By Taponeel Mukherjee
The importance of the flow of capital into the power and housing sectors in India cannot be overemphasised. Recent developments in both sectors once again bring to the fore the critical issues of effective payment mechanisms and price transparency as vital factors to boost the economy.
Let us examine the issue in the two sectors separately.
The Supreme Court striking down the Reserve Bank of India (RBI) circular giving stressed power companies more time to find resolutions outside the bankruptcy court has started debates around paths that are ideal for resolving woes of the power sector. Amid the din and noise, it is essential to not lose sight of the core issues at hand, i.e., the late and in many cases non-payment of dues by state-run power distribution companies (discoms) in India.
While not all the stressed assets of thermal power sector are attributable to non-payment issues from discoms, delayed payments are significant contributors to the mess. Late payments lead to debt servicing issues and major negative working capital problems. The most critical aspect of the problem is that not just thermal power sector assets but energy sector assets in general, including the high-growth renewable energy sector, will face identical or similar issues in the foreseeable future unless the delayed payments issue is gradually sorted out.
For instance, in the solar energy sector, which is known for its high capital intensity with the majority of the capital expenditure required upfront, the entire business model is highly dependent on the power purchase agreement (PPA) being honoured. Given the fixed-income nature of payments, it is only natural that debt is utilised to fund a significant component of the business. Delays in payments from discoms will lead to solar energy developers facing debt-servicing issues and therefore, eventually adding to the non-performing assets (NPAs).
The issues around debt-servicing and NPAs has serious ramifications from a cost of capital perspective. An improved payment mechanism, timely payment of interest coupons and lower-risk have the cascading positive effect of the lower cost of capital for any given sector. Hence, as the cost of capital in general declines, energy projects with a lower return on asset become viable. Therefore, a lowering of the cost of capital in the energy sector provides a significant boost to asset creation. The reverse holds true: when risk perceptions amongst investors for a sector rise, they reduce the flow of capital to the sector and thus render projects unviable.
Resolving issues around discom payments is critical for India’s push towards renewable energy. While solutions will require some hard decisions to be taken, the government must push in the right direction. Most importantly, the new sunrise sectors such as renewable energy must learn lessons from the thermal power sector of avoiding payment delays, excessive leverage and unsustainable tariffs. Issues in the thermal power sector provide a template of the pitfalls to avoid in energy sectors across the spectrum.
The second sector of our concern here that has seen interesting developments of late is housing finance. Given the recent liquidity crunch faced by the Non-Banking Financial Companies (NBFCs), the news that the Reserve Bank of India (RBI) has set up a panel to review the development of the housing finance securitisation market is a welcome step. The broader aim of the panel is to facilitate the flow of high-quality capital to the NBFC sector to boost credit creation in India.
Of all the steps towards the standardisation of the housing finance securitisation market, one that deserves most attention is ensuring a mechanism that allows for mark-to-market valuation of the securitised loans. In the long-run for the housing finance securitisation market to indeed facilitate the flow of sizeable quantities of capital and yet avoid major mishaps during periods of credit busts, access to constant pricing information in the market is vital.
Standardisation of the pricing of debt-securities can be more challenging than that for equity-based securities. The difficulty arises from the fact that debt-based instruments are issued for multiple tenures as opposed to equity that does not have a maturity date. Hence, standardisation is harder in the case of debt-instruments.
Lessons from credit markets in the developed economies in creating credit-based indices that assist the market in pricing loans in the secondary market are crucial.
Going forward we must not lose focus on the core issues of “ensuring payment mechanisms” and “price transparency” to boost investor sentiment regarding the crucial power and housing markets in India.
(The views expressed are personal. Taponeel Mukherjee heads Development Tracks, an infrastructure advisory firm. He is reachable [email protected] or @Taponeel on Twitter)