The burden of subsidies

November 7, 2011

(The views expressed in this column are the author’s own and do not represent those of Reuters)

At the Indian media meet at Cannes, the economist in Prime Minister Manmohan Singh came out spontaneously when he said the prices of petroleum products should find their ‘market level’. For a time at least he ignored political compulsions.

The government has defied the market by keeping administered prices of fertilisers, petroleum products and food grains deliberately low, the difference being funded from subsidies. It is easy to give but extremely difficult politically to reduce or remove subsidies. On the contrary, it is natural for subsidies to expand and bring the government budget under stress.

Subsidies now amount to more than a half of the revenue deficit. That deficit has to be funded from market borrowing which reduces investment in private sector to support consumption by the people. Both reduce growth and fuel inflation.

In the last eight years, subsidies have shot up four fold from 435 million rupees to 1.6 trillion rupees in 2010-11. Of the three major subsidies, fertiliser subsidy accounts for 33 percent, food subsidy 36 percent and petroleum subsidy 26 percent of the total subsidies. Are these subsidies really necessary?

The original intention of fertiliser subsidy was to incentivise the farmers to adopt green revolution technology. The farmers are now fully aware of the benefits of using fertilisers and do not have to be motivated any more. But the subsidy continues simply because farmers make a good vote bank.

The petroleum subsidy was unnecessary right from the start. Petroleum consumption has to be minimised with efficient use which automatically follows with market prices. The government has now decontrolled petrol prices but diesel, kerosene and LPG continue to be heavily subsidised. This has forced the companies into 1.32 trillion rupees under-recoveries which will have to be eventually subsidised either by Indian oil producing companies or the government.

The considerations with food subsidy are different. This subsidy is really an investment in human capital which would give yields in future. The Food Security Bill which will be introduced in the winter session of parliament will increase the subsidy to 1.2 trillion rupees as estimated by the Minister for Agriculture. Even that cannot be grudged. But, as the Planning Commission had reported, PDS results in 57 percent of the food grains getting diverted to unintended beneficiaries. An alternative system of distribution has to be thought of.

Since food subsidy is justified, the burden on the budget can be lightened if the mere populist subsidies are knocked off. That would also leave a little surplus which can reduce revenue deficit. But even the food subsidy should be subject to conditions.

First, any increase in procurement prices should be followed by a corresponding increase in issue prices. With that, the margin will be constant and so also the amount of subsidy. Second, the Food Security Act should have a fixed tenure after which it should lapse unless reintroduced or modified by parliament. These conditions will impart greater viability to the budget and promote higher growth.

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Its a regular knowledge of reader that oil subsidies are a thorn in Indian development. Sir, Please opine as to How and Why it is the biggest ‘ Future’ Roadblock in Indian Economic development and Energy Independence …

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