Events & Issues

New Delhi, 16 June 2014

Rationalising Subsidies

MODI’s FIRST LITMUS TEST

By Col (Dr) PK Vasudeva (Retd)

Since Independence the Central Government subsidises many industries and products, from petrol to food. Whereby, on one hand it assists loss-making public sector enterprises and on the other gives free electricity to farmers. Pertinently, if nine years ago in 2005 doles totalled 14 per cent of the GDP, the figure has risen manifold. Worse, over 39 per cent of the subsidised kerosene is stolen.

Notably, India spends relatively little on education, health and infrastructure. Shockingly, the country’s investment in urgently needed infrastructure development is abysmal. In fact, it is much lower than our neighbour China. Also, according to UNESCO, we have the lowest public expenditure on higher education per student in the world. Resulting in the World Bank coming down heavily on these doles as they only led to increasing economic inefficiency.

Undoubtedly, one of the formidable challenges before the Narendra Modi Government is the rationalisation of various subsidies handed over by its predecessor Congress-led UPA. Underscored by the Prime Minister last week. Said he, “The UPA left everything empty, the financial health is rock bottom.”

Recall, between 2007-08 and 2013-14, the Centre’s total subsidy bill spiralled from under Rs 71,000 crore to around Rs 2,56,000 crore or might be even higher if the estimated Rs 75,000 crore of uncovered petroleum and fertiliser subsidies rolled over to the current fiscal is also added.

There is no gainsaying, this situation is clearly unsustainable; particularly at a time when the Centre needs to increase its own capital spend to kick-start investments in an economy that has been in slowdown mode for more than three years. Towards that end, pruning subsidies might help release substantial resources that could be redirected towards productive investments.

The important thing in subsidy rationalisation is to distinguish between good and bad. The abysmal doles are the ones that are recurrent and promote inefficient resource use. Fertiliser and fuel subsidies fall under this category. Besides, it is common knowledge how artificially low prices of urea have promoted excess nitrogen application and contributed to severe soil nutrient imbalance. The same holds true with under-pricing of diesel, which not too long ago led to an artificial spurt in sales of SUVs apart from being diverted to various industries fire boilers and furnaces.

Thankfully, the decision by the erstwhile UPA Government to effect small monthly increases in prices has reduced the under-recovery on diesel sales by oil marketing companies to roughly Rs 4.4 a litre presently. The Modi Sarkar needs to complete this process and start phasing out subsidies in LPG, kerosene, urea and other fertilisers. An achievable goal if one follows a three-year timeline which is feasible, even politically.

Moreover, food subsidies are recurring alongside but they need to be viewed differently. In a country where millions of people suffer from extreme poverty, it is only just that the State is firmly committed to ameliorative poverty through sound policies. But even here, it is desirable to replace the current distortionary system — of physical grain procurement by the Government at high support prices only to resell it at highly subsidised rates through ration shops — with targeted direct cash transfers.

Indeed, cash transfers are the way forward even in the case of LPG and kerosene purchases, subject to the condition that the beneficiaries truly belong to low-income groups. In general, the principle should be to welcome subsidies that are one-time and have strong positive externalities in terms of resulting in broader society benefits.

In addition, the fortunes of upstream state-run producers might be revived after several years amid expectations that the peak of subsidy sharing could now be behind us. Over the past 10 years, in the wake of rising international prices, upstream oil & gas producers such as ONGC and Oil India have borne a major brunt of selling kerosene, natural gas and other petroleum products like transportation and cooking fuels below cost to fertilizers and power industries (which use such products as inputs) along-with consumers.

Take ONGC. This mechanism which started nearly a decade ago witnessed the subsidy burden increase from about Rs 2,700 crore in 2004 to about Rs 56,000 crore in 2014. According to some reports the NDA Government is contemplating increasing the kerosene and liquefied petroleum gas (LPG) prices. As the total subsidy burden for this sector last year was Rs 140,000 crore, out of which, about Rs 63,000 crore was for diesel alone, Rs 30,000 crore for kerosene and another Rs 46,000 crore for LPG. Thus, if the Centre decides to raise prices, the subsidy burden would definitely go down. 

Further, India is considering a proposal to raise the price of urea, the fertiliser most used by farmers, by at least 10 per cent in order to contain the huge subsidy costs that are straining the Budget. With Fertiliser Minister Ananth Kumar backing this measure, it has bolstered the chances of this being implemented.  

In fact, this would be the first major price hike in four years and underline an important step by Prime Minister Modi towards cutting wasteful use of urea as also easing fiscal pressures resulting from a weak economy. Furthermore, it would boost the relative appeal of potash and phosphate fertilizer, given that the domestic selling prices of these have been allowed to rise since 2010.

True, the Agriculture Ministry is not responsible for urea prices, but any increase would lead farmers to demand higher minimum support prices for their crops. However wasteful and indiscriminate use of urea by the agriculturists would help reduce the production cost of food products.

Significantly, subsidising primary healthcare and education, immunisation, provision for clean drinking water and water-saving irrigation systems fit into this category of ‘merit’ subsidies. All other doles fall in the ‘non-merit’ bracket conferring no significant positive externalities or equity benefits. Alas, these constitute the bulk of what the Government spends today and need to be weeded out. Clearly, if Modi follows this framework, it is possible to achieve meaningful subsidy rationalisation that balances resource use efficiency, equity and fiscal sustainability concerns. ----- INFA

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