Fitch: India Discom Reforms - Promising Start, But Efficiency Gains Key

Fitch Ratings says that the voluntary rehabilitation scheme of India's central government - Ujwal Discom Assurance Yojana (UDAY) - for financial and operational turnaround of distressed state distribution utilities (discoms) has already seen a large number of important states signing up for the programme. However, the immediate relief provided by interest-expense reduction, while beneficial to the cash flow positions of the discoms, is inadequate to turn these entities profitable; achieving this goal by March 2019 (FY19) as per the plan is highly predicated on the ambitious efficiency improvements, coupled with tariff increases that are politically sensitive in India.

UDAY, launched in November 2015, is more comprehensive than previous packages which had focused primarily on debt restructuring. The merits of UDAY are its four-pronged 'carrot and stick'-based strategy that targets not only a reduction in interest burden, but also operational efficiency improvement, reduced cost of power purchased, and financial discipline. There are also financial implications for states signing up for UDAY that do not meet the agreed targets under the programme.

Twenty Indian states and one union territory (UT) have given in-principle approval for UDAY; 16 have already signed up for the scheme. Participation by a number of states which are not ruled by the key ruling political party at the centre - the Bharatiya Janata Party - reflects the various merits and wider acceptance of the package. The committed states and UT accounted for almost 77% of the total FY14 net cash losses reported by discoms, and around 58% of the total debt outstanding at end-September 2015. These states house about 56% of India's total installed capacity. Tamil Nadu stands out among those which have not opted for UDAY, and accounted for 25% of FY14 net cash losses of all discoms.

The debt-restructuring slated within the scheme will provide some immediate breathing space, following the transfer of 75% of outstanding debt to the states and capping the interest cost on the balance. However, discoms in as many as 12 of the 16 committed states/UTs reported cash losses in FY14. Most of these (based on FY14 numbers) would continue with cash losses even after accounting for the immediate interest savings, highlighting the need for higher efficiencies and cost-reflective tariffs for a sustainable improvement of discoms' financial health.

The aggregate technical and commercial (AT&C) loss in the Indian power sector is very high - ranging from 11% to 71%, with many of the states in excess of 20%. UDAY aims to get the discoms to cut these losses significantly (more than 50% in many cases) through FY19, which is a significant challenge; the savings benefits from lower AT&C losses alone account for around half of the total savings on average for the states that have committed. For the majority of states, tariff increases are required to reach break-even status even after the other savings to which they are committed.

A meaningful improvement in discoms' economics will especially benefit power generation companies via higher utilisations and timely clearance of dues. The current low capacity utilisation of power plants is driven primarily by stressed discoms, which are unable to buy electricity because of weak financial positions. We believe financially stronger discoms will support India's strong drive for renewables and financings of those projects, along with other power sector investments in the country.

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