Forex & Fertiliser: Let the Market Decide (GS Paper 3, Economy)
Context: Fertilizer Subsidies and the Impact of Currency Depreciation
- The depreciation of the Indian rupee, from around 83.8 to 85.8-to-the-dollar between end-September and now, has introduced uncertainty for economic agents and policymakers, especially in sectors reliant on imports, like the fertiliser industry.
Impact on Commodities and Costing
Dollar-Rupee Exchange Dynamics
- For nearly two years, the rupee stayed in the 82-84 range, making pricing calculations relatively predictable.
- The current exchange rate of 85.8 introduces additional complexity, with pricing now influenced by both dollar-denominated costs and the fluctuating rupee exchange rate.
Rising Commodity Prices
- The surge in Brent crude prices to over $75/barrel has further strained fiscal calculations, increasing the cost of key imports, including fertilizers.
Fertiliser Industry
Impact on DAP (Di-Ammonium Phosphate)
- DAP, India’s second-most consumed fertiliser after urea, has seen its landed import price exceed $630/tonne.
- A depreciation of Rs 2-to-the-dollar raises the import cost by Rs 1,260/tonne, further increasing the financial burden.
Government and Industry Challenges
- Fertiliser companies are hesitant to import due to higher costs and uncertainty regarding the government’s stance on passing these costs to farmers.
- The government has maintained a maximum retail price (MRP) of Rs 27,000/tonne, which puts significant pressure on fiscal policy.
Government Subsidy Measures
- To alleviate the burden, the government extended a special subsidy of Rs 3,500/tonne for DAP for another year.
- However, this subsidy does not fully offset the increased costs resulting from rupee depreciation.
- The government faces a dilemma: either increase the MRP or absorb a higher fertiliser subsidy bill.
Economic Implications
Wake-Up Call for Key Stakeholders
- The rupee’s depreciation exposes vulnerabilities for both government and businesses with unhedged foreign currency exposures.
- An overvalued rupee previously made it easier for the government to keep imported fertiliser prices and fuel prices artificially low, benefitting farmers and consumers.
- It also allowed firms to borrow cheaply in dollars without hedging against currency risks.
Way Forward: Recommendations
Strengthen Domestic Supply Chains
- To reduce dependency on imports, companies must invest in domestic production capacities for fertilisers.
- A more self-reliant supply chain will help mitigate the impact of currency fluctuations.
Encourage Hedging Practices
- Businesses with foreign currency exposure should adopt hedging mechanisms to protect against exchange rate volatility and reduce risks associated with currency movements.
Gradual Market Liberalization
- Allowing market forces to play a larger role in setting fertiliser prices will gradually reduce fiscal burdens.
- This would help reflect true costs and ensure a more efficient pricing mechanism for critical inputs like fertilisers.
Subsidy Rationalization
- The government needs to re-evaluate its subsidy policies to ensure a balance between fiscal sustainability and consumer affordability.
- Reducing over-reliance on subsidies and encouraging a more market-driven approach would benefit both the economy and the agricultural sector in the long term.
Conclusion
- The rupee’s depreciation presents both challenges and opportunities.
- In the short term, it increases import costs and creates fiscal pressure, but it also serves as a crucial reminder for policymakers and businesses to adapt to changing global and domestic dynamics.
- Strengthening domestic production capabilities, reducing reliance on subsidies, and embracing a market-driven approach will help India navigate these challenges and ensure a more sustainable and resilient economy.
