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.