Bailouts don't work. Will this one be different? - Views on News from Equitymaster

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Bailouts don't work. Will this one be different?

Dec 20, 2011

The Power Sector in the country is in an unholy mess. With capacity addition well below target, policy inaction, and unavailability of fuel, etc. problems just seem to be compounding. The distribution companies (discoms) are clearly the black hole of the sector and are begging for reforms. But, it's not just these entities which are facing trouble. Banks and specialized NBFCs such as Power Finance Corp (PFC) and Rural Electrification Corp (REC) have disbursed massive loans to the troubled SEBs. Write-offs and provisions for non performing assets (NPAs) may be on the anvil if this sector doesn't pull up its socks, or puts on a new cloak with reforms.

This is exactly what a part of the Planning Commission -'The Shunglu Committee' plans to do. The committee was touted to come up with some ideas to help reform the bleeding State Electricity Boards (SEBs). However, how does one reform an animal which one doesn't understand? A full picture of the financials of these utilities is just not available. Accounts are either in arrears, journals and ledgers have not been maintained or some data is just plain unreliable. Having said that, the poor health of the SEBs cannot be denied.

The dismal financial state

As can be seen in the following table, the financial state of SEBs is quite pathetic. Loans to these entities have increased at a phenomenal rate. However while the fixed assets and revenues have increased only 2 times over the past five years, accumulated losses (in the balance sheet) have seen a 6 times cumulative jump. However, the aggregate losses for the entire 5 year period are much worse. The collection period also has a huge time lag. Please note that these figures are dated. With the external environment souring, the current state could only be worse.

Financial details March 05 March 10 Change
Loans-State Govt 150 240 60%
Loans-Others 560 1610 188%
Accumulated losses (balance sheet) 190 1070 463%
Fixed assets 670 1280 91%
Revenue 900 1500 67%
Collection period (range of days) 54-933 36-645  
Source: Planning Commission Report: December 2011, figures in rupees billions

As of March 2010, losses before subsidies amounted to Rs 1.8 trillion. It amounted to Rs 820 bn after subsidies. These losses primarily came because of an Rs 0.6/kwh (kilo watt hour) gap between the average cost and average revenue. Aggregate Technical and Commercial (AT&C) losses were also high, further widening the losses. Out of these Rs 820 bn losses, around 70% of these losses are funded by public sector banks. This is a major reason why the valuations of these PSU banks have taken a hit so far this year. The fear is that write-offs and restructuring in these accounts may increase provisioning and sharply reduce profits for the banks. Plus, only 42% of these loans are backed by state government guarantees.

Bank details Total Loans % backed by state guarantee
Public sector banks 491.3 42%
Other commercial banks 21.9 42%
Cooperative banks 5.3 -
Total 518.5 42%
Source: Planning Commission Report: December 2011, figures in rupees billions

An SPV to buy distressed assets and other reforms

As per the Central Electricity Authority (CEA) forecasts, losses of all SEBs will decline from Rs 270 bn in FY10 to Rs 220 bn in FY17. A Rs 50 bn performance improvement. There are two key assumptions for the same. 1) That units available would double and 2) that aggregate losses would decline from 24% to 17% by FY17. In order to achieve these targets and prevent these entities from defaulting, reforms are clearly the need of the hour.

One key proposal is that the committee has come up with is the floating of a Special Purpose Vehicle (SPV). This would be majority (76%) owned by the Reserve Bank Of India (RBI) and PFC and REC would share the rest of the capital. The RBI would provide a line of credit to this SPV which would in turn buy the distressed debt of banks to distribution companies. This means that there would be no immediate write-off, and banks would be safe for now. However, in the long run the state government would have to repay the SPV.

Either way buying out the loans of discoms from banks would depend on a number of conditions. These include state governments' agreements for regular tariff increases, meeting technical and operational parameters, agreements between the state government and banks on interest rates, period and amount of repayment, etc. This move is positive for banks as they can transfer risky assets off their books, and the onus is on State Governments to pay up the debt. Plus, with the RBI as the owner/operator of the SPV, one can ensure that it will take matters into its own hands to ensure compliance. In other words, both the SEBs and PSU banks will be bailed out from financial crisis for the time being.

The reform measures also include more autonomy for SEBs, enabling them to increase tariffs regularly and reduce distribution losses. Restructuring the SEBs, imposing penalties on consumers in high theft areas, prepaid metering for non-paying customers and billing agricultural users could also address some problems.

Will they work?

Reforms are desperately needed. However some are controversial, radical and may take some time to implement. While the SPV concept is revolutionary, it remains to be seen whether it will actually work in practice. Penalties in certain areas and billing agricultural users may also be harder to implement. Tariffs were earlier adjusted according to the whims of political parties and now this has to stop. But with impending elections in several states and the general elections due in 2014, politicians may be extremely averse to hiking tariffs. All in all, while losses may not magically disappear with the wave of a wand, at least these reforms address a potent problem and are at least a step in the right direction.

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