Opinion Discounting the accounting

So where do we go from here? At a minimum,we should have a balanced debate,a balanced appraisal and an even more balanced remedy. An essential part of this balancing act is that we do not exaggerate the problem in order to either draw attention,or be holier than thou. Or indeed to be disingenuous.

It is with this as background that I want to discuss two recent debates in India — the intellectual corruption with respect to poverty in India (next week),and money corruption with respect to the coal allocations. Last week (‘Where donkeys fly’,Indian Express,March 24,goo.gl/ LaEZb),I had assessed the CAG’s allegation that Rs 10.67 lakh crore had accrued as windfall gains to those who had been allotted licences to explore coal mines in India during the UPA reign from 2004 to 2009. By any criterion,this is a woman-bites-dog story. The alleged corruption amount is not small. It is more than five times the exaggerated notorious figure of Rs 1.76 lakh crore that the CAG had imagined was lost with respect to the 2G scam. It is close to 7.6 per cent of India’s GDP in 2011,or close to the entire consolidated central and states fiscal deficit of India.

How realistic was/is this number? Not very,and that was the point of my earlier article. In an informed,and informative,Financial Express editorial on the same day (goo.gl/yaUv1),the same point was made — the Rs 10.7 lakh crore was,at best,a wild exaggeration. Should one dare say,a corrupt exaggeration? Despite these assessments,and despite an initial withdrawal from the CAG of its figure (it is just a preliminary report etc),we now receive the news that the CAG report is about to be finalised,as is. Further,that the Rs 10.7 lakh crore figure was conservative,implying thereby that the “true” figure was very likely to be considerably higher. And,in the words of the CAG chairman,Vinod Rai,the CAG was internationally renowned for its accounting research and had been hired by international organisations.

As an Indian,I am always proud of Indian accomplishments and Rai’s comments are reassuring with regard to the credibility of the Rs 10.7 lakh crore figure. Case closed — not quite. The reality is that the CAG,at least in its Coalgate report,betrays a complete lack of understanding of even the first principles of accounting/auditing — and auditing is the CAG’s middle name.

On page 34 of the 111-page draft report,the CAG presents a detailed table of the “windfall gains” that accrued to Indian corporations with the 33 billion tonnes of coal reserves allocated between 2004 and 2009. The table also states that the windfall gain accruing at prices prevailing at the time of allotment was a 41 per cent lower figure of Rs 6.3 lakh crore. The footnote to the table,in bold italics,also correctly warns that “the actual amount of gain to the allocattees may change depending upon the mining plan,cost of extraction of coal by the allocattees,market price of the coal and quality of coal”.

Forewarned is forearmed but not as far as the rockstar publicity-hungry CAG and the lap-it-up media is concerned. What was splashed in the papers,and in the equally publicity-at-any-cost opposition politicians’ domain,was the Rs 10.67 lakh crore figure,and not the Rs 6.3 lakh crore figure. The latter figure is more relevant because it takes costs and sale price and assumed windfall gains in the years of allocation. The Rs 10.67 lakh crore figure projects the benefit at the 2011 sale prices,but not at the 2011 cost of production. Further,nowhere was it mentioned that practically very little of the Rs 6.3 lakh crore profit had actually been realised — all of this was projected and in the far distant future of 25 to 30 years,i.e. the typical amount of time it takes for coal to be extracted,and sold for the “windfall gain”.

Imagine I ask you to give me Rs 2,500 in exchange for which I will give you Rs 100 for the next 25 years. Fair exchange,they say,is no robbery but even an accounting sophomore,and especially an accounting sophomore,will reject the deal. Why? Because there is a time cost to the money,a cost that depends on the safest alternative investment. Rs 100 invested today will be 10 per cent higher next year; alternatively,Rs 100 received next year is worth less than Rs 100 this year.

Assume for a moment that the windfall gains of Rs 6.3 lakh crore accrue evenly over the next 25 years,i.e. Rs 25,200 crore per year. How much is this flow today,assuming the risk-free deposit rate is 10 per cent? It is 60 per cent lower. So Rs 6.3 lakh crore is actually Rs 2.5 lakh crore in accounting,and auditing,terms. Further,the CAG rather ambitiously and optimistically and unrealistically assumes that 90 per cent of allocated coal will be extracted. From the red herring prospectus of CIL,one obtains the insight that of its own “superior quality” reserves,CIL deems only 42 per cent of its proven reserves to be extractable. Applying the same factor to the 33 billion tonnes (the actual factor is likely to be less) one obtains the result that the windfall gain is not Rs 6.3 lakh crore but only Rs 1.18 lakh crore.

Also,instead of doing the discounting,both in terms of time value of money and extractability of coal reserves ourselves,the market itself provides a figure through the market capitalisation of CIL. This is presented as estimate 2 in the table. Assuming the same market-cap-to-reserves ratio since CIL has been taken as the benchmark,the private sector’s gain is Rs 62,000 crore,a number which by its striking proximity to the first estimate of Rs 55,000 crore reaffirms its correctness.

There is one further necessary adjustment/calculation. The CAG seems to be of the opinion that profits that accrue to CIL are holy,but the profits accruing to other public sector firms are not. Why this Kolaveri Di treatment to NTPC and other PSUs? So,without rage,let us calculate profit accruing to the bad private sector capitalists. Well,these coal dirty capitalists were only able to garner about 47 per cent of the windfall coal allocation. So the windfall gain accruing to them has a present discounted value of Rs 55,000 crore,which is only 5.1 per cent of the much-bandied corruption figure of Rs 10.67 lakh crore. Furthermore,profits should accrue to those who undertake the risks of the venture,so it is not exactly clear how all of this is “corrupt”.

These calculations are what a good accountant would do —CAG,are you listening?

The author is chairman of Oxus Investments,an emerging market advisory firm