Demystifying UDAY — Impacts on Key Stakeholders
In November 2015, Central Government of India launched a scheme called UDAY which provides a much needed financial package to revive the electricity distribution companies (a.k.a. DISCOMs). Key beneficiaries of this scheme are DISCOMs — who get a chance to wiggle out of huge debt of INR 4.3 trillion (USD 60 billion) that they have amassed over the years.
Tip 1: Please first read my overall analysis of the scheme if you are completely unaware of the UDAY. You can find it below.
Tip 2: If financial jibber-jabber doesn’t fascinate you, the infographic might come in handy! :)
State Governments bear the financial burden (current debts plus potential future interest obligations, in case DISCOMs aren't able to reach efficiency targets set as a part of the scheme). Added to this is the risk of failure of the whole scheme which could put a serious dent in state budgets FY:2017-18 onwards. In particular, for the 6 states whose DISCOMs are under highest debts - Andhra Pradesh, Haryana, Rajasthan, Tamil Nadu, Telangana and Uttar Pradesh - which account for 70% of total DISCOM debt.
States have been directed to fund DISCOM debt by issuing non-SLR State Development Loans (SDLs) in the market or directly to the banks holding the debts right now. If all States participate in the Scheme, the amount of bonds that would need to be issued is as large as INR 2.15 trillion in 2015-16 and INR 1.08 trillion in 2016-17. These numbers are quite substantial, when compared to the gross SDLs worth INR 2.4 trillion raised by all 29 States in 2014-15. That puts feasibility of the scheme under question.
A further issue here is that of finding eligible buyers of these SDLs outside the existing Lenders. Until now, all SDL issued to market participants by States are eligible for SLR, the less-risky product as compared to the more risky non-SLR instruments. The appetite for investment in non-SLR SDL is quite unclear, given the lack of a track record. Admittedly, Reserve Bank of India (RBI) has recently opened up SDLs to Foreign Portfolio Investors (FPIs) in a carefully phased manner. This could bring in additional pool of buyers for these SDLs. However, the calibrated growth in these FPIs till March 2018 can be foreseen to fall very considerably short of the total SDL bonds to be issued to cover the DISCOM debts.
What this means is that State Governments might have to bank (excuse the pun) heavily on the original Lenders to buy the bonds on the restructured debts owed by the DISCOMs to the same Lenders.
Now let's evaluate what this financial juggling means for the original Lenders, mostly public sector banks (PSBs).
Banks will be gainers in the long run because their vulnerability and exposure to the power sector will decrease.
This includes the debts to DISCOMs as well as the existing exposure to Independent Power Producers (IPPs). Because with improvement in financial health of DISCOMs, the counterparty risk for IPP borrowings will come down. Further acceleration in signing of Power Purchase Agreements (PPAs) by DISCOMs could lead to additional off-taking of banks' risk in existing (and future) deals with IPPs. Furthermore, the provisions (5% of credit amount) reserved for bad fallout of the DISCOMs loans would be reversed, essentially freeing up some tied-down capital within the banks.
On the flip side, the immediate impact would be reduction in Net Interest Margins (NIMs) for the banks. NIM is essentially a measure of difference between interest earned by the banks and the interest paid out to the deposits. As states take over 75% of the potentially high-performing (contracted @ 14-15% p.a.) debts to be restructured into SDL bonds issued by the government to them yielding about 8-9% p.a. in returns, NIM figures take the blow.
However, since banks credit risky exposure gets converted to liquid state bonds, they could consider selling these bonds to protect their NIMs.
Also on the flip side, UDAY scheme could shrink the banks' credit book by 1-7%, depending on share of DISCOMs loans in total credit book. That puts more pressure on banks to find borrowers over the period of FY: 2016-17, leading to further pressures on country's growth, which has already moderated to single digit in FY:2015 and in the current fiscal.
Now coming to the intended beneficiaries - the state DISCOMs. They benefit from the obvious relief in debts, savings in interest costs and cost of power purchased over the coming years. But with that, comes the obligation to invest more in infrastructure to reduce losses in the system, to introduce cost-reflective tariffs and to improve supply quality.
ICRA estimates that overall benefit package to DISCOMs, if all states participate in the scheme, would be INR 880 billion per year. That translates to a reduction in losses by around INR 0.95 per kWh of electricity sold all over India. This should enable the DISCOMs to break-even over the next 3-4 years!
However (and that's a big one), success of UDAY scheme to any degree depends largely on the DISCOMs changing their current operational practices and their ability to work together with their state-owners. And the precedent in this isn’t very encouraging.
If truly successful, it would be a one-of-its-kind cooperation between the Centre and States to solve a big problem that’s crippling India’s growth.
For a more detailed analysis of the scheme, the progress made so far and what it means for the startup ecosystem, please read the other article below.
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