Jul 23, 2012 09:13 AM IST | Source: CNBC-TV18

Experts agree on carrot-stick method for discom rescue plan

CNBC-TV18’s banking editor Latha Venkatesh, in this edition of Indianomics, speaks to former NDA power minister, Suresh Prabhu and MD Mallya, chairman, Bank of Baroda to try and understand if the plan to rescue the state electricity distribution companies is going to work.

Electricity distribution companies (discoms) have been an area of darkness especially for bankers. Cumulatively, discoms owe banks Rs 2 lakh crore which have so far been kept the same because the loans have been rescheduled very often. The government is making a fresh effort to wipe out this legacy burden and ensure the distribution companies don’t slip into losses again.

The government’s plan is to take over 50% of loans owed to banks via bonds issued by state governments that can be traded or sold. The balance 50% will be converted into long-term loans of 10 years maturity. Discoms will not have to pay interest or principal for three years and can repay the balance in the next seven years.

The banks, in the first year of the government’s rescue effort, will fund 70% of discoms’ losses to the extent to which revenues don’t fall short of expenses.  In the second year, the banks will fund 35% of the losses.  By the third year, the discoms will have to stop making losses. To reduce losses, discoms are to raise tariffs every six months over a span of two years till revenues meet expenses and discoms should show proof of reducing transmission losses.

Besides, banks will also have an escrow facility on discoms revenues which allows the first right to revenues for interest payments. However, bankers are hopeful that discoms and state governments don't stoop to populist demands again.

CNBC-TV18's banking editor Latha Venkatesh, in this edition of Indianomics, speaks to former NDA power minister, Suresh Prabhu  and MD Mallya, chairman, Bank of Baroda to try and understand if this plan to rescue the state electricity distribution companies is going to work.

Below is an edited transcript of the interview on CNBC-TV18.

Q: The proposal says that 50% of the loans will become bonds floated by state government companies and guaranteed by the state governments. Does this reassure the banking community? What if the governments don’t honour the guarantees?

Mallya: The government is yet to come up with a roadmap regarding takeover of 50% of the liabilities from the banks, in terms of the unsecured loans, which have been lent. Only when a regular roadmap is announced, will more details be made available. But the fact remains that 50% of the liability of the banks will have to be taken over by the state government.

Q: Are you happy with the guarantee arrangements? On several occasions, state-governments haven not honoured their guarantees. Former Oriental Bank of Commerce chairman Narang said on one occasion he wrote 30 letters to the state-government and did not even get a single reply?

Mallya: I don't think there has been any instance that I have come across wherein the state government has not been able to discharge their liabilities. By and large, all the loans where we participated did not have any problems and were honoured by the government. 

Q:The proposal says banks have to fund 70% of the losses in the first year, are you comfortable with this arrangement?

Mallya: According to the terms of the package, 50% of the gap in revenue in the first year, ie. 2012-2013, will have to be funded by the banks. And the rest of the 25% gap in revenue will have to be funded by banks in the subsequent years i.e. 2013 and 2014. Thereafter, banks would no longer be required to fund any losses in revenue. Overall, the package is an attempt to see that the discoms are properly rehabilitated.

There are attendant items which need to be confirmed and complied by the discoms. I will only point out three major items. First is the question of tariff revision, which I think all discoms are ready to taken up in right earnest. Second, is the portion of costs that will be  passed on to the ultimate consumer. And third, establishing a transparent mechanism of reducing distribution losses of 20-22% as of far as a few discoms are concerned.

If these and other appropriate measures are taken, I am certain that the loss in revenue would come down in the days to come and facilitate the discoms to generate surplus, which can be utilised to meet repayment obligations.

Q: What if you pay for the 70% of the losses, but the discoms don’t keep their side of the bargain? Suppose they don’t raise tariffs?

Mallya: This again brings us back to the specific problem of a particular discom and thart depends on the overall scheme as far as the roadmap is concerned. Regarding the revision  of tariff, prices have to be increased periodically. Any increase in the tariff depends on the overall cost structure as far as the discoms are concerned and they need to ensure that gap in revenue is reduce over a period of time or made positive. I think the whole viability study and the plan of rehabilitation depends on the capability to ensure that there is a feasible model in place.

Q: Is there scope for a quarterly or monthly review and authority to the banks to halt will funding if the discoms refuse to raise rates?

Mallya: Obviously, that is in place. The ultimate reduction of the gap in revenue doesn’t happen on the very first day. Disbursements will be linked to the fund-flow requirement or the cash deficit, which is projected by the discoms. Funds from the banking system will be released in coordination with the overall cash deficit as projected. So an appropriate monetary mechanism will definitely be put in place.


Q: Ten years ago, a similar arrangement was established, but the problems only increased and by several times over?

Mallya: No, I don’t think one needs to be so pessimistic about the whole future as far as discoms are concerned. They are there to stay as far as there is a requirement for power. Going by what has happened in the recent past, an appropriate mechanism put in place by the state-governments and the discoms to ensure that the lessons of the past are appropriately learnt in ensuring that a viable model is appropriately implemented. I am optimistic about this.

Q: Since you say the loans lent to discoms are standard, do you expect any impact on your P&L because of this proposal?

Mallya: At the moment, none of the loans lent to discoms have turned into NPAs for any of the other banks. Therefore, if the whole proposal of rehabilitation is put through, a process of restructuring will place, but I don’t think the loans will become an NPL. On the other hand, I think the provision requirement will be substantially more from the present level of 0.4% for a standard asset and could go up to about 2%.

Q: You did put up the scheme and at one point in time it seemed that the new regime was in place. But nothing really happened. The electricity sector regulators turned out to be government appointees and did not correct SEBs or discoms that did not raise tariffs. Do you think the new package will work, precisely because the electricity regulators are still state-government appointees?

Prabhu: That’s absolutely right. One of the things that we did when we actually mulling over a plan to rescue the ailing discoms, we decided it would be futile just to implement one package to rid debt off the books of the state electricity boards by taking it into the balance-sheets of the state-governments and then the state-governments issuing bonds.

What was important were reforms in terms of tariff revision by appointing a regulator. One of the mistakes that we made was in not creating an adequate mechanism that would enable the appointment of regulators.

The government, I think, has now come out with another package. It is going to be a disaster because the government can’t afford the luxury of writing off millions of rupees year after year.

So I think what really needs to be done? If at all the government wants to do it, this has to be the last time. But how do you make sure it lasts? The government must initiate an entire chain of events to create a value chain through which power is sold.

So the government has to start with generating companies, go down to the distribution companies, and then reach out to the level where the collection is made. The entire chain must be made fool-proof from tampering. This is what needs to be done.

Q: How do you stop this tampering? Is it possible to stop theft or at least even to reduce it?

Prabhu: What really needs to be done is get technology into the distribution end. If you recall, 25 years ago theft was common in telecom. People without making a single call would get a bill for calls worth thousands of rupees.


Q: Yes, you could bribe a linesman of MTNL like that.

Prabhu: How did it stop? Did the linemen take a dip in Ganga that changed their mindset? No. it was technology that prevented theft. I had appointed Nandan Nilekani as a chairman of a group in the power ministry to study how communication and information technology (CIT) could be deployed at the distribution end.  Another measure to prevent theft is the use of transmission and distribution networks of higher strengths as any attempt to steal would result in electrocution and death.

Institutions and the government must provide money as the carrot, but must also use the stick. Funds must be provided in a manner that it is used properly tapped and is linked to milestones which will result in improvement of the system.

I have been telling my friends in the IT industry that instead of worrying about right now Europe or America is not giving, they could deploy their technological knowledge in implementing new end-to-end solutions for transmission and distribution of electricity. There is no need for the IT companies to acquire anything. All they have to do is to tell the banks to fund the process of creating and implementing a solution. I think that will be a win-win situation.

Q: Whether a Congress government or a non-Congress government is in power, electricity boards have been found to be badly run. Why is there  no political will to communicate to the public that if the supply and quality of power is to be consistent, the tariffs will have to be revised?

Prabhu: You are absolutely right. We have organised over 2,500 roadshows across India in this regard. Fortunately, we were able to table the Electricity Act and get it passed in Parliament without serious opposition, because the people realised the need for reform. Tariff is something which people are not opposed to. What they are opposed to is high tariff and no power. Low quality power and high tariffs that is what people don’t want.

So what really needs to be done is to assure good quality power. And how can that be done? We formulated the Accelerated Power Development Programme (APDP) for this purpose, which we unfortunately could not implement.

There any solution to reform the power sector, must take on board the banking and technology sectors, the Federal and the state-governments and the unions. Interestingly, the farmers’ organisations that I talked to said that they didn’t want free power, but a consistent supply of power. So I think nobody is opposed to tariff hikes, except increase in tariff with no relevance to the improvement in the quality and consistency of power supply.

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