Foreign Direct Investment: Spurring the Economic Growth

          An investment or an acquisition is termed Foreign Direct Investment (FDI) when an individual or business owns 10% or more of the shares in the target foreign company's capital. All later financial transactions are extra direct investments. If an investor owns less than 10%, it's considered an addition to his or her stock portfolio. A 10% ownership, however, doesn't give the investor a controlling interest but does give a significant influence on the company's management, operations, and policies. FDI is actually a particular type of foreign capital, as opposed to domestic investment. What makes investment “direct” as opposed to other forms of foreign capital is the concept of managerial control over an enterprise in which foreign capital participates.

          FDI is commonly classified as vertical or horizontal. Vertical FDI involves a geographical decentralization of the firm’s production chain, where foreign affiliates in low-wage countries typically produce labour-intensive intermediates that are shipped back to high-wage countries, often to the parent company itself. Vertical FDI is sometimes referred to as “efficiency seeking” FDI, since the main motive for the investment is to improve the cost effectiveness of the firm’s production.

          For example, in the textile and clothing industry, global supply chains are common. The capital-intensive stages (textiles) are located in relatively capital rich countries, human capital-intensive stages (design and up-market apparel) are located in human capital rich countries and labour-intensive stages (apparel manufacturing) are located in labour abundant countries.

          Horizontal FDI involves multinational companies producing the same product in multiple plants, and service local markets through affiliate production rather than through exports from the home country of the MNE (multinational enterprises). Most of the global FDIs is horizontal. Horizontal FDI is sometimes referred to as “market seeking” FDI. The advantage of being close to the customers may be due to factors such as reduced transportation costs, smaller cultural barriers or avoidance of tariffs.

          In addition to the horizontal and vertical dimensions of FDI, investments may also be classified as either green-field or acquisitions. A green-field investment involves the establishment of a new production unit, whereas an acquisition is the purchase of (shares in) an already existing foreign company. Most of the growth in FDI taking place in recent years has been in the form of acquisitions. Indeed, in 1999, acquisitions accounted for more than 80 percent of global FDI. Between 60 and 80 percent of FDI flows to developing countries, however, have been in the form of green-field investments during the period 1995–99.

          For a firm to choose to invest in a foreign country, there must exist some comparative locational advantages or attractions in that foreign country before the final investment decision is made. The advantages may come in different forms; firms aiming at reducing costs may be attracted by low wages, firms wishing to expand their international market share may be attracted by a large home market, and so on.

          These advantages may also include a greater control over technology or reduced transaction costs for the said company. Inefficient public policies may, however, discourage investments. As an example, 16 leading MNEs operating in India named regulatory control, bureaucratic intervention, and the lack of adequate infrastructure, particularly telecommunications and transportation, as major difficulties in operating in this country.

          A widely used instrument to attract foreign firms is tax policy. We have seen that several Asian and African countries have given special tax privileges to foreign investors, particularly in the manufacturing sector. Offering various incentives to attract FDI may certainly be a rational policy if foreign investment generates positive spillovers, since market forces alone would then attract too little foreign entry.

          An investment involves a long-term exposure to the economic and political conditions in the host country, and firms, therefore, look for some commitment from the government. They need to be assured that their investment is safe from expropriation, that profits can be transferred out of the country, and that potential disputes between the host government and the multinational firm will be solved in a fair and efficient way. Countries with a record of economic, political and social stability are likely to be more attractive to foreign investment.

          Economists tend to favour the free flow of capital across national borders because it allows capital to seek out the highest rate of return. Capital goes to whatever businesses have the best growth prospects anywhere in the world. That's because investors seek the best return for their money with the least risk. This profit motive is color-blind and doesn't care about religion or form of government.

          Capital inflows from other countries in the nature of FDI have been considered very important contributor to augmenting availability of capital for funding of infrastructure, industries and other economic ventures. Equity inflows are more stable and bring in new management practices and technology together with the investment. For encouraging FDI inflows, the FDI policy is reviewed on an ongoing basis, with a view to make it more investor-friendly.

          FDI is perhaps the clearest sign of globalization in the past decade. The average annual growth rate of FDI has been 23 percent since 1986, which is twice as much as that of trade. However, during the 1990s, and until the Asian financial crisis in 1997, the share of FDI hosted by countries in the developing world increased.

          The Asian financial crisis in 1997–98 fully exposed the weakness of the corporate structures. Like crises before, this one also forced reforms, including the opening up of the economy to foreign investment. FDI, however, has proved to be resilient during financial crises. For instance, in East Asian countries, such investment was remarkably stable during the global financial crises of 1997-98.

          In sharp contrast, other forms of private capital flows namely portfolio equity, debt and short-term flows were subject to large reversals during the same period. The resilience of FDI during financial crises was also evident during the Mexican crisis of 1994-95, the Latin American debt crisis of the 1980s or the financial crisis during 2007-08.

          Even though a major reason for soliciting FDI includes a sustained flow of capital and technology, FDI, however is not the only source of capital and technology. Countries may rely on their own savings or borrow money in international markets to add to the capital stock. Or the countries may rely on domestic research and development (R&D) in order to upgrade technological sophistication. The experience of South Korea with regard to attracting FDI is notable in this regard. The main lesson from the South Korea is perhaps that FDI is not necessary for economic growth. There are alternative ways of accessing capital and technology; purchasing machines on the international market and hiring foreign experts to communicate the technology to local workers has been the growth strategy of South Korea. Whether this strategy is the most cost effective way to access foreign technology is of course debatable.

          FDI, however, has been deemed critical for developing and emerging market countries. Their companies need the sophisticated investors' funding and expertise to expand their international sales. In 2014, they received more than half (55 per cent) of total global FDI. Developing Asia attracted more foreign investment than either the EU or the United States. The developed world also needs cross-border investment, but for different reasons. Most of their investment is via mergers and acquisitions between mature companies.

Advantages of Foreign Direct Investment:

·        FDI benefits the global economy, investors and recipients as a whole if pursued with a right mix of policies. FDI not only creates profits for the investors, but also corporate tax revenue for the host country, not to speak of creation of the huge employment and other opportunities. In principle, therefore, FDI contributes to investment and growth in host countries through these various channels.

·        Recipient businesses receive "best practices" in management, accounting or legal guidance from their investors. They also benefit from the latest technology, innovations in operational practices and new financing tools. The FDI, thus, allows the transfer of technology, particularly in the form of new forms of capital inputs that cannot be achieved through financial investments or trade in goods and services. FDI also promotes competition in this domestic input market. Recipients of FDI often gain employee training in the course of operating the new businesses, which contributes to human capital development in the host country.

·        Another advantage of FDI is that it offsets the volatility created by ‘hot money’ or portfolio investment in the national stock market. That creates a kind of boom-bust cycle that often ruins economies a la the East Asian crisis of the late 1990s. FDI, on the other hand, takes longer to set up and has a more permanent footprint in a country.

·        Unrestricted, international capital flows reduce the risk faced by owners of capital by allowing them to diversify their lending and investment.

·        The global integration of capital markets can contribute to the spread of best practices in corporate governance, accounting rules, and legal traditions.

·        The global mobility of capital limits the ability and penchant of governments across the world to pursue bad policies. Capital unfriendly policies may lead to the flight of capital to the more attractive shores.

·        An additional benefit is that FDI is thought to be "bolted down and cannot leave so easily at the first sign of trouble." Unlike short-term debt or portfolio investment, direct investments in a country are immediately re-priced in the event of a crisis.

·        Mostly, FDI is a boon for environmental protection given the new resources it brings for improving efficiency, transferring knowledge, and addressing existing pollution.

·        While FDI is not necessary to achieve economic development, the entry of foreign firms may play an important role in adding technology and competition to the host economies thereby making it more efficient.

Disadvantages of Foreign Direct Investment:

          Even though economic theory and praxis through recent empirical evidence suggest that FDI has a beneficial impact on developing host countries, many studies also points to some potential risks with an over-exposure to FDI. The same are mentioned as below:

·        FDI can be excessive owing to adverse selection and fire sales. Often domestic companies are not able to complete with the foreign corporations. Taking advantage of the same, foreign corporations may, while pursuing a predatory marketing policy, buy a local company to shut it down in a bid to capture the local market completely.

·        Sophisticated foreign investors might strip the business of its value without adding any. They can sell off unprofitable portions of the company to local, less sophisticated investors.

·        A high share of FDI in a country's total capital inflows may reflect its institutional weakness rather its strength. A country’s relative economic backwardness and underdevelopment goads it to look for its growth and development by seeking FDI.

·        More exposure to FDI may also sometimes lead to increased imports. This is because the foreign companies, in a bid to maximize their profits, often try to source cheapest materials from different sources, which often result in increased imports thereby affecting the balance of payment situation.

·        Repatriation of profits by the foreign companies often stresses the domestic balance of payments situation. Thus, FDI can be reversed through financial transactions;

·        The tendency of governments to extend tax holidays to foreign corporations to attract FDIs often leads to loss of revenue for the government.

·        Higher wages in foreign corporations often lead to talent drain to foreign companies thereby reducing domestic corporations’ competitiveness.

·        Countries should not allow too much foreign ownership of companies in strategically important industries. That not only lowers the comparative advantage of the country, but also often becomes problematic from the point of national security.

Foreign Direct Investment in India:

          Significant changes have been made in the FDI policy regime in the recent times to ensure that India remains an increasingly attractive investment destination. The Government regularly disseminates information on the investment climate and opportunities in India as well as advises prospective investors about investment policies, procedures and opportunities. International cooperation for industrial partnerships is solicited both through bilateral and multilateral arrangements including through interaction with the industry associations.

          In order to make the FDI policy more liberal and investor-friendly, further rationalization and simplification has been done. Government has allowed FDI up to 100 per cent on the automatic route for most activities and a small negative list was notified where either the automatic route was not available or there were defined limits on FDI. The Government also reviewed the FDI policy in pharmaceuticals sector and decided that the existing policy would continue with the condition that ‘non-compete’ clause would not be allowed except in special circumstances with the approval of the Foreign Investment Promotion Board.

          The FDI policy on defence was reviewed to allow FDI up to 49 per cent through Government route though management control is to be in Indian hands. FDI up to 100 per cent has been allowed through automatic route in construction, operation and maintenance of suburban corridor projects through PPP; high speed train project; dedicated freight lines; rolling stock including train sets, and locomotives/coaches manufacturing and maintenance facilities; railway electrification; signalling systems; freight terminals; passenger terminals; infrastructure in industrial park pertaining to railway line/sidings including electrified railway lines and connectivities to main railway line; and mass rapid transport systems.

          The amended policy regarding construction development sector includes easing of area restriction norms, reduction of minimum capitalization and easy exit from project. Further, in order to give boost to low cost affordable housing, it has been provided that conditions of area restriction and minimum capitalization will not apply to cases committing 30 per cent of the project cost towards affordable housing.  

          The Government has also allowed 100 per cent FDI on automatic route for manufacture of medical devices. The Government increased FDI limits for insurance sector from 26 per cent to 49 per cent, effective from March, 2015. FDI up to 49 per cent has been permitted in the Pension Sector from April, 2015. The Government revised the investment limit from 1,200 crores to 3,000 crores, for cases requiring prior approval of the Foreign Investment Promotion Board (FIPB)/Cabinet.

          The Government reviewed the FDI Policy on investments by Non Resident Indians (NRIs), Persons of Indian Origin (PIOs) and Overseas Citizens of India (OCIs). The Government amended the definition of Non Resident Indian as contained in the FDI Policy and also to provide that for the purposes of FDI Policy, investment by NRIs under schedule 4 of FEMA (Transfer of issue of Security by Persons Resident outside India) Regulations will be deemed to be domestic investment at par with the investment made by residents.

          FDI Inflows in the industrial sector manufacturing sectors were the first ones to be opened up for FDI inflows as with the product market reforms, it was considered necessary to invite FDI inflows in these sectors. The infrastructure and services sector were gradually opened up in subsequent phases partly because these were for a long time considered to be the public sector responsibility. The overall equity flow, however, indicate that industrial sector covering mining, manufacturing and power as of today accounted for nearly 50 per cent of the total equity inflows.

          FDI has particularly been active in sectors like machinery, chemicals, auto sector, miscellaneous manufacturing, telecommunication and power. In case of telecommunication, the FDI is both for setting up of production base and also for providing telecommunication services. In traditional sectors of Indian industry, inflow of FDI has been limited. This may be partly because of a low technological intensity of these sectors. It may also be due to the strength of domestic industry and the perception of foreign investors with regard to these sectors.

Some Recent Government Measures to Attract FDI in India:

          The measures taken by the Government are directed to open new sectors for foreign direct investment, increase the sectoral limit of existing sectors and simplifying other conditions of the FDI policy. FDI policy reforms are meant to provide ease of doing business and accelerate the pace of foreign investment in the country. The important steps taken recently in this regard include:

·         49% FDI under automatic route permitted in Insurance and Pension sectors;

·         Foreign investment up to 49% in defence sector permitted under automatic route. The foreign investment in access of 49% has been allowed on case to case basis with Government approval in cases resulting in access to modern technology in the country or for other reasons to be recorded;

·         FDI limit for defence sector made applicable to Manufacturing of Small Arms and Ammunitions covered under Arms Act 1959;

·         FDI up to 100% under automatic route permitted in Teleports, Direct to Home, Cable Networks, Mobile TV, Headend-in- the Sky Broadcasting Service;

·         FDI up to 100% under automatic route permitted in Up-linking of Non-‘News & Current Affairs’ TV Channels, Down-linking of TV Channels;

·         In case of single brand retail trading of ‘state-of- art’ and ‘cutting-edge technology’ products, sourcing norms can be relaxed up to three years subject to Government approval;

·         Foreign equity cap of activities of Non-Scheduled Air Transport Service, Ground Handling Services increased from 74% to 100% under the automatic route;

·         100% FDI under automatic route permitted in Brownfield Airport projects;

·         FDI limit for Scheduled Air Transport Service/Domestic Scheduled Passenger Airline and regional Air Transport Service raised to 100%, with FDI upto 49% permitted under automatic route and FDI beyond 49% through Government approval;

·         Foreign airlines would continue to be allowed to invest in capital of Indian companies operating scheduled and non-scheduled air-transport services up to the limit of 49% of their paid up capital;

·         In order to provide clarity to the e-commerce sector, the Government has issued guidelines for foreign investment in the sector. 100% FDI under automatic route permitted in the marketplace model of e-commerce;

·         100% FDI under Government route for retail trading, including through e-commerce, has been permitted in respect of food products manufactured and/or produced in India;

·         100% FDI allowed in Asset Reconstruction Companies under the automatic route;

·         74% FDI under automatic route permitted in brown-field pharmaceuticals. FDI beyond 74% will be allowed through government approval route;

·         FDI limit for Private Security Agencies raised to 74%;

·         For establishment of branch office, liaison office or project office or any other place of business in India if the principal business of the applicant is Defence, Telecom, Private Security or Information and Broadcasting, approval of Reserve Bank of India would not be required in cases where FIPB approval or license/permission by the concerned Ministry/Regulator has already been granted;

·         Requirement of ‘controlled conditions’ for FDI in Animal Husbandry (including breeding of dogs), Pisciculture, Aquaculture and Apiculture has been done away with.

GST: Ushering A Common Indian Market

          The passing of the 122^nd Constitution Amendment Bill, 2014 by the parliament has resulted in the introduction of the Goods and Services Tax (GST) in the country which is considered as the biggest economic reforms since 1991. The same has been introduced not only to get rid of the current patchwork of indirect taxes that are partial and suffer from infirmities in the form of exemptions and multiple rates, but also to improve tax compliances.

          GST is an indirect tax bringing together multiple taxes imposed on all goods and services (except a few) under a single banner. This is meant to bring together the state economies and create a single taxation system for the entire country for all goods and services. It is based on a tax-on-value-add concept which avoids duplication of taxes. Currently, there are various taxes being managed differently by Central and state government in India including Central excise duty, octroi, turn-over tax,  service tax and customs duties at the Central level and VAT (value-added tax), entertainment tax, luxury tax or lottery taxes at state level. Everything now gets replaced by one single point of taxation i.e. GST.

          This is in contrast to the present system, where taxes are levied separately on goods and services. The GST, however, is a comprehensive form of tax based on a uniform rate of tax for both goods and services. However, the GST is payable only at the final point of consumption. In simple terms, the GST reduces the number of instances where taxes need to be paid thereby reducing the possibility of manipulation on the part of tax authorities and is therefore assumed to be a more transparent way of administering taxes. It will alleviate the burden of cascading taxes for individuals. It is also expected to boost revenue collection in certain states and to reduce the prices of goods.

          GST is likely to facilitate more seamless movement of goods and services across the nation. It reduces the overall transactional cost of running the business and thereby also reduces the need for following multiple tax rules and obligations. It would also reduce corruption and bring more efficiency in running businesses. By integrating the state economies, GST has created a single, unified Indian market to boost overall growth and make the economy stronger.

          However, the end consumer bears this tax as he is the last person in the supply chain. Experts say that GST is likely to improve tax collections and boost India’s economic development by breaking tax barriers between states and integrating India through a uniform tax rate. Under GST, the taxation burden is to be divided equitably between manufacturing and services, through a lower tax rate by increasing the tax base and minimizing exemptions. It is expected to help build a transparent and corruption-free tax administration.

          GST is to be levied only at the destination point, and not at various points from manufacturing to retail outlets. Presently, a manufacturer needs to pay tax when a finished product moves out from a factory, and it is again taxed at the retail outlet when sold. This anomaly of double taxation goes with GST. It is estimated that India will gain $15 billion a year by implementing the Goods and Services Tax as it would promote exports, raise employment and boost growth. It will divide the tax burden equitably between manufacturing and services.

          In the GST system, both Central and State taxes will be collected at the point of sale. Both components (the Central and State GST) are to be charged on the manufacturing cost. This will benefit individuals as prices are likely to come down. Lower prices will boost more consumption, thereby spurring demands and subsequent economic growth. India has opted for a dual GST system. Under dual GST, a Central Goods and Services Tax (CGST) and a State Goods and Services Tax (SGST) are to be levied on the taxable value of a transaction. All goods and services, barring a few exceptions, would be brought into the GST base.   

          The GST, to give the Centre and states concurrent powers to tax goods and services, is a right step. However, the experts have criticized the 1% extra levy proposed to be charged when goods move from one state to another. If Rajasthan imports goods from Maharashtra, it will pay 1% tax to Maharashtra, but the levy will not be charged if the goods are imported from outside India. Also, the 1% tax would apply multiple times, every time goods move from one state to another, and could cumulate to as much as 5% in a typical supply chain. This will add to the cascade of taxes that products bear and raise the cost of raw materials, capital and finished goods.

          As there will be no set-offs on the extra levy – it is to be in force for two years or such other period as the GST Council may recommend. However, producing states want the levy on the grounds that they will lose out when the central sales tax is scrapped. There is no logic as the Centre has already guaranteed compensation to states while transiting to GST. The extra levy scuttles the ‘Make in India’ plan. It goes against the grain of GST and renders our exports uncompetitive. Hence, the extra levy needs to be scrapped.

          Many feel that keeping real estate out of GST is a bad idea as credit will not be available for taxes paid on inputs used in construction such as cement and steel. Construction capital expenditure is 40% of total capital investment in a year, and that’s not small change. Bringing real estate under GST will raise investment and push growth. 

          A unified GST is an economically efficient solution even for the multinationals, which have to compete with the companies in the unorganised sector, as it simplifies the indirect tax structure to one general rate that can be paid by all companies. Under the GST structure, every company gets a deduction on the taxes already paid by its suppliers. That results in every buyer ensuring that his supplier has paid his part to claim his deductions.

          The bill has kept certain goods out of the purview of GST for the moment, which have been a bone of contention between state governments and the Centre. These inter alia include crude petroleum, high speed diesel, natural gas, aviation turbine fuel and alcohol for human consumption. States shall have the power to levy taxes on these items, except in the case of imports and inter-state trade.

          Critics have termed GST to be a regressive tax, which has a more pronounced effect on lower income earners, as GST consumes a higher proportion of their income, compared to those earning large incomes. A study has found that the introduction of the GST negatively impacts the real estate market as it adds up to 8 percent to the cost of new homes and reduces demand by about 12 percent.

          The spread of GST across the globe has been one of the most significant developments in taxation over the last six decades. More than 150 countries have adopted the GST because of its capacity to raise revenue in the most transparent manner. It is estimated that India will gain $15 billion a year by implementing the GST as it would promote exports, raise employment and boost growth. One is sure that introduction of GST will further unleash the pent-up growth potential in the Indian economy and boost the economic growth as expected.

Role of Public Distribution System in Food Security

          A large public distribution system (PDS), supplemented by arrangements for moderating prices in the open market and concerted efforts for achieving self - sufficiency in food-grains, coupled with measures for maximising procurement from surplus areas, have been the twin objectives of food policy in modern India, ever since the Bengal famine of 1943. The PDS is one of the instruments for improving food security at the household level in India.

          The PDS ensures availability of essential commodities like rice, wheat, edible oils, and kerosene to the consumers through a network of outlets or fair price shops. These commodities are supplied at below market prices to consumers. With a network of more than 28 462,000 fair price shops (FPS) distributing commodities worth more than Rs. 300 billion annually to about 160 million families, the PDS in India is perhaps the largest distribution network of its kind in the world.

          The PDS evolved as an important instrument of government policy for management of scarcity and for distribution of food-grains at affordable prices. Supplemental in nature, the scheme is not intended to make available the entire requirements of food-grains of the households. Self-sufficiency of food-grains at national level and availability of food-grains at affordable cost at local level have not got translated into household level food security for the poor.

          The PDS that existed till recently has been widely criticised for its failure to serve the population below the poverty line (BPL) , its urban bias, iniquitous distribution as reflected in the poor coverage in the States with the highest concentration of the poor, lack of transparent and accountable arrangements for delivery and the consequent heavy leakages. Realising this, the Government has streamlined the PDS by targeting it to the BPL population at specially subsidised prices and with better monitoring of the delivery system. The new system, named Targeted Public Distribution System (TPDS), has come into operation with effect from 1st June, 1997.

            The Targeted PDS (TPDS) was introduced in 1997 and under this scheme special cards were issued to families below poverty line (BPL) and food-grains were distributed at a lower price for these families compared to those above the poverty line (known as APL families). The entire population was divided into three categories – BPL (Below Poverty Line), APL (Above Poverty Line) and AAY – Antyodaya Anna Yojana (for destitutes).

          The BPL population are provided 35 kg of food-grains per month at subsidized price. Under AAY, the destitute households (part of BPL households) are provided a monthly provision of 35 kg of food-grains at specially-subsidized rates (Rs. 2 per kg for wheat and Rs. 3 for rice). About 25 million (38 per cent of BPL) people have been covered under AAY. The central government allocates food-grains to different states of India based on poverty ratios. States in turn distribute food-grains based on the BPL list.

          PDS providing food-grains at affordable prices is one of the key elements of the Government's Food Security system. In spite of obvious limitations PDS did play a role in improving regional food security, specially in drought prone areas. In an attempt to improve availability of food to population living in most vulnerable areas (remote, tribal and drought-prone regions), the revamped public distribution system gave priority for establishment of PDS in such vulnerable areas. In spite of mounting food subsidies, evaluation studies indicate that supply of subsidised food given through PDS has not resulted in improvement in household level food security.

Impact of Public Distribution System (PDS):

          The main purpose of the PDS was to act as a price support programme for the consumer in 1960s. Those were the years of food shortage. The basic items covered were rice, wheat, sugar, edible oil, and kerosene to be sold at subsidized prices.       There had been a growing feeling that the non-poor were the beneficiaries of PDS in large numbers, especially in respect of sugar and Kerosene oil.

          The PDS has remained very ill-manned, expensive and largely untargeted programme. The very poor are unable to take the benefit of the PDS for a variety of reasons. They do not have a regular income. They are unable to lift a month or a fortnight’s quota at one time for want of enough money.

          At one extreme, economists advocate replacing the PDS in its entirety with cash transfers, others have suggested the implementation of cash transfers without dismantling the PDS or moving to a system of food coupons. States like Andhra, Rajasthan, and recently Bihar have introduced food coupons and considerable improvements have been reported as a result. This measure has helped in reducing the number of bogus ration cards and has been effective in checking PDS grains from being diverted into the open market. An alternative viewpoint emphasises that the solution is to strengthen the PDS and make it more inclusive rather than undermining it, especially given the impressive improvements in its functioning in many parts of the country.

           

          Cash transfers are, in theory, cost-effective because they have lower transaction costs and avoid the problem of having to procure, store, transport and distribute commodities. They also offer beneficiaries the freedom to direct the cash to particular household needs. In the context of food, for instance, this could imply a more diverse diet or better quality grain. Cash is also deemed to have multiplier effects that could potentially support local market development. In the Indian context, most proponents of cash transfers as a replacement for the PDS see it as a cost-effective alternative that is less prone to leakage or corruption.

          A recent survey found that in states where the PDS functions reasonably well, an overwhelming proportion of the respondents are in its favour and are averse to a cash transfer system. Overall, more than two-thirds preferred food and less than a fifth preferred cash, with the others either having a conditional preference for one or the other or no clear preference at all. The greatest support for cash transfers was in states where the PDS does not function well, with people suggesting that they would be happy with an equivalent amount of cash.

          It is not surprising that this variation across states in performance of the PDS is highly correlated with poor performance of other programmes as well. In particular, Bihar, which performs poorly in the PDS also topped the states in perceived corruption in the public sector in general. A silver lining, therefore, is that there are improvements even in states that have routinely had a poor record in the implementation of welfare programmes.

          Among states where the PDS functions effectively, a shared feature has been the use of IT-based transparency measures, starting with a simple computerised record-keeping system of the entire supply chain. Combined with Global Positioning System (GPS) tracking of delivery trucks and Short Messaging Service (SMS)-based transmission of information to users, there are checks and balances that make diversion of food-grains to the open market very difficult.

          In Tamil Nadu, consumers can obtain the stocks position via SMS, and in Chattisgarh, the timing of the arrival of the supplies to the fair price shop. Tamil Nadu and Chattisgarh also have functional grievance redressal mechanisms. Chhattisgarh has a system for tracking the entire chain from farmer to consumer of PDS grain in its local procurement operations. The use of digital smart cards at PDS outlets in Andhra Pradesh and coupons in Rajasthan for PDS are known to have been effective in curtailing leakages in the ‘last mile’, although more rigorous research is required to understand the efficacy of these latter measures.

          Attempts to use technological solutions to curb leakages have been initiated both by the national government as well as by individual states. While the national government's focus has been overwhelmingly on a unique biometric identification project, which would eventually require real-time authentication of the beneficiary, various states have experimented with more user-friendly alternatives like smart cards that work on point of sale devices and using the unique biometric identification merely to weed out duplicates and ghost cards.

          There must be focus on ways the food delivery system can be overhauled to reduce costs along the supply chain, procurement, storage and delivery. Local procurement of food-grains, where feasible, is likely to significantly bring down transaction costs. Chattisgarh's experiment with local procurement offers scope to examine the economics of localising food-grain procurement and the feasibility of restricting long hauls only to transfer grain from food surplus to food deficit regions.

          While Public Distribution System (PDS) does provide some immediate relief, it fails to provide enduring food security to the poor. It would be more appropriate to focus on strategies that reduce poverty and stabilize prices of food grains. There is need for certain reforms in procurement and distribution for better functioning of TPDS. These are:

(i)                decentralization of procurement and distribution;

(ii)              involving panchayats (elected village representatives) in PDS;

(iii)           streamlining FCI and involvement of private sector farmers’ cooperatives, SHGs, etc. in procurement and distribution;

(iv)           viability of FPSs, giving them higher margin, making monitoring compulsory;

(v)              computerization of records for cross-checking, opening of grievance cells, and strengthening the role of Panchayats and NGOs;

(vi)           devising an appropriate criterion for selection and strict enforcement of the criterion; and

(vii)        punishment system for the defaulters.

            An ambitious and holistic programme of food security necessarily requires adequate supply of food at the macro level to meet the effective demand of the country as a whole, but also one that ensures superior dietary quality. Although detractors perceive this to be an expensive and largely wasteful exercise that hinges on a faulty mechanism for procurement and distribution via fair price shops under the PDS, supporters suggest that this is the best way to ensure food access to the disadvantaged. The immediate challenges for India lie in revisiting operational aspects of food procurement and distribution for a more cost-effective and nimble system.

          A well targeted and subsidised Public Distribution System (PDS) is an important constituent of the strategy for poverty alleviation. A subsidised PDS should essentially be viewed as a mechanism for income transfer to low income segments of the population. While conceptually the function of income transfer to the low income groups can be better performed by food coupons, for several reasons it may not be workable in the Indian situation.

          First, dismantling of the PDS implicit in food coupons system may not be acceptable. Second, PDS is linked to the system of support prices and procurement operations as a part of the current agricultural price policy. The time is not yet ripe to disband the price support operations and therefore, the PDS which provides an outlet for offloading the food-grains procured from surplus areas to deficit areas.

          Third, food coupon system is fraught with unmanageable administrative problems associated with security printing of coupons, fraud prevention, fresh issue of stamps due to periodic indexation etc. Fourth, food coupons have characteristics similar to cash and are liable to be misused. Fifth, and more important, it has been argued that coupons (equivalent to cash) would typically enhance the demand for highly subsidised food-grains (due to shift in the demand curve to the right) while the supply remains the same. This will cause food prices to rise. Increase in food price would mean deterioration in the well being of those who are left out of the coupon programme. Under the circumstances, a poverty-based targeting of PDS is a better option from the point of view of ensuring the food security of the poor.

          In view of the fact that the poor devote a substantial part of their expenditure on food-grains, it is essential to protect them from a continuous upward pressure on food-grains prices. If the poor are not protected from the impact of ever increasing prices of food-grains, the effects of many of the poverty alleviation measures and programmes would get neutralised. In other words, a system of food subsidy becomes an essential element of food security.

          The challenge, however, is to contain the total food subsidy to the minimum necessary through a system of targeting, so that the subsidies benefit only those sections whom the State wants to protect. With the proposed NFSA (National Food Security Act), the improved functioning of the PDS would become most essential and concerted efforts would have to be made in effectively plugging leakages and ensuring a streamlined functioning of the PDS.