Explainer: How the new urea policy tackles currency risk

l What does the new policy seek to achieve?

THE NATIONAL INVESTMENT Policy for Urea—2026 seeks to attract investment in eight or nine gas-based plants with combined capacity of around 10 million tonne annually. India consumes nearly 40 million tonne of urea but produces close to 30 million tonne, leaving imports to bridge the gap. The proposed capacity could, thus, make the country broadly self-sufficient, although actual output, plant utilisation and demand growth will determine the final balance.

The policy replaces the investment framework introduced in 2012, whose investment window closed in October 2019. India currently has 33 operational urea units with installed capacity of 26.94 million tonne; six plants were added over the past decade. Apart from reducing import dependence, additional domestic capacity could improve supply security during wars, shipping disruptions or fertiliser shortages. However, gas-based production does not eliminate external vulnerability: plants may still depend on imported LNG, exposing production costs to international gas prices, exchange-rate movements and disruptions to major shipping routes.

l  How does NIPU-2026 change the pricing & returns framework?

UREA IS SOLD to farmers at a controlled price. Manufacturers are compensated through subsidies based on approved costs. The investment policy must, thus, provide investors a reasonable return without creating an open-ended liability for the exchequer. NIPU-2026 separates fixed (investment in the plant and associated capital charges) and variable costs (gas and other expenses that change with production).

The policy reportedly offers a minimum return on equity of 12% and caps it at 16%, limiting both downside risk for investors and excessive returns at taxpayers’ expense. The government estimates that the revised framework will save more than Rs 250 crore for each plant compared with projects approved under the 2012 policy. Its success will depend on whether the assured return is sufficient to attract investment when construction costs, imported equipment, financing expenses and gas-price risks remain high.

l  Why there’s forex risk in a domestic plant

BUILDING A MODERN plant may require imported machinery, licences, engineering services, licences and technology. A firm may need to borrow foreign currency. A depreciation of the rupee raises the domestic-currency value of these costs. Suppose imported equipment costs $500 million. At Rs 80 to the dollar, its rupee value is Rs 4,000 crore; at Rs 90, it becomes Rs 4,500 crore—an increase of Rs 500 crore without any change in the dollar price.

If the pricing formula does not recognise this movement, the investor’s recoverable fixed cost and expected return may be eroded. If every subsequent currency movement is passed through indefinitely, however, the government’s subsidy liability becomes unpredictable. NIPU-2026 seeks a middle path: it allows exchange-rate movements to be reflect-ed during the initial period and then converts the recognised fixed-cost base permanently into rupees after four years.

l  How converting fixed costs into rupees after four years will help

CONSIDER A PLANT with a recognised foreign-currency-linked fixed cost of $100 million. At commissioning, when the exchange rate is Rs 80 a dollar, this equals Rs 800 crore. If the rupee falls to Rs 90 over the following four years, the rupee value rises to Rs 900 crore. Under the new mechanism, the fixed cost will be converted at that rate and locked in at Rs 900 crore for pricing purposes.

If the rupee further falls to Rs 95, the recognised cost would not rise to Rs 950 crore; if it strengthens to Rs 85, it would not fall to Rs 850 crore. This gives the investor and the government a predictable rupee cost base after the fourth year. Importantly, this is a regulatory conversion, not necessarily a financial hedge. If the firm still owes a dollar-denominated loan, it must service that loan at the actual exchange rate. The policy protects the cost recognised in urea pricing; it does not automatically extinguish the firm’s underlying currency exposure.

l  Who benefits and what risks remain?

INVESTORS GAIN GREATER certainty because currency movements during the initial stabilisation period can be captured before the fixed-cost base is frozen. Lenders may find projects easier to finance when future rupee revenues and recognised costs are more predict-able. The government benefits because its exposure to exchange-rate escalation does not persist throughout the plant’s life. Using our example, if the rupee later falls from Rs 90 to Rs 100, the recognised fixed cost remains Rs 900 crore, limiting the subsidy burden.

The trade-off is that the plant owner may bear any mismatch between the locked-in sum and actual foreign-currency repayments after year four. Companies will still need hedging, rupee loans or carefully matched debt maturities. Much will depend on the detailed guidelines: the exchange-rate reference date, currency used, eligible cost components, treatment of refinancing and whether four years are counted from approval, financial closure, commissioning or commercial production. These details will determine the protection’s real value.