COMMENTARY

Budget 2012
Tinkering with Subsidies
Mala Lalvani

With major issues confronting the

fertiliser and petroleum sector
being left untouched, the small
reduction in subsidy numbers in
Budget 2012-13 is mere tokenism
and lacks credibility. However,
there seems to be some thinking
in favour of direct cash transfers
as a substitute for the existing
structure of subsidies. It is true
that this alternative has its
limitations. Just the fact that
an alternative is being thought
about in the form of pilot studies
for kerosene and some initiative
is being taken in the fertiliser
sector is the high point of
Budget 2012-13.

he issue of subsidies is one that

most finance ministers tend to
keep at arms length. The fact that
Budget 2012 raised the issue and devoted
five paras (paras 21 to 25) to it certainly
calls for appreciation. When the finance
minister announced a cut in subsidies to
2% of GDP and a further reduction to
1.75% over the next three years, our past
experience led us to believe that this
would evoke sharp reactions from the
beneficiaries of these subsidies. However,
nothing of the sort happened. This aroused
our curiosity and provided the motivation
for looking at the fine print of Budget 2012
relating to subsidies especially petroleum
and fertiliser (the two major subsidies after
food subsidy) which the finance minister
has hinted at putting a check on. In para
22 of the speech the finance minister
said The Government has decided that
from 2012-13 subsidies related to food
and for administering the Food Security
Act will be fully provided for. All other
subsidies would be funded to the extent
that they can be borne by the economy
without any adverse implications.
1 Explicit Subsidies
Table 1 looks at the share of various explicitly mentioned subsidies in the budget.
It shows that food, petroleum and fertiliser are the three prominent subsidies.

Surprisingly, despite the explicit mention of curbing subsidies the actual allocations show a hike of 34% over the previous years budget estimate. It is lower
than the revised estimate (RE) of 2011-12
which itself overshot the target by almost
1% of GDP. Thus the first impression
from the budget speech, of a bold step
being taken to curb the sensitive subsidies is not borne out by the budgetary
allocations.
In the sections that follow we look at
the issue of subsidies in the petroleum
and fertiliser sectors where curbing of
subsidies are hinted at by the finance
minister in his budget speech.
2 Petroleum Subsidy
The subsidy estimates by the Ministry of
Petroleum and Natural Gas are based on
under-recoveries of the oil marketing
companies, what the oil companies
would have paid to buy products if they
were imported from abroad (import
parity). As such, the estimate for under
recovery should be considered as notional
losses since the actual costs incurred by
oil companies are likely to be different
given that their crude oil costs would
not necessarily be the same as the
market prices elsewhere, and they do
not count refining profits or losses.
Under-recoveries exist for liquefied
petroleum gas (LPG), kerosene, diesel
and petrol. Budgetary subsidies are provided for kerosene and LPG. The underrecoveries of petrol and diesel companies
are shared by the government via oil
bonds or cash assistance.
Sethi (2006) points out that all the
three committees set up to look at

Table 1: Explicit Subsidies in Budget 2012 (Rs crore)

Sincere thanks to Ajit Karnik, Abhay Pethe

and Romar Correa for their comments and
suggestions. The usual disclaimer applies.
Mala Lalvani (mala.lalvani@gmail.com)
teaches at the department of economics,
University of Mumbai.
Economic & Political Weekly

EPW

april 14, 2012

Actual 2010-11

Budget 2011-12

Revised 2011-12

Budget 2012-13

Major subsidies
1,64,516.32
Fertiliser subsidy
62,301.21
Food subsidy
63,843.79
Petroleum subsidy
38,371.32
Interest subsidies
4,680.20
Other subsidies
4,223.06
As % of total expenditure on subsidies
Fertiliser subsidy
37.87
Food subsidy
38.81
Petroleum subsidy
23.32
Interest subsidies
2.84
Other subsidies
2.57
As % of GDP
Major subsidies
2.16

1,34,210.85
49,997.87
60,572.98
23,640.00
6,868.47
2,490.35

2,08,502.94
67,198.94
72,823.00
68,481.00
5,791.31
2,002.48

1,79,554.10
60,974.10
75,000.00
43,580.00
7,967.65
2,493.38

37.25
45.13
17.61
5.12
1.86

32.23
34.93
32.84
2.78
0.96

33.96
41.77
24.27
4.44
1.39

1.52

2.36

1.78

Source: Budget Documents 2012-13, Expenditure Budget, Vol I.

vol xlviI no 15

15

COMMENTARY

pricing of the sensitive petroleum products propose to free up pricing of petrol

and diesel and to gradually reduce subsidies on kerosene and LPG. It is his contention that there are no net subsidies in
the petroleum sector even inclusive of the
erroneously claimed under-recoveries.
Contrary to the tenor of the Parikh Committee report, the total tax collected from
the petroleum sector by the central and
state governments is a multiple of the
combined fiscal subsidies and the claimed
under-recoveries. So according to Sethi
(2006) any price liberalisation must also
address oil sector taxation.
Table 2 gives details of the net contribution to the central exchequer in more
recent years and we find that while in
2008-09 a negative net contribution was
recorded, since 2009-10 once again
there is a large positive contribution. Of
course if we add the sales tax paid to the
state governments then even the 2008-09
figure would be a positive net contribution.

ruled out due to the wide gap between the

retail price of LPG for domestic use and
the market price for commercial LPG and
also PDS kerosene and petrol/diesel as
well as for non-PDS usage (http://www.
thehindubusinessline.com/industry-andeconomy/article1520814.ece). Thus reduction of subsidies and rationalisation
of prices as a general economic principle
would certainly be a step in the right direction.
A look at the details of the budgetary
allocations for the petroleum subsidy in
Table 3 shows that allocation of subsidy
on LPG, kerosene, freight is the same as
the budget estimate (BE) of 2011-12 and
marginally higher than the RE 2011-12.
The subsidy allocated for supply of
natural gas to the north-eastern region
has been reduced by Rs 60 crore as
compared to the BE 2011-12. One cannot
help wondering what could have
changed in this respect to merit this
reduction! Finally, much to our surprise

Table 2: Net Contribution to Central Exchequer (Rs crore)

Contribution to central exchequer due to tax/duties on petroleum products
Payout by government to oil marketing companies (OMCs)
(A) Oil bonds/cash assistance by government towards OMCs under-recoveries
(B) Subsidy on PDS SKO (kerosene) and domestic LPG
(C) Freight subsidy on PDS SKO and domestic LPG
(D) Gas subsidy for north-east
Total payout to OMCs
Net contribution to central exchequer

2008-09

2009-10

71,190

78,443 1,03,580

2010-11

71,292
2,688
22
142
74,144
-2954

26,000
2,770
22
159
28,951
49,492

41,000
2,904
22
445
44,371
59,209

Source: Answer to Lok Sabha Question No 588 dated 15 March 2012.

Table 3: Subsidies to Ministry of Petroleum and Natural Gas (Rs crore)

Subsidy on LPG and kerosene for PDS

Freight subsidy
Subsidy to oil companies for supply of natural gas to north-eastern region
Total-Post APM subsidies and other expenditure (A)
Compensation to oil companies for under-recoveries on account
of sale of sensitive petroleum products (B)
Total subsidy to petroleum sector (A+B)

Budget
2011-12

Revised
2011-12

Budget
2012-13

3,050
26
564
3,640

3,000
26
458
3,481

3,050
26
504
3,580

20,000
23,640

65,000
68,481

40,000
43,580

Source: Budget Documents 2012-13, Expenditure Budget, Vol II.

Thus, although from the numbers

above it would seem that Sethis argument continues to hold and there is
indeed a positive net contribution to the
exchequer, misuse of subsidy in the sense
of black marketeering of PDS kerosene and
LPG is rampant. The minister for petroleum
and natural gas, S Jaipal Reddy, himself
admitted that the possibility of blackmarketeering/diversion of subsidised
domestic LPG cylinders and PDS kerosene
by unscrupulous elements cannot be
16

the allocation for compensation to

oil companies for under-recoveries has
doubled from the allocation in BE 2011-12
but is lower than RE 2011-12, a balancing
act it would seem. Clearly the finance
minister is gambling on a reduction in
world oil prices, hence the allocation is
lower than RE 2011-12. At the same time
he has played it safe by doubling the
allocation for compensation of underrecoveries from BE 2011-12. All in all the
allocations suggest that no major reforms
april 14, 2012

can be expected in terms of curbing

subsidies to the petroleum sector.
In the context of addressing the problem
of the petroleum subsidy the finance
minister in para 24 of his budget speech
talks of pilot projects wherein direct
cash transfer of subsidies are made. He
points out that the Aadhaar platform has
also been successfully used to validate
PDS ration cards in Jharkhand. Critics of
direct cash transfers are quick to point
out that such money transfers are prone
to being misused. There is especially the
danger of it being squandered away.
Several other accompanying problems
of cash transfers have been raised by
Kapur (2011) who argues that cash transfers may not necessarily be the best
option in all cases. According to him unless discussions on transfers are part and
parcel of a broader strategy, any change
in favour of cash transfers will simply
amount to tactical differences and not
address long-term challenges. In the case
of kerosene subsidies Kapur (2011) points
out that with most of Indias poor using
kerosene for lighting rather than cooking,
might it not be better to scrap the PDS
kerosene and instead of moving to cash
transfers, simply provide all rural households and urban below the poverty line
(BPL) households with solar lanterns. He
admits that this would not address the
use of kerosene for cooking purposes.
We agree with Kapur that cash transfers must be considered as a part of a
broader strategy. However, given that
his scheme does not address the issue of
kerosene for cooking purposes we do
believe that pilot studies examining direct
cash transfers to address the kerosene
subsidy is an experiment worth making.
Following this line of reasoning, could
we think of a scheme to address diesel
underpricing? We could let the oil companies fully pass through the cost of producing diesel. Truck owners can claim
whatever is the subsidy involved directly
and have it deposited in their bank accounts. One problem which exists is that
almost 90% of truck operators are single
truck owners but still the number cannot
be larger than the number of those who
purchase kerosene. The criticism that
the reimbursed subsidy will be misused
(as in the case of kerosene) does not
vol xlviI no 15

EPW

Economic & Political Weekly

COMMENTARY

apply here if the truck owner does not

use the reimbursed subsidy his business
will close down. There is one more
advantage in this approach the single
truck owner will have to file a claim for
the reimbursement which will depend
on the amount of kerosene/diesel purchased for which bills/receipts will be
required. Of course, people will want to
inflate this bill and claim a larger amount
of reimbursement than what they are
entitled for. But this will trap them into
paying income tax: higher reimbursement claim means higher purchase of
diesel; higher purchase of diesel means
higher volume of business; higher volume
of business means higher income which
will be taxed (our approach is along the
lines of the principle underlying VAT).
Could this be an incentive compatible
mechanism which will force truck operators to be honest? This mechanism can
also be operationalised using the Aadhaar
scheme which is also referred to in para
24 of the budget speech.
In the case of petrol owners, however,
this approach need not be implemented
as they would have to pay the market
price. When considering a scheme such
as the one suggested above it must be
recognised that allowing full passthrough of diesel prices will raise the cost
of transportation and have an effect on
inflation (see: http://www.dnaindia.com/
money/report_diesel-price-hike-coulddash-rate-cut-hopes_1666145). However,
this needs to be weighed against the cost
of encountering the perpetual problem of
under-recoveries followed by oil bonds.
3 Fertiliser Subsidy
The fertiliser policy of the Government
of India which decontrolled phosphatic
and potassic (P&K) fertilisers with effect
from August 1992 led to a sharp increase
in the market price for these fertilisers, a
reduction in demand and an imbalance
in the usage of the nutrients of Nitrogen,
Phosphate and Potash (N, P & K) and the
productivity of the soil. Subsequently a
concession scheme was introduced for
decontrolled fertilisers on an ad hoc
basis which continued up to March 2010
with changed parameters from time to
time. The government then introduced
a Nutrient-Based Subsidy Policy in
Economic & Political Weekly

EPW

april 14, 2012

continuation of the erstwhile concession

scheme for decontrolled P&K fertilisers.
The basic purpose of the concession
scheme and the Nutrient-Based Subsidy
Policy has been to provide fertilisers to
farmers at the subsidised prices. Under the
present subsidy regime, fertilisers are provided to farmers at the maximum retail
price (MRP), which is much below the
actual cost of fertilisers. Accordingly, the
farmers pay 25-40% of the actual cost of
fertilisers and rest of the cost is borne by the
government. However, the policy for urea,
the key fertiliser (which accounts for 50%
of all fertilisers) has remained untouched.
In Budget 2012 the finance minister has
a number of positives for the fertiliser
sector such as exemption for imports,
reduction in customs duty, lower tax
rates on interest payments arising out of
external commercial borrowings (ECBs),
etc. However, the two key issues of reforms
on freeing urea prices and addressing the
incentive structure to make investments
attractive have been left unaddressed.
The uncertainty on price reforms in
urea has discouraged new investment in
the fertiliser industry for over a decade.
As a result, though the demand for urea
has been rising, its supply is constrained
owing to absence of new investment.
There has hardly been any expansion in
production capacity for nearly a decade.
Consequently, urea imports have risen
sharply, from a meagre 0.64 million tonnes
in 2004-05 to a whopping 5.21 million
tonnes in 2009-10. The governments
efforts to ease import dependence by
wooing fresh investment in domestic
capacity addition came to naught when
the new investment promotion policy,
notified in September 2008, failed to
receive any response. The new investment
policy announced in February 2012 has
reported an increase in the ceiling of
natural gas prices but investors are not
happy about the band of price rise that has
been allowed hence the immediate reaction from the industry is somewhat muted
(http://articles.economictimes.indiatimes.
com/2012-02-28/news/31107942_1_mmbtu- urea-policy-gas-price).
As regards raising the urea prices, no
reform seems to be on the anvil. Raising
the price of this fertiliser is probably
one of the more difficult decisions to take

vol xlviI no 15

for any government in India. A strong

and vocal farmers lobby and serious
political backing for this ruinous attachment have ensured its continuity for
long (http://www.livemint.com/2011/08/
08223814/OurviewDecontrolling-ureap.html). Recently, attention was drawn
to the issue of urea prices by the chairman of the Prime Ministers Economic
Advisory Council (PMEAC) C Rangarajan
who has pitched for deregulation of urea
prices and said that partial reforms in
the fertiliser subsidy regime of introducing nutrient-based subsidisation will not
be effective unless the price of urea is
decontrolled or at least raised substantially (http://www.business-standard.
com/india/news/decontrol-urea-pricesraise-excise-duty-pmeac/158626/on).
An important positive announcement
in the context of the fertiliser sector in
Budget 2012 was an announcement of
a mobile-based Fertiliser Management
System (mFMS), which is a step towards
direct cash transfers. It is true that a direct
cash transfer system in the fertiliser sector suffers from limitations. Kapur (2011)
argues that given that this is a subsidy
that was intended not only as an inputsupport to individual farmers, but as a
subsidy vital to both the agriculture
sector as a whole and to the domestic fertiliser industry, we must consider the implications of this shift at multiple levels.
He is of the view that while there is no
doubt that India will have to move to a
greater use of cash transfers, it may not
necessarily be the best option in all cases.
Sharma and Thaker (2010) too find that
a fair degree of equity exists in the distribution of the fertiliser subsidy among
farm sizes. Based on their results, they
justify fertiliser subsidies and question
the rationale for a direct transfer of the
subsidy to farmers. At the other end of
the spectrum we have the study of Gulati
and Narayanan (2003) who pointed out
that in 1999-2000 the share of industry
in the fertiliser subsidy was 54.9%. What
was more disappointing was their in-depth
analysis of urea plants, which drew
attention to the inefficiency prevalent in
the urea industry. Based on their resource
cost estimates of urea plants they observe
that unless the cost of production is
reduced, 32% of urea production would
17

COMMENTARY
Table 4: Budgetary Allocation for Fertiliser Subsidy (Rs crore)
Period

2006-07
2007-08
2008-09
2009-10
2010-11
2011-12 (BE)
2011-12(RE)
2012-13(BE)

Amount of Concession
Disbursed on Decontrolled
Fertilisers (Indigenous+ Imported)
Total (P&K)

Amount of Subsidy Disbursed on Urea

Total for All

Fertilisers

Indigenous Urea

Imported Urea

Total (Urea)

10,298.12
16,933.80
65,554.79
39,452.06
40,766.57
29,706.87
34,207.94
28,576.10

12,650.37
16,450.37
17,968.74
17,580.25
15,080.73
13,308.00
19,108.00
19,000.00

5,071.06
9,934.99
12,971.18
6,999.98
6,453.91
6,983.00
13,883.00
13,398.00

17,721.43
26,385.36
33,939.92
24,580.23
21,534.64
2,0291.00
3,2991.00
32,398.00

28,019.55
43,319.16
99,494.71
64,032.29
62,301.21
67,198.94
67,198.94
60,974.10

Source: Budget Documents, Vol I, various issues.

become economically unviable if import

parity price were to prevail. With urea
prices continuing to be administered
nothing much could have altered in the
urea plants on the efficiency front. Clearly,
an issue of such importance needs a closer
look and wider debate. Thus, we believe
that despite limitations of the direct cash
transfer system controlled experiments
in the form of pilot studies and initiatives like the mFMS will help understand
the issue better and be a step forward.
Bearing in mind the issues confronting
the fertiliser sector in the backdrop, we
took a close look at the budgetary allocation for fertiliser subsidies in Budget 2012
(Table 4). It shows a 16% reduction in
allocation for imported non-urea fertiliser;
3.5% reduction for imported urea and a
0.5% reduction for indigenous urea when
compared to RE 2011-12. However, when
compared to BE 2011-12 it is a hike of 42%
in the case of indigenous urea and 92%
in the case of imported urea. In the case
of non-urea fertilisers (which are largely
imported) the reduction is a mere 3%
when compared with BE 2011-12. The
budgetary allocations for imported and
indigenous urea signal that the government does not expect any major change
to happen in the fertiliser sector. Clearly
the hard decisions relating to urea price
policy and investment incentives in
terms of a further rise in price of natural
gas are not likely to come soon.
With the two major issues confronting
the fertiliser sector, viz, reforms of pricing
of urea and incentives to industry for
investment, being left untouched in
Budget 2012 we believe that the small
reduction in subsidy numbers is mere
tokenism and lacks credibility. Till the
major reforms on these two fronts are
not addressed, the budgetary subsidy
18

numbers are a mere guesstimate with a

high probability of missing the target.
4 Conclusions
This article has looked at the crucial
issue of budgetary subsidies, a topic that
the finance minister has ventured to
touch upon in Budget 2012. The stigma
attached to the very issue of subsidies
makes most finance ministers keep away
from it. Just the fact that he did touch
upon this issue calls for appreciation.
We have argued that a look at the
budgetary allocation for subsidies alone
is not sufficient and it needs to be understood in the context of the issues confronting the relevant sector. This article
has sought to look at the petroleum and
the fertiliser subsidies against the backdrop of fertiliser and petroleum policies.
A look at the fine print of reduction in
budgetary subsidy allocations in the

petroleum and fertiliser sectors suggests

the reduction is too small to make any
major dent in the burgeoning subsidy
bill. To add to this is the uncertainty that
surrounds the budgetary numbers as the
probability of its going awry on account
of changes in the world price of crude
and fertilisers is very high indeed.
The ray of hope that we can spot in
Budget 2012 in connection with subsidies
is not in the reduced allocations per se,
which we believe is mere tokenism, but in
some announcements of a move towards
direct cash transfer of subsidies. Pilot
projects have been mentioned for petrol
and the announcement of a mFMS. While
direct cash transfers are not necessarily a
panacea for all the ills that prevail in the
fertiliser and petroleum sectors, the fact
that an alternative is being thought
about in the form of controlled experiments for kerosene and some initiative
has been taken in the fertiliser sector is
for us the high point of Budget 2012-13!
References
Gulati, A and S Narayanan (2003): The Subsidy
Syndrome (New Delhi: Oxford University Press).
Kapur, D (2011): The Shift to Cash Transfers: Running Better But on the Wrong Road?, Economic
& Political Weekly, 21 May.
Sethi, S (2006): Analysing the Parikh Committee
Report on Pricing of Petroleum Products,
Economic & Political Weekly, 27 March.
Sharma, V P and H Thaker (2010): Fertiliser
Subsidy in India: Who Are the Beneficiaries?,
Economic & Political Weekly, 20 March.

COUNCIL FOR SOCIAL DEVELOPMENT, NEW DELHI

SANGHA RACHANA, 53 LODI ESTATE,
NEW DELHI -110003 (INDIA)
The Council for Social Development, New Delhi invites application for the post
of Sr. Fellow, Fellow and Associate Fellow in the UGC Scale of Professor,
Associate Professor and Assistant Professor respectively.
Qualification and Experience:
The candidate should posses Ph.D. in Economics/Sociology and other relevant
Social Science disciplines. Applicants with adequate research experience and
publications in the fields of education/health/agriculture and rural development
are encouraged to apply.
Other things being equal, candidates having experience of working with academic
organizations will be preferred.
We encourage equally qualified women candidates to apply.
The last date for submission of application is April 30, 2012.
Sheela Sabu
Administrative Officer
csdnd@del2.vsnl.net.in / ao@csdindia.org.
Telephone No: 91-011-24615383, 24611700,
Fax: 91-011-24616061
april 14, 2012

vol xlviI no 15

EPW

Economic & Political Weekly