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Monday, September 08, 2014

The fiscal correction that India requires is feasible: Aadhaar and subsidy reform holds the key

The size of the task

Last year (i.e. 2013-14 RE), the fiscal deficit was 4.6% of GDP. The fiscal deficit budgeted for 2014-15 is 4.1% of GDP. The budget speech has said that the target for 2015-16 is 3.6% and then the target for 2016-17 is 3% of GDP. For India to achieve macroeconomic stability, this fiscal contraction is extremely important.

How are we going to get this overall gain of 1.6 percentage points of GDP from 2013-14 till 2016-17? The international experience suggests that sustained fiscal corrections are dominated by reduced expenditure; attempts at increased tax revenues tend to peter out as the economy changes its behaviour in response to short-termist tax measures. Hence, we have to focus upon expenditure reductions.

How might we get an expenditure reduction of 1.6 percentage points? Will it be done by doing a little bit here and a little bit there? The trouble is: 1.6 percentage points of GDP is a full Rs.2,06,026 crore (i.e. Rs.2.06 trillion or $33 billion). Minor initiatives will not move the needle. Any one initiative which yields an impact of below Rs.10,000 crore is not a big element of this task. What this requires is the pursuit of qualitative change.

Aadhaar offers a stab at the task

In November 2012, we at the Macro/Finance Group of NIPFP had done a cost-benefit analysis of UIDAI. At the time, the key focus was on the question: Is the construction of UIDAI an NPV-positive project? The answer of this calculation was in the affirmative. The extremely conservative estimates made in that calculation are revealing about the far-reaching consequences of Aadhaar for improvements in numerous expenditure programs. A big area for focus is on better engineering, and reforming, subsidy programs. We should think about it in three parts:

  1. Superficial change: just add biometric authentication. The first and easy area for progress is the removal of duplicates (i.e. payment to the same person twice) and ghosts (i.e. payment to a non-existent person). This is low hanging fruit and only requires systems engineering of existing programs using UIDAI. At this stage, nothing changes on the working of the existing program. People continue to buy subsidised LPG through the existing subsidy program; there’s just a biometric check which establishes that the same person is not buying many cylinders. NREGA continues to operate; we just use Aadhaar to eliminate ghosts and duplicate payments.

  2. Deeper change: Commodity-specific subsidies continue, but transfers are in cash. The second stage is deeper changes in the design of the program. As an example, consider the LPG subsidy. Progress had begun with direct benefit transfer for LPG (“DBTL”). In 289 districts, consumers got cash of Rs.435 a month into their bank accounts when they purchased LPG at the market rate. This program was working; Rs.5,400 crore was transferred into 28 million accounts. Unfortunately, the UPA government lost nerve and on 30 January 2014, this initiative was shut down.

  3. Eliminating commodity linked and other subsidies, and doing income support. Once enough people are plugged into Aadhaar-enabled payments, it becomes possible to replace commodity-linked subsidies by a cash subsidy. This is more efficient as the government would not distort commodity markets or intrude on the preferences of households. Government would empower poor people with money and not get into decisions about whether consuming LPG is a good thing. The construction of such a cash-based subsidy involves its own design choices. This design work can start now, and one year from now, Aadhaar adoption will be on a scale large enough to support implementation.
All this was quite novel a few years ago, but by now these ideas are ripe for implementation. The policy analysis and workplan documents are ready on the fertiliser and fuel subsidy, use of Aadhaar for large-scale payments infrastructure, and restarting DBT for LPG.

 The low hanging fruit from Aadhaar adoption in the implementation of subsidies works out to around Rs.75,000 crore a year. While this does not take us all the way to the required Rs.2,06,026 crore, this is big enough to move the needle in a way that tinkering at the margins is not. Re-engineering subsidy programs using Aadhaar also sets the stage, and changes the political possibilities, for deeper subsidy reform (e.g. capping the number of cylinders per household, or kilograms of subsidised fertiliser per farmer) through which the remainder of the required reduction in expenditure can be obtained.

The early initiatives which can be easily rolled out are reviving the DBTL (that was done for LPG) and using the same framework for Kerosene, Fertiliser and Food. Alongside this, state governments can also use DBT for water and electricity subsidies, which will help free up fiscal resources at the state level. As with DBT for LPG: when the household pays a water or electricity bill, the subsidy would show up in the household’s bank account.

DBT can help in all government to person payments including : MNREGA, scholarships, salaries, pensions. It can help in delivering stipends and incentives to the 1-2 million contract workers associated with the government: SSA school teachers, anganwadi workers, ASHA workers etc. The WTO may require India to put an end to procurement from farmers; we can shift to delivering cash to farmers using DBT.

 It is important to remember that every time we shift from a price-based subsidy to an income support, this simultaneously yields an impact of GDP growth, as the distortions associated with price-based subsidies are removed. Hence, such an approach to reform simultaneously hits the numerator (fiscal deficit measured in rupees) and the denominator (GDP), and thus gives a bigger bang for the buck.

A few minor things or grand schemes?

To summarise, Aadhaar is the big idea around which we can take a stab at the required 1.6 percentage points of GDP of a reduction in expenditure by 2016-17. This generates cost savings right away, and sets the stage for deeper subsidy reform which will generate the remainder of the required fiscal correction. Aadhaar has been constructed and is ready to go. The BJP government has reaffirmed its interest in continuing with this program. What a difference a few years makes: Aadhaar was viewed as a complex, risky, new system, but now it’s a big working system:

  • 670 million Aadhaar numbers have been issued, and the system is at its point of inflection into near-complete coverage of the poor people who would be beneficiaries of subsidies.
  • A few thousand crore have been transferred through Aadhaar DBT.
  • Over 60 million bank accounts are linked to Aadhaar.
  • Several million authentications have been done so this is also a proven capability.
  • Jan Dhan Yojana will use Aadhaar e-KYC, which is a statement of the maturity of this capability.
  • Jan Dhan Yojana, as presently envisaged, has many problems: it is a continuation of 60 years of failed RBI thinking on financial inclusion. But this work could be channelled into a big push for getting a Aaadhar-linked mobile-based payments mechanism to every citizen of India, which would be a pretty good thing.

As with all important progress in India, what matters is obtaining execution on grand schemes, and not tinkering at the margin. Our present ways in public administration are broken: we need to think big, and implement new systems. The centrepiece of our journey is implementing five big transformational projects: Aadhaar, the Goods and Services Tax, the Indian Financial Code, the Direct Taxes Code, and the Delhi-Mumbai Industrial Corridor. These are the five initiatives where the analysis and thinking is complete, and we’re ripe for execution. They are big enough to move the needle for the Republic.

For many bureaucrats, it is far more comfortable living around little initiatives, and being fashionably cynical about grand schemes. The little stuff is, however, a bad use of top management time, and becomes irrelevant in a few years. A more intellectual perspective shows us, by looking back into 20 years, that it was only the grand schemes that mattered.


  1. If nominal gdp grows at the rate of 13-15% as it has over the last few years then fiscal deficit (as a percent of this increasing gdp) will come down to 3% if expenditure is kept at current "absolute" levels. Is that right? So, deficit would reduce from 4.6/1 to 4.6/1.5=3 if nothing was done. I suppose if spending is proportional to gdp as opposed to absolute amounts (which it probably is, or should be), then of course it wouldn't help as the numerator would increase proportional to gdp. Nonetheless, the point is that the best way to manage debt/deficit is to grow the denominator (gdp).

  2. Kindly check the numbers. According to the excel calculations, the NPV of the project (@10% discount rate) is ~ 28,000 over 10 years, translating to a ~ 2,800 Crore benefit per year (present value). This is quite small compared to the overall deficit figure of over 2 lakh crore (per year) provided

  3. I think one of the big aspects of Jan Dhan yojna not being spoken about is the intended but not spelt out intentions to implement DBT. One big aspect of DBT to work is having a bank account in the first place. Without that in place how does one implement DBT. So first open the bank accounts, then seed them with Aadhaar numbers, then use biometric based authentication to start moving all kinds of govt payouts directly to bank accounts rather than in cash.

  4. (1) Aadaar is only half the story. There is an equal amount of work involved in validating and computerizing the addresses using the postal system and linking the addresses to all the residents. Indian govt has not even started on this work.

    (2) Regarding fiscal deficit, there is an important difference between the western world and India. Part of the govt spending goes towards public "investments" and other part of the spending is towards running the govt. It is important to reduce the "running" component and increase the " investment" component. Hopefully the replacement of planning commission is capable of making this distinction and recommend meaningful contribution towards identifying, evaluating and prioritizing public "investments".

  5. I think aadhaar is a project which needs care to implement. It cannot be forced upon people without consultations. It is a good thing to move towards cash transfers but such a large system re-engineering needs lot of managerial skills. Strategy needs to be perfect. Policies need to be fine-tuned. People need to be taken into confidence. They need to be educated to handle the ATM card and also know to operate the ATM. People need to have trust and confidence in the system. Whatever measures you and nandan dish out is not the final gospel. Government has the right to take the positive steps in them after all the government has to answer the people. People will ask who will benefit from this scheme. Benefits to people should be evident within 2019 or else NaMo will be voted out because of DBT and Aadhaar implementation. I think they have very little time.


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