One of the planks on which Modi got mandate to govern was his promise to deliver on fiscal consolidation. In its maiden budget for 2014-15, government has pledged to achieve this by pruning subsidies and higher tax revenue based on lower rates.
Recently, prime minister approved constitution of an expenditure management commission (EMC) under chairmanship of Dr Bimal Jalan former governor RBI to recommend a road-map up for rationalizing and phasing out major subsidies viz., food, fertilizers and oil. The commission has been asked to submit its report within 18 months. However, it will submit an interim report in 6 months.
The protracted time frame for the committee should not be taken to mean any dilution of government’s commitment on this crucial reform. It has not only laid down a road-map but also implemented some credible steps in that direction.
Jaitely has announced reduction in these subsidies to 2% of GDP in 2014-15, 1.7% in 2015-16 and 1.6% in 2016-17 and vowed to abandon extant system of subsidizing product sales (selling below cost) in favor of direct cash transfer to beneficiaries.
Subsidies on petroleum products (POL) are biggest drag on national exchequer. During 2013-14, under-recovery on their sale was Rs 140,000 crores. Of this, Rs 74,000 crores was paid by GOI as subsidy and balance by ONGC/OIL as discount on supply of crude oil to public sector refineries.
Diesel alone accounted for nearly 60% of POL under-recoveries. To deal with it, erstwhile UPA dispensation had initiated a calibrated plan in January 2013 to increase its price by 50 paise every month. The present government has continued this plan.
This together with drop in crude price has led to progressive decline in under-recovery to Rs 1.8 per litre. Meanwhile, consumers have got used to small hikes and no adverse effect on off-take was observed. In fact, in July there was spurt in consumption.
In this backdrop and expected complete elimination of under-recovery in a couple of months, Government is considering a proposal to de-regulate diesel. This is a perfect and well timed move and should be accompanied by freedom to import and removal of restriction on entry of private sector in oil retailing.
Already, RIL and Essar Oil have a large number of retail outlets. These were lying dormant due to their inability to compete with oil PSUs selling at lower price – under government directions – and getting compensated for under-recovery. Withdrawal of subsidy support to latter will create a level playing field for former thereby leading to their resurrection.
With both public and private sector players in the fray and further boost through freeing of supplies from import route, competition in market place will intensify. Suppliers will be under pressure to improve efficiency and reduce cost in the entire supply and distribution chain eventually benefiting consumers.
De-regulation and free play of market forces will also bode well for upstream majors viz., ONGC/OIL as they need not have to give any discount on crude supplies to oil PSUs. The money thus saved will come handy for plugging investment gaps for their exploration and development plans.
LPG accounts for nearly 30% of POL subsidies. According to Economic Survey, only 0.07 per cent of LPG subsidy in rural areas went to the poorest 20 per cent households. In urban areas, 8.2 per cent of subsidies went to the poorest 20 per cent households.
Considering that benefit of LPG subsidy goes predominantly to better-off and Modi’s commitment to restrict subsidy only to the poor, government can take a call on this right away. In fact, with launch of PM Jan Dhan yojna (PMJDY) – first phase to be completed by August, 2015 – it may already be readying for this.
Once each of 75 million households has a bank account as promised under PMJDY, it should be possible to transfer LPG subsidy directly to account of poor households. It will be great if banks can coordinate with state governments to impregnate income status of household on account alongside bio-metric identification.
While, switch-over to direct transfer can happen after an year say from August 2015, during interregnum government should consider implementation of diesel type plan of increase in price of subsidized cylinders in small lot. A monthly hike of Rs 25/- may be considered. This will knock off current gap of Rs 500/- by Rs 300/- in an year assuming crude price stays at existing level.
Almost all of subsidized kerosene is cornered by dubious traders to adulterate with diesel. With latter gliding towards market rate, incentive for making money is even higher. Modi should catch bull by the horn. He must gear up to stop subsidized sale by August 2015 and put money in account of poor household.
In regard to food, government recognizes that flawed procurement policies have led to excessive build-up of stocks which as on June (end) was 70 million tons or 2.2 times requirement. The carrying cost of the excess is about Rs 88,000 crores.
It has directed Food Corporation of India (FCI) to restrict its food grain purchases from farmers only to the extent of requirement for public distribution system (PDS) and strategic reserves. Where states (MP, Rajasthan, Chattisgarh) ride piggy back on FCI in procurement, former have been told that the center will not reimburse the cost of excess purchase made by them.
These states have also been indiscriminately resorting to granting bonus over and above the minimum support price (MSP) fixed by central government. This is at huge cost to exchequer. GOI has directed them to strictly adhere to MSP. According to an estimate, implementation of these steps would result in saving of close to Rs 25,000 crores in food subsidy.
A lot more saving would be generated if Modi-administration goes hammer and tongs after large-scale diversion of PDS food which on an average is about 50% and substantially higher in some states. On this front, emphasis on good governance and improved efficiency in administration can yield rich dividend.
Eventually, government should switch to direct cash transfer to poor if it is to make a lasting dent on food subsidy. It needs to seriously consider reducing subsidy entitlement from extant 2/3rd of population under Food Security Act (FSA) to only those who are poor i.e. 30% (as per Rangarajan formula).
As regards fertilizer subsidy, though EMC has been mandated to address this and formulate a new urea policy, the government can at least kick start the process of reforms in this critical sector by affecting gradual hike in urea selling price.