A CASE FOR PHASING OUT THE SUBSIDY ELEMENT: PETROLEUM PRODUCTS, FOOD AND FERTILISERS: A STUDY FOR THE TWELFTH FINANCE COMMISSION
BY: Prof. K.S. RAMACHANDRAN
Economist & Author
Research & Editorial support: Ms. Y. Vijayasri
Secretarial Assistance: Mr. K.M. Sinha
SL. NO. / CHAPTERS / CONTENTS / PAGE No.1. / Chapter I / Terms of Reference / 3
2. / Chapter II A / Study Outline / 4
Chapter II B / A Critique of ERC Report / 11
Chapter II C / The Agenda for end March, 2010 / 16
3. / Chapter III / About the Author / 19
4. / Chapter IV / Subsidy Phase-out / 20
5. / Chapter V / The Petroleum Sector / 23
6. / Chapter VI / Food Subsidy / 31
7. / Chapter VII / Fertiliser Subsidy / 50
8. / Chapter VIII / Safety net concepts as evolved by the World Bank / 64
9. / Chapter IX / Subsidies – The International Experience / 66
10. / Chapter X / From Reports of Earlier Finance Commissions / 84
11. / Chapter XI / From Earlier Studies on Central Subsidies / 85
12. / Chapter XII / Winding up / 103
TERMS OF REFERENCE OF STUDY ON EXPLICIT SUBSIDIES ON PETROLEUM PRODUCTS, FOOD AND FERTILISERS
(i) Trends in explicit subsidies given by Central Government. Rationale for subsidies with an analysis of the pros and cons of identification of particular goods for grant of subsidies. International practice in regard to subsidies.
(ii) Recommendations of the Expenditure Reforms Commission (ERC) on each of the explicit subsidies and the extent of their implementation. Impact of the modification made by the Government while accepting the ERC’s recommendations along with a quantification of the same in terms of the financial implications thereof.
(iii) Analysis of the methodology and criteria for determination of the quantum of each subsidy. Targeting of subsidies and achievement in this regard – evaluation studies, if any, undertaken in this regard, conclusions thereof and the action thereon.
(iv) Fertiliser subsidy – advantages of the new pricing policy and its impact on target groups. Extent to which the subsidy has been able to achieve the stated objectives. Whether the new policy has adequate incentives for efficiency. Reforms required in fertiliser subsidy to ensure better targeting and phasing out.
(v) Food subsidy – Analysis of the present pattern of the subsidy and whether it meets the objectives as far as target groups are concerned. Feasibility of phasing out of the food subsidy or increasing efficiency through greater decentralization. Reform required in the manner of determination of Minimum Support Price. Road map for decentralization and quantification of its impact.
(vi) Subsidy on petroleum products, its rationale and road map for its phasing out.
(vii) Approach followed by earlier Commissions with regard to explicit subsidies. Reasons for the spurt in the level of subsidies in recent years, notwithstanding the views/recommendations expressed and assumptions made by the previous Finance Commissions on the subject. Road map for desirable policy initiatives in regard to subsidy reform. Suggested approach for the Twelfth Finance Commission in regard to explicit subsidies along with the suggestions on making projections of expenditure on account of subsidies during the award period of the Commission.
(Rakesh Sharma)
Deputy Director (Sectt-II)
15th December, 2003
(II A) STUDY OUTLINE
A) CORE ISSUES
(i) FOOD SUBSIDY
a) Narrowing the focus of PDS to only the poorest of the poor – using the Antyodaya Anna Yojana as the basis.
Marginalising the public procurement system over a five year period. Introducing a special scheme to take care of small and marginal farmers.
b) Marginalising the FCI.
c) Phasing out the system of statutory price fixation.
d) Accepting the demand made by the developed countries at the forum of WTO for transparency over procurement price as well as operations, and voluntarily giving up the benefit of exclusion of PDS – for the purpose of farm subsidy reforms – available under WTO-related provisions on agriculture.
e) The foodgrains stockpile must be reduced to the absolute minimum level necessary to take care of calamities, natural or man-made. Generally, the Government must adopt a policy of buying foodgrains from the open market or importing on an ad hoc basis to take care of emergency requirements.
(ii) FERTILISER SUBSIDY
I a) In regard to the producer component of it, the subsidy must get transformed into an efficiency booster and stop being used to reward inefficiency and to punish efficiency.
b) The unit-wise retention scheme for fertiliser pricing has given way to the group concession scheme, but the principle remains the same – rewarding de-merit and penalising merit.
c) This has to change and the plants that cannot stand the real test of competition must be offered for sale to pave the way for their commercial rehabilitation or liquidation.
d) Rising global fertiliser prices must stop being offered as a justification for pampering sick units like NFL.
II Coming to the consumer component, a limited subsidy must be given but only to poor and small farmers.
(iii) OIL SUBSIDY
There should be no subsidy on LPG, effective March end, 2005, while subsidised kerosene must continue to be available only to the poorest of the poor – the population segment covered by the Antyodaya Anna Scheme. The principle of import parity prices must apply to all petroleum products. In regard to non-domestic category of LPG, there is a perfectly genuine case for subsidising the supply earmarked for poor hawkers and small shopkeepers. The latter should stop being treated on par with proven commercial users of LPG like hotels and restaurants.
(iv) POVERTY CRITERION
This must be strictly in terms of nutritional standards, not income. The time has come to differentiate between population that is deemed to be below the poverty line on the basis of income levels and those close to destitution. Subsidies must be targeted at the latter. In favouring nutritional standards, we must refuse to proceed on the basis that the poor, along with the better – off sections of the community are voluntarily opting for low nutrition food articles. Indeed, if such is the consumer preference among people near the level of destitution, it is all the more reason why efforts towards poverty alleviation should focus sharply on propagating consumption of cheap goods but with the required level of calories.
Table IEstimate of incidence of poverty in India
Year / Poverty ratio (%) / Number of poor (million)
Rural / Urban / Combined / Rural / Urban / Combined
1973-74 / 56.4 / 49.0 / 54.9 / 261.3 / 60.0 / 321.3
1977-78 / 53.1 / 45.2 / 51.3 / 264.3 / 64.6 / 328.9
1983 / 45.7 / 40.8 / 44.5 / 252.0 / 70.9 / 322.9
1987-88 / 39.1 / 38.2 / 38.9 / 231.9 / 75.2 / 307.1
1993-94 / 37.3 / 32.4 / 36.0 / 244.0 / 76.3 / 320.3
1999-00 / 27.1 / 23.6 / 26.1 / 193.2 / 67.1 / 260.3
2007* / 21.1 / 15.1 / 19.3 / 170.5 / 49.6 / 220.1
* Poverty projection for 2007
Source: Tenth Five Year Plan, Vol. 1, Planning Commission.
B) EXPLAINING THE FOCUS
With the Centre having formally committed itself, under the Fiscal Responsibility and Budget Management (FRBM) Act, to wiping out the revenue deficit by end March, 2008, a time bound plan of action has to be thought out to drastically contain the open (and acknowledged) subsidies – as well those that are hidden / implicit – of the Centre and simultaneously those of various state governments. A study sponsored by the 12th Finance Commission recommending an end to universal subsidies on food, fertilisers and petroleum products and its replacement by selective relief targeted exclusively to the economically weakest sections of the community should hasten fulfillment of this critical aspect of economic reform. The Commission is entirely justified in undertaking this task given the harsh reality of 85 to 90 percent of its constitutional non-plan revenue transfers to states going towards funding the wage bill of the respective governments, and thereby leaving virtually no resources for developmental activities. By its sharp thrust on an effective reform of explicit subsidies, the Commission places itself in a position from where it can put a lot of pressure on policymakers as well as administrators at the Central as much as the state level to address clinically the removal of the massive subsidies that are hidden and go unacknowledged and unreported. The Commission would, thus, contribute to bringing to the limelight a long neglected part of the reform effort, the unfinished agenda.
C) THE REAL PROBLEM: AN APPRAISAL
While a major component of non-plan expenditure of the Central Government –defence – is outside the reform agenda and is more or less beyond the control of the administration, the other two, interest payments and subsidies, not only are controllable but also demand strong counter-action. In recent years, successive Finance Commissions have sought to weaken the internal debt trap – representing a situation, that emerged, according to RBI, in fiscal year 1991-92, where fresh market borrowings were sufficient merely to take care of the interest liabilities, unlike in the past when new loans had been raised in a somewhat mechanical fashion to pay off the old debts – by easing the indebtedness of state governments. In recent months, a plan involving use of additional market borrowing and small savings by state governments has emerged to facilitate retirement of high interest bearing debts and recourse to cheaper, new loans –
benefiting thereby from the present low interest regime – and this should reduce the debt service burden for the present. Yet, this is no lasting solution to the fact that Central and state governments cannot any longer treat market borrowing as a net resource. This must receive serious attention in the light of the compelling demands of the FRBM Act.
Obviously, an efficient management of the economy and the fiscal regime duly reflected in (as well as by) a sharp reduction in open as well as hidden subsidies can (and should) soften the strains of debt servicing by facilitating normal (as against a contrived mechanism that is in force now) retirement of debts and by postponing new loans and also scaling these down. However, this is not the goal of the study undertaken. Here, I only seek to work out a feasible remedy to the mounting subsidies. The impact this will have is not going to be ignored, but this will get only passing notice.
In regard to food, I propose to argue against an indefinite retention of the system of public procurement of foodgrains on the basis of a perpetually rising price structure as much as the continuation of an universal system of public distribution sustained by a truly massive stockpile. While the budget provision for this purpose (Rs.21,200 Crore during 2002-03 and Rs.27,800 Crore in 2003-04) is itself cause for considerable worry, what is even more disturbing is that procurement prices are raised arbitrarily over and above what are recommended by the requisite authority. More importantly, do we need a PDS targeted towards all? This is a question that concerns not only the Central and state governments but also constitutional bodies like the Finance Commission entrusted with the delicate task of outlining the distribution of the nation’s resources between the Centre and states and among the various states themselves. It is in the overall interest of sound national finances that a mechanism should come into being which provides easy and economical access to food to only the most needy among the nation’s population. The Antyodaya Anna Yojana should be strengthened to provide such access. Simultaneously, the system of public procurement and statutory price fixation must be phased out and a special scheme formulated for small and marginal farmers.
On fertiliser, a subsidy amounting to around Rs.4,100 per tonne of urea sold to farmers is borne by the Government which added up to a total Rs.7004 crore for 2002-03 (B.E.). But, this is not all. The total subsidy was Rs.11,009 crore in 2002-03 (R.E.) and the budget estimate for 2003-04 has been Rs.12,720 crore. There are two aspects of the fertiliser subsidy: inefficient producers are rewarded even as indiscriminate or overuse of fertilisers is encouraged. Despite well over a decade of reform, efforts to introduce an element of discrimination in the distribution of subsidies have not made any significant headway. Here, the goal for the current Finance Commission would be to introduce a pricing mechanism that would help promote efficiency in fertiliser production and rid the industry of weak performers. The Commission cannot, obviously, accept an approach to disinvestments that shows undue haste – for the shortsighted fiscal reason of easing the strains on Central revenue – in respect of excellent players in the oil segment like BPCL and HPCL (held up by the Supreme Court though for entirely different reasons). It cannot also endorse the reluctance on disinvestments of poorly functioning fertiliser plants like NFL. The Government has replaced the unit-wise retention price scheme with the group concession scheme but this is only a compromise of sorts. That expediency is still the guiding factor emerges easily from the fact that the high price of fertiliser in the global market is being opportunistically used by the Government to paper over the operational weaknesses of domestic plants. The Commission must ask for a pricing policy that rewards efficient producers and expedites the exit of those consistently in the red. As regards price incentives to consumers, these must be limited to the small and marginal farmers only.