India News and Features Alliance (INFA) - Govt Expenditure:CUT DOWN WASTEFUL SUBSIDIES, by Dr. Vinod Mehta,25 March 2008

More than a decade ago it was decided to phase out subsidy on cooking gas. Banking on this decision, a few private sector companies entered the cooking gas distribution business thinking that in a few years there would be a level-playing field. But the Government hasn’t been able to phase out subsidy on cooking gas. The few private firms that had entered the gas distribution sector eventually had to close down their business, as they simply couldn’t compete with the subsidized gas distribution network of the public sector undertakings.

India, according to a study by the University of Texas, “is struggling to attract investment in the fuel sector. The issues in the LPG industry are demonstrative. In 1992, 35 private sector companies developed plans for the import and distribution of LPG in the hope that they would be able to benefit from the 10-million consumer-long queue for LPG connections. However, while the companies have added just over a million customers to their roster, the public sector oil companies have managed to rope in a phenomenal 14 million new customers during the same period mainly based on prices that are highly subsidized. Private LPG turned out to be too expensive for the price-sensitive Indian market.”

The study further adds that: LPG distributed by public oil companies was sold for $5.09 (Rs 241) a cylinder (of 14.2 kg) in Delhi whereas a 12-kg cylinder from a private company cost $8.44 (Rs 400). (Private companies may only sell LPG in 12 and 17-kg cylinders.) “As long as the government subsidizes the public companies and private companies have to pay import duties as high as 23 per cent, the private LPG players cannot establish themselves in the market. Currently, only about 30 per cent of private LPG capacity is being utilized.” Similarly subsidy on Kerosene and diesel is affecting the price of petrol.

All kinds of Central and State subsidies (open as well as hidden) are reported to account for 15 per cent of the GDP. About 90 per cent of subsidies go for "non-merit goods and services" -- the non-merit goods and services as identified in one of the budgets include milk, power, transport, irrigation, education etc.

Take for instance the subsidy on fertilizer. As per data available the amount of subsidy being paid on fertilizers is very high. This subsidy is expected to keep the price of fertilizer low for the farmers; but nearly 50 per cent of the fertilizer subsidy actually goes to the producers/suppliers rather than to the farmers.

Subsidy paid out on food rarely percolates down to the consumer but gets absorbed in costs of handling and storing food grains. Similarly, a significant portion of subsidies in higher education is appropriated by middle to high-income groups.

Unnecessary subsidies are leading to wastage of scarce resources. For instance, it has been mentioned that extremely low recovery rates in sectors like irrigation, water, electricity and diesel lead to their wasteful use as these have been withdrawn from some other sectors in which these could have been very useful. Provision of free electricity to farmers is a big drain on resources. It may be mentioned that except for petrol all other petroleum products like diesel, domestic gas, wax, naphtha, etc. are being subsidized in a big way.

Of the total subsidies paid on petroleum products nearly half of it goes to diesel, kerosene and domestic gas in that order. As per the Rangarajan Committee Report on petroleum prices, the current -subsidy on cooking gas is still a whopping Rs.171 per cylinder.

Similarly, railways are providing huge subsidy every year on movement of passengers and low cost goods. The subsidy in railways goes to ensure lower freight rate on essential items and second-class travel.

One could go on and on but it is sufficient to say that the nation cannot afford to go on paying subsidies on every conceivable product and service. Subsidies beyond a certain level are harmful to the economy in various ways.

Firstly, it leads to wasteful use of resources. If a farmer is getting diesel or electricity at cheap rates he wouldn’t bother about economizing on the use of these two inputs. Moreover, who knows whether electricity and diesel are being used by farmers for other non-agricultural purposes? According to the National Council of Applied Economic Research, as much as 39 per cent of the subsidized kerosene was diverted by middlemen to other users in 2004. These other users gladly paid above the price set by the government because even at a 100 percent premium, subsidized kerosene is a cheap source of energy.

Wasteful use of electricity and diesel by the agricultural sector means that some other important sector of the economy such as the industry is being denied optimum use of these inputs.

Secondly, subsidies lead to distortion of relative prices in the country and send wrong signals to business units. For instance, railways are known to be the cheapest mode of transport for bulk commodities. But by subsidizing diesel we are artificially propping up the motor transport sector and at the same time also forcing the railways to keep its freight rates relatively lower than those of the motor transport etc. None of these two sub sectors have any incentive to economize on the use of diesel, coal and electricity or to improve their efficiency by reducing operational expenses.

Thirdly, subsidies beyond a certain level also imply that either the country resorts to deficit financing or imposes higher taxes on the people. Subsidies are not produced out of thin air; somebody has to pay for it. Subsidies are essentially, what economists call transfer incomes. They are in fact, a modern version of the old saying “Robbing Peter to pay Paul". Therefore, at one level the choice boils down to either having more subsidies and more taxes or fewer subsidies and fewer taxes.

Fourthly, the subsidies are also inimical to the export sector. They make the cost of export lower to foreign buyers; to that extent the domestic population is aiding the consumption of foreign buyers. One cannot afford to support the export sector on the basis of subsidized inputs for all times to come. Subsidies only reflect the uncompetitiveness of the domestic production and hence there is no incentive for the exporters to improve their efficiency by reducing production costs.

Therefore, what the country needs is to have a dispassionate look at all kinds of subsidies and decide as to which subsidies need to be continued, be reduced and be discarded. This cannot be a one-time affair, but a continuous process. Every three to four years, the effect of subsidies needs to be reviewed so that it can be seen whether they are fulfilling their role. Following which a decision would need to be taken as to whether subsidies need to be continued, reduced or discarded.

Part from downsizing, the Government can also save funds by introducing a kind of contractual employment at a higher level, where services of specialists are needed for a specific purpose and a specific period. For instance, it may be less expensive to employ a doctor or a health specialist or two to prepare the health policy than to allow a non-specialist bureaucrat to develop a health policy with the help of a specialists committee. This will also help save lots of money, which currently goes into meeting the expenditure related to the organization of committee meetings which includes cost of air travel, daily maintenance, honorarium or sitting fee and so on.

At the moment a large part of administrative expenditure goes into maintenance of law and order especially in disturbed areas such as the North East, Jammu and Kashmir etc. If these problems could be settled politically, a large chunk of money, which is being spent on military and para-military forces in these areas today, could be saved.

It is high time, that along with pruning subsidies, the Centre comes out with appropriate policies and takes steps required to cut down the size of a bulging bureaucracy, expenditure on stationery, telephones, electricity etc and on maintenance of law and order. In effect it would cut down the cost of administration and divert the funds so saved to more purposeful activities like education, health, housing, food etc.

The reduction of subsidies is a politically sensitive issue as many interest groups wouldn’t like any curtailment. But, the Finance Minster could at least initiate the process of streamlining subsidies and curbing wasteful expenditure. It has been estimated that if the government cancels the subsidies and redistributes the money as cash, each of the 160 million households will get $600 a year at current prices!---INFA