Will Letters Of Credit By Discoms Help Curb Payment Delays Of Power Producers?

India asked power distributors to offer letters of credit as a security against delays in payments to generation companies. But analysts are divided if that would help curb mounting unpaid dues.

Discoms must mandatorily open and maintain adequate letters of credit as a payment security mechanism under power purchase agreements from Aug. 1, an order approved by RK Singh, union minister of state for power and new & renewable energy (independent charge), said last week.

The provision existed even before but it was generally taken as a lighter clause, according to Siva Subramanian, director (global infrastructure) at India Ratings and Research. “There are several lapses in the way PPA (power-purchase agreement) clauses are adhered to,” he said over the phone, adding that while letters of credit are mentioned in pacts, no one created them.

The move stems from payment delays by discoms. Outstanding dues to power producers, according to the government’s Praapti portal, swelled to Rs 35,841 crore as on April 2019. That hampers cash flow of generators which incur advance costs like paying for coal transportation, among others. Not getting paid on time can even lead to lower power output.

So the decision to provide payments security is certainly positive for power generators, said Girishkumar Kadam, vice-president and sector head of corporate ratings at ICRA Ltd. But he also has concerns about implementation.

Moreover, Kadam said, adequate tariff revision and timely subsidy support from state governments is also extremely crucial to improve cash flows of discoms.

Will Banks Do It?

According to Subramanian, the order will pose problems for the banking system. “Letters of credit for about Rs 300 billion will be required to comply with the Ministry of Power’s order,” he said. “Does the banking system have the capacity to create it in a short span of time?”

The national and regional load despatch centres shall transmit power only after they are informed by the power generators or distributors that a letter of credit for the desired quantum of power has been opened, copies of which have been made available to the generator in question, the minister’s order said.

Even if banks decide to do it, Subramanian said, they will have to evaluate the credit profile of more than 50-odd discoms in a month. “Are we equipped enough to take care of this as a country?”

That apart, he said, lenders would be wary of their exposure to loss-making discoms and the margin requirement for opening letters of credit can be prohibitive.

The combined losses of state discoms that signed up for the Ujjwal Discom Assurance Yojana—intended to nurse them back to financial health—rose to about Rs 24,000 crore ($3.4 billion) in the first nine months of the last fiscal, a 62 percent jump on a yearly basis, Bloomberg reported.

Still, other analysts expect the order to help power producers.

Companies like NTPC Ltd., Tata Power Ltd. and JSW Energy Ltd. would be the key beneficiaries apart from renewable energy firms, Abhishek Puri, power analyst at Axis Capital, wrote in a report.

This will resolve working capital issues for power generators and force discoms to maintain financial discipline and improve operational efficiency, Swarnim Maheshwari, power analyst at Edelweiss Securities Ltd., wrote in a report. The move would help plug pilferage as it would protect generators, ensure timely payments and reduce counter-party risk, Maheshwari said.

Maheshwari recommended buying NTPC Ltd., CESC Ltd., and Tata Power in that report.