Test Series for UKPCS-2012,SAMVEG IAS DEHRADUN

success,samveg ias ,dehradun

A plan for coal

There is a fascinating ongoing debate on how to price coal. But in the noise, sensible principles on pricing non-renewable resources like coal have become casualties. India is short of metallurgical coal but has an almost unlimited stock of power-grade coal. Oversight agencies and public sector companies are sternly told to work out the cost of production and accordingly price the coal. There is a comical aspect to all of this.

Is the price of coal the cost of mining it? This question was raised at the golden jubilee celebration of the Central Bureau of Investigation during a special session on coal prices. I was asked to participate in this session by the CBI director and, out of curiosity, accepted the invitation.

The other member on the panel, an Australian lawyer, demolished the notion that auctions are always fair or even efficient. To make life more difficult, I started by citing Augustin Cournot, who had worked out the principles for monopolist pricing, applicable to both privately owned and government-owned companies, a century and a half ago. With a little algebra, Cournot elegantly showed that a market-based profit-maximising solution would be neither welfare enhancing nor efficient in terms of optimising output. The profit-maximising market price would be double the efficient price. So what should the price be and what is the cost of mining?

I tried to answer this question in a series of reports on coal prices in the mid-1980s, with the help of commissioned work from some of the country’s top economists, who were young then but have since become superstars. They had to make some reasonable assumptions, such as what the output of coal over the next four to five years would be. There were technical issues that had to be factored in, too, like shift lengths, gaseousness, ore strength and so on. These were measured and helped determine the long-term marginal cost and, consequently, coal prices. It would be unwise, both from the environmental angle and also from the point of view of inter-generational equity, to only mine open fields of coal and leave the reserves underneath untouched.

These days, planning is out of fashion in government. But in an expert meeting called by the Planning Commission before it was abolished, experienced hands argued that in areas like demographics, energy, water, land and non-renewable resources, long-term considerations are important. If for no other reason than the future welfare of our children.

I remember working out estimates and projections for what the coal sector would look like by 2020 at the beginning of this century. Kirit Parikh kept this work up in the Planning Commission and updated it after correcting for slippages in thebase in his fuel policy report. So, there are ways of developing long-term coal prices. It is not impossible. There was a time that such exercises were taken seriously by the government. I have set prices for agricultural products in my capacity as chairman of the Agriculture Price Commission in 1982 (the body was later renamed the Commission for Agricultural Costs and Prices) and as chairman, Bureau of Industrial Costs and Pricing. If the courts ever wanted an explanation, they would send somebody over and we would be very happy to spell out the details of our work. Usually, they were of the view that if an expert panel had taken a particular position, that would not be questioned. Nowadays, the market dictates the terms. But can we ignore the long-term costs to society from exploiting our natural resource endowment? Transparency is an all-time essential and facts should always be made public. In any case, our understanding of environmental costs is also much improved. But to ignore the basic factors at play would imperil our inheritance of natural resources and the welfare of future generations. I hope somebody out there is listening -

-

After managing to rein in non-Plan expenditure, the government now has the chance to introduce durable reforms in the subsidies regime

The latest data on the Union government's finances have raised concerns in some quarters over the feasibility of thefiscal deficit target Finance Minister Arun Jaitley had set for 2014-15. At the end of the first five months of the current financial year, the fiscal deficit has widened to almost 75 per cent of the full year's projection of Rs 5.31 lakh crore (4.1 per cent of gross domestic product or GDP). At the same time in 2013-14, the fiscal deficit was 74.6 per cent of the full year's estimate of Rs 5.24 lakh crore (4.6 per cent of GDP).

In an ideal world, fiscal deficit numbers should move in tandem with the progress of the financial year. For instance, the deficit level at the end of six months should be around 50 per cent of the annual projection. But that is not how the central finances have been managed in spite of efforts by many finance ministers to stagger the government's annual expenditure during the year in tune with the pace of revenue flows. Thus, the level of fiscal deficit last year crossed 100 per cent of the annual projection by the end of January 2014, though two months later it settled down at a level lower than even what was estimated at the start of the year.

That this imbalance between expenditure and revenue flows continues even in the current year should certainly cause some concern. And this needs to be corrected. But a closer look at the government's finances in the April-August period of 2014-15 shows a few more interesting trends that point towards a likely improvement in government finances.

Yes, the revenue flows in the first five months of the current fiscal year have been a little lower than they were last year. But the shortfall has been made good by a relative slowdown in expenditure, particularly in the non-Plan category, which accounts for over two-thirds of the total government expenditure of an estimated Rs 17.95 lakh crore. Jaitley had projected 9.4 per cent growth in non-Plan expenditure for the Union government in 2014-15. But in the first five months of the current year, non-Plan expenditure grew by a little more than four per cent over the previous year. The growth in non-Plan expenditure is much slower than that in Plan expenditure.

How has the government managed to rein in growth in non-Plan expenditure? Almost a fifth of such expenditure is accounted for by subsidies on fertilisers, food and petroleum products. In other words, subsidies for these three sectors are estimated to cost the government Rs 2.51 lakh crore (out of a total non-Plan expenditure of Rs 12.2 lakh crore).

The squeeze on the government's subsidies expenditure in the first five months is quite evident from the numbers. It spent only Rs 1.38 lakh crore in April-August 2014-15 on subsidies, a drop of 16 per cent over Rs 1.64 lakh crore spent in the same period last year. Thus, while 67 per cent of subsidies expenditure were used up in the first five months last year, only 55 per cent was spent in the same period this year.

Note that the gains here have come largely from a containment in subsidies expenditure on fertiliser and petroleum products. Food subsidies, too, have shown a deceleration in growth at Rs 62,000 crore in this period, compared to last year. And this has happened because the programme of supplying food grain at subsidised prices under the new food security law is yet to be rolled out in several states. This has been aided by the government's decision to not buy grain from states that announce special incentives over and above the procurement prices it has mandated. In spite of that, however, the squeeze on food subsidies expenditure has been far less than that on fertiliser and petroleum products.

This is because international crude oil prices have seen a steady decline since June this year. And going by the latest projections, crude oil prices should remain depressed for the next year or so. At the start of the year, the government had budgeted for the petroleum subsidies bill on the assumption that international crude oil prices would hover between $105 and $110 a barrel. Compared to that, the prices have gone down to $92 a barrel. The full year's benefit of the lower crude oil prices for the government's subsidies bill on petroleum products and fertiliser will be substantial. It is even likely that the government may show some savings on account of its subsidies bill, instead of the extra expenditure it has had to budget for in previous years.

For the newly set up expenditure management commission, this should come as an opportunity for effecting durable reforms in the government's subsidies regime. Apart from decontrolling diesel prices, the government should take the bold steps of devising new criteria, for instance, by restricting the supply of subsidised kerosene and cooking gas only to those who do not pay income tax. Remember that non-subsidised prices of cooking gas and kerosene are also declining and the time is opportune to move to a better-targeted subsidies regime.

The public-private-partnership model for infrastructure may benefit from reversing the financing sequence

A look at how businesses have traversed the path between start-up and the stock market over the past few decades clearly indicates a transition process that can aptly be described as a "capital ladder". Each step in the ladder is increasingly being provided by specialised entities, which have developed the capabilities best suited to that particular step. I believe this approach is a useful way to address the problems of India's infrastructure.

Let me identify five steps in the capital ladder - angel, early-stage venture, late-stage venture, private equity and public equity. We're all very familiar with these steps in the context of technology sectors, but the fact is that, in one form or another, every business needs to climb the ladder. For less esoteric activities - garments or footwear, for example - the lower steps of the ladder may not be provided my marquee names, but family and friends, often an extended kin or community group, play just as important a role.

Regardless of the entity associated with a particular step, the key differentiating factor between them is the level of risk intrinsic to each step. The reason why entities tend to specialise with respect to one or perhaps two steps is that to survive, they have to develop the capabilities to assess risk and buffer themselves against it. Associated with different levels of risk is the capacity to leverage equity by taking on debt. Obviously, the lower the step, the greater the risk and the lower the capacity to leverage. If you want to start up a business, you would almost never "borrow" money in the strictest sense of the term.

However, when we look at how infrastructure projects evolve, it may appear that they are exceptions to the ladder rule. Typically, infrastructure is a high-leverage business - debt-equity rations are higher than for most other businesses - because of the relative predictability and stability of earnings. I'll come back to this point later; the key question here is whether the steps in the ladder can somehow be bypassed when an infrastructure project is initiated.

India's public-private partnership (PPP) tried this bypass. In return for a guarantee on cash flows, private promoters were expected to put in their equity and then leverage it heavily by borrowing from whoever was willing to lend to them - in this case, banks. The assumption clearly was that project execution timelines would be adhered to and revenues would flow in as scheduled. With this level of certainty, servicing bank loans would not be difficult; when the time came, banks could unload their exposures to other investors with longer horizons, whose returns would come from earnings out of operations.

But as experience showed us, risk assessment in new projects can be tricky. Real life was a far cry from the assumptions about flawless execution and on-schedule completion. The tribulations that infrastructure projects typically went through brought into the picture a set of risks that the funding model simply could not accommodate. Bottlenecks everywhere, leading to delays, increasing costs and pushing the prospect of earnings further and further away. With this risk profile, the capital-ladder framework would have suggested that taking on so much debt at the beginning of the venture was inadvisable. Better to find other means of finance, with a different risk appetite coming into play as the project went through stages of execution and gradually approached its full operational phase.

This seems like a reasonable proposition, except when one asks: are there, in fact, entities who would facilitate the early steps of the capital ladder for infrastructure, like they do for technology or e-commerce companies? Or will the sheer scale of each project and the time taken for each step deter them? The prudent answer to these two questions are: no and yes. The ability to fund infrastructure in the way that other businesses are typically funded just doesn't seem to be there. This is not unique to India, as the long history of multilateral, regional and national financial institutions will attest to.

To the extent that countries have had success with setting up adequate infrastructure, it is not by bypassing the lower steps of the capital ladder. Rather, it is by creating a set of institutions that played appropriate roles in the process. While the specifics of the model may have varied across countries and over time, the common feature seems to be that the government, either directly or indirectly, absorbed the risks inherent in the early stages of infrastructure projects.

In the Indian context, these risks have proved to be significant and will, in all likelihood, remain so. Procedural and decision-making streamlining will help contain, but not eliminate them. As much as we are tempted to take the government out of infrastructure investment, our PPP experience sends out a very strong message that it just will not work that way. The government may play little or no role in project execution, but it must resume its role as the primary source of financing in the early stages of a project. In terms of the five-step ladder, this comprises the first three stages.

All said and done, there is no greater capacity in the system to absorb risk than in the government. Public funds may often be used inefficiently, but if this is guarded against, they can make the difference between functional and dysfunctional infrastructure programmes.

Based on this reasoning, in the early stages of the process, PPP needs to be a combination of public funding and private execution. It is only at a later stage - the last two steps on the capital ladder - that private funding becomes viable. Proximity to the beginning of the revenue stream for the project - the predictability and stability that I alluded to earlier - is the determinant for effective entry of private financing into the process.

Just as the entities associated with the each successive step of a capital ladder make their money by selling their stakes to the entities specialising in the next step, public funding of infrastructure can, at an appropriate time, sell stakes in projects to private entities, using the money thus made to finance new infrastructure projects. And so on. To give the concept clarity, PPP should perhaps be re-labelled FPTP - First Public, Then Private.

Bullet trains, in perspective

Bullet trains are a marquee project for the Narendra Modi government and foreign companies are falling over themselves to get a share of the pie. But in a hurry to get bullet trains running, the government must not make strategic blunders.

With ‘Make in India’ the new buzzword, foreign collaborators should be encouraged to set up plants to manufacture rolling stock and other machinery for broad gauge requirements.

Technology and financing are no longer real constraints in bringing high-speed trains to India. Competing foreign collaborators are willing to offer generous financial terms and technology transfer. The key issues are financial viability, optimal resource utilisation and benefits to the people. Answers to these questions are more involved and depend on our strategic choices. These decisions will have profound long-term implications for the commercial viability of not only bullet trains, but also the Indian Railways (IR).

It is important that bullet trains fit into our overall vision for rail transport. The vision should be to provide the country with a fast, safe and comfortable passenger rail system. Besides speeding up Shatabdi-type day trains and overnight trains, journey time for the longest-running passenger trains should be reduced to less than 24 hours. Building a few isolated high-speed corridors will not fully serve the purpose, but integrating bullet trains with the existing IR network can help provide faster, direct connections to a large number of cities in the hinterland. Improving the accessibility of smaller cities would reduce the pressure on the megacities. It can also catalyse the development of “smart cities” as envisaged in the budget.

Currently, the inter-city passenger demand estimate is the main criterion to assess the financial viability of a high-speed corridor. But integration of these corridors with the IR can help reduce journey time for a large number of existing train services. These additional network benefits can make many new high-speed corridors economically viable. Irrespective of their management structures, bullet trains should have a symbiotic relationship with the IR system by improving the efficiency of the existing rail network while gaining extra ridership by leveraging it. This requires interoperability of trains so that tracks and terminal infrastructure can be shared.

Interoperability entails a compatible choice of track gauge, train sets, locomotives, signalling and traction systems. Track gauge is the most crucial and contentious of these. The world over, standard gauge is adopted for high-speed trains. But India has a pre-existing broad gauge network. Many experts argue that the adoption of broad gauge for bullet trains would lead to higher construction costs, delays in rolling stock procurement and difficulties in technology transfer. However, the long-term costs of not adopting broad gauge for the high-speed network will be higher. There is already a project underway to convert different gauges tobroad gauge, and selecting standard gauge for bullet trains would be regressive. Though it is possible to have gauge changers and specialised rolling stock to ride over a break in gauge, it would be costly and restrictive. With “Make in India” the new buzzword, foreign collaborators should be encouraged to set up plants to manufacture rolling stock and other machinery for broad gauge requirements. Indigenous manufacturing will necessitate technology transfer, absorption and further innovation. However, standard loading gauge may be adopted for a broad gauge track, which will reduce the efforts required to customise designs for broad gauge. Some experts cite, as a counter-example, the successful adoption of standard gauge for metro rail systems in India. This is a flawed argument, as metro rails are standalone systems while bullet trains will have to leverage the IR network to realise their full potential. Completion of dedicated freight corridors (DFC) already under construction on the Delhi-Mumbai, Delhi-Kolkata and Delhi-Ludhiana routes will release line capacity for exclusive passenger usage on the parallel IR network. This excess capacity offers a window of opportunity to upgrade the parallel IR tracks to high-speed standards without a major disruption in existing train services. The construction of new high-speed corridors along these routes would be a waste of resources, spelling financial doom for both the IR and bullet trains. Wherever possible, existing train stations in city centres should be redesigned to handle high-speed, conventional and metro trains through a common concourse, which will give bullet trains the advantage of easy access over airlines. This is, of course, easier said than done. Foreign collaborators will have to be more patient. A greenfield high-speed corridor with standard gauge is likely to take less time in construction (provided land acquisition is sorted out) than a brownfield project with broad gauge. Still, the government must avoid this expedient but ultimately costly temptation.

- 

Banking on diversity

Diversity lends strength to any ecosystem — a monoculture tends to be fragile, especially in the financial sector, where following each other’s strategies builds risks. So even though public sector bank ownership is often attacked as a weakness, a diversified banking system may be a source of strength.

Freer post-reform entry resulted in an even split in ownership by 2009-10: 27 public sector banks (PSBs) with majority government ownership, 22 private sector banks, and 32 foreign banks. PSBs, however, still dominated, with 75 per cent of the assets of the banking system. But this was less than their 1991 share of a little over 90 per cent. With diverse ownership in place, policy now aims to diversify by activity-type.

Changes in relative competitiveness illustrate the benefits from diversity. The public sector did unexpectedly well after the reforms of the 1990s, and even overtook private banks on some parameters. It also outperformed them during
and immediately after the global financial crisis.

Reforms reduced excessive government ownership. A new philosophy of regulation shifted from micro intervention to a strategy of macro management. High growth and legal reform that made debt recovery easier also contributed to non-performing assets (NPAs) falling to historic lows. As a ratio to gross advances, NPAs fell to 2.4 per cent in 2009-10 from 12.8 per cent in 1991. There were structural improvements in the health of Indian banks.

Systemic failures were also avoided. The Basel Accord capital standards were implemented as part of the reforms, but a standardised version was followed. Given diverse capabilities, banks were allowed learning time to migrate to internal risk rating-based capital buffers. It was feared that the lack of historical data for wholesale and retail, together with the absence of industry benchmarks to be used in the calculation of internal parameters, could distort risk-based pricing. Indian capital adequacy norms were kept higher than the Basel norms to make sure risky exposures were not undercapitalised, despite the difference in approach. Additional prudential (safety) norms included risk weights and provisioning requirements that effectively moderated sectoral booms. Simpler regulation based on broad patterns was used partly because the skills for complex risk-based regulation were missing, but turned out to have good stability-enhancing incentives. A risk assessment methodology not based wholly on self-assessment was protective.

Features such as high leverage, short-term market-based funding, risky endogenous expansion of balance sheets and exposure to cross-border risks, which had led to massive bank failures in the West, were limited. Most banks followed a retail business model. Loans dominated market investments on bank balance sheets. But this varied by bank type. In 2010-11, contingent liabilities as a percentage of the group’s total liabilities were 41.4 per cent for PSBs, 167.9 per cent for private banks and 1,892.7 per cent for foreign banks. Although technology and skills improved, PSBs lagged behind private banks in systems, fee-based services and use of sophisticated products and derivatives. Or perhaps this reflects the choice of a different business model. Business contracted for private banks after the global financial crisis, and some were in trouble.

PSBs heeded the government’s post-crisis call and participated much more than private banks in infrastructure financing. Meanwhile, private banks concentrated on retail. They used their more flexible hiring patterns to design effective services for the growing middle class, overtaking foreign banks concentrating on high-net worth accounts. The paralysis in many large infrastructure projects and interest rate hikes hit PSBs. A loan-based system is highly sensitive to a rise in interest rates. But again, regulations, such as position and sectoral exposure limits, were protective. In 2011, banks had reached the exposure limit in financing infrastructure.

NPAs are not expected to rise above 4 per cent, and may come down as the economy revives and projects start moving. While some PSBs may have made non-commercial decisions, external shocks were also responsible for outcomes. Errors are always possible, but stronger boards and improved governance mechanisms can ensure that independent decisions are made on purely commercial grounds. Disincentives from taxpayer support are not limited to PSBs, since no large bank is allowed to fail for fear of systemic spillovers.

Diversity helped again, since private banks did well in this period. In 2011, the market capitalisation of 24 listed public sector banks, still controlling 73 per cent of bank deposits, fell below that of the 15 listed private sector banks for the first time. The latter also tended to have more foreign investment.

The recent emphasis on technology-driven financial inclusion and mobile banking may again lead to some surprise reversals. The SBI has the highest number of mobile banking accounts, more than double those of ICICI, which is in second place. PSBs tend to follow government directions, but this need not be harmful so long as social purposes are consistent with viable business decisions.

The Jan Dhan Yojana may not lead to a rise in NPAs down the road, since it aims for a basket of financial services meeting the needs of its target group. Along with lower transaction costs and supporting technological advances, these accounts may actually be used to generate revenue. A large under-banked population implies a huge potential market for a well-designed set of banking services. Proposed diversity in types of banks and easier entry may lead to a new phase of beneficial competition. Whatever the type of bank that leads next, the people should gain.

-