Chapter 4 - Government Subsidies – Policy Perspectives

One of the most hotly debated topics in the contemporary world is about the

need and size of the subsidies offered by various Governments to their citizens.

It is pertinent to recall what President John F Kennedy, the youngest President

of the world’s most developed country US said in his inaugural address in 1961.

“To those peoples in the huts and villages across the globe struggling to break

the bonds of mass misery, we pledge our best efforts to help them help

themselves, for whatever period is required—not because the Communists may

be doing it, not because we seek their votes, but because it is right. If a free

society cannot help the many who are poor, it cannot save the few who are

rich.”161

The Oxford Dictionary162 defines subsidy as a sum of money granted from

public funds to help an industry or business to keep the price of a product or

service low or a sum of money granted to support an undertaking that is in the

public interest.

A subsidy, often viewed as the converse of the tax, is an instrument of fiscal

policy. Derived from the Latin word `subsidum’, a subsidy literally implies

coming to assistance from behind. The beneficial potential of a subsidy will be

161
See Speech at - http://www.bartleby.com/124/pres56.html
162
http://oxforddictionaries.com/definition/subsidy

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at its best when it is transparent, well targeted, and suitably designed for

practical implementation.

According to the WTO’s Agreement on Subsidies and Countervailing

Measures163 (SCM Agreement) the definition of subsidy contains three basic

elements:

i) A financial contribution,

ii) By a government, (or) any public body within the territory of a

member country, and

iii) Which confers a benefit.

All three of these elements must be satisfied in order for a subsidy to exist.

The SCM Agreement contains a list of measures that represent a financial

contribution e.g., grants, loans, equity infusions, loan guarantees, fiscal

incentives, the provision of goods and services and the purchase of goods and

services.

In order for a financial contribution to be a subsidy, it must be made by or at the

direction of a government or any public body within the territory of a member

country. Thus, the SCM Agreement applies not only to measures of national

163
http://www.wto.org/english/tratop_e/scm_e/subs_e.htm

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governments, but also to measures of sub-national governments and of such

public bodies as state owned companies.164

A financial contribution by a government is not a subsidy unless it confers a

“benefit”. In many cases as in the case of a cash grant, the existence of a

benefit and its valuation will be clear. In some cases, however, the issue of

benefit will be more complex. Although the SCM Agreement has provided

some guidelines to determine whether certain types of measures confer a

benefit, the issue of the meaning of “benefit” is not fully resolved.165

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

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

at166:

i) inducing higher consumption / production;

ii) offsetting market imperfections

iii) achievement of social policy objectives including redistribution

of income, population control, etc.

164
Id
165
See generally Anne Van Aaken & Jürgen Kurtz, ‘The Global Financial Crisis And International
Economic Law at http://www.cepr.org/meets/ltm/2407/AAKEN_KURTZ.pdf
166
http://en.wikipedia.org/wiki/Subsidies_in_India

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 4.1 Benefits of Subsidies

The Governments offer subsidies on education, health care, drinking water,

irrigation, electrical energy, petrol, diesel, kerosene, LPG, fertilizers, seed,

interest on bank loans, industrial incentives, food and nutrition. In addition,

there are a large number of hidden subsidies. Subsidies are justified on many

grounds, the chief among them being the sheer necessity of higher consumption

levels than what would be obtained on the basis of what a majority of the poor

can afford. Recently, when the global petroleum and fertilizer prices sky

rocketed disproportionate to the demand-supply gap, the Government of India

heavily subsidized these products, as passing the price increases to the people

was not possible because it would simply have been unaffordable for the

majority of people in the country.167

In addition, subsidies are sometimes justified for well-defined redistributive

objectives. Subsidies play a vital role in the economy of a country. A country

has various resources which are to be gainfully deployed for the benefit of the

population of the whole country. Subsidies are provided to ensure equitable

utilization of the resources for the people. Subsidy is money granted by a

Government to keep down the prices of commodities or services etc. As

subsidies may impact the prices of commodities they lead to changes in

demand/ supply decisions.

167
‘Reports on selected themes in natural resources development in Africa: Renewable energy
technologies (RETs) for poverty alleviation’ United Nations Economic And Social Council
Document No: ECA/SDD/CSD.3/5, 29 August 2003

122
A cash transfer to the citizens is an easily understandable form of a subsidy.

However, it also has many invisible forms. Thus, it may be hidden in reduced

tax-liability, low interest government loans or government equity participation.

If the government procures goods, such as food grains, at higher than market

prices or if it sells at lower than market prices, these amount to subsidizing.

The developed, developing and underdeveloped countries have various items of

subsidies. Developing countries like India provide subsidies for their population

for improving standards of living; the underdeveloped countries provide

subsidies for meeting bare minimum needs of the vast majority of the

population. Subsidies represent a sizeable proportion of the Central and State

Governments’ non-plan revenue expenditure. For properly appreciating the role

and importance of subsidies, it is important to understand why India needs

subsidies or why it should not? 168

No doubt, a developing country like India needs subsidies due to various

reasons. Providing minimum consumption entitlement to the poor by

subsidizing the items consumed by them is extremely important for the welfare

of the country. Providing free education or free or subsidized health care,

housing, electricity, drinking water etc. for deprived sections of the society is

the most essential part of social justice is an overriding concern in all welfare

states.

168
http://theviewspaper.net/does-india-really-need-subsidies/

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In the context of trade and business, subsidies have a tendency to hurt the

interests of other traders particularly in the area of international trade. The

tenets of free economy dictate fair play of forces of demand and supply.

However, countries at times resort to intervention measures to protect their

genuine economic interests. As long as such interventions are going to benefit

uniformly every enterprise or industry, they are welcome as they are useful and

necessary. Yet, they may be resisted by other affected parties particularly the

competing enterprises or industries of other countries giving rise to disputes.

These disputes need to be resolved to ensure the free flow of transactions of

trade and commerce across the countries.

4.1.1. Rationale behind Subsidies

Subsidies are a kind of incentive which plays an important role in economic

development of developing countries. Subsidies bring out desired changes by

effecting optimal allocation of resources, stabilizing the price of essential goods

and services, redistributing income in favour of poor people thus achieving the

twin objective of growth and equity of nation.

The general rationale for providing subsidies is169:

 Correcting market failures

169
Meeta K Mehra, Mayank Sinha and Sohini Sahu, ‘Trade-Related Subsidies – Bridging the
North-South Divide: An Indian Perspective’, 2004 International Institute for Sustainable
Development

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  Protecting national production from competition

 Reducing import dependence

 Encouraging national employment

 Ensuring balanced regional development

 Enabling access to and affordability of basic services or goods by all

 Stimulation of economic growth.

Subsidies are justified in the presence of positive externalities because in these

cases, consideration of social benefits would require higher level of

consumption than what would be obtained on the basis of private benefits only.

Subsidies as converse of an indirect tax constitute an important fiscal

instrument for modifying market determined outcomes. While taxes reduce

disposable income, subsidies inject money into circulation. Subsidies affect the

economy through the commodity market by lowering the relative price of the

subsidized commodity, thereby generating an increase in its demand.

With an indirect tax, the price of the taxed commodity increases, and the

quantity at which the market for that commodity is cleared, falls, other things

remaining the same. Taxes appear on the revenue side of government budgets,

and subsidies on the expenditure side.

125
India is perhaps the first country in the world which has taken upon itself the

responsibility for the economic and social welfare of the people by making it an

obligation under the Constitution of India. Chapter IV of the Constitution of

India170 dealing with the subject of Directive Principles of State Policy

mandates that:

Article 38 (1): The State shall strive to promote the welfare of the people by

securing and protecting as effectively as it may a social order in which justice,

social, economic and political, shall inform all the institutions of the national

life.

Article 38 (2): The State shall, in particular, strive to minimize the inequalities

in income, and endeavour to eliminate inequalities in status, facilities and

opportunities, not only amongst individuals but also amongst groups of people

residing in different areas or engaged in different vocations.

Article 39: The State shall, in particular, direct its policy towards securing—

(a) that the citizens, men and women equally, have the right to an

adequate means of livelihood;

(b) that the ownership and control of the material resources of the

community are so distributed as best to sub serve the common good;

170
http://indiacode.nic.in/coiweb/coifiles/p04.htm

126
 (c) that the operation of the economic system does not result in the

concentration of wealth and means of production to the common

detriment;

(d) that there is equal pay for equal work for both men and women.

State to secure a social order for the promotion of welfare of the people.

Article 41: The State shall, within the limits of its economic capacity and

development, make effective provision for securing the right to work, to

education and to public assistance in cases of unemployment, old age, sickness

and disablement, and in other cases of undeserved want.

Article 45: The State shall endeavour to provide early childhood care and

education for all children until they complete the age of six years.

Article 46: The State shall promote with special care the educational and

economic interests of the weaker sections of the people, and, in particular, of

the Scheduled Castes and the Scheduled Tribes, and shall protect them from

social injustice and all forms of exploitation.

Article 47: The State shall regard the raising of the level of nutrition and the

standard of living of its people and the improvement of public health as among

its primary duties and, in particular, the State shall endeavour to bring about

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prohibition of the consumption except for medicinal purposes of intoxicating

drinks and of drugs which are injurious to health.

4.1.2 Subsidies in the WTO Regime

The SCM Agreement of WTO classifies a subsidy as “specific” when it is

available only to an enterprise, industry, group of enterprises or group of

industries.171 Specific subsidies can be:

a) In the form of domestic support which need not be directly

related to exports, and

b) Subsidies that are tied to exports.

The SCM Agreement applies only to subsidies that are specifically provided to

an enterprise or industry or group of enterprises or industries and defines the

terms `subsidy’ and `specificity’.

SPECIFICITY

Assuming that a measure is a subsidy within the meaning of the WTO SCM

Agreement, nevertheless it is not subject to the SCM Agreement unless it has

been specifically provided to an enterprise or industry or group of these. The

basic principle is that a subsidy that distorts the allocation of resources within

171
See generally Santiago Ibáñez Marsilla, ‘Recent Stimulus Packages And WTO Law On
Subsidies’, [2009] World Customs Journal Vol. 3(2).

128
an economy should be subject to discipline. Where a subsidy is widely

available within an economy, such a distortion in the allocation of resources is

presumed not to occur. Thus, only “specific” subsidies are subject to SCM

Agreement disciplines. There are four types of “specificity” within the

meaning of the SCM Agreement.

• Enterprise-Specificity: A government targets a particular

company or companies for subsidization.

• Industry-Specificity: A government targets a particular sector or

sectors for subsidization.

• Regional-Specificity: A government targets producers in

specified parts of its territory for subsidization.

• Prohibited Subsidies: A government targets export goods or

goods using domestic inputs for subsidization.

Categories of Subsidies:

The SCM Agreement creates two basic categories of subsidies172:

i) those that are prohibited, and

ii) those that are actionable.

All specific subsidies fall into one of these categories.

172
Anwarul Hoda & Rajeev Ahuja, ‘Agreement On Subsidies And Countervailing Measures:
Need For Clarification And Improvement’ Working Paper No. 101 (2003) at
http://www.icrier.org/pdf/WP101.pdf

129
Prohibited Subsidies:

Two categories of subsidies are prohibited by the Article 3 of the SCM

Agreement. The first category consists of subsidies contingent on export

performance and are called “export subsidies”. The second category consists of

subsidies contingent upon the use of domestic over imported goods. These are

called as “local content subsidies”. These subsidies are prohibited because they

are designed to directly affect the trade and thus are most likely to have adverse

effects on the interests of other member countries.

These subsidies are given to recipients who meet certain export targets or use

domestic goods instead of imported goods. They are prohibited because they

distort international trade, and are, therefore, likely to hurt trade of other

member countries.

Prohibited subsidies can be challenged under the WTO Dispute Settlement

procedure where they are heard under an accelerated time table. If the dispute

settlement procedure confirms that the subsidy is prohibited, it must be

withdrawn immediately. Otherwise, the complaining member country can take

counter measures such as imposition of countervailing duty.

Actionable Subsidies:

Most subsidies, such as production subsidies, fall in the category of

“actionable” category. Actionable subsidies are not prohibited. However, they

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are subject to challenge in the event that they cause adverse effects. There are

three types of adverse effects.

First, there is injury to a domestic industry due to subsidized imports in the

territory of the complaining member. This is the sole basis for resorting to

countervailing action.

Second, there is serious prejudice arising as a result of adverse effects (e.g.,

export displacement) in the market of the subsidizing member or in the third

country market. Thus, unlike injury, it can serve as the basis for a complaint

related to harm to a member’s export interest.

Finally, there is nullification or impairment of benefits accruing where the

improved market access presumed to flow from a tariff reduction is undercut by

subsidization.

Conversely, the complaining country has to show that the subsidy has an

adverse effect on its interests. Otherwise, the subsidy is permitted. The SCM

Agreement defines three types of damages that can be caused by actionable

subsidies.173

173
See generally J.H.H. Weiler & Sungjoon Cho ‘International and Regional Trade Law: The Law
of the World Trade Organization’ at
http://centers.law.nyu.edu/jeanmonnet/wto/units/documents/WTO_2006_UnitXII_Dumpinga
ndSubsidies_Revised.pdf

131
 i) Products benefiting from subsidies in the exporting country

hurting domestic industry in the importing country;

ii) Subsidized products hurting rival exporters from another country

when the two countries compete in third markets; and

iii) Domestic subsidies hurting exporters of another country trying to

compete in the subsidizing country’s domestic market.

Transfers and Subsidies

Transfers which are straight income supplements needs 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 expenditure.

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 subsidized 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 subsidized 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 subsidizing the price

of some commodities, and

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 (ii) transfer payments can be better targeted at a specific income groups

as compared to free or subsidized goods.174

Exclusion errors and Inclusion errors:

Subsidies can be distributed among individuals according to a set of selected

criteria, e.g. 1) merit, 2) income-level, 3) 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.175

SUBSIDY BOXES (WTO terminology)176

In WTO terminology, subsidies in general are identified by boxes which are

given the colours of traffic lights; green (permitted); amber (slow down – i.e. to

be reduced) and red (forbidden).

In agriculture things are usually complicated. The Agriculture Agreement has

no “Red” box, although domestic support exceeding the reduction commitment

levels in the Amber box is prohibited. The Blue box stands for subsidies that

are tied to programmes that limit to production. There are also exemptions for

174
http://www.ndtvmi.com/b4/dopesheets/rahul.pdf
175
http://www.regulationbodyofknowledge.org/faq/socHigherIncomeCustomers/
176
http://www.wto.org/english/tratop_e/agric_e/agboxes_e.htm

133
developing countries and subsidies to these countries sometimes called an S&D

box.

Amber Box

All domestic support measures considered to distort production and trade, with

some exceptions, fall into the amber box. These include measures to support

prices, or subsidies directly related to production quantities. The total value of

measures must be reduced.

These supports are subject to limits. Minimal supports are allowed at 5% of

agricultural production for developed countries, 10% for developing countries.

30 WTO members that had larger subsidies than the prescribed limits have

committed to reduce these measures (subsidies).

Blue Box

This is the “amber box with conditions” – conditions designed to reduce

distortion. Any support that would normally be in the amber box is placed in

the blue box if the subsidy also requires farmers to limit production by

imposing production quotas.

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Green Box

All those subsidies (supports) that do not distort trade are placed in the green

box. Such subsidies have to be government-funded and must not involve price

support.

These categories of subsidies tend to be measures that are not targeted at

particular products and include direct income supports for farmers that are not

related to (decoupled from) current production levels or prices. They also

include environmental protection and regional development programmes.

Green box subsidies are, therefore, allowed without limits, provided they

comply with the WTO policy prescription.

4.1.3. Merits and Demerits of Subsidies

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.177

177
http://wapedia.mobi/en/Subsidies_in_India

135
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.

In India, as also elsewhere, subsidies now account for a significant part of

government’s expenditures although, like that of an iceberg, only their tip may

be visible. These implicit subsidies not only cause a considerable draft on the

already strained fiscal resources, but may also fail on the anvil of equity and

efficiency as has already been pointed out above.

On the face of it, therefore, there is absolutely nothing wrong in giving

subsidies on various items for various sections of population that are socially

and economically deprived. Indeed, as is made out in the Directive Principles of

State Policy of the Constitution of India, it is the bounden duty of the State to

provide free education, health care and food and nutrition to the people at

affordable cost. So, the social and economic compulsions determine the nature,

size and extent of subsidies.

The ideal situation is when the Government is able to provide everything free of

cost to its citizens. But it is not possible due to paucity of resources – both

financial and physical. The economic activity has to go on according to

universally accepted principles.

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Economic effects of Subsidies:

Economic effects of subsidies can be broadly grouped into

i) Allocative effects: these relate to the sectoral allocation of

resources. Subsidies help draw more resources towards the

subsidized sector.

ii) Redistributive effects: these generally depend upon the

elasticities of demands of the relevant groups for the subsidized

good as well as the elasticity of supply of the same good and the

mode of administering the subsidy.

iii) 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.

iv) 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.

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Ultimately, the primary sources of revenues to the Governments are taxes and

fees. There is a limit beyond which these cannot be resorted to. Similarly, there

is a limit beyond which the revenue deficit and the fiscal deficit of a

Government cannot go. One of the major allegations against the subsidy

system all over the world is that it is more a product of political compulsions

and opportunism rather than the economic and social compulsions.

Because of the increase in the political competition, each political party has

been trying to entice the people with many unfortunate types of bait. Some of

the political parties have even offered free colour TVs, free rice, free electricity,

free houses etc.

With every election, the list has been increasing and along with it the revenue

deficits and the fiscal deficits. The adverse impact of the fiscal deficits results in

the expansion of money supply leading to inflation.

There are consumptive subsidies and productive subsidies. As long as subsidies

have the positive effect of creating extra wealth and employment, they are

considered to be good. Offering subsidies for personal consumption on a long

term may not be very desirable.

The benefits can however be maximized only when the subsidies are

transparent, well targeted, and are so designed as to be effective in terms of

138
implementation without any leakages. It is often complained that the

Government is granting subsidies which do not reach their target groups and on

the other hand are manipulated by the rich. The whole issue of granting

subsidies or not has given rise to many questions which need to be answered by

the Government, economists and politicians as well. The subsidies in effect are

inverse of taxes.

Just as taxes increase the prices of the products taxed, subsidies reduce the price

of the product subsidized. And just as taxes increase a Government’s income,

subsidies reduce it. Hence, subsidies are sometimes called negative taxation.

There is a broad consensus that subsidies are not bad as long as they reach the

targeted groups and for a specific purpose and time. No Government can afford

to make its citizens dependent on it for each and every thing eternally. All these

subsidies have to be for a specific time intended to accomplish a particular

target. Otherwise, it will become untenable, as it is happening in India

presently.

In recognition of the growing concern over the increasing proportion of

subsidies both in absolute terms and as proportion to the gross domestic product

of the country, the Government of India had brought out a discussion paper in

the year 1997 on the subject of subsidies. The paper was widely discussed and

debated. The National Institute of Public Finance and Policy published a book

139
on “Budgetary Subsidies in India” in March 2003, the executive summary of

which is extracted below:

Government subsidies, which often remain hidden in the budgetary magnitudes,

were discussed at length in a Discussion Paper which the Government of India

brought out in May 1997 (DP 1997). This paper had considered the subsidy

regime in India as unduly large, non-transparent, largely input-based, poorly

targeted, generally regressive and inducing waste and misallocation of

resources. The present study revisits the issue of budgetary subsidies in India,

provides an estimate of the implicit budgetary subsidies for 1998-99, examines

recent trends, and discusses critical policy issues in the context of subsidies.

Meaning and Rationale

Goods and services provided by budgetary resources may be classified as

public and private goods. But there are many congestible goods in the

intermediate space. In a budgetary context, subsidies are taken as unrecovered

costs of public provision of goods that are not classified as public goods. These

are private goods or congestible goods where user charges can be levied either

according to individual consumers or according to groups of consumers. In

particular, the present study (as in DP 1997), focuses on governmental

provision of social and economic services.

Subsidies are justified in the presence of positive externalities because in these

cases social benefits require higher consumption levels than what would be

140
obtained on the basis of private benefits only. In addition, subsidies are

sometimes justified for well-defined redistributive objectives.

However, the financing of subsidies induces its own costs whether these are

financed through additional taxation or borrowing. The welfare gains of

subsidies should be matched against the costs of financing subsidies. Over-

subsidization could adversely affect allocation of resources and environment.

Subsidies in this study, as in the comparable previous studies including DP

1997, are measured as the excess of costs over receipts on relevant budgetary

heads in social and economic services. The costs are calculated as the sum of

current costs and annualized capital costs. The receipts comprise interest

receipts, dividends and other revenue receipts from user charges.

4.2. Subsidies in India

The reforms programme initiated by the Government of India in 1991 aimed at,

among other things, reducing fiscal imbalances and improving allocative

efficiency by minimizing the distortions in relative prices arising from

budgetary and fiscal imprudence. Containing and targeting subsidies constituted

an important element of reforms. Subsidies are the converse of indirect taxes

and are specific to goods and services. Subsidies are different from transfer

payments, which are straight income supplements to individuals, who are

141
normally the poor and the vulnerable. Providing minimum consumption

entitlement to the poor by subsidizing the items consumed by them is an

extremely important welfare dimension of fiscal policy. Subsidies can correct

for the under-consumption of goods with positive externalities. With the social

benefits of a particular service or commodity exceeding the aggregate of private

benefits to individual consumers, market solutions result in under-consumption

and subsidies can make the necessary correction. However, the benefits can be

maximised only when the subsidies are transparent, well targeted, and suitably

designed for effective implementation without any leakages.178

The size, incidence, allocation distortions, and recent upsurge in some subsidies

are the key issues in the context of budgetary subsidies in India. The main

issues pertaining to subsidies in India may be listed as179:

(i) are budgetary subsidies provided for the right reasons;

(ii) are many wrong goods/services being subsidised;

(iii) does over-subsidisation lead to harmful effects;

(iv) are subsidies too large relative to resources;

(v) what are the implications of cross-subsidies and off-budget

subsidies;

(vi) has there been an upsurge in some subsidies in recent years;

(vii) what are the implications of subsidising inputs;

178
Department of Economic Affairs, Ministry of Finance, ‘Central Government Subsidies In
India - A Report, (Prepared with the assistance of the National Institute of Public Finance &
Policy) December, 2004 at http://finmin.nic.in/reports/cgsi-2004.pdf
179
See generally Parthapratim Pal, ‘Current WTO Negotiations On Domestic Subsidies In
Agriculture: Implications For India’ at http://www.icrier.org/pdf/WP%20177.pdf

142
 (viii) is the subsidy regime in India regressive;

(ix) what is the interface of subsidies with inefficiencies;

(x) is there a case for increasing subsidies in some sectors; and

(xi) is there a need for distinguishing long-term subsidies from those that

should have a limited life?

Central Budgetary Estimates: Magnitudes and Trends

Aggregate central budgetary subsidies in 1998-99 were estimated to be Rs.

79828 crore, amounting to 4.59 percent of GDP at current market prices, and

constituting 53.40 percent of the net revenue receipts of the centre, which, as an

item, is the highest draft on revenue receipts as compared to estimates for

earlier years.

The central subsidies decreased from 4.25 percent of the GDP in 1994-95 to

3.49 percent of the GDP in 1996-97. Reversing the trend of a decline since

1994-95, they increased to 4.59 percent of GDP in 1998-99. Four reasons

account for the inordinate increase in the central budgetary subsidies in 1998-

99180:

(i) the impact of salary revisions in the wake of the recommendations

of the Fifth Central Pay Commission;

(ii) the deterioration of position of railways from a surplus sector into a

subsidy sector;

(iii) large increase in explicit subsidies of the centre; and

180
Id

143
 (iv) increase in other input costs unaccompanied by any improvement in

recovery rates. The explicit subsidies, especially in food have risen

sharply since 1996-97. 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.181

In the case of central subsidies, economic sector subsidies are nearly five and

half times as large as those for the social sector. Economic sectors arranged in

diminishing order of size of subsidies are: agriculture and allied services,

industry and minerals, energy, general economic services, and transport.

In the context of central subsidies, current costs dominate total costs in both

social and economic services, and more so in social services. The energy sector

is a notable exception where the capital costs have a much larger share.

Governments are prone to give subsidies for variety of activities, both for

boosting economic activity and for political compulsions. It is very often

noticed that ineligible people / groups get onto the bandwagon and eligible and

genuine ones are left out. Since they are not always linked to economic, social

and other platonic objectives, they tend to breed corruption, inefficiency and

181
Id

144
wastages in their implementation. Moreover, there would be tremendous

financial strain on the State exchequers. Therefore, there is need to have a

relook into subsidy issues in India.

In a study182 on the kerosene subsidy in India it was found that a major reform

and overhaul of the system of the subsidy was the need of the hour. The subsidy

was established during World War II and although it started as a distribution

scheme to consider shortages at that time it became a subsidy soon after and has

remained ever since. Although numerous attempts have been made for the

subsidy reform none have been implemented as yet. The study found that

subsidies become permanent if not efficiently implemented and also give rise to

corruption if not monitored well.

State Subsidies: Broad Trends

Budgetary subsidies of the state governments amounted to 8.96 per cent of the

GDP and about 90 percent of their revenue receipts. After adjustment for salary

arrears paid in 1998-99, the state budgetary subsidies are estimated at 8.47

percent of the GDP.

Relative to the GDP, aggregate budgetary subsidies of the state governments

have fallen in 1998-99 as compared to the earlier available estimates for 1994-

95. The recovery rate has also fallen. This can only be explained by a fall in

182
Dr. Bhamy V. Shenoy, ‘Lessons Learned from Attempts to Reform India’s Kerosene Subsidy’
March 2010, available at http://www.iisd.org/pdf/2010/lessons_india_kerosene_subsidy.pdf

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expenditure (relative to GDP), revenue and capital, allocated to social and

economic services in the State budgets.

Agriculture and irrigation sectors account for the largest share in the state

subsidies, followed by elementary education, energy, secondary education and

medical and public health.

For the special category states, subsidies relative to their GSDPs are extremely

high amounting to 22 percent for the larger special category states, and about 34

percent of their GSDPs for the smaller special category states.

Per capita state subsidies generally show a regressive pattern: the higher the per

capita income of a state, the higher are the per capita subsidies. Per capita

subsidies in the special category states are noticeably higher than those in the

general states.

The state public sector has drawn an implicit subsidy amounting to Rs. 9561

crore. The overall recovery rate in the state level public sector for the budget is

dismally low at 1.64 percent of the costs.183

183
See Prof. Suneel Gupta, ‘Subsidies in India’ at www.slideshare.net/avnishbajpai/subsidies-
in-india

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Per capita subsidies in education and health showed a regressive pattern where,

in comparative terms, low subsidies are available to residents of low income

states and vice-versa.

All India Subsidies184

In 1998-99, aggregate budgetary subsidies of the central and state governments

are estimated to be 13.54 percent of GDP at market prices, and 85.8 percent of

the combined revenue receipts of the centre and states. After adjustment done

for salary arrears paid in 1998-99, the aggregate all India subsidies are

estimated to be about 13 percent of GDP.

As compared to 1994-95, subsidies as percentage of GDP have virtually

remained unchanged. Although central subsidies have increased as percentage

of GDP, the state subsidies show a small fall. The relative share of the centre is

about one-third of the total subsidies, and that of the states, about two-thirds.

Agriculture, irrigation, energy, and industry and minerals have the highest

shares in that order, followed by elementary education.

Together, the public sector covering both central and state level public

enterprises, obtains a subsidy from the budget of an estimated amount of Rs.

20,540 crore which is a little more than one percent of GDP.

184
See generally Rishi Muni Dwivedi, ‘Subsidies in India,’ 2006, New Century Publications, pp.
430 pages

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Policy Issues

Cross-subsidies arise in the context of regulated price structures which

distinguish between prices according to use/products for the same group of

goods/services. Considerable cross-subsidies exist, for example, in the power

and, until recently, in the petroleum sectors.

There are many off-budget subsidies in the system. An important off-budget

subsidy in the petroleum sector has recently been brought on the budget.

Subsidies that arise due to guarantees extended by governments for loans taken

by the public enterprises are also off-budget subsidies. These have the potential

of becoming budgetary liabilities if there are defaults in loans guaranteed by the

government or if deficits and surpluses do not balance out as in the case of the

Oil Pool Account.

Subsidies often promote inefficiencies. For example, fertiliser subsidies

promote inefficiencies, and are ill-targeted. In general, administering subsidies

through inputs should be discouraged. In the case of fertiliser, presently the old

RPS system is being given up. After an adjustment period of five years,

fertiliser’s subsidies should be given up in their present form. At best, there

may be a case of subsidising small and marginal farmers to a limited extent.185

185
Vijay Paul Sharma & Hrima Thaker, ‘Fertilizer Subsidy in India: Who are the Beneficiaries?
W.P. No. 2009-07-01 at http://www.iimahd.ernet.in/publications/data/2009-07-01Sharma.pdf

148
In the case of food subsidies greater decentralisation can lead to efficiencies in

carrying and transportation costs, and delivery and targeting mechanism. A

well-designed two tier intervention can increase efficiencies and reduce

subsidies to the public distribution system, while providing for the food needs

of the BPL population better. Subsidisation of food, targeted towards the BPL

population, as a policy objective should be delinked from that of support

provided to agriculture. These objectives should be addressed through separate

policy instruments.186

Improving the quality of publicly provided services is crucial to persuading

users to pay higher charges. At the same time unit costs need to be reduced to

ensure full cost recovery, wherever desirable, and viable. Surplus employment

and other operational inefficiencies must be reduced.

Subsidy reforms must focus on selected sectors in the first instance which

would yield maximum results. In particular, attention can be focused on food

and fertiliser subsidies at the central level, and agriculture, irrigation, power,

industries, and transport sectors at the state level.

Increase in input costs depends significantly on market conditions and is almost

continuous. Increase in user charges should be synchronized with this in terms

of automatic periodic revisions. Autonomous bodies that can look after the

186
See P. S. George, ‘Costs and Benefits of Food Subsidies in India’ at
http://www.ifpri.org/sites/default/files/pubs/pubs/books/ppa88/ppa88ch16.pdf

149
interests of the users as well as service providers are needed to constantly

monitor the link between cost escalation and user charges.

The most alarming aspect of the surging subsidies is not the size, but the

manner and purpose of spending on them. Subsidies provided in India187 suffer

from both inclusion error (wrong kind of people benefiting) and exclusion error

(deserving people left out of subsidies). Efficient subsidies must be transparent,

targeted and-in any case should be for a limited period.

It is clear from this document that the issue is not about removing subsidies but

about how to make them effective so that they reach the target consumers and

people are benefited from it. The policy- makers should try out new-

mechanisms to reach the target consumers more effectively.

The Government has to work on arriving at a political and national consensus

on the subsidy issue. It is important that we restructure subsidies so that only

the really needy and the poor benefit from them and all leakages are plugged.

All subsidies should be targeted sharply at the poor and the truly needy like

small and marginal farmers, farm labour and urban poor.

187
D. K. Srivastava, C. Bhujanga Rao, Pinaki Chakraborty & T. S. Rangamannar, ‘Budgetary
Subsidies in India: Subsidising Social and Economic Services’ National Institute of Public
Finance and Policy, March 2003 at
http://planningcommission.nic.in/reports/sereport/ser/stdy_bgdsubs.pdf

150
Reforms can only be made in the subsidy system when the policy- makers,

politicians and economists will understand that the question is not whether to

subsidise or not, but who to subsidize and how.

It may be important to look at the following measures for effective utilization of

subsidies:

1. The focus should be on physical achievements and not on

financial disbursements.

2. The effects of subsidies should be monitorable and measurable in

terms of quality or quantity.

3. Subsidies should be given as a one-time help or for a short

period. Subsidies on continuing basis should be avoided.

4. The parameters fixed on subsidy should be transparent.

5. Subsidies should be cost- effective. Most of the assistance should

reach the intended beneficiary and very small amount should be

spent on administrative arrangements.

6. Subsidies should be properly targeted, i.e. benefit should go to

the really deserving.

7. Timing of subsidies should be made proper. For example, free

seed distribution should be just before sowing.

The first corrective steps were taken by the 12th Finance Commission headed

by Dr. C. Rangarajan. This Commission made a large number of

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recommendations for keeping the revenue and the fiscal deficits both of Central

and State Governments under control. They recommended a legislative frame

work for the fiscal responsibility. They fixed certain targets for reducing the

revenue and the fiscal deficits in a phased manner. This has indeed contributed

in a large way during the last five years, during which period, most of the States

have been able to abide by the targets set in the Fiscal Responsibility and

Budget Management (FRBM) Act, 2003.188

It may be seen from the RBI’s State Finances report for the year 2008-09 that

the gross fiscal deficit of all the States together which was 4.2%, 4.6%, 4.2%,

4.1%, 4.4% respectively for the years 1999-2000, 2000-01, 2001-02, 2002-03

and 2003-04 has come down to 3.4% for 2004-05 and to 2.5% for 2005-06,

1.9% for 2006-07 and 2.1% for 2008-09. Similarly the revenue deficit which

was as high as 2.8% for the year 1999-2000 has come down to (-)0.5% , which

in fact means a revenue surplus. This is a phenomenal success. As a result,

various State Governments have been able to step up the much desired Plan and

Capital Expenditure giving momentum to virtuous cycle of economic growth.

Still the main issues, viz., transparency and proper targeting of beneficiaries

continue to dominate the debate.

It is not as if the problem of subsidies exists in only poor and developing

countries. It is much more in developed countries like the US and European

Union.

188
For the text of the legislation see http://www.finmin.nic.in/law/frbmAct2003.pdf

152
With the emergence of World Trade Organization removing the trade barriers

between countries, the subject of subsidies – both internal and external – has

once again become contentious between the developing and developed

countries particularly in regard to the agricultural subsidies.

The sector-wise subsidies given in the State of Andhra Pradesh are given in the

statement at Table-1 (Annexure-A).

The statement clearly indicates that during the last 5 years, commencing from

2006-2007, the component of subsidies vis-à-vis budget allocations vary from

25.46% in 2006-2007 to 38.40% in 2010-2011. The maximum subsidy, in

terms of amount, relates to the following sectors during 2010-2011.

i) Power ..Rs.4,500 crore

ii) Rice & Essential commodities ..Rs.3,000 crore

iii) Agricultural input & related activities ..Rs. 447 crore

iv) Imputed subsidies to DCU Departments ..Rs.8,149 crore

Departmental Commercial Undertakings

The Departmental Commercial Undertakings (DCUs) are incorporated

enterprises owned, controlled and run directly by the public authorities. These

undertakings normally do not hold or manage financial assets and liabilities

apart from their working balances and business accounts payables and

153
receivables. These undertakings charge for the goods and services they provide

on commercial basis.

Imputed Subsidies

Operating losses of Departmental Enterprises in electricity, manufacturing,

transport, etc. with the exception of irrigation, were treated as negative

operating surplus. The Departmental Enterprises incur losses as a result of

government policies on pricing of the final products. Such losses due to

charging non-market prices for the products have been treated as imputed

subsidies.

4.3 Andhra Pradesh Government Subsidies

Till the 1980s, both the Central and State Governments have managed their

finances well within their means. There was hardly any revenue deficit as

percentage of the GDP / GSDP. Consequently, even the fiscal deficits were well

within the accepted limits. The menace of increasing revenue deficits

particularly as a result of ever growing subsidies as part of non-plan

expenditure has been seen particularly post 1990s.

For instance, in case of Andhra Pradesh, the State had a cumulative revenue

surplus of Rs.128 crores for a period of 38 years ending on 31-03-1994. As a

154
result, the State invested the borrowings together with its revenue surplus in the

long term assets that have the potential for generating revenues and

employment leading to an asset liability ratio of 101:100 as on 31-03-1994.

This was a healthy position by any reckoning.

As against that, for the 10 years period 1994-2004, the State suffered a huge

revenue deficit of Rs.22,000 crores which necessitated diverting the borrowings

meant for creation of long term assets for meeting the revenue expenditure; so

much so that, the asset liability ratio as on 31-03-2004 fell precariously to

63:100. The Government had to enact Fiscal Responsibility and Budget

Management (FRBM) Act, 2003 by imposing upon itself the responsibility of

bringing down the share of revenue deficit to GSDP to 3% by the year 2008-09.

If subsidies which are in the revenue nature go on increasing both in absolute

terms and as percentage of the revenues and GDP, the country has to postpone

important expenditure on creation of infrastructure and assets that have the

potential for creation of employment and revenues. The country will inevitably

get into a vicious cycle of economic activity and not the much needed virtuous

cycle of economic growth. And this is the surest way of keeping any country

for ever poor and underdeveloped. We therefore, have to make a balance

between welfare and development.

We take the case of AP Government which had to address these issues on a

priority basis, given the negative asset / liability ratio. The main priority was to

155
reduce the revenue deficit and if possible eliminate the same completely even

before the due date mandated in the FRBM Act. This naturally means an

increase in the Plan expenditure and an increase in the Capital expenditure.

Following are the excerpts from the Budget speech of the Hon’ble Finance

Minister of Andhra Pradesh delivered in 2009 to the State Legislature189:

‘One of the greatest achievements of our Government is to restore the fiscal

health of the State, which was in a very poor state in the year 2004. The State

had a cumulative revenue surplus of Rs.128 crore for the 38 years period

ending on 31-3-1994. As against that, most unfortunately, the State ended up

with a cumulative revenue deficit of over Rs.22, 000 crore in the 10 years

period of 1994-2004. Most of the moneys borrowed went towards meeting the

revenue deficits and not for capital asset creation during that decade. Members

will be happy to note that the State has met the targets set in the AP FRBM Act

2005 in respect of Fiscal Deficit and Revenue Surplus well in advance.

The State earned revenue surplus for the year 2006-07 and 2007-08, while

suffering only a marginal revenue deficit of Rs.64.11 crore for the year 2005-

06. With the result, the capital expenditure as percentage of fiscal deficit for the

period 2004-08 increased to 150% as against 45% during the period 1994-

2004. Members will be happy to note that the State Government could carry on

its fiscal management without having to resort to ways and means advances or

189
http://budget.ap.gov.in/

156
the overdraft facility even once during the last five years which was a matter of

routine during the previous regime.

As per the latest report of RBI on State finances for the year 2008-09, AP stood

first in the country in respect of its allocation on plan expenditure, development

expenditure, social sector expenditure and capital expenditure. As per that

report, AP’s social sector allocation is Rs.38,544 crore for the year 2008-09, as

against the actual expenditure of Rs.13,267 crore for the year 2003-04. Even

for the year 2007-08, AP stood first in respect of per capita expenditure on all

the above sectors as against States with more than three crore of population.

Members will be happy to note that for the third consecutive year, AP’s Plan

Expenditure has been highest for any State in the country in absolute terms. The

total Plan Expenditure in the State has gone up from Rs.10,759 crores in 2003-

04 to Rs.36,184 crores in 2008-09 and the budget for the next fiscal is

Rs.38,477 crores. Similarly, the capital expenditure has gone up from Rs.3,804

crores in 2003-04 to Rs.17,359 crores in 2008-09 and the budget for the next

fiscal is Rs.18,236 crores.”

Andhra Pradesh could provide subsidies without increasing the tax rates or

power tariff for any class of consumers for a full period of five years. This

could happen because the revenues grew at much higher pace than the national

level for the five years period 2004-09 because of increased economic

buoyancy.

157
It is interesting to note that the Government of AP has implemented many

welfare programmes in an unprecedented manner during the five years period

2004-09. 190

Some of the important schemes are – (i) an additional 55 lakh pensions were

sanctioned to the old-aged, destitute, physically challenged etc., (ii) two rupees

a kg rice scheme has been extended to cover about 80% of the State’s

population, (iii) for the first time, in any State in the country, Rajiv Arogyasri

scheme has been implemented, meeting hospitalization expenditure upto rupees

two lakhs per family per annum covering about 80% of the State’s population,

(iv) about 40 lakh weaker section houses were constructed during 2004-09, (v)

free education at all levels for the children of parents whose annual income is

below Rs.1 lakh per annum, (vi) the Government has been providing free power

to farmers – 1600 crore units of power per annum, in addition to subsidizing

interest on crop loans and (vii) loans to women SHGs so as to enable the

beneficiaries to pay only 3% interest per annum.191

The Government could do this and still earn revenue surplus. The US-based

CATO Institute in association with Indicus Analytics and the Friedrich

Naumann Foundation recently published the rankings in terms of Economic

Freedom Index of Indian States. Mr. Swaminathan Ankilesaria Iyer, a

renowned economist and a former World Bank advisor, summarizing the

190
See generally http://www.aponline.gov.in/apportal/HomePageLinks/schemes.htm
191
http://siadipp.nic.in/state/ind_policy_ap.htm

158
Report, in his article entitled ‘Exemplary Andhra’ published in Financial

Express dated 19th March, 2011 wrote192:

“Between 2005 and 2009, Andhra Pradesh and Gujarat were the two

states that registered the biggest improvements in economic freedom,

with their overall scores going up by 0.11 points each. Andhra

Pradesh’s score went up from 0.40 to 0.51, which is proportionately

faster than Gujarat’s move from 0.46 to 0.57. In overall state rankings,

Andhra Pradesh moved up from 7th position in 2005 to 3rd position in

2009.”

This improvement in economic freedom and business climate has helped almost

double the state’s growth rate. In the Ninth Five Year Plan period (1997-98 to

2001-02) the state had an average annual Gross State Domestic product (GSDP)

growth of 5.59%. But in the last five years for which data is available (2004-05

to 2008-09), GSDP growth accelerated to an average of 9.07% per year. The

state was an outperformer, consistently growing faster than India as a whole,

save in the drought of 2008-09.

The indicators relating to the size of the state show encouraging progress. The

ratio of GSDP to the revenue expenditure of the government (excluding capital

spending) shot up from 3.4 in 2005 to 7.93 in 2009. In other words, GSDP rose

more than twice as fast as government spending on administrative matters,

including subsidies and employment schemes. But this did not mean at all that

192
http://www.financialexpress.com/news/exemplary-andhra/764484/

159
government spending was muted. On the contrary, there was a veritable

spending boom.

This spending boom focused on irrigation and infrastructure, aiming to improve

conditions for farmers and businessmen. In this, the approach succeeded rather

well. Agricultural growth averaged 6.82% per year in 2004-09, more than

double the all-India average of 3.26%. And industrial growth in the state

averaged 10.75%, against the national average of 8.70%. While the government

grew bigger, the state economy grew still bigger, so the relative size of

government declined.”

This clearly establishes the fact that the State did not resort to increasing taxes.

So, as long as the Governments are able to manage the fiscal position according

to the accepted norms and within their means, there is nothing wrong in

implementing a plethora of welfare measures. It is however very important to

note that in no case Governments can afford to make their citizens depend on

them for bare necessities in a long run.

After all, good governance should lead to helping citizens help themselves for

as long a period as it is required. Needless to say, the Government has to create

opportunities and remove inequalities so that people can find gainful

employment to support themselves.

160
The analysis of AP Governments economic policies shows that the government

has supported development in the form of subsidies and welfare programs. The

role of Intellectual Property for sustainable economic development has been

well documented in addition to increasing importance of IP in global trade. GIs

being an important Intellectual Property tool and a collective private right

however has not seen rapid protection since the ownership lies with a group of

people rather than being individually vested upon. Therefore GIs makes an apt

case for support from the Government in order that it gains prominence and

provides for sustainable economic development.

However any subsidies which might be given to GIs should be well designed,

transparent and focused. Enough consideration should be given to the type of

subsidies considering the nature and scope of GI. The type of subsidy should

also be based on the consumption or protection pattern of the concerned GI.

The benefits of permanent subsidies which are usually not in the interest of the

state vis-à-vis short term and medium subsidies with a provision for review of

the effectiveness of the subsidy should be evaluated before implementation.

161