Wednesday, 19 February 2014

Politics of Subsidies

    Seems like every political party is luring a common man to gain his support. Recent two moves of AAP and Congress -Subsidization and free distribution of electricity by AAP and subsidization of LPG cylinders from 9 to 12 by Congress suggest the same.

    On the one hand the government are trying to cover these actions under the umbrella of welfare of people and to earn votes, on the other hand various Economists and opposition are not missing their opportunities to condemn their policies. The economists have expressed reservations on increasing the burden of subsidies while the opposition is crying that it will lead to fiscal indiscipline.  All these disturbances raise the most basic question: What exactly the subsidy - a boon or curse or just a charity shop to make political gains by wooing the voters.
    RBI governor Rnagrajan stated- "we need to get careful with these expanding and misdirected subsidies". Hopefully this statement answers this basic question. But it does not explain the term 'misdirected' which is crucial to cut down anything. We will focus on various repercussions of these moves on the state economy. And for that we need to study the increasing gap between the government saving and expenditure.

    The recent move of Union government to increase number of cylinders from 9 to 12 will cost the exchequer an additional Rs. 5,000 crore annually.  This step might bring some relief to millions of middle class and poor Indians who are battling high rates of inflation during recent times. But the cost to public exchequer is definitely going to deteriorate the state of Indian economy.

    At this moment of time, resources needed to foot the bill for the fuel, food and fertilizer subsidies are not sufficient. Here comes a new term to  create illusion- "convenient accounting". This term refers to pushing this year’s expenditure to the next fiscal’s accounts. The Finance Ministry plans to book in next financial year, 2014-15, the expenditure that will be incurred on subsidies during the remaining months of the current fiscal (January-March). This will keep the fiscal deficit for 2013-14 within the target of 4.8 per cent of gross domestic product (GDP) — at least on paper.

    The Budget Estimates (BE) for 2013-14 for these subsidies is Rs.2.21 lakh crore. The Finance Ministry has not so far raised before Parliament a demand for additional grants for these subsidies. However, as per latest official data, at the end of November, 2013, the fiscal deficit was already 94 per cent of the BE for 2013-14. With four months still to go in the current fiscal year, the Finance Ministry has limited space to manage the fiscal deficit, the excess of the government’s expenditure over its income. The UPA Government has not been able to garner through disinvestments the Rs.40,000 crore projected in the Union Budget. Moreover, tax collections are growing at a rate less than the target of 19 per cent. Union Finance Minister P. Chidambaram has pressed in budget cuts in social schemes in an election year to keep the fiscal deficit below 4.8 per cent but they are not going to be enough.

    Mr. Chidambaram has said that the UPA Government will not let the India’s fiscal deficit for 2013-14 breach the 4.8-per cent target. International rating agencies have warned that a slip-up will trigger a rating downgrade for India.

    This situation has dramatically undermined the confidence in the government’s ability to manage the macro-economy.
    After having a quick glance over the current state of economy, lets try to figure out why this is happening and what is the way out? Lets have a look over the need of subsidy and various issues out of it.
    The broad purpose of subsidy is redistribution of income, offset market imperfections and other social policy objectives as needed.

    Subsidies have fiscal effects, trade effects and redistributive effects. And the most lasting and worrisome effect is that it creates vested interests and acquire political hues. And subsidies have tendency to continue indefinitely irrespective of regime. Subsidy have proliferated in India for several reasons:
    1. Wide expansion of governmental activities: Even after 20 years of privatization, governmental activities have substantial amount of area to work on. These sectors includes social policy, railways, food security, fertilizer and monetary policy.
    1. Weak determination of governments to recover costs from the respective users of the subsidies: Subsidies amounted to 14% of GDP, but the Tax GDP ratio in India is 17.7, one of lowest in the world. We have 42500 super rich(having income greater than 1 crore), but our tax collection doesn't justify it. There is a government document,
    Statement of revenue  foregone which lists the income which government  could have earned but hadn't earn. In India, for every 100 Rupees, government is leaving 60 Rupees unearned. Sometimes, this revenue forgone is given to big industries and taxpayers as part of concessions and sometimes it is the inefficiency to collect.  Effective corporate tax rate is 20% instead of 33% on paper. Further due to the complicated procedures for paying tax, a common man prefers evading tax rather than getting involved into it.
    1. Low efficiency of governmental activities- Wide spreading corruption is the overt testimony for this. 39% of subsidized kerosene is stolen. Malpractices in targeting results in inclusion and exclusion errors accounting to more gap between the needy and the better offs.

    The most general issues arising from subsidies are: a) distortionary effects of agricultural subsidies on the cropping pattern, b) their impact on inter-regional disparities in development, c) the sub-optimal use of scarce inputs like water and power induced by subsidies, d) Inadequate targeting of subsidies, e) discouraging effect on economic growth of sectors not covered by the subsidies, and last but not least f) environmental sustainability.
    An example of sustainability issues arising from the subsidy structure can be seen in problems of water and energy consumption in agricultural sector. During green revolution, liberal subsidy in irrigation resulted in decline of groundwater from 20 cm per year in Punjab to 3 to 5 meters in Gujarat.

    As subsidies are politically sensitive, nobody wants to take stand on rationalizing it. At present subsidy in India is footed on 3 fs- food, fuel and fertilizers which are making a burden on public exchequer. And the more worrisome concern is that it is not well targeted resulting in nulling out of the overall objective of subsidy.

    The requirement of subsidy in the country like India cannot be denied in a country where social and economic inequality is prevalent. But its appropriate projection is a must condition.

    The Way Forward
    1. First and foremost need is to reduce the overall scale of subsidies. And energy subsidy could be the most important sector to focus to bring sustainable economy.
    2. Another thing is that there is no subsidy on productivity related sectors. Like infrastructure(one dimension is connectivity), skill development,  education, health, life standard. India spend less on these which would be beneficial in long run. Further essential needs should be subsidized. According to UNESCO, India has lowest public expenditure on higher education per student in the world- an important parameter in deciding the wellness of a country. Even World bank has criticized India for increasing economic inefficiency due to its vast subsidy bills.
    1. There is need is to create subsidy for job creation in small sectors rather than supporting just only industry giants by giving concessions.
    1. There is urgent need to fill the holes in the existing economic policies and bring transparency in the procedures(as in concession given to corporates).
    2. Further policy arbitrariness should be eliminated. As seen in the recent decision of increasing cylinders from  6 to 9 and then 9 to 12 cylinders. While Verrapa Moily himself gave the statement average requirement in India is 6.9 per person and more than 89% people are sufficient with 9 cylinders. Then there was no reason to increase it to 12.
    3. As fuel subsidy constitutes major amount of total subsidy and also with the rising price of oil products  in international market and increasing subsidy, the rates of petrol are quite fluctuating. We need to focus more on self dependency rather than relying on imports by increasing production and encouraging conservation
    1. Subsidy should be correctly targeted, introduction of technology, computer based system will be helpful.
    1. Demolishing public sector monopolies and promoting private investment so as to increase production.
    2. Preventing natural resources by incentivizing environmental friendly technologies. Energy economy and a budgeted carbon emission were a means of achieving ecological sustainability, and one way of getting there was to cut “unjustified elements” of subsidies.
    3. Governments must ensure sustainability through regulatory and price-cum-incentives approach and also that companies adhered to the overall national sustainability agendas.
    4. Outcome based calculation and reviewing periodically to eliminate unnecessary things.
    5. Clarity on the proposed term for any scheme.
     These reforms are necessary to form a multipronged national strategy to fight against the setbacks of subsidy.

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