Contrary to expectation, there was no big bang reform in regard to subsidies in Modi-government’s maiden budget presented on July 10, 2014. However, Arun Jaitley announced setting up of an expenditure reforms commission (ERC).
While, we may have to wait for ERC recommendations until next budget in February, 2015, meanwhile Jaitley has given some ideas on direction in which government intends to move forward.
Thus, he opines that extant dispensation of subsidies which he describes as ‘un-quantifiable’ and beneficiaries ‘un-identifiable’ cannot be allowed to continue. He emphasized need for replacing this by a system of direct subsidy transfer to poor.
To countenance menace of subsidies, Jaitely alluded to fundamental need for consumers/users to pay for increase in cost of goods and services. Or else, not only their quality will suffer, there is even a risk of delivery systems collapsing!
The erstwhile UPA regime was well aware of this principle. Unfortunately, it was lax in implementation. This is amply demonstrated by virtual freeze on retail prices of urea, kerosene, diesel, LPG, power tariff, passenger fares etc for prolonged periods.
Modi is keen to act but, how much he will deliver and when remains to be tested. Another aspect no less crucial to make a dent on subsidies relates to cost of supply. This was blatantly ignored by UPA. How NDA will handle this, is shrouded in secrecy.
Why is cost so crucial? Subsidy per unit is excess of cost of production/import and distribution on one hand and maximum retail price (MRP) on the other. When, cost increases MRP remaining un-changed, subsidy will increase and vice versa.
The subsisting mechanisms for cost reimbursement and settlement of claims in various sectors provide little incentive to control costs. Far from that, suppliers and service providers get ample opportunity to indulge in cost padding and inflating capital expenditure.
Even worse, increasing cost is considered sacrosanct even as regulatory institutions merrily approve figures submitted by companies without accountability. What Comptroller Auditor General (CAG) does is a mere post-mortem. In some cases, even this is resisted or gets scuttled.
The proof of putting is in eating. Take case of oil subsidies where the under-recoveries on sale of petroleum products viz., diesel, kerosene and LPG was Rs 138,000 crores in 2011-12, Rs 161,000 crores in 2012-13 and Rs 139,000 crores in 2013-14.
In its report on pricing policy for major petroleum products recently submitted to parliament, the CAG has pointed out that these are priced as if they are imported from abroad whereas in reality, they are produced in domestic refineries.
This results in a situation whereby the refineries are reimbursed notional import related expenses such as customs duty, freight and insurance that is not incurred. During 2007-12, such reimbursements amounted to about Rs 50,000 crores.
Refineries incur such expenses on import of crude oil which is used in manufacture of petroleum products. During 2007-12, these were Rs 24,000 crores. After off-setting these, extra payment to oil marketing companies (OMCs) would be Rs 26,000 crores.
OMCs also purchase products from standalone/private refineries to meet shortfall in supplies. Private refineries too are paid import linked prices resulting in undue benefit. During 2011-12, on diesel alone this was Rs 667 crores.
OMCs incur interest cost due to delayed settlement of under-recoveries. During 2007-08 to 2011-12, they suffered loss of Rs 5180 crores on this score. But, that does not offer any valid ground for letting huge notional payments pass muster.
Even so, adjusting for this loss, the un-warranted gain to OMCs would be unprecedented at over Rs 20,000 crores. And, all this gets camouflaged in subsidies in the name of support to millions of poor and vulnerable consumers.
In food sector, wherein also subsidy is huge Rs 115,000 crores (allocation for 2014-15), story is no different. For rice, against minimum support price (MSP) of Rs 20 per kg, economic cost which includes handling, storage and distribution in addition to MSP is substantially higher at around Rs 28 per kg.
The handling, storage and distribution charges are reimbursed to FCI and other state agencies on ‘actual’ basis. There are no norms governing such reimbursements. The dispensation is prone to in-efficiency, leakages and corruption.
The scenario in power sector is equally disturbing. Power distribution companies (PDC) in Delhi carry on their balance sheets so called regulatory assets (jargon for amount remaining un-paid) of over Rs 20,000 crores. A major slice of these are inflated cost claimed by PDCs as pointed out by ex-CM, Kejriwal.
Kejriwal had ordered CAG audit of PDCs to unravel irregularities and disallow inflated expenses. On this basis, he had even promised a reduction of 50% in tariff to all Delhi consumers. While, there is little progress in audit meanwhile, the regulator has already sanctioned another round of hike.
In gas, CAG has pointed towards gold plating of capital expenses by RIL in KG-D6 field. Based on field development plan (FDP) submitted in 2004, government had initially approved US$ 2.4 billion for production of 40 million standard cubic meter (mmscmd). In 2007, powers that be hiked these expenses to US$ 8.8 billion (based on an addendum to FDP submitted by operator in 2006) corresponding to production of 80 mmscmd!
These inflated expenses propelled by rhetoric of risky exploration and production business are used by companies to justify their demand for increase in gas price (even CEOs of public sector companies viz., ONGC join the bad wagon). Here also, CAG audit of RIL is stuck in grooves due to lack of cooperation by operator.
The government cannot make a dent on subsidies merely by increase in retail price of goods and services. It has to act with equal force on reining in cost. For all sectors, it should come up with transparent methods and norms for granting cost reimbursements. The regulators must stick to these norms while approving claims.
Where ever audits are pending, these must be completed expeditiously within set time lines and recommendations/findings of CAG implemented immediately so as to yield required relief either by way of reduction in subsidy or lowering of tariff as in power.
In gas sector, for granting acreages under 10th NELP (new exploration and licensing policy) round, government should go for ‘revenue sharing’ model as recommended by Rangarajan Committee. This will strikes at the very root of any attempt to inflate expenses.
In all other areas viz., oil, food, fertilizers, Modi should start preparing ground for giving subsidy only through a scheme of direct cash transfer to poor within a set time frame. This may be a tough call but, public has already given him a decisive mandate to effectively respond.