The Indian Power Sector has been weighed down by the political and regulatory environment along with theinefficiencies of the State Electricity Boards (SEBs) and chronic shortages and pressures to meet demand.This has deterred private investment from flowing into the sector. The government's first stab on this i.e. the1990s strategy of bringing in global sponsors to build Independent Power Producers (IPPs) was notparticularly successful and Dhabol plant left a bad taste in everyone's mouth. But with the passage ofElectricity Act 2003, new rays of hope have opened for growth. The Electricity Act has an overall positiveimpact on the profitability of the power sector and encourages investment and efficiency. The new powerstrategy visible in India has much more of a domestic flavour even though bidding is open to foreign players.The government is keen to attract significant private capital into its power sector, which is facing a hugedemand-supply gap. Badly affected states such as Maharashtra have 19% energy shortages, and this canrise to 27% peak power shortage levels. This power shortage is holding back industrial growth andcorresponding economic development, and the World Bank has estimated that if India is to sustain currentGDP growth levels in the 8% to 9% per annum range, it will need to add 160,000 MW of generating capacityover the next 10 years. The basic template evident is domestic sponsors raising cash on the stock market,and using this source of funding as the project equity component for competitive bids. In this newenvironment, Project Finance will be the key financing mechanism for growth. Also the investment will haveto be directed towards all the components of the electricity delivery chain i.e. Generation, Transmission andDistribution. This would help India to overcome the bottlenecks in the long neglected Transmission andDistribution segments. The financing also needs to move to the next level of Public Private Participation withthe Financial Institutions providing equity to the sector and not just debt. The sector also needs incentives inthe form of lower duties, tax holidays and measures such as a higher return on equity (RoE) to attract moreinvestments. Payment risks associated with SEBs which has been a major concern for IPPs have overcometo some extent with SEB restructuring and improvement in the security and payment mechanismsarrangements. But a word of caution needs to be attached to this optimistic view as the efficacy depends onthe commitment of the Centre and State machinery to the reforms process. Except for the limited success bya few generation companies in accessing the debt market, transmission and distribution utilities have notmanaged to raise debt successfully from the open market. The availability of easily accessible debt fromgovernment backed financial institutions like the Power Finance Corporation (PFC) and the RuralElectrification Corporation (REC) has had the effect of "crowding out" the development of a private debtmarket. It is therefore important that these institutions scale down their activity, and confine themselves tothe smaller and weaker utilities. The state utilities are too cash strapped for internal resources to be of anysignificance. Given the excellent commercial potential of merchant power plants, the equity market is a goodsource of raising funds. In any case, the Indian equity and especially debt market is too narrow and does nothave the required depth and breadth to finance these huge requirements. It is therefore inevitable thatForeign Direct Investment (FDI) be incentivized, so as to meet the huge investment requirements.
7Project Financing
The Indian economy is poised for higher economic growth in the years to come. This willrequire large investment in the infrastructure sectors including the power sector. TheNational Electricity Plan of India aims to provide access to electricity to all households by2010 and to meet all shortages by 2012. This will require an investment of around USD200 billion to finance generation, transmission, distribution and rural electrification projects.
During the 1990s, up to 80% of power sector funding came from the public sector,followed by the private sector (10-15%) and official development assistance (5-10%).Increasingly, both the central and state governments are facing the need to meetcompeting budgeting requirement from other social sectors such as health and primaryeducation. The need for enhanced fiscal discipline and macroeconomic stability is alsoplacing a limit on borrowing capacity of the government both at central and state level.Given the limited fiscal space for budgetary support for such investments, greater privatesector participation is inevitable. Inefficiency, administrative bottlenecks and poor andinadequate infrastructure facilities, in particular continued shortage of electricity in Indiaunder public ownership has necessitated enhanced private participation in the sector.
Power sector reforms have been initiated in India with the aim of creating an enablingenvironment for private investment thereby helping to bridge the gap in publicinvestment. Persistent power shortages, inadequate public investment and the economiccrisis faced by India in the early 1990s led to the opening up of the power sector toprivate investment and major policy initiatives were undertaken to encourage private andforeign investment. The investment climate was further strengthened through gradualrestructuring of the state electricity boards (SEBs) and initiation of regulatory reforms atthe central and state level. More recently, enactment of the Electricity Act 2003 includesenabling provisions for enhancing competition in the sector and to improve theenvironment for private participation. The abolition of the single buyer model and phasedaccess to consumers has unlocked substantial potential for private investment in the sector.
7.1Types and Sources of Finance
7.1.1 Debt
Given the capital-intensive nature of power projects, mobilization of long-term debtbecomes critical to the development of power projects. Project finance debt is generallysecured by projects assets such that after paying operating expenses, debt and debtservice is paid from cash flows. Debt typically constitutes up to 70% of the power projectcosts in India. The type of debt used in power projects finance structures has beenvaried. The following are some of the sources of debt available to power projects developers:
Government:
Traditionally, the main source of debt has been the government. Both the centraland state governments lend the money to utilities from time to time for expansionplans or working capital. They extend loans for longer tenure and at lowerinterest rates than commercial rates.
Multilateral Agencies
In the past, multilateral agencies have funded expansion plans of central utilitiessuch as NTPC, NHPC or PGCIL. In the mid-nineties, they switched their focusfrom lending to support power sector reforms in states aimed at mobilizinginvestments and increasing economic efficiency. The have funded restructuringand reforms efforts of SEBs. The tenure of these loans typically ranges from 15-25 years, with moratorium of five years. However, the investments yielded limitedresults, with the state governments faltering on the milestones attached to thefunding. Subsequently, the agencies discontinued lending to state reformprogrammes. In the last couple of years, these agencies have shown greaterconfidence in the sector, mainly due to Electricity Act 2003 and follow-up policies.Majority of the funds from these agencies are still provided to Central Public Sector Undertakings (CPSUs).
Commercial Banks and Financial Institutions
Commercial banks and Financial Institutions (FIs) have consistently increasedlending to power sector in the last 4-5 years. Most of the lending has beenskewed towards the generation segment. With the opening up of the T&Dsegment to the private sector, commercial lending is likely to increase in future.For generation projects, the standard tenure of loans is 13-14 years, whichincluded construction period and repayment period of 10 years.
Earlier the lending use to be under recourse financing, but in the last 4-5 years,the lending institutions have become more liberal and comfortable with lending tobankable power projects.
Although, commercial banks and FIs continue to increase their exposure to thepower sector, individual exposure of banks to the sector remains limited. This ismainly because they are still constrained by financing limits as per prevalentprudential norms prescribed by the Reserve Bank of India (RBI).
Niche Institutions
There are also niche institutions such as Power Finance Corporation (PFC) andRural Electrification Corporation (REC), which provide loans specifically to powersector. While PFC provides loans for all kinds of investments, REC focusesmainly on rural electrification. The state sector's reliance on these institutions fordebt is very high mainly due to the competitive rates and liberal terms andconditions offered by them.
In the recent past, due to their experience and expertise in the sector, theseinstitutions have been competing with commercial banks. Moreover, since issueslike asset-liability mismatch and exposure limits are not applicable to PFC andREC, it is easier for these institutions to lend to the sector.
Insurance Companies
Insurance companies like the Life Insurance Corporation of India (LIC), GeneralInsurance Corporation of India (GIC) have extended financial support to thepower sector. There are limits on the investments prescribed by the InsuranceRegulatory and Development Authority of India (IRDA). Life insurance andgeneral insurance companies have to invest at least 15% and 10% of the fundrespectively to the infrastructure and social sectors.
External Commercial Borrowings
External commercial borrowings (ECBs) were quite a popular means to raisefinances until some time back, especially for large projects funding. These loansare raised at Libor-plus rates, which are generally lower than the interest rates inthe domestic market. ECBs have declined of late due to RBI restrictions onforeign funds flows for rupee expenditure and due to an increase in borrowingcosts as a result of the sub-prime effect.
Export Credit Agencies
Loans from export credit agencies are cheaper than commercial loans and aregenerally used when equipment needs to be imported from a particular country.These are likely to gain importance in the medium term mainly fuelled by therequirement of importing super-critical units in the eleventh and Twelfth planperiods, and until this demand is met by the domestic market.
Bonds
Several utilities and state power corporations have resorted to issuing bonds toraise funds. These are generally subscribed by provident and pension funds,gratuity trusts, insurance companies, mutual funds, individual, etc. These bondstypically have tenure of 7-8 years.
7.1.2 Equity
The equity in power projects, like in other projects, is driven by the rate of return that isexpected from the investment apart from acting as a cushion to project finance. In thepower sector, the return on equity is fixed at 15.5% on 30% of the equity investment.The sources of equity are promoter's equity, internal accruals, equity funds and strategicequity investors. Raising funds from capital markets is also becoming increasinglypopular. The following are some of the sources of equity available to power projectdevelopers:
Promoter's Equity And Internal Accruals
Most project developers invest some amount of the total project cost aspromoter's equity to be able to earn the minimum return on equity and raise therequired debt. Many CPSUs, including National Thermal Power Corporation(NTPC) are increasingly relying on internal accruals for investing equity in newprojects.
Primary/Capital Markets
In recent times, power sector companies have been raising funds from primarymarkets through Initial Public Offerings (IPOs). Almost all IPOs of powercompanies in the last two to three years have met with an overwhelmingresponse from investors or have been performing well in the stock markets.Some of the successful IPOs have been those of CPSUs like NTPC, and PGCIL,private developers like Suzlon Energy, JP Hydro and Reliance Power andinfrastructure companies like GMR, GVK and Lanco. Many power companies areexpected to launch their IPOs in the coming years. NTPC is also planning tocome out with a follow-on public offer.
Qualified Institutional Placements
Another source of equity, which is increasingly being tapped by power sectorcompanies, is private placement with qualified institutional investors. Forinstance, GVK Power & Infrastructure Limited (GVKIL) and Kalpataru Power
Transmission raised USD 300 million and USD 85 million respectively throughthis route in May 2007 and September 2006 respectively. PTC India also raisedaround USD 29 million through this route in January 2008 by allotting shares toinstitutional buyers like LIC and Morgan Stanley, among others.
Equity Funds
Specialized equity funds such as India Development Fund by InfrastructureDevelopment Finance Company (IDFC) have been set up to invest in equity inprivate sector power sectors. The India Power Fund by PFC which was expectedto be launched in 2004 is however, yet to start operations. India InfrastructureFinance Company Limited (IIFCL), Citigroup, Blackstone have also instituted aUSD 5 billion India infrastructure financing initiative for investing in infrastructureprojects. The Anil Dhirubani Ambani Group and Singapore's Temasek Holdingsconstituted the Reliance India Power Fund with equal contributions.
Others planning to set up infrastructure funds, which would pick up equity inpower projects as well, include a USD 2 billion infrastructure by ICICI bank, theUSD 1 billion Macquarie India Infrastructure Opportunities Fund by Macquarieand International Finance Corporation (IFC), a USD 1 billion India focusedinfrastructure private equity fund by Standard Chartered and IL&FS InvestmentManagers and a USD 2 billion India Infrastructure Fund by JP Morgan andChase Company. PTC India's investment arm PTC Financial Services also plansto pick up equity in power projects through an Energy Equity Fund.
7.2Trends in Power Sector Financing
Increased investor confidence resulting in commitment and disbursement of
more funds
IPP revival triggered by increased investor confidence
Gradually increasing interest rates leading to increased project costs
Increased availability of longer-term debt
Skew towards investment in generation continues
External Commercial Borrowings (ECB) loses sheen as RBI tightens norms
As local capital market mature, more companies are opting for IPOs
Lenders no longer demand government guarantees, counter guarantees.
Bankable and competitively priced projects are able to raise funds easily.
Project financing criteria relaxed by financiers for new types of projects.
Promoter's track record is a important consideration
7.3Key Power Financing
Power companies continue to raise funds through a variety of vehicles including publicoffers, bond issues and debt syndication. Multilateral agencies have shifted back to utilityfinance. Commercial Banks and FIs have also increased lending to the sector apart fromPFC and REC. The IPP segment has seen renewed vigour
7.3.1 Financial Closures
Over the last year and a half, over 8,000 MW of private sector power projects have
achieved financial closure. Some of those projects are as under:
1,200 MW Rosa power project in Uttar Pradesh being developed by Reliance
Energy Limited.
500 MW Teesta VI hydro project in Sikkim being developed by Lanco Infratech.
1,200 MW imported coal based power project at Ratnagiri, Maharashtra being
developed by JSW Energy.
330 MW Shrinagar hydro projects in Uttarakhand being developed by GVK.
1,015 MW coal based Nagarjuna power project at Mangalore, Karnataka being
developed by Lanco Infratech and Nagarjuna Group.
1,000 MW Karcham Wangtoo hydro project being executed by Jaypee Group.
1,200 MW Teesta-III hydro project being executed by Teesta Urja Limited.
540 MW captive thermal power project at Chandrapur, Maharashtra being
developed by KSK Energy Ventures.
1,000 MW lignite based power project in Rajasthan being developed by JSW Energy.
7.3.2 Central Sector Project Financing
In the past, NTPC and PGCIL have raised funds in the form of equity and debt. Theirequity component includes internal accruals, government budgetary support and jointventures (JVs), while the debt component comprises private placement of bonds, marketborrowings from FIs and niche institutions and loans from multilateral agencies. Thefollowing are the details of some of the recent financings:
NTPC
In September 2006, NTPC entered into a loan agreement of USD 300 million with AsianDevelopment Bank (ADB) under latter's complementary finance scheme for Sipat andKahalagaon Stage II projects
In February 2007, NTPC received a grant of USD 12 million from the ministry toimplement 14 distributed projects. The grants were given under the Ministry ofPower's Delivery through Decentralized Management (DDM) scheme.
In March 2007, NTPC signed a loan agreement of USD 100 million with KfW topart finance the expenditure on R&M of NTPC plants. This is the first loanprovided by KfW directly to NTPC.
In July2007, NTPC signed a MoU with ADB to set up a JV for renewable powergeneration. NTPC and other government entities will hold 50% stake, whilestrategic investors will hold the remainder. ADB is expected to acquire 20% stakeat a later stage. The JV is expected to hold a portfolio of about 500 MW ofrenewable generation over the next three years, the initial focus being windpower and mini and micro hydro power projects.
PGCIL
In 2006-07, PGCIL undertook capital investment of USD 1.5 billion. Of this itmobilized USD 1 billion through private placement of bonds and the balance frominternal resources and multilateral agencies.
In the past, World Bank has extended USD 450 million as loan to PGCIL forPower grid System Development Project II in 2001 and USD 400 million forProject III in 2006. Other multilateral agencies such as ADB and JBIC haveextended a USD 400 million in 2004 and USD 3.14 billion in 2005 respectively toPGCIL.
For funding its future projects, PGCIL is negotiating with the World Bank and
ADB for loan assistance of USD 600 million each
Major Financiers in Power Sector
Power Finance Corporation
Rural Electrification Corporation
World Bank
International Finance Corporation
Asian Development Bank
Japan Bank for International Cooperation
Kreditanstalt fuer Wiederaufbau
Department of International Development
India Infrastructure Finance Company Limited
Infrastructure Development Finance Company
Life Insurance Company
Punjab National Bank
ICICI Bank
IDBI Bank
State Bank of India
SBI Capital Markets
Risks associated with Indian Power Sector
Historically, since its commencement of economic liberalization in 1991, India'sincreasingly insatiable power needs, along with its general trend toward economicliberalization, led to much interest among foreign investors in establishing IPP projects inIndia. While dozens of projects were approved, and the foreign and Indian privatesectors constructed several such power plants between 1992 through 2004, most of thelargest projects have been stalled by considerable payment risk issues. A number offactors in the power sector hampered IPPs from attaining financial closure. Thesefactors include, but are not limited to, the following:
Lack of credit worthiness of the SEBs
Substantial cross-subsidies and politicized tariff setting
Inadequate off-take and payment guarantee mechanisms
Inadequate fuel supply and transportation agreements, with the significant issues
involving how to cover risks between the SEBs, Coal /Gas supply
8.1Project Evaluation and Risks
A credit analysis on the sponsors is conducted for every project before finances can bearranged. These reviews are often conducted according to a process that differs fromone bank to another, but certain fundamentals are constant. Typically, a separate creditdepartment that uses a rigorous set of criteria to determine the creditworthiness of theproject, the sponsor, and the off taker performs the analysis.
Power has always been used as a Political handle in the country due to its widespreadeconomic implications both for the industrial as well as the agricultural sector. Thus themajor risks in the Indian Power Sector would be country, political and economic risks,lending risks and project risks. Also an analysis is warranted for company management.
The following risks are typical of the Indian scenario:
Permitting risk and Political opposition to the project
Inability to obtain a financeable power purchase agreement, either because thepower price is too low or the terms are not acceptable
Regulatory disapprovals and Change in law
Risk Mitigating Mechanism
To reduce the exposure to the financially weak SEBs and their business risk, the
mechanism relies on the IPP to establish multiple layers of security from the SEB and
the state government to support its power purchase agreement (PPA).
Irrevocable Letter of Credit by the SEB in favor of the IPP
A designated prime area escrow account
SEB reforms
PTC Power Purchases
State Govt. guarantee if applicable
Conclusions andRecommendations
It is necessary to appreciate that inspite of all the encouragement and reforms; thepower sector is still riddled with many gross uncertainties. Emerging economies such asIndia has therefore much to do and learn about the execution of the reform processes.The reforms process should be carried out in gradual steps and the sector should not beleft to market forces from the very outset. Financing of the power sector will involve athorough analysis of the risks involved and the following observations can be used forarriving on financing and investment decisions by lenders and private investors respectively.
9.1 Generation
Power generation is the only sector wherein the lenders insist for long termselling arrangement, whereas in other capital intensive industry like mining,petroleum, etc. there is no such expectation from the lenders.
Financial closure is achieved with certain tariff regulations and any changeduring implementation affects investors confidence and risk perception ofthe project.
Though the private sector has shown some interest in capacity addition,however, still major part of the capacity addition, has to come from central &state power utilities. Since neither central nor state governments are able toprovide budgetary support, all future capacities in the government sector willhave to be funded by the utilities out of their internal resources.
Utilities can generate the resources only through the tariff allowed. Therefore,tariff norms must consider requirement of resources to be generated in the sector.
The regulatory certainty for longer periods could attract investments.
The primary off takers of power i.e. the SEBs need to reform even if the process
at hand seems long and politically fragile.
The repayment risk from the weak financial standing of the SEBs should be
addressed with innovative payment security mechanisms.
There is still lack of alternatives in case the primary customer defaults.
Development of power markets would mitigate the risks.
Adequate rate of return considering the market expectation, risk perception and
need to attract substantial investment in the power generation
The major road block in financial closures is the lack of confidence in the powermarket structure and power utilities and payment security mechanism forrecovery from the purchasers.
Proactive support to merchant power capacity addition through facilitatory
measures such as timely fuel allocation and other clearance requirements
The perennial problem of lack of transmission infrastructure unless addressed at war footing, will not allow generation to achieve cost efficiency.
Transmission
With an increased awareness of transmission being the bottleneck in Indianpower scenario, a much more concerted effort on part of the governments,PGCIL and private players is the need of the hour.
The growth in the sector has been slow to begin with, with only few privateprojects taking off. The investor apprehension is due to the virgin territory ofinvestments.
The lender needs to get more involved in the strategic thought process of the
borrowers to gauge the risks involved.
The government on its part should identify and facilitate clearances incase of
projects for private sector participation.
Appropriate transmission pricing regime that provides right locational signals can
attract substantial investment in the power transmission.
Accountability needs to be fixed by Regulators to provide assurance about timely
processing of applications.
Augmentation of transmission capacity in line with generation capacity to ensure
a de-bottlenecked transmission system.
Transmission pricing and Wheeling Charges (including losses) need to be
addressed on commercial principles.
RoE for the sector should be based on the principles of sustainability and future
growth outlook through adequate public/private investments
The outlook is optimistic as the sector will involve huge investments in the future
Distribution
Total revenue in the power sector (including the revenue for generators, fuelsuppliers, transmission, and distribution) has to come from the consumers,channelised through Distribution/Supply Licensee and open access to theconsumers. Therefore, interface with consumers needs highest attention.
Preparation of Road Map for reduction of losses and cross subsidies through
efficiency improvements by way of privatization
Success and Strength of Distribution is the key for catalyzing investment in
power sector.
Power Distribution and Supply business need to be streamlined and
strengthened for catalyzing investment.
Separation of Distribution and Supply business
If power supply is to be subsidized, it should be done by the government and not
at the cost of others through cross subsidy.
Create awareness among Distribution Utilities; provide them appropriate Govt./
Regulatory flexibility and support
The Electricity Act, 2003 aims to bring in more competition in the power sector in India toincrease the efficiency of the system in general and the State Electricity Boards inparticular. Yet thus far, the pace and implementation of reform has not proved
uccessful in raising tariffs to cover costs, and although some states have madeprogress, work must still be done to improve abysmal bill collection rates. Therenegotiation and cancellation of PPAs in India reflected these failures of reform byforcing heavily burdened SEBs and regulators to squeeze private investors when facinga budgetary impasse, which was aggravated by political transitions. But unless the nextfew years continue corporatizations and subsequent privatizations of the SEBs, the goodintentions may never materialize. However, with the retreat of global energy investorsand contractors, well established domestic electricity and infrastructure companies suchas Tata and Reliance have partially filled the gap and may continue to hold thecompetitive advantage
The Ministry of Power needs to accelerate the development of the National Gridbecause the lack of Transmission capacity is harming the cost effectiveness of deliveredpower. As for financing the sector, the Inter-Institutional Group needs to start working onthe Public Private Participation model wherein the Private entrepreneurial skills areactively supported by public funds not just in the form of debt financing but also equityparticipation. Direct incentives should also be provided to the Independent PowerProducers in terms of lowering of Customs and Excise duties on project imports forIPPs. To improve the inherent financial viability of the sector the government needs tointroduce multi-year tariff regime to improve predictability of investment outcome andalso eliminate cross subsidies that hamper rationalization of tariffs.
