Powerless

In early 2000, state-owned power producers such as NTPC were forced to sign a Rs 40,000 crore one-time settlement with state-owned power distribution companies (discoms). The states issued tax-free bonds to power producers as recommended by the group of experts headed by former member of planning commission Montek Singh Ahluwalia. In less than a decade, the discoms were back with a begging bowl before the banks to restructure over Rs 2 lakh crore outstanding loans. Banks did restructure the loans, but not without setting stringent conditions for revival including increasing power tariffs, cutting distribution losses and also reducing power costs. But that was not to be.

In the past five years, the performance of discoms has only deteriorated, with accumulated losses at a staggering Rs 3.8 lakh crore. The outstanding loan has more than doubled, from Rs 2 lakh crore to Rs 4.3 lakh crore. Indeed, the discoms are on the verge of default on an amount of Rs 40,000 crore this year as the principal repayment was due to banks. The government, as it had done earlier, pulled another rabbit out of its hat to save the discoms. The Ujwal Discom Assurance Yojana (UDAY) has states taking over 75 per cent of the loans of discoms by March 2017. The states, in turn, will issue bonds to lending banks and other market participants. The balance 25 per cent of the loan on the books of discoms will be converted into credit at concessional rate - base rate plus 10 basis points or issued as bonds in the market. Call it yet another financial restructuring or a permanent revival strategy, the UDAY scheme comes with similar promise of improving operational as well as financial performance. And in the bargain, the banks, especially the public sector banks are once again getting shortchanged as they will end up subscribing to UDAY bonds.

There are some experts who compare Uday bonds to oil bonds issued way back in 1997/98. Faced with fiscal constraints , the United Front government issued bonds to oil marketing companies (OMCs) in lieu of pending subsidy arrears. OMCs, which got the bonds, often came to market to sell them whenever they needed money. "This used to result in over supply of bonds and would lead to price disturbance in the market," says Pandya of Peerless. The oil bonds saw a sharp fall in prices and consequent firming up of yields. Experts fear similar reaction in UDAY bonds as banks, who were stuck with discom exposures for decades, will now offload them in the market. "If the banks would offload the bonds in the market in a significant way, it may lead to a glut and the prices would fall," says Pandya of Peerless MF. "This would cause price disturbance in market which may be otherwise stable."

The implications of such a reaction would be twofold. First, banks holding UDAY bonds as AFS would have to book mark-to-market losses. Second, the new additional offering , if any of such bonds , would have to offer a higher coupon rate. In fact, the impact of UDAY bonds on state finances will be visible after two years. Indeed, states have been given special concession for not including the loan taken over for calculation of fiscal deficit. "With UDAY bonds coming into operation, it is unlikely that states will be able to shrink their deficits, which puts pressure on the centre to adjust more," states the RBI study of State budgets of 2015/16.

Will discoms be third time lucky? The banks, RBI and the states have done their bit. It is now the turn of discoms to deliver operational and financial performance. First, they have to wipe out the annual losses of over Rs 60,000 crore as well as accumulated losses of Rs 3.8 lakh crore. Surprisingly, UDAY has set a very ambitious break even target of two-three years when almost all the discoms would be profitable as per the plan.

Like in the past, the major hurdle is going to be the tariff increase by states as it often becomes a big political issue. With two big states - UP and Punjab - going to polls soon, the UDAY Scheme would face many such hurdles going forward. Clearly, the focus is gradually shifting from banks to states. Banks, which would be eventually sitting on UDAY bond exposure of over Rs 4 lakh crore, would certainly pray for discoms to be third time lucky.