"The poor financial health of discoms in India is one of the key factors weighing on the asset quality of the country's banks," says Srikanth Vadlamani, a Moody's Vice President and Senior Analyst.
"So far, these problems have almost exclusively affected public-sector banks, which represent more than 70% of total banking system assets, and which are directly and indirectly exposed to the credit quality of discoms," adds Vadlamani.
"While private-sector banks have almost no direct exposure to discoms, they are exposed indirectly if problems with discoms affect the credit quality of other borrowers in the electricity supply chain, especially power-generating companies, which are also creditors of the discoms," says Vadlamani.
"The two government-owned financial institutions specializing in the provision of funds to the electricity sector: Power Finance Corporation (Baa3 Stable) and Rural Electrification Corporation (Baa3 Stable), are not completely immune from the power-sector challenges. However, Moody's views these specialized financial institutions' position as being comparatively more stable, as they benefit from a number of protections, including an escrow account structure that effectively grants them priority of claims on their borrower's receivables, including those of discoms."
Moody's analysis is contained in its just-released report titled "Answers to Frequently Asked Questions on Indian Bank' Exposures to State Electricity Board Distribution Companies (Discoms)," and is authored by Vadlamani.
Moody's report answers the following questions on the asset quality of Indian banks, given their direct or indirect exposures to discoms:
1) How important are discoms to the asset quality of Indian banks?
2) Why do discoms have poor finances?
3) How have the 2012 reforms helped discoms, and what areas have the reforms failed to fully address?
4) How have the reforms improved asset quality for rated banks?
5) What are the risks to the government-owned Power Finance Corporation and Rural Electrification Corporation?
Moody's report points out that of all impaired loans at public-sector banks, 20% are discom exposures, with the proportion ranging as high as 48% at some of the most exposed banks. For instance, share of discom exposures in impaired loans is as high as 46% at the Oriental Bank of Commerce (Baa3 stable, D/ba2 negative) and 48% at the Central Bank of India (Baa3 negative, E+/b3 negative).
Moody's report says government measures taken over the last two years have only provided temporary relief to the banks exposed to discom loans. The measures included the substitution of impaired loans with government obligations and some operational improvements including tariff hikes.
At the same time, Moody's believes that the discoms' key structural problems -- pricing based on non-commercial considerations and inefficient operations -- have not been sufficiently addressed, and a political consensus to allow discoms to price power based on commercial considerations continues to be lacking.
"The fact that the discoms are the domain of state governments makes it difficult for the central government to take many steps directly to reform discoms, although, admittedly, key reforms that have happened in the past decade have been a result of central-government, rather than state-government initiatives" Vadlamni explained. As examples, he mentioned the unbundling of state electricity boards into generation, transmission and distribution companies, the establishment of the State Regulatory Commissions as well as measures to reduce technical and commercial losses incurred by the discoms.
"This leaves some hope that a new central government committed to addressing the root problems in a timely manner could successfully turn the situation around", concludes Vadlamani.
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