By Errol D’Souza

Budget 1999-2000 has focussed on reducing the fiscal deficit to around 2 per cent of GDP and alongwith it to attaining a high GDP growth of 8 per cent together with stability. The focus of the entire exercise is to bring about a qualitative improvement in the fiscal deficit.

The finance ministry for the first time has announced hard hitting measures of pruning subsidies and making them more focussed so as to improve the welfare of the masses which would help in the long run improve the productivity of the nation.

The increasing subsidy burden is a prominent contributing factor to India’s relatively poor economic performance on fronts such as international trade and agriculture, the inefficiency of the public sector , and the growth of government consumption. These subsidies, which are a result of non - recovery of the costs of production and provision of goods and services, occur through direct transfer expenditures in the budget or foregone revenues.

While recognising that there are efficiency reasons for subsidies such as when the social benefits exceed the social costs (as in the education and public health sectors for example), much of the focus of the discussion on subsidies hovers around the equity issue - that is the claim that a large part of the subsidies are cornered by people who are not so poor.This concern for equity has generated a consensus that subsidies should be targeted and much effort in policy making is currently devoted to effective targeting of subsidies.

Focusing subsidies on the poor through good targeting at the same time produces a welcome by-product. By excluding the non-poor, the amount of subsidies diminishes and this enhances the health of the fiscal through a reduction of the deficit.

Wide off the mark
That many subsidies go to the not so poor is borne out by glaring examples such as the underpricing of LPG cylinders which is the case of the government opting to forego revenues.The bulk of the direct budgetary subsidy outlays, however, as is well known, are on food and fertilisers.

The finance ministry is of the opinion that the way to reduce the outlay on food and subsidies as well as to better target the poor is through a double-pronged strategy. First, by issuing grain through the PDS to families above poverty line at the price equal to the economic cost of the Food Corporation of India (FCI) and second, by doubling the allocation of grain (to 20 kg) through the FCI to families below the poverty line at a price equal to 50 per cent of the economic cost of the FCI. This strategy has drastic implications for food security in the country.

Currently, the poor depend on the PDS for for only around 15 per cent of their cereal needs according to National Sample Survey estimates.Also, an average family of five consumes more than 60 kg of cereal per month which is more than thrice the allocation of 20 kg through the PDS. Given a significant dependence on the market rather than the PDS cereals to 50 percent of the economic cost of the FCI also implies (according to a rough calculation) that they will now pay Rs 4.20 for wheat in place of Rs 2.50 charged earlier and Rs 5.85 for rice instead of Rs.3.50 charged earlier through the PDS. This, over 65 per cent rise in the price of cereals will affect BPL families without adequate purchasing power adversely and further push them towards impoverishment.

For below the line poverty families closer to the poverty line, the rising issue price of PDS grain causes them to substitute their demand for grain to the open market as the differential between the PDS issue price and the market price narrows.Accentuating this shift in the purchase of cereals through the market is the inferior quality of grain supplied through the PDS.

The shift in demand due to the flight to quality as well as the narrowing of the price differential implies that the FCI ends up holding larger stock of food.Indeed, the food stock at over 30 million tons are well over the norm of around 17 million tons.The farmers’ lobby has been pressurising the government not to allow the FCI to offload its stocks so that the market price remains high and this contributes to the rising carrying costs of grain for the FCI.In effect, the BPL families are being asked to pay 50 per cent of the cost of storage of stocks by the FCI which is in excess of the minimum buffer stocks required for food security - a stock which is being held to accommodate surplus farmers.The increased food subsidy is thus due to increased carrying costs which are a result of the inefficient operation of the FCI and below poverty line families are being asked to foot the bill so that the government may assuage the rich farmers who produce a marketable surplus. This is definitely notbetter targeting of food subsidies - it is surely iniquitous to ask the poor to pay for the higher grain prices being sought by rich farmers.The by product of a reduced deficit will also be affected as the higher carrying costs of the FCI results in a bigger food subsidy bill for the government.

Fertiliser fiasco
In the case of the fertiliser subsidy, the finance ministry has adopted the strategy of raising the prices of fertilisers for farmers.This is despite approximately half of the subsidy going to the fertiliser industry or its feed stock agencies and the other half going to cultivators.Fertiliser use by farm size reveals that fertiliser adoption is positively related to farm size but the proportion of area fertilised does not vary much across farm size.Hence, per hectare fertiliser consumption is not lower for marginal and small farmers as compared to large farmers.

The raising of the farmer’s price by 15 per cent will have an adverse impact on the credit-constrained small farmer’s use of fertiliser.The subsidy to the fertiliser industry is in the form of a Retention Price Scheme (RPS) which is decided for a urea plant depending on its cost, subject to certain norms of capacity utilisation.

The inefficiency of these plants is attributed to the high price of gas in India vis-a-vis the Gulf.Thus, it would be better to replace the RPS with a single flat subsidy that takes into account the difference between domestic and the import prices of urea.A pre-announced reduction of such a working subsidy will provide an incentive for urea plants to attempt to become competitive.

The great whitewash
Finally, there are many indirect subsidies that do not have a passage through the budgetary channel and which create distortions.These subsidies that charge different rates to different categories of consumers with the ostensible goal of promoting social justice are a result of the differential pricing of public sector products and are thus non transparent.For example, electricity charges paid by industry are higher than those paid for by households and the agriculture sector.

This impacts the cost efficiency of industry which weakens its capacity to generate exports and employment.Also, free power to farmers result in the overuse of electricity and causes a deterioration in the financial health of state electricity boards, which, in turn, affects the stability of the supply of power to farmers.Subsidies are being used as a political tool to gain popularity and win elections - witness the free power to farmers under Jayalalitha’s government, NTR’s two rupee kilo scheme,loan melas, etc.