The nutrient-based subsidy (NBS) regime has worked favourably for the industry and the Union Government in the past couple of years. However, it is time now to enhance the benefits of NBS and extend it to urea. Progress on balanced soil nutrition will be tangible only after urea is decontrolled.

In the NBS regime, the subsidy amount is fixed. Manufacturers are, therefore, more vulnerable to fluctuations in raw-material prices and foreign-exchange (forex) rates. However, NBS also gives manufacturers the flexibility to adjust retail prices to reflect market dynamics. The sharp depreciation in the rupee from September 2011 onwards and escalation in international prices of key raw materials have caused the cost of production to increase by more than 65 per cent in 2011-12 (chart 1). Manufacturers, therefore, had to hike prices significantly and pass on increased landed costs of raw materials to farmers. Efficient manufacturers have benefited from raw-material linkages and their ability to alter product mix, as they have substituted di-ammonium phosphate (DAP), which is in short supply, with other nitrogen-phosphorus-potassium (NPK) fertilisers.

Skewed consumption

The NBS has also aided the Government in containing its subsidy bill and in improving its fiscal planning and management. Crisil estimates that the Government saved Rs 12,000-15,000 crore in 2011-12 on its subsidy bill of complex fertilisers due to the NBS regime. While the subsidy outgo on urea increased by 55 per cent, that for P and K fertilisers declined by 11 per cent.

Balanced soil nutrition, a desired objective of the Government when NBS was introduced, is, however, yet to be fully achieved. Control on the price of urea continues to distort the consumption equilibrium. The ideal NPK ratio for India is 4:2:1. Urea prices have remained unchanged at Rs 5,310 a tonne — the token hike of Rs 50 a tonne announced recently falls way short of the required increase — distorting fertiliser consumption patterns in the country.

With prices of DAP and other NPK fertilisers rising significantly, the gap between prices of urea and other fertilisers has widened. High consumption of urea, which provides nitrogen to the soil, skews the nutrition ratio unfavourably and reduces crop responsiveness to fertilisers. The nutrition imbalance was amplified in financial year 2011-12 when consumption of urea continued to grow at about 4 per cent, but that of P and K fertilisers was arrested. One would, therefore, believe that the next step for reform in the fertiliser sector — to bring urea under a market-driven pricing regime and spur balanced soil nutrition — is overdue.

Deficient monsoon

For 2012-13, the Centre has reduced subsidy on N and K nutrients by around 10 per cent, while subsidy on P was slashed by over 32 per cent.

The new rates provide an incentive to manufacturers to produce fertilisers with less phosphate, including single super phosphate (SSP), and also help the Government in containing the subsidy bill. In the post-NBS period, the growth of use of NPK fertilisers and SSP have outpaced that of DAP. NPK fertilisers’ use grew at 18 per cent and 12 per cent in 2010-11 and 2011-12 respectively. DAP use grew at a lower rate, and even dropped by 3 per cent in 2011-12.

The trend is likely to continue under the NBS regime, with NPK fertilisers being the main drivers of growth. Overall fertiliser demand in 2012-13 will depend on the monsoon, which by most estimates has been deficient in parts of the country. Because of the deficient monsoon, kharif production may fall. More rains in the remainder of the season may, however, extend the sowing period and support the rabi crop. The complex-fertiliser manufacturers in Crisil’s ‘high safety’ and ‘adequate safety’ categories are likely to maintain their profitability over the medium term because of their pricing power and strong operating efficiencies. Prices of a few raw materials have already dropped. Taking a cue from the Government’s subsidy rates for 2012-13, new contracts are being re-negotiated at lower rates, but the depreciating rupee remains the key determinant of price trend and profitability.

New capacities

The capital expenditure for setting up new capacities in the complex fertiliser industry is low. Incremental debt contracted by manufacturers will, therefore, remain under control. Complex players will, however, look to acquire strategic assets and forge alliances that enhance their access to competitively priced raw material. For working capital, subsidy payments from the Government were on time up to November, but were delayed in the second half of the financial year 2012 resulting in higher short-term borrowings as on March 31. This delay occurred because the Government had exhausted its entire fertiliser subsidy budget by November — budgeting was based on subsidy rates announced in February 2011 that were later revised up in May 2011.

Moreover, after a long hiatus, manufacturers sold fertilisers on credit to farmers, resulting in build-up of receivables from farmers as on March 31. Even though subsidy receipts from the Government were delayed in the second half of 2011-12, manufacturers’ dependence on the Government for revenue collection will reduce further, improving cash collection cycle. Crisil believes that NBS will begin to yield benefits such as improved discipline in subsidy dispensation. Thus, the capital structure of complex-fertiliser players rated ‘high safety’ and ‘adequate safety’ will remain steady in 2012-13, supporting their credit-risk profiles.

(The author is Director, CRISIL Ratings,)

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