MUMBAI : The Union power ministry has made it mandatory for electricity-distribution licensees to open letters of credit as a payment-security mechanism under the power-purchase agreements. The move comes against the backdrop of mounting dues of power producers.

If implemented in spirit, the proposal will infuse discipline in the sector. The threat of encashing a letter of credit will deter power distribution companies (discoms) from inordinately delaying payments. They will be compelled to improve realizations through rationalizing tariffs or reducing transmission and distribution losses or through billing recoveries.

For consumers and producers, this will eliminate unnecessary costs. Producers will no longer need to bankroll receivables. For consumers, the improvement in the payment mechanism at the discom level can weed out unnecessary costs. Power generators right now are allowed to recover costs associated with payment delays from discoms, which in turn is realized from consumers.

“Generators have faced stretched working-capital cycles due to the burden of advance payments for fuel supply/transportation while discoms have dilly-dallied paying dues. The new payment-security mechanism, in our view, is a very positive development for the power sector and plugs major pilferage in the system," said a note by analysts at Edelweiss Securities Ltd.

However, as good as the proposal sounds, it can have unintended consequences for electricity generators. The mechanism can crimp demand, at least till discoms get their act together. Discoms, after all, do not have unlimited access to financial resources.

Discoms improved power availability, despite high transmission and distribution losses, by farming out costs to other stakeholders. This includes generators, too, however unfair it may be. Now, pushed to the corner, they will rationalize purchases according to their financial situation.

“It can lead to demand curtailment (power cuts) in the near term as discoms/states will have to start adhering to reforms (tariff hikes/subsidy payments/reduction in aggregate technical and commercial losses, etc)," said a note by analysts at JM Financial Institutional Securities Ltd.

However, the proposal will curtail profligate moves of state governments such as free/subsidized distribution of power. It will even impel states to usher in distribution reforms.

How seriously states implement this is the question.

If the much-publicized Ujwal Discom Assurance Yojana has achieved its intended purpose, there will be no need for the latest order.

“We wait to see how discoms purchasing behaviour changes with pressures on cash flows and now on power despatches. This could lead to better power planning and, hence, the opening up of the power-purchase cycle in the long term, though there could be stress in the near term," said the note by analysts at JM Financial.