1. Final Report for IEGC Project on
“Subsidies in India: Evolution and Relationship with
Macroeconomic Indicators”
Submitted on March 23rd
, 2013
Submitted to
Prof. Yogesh Doshit
Submitted by:
Ashish Agarwal 121115
Shuchi Bhatnagar 121154
Pramod Ghanshani 121140
3. Introduction
Subsidy is a term which refers to any benefit given by the government to groups or
individuals usually in the form of cash payment or tax reduction (Investopedia). The purpose
of this subsidy is to reduce the burden on general public. There are many different types of
subsidies given by the government for example: food subsidy, oil subsidy, fertilizer subsidy,
farming subsidies and subsidy in the power sector. Some of these subsidies are aimed at
increasing the level of production by providing incentives in the form of subsidies to protect
the producers and motivate them to produce.
Rationale
Subsidies are but a necessary evil. All this subsidies increases the government expenditure
and thus add to the woes of the government by increasing the fiscal deficit due to intensive
borrowing done by the government from external sources to meet the requirement of the
subsidies which it gives. The only source of revenue for the government is taxes which is not
enough to bridge the gap between the government spending and earnings. Currently it is
estimated that the fiscal deficits are going to rise to 5.8% of GDP higher than the government
targets of containing it to 5.1%. India's fiscal deficit is the widest among major emerging
economies due to huge spending on subsidies for items such as food, fuel and fertilizer.
Subdued tax revenues in a slowing economy have aggravated fiscal strains and both Standard
and Poor's and Fitch have placed "negative" outlooks on India's current BBB-minus ratings.
Thus we see that there is an extreme need to contain the amount of subsidies so as to bring
our fiscal deficit to manageable levels and prevent the downgrade by S&P.
Objective
Our objective to conduct this study is to analyse how the subsidies affect GDP, fiscal deficit
and the growth of the economy and we will also attempt to develop a forecast model based on
past data to estimate the future levels of subsidy and its affect on the Indian economy as a
whole.
Page 3
4. Literature Survey
A general equilibrium analysis of production subsidy in a Harris-Todaro developing
economy: an application to India; Applied Economics; (Sep2009, Vol. 41 Issue 21,
p2767-2777, 11p)
Since 1950s India has advocated import substituting industrialization policies to promote its
manufacturing sector. The end result was creation of a dual economy: highly favoured
manufacturing sector with high and rigid wages and neglected agricultural sector with low
wages and poverty. Because of the higher wages in the manufacturing sector, the rural
labourers migrate to the urban sector, a typical characteristic of the Harris-Todaro
developing economy. Realizing this crisis, the Indian government recently initiated policies
and introduced agricultural production subsidy to boost agricultural production and curb the
labour migration. Findings show that agricultural production subsidy increases agricultural
production, reduces unemployment, raises the wage rate in the agriculture sector, augments
the consumption among the rural and urban households, and increases the rental rate for
capital in agricultural sector.
(Reforming Food Subsidy Schemes: Estimating the Gains from Self-targeting in India ;
Review of Development Economics; May2004, Vol. 8 Issue 2, p309-324, 16p)
Many countries implement safety nets and anti-poverty programs whose purpose is to
provide benefits especially to the poor. However the task to identify the poor is not an easy
one. This makes it crucial to design schemes so that the non target groups are excluded from
these benefits.
Self targeting in food subsidies can work by subsidizing commodities consumed primarily
by the poor. Despite the widespread use of food subsidy programs in different countries,
there have been very few formal Quantitative analyses of these programs.
Determining the right basket of commodities to be subsidized and also analysing its
influence on social is very crucial. In principle, the contemplated change could be in the
rates of the existing basket of goods or in the introduction of a new commodity into the
basket of subsidized goods.
A model consisting of five commodities: rice and wheat supplied through the PDS, denoted
as commodities 1 and 2, respectively; coarse cereals denoted as commodity 3; and rice and
wheat sold in the open market which are commodities4 and 5, respectively.
The rice and wheat supplied through the PDS are sold at prices fixed by the government
while the market determines the prices of the other commodities.
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5. Suppose that the government increases the price of commodities 1 and 2 and uses the
proceeds to subsidize the market sales of commodity 3 (coarse cereals).Then what happens
to the welfare?
The results of tax reform analysis indicate that self-targeting by subsidizing an inferior
commodity does not always lead to higher welfare even when the welfare function is
weighted in favour of the poor
This happens because the welfare gains also depend on the shares of the subsidized
commodities and of coarse cereals in the budgets of the poor.
Methodology
Data Collection
In our study we are going to use secondary data which is already available. We will be taking
a time series analysis by using the past 10 years data of subsidies given towards various
sectors like agriculture, power and manufacturing industries and then we will be also collect
the data of the fiscal deficit and the percentage break up due to different areas and the percent
each sector contribute towards the GDP.
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6. Subsidies Vis-à-vis Macroeconomic Variables
Year Sub GDP Fisc deficit
2002-03 43,533 24,54,561 1,45,065
2003-04 44,323 27,54,620 1,23,407
2004-05 45,957 32,42,209 1,25,798
2005-06 47,522 36,92,485 1,46,592
2006-07 57,125 42,93,672 1,42,550
2007-08 70,926 49,86,426 1,27,154
2008-09 1,29,708 55,82,623 3,37,190
2009-10 1,41,351 64,57,352 4,18,436
2010-11 1,73,420 89,80,860 4,31,979
2011-12 2,16,297 89,12,179 5,22,254
2012-13 1,90,015 1,01,59,884 5,14,090
Table 1: Ten year’s data of macro economic indicators
(Source: Planning commission data book and author’s calculation)
Fig 1: Subsidies and Macro Economic Variables in India Over a period of time
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7. Data Analysis
Using these data we will be able to find a distinct co relation exists between each of the
factor. Based on the data we will make a model which would explain the current plight of the
Indian economy. We are also planning to do a sector specific analysis as to which sector the
subsidies are more beneficial and where subsidies are required. We have made some basic
hypotheses that needs to be tested.
Ha: Subsidies do not have any significant effect on the GDP.
Hb: Subsidies do not have any significant effect on the fiscal deficit.
Models Used
Firstly we need to check if there is a significant co relation between the independent variables
namely, subsidies and fiscal deficit with the GDP of the country. After establishing the co
relation we would run a regression analysis to find out the effect of each variable on the GDP
of the country. Finally, we will club both the variables and then see the effect on GDP.
The model that we will be using is kind of a forecast model. We are planning to do a multiple
regression using these macroeconomic indicators and then find out the optimum amount of
subsidy to be given. For example we will set a target GDP and then we can find the optimum
amount of subsidy given so that we can reach that target. The past 10 years data will help us
in establishing a trend line which can be used to forecast GDP given the amount of subsidy.
Based on this we can decide on what policy the government should follow for the betterment
of India and reduce the fiscal deficit.
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8. Analysis
Co-relation of GDP Vs Subsidy
Correlations
Subsidies GDP
Subsidies Pearson Correlation
1 .957(**)
Sig. (2-tailed)
.000
N
11 11
GDP Pearson Correlation
.957(**) 1
Sig. (2-tailed)
.000
N
11 11
We can see from the SPSS output that there is a high degree of co-relation between subsidies
and GDP. A co-relation value of +.957 denotes that as the subsidies increase GDP
increases.
Co-relation of Fiscal Deficit Vs Subsidy
Correlations
Subsidies Fiscal Deficit
Subsidies Pearson Correlation
1 .983(**)
Sig. (2-tailed)
.000
N
11 11
Fiscal Deficit Pearson Correlation
.983(**) 1
Sig. (2-tailed)
.000
N
11 11
We can see from the SPSS output that there is a high degree of co-relation between subsidies
and fiscal deficit. A co-relation value of +.957 denotes that as the subsidies increase fiscal
increases.
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9. Co-relation of Fiscal Deficit Vs GDP
Correlations
Fiscal Deficit GDP
Fiscal Deficit Pearson Correlation
1 .933(**)
Sig. (2-tailed)
.000
N
11 11
GDP Pearson Correlation
.933(**) 1
Sig. (2-tailed)
.000
N
11 11
We see that there is a high positive relationship between GDP and fiscal deficit. It may be
because as the government borrows money which increases the fiscal deficit but as a
consequence of that borrowing domestic output increases which in turn increases GDP.
Regression Analysis between Subsidies and GDP
Model
Sum of
Squares df Mean Square F Sig.
1 Regression 670864622
07397.400
1
67086462207
397.400
98.781 .000(a)
Residual 611228176
3852.140
9
67914241820
5.794
Total 731987439
71249.600
10
a Predictors: (Constant), Subsidies
b Dependent Variable: GDP
Regression analysis was done between GDP and subsidies taking subsidies as a independent
variable and GDP as an dependent variable. We find that subsidies given out has a significant
effect on the GDP.
GDP = f(Subsidies)
GDP = 39.09(Subsidies) + 1470727
This is the regression equation that we receive after doing the regression analysis.
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10. Regression Analysis between Subsidies and Fiscal Deficit
ANOVA(b)
Model
Sum of
Squares df Mean Square F Sig.
1 Regression
27587759395
2.121
1
275877593952.1
21
261.027 .000(a)
Residual
9512025915.
419
9 1056891768.380
Total
28538961986
7.541
10
a Predictors: (Constant), Subsidies
b Dependent Variable: Fiscal Deficit
Regression analysis was done between fiscal deficit condition and subsidies taking
subsidies as an independent variable and fiscal deficit as a dependent variable. We find that
an amount subsidy given out has a significant effect on the fiscal deficit.
Fiscal Deficit = f (Subsidy)
Fiscal Deficit = 11551 + 2.506(Subsidies)
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10
11. Regression Analysis between Subsidies, Fiscal Deficit, GDP
In this analysis we will take GDP as a dependent variable and fiscal deficit and subsidy as
independent variables.
ANOVA(b)
Model
Sum of
Squares Df Mean Square F Sig.
1 Regression 67251973807
752.800
2
33625986903876.
410
45.236 .000(a)
Residual
59467701634
96.790
8
743346270437.10
0
Total
73198743971
249.600
10
a Predictors: (Constant), Fiscal Deficit, Subsidies
b Dependent Variable: GDP
Regression analysis was done between fiscal deficit condition, subsidies and GDP taking
subsidies and fiscal deficit as independent variables and GDP as a dependent variable. We
find that both variables together has a significant effect on the GDP.
GDP = f (Subsidy, Fiscal Deficit)
GDP = 49.533(Subsidies) - 4.171(Fiscal Deficit) + 1518914
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11
12. We see that both subsidies and fiscal deficit affect GDP as the model gets rejected at 95
significant models. Now we know that each of the variables affect the GDP significantly.
Also we see that the independent variables also affect each other so seeing into account the
multi co linearity index we see:
Collinearity Diagnostics(a)
Model Dimension
Eigenvalue
Condition
Index Variance Proportions
(Constant) Subsidies Fiscal Deficit (Constant) Subsidies
1 1 2.813 1.000 .03 .00 .00
2 .183 3.923 .96 .01 .01
3 .004 25.419 .02 .99 .99
a Dependent Variable: GDP
We see that the coalition index is greater than 15 which means that there is a chance of multi
co linearity but we see that still the effect is not that bad. Hence we can say that GDP is
severely impacted by fiscal deficit and subsidies.
Conclusion
We see that subsidies are required in every industry and sector. It fosters growth of the sector
and also provides the incentive for the people involved and also the support which is
necessary. In the agriculture sector subsidized HYV seeds are necessary to support farmers as
they take risk and without any benefit there will be no motivation to do that. We can say that
subsidies are necessary but there should be a cap on it otherwise the cost involved will
outgrow the returns received.
Recommendation
Value of GDP at
growth@ 7%
Required Growth Rate of Subsidies
vis a vis previous year
10871075.88 8.18%
11632051.19 8.10%
12446294.78 8.01%
To grow at a rate of 7% we must require to increase our subsidy spending by >8% from last
year.
Growth of GDP@ Required growth in fiscal deficit vis
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12
13. 7% a vis previous year
10871075.88 7.57%
11632051.19 7.49%
12446294.78 7.42%
Growth at 7% will bring about a growth of fiscal deficit of 7.57% which is very high so we
need to find some alternative method to grow or to grow at a higher percentage to make the
growth sustainable.
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13
14. References
Applied Economics; Sep2009, Vol. 41 Issue 21, p2767-2777, 11p
http://planningcommission.nic.in/data/datatable/0512/databook_22.pdf
http://planningcommission.nic.in/data/datatable/0512/databook_15.pdf
Reforming Food Subsidy Schemes: Estimating the Gains from Self-targeting in India ; Review of
Development Economics; May2004, Vol. 8 Issue 2, p309-324, 16p
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14
