Government’s policy of price control is a major disincentive for capacity addition

Inadequate supplies of natural gas will limit capacity additions in urea, leading to an increase in imports. Increased urea imports (where the subsidy burden per tonne is higher compared to domestic urea) along with high global prices of raw materials for complex fertilizers are likely to derail the government’s efforts to contain fertilizer subsidies in the medium-term. We believe that, keeping in view the expectations of a steady increase in demand, the quantum of subsidy will actually go up over the next few years.

Natural gas is the predominant input in the manufacture of urea, which accounts for 50 per cent of fertilizer consumption in the country. The government has accorded priority to allocation of natural gas to fertilizer units, but we do not expect any fresh urea capacities to come on stream in the next few years due to gas scarcity. According to a 2011 Planning Commission report, investments in urea worth around Rs.25,000-30,000 crore are on hold because of lack of clarity over availability of gas in the long-term. Around 20 per cent of existing urea capacity still operates on either naphtha or fuel oil as feedstock due to non-availability of natural gas.

Another major disincentive for capacity addition in the fertilizer sector has been the government’s policy of price control, because fertilizer is a key agricultural input. Fertilizer cost accounts for 6-8 per cent of total cost of cultivation of major principal crops such as wheat, paddy, bajra, and maize. Due to negligible capacity additions, imports have played a significant role in the sector. And, we believe that despite the introduction of schemes such as the nutrient-based subsidy (NBS) scheme for complex fertilizers (aimed primarily at reducing the government’s subsidy burden), imports will remain significant even in the next few years, due to a steady growth in demand and high raw material prices. India is the world’s second biggest consumer of fertilizers after China, and total domestic fertilizer consumption is expected to go up by 8 per cent compounded annual growth rate (CAGR) to 78 million tonnes by 2015-16. Imports, as a proportion of consumption, are projected to increase to 35 per cent by 2015-16 from 31 per cent in 2011-12.

The dependence on imports will be particularly true in the case of complex fertilizers. India is the single biggest buyer of DAP (di-ammonium phosphate, a phosphatic fertilizer) in the global market, as it imports around 52 per cent of globally-traded DAP, or equivalently 60 per cent of its domestic consumption. Similarly, the country imports all its requirement of muriate of potash (a potassic fertilizer). Together, these two fertilizers account for around 23 per cent of total consumption. Further, in the case of domestically-manufactured DAP, India imports nearly 90 per cent of its requirement of phosphoric acid (which is the raw material in the manufacture of DAP).

Farmgate prices of urea (a nitronegous fertilizer) and complex fertilizers have traditionally been controlled by the government. Consequently, any increase in the cost of production for fertilizer companies was reimbursed by the government in the form of a subsidy. To rein in the ballooning fiscal deficit, the government, in 2010, introduced an NBS regime in complex fertilizers, under which the subsidy was fixed for each nutrient. Simultaneously, farmgate prices of complex fertilizers were decontrolled. It was thought that the new regime would give pricing flexibility to the manufacturer, and partly insulate the Centre's subsidy burden from the volatility in global raw material as well as product prices. However, the scenario since introduction of NBS in complex fertilizers has been mixed. The subsidy payout was lower in 2010-11, but since then international prices of raw materials for complex fertilizers have risen continuously, necessitating an upward revision in subsidy on more than once to avoid sharp increase in retail prices.

However, we believe that despite such temporary blips, NBS is a step in the right direction. Already, one negative consequence of not implementing NBS in urea while implementing it in complex fertilizers is that the sharp difference in the retail prices make it more attractive for farmers to purchase urea. At present, the government is able to restrict this practice because it controls 50 per cent of urea supply. Any tilt towards urea consumption would disturb the targeted nutrient ratio and increase the dependence on imported urea. NBS in urea is, therefore, an imperative not only to achieve balanced nutrient consumption but also to improve the government’s finances.

The author is Director, Crisil Research, a division of Crisil.

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