Will There Be Light?

On 27 October Axis Bank told the world it had unloaded two power loans for Rs 650 crore — at a steep discount of 65 per cent— to asset reconstruction companies. The bank, however, refused to reveal the identity of the borrower, citing confidentiality clauses. But sotto voce says it was Abhijeet Mihan Nagpur Energy (AMNEL). Now AMNEL’s woes — its 240-megawatt unit set up to power the Mihan-special economic zone is wound up in a legal mess — are not reflective of all that’s wrong with the power business. But at the analysts’ concall after Axis Bank’s second quarter results were released, a few were irked that these loans were treated as “standard” in the preceding quarter. And by extension, were not averse to conclude the power sector has a lot more skeletons.

On 9 November, Piyush Goel, union minister for power, coal and new and renewable energy gave us Ujwal DISCOM Assurance Yojana (Uday) to revive debt-laden power distribution companies (discoms). If it plays out right, there will be no darkness. Will there?

Uday was eagerly awaited ever since the Reserve Bank of India’s (RBI) Financial Stability Report (FSR; June 2015) red-flagged the power-loan mess surrounding banks. Banks had restructured Rs 53,000 crore in discom debt under a financial restructuring plan (FRP) three years ago; the moratorium for repayment of Rs 43,000 crore in principal ended in March 2015.

“Considering the inadequate fiscal space, it’s quite likely that the state governments might not be in a position to repay the overdue principal and instalments in time… the probability of slippage of this exposure into NPAs (non-performing assets) is very high considering the implementation of new regulatory norms on restructuring of loans and advances effective 1 April, 2015”, said Mint Road. It was a reference to the new classification norm: restructured loans are to be treated as NPAs from the current fiscal.

Who Wins, Who Loses
Why should you and I (the tax-payer) foot the bill for discoms on life-support (with debt moratoriums)? At first glance, it would appear that Uday has eased the burden on us. Well, think again — it’s a mixed bag really.

Eight states — Andhra Pradesh, Bihar, Haryana, Jharkhand, Rajasthan, Tamil Nadu, Telangana (earlier clubbed under Andhra Pradesh) went under the FRP knife in October 2012. Life after Uday will see the gross fiscal deficit of these states northbound due to the additional interest payout and absorption of losses (of discoms). So too aggregate indebtedness — the ratio of debt to gross state domestic product — it will be 26 per cent in 2018 (23 per cent in 2016).

To the advantage of the states, there is a small matter of detail. As minister Goel pointed out, “Discom debt is de facto borrowing of the states which is not counted in de jure borrowing”. Simply put, they are basically on the same book, for all practical purposes. While the principal debt (as on end-September 2015) taken over (5o per cent in 2015-16 and 25 per cent in 2016-17) is not to be included in the fiscal deficit of states, Sudip Sural, senior director of Crisil Ratings says, “It will impact fiscal flexibility and reduce wherewithal for long-term asset-creating productive expenditure”. It’s another way of saying financial engineering may make accountants happy, but that’s about it.

Uday: Yet Another Bailout Plan?
It has been a recurrent theme — the bailout of state-run discoms; three efforts in the past 13 years. But little has been done to tackle the nub of the mess: acute mismanagement. You can take your pick from a failed regulatory apparatus, political interference, non-cost reflective tariffs, a poor fuel-cost pass-through mechanism and inadequate attention to improve efficiency like in a significant cutback in aggregate technical and commercial (AT&C) losses.

Uday may well prove to be more of the same. It’s just a window-dressing of losses — from the books of state-run discoms to state governments. It’s no wonder that RBI governor Raghuram Rajan recently said that given the state of state electricity boards (SEBs), another bailout package would soon be inevitable. Former power secretary Anil Razdan, seconds it: “It’s a case of mismanagement and governance of the sector. Public sector management of the problem is not the solution.” Franchisee development or privatisation is Razdan’s prescription; he’s spot on, but then it’s a political hot-potato.

The power secretaries of two states, on the condition of anonymity, say, while the adoption of Uday is voluntary, the incentives are not sufficient for states to adopt it. The only upfront incentive is that the loans taken-over will not impact states’ fiscal responsibility and budget management limits for the current fiscal or the next. Uday hinges on the Centre’s confidence that with loans off their books, rejuvenated discoms will be able to dispose off the rest of their outstanding as bonds backed by state government guarantees.

Banks Smile All the Way
With Uday, discoms get to breathe easy. That’s because while the average interest rate on discom debt is 12 per cent (it can go as high as 15 per cent for some), states borrow at 8 per cent. Under the scheme, states will have to issue non-statutory liquidity ratio (SLR) bonds (they do not qualify for investment under banks’ SLR) with a tenure between 10 years and 15 years and a moratorium (on principal) of “up to five years”. The coupon rate: 7.92 per cent (from the cut-off at the RBI auction ahead of Uday; it can move up or down though going ahead) plus 25 basis points (bps) or an all-in cost of well under 9 per cent. But what’s in it for banks, especially state-run banks?

The conversion of discom loans into bonds would lead to capital savings of Rs 12,000 crore for state-run banks due to a reduction in risk weights. But the lower coupon rate of 300 bps on non-SLR bonds (which means lower earning for banks) compared to loans to discoms, which are priced higher, means an annual reduction of Rs 4,300 crore in post-tax profits for these banks (till the bonds mature). Says Rajat Bahl, director, Crisil Ratings, “This is tantamount to 8 per cent of these banks’ profit estimated for fiscal 17. On the bright side, they will gain from a one-time provisioning write-back of Rs 5,000 crore on restructured discom loans converted into bonds.”

Is Uday Any Different?
‘Uday’ makes it clear that tariff hikes are no substitute for efficiency improvement; that regulators can’t pass on the inefficiency of discoms to consumers; states with 30-40 per cent losses can’t expect consumers to pay for their inefficiency; after all, most states have been on a tariff hike trajectory — there has been an average annual increase of 8 per cent in the last five years. That’s a fair enough stand to take, but it also tells you that “power” is sold as a “political good” — the political class knows it will have to bear the cost of tough measures at the hustings! “We believe commitment by the state governments towards addressing inefficiencies at the discoms is key to successfully addressing the issue. The package does not address tariff reforms directly — a very politically sensitive subject,” says Muralidharan Ramakrishnan, analyst at Fitch Ratings.

Analysts point out that whatever be the public stand of the powers-that-be, financial engineering will not stem the rot — there has to be annual tariff hikes and a reduction in AT&C losses. This was the reason why the FRP — not very different from Uday in intent — was a stellar flop.

Fitch Ratings says the debt-restructuring plan will substantially reduce discoms’ near-term debt burden; and more importantly, the high interest costs, which account for a large share of the discoms’ losses. It notes that the Centre recognises that rising power tariffs continue to be a challenge for state governments; thus addressing the remaining losses is largely expected by reducing technical and commercial losses over the next two to three years, and lowering generation costs via improved availability of low-cost fuel. “The long-term success of the programme relies heavily on the latter. States opting for the package will have to agree on milestones on efficiency improvements and loss reduction”, says Ramakrishnan of Fitch Ratings.

There’s also a case to bring in discoms under the RBI’s Strategic Debt Restructuring (SDR) scheme unveiled earlier this year under which banks can band together and ring in management change. As on date, “vast tracts” of state-run businesses work on perverse logic. Discoms are a classic case — state-run banks have dished out loans to discoms despite the latter’s poor financials as they know they will get paid somehow. This, even as they charge discoms higher interest rates which makes them an even bigger basket case. So why not get discoms under SDR, if it holds good for the private sector? For instance, the 500-mw Lanco Teesta hydropower project ran into trouble due to delays and cost overruns. ICICI Bank, the lead-banker in the consortium opted for the SDR route in August this year to recover debt of Rs 2,400 crore; Rs 78o crore is to be converted into equity.

Under FRP’12, short-term liabilities of discoms with weak credit profiles were restructured — sponsor states took over 50 per cent of it through state-guaranteed bonds in a phased manner; the rest was converted into long-term loans guaranteed by the state governments with a moratorium on principal repayment for three years. This provided much-needed liquidity relief, but losses in states that went in for the FRP did not reduce by the end of their moratorium period as AT&C losses mounted; tariff hikes tapered off (it was regular and high in the first two years). Around this time, there was also talk of allowing lenders greater say in the day-to-day running of the SEBs. But keeping impending elections in mind, little wonder that the matter was brushed under the carpet.

Will Uday correct the wrong? Let’s hope so.

Raghu@businessworld.in; suchetana@businessworld.in
@tabonyou; @suchetanaray

(This story was published in BW | Businessworld Issue Dated 28-12-2015)