Reforming the fertilizer sector in India

Recent reforms in fertiliser sector include Neem Coated Urea and Gas Price Pooling. Neem-coating prevents diversion of urea to industrial uses. 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.  Gas price pooling has induced efficiency of domestic urea production.

Major distortions in urea

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.  In fact, subsidised urea suffers from 3 types of leakage:

• 24 per cent is spent on inefficient urea producers
• Of the remaining, 41 per cent is diverted to non-agricultural uses and abroad;
• 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.

Of all the fertilisers, urea is the most produced (86 per cent), the most consumed (74 per cent share), and the most imported (52 per cent).

Optimal N:P:K ratio

The optimal N:P:K ratio varies across soil types but is generally around 4:2:1.

Nutrient Based Subsidy (NBS)

NBS is based on a formula that determines the amount of N, P and K in a given amount of fertiliser.

What are the government interventions in case of Urea?

• It sets a controlled Maximum Retail Price (MRP) at which urea must be sold to farmers.
• It provides a subsidy to 30 domestic producers that is firm-specific on a cost-plus basis, meaning that more inefficient producers get larger subsidies.
• It provides a subsidy to importers that is consignment-specific.
• Imports are canalised—only three agencies are allowed to import urea into India.
• 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.

Black market of Urea

Urea is only subsidised for agricultural uses. The 75 per cent subsidy on agricultural urea creates a large price wedge which feeds a thriving black market diverting urea to industry and possibly across the border to Bangladesh and Nepal.

Due to black market, it is estimated that about 51 per cent of Indian farmers buy urea at above-MRP.

The black market prices are, on average, about 61 per cent higher than stipulated prices.

Canalisation is further aggravating the black market of urea. Every season the Fertiliser Department estimates how much imports are required by forecasting domestic supply and demand. But 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 particularly costly during the peak demand period when timely availability of urea is essential for proper plant growth.

Inefficient fertiliser manufacturers

The other source of leakage in urea is some of the urea subsidy going to sustaining inefficient domestic production instead of going to the small farmer. Today, there are 30 manufacturing units with varying levels of efficiency. The urea subsidy model is based on cost of production i.e. the greater the cost, the larger the subsidy.  As a result, inefficient firms with high production costs survive and there is no incentive to lower cost production. Though the 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. A few plants stopped production, while some big conglomerates like Tata Chemicals, which owns one of the most energy-efficient urea units, have threatened exit. This year, the government has revised its policy, taking steps in the right direction.

What are the urea over-used areas in India?

In absolute amounts, the over-use of urea is in many of the larger states, especially in Punjab, Haryana, and Uttar Pradesh. In India 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.  This pattern is also observed in the most productive states like Punjab, Haryana, UP and Gujarat. The distortions are less in Maharashtra, Karnataka, and Kerala, which consume close to the optimal ratio. This could simply be the result of different crop mixes.

The overuse of nitrogen as compared to potash is even more extreme. In some Indian states the distortions are so extreme – 4500 per cent more N than K in Rajasthan, 1300 per cent high in Punjab and Haryana.

Reform steps in fertiliser industry

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 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 (Diammonium Phosphate) and MOP (Muriate of Potash) would allow domestic producers to continue receiving fixed subsidies based on the nutritional content of their fertilizer, while deregulating the market would allow domestic producers to charge market prices. This would encourage fertilizer manufactures to be efficient, as they could then earn greater profits by reducing costs and improving urea quality. And this in turn would benefit farmer.

Third, the case for implementing direct transfers in fertilisers is to reduce leakages to the black market. Technology could be further used to curtail leakages and improve targeting of fertiliser subsidies. Fertiliser is a good sector to pursue JAM because of a key similarity with the successful LPG experience: the centre controls the fertiliser supply chain. But the relatively low levels of last-mile financial inclusion in much of rural India also suggest that it would be risky to replace subsidized fertilizer with cash, due to beneficiaries’ weak connection to the banking system.

Fourth, a preferred option would be to set a cap on the number of subsidized bags each household can purchase 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 subsidized bags each farmer can purchase would improve targeting. Small farmers would still be able to get all their urea at subsidized prices but large farmers may have to pay market prices for some of the urea they buy.

Finally, to secure long term fertiliser supplies from locations where energy prices are cheap, it might be worth encouraging Indian firms to locate plants in countries such as Iran following the example of the Fertiliser Ministry’s joint venture in Oman, which allowed India to import fertiliser at prices almost 50 per cent cheaper than the world price.