Coal Auctions: The Role Of Government And The People

Why auctioning of the coal blocks is the right thing to do, economically

The last week has been big. Massive, dare I say, in terms of what future beholds. To put things in perspective, the CAG had said in its report, tabled in Parliament in 2014, that the loss to the government was about 1,86,000 crore rupees. This was in reference to UPA-2’s seemingly surreptitious procedure of arbitrarily allocating more than 200 coal blocks in its tenure.

In comes the new govt, the SC deallocates the blocks meanwhile, and we have a new auction. An auction of merely 21 coal mines. And what does it fetch? A whooping 1,00,000 crore! It’s evident as to who is having the last laugh here.

Why isn’t everyone happy with the auctions? I will try to deal with this in somewhat a normative manner. What is it that we want, in the end? It’s important to have clarity on this. I think it’s perfectly reasonable to say that we care only about the end result – the real price that the consumers pay for their electricity. With this goal in mind, we can analyse the old system and the new one. Typically, when it comes to any topic like coal block allocation, people keep shifting the goalpost by saying, what about the wealth creating corporates, what about the risk, and what not. While they all could be fair points, I don’t think going into each of those adds much value.

The crux of the matter, as I see it, is whether in an attempt to have a procedure to avoid losses to the exchequer, the government has gone overboard in creating strong disincentives for corporates. And, whether the cost of higher coal prices will be borne, eventually, by the consumers.

During UPA’s time, coal blocks were allocated through a discretionary mechanism without any auction, for “free”. Free is in quotes because even five-year old in India would know that in order to procure the blocks, the companies would have paid the money to the ministers and his colleagues. Since that is completely unobservable, we have to take wild guesses for the same. But at any rate, I think it’s only fair to assume that the price they would have had to pay in bribes would be considerably less than the price they paid in the auction.

The whole idea behind these auctions is that the government will redistribute the revenues to the consumers. One might think then that this will be a zero sum game. But it isn’t. Let’s take a very simple example. Suppose there’s a producer who procures coal, turns it into a diamond and sells to a consumer. The consumer can pay at most 100 rupees for a diamond. The final price depends on whether the producer is a monopolist, an oligopolist, or if he is in, what is known as perfect competition. In perfect competition the producer makes zero profits by charging at the cost. Let’s look at these scenarios in the auction vs bribe environment.

Suppose in UPA’s time, the producer would have paid a bribe of 10 rupees to the govt. He can charge at most 100 if he is a monopolist and would have to charge 10 in perfect competition. The price for an oligopolist would be somewhere in between.

In case of auction, it is obvious that the coal company will not pay more than 100. Let’s say the government fixes the reserve price at 90. The point is, even then there will be takers as there are profits on the table. Let’s say the winning bid is also 90. In case of perfect competition it won’t be, but let’s say it is. The table above summarizes what happens in each of those settings. In real world, the outcome will be somewhere in between the two extremes of monopolist and perfect competition.

From this, one may be tempted to conclude that with the auction, if you look at the consumer’s profit he is worse off! And hence auctions are bad. But that is the whole point. The idea is the government will redistribute the money and the consumers will earn a lot of profit. The government will transfer 90 rupees to the consumer earning him a profit of 90 if he’s facing a monopolist and 100 if he’s facing perfect competition. Contrast that with the bribe environment. Who has lost out then?

It is obvious that it is the corporates whose profits have been squeezed. If that was the motive then auctions are a great way to do it. Bear in mind that the kind of bidding we have seen bears testimony to the fact that the corporates do see immense profit there.

Most importantly, in the old regime, the revenue would have gone to the minister and hence could not have been transferred even if the minister wishes to do so. Secondly, due to the illegal nature of the transaction, the amount transferred to the minister would have been tiny in comparison with the bids. Therefore, the entire “surplus” or the profits in the previous regime went to the corporates.  Yet, ironically, it is Modi who is called the corporate agent.

When it comes to real world, the issue in a country like India, is the leakages when the goverment transfers money to people through public schemes. Often, if 100 rupees are transferred, say, 10 will reach the consumer. In such cases it is obvious that essentially the goverment has burned the money. Because it has reduced the profits of corporates and consumers are no better off either. However, that simply cannot be a criticism of the current government. The correct thing to do is to have auctions and a leakage-proof mechanism for transfers. Because the latter doesn’t exist at the moment, allowing goverment officials to indulge in quid-pro-quo acts sets a precedent that’s largely responsible for all the mess we are in today. We have taken one step in the right direction. The next, from what it seems, should follow.

There are mainly two criticisms of the auction. One is that it is punishing the wealth-generating corporates. I fail to understand this. No corporate is going to bid more than what they can earn back. First of all, in all likelihood, the corporates were anyways closer to a monopoly pricing before. Now, with the increased cost even if they increase prices to pass on some of the costs to the consumer, recall the example of the coal-diamond. The government can and will transfer money to the consumers to shield them from such gouging. Secondly, why should we care if the corporates’ profit margins are squeezed? The coal block belongs to the exchequer and they should get the surplus, not the mining companies.

Second, for some mysterious reasons, Mr Mihir Sharma in his Business Standard piece, primarily criticizes the government for the possibility of maximizing current revenue at the cost of future revenue and also for reserving some coal blocks for power sector. The argument is somewhat disturbing. The companies are looking at a 30 year time frame when bidding. Are we supposed to believe that companies are bidding “aggressively out of desperation” as he likes to think and after 30 years we will have a crisis? As Anil Swarup, the coal secretary said in this interview, “I am hoping that people who are bidding are doing so with their eyes wide open, which I am sure they are.”. For Mihir Sharma to assume that corporates may be bidding out of psychological reasons in hundreds of crores is naive. Secondly by separating coal blocks into different uses, he argues, companies in regulated sector will pay a price that does not make sense from the perspective of the economy. Sounds sensible until you realize it’s vacuous. What does it mean to say that a price x doesn’t make sense from the perspective of the economy? What is the right price? It would have been far better had Mr Sharma tried making a precise argument as to why this split into regulated and unregulated sector is not good.

The argument would be “efficiency”. This split is going to create a situation where companies that value coal the most may not necessarily get it. However, the point to realize is, as a government, along with raising revenue it also wants to ensure that power tariffs don’t go up. So, it has to be ensured that the power companies get as much coal as they want. Fundamentally, from the perspective of economics, it’s not required as the government can generate more revenues by having the auction without this split and compensating the power companies for the differential price they face in the new market for coal. But, this is hardly worth breaking one’s head on. And in any case, Mr Sharma isn’t making a clear point on this line.

Moreover, observe that even after a 30% price fall in the international coal price, the domestic coal still remains extremely cheap. So be rest assured that we aren’t doing the noble corporates any disservice. Sometimes I do feel though, that those who shed so many tears for the corporates, wept a little for the workers in those coal mines too. As I have said in the past, having the heart in the right place isn’t that difficult. And will probably have great returns.

For now though, I hope people celebrate wholeheartedly one of the greatest feats of the current government. “Where are the 1.78 lakh crores?”, Manish Tewari had asked mocking the CAG. The corporates of India have given their answer, emphatically. They are with the government Sir, and using almost the first principles of economics. Institutions and countries evolve by taking baby steps. Let’s welcome the first step with an open mind, leaving aside our political affiliations for a moment.