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USAID Evaluation Highlights No. 54


Privatizing Fertilizer Distribution: Bangladesh Case Study


April 1996

(PN-ABS-524)



Summary


In the early 1980s USAID began to support development of private

agribusiness. Most programs concentrated on institutions that

support agribusiness, helping entrepreneurs with agroprocessing

and marketing, and aiding market development for agricultural

products. But programs in two countries--Bangladesh and Cameroon--adopted a narrower strategy: privatizing delivery of

agricultural inputs. The aim of the Bangladesh program was to

privatize fertilizer marketing and distribution to improve market

efficiency and promote entrepreneurship.


The program succeeded beyond expectations, even though direct

program assistance from USAID and the Bangladesh Government

reached proportionately few firms and did not address all the

problems agribusinesses face. Fertilizer is critical to rice

production (which accounts for 75 percent of agricultural output

in Bangladesh), and as soon as the subsector was privatized,

hundreds of firms emerged to import and distribute fertilizer.

More than 100,000 entrepreneurs entered the marketplace to meet

the immediate retail demand for fertilizer, dramatic evidence

that private firms can flourish, even without direct assistance,

when there is demand for what they are selling. 


The simple, consistent, strongly felt vision behind the program

was critical to its success. The USAID Mission was intent on

increasing the availability of fertilizer at a lower cost but had

no preconceived ideas about how this was to be achieved. USAID

was working with the International Fertilizer Distribution Center

(IFDC), however, whose team leader aimed to make fertilizer

distribution as efficient and market-responsive as possible. The

team leader also favored privatization. 


Several forces were working together. The Government of

Bangladesh was wrestling with severe budget problems and was

eager to reduce its subsidy programs. It also wanted to make

fertilizer more widely available, especially to rice farmers.

There was a growing consensus among technocrats to move away from

socialism toward free markets, and many donors were encouraging

economic liberalization. Tangible early results also strengthened

public commitment to the program.


Privatization of fertilizer marketing and distribution

significantly improved both employment and agricultural

production. A solid 45,000 jobs were created. The improved

fertilizer distribution system was an economic boon because it

was part of a full, economically viable technical package that

also included high-yielding rice varieties and improved

irrigation. (The seeds were available mainly because of

USAID-funded research in the 1960s, and the irrigation equipment

became available and affordable in the mid- to late-1980s because

of policy reforms supported by the World Bank and the Asian

Development Bank.) 


Cultivation of high-yielding varieties of paddy required 32.5

more person-days per hectare than did cultivation of the

traditional variety. It also improved efficiency and increased

farmer profits 35 percent. Production increased most dramatically

in the dry season. Smallholders especially benefited, as 61

percent of Bangladeshi farmers who use fertilizer own less than 1

hectare. As a result of the program, income increased $600

million a year for paddy production and $750 million a year for

all crops.


Those who received training, information, marketing advice, and

help in day-to-day problem solving were virtually unanimous in

praise and appreciation for USAID's technical assistance. But the

main reason the fertilizer distribution and marketing system

improved was that the policy environment improved. Even with

little or no direct assistance from program staff, private

businesses would have survived in the reformed fertilizer market.

The fertilizer distribution program offers strong evidence that

the private sector responds efficiently to undistorted open

markets.



Background


With per capita income of about $180 a year, Bangladesh is one of

the world's poorest countries. It is also one of the most densely

populated, with an average 2,087 people per square mile. Economic

growth since the mid-1970s has been steady but not spectacular.

Gross national product growth averaged about 4 percent a year

(nearly 2 percent per capita). 


Growth in agricultural production barely exceeded the 2 percent

population growth rate in the last decade. Still, the agriculture

sector accounts for 70 percent of all employment, 38 percent of

gross domestic product, and 9 percent of exports. Rice makes up

three fourths of farm output. 


Economic development was hampered by heavy-handed public

controls, among them an overvalued currency and government

control of key input and crop markets. Under the old marketing

system, in use since the 1960s, agricultural inputs--including

fertilizer, seeds, and irrigation equipment and services--were

procured and distributed by the state-owned Bangladesh

Agricultural Development Corporation (BADC). A national network

of appointed dealers handled retail sales. From 1962 to 1978,

fertilizer sales increased nearly 10-fold--from 73,000 tons to

720,000 tons--but the market was heavily controlled and

subsidized by the government. In recent years, in an effort to

reduce its subsidy programs, the government has decontrolled

markets for farm inputs and currency and privatized public

enterprises. This program was part of that move toward decontrol. 



USAID's Assistance Approach


Under the old marketing system, BADC had no incentive to cut

costs, and retailers, who operated on fixed commissions, were

limited in their ability to take advantage of changing markets.

Moreover, neither BADC nor retailers effectively promoted the use

of fertilizer. To address these problems, USAID and the

Bangladesh Government undertook two fertilizer distribution

improvement projects over a 16-year period: FDI-1, which began in

1978, and FDI-2, which began in 1987.


The goal of FDI-1 was to increase agricultural production (to 4

percent annual growth, and 6 percent for holdings of less than 1

hectare) by increasing the use of fertilizer (by 15 percent a

year generally, and 22 percent for holdings of less than 1

hectare). The thrust of FDI-1 was to replace the old marketing

system with a new one by liberalizing marketing policy, making

BADC more efficient and market-oriented, and strengthening the

role and effectiveness of private dealers. This was to be done

mainly by providing technical assistance to BADC under a contract

with the IFDC. 


FDI-1 is considered a major success. It halted increases in

BADC's distribution costs, privatized fertilizer distribution at

the retail level, and deregulated fertilizer retail prices.

Nonetheless, BADC operations and dealer policies needed

improving: Products were consistently in short supply, and BADC

had trouble shifting to a market orientation. Consequently, USAID

and the Bangladesh Government agreed to launch FDI-2. This

program concentrated less on strengthening BADC and more on

strengthening the role of the private sector.


There has been steady progress toward the government's full

disengagement from fertilizer distribution. This has been a

step-by-step process, essentially spearheaded by the Ministry of

Agriculture and eased by a sustained policy dialogue between

USAID and the Bangladesh Government. The FDI-2 technical team

also assisted by providing analysis and information to key

government officials, especially in the Ministry of Agriculture. 


FDI-1 removed BADC from retail sales without threatening the

organization's role in distribution. But allowing private dealers

to purchase in large quantities from a few BADC-owned "transport

discount points" was to be the first step toward privatizing

distribution. When private dealers quickly took advantage of the

opportunity, BADC recognized that its distribution network would

be reduced from 75 wholesale depots to about 10 transport

discount centers nationwide. Staff reacted by obstructing the use

of discount centers, forcing private wholesalers to continue

using the more widely dispersed wholesale depots. 


This attempted obstruction ultimately expedited privatization: In

1989, with private distributors unable to purchase from the

transport discount centers, the Minister of Agriculture decided

to allow private distributors to bypass them and purchase

directly from factories and ports. BADC's only remaining role,

then, was to import fertilizer. By 1992-93, however, fertilizer

imports too had been fully privatized.


Program Achievements


As a result of FDI-1 and FDI-2, fertilizer distribution in

Bangladesh improved considerably. The program fulfilled its main

objectives:


1. Liberalizing and privatizing the fertilizer market. In 1978,

when FDI-1 started, the entire fertilizer distribution system was

government controlled from port and factory to the consumer. BADC

distributed all fertilizer through a network of 20,000 private

retailers it appointed and permitted to sell at set prices and

locations. By 1992 the government was completely disengaged from

the fertilizer market, prices were decontrolled, and fertilizer

subsidies had ended.


2. Increasing the number and effectiveness of private fertilizer

importers, distributors, and dealers. In 1978 BADC sold 720,000

tons of fertilizer to 20,000 BADC-appointed private dealers who

were allowed to sell only within prescribed areas and at set

prices. By 1985, 5,000 wholesalers, which sold to about 12

retailers each, had replaced the 20,000 private dealers. Today

10,000 wholesalers serve more than 100,000 retailers.


3. Making the fertilizer market more efficient. The privatized

system is more responsive to markets and customer needs, and

prices are intensely competitive. Distributors make timely,

reliable deliveries, provide good dealer service, and anticipate

farmers' needs and demands. Competition is strong all along the

marketing chain and in every part of the country. Margins are

small, and distributors and dealers constantly seek ways to

minimize costs. As a result of this more efficient marketing

system, costs to farmers are considerably lower.




Economic Impact


FDI's effect on the economy stemmed almost entirely from its

influence on fertilizer use, which has increased agricultural

production, rural incomes, and food self-sufficiency. In the

decade before FDI started, growth in fertilizer sales (an average

9.4 percent a year) was achieved mainly through government

subsidies, which covered roughly 65 percent of the cost. By 1978,

when FDI-1 started, the subsidy was unsustainable, and donors and

the government generally agreed the subsidy had to be reduced if

not eliminated. Moreover, fertilizer costs (including marketing

costs) were increasing rapidly, and the fertilizers farmers

needed were often in short supply. 


While the subsidy was being eliminated and as marketing costs

fell, the price of fertilizer as a share of the price of rice

actually declined slightly. As costs fell and distribution and

marketing improved, fertilizer sales nearly tripled--from 750,000

tons in 1978 to 2.3 million tons in 1993.


Rice production is now about 5 million tons greater than it would

have been if fertilizer use had not increased during the 1980s.

Rice prices would have risen, and Bangladesh would still be a

major rice importer. As a result of increased use of fertilizer,

in the decade 1973-82 rice production grew 42 percent (10 percent

by area and 26 percent by yield). In the following decade

(corresponding roughly with the FDI program), production

increased 30 percent (3 percent by area and 26 percent by yield).

The price of rice fell steadily from 1970 on, and in 1992-93

Bangladesh became self-sufficient in rice.


The main rice crop is aman, which coincides with the late monsoon

period. This season accounts for more than half of total rice

production. Production increases for aman rice have come almost

entirely from the increased use of high-yield varieties and

fertilizer. Without fertilizer, high-yield varieties produce

little more than local varieties. The availability of fertilizer

allowed farmers to increase cropland planted in high-yield

varieties from 4 percent of total cultivated area in 1980 to 40

percent in 1993. If fertilizer use had leveled off at 1 million

tons (a distinct possibility under BADC), aman production would

have been about 8 million tons instead of the current 9.7 million

tons.


But the most dramatic growth has occurred in boro (dry season)

production--averaging 6.4 percent a year during the life of the

program. In the 5 years ending in 1985, production grew 10

percent a year, and in the 5 years after that, 9 percent a year.

Boro rice depends almost entirely on irrigation, the high cost of

which dictates that farmers get maximum yields. For the boro

season, the key factor in fertilizer use is availability, not

price. Had fertilizer availability remained at the 1-million-ton

level, boro production in 1992-93 would probably have been 3.5

million tons instead of the 6.5 million tons it was. 


Farm budget studies conducted under FDI-2 indicate that every

year 173,000 more person-years are used in producing aman paddy,

and 530,000 more person-years are used in producing boro paddy.

Additional returns to land and draft animals during the boro

season have a value of about $190 million. And farms using the

high-yield variety technical package as a result of the FDI

program are generating increased profits of about $288 million a

year. Increased income from rice production is about $600 million

a year (from all crops, more than $750 million a year). That

translates into about 1.7 million new farm-level full-time

equivalents. (An equivalent is 240 8-hour days.) 


Ultimately, outlays for FDI-1 and FDI-2 were $222 million and $66

million, respectively. The program succeeded in privatizing

fertilizer marketing and producing substantial efficiency gains

for the country (see box). Was the program worthwhile in terms of

costs and benefits? USAID analysts calculate an internal rate of

return of 12 percent and a net present value of $44 million

(based on a 10 percent discount rate), even with a full

accounting of costs. But it is probably inappropriate to include

all project costs, because 60 percent of the budget went to

fertilizer imports that generated funds to support general

government spending. Excluding the cost of fertilizer imports,

the internal rate of return is 21 percent and the estimated net

present value is $160 million. By any standards, these are

respectable returns on investment. 


Social Impact


With privatization of fertilizer distribution, 45,000 jobs were

created in agricultural input supplies. (Although data were not

available, the proportion of women employed was undoubtedly low

because of cultural and economic barriers to their employment.)


But the main effects were on farms. High-yield variety paddy

required 32.5 more person-days per hectare than the traditional

variety (grown mostly during the rainy season). About 2 million

additional hectares in the rainy season and 1.7 million more in

the dry season were under production under the high-yielding

technical package (including seeds, irrigation, and fertilizer). 


Smallholders have especially benefited. Use of fertilizer

increases as the size of the farm drops, and in Bangladesh, 61

percent of farmers who used fertilizer owned less than 1 hectare.


Not only has the price of rice dropped over time--about 30

percent in real terms from 1972-1992--but rice prices have also

become more stable because of increased production during the dry

season. The drop in prices has increased the real incomes of the

poorest segments of the population, who now spend proportionately

less on rice. According to a recent IFDC survey, when the price

of rice drops 20 percent, 10 million people move from inadequate

to adequate daily caloric intake. The same survey found that the

extra real income is spent on nutrition. Consumption of meat has

increased 75 percent, adult body weight has increased measurably,

and the number of malnourished children has declined.



Findings 


USAID efforts succeeded in privatizing the supply, marketing, and

distribution of inputs. The success of the intervention was

attributable partly to the simple, consistent, and strongly felt

vision underlying the program. That vision provided the framework

for a step-by-step process that was implemented over 16 years.

Although the program was ideologically driven to some extent (in

USAID as well as in IFDC), the underlying objective was always to

identify changes in fertilizer policies that would increase the

availability and reduce the delivered cost of fertilizer. Without

this emphasis, and without strong pressure to liberalize the

economy, BADC and its supporters might have prevented the

termination of subsidies and the privatization of fertilizer

distribution and marketing.


USAID ultimately aimed to dismantle rather than strengthen BADC,

but it did so by stages, first downsizing the BADC operation and

then relieving BADC of its responsibility for fertilizer

distribution. The political commitment of the United States and

the Bangladesh Government, and a focused intervention strategy

contributed to the success of the intervention. So did

Bangladesh's firm assurance--designed to reduce labor resistance--that BADC employees would not lose their jobs.


It might seem incongruous that FDI-1 aimed to strengthen

fertilizer distribution through BADC and that FDI-2 aimed to

eliminate BADC from fertilizer distribution, but, as a practical

matter, increasing BADC's effectiveness was a necessary step in

privatization. One reason for the program's success was the

priority put on demonstrating the effects of policy changes at

every stage of reform. Successful pioneering firms set examples

others could follow, and first-comer firms developed expertise

they later shared with latecomers; indeed, some new businesses

were established by former employees of pioneering firms. BADC

could not have been removed from fertilizer distribution if the

program had not first shown conclusively that the private sector

would be able to distribute fertilizer more effectively and

inexpensively.


A key program component was technical assistance to the

government in fertilizer marketing policy. As issues surfaced,

the IFDC provided data and analysis and brought in experts from

the United States to provide the government with the most

complete and accurate information possible. Changes were made

only when government decision-makers understood and supported

them. One key to the program's success was its reliance on data,

analysis, and demonstrated results, rather than on USAID-imposed

conditions. The fertilizer privatization strategy was not only

focused, but also empirically grounded in a realistic assessment

of obstacles to the growth of agribusiness. As a senior

government official put it, "The reform process was not slow, it

was gradual, and that is what ensured its acceptability." 


An economically viable technical package made fertilizer use

profitable, especially combined with irrigation and high-yielding

rice varieties. Farm households that used fertilizer to grow

high-yielding rice in the aman season earned 40 percent more per

hectare than households that grew traditional varieties without

fertilizer. Incentives were even greater in the boro season. When

the distribution of irrigation equipment was liberalized, the

irrigated area in the dry season increased dramatically. But the

cost of irrigation was so high that without ensured access to

fertilizer, the investment would not have been profitable.

Availability of the full technical package was ess