In a surprise move, the federal government withdrew subsidies on urea and DAP fertilizer

with immediate effect. The market, in a knee jerk reaction, sent the fertilizer stocks

plunging yesterday. Recall that the government had earlier earmarked subsidy to the tune of

Rs43 billion for urea, which was supposed to continue till the end of FY17.

Rs17 billion out of Rs42 billion was governments contribution in the form of cash subsidy

to manufacturers. An amount exceeding Rs20 billion was drawn from reduction in sales tax

from 17 percent to 5 percent. The sudden withdrawal has left many wondering, and the market

expects urea demand to nosedive, which could be a headache for local manufacturers already

faced with slow demand growth.

That said, it must be noted that of the allocated Rs17 billion in the form of cash subsidy,

two-thirds has already been exhausted. Our channel checks suggest urea off-take in December

stood around 0.9 million tonnes, which makes the 2HCY16 the highest ever urea off-take

period. In that light, the decision lacks wisdom, as just another Rs6 billion for 1HCY17 in

the form of direct cash subsidy would have done well. Yes, the government may well be

cash-strapped, but Rs6 billion, in the larger scheme of things, is not a seriously huge

amount.

There still remains ambiguity whether the government will also withdraw the sales tax

reduction. Ruhail Mohammed, CEO Engro Fertilizers, speaking to BR Research said that, We

have not revised our prices yet and we await more clarity on the GST matter. Be that as it

may, there will be some consequences for local players, but not necessarily for urea demand

in general.

The industry currently sits with huge inventory pile of urea, exceeding 1.5 million tons;

comfortably enough for another quarter, assuming nothing is imported or produced. The

governments own inventory is also believed to be nearing 0.5 million tons, and it has been

struggling to clear the same, as local players have been selling at discounts of late.

The move could well be aimed at clearing the current inventory pile, without hurting the

off-take significantly. International prices have of late surged to $250 per ton, and should

offer enough room for the local manufacturers to pass on some of the impact in case the

government pulls one of its import-stuffing levers.

So, while the off-take may slow down a bit, it should not drop to alarming levels, as the

first half of calendar years has traditionally seen muted buying. There are fears of

slowdown in off-take on anticipation of another package, but that scenario has more often

than not evened out things at the end. What is for sure is that the pricing power of local

players would again be tested, but rising commodity prices suggest it will not be as tough

this time around.

There are many who believe the government would keep the existing GST at 5 percent. Having

forgone around Rs13 billion in the 1HCY16 in lieu of reduced GST, Dar would dearly want some

of it back in the kitty. Nothing else explains the desperate call to withdraw subsidies all

of a sudden. Should the GST stay where it is, it would rather be an easy pass on for the

industry, without a hard-hitting impact on off-take.

The next big question is whether something else is coming up in the form of subsidies. There

is absolutely no question that Pakistan cannot expect the local farming industry to compete,

especially when the likes of India offer huge fertilizer subsidies. With commodity prices

rising, the need for subsidy will only grow.

Regardless of whenever the next subsidy mechanism is announced, the need is to do it

properly this time around. There is no denying that the farmer has benefitted even from the

current disbursement mechanism, but the current mechanism also reeks of protectionism. Why

should the government pay cash subsidy to local manufacturers, where the local players

themselves contribute only Rs50 per bag, against Rs156/bag cash subsidy from the government?

Pakistans fertilizer manufacturers have long enjoyed some of the highest profitability

margins in the region. The EBITDA and net profit margins in the past four years have

averaged 38 and 20 percent, respectively, for the big three companies. These are margins

unheard of, in the fertilizer industry across the globe.

Recall that some companies made merry when gas supply was low, and made windfall gains.

Should they not also bear some brunt when the chips are down? Here is hoping the government

would come up with a more targeted mechanism for fertilizer subsidy next time around, and

not seek to protect someones profits.

Copyright Business Recorder, 2017