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Budget 2012: Tinkering with Subsidies

With major issues confronting the fertiliser and petroleum sector being left untouched, the small reduction in subsidy numbers in Budget 2012-13 is mere tokenism and lacks credibility. However, there seems to be some thinking in favour of direct cash transfers as a substitute for the existing structure of subsidies. It is true that this alternative has its limitations. Just the fact that an alternative is being thought about in the form of pilot studies for kerosene and some initiative is being taken in the fertiliser sector is the high point of Budget 2012-13.


Budget 2012

Tinkering with Subsidies

Mala Lalvani

With major issues confronting the fertiliser and petroleum sector being left untouched, the small reduction in subsidy numbers in Budget 2012-13 is mere tokenism and lacks credibility. However, there seems to be some thinking in favour of direct cash transfers as a substitute for the existing structure of subsidies. It is true that this alternative has its limitations. Just the fact that an alternative is being thought about in the form of pilot studies for kerosene and some initiative is being taken in the fertiliser sector is the high point of Budget 2012-13.

he issue of subsidies is one that most finance ministers tend to keep at arm’s length. The fact that Budget 2012 raised the issue and devoted fi ve paras (paras 21 to 25) to it certainly calls for appreciation. When the fi nance minister announced a cut in subsidies to 2% of GDP and a further reduction to 1.75% over the next three years, our past experience led us to believe that this would evoke sharp reactions from the beneficiaries of these subsidies. However, nothing of the sort happened. This aroused our curiosity and provided the motivation for looking at the fine print of Budget 2012 relating to subsidies especially petroleum and fertiliser (the two major subsidies after food subsidy) which the fi nance minister has hinted at putting a check on. In para 22 of the speech the fi nance minister said “The Government has decided that from 2012-13 subsidies related to food and for administering the Food Security Act will be fully provided for. All other subsidies would be funded to the extent that they can be borne by the economy without any adverse implications.”

1 Explicit Subsidies

Table 1 looks at the share of various explicitly mentioned subsidies in the budget. It shows that food, petroleum and fertiliser are the three prominent subsidies.

Table 1: Explicit Subsidies in Budget 2012 (Rs crore)

Surprisingly, despite the explicit mention of curbing subsidies the actual allocations show a hike of 34% over the previous year’s budget estimate. It is lower than the revised estimate (RE) of 2011-12 which itself overshot the target by almost 1% of GDP. Thus the fi rst impression from the budget speech, of a bold step being taken to curb the sensitive subsidies is not borne out by the budgetary allocations.

In the sections that follow we look at the issue of subsidies in the petroleum and fertiliser sectors where curbing of subsidies are hinted at by the fi nance minister in his budget speech.

2 Petroleum Subsidy

The subsidy estimates by the Ministry of Petroleum and Natural Gas are based on “under-recoveries” of the oil marketing companies, what the oil companies would have paid to buy products if they were imported from abroad (import parity). As such, the estimate for under recovery should be considered as notional losses since the actual costs incurred by oil companies are likely to be different given that their crude oil costs would not necessarily be the same as the market prices elsewhere, and they do not count refi ning profits or losses. Under-recoveries exist for liquefi ed petroleum gas (LPG), kerosene, diesel and petrol. Budgetary subsidies are provided for kerosene and LPG. The underrecoveries of petrol and diesel companies are shared by the government via oil bonds or cash assistance.

Sethi (2006) points out that all the three committees set up to look at

Actual 2010-11 Budget 2011-12 Revised 2011-12 Budget 2012-13
Major subsidies 1,64,516.32 1,34,210.85 2,08,502.94 1,79,554.10
Fertiliser subsidy 62,301.21 49,997.87 67,198.94 60,974.10
Food subsidy 63,843.79 60,572.98 72,823.00 75,000.00
Petroleum subsidy 38,371.32 23,640.00 68,481.00 43,580.00
Interest subsidies 4,680.20 6,868.47 5,791.31 7,967.65
Other subsidies 4,223.06 2,490.35 2,002.48 2,493.38
As % of total expenditure on subsidies
Fertiliser subsidy 37.87 37.25 32.23 33.96
Sincere thanks to Ajit Karnik, Abhay Pethe Food subsidy 38.81 45.13 34.93 41.77
and Romar Correa for their comments and Petroleum subsidy 23.32 17.61 32.84 24.27
suggestions. The usual disclaimer applies. Interest subsidies 2.84 5.12 2.78 4.44
Mala Lalvani ( Other subsidies 2.57 1.86 0.96 1.39
teaches at the department of economics, University of Mumbai. As % of GDP Major subsidies 2.16 Source: Budget Documents 2012-13, Expenditure Budget, Vol I. 1.52 2.36 1.78
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pricing of the sensitive petroleum products propose to free up pricing of petrol and diesel and to gradually reduce subsidies on kerosene and LPG. It is his contention that there are no net subsidies in the petroleum sector even inclusive of the “erroneously claimed” under-recoveries. Contrary to the tenor of the Parikh Committee report, the total tax collected from the petroleum sector by the central and state governments is a multiple of the combined fiscal subsidies and the claimed under-recoveries. So according to Sethi (2006) any price liberalisation must also address oil sector taxation.

Table 2 gives details of the net contribution to the central exchequer in more recent years and we find that while in 2008-09 a negative net contribution was recorded, since 2009-10 once again there is a large positive contribution. Of course if we add the sales tax paid to the state governments then even the 2008-09 figure would be a positive net contribution.

ruled out due to the wide gap between the retail price of LPG for domestic use and the market price for commercial LPG and also PDS kerosene and petrol/diesel as well as for non-PDS usage (http://www. Thus reduction of subsidies and rationalisation of prices as a general economic principle would certainly be a step in the right direction.

A look at the details of the budgetary allocations for the petroleum subsidy in Table 3 shows that allocation of subsidy on LPG, kerosene, freight is the same as the budget estimate (BE) of 2011-12 and marginally higher than the RE 2011-12. The subsidy allocated for supply of natural gas to the north-eastern region has been reduced by Rs 60 crore as compared to the BE 2011-12. One cannot help wondering what could have changed in this respect to merit this reduction! Finally, much to our surprise

Table 2: Net Contribution to Central Exchequer (Rs crore)

2008-09 2009-10 2010-11

Contribution to central exchequer due to tax/duties on petroleum products 71,190 78,443 1,03,580 Payout by government to oil marketing companies (OMCs)

  • (A) Oil bonds/cash assistance by government towards OMCs’ under-recoveries 71,292 26,000 41,000
  • (B) Subsidy on PDS SKO (kerosene) and domestic LPG 2,688 2,770 2,904
  • (C) Freight subsidy on PDS SKO and domestic LPG 22 22 22
  • (D) Gas subsidy for north-east 142 159 445
  • Total payout to OMCs 74,144 28,951 44,371

    Net contribution to central exchequer -2954 49,492 59,209

    Source: Answer to Lok Sabha Question No 588 dated 15 March 2012. Table 3: Subsidies to Ministry of Petroleum and Natural Gas (Rs crore)

    Budget Revised Budget 2011-12 2011-12 2012-13

    Subsidy on LPG and kerosene for PDS 3,050 3,000 3,050

    Freight subsidy 26 26 26

    Subsidy to oil companies for supply of natural gas to north-eastern region 564 458 504

    Total-Post APM subsidies and other expenditure (A) 3,640 3,481 3,580

    Compensation to oil companies for under-recoveries on account of sale of sensitive petroleum products (B) 20,000 65,000 40,000

    can be expected in terms of curbing subsidies to the petroleum sector.

    In the context of addressing the problem of the petroleum subsidy the fi nance minister in para 24 of his budget speech talks of pilot projects wherein direct cash transfer of subsidies are made. He points out that the Aadhaar platform has also been successfully used to validate PDS ration cards in Jharkhand. Critics of direct cash transfers are quick to point out that such money transfers are prone to being misused. There is especially the danger of it being squandered away. Several other accompanying problems of cash transfers have been raised by Kapur (2011) who argues that cash transfers may not necessarily be the best option in all cases. According to him unless discussions on transfers are part and parcel of a broader strategy, any change in favour of cash transfers will simply amount to tactical differences and not address long-term challenges. In the case of kerosene subsidies Kapur (2011) points out that with most of India’s poor using kerosene for lighting rather than cooking, might it not be better to scrap the PDS kerosene and instead of moving to cash transfers, simply provide all rural households and urban below the poverty line (BPL) households with solar lanterns. He admits that this would not address the use of kerosene for cooking purposes.

    We agree with Kapur that cash transfers must be considered as a part of a broader strategy. However, given that his scheme does not address the issue of kerosene for cooking purposes we do believe that pilot studies examining direct cash transfers to address the kerosene subsidy is an experiment worth making.

    Total subsidy to petroleum sector (A+B) 23,640 68,481 43,580

    Source: Budget Documents 2012-13, Expenditure Budget, Vol II.

    Thus, although from the numbers above it would seem that Sethi’s argument continues to hold and there is indeed a positive net contribution to the exchequer, misuse of subsidy in the sense of black marketeering of PDS kerosene and LPG is rampant. The minister for petroleum and natural gas, S Jaipal Reddy, himself admitted that the possibility of blackmarketeering/diversion of subsidised domestic LPG cylinders and PDS kerosene by unscrupulous elements cannot be the allocation for compensation to oil companies for under-recoveries has doubled from the allocation in BE 2011-12 but is lower than RE 2011-12, a balancing act it would seem. Clearly the fi nance minister is gambling on a reduction in world oil prices, hence the allocation is lower than RE 2011-12. At the same time he has played it safe by doubling the allocation for compensation of underrecoveries from BE 2011-12. All in all the allocations suggest that no major reforms

    april 14, 2012

    Following this line of reasoning, could we think of a scheme to address diesel underpricing? We could let the oil companies fully pass through the cost of producing diesel. Truck owners can claim whatever is the subsidy involved directly and have it deposited in their bank accounts. One problem which exists is that almost 90% of truck operators are single truck owners but still the number cannot be larger than the number of those who purchase kerosene. The criticism that the reimbursed subsidy will be misused (as in the case of kerosene) does not

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    apply here – if the truck owner does not use the reimbursed subsidy his business will close down. There is one more advantage in this approach – the single truck owner will have to fi le a claim for the reimbursement which will depend on the amount of kerosene/diesel purchased for which bills/receipts will be required. Of course, people will want to inflate this bill and claim a larger amount of reimbursement than what they are entitled for. But this will trap them into paying income tax: higher reimbursement claim means higher purchase of diesel; higher purchase of diesel means higher volume of business; higher volume of business means higher income which will be taxed (our approach is along the lines of the principle underlying VAT). Could this be an incentive compatible mechanism which will force truck operators to be honest? This mechanism can also be operationalised using the Aadhaar scheme which is also referred to in para 24 of the budget speech.

    In the case of petrol owners, however, this approach need not be implemented as they would have to pay the market price. When considering a scheme such as the one suggested above it must be recognised that allowing full passthrough of diesel prices will raise the cost of transportation and have an effect on inflation (see: money/report_diesel-price-hike-could- dash-rate-cut-hopes_1666145). However, this needs to be weighed against the cost of encountering the perpetual problem of under-recoveries followed by oil bonds.

    3 Fertiliser Subsidy

    The fertiliser policy of the Government of India which decontrolled phosphatic and potassic (P&K) fertilisers with effect from August 1992 led to a sharp increase in the market price for these fertilisers, a reduction in demand and an imbalance in the usage of the nutrients of Nitrogen, Phosphate and Potash (N, P&K) and the productivity of the soil. Subsequently a concession scheme was introduced for decontrolled fertilisers on an ad hoc basis which continued up to March 2010 with changed parameters from time to time. The government then introduced a “Nutrient-Based Subsidy Policy” in continuation of the erstwhile concession scheme for decontrolled P&K fertilisers. The basic purpose of the concession scheme and the Nutrient-Based Subsidy Policy has been to provide fertilisers to farmers at the subsidised prices. Under the present subsidy regime, fertilisers are provided to farmers at the maximum retail price (MRP), which is much below the actual cost of fertilisers. Accordingly, the farmers pay 25-40% of the actual cost of fertilisers and rest of the cost is borne by the government. However, the policy for urea, the key fertiliser (which accounts for 50% of all fertilisers) has remained untouched.

    In Budget 2012 the finance minister has a number of positives for the fertiliser sector such as exemption for imports, reduction in customs duty, lower tax rates on interest payments arising out of external commercial borrowings (ECBs), etc. However, the two key issues of reforms on freeing urea prices and addressing the incentive structure to make investments attractive have been left unaddressed.

    The uncertainty on price reforms in urea has discouraged new investment in the fertiliser industry for over a decade. As a result, though the demand for urea has been rising, its supply is constrained owing to absence of new investment. There has hardly been any expansion in production capacity for nearly a decade. Consequently, urea imports have risen sharply, from a meagre 0.64 million tonnes in 2004-05 to a whopping 5.21 million tonnes in 2009-10. The government’s efforts to ease import dependence by wooing fresh investment in domestic capacity addition came to naught when the new investment promotion policy, notified in September 2008, failed to receive any response. The new investment policy announced in February 2012 has reported an increase in the ceiling of natural gas prices but investors are not happy about the band of price rise that has been allowed hence the immediate reaction from the industry is somewhat muted (http://articles.economictimes.indiatimes. com/2012-02-28/news/31107942_1_mmbtu- urea-policy-gas-price).

    As regards raising the urea prices, no reform seems to be on the anvil. Raising the price of this fertiliser is probably one of the more difficult decisions to take for any government in India. A strong and vocal farmers’ lobby and serious political backing for this ruinous attachment have ensured its continuity for long ( 08223814/Ourview–Decontrolling-urea- p.html). Recently, attention was drawn to the issue of urea prices by the chairman of the Prime Minister’s Economic Advisory Council (PMEAC) C Rangarajan who has pitched for deregulation of urea prices and said that “partial reforms in the fertiliser subsidy regime of introducing nutrient-based subsidisation will not be effective unless the price of urea is decontrolled or at least raised substantially” ( com/india/news/decontrol-urea-pricesraise-excise-duty-pmeac/158626/on).

    An important positive announcement in the context of the fertiliser sector in Budget 2012 was an announcement of a mobile-based Fertiliser Management System (mFMS), which is a step towards direct cash transfers. It is true that a direct cash transfer system in the fertiliser sector suffers from limitations. Kapur (2011) argues that given that this is a subsidy that was intended not only as an inputsupport to individual farmers, but as a subsidy vital to both the agriculture sector as a whole and to the domestic fertiliser industry, we must consider the implications of this shift at multiple levels. He is of the view that while there is no doubt that India will have to move to a greater use of cash transfers, it may not necessarily be the best option in all cases. Sharma and Thaker (2010) too fi nd that a fair degree of equity exists in the distribution of the fertiliser subsidy among farm sizes. Based on their results, they justify fertiliser subsidies and question the rationale for a direct transfer of the subsidy to farmers. At the other end of the spectrum we have the study of Gulati and Narayanan (2003) who pointed out that in 1999-2000 the share of industry in the fertiliser subsidy was 54.9%. What was more disappointing was their in-depth analysis of urea plants, which drew attention to the inefficiency prevalent in the urea industry. Based on their resource cost estimates of urea plants they observe that unless the cost of production is reduced, 32% of urea production would

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    Table 4: Budgetary Allocation for Fertiliser Subsidy (Rs crore) petroleum and fertiliser sectors suggests

    Period Amount of Concession Amount of Subsidy Disbursed on Urea Total for All Disbursed on Decontrolled Fertilisers Fertilisers (Indigenous+ Imported) Total (P&K) Indigenous Urea Imported Urea Total (Urea)

    2006-07 10,298.12 12,650.37 5,071.06 17,721.43 28,019.55

    2007-08 16,933.80 16,450.37 9,934.99 26,385.36 43,319.16

    2008-09 65,554.79 17,968.74 12,971.18 33,939.92 99,494.71

    2009-10 39,452.06 17,580.25 6,999.98 24,580.23 64,032.29

    2010-11 40,766.57 15,080.73 6,453.91 21,534.64 62,301.21

    2011-12 (BE) 29,706.87 13,308.00 6,983.00 2,0291.00 67,198.94

    2011-12(RE) 34,207.94 19,108.00 13,883.00 3,2991.00 67,198.94

    the reduction is too small to make any major dent in the burgeoning subsidy bill. To add to this is the uncertainty that surrounds the budgetary numbers as the probability of its going awry on account of changes in the world price of crude and fertilisers is very high indeed.

    The ray of hope that we can spot in Budget 2012 in connection with subsidies

    2012-13(BE) 28,576.10 19,000.00 13,398.00 32,398.00 60,974.10 is not in the reduced allocations per se,

    Source: Budget Documents, Vol I, various issues.

    become economically unviable if import parity price were to prevail. With urea prices continuing to be administered nothing much could have altered in the urea plants on the efficiency front. Clearly, an issue of such importance needs a closer look and wider debate. Thus, we believe that despite limitations of the direct cash transfer system controlled experiments in the form of pilot studies and initiatives like the mFMS will help understand the issue better and be a step forward.

    Bearing in mind the issues confronting the fertiliser sector in the backdrop, we took a close look at the budgetary allocation for fertiliser subsidies in Budget 2012 (Table 4). It shows a 16% reduction in allocation for imported non-urea fertiliser; 3.5% reduction for imported urea and a 0.5% reduction for indigenous urea when compared to RE 2011-12. However, when compared to BE 2011-12 it is a hike of 42% in the case of indigenous urea and 92% in the case of imported urea. In the case of non-urea fertilisers (which are largely imported) the reduction is a mere 3% when compared with BE 2011-12. The budgetary allocations for imported and indigenous urea signal that the government does not expect any major change to happen in the fertiliser sector. Clearly the hard decisions relating to urea price policy and investment incentives in terms of a further rise in price of natural gas are not likely to come soon.

    With the two major issues confronting the fertiliser sector, viz, reforms of pricing of urea and incentives to industry for investment, being left untouched in Budget 2012 we believe that the small reduction in subsidy numbers is mere tokenism and lacks credibility. Till the major reforms on these two fronts are not addressed, the budgetary subsidy numbers are a mere guesstimate with a high probability of missing the target.

    4 Conclusions

    This article has looked at the crucial issue of budgetary subsidies, a topic that the finance minister has ventured to touch upon in Budget 2012. The stigma attached to the very issue of subsidies makes most finance ministers keep away from it. Just the fact that he did touch upon this issue calls for appreciation.

    We have argued that a look at the budgetary allocation for subsidies alone is not sufficient and it needs to be understood in the context of the issues confronting the relevant sector. This article has sought to look at the petroleum and the fertiliser subsidies against the backdrop of fertiliser and petroleum policies.

    A look at the fine print of reduction in budgetary subsidy allocations in the which we believe is mere tokenism, but in some announcements of a move towards direct cash transfer of subsidies. Pilot projects have been mentioned for petrol and the announcement of a mFMS. While direct cash transfers are not necessarily a panacea for all the ills that prevail in the fertiliser and petroleum sectors, the fact that an alternative is being thought about in the form of controlled experiments for kerosene and some initiative has been taken in the fertiliser sector is for us the high point of Budget 2012-13!


    Gulati, A and S Narayanan (2003): The Subsidy Syndrome (New Delhi: Oxford University Press).

    Kapur, D (2011): “The Shift to Cash Transfers: Running Better But on the Wrong Road?”, Economic & Political Weekly, 21 May.

    Sethi, S (2006): “Analysing the Parikh Committee Report on Pricing of Petroleum Products”, Economic & Political Weekly, 27 March.

    Sharma, V P and H Thaker (2010): “Fertiliser Subsidy in India: Who Are the Benefi ciaries?”, Economic & Political Weekly, 20 March.


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