UDAY Scheme’s Impact on Renewable Energy Sector

The UDAY scheme was launched by the government in November 2015, and so far as met with a good response from the states (16 states representing more than 90% of DISCOM losses has joined) and from industry observers. These cover most of the large consumption states, but also most of the large RE rich states (see map). Notable exception from the RE rich category are Tamil Nadu and Karnataka.  The problem that the UDAY scheme aims to solve is a huge one.
CLSA (an equity analysis firm), points out that the collective outstanding of DISCOMs to financial institutions is in excess of Rs 5.5 lakh crore. This equivalent to two-and-a-half times the defence budget; roughly six times the amount that will be spent this financial year on building roads; and enough to wipe out India’s fiscal deficit.
The UDAY scheme aims to revive DISCOMs by working on three pillars – achieve operational efficiency (this will primarily be achieved by reducing AT&C losses and smart metering), reducing the cost of power (by reducing the interest cost and coal costs) and financial discipline (tariff increases and constraints on banking). These approaches have several sub-steps like smart metering, billing efficiency, etc.
A major area of reform is financial. The scheme requires that 75% of the existing debt of the DISCOM be taken over by the state. States have some moratorium before the debt is included in their overall fiscal limits. However, this step has two major impacts:

1. It transfers the problem of DISCOM finances into the hands of its creators – States (and their politicians) are largely responsible for the current situation. Political patronage has kept AT&C losses high due to un metered supply and theft, and tariff increases have lagged costs
2. It ‘bails out’ the banks – in RBI’s own words – “…UDAY, will essentially be shifting the stress from financial institutions to the state governments, though the initiative would instil financial discipline at the sub-sovereign level, especially in ensuring recovery of user charges.”

 
Impact on RE Sector
We believe that over the longer term, improvement in DISCOM finances will have a significant positive impact on the RE sector. In many DISCOMs step-motherly treatment to RE continues due to its perception of being costly and infirm power. Easing financial situation will create more openness to RE power.
The immediate impacts are likely to be felt strongly also.
The first one is likely on the REC markets – the scheme document says – “DISCOMs opting for the scheme will comply with RPO outstanding since April 1, 2012 within a period to be decided in consultation with MoP”. The participating states have many large power consuming states, and many have large outstanding RPO obligations (eg. UP, MP). This condition is likely to push RECs trading significantly.
The second impact is likely to be on the mode of power procurement in the near future. Increasingly, fixed preferential tariffs for RE look out of place. The scheme document says – “To reduce power costs, States shall take steps for: prospective power purchase through transparent competitive bidding by DISCOMs.”
The third impact is likely to be the worsening of the payment cycle to RE generators in the immediate term. This is because bank funding will dry up immediately and be severely constrained for working capital requirements. The document says – “Henceforth, Banks/ FIs shall not advance short term debt to DISCOMs for financing losses” and “for working capital, Banks/FIs shall lend to DISCOMs only up to 25% of previous year’s annual revenue, or as per prudential norms”
Improved financial situation of the DISCOMs will help in the long run, but in immediate term, payment cycles to RE producers are likely to get worse.
The fourth impact is likely to be on the off take side. With potential for faster and steeper tariff rise, RE projects are likely to get competitive in more states. It would have been helpful if the scheme document had also required mandatory open access in participating states.
 
Pitfalls
Like any previous DISCOM package, the key risk of failure is political. In the past, while DISCOMs have enjoyed the funding that such packages bring, state politicians have not allowed for tariff increases or long-term changes.
Even the current scheme has political overtones – a look at the map above suggests that mostly BJP ruled states have signed up. RBI has also recognized this, stating the issue is now in the hands of the “sub-sovereign level”.
However, compared to DISCOM packages of the past, this one appears to have more checks and balances through the state being the bond-issuer.
 
Conclusion
With DISCOMs being shut out of bank financing, the key question is – if they don’t sign up, what alternative do states have? No option sounds less bitter than the UDAY pill.
Therefore, overall, there is ample reason to hope the scheme will bring genuine and lasting changes at DISCOM level. This will be great news for the RE sector.
The Hindu article can be accessed  here.
The RBI report can be accessed  here.