How protected is Reliance?

RATIONAL EXPECTATIONS

Contrary to what many may think, this piece is not about the level of protection the Reliance group enjoys in political circles, the kind of protection that, for instance, saw the government completely overturn policy to allow Reliance a back-door entry into the booming cellular market.

What it is about, instead, is how, despite the cuts in import tariffs in the 'mini-budget' a few days ago, India's import tariffs afford companies like Reliance a whopping 50-60 per cent duty protection "" this was close to 125 per cent a decade ago.

While everyone acknowledges Reliance is one of India's most efficient firms, such absurdly high levels of tariff protection obviously play a big role in its success.

The same logic, by the way, applies to most other Indian companies as well, and points to just how flawed the finance ministry's import duty proposals are, and how much further finance minister Jaswant Singh has to go when he, or whoever, presents the full-budget in June/July.

Whether he will, of course, is an open question, and it is depressing to note that while this point was made by the Arvind Virmani Committee in 2001, the suggestion of having just one single rate of import duty was rejected by the Kelkar committee in 2002 "" Kelkar, in fact, has recommended a four-tier import duty structure for 2006-07.

But how do the products of Reliance's Jamnagar refinery, indeed those of any refinery belonging to public sector firms like IOC and HPCL as well, get a 60 per cent protection, when the import duty on refinery products is a mere 20 per cent?

The reason, of course, is not intuitively obvious "" in fact, when I put the question to friends in the petroleum sector, most said the effective protection was just 10 per cent! Their argument was simple: imports of crude oil face a tariff of 10 per cent, while imports of refinery products pay an import duty of 20 per cent, hence Reliance enjoys a protection of only 20 minus 10, or 10 per cent on the products made by its refinery.

The correct way to calculate the level of effective protection, both Virmani and former chief economic advisor Shankar Acharya have explained to me at different points in time, is different.

Reliance, the argument goes, doesn't get a 20 per cent import duty on its entire production, it gets this 20 per cent protection on the value it creates by refining crude oil "" since this value addition is much smaller, the effective protection is many times higher than 20 per cent. The use of some maths will help make this clear.

Let's say Reliance buys crude oil worth Rs 100, and converts this into products worth Rs 120 (this, by the way, is roughly the conversion norm for the industry). Now apply the 20 per cent import duty on this (assuming global prices are also Rs 120), and the import duty will be Rs 24. But the Rs 24 of import protection that Reliance is getting is really for its Rs 20 value addition. So, the import duty protection is actually 120 per cent.

While this example is quite easy to understand, life gets more complicated once you allow for the fact that the crude oil and other inputs for the refinery are also subject to an import duty. There's no point tiring readers with the details of the calculation-spectrum, as those interested would do well to see Virmani's paper on the Planning Commission's website (http://www.planningcom mission.nic.in/reports/wrkpa pers/wp_vat.pdf).

Suffice it to say, that with the current import duty structure of 10 per cent on crude oil and 20 per cent on petroleum products and a 20 per cent value addition, the effective protection for a petroleum refinery is 60 per cent.

If the value addition is lower, say 10 per cent, the effective protection will be even higher at 110 per cent. If, however, the value addition is higher, at 90 per cent, the effective protection will be 21 per cent.

This is the moral of the story: the lower the value addition, the higher the effective protection. There is no exception to the rule. It's like maths: 2 plus 2 always equals 4. The only case where the effective protection is exactly equal to the stated import tariff, irrespective of the value addition made, is where the import duty on the inputs used (crude oil in the Reliance case) is exactly equal to the import duty on the final product (petrol, diesel in the Reliance case).

So, if the government wishes to provide a protection of, say X per cent for a product, the only way to ensure the actual protection is not more than X, is to ensure all other inputs that go into making that product are subject to an import duty of X.

Confront any government with these protection figures, and the answer will be that the high duties protect employment in these industries. This is just so much nonsense, as the employment lost from a refinery closing, say if import duties are reduced, will be more than made up by, to use the same example, the explosion in transport services once petrol and diesel become cheaper.

Whether Jaswant Singh will move towards a single import duty when (and if) he returns to his current job is to be seen, but if he does, it will mean more 'garib ke pet mein anna' instead of just in the stomach of fat-cat industrialists.

suniljain@business-standard.com