Subsidies: Fiscal Policy


• Subsidy has been defined as the “money granted by state, public body, etc., to keep down the prices of commodities, etc.”
• A subsidy is a grant or other financial assistance given by one party for the support or development of another.
• Subsidies affect the economy through the commodity market by lowering the relative price of the subsidized commodity, thereby generating an increase in its demand.
• Taxes appear on the revenue side of government budgets, and subsidies appear on the expenditure side.
• While taxes reduce disposable income, subsidies inject money into circulation.
• Subsidies have been advocated for redistributive objectives, especially to ensure minimum level of food and nutrition to all sections of society.
• Subsidies are justified in the presence of positive externalities (social benefits above private benefits), 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.
• Primary education, preventive health care, and research and development are prime examples of positive externalities. In these cases, private valuation of the benefits from such goods or services is less than their true value to society.

Types of subsidies
1. Direct Subsidies – Direct subsidies are given in terms of cash grants, interest-free loans and direct benefits. For example- Direct farm subsidies are the kinds of subsidies in which direct cash incentives are paid to the farmers in order to make their products more competitive in the global markets. Direct farm subsidies are helpful as they provide a purchasing power to the farmer and can significantly help in raising the standards of living of the rural poor.

2. Indirect subsidies – Indirect subsidies are provided in terms of tax breaks, insurance, low-interest loans, depreciation write-offs, rent rebates. For example- Indirect farm subsidies: These are the farm subsidies which are provided in the form of cheaper credit facilities, farm loan waivers, reduction in irrigation and electricity bills, fertilizers, seeds and pesticides subsidy as well as the investments in agricultural research, environmental assistance, farmer training etc.

The benefits of subsidy as a policy are:
1. Inducing higher consumption/production.
2. Achievement of social policy objectives including redistribution of income, population control etc.
3. It helps in controlling the prices to maintain stability.
4. Especially in case of agriculture where food is basic right of all, you cannot leave everything to market.
5. Offsetting market imperfections including internalization of externalities.

(1) Input Subsidies: Subsidies can be granted through distribution of inputs at prices that are less than the standard market price for these inputs. The magnitude of subsidies will therefore be equal to the difference between the two prices for per unit of input distributed. Naturally several varieties of subsidies can be named in this category

(a) Fertilizer Subsidy:
• It includes Distribution of cheap chemical or non-chemical fertilizers among the farmers. It amounts to the difference between price paid to manufacturer of fertilizer (domestic or foreign) and price, received from farmers.
• This subsidy ensures:
– Cheap inputs to farmers,
– Reasonable returns to manufacturer,
– Stability in fertilizer prices, and
– Availability of fertilizers to farmers.
• In some cases this kind of subsidies are granted through lifting the tariff on the import of fertilizers, which otherwise would have been imposed.

(b) Irrigation Subsidy:
• Subsidies to the farmers which the government bears on account of providing proper irrigation facilities.
• Irrigation subsidy is the difference between operating and maintenance cost of irrigation infrastructure in the state and irrigation charges recovered from farmers.
• This may work through provisions of public goods such as canals, dams which the government constructs and charges low prices or no prices at all for their use from the farmers.
• It may also be through cheap private irrigation equipment such as pump sets.

(c) Power Subsidy:
• The electricity subsidies imply that the government charges low rates for the electricity supplied to the farmers. Power is primarily used by the farmers for irrigation purposes. It is the difference between the cost of generating and distributing electricity to farmers and price received from farmers.

(d) Seed Subsidies:
• High yielding seeds can be provided by the government at low prices. The research and development activities needed to produce such productive seeds are also undertaken by the government, the expenditure on these is a sort of subsidy granted to the farmers.

(e) Credit Subsidy:
• It is the difference between interest charged from farmers, and actual cost of providing credit, plus other costs such as write-offs bad loans. Availability of credit is a major problem for poor farmers. They are cash strapped and cannot approach the credit market because they do not have the collateral needed for loans. To carry out production activities they approach the local money lenders.

(2) Price Subsidy
• It is the difference between the price of food-grains at which FCI procures food-grains from farmers, and the price at which PCI sells either to traders or to the PDS.
• The market price may be so low that the farmers will have to bear losses instead of making profits. In such a case the government may promise to buy the crop from the farmers at a price which is higher than the market price.
• The difference between the two prices is the per unit subsidy granted to the farmers by the government. The price at which the government buys crops from the farmers is called the procurement price.
• Such procurement by the government also has a long run impact. It encourages the farmers to grow crops which are regularly procured.

(3) Infrastructural Subsidy
• Private efforts in many areas do not prove to be sufficient to improve agricultural production. Good roads, storage facilities, power, information about the market, transportation to the ports, etc. are vital for carrying out production and sale operations.
• These facilities are in the domain of public goods, the costs of which are huge and whose benefits accrue to all the cultivators in an area.
• The government takes the responsibility of providing the public goods and given the condition of Indian farmers a lower price can be charged from the poorer farmers.

(4) Export Subsidies
• This type of subsidy is not different from others. But its purpose is special. When a farmer or exporter sells agricultural products in foreign market, he earns money for himself, as well as foreign exchange for the country. Therefore, agricultural exports are generally encouraged as long as these do not harm the domestic economy. Subsides provided to encourage exports are referred as export subsidies.

Objectives of Agricultural Subsidy
Economic objectives:
– Stimulate agricultural production.
– Compensate for high costs of transport from port or factory to farms that raise costs of inputs.
– Improve soil quality and combat soil degradation (in the case of fertilizer).
– Make inputs affordable to farmers who cannot buy them, owing to poverty, lack of access to credit, and inability to insure against crop losses.
– Learning — to allow farmers to try novel inputs and become familiar with their advantages.

Social objectives:
– Social equity – to transfer income to farmers who are poor, live in remote disadvantaged areas, or both

WTO and Agricultural Subsidies
The WTO Agreement on Agriculture (AoA), 1995 permitted the developed countries to continue to provide farm subsidies, but under certain restrictions. In WTO terminology, agricultural subsidies have been segregated into various ‘boxes’:

1. Green Box subsidies – It includes amounts spent on research, disease control, and infrastructure and food security. These also include direct payments made to farmers such as income support that do not stimulate production. These are not considered trade distorting and are encouraged.

2. Blue Box subsidies – It includes direct payments to farmers to limit production and certain government assistance to encourage agriculture and rural development in developing countries. Blue Box subsidies are seen as being trade distorting.

3. Amber Box subsidies – It includes all agricultural subsidies that do not fall into either blue or green boxes. These include government policies of Minimum support Prices (MSP) for agricultural products or any help directly related to production quantities (e.g. power, fertilizer, seeds, pesticides, irrigation, etc.). These are subject to reduction commitment to the de-minimus level of agricultural outputs- to 5% for developed and 10% for developing countries. India insisted that developed countries should first dismantle their agricultural subsidy structure before asking developing countries to open up their market for farm imports.

• Urea is highly subsidized for Indian Farmers.
• However, the skewed subsidy regime, resulting in farmers paying lesser for urea compared to phosphorus and potassium, had led to urea overuse.
• India purchases about 50 lakh metric tonnes of excess urea, leading to farmers and the government wastefully spend Rs. 2,680 crore and Rs. 5,860 crore respectively, further putting constraint on government’s resources.
• The distorted policy has also led to stagnation of private investment in the sector, especially in urea, and increased reliance on imports. The fertilizer subsidy hurts everyone — farmers, firms, taxpayers and consumers.

• Selling fuel at less than market prices result in under-recoveries for Oil Marketing Companies (OMCs) like Indian Oil Corporation Ltd (IOCL), Bharat Petroleum Corporation Ltd (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL).
• Govt compensates these OMCs by directing upstream oil companies like Oil and Natural Gas Corporation Ltd (ONGC), Oil India Ltd (OIL), GAIL India Ltd to provide discount on crude oil purchases by these companies and issuing oil bonds. The government has over the years ensured that OMCs remain profitable and honour their financial obligations.
• Subsidies on kerosene have increased from Rs. 12.92/litre to Rs. 34.80/litre and LPG cylinders from Rs. 175.04/cylinder to Rs. 522.10/cylinder during the same period. Diesel accounts for 45%, LPG 33% and kerosene 22% of the total under-recoveries. To rein in subsidies, petrol prices were de-controlled in June 2012. However, it did not have a significant impact on under recoveries because petrol accounts for only 10% of total petroleum product consumption in the country.

• To ensure food security at the individual or household level, the Government of India implements various schemes in partnership with State Governments and Union Territory Administrations.
• The Government is implementing the Targeted Public Distribution system (TPDS) under which food-grains at subsidized rates are provided to Below Poverty Line and Above Poverty Line Households through a network of more than 5 lakh fair price shops spread across the country.
• Currently, allocations of subsidized food-grains is being made for about 6.5 crore BPL households.
• Besides, Government is also implementing schemes to specifically address the concerns related to malnutrition, especially among women and children, through schemes like Integrated Child Development Services, Mid-Day Meal, Annapurna, etc.

Some of the major highlights of the Food Security Bill are:
• Up to 75% of the rural population (with at least 46% from priority category) and up to 50% of urban population (with at least 28% from priority category) are to be covered under Targeted Public Distribution System.
• 7 kg of food-grains per person per month to be given to priority category households which include rice, wheat and coarse grains at Rs. 3, 2, and 1 per kg, respectively.
• At least 3 kg of food-grains per person per month to be given to general category households, at prices not exceeding 50% of Minimum Support Price.
• Women to be made head of the household for the purpose of issue of ration cards.
• Maternity benefit to pregnant women and lactating mothers.
• End-to-end computerization of Targeted Public Distribution System.
• Three-tier independent grievance redressal mechanism.
• Social audit by local bodies such as Gram Panchayats, Village Councils etc.
• Meals for special groups such as destitute, homeless persons, emergency/disaster affected persons and persons on the verge of starvation.

Targeted Public Distribution System (TPDS)
• In June 1997, the Government of India launched the Targeted Public Distribution System (TPDS) with focus on the poor.
• India’s Public Distribution System (PDS) with a network of 4.78 Lakh Fair Price Shops (FPS) is perhaps the largest retail system of its type in the world.
• The objectives of PDS are:
– Providing food grains and other essential items to vulnerable sections of the society at reasonable (subsidized) prices
– To put an indirect check on the open market prices of various items and
– To attempt socialization in the matter of distribution of essential commodities
• Under the TPDS, States are required to formulate and implement foolproof arrangements for identification of the poor for delivery of food grains and for its distribution in a transparent and accountable manner at the FPS level.
• The TPDS system today supports over 40 Crore Indians below the poverty line with monthly supply of subsidized food grains. The system also provides gainful employment for 4.78 Lakh Fair Price Shops Owners, their employees and hired labour who work at the FCI and state ware housing godowns.
• PDS also has become a cornerstone of government development policy and is tied to implementation of most rural development programs.
• PDS is also a key driver of public sentiment and is an important and very visible metric of government performance.
• Apart from supplying food grains under the TPDS, other welfare schemes related to food are also executed. They are:
– Mid-Day Meal Scheme
– Wheat Based Nutrition Program (WBNP)
– Scheme For Supply of Foodgrains to SC/ST/OBC Hostels/Welfare Institutions
– Annapurna Scheme
– Sampoorn Gramin Rozgar Yojna (SGRY)
– National Food For Work Program (NFFWP)
– Foodgrains To Adolescent Girls , Pregnant And Lactating Mothers ( AGPLM)
– Village Grain Banks Scheme
– World Food Program

There are many systemic challenges that plague the PDS system today
1. PDS Leakages
a. A large number of families living below the poverty line have not been enrolled and therefore do not have access to ration cards
b. A number of bogus ration cards which do not correspond to real families, exist in the BPL & AAY categories.
c. A number of instances where benefits are being availed in the names of rightfully entitled families without their knowledge.
d. Errors in categorization of families that lead to BPL families getting APL cards and vice versa.

2. Scale and Quality of Issue – The scale of issue and the quality of food grains delivered to the beneficiary is rarely in conformity with the policy. Many FPS are open only for a few days in a month and beneficiaries who do not visit the FPS on these days are denied their right.

3. System Transparency and Accountability –The most serious flaw plaguing the system at present is the lack of transparency and accountability in its functioning.

4. Grievance Redressal Mechanisms – There are numerous entities like Vigilance Committee, Anti-Hoarding Cells constituted to ensure smooth functioning of the PDS system. Their impact is virtually non-existent on the ground and as a result, malpractices abound to the great discomfiture of the common man.

• Recent studies by the Planning Commission have shown that the Public Distribution System has become so inefficient that 58% of the subsidized grains do not reach the targeted group and almost a third of it is siphoned off the supply chain. According to the Finance Ministry the inefficiencies of the PDS ensure that the Government is forced to spend Rs.3.65 for transferring of Rs. 1 to the poor.
• The idea behind the Direct Cash Transfer is to cut down wastage, duplication and leakages and also to enhance efficiency. The idea is to move to a completely electronic cash transfer system for the entire population.

Launch of the programme
• The programme is now called direct benefit transfer (DBT).
• On January 01, 2013, the government of India rolled out the DBT covering seven welfare schemes in 20 districts in 16 states.
• The programme covers schemes like educational scholarship for the Scheduled Castes and the Scheduled Tribes and pensions to widows. Food, fertilizers, LPG, diesel and kerosene have been kept out for the present.
• Among other objectives like better delivery, more accurate targeting, giving broader choice to the beneficiaries, reducing pilferage and corruption, the programme is also  aimed at cutting the massive subsidy bill of Rs 1,64,000 crore .

Scope of DBT
• The DBT program aims that entitlements and benefits are transferred directly to the beneficiaries. The beneficiaries could include widows, students and pension takers. This would be done through biometric-based Aadhaar-linked bank accounts. This would reduce several layers of intermediaries and delays in the system.

Advantages of DBT system
• The use of Aadhaar or other biometric based systems would dissolve problems like duplicates or ghosts. Duplicates are when the name of the beneficiary is repeated and Ghosts is when the name of a nonexistent beneficiary is mentioned.
• It helps in the quick and direct cash transfer to the intended beneficiary.
• The cash transfer happens through a dense Business Correspondent system on the ground with micro ATM’s.
• This ensures that the poor get the same level of service that the rich and the middle classes in the society receive.
• The financial inclusion offered by the DBT infrastructure can also be used by internal migrants to send their remittances.
• The Aadhaar-based micro-ATM network could ensure that remittances take place instantly and at much lower cost to migrants.

Subsidies and Export Promotion
• As a part of export promotion strategy, besides various other measures, various types of export incentives have been evolved. These have been altered and modified from time to time to meet varying conditions. Broadly, these incentives can be classified into three categories, viz.

Fiscal Incentives – Under fiscal incentives, the important measures that have been in vogue are income tax concessions, customs draw-backs, refund of excise duty,- exemption from sales tax, provision for export undertaken, and facility for manufacture under bond.

Financial Incentives – These incentives refer to the provision of cash assistance for specified export promotional efforts and export facilities.

Special Incentive Schemes – Besides the recent reforms in the export incentive structure, export profitability was sought to be improved through a variety of fiscal concessions, and explicit and implicit subsidies. These measures were considered necessary to neutralise the negative financial impact of high administered prices of inputs and differential tax incidence that exporters suffer vis-a-vis ‘across the border’ competitors.


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