Month: June 2019

All eyes are on the new government as there is talk building up of an ambitious 100-day reform agenda. Expectations are rising now that the government has won a decisive mandate and there is pressure to deal with a multitude of macroeconomic troubles. It is reassuring to note that resolving DISCOM offtake risk seems high on the agenda of the new government. News sources quoting senior government officials give us a peek into various solutions being considered by the government – payment security fund, restructuring of tariff subsidies, penalising DISCOMs for failure to provide a basic minimum standard of service and a joint power sector council comprising the central and state governments.

A permanent structural reform is needed to sort out DISCOM finances forever;

The joint power council could free DISCOMs from local government interference by developing a consistent set of operating standards and guidelines;

GST implementation and constitution of the GST council should provide a useful template;

Financially weak DISCOMs are a source of most of the challenges pervasive in the power sector including poor customer service, suppressed demand, low investment in T&D infrastructure, lack of financing and policy reversals. The country can’t afford another expensive DISCOM bailout and a radical permanent fix is needed to sort out this problem forever.

We don’t believe that creating another payment security fund or mitigating offtake risk through an intermediary like NTPC or SECI is a solution. Rather it is a wasteful way of living with the problem. It increases costs for developers and consumers, and creates a false sense of security only for the crisis to grow bigger and bite back at a later date. Amendments in tariff policy, non-binding in nature, to reform subsidies and hold DISCOMs accountable, do not appear an attractive option either. A policy move along these lines will take a long time in implementation and face enforcement challenges.

In contrast, the idea of a joint power sector council is very powerful. The proposed council would be headed by the Indian power minister and have power ministers of all states as members. It is proposed to be assisted by a committee comprising top finance and energy bureaucrats from the central and state governments. The council is expected to develop a consistent set of operating standards and guidelines to free DISCOMs from local government interference. While there is no change expected to regulatory regime in the tentative plans, we argue that the government should go one step further and disband state regulators, who have been complicit in this crisis. State level regulation is an outdated idea without parallel – all other sectors (aviation, telecom, real estate) have one national level regulator. To this end, CERC should be strengthened and armed with all necessary powers to adjudicate across the country.

The two big questions are – does the Indian government have the commitment to reform and will the state governments comply? The answer lies in the recent constitution of the GST council and implementation of a nationwide indirect tax regime after decades of resistance from state governments.

On the long road to electric mobility revolution

Electric mobility is expected to be the next big frontier in energy transition. But the roadmap is fuzzy and the technical and financial challenges are so arduous that the Indian government is having difficulties in laying out a clear vision. After dismissing an earlier talk of 100% electrification of vehicles by 2030 and subsequently reducing the target to 30%, there are new proposals mooted by NITI Aayog to achieve faster electrification of new vehicle sales by 2026. But the automobile industry is unhappy with the aggressive proposals and the Minister of Road Transport and Highways has waded into debate by calling for wider consultation.

The new proposals warrant all new two-wheeler, three-wheeler and commercial vehicles sold from April 2026 onwards to be in the form of electric vehicles (EVs);

Registered four-wheeler EVs accounted for a miniscule 0.1% share of total car sales in FY 2018-19 as consumers remain concerned about high cost and lack of charging infrastructure;

Unlike other countries, India has little financial capacity to significantly subsidise development of the EV market;

The NITI Aayog has recommended that all new two-wheeler, three-wheeler, and commercial vehicles sold from April 2026 onwards should be in the form of EVs. It has also recommended a phased introduction for commercial four-wheeler EVs rising from 2.5% in FY 2020-21 to 40% in FY 2025-26. That effectively covers more than 90% of total automobile sales in India (23 million vehicles annually based on actual sales volumes in FY 2018-19).

A quick dose of reality is needed. EVs accounted for 3% of total domestic automobile sales with sales of 759,600 units in FY 2018-19. But cheap two-wheelers and three-wheelers, mostly unregistered and uncertified, constituted vast majority of this market (99.6% share). Four-wheelers accounted for a tiny 0.4% with sales of only 3,600 vehicles in FY 2018-19. Reasons for slow uptake include high cost, low demand (and supply), and lack of charging infrastructure.

The government has recently sanctioned phase-II of the Faster Adoption and Manufacturing of Electric Vehicles (FAME) scheme with INR 86 billion (USD 1.2 billion) in financial incentives. The target is to achieve cumulative sales of 1.5 million vehicles by March 2022. The scheme rightly incentivises only vehicles using lithium-ion batteries or other modern technologies. The primary focus is on two-wheelers, three wheelers and fleet vehicles. 100% success rate for the scheme would amount to about 2% share for EVs in the next three years.

Table: FAME-II subsidy plan

Source: Ministry of Heavy Industries and Public Enterprises notification

As observed internationally, subsidies have a crucial role to play in spurring market growth, but the Indian government does not have the fiscal headroom to significantly enhance subsidy budget. Moreover, the subsidy-based schemes in India are notorious for their poor track record and implementation. Phase-I of the FAME scheme had targeted allocation of INR 8 billion in subsidies in 2 years but only INR 5.8 billion was allocated over nearly four years.

The Indian government needs to think big but also pay due regard to various technical, operational, and financial challenges at the same time. Our belief is that the EV market would remain nominal in size for another 4-5 years until cost-technology proposition becomes more amenable.

The US government has decided to end generalised system of preferences (GSP) to Indian exports from June 5, 2019 onwards after keeping the move on hold in light of the ongoing general elections in India. GSP allowed preferential duty-free imports of solar cells and modules into the US from India.

Under the new regime, a tariff of 30% is applicable on module imports in the first year. The tariff would reduce by 5 percentage points every year until the 4th year and stabilise at 15% thereafter. The levy of tariffs shall erode price arbitrage enjoyed by Indian manufacturers compared to Chinese and Vietnamese players. As a result, we expect the Indian manufacturers to lose market share to their international competitors. Indian exports to European markets have already been hurt post lifting of minimum import price (MIP) restrictions on Chinese manufacturers in 2018.

Exports account for a significant share of some manufacturers but the total quantum is relatively small at about USD 120 million (approximately 600 MW) per annum, about 25% of annual production or 6% of total domestic demand. US accounts for nearly half of total exports, so it is possible that export volumes may shrink by 150-200 MW annually as a result of the US move.

Figure: Indian solar module export destinations, April 2018-February 2019

Source: Ministry of Commerce, Government of India

Even though US levies will hurt some manufacturers in the short-term, the long-term impact of this move is expected to be minimal. The Indian government has announced various initiatives including 12 GW PSU scheme, 25 GW solar irrigation scheme (KUSUM) and 4 GW residential rooftop solar scheme, mandating usage of domestically manufactured cells and modules. Even mild progress on these schemes shall more than compensate for the loss of US export volumes.

Total pipeline of utility scale solar and wind projects has reached a near all-time high of 32.1 GW. After a relatively lull FY 2018-19 when only 6,174 MW was installed (down 43% over previous months), installation activity should be expected to boom over the next 24 months. As per our database, based purely on commissioning schedules specified under the tenders, India should add 17.8 and 13.8 GW of total solar and wind capacity in 2019 and 2020 respectively. However, sharp deterioration in debt financing environment is threatening to disrupt this positive outlook. Both availability of debt and cost have become significantly tighter because of drying up of liquidity in the debt market.

Figure: Scheduled commissioning timeline for solar, wind and hybrid projects

Source: BRIDGE TO INDIA research

There are several exogenous reasons for the current situation. After the IL&FS financial crisis late last year, the non-banking financing companies (NBFCs) – a crucial source of debt finance for the renewable sector – have been hit hard by lack of liquidity. Commercial banks, their most common source of funding, have closed the taps. The Reserve Bank of India (RBI) has been tightening lending and risk norms. The private NBFCs have almost shut down for new business while the public sector ones are more cautious. Merger of the two government owned NBFC giants, PFC and REC, has also contributed to the slowdown.

India’s relatively new insolvency law, mandated to clean up bank balance sheets, improve ease of doing business and implementation of the bankruptcy code has further sent banks in a spin. The prospect of recognising losses on almost INR 12 trillion (USD 170 billion) of bad assets is scaring them. The messy state of power sector is not helping. Thermal power is believed to account for a significant chunk of bad assets. Lenders are spooked by worsening DISCOM financial position and constant talk of renegotiation by state governments.

Consequently, cost of debt has risen by as much as 1.5-2.0% to 11.00-11.50% per annum putting financial viability of most projects at risk. But more importantly, there is a serious question mark over availability of debt funding and installation timelines. We understand that some lenders are completely refusing to lend to projects with direct DISCOM or state government exposure. They prefer projects where offtake risk is intermediated by central government owned NTPC or SECI.

There are two silver linings here. One, the pipeline is highly concentrated as the smaller players have been squeezed out by falling returns, growing execution challenges and increasing project sizes. Top developers are generally strongly capitalised. They should be better placed to raise funding through short-term resources, access to capital markets and corporate resources. Two, the macro-economic environment is expected to improve post-elections. There are expectations of aggressive rate cuts by RBI as well as a strengthening Rupee, both of which could help ease the crunch.

Figure: Share of top renewable developers

Source: BRIDGE TO INDIA research