Subsidies on food, fertilizers and petro-products have been a continuing and disturbing feature of our budgets. The national common minimum programme promised a report on this subject, with a view to targeting the subsidies to the really deserving poor, both rural and urban. The finance minister made the same commitment in his July 2004 budget. This survey of subsidies is now public, prepared with the help of the National Institute of Public Finance and Policy by the finance ministry. It analyses the growth and structure of subsidies and makes a few suggestions to restructure them.
As in its earlier study, the NPFP has now also divided the total subsidies into merit and demerit subsidies. The analysis further makes two sub-divisions under 'merit': merit I and merit II subsidies. The subject being subsidies, this division is rather subjective. The report presents merit I subsidies as covering elementary education, primary healthcare, prevention and control of diseases, soil and water conservation and environment. Merit II covers higher education, family welfare, agricultural research and education, land reforms as well as flood control and drainage.
Value judgments as to whether the demerit subsidies group ranks lower in welfare and economic consequences than merit subsidies can differ. Policies can differ according to whether a subsidy is merit I or merit II. The report does not specify such differential policies.
The report points out that merit subsidies as a whole are only 34 per cent of total subsidies. Non-merit subsidies cover the balance of the subsidy bill. The distribution of subsidies between the two categories reflects the sense of priorities in national economic policy-making. It can be argued that some non-merit subsidies may even be more productive of beneficial results favouring poverty alleviation than demerit subsidies. The judgment has to be made on a case-to-case basis.
The report on subsidies is interesting not merely for the data it analyses but also ' and more importantly ' for the suggestions on policy it makes with regard to specific subsidies. It has a few suggestions for reallocating subsidies in food and fertilizers. But it skips the complexities of power subsidies, which both directly and indirectly contribute a very heavy burden to the country's budgets, particularly those of the states.
Concerning food subsidies, the report says that growth of expenditure on them has been sharp in absolute terms. They have grown from Rs 2,450 crore in 1990-91 to Rs 25,800 crore in 2003-04 (revised estimate) ' a tenfold growth at a time of reforms when fiscal austerity was supposed to be the rule. This has happened in spite of the fact that the Central issue price for food grains to the 'below poverty line' consumer has increased by 61 per cent in the period 1997-98 to 2003-04, while general rise in the consumer price index for agricultural labour was only 25 per cent. This means that issue prices have not been depressed unduly and policy-makers have resisted populist pressures for still lower issue prices.
The core of the problem of rising food subsidies is, however, not the Central issue price, but the practice of fixation of high support price for growers of both rice and wheat. There is need to be more rational in this regard. High minimum support prices for foodgrains not only lead to high subsidy bills, but also to other adverse economic consequences apart from high subsidies. Farmers are induced to concentrate on production of foodgrains to the exclusion of oilseeds and pulses when the country is facing shortages. Further, high minimum support prices for rice and wheat can lead to wasteful use of water by farmers growing these water-intensive crops. Not to speak of the accumulation of food stocks with the Food Corporation of India, which leads to the anomaly of a poor country having to 'subsidize' exports of foodgrains to foreign countries, when millions of its citizens can scarcely afford a full meal.
The report generally traverses the ground covered competently by the foodgrains policy review committee. While it emphasizes the need to be more rational in fixing minimum support prices, it also suggests exploring the possibility of decentralizing procurement to states. But this can have adverse consequences, especially since states will decide whether foodgrains can move to needy states. Buffer stocks under the FCI have played a strategic role in averting shortages in various parts of India. Dismantling the FCI's crucial role in this demands caution.
The report has touched on the issue of petro-product subsidies. It says that LPG subsidies are not properly targeted. But it is rather short on suggestions here, particularly on the issue of kerosene subsidies, which distort the use of diesel by facilitating its adulteration. Also, kerosene, available cheap in India, provides a temptation for smuggling to other countries, like Bangladesh. Cheap kerosene is a populist slogan, but it is doubtful whether it reaches the really poor.
The issue of petro-product subsidies is a complex one, rooted in the political domain, where the United Progressive Alliance's coalition partners are bent on reducing prices and increasing subsidies. This is an economically distortionary policy as long as we are heavily dependent on imports of crude and gas. The policy of keeping petro-products' price cheap hurts domestic refiners, particularly in the public sector and decreases the dividend and tax flow from them to the fisc. This is a double-whammy, which the populist supporters of low petro-product prices are ignoring. It also reduces the prospect of higher future investment in the sector.
Let us now turn to the ticklish subject of fertilizer subsides. The report gives a frank assessment of the dilemma the government faces. The fertilizer subsidy is ultimately the result of the government's desire to keep farm-gate prices of fertilizers low in spite of the rise in cost of production and distribution. The government has tried to address this question over the years by subsidizing the difference between costs and farm-gate prices, paying it to the fertilizer producers, who are mandated to sell it at uniform fixed prices. The complexities of the process had led first to a unit-based retention price, based on costs, which has now been changed to a group retention price. The changes effected in this regime have led to fertilizer producers being hurt sharply in recent years.
A statistic disclosed by the report shows that the subsidy portion passed on to industry has declined to a negative figure of (-)27.83 per cent in 1995-96. This negative subsidy implicitly shows that the fertilizer industry was exposed to a tax of this high order as a result of the operation of the fertilizer subsidy scheme in its present form. So there are reports of fertilizer shortages all around the country, the fertilizer industry having lost its raison d'etre to produce more fertilizers and thereby incur more losses.
The report suggests that a way out of the fertilizer subsidy problem is to phase it out. But that means either the fertilizer prices have to be increased to cover costs of production or India will have to import cheaper fertilizer from abroad. The latter solution may turn out to be worse than the disease it is intended to cure, since India has a large demand for fertilizers and may raise global prices. The report states that the rise in fertilizer prices need not by itself affect food production adversely since there are other factors, such as better irrigation, that can step up production even if fertilizer use decreases. This totally ignores the vital role that fertilizers play in India's modern agriculture. We cannot ignore the vital contribution fertilizer application makes to agricultural production, especially after the Green Revolution. There is no escape from increasing fertilizer prices to meet the costs of production, nor from increase of food prices as a result of that increase. Subsidies to fill the gap are counter-productive.
Overall, the report is a thought-provoking one. But the roadmap it attempts to set out is not definitive. The parliament will do well to refer the report to a consultative committee, which can come out with specific suggestions to target the subsidies to the poor without affecting economic efficiency and growth.