Hoping for a coronavirus-induced fertilizer reforms

Even as Prime Minister Narendra Modi has declared his intent to use Covid–19 as an opportunity to implement big bang reforms, the government is silent on fertilizers – a sector that has been crying for reforms for far too long. To put things in perspective, let us take a look at some basic facts on existing policies.

Prior to the 1990s, both urea --main source of nitrogen (N)--and phosphate (P) and potash (K) fertilizers such as di-ammonium phosphate (DAP) and a whole range of complex fertilizers containing N, P&K in different proportion etc, fell under pricing and distribution controls.

The maximum retail price (MRP) of each fertilizer was controlled at a low level and excess of cost of production and distribution over MRP was reimbursed to manufacturers as subsidy on unit-specific basis under a unique system called Retention Price Scheme (RPS)--introduced for urea in 1977 and for P&K fertilizers in 1980.

Under this system, even as production and consumption of fertilizers showed phenomenal jump, in turn contributing to increase in food grain production, there was a substantial increase in fertilizer subsidy also as the cost of production and distribution increased sharply in the face of low MRP.

Meanwhile, the balance of payment crisis of early 1990s forced the then government led by Narasimha Rao to kick off far-reaching reforms in fertilizers. On August 25, 1992, the government decontrolled P&K fertilizers and abolished subsidy even as it kept urea under control and even reduced its MRP.

The resulting steep increase in the selling price of former (inevitable when manufacturers realize full cost from farmers with no subsidy support) invited strong reaction and within five weeks, it was forced to resurrect subsidy under a new incarnation ‘ad-hoc concession’ from October 1, 1992. But, unlike urea where every unit continued to receive subsidy specific to it, all manufacturers of P&K got a uniform concession/subsidy.

Since then, the basics of the scheme--‘fixed’ and ‘uniform’ subsidy have remained unaltered even as the manner of calculating the amount as also the nomenclature have been changed (from ‘ad-hoc concession’ to ‘concession’ to ‘subsidy’). At present, manufacturers of P&K fertilizers get subsidy under the Nutrient Based Scheme (NBS) in vogue since April 2010. On the other hand, urea MRP continues to be under control even as manufacturers get unit-wise subsidy under the New Pricing Scheme (NPS)--an improvised version of the erstwhile RPS introduced in 2003.

The policy dispensation is heavily biased towards urea. Herein, subsidy accounts for 50-75% of production cost, input cost escalation normally absorbed by subsidy, movement cost up to the retail point is reimbursed and it gets priority in allocation of domestic gas (albeit cheaper). In case of P&K fertilizers, subsidy is only 25-30% of the cost, cost escalation is passed on to MRP, cost of movement by rail to unloading rake point only is allowed and manufacturers have no access to domestic gas.

Decontrol of urea and direct benefit transfer (DBT) of fertilizer subsidy to farmers has been on the radar of our policy makers for over two decades. But, no government has dared to go for it. However, the economic crisis triggered by Covid–19 offers a golden opportunity.

Crude price

About 90% of urea production in India is based on natural gas with nearly two-thirds of gas supply from domestic source and the other one-third imported gas. The price of domestic gas is benchmarked to its price at four international locations. These prices in turn, are linked to movement in price of crude oil. The price of imported LNG (liquefied natural gas) is also linked to crude.

Large scale destruction of demand in the wake of corona crisis has led to a steep decline in price of crude from a high of over $70 per barrel at the start of 2020 to a low of $20 per barrel. This has led to the corresponding reduction in the price of gas.

Considering that low gas price is likely to sustain for a couple of years, this could be a good time to crack the whip as after decontrol, the MRP (without subsidy) will not be significantly higher than what it is today. The poor farmers can be taken care of by crediting subsidy directly in their account using the database under PM–Kisan scheme.

Concurrently, the government should reform taxation of fertilizers which is hamstrung by an inverted duty structure. At present, even as all fertilizers attract GST of 5%, the duty on raw materials and intermediates used in their production is much higher.

Natural gas is ‘zero rated’ under GST implying that it continues to attract excise duty (ED) and value added tax (VAT) as in the past. Even as ED on gas is ‘nil’, VAT varies from state to state with a low of 5% in Rajasthan and high 21% in Uttar Pradesh. Imported gas attracts customs duty (CD) of 2.5% while CD on import of ammonia, phosphoric acid and sulphur is 5%. Ammonia and phosphoric acid attract GST of 18% and 12% respectively.

The tax on output (read: fertilizers) being 5% and that too on artificially suppressed MRP falls far short of input tax which is high due to higher tax - apart from the basic price of inputs itself being high. This results in unabsorbed input tax credit. The anomaly can be removed by bringing gas under GST and taxing it at 5%. A uniform tax across all states (unlike present VAT regime with wide variation in tax rate) will also help in smooth transition to urea decontrol.

The GST on ammonia and phosphoric acid also needs to be brought down from existing 18% and 12%, respectively, to 5% on each to correct the duty inversion in P&K fertilizers. Will Modi crack the whip?

(The writer is a New Delhi-based policy analyst)