Views expressed in this section are of the author, which may not necessarily be shared by members of ERG. Economic Research Group is committed to promote professional exchanges in the field of economics and development issues. This is the first in the series of writings on contemporary issues, and will hopefully, encourage others to contribute. For query and contribution to this section, please write to info@ergonline.org. The following paper of Professor Wahiduddin Mahmud reached ERG in March 2006.

Summary

Comments on the Proposed Investment by Tata Group in Bangladesh

by Wahiduddin Mahmud
Professor in Economics, Dhaka University
Chairman, Economic Research Group

<The report was prepared at the request of the Board of Investment, Government of Bangladesh>

 

The issue of gas pricing is the key to the determination of Bangladesh’s net economic benefit from the investments proposed by Tata. On the face of it, the proposed steel-power complex appears promising, since it combines the advantage of the availability of iron ore and energy resources in India and Bangladesh respectively; however, many strategic issues need to be resolved, particularly regarding infrastructure provision, land acquisition and the feasibility of coal mining.

The economic viability of the fertiliser project may depend largely on subsidised gas supply, particularly when the investment returns need to cover the country-risk factor as perceived by a foreign investor.

Tata’s investment proposal is a complex one with several components. The proposed urea plant is an entirely separate project with no link with the rest of the investment proposal; as such, its merit is better judged separately. The other part of the investment project is an integrated one involving steel production, power generation and coal mining. Even for this integrated project, the possibility of generating power by gas and thus leaving out the coal mining component may be kept open as an alternative, given the many unresolved issues regarding coal mining.

Tata’s projected profits from the investments seem to be large enough, particularly for the steel-power complex, so as to provide ample scope for bargaining in order to arrive at a fair win-win deal. There does not seem to be any strong case for allowing tax-breaks or other incentives beyond what are allowed under the existing structure of incentives for such investments. Special incentives beyond the existing rules also create precedence for giving such incentives to other prospective investors.

Further negotiations with Tata would be facilitated if more detailed information is made available regarding the project profile for each component of the project. As far as one can see from Tata’s documentation, there seems to be discrepancies in the estimated value-added, the annual tax payments and the implied profits to be retained by Tata.

Natural gas will be the critical input to Tata’s operations. The benefit from the direct investment impact will be thus highly sensitive to the pricing of gas. A subsidy of US$ 1 per unit (i.e. per mcf) of gas sold to Tata will imply a subsidy of  US$ 68 million annually - or US$ 83 million if captive power for the steel plant were to be generated from gas instead of coal. Against this, the direct benefit from Tata’s operations will consist of an estimated US$ 20 to US$ 30 million annually in terms of salaries and another US$ 38 million in tax revenue estimated as the annual equivalent of the tax payments to be made by Tata with a ten-year tax holiday (or US$ 63.5 million in case of a six-year tax holiday).

Bangladesh has a history of subsidised gas supply.  Whatever may be the rationale for such subsidy, the use of gas should be guided by its true economic price based on the principle of the opportunity cost. There is a need for devising economic pricing mechanisms for gas, based on the predictions regarding how long the gas reserves will last and what will be the cost of importing alternative fuel when the country will run out of gas. While the current gas price of US$ 2.35 per unit (mcf) for industrial use may not be highly misaligned, it will need to be flexibly adjusted in future.

For ensuring proper use of gas, the government should commit to a flexible gas price policy reflecting at least in part the true economic pricing of gas. There should be an explicit rationale for providing any gas subsidy. Tata may be offered gas at the prevailing price for industrial use without any favour or discrimination. An arrangement is also suggested for ensuring gas supply to Tata that involves a fair sharing of risk.

The negotiations with Tata regarding gas supply arrangements demonstrate a fundamental weakness in our energy policy. The lack of knowledge regarding gas reserves poses a severe constraint in formulating a gas utilisation policy and making commitment for any long-run use of gas.

There is a problem in depending on the international oil companies (IOCs) entirely for gas exploration. The high and low projections of domestic gas demand vary widely. The IOCs will tend to plan their exploration and gas-field development activities keeping in view the low demand projection, since they would like to be sure about getting quick returns from their investments through full-capacity production from the discovered fields. For this reason, it is important to strengthen the domestic capacity for gas exploration.

The indirect benefits from Tata’s projects will come from the balance of payments support and from the positive spill-over effects on other sectors created through outsourcing and the purchase of inputs. While these benefits are important, the report produced by the Economic Intelligence Unit (EIU) of the Economist makes highly exaggerated claims in these respects. In estimating the indirect impact on other sectors, it ignores the fact that the expansion of production activities in an economy like Bangladesh is generally constrained by lack of inadequate production capacity rather than by demand deficiency.

There will be of course some demand-driven expansion of activities in sectors where employment can be created with very little investment in fixed capital. Such employment will be mainly in service sectors – such as the employment created in and around the township that will grow around the proposed steel mill.

It is estimated that Tata’s operations will provide balance of payments support of US $ 628 million annually through net exports and US$ 323 million through import substitution. The actual balance of payments support will be of course much lower because of the repatriation of profits – a fact that has been curiously overlooked in the EIU report.

Tata’s project will produce about US$ 1 billion worth of steel annually, 75 percent of which will be initially exported after meeting the country’s entire domestic demand. The domestic price of steel will perhaps be lower than if steel were to be imported. There are a whole range of industries and construction activities that will get a boost directly or indirectly from the cheaper supply of steel, and the benefit will increase with the growth of steel-based industries in the country. Although some existing facilities for steel production, mostly from scraps, may be adversely affected, this will be much more than compensated by the benefit.

Tata’s operations will lead to increased demand on railway transportation for the import of iron ore and the export of steel and coal. This will need substantial investment in railway infrastructure, along with improvement in management efficiency to ensure that the government does not incur losses from such investment. The viability of the investments will also depend on the tariffs charged, given the fact that the public transport systems, including railways, are heavily subsidised in Bangladesh. 

The implementation of Tata’s proposed projects will need land acquisition and resettlement of residents and the construction of road links to the plants. Agreement will be needed about how Tata proposes to pay for the costs involves. While Tata has proposed to buy the land at market prices, an alternative would be for the government to incur the entire costs and to recover it through renting or leasing the infrastructure to Tata. Land being the scarcest resource in Bangladesh and as it becomes even scarcer with the growth of economic activities, land prices tend to increase quite rapidly in real terms. Thus, buying land and even keeping it idle may prove a profitable investment. The sale of land to foreign investors could thus lead to windfall gains to them at the time of winding up the investment project.