The Ujwal Discom Assurance Yojana ("UDAY"), a scheme for the financial turnaround of power distribution companies ("Discoms"), was approved by the Cabinet on November 5, 2015, with an objective to improve the operation and financial efficiency of State owned Discoms. The UDAY scheme intends to achieve this through (a) improving operational efficiencies of Discoms, (b) reducing the cost of power generation by Discoms, (c) financial turnaround of Discoms through State(s) takeover of Discoms debts, and (d) financing future losses and working capital of Discoms by State(s).
By way of brief background, Discoms are predominantly State-owned and have been financially distressed for several years despite reforms in the power sector aimed at unbundling power generation, transmission and distribution activities and functions into separate profit centres. Discoms have been historically plagued by transmission and distribution ("T&D") losses (arising mainly from theft of electricity, subsidized tariff for agricultural consumption, leakages in transmission and distribution systems, etc.), and aggregate technical and commercial ("AT&C") losses (primarily due to billing and collection inefficiencies). Discoms' accumulated losses as at March 2015 is estimated at Rs. 4.3 trillion, a substantial part of which is debt funded by banks and financial institutions.
Salient features of the UDAY scheme
- To improve operational efficiency, the UDAY scheme has identified specific areas for improvement (for example, compulsory feeder and distribution transformer metering, indexing and mapping of losses and quarterly tariff revisions) within a specified time frame, and measured against AT & C losses as per trajectory to be finalized by the Ministry of Power ("MoP") and participating State(s).
- Recognising costly power as a primary reason for the systemic financial distress of Discoms, the UDAY scheme has proposed steps to be taken to reduce cost of power. For example, increased supply of domestic coal, coal linkage and coal price rationalization, supply of washed and crushed coal by Coal India Limited ("CIL") within specified dates, allowing coal swaps from inefficient plants to efficient plants, etc.
- For the financial turnaround of Discoms, the UDAY scheme
- Participating States to take over 75% of the debts of Discoms (by way of grant), as on September 30, 2015 over a period of two years: 50% of such debts will be taken over in the financial year 2015-16 and 25% in the financial year 2016-17;
- Participating States to issue non-statutory liquidity ratio ("SLR") bonds, including state development loan ("SDL") bonds against Discoms' loans, for subscription firstly by pension funds, insurance companies and other institutional investors. The balance bonds (not taken up by pension funds, insurance companies, etc.) to be offered directly to lender banks/financial institutions in proportion to their current lending to Discoms. Proceeds of such issues of bonds will be transferred to Discoms for paying off their loans to lender banks/financial institutions;
- Lender banks/financial institutions not to levy prepayment charge on Discoms' debts. Lenders to also waive off unpaid overdue interest (including penal interest) on Discoms' debt, and to adjust such overdue/penal interest paid since October 1, 2013; and
- 50% of Discoms' debt as on September 30, 2015 (after any waivers as aforesaid), which remain with Discoms, to be converted into loans or bonds with interest rate not exceeding the concerned Bank's based rate plus 0.1%. Alternatively, Discoms may issue State guaranteed bonds against the aforesaid debt at a rate not exceeding the bank's base rate plus 0.1%. The State will take over 50% of the remaining 50% debt (i.e., 25%) in 2016-17 as aforesaid. The balance 25% remaining with Discoms will be dealt with through a mechanism to be development by the MoP.
- For financing future losses and working capital of Discoms, States will take over and fund future losses of Discoms in a graded manner until the financial year 2020-21. Also, lender banks/financial institutions are no longer to advance short term loans to Discoms for financing losses but may finance Discoms' working capital requirement by way of loans (or by letters of credit wherever possible), only upto 25% of the concerned Discom's previous year's annual revenue (or as per prudential norms).
- States which achieve operational milestones of the UDAY scheme will be entitled to additional/priority funding through various funds/schemes of the MoP and Ministry of New and Renewable Energy.
So far as debt restructuring and debt recast go, the UDAY scheme is, in some ways, similar to the failed 2012 MoP restructuring scheme which also required Discoms to issue bonds on behalf of States against 50% of their short term debt, and which bonds were subsequently to be taken over by the States. The 2012 restructuring scheme reportedly failed because participating States did not meet the requisite performance criteria in terms of the financial restructuring plan. In other words, States/Discoms were not able to reduce AT&C losses. Further, States were slow in taking over debts of Discoms as they didn't have the fiscal space to maneuver within their respective fiscal responsibility and budget management ("FRBM") targets, or within their borrowing ceilings, to bankroll debts of the Discoms. One reason that probably contributed largely to the failure of the 2012 restructuring scheme was that it was implemented almost 18 months after it was announced and the pending 2014 general elections did not help matters. This resulted in severe slippages in implementation, and ultimately failure.
The UDAY scheme assumes certain premises including:
- That issue of bonds will be within the FRBM targets of participating States, or if not, that there is an ability to obtain an extension of the FRBM targets. The argument against extension of FRBM targets for purposes of taking over the debts of Discoms is that it may result in profligate issue of bonds by States (as State loans bear a lower interest rate than lender bank/financial institutions' loans), without any otherwise corresponding fiscal discipline or reform by States/Discoms.
- That there exists keen appetite for the bonds to be issued. (Some pension and mutual funds, and insurance companies have reportedly shown interest in State issued bonds). This assumption needs to be examined in view of differing credit risks of participating States though the bonds will be uniformly priced irrespective of the issuing State. Bonds issued by a participating State with healthy finances may be quickly snapped up while other participating States' bonds are not subscribed. Also, there is need to consider the appeal of non-SLR bonds in case an investor does not want to remain invested upto maturity.
- That subscription to non-SLR and SDL bonds (which assume SLR status) will be within policy and prudential limits/norms laid down by the Board of the lender banks and financial institutions and the Reserve Bank of India ("RBI"), with respect to investments in non-SLR and SDL bonds, respectively.
- Going forward, working capital requirements of Discoms can be sustained with loans only upto 25% of their annual revenue. This depends on how quickly Discoms are able to reduce the gap between revenue generated/realised and cost of supply.
To an extent, the UDAY scheme is as good as these premises hold fast.
Proponents hold that the UDAY scheme is a win-win for everyone – Discoms' debt burden will be taken over and debt cost will be reduced while concerned lender banks and financial institutions lenders are assured of payment, as and when due; that though the recast of Discoms' debt by way of interest payment reduction and waivers will impact lender banks'/financial institutions' profitability, the write back of loans into bonds and recast of the balance with lower interest rates, will improve their books and help with their capital adequacy ratios. What is overlooked is that the same lender banks and financial institutions would be helping finance the repayment of the Discoms' debts by subscribing to bonds issued by participating States, resulting in a vicious recycling of debt.
However, unlike the failed 2012 restructuring scheme which provided for vague recommendatory actions to be taken, the UDAY scheme identifies certain steps to be taken by Discoms within specified timelines to cut T&D and AT&C losses and improve operational and functioning efficiency. Some steps, for example, quarterly tariff revisions, will require political will on the part of the State to implement, as tariff hikes have typically assumed political hues. Other steps, for example, checking power theft, are in the nature of information, education and communication campaigns. A World Bank report has demonstrated that such campaign when coupled with careful planning and political commitment succeeded in controlling electricity theft and improved revenue collection in Andhra Pradesh.
The UDAY scheme also rightly identifies reduction of the cost of power as a measure to achieve operational and financial efficiency of Discoms, though the scheme focuses more on improving domestic coal supply and rationalizing coal prices by Coal India Limited ("CIL"), another Government owned company. "Reducing the cost of power" is a constant refrain in all verticals of the power sector – be it generation, transmission or distribution. Reducing the cost of power would therefore need a coordinated effort of all parties involved in the power sector including the regulators. The focus on improving coal supply and rationalizing coal prices is not surprising given that coal is the primary fuel for electricity generation in India. However, past efforts to get CIL to rationalize coal prices have largely not been successful as there is pressure on CIL and its subsidiaries to post profits. Also, the cost of washing or scrubbing domestic coal has to be assessed against cost benefits arising from consequent reduction in coal usage due to increases in calorific value of washed coal. Further, the assumption that the Government will be able to increase supply of domestic coal needs to be assessed against rising environmental pressures for alternative clean fuels/energy.
On the whole, the UDAY scheme only goes a step beyond previous restructuring schemes for Discoms, and its success will, to a large extent, depend on the support it receives from the participating States in carrying out the spirit and intent of the scheme, as well as assumptions on which the scheme is premised, holding true. So far, the UDAY scheme has reportedly been well received with some fourteen States already signing up for it. Hopefully this time around, political will of the States matches the spirit and intent of the UDAY scheme.
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