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Impact of subsidies on Indian economy

Subsidies are inverse of taxes. Tax increases prise of goods whereas subsidies reduce prise of goods. And just as taxes increase a governments income, subsidies reduce it. Therefore, subsidies are sometimes known as negative taxation. Subsidies have a vital role in the economy of a country. A country possesses various resources which are to be efficiently deployed for the benefit of the population of the whole country. Subsidies ensure equitable utilization of the resources for the people of the country. The developed, developing and underdeveloped countries have different kinds of subsidies. India provides subsidies to their population for improving standard of living; the underdeveloped countries provide subsidies for meeting bare minimum needs of the vast majority of population. For studying importance and and role of subsidies, one needs to understand that why India needs subsidies or why it does not. India needs subsidies due to various reasons. To provide minimum consumption entitlement to the poor by subsidizing the items consumed by them is extremely important for the welfare of the economy. Food prices play a vital role in the well-being of the poor and poverty reduction in developing countries. Therefore, government interventions in food grains markets are required in one form or another for several years, starting during the Second World War. Although there has been a decline in the portion of expenditure on food items in last few Years in both urban and rural areas but poor consumers still spend a large portion of budget on food in developing countries (Pinstrup-Andersen, 1985), in India the proportion of expenditure on food items has declined by about 9.5 percentage points in the rural areas and by 15.9 percentage points in the urban areas between 1988-89 and 2010-11 (NSSO, 2012) but bottom decile class of consumers spends about 64 percent of total spending on food items in rural areas and about 61 per cent in urban areas.

Therefore, the role of the state in providing food subsidies to poor consumers is socially justifiable as food subsidies are needed to protect the welfare and nutritional status of the economically disadvantaged people. However, food subsidies are under increasing criticism because of their large impact on government budget deficitsand inefficiency because it is generally argued that the benefits often do not reach the poor.

Subsidies in Indian agriculture have been increasing significantly since the post-reforms period. Food subsidies increased from Rs. 2,85.0 million in 1991-92 to about Rs. 72,82.3 million in 2011-12, an increase of over 25 times in 22 years . As a result, its share in total central government subsidies under non-plan expenditure increased from 23.3 percent to 33.7 percent between 1991-92 and 2011-12.

As a percentage of agricultural GDP, the food subsidy increased from 1.7 percent to 5.5 per cent during 1993-94 and 2009-10.Food subsidy, which increased at an annual compound growth rate of about 17.7 percent during the 1990s, remained stable between 2003-04 and 2006-07 mainly due to low off take of food grains and marginal increases in procurement prices.

However, there has been a increase in food subsidy during the last few 5-6 years. For example, food subsidy more than tripled from Rs. 24,01.4 millions in 2006-07 to Rs. 72,82.3 millions in 2011-12 and is estimated to cross Rs. 75,00. million in 2011-12, at an annual compound development rate of 21.3 percent.

The average consumer subsidy on wheat for Antyodaya Anna Yojna (AAY) households has increased from Rs. 683 per quintal in 2001-02 to about Rs. 1453 per quintal during 2011-12 and in case of Below Poverty Line (BPL) households from Rs. 468 to about Rs. 1239 during the corresponding period (more than 2.5 times increase). In case of Above Poverty Line (APL) households, average subsidy has more than tripled from Rs. 303 to about Rs. 1044 between 2002-03 and 2011-12.

Almost a similar trend was observed in case of rice, where average subsidy for APL households increased by more than 3.49 times from Rs. 371 in 2002-03 to Rs. 1353 in 201112, for BPL consumers from Rs. 604 to Rs. 1618 and in case of AAY consumer subsidy more than doubled. The proportion of cost of carry subsidy varied from about 2.1 per cent during 2005-06 and 2006-07, mainly due to low stocks of food grains, to 26.4 percent in 2002-03 when the stocks were very high. The share of buffer stock subsidy recorded an increasing trend since 2007-08 due to build-up of food grains stocks with the FCI.

Food Inflation continues the North ward spiral with latest figures revealing inflation to be at17.55%. RBI seeks to coordinate the fledging growth with monetary and fiscal policy. As food inflation rises at threatening rates the RBI walks a tightrope between tightening credit policy and the nascent recovery. At the quarterly credit policy review the RBI increases the CRR by 74 basis points (0.75%) rather than the expected 49 basis points. The RBI however leaves the repo rate as it is, though it was expected to be increased by 50 basis points.

The present inflationary situation however is supply side based, affecting the Consumer Price Index. The credit policy however has a larger impact on the Whole Sale Price Index (WPI). The CRR rise shall phase out Rs 36,00.0 million ($7.2 billion) worth of liquidity from the system. The RBI has further initiated a phased rollback of fiscal expansionary policy by raising the SLR to the pre-crisis level of 24% from 23%. Stronger inflationary measures may however damage the recovery.

Food inflation is however being joined by wider system inflation driven by demand side factors as expansionary factors work their way through the system. The RBI should coordinate the fiscal and monetary policies to get the fiscal deficit target and yet keeping the stimulus in place to allow the recovery to strengthen. However raising global commodity

prices, principally crude oil prices are threatening to affect the fiscal deficit and the WPI. The Kirit Parikh Committee recommended a amazing increase in the prices of the primary petroleum products. While petrol and diesel should be allowed free pricing the kerosene subsidy must be decreased by Rs 4/litre and LPG subsidy be decreased by Rs 100/ltr according to the recommendations of the committee.

While these recommendations are too drastic as short term measures the 4th February Chief Ministers Meeting with the PM may see a price hike of Rs3/ltr in petrol and Rs3-4/ltr in diesel. This shall reduce the fiscal deficit pressure on the government and allow the oil companies more headroom to increase profit margin , but it shall lead to a increase in the WPI. To service the fiscal deficit target without jeopardizing the WPI the government must fast track the disinvestment programme as the increased cash flow situation shall allow it postpone increases in the basic crude commodities that have amongst the highest weightage in the WPI.

While the current growth in the WPI is demand based showcasing the positive impact of the expansionary fiscal policy the global oil prices threaten to turn the WPI growth into a supply side inflation that shall lead to deceleration of industrial growth that is presently the highest in 17 months. It is therefore necessary to postpone increases in the petroleum prices till industrial growth recovers fully.

Increasing the rates shall not help the problem as it will increase bond yields and will increase the interest payment on debt thus further affecting the fiscal deficit position. Thus keeping the growth, the WPI and fiscal deficit in mind it is must for the central government to accelerate the disinvestment process that will allow the Union government to maintain commodity prices at current levels leaving the industrial based inflation constant at the current 8.4% year on year.

In the meantime however the Union and State Government must act in coordination to increase the supply of essential grains in the country. To fight the supply side inflationary pressures the government should actively mobilise the PDS and release the grain supplies into the open market..

The annual budget may see an increased allocation for the farm sector, rural infrastructural improvement and tax incentives to food processing industries with the aim of increasing supplies in the long term. In the year 2008-2009 Rs 57,00. million of agricultural food items were affected by infrastructure deficit.

In conclusion the RBI and the Union government should coordinate the priorities of industrial and wider based GDP growth with comparison to the supply side food inflation affecting the poor man and the demand side Wholesale Index inflation that threatens industrial recovery. Furthermore fiscal deficit and monetary policy required to be reviewed with the disinvestment programme being accelerated to include the government expenditure on petroleum subsidy and expansionary credit policy.

Now the time has come when the Planning Commission, the Central Government, and the NDC will work on building a political and national desire on this issue. It is important that we reframe subsidies so that only the really deserving and the poor benefit from them and all leakages are stopped. All subsidies should be targeted properly at the poor and the truly deserving like small and marginal rural farmers, farm labour and urban destitute.