Context:

  • The Union government has ordered State-run oil companies to raise the prices of subsidized cooking gas(LPG) by Rs 4 a cylinder every month to eliminate all subsidies by March next year.

Background:

  • The government had previously asked Indian Oil, Bharat Petroleum and Hindustan Petroleum to raise rates of subsidized domestic LPG by Rs 2 a 14.2 kg cylinder per month (excluding VAT).
  • Public sector oil marketing companies (OMCs) were authorized to increase the price of the subsidized domestic LPG cylinder by Rs 2 per cylinder (14.2 kg) per month (excluding VAT) with effect from July 1, 2016.
  • The government vide its order dated May 30, 2017, has again authorized oil marketing companies to continue to increase the effective price of subsidized domestic LPG by Rs 4 per cylinder effective June 1, 2017 till the reduction of government subsidy to ‘nil’, or till March 2018, or till further orders, whichever is earliest.
  • Oil companies have raised rates twice since then, the last being on July 1 when rates were up by steep Rs 32 per cylinder-the steepest increase in six years. This hike reflected the higher tax rates under the GST regime.

Meaning of subsidies:

  • A subsidy is a form of financial aid or support extended to an economic sector (or institution, business, individual) with the aim of promoting economic and social policy.
  • Subsidies come in various forms including direct (cash grants, interest-free loans) and indirect (tax breaks, insurance, low-interest loans, accelerated depreciation, rent rebates).
  • A subsidy is a benefit given by the government to groups or individuals, usually in the form of a cash payment or a tax reduction.
  • It is used in the overall interest of the public.
  • The subsidy in India comprises of four broad categories of expenditure: fuel, fertiliser, food and employment (MNREGA).

 Examples of subsidies:

There are many forms of subsidies provided by the government, including, welfare payments, housing loans, student loans, and farm subsidies.

Direct vs Indirect subsidies:

  • Direct subsidies are those that involve a direct payment toward a particular group or industry.
  • In a direct subsidy, cash can be provided to the targeted group in the form of a check.
  • Indirect subsidies are those that do not hold predetermined monetary value that is specifically directed toward a particular industry or individual. For example, activities like price reduction for required goods or services that can be government supported.
  • Indirect subsidies allow the needed items to be purchased below the current market rate, resulting in savings that is ultimately determined by the amount of participating activity.

Purpose of providing subsidies:

A welfare state without subsidies cannot be imaged. Governments have to provide subsidies to achieve the following objectives:

For beneficiary:

  • Making basic necessities affordable to poor sections of society through extension of consumer services.
  • Better nutrition – When there is cash transfer poor will be able to diversify their diet by including more items like pulses, eggs etc. This will increase their protein intake.
  • Subsidies are meant for poor people and they shall ensure equitable redistribution of resources.
  • It create job opportunities
  • It gives a customer better price for the goods of daily use.
  • If the government gives subsidy to certain industry then it directly means to increase their investment and support in their work.

For Economy:

  • When the economy is at lower stages of development, it is often unviable and unaffordable for private sector to step in production. In such a situation government provide a helping hand by supporting private sector by extending subsidies
  • A subsidy is generally used as a form of support for particular portions of a nation’s economy
  • It can assist struggling markets by lowering the burdens placed on them, or encourage new developments by providing financial support for the endeavors
  • Government seeks to implement subsidies to encourage production and consumption in specific industries
  • On the supply side, government subsidies help an industry by allowing the producers to produce more goods and services
  • Government subsidies can help an industry on both the supplier side and the consumer side
  • They help in poverty intact and create inefficiencies in economy which culminates in inflation and corruption.

Problems in providing subsidies:

  • In a democracy like India, subsidy once extended becomes a politically sensitive issue and governments suffer huge political risk if they phase out such subsidies.
  • These are considered a heavy toll on government’s expenditure.
  • They are forced to cut allocation to developmental and infrastructure avenues.
  • Higher subsidy expenditure pushes up fiscal and revenue deficits as government starts spending more than it earns.
  • Most significant consequence of providing subsidies is that money is squeezed out of economy and which results in lower consumption and demand. This ultimately hits the growth in economy
  • Careless or politically motivated subsidy results in lower revenues for government and higher unproductive expenditure.
  • If government is unable to borrow money or to raise taxes, it will have to print new currency notes to finance deficit, which increases money supply in the economy. This creates inflationary trends in economy. Incoherent subsidy regime unintendedly does more danger than good for the cause it stands-socio-economic development.
  • Increased spending on subsidies is compensated by increased taxes and lower government spending.
  • When taxes goes-up, people purchasing power go down. They spend less and thus overall demand in country falls. This lowers GDP growth rate.
  • Lower government spending means less developmental projects in country.

Why government aims to end all subsidies?

  • 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 are meant to have a cushioning effect on the unaffordability of food and fuel by the poor. But unfortunately it has no achieved the desired result.

Some subsidies led distortion in India:

Given below are few examples of subsidy support gone wrong.

  1. Energy- Groundwater nexus:
  • Agriculture sector is perhaps having most justifiable claim on subsidized inputs given the dismal situation of the farmers in the country.
  • Water and Electricity for an agricultural use are heavily subsidized by state governments
  • Again politics seeped into this economic cause and most governments have failed to ensure rational and sustainable use of subsidized water and electricity.
  1. Fertilizers subsidy
  • Nutrient Based Subsidy was introduced in 2010 with objective to promote balanced use of fertilizers and to limit fertilizer subsidy of the government.
  • Presently Urea is not covered under the scheme due to political compulsions.
  • Potassium and Phosphorous are covered under the scheme and a fixed subsidy as per content of nutrients is given to suppliers and they change Maximum Retail Price as per market signals.
  • The actual use of NPK is in ratio of around 8:3:1 while recommended use is 4:2:1.
  • While urea consumption has increased from 59 per cent to 66per cent of total consumption in 2012-13 over eh 2010-11, per hectare consumption of fertilizer has declined from 140 kg to 128 kg over the same period.
  • Cultivation of wheat, Rice and sugarcane at cost of pulses, horticulture crops and coarse:

Consumption patterns in India are shifting rapidly from calorie rich diet to protein and vitamin rich one. Despite this fact, protein based diet in India is abnormally expensive. The main source of protein is pulses. Higher MSP for pulses is not so high to make whole value of produce more remunerative for farmers.

  • Railways:

Between 1993-2011, the wholesale price index rose by 295% and the fares of sleeper class and second class travel rose just by 144% and 106% respectively. Consequently, railway runs at heavy loss, which can be construed as subsidy to passengers of the railways.

  • Agricultural Finance:

Farmers are entitled to pre-harvest loan at 7% interest rate.  They further allowed 3% subvention in case of timely payment. Farmers can also take loan for post-harvest time against negotiable warehouse receipt.

Solutions:

  • The government should find ways to deliver the benefits of fertilizer subsidies directly to the farmers instead of passing these to fertilizer manufacturers and importers.
  • In the long term, a calibrated approach is needed in designing of subsidy policy
  • The government needs to get on with the policy reforms and at the same time start cutting back on the subsidies.
  • The benefits can be maximized only when the subsidies are transparent, well targeted, and designed for effective implementation without any leakages.

Direct Benefit Transfers as a solution:

Given above are only few examples of subsidy support gone wrong. In such scenario, direct benefit transfers comes to rescue government from this problem. It is likely to have multiple benefits –

  • It hits at roots of corruption: Subsidized fertilizer is diverted to industrial use from agricultural sector, kerosene is mixed in diesel and PDS food is leaked in black markets. Subsidy regime has nurtured a mammoth corrupt ecosystem and black economy in India.
  • Direct transfers will eliminate intermediaries which will end system of rent seeking from the beneficiaries.
  • It is likely to control inflation. Distortions created by subsidy regimes discourage investment in relevant sectors. This creates supply side constraints in economy.
  • Better nutrition – When there is cash transfer poor will be able to diversify their diet by including more items like pulses, eggs etc. This will increase their protein intake.

Government’s initiative:

  • The government launched PAHAL scheme-pan India initiative for transfer of direct benefit for Liquefied petroleum gas.
  • Direct Cash Transfer is also being implemented for transfer of wages in MGREGS scheme. It has resulted in reduction in delay and fake payments in relevant areas.
  • Direct Benefit Transfer for fertilizers and kerosene is on the cards. In case of fertilizers government is facing problems in determination of beneficiaries because there is lack of clear land titles.
  • JAM Trinity- Jan Dhan Yojna, Adhaar and Mobile base: Direct benefit transfers intend to transfer subsidies directly to account of beneficiaries.
  • Apart from these initiatives, behavioral and technical remediesmay be of immense use to control and target subsidies better.
  • Under ‘Give it up’ campaigning, about 50 lakh LPG users have voluntarily given up there subsidy entitlements.
  • On technological side, Urea is being neem coated, which while enhancing agricultural productivity, makes it unfit for industrial use.

Conclusion:

Rationalization of subsidy regime will improve markets in India which will then attract more investment. This can turn the wheel of a virtuous economy which creates more employment and attacks poverty at its roots.

 

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