Food Security Bill – Mother of All Subsidies

We have seen various social benefit schemes operating across different economies of the world, but Food Security Bill is a mother of all benefits. There is no doubt about the motive of the bill which is very pious – it aims to wipe out hunger in India. The scheme provides the right to ‘priority households’ to buy five kilograms of food grains every month at subsidised rates which have been fixed for next 3 years. These rates are :
Rice – Rs. 3 per kg
Wheat – Rs. 2 per kg
Course Grains – Rs. 1 per kg

The scheme would cost Rs. 1.27 lac crore or 1.270 trillion Rupees or $21 billion. You can pick what ever denomination you like, but the bottom line is that the number is huge !  This number is just the subsidy between the cost of grains procured by the government and  provided to the beneficiaries. The other hidden subsidies like fertilizers, power, low financing cost which will go behind the scene to incentivise the farmers to enhance their cultivation is an additional number on top of the cost of the scheme.

Sounds excellent, but the two important pillars behind any such reform are :

1. Sourcing of Food grains to meet the massive demand.
2. Sufficiency of funds to provide the subsidy.

 

Funding Element of the Scheme

At times I think money really grows on trees, specially even more when I see our politicians coming up with innovative benefit schemes distributing trillions of rupees without having a backup to source such funds. Are there many options available with the government to fund such schemes ? Let me detail the only two options which comes in my mind. They are very simple – either you earn the money or you borrow it :

1. Raise taxes – You may have noticed the proposed 35% tax slab for super rich. Perhaps this is the start. As per our Finance Minister, less than 3% of Indians pay taxes. If that is true, be ready for the tax man to come up with more proposals to bring more people under the taxable income net and boost the exchequer. After all taxes are the major sources of Income for funding government expenditures.
2. Borrow more money – If a Government borrows money, it needs to pay it back as well ! They are no special creatures. Borrowing and repaying back for capital consumption is a good idea as the capital assets tend to generate the revenues which shall be used to repay the loans. But borrowing for the purpose of subsidies is not going to generate revenues. If such wasteful borrowing is not controlled, in long term the funds ear marked for investments and infrastructure will get diverted towards debt repayments resulting in wiping off the potential of an economy to further grow consistently in future. Another tool which government has unlike us as individuals, it can print money to repay its loan. In short run the consequences are not visible, but printing money could horribly spiral up inflation owing to increased money supply in the economy.

 

Where to source food

A much bigger question which comes in my mind beyond finance, where would the government source the food ? They can obviously try to fetch it locally within India. The demand created by the Food Security Bill would create immense pressure on the existing supply of food grains in India.  Since food doesn’t drop like water from the clouds, there are only two ways to increase this supply :

1. Increase Food Production in India – Food production can be increased by either increasing the area which is being cultivated or by enhancing the yield or both. While increasing the cultivation area is a big question mark (instead it may decrease with rapid urbanisation and industrialisation), the hope should be on increasing the yield by enhanced usage of fertilizers, pesticides, irrigation and preventing inefficiencies. But these yield enhancing measures, specifically Fertilizers do not come to us at a a cheap price and accounts for a massive subsidy bill yet again. As per the planning commission reports, the overall subsidies have increased from 43,553 crores to over 2.16 lac crore (or 2.17 trillion rupees / 36 billon dollars) per year. Of this fertilizer subsidy comprises 1/3rd of the overall subsidy burden (source planningcommission.nic.in). We believe that this amount would increase further owing to higher consumption of fertilizers by the farmers and hence bleeding into the finances of India.
2. Import Food from other countries – This is a much easier and quicker solution to bridge the gap between the demand and supply of food. Float a tender, get quotation (I am not going to comment about the possibility of any scams if they happen in this process) and import the food grains needed to fulfill the requirements of the Bill. However the consequences are – Current Account Deficit (CAD) which would result in further depreciation of Indian currency. The more India imports in future, the wider the CAD will become. And importing for consumption is not going to help the CAD as it won’t add to exports in future. You can read more on CAD at Current Account Deficit – CAD – How Does It Matter to Me ?

 

Impact on Indian Economy

In the words of Moody’s credit rating agency – “The measure is credit negative for the Indian government because it will raise government spending on food subsidies to about 1.2 percent of GDP per year from an estimated 0.8 percent currently, exacerbating the government’s weak finances.”

We anticipate that the Food Security Bill coupled with other poor economic policies may have far reaching consequences on India’s economic affairs. To name a few :
1. Increased subsidy burden resulting in further increase of Fiscal Deficit. This could result in Credit Rating agencies to down grade India’s credit rating. You can read further impact of this at If India’s Credit Rating Gets Downgraded.
2. Increased inflation owing to demand pressures on limited food supply.

3. Depreciation of Indian Rupee against global currencies. You can read Rupee Depreciation – How Does it Affect YOU for details on its impact on you.

4. Higher subsidies driving profitable Public Sector Companies into loss making companies and perhaps even to the verge of bankruptcy.

5. Qualitative impact on quality of food supply owing to enhanced usage of fertilizers, pesticides, etc. 

 

Undoing the Subsidies
We all realise it that it feels very nice to get things at a discount via subsidies from the government. Petrol costing Rs. 70-80 a litre was provided to the public at sub 40 levels. Now considering this subsidy burden as unsustainable, the government is deregulating the prices and we all know how much it is pinching our pockets. The public is changing its lifestyle to adapt to the higher fuel cost regime, and we all know that it is not a pleasant feeling. It could be a similar case with the Food Security Bill. Perhaps 5 years down the line, the next government(s) may find the subsidy costs as unsustainable and may go through a massive public resistance to undo the financial mess which Congress is creating now.
Again, I would emphasise that I am not after the moral intention behind the bill. It is more a matter of funding the proposal – both financially as well as with supplies of food stock to ensure that it doesn’t add to the existing burden which India is desperately trying to shed. And if this is all geared towards selfish political reasons, then perhaps this blog note also aims to spread a voice about being extra careful while selecting the future leaders of India in 2014 elections!

Related Posts:

• If India’s Credit Rating Gets Downgraded..
• Current Account Deficit – CAD – How Does It Matter to Me ?