MICROECONOMICS PROJECT

Subsidies in India: Is a case for failure of government

intervention?

Submitted to Dr. Venkatraja B

By Group No. 3 Section B

Anish S A 18066
Mallepogu Tarun Kumar 18076
Vishnu Menon R 18086
Bille Sai Dinesh 18096
Pratik B Bathia 18106
Nisarga Ganesh 18116
Contents
INTRODUCTION.....................................................................................................................................2
OBJECTIVES OF SUBSIDIES................................................................................................................3
TYPES OF SUBSIDIES............................................................................................................................3
CENTRAL GOVERNMENT 2018-2019 BUDGET ASSESSMENT.....................................................3
PRODUCERS SUBSIDIES.......................................................................................................................7
FOOD SUBSIDY.....................................................................................................................................10

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INTRODUCTION
India, at the eve of independence was left with uphill task of socio-economic development.
Markets were almost nonexistence, masses lived in abject poverty and illiteracy, we were not
producing enough food to satiate hunger of masses, life expectancy was just 32 years; in short,
there was crisis in every sphere; be it agriculture, industry, health or education; partly due to
colonial legacy. Given such circumstances, founding fathers of democratic India rightly
envisaged Indian state to be a welfare state. However, 70 years down the line only few problems
have abated, while new ones cropped up and poverty still stubbornly remains a pressing problem.

In this context, latest economic survey rightly points out that despite spending as high as 3.77
lakh crore rupees annually on subsidies there is no ‘transformational impact’ on standard of
living of masses. While subsidies have helped some poor people to do firefighting in life, main
allegation on a subsidy economy is that, through subsidies, money meant for poorest is
appropriated by richer sections of the society due to mistargeting and leakages.

Subsidies should be aimed at specific development objectives. On achievement of these

objectives subsidies should be phased out. It is only then that subsidies can go well with an
undistorted market economy.

However, in a democracy, subsidy once extended becomes a politically sensitive issue and
governments suffer huge political risk if they phase out such subsidies. Overtime, new subsidies
are extended which pile up on older ones and they soon consume scarce revenue resources of
government. This takes a heavy toll on other expenditure of the government. They are forced to
cut allocation to developmental and infrastructure avenues. Further, higher subsidy expenditure
pushes up fiscal and revenue deficits as government starts spending more than it earns. This
fiscal deficit can be closed preferably by raising more revenue through new taxes (proactively) or
by borrowing money.

Most significant consequence of either of this alternative is that money is squeezed out of
economy and which results in lower consumption/demand. This, in turn hits the growth in
economy. Less growth results in lower collection of taxes. On other hand subsidy burden
remains same or even increases. Further, higher borrowing results in higher amount of interest to

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be paid. So, in short, careless or politically motivated subsidy results in lower revenues for
government and higher unproductive expenditure.

Further, if government is unable to borrow money or to raise taxes, it will have to print new
currency to finance deficits, which increases money supply in the economy. This creates
inflationary trends in economy. Incoherent subsidy regime unintendedly does more harm than
good for the cause it stands – socio- economic development.

OBJECTIVES
The Major specific objectives are:

1. To study the types of subsidies provided by the government in India

2. To examine, compare and deciding whether the subsidies are boon or curse for
economic development.

TYPES OF SUBSIDIES
1. Direct Subsidies – Direct subsidies are given in terms of cash grants, interest-free
loans and direct benefits. For example- Direct farm subsidies are the kinds of
subsidies in which direct cash incentives are paid to the farmers to make their
products more competitive in the global markets.
2. Indirect subsidies – Indirect subsidies are provided in terms of tax breaks, insurance,
low-interest loans, depreciation write-offs, rent rebates. For example- Indirect farm
subsidies: These are the farm subsidies which are provided in the form of cheaper
credit facilities, farm loan waivers, reduction in irrigation and electricity bills,
fertilizers, seeds and pesticides subsidy.

CENTRAL GOVERNMENT 2018-2019 BUDGET ASSESSMENT

Subsidies and interest payments constitute a major portion of government’s committed revenue
expenditure. In contrast to 2017-18 (RE) when major subsidies declined by 106.2 billion from
the budget estimates in a broad-based manner, they are slated to increase by 15.1 per cent in
2018-19 mainly because of increase in food subsidies by 20.7 per cent. The share of major
subsidies is, however, budgeted to remain unchanged at 1.4 per cent of GDP in 2018-19 (BE).
Due to increase in global crude and gas prices, Petroleum and fertilizers cost may rise. Due to

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increase in MSP, there can be slight increase in Food subsidy. The budget outgo of major
subsides can reduce in medium term due to direct benefit transfer scheme and digitization
reducing the leakages.

Major Subsidies of Central Government

2016-
Items 2017(Actual) 2017-2018(BE) 2017-2018(RE) 2018-2019(BE)
Amoun
Amount Amount Amount t
(in Rs % of (in Rs % of (in Rs % of (in Rs % of
  Billon) GDP Billon) GDP Billon) GDP Billon) GDP
Total Major
Subsidies 2040.2 1.3 2403.4 1.4 2297.2 1.4 2643.4 1.4
1. Food 1101.7 0.7 1453.4 0.9 1402.8 0.8 1693.2 0.9
2. Fertilizer 663.1 0.4 700 0.4 649.7 0.4 700.8 0.4
3. Petroleum 275.4 0.2 250 0.1 244.6 0.1 249.3 0.1

FERTILIZER SUBSIDES

Intensity of fertilizer usage in terms of nutrients per hectare area and the extent of fertilization as
measured by the ratio of fertilized area to total cropped area in many developing countries
including India are lower than developed countries. However, fertilizer use has been and will
continue to be a major factor in the increasing agricultural production and productivity. The
fertilizer prices at both producer and farmer levels are determined directly or indirectly by the
government in most of the countries and such government, Interventions generally have two
basic objectives:

1. to provide fertilizers to farmers at stable and affordable prices in order to increase

agricultural production through higher fertilizer use
2. to encourage domestic production by allowing fertilizer producers a reasonable return
on their investments.

The Indian Fertilizer industry, given its strategic importance in achieving self-sufficiency of food
grains production in the country, has for decades, been under government control. With the
objective of providing fertilizers to farmers at an affordable price and ensuring adequate returns

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on investments to entrepreneurs, a fertilizer policy was envisaged of providing fertilizers to
farmers at subsidized prices to induce farmers to use fertilizer. In order to achieve this objective,
government introduced the Retention Price cum Subsidy scheme (RPS). Under RPS the retail
price of fertilizers was fixed and was uniform throughout the country and difference between the
retention price (adjusted for freight and dealer’s margin) and the price at which the fertilizers
were sold to the farmer was paid back to the manufacturer as subsidy. The RPS did achieve its
objective of development of large domestic industry and near self-sufficiency in fertilizer
production and increased consumption of chemical fertilizers but it had not been free from
criticism of fostering inefficiency leading to huge burden of subsidies.

The mounting burden of subsidies compelled the policy planners to make a serious attempt to
reform fertilizer price policy to rationalize the fertilizer subsidy. As part of economic reforms
initiated in early-90s, the government decontrolled the import of complex fertilizers such as di-
ammonium phosphate (DAP) and muricate of potash (MOP) in 1992 an extended a flat rate
concession on these fertilizers. But, urea imports continue to be restricted and canalized. Based
on the recommendations of various committees including the High-Powered Fertilizer Pricing
Policy Review Committee (HPC) and Expenditure Reforms Commission (ERC), a New Pricing
Scheme (NPS) for urea units was implemented in a phased manner from April 2003 with an
objective to bring transparency, uniformity, an efficiency and reduce cost of production.
Similarly based on the recommendations of the Expert Group on P and K fertilizers, policy for
phosphatic and potassic fertilizers has been implemented. The main objective of all policy
interventions has been to contain and target fertilizer subsidies However, estimates of fertilizer
subsidy as per Central government budgets over the years in the post-reforms era show that
fertilizer subsidy has increased significantly the estimates of major subsidies including the food
and fertilizer subsidies in the post-reforms period (1991-92 to 2008-09). It is evident form the
Table that total subsidies have increased from Rs. 12158crore in 1990-91 to Rs. 129243crore in
2008-09, an increase by 10.6 times. The fertilizer subsidy has increased from Rs. 4389crore in
1990-91 to Rs. 75,849crore in 2008-09 representing an increase of over 17 times. As a
percentage of GDP, this represents an increase from 0.85 percent in 1990-91 to 1.52 percent in
2008-09 The fertilizer subsidy in India as percentage of the GDP varied from 0.47 in 2002-03 to
1.52 percent in 2008-09. The total food subsidy has jumped to Rs. 43627crore in 2008-09 from
2450 crores in 1990-91, about 18-fold increase in less than two decades in absolute terms. But if

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one looks at the percentage of GDP, then the burden of food subsidies in India is much less than
that of many other developing countries. The food subsidy in India as percentage of the GDP has
varied from 0.41 in 1992-93 to 1.02 in 2002-03, and on an average remained at 0.66 percent over
the last 19 years.

Who Benefits from Fertilizer Subsidy?

The benefits of fertilizer subsidy are heavily tilted to large farmers growing water-intensive
crops like rice, sugarcane, wheat, cotton, in a handful of states. As per the estimates by Gulati
and Narayanan (2003), the share of farmer in the fertilizer subsidy increased from 24.54 per cent
in the triennium average ending (TE) 1983-84 to 75.62 percent in TE 1995-96 with an average
share of 67.5 percent for the period 1981-82 to 2000-01 and the rest goes to the fertilizer
industry. These estimates of share of fertilizer subsidy going to farmers and/or industry have
been computed by comparing subsidy estimates through import parity price and farm gate prices
of fertilizers with the amount of subsidy given in the Central Government budget. Some of the
recent policy announcements like the intention of the government to move to a system of direct
transfer of subsidy to the farmer are based on such findings which are based on unrealistic
assumptions. For example, the study assumes that India’s entry into the world fertilizer market as
an importer would not affect world prices and world fertilizer markets are perfectly competitive

Direct Transfer of Subsidy to Farmers

With a shift from the earlier cost-plus based approach to import parity pricing (IPP), the Indian
fertilizer industry has been exposed to the world competition and only efficient units would
survive in the brave world of trade liberalization and globalization. Since the basic notion of
about one-third of subsidy going to fertilizer industry does not hold true, the policy of direct
transfer of subsidy to farmers is neither desirable nor practically implementable. It would be
difficult to ensure that direct transfer of subsidy to millions of farmers is actually used by farmers
for only buying fertilizer and there are no leakages in transfer of subsidy. If the subsidy is not
used for fertilizer, it might adversely affect agricultural production in the country. Under the
changed scenario, it is advisable to route the subsidies through the existing mechanism which is
easy to monitor as well as ensure usage of fertilizers by all categories of farmers. Therefore,
direct transfer of subsidy to farmers is not a right policy decision. However, a new nutrient-based

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pricing policy instead of product pricing regime for fertilizers is a welcome step as it would
ensure balanced application of nutrients and growth of fertilizer industry.

Rising global oil prices could lead to the Centre’s fertilizer subsidy Bill overshooting the budget
estimate (BE) of Rs 70,079.85 crore for the coming fiscal, even as the Narendra Modi
government is unlikely to allow the rates paid by farmers to increase in its last year ahead of the
general elections in 2019.The subsidy outgo on urea and decontrolled fertilizers (whose retail
prices are not fixed) has fallen from Rs 99,495 crore in 2008-09 to Rs 66,313 crore in 2016-17.
Even for the current fiscal, the Centre had budgeted a figure of Rs 70,000 crore, which has,
however, been slashed to Rs 64,973.50 crore in the revised estimates (RE).

From the accompanying table, much of the subsidy reduction has taken place due to the slide in
global fertilizer prices from their 2008-09 peaks.

PRODUCERS SUBSIDIES
A Subsidy is a payment by the government to suppliers that reduce their costs of production
which increase their profit margin and encourages them to increase the output.

 State subsidies are financed from general taxation or by borrowing

 Subsidy causes the firm’s supply curve to shift to the right
 The amount spent on the subsidy is equal to the subsidy per unit multiplied by total
output

Showing a producer subsidy in a supply and demand diagram

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In the above diagram,

P1 and Q1 are the equilibrium price and quantity demanded respectively which are
predetermined by the market forces (demand and supply) before the government intervention
(implementation of the subsidies)

P2-Due to the implementation of the subsidies, the Price comes down from P1 to P2 thereby
increasing the quantity of the demand from Q1 to Q2

The gap between the supply curves represent the amount of the subsidy i.e. provided by the
government

Different Types of Producer

Subsidy

1. A guaranteed payment on the factor cost of a product – e.g. a guaranteed

minimum price offered to farmers such as under the old-style Common Agricultural
Policy (CAP).
2. An input subsidy which subsidises the cost of inputs or raw materials used in
production – e.g. an employment subsidy for taking on more workers.
3. Government grants to cover losses made by a business – e.g. a grant given to
cover losses in the railway industry or that of a loss-making airline.
4. Bail-outs e.g. for financial organisations in the wake of the credit crunch
5. Financial assistance (loans and grants) for businesses setting up in areas of high
unemployment – e.g. as part of a regional policy designed to boost employment
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Different Producer Subsidies given by Government

Credit Linked Capital Subsidy Scheme [CLCSS]

Many of the Small-Scale Industries (SSI) in India continue to manufacture goods and products
with outdated technology and plant & machinery due to the lack of awareness about access to
capital, quality standards and modern technology. However, the globalization and liberalization
of the market, has necessitated upgradation and modernization of equipment to ensure survival
and growth of the unit. Therefore, to facilitate the technology upgradation of SSI in India, the
Ministry of Small Scale Industries is operating a scheme for technology upgradation called the
Credit Linked Capital Subsidy Scheme.

The CLCSS provides 15% capital subsidy to SSI units for the induction of well-established and
improved technology in many of the sub-sectors/products approved under the scheme for a loan
of up to Rs.1 crore.

Subsidy for Establishing Cold Chain

A strong and dynamic food processing sector plays a vital role in reduction in the wastage of
perishable agricultural produce, enhancing shelf life of food products, enhancing income of
farmers. Therefore, to develop a strong food processing industry, the Ministry of Food
Processing Industry provides a subsidy for establishing cold chain. The objective of this scheme
is to provide financial assistance for integrated cold chain and preservation infrastructure
facilities without any break from the farm gate to the consumer. Financial assistance (grant-in-
aid) of 50% the total cost of plant and machinery and technical civil works in general areas and
75% for NE region including Sikkim and difficult areas (J&K, Himachal Pradesh and
Uttarakhand), subject to a maximum of Rs.10 crore is provided as financial assistance under this
scheme.

Capital Subsidy for Solar Lighting and Small Capacity PV Systems

The Government of India has launched the Jawaharlal Nehru National Solar Mission (JNNSM)
to promote sustainable energy generation and support the growing need for energy in India while

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addressing India’s energy security challenge. The JNNSM provides a host of subsidies and soft
loans for the promotion and penetration of solar energy generation in the nation.

Through the capital subsidy for solar lighting, the JNNSM provides capital subsidy of up to 40%
of the approved unit cost (benchmark cost) for solar lighting systems and small capacity
Photovoltaic systems. Capital subsidy of 90% of the benchmark cost, would be available for
special category states, viz. NE, Sikkim, J&K, Himachal Pradesh and Uttarakhand.

Subsidy for Acquiring Quality Management System

With a competitive global market, implementation of quality standard has become mandatory for
MSME units to successfully compete and improve profitability by optimizing internal processes.
Therefore, in an effort to increase the adoption of quality standards by Indian MSME units, the
Government of India provides a subsidy, wherein the cost of acquiring ISO Certifications like
ISO 9000 and ISO 14001 is subsidized.

The scheme provides for all units having an SSI Registration to have reimbursement of charges
of acquiring ISO-9000/ISO-14001 certifications to the extent of 75% of the expenditure subject
to a maximum of Rs.75,000/- in each case. Click here to know more about Subsidy for
Technology Quality Upgradation.

FOOD SUBSIDY
Introduction:

Food Subsidy is a financial aid supplied by a government, to industry, farmers, or consumers, to

make low cost food available to poor people. Food subsidy in India is a welfare program to feed
the impoverished. This is a mechanism, where the government uses money from its exchequer to
buy food from the farmers at a Minimum Support Price and then distributes those food items to
the poor at a much cheaper rate.

Objectives:

The main aims of this subsidy are

1. Ensure profitable prices to the farmers in order to increase food grains production.
2. Improve access to food for below poverty line people.

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 3. To stabilize food grains prices and availability in the country.

What is Minimum Support Price?

Minimum Support Price is the price at which government purchases crops from the farmers, to
safeguard the interests of the farmers.

What is Buffer Stock?

A buffer stock is a system or scheme which buys and stores stocks at times of good harvests to
prevent prices falling below a target range (or price level), and releases stocks during bad
harvests to prevent prices rising above a target range (or price level).

What is Public Distribution System?

Public Distribution System was established by the Govt Of India under Ministry of Consumer
Affairs, Food and Public Distribution to distribute subsidized food and non-food items to the
poor people of India.

Major commodities distributed include staple food grains, such as wheat, rice, sugar and
kerosene through a network of fair price shops (also known as ration shops or FPS) established
in several states across the country.

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What are Fair Price Shops?

A public distribution shop, also known as fair price shop (FPS), is a part of India's public system
established by Govt of India which distributes rations at a subsidized price to the poor. Locally
these are known as “ration shops".

What is Food Corporation of India (FCI)?

The Food Corporation of India is an organization created and run by the Government of India.
Their Objectives are as follows:

1) Effective price support operations for safeguarding the interests of the poor farmers.

2) Distribution of food grains throughout the country for Public Distribution System.

3) Maintaining satisfactory level of operational and buffer stocks of food grains to ensure
National Food Security.

4) Regulate market price to provide food grains to consumers at a reliable price.

What is CACP (Commission for Agricultural Costs & Prices)?

Commission for Agricultural Costs and Prices (CACP) is a decentralized agency of the
Government of India. It is mandated to recommend minimum support prices (MSPs) to
incentivize the cultivators to adopt modern technology and raise productivity and overall grain
production in line with the emerging demand patterns in the country.

How Food Subsidy affects economy?

The diagram below explains how the change in demand affects the change in price. In the graph,
the consumed quantity shifts from q1 to q2 due to ‟n”. And price shifts from p1 to p2 line. The
darker portion of the graph represents the inflation, n is food consumption change due to subsidy.

Demand Pull Inflation: Aggregate demand growing faster than aggregate supply.

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Fiscal Deficit

A fiscal deficit occurs when a government's total expenditures exceed the revenue that it
generates, excluding money from borrowings. With escalating economic costs, stagnant food
grain issue prices, poor targeting, increasing procurement of food grains and rising buffer
carrying cost, the food subsidy bill has reached a level that is a significant proportion of the total
government expenditure. Therefore, when the expenditure is high, there will be less savings, or
they will be deficit.
Advantages of Food Subsidies

1. Food subsidy has been the main tool for poverty alleviation in India. If government
doesn’t provide subsidized food to the underprivileged then their future generation
will be underdeveloped and undernourished leading to a huge population which can
never properly participate in the development of the nation.
2. Food subsidy has been effective in tackling malnutrition in India. With essential
pulses and cereals being delivered to APL & BPL population at subsidized rates,
government has ensured balanced nourishment to under privileged thereby providing
them support to be effective in nation building.

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 3. Buffer stock of food grains maintained by FCI provides food security to entire nation.
These can be effectively used in case of poor crop season or in surplus scenario can
be exported in international food grain market.
4. A poor crop season offers weak demand, in such a scenario, MSP ensures significant
returns to their produce and ensure financial security.

Disadvantages of Food Subsidy

1. Indian farmers are denied the opportunity to sell food grains in the international
markets through export bans thereby limiting their chances to reap profit from
fluctuation in price of food grains in international market.
2. Fiscal Deficit as expenditure increases.
3. Inflation Occurs.
4. Growing instances of the consumers receiving inferior quality food grains in ration
shops.
5. Deceitful dealers replace good supplies received from the FCI (Food Corporation of
India) with inferior stock and sell FCI stock in the black market.
6. Illicit fair price shop owners have been found to create large number of bogus cards
to sell food grains in the open market.
7. Many FPS dealers’ resort to malpractice, illegal diversions of commodities, holding
and black marketing due to the minimum salary received by them.
8. Numerous malpractices make safe and nutritious food inaccessible and unaffordable
to many poor thus resulting in their food insecurity.

Reforms on Subsidy

1. Vigilance squad should be strengthened to detect corruption, which is an added

expenditure for taxpayers.
2. F.C.I. and other prominent agencies should provide quality food grains for
distribution, which is a tall order for an agency that has no real incentive to do so.
3. Frequent checks & raids should be conducted to eliminate bogus and duplicate cards.
4. The fair price dealers seldom display rate chart and quantity available in the block-
boards in front of the shop. This should be enforced.
5. Direct Benefit Transfer has been introduced.

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Conclusion

The government has done many good projects and launched many potential schemes to offer
help on us, as consumers, and farmers, as agricultural workers and as producers. It did provide
stability for the prices of fuel, fertilizer, food and reduce poverty to a certain extent though not
completely effective. Hence, we should really appreciate help from them and make the economy
better. Food, Fertilizer and Producer Subsidies as a philosophy is not wrong whereas the
administration of these subsidies should be fool proof. It is misutilized, it is being given for
people who don’t deserve it. It is not the system which is at fault but the implementation of the
subsidy. Hence Subsidy should be given as it is good for the people especially for a developing
country like India where there is a large population living under Below Poverty Line.

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References:

1) https://ageconsearch.umn.edu/bitstream/206331/2/Sharma_Alagh68_2.pdf
2) https://www.quora.com/What-impact-will-rising-food-subsidies-have-on-the-
exchange-rate-of-the-rupee-in-India-Also-how-will-the-impact-of-food-subsidies-on-
the-Indian-economy-be-different-from-that-of-a-petroleum-subsidy
3) http://vikaspedia.in/agriculture/market-information/minimum-support-price
4) http://www.economicsonline.co.uk/Definitions/Buffer_stock.html
5) https://en.wikipedia.org/wiki/Public_distribution_system
6) https://en.wikipedia.org/wiki/Food_Corporation_of_India
7) https://www.clearias.com/public-distribution-system-pds-challenges-reforms/
8) https://cacp.dacnet.nic.in/content.aspx?pid=32
9) https://www.researchgate.net/publication/267505987_Impact_of_Food_Subsidy_o
n_Inflation_and_Growth_in_India
10) http://globalbizresearch.org/Chennai_Conference_2016_April/docs/conf%20paper/
1.%20Global%20Business,%20Economics%20&%20Sustainability/C642.pdf
11) http://www.academia.edu/15615289/A_STUDY_OF_EFFECT_OF_FOOD_SUBSIDY_O
N_INDIAN_ECONOMY

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