A

Project Report on
“SUBSIDY MANAGEMENT”

SUBMITTED IN
POST-GRADUATE OF
MASTER OF COMMERCE
4th SEMESTER
(2017-2019)

Submitted by

BISWAKETAN SAMAL
Enrollment No. : 1703030090900275

Under the Supervision of

Mr. Giridhari Sahoo
Academic Consultant, Commerce

DIRECTORATE OF DISTANCE AND CONTINUING

EDUCATION
UTKAL UNIVERSITY, VANIVIHAR
BHUBANESWAR-751007
 CERTIFICATE

This to certify that the project entitled “SUBSIDY MANAGEMENT”

Submitted to DIRECTORATE OF DISTANCE AND CONTINUING
EDUCATION (DDCE),UTKAL UNIVERSITY for the award of the
Master degree of MASTER OF COMMERCE is the record of the
bonafide research work carried by Biswaketan Samal under the guidance
& supervision of Mr. Giridhari Sahoo, Academic Consultant, Commerce.
This Project has not been submitted to any other university or institutions
for the award of any degree or diploma.

Mr. Giridhari Sahoo

(Academic Conultant,Commerce)
 DECLARATION

I Biswaketan Samal, hereby declare that the project work entitled

“SUBSIDY MANAGEMENT” submitted by me to DIRECTORATE OF
DISTANCE AND CONTINUING EDUCATION (DDCE), UTKAL
UNIVERSITY in the partial fulfillment of the requirement for the award of
the Master Degree of MASTER OF COMMERCE is an original work
done by me and not submitted to any other university or institutions for the
award of any degree or diploma.

BISWAKETAN SAMAL
Date: Master Of Commerce (M.COM),
4th Semester
Enrollment No. - 1703030090900275
 ACKNOWLEDGEMENT
My Sincere thanks to being extended through this acknowledgment to
all the individuals and organisations as well form when I have got direct
and indirect help to complete this project work entitled “SUBSIDY
MANAGEMENT”.
I express my deep sense of gratitude to my esteemed guide
Mr. Giridhari Sahoo, a shining name in DIRECTORATE OF DISTANCE
AND CONTINUING EDUCATION (DDCE), UTKAL UNIVERSITY,
VANI VIHAR, BHUBANESWAR for taking interest in my research work
and guiding me throughout the preparation of this project.
Also, I am thankful to our Lecture Dr. Sujit Kumar Acharya,
Dr. Biswo Ranjan Mishra, Dr. Rasmi Ranjeeta Das for their guidance and
co-operation.
I remain grateful to my parents and my sister for their encouragement
and co-operation.

BISWAKETAN SAMAL
Master Of Commerce (M.COM),
4th Semester
Enrollment No. – 1703030090900275
 CONTENTS
CHAPTER SUBJECTS

I INTRODUCTION

II SUBSIDY: MEANING AND ECONOMIC

RATIONALE

III TYPES OF SUBSIDIES IN INDIA

IV SUBSIDIES LED DISTORTION IN INDIA

V TRENDS IN CENTRAL & STATE GOVT.

SUBSIDIES

VI METHODOLOGY FOR ESTIMATION OF

SUBSIDIES IN INDIA

VII BENEFIT & ISSUES OF SUBSIDIES IN INDIA

VIII EXPENDITURE ON SUBSIDY OF GOVT.

(Budget 2018-19)

 CONCLUSION

 SUGGESTIONS
 Chapter - I
INTRODUCTION
A subsidy is money that is paid by a government or other authority in order
to help an industry or business, or to pay for a public service. A subsidy, often
viewed as the converse of a tax, is an instrument of fiscal policy. Derived from
the Latin word 'subsidium', a subsidy literally implies coming to assistance from
behind. However, their beneficial potential is at its best when they are
transparent, well targeted, and suitably designed for practical implementation
subsidies are help full for both economy and people as well. A subsidy is a
benefit given to an individual, business or institution, usually by the government.
It is usually in the form of a cash payment or a tax reduction. The subsidy is
typically given to remove some type of burden, and it is often considered to be in
the overall interest of the public, given to promote a social good or an economic
policy.
Subsidies are having long-term impact on economy like green revolution
etc are only because farmers were given good quality of grain on subsidised
prices likewise we can see that how govt of India is trying to reduce air pollution
to subsidies LPG. Like indirect taxes, they can alter relative prices and budget
constraints and thereby affect decisions concerning production, consumption and
allocation of resources. Subsidies in areas such as education, health and
environment at times merit justification on grounds that their benefits are spread
well beyond the immediate recipients, and are shared by the population at large,
present and future. For many other subsidies, however the case is not so clear-
cut. Arising due to extensive governmental participation in a variety of economic
activities, there are many subsidies that shelter inefficiencies or are of doubtful
distributional credentials. Subsidies that are ineffective or distortionary need to
be weaned out, for an undiscerning, uncontrolled and opaque growth of subsidies
can be deleterious for a country's public finances.
Subsidy, a direct or indirect payment, economic concession, or privilege
granted by a government to private firms, households, or other governmental
units in order to promote a public objective.
In the context of their economic effects, subsidies have been subjected to an
intense debate in India in recent years. Issues like the distortionary effects of
agricultural subsidies on the cropping pattern, their impact on inter-regional
disparities in development, the sub-optimal use of scarce inputs like water and
power induced by subsidies, and whether subsidies lead to systemic
inefficiencies have been examined at length. Inadequate targeting of subsidies
has especially been picked up for discussion.
Department of Economic Affairs (Ministry of Finance) in 1997, aims to
provide a comprehensive estimate of budget-based subsidies in India. In addition,
recent trends have been included from the Economic Survey for the year 2004-
05. Attention is focused on bringing out the magnitude of the implicit subsidies,
in addition to the explicit ones, to form an idea as to how heavy a draft do they
constitute on the fiscal resources of the economy.
A subsidy is a form of financial aid or support extended to an economic
sector (or institution, business, or individual) generally with the aim of promoting
economic and social policy. Although commonly extended from government, the
term subsidy can relate to any type of support – for example from NGOs or as
implicit subsidies. Subsidies come in various forms including: direct (cash
grants, interest-free loans) and indirect (tax breaks, insurance, low-interest loans,
accelerated depreciation, rent rebates).
Furthermore, they can be broad or narrow, legal or illegal, ethical or
unethical. The most common forms of subsidies are those to the producer or the
consumer. Producer/production subsidies ensure producers are better off by
either supplying market price support, direct support, or payments to factors of
production. Consumer/consumption subsidies commonly reduce the price of
goods and services to the consumer.

Subsidies are implemented through a variety of financial techniques, such

as -
(1) direct payments in cash or kind
(2) governmental provision of goods or services at prices below the normal
market price
(3) governmental purchase of goods or services at prices in excess of the
market price
(4) tax concessions and similar inducements.

In addition, there are numerous governmental policies that have subsidy

effects, such as regulatory statutes that soften the full force of competition,
policies that require the purchase of goods from favoured producers or nations,
and protective wage and price legislation.

Subsidy help in making basic necessities affordable to poor people through

extension of consumer services and to prepare a foundation of various economic
sectors in which private sector can participate later. When economy is at lower
stages of development, it is often unviable and unaffordable for private sector to
step in production. This is mainly because there are limited resources with
private investors and there are informational externalities/uncertainties. In such
case government do handholding by supporting private sector by extending
subsidies and withdrawing them when private sector becomes competitive.
Subsidies should be aimed at specific development objectives. On achievement
of these objectives subsidies should be phased out. It is only then that subsidies
can go well with an undistorted market economy.

However, in a democracy, subsidy once extended becomes a politically

sensitive issue and governments suffer huge political risk if they phase out such
subsidies. Overtime, new subsidies are extended which pile up on older ones and
they soon consume scarce revenue resources of government. This takes a heavy
toll on other expenditure of the government. They are forced to cut allocation to
developmental and infrastructure avenues. Further, higher subsidy expenditure
pushes up fiscal and revenue deficits as government starts spending more than it
earns. This fiscal deficit can be closed preferably by raising more revenue
through new taxes (proactively) or by borrowing money. Further, if government
is unable to borrow money or to raise taxes, it will have to print new currency to
finance deficits, which increases money supply in the economy. This creates
inflationary trends in economy. Incoherent subsidy regime unintendedly does
more harm than good for the cause it stands socio-economic development.

There are many forms of subsidies given out by the government. Two of
the most common types of individual subsidies are welfare payments
and unemployment benefits. The objective of these types of subsidies is to help
people who are temporarily suffering economically. Other subsidies, such
as student loans, are given to encourage people to further their
education. Subsidies to businesses are given to support an industry that is
struggling against international competition that has lowered prices, such that the
domestic business is not profitable without the subsidy. Historically, the vast
majority of subsidies in the United States have gone towards four industries:
agriculture, financial institutions, oil companies and utilities companies.
 Subsidies are one of the quintessential attributes of any welfare state.
India, at the eve of independence was left with uphill task of socio-economic
development. Markets were almost nonexistence, masses lived in abject
poverty and illiteracy, we were not producing enough food to satiate hunger
of masses, life expectancy was just 32 years; in short, there was crisis in
every sphere; be it agriculture, industry, health or education; partly due to
colonial legacy. Given such circumstances, founding fathers of democratic
India rightly envisaged Indian state to be a welfare state. However, 70 years
down the line only few problems have abated, while new ones cropped up
and poverty still stubbornly remains a pressing problem.

In this context, latest economic survey rightly points out that despite
spending as high as 3.77 lakh crore rupees annually on subsidies there is no
‘transformational impact’ on standard of living of masses. While subsidies
have helped some poor people to do firefighting in life, main allegation on a
subsidy economy is that, through subsidies, money meant for poorest is
appropriated by richer sections of the society due to mistargeting and
leakages.
 The following table shows financial size of the social security subsidies in
India funded by the Union government of India. The social security subsidies
offered by various state governments is estimated to be above Rs. 600 billion
(US$10 billion). Thus, total subsidies become Rs. 3,600 billion (US$60 billion).
 Chapter - II
SUBSIDY: MEANING AND ECONOMIC RATIONALE
2.1: Meaning
A subsidy is a benefit given to an individual, business or institution, usually
by the government. It is usually in the form of a cash payment or a tax reduction.
The subsidy is typically given to remove some type of burden, and it is often
considered to be in the overall interest of the public, given to promote a social
good or an economic policy.

A subsidy takes the form of a payment, provided directly or indirectly,

which provides a concession to the receiving individual or business entity.
Subsidies are generally seen as a privileged type of financial aid, as they lessen
an associated burden that was previously levied against the receiver or promote a
particular action by providing financial support.

A subsidy typically supports particular sectors of a nation’s economy. It can

assist struggling industries by lowering the burdens placed on them, or encourage
new developments by providing financial support for the endeavours. Often,
these areas are not being effectively supported through the actions of the general
economy or may be undercut by activities in rival economies.

2.2: Objectives

Subsidies, by means of creating a wedge between consumer prices and

producer costs, lead to changes in demand/ supply decisions. Subsidies are often
aimed at:

1. Inducing higher consumption/ production

2. Offsetting market imperfections including internalisation of externalities;
 3. Achievement of social policy objectives including redistribution of income,
population control, etc.

2.3: Transfers and Subsidies

Transfers which are straight income supplements need to be distinguished
from subsidies. An unconditional transfer to an individual would augment his
income and would be distributed over the entire range of his expenditures. A
subsidy however refers to a specific good, the relative price of which has been
lowered because of the subsidy with a view to changing the consumption/
allocation decisions in favour of the subsidised goods. Even when subsidy is
hundred percent, i.e. the good is supplied free of cost, it should be distinguished
from an income-transfer (of an equivalent amount) which need not be spent
exclusively on the subsidised good.
Transfers may be preferred to subsidies on the ground that,
i) any given expenditure of State funds will increase welfare more if it is
given as an income-transfer rather than via subsidising the price of some
commodities
ii) transfer payments can be better targeted at a specific income groups as
compared to free or subsidised goods
2.4: Direct vs Indirect Subsidies
 Direct subsidies are those that involve an actual payment of funds toward a
particular individual, group or industry.
 Indirect subsidies are those that do not hold a predetermined monetary
value or involved actual cash outlays. They can include activities such as
price reductions for required goods or services that can be government-
supported. This allows the needed items to be purchased below the
current market rate, resulting in a savings for those the subsidy is designed
to help.

2.5: Mode of administering a subsidy

The various alternative modes of administering a subsidy are:

1. Subsidy to producers

2. Subsidy to consumers
3. Subsidy to producers of inputs
4. Providing Incentives Instead of Subsidising
5. Production/sales through public enterprises
6. Cross subsidisation

2.6: Subsidy targeting

Subsidies can be distributed among individuals according to a set of

selected criteria, e.g. merit, income-level, social group etc. two types of errors
arise if proper targeting is not done, i.e. exclusion errors and inclusion errors. In
the former case, some of those who deserve to receive a subsidy are excluded,
and in the latter case, some of those who do not deserve to receive subsidy get
included in the subsidy programme.

2.7: Effects of subsidies

Economic effects of subsidies can be broadly grouped into

1. Allocative effects: these relate to the sectoral allocation of resources.

Subsidies help draw more resources towards the subsidised sector
2. Redistributive effects: these generally depend upon the elasticities of
demands of the relevant groups for the subsidised good as well as the
elasticity of supply of the same good and the mode of administering the
subsidy.
3. Fiscal effects: subsidies have obvious fiscal effects since a large part of
subsidies emanate from the budget. They directly increase fiscal deficits.
Subsidies may also indirectly affect the budget adversely by drawing
resources away from tax-yielding sectors towards sectors that may have a
low tax-revenue potential.
4. Trade effects: a regulated price, which is substantially lower than the
market clearing price, may reduce domestic supply and lead to an increase
in imports. On the other hand, subsidies to domestic producers may enable
them to offer internationally competitive prices, reducing imports or raising
exports.

Subsidies may also lead to perverse or unintended economic effects. They

would result in inefficient resource allocation if imposed on a competitive market
or where market imperfections do not justify a subsidy, by diverting economic
resources away from areas where their marginal productivity would be higher.
Generalised subsidies waste resources; further, they may have perverse
distributional effects endowing greater benefits on the better off people. For
example, a price control may lead to lower production and shortages and thus
generate black markets resulting in profits to operators in such markets
and economic rents to privileged people who have access to the distribution of
the good concerned at the controlled price.
Subsidies have a tendency to self-perpetuate. They create vested interests and
acquire political hues. In addition, it is difficult to control the incidence of a
subsidy since their effects are transmitted through the mechanism of the market,
which often has imperfections other than those addressed by the subsidy. On 29
June 2012, C Rangarajan, Chairman of the Prime Minister's Advisory Council in
view of present difficult economic position, advocated cutting down of fuel and
fertiliser subsidies to keep the fiscal deficit within the budgeted level of 5.1 per
cent.
 Chapter - III
TYPES OF SUBSIDIES IN INDIA
The Indian government has, since independence, subsidised many
industries and products, from fuel to food. Loss-making state-owned enterprises
are assisted by the government and farmers are given access to free electricity.
Overall, a 2005 article by International Herald Tribune stated that subsidies
amounted to 14% of GDP. As much as 39% of subsidised kerosene is stolen. On
the other hand, India spends relatively little on education, health, or
infrastructure.
Types of subsidies in India
3.1:Grants and other direct payments

The most basic form of a subsidy, and the one that still defines a subsidy in
some dictionaries, is a cash payment or grant. Although few grants are paid out
in currency any more (most are paid via cheque or bank transfer), it is still
common to refer to them as "cash" grants, payments or subsidies. Normally, a
grant refers to a time-limited payment, either in connection with a specific
investment, or to enable an individual, company or organization to cover some or
all of its general costs, or costs of undertaking a specific activity, such as
research.
Other direct payments may be linked to the volume of production or sales.
In previous centuries, and still in Australia, these types of subsidies were called
bounties. They are far from archaic, however. In some states of the United States,
for example, companies producing liquid biofuels receive direct subsidies for
every gallon of ethanol they produce. Cash payments to producers are also
sometimes linked to prices. The main form is a deficiency payment, which makes
up the difference between a target price for a good (typically an agricultural
commodity) and the actual price received in the market.
Various cash subsidies are paid to workers. Canada, for example, provides
targeted wage subsidies to assist individuals to prepare for, obtain and maintain
employment. Many countries provide grants in order to encourage people who
are out of work to undergo training in new skills, or to relocate.
Consumers also benefit from direct payments or vouchers, particularly for
the purchase of necessities, like food, medicine or heating fuels. Alternatively, a
government may regulate the consumer price for a good or service, and instead
pay a subsidy to the supplier of that good or service, to cover its losses.

3.2: Tax concessions

In countries with well-developed tax systems, subsidies provided by
reducing companies' tax burdens are commonplace. Examples include tax
exemptions (when a tax is not paid), tax credits (which reduce a tax otherwise
due), tax deferrals (which delay the payment of a tax) and a host of other
instruments. In common language these preferential tax treatments are called tax
breaks or tax concessions; public-finance economists refer to them as tax
expenditures. They should not, however, be confused with general tax
reductions. Generally, when a government provides a tax break its budget is
affected in much the same way as if it had spent some of its own money. The
exception is a tax credit, which is worth more to a corporate recipient (and costs
a government more) than a direct payment of an equivalent nominal value, as a
direct payment raises a company's taxable income and therefore is itself taxable.
Besides adding complexity to tax systems, tax concessions are often
criticized by economists as being less transparent than grants, and more resistant
to change. Several national governments, and even a few sub-national
governments, produce annual tax expenditure budgets. But the information
contained in these "budgets" is often reported at a highly aggregate level.
Information on the value of tax breaks received by particular industries or
companies is usually much more difficult to find.
When creating a new tax break, lawmakers sometimes set a limit on how
long it may be used. But many tax breaks, once incorporated into the tax code,
continue indefinitely. In contrast with a grant or similar subsidy, which has to be
re-approved with each budget cycle, a tax break requires an active decision by
lawmakers to eliminate it.

3.3: In-kind subsidies

The phrase "in-kind" means provided in a form other than money. Typical
in-kind benefits provided by governments are subsidized housing, specific
infrastructure (like a road servicing a single mine or factory), the services
required to maintain that infrastructure, and various services to help exporters.
They may be considered subsidies if they involve expenditure (or foregone
revenue) by a government and they confer a specific benefit on the recipient.
However, government provision of general infrastructure - e.g., highways and
ports - is often excluded from the definition of an in-kind subsidy, as is the case
in the WTO's general agreement on subsidies, the Agreement on Subsidies and
Countervailing Measures.
The value of an in-kind benefit depends on the price charged for the
resource, good or service. When a government undercharges for something, the
unit subsidy is usually considered equal to the difference between the price paid
and the market price. When it charges a market price, the transaction is
considered commercial, and not a subsidy. Often, however, the government is a
monopoly supplier of a good or service - i.e., there is no private market against
which the government's prices can be compared - which increases significantly
the difficulty of determining whether a subsidy is involved.
 One important variant of an in-kind subsidy is privileged access to a
government-owned or controlled natural resource. Primary industries benefit
greatly from such access - e.g., to public lands for mining or grazing livestock, to
state forests for logging, to rivers for irrigation, and to foreign seas (through so-
called "access agreements") for fishing - for free or at a below-market price.
International disputes over the subsidy element of privileged access to natural
resources have been among the most contentious and long-running.

3.4: Cross subsidies

A cross subsidy is a market transfer induced by discriminatory pricing
practices within the scope of the same enterprise or agency. Typically, it exists
when a government-owned enterprise, such as a public utility, uses revenues
collected in one market segment to reduce prices charged for goods in another.
Some definitions also include similar practices carried out by private firms, as
when an integrated airline allocates part of the costs of its activities in a highly
contested geographical or product market (e.g., the transport of freight) to
another market (e.g., passenger transport) that is better able to bear those costs.
For example, some airports cross-subsidize costs associated with serving airline
passengers through sales on duty-free goods.
One of the most common forms of cross subsidy is that between consumers
of electricity and consumers of irrigation water. Managers of large hydro-electric
works that store and channel water for irrigation as well as generate electricity
have to decide how to allocate the costs that are common to both activities
(notably, the construction and maintenance of the dam and reservoir) between
farmers and buyers of electricity. Government regulations will often dictate that
an even smaller portion of the costs be allocated to irrigation than would be
efficient according to established pricing principles.
 Not all instances of price discrimination are evidence of cross subsidies,
however. For example, differences in the volume (if there are economies of scale
in delivery) and interruptibility of service, among other factors, can lead to
different price schedules for different classes of customers.

3.5: Credit subsidies and government guarantees

Many subsidies that have budgetary implications - that is, can create
financial obligations for governments in the long run - never actually appear in
budgetary statements. These "hidden" subsidies are common whenever a
government takes on the role of a banker or insurer to a company or industry.
When a government loans money to a company at a lower rate of interest than a
commercial bank would offer, or requires less collateral to back up its loan,
defers repayment or allows for a longer period to pay off the loan, the company
saves money.
Governments also sometimes guarantee loans taken out by companies or
individuals through commercial banks. That means that the government assumes
the risk of default on the loan, rather than the bank, which in turn means that the
bank can offer the borrower more favourable lending terms, such as a lower rate
of interest.
Governments also serve as an insurer of last resort for private investments.
All OECD governments with nuclear power plants, for example, are signatories
to an agreement that limits the financial liability of power-plant owners in the
event of a catastrophic accident. Similarly, many governments would be stuck
with part of the bill following the failure of a large hydro-electric dam. For this
type of support, years may pass before a government incurs any actual costs. But
when an accident does occur, the financial burden (not to mention human cost)
can be huge.

3.6: Hybrid subsidies

Economic systems can be likened to ecological systems. In the steaming
jungle that defines the borderland between private industry and government,
camouflage and parasitism are common adaptive responses to competition.
Subsidy hybrids, particularly instruments that exploit the tax system to lower the
costs of private investment, are an inevitable result of those evolutionary forces.
At the base of the evolutionary ladder are tax-free government bonds. A
bond is a financial instrument that promises its holder a fixed annual dividend
over a specified period of time, typically 10 to 20 years. National governments
issue bonds to help finance their general activities. Municipalities, sub-national
governments and their agencies (e.g., air-pollution control districts) also issue
bonds, more commonly tied to specific projects, like water-treatment plants. The
dividends paid to holders of such bonds are not taxed. Since tax-free status raises
the net return on investment, particularly for bond holders in high marginal
income-tax brackets, the bonds can offer a lower rate of interest than would have
to be offered to buyers of private, commercial bonds in the same risk category.
Tax-free bonds are used also in some places to finance private investment:
a corporation borrows money from a private lender, the bond buyer, which is
issued by a public authority to become tax free.
Higher up the evolutionary ladder are instruments like tax increment
financing (TIF), a peculiar form of subsidy found in the United States. Tax-
increment financing enables a city to split off future additional property tax
revenues associated with a designated development and to provide a loan to the
company undertaking that development, using the future incremental tax
revenues as collateral. In effect, this revenue stream is diverted away from
normal property tax uses, such as the funding of schools, and into the TIF
district.

3.7: Derivative subsidies

Subsidies have a tendency to beget other subsidies. Some of these are
described below:
Sympathetic support: When support is used to influence the direction of
technological developments, it often does so in a manner designed to benefit
domestic producers. Many examples of this can be found in the energy sector,
such as when governments support the construction of coal-fired "demonstration"
power plants that are dependent on coal from high-cost domestic mines rather
than on imported coal, or for biofuel refineries that use domestic feedstocks.
Compensatory or countervailing support: When support leads to higher
input prices for downstream consumers, especially those that derive a significant
proportion of their sales from exports, compensation is often provided in order to
keep them buying domestically produced raw materials. Subsidies to food
processing industries and to biofuel producers are common examples.
Subsidy clusters: As the subsidy expert Doug Koplow has observed, when
support -or failure to consider opportunity costs - leads to lower prices for natural
resources, a chain reaction can take place, whereby new investment occurs to
take advantage of the cheap input. Often downstream consumers receive
additional incentives from governments to do so. Hence aluminum plants are
attracted to major hydroelectric projects, which are then followed by airframe
manufacturers, and so forth.
Taken together, these derivative subsidy forms lend support to the notion that bad
subsidies tend to chase out good ones - what the agricultural economist C. Ford
Runge has called "Gresham's law of subsidies". Political economy also suggests
that the "good" subsidies will over time be politically outmaneuvered by the
established groups to redirect public spending to themselves.

3.8: Subsidies through government procurement

The WTO Agreement on Subsidies and Countervailing Measures (ASCM)
recognizes that a subsidy can exist when a government purchases goods "and a
benefit is thereby conferred." The benefits the drafters of the ASCM had in mind
were those resulting from purchases that take place under circumstances that do
not accurately reflect normal market conditions.
Governments practice preferential purchasing routinely, expressly
favouring domestic over foreign suppliers of similar-quality goods - e.g., by
paying domestic suppliers higher prices or offering special financing
arrangements. The conflict of interest faced by governments is understandable.
They are expected by taxpayers to be savvy buyers but are also under constant
pressure to support domestic producers.
The magnitude of government procurement is enormous. A study from
2000 estimated that each year OECD countries spend USD 4, 733 billion
procuring goods and services, particularly for state-run health services, public
works, and the military. Much of these purchases are made at market prices, but
it is believed that a significant fraction of them include an element of subsidy.
The WTO has been trying to establish ground rules for government
procurement since the 1980s. The latest rules are set out in the Agreement on
Government Procurement (AGP), signed in 1994. Being a "plurilateral"
agreement it applies only to its signatories, which are mainly OECD economies.
By establishing recommended procedures for tendering, negotiating and
awarding government contracts, it outlines a desirable system of government
procurement. However, monitoring and enforcement of the AGP is weak, and
there are many ways in which governments can bypass its disciplines, such as by
excluding certain types of purchases (e.g., for the military) or setting thresholds -
higher than the lower limits contained in the Agreement itself - below which the
AGP does not apply.

3.9: Market price support

Transfers of money to producers are typically divided into two broad
categories: those provided at a cost to government, such as grants and tax
concessions, and those provided through the market as a result of policies that
raise prices artificially. The latter, called market price support (MPS), may derive
from a domestic price intervention (for example, a minimum-price policy), and is
usually supported by foreign trade barriers such as a tariff or quantitative
restriction on imports. The OECD defines MPS formally (for agriculture) as "an
indicator of the annual monetary value of gross transfers from consumers and
taxpayers to agricultural producers arising from policy measures creating a gap
between domestic producer prices and reference prices of a specific agricultural
commodity measured at the farm-gate level."
MPS is an element that is included in many studies of support to particular
goods or sectors and is added together with other subsidies to yield an estimate of
total support. The concept of market price support is simple enough. By
maintaining an import tariff on a good, for example, a government raises the
price of that good above what it could sell at in the absence of the tariff. From the
producers' standpoint, the revenues they will receive would be similar to those
they would receive were the government instead to pay them an equivalent
premium per unit produced. The main difference is that MPS raises domestic
prices and may therefore dampen demand compared with a budget-financed price
premium, especially if there are close substitutes that, as a result of raising the
price of the targeted good, become relatively cheaper. In such situations, such as
for coal for power generation, governments have sometimes solved the problem
of changed relative prices by constraining the ability of consumers to shift to the
competing product.
From the government's perspective, the advantage of providing support
indirectly, through a market intervention, is that it is less transparent, and the
transfers do not appear in its budget. Rather than taxpayers, consumers bear the
burden. For this reason, MPS is considered by economists to be one of the most
market-distorting forms of support provided through government policies.
Unfortunately, it is also still one of the largest elements of total support,
especially in agriculture.
(Subsidies as a % of total Subsidies)
 Chapter - IV
SUBSIDIES LED DISTORTION IN INDIA
4.1: Energy- Groundwater nexus: Agriculture sector is perhaps having most
justifiable claim on subsidized inputs given the dismal situation of the farmers in
the country. On these lines, water and electricity for 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. Owing to this, in large parts of India,
groundwater is being extracted indiscriminately as electric pump consume
electricity that is almost free of cost. This has led to dramatic fall in groundwater
levels. Wells have gone dry at numerous places. Water extracted from deep earth
often gets contaminated by arsenic mineral. This, together with erratic monsoon
due to climate change, has pushed rural India in deep distress.
To remedy this problem, government has plans to separate agriculture feeder
network from rest, under Deen Dayal Upadhyay Gram Jyoti Yojna. This separate
agriculture feeder will supply electricity only for a few hours a day. This was
first tried by Gujarat and results were encouraging as it had role in making
Gujarat a power surplus state, along with arresting continuous decline in
groundwater levels.

4.2: Subsidized fertilisers: Nutrient Based Subsidy or NBS was introduced in

2010 with objective to promote balanced use of fertilizers and to limit fertilizer
subsidy of the government. Idea was to fix subsidy as per nutrients (in per Kg) in
the fertilizer and leave the determination of price to suppliers. Presently Urea is
not covered under the scheme due to political compulsions. Consequently,
subsidized price of Urea remained stagnant even when real costs of production
have risen significantly. On the other hand, 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.
Secondary and Micronutrients are also covered under the scheme. As a result,
actual use of NPK is in ratio of around 8:3:1 while recommended use is 4:2:1.
This additional use of urea doesn’t give any additional benefit to the farmer.
Instead this can degrade soil and harm crop. Productivity and quality of a crop
depends upon use of diversified mix of macro and micronutrients, which vary
from soil to soil. While urea consumption has increased from 59 per cent to 66
per cent of total consumption in 2012-13 over 2010-11, per hectare consumption
of fertilizer has declined from 140 kg to 128 kg over the same period.
Fertilizer subsidy was `67,971 core in 2013-14, an increase of 11 per cent over
2009-10. Large part of this went to production and consumption of urea that was
not needed at all.
Also, due to excessive use of fertilizers groundwater is also getting polluted and
chemical bioaccumulation problem is impacting health of people.
Apart from Urea, farmer is not even getting benefit due from NBS in case
of subsidized potassium and phosphorus. Subsidy is provided to manufacturers,
who in turn are responsible to pass this subsidy to farmers in form of reduced
retail prices. Rather, manufacturers have increased their prices forming a cartel
and have usurped subsidy meant for farmers. It’s only now that Ministry of
Chemicals and Fertilizers has undertaken review of prices charged by registered
manufacturers. It has plans to penalize and cancel registration wrongdoers.
Another mistargeting of fertilizer is that most of this is consumed by rich
farmers of Punjab, Haryana and North West Uttar Pradesh. Uptake of fertilizers
depends a lot on sufficient supply of water to the crop. As about 60% of total
cultivated area of India is rain fed, subsidy is cornered overwhelmingly by well
irrigated states.

4.3:Cultivation of wheat, Rice and sugarcane at cost of pulses, horticulture

crops and coarse but nutritious grains:
Consumption patterns in India are shifting rapidly from calorie rich diet to
protein and vitamin rich one. Despite this, protein-based diet in India is
abnormally expensive. Main source of protein for Indian masses is pulses. Last
whole year there was clamour on the issue of skyrocketing prices of pulses.
India’s subsidy regime had its hand behind this problem.
Pulses are most suitable to be grown in areas of Maharashtra and Madhya
Pradesh, yet large parts of these areas are under cultivation of sugarcane.
Sugarcane due to high ‘fair and remunerative price’ is being sown in these areas.
This create two problems – one, it deprives Indians of their source of protein;
two, these areas are water deficit and sugarcane is water guzzling crop. This crop
is sucking scarce water rapidly and when monsoon failed again this time, mainly
in Marathwada; farmer had no way to escape.
Ironically, pulses are water efficient crops with capacity to rejuvenate soil
by process of nitrogen fixing and farmer chooses crop like sugarcane which later
proves to be a gross liability for him. Sugarcane is suitable to be grown in areas
of Bihar and Bengal given abundant water, but it is not due to lack of electricity
and irrigation.
Similar is the case for cultivation of Wheat and Rice. These two crops yield
much larger quantity (about 5 times) per acre/hectare than crops like pulses.
Higher MSP for pulses is not so high to make whole value of produce more
remunerative for farmer. So, he prefers conventional grains. This has led to huge
stockpile of wheat and rice (40-50 million tons) in government inventory which
decays and is carried forward at cost of Rs 5/ year. On the other hand, India has
to import more than 25% of its consumption of pulses.

4.4: Railways: Subsidization and Cross- subsidization – Between 1993 and

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. It’s only natural that railway has failed to expand capacity and
improve quality to serve needs of booming Indian economy. When British left
India had network of 52000 Kms, which now increased to measly 64000 Km.
Apart from this, freight carriers of railways are even more uncompetitive,
because railway subsidizes passenger fare further by charging higher freight
charges. Accordingly, in 1970’s freight used to contribute 65% of railway
revenues and now it does only 33%. This is due to shifting of freight carriage
from rail to road transport, which much costlier, more polluting and more time
consuming. This has made our economy a lot more uncompetitive.

4.5: Agricultural Finance: Farmers are entitled to pre- harvest loan at 7%

interest rate. They are allowed further 3% subvention in case of timely payment.
Farmers can also take loan for post-harvest time against negotiable warehouse
receipt.
Economic survey notes three discrepancies in this subsidy. One, trend indicates
that amount for a single loan is increasing for most of these subsidized loans.
This means that more subsidies are going in favour of rich farmers. Two,
extension of subsidized credit is concentrated in last three months of the financial
year, which indicates that reluctant banks otherwise unable to meet priority
sector lending targets, desperately disburse loans to reach target at the end only.
It is unlikely that this way credit will reach to desirable party. Third, agriculture
credit is getting concentrated on peripheries of urban areas, which means that
money is being diverted to non-agricultural use.

4.6: Food inflation: Fact that India produces surplus food grains doesn’t mean
that these are available to consumers at cheaper prices. Rather, India till couple
of years back witnessed spiralling double digit inflation driven by expensive
food, even when world was reeling under deflation. This distortion is mainly due
to increasing input costs to farmer coupled with persistent increase in Minimum
Selling Price declared by government. This forces government’s agency FCI
(Food Corporation of India) to procure food grains in open ended manner. As a
result, government ends up procuring 25-33% of total food grains production in
the country. Apart from this, about 33% of food grains are captively consumed
by farmers. All this leaves just 33%-45% of total food grains for open market.
This. At times, culminates in an absurd situation, where there is shortage of
grains in open market which push prices upward and millions of tons of grains
stored in FCI (Food Corporation of India) go downs.
Few experts believe that entitlements under Food Security Act are sufficient only
to fulfil 50% of requirement of food grains for a household. For this 50%, there is
massive but inefficient storage and PDS system. This in many ways significantly
increases price of remaining 50% food grain need of households. So, a well-
intended system may be actually working counter to its stated goals.
 Chapter - V
TRENDS IN CENTRAL & STATE GOVT. SUBSIDIES

5.1:Trends in the subsidies given by Central Government

 The bulk of the Central Govts. subsidies arise on the provision of economic
services, which account for 88% of the total subsidies (10% on merit services
and 78% on non-merit).
 The recovery rates in the social and economic services are very low (around
10%).
 Subsidies on non-merit goods are more than five times those on merit
goods, which reflects on an unduly large and ill-directed subsidy regime.
 The bulk of subsidies on merit goods go for the construction of roads and
bridges, followed by elementary education and scientific research.
 Amongst non-merit services, the biggest recipients are industries and
agriculture and allied services.
 78% of subsidies which go for non-merit economic services are amenable
to economic pricing. Even if one allows for a part of these subsidies being
given in the interest of redistribution or provision of human needs, a
substantial part must be due to inefficiency costs of public provision of these
services and/or inessential input or output subsidies.
 Subsidies to Central Public Enterprises are estimated separately as the
excess of imputed return on the equity held and loans given by the central
government to these enterprises, over actual receipts in the form of dividends
and interests. Subsidy in this manner is calculated for each enterprise. They
are aggregated according to cognate groups.
5.2: Trends in the subsidies given by State Government

 Subsidies in social services and economic services both constitute half each
of the total subsidies given by the States.
 The proportion of merit subsidies is much higher in social services vis-à-vis
economic services.
 The overall recovery rate is 5.81% of the total cost (less than 2% in social
services and approx. 9% in economic services).
 There is a distinct tendency for the per capita subsidies to rise as the per
capita incomes rise.
 None of the 15 States spends more than 30-35% of total subsidies on merit
goods.
 The recovery rates for merit services show variation in a narrow band
whereas the largest variations are recorded for recovery rates for non-merit
economic services.
 The near zero surpluses for all services show that subsidies are mainly
financed by tax-revenues and borrowing in the States.
 More than one-fifth of non-merit social subsidies accrue to education,
sports and art & culture.
 In economic services, irrigation accounts for nearly a quarter of services
whereas power accounts for around 12%.
 Lastly, subsidies to States' public enterprises are large but recovery in the
form of interests and dividends is extremely low.
 Chapter - VI
METHODOLOGY FOR ESTIMATION OF SUBSIDIES IN INDIA
Alternative approaches and conventions have evolved regarding
measurement of the magnitude of subsidies. Two major conventions relate to
measurement through (i) budgets, and (ii) National Accounts. The latter
estimates comprise explicit subsidies, and certain direct payments to producers in
the private or public sectors (including compensation for operating losses for
public undertakings) that are treated as subsidies. This, however, does not
encompass all the implicit subsidies.

The estimates of budgetary subsidies are computed as the excess of the costs
of providing a service over the recoveries from that service. The costs have been
taken as the sum of:

1. Revenue expenditure on the concerned service

2. Annual depreciation on cumulative capital expenditure for the creation of
physical assets in the service;
3. Interest-cost (computed at the average rate of interest actually paid by the
respective governments) of cumulative capital expenditure, equity
investments in public enterprises, and loans given for the service concerned
including those to the public enterprises. The recoveries are the current
receipts from a service, which are usually in the form of user charges, fees,
interest receipts and dividends.
Mathematically, the subsidy (S) in a service is obtained by:

S = RX + (d + i) K + i(Z + L) - (RR + I + D)

Where:
RX = revenue expenditure on the service
L = sum of loans advanced for the service at the beginning of the period
K = sum of capital expenditure on the service excluding equity investment at the
beginning of the period.
Z = sum of equity and loans advanced to public enterprises classified within the
service category at the beginning of the period.
RR = revenue receipts from the service
I + D = interest, dividend and other revenue receipts from public enterprises
falling within the service category.
d = depreciation rate
i = interest rate

In the estimation of subsidies these governmental services are divided into

three groups:

Group1: all general services, secretariat expenses in social and economics

services, and expenditure on natural calamities are included in this subgroup.
Being public goods, these are financed out of taxation and are therefore not
included in the estimation of subsidies.

Group 2: it consists of services with strong externalities associated with them. In

the case of these services, it is arguable that even though the exclusion may be
possible, these ought to be treated as merit goods or near-public goods. The
provision of subsidies is most justified in this case. Near zero recovery rates in
these cases only indicate the societal judgments that these may be financed out of
tax-revenues.

Merit social services: elementary education, public health, sewerage and

sanitation, information and publicity, welfare of SC, ST's and OBC's, labour,
social welfare and nutrition etc.

Merit economic services: soil and water conservation, environmental forestry and
wildlife, agricultural research and education, flood control and drainage, roads
and bridges, space research, oceanographic research, other scientific research,
ecology and environment and meteorology.

Group 3: all the remaining services are clubbed under this head. In these cases,
consumption is rival and exclusion is possible, therefore cost-recovery is possible
through user charges. These services are regarded as non-merit services in the
estimation of subsidies.

The distinction between merit and non-merit services is based on the

perceived strong externalities associated with the merit services. However, it
does not imply that the subsidisation in their case needs to be hundred percent. In
addition, even if small recoveries are advocated for merit services, the issues
relating to the costs of their provision, leakages to non-target beneficiaries, and
their effectiveness in attaining the objectives for which they are provided, need to
be examined. It also does not mean that there are no externalities associated with
non-merit services, or that the subsidies associated with them should be
completely eliminated.
 Chapter – VII
BENEFIT & ISSUES OF SUBSIDIES IN INDIA

7.1: Benefit of subsidies

The relative distribution of the benefits of a subsidy may be studied with
respect to different classes or groups of beneficiaries such as consumers and
producers, as also between different classes of consumers and producers.

 In case of food subsidy, PDS (Public Distribution System) suffers from

considerable leakage and apart from a low coverage of poor; the magnitude of
benefit derived by the poor is very small.
 In case of electricity, the subsidy rates have been rising for both agriculture
and domestic sectors because the unit cost has been rising faster than the
relevant tariff-rate. Also, there is considerable variation in the level of per
capita electricity subsidy indicates that, in the richer States, the per capita
subsidy is substantially higher as compared to that in the poorer States.
 In case of public irrigation, water has a very high marginal productivity
when used in conjunction with HYV of seeds, chemical fertilisers, power and
other related inputs. It is the richer farmers who may derive relatively larger
benefits because of their capacity to use these allied inputs.
 Subsidies to elementary education form about half of the total subsidies on
general education. However, this is not true for all individual States: the share
of elementary education is lowest in the high income States and the highest in
the low income States (Goa, Punjab and West Bengal actually give higher
subsidies to secondary education than primary education). A negative
correlation between the level of per capita income and the share of subsidies
to elementary education is thus discernible. Most subsidies to higher
education accrue predominantly to the better-off sections of society as they
 have an overwhelming advantage in competing out prospective candidates
from the poorer sections in getting admission to courses that are characterised
by scarcity of seats.
 For subsidies of health, the greater emphasis on curative health care
expenditure often reflects a bias towards the better-off people whereas
preventive health care expenditure with much larger externalities would
clearly be of greater help to the economically weaker sections of the society.

7.2: Issues of Subsidies

Subsidies have increased in India for several reasons. In particular this
proliferation can be traced to 1) the expanse of governmental activities 2)
relatively weak determination of governments to recover costs from the
respective users of the subsidies, even when this may be desirable on economic
grounds, and 3) generally low efficiency levels of governmental activities.

In the context of their economic effects, subsidies have been subjected to an

intense debate in India in recent years. Some of the major issues that have
emerged in the literature are indicated below:

 Whether the magnitude and incidence of subsidies, explicit and implicit,

have spun out of control; their burden on government finances being
unbearable, and their cost being felt in terms of a decline of real public
investment in agriculture.
 Whether agricultural subsidies distort the cropping pattern and lead to inter-
regional disparities in development
 Whether general subsidies on scarce inputs like water and power have
distorted their optimal allocation
 Whether subsidies basically cover only inefficiencies in the provision of
governmental services
 Whether subsidies like (food subsidies) have a predominant urban bias
 Whether subsidies are mistargeted
 Whether subsidies have a deleterious effect on general economic growth of
sectors not covered by the subsidies
 Whether agricultural subsidies are biased against small and marginal
farmers
 How should government services be priced or recovery rates determined
 What is the impact of subsidies on the quality of environment and ecology.
 Chapter - VIII
EXPENDITURE ON SUBSIDY OF GOVT. (Budget 2018-19)
In the Union Budget 2018-19, presented in Loka Sabha on Thursday,
Finance Minister Arun Jaitley proposed a 15 per cent higher subsidies at Rs. 2.64
lakh core on food, fertilisers and petroleum products. The subsidy for the fiscal
year 2018-19 on food, petroleum and fertilisers is estimated at Rs. 2,64,335.65
cores in the last full budget presented by Mr. Jaitley before the 2019 general
elections.
As per the Revised Budget Estimates, the subsidy on these three categories
has been pegged at Rs. 2,29,715.67 cores for the ongoing fiscal year.
A sum of Rs. 1,69,323 cores have been allocated towards food subsidy for
2018-19, as against Rs. 1,40,281.69 cores in the Revised Estimate of the current
fiscal year.
The fertiliser subsidy has been raised to Rs. 70,079.85 cores for 2018-19,
compared with Revised Estimate of Rs. 64,973.5 cores in the current financial
year.
Under fertilisers, the government has set aside Rs. 44,989.5 cores in the
next fiscal year for the urea sector, as against Rs. 42,721.7 core allocations in this
fiscal.
The outlay on phosphatic and potassic (P&K) fertilisers under the Nutrient
Based Subsidy Scheme has been increased to Rs. 25,090.35 cores in the next
fiscal year, up from Rs. 22,251.8 cores in the current year.
The petroleum subsidy has been hiked to Rs. 24,932.8 cores for 2018-19,
which is up from estimated the Rs. 24,460.48 cores outlay for this fiscal year. Of
the allocation for the next fiscal, that for Liquified Petroleum Gas is at 20,377.80
cores and for kerosene the subsidy bill is Rs. 4,555 cores.
For 2017-18, LPG and kerosene subsidies have been pegged at Rs. 15,656.33
cores and Rs. 8,804.15 cores respectively.
Mr. Jaitley's focus has been on rural India and agriculture, perhaps with an
eye on electoral gains for the ruling party at the Centre next year.
For the Kharif agricultural output, the Minister increased the minimum
support price to one-and-a-half times the production cost, raising institutional
farm credit to Rs. 11 lakh cores in 2018-19 from Rs. 8.5 lakh core.
He also made a significant announcement of fiscal slippage with
implications for pushing inflation, revising upwards the government's fiscal
deficit target for 2017-18 to 3.5 per cent of the GDP, or the equivalent
of Rs. 5.95 lakh core. The higher target came in place of the 3.2 per cent for the
current fiscal announced earlier.
Mr. Jaitley further projected a fiscal deficit of 3.3 per cent of GDP for the
coming financial year.
Meanwhile, official data later on Thursday showed the Centre's fiscal
deficit for the first nine months of 2017-18 stood at 113.6 per cent -- Rs. 6.20
lakh core -- of the full year's target of Rs. 5.46 lakh core.
(Expenditures on Subsidies)
 CONCLUSION
The study brings to the fore the massive magnitude of subsidies in the
provision of economic and social services by the government. Even if merit
subsidies are set aside, the remaining subsidies alone amount to 10.7% of GDP,
comprising 3.8% and 6.9% of GDP, pertaining to Centre and State subsidies
respectively. The average all-India recovery rate for these non-merit
goods/services is just 10.3%, implying a subsidy rate of almost 90%.

The macroeconomic costs of unjustified subsidies are mirrored in persistent

large fiscal deficits and consequently higher interest rates. In addition, unduly
high levels of subsidisation reflected in corresponding low user charges produce
serious micro-economic distortions as well. Its prime manifestations include
excessive demand for subsidised services, distortions in relative prices and
misallocation of resources. These are discernible in the case of certain input-
based subsidies. These problems are further compounded where the subsidy
regime is plagued by leakages which ensure neither equity nor efficiency.
 SUGGESTION
There are a few different ways to evaluate the success of government
subsidies. Most economists consider a subsidy a failure if it fails to improve the
overall economy. Policymakers, however, might still consider it a success if it
helps achieve a different objective. Most subsidies are long-term failures in the
economic sense, but still achieve cultural or political goals.

Therefore, to achieve success reform should focus on:

 Reducing the overall scale of subsidies

 Making subsidies as transparent as possible
 Using subsidies for well-defined economic objectives
 Focusing subsidies to final goods and services with a view to maximising
their impact on the target population at minimum cost
 Instituting systems for periodic review of subsidies