gfiles magazine

November 13, 2011

gfiles Magazine November Issue 2011

government misfeasance fertilizer subvention
The subsidy mess
Instead of reforming the existing mechanism, the government is washing its hands of the botched reforms in which Manmohan Singh once took pride
“It is also indicative of the speed at which the new Finance Minister is capable of learning about the hard grassroot political realities. I am sure that the speed at which I am learning will no doubt please my esteemed friend, Shri Jaswant Singh, who out of his genuine concern for, my welfare, was deeply worried that because of my alleged political inexperience, I could well end up as the proverbial sacrificial lamb. He will be pleased to know that we are once again going to disappoint the prophets of doom and gloom. Three cheers for democracy.”
That was how Dr. Manmohan Singh rationalized the start of fertilizer subsidy reforms in Parliament on 6 August 1991, ending a virtual decade-old freeze on statutory fertilizer prices.
With a section of the Opposition threatening to topple the Government on fertilizer price hikes, Dr. Singh moderated the hike to 30% from 40% announced a fortnight earlier. He also exempted small & marginal farmers from the price hike, a dual pricing scheme that miserably failed.
The significance of Dr. Singh’s self-advertised political dexterity lies in the fact his reforms laid the foundation for bad governance of subsidy regime. This fact has been brought home well by the Comptroller and Auditor General’s (CAG’s) performance audit report on fertilizer subsidy presented in August 2011.
The CAG’s report discovered that a staggering Rs 50,587 crore of subsidy paid on sale of decontrolled fertilizers (excluding single super phosphate) for 2007-10 remains unverified!
CAG discovered that a staggering Rs 50,587crore subsidy paid on sale of decontrolled fertilizers (excluding single super phosphate (SSP) for period 2007-10 remains unverified!
The subsidy accounts are a blend of estimates and dubious conjectures. It can be ascertained from the financial results of major fertilizer companies as well as their annual accounts.
As the accounts of companies are always tentative with subsidy estimates constituting a big chunk of sales income, the real state of fertilizer industry is hard to gauge. One can expect CAG to also study this issue in future.
The Conundrum
“Politically, once in place, subsidies are difficult to remove,” says Organization for Economic Cooperation and Development (OECD), 34-member rich countries club. This observation in an OECD paper released in November 2010 aptly applies to Indian fertilizer subsidy scenario.  
Introduced to cushion the impact of first oil shock in the seventies, the fertilizer subsidy has ballooned from Rs 24.88 crore in 1977-78 to Rs 4389.06 crore in 1990-91, i.e., a few months before Dr. Singh embarked on savage reforms.
The subsidy, however, increased during the reforms to 4799.60 crore in 1991-92 and to Rs 5836.14 crore in 1992-93. It peaked to Rs 99,494.71 crore in 2008-09 but to Rs 54,976.68 crore in 2010-11.
The subsidy bill is bound to rise substantially in current financial year due to steep rise in global prices of both potassic and phosphatic fertilizers and prices of fertilizer raw materials.
The Government subsidizes both domestic and imported fertilizers. The subsidy is doled out through two schemes – new pricing scheme for urea and nutrient-based subsidy (NBS) scheme for decontrolled fertilizers. NBS currently covers 25 grades of phosphatic, potassic and complex fertilizers. The Government says that the farmers are currently paying only 27% to 58% of the delivered cost of phosphatic and potassic fertilizers covered NBS.
The country is completely dependent on imports for meeting its potash requirements. It is also relies heavily on imported phosphatic fertilizers and their raw materials. Indigenous inputs barely meet 10% of the raw materials requirements of domestic phosphates industry. As for nitrogenous fertilizers, the country’s self-reliance in urea production proved short-lived due to the Government’s reluctance to facilitate expansion of the industry. Urea imports, which were resumed in 2002, have been rising year after year.
The country today meets 40% of its total fertilizer requirement through imports. Fertiliser subsidy is interplay of several factors. These include collective aversion of the political parties to increase retail prices of urea, subsidy leakages and wastages and failure to control the prices of indigenous inputs such as gas and naphtha
A few other factors contributing to subsidy balloon are the runaway increase in prices of imported fertilizers and raw materials, slow pace in forming overseas joint ventures to secure long-term supply of fertilizers and raw materials with price discounts and the Government’s reluctance to initiate integrated fertilizer-cum-food subsidy reforms.
CAG noticed several instances of diversion of subsidized fertilizers for non-agricultural purposes, avoidable expenditure on subsidy and favours to foreign suppliers in certain cases resulting in excess expenditure on subsidies. It also came across instances of smuggling of fertilizers to neighbouring countries where prices are higher.
The Finance Ministry constituted the Task Force on Direct Transfer of Subsidies (TFDTS) has also raised alarm at illegal diversion of subsidized fertilizers.
Direct fertilizer subsidy has come under close scrutiny under two successive Finance Ministers — first under Chidambaram (above, left) in 2007-08 and now under Mukherjee.
In its interim report submitted in July 2011, TFDTS stated: “Urea is used for the production of urea formaldehyde which is used in garment manufacturing, melamine production, fish farming, milk production and soap manufacturing among other industries. MOP (muriate of potash) is used for manufacturing potassium chlorate which finds applicability for explosives, match and fire-cracker industries. SSP is used for the production of di-calcium phosphate, an animal feed. There is anecdotal evidence indicating that fertilizers are also smuggled out of the country to neighboring ones where prices for equivalent products are higher.”
A case of subsidy misuse akin to the proverbial fence eating the grass is that of fertilizer mixing units consumed subsidized fertilizers. They sell the resulting product, called fertilizer mixtures, at higher/free market rates. CAG contends that such consumption breaks the subsidy chain as these units consumer subsidized fertilizers at the expense of farmers.
CAG has observed “numerous instances of non - availability/shortages of fertilizers” After surveying 5498 farmers across the country, CAG concluded 45% of them bought fertilizers at prices higher than maximum retail prices (MRPs) and 56% of them didn’t know that Government fixed MRPs.
The subsidy mess appears more alarming, if one factors in the inverse correlation between the increase in subsidy and the decrease in crops’ response to fertilizer application!
The imbalanced use of three primary plant nutrients, nitrogen, phosphorous and potash (NPK) and inadequate or non-application of secondary nutrients such as sulphur and micro-nutrients such as zinc  has become a big hurdle in increasing crop yields.
Farmers are getting less benefit from increased but imbalanced use of fertilizers. They have suffered monetary loss due to damage to their soil from imbalanced usage of nutrients.
Farm experts measure fertilizers use efficiency as crop response ratio. This is expressed as ‘X’ kilograms of foodgrain facilitated by the application of one Kg of NPK. This ratio has declined over the years due to excessive use of certain nutrients such as nitrogen and deficient use of others such as potash and sulphur.
As put by Dr. Ramesh Kumar, an Agriculture Ministry official at a conference in September last, crop response ratio has plummeted from 15 kg of grain per one kg of NPK in the fifth plan (1974-79) to 6 kg of grain per one Kg of NPK in the 11th five year plan (2007-12).
Ambivalence and ambulation
The Government has blown hot and cold while grappling with subsidy since the start of fertilizer reforms on 25 July 1991. It then decontrolled the prices of four fertilizers, calcium ammonium nitrate (CAN), ammonium sulphate (AS), sulphate of potash (SOP) and ammonium chloride (ACL).
This deregulation was done ostensibly on the ground that the nutrient content of these products was lower than that of other fertilizers. Such low-analysis fertilizers required more freight subsidy for transport of same amount of nutrient as compared to products having higher nutrient content.
The Government, however, did somersault on 25 August 1992 by bringing back CAN, AS and ACL under price control as recommended by Joint Parliamentary Committee (JPC) on fertilizer pricing. The justification for the U-turn was that these products are indigenous and need to be subsidized along with urea.
On the same day, the Government decontrolled the prices of all phosphatic and potassic and complex fertilizers on the recommendations of JPC to achieve annual subsidy saving of Rs 3300 crore.
The Government did this within five days after receipt of JPC report, brushing aside its dissent notes. JPC’s majority view was that fertilizers for whose supply the country was dependent on imports might be decontrolled.
The Government also reduced urea price by 10% as recommended by JPC.
The JPC report thus laid the foundation for imbalanced use of nutrients and its deleterious impact on crop response ratio and soil fertility.
The prices of decontrolled fertilizers skyrocketed immediately after the deregulation. The price of muriate of potash (MOP), for instance, shot up to Rs 5600-5900/tonne from the pre-decontrol price of Rs 1700/tonne. The sale of decontrolled fertilizers tapered off immediately after de-control.
This, in turn, led the Agriculture Ministry into offering one-time price concession on decontrolled fertilizers to help growers adjust to free market prices. It provided an ad hoc subsidy of Rs. 1000 per tonne of diammonium phosphate (DAP) & MOP and proportionate P&K nutrient-based subsidy on NPK complex fertilizers with total outlay of Rs 340 crore for Rabi 2002.
Later, this one-time relief transformed into ad hoc subsidy scheme (ADS) that neither JPC nor Dr. Manmohan Singh ever dreamt of. The ADS’ validity was extended on half-yearly basis.  The Government substituted ADS with nutrient-based subsidy scheme (NBS) in February 2010.
When ADS was launched in Rabi 1992, the Government excluded imported DAP and provided Rs 1000/tonne concession only on indigenous DAP. It later brought back imported DAP under ADS.
The arbitrary exclusion or re-inclusion under subsidy regime again showed its ugly face in June 1994 when CAN, ACL and AS were again decontrolled.
The arbitrariness re-surfaced in March 2010 when imported AS and domestic AS produced by steel plants were excluded from NBS. The Government thus now gives subsidy on only domestic AS produced by two fertilizer companies GSFC and FACT.
NBS is discriminatory as it has kept several micronutrients and complex fertilizers such as water-soluble fertilizers from its purview.
The farmers are thus getting lesser benefit from increased but imbalanced use of fertilizers. They have also suffered incalculable monetary loss due to damage to their soils on account of imbalanced usage of nutrients.
It is here pertinent to recall what late US President Franklin D. Roosevelt’s penned letter to all State Governors on a Uniform Soil Conservation Law in 1937.  He wrote: “The Nation that destroys its soil destroys itself.”
India is belatedly learning such bitter truths the very hard way. Since April 2008, the Government has been introducing patchwork corrections in subsidy schemes to undo the damage caused by the goofed-up reforms.
The first corrective initiative was the end of the step-motherly treatment towards single super phosphate (SSP) fertilizer in the wake of steep hike in global DAP prices and shortages.
The Government approved a new policy on pricing and subsidy of SSP, which contains 16% phosphate, 11% sulphur and 16% calcium. As SSP provides more nutrients than DAP, it is lately being identified as a ‘generic customized fertilizer’.
The favourable SSP policy has lured several companies into setting up new SSP plants.
Another corrective taken in 2008 include the maiden policy for coating/fortifying popular fertilizers with micro-nutrients to produce products such as zincated urea.
The Government also introduced nutrient-based subsidy (NBS) for complex fertilizers on a limited scale in June 2008. This was followed up with the unveiling of enlarged NBS in February 2010.
NBS, however, cannot yield all benefits as long as urea remains out of its ambit. Urea accounts for more than half of the country’s total fertilizers consumption. Urea, the only fertilizer whose price is statutorily controlled, is more subsidized than all other fertilizers covered under NBS.
The Government has turned blind to recommendations from different committees for ending the political bias for urea. The 2004 official study on Central Government Subsidies stated that a hike in urea price would have a “significant salutary impact” on balanced application of N, P & K.
The Government can increase the efficacy of fertilizer subsidy dramatically by restructuring the existing total allocation on the pattern of NPK ratio of 4:2:1.  This is considered ideal average NPK ratio for the country, though the specific blend of nutrients would vary from soil to soil especially in intensive farming area where the use of secondary and micro nutrients such as sulphur and zinc is essential.  
Though the Government is reconciled to bringing urea under NBS as recommended by two expert committees, it has not yet indicated when it would translate intent into action. A group of ministers has been grappling with this issue for several months.
As put by Cabinet Secretariat-appointed Committee on ‘Optimumization of Fertilizer Usage’, “urea has to be brought under the free pricing regime sooner than later. In any case, there is a strong case for reducing the subsidy on urea and allowing a higher price to discourage unproductive use. Farmers can be assisted by providing appropriate subsidies on other critical nutrients.
In its report submitted in September 2010, the Committee also stated: “the underlying concept of NBS is equal subsidy for the same nutrient in any form; either as a straight fertilizer or as a complex/mixture. This needs to be operationalised for all FCO (Fertilizer Control Order) approved fertilizers at the earliest.”
Experts suggest that the Government should dereserve manufacture of all micro-nutrients to enable large fertilizer companies to produce them. It must encourage production of customized fertilizers with an eye on site specific nutrient management.
Instead of comprehensive reforming the existing subsidy mechanism, the Government is keen to wash its hands off from the botched reforms in which Dr. Singh once took pride. 
It intends to change-over from the present mechanism of subsidy delivery through the industry to a system under which subsidy is transferred directly to farmers. The options for directly include bank accounts/smart cards/ tradable coupons.
The idea of direct fertilizers subsidy (DFS) has been circulating in different forms within the Government for almost 12 years. It has, however, come under close scrutiny under two successive finance ministers – first under P. Chidambaram in 2007-08 and now under the incumbent Finance Minister Pranab Mukherjee. The Finance Ministry thus constituted TFDTS in February 2011.
In its interim report submitted under the chairmanship of Nandan Nilekani, Chairman, Unique Identification Authority of India (UIDAI), TFDTS said: “the fertilser subsidy is given by the Government to the Manufacturers/Importers directly. In the Interim proposed framework, the subsidy is planned to be provided to the retailers and ultimately to the intended beneficiaries (farmers).”
It has formulated a three-phase approach for DFS. Under the first phase, the Department of Fertilizers (DOF) would facilitate generation of information visibility of the flow of fertilizers along the supply chain from the manufacturer/impoters till the retailer. The implementation of this phase is planned in November-December 2011. Under phase II, the subsidy would be released directly to the retailer’s bank account on receipt of fertilizers from the wholesaler.  The start of this phase is planned in June 2012. Under phase III, the subsidy would be directly transferred to the bank accounts of farmers. 
One has to wait for TFDTS’ final report expected in December 2011 to authoritatively weigh the prospects of DFS.   There is, however, no guarantee that DFS would not misfire due to certain  intractable issues. One such factor would be the failure to create a mechanism to ensure that fertilizers reach every nook and corner and is available in adequate quantities and at the right time. Without freight subsidy, why should any company haul fertilizers to remote or low-demand areas?
Another imponderable would be the lack of mechanism to ensure that farmers put the cash to the intended use. Yet another factor would be the Government’s unwillingness to increase the cash dole-out in tandem with the increase in market prices of fertilizers.
One also has to work out compare the cost of administering indirect fertilizer subsidy (implemented through a few hundred companies) with that of DFS scheme that would target subsidies to over 115 million farm land holdings and 2, 85,000 fertilizer traders.
A basic requirement for DFS is computerization and updating of all land records. The Government has not yet disclosed when these pre-requisites would be put in place. It is not clear whether the Government has the political will to deal with the issue of delivering subsidy to absentee farmers.
It has also not indicated how it would ensure that DFS promotes the balanced use of all nutrients.  Fertilizer subsidy, whatever the delivery mode, has to be managed diligently. If used judiciously, the nutrients can do wonders to food security. If mismanaged, subsidy can harm soils. It can result in precipitous drop in crops response to nutrients in terms of yields. Badly governed subsidy can also reduce the quality of farm produce and stunt the growth of fertilizer industry. Dr. Singh should revisit the grassroot political and economic realties. g

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