The Hindu Business Line : Ambiguities in fertiliser policy — Major stumbling block to privatisation

With the Government reviving the divestment process in a host of PSUs, including in the fertiliser sector, it should announce that the pricing schemes in both the nitrogen and phosphate sectors will be withdrawn by a specified date and benchmark pricing to the import parity price. This will ensure transparency and fair valuations of the fertiliser PSUs put on the block.

THE Supreme Court has recently clarified that the Government does not need its approval for privatising public sector undertakings that were not set up under an Act of the Parliament. Following this, the Government has reactivated the process of strategic sale of its equity in a host of PSUs, including those in the fertiliser sector.

The fertiliser PSUs lined up for disinvestment include National Fertiliser Limited (NFL), Rashtriya Chemicals and Fertilisers Limited (RCF), Madras Fertilisers Limited (MFL) and Fertilisers and Chemicals Travancore Limited (FACT). But it is doubtful if the Government has factored in the impact of the policy environment on this exercise.

The overriding factor in a purchase decision is the strategic investor's assessment of the capacity of the acquired company to deliver good returns on a sustained basis. The return, in turn, is a function of the price realisation, which is controlled by the Government under the existing policy dispensation.

Under it, all fertiliser manufacturers are required to sell the product at a uniform controlled price. This price being invariably lower than the cost of production and distribution, the Government also fixes the amount admissible in respect of the latter and reimburses the difference as subsidy.

The investor must know the basis of determining the admissible production cost over the long term. This, of course, presupposes that price controls will continue. If, on the other hand, the Government intends to remove these, the investor must know when this will be done. So, what is on the plate?

For urea units, from April 1, 2003, the Government introduced a New Pricing Scheme (NPS) in replacement of the existing unit-wise retention price scheme (RPS). But this is applicable only for three years — up to March 31, 2006. For the period beyond this point, the Notification merely states that the policy will be decided after reviewing the experience with the NPS.

The recent policy announcement in regard to pricing on the principle of LRAC (long-run average cost) — applicable for five years — and thereafter benchmarking to the import parity price (IMPP) covers only the new projects, including substantial expansion at existing sites. It does not apply to the existing units for which the NPS is applicable.

In view of the above, the investor does not know what will be on his plate two years from now. Can he proceed on the basis that the existing dispensation will continue? This could be highly risky in view of the following:

First, the Expenditure Reforms Commission (ERC) had in 2000 recommended the complete decontrol of urea from April 1, 2006, when all domestic manufacturers would be expected to cut their production costs to the level of the IMPP of urea. In the Budget for 2001-02, the Finance Minister even promised to implement it. This still hangs over the producers' heads like a Damocles sword.

Second, at present, the Government restricts urea import by routing these only through designated state trading enterprises (STE) which act as a virtual shield for domestic manufacturers. This arrangement is unsustainable. India's obligations under WTO would require it to allow free import of urea sooner than later.

Third, there is not much scope for protection through levy of import duty. This is because the current duty is only 5 per cent and in view of our international commitments (India is committed to align its duty structure to Asean levels), the Government would find it extremely difficult to raise it beyond the 10 per cent level.

The winds of change are, therefore, at our shores. The Government can neither afford to ignore the recommendation of the ERC (its major thrust was on complete elimination of agricultural subsidies, including on fertilisers) nor its commitments under WTO. Clearly, the existing regime will have to give way to a new policy. In all probability, the realisation of all manufacturers will have to be benchmarked to IMPP of urea with a modest Customs duty of 5-10 per cent factored into it. Against this, the group concession scheme (GCS) under NPS protects substantially higher levels of production cost of these plants.

Under GCS, the urea plants of FACT and MFL are in the pre-1992 naphtha-based group. Naphtha being the most expensive feedstock, the weighted average (WA) cost of production of all plants in this group is higher than WA of all other groups.

Within the pre-1992 naphtha group, the MFL and FACT plants are "outliers" (retention price higher than WA by more than 20 per cent). In view of this, they are given a special allowance equal to 50 per cent of the difference between their retention price and the WA. In other words, their concession is even higher than the group average.

The three plants of NFL — at Bhatinda, Panipat and Nangal — are in the fuel-oil group. The WA of all plants in this group is significantly higher than WA for the gas groups (pre-1992 and post-1992), though somewhat lower than WA for the naphtha group. The WA for the fuel oil group is also significantly higher than the IMPP of urea.

This group also includes Gujarat Narmada Valley Fertiliser Company (GNFC) plant at Bharuch, whose production cost is substantially lower than cost of NFL plants. But GNFC, being an outlier (retention price lower than WA by more than 20 per cent), is excluded while computing WA. This helps the NFL plants in getting a much higher concession.

The Thal unit of RCF is in the mixed-feed group — gas-based plants that use alternative feedstock by more than 25 per cent of total energy requirements. This enables it to get a substantially higher concession than the amount available to plants in the pure gas groups (pre-1992 and post-1992). This would also be higher than the IMPP.

A provision under GCS allows escalation in price of feedstock and fuel using unit-specific energy consumption norm (fixed for the 8th pricing period under the erstwhile RPS) instead of the implicit WA for the group. For plants under reference, the former being significantly higher than latter, this helps them get higher amount towards escalation.

The above sops meant to accommodate the handicaps of individual plants — due to inferior feedstock or old technology or vintage or inefficiency in operations — will automatically disappear the day the GCS is dismantled and an IMPP-based regime is put in place. That will result in a steep fall in their realisation.

While NFL is engaged primarily in urea manufacturing activity, RCF, FACT and MFL also produce complex fertilisers in addition to urea. The cost of complex fertilisers produced by these plants is also high largely because of the high cost of ammonia based on naphtha (or a combination of gas and naphtha with significant use of the latter in RCF) besides operational inefficiencies.

Under the two-part concession scheme introduced from April 1, 2002, the Government has protected the higher production cost of the MFL and FACT plants by giving them a substantially higher concession than that allowed to the plants using imported ammonia. One wonders how long this scheme will continue!

FACT is also engaged in the manufacture of DAP. Based on the recommendations of the Tariff Commission, the Cabinet has recently approved a two-part concession scheme for DAP manufacturers. Under it, the plants based on imported phosphoric acid (Group II) get higher concessions than those based on captive phosphoric acid (Group I).

The global suppliers of phosphoric acid have formed a cartel and charge a price that is substantially higher than the cost of production plus handling and ocean freight. This is accommodated in the higher concession to plants in Group II (a typical case of using subsidy to prop up the profits of exporters). FACT, being in Group II, gets this protection.

To meet our commitments under WTO, the above schemes will have to be dismantled. Under the resultant IMPP-based regime, the realisations from production of DAP and complex fertilisers will also fall drastically. The levy of Customs duty will be of little help as the current duty rate on DAP is only 5 per cent which, being the bound rate under the WTO, cannot be raised.

If a scenario were to unfold in the manner indicated above (a very likely possibility indeed), this could affect the valuations of the fertiliser PSUs put on the block. However, that should not deter the Government from adopting an open and totally transparent approach.

The current approach of not disclosing the policy environment in the medium to long run may help the Government in projecting the concerned PSUs in better financial health and, in turn, fetching a good price. But that would erode the credibility of the entire privatisation exercise!

To be fair to the investors, the Government should clear the maze and announce right now that the existing pricing schemes in both the nitrogen and phosphate sectors will be withdrawn by a specified date — say, 2006. It should also categorically state that from then onwards, the price realisations of all producers in all product categories will be determined by the respective IMPP levels.

Under the Exim Policy, the Government has made exports of phosphate fertilisers totally free (their imports are already free since 1992). However, it continues to maintain restrictions on both exports and import of urea. It should allow total freedom of trade in urea from the day the IMPP regime is put in place. An announcement regarding this should be made now.

The above announcements will enable the strategic investors make a realistic assessment about the future earning profile of the undertakings and accordingly arrive at their valuations. They can also do definitive planning with regard to restructuring and revamp of the plants and implementing other steps needed for running them profitably.

The PSUs on the bloc own huge property and real estate (some of them in prime locations) worth hundreds of crores of rupees. They also have geographically well-spread-out selling and distribution networks (for instance, NFL in the north and RCF in west and south). These strengths can be leveraged much more effectively under a definite and stable policy framework.

(The author, an economist, is an expert on fertiliser policy. Feedback may be sent to uttamgupta2003@yahoo.co.in)

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