Key determinants of Sri Lanka’s fertiliser subsidy: Some research findings for policymakers

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By Chatura Rodrigo – Research Economist, IPS As in many developing countries, fertiliser subsidies represent a major component of agricultural policy in Sri Lanka. This is particularly true of the paddy sector. With rice being the staple food in Sri Lanka, successive governments have provided significant fertiliser subsidies for paddy with the primary aim of the paddy production. Paddy cultivation is a major source of livelihood in Sri Lanka – Pic by Sameera Wijesinghe     Since 2005, the fertiliser subsidy has accounted for 2-2.5% of total government expenditure and the subsidy is given for all three major fertilisers (Urea, Murate of Potash – MoP, and Triple Super Phosphate - TSP). Over the years, the subsidy has significantly contributed to increasing paddy production, stabilising the milled rice price and helping the country attain self-sufficiency in rice. However, there are questions over the effectiveness and sustainability of the program because of concerns around the overuse of subsidised fertiliser and its use for crops other than paddy. The excessive use of fertiliser has also raised concerns over soil and water pollution, food safety and the burden on the national budget. In response to these concerns, especially the burden on the Budget, the Government of Sri Lanka reduced the fertiliser subsidy by 25% in the 2013 Budget. It further aimed to encourage farmers to adopt organic fertiliser. However, paddy farmers complained to the Government that they are not in a position to shift to organic fertiliser within a short time and announced a possible price hike for rice. After the reduction in the fertiliser subsidy and the consequent price hike, paddy production declined as farmers did not cultivate to their full extent. In response, the Government revised their decision in 2014 by reducing the subsidy by only 10% instead of the original 25%. This shows the inconsistency in recent agricultural policies and calls for better evidence-based policymaking.   Paddy – A mainstay Paddy cultivation is a major source of livelihood in Sri Lanka, providing more than 1.8 million people with employment opportunities. So, in terms of food security and rural employment, the Government is under constant pressure to continue with the subsidy scheme. Furthermore, the subsidy has become a politically-sensitive issue, since paddy farmers make up a high share of the voter base. This is very common in most developing countries. However, a sufficient and effective decision on the reduction of the subsidy is not possible without a clear understanding of the factors that determine the demand for fertiliser.   A new study There are several studies in Sri Lankathat have examined the factors that determine the demand for fertiliser in paddy cultivation. However, these have failed to consider recent data that capture the fertiliser subsidy implemented since 2005; they only take into account a handful of variables that determine the demand for fertiliser. Moreover, data on fertiliser use in Sri Lanka needs to be studied considering the two main paddy-harvesting seasons. In order to address these limitations, a new study by IPS uses panel data regressions in fixed and random effects scenarios to investigate the factors that affect fertiliser demand in the major paddy producing areas of Sri Lanka between 1990 and 2011. This study uses fertiliser consumption, prices and cost of cultivation data published by the Department of Agriculture.   Significant findings Estimation results suggest that the price of fertiliser, price of seed paddy, price of labour, quantity of paddy output, cost of materials, cost of pest management, provision of fertiliser subsidy and whether the paddy cultivation is commercial or not, all have significant implications on the demand for fertiliser. However, the use of machinery - which represents the degree of mechanisation in paddy farming - does not have a significant impact on the demand for fertiliser. The demand for fertiliser decreased as the price of fertiliser and the price of seed paddy increased. However, the increases were relatively inelastic. Both fertiliser and seed paddy do not have close substitutes. Even though organic fertiliser can be used in place of chemical fertiliser, it is not widely practiced in Sri Lanka and commercial paddy farming is predominantly based on chemical fertilisers. Therefore, simply reducing the fertiliser subsidy would not encourage farmers to adopt organic fertiliser. Adoption of organic fertiliser in the short run may hinder production unless farmers are compensated for possible yield reductions. The demand for fertiliser increases as the price of labour increases which could possibly be explained by the labour scarcity. An increase in the cost of materials (mainly the cost for weed management) pushes farmers to use more fertiliser while an increase in the cost of pest management reduced the demand for fertiliser. On average, farmers use more fertiliser when the fertiliser subsidy is provided. But the increase in demand, under the subsidy, is significantly smaller. Finally, the study finds that more fertiliser is demanded by commercial paddy cultivating areas.   Policy recommendations This study proposes several major policy recommendations based on three major outcomes: self-sufficiency in the production of rice; prevention of the overuse of chemical fertiliser and the gradual removal of the fertiliser subsidy. The relatively inelastic relationship between the price of and demand for fertiliser, the limited availability of organic fertiliser and the possible yield drops with organic fertiliser use all create issues in the adoption of organic fertiliser among Sri Lankan paddy farmers. Therefore, the objective of promoting organic fertiliser requires farmer support programs to ensure supply of fertiliser as well as possible production cuts. The price of seed paddy has a significant impact in sustaining paddy production in Sri Lanka. While increasing the seed price would reduce the farmers’ incentive to overuse fertiliser, this might actually limit farmers’ full production potential. Therefore measures are needed to stabilise prices of seed paddy. This study recommends that in order to reduce the overuse of the fertiliser, the price of labour needs to be stabilised and there should be measures to reduce the cost of weedicides. Labour is becoming scarcer in paddy farming. There is an out-migration of labour and the farm workforce is ageing. Therefore, farmers who depend on hired labour would want to make the best out of what they spend and thus apply more fertiliser when the labour is employed. This could potentially lead to an overuse of fertiliser. Mechanisation has the potential to reduce this overuse while simultaneously tackling the labour constraint. Mechanisation was significant in reducing the demand for fertiliser until 2005. However, since then the price of labour has become a more significant factor in determining fertiliser demand.   Way forward Undoubtedly, the fertiliser subsidy has greatly influenced the increase in paddy production and contributed to achieving rice self-sufficiency in Sri Lanka. However, this study recommends the gradual removal of the fertiliser subsidy in the long-run, in a phased manner. The short-run reduction of the fertiliser subsidy can be done for non-commercial paddy producing areas since their fertiliser usage is low. Organic paddy farming is ideal for these areas. While the fertiliser subsidy is more important to commercial paddy producing areas, the amount of subsidy given to them can be reduced in several stages by gradually introducing organic fertiliser. Yet, for that to happen, farmer awareness and willingness needs to be heightened, while the necessary supply chain is developed as well. The removal of the fertiliser subsidy in the long run will provide room for the establishment of local fertiliser markets, reduction of negative environmental externalities and a decreased burden on public finances. Additionally, it will encourage the growth of cultivation and consumption of organic foods.   (Chatura Rodrigo is a Research Economist at the IPS. He wrote this article as part of the Australian Awards Fellowship Program, coordinated by Monash University, Australia, and funded by the Department of Foreign Trade and Investments, Australia. To comment on this article and view references, visit ‘Talking Economics’