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Apart from the dearth in basic raw materials required to make fertilizers, the country is also deficient in natural gas, which works as feedstock. Photo: HT
Apart from the dearth in basic raw materials required to make fertilizers, the country is also deficient in natural gas, which works as feedstock. Photo: HT

L’enfant terrible among all government subsidies

Narendra Modi will have to spend significant political capital if he wants to restructure fertilizer subsidies

On 25 August, minister for chemicals and fertilizers Ananth Kumar announced the government proposes to come out with a new holistic fertilizer policy. It is expected to set up a new task force of experts. Kumar stressed the fact that the decision came at the behest of Prime Minister Narendra Modi.

This is good news considering that India spends over 70,000 crore on fertilizer subsidies, which is roughly twice the amount allocated to the much-reviled rural jobs guarantee scheme.

However, since the early 1950s, the fertilizer sector has been so remarkably controlled with convoluted laws and regulations that several governments have come and gone without really changing anything. In fact, one would be wary of rejoicing at another task force if the implementation of the nutrient-based subsidy (NBS) regime, was recommended by a group of ministers during the United Progressive Alliance (UPA) government’s first term, is anything to go by.

The fertilizer sector in India is an oddity of epic proportions. There are several strands to this. One, while India wants to remain self-sufficient in agricultural production and fertilizers are a key component in achieving that goal. But it comes to fertilizers, India has been hugely dependent on imports. Among the three main groups of fertilizers, India imports 60% of nitrogenous (N) fertilizers and between 90% to 100% of both phosphatic (P) and potassic (K) fertilizers.

Apart from the dearth in basic raw materials required to make fertilizers, the country is also deficient in natural gas, which works as feedstock. In any year, the shortage of gas is roughly 25-30%. This gap is made up by costly imported gas, which adds to the subsidy bill. Gas prices make up about 70% of production costs.

The other strand is that the bulk of the subsidy is routed through companies. In essence, the government fixes the market price of the fertilizer so that the farmers can buy it cheap and reimburses the firms. This looks bizarre but many experts say that unless the government has a foolproof way of giving direct subsidies, this indirect method may actually be better for the farmers.

However, this indirect method is not welcomed by the companies. Almost every year, the government defers significant chunks (almost 30%) of subsidy reimbursements to the next fiscal year. This hurts working capital requirements. The complicated manner in which the fertilizer subsidy is calculated essentially kills any incentive for companies to become more efficient. It is no surprise that despite two new investment policies in 2008 and 2013, no new investment has actually taken place.

Finally, the biggest oddity of all is that after all these intricate manipulations, the resultant policy has lead to an acutely imbalanced use of fertilizers in the country. In other words, because of the way subsidies were given, farmers actually made their soils worse. The key reason was the overuse of urea, which is the main nitrogenous fertilizer used in India.

Between 2007 and 2009, the UPA’s ministerial panel deliberated on this issue and decided that instead of subsidizing specific fertilizer products, the government should only subsidise the nutrient content in a product. Doing so would have freed the market prices of all fertilizer products and allow companies to come up with better, customized products for different parts of India. More importantly, it would remove the perverse incentive that policy had created—by keeping urea much cheaper than other products—for the farmer to overuse urea. As a corollary, it would also bring down subsidies to some extent.

But when it came to implementing NBS, the government kept urea out of it, fearing a backlash from farmers. As a result, urea became even more affordable, as it were, and NBS ended up further accentuating the imbalanced use of urea—the one thing it was set out to resolve. In 2013-14, farmers used N, P and K fertilisers in the ratio of 8.3:2.7:1, which is significantly worse than what it should be—4:2:1 and what it was in 2009-10 when NBS was put in place.

The key lesson from this tale is that while it is fine to have another task force, reforming fertilizer subsidies would require Modi to expend a significant amount of his slowly depleting political capital and decontrol urea prices to move towards an honest implementation of the nutrient-based subsidy regime. Short of that, we will just have another layer of complications.

Policy Puddle runs each Thursday and comments on public policy developments.

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