A note on the inflationary potential of cash transfers
Source:R2, National Institute of Advanced Studies, Bangalore, Bangalore (2011)
The government of India has initiated a series of moves to replace the current system of subsidies embodied in the price of essential commodities sold in the Public Distribution System with one of cash transfers to the poor. The Finance Minister announced the step in this direction in his budget Speech in February 2011 and pilot projects are being launched in selected districts. The case for this fundamental transformation is built around the widespread belief that corruption has eroded the Public Distribution System (PDS). It is argued that a major portion of current subsidies is wasted as the subsidized commodities don't reach the poor. it would then be more efficient if, instead of subsidizing the commodity, money was directly transferred to the bank accounts of the poor. The simplicity of this argument makes its conclusion appear obvious. But this very simplicity hides a number of assumptions. Once these assumptions are made explicit it is clear that they are not quite realistic. And when they are dropped, it is no longer certain that the cash transfers will be better than the present system. On the contrary, once the assumptions are dropped it becomes evident that such a change in the way subsidies are distributed brings with it major risks of inflation as well as a worsening in the already serious problem of malnutrition.
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