The centrepiece of the government's fertiliser pricing policy is the Retention Pricing Scheme (RPS), whose objectives are to stimulate consumption of fertilisers, while promoting the growth of the domestic fertiliser industry and enabling indigenous fertiliser producers to earn a reasonable return on investment.Under the RPS, a fair ex-factory price -- commonly referred to as the retention price (RP) -- is set. The RP is fixed to enable the reasonable costs of production to be recovered, subject to prescribed efficiency norms regarding capacity utilisation and consumption of raw material and utilities.
The retention price is the sum of the reasonable costs of production plus a margin of profit--currently set at 12 per cent of net worth, on a post-tax basis. For the purpose of price fixation, the 12 per cent figure is grossed up, based on the corporate tax rate prevailing. Thus, with the corporate tax rate currently at 35 per cent, the corresponding pre-tax return built into the RP is 18.46 per cent. Incidentally, the prescribed 12 per cent return, fixed way back in 1977 when the RPS was introduced, remains unchanged to this day.
The reasonable cost of production varies from unit to unit, since it is a function of how old the plant is, its location, the technology used, feedstock, as also factors such as historical investment costs and the financing pattern. Hence, each unit is allowed a RP specific to it. Currently, there are 34 RPs, one for each of the urea producing plants in the country.
Urea is sold to farmers at a uniform price, currently at Rs 3,660 per tonne. This is, however, subject to local taxes. Every state government is free to decide whether to tax fertiliser sales or not, and also the rate of tax applicable.
The RPS has achieved its broad objectives. Its umbrella has fostered growth in installed capacity, production and consumption, all flowing through into higher foodgrains production to meet the demands of a growing population. Even so, with the passage of time, some cracks have started to show in the RPS.
Under the RPS the reasonable costs of production are reimbursed. Initially, when the RPS was introduced, the intention was to fix a common norm across a group of plants. However, as it stands, the focus is more on a plant-specific norm. Thus, even if one unit uses energy more efficiently than another, each unit is compensated on the basis of its actual consumption, rather than a standard norm. As a result, there is little incentive to force improvements in efficiency. In fixing the retention price, capital related charges (CRC) are allowed on the basis of the actual investment and financing pattern, subject to certain disallowances such as escalation arising from time and cost overruns. However, this approach is flawed. In the absence of a capital cost benchmark, there is little incentive to cut project costs. The RPS involves the exercise of discretionary powers, and these can have a significant economic impact.
Often, the differences in the RP between different units cannot be explained adequately only on the basis of variances in the underlying factors such as feedstock costs and age of the plant. Compounding the fog is the general absence of transparency in implementing the scheme.
Under the RPS, old units are at a serious disadvantage vis-a-vis new units, because pricing on a historical cost basis results in lower returns for the older, depreciated plants, which have a lower net worth. Stepping up capacity utilisation does not bring about any appreciable increase in profitability because, unlike in the case of new units, capital related charges are low for old units. This works against the imperative of modernising older plants, if they are to continue operating at optimal levels. Revamping the older plants involves heavy investments at current costs.
Thus the Catch 22 situation: capital is hard to come by; the RPs effectively constrains the internal generation of funds; and this, in turn, shuts off the flow of external resources. The fertiliser industry has, for long, maintained that it be insulated from generalised increases in the prices of key inputs such as feedstock, fuel, power and railway freight. But this has rarely happened and, in the 1990's never. The government, by allowing frequent price increases for fertiliser inputs is, in effect, robbing itself.
Given the distortions built up over the years, the RPS needs to be revamped so as to provide a greater role for incentives. This alone can help to reduce capital costs, improve operating efficiencies and increase output.
(Deepak Mehta is an economist; NL Jain is president with Indo-Gulf Fertilisers and Chemicals Corporation)
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
