Unintended effects of urea subsidy

Subsidies are usually extended on essential goods to make them accessible to consumers who can’t afford them. But maintaining the price of a freely traded product at artificially low levels, via subsidy, can backfire too.

There can be no better illustration of this than the recent experience with diesel subsidies. In order to keep costs low for the transport sector and ensure modest inflation, diesel prices were kept under check through subsidies, even as petrol prices were freed to market forces.

As international oil prices shot through the roof, the gap between petrol and diesel prices widened sharply. Affluent vehicle buyers, keen to save on running costs, switched from mid-sized petrol cars to high-end sports utility vehicles that guzzle diesel.

The subsidy on diesel ended up offering unintended benefits to a section of consumers who scarcely needed it. The recent hike in diesel prices by the government is an attempt to correct this anomaly.

Pricing anomaly

Now that the government has acted on diesel subsidies, it may be time for similar decisive action on fertilisers, too.

Ever since phosphatic and complex fertilisers were moved to a nutrient-based subsidy regime which allowed producers to freely set prices, these fertilisers have seen their domestic prices spiral in line with global trends.

In the last two years, manufacturers of DAP and complex fertilisers have effected a steep increase in their selling prices, responding to increases in the cost of imported inputs such as rock phosphate, ammonia and sulphur.

But selling prices of urea, still capped by the government, have stayed low, reflecting neither the upward spiral in production costs due to global feedstock prices nor the depreciating rupee.

The selling price of urea in India today stands at $96/tonne even as global prices of the product hover at over $400/tonne. As a result, about 75 per cent of the production cost of urea is subsidised by the Indian government.

In the domestic context, this has created stark imbalances between the prices of nitrogenous and phosphatic fertilisers too. In this kharif season, while urea retailed at Rs 5,310 per tonne, DAP sold at Rs 26,500 per tonne.

A bag of DAP has retailed at roughly 2 to 2.5 times the price of urea for much of the last decade. It now sells at nearly five times the latter’s price. This adverse ratio has created several distortions in the marketplace.

Distorted usage

One, it has skewed fertiliser use, moving it significantly away from the ideal ratio required to maintain the productivity of farmland. From a ratio of 4.3:2:1 for the three nutrients Nitrogen (N), Phosphorous (P) and Potassium (K) in 2009-10 reflecting a balanced nutrient use, the ratio has shifted to 6.5:2.9:1 by 2011-12.

Correcting such distortions in NPK use has been a long-standing objective of India’s fertiliser policy. When phosphatic and potassic fertilisers were first decontrolled in August 1992, there was a similar spurt in nitrogen usage, to the detriment of these fertilisers. It was only after the former’s prices were moderated through new subsidies that the nutrient balance began to witness a steady improvement. It changed from 10:2.9:1 in 1996-97 to healthier levels by 2009-10.

The widening gap between urea and other fertilisers has now resurrected the threat of a skewed NPK balance.

From milk to explosives

Two, the inordinately low prices of urea (it is now cheaper than common salt) have led to this manufactured product being diverted to other industrial and commercial uses.

Urea is said to be used for producing plastics, glues and pesticides. There are recurring reports of urea being used to adulterate milk, by artificially simulating some of its chemical properties. There have even been reports of the inexpensive and freely available urea being used by anti-national elements to fashion home-made explosives!

Recent Business Line reports suggest that the government is aware of such diversion. The Central government, last week, constituted special teams in 17 States to monitor urea supply and use, with a view to curbing its illegal diversion. The teams, consisting of officials from the Fertiliser Ministry, will regularly review urea availability in these States to curb practices such as black marketing, hoarding and smuggling.

Smuggled out

Finally, in these days of free global trade, artificially low prices of a commodity in any one region are an invitation to grey market trade. The long-standing cap on urea selling prices in India has resulted in a yawning gap opening up between Indian urea prices and those in the neighbouring nations. While a bag of urea in India costs $4.80, it retails at over twice that level ($13.3) in neighbouring Pakistan and $14.75 in China. A bag of urea costs $26.3 in the US.

The Fertiliser Association of India alleges that this price differential encourages smuggling of urea into countries such as Nepal and Bangladesh. According to one estimate, the quantity of urea diverted into such unauthorised uses could stand at 5-6 million tonnes, a fifth of domestic consumption.

So what’s the solution to all this? A calibrated increase in the selling price of urea seems to be the best way forward. Given the huge gap between current market prices of urea and its actual cost of production, completely doing away with the subsidy would clearly hurt farmer interests.

Therefore, the best long-term solution to keep the subsidy bill under check would be for the government to expedite targeted fertiliser subsidies so that they flow only to most needy farmers. What India needs is a workable mechanism to effect direct transfers of subsidy to the poor and marginal farmers alone.

( blfeedback@thehindu.co.in )

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