Wednesday, February 29, 2012

What's common between the PIIGS and India's electricity utilities?

For a start, both are deeply in the red and require debt restructuring programs that need to go beyond mere rescheduling or re-packaging. Further, both need fundamental reforms that the respective policymakers and governments appear unwilling to embrace! And finally, in both cases, so far governments have been interested in merely kicking the can down the road.

Both governments appear to be treating the symptoms instead of the underlying problems. The Eurozone needs to face up to the reality that its peripheral economies' debt problems can recede only if their economies grow fast enough to bring down the debt-to-GDP ratios. This would require abandoning the current austerity programs and embracing policies that address fundamental issues like competitiveness problems (Ken Rogoff says wages should be halved), banking solvency, and fiscal transfers from the core economies.

In Eurozone, everyone realizes that the immediate problem is the resolution of the massive debt overhang faced by governments and financial institutions in many peripheral economies. After having exhausted all the conventional interest rate monetary policy tools and faced with ballooning debt finance costs by countries like Greece, the European Central Bank (ECB) first introduced a bond-purchase program in May 2010. After it failed to unfreeze the credit markets and lower yields and when fears of defaults mounted, threatening even Italy and Spain, in August 2011 the ECB announced a three-year concessional long-term capital provision program for Eurozone banks.

Some of those banks in turn used the money to buy higher-yielding government bonds, facilitating governments’ access to affordable credit without violating a legal ban that prevents the central bank from financing governments. The first infusion involved provision of of €489 billion (or $642.5 billion at the current exchange rate) in low cost three-year loans to 523 banks. The second round is slated for February 29, 2012.

In case of India's mostly state-owned distribution utilities, faced with an estimated losses (or non-performing loans) worth nearly Rs 70000 Cr over the last five years (since 2006) and a possible cumulative losses of over Rs 1.75 lakh Cr, the Government of India (GoI) is training its energies on a way out of this massive debt gridlock. A Planning Commission report has suggested that these loans be ring-fenced into special purpose vehicles guaranteed by the state government.

However, any sustainable solution would need both GoI and the state governments to implement policies that dramatically lower the shamefully high distribution losses, increase tariffs periodically to bring it in line with cost of service, and reduce the haemorrhage due to the free power for agriculture. A report released by credit rating agency Crisil estimated the gap between the average cost of supply per unit of power and the realization per unit was as high as 86 paise.

All stakeholders would do well to remember that such debt restructuring is not new to the electricity sector. Early last decade, before the current wave of deregulation and liberalization in the sector started, the accummulated losses of the State Electricity Boards (SEBs) were hived off their balance sheets and the SEBs were unbundled. Ten years down the line, nothing much appears to have changed as the next round of debt restructuring looms large.

In conclusion, both Eurozone countries and distribution utilities need to not only shake-away their debts but also undertake fundamental structural reforms. In the former, it will have to involve policies that sets the stage for recovery and economic growth, which in turn will reduce the debt-to-GDP ratios. The latter will have to follow a two-pronged approach of atleast partially off-loading their debts and simultaneously embracing all the earlier mentioned reforms.

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