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http://www.kotaksecurities.com/pdf/indiadaily/indiadaily26032012.pdf
No longer a matter of philosophy. Recent press articles on purported large losses to
the exchequer as computed by India’s CAG on coal blocks awarded to the private
sector in the past will likely raise questions about (1) the Government’s response in
‘taxing’ the profits derived from natural resources awarded at low cost in the past and
(2) award of such natural resources in the future. Our February 28, 2012 report, titled
Philosophical questions but logical outcomes, deals with these issues in great detail.
Be prepared for higher royalty or taxes on natural resources awarded below-market prices
As discussed in our February 28, 2012 report, we do not rule out the possibility of the Government
taxing the profits of companies that (1) had received natural resources for free or below-market
prices in the past and (2) sell their products based on the natural resources at market (invariably
global) prices. Coal blocks and mineral mines would come in this category. We think that
imposition of royalty on revenues or tax on profits will be the most logical outcome of this debate.
Even Government companies will have to pay more for nominated blocks
The Government’s (1) recent decision to raise the rate of cess on crude oil and (2) intention to
implement the Mines and Mineral (Development and Regulation) Bill that specifically contains
provisions for a mining tax on profits of companies further strengthen our viewpoint. We also
expect royalty rates on nominated blocks of Coal India, OIL and ONGC to go up further as the
Government aligns their selling prices to global levels over a period of time. Nonetheless, these are
the only entities that can raise prices (political and social factors permitting) to offset the impact of
higher taxes. Their private-sector counterparts already sell their products at global prices and thus,
would not be in a position to raise prices further.
Award of natural resources only through auctions in future
The Supreme Court’s February 2, 2012 judgment on the 2G scam case and heightened public
scrutiny of Government actions practically rule out the awarding of natural resources on a
discretionary basis, in future. The Government has filed a review petition in the Supreme Court
arguing against judicial intrusion over executive matters. Nonetheless, we can rule out the old
process of awarding natural resources, such as coal blocks and mineral ores, on a discretionary
basis irrespective of the outcome of the review petition.
The old order changeth, but where is the new one? Beware the investment cycle
India’s evolution to a country with more transparent systems and stronger democratic institutions
will eradicate vestiges of an earlier discretion-based system in the few remaining areas (coal blocks
and mineral ores). However, this would also mean that India’s investment cycle will suffer unless it
can quickly evolve new rule-based transparent processes for award of all natural resources. In
particular, it is imperative that India’s Government (1) exorcises a growing feeling of undue State
intervention among investors through the establishment of rule-based transparent processes and
systems and (2) fixes its coal sector to kick-start a flagging investment cycle. India has tremendous
reserves of coal (see Exhibit 1) but exploitation has been sub-optimal so far.
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