Opinion If the math and stars align

But on oil and gas exploration,the budget takes a wrong turn

March 1, 2013 10:49 PM IST First published on: Mar 1, 2013 at 10:49 PM IST

Will the math work out? I have not had the time to look at the fine print of the finance minister’s budget to ascertain whether the assumptions that underlie his projections for the fiscal deficit are much too dependent on factors beyond his control and hence subject to a greater degree of uncertainty than was conveyed,or if they are sui generis. Still,I have to admit that as I listened to his speech and heard him announce various proposals that will draw on the exchequer,this question ran through my mind. I looked for the roadmap that would match this expenditure hike with enhanced revenues and confirm that the pathway to a reduction in the fiscal deficit,from 5.2 to 4 .8 per cent of the GDP was solid and not drawn by an accountant,but I could not find it. That said,I have great respect for the FM’s experience and intellect and doubt that he would make a public commitment without a clear sense of how he will get from here to there. So,for me,he gets the benefit of the doubt.

The FM rose to deliver his speech against a challenging backdrop. Every macro index was trending downwards. Growth has slipped to 5.3 per cent,the lowest in a decade; CPI inflation is rigidly stuck in the double digits; the current account deficit,at around 4.5 per cent,is the worst in years and the quality of this deficit,caused by imports of non-productive items like gold and oil,has seldom been so poor; and the combined Central and state government deficit of 8 per cent has raised the Damocles’s sword of the credit -rating agencies over everyone’s head. To make matters worse,the European economy is showing no signs of recovery,the US administration is once again embroiled in a game of economic chicken with Congress,and the international price of oil has been vacillating around $110 per barrel. All this against the political compulsions of an oncoming general election. If ever there was a need to walk a tightrope,it was now.

The FM’s opening remark framed the challenge starkly. He said he had limited economic space but that the economy had to be pushed back onto the path of growth. He accepted that this could be achieved only by reinvigorating investment and that in this context,FDI and FII had to be solicited. He made clear that his budget intent was to galvanise investment. And then he moved onto — as expected — his social agenda. In a masterful sweep,he had something for everyone in the bottom and the middle of the pyramid: the poor,SCs and STs,minorities,the disabled,youth and women. Judging from the fact that he was hardly interrupted,he was striking the right notes.

He returned to the theme of investment after he had completed this sweep. And here he made some strongly positive statements but which,ironically,also threw into relief his vulnerability. He announced a slew of incentives to encourage investment in roads,power,coal mining and clean energy. But having done that,he asked his colleagues to ensure that they did not allow internal bureaucracy and procedure to delay implementation,and that they fully utilised the allocated funds. And there,in my view,lies the rub.

What if these hopes are not realised? What if the trend that we have seen,so far,of delayed projects,continues into next year? After all,the cabinet committee on infrastructure has been in existence for months but projects worth thousands of crores are still stuck in the bureaucratic mire. How will the creation of a new regulatory authority on highways overcome the obstacles that have so far thwarted the highways programme? Will the PPP model for coal mining succeed where PPP models in power,ports and other infrastructure sectors have had mixed results? History is an imperfect guide,but sometimes it is all we have. And history suggests that given that the FM has limited control over the other ministries and the state governments,he should remain,at best,cautiously optimistic.

In one area the FM has taken the wrong turn,and that is with regard to oil and gas exploration. He announced that the government would shift from the current profit-sharing contract model to a revenue sharing model. Currently,the model allows a company to first recover its costs and then share the profits. The first call on the revenue flow is for the recovery of all exploration costs and only after that is the revenue split with the government. This is a time tested and internationally accepted model and was developed keeping in view the capital intensive and high risk nature of exploration.

Our government’s concern,first highlighted by the CAG,is that this model encourages gold plating. The revenue sharing model is to counter this risk. There are two problems with this model. One,it signals to the industry that the government does not trust it and that the international practice for auditing costs through well reputed external auditors is not enough of a safeguard. This signal will exacerbate an already tenuous environment. The industry has ongoing unresolved concerns related to the sanctity of contracts,the price of gas,transfer pricing,and this will only add grist to their mill.

The second problem is more serious because it has longer term ramifications. India has hydrocarbon reserves,but it has had difficulty harnessing them. That is because these reserves are difficult and costly to locate,and even when located,difficult and expensive to develop and produce. For instance,an offshore deep water well can cost upwards of $50 million. Against this backdrop of “non-easy” hydrocarbons,petroleum companies will only risk their capital if they can be assured of a commensurate reward. A contract model that does not allow them to recover their costs will raise their threshold of acceptability. The revenue sharing model works in countries where the risk-reward balance is not so sharp. It does not encourage investors to invest in high risk geologies.

This is a difficult budget to score. All the right steps have been announced. But the arithmetic depends so much on factors beyond the FM’s control that one has to hope the stars are aligned. If not,then we will all be headed into an election against an even more dismal economic and financial backdrop than today.

The writer is former chairman of Shell India. Views are personal