The power sector has been one of the major contributors to the stressed assets of the banking system in India, primarily on account of low power offtake, inadequate coal supply and lack of power purchase agreements (PPAs). A recent move that has significantly affected the power sector has been the issuance of the Reserve Bank of India’s (RBI) new guidelines for early identification of stressed assets and their resolution. Among other things, a strict 180-day timeline has been given to banks to agree on a resolution plan in case of a default or else initiate insolvency proceedings. Power Line seeks the opinion of industry experts on the new guidelines…
What are the likely implications of RBI’s new norms on stressed assets for the power sector?
Dr Pramod Deo
Currently, a number of projects in the power sector are stressed, primarily because of very low demand from state-owned discoms and their reluctance to enter into long-term PPAs. The absence of PPAs means coal linkage cannot be sought. On the other hand, a private generator may have a coal linkage but, because of the lack of a buyer for the electricity to be generated, is left with stranded capacity. Due to these dual challenges, there will be no buyers interested in taking over such stressed power projects. The new RBI norms may prescribe a swift taking over of stressed assets. But unless the challenges related to the purchase of power are addressed, the taking over of stressed assets of defaulters will not help in the recovery of bad loans.
Dr Ashok Haldia
The RBI’s new norms on stressed assets have a significant impact on existing projects, both under construction and completed ones. At present, projects with an installed capacity of about 72 GW in the thermal and hydro segments are under stress due to a variety of issues, including slack demand and the non-availability of coal. In essence, projects are stranded or are not able to generate sufficient cash flows to service the debt. Stress resolution requires multiple measures at the government, regulator, lender and promoter levels, and needs an effective strategy and action plan. The measures include growth in power demand, long-term PPAs and coal availability. The RBI initiatives and the Insolvency and Bankruptcy Code (IBC) at best provide a mechanism for a company-specific resolution or, in the alternative, a legal exit. As per current trends, projects under stress are able to realise a meagre 15-50 per cent of their economic value or loan amount. The situation is untenable given its colossal impact on the lenders’ financial position and on the overall health of the financial sector.
During the past year, banks/NBFCs prepared corrective action plans within RBI’s framework for revitalising distressed assets in the economy, like Scheme for Sustainable Structuring of Stressed Assets, strategic debt restructuring (S4A), the 5/25 scheme and change in ownership of borrowing entities, and were in the process of executing these action plans. Post the issue of the new norms, these projects suffered the most as the time for execution of the resolution plan was reduced to six months from the existing 18 months and the resolution plan needed RP4 rating from two rating agencies. Under the new norms, even a single-day default requires the preparation of a resolution plan, which, in many cases, may not be feasible/practical. Considering the present power sector scenario, banks/NBFCs may have to take a major haircut, good enough to give a desirable return to the new promoter and get RP4 or above rating.
As per the guidelines laid out in the recent RBI circular, even a one-day default in debt servicing would need to be reported to the RBI followed by the implementation of a resolution plan. Further, all default accounts with an exposure of Rs 20 billion and above on or after March 1, 2018 have to formulate a resolution plan. According to the plan, if a loan has been restructured, the asset will remain sub-standard in the books till 20 per cent of the loan is repaid. Usually, for infrastructure projects, it takes four to five years to repay 20 per cent of the loan and, therefore, banks would continue with the provisioning for four to five years. This means banks would have little incentive to implement restructuring proposals. Thus, the guidelines disincentivise loan restructuring and instead push for the sale/change of control for any entity that has some stress (structural or short/medium term) and raises the stakes/risks for developers and equity investors.
Currently, more than 75,000 MW of assets are either under operation or under construction, which are severely stressed due to various reasons such as lower availability of coal, lack of long-/medium-term power purchase agreements, divergence between policy and regulations on the pass-through of incontestable change-in-law factors, huge delays in regulatory orders and pending receivables from discoms – all beyond the control of developers.
There are more than 20,000 MW of private sector assets, with an overall investment of Rs 1,000 billion, operating under long-term PPAs with the necessary fuel supply arrangement.
However, these assets are still under stress due to various factors. The three main factors are: large receivables from discoms (Rs 83 billion), regulatory assets that have been delayed two to three years on account of delays and inconsistencies in pronouncements pertaining to incontestable change-in-law cases (Rs 78 billion, increasing with every delay), and a faulty coal and coal transportation price escalation index, leading to huge under-recoveries-the example of G11-13 grades of coal can be taken, where the estimated cumulative Central Electricity Regulatory Commission’s ((CERC) coal price escalation during the years 2014 to 2019 has been 25 per cent, compared to the actual coal price increase of 48 per cent during the same period.
The system has to be tolerant of genuine difficulties while coming down heavily on mismanagement and fraud. The guidelines provide for uniform treatment across different infrastructure sectors – energy, telecom and steel. These three sectors have vastly different issues to be resolved. Therefore, the application of these guidelines without considering the sector-specific difficulties being faced by developers implies that all the stressed capacity is likely to face bankruptcy proceedings in due course. The new owners can only resolve the stress if it is due to technical, managerial or financial inputs. However, if the stress is because of the non-availability of PPAs (government controlled), the non-availability of fuel (government controlled), or regulatory issues, there will not be any takers and this would lead to liquidation – an avoidable situation as the country needs power.
Dr S.L. Rao
It is good that the government is finally focusing on the issue of stressed assets. This is important, particularly for the distribution segment. Although the government had introduced the Ujwal Discom Assurance Yojana (UDAY) to relieve the sector of financial stress, there has not been much movement on that front. The solution for alleviating assets from the current stress lies in making the discoms profitable. Given that a majority of the discoms are owned by the state governments, it has resulted in large-scale power theft, labour indiscipline, staff collusion, severe restraints on optimising power purchase through open access (though this has improved somewhat), continuation of many inefficient and aged state-owned generating plants, governance of power generation and distribution by central and state government bureaucrats instead of professional managers, and the selection of power regulators mainly from among retired bureaucrats. Making the segment profitable would require revising tariffs and minimising losses on account of thefts in the sector.
At present, the distribution segment is not adequately incentivised. Further, the government’s decision to provide free power to the agricultural sector has a huge bearing on the finances of discoms. Thus, there are several unresolved challenges that the sector is currently grappling with.
That said, the RBI norms are an appreciable step in this direction. This is the first major move towards resolving the issue of stressed assets in the country.
What are the possible strategies and solutions for addressing the stressed assets problem in the power sector more holistically?
Dr Pramod Deo
The Supreme Court had in the Tata and Adani Mundra projects ruled against any compensatory rates for suppliers of electricity (using imported coal) due to a change in international regulations. While reporting this judgment widely, the media overlooked one very important aspect of the order: it also upheld the CERC’s regulatory power to address the tariff issues arising in competitively bid projects under Section 63 of the Electricity Act, 2003.
The Supreme Court order dated April 11, 2017, says: “In a situation where there are no guidelines framed at all or where the guidelines do not deal with a situation, the Commission’s regulatory powers under Section 79(1)(b) can then be used.”
In its 2013 order, the central commission saw a lot of merit in the generators’ plea that promulgation of the Indonesian Regulation had led to an abnormal increase in the cost of generation, making their projects unviable. Unless the concerns of generators are addressed, the possibility of them defaulting in discharging their obligations under the PPAs due to the perceived financial burden cannot be totally ruled out and that will affect consumer interests. In that event, the state utilities would have been required to invite fresh bids to meet their power requirement and till the selected project or projects are commissioned, consumers would have been deprived of power.
Moreover, the tariff discovered for new projects then was in the range of Rs 3.50 to Rs 7 per unit, which consumers of the Mundra Ultra Mega Power Project (UMPP) would have had to pay. Thus, at the macro level, it would have been a serious setback for the electricity sector and would have adversely affected investment in the sector. At the micro level, it would have affected the supply of continued and reliable power to consumers. In view of this, the CERC deemed it necessary to intervene in the interests of consumers, investors, lenders and the power sector as a whole. It should not be forgotten that for such large projects, public financial institutions contribute 70-80 per cent as loans. If running a power project becomes unviable for investors, the lenders will be left with non-performing assets (NPAs).
First, it is well to remember that unlike industrial products like steel, there is little scope for exporting electricity in the external market. Second, loan recovery is possible only by selling the final product, that is, electricity. Finally, an NPA like a power plant will rapidly depreciate to “junk status”. In view of this, the expert committee tasked to frame fresh bidding documents for power projects (of which I am a member) has unanimously recommended that in case of a default by the successful bidder, the power plant should be immediately offered to other parties at the originally agreed power tariff. However, if no party is willing to supply electricity at the previously bid rate, a second round of bidding should be conducted to make the plant operational.
In short, the RBI guidelines for defaulting power generators must factor in the above issues and work on solutions to make the assets created with public money productive in order to recover the loans of public financial institutions.
Dr Ashok Haldia
The approach to effectively resolving the problem of stressed assets in the conventional energy sector has to be pragmatic. One has to identify the root causes of stress and act upon those. This alone would help in restoring the long-term economic value of these assets and reduce the losses that lenders have to suffer. It will also ensure that such a situation does not recur in the future. The root causes of stress in the power sector emanate mainly from the lack of power offtake through long-term arrangements, depressed merchant power prices, slackness in power demand, uncertainties in coal supply/availability, and delays in payment from discoms, leading to stretched working capital cycles and liquidity issues. It is only the redressal of these that would help in resolving the stress in the power sector in the short as well as the long term.
Referring all the stressed assets to the National Company Law Tribunal (NCLT) is not a solution in itself and, given the time frame, the majority of assets will end up in liquidation and the minority of those that get resolved, will most likely force the lenders to take big haircuts. Hence, in those cases where the lenders are already neck-deep in asset restructuring under various schemes of the RBI, the lenders should be allowed to complete the process and if the process fails, these assets should be referred to the NCLT.
That being said, the new RBI norms for the resolution of stressed assets and the IBC provide an optimal framework for dealing with the problem of stressed assets and would go a long way in restoring the financial health of the sector and, at the project level, in the early diagnosis of sickness and its effective redressal. The IBC mechanism is still evolving and, together with the RBI framework, would help in creating a market for junk/stressed assets. In the present context, the real benefits could, however, be reaped only when the challenges in all the links across the value chain and the transitional issues in giving effect to a new RBI framework are comprehensively addressed. In the absence thereof, the resolution of stress through financial restructuring or forced exits could at best be temporary and in any case, a non-optimal solution.
Before coming to the specifics regarding the strategy, it must be understood that the country needs power for economic growth and social well-being. Mothballing these assets through the NCLT route will not help but will sow the seeds of bigger problems for the future. With capacity addition declining, these assets can be put to use progressively to meet the country’s power requirement. Therefore, for these assets, the NCLT is not the appropriate way forward. The strategy has to be two-fold: the policy and regulatory response, and financial forbearance.
Financial forbearance: Relaxations requested from the RBI would provide the necessary time required for regulatory and policy interplay for initiating necessary measures. The relaxations required are:
- Where the process of restructuring is under way under the earlier schemes, the same should be allowed to continue, with the sunset clause as September 30, 2018.
- Increase the default reference date from only one day now to 30 days.
- Change the majority required for the approval of the resolution plan from 100 per cent to 75 per cent.
- Extend the implementation period of the resolution plan from 180 days to 365 days, as 180 days is not practical.
The RBI, while providing the above relaxations, should make it clear to the policy-makers that an action plan needs to be formulated to remove the causes of stress by bringing necessary changes in the policy and regulatory framework.
Policy and regulatory response: Depending on the stress factor, the stressed capacity can be categorised under four heads. The details of the cause and the suggested way forward are detailed below:
- Projects stressed due to under recovery
- The stress here is on account of discord between policy and regulations. The current coal and coal transportation price escalation index is faulty and does not reflect the price increases undertaken by Coal India Limited.
- A high-level meeting between the policy-makers and the regulator can easily resolve this issue.
- Projects without PPAs
- Regarding the paucity of power offtake agreements, the way forward appears to be strict implementation of the universal supply obligation. The power minister has pronounced his intent, but we are yet to see this translated into tariff policy formulation – to make it mandatory to supply power to all, if available.
- The government should speed up the process to decommission inefficient power plants. It can lead to demand revival and more efficient use of coal, with lower emissions.
- Recently, the Ministry of Power announced a pilot project of 2.5 GW of aggregate demand. However, looking at the quantum of assets without PPAs (19.7 GW), the aggregator may think of enlarging the basket to 4 GW of aggregate demand.
- Stressed gas-based projects
- The options available are: restarting the earlier E-RLNG scheme, and devising the hybrid model of gas in combination with renewables to ensure 24×7 power availability and meet grid balancing requirements.
- Stressed projects with imported coal
- NTPC Limited and Bharat Heavy Electricals Limited (BHEL) are working on new technologies to see if the boiler design/turbine calibration can be changed so as to make the existing plants suitable for domestic coal. Till that time, banks and distribution companies need to do handholding, as these projects have come up with very low capital costs and are competitive in the market even with compensatory tariffs.
Dr S.L. Rao
The key is making the discoms profitable. The first major step in this direction should be regulating the supply of free power to the agricultural sector. A lot of theft in the sector is concealed under agricultural consumption. When you put new norms in place, the discoms will have no choice but to function in an efficient manner. However, here again, the challenge would be with regard to the state governments. The state governments are unlikely to raise tariffs or improve efficiency. Thus, the solution would have to be driven by the central government. The Finance Commission should demand that the state governments do not run wasteful enterprises such as discoms. Once the directives are issued by the central government, the state governments are likely to follow suit. My view is that these norms can prove to be effective; however, the real obstacle is the implementation. If implemented in an efficient manner, they can contribute significantly to resolving the stress in the sector.