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Legalese | September 2016

UDAY An Ambitious Indian Distribution Sector Bailout

With our discoms posting staggering losses and drowning in debt, UDAY is geared towards achieving tangible goals with a sensible method that represents a multi-pronged approach to rid the sector of its chronic ailments.

An efficient and financially sustainable power sector is crucial to relay the benefits of economic development to all sections of society. However, the distribution sector in India has been a major bottleneck. Attempts at addressing systemic issues including the Accelerated Power Development and Reforms Programme (APDRP) and thereafter the Restructured APDRP more recently the Financial Restructuring Plan (FRP) were all targeted at improving the financial health of the distribution companies (discoms), but yielded limited results. Estimates show discom losses were pegged at a staggering Rs.3.8 lakh, with additional debt of approximately Rs.4.3 lakh crore. It is on this background that the Ujwal Discom Assurance Yojna (UDAY) has evoked significant interest. Thus, UDAY is geared towards achieving tangible goals with a methodology which appears sensible and represents a multi-pronged approach to rid the sector of its chronic ailments.

Strategy Employed
Improving operational efficiencies of discoms is one of the main concerns. To address this, incremental changes like compulsory smart metering, upgradation of transformers and switching to energy efficient LED lighting are being stressed on which will bring down the Aggregate Technical and Commercial (AT&C) losses to half the current levels and minimise the difference between the average revenue realised and average cost of supply. Reduction of cost of power is undeniably a primary consideration both from the perspective of growth and political expediency. Ready availability of cheap domestic coal and to that end, rationalisation of coal linkages, liberal coal swaps from inefficient to efficient plants, coal price rationalisation based on gross calorific value, supply of washed and crushed coal, and faster completion of transmission lines are rightly being pursued.

Containment of interest cost of discoms and enforcing financial discipline on through alignment with state finances is however the most critical item on the to-do list and actioning this is absolutely imperative if the distribution sector is to stand on its own feet. UDAY proposes that state governments take over 75 per cent of the debt liability of their discoms over a two-year period, but which will not be counted towards estimation of fiscal deficit of the relevant state for financial years 2015-2017. The states will then issue bonds, including SDL bonds, in the market or directly to institutions who are currently bearing the discoms debt in a proportionate manner. The remaining debt may be issued as state guaranteed discom bonds by discoms at market rates and an additional 0.1 per cent or by the financial institution or bank at up to 0.1 per cent above the bank´s base rate.

Approach to Goal
UDAY seeks to adopt a ´carrot and stick´ approach. Performance is linked to benefits under allied programmes such as the Deendayal Upadhyaya Gram Jyoti Yojana (DDUGJY), Integrated Power Development Scheme (IPDS), Power Sector Development Fund etc. Successful states will also be eligible for additional coal at notified prices and, in case of availability through higher capacity utilisation, low cost power from NTPC and other CPSUs. Non-performance can lead to obstructions of claims for DDUGJY and IPDS grants.

Undeniably, UDAY does have traces of earlier schemes with similar objectives, but the possibility of success is generally seen as higher compared to the earlier attempts. These are not difficult to understand. For starters, it focuses on improving operational efficiencies as a key part of its turnaround plan. Importantly, UDAY seeks to make state governments partners in turning the discoms around, largely putting the fate of the respective discoms in the hands of the state governments. This is a powerful incentive for states seeking to grow its economic situation. In doing so, it seeks to put in place a regime where state governments can assume liabilities of the discoms without adversely affecting budgetary considerations.

Projections have been promising with some estimates claiming that UDAY can halve the discom debt while also resulting in a capital infusion for banks. There is a realistic chance of breaking even within the next five years if states and discoms follow through on obligations. Inescapably, there will be an impact on indebtedness of states on account of interest rates and absorption of losses but if this is viewed as - as it should be - the opportunity cost of redressing the larger problem, it should go a long way in alleviating a significant portion of the problems.

Challenges will always be omnipresent but must be surmounted. To begin with, it is important that participation by all major states within a reasonable timeframe is achieved. Crucial states such as Tamil Nadu are yet to formally join the programme. Implementation of operational improvements by discoms remains fundamental as without higher cost-efficiency, there will be no significant improvement in the sector. Timely review of tariffs and subsidies in a manner which is apolitical to the extent reasonably possible driven by an effective revenue model based on a realistic reflection of costs is a must.

The good news however is that if implemented in its right spirit, UDAY has the potential to unlock immense potential.

Authors: Upendra Joshi, Partner and Shivanshu Thaplyal, Associate Partner. The authors would like to thank Adithya Iyer, Associate for his contribution to the article.

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