Generating buzz

Market Insight

With the Eleventh Plan aiming to add about 100,000 MW of new capacity by 2012, the power sector is now the focus of a lot of investments.

In 1991, during the balance of payments crisis, it was an even-money bet that India would become a basket case. In hindsight, it was a great entry-point for investments because the economy made a spectacular recovery. But nobody could have been sure about the turnaround.

That macro-economic surge translated into great stock market returns. In 1991, less than 20 per cent of the GDP was represented by the listed corporate sector. So the linkages between GDP and corporate earnings weren't particularly strong.

Things have changed. Although there could be a slowdown through 2008-09, the economy is pretty healthy and short of a nuclear disaster or something on those lines, it's unlikely to head below 8 per cent GDP. A far larger chunk of the 2008 economy is listed and the linkages with the market will grow stronger as new investments pour into areas traditionally reserved for PSUs and direct government investments.

One of those new areas is power. Power is now the focus of a large quantum of investments and it is generating more buzz than ever before. The Eleventh Plan aims to add about 100,000 MW of new capacity by 2012 as well as beefing up transmission and distribution systems. By 2012, the government hopes every village will be electrified.

Power sector IPOs of the past few years (NTPC, PGCIL, PFC, Suzlon) have been very successful and practically every industry player (REL, CESC, JP Hydro and Tata Power) is trading high. Equipment manufacturers such as Siemens, BHEL, Alsthom, etc, also trade at high valuations, as does power-trader PTC. There is every reason to believe that Reliance Power's mega IPO will generate enough interest to raise several multiples of the Rs 11,700 crore the Anil Dhirubhai Ambani group is looking for, without breaking into a sweat.

However, the sector is also on the verge of bankruptcy. It could easily go bust in the next two or three years and take macro-economic growth dreams down with it. Despite all efforts, overall technical and commercial losses are still around 30 per cent, most state electricity boards (SEBs) run at losses and the national plant load factor is a low 76 per cent. In 2006-07, losses across the sector amounted to nearly 1 per cent of GDP. What is more, fuel prices have spiked and are unlikely to ease soon.

More than just operational and supply chain problems, (which are large enough), the power sector is hampered by decades of continuous political interference at both state and central level. The ensuing inefficiencies constrain growth across the entire economy.

Given that reforms through initiatives such as the accelerated power development and reform programme (APDRP) have been only partially successful, unbundling is not yet complete and privatisation is marginal, a complete turnaround is odds-against. Yet, if there isn't a turnaround, the sector will go bust.

It requires very optimistic investors to volunteer in these circumstances. The investor /operator who is long on power is accepting very high risks for potentially high rewards - quite similar to the position that anybody investing in India was in, during 1991. Also, it's not a situation where either policy makers or investors can afford to wait.

There's no dearth of optimists and there is action on the policy front. A new avatar of the APDRP is being worked out. Private generators are increasingly free of the obligation to sell to bankrupt SEBs, and more SEBs are unbundling operations. The government is allotting captive coal blocks to help producers sort out fuel problems. As the transmission system improves, trading is growing.

But the bottomline is that, until Sarkari bottomlines turn profitable, there will be a huge dollop of risk attached to most investments in the sector. Unfortunately the health of SEBs and their successors depends to a large extent on the political convictions of shaky, insecure, state governments. There is another point that many people forget. The world over, power utilities are cash cows rather than growth stories "� they generate predictable dividends but there is a natural cap on growth. The extraordinary returns we've seen in India are only available because the industry is at a saddle-point where it could turnaround. The operative word is "could" - not only are there no guarantees, anybody who knows the history of the sector will wonder whether it will really happen.