Is regulating a monopoly the only solution?

Apr 16, 2012

In this issue:
» Freeing diesel prices a solution for fiscal deficit?
» Does US need a new housing policy for revival?
» China loosens the noose on its currency
» Steel consumption to grow in FY13
» ...and more!

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Legendary value investors Charlie Munger and Warren Buffett love monopolies. And they have every reason to. Monopolies are typically companies that control the entire market for a specific good or service. This means that they have the pricing power. This power gives them a wide moat of safety. This moat helps them earn above average returns. And this moat is something that value investors, particularly Buffett, value so much. But the big question is- are monopolies equally good for the economy as a whole?

There is no clear answer to this. But in the case of India, one particular monopoly has been creating havoc for its customers. And these customers provide the backbone of the Indian economy. Therefore this monopoly is quintessentially threatening the economy. We are referring to the monopoly of India's largest coal producer, Coal India Ltd. (CIL). The company's disturbed coal supplies have put the Indian power companies in a fix more than once. Though a presidential directive has directed CIL to sign fuel supply agreements (FSA) with the power producers, it is yet to do so. Moreover, the quantum of penalty for failing to meet the FSA has been left to be decided by CIL itself. And the company has clearly stated that it will try and keep the amount of penalty as low as possible.

Needless to say, this has annoyed the power companies. As a result, the Union Ministry of Power has pushed for the need of a regulator for the coal sector. The Coal Minister too has stated that a draft Bill outlining the need and duties of a regulator has already been finalized. Once it is approved, there will be a coal regulator who would decide the allotment and pricing of coal. Considering the way that CIL has exploited its monopoly position, regulating it seems to be the only answer.

Alternatively, the sector could be opened up to competition. This way the mechanics of pricing would be decided by the natural competitive forces. However, this alternative would not always work in the favour of the economy as a whole and the government in particular. This is because it could lead to over mining for profits, as seen in Karnataka for iron ore. This in turn would cause more harm to the country than benefit. Therefore regulating the sector for now seems to be the best and only alternative. But it has to be done properly. Not drawing out ambiguous or ridiculous policies as we have already seen in other sectors.

Do you think that coal sector should be regulated or opened up for competition? Share your comments with us or post your views on our Facebook page / Google+ page.

 Chart of the day
In today's world, internet is virtually the lifeline of every nation. In India too internet has become a household word. But it has not really picked up at the pace that it has in the developed countries. Nevertheless, the number of broadband subscribers in India has steadily been on the rise. From merely 5.5 m subscribers in December 2008, the number has grown at a compounded annual growth rate of 34% to reach 13.35 m by the end of December 2011.

Source: Telecom Regulatory Authority of India (TRAI)

Till date, a lot of solutions have been offered to lower India's fiscal deficit. Here comes another one. From none other than Raghuram Rajan, the former chief economist of the IMF. Rajan is of the view that deregulating the prices of diesel will go a long way towards addressing India's fiscal deficit problem. "It will eliminate one source of concern that the international investor may have and help bring down the fiscal deficit," Rajan is believed to have said. He also argued that India should treat its foreign investors well as they are not an enemy but a friend. There is no doubt a lot of merit in both of Rajan's comments. But we guess they will again tend to fall on deaf ears. For a Government that is keener on winning elections than thinking about long term benefits, the idea of deregulating diesel prices is akin to hot potato. We will have to live with it for quite some time to come may be. And be happy with the 6%-7% growth rather than aim for 8%-9%.

The mortgage market in the US is where the seeds of the subprime crisis and then a full blown global crisis were first sown. Not surprisingly, housing prices in the US plunged and so did the country's economy. Now more than four years of the crisis, the battered US housing market appears to have shown some signs of life. But this could be illusory. There still around 11 m Americans whose houses are worth less than their mortgages. Thus, unless this backlog of potential foreclosures is cleared, US housing recovery will be slow. Meanwhile, political differences on this issue continue to plague the White House. President Barack Obama has been favouring large write-downs of the principal mortgages of delinquent borrowers. He is, however, being opposed by the housing regulator Edward de Marco. The latter does not favour such a move on the grounds that it is against the interest of tax payers. It would incentivise those who are current on their mortgages to default and get assistance.

The current government's various bailout plans have not really made much of a difference to a sustainable US recovery. But regards the housing market, certain factors have to be taken into account. For instance, the subprime borrowers in the US have already defaulted. This means that the current home owners are not really behind on their mortgages and are punished simply because of market conditions and the wave of foreclosures around them. Given that the meltdown in the US housing market has affected almost each and every American, political leaders need to push aside politics and focus more on how to ensure that this market recovers going forward.

That China cannot rely on exports alone for GDP (Gross Domestic Product) growth is not lost on its policy makers. The government has therefore already initiated steps to encourage domestic consumption. In fact in what is seen as a reform move, China has fixed a wider trading band for the Yuan against the US dollar. Many regulators, including the World Bank and IMF see this as a transition towards free exchange rate. Chinese officials have pledged to keep loosening controls on currency flows until 2015. Thus the wider band should help boost domestic consumption and stimulate growth in the meanwhile. Having said that we do not see any reason for China to steadily change its forex polices. For rapid appreciation of the currency will mean losing edge in the export markets. At the same time, allowing more investments overseas could lead to only marginal depreciation of the currency. Thus the rest of the world may read a lot into China's revamped forex policies. But for India it may be too soon to celebrate. For gaining an edge over China in export markets cannot be possible only through forex moves.

The fortunes of the steel industry are directly linked to how well or badly the economy behaves. The Indian steel industry witnessed a major slowdown in FY12. Country's steel consumption is estimated to have grown by only 5.5 % in FY12 as compared to the 9.9% seen in FY11. This was due to high inflation and high interest rates. To check inflation the Reserve Bank of India (RBI) had raised key policy rates 13 times totaling 375 basis points (3.75%) since March 2010, driving up borrowing costs substantially. The multiple hikes in interest rates by the central bank impacted the industry's growth directly and indirectly through their effect on the growth of key user industries. Infrastructure and automobile sector who are the main users of steel suffered which in-turn led to low demand for steel. The outlook for FY13 is also not promising. It is estimated that steel consumption will grow by just 4-5% on back of slowing domestic economy and global uncertainties. However with inflation showing signs of cooling off, the RBI might be prompted to cut key lending rates which might just give a boost to the sector and lead to higher demand.

Government employees are entitled to various fringe benefits. And if you happen to be the President of India the extravagance could be imagined. But should that be at the cost of public money? As per news reports, President Pratibha Patil is building a lavish 4,500 sq ft bungalow near Pune. It should cost Rs 80 m. But for that two defence bungalows meant for soldiers and officers have been brought down. Approximately 261,000 sq ft of land has also been taken over to build this paradise. Now, as per law the president is entitled to 2,000 sq ft bungalow in any part of the country. So, there is a clear violation of space. The irony is that once the entire episode came into picture the government is coming out with lame excuses to defend its move. The Rashtrapati Bhavan says that the defence bungalows are being pulled down for renovation and the space guidelines for presidential residence are indicative in nature. Now, no matter what the truth/guideline is. The said act displays that Right to Information (RTI) act should be made stringent.

In the meanwhile, after opening the day in the red, the Indian stock markets are now trading flat. At the time of writing, BSE Sensex was up by 15 points (0.1%). Barring stocks in the energy and technology sectors, most of the other sectoral indices are trading in the green. Stocks in realty space are leading the gains. The other major Asian stock markets have closed the day in the red with Japan and Taiwan witnessing maximum losses. European markets too have opened the day on a negative note.

 Today's Investing mantra
"Value investing is the discipline of buying securities at a significant discount from their current underlying values and holding them until more of their value is realized. The element of a bargain is the key to the process." - Seth Klarman

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5 Responses to "Is regulating a monopoly the only solution?"

saby chacko

Apr 28, 2012

I do not agree with Mr Raghuram of world bank regarding removing price control of diesel to reduce a/c deficit as there are several other means to do it. Even a child in india knows that increasing of diesel prices will shoot up the price of everything in India and the inflation will be beyond anybody's control. cost of leaving goes up rapidly and also the labour cost. Perhaps with his advise the beneficiary will be not indians in India but the cost of our products will go very high and exports will be not really competitive and will loose the market share in our exports.



Apr 17, 2012

The only known wealth creator is either a Monopoly or Appreciation of asset value, which is the third in a manufacturing industry
In the service industry time is money any service provider who can have a service that saves time too will create wealth


Ragini Ghanekar

Apr 16, 2012

I do not know details of disrupted supplies and exploitation by Coal India. Disrupted supplies indicate that company is not being run efficiently. Management should be held responsible and pulled up for it. Since there is a separate coal minister it seems to be his job to chastise management. If it does not fall within his duties regulator is a good solution since regulators like SEBI and insurance regulator are doing a good job. As to the pricing it should be tied to the cost and a reasonable margin of profit. It should not make exorbitant profit but at the same time should not be asked to subsidize power sector. Subsidy is a malice which should be gradually eradicated. It may be painful and bitter medicine but it will create a realistic and beneficial picture in long term.


Rahul khemani

Apr 16, 2012

This post is designed
not by a master, but
by a Masterpiece. This
daily, wrapped up
with every useful
economic data or
news, or a part as a
whole. Thank you


Brij Kumar SIngh

Apr 16, 2012

Regulating the natural resources is a desirable option and every citizen should welcome this step. But prior to this the resources need to be freed from the clutches of polticians and their yes man bureaucrats. Regulator is a beautiful word but the person who occupis this position is more important. India needs dedicated honest people with more common sense to govern this country rather bookish people who through their GOD gifted brain and hard work have occupied the high portals of administration. The lure of money & power in the civil services,brings every year many doctors, enginners scientists who could have done miracles in their own field. All most all the bodies like Ganga ation plan, yamuna cleaning drive etc are all stuffed by the yes man from civil services and the real workers-scientist are left to do the real hard work. It will be wonderful to study the life style and function of a District Magistrate of a district to get an answer in the root cause of deteriorating moral ethical monetary standard of life in this country.

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