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Finance | August 2013

A game of wait and watch

Given that prerequisite policy reforms implementation will be the major factor for the revival of investor sentiments in power sector, industry will have to wait and watch for a turnaround.

Last year was not much financially favourable for the power sector, due to slow execution of several projects. Constraints related to fuel, policy reforms and regulatory affairs had a major impact on these projects. Albeit, instigating refinancing of short-term debt for state discoms was a welcome move by the government, but industry players do not see it as a long-term relief for the sector.

Raising fresh funds and debt repayment has become a major concern for the sector, while lenders have shown concern on increasing NPAs on their book, over exposure to infrastructure sector are cautious about fresh loan sanctions. However, major lenders like SBI, Bank of Baroda, Bank of India and other major private lenders have expressed that the financial environment is challenging, but raising funds would not be a challenge for good projects, which are backed by companies with healthy track records.

Going ahead, the sector analysts and industry experts are of the view that the investment sentiments are still subdued and it may only improve after fast tracking the implementation of pending reforms and resolution of fuel issues.

The sector has faced several challenges in the recent past mainly on the account of fuel-related issues, as well as creditworthiness of the state electricity boards. However, the recent government regulations such as power tariff hikes, coal price pooling and restructuring of state electricity boards have alleviated investor concerns to a large extent.

'We like companies with better fuel security and sustainable tariff models, which provide revenue visibility. Going forward, we expect to see increased opportunities not only in power generation, but also in sectors like transmission, distribution and allied sectors. says Archana Hingorani, CEO and ED, IL&FS Investment Managers Ltd. Overall, the long-term fundamentals will always be healthy in the country, because demand for power remains strong.

Meanwhile, India Ratings & Research, a Fitch Group company, has observed that higher fuel costs and weak financial profiles of power distribution companies may pose major challenges to the sector in near term. However, the rating agency expects that the sector could be benefitted from favourable tariff mechanism, comfortable liquidity and support from the central and state governments.

Continuing negative outlook
India Ratings & Research predicts negative outlook on the infrastructure sector including power for the second half of the FY14. The credit quality of many power projects and transportation assets, which are under construction or in early ramp-up phases, stands strained. Some operating projects have weathered the storm and exhibited improving cash flow generating capacity, resulting in a few rating upgrades. As of July 15, 2013, about 21 per cent of Ind-Ras portfolio carried a negative outlook (up from 8 per cent as of December 2012).

Significant downgrades over the last six months have meant that 74 per cent of the ratings in the agency's portfolio still have a stable outlook. Around 71 per cent of the projects in Ind-Ra's portfolio are rated at 'IND BBB-' or below.

Loan restructuring:
The need for stressed projects to seek lenders' approval for restructuring the project loans based on specific situations is likely to continue unabated. Defaults and restructuring on project bank debt have resulted in a sharp increase in rating downgrades. A combination of project-level failings and negative macroeconomic conditions has contributed to the deterioration in credit profiles. Around 7 per cent of the ratings were downgraded to 'IND C' or 'IND D' during the last six months to reflect defaults in payment of debt service or pending finalisation of loan restructuring packages.

However, the long-term credit fundamentals for infrastructure projects remain protected, underpinned by India's massive infrastructure deficit, leading to favourable demand trends.

Unfavourable macro-economic conditions: A decline in the Gross Domestic Product (GDP) growth rate, subdued equity markets, high interest rates and sharp rupee depreciation will continue to exert pressure on revenue performance of infrastructure assets in the near term. These factors also affect the already weak financial structures. They also limit sponsors' capacity to support individual projects on an ad-hoc basis, which is an integral assumption in current rating levels. Systemic fuel shortages, though showing signs of being addressed through various governmental actions, will force many power projects to operate at sub-optimal levels.

Prolonged fuel shortages, execution risks:
Impediments to land acquisition and continued delays in obtaining statutory permits for captive coal blocks (CCB) allocated to 11 per cent of the rated portfolio of power projects have delayed the commencement of mining operations. This has resulted in a regulatory threat of CCB revocation. Should this threat materialise, the projects would be forced to tap the costlier imported coal market, which would adversely impact their forecasted financials. Unless the contracted quantities of coal of specified quality are delivered to power projects having fuel supply agreements with Coal India, their ability to operate at break-even plant load factor levels, as a minimum, could be impaired. Weaker sponsors will struggle to inject residual equity to ensure timely project completion or bridge cost overruns, resulting in the need to seek restructuring of bank loans.

Impact of policy action:
The Government of India has announced a host of policy reform measures. These include constitution of the cabinet committee on investments, proposal to set up regulators for the roads and coal sectors, restructuring of state-owned power distribution companies, proposal to permit deferral of fixed premium committed by road projects to the highways authority, permitting sponsors to divest 100 per cent of their equity in operating road projects.

These measures and the Supreme Court's order de-linking forest and environmental clearances are positive for the sector, but their impact on credit quality will be felt only over the medium term. If translated into quick and effective actions, these measures will help remove impediments to timely completion, improve counterparty credit quality and facilitate induction of strong sponsors. They will also help arrest further impairment to projects' credit profile and improve rating levels over the next 12-24 months. Limited impact of currency depreciation: Despite an 11 per cent fall in Indian rupee against dollar in first half of the fiscal, Ind-Ra expects minimal impact on its infrastructure portfolio in the short term. This is because of the limited exposure (although unhedged) of projects to foreign currency loans and external commercial borrowings (ECBs). Also, the current lower interest rate on ECBs compared with long-term domestic loans is likely to cushion the effect of currency depreciation to some extent.

However, sustained currency depreciation can pressurise ratings in the medium to long term. This is primarily due to the heavily back-ended structure of foreign currency loans and ECBs, where their compulsory conversion to rupee term loans could occur at possibly much higher exchange rates prevailing 5-6 years from now.

Bond issuances, consolidation: Consolidation in the sector with ownership of projects passing from weaker to stronger hands is almost inevitable in several cases where even debt restructuring may offer only temporary respite from fundamental weaknesses. While Ind-Ra expects sponsors of operating projects to continue exploring options for partial/full sale of equity interest in projects, a mismatch in valuation expectations would mean that the number of transactions that are finally closed would be limited in number.

What could change the outlook
Macro factors: An improvement in the economic growth rate, the overall investment climate and rapid follow-up action on the series of policy announcements could have a salutary effect on project credit quality.

Debt restructuring:
Projects with strong fundamental economic rationale, which were subject to stress on account of weak financial structuring, could witness a bounce in rating levels upon satisfactory conclusion of debt restructuring packages.

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