Why is there such a big gap between what the government preaches, on the one hand, and the situation on the ground, on the other? In order to understand this, it is important to throw some light on the concept of subsidy. Briefly, subsidy arises because the Government of India directs manufacturers to sell urea - it is a statutory order - at a price farmers can afford. Currently, this is Rs 4,000 per tonne with effect from January 28, 1999.

The government also fixes distribution margins. Currently, this is a uniform Rs 130 per tonne on sale through institutional channels and Rs 150 per tonne on sale through private trade. Afterdeducting this from selling price, the producer gets an ex-factory realisation of Rs 3,850 to Rs 3,870 per tonne.

In a world of inflation and, in particular, the rising cost of hydrocarbons and other inputs, reasonable cost of production is substantially higher. This is fixed unit-wise on the basis of prescribed efficiency norms viz., 90 per cent capacity utilisation for a gas based ammonia/urea plant. Known as retention price (RP), it includes a margin of profit currently at 12 per cent post tax on net worth. The excess of RP over net-back from sales is reimbursed as subsidy to the manufacturer to ensure viability of supplies.

The cost of transporting urea from factory to the consumption point is also reimbursed separately as equated freight. This too is normatively determined on the basis of rational allocation plan under ECA, average lead of movement and optimum rail-road mix.

Left to themselves, manufacturers would have sold the material at a higher market-determined price. There would have been nosubsidy. However, since the government controls selling price at a low level to induce an increase in consumption and, in turn, production of foodgrains, subsidy is inevitable. Thus, fertiliser subsidy has an inextricable linkage with the goal of food security.

The subsidy rate i.e., rupees per tonne is RP plus freight minus net-back from sales. Apart from the latter, the former is also indirectly controlled by the government by way of control on prices of hydrocarbons and utilities viz., power and water and services i.e., the railway freight. Ever since the beginning of the eighties, these have progressively moved apart, leading to an increase in subsidy.

The selling price of urea increased from Rs 2,350 per tonne in 1980 to Rs 3,660 per tonne (prior to the January 28, 1999 hike). In sharp contrast, the ex-refinery price of naphtha increased from Rs 596.31 per tonne in 1980 to Rs 7,575 per tonne as of November 1998. While this alone would have increased the production cost by about Rs 4,900 per tonne,the increase in realisation from higher selling price was only Rs 1,310 per tonne.

An exercise done by the Fertiliser Association of India (FAI) in respect of 17 units - these account for about 50 per cent of the total urea production - shows that between 1990-91 and 1996-97, the increase in subsidy to them was Rs 535.63 crore. This is the net of gross increase in cost i.e., about Rs 1,416.20 crore minus the extra realisation from increase in selling price of Rs 780.57 crore.

Of the gross increase in cost, the contribution of increase in hydrocarbon prices, utilities and railway freight - all supplied by government agencies - alone was Rs 1,040.57 crore. Had there been no increase in these, far from any increase in subsidy, these units would have given to the exchequer an additional amount of Rs 505 crore.

In view of the above, fertiliser subsidy is not a net burden on the exchequer. It is a mere transfer from the budget head to revenues of agencies owned and controlled by it viz., IOC, ONGC, GAIL, OIL,CIL, SEBs, Railways etc. Rising fertiliser subsidy has also contributed to increasing surplus in the Oil Pool Account (OPA).

And yet, if, for whatever reasons, the government intends to reduce or even eliminate subsidy then, the only viable and practical option is to increase the selling price of urea in small doses on the hand and take appropriate steps to reduce the prices of hydrocarbons, utilities and services on the other.

The writer is Chief economist, The Fertiliser Association of India, New Delhi