India needs a truly open market for coal.

Photographer: Enrico Fabian for The Washington Post via Getty Images

Modi's Coal Conundrum

Dhiraj Nayyar is a journalist in New Delhi. Trained as an economist, he has worked at the Financial Express, India Today and Firstpost.com. He is editor of "Surviving the Storm: India and the Global Financial Crisis."
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Even as Indian Prime Minister Narendra Modi gears up to try and push through his biggest reform yet, easing the process for acquiring land for industrial development, questions have arisen about one of his earliest successes. Modi won plaudits for swiftly responding to a Supreme Court decision invalidating the allocation of coal blocks to private companies. In less than five months, the government had successfully redistributed 19 licenses by auction; another 14 went on the block last week. Supplies of coal -- the main power source for energy-starved India -- appeared set to continue flowing.

QuickTake India's Aspirations

Then on Tuesday, India’s top coal official told the media that the government would reexamine bids for nine of those blocks. No official explanation was given, but speculation centered on the prospect that some bidders may have colluded to drive down prices. The winning bids came in only marginally above the government-set reserve price -- in one case, just 108 rupees per metric ton compared to the reserve price of 100 rupees per metric ton. All of the bids were significantly lower -- by at least a third -- than those for the other coal blocks.

Whatever the outcome of the investigation, a cloud now hangs over the whole allocation process. Cartelization is always hard to prove. If the successful bidders did indeed conspire at the auction, and the charge cannot be backed up, it will be an indictment of government policy. If on the other hand the government cancels the allocations (with some, probably indirect, evidence of manipulation), the decision will once again vitiate the atmosphere of doing business in India, something Modi is desperate to avoid.

The dilemma underscores the limitations of the government's current reform policy. The coal sector has always needed a drastic overhaul. With its monopoly over the mining and sale of coal for the open market, state-owned Coal India has little incentive to ramp up production to meet the demands of India’s power-hungry economy. Despite abundant reserves, India imports 150 million metric tons of coal a year. Rather than privatizing the inefficient behemoth, the government has tinkered around the edges by permitting so-called captive mining, whereby companies that run power or steel plants are allowed to mine coal specifically to feed those plants.

All that Modi's government did was stop handing out licenses for captive mines and put them up for auction instead, to avoid the taint of corruption. Auctions are hardly a panacea, though, especially when the pool of bidders is strictly limited. It's entirely feasible for the major private producers of coal-based power and steel/aluminum (there are only a handful) to divide the spoils between them in a way that doesn’t drive up prices at auction.

The auctions should instead have been thrown open to anyone interested in mining coal and selling it on the open market, in direct competition with Coal India. A far greater number of players would have bid then, greatly lowering the chances of manipulation. An open and efficient energy sector would also be a major boost for the economy. On the World Bank’s Ease of Doing Business rankings, India ranks a poor 137th on the parameter of getting electricity. That needs to improve dramatically to attract investment.

This illustrates a larger problem. As I wrote earlier this week, Modi's preference is clearly for incremental reforms that can build upon one another to create momentum for growth. This is eminently reasonable: Economic reform has to be supported by political feasibility. The government lacks a majority in India’s upper house of Parliament, and a big-bang approach that fails could be more damaging than small, progressive changes. But in certain cases, such as reforms in the banking and energy sectors, the strategy can backfire and threaten the government's other initiatives.

This should be a wake-up call. If privatizing Coal India remains impossible politically, the government should at least widen the pool of companies bidding to mine coal. It must encourage competition and the development of an open market. If it continues to tinker instead, it may find even its more modest reforms stalling out.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Dhiraj Nayyar at dhiraj.nayyar@gmail.com

To contact the editor on this story:
Nisid Hajari at nhajari@bloomberg.net