Production: One of India's key budgetary subsidies is for fertiliser, estimated at around US$ 2.8 billion during 2000-01. As an element for attaining self sufficiency in food production, the Indian Government has over many decades maintained the necessity of producing a significant percentage of national fertiliser consumption. India produces about 90 per cent of its requirements for nitrogen fertilisers, mainly urea, and about 70 per cent of phosphate fertilisers, while importing all potassium fertilisers. Domestic production of urea by various government-owned manufacturing units is about 21 million tons. Sixty per cent of India's installed nitrogen fertiliser capacity is based on gas, with the remaining 40 per cent based on the now more expensive naphtha or fuel oil feed stocks. Both domestic and imported fertilisers are sold to farmers at a set price, somewhat well below the prevalent world prices.

Prices and Costs: India's production costs for urea, until a few years ago was below world prices, currently average well above world levels and vary across manufacturing units in the country, ranging from US$ 100/ton to more than US$300/ton. High domestic prices and high taxes on naphtha/fuel oil/low sulfur feed stocks in most states are a major factor in pushing the costs up.

Whereas, the import price for urea ranges from US$150/ton to US$188/ton. Indian farmers pay about Rs. 4600/ton (US$ 98/ton) compared to Bangladesh US$ 119/ton, Malaysia US$ 191/ton, Pakistan US$ 160/ton and Thailand US$ 174/ton. While a large chunk of the subsidy goes to the farmer, the urea producers benefit heavily under the retention-price-cum-subsidy (RPS) scheme, under which they get their cost (calculated by plant) plus 12 per cent reimbursed by the government. Phosphate producers in contrast get a flat subsidy amount adjusted on an annual basis. As a result, this huge subsidy has enriched fertiliser producers and rewarded the most inefficient producers in the country.

A Failed Mechanism: The plant specific RPS price scheme has encouraged urea producers to shift production to high cost plants and has discouraged efficiency. The industry faces strict controls, shortages of feed stocks, delayed subsidy payments, a controlled selling price, and restrictions on new investment, which mainly occurs in planned expansions of capacity at public sector units, which themselves choose the most expensive options.

The industry has complained that it is not getting its required annual return of 12 per cent. In fact, the fertiliser industry argues that the real benefit of the subsidy goes to the petroleum and gas companies, mainly public sector oil enterprises, and comes back to the government as profits from these undertakings. Further, the higher subsidies on nitrogen fertilisers have severely distorted the mix of fertilisers used by farmers away from the optimum ratio of 4:2:1 for nitrogen/phosphate/potassium to 8:3:1.

WTO and its implications: As is common knowledge, all nitrogen fertiliser imports are channeled through the government, which subsidises the price of imported as well as domestic fertiliser. The imports of phosphate and potassium fertilisers are free, but the government still subsidizes their sale, though in the case of phosphate fertilisers domestic production gets a higher subsidy than imported products.

Until recently, fertiliser had a zero duty, though in the last year the government imposed a five per cent customs duty, despite the fact that the government pays the additional cost. WTO commitments should eventually force the government to end channeled imports of urea. The tariff on phosphate fertiliser is bound at 5 per cent but urea it is not. Though, India would be able to levy urea tariffs to protect domestic industry against imports but that would complicate farmer subsidies and it would no longer be able to pay differential subsidies on domestic and imported fertilisers. Thus it is expected that the fertilizer subsidy to both farmers and industry will get cut or reduced over a short period of time. To study the impacts of the WTO agreements on the Indian fertiliser industry, the fertilizer ministry has set up a task force which is being headed by the secretary for fertiliser.

The Changed Scenario: India has been importing as much as 60-65 per cent of all finished di-ammonium phosphate (DAP) from the United States. Since decontrolling phosphatic fertilizer imports the Indian government has constantly adjusted the levels of subsidies to DAP producers and importers, with higher subsides going to producers. The subsidy for imports has not matched recent hikes in world prices for DAP, making it uneconomical for private players to import the product. The government-owned fertiliser trading company has stepped in to cover the import shortfall at a loss, but the company this time has not chosen from traditional US.

Seeing this step as a major loss to the US fertiliser industry, the representatives from the US industry have initiated informal discussions with the Indian government and trade officials to check what has evolved as a "recanalization" of DAP imports and reversal of the efforts to liberalize fertilizer imports. It may be interesting to note here that the imports of finished di-ammonium phosphate (DAP), from the United States has reduced from US$ 200-300 million down to nil in the current year.

Rationalising Fertiliser Subsidies: The deadly combination of rising production costs, increased pressure to cut subsidies and possible new trade requirements is driving a push for reform in the Indian fertiliser sector.

The complexity of the problem has triggered a heated debate on how best to make a transition from a protected pricing environment to a market driven regime. The high-powered Hanumantha Rao Committee (HRC) on fertiliser pricing in 1998 recommended gradually deregulating the industry, discontinuing the RPS for urea plants and instituting a uniform subsidy based on a referral price.

The Ministry of Chemicals and Fertilizers released a draft long-term fertiliser policy based on the HRC report, in July this year (2000), which aims to adopt a single retention price for the entire industry, while providing some cost reimbursements to less efficient units using naphtha and fuel oil for a limited period. The fertiliser ministry has also started several "road-shows" to invite the views of farmers, consumer organizations, media, industry, and government officials on the draft fertilizer policy to incorporate their views in the final version.

Meanwhile, the Expenditure Reforms Commission (ERC), set up by the finance ministry in September 2000, recommended gradually phasing out fertilizer subsidies by 2006, with a seven per cent annual real increase in urea prices. The ERC proposed group, rather than unit, pricing for the industry component of the subsidy.

To protect small farmers, the ERC recommends the distribution of subsidized fertilizers of 120 kgs for each cultivator. A few are of the view that the RPS be replaced with a flat rate of subsidy of Rs. 1500/ton reduced over several crop seasons. For plants that are badly hit, a one-time capital subsidy can be considered. Though the industry has opposed the move away from unit pricing, arguing that half of the urea units would be forced to close because even their short-term variable costs are higher than import prices. They predict dire results; lower domestic production would push up import prices and reduce fertilizer use and agricultural production.

Back to the Future: Though, varying in detail, most of the recommendations are basically similar, such as - end the RPS and adopt uniform industry subsidy that is phased out over time. Many recommend phasing out or at least reducing farmer subsidies. During most of the history of fertilizer subsidies, farmers were penalized by receiving below world prices for food grain. Today, in fact, farmers get more than world prices, so little justification remains for subsidizing a key input.