IT took Finance Minister P. Chidambaram 10 months—and a reincarnation in between—to unveil the Discussion Paper on subsidies promised in his 1996 Budget speech. But the Pandora's box he has now opened threatens to turn the innocuous white paper into the subject of a highly controversial and political debate countrywide.
Consider the startling facts:
What is a subsidy and why is it bad? The Concise Oxford Dictionary defines subsidy perfectly as "money granted by state, public body, etc to keep down the prices of commodities or services". Its effect is to reduce the relative prices of goods and services for a section of users. For instance, those with a ration card get to buy sugar at Rs 10.50 a kg instead of the market rates of Rs 16-18. Or, poor children in rural areas are allowed to study in primary schools free of cost. Says D.K. Srivastava, professor, National Institute of Public Finance and Policy (NIPFP): "Subsidies, which is the converse of indirect taxes, are useful provided they are time-specified, benefit the target section and do not distort the overall market for the specific good or service."
But like indirect taxes, they are regressive and affect sections beyond the target beneficiary. Instead, direct transfers, the converse of direct taxes, are preferable as they raise the income/purchasing power of the target group. In India, populist politics have distorted and institutionalised the subsidy regime and extended it to areas where subsidy is not intended to be given or not needed at all. Most of these are unaccounted for and hidden from public eye. For instance, the subsidies directly given through the budget amount to a little under Rs 17,000 crore and are only 30 per cent of the subsidy iceberg. Even these budgeted subsidies have grown by an average 20 per cent every year, from only Rs 170 crore in 1970-71.
That misdirected subsidies were increasingly subverting market forces and forcing government expenditure to zoom caught expert attention in the eighties. The first attempt to quantify subsidies was made by Sudipto Mundle and M. Govinda Rao of NIPFP for 1987-88, which was extended by A.C. Tiwari of the Indian Council for Research on International Economic Relations (ICRIER) for 1992-93 (see Outlook, August 14 and September 11, 1996).
The Finance Ministry's white paper is a 20-page summary of the third and latest study on government subsidies in India, by a three-member NIPFP team headed by Srivastava. Apart from calculating interest and depreciation differently, this study also differs from its predecessors in terms of methodology. One, it does not adjust with the subsidies the surpluses accruing to government in some economic sectors like communication and railways. Two, it makes an important distinction between merit and non-merit goods to show just how much of the subsidies are redundant.
Goods and services provided by the government are classified into: Public Goods,like defence and administrative expenditure, the benefits of which accrue to everyone and aren't easy to estimate; Merit Goods, whose social benefits exceed the total of private benefits, for instance, the education of an individual enriches the entire nation; and Non-merit Goods, which don't fall under the first two categories. It is the subsidy on non-merit goods, mostly economic goods and services provided by the government to supplement private suppliers (as in transport or power), that has zoomed and become a drain on capital expenditure. A recovery rate of 10 per cent on non-merit goods implies, simply, that not only are the wrong goods being subsidised heavily but also, as a result, the right things are not being subsidised enough.
Let's take merit goods first. The importance of subsidising education, especially at the primary level to equalise access across income segments, can't be overstressed. Education subsidy touched Rs 18,620 crore in '93-94, with less than one per cent recovery. But most high-income states like Goa and Punjab have been subsidising secondary education more than elementary education. Says Srivastava: "The present rates for higher education are self-defeating. A college student has been paying Rs 12 a month for the last 50 years, while the cost of providing the education has increased with the the inflation rate. By providing cheap higher education, the state is helping better-off students who have improved access to education. Also, the subsidy relative to cost is much more
at the higher levels."
The problem is similar in health which shows a nonrural and pro-rich bias, with 76 per cent of the subsidies going to urban areas. In fact, central health subsidies do not reach the rural poor at all. If at all they are using such facilities, the considerable time and expense needed to make the journey to the nearest urban centre certainly makes the subsidy quite pointless. The case for social subsidies is, therefore, a case for proper targeting and minimising diffusion. What is shocking is that subsidy on non-merit goods/services, which should be priced economically, has touched more than five times those on merit goods. Says the study: "Even if one allows for a part of these subsidies being given in the interest of redistribution or provision of minimum needs, a substantial part must be due to inefficiency costs of public provision of services and/or inessential input or output subsidies. "
TAKE non-merit goods food and fertiliser subsidies, strategically the most important subsidies in India. Only 73 per cent of food subsidy actually reaches the consumer. The state is needlessly involved in procuring, storing, transporting and distribution of foodgrains, and making a loss on the entire operation which could have been profitably left to the market. Also, the loopholes in the PDS only help to benefit the urban middle class. A much better option for the state would be to get out of the food market, periodically issue coarse grain coupons to the target section, and play only a regulatory role. Thereby cutting its losses completely, yet benefiting the weaker sections. In non-merit goods, in fact, direct income transfers also work better, like the food for work programme. Similarly, there is little case for providing fertiliser subsidy—which was Rs 7,767 crore last year—to public sector plants, as opposed to farmers who actually benefit from it, and continue to protect their production inefficiency. A much better way would be to import fertilisers directly and sell it to farmers cheap.
However, none of the farm subsidies—fertiliser, irrigation or electricity—benefit the landless labour, the most disadvantaged of the rural population. There isn't much evidence of these helping the small farmers either. Scientifically, irrigation benefits the farmer when he can increase the use of accompanying inputs like chemical fertilisers in the same proportion. Otherwise, the gains increase proportionately with farm size. Still, power subsidy to agriculture is expected to be Rs 17,285 crore this year. In 1986-87, the unrecovered cost of irrigation projects was a staggering Rs 15,525 crore. Continuing with the tradition, irrigation projects earned not even 10 per cent of their total expenses in 1992-93.
The worst of the subsidies go to support government enterprises, especially in the states, with the recovery rate varying from 33.63 in Andhra Pradesh to 0.17 in Bihar. In physical terms, the richer states can perhaps afford to waste enough to protect labour votebanks. Like Gujarat, which has Rs 307 crore subsidy, and Haryana with its Rs 166 crore. The Centre manages to recover a little more—5.36 paise out of every rupee—from its various departmental undertakings.
This mindless subsidy regime has led to cross-subsidies, which was Rs 8,666 crore out of the total petroleum subsidy of Rs 18,440 crore last year. To provide kerosene at less than the price of crude oil, petrol is priced higher than global rates and the urban middle class pays through its nose, while the richer go in for luxury cars with diesel engines. Ironically, most of the diesel subsidy goes to benefit either the government—including the railways, which anyway raise freight every year affecting the poor, and the vast fleet of state transport—or the rich with their diesel pumpsets or generator sets. Similarly, while the rich farmer continues to use power free, industry must shell out ever more for its consumption.
In a string of concluding recommendations, the study wants subsidies to be:
So does the finance ministry discussion paper, faced with the compulsion and commitment of reducing fiscal deficit to 2 per cent in five years. Says Srivastava: "Some of the subsidies may just have to be scrapped and some reduced to 50 per cent over the next five years. But in most of the cases, the economic message is clear and should override political compulsions." The onus, however, is more on the states than on the finance minister, who anyway seems more eager to cut petroleum subsidy than rationalise food and fertiliser subsidies. The states leading the way to reform will be the future winners.
