A Closer Look at the Ujwal Discom Assurance Yojana (Uday) Scheme

A Closer Look at the Ujwal Discom Assurance Yojana (Uday) Scheme

The Ujwal Discom Assurance Yojana (“UDAY”), a scheme for the financial turnaround of strength dispensing companies (“Discoms”), was approved by the Cabinet on November 5, 2015, with an objective to enhance the operation and financial efficiency of State owned Discoms. The UDAY scheme intends to unprotected to this by (a) improving operational efficiencies of Discoms, (b) reducing the cost of strength generation by Discoms, (c) financial turnaround of Discoms by State(s) takeover of Discoms debts, and (d) financing future losses and working capital of Discoms by State(s).

By way of fleeting background, Discoms are predominantly State-owned and have been financially distressed for several years despite reforms in the strength sector aimed at unbundling strength generation, transmission and dispensing activities and roles into separate profit centres. Discoms have been historically plagued by transmission and dispensing (“T&D”) losses (arising mainly from theft of electricity, subsidized tariff for agricultural consumption, leakages in transmission and dispensing systems, etc.), and aggregate technical and commercial (“AT&C”) losses (chiefly 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 edges and financial institutions.

Salient features of the UDAY scheme

1. To enhance operational efficiency, the UDAY scheme has identified specific areas for improvement (for example, compulsory feeder and dispensing transformer metering, indexing and mapping of losses and quarterly tariff revisions) within a stated time frame, and measured against AT & C losses as per trajectory to be finalized by the Ministry of strength (“MoP”) and participating State(s).

2. Recognising costly strength as a dominant reason for the systemic financial distress of Discoms, the UDAY scheme has hypothesizedv steps to be taken to reduce cost of strength. 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 stated dates, allowing coal swaps from inefficient plants to efficient plants, etc.

3. For the financial turnaround of Discoms, the UDAY scheme seeks:

• 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 edges/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 edges/financial institutions;

• Lender edges/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 keep 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 by a mechanism to be development by the MoP.

4. 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 edges/financial institutions are no longer to improvement 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 past year’s annual revenue (or as per prudential norms).

5. States which unprotected to operational milestones of the UDAY scheme will be entitled to additional/priority funding by various funds/schemes of the MoP and Ministry of New and replaceable Energy.

Closer Look

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 afterward to be taken over by the States. The 2012 restructuring scheme reportedly failed because participating States did not meet the required 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 harsh 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 acquire 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 consequence 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 allurement of non-SLR bonds in case an investor does not want to keep invested upto maturity.

• That subscription to non-SLR and SDL bonds (which assume SLR position) will be within policy and prudential limits/norms laid down by the Board of the lender edges and financial institutions and the save Bank of India (“RBI”), with respect to investments in non-SLR and SDL bonds, respectively.

• Going forward, working capital requirements of Discoms can be consistent 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 keep up fast.

Proponents keep up 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 edges 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 edges’/financial institutions’ profitability, the write back of loans into bonds and recast of the balance with lower interest rates, will enhance their books and help with their capital adequacy ratios. What is overlooked is that the same lender edges 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 stated timelines to cut T&D and AT&C losses and enhance 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 strength theft, are in the character 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 strength as a measure to unprotected to 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 strength” is a continued refrain in all verticals of the strength sector – be it generation, transmission or dispensing. Reducing the cost of strength would consequently need a coordinated effort of all parties involved in the strength sector including the regulators. The focus on improving coal supply and rationalizing coal prices is not surprising given that coal is the dominant 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 different clean fuels/energy.

On the whole, the UDAY scheme only goes a step beyond past restructuring schemes for Discoms, and its success will, to a large extent, depend on the sustain it receives from the participating States in carrying out the spirit and intent of the scheme, in addition 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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