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Cover Story | January 2016

Ushering in a new Dawn

Ujwal Discom Assurance Yojana (UDAY) announced in the first week of November 2015 to overhaul the operations of distribution companies (discoms) though a slew of carrots and sticks has evoked hopes that the scheme could usher in a new dawn for the Indian power sector, which has been saddled with numerous problems. Though the NDA government scheme is primarily targeted at eight discoms that are caught in operational and financial mess, the features of the scheme, if implemented in letter and spirit across the segment, is expected to resolve most of the problems faced by the power sector on a sustainable basis, thus enabling achievement of a broader ´Power for All´ dream in due course.

However, there are lingering doubts among some experts, if this discom revival scheme, third in the series in the last 13 years, will at all be successful in bringing efficiency to discom operations, which together have posted over Rs.62,000 crore of net loss in 2013-14. Ultimately, the commitment of the state governments towards addressing inefficiencies at the discoms will hold the key to successfully addressing the issue, they feel.

The electricity distribution sector is a national embarrassment, brought about by decades of turning a blind eye to the misdemeanours of this sector - Poor operational efficiencies leading to high aggregate technical and commercial (AT&C) losses, the state governments not inclined to hike tariffs in line with rising cost, and huge interest burden due to funding of losses through debt. This had necessitated two bailouts by the central government in the past, though they have failed to bring in the desired results, despite heavy toll on exchequer.

As on March 31, 2014, SEBs had accumulated losses of around Rs.3.5 lakh crore. About 40 per cent of which are attributed to AT&C losses and the rest due to tariffs not keeping pace with rising costs of supply.

However, the glimmer of hope is that the all-India discom losses have been coming down over the last three years - from Rs.72,369 crore in 2011-12 to Rs.70,894 crore in 2012-13 to Rs.63,765 crore in 2013-14.

It is estimated to be at around Rs.62,000 crore in 2014-15.

The Scheme
UDAY aims to provide a sustainable solution by addressing discom issues in a comprehensive manner beginning with the takeover of 75 per cent of the debt of discoms as on September 30, 2015, by their respective states in a staggered manner by fiscal 2017. These will be converted into state bonds offering an interest rate of 8-9 per cent. The rest of the debt will have to be re-priced at the banks´ base rate plus 0.1 per cent. The other salient features include plugging of AT&C losses to bring them down to 15 per cent from 22 per cent by adopting smart metering technologies in states, takeover of discom losses by the state governments from 2017-18 in a staggered manner covering 100 per cent by 2021 and stop bank funding against losses.

The loss-making discoms used to show their losses in their financial statements as ´Regulatory Asset´. In 2001, when reforms were introduced in the power sector, SEBs losses amounting to Rs.35,000 crore were shown under this category and it was thought that the state SEBs will outperform and the distribution segment will be revamped. But there is no change in the situation over the years. Again the distribution sector has piled up with debt burden of Rs.1.9 lakh crore by 2012.

UDAY tackles the issue of efficiency improvement and cost-reflective tariff hikes by making the states formally accountable. The scheme will focus on both liquidity improvement and a sharp reduction in losses by lowering the interest burden. This will provide discoms an opportunity to start afresh. Over the long term, UDAY can imbue a commercial orientation to the discoms of the implementing states.

The scheme envisages additional support by the centre to the states, those who are accepting the scheme and performing as per the set standards. The scheme talks about additional funding, through the Deen Dayal Upadhaya Grameen Jyoti Yojna (DDUGJY) or the Power System Development Fund or the Integrated Power Development Scheme (IPDS). It also proposes additional coal support at notified prices, which is a big incentive for the state. So, these two factors as well as additional coal and then low cost power allocation through NTPC and other central generating stations, could prove to be big incentives and will go a long way in achieving the targets.

If the state defaults on servicing these bonds, the Centre would step in and commandeer parts of financial grants/ devolutions to the state. It is hoped that this additional pressure on the state finances will force them to implement tough distribution sector reforms. It is, thus, considered to be a more comprehensive solution compared with the financial restructuring package (FRPs) of the past.

Earlier FRPs
The financial restructuring package (FRP) introduced in 2002-2003 had many characteristics of UDAY. Throughout 2002-2003, the Union Ministry of Power (MoP) signed agreements with different state governments and their discoms. It was not a memorandum of understanding (MoU) but was a non-binding agreement on non judicial stamp paper. MoP started monitoring their physical performances in terms of AT&C loss reduction. It was linked to the Accelerated Power Development and Reform Programme (APDRP). So since 2002-2003 and throughout about 2006, 2007 and 2008, the discom losses were contained. In many cases, the Centre had financed the losses. The concept of free-power was totally eliminated by 2003 itself. Thus, the government has proclaimed the success of the scheme by 2007-08. However, things drifted again.

The 2012 plan has given discoms a three-year window. The first year 100 per cent of the losses will be funded, the second year, it will be 50 per cent of the losses and in the third year it will be 25 percent and after that banks will not fund the discom losses. Thus, the tap was not turned off suddenly out of fear that the entire system will collapse. Actually, the FRP has entered the ´no loss funding´ zone only during the current fiscal, and the new package is being proposed.

It is also evident from the Rs.10,000-crore ´Montek Bonds´ of 2002 and the Rs.2-lakh-crore-plus FRP for discoms of 2012 that have not yielded proportionate results in terms of efficiencies of the discoms. The earlier two bailouts have failed miserably with losses of various discoms adding up to Rs.3.8 lakh crore.

In this context, Fitch Rating said in its report, ´We see the new power-sector reform plan for the state discoms announced in November 2015 as better structured than its 2012 predecessor, which was not very successful.´

While the earlier FRPs were looking into what the state governments should do to improve the efficiency of discoms, under UDAY, the Centre is looking into what it can do to help the states bridge the gap between revenue and costs and what support to has to provide to help them achieve the targets. That makes a lot of difference.

Impact
Sudip Sural, Senior Director, CRISIL Ratings exuded hope that UDAY can bring in a transformational change in the power sector as a whole if it is implemented as planned. He said in a report, ´If the larger states adhere to their milestones by reducing AT&C losses to around 15 per cent by fiscal 2019 through efficiency improvements, UDAY could spawn a transformational change in India´s power sector.´

CRISIL believes UDAY, can potentially halve the discom losses of eight states that had participated in FRP-2012 by fiscal 2018. The eight discoms are estimated to have a ´gap´ (average revenue realised minus average cost of supply) of Rs.1.40 per unit. UDAY could potentially narrow this to around 70 paise by the end of fiscal 2018. The scheme has the potential to wipe out losses of discoms in Haryana, Andhra Pradesh and Telangana by fiscal 2018. For discoms in Tamil Nadu, Rajasthan, Uttar Pradesh, Bihar and Jharkhand, losses will reduce, but total elimination can happen only by achieving milestones on operational efficiencies, the rating firm said.

The scheme is expected to substantially reduce discoms´ near-term debt burden, primarily their high interest costs, which account for a large share of their losses.

Global investment banker, CLSA says that while a recovery in finances may take time, the losses should bottom-out in 2015-16. This should also kick-start state power generation capital expenditure. Multiplier effect of power availability to the economy is a well-documented fact.

Leading rating agency, ICRA estimates that if the scheme is implemented, the aggregate relief to distribution companies (discoms) is likely to be around Rs.88,000 crore per year by 2018-19, which translates into a reduction in losses by around Rs.0.95/unit on an all India basis. This in turn should enable the distribution utilities to break-even over the next 3-4 year period.

Leading financial services firm, Edelweiss called UDAY a step in the right direction, which has potential to unclog the entire power chain as operational efficiency improvements to reduce the distribution losses and eliminate the gap between average revenue and average cost in the next four years.

UDAY would, however, affect the credit metrics of states, albeit marginally, said CRISIL in a report. The gross fiscal deficit of these eight states would increase up to 60 basis points in next two years because of the additional interest burden, coupled with absorption of losses (5 per cent in fiscal 2018). The transfer of debt will increase their aggregate indebtedness (ratio of debt to gross state domestic product) from 23 per cent in fiscal 2016 to 26 per cent in fiscal 2018. This would impact fiscal flexibility and reduce wherewithal for long term asset-creating productive expenditure.

´Over the next 3 years, the (discom) losses are expected to reduce due to lower interest costs, deriving benefit from implementation of UDAY. However this would remain contingent upon level of adherence to milestones for reduction of AT&C losses prescribed by UDAY,´ Manish Gupta, Director, CRISIL Ratings said.

PPAs
The debt-ridden discoms have stopped signing new power purchased agreements (PPAs) over the last two years, rendering built capacities of around 10,000 MW stranded. With discoms resorting to power shedding instead of singing PPAs, all-India plant load factor (PLF) of coal based power plants had declined to 60 per cent for 6 months ended September 30, 2015 (from 65 per cent in the corresponding period a year ago) despite improving coal availability. The PLF of gas based power plants is even worse, at 20 per cent.

Responding to a query, Manish Gupta said, ´UDAY will result in liquidity improvement and sharp reduction in discom losses, thus improving the ability of discoms to procure power and reinitiate signing of long-term power-purchase agreements (PPAs).´

Critical Success Factors
Is failure of UDAY an option? No. ´A failure of the discom reforms would be negative for the whole electricity sector. Furthermore, any increase in receivable days for central utilities like NTPC, NHPC, PGCIL etc., following the expiry of tri-partite agreements, would be negative for the financial profiles of these entities,´ says Fitch, emphasising the importance of success of UDAY.

Under the existing tripartite agreements (between the entity, state governments and the central government) the central utilities have benefitted as they helped them in timely collection of dues from discoms. These agreements lapse in October 2016 and there is no clarity as to whether these will be rolled over. On tariff front also, these companies will benefit from regulatory certainty under the current five-year tariff period through end-March 2019.

Fitch believes that commitment by the state governments towards addressing inefficiencies at the discoms is a key to successfully addressing the issue. However, the take-up rate for the assistance package offered to states governments, and delivering on medium-term commitments on increasing efficiencies and further reducing losses at discoms by the state governments, will determine the success of the new measures.

While there is an argument that the pressure by the Centre on discoms to reduce the AT&C losses or to reduce the gap between revenue and cost of service, may not yield results, there is a counter argument that the Centre has a lot of clout in influencing the states as it is, instead of trying to do the same thing through banks. Banks were used to put pressure on discoms to put their house in order in the past, but not with desirable results as they are more than willing to lend to discoms only because their loans are secured by the state governments, which are risk-free.

Frequent monitoring of performance is set to put a lot of pressure on the state government to fall in line with the scheme and its targets. The Centre is talking of quarterly monitoring of performances of various loss-making discoms, if not across the board. It is hoped that additional pressure on the state finances arising from transfer of discom losses to them will also make them to implement tough distribution sector reforms.

States are naturally apprehensive on taking debt on their books. But the point is: Do they have a choice? If they do not agree to the package, they continue to face power shortages. That will put the ruling parties at a disadvantage in elections.

So it is better to improve efficiency and get back to health. Political will to succeed will make a lot of difference in success in power sector reforms. But will state governments go beyond scoring political points and implement UDAY in spirit, given that discoms are in the state governments´ domain and that the Centre has limited leverage? That is a million dollar question. However, the Centre cannot shirk its responsibility in trying to find a sustainable solution to this debilitating anomaly in the power sector.

Privatisation
There was no mention of privatisation of discoms in UDAY, despite success displayed by some private players over the last five years under the government´s franchisee model. (See in-box) Is privatisation one of the means to achieve the objective of turning loss-making discoms around? Gupta of CRISIL says, ´Privatisation will bring in higher operating efficiencies especially in reduction of AT&C losses as demonstrated in privatised discoms in Mumbai, Ahmedabad, Delhi or Kolkata. However, cost reflective tariff hikes and imparting commercial orientation to discoms, will be imperative for sustainable operations of discoms.´

Bank debt
But UDAY may not dawn a new era on the public sector banks and power finance companies to whom discoms owed about Rs.5.46 lakh crore at the end-March 2014, says global investment banker, CLSA in a report. This volume of discom debt is equivalent to two-and-a-half times the defence budget; roughly six times the amount that will be spent this financial year on building roads; and enough to wipe out India´s fiscal deficit. Rajasthan alone had a debt of Rs.85,000 crore, followed by Tamil Nadu at Rs.70,000 crore and UP at Rs.32,000 crore.

Public sector banks consider loans to discoms are safe bets as they are backed government guarantee. This scheme once again buttresses this point.

Rajat Bahl, Director, CRISIL Ratings, said, ´The profitability impact for banks will be around Rs.4,300 crore per year, which tantamounts to 8 per cent of the profit of PSBs estimated for fiscal 2017. PSBs will, however, benefit from a one-time provisioning write back of Rs.5,000 crore on restructured discom loans converted into bonds.´ The conversion of discom loans into bonds would lead to capital savings of Rs.12,000 crore for PSBs because of a reduction in risk weights.

As such, the main beneficiaries of UDAY are sector lenders, Power Finance Corporation of India (PFC) and Rural Electrification Corporation (RFC). From among the public sector banks Vijaya Bank, Indian Overseas Bank, Union Bank, Oriental Commercial Bank, Canara and Andhra Bank would be the main beneficiaries, while Bank of Baroda and State Bank of India are marginal beneficiaries, said the financial services company, Anand Rathi Securities.

Conclusion
Many energy sector aficionados know that a slew of concurrent measures are needed to attack the cancer that is eating away the vitals of the energy distribution system, in turn affecting the power sector as a whole. ´Raising tariffs will not solve the problems of power distribution companies, said Piyush Goyal, Minister of State (Independent Charge) of Power, Coal and New and Renewable Energy, once. He was right in highlighting the need for improved and all-round efficiency of discoms. Whatever the pressures from UDAY on state governments to raise the price of power to cover the cost of supply, there will be some resistance from the elected governments to do so. One best way to tackle this issue is frequent tariff revision in the intervals of quarterly or half-yearly, at smaller rates than hiking it in spurts of over 10 per cent at a time. Depoliticising tariff regulators is as important.

Electricity is the only business where retail is being handled by the state controlled entities today. The government should give a shot at franchise model, which proved successful in the recent past, once more with some kind of checks and balances. In the same breath, PPP model of distribution management can also be given a chance, if necessary by floating a national power distribution company to effectively challenge the hegemony of state-owned discoms. Multiple discoms should also be allowed to operate in metropolitan cities to start with, before expanding it to other palaces. For bringing down AT&C loses ´smart metering´ should be adopted at all levels on a war-footing and ensure that no single power consumer is left unmetered. The jury is out. Ultimately, it will take at least three years to feel the real impact of UDAY.

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