Should India do away with subsidies?

Dec 30, 2013

In this issue:
» Lessons for RBI from Volcker rule
» Is good monsoon a reason to buy Indian stocks?
» PSU banks line up QIP issues worth over Rs 150 bn
» Should your investment strategy change year after year?
» and more....

One of the big challenges that India faces today is huge fiscal deficit. And subsidies have been partly blamed for it. Subsidies have been meant for the poor since the beginning of the planning process in India, and they were meant to have a cushioning effect on the unaffordability of food and fuel by the poor. But unfortunately it has not achieved the desired result. So would it be wrong to say that India should simply do away with the subsidies?

For this, one needs to look into the negative effects of subsidies which are far more than the positive effects. Once received, people become dependent on the subsidies. Subsidies make the beneficiaries lethargic. Even the RBI deputy Governor has said that subsidy kills innovation and interest of people. It makes the system uncompetitive, and result in lack of transparency. Misuse of subsidies for political purpose is also known worldwide.

The subsidy in India comprises of four broad categories of expenditure: fuel, fertiliser, food and employment (MNREGA). Even the government does not argue that the first two do little to help the poor. Less than 15% of subsidy regarding food and employment actually reaches the targeted poor. And the remaining 85% does not even get accounted for.

So what is the reason behind this dismal record? For starters, subsidies have unintended beneficiaries: people who can afford to pay higher prices. Why should the government subsidise diesel for cars and LPG cylinders for cooking for the rich. A second is that artificially low pricing encourages leakages and improper use. Subsidised grain and kerosene meant for ration cardholders is sold for profit in the open market.

All the above criticisms about these programmes are true but there are obvious steps that the government could take to make improvements. For instance, the government could find ways to deliver the benefits of fertiliser subsidies directly to the farmer instead of passing these to fertiliser manufacturers and importers. It could speed up on the direct cash transfer system. That would ensure that the right sections of the society benefit from the subsidy system. The benefits can be maximized only when the subsidies are transparent, well targeted, and designed for effective implementation without any leakages.

In the long term, a calibrated approach is needed in designing of subsidy policy. This means that the government needs to get on with the policy reforms and at the same time start cutting back on the subsidies. Doing just one without the other would not help achieve the desired result. Reforms can only be made in the subsidy system when the policy- makers and politicians will understand that the question is not whether to subsidise or not, but who to subsidise and how.

Should India do away with subsidies? Let us know your comments or post them on our Facebook page / Google+ page.

 Chart of the day
It wasn't long ago that emerging markets were considered to be the growth engines of the global economy. The huge promise that investors saw in these economies was embodied by the popularity of the term BRICS. When most of the developed economies fell like a pack of cards in the crisis of 2008, the BRIC club showed amazing resilience. No wonder, these economies became hotbeds for investors. However, if the year 2013 is anything to go by, all that glory seems to be a thing of the past.

The year 2013 saw developed markets surpassing emerging ones. While the stimulus gave a boost to developed markets, emerging economies seemed to be losing their sheen and appeal due to the fear of US tapering. The positive growth surprise in the developed economies was in stark contrast to the poor growth for emerging markets including India. Today's chart of the day shows that stock markets of developed countries outperformed stock markets of emerging countries.

Which stock markets performed the best in 2013?

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'Focus on core' was the key learning for the 'too big to fail' banks in the aftermath of 2008 crisis. Their attempt to profit from proprietary trading activities led to the subprime crisis assuming gargantuan proportions. The 'Volcker rule' that bans banks from trading to profit for their own accounts nailed the root of the crisis. However the fine difference between banks profiting from their own accounts and the clients' money makes things difficult for regulators. For instance, JP Morgan's US$ 6.2 bn loss on the derivative bet called 'London Whale' was touted as a hedging activity for the client. However this too was subsequently added under the Volcker rule. The RBI has so far not made it mandatory for banks to make a clear disclosure of their proprietary trading activity. Moreover the top management of the bank does not have to certify compliance with laws for all such activities. Given that the RBI is otherwise a proactive central bank, it is time it pays more attention to the Volcker rule. As an article in the Hindu Business Line suggests taking cues from the Volcker rule could save the RBI a lot of headache in the days ahead.

Now that 2013 is at an end, various discussions have already begun on what the outlook will be for the stock markets in 2014. As per an article on Mint, the consensus seems to be an expected gain of around 9% for the Sensex. One of the reasons being cited for this is healthy monsoons in 2013 in what was otherwise a poor year for the country in terms of GDP growth. There is a lot banking on big harvests and the government's $77 billion funding for rural areas. This is expected to increase the incomes in the hands of rural people inducing them to spend. The government clearing some big infra projects is also expected to drive the stock market. Whether this actually happens remains to be seen.

We are of the view that not much of note is expected to take place in terms of reforms in the infra space before the general elections. Also, whether the rural population will significantly spend in 2014 will be a product of how inflation pans out. Indeed, despite healthy monsoons, consumer prices have remained in double digits causing much pain to the common man. Thus, rather than predicting the movement in stock markets based on certain events, it makes more sense to focus on investing in good quality companies trading at attractive valuations.

As per Economic Times, public sector lenders are gearing up to increase their capital base through the qualified institutional placement (QIP) route. Leading PSU lender State Bank of India (SBI) is planning to raise Rs 95.8 bn during the upcoming quarter. IDBI Bank is also planning to shore up Rs 12 bn via share sale to institutional investors. Apart from these two banks, other PSU banks such as Indian Overseas Bank, Dena Bank and Allahabad Bank have also shown interest in raising funds via the QIP route.

Together, these banks are likely to raise about Rs 150 bn through proposed share sale. It must be noted that this would be over and above Rs 140 bn capital infusion to be made by the government during this fiscal year. The infusion of funds will boost the capital base of these banks and will enable them to maintain growth in the future. It will also enable them to meet the Capital Adequacy Ratio (CAR) under new global risk norms.

Is a certain investment strategy timeless? Or does one have to adapt to changing times in order to keep beating the markets year after year? We were curious to know the answer to these questions when we came through a recent interview of Peter Lynch. Now, as most of us would be aware that when it comes to amongst the greatest fund managers, Lynch's name would be hard to leave out. Thus, we are excited to know how differently he would have approached investing had he been managing money today. Well, you would be happy to know that he wouldn't change a thing. As a matter of fact, he was of the view that retail investors have an even better chance of beating fund managers over the long term on account of wide availability of information. He reminisced how he had to wait for letters in their physical mailboxes to know something as an inventory of a firm. These days though it is available at a click of a button to almost anyone who wishes to access these.

Lynch also had a great advice on people wanting to start investing. He argued that people start building a paper portfolio of around 10 stocks first and keep a record of why they are buying these stocks. And then after few months they should check on what clicked and what did not and the reasons behind the same. This way over time they will get to know their strengths and weaknesses and then they can build on their strengths and become a successful investor. Some great words of wisdom there we believe.

After starting the day on a firm note, the Indian markets dropped below the dotted line and continued to trade in a range bound manner since. At the time of writing, the BSE-Sensex was trading lower by about 50 points or 0.2%. Losses were seen in stocks across the board, barring those from the FMCG, metal and oil and gas spaces. Mid and smallcap stocks were in favour today with their respective indices up by 0.1% and 0.4% respectively. Stock markets in other parts of Asia ended the day on a firm note with Hong Kong and Japan up by about 0.01% to 0.7%.

 Weekend investing mantra
"The extravagance of any corporate office is directly proportional to management's reluctance to reward shareholders." - Peter Lynch

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7 Responses to "Should India do away with subsidies?"


Dec 31, 2013

There should never be a subsidy on consumption, it encourages people to over-consume, encourages wastages. It should always be on production, more a farmer produces more his production be subsidised.

Like (2)


Dec 31, 2013

Yes, We should away from subsidies, if government feels the poor is
able buy, then plan to eradicate poverty by proper employment (not
like MNREGA) so that they will get buying power. Agricultural
products prices shall be raised so that formers shall feel the
agriculture is a profitable business and have buying power.

Like (5)

Abhay Dixit

Dec 31, 2013

Yes, over may 5-8 years. Instead the money should be used to improve education standards, health care facilities in villages and smaller towns. However, this involves hard work so politicians will shun it. Giving subsidies requires no efforts.

Like (2)


Dec 30, 2013

Subsidy to any person for anything makes him dependent and non enterprising. It will be better if the market forces are allowed to take their free path and people pay the price . Only the ones who can not afford the basic needs like food and shelter are provided these basic needs. This is well known fact that the subsididised items are primarily used by the ones who do not need these like subsidised diesel being used by rich in their cars.

Like (2)

G S Apte

Dec 30, 2013

Government should do away with subsidies in calibrated manner, as suggested by Equitymaster. I think, many people will agree with it.

As we have seen in the past 60 years, real benefits of subsidized items do not always reach poor sections of society due to various practical reasons.

Also, inflation is another area of concern in India. As it is evident that, economies with low inflation have done well in terms of stock market performance in year 2013, and may continue to outperform India in another 1-2 years or so.

Government should focus on reducing retail inflation to around 5% in India. This would kill multiple birds in one stone. Not only it will increase saving rate of Indians, but also will fuel industrial and job growth, and additional savings from the urban India can flow into the markets and economy in general, thus creating much more jobs for young Indians.

Like (2)


Dec 30, 2013

Yes, all the subsidies should be discontinued as it is proved time and again that the purpose for which the system of subsidies was started has not achieved its objective and has resulted into deep routed corruption leading to deficit in govt. finances which again resulted in having high taxes levied by the govt. The govt. should abolish the present system of subsidies and go for direct cash transfer to eligible citizens by using the information technology driven system based on correct identity of the beneficiaries. By this the leakage of resources can be stopped and the resources can be properly utilized in the development of our country.

Like (2)

Balakrishnan R

Dec 30, 2013

Subsidies may be limited to Education and Health Care. Removal of subsides in other areas shall stimulate interest in innovation to reduce the costs or to get alternates.

Like (2)
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