Financial engineering is back: A feeling of Deja-vu..

It is deja-vu all over again. In the latter phase of UPA-I we had oil, fertilizer and food bonds. All these bonds were neatly kept off the government balance sheet masking the true fiscal deficit. Now we  have power bonds which will be structured differently and pose different challenges. In context of power sector, we had similar attempts in 2001 as well when we broke up utilities into generation, transmission& distribution legs. However, nothing much has changed since and we have another round of losses.

The new idea is a fascinating piece of financial engineering like earlier ideas. I was trying to make sense of the release. From whatever I could make out here it goes:

  • Say a state electricity board has liability of Rs. 100  to be paid to Bank A
  • 50% of this or Rs 50 will be taken over by state governments.
  • This Rs 50 of loan will be converted into a special bond of Rs 50 backed by state guarantee.
  • So Bank A now has a bond to be paid by the state government (and not discom).
  • This transfer of liability from Discom to States to come in 2-5 years. So there is a possibility that instead of immediate Rs 50 bond, around Rs 10 are issued in first year, Rs 2o in second year and so on..
  • The Rest Rs 50 will be will be rescheduled/restructured with Bank A based on conditions. So a waiving of the loan or lower interest rates will be based on whether Discom will show any financial improvement.
  • This will in turn be monitored by two committees at state and centre levels
  • Centre has provided an additional carrot to State Governments which agree to cut down their AT&C losses..

So that is what it looks like based on several reads so far..

Well one knew something was going to come when we had a change in Finance Ministry. But this was a bit too much of a financial engineering. A very confused press release to explain what is actually very important. Several issues have cropped up:

  • The bond bit has led to huge confusion. Whether they will be given SLR status or not? If SLR status is given, then it could lead to higher yields in G-sec as banks try to diversify to power bonds. But overall G-sec is still the largest portion and will just be a minor shift if at all. So not much impact on yields barring knee jerk reactions over announcements. This was seen today when Minister announced they will be given SLR status (led to higher yields) and then refuted by the Power Secretary (calmed markets).
  • How will states finance this additional liability? They will have to either cut expenditure or raise revenues. Will the states need to retort to additional borrowing (State Development Loans) apart from above to finance these liabilities?

The core issue remains unresolved. Hardly any mention of why states do not allow discoms to hike prices regularly. And then all losses pile up and we need another such scheme.

  • Gulzar says it will be another failure if things like free power to agri not resolved
  • ET edit says  Power sector needs right kind of politics, not financial bailout

People like us are trying to figure out the financial engineering bit. Need to await more details..

Financial engineers in private sector have been heavily criticised in this crisis. What about savvy fin engg in public sector?

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