Centre considers REC-PFC merger to bridge budget gap ahead of 2019 polls

India is considering a proposal to combine two state-run lenders to utilities, REC Ltd. and Power Finance Corp., according to people familiar with the discussions, as it seeks to raise funds to bridge a budget gap.

The first phase of the deal will see REC acquiring a majority stake in Power Finance valued at $2.5 billion possibly by the year ending March 2019, the people said, asking not to be named as the talks aren’t public. Subsequently, the plan is to merge the subsidiary with REC, a departure from the original plan to keep their operations separate. Power Finance had a market value of 268.8 billion rupees ($3.8 billion) on Tuesday.

Prime Minister Narendra Modi’s government is seeking ways to narrow the country’s budget deficit to help finance public welfare projects ahead of elections. The sale of stake in Power Finance mirrors a similar deal earlier this year, when state explorer Oil & Natural Gas Corp. bought a controlling stake in refiner Hindustan Petroleum Corp.

The merger plan is being considered after REC expressed concern that just acquiring a controlling stake in Power Finance would weaken its credit profile and wouldn’t yield any operational benefit. On the other hand, New Delhi-based REC has informed the power ministry that a combined entity will be complementary as it would eliminate competition among them in raising funds or finding customers, according to the people involved in the plan.

The sale of stake in Power Finance, expected to fetch about $2.5 billion based on the lender’s last closing price, mirrors a similar deal last year, when state explorer Oil & Natural Gas Corp. bought a controlling stake in refiner Hindustan Petroleum Corp.

Affordable Power

A combined power sector lender can leverage its size to borrow at lower rates and help fund the nation’s goal of ensuring round-the-clock supply of affordable electricity for all Indians and also help fund projects beyond the electricity sector. A bigger lender will also help instill better discipline among borrowers, especially distribution companies, the people said.

Press offices at REC, Power Finance and the power ministry didn’t respond to emails seeking comment, while calls made to the finance ministry’s spokesman were not answered.

The government has a 65.6 percent holding in Power Finance, which has gained 29 percent since Bloomberg first reported the government’s plan to sell its stake to REC on Sept. 24, while REC has advanced 24 percent.

REC is keen on the merged entity to subsequently extend its lending book beyond the power sector and wants oversight of its operations shifted to the finance ministry, the people said. The company changed its name, discarding the earlier Rural Electrification Corp., last month as it limited the scope of doing business.