difference between the retail price of these products and the subsidies provided.

Generally, regressive effect of subsidies is high. Whereas relatively rich States enjoy the highest per capita merit subsidies on education and health services, poorer States make do with much less.

For instance, in Maharashtra and Gujarat, per capita subsidy on education is almost 17 and 34 times more respectively than in, say, Bihar.

However, as stated earlier, the viability of income supplements in the Indian economy, where the number of farms runs into lakhs, is likely to prove administratively cumbersome. This does not, however, obviate the necessity of slashing the subsidy bill considerably.

Appropriateness of subsidies

Time and again, it has been stressed that better targeting of consumption subsidies and appropriate pricing is needed. The High Level Committee on Long Term Grain Policy recommended in its final report that the BPL price be reduced to 50 per cent and APL price to 80 per cent of the economic cost, excluding statutory levies. This would help to improve the viability of the fair price shops in the distribution network.

In the case of producer subsidies, the alignment between MSP and cost of production needs to be worked out clearly. This is important for two reasons:

Stories in this Section
Joblessness on the rise

Copyright © 2003, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line