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Monday, September 15, 2014

Technology and institutional machinery that will save Rs.75,000 crore a year

by Viral Shah.

In a recent article, Ajay Shah discussed the potential for Aadhaar to help save Rs.75,000 crore per year, by overhauling the administration of susbidies. The first level gains come from using Aadhaar numbers in the databases of every scheme to elimnate ghosts, fakes and duplicates. The second level gains come from enforcing a one price policy. There is an incentive for arbitrage when and only when a commodity has two different prices in the market. Aadhaar technology helps ensure that all subsidised goods are sold at market prices, and the subsidy is transferred directly to the targeted beneficiary. Finally, there is a need to rationalise the subsidy and social safety net policies - who gets subsidies, how do they get them, how are subsidised goods produced, and how they get distributed.

Let's go closer into these questions, envisioning the concrete actions required on some of these fronts.

LPG subsidy

An implementation plan for the LPG was in the Report of the Task Force for Direct Transfer of Subsidy for LPG, Fertilisers and Kerosene where Nandan Nilekani was the Chairman.

The first step of implementing this plan was the cap on the number of cylinders of LPG that can be purchased by a household. Starting with 6 initially, political considerations led to this limit to be raised to 9 and then 12 subsidised cylinders annually. However, as the report notes, the average consumption of cylinders is less than 9 cylinders annually, and this decision should be reverted to 9 cylinders. While this cap has immediately led to a gain, over time, fake LPG consumer connections will be created as there is ample incentive to do so.

To address this requires implementing the second recommendation: to link every LPG connection with an Aadhaar number and deliver cylinders at market prices. The subsidy amount for the first 12 cylinders is transferred directly to the consumer into their Aadhaar-linked bank account as soon as the cylinder is delivered. While this sounds like science fiction, the Dhande Committee Report finds that this scheme had been rolled out in 291 districts with high levels of Aadhaar registration, and Rs.5400 crore of subsidy was transferred into 28 million Aadhaar-linked bank accounts. This is about 10% of the total subsidy for the year of 2013-14, which was Rs.46,000 crore, with 120 million subscribers in all. The tangible outcomes obtained through this work were: 0.6 million duplicate connections detected, and an 18% reduction in the sale of domestic LPG cylinders.

It took years to align all the stakeholders - the Oil Marketing Companies, Banks, National Payments Corporation of India, UIDAI, Ministry of Petroleum and Natural Gas, the Ministry of Finance, the distributors - to develop the IT systems, processes, exceptions, training materials, etc. Today, this is a scheme that can be rolled out at scale, after one signature on a green sheet by the Petroleum minister. Conservatively, this signature can deliver a saving of Rs.10,000 crore within 2 years.

Today, the private sector cannot enter the domestic LPG business, since the subsidies are funded as under-recovery by the Ministry of Petroleum and Natural Gas, and this is available to the Government owned Oil and Marketing Companies. Once LPG is sold to the customers at market price, it also allows for the entry of the private sector in this business, since the subsidy is directly transferred to consumers. There has been very little innovation in this business due to lack of competition. We will most likely see more investment in LPG import terminals, innovations such as LPG cylinders made from lighter materials, and operational improvements such as in logistics as the sector sees higher competition. Consumers will benefit with lower prices and better service if there with more competition. No signatures are required for this to happen!

Fertiliser subsidy

The same report also outlines a solution for fertiliser subsidy based on the same principles. The size of the fertiliser ecosystem is the same as that of LPG. While 120 million consumers benefit from LPG subsidy, there are about 100 million farmers who benefit from subsidised fertilisers. There are major differences though. LPG is largely sold in dense urban areas, whereas fertilisers have to delivered in sparsely populated rural areas. The distribution of LPG is carried out by Oil and Marketing Companies that have fully computerised operations across the country, and directly appoint their own distributors. In the case of fertilisers, the production and imports is mostly in the private sector, which largely receives the subsidy at source. The Central Government administers the movement of fertilisers up to the district level. Beyond that, the State Government's Department of Agriculture takes over, and different States have different distribution models.

Every aspect of fertiliser manufacturing is controlled and subsidised. Given the importance of food security, even inefficiencies are tolerated to a great extent. Take the case of Urea, which is manufactured from both, natural gas and Naphtha, with natural gas being significantly cheaper. However, natural gas pipelines are not available to factories in the south, which continue to use Naphtha, and the Government covers the additional cost. Not only is the price of Urea controlled, but so is the supply of natural gas (yes, fertiliser manufacturing gets priority when there are disruptions in natural gas imports or production), movement, allocation of railway carriages, freight subsidy, etc. There has been no investment in this sector in over a decade, and no technological improvements due to the cost-plus model of manufacturing.

As a result, we live in a society today, where people camping for iphones overnight are cheered, but farmers camping overnight for fertilisers get hell. Here is an interview with a farmer in Uttar Pradesh that sums up all the problems with fertiliser subsidy.

The subsidy on fertilisers has cost us close to Rs.100,000 crore in 2013-14. India has the largest subsidy in place worldwide, which leads to overuse of urea that decreases soil quality, and far too much control in the manufacturing and distribution that leads to perennial shortages and rampant black marketing. (See page 42 of Chapter 2 of the 2014 Economic Survey from the Ministry of Finance).

The savings in the problem of fertiliser subsidy can be conservatively estimated at Rs.20,000 crore per year. However, the implementation is a lot more challenging than the LPG case, due to involvement of the Central and State Governments, a less technologically skilled ecosystem, and the geographical spread of the solution, the grip of co-operatives in many states, etc. At the same time, just because it is difficult, this does not mean it cannot be done.

If Urea is fully decontrolled, we can expect entry of the private sector. Selling at market prices will get rid of the black marketing, and higher customer service levels will emerge from multiple producers competing for customers.

One possible way to deal with fertiliser subsidy is to eliminate it altogether, and instead adjust the higher input costs as part of the Government procurement of foodgrains. In the same way, many other input subsidies such as electricity and water subsidies offered by the state governments can be eliminated altogether and adjusted in procurement.

Reforming the PDS and Kerosene Subsidy

Many of the ideas above can also be implemented in the PDS, where the food subsidy is on the order of Rs.60,000 crore. The Report of the Task Force on an IT strategy for PDS also chaired by Nandan Nilekani provides a comprehensive set of steps to reform the PDS.

The kerosene subsidy is also administered by the State Governments, who receive subsidised kerosene from the Centre. Both, food and kerosene subsidy require better administration.

Again, by Aadhaar-linking and administering these subsidies directly into the bank accounts of the beneficiaries, there are significant gains possible. The beneficiaries can then procure foodgrains from any retail shop or grocer in the country, which has its back-end tied into the subsidy administration platform as outlined in the above report.

The expected savings from these initiatives can be on the order of Rs.20,000 crore.


An electronic payment architecture for administering Aadhaar-linked subsidies and payments is the backbone of the entire idea. This has already been put in place for purposes of LPG subsidy, and the same architecture can be leveraged for all other subsidies and entitlements.

The ideas behind linking Aadhaar and payments are detailed in the Report on Aadhaar-enabled payment infrastructure. Translating these into implementation gave the following institutional infrastructure:

  • Aadhaar Payments Bridge, operated by National Payments Corporation of India. This is a back-end payments platform through which payments can be sent to bank accounts simply on the basis of the Aadhaar number. This system worked, on scale, for the LPG subsidy transfer.
  • The MicroATM device design and interoperable network through which any shop owner with a mobile phone and biometric reader can become a Business Correspondent. The specifications were designed by an RBI appointed committee and have full stakeholder acceptance, that includes the Indian Banks Association, all banks, IDRBT, and UIDAI. Without issuing any token such as debit cards or mobile phone linkage, anyone in the country can access their accounts simply with their Aadhaar number and biometric authentication. This is working, on scale, in Andhra Pradesh for MGNREGS payments by India Post. A national rollout can be carried out in a matter of months with a decision from the Department of Financial Services as part of the Jan Dhan scheme.
  • The Aadhaar e-KYC service provides electronic KYC for opening of bank accounts and satisfying KYC requirements in any domain.

Every government scheme -- from the MGNREGS, every form of social security pension, Janani Suraksha Yojana, scholarships, and payments to para-workers such as Aanganwadi workers and Asha workers -- can be routed through these payment. These form of payments add up to roughly Rs.100,000 crore. We may guess that Rs.25,000 crore will be saved through computerisation and elimination of fakes and ghosts.


These calculations suggest that it is feasible to save Rs.75,000 crore per year, by fully utilising these ideas and institutional infrastructure. Achieving important change in India is about this two part process: (a) going after big ideas that can move the needle and then (b) building State capacity for the institutional machinery which will make these ideas happen. We fail when we stick to small ideas and we fail when we fail to back big ideas with execution.

The work described above took place over a period of three years at UIDAI, under the leadership of Nandan Nilekani. I was part of the secretariat. The behind-the-scenes stories, and more, are going to be in a book Rebooting Government, that is presently being written by Nandan Nilekani and me.

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