5. Subsidy Through Direct Cash Transfer- A Critique

IMC- Economic Research & Training Foundation

Working Paper Subsidy through Direct Cash Transfer - A Critique

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IMC-ERTF Economic Research & Training Foundation

IMC Working Paper Subsidy through Direct Cash Transfer - A Critique

The Policy on Direct Cash Transfer (DCT) of subsidies, initiated by the Finance Minister in his budget speech last year, is a new policy measure which will be implemented in phases with the aim to remove numerous anomalies of the present subsidy edifice by ensuring greater efficiency, cost effectiveness and better delivery of kerosene, fertilizers and LPG. This paper examines-

The Pros and Cons of the proposed DCT policy to deliver subsidies The delivery mechanism and The correct identification of the target beneficiaries.

I. The DCT Policy Framework proposed by the Government: Major Planks of DCT policy are:

One market price for subsidized goods to replace the dual pricing under the current subsidy system.

Strengthening the service delivery of subsidies to intended beneficiaries through a cost effective workable system.

Direct subsidy transfers as complementary to other welfare programmes. In sum, DCT aims to achieve Inclusive Growth in real spirit. I.1 Proposed Framework for DCT as given by the Task Force: Government intends to transfer fuel subsidy for kerosene and liquid petroleum gas (LPG) cylinders directly to the poor families instead of giving it to the state run agencies. This platform would be extended to fertilizer and public distribution system of food grains. A phase wise implementation for Fertilizer, Kerosene and LPG subsidies is recommended by the Task Force.

A Road Ahead Of Direct Cash Transfer LPG Fertilizer Kerosene

Phase I

Government to cap consumption of

subsidized cylinder per household

Software capability & technological support to

track movement of fertilizer from retailers

to farmers to be created. Information

visibility up to the retailer level is to be

facilitated.

States purchase kerosene at market

rates. Centre transfers cash based on actual offtake of

Kerosene

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Timelines

(within 3 months of approval of policy)

(Pilot Dec 11) (N.A)

Phase II

Timelines

All consumers start buying LPG at market

rates with direct transfer of subsidy into bank accounts

(Pilot Dec 11)

Infrastructure to facilitate direct cash

transfer to bank accounts of retailers to

be set up.

(Pilot June 12)

Consumers buy at market rates and

State governments to transfer cash to their

accounts

(N.A.)

Phase III

Timelines

Government to identify and target

specific segment of customers for subsidy

(As per Government approval)

Government to set up the system where

farmers buy at market rates from retailers and

get cash transfer of subsidies to their

accounts (N.A.)

Source: Interim report on Task force on DTS: June 2011

Successful implementation of such a system for Kerosene and LPG will pave the way for direct food subsidy to the BPL families at a later stage. I.2. The DCT policy will be rolled out with the help of UID and online IT based interventions which will ensure minimal errors in the delivery system of the policy. All the subsidy benefits under this scheme will be delivered through direct transfers into Aadhaar enabled Bank /Post office Accounts (AEBA) using the Aadhaar Payments Bridge. The payment mechanism will work as follows: I.3 Under this system, a person can even withdraw money at his or her doorstep from an Aadhaar enabled no frills bank account through Business Correspondents. As of now, 200 mn cards have been issued under Aadhar and by 2013, as many as 600 mn populations is expected to be covered under Aadhar.

Government Department → Sponsor Bank →Central Payment Managment System → Beneficiary’s Bank → Beneficiary

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II. Pros and Cons of the Government’s DCT Policy: Much depends on proper execution of the DCT Policy II.1 Pros: 1. Market price for essential fuel and fertilizers will replace the existing distortionary dual

pricing. 2. Market malpractices like hoarding, black marketing and adulteration thrive when prices are

controlled arbitrarily. With DCT mechanism in place, such malpractices can be restricted with one market price.

3. De-regulation in case of fuel and oil subsidies will raise participation of Oil & Gas Exploration Companies with free market pricing mechanism. Market price of LPG and Kerosene would eliminate under recovery of Oil companies and illegal diversion on LPG and Kerosene would reduce to a considerable extent.

4. Economical use of resources would be possible under DCT policy since pilferages and leakages would be minimized.

5. Aadhar based payment platform will ensure- a. Delivery of subsidies to the targeted beneficiaries. b. Eliminate pilferage, diversion, leakages of essential goods c. Introduce transparency in the delivery of the subsidies d. Bring about rapid strides in financial inclusion and thereby transform the rural

economy. II.2: Cons:

1. DCT will lead to inflation because of market linked pricing. This affects poor and also middle class adversely.

2. Where all public delivery systems have some element of leakage and diversion there is an apprehension that the cash transferred will be frittered away on wasteful expenditures.

3. In case of misuse of funds by the beneficiaries, serious problems may arise. For instance if the farmers who receive cash for fertilisers do not use it for the purchase of fertilisers, it may result in reduction in the usage, which will subsequently lead to low food grain production or shift in crop plantation (farmers may switch to cash crops) and create supply scarcities in the country.

4. The risk with free market pricing of commodities under DCT is that the increased demand pressures may shoot up the prices of essential commodities in the market resulting in high inflation situation in the country. This ultimately will increase poverty and affect the nutrition security negatively.

5. Execution requires high political willingness and there should be cooperation between state and centre. This is because, even though the policy formulation is at the Central level, the implementation is carried out by state agencies. Hence coordination among the two is crucial.

6. Also entitlements that put income into the hands of beneficiaries without simultaneously making a claim on their time in other words, money that comes in for free, without doing anything, even going through the motions of work (i.e. Procurement of goods from PDS Shop) would be used mostly for unproductive uses.

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7. An issue about male dominance has been repeatedly raised. Even though cash transfer may take place in the name of the adult woman in the household, the adult male may still extort the money for his own undesired purpose.

8. Also shortage of supply of the subsidized items may create major unrest and conflict in the country, since beneficiaries may have cash in hand but no goods to buy.

9. Managing a smooth transition to the new system including creation of new infrastructure arrangement and human resources will be a major challenge.

10. The success of DCT depends upon the healthy cooperation between the Centre and the States. This can prove to be a big challenge for implementation of DCT since any lapse would result in severe losses.

11. Direct Cash Transfer System can give rise to a situation where Inflation increases by double digits but the cash provided to the beneficiaries may increase only after extended period of time. Challenge of instant matching of subsidy with inflation. Also, if all the beneficiaries receive cash at the same time, it may result in price-rise of the essential commodities since demand will suddenly shoot up.

12. Lastly, the price volatility in the world market of the subsidized goods such as kerosene and pulses which are imported may put pressure on government to increase the amount of cash transfers, thereby adding to fiscal deficit.

III. Key Issues/Challenges to Be Addressed

1. Ensuring proper Delivery of Subsidies through DCT: Under DCT scheme the government envisions the creation of an interoperable network of 10 lakh Business Correspondent agents using the combined infrastructure of India Post and banks. Hence Banking and Postal infrastructure in the country needs to be strengthened.

1.1 Strengthening the infrastructure would involve huge costs to the banks. This should not

result in bank customers having to bear the burden or stakeholders being penalised. It would, therefore, be necessary for the government/RBI to think in terms of Incentivisation Schemes which will make it attractive for the banks to venture into the rural hinterland on their own volition and make it a win-win proposition.

1.2 In case of Delivery of subsidies, there needs to be a clear differentiation in the mechanism for delivering fertiliser, LPG, and Kerosene. In case of Fertiliser subsidies, for instance, government proposes to deliver direct cash into the UID linked Bank accounts of the farmers. But this does not ensure the usage of funds for the intended purpose. Hence, another alternative could be to transfer the subsidy amount to the farmer’s account only on the basis of UID card and proof of purchase of fertilisers. But here the problem of counterfeit receipts of purchase may arise and money therefore could be once again misutilised. To overcome these challenges, there could be another alternative: the subsidy should be directly transferred to the retailer’s account, as it is done now and on furnishing the UID, the fertiliser must be delivered to the farmer at the subsidised price.

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So also, in case of LPG, the question arises whether the DCT is to be made regardless of whether the LPG is purchased by the beneficiary.

1.3 Under DCT, there would be no need for fair price shops and it would be necessary to ensure that the existing distribution network continues either under private or a public-private model.

1.4 In case of Banks, the capacities must be expanded to handle the pressure of DCT. 1.5 The way postmen dispense money orders to individuals currently; in the same way they

can be used for delivering cash to the beneficiaries by using simple technological tools that could be used to link the UID with the cash delivery mechanism. For this purpose, the post offices need to be upgraded and postmen need to be educated about the technological tools that will be used in this regard.

2. Correct Identification of Target Beneficiaries:

2.1 Identification of Target Beneficiaries is a major challenge that needs to be tackled for the successful implementation of DCT under LPG, Fertilisers and Kerosene. The concern is that the policy framework doesn’t lay down clear guidelines about identification of target segment of beneficiaries. The important point here is ‘Who should get the subsidies?’ Under phase two for instance in case of fertiliser, LPG and Kerosene subsidies, even the rich would be allowed to avail the subsidies; which is unfair. Even though UID linkage would solve majority of issues, still most important concern about the wrongful inclusion and exclusion of beneficiaries would still persist, since the eligibility criteria are not clearly defined. Different eligibility criteria must be applied for subsidies to farmers and to households. For instance, eligibility for farmers in case of fuel and Kerosene subsidies could be the size of landholdings whether owned or leased. Only small and marginal farmers with landholdings say less than 2 hecters only may be eligible for subsidies.

Similarly government must also consider on what basis the Diesel subsidy would be delivered to the Farmer. Clear exclusion criteria for rich farmers should be worked out in detail.

Most important issue under DCT is that the fuel and Kerosene are the items of ‘family consumption’. Hence the subsidies are for families and not individuals. But the UID number will be given to the individual members of the household; hence there may be problems of duplication of payments in some cases where the individual members claim subsidies more than once and also absence of payments or denial of right to use if the head of the household is absent or denies access to the money.

The migration of population in both ways from BPL status to APL status and also from APL to BPL also poses a serious challenge in identifying the correct beneficiaries as well.

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2.2 Apart from identifying beneficiaries based on UID number, an important question arises as to how does the government will ensure delivery of subsidies to the non UID card holders? Since, nationwide UID linkage would take considerable amount of time, government must think of an alternative solution for correct identification of target beneficiaries.

2.3 The Definition of Poverty needs to be updated, modified and made suitable for subsidies under different heads. For instance, under provision of direct cash transfer for fertiliser subsidies the current definition of calorie based poverty line would not be suitable. Also while considering eligibility criteria for dispensing fertiliser subsidies, one must take into account an important fact that, small and marginal farmers do not ‘own’ the land but merely work as the labour on the land owned by the landlords or rich farmers. In that case, identifying the right farmers would be a major challenge. Another important point is that the current estimates of population below poverty line are based on year 2000 Census and hence the data is not updated and reliable.

3 Other Issues

i. How is the cash component going to be fixed? Will it be a fixed amount per person/per

farmer/per family or will it be in terms of an amount that may vary with the prevailing market price of the fertilizer/LPG/Kerosene?

ii. Transparency in governance is essential for efficient implementation of DCT scheme. There is a need for simple regulatory system for expeditious approvals. Simplification of regulatory system will ensure faster implementation of the cash transfer scheme.

iii. Political will and good governance for implementation of DCT are most essential. Hence, the economics of DCT must be completely de-linked with political motivations which is highly unlikely.

iv. Along with the DCT scheme other complementary policy reforms must be implemented in order to ensure that the programme benefits the target beneficiaries. For instance, the roadmap for Goods and Services Tax (GST) reforms should be synchronised with the roadmap of DCT, since GST will have a significant impact on the supply chain, sourcing and distribution decisions, inventory costs and cash flows, pricing policy and transactions management practices of goods and services in India. The importance of the above components in implementation of DCT is obvious with GST abolishing the entire PDS infrastructure. Hence, success of GST is linked with the success of Subsidy through DCT scheme.

v. India must see cash transfers as development grants that are to be invested in youth and stimulate growth instead of being ONLY safety nets. The DCT scheme must be implemented efficiently to reduce poverty in India. The scheme should not viewed merely as a way to provide essential items of consumption to the poor but as an opportunity to invest in human capital development of the country.

vi. The social audit of all social programmes such as DCT should be made mandatory. Here Community development organisations would play an important role in this regard. Social

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audit of the DCT scheme can be conducted through Panchayats, Self-Help Groups and Farmer cooperatives.

vii. There must be improvement in Financial Inc/Economic Inclusion- by taking demand and supply side initiatives including improving human and physical resource endowments, enhancing productivity, mitigating risk and strengthening market linkages. If this is implemented appropriately and there is proper utilization of subsidy funds then the delivery systems of the Indian food, fertilizer, LPG and Kerosene markets would be improved, both conventionally and innovatively.

viii. The cash transfers should not be seen as a substitute for state actions. States should not avoid their responsibilities by merely transferring cash to the poor. If beneficiaries use their additional income through cash transfers to buy goods and services from private actors, then states must take efforts to improve market infrastructure, in terms of access to roads or rural supply chains that would ensure that poor buyers will enjoy more choice and therefore get greater value for their money.

ix. Government must carefully consider possible exit options under which cash transfers might decrease or cease to exist, as beneficiaries’ status changes, programme objectives are met, or critical effects urge a rethink of the direction of the strategy and its interaction with other priorities. Therefore, unless sunset clauses or incentives are built into the cash transfer programmes for the target beneficiaries to move out of them, there will be a natural lock-in effect.

x. An important concern raised about implementation of DCT under Aadhar is of security breach. There have been fears about Individual security being compromised if DCT is linked with UID.

xi. Many problems that have arisen in MNREGA – similar issues may crop up in DCT– such as delays in payment, shortage of labour due to cash in hand, entry of wrong data or miscalculation.

xii. Under fertilizer subsidies, just paying money to the farmers will not ensure purchase of high quality fertilizers. This may affect the nutrient level in food grains.

xiii. In case of supply of fuel and LPG in the country, with high level of volatility in world oil prices, the availability of the above becomes a major concern.

xiv. The data about the estimates on subsidies needs to be adequate. At present various estimates on subsidies and its composition are seen. This results in chaos and ambiguity in envisaging the correct impact of DCT policy on the Indian Economy.

xv. Even though under DCT, there would be cost savings, the government under would require to allocate the cash transfer money adequately, to avoid the shortages in money supply once the scheme is implemented fully. But the question arises from where the initial cash transfer money will come from? Of course this implies a correct estimate of cash transfer amount. Will the government raise money through diversion of funds from current subsidy expenditure or out of profit from PSUs or any other government expenditure on different sectors?

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xvi. Availability and access to the subsidised commodities is a big concern to be faced while implementing DCT. The focus should be on providing access to goods and services at an affordable price.

xvii. Dispensation of cash to get converted in consumption of essential items is essential for the success of DCT programme. Learning from the experience in Haryana pilot project, points out towards the great need for establishing monitoring systems. Since, in Haryana, all the money transferred in beneficiaries’ account was withdrawn by them for purposes other than the intended ones. The post usage of funds can be ensured either by way of asking for proof of consumption before next instalment of cash for subsidies has been transferred. Another suggestion is to transfer cash, post consumption by way of reimbursement, but then liquidity issue crops up which is that, the poor households will have to arrange for money to purchase the goods in the first place to get the reimbursement.

IV. View on Conditional Cash Transfers: Conditional Cash Transfer (CCT) could be an alternate way of distributing subsidies through DCT, in India its applicability is highly questionable inspite of international experiences in Brazil, Mexico, Bangaladesh favouring the CCT. The goals and aims of such policies are generally highly contextual. IV.1 Indian Scenario: Quality of education and health infrastructure in India is a major obstacle. For instance there was a case about a primary health centre in Andhra Pradesh where a maternity ward was built. But the first delivery was done in this ward 18 years after it was built. This depicts the sorry state of infrastructure in the country. Also it is a well known fact that education infrastructure in rural India is very poor. There are hardly any secondary or higher secondary schools in the villages. Also in the existing schools they severely lack water, sanitation and other basic facilities and also face the problem of teachers’ absenteeism. All these elements pose a serious challenge in implementing CCT successfully. Under CCT, the cash transfer is discontinued if the conditions are not fulfilled. But one has to keep in mind that the schemes such as DCT are formulated with the aim of helping the poor households, hence they should not be given a discriminatory treatment. The poor in India should not be penalised for lack of infrastructure in the country. Otherwise the very purpose of these subsidies would be defeated. In countries like Brazil, Bangladesh etc. were successful in implementing CCT as they were small in size and less in Population and hence easier to manage. But India is a vast and diversified country. The dieversification is not only in terms of geography, demography and culture but there is wide diversity in terms of level of Development. Different states in India have different levels of development and hence it is practically impossible and unfair to put a universalized condition for the subsidies to be transferred under CCT.

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Conclusion: In sum, it may be stted that the DCT policy is good and necessary as it only attempts to address all the ills of the current subsidy system but also marks a big stride towards transforming India into a full-fledged market economy without a distortionary pricing system. The DCT policy also meets the the ‘STEEPLE’ parameters S- Socially desirable T- Technologically viable E- Economically feasible E- Environment friendly P- Politically expedient L- Legally in order E- Ethically correct No doubt it will result in price rise of essential goods but it is ought to be recognised that it was an artificially suppressed pricing system to begin with. However, as outlined earlier , if the policy is to be a success the four critical actions will have to precede its implementation and post implementation also. Actions prior to implementation:

1. Frame separate incentivisation Schemes- one for banks and the other for post offices (cf.para: III 1.1)

2. Decide and make transperant- The basis for fixing the cash component – is it to be market price related and if so how much—(cf. para: III 3.1)

3. Decide and make trasnperant – The delivery mechanism for each of the subsidised items. (cf. para: III 1.2)

4. Decide and make transperant – The target beneficiaries for each of the subsidised items. (cf para: III 2.1)

5. Even if the ‘Poverty Line” is not to be a basis for targeting beneficiaries, the government must have an announced definition of poverty line in terms of money income, as also calorie intake. (cf para: III 2.3)

6. Decide the basis for identifying non-UID crd holding beneficiaries. (cf para: III 2.2) 7. The road map for GST must be synchronised with the road map for DCT. ( cf para: III 3.4) 8. Devise a framework for social audit of the scheme post implementation. (cf para: III 3.6) 9. Sunset clauses should be built into the policy framework. (cf para: III 3.9)

Actions during implementation:

1. Political will to ensure firm regulatory actions to prevent inflation. ( cf para: III 3.3) 2. Transparent and firm governance of the system. (cf para: III 3.2)

Actions post implementation: 1. Mandatory Social audit must be conducted. ( cf para: III 3.6)

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To conclude, if key actions and challenges outlined in this paper are taken care of, and the pricing policy is implemented in a phased manner, DCT will be prove to be a big game changer for the government in transforming India into a globalized market economy. Annexure: In 2010-11 government had spent ` 20,496 Cr on Kerosene subsidy, ` 23999 Cr on Domestic LPG, ` 54977 Cr on Fertilisers, and `60600 on food which amounted to the total of ` 1.6 lakh Cr. In comparison to the above figures, in 2011-12, government expenditure on subsidies together amounted to ` 2.3 lakh crore.

As of now, 200 mn cards have been issued under Aadhar and by 2013, as many as 600

million population is expected to be covered under Aadhar. Around 500,000 FPS outlets FCI ends up holding over 50 mn tonnes of grains which at an average economic cost of Rs

18,000 per tonne works around Rs 90,000 cr of capital that is blocked. This gives rise to wastage due to rotting of grains as warehousing capacity is limited. FCI is today largest holder of rice and wheat and does not know what to do with these stocks.

Annual Subsidy Spending on Petroleum Products and Fertilisers (Rs crore)

Year PDS Kerosene Domestic LPG Petrol Diesel Fertilisers Food

2000-01 7,522 6,724 0 7,522 13,811 12,010

2001-02 5,310 5,830 0 5,310 12,596 17,494

2002-03 3,018 5,760 5,225 3,018 11,015 24,176

2003-04 3,751 9,158 6,292 0 11,847 25,181

2004-05 10,627 10,146 150 2,154 15,879 25,798

2005-06 15,441 11,851 2,723 12,647 18,460 23,077

2006-07 18,853 12,255 2,027 18,776 26,222 24,014

2007-08 20,080 17,186 7,332 35,166 32,490 31,328

2008-09 29,199 19,314 5,181 52,286 75,849 43,627

2009-10 18,321 16,071 5,151 9,279 61,264 52,490 Sources: MoF; Indian Public Finance Statistics: 2009-10, Table 7.8, India Expenditure Budget, Vol I: 2011-12, p 19.

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Bibliography:

Interim Report of the Task Force on Direct Transfer of Subsidies on Kerosene, LPG and Fertiliser by Finance Minister

Montek Singh Ahluwalia (2005): Planning Commission Performance Evaluation of Targeted Public Distribution System (TPDS), (pages 15-35)

Kapoor, Mukhopadhyay and Subbramanian April (2008): ‘Case for Direct cash transfer to the Poor’

Sudha Narayan, (May 2011): ‘A case for reframing the Cash Transfer debate in India’ Devesh Kapur (May 2011) : ‘The Shift to Cash Transfers: Running Better But on the Wrong

Road’ Article by Mr Arvind Subramanian in Business Standard on Feb 22, 2012 Ch. Srinivas& S. Abdul Thaha, Glocal Research and Consultancy Services Hyderabad

(2004): A study on Alternative Public Distribution System, A Novel Initiative of Deccan Development Society, (pages 13-15)

Misra S.K. &Pun.K. (1996), Food Problem, Food Policy and Public Distribution System, Himalaya Publishing House, New Delhi.

U.K.Singh (1991), Public Distribution System, Mittal Publications, NewDelhi Mishra, Bhasshal (1985), Economics of PDS in Food Grains, Asia Publication House, New

Delhi. Ministry of Consumer Affairs, Food and Public Distribution, (2010-11): DEPARTMENT OF

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Maharashtra, (2010-11): Economic Survey of Maharashtra, (pages 33-52) SudarshanIyengar (2003): Gujarat Institute of Development Research Gota, Ahmedabad -

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United Nations Development program, India (2009): Conditional Cash Transfer Schemes for Alleviating Human Poverty: Relevance for India, Annexure I: CCT Schemes in Select Countries.

Dr. S. Nakkiran (2003): Principal (Retd.) TBML Collage, Porayar, TamilNadu- A Study on the Effectiveness of Public Distribution System In Rural Tamilnadu (pages 11-34)

Article by Dr. Swaminathan Aiyer: ‘Cash Transfters are a good idea but hasten slowly.’ http://swaminomics.org/?p=1960

http://forbesindia.com/article/briefing/are-direct-cash-subsidies-better/23422/1 http://www.thehindu.com/news/national/article2161785.ece http://indiagovernance.gov.in/blog/?blog=24 http://pdscvc.nic.in/Annex

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