PFC - Financing of Power Sector in India

POWER SCENARIO
India had a generating capacity in power utilities of about 85,000 MW as on March 31, 1997 i.e. the end of Eighth Five Year Plan. About 63% of this capacity was with state power utilities about 32% with Central power utilities and only about 5% in private sector. This generating capacity, however, could not meet the demand for power, leading to electricity energy shortage of about 11% and peaking shortages of about 18% as on March 31, 1997. For a 6.5% rate of growth projected for the economy, the demand for power will grow at the rate of about 9.10% per annum. Capacity addition during first two years of the Ninth Plan have been about 7500 MW. This is expected to pick up towards the end of Ninth Plan (2001-02) when an annual capacity addition rate of about 8000-10000 MW may be achieved. This would require an investment of about Rs. 50,000-60,000 crores ($ 12-15 billion) per annum for additional generating capacity and the associated transmission & distribution systems as well as other related schemes in order to ensure that power is supplied to the consumers in the required quantity and quality. During Tenth Plan (2002-2007), the requirement for investment in the power sector may go up to about Rs. 80,000-90,000 crores ($ 20 billion) per annum.
After the Indian power sector was opened up for private investment in generation in 1991, considerable interest was shown by private investors-both from within the country and abroad. However, the actual progress on setting up of the IPPs has been very slow. Apart from the fact that many of the project proposals come from non-serious promoters, there were also many policy related problems. From the government side, most of these policy problem areas coming in the slow development of IPPs, such as fuel linkages both for coal and hydrocarbons, power purchase agreements, various clearances, incentives etc. have been solved over the last few years. A hydro power policy and mega power projects policy has been announced. A Power Trading Corporation has been set up. After necessary legislation, a Central Electricity Regulation Commission has been constituted a number of state governments have also set up State Electricity Regulatory Commissions. Another legislation has allowed the entry of the private sector investors in transmission projects. A Crisis Resolution Group headed by Minister of Power has been established to expedite financial closure of IPPs. A number of states have initiated or committed to initiate reforms in the state power sector. The stage is now set for rapid private sector investment in the power sector.
FINANCING OF PUBLIC SECTOR POWER PROJECTS
According to Ninth Plan, an outlay of Rs. 1,24,000 crores have been provided for the power sector (Rs. 53,000 crores in the Central Sector and Rs. 71,000 crores in the states sector) This would work out to an average of about Rs. 25,000 crores per annum.
In our planning system for the public sector the investment indicated as outlays in the Five year/Annual Plans, the sources of funding are generally as follows:-

Internal resources of the organisation
Financing from govt. budget in the form of equity/loan
Multilateral/Bilateral assistance routed through budget
Multilateral/Bilateral loans directly to the organisation
Financial assistance from financial institutions in the form of term loans, leasing, bill discounting etc.
Bonds/debentures from domestic market
Suppliers credit(domestic/external)
Credit from External Credit Agencies (ECAs)
External Commercial Borrowings(ECB)
Other sources such as leasing from private non-banking financial companies, deposits from consumers, sale of assets etc.

FINANCING OPTIONS FOR PRIVATE SECTOR PROJECTS
During the Ninth Plan, balance investment requirement reaching a level of about Rs. 25,000 crores per annum by the end of the Ninth Plan will need to come from private sector funding including Financial Institutions.
Govt. policy guidelines allow a debt equity ratio for private IPPs of 4:1. While lending to these projects, most Financial Institutions, however, insist on a debt equity ratio of 70.30 as a prudent policy. Private sector promoters were earlier permitted assistance of maximum of 40% of the cost of the projects from the Indian Financial Institutions(FLs) including Banks. This limit has recently been relaxed in certain cases and decision left to the FLs.
EXTERNAL SOURCES OF FUNDS FOR POWER PROJECTS
Any country which has to invest more than it saves itself has not another alternative but to utilise foreign investments to fill the gap. The government can either borrow the funds itself directly or through its public sector institutions/organisations, or alternatively, it can attract foreign investment into its private sector. The foreign private investment can come in two forms namely debts instruments (loans, bonds etc.) by banks, institutions, investors, or direct investment (FDI) by project promoters as equity or loans. In the long run, FDI is considered more attractive as the promoters not only bring in better technology and managerial efficiency but also share risks. Some host countries are, however, still apprehensive of the foreign direct investment(FDI) and consider it necessary to regulate its inflow. Foreign direct investment plays a key role in the development of emerging nations, In recent years, there has been strong growth in international capital flows, but the flow of FDI to developing countries has not been enough. India has received relatively lower level of FDI and in many cases particularly in power sector the actual inflow has been far less than the approvals given.
Today the foreign private investors have a choice to invest in various developing countries vying with each other to attract such investment. What matters with the investors are the incentives and expected returns, risks and securities and the procedural time taken in clearances, controls etc. Many of the foreign investors would not like to tie down expensive skilled staff resources for long periods, waiting for the project to be awarded, contracts to be signed and other procedures to be completed before they can achieve financial closure.
Foreign investors are concerned that private sector development and investments in a host country should be underpinned by the rule of law. The legal system of each country should facilitate easy flow of investments. A greater uniformity of investment rules is needed, to provide the actors in the development process with the confidence that they will receive justice and fair terms when rules are changed.
Another concern of foreign investors is the risk of adverse legislative change, particularly the imposition of discriminatory taxes or other discriminatory treatment and political changes when earlier laws, policies, agreements can be arbitrarily changed. The Complexity of tax laws is by itself a impediment to investment. Foreign investors are more concerned about the threat of adverse change over the long term period than about the attractiveness of short term incentives.
The main sources of international finance are the following:-
Multilateral Institutions
Institutions like World Bank, IFC-Washington, ADB and Commonwealth Development Corporation(CDC) have traditionally been financing infrastructure projects in developing countries. The financing comes with restrictive convenants, affordable cost, long tenure (of usually more than 7 years) and in an assured manner. The co-financing facility extended by some of the multilateral institutions is gaining popularity. In many of these loans, sovereign guarantee is required.
Export Credit Agencies (ECA)
ECAs are important sources of bilateral funding. Credit is provided by ECAs such as, US Exim Bank, Exim Japan, OPIC-USA,ECGD-UK, etc. ECAs have a long history of providing cheaper finance for all types of power equipments, which is purchased from the respective country. There are certain limitations in ECA financing like exposure limit, exchange risk transfer to IPP, limitations of funding to 85% of equipment in many cases, guarantee requirements and cost of insurance etc.
External Commercial Borrowings (ECB)
These include Yankee Bonds, Samurai Bonds, Dragon Bonds, Euro currency syndicated loans, US 144 A Private Placement, Global Registered Notes (GRNs),Global Bonds, Medium Term note programme(MTNs).
Credit from Foreign Banks
Many foreign banks are helping to provide term loans/funds. In some cases, these funds may be linked to purchases/supplies from the respective countries.
Syndicated Loans
The special features of syndicated loans are that they are available for medium to longer period; specific to the requirements of the borrowers to suit their projects, and availability of floating rate of interest. Most of the investors are Asian/European Banks, Fls, Insurance Companies and pension funds.
US Rule 144 A Private Placement
Rule 144 A allows for private placement of debt to financial institutions known as QIB without the kind of stringent disclosures requirements needed for equity issues. Long tenure of bonds and less restrictive convenants make this proposition conducive for financing power projects.
Global Depository Receipts (GDRs)
GDRs present an attractive avenue of funds for the Companies. Companies can collect a large volume of funds in foreign currency through GDR issues. GDRs are usually listed in Luxembourg and traded in London in the over the counter market or among a restricted group such as qualified Institutional Buyers (QIBs) in the USA.
Equity/Credit from Suppliers/Contractors
In many projects, the equipment suppliers, EPC contractors can join hands with promoters and participate in the equity. In many other cases they can provide credit on their own or arranged through banks/investors.
The flow of foreign private investment to developing countries is also related to the global capital markets and economic situations in recipient countries. The turmoil in global markets and economic situations in some of the countries in the region is well known. It has adversely affected the flow of foreign investment, both in terms of quantum of funds as well as cost of funds, besides many other problems including risk coverage.
RISKS IN FINANCING OF PRIVATE PROWER PROJECTS
Project Risks
With the large capital outlay and long gestation period, the risk levels in power projects are quite high. Various risks involved are :

Project implementation risks, including geological risk
Operational risks-including fuel supply risk
Commercial risks
Political risks

Some of these risks have to be borne by project promoters while for some like fuel supply, necessary commercial arrangements to pass through to buyers of powers and security mechanism are generally considered.
Exchange Rate and Risk Management
Exchange rate fluctuations may affect international loans sizeably and necessary precaution has to be taken into account. Various risks like currency risk, commodity rate risk and interest rate risk may arise in the market.
Risk management is a way of insuring against future exchange rate, interest rate and commodity price changes. Emergence of Derivative tools like hedging forwards, options, futures, and swaps, etc. are in a way help in risk management.
Security Package against Risks.
The major risk , as perceived by private power projects is the risk relating to low credit worthiness of State Electricity Boards who will purchase power from IPPs. The initial policy framework provided for a Central Govt. counter guarantee for payments for power purchased from the seven "Fast Track" projects. This is not available for other projects. In the absence of Central Govt. counter guarantee, following alternatives have often been suggested :-

Direct supply to HT customers
Revolving L/C and Escrow account with Utility
Escrow with FI counter guarantee
Linking generation with distribution
Escrow with charge on central government devolution of state govt. funds
Supply to the Power Trading Corporation backed by a security mechanism.

However, the major problem and limiting factor is the escrowable capacity of the state power utilities due to their poor financial health. There is no alternative but to improve the financial status of these utilities through necessary reforms which help in cutting losses, increasing efficiency, ensuring quality, adequate tariff and return on investment.
ROLE OF PFC FUNDING OF POWER PROJECTS
Power Finance Corporation(PFC) had in the past been providing financial assistance mainly to the state power utilities. Since 1998-99 it has started lending to the private sector. From a lending level of about Rs. 800 crores in 1994-95, the Corporation increased the disbursement to about Rs. 2500 crores in 1998-99. It has projected a level of over Rs. 5,000 crores by the end of 9th Five Year Plan. The Corporation has raised bonds in domestic and international markets at very attractive rates. The interest rates charged by the Corporation are very competitive, in fact the lowest for the power sector among all Fls.
The Corporation is giving highest priority to renovation, modernisation, life extension and upgradation of existing generation projects system improvement, environment related projects and completion of generation projects which have been held up for want of adequate funds. All these are expected to yield benefits in a short period of next 2-3 years.
The Corporation is giving next priority to hydro power generation and transmission/distribution projects. The interest rates charged by corporation are linked to the type of projects, being lowest for the highest priority projects such as R&M system implemented etc. and it gradually increases for other types of projects.
The Corporation has adopted a three pronged approach in increasing its operations. Firstly it is now using all instruments for financial assistance including term lending, leasing, bill discounting, guarantees etc. Secondly, it has widened the scope of projects to cover all types of power projects and power associated projects which may be in other related sectors. Thirdly, it has widened the clientele base to cover all types of borrowers. The Corporation follows a well established appraisal system which goes in details of the viability of the projects and credit worthiness of the borrowers.
As mentioned earlier, one of the main reasons for the slow progress has been the poor financial health of the state power utilities (State Electricity Boards) which would be the main buyers of the power from these IPPs. Majority of these utilities are faced with high transmission and distribution losses, low efficiency and low tariff compared to cost of supply (particularly in the agricultural sector). Power Finance Corporation has been working towards effecting improvements in the state power utilities by marking such improvement action plans like Operational and Financial Action Plan (OFAP) as a condition of loans to them. Though earlier there was some improvement in some State Electricity Boards, the situation has worsened recently and it has been utilities, it will be difficult to make them financially viable and to attract the private investments in power sector.
The World Bank and Asian Development Bank have been working with a few state power utilities, using the leverage of major loans, for initiating major reforms. Three states (Orissa, Haryana, Andhra Pradesh) have already gone ahead with such reforms with the help of World Bank, involving setting up to independent Regulatory Commissions, unbundling and privatisation of distribution. Two more states (Rajasthan, U.P are expected to take up reforms with the help of World Bank. Two states (Gujarat, M.P. are expected to take up reforms with the help of ADB. Another eight states have committed to take up similar major reforms with the help of PFC. Remaining states are also expected of follow suit as reforms are inevitable for the development of the power sector. It is expected that the reforms in state power sector will ultimately lead to financially viable utilities both in public and private sector and will help in accelerating private sector investment in IPPs, transmission and distribution. This will help in filling the gap between demand and supply of power and also improve the quality of supply to consumers, at the same time reducing the cost of supply through better performance, higher efficiency and cutting down losses.