Why the disinvestment process is getting messier

market fall
Vivek Kaul

This song from the 1968 Hindi movie Teen Bahuraniyan best explains the state of the Congress party led United Progressive Alliance government. As the lines from the song go “aamdani atthani kharcha rupaiya, bhaiya, na poocho na poocho haal, nateeja than than gopal”. Loosely translated this means that when you keep spending more than what you earn, you are bound to end up in a mess sooner rather than later.
One area where the mess is getting more obvious by the day is the area of disinvestment of shares held by the government in public sector companies. The idea was that by selling these shares the government would be able to reduce a part of its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.
During the course of this financial year (i.e. the period between April 1, 2012 and March 31, 2013) the government had expected to earn Rs 30,000 crore by selling shares of public sector companies to the public. This number has since been revised to Rs 24,000 crore.
This has been a tad better than the last financial year (i.e. the period between April 1, 2011 and March 31, 2012) when the government had targeted to raise Rs 40,000 crore through the disinvestment of shares but finally managed to raise only
Rs 13,894 crore.
What is interesting is that even the amount that will be raised by selling shares of the PSUs during the course of this financial year, wouldn’t have been raised if the government hadn’t forced the Life Insurance Corporation (LIC)of India to come to its rescue.
The insurance major is supposed to have bought 46% of the 69 million shares of RCF that were disinvested last week. LIC as expected denied that it had rescued the government. “We have not bailed out anyone. We have examined this (RCF) issue by its own strength and then taken a decision to participate. We will examine the future issues in a similar manner and then take a call,” D K Mehrotra, chairman of LIC, told Business Standard on March 13, 2013. In November 2012, LIC had come to the rescue of the government by picking up 43.6% of the nearly 52 million shares of Hindustan Copper that were being sold.
In March 2012, LIC had picked up 88.3% of the 427 million shares of ONGC that were being sold. When a government owned insurance company has to pick up 88% of the shares being sold, what it clearly tells you is that there was no real demand for the share in the stock market. The government thus raised around Rs 11,275 crore from LIC. 
The government was also expected to sell shares in Metals and Minerals Trading Corporation(MMTC) of India, but that has been postponed. The government and the merchant bankers of the issue could not agree on the price at which the shares of MMTC would be sold. The merchant bankers seem to have told the government that Rs 75 per share was a fair price of an MMTC share. The trouble though is that currently one MMTC share is worth around Rs 302 (as I write this) in the stock market.
But there is a simple explanation for this huge difference. As an editorial in Business Standard points out “However, rather than getting carried away with the wide gap between the market price and the fair value assigned to the company’s shares by merchant bankers, the government should note that the current stock price of MMTC Ltd is produced by market dynamics – but with constrained supply. Only 0.6 per cent of the stock is freely floating.”
The point is that the government is being greedy here. But that ‘greed’ of course comes with the confidence that LIC can always be made to buy these shares. The MMTC situation is similar to that of ONGC, where the shares were priced so high that the investors were simply not interested in buying it. As the Business Standard points out “ The government may have deferred the proposed stake sale in the state-owned mineral trading company MMTC Ltd over valuation differences with merchant bankers, but it would do well to recall the debacle associated with the share sale of the state-controlled oil company ONGC last March. On that occasion, the government priced ONGC’s shares at Rs 290 each; institutional investors saw little value in bidding for them at that price – higher than the market price that was prevailing then. The government had to ask the Life Insurance Corporation of India to bail out the issue.”
The disinvestment of other companies like Steel Authority of India Ltd (SAIL) and National Aluminium Company Ltd (NALCO) also seems to be in trouble. The share price of both these companies is currently at more or less their one year low levels. The same stands true for MMTC as well.
What the ONGC experience hopefully must have taught the government is that while selling shares of a company which is already listed on the stock exchange it cannot demand a price that is higher than the price the share is selling at, in the stock market. So if a share is selling at a price of Rs 100, the government cannot demand Rs 120, simply because the investor has the option of buying the share from the stock market.
Given this, it means that if the government wants to sell the shares of SAIL, MMTC and NALCO, it will have to sell them at a price which is lower than their market price to make it an attractive proposition for investors. And since the market price is at around the one year low level, the government will be unable to raise as much money from these stake sales as it had expected to. Of course the government can always dump these shares on LIC , which would be more than happy to buy it. The disinvestment of NALCO which is located primarily in Orissa is being opposed by the ruling party in the state, the Biju Janta Dal.
There are several points that stand out here. If the government is having so much trouble achieving a scaled down disinvestment target of Rs 24,000 crore for this year, how will it achieve the target of Rs 54,000 crore which it has set for itself in the next financial year? It also raises the question that was a high figure of Rs 54,000 crore just assumed to project a lower fiscal deficit for the next year?
The second point is that at Rs 54,000 crore, disinvestment receipts are expected to bring in 6% of the total revenues of the government during the next financial year. This a rather huge number to be left to the vagaries of something as moody as the stock market. The government is only doing this because it is confident that it can get LIC to pick up the tab if the stock market is not interested.
In fact that is why it has passed a special regulation allowing LIC to own upto 30% of shares in a company against the earlier 10%. This in a scenario where the other insurance companies can own only upto 10% of a listed company. How can there be two separate rules for companies in the same line of business?
Also what happens in a situation when LIC ends up investing in a company which turns out to be a dud? Imagine what would happen when LIC decides to get out of the shares of such a company. The stock price of the company will fall, impacting returns of investors who have bought insurance plans from LIC. As the old saying goes, “putting all eggs in one basket” is a pretty risky proposition and goes against the basic principles of investing. What makes the situation even more dangerous is the fact that it is public money that is at stake.
Also when LIC has to anyway pick up these shares why go through this entire charade of disinvestment in the first place? The government can simply sell these shares directly to LIC and get done with it.
There is another basic issue here. Amay Hattangadi and Swanand Kelkar of Morgan Stanley Investment Management point this out in a report titled Connecting the Dots: “As trained Accountants, we have learnt that sale of Assets from the Balance Sheet are one-off or non-recurring items.”
In simple English what this means is that shares once sold cannot be resold. By selling shares the government is raising a one time revenue. On the other hand, using this revenue it is committing to expenditure which is more or less permanent. And that really can’t be a good thing in the long run.
But politicians really don’t live for the long run. They survive election by election. And there is one due next year.
The article originally appeared on www.firstpost.com on March 14, 2013. 

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

CAG was over-conservative in its Rs 1,86,000 cr loss number

Vivek Kaul

The Congress party seems to be hell bent on discrediting Vinod Rai, the Comptroller and Auditor General(CAG) of India, who has put the estimate of the losses on account of coal-gate at Rs 1.86 lakh crore.
The latest Congress politician to join the “pull Rai down” bandwagon is Digvijaya Singh.
Singh told The Indian Express that “the way the CAG is going, it is clear he(i.e. Vinod Rai) has political ambitions like TN Chaturvedi (a former CAG who later joined the BJP). He has been giving notional and fictional figures that have no relevance to facts. How has he computed these figures? He is talking through his hat.”
Let’s try and understand why what Singh said is nonsense of the highest order and anyone who has read the CAG report wouldn’t say anything that was as remarkably stupid as this. But before I do that let me just summarise the coalgate issue first.
Between 1993 and 2011, the government of India gave away 206 coal blocks for free to government and private sector companies. The idea being that Coal India Ltd wasn’t producing enough coal to meet the growing energy needs of the nation. So free coal blocks were given away so that other companies could produce coal to meet their own coal needs.
Of these blocks given away for free, 165 blocks were given away free between 2004 and 2011. The Congress led United Progressive Alliance(UPA) has been in power since May 2004. Hence, 80% of the coal blocks have been given away for free during the reign of the Congress led UPA government.
This explains to a large extent why the Congress leaders are trying to discredit the CAG. Before Digvijaya Singh, the Prime Minister Manmohan Singh broke his silence for once, and said that the CAG report could be questioned on a number of technical points. The finance minister P Chidambaram said there had been no losses because of free coal blocks allocations and then denied making the statement a little later.
The CAG report on the coalgate scam explains in great detail the method they have used to arrive at a loss figure of Rs 1.86 lakh crore. Hence Singh’s question “how has he computed these figures?” is sheer rhetoric and nothing else.
As is the case with any estimate the CAG made a number of assumptions (for those who have a problem with this, even the government’s annual budget is an estimate which is replaced by a revised estimate a year later, and the actual number two years later). The CAG started with the assumption that the coal mined out of the coal blocks has been given away for free. This coal could be sold at a certain price. Since the government gave away the blocks for free, it let go of that opportunity. And this loss to the nation, the CAG has tried to quantify in terms of rupees, in its report.
There were other assumptions that were made as well. Only the coal blocks given out to private companies were taken into account while calculating losses. Blocks given to government companies were ignored. Personally, I would have liked CAG to take the government companies into account as well while calculating the losses, because a loss is a loss at the end of the day. Also, transactions happen between various sections of the government all the time and the money earned on account of these transactions is taken into account. So should the losses. Out of the 165 blocks allocated since 2004, 83, or around half were allocated to government owned companies.
The amount of coal in a block is referred to as the geological reserve. The portion that can be mined is referred to as the extractable reserve. The CAG calculated extractable reserves of the private coal blocks to be around 6282.5million tonnes. This is the amount of coal that could have been sold.
The second part of the calculation was arriving at a price at which this coal could have been sold. For this the CAG looked at the prices at which Coal India, which produces 80% of India’s coal, sells its various grades of coal. Using these prices it arrived at an average price of Rs 1028.42 per tonne of coal. Obviously there is a cost involved in producing this coal as well. The average cost of production came to Rs 583.01 per tonne. Other than this a financing cost of Rs 150 per tonne was also taken into account.
This meant a profit of Rs 295.41 per tonne of coal (Rs 1028.42 – Rs 583.01 – Rs 150). Hence the government had lost Rs295.41 for every tonne of coal that it gave away for free. Hence, the losses were estimated to be at Rs 1,85,591.33 crore (Rs 295.41 x 6282.5 million tonnes).
This brings me back to Digvijaya Singh. “He has been giving notional and fictional figures that have no relevance to facts,” a part of his statement said. The numbers are not fictional at all. They are backed by hardcore data. If you don’t use the numbers of Coal India, a company which produces 80% of the coal in India, whose numbers do you use? That is a question that Singh should answer.
Also, the price at which Coal India sells coal to companies it has an agreement with, is the lowest in the market. It is not linked to the international price of coal. The price of coal that is auctioned by Coal India is much higher than its normal price. As the CAG points out in its report on the ultra mega power project, the average price of coal sold by Coal India through e-auction in 2010-2011 was Rs 1782 per tonne. The average price of imported coal in November 2009 was Rs 2874 per tonne (calculated by the CAG based on NTPC data). The CAG did not take into account these prices. It took into account the lowest price of Rs 1028.42 per tonne, which was the average Coal India price.
Let’s run some numbers to try and understand what kind of losses CAG could have come up with if it wanted to. At a price of Rs 1,782, the profit per tonne would have been Rs 1050 (Rs 1782-Rs 583.01- Rs 150). If this number had been used the losses would have amounted to Rs6.6lakh crore.
At a price of Rs 2874 per tonne, the profit per tonne would have been Rs 2142(Rs 2874 – Rs 583.01 – Rs 150). If this number had been used the losses would have been Rs 13.5lakh crore. This number is a little more than the Rs 13.18 lakh crore expenditure that the government of India incurred in 2011-2012.
Even a weighted average price of these three prices would have implied a loss of Rs 7.3lakh crore. And this when the coal blocks given to government companies haven’t been taken into account at all.
So the point is that the CAG like a good accountant has worked with very conservative estimates and come up with a loss of Rs1.86 lakh crore. It could have easily come up with substantially bigger numbers as I just showed.
Now coming to the final charge of Vinod Rai having political ambitions. “The way the CAG is going, it is clear he(i.e. Vinod Rai) has political ambitions like TN Chaturvedi (a former CAG who later joined the BJP),” said Singh. Well just because one former CAG joined politics does not mean that every other CAG will follow him.
Singh should well remember the old English adage: “one swallow does not a summer make”.
(The article originally appeared on www.firstpost.com on September 1,2012. http://www.firstpost.com/business/cag-was-over-conservative-in-its-rs-186000-cr-loss-number-439355.html)
(Vivek Kaul is a writer and can be reached at [email protected])