Column : Show me the money!

Written by Sajjid Chinoy | Updated: Jan 25 2013, 06:32am hrs
The value of cash transfers will be huge when fully rolled out, for now the savings will be just 0.01% of GDP

Few topics have attracted as much attentionbut also confusionas the governments recent thrust to transition Indias creaky, product-centered subsidies to a system of electronic, direct cash transfers. In some quarters they are (wrongly) seen as a panacea to all our current illsexpected to result in significant fiscal savings, better identification of the poor, while simultaneously boosting consumption. In other quarters, they are simply seen as a political gimmick that will necessarily result in more inflation.

Where does the truth lie Are cash transfers, per se, the source of fiscal savings Or is it unique identification that drives the savings How large could the end-state savings be And is this a game changer in the next year or two Can the combination of unique identification and cash transfers simultaneously result in fiscal savings and higher aggregate demand And what does the experience of other countries tell us about the design and efficacy of cash transfers

In the first part of a two-part series we try and sift through these fundamental issues: why it is important not to confuse unique identification with cash transfers, what the quantum of the end-state savings may be and why, in the near term, intent will be more important than technology in improving the fisc.

Are cash transfers the source of fiscal savings

No! Cash transfers, by themselves, do not necessarily lead to fiscal savings. To understand why, it is critical to distinguish between Aadhaar (unique identification) and direct cash transfersconcepts wrongly used interchangeably.

Aadhaars role is to establish a unique identification backed by bio-metric confirmation. All Aadhaar does is to confirm that X is truly X. And this is where the bulk of the fiscal savings lieby rooting out fake beneficiaries, ghost ration cards and identification-error related leakages. Currently, for example, three different people may claim to be John Doe and claim the benefits intended for him. A unique identification system is expected to root out the pretenders.

None of this has anything to do with cash transfers! In theory, the government can continue to have product-based subsidies and experience savings by simply bringing them under the ambit of Aadhaaras pilot studies have demonstrated. Why is this distinction important Because financial inclusion and bank accounts may take significantly longer to enable. But as long as the current welfare programmes come under the ambit of Aadhaar, the fiscal savings will accrue.

How large could end-state savings be

Studies have found that leakages on account of identification errors (fake beneficiaries, ghost ration cards) typically run between 15-20%. For example, a government study in 2005 found that diversion of subsidised grains to non-existent beneficiaries was about 17%. Another study on MGNREGA found leakages to be about 12% on account of ghost workers and manipulated muster rolls. But averages mask the horror stories. One study found that only 61% of the claimed wage payments was actually received by workers in a particular state. In another case, 901 ration cards had been issued in the name of one person. On average, however, previous studies and more recent pilots seem to converge on savings from identification errors being in the order of 15-20%.

So whats the big picture The governments allocation for the schemes potentially eligible to be brought under AadhaarPDS food and kerosene, LPG, fertiliser, MGNREGA, scholarships, pensions, Indira Awaas Yojanain FY13 is likely to be about R3 lakh crore. If all of these schemes are eventually brought under Aadhaar and the programme is rolled out in the entire country, a conservative leakage savings estimate of 15% would result in aggregate savings of R45,000 lakh croreor almost 0.5% of GDP. If it does better than expected and plugs leakages to the tune of 25%, this would result in savings of about 0.8% of GDP. These are substantial savings but are contingent on the perfect stormall programmes covered in the entire country.

But can this solve our fiscal problem in the near term

It should be clear that even though the end-state savings could be significant, near-term benefits will be far more modest. Aadhaar-enabled cash transfers were rolled out across just 20 districts (3% of all 600 districts) in January 2012, and will gradually ramp-up to 51 districts later this year.

More importantly, only a very small sliver of the 3% of GDP that the government spends on welfare programmes and subsidies will initially come under the ambit of Aadhaar and cash transfers. Much is made of scholarships and pensions, but total spend in those areas, for example in FY12, was about R14,000 crore (0.15% of GDP). Even assuming 25% savings using Aadhaar would generate savings of just 0.04% of GDP in the next fiscal, even assuming this is rolled out to the entire country by then, which appears doubtful. An NIPFP study, for example, estimates total savings from Aadhaar in FY14 at about R1,000 crore (in constant prices) equivalent to 0.01% of GDP.

Bottom line: Aadhaar will not solve our fiscal problems in the next two years. Not even close. Instead, the government needs to be commended on biting the bullet on diesel subsidies last week. While technology will help in the medium term, in the short run fiscal intent of the kind shown last week will still be the key.

So whats the value of direct cash transfers in all this

Notice, none of discussion thus far had to do with cash transfers! Savings can be achieved simply by staying on the product-subsidy system, and eliminating identification errors.

Yet this should no way diminish the other benefits that cash transfers offer. A key benefit is bypassing layers of bureaucracy and middlemen to ensure the benefit intended for John Doe actually reaches him. So while Aadhaar will weed out the fake John Does, cash transfers will weed out the middlemen and ensure that a greater fraction of the benefit directly reaches John Doe. The primary benefit therefore is not fiscal savings, per seas is being toutedbut better service delivery. Remember, several of Indias welfare programmes are already paid out in cash. Whats different is that they will be direct electronic cash transfers.

But the value will perhaps be felt most for subsidies that are currently product-based. A key source of corruption and misallocation of resources is the dual pricing of products under the current PDS system that incentivises agents to misdirect resources. Moving to cash transfers would eliminate the dual pricing and ensure a single market pricewith the subsidised component being transferred ex-ante or ex-post as an electronic cash transfer. This might play a huge role in reducing the black market and improving allocative efficiency.

Of course, true allocative efficiency is only achieved when cash transfers are made truly unconditional (i.e. the recipient/family can spend the money as they like) rather than being forced to consume predetermine quantities of food and fuel that the government deems fita one size fits all. Unconditional transfers would almost definitely mean that recipients substitute their consumption of grain to other food groups, for example, and should logically mean that there will be no need for the government to procure enormous quantities of grain, and therefore not have to incentivise farmers to produce sub-optimally large quantities of it by sharp increases in MSPs. It is in response to these distorted price signals, that a supply response has not emerged for other food groups that have experienced stubbornly high rates of inflation. But even if there are significant efficiency gains to be had from unconditional cash transfers, it is a political hot potato.

One criticism against unconditional transfers is that they would result in the money being spent out on undesirable goods. The experience of other countries, however, does not bear this out! In a follow-up piece, we look more generally at what the experience of other countries has to offer on cash transfers. And more fundamentally on what Aadhaar and cash transfers could do to aggregate demand, growth and inflation Will the government be able to have its cake and eat it tooachieve fiscal consolidation without reducing aggregate demand

This is the first of a two-part series

The author is India economist, JP Morgan