Do a FRBM on subsidies, Mr FM, put a cap on the subsidy bill

http://firstbiz.firstpost.com/budget/budget-2014-mr-jaitley-do-a-yashwant-sinha-on-subsidy-enact-a-law-to-cut-it-progressively-89938.html

President Pranab Mukherjee, once the finance minister, has often been blamed for the mess the economy itself is in. Why, even his successor from his own former party, P. Chidambaram, has often hinted that the economy may have been in better shape if the fiscal easing that Mukherjee had done in the wake of the global meltdown had been reversed a year earlier than it ultimately was.
But one has to give credit to Mukherjee for one initiative in his last budget in March 2012, which has not got the attention it deserved. Dealing with the vexed issue of subsidies, Mukherji had said he would try to restrict the subsidy bill of the Centre to under 2 per cent of GDP in 2012-13 and bring it down to 1.75 per cent of GDP over the next three years.
It is another matter that the subsidy bill in 2012-13 actually shot up to 2.54 per cent of GDP, up from 2.41 per cent in 2011-12. Mukherjee could perhaps disown responsibility, using the excuse that he had moved to Rashtrapati Bhavan within a few months of that landmark statement.
But it is a pity – and a surprise - that Chidambaram did not take this ball and run with it. After all, he had, in his first stint in North Block in the United Front government backed by the communist parties, made bold to commission a discussion paper on government subsidies. He got an update done in 2004 soon after assuming charge during his second shift. In both his stints – and in between – he had constantly stressed the need to trim this bill.
Capping the subsidy bill is a sound idea and one that Arun Jaitley needs to push. It imposes a measure of discipline on the government, saying this is all the cloth you have, now cut it in a manner as to make the most of it. Decide which subsidies are more important, give more to those, less to the others but all within this limit.
Mukherjee took the initial step; Jaitley needs to take the next one and get legislative backing for this, something similar to the Fiscal Responsibility and Budget Management (FRBM) law. Once the cap is set – to be achieved in a phased manner over a period of time like Mukherjee suggested - any move to spend more than the cap will have to be get parliamentary approval. How will this help?
Right now the subsidy burden is a problem of only the government in power. When it attempts any trimming exercise, the rest of the political class comes together to force it to roll back subsidy cuts. Getting legislative backing for a subsidy cap will force Parliament to debate on an appropriate ceiling. Hopefully, it will be one that will not threaten macroeconomic fundamentals. Indeed, the very process of debating the need and level of the cap will reinforce the logic of reining in subsidies, highlight wasteful and unjustified ones, bring out hidden ones, strengthen the case for the necessary ones and focus attention on effective delivery. Importantly, the ownership of that cap will be that of Parliament as a whole.
Since breaching this cap will also require parliamentary approval – an exercise that will involve going through the legislative rigmarole – governments will not be so cavalier in infringing it. This might force more serious efforts at ensuring that only the really deserving get subsidies.
And even if a government does go back to Parliament, once again the entire debating process will again highlight its own inefficiencies and put a black mark on its fiscal performance. So it will try to come back on track soon.
This does sound too easy and good to be true. After all, Parliament did legislate the FRBM Act. And Parliament itself allowed it to be breached. But no party is denying the legitimacy of the milestones set in the FRBM Act and the fact that the UPA government breached it is something that it is constantly pilloried for. The whole process of legislating the FRBM Act – from the time the idea was floated to actual enactment – took a few years and intense debate. Thanks to this, Parliament is serious about it; there is no talk of raising the deficit caps or postponing implementation or even scrapping it.
In taking the initiative to legislate a cap on subsidies, Jaitley can show his party as a fiscally responsible one. It was Yashwant Sinha, during the NDA regime, who initiated the FRBM legislation. It just so happened that the Act got passed toward the end of the government’s tenure and the UPA government notified the rules, allowing it to take credit. But the sheen was taken away from that credit by the fact that first Chidambaram asked for a pause in its implementation (in 2005) and then Mukherjee amended it to relax the deadlines.
Jaitley can now do for subsidies what Sinha did for overall fiscal consolidation.  It will be a feather in the BJP’s cap both economically and politically.

Some bad days are needed for good times to roll

This was published in Nai Dunia, 17 June 2014. 
http://naiduniaepaper.jagran.com/Details.aspx?id=686267&boxid=13104
Giving below the English draft that I sent.

Prime Minister Narendra Modi’s remarks in Goa on Saturday that tough economic measures will have to be taken to put the economy back on track have invited predictable jokes about achche din and bure din. Perhaps the BJP brought these jokes upon itself by overdoing the achche din aane vaale hain message during the elections, but this is neither the time nor the subject for jokes.
Because the simple truth is that the economy is in a bad state and government finances are in even worse shape. It is true that the UPA government was not fiscally responsible. Former finance minister P. Chidambaram may have kept the fiscal deficit at 4.6% of GDP, but this has been done by postponing some expenditure (which the new government will have to bear) and getting some revenue in advance. So the Modi government’s first economic step will have to be to restore some order to government finances. Sound government finances are the foundation of a robust economy.
The other major problem facing the government is that of inflation, which is still not in the comfort zone. The Reserve Bank of India governor Raghuram Rajan has moderated his hawkish stand on interest rates to give the new government time to address the structural issues that are fuelling inflation. The government needs to get cracking on these to create an environment where he can bring down interest rates. 
So what are the tough measures that Modi is planning? It is clear by now that the only person who knows Modi’s mind is Modi himself, but if he is really serious about doing what he has indicated, these are some of the steps he could – and should - take.
One, on the revenue side, increase in tax exemption limits may not happen (though media reports say this is expected). The inflation monster has not been tamed yet and giving people more money to spend without addressing supply shortages and bottlenecks will not be a wise step. The economy certainly needs a demand push, but this has to be calibrated. Besides, an increase in the exemption limit to Rs 3 lakh is expected to cost the exchequer Rs 60,000 crore a year, according to the finance ministry. This is certainly not the time for such giveaways. The corporate sector, too, will have to reconcile itself to having some excise cuts given by the previous government taken away.
Two, on the expenditure side, there will be a drastic overhaul of the subsidy regime. The President’s address and Modi’s own statements during the elections show a welcome emphasis on infrastructure. This will mean that the bias towards revenue expenditure – which is 86% of total expenditure – will be corrected and capital expenditure will get the focus it sorely needs.
But revenue expenditure has one item that is committed expenditure – interest payments, which absorb over 40% of tax revenues. Defence and salaries too cannot be touched. That leaves subsidies, which eat up 25% of tax revenues. Interest payments do not affect people’s budgets directly, so it can be safe to assume that when Modi speaks of tough measures, he intends to cut the subsidy burden significantly. This is something the economy has been crying out for.
Subsidy reform will not mean withdrawing all subsidies or drastically cutting allocations across the board. What it will mean is better targeting, which means only the genuinely needy will get subsidies and a lot or undeserving people will not.
If Modi is really serious about subsidy reform, then the cap on subsidised LPG cylinders should go back to nine. That will not only result in a saving of nearly Rs 4000 crore, but it will still cover 89% of the population.
His government should also allow decontrol of diesel prices or at least allow price hikes. This will have an immediate inflationary effect, but that will fade out in time. Importantly, it will also moderate wasteful consumption and bring enormous savings to the government.
A far more tricky issue will be tackling the food subsidy, the biggest subsidy item at nearly 40% of the total bill. The BJP backed the National Food Security Act (NFSA) which could lead to the food subsidy bill ballooning. But this problem will have to be tackled. One way to bring down the food subsidy bill would be to bring down the cost of procuring foodgrains. This could mean not allowing huge increases in the minimum support price. There are other ways to reduce this cost – reforming the procurement mechanism and eliminating inefficiencies but that will be a long-drawn out process. The farmers will be up in arms, but the government will have to remain firm. 
There are a whole lot of other tough measures that the economy needs but these are the ones that will bite the people. That is why governments are generally loath to take them. The fact that Modi seems to be preparing the climate for these unpopular measures is a good sign. It shows two things. One, that he is not going to let politics prevail over good economics. Two, he has realised the necessity of explaining things to the people, something all reforming prime ministers and finance ministers from 1991 onwards have ignored.
People are not unwise. They know the need for belt tightening and cutting wasteful expenditure – they do it all the time with their household budgets. Surely, they will realise that if they want achche din forever, they will have to put up with bure din for some time.

Bite this: Survey proves cash transfer critics wrong

first published in firstpost.com: http://www.firstpost.com/economy/bite-this-survey-proves-cash-transfer-critics-wrong-829793.html

Cash transfers to the poor, so the cynics would have us believe, are a bad idea because they will be misused. Men will divert money for food, education and health to alcohol and tobacco consumption. Don’t think, they say, that giving money to the woman in the household will check this. She doesn’t take decisions in the family and she won’t have the power to check the man. But a survey based on two pilot projects on cash transfers in nine Madhya Pradesh villages from June 2011 to January 2012, jointly conducted by trade union body SEWA Bharat and UNICEF, rebuts almost every charge that the cash transfer pessimists throw at this alternative method of delivering welfare benefits to the poor. 

Bite this. Cash transfers did not increase spending on the ‘private bads’ in the project villages. On the contrary, ‘good’ spending increased across a range of expenditure heads – education, health, food and sanitation.

And chew on this. The proportion of underweight children came down; incidence of illnesses came down; the number of children working as wage labour fell; wage labour among adults too declined and self-employment increased; and indebtedness reduced. 

“Cash has a transformative effect by unlocking constraints to development,” Guy Standing, of the School of Oriental and African Studies, University of London, who led the survey said while presenting the preliminary findings at a conference in New Delhi.

The first pilot, Madhya Pradesh Unconditional Cash Transfer (MPUCT), covered eight villages, while the second, Tribal Village Unconditional Cash Transfer (TVUC), was conducted in one tribal village. In both pilots, the behaviour of the beneficiaries was compared to that of people in other villages (12 in the case of the first pilot and one in the case of the second) who did not get any cash handouts. The cash transfers were unconditional and universal. That is, every single person (a total of 6,000) in the pilot villages around Indore were given monthly cash grants – Rs 300 per adult and Rs 150 per child – without any conditions about how they were to spend it. They were free to use it in any way they wished. “Conditions,” noted Renana Jhabvala, president of SEWA Bharat (part of the SEWA family), “lead to corruption and harassment.” 

Freed from any nanny-like supervision, people who got cash handouts showed they could be quite responsible in spending it. Education got top priority, with those in the cash transfer villages spending 40 percent more on schooling than non-cash transfer villages. Though only 40.2 percent of households in the cash transfer villages had a school within one km distance of their homes, the children spent less time in commuting as compared to those in non-cash transfer villages, where 48.3 percent of households had a school within 1 km distance. The fact that those in the cash transfer villages were spending more on transport to send their children to school is evident from the 10 percent difference in transport spend between the two sets of villages. That is probably why, though there was no significant difference in enrolment in cash transfer and non-cash transfer villages in the baseline study, the final evaluation study showed a 11 percent increase in enrolment in the former set of villages. There was also an increase in spending on uniforms, books and stationery. 

People also started spending more on foods higher in the value chain, with 52.6 percent buying more fresh vegetables and 63.9 per cent buying more milk than before. In the tribal villages, households reporting sufficiency of food increased from 51 percent to 82 percent between the baseline and final evaluation survey. With better nutrition and better basic living standards (31 percent of cash transfer villages spent on changing their toilets, and more people switched to electricity and gas for lighting and cooking), health indicators also went up. In the cash transfer villages, 47.4 percent households reported no illnesses in three months prior to the survey against only 34. 6 percent in the non-cash transfer villages. 

With women getting money in their individual capacities, there was a 33 percent increase in them getting medical treatment for illnesses. Women also took medicines more regularly, whereas earlier there were spikes in medicine intake depending on the availability of money. More importantly, the physically disabled in homes got better treatment. The survey showed 48 per cent disabled individuals in the cash transfer villages was hospitalised for treatment against only 2 per cent in the non-cash transfer villages. There was also an increase in resort to private healthcare, showing that cash grants gave people more choice. 

Another criticism against cash transfers as an income support measure is that it discourages people from working. (It’s another matter that they don’t subject the National Rural Employment Guarantee Scheme to the same criticism.) The survey showed that wage labour accounted for 40 percent employment in cash transfer villages against over 50 per cent in non-cash transfer villages. The proportion of self-employment was higher in the former against the latter. Many families, the survey showed, used cash grants to buy tools (ranging from sewing machines to seeds and fertilisers) or livestock to increase production. 

Does this mean that the debate over cash transfers has been definitively decided in its favour? Not quite. These findings need some caveats. As NC Saxena, member of the National Advisory Council, pointed out at the conference, the cash transfer in the project was an additional sum that people got and was not a substitute for subsidised government schemes. So it gave people extra cash, which made it easier for them to make choices. Would that same effect have been possible if the cash transfer had been accompanied by a withdrawal of a public service, whether it is ration shops or government clinics or schools? 

The area around Indore was also more prosperous and developed, increasing the chances of positive findings. Sonalde Desai of the National Council of Applied Economic Research, who gave the expert response on the findings, noted that the survey results should take into account the bias factor in the perception-based responses – people would tend to paint a rosy picture when quizzed on the benefits of any cash support. 

But the value of the pilots and the survey is that this is the first-ever attempt to cut through the ideology-driven posturing on cash transfers and pave the way for policy making based on hard empirical evidence. And that is a big, big step forward.

I subsequently wrote a more detailed piece on this for Forbes India. Here is the link to that.http://forbesindia.com/article/real-issue/direct-cash-transfers-what-money-can-buy/35525/1