Subsidies: Why, How Not & How?

by Dr Kirit S Parikh Member, Planning Commission

Subsidies: Why, How Not & How ?Subsidy is not a dirty wordMany subsidies are introduced for legitimate and sensible reasonsHowever they get hijacked, get distorted, become wasteful, inefficient and do not reach the target groupIn fact they become counterproductive so that the end impact on target group is often negativeSubsidy should be provided in ways which do not lead to degeneration

Power SubsidyIntended 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.

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Costs to Farmers of Poor Power QualityElectricity 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 supplyIn Andhra Pradesh burnout rate is 29 percent

* Farmers have to invest in high capacity pumpsdiesel back upfrequent repairsFarmers cannot get maximum returns from irrigationWhat 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 ImpactsNegligible increase in agricultural GDPNon-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 & WheatOutput higher - rice by 1.6% & wheat by 2.6%Only in the year immediately after the price hikeOutput growth not sustained due to fall in agricultural investments and irrigated area3% to 3.5% rise in price at all levels - producer, ration & consumer prices Overall consumption of rice & wheat falls BUTSelf-consumption actually increasesRation and market purchases declineStocks 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 ImpactsSignificant increase in population in the poorer classes-both rural & urbanAverage per capita equivalent income declines immediately after price hike, but increase later onWelfare comparisons using Willig and Bailey (1981) approachTakes into account changes in both equivalent incomes and population proportions across classesWelfare worsens forBottom 80% of rural population All of urban populationWelfare loss in a regressive manner

Fertiliser SubsidyWhy Subsidize? To promote HYV To compensate for Low Output Price

Chart1

99.9999599.999996299.99999885

106.337975108.196717291.48936065

107.0422112.295077791.48936065

110.563325116.393438299.99999885

114.08445119.672126699.99999885

116.90135122.95081599.99999885

121.830925131.14753699.99999885

128.873175151.639338599.99999885

158.450625168.032780599.99999885

193.661875188.524583130.21276446

232.39425221.311467117.44680716

246.47875254.098351117.44680716

253.521278.688514141.27659412

271.83085297.5409723141.27659412

334.506875311.475398155.74467906

359.15475340.1639215155.74467906

387.32375360.6557241998-99

Pro. Price Wheat

Pro Price Rice

Urea Price Farmgate

Index of Procurement Prices of Wheat & Rice and Farmgate Price of Urea

Self Suff Ratio in Fertz.

Self Sufficiency Ratios in Fertilizer

ConsumptionProductionDom Prod/ConspDom Prod/Consp

YearNPNPYearNP

1981-8240.6913.2231.449.491981-820.7726714180.7178517398

1982-8342.2414.3734.249.81982-830.81060606060.6819763396

1983-8452.0517.334.8510.481983-840.6695485110.6057803468

1984-8554.8718.8639.1712.641984-850.71386914530.6702014846

1985-8656.6120.0543.2814.281985-860.76452923510.7122194514

1986-8757.1620.7954.116.61986-870.94646606020.7984607985

1987-8857.1721.8754.6616.651987-880.95609585450.7613168724

1988-8972.5127.2167.1222.521988-890.92566542550.8276368982

1989-9073.8630.1467.4717.961989-900.91348497160.595885866

1990-9179.9732.2169.9320.521990-910.87445291980.6370692332

1991-9280.4633.2173.0125.621991-920.90740740740.7714543812

1992-9384.2728.4474.323.061992-930.88168980660.8108298172

1993-9487.8926.6972.3118.161993-940.82273296170.6804046459

1994-9595.0729.3179.4524.931994-950.83570001050.8505629478

1995-9698.2328.9887.7725.581995-960.89351521940.8826777088

1996-97103.0129.7785.9925.561996-970.8347733230.8585824656

1997-9810939.15100.8629.761997-980.92532110090.7601532567

1998-99113.5441.12104.831.441998-990.92302272330.7645914397

1999-2000124.7549.08110.6733.451999-20000.88713426850.6815403423

Self Suff Ratio in Fertz.

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N

P

Year

Self Sufficiency Ratios for N and P(Domestic Production / Consumption)

Normalized Fig.

YearWheatRiceUrea Price FarmgateCol G/Col H

1982-83100.00100.00100.00100.00

1983-84106.34108.2091.49112.35

1984-85107.04112.3091.49106.78

1985-86110.56116.39100.0090.57

1986-87114.08119.67100.00123.89

1987-88116.90122.95100.00152.81

1988-89121.83131.15100.00141.05

1989-90128.87151.64100.00182.69

1990-91158.45168.03100.00188.69

1991-92193.66188.52130.21177.87

1992-93232.39221.31117.45155.73

1993-94246.48254.10117.45155.71

1994-95253.52278.69141.28214.15

1995-96271.83297.54141.28310.25

1996-97334.51311.48155.74

1997-98359.15340.16155.74

1998-99387.32360.66

Normalized Fig.

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Pro. Price Wheat

Pro Price Rice

Urea Price Farmgate

Index of Procurement Prices of Wheat & Rice and Farmgate Price of Urea

Normalized Value

0.04255319156274.3129627306

Procurement PricesUria PriceImport ParityUria Prod.Cost of Uria Prod.Value added in AgriRatio

YearWheat (Rs/Quintal)Rice(Rs/QuintalFarmgate(Rs/PMT)(Rs/PMT)(000 tonnes)at Import Parity Price in Crsat Current Price (Rs.Crs.)

1982-8314212223501308.786019.9788494351.6

1983-8415113221501771.246073.81076600781.8

1984-8515213721501620.476687.91084636801.7

1985-8615714223501317.717467.3984681631.4

1986-8716214623501489.919576.61427722592.0

1987-8816615023502009.739834.81977811582.4

1988-8917316023501914.5211867.122721010632.2

1989-9018318523502613.891248632641120902.9

1990-9122520523503086.212835.939611317273.0

1991-9227523030603426.3612831.343961550862.8

1992-9333027027603273.3113125.942971731072.5

1993-9435031027603791.8413150.249862009262.5

1994-9536034033205626.3914137.179542330453.4

1995-9638636333207770.7715805.6122822483854.9

1996-9747538036607308.3615628.711422

1997-9851041536605855.2518594.510888

1998-9955044019292.20

Procurement PricesProcurement PricesUria Price

YearWheatRiceFarm GateCol G/Col H

1982-8399.9999599.999996299.999998859999.713754762

1983-84106.337975108.196717291.4893606511235.4018997951

1984-85107.0422112.295077791.4893606510678.0977305579

1985-86110.563325116.393438299.999998859057.3452998362

1986-87114.08445119.672126699.9999988512389.2671033661

1987-88116.90135122.95081599.9999988515280.5185359522

1988-89121.830925131.14753699.9999988514105.1758140466

1989-90128.873175151.639338599.9999988518268.7969487482

1990-91158.450625168.032780599.9999988518868.6909339242

1991-92193.661875188.524583130.2127644617786.7760007378

1992-93232.39425221.311467117.4468071615572.8384610952

1993-94246.47875254.098351117.4468071615570.8529491479

1994-95253.521278.688514141.2765941221414.9247710623

1995-96271.83085297.5409723141.2765941231025.2904970933

1996-97334.506875311.475398155.744679060

1997-98359.15475340.1639215155.744679060

1998-99387.32375360.6557240

Normalized Value

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Cost of Urea at Import Parity Price as a Percent of Value Added in Agriculture

Fer. Sub. as % of GDP

Fertilizer SubidiesGDP at Current PriceFertilizer Subidies

Yearin (Rs Crs)(Rs Crs)Yearas % of GDP

1980-815051224271980-810.41

1981-823751442311981-820.26

1982-836051588511982-830.38

1983-8410421859911983-840.56

1984-8519272078691984-850.93

1985-8619242341591985-860.82

1986-8718972600301986-870.73

1987-8821642948511987-880.73

1988-8932013527031988-890.91

1989-9045424086611989-901.11

1990-9143894778141990-910.92

1991-9248005527681991-920.87

1992-9357966307721992-930.92

1993-9444007813451993-940.56

1994-9552419141941994-950.57

1995-96623510672201995-960.58

1996-97609312372901996-970.49

1997-981002613844461997-980.72

1998-991138816123831998-990.71

Fer. Sub. as % of GDP

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Fertilizer Subidies

Year

Fertilizer Subidies as % of GDP

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 510.04 mt (nutrients N+P+K)1966 670.43 mt1999 0014.89 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 CostPublic507 croresCoop648 croresPrivate702 crores

Variable costs can also be negotiated.

All Expert Committees have recommended against UNIT WISE RPS 1977FPC did not recommend unit wise RPS 1986High Powered Committee of Secretaries 1987HPC on Fertilizer Prices 1992BICP study 1991JPC 1998HPRC

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

PlantsFeed stockVariable CostConv. CostCap.CostRetention Cost16GAS1702 to 7964480 to 1218573 to 47903582 to 975412Naphtha5325 to 13685535 to 1718378 to 401510182 to 187226F.O.5768 to 8690788 to 2093425 to 10777633 to 11208

Distribution of Operated Area 1992

Operated Area per hh. (ha.)Cumulative percent of households020< .242< .555< 170< 284< 1099All100

All farmers use almost same fertilizer / hectare

Source: Based on input survey (1991-92)

Size class of farmersTotal area operated(000 ha.)Fertilizer applied (kg. of nutrient per ha.)Total fertilizer consumed (000 tonnes nutrient)NN+P+KNN+P+KMarginalIrrig.1303774.51112.599751468Unirrig1644625.8140.12430660SmallIrrig.1328871.36109.269801452Unirrig.2008123.0036.50460733All groupsIrrig.6322474.22111.7448007065Unirrig.10697330.5520003268

Food Subsidy: PDSValue = (Market Price Ration Price) * Quantity of ration purchasedIn most States less than Rs. 3 per person per month (1986-87)Same amount for bottom 80 percentLess than 20 paise reach the poor out of every rupee spent on subsidy1/3 sold in the black market: because an honest ration shopkeeper cannot survive

Employment Guarantee SchemeIn Maharashtra since mid 80s experience

50 paise out of a rupee reach the poorDemand 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.

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