Cleaning up the mess: Why the unions of Coal India are becoming increasingly irrelevant

coal

Vivek Kaul

It’s always about timing. If it’s too soon, no one understands. If it’s too late, everyone’s forgotten – Anna Wintour

For their threats to be credible it is important that the trade unions get their timing right. Gurudas Dasgupta, the general secretary of the All India Trade Union Congress, has clearly got the timing all wrong, in trying to derail the government’s initiatives for sorting up the mess in the coal sector.
The government has promulgated an ordinance which will give it the power to e-auction coal blocks. The Supreme Court in a decision given in September 2014 had cancelled the allocation of 204 out of the 218 blocks that various governments since 1993 had allocated to companies for captive consumption.
These blocks will now be auctioned. And this hasn’t gone down well with Dasgupta and other trade union leaders who have threatened to protest and possibly even go on a strike. Dasgupta said that the government decision on coal blocks is “a backdoor entry for taking over the entire coal sector by the private corporates”.
Jibon Roy, the general secretary of the All India Coal Workers Federation (AICWF) said that “to protest against the enabling provision and proposed e-auction, the workers would stage nationwide dharna on November 5 to 7.”
The decision to allot coal blocks to private players for captive consumption was made in 1993. The idea, as the Economic Survey of 1994-1995 pointed out, was to “encourage private sector investment in the coal sector, the Coal Mines (Nationalisation) Act, 1973, was amended with effect from June 9, 1993, for operation of captive coal mines by companies engaged in the production of iron and steel, power generation and washing of coal in the private sector.”
This allowed private companies engaged in the production of iron and steel, power and cement to own coal blocks for their captive use. Hence, if a coal block had been allocated to a power plant, the coal produced needed to be passed on to the power plant.
In 1993, the government allocated only one coal block. Until 2002, the government had allocated only 19 coal blocks in total. The allocation of coal blocks picked up since 2003. During that year 20 coal blocks were allocated. A considerable number of these blocks were allocated to private companies for captive consumption.
The question is why are the trade unions protesting now? The allocation of coal blocks to private companies had been on for a while. The government has decided to go in for an e-auction of the coal blocks after the Supreme Court cancelled most of the allocations that had been made. Hence, only the method of allocation has changed and not its purpose. So why are the trade unions protesting now?
Further, the process of auctioning is transparent, unlike the earlier “screening committee” method of allotment which was fairly opaque as well as arbitrary, leading to crony capitalists gaining in the process. Also, the government has decided to hand over the money raised from the auction to the state government where the coal block is based. Why have the unions got a problem with all this?
The government has also said that sometime in the future it will allow private companies to commercially mine coal. Currently only the government owned Coal India is allowed to do that. The trade unions are bound to have a problem with this. As Dasgupta put it “We strongly protest and call upon the government to reverse the decision as there is an enabling clause in the Ordinance which gives rise to concerns and apprehensions of sweeping privatisation of coal sector.”
This, Dasgupta said could lead to “serious industrial disturbances,” and added that allowing private companies to commercially mine coal would jeopardise “national interest” and weaken Coal India.
Let’s look at this statement of Dasgupta in detail. Coal India had an average manpower of 4,76,577 individuals in 2004-2005. Since then the number of employees has constantly come down. In 2013-2014, the average manpower stood at 3,52,282. The number has fallen further, and as on August 31, 2014, it stood at 3,39,769 individuals.
Hence, between 2004-2005 and 2013-2014, the total manpower of Coal India came down by 26% and the unions haven’t been able to do anything about that. During the same period, the total production of coal went up by 43% from 323.58 million tonnes to 462.42 million tonnes.
So, the coal production went up despite the number of employees coming down.
This has happened due to two reasons. Coal India was overstaffed and has not been filling up the posts of retiring employees. Further, over the years Coal India has been extracting more and more coal by outsourcing work to private contractors. Between 2010-2011 and 2013-2014, the contractual expenses of Coal India jumped by 47.9% to Rs 7,812.71 crore. These expenses came in third after salaries and and provident fund expenses of employees.
A major part of coal is now extracted through outsourcing to private contractors. The private contractors don’t have to pay their employees as much as Coal India does to its workers, and hence coal is extracted at cheaper rates than it would be if employees were to do the job.
Over and above this, what is interesting is that some of the subsidiaries of Coal India, which have the least number of employees, produce most of its coal. Take the case of Mahanadi Coalfields Ltd. As on August 31, 2014, it employed
22,206 individuals or 6.5% of the total number of people working for Coal India. During the course of 2013-2014 it produced 114.34 million tonnes of coal or nearly one fourth of the coal that was mined by Coal India.
Or take the case of Northern Coalfields Ltd. The company employed 16,515 individuals as on August 31, 2014 or around 4.86% of the total number of people working for Coal India. In 2013-2014, it produced 72.11 million tonnes of coal or around 15.6% of the total coal produced by Coal India.
This is primarily because these companies have taken to outsourcing. Also, the coal mines of Northern Coalfields are highly mechanised. Now let’s compare this to Eastern Coalfields Ltd, which employs 70,191 individuals or around 20.7% of the Coal India total. In 2013-2014, it produced just 36.25 million tonnes or 7.8% of the coal produced by Coal India. The same was the case with Bharat Coking Coal, which employed 17% of total Coal India employees but produced only 7.4% of coal that was produced.
One reason for this is that a lot of mines run by Eastern Coalfields and Bharat Coking Coal are underground mines, where the technology used to mine coal is still very labour intensive.
Also, the trade unions are stronger in this part of the country (Eastern Coalfields is head-quartered at Sanctoria in West Bengal and Bharat Coking Coal at Dhanbad in Jharkhand, but right on the Bengal border) and that is another reason why these companies employ so many people to produce a minuscule amount of coal in comparison to other subsidiaries of Coal India.
Dasgupta feared that recent moves of the government were “a backdoor entry for taking over the entire coal sector by the private corporates”. But as far as coal mining is concerned that has already happened. Dasgupta and others of his ilk should have started protesting many years back. This protest has come too little too late. It is interesting nonetheless to observe that the contractual expenses of Eastern Coalfields have risen by 117% since 2009-2010.
Coal India has privatized a major part of coal mining and is reaping in tremendous benefits because of the same. As on March 31, 2014, it had cash and bank balances amounting to Rs 52,389.93 crore.
The number would have been greater than Rs 70,000 crore had the company not been forced to give a dividend of close to Rs 20,000 crore to the government to help control the fiscal deficit. The fiscal deficit is the difference between what a government earns and what it spends.
It needs to be pointed out that the country needs more coal right now than what is being produced. Despite having the fifth largest coal reserves in the world of 301.6 billion tonnes, India was the third largest importer of coal in 2013-2014 at 104.7 million tonnes. What this tells us is that Coal India, which produces most of the coal produced in the country, hasn’t been able to keep pace.
In fact as of last week 64 out of 103 power plants had a coal inventory of less than a week. Between 2010-2011 and 2013-2014, the rate of coal production of Coal India increased at a minuscule rate of 1.76% per year.
To conclude, it is important that India produces more coal. For this, the monopoly of Coal India needs to be broken and private players (including foreign players) need to be allowed to commercially mine coal.
As Dasgupta said allowing private players would “weaken” Coal India. That is precisely what needs to happen, for the country as a whole to produce more coal. The comparable example for this is what happened after private telecom players were allowed to offer services. Despite the scams and the controversies that have happened over the years, the tele-density increased big time. Why shouldn’t that happen in the coal sector as well? Maybe Dasgupta has an answer for that.

The article originally appeared on www.FirstBiz.com on Oct 22, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Don’t blame Rajan: It’s time the interest-rate-wallahs stopped punching the RBI

ARTS RAJANVivek Kaul

It fashionable these days to criticize the Reserve Bank of India at the drop of a hat. The senior columnist Prem Shankar Jha is the latest person to join this bandwagon. The newest interest-rate-wallah on the block in a column in The Times of India held the RBI responsible for India’s slow economic growth over the last few years. As he writes “[The] Indian economy is not on the road to recovery. The reason is the sustained high interest rate regime of the past four years. Industry has been begging for cuts in the cost of borrowing since March 2011… On August 5, RBI governor Raghuram Rajan surprised the country by announcing that he would not lower interest rates, because at 8% consumer price inflation was still too high.”
I guess Jha must have among the few people surprised by Rajan’s decision given that among those who follow the workings of the Indian central bank closely, almost no one had expected Rajan to cut interest rates.
The premise on which
interest-rate-wallahs work is that at lower interest rates people will borrow and spend more, which will lead to economic growth. But the entire premise that low interest rates will lead to a pick up in consumption and hence, higher economic growth, doesn’t really hold. (As I have explained here).
The other big reason offered is that companies can borrow at lower rates of interest. The bigger question that
interest-rate-wallahs tend to ignore is how much control does the RBI really have over interest rates that banks pay their depositors and in turn charge their borrowers? Over the last few weeks, banks have cut interest rates on their fixed deposits. The list includes State Bank of India, Punjab National Bank and Central Bank of India. (You can read about here, here and here). The Indus Ind Bank also cut the interest it pays on its savings account to 4.5% from the earlier 5.5% for a daily balance of up to Rs 1 lakh, starting September 1, 2014.
All these cuts in interest rates have happened despite the RBI maintaining the repo rate at 8%. Repo rate is the interest rate at which the RBI lends to banks. So what has changed that has allowed these banks to cut the interest rates at which they borrow?
Let’s look at some numbers. As on October 3, 2014, over a period of one year, the loans given by banks rose by 9.87%. During the same period the deposits raised by banks rose by 11.54%. How was the situation one year back? As on October 4, 2013, over a period of one year, the loans given by banks had risen by 15.18%. During the same period the deposits had grown by 12.9%.
Hence, the rate of loan growth for banks has fallen much faster than the rate at which their deposit growth has fallen. Given this, it is not surprising that banks are cutting fixed deposit rates, given that their rate of loan growth is falling at a much faster rate.
As Henry Hazlitt writes in
Economics in One Lesson “Just as the supply and demand for any other commodity are equalized by price, so the supply of demand for capital are equalized by interest rates. The interest rate is merely a special name for the price of loaned capital. It is a price like any other.”
As Hazlitt further points out “If money is kept…in…banks…the banks are eager to lend and invest it. They cannot afford to have idle funds.”
Hence, given that the rate of loan growth is much slower than the rate of deposit growth, it is not surprising that banks are cutting interest rates on their fixed deposits. Given this, the impact that RBI’s repo rate has on interest rates is at best limited. It is more of a broad indicator from the RBI on which way it thinks interest rates are headed.
Further, it also needs to be remembered that financial savings in India have fallen dramatically over the last few years. The latest RBI annual report points out that “the household financial saving rate remained low during 2013-14, increasing only marginally to 7.2 per cent of GDP in 2013-14 from 7.1 per cent of GDP in 2012-13 and 7.0 per cent of GDP in 2011-12…the household financial saving rate [has] dipped sharply from 12 per cent in 2009-10.”

Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. It has come down from 12% of the GDP in 2009-10 to 7.2% in 2013-14. A major reason for the fall has been the high inflation that has prevailed since 2008.
The rate of return on offer on fixed income investments(like fixed deposits, post office savings schemes and various government run provident funds) has been lower than the rate of inflation. This led to people moving their money into investments like gold and real estate, where they expected to earn more. Hence, the money coming into fixed deposits slowed down leading to a situation where banks could not cut interest rates., given that their loan growth continued to be strong.
What also did not help was the fact that the borrowing requirements of the government of India kept growing over the years.
The RBI was not responsible for any of this. The only way to bring down interest rates is by ensuring that inflation continues to remain low in the months and the years to come. If this happens, then money flowing into fixed deposits will improve and that, in turn, will help banks to first cut interest rates they offer on their deposits and then on their loans.
The government needs to play an important part in the efforts to bring down inflation. In fact, it has been working on that front. In a recent research report analysts Abhay Laijawala and Abhishek Saraf of Deutsche Bank Market Research write that the “the government is firmly ‘walking the talk’ on fiscal consolidation” through a spate of “recent administrative moves on curbing food inflation (such as fast liquidation of surplus foodstock, modest single-digit hike in MSPs, an effort to eliminate fruits and vegetables from ambit of APMC etc.)”
To conclude, RBI seems to have become everyone’s favourite punching bag even though its impact on setting interest rates is rather limited. It is time that
interest-rate-wallhas like Jha come to terms with this.

The article originally appeared on www.FirstBiz.com on Oct 22, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Dear Modi govt, ordinance on coal blocks won’t help much, privatisation will

coal

Vivek Kaul

The coal sector in India is in a mess. Yesterday, the government started the process to set it right. It plans to promulgate an ordinance to start with. This ordinance will give the government the power to e-auction coal blocks. The Supreme Court in a decision given in September 2014 had cancelled the allocation of 204 out of the 218 blocks that various governments since 1993 had allocated to companies for captive consumption.
The blocks had been allocated to several companies so that they could use the coal produced in the production of cement, power, aluminium, steel etc. The Supreme Court deemed the process of allocation to be suffering from the
“vice of arbitrariness” and cancelled these blocks.
These blocks will now be auctioned. As finance minister Arun Jaitley said yesterday “
As far as the private sector is concerned, the actual users of coal in the cement, steel and power sectors who apply for a certain number of coal mines will be put in the pool and there would be an e-auction. A sufficient and adequate number of mines would be put so that actual users go back with the mines.”
This is a good step given that it makes the entire process transparent instead of the arbitrary manner in which coal blocks were allocated through the earlier screening committee method. Further, the system of allocation of coal blocks for free through the screening committee method was discriminatory. It offered a huge premium to companies which managed to get a free coal block, in comparison to ones that did not.
Nevertheless it is important that auctions are designed properly.
Earlier this year the government tried to auction a few coal blocks and found no takers. Take the case of the Jhirki west coal block. The auction for this block had a fixed price of Rs 177 crore. Over and above this a minimum price of Rs 2,902 per tonne needed to be paid. Then there was the cost of excavating coal and getting the block up and running.
Once these factors were taken into count the total cost worked out at Rs 8,000 per tonne. The block had low quality coking coal. And at this price good quality coking coal could be imported from Australia. Given this, it is not surprising that the government found no takers for the block. Hence, it is important that the auctions be designed properly.
Further, 42 out of the 218 coal blocks whose allocation has been cancelled are already operational.
The ordinance will allow the transfer of land from companies which own these cancelled mines to the companies which emerge as the winning bidder in the e-auction.
A committee will decide on the price of land.
Interestingly, a PTI report points that “Sources said successful bidders in the fresh auction of coal blocks along with the land and plant standing on it would be liable to pay the earlier allottees the cost of the land and the plant along with 12 per cent annual interest on the amount that was originally invested for purchasing the land and setting up plant.”
This process needs to be handled with care. Many of the companies which were allotted coal blocks are basically crony capitalists and may try to come up with trumped up estimates of the cost of land and plant. Also, in case of mines that are operational, a certain amount of coal has already been mined. This will have to be taken into account so that the prospective bidders in the auction know the amount of coal they can hope to mine, and can accordingly come up with a bid price.
In fact, the companies which were allocated coal blocks had to use the coal produced for captive consumption only. Hence, if a coal block had been allocated to a power plant, the coal produced needed to be passed on to the power plant. Any excess coal had to be handed over to the local subsidiary of the government owned Coal India Ltd.
Nonetheless there have been a spate of media reports suggesting that the excess coal that was produced was being sold in the open market.
As a report in The Economic Times points out “What happened to the surplus coal extracted? In some cases, illegally mined coal has found its way to places like the coal mandi near Varanasi.”
This factor will also have to be taken into account before the auction. And it is here that the things can get a little tricky because some companies have mined more coal than they have actually reported.
The government plans to hand over the money generated through the auctions to the state in which the block is located. This is an excellent move, given that the permissions at the state level take a lot of time for a coal mine to get operational. With states being made a part of the process, they have some incentive in not creating hurdles in the production of coal, as has been the case in the past.
Interestingly, Jaitley also said that coal mining will be opened up for the private sector. Currently only Coal India Ltd is allowed to do excavate and sell coal to end users. As Jaitley put it “There will be an enabling provision for the future where under rules which are framed for commercial users of mines could also be decided by the Central government. This would lead to an optimal utilisation of the natural resource.”
This will call for the amendment of the Coal Mines (Nationalization) Act of 1973.
India currently has a
total of 301.6 billion tonnes of coal reserves. Despite having the fifth largest coal reserves in the world, India is the third largest importer of coal having imported around 104.7 million tonnes in 2013-2014. These imports cost around $20 billion a year, as per Jaitley.
Given this, it is a no-brainer to suggest that India needs to produce more coal.
During the year 2010-2011, Coal India produced around 431.26 million tonnes of coal. In 2013-2014, it produced 462.42 million tonnes. Hence, the production of coal has increased at the rate of a minuscule 1.76% per year.
Coal India produces a bulk of India’s coal. And it is obvious that it has been unable to increase its rate of production over the years. Given this, more companies need to be allowed to excavate coal. Taking that into account, the decision of the government to open coal mining to the private sector is a good one.
As former coal secretary PC Parakh writes in his book
Crusader or Conspirator—Coalgate and Other Truths : “Had we opened up coal mining to private sector for commercial mining, along with power sector, in the early 1990s, we would by now have at least half a dozen large coal mining companies in the private sector. This is what happened in the telecom sector. The country would not be facing huge shortage of coal and large outgo of foreign exchange on import of coal.”
Also, production of coal for captive use is not the most optimum way to go about the whole thing.
As Partha Bhattacharya, former chairman of Coal India, wrote in a column in The Indian Express “Captive end-users mining coal is not optimal. Nor is it known to have succeeded elsewhere in the world. Coal-mining has its own challenges and needs core competence, which the end-users are unlikely to possess.”
Given this, allowing private companies into commercial coal mining is required.
The first thing opening up of the sector will do is to create some competition for Coal India and hopefully improve its productivity.  
As Swaminathan Aiyar pointed out in a recent column in The Economic Times “In Australia, collieries produce 75 tones per manshift (of eight hours) in open-cast mines and 40 tonnes per manshift in underground mines. Coal India averages barely 7 tonnes and 0.8 tonnes respectively…Coal India’s machines work 15 hours per day , against 22 hours per day in efficient mines.”
Nevertheless, there are a few issues that need to be highlighted here. First and foremost no date has been set for allowing private commercial mining of coal.
As Parakh told The Times of India “I won’t say it is a big ticket reform…There is no timeline. This was an opportunity to come clean on the coal sector and allow commercial mining.” And that hasn’t happened.
Further, no foreign companies will be allowed to carry out commercial mining of coal. This is where things get tricky. The expertise in India to set up and run a coal mine is limited to Coal India. If only Indian companies are allowed to commercially mine coal, they will end up poaching people from Coal India to run their mines. Hence, is important that we allow international companies to enter this sector. If this happens, these companies can bring in their technology and in the process hopefully improve India’s low coal productivity.
Also, this is likely to keep the crony capitalism in India under some control. As Raghuram Rajan and Luigi Zingales write in
Saving Capitalism from the Capitalists The most effective way to reduce the power of incumbents to affect legislation is to keep domestic markets open to international competition…Openness creates competitions from outsiders—outsiders that incumbents cannot control through political means.”
To conclude, the government has done well to address the issues plaguing the coal sector in India. Nevertheless, given the mess that the coal sector is in, a lot more needed to be done.

The article originally appeared on www.FirstBiz.com on Oct 21, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Deregulating diesel prices: A good decision that will be tested when oil prices rise again

light-diesel-oil-250x250

Vivek Kaul

The government on Saturday announced the decision to deregulate diesel prices. “Henceforth—like petrol—the price of diesel will be linked to the market,” the finance minister Arun Jaitley said after a cabinet meeting. “Whatever the cost involved, that is what consumer will have to pay,” he added.
After this decision the price of diesel was reduced by around Rs 3.50 per litre (the cut would vary all around India given the different rates of taxes in different states). This was the first cut in the price of diesel since January 2009.
The proposal to allow oil marketing companies to decide the price of diesel was first made in 1997, when Inder Kumar Gujral was the prime minister. The price of petrol and diesel were finally deregulated in April 2002, under the regime of Atal Bihari Vajpayee.
But this decision was over turned in late 2004, around the time oil prices had touched $50 per barrel. In November 2004, Mani Shankar Aiyar, the then Petroleum Minister said “since January 1, 2004, government was dictating even petrol and diesel prices… We have been far more honest in saying the government will control prices of cooking and auto fuels.”
This led to the oil marketing companies having to sell oil products at a price at which they incurred under-recoveries. The government compensated a part of these under-recoveries. And due to this the government expenditure and in turn, the fiscal deficit went up. Fiscal deficit is the difference between what a government earns and what it spends.
In the last two financial years (i.e. 2012-2013 and 2013-2014) the total petroleum subsidy (subsidy for diesel, cooking gas and kerosene) amounted to Rs 1,82,359.9 crore. As an article in The Wall Street Journal points out “Around half of that was for diesel. Before diesel prices were freed, economists estimated that a $1 per barrel rise in the global price of oil would increase India’s subsidy bill by around $1 billion a year.”
As government expenditure in order to pay for the under-recoveries of the oil marketing companies went up over the years, so did its borrowing. When the government borrows more, it crowds out the other borrowers i.e. it leaves lesser on the table for the private borrowers to borrow. This, in turn, pushes up interest rates, as the other borrowers now need to compete harder.
The high interest rate scenario that has prevailed in India over the last five-six years has been because of this increased government borrowing. If diesel prices had continued to be deregulated this wouldn’t have happened.
Other than the high interest rates, there were several other things that happened. But before we get into that let’s see what the economist Henry Hazlitt writes in
Economics in One Lesson “We cannot hold the price of any commodity below its market level without in time bringing about two consequences. The first is to increase the demand for that commodity. Because the commodity is cheaper, people are tempted to buy, and can afford to buy, more of it…In addition to this production of that commodity is discouraged. Profit margins are reduced or wiped out. The marginal producers are driven out of business.”
The demand for diesel went up in the form of people buying more and more passenger cars that ran on diesel, given the substantial difference between the price of petrol and diesel. This led to the government of India indirectly subsidising car owners over the last few years. Hence, rich consumers ended up consuming more than their fair share of diesel.
As Hazlitt writes in this context: “Unless a subsidized commodity is completely rationed, it is those with the most purchasing power than can buy most of it. This means that they are being subsidized more than those with less purchasing power…What is forgotten is that subsidies are paid for by someone, and that no method has been discovered by which the community gets something for nothing.”
The move to dismantle diesel price deregulation also drove private marketers of oil (Reliance, Essar etc) out of business, as suggested by what Hazlitt had to say on the issue. The government owned oil marketing companies (Indian Oil, Bharat Petroleum, Hindustan Petroleum) were compensated by the government and the upstream oil companies (like ONGC, Oil India Ltd) for selling diesel at a lower price. There was no such compensation for the private oil marketers and hence, they had to shut down their business.
Once all these factors are taken into account the decision to deregulate diesel prices is a brilliant one even though it took a long time to come. Nevertheless, it will not lead to any major immediate benefits for the government. Since Narendra Modi took over as the prime minister of the country, the oil price has fallen dramatically.
As per the Petroleum Planning and Analysis Cell, the international crude oil price of Indian Basket as on October 17, 2014, stood at $ 85.06 per barrel. This price had stood at $108.05 per barrel on May 26, 2014, the day Modi took over as the prime minister.
Interestingly, during April to June 2014, the first quarter of this financial year, the under-recoveries of oil marketing companies on the sale of diesel, cooking gas and kerosene were at Rs 9,037 crore. This is much lower in comparison to the huge under-recoveries that these companies suffered over the last few years.
Also, since January 2013, the price of diesel has been raised by 50 paisa every month. This has led to the under-recoveries of oil marketing companies coming down significantly. Interestingly, for the fortnight starting October 16, 2014, the over-recovery on diesel stood at Rs 3.56 per litre. And that explains why the government was able to cut the price of diesel by around Rs 3.50 per litre.
What this tells us clearly is that there will be no immediate benefit on the fiscal front of diesel price deregulation to the government. Further, the real benefit of this reform will kick in only once oil prices start to rise. And it is at that point of time, the government of the day will have to resist any temptation to start controlling diesel prices, as has been the case in the past.
If it resists this temptation, the upstream oil companies (ONGC, Oil India) will also benefit because the government will not strip them of their profits to pay off the under-recoveries of the oil marketing companies. This explains why the share price of ONGC is up by more than 5% today.
Nevertheless, one immediate benefit of the diesel price cut will be a slightly lower inflation. On the flip side, this also means that if and when oil prices start to go up, the inflation will start reflecting a higher price of diesel more quickly than was the case in the past.
Another benefit of the deregulation will be that private marketers can now look to get back into the business. This is good news for the Indian consumer as it will mean more competition, which may lead to better services. In fact, one huge problem with the products sold by the public sector oil marketing companies is adulteration. Given the cheap price of kerosene, there is lot of adulteration of petrol and diesel. Private marketers can make in roads into the market by providing pure petrol and diesel, and hope to attract the attention of the consumer.
To conclude, there are a few immediate benefits of diesel price deregulation, but the real challenge and the benefit for the government will only come, once oil prices start to go up again.

The article originally appeared on www.FirstBiz.com on Oct 20, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Reversification: A one-word explanation for what’s wrong with the world of finance

how to speak money

Vivek Kaul

When MTV first came to India in the early 1990s, I was hooked on to the channel in a matter of a few months. Growing up in a small town, the channel was my first “real” exposure to what we called “English” music. Until then my only exposure to English music was “Michael Jackson” and like others of my generation I was more aware of his mannerisms than his songs.
One of the things that got me hooked to MTV was reggae music. And one of the first reggae songs that I heard was Inner Cirlce’s
Games People Play. Other than the music of the song which was very peppy, what I liked was that for the first time I was able to make out the lyrics of an English song.
One paragraph of the song went like this:
Oh the games people play now
Every night and evety day now
Never meaning what they say, yeah
Never saying what they mean.

This paragraph has stayed with me since then and I have realized its meaning in various contexts at various points of time over the last two decades. One area where this paragraph particularly applies is finance. The writer John Lanchester in his new book
How to Speak Money comes with a new term to explain this . He calls the term “reversification”. He defines reversification as a “process in which words come, through a process of evolution and innovation, to have a meaning that is opposite to, or at least very different from, their initial sense.”
A good example of reversification in finance is the much used term “Chinese wall”. In real life, the Great Wall of China is a very big wall that was built over several centuries to keep the enemies out of China. One of the biggest misconceptions about it is that it is visible from the moon.
So, what does it mean in finance? “Inside the world of money, though, the term ‘Chinese wall’ means an invisible barrier inside a financial institution which is supposed to prevent people from sharing information across it, in order to avert conflict of interests,” writes Lanchester.
Let’s take the example of the Chinese walls that are supposed exist between stock analysts who make investment recommendations to investors (i.e. whether to buy, sell or hold the stock of a company) and the investment banking division, which takes companies public, by getting them listed on a stock exchange.
This wall is regularly broken whenever a profitable investment opportunity comes up. Take the case of the dotcom bubble in the United States in the 1990s.
Even with many internet firms wanting to go public, Wall Street still wasn’t in a bargaining position. The bargaining power was with the 20–30 year olds, who ran most of these new internet companies, or the Silicon Valley venture capitalists (VCs) who had backed them. The youngsters and the VCs did not ask for a cut in Wall Street’s fee. What they wanted instead was an assurance that the Wall Street firm would support the price of the stock after it had been listed on the stock exchange.
And, of course, this had to be done legally. This was important for the Wall Street firms because new companies wanting to come out with their IPOs looked at this parameter before choosing the Wall Street firm which would handle its public offer.
The way Wall Street handled this was very clever. Before going public, the Wall Street firm promised the company that the in-house analyst of the firm would initiate coverage of the stock a few days after it got listed on the stock exchange. No favourable coverage or for that matter, a “buy” rating was promised because that would have been going against the law. It was assumed that the Wall Street firm would have nice things to say about the company it had just taken public. And so the Chinese wall was broken. Even in India, it has been observed that the stock broking division of a financial institution has nice things to say about a company that has just been taken public by the investment banking division of the same financial institution.
The way the financial system has evolved large financial institutions have different businesses which “if the system is to function without conflicts of interest – shouldn’t really be there.” But that is not the case. Hence, as Lanchester puts it “the Chinese walls…were worse than non-existent; they were opportunities for the bank to make money…that’s reversification.”
Another excellent example of reversification is a hedge fund. As Lanchester writes “the word ‘hedge’ began its life in economics as a term for setting limits to a bet, in the same way that a hedge sets a limit to a field…The idea is that by putting a hedge around a bet, you delimit the size of your potential losses.”
But is that the case? Before we get into that let’s try and understand what really is a hedge fund. Legally, there is no term called a “hedge fund,” unlike, say, “mutual fund.” The term “hedge fund” was apparently first used by the
Fortune magazine in a 1966 article to describe an investment fund managed by Alfred Jones, a Columbia University sociologist, diplomat and steamboat purser who had turned into a fund manager. The article had a very interesting title. It was headlined “The Jones Nobody Keeps Up With”.
In 1952, Jones wanted to launch an investment fund which would not only buy stocks on which he was bullish on, but also short-sell the stocks (i.e., borrow and sell) which he felt were overpriced and, thus, would fall in price in the days to come. At the same time, he thought that with the expertise he brought to the table, the investors in the fund should be willing to pay him a slice of the profits he made for them.
Jones wanted to buy as well as short-sell stocks. The money that he generated from short-selling stocks would partially fund the buying of stocks which he felt were undervalued. This way, he ensured that the exposure was “market neutral,” or, in a simpler language, he “hedged his bets.”
The strategy of Alfred Jones of buying some stocks and selling some others came to be known as the equity long-short strategy. He outperformed the mutual funds which could only go long, that is, buy stocks. They could not sell them short because it was deemed to be a risky strategy. Jones also used leverage, that is, borrowed money, to spruce up his returns. Jones received 20 percent of the returns he generated for the fund as compensation.
The success of Alfred Jones was copied by many others. “The classic hedge fund technique, as created by Jones, is still in use: funds employ complex mathematical analysis to bet on prices going both up and down in ways which are supposedly guaranteed to produce a positive outcome,” writes Lanchester.
But is that really the case? A majority of the hedge funds fail. As Lanchester points out “90% of all hedge funds that have ever existed have closed down or gone broke. Out of total of about 9,800 hedge funds worldwide, 743 failed or closed in 2010, 775 in 2011, and 873 in 2012 – so in three years, a quarter of all the funds in existence three years earlier disappeared. The overall number did not decrease, because hope springs eternal, and other new hedge funds kept being launched at the same time.”
This is reversification at its best, where the word ‘hedge’ has been turned into exactly opposite of what it originally meant.
Another excellent example of reversification is securitization, which has “nothing to do with making things more secure.” Let’s try and understand this step by step.
A big financial institution sells financial securities and raises money. The money is used to buy home loans or mortgages from banks. These home loans are then pooled together. The people who have taken these home loans pay interest on these loans as well as repay their principal. This money comes into the common pool. From this pool, the financial institution pays interest on the securities it has sold to investors. It also repays the principal out of it. This process is referred to as securitization.
In the days when banking was a boring business, banks lent out the money they had collected from deposits. They also kept the loans on their books till they matured. They made money as long as the interest they paid on their deposits was less than what they charged on their loans,a ssuming that the borrower did not stop repaying.
But with securitization the bank does not maintain the loan on its books any more. It passes on the risk to the investor who buys the securities being issued. As Lanchester puts it “It[i.e. the bank] only takes the RISK of the loan for the amount of time between making the initial house loan, and the moment when it has sold the resulting security – which can be a matter of days. The bank has no real interest in the financial condition of the borrower. The basic premise of banking – that you only lend money to people who can pay it back – has been broken.”
Hence, the bank is more interested in giving out home loans rather than verifying whether the borrower has the capability to repay. This was a major reason behind the current financial crisis which started in September 2008.
Lanchester in coining “reversification” has come up with a term which explains a lot of what is wrong in finance. The examples discussed above clearly show that. As Lanchester writes “These are all examples of how process of innovation, experimentation and progress in the techniques of finance have been brought to bear on language, so that words no longer mean what they once meant.”
And this has created a major problem. “It is not a process intended to deceive…But the effect is much the same: it is excluding and it confines knowledge to within a priesthood – the priesthood of people who can speak money,” concludes Lanchester.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)