The Central Government’s financial debt restructuring plan for state distribution companies (discoms) is a well thought-out scheme. The restructuring plan takes into account the fiscal consolidation roadmap suggested by the Thirteenth Finance Commission (TFC) and exerts minimal stress on states’ fiscal profiles, writes Devendra Kumar Pant.
The Cabinet Committee on Economic Affairs on 24 September 2012 approved the scheme for financial debt restructuring of discoms. The scheme outlines measures to be taken by discoms and state governments for financial turnaround by restructuring their debt with support through a transitional finance mechanism (TFM) by the Central Government.
State support to the power sector is not new, state electricity boards (SEBs) before unbundling were state entities; and even after unbundling, most of the successor entities are fully owned by the states. Privatisation has been limited to some discoms. The generation and transmission arms of erstwhile SEBs still rest with state entities.
Second instance of financial support in less than a decade: State governments provide assistance to state power utilities (SPUs) through state budgets. In September 2003, state governments issued power bonds of Rs 289.84 billion to central public sector undertakings to clear their outstanding dues from SEBs. At end-March 2012, power bonds amounting to Rs 115.2 billion were still outstanding on the books of state governments.
State support to SPUs consists mainly of subsidies, subventions, contributions to equity, direct loans and loan guarantees. In FY08, guarantees to SPUs were 36 per cent of the total guarantees provided by state governments. If these are devolved, it will weaken the fiscal profile of state governments.
The present scheme inter alia includes taking over of 50 per cent of the outstanding STL as of 31 March 2012 by state governments. This shall be first converted into bonds to be issued by discoms to participating lenders, backed by a state government guarantee. State governments will take over the liability during the next two to five years by issuing special securities in favour of participating lenders in a phased manner, keeping in view the fiscal space available till the entire loan (50 per cent of STL) is taken over by state governments.
The balance 50 per cent of STL will be rescheduled by lenders and serviced by discoms with a principal moratorium of three years. Repayment of principal and interest would be fully secured by a state government guarantee.
Central Government support for scheme
A TFM by the Central Government is available, subject to fulfilling of mandatory conditions. The Central Government would provide liquidity support by way of grants equal to the value of the additional energy saved through accelerated aggregate technical and commercial (AT&C) loss reduction beyond the loss trajectory specified under the restructured accelerated power development and reform programme. A state would be eligible for grants only if it could reduce the gap between average revenue realised (ARR) and average cost of supply (ACS) for the year by 25 per cent during the year judged against the benchmark for FY11. The scheme would be available only for three years beginning from FY13.
The Central Government would provide capital reimbursement incentive equal to 25 per cent of principal repayment by the state government on liabilities undertaken. Unlike the earlier scheme (September 2003), the present scheme has a number of associated conditions. India Ratings expects states would take advantage of this scheme to improve financial health of discoms. The agency is of the view that this scheme is similar to DCRF extended by the Twelfth Finance Commission to state governments to consolidate their fiscal situation. Enactment of the state Fiscal Responsibility and Budget Management (FRBM) Act was a pre-condition for availing benefits under DCRF. All states except West Bengal and Sikkim enacted FRBM Act and availed of DCRF.
Fiscal impact of financial restructuring of discoms
As on 5 October 2012, information on phasing out special securities to be issued by state governments to discoms is available for seven states. Total STLs of discoms of these seven states at FYE12 is estimated as Rs 1,196.26 billion.
Fiscal impact on Central Government: The fiscal impact on the Central Government would be in the form of capital reimbursement support of 25 per cent of principal repayment by state governments on STLs and amount to Rs 149.53 billion. The phasing out of Rs 149.53 billion would depend on the terms of bond issuances by state governments.
It is difficult to evaluate the fiscal impact of TFM on the Central Government. However, considering the reduction in AT&C losses by states in the past, without serious reform efforts of controlling the losses, it will be very difficult for states to take advantage of TFM. To take advantage of TFM, Madhya Pradesh and Uttar Pradesh will have to reduce their AT&C losses by over 3 per cent, and the gap between ARR and ACS should be reduced by over Rs 0.23 per unit and Rs 0.21 per unit, respectively.
While in other five states, AT&C losses should decline by over 1.5 per cent to take advantage of TFM. The gap between ARR and ACS in these five states will have to be reduced in the range of Rs 0.20 per unit to Rs 0.60 per unit. India Ratings believes it would be difficult for Rajasthan and Tamil Nadu to reduce the gap by Rs 0.57 per unit and Rs 0.60 per unit, respectively, which translates into an average tariff increase of around 24 per cent. However, the probability of achieving gap reduction targets for Rajasthan and Tamil Nadu has brightened after the hike in power tariffs in FY12.
Fiscal impact on state governments: The impact on state government finances will be in two forms – interest payment on bond issuances by states and an increase in debt. TFC has prepared a fiscal consolidation roadmap for each state. The roadmap is prepared in terms of revenue balance, fiscal balance and outstanding debt. The financial restructuring scheme has taken cognisance of FRBM targets and allowed states to takeover liabilities in a phased manner in the next two to five years as per the fiscal space available to each state.
Bonds’ interest payments will impact both revenue and fiscal balance. The states would have to make a balancing act to prioritise expenditure to absorb shock of additional interest payments without compromising on the TFC’s fiscal consolidation targets and their own FRBM acts. Any change in fiscal balance will have a direct impact on states’ debt and exert pressure on their fiscal position in the coming years.
Economic growth has a direct bearing on Central and state government finances. Indian government’s expenditure pattern is sticky and Indian fiscal consolidation is mainly revenue-driven, as witnessed during FY04-FY08. Although from FY10, while the Central Government’s fiscal position has deteriorated, the extent of deterioration of states’ aggregate fiscal position was less than that for the Central Government. Importantly, the decadal adverse shock of salary hike is also over in most states. However, the low growth phase of Indian economy would impact state government finances on account of both states’ own revenue, and grants and devolutions from the Central Government.
Impact on individual states has to be evaluated in relation to the TFC targets. The revenue balance target for these seven states barring Punjab is zero per cent of GSDP during FY13-FY15. Punjab has a target of 1.2 per cent in FY13, 0.6 per cent in FY14 and zero per cent of GSDP in FY15. The fiscal deficit target for all these seven states is 3 per cent of GSDP for FY13-FY15, only Punjab has a target of 3.5 per cent in FY13. Outstanding debt/GSDP targets for these seven states are presented below. According to the FY13 Budget of the seven states, only Haryana and Punjab have budgeted for a revenue deficit. All other five states have budgeted for a revenue surplus in FY13 and these states had a revenue surplus in FY12 also. Punja’s budgeted revenue deficit in FY13 is the same as the TFC target. Both Haryana and Punjab have deviated from the TFC revenue balance target in FY12. Haryana’s budgeted revenue balance target in FY13 is also deviating from the TFC target. Budgeted revenue balance in other five states provides them some fiscal space to accommodate higher-than-budgeted revenue expenditure. In terms of budgeted fiscal deficit in FY13, all seven states have a lower fiscal deficit. All seven states, except Punjab, have limited their fiscal deficit in FY12 within the TFC target. Limiting fiscal deficit lower than the TFC target allows these states to expand their capex, which is a credit positive for long-term growth.
Estimated outstanding debt of these states as per the FY13 Budget is much lower than the TFC target. This implies that the states have a cushion to absorb discoms’ debt on their books without compromising on the outstanding TFC debt targets.
Impact of discoms debt restructuring on state deficit: In analysing the impact of financial restructuring of discoms debt, India Ratings has assumed a 10 per cent interest rate on state government securities. These securities are assumed to have annual interest payments. Hence, the impact of financial restructuring on states’ deficit would be felt only in FY14.
Impact on additional interest payment would be the highest for Rajasthan in FY14 (0.06 per cent of GSDP) and FY15 (0.13 per cent of GSDP). All states except Haryana and Punjab have a revenue surplus in FY13 and budgeted for a revenue surplus in FY14 also. While Haryana has budgeted for a revenue deficit in FY13, it has a projected revenue surplus in FY14. Punjab’s revenue deficit projection in FY14 is same as the TFC target.
In FY13, the budgeted fiscal deficit of all seven states is within their TFC targets. Andhra Pradesh, Madhya Pradesh and Punjab rather than providing rolling fiscal deficit targets for FY14 and FY15 have mentioned the TFC targets in their MTFPs. As a result, based on state MTFPs, Andhra Pradesh and Punjab are likely to have a higher-than-targeted fiscal deficit in FY14 and FY15. Andhra Pradesh in FY13 has budgeted a fiscal deficit of 2.58 per cent of GSDP and consistently maintained a lower-than-targeted fiscal deficit. India Ratings expects Andhra Pradesh to absorb the adverse impact of debt restructuring of discoms on its books of account. Madhya Pradesh, Punjab and Uttar Pradesh are very close to the TFC targets and their capabilities to manage their finances in line with the TFC recommendations will be tested.
Impact of discoms debt restructuring on state debt: While the impact of discoms debt restructuring on deficit would be felt only in FY14, its impact on debt would be felt in FY13. Additional debt on state government books due to financial restructuring of discoms will result in Rajasthan’s debt increasing by 2.07 per cent of GSDP in FY15, followed by Haryana (increase of 1.62 per cent of GSDP in FY15); however, for the remaining five states it is likely to be below one per cent of GSDP.
Debt/GSDP reported in states’ MTFPs indicates that Andhra Pradesh and Punjab would breach the TFCs FY15 debt/GSDP target. However, India Ratings expects that the states would be able to limit their debt/GSDP ratio within the TFC targets after a closer scrutiny of the two states’ MTFPs, debt/GSDP trend during FY11-FY13, and projected deficit (including additional interest on special securities to be issued by state governments for 50 per cent STLs of discoms).
Risks to TFC’s fiscal consolidation roadmap
State governments’ MTFPs indicate that most of the states would be able to absorb adverse impacts of discoms debt restructuring, exceptions being Punjab, Haryana, Madhya Pradesh and Uttar Pradesh which would face some problem in absorbing the shock.
States receive a significant proportion of their revenue from the Central Government in the form of grants and devolution. Even in FY13 till date, the Central Government’s revenue collections have not been in line with the budget assumption. An economic slowdown will adversely affect not only the Central Government’s ability to extend grants to states but also states’ own revenue.
States which are more integrated with the global economy will struggle to absorb adverse impacts of discoms debt restructuring. Andhra Pradesh and Tamil Nadu’s economic growth is linked to the global economic scenario. Tamil Nadu’s industrial production has a large proportion of textiles, and auto and auto ancillaries. The cur¡rent exports slowdown and sluggish auto sector demand would impact Tamil Nadu’s economic growth and thus the state’s finances.
If the current economic slowdown extends further, it would be difficult for states to absorb additional debt due to discoms debt restructuring and adhere to fiscal consolidation targets set by the TFC and their own MTFPs. Globally, capex bears the brunt of fiscal consolidation, which has a long-term impact on growth and fiscal profile. India Ratings expects states to continue their movement along the fiscal consolidation path by rationalising their current expenditure rather than cutting capex growth.
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