Policy

Context to the Supreme Court Order on stressed assets of banks

The increasing Non-Performing Assets (NPAs) in the Indian banking sector has recently been the subject of much discussion and scrutiny.  Yesterday, the Supreme Court struck down a circular dated February 12, 2018 issued by the Reserve Bank of India (RBI).  The RBI circular laid down a revised framework for the resolution of stressed assets.  In this blog, we examine the extent of NPAs in India, and recent events leading up to the Supreme Court judgement.

What is the extent and effect of the NPA problem in India?

Banks give loans and advances to borrowers. Based on the performance of the loan, it may be categorised as: (i) a standard asset (a loan where the borrower is making regular repayments), or (ii) a non-performing asset. NPAs are loans and advances where the borrower has stopped making interest or principal repayments for over 90 days.

As of 2018, the total NPAs in the economy stand at Rs 9.6 lakh crore.  About 88% of these NPAs are from loans and advances of public sector banks.  Banks are required to lend a certain percentage of their loans to priority sectors.  These sectors are identified by the RBI and include agriculture, housing, education and small scale industries.[1]  In 2018, of the total NPAs, 22% were from priority sector loans, and 78% were from non-priority sector loans. 

In the last few years, gross NPAs of banks (as a percentage of total loans) have increased from 2.3% of total loans in 2008 to 9.3% in 2017 (see Figure 1). This indicates that an increasing proportion of a bank’s assets have ceased to generate income for the bank, lowering the bank’s profitability and its ability to grant further credit.

Figure 1: Gross NPAs (% of total loans)

Source: Reserve Bank of India; PRS

What has been done to address the problem of growing NPAs?

The measures taken to resolve and prevent NPAs can broadly be classified into two kinds – first, remedial measures for banks prescribed by the RBI for internal restructuring of stressed assets, and second, legislative means of resolving NPAs under various laws (like the Insolvency and Bankruptcy Code, 2016).

Remedial Measures

Over the years, the RBI has issued various guidelines for banks aimed at the resolution of stressed assets in the economy. These included introduction of certain schemes such as: (i) Strategic Debt Restructuring (which allowed banks to change the management of the defaulting company), and (ii) Joint Lenders’ Forum (where lenders evolved a resolution plan and voted on its implementation).   A summary of the various schemes implemented by the RBI is provided in Table 1. 

Table 1: Non-legislative loan recovery framework

Loan restructuring

  • Banks internally undertake restructuring of loans, if the borrower is unable to repay the amount.  This involves changing the terms of repayment, which includes altering the payment schedule of loans or interest rates.

Corporate Debt Restructuring

  • Allows for restructuring of a borrower’s outstanding loans from more than one bank.  This mechanism is available if the borrower’s outstanding loans are more than Rs 10 crore.[2]

Joint Lender's Forum

  • Lenders evolve an action plan to resolve the NPA of a defaulter.[3]  If 60% of the creditors by value, and 50% of the creditors by number agree, a recovery plan will be implemented.[4]

5:25 Scheme

  • Banks can extend loan term to 25 years based on cash flow of projects for which the loan was given.  Interest rates and other terms of the loans may be readjusted every five years.[5]

Strategic Debt Restructuring

  • Banks convert their debt into equity to hold a majority of shares in a company.  This allows banks to change the management of the defaulting company.[6]

Sustainable Structuring of Stressed Assets

  • Allows for conversion of a part of the outstanding debt to equity or preference shares if: (i) project for which loan was taken has commenced operations, and (ii) borrower can repay over 50% of the loan.[7]

Sources: RBI scheme guidelines; Economic Survey 2016-17; PRS.

Legislative Measures

  • The Insolvency and Bankruptcy Code (IBC) was enacted in May 2016 to provide a time-bound 180-day recovery process for insolvent accounts. When a default occurs, the creditors or debtor may apply to the National Company Law Tribunal for initiating the resolution process. Once the application is approved, the resolution process will have to be completed within 180 days (extendable by 90 days) from the date of approval.  The resolution process will be presided over by an insolvency professional to decide whether to restructure the loan, or to sell the defaulter’s assets to recover the outstanding amount.  If a timely decision is not arrived at, the defaulter’s assets are liquidated.
  • The Banking Regulation (Amendment) Act, 2017: The amendment allows RBI to direct banks to initiate recovery proceedings against defaulting accounts under the IBC.  Further, under Section 35AA of the Act, RBI may also issue directions to banks for resolution of specific stressed assets. 

In June 2017, an internal advisory committee of RBI identified 500 defaulters with the highest value of NPAs.[8]  The committee recommended that 12 largest non-performing accounts, each with outstanding amounts greater than Rs 5,000 crore and totalling 25% of the NPAs of the economy, be referred for resolution under the IBC immediately.  Proceedings against the 12 largest defaulters have been initiated under the IBC. 

What was the February 12 circular issued by the RBI?

Subsequent to the enactment of the IBC, the RBI put in place a framework for restructuring of stressed assets of over Rs 2,000 crore on or after March 1, 2018.  The resolution plan for such restructuring must be unanimously approved by all lenders and implemented within 180 days from the date of the first default.  If the plan is not implemented within the stipulated time period, the stressed assets are required to be referred to the NCLT under IBC within 15 days.  Further, the framework introduced a provision for early identification and categorisation of stressed assets before they are classified as NPAs.

On what grounds was the RBI circular challenged?

Borrowers whose loans were tagged as NPAs before the release of the circular recently crossed the 180-day deadline for internal resolution by banks. Some of these borrowers, including various power producers and sugar mills, had appealed against the RBI circular in various High Courts. A two-judge bench of the Allahabad High Court ruled in favour of the RBI’s powers to issue these guidelines, and refused to grant interim relief to power producers from being taken to the NCLT for bankruptcy. These batch of petitions against the circular were transferred to the Supreme Court, which issued an order in September 2018 to maintain status quo on the same.

What did the Supreme Court order?

The Court held the circular issued by RBI was outside the scope of the power given to it under Article 35AA of the Banking Regulation (Amendment) Act, 2017.  The Court reasoned that Section 35AA was proposed by the 2017 Act to authorise the RBI to issues directions only in relation to specific cases of default by specific debtors.  It held that the RBI circular issued directions in relation to debtors in general and this was outside their scope of power.  The court also held that consequently all IBC proceedings initiated under the RBI circular are quashed. 

During the proceedings, various companies argued that the RBI circular applies to all corporate debtors alike, without looking into each individual’s sectors problems and attempting to solve them.  For instance, several power companies provided sector specific reasons for delay in payment of bank dues.  The reasons included: (i) cancellation of coal blocks by the SC leading to non-availability of fuel, (ii) lack of enough power purchase agreements by states, (iii) non-payment of dues by DISCOMs, and (iv) delays in project implementation leading to cost overruns.  Note that, in its 40th report, the Parliamentary Standing Committee on Energy analysed the impact of the RBI circular on the power sector and noted that the ‘one size fits all’ approach of the RBI is erroneous. 

 

 

[1]Priority Sector Lending – Targets and Classification’ Reserve Bank of India, July 2012, https://rbi.org.in/scripts/NotificationUser.aspx?Id=7460&Mode=0

[2] Revised Guidelines on Corporate Debt Restructuring Mechanism, Reserve Bank of India, https://www.rbi.org.in/upload/notification/pdfs/67158.pdf

[3]Framework for Revitalising Distressed Assets in the Economy – Guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan (CAP)’, Reserve Bank of India, February 26, 2016, https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8754&Mode=0

[4] Timelines for Stressed Assets, Press Release, Reserve Bank of India, May 5, 2017, https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10957&Mode=0

[5] Flexible Structuring of Long Term Project Loans to Infrastructure and Core Industries, RBI, July 15, 2014, https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=9101&Mode=0

[6] Chapter 4, The Economic Survey 2016-17, http://unionbudget.nic.in/es2016-17/echap04.pdf

[7]RBI introduces a ‘Scheme for Sustainable Structuring of Stressed Assets’’ Press Release, Reserve Bank of India, June 13, 2016, https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=37210

[8] RBI identifies Accounts for Reference by Banks under the Insolvency and Bankruptcy Code (IBC), Reserve Bank of India, June 13, 2017, https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=40743

Indian Railways rationalises freight fares

Recently, the Indian Railways announced rationalisation of freight fares.  This rationalisation will result in an 8.75% increase in freight rates for major commodities such as coal, iron and steel, iron ore, and raw materials for steel plants. The freight rates were rationalised to ensure additional revenue generation across the network. An additional revenue of Rs 3,344 crore is expected from such rationalisation, which will be utilised to improve passenger amenities. In addition, the haulage charge of containers has been increased by 5% and the freight rates of other small goods have been increased by 8.75%. Freight rates have not been increased for goods such as food grains, flours, pulses, fertilisers, salt, and sugar, cement, petroleum, and diesel. In light of this, we discuss some issues around Railways’ freight pricing.

Railways’ sources of internal revenue

Railways earns its internal revenue primarily from passenger and freight traffic. In 2016-17 (latest actual figures available), freight and passenger traffic contributed to about 63% and 28% of the internal revenue, respectively. The remaining is earned from miscellaneous sources such as parcel service, coaching receipts, and platform tickets.

Freight traffic: Railways majorly transports bulk freight, and the freight basket has mostly been limited to include raw materials for certain industries such as power plants, and iron and steel plants. It generates most of its freight revenue from the transportation of coal (43%), followed by cement (8%), food-grains (7%), and iron and steel (7%). In 2018-19, Railways expects to earn Rs 1,21,950 crore from its freight traffic.

Railways fig1

Passenger traffic:  Passenger traffic is broadly divided into two categories: suburban and non-suburban traffic.  Suburban trains are passenger trains that cover short distances of up to 150 km, and help move passengers within cities and suburbs.  Majority of the passenger revenue (94% in 2017-18) comes from the non-suburban traffic (or the long-distance trains).

Within non-suburban traffic, second class (includes sleeper class) contributes to 67% of the non-suburban revenue.  AC class (includes AC 3-tier, AC Chair Car and AC sleeper) contributes to 32% of the non-suburban revenue.  The remaining 1% comes from AC First Class (includes Executive class and First Class).

Railways’ ability to generate its own revenue has been slowing

The growth rate of Railways’ earnings from its core business of running freight and passenger trains has been declining.  This is due to a decline in the growth of both freight and passenger traffic.  Some of the reasons for such decline include:

Freight traffic growth has been declining, and is limited to a few items

Growth of freight traffic has been declining over the last few years.  It has declined from around 8% in the mid-2000s to a 4% negative growth in mid-2010s, before an estimated recovery to about 5% now.

The National Transport Development Policy Committee (2014) had noted various issues with freight transportation on railways.  For example, Indian Railways does not have an institutional arrangement to attract and aggregate traffic of smaller parcel size.  Further, freight services are run with a focus on efficiency instead of customer satisfaction.  Consequently, it has not been able to capture high potential markets such as FMCGs, hazardous materials, or automobiles and containerised cargo.  Most of such freight is transported by roads.

Figure 2_Railways

The freight basket is also limited to a few commodities, most of which are bulk in nature.  For example, coal contributes to about 43% of freight revenue and 25% of the total internal revenue.  Therefore, any shift in transport patterns of any of these bulk commodities could affect Railways’ finances significantly.

For example, if new coal based power plants are set up at pit heads (source of coal), then the need for transporting coal through Railways would decrease.  If India’s coal usage decreases due to a shift to more non-renewable sources of energy, it will reduce the amount of coal being transported.  Such situations could have a significant adverse impact on Railways’ revenue.

Freight traffic cross-subsidises passenger traffic

In 2014-15, while Railways’ freight business made a profit of about Rs 44,500 crore, its passenger business incurred a net loss of about Rs 33,000 crore.17  The total passenger revenue during this period was Rs 49,000 crore.  This implies that losses in the passenger business are about 67% of its revenue.  Therefore, in 2014-15, for every one rupee earned in its passenger business, Indian Railways ended up spending Rs 1.67.

These losses occur across both suburban and non-suburban operations, and are primarily caused due to: (i) passenger fares being lower than the costs, and (ii) concessions to various categories of passengers.  According to the NITI Aayog (2016), about 77% to 80% of these losses are contributed by non-suburban operations (long-distance trains).  Concessions to various categories of passengers contribute to about 4% of these losses, and the remaining (73-76%) is due to fares being lower than the system costs.

The NITI Aayog (2016) had noted that Railways ends up using profits from its freight business to provide for such losses in the passenger segment, and also to manage its overall financial situation.  Such cross-subsidisation has resulted in high freight tariffs.  The NTDPC (2014) had noted that, in several countries, passenger fares are either higher or almost equal as freight rates.  However, in India, the ratio of passenger fare to freight rate is about 0.3.

Fig 3_Railways

Impact of increasing freight rates

The recent freight rationalisation further increases the freight rates for certain key commodities by 8.75%, with an intention to improve passenger amenities.  Higher freight tariffs could be counter-productive towards growth of traffic in the segment.  The NTDPC report had noted that due to such high tariffs, freight traffic has been moving to other modes of transport.  Further, the higher cost of freight segment is eventually passed on to the common public in the form of increased costs of electricity, steel, etc.  Various experts have recommended that Railways should consider ways to rationalise freight and passenger tariff distortions in a way to reduce such cross-subsidisation.

For a detailed analysis of Railways revenue and infrastructure, refer to our report on State of Indian Railways.

Explained: The recent rise in petroleum prices

In the past few months, retail prices of petrol and diesel have consistently increased and have reached all-time high levels.  On September 24, 2018, the retail price of petrol in Delhi was Rs 82.72/litre, and that of diesel was Rs 74.02/litre.  In Mumbai, these prices were even higher at Rs 90.08/litre and Rs 78.58/litre, respectively.

The difference in retail prices in the two cities is because of the different tax rates levied by the respective state governments on the same products.  This blog post explains the major tax components in the price structure of petrol and diesel and how tax rates vary across states.  It also analyses the shift in the taxation of these products, its effect on retail prices, and the consequent revenue generated by the central and state governments.

What are the components of the price structure of petrol and diesel?

Retail prices of petrol and diesel in India are revised by oil companies on a daily basis, according to changes in the price of global crude oil.  However, the price paid by oil companies makes up 51% of the retail price in case of petrol, and 61% in the case of diesel (Table 1).  The break-up of retail prices of petrol and diesel in Delhi, as on September 24, 2018, shows that over 45% of the retail price of petrol comprises central and states taxes.  In the case of diesel, this is close to 36%.

At present, the central government has the power to tax the production of petroleum products, while states have the power to tax their sale.  The central government levies an excise duty of Rs 19.5/litre on petrol and Rs 15.3/litre on diesel.  These make up 24% and 21% of the retail prices of petrol and diesel, respectively.

Table 1

While excise duty rates are uniform across the country, states levy sales tax/value added tax (VAT), the rates of which differ across states.  The figure below shows the different tax rates levied by states on petrol and diesel, which results in their varying retail prices across the country.  For instance, the tax rates levied by states on petrol ranges from 17% in Goa to 39% in Maharashtra.

Effective Sales Tax

Note that unlike excise duty, sales tax is an ad valorem tax, i.e., it does not have a fixed value, and is charged as a percentage of the price of the product.  This implies that while the excise duty component of the price structure is fixed, the sales tax component is charged as a proportion of the price paid by oil companies, which in turn depends on the global crude oil price.  With the recent increase in the global prices, and subsequently the retail prices, some states such as Rajasthan, Andhra Pradesh, West Bengal, and Karnataka have announced tax rate cuts.

How have retail prices in India changed vis-à-vis the global crude oil price?

India’s dependence on imports for consumption of petroleum products has increased over the years.  For instance, in 1998-99, net imports were 69% of the total consumption, which increased to 93% in 2017-18.  Because of a large share of imports in the domestic consumption, any change in the global price of crude oil has a significant impact on the domestic prices of petroleum products.  The following figures show the trend in price of global crude oil and retail price of petrol and diesel in India, over the last six years.

Petrol

Diesel

The global price of crude oil (Indian basket) decreased from USD 112/barrel in September 2012 to USD 28/barrel in January 2016.  Though the global price dropped by 75% during this period, retail prices of petrol and diesel in India decreased only by 13% and 5%, respectively.  This disparity in decrease of global and Indian retail prices was because of increase in taxes levied on petrol and diesel, which nullified the benefit of the sharp decline in the global price.  Between October 2014and June 2016, the excise duty on petrol increased from Rs 11.02/litre to Rs 21.48/litre.  In the same period, the excise duty on diesel increased from Rs 5.11/litre to Rs 17.33/litre.

Over the years, the central government has used taxes to prevent sharp fluctuations in the retail price of diesel and petrol.  For instance, in the past, when global crude oil price has increased, duties have been cut.  Since January 2016, the global crude oil price has increased by 158% from USD 28/barrel to USD 73/barrel in August 2018.  However, during this period, excise duty has been reduced only once by Rs 2/litre in October 2017.  While the central government has not signalled any excise duty cut so far, it remains to be seen if any rate cut will happen in case the global crude oil price rises further.  With US economic sanctions on Iran coming into effect on November 4, 2018, India may face a shortfall in supply since Iran is India’s third largest oil supplier.  Moreover, Organization of Petroleum Exporting Countries (OPEC) and Russia have not indicated any increase in supply from their side yet to offset the possible effect of sanctions.  As a result, in a scenario with no tax rate cut, this could increase the retail prices of petrol and diesel even further.

How has the revenue generated from taxing petroleum products changed over the years?

As a result of successive increases in excise duty between November 2014 and January 2016, the year-on-year growth rate of excise duty collections increased from 27% in 2014-15 to 80% in 2015-16.  In comparison, the growth rate of sales tax collections was 6% in 2014-15 and 4% in 2015-16.  The figure below shows the tax collections from the levy of excise duty and sales tax on petroleum products.  From 2011-12 to 2017-18, excise duty and sales tax collections grew annually at a rate of 22% and 11%, respectively.

Tax revenue

How is this revenue shared between centre and states?

Though central taxes are levied by the centre, it gets only 58% of the revenue from the levy of these taxes.  The rest 42% is devolved to the states as per the recommendations of the 14th Finance Commission.  However, excise duty levied on petrol and diesel consists of two broad components – (i) excise duty component, and (ii) road and infrastructure cess.  Of this, only the revenue generated from the excise duty component is devolved to states.  Revenue generated by the centre from any cess is not devolved to states.

The cess component was increased by Rs 2/litre to Rs 8/litre in the Union Budget 2018-19.  However, this was done by reducing the excise duty component by the same amount, so as to keep the overall rate the same.  Essentially this provision shifted the revenue of Rs 2/litre of petrol and diesel from states’ divisible pool of taxes to the cess revenue, which is entirely with the centre.  This cess revenue is earmarked for financing infrastructure projects.

At present, of the Rs 19.5/litre excise duty levied on petrol, Rs 11.5/litre is the duty component, and Rs 8/litre is the cess component.  Therefore, accounting for 42% share of states in the duty component, centre effectively gets a revenue of Rs 14.7/litre, while states get Rs 4.8/litre.  Similarly, excise duty of Rs 15.3/litre levied on diesel consists of a cess component of Rs 8/litre.  Thus, excise duty on diesel effectively generates revenue of Rs 12.2/litre for the centre and Rs 3.1/litre for states.

Examining the Consumer Protection Bill, 2018

The Consumer Protection Bill, 2018 was introduced in Lok Sabha in January 2018. The Bill replaces the Consumer Protection Act, 1986. Previously in 2015, a Bill had been introduced to replace the 1986 Act. The 2015 Bill acknowledged that the rapid change in consumer markets, introduction of practices such as misleading advertisements, and new modes of transactions (online, teleshopping, etc.) had necessitated the need for a new law. The Bill was subsequently referred to a Standing Committee, which recommended several changes to it. The Bill was withdrawn and replaced with the Consumer Protection Bill, 2018. The Bill is listed for passage in the ongoing Monsoon Session. In this post, we analyse the Bill in its current form.

How is the 2018 Bill different from the 1986 Act?

The Bill adds various provisions for consumer protection that were absent in the 1986 Act. Key among them are the provisions on product liability and unfair contracts. Under product liability, when a consumer suffers an injury, property damage or death due to a defect in a product or service, he can file a claim for compensation under product liability. The Bill outlines cases in which the product manufacturer, service provider and seller will be held guilty under product liability. Under the proposed law, to claim product liability, an aggrieved consumer has to prove any one of the conditions mentioned in the Bill with regard to a manufacturer, service provider and seller, as the case may be.

An unfair contract has been defined as a contract between a consumer and manufacturer/ service provider if it causes significant change in consumer rights. Unfair contracts cover six terms, such as payment of excessive security deposits in an arrangement, disproportionate penalty for a breach, and unilateral termination without cause. The consumer courts being set up under the Bill will determine contract terms to be unfair and declare them null and void.

What are the different bodies being set up under the Bill?

The Bill sets up Consumer Protection Councils as advisory bodies, who will advise on protection and promotion of consumer rights. However, it does not make it clear who these Councils will render advise to. Under the 1986 Act, the Consumer Protection Councils have the responsibility to protect and promote consumer rights.

To promote, protect, and enforce consumer rights, the Bill is setting up a regulatory body, known as the Central Consumer Protection Authority. This Authority can also pass orders to prevent unfair and restrictive trade practices, such as selling goods not complying with standards, and impose penalties for false and misleading advertisements.

The Bill also sets up the Consumer Disputes Redressal Commissions (known as consumer courts) at the district, state and national levels. These Commissions will adjudicate a broad range of complaints, including complaints on defective goods and deficient services of varying values. These Commissions are also present under the 1986 Act. However, their pecuniary jurisdiction (amount up to which they can hear complaints) has been revised under the Bill. The Bill also adds a provision for alternate dispute redressal mechanism. As part of this, mediation cells will be attached with the Consumer Disputes Redressal Commissions.

What are the penal provisions under the Bill?

The Bill increases penalties for different offences specified in it. It also adds penalties for offences such as issuing misleading advertisements, and manufacturing and selling adulterated or spurious goods. For example, in case of false and misleading advertisements, the Central Consumer Protection Authority can impose a penalty of up to Rs 10 lakh on a manufacturer or an endorser. For a subsequent offence, the fine may extend to Rs 50 lakh.  The manufacturer can also be punished with imprisonment of up to two years, which may extend to five years for every subsequent offence. The Authority can also prohibit the endorser of a misleading advertisement from endorsing any particular product or service for a period of up to one year.  For every subsequent offence, the period of prohibition may extend to three years.  There are certain exceptions when an endorser will not be held liable for such a penalty.

Are there any issues to think about in the Bill?

The 2018 Bill is a marked improvement over the 2015 Bill and addresses several issues in the 2015 Bill. However, two major issues with regard to the Consumer Disputes Redressal Commissions remain. We discuss them below.

First issue is with regard to the composition of these Commissions. The Bill specifies that the Commissions will be headed by a ‘President’ and will comprise other members.  However, the Bill delegates the power of deciding the qualifications of the President and members to the central government.  It also does not specify that the President or members should have minimum judicial qualifications.  This is in contrast with the existing Consumer Protection Act, 1986, which states that the Commissions at various levels will be headed by a person qualified to be a judge.  The 1986 Act also specifies the minimum qualification of members.

Under the current Bill, if the Commissions were to have only non-judicial members, it may violate the principle of separation of powers between the executive and the judiciary.  Since these Commissions are adjudicating bodies and will look at consumer dispute cases, it is unclear how a Commission that may comprise only non-judicial members will undertake this function.

Second issue is with regard to the method of appointment of members of the Commissions. The Bill permits the central government to notify the method of appointment of members of the Commissions.  It does not require that the selection involve members from the higher judiciary.  It may be argued that allowing the executive to determine the appointment of the members of Commissions could affect the independent functioning of the Commissions.  This provision is also at variance with the 1986 Act.  Under the Act, appointment of members to these Commissions is done through a selection committee.  These section committees comprise a judicial member.

As mentioned previously, the Commissions are intended to be quasi-judicial bodies, while the government is part of the executive.  There may be instances where the government is a party to a dispute relating to deficiency in service provided by a government enterprise, for e.g., the Railways.  In such a case, there would be a conflict of interest as the government would be a party to the dispute before the Commissions and will also have the power to appoint members to the Commission.

Amendments to the IBC: Implications for real estate allottees

The Insolvency and Bankruptcy Code, 2016 was enacted to provide a time-bound process to resolve insolvency among companies and individuals.  Insolvency is a situation where an individual or company is unable to repay their outstanding debt.  Last month, the government promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 amending certain provisions of the Code.  The Insolvency and Bankruptcy Code (Second Amendment) Bill, 2018, which replaces this Ordinance, was introduced in Lok Sabha last week and is scheduled to be passed in the ongoing monsoon session of Parliament.  In light of this, we discuss some of the changes being proposed under the Bill and possible implications of such changes.

What was the need for amending the Code?

In November 2017, the Insolvency Law Committee was set up to review the Code, identify issues in its implementation, and suggest changes.  The Committee submitted its report in March 2018.  It made several recommendations, such as treating allottees under a real estate project as financial creditors, exempting micro, small and medium enterprises from certain provisions of the Code, reducing voting thresholds of the committee of creditors, among others.  Subsequently, the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018, was promulgated on June 6, 2018, incorporating these recommendations.

What amendments have been proposed regarding real estate allottees?

The Code defines a financial creditor as anyone who has extended any kind of loan or financial credit to the debtor.  The Bill clarifies that an allottee under a real estate project (a buyer of an under-construction residential or commercial property) will be considered as a financial creditor.  These allottees will be represented on the committee of creditors by an authorised representative who will vote on their behalf.

This committee is responsible for taking key decisions related to the resolution process, such as appointing the resolution professional, and approving the resolution plan to be submitted to the National Company Law Tribunal (NCLT).  It also implies that real estate allottees can initiate a corporate insolvency resolution process against the debtor.

Can the amount raised by real estate allottees be considered as financial debt?

The Insolvency Law Committee (2017) had noted that the amount paid by allottees under a real estate project is a means of raising finance for the project, and hence would classify as financial debt.  It had also noted that, in certain cases, allottees provide more money towards a real estate project than banks.  The Bill provides that the amount raised from allottees during the sale of a real estate project would have the commercial effect of a borrowing, and therefore be considered as a financial debt for the real estate company (or the debtor).

However, it may be argued that the money raised from allottees under a real estate project is an advance payment for a future asset (or the property allotted to them).  It is not an explicit loan given to the developer against receipt of interest, or similar consideration for the time value of money, and therefore may not qualify as financial debt.

Do the amendments affect the priority of real estate allottees in the waterfall under liquidation?

During the corporate insolvency resolution process, a committee of creditors (comprising of all financial creditors) may choose to: (i) resolve the debtor company, or (ii) liquidate (sell) the debtor’s assets to repay loans.  If no decision is made by the committee within the prescribed time period, the debtor’s assets are liquidated to repay the debt.  In case of liquidation, secured creditors are paid first after payment of the resolution fees and other resolution costs.  Secured creditors are those whose loans are backed by collateral (security).  This is followed by payment of employee wages, and then payment to all the unsecured creditors.

While the Bill classifies allottees as financial creditors, it does not specify whether they would be treated as secured or unsecured creditors.  Therefore, their position in the order of priority is not clear.

What amendments have been proposed regarding Micro, Small, and Medium Enterprises (MSMEs)?

Earlier this year, the Code was amended to prohibit certain persons from submitting a resolution plan.  These include: (i) wilful defaulters, (ii) promoters or management of the company if it has an outstanding non-performing asset (NPA) for over a year, and (iii) disqualified directors, among others.  Further, it barred the sale of property of a defaulter to such persons during liquidation.  One of the concerns raised was that in case of some MSMEs, the promoter may be the only person submitting a plan to revive the company.  In such cases, the defaulting firm will go into liquidation even if there could have been a viable resolution plan.

The Bill amends the criteria which prohibits certain persons from submitting a resolution plan.  For example, the Code prohibits a person from being a resolution applicant if his account has been identified as a NPA for more than a year.  The Bill provides that this criterion will not apply if such an applicant is a financial entity, and is not a related party to the debtor (with certain exceptions).  Further, if the NPA was acquired under a resolution plan under this Code, then this criterion will not apply for a period of three years (instead of one).  Secondly, the Code also bars a guarantor of a defaulter from being an applicant.  The Bill specifies that such a bar will apply if such guarantee has been invoked by the creditor and remains unpaid.

In addition to amending these criteria, the Bill also states that the ineligibility criteria for resolution applicants regarding NPAs and guarantors will not be applicable to persons applying for resolution of MSMEs.  The central government may, in public interest, modify or remove other provisions of the Code while applying them to MSMEs.

What are some of the other key changes being proposed?

The Bill also makes certain changes to the procedures under the Code.  Under the Code, all decisions of the committee of creditors have to be taken by a 75% majority of the financial creditors.  The Bill lowers this threshold to 51%.  For certain key decisions, such as appointment of a resolution professional, approving the resolution plan, and making structural changes to the company, the voting threshold has been reduced from 75% to 66%.

The Bill also provides for withdrawal of a resolution application, after the resolution process has been initiated with the NCLT.  Such withdrawal will have to be approved by a 90% vote of the committee of creditors.

Explained: Recent changes in MSPs

Recently, the Cabinet Committee on Economic Affairs approved an increase in the Minimum Support Prices (MSPs) for Kharif crops for the 2018-19 marketing season.  Subsequently, the Commission for Agricultural Costs and Prices (CACP) released its price policy report for Kharif crops for the marketing season 2018-19.

The central government notifies MSPs based on the recommendations of the CACP.  These recommendations are made separately for the Kharif marketing season (KMS) and the Rabi marketing season (RMS).  Post harvesting, the government procures crops from farmers at the MSP notified for that season, in order to ensure remunerative prices to farmers for their produce.

In this blog post, we look at how MSPs are determined, changes brought in them over time, and their effectiveness for farmers across different states.

How are Minimum Support Prices determined?

The CACP considers various factors such as the cost of cultivation and production, productivity of crops, and market prices for the determination of MSPs.  The National Commission on Farmers(Chair: Prof. M. S. Swaminathan) in 2006 had recommended that MSPs must be at least 50% more than the cost of production.  In this year’s budget speech, the Finance Minister said that MSPs would be fixed at least at 50% more than the cost of production.

The CACP calculates cost of production at three levels: (i) A2, which includes cost of inputs such as seeds, fertilizer, labour; (ii) A2+FL, which includes the implied cost of family labour (FL); and (iii) C2, which includes the implied rent on land and interest on capital assets over and above A2+FL.

Table 1 shows the cost of production as calculated by the CACP and the approved MSPs for KMS 2018-19.  For paddy (common), the MSP was increased from Rs 1,550/quintal in 2017-18 to Rs 1,750/quintal in 2018-19.  This price would give a farmer a profit of 50.1% on the cost of production A2+FL.  However, the profit calculated on the cost of production C2 would be 12.2%.  It has been argued that the cost of production should be taken as C2 for calculating MSPs.  In such a scenario, this would have increased the MSP to Rs 2,340/quintal, much above the current MSP of Rs 1,750/quintal.

Figure 1

Which are the major crops that are procured at MSPs?

Every year, MSPs are announced for 23 crops.  However, public procurement is limited to a few crops such as paddy, wheat and, to a limited extent, pulses as shown in Figure 1.

Figure 2

The procurement is also limited to a few states.  Three states which produce 49% of the national wheat output account for 93% of procurement.  For paddy, six states with 40% production share have 77% share of the procurement.  As a result, in these states, farmers focus on cultivating these crops over other crops such as pulses, oilseeds, and coarse grains.

Due to limitations on the procurement side (both crop-wise and state-wise), all farmers do not receive benefits of increase in MSPs.  The CACP has noted in its 2018-19 price policy report that the inability of farmers to sell at MSPs is one of the key areas of concern.  Farmers who are unable to sell their produce at MSPs have to sell it at market prices, which may be much lower than the MSPs.

How have MSPs for major crops changed over time?

Higher procurement of paddy and wheat, as compared to other crops at MSPs tilts the production cycle towards these crops.  In order to balance this and encourage the production of pulses, there is a larger proportional increase in the MSPs of pulses over the years as seen in Figure 2.  In addition to this, it is also used as a measure to encourage farmers to shift from water-intensive crops such as paddy and wheat to pulses, which relatively require less water for irrigation.

Figure 3

What is the effectiveness of MSPs across states?

The MSP fixed for each crop is uniform for the entire country.  However, the production cost of crops vary across states.  Figure 3 highlights the MSP of paddy and the variation in its cost of production across states in 2018-19.

Figure 4

For example, production cost for paddy at the A2+FL level is Rs 702/quintal in Punjab and Rs 2,102/quintal in Maharashtra.  Due to this differentiation, while the MSP of Rs 1,750/quintal of paddy will result in a profit of 149% to a farmer in Punjab, it will result in a loss of 17% to a farmer in Maharashtra.  Similarly, at the C2 level, the production cost for paddy is Rs 1,174/quintal in Punjab and Rs 2,481/quintal in Maharashtra.  In this scenario, a farmer in Punjab may get 49% return, while his counterpart in Maharashtra may make a loss of 29%.

Figure 5

Figure 4 highlights the MSP of wheat and the variation in its cost of production across states in 2017-18. In the case of wheat, the cost of production in Maharashtra and West Bengal is much more than the cost in rest of the states.  At the A2+FL level, the cost of production in West Bengal is Rs 1,777/quintal.  This is significantly higher than in states like Haryana and Punjab, where the cost is Rs 736/quintal and Rs 642/quintal, respectively.  In this case, while a wheat growing farmer suffers a loss of 2% in West Bengal, a farmer in Haryana makes a profit of 136%.  The return in Punjab is even higher at 1.5 times or more the cost of production.

Food Processing Infrastructure in India

Recently, there have been reports of price crashes and distress sales in case of farm produce, such as tomatoesmangoes, and garlic.  In some cases, farmers have dumped their produce on roads.  Produce such as fruits and vegetables are perishable and therefore have a short shelf life.  Further, due to inadequate storage facilities and poor food processing infrastructure farmers have limited options but to sell the produce at prevailing market prices.  This can lead to distress sales or roadside discards (in some cases to avoid additional cost of transportation).

Food processing allows raw food to be stored, marketed, or preserved for consumption later.  For instance, raw agricultural produce such as fruits may be processed into juices, jams, and pickles.  Activities such as waxing (for preservation), packaging, labelling, or ripening of produce also form part of the food processing industry.

Between 2001-02 and 2016-17, production of food grains grew annually at 1.7% on average.  Production of horticulture crops surpassed food grains with an average growth rate of 4.8%.  While production has been increasing over the years, surplus produce tends to go waste at various stages such as procurement, storage, and processing due to lack of infrastructure such as cold storages and food processing units.

Source: Horticulture Statistics at a Glance 2017, Union Budget 2018-19; PRS.

Source: Horticulture Statistics at a Glance 2017, Union Budget 2018-19; PRS.

Losses high among perishables such as fruits and vegetables

Crop losses ranged between 7-16% among fruits and around 5% among cereals in 2015.  The highest losses were witnessed in case of guava, followed by mango, which are perishable fruits.  Perishables such as fruits and vegetables are more prone to losses as compared to cereals.  Such crop losses can occur during operations such as harvesting, thrashing, grading, drying, packaging, transportation, and storage depending upon the commodity.

It was estimated that the annual value of harvest and post-harvest losses of major agricultural products at the national level was Rs 92,651 crore in 2015.  The Standing Committee on Agriculture (2017) stated that such wastage can be reduced with adequate food processing facilities.

Sources: Annual Report 2016-17, Ministry of Food Processing Industries; PRS.

Sources: Annual Report 2016-17, Ministry of Food Processing Industries; PRS.

Inadequate food processing infrastructure

As previously discussed, perishables such as fruits and vegetables are more prone to damages as compared to cereals.  Due to inadequate processing facilities in close proximity, farmers may be unable to hold their produce for a long time.  Hence, they may be forced to sell their produce soon after harvest, irrespective of the prevailing market situations.  Expert committees have recommended that agri-logistics such as cold chain infrastructure and market linkages should be strengthened.

Cold chain infrastructure: Cold chain infrastructure includes processing units, cold storages, and refrigerated vans.  As of 2014, out of a required cold storage capacity of 35 million metric tonnes (MT), almost 90% (31.8 million MT) of the capacity was available (see Table 1).  However, cold storage needs to be coupled with logistical support to facilitate smooth transfer of harvested value from farms to distant locations.  This includes: (i) pack-houses for packaging and preparing fresh produce for long distance transport, (ii) refrigerated transport such as reefer vehicles, and (iii) ripening chambers to ripen raw produce before marketing.  For instance, bananas which are harvested raw may be ripened in these chambers before being marketed.

While there are sufficient cold storages, there are wide gaps in the availability of other associated infrastructure.  This implies that even though almost 90% (32 million tonnes) of cold storage capacity is available, only 15% of the required refrigerated transport exists.  Further, the shortfall in the availability of infrastructure necessary for safe handling of farm produce, like pack-houses and ripening chambers, is over 90%.

Table 1:  Gaps in cold chain infrastructure (2014)

Facility Required Available Gap % gap
Cold storage
(in million MT)

35.1

31.8 3.2

9.3%

Pack-houses

70,080

249 69,831

99.6%

Reefer vehicles

61,826

9,000 52,826

85.4%

Ripening chambers

9,131

812 8,319

91.1%

Source: Standing Committee on Agriculture 2018; PRS.

To minimise post-harvest losses, the Standing Committee (2017) recommended that a country-wide integrated cold chain infrastructure network at block and district levels should be created.  It further recommended that a Cold Chain Coordination and Monitoring Committee should be constituted at the district-level.  The Standing Committee also recommended that farmers need to be trained in value addition activities such as sorting, grading, and pre-cooling harvested produce through facilities such as freezers and ripening chambers.

Between 2008 and 2017, 238 cold chain projects were sanctioned under the Scheme for Integrated Cold Chain and Value Addition Infrastructure.  Grants worth Rs 1,775 crore were approved for these projects.  Of this amount, Rs 964 crore (54%) has been released as of January 2018.  Consequently, out of the total projects sanctioned, 114 (48%) are completed.  The remaining 124 projects are currently under implementation.

Transport Facilities:  Currently, majority of food grains and certain quantities of tea, potato, and onion are transported through railways.  The Committee on Doubling Farmers Income had recommended that railways needs to upgrade its logistics to facilitate the transport of fresh produce directly to export hubs.  This includes creation of adjoining facilities for loading and unloading, and distribution to road transport.

Mega Food Parks: The Mega Food Parks scheme was launched in 2008.  It seeks to facilitate setting up of food processing units.  These units are to be located at a central processing centre with infrastructure required for processing, packaging, quality control labs, and trade facilitation centres.

As of March 2018, out of the 42 projects approved, 10 were operational.  The Standing Committee on Agriculture noted certain reasons for delay in implementation of projects under the scheme.  These include: (i) difficulty in getting loans from banks for the project, (ii) delay in obtaining clearances from the state governments and agencies for roads, power, and water at the project site, (iii) lack of special incentives for setting up food processing units in Mega Food Parks, and (iv) unwillingness of the co-promoters in contributing their share of equity.

Further, the Standing Committee stated that as the scheme requires a minimum area of 50 acres, it does not to promote smaller or individual food processing and preservation units.  It recommended that smaller agro-processing clusters near production areas must be promoted.  The Committee on Doubling Farmers Income recommended establishment of processing and value addition units at strategic places.  This includes rural or production areas for pulses, millets, fruits, vegetables, dairy, fisheries, and poultry in public private-partnership mode.

Examining the National Medical Commission Bill, 2017

The National Medical Commission (NMC) Bill, 2017 was introduced in Lok Sabha in December, 2017.  It was examined by the Standing Committee on Health, which submitted its report during Budget Session 2018.  The Bill seeks to regulate medical education and practice in India.  In this post, we analyse the Bill in its current form.

How is medical education and practice regulated currently?

The Medical Council of India (MCI) is responsible for regulating medical education and practice.  Over the years, there have been several issues with the functioning of the MCI with respect to its regulatory role, composition, allegations of corruption, and lack of accountability.   For example, MCI is an elected body where its members are elected by medical practitioners themselves, i.e. the regulator is elected by the regulated.  In light of such issues, experts recommended nomination based constitution of the MCI instead of election, and separating the regulation of medical education and medical practice.  They suggested that legislative changes should be brought in to overhaul the functioning of the MCI.

To meet this objective, the Bill repeals the Indian Medical Council Act, 1956 and dissolves the current Medical Council of India (MCI) which regulates medical education and practice.

Who will be a part of the NMC?

The NMC will consist of 25 members, of which at least 17 (68%) will be medical practitioners.  The Standing Committee has noted that the current MCI is non-diverse and consists mostly of doctors who look out for their own self-interest over larger public interest.   In order to reduce the monopoly of doctors, it recommended that the MCI should include diverse stakeholders such as public health experts, social scientists, and health economists.  In other countries, such as the United Kingdom, the General Medical Council (GMC) responsible for regulating medical education and practice consists of 12 medical practitioners and 12 lay members (such as community health members, and administrators from the local government).

How will the issues of medical misconduct be addressed?

The State Medical Council will receive complaints relating to professional or ethical misconduct against a registered doctor.  If the doctor is aggrieved by the decision of the State Medical Council, he may appeal to the Ethics and Medical Registration Board, and further before the NMC.  Appeals against the decision of the NMC will lie before the central government.  It is unclear why the central government is an appellate authority with regard to such matters.

It may be argued that disputes related to ethics and misconduct in medical practice may require judicial expertise.  For example, in the UK, the GMC receives complaints with regard to ethical misconduct and is required to do an initial documentary investigation.  It then forwards the complaint to a Tribunal, which is a judicial body independent of the GMC.  The adjudication and final disciplinary action is decided by the Tribunal.

What will the NMC’s role be in fee regulation of private medical colleges?

In India, the Supreme Court has held that private providers of education have to operate as charitable and not for profit institutions.   Despite this, many private education institutions continue to charge exorbitant fees which makes medical education unaffordable and inaccessible to meritorious students.  Currently, for private unaided medical colleges, the fee structure is decided by a committee set up by state governments under the chairmanship of a retired High Court judge.  The Bill allows the NMC to frame guidelines for determination of fees for up to 40% of seats in private medical colleges and deemed universities.  The question is whether the NMC as a regulator should regulate fees charged by private medical colleges.

NITI Aayog Committee (2016) was of the opinion that a fee cap would discourage the entry of private colleges, therefore, limiting the expansion of medical education.  It also observed that it is difficult to enforce such a fee cap and could lead medical colleges to continue charging high fees under other pretexts.

Note that the Parliamentary Standing Committee (2018) which examined the Bill has recommended continuing the current system of fee structures being decided by the Committee under the chairmanship of a retired High Court judge.  However, for those private medical colleges and deemed universities, unregulated under the existing mechanism, fee must be regulated for at least 50% of the seats.  The Union Cabinet has approved an Amendment to increase the regulation of fees to 50% of seats.

How will doctors become eligible to practice?

The Bill introduces a National Licentiate Examination for students graduating from medical institutions in order to obtain a licence to practice as a medical professional.

However, the NMC may permit a medical practitioner to perform surgery or practice medicine without qualifying the National Licentiate Examination, in such circumstances and for such period as may be specified by regulations.  The Ministry of Health and Family Welfare has clarified that this exemption is not meant to allow doctors failing the National Licentiate Examination to practice but is intended to allow medical professionals like nurse practitioners and dentists to practice.  It is unclear from the Bill that the term ‘medical practitioner’ includes medical professionals (like nurses) other than MBBS doctors.

Further, the Bill does not specify the validity period of this licence to practice.  In other countries such as the United Kingdom and Australia, a licence to practice needs to be periodically renewed.  For example, in the UK the licence has to be renewed every five years, and in Australia it has to renewed annually.

What are the issues around the bridge course for AYUSH practitioners to prescribe modern medicine?

The debate around AYUSH practitioners prescribing modern medicine

There is a provision in the Bill which states that there may be a bridge course which AYUSH practitioners (practicing Ayurveda, Yoga and Naturopathy, Unani, Siddha and Homoeopathy) can undertake in order to prescribe certain kinds of modern medicine.  There are differing views on whether AYUSH practitioners should prescribe modern medicines.

Over the years, various committees have recommended a functional integration among various systems of medicine i.e. Ayurveda, modern medicine, and others.  On the other hand, experts state that the bridge course may promote the positioning of AYUSH practitioners as stand-ins for allopathic doctors owing to the shortage of doctors across the country.  This in turn may affect the development of AYUSH systems of medicine as independent systems of medicine.

Moreover, AYUSH doctors do not have to go through any licentiate examination to be registered by the NMC, unlike the other doctors.  Recently, the Union Cabinet has approved an Amendment to remove the provision of the bridge course.

Status of other kinds of medical personnel

As of January 2018, the doctor to population ratio in India was 1:1655 compared to the World Health Organisation standard of 1:1000.  The Ministry of Health and Family Welfare stated that the introduction of the bridge course for AYUSH practitioners under the Bill will help fill in the gaps of availability of medical professionals.

If the purpose of the bridge course is to address shortage of medical professionals, it is unclear why the option to take the bridge course does not apply to other cadres of allopathic medical professionals such as nurses, and dentists.  There are other countries where medical professionals other than doctors are allowed to prescribe allopathic medicine.  For example, Nurse Practitioners in the USA provide a full range of primary, acute, and specialty health care services, including ordering and performing diagnostic tests, and prescribing medications.  For this purpose, Nurse Practitioners must complete a master’s or doctoral degree program, advanced clinical training, and obtain a national certification.

What impacts petroleum prices?

Over the last few days, the retail prices of petrol and diesel have touched an all-time high.  In Delhi, petrol was selling at 74.6/litre on April 25, 2018, while diesel was at 66/litre.

Petroleum products are used as raw materials in various sectors and industries such as transport and petrochemicals.  These products may also be used in factories to operate machinery or generators.  Any fluctuation in the price of petrol and diesel impacts the production and transport costs of various items.  When compared to other neighbouring countries, India has the highest prices for petrol and diesel.

Note: Prices as on April 1, 2018. Prices for India pertain to Delhi. Sources: Petroleum Planning and Analysis Cell, Ministry of Petroleum and Natural Gas; PRS.

Note: Prices as on April 1, 2018. Prices for India pertain to Delhi.
Sources: Petroleum Planning and Analysis Cell, Ministry of Petroleum and Natural Gas; PRS.

How is the price of petrol and diesel fixed?

Historically, the price of petrol and diesel in India was regulated, i.e. the government was involved in the deciding the retail price.  The government deregulated the pricing of petrol in 2010 and diesel in 2014.  This allowed oil marketing companies to determine the price of these products, and revise them every fortnight.

Starting June 16, 2017, prices for petrol and diesel are revised on a daily basis.  This was done to with the idea that daily revision will reduce the volatility in retail prices, and protect the consumer against sharp fluctuations.  The break-up of retail prices of petrol and diesel in Delhi on April 25, 2018 can be found below.  As seen in the table, over 50% of the retail price of petrol comprises central and states taxes and the dealer’s commission.  In case of diesel, this amount is close to 40%.

Table 1: Break-up of petrol and diesel prices in Delhi (on April 25, 2018)

Component

Petrol

Diesel

Rs/litre % of retail price Rs/litre

% of retail price

Price Charged to Dealers 35.7 48% 38.4 58%
Excise Duty (levied by centre) 19.5 26% 15.3 23%
Dealer Commission 3.6 5% 2.5 4%
VAT (levied by state) 15.9 21% 9.7 15%
Retail Price 74.6 100% 65.9 100%
Source: Price Build-up of Petrol and Diesel at Delhi effective April 25, 2018; Indian Oil Corporation Limited.

 

Does India produce enough petroleum to support domestic consumption?

India imports 84% of the petroleum products consumed in the country.  This implies that any change in the global prices of crude oil has a significant impact on the domestic price of petroleum products.  In 2000-01, net import of petroleum products constituted 75% of the total consumption in the country.  This increased to 95% in 2016-17.  The figure below shows the amount of petroleum products consumed in the country, and the share of imports.

Note: Production is the difference between the total consumption in the country and the net imports. Sources: Petroleum Planning and Analysis Cell; PRS.

Note: Production is the difference between the total consumption in the country and the net imports.
Sources: Petroleum Planning and Analysis Cell; PRS.

What has been the global trend in crude oil prices? How has this impacted prices in India?

Over the last five years, the global price of crude oil (Indian basket) has come down from USD 110 in January 2013 to USD 64 in March 2018, having touched a low of USD 28 in January 2016.

While there has been a 42% drop in the price of global crude over this five-period, the retail price of petrol in India has increased by 8%.  During this period, the retail price of diesel increased by 33%.  The two figures below show the trend in prices of global crude oil and retail price of petrol and diesel in India, over the last five years.

Petrol price

Diesel price

 

Note: Subsidy indicated in the graphs is notional.  While calculating the subsidy amount, other factors such as cost of domestic inputs will also have to be accounted.  Global Crude Oil Price is for the Indian basket.  Figures reflect average monthly retail price of petrol and diesel in Delhi.
Sources: Petroleum Planning and Analysis Cell; Indian Oil Corporation Limited; PRS.

 

How has the excise duty on petrol and diesel changed over the last few years?

Under the Constitution, the central government has the powers to tax the production of petroleum products, while states have the power to tax their sale.  Petroleum has been kept outside the purview of the Goods and Services Tax (GST), till the GST Council decides.

Over the years, the central government has used taxes to prevent sharp fluctuations in the retail price of diesel and petrol.  In the past, when global crude oil prices have increased, duties have been cut.  Since 2014, as global crude oil prices declined, excise duties have been increased.

Sources: Petroleum Planning and Analysis Cell; PRS.

Sources: Petroleum Planning and Analysis Cell; PRS.

 

As a consequence of the increase in duties, the central government’s revenue from excise on petrol and diesel increased annually at a rate of 46% between 2013-14 and 2016-17.  During the same period, the total sales tax collections of states (from petrol and diesel) increased annually by 9%.  The figure below shows the trend in overall collections of the central and state governments from petroleum (including receipts from taxes, royalties, and dividends).

 

Notes: Data includes tax collections (from cesses, royalties, customs duty, central excise duty, state sales tax, octroi, and entry tax, among others), dividends paid to the government, and profit on oil exploration. Data sources: Petroleum and Planning Analysis Cell; Central Board of Excise and Customs; Indian Oil Corporation Limited; PRS.

Notes: Data includes tax collections (from cesses, royalties, customs duty, central excise duty, state sales tax, octroi, and entry tax, among others), dividends paid to the government, and profit on oil exploration.
Data sources: Petroleum and Planning Analysis Cell; Central Board of Excise and Customs; Indian Oil Corporation Limited; PRS.

Central Transfers to States: Role of the Finance Commission

In November 2017, the 15th Finance Commission (Chair: Mr N. K. Singh) was constituted to give recommendations on the transfer of resources from the centre to states for the five year period between 2020-25.  In recent times, there has been some discussion around the role and mandate of the Commission.  In this context, we explain the role of the Finance Commission.

What is the Finance Commission?

The Finance Commission is a constitutional body formed every five years to give suggestions on centre-state financial relations.  Each Finance Commission is required to make recommendations on: (i) sharing of central taxes with states, (ii) distribution of central grants to states, (iii) measures to improve the finances of states to supplement the resources of panchayats and municipalities, and (iv) any other matter referred to it.

Composition of transfers:  The central taxes devolved to states are untied funds, and states can spend them according to their discretion.  Over the years, tax devolved to states has constituted over 80% of the total central transfers to states (Figure 1).  The centre also provides grants to states and local bodies which must be used for specified purposes.  These grants have ranged between 12% to 19% of the total transfers.

Fig 1Over the years the core mandate of the Commission has remained unchanged, though it has been given the additional responsibility of examining various issues.  For instance, the 12th Finance Commission evaluated the fiscal position of states and offered relief to those that enacted their Fiscal Responsibility and Budget Management laws.  The 13th and the 14th Finance Commissionassessed the impact of GST on the economy.  The 13th Finance Commission also incentivised states to increase forest cover by providing additional grants.

15th Finance Commission:  The 15th Finance Commission constituted in November 2017 will recommend central transfers to states.  It has also been mandated to: (i) review the impact of the 14th Finance Commission recommendations on the fiscal position of the centre; (ii) review the debt level of the centre and states, and recommend a roadmap; (iii) study the impact of GST on the economy; and (iv) recommend performance-based incentives for states based on their efforts to control population, promote ease of doing business, and control expenditure on populist measures, among others.

Why is there a need for a Finance Commission?

The Indian federal system allows for the division of power and responsibilities between the centre and states.  Correspondingly, the taxation powers are also broadly divided between the centre and states (Table 1).  State legislatures may devolve some of their taxation powers to local bodies.

Table 1

The centre collects majority of the tax revenue as it enjoys scale economies in the collection of certain taxes.  States have the responsibility of delivering public goods in their areas due to their proximity to local issues and needs.

Sometimes, this leads to states incurring expenditures higher than the revenue generated by them.  Further, due to vast regional disparities some states are unable to raise adequate resources as compared to others.  To address these imbalances, the Finance Commission recommends the extent of central funds to be shared with states.  Prior to 2000, only revenue income tax and union excise duty on certain goods was shared by the centre with states.  A Constitution amendment in 2000 allowed for all central taxes to be shared with states.

Several other federal countries, such as Pakistan, Malaysia, and Australia have similar bodies which recommend the manner in which central funds will be shared with states.

Tax devolution to states

Table 2The 14th Finance Commission considerably increased the devolution of taxes from the centre to states from 32% to 42%.  The Commission had recommended that tax devolution should be the primary source of transfer of funds to states.  This would increase the flow of unconditional transfers and give states more flexibility in their spending.

The share in central taxes is distributed among states based on a formula.   Previous Finance Commissions have considered various factors to determine the criteria such as the population and income needs of states, their area and infrastructure, etc.  Further, the weightage assigned to each criterion has varied with each Finance Commission.

The criteria used by the 11th to 14thFinance Commissions are given in Table 2, along with the weight assigned to them.  State level details of the criteria used by the 14th Finance Commission are given in Table 3.

  • Population is an indicator of the expenditure needs of a state. Over the years, Finance Commissions have used population data of the 1971 Census.  The 14th Finance Commission used the 2011 population data, in addition to the 1971 data.  The 15th Finance Commission has been mandated to use data from the 2011 Census.
  • Area is used as a criterion as a state with larger area has to incur additional administrative costs to deliver services.
  • Income distance is the difference between the per capita income of a state with the average per capita income of all states. States with lower per capita income may be given a higher share to maintain equity among states.
  • Forest cover indicates that states with large forest covers bear the cost of not having area available for other economic activities. Therefore, the rationale is that these states may be given a higher share.

Table 3

Grants-in-Aid

Besides the taxes devolved to states, another source of transfers from the centre to states is grants-in-aid.  As per the recommendations of the 14th Finance Commission, grants-in-aid constitute 12% of the central transfers to states.  The 14th Finance Commission had recommended grants to states for three purposes: (i) disaster relief, (ii) local bodies, and (iii) revenue deficit.