Let’s not get our hopes up just yet – India’s state electricity boards are nowhere near tapping the international bond market the way Indonesia’s state electricity utility Perusahaan Listrik Negara (PLN) did on October 16.
But even if India’s state electricity boards (SEBs) are struggling to generate a profit and will have to experience a painful restructuring programme that has been approved September 24, the idea that these utilities will be able to access funding from foreign bond investors in the future is definitely achievable if they are able to emerge as more efficient, transparent bodies.
The rationale of comparing PLN and India’s SEBs stems from the fact that all have similar problems, although India’s utilities are in a much deeper debt hole. India’s power sector had INR3.4 trillion (US$62.5 billion) in outstanding loans to banks as of the end of July 2012, according to the Reserve Bank of India. Meanwhile, Standard & Poor’s projects that PLN’s ratio of debt to Ebitda is approximately 6.5 times book this year due to its largely debt-funded expansions.
Both utilities are also suffering from foreign currency risks, as they purchase coal and oil with US dollars but generate revenue in the rupiah and rupee, two of Asia’s weakest currencies this year. Volatile commodity prices are also forcing them to inevitably raise electricity prices in their respective countries, where governments provide energy subsidies.
Despite these issues, the Indonesian utility was able to price a US$1 billion deal that attracted an order book of US$11.5 billion this week. The company first entered the international bond markets last November with US$1 billion 10-year bond yielding 5.625% at a time when the credit markets were still reeling from the European debt crisis.
PLN’s ‘BB’ rating is supported by the fact that credit agencies believe the state-owned utility is highly likely to receive financial support from the Indonesian government if it were to run into financial trouble. That belief has also paved the way for the company to attract massive liquidity from the bond markets.
This is why India’s SEBs should seriously consider issuing bonds to global investors. If they are able to garner government support for the bond, the utilities can expect to see a leg up in their credit rating. That is why PLN’s standalone credit rating is a ‘B+’ compared to its final rating of ‘BB.’ The existence of sovereign backing also gave numerous state-owned Indian companies, such as electricity generator NTPC, and banks a strong reception in the bond market this year, as the lack of a sovereign dollar bond from India caused investors to buy these credits as a proxy.
Government support has helped Syndicate Bank price the tightest bond spread for a commercial bank this year, with a US$500 million deal issued 355 basis points over Treasuries.
A discounted withholding tax to 5% for Indian infrastructure companies will also help it cut interest costs, while opening its books to bond investors will force the SEBs to be more transparent and accountable.
In fact, the global bond market may become a viable option for the Indian government to prop up SEBs. The restructuring process has required state governments to shoulder 50% of SEB debt, but the problem is that many of India’s state governments simply cannot afford to do this. Many have reached a ceiling introduced in 2003 with the Fiscal Responsibility and Budget Management Act that is aimed at controlling the deficit.
The country’s banks, which will be taking over the other half of utility debt, are also under pressure to tame rising non-performing loan ratios, which Fitch estimates will climb to 3.75% next fiscal year from 2.9% this financial year.
But in order for the SEBs to even dream of approaching foreign bond investors, these utilities will need to accelerate reforms in the electricity sector. The first step is to continue raising electricity tariffs - despite public opposition - to allow SEBs to break even, as electricity costs are too low for the utilities to generate a profit. Major states such as Uttar Pradesh will need to increase tariffs by 40% immediately, according to a June 25 report published by HSBC.
States such as Tamil Nadu, Delhi and Punjab have hiked tariffs as much as 37% this year, but the process has been slow due to the sensitivity of the issue amid upcoming state elections.
State governments should educate the populace on the advantages of a tariff hike by saying that such a move would help avert an electricity crisis, increase investment in technologies that will improve the grid and rule out the possibility of national blackouts. Higher tariffs will also accelerate the SEBs’ debt payments to banks.
The power sector should also allow room for privatisation. The SEBs are managed by career government officials with limited expertise on operating a company and responding to shocks in commodity prices and currency fluctuations. The extreme indebtedness of these state utilities will require the financial knowledge of experienced professionals to help the utilities restructure its debt swiftly and efficiently so that they do not fall into a bigger debt trap.
India’s SEBs should work towards cutting tariffs and rearranging SEB management while keeping in mind the possibility of attracting funds from global debt investors. If they are able to improve their firms and cut debt levels, that may clear the way for a more optimistic future in visiting the bond markets.
Improved SEB financial statements will surely catch the eyes of potential investors. India’s power sector, although troubled for now, harbors immense opportunity. The economy is one of the fastest growing in the world, and many parts of the country are still lacking electricity. Once these SEBs are whipped into shape and are able to increase electricity generation capacity, it will be able to service a customer base of close to a billion people. The prospects for profit will be enormous.