governance, political economy, institutional development and economic regulation

Posts tagged ‘subsidy’

Lighting for all by Deepawali 2018

India diwali night

Poor or profligate households are often forced to borrow for meeting current expenditure. But most borrowers ensure that they are able to fund the interest payable from current income. Not so the Government of India. In fiscal 2016-17, interest payments on government loans amounted to Rs 4.8 trillion. The government had to borrow Rs 1.4 trillion (effective revenue deficit) to meet its interest payments.

Non merit subsidies compress the fiscal space

The reason government ran short, is that it spent Rs 2.3 trillion to reduce the cost of fertilizers for farmers; supply cheap cereals to the poor and reduce the price of cooking gas and kerosene. This income transfer mechanism is leaky – it benefits many more than just the poorest; it is expensive to administer; and it leads to the environmentally disastrous overuse of fertilizer by a few farmers with assured irrigation, as in Punjab and Haryana; encourages profligate use of cooking gas and adulteration of diesel with kerosene.

FM Jaitley – a fierce, fiscal Ayatollah

Jaitley ayatollah

To be fair, Finance Minister Jaitley, has leashed subsidies since 2015-16. In 2017-18 subsidy, on these three accounts, is budgeted only marginally higher than the previous year. But, interest payments are budgeted to increase to Rs 5.2 trillion, even as the net borrowing is budgeted to decrease to Rs 1.26 trillion. Reduced borrowing is unlikely. Significantly lower than anticipated growth and lower inflation will depress nominal revenues and increase the need for loans.

But politics beckons

BJP politics

The launch, by Prime Minister Modi, of a scheme this week to connect the estimated 16% households (40 million out of 248 million) who live sans electricity, will be welcomed by the beneficiaries. But the fiscal implications are worrisome.

Two options exist. Either connect these households by distributed solar power or extend the distribution grid into their homes. Of the two, renewable supply is a better option.  It requires capital expenditure to buy equipment. But the recurrent cost on maintenance is minimal, at least for the first three years, till the battery is replaced. Of course, this is not an option if solar intensity is low; rooftops are not available or if the maintenance supply chain is dodgy.

Renewable energy micro-grids – a sustainable option

Micro grid

Some of these downsides can be met by opting for renewable energy micro grids, managed by a private franchisee. This model is used in several states, including Bihar, with which R.K. Singh, the new minister for power, is familiar. The franchisee can make a profit, even where the utility cannot, because distribution line-loss, which on average is 20%, is minimized; private workers cost less and work more than public sector workers and the renewable capital cost is subsidized.

What customers prefer is to be connected to a grid, managed by the distribution utility. This assures them that as their needs ramp up, they would get better supply on demand. The problem is of asymmetric expectations. Distribution utilities do not want more low value, domestic customers because subsidy compensation from state governments are patchy and there is no profit to be made.

Grid power – burdened by past indiscretions

Of the 41 distribution utilities, assessed by ICRA/CARE for Power Finance Corporation in 2017, as many as 22 or more than 50%, ranked below average due to unsatisfactory financials. Expectedly, most, though not all, are in the poorer states of Uttar Pradesh, Bihar, Jharkhand, Madhya Pradesh and Rajasthan, where the share of industrial and commercial load is low.  Industry pays double of what it costs to service them whilst farmers and small domestic users pay, either nothing at all, or just a fraction of what it costs to service them. High electricity prices for industry and commercial users is one reason why business flounders or opts instead for self-owned oil based generation. This is a triple whammy for Make in India; energy security and environmental sustainability. Map the highest electricity supply rates for industry across states and you will have a map of de-industrialized India.

Last year, under the Uday Scheme, 16 distribution utilities transferred debts exceeding Rs 2 trillion to their state governments. These debts had funded their annual revenue loss. Going forward state governments are to compensate the loss of distribution utilities. Increasing the number of poor customers significantly will either deteriorate utility finances or stress state government budgets.

Being stingy with current expenditure is virtuous

Electricity is different from telecom. Each additional customer comes with significant marginal cost. Nearly two thirds of the cost of supply is the cost of fuel; metering, billing and collecting; installing and operating transformers to step down electricity supply to domestic use voltage levels and wires to connect with the customer. These add to the cost and the potential for theft. All this is neatly sidestepped in mobile telephony, by just topping up your pre-paid SIM. Pre-paid meters are possible in electricity too but they are too expensive for small users and susceptible to tampering.

Union government finances are under threat in fiscal 2017-18. State governments also risk overshooting their fiscal deficit targets. Limiting current expenditure to the revenue available is an urgent, near-term objective. This is best done by deepening the Finance Minister’s stance of freezing subsidies at nominal levels, within the existing envelop. Dovetailing the renewable power generation program with the target of lighting every home by Deepawali 2018, is a sustainable and “best fit” option.

Also available at https://blogs.timesofindia.indiatimes.com/opinion-india/lighting-for-all-by-deepawali-2018/

Budget 2015: Swap higher outlays for efficient spending

jaitley dnaindia.com3  

(photo credit: http://www.dnaindia.com)

A cold Republic Day had FM Jaitley looking dapper under his stylish cap as he snuggled into his overcoat on a rain lashed Rajpath munched nuts and broodingly watched the parade go past.

PM MODI’s OFF-SWING

Was he fleshing out what he would say in his budget speech to the Indian Parliament just one month away?  Should he bowl a leg-spin veering sharply left towards equity or an off-swing veering right and towards growth? Around him, on its 66 Republic Day, Modi India was visibly exhilarated celebrating its “off-swing” to the right.

China, possibly stung by this sudden change of events, after the cozy, bon homie of the recent jhula swing on the banks of the Sabarmati, retorted by clasping Pakistan even tighter as an eternal friend. Meanwhile the Greek “loony left”, united with the “loony right” to aspire to become a sovereign debt defaulter with the rest of Southern Europe waiting to follow, should their anarchic tactic succeed.

SOVEREIGN DEBT STRATEGY

Avoiding payment by default is not a new strategy. Latin America similarly exploited the short memories of lenders with serial debt defaults.  In contrast Asia, in general and India, in particular, has been very puritanical about its debt obligations, never having defaulted even once in the last forty years, though we came close to it in 1991.

Whilst morally correct, it is unclear if this is a good fiscal strategy. Standard and Poors rates India sovereign debt BBB-, the same as Brazil (which defaulted thrice-1983, 1986 and 1990 in the last 40 years) and lower than Peru-BBB+ (which defaulted twice in 1980 and 1984). From this perspective, debt default is not about “prestige”, “national honour” or about financial rewards. It is merely a game of brinksmanship to be played with the market, if it serves us well.

Was FM Jaitley pondering the merits of doing a Latin America; borrowing recklessly to finance a populist, public investment binge, which “growth-wallahs” are crying themselves hoarse demanding?

Borrowing more is the “soft” option to reforming expenditure since tax collections have dipped. Our borrowing capacity for FY 2015-is limited by a Fiscal Deficit (FD) envelop of 3.8% of GDP, down from the target of 4.1% in the current year. Even the higher FD level severely constrained resources though this constraint remained hidden. The previous UPA-II government put so many non-fiscal barriers on investment-lengthy environmental approvals; land acquisition constraints and contractual inconsistencies which ensured that the project stream froze thereby avoiding additional cash outflows.

The present government is working overtime to unclog the pipes and clear payment arrears. These have built up over time but they do not show up in the budget. Unlike Indian companies, the government follows the “cash” and not the “accrual” accounting system. Both unpaid current liabilities and uncollected current assets are not accounted for in the annual budget. This loop hole enabled the previous government to “sell our future” by collecting arrears whilst falsely showing a robust budget allocation.

GROWTH AND INFLATION

Indian “growth-wallahs” are prepared to risk inflation if it means pushing growth to 7% from the 5.5% it is likely to record in the current year. But the trade off, at the margin, between growth, inflation and jobs is unclear. This is dangerous ground for those living on the edge.

Growth is just a meaningless number for the average citizen. Jobs are welcome of course. But we do not have a “jobs filter” that can assess competing investment.  We do not even measure changes in employment through the year. In comparison inflation is an everyday reality which the poor and the urban lower middle class have to battle with daily.

If there is a choice between growth and more inflation, the FM would be well advised to choose containing inflation to below 5% even at the cost of chugging along at a 6% growth level.

PUBLIC INVESTMENT IS HIGHLY INEFFICIENT

The real question is if the domestic and international private sector is unwilling to invest, as for example in Nuclear energy, how can it be desirable for public investment? Clearly, an unhelpful institutional context makes these investments into “lemons”. Unless the root causes of their unviability are addressed, such projects are neither good for the private nor the public sector.

Public investment stoked growth is strongly dependent on the efficiency of public expenditure and the avoidance of “pork”- gold plated projects which fail to provide social returns and jobs. Excessive investment in new renewable energy (a rapidly evolving technology) has precisely this risk.

NO BUBBLES PLEASE

Of course the stock markets will not be enthused by such fiscal caution. But who really gains from the irrational financial exuberance (or despair) of stock markets except a few savvy speculators with deep pockets- not all of them Indian either.

Real Estate is another sector which should be left to lag not lead growth. It is a safe haven for “black money” fed speculation. Five years of cheap money since 2009, high inflation and massive corruption are the drivers of the Indian realty bubble. We have to guard against such bubbles, which consume the savings of the middle class, as in Japan (1980 to 1990) and more recently in the US (2004 to 2012).

LOOKING BACK TO THE FUTURE

One stratagem to inject conservatism into the budget would be to project the FY 2015-16 budget on the growth and revenue numbers which were achieved in 2014-15.

Looking backwards to define the fiscal envelop will further constrict spending estimates. But this would be a useful, albeit unorthodox mechanism, to drive better collection of tax and non-tax revenues and contain “pork” in the spending estimates.

If there are “happy” surprises – revenue exceeding estimates or growth exceeding forecast levels, the surplus generated could be allocated to pre-defined schemes in a supplementary budget later in the fiscal year. Leaving something on the table is good strategy anyway to keep stakeholders engaged and responsive.

Our biggest worry is that populism will trump reason. Subsidies are the elephant in the room of fiscal responsibility. Rationalizing them has become a political hot potato with potentially high political costs. This is why reform needs to be both well timed and appropriately sequenced.

LIMITED REFORM WINDOW

FY 2015-16 is the only reform window available to India for the next four years. If we can’t do it now we never shall. The 2016-17 budget shall be populist since Bihar (2016), UP (2017) and then Rajasthan, Karnataka, Madhya Pradesh and Chhattisgarh go to the polls (2018) followed by National Elections in 2019.

Can we, for starters at least, legislate a cap on subsidies just as there is a medium term trend and cap on FD? We don’t know enough about the extent, substance, nature and social impact of subsidies. Why not make these aspects more explicit by changing the way in which we present the budget documents?

Two subsidy reform steps are immediately doable.

First, making petroleum prices market determined is a no-brainer in the present scenario of cheap energy. This will plug one gap in the subsidy envelop.

Second, rationalize agricultural subsidies which are provided through multiple mechanisms; assured purchase prices for cereals; cheap fertilizer; cheap power; cheap irrigation water; no tax on income and minimal tax on land. Despite these subsidies, rural wages remain low and migration to urban areas is the only options for landless workers and marginal land owners.

These subsidies have only served to create a class of elite “millionaire” farmers; a tiny fragment at the very tip of the 600 odd million strong farming community. Why not use it to better target the poor, rural folk instead? An additional advantage would be that the rural poor have a significant overlap with Dalits and Muslims, neither of which are part of the BJPs traditional support base.

Will FM Jaitley grasp the moment and push through reform or do we have to wait till 2020 for substantive change?

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