Economy Aug 27, 2013
Historians often ask counterfactual questions to figure out how history could have evolved differently. Ramachandra Guha asks and answers one such question in an essay titled A Short History of Congress Chamchagiri, which is a part of the book Patriots and Partisans.
In this essay Guha briefly discusses what would have happened if Lal Bahadur Shastri, the second prime minister of India, had lived a little longer. Shastri died on January 11, 1966, after serving as the prime minister for a little over 19 months.
The political future of India would have evolved very differently had Shashtri lived longer, feels Guha. As he writes "Had Shastri lived, Indira Gandhi may or may not have migrated to London. But even had she stayed in India, it is highly unlikely that she would have become prime minister. And it is certain that her son would have never have occupied or aspired to that office...Sanjay Gandhi and Rajiv Gandhi would almost certainly still be alive, and in private life. The former would be a (failed) entrepreneur, the latter a recently retired airline pilot with a passion for photography. Finally, had Shastri lived longer, Sonia Gandhi would still be a devoted and loving housewife, and Rahul Gandhi perhaps a middle-level manager in a private sector company."
But that as we know was not to be. Last night, the Lok Sabha, worked overtime to pass Sonia Gandhi's passion project, the Food Security Bill. India as a nation has made big mistakes on the economic and the financial front in the nearly 66 years that it has been independent, but the passage of the Food Security Bill, might turn out to be our biggest mistake till date.
The Food Security Bill guarantees 5 kg of rice, wheat and coarse cereals per month per individual at a fixed price of Rs 3, 2, 1, respectively, to nearly 67% of the population.
The government estimates suggest that food security will cost Rs 1,24,723 crore per year. But that is just one estimate. Andy Mukherjee, a columnist with Reuters, puts the cost at around $25 billion. The Commission for Agricultural Costs and Prices(CACP) of the Ministry of Agriculture in a research paper titled National Food Security Bill - Challenges and Options puts the cost of the food security scheme over a three year period at Rs 6,82,163 crore. During the first year the cost to the government has been estimated at Rs 2,41,263 crore.
Economist Surjit Bhalla in a column in The Indian Express put the cost of the bill at Rs 3,14,000 crore or around 3% of the gross domestic product (GDP). Ashok Kotwal, Milind Murugkar and Bharat Ramaswami challenge Bhalla's calculation in a column in The Financial Express and write "the food subsidy bill should...come to around 1.35% of GDP, which is still way less than the numbers he(i.e. Bhalla) put out."
The trouble here is that by expressing the cost of food security in terms of percentage of GDP, we do not understand the seriousness of the situation that we are getting into. In order to properly understand the situation we need to express the cost of food security as a percentage of the total receipts(less borrowings) of the government. The receipts of the government for the year 2013-2014 are projected at Rs 11,22,799 crore.
The government's estimated cost of food security comes at 11.10%(Rs 1,24,723 expressed as a % of Rs 11,22,799 crore) of the total receipts. The CACP's estimated cost of food security comes at 21.5%(Rs 2,41,623 crore expressed as a % of Rs 11,22,799 crore) of the total receipts. Bhalla's cost of food security comes at around 28% of the total receipts (Rs 3,14,000 crore expressed as a % of Rs 11,22,799 crore).
Once we express the cost of food security as a percentage of the total estimated receipts of the government, during the current financial year, we see how huge the cost of food security really is. This is something that doesn't come out when the cost of food security is expressed as a percentage of GDP. In this case the estimated cost is in the range of 1-3% of GDP. But the government does not have the entire GDP to spend. It can only spend what it earns.
The interesting thing is that the cost of food security expressed as a percentage of total receipts of the government is likely to be even higher. This is primarily because the government's collection of taxes has been slower than expected this year. The Controller General of Accounts has put out numbers to show precisely this. For the first three months of the financial year (i.e. the period between April 1, 2013 and June 30, 2013) only 11.1% of the total expected revenue receipts (the total tax and non tax revenue) for the year have been collected. When it comes to capital receipts(which does not include government borrowings) only 3.3% of the total expected amount for the year have been collected.
What this means is that the government during the first three months of the financial year has not been able to collect as much money as it had expected to. This means that the cost of food security will form a higher proportion of the total government receipts than the numbers currently tell us. And that is just one problem.
It is also worth remembering that the government estimate of the cost of food security at Rs 1,24,723 crore is very optimistic. The CACP points out that this estimate does not take into account "additional expenditure (that) is needed for the envisaged administrative set up, scaling up of operations, enhancement of production, investments for storage, movement, processing and market infrastructure etc."
Food security will also mean a higher expenditure for the government in the days to come. A higher expenditure will mean a higher fiscal deficit. Fiscal deficit is defined as the difference between what a government earns and what it spends.
The question is how will this higher expenditure be financed? Given that the economy is in a breakdown mode, higher taxes are not the answer. The government will have to finance food security through higher borrowing.
Higher government borrowing by the government as this writer has often explained in the past crowds out private borrowing. The private sector (be it banks or companies) in order to compete with the government for savings will have to offer higher interest rates. This means that the era of high interest rates will continue, which will not be good for economic growth.
Also, it is important to remember that the food security scheme is an open ended scheme. As Nitin Pai, Director of The Takshashila Institution, writes in a column "The scheme is open-ended: there's no expiry date, no sunset clause. It covers around two-thirds of the population-even those who are not really needy. This means that the outlays will have to increase as the population grows."
This might also lead to the government printing money to finance the scheme. It was and remains easy for the government to obtain money by printing it rather than taxing its citizens. F P Powers aptly put it when he said that money printing would always be "the first device thought of by a finance minister when a large quantity of money has to be raised at once". History is full of such examples.
Money printing will lead to higher inflation. Prices will rise due to other reasons as well. Every year, the government declares a minimum support price (MSP) on rice and wheat. At this price, it buys grains from farmers. This grain is then distributed to those entitled to it under the various programmes of the government.
The grain to be distributed under the food security programme will also be procured in a similar way. But this may have other unintended consequences which the government is not taking into account. As the CACP points out "Assured procurement gives an incentive for farmers to produce cereals rather than diversify the production-basket...Vegetable production too may be affected - pushing food inflation further."
And this will hit the very people food security is expected to benefit. A discussion paper titled Taming Food Inflation in India released by CACP in April 2013 points out the same. "Food inflation in India has been a major challenge to policy makers, more so during recent years when it has averaged 10% during 2008-09 to December 2012. Given that an average household in India still spends almost half of its expenditure on food, and poor around 60 percent (NSSO, 2011), and that poor cannot easily hedge against inflation, high food inflation inflicts a strong 'hidden tax' on the poor...In the last five years, post 2008, food inflation contributed to over 41% to the overall inflation in the country."
Higher food prices will mean higher inflation and this in turn will mean lower savings, as people will end up spending a higher proportion of their income to meet their expenses. This will lead to people spending a lower amount of money on consuming good and services and thus economic growth will slowdown further. It might not be surprising to see economic growth go below the 5% level.
Lower savings will also have an impact on the current account deficit. As Atish Ghosh and Uma Ramakrishnan point out in an article on the IMF website "The current account can also be expressed as the difference between national (both public and private) savings and investment. A current account deficit may therefore reflect a low level of national savings relative to investment." If India does not save enough, it means it will have to borrow capital from abroad. And when these foreign borrowings need to be repaid, dollars will need to be bought. This will put pressure on the rupee and lead to its depreciation against the dollar.
There is another factor that can put pressure on the rupee. In a particular year when the government is not able to procure enough rice or wheat to fulfil its obligations under right to food security, it will have to import these grains. But that is easier said than done, specially in case of rice. "Rice is a very thinly traded commodity, with only about 7 per cent of world production being traded and five countries cornering three-fourths of the rice exports. The thinness and concentration of world rice markets imply that changes in production or consumption in major rice-trading countries have an amplified effect on world prices," a CACP research paper points out. And buying rice or wheat internationally will mean paying in dollars. This will lead to increased demand for dollars and pressure on the rupee.
The weakest point of the right to food security is that it will use the extremely "leaky" public distribution system to distribute food grains. As Jagdish Bhagwati and Arvind Panagariya write in India's Tryst With Destiny - Debunking Myths That Undermine Progress and Addressing New Challenges "A recent study by Jha and Ramaswami estimates that in 2004-05, 70 per cent of the poor received no grain through the pubic distribution system while 70 per cent of those who did receive it were non-poor. They also estimate that as much as 55 per cent of the grain supplied through the public distribution system leaked out along the distribution chain, with only 45 per cent actually sold to beneficiaries through fair-price shops. The share of food subsidy received by the poor turned out to be astonishingly low 10.5 per cent."
Estimates made by CACP suggest that the public distribution system has a leakage of 40.4%. "In 2009-10, 25.3 million tonnes was received by the people under PDS while the offtake by states was 42.4 million tonnes- indicating a leakage of 40.4 percent," a CACP research paper points out.
Bhagwati and Panagariya also point out that with the subsidy on rice being the highest, the demand for rice will be the highest and the government distribution system will fail to procure enough rice. As they write "recognising that the absolute subsidy per kilogram is the largest in rice, the eligible households would stand to maximize the implicit transfer to them by buying rice and no other grain from the public distribution system. By reselling rice in the private market, they would be able to convert this maximized in-kind subsidy into cash...Of course, with all eligible households buying rice for their entire permitted quotas, the government distribution system will simply fail to procure enough rice."
The jhollawallas' big plan for financing the food security scheme comes from the revenue foregone number put out by the Finance Ministry. This is essentially tax that could have been collected but was foregone due to various exemptions and incentives. The Finance Ministry put this number at Rs 480,000 crore for 2010-2011 and Rs 530,000 crore for 2011-2012. Now only if these taxes could be collected food security could be easily financed the jhollawallas feel.
But this number is a huge overestimation given that a lot of revenue foregone is difficult to capture. As Amartya Sen, the big inspiration for the jhollawallas put it in a column in The Hindu in January 2012 "This is, of course, a big overestimation of revenue that can be actually obtained (or saved), since many of the revenues allegedly forgone would be difficult to capture - and so I am not accepting that rosy evaluation."
Also, it is worth remembering something that finance minister P Chidambaram pointed out in his budget speech. "There are 42,800 persons - let me repeat, only 42,800 persons - who admitted to a taxable income exceeding Rs 1 crore per year," Chidambaram said.
So Indians do not like to pay tax. And just because a tax is implemented does not mean that they will pay up. This is an after effect of marginal income tax rates touching a high of 97% during the rule of Indira Gandhi. A huge amount of the economy has since moved to black, where transactions happen but are never recorded.
To conclude, the basic point is that food security will turn out to be a fairly expensive proposition for India. But then Sonia Gandhi believes in it and so do other parties which have voted for it.With this Congress has firmly gone back to the garibi hatao politics of Indira Gandhi. And that is not surprising given the huge influence Indira Gandhi has had on Sonia.
As Tavleen Singh puts it in Durbaar "When she (i.e. Sonia) refused to become Congress president on the night Rajiv died, it was probably because she knew that if she took the job, she would be quickly exposed. In her year of semi-retirement she learned to speak Hindi well enough to read out a speech written in Roman script, and studied carefully the politics of her mother-in-law. There were rumours that she watched videos of the late prime minister Indira Gandhi so she could learn to imitate her mannerisms."
Other than imitating the mannerisms of Indira Gandhi, Sonia has also ended up imitating her politics and her economics. Now only if Lal Bahadur Shastri had lived a few years more...
Vivek Kaul is a writer. He tweets @kaul_vivek
More From Vivek Kaul.