These non-bank lenders bear the pain of India’s power sector

The Indian government is relying on two state-owned non-bank lenders to provide relief to struggling power utilities, which in turn were delaying payments to power producers.

To break the cycle, Power Finance Corp. Ltd. and Rural Electrification Corp. Ltd. were responsible for providing nearly Rs 90,000 crore on loan to state nightclubs. The rules have also been relaxed to ensure that funds can flow to electricity distributors beyond the loan limits allowed so far.

Although these loans are guaranteed by states, risks could arise if public finances and state finances weaken, causing payment delays on these loans.

Emails sent to PFC and REC on Thursday for details of their disco package lending strategy went unanswered.

The package Rs 90,000 Crore

The package of Rs 90,000 crore, approved by the government in May, was to be in the form of soft loans, backed by guarantees from the state government.

To ensure that regulatory restrictions do not hamper full disbursement of the package, the government on August 19 provided a one-time easing allowing PFC and REC to provide working capital loans to distribution companies, above the 25% ceiling of previous year’s earnings set under Ujwal Discom Yojana insurance.

The package was announced as overdue invoices from production companies began to rise after the Covid-19 crisis. “With weak electricity demand and high cash losses in the middle of the Covid-19 pandemic, discoms would end up owing lenders a crore of Rs 4.5 lakh by the end of this fiscal year, or 30 % more than the last financial year ”, rating agency Crisil Ltd. said in a note in June.

While the program was announced in May, disbursements are only now starting to increase, said Vinayak Chatterjee, chairman of the Feedback Infrastructure Group. “I don’t think there were a lot of disbursements in the June quarter and the discoms didn’t get substantial funding in the first quarter of this year,” he said. In many cases, the funds have gone to production companies when this is reflected as a loan in the books of the nightclubs, Chatterjee said.

According to an investor presentation made by REC after its first quarter results, the lender saw penalties climb 73% to Rs 41,959 crore at the end of June. Disbursements were slightly lower than last year. For PFC, data on loan penalties was not provided, but disbursements increased 65% to Rs 17,271 crore.

Risk for PFC, REC?

Borrowing is structured to be supported by state governments.

The official quoted above said that lenders do not see the risk of future discom defaults because the loans are backed by guarantees from the state government. However, dcoms delays could increase from their current levels, this person said.

Ok Vinayak Chatterjee, president of Feedback Ventures Group. Although the nightclub working capital cycle was negatively impacted by the Covid-19 crisis, since the loans are guaranteed by state governments, they would not be considered a potential bad debt. However, the financial health of nightclubs will need to be addressed, he said. “There is no doubt that there is a financial crisis for the nightclubs and the electricity industry that the new Electricity Law Amendment Bill of 2020 seeks to address,” Chatterjee said.

Liquidity and capital support

The additional loans that PFC and REC must make also mean that both lenders will have to borrow more in the markets.

However, the borrowings concluded so far may not be entirely intended for new loans, but also for refinancing.

While the asset-liability management of PFC and REC has always been characterized by lags, the differences have widened during the current year following a 40 to 60% drop in recoveries due to the moratorium extended by these entities, said an analyst who spoke on condition of anonymity. As a result, borrowings in the market have increased to match refinancing needs and funding the gap, this person said.

Both entities may also need a capital injection from the government down the line. While their capital ratios are above the regulatory minimum, the Reserve Bank of India has urged all lenders to raise more equity to protect against rising risks.

In the case of PFC and REC, this equity may have to come from the government. At this time, there is no indication that the government will provide additional equity funds to PFC or REC, the person quoted above said.

An electricity sector analyst said the requirement for additional public capital would depend on the ability of state governments, whose finances are affected by the pandemic, to cope with any defaults.

Gradually, loans are given to state government entities, which gives comfort to both REC and PFC for the time being. But since we expect demand from the power sector to be weaker this year, it will hurt nightclub finances. So there is a credit risk for lenders if power producers or state-owned transmission companies fail, the person said on condition of anonymity.

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