Before reading this chapter, it’s important that you read Chapter three – spreading JAM, chapter two – exit problem/ chakravyuha challenge and fundamentals of subsidy.

• Fertilizer accounts for large fiscal subsidies (0.73 lakh crore or 0.5 %of GDP), the second-highest after food.
• Only 17,500 crores or 35 per cent of total fertilizer subsides reaches small farmers

Where does the rest (65%) of subsidy amount go?

Obviously it leaks out to black market, large framers (bounty for the well off) and inefficient producers (exit problem).

We will come to the question of leakages later but before that let us know a few basics about fertilizer sector and it’s regulation in India.

1. There are 3 basic types of fertilizer used—Urea, Diammonium Phosphate (DAP), and Muriate of Potash (MOP) i.e N,P,K fertilizers.
2. Urea dominates the sector. It is the most produced (86%), the most consumed (74%) and the most imported (52%).
3. Urea also faces the most government intervention <50% under movement control compared to 20% for other two fertilizers,>
4. Urea also receives maximum subsidy (70% of total fertilizer subsidy) as well as in per unit terms (75% of cost of urea is subsidized compared to 35% for other two)
5. Urea is also not included in nutrient based subsidy regime

Nutrient based subsidy

Under this method, subsidy is given on the basis of nutrient content in the fertilizer. Suppose govt decided it would give 100 rs subsidy per kg of potash. Now, if cost of a fertilizer which contains 1 kg of potash is 1000 rs, govt will give 100 rs and he would be able to sell it at 900 rs. <govt does not fix retail price, govt gives same amount of per kg subsidy to all manufacturers, if production cost is less, you can sell it lower prices and capture market. It incentivises inefficiency this way.

Contrast this with urea subsidy which is cost plus based . In this regime govt fixes price of urea. Suppose govt fixed urea price at 500 rs per kg. Firm A produced 1 kg urea at 700, govt will give it 200 rs (700-500) so that it could sell it at 500. If more efficient firm B produced 1 kg of Urea at 600 rs, it will get 100 rs subsidy (600-500). Clearly, there’s no incentive to be efficient. More inefficient you are, more subsidy you get.

Other benefits of nutrient based subsidy

• Note that in cost plus method, govt can only subsidize a few fertilizers. But in NBS, govt has to simply state, it will give 100 rs per kg for N, K, P, Boron, Sulfur, Zinc etc. It will thus encourage production of complex fertilizers <many nutrient including micro nutrients in the one fertilizer>
• Complex and micro nutrients will increase the productivity of soil.
• It will encourage greater competition , leading to productivity gains.

Now let’s discuss 5 kind of govt intervention in urea sector

1. Controlled maximum retail price <encourages diversion and black marketing>
2. Firm specific cost plus subsidy <inefficient firms get larger subsidies>
3. Consignment specific subsidy to importers
4. Canalization of imports Only 3 agencies allowed to import <shortages when domestic production falls>
5. Movement control <govt tells how much to import and where to sell>

All these controls result in leakages. As we saw earlier only 35% of subsidy reaches small and marginal farmers.

1. Black marketing– Simply because the principle of one product one price (we discussed it w.r.t. LPG earlier) is violated.

Urea is only subsidized for agricultural uses but it is used for industrial purpose also < one of the ingredients in chemical industry, explosives, automobile systems, laboratories, medical uses, flavour enhancing additive in cigarettes and others>. As we know cost of subsidised urea is 75% lower than cost of non subsidised urea which gives strong incentive to divert it to the black market. Why?

• Simple- Suppose urea for agri use is 250 rs and for industrial use is 1000 rs, there’s strong incentive to sell it to industrial consumers at 750 rs and show it as urea for agri use.
• Similarly, urea is diverted to B’desh, Nepal where urea prices are high.

Result- Shortage of urea in domestic market.

Who suffers – small and marginal farmers. Rich farmers are well connected and get subsidies urea while small farmers have to buy urea from black market at much higher price <51% of farmers buy urea at above M.R.P.>

In the three eastern states bordering Bangladesh, 100 per cent of farmers had to buy urea at above MRP in the black market <diversion to B’desh>

Black market effects are aggravated by a further regulation—canalisation. As we saw , only three firms are allowed to import urea into India, and they are also instructed when to import, what quantities to import, and in which districts to sell their goods. And we all know how good govt is in forecasting needs.

Result- Shortages and shooting up of urea prices when demand is at it’s peak and invariably small farmers suffer disproportionately.

Reform by govt.-neem-coating urea

• Neem-coating makes it more difficult for black marketers to divert urea to industrial consumers.
• Neem-coating also benefits farmers by reducing nitrogen losses from the soil by providing greater nutrient to the crop <less urea required>
• Work as pesticide
• Less water pollution

2. Benefits large farmers– A regressive subsidy. As we saw small farmers suffer due to black marketing while large well connected farmers take advantage of subsidies.

3. Subsidy to inefficient firms– result of cost plus regime which does not encourage efficiency gains.

Result – even though 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. Efficient firms are forced to shut their shops.

Externalities of urea prices

What is externality?

an externality is the cost or benefit that affects a party who did not choose to incur that cost or benefit <for instance, vehicle owners pollute the environment, we all suffer the consequences an example of negative externality. Can you give us an example of positive externality in comments plz>

• It’s clear urea is under priced compared to other fertilizers resulting in excessive usages.
• Ideal N:P:K ratio for Indian soil is 4:2:1 but actual ratio is 8.2:3.2:1 i.e excessive usage of urea

Result-

• Deterioration of soil quality
• Fertilizer leaching to water bodies resulting in pollution of water
• Algal bloom

Reforms- aim of reform is to eliminate leakages while benefiting small farmers

1. 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
2. bringing urea under the Nutrient Based Subsidy program

Turning fertiliser into JAM

Fertilizer subsidy is an ideal case for JAMming (Chapter three) as leakages are high and central govt controls fund flows.

Also, urea manufacturing is not labour intensive so no harm to workers.

Ideally fertiliser subsidies would be targeted only at small and marginal farmers. But there are problems with targeting

1. Assessing poverty—based on landholdings or some other measure—will be difficult
2. How to target tenant farmers and sharecroppers <10% of all farmers are such farmers and they should not be excluded in any case>
3. Relatively low levels of last-mile financial inclusion in much of rural India <last mile challenge, chapter three>

What can be done if not JAM?

Set a cap on the number of subsidised bags each household can purchase <just like 12 subsidized LPG cylinders> and require biometric authentication at the point of sale (POS) <BAPU (chapter three)>

• Requiring biometric authentication would make it harder to conduct large-scale diversion
• Imposing a cap on the total number of subsidised bags each farmer can purchase would improve targeting <Small farmers would still be able to get all their urea at subsidised prices but large farmers may have to pay market prices for some of the urea they buy>

As urea is more sensitive, it could be initiated first for other fetilizers

Other reforms-

• Rationalise subsidies to domestic firms <shifting to NBS regime> which would release fiscal funds to spend more effectively on schemes that help poor farmers, such as drip irrigation and connectivity through the Pradhan Mantri Gram Sadak Yojana
• Secure long term fertiliser supplies from locations where energy prices are cheap
• Encourage 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.

Suggested reading- Fertilizers and challenges of reform

Self study- New Urea Policy 2015