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Demystifying the UDAY State SEB Reform Program: A 21,000 cr. Hit to Lenders

Power reforms are here! The press note introduces UDAY, The Ujjwal Discom Assurance Yojana.

The problem currently is that

  • State Electricity Boards (called Distribution Companies or DISCOMs) are in deep trouble
  • They have a lot of debt – 4.3 lakh crore as of March 2015
  • They are hugely loss making – 3.8 lakh crore of accumulated losses as of March 2015
  • They pay huge interest costs on that debt, at 14% to 15%
  • And it’s really a government debt (of the state government) because the state owns them
  • So the UDAY piece will help, But how?
  • They will reduce cost of debt (interest rates)
  • They will reduce the cost of power
  • States will be forced to not keep losses in DISCOMS since they have to show that debt in their fiscal statements, so ‘fiscal discipline
  • It will push them to be more efficient

But How?

Firstly they’ll muck around the debt.

States can borrow at 8-9% through bonds. The DISCOMs borrow at 14%. If the states borrow and payback the DISCOM debt, technically the cost of debt comes down to 8-9%. This is what will happen:

  • States will take 3/4th over the debt in phases. 50% this year, and 25% in the next year.
  • They will issue non-SLR bonds to get the money. Banks can’t keep it for their statutory liquidity ratio so they will demand a higher interest rate, but current state loans go for about 8%, so max of 9% is expected.
  • Banks will be forced to lend at Base Rate plus 0.1% for the remaining debt.

These bonds will not be in the fiscal deficit calculations of 2016 and 2017.

States to Fund Future Losses

To ensure that this is one time, the DISCOMs future losses will be funded by states directly. (Meaning it will have to be part of their budgets)

  • Till 2017-18 no losses need to be taken over (they’re taking over the 75% of the debt, remember)
  • After that over four years (till 2020-21) they will gradually take over upto 50% of the DISCOM’s losses. (5%, 10%, 25% and 50% in those four years)

DISCOM funding through other schemes and power grants

NTPC will offer lower cost power to such states that accept the UDAY program.

They’ll also get lower cost coal at “notified” prices.

Plus, they will get funding from additional schemes from the government, which have complex acronyms and are too complex to delve into. Basically this is like an incentive to drive states to join.

Is This Good?

Think about this – there is Rs. 430,000 crore of debt at 14%. None of this is considered “bad” because it’s after all quasi guaranteed by the state governments. So you can assume there is about Rs. 56,000 cr. of interest that’s being earned by banks and financial institutions.

Suddenly, 75% of that money will be at 8-9%. The rest goes to base rate + 0.1% which is still about 9.5% or so. Consider a 5% drop in interest, on 430,000 cr. – for a lender, this is “good” debt that suddenly will pay Rs. 21,000 cr. less!

Further, taking bonds as a payment is a mess because being non-SLR, these bonds will not sell easily. (But hey, I would be happy to pay for these bonds if they were guaranteed by a state, and paid 9%! However, you and I can’t buy these bonds).

To any lender this is horrible. And we saw stocks of the biggies – Power Finance Corporation and Rural Electrification Corporation (which have exposure to such loans) fall 10% and 8% respectively.





But the reform is good.

It will force losses on to states, who will have to maintain fiscal discipline and thus not give stupid things like free power.

They will have to work out a mechanism to raise tariffs.

States will need this mechanism to get lower cost power otherwise the SEB losses will keep going up. A state can choose to go against the UDAY scheme and not accept it but we expect that RBI will ask banks to consider those loans as “bad” loans if a state ditches the UDAY program. Which will mean a massive funding crunch for the SEB, so most will have to accept.

The point is – this is good reform, but states will attempt to resist it until they are forced to accept it at gunpoint. But if that’s what’s required, that’s what has to be done.

Lenders are in a soup anyhow, and let’s hope this veil of a “good loan because it’s an SEB” is removed and we can finally see bank books for what they really are – quasi lenders to the government most of the time. When that is known, they will have to convert their portfolio to lend more to the economy.

However, we expect scheme specifics will change. (Currently all states are sitting with the center in a 2 day meeting, to discuss these reforms. There will be some changes over the weekend).

  • Shan says:

    I am not an optimist in this issue. Multiple things:
    1. The only way to recover the money is by increasing power rates and decreasing thefts and losses.
    2. Increasing power rates is a political death blow. Farmers will revolt, industrialists will revolt, communists will revolt, AAP will revolt and so on. The first state to do this will be in the line of fire. Who’s going to bite the bullet? No one. Because the downside is losing the elections disgracefully. Rather die fighting (by not raising power tariffs) than commit political suicide.
    3. Stopping power theft is easier said than done. If they couldn’t do it till now it ain’t happening. Most of the power theft is ‘sanctioned’ by politically influential folks. You can’t change this.
    4. States have managed to successfully make this a central issue. This is the real reason this will fail. Now if the center is involved why should the state fix this issue? And if this issue is not fixed the states will continue to blame the center. Its heads I win and tails I don’t lose kinda situation for the states. I bet they’re not going to do anything at all.

  • Paddy says:

    Thanks Deepak!. This makes interesting economics, but at the end looks like its a Zero Sum Game with some interesting outcomes impacting free cycles in Karnataka to affording a Rs 2/- Idli in TN.
    We are just moving the liability from one bucket to another. Most lenders to SEB or Bond subscribers to SEB issues are PSU Banks and Insurance companies. We are just moving the liability from State Run banks (i.e. Tax Payer Funded Banks) to the State Government Balance Sheets (I.e. Tax Payer Funded Budgets). These borrowings will obviously increase State Debt and after two years states will have to adhere to FRBM. Their interest rates will go higher but they will have to make difficult choices of choosing between different populist schemes.
    But definitely there’s a silver lining: Since FRBM puts a cap on what states can spend, the state now has to carefully on what it can afford to splurge on. Some free schemes has to be done away since a portion of the moolah will now have to be solely dedicated to fund SEB losses (which will not go away that soon). Imagine this!: The CM in Karnataka will now have to choose between between Shaadi Bhagya, Anna Bhagya, Jyoti Bhgaya, Cycle Bhagya…… N^2 Bhagya………. and for TN it is still tougher – To choose wisely between splurging money on Free television sets, Amma canteens (Rs 2 Idli, Vada, Pongal), Grinders or Electricity. Tough choice!
    Bottom Line: I guess this is akin to moving off balance sheet items to Balance sheet. Modi government should think about similar innovations that will necessitate moving State PSU debts directly into the state government accounts and finally make Governments accountable! Brilliant Move!!!

  • Sai Raghavendran says:

    I guess the TN government will be hiking liquor prices & taxes shortly to compensate for the huge impact this will have on the budget next year.

  • Phoenix says:

    Excellent. Very well said.
    My guess is the States will find some new taxes to screw the common man more. As it is power rates are abusive and promote cross subsidization.