By Afeena Ashfaque —

• Status: Incomplete – The Modi government announced in 2015 that it would continue the current fertilizer subsidy policy for another four years, demonstrating a lack of intent in tackling this reform
• Difficulty: High – With India’s farming community serving as an important political constituency, undertaking such a reform will be extremely difficult given the electoral considerations.

This is the twelfth installment in a series of articles on the Modi Reforms Scorecard by the staff and experts at the Wadhwani Chair in U.S.-India Policy. The series seeks to provide analysis on why reforms marked as “Incomplete” or “In Progress” have not been completed, and what impact such reforms could have on specific sectors or the economy at large.

The government in India is under pressure to improve its current fertilizer subsidy program because of concerns about its negative fiscal and environmental impacts. In an effort to avoid future electoral defeats, a likely path to reform which has been proposed is to scrap the current subsidy system in favor of a new program that would provide direct cash transfers into farmers’ bank accounts. However, as the government considers improving the current system or implementing the alternative proposal, it will need to reckon with two considerations: problems in implementation of the subsidies and India’s overburdened fiscal situation.

Implementation Issues

The distress in India’s agriculture sector has become a major political liability for the government in India. Farmers are being hard hit by input costs that are rising faster than the prices they get for their agricultural goods. Currently, the government attempts to help farmers by providing a complex system of agricultural subsidies for fertilizers, crop insurance, interest on farm loans, and other inputs. According to the State Bank of India, the central government’s most recent budget allocation for these programs totaled around $14.1 billion (Rs. 981 billion) – which is approximately 2.9 percent of India’s gross domestic product.

One key criticism of this program is that the fertilizer subsidy sends the wrong economic signals to fertilizer manufacturers, which are incentivized by the per-unit protections offered by the National Price Support system and shielded from real market competition. Insufficient government funds have also often caused delays in the payment of subsidies to manufacturers, further undermining their efficiency. Moreover, the government places no limits on how much subsidized fertilizer farmers can purchase, thereby encouraging the overuse of fertilizers with damaging effects on soil quality, ground water pollution and negative health impacts on farming communities.

As a result, the proposal to use direct benefit cash transfers has gained more traction among those seeking to reform this program. The basic idea behind the proposal is that by putting cash directly into the hands of farmers, India could cut the subsidies it currently gives to fertilizer manufacturers, and farmers could buy fertilizer from the manufacturers at market prices. Such market-oriented reforms would incentivize farmers to not overuse fertilizers and would make the entire system more cost-efficient.

However, this proposal, too, comes with its fair share of problems. One problem is ensuring that those who need the benefits receive it. Until now, not all farmers in India have yet received an Aadhar card, and the cards cannot guarantee that the cardholder is truly a farmer. Moreover,  landless farmers who comprise 56 percent of India’s rural households would be left out of the program. Another problem is with the efficacy of the direct benefit transfer. Direct transfers would not address the problem of fluctuating market prices for fertilizers, a key structural issue with the subsidy regime. Moreover, because fertilizer use varies from crop to crop, the direct cash transfers would have to be tailored to different crops and regions.

Fiscal Considerations

Another major issue with India’s fertilizer subsidy regime is the high cost of the current system. Expenditures for this subsidy program contribute significantly to India’s fiscal deficit, which currently exceeds its target of 3.3 percent of gross domestic product. Currently, the government is likely to exceed its fertilizer subsidy bill by $4.2 billion for this financial year. A rise in fertilizer prices on world markets and a fall in the value of the Indian rupee have also made imported fertilizers more expensive, lifting the total subsidy requirement for the year to $14.4 billion (1 trillion rupees), the highest ever recorded.

This has led to the Comptroller and Auditor General of India calling for action on the part of the government, noting in a recent report that the government is increasingly resorting to “off-budget financing.” Such “off-balance financing” includes asking state-owned banks to fund the subsidy gap, which doesn’t reflect on the deficit, but still presents major concerns about the fiscal implications. To continue funding this program, India will need to increase the tax base. However, this, too, remains a difficult and politically sensitive reform that will take an enormous amount of time and political will.

India’s current fertilizer subsidy program faces major criticism on two fronts: poor implementation and the impact on India’s fiscal deficit. As India considers how to reform and deregulate its fertilizer subsidy regime – either by improving the current system or undertaking direct benefit transfers, it will need to address both concerns. Short of that, this reform will remain incomplete.

Ms. Afeena Ashfaque is a Program Coordinator & Research Assistant with the Wadhwani Chair in U.S.-India Policy Studies at CSIS. Follow her on twitter @AfeenaAshfaque.