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Reforming The Fertiliser Sector

  • reforms in the fertiliser sector, including neem-coating to prevent diversion of urea to industrial uses, and gas-pooling to induce efficiency in production, are steps in the right direction
  • Fertiliser accounts for large fiscal subsidies (about 0.73 lakh crore or 0.5 percent of GDP), the second-highest after food.
  • only 17,500 crores or 35 per cent of total fertiliser subsides reaches small farmers.
  • Introduction

    • The urea sector is highly regulated which: creates a black market that burdens small farmers disproportionately; incentivises production inefficiency; and leads to over-use, depleting soil quality and damaging human health.
    • neem-coating of urea, which has likely reduced the diversion of fertiliser meant for Indian farmers;
    • gaspooling, which should increase efficiency of domestic urea production
    • Nearly 70 per cent of this amount was allocated to urea, the most commonly used fertiliser, making it the largest subsidy after food.
  • Distortions in urea are the result of multiple regulations

    • First, there are large subsidies based on end use—only agricultural urea is subsidised—which creates incentives to divert subsidised urea to industry and across the border.
      • subsidised urea suffers from 3 types of leakage:
        • (i) 24 per cent is spent on inefficient urea producers
        • (ii) of the remaining, 41 per cent is diverted to non-agricultural uses and abroad
        • (ii) of the remaining, 24 per cent is consumed by larger—presumably richer— farmers.
    • Second, under-pricing urea, relative to other fertilisers, especially P & K, encourages overuse, which has resulted in significant environmental externalities, including depleted soil quality.
    • Third, multiple distortions—price and movement controls, manufacturer subsidies, import restrictions—feed upon each other, making it difficult to reallocate resources within the sector to more efficient uses. The fertiliser sector is thus one example of the exit problem
    • There are 3 basic types of fertiliser used—urea, Diammonium Phosphate (DAP), and Muriate of Potash (MOP).
      • urea dominates the sector. Of all the fertilisers, it is the most produced (86 per cent), the most consumed (74 per cent share), and the most imported (52 per cent).
      • Urea is the most physically controlled fertiliser, with 50 per cent under the Fertiliser Ministry’s movement control order compared with 20 per cent for DAP and MOP.
      • It also receives the largest subsidies, in outlay terms (accounting for nearly 70 per cent of total fertilisers subsidy) and as proportion of actual cost of production (75 per cent per kg, compared with about 35 per cent for DAP and MOP).
      • why NBS works fine?

        • DAP and MOP producers and importers receive a Nutrient Based Subsidy (NBS) based on a formula that determines the amount of N, P and K in a given amount of fertiliser.
        • Per kg subsidies on DAP and MOP fertiliser are hence fixed—they do not vary with market prices.
        • Imports of DAP and MOP are also not controlled.
        • The prices farmers face are thus deregulated market prices adjusted by fixed nutrient subsidy.
        • Government involvement in DAP and MOP is limited to paying producers and importers a fixed nutrient based subsidy which works out to be roughly 35 per cent of the cost of production.
  • The case of Urea is very different. The government intervenes in the sector in five ways:
    1. It sets a controlled Maximum Retail Price (MRP) at which urea must be sold to farmers. This price is currently R 5360 per metric tonne—approximately R268 per 50 kg bag—less than one-third the current imported price (R18600 per tonne)
    2. It provides a subsidy to 30 domestic producers that is firm-specific on a costplus basis, meaning that more inefficient producers get larger subsidies2 ;
    3. It provides a subsidy to importers that is consignment-specific;
    4. Imports are canalised—only three agencies are allowed to import urea into India;
    5. about half of the movement of fertiliser is directed—that is, the government tells manufacturers and importers how much to import and where to sell their urea.
  • Thus nearly all actors—consumers, producers, importers, distributers—are controlled. These distortions feed upon each other, and together create an environment that leads to a series of adverse outcomes
  • Leakage 1 – Black Market

    • Urea is only subsidised for agricultural uses
    • this violate what we call the One Product-One Price principle—the intuition that products which are essentially the same should be charged essentially the same price, else there will be incentives to divert the subsidised commodity from eligible to ineligible consumers.
    • The 75 per cent subsidy on agricultural urea creates a large price wedge which feeds a thriving black market diverting urea to industry3 and possibly across the border to Bangladesh and Nepal4.
    • 41 per cent of urea is diverted to industry or smuggled across borders.
    •  these black market prices are, on average, about 61 per cent higher than stipulated prices (i.e. MRP plus local taxes), indicating that black marketing
    • imposes significant pecuniary costs on farmers—in addition to creating uncertainty of supply.
    • Black market effects are aggravated by a further regulation—canalisation. Only three firms6 are allowed to import urea into India, and the canalisers are also instructed when to import, what quantities to import, and in which districts to sell their goods. Every season the Fertiliser Department estimates how much imports are required by forecasting domestic supply and demand.
    • Forecasting  fertiliser demand is a difficult business, and misestimates— especially shortages— are difficult to correct because the system to procure imports is time consuming
    • The entire process—from the time the Fertiliser Department decides to import to the time urea reaches consumer centres—takes about 60-70 days. These delays can exacerbate shortages, and are p
    • These delays can exacerbate shortages, and are particularly costly during the peak demand period when timely availability of urea is essential for proper plant growth. Farmers are thus pushed to purchase in the black market.
  • Leakage 2 – Small Farmer Inability to derive full benefits

    • happens because large farmers are typically better connected and
    • therefore able to secure scarce subsidised urea.
  • Leakage 3 – Inefficient Fertiliser Manufacturers

    • A third source of leakage arises from some of the urea subsidy going to sustaining inefficient domestic production instead of going to the small farmer.
    • led to a model where the subsidy a firm receives is based on its cost of production: the greater the cost, the larger the subsidy.
    • As a consequence, inefficient firms with high production costs survive and the incentive to lower costs is blunted.
    • more inefficient the firm, the more subsidies it receives
    • government has revised its policy, taking steps in the right direction, but the essential features of being firm-specific and inversely related to efficiency remain
    • A consequence of fixing retail prices—combined with the costplus subsidy regime—is that even though urea consumption has increased steadily over the last 15 years, no new domestic production capacity has been added, leading to a large dependence on imports.
  • Externalities of urea Prices

    • Worsening soil quality
    • The first is urea overuse which leads to the detriment of the soil.
    • Agricultural scientists recommended that for Indian conditions, Nitrogen, Phosphorus and Potassium—N, P and K—should be used roughly in the ratio of 4:2:1.
    • in absolute amounts, there seems to be over-use of urea in many of the larger states, especially in Punjab, Haryana, and Uttar Pradesh. The over-use is pronounced compared with the US, the world and many Asian countries. Two exceptions are noteworthy: overuse in China is even greater than in India, while not all states overuse urea. Indeed many, especially in the North East, use less nitrogenous fertiliser per hectare than the world average
    • Most states use almost twice more nitrogen as compared to phosphorous than is recommended.
    • The distortions are less in Maharashtra, Karnataka, and Kerala, which consume close  to the optimal
    • The overuse of nitrogen as compared to potash is even more extreme
    • Bangladesh uses only 4 per cent more nitrogen than potash while on average India uses 100 per cent more than recommended.
  • Reforms

    • First, decanalising urea imports—which would increase the number of importers and allow greater freedom in import decision–would allow fertiliser  supply to respond flexibly and quickly to changes in demand.
      • This would be timely as climatic fluctuations are making it much more difficult for governments to forecast agricultural conditions and centrally manage supply. This would reduce the likelihood and severity of shortages, decrease black marketing and thereby benefit the small farmer.
    • Second, bringing urea under the  Nutrient Based Subsidy program currently in place for DAP and MOP would allow domestic producers to continue receiving fixed subsidies based on the nutritional content of their fertiliser, while deregulating the market would allow domestic producers to charge market prices. This would encourage fertiliser manufacturers to be efficient, as they could then earn greater profits by reducing costs and improving urea quality. And this in turn would benefit farmers.
    • Turning fertiliser into JAM

      • The case for implementing direct transfers in fertilisers is to reduce leakages to the black market.
      • The government’s policy of neem-coating urea is a step in exactly this direction. Neem-coating makes it more difficult for black marketers to divert urea to industrial consumers.
      • Neem-coating also benefits farmers by reducing nitrogen losses from the soil by providing greater nutrient to the crop. As a result, farmers need less urea to achieve the same effect.
      • Technology could be further used to curtail leakages and improve targeting of fertiliser subsidies.
    • Universal subsidy with cap on number of bags

      • A preferred option would be to set a cap on the number of subsidised bags each household can purchase and require biometric authentication at the point of sale (POS). This is the approach adopted for kerosene and food in Andhra Pradesh
      • Imposing a cap on the total number of subsidised bags each farmer can purchase would improve targeting.
      • Small farmers would still be able to get all their urea at subsidised prices but large farmers may have to pay market prices for some of the urea they buy.
  • Conclusion

    • Fertiliser subsidies are very costly, accounting for about 0.8 per cent of GDP (including arrears)
    • They encourage urea overuse, which damages the soil, undermining rural incomes, agricultural productivity, and thereby economic growth.