Subsidies and Fiscal Deficit in Post-Reforms India

Subsidies and Fiscal Deficit in Post Reforms India

Jasoda Jena and Chittaranjan Nayak

ABSTRACT

The Government of India has been subsidising various economic goods, mainly

food, fertiliser and petroleum. It is argued that subsidies are responsible for

persistent high fiscal deficit over the years. The present paper attempts to study

the trend of major subsidies given by the Government of India, and then

examines whether all the forms of subsidies are uniformly responsible for fiscal

deficit or otherwise. Based on annual time series data from 1992-93 to 2012-13,

the study observes that in the post-reforms period, food and fertiliser subsidies

have grown at a sharper rate than petroleum subsidies. The regression results also

confirm that food and fertiliser subsidies have a positive and significant impact

on fiscal deficit. The analysis of petroleum subsidies is more complicated. If we

see only the explicit subsidies for petroleum products, then their rise is not

significant over the post-reforms period, except for 2008-12. However, when we

include the under-recoveries of Oil Marketing Companies (OMCs), the story of

petroleum subsidies becomes completely different. While the effectiveness of

subsidies vis-à-vis their fiscal burden need a detailed scrutiny, the present paper

argues for a National Policy on Subsidies.

Keywords: Subsidies, Fiscal deficit, Augmented Dickey-Fuller test

1.0 Introduction

The Indian government has been subsidising many industries and

products- from petrol to food-since Independence. Subsidies are given not just

from social considerations but also from economic standpoint. Subsidies to

consumers are basically welfare-oriented whereas production subsidies are

considered to be growth-oriented.

_________________________

Ms. Jasoda Jena, Department of Economics, Ravenshaw University, Cuttack.

Dr. Chittaranjan Nayak, Department of Economics, Ravenshaw University, Cuttack.

60 MANTHAN: Journal of Commerce and Management

Some recent literature has been highly critical of the ongoing subsidy

mechanism. It is argued that subsidies increase fiscal deficit and interest rates;

thereby hamper the prospect of growth of the economy. The debate continues in

the mainstream literature despite the fact that the economy is considered to be

under the grip of the neoliberal philosophy, which advocates reduction of

subsidies for fastening the growth process and bringing efficiency in the

economy. However, what has actually happened to subsidies in India is a

matter of empirical scrutiny.

The present paper attempts to examine the trend of different categories of

subsidies, and also examines if subsidies raise fiscal deficit significantly. The

remainder of the paper is organised in three sections. Section II presents a brief

review of literature. In Section III, we have given an explanation of data, key

variables and methodology. The findings of our study are presented in Section

IV, and Section V summarises.

2.0 Literature Review

The literature on the impact of different categories of subsidies on fiscal

deficit is quite divided. Some recent studies have observed that petroleum

subsidies are both “inefficient and inequitable”. They encourage

overconsumption of petroleum, delay the adoption of energy-efficient

technologies, and crowd out high-priority public spending, including spending

on physical infrastructure, education, health and social protection [Coady, et

al.2010; Anand, et al.2013; IISD, 2012, 2012a]. Corroborating the above

observation, Arze et al. (2012) find “Most of the benefits of fuel subsidies also

go to higher income groups who tend to consume more”. Recognition of these

shortcomings has led to an active debate in India as to the merits of replacing

these subsidies with better targeted measures. Therefore, fuel subsidy becomes

an inefficient instrument for protecting the poor households and ascertaining

equity (ibid).

Bhattacharya & Batra (2009) attempt to show differential impact of

international oil prices on domestic inflation and output growth in India under

two alternative scenarios. One, when domestic fuel prices are allowed a

formula-based automatic alignment with international oil prices; and two, when

Subsidies and Fiscal Deficit in Post Reforms India 61

as per the current policy, fuel prices evolve as a consequence of revisions

specified periodically by the government. By using a sophisticated vector

autoregressive framework using the technique of innovating accounting they

conclude that:

“Fuel prices if left free to adjust automatically to international price

variations will impact inflation in a more sustained fashion. The impact

of prices aligned with international oil prices in contrast with that of

government regulated prices on inflation and output growth not just lasts

longer but is also more magnified… A way out has therefore to be found

so as to implement price reform with minimum social costs.”

Sharma (2012) has analysed in detail the issues relating food subsidy in

India. He states that “food subsidy programmes in the world that has created a

relatively effective social safety net but is also under increasing criticism because

of its large contributions to government budget deficits, economic inefficiency

and poor targeting”. In order to better target food subsidies, the government had

redesigned the public distribution system, known as Targeted Public Distribution

System (TPDS), in 1997 (Mane, 2006). The Targeted Public Distribution System

invited a lot of criticisms such as exclusion of a large number of deserving

households due to problems associated with identification, exclusion and

leakages and diversion of grains, etc. (Swaminathan, 2000; Dutta & Ramaswami,

2001; Jha & Ramaswami, 2010).

As regards fertiliser subsidies, they have played an important role in

promoting use of fertilisers and contributed to significant increases in yields

although their contribution to agricultural growth and poverty reduction has

declined steadily over time (Fan et. al., 2007). Fertiliser subsidies in India have

increased significantly during the last decade. In 2008-09 India spent nearly 60

per cent of total subsidies on fertilisers and fertiliser subsidy at Rs. 99494.7 crore

was more than 3.5 times the total public investment (Rs. 28035 crore at current

prices) in agriculture (Government of India, 2012).

Different studies have taken different data and their methodologies differ.

Most of these studies have done analysis by taking absolute values of macro-

variables, which are prone to produce higher standard errors of estimation. The

present study attempts to find the inter-relationship between the growth rates of

the selected variables.


3.0 Data and Methodology

The study begins with examining the trend and growth rates of different

explicit subsidised products, viz. petroleum subsidies (PS), food subsidies (FS)

and chemical fertiliser subsidies (CS). It may be noted that data on petroleum

subsidies are available since 1992-93. The present study, therefore, has made use

of annual time series data for the period 1992-93 to 2012-13. Fiscal deficit data

have been collected from Handbook of Statistics on Indian Economy, Reserve

Bank of India; FS and CS data from Planning Commission and Ministries of

Chemicals & Fertilisers, and Agriculture, Government of India, and PS data are

collected from www.indiastat.com cross checked from Ministry of Petroleum and

Natural Gas web site

In order to measure the annual compound growth rate we have fitted

semi-log regression models for each category of subsidies on the trend variable

„t‟. The variables have been tested for stationarity by using ADF test and we have

estimated a multiple regression model to analyse the relationships among the

growth rates of the selected variables by fitting difference of the specified

variables.

4.0 Results and Discussion

As in many developing countries, use of agricultural subsidies is a highly

political and a very sensitive issue in India because it is linked to the food

security, livelihood and welfare issues of millions of small and marginal farmers.

The government continues to allocate a significant share of budget to agricultural

subsidies. The 2012-13 budgets allocated Rs. 190015 crore to subsidies food,

fertiliser, petroleum, credit, pulses, edible oils, etc., of which the first two

accounted for bulk of resources ( about 72 per cent). However, these subsidies

have been widely criticised as being inequitable, inefficient and leading to fiscal

burden.

4.1 Trends in food subsidy

Food subsidies increased from Rs. 2,850 crore in 1991-92 to about Rs.

72,823 crore in 2011-12 (Appendix Table 1), an increase of over 25 times in 21


years. Consequently, the share of food subsidies in total central government

subsidies increased from 23.3 per cent to 33.7 per cent between 1991-92 and

2011-12. As a percentage of agricultural GDP, the food subsidy increased from

1.8 per cent to 5.8 per cent during 1991-92 and 2010-11. However as percentage

of the overall GDP, it has doubled from 0.4 to 0.8 per cent from 1992 to 2012

(Figure 1). Food subsidy, which increased at an annual compound growth rate of

about 17.8 per cent during the 1990s, remained stable between 2002-03 and

2006-07 mainly due to low off-take of food grains and marginal increases in food

subsidy during the last 5-6 years. But it tripled from Rs. 24,014 crore in 2006-07

to Rs. 72, 823 crore in 2011-12 and crossed Rs. 75,000 crore in 2012-13.

4.2 Trends in fertiliser subsidy

Fertiliser subsidies in India have increased significantly during the last

decade. There has been a growing concern about steep increase in the subsidy

during the last few years. Several factors have contributed to higher fertiliser

subsidy bill but more important being steady increase in consumption, sharp

increase in prices of imported fertilisers, feedstock and intermediaries, and

unchanged farm gate prices of fertilisers for a long time. Between 2007 and 2008,

prices of all three major Fertilisers i.e. urea, di-ammonium phosphate (DAP) and

muriate of potash (MOP) increased manifold. In 2008-09, India spent nearly 60

per cent of total subsidies on fertilisers and fertiliser subsidy, at Rs. 99494.7

crore, was more than 3.5 times the total investment (Rs. 28035 crore at current

prices) in agriculture (Government of India, 2012).

The Prime minister‟s Economic Advisory Council (PMEAC) in its latest

Economic Outlook 2012/13 argued for “dismantling of fertiliser subsidy because

agricultural input subsidies are progressively losing their relevance, becoming an

unbearable fiscal burden and their role in contribution to productivity

enhancement is fast disappearing”. The share of fertiliser subsidy in total

subsidies varied from about 25 per cent in 2002-03 to about 59 per cent in 2008-

09. The fertiliser subsidy reached a peak of Rs. 99495 crore in 2008-09 and then

witnessed a declining trend. After two consecutive annual decreases in 2009-10

and 2010-11, fertiliser subsidy started increasing mainly due to rise in world

prices of fertilisers and fertiliser prices in 2011 averaged 43 per cent higher than


2010 and are expected to rise in 2012 in response to high energy prices and

strong worldwide fertiliser demand driven by rising crop prices.

Figure 1: Subsidies as per cent of GDP

Note: FS - food subsidies; CS-chemical fertiliser subsidies; PS-petroleum subsidies.

Source: FS and CS data from Planning Commission and Ministries of Chemicals & Fertilisers,

and Agriculture, Govt. of India, and PS data from www.indiastat.com cross checked from

Ministry of Petroleum and Natural Gas web site

4.3 Trend of petroleum subsidy

The unprecedented steep rise in the domestic consumption and

international prices of the crude in recent years has led to an increase in the

explicit subsidy bill for petroleum products from Rs. 5,225 crore in 2002-03 to

Rs. 68,481 crore in 2011-12. Actually the rise has been steeper during 2008-12

(Figure 1).

Diesel, kerosene and LPG together constitute almost two-third of the total

petroleum consumption in the country. Since 2002 reforms, when the

Administered Price Mechanism (APM) has been dismantled for petrol, the

government has been providing a fixed per-unit subsidy to the selected petroleum

products, viz. LPG, Kerosene and Diesel. The total petroleum subsidy shows a

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Sub

sid

ies

as p

erc

en

tage

of

GD

P

FS%GDP

CS%GDP

PS%GDP

Year


declining trend from 1999-00 to 2008-09. The increase since 2008-09 is due to

the galloping consumption of petroleum products and international oil price rise.

The trends of subsidies are almost similar when we see them as percent of GDP

and fiscal deficit separately.

4.4 Comparison of petroleum subsidy with food and fertiliser subsidies

Food and fertiliser subsidies are considered to be the other important

types of subsidies. In order to make a comparison, we have taken these subsidies

as percent of GDP and fiscal deficit, which are presented in Figures 1 and 2.

Except for petroleum subsidy, other two subsidies witnessed sharp rise as a

percentage of GDP during 2001-08. Petroleum subsidy increased exorbitantly

during 2008-11 before a fall in 2012-13. Although owing to certain reform

measures, petroleum and fertiliser subsidies have shown symptoms of fall, food

subsidy is expected to be on the rising trajectory. Considering the recent

enactment of the National Food Security Act, this is expected to rise further.

Figure 2: Subsidies as per cent of fiscal deficit

Source: Same as Figure 1.

0

5

10

15

20

25

30

Sub

sid

ies

as p

erc

en

tage

of

FD

PS as % FD

FS as % FD

CS as % FD

Year


The annual compound growth rates of these three categories of subsidies are

stated in table 1.

Table 1. Regression results of semilog trends of PS, FS and CS:

Dependant

variable

( )

Intercept

(p-

value)

Slope

coefficient (β1)

(p-value)

Annual compound

growth rate (r)

Adj R2

(p-value

of F)

PS -63.8

(0.368)

0.0364

(0.306)

3.71 0.0054

(0.306)

FS -302.714

(0.00)

0.15607

(0.00)

16.89 0.97

(0.00)

CS -282.065

(0.00)

0.1457

(0.00)

15.68 0.8897

(0.00) Note: FS= food subsidy, CS= (chemical) fertiliser subsidy, and PS= petroleum subsidy n=21,

β=exponential growth rate stated in proportion.

The annual compound growth rate (r)= [antilog( ) -1]. This is multiplied by 100 to express in

per cent. Source: Authors‟ own calculation from subsidy data sources stated in Figure 1.

The study found that food subsidy has experienced the highest per cent of

annual compound growth rate followed by fertiliser subsidy. Both these have

grown above 15% on an average, which are statistically significant (please see

the p-values). The growth rate of petroleum subsidy has been the lowest and

insignificant in this category.

4.5 Nature and relationship of FD with Subsidies

The impact of petroleum subsidies, food subsidies and fertiliser subsides

on fiscal deficit is examined by a Linear multiple regression model. Before

analyzing the regression, we have examined the stationarity of the variables by

using ADF test. For this test, all the variables have been taken in level forms (not

in percentage form). The results are presented in Table 2.


Table 2. Augmented Dickey-Fuller (ADF) Test (Trend Lag=0)

Variable Level form First difference of variables

Test

Statistic

Mackinnon

Approximate p-Value

For Z(t)

Test

Statistics

Mackinnon

approximate p-

Value For Z(t)

PS -1.149 0.6950 -3.313 0.0143

FS 2.066 0.9988 -2.044 0.2676

FD 0.351 0.9796 -4.954 0.0000

CS -0.992 0.7562 -5.415 0.000

Source: Authors‟ calculation using STATA, n=21 for level form, n=20 for first difference, trend

lag=0, PS=Petroleum subsidy, FS= food Subsidy, CS=Chemical or fertiliser subsidy and

FD=fiscal deficit

ADF test is based on the null hypotheses that there is a unit root in the

time series processes. That means the time series are non-stationary. All the

Mackinnon approximate p-values of the variables are greater than 0.1, which

indicate that these are non-stationary at level form. However, all the variables,

except for fertiliser subsidy, are stationary if we take first order difference of the

original variables. FS is not significant at any level of significance. It is to be

noted that FS is stationary at less than 5 percent level of significance if we

include drift (p value=0.0284). Thus the null hypotheses of presence of unit roots

are rejected and the variables are stationary at the first difference form.

The extent of pair-wise correlation among the selected variables is presented

through the following correlation matrix (Table 3).

Table 3. Correlation Matrix

dFD dPS dFS dCS

dFD 1.000

dPS 0.2431 1.000

dFS 0.6443* 0.2868 1.000

dCS 0.4716* -0.0113 0.0945 1.000 Source:-Author‟s calculation using STATA,

* indicates significant at 5 percent level


The study observes that as per expectation, there is positive relationship

between petroleum subsidies, food subsidies and fertiliser subsidies with fiscal

deficit and the correlation coefficients between subsidies and fiscal deficit are

significant except for petroleum subsidy.

4.6 Result of Regression

We have attempted for a multiple linear regression in order to assess the

impact of PS, CS and FS on FD. As per observation from ADF test, all the

variables are taken in first difference form. The results are stated in Table 4.

Table 4: Regression Results

Variable Coefficient Std. Error t-Statistic p-value of t

Constant -10111.63 12182.68 -0.83 0.421

dCS 1.594 0.613 2.60 0.019

dFS 7.820 2.254 3.47 0.003

dPS 0.413 0.860 0.48 0.634

Dependent variable: dFD, R2=0.5913, Adj R

2=0.5147, No. of observation=20,

F(3,16)=7.72, Prob>F=0.0021

Table 4 explains that food subsidy has the largest positive significant

impact on fiscal deficit. If food subsidy increases by Rs. 1cr, fiscal deficit

increases by Rs 7.82 crores. Similarly, the regression coefficient of CS is

significant at 1 per cent level of significance. Because the estimated slope

coefficient is 1.594, this indicates that for one crore increase in subsidy for

fertiliser, fiscal deficit increases by Rs 1.594 crore. On the contrary, petroleum

subsidy has no significant impact on fiscal deficit because the p-value is 0.634.

Further, in this equation, R2

is 0.5913. This implies that 59.13 percent variation in

fiscal deficit has been explained by the regressors CS, PS and FS. So, the null

hypothesis that food subsidy, fertiliser subsidy and petroleum subsidy do not

increase fiscal deficit is summarily rejected. The present study observes that in

case of India food subsidy and fertiliser subsidy contributes large fiscal deficit

than explicit petroleum subsidy.


4.7 A note on under-recoveries

The discussion may be conceived as half true if we do not mention a

few lines on under-recoveries of Oil Marketing Companies (OMCs). The issue

of under-recoveries was examined in detail by the Committee on Pricing and

Taxation of Petroleum Products (Rangarajan 2006). According to this report,

the difference between the cost price and realized price represents the under-

recoveries of the OMC. In fact the fiscal subsidies are very small when

compared with these under recoveries. A large part of these under-recoveries is

compensated for by additional cash assistance from the Government (over and

above the fiscal subsidy), while another portion is covered by financial

assistance from upstream National Oil Companies (NOCs), which are engaged

in exploration and production of oil and gas. The remaining portion remains

uncompensated to the OMCs.

This is noteworthy here that there has been a significant debate in India

over the appropriateness of „under-recoveries‟ as a category for measuring the

burden of current pricing policy on OMCs. In order to lessen the burden of

under-recoveries, the central Government has developed the Equitable Burden

Sharing Mechanism (EBSM). Under this, it was agreed that India‟s upstream

public oil companies like Oil and Natural Gas Corporation (ONGC), Oil India

Limited (OIL) would shoulder one third of the burden of under-recoveries. The

present study has taken explicit petroleum subsidy without reflecting on under-

recoveries of OMCs

5.0 Summary and conclusions

The study observes that in post-reforms period food and fertiliser

subsidies have grown at a sharper rate than petroleum subsidies. The petroleum

subsidy has been fluctuating since 1992, albeit there was near stability during

2004-08 after that it increased. Further to add that petroleum subsidy has not

actually increased as fast as food and fertiliser subsidies. From a closer look of

the trends of all these three major subsidies, it may be concluded that the rise in

petroleum subsidy has been the smallest, whereas food and fertiliser subsidies

have grown in double digits on an average. The regression results also confirm

that food and fertiliser subsidies have positive and significant impact on fiscal


deficit. The analysis of petroleum subsidies is more complicated. If we see only

the explicit subsidies for petroleum products, then their rise is not significant over

the post-reforms period, except for 2008-12. However, unless we see the under-

recovery component, it would be a lopsided conclusion to state anything about

trend in petroleum subsidies and their impact. The study calls for a National

Policy on Subsidies.

References

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James P. (2013). The fiscal and welfare impacts. International Monetary Fund

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Appendix Table 1. GDP, Subsidies and Fiscal Deficit (Rs. crore)

Year

GDP

Fertiliser

subsidy

Food

subsidy

Petroleum

subsidy

Fiscal

Deficit

1992-93 703723 5796 2800 5686 40173

1993-94 817961 4562 5537 6596 60257

1994-95 955385 5796 5100 6560 57703

1995-96 1118586 6735 5377 9360 60243

1996-97 1301788 7578 6066 18000 66733

1997-98 1447613 9918 7900 7480 88937

1998-99 1668739 11596 9100 8370 113348

1999-00 1847273 13244 9434 17714 104716

2000-01 1991982 9492 12010 23091 118816

2001-02 2167745 8092 17494 11140 140955

2002-03 2338200 7790 24176 5225 145072

2003-04 2622216 8521 25181 6292 123273

2004-05 2971464 10737 25798 2956 125794

2005-06 3390503 11774 23077 2683 146435

2006-07 3953276 26222 24014 2699 142573

2007-08 4582086 32490 31328 2820 126912

2008-09 5303567 76603 43751 2852 336992

2009-10 6108900 61264 58443 14951 418482

2010-11 7267000 65836 63844 38371 373592

2011-12 8353500 73790 72823 68481 515990

2012-13 9461013 65592 75000 43580 520925 Source: Fiscal deficit data from Handbook of Statistics on Indian Economy, Reserve Bank of

India; FS and CS data from Planning Commission and Ministries of Chemicals & Fertilisers, and

Agriculture, Govt. of India, and PS data from www.indiastat.com cross checked from Ministry of

Petroleum and Natural Gas web site


Appendix Table 2. Subsidies as per cent of GDP and Fiscal Deficit

Year FS as %

of GDP

CS as % of

GDP

PS as % of

GDP

PS as %

OF FD

FS as %

FD

CS as %

FD

1992-93 0.397 0.823 0.807 14.153 6.9698 14.427

1993-94 0.676 0.557 0.806 10.946 9.1889 7.571

1994-95 0.533 0.606 0.686 11.368 8.838 10.044

1995-96 0.480 0.602 0.836 15.537 8.925 11.1797

1996-97 0.465 0.582 1.382 26.970 9.089 11.355

1997-98 0.545 0.685 0.516 8.410 8.882 11.151

1998-99 0.545 0.694 0.501 7.384 8.028 10.230

1999-00 0.510 0.716 0.958 16.916 9.009 12.647

2000-01 0.602 0.476 1.159 19.434 10.108 7.988

2001-02 0.807 0.373 0.513 7.903 12.411 5.740

2002-03 1.033 0.333 0.223 3.601 16.664 5.369

2003-04 0.960 0.324 0.239 5.104 20.427 6.9123

2004-05 0.868 0.361 0.099 2.349 20.508 8.535

2005-06 0.680 0.347 0.079 1.832 15.759 8.0404

2006-07 0.607 0.663 0.068 1.893 16.843 18.391

2007-08 0.683 0.709 0.061 2.222 24.684 25.600

2008-09 0.824 1.444 0.053 0.846 12.982 22.731

2009-10 0.956 1.002 0.244 3.572 13.965 14.639

2010-11 0.878 0.905 0.528 10.270 17.089 17.622

2011-12 0.871 0.883 0.819 13.271 14.113 14.300

2012-13 0.792 0.693 0.460 8.365 14.397 12.591

Source: Same as Appendix Table 1

Subsidies and Fiscal Deficit in Post-Reforms India

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