Rationalising subsidies is critical to improve the health of the economy

By Dinesh Unnikrishnan and Kishor Kadam

Managing large chunks of subsidy payments is always a nightmare to finance ministers as they sit down to formulate the budget documents. Subsidies punch a hole in government balance sheets.

That’s precisely the reason why the 19-month-old Narendra Modi government has been hurrying to channel subsidies directly to the beneficiary bank accounts hoping to plug the leakages in the public distribution system (PDS) and, thus, lessen the subsidy burden on the exchequer.

The efforts seem to be progressing.

The whole subsidy rationalisation exercise began in January 2015, when the government brought the LPG subsidy under the Direct Benefit Transfer (DBT) route, a plan originally kicked off by the Congress-led UPA government in January 2013. It later followed up by encouraging the well-off to give up their subsidies and, later, denying subsidies to those with taxable income above Rs 10 lakh a year.

After piloting DBT in segments such as MNREGA, food and various scholarships, the government now wants to do the same with kerosene beginning April this year.

At Rs 2.6 lakh crore, total subsidy burden of the government is estimated to have constituted 16 percent of the total government expenditure in fiscal year 2015. The government hopes to bring down this to Rs 2.43 lakh crore or 13.73 percent of the expenditure. India spends major subsidies on food, fuel and fertilizers.

Firstpost takes a look at how the NDA-government is approaching the whole subsidy burden across segments.

Fuel subsidy

The government saved Rs 15,000 crore in fiscal year 2015 through the LPG subsidy rollout through DBT channels. This gain is likely to continue in the current fiscal as well. That apart, on account of the lower crude prices, yet another Rs 30,000 crore can be saved both on LPG and kerosene subsidy payments.

As for kerosene, until now, the government used to transfer the full amount of kerosene subsidies in bulk to state governments, who, in turn, distribute this to the beneficiaries. But, large-scale diversion of subsidies spoiled the efficiency of this channel.

The National Sample Survey 2011-12 indicated that the total consumption of kerosene in the country, including both open market and PDS, stood at 71.30 lakh kilolitres. Despite Kerosene consumption coming down over years, 86.85 lakh kilolitres of subsidised PDS kerosene was allocated to the states in fiscal year 2015-16, higher than the total household kerosene demand in the country.

"Thus, there is evidence that some part of the kerosene allocation is diverted for non-eligible purposes," said a statement from the Ministry of Petroleum and Natural Gas issued on January 1.

But, with the government readying for DBT rollout beginning April, one must assume that it has got hold of the actual beneficiary base. The beneficiaries will now have to pay the market price of Rs 43 per L, while they receive the subsidy amount of Rs 31 per L directly in their account.

In the fiscal year 2015, the total subsidy burden on the government on kerosene alone stood at about Rs 25,000 crore. There is no actual estimate of the amount of subsidy that can be saved on kerosene post the full DBT rollout but a rough calculation based on the difference of kerosene demand (as cited by the NSS) and the final allocation for fiscal year 2016, shows that the government can save around Rs 4,820 crore. This is indeed a substantial saving.

Food subsidy

On food subsidy, another major item on the expenditure side, the total savings on account of DBT would be in the range of Rs 30,000 crore to Rs 50,000 crore if indeed the government manages to shift the whole subsidy through direct beneficiary channels.

The work on this has already begun with the DBT on food subsidy already experimented successfully in some of the Union territories. If the current plan is any indication, the full food subsidy rollout will begin early next fiscal year.

Rating agency Crisil estimates the government could cut its subsidy expenditure on account of DBT by about 20 percent or Rs 25,000 crore, ensuring better targeting and lower pilferage. By doing this, the government will generate fresh cash transfers of Rs 5,800 per year for a family of 5.

Although this figure appears small, it is actually higher than the total annual expenditure of the poorest 5 percent of the rural households in the country and more than half of the annual expenditure of the poorest 10 percent households. In that sense, the cash flow indeed offer a relief to them.

According to 2014-15 economic survey, the government’s food subsidy bill shot up in the past few years. The unpaid subsidies are typically rolled over to subsequent years adding burden of the exchequer. According to the government’s fiscal year 2016 budget estimates, the total outgo on account of food subsidies is around Rs 1.2 lakh crore. If one accounts for the unpaid arrears of last year (about Rs 60,000 crore), the resultant burden is even higher.

Fertlizer subsidy

Arguably the most politically sensitive subsidy item, urea is heavily sought by Indian farmers for cultivation. Going by the government’s budget estimates, total fertiliser subsidy payments by the government in the fiscal year 2016 would be about Rs 72,969 crore. Of this, urea constitutes about Rs 50,500 crore.

As Firstpost noted in an earlier article, this is where the government should act next on subsidy rationalisation after fuel. The urea subsidy burden is huge. The urea subsidy burden has increased in India from around Rs 18,500 crore in 2005-06 to Rs 73,000 crore in 2015-16. Currently, about 75 percent of the total cost of production is subsidised.

Besides the savings gained through DBT, the government has made notable progress in the distribution of LED bulbs at subsidised rate. Since January, 2014, the government has distributed 4.41 crore LED lamps at discounted prices to market rates, hoping that the usage of these bulbs will result in the power savings. The prices of these bulbs have come down substantially since the launch of the scheme to an average Rs 77 in June, 2015 from Rs 310 from January, 2014.

A back of the envelop calculation shows that the whole exercise saved about Rs 2,200 crore to power producers in the past one year, in terms of energy efficiency.

Tackling subsidy theft

The bigger hurdle for the government, as mentioned earlier, is ensuring that subsidy doesn’t reach the wrong targets. The DBT can plug a substantial chunk of leakages in the distribution system, but the task for the government is to ensure that subsidies reach the intended beneficiaries and not go to undeserving hands. This can be achieved by seeding bank accounts with Aadhhar.

Till now, some 19 crore bank accounts have been opened under Prime Minister’s flagship financial inclusion programme, Jan Dhan Yojna and about 95 crore Aadhaar cards have been issued. The Aadhaar-bank account linkage should be used to include those who are hitherto excluded from the PDS.

According to a paper by the Indian Council for Research on International Economic Relations, leakages from the PDS have been steadily rising — from 24 per cent of all grain distributed by the Food Corporation of India in 1999-2000 to a little under 47 per cent (or 26 million tonnes) in 2011-12.

Rationalising subsidies is critical to improve the health of the economy on two fronts — it puts more money in the hands of people to spend and help the government control its balance sheet. As is evident from the calculations above, if DBT is implemented across all these sectors, the total estimated annual savings for the government can be up to a whopping Rs 70,000 crore.

As Crisil pointed out, the Modi government’s challenge is to switch unnecessary subsidy expenditures to productive use. True, global rating agencies are particular on fiscal deficit numbers. But, the government should make a case to prove that the quality of spending is even more critical.