Is India’s fertilizer subsidy poorly targeted?

About a decade ago, with the onset of giveaways galore, the Election Commission (EC) advised all recognized political parties to spell out the proposed freebies in their election manifestos. No doubt, freebies, if properly planned and used, have a positive impact on economic growth; otherwise, it betrays misallocating limited resources and becomes an excruciating burden on taxpayers' money. The Supreme Court on 11 Aug 2022 observed that a balance must be struck between the economy losing money owing to benefaction and welfare measures undertaken by the governments as both are two different things. Some freebies may benefit low-income people if properly targeted with minimal leakages, but their advantages must be evaluated against the high fiscal costs and inefficiencies that distort prices and misallocate resources.

The provision of fertilizer subsidy is one such freebies that raise several questions in the mind of academicians and policymakers. These questions call for immediate answers but remain unanswered. What is the quantum of burden on tax payer's money? Is there any leakage in the subsidy regime? Are there environmental consequences? Do the social benefits exceed the cost of the subsidy provision?

From a micro perspective, subsidy provision, either through input subsidy or income transfers, burdens the government exchequer and trudge in consumption level. The economic framework suggests that direct income transfer is less burdensome on taxpayers' money, but it cannot guarantee the consumption level. Further, the cash transfer equivalent leads to a more significant increase in welfare but does not ensure the increase in agricultural production for which it was granted. So, the criterion of a lesser burden on taxpayers' money cannot be validly applied to the government subsidy programme.

Though input subsidy is a micro-intervention, it constituted 3% of GDP and 8.5% of agricultural income in 2021, making it a macroeconomic issue. Subsidies change how resources are distributed among individuals and thus have welfare implications. It has a substantial impact on the fiscal deficit. The 3-Fs, known as food, fertilizer and fuel subsidy, constitute 95% of the total subsidy. In 1991, fertilizer subsidies amounted to 4,389 crores, up to 81,124 crores in 2020 (extrapolated), representing a twenty-fold increase (Fig-1). At present, per hectare allotted subsidies on fertilizers is around Rs.3330/- which was Rs.941/- in 1991, reflecting a thirty-fold increase in 30 years. Power subsidy (POWS) expenditure is highest at 46 per cent, followed by fertilizer and irrigation subsidies at 40 and 14 per cent, respectively.

Source: Agricultural Statistics at a Glance 2021

A massive leakage in fertilizer subsidies is also a matter of grave concern. In the case of urea, the price of fertilizers for agricultural and industrial use differs. Such price differential paves the way for leakages to even industries of neighbouring countries such as Nepal and Bangladesh. The extent of leakage was 51 per cent (Cost of Cultivation Survey 2013). The figure was higher in the states sharing borders with Bangladesh and Nepal (West Bengal, Bihar and Assam). GOI developed 100%‘neem-coating' of urea to overcome the diversion to industries in 2015. The second kind of leakage lies in covering the inefficiency of the fertilizer-producing plants. There are roughly 37 producers (30 public enterprises and seven private enterprises) of urea, and each gets a subsidy based on the cost of production. A higher cost of production means a higher amount of subsidy. Gulati and Banerjee (2019) estimated that the average urea production cost in 2018-19 exceeded India's import parity price.

The environmental consequences could be well understood using the NPK ratio in fertilizers. The ideal ratio of Nitrogen, Potassium and Phosphate fertilizers at the all-India level is 4:2:1 as a rule of thumb (Economic Survey 1993 - 94). Since urea is subsidized to the extent of more than 200 per cent, excessive consumption is there. The ratio of N/K use at all India levels in 2021 is 6.4:1, far beyond the ideal ratio (Fig.-2).

Figure-2: Distortions in N: K use among states in 2021

Source: Agricultural Statistics at a Glance 2021

Reckless use of urea and underconsumption of some micronutrients led to the deterioration in soil quality leading to a declining crop response ratio in India (13.4 kg Grain/Kg NPK use in 1970 to 3.7 kg Grain/Kg NPK use in 2007 as observed by Biswas and Sharma) and health hazards as a byproduct. In the Muktasar district of Punjab, there are 136.3 cancer cases per lakh population against all India figures of 80. It calls for a re-examination of urea subsidy management in agriculture, also considering the sustainability aspects in the long run.

One of the repercussions of having huge subsidy expenditure is that there exists a trade-off between subsidies and investment. It means more subsidies signify less investment. Gulati and Terway (2018) established an intriguing estimate that the number of persons escaping poverty is five to ten times greater when money is spent on public investment instead of input subsidies. Ironically, public investment growth has followed a linear pattern, while growth in input subsidies has been exponential during the last three decades (Fig.-3).

Figure-3: Trend of input subsidies and public farm investment at 2011-12 prices

Source: Calculated by authors.

At 2011–12 prices, the sum of three key input subsidies (fertilizer, electricity, and irrigation) increased from 492 billion in 1991–92 to 1513.21 billion in 2018–19. Public investment

increased from 198 billion to 460 billion during the same period. Gulati et al. (2018) observed that public farm investment as a percentage of agricultural GDP has declined from 3.9 per cent in 1980-81 to 3.7 per cent in 2015-16. On the other hand, input subsidies as a percentage of agricultural GDP have increased from 2.8 per cent in 1980-81 to 8.0 per cent in 2014-15.

The fertilizer subsidy is poorly targeted, coupled with significant leakages, inefficient firms, deterioration in soil quality, environmental deterioration and health hazards. The fiscal issues are grave as around 8 per cent of agricultural income currently accrues to subsidies, and around 40 per cent of expenditure goes to fertilizer. It resulted in crowding out of public investment in the farm sector and overutilizing subsidized fertilizer, resulting in a low crop response ratio. A price mechanism is needed to rationalize the subsidy regime, particularly fertilizer. The direct benefit transfer might eliminate production inefficiencies. There is a time to re-design the policies.

Views are personal. Tarique is Professor, Dept. of Economics, AMU, Aligarh; Zafar is Assistant Professor, Presidency University, Bangaluru.