So the Prime Minister (PM) Manmohan Singh has finally spoken. But there are multiple reasons why his defence of the free allocation of coal blocks to the private sector and public sector companies is rather weak.
“The policy of allocation of coal blocks to private parties…was not a new policy introduced by the UPA (United Progressive Alliance). The policy has existed since 1993,” the PM said in a statement to the Parliament yesterday.
But what the statement does not tell us is that of the 192 coal blocks allocated between 1993 and 2009, only 39 blocks were allocated to private and public sector companies between 1993 and 2003.
The remaining 153 blocks or around 80% of the blocks were allocated between 2004 and 2009. Manmohan Singh has been PM since May 22, 2004. What makes things even more interesting is the fact that 128 coal blocks were given away between 2006 and 2009. Manmohan Singh was the coal minister for most of this period.
Hence, the defence of Manmohan Singh that they were following only past policy falls flat. Given this, giving away coal blocks for free is clearly UPA policy. Also, we need to remember that even in 1993, when the policy was first initiated a Congress party led government was in power.
The PM further says that “According to the assumptions and computations made by the CAG, there is a financial gain of about Rs. 1.86 lakh crore to private parties. The observations of the CAG are clearly disputable.”
What is interesting is that in its draft report which was leaked earlier in March this year, the Comptroler and Auditor General(CAG) of India had put the losses due to the free giveaway of coal blocks at Rs 10,67,000 crore, which was equal to around 81% of the expenditure of the government of India in 2011-2012.
Since then the number has been revised to a much lower Rs 1,86,000 crore. The CAG has arrived at this number using certain assumptions.
The CAG did not consider the coal blocks given to public sector companies while calculating losses. The transaction of handing over a coal block was between two arms of the government. The ministry of coal and a government owned public sector company (like NTPC). In the past when such transactions have happened revenue from such transactions have been recognized.
A very good example is when the government forces the Life Insurance Corporation (LIC) of India to forcefully buy shares of public sector companies to meet its disinvestment target. One arm of the government (LIC) is buying shares of another arm of the government (for eg: ONGC). And the money received by the government is recognized as revenue in the annual financial statement.
So when revenues from such transactions are recognized so should losses. Hence, the entire idea of the CAG not taking losses on account of coal blocks given to pubic sector companies does not make sense. If they had recognized these losses as well, losses would have been greater than Rs 1.86lakh crore. So this is one assumption that works in favour of the government. The losses on account of underground mines were also not taken into account.
The coal that is available in a block is referred to as geological reserve. But the entire coal cannot be mined due to various reasons including those of safety. The part that can be mined is referred to as extractable reserve. The extractable reserves of these blocks (after ignoring the public sector companies and the underground mines) came to around 6282.5 million tonnes. The average benefit per tonne was estimated to be at Rs 295.41.
As Abhishek Tyagi and Rajesh Panjwani of CLSA write in a report dated August 21, 2012,”The average benefit per tonne has been arrived at by first, taking the difference between the average sale price (Rs1028.42) per tonne for all grades of CIL(Coal India Ltd) coal for 2010-11 and the average cost of production (Rs583.01) per tonne for all grades of CIL coal for 2010-11. Secondly, as advised by the Ministry of Coal vide letter dated 15 March 2012 a further allowance of Rs150 per tonne has been made for financing cost. Accordingly the average benefit of Rs295.41 per tonne has been applied to the extractable reserve of 6282.5 million tonne calculated as above.”
Using this is a very conservative method CAG arrived at the loss figure of Rs 1,85,591.33 crore (Rs 295.41 x 6282.5million tonnes).
Manmohan Singh in his statement has contested this. In his statement the PM said “Firstly, computation of extractable reserves based on averages would not be correct. Secondly, the cost of production of coal varies significantly from mine to mine even for CIL due to varying geo-mining conditions, method of extraction, surface features, number of settlements, availability of infrastructure etc.”
As the conditions vary the profit per tonne of coal varies. To take this into account the CAG has calculated the average benefit per tonne and that takes into account the different conditions that the PM is referring to. So his two statements in a way contradict each other. Averages will have been to be taken into consideration to account for varying conditions. And that’s what the CAG has done.
The PM’s statement further says “Thirdly, CIL has been generally mining coal in areas with
better infrastructure and more favourable mining conditions, whereas the coal blocks offered for captive mining are generally located in areas with more difficult geological conditions.”
Let’s try and understand why this statement also does not make much sense. As The Economic Times recently reported, in November 2008, the Madhya Pradesh State Mining Corporation (MPSMC) auctioned six mines. In this auction the winning bids ranged from a royalty of Rs 700-2100 per tonne.
In comparison the CAG has estimated a profit of only Rs 295.41 per tonne from the coal blocks it has considered to calculate the loss figure. Also the mines auctioned in Madhya Pradesh were underground mines and the extraction cost in these mines is greater than open cast mines. The profit of Rs 295.41was arrived at by the CAG by considering only open cast mines were costs of extraction are lower than that of underground mines.
The fourth point that the PM’s statement makes is that “Fourthly, a part of the gains would in any case get appropriated by the government through taxation and under the MMDR Bill, presently being considered by the parliament, 26% of the profits earned on coal mining operations would have to be made available for local area development.”
Fair point. But this will happen only as and when the bill is passed. And CAG needs to work with the laws and regulations currently in place.
A major reason put forward by Manmohan Singh for not putting in place an auction process is that “major coal and lignite bearing states like West Bengal, Chhattisgarh, Jharkhand, Orissa and Rajasthan that were ruled by opposition parties, were strongly opposed to a switch over to the process of competitive bidding as they felt that it would increase the cost of coal, adversely impact value addition and development of industries in their areas.”
That still doesn’t explain why the coal blocks should have been given away for free. The only thing that it does explain is that maybe the opposition parties also played a small part in the coal-gate scam.
To conclude Manmohan Singh might have been better off staying quiet. His statement has raised more questions than provided answers. As he said yesterday “Hazaaron jawabon se acchi hai meri khamoshi, na jaane kitne sawaalon ka aabru rakhe”.For once he should have practiced what he preached.
(The article originally appeared in the Daily News and Analysis on August 29,2012. http://www.dnaindia.com/analysis/column_why-manmohan-singh-was-better-off-being-silent_1734007))
(Vivek Kaul is a writer and can be reached at [email protected])
As I sit down to write this it is a rather cloudy, dull and insipid morning in Mumbai. An old Tamil number Vaa Vennila composed by the music maestro Ilaiyaraaja and sung by S P Balasubrahmanyam and S Janaki, is playing in the background. I happened to discover this song a few days back, quite by chance, and it has been playing nonstop on my laptop since then. It’s the most melodious composition that I have heard in a long-long time.
Dear Reader, before you start breaking your head over why am I talking about an old Ilaiyaraaja number, when the headline clearly tells you that I should be talking about other things, allow me to explain.
For a music director to be able to create melody a lot of things need to come together. First and foremost the tune has to be good. On top of that the musicians have to be able to flesh out the tune in a way that the music director had originally envisaged it. The lyrics need to make sense. The singers need to get the right emotion into the song and of course not be out of tune. The director of the movie needs to have the ability to recognize a good song when he hears one and not fiddle around with it. And so on.
The point I am trying to make is that “melody” cannot be created in isolation. A lot of things need to come together to create a melodious song and to have an individual born and brought in erstwhile Bihar of Kashmiri Pandit parents, who does not speak a word of Tamil (and not much Kashmiri either), humming it nearly 26 years after it was first released.
What is true about Ilaiyaraaja’s ability to create melody is also true about the ability of Duvvuri Subbarao, the governor of the Reserve Bank of India(RBI), to influence the Indian economy and take it in the direction where everyone wants him to.
The inflation number
The wholesale price index (WPI) inflation number for the month of June 2012 was released sometime back. The inflation has fallen to 7.25% against 7.55% in the month of May. The number has come in much lower than what the analysts and the economists were expecting it to be.
This is likely to lead to calls for the Reserve Bank of India (RBI) RBI to cut the repo rate.
The first quarter review of the monetary policy of the RBI is scheduled on July 31,2012. Industrialists, economists and analysts would want the RBI to cut the repo rate on this day. The repo rate is the interest rate at which RBI lends to the banks.
The first quarter review of the monetary policy is scheduled on July 31,2012. Industrialists, economists and analysts want the RBI to cut the repo rate on this day. The repo rate is the interest rate at which RBI lends to the banks.
So what is the idea behind this? When the RBI cuts the repo rate it is trying to send out a signal to that it expects the interest rates to come down in the months to come. If the banks think that the signal by the RBI is credible enough then they lower the interest rate they pay on their deposits. They also lower the interest rates they charge on their long term loans like home loans, car loans and loans to businesses. With people as well as businesses borrowing and spending more it is expected that the slowing economic growth will be revived.
That’s how things are expected to work in theory. But economic theory and practice do not always go together. The trouble is that even if the RBI cut the repo rate right now, the credibility of the signal would be under doubt, and banks wouldn’t cut interest rates. This is primarily because like Ilaiyaaraja, Subbarao and the RBI also do not work in isolation.
More loans than deposits
The incremental credit deposit ratio of the banks in the six month period between December 30,2011 and June 29,2012, has been 108%. What this means that during this period for every Rs 100 that banks have borrowed by raising deposits, they have loaned out Rs 108. Hence, banks have not been able to match their deposits to loans. They have been funding their loans out of deposits they had raised in periods previous to the six month period considered here. Given the shortage of deposits that banks are facing it doesn’t make sense for them to cut the interest rates on their deposits, even if the RBI were to go ahead and cut the repo rate. And if they can’t cut interest rates on their deposits there is no way the banks are going to cut interest rates on their loans. But why are banks facing a shortage of deposits?
The oil subsidy for this year is already over
The budget for the year 2012-2013 had made a provision of Rs 43,580 crore for oil subsidies. This provision is made to compensate the oil marketing companies (OMCs) Indian Oil Corporation, Bharat Petroleum and Hindustan Petroleum, for selling diesel, kerosene and LPG at a loss. Four months into the financial year the government has already run out of this money. The government has compensated the OMCs to the extent of Rs 38,500 crore for products at a loss in the last financial year (i.e. the period between April 1, 2011 and March 31,2012). This payment was made in this financial year and hence has been adjusted against the Rs 43,580 crore provisioned against oil subsidies in the budget for the current financial year.
The OMCs continue to sell these products at a loss. In the month of April 2012 they lost around Rs 17,000 crore by selling diesel, kerosene and LPG at a loss. In the last financial year the government compensated 60% of this loss. The remaining loss the government forced the oil producing companies like ONGC and Oil India Ltd, to compensate. So using the rate of 60%, the government would have to compensate around Rs 10,200 crore for the losses faced by the OMCs in the month of April. Add this to the Rs 38,500 crore of payment that has already been made, we end up with Rs 48,700crore. This is more than the Rs 43,580 crore that had been budgeted for.
The OMCs continue to lose money
The losses made by OMCs have come down since the beginning of the year. In April, the OMCs were losing Rs 563crore per day. A recent estimate made by ICICI Securities puts the number at Rs 355crore per day. At this rate the companies will lose around Rs 130,000 crore by the end of the year. Even if oil prices were to continue to fall the companies will continue losing substantial amount of money.
All this will mean an increase in expenditure for the government as it would have to compensate these companies to help them continue their operations and prevent them from going bust. An increase in expenditure would mean an increase in the fiscal deficit. Fiscal deficit is the difference between what the government spends and what it earns. The fiscal deficit for the current year has been budgeted to be at Rs 5,13,590 crore. It is highly unlikely that the government will be able to meet this target, given the continued losses faced by the OMCs.
Further borrowing from the government would mean that the pool of savings from which banks and other financial institutions can borrow will come down. This means that to banks will have to continue offering higher interest rates on their fixed deposits and hence keep charging higher interest rates on their loans.
The consumer price index (CPI) inflation for the month of May stood at 10.36%, higher than the 10.26% in April. This is likely to go up even further in the days to come. The WPI inflation coming for the month of June has come in at xx%. And this is likely to push the CPI also in the days to come. CPI inflation will be pushed further given that the government increased the minimum support price on khareef crops from anywhere between 15-53% sometime back. These are crops which are typically sown around this time of the year for harvesting after the rains (i.e. September-October). The MSP for paddy (rice) has been increased from Rs 1,080 per quintal to Rs 1,250 per quintal. Other major products like bajra, ragi, jowar, soybean, urad, cotton etc, have seen similar increases. Also, after dramatically increasing prices for khareef crops, the government will have to follow up the same for rabi crops like wheat. Rabi crops are planted in the autumn season and harvested in winter. This will further fuel food inflation. Food constitutes around 50% of the consumer price index in India. In this scenario of higher inflation it will be very difficult for the RBI to cut the repo rate. And even if it does cut interest rates it is not going to be of any help as has been explained above.
The way out of this mess is rather simple. Oil subsidies need to be cut down. That is the only way the government can hope to control its fiscal deficit. If things keep going the way they are I wouldn’t be surprised if the fiscal deficit of the government even touches the vicinity of Rs 6,00,000 crore against the budgeted Rs 5,13,590 crore.
Only once the government gives enough indications that it is serious about controlling the fiscal deficit, will the market start taking the interest rate policy of the RBI seriously. Before that even if the RBI were to cut interest rates it wouldn’t have an impact.
For Duvvuri Subbarao to make melody like Ilaiyaraaja does a lot of things which are not under his control need to come together. Ilaiyaraaja has control over the people he works with. He can tell his musicians what to play. He can ask his singers to sing in a certain way. He can ask his lyric writer to write a certain kind of song. And so on. Subbarao does not have the same control over the other players in the economy.
So in the meanwhile it is safe to say that try he might as much to make melody like Ilaiyaraaja, chances are he is likely to come up a song Baba Sehgal once made. It was called “Main Bhi Maddona”. For those who have heard the song will know that melody has never been “murdered” more.
(The article originally appeared on www.firstpost.com on July 16,2012. http://www.firstpost.com/economy/post-wpi-subbaraos-music-may-be-more-baba-sehgal-than-ilaiyaraaja-378448.html)
Vivek Kaul is a writer and can be reached at [email protected]
India is country that lives on hope, gods and pipedreams. The Prime Minister Manmohan Singh is no different when it comes to this. In a recent interview after taking over as the finance minister of the country he said he was focusing on controlling the fiscal deficit through a series of measures that the officials were working on.
He did not explain what these measures were. But with things as they stand now, it is next to impossible for the government to control the fiscal deficit and the PM can just hope for the best.
Fiscal deficit is the difference between what the government earns and spends. For the financial year 2012-2013 (from April 1, 2012 to March 31, 2013) this number is expected to be at Rs 5,13,590 crore. The government finances the deficit by borrowing money or taking on debt as it is technically referred to as.
There are several reasons why the fiscal deficit is likely to turn out to be higher than the projected number. Let’s start with oil subsidies. Oil subsidies for the year have been budgeted at Rs 43,580crore. The government has more or less run out of this money. It has paid Rs 38,500 crore to oil marketing companies (OMCs) like Indian Oil Corporation, Bharat Petroleum and Hindustan Petroleum for selling diesel, kerosene and LPG, at a loss during the last financial year. This payment was made only in the current financial year and hence has had to be adjusted against the oil subsidies budgeted for the current financial year.
This leaves only around Rs 5080 crore (Rs 43,580 crore – Rs 38,500crore) with the government for compensating the OMCs for the losses for the remaining part of the year.
International oil prices have come down since the beginning of April. Back then the OMCs were losing around Rs 563crore per day. A recent estimate made at the beginning of July by ICICI Securities puts this loss at Rs 355crore a day. Oil prices have fallen further by around 8% since this estimate was made. Adjusting for that the oil companies continue to lose around Rs 325crore per day or around Rs 10,000 crore per month. Hence the Rs 5080 crore that the government has remaining in its oil subsidy account would be over in a period of 15 days, at the current rate of losses.
Oil prices have fallen by 32% to $85 per barrel since the beginning of April. It’s is unlikely that the price will continue to fall given that at some stage the oil cartel, Organization of Petroleum Exporting Countries (OPEC), will intervene and start cutting production to push up prices. Also, the threat of confrontation between Iran and the United States has been on for a while. Even a whiff of a crisis can push up oil prices. Iran is the second largest producer of oil in OPEC after Saudi Arabia. It has been trying to sell oil in currencies other than the US dollar for the past few years, much to the annoyance of the US.
So if the OMCs continue to lose money at the current rate, the projected losses for the year will be over Rs 120,000 crore. In 2011-2012 the government compensated around 60% of the losses. It got oil producing companies like ONGC and Oil India Ltd to pay the OMCs for the remaining losses. If the same ratio is followed in this financial year as well, it would mean an extra burden of around Rs 72,000 crore for the government (60% of Rs 1,20,000 crore). The fiscal deficit would go up by a similar amount.
Oil subsidies are the not the government’s only problem. On June 14, 2012, the government had approved the minimum support price (MSP) of rice to be increased by 16% from Rs 1250 per quintal from Rs 1080 per quintal. The Food Corporation of India buys rice from the farmers at the MSP. The food subsidy for the current financial year has been set at Rs 75,000 crore. Experts believe that this number is terribly under-provisioned given the various programmes of the government. Also with a significant increase in the MSP of rice the food subsidy is expected to cost the government around Rs 40,000 crore more from its current estimates. Even this number is likely to be beaten because after increasing the MSP of rice significantly, a similar price increase would have to be made for wheat during the coming months.
What does not help is that interest payments on all the money that the government has previously borrowed, comes to Rs 3,19,759 crore. Other than paying interest the government also needs to repay the past debt that is maturing. This amount comes to Rs 1,24,302 crore. Hence the cost of total debt servicing comes to Rs 4,44,061 crore or around 87% of the projected fiscal deficit of Rs 5,13,590 crore for the year. There is nothing that Manmohan Singh and the government can do to control this.
If all these problems were not enough the monsoon till now has been 23% deficient. This impacts the purchasing power of “rural” India and means lower sales of cars, bikes, white goods and fast moving consumer products in rural India, leading to a lower collection of indirect tax for the government. Lower taxes can drive up the fiscal deficit further.
So what is the way out? The subsidy on various oil products needs to be brought down. That’s the only solution that Manmohan Singh led government has to this problem. But the question is will they bite the bullet and make some tough decisions? From the past record it can be safely said, the answer is no. Given these reasons hoping to control the fiscal deficit remains a distant pipe dream.
Hence it’s time for Manmohan Singh to do what most Indians do when they are stretched and stressed. Pray to god. And hope for the best.
(The article originally appeared in the Asian Age/Deccan Chronicle on July 16,2012. http://www.deccanchronicle.com/editorial/dc-comment/fiscal-deficit-and-prayer-god-905)
(Vivek Kaul is a writer and can be reached at [email protected])
The Congress led United Progressive Alliance (UPA) government finally acted hoping to halt the fall of the falling rupee, by raising petrol prices by Rs 6.28 per litre, before taxes. Let us try and understand what will be the implications of this move.
Some relief for oil companies:
The oil companies like Indian Oil Company (IOC), Bharat Petroleum (BP) and Hindustan Petroleum(HP) had been selling oil at a loss of Rs 6.28 per litre since the last hike in December. That loss will now be eliminated with this increase in prices. The oil companies have lost $830million on selling petrol at below its cost since the prices were last hiked in December last year. If the increase in price stays and is not withdrawn the oil companies will not face any further losses on selling petrol, unless the price of oil goes up and the increase is not passed on to the consumers.
No impact on fiscal deficit:
The government compensates the oil marketing companies like Indian Oil, BP and HP, for selling diesel, LPG gas and kerosene at a loss. Petrol losses are not reimbursed by the government. Hence the move will have no impact on the projected fiscal deficit of Rs 5,13,590 crore. The losses on selling diesel, LPG and kerosene at below cost are much higher at Rs 512 crore a day. For this the companies are compensated for by the government. The companies had lost Rs 138,541 crore during the last financial year i.e.2011-2012 (Between April 1,2011 and March 31,2012).
Of this the government had borne around Rs 83,000 crore and the remaining Rs 55,000 crore came from government owned oil and gas producing companies like ONGC, Oil India Ltd and GAIL.
When the finance minister Pranab Mukherjee presented the budget in March, the oil subsidies for the year 2011-2012 had been expected to be at Rs Rs 68,481 crore. The final bill has turned out to be at around Rs 83,000 crore, this after the oil producing companies owned by the government, were forced to pick up around 40% of the bill.
For the current year the expected losses of the oil companies on selling kerosene, LPG and diesel at below cost is expected to be around Rs 190,000 crore. In the budget, the oil subsidy for the year 2012-2013, has been assumed to be at Rs 43,580 crore. If the government picks up 60% of this bill like it did in the last financial year, it works out to around Rs 114,000 crore. This is around Rs 70,000 crore more than the oil subsidy that the government has budgeted for.
Interest rates will continue to remain high
The difference between what the government earns and what it spends is referred to as the fiscal deficit. The government finances this difference by borrowing. As stated above, the fiscal deficit for the year 2012-2013 is expected to be at Rs 5,13,590 crore. This, when we assume Rs 43,580crore as oil subsidy. But the way things currently are, the government might end up paying Rs 70,000 crore more for oil subsidy, unless the oil prices crash. The amount of Rs 70,000 crore will have to be borrowed from financial markets. This extra borrowing will “crowd-out” the private borrowers in the market even further leading to higher interest rates. At the retail level, this means two things. One EMIs will keep going up. And two, with interest rates being high, investors will prefer to invest in fixed income instruments like fixed deposits, corporate bonds and fixed maturity plans from mutual funds. This in other terms will mean that the money will stay away from the stock market.
The trade deficit
One dollar is worth around Rs 56 now, the reason being that India imports more than it exports. When the difference between exports and imports is negative, the situation is referred to as a trade deficit. This trade deficit is largely on two accounts. We import 80% of our oil requirements and at the same time we have a great fascination for gold. During the last financial year India imported $150billion worth of oil and $60billion worth of gold. This meant that India ran up a huge trade deficit of $185billion during the course of the last financial year. The trend has continued in this financial year. The imports for the month of April 2012 were at $37.9billion, nearly 54.7% more than the exports which stood at $24.5billion.
These imports have to be paid for in dollars. When payments are to be made importers buy dollars and sell rupees. When this happens, the foreign exchange market has an excess supply of rupees and a short fall of dollars. This leads to the rupee losing value against the dollar. In case our exports matched our imports, then exporters who brought in dollars would be converting them into rupees, and thus there would be a balance in the market. Importers would be buying dollars and selling rupees. And exporters would be selling dollars and buying rupees. But that isn’t happening in a balanced way.
What has also not helped is the fact that foreign institutional investors(FIIs) have been selling out of the stock as well as the bond market. Since April 1, the FIIs have sold around $758 million worth of stocks and bonds. When the FIIs repatriate this money they sell rupees and buy dollars, this puts further pressure on the rupee. The impact from this is marginal because $758 million over a period of more than 50 days is not a huge amount.
When it comes to foreign investors, a falling rupee feeds on itself. Lets us try and understand this through an example. When the dollar was worth Rs 50, a foreign investor wanting to repatriate Rs 50 crore would have got $10million. If he wants to repatriate the same amount now he would get only $8.33million. So the fear of the rupee falling further gets foreign investors to sell out, which in turn pushes the rupee down even further.
What could have helped is dollars coming into India through the foreign direct investment route, where multinational companies bring money into India to establish businesses here. But for that the government will have to open up sectors like retail, print media and insurance (from the current 26% cap) more. That hasn’t happened and the way the government is operating currently, it is unlikely to happen.
The Reserve Bank of India does intervene at times to stem the fall of the rupee. This it does by selling dollars and buying rupee to ensure that there is adequate supply of dollars in the market and the excess supply of rupee is sucked out. But the RBI does not have an unlimited supply of dollars and hence cannot keep intervening indefinitely.
What about the trade deficit?
The trade deficit might come down a little if the increase in price of petrol leads to people consuming less petrol. This in turn would mean lesser import of oil and hence a slightly lower trade deficit. A lower trade deficit would mean lesser pressure on the rupee. But the fact of the matter is that even if the consumption of petrol comes down, its overall impact on the import of oil would not be that much. For the trade deficit to come down the government has to increase prices of kerosene, LPG and diesel. That would have a major impact on the oil imports and thus would push down the demand for the dollar. It would also mean a lower fiscal deficit, which in turn will lead to lower interest rates. Lower interest rates might lead to businesses looking to expand and people borrowing and spending that money, leading to a better economic growth rate. It might also motivate Multi National Companies (MNCs) to increase their investments in India, bringing in more dollars and thus lightening the pressure on the rupee. In the short run an increase in the prices of diesel particularly will lead higher inflation because transportation costs will increase.
Freeing the price
The government had last increased the price of petrol in December before this. For nearly five months it did not do anything and now has gone ahead and increased the price by Rs 6.28 per litre, which after taxes works out to around Rs 7.54 per litre. It need not be said that such a stupendous increase at one go makes it very difficult for the consumers to handle. If a normal market (like it is with vegetables where prices change everyday) was allowed to operate, the price of oil would have risen gradually from December to May and the consumers would have adjusted their consumption of petrol at the same pace. By raising the price suddenly the last person on the mind of the government is the aam aadmi, a term which the UPAwallahs do not stop using time and again.
The other option of course is to continue subsidize diesel, LPG and kerosene. As a known stock bull said on television show a couple of months back, even Saudi Arabia doesn’t sell kerosene at the price at which we do. And that is why a lot of kerosene gets smuggled into neighbouring countries and is used to adulterate diesel and petrol.
If the subsidies continue it is likely that the consumption of the various oil products will not fall. And that in turn would mean oil imports would remain at their current level, meaning that the trade deficit will continue to remain high. It will also mean a higher fiscal deficit and hence high interest rates. The economic growth will remain stagnant, keeping foreign businesses looking to invest in India away.
Manmohan Singh as the finance minister started India’s reform process. On July 24, 1991, he backed his “then” revolutionary proposals of opening up India’s economy by paraphrasing Victor Hugo: “No power on Earth can stop an idea whose time has come.”
Good economics is also good politics. That is an idea whose time has come. Now only if Mr Singh were listening. Or should we say be allowed to listen..
(The article originally appeared at www.firstpost.com on May 24,2012. http://www.firstpost.com/economy/petrol-bomb-is-a-dud-if-only-dr-singh-had-listened-319594.html)
(Vivek Kaul is a writer and can be reached at [email protected])
“We’re slowly learning that fact. And we’re very, very pissed off.”
—Lines from the movie Fight Club
The government’s piggybank is in trouble. Well not major trouble. But yes some trouble.
The global credit rating agency Moody’s on Monday downgraded the Life Insurance Corporation (LIC) of India from a Baa2 rating to Baa3 rating. This is the lowest investment grade rating given by Moody’s. The top 10 ratings given by Moody’s fall in the investment grade category.
Moody’s has downgraded LIC due to three reasons: a) for picking up stake in the divestment of stocks like ONGC, when no one else was willing, to help the government reduce its fiscal deficit. b) for picking up stakes in a lot of public sector banks. c) having excessive exposure to bonds issued by the government of India to finance its fiscal deficit.
While the downgrade will have no impact on the way India’s largest insurer operates within India, it does raise a few basic issues which need to be discussed threadbare.
From Africa with Love
The wives of certain African dictators before going on a shopping trip to Europe used to visit the central bank of their country in order to stuff their wallets with dollars. The African dictators and their extended families used the money lying with the central banks of their countries as their personal piggybank. Whenever they required money they used to simply dip into the reserves at the central bank.
While the government of India has not fallen to a similar level there is no doubt that it treats LIC like a piggybank, rushing to it whenever it needs the money.
So why does the government use LIC as its piggybank? The answer is very simple. It spends more than what it earns. The difference between what the government earns and what it spends is referred to as the fiscal deficit.
In the year 2007-2008 (i.e. between April 1, 2007 and March 31,2008) the fiscal deficit of the government of India stood at Rs 1,26,912 crore. Fiscal deficit is the difference between what the government earns and what it spends. For the year 2011-2012 (i.e. between April 1, 2011 and March 31, 2012) the fiscal deficit is expected to be Rs 5,21,980 crore.
Hence the fiscal deficit has increased by a whopping 312% between 2007 and 2012. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore. The expenses of the government have risen more than eight and half times faster than its revenues.
What is interesting is that the fiscal deficit numbers would have been much higher had the government not got LIC to buy shares of public sector companies it was selling to bring down the fiscal deficit.
Estimates made by the Business Standard Research Bureau in early March showed that LIC had invested around Rs 12,400 crore out of the total Rs 45,000 crore that the government had collected through the divestment of shares in seven public sector units since 2009. The value of these shares in March was around Rs 9,379 crore. Since early March the BSE Sensex has fallen 7.4%, which means that the LIC investment would have lost further value.
Over and above this the government also forced LIC to pick up 90% of the 5% follow-on offer from the ONGC in early March this year. This after the stock market did not show any interest in buying the shares of the oil major. The money raised through this divestment of shares went towards lowering the fiscal deficit of the government of India.
News reports also suggest that LIC was buying shares of ONGC in the months before the public issue of the insurance major hit the stock market, in an effort to bid up its price. Between December and March before the public offer, the government first got LIC to buy shares of ONGC and bid up the price of the stock from around Rs 260 in late December to Rs 293 by the end of February. After LIC had bid up the price of ONGC, the government then asked it to buy 90% of the shares on sale in the follow on public offer.
This is a unique investment philosophy where institutional investor managing money for the small retail investor, first bid up the price of the stock by buying small chunks of it, and then bought a large chunk at a higher price. Stock market gurus keep repeating the investment philosophy of “buy low-sell high” to make money in the stock market. The government likes LIC to follow precisely the opposite investment philosophy of “buying high”.
Estimates made by Business Standard suggest that LIC in total bought ONGC shares worth Rs 15,000 crore. The stock is since down more than 10%.
The bank bang
LIC again came to the rescue of the cash starved government during the first three months of this year, when it was force to buy shares of several government owned banks which needed more capital. It is now sitting on losses from these investments.
Take the case of Viajya Bank. It issued shares to LIC at a price of Rs 64.27 per share. Since then the price of the stock has fallen nearly 19%.
The same is case with Dena Bank. The stock price is down by almost 10% since allocation of shares to LIC. The share price of Indian Overseas Bank is down by almost 19.7% since it sold shares to LIC to boost its equity capital. While the broader stock market has also fallen during the period it hasn’t fallen as much as the stock prices of these shares have.
There are more than a few issues that crop up here. This special allotment of shares to LIC to raise capital has pushed up the ownership of LIC in many banks beyond the 10% mandated by the Insurance Regulatory and Development Authority of India, the insurance regulator. As any investment professional will tell you that having excessive exposure one particular company or sector isn’t a good strategy, especially when managing money for the retail investor, which is what LIC primarily does. What is interesting is that the government is breaking its own laws and thus not setting a great precedent for the private sector.
If LIC hadn’t picked up the shares of these banks, the fiscal deficit of the government would have gone up further. The third issue here is why should the government run so many banks? The government of India runs twenty six banks (20 public sector banks + State Bank of India and its five subsidiaries).
While given that banking is a sensitive sector and some government presence is required, but that doesn’t mean that the government has to run 26 banks. It is time to privatise some of these banks.
Gentlemen prefer bonds
As of December 31, 2011, the ratio of government securities to adjusted shareholders’ equity in LIC was 764%. This is understandable given that the subsidy heavy budget of the Congress led UPA government has seen its fiscal deficit balloon by 312% over the last five years. Again basic investment philosophy tells us that having a large exposure to one investment isn’t really a great idea, even if it’s a government.
The Rahul factor
But the most basic issue here is the fact that the government is using the small savings of the average Indian who buys LIC policies to make loss making investments. This is simply not done.
LIC has turned into the behemoth that it has over the years by offering high commissions to its agents over the years. It sells very little of “term insurance”, the real insurance. What it basically sells are investment policies with very high expenses which are used to pay high commissions to it’s the agents. The high commissions in turn ensure that these agents continue to hard-sell LIC’s extremely high cost investment policies to normal gullible Indians. The premium keeps coming in and the government keeps using LIC as a piggybank.
The high front-loading of commissions is allowed by The Insurance Act, 1938. The commission for the first can be a maximum of 40 per cent of the premium. In years two and three, the caps are 7.5 per cent, and 5 per cent thereafter. These are the maximum caps and serve as a ceiling rather than a floor.
The Committee on Investor Protection and Awareness led by D Swarup, the then Chairman of Pension Fund Regulatory and Development Authority, had proposed in September 2009 to do away with commissions across financial products. “All retail financial products should go no-load by April 2011,” the committee had proposed in its reports.
The National Pension Scheme(NPS) was already on a no commission structure. And so were mutual funds since August 1, 2009. But LIC and the other insurance companies were allowed to pay high commissions to their agents. “Because there are almost three million small agents who will have to adjust to a new way of earning money, it is suggested that immediately the upfront commissions embedded in the premium paid be cut to no more than 15 per cent of the premium. This should fall to 7 per cent in 2010 and become nil by April 2011,” the committee had further proposed.
Not surprisingly the government quietly buried this groundbreaking report.
While insurance commissions have come down on unit linked insurance plans, the traditional insurance policies in which LIC remains a market leader continue to pay high commissions to their agents. These traditional insurance policies typically invest in debt (read government bonds which are issued to finance the fiscal deficit).
This is primarily because the Congress led UPA government needs the premium collected by LIC to run LIC like a piggybank. The piggybank money can and is being used to run subsidies in the hope that the beneficiaries vote for Rahul Gandhi in 2014.
Is the objective of LIC to generate returns and ensure the safety of the hard earned money of crores of it’s investors? Or is it to let the UPA government run it like a piggybank in the hope that Rahul baba becomes the Prime Minister?
The country is waiting for an answer.
(This post originally appeared on Firstpost.com on May 15,2012. http://www.firstpost.com/politics/lic-money-is-it-for-investors-benefit-or-rahul-election-309545.html)
(Vivek Kaul is a writer and can be reached at [email protected])