UDAY is a revival plan for discoms rather than a bailout package

Power sector distribution companies are being bailed out by the government for the third time in 13 years. The earlier two bailouts have failed miserably with losses of various distribution companies (discoms) amounting to Rs 3.8 lakh crore and the Reserve Bank of India pointing out in its Financial Stability Report of June 2015 that Rs 53,000-crore exposure of banks to seven state electricity boards had a "very high probability" of turning into non-performing assets by the quarter ending September.

Failure of the previous two bailout packages was more on account of political reasons than operational inefficiencies of the discoms. So does this package also have the same political risk as the earlier ones?

Prima facie it does look so as the state governments are being asked to take over 75% of the debt of the discoms over two years -- 50% in 2015-16 and 25% in 2016-17.

CLSA points out that collectively discoms owe banks Rs 5.5 lakh crore. This is a sum 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 having a debt of Rs 85,000 crore, followed by Tamil Nadu at Rs 70,000 crore and UP at Rs 32,000 crore.

States are naturally apprehensive on taking the 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. Power plants are operating at their lowest level of 59% of their capacity as discoms do not have the money to buy power.

Though state governments treat discoms loans separately rating analysts and multilateral agencies consider the debt of the discoms as that of the state government since they guarantee the payment. Most of the trouble of discoms is because state government’s for political reasons did not allow them to raise tariff in line with the cost. However, central government in the present package is giving the states a sweetener by not including the loans of the discoms in calculation of the state’s deficit till 2016-17.

The holistic approach taken by the government has the approval of market experts. Sambitosh Mohapatra, partner, power and utilities, at PricewaterhouseCoopers Pvt. Ltd calls the package as a discom revival plan rather than a simple debt restructuring package. It has all the three elements — clear up the legacy issues of past losses and debt, provide a financial road map to bring tariffs in line with costs by FY19 and provide enough deterrents for the state government to not allow the state discoms to become loss ridden post FY18 — as losses start to impact their FRBM limits.

The Ujwal DISCOM Assurance Yojana (UDAY) focuses on four major initiatives improving operational efficiencies of discoms; reduction of cost of power; reduction in interest cost of discoms and enforcing financial discipline on discoms through alignment with state finances says a CLSA report.

Debasish Mishra, senior director, consulting, Deloitte Touche Tohmatsu India Pvt. Ltd rates UDAY as being more comprehensive than any other SEB restructuring scheme seen till date. It talks about cost-side efficiency such as immediate reduction of interest service burden, reduction in fuel cost through coal swapping, time-bound loss reduction, etc. On the revenue side, it talks about a strict discipline of quarterly fuel cost adjustment, annual tariff increase, taking regulators on board and finally including discom losses in the FRBM limits for the states.

Edelweiss calls UDAY a step in right direction which has potential to unclog the entire power chain (if implemented as intended) as operational efficiency improvements to reduce the distribution losses from around 22 per cent to 15 per cent and eliminate the gap between average revenue and average cost by FY19.

But key to the success of the scheme is acceptance and implementation by state governments. In the current policy central government is using a carrot and stick approach to see that states toe the line. As an incentive, the states adhering to the operational milestones will be given additional central funding through Deendayal Upadhyaya Gram Jyoti Yojana, Integrated Power Development Scheme, Power System Development Fund or other such schemes by the ministry of power and renewable energy. However, the laggards "would be liable to forfeit their claim on IPDS and DDUGJY grants.

Analysts are upbeat on the scheme. CLSA says that while a recovery in finances may take time, the losses should bottom-out in FY16. This should also kick-start state power generation capex. Multiplier effect of power availability to the economy is a well-documented fact.

So is UDAY the big bang reform we were waiting for?