Posted in Finance Articles, Total Reads: 7365
, Published on 28 September 2013
Direct Cash Transfers are direct payments of money to intended beneficiaries. It was created to improve the living conditions of marginalized sections of society by providing cash to buy necessities. The difference between market price and subsidized price is directly transferred to eligible beneficiaries proportionate to quantity uplifted from market.
As per government estimates, fertilizer subsidy is pegged at Rs 60,974 crores for current financial year. Fertilizer subsidies have ensured that food security is attained by sustaining a minimum level of usage, and thereby maintaining good agricultural productivity. The magnitude and importance of fertilizer subsidies have driven the need for DCT schemes in fertilizer industry.
Fig 1: Increasing subsidy burden on fertilizers
2. Current Subsidy System versus Direct Cash Transfer (DCT)
As per current system of subsidy provision, fertilizer manufacturers receive subsidy from government equivalent to the difference between normative cost of production and their subsidized Maximum Retail Price (MRP).
Fig 2: Current Subsidy Provision System
2.1 Diversion and Leakage
Urea, Muriate of Potash (MOP) and Single Super Phosphate (SSP) are alleged to be illegally transferred for industrial use. Fertilizers are also known to be smuggled to neighboring countries where equivalent prices are higher.
Under DCT, the manufacturer does not have any incentive to illegally sell or transfer fertilizers to other industries as the fertilizers will be available at market price and thereby reduces incentives to pilfer.
2.2 Inefficiency and Market Distortion
Manufacturers have been unable to operate at optimum efficiency levels owing to their reliance on subsidies. The current policy does not provide any incentive for the manufacturer to improve production and distribution by making large investments.
There are delays in transferring subsidies as all claims submitted by manufacturers need to be corroborated with documentation maintained by wholesalers and retailers. This affects the manufacturing cycle and has an unfavorable impact on imports and availability of fertilizers.
Under DCT, manufacturers will be competing at market price and would encourage them to improve their productivity and distribution reducing the problem of overcrowding and market distortions.
2.3 Dual Pricing
Under DCT, the problems of dual pricing wherein same product i.e. fertilizer is sold at different prices in the market are eliminated.
2.4 Electronic Service Delivery – Aadhar UID
Electronic payments could save an estimated `1 trillion a year—nearly 10% of the total payment flows between the government and households, a 2010 report by consulting firm McKinsey had said. “The benefits of an e-payment system far outweigh the costs”.
DCT facilitates monitoring of subsidy transactions carried out at various levels in the supply chain. All details about the list of beneficiaries, details of benefit etc. can be readily and easily accessed. Complaints and grievances can be addressed in a more efficient and effective manner with the adoption of modern technology. This would greatly improve and enhance the transparency of entire system.
2.5 Targeting of Beneficiaries
Targeting errors are normally of two types namely
a) Errors of Inclusion – Wrongful inclusion of ineligible beneficiaries (fakes and ghost beneficiaries)
b) Errors of Exclusion – Wrongful exclusion of eligible beneficiaries
Under DCT, targeting of beneficiaries is simplified and improved as targeting errors are minimized by usage of UIDAI for real-time authentication of identity by biometric verification.
3. Current Subsidy Model versus Recommended Cash Transfer Model
3.1 Current Fertilizer Subsidy Model
As per current system, the price at which producers or suppliers sell fertilizers is fixed by the government.
For UREA fertilizers, a differential amount is reimbursed to the producer as subsidy. This amount varies depending on the supply source by verifying if it is indigenous or imported.
Decontrolled P&K fertilizers are also subsidized. Unlike urea, the producers are provided subsidy at a fixed or uniform rate. However, the producers have the freedom to fix the selling price.
Since these prices are significantly lower than the prevailing market price, the government reimburses this difference in amount to the producers through its budget expenditure. Normally, these funds are sourced by the government agencies from the tax payer. The current subsidy system provides subsidies based on costs incurred and therefore provides incentives for inefficient suppliers. Instead of providing subsidized fertilizers to small and marginalized farmers, the current model provides subsidized fertilizers to all farmers. Economic theories advocate that subsidy of any kind entails dead weight loss which refers to the aggregate loss to the economy owing to intervention of government in market forces of supply and demand.
Fig 3: Deadweight losses on account of subsidies
The Indian government has subsidized and retained the price of urea over the last decade.
Since this price is fixed (and low) for the farmers, the incentive for effective usage of urea is low. This follows the norms of consumer theory which states that, in the absence of incentives and stimulus, resources are not used efficiently.
Thus, providing subsidies for urea leads to inefficient usage and negatively impacts the sales opportunity for sellers resulting in dead weight losses.
3.2 Recommended Model of Direct Cash Transfer
The goal of Direct Cash Transfer is to provide cash directly to the beneficiary and provide them with the power of choice. This would be achieved by the plugging of leakages and elimination of middlemen who siphon off a chunk of the subsidy at different levels. Families with Aadhar card will get money transferred directly to their bank accounts. Options will be given to claim the cash subsidies at identified bank branches, by means of cash card.
In view of the benefits of Direct Transfer which are listed above, the above model is proposed for Direct Transfer to retailers. The major reasons for adopting this model instead of direct transfer to farmers are:
a) If subsidies are transferred post-sale, it could lead to liquidity crunch for farmers buying fertilizers
b) In case of fixed subsidies, poor families may waste cash on non-essential goods
Presently, only 21 crore of 120 crore population have been supplied Aadhar cards in India. Most Below Poverty Line (BPL) families do not have access to bank accounts and many villages do not even have bank branches. The cost of visiting the bank premises may eat up a huge chunk of the subsidy, which is equivalent to another form of leakage at the distribution level. The penetration of Internet is also low in rural India although it has grown from 2.6% in 2010 to 4.6% in 2012 as per a report published by Internet and Mobile Association of India (IAMAI). Therefore, modern technology also needs to be spread to rural areas in order to gain maximum benefits as online banking has become preferred choice in urban centers since it helps users track and maintain their accounts from remote locations.
Therefore, this model is proposed as a short term solution. After the successful implementation of Aadhar project and facilitation of easier access to banking services in remote areas, it is proposed that cash be transferred directly to farmers account as a long term measure.
Fig 4: Recommended Model for Direct Transfer
4. International Practices
The largest and most successful conditional cash transfer program is the Bolsa Familia Program in Brazil that covered close to 100 percent of poor population in Brazil in 2007. As per this system, the government transfers cash straight to families subject to certain conditions such as nutritional monitoring, school attendance, pre-natal and post-natal tests. The entire system is managed through effective and efficient targeting of intended beneficiaries, organized disbursement and continuous tracking of disbursed funds.
Several countries including Turkey, Chile and Mexico have adopted this system in the form of Conditional Cash Transfer Programs (CCT). Under such programs, direct cash is administered to underprivileged families on condition that it is used for verifiable financing of human capital development.
CCT could prove effective to ensure that the cash disbursed to BPL families is spent for the right purposes and not frittered away on frivolous purposes such as entertainment or liquor.
Spreading and increasing awareness about the rights of women and children, educating the masses, role of social activists would be crucial to ensure efficient utilization of cash disbursed.
The article has been authored by Chirayu Gandhi, MDI Gurgaon.
1) Interim Report By Task Force set by Government
2) UNICEF Report on Direct Transfer
3) McKinsey Report
4) Articles on Direct Transfer Issues by The Hindu and Mint.
If you are interested in writing articles for us, Submit Here