Monday, May 21, 2018

Will corporate India come to the rescue of India’s farmers?

Farmers across the country are extremely agitated.

A quick scan of just the English language media – which typically does not show much interest in rural India – reveals the numerous protests in which they have taken part, among the recent being the long march to Mumbai by tens of thousands of farmers. More protests are expected in the coming days.

Common to all the protests are the demands for a complete loan waiver and fair prices for farm produce. As an earlier piece explains, the returns to the farmer are barely sufficient to sustain him and often below the cost he incurs. At the same time, wholesale traders bringing the farmer’s produce to the consumer enjoy hefty margins unjustified by the value they add. The market has failed the Indian farmer and this is at the root of the farm crisis.

How is this situation to be remedied? There are two diametrically opposing views.

One view is that the state must accept responsibility for the well being of the farmer and weigh in on the side of the farmer to compensate for the fundamental asymmetry in the economic standing of farmers and traders.

The other view derives from an unquestioning belief in the efficacy of the free market. It is useful to consider this in some detail because of the influence it has on policy makers.

The free market vision

‘Free marketers’ believe that state interventions and controls in the agriculture market have distorted prices. Freed from these, the market itself would enable true price discovery and improve the terms of trade for farmers.

The specific interventions that India’s free marketers would like to see ended are the state declaring Minimum Support Prices (MSPs), procuring grains and pulses, regulating wholesale trade with farmers, controlling stocks with traders and controlling exports.

But this is not all. The free marketers would like the state to “free” land markets too so that farm land can be sold or leased freely. This would enable aggregation (by buying or renting) of farm land into large farms. An editorial in Livemint (Mar 21, 2018) lays out the wish list of the free marketers in full.

The United States is possibly the inspiration for these free marketers.

The US has 2.1 million farms compared to India’s 90 million. Just 8% of farms that are >1000 acres in size account for 70% of overall farmland (US Census of Agriculture). The large farm sizes are possible because 40% of farmland is leased. In the US, the agricultural supply chain is dominated by massive companies such as Cargill, ADM and Bunge whose operations range from global trading in agricultural commodities to transforming crops into packaged products for supermarket shelves.

In the world of agriculture envisioned by the free marketers, India would have far fewer farmers and a large fraction of agricultural land consolidated into large farms. Corporations trading in and processing food would be directly able to deal with farmers and the government would have no influence or control on the price of agricultural commodities.

But how would the farmers ousted from agriculture find alternate livelihoods when there are no jobs even for the youth entering the labour force? The free marketers will not be bothered by such questions.

While the present Indian government does not want to give up its ability to influence price and availability of agricultural commodities (by doing away with MSP, procurement and export controls), it has bought into the prescriptions of the free marketers to dismantle existing regulations governing wholesale purchases from farmers. Before delving into how this is driving policy, a brief introduction to the existing agriculture supply chain structure will be useful.

Mandis and their regulatory capture

The wholesale purchase of produce from farmers in India is governed by the Agricultural Produce Marketing Committee (APMC) Act. Agriculture is a state subject and each state has its own version of the law based on the template put out by the centre.

According to the APMC Act, wholesale transactions between farmers and traders must take place in designated market yards (mandis) and follow certain rules. These yards have been established throughout the country in agricultural production centres. The yards are managed by an elected authority with government supervision.

The concerns of this law can be better understood when seen in the context of the 60’s and 70’s when the APMC’s were set up. Small farmers were extremely vulnerable to being cheated by agents who would purchase their produce locally in the village. In the APMC yards, farmers got a better feel for the price. The sale of produce under public scrutiny brought a level of protection against being cheated on weights and measures and price. The APMC markets were clearly an advance on the situation prevailing earlier. Most trading shifted to the regulated mandis though there is still a significant fraction that takes place in the villages.

Over time, traders have established their control over the regulated markets. That this has happened is not hard to understand if one takes into account the huge asymmetry in the economic standing of traders and farmers.

The market committees are elected bodies and APMC elections too are fought with political affiliations. Traders with their economic power and ties to the major political parties end up controlling the committees. Government supervision is weak at best and cannot stand up to the economic and political clout of traders. Traders can cartelize with ease and set prices for agricultural produce right in the face of regulations meant for farmer’s protection.

Farmers are unable to stand up to this cartelization. They lack pricing power as suppliers. Added to this, they are often beholden to traders who help them through the production cycle with short term loans, transport and storage. Though aware that prices are fixed, they have no option other than to play along.

Reforming the mandis through competition

The government acknowledges the cartelization that happens in APMC markets right under state supervision. However, it does not want to acknowledge this as a governance failure. Instead, in line with the thinking of the free marketers, it argues that what is necessary are alternate channels which can compete with the regulated APMC mandis for farmer’s produce. This competition, it is claimed, will lead to farmers getting better prices and more investment flowing into the agriculture supply chain. This is thinking is behind the new (model) agricultural produce and livestock marketing (APLM) Act of 2017 that the present central government has unveiled.

The Prime Minister was reported to have written to the chief ministers of states recently emphasising the need to “swiftly undertake market reforms of our decades old and restricted agriculture produce and marketing committee (APMC) architecture”. The government is clearly in a hurry to get the states to adopt the new law which will replace the APMC Acts.

The alternative channels to APMC markets for farmers are to be privately managed markets and farmer-consumer markets. But most importantly, large buyers such as firms engaged in food processing, large scale retail or exports will be able to bypass the wholesale markets and buy directly from the farmer.

Actually, all the above measures to “free” the agricultural market are old hat. Back in 2003, the then BJP government put together a ‘model’ regulation (APMC Act 2003) for allowing alternate channels in agricultural marketing and the Congress government notified the rules to go with the regulation in 2007.

26 states have since carried out modifications to their state specific APMC Acts in line with this model Act. Bihar has gone to the extent of getting rid of the APMC regulated markets altogether to allow free private play.

What has been the impact of these changes on the markets?

Private markets have been a non-starter. While a number of licences have been issued in Maharashtra and a few in Karnataka, Gujarat and Andhra, most licensees do not seem to be operating markets on the ground. It seems no one wants to invest in setting up market yards just to earn the market fee of 2% of transaction value.

Bihar too has seen no investment in private market infrastructure. As reported in the Hindu Business Line (Feb 8, 2015), trade happens in informal makeshift markets that have no facilities and no competitive price discovery; their only advantage seems to be the ease of access for farmers.

There are farmer-consumer markets in several states – AP, Tamil Nadu, Punjab, Haryana – variously named rythu bazar, apni mandi, etc. They have not made a difference as a whole as few farmers can afford to take their produce to these markets which need to be located near cities.

What about the ‘direct marketing licences’ issued to large firms to procure directly from farmers?

Maharashtra has been in the forefront giving licences to many large firms including Tatas, Aditya Birla, Reliance, Big Bazaar, ITC, ADM Agro and Mahindra & Mahindra. But as of 2016, their purchases represented only a tiny fraction of the total purchases from farmers - 1000 crore annually against 60-75,000 crore transactions in APMC mandi’s and 25,000 crore in village and other informal markets (Indian Express, July 21, 2016). Big retailers, it appears, prefer to recruit existing middlemen as their agents and buy in the APMC markets. This is not surprising, for which corporation would like to directly deal with lakhs of small farmers?

Pinning the hope on big corporations

The government is acutely aware of the failure of the previous reforms. There is no private investment flowing into public use infrastructure that can benefit the farmers. Neither is there any movement towards farmers getting fair prices. The government however argues that this is because private firms wishing to set up alternate channels still do not have a “level playing field”.

With this argument, the APLM Act 2017 goes beyond the earlier reforms to make things extremely attractive for private firms wanting to enter the agricultural supply chain.

Under existing law, states are territorially divided into market areas and the market committees constituted under the APMC Act exercise regulatory functions (such as collecting market fees) over their respective market areas. This also places certain constraints on the movement of agricultural produce across market area boundaries.  

The new law confines the role of these market committees to within the publicly owned mandis. Licensing and regulation of private firms and traders is vested with the state government and licensed entities can operate anywhere within the state.

The government claims that the new law by allowing the farmer to sell anywhere in the state and to whomever he chooses will help the farmer realize better prices. The fact is that farmers have difficulty transporting their produce even to the nearest market yard. It is the private firms and traders who will now have the freedom to buy anywhere and profit from arbitrage.

Further, while traders must still operate within private or public market yards, licensed firms can make their purchases in front of the existing market yards without any need for investing in private yards. They have to pay a market fee only 1/4th of what is charged in the market yards. It is not clear by what logic this number was arrived at. There are also no transparency requirements imposed on them in respect of trades.

In summary, the APLM Act 2017 goes all out to help corporations entering the food chain to buy direct from the farmers by allowing them unfettered access to aggregation centres (the existing market yards) throughout the state for a token market fee, without having to invest in their own yards.

Will the entry of a new class of buyers help farmer producers realize a better price?

The fact is that the basic lack of pricing power among farmers does not change when they deal with corporations instead of traders. The experience of the last 11 years shows that corporations tend to merge into the existing supply chain at the last mile to the farmer. There is no reason to assume that the margins they make because of bringing in greater efficiency in the supply chain will be shared with farmers. Corporate India is not going to come to the rescue of India’s farmers.

The 2003 APMC reforms did not lead to any appreciable improvement in the lives of farmers; neither will the APML Act 2017 being pushed by the present government. These reforms are not about helping farmers realize better prices, but about opening up more opportunities for corporate India.

Thursday, May 3, 2018

The market has failed the Indian farmer

India’s farmers face an existential crisis. Dramatic protests, demands for loan waivers and mounting suicides are symptomatic.

Fundamentally, the crisis stems from the routinely low returns from agriculture even after a normal monsoon. Then there are risks to even obtaining these low returns. While drought or pest attacks can decimate returns, ironically, so can a bumper crop.

Markets are supposed to help find a price that works for both the producer and the consumer. Economic theory presupposes that a producer will produce something only if he can make a profit by selling it in the market at the prevalent price. This does not seem to apply to the Indian farmer.

A few examples will illustrate.

The struggle to recover cost

Take Maharashtra, a hotbed of farmer’s protests. The Indian Express (Apr 15, 2018) reports that in Maharashtra with the exception of Soyabean all commodities are trading below the Minimum Support Price (MSP) fixed by the government.

Farmers sell their produce mainly in yards of designated agricultural markets. The government run ‘agmarknet’ portal provides price information from agricultural markets across the country on different agricultural commodities. A visit to the portal shows that the market price of food grains, oil seeds and pulses is routinely below MSP.

Tracking the details of a specific commodity provides more insight. 

Tur (Arhar) dal is an important part of the diet in both South and North India. Production is insufficient to meet local demand and India regularly imports Tur. Karnataka is a major producer with Kalaburgi district accounting for most of the produce. The harvest is brought to the wholesale markets starting January. The MSP has been set at Rs 5450/quintal by the central government, while the state government has fixed a higher support price of Rs 6000/quintal, making good the difference from its resources.

Following a relatively good monsoon, the ‘modal’ prices registered at the wholesale market in Kalaburgi in Jan 2018 were in the Rs 4100-4200 range. Transactions happen over a price spread around the ‘modal’ price and there will be many farmers getting lower than the reported ‘modal’ price.

What does it mean to get a price below MSP?

The MSP declared by the government is based on the recommendations of the ‘Commission on Agricultural Costs and Prices’ (website: https://cacp.dacnet.nic.in/ ). The Commission is asked to recommend the MSP based on the total cost of production including input costs, labour and capital employed as well as other considerations such as demand and supply, inter-crop parity, etc. 

In the case of Tur dal, the production costs for 2017-18 work out to Rs 4612/quintal and the recommended MSP is Rs 5450/quintal, 18% above production costs. When farmers get paid significantly less than the MSP, they may not even be recovering the cost of inputs.

Why the MSP provides no price support

The government appointed ‘National Commission on Farmers’ headed by the well known agricultural scientist, Dr Swaminathan recommended way back in 2006 that MSP should be fixed at 50% above the cost of production to allow for a decent margin for the farmer. The present government announced in the 2018 budget that it would fix MSP’s according to this recommendation. There is no clarity yet on how or when it will do it.

The MSP as it is currently fixed has barely enough margins built in for a small farmer to survive. However, the central government does not adequately support even this MSP.

Firstly, a commodity may have an announced MSP, but will not be procured unless it is also a commodity distributed through the PDS.

Secondly, the government places limits on how much can be procured on certain crops and procures selectively in certain regions. Returning to our example of Tur dal, because of these restrictions, each farmer in Karnataka can sell only a maximum of 20 quintals at MSP to the state agencies as reported in the Hindu (Feb 3, 2018).

Drilling further into government procurement reveals some of these details.

The NSSO survey of farming households, ‘Key Indicators of Situation of Agricultural Households in India, NSS 70th round, Dec 2014’ (NSS70), reports the estimates of procurement by government and co-operatives at MSP and these are captured in the table.


Share of crop on sale procured by government and co-operatives at MSP (Data from NSS 70th round, 2014)

%age of crop
%age of farmer beneficiaries
Sugarcane
52
39
Wheat
19
3
Paddy
14
4
Maize
9
1
Cotton
7
5
Groundnut
3
2
Onion
3
1


The table shows the  relatively high procurement in sugarcane, wheat and paddy. The procurement in commodities not appearing in the table including Tur dal was 1% or less of the total produce on offer for sale. These numbers provide an idea of commodities with some price support and commodities where MSP is just a number.

There is another number of interest - the percentage of farmers selling a particular commodity who are able to get the benefit of sale at MSP to government. From the table, it can be seen that this is always lower than the percentage of produce procured indicating that larger farmers have better access to government procurement.

The contrast between the percentage of farmers selling to government agencies and percentage of produce procured is particularly striking in the case of wheat, paddy, maize and onion. This is because procurement in these crops is concentrated in regions with large scale production where there are also large farmers specializing in the crop.

Punjab and Haryana currently account for nearly 50% of the paddy and 70% of the wheat procured. This means that even for commodities with price support, the support may be available only in some regions.  In February 2018, both paddy and wheat were selling below MSP in many markets of Karnataka.

The unjustifiable cost of intermediation

There is another revealing characteristic of India’s agricultural markets. This is the huge spread between the price realized by the farmers and the price paid by consumers. Returning to the example of Tur dal, in Jan 2018, while farmers were getting paid Rs 41/kg, consumers were paying almost double, Rs 79/kg in Bengaluru, according to the state civil supplies price monitoring cell.

This spread is not warranted by the value added by the middlemen in the agricultural supply chain. It means that the middlemen – primarily commission agents, traders and wholesale merchants – are able to control prices paid to the farmers and prices charged from consumers to their advantage. Farmer’s income falls well short of potential because of the high cost of intermediation.

Intermediaries corner the profits even when market prices are high because of supply shortages, denying farmers most of the upside in prices. Returning to the Tur example, following severe rainfall deficit in 2015, in Jan 2016, the retail prices in Bengaluru climbed to 170/kg. However the farmers with reduced quantities to sell were getting only a price of between 90-98/kg in the Kalaburgi mandi.

The returns below MSP to the farmer along with the high intermediation costs point to a market failure. The debt of the Indian farmer is a consequence. NSS70 estimates that small and tiny farmers - with 1 ha or less of land constituting nearly 70% of agricultural households - on average earned income less than consumption expenditure.  

Unsurprisingly, 52% of agricultural households were indebted in 2013 with an average outstanding loan of Rs 47,000. Across farmers, 40% of the borrowing was from non-institutional sources such as money lenders, shop keepers etc, typically paying high interest.

The debt incurred by farmers is for buying seeds and fertilizer and other inputs, the working capital if you please, and to meet consumption expenditure. The low returns on average means that the farmer is never able to repay his debt. It also means that there is very little investment in agriculture.

Why the market does not work for the farmer

It does not require rocket science to spot the reasons for this market failure.

The basic hypothesis of the ‘market’ is that any producer will produce and sell only at a price where he makes profit. This unfortunately is not true for India’s farmers.

Firstly, there is the issue that is common to agriculture everywhere in the world. Unlike in industry where producers get continuous price signals and can react by stepping up (or down) production, farmers have no control over production once they have sown the seeds. The production cycle once set in motion has to be carried through till harvest irrespective of what price their produce will eventually fetch. Decisions on what to produce have to be made based on expectation of future price. If the expectation proves wrong, the farmer is faced with losses.

Coming specifically to Indian agriculture, there are tighter constraints. 

India’s 90 million agricultural households (as of 2013) work tiny pieces of land - 85% work less than 2 hectares - mostly lacking irrigation and dependent on rainfall. They have limited choice on what they can grow under these conditions. Soil type, rainfall, climate are the determinants. There are of course exceptions to this rule such as the farmers who have irrigation in the Punjab or the sugarcane belt of UP.

Farmers do not have the option to stop farming as they are mostly already in debt, there are no other job options available and the income from farming is essential for survival. This means that farmers will continue to produce the crops they have done season after season and in particular, try to increase production as the only way known to them to maximise income. At best, they will choose to grow crops (if they have do have a choice), based on expectation of future prices.

The lack of access of farmers to storage facilities means that on harvest, they have no other option but to sell even their non-perishable crops at whatever price they get.

Farmers as a whole have no pricing power, no ability to reduce production even if the sale of their produce is not profitable. They are also often beholden to the very traders with whom they trade for these traders would have helped them through the production cycle with short term loans, transport and storage.

In the backdrop of the fundamental asymmetry in the economic standing of farmers and traders, regulations intended to protect farmers interests do not work. Traders effectively control the regulated mandis, cartelize with ease and set prices. The farmers are aware of this but have no option but to play along.

Do farmers need out-of-the-box ideas?

How is this situation to be remedied? There are two diametrically opposite views.

In the view of what one may call the “free marketers”, what farmers need are alternate channels to the regulated mandis to sell their crops. With full freedom to sell to whomever they please, the claim is that farmers will be able to get the best prices. The hopes for establishing these alternate channels are pinned on big corporations.  

The BJP government put together a ‘model’ regulation for allowing alternate channels in agricultural marketing in 2003 and the Congress government framed the rules to go with the regulation in 2006. Most states adopted these changes in the following years.

We will defer a detailed discussion to a subsequent piece, but suffice it to say that 12 years after the wholesale agricultural market was opened up to corporate India, there is no appreciable change in the way the market functions or the returns that farmers get.

The fact is that the basic lack of pricing power among farmers does not change when they deal with corporations instead of traders. Also, there is no reason to assume that the margins that corporations make because of bringing in greater efficiency in the supply chain will be shared with farmers. Corporations are not going to bail out farmers.

The state therefore must intervene!  It needs to weigh in on the side of farmers so that they have better pricing power. This requires the extension of MSP to all major produce and active government procurement to ensure these price floors hold. This is the safety net the farmers need.

It requires small market yards and storage facilities that are easily accessible to the farmers. It requires use of technology and better governance of agricultural markets to inhibit cartels and bring transparency. It requires supply chains in the public sector to compete with the private supply chains.

But all this is well known.

Addressing policy planners at a recent meeting organized by the agriculture ministry, the Prime Minister was reported calling for “hackathons” in the IIT’s for out-of-the-box ideas to increase farm income. 

The ideas and schemes to further the interests of India’s farmers outlined above have been around for a long time. What is required is commitment of adequate resources and efficient implementation. That may also be described as good governance.


Sunday, July 9, 2017

Air India privatization is not a "reform"

(Published in the EPW issue of 8th July 2017)

The government appears to be on the fast track to privatise Air India (AI), the country’s flag carrier airline with the union cabinet giving its approval soon after a recommendation from the Niti Aayog. The chief executive officer (CEO) of the NITI Aayog revealed that it took only 15 days to come up with the report recommending total privatisation of the carrier. The Aayog did not see any need to consult the stakeholders of AI—employees, management or even the Ministry of Civil Aviation (MCA).
The last time a plan for privatisation of India’s public sector airlines had been mooted—only to be quickly abandoned—was during the tenure of the National Democratic Alliance (NDA) government of 2000–04 (PAC 2014: 154). The years following this were extremely traumatic ones for both the Indian Airlines and AI and after their merger in 2007, also for the merged entity, with a rapid deterioration of its finances.
In April 2012, the government signed a 10-year restructuring plan with the AI. Since then, as required by the plan, it has been continuously monitoring the performance of the airline. Repeated statements by the MCA in Parliament over the years, the last as recently as on 9 March, have testified that the government is largely satisfied that the AI is progressing as per the turnaround plan (MCA 2017a). Against this backdrop, the Minister of Finance Arun Jaitley’s highlighting of AI’s debt and market share as reasons to proceed with its privatisation, is to say the least, curious.
So what caused AI’s finances to deteriorate rapidly till 2012?
The Making of a Crisis
AI and Indian Airlines had been running profitably till 2005–06. However, their future had already been compromised by then.
During the period 1998–2004, no new planes were ordered for AI or Indian Airlines. This was at a time when competition was increasing from private airlines which were rapidly expanding their fleet. The NDA government was keen on privatising Indian Airlines and did not take decisions on the proposals for fleet expansion by Indian Airlines and AI (PAC 2014: 141, 154).
Fleet expansion proposals were finally approved by the government (now of the United Progressive Alliance—UPA) in 2005–06. The orders for new aircraft would have been large ones considering that they came after a long interval. However, even here, the government interfered with the erstwhile AI to its detriment. An AI (pre-merger) board approved proposal for 28 aircraft in January 2004 which was revised to 68 aircraft by November 2004! The total estimated cost of the aircraft on order by the two airlines was over ₹41,000 crore and the only equity infusion planned was ₹325 crore for Indian Airlines. The acquisition was to be funded by debt to be repaid through revenue generation (CAG 2011: viii).
With the two airlines in a precarious situation, the government in its wisdom carried out their merger in 2007 at one stroke. The unions representing airline workers and staff were not consulted. From all accounts, it appears that it was an ill-thought-out act for it would have been difficult to find synergy in the two organisations. The two airlines flew different types of planes and hence the skills of pilots and engineers were different. They had different ticketing systems, and a different organisational culture. The merger imposed huge immediate financial costs and severely affected the morale of the employees.
Between 2007–08 and 2012, AI chalked up increasing losses each year. This along with loans taken to pay for the 111 planes on order added up to a huge debt. By April 2012, when the government finally signed on a turnaround plan for AI, the annual operational loss of the airline had increased to around ₹5,000 crore and its accumulated debt had reached nearly ₹43,500 crore. It was then operating on a capital base of ₹3,345 crore (AI 2012).
Even while the AI was struggling with aircraft shortage, the government went ahead and increased bilateral entitlements (including interior points of call in India) with West Asian countries much beyond the dictates of mutual traffic. At that time, the AI was not even able to utilise its existing quota on what were its most profitable routes. The West Asian carriers used sixth freedom traffic rights (the right to fly from one foreign country to another foreign country after stopping in one’s own country) to transport people from India to Europe and the United States (US) via their West Asian hubs, eating into AI’s share of passenger traffic in/out of India to these countries (CAG 2011: xii). The lack of planes to fly within India resulting from the delay in ordering new aircraft also had an effect on the AI’s passenger share within the country. The national carrier’s share of domestic passengers dropped from 23.1% in 2005–06 to 13% in 2011–12 (DGCA 2017).
Work in Progress
As part of the turnaround plan, the government agreed to restructure some of AI’s debt to reduce the interest burden and also infuse capital to cover the cost of new aircraft. This was however conditional on AI meeting specific performance targets every year. The infusion of capital, had it happened immediately, would have helped it in its turnaround initiatives. Instead, the government went for piecemeal recapitalisation on an uncertain schedule.
Subsidiaries were created for maintenance repair and overhaul (MRO) and ground handling services. An old criticism of AI was that it employed too many people and hence was inefficient. With the creation of the subsidiaries, the manpower employed per aircraft became comparable to other private airlines.
Between 2011–12 and 2015–16 (financial years), the last year for which official financial results are available, the airline showed a steady improvement in terms of its operational profit/loss as well as passenger load factor—the percentage of seats on offer that were filled. In 2015–16, the airline made a small operational profit, two years in advance of the turnaround milestone. Its low cost international airline subsidiary, Air India Express and its ground and cargo handling services company, AISATS also made profits (Table 1).



Table 1: Operational Parameters of Air India
                   Operational                      Passenger Load
                   Profit (` crore)                   Factor (%)
2011–12       -4,901                               67.9
2012–13       -3,806                               72.4
2013–14       -3,978                               73.3
2014–15       -2,636                               73.7
2015–16           105                               75.6
2016–17        1,086*                              76.4**

*Provisional estimate (MCA 2016a). **Estimate (MCA 2017b).
Source: Air India Annual Reports at http:www.airindia.in.

AI’s financial results for 2016–17 are not officially available but indications are that there will be a significant improvement over the previous financial year in EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) (Ghosh and Ghosh 2017). In answers to questions raised in the Lok Sabha, the MCA stated that AI was expected to improve its revenues in 2016–17 by 10%, revenue passenger km (RPKM) by 6.8% and passenger load factor by 6.2% (MCA 2017b). The provisional estimate for 2016–17 (financial year) was an operational profit of ₹1,086 crore and a net loss of 1,989 crore (MCA 2016a). Though AI continues to make a net loss because of interest outgo on debt which in 2015–16 was about ₹4,000 crore, the secretary, civil aviation, went on record in October 2016 to state that he expected a net profit by 2018–19, ahead of the turnaround plan which projects net profits only by 2021–22 (Mishra 2016). All information available publicly points to a continuing improvement in performance.
However, for AI to remain competitive in the longer term, steps need to be taken about its huge debt that has been a drag on the airline. Leaving aside low interest aircraft loans, the outstanding debt is around ₹30,000 crore, 90% of it is from public sector banks and financial institutions (MCA 2016b). The airline has prime real estate assets which it has found difficult to sell because of bureaucratic delays. If the government were to provide assistance in restructuring the debt, selling AI’s real estate assets and speed up infusion of the remaining capital of about ₹6,000 crore promised as part of the turnaround plan, the airline should be on a good wicket.
Chequered History
The basic credo of supporters of privatisation is that the state should withdraw from the provision of all services (and production of all goods) which private corporations are able and interested in providing (producing). The only exception to this would be a “market failure” which render private players incapable of providing (or unwilling to provide) these services. The argument in support of such a belief is that state-controlled enterprises cannot function as efficiently as private corporations.
How does this argument stand up against the actual performance of India’s airlines over the last two decades?
Several early players such as Damania, Modiluft, Natural Energy Processing Company (NEPC) and EastWest folded up, some under a cloud. Air Deccan, the second largest airline in India in 2007, ran into losses and was ultimately taken over by Kingfisher Airlines. Kingfisher became defunct after borrowing ₹7,000 crore from public sector banks. Sahara was taken over by Jet Airways. Spicejet went close to bankruptcy in 2014–15 stopping operations and stranding passengers without notice and has come back only after a large equity infusion from a promoter.
In 2003–04, before the emergence of competition from low cost carriers, Jet Airways accounted for 44% and the public sector airlines together 43% of domestic passenger shares (DGCA 2017). An IMRB survey in October 2004 rated the Indian Airlines as the “most preferred airline”, above Jet (Sen 2009). The low cost carriers had a huge effect on the full service carriers of that period—IA (AI), Jet and Kingfisher. Kingfisher became bankrupt in 2012. Jet was able to survive only after equity infusion by Etihad of Abu Dhabi in 2013. The government appears to have played a role in the rescue by increasing the bilateral entitlements of Abu Dhabi (the number of passenger seats each way between India and Abu Dhabi), which coincided with the Jet–Etihad deal (Phadnis 2013). In 2017 till May end, Jet’s share of domestic passengers was 15.4% and AI’s was 13.3%, the rest being taken by low cost carriers (DGCA 2017). Jet and Indian Airlines (now Air India) have had a similar fall in share of passenger traffic within India after the entry of low cost carriers.
The finance minister has used the low passenger share to deride AI publicly to create public opinion in favour of its privatisation. The fact is that in 2015–16 compared to 2012–13, AI has flown 29% more passengers within India and increased its passenger load to 78.9% from 68.3%. During this period, the AI’s “available seat kilometres” increased only by 6% (DGCA 2017). What this points to is that its passenger share has been limited by the number of aircraft it has available to fly. As the MCA itself revealed in Parliament, there has been no capacity induction into the AI while private airlines have added substantial capacity. Between 2013–14 and 2015–16, AI’s capacity share in the domestic market came down from 17% to 15% (MCA 2016c). Its market share has come down because of decreasing capacity share. The government must own its share of responsibility for this situation.
If the measure of “efficiency” of an airline includes efficient use of capital and labour and providing services without disruption, then looking at the two decades of turmoil in the airline industry, it is hard to accept that private airlines in general have been necessarily managed efficiently.
Unsustainable Debt
Extending the discussion of efficiency to India’s private corporate sector as a whole, it is useful to delve into what has been termed the “twin balance sheet problem.”
Over the years, India’s private corporations have borrowed heavily from banks to grow their businesses. Some of these businesses have failed and others are not generating enough revenue to service their debt. The banks who have lent them money have lost interest income and are in danger of having to write off their debts. It is estimated that three-fourths of all corporate lending could be from public sector banks (Chakravarty 2016).Public sector banks bear the brunt of the bad loan problem.
The government has stonewalled attempts to get the banks to name the bad debtors among private corporations. However, piecing together information from different sources, one finds that more or less all of India’s large industrial houses are involved.
A 2012 Credit Suisse report featured 10 large manufacturing houses—Lanco, Jaypee, GMR, Videocon, GVK, Essar, Adani, Reliance (Anil Ambani), JSW and Vedanta—with high levels of debt that they would find hard to service. A follow-up by Credit Suisse in 2015 found that the financial condition of these groups had deteriorated despite their attempts to sell assets to pare debts. These groups accounted for 27% of all corporate loans from the banking system (Sanjay 2015). In August 2016, the government stated in Parliament that the top 10 corporate groups owed public sector banks and financial institutions ₹5.7 lakh crore (PTI 2016). The businesses of these groups span areas extending from military hardware to steel, coal, power, oil and gas, roads, airports, railways and ports.
In June 2017, the Reserve Bank of India (RBI) identified companies of three groups from the list—Lanco, Essar and Jaypee—and nine other companies which together owed ₹1.75 lakh crore to banks to be dealt with under the bankruptcy code. It is estimated that at least half the debt will have to be written off by the banks.
In the telecom sector, the debt of India’s top seven telecom companies—Bharti Airtel, Vodafone, Idea, Reliance Communications, Reliance Jio and Tata Teleservices—increased by 20% in 2016–17 to ₹3.6 lakh crore and all the companies (except for the new entrant Reliance Jio) have problems servicing their debt (Sarkar 2017). The State Bank of India has the largest exposure to the industry and its chairperson has pleaded with the government to help the industry by deferring spectrum payments, providing duty waivers and reducing the goods and services tax (GST) rate in order to prevent its loans from imminently becoming non-performing assets (NPAs) (TNN 2017). While the incumbent operators blame Reliance Jio for their debt servicing problems, the latter points out that these companies were working with insufficient equity, relying too much on debt financing (PTI 2017).
A recent example from the power sector involves three large corporate houses—Tata, Adani and Essar. All of them won competitive bids based on tariff and set up power plants in Gujarat using imported coal. Their contracts have no provisions to link tariff with coal prices and the companies are running at a loss after coal prices increased and are unable to service their debt. The government is reportedly putting together a rescue package where the companies will be brought under state ownership (Dutta 2017).
The above examples do not capture the enormity of the bad debt problem. During the period 2013–15, public sector banks wrote off ₹1.14 lakh crore of debt (Mathew and Narayan 2016). Several additional lakh crore will likely be written off in the coming years. Eventually, the banks will have to be “bailed out” by the government through capital infusion.
The unsustainable debt of so many private corporations across a swathe of sectors periodically requiring government rescue—including debt write-off by public sector creditors—hardly speaks well about the innate superior efficiency of the private sector.
Timing of Privatisation Decision
Why has the government announced the decision to privatise AI—a decision taken in great haste—just at a time when the airline is on the verge of becoming profitable?
The decision comes at a time when the government’s “reform” credentials are coming under question. These “reforms” which were eagerly anticipated by business leaders and foreign investors have got derailed and include making land acquisition easy, relaxing labour regulations for large factories and doing away with the obligations of banks to lend to the “priority sector” (farmers, small businesses, etc). The government’s inability to make a major dent in the “twin balance sheet problem” has severely affected new lending by banks to the private corporate sector. All this has affected the sentiment of business towards the government.
The announcement of the privatisation of the AI, considered a “soft target” by the government, is perhaps aimed at reversing this state of affairs. As a business newspaper editorialised,
(T)he privatization of Air India will boost investor sentiment in a big way as it demonstrates the government’s willingness and ability to take the reforms process forward. (Mint 2017)
Case against Privatisation
Private investors are interested in the AI because it is an operationally profitable airline with a large fleet of mainly new aircraft, a profitable low cost international carrier like Air India Express, a profitable ground handling services venture, valuable immovable assets in land, offices, hotels and hangers; skilled human resources in the form of a large number of pilots and engineers; the only MRO set-up in India, prime slots at airports in the country and around the world, membership of Star Alliance, etc. The AI is also the largest Indian carrier of passengers across the country’s borders.
The privatisation of AI is only possible if the government writes off a significant part of its debt. This debt accumulated for the large part until 2012 has acted as a millstone around the airline’s neck and delayed its return to profitability. There are various proposals being mooted to once again restructure AI to make its main business—that of flying passengers—attractive to potential buyers. Whatever restructuring is done, there is no getting away from the fact that its debt has to be written off.
The responsibility for this debt rests squarely with the government and is due to its many omissions and commissions in the past—delayed acquisition of aircraft, late capitalisation of the airline, interference in decisions related to aircraft acquisition, the ill-thought-out merger of the AI and Indian Airlines and not providing a level playing field to the national carrier on international routes.
If the government extends the same benefits to the public sector airline (that it wants to for a possible private owner by writing off part of its debt), it will be able to forge ahead. However, given that the airline is close to becoming profitable, it appears that even assistance with restructuring of its debt to public sector banks and sale of its properties will help it to reach profitability and manageable levels of debt.
Publicly owned airlines can also be run efficiently. Singapore Airlines is an example. An efficiently run public carrier can bring stability to air transport services and provide the right competition to private airlines. It can also fulfil objectives that are not dictated by the exigencies of maximising profit—like providing essential coverage to underserved areas or unscheduled services to the Indian diaspora during an emergency— as it does now.
The corporate business press is lauding the government’s privatisation decision, hailing it as the resumption of “reforms” which will consist of more disinvestment and privatisation. It is hard to understand how mismanaging public assets and then selling them is “reform.” Only those who see opportunities for profit in such sales can pretend that these are reforms.
The real reform that India needs is in the manner that public sector enterprises are managed. This reform must ensure at a minimum that there are well-defined policy guidelines for these enterprises available in the public domain, that the enterprises are compensated for costs incurred in implementing specific government policies not in line with their commercial objectives, that there is professional management in place and that this management is shielded from interference from politicians and bureaucrats.
The present government came with the claim of providing “good governance.” There is no reason why this should not extend to the management of public sector enterprises.
References
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