P.Chidambaram has questioned the purchase of Rafale on two vital issues. 1) Why did the government settle for 36 fighter jets instead of 126 and thereby jeopardise our security and 2) Since payment is made over 3 years instead of 10 years the net present value of money received by Dassault is higher and therefore they are 'laughing all the way to the bank'.
Both are good questions, but not good enough to come from a former Finance Minister.
1) The relevant comparison is not between 36 jets and 126 jets. There was no contract for 126. The UPA government lost 10 years dillydallying on the proposal and never reached any finality. The government was comatose. So the comparison is between 36 jets and 0 jet. The answer is obvious.
2) Fixed cost incurred by the supplier has to be recovered through pricing. If more jets are bought, fixed cost per jet will obviously come down. One may argue that if we buy 252 jets instead of 126 jets, price per jet will come down further. But the moot question is how much money can we afford to pay. The trade-off between security needs and cost affordability has been struck at 36 aircraft. Chidambaram's argument is the present value of money given in the 10th year is less than the same money given in the third year. Up to this point the argument is genuine. But we also should take into account the fact that in one case we will receive the jet only in the 10th year whereas in the other case the product is received in the 3rd year itself. These are actually 'forward' transactions and money is paid when supply of jet is made. Comparison is not between money paid in the tenth year and the one paid in the third year. The composite comparison is between the jet received and money paid both in the tenth year on the one hand and the jet received and money paid both in the third year on the other. Obviously getting the jet in the third year is better than getting it in the tenth year. If we calculate the present value of price paid, we must also calculate the present value of the aircraft received. Going further, the risk of the product becoming obsolete is much more in the tenth year than in the third year. Therefore the 3-year contract is better than the 10-year contract.
The honourable former minister may also fallaciously argue that the forward price for a 10-year transaction is cheaper than the same forward price for a 3-year transaction assuming there is no further premium for the intervening 7 years. But actually there is a huge premium paid by the purchaser because of product obsolescence risk in the intervening 7 years.
Chidambaram is too smart to be ignorant of these simple principles. But he is under political compulsions to make unprincipled and dubious arguments. Intellectual integrity has never ever suffered such a sharp debasement..
Both are good questions, but not good enough to come from a former Finance Minister.
1) The relevant comparison is not between 36 jets and 126 jets. There was no contract for 126. The UPA government lost 10 years dillydallying on the proposal and never reached any finality. The government was comatose. So the comparison is between 36 jets and 0 jet. The answer is obvious.
2) Fixed cost incurred by the supplier has to be recovered through pricing. If more jets are bought, fixed cost per jet will obviously come down. One may argue that if we buy 252 jets instead of 126 jets, price per jet will come down further. But the moot question is how much money can we afford to pay. The trade-off between security needs and cost affordability has been struck at 36 aircraft. Chidambaram's argument is the present value of money given in the 10th year is less than the same money given in the third year. Up to this point the argument is genuine. But we also should take into account the fact that in one case we will receive the jet only in the 10th year whereas in the other case the product is received in the 3rd year itself. These are actually 'forward' transactions and money is paid when supply of jet is made. Comparison is not between money paid in the tenth year and the one paid in the third year. The composite comparison is between the jet received and money paid both in the tenth year on the one hand and the jet received and money paid both in the third year on the other. Obviously getting the jet in the third year is better than getting it in the tenth year. If we calculate the present value of price paid, we must also calculate the present value of the aircraft received. Going further, the risk of the product becoming obsolete is much more in the tenth year than in the third year. Therefore the 3-year contract is better than the 10-year contract.
The honourable former minister may also fallaciously argue that the forward price for a 10-year transaction is cheaper than the same forward price for a 3-year transaction assuming there is no further premium for the intervening 7 years. But actually there is a huge premium paid by the purchaser because of product obsolescence risk in the intervening 7 years.
Chidambaram is too smart to be ignorant of these simple principles. But he is under political compulsions to make unprincipled and dubious arguments. Intellectual integrity has never ever suffered such a sharp debasement..
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