What is the root cause of the rising fiscal deficit and what needs to be done?
It is well known that the three major factors responsible for rising expenditures are interest payments, subsidies and defence. These rising expenditures then translate into fiscal deficits. Interest payments account for 30 per cent of total expenditures (Budget 2000-01), 36 per cent of revenue expenditures and 51 per cent of revenue receipts. Subsidies account for about 7 per cent of total expenditures, 8 per cent of revenue expenditures and 11.5 per cent of revenue receipts. Defence accounts for 17 per cent of total expenditure.

It is important to bear in mind that interest payments and subsidies affect revenue expenditures; on the other hand defence expenditures are more likely to be mainly on the capital account. Considering revenue expenditures only, interest payments plus subsidies account for 44 per cent and these take away almost 63 per cent of revenue receipts. In addition to these the burden of the Fifth Pay Commission has also been reflected in the rising expenditures.

What attempts has the government made to reduce the subsidies burden ?
One of the successful cuts in subsidies was carried in Manmohan Singh's first Budget when export subsidies were eliminated. But it can be argued that exporters were not a strong enough lobby to prevent these cuts and the crisis situation prevailing then compelled the government to take harsh measures. After that it has been very difficult to cut politically sensitive subsidies.

The recent budget has proposed cuts in food and fertiliser subsidies and it is not at all certain that the government will have the political nerve to withstand the pressures to roll back these cuts. Apart from this, it must be remembered that there are implicit subsidies that are being given by the government. Whenever the sale of public sector output/service earns less than it cost to produce, a subsidy is involved. Very little attempt is being made to tackle these implicit subsidies.

In your opinion what should the government do to make subsidies more profitable?
Targeting subsidies seems like a very good idea but it is extremely difficult to implement.

The government needs a lot of information to ensure that subsidies intended for a particular group are not consumed by others. Thus, if income is the criterion for receiving subsidised food, say for persons below poverty line (BPL), it is in the self-interest of those above poverty line to pretend to be below the poverty line.

Unless the government has full information on income levels, it will not be able to separate those above and below the poverty lines, leading to leakages.

Besides this, political parties will also be interested in making available subsidised food to their supporters.

Ideally, self-selection will lead to the best targeting of subsidies; for example, massive food-for-work programmes, food for pregnant/lactating mothers and school going children, etc.

Where do you think the major chunk of subsidies is going?
The main explicit subsidies are on food and fertilisers. But there are a significant number of implicit subsidies, which are also imposing a burden on the government.

Even though one can identify explicit subsidies easily enough, it is not easy to identify the beneficiaries of the subsidies. Thus even though food subsidies are rising, the main beneficiaries are not those who buy from the PDS.

If one looks at the reasons for rising food subsidies, it will be found that the main driving force is the continuous and often unwarranted hikes in procurement prices of foodgrains.

Since these hikes cannot be passed on to the consumers, food subsidy rises. But in this case I will argue that the main beneficiaries are the large farmers who can sell food to the government at high prices. Smaller farmers do not benefit from hikes in procurement prices since most of them are net consumers of food and hardly sell any to the government or in the market.

Will taxing agricultural income help reduce subsidies ?
Well, this will not reduce subsidies, but, since revenue collection increases, the gap between revenues and expenditures will reduce. This will ease the pressure on fiscal deficits. But if there is such a lot of protest against a marginal hike in fertiliser prices, can you imagine what will happen if the government proposes an agricultural income tax? I would welcome such a tax since currently the agricultural sector gets the best of both worlds: not only does it escape the tax net, but it also receives a lot benefits in the form of subsidies from the expenditure side of the budget.

What in your opinion should be the per cent of subsidies to GDP today?
If one considers only the explicit subsidies, the proportion of these to GDP for the fiscal year just ended is 1.3 per cent. However, as I have said above, apart from explicit subsidies the government gives out a huge amount in implicit subsidies. Now implicit subsidies have to be estimated since the amount spent on these is nowhere mentioned in the budget papers.

Some estimates put explicit plus implicit subsidies at over 10 per cent of GDP. In fact the government‘s White Paper on Subsidies stated that even if the rate of subsidisation is reduced by 50 per cent, fiscal deficits to GDP ratio will fall to about 2 per cent.

The present budget has taken some harsh measures. Will these be effective in reducing subsidy burden?
To the best of my knowledge there is no explicit export subsidy any more. One could however view the various benefits being given to the sector as implicit subsidies. To the extent that some part of export income is taxed it will add to revenue generation and help bridge the fiscal deficit. However, the steps taken to tax export income come out of our WTO requirements and do not reflect any resolve on the part of the government to curb subsidies.

Today is the PDS system effective in helping distribution of subsidies ?
As I said above a well-targeted system is very difficult to implement. Ideally one should devise a self-selection mechanism so that only the intended beneficiaries receive subsidised food. I gave examples of self-selection above. As far as the urban bias is concerned, this is a political economy issue since urban centres consist of vocal groups which demand benefits whether they deserve them or not. Over all I think the poor are going to be badly hit by the changes proposed in the recent budget.

I would have been very slow on across -the-board changes in food subsidies and been aggressive on fertiliser subsidy. Both food and fertiliser cuts are facing strong opposition from political parties. I think eventually the compromise will be that fertiliser subsidy cuts will be rolled back while food subsidy cuts will remain.

That’s a depressing scenario, but that’s what political economy considerations will dictate. I hope I am wrong here and the reverse happens.

Will reducing subsidies bring about a drop in inflation? What about the increase in the cost of living ?
Inflation may not be affected but you are right about the increase in the cost of living of those whose food subsidy has been cut. Those who depend on the PDS system will be adversely affected.