India’s direct cash transfers present an illusory welfare scheme

Author: Raghbendra Jha, ANU

As of March 2013, the Unique Identification Authority of India has generated over 287 million identification numbers as part of what will be the world’s largest biometric database.

Indian schoolchildren wait in line for their midday meal at a government primary school in the outskirts of Hyderabad. (Photo: AAP)

The central government intends the new identification system, known as Aadhaar, to form the basis of a new system of direct cash transfers (DCTs) to the poor, in lieu of the various subsidies currently available for necessities such as fuel and food. Individuals can use their Aadhaar cards to facilitate the opening of a bank account linked to the card (though they are not obliged to), which will then enable them to receive funds directly from the government. The government hopes to use DCTs to improve the welfare of low-income earners by eliminating the middlemen who run the current, often corrupt, subsidy distribution systems. But there are a number of practical impediments to the effective implementation of DCTs.

First, a few points about what Aadhaar is and is not should be noted. Acquiring an Aadhaar number is voluntary and, in principle, available to every Indian resident. Individuals are assigned random 12-digit numbers which can be used to uniquely identify them. Aadhaar cards contain data on the biometric and demographic characteristics of any individual, and the data are centrally stored. But they are not identity cards in the traditional sense of a driver’s licence or a voter registration card, and they do not replace any other form of identification. Cards also do not record data on caste, religion, ethnicity or income.

A key problem is that Aaadhar cards do not supply any specific criteria to identify the poor, or provide an automatic avenue for direct transfers to bank accounts of the poor. Unless other measures are designed, the current Below the Poverty Line (BPL)/Above the Poverty Line criteria will continue. These criteria have been widely criticised and it is currently unclear how the link will be made between Aadhaar, which serves the individual, and the BPL category, which is based on household rather than individual income.

Another barrier to the effective implementation of DCTs is the requirement that every adult (or at least one person from every poor household) has a bank account. The World Bank estimates that in 2012 only 35 per cent of all Indian adults and only 21 per cent of those in the poorest quintile had bank accounts. Against this backdrop, the use of bank accounts to directly transfer cash to the poor is currently no more than a pipe dream.

Other factors determining the success of the DCT include whether poor individuals are correctly identified and included; whether non-poor individuals are also correctly identified and excluded; whether all poor households opt to provide bank account details; and whether the system of transfers can be kept free of fraud and abuse. These factors are all determined by the reality of how economic and social activity is conducted in India. They represent potential pitfalls which may prevent the Aadhaar system from fulfilling its noble aspiration of weeding out the middlemen standing between the government and the poor. DCTs work better in countries with large formal sectors, low poverty and a high density of banks. Brazil and Mexico, two countries where DCTs have worked well, both satisfy these characteristics.

So what will DCTs actually achieve? Hundreds of millions of rupees in subsidies will flow into bank accounts. Hopefully, most, if not all, of these transfers will reach people from poor households, though this is not guaranteed. Yet, even if DCTs do successfully reach the poor, the scheme may not improve their welfare in real terms. When someone receives a kilogram of rice at subsidised rates (fixed in nominal terms) through the Public Distribution System it is clear what he/she is receiving. But if they receive an implied subsidy through a DCT the real value of the subsidy will fall sharply in the current environment of high inflation, because the transfers will be in nominal terms (rupee values) and will only be adjusted after a time lag.

The end result is a drop in the real subsidy costs of the government. For a government that is struggling with a huge fiscal deficit this will come as a huge relief. The new system may also yield political dividends for the ruling coalition if the beneficiaries mistake the nominal transfer for a real transfer. But in reality DCTs will reduce the welfare of those they are designed to benefit and will subsequently act like an implied tax on the poor.

Raghbendra Jha is Professor of Economics and Executive Director at the Australia South Asia Research Centre, the Australian National University.

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