DISCUSSION

Economic & Political Weekly EPW march 17, 2012 vol xlviI no 11 69

NCAER’s Report on GoaA Rejoinder

R Venkatesan

R Venkatesan (rvenkatesan@ncaer.org) is a senior consultant at National Council of Applied Economic Research, New Delhi.

This is a response to the two sets of criticisms (EPW, 12 November 2011 and 21 January 2012) of the report of the National Council of Applied Economic Research comparing benefi ts and costs of mining and forest services in Goa. The response focuses on the conceptual fallacies in the method proposed by the critics in estimating “social benefi ts” associated with iron ore mining and also comments on the alternative total economic value approach proposed by them.

This is a rejoinder to the article en-titled “Missing the Woods for the Ore: Goa’s Development Myopia”

(epw, 12 November 2011), by Pranab Mukhopadhyay and Gopal K Kadekodi (hereafter M-K). It also briefl y responds to Rahul Basu’s comments “Mining in Goa: Beyond Forest Issues” (epw, 21 Jan-uary 2012). The authors argue that a scru-tiny of the metho dology of the recent re-port by the National Council of Applied Economic Research (NCAER) comparing benefi ts and costs of mining and forest services in Goa revealed an overvalua-tion of social benefi ts and costs. This rejoinder is from the main author of the NCAER report.

This rejoinder is formulated in two parts. In the fi rst part, we focus on con-ceptual fallacies in the method proposed by the authors in estimating “social ben-efi ts” associated with iron ore mining. For instance, observations such as the taxes and duties can be exported or that foreign exchange should not be valued at a premium, etc, fall under this category. The NCAER report focused mainly on estimation of benefi ts and integrated various studies on social costs of “defor-estation” by updating social costs to the base year 2008-09.

In the second part, we comment on the alternative Total Economic Value (TEV) approach proposed by the authors M-K and review Basu’s concerns.

Introduction

In the Introduction the authors observe that NCAER using a 12% social discount rate (SDR) and a time frame of 25 years, fi nds that “the opportunity cost of min-ing is Rs 14,449 crore measured as net present value (NPV) of losses to be in-curred if mining was disallowed”. While we concur with their above observa-tions, we feel that their observation that

“the NCAER (2010) report attempts to lay the economic justifi cation for permitting further land use change of Goa’s forests in favour of mining” as inaccurate and unwarranted. In project appraisal meth-odology, the option of computing the opportunity cost of disallowing mining assumes that the extraction rates, price of mineral, extraction costs, and so on, are frozen at the 2008-09 production and price levels (period of analysis).

Issues in Valuation and Evaluation

The numeraire used in the NCAER study is the uncommitted social income in the hands of government measured in do-mestic prices. The study also assumes a positive elasticity of marginal utility to an increased consumption as well as the below poverty line (BPL) income group as the reference income level (at which private gains equal governmental in-come); with the result, the private sector income gains were accorded negligible weights. This brief back ground about the numeraire will clarify some of the explana-tions given below.

Appropriate SDR

The authors argue for use of a 0% SDR instead of the 12% adopted by NCAER. “The logic of 0% SDR is that societies may value each generation equally and therefore any positive SDR tends to dis-count the welfare of future generations, which is not ethically acceptable…”.

SDR is often set as the real rate of re-turn in economic prices on the marginal unit of investment in its best alternative use (ADB 1997). This is the logic of as-suming an SDR of 12%. A lower SDR would result in suboptimal projects being undertaken initially, while deserv-ing ones starve of funds which arrive later while a very high SDR would result in non-utilisation of surplus funds.

For providing sectoral preferences to chosen sectoral projects, the cut-off eco-nomic yield rate is set at lower values. For net cash fl ows with more than one sign change where multiple internal rate of re-turns (IRRs) can result, special procedures are adopted (Venkatesan 1981: 72-80).

DISCUSSION

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Overvaluation of Mining Benefi tsThe authors argue that in order to enhance the estimates of social benefi ts of mining, NCAER has listed various claims, “which on scrutiny we fi nd ineli-gible to be counted as social benefi ts”. Our rejoinder:

Double Counting: According to the authors, “NCAER (2010) claims a number of central and state taxes as social benefi t. However, all these taxes have already been added in the fi rms’ price of the ore. So the taxes and cesses should not be added to social benefi ts as it would lead to double counting.”

The authors make a grave error in this judgment. All of Goan iron ore is exported and economists know that taxes and cesses cannot be exported. Since our numeraire is the uncommit-ted income in the hands of the govern-ment, obviously these income fl ows from taxes and duties represent social benefi ts. The authors’ remarks are inap-propriate and incorrect.

Foreign Exchange: The authors’ argu-ment “The major item claimed as a ben-efi t is a bonus for (10% of) foreign ex-change earnings by the industry, Rs 908 crore. The import tax according to this claim supposedly refl ects the scarcity value of foreign exchange.…There are

many reasons why import taxes are im-posed and forex scarcity may be only one of the factors that may determine import tax rates, say, for example, the infant industry argument” has a major fallacy. I quote the Asian Development Bank (ADB) for computing the shadow exchange rate (ADB 1997):

Shadow exchange rate refers to the eco-nomic price of foreign currency used in the economic valuation of goods and services. The shadow exchange rate can be calculated as the weighted average of the demand price and the supply price for foreign exchange. Alternatively, it can be estimated as the ratio of the value of all goods in an economy at domestic market prices to the value of all goods in an economy at their border price equivalent values. Generally, the shadow exchange rate is greater than the offi cial exchange rate, indicating that domestic purchasers place a higher value on foreign currency resources than is given by the of-fi cial exchange rate.

For economic analysis using the domestic price numeraire, SERF is ap-plied to all outputs and inputs, including labour and land that have been valued at border price equivalent values, with project effects measured at domestic market price values left unadjusted. Any expert would agree with the appropri-ateness of such an approach if he exam-ines the trend in depreciation over the last four months or over the last two years since the analysis was carried out.

Transport of Ore: The fi rst in this list are the claims that pertain to the trans-port of ore. Iron ore in Goa is largely ex-ported by sea. It is transported from the mines to Mormugao Port Trust by barges by way of river navigation.

NCAER (2010) has claimed carbon credits worth Rs 10.9 crore for the mining industry due to use of barges for transporting iron ore from the mines and Rs 30.6 crore due to reduced diesel subsidy for the same means of transport. The basis of this claim is that these benefi ts accrue because barges are clean and more effi cient transport alterna-tives to trucks. The authors argue that these are false claims on the following counts.

Carbon Credit: The carbon credit claim is invalid as the use of barges is the least cost-effi cient alternative for the mining fi rms and no additional expense is in-curred by way of use of an eco-friendly alternative (to a polluting) transport op-tion (NCAER 2002).

Our rejoinder is that just for the rea-son that the eco-friendly transportation mode also happens to be the least cost option, this would not disqualify the in-dustry from claiming carbon credit bene-fi ts. The market void created by the ab-sence of Goan ore exports can easily be fi lled up by exports from Orissa, Karna-taka, and so on, which could adopt a less energy effi cient mode of transportation.

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DISCUSSION

Economic & Political Weekly EPW march 17, 2012 vol xlviI no 11 71

Barge Tax: There is a claim of social benefi ts due to the annual barge tax of Rs 12 crore. Barges, when they travel down the river with their loads of mining ore, lead to quicker “wear and tear” of embankments. Again, barge tax is the in-come fl ow in the hands of government, and per our numeraire, represents the uncommitted income. Maintenance of embankments, roads, etc, is a major state government responsibility and these tax fl ows augment state government outlays.

Road Cess: The authors use similar reasoning to disallow cess income to government. “A similar argument holds for the road infrastructure cess. Mining trucks are the main users of the roads in the forest areas and their heavy load on the major tarred roads of the state cause considerable damage. This cess payment needs to be treated as compensation.” Our rejoinder to this is the same as the one mentioned for barge tax.

Royalty: The authors state that the issue of royalty needs to be seen from a re-source compensation principle. They argue, “The equilibrium price for an exhaustible resource is: Exhaustible resource price = Marginal cost of ore extraction + Exhaustibility rent (same as royalty rent in theory)”.

The authors argue: “NCAER (2010: 43) claims that the royalty paid by fi rms is the net benefi t to society (Rs 300 crore). This is an accounting fallacy since the royalty paid is supposed to be the resource rent for consuming a sub-soil asset. It is the opportunity cost for deple-tion of natural capital.”

Since the numeraire is the uncommit-ted income in the hands of government, the royalty payment needs to be added to the benefi ts stream. The state can levy one-time payments such as the auction fee or recurring payment request such as depletion premium. These can be addi-tional sources of income for the state government as these need not be viewed as mutually exclusive options.

The ADB guidelines defi ne the deple-tion premium as the premium imposed on the economic cost of depletable resources representing the loss to the national economy in the future of using

up the resource today. The premium is frequently estimated as the additional cost of an alternative supply of the re-source, or a substitute, when the least cost source of supply has been depleted. In the case of iron ore, since Goa ore is of low grade an application of depletion premium is not warranted.1

To say that the royalty is the compen-satory payment in lieu of depletion pre-mium or one-time leasing bid costs and ignoring the royalty payments would be an accounting fallacy.

Useful Life of the Project

The authors argue that an assumption of a useful life of 25 years would be in-correct as the reserves will last only for 21 years. “In 2008-09, Goa produced 33 mega tonnes of iron ore for an estimated value of Rs 38.8 billion… Simple arith-metic suggests that for 712 mega tonnes of ore to be extracted at an annual rate of 33 mega tonnes would take only 21 years for the reserves to end.”

Our rejoinder to this observation is that the total reserves as per records of IBM stand at 926 million tonnes (712 mil-lion tonnes of haematite and 214 million tonnes of magnetite). The authors have considered only haematite ore deposits for exports. Even if the useful life is set at 21 years, the results at 12% discount rate would not be dif ferent for the discounting

weights past the 20 year horizon would be negligible for an SDR of 12%. To sum up, all benefi t items except diesel subsi-dy, would not stand altered. We repro-duce the table for ready reference.

Table: Benefit Calculation by NCAER (2010)Item Benefit Attributed (in Rs crore)

Carbon credit 10.9

Subsidy on diesel 30.6

Forex benefits 908

State tax royalty 300

Barge 12

Road infra cess 50

Central tax export duty 250

Corp tax difference 748

Total 2,309.5

Source: NCAER (2010: 43).

Benefi ts Not Considered in the NCAER ReportOn the benefi t side, employment bene-fi ts provided by the industry that accrue to the state (this can be approximated as the promotional expenses the state has to incur to absorb in services or industry sectors such as eco-tourism, business services, etc) have not been factored for want of authentic data on this aspect.

Social Costs

All about Forest Values: The authors ar-gue, “NCAER (2010: 61) claims to have adapted forest values gener ated by IRADE

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DISCUSSION

march 17, 2012 vol xlviI no 11 EPW Economic & Political Weekly72

(2008) using Verma (2000) methodology. But curi ously, both IRADE and NCAER de-duct most of the benefi ts in their computa-tion of the economic value of forests…”

We had decided to adopt numerous studies on social costs of deforestation in the public domain. Except for changing the cost fi gures to refl ect 2008-09 price levels using gross state domestic product defl ators, we adopted these to compute social costs. We attempted at measuring the social benefi ts in a systematic man-ner as no work was done on this aspect, while many studies on social costs were available in the public domain.

The authors advocate use of the TEV method as a point for discussion in this context. According to them the logic of TEV is that resources have multiple “use” (direct and indirect) and “non-use” ben-efi ts (whether the non-use benefi ts need to be factored in needs a wider debate). If all these items could be added up then we would arrive at a composite value for one or more natural resources.

According to my understanding, au-thors argue that the preservation of for-ests as the basic objective and mining in the forest areas should have a threshold value beyond which preservation of eco-system is not feasible.

Rahul Basu comments on the report are based on the assumption that M-K’s critique is valid and intends to add to them. We, in the earlier section, had argued that M-K’s social benefi ts compu-tations are conceptually fl awed. Our brief comments on Rahul Basu’s other concerns are as under:

On methodological issues Basu’s con-tention is that the NCAER’s (iron ore) price expectations are poorly informed.

Our rejoinder is that the Economic Sur-vey 2008-09 (Chapter 2: “Challenges, Poli-cy Response and Medium Term Pros-pects”) briefl y analyses commodities price movement, global developments and the Indian economy. It analyses the iron ore market vis-à-vis other commodities such as crude, edible oil, etc. The structural change in iron ore prices was inferred based on the analysis and 2008-09 prices were used as border prices.

Basu laments that the NCAER’s calcu-lation on input-output table has not been placed in the public domain, if the

author needs any clarifi cation/discus-sion, he could address his queries to me and I can put him in touch with the concerned expert.

The author has contended that the barges only transport 86% Goan ore, while 14% of ore is from other regions, etc. Since the Goan iron ore needs to be blend-ed with the higher grade ore to meet mini-mal requirements of exporters’ norms, there exists a market for the 14% higher grade ore. Thus, the loss of job in barges transportation cannot be limited to 86%.

Ethical Concerns: Basu’s contention that the 62 page report is priced at Rs 1,000 etc, and sold by the NCAER is incorrect. Indeed, some of the reports prepared for the ministries/departments are placed on their respective websites. As a researcher, I do not wish to comment further on ethical concerns.

To conclude, the important takeaway for the state government, in my opinion, is a consideration of issues such as (a) freezing the export volumes at 2008-09 level, (b) deciding on the ap-plicability of state-level depletion pre-mium for iron ore, and (c) incurring promotional schemes for job-creation in services/ industry sectors to combat the current high unemployment levels, and so on. These emergent key policy issues need to be included in the agenda of

state government’s policy initiatives to be considered.

Note

1 India’s high-grade ore (+65% Fe content) re-serves, proven and probable, amount to only 0.58 billion tonnes. And even if we were to factor in indicative and inferred reserves (probable/feasible reserves), the total reserves (proven and possibly future potential) would be only 0.92 billion tonnes.

India’s medium-grade ore (+62% Fe to –65% Fe) reserves, proven and probable, is only 1.3 billion tonnes. Here too, if we factor in indica-tive and inferred (probable/feasible and pre-feasibility estimated) reserves, the total re-serves (proven and possibly future potential) will be only 2.8 billion tonnes. India’s high-grade and medium-grade iron ore reserves would not last more than 20 years and thus warrant use of a depletion premium.

India’s low grade ores are relatively abundant and thus do not warrant use of a depletion pre-mium.

References

ADB (1997): Guidelines for the Economic Analysis of Projects (Asian Development Bank: Economics and Development Resource Centre).

IRADE (2008): Natural Resource Accounting in Goa, Phase II, Project Report of the Integrated Research and Action for Development, New Delhi, viewed on July 2011 (http://mospi.nic.in/Goa_report_ 21apr08.pdf).

NCAER (2002): Role of Mineral Exports in the Economic Development of Goa: A Historical and Economic Enquiry (New Delhi: National Council of Applied Economic Research).

– (2010): A Study of Contributions of Goan Iron Ore Mining Industry, New Delhi.

Venkatesan (1981): “Interpretation and Integration of Economic Effi ciency Criteria through Use of Projected Cash Flow Statements”, The Engi-neering Economist Fall: 72-80.

Verma, Madhu (2000): “Economic Valuation of Forests of Himachal Pradesh”, mimeo, Indian Institute of Forest Management, Bhopal.

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