Non-merit freebies unsustainable: RBI article

CHENNAI: Against the backdrop of the Sri Lankan crisis, the RBI put out an article in June in an attempt to put the spotlight on fiscal risks confronting State governments. Among the new sources of risks it identified was what it termed ‘non-merit freebies’.

Edited excerpts:

In the recent period, State governments have started delivering a portion of their subsidies in the form of freebies. While there is no precise definition of freebies, it is necessary to distinguish them from public/merit goods, expenditure on which brings economic benefits, such as the public distribution system, employment guarantee schemes, states’ support for education and health. On the other hand, provision of free electricity, free water, free public transportation, waiver of pending utility bills and farm loan waivers are often regarded as freebies, which potentially undermine credit culture, distort prices through cross-subsidisation eroding incentives for private investment, and disincentivise work at the current wage rate leading to a drop in labour force participation.

Some freebies may benefit the poor if properly targeted with minimal leakages, but their advantages must be evaluated against the large fiscal costs and inefficiencies they cause by distorting prices and misallocating resources. Additionally, the provisions of free electricity and water are known to accelerate environmental degradation and depletion of water tables.

The GST compensation payout coming to an end will further reduce the headroom available for social sector expenditure. In such a situation, a multitude of social welfare schemes in the form of freebies will not only put a heavy burden on the exchequer but will also exert upward pressures on yields if they are financed through market borrowing.

It will be important, therefore, for the State governments to reprioritise their expenditure to achieve optimum long-term welfare advantages by ensuring that the beneficiaries get empowered permanently and forego such benefits. Also, states should ensure that there is a sunset clause for each social sector scheme.

Reducing the quantum of subsidies by ensuring that only the deserving receive them will free up resources to invest in health, education, agriculture, R&D and rural infrastructure, which will help create more jobs and reduce poverty on a sustainable basis.