Budget 2022: The Government's Burgeoning Subsidy Bill

India's subsidy bill is likely to see a steep upward revision in FY22.

<div class="paragraphs"><p>Sacks of wheat sit under tarps while being stored in the open at the site of a Food Corporation of India grain warehouse as signage for the government agency is displayed at the site's entrance in Sonepat, Haryana, India, on Monday, July 28, 2014. Photographer: Prashanth Vishwanathan/Bloomberg</p></div>
Sacks of wheat sit under tarps while being stored in the open at the site of a Food Corporation of India grain warehouse as signage for the government agency is displayed at the site's entrance in Sonepat, Haryana, India, on Monday, July 28, 2014. Photographer: Prashanth Vishwanathan/Bloomberg

As the Covid crisis battered the Indian economy, the central government has had to step up expenditure on subsidies and social welfare programs.

This expenditure, which soared in 2020-21, is expected to remain high in the revised estimates of the current fiscal year. With the economic recovery incomplete, some of these increased commitments may linger on in the new financial year as well.

Expenditure on food, fertilisers and petroleum, which is the government's largest revenue expense after interest payments, soared to nearly 3% of GDP in FY21.

  • Together, the government spent an estimated Rs 5.95 lakh crore on these items in FY21 — a 161% increase over the pre-Covid year.

  • In FY22, the government had hoped to bring down the expenses on subsidies to Rs 3.35 lakh crore or about 1.5% of GDP.

During the year, however, the government has had to step up commitments towards free foodgrain and has announced additional subsidy on fertilisers.

  • Free foodgrain, under the Pradhan Mantri Garib Kalyan Anna Yojana, is being provided until March 2022. The estimated outgo on this is Rs 3.9 lakh crore, higher than the budget estimate of Rs 2.4 crore for food subsidies.

  • The government has also increased the amount of fertiliser subsidy it provides amid rising prices. This could push the fertiliser subsidy bill to an all-time high of Rs 1.4 lakh crore, compared to the budget estimate of Rs 79,530 crore.

As a result, the total subsidy outgo is estimated at Rs 5.4 lakh crore, according to rating agency ICRA.
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Debate Over Subsidies: Merit Vs. Non-Merit

For years, India has debated the extent and nature of subsidies the government should provide. An attempt to bring down the subsidy bill to close to 2% of GDP had prompted the unwinding of subsidies on fuel products like petrol and diesel.

As a result, the share of fuel in the government's total subsidy bill has reduced to just 3.9% as of the budget estimates of FY22.

Food now accounts for 72.4%, while fertliiser accounts for 23.7% of total subsidies.

A subsidy is anything where the government provides services to the public and does not recover its costs, said Sudipto Mundle, senior advisor at NCAER and member of the Fourteenth Finance Commission. Food, fertiliser and petroleum are visible subsidies, separately carved out in the budget.

Not all subsidies are undesirable. In a research paper published in September 2020 titled "Subsidies, Merit Goods, and Fiscal Space," authors Sudipto Mundle and Satadru Sikdar wrote that for some goods and services, the social benefit of subsidising consumption is high. "For such items, a subsidy is socially desirable to induce private consumption beyond the level dictated by the private cost-benefit calculus at market prices."

The authors label subsidies for primary and secondary education, health services, and food as merit subsidies. All others are treated as non-merit subsidies.

As such, while food is a merit subsidy and increased bill for that may be justified, fertilisers subsidy is classified as non- merit and may need to be brought down.

Fertiliser subsidy appears to benefit fertiliser companies rather than the farmers it is intended for.
Sudipto Mundle, Senior Advisor, NCAER

The cost of fertiliser production in India is high and a lot of these companies, including public sector undertakings, would have to shut if they had to compete with fertiliser imports, he said.

Instead Mundle suggests income transfers to farmers. "They are less patronising, more transparent and with fewer leakages."

Mundle also suggests looking at subsidies in aggregate, including those provided by the centre and states. As a percentage of GDP, subsidies by the centre have declined over the years, as per Mundle. However, in the case of states, the picture is mixed, with no clear signs of a reduction on an aggregate.

Non-merit subsidies by the centre and state still amount to over 5.7% of GDP, according to analysis by Mundle and Sikdar.

As such, "rationalisation of the prevailing large volume of non-merit subsidies should constitute a major component of deep fiscal reforms," the paper said. Such reforms could free up the fiscal space needed to address the challenge of declining growth since 2017-18 — a challenge that has been greatly aggravated by the Covid-19 shock, and the stringent nationwide lockdown which followed.

Some reduction in the central government's subsidy burden may be seen in the upcoming budget.

Food subsidies may reduce if the additional free foodgrain provided during the Covid crisis is withdrawn. Fertiliser subsidies, however, may remain high, ICRA's Aditi Nayar warned.

The budget estimate for food subsidy is likely to be approximately Rs 2.5 lakh crore. While the requirement for fertiliser subsidies is estimated at Rs 1.4 lakh crore.
Aditi Nayar, Chief Economist, ICRA

Rising Social Spends

Alongside the rising subsidy bill, the government has also had to commit more towards social welfare spending.

For instance, spending on two of the largest social schemes—MGNREGA or the rural jobs guarantee scheme—and PM Kisan, rose by 46.5% to Rs 1.76 crore as per revised estimates for FY21. In FY22, the schemes were together estimated to cost Rs 1.4 lakh crore.

Here too, the government has had to step up expenditure under MGNREGA as demand for work under the scheme has remained elevated amid weak labour markets especially for the informal sector. As a result, the budgeted spend on providing rural jobs will rise to an estimated Rs 95,000 crore this year.

Economists expect this component of spending to ease only once the pandemic subsides.

"When an economy is in as much distress as India has been during the last two years on account of the pandemic, social support was bound to go up to save lives and livelihoods," R Nagaraj, visiting professor at the Centre for Development Studies, said. But these expenditures will peter off as the economy springs back to life.

Government Expenditure: Revenue vs. Capex

Will the higher revenue expenditure, unless balanced by a cut in other items, squeeze out the government's ability to step up capital expenditure?

Radhika Pandey, senior fellow at NIPFP, doesn't think so.

In the upcoming budget, spending on subsidies will be on need basis but the government's stated priority remains to increase capex, Pandey said. "Between increasing social welfare spending and the need to enhance capex, the two are not competing expenditures and capex remains the priority," she said.

Pandey also believes that the increased spending on both subsidies and social welfare schemes will not throw the government's budget math off-track. "Revenue has remained buoyant and the fiscal deficit target is unlikely to veer too far from what has been estimated," she said.

The medium term fiscal policy statements, in the past, have articulated the need to trim the subsidy bill. "While we may not be able to get a clear articulation on that in this budget because of the pandemic and the need of the hour, reducing that spend will once again be in focus in later budgets," she added.

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