ICRA Rating Feature

STATE-OWNED ELECTRICITY DISTRIBUTION COMPANIES: Some positives, though several concerns remain...
Anjan Ghosh
HeadCorporate Ratings aghosh@icraindia.com +91-22-30470006

Sabyasachi Majumdar
sabyasachi@icraindia.com +91-124-4545304

ICRA estimates the losses for discoms (before accounting for government subsidy) in the country at Rs. 80,000 crore in FY 2012, up from around Rs. 63,500 crore in FY 2010. The estimate is based on our study of distribution companies (Discoms) functioning in eleven Indian states. ICRA expects the overall subsidy support for discoms at around Rs. 43,000 crore in FY 2012, which represents an increase of 13% y.o.y. from FY 2010. Taking the subsidy into account, the total book losses for discoms are estimated at Rs. 38,000 crore in FY 2012. As per ICRAs estimates, six states namely Uttar Pradesh, Tamil Nadu, Madhya Pradesh, Rajasthan, Punjab and Haryana would account for about 70% of the total losses in FY 2012. Such losses have largely been funded through bank borrowings (mainly short-to-medium term in nature) and stretched payments to power creditors, mainly stateowned generating companies. However, with increasing concerns over the credit quality of discoms, the availability of bank funding for such losses has been affected from FY 2012 onwards, thus resulting in a stretched liquidity position. This has affected debt repayments and resulted in delays in payments to power and fuel suppliers. Consequently, debt restructuring is being done for some of loans on the books of the discoms in the states of Rajasthan, Haryana and Uttar Pradesh. The ruling of the Appellate Tribunal of Electricity (ATE) is aimed at regulatory discipline by State Electricity Regulatory Commissions (SERCs) for timely and cost-reflective tariff determination. ICRA views this as a positive development. The Shungulu Committee has suggested measures to improve the viability of the distribution segment, which is critical for the entire power sector. However, ICRA expects the implementation of the recommendations to be particularly challenging, given that several stakeholders such as discoms, state governments and regulatory entities (SERCs) will have to be involved. ICRA has observed that tariff revisions have been carried out for discoms across many states for FY 2012. However, the quantum of hikes is well short of what is required for full recovery of costs in most states and is also accompanied by significant delays. Even with respect to tariff petition for FY 2013 and true-up for past periods (upto FY 2011), ICRA observes that petitions are yet to be filed by discoms in some states, which is against the spirit of the ATE ruling. Also, while Fuel & Power Purchase Cost Adjustment (FPPCA) principles have been implemented across states, they continue to vary with a significant lag period for recovery in some of these states, which in turn adversely affects the liquidity position of the discoms. Nonetheless, ICRA derives comfort from the fact that several states, including some of the most vulnerable ones, have obtained fairly stiff tariff hikes for FY 2012 or filed for

Girishkumar Kadam
girishkumar@icraindia.com +91-22-30470032

MARCH 2012

very large tariff hikes in a reasonably timely manner. Thus, the overall trajectory in terms of tariff trends is positive.

Key Trends & Concerns

We have assessed the key trends in the operating/regulatory environment and the financial position for discoms in eleven key states, which approximately contribute to about 82% of the overall power consumption in the country. These states are Gujarat, Maharashtra, Andhra Pradesh, Karnataka, Punjab, Haryana, Rajasthan, Uttar Pradesh, Madhya Pradesh, Tamil Nadu and West Bengal. Overall, the discoms in many states continue to face challenges arising from inadequate tariffs as compared with their cost of supply, rising subsidy dependence and high operational in-efficiencies.

Discom losses before accounting for subsidy support estimated at Rs. 80,000 crore for FY 2012
ICRA expects the overall financial losses (without accounting for subsidy) for the discoms in India to be at around Rs. 80,000 crore in FY 2012, which is an increase of 14% over FY 2010. As in the past, losses are contributed by several factors such as increasing subsidy dependence; inability to meet distribution loss levels as per targets laid by SERCs and rising power purchase expenses, which are not being passed on through tariff revision/FPPCA. In ICRAs view, these losses have increased in FY 2011 and FY 2012 as compared to FY 2010 because of higher power purchase costs and interest burden without commensurate tariff increases. After factoring in subsidy receivable from the respective State Governments, the overall book loss levels for FY 201112 are estimated at about Rs. 38,000 crore. About 70% of these losses are expected to be contributed by discoms in six states, namely, Rajasthan, Tamil Nadu, Uttar Pradesh, Haryana, Punjab and Madhya Pradesh, which consume around 40% of power in the country. The main reason for the losses is either limited or absence of tariff revision for prolonged periods besides inability to control distribution loss levels in some of these states.

Subsidy dependence for discoms estimated at about Rs. 43,000 crore in FY 2012
ICRA expects the overall subsidy dependence for discoms on an all-India basis at about Rs. 43,000 crore in FY 2012, which represents an 1 increase of 13% from FY 2010. Also, the overall subsidy dependence as a percent of revenues approved by SERCs for FY 2012 is significant at about 20%. However, this varies widely across the states : from a low of 5% in West Bengal to a high of 50% in Rajasthan. Given such high subsidy dependence for discoms, ICRA notes that timely and adequate receipts of subsidy from State Governments remains extremely critical for the liquidity profile of the discoms. There have been delays in many states such as Rajasthan, Punjab, Karnataka and Andhra Pradesh, which in turn, has adversely affected the financial and liquidity position of the discoms in such states. Given that the extent of subsidy declared by the State Governments towards certain consumer categories is unlikely to come down, timely receipt of subsidy would be a key factor in terms of liquidity profile.

This is mainly contributed by continued power supply at either heavily subsidised rate or free power (as per the State Governments directives) to agriculture category and certain small sections of domestic category and rising fuel and power purchase costs.

ICRA Rating Feature Large-scale restructuring expected

The losses of discoms have largely been funded through bank borrowings (typically short-to-medium term in nature) apart from delaying payment to power and fuel creditors with state owned gencos typically bearing the brunt of these delinquencies on creditors. ICRA expects the discoms in the most vulnerable states of UP, Tamil Nadu, Rajasthan, MP, Punjab and Haryana to account for over 70% of the total debt of discoms in India. However, with increasing concerns over the credit quality of discoms, the availability of bank funding for such losses was adversely affected from FY 2012, resulting in stretched liquidity situation, which in turn has led to increased levels of delays on payments to power and fuel suppliers. Consequently, debt restructuring is being done for some of the loans on the books of discoms in the states of Rajasthan, Haryana and Uttar Pradesh. ICRA believes that in some of the most vulnerable discoms, financial restructuring is thus inevitable, whereby, debt restructuring and support from State Government for cleaning up the balance sheets would be required apart from operational efficiency measures and timely tariff revisions for maintaining the sustainability of state utilities.

Tariff revisions in several states in FY 2012, although with delays

As may be seen in Chart 2, several states have seen tariff revision in FY2011. While this is a positive, ICRA notes that the bulk of these tariff revisions (for FY 2011-12) happened well after the due date which is 31 March 2011. Further, in some of the states such as Uttar Pradesh, West Bengal, Maharashtra, Karnataka and Madhya Pradesh, tariff/ARR petitions for FY 2012-13 and trueup petitions for FY 2010-11 (as per MYT regulatory framework) are yet to be filed with SERCs, whereas the same should have been filed by 30 November 2011. There have also been instances of roll-back of previous tariff-hike during FY 2012, as observed in the state of West Bengal, which led to adverse impact on the financial and liquidity position of its distribution utility. Such regulatory uncertainties cannot be ruled out for other states in the future. Also, the extent of tariff revision has been varied from as low as 0.4% to 24%; and is inadequate to meet the actual cost of supply in many states, thus resulting in large, uncovered revenue deficits.

Tariff hike required to cover existing revenue gap itself is on higher side; Further, unsustainable levels of regulatory assets cause concern in some of the states

ICRA Rating Feature

ICRA has observed that SERCs have not allowed full recovery of costs (including arrears for past years and return on equity (RoE) element) in several states in order to avoid tariff shock to consumers, which in turn has resulted in continued deficits. This uncovered revenue deficit, which is however recognised by SERCs and 2 proposed to be covered through future tariff hikes, is also termed as regulatory asset (RA) . As seen above in Table 1, tariff hike required so as to cover the existing revenue gap (i.e. gap between revenue requirement and cost of supply even without considering recovery of outstanding regulatory assets) for utilities remains on 3 4 significantly higher side for discoms in states such as Tamil Nadu , Rajasthan and Madhya Pradesh. As per provisions of the EA and ATE ruling, such RAs ought to be recovered over a three-year period. There has been substantial regulatory asset build-up for discoms in many states such as Tamil Nadu, Rajasthan, Punjab, Uttar Pradesh, Haryana, Delhi and West Bengal, resulting in huge debt burden to fund the deficits. Should SERCs provide for this, overall tariff-hike requirement would be even higher for FY 2013 than the above estimates resulting in a tariff shock. Under these circumstances, ICRA believes that recovery of RA is likely to be staggered over a much longer time horizon. In our opinion, this poses a challenge for SERCs for adequate tariff determination in these states, given the critical need for tariff revision to improve the financial position of the utilities, and also in view of the interests of the consumers to avoid any tariff shock.

ATEs directive to SERCs for timely tariff determination: a key positive development
The Appellate Tribunal for Electricity (ATE) issued a judgement in its order dated 11 November 2011 and in its judgement has directed all SERCs to initiate suo-moto proceedings for tariff determination in case of delays by the utilities in filing their tariff petitions. The key features of ATEs directive are mentioned in Box 1.
Box 1: Salient Features of ATEs Order dated 11 November 2011 It should be the endeavour of every State Commission to ensure that the tariff for the financial year is st decided before 1 April of the tariff year, for which tariff petition should be filed by the end of November of the previous year. Truing-up should also be an annual exercise. In the event of any delay in filing the ARR, truing-up and Annual Performance Review, one month beyond the scheduled date of submission of the petition, the State Commission must initiate suo-moto proceedings for tariff determination. The recovery of the Regulatory Asset (RA) should be time-bound and within a period not exceeding three years at the most and preferably within the control period. The carrying cost of the RA should be allowed to the utilities in the ARR of the year in which the RA are created to avoid the problem of cash flow to the distribution licensee. Fuel and Power Purchase cost is a major expense of the distribution company, which is uncontrollable. The Fuel and Power Purchase cost adjustment should preferably be on a monthly basis but in no case exceed a quarter. Any State Commission that does not already have such a formula/mechanism in place must put in place such a formula/ mechanism within 6 months of the date of this order.
5 6

We note this as a very positive development on the regulatory front for the power distribution sector. However, the impact of this judgement by ATE on the financial position of the utilities will hinge upon its implementation by SERCs in an independent manner without any kind of influence from the state government/utility. In addition, poor data availability, given the significant delays in the finalisation of accounts as well as operational in-efficiencies in energy audit system, in some cases, could constrain initiation of such tariff proceedings by SERCs.

2 Regulatory asset is cost item (as approved by SERC) which is allowed to be recovered in future tariff determination. The cost of carrying of the regulatory asset is also an allowed expense for estimation of ARR or cost of supply. 3 For the distribution utility in Tamil Nadu, the accumulated losses till end of FY 2010 will be treated (as notified by State Government) as part of financial restructuring in the final transfer scheme associated with transferring the assets and liabilities of erstwhile TNEB to successor entities (i.e. TANGEDCO, TANTRANSCO and TNEB Limited). (Source: Tariff Petition dated November 15, 2011). Regulatory asset estimate is for FY 2011 and FY 2012, as estimated by TNERC in its tariff order dated July 2011. 4 For the discoms in Rajasthan, unrecovered revenue deficits pertaining till FY 2009 are funded as agreed by State Government and hence, not considered in estimation of regulatory asset by SERC ( Source : Tariff Order dated September 8, 2011). Regulatory asset estimate is thus for FY 2010, FY 2011 and FY 2012. 5 In line with the provision of Electricity Act (EA) 2003, the Central Government has established an Appellate Tribunal to be known as the Appellate Tribunal for Electricity to hear appeals against the orders of the adjudicating officer or the Appropriate Commission. As per the section 121 of EA-2003, The Chairperson of the Appellate Tribunal shall exercise the general power of super-intendance and control over the Appropriate Commission. 6 A suo-moto request petition was initiated by the Ministry of Power, Government of India to ATE in January 2011 so that ATE can exercise its regulatory authority under section 121 of the EA-2003 to provide directions to all SERCs.

ICRA Rating Feature

Implementation of FPPCA principles being observed in more states

In our sector comment tiled State Owned Electricity Distribution Companies : Key Performance Indicators & Credit Perspective, dated January 2011, we had highlighted the concern arising from inconsistency in FPPCA framework and delays in filing of FPPCA petitions, which in turn strain the liquidity profiles of discoms. Regular pass-through of FPPCA in retail tariff (and in the case of agriculture consumption, through increased subsidy from the state government) remains very crucial for discoms from their credit/liquidity perspective. Table 2 presents the current status of FPPCA mechanism applicable across discoms:
Table 2: Status on FPPCA Mechanism available for Discoms across States FPPCA Mechanism Remarks Approved @ 96 paise/unit w.e.f. February 2012 Gujarat Yes, Quarterly Capped at 10% of the prevailing energy charge Maharashtra Yes, Monthly Andhra Pradesh Yes, Quarterly Significant delays in filing for FPPCA petition by discoms; Order for FPPCA for Q4-FY'10 and Q4- FY'09 was issued by APERC on 17 January, 2012 based on FAC petition filed on 25 August 2011; e.g. FPPCA admitted for January March 2010 is allowed to be recovered between November 2012 and January 2013, reflecting a lag period of 35 months. No Considered by SERC at the time of APR and Final true-up Karnataka FPPCA framework is now suggested by TANGEDCO in its tariff petition submitted to Tamil Nadu No TNERC in November 2011 Rajasthan Yes, Quarterly As per the regulations dated January 2009, FPPCA is capped at 10% of the energy charge or any other ceiling as stipulated by SERC. However, there is no petition filed for claim of FPPCA by discoms so far. Punjab Yes, Quarterly Subject to approval by SERC based on filings by discom. FPPCA for Q3-FY 11 is approved by SERC in ARR approved for FY 2012 vide Tariff Order dated 9 May 2011. Haryana Yes, Monthly Issued in May 2010; however, capped at 10% of approved energy charge; last tariff order for FY 12 dated May 2011 allowed FPPCA of an average of 30 paise/unit in the tariff. Uttar Pradesh No Commission has directed UPPCL to suggest FSA mechanism in its tariff order dated March 2010 No Considered by SERC at the time of True-up of ARR Madhya Pradesh West Bengal Yes; Monthly Introduced in April 2011 and discontinued in May 2011, which subsequently was made operational in January 2012; currently, FPPCA is admitted at 82 paise/unit. Delhi Yes; Quarterly Introduced in August 2011; subsequently, 5% surcharge on applicable tariff for Fuel & Power Purchase Adjustment has been allowed recently (in February 2012) by DERC for discoms Source: ICRA Research, SERC Regulations across States

Among the states as mentioned in Table 2, FPPCA is well operationlised in Gujarat and helps the discoms to maintain healthy liquidity profiles. However, in states such as in Uttar Pradesh, Karnataka, Madhya Pradesh & Tamil Nadu, this mechanism has been absent so far. While ATE has given the direction to SERCs, which do not already have such a formula/mechanism in place, to put in place the same by June 2012, it is to be noted that timely filing for FPPCA petition by utilities also remains important. Further, there is no suo-moto direction available for determination/approval of FPPCA to SERCs in case of delays in filing of such petitions. Also, as observed in the state of West Bengal, FPPCA mechanism, although introduced by SERC in April 2011, could not be operationalised by the discom for a prolonged period of about 9 month during FY 2011-12 and such risk cannot be ruled out in other states.

Implementation of the recommendations of Shungulu Committee could be challenging

A high level panel headed by Shri. V. K. Shungulu, former CAG, appointed by the Planning Commission in July 2010 (with the objective of study to suggest measures for improvement in the commercial viability of the 7 distribution sector) issued the report on the financial position of distribution utilities in December 2011. The implementation of the recommendations of the Shungulu Committee could be particularly challenging, given that several stakeholders such as discoms, state governments and regulatory entities (SERCs) need to be involved. Further, the Shungulu Committee has recommended that banks could sell loans under stress to a new SPV, which is proposed to be 76% held by RBI. However, there is no clarity on RBIs view on the same.

The report has assessed a) the financial position of distribution utilities between FY 2005 and FY 2010, b) electricity tariff determination process including roles of State Government, SERCs and utilities, c) system improvement measures & operational issues and d) action plan to achieve the financial viability for the distribution sector by 2017.

ICRA Rating Feature

Box 2 gives the key recommendations of the Shungulu Committee: Box 2: Key Recommendations of the Shungulu Committee
SPV to be set up as a corporate entity (76% held by the RBI and the balance by PFC and REC), which will be entitled to purchase loans (which are likely to be restructured) of the banks, subject to certain conditions. o These conditions include a) banks to negotiate with the state government/utility for the revised payment schedule and b) state government to agree upon regular tariff increase, operational plan to meet certain technical/ operational performance parameters and implementation of capital expenditure for system improvement as a first priority. o RBI would provide a line of credit to SPV for purchase of loans from the banks. In case of noncompliance of terms set by SPV, the state government undertaking should be available to RBI that the amount defaulted would be debited to the State Governments account with the RBI. Thus, intentional default or non-adherence to the action plan would be unlikely. Recommendations on the process of tariff determination are reiterated as per the directives of ATEs judgement In addition to the basic tariff (which is fixed taking into account the targeted loss levels by SERCs), a loss surcharge should also be levied, which can vary area-wise within the license area so as to bring consumer awareness and improve the accountability of the utilitys staff. Selection committee for SERC should be broad-based so as to make the selection process fair, objective and independent. Also, a person who has worked during the preceding five years with the state government or any of its undertaking should not be eligible for appointment as a member or chairman of 1 the commission in the same state. Committee to be appointed for oversight of the functioning as well as periodic evaluation of the performance by the SERCs, with the main objective to ensure the accountability of the regulators. Distribution Franchisee Model would be the way forward on an urgent basis for the utilities to bring down their distribution loss levels significantly, given the advantages over the public-private partnership model and successful implementation of the franchisee model for the Bhivandi Circle in Maharashtra. This should be extended to the states during the next few years to at least 255 towns, which account for over 40% of the consumption. R-APDRP scheme is a key step taken by the Central Government to reduce distribution losses; and should be extended to the next Plan period with applicability to all towns above a population of 30,000 based on Census 2011. Utilities need to have a core team of IT experts in-house to work with IT consultants appointed under RAPDRP; also, there is a need for skilled professionals in the human resource development and Finance departments.

ICRA Rating Feature

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