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Why the subsidy bill for Modi govt’s second term is much higher than the first

Context- The Narendra Modi government in India shifted from “New Welfarism” to a renewed emphasis on subsidies and transfers between its first and second terms. The first term, known as Modi 1.0 (2014-15 to 2018-19), launched numerous schemes to ensure universal access to essential goods and services like housing, toilets, drinking water, bank accounts, electricity, and cooking gas connections. Despite increased public funding for these services, the government’s subsidy bill decreased both in absolute and relative terms.

From 2013-14 to 2018-19, spending on major subsidies (food, fertilizer, and fuel) dropped from Rs 244,717 crore to Rs 196,769 crore, and relative to GDP, it more than halved from nearly 2.2% to just over 1%. Even after adding outlays under the Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA) and Pradhan Mantri Kisan Samman Nidhi (PM-Kisan), the decline was from 2.5% to 1.4% of GDP.

Making a comeback

  • The second term of the Narendra Modi government, known as Modi 2.0, has seen a reversal in the trend of subsidies. Major subsidies increased from 1% of GDP in 2018-19 to 3.6% in 2020-21, and from 1.4% to 4.4% when combined with MNREGA and PM-Kisan transfers.
  • Although these have since decreased to 1.9% and 2.5% in 2022-23, they are roughly at the levels when the Modi government first took office. In absolute terms, the 3F subsidies (food, fertilizer, and fuel) peaked at Rs 707,707 crore in 2020-21 (Rs 879,866 crore with MNREGA and PM-Kisan expenditures).
  • Even at Rs 530,959 crore (Rs 680,359 crore) in 2022-23, they were over two-and-a-half times their corresponding levels of 2018-19.

The drivers: Modi 1.0

  • During the first term of the Modi government (Modi 1.0), the reduction in the subsidy bill was mainly due to lower international oil and fertilizer prices. The cost of crude oil imported by Indian refiners averaged $60.84 per barrel from 2014-15 to 2018-19, compared to $96.05 in the previous five financial years.
  • The government did not pass on the full benefit of these lower global prices to Indian consumers, but instead increased the excise duties on diesel, petrol, and other fuel products.
  • In 2012-13 and 2013-14, the government’s subsidy expenditure on petroleum products exceeded its excise revenues. However, by 2017-18 and 2018-19, the fuel subsidy was significantly lower than the excise collections.
  • The government used the decrease in international crude prices to not only reduce its fuel subsidy outlay but also to mobilize additional resources to finance other expenditures, including the “new welfarism” schemes.
  • The petroleum subsidy was then limited only to sales of LPG cylinders and providing connections to poor/low-income households, while diesel and petrol became significant revenue sources for the government.
  • Similarly, the government retained the benefits from the lower landed costs of imported finished fertilizers and raw materials, resulting in subsidy savings, which were not passed on to the farmers.

The drivers: Modi 2.0

  • The increase in subsidies and transfers during the second term of the Modi government was driven by two main factors.
  • Firstly, a policy decision was made to fully fund the food and fertilizer subsidy. Before 2020-21, the Centre did not fully fund the difference between the Food Corporation of India’s (FCI) economic cost and its average issue price. This also applied to fertilizer companies selling nutrients below production or import cost.
  • To cover this gap, these entities had to borrow heavily. Finance Minister Nirmala Sitharaman made a one-time provision to help FCI repay some Rs 339,236 crore of outstanding loans and clear dues to the fertilizer industry, leading to a spike in the Centre’s overall subsidy in 2020-21.
  • Secondly, the Covid pandemic and the Russia-Ukraine war also contributed to the increase. The economic distress caused by the pandemic led to a record uptake of rice and wheat through the public distribution system (PDS), with the government doubling the monthly grain quota for beneficiaries from April 2020 to December 2022. Spending on MNREGA also increased.
  • The war mainly impacted international fertilizer prices, with the average landed price of imported urea, di-ammonium phosphate, and muriate of potash all increasing significantly.
  • The government chose not to pass these higher costs onto farmers, resulting in the fertilizer subsidy nearly doubling from Rs 127,922 crore to Rs 251,339 crore between 2020-21 and 2022-23.

The road ahead

  • The maximum retail price of urea has been Rs 5,360 per tonne since November 1, 2012, with the only change being a 5% extra charge for neem oil coating, made mandatory from May 25, 2015.
  • The Public Distribution System (PDS) issue price for wheat and rice was set at Rs 2/kg and Rs 3/kg respectively after the National Food Security Act was implemented on July 5, 2013. However, these prices were reduced to nil by the Modi government from January 1, 2023. Retail prices of petrol and diesel were cut on May 22, 2022 and have not been revised since.
  • The Interim Budget for 2024-25 is not expected to alter these prices. The Centre may increase the annual direct benefit transfer under the PM-Kisan scheme from Rs 6,000 to Rs 9,000 ahead of the Lok Sabha elections.
  • Any rationalization of subsidies, with most economists favouring targeted Direct Benefit Transfer (DBT) or income support payments over supplying goods and services at below cost, may have to wait until the next government comes into power.

Conclusion- The Modi government’s approach to subsidies has seen a significant shift from its first to second term. Initially, the government reduced subsidies and introduced “new welfarism” schemes, leveraging lower international prices for oil and fertilizers.

However, the second term saw a reversal in this trend due to policy changes and external factors such as the Covid pandemic and the Russia-Ukraine war. Despite the increase in subsidies, the retail prices of essential commodities like urea, wheat, rice, petrol, and diesel have remained stable or even decreased. Looking ahead, any rationalization of subsidies, possibly through targeted Direct Benefit Transfers or income support payments, is likely to be a task for the next government.

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