Subsidies, Public Debt and Fiscal Federalism

Why subsidies exist

A subsidy is a payment or benefit from the government that lowers the cost of a good or service for producers or consumers. Subsidies are justified when:

• markets under-supply merit goods (education, health, nutrition);
• there are positive externalities, as with vaccination, clean energy or irrigation;
• they help the poor through redistribution;
• they support strategic sectors, such as food security or energy.

Subsidies become problematic when they are poorly targeted, distort prices (cheap power encourages over-pumping of groundwater), crowd out investment, or create fiscal burdens that are hard to reverse.

Major Central subsidies

Major subsidies peaked during the pandemic and the 2022 commodity price shock (when global fertiliser and food prices rose sharply), then fell as a share of GDP.

Reform tools

• Direct Benefit Transfer (DBT), launched in 2013: transfers cash or in-kind benefits directly to beneficiaries' bank accounts using Aadhaar. The government reports substantial savings from removing duplicate and fake beneficiaries. Treat the official cumulative savings figure as a government estimate.
• PAHAL (DBTL) for LPG (2014–15): the subsidy is paid into the bank account, and the cylinder is bought at market price. The Give It Up campaign invited better-off households to surrender their subsidy voluntarily.
• DBT in fertilisers (2018): subsidy is paid to companies after sale is authenticated on point-of-sale devices at retailers. A shift to direct payment to farmers has been debated.
• Neem-coated urea (2015): reduces diversion to industry and improves nitrogen-use efficiency.
• Nano urea (IFFCO, 2021), a liquid fertiliser. Its yield claims have been questioned in some field studies.
• Targeting and capping: the Shanta Kumar Committee proposed reducing NFSA coverage, and the Economic Survey proposed a Universal Basic Income in 2016–17. Neither was adopted.

"Freebies" debate: the Supreme Court has been hearing petitions on pre-election promises of free goods since 2022. The RBI and the Economic Survey have warned about the fiscal stress caused by state-level giveaways, such as free power and cash transfers. The distinction between welfare (merit goods, social protection) and unproductive freebies is contested; answers should define criteria such as targeting, fiscal sustainability and long-term productivity.

Public debt

Composition: the Centre's liabilities include:

• internal debt: dated securities (G-secs), treasury bills (91, 182 and 364 days) and cash management bills;
• external debt: from multilateral and bilateral lenders, a small share;
• other liabilities in the Public Account: small savings, provident funds and reserve funds.

Management: the RBI manages the Centre's market borrowings and acts as banker to the government (RBI Act 1934, sections 20–21). A separate Public Debt Management Agency has been proposed but not created.

Levels:

• General government debt is above 80% of GDP. It rose sharply in 2020–21 and has since declined slightly.
• Central government debt is about 56–57% of GDP.

Sustainability: debt is sustainable if the growth rate of nominal GDP (g) exceeds the interest rate on debt (r) and the primary deficit is contained. India's r−g gap has generally been favourable, which helps. Risks come from high interest payments, contingent liabilities (guarantees to PSUs and discoms) and rising state debt.

Why India's debt is relatively safe:

• It is mostly domestic and in rupees.
• It has a long maturity profile.
• It is held largely by domestic banks, insurers and the RBI.

Indian government bonds were included in the J.P. Morgan GBI-EM index from June 2024, followed by the Bloomberg and FTSE indices, which brought foreign inflows. Sovereign green bonds were first issued in 2023.

Fiscal federalism

Vertical imbalance: the Centre has more buoyant tax powers, while the states carry larger spending responsibilities (health, education, police, agriculture). Horizontal imbalance: states have different fiscal capacities. Instruments to correct both:

1. Finance Commission (Article 280): tax devolution and grants. The 15th FC (N.K. Singh) set the states' share at 41% (2021–26). The 16th FC (Arvind Panagariya) covers 2026–31. Its report was submitted in 2025 and its recommendations were taken up in the 2026–27 budget; verify specifics against the official report.
2. Centrally Sponsored Schemes (with matching shares).
3. Special assistance, such as the Scheme for Special Assistance to States for Capital Investment (50-year interest-free loans, from 2020–21).
4. Borrowing limits set by the Centre under Article 293(3). The net borrowing ceiling is about 3% of GSDP, plus an extra 0.5% linked to power sector reforms. Disputes have reached the courts: Kerala's suit against the Centre's borrowing curbs (2023–24) was referred to a constitution bench.

Issues states raise:

• The rising share of cesses and surcharges, which are not shared.
• GST compensation has ended.
• Conditional transfers reduce autonomy.
• Better-performing southern states argue that population-based criteria penalise them.

Defenders of the system point to large untied devolution and to horizontal equity.

Analysis: what makes public spending effective?

• Outcome budgeting: the Output–Outcome Monitoring Framework links funds to results.
• Just-in-time fund release: the SNA-SPARSH system (2023) releases central funds to scheme accounts only when payments are due, reducing idle balances.
• Public Financial Management System (PFMS): tracks funds down to the beneficiary.
• Zero-based budgeting and expenditure reviews: the Expenditure Management Commission (2014, Bimal Jalan).
• Independent fiscal institutions, which the N.K. Singh Committee recommended.

Common prelims traps

• Treasury bills are short-term (under one year) and issued at a discount. Dated securities are long-term.
• Ways and Means Advances from the RBI cover temporary mismatches; they are not permanent financing.
• Urea is not under NBS; it has a statutorily fixed MRP.
• The 16th Finance Commission covers 2026–31.

Practice: Mains question

*"Rationalisation of subsidies is essential for fiscal sustainability, but must protect the vulnerable." Discuss with reference to food and fertiliser subsidies. (150 words)*

Quick self-test

1. *Why is cash transfer preferred over price subsidy by many economists?* It does not distort market prices, reduces leakages and gives beneficiaries choice. Critics, however, worry about inflation eroding cash, banking access, and whether cash is used for nutrition.
2. *What is a contingent liability?* A potential obligation, such as a government guarantee on a PSU or discom loan, which becomes actual debt only if the borrower defaults.
3. *Which committee proposed a Universal Basic Income?* None; it was discussed in the Economic Survey 2016–17.

1. *Which deficit financing method is most inflationary?* Monetisation, meaning direct RBI financing of the deficit, because it creates new money.