Shirin Mohammadi, Associate Analyst and Atsi Sheth, Senior Vice President, Sovereign Risk Group, Moody's Investors Service Singapore
On 21 January, a panel appointed by India (Baa3 stable) Prime Minister Narendra Modi recommended reforms to the country's food subsidy and distribution system. We expect the recommendations to prompt policies that will improve the efficiency of India's food supply chain, a credit positive because it will reduce inflationary pressures and the government's fiscal deficit, two key constraints on the sovereign's credit quality.The reforms include decentralizing grain procurement, a process for disposing of excess food grains, delivering food and fertilizer subsidies via direct cash transfers, and reducing food subsidy coverage as mandated by the National Food Security Act to 40% of the population from 67%.
The country's CPI inflation rate has averaged 9% over the past five years, driven largely by food inflation. India's current food subsidy and distribution system support demand for food by lowering its costs to targeted consumers, but suppress the price signals that would prompt a supply response to India's growing food demand. Furthermore, the loss of grain stocks through inefficiency or corruption has raised costs and lowered the socio-economic benefits of the system.
Greater transparency and efficiency will lead to both demand and supply responding more quickly to price signals, diminishing the distortions that have kept food price inflation higher in India than globally (see exhibit). Because food accounts for about 50% of the average household consumption basket, lower food inflation will dampen wage inflation, improve the interest rate environment and increase the economy's competitiveness. Additionally, because the government is likely to reduce, but not eliminate, food subsidies, lower food inflation will cap its own food subsidy bill going forward.
India's general government fiscal deficit ratio of 7.2% of GDP for the fiscal year ended March 2014 ranks in the top decile of all Moody's-rated sovereigns. Annual spending on food subsidies grew by 20% on average over the past eight years, compared with 16% overall expenditure growth during the same period. The central government spent about 0.88% of GDP on food subsidies in fiscal 2014, which accounted for 18% of its fiscal deficit.
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The exact reduction in subsidy costs will depend on the measures that the government eventually adopts. At a minimum, changes to the system will keep food subsidy expenditures from rising as rapidly as they have in past years, and as efficiency gains emerge over the next few years, subsidy costs could fall as a percentage of GDP. This, in turn, would help narrow the government's overall fiscal deficit ratios.
A reduction in food subsidy coverage is politically sensitive in India, where annual per capita income was $1,509 in fiscal 2014. Therefore, it will be difficult to obtain parliamentary approval to amend the National Food Security Act and reduce the percentage of the population eligible for food subsidies. But many of the panel's other recommendations were made in consultation with state governments, suggesting a political and policy consensus that could smooth their implementation. The central government recognizes that the level and volatility of food prices poses risks to its fiscal target of reducing the central government deficit to 3% of GDP in 2017 from a planned 4.1% in fiscal 2015. Therefore, food subsidy reform is likely to remain part of its fiscal consolidation strategy. And the government, as it has done with other policy reforms in recent months, is likely to administer changes in food policy and process that do not require legislative amendments.
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