Subsidies:

Why, How Not & How?

by
Dr Kirit S Parikh
Member, Planning Commission

Subsidies: Why, How Not & How ?

Subsidy is not a dirty word
Many subsidies are introduced for legitimate and
sensible reasons
However they get hijacked, get distorted, become
wasteful, inefficient and do not reach the target group
In fact they become counterproductive so that the end
impact on target group is often negative
Subsidy should be provided in ways which do not lead to
degeneration

Power Subsidy
Intended to benefit farmers; have led to massive problems:
Unmetered supply to farmers, provided cover for pilferage, the so called
T&D losses now range from 35 to 45 percent in different State
Electricity Boards (SEBs)
The SEBs are financially sick and cannot invest in expanding capacity
Leads to poor quality supply, frequent breakdowns, voltage fluctuations
and cost on the users.
The burden of subsidies in many States exceeds what the State spend on
health, irrigation capacity expansion and rural development
expenditure
As a percentage of State fiscal deficit power sector subsidies to agriculture
is almost 35 percent in Madhya Pradesh and exceeds 25 percent in
many States.

Costs to Farmers of
Poor Power Quality
Electricity available for as little as 4 hours per day
In Haryana transformer failures have a rate of 26 percent,
repairs of transformers take 10 days during which farmers
have no supply
In Andhra Pradesh burnout rate is 29 percent
* Farmers have to invest in
high capacity pumps
diesel back up
frequent repairs

Farmers cannot get maximum returns from irrigation

What they save in electricity tariffs they pay more in other
costs

Minimum Support Price

The support price today for wheat and rice leads
the farmers to produce more
However at this price consumers do not demand
all the wheat and rice that farmers produce
To support the MSP the Government through FCI
buys surplus wheat and rice when cost
increase
Government has to finance this and investment in
agriculture such as irrigation goes down
In the long run agriculture suffers

Increase MSP of Wheat & Rice

by 10 %: What would happen?
Examined through simulation by a
computer model

MSP Increase by 10 %
Results: Macro Impacts

Negligible increase in agricultural GDP

Non-agricultural GDP falls by 0.45%
Overall GDP falls by 0.33%
Aggregate price index increases by 1.5%
Investments lower by 1.9%
Government expenditure on stocks increase by
35.6%
Gross irrigated area lower by 0.14%
Gross cropped area lower by 0.03%

MSP Increase by 10 %
Results: Impacts on Rice & Wheat
Output higher - rice by 1.6% & wheat by 2.6%
Only in the year immediately after the price hike
Output growth not sustained due to fall in agricultural investments and
irrigated area

3% to 3.5% rise in price at all levels - producer,

ration & consumer prices
Overall consumption of rice & wheat falls BUT
Self-consumption actually increases
Ration and market purchases decline

Stocks of wheat and rice higher by 16.5 m.t. in the

3rd year-reaches 66.6 m.t.

MSP Increase by 10 %
Results: Welfare Impacts
Significant increase in population in the poorer classes-both rural
& urban
Average per capita equivalent income declines immediately after
price hike, but increase later on
Welfare comparisons using Willig and Bailey (1981) approach
Takes into account changes in both equivalent incomes and
population proportions across classes
Welfare worsens for
Bottom 80% of rural population
All of urban population
Welfare loss in a regressive manner

Fertiliser Subsidy
Why Subsidize?
To promote HYV
To compensate for Low Output Price

Retention Price Scheme (RPS)

12% post-tax return on net worth at 85% capacity
utilization
Price fixed per fertilizer factory
To promote self-sufficiency
1950 51
1966 67
1999 00

0.04 mt (nutrients N+P+K)

0.43 mt
14.89 mt

Consequences of RPS
High Costs
No incentive to be efficient
Inflate costs
Understate capacities
- Average capacity utilization of urea plants > 120
some > 140%
- 1988: 3 plants, same capacity of 7.26 lakh T Urea

Capital Cost
Public
507 crores
Coop
648 crores
Private
702 crores

Variable costs can also be negotiated.

All Expert Committees have

recommended against UNIT WISE RPS

1977
1986
1987
1992
1991
1998

FPC did not recommend

unit wise RPS
High Powered Committee of
Secretaries
HPC on Fertilizer Prices
BICP study
JPC
HPRC

Impossible to Administer
Range of RPS for UREA (1/1/2000)
Plants

Feed
stock

Variable
Cost

Conv. Cost

Cap.
Cost

Retention
Cost

16

GAS

1702 to
7964

480 to
1218

573 to
4790

3582 to
9754

12

Naphtha

5325 to
13685

535 to
1718

378 to
4015

10182 to
18722

F.O.

5768 to
8690

788 to
2093

425 to
1077

7633 to
11208

Distribution of Operated Area 1992

Operated Area
per hh. (ha.)

Cumulative percent
of households

20

< .2

42

< .5

55

<1

70

<2

84

< 10

99

All

100

All farmers use almost same

fertilizer / hectare
Size class of
farmers

Total area
operated
(000 ha.)

Fertilizer applied (kg.

of nutrient per ha.)

Total fertilizer consumed

(000 tonnes nutrient)

N+P+K

N+P+K

Irrig. 13037

74.51

112.59

975

1468

Unirrig 16446

25.81

40.12

430

660

Irrig. 13288

71.36

109.26

980

1452

Unirrig. 20081

23.00

36.50

460

733

74.22

111.74

4800

7065

30.55

2000

3268

Marginal

Small

All groups
Irrig. 63224
Unirrig. 106973

Source: Based on input survey (1991-92)

Food Subsidy: PDS

Value = (Market Price Ration Price) *
Quantity of ration purchased
In most States less than Rs. 3 per person per
month (1986-87)
Same amount for bottom 80 percent
Less than 20 paise reach the poor out of every
rupee spent on subsidy
1/3 sold in the black market: because an honest
ration shopkeeper cannot survive

Employment Guarantee Scheme

In Maharashtra since mid 80s experience

50 paise out of a rupee reach the poor

Demand for employment adjust to agriculture
employment

Thus it is self targeting, self adjusting and self liquidating

In conclusion, subsidies when

needed should be provided in
ways that are
self targeting, self adjusting
and self liquidating.