The Hindu Business Line : Fertiliser subsidy imbroglio: Decontrol the only way out

In keeping with the spirit of economic reforms the Government should remove all controls on fertilisers, including price control, and arrange to directly reach the subsidy to such farmers who really need protection. Such a proactive step will remove the uncertainty that dogs the fertiliser sector and pave the way for its restructuring and switchover to more efficient feedstock, say Viren Kaushik and Uttam Gupta.

IN VIEW of a statement by the Finance Minister in his post-Budget briefing that the benefit of fertiliser subsidy does not go to the farmers but, instead, to the fertiliser manufacturers, there is an urgent need for taking a de novo look at the issue of agricultural subsidies in India, including that on fertilisers.

Agricultural subsidies are a worldwide phenomenon — a creation of modern economies, which make stand-alone agriculture the least remunerative occupation.

The developed countries subsidise their agriculture on a much larger scale than India does. In 1999, subsidy payments to agriculture were $54.0 billion in the US, $114.5 billion in EU countries and $58.9 billion in Japan, against $7.2 billion in India.

On a per farmer basis, the subsidy was $21,000 in US, $17,000 in EC, $26,000 in Japan, and a measly $66 in India. Expressed as percentage of the value of agricultural production, the subsidy was 24 per cent in US, 49 per cent in EC and 65 per cent in Japan, but just 6.5 per cent in India.

In India, there are 107 million cultivator households, of which about 83 million are subsistence farmers. The Government is fully aware that any scheme of giving subsidy directly to the millions of farmers is cumbersome, cost-ineffective and prone to misuse, and has, therefore, chosen the route of subsidising the supply of agricultural inputs, including fertilisers.

With this objective in view, the Government controls the maximum retail price (MRP) of fertilisers at a level affordable to the farmers. Since, in an inflationary situation, the cost of production and distribution is higher, the manufacturers are compensated for the difference as subsidy.

Clearly, the benefit of subsidy accrues to the farmers. The fertiliser industry is merely a conduit for reaching subsidy to them with ease of administration and cost-effectiveness, and for preventing its misuse.

The situation in fertilisers is similar to that for kerosene and LPG. The oil companies are directed by the Government to sell these products at prices below the cost of production and distribution. The difference between the two is reimbursed to them as subsidy. Just as in this case the benefit of subsidy accrues to the consumers and not to the oil companies, in fertilisers also, the consumer farmers are the beneficiaries of the subsidy and not the industry.

The manufacture of fertilisers involves usage of large quantities of hydrocarbons, which account for about 65-80 per cent of the production cost. Between 1980 and now, the price of naphtha has increased by 29 times, fuel oil by 15 times, natural gas by 9 times at the landfall point and 12 times along HBJ pipeline, whereas the selling price of urea has gone up by only 2.5 times.

The ever-widening gap between the cost and the selling price has largely contributed to increase in subsidy.

According to a detailed analysis done by the FAI, of the total increase in subsidy on domestic urea by Rs 6,595 crore between 1990-91 and 1999-2000, the increase in the prices of hydrocarbons alone accounted for about Rs 4,500 crore (setting off the extra recovery from increase in the selling price).

Of the balance, an increase of Rs 1,127 crore was accounted for by increase in production, Rs 297 crore by increase in rail freight and Rs 671 crore by increases in other costs, such as wages and salaries, repair and maintenance, working capital, marketing and selling expenses.

Clearly, the bulk of the increase in subsidy is in the nature of an intra-economy transfer and, to that extent, it is not even a net burden on the exchequer. A view in some quarters that the rich farmers corner the fertiliser subsidy is a myth. According to a survey by Ministry of Agriculture, the small and marginal farmers (those having land holdings of 1-2 hectares and up to 1 hectare respectively) account for about 42 per cent of the fertiliser consumption, while farmers with over 10 hectares account for only about 10 per cent.

The intermediate farmers constitute the remaining 48 per cent. In view of these facts, only 10 per cent of the fertiliser subsidy goes to the so-called rich farmers.

Notwithstanding the above facts, and based on the misconception that the benefit of fertiliser subsidy goes to the manufacturers, in recent years, the Government has attempted to contain the subsidy burden by unreasonable tightening of the pricing norms, to the extent that some units have even become unviable.

But these changes have failed to make any significant dent on the subsidy bill, as the key factors contributing to its increase have not been addressed. Far from that, recent developments point towards further widening of the gap between the cost and the selling price.

First, the increase in the selling price of various fertilisers announced in the Budget for 2003-04 was fully rolled back. Second, the Ministry of Petroleum and Natural Gas has mooted a proposal, which, on implementation, will lead to an increase in the price of natural gas by almost 100 per cent. Third, in the wake of the Iraq war, the prices of naphtha, fuel oil and LSHS have increased further and may continue to rise if the war is prolonged. All this will lead to a steeper increase in the subsidy bill.

It may be pertinent to note here that the fertiliser subsidy was neither introduced at the behest of the industry nor has the industry any vested interest in its continuation. The Government may, therefore, remove all controls on fertilisers, including price control. This will be consistent with the spirit of economic reforms and liberalisation.

In a decontrolled scenario, since the Government will no longer be fixing the selling price, it will not be under any obligation to give compensation to the manufacturers. While the farmers may still have to be protected, the Government could make arrangements to give the subsidy directly to them.

It can also direct the subsidy to a target group of, say, small and marginal farmers. Under this dispensation, there will be no ambiguity whatsoever about the beneficiary of the subsidy. The real challenge lies in operationalising these principles. SAnother mechanism for compensating the farmers for higher input price could be to increase the minimum support/procurement price of the foodgrains.

In that case, the small and marginal farmers need to be given special relief by giving them employment in off-farm activities. The income generated from these activities will provide them the much-needed cushion for absorbing the unavoidable escalation in input costs.

In the prevailing dispensation, since increases in input costs get compensated by way of increase in subsidy, the oil companies have in-built incentives for indiscriminate increases in the price of hydrocarbons, ignoring the principle of pricing on a rational basis.

In a decontrolled scenario, they will be forced to exercise restraint due to farmers' resistance to consequential increases in fertiliser prices, on the one hand, and pressure from the Government (as it tries to rein in direct subsidy payments), on the other.

For several years now, an uncertain policy environment has dogged the fertiliser industry in India. This has affected fresh investment and impaired the ability of existing units to plan for the future and take business decisions. The removal of price controls will eliminate this uncertainty and pave the way for a stable policy environment.

This will also facilitate restructuring of the industry and, specifically, switchover of the naphtha and fuel oil based plants to the use of better and more efficient feedstock, such as LNG or domestic natural gas.

The above changes will also enable domestic manufacturers to overcome the feedstock handicap. Already, the gas-based plants in India produce urea at a cost significantly lower than the cost of imported urea. The production cost from naphtha-based plants is higher primarily because of the prohibitive cost at which feedstock is supplied to them. If only the feedstock were available to them at the same price as to gas-based plants, they too can compete with imports. A free market scenario will help in achieving this.

The industry welcomed the decontrol of phosphatic and potassic fertilisers in August 1992. But the inevitable increase in the prices of P and K nutrients led to a substantial drop in their consumption, forcing the Government to introduce backdoor control in the garb of concession in lieu of subsidy.

The Government should, therefore, weigh all the pros and cons before deregulating the sector as any `rollback' of the decontrol would be retrograde.

The fertiliser industry has lived in turmoil and turbulence for too long. The industry believes that the root cause for this is the very act of routing subsidy to the farmers through it. The industry should no longer be made a whipping boy for the Government's inability to rein in the subsidy.

While the Government may have to continue with agricultural subsidies to pursue the broader goals of food security and protecting the income of farmers, these should be given to them directly. This seems to be the only way to bring peace to this vital industry and enable it to serve Indian agriculture effectively.

(Viren Kaushik is Director General, and Uttam Gupta Additional Director (Economics), Fertiliser Association of India, New Delhi.)

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