Fertiliser subsidy demystified

Viren Kaushik

FERTILISER subsidy in India has attracted a lot of attention, comments and criticism in recent years. Its critics say that the burden of nearly Rs 12,000 crore annually cannot be sustained in a free and market-driven economy.

In fact, it has become fashionable to criticise subsidies per se and there have been several comments/views in the media that would not have been expressed but for a misunderstanding of the basic issues.

In all modern economies, agricultural activity cannot be sustained on a commercial basis without some kind of government support.

The manner and quantum of support, of course, varies from country to country. Despite the seemingly high tag, agricultural subsidies in India are still far lower than those in the developed economies.

To quote the latest data available from Ministry of Agriculture, the subsidy per hectare in India is of the order of $53 compared to $218 in OECD countries. In the US, agricultural subsidy per farmer is $21,000, compared to a measly $66 in India.

Agricultural subsidies are permitted under the WTO regime too. As per Article 6/Part IV of Agreement on Agriculture, India can give non-product-specific subsidies to the de minimis level of 10 per cent of the value of total agricultural production (Aggregate Measurement of Support) whereas the actual subsidies are much lower. So much on the need for subsidy.

Now for the mechanism of delivering subsidy. In India, the government has followed the policy of subsidising agriculture by providing subsidised inputs, such as power, irrigation and fertilisers. The government chose this route for two reasons — one, for administrative convenience in view of the huge number (nearly 12-crore) of farm holdings and about 55 crore population engaged in agriculture. Any mechanism for giving subsidy directly to such a vast population would not only be cumbersome and expensive but also susceptible to revenue leakage, given the administrative set-up at the village level.

Two, over 80 per cent of farmers are small and marginal, producing primarily for self-consumption and left with little marketable surplus. For this class of farmers it is important to have low input prices.

In line with this policy of subsidising inputs, the retail prices of fertilisers are fixed by the Government at a low level which can be afforded by the small and marginal farmers.

The retail price is lower than the normative cost of production and distribution. The difference between the two is reimbursed by the government to the manufacturers as subsidy/concession.

The fertiliser subsidy is, therefore, to the farmer — to keep the input costs at his end low.

The fertiliser sector does not derive any benefit through this mechanism and has, time and again, requested the Government that the industry should also be freed from controls and that alternative routes should be found to subsidise farmers. However, the Government, for its own reasons, finds it expedient to route the subsidies to 12 crore farmers through fertiliser manufacturers, whose number is less than 100. Despite the above position, the debate has been raised by some economists on whether the subsidy is going to the farmers or to the fertiliser industry.

The view taken by this section of economists is that the option of free imports should be considered in a hypothetical "free trade" regime.

The farmgate price of imported fertilisers (the c.i.f. price plus handling, marketing and transportation expenses) should be compared with the average price paid by the Government to the domestic industry and the price farmers actually pay to determine where the subsidy is going.

For example, if the farm-gate price of imported urea is Rs 10,000/tonne, the retail price is Rs 6,000/tonne, and the weighted average price paid by the government to domestic manufacturers is Rs 11,000/tonne, then, the subsidy to farmer is (10,000 - 6,000) = Rs 4,000/tonne, and subsidy to the industry is (11,000 - 10,000) = Rs 1,000/tonne.

On the other hand, if the weighted average price paid by the Government to domestic manufacturers is lower than the import price, say Rs 8,000/tonne, then, the fertiliser industry is implicitly taxed to the tune of Rs 2,000/tonne or, in other words, the industry is giving a subsidy of this amount to the Government.

Based on this premise, and taking only a limited arbitrarily chosen time period, it has been generalised that of the total fertiliser subsidy given by the government, only a part goes to the farmer and the balance goes to the fertiliser industry.

This generalisation suffers from several flaws.

First, the international prices fluctuate wildly as these are not cost-based but are determined by the forces of demand and supply. Conclusions drawn on this basis would also, therefore, alternate between the two situations — either the government subsidising the industry or the industry subsidising the government.

A look at the historical urea prices reveals that these have fluctuated from the lows of $61/tonne c.i.f. in 1971, $86/tonne in 1999, to the highs of $274/tonne c.i.f. in 1975 and $251/tonne in 1995, depending upon the quantities imported by India and China.

In such a fluctuating situation, the answer to the question whether the domestic industry is "subsidised'' or conversely "taxed" would depend on the time-span under consideration. Thus, for some years, the industry may appear to be subsidised whereas in others, it may appear to be doing the reverse — all depending on the arbitrary choice of the time-span. No general conclusion can, therefore, be drawn on this basis.

Second, and more important, the hypothesis ignores the fact that international price is not an independent variable but is very much determined by the level of imports by India. The above hypothesis implicitly assumes that entry of India into the world market for imports would not have affected the international prices and uses the historical prices as "free trade" prices, which is not correct.

Third, the official exchange rate is used in estimating c.i.f. prices, ignoring the existence of shadow exchange rate especially in the decades of the 1970s and the 1980s.

It can, therefore, be seen that viewing the fertiliser subsidies from such a narrow perspective would lead to fluctuating and conflicting conclusions.

For example, currently the farm-gate cost of imported urea is over Rs 12,000/tonne whereas the weighted average farm-gate cost of domestic urea is about Rs 9,000/tonne.

By the above reckoning, it would mean that the fertiliser industry subsidises the Government to the tune of Rs 3000/tonne !

Currently, the situation is such that despite no imports by India and China, other alternative markets have developed, and the price of imported urea is higher than the cost of domestic urea. Re-entry of India or China into the import market would only push the prices further up.

Given its flaws and limitations, the concept of viewing subsidies from a "free trade" price concept has only limited utility. As a matter of fact, the problem is not with the concept but with the selective reference to a particular time-span and arriving at a universal conclusion.

From the above discussion, it is apparent that the actual benefit of subsidy goes to the farmer only and the fertiliser industry is only a conduit for channelling this subsidy to the farmer.

The fertiliser industry is unreasonably blamed by some who say that subsidy benefits the industry, or that it is surviving on subsidies.

The fertiliser industry has made repeated pleas to the Government that it should be freed from all controls and given the freedom as enjoyed by other sectors of the economy. In its zeal to contain the fertiliser subsidy bill, the Government has not addressed the real causes behind the rising subsidy bill but has instead tightened the subsidy parameters to such an extent that profitability of the industry is badly eroded.

It is for this reason that, when all other sectors of the economy are booming, the fertiliser sector has not attracted any FDI or FII investment and is not a favourite of domestic investors.

It is time that the Government takes a bold decision and frees the fertiliser industry from the shackles of subsidy and controls.

(The author is Director-General, Fertiliser Association of India, New Delhi.)