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Tuesday, Dec 07, 2004

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Powering projects with forex reserves

S. Padmanabhan

In the power sector, the equity investment climate has always been buoyant. But the expected investment has not flowed into this area because of viability and bankability issues. Once deficit financing reaches out to strengthen these areas, equity and debt investments will start, says S. Padmanabhan.

THE Planning Commission Deputy Chairman, Dr Montek Singh Ahluwalia, has proposed that a part of the country's $119-billion foreign exchange reserves be used for infrastructure development by setting up special purpose vehicles (SPVs) — both in the public and joint sectors — in which the Reserve Bank of India would invest funds against long-dated securities. These funds will be invested in projects to build infrastructure facilities. Where necessary, the funds would be used to buy foreign exchange from the country's reserves. This, in effect, is direct deficit financing, as the RBI buying the securities would amount to printing new money.

This is a welcome proposal as many developing countries, such as China and Taiwan, have resorted to such financing to achieve growth — China used more than $45 billion of its reserves to support the capital of state-run banks and Taiwan more than $10 billion to refinance infrastructure projects.

The key issue is to prioritise the areas of investment. In the power sector, the equity investment climate has always been buoyant for the foreign investors as well as the Indian public and private sectors. Indian and foreign banks also have been more than willing to finance "viable" and "bankable" power projects. Given the phenomenal rise in bank deposits and the country's stable credit rating , the abundant liquidity in the system will ensure that new power projects will not need any deficit financing by the RBI.

The growth in this area, however, has not been significant due to the "viability" and the "bankability" issues. State utilities have not been able to rid the projects of credit and market risks and there have been huge defaults by the States in honouring commitments under the PPAs (power purchase agreements).

Therefore, it is necessary to strengthen the areas prone to credit and market risks so that the projects become bankable and viable. Once deficit financing reaches out to strengthen these areas, equity and debt investments in this sector will start automatically flowing in.

What are the areas crying out for deficit financing? Energy security and providing the optimum fuel mix is the most critical sector. Even at lower crude price levels, some States defaulted on the PPAs of several large projects with naphtha and diesel as fuel. The natural gas-based projects, which survived because of the concessional pricing by GAIL, will be at stake if the natural gas PSU resorts to market pricing.

LNG has proved uneconomical and could be impacted by rising crude prices. Even rich countries like Japan cannot afford LNG linked to crude prices. It is, therefore, necessary for New Delhi to build an economically prudent fuel mix for the power sector. Coal alone can be a viable low-cost option in the long run to sustain the tariff pressures.

Coal India needs large investments to modernise its mines to improve efficiency and productivity. Large-scale coal beneficiation washeries are the need of the hour to make domestic coal a more acceptable fuel.

Privatisation of the coal-mining sector has not attracted much interest because of the long gestation in addition to the large scale of investments required. There has to be large-scale investment in this sector in the coal States of Bihar, Jharkhand, Chhattisgarh,West Bengal, Madhya Pradesh and Maharashtra.

Ash disposal is a serious environmental issue. To minimise ash generation as well as to increase productivity, it is necessary to use imported coal along with domestic coal. To provide for long-term supplies and price stability it would be ideal if Indian companies owned captive coal mines abroad. There is much untapped potential in Indonesia, Australia and South Africa. But an acquisition exercise would need huge funds that can be provided by the RBI through the suggested scheme. The international sea freight of coal soared from a long-time level of $9-10 per tonne to a peak of $45-55 a tonne and still remains significantly high, making imported coal an inefficient long-term fuel. The basic price of coal at foreign ports has remained stable at $19-22 a tonne over the past several years. To retain the transport and freight costs at stable and low levels, it is necessary to build a large, state-owned shipping fleet dedicated to the transport of imported coal. This will provide electricity at a stable tariff in the long term. The burgeoning forex reserves can be used to build a large coal transporting fleet.

The transmission sector too needs large investments. The practice of setting up projects all over the country is not economical. Coal projects must be set up at pitheads or near sea-ports, where domestic or imported coal can be brought in easily. It is easier and cheaper to transport electricity than its fuel.

The Electricity Act 2003 and the lack of controls will see large investments in this sector. This would need large-scale investments in the inter-State transmission segment. Because of various factors such as right of way for land access, and so on, standalone private transmission companies are a distant dream and, hence, there may be no other option than to allow the Power Grid Corporation of India (PGCIL) — alone or in JVs — to handle these issues, with the capital provided by the RBI.

Hydel projects would form an important component of the power policy mix that aims at a long-term, low-tariff regime. Huge potential exists in the North-East; this will need not only investment in the generation sector but also transmission of the generated power to the mainland.

A key element of the hydel power and transporting sector will be the river-linking project across the country. A task force has conservatively estimated this at Rs 1,60,000 crore. Providing funds to the hydel sector and interlinking of rivers are perhaps the most important priorities in the next few years. Helping the States with long-term financing in certain areas is of great importance. These include:

(a) supporting them for the subsidy provided to the agriculture and the poorer sections of the society;

(b) underwriting revenue losses arising out of the petro fuel-based projects to honour PPA commitments;

(c) buying out and closing the high-cost, high-tariff projects

(d) putting in place intra transmission projects to improve efficiency of the system to drastically reduce transmission losses

(e) providing new and replacing existing distribution lines which have become inefficient and/or dangerous to the users

(g) changing over to a suitable system, such as transformer-based consumption accounting system, to make the SEBs more accountable for thefts and misuse (h) renovation and modernisation of the State sector power projects which are functioning at sub-optimal levels, and last,

(i) providing a safety net for the employees of the State electricity boards to ensure that the human resource issues of the reforms are appropriately addressed.

Rural electrification is another area that needs immediate attention for financing. Distributed generation and setting up independent rural feeders are two areas that need attention. Thousands of villages and hamlets which need electrification cannot be economically accessed by transmission and distribution systems that are primarily urban-based.

It will be economically viable to set up standalone generation centres in such villages linked by localised distribution systems — all of it managed by the local community — and delinking these villages and hamlets from the national transmission network. This will ensure that the local and small communities do not have to bear the cost of the urban-based infrastructure.

Priorities and targets need to be set for investments in these sectors. While the fund requirements are indeed enormous, domestic and foreign investors will put in funds once the Government shows its willingness to progress on the lines suggested and initiates policy and regulatory changes to allow such financing.

All the measures described are productive and, in the long term, will bring substantial gains to the economy without setting off any of the inflationary pressures normally associated with deficit financing.

(The author, a power consultant, can be reached at

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