The figure of Rs 10.67 lakh crore is a mind-numbing one. The numeral one followed by 13 zeroes. It is over 10% of the annual size of India’s economy today, and around 9% of the total value of India’s existing coal reserves. But this is the loss to the exchequer, or the unintended gains to private and public sector players, calculated by the government auditor, the comptroller and auditor general (CAG), on account of the allotment of 155 coalfields during the 2004-09 period.

Recently, when the contents of CAG’s draft report on coal became public, it shocked the nation. The impact was similar to the auditor’s 2010 report on 2G spectrum, in which the maximum presumptive loss to the nation was put at Rs 1,76,000 crore. While one can surely accept CAG’s contention that the country should have auctioned resources like coal and spectrum, rather than give them away unilaterally, the figures for the losses seem to be exaggerated.
It appears that the main purpose of CAG in both these instances was to awe and stun the people. In the process, its arithmetic has turned out to be wrong, assumptions underlying the methodology unscientific, and conclusions biased and lopsided. The auditors, one can say, did not understand the manner in which business is conducted in India and abroad. There are several lacunae in the calculations of the loss figures in both 2010 and 2012.

Let’s begin with the methodology of the draft report on coal. CAG said that since the blocks were not auctioned, the buyers (private and state-owned firms) did not pay fair market-related prices for them. The auditor found out the difference between the cost of production and selling price of Coal India Ltd (CIL), the monopoly state-owned player in the sector, for similar fields in the year of allotment. This was the per-tonne windfall gain for the newcomers. CAG multiplied this figure with 90% of the potential reserves in the 155 fields, and arrived at the whopping figure of a loss of Rs 10,67,000 crore.

The first problem with such a methodology is that both costs and prices tend to vary significantly over the lease period (20 years) of any mines. In the case of most minerals, including coal, both the domestic and global prices have behaved in a highly volatile manner in the past five years. And they will continue to rise and fall dramatically over the next two decades. So, to choose figures for a specific year or period and maintain that the operating profit margins will remain the same for the next 20 years seems a suspect way to arrive at any overwhelming and sweeping generalisations.

Second, if one agrees with CAG that its assumptions are right, one will have to instantly concur that CIL, the only coal player in the country, is earning, and has earned, supernormal profits. Since, there is a huge difference between its costs and sale prices, the government should intervene in a bid to reduce its profits so that the nation can benefit in the form of lower coal prices to crucial sectors such as power and steel. In the quarter ended December 2011, CIL’s net profit was over Rs 4,000 crore. But would one advocate this?

Most people tend to forget that CAG’s figure for losses, or unintended gains, was calculated for the entire life of the lease period, or 20 years. Even if its calculations are right, the Rs 10,67,000 crore profits will be earned by the new users of the 155 coal blocks over the next two decades. The yearly figure comes to just over Rs 53,000 crore. This is exactly why Surjit Bhalla, an economist, was able to rip apart the CAG calculations in his piece in the Indian Express (March 24, 2012).

With great sarcasm and glee, Bhalla pointed out that CAG’s alternative and lower windfall loot figure of Rs 6,30,000 crore (based on average prices during the 2004-09 period, and not on 2011 prices as is the case with the higher figure of Rs 10,67,000 crore) came to Rs 1,05,000 crore a year. “In 2004-09, all-India corporate taxes averaged Rs 1.2 trillion (Rs 1,20,000 crore) a year. So, the typical loot was almost equal to all corporate taxes gathered in India? Plausible, but not likely.”

He added that “coal production a year averaged 472 metric tonnes, coal prices Rs 720 a metric tonne, for average coal revenues of Rs 0.34 trillion a year. All coal revenues, therefore, is a third of the CAG excess profit calculation.” Obviously, what Bhalla failed to tell his readers was that while he had taken the loss figure to be the total for the 2004-09 period, CAG had worked out the math on the assumption that this was the profit that the new buyers will earn over the next 20 years.

One does not know for sure how CAG arrived at CIL’s production costs and sales figures. Did it include its operational profits (minus interest, depreciation and tax) or net profits? This distinction will reduce the loss estimates by a considerable amount. More importantly, CAG would not have considered the capital expenses borne by any miner before it can recover the reserves. There are several costs attached to such an expenditure, including opportunity costs, risk-related ones, and interest burden. Thus, while computing the realistic gains, these need to be taken into account.

At the core is the issue of how the government can ask a miner to pay market-related prices for the natural resources. On the flip side, what is the fair price that a user is willing to pay, even if the resources are allocated through an auction? If he or she has to dole out the difference between the average costs and ruling prices, as GAG has suggested, he/she does not gain anything. Moreover, he/she will not pay this difference upfront for 90% of the reserves, most of which will be mined over 20 years. Neither of these expectations makes business logic or sense.

A similar mistake was made by CAG in its 2G spectrum report. In one of its calculations related to the presumptive losses in spectrum allocation, it said that within months of the licences, several telecom players sold stakes to foreign entities at a huge premium. Since the sellers hadn’t started their operations, CAG assumed that the buyers essentially paid for the spectrum. Hence, the price paid by the latter was a fair price in the absence of 2G auctions.

The point that CAG missed out was the fact that the buyers may have paid a premium for several reasons. One, of course, was for the spectrum. Two, the foreigner short-circuited its entry into a lucrative Indian market since it had no idea when the next round of licences would be given by the telecom ministry. Most corporations pay a huge premium, up to 20-30%, to surmount entry barriers. Three, the buyers had to compensate the licence holder for his/her efforts. Thus, the actual loss could not have been equated with the entire premium paid for the licences.

Although the supreme court, CAG and several other critics maintain that to make the allocation of natural resources a transparent process, auction is the preferred route. It will establish what the market is willing to pay and, therefore, be non-controversial. In its 2G order, the apex court has categorically said so, and CAG’s draft report on coal has quoted it. What most people fail to recognise is that auctions, like any other sale process, can be rigged, manipulated and made restrictive.

In the auction for broadband wireless access (BWA) spectrum in 2010, there were allegations that Infotel, the only bidder to get a pan-India BWA licence, acted as a front for Reliance Industries Ltd (RIL). The day the government announced the winners, RIL announced that it would buy majority stake in Infotel. In the case of auction for national highway projects, there has been a controversy that some of the players were asked not to bid for specific contracts. In that sense, the bidding process was restrictive.

Even in the case of internationally competitive bidding for government projects in sectors like power, allegations have been hurled by state-owned units, like BHEL, and foreign entities that the technical and financial specifications of the bids had been deliberately tailor-made to benefit specific bidders. Lalit Modi, the suspended IPL chairman, was accused of doing the same when the BCCI wanted to add two new teams for the league during the fourth 2011 season.
Therefore, the only thing that can ensure fair play in awarding contracts or allocating natural resources is a transparent mechanism, be it through auction and tender, or by invitation. As long as the public knows what has happened, and how, the process will not be tainted. Meanwhile, CAG should hone its calculative and mathematical skills to audit them better. 

This article first appeared in the April 1-15 issue of Governance Now.

Srinivas is a business analyst who has written several books.