March 7th, 2016
Fertiliser accounts for the second largest subsidy provided in India. About 70% of this goes to urea. However, it is a sad fact that only 35% of this subsidy goes to the intended beneficiaries, i.e. small and poor farmers. A large chunk of the subsidy is siphoned off from the system.
Thus, it becomes imperative to explore the issue, since it harms the food provider of the nation. This comes at a time when a large number of indebted farmers are ending their precious lives.
Some basic facts about fertilizer
- There are 3 basic types of fertiliser used:
- Urea – Nitrogen (N)
- Diammonium Phosphate (DAP) – Phosphate (P)
- Muriate of Potash (MOP) – Potassium (K)
- Of these, urea dominates the sector. It is the most produced, the most consumed, and the most imported. It also faces the most government intervention and is the most physically controlled fertilizer. Moreover, it also receives the largest subsidies.
- DAP and MOP producers and importers receive a fixed Nutrient Based Subsidy (NBS) based on a formula. Since government involvement is less, the prices of these fertilizers are deregulated market prices adjusted by fixed nutrient subsidy.
However, government intervention in Urea is in 5 ways:
- It sets a controlled Maximum Retail Price (MRP) at which urea must be sold to farmers.
- It provides a subsidy to domestic producers, which is firm-specific on a cost plus basis, meaning that more inefficient producers get larger subsidies.
- It provides a subsidy to importers.
- Imports are canalized i.e. only three agencies are allowed to import urea into India
- About half of the movement of fertiliser is directed i.e. the government tells manufacturers and importers how much to import and where to sell their urea.
Distortions in urea
- Subsidised urea suffers from 3 types of leakage:
- Spent on inefficient urea producers.
- Diverted to non-agricultural uses and abroad.
- Consumed by larger and richer farmers.
- Under-pricing urea, relative to other fertilisers, encourages overuse, which has resulted in significant environmental implications, including depleted soil quality.
- Multiple distortions—price and movement controls, manufacturer subsidies, import restrictions—makes it difficult to reallocate resources within the sector to more efficient uses.
Leakage 1: Black Market
Urea is subsidised only for agricultural uses. There is a thriving black market diverting urea to industry and across the border to Bangladesh and Nepal. Thus, 41 per cent of urea is diverted to industry or smuggled across borders.
Black market effects are aggravated by a further regulation—canalization. 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- everything is done by “forecasting”. Forecasting creates uncertainties and misestimates and the correction process takes around 60-70 valuable days. Farmers are thus pushed to purchase in the black market.
Leakage 2 – Small farmers unable to derive full benefits
The black market hurts small and marginal farmers more than large farmers since a higher percentage of them are forced to buy urea from the black market. Large farmers are typically better connected and therefore able to secure scarce subsidized 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. We have arrived at 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. This in effect means more inefficient the firm, the more subsidies it receives.
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.
There is over-use of urea in many of the states, much more than global standards. Urea overuse leads to the detriment of the soil. Moreover, there is a marked distortion in the proportions in which the fertilizers are used. Agricultural scientists recommended that for Indian conditions, N:P:K ration should be used roughly as 4:2:1. However, this ratio is least followed in most of the states.
Any reform by the government should address each of the problems identified above—the three leakages and skewed mix of fertilizer use—with the primary aim of benefiting the small farmers.
The government took a good measure in this direction last year in the form of coating urea with neem. 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.
More needs to be done
A few measures that can be implemented to address the issues:
- Decanalising urea imports—which would increase the number of importers and allow greater freedom in import decision–would allow fertilizer supply to respond flexibly and quickly to changes in demand. This would reduce the likelihood and severity of shortages, decrease black marketing and thereby benefit the small farmer.
- 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.
- Implementing Direct Benefit Transfers (DBT) in fertilisers to reduce leakages to the black market. This is the best alternative to address all the problems as seen from the success of such shift in case of LPG subsidy transfers. However, some issues like difficulties in targeting the poor, targeting tenant farmers and sharecroppers, weak penetration of banking facilities in rural areas, etc needs to be addressed first.
- Set a cap on the number of subsidised bags each household can purchase (as is the case with subsidized household LPG) and require biometric authentication at the point of sale (POS). Requiring biometric authentication would make it harder to conduct large-scale diversion. 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.
- To secure long term fertilizer supplies from locations where energy prices are cheap, e.g. encouraging Indian firms to locate plants in countries such as Iran following the example of the Fertiliser Ministry’s joint venture in Oman.
The Logical Indian is hopeful of more positive measures by the government to protect the rightful interests of poor farmers in form of rationalization of fertilizer subsidies.