Biting the subsidy bullet

Next Budget should reduce illegitimate subsidies aggressively

An immediate imperative for the new government is to bring the subsidy bill under control. Total subsidies paid out by the government have mushroomed, which, in the name of fiscal discipline, has crowded out legitimate and growth-inducing capital expenditure. This is hardly the right way to correct the fiscal situation; the government needs to find more money, and quickly, to make a variety of investments. If it reduces subsidies significantly, there is a realistic chance that this can happen. If it doesn't, there is virtually no chance at all. From a strategic perspective, the positive experience with the Fiscal Responsibility and Budget Management (FRBM) Act of 2003 suggests that explicit fiscal rules can help. In fact, the proposal made in the 2012-13 Budget to embed an explicit fiscal deficit ceiling of two per cent of gross domestic product (GDP) in a new FRBM Act (the first one terminated in 2010) has merit and should be seriously considered by the government, even before it takes a decision on whether to move forward on new legislation. The upcoming Budget provides an opportunity to act aggressively on this front, while still basking in the goodwill generated by its electoral performance.

On the fuel front, there is clearly some improvement with regard to diesel, as a result of regular price increases and rupee appreciation. But, while the gap has narrowed, it is still significant. A relatively large price increase soon is warranted. The inflationary risk of this is, of course, something to be considered, particularly in a poor monsoon year. But if the monsoons turn out to be non-threatening, which will be known by mid-July, the opportunity must be seized. Beyond this, the long-term distortion caused by the significant under-pricing of diesel needs to be recognised. It is striking that there are more diesel passenger cars being sold than petrol vehicles. Also, ownership of two-wheelers is considered a first realisation of middle-class aspirations. Why should this cohort pay substantially more per litre for their fuel than the affluent owners of diesel-fuelled SUVs? As regards the large subsidy on liquefied petroleum gas, or LPG, experiments with direct cash transfers to legitimate beneficiaries show some promise in reducing arbitrage opportunities provided by cheap gas. These pilots must be scaled up as quickly as possible.

Coming to fertilisers, the intent to decontrol urea prices has been long-standing, but not implemented. Here again, while there are some inflationary risks, more efficient use of correctly priced fertilisers will provide some offset. Over the longer term, land productivity, which is adversely impacted by excessive urea use, will benefit from a lower and better balanced fertiliser input.

Finally, with reference to food, the whole procurement framework, which offers unlimited purchase by the government at a guaranteed price, has to be redesigned. In addition to the price paid to farmers, state governments have piggybacked on these guarantees by levying all manner of charges on grains procured in their jurisdictions. This has become a back-door fiscal transfer with no merit whatsoever. The bottom line is that while some subsidies are entirely legitimate from a social welfare perspective, the system has gone haywire. An overall ceiling will exert pressure on the government to prioritise and find more efficient ways to deliver legitimate subsidies.