Indian Mining Sector Investment Climate Needs Overhaul - My article in the Mining India magazine
Mining industry as the prime mover
Growth in the Indian industry as reflected by the recent Index of Industrial Production is being pulled down by poorer than expected growth rates in mining sector. The year-on-year industrial growth for October 2011 has been reported as negative 5.1%, which has mining sector growth pegged at negative 7.1%. Coal production has fallen for the third month in a row while the iron ore mining has been in doldrums since the ban on Karnataka mining. While the optimism for the economic growth of India on a medium to long term still persists, there are serious concerns about how those targets would be achieved without each of the components of the economy performing to expectation.
Mining industry in India is likely to remain the prime mover. For example, coal sector is still to contribute to 70% of power generation capacity addition being planned for the 12th Five Year Plan. Targets of large capacity addition in steel sector, similarly, will depend on development of iron ore mines. With such leverage on mining sector, it is about time that the sector is assessed for investment climate.
The typical framework for assessment of mining sector investment climate in India will include review of political environment; social environment; statutory and regulatory environment; and economic and fiscal regime for mining.
Political Environment for Mining
The political system in India has been stable form of democracy but the influence of parochial interest groups have led to several regressive measures being taken that may have significant impacts on mining sector investments. Politics of mining has been raising its influence in the mineral rich States such as Karnataka and Goa. Karnataka witnessed a change in the leadership of the government due to forces of iron ore mining from Bellary that found allegations of large scale illegal mining and exports surfacing. That there are growing number of miners in the political arena and growing number of political interests in mining is given due to commodity prices seeing rising trends leading to windfall cash flows for commodities like iron ore. For the same reasons, there has been maddening competition for new mining licenses. Such has been the competition that it has become difficult for the agencies to decide in favor of one and rejecting others without raising challenges and potential litigations. Even for coal block allocations, where the union government plays a larger role, 2006 allocation saw 748 applications for 16 coal blocks for power generation end use. Political influence in such cases makes the process abysmally slow and, in some instances, has stalled issue of new licenses altogether.
Political environment also has to concern the state and union government relations. Mining industry being subject to several union and state laws, rules and regulations are likely to be affected by the relationship between the state and union governments. It has been observed that the mineral rich states have tended to have government from parties that are in the opposition at the union level. These have sometimes led to delays in approvals and clearances to mining and end-use projects in the state. These do not support the investment climate in mining.
Corruption has been another major concern in the political, regulatory, and legal systems, and India needs to take this issue head-on by instituting new controls, such as Lokpal, to improve the investment environment in mining sector.
Social environment
Social issues concerning land acquisition, forest clearances and rehabilitation & resettlement, which have seen several mining projects delayed and some even shelved altogether. Delay in iron ore lease to Korean steel manufacturer along with delays in land acquisition for the steel plant itself has seen potentially one of the largest foreign direct investments in abeyance for more than 7 years. Land acquisition issues have also affected several bauxite mining projects in the states of Andhra Pradesh and Orissa. Several coal mining projects across the country has been delayed due to social concerns, these include expansion of existing mines as well.
The social issues have been of the nature of manifestation of ‘resource curse’ for the states and regions that have seen the mining projects not benefitting the project affected people. The watchwords in the mining industry such as sustainable development, social license to operate and such others have gained currency, the mining industry one hand is still to adopt and implement in letter and spirit, and on the other the same principles have often been used by opponents to delay or completely halt mining projects.
These get compounded by issues such as Naxalism and Maoist terrorism, which have resulted in strong negative perception about investment potential in certain regions of the country, which are mineral rich. While the politics of the state and the union determines the degree of support for the development of mining projects in such areas, suffice it to say that the investments fall in low priority zone for such regions.
The union government has been working on the new land acquisition bill that is likely to have a far reaching impact on how mining business will be done in India. The provisions for high initial payments are appended with annual payments which create future liabilities on the project. There has not been a political consensus on the subject, and this has also fuelled uncertainty in investments.
Statutory and Regulatory Environment
Indian statutory and regulatory environment has been in a flux for long. The Coal Mines nationalization (Amendment) Bill has been pending with the Parliament for more than a decade. The Mines and Minerals (Development & Regulation) Act (MMDR) has been amended once and then several other amendments have been debated for long with no consensus in sight. These statutory pieces have significant potential for impacting the mining sector investment scenario in India.
Positives of the new bill are the provisions for making investments in exploration and prospecting attract risk capital and have exit options. These will help private sector investments in much needed exploration and also allow specialized firms to invest in various stages in the life of a mine. By removing restrictions in transactions of licenses, the objectives of creating better investment environment can be achieved. This will build upon the other positive move made earlier of the inclusion of competitive bidding for allocation of mineral resources. This has set the platform for efficient and transparent mechanism for allocation of resources to deserving players. While the details of the processes for various minerals are still emerging, this provision has the potential to instill confidence in the process of allocation.
The negative seems to emanate from the concerns regarding the 26% profit share for coal and one-time royalty equivalent payment for other minerals aimed at social development. The benefits of adopting sustainable development approach to mining are manifolds, which are the reasons why the Indian mining industry is willing to invest in the societies around their operations and obtain their social license to mine. Risks of antagonizing the social set up can manifest in projects being shelved or substantial cost overruns. In view of these making a mandated payment for the same, while there are challenges in effective delivery of these social goods through government-owned mechanisms has been a drawback.
Speedy implementation of projects depends upon land acquisition, rehabilitation & resettlement and several clearances & approvals. The profit share for social development may help to a certain extent as the project affected people may see reasons to believe that their long term interests are likely to be protected. However, degree of its effectiveness will largely depend on the expectation of government machinery to deliver. On the clearances and approvals, whose process are labyrinthine and involve both central and state agencies, the Bill may not have provided a relief. The long standing demand from the industry for a single-window clearance system remains unmet.
For the captive coal miners, in particular, the cost of power generation or any other approved end use will increase. Although in the scenario of competitive electricity procurements by the utilities, it will remain to be seen how much of the additional cost can be passed on to the consumer. This may have an impact on the attractiveness of investments in coal mining as well as power generation industries. On the operational side, the issues of determination of optimum cost of coal mining and appropriate transfer price will arise soon, which will typically determine the extent of profit share.
There is a need to make process of clearances and approvals of mining and prospecting licenses predictable and time bound. The process needs objectivity and must have a defined measurable parameters for an application to be evaluated. The procedure also needs to have close coordination between the central and state agencies, which could be institutionalized through appropriate provisions in the Bill.
On the Policy Potential Index (PPI) of the Fraser Institute’s annual survey of mining companies for 2010-11, India ranks among the bottom 10 along with Indonesia, Zimbabwe, Wisconsin, Madagascar, Guatemala, Bolivia, DRC (Congo), Venezuela, and Honduras. The Institute defines the PPI as a composite index that measures the effects on exploration of government policies including uncertainty concerning the administration, interpretation, and enforcement of existing regulations; environmental regulations; regulatory duplication and inconsistencies; taxation; uncertainty concerning native land claims and protected areas; infrastructure; socioeconomic agreements; political stability; labor issues; geological data base; and security. The low score of India on the PPI shows that the statutory and regulatory environment in India may not be attractive for investments. The cause of concern is also the fact that between 2009-10 and 2010-11, the score on this account for India has fallen, indicating a deteriorating investment environment.
Economic and Fiscal Environment
The economic environment for mining has been challenging in the recent past due to cost push and shortage of equipment and labor. The talent pool for mining management has also been shallow and there are competition from other industries such as information technology for hiring talent that are trained in mining and geosciences. Cost push has come from higher costs of labor and talent; expensive power and higher consumables costs. The capital costs have also gone up due to higher costs of steel and other manufacturing inputs. The working capital investments are higher too since the lead times for procurement of spares have increased substantially; and their availability and quality have been concerns to. According to an estimate the lead time for procurement of dump truck tyres has increased to nearly two years and there are no availabilities guaranteed. While the Chinese manufacturers have gained market share in tyres, there are some questions regarding their quality.
Another input for mining, namely explosives, has become expensive as well due to their fuel oil component (typically diesel) whose prices are higher due to higher crude oil prices in the international markets.
In India, public sector companies typically do not resort to loans and borrowings for capital expenses. However, with greater participation of private sector in mining, debts will be a major source of funding mining projects, and their costs will be a component of cost of mining. In the recent past, the borrowings from banks and domestic financial institutions have become expensive. The Reserve Bank of India has revised the policy rates several times in the last year to tighten inflationary situation in India which has in turn increased the borrowing costs for mining projects and have had squeezing impact on cash flows for equity holders and profit potential of the projects.
On fiscal front, there are uncertainties pertaining to direct tax code and Goods and Services Tax, which have been hanging in the balance for quite some time now. Royalties have been now ad valorem based which link in most cases to international prices of metals. The provision for 26% profit share for coal mining and one-time-royalty-equivalent payment for social development, although not strictly a fiscal measure, also have created uncertainties on the financial viabilities of marginal mining projects.
Conclusion
The investment environment in mining sector in India requires substantive measures to improve the perceptions. The key challenges will be to contain corruption and negative political influences through improving transparency in allocation of mineral resources and all transactions of minerals. Information technology enabled governance can help this cause. Social issues need to be addressed with a balanced approach so that project affected people are duly compensated and the projects are economically viable and do not the risk of time and cost overruns. On statutory and regulatory front, there is clearly a need for streamlining the clearances and approval processes, a joint coordination committee from the union and state governments with empowerment may be a way out. On economic and fiscal issues there is a need to maintain stability and create facilities to fund mining projects. These put together can help improve Indian mining sector investment climate and help develop new projects that can help meet the growing demand for minerals.
Growth in the Indian industry as reflected by the recent Index of Industrial Production is being pulled down by poorer than expected growth rates in mining sector. The year-on-year industrial growth for October 2011 has been reported as negative 5.1%, which has mining sector growth pegged at negative 7.1%. Coal production has fallen for the third month in a row while the iron ore mining has been in doldrums since the ban on Karnataka mining. While the optimism for the economic growth of India on a medium to long term still persists, there are serious concerns about how those targets would be achieved without each of the components of the economy performing to expectation.
Mining industry in India is likely to remain the prime mover. For example, coal sector is still to contribute to 70% of power generation capacity addition being planned for the 12th Five Year Plan. Targets of large capacity addition in steel sector, similarly, will depend on development of iron ore mines. With such leverage on mining sector, it is about time that the sector is assessed for investment climate.
The typical framework for assessment of mining sector investment climate in India will include review of political environment; social environment; statutory and regulatory environment; and economic and fiscal regime for mining.
Political Environment for Mining
The political system in India has been stable form of democracy but the influence of parochial interest groups have led to several regressive measures being taken that may have significant impacts on mining sector investments. Politics of mining has been raising its influence in the mineral rich States such as Karnataka and Goa. Karnataka witnessed a change in the leadership of the government due to forces of iron ore mining from Bellary that found allegations of large scale illegal mining and exports surfacing. That there are growing number of miners in the political arena and growing number of political interests in mining is given due to commodity prices seeing rising trends leading to windfall cash flows for commodities like iron ore. For the same reasons, there has been maddening competition for new mining licenses. Such has been the competition that it has become difficult for the agencies to decide in favor of one and rejecting others without raising challenges and potential litigations. Even for coal block allocations, where the union government plays a larger role, 2006 allocation saw 748 applications for 16 coal blocks for power generation end use. Political influence in such cases makes the process abysmally slow and, in some instances, has stalled issue of new licenses altogether.
Political environment also has to concern the state and union government relations. Mining industry being subject to several union and state laws, rules and regulations are likely to be affected by the relationship between the state and union governments. It has been observed that the mineral rich states have tended to have government from parties that are in the opposition at the union level. These have sometimes led to delays in approvals and clearances to mining and end-use projects in the state. These do not support the investment climate in mining.
Corruption has been another major concern in the political, regulatory, and legal systems, and India needs to take this issue head-on by instituting new controls, such as Lokpal, to improve the investment environment in mining sector.
Social environment
Social issues concerning land acquisition, forest clearances and rehabilitation & resettlement, which have seen several mining projects delayed and some even shelved altogether. Delay in iron ore lease to Korean steel manufacturer along with delays in land acquisition for the steel plant itself has seen potentially one of the largest foreign direct investments in abeyance for more than 7 years. Land acquisition issues have also affected several bauxite mining projects in the states of Andhra Pradesh and Orissa. Several coal mining projects across the country has been delayed due to social concerns, these include expansion of existing mines as well.
The social issues have been of the nature of manifestation of ‘resource curse’ for the states and regions that have seen the mining projects not benefitting the project affected people. The watchwords in the mining industry such as sustainable development, social license to operate and such others have gained currency, the mining industry one hand is still to adopt and implement in letter and spirit, and on the other the same principles have often been used by opponents to delay or completely halt mining projects.
These get compounded by issues such as Naxalism and Maoist terrorism, which have resulted in strong negative perception about investment potential in certain regions of the country, which are mineral rich. While the politics of the state and the union determines the degree of support for the development of mining projects in such areas, suffice it to say that the investments fall in low priority zone for such regions.
The union government has been working on the new land acquisition bill that is likely to have a far reaching impact on how mining business will be done in India. The provisions for high initial payments are appended with annual payments which create future liabilities on the project. There has not been a political consensus on the subject, and this has also fuelled uncertainty in investments.
Statutory and Regulatory Environment
Indian statutory and regulatory environment has been in a flux for long. The Coal Mines nationalization (Amendment) Bill has been pending with the Parliament for more than a decade. The Mines and Minerals (Development & Regulation) Act (MMDR) has been amended once and then several other amendments have been debated for long with no consensus in sight. These statutory pieces have significant potential for impacting the mining sector investment scenario in India.
Positives of the new bill are the provisions for making investments in exploration and prospecting attract risk capital and have exit options. These will help private sector investments in much needed exploration and also allow specialized firms to invest in various stages in the life of a mine. By removing restrictions in transactions of licenses, the objectives of creating better investment environment can be achieved. This will build upon the other positive move made earlier of the inclusion of competitive bidding for allocation of mineral resources. This has set the platform for efficient and transparent mechanism for allocation of resources to deserving players. While the details of the processes for various minerals are still emerging, this provision has the potential to instill confidence in the process of allocation.
The negative seems to emanate from the concerns regarding the 26% profit share for coal and one-time royalty equivalent payment for other minerals aimed at social development. The benefits of adopting sustainable development approach to mining are manifolds, which are the reasons why the Indian mining industry is willing to invest in the societies around their operations and obtain their social license to mine. Risks of antagonizing the social set up can manifest in projects being shelved or substantial cost overruns. In view of these making a mandated payment for the same, while there are challenges in effective delivery of these social goods through government-owned mechanisms has been a drawback.
Speedy implementation of projects depends upon land acquisition, rehabilitation & resettlement and several clearances & approvals. The profit share for social development may help to a certain extent as the project affected people may see reasons to believe that their long term interests are likely to be protected. However, degree of its effectiveness will largely depend on the expectation of government machinery to deliver. On the clearances and approvals, whose process are labyrinthine and involve both central and state agencies, the Bill may not have provided a relief. The long standing demand from the industry for a single-window clearance system remains unmet.
For the captive coal miners, in particular, the cost of power generation or any other approved end use will increase. Although in the scenario of competitive electricity procurements by the utilities, it will remain to be seen how much of the additional cost can be passed on to the consumer. This may have an impact on the attractiveness of investments in coal mining as well as power generation industries. On the operational side, the issues of determination of optimum cost of coal mining and appropriate transfer price will arise soon, which will typically determine the extent of profit share.
There is a need to make process of clearances and approvals of mining and prospecting licenses predictable and time bound. The process needs objectivity and must have a defined measurable parameters for an application to be evaluated. The procedure also needs to have close coordination between the central and state agencies, which could be institutionalized through appropriate provisions in the Bill.
On the Policy Potential Index (PPI) of the Fraser Institute’s annual survey of mining companies for 2010-11, India ranks among the bottom 10 along with Indonesia, Zimbabwe, Wisconsin, Madagascar, Guatemala, Bolivia, DRC (Congo), Venezuela, and Honduras. The Institute defines the PPI as a composite index that measures the effects on exploration of government policies including uncertainty concerning the administration, interpretation, and enforcement of existing regulations; environmental regulations; regulatory duplication and inconsistencies; taxation; uncertainty concerning native land claims and protected areas; infrastructure; socioeconomic agreements; political stability; labor issues; geological data base; and security. The low score of India on the PPI shows that the statutory and regulatory environment in India may not be attractive for investments. The cause of concern is also the fact that between 2009-10 and 2010-11, the score on this account for India has fallen, indicating a deteriorating investment environment.
Economic and Fiscal Environment
The economic environment for mining has been challenging in the recent past due to cost push and shortage of equipment and labor. The talent pool for mining management has also been shallow and there are competition from other industries such as information technology for hiring talent that are trained in mining and geosciences. Cost push has come from higher costs of labor and talent; expensive power and higher consumables costs. The capital costs have also gone up due to higher costs of steel and other manufacturing inputs. The working capital investments are higher too since the lead times for procurement of spares have increased substantially; and their availability and quality have been concerns to. According to an estimate the lead time for procurement of dump truck tyres has increased to nearly two years and there are no availabilities guaranteed. While the Chinese manufacturers have gained market share in tyres, there are some questions regarding their quality.
Another input for mining, namely explosives, has become expensive as well due to their fuel oil component (typically diesel) whose prices are higher due to higher crude oil prices in the international markets.
In India, public sector companies typically do not resort to loans and borrowings for capital expenses. However, with greater participation of private sector in mining, debts will be a major source of funding mining projects, and their costs will be a component of cost of mining. In the recent past, the borrowings from banks and domestic financial institutions have become expensive. The Reserve Bank of India has revised the policy rates several times in the last year to tighten inflationary situation in India which has in turn increased the borrowing costs for mining projects and have had squeezing impact on cash flows for equity holders and profit potential of the projects.
On fiscal front, there are uncertainties pertaining to direct tax code and Goods and Services Tax, which have been hanging in the balance for quite some time now. Royalties have been now ad valorem based which link in most cases to international prices of metals. The provision for 26% profit share for coal mining and one-time-royalty-equivalent payment for social development, although not strictly a fiscal measure, also have created uncertainties on the financial viabilities of marginal mining projects.
Conclusion
The investment environment in mining sector in India requires substantive measures to improve the perceptions. The key challenges will be to contain corruption and negative political influences through improving transparency in allocation of mineral resources and all transactions of minerals. Information technology enabled governance can help this cause. Social issues need to be addressed with a balanced approach so that project affected people are duly compensated and the projects are economically viable and do not the risk of time and cost overruns. On statutory and regulatory front, there is clearly a need for streamlining the clearances and approval processes, a joint coordination committee from the union and state governments with empowerment may be a way out. On economic and fiscal issues there is a need to maintain stability and create facilities to fund mining projects. These put together can help improve Indian mining sector investment climate and help develop new projects that can help meet the growing demand for minerals.
posted by Dipesh Dipu @ 12:50 AM
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