The Hindu Business Line : Analytical review of subsidies: Drawing up an alternative roadmap

IN ITS National Common Minimum Programme (NCMP), the UPA Government had pledged that all subsidies will be targeted sharply at the poor and the truly needy — the small and marginal farmers, farm labour and urban poor. A commitment to the same effect was made in the Union Budget, which stated that the National Institute of Public Finance and Policy would prepare a blueprint to accomplish these objectives.

The Finance Minister had promised to place this report before the House of Parliament, and done so now. The stated purpose of the report is to elicit views to outline some policy issues for public debate on the subject before a roadmap is unveiled and implemented. Does the report serve the purpose? What are the issues it raises? What are its suggested solutions?

At the outset, one has to be clear about why subsidies constitute such an important subject of economic concern. They involve government intervention to ensure availability of goods and services at lower than the cost incurred in producing and distributing them. If market forces are to determine these prices, it will not only be the cost of production and distribution but the effect of demand that will set prices.

But the government by its intervention arranges to get prices set at lower than the market-determined prices. The difference represents a net outgo from government coffers, either implicitly or explicitly. It is a burden on the fisc and is distortionary in its effects on the structure of production and distribution. It can be economically inefficient.

The subsidy review proceeds on the lines familiar to us in the earlier effort of the National Institute of Public Finance. It divides subsidies into merit and demerit subsidies, the division obviously reflecting the subjective preferences of the analyst.

In the current scheme, merit-I subsidies include subsidies in respect of elementary education, primary health care, prevention and control of diseases, social welfare, soil and water conservation and environment. Into merit-II are grouped higher education, family welfare, agricultural research and education, land reforms as well as flood control and drainage.

Whether these latter subjects rank lower in priority or economic consequence than the former is a matter which can be disputed. But, for the purposes of the review, the analysts have settled on this classification. All subjects not included in merit-I or II are demerit goods.

The first material observation of the report is that merit subsidies account for only 34 per cent of total subsidies. Non-merit subsidies accounted for 66 per cent in 2002-03, decreasing marginally to 58 per cent in 2003-04. It is also significant that non-merit subsidies declined in absolute terms during the two-year period. According to the "value judgment" of the review, the trend should be improved upon.

The crux of the review lies in the policy suggestions it makes for reducing the level of subsidies over the years. It points out that the weight of food subsidies and fertiliser subsidies is rather high in the total, apart from the subsidies especially borne now in respect of petroleum product prices. The suggestions in respect of reducing the subsidies constitute the tentative roadmap placed before the country.

In respect of food subsidies, the report points out that they have grown from Rs 2,450 crore in 1990-91 to Rs 25,800 crore in 2003-04 (RE). As percentage of GDP, they have grown from 0.43 to 0.93.

In an interesting Table in the report, the experts point out that the rise in issue price to the "below the poverty line" consumer from 1997-98 to 2003-04 has been 61 per cent while the general CPI increase for agricultural labour has been only 25 per cent in the same period.

The policy-makers must be surprised at their success in containing pressures for reducing BPL prices.

There are, of course, pressures for further decreases, which are essentially in the political domain. The review ignores the substantial additional subsidies given by some State Governments.

The origin of high subsidy commitment in respect of foodgrains is obviously the fixation of high minimum support prices by the Government for both rice and wheat. The report emphasises the need to be rational for this purpose and effectively cautions against yielding to pressures from growers' lobby for higher prices.

This tendency has led to accumulation of food-stocks above the desired norm as also the avoidable over-concentration on foodgrain production, excluding oilseeds and pulses. It also implies excessive use of water and power and consequent environmental damage.

The call is obviously to restrain the impulse to declare politically attractive minimum support prices for wheat and rice. But the question is how will a coalition government manage its internal contradictions to tread the straight and narrow path. Declaring a high minimum support price is politically attractive, but fiscally suicidal.

The report has a few suggestions in regard to reduction of the food subsidy bill, which cover ground already traversed by other committees, including the Foodgrains Policy Review Group. One such idea is that of food coupons or stamps.

Whether this device will succeed in a poor country is a moot question. But it is an experiment worth trying.

The report also toys with the idea of decentralising procurement to the States. Carried to its extreme, this may mean the end of buffer stock role played by FCI.

Foodgrain producing States, such as Punjab, Haryana and Andhra Pradesh, can play havoc with the food economy by arbitrarily banning inter-State transfer of foodgrains. The suggested remedy may be worse than the disease.

The report touches on the subject of elimination of petro-product subsidies. The answer lies obviously in raising petro-product prices to the extent dictated by international prices, costs of refining and distribution. There can be no escape from biting this bullet. There is need to effect this policy change as quickly and as frequently as necessary.

Obviously, this is a difficult decision for a coalition government to take. How long can the fisc bear the impost levied on the economy by the Sheiks of Arabia!

The fiscal cost of continuing to supply petro-products cheaper than cost can be serious, if OPEC continues to pursue its policy of gouging the rest of the world.

The report touches on the ticklish issues concerning fertiliser subsidy. The root of the fertiliser subsidy is the desire of government to keep the price of fertilisers low in spite of increases in production costs.

The mechanisms to subsidise the difference have changed over time, from the earlier unit-wise retention price to the recent group-wise pricing scheme. But at the core of the problem is the question of when and how to transfer the costs to the farmer.

The report discusses whether the industry is pocketing the subsidy. It points out that the portion of the subsidy passed to industry has decreased from 75 per cent in the triennium ending 1983-84 to 24 per cent in the triennium ending 1992-93 and further to -27.83 per cent in 1995-96. A negative subsidy indicates that the fertiliser industry was implicitly taxed in the triennium ending 1995-96. The industry had good reason to be non-cooperative when urged to increase production!

According to the report, the latest position is that the share of subsidy accruing to farmers is 62 per cent. Further, the nominal protection coefficient — which is the ratio of the subsidised price paid by farmers to the hypothetical price payable under free trade was higher in the 1980s than in the 1990s.

Leaving aside this insight into history, the report suggests that the solution is to phase out fertiliser subsidy.

It concedes that there is a possible criticism that an increase in fertiliser price without an increase in foodgrains price may lead to a fall in food production. The report suggests that better use of irrigation facilities and spread of HYVs can compensate for the negative effect of higher price of fertilisers.

This suggestion that non-price factors can mitigate the effect of a rise in fertiliser price shows little awareness of the complexities of agricultural production responses in a highly fertiliser-dependent environment.

There is no escape from the higher farm-gate price of fertilisers if subsidy is to be reduced. There also can be no escape from higher farm product prices. This is the law of economics and we would be living in a fool's paradise if we think otherwise.

All in all, the report on subsidies is thought-provoking, although its suggestions may not all be acceptable. The fact that it does not cover the whole area of power subsidies, which does impact the States' fisc primarily, detracts from its coverage.

But, when it does deal with critical issues, it brings up the possible alternatives transparently and is the best effort to date to delineate the choices before our policy-makers.

Now that we are informed how complex the problems are, are we ready to deal with them? A roadmap is good only if we are ready to follow it.

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