Understanding Subsidies in India

12 May 2017, Manish Padhi

In this context, latest economic survey rightly points out that despite spending as high as 3.77 lakh crore rupees annually on subsidies there is no ‘transformational impact’ on standard of living of masses. While subsidies have helped some poor people to do firefighting in life, main allegation on a subsidy economy is that, through subsidies, money meant for poorest is appropriated by richer sections of the society due to mistargeting and leakages.


Subsidies and its opportunity costs

Subsidies are that part of government expenditure that is ‘consumed’ by beneficiaries. In economics, debate between two alternative uses of money: Consumption and Investment is quite old.

Same concept goes for economy as a whole. We have Tax to GDP ratio of around 17.7%. (Center plus states) With this amount government has to provide for interest payments of its debt, expenses for its humongous administration, defence of the country, devolution to states and panchayats, developmental work, infrastructure and for subsidies.

In 2013, total expenditure by government was 13.8% of GDP. Out of this revenue expenditure (consumption) was 12.1% of GDP, leaving just 1.7% of GDP for Capital expenditure (investments). Out of this revenue expenditure, non-plan expenditure was 9.5% of GDP. Further, non-plan expenditure had following breakup –

  1. Interest payments – 36.9%
  2. Defense Services – 12.1%
  3. Subsidies – 24.2%
  4. Grants to states and U.T.s – 6.3%
  5. Pensions – 7.3%
  6. Others – 13.2%

Some subsidies led distortion in India:

  1. Energy- Groundwater nexus – Agriculture sector is perhaps having most justifiable claim on subsidized inputs given the dismal situation of the farmers in the country. On these lines, water and electricity for agricultural use are heavily subsidized by state governments. Again, politics seeped into this economic cause and most governments have failed to ensure rational and sustainable use of subsidized water and electricity. Owing to this, in large parts of India, groundwater is being extracted indiscriminately as electric pump consume electricity that is almost free of cost. This has led to dramatic fall in groundwater levels. Wells have gone dry at numerous places. Water extracted from deep earth often gets contaminated by arsenic mineral. This, together with erratic monsoon due to climate change, has pushed rural India in deep distress.

To remedy this problem, government has plans to separate agriculture feeder network from rest, under Deen Dayal Upadhayay Gram Jyoti Yojna. This separate agriculture feeder will supply electricity only for a few hours a day. This was first tried by Gujrat and results were encouraging as it had role in making Gujrat a power surplus state, along with arresting continuous decline in groundwater levels.  

  1. Subsidized fertilizers – Nutrient Based Subsidy or NBS was introduced in 2010 with objective to promote balanced use of fertilizers and to limit fertilizer subsidy of the government. Idea was to fix subsidy as per nutrients (in per Kg ) in the fertilizer and leave the determination of price to suppliers. Presently Urea is not covered under the scheme due to political compulsions. Consequently subsidized price of Urea remained stagnant even when real costs of production have risen significantly. On the other hand Potassium and Phosphorous are covered under the scheme and a fixed subsidy as per content of nutrients is given to suppliers and they change Maximum Retail Price as per market signals. Secondary and Micronutrients are also covered under the scheme. (In short urea is still controlled and P,K, are decontrolled)

As a result, actual use of NPK is in ratio of around 8:3:1 while recommended use is 4:2:1. This additional use of urea doesn’t give any additional benefit to the farmer. Instead this can degrade soil and harm crop. Productivity and quality of a crop depends upon use of diversified mix of macro and micronutrients, which vary from soil to soil. While urea consumption has increased from 59 per cent to 66 per cent of total consumption in 2012-13 over 2010-11, per hectare consumption of fertilizer has declined from 140 kg to 128 kg over the same period. 

Fertilizer subsidy was `67,971 crore in 2013-14, an increase of 11 per cent over 2009-10. Large part of this went to production and consumption of urea that was not needed at all.

Also, due to excessive use of fertilizers groundwater is also getting polluted and chemical bioaccumulation problem is impacting health of people.

Apart from Urea, farmer is not even getting benefit due from NBS in case of subsidized potassium and phosphorus. Subsidy is provided to manufacturers, who in turn are responsible to pass this subsidy to farmers in form of reduced retail prices. Rather, manufacturers have increased their prices forming a cartel and have usurped subsidy meant for farmers. It’s only now that Ministry of Chemicals and Fertilizers has undertaken review of prices charged by registered manufacturers. It has plans to penalize and cancel registration wrongdoers.

Another mistargeting of fertilizer is that most of this is consumed by rich farmers of Punjab, Haryana and North West Uttar Pradesh. Uptake of fertilizers depends a lot on sufficient supply of water to the crop. As about 60% of total cultivated area of India is rain fed, subsidy is cornered overwhelmingly by well irrigated states.    

  1. Cultivation of wheat, Rice and sugarcane at cost of pulses, horticulture crops and coarse but nutritious grains

Consumption patterns in India are shifting rapidly from calorie rich diet to protein and vitamin rich one. Despite this, protein based diet in India is abnormally expensive. Main source of protein for Indian masses is pulses. Last whole year there was clamour on the issue of skyrocketing prices of pulses. India’s subsidy regime had its hand behind this problem.

Pulses are most suitable to be grown in areas of Maharashtra and Madhya Pradesh, yet large parts of these areas are under cultivation of sugarcane. Sugarcane due to high ‘fair and remunerative price’ is being sown in these areas. This create two problems – one, it deprives Indians of their source of protein; two, these areas are water deficit and sugarcane is water guzzling crop. This crop is sucking scarce water rapidly and when monsoon failed again this time, mainly in Marathwada; farmer had no way to escape.

Similar is the case for cultivation of Wheat and Rice. These two crops yield much larger quantity (about 5 times) per acre/hectare than crops like pulses. Higher MSP for pulses is not so high to make whole value of produce more remunerative for farmer. So he prefers conventional grains. This has led to huge stockpile of wheat and rice (40-50 million tons) in government inventory which decays and is carried forward at cost of Rs 5/ year. On the other hand, India has to import more than 25% of its consumption of pulses.

  1. Railways: Subsidization and Cross- subsidization – Between 1993 and 2011, the wholesale price index rose by 295% and the fares of sleeper class and second class travel rose just by 144% and 106% respectively. Consequently, railway runs at heavy loss, which can be construed as subsidy to passengers of the railways. It’s only natural that railway has failed to expand capacity and improve quality to serve needs of booming Indian economy. When British left India had network of 52000 Kms, which now increased to measly 64000 Km.

Apart from this, freight carriers of railways are even more uncompetitive, because railway subsidizes passenger fare further by charging higher freight charges. Accordingly, in 1970’s freight used to contribute 65% of railway revenues and now it does only 33%. This is due to shifting of freight carriage from rail to road transport, which much costlier, more polluting and more time consuming. This has made our economy a lot more uncompetitive.

  1. Agricultural Finance: Farmers are entitled to pre- harvest loan at 7% interest rate. They are allowed further 3% subvention in case of timely payment. Farmers can also take loan for post-harvest time against negotiable warehouse receipt.

Economic survey notes three discrepancies in this subsidy. One, trend indicates that amount for a single loan is increasing for most of these subsidized loans. This means that more subsidies is going in favor of rich farmers. Two, extension of subsidized credit is concentrated in last three months of the financial year, which indicates that reluctant banks otherwise unable to meet priority sector lending targets, desperately disburse loans to reach target at the end only. It is unlikely that this way credit will reach to desirable party. Third, agriculture credit is getting concentrated on peripheries of urban areas, which means that money is being diverted to nonagricultural use.    

  1. Food inflation: Fact that India produces surplus foodgrains doesn’t mean that these are available to consumers at cheaper prices. Rather, India till couple of years back witnessed spiraling double digit inflation driven by expensive food, even when world was reeling under deflation. This distortion is mainly due to increasing input costs to farmer coupled with persistent increase in Minimum Selling Price declared by government. This forces government’s agency FCI to procure foodgrains in open ended manner. As a result, government ends up procuring 25-33% of total foodgrains production in the country. Apart from this, about 33% of foodgrains are captively consumed by farmers. All this leaves just 33%-45% of total foodgrains for open market. This. At times, culminates in an absurd situation, where there is shortage of grains in open market which push prices upward and millions of tons of grains stored in FCI godowns.

Few experts believe that entitlements under Food Security Act are sufficient only to fulfill 50% of requirement of foodgrains for a household. For this 50%, there is massive but inefficient storage and PDS system. This in many ways significantly increases price of remaining 50% food grain need of households. So, a well-intended system may be actually working counter to its stated goals.      

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