Power sector NPAs: A crisis too near

The impact of non-performing assets (NPAs) of Indian banks extends far beyond the financial sector and poses a serious threat to our political economy and to society. Resources are indeed being channelled to address the issue, but our apparent inability to resolve the problem is a massive drag on the economy. The reasons appear to be inherent contradictions, poor understanding or incompetence, and piecemeal, not cohesive, decisions. The latest turn concerns the power producers’ petition for extending repayment deadlines.

Recall that NPAs rose from 2011 when they were 2.5 per cent of loans, because of overleveraging after a high growth period (2004-05 to 2007-08). Corporate debt invested in [long-gestation] infrastructure projects encouraged by the government (power, mines, auctions for spectrum and coal) resulted in investments as a percentage of gross domestic product (GDP) rising from 27 per cent in 2004-05 to 38 per cent in 2007-08. Bank credit doubled during this period.

Then two things happened: The price of oil and other imports increased 2.4 times between 2010 and 2014. The rupee dropped sharply against the dollar, increasing foreign borrowing costs. Domestic borrowing costs also rose by as much as eight per cent by mid-2016. Additional problems surfaced in project implementation such as in land acquisition, environmental and other government clearances, and fuel supply.

By 2013, nearly a third of Indian companies had interest cover less than one (ICR1), with annual earnings before interest and tax less than interest expense. By 2015, this had risen to almost 40 per cent. Overall, there was insufficient cash flow generated to service debt from 2014, and NPAs rose from 2.5 to 11.6 per cent by March 2018, and could be 12.2 per cent by March 2019.

When the RBI initiated a hard line on NPA classification in 2016, the evergreening of loans stopped abruptly. However, chronic delays in payments by state distribution companies, problems with fuel availability, and lags in tariff changes continued. In addition, the slowing economy with a number of power projects coming on stream resulted in an apparent oversupply. 

The Allahabad High Court (AHC) order on the power producers’ petition reflects many contradictions, perhaps arising from inadequate presentation of the financial aspects. The order denies the petition, but allows that the petitioners may “apply for urgent interim relief if need so arises” (paragraph 135). It instructs the government to consider intervention under Section 7 of the RBI Act (instructing the RBI to extend repayment time) within 15 days. Separately, a committee set up by the power ministry as recommended by the Standing Committee of Parliament on Energy (SCOPE) is to submit its report within two months from the date of constitution.

Notably, except for a brief section in the 124-page order, the elephant in the room, cash flows and their effects, are entirely absent from the presentation and the judgment. The section begins: “It is expected that the banks will have sufficient avenues to raise additional capital so as not to face any capital constraints”. If only that were true!

Illustration by Binay Sinha
The AHC appears unaware of the magnitude of our financial predicament, of an immediate and pressing need for relief, and of the extent of damage to the power sector, the banking system and the economy as a whole from the lapses in control and performance over many years (not only in power), because of blundering and wrangling. The latter began with the RBI applying a guillotine in classifying NPAs, and extends to the minutiae of administrative and regulatory procedures (such as the government seeking a repayment extension for the producers from the court, while remaining adamant that bankruptcy procedures be applied rigorously across the board). 

One observation defines the unresolved contradictory circumstances: “These NPAs were always there. We are now recognizing them.”The judgment acknowledges the validity of arguments against the application of the RBI directive on NPAs, such as the report of the SCOPE and testimony of the Ministry of Power, as also that extraneous reasons such as flawed implementation of regulations, a fuel supply crisis, inadequate power evacuation systems, and delinquent payments eroded the financial stability of the power sector.

Despite the Additional Solicitor General seeking another 180 days for the petitioners to repay, and the chairman of the State Bank of India and of the Rural Electrification Corporation opining that the RBI’s stipulation of 180 days is insufficient, the judgment cites three compelling reasons for denying the petition:

a) The contradictory stand of the government in seeking time for the petitioners while supporting the RBI's directive on NPAs, noting that the government "must no longer remain ambivalent or inert".

b) The AHC’s interpretation that the RBI's directive under Section 5 (b)(i) requires all lenders to approve a Restructuring Process (RP), whereas under the Indian Bankruptcy Code, approval is needed from only 66 per cent of lenders.  The RBI could demonstrate that this interpretation is incorrect, or explain why all lenders need to approve.

c) The delay in the RBI’s notification of credit rating agencies (CRA) (May 21, 2018), whereas the 180-day deadline for the RBI directive began on March 1, 2018 (Rs 80 days earlier). [An RP requires an independent credit evaluation by an authorised CRA]

The order states: "Ultimately what has weighed while arriving at this conclusion is the absence of lenders before the Court, their individual views not being known and the serious issue of the health of the financial sector of the country and its overall impact on public debt. Measures adopted to address such complex economical issues must at present, be left to the wisdom of experts."

While many areas in India are chronically short of power, there is apparently excess overall capacity. Meanwhile, states renege on power purchase agreements for cheaper electricity on spot markets, resulting from aggressive bids for solar and wind projects. This results in sound projects run below capacity because of the inability of distribution companies to pay, while financial gambits disrupt the generation market through low bids. Besides the banks, a number of large projects are in jeopardy. There is no substitute for cohesive, end-to-end policies and the resolution of internal contradictions.