Known unknowns of the fertiliser subsidy

Source: The post is based on an article “Known unknowns of the fertiliser subsidy” published in Business Standard on 31^st January 2023.

Syllabus: GS 3 – Indian Economy

Relevance: concerns associated with subsidy on fertilisers

News: The government last year came up with measures to bring down the fertiliser subsidy bill. The article provides an analysis of those measures.

What were the measures proposed by the government?

First, it asked the fertiliser companies to buy up to 20 per cent of their LNG needs directly or via the Indian Gas Exchange (IGX).

Second, the government decided to review the domestic gas pricing formula, and caps rates.

What are the problems associated with the fertilizer subsidies?

Fertilizer along with food take up a huge amount of budget.

Fertilizer subsidy goes to manufacturers, mainly urea makers, to compensate them for selling fertilizer below market rates. These fertilizer makers are the biggest consumers of imported LNG.

The cost of buying LNG is further growing due to the increasing global gas rates and stagnant domestic production. Due to which, the Finance Ministry had allotted Rs 1.05 trillion for 2022-23 to compensate fertilizer makers.

However, the amount allotted for the subsidy is expected to increase further due to the Ukraine conflict, high international prices of raw materials and finished fertilizers, currency depreciation, etc.

Moreover, a large amount of fertilizer subsidy goes to the foreign gas suppliers because 80 percent of the cost of urea is natural gas.

Therefore, it is expected that the cost of subsidy will go up for FY24. Hence, due to these difficulties, the government came with those two proposals.

How would the first proposal for asking the fertilizer companies to buy up to 20 percent of their LNG needs will lower the subsidy costs?

It will allow fertilizer companies to buy in a most cost-effective way and find an exchange most suited for their purpose. This has huge potential to save on gas subsidies.

However, the government needs to change the regulations for companies to gain from this proposal.

At present, fertilizer units source LNG using a pooling mechanism managed by Gail India. But the way the pool works is that efficient fertilizer plants end up subsidizing inefficient ones.

Even if an efficient fertilizer maker gets gas from IGX under the new 20 percent sourcing rules, it would still need to pay the difference between the IGX rate and the average pool price.

This would reduce the incentive for efficient fertilizer units to seek gas outside the pool.

Therefore, the 20 percent procurement volumes should have been kept out of the pooling price mechanism.

Moreover, the government’s second proposal to cap on domestic gas prices could help in reducing the pooled gas prices.

How would the second proposal of the government on capping the prices help in reducing the prices of gas?

The Parikh Committee recommended capping domestic gas rates, and changing the fixed prices for domestic gas from global gas benchmarks to crude oil rates.

This is because industrial customers have switched to crude-linked alternatives due to lower crude prices than gas prices.

Therefore, the adoption of recommendations could lower domestic gas prices and, thus, the pooled gas prices for fertilizer companies.

What are the challenges with India?

India has adopted these domestic policies but these domestic polices may have limited impact due to the global cause of leading to higher prices of natural gas.

The LNG production is limited and the demand is soaring all over the world which is ultimately increasing the price. Hence, the government might to have bear the burden of subsidy for a longer period.