Direct cash transfers: a panacea for poverty and inequality in India?

Author: Pravakar Sahoo, IEG

India’s job-less and non-inclusive growth story in the last two decades has made little impact on incidences of poverty and inequality.

This has forced the government to extend existing welfare schemes and initiate new grand social programmes such as the National Rural Employment Guarantee Act, mid-day meals, the right to education, and the proposed food security bill to bring distressed low-income families and above the poverty line. As a result, the cost of government welfare programs for poverty elimination remains high at 2 per cent of GDP and is increasing.

India’s welfare schemes have long been dogged by leakages, corruption and poor delivery. For example, less than 50 per cent of food provided by the Public Distribution System (PDS) is reaching the targeted beneficiaries. To improve efficiency in delivery and the value of subsidies, the government has finally implemented a Direct Cash Transfers (DCT) scheme covering 20 districts and seven welfare schemes as of 1st of January 2013. While the DCT was originally intended to cover 51 districts and 20 schemes, this is still a big step forward.

The DCT requires beneficiaries to have a Unique Identity (UID) card or an Aadhar card and bank account so that money can be directly transferred. The DCT is designed to ensure the poor have basic necessities like food, health and education. It is expected to bring down poverty and inequality in India in the same way the successful Bolsa Familia programme did in Brazil. The DCT is also expected to achieve this success with a smaller subsidy thanks to better targeting and lack of corruption. The evidence shows that direct cash transfers increased the income of 80 per cent of Bolsa Familia households and reduced Brazil’s Gini coefficient — a measure of inequality — by 21 per cent. Though initial administrative costs are high, the experiences of Brazil and Mexico show a substantial reduction in cost in subsequent periods.

DCT could be a game changer in delivering welfare directly to the poor, but only if it is properly designed in terms of supporting infrastructure, institutions and monitoring mechanisms. First, it is necessary to make sure that poor families who are mostly uneducated and illiterate have bank accounts and a UID number. So far, only 40 per cent of all households in India have bank accounts, and these are mostly at the top of the wealth pyramid. Banks may not be keen to simply open branches in rural areas and open no-frill accounts to help poor people. The banking system also needs to have the requisite infrastructure such as bandwidth, information technology and staff to effectively support the cash transfer system. Government has to improve the breadth and depth of the financial system in India if it wants to ensure financial inclusion. In this regard, it is important to note that the UID programme is incomplete. It only covers around one-fifth of the total population.

It was easier to implement direct cash transfer programmes in Brazil and Mexico with 6 per cent and 1 per cent poverty ratios respectively (at 1.25 $ per day) compared to 32 per cent in India. The targeted population for the DCT programme in India is also more than the populations of Mexico and Brazil combined. The conditions and necessary infrastructure are also very different. For example, bank branches per hundred thousand population in Brazil and Mexico are 14 and 15 respectively, where as in India it is 10. The adult literacy rate in Brazil and Mexico is 90 per cent and 95 per cent respectively, where as in India it is 75 per cent. In Mexico and Brazil 80 per cent of the population lives in urban areas, where as in India around 80 per cent of the population still lives in rural areas.

There are arguments that the Indian government should not replace the existing public provision of services, particularly food grain, health and education with cash transfers. For example, under the Public Distribution Scheme (PDS) the government has been buying food from producers in surplus regions and distributing it across the states. If the PDS is dismantled and replaced by cash transfers it may skew the availability of food grains across regions. The private sector might exploit such a situation, which would not be good for food producers, food prices or food security. There are already pilot studies which show that households, particularly females in households, prefer food through the PDS rather than cash transfers. The reason for this is the availability of food even in the absence of markets nearby. But if the PDS were retained, its ability to deliver quality food items would need to be improved.

Direct cash transfers to the poor allowing them to buy basic services provided by the private sector can be effective but government needs to monitor the price of essential commodities like food and fuel in a deregulated market to avoid un-affordability and subsequent vulnerability of the poor. Direct cash transfers may help poor people to afford basic necessities and rise above the poverty line in the short term, but creating employment opportunities and income generating assets for the poor are crucial for long term poverty reduction.

Given the poor performance of welfare schemes in India to date, DCT is an important idea and expected to change millions of lives. But it is debateable whether it may be better to just improve efficiency in the existing system than attempt to introduce a new system without proper infrastructure. The key issues for DCT are identifying beneficiaries and deciding the size of transfers. Government should also make cash transfers conditional so that beneficiaries spend the money on intended goods and services. The Bolsa Familia scheme in Brazil comes with conditions such as attending school and vaccinations and has resulted in improvements to education and health outcomes as well as reduced poverty.

Pravakar Sahoo is Associate Professor at the Institute of Economic Growth (IEG), India.