Decision Support System for Design and Evaluation of Pipeline Projects

Petronet India Limited (PIL) was created to give impetus to investments in pipeline projects for transportation of petroleum products in the country. Since these projects have a long life and require large investments, correct assessment of location, capacity and financial viability are of critical importance. This paper is based on the study undertaken for PIL to evaluate a few of their pipeline projects. The study resulted in creation of a comprehensive software package that is capable of operational and financial evaluation of pipeline projects based on countrywide view on production and distribution of petroleum products. The core of the package is an LP based optimization model. The package is capable of performing sensitivity analysis to investigate the impact of uncertainty on the proposed project due to from changes in the values of key factors including distribution network and capacities, refining capacities and pattern of demand. •A model is developed for identification of viable pipeline projects, taking into account the demand and capacity additions to production and distribution network for petroleum products in the future. •The model can be used for financial evaluation of such projects based on appropriate assumptions to forecast the investments required as well as the net cash flows from the project. •The solution procedure is implemented for the models developed in the form of a software package that would allow the decision maker to experiment with assumption and generate solutions with ease and with little manual intervention. •The software package developed above is further embellished so that it also provides additional information to the decision maker in the form of reports that contain details of movement of products and the mode combinations used for the movements.

Financial Sector Reform: Institutional and Technological Imperatives

This paper takes the view that financial sector reform is not only a matter of jettisoning old regulations nor even merely a matter of prudential regulation accompanying structural deregulation; it is intimately bound up with institutional and technological issues. On the basis of a detailed analysis of the stock market, debt market and the banking system the paper demonstrates the need for major institutional and technological changes in the Indian financial sector in order to face the challenges posed by liberalization and rapid growth. In our view, the government and regulatory authorities have an important role in facilitating this modernization. Not only should regulatory hindrances be removed, but there should be a positive bias in favour of change. We do believe that changes would take place even without regulatory support, but we also believe that regulatory intervention could hasten the process and make it less painful. This is because the technology is characterized by large externalities and often requires action at the industry level.

Securities Scam Genesis, Mechanics and Impact

The term "securities scam" refers to a diversion of funds to the tune of over Rs. 3500 crores from the banking system to various stockbrokers in a series of transactions (primarily in Government securities) during the period April 1991 to May 1992. The scam has for several months become a permanent feature of the front pages of the newspapers. Despite the massive media coverage of the scam, most readers found it hard to understand it particularly when they were confronted with arcane terms and acronyms like ready forward, double ready forward, SGL, PDO, BR, PMS etc. Nevertheless an understanding of the scam is a prerequisite for any meaningful analysis of policy alternatives to improve the functioning of the financial system. This paper presents a plausible reconstruction of how the scam originated, how it was perpetrated, and what would be its aftermath. The paper is expository in nature and the authors make no claims to omniscience. The paper goes on to discuss the response of the government to the scam in terms of 1) discovering and punishing the guilty, 2) recovering the money, and 3) reforming the system. While agreeing with the importance of discovering and punishing the guilty, the paper argues that the attempt of the government to recover the money by such measures as the tainted shares law which cause severe and unjustified hardship to genuine and innocent investors is misguided. Turning to the arena of reforms of the financial system, the paper argues that the origins of the scam lie in overregulation of our markets. It recommends that normal transactions must be allowed to be done openly and transparently, and the role of brokers as market makers must be recognized. The second lesson from the scam is that artificial insulation of closely related markets from each other is counterproductive in the long run. Artificial barriers between the money market and the capital market, between the market for corporate securities and the market for government securities and between the formal money market and the informal one must be eliminated.

Estimation Errors and Time Varying Betas in Event Studies - A New Approach

The event study is one of the most powerful techniques for studying market efficiency. Over a period of time, researchers have made several modifications to the original methodology of Fama, Fisher, Jensen and Roll (1969). Nevertheless, the current methodology continues to suffer from several grave deficiencies. These deficiencies arise due to (a) a failure to take into account the variance covariance structure of the estimated abnormal returns (across time and across securities) and (b) fundamental shortcomings of the moving window technique used to deal with possible changes in the betas in the neighbourhood of the event. Our proposed methodology overcomes these deficiencies and provides statistically efficient estimates. We then extend the analysis to handle nonstationary parameters evolving according to a Kalman Filer model.

Reform of the Fiscal and Subsidy Regime for the Petroleum Sector (Based on a Report Commissioned by the Petroleum Federation of India)

Reform of the oil sector is long overdue. The problems in the sector emanate from the structure of central taxes and the system of subsidisation through prices. Solutions to the problems necessarily have to address both tax and subsidy simultaneously. The social losses include, misuse / wasteful use of scarce petroleum resources, diversion, adulteration, other avoidable negative externalities, improper substitution between products, tax arbitrage, distortion of consumer preferences and input choices of industries, and international cross hauling of petroleum. Nearly all these costs, and problems arise not because of subsidisation per se but due to the use of varying retail prices that are used to subsidise. Prices for the same product vary for different consumers besides. They also vary across products. These tax /subsidy variations are the root cause of nearly all problems in the sector. Autonomous price variations (i.e. those resulting from the actions of firms (under a regime of non-distortionary subsidies) would be small and not subject to ‘arbitrage’ i.e. to the realisation of rents through diversion and adulteration. Tax reform – viz casting all taxes in the form of value added taxes has not taken place in the sector despite the passage of nearly 15 years since such reform was put in place in nearly all other sectors of manufacturing. Complete deregulation of the sector allowing oil producers, oil refiners, marketing companies, and integrated operators to price their products as they deem fit. Recast central indirect taxes (excise whether specific or ad valorem) into a value added tax, as for any other product., i.e., allowing input credit for all registered intermediate users of petroleum products is overdue. Central government revenues can be protected by working out a revenue neutral value added tax rate. This we have estimated approximately to be 110-120% of value added uniformly to all segments in the industry. Such a tax regime would also be neutral to the degree of vertical integration and remove the biases in the use of products. The Public Distribution System (PDS) is not necessary and ought to be dismantled. Kerosene would then be sold in the open market for all consumers. Kerosene could also be sold by retail outlets, kirana shops, other retail outlets, and by current PDS retailers on par with kirana shops/ ROs. Ditto for LPG. Subsidies are administered through endowments defined upfront, which allows the subsidised consumer to access his/her endowments, trade the same, convert the same into cash all without the causing any distortion. Only pipelines are subject to regulation by the Petroleum and Natural Gas Regulator. The second best proposals involve the changes/recommendations as before but additionally creates a “Crude Price Stabilisation Fund” (CSF) that allows crude prices (both sharp rises and sudden falls) to be moderated, so that pass thru is influenced by the managers of the CSF. It is important that the CSF is set up as in independent body and insulated from the government and is governed by strict and automatic rules that make rapid price adjustment (to the market prices) necessary when the fund position is low, so that the probability of the fund going bankrupt is kept at nearly zero. A fund between $25 to 40 billion is envisaged. A fund of$40 billion (Rs. 200,000 crore) envisaged as a credit line would work in most situations. The fund would operate with strict limits on the quantum of the credit line used to pay out stabilization subsidies during the boom phase of the price cycle as also on the accumulated reserves built up from stabilization taxes during the bust phase of the price cycle. To ensure that such crude stabilisation measures do not affect the competitiveness of the industry exports of product (and crude) are taxed when crude is subsidised, and subsidised when crude is taxed. Appropriate conversion factors would apply. The conversion factor should be based on a refinery loss of between 10 and 7% say 8.5%.

Research on the Indian Capital Market: A Review

In this paper we present a review of research done in the field of Indian capital markets during the fifteen years from 1977 to 1992. The research works included in the survey were identified by two search procedures. Firstly, we wrote to 118 Indian university departments and research institutions requesting information on the works done in this field in their department/institution. After three reminders, we obtained responses from 53 institutions. Simultaneously, we searched through various Indian journals in our library, located books listed in the library catalogue and traced through the list of references provided in various research works. Considering the size, vintage and development of the Indian capital market, the total volume of research on it appears to be woefully modest - about 0.1 unit of work per institution per year! Moreover, a large number of works are merely descriptive or prescriptive without rigorous analysis. Certain areas such as arbitrage pricing theory, option pricing theory, agency theory, and signalling theory are virtually unresearched in the Indian context. Besides, very little theoretical work has been done by researchers in India. However, with improved availability of databases and computing resources, and with increasing global interest in Indian markets, we expect an explosion of work in the near future.

Indian Convertible Bonds with Unspecified Terms: An Empirical Study

Indian convertible bonds have two peculiar features that make them possibly unique in the world: a) the bonds are compulsorily converted into equity without any option, and b) the conversion terms are not specified at the time of issue but are left to be determined subsequently by the Controller of Capital Issues (CCI) who is the government functionary regulating capital issues in India. A naive model would say that the market simply forms an estimate of the likely conversion terms and then values the bond as if these terms were prespecified. This paper examines the market prices of one of the largest issues of Indian convertible bonds with unspecified terms. The empirical investigation convincingly rejects the naive model and demonstrates that changes in the markets expectation of the conversion terms are a significant factor affecting the pricing relationship. These changes are significantly correlated with the stock price itself. We do not, however, find any evidence that the market expects the CCI to adjust the conversion terms on the basis of the actual market price to protect the bondholder. But, there is strong evidence that changes in expected conversion terms affect the share price through the dilution effect. Since the unspecified terms have only added to the uncertainty of the bondholders without giving them any perceived benefits we recommend that this system should be abolished. In a companion paper, Barua and Varma (1991) present a theoretical valuation model for the Indian convertible bonds with unspecified terms. The empirical results in this paper confirm the predictions of that model.

Board Interlocks and Their Impact on Corporate Governance: The Indian Experience - Coping with Corporate Cholesterol

Board interlocks occur when a director of one organization sits on the board of directors of another organization. The causes and consequences of these interlocks have been much debated in the western literature but comparatively little is known about interlocks in Indian corporate boards. Board interlocks are essentially analogous to cholesterol. Both are facts of life. Like good cholesterol, there are aspects of interlocking directorates that are beneficial and there are others that are detrimental to the corporation and its stakeholders and their respective interests. In this study, we find that board interlocks are quite widespread in India. Taking a (numerically) small but nevertheless (in terms of market capitalization) an important slice of available corporate data, we observed that in 2010, ‘highly boarded’ directors (defined as those on the board of 5 or more listed NSE companies) who constitute just 6 percent of the overall pool of directors among NSE100 companies are associated with 486 NSE listed companies which account for a whopping 66 percent of the total market capitalization of all NSE listed companies. Interestingly, there appears to be a marked increase in market capitalization of these ‘highly boarded’ companies, which these ‘highly boarded’ directors are linked to over the last several years. For instance, for the 3 years from 2001 to 2003, the market capitalization of ‘highly boarded’ companies ranged between 33 percent to 43 percent; it moved up to peak of 70 percent in 2007 and was at 66 percent in 2010 (the latest year in the study period). The substantive rise in market capitalization of these ‘highly boarded’ companies has coincided with only a marginal increase (from 5% to 6%) in the proportion of ‘highly boarded’ directorships. These trends suggest that despite the well-intentioned regulatory reforms (a) the extent of over-boarding/interlocking among directors has not come down (there is actually a marginal increase) and (b) there appears to be increasing concentration of power among key individuals. Given the general view that concentration of power in a few individuals or entities is not desirable in the larger interests of society, it would appear that the observed trends in the concentration of power among a handful of the country’s corporate elite is a matter for substantive public policy concern. Finally, the regression analysis indicates a positive impact on Return on Assets (ROA) for ‘highly boarded’ directors signifying a negation of the agency centric conceptualization on the role of multiple directors. Instead, connectedness variables (Eigen vector) which proxy for the Resource dependency hypothesis are quite strongly supported. In a nutshell, from public policy perspective, the analysis potentially reflects the ‘bad cholesterol’ elements of multiple directorships in terms of a tiny segment of ‘highly boarded’ directors controlling a significant portion of the country’s economic prowess, whereas the positive influences on company performance provide some evidence of the ‘good cholesterol’.

A First Cut Estimate of the Equity Risk Premium in India

We estimate the equity risk premium in India using data for the last 25 years. We address the shortcomings of existing indices by constructing our own total return index for the 1980s and early 1990s. We use our estimates of the extent of financial repression during this period to construct a series of the risk free rate in India going back to the early 1980s. We find that the equity risk premium is about 8�% on a geometric mean basis and about 12�% on an arithmetic mean basis. There is no significant difference between the pre reform and post reform period: the premium has declined marginally on a geometric mean basis and has risen slightly on an arithmetic mean basis. The reason for this divergence between the sub period behaviour of the two means is the increase in the annualized standard deviation of stock market returns from less than 20% in the pre reform period to about 25% in the post reform period. The higher standard deviation depresses the geometric mean in the post reform period.

A Scheme for Efficient Subsidisation of Kerosene in India

The distortions in price based subsidisation are very severe. The direct fiscal cost of ensuring that a rupee of value is delivered to all household users of kerosene is as high as Rs.3 and when the consideration is the benefit that finally reaches the poor “below the poverty line” consumers it is much more. This is well known. This excludes the indirect costs in the form of negative externalities imposed by adulteration, and environmental costs. Worse still are the “third order” effects of entrenched rent seeking and corruption of distribution networks and the conversion of retailing to patronage. In such situation reform and deregulation become problematic. At the core of all these failures in the “price arbitrage” that arises when price based subsidies are resorted to. The total fiscal losses on account of kerosene subsidisation are in excess of Rs. 24,000 crore far above the conventional estimates (around Rs. 8000 – 10,000 crore) which do not recognise the fiscal cost of diversion and adulteration. This paper studies the current design of the public distribution system and price based subsidisation to bring out the perversities, and argues that a complete replacement is called for. The Public Distribution System (PDS) which had value in an era of shortage and rationing has no role today. Market based distribution can bring down the direct costs since now kerosene distribution could then enjoy the synergies of oil and provisions distribution channels. There is clear evidence that a significant percentage (about 40) of kerosene is diverted out of the PDS and sold at higher prices. The commission paid to the distribution channel, in particular to the retailers of kerosene does not make the business financially viable. The rents being earned by those associated with the distribution channel for kerosene are very large. The rent extractors have become so well entrenched over time that it is plausible that other agencies in the system and even the regulatory process itself may be hostage today to their influences. The indirect losses from use of sub-optimal fuel mix, product mix and investment decisions are very large and may harm the economy significantly in the long term. The subsidy through uniform low pricing of kerosene, though intended for the poor, is in fact not reaching them as they are in no position to buy much of the kerosene allotted to them even at the low issue prices being charged by the fair price shops. It is imperative to bring into play information and communication technologies so as to break the stranglehold of the distribution channel by capturing information at the point of sale and thereby creating a permanent audit trail of all relevant transactions. Only by empowering the target segment, the BPL families, by providing them with the freedom to choose the manner in which they would like to consume the subsidy intended for them can the problem be overcome. The well-documented failure of TPDS (Targeted Public Distribution System), implemented on an experimental basis, clearly demonstrates that tinkering with the existing system would not achieve the twin goal of benefiting the really poor and not-benefiting the non-poor. The direct subsidy scheme, which is based on free market pricing of kerosene, and therefore a radical departure from the current method of uniform low pricing is the answer for achieving effectiveness of subsidization. The subsidy is to be disbursed to the poor through smart cards and the accounting of disbursal is to be done using systems similar to those used by credit card companies. The purchasing power put in the hands of the beneficiaries would allow them to use it for spending on their choice of commodities and services and thereby not only enhance the use of subsidy to the full but would also add greatly to their welfare. The proposed system would almost completely eliminate the indirect losses arising from distorted choices since the price of kerosene would be market determined and therefore not relatively cheap compared to alternate fuels. A task force (TF) must be set-up for implementation, with wide-ranging powers and full financial backing of the government of India so as to be able to function autonomously. The task force should consist of eminently qualified individuals with diverse skills and known for their integrity and appreciation for the significance of the task to be performed. The critical task of identifying the beneficiaries at micro-level should be done using all possible sources of data and information (outlined in the report) so as to minimize both, Type I and Type II errors, that is, chance of exclusion of genuine beneficiary and chance of inclusion of spurious beneficiary in the list of target beneficiaries. There are interesting ways by which private information can be brought to bear, and incentive compatibility ensured in correct identification. The disbursement of subsidy should be such that the disbursement is recorded at the point of transaction and get immediately captured in a large centralized database, thereby creating a permanent audit trail, akin to operation of credit cards (details outlined in the report). The activities associated with initial identification of beneficiaries, disbursement of subsidies and updating the list of beneficiaries is to be done by well-qualified private agencies. The operations of the system should be monitored by an SPV to be specially created for the purpose and working under the broad supervision and direction of the task force. The SPV and the TF should ensure full transparency of operation of the private vendor and the scheme by making public all relevant information on the operation of the system and opting for periodic audit of operations. The appropriate organisation design and policy framework for the same is elaborated. The immediate gain to the exchequer from the proposed system, due to market based pricing of kerosene would be an estimated inflow of Rs. 14000 crore per year by way of additional taxes. This gain from additional taxes, based on certain assumptions, is expected to rise to over Rs. 37000 crore in 2010-11, at Jan. 2006 petroleum prices. The gain to the economy and society at large from elimination of indirect losses due to sub-optimal choices of fuel-mix, product-mix, and asset mix would be immense as they would be completely eliminated in the new system. The most important gain however is that the beneficiaries would be in a position to fully utilize their entitlements and spend the same on products and services of their choice, significantly enhancing thereby the utility of their consumption. This should also make direct subsidies politically rewarding.