Tata's investment proposal: A reply

Thank you for commenting on my report on the proposed investments by Tata group in Bangladesh. As someone far removed from the world of corporate business, I find your comments very instructive.

You have found my conceptualization of gas pricing (based on the projected date of reserve exhaustion along with the discounted costs of importing alternative fuel) "interesting" but perhaps rather intriguing. This kind of approach is quite familiar in the literature on the economics of exhaustible resources, although you note that this is not how gas is "valued and priced" internationally. You may be right. The concept of economic price is not about the actual price, it is a tool for assessing what is the value to society of an extra unit of gas (economist became careful in distinguishing between the two ever since Oscar Wilde accused them of knowing the price of everything and the value of nothing!). It is a useful policy tool because it tells us that an extra unit of gas should not be used in any activity (including export by, say, pipeline) which will yield benefit to society less than its economic price.

There may be perfectly legitimate reasons why gas is actually priced lower than the economic price, such as to attract FDI or to promote a domestic sector; but the subsidy involved needs to be part of conscious policymaking based on an assessment of costs and benefits. This concept of "subsidy" (or call it by any other name) is different from the more familiar one based on actual prices being lower than costs resulting in financial losses. You have rightly pointed out this commonly understood meaning of subsidy. No wonder economists are hated for making simple things complex!

The economics of exhaustible resources like gas essentially involves inter-generational welfare considerations. Some countries set an upper limit to the annual production of gas in relation to the size of reserves in order to ensure that the reserves are not depleted too fast. Such a policy is justified on grounds of ensuring energy security. The concept of economic pricing of gas that I have used is another way of ensuring that the gas reserves are used in a "socially optimal" way, taking inter-generational welfare into consideration. Of course, as you rightly point out, big assumptions have to be made about the future replacement cost of gas and the social discount rate, but I find this way of conceptualizing the problem superior to, and less arbitrary than other policy stances that go in the name of so-called energy security.

You point out that my methodology of economic pricing of gas could lead to a very low present price - less than US$ 1 per mcf - if gas exhaustion takes place at or after 25 years. If that be the case, the cost of acquisition of gas would provide the floor for economic pricing, since the benefit or value that society gets out of using gas must be at least as much as the cost of its acquisition. My report does discuss such cost-based pricing, but I suspect that my numbers may differ from PetroBangla's cost calculations that you refer to. Since Tata's demand for gas will have to be met by additional supply of gas annually, it is the cost of acquisition of extra amounts of gas that matters. My assumption is that this increased supply will come largely from the oilfields operated by the international oil companies (IOCs). As it is, the proportion of total gas supply coming from state-owned gas-fields will decline in future and that will have a bearing on the average cost of gas acquisition.

You seem to have got the wrong impression that I have suggested a particular price for selling gas to Tata. I have only provided a range of numbers for benchmarking the economic price of gas, against which the benefit from Tata's investments may be weighed. I have also suggested that (a) the sale of gas to Tata should come under a general gas price policy which, while differentiating among different kinds of users, should not provide concessions specific to particular investment, and (b) there should be some sharing of risk arising from the uncertainty regarding gas reserves.

In your view, I have ignored the benefit from Tata's operations arising from the creation of a coal industry and the increased provision of power to the national grid. I think everybody will agree that Tata may be given the same incentives as given to other foreign investors such as the independent power producers. These incentives should have arisen out of a competitive bidding process, so that these may be taken as reflecting a "fair" sharing of benefits. To claim these as additional benefits while negotiating for the other components of Tata's investment package would then be tantamount to double-counting the benefits.

The report of the Economic Intelligence Unit (EIU) in fact puts considerable emphasis on the potential contribution to GDP growth coming from the additional power generation by Tata's operations. The underlying assumption is that economic growth in Bangladesh in the medium term will be constrained by power shortage, so that any mitigating measure will be of great benefit. This scenario may appear plausible given the dire state of things prevailing in the country's power sector. But this is an unacceptable assumption from a policy-maker's point of view. Adequate measures must be taken to attract enough investment so as to fully meet the country's entire future power demand; there is no policy alternative to that. The EIU report does us a service, though in an unintended way, by drawing our attention to this development imperative in Bangladesh.

The EIU report estimates the net balance of payments support provided by Tata's operations by adjusting the trade balance for the outflows to shareholders and lenders estimated at US$ 467 million annually. I have indeed overlooked this adjustment and I stand corrected. It would have been still more appropriate to refer to Bangladesh's gains in gross national income or GNI (which excludes these foreign incomes) instead of GDP (which does not).

My main difficulty with the EIU report however concerns the approach it takes generally to estimate the impact of Tata's operations, which appears to be rather like describing the virtues of mother's milk! While admitting that Bangladesh is a "severely capital-constrained economy", its estimation of the so-called "multiplier" effect of Tata's operations on GDP gives the impression as if generating demand alone is what matters to production expansion. As I have discussed in my report, one has to be much more discriminating and careful in ascribing to a project the economy-wide benefits arising from its purchase of goods and services from local suppliers and from its sale of inputs to other industries. While I do not want to underestimate the importance of these indirect benefits, there is no reason why the merit of Tata's investment proposals needs to be linked with the merit of the EIU report.

Tata's approach is to offer Bangladesh the best possible gas price consistent with maintaining the global competitiveness of its operations. There is no reason to doubt the genuineness of this approach, given Tata's reputation in respect of business integrity and corporate social responsibility. Bangladesh's approach to these negotiations, however, needs to be based on considerations of optimal use of its gas resources and the expected social benefit to be derived from Tata's investments. The test of the viability of these investments lies in the reconciliation of these two very different sets of considerations - whether these two approaches can find a meeting ground. I hope they can. Otherwise, the two sides can part as friends.

Wahiduddin Muhmud is a renowned economist.
Part II of report will appear tomorrow.