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Subsidies: Funding inefficiency? - Views on News from Equitymaster
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  • Feb 28, 2002

    Subsidies: Funding inefficiency?

    The markets off late have been discussing quite a bit on the fiscal state of the economy. The Finance Minister had projected a fiscal deficit of 4.7% in the last year’s budget against which the fiscal deficit stands at 5.7%. But it has to be mentioned that a sluggish industrial sector and repercussions of the September 11 attacks on the US have made enough to dent profits of India Incorporated. In the current fiscal, the government has managed to maintain a hold on the expenses. We take a look at the Finance Minister’s projections on subsidies in the coming fiscal.

    Due to higher carrying cost necessitated on account of large stocks with the Food Corporation of India (FCI) and reduction in the issue prices, food subsidy shot up significantly for the fiscal year 2002. It is estimated that close to 20% of food stock with FCI is left to rot each year. Consequently, food subsidy as a percentage of the total subsidy has increased from 45% in FY01 to 58% in FY02. In the coming fiscal, the government expects food subsidy to increase by 20% to Rs 212 bn. Why is it so? On one hand, the government procures food grains on an open-ended basis at a high price and then disposes them at a heavily subsidised price through the public distribution system (PDS). This is not sustainable in the long run.

    The way out is to either reduce procurement price or increase prices that are distributed through the PDS scheme. Another way out is the concept of decentralised procurement, wherein the respective state government procures food grains from farmers at a viable price, keeping in mind their fiscal state. However, this has not yet found favour with the state government due to political reasons. Going forward, it seems unlikely in light of the recent assembly election results. In light of maintanence costs involved with food stock, the Finance Minister has taken a number of measures.

    These measures include: increased allocations for BPL families (below poverty line), launching of a major food for work programme, allocation of 3 million tonnes (MT) of free food grains to states for relief works in areas affected by natural calamities, open market sales of 3 MT this year compared to 0.5 MT in FY01 and enhanced incentives for export of food grains.

    The government has managed to keep a tab on expenses in the current year on account of lower fertilizer bill. The decrease however, is due to less than expected consumption of fertilizers and reduction in cost of inputs. The government hopes to reduce fertilizer subsidy by another 12% in the coming fiscal. Toward dismantling the administered price mechanism by FY05 and gradually removing subsidy the government has hiked prices of urea in the current fiscal.

    Cumulative subsidy in the coming fiscal is expected to rise by 30% to Rs 398 bn. But this is largely on account of inclusion of petroleum subsidy. With the dismantling of APM in the petroleum sector, subsidies for domestic LPG, PDS kerosene, freight subsidy for far flung areas and other related compensation have been provided, for the first time, in 2002-03. This is to the tune of Rs 65 bn. The government hopes to extinguish the oil pool deficit partly by issue of government bonds to the petroleum companies.

    We would stick with these subsidies because these together would account for almost 88% of the subsidy bill in 2002-03. Due to a rise in subsidy, the budgeted expenditure estimates for 2002-03 show an increase of Rs 458 bn over revised estimates of 2001-02. While increase in non-plan expenditure is Rs 315 bn, plan expenditure is expected to increase by Rs 143 bn.

    One of the major problems on the subsidies front is that they have been misdirected to a large extent till now. The government has been paying for all the inefficiencies of fertiliser manufacturers till now, who could manipulate production figures. As Mahesh Vyas, Executive Director at CMIE puts it “We should only correct the misdirected aspect of it. We need to correct that and we should not cut down subsidies. It is a mismanaged expenditure”.

    It is not that subsidies are not at all required. But one only hopes that the government takes due care to make sure that it reaches to those sections of the society towards whom it was intended to. So, in this context, the need for expenditure reforms cannot be understated.



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