When a subsidized product is not available in the market, questionable characters will have nothing to attack
It’s budget time. After two years of madness, Finance Minister Nirmala Sitharaman has hinted at a return to fiscal consolidation. A major area deserving attention is the fertilizer subsidy which has increased from `80,000 crore in 2019-20 to `134,000 crore in 2020-21 and is projected to be `140,000 crore in 2021-22.
The fertilizer subsidy arises because the Union government wants the manufacturers/importers to sell the fertilizers to the farmers at a low maximum retail price, unrelated to the cost of production, importation and distribution, which is a lot higher. In the case of urea, it exercises mandatory control over the MRP and reimburses manufacturers for the cost in excess of it as a subsidy on a “unit specific” basis under the new pricing system. In the case of phosphate and potash (P&K) fertilizers, it sets a “uniform” subsidy per nutrient for all manufacturers and importers under the nutrient-based regime.
Since the subsidy per tonne is the difference between the cost and the MRP, if the cost increases, the MRP remaining unchanged, on each tonne of fertilizer sold, the subsidy will increase. On the other hand, if the MRP decreases, the cost remaining unchanged, then the subsidy will also increase. Third, for any given level of subsidy per tonne, an increase in the quantity of fertilizer sold leads to an increase in the total subsidy payment.
The factors influencing the cost of urea are: the cost of natural gas – raw material/fuel used in its production and the price of imported urea (it represents 1/3 of consumption). In the case of P&K fertilizers, the factors are the cost of raw materials, i.e. phosphoric acid, ammonia and the price of imports in finished form, i.e. di-ammonium phosphate (these represent almost 50% of DAP consumption) and the price of sodium muriate. potash – fully imported.
Given the preponderance of imports in the provision of urea and non-urea fertilizers (even for domestic urea production, 1/3 of gas needs are met by imports), the government cannot do much -something to control these costs.
However, there are plant-specific inefficiencies (in addition to interstate gas VAT variations) that lead to widely varying costs. Out of about 35 million tons of annual urea supply, there are tonnages supplied at `20,000 per ton, `25,000 per ton, `30,000 per ton and so on. The import cost is even higher. In the current year, some supplies have even reached US$900 per ton, which equates to around $70,000 per ton on the farm.
A ridiculously low MRP of urea (currently at `5360 per tonne, almost the same as two decades ago) in the face of rising costs causing rising subsidies per tonne. Add to this the increase in quantity that comes from (i) overuse: a low price induces farmers to use more than is required by the soil; (ii) undeserving large/wealthy farmers also have access to subsidized urea; (iii) large scale diversion such as smuggling to neighboring countries, industrial use, etc. – unavoidable when the market price is 4 to 5 times higher. The result is an inflated total subsidy bill.
Excessive use is undesirable as it leads to an imbalance in fertilizer use, erosion of soil health (which in turn compromises the sustainability of agriculture in the medium to long term) and a negative impact on the environment in addition to human health. Giving cheap urea to those (read: wealthy farmers) who can afford to pay more is also patently unfair. But, the diversion or abuse of subsidized (however heavily) urea will shake the conscience of any sane person. Yet this has been going on for decades and could be as high as 30%. Look at the dynamics of how this happens.
In the early years of the scheme in place (it has been in vogue since 1977), most of the subsidy amount was paid to manufacturers when the equipment was “shipped” from the factory. Although they were required to ensure that fertilizers were actually sold to farmers, there was no foolproof institutional mechanism to verify this. Disappearance of the product at different levels of the supply chain, viz. the head end, neighborhood stock point and retailer were rampant.
In the early 2000s, the arrangement was changed to provide for the payment of 95% of the urea subsidy upon receipt of the materials in the district (for non-urea fertilizers the share was 85%) and the 5% balance upon confirmation by the state government. (15 percent in the case of P&K fertilizers). Under this scheme too, the field was wide open for dubious actors to tackle subsidized products – beyond the stocking point in the district.
From April 2018, the Modi government linked the payment of subsidies to manufacturers to the sale of fertilizer to farmers by retailers. Under the new scheme, manufacturers receive 100% of the subsidy after delivery of the fertilizer to the farmer and his identity, viz. Aadhaar is captured on an electronic POS machine in the dealer’s shop. While this is a significant improvement, even this is subject to diversion, albeit at the retail level. This especially since anyone (including non-farmers) with a unique Aadhaar identification number can buy the subsidized product.
The government has also tried other measures. These include (i) requiring all manufacturers/importers to cover all urea supplies with neem (2015); (ii) limit the purchase by each buyer to 100 bags per transaction (compared to 999 bags previously) and limit the number of transactions per month (August 2020) and (iii) track the top 20 urea buyers in each district and take action against those who violate purchasing standards, etc. These also did not deliver.
Now the government is working on a plan to limit the number of bags of subsidized fertilizer individual farmers can buy in any one growing season. But that won’t help either.
In fact, as long as the heart of the system, ie the “manufacturer subsidy channel”, remains intact, there is no way it can mitigate the scourge of diversion.
The way forward is direct benefit transfer (DBT) of the grant. The government should provide subsidies “directly” to farmers and allow manufacturers to sell at the price determined by the market. This will completely eliminate diversion; when a subsidized product is not available on the market, questionable characters will have nothing to attack. This will also limit overuse; when the product carries the right price, farmers will use it wisely. It will also be possible to target subsidies only to poor farmers.
Contraction of demand from all three sources will result in huge subsidy savings (quantity effect). There will also be an indirect gain. India being a major fertilizer importer, a significant reduction in demand driven imports will reduce the international price and in turn reduce the cost of imports. As a result, the subsidy per tonne will also decrease.
In conclusion, DBT will contribute to fiscal consolidation, reduction of the trade deficit, reduction of the imbalance in the use of fertilizers, improvement of soil health, promotion of sustainable agriculture and respectful of the environment. There will also be losers: inefficient/costly producers who will have to close their shop; dubious traders and corrupt politicians/bureaucrats who make a lot of money from leaks/hijackings; wealthy farmers who are the main beneficiaries of the existing scheme.
The fertilizer subsidy DBT has been on the government’s radar since 2012-13. So far, its launch has been blocked due to the influence of these lobbies. Can the Prime Minister overcome it?
(The author is a policy analyst. Opinions expressed are personal.)