News reports say that the Government is considering speeding up the process of dismantling the administered pricing mechanism (APM) by two years. This it plans to do by reducing the customs duty on crude oil from 22 per cent to 15 per cent while at the same time increasing the duty on other petroleum products by 10 per cent. However, according to the Nirmal Singh Committee recommendation, import duty on crude oil should have been lowered to 10 per cent by 1999-00, while the duties on other petroleum products should have either remained constant or decreased. There are other reports that suggest that the Government is planning to increase excise duties on downstream products. However, the increase in excise duty will be absorbed by the oil pool account and will not be passed on to the consumers.

Thus the moves likely to be taken up suggest that rather than speeding up the dismantling process, the government is further complicating it. In fact, the moves will do more harm for thedownstream petrochemical sector and the oil pool account. The idea of cutting down the import duty on crude oil is that imports of the commodity are likely to increase with the commissioning of over 35 million tonnes capacity by the end of the next fiscal. With ONGC production showing no signs of improvement, imports are bound to be high. Thus, the cut in duty rates is unlikely to reduce collections.

On the other hand, by increasing the duties on petroleum products, the government wants to discourage imports of these products, there by saving valuable foreign exchange. This move will also act as a protection for the new refineries that are coming up. For refineries, the reduction in import duty on crude oil will mean that their costs will come down. In other words their margins are likely to improve. Margins will also get a boost if import duties on the final products are increased. It may be noted that operating margins of refineries in the current fiscal has taken a beating after the Centre dismantled theassured returns mechanism from April 1, 1998.

The other policy change being considered by the Centre is increasing the import duty of petroleum products. The downstream petrochemicals unit are already hit by higher price on inputs and lower final product prices. Petrochemicals units in the country are in any case having a terrible time with prices of their final products declining by over 30 per cent in one year. Unless import duties on their final products are not increased, the petrochemicals and chemicals units are in for some tough time next year. The third change likely to be proposed is the increase in excise duty on motor spirit (MS) and aviation turbine fuel (ATF). Though this hike is in line with the Nirmal Committee recommendation, what is not, is the fact that the government is proposing to absorb the hike in the oil pool account. This move will slow down the redemption of the oil bonds to the oil companies. If crude oil prices increase in future, the surplus generated in the pool will vanish,further affecting the liberalisation of the oil sector.

Power projects

While it is an undisputed fact that foreign equity is much needed in the capital intensive power sector, it also cannot be denied that foreign exchange variation often leads to high costs. On the other hand, as the projects promoted by domestic companies are financed in rupees, they often work out to be cheaper. In the absence foreign equity the forex risk cover is not required and in the case of jointly promoted projects such cover is required only to the extent of the foreign equity contribution.

For a power project, since the rate of return on equity is fixed and is payable in the currency of investment, projects with large foreign currency components become expensive every year. This is because the rupee tends to depreciate against dollar (the widely used currency for investment).

Similarly, power tariff fixed in dollars will increase in terms of rupees.On the other hand, the payment determined in rupees remains samethroughout the period of agreement. Apart from these, the foreign promoters include the foreign investment risk in the project cost. They also have to repatriate profits unlike the local promoters. Though the power purchase agreement of the Dabhol power project was signed years ago, the cost of power has already gone up as the rupee has depreciated more than 10 per cent since then. This will increase further in the coming years.

Promoted by the three American companies, Dabhol Power Company has been given protection on the entire foreign currency investment (equity and debt) in the project. (The Maharashtra State Electricity Board subsequently purchased 30 per cent equity in the 740 mw phase one of the project.) The provision of the counter guarantee was announced for the eight fast-track power projects to attract investment in the sector. The Centre, however, has reduced the counter cover by linking it only to the foreign equity component of these projects.

It is important to attract investment in theindustry not only from the public and private sector but also from international sources. However, considering the price-sensitivity of the product and the long term commitment of payment from the state electricity boards (SEBs) and Government agencies, the financing pattern of the projects need special attention.

It might be a good idea to encourage projects in which a foreign company invests jointly with a local partner. As the initial risks associated with the project (besides the forex risk) are taken care of by the local partner, the risk premium that the foreigner would expect would accordingly be lower. Besides, no counter-guarantees need to be given for such projects and the foreign partner always has the option of buying out the local partner at a later stage.

Emcee (With contributions from Shishir Asthana and Vandana Saxena)