CENTRAL GOVERNMENT SUBSIDIES

Total Central Government subsidies, as a proportion of GDP, amounted to 4.25

percent in 2002-03 and 4.18 percent in 2003-04. Such subsidies, after declining
from a peak of 4.92 per cent in 1992-93 to 3.49 per cent in 1996-97, increased in
recent years because of three reasons. First, subsidies in the petroleum sector,
which were off-budget, have been explicitly incorporated in the Central
Government’s budget from 2002-03. Second, there has been an increase in the
share of explicit subsidies. Third, while input costs have gone up, recovery rates
have not gone up commensurately.

Explicit subsidies

Only a part of the Central Government subsidies is clearly visible in the

Government’s budget document. Such explicit subsidies, mainly on food, fertilizer
and petroleum, account for about 38 per cent of total Government subsidies,
including those ‘hidden’ in the provision of social and economic services. II.3
Data from 1991-92 (Table 2.1) reveal that the declining trend in explicit subsidies
observed up to 1995-96 was rapidly reversed in the subsequent period.
Furthermore, growth in subsidies accelerated further from 2000-01. Food
subsidies, which grew rapidly from Rs. 2,450 crore in 1990-91 to Rs. 5,377 crore
in 1995-96, were still limited in absolute terms until the mid-1990s. With
sustained growth, such subsidies grew in overall significance, and with the higher
base, started to dominate overall subsidy behaviour in the subsequent period.
The decline in the trend growth of fertiliser subsidy observed since 2000-01 was
not enough to neutralise the increasing trend in food subsidies. Explicit subsidies
on interest, though modest in absolute terms at around Rs. 207 crore in 2003-04,
have been quite large at over Rs. 1,000 crore in 1996-97, 1998-99 and 1999-00.
In recent years, petroleum subsidies have been an important item. In 2002-03,
when petroleum subsidies were shown explicitly in the Budget for the first time,
they were as much as Rs. 5,225 crore. II.4 Explicit subsidies accounted for about
1.8 per cent and 1.7 per cent of GDP in 2002-03 and 2003-04 respectively.
Another measure of the relative size of subsidies is its ratio to net revenues of
the Government. Aggregate explicit subsidies relative to net revenue receipts,
after falling from its peak in 1990-91 continuously until 1999-00 (except for the
year 1998-99), started to rise thereafter.

Estimates of total Government subsidies

Explicit subsidies provide only a limited view of the overall volume of subsidies.
In order to have a complete picture, there is a need to estimate the implicit
subsidies resulting from unrecovered costs of public provision of goods and
services not classified as public goods. The cost of providing a service comprises
of three elements: current costs, annualized capital costs (opportunity costs of
funds used for capital assets and imputed depreciation), and opportunity cost of
funds invested in the form of equity or loan for the service. In cases other than
pure public goods, there is scope for cost recovery from the beneficiaries.

Explicit and implicit subsidies are estimated at Rs. 1,04,913 crore for 2002-03
and Rs. 1,15,824 crore for 2003-04, which are, as a proportion of GDP,
equivalent to 4.25 per cent and 4.18 per cent, respectively. As proportions of net
revenue receipts, such subsidies are estimated at 45.27 per cent and 44.04 per
cent, respectively. Tables 2.2 and 2.3 provide the broad aggregates of the
different categories of subsidies. For 2002-03, subsidy is estimated at Rs. 20,306
crore on social services, and at Rs. 84,607 crore on economic services. For
2003-04, the corresponding figures are Rs. 24,475 crore and Rs. 91,350 crore,
respectively.

FOOD SUBSIDIES

Food subsidies in India comprises subsidies to farmers through support prices

and purchase operations of the Food Corporation of India (FCI), consumer
subsidies through the public distribution system (PDS), and subsidies to FCI to
cover all its costs. Food subsidies are mainly on account of paddy and wheat.
The rapid increase in food subsidy in recent years is attributable to what is called
the ‘economic costs’ of foodgrains, which include the minimum support prices
paid to farmers in the procurement process.

FERTILIZER SUBSIDIES

The fertilizer subsidy bill has escalated from Rs 500 crore in 1980-81 to more
than Rs. 6,000 crore by the mid-nineties, and further to Rs. 12,662 crore (BE) in
2004-05. The Retention Price Scheme (RPS), which is at the root of the growing
subsidy, and how much of the benefit of the subsidy is going to farmers rather
than the producers of fertilizer have been matters of some debate in the country.

V. PETROLEUM SUBSIDIES
Prior to April 2002, prices of motor spirit, high speed diesel, kerosene for public
distribution system (PDS) and domestic liquified petroleum gas (LPG) were
decided by the Government and administered through the Oil Coordination
Committee (OCC), and there was an elaborate system of crosssubsidisation of
PDS kerosene and domestic LPG through higher prices of motor spirit. The
subsidies on kerosene alone reached Rs. 8,151 crore in 1999-2000 and started
to decline thereafter. Similarly, subsidy on LPG increased up to 2000-01 and
started to decline thereafter (Table 5.1). The net result from cross subsidization
of products by petroleum companies, predominantly public sector companies
both in the upstream and downstream sectors, constituted the so-called oil-pool
surplus or deficit. These balances were carried on the books of the state-owned
oil companies, and occasionally settled by Government intervention. Thus,
subsidisation in the oil sector was in the nature of a quasi-fiscal operation.
SUBSIDY REFORMS
Three reasons account for the increase in the Central Government subsidies in
recent years: (i) moving the petroleum sector to a transparent system of
budgetary subsidies and delay in the announced phasing out of the subsidies on
PDS kerosene and domestic LPG; (ii) increase in explicit budgetary subsidies on
food and fertilizer; and (iii) increase in input costs unaccompanied by any
improvement in recovery rates resulting in escalation of implicit subsidies on a
variety of economic and social services.

Operational inefficiency in the case of provision of any public good or service

leads to higher cost of production and greater subsidies. There is a wedge
between subsidies that are actually received by the users of the service and
subsidies that are borne by the Government. Several types of inefficiencies may
accompany the public provision of services. Apart from direct costs like
overstaffing, poor maintenance of assets, procedural delays, and delays in taking
critical decisions, there are systemic inefficiencies.

Subsidy reforms should aim at (i) reducing their volume relative to revenue
receipts; (ii) limiting these to only Merit I and Merit II categories while eliminating
the non-Merit subsidies; (iii) administering subsidies more directly to the targeted
beneficiaries, thereby eliminating input subsidies and focusing more on transfers
rather than subsidies; (iv) making these subsidies transparent by showing them
explicitly in the budget; and (v) avoiding multiple subsidies to serve the same
policy objective.

Any subsidy restructuring has to address the issue of food subsidy. For
foodgrains, support prices should be kept at the C2 level recommended by the
CACP. To contain operational costs, reimbursement of expenses to the FCI
should be based on normative unit costs and actual quantities involved. With
respect to PDS, the system of dual prices encourages leakages. A uniform price
policy with a system of food coupons for the BPL families needs serious
consideration. The system may be implemented in phases.

In the case of fertilizer, both farmers and fertilizer industry have been subsidized.
There is a need for policy measures to reduce subsidy to both the groups.
Fertilizer subsidies should be done away with in their present form. Urea imports
should be de-canalized and a flat rate subsidy system may be introduced with
two different rates of subsidy for domestic producers and importers in the short
run, and a single rate in the medium term. Further, given the problem of domestic
availability of natural gas, which is the cheapest feedstock, the option of setting
up fertilizer plants in countries where natural gas is available in plenty may be
considered. The fertilizer produced there can be shared between the host
country and India as per the agreement reached. Another reason for the
mounting burden of fertilizer subsidy is the lack of a mechanism to increase the
farm-gate price of urea at regular intervals. A system that provides for such a
periodic increase is required.

The domestic LPG and PDS kerosene subsidies seem to be ineffective in serving
the desired objectives. Therefore, the domestic LPG subsidy may be gradually
reduced or at least substantially restricted, while a more cautious approach
should be pursued in the reduction of kerosene subsidies. About a half of the
rural households use kerosene primarily to light their homes. Only state-owned
oil companies have been permitted to market subsidized domestic LPG and PDS
kerosene. This has stifled competition by curtailing the entry of private retailers. A
market environment encouraging fair and healthy competition is the most
effective way to expand the supply and availability of competitively priced
kerosene and LPG.