Utilities: The Shunglu Committee - earnest observations, tricky implementation ::Kotak Securities

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Utilities
India
The Shunglu Committee—earnest observations, tricky implementation. The
much-awaited report of the Shunglu Committee made some earnest observations—(1)
lack of political will and independence of regulators in setting tariffs, (2) unbundling of
SEBs only on paper not in operations, and (3) constrained ability of utilities to meet debt
service obligations. The committee recommends (1) privatization through franchise
model, (2) setting up an SPV to acquire restructured debt of utilities, and (3) expanding
the scope of extant reform programs to expedite reduction in T&D losses. While the
recommendations are encouraging, we maintain our cautious stance aligning with
integrated utilities with control over fuel costs.
Losses likely to stagnate at current levels, even with improving operating metrics
Attributing the current state of state distribution utilities to (1) lack of regular tariff increases, (2)
slower-than-expected reduction in transmission and distribution losses, and (3) and overall lack of
political will, the Shunglu Committee recommends privatization of state distribution utilities and
restructuring of outstanding loans through the creation of an SPV to enable SEBs to wiggle out of
its current financial mismanagement towards a path of sustainability. We discuss the key
observations and recommendations of the committee in detail in subsequent sections. We have
not touched upon the financial and operational performance (dealt in detail in our report
titled ’SEBs: Losses mount as tepid tariff hikes fail to reverse the trend‘ dated October 20, 2011).
Privatization via the franchise model as the suggested way forward
The committee identified the ownership of the state as a conflict for distribution utilities to run on
commercial principles. The committee has recommended immediate implementation of the
franchise model of distribution to be implemented across 255 of the 1,400 towns currently
covered under the R-APDRP scheme; further, extension of the scope of R-APDRP scheme to all
areas covering the non-agriculture and non-private distribution space as reduction in T&D losses
remains integral to sustainable improvement in the health of distribution utilities.
Addressing the credit woes – formation of SPVs to tap in to RBI’s credit line
Public sector banks funded ~70% of the losses of distribution utilities, of which only a modest
42% is guaranteed by the state government. Noting the inability of distribution utilities to service
these obligations, the committee recommends formation of Special Purpose Vehicles (SPVs) that
would be entitled to purchase restructured loans of public sector banks extended to state
distribution utilities. The committee emphasizes preconditions for such purchases of loans such as
(1) assurances to carry out regular tariff hikes, and (2) chalking out the long-term plan to improve
operational and technical performance parameters.
Maintain conservative stance despite recent tariff hikes and policy impetus
We are encouraged by (1) the tariff hikes being announced/ implemented in various states, (2)
urgency shown by policymakers to address the problem of deteriorating financials of SEBs, and (3)
a more prudent lending by the banking system.
However, in a scenario of deteriorating demand-supply imbalance of coal and not-so-encouraging
financial health of SEBs, we recommend aligning with utilities which are integrated with enddistribution
business (Tata Power, CESC), or are not dependent on coal from Coal India (NHPC)
thereby minimizing exposure to state-owned distribution companies and/or linkage coal from Coal
India.