Column: Taming the 3Fs

Updated: Oct 28 2014, 07:05am hrs
One of the major challenges confronting the finance minister is to keep the fiscal deficit under control, preferably bring it back to 3% of the GDP in the next two to three years. This is a level which is desirable for prudent fiscal management under the Fiscal Responsibility and Budget Management Act, 2003. While raising tax revenues through a wider tax net and better compliance is one area he has to work on constantly, the other big area is to prune less productive expenditures. It is here that the three most prominent subsidieson fuel, food and fertiliser, the 3Fsneed to be tackled.

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The expenditure budgets of the Centre for various years reveal the rising trend in subsidies over the last fifteen yearsalmost a ten-fold increase, from R26,838 crore in FY01 budget to R2,60,658 crore in FY15 budget estimates. Obviously, in current prices, this does not mean much to an economist, but as a proportion of the GDP, this has gone up from 1.19% in FY01 to 2.16% in FY14. The expenditure budget data also reveals that food, fertiliser, and fuel (oil and gas) subsidies are the most dominant of all Central government subsidies, claiming almost a 95% share, on an average, during the last 15 years.

More interestingly, there has been a structural break in the rising trend of these three subsidiesfuel, food and fertilisers, which averaged 1.36% of the GDP during FY01 to FY08, shot up to 2.28% of the GDP between FY09 to FY14, almost a 68% increase. This seems to be in line with the changed economic philosophy of the UPA II government, of putting distribution policies before production and investment policies, bringing back the socialist ideology to the table. Raining subsidies, presumably on the advice of NAC, became the norm and the fisc became the victim. It ultimately contributed to high food inflation, at least partly. Chidambaram realised that it was unsustainable, but it was too late. And now, the biggest challenge before Jaitley is to tackle the 3Fs.

Of these, pricing of diesel has been largely tackled with its decontrol. Pricing of gas within the fuel mix still remains a challenge despite the recent hike in prices. However, the hardest nut to crack in the years to come would remain the food and fertiliser subsidies.

Food subsidy is budgeted at about R1.11 lakh crore. The full roll out of the National Food Security Act, which promises to give more than 61 million tonnes of rice/wheat/coarse grains at R3/2/1 kg, respectively, envisages a bill of at least R1.25 lakh crore. What is less known is that there is already an unpaid bill of about R50,000 crore on account of food subsidy that is not reflected in the expenditure budget. Similarly, fertiliser subsidy is budgeted at about R73,000 crore, and there are pending bills of about R38,000 crore. How does one tackle these without hurting the interests of consumers and farmers This is the real challenge.

Our detailed research in these two areas reveals that there is a possibility of saving at least 20-25% of food and fertiliser subsidies, amounting to R40,000-50,000 crore annually, if the government chooses to move to conditional direct cash transfers to beneficiaries. Food subsidy is to be given to the beneficiaries as the difference between market price and central issue price of rice and wheat on a per kg basis, subject to the condition that they send their children to schools and get the infants immunised as per the doctor's advice. The fertiliser subsidy, at the rate of R4,000/hectare, is to be given to farmers, subject to their getting soil health cards. The Jan Dhan Yojana, and its dovetailing with Aadhaar, will be handy when it comes to plugging leakages and switching to conditional cash transfers.

In this switch towards cash transfers, the interests of consumers and producers will be fully protected. The loser would be the rent-seeking class, which pilfers and diverts the benefits besides charging high costs for operations. These vested interests will have to be taken head on.

It also must be realised that the objective to serve vulnerable groups, be it poor consumers or small and marginal producers, through targeted subsidies is a good idea and India must follow that at its current stage of development. But the choice of policy instruments needs a change, from price to income policy. Since the socialist days, India has been using price policy (like cheap food through PDS, cheap fertilisers, especially urea) to attain basically equity objectives of helping the vulnerable. And it has failed miserably in its attempt to do so, with the PDS riddled by massive leakages and fertilisers being used very inefficiently (NPK ratios in Punjab-Haryana belt are totally out of line with any optimum ratios) and also being diverted to non-agricultural uses and even being smuggled to neighboring countries. Quite often one blames the people for being corrupt, but in reality, it is the policy-making that is bankrupt of the very basic understanding of goals and instruments. The job of price policy is efficient allocation of resources while promoting growth. The job of income policy, on the other hand, is to attain equity by targeting the vulnerable sections of society. Our current policy design has messed up when it comes to these basic fundamentals, by trying to achieve equity through price policy. This leads to massive inefficiency and diversions, and ultimately these efficiency losses outweigh the equity goals one is trying to achieve.

It is time to turn to income policy for equity objectives. Given India's strength in IT, one can reach millions at very low costs. The top end of the economic pyramid, IT professionals, must help those at the bottom of pyramid, if India's development is to leap-frog and its poverty abolished. But the political masters must understand this subtle difference in aligning objectives with the right policy instruments and be bold to move in that direction.

Ashok Gulati & Pritha Banerjee

Gulati is Chair Professor and Banerjee is Research Associate, ICRIER