Thursday, November 29, 2012


This question has come to fore after ONGC's overseas arm, ONGC Videsh (OVL), purchased 8.4% of the giant Kashagan oil field in Kazakhstan for $5 billion in a deal which is for the span of 25 years. Located in the north Caspian Sea, this is the world's largest oil discovery since 1968, with reserves estimated to be as high as 30 billion barrels.  Let’s look at some other major countries for comparison. China prefers acquiring assets; Japan opts buying oil, instead. India opts for both. So now lets look at both cases. With crude prices at $100 per barrel, OVL will recover the full value of its investment in a little more than six years. If prices fall, it will take longer. Thus this deal might not be good in near term. This Kashagan oil field is estimated to have very high capacity and output capacity of 3mn barrels/day. Keeping this factor it looks quite a lucrative deal in long term but, if it turns out to be a disaster similar to its $2-billion deal to buy Russia's Imperial Energy it would dent the comapny and the country very badly as OVL has exhausted all its reserves in this deal. But the Kashagan deal is unlikely to suffer the same fate because of its huge estimated capacity. One more fear was that it might be difficult to transport this oil to India but this fear is warded off as this output can be swapped with any other seller worldwide. Thus this recent buying spree may be good to secure energy sources for the country and meet its long-term production goals. The other side of discussion i.e. importing oil cannot be declined this easily. Experience shows that functional oil markets offer security, with some reserves thrown in and oil markets functioned even during the two Gulf wars. It is completely the government’s policies whether it wants to stick to importing or go for buying fields. So is it right to buy fields or import oil?

Tuesday, November 20, 2012

India Inc.'s Dilemma

The recent news regarding the latest tussle between the insurance regulator IRDA and the finance ministry shows some signs of desperation on the side of the ministry to meet the disinvestment target. The finance ministry expects to raise Rs. 30,000 crore through the sale of government stakes in state owned companies.However this target seems to be far from being achieved.
The main reason for this type of disinvestment is the rising fiscal deficit which has to be reduced if India does not want to be in trouble.

 The recent 2G auctions have also left the government concerned about meeting the target of reducing the fiscal deficit to 5.3% of India's GDP. The estimated revenues from the auction were Rs.40,000 crore however the auctions were able to raise only Rs.9,400 crore.

With this two problems in front of GoI it is obvious for them to get worried and hence they do not want to take any risks. So they have now decided to allow LIC , India's largest insurer to invest in buying stakes of listed companies up to 25% (up from 10% previously). This decision might be a bane because it might increase LIC's exposure to risk and thus investor's money might be at risk. So IRDA is opposing this.

Whether this decision is useful or like the other two trials this too will prove to be a flop for GoI is a question which is yet to be answered.

Parth Pandya
SIMSREE Finance Forum

Sunday, November 11, 2012

US Elections and India

Last Wednesday the world got a very important news - Mr. Barack Obama being re-elected as the president of the United States of America. However it is such a news that would not leave even a single country in the world unaffected. For India there were mixed feelings.

For the India IT industry this news is considered to be somewhat bad  because of the stricter visa rules that would make it difficult for Indian IT industry to send their people to the U.S. where lie the majority of its customers. 

However if we look at the global economic scenario this news is not bad at all. The world is well known by the phrase "fiscal cliff" by now. Mr. Obama is believed to take a softer stand with respect to tax reforms and reducing the fiscal spending of the U.S. thus benefiting the growth f both the U.S. and the world economy and hence the Indian economy as we will see more FIIs investing heavily in growing markets like India. By December this year the decision regarding the fiscal cliff is expected to come making things much more clear.

On the other hand India must take care that the internal policies must not act as a hindrance to the investments. There are several reforms which await the winter of the parliamentary session for their approval. So there is one more reason to wait for this December.

Parth Pandya
SIMSREE Finance Forum

Thursday, November 1, 2012

Auction - The only way of allocating Natural Resorces to Private Firms?

The article is written by Khushal Shah and Chetan Dhawan from SIMSREE in the Arthneeti Article Writing Competition (September 2012)
Dr Manmohan Singh is standing at a very precarious position today. The Comptroller and Auditor General of India, in his recent report, has pulled up the government for financial wrong doing due to its policy of allocating captive coal blocks to private companies without a competitive bidding procedure. Dr Singh has justified his stance by arguing that the CAG has gone wrong with its numbers and that it is the government prerogative to decide on policy regarding allocation of natural resources. Has Dr Singh erred in handing out coal blocks for free and subsequently justifying the government’s decision?

To answer this let us first look at how the allocation of natural resources started in India. The Mines and Mineral Development and Regulation Act was enacted in 1957 when we hardly had any information about the extent of our natural resources. Also, there was very limited private investment. Under such a scenario, the government promoted first-cum-first-serve scheme whereby any willing investor was given the lease and the license to extract the minerals.The reason for implementation of the scheme being that ultimately the method of allocation of natural resources including airwaves, coal, minerals, oil and gas, forest land, to name a few, should also take into account public interest which includes within its ambit the larger economic perspective and not merely financial gain. However the recent revelations by the CAG accusing the government of causing a notional loss of lakhs of crores of rupees to the national exchequer and the prima facie reports by the CBI accusing several government ministers of nepotism indicating collusion between corporates and bureaucrats call into question the feasibility of a first cum first served allocation policy for any natural resource.

            Today, we are faced with such a low level of public trust that the auction process is seen as the 'best' way to ensure adherence to transparency and openness in resource allocation and maximising revenues to the government. Even the apex court, following 2G spectrum revelations, commented that ‘If scarce natural resources were to be alienated by the state, then the ‘only’ legal method was a transparent public auction’. So why is it that an ‘auction’ is perceived to be the only best possible method?

            To answer this, let us first see how resource allocation under auctions takes place. Generally in this scheme government comes up with a ‘Base Price’, which is the minimum price at which the government expects to sell the resource. The bidders are then expected to bid above the base price based on their perceived value of the resource. The bidding goes on till only one highest bidder remains. Now the resource is allocated to the bidder at this discovered highest price.Since the entire process is transparent,chances of collusion and corruption reduce drastically, securing the best possible price for the government.Perhaps, we can take a clue from the recently conducted 3G auctions which took place by means of an online auction. The bidding went on till the highest bid was realized. The process ensured transparency during the entire process by means of specially designed secure software. Clearly, an auction is a way to determine market demand and price. But why fixate on auctions as the only way to ensure market orientation, transparency and efficiency in the allocation and pricing of natural resources in India?

While auctions could be a ‘preferred’ option since they bring about transparency and secure the best possible price, revenue enhancement cannot be the only consideration while allocating natural resources.The disposal and distribution of natural resources has to be made in accordance with the sector specific requirement of each natural resource. The method of distribution of natural resource has to take into account the nature of natural resource and economic policy underlying the effective utilisation of such resource. There are various other factors such as national inclusion, service affordability, final product pricing, rural penetration etc that have to be taken into consideration to arrive at informed and reasoned decision of the methodology of allocating natural resources.           

Apart from these there are certain problems which the government might have to overcome before it can enforce the auction policy for all natural resource.First, the Centre has to convert this policy to law by way of amending Section 11(2) of the 1957 Act to auction natural resources like minerals, which is time-consumingFor example, the government tried to amend the Act to introduce auctions for allotment of coal blocks in 2004, but has not yet finalised its modus operandi.Secondly, the past experiences of some State Government for allocating leases by competitive bidding have not been encouraging. In 1991, Odisha suddenly realised that mining gemstones by the State-owned Orissa Mining Corporation was not remunerative and decided to auction gem-rich blocks by competitive bidding through Orissa Mining Corporation.The State Government identified 12 such blocks for aquamarine and sapphire in Bolangir and Kalahandi districts for a reserve price of Rs 20 lakh. Out of 12, the State Government could auction only five blocks for Rs 22 lakh. Thirdly, the Supreme Court in its order of February 2 this year observed that while allocating natural resources through auctions, the doctrine of public interest within the framework of the Constitutional rights of the people has to be adhered to, which is not possible if the government adopts only auction route for allocation of all natural resources. For example, if we auction fish resources of the Bay of Bengal, the Japanese trawler companies may bid the highest price, but the livelihood of the east-coast fishermen will be in jeopardy. Fourthly, it is observed that the cost of buying at a high price from an auction is more often than not passed on to the final consumer. For example the recent auction of third generation airwaves did fetch the government a huge sum, but the services have not found widespread acceptance among the general public because the companies, in order to recover the bid price, had to price these services at a higher price. Compare this to the allocation of 2G spectrum. It is widely believed that while the awarding of 2G spectrum on a so-called first-come-first-served basis in 2008 may have caused massive losses to the exchequer, the consumers, nevertheless, benefited from call rates dropping due to the entry of new mobile operators and very low call rates.

Another alternative for allocation of natural resources which can be beneficial to both the government and the companies can be a royalty based mechanism. A royalty based mechanism is similar to a tax based on assessed value of a property.The royalty should be tied to the market prices, rather than a fixed amount. A royalty based mechanism would enable the government to charge royalty at the current market price, rather than at the beginning when the resources are allocated. It would ensure continuous supply of revenue to the government. Since the royalty is associated with the actual market price, it would ensure higher revenue generation for the government. The time period for revising the royalty value should not be kept very long. Although the royalty based mechanism is prevalent in India, the royalty amount is fixed and revised every three years, which is a very long period considering the fluctuations in the prices.

            Considering the diverse needs of the country, it would be very difficult to pin point on a specific policy as the best alternative, given that the main aim of the government is to bring in transparency and safeguard the resources belonging to the country. Auctions are meant to allocate scarce resources in a transparent manner. In case the government wants to deviate from market based pricing, driven by overriding public concern, then the rationale behind policy making must be clearly manifested. In the larger public interest, if prices of end products need to be kept at a threshold, then the good or service should be subsidised at the consumer end rather than at the input end. Ensuring that benefit given at the input end to corporates will be passed on to the consumer is very difficult.The best choice would be the one which would ensure sustainability, effectiveness and transparency in the utilisation of the scarce natural resources.