What’s the best way to solve the stressed assets problem in the power sector? That’s a $53-billion (₹ 3.6 trillion) question. According to Bank of America Merrill Lynch, that’s the total amount of stressed debt in the power sector.
The Reserve Bank of India’s (RBI’s) unyielding stance on stressed power assets could be for the larger economic good. The central bank wants power projects that have defaulted on bank loans to undergo resolution under the insolvency process, just like their industrial counterparts.
Promoters claim their situation is different, blaming external reasons for their woes. Banks and the government seem to agree, suggesting an alternative—which was proposed some years ago too—such as an asset reconstruction company (ARC), that will take over these stressed power assets.
Insolvency may seem harsh but it can do a few things. One, it will right-size the debt and equity invested in these projects. The repricing of liabilities should lower the servicing cost, in turn improving project economics since fixed costs will decline.
For instance, a February 2018 India Ratings report analysed a notional coal-based power plant, with a capital cost of ₹ 6 crore/megawatt and a 70:30 debt-equity funding. If state distribution companies are willing to pay only ₹ 3.35/kilowatt hour, then this plant becomes viable only if its enterprise value (EV) is cut by a third. After the cut in EV, it can possibly service its debt and provide a 10% return on equity at a 60% plant load factor. Now, EV is both equity and debt, meaning both sides have to sacrifice.
Lastly, the present installed thermal power capacity is about 222 gigawatts (GW). Comparatively stressed assets are pegged at 60-80 GW, which are either not operational or operating below desired levels (these are over and above the existing capacity). That’s substantial and correcting this problem will see total power supply increase.
That’s good for the economy as supply at a reasonable cost can itself create demand. Remember that state utilities were shopping in the spot power market when tariffs fell to record lows, backing down from their existing contracts. Their action may be due to their poor financial condition, but it also suggests that cheap power will find takers.
Also, despite all talk of subdued demand growth, India remains underserved. In Uttar Pradesh, after a change in government saw power supply improve, peak demand in India’s most populous state jumped 18% in FY18, according to Central Electricity Authority. In the five years till FY17, peak demand on an average increased by 7.4% per annum.
If all stressed power assets are transferred to an ARC, that may not solve the problem. This column had recently pointed out it could take three-four years for these projects to turn viable, which assumed steady growth in demand and balancing of the current overcapacity situation. A plain vanilla restructuring of debt will not move the needle of resolution by much.
Evergreening does not serve the objective of resolution, and it is better to sell a project that is not generating power now than wait for three-four years, said Alka Anbarasu, vice president (financial institutions) at Moody’s Investors Service.
Many projects have structural problems, such as lack of long-term power purchase agreement, fuel supply agreement, under-utilization, lack of equity funding, and in some cases not having required clearances. The debt haircut required across stressed assets is likely to be in the range of 20-70%, averaging at about 35-40%, says Girishkumar Kadam, vice president and sector head (corporate ratings) at Icra Ltd.
Banks may baulk at the level of sacrifice required, and also ponder over the risk of these “discretionary" decisions being investigated years later. Promoters too have to bring in fresh equity as part of their commitments and delays on their part can adversely affect the success of this restructuring.
That’s where the Insolvency and Bankruptcy Code’s framework comes in. It allows lenders to take decisions about restructuring debt and selling assets without fear. The new owner has to propose a resolution and is held accountable to it. If lenders don’t approve any proposal, the asset goes into liquidation. That’s unfortunate but then, it is probably better now than three-four years down the line, with even more debt at stake.
There may be a case for a few projects that the government can move into an ARC. The others should go through the insolvency process. Instead, if things remain as usual, one runs the risk of carrying over the current inefficiencies—high-cost plants contributing to high-cost electricity supply—into the future.
Post-resolution, these plants should be able to supply power at competitive rates, more acceptable to state utilities. Rising power demand should ensure that the supply is absorbed eventually. A well-supplied energy market can act as a tailwind in India’s quest for sustainable economic growth.