More fundamental reforms must be undertaken, says Moody’s

The power sector will continue to be a source of asset quality risk for public and private sector banks in India if the financial condition of State electricity board distribution companies (discoms) do not improve through structural reforms, says Moody’s Investor Service.

The poor financial health of discoms in India is one of the key factors weighing on the asset quality of Indian banks, says the credit rating agency in its report, ‘Indian Banks: Exposures to State Electricity Board Distribution Companies.’

So far, these problems have almost exclusively affected public sector banks, which represent more than 70 per cent of total banking system assets, and which are directly and indirectly exposed to the credit quality of discoms.

While loans to discoms form a relatively small portion of the overall loans, it is a much larger share of many public sector banks’ impaired loans.

Impaired loans

Impaired loans to discoms comprise more than 10 per cent of the total impaired loans at all public sector banks except State Bank of India; it is as high as 46 per cent for Oriental Bank of Commerce and 48 per cent for Central Bank of India. In contrast, private sector banks have almost no direct exposure to discoms.

The fundamental problem with discoms’ finances has been the uneconomical pricing of power sold. Discoms, on an average, lose money on every kilowatt-hour of power they provide to users, even after the government subsidies they receive are included, says Moody’s.

Discoms also suffer from significant operational deficiencies — both in technical terms and in collecting cash — in part due to the underinvestment in back-end support systems. On the technical front, transmission and distribution (T&D) losses are high, reflecting issues such as low metering efficiency and power theft. Even when the discoms accurately bill the end user for the power consumed, their ability to collect money is poor in many cases.

Moody’s said government measures taken over the last two years have provided temporary relief to the banks. These include the substitution of some impaired loans with government obligations and operational improvements in electricity distribution and tariffs.

However, Moody’s believes that the structural issues have not been fully addressed and unless more fundamental reforms are undertaken, discoms will continue to pose a threat to the banks.

“Worse, if the poor financial profile of discoms is not addressed, it could increase the risk of defaults by other borrowers in the electricity supply chain, especially power generating companies which are also creditors of the discoms.

“In turn, both public and privatesector banks are exposed to the power generation sector,” the rating agency added.

Meanwhile, government-owned financial institutions specialised in the provision of funds to the electricity sector — Power Finance Corporation and Rural Electrification Corporation (REC, Baa3 stable) — remain relatively insulated from risks.

This is because they benefit from a number of special protections due to their special status, including an escrow account structure that gives them the priority of claim over their borrower’s receivables.

(This article was published on June 18, 2014)
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