The Indian fertiliser industry – particularly urea – is at a crossroads.

It has been unable to make up its mind whether any gas price hike will spell doom for the industry or whether it will not really matter at all because all input costs are 'pass-throughs'. The government pays the bill for all additional costs over and above what the farmer or the end consumer is willing to pay.

Linked to the gas pricing issue is the one related to the conversion of existing naphtha-based urea plants to gas-based manufacturing facilities. Will it make sense to opt for conversion if the gas prices climb very high? Moreover, does it make sense to import cheaper fertilisers instead of producing expensive fertilisers within India? .

Finally, there is the issue of subsidies itself. The fertiliser subsidy is already quite high at Rs 67,970 crore. If the additional gas price of $4 per million British thermal unit (mmBtu) is implemented, it will mean an additional cost of Rs 38,848 crore (see table). (http://www.dnaindia.com/money/1858455/report-policy-watch-is-govt-taking-refuge-in-poison-pillpolicy). This could bring the total subsidy bill for fertilisers to a mind-boggling Rs 104,818 crore per annum. Does paying such a subsidy amount make sense?

To understand all this, it makes sense to first take a look at the current market situation. As of March 2012, India's fertiliser production stood at 120 lakh tonne, of which the private sector accounted for a share of 54% (see table).

But India still falls short of fertiliser it requires, and thus has to resort to imports (see chart). And according to the data presented before the Rajya Sabha in February this year, India imported around 68 lakh tonne of urea. The average cost of import was $282.77 a tonne or Rs 16,766.

"But these prices don't mean anything," says R Mukundan, managing director, Tata Chemicals, because India is the second-largest consumer of fertilisers in the world, and the largest importer. The sheer volumes imported make India the import price setter. If India and China were to go to the global markets together, fertiliser import prices could double or even triple. And if India were to abandon domestic production of urea, the country would be at the mercy of international traders. If India has to have fertiliser security, it must produce at least two-thirds of the urea it needs.

The other thing is that the biggest bang for the buck in terms of gas use will always come from fertilisers. This is because while gas used for power generation only burns up the fuel and releases carbon into the atmosphere, gas used for urea traps carbon as nutrient in the soil. The value one gets from gas converted into fertiliser is a lot more than gas used as a fuel.

But then, India does not have enough gas (see table). So what should India do?

If the budget wishes to address all these issues, it must do three things.

First, it must adopt a nutrient-based subsidy regime, so that each farmer gets fertiliser only to the extent that his fields and his plants require urea, phosphates and potash. But this will mean having soil cards for each land holding just as Gujarat has done. It will also require promoting micro-irrigation with farmer extension services, so that fertiliser (and pesticide) gets dropped only at the root of the plant, and is not sprinkled on the remaining soil which can lead to degradation of the soil (as has happened in Punjab). Judicious fertiliser consumption will reduce volumes consumed, and hence lower the subsidy bill, even while boosting farm output.

Second, the government must immediately enter into discussions with gas producing countries where gas is available for under $4-6 per mmBtu, and produce urea there with a buyback clause. This can only be achieved through a government-to-government negotiations.

Third, all subsidies to fertiliser producers must be incentivised on the basis of their manufacturing plant efficiencies. For instance, some Indian urea producers use 22 mmBtu to produce one tonne of urea while the norm overseas is 20 mmBtu. Unless this is done, India will pay subsidies for inefficiency.

If the budget addresses all the three concerns, it could go a long way towards bringing in greater efficiency in the fertiliser industry and also reduce the subsidy bill. Most importantly, it will bring greater prosperity to the farmer.

It remains to be seen what the budget provisions actually provide.