The Banking Business…Note Quote

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Why is lending indispensable to banking? This not-so new question has garnered a lot of steam, especially in the wake of 2007-08 crisis. In India, however, this question has become quite a staple of CSOs purportedly carrying out research and analysis in what has, albeit wrongly, begun to be considered offshoots of neoliberal policies of capitalism favoring cronyism on one hand, and marginalizing priority sector focus by nationalized banks on the other. Though, it is a bit far-fetched to call this analysis mushrooming on artificially-tilled grounds, it nevertheless isn’t justified for the leaps such analyses assume don’t exist. The purpose of this piece is precisely to demystify and be a correctional to such erroneous thoughts feeding activism. 

The idea is to launch from the importance of lending practices to banking, and why if such practices weren’t the norm, banking as a business would falter. Monetary and financial systems are creations of double entry-accounting, in that, when banks lend, the process is a creation of a matrix/(ces) of new assets and new liabilities. Monetary system is a counterfactual, which is a bookkeeping mechanism for the intermediation of real economic activity giving a semblance of reality to finance capitalism in substance and form. Let us say, a bank A lends to a borrower. By this process, a new asset and a new liability is created for A, in that, there is a debit under bank assets, and a simultaneous credit on the borrower’s account. These accounting entries enhance bank’s and borrower’s  respective categories, making it operationally different from opening bank accounts marked by deposits. The bank now has an asset equal to the amount of the loan and a liability equal to the deposit. Put a bit more differently, bank A writes a cheque or draft for the borrower, thus debiting the borrower’s loan account and crediting a payment liability account. Now, this borrower decides to deposit this cheque/draft at a different bank B, which sees the balance sheet of B grow by the same amount, with a payment due asset and a deposit liability. This is what is a bit complicated and referred to as matrix/(ces) at the beginning of this paragraph. The obvious complication is due to a duplication of balance sheet across the banks A and B, which clearly stands in need of urgent resolution. This duplication is categorized under the accounting principle of ‘Float’, and is the primary requisite for resolving duplicity. Float is the amount of time it takes for money to move from one account to another. The time period is significant because it’s as if the funds are in two places at once. The money is still in the cheque writer’s account, and the cheque recipient may have deposited funds to their bank as well. The resolution is reached when the bank B clears the cheque/draft and receives a reserve balance credit in exchange, at which point the bank A sheds both reserve balances and its payment liability. Now, what has happened is that the systemic balance sheet has grown by the amount of the original loan and deposit, even if these are domiciles in two different banks A and B. In other words, B’s balance sheet has an increased deposits and reserves, while A’s balance sheet temporarily unchanged due to loan issued offset reserves decline. It needs to be noted that here a reserve requirement is created in addition to a capital requirement, the former with the creation of a deposit, while the latter with the creation of a loan, implying that loans create capital requirement, whereas deposits create reserve requirement.  Pari Passu, bank A will seek to borrow new funding from money markets and bank B could lend funds into these markets. This is a natural reaction to the fluctuating reserve distribution created at banks A and B. This course of normalization of reserve fluctuations is a basic function of commercial bank reserve management. Though, this is a typical case involving just two banks, a meshwork of different banks, their counterparties, are involved in such transactions that define present-day banking scenario, thus highlighting complexity referred to earlier. 

Now, there is something called the Cash Reserve Ratio (CRR), whereby banks in India (and elsewhere as well) are required to hold a certain proportion of their deposits in the form of cash. However, these banks don’t hold these as cash with themselves for they deposit such cash (also known as currency chests) with the Reserve Bank of India (RBI). For example, if the bank’s deposits increase by Rs. 100, and if the CRR is 4% (this is the present CRR stipulated by the RBI), then the banks will have to hold Rs. 4 with the RBI, and the bank will be able to use only Rs. 96 for investments and lending, or credit purpose. Therefore, higher the CRR, lower is the amount that banks will be able to use for lending and investment. CRR is a tool used by the RBI to control liquidity in the banking system. Now, if the bank A lends out Rs. 100, it incurs a reserve requirement of Rs. 4, or in other words, for every Rs. 100 loan, there is a simultaneous reserve requirement of Rs. 4 created in the form of reserve liability. But, there is a further ingredient to this banking complexity in the form of Tier-1 and Tier-2 capital as laid down by BASEL Accords, to which India is a signatory. Under the accord, bank’s capital consists of tier-1 and tier-2 capital, where tier-1 is bank’s core capital, while tier-2 is supplementary, and the sum of these two is bank’s total capital. This is a crucial component and is considered highly significant by regulators (like the RBI, for instance), for the capital ratio is used to determine and rank bank’s capital adequacy. tier-1 capital consists of shareholders’ equity and retained earnings, and gives a measure of when the bank must absorb losses without ceasing business operations. BASEL-3 has capped the minimum tier-1 capital ratio at 6%, which is calculated by dividing bank’s tier-1 capital by its total risk-based assets. Tier-2 capital includes revaluation reserves, hybrid capital instruments and subordinated term debt, general loan-loss revenues, and undisclosed reserves. tier-2 capital is supplementary since it is less reliable than tier-1 capital. According to BASEL-3, the minimum total capital ratio is 8%, which indicates the minimum tier-2 capital ratio at 2%, as opposed to 6% for the tier-1 capital ratio. Going by these norms, a well capitalized bank in India must have a 8% combined tier-1 and tier-2 capital ratio, meaning that for every Rs. 100 bank loan, a simultaneous regulatory capital liability of Rs. 8 of tier-1/tier-2 is generated. Further, if a Rs. 100 loan has created a Rs. 100 deposit, it has actually created an asset of Rs. 100 for the bank, while at the same time a liability of Rs. 112, which is the sum of deposits and required reserves and capital. On the face of it, this looks like a losing deal for the bank. But, there is more than meets the eye here. 

Assume bank A lends Mr. Amit Modi Rs. 100, by crediting Mr. Modi’s deposit account held at A with Rs. 100. Two new liabilities are immediately created that need urgent addressing, viz. reserve and capital requirement. One way to raise Rs. 8 of required capital, bank A sells shares, or raise equity-like debt or retain earnings. The other way is to attach an origination fee of 10% (sorry for the excessively high figure here, but for sake of brevity, let’s keep it at 10%). This 10% origination fee helps maintain retained earnings and assist satisfying capital requirements. Now, what is happening here might look unique, but is the key to any banking business of lending, i.e. the bank A is meeting its capital requirement by discounting a deposit it created of its own loan, and thereby reducing its liability without actually reducing its asset. To put it differently, bank A extracts a 10% fee from Rs. 100 it loans, thus depositing an actual sum of only Rs. 90. With this, A’s reserve requirement decrease by Rs. 3.6 (remember 4% is the CRR). This in turn means that the loan of Rs. 100 made by A actually creates liabilities worth Rs. Rs. 108.4 (4-3.6 = 0.4 + 8). The RBI, which imposes the reserve requirement will follow up new deposit creation with a systemic injection sufficient to accommodate the requirement of bank B that has issued the deposit. And this new requirement is what is termed the targeted asset for the bank. It will fund this asset in the normal course of its asset-liability management process, just as it would any other asset. At the margin, the bank actually has to compete for funding that will draw new reserve balances into its position with the RBI. This action of course is commingled with numerous other such transactions that occur in the normal course of reserve management. The sequence includes a time lag between the creation of the deposit and the activation of the corresponding reserve requirement against that deposit. A bank in theory can temporarily be at rest in terms of balance sheet growth, and still be experiencing continuous shifting in the mix of asset and liability types, including shifting of deposits. Part of this deposit shifting is inherent in a private sector banking system that fosters competition for deposit funding. The birth of a demand deposit in particular is separate from retaining it through competition. Moreover, the fork in the road that was taken in order to construct a private sector banking system implies that the RBI is not a mere slush fund that provides unlimited funding to the banking system.  

The originating accounting entries in the above case are simple, a loan asset and a deposit liability. But this is only the start of the story. Commercial bank ‘asset-liability management’ functions oversee the comprehensive flow of funds in and out of individual banks. They control exposure to the basic banking risks of liquidity and interest rate sensitivity. Somewhat separately, but still connected within an overarching risk management framework, banks manage credit risk by linking line lending functions directly to the process of internal risk assessment and capital allocation. Banks require capital, especially equity capital, to take risk, and to take credit risk in particular. Interest rate risk and interest margin management are critical aspects of bank asset-liability management. The asset-liability management function provides pricing guidance for deposit products and related funding costs for lending operations. This function helps coordinate the operations of the left and the right hand sides of the balance sheet. For example, a central bank interest rate change becomes a cost of funds signal that transmits to commercial bank balance sheets as a marginal pricing influence. The asset-liability management function is the commercial bank coordination function for this transmission process, as the pricing signal ripples out to various balance sheet categories. Loan and deposit pricing is directly affected because the cost of funds that anchors all pricing in finance has been changed. In other cases, a change in the term structure of market interest rates requires similar coordination of commercial bank pricing implications. And this reset in pricing has implications for commercial bank approaches to strategies and targets for the compositional mix of assets and liabilities. The life of deposits is more dynamic than their birth or death. Deposits move around the banking system as banks compete to retain or attract them. Deposits also change form. Demand deposits can convert to term deposits, as banks seek a supply of longer duration funding for asset-liability matching purposes. And they can convert to new debt or equity securities issued by a particular bank, as buyers of these instruments draw down their deposits to pay for them. All of these changes happen across different banks, which can lead to temporary imbalances in the nominal matching of assets and liabilities, which in turn requires active management of the reserve account level, with appropriate liquidity management responses through money market operations in the short term, or longer term strategic adjustment in approaches to loan and deposit market share. The key idea here is that banks compete for deposits that currently exist in the system, including deposits that can be withdrawn on demand, or at maturity in the case of term deposits. And this competition extends more comprehensively to other liability forms such as debt, as well as to the asset side of the balance sheet through market share strategies for various lending categories. All of this balance sheet flux occurs across different banks, and requires that individual banks actively manage their balance sheets to ensure that assets are appropriately and efficiently funded with liabilities and equity. The ultimate purpose of reserve management is not reserve positioning per se. The end goal is balance sheets are in balance. The reserve system records the effect of this balance sheet activity. And even if loan books remain temporarily unchanged, all manner of other banking system assets and liabilities may be in motion. This includes securities portfolios, deposits, debt liabilities, and the status of the common equity and retained earnings account. And of course, loan books don’t remain unchanged for very long, in which case the loan/deposit growth dynamic comes directly into play on a recurring basis. 

Commercial banks’ ability to create money is constrained by capital. When a bank creates a new loan, with an associated new deposit, the bank’s balance sheet size increases, and the proportion of the balance sheet that is made up of equity (shareholders’ funds, as opposed to customer deposits, which are debt, not equity) decreases. If the bank lends so much that its equity slice approaches zero, as happened in some banks prior to the financial crisis, even a very small fall in asset prices is enough to render it insolvent. Regulatory capital requirements are intended to ensure that banks never reach such a fragile position. In contrast, central banks’ ability to create money is constrained by the willingness of their government to back them, and the ability of that government to tax the population. In practice, most central bank money these days is asset-backed, since central banks create new money when they buy assets in open market operations or Quantitative Easing, and when they lend to banks. However, in theory a central bank could literally spirit money from thin air without asset purchases or lending to banks. This is Milton Friedman’s famous helicopter drop. The central bank would become technically insolvent as a result, but provided the government is able to tax the population, that wouldn’t matter. The ability of the government to tax the population depends on the credibility of the government and the productive capacity of the economy. Hyperinflation can occur when the supply side of the economy collapses, rendering the population unable and/or unwilling to pay taxes. It can also occur when people distrust a government and its central bank so much that they refuse to use the currency that the central bank creates. Distrust can come about because people think the government is corrupt and/or irresponsible, or because they think that the government is going to fall and the money it creates will become worthless. But nowhere in the genesis of hyperinflation does central bank insolvency feature….

 

“The Scam” – Debashis Basu and Sucheta Dalal – Was it the Beginning of the End?

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“India is a turnaround scrip in the world market.”

“Either you kill, or you get killed” 

— Harshad Mehta

“Though normally quite reasonable and courteous, there was one breed of brokers he truly detested. to him and other kids in the money markets, brokers were meant to be treated like loyal dogs.”

— Broker

The first two claims by Harshad Mehta could be said to form the central theme of the book, The Scam, while the third statement is testimony to the fact of how compartmentalization within the camaraderie proved efficacious to the broker-trader nexus getting nixed, albeit briefly. The authors Debasish Basu and Sucheta Dalal have put a rigorous investigation into unraveling the complexity of what in popular culture has come to be known as the first big securities scam in India in the early 90s. That was only the beginning, for securities scams, banking frauds and financial crimes have since become a recurrent feature, thanks to increasing mathematization and financialization of market practices, stark mismatches on regulatory scales of The Reserve Bank of India (RBI), Public Sector Banks and foreign banks, and stock-market-oriented economization. The last in particular has severed the myth that stock markets are speculative and had no truck with the banking system, by capitalizing and furthering the only link between the two, and that being banks providing loans against shares subject to high margins.  

The scam which took the country by storm in 1992 had a central figure in Harshad Mehta, though the book does a most amazing archaeology into unearthing other equally, if not more important figures that formed a collusive network of deceit and bilk. The almost spider-like weave, not anywhere near in comparison to a similar network that emanated from London and spread out from Tokyo and billed as the largest financial scandal of manipulating LIBOR, thanks to Thomas Hayes by the turn of the century, nevertheless magnified the crevices existing within the banking system and bridging it with the once-closed secretive and closed bond market. So, what exactly was the scam and why did it rock India’s economic boat, especially when the country was opening up to liberal policies and amalgamating itself with globalization? 

As Basu and Dalal say, simply put, the first traces of the scam were observed when the State Bank of India (SBI), Main Branch, Mumbai discovered that it was short by Rs. 574 crore in securities. In other words, the antiquated manually written books kept at the Office of Public Debt at the RBI showed that Rs. 1170.95 crore of an 11.5% of central government loan of 2010 maturity was standing against SBI’s name on the 29th February 1992 figure of Rs. 1744.95 crore in SBI’s books, a clear gap of Rs. 574 crore, with the discrepancy apparently held in Securities General Ledger (SGL). Of the Rs. 574 crore missing, Rs. 500 crore were transferred to Harshad Mehta’s account. Now, an SGL contains the details to support the general ledger control account. For instance, the subsidiary ledger for accounts receivable contains all the information on each of the credit sales to customers, each customer’s remittance, return of merchandise, discounts and so on. Now, SGLs were a prime culprit when it came to conceiving the illegalities that followed. SGLs were issued as substitutes for actual securities by a cleverly worked out machination. Bank Receipts (BRs) were invoked as replacement for SGLs, which on the one hand confirmed that the bank had sold the securities at the rates mentioned therein, while on the other prevented the SGLs from bouncing. BRs is a shrewd plot line whereby the bank could put a deal through, even if their Public Debt Office (PDO) was in the negative. Why was this circumvention clever was precisely because had the transactions taken place through SGLs, they would have simply bounced, and BRs acted as a convenient run-around, and also because BRs were unsupported by securities. In order to derive the most from BRs, a Ready Forward Deal (RFD) was introduced that prevented the securities from moving back and forth in actuality. Sucheta Dalal had already exposed the use of this instrument by Harshad Mehta way back in 1992 while writing for the Times of India. The RFD was essentially a secured short-term (generally 15 day) loan from open bank to another, where the banks would lend against Government securities. The borrowing bank sells the securities to the lending bank and buys them back at the end of the period of the loan, typically at a slightly higher price. Harshad Mehta roped in two relatively obscure and unknown little banks in Bank of Karad and Mumbai Mercantile Cooperative Bank (MMCB) to issue fake BRs, or BRs not backed by Government securities. It were these fake BRs that were eventually exchanged with other banks that paid Mehta unbeknownst of the fact that they were in fact dealing with fake BRs. 

By a cunning turn of reason, and not to rest till such payments were made to reflect on the stock market, Harshad Mehta began to artificially enhance share prices by going on a buying spree. To maximize profits on such investments, the broker, now the darling of the stock market and referred to as the Big Bull decided to sell off the shares and in the process retiring the BRs. Little did anyone know then, that the day shares were sold, the market would crash, and crash it did. Mehta’s maneuvers lent a feel-good factor to the stock market until the scam erupted, and when it did erupt, many banks were swindled to a massive loss of Rs. 4000 crore, for they held on to BRs that had no value attached to them. The one that took the most stinging loss was the State Bank of India and it was payback time. The mechanism by which the money was paid back cannot be understood unless one gets to the root of an RBI subsidiary, National Housing Bank (NHB). When the State Bank of India directed Harshad Mehta to produce either the securities or return the money, Mehta approached the NHB seeking help, for the thaw between the broker and RBI’s subsidiary had grown over the years, the discovery of which had appalled officials at the Reserve Bank. This only lends credibility to the broker-banker collusion, the likes of which only got murkier as the scam was getting unravelled. NHB did come to rescue Harshad Mehta by issuing a cheque in favor of ANZ Grindlays Bank. The deal again proved to be one-handed as NHB did not get securities in return from Harshad Mehta, and eventually the cheque found its way into Mehta’s ANZ account, which helped clear the dues due to the SBI. The most pertinent question here was why did RBI’s subsidiary act so collusively? This could only make sense, once one is in the clear that Harshad Mehta delivered considerable profits to the NHB by way of ready forward deals (RFDs). If this has been the flow chart of payment routes to SBI, the authors of The Scam point out to how the SBI once again debited Harshad Mehta’s account, which had by then exhausted its balance. This was done by releasing a massive overdraft of Rs. 707 crore, which is essentially an extension of a credit by a lending institution when the account gets exhausted. Then the incredulous happened! This overdraft was released against no security!, and the deal was acquiesced to since there was a widespread belief within the director-fold of the SBI that most of what was paid to the NHB would have come back to SBI subsidies from where SBI had got its money in the first place. 

The Scam is neatly divided into two books comprising 23 chapters, with the first part delineating the rise of Harshad Mehta as a broker superstar, The Big Bull. He is not the only character to be pilloried as the nexus meshed all the way from Mumbai (then Bombay) to Kolkata (then Calcutta) to Bengaluru (then Bangalore) to Delhi and Chennai (then Madras) with a host of jobbers, market makers, brokers and traders who were embezzling funds off the banks, colluded by the banks on overheating the stock market in a country that was only officially trying to jettison the tag of Nehruvian socialism. But, it wasn’t merely individuated, but the range of complicitous relations also grabbed governmental and private institutions and firms. Be it the Standard Chartered, or the Citibank, or monetizing the not-even in possession of assets bought; forward selling the transaction to make it appear cash-neutral; or lending money to the corporate sector as clean credit implying banks taking risks on the borrowers unapproved by the banks because it did not fall under the mainline corporate lending, rules and regulations of the RBI were flouted and breached with increasing alacrity and in clear violations of guidelines. But credit is definitely due to S Venkitaraman, the Governor of the RBI, who in his two-year at the helm of affairs exposed the scam, but was meted out a disturbing treatment at the hands of some of members of the Joint Parliamentary Committee. Harshad Mehta had grown increasingly confident of his means and mechanisms to siphon-off money using inter-bank transactions, and when he was finally apprehended, he was charged with 72 criminal offenses and more than 600 civil action suits were filed against him leading to his arrest by the CBI in the November of 1992. Banished from the stock market, he did make a comeback as a market guru before the Bombay High Court convicted him to prison. But, the seamster that he was projected to be, he wouldn’t rest without creating chaos and commotion, and one such bomb was dropped by him claiming to have paid the Congress Prime minister PV Narsimha Rao a hefty sum to knock him off the scandal. Harshad Mehta passed away from a cardiac arrest while in prison in Thane, but his legacy continued within the folds he had inspired and spread far and wide. 

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Ketan Parekh forms a substantial character of Book 2 of The Scam. Often referred to as Midas in privy for his ability to turn whatever he touched into gold on Dalal Street by his financial trickery, he decided to take the unfinished project of Harshad Mehta to fruition. Known for his timid demeanor, Parekh from a brokers family and with his training as a Chartered Accountant, he was able to devise a trading ring that helped him rig stock prices keeping his vested interests at the forefront. He was a bull on the wild run, whose match was found in a bear cartel that hammered prices of K-10 stocks precipitating payment crisis. K-10 stocks were colloquially named for these driven in sets of 10, and the promotion of these was done through creating bellwethers and seeking support fro Foreign Institutional Investors (FIIs). India was already seven years old into the LPG regime, but still sailing the rough seas of economic transitioning into smooth sailing. This wasn’t the most conducive of timing to appropriate profits, but a prodigy that he was, his ingenuity lay in instrumentalizing the jacking up of shares prices to translate it into the much needed liquidity. this way, he was able to keep FIIs and promoters satisfied and multiply money on his own end. This, in financial jargon goes by the name circular trading, but his brilliance was epitomized by his timing of dumping devalued shares with institutions like the Life Insurance Corporation of India (LIC) and Unit Trust of India (UTI). But, what differentiated him from Harshad Mehta was his staying off public money or expropriating public institutions. such was his prowess that share markets would tend to catch cold when he sneezed and his modus operandi was invest into small companies through private placements, manipulate the markets to rig shares and sell them to devalue the same. But lady luck wouldn’t continue to shine on him as with the turn of the century, Parekh, who had invested heavily into information stocks was hit large by the collapse of the dotcom bubble. Add to that when NDA government headed by Atal Bihari Vajpayee presented the Union Budget in 2001, the Bombay Stock Exchange (BSE) Sensex crashed prompting the Government to dig deep into such a market reaction. SEBI’s (Securities and Exchange Board of India) investigation revealed the rogue nature of Ketan Parekh as a trader, who was charged with shaking the very foundations of Indian financial markets. Ketan Parekh has been banned from trading until 2017, but SEBI isn’t too comfortable with the fact that his proteges are carrying forward the master’s legacy. Though such allegations are yet to be put to rest. 

The legacy of Harshad Mehta and Ketan Parekh continue to haunt financial markets in the country to date, and were only signatures of what was to follow in the form of plaguing banking crisis, public sector banks are faced with. As Basu and Dalal write, “in money markets the first signs of rot began to appear in the mid-1980s. After more than a decade of so-called social banking, banks found themselves groaning under a load of investments they were forced to make to maintain the Statutory Liquidity Ratio. The investments were in low-interest bearing loans issued by the central and state governments that financed the government’s ever-increasing appetite for cash. Banks intended to hold these low-interest government bonds till maturity. But each time a new set of loans came with a slightly higher interest rate called the coupon rate, the market price of older securities fell, and thereafter banks began to book losses, which eroded their profitability,” the situation is a lot more grim today. RBI’s autonomy has come under increased threat, and the question that requires the most incision is to find a resolution to what one Citibank executive said, “RBI guidelines are just that, guidelines. Not the law of the land.” 

The Scam, as much as a personal element of deceit faced during the tumultuous times, is a brisk read, with some minor hurdles in the form of technicalities that intersperse the volume and tend to disrupt the plot lines. Such technical details are in the realm of share markets and unless negotiated well with either a prior knowledge, or hyperlinking tends to derail the speed, but in no should be considered as a book not worth looking at. As a matter of fact, the third edition with its fifth reprint is testimony to the fact that the book’s market is alive and ever-growing. One only wonders at the end of it as to where have all such journalists disappeared from this country. That Debashis Basu and Sucheta Dalal, partners in real life are indeed partners in crime if they aim at exposing financial crimes of such magnitudes for the multitude in this country who would otherwise be bereft of such understandings had it not been for them. 

Hydropower Financing in India (Working Draft)

India is the seventh largest hydroelectric power generator in the world with a capacity approximating 45 GW comprising 13.5% of its total power generational capacity.1 Add to that a capacity of 4.4 GW of smaller hydroelectric power units, the total installed and generational capacity is furthered by 1.3%. The hydroelectric power potential is almost double of what is installed at the moment and stands at 84 GW at 60% of the load factor.2

The history of hydroelectric power generation in the country dates back to more than a century, when the British engineered the Sidrapong-1 in Darjeeling in West Bengal in 1897, which is still under operation. What really drives the efficiency of hydropower technology is design-oriented, but the advantages of longevity and cost of generation face compromises via energy mix, cases where India is well positioned to offset the advantages with reliance on fossil fuels. This has been witnessed from the decade of the 1960s, when hydropower accounted for close to 65% of total utility till the present times, where the proportion has fallen to 13.5%, thanks largely due to offsets created by thermal power. Although, the plummeting slide has been arrested of late due to environmental, social, economic and political factors, the other major reason for the reduction in hydropower portfolio has been attributed to consistently non-attainability of energy installation and generation targets.

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The Government of India has taken many policy initiatives for sustainable hydropower development. In 2008, the Government came out with a hydro policy3 with an objective to achieve the implementation of these projects. Thereafter, the Centre and the states initiated hydropower projects through Public Private Partnerships (PPPs) to attract investors for the development of water resources in an environmentally-friendly manner and generate revenue while ensuring project viability. Despite the mechanism of PPP, many of these projects have had to struggle due to rehabilitation and resettlement concerns, problems associated with land acquisition, clearance and approval procedures, capability of developers, to name a few. These factors have indeed given the projects a troubled track record, but what is concerning are inherent risks associated with the hydro sector that makes investors averse to entering the fray. Inherent risks include geological surprises, calamities, environmental and forest-related concerns, and commercial risks, the last of which include high capital costs, and long payback period resulting from long gestation period culminating in a deterrence for the entry by the private players. Furthermore, hydropower projects are capital-intensive and thus financing them for long periods become a challenge. But, textbook project financing still continues to place private players as the fulcrum of financing hydro as well as renewables for the simple reason that these players seek commensurate returns with respect to risks involved in the sector. For these risks to effectuate into implementation, it is the onus of the Government to remove impediments along the way by either restoring investor faith in the sector or by creating an enabling environment.

The Financial Ecosystem

This section gives an overview of what financial players are involved in the hydropower sector.

The Indian hydropower financial sector could be zeroed in National Hydroelectric Power Corporation (NHPC) to begin with. NHPC, though a centrally-owned institution is not a typical financial intermediary, in that, it invests the funds that it raises directly. With an investment base of Rs. 3,87,180 million, the authorized share of this Mini Ratna Category-1 Government of India Enterprise is close to Rs. 1,50,000 million, which is exclusively held by the Government. Though, the mandate might seem to be wide-ranging, the portfolio of NHPC is actually quite modest, and the only noticeable expansion is the inclusion of development of wood and tidal power. NHPC pays only a nominal dividend on the equity capital which the Government holds, and receives a considerable grant support from the Ministry of Power. The main income is through sale of electricity and consultancy services, where the main clientele happens to be state electricity boards. NHPC has to put up 30% of the cost of every project which it develops s share capital. as it cannot develop this equity from the limited revenues of its own projects, the government needs to regularly increase its share capital. The other 70% of the cost is financed through debt. during the initial period of NHPC’s existence, this debt was provided by the Government. However, since the decade of the 1980s, NHPC started raising debts through commercial loans and bonds, both as private placements and public issues. The international source of funds for NHPC is through export credit agencies, and not through the multilateral development banks like the World Bank, or the Asian Development Bank.4

The other main agency involved in financing power is Power Finance Corporation, which unlike NHPC is a financial intermediary. The major part of PFC’s funds are raised through rupee-denominated bonds. Bonds issued by PFC enjoy the highest ratings in Indian and international markets and are on par with India’s sovereign rating. It borrows short-term and long-term from various banks and other financial institutions in addition to raising external commercial borrowings through private placement in the US market. PFC is the primary institution of the government of India for financing generation, transmission and distribution projects of the state electricity boards. Hydro projects up to 25 MW are financed by the Rural Electrification Corporation. Like the NHPC, PFC also provides consultancy services to its clientele. Like the international financial institutions, PFC has an attached conditionality clause to its loans, where the borrowers need to carry out Operational Financial Action Plans (OFAPs) in order to avail loans. The divide is clear between states that have undertaken power restructuring reforms getting loans at lower rates, while the states that have failed to undertake any such reforms have eventually lost out on PFC loans. The Government of India supports PFC’s resource mobilization in that PFC is attributed a large share of tax-free bonds on the Indian capital market. Rupee-bonds, loans from the Government and loans from Indian banks and other financial institutions form the domestic sources, while multilateral and bilateral agencies form the major sources of funds from international sources.5

Other major financial players happen to be Industrial Credit and Investment Corporation of India (ICICI), which extends rupee and foreign currency loans by raising capital internally and externally through concessional bonds6 from the Reserve Bank of India, or from syndicated loans as sourced from foreign commercial institutions, and bilateral credit lines from JBIC, KfW DFID; Industrial Development Bank of India (IDBI) extending loans and other assistance in rupees and foreign currencies by raising capital on both the domestic as well as international markets; and Infrastructure Development Finance Corporation (IDFC), which came into existence in 1997 with the aim to provide additional financing for private infrastructure projects. With Vishnuprayag in Uttarakhand and Srinagar in Uttar Pradesh, IDFC made forays into the hydroelectric sector sourcing its funds from bonds sold in the Indian capital market along with its share capital. IDFC, which has signed on to equatorial principles is probably India’s only financial institution to have any environmental policy. It has been quite disciplinarian in refusing loans to questionable projects, and thus has next to no non-performing assets in its portfolio.

Speaking of non-performing assets, the largest commercial bank in India, state Bank of India is facing quite a quagmire. Engaged in long-term project finance in the infrastructure sector, the bank is ignominious with the largest share of non-performing assets. The State Bank of India has played an advisory role in the possible merger of NHPC and National Thermal Power Corporation (NTPC), and in assessing the escrow capacities of state electricity boards for independent power producers (IPPs). As part of long-term infrastructure financing, the bank has ventured into hydropower directly, as well as extending funds for financial institutions and operators in the power sector. The major source of funding for the State Bank of India are its retail deposits, while bonds make up for long-term lending. Other sources include mobilizing foreign currency funds through international branch network. Its strong international position enables it to extend foreign currency loans directly from its foreign deposits, and to arrange international loan syndications. For example, the Bank provided loans to Maheshwar Hydro Electric Project through its Frankfurt branch.7

Hydropower lending is not just confined to commercial banks and development financial institutions, but even non-banking financial institutions. The leader in this category happens to be Life Insurance Corporation of India, or LIC in short. LIC has taken up bonds from and extended loans to state electricity boards and centrally-owned institutions like NTPC, NHPC, PFC, and the Power Grid Corporation. The issue of non-performing assets has plagued LIC, and the insurance company is almost on par with the State Bank of India with its distressed assets. Other non-banking financial companies like the General Insurance Corporation of India (GIC) and Unit Trust of India (UTI) are fast picking up their stakes in the power sector, and the reason for their lagging in comparison to LIC is because their funds do not have the same extended maturity as the funds of life insurer.

Since most of these institutions are Government owned, the role of private sector participation isn’t very much evident, but this should not be taken to mean that private sector involvement is compromised by the involvement of these public institutions. On the contrary, private-sector involvement is considered to be a catalyst for infrastructural development, though there are differing opinions about their role, or even if at all they should be invited. Notwithstanding the rationale behind their involvement, it is obligated we look at what promoted their invitation to the electricity sector in general and to hydropower in particular.

In 1991, the Government of India opened the hydropower development in the country to private participation and allowed 16 per cent return on equity (ROE)8 in 1992. The doors to private participation were further greased by the Electricity Act 20039, whose main objective was to promote competition for consumers to have the best possible price and quality of supply. The model to be adapted was similar to the World Bank model that was implemented in Odisha (then called Orissa) and thereafter picked up by other states. Called the “Single Buyer Mode”, the Act mandated that state electricity boards undertake unbundling of generation, transmission and distribution. The principal point in order to enhance generation, licensing had to be done away with completely excepting the need for techno-economic clearance for hydro projects. The Act was aimed at providing an investor friendly environment for potential developers in the power sector by removing administrative hurdles in the development of power projects by providing impetus to distribution reforms in India. Provisions like delicensing of thermal generation, open access and multiple licensing, and removal of surcharge for captive generation paved the basis for a competitive environment through private participation.

In 2008, Government came out with a policy called Power to All by 2012. Called the Hydro policy 2008, it encouraged private participation by giving incentives for accelerating the development of hydropower development in the country. Having failed in achieving its target of power to all by 2012, certain impeding factors like long gestation period, and capital intensive nature of the projects were held culpable. Private-sector implementation was augmented by the rise of Public Private Partnerships (PPPs), which are projects based on a contract or a concession agreement, between a government or statutory entity on the one side and a private sector company on the other side, for delivering an infrastructure service on payment of user charges. That PPP has been a policy game changer could be adduced from the fact that the Government is laying emphasis on it in order to resolve budgetary constraints, faster implementation of projects, reduced whole life costs, better risk allocation, improved quality of services, transfer of technology and project stability.10 though, how much of it is achieved and what are the likely hurdles in this model of development are subsequently discussed.

Private Engineering: Public Private Partnerships (PPPs) and Special Purpose Vehicles (SPVs)

India, undoubtedly has vast potential for renewables, but the execution is far from encouraging. One serious reason attributable to this has been the presence of strong coal-lobby in the country. Apart from this, energy economics plays its part, in that, any investment in hydropower development is decided by the cost of debt and the interest rate on capital. It is here that many of the private players who are majorly equity investors maintain focus on capital rates rather than on equity returns. Even if the operating portfolio of private investors is much larger thus facilitating easy accessibility to cheaper debt, unless the focus is on projects, which are profitable with adequate cash flow, renewable energy and infrastructure development in India would continue to face hurdles. For example, if a project is invested into with a debt-to-equity ratio of 70:30, with a typical interest rate of 14% and a repayment period of 8 years, an approximate 22% of the total project cost in the first year is outflow to service debt. It is well nigh difficult for projects to generate this kind of cash in the first year, simply owing to the fact that revenue assessment is not very critical. Bouncing off this critical gap are challenges that projects are more often than not over-advertised with under-estimation of revenue project costs and over-estimations of energy production potential leading to inconsistency in meeting the standard benchmark for haircuts. This is in close affinity with valuation expectations by developers where missing the woods for the trees is a high commonality due precisely to inadequate diligent processes.

But, does that mean this sector is riddled with detriments that cannot challenged off? It would be too far fetched to conclude this. Instead if the key issues like stringent adherence to budgets and timelines, reliable cash flow and accurate project valuations are held on to, these over-the-board-sounding-idealistic situations planned for contingencies, then most of the risks associated with financing and eventual implementation could be offset.

One of the two key instruments of private engineering happens to be Public Private Partnership (PPP). Public Private Partnerships are contractual arrangements between a public agency and a privately owned service provider. They are used to finance and operate projects that are considered important or desirable to the general public. Private agencies are incorporated because it has become increasingly apparent to both governments and donors that private enterprises are more cost-efficient and effective at delivering valuable products and services. The other instrument happens to be a Special Purpose Vehicle (SPV), which function as subsidiary entities for larger parent organizations and are typically used to finance new operations at favorable terms. The SPV can raise capital without carrying the debt or other liabilities of the parent organization even though the subsidiary is often operated by the same individuals and serves purposes that benefit the parent organization. SPVs are first and foremost an off-balance-sheet capital tool. This means that companies can change their overall asset/liabilities framework without having it show up in their primary financial statements. Many private partners in a PPP demand an SPV as part of the arrangement. This is especially true for very capital-intensive endeavors, such as an infrastructure project. The private company wants to limit its exposure to liabilities, so an SPV is created to absorb some of the risks. There isn’t a uniform operational role or legal design for the use of SPVs in a PPP; the particulars vary depending on the agreements of the actors and stakeholders in the project. However, every SPV needs to be created in accordance with the proper legal and accountancy rules in the jurisdiction. Most public projects rely on support from commercial banks or other financial institutions. Almost always, the SPV represents the financing wing and is used to attract funds from other lenders and investors. This protects the parent company and all financing parties from immediate counter-party risk. In the case of non-recourse financing, the lender’s only valid claims are limited to project assets in the case of default or non-completion. In turn, the SPV is not directly exposed to balance sheet issues with the parent or government agency. The government agency is often able to keep project debt and liabilities off its own balance sheet. This leaves more fiscal space for other public obligations. This can be especially important for governments that issue bonds because more fiscal space equates to higher bond credit ratings.11

Although SPVs and PPPs have come under tremendous criticism, which we would look into shortly, an example to show why even in the first place are these instruments required would help ease matters a bit. Consider a $1 billion collection of risky loan, obligations of borrowers who have promised to repay their loans at some point in future. Let us imagine them sitting on the balance sheet of some bank XYZ, but they equally well could be securities available on the market that the Bank’s traders want to purchase and repackage for a profit. No one knows whether the borrowers will repay, so a price is put on this uncertainty by the market, where thousands of investors mull over the choice of betting on these risky loans and the certainty of risk-free government bonds. To make them indifferent to the uncertainty these loans carry, potential investors require a bribe in the form of 20% discount at face value. If none of the loans default, investors stand a chance to earn a 25% return. A good deal for investors, but a bad one for the Bank, which does not want to sell the loans for a 20% discount and thereby report a loss.

Now imagine that instead of selling the loans at their market price of $800 million, the Bank sells them to an SPV that pays a face value of $1 billion. Their 20% loss just disappeared. Ain’t this a miracle? But, how? The SPV has to raise $1 billion in order to buy the loans from the Bank. Lenders in SPV will only want to put $800 million against such risky collateral. The shortfall of $200 million will have to be made up somehow. The Bank enters here under a different garb. It puts in $200 million as an equity investment so that the SPV has enough money now to buy the $1 billion of loans.

However, there is a catch here. Lenders no longer expect to receive $1 billion, or a 25% return in compensation for putting up the $800 million. SPV’s payout structure guarantees that the $200 million difference between face value and market value will be absorbed by the Bank, implying treating $800 million investment as virtually risk-free. Even though the Bank has to plough $200 million back into the SPV as a kind of hostage against the loans going bad, from Bank’s perspective, this might be better than selling the loans at an outright $200 million loss. This deal reconciles two opposing views, the first one being the market suspicion that those Bank assets are somehow toxic, and secondly the Bank’s faith that its loans will eventually pay something close to their face value. So, SPVs become a joint creation of equity owners and lenders, purely for the purpose of buying and owning assets, where the lenders advance cash to the SPV in return for bonds and IOUs, while equity holders are anointed managers to look after those assets. Assets, when parked safely within the SPV cannot be redeployed as collateral even in the midst of irresponsible buying spree.

So, if an SPV is such a robust engineering tool, why does it have to face up to criticisms? The answer to this quandary lies in architecture, the architectural setup of SPVs drawing on the Indian context. SPVs are invested with responsibilities to plan, appraise, approve, releasing funds, implement, and evaluate development projects within the ambit of financing renewable projects, including hydropower. According to the Union Government, every SPV will be headed by a full-time CEO, and will have nomination from the central and state government in addition to members from the elected Urban Local Bodies (ULBs) on its Board. Who the CEO isn’t clearly defined, but if speculation is to be believed in concomitance with PPP, these might be from the corporate world. Another justification lending credence to this possibility is the proclivity of the Government to go in for Public-Private Partnerships (PPPs). The states and ULBs would ensure that a substantial and a dedicated revenue stream is made available to the SPV. Once this is accomplished, the SPV would have to become self-sustainable by inculcating practices of its own credit worthiness, which would be realized by its mechanisms of raising resources from the market. It needs to re-emphasized here that the role of the Union Government as far as allocation is concerned is in the form of a tied grant through creating infrastructure for the larger benefit of the people. This role, though lacks clarity, unless juxtaposed with the agenda that the Central Government has set out to achieve, which is through PPPs, Joint Ventures (JVs) subsidiaries and turnkey contracts.

If one were to look at the architecture of SPV holdings, things get a bit muddled in that not only is the SPV a limited company registered under the Companies Act 201312, the promotion of SPV would lie chiefly with the state/union territory and elected ULB on a 50:50 equity holding. The state/UT and ULB have full onus to call upon private players as part of the equity, but with the stringent condition that the share of state/UT and ULB would always remain equal and upon addition be in majority of 50%.13 So, with permutations and combinations, it is deduced that the maximum share a private player can have will be 48% with the state/UT and ULB having 26% each. Initially, to ensure a minimum capital base for the SPV, the paid up capital of the SPV should be with an option to increase it to the full amount of the first installment provided by the Government of India. This paragraph commenced saying the finances are muddled, but on the contrary this arrangement looks pretty logical, right? There is more than meets the eye here, since a major component is the equity shareholding, and from here on things begin to get complex. This is also the stage where SPV gets down to fulfilling its responsibilities and where the role of elected representatives of the people, either at the state/UT level or at the ULB level appears to get hazy. Why is this so? The Board of the SPV, despite having these elected representatives has in no certain ways any clarity on the decisions of those represented making a strong mark when the SPV gets to apply its responsibilities. SPVs, now armed with finances can take on board consultative expertise from the market, thus taking on the role befitting their installation in the first place, i.e. going along the privatization of services in tune with the market-oriented neoliberal policies in new clothes sewn with tax exemptions, duties and stringent labour laws in bringing forth the most dangerous aspect, viz. privatized governance.

In India, private engineering is plugged in with Government initiatives through a host of measures by the latter in creating fecund grounds furthering efficiency and faster execution. Responsibilities are no more split between Ministry of Power, Ministry of Coal and Ministry of New and Renewable Energy, for hitherto it was difficult managing projects under departments working in silos at the central level. Ever since the present ruling dispensation of National Democratic Alliance (NDA) stressed on making hydropower a cardinal component in the energy mix for the country, the Government of India has undertaken a number of initiatives in the recent past, supported by various policy-level changes to promote hydropower development and facilitate investment in the sector. As a part of these initiatives, the government has increased financial allocation, along with other non-financial support, and is also in the process of establishing a dedicated hydropower development fund14 to improve the investment attractiveness of the sector. Other than that, the government could use the clean energy fund to provide loans to hydro projects at a lower rate of interest. On a smaller scale, the Indian Renewable energy Development Agency (IREDA), National Clan Energy Fund (NCEF) has already launched a refinancing scheme by providing loans at 2% for the revival of operational small hydro-projects (SHP) and biomass projects which have been affected by low tariffs, low plant load factor (PLF) levels, or force majeure conditions.15 Government’s promise to offer long-term finance to infrastructure projects, and meet the country’s target of generating 15% of its energy from renewable sources affirms its commitment to providing financial and administrative assistance to hydropower generation, the economic viability of which would be determined by investors and developers. It needs to be noted that as of now, not all of hydropower is considered to be renewable, but the government is mulling over the fact that all of hydropower needs to be categorized as such. At present, hydropower projects below 25 MW are considered renewables, and comes under the purview of the Ministry of New and Renewable Energy. Large hydro is with the Ministry of Power, as is National Hydro Power Corporation (NHPC). If all of hydropower is categorized under renewable energy, it would facilitate the Government to meet its Intended Nationally Determined Contributions (INDC) targets, as committed in the Paris Climate-Change summit 2016. The Indian government had committed to 40% of its total energy generation from renewable sources. Solar and wind power cumulatively contribute 15% to the energy mix. Adding hydro would take the total close to 30%. The current generation capacity of hydro is 44,189 MW out of the total installed capacity of 314,000 MW. According to Piyush Goyal, Former Minister for Power, Coal, Mines and Renewable Energy, getting to consider all of hydropower as renewable would ensure coverage under RPO16 and qualify for dispatch priority. Recognising hydropower as renewable might, however, not mean that its purchase will be included in the renewable purchase obligation (RPO) of distribution companies. Currently, the government guidelines for the long-term RPO trajectory keep hydropower out of the calculation of total energy consumption, and thus for any change to be effectuated, the Government would have to discuss the details with the stakeholders, including segment regulators. 17 18

 

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Considering an energy elasticity of 0.819, India is projected to require around 7% annual growth in electricity supply to sustain a GDP growth of around 8.5% p.a. over the next few years. This requires tapping all potential sources to address the deficit and meet the demand growth for accelerating economic development while taking into account considerations of long-term sustainability, environmental and social aspects. Though reservoir-based hydropower projects have come under criticism due to CO2 and methane emissions beyond acceptable limits, most hydro-rich countries have followed an integrated full life-cycle approach for the assessment of the benefits and impacts to ensure sustainability20. India is no different in this regard.

Financing Power: Generic Trends

This section focuses on the generic trends that involve financing power in the country, and many of the trends overlap across sectors, in that these are true for thermal, hydro and renewable energy generation. Moreover, the section, though slightly technical in nature, is interspersed with what may eventually count as accommodating structure for procurement of funds and thus departs from the norm in that it looks to policy and regulatory mechanisms in place and those that are aspirational or in the form of recommendations. Moreover, the section also delves into what is probably the hardest challenge facing the Indian Banking sector at the moment, viz. Non-Performing Assets (NPAs). There are documents and reports by the score that highlight how infrastructure development, including the power sector in India is riddled with NPAs.21 As a caveat, one maybe at a loss in linking this section with hydropower in particular due to its genericity, but one needs to comprehend the financial complexities from policy and regulatory points of view in order to appreciate the fuller magnitude of financing hydropower in particular and power sector in general.

Banks and Infrastructure Finance Companies (IFCs) are the predominant sources of financing of power sector in India. Balance sheet size of many Indian banks and IFCs are small vis-à-vis many global banks. Credit exposure limits of banks and IFCs towards power sector exposure is close to being breached. Any future exposure seems to be severely constrained by balance sheet size, their incremental credit growth and lack of incentives to lend to power sector. The desirability and sustainability of sectoral exposure norms of the banks in the future may be examined in view of the massive exposure of the banks and projected fund requirements for the power sector. Further, any downgrade in the credit rating of power sector borrowers would adversely impact the ability of the major Non Banking Financial Companies (NBFCs) viz. Power Finance Corporation (PFC) and National Hydro Power Corporation (NHPC) to raise large quantum of funds at a competitive rate from domestic as well as international capital markets. In such a scenario, the sources of funds available for power sector projects are expected to be further constrained.

The capital intensive nature of power projects requires raising debt for longer tenure (more than 15 years) which can be supported by life of the Power Project (around 25 years). However, there is wide disparity between the maturity profiles of assets and liabilities of banks exposing them to serious Asset Liability Maturity mismatch (ALM). Accordingly, the longest term of debt available from any bank or financial institution is for 15 years (door-to-door) which could create mismatch in cash flow of the Power project and may affect the debt servicing. Options like refinancing are explored to make funds available for the power project for a long tenor. Though maturity profiles of funds from insurance sector and pension funds are more suited to long gestation power projects, only a minuscule portion is deployed in power sector. At this stage, it becomes appropriate to talk of how and why pension funds are not really the funds to run after when it comes to financing Hydropower in the country. That these funds are not the de facto choice would be statement made in a hurry, for the government could in time switch financing instrumental gears to cater to investments in hydropower, provided these are amalgamated with Green bonds.  Internationally, the Green bonds base is up-north of $82 billion, whereas in India, the Green bonds are minuscule, but all slated for an exponential growth. Banks like Yes Bank and World Bank have launched green bonds. Green Bonds as a debt instrument by an entity raising funds ‘earmarked’ for use towards financing ‘green’ projects, assets, and business activities with environmental benefits. It attracts new class investor base – insurance funds, pension funds, sovereign wealth funds apart from the traditional investors. It helps in enhancing an issuer’s reputation illustrates green credentials of the issuer and demonstrates commitment towards the development and sustainability of the environment. The caution is that green bonds come with currency risk. However, if one raises green masala bonds, one will not have the risk of forex. To have the need for appropriating fiscal incentives in order to explore the ways to channelize savings, new debt instruments and sources of funds viz. Infrastructure Debt Fund, Clean Energy Funds etc. are identified for the purpose of infrastructure financing.

When it comes to cost of funds, cost of Rupee funding is high as compared to foreign currency funding due to currency fluctuations in the form of appreciation and depreciation. In a competitive bidding scenario, higher cost of borrowing could adversely affect the profitability and debt servicing of loan. External Commercial Borrowings (ECBs) for power projects is not well suited due to issues relating to tenor, hedging costs, exposure to foreign exchange risks etc. Project financing by multilateral agencies (World Bank, Asian Development Bank) has been low due to various issues.22 While bond offerings are a lower cost option to raise funds vis-à-vis syndicated loans, corporate bond market for project financing is virtually absent in India. Innumerable committees have opined on the reasons for the relative underdevelopment of India’s corporate bond market. However, despite several recommendations being implemented, there is still anaemic activity in existing corporate bonds, and anaemic issuance of new corporate bonds in relative terms. In addition, it appears that debt to equity ratios of Indian corporates have been falling steadily since the late 1990s, potentially a symptom of relative reductions in activity in the corporate debt market. Theoretically the presence of corporate bonds would provide an important alternative source of funding for corporations, which will enable them to optimize capital structure in an environment of friction. Such a market should enable additional cash to fund operations or long-term expansion plans without diluting corporate control. The government should also welcome the development of the corporate bond market because it would spur corporate activity and thus economic growth. Finally, investors such as pension funds and insurance companies should welcome corporate bonds as an additional set of instruments in which to invest, providing, in theory, a better overall risk to reward trade-off since there would be more opportunities for diversification. But, despite all these positives, the corporate bond market in the country is anemic. One important fact might hold the clue to explaining the lack of growth of this market. That is the huge pile of corporate debt that is currently being held in the form of loans, especially by state-owned banks. This massive inventory of loans generates significant incentives for three parties – banks, corporations and the government – to delay or inhibit the development of a significant corporate bond market. It goes without saying that large corporations with significant levels of unsustainable debt have no incentive to issue increased levels of debt, and indeed, have significant incentive to ensure the creation and perpetuation of information asymmetries that will inhibit liquidity in the market for their debt. So, the problem is not merely a problem of demand – from banks, but, also extends to debt supply. From the government’s point of view, there is a trade-off. In the short run, enabling a vibrant corporate bond market will result in significant losses to the banking sector, especially for nationalized banks, which are significantly exposed to bad corporate loans. This is because better price discovery will reveal the full extent of the problem of non-performing assets resulting from exposure to over-leveraged corporates. It is also the case that there may be more corporate failures if the full scale of the bad loans problem is revealed to the world. But, it must also be remarked that the credit rating of the power projects being set up under Special Purpose Vehicle (SPV) structure is generally lower than investment criterion of bond investors and thus there is a need for credit enhancement products.

Creation of specialized long-term debt funds to cater to the needs of the infrastructure sector; a regulatory and tax environment that is suitable for attracting investments is the key for channelizing long-term funds into infrastructure development. Reserve Bank of India (RBI) may look into the feasibility of not treating investments by banks in such close-ended debt funds as capital market exposure. Insurance and Regulatory Development Authority of India (IRDA) may consider including investment in Securities and Exchange Board of India (Sebi) registered debt funds as approved investments for insurance companies. Insurance Companies, Financial Institutions are encouraged/provided incentives to invest in longer dated securities to evolve an optimal debt structure to minimize the cost of debt servicing. This would ensure lowest tariff structure and maximum financial viability. Option of a moratorium for an initial 2 to 5 years may also reduce tariff structure during the initial years. One of the most serious contenders for acquiring funds and one that has been extensively experimented with is the Viability Gap Funding (VGF). The power projects that are listed under in generation or transmission and distribution schemes in remote areas like North-eastern region, J&K etc and other difficult terrains need financial support in the form of a viability gap for the high initial cost of power which is difficult to be absorbed in the initial period of operation. A scheme may be implemented in the remote areas as a viability gap fund23 either in the form of subsidy or on the lines of hydropower development fund, a loan which finances the deferred component of the power tariff of the first five years and recovers its money during 11th to 15th year of the operation may be introduced. Any extra financing cost incurred on such viability gap financing should also be permitted as a pass through in the tariff by regulators.

Green Bonds

Shifting terrain here, it is obligatory to talk of green bonds and how they could be the next ‘big’ thing in financing. Green bonds are like other bonds with the key difference being the former are specifically used for ‘green’ projects that are environmentally friendly. These bonds could help reduce the cost of capital if there are open door policies aimed towards attracting foreign investment, and especially so, when Foreign Direct Investment policies in India are getting more and more market friendly. The history of ‘green’ bonds could be dated back to 2007, when the European Investment Bank and the World Bank launched these bonds. Subsequently, 2013 witnessed corporation participation leading to its overall growth. In India, Yes Bank became the first bank to issue these bonds worth Rs. 1000 crore in 2015.

So, what of Sebi24 and any of rules and regulations mandating additional information about these bonds? For designating an issue of a corporation bond as a ‘green’ bond, an issue apart from complying with the issue and listing of debt securities regulations, the corporation would have to disclose additional information in the offer document such as use of proceeds. Sebi’s board had considered and approval a proposal for issuance and listing of green bonds way back in January 2016 to help meet the huge financing requirements worth USD 2.5 trillion for climate change actions in India by 2030. It is to be noted that ‘green’ bonds can be key to help meet an ambitious target India has of building 175 gigawatt of renewable energy capacity by 2022, which will require a massive estimated funding of $200 billion. Hydropower has a significant role to play in achieving the goals of the Paris Agreement.25 Supporting the growth of the green bonds market is an important step towards aligning emission reduction targets with appropriate market signals and incentives.26 One example of Green bonds being used to finance hydropower in India is the Rampur Hydropower Project, across River Satluj in Simla and Kullu districts of Himachal Pradesh. This 412 MW installed capacity project has been financed on a 70:30 debt equity ratio basis, and is backed by a US$ 400 million by the World Bank.27

Shifting terrain once more, let us now focus on policy-wide measures that feed into renewables.

Policy-wide Measures for Take-out Financing

The Reserve Bank of India (RBI) has stipulated guidelines for Take-out Financing through External Commercial Borrowings (ECB) Policy.28 The guidelines stipulate that the corporate developing the infrastructure project including Power project should have a tripartite agreement with domestic banks and overseas recognized lenders for either a conditional or unconditional take-out of the loan within three years of the scheduled Commercial Operation Date (COD). The scheduled date of occurrence of the take-out should be clearly mentioned in the agreement. However, it is felt that the market conditions cannot exactly be anticipated at the time of signing of document and any adverse movement in ECB markets could nullify the interest rate benefit that could have accrued to the project. Hence, it is suggested that tripartite agreement be executed closer to project COD and instead of scheduled date of occurrence of the take-out event, a window of 6 or 12 months could be mentioned within which the take-out event should occur.

Further, the guidelines stipulate that the loan should have a minimum average maturity period of seven years. However, an ECB of average maturity period of seven years would entail a repayment profile involving door-to-door tenors29 of eight to ten years with back-ended repayments. It is likely that ECB with such a repayment profile may not be available in the financial markets. Further, the costs involved in hedging foreign currency risks associated with such a repayment profile could be prohibitively high. Hence it is suggested that the minimum average maturity period stipulated should be aligned to maturity profiles of ECB above USD 20 million and up to USD 500 million i.e. minimum average maturity of five years as stipulated in RBI Master Circular No.9 /2011-12 dated July 01, 2011.30 RBI exposure norms applicable to IFCs allow separate exposure ceilings for lending and investment. Further, there is also a consolidated cap for both lending & investment taken together. In project funding, the IFCs are mainly funding the debt portion and funding of equity is very nominal.31 Therefore, the consolidated ceiling as per RBI norms may be allowed as overall exposure limit with a sub-limit for investment instead of having separate sub-limits for lending and investment. This will leverage the utilization of un-utilized exposures against investment. It is well justified since lending is less risky as compared to equity investment. This will provide additional lending exposure of 5% of owned funds in case of a single entity and 10% of owned funds in case of single group of companies, as per existing RBI norms. RBI Exposure ceilings for IFCs are linked to ‘owned funds’ while RBI exposure norms as applicable to Banks & FIs (Financial Institutions, but also Financial Intermediaries) allow exposure linkage with the total regulatory capital i.e. ‘capital funds’ (Tier I & Tier II capital). Exposure ceilings for IFCs may also be linked to capital funds on the lines of RBI norms applicable to Banks. It will enable to use the Tier II capitals like Reserves for bad and doubtful debt created under Income Tax Act, 196132, for exposures.

RBI norms provide for 100% provisioning of unsecured portion in case of loan becoming ‘doubtful’ asset. Sizable loans of Government IFCs like PFC and NHPC are guaranteed by State Governments and not by charge on assets. On such loans, 100% provisioning in first year of becoming doubtful would be very harsh and can have serious implication on the credit rating of IFC. Therefore, for the purpose of provisioning, the loans with State/Central Government guarantee or with undertaking from State Government for deduction from Central Plan Allocation or Direct loan to Government Department may be treated as secured. As per RBI norms, the provisioning for Non-Performing Assets (NPAs) is required to be made borrower-wise and not loan-wise if there is more than one loan facility to one borrower. Since Government owned IFC’s exposure to a single State sector borrower is quite high, it would not be feasible to provide for NPA on the total loans of the borrowers in case of default in respect of one loan. Further, the State/Central sector borrowers in power sector are limited in numbers and have multi-location and multiple projects. Accordingly, default in any loan in respect of one of its project does not reflect on the repaying capacity of the State/Central sector borrowers. A single loan default may trigger huge provisioning for all other good loans of that borrower. This may distort the profitability position. Therefore, provisioning for NPAs in case of State/Central sector borrowers may be made loan-wise. In case of consortium financing, if separate asset classification norms are followed by IFCs as compared to other consortium lenders which are generally banking institutions; the asset classification for the same project loan could differ amongst the consortium lenders leading to issues for further disbursement etc.

Prudential Norms relating to requirement of capital adequacy are not applicable to Government owned IFCs. However, on the other side, it has been prescribed as an eligibility requirement for an Infrastructure Finance Company (IFC) being 15% (with minimum 10% of Tier I capital). Accordingly, Government owned IFCs are also required to maintain the prescribed Capital Adequacy Ratio.33 Considering the better comfort available in case of Government owned IFCs, it is felt that RBI may consider stipulating relaxed CAR requirement for Government owned IFCs. It will help such Government owned IFCs in better leveraging. RBI prudential norms applicable to IFCs require 100% risk weight for lending to all types of borrowers. However, it is felt that risk weight should be linked to credit rating of the borrowers. On this premise, a 20% risk weight may be assigned for IFC’s lending to AAA rated companies. Similarly, in case of loans secured by the Government guarantee and direct lending to Government, the IFCs may also assign risk weight in line with the norms applicable to banks. Accordingly, Central Government and State Government guaranteed claims of the IFC’s may attract ‘zero’ and 20% risk weight respectively. Further their direct loan/credit/overdraft exposure to the State Governments, claims on central government will attract ‘zero’ risk weight.

As per extant ECB Policy, the IFCs are permitted to avail of ECBs (including outstanding ECBs) up to 50% of their owned funds under the automatic route, subject to their compliance with prudential guidelines. This limit is subject to other aspects of ECB Policy including USD 500 million limit per company per financial year. These limits/ceilings are presently applicable to all IFCs whether in State/Central or Private Sector. Government owned IFCs are mainly catering to the funding needs of a single sector, like in Power sector where the funding requirements for each of the power project is huge. These Government owned IFCs are already within the ambit of various supervisory regulations, statutory audit, CAG audit, etc. It, is, therefore, felt that the ceiling of USD 500 million may be increased to USD 1 billion per company per financial year for Government owned IFCs. Further, the ceiling for eligibility of ECB may also be increased to 100% of owned funds under automatic route for Government owned IFCs to enable them to raise timely funds at competitive rates from foreign markets. Thus, these measures will ensure Government owned NBFC-IFCs to raise timely funds at competitive rates thereby making low cost funds available for development of the infrastructure in India.

Enabling and Disabling Environment for Hydropower (Conclusion)

Though some bottlenecks remain. With the present power scenario and major policy initiatives to increase renewable capacity (mainly solar and wind), it is becoming difficult to sell hydropower. There is reluctance on the part of distribution utilities to enter into long term Power Purchase Agreements (PPAs). The government should declare all Hydropower Projects, regardless of the capacity, as “Renewables”, particularly, the Run of the River ROR (with or without diurnal pondage) projects. Presently Ministry of Power gives pooled quota of electricity from Central Public Sector Undertakings to various states. Ministry of Power should include Hydropower projects in the pooled quota for enabling faster PPAs. There should be separate Hydropower Purchase Obligation (HPO), too. The other bottleneck remains to be addressed is Tariff. Tariffs from hydropower projects are higher in the initial years as compared to other sources due to lack of incentives like tax concessions, financing cost and construction of projects in remote areas with inadequate infrastructure. Mega Power benefits were terminated in 2012. Major benefits associated with the Mega Power status were custom duty exemption on import of capital equipment and excise duty exemption. Mega Power benefits should be reintroduced. Since taxes constitute 15-25 per cent of project cost, it is still too early to fathom the import of Goods and Services Tax (GST) on the sector to contour its full consequences. Long term funding for hydropower project development is essential and needs to be directed through a policy. Creation of sub sectoral limit for lending to hydropower projects on priority basis by banks is the need of the hour to revive hydropower sector in India. The Banks should be advised to earmark at least 40 per cent of the total lending to power sector dedicated only for hydropower projects. Since Hydro Electric Projects are prone to various risks and uncertainties, the Return on Equity should not be decreased, except in cases of delays on account of developer. Service tax exemption to services used for Hydro Power Projects shall also lead to reduction of tariff. To reduce the weighted average cost of capital for competitive tariff, it is suggested that Debt to Equity ratio should be kept flexible say 80:10:10 with mandatory incurrence of equity portion minimum of 50 per cent before any disbursement. Funding could be 80 per cent Debt and 10 per cent Subordinate Debt. This could, by way of promoting hydropower as a renewable source of energy be considered as a positive for India, but what really has not been accounted for is socio-environmental and economic consequences, which would in many a cases be irreparable. The third crucial aspect that needs to be addressed is financing, or rather hurdles to financing. Due to long construction period of hydro projects, interest on loan plays a very critical role in increasing project cost. Also, during operation period, higher interest on outstanding loan leads to higher yearly tariff. Non-availability of longer tenure loan necessitates higher provision for depreciation so as to generate resources required to meet repayment obligations. Benefits under section 10(23)g of IT Act, 1961 to Hydro Power Projects, which allowed for the exemption of tax on the interest income earned by the Financial Institutions from Infrastructure projects, were withdrawn and is not available with respect to infrastructure projects. As per the current regulations, State Government is to be provided 12 per cent free power as royalty from any Hydro Power Project to be developed in the State. This provision of free power to the State affects the financial viability of the project severely. Due to the very challenging and difficult logistics, cost of the Project in any case is high and provision of high royalty in terms of free power, makes the project even more costlier and tariff becomes almost unsustainable. A review and revision of the financing policies for hydro projects are required with a view to provide longer tenure debt to hydro sector (say 25-30 years). Subsidy on the rate of interest on debt during the construction period of the projects should be introduced to reduce the Interest During Construction (IDC). Softer interest rates should be extended to large Hydro Plants. Tax Holiday under Section 80I (A) of the Income Tax Act, 1956 should be made applicable for 15 years for all Hydro Power Projects including under implementation projects. Hydropower projects are subjected to various types of risks like hydrological risk, power evacuation risk, geological surprises, construction risk, connectivity issues due to remote locations, extreme terrain etc. But after the commissioning of the Hydro-Electricity Plant, the majority of the risks are mitigated. The Financial Institutions, along with consortium lenders should be advised to extend the interest rebate on long term loans post commissioning of the project.

It is not just financing alone that is driven by development banks, but even building policy and regulatory mechanisms that are taken on board for creating an enabling environment to realize the true potential of hydropower leading to a spur in investments. This is mostly done with an emphasis on treating hydropower potential as a solution to long-term energy goals. The private arm of the World Bank, International Finance Corporation (IFC) has classified a new source of finance termed “Infraventures”, also known as the IFC Global Infrastructure Project Development Fund, is a $150 million global infrastructure fund that aims to develop a “bankable” pipeline of public-private partnerships and private projects for infrastructure.  This fund and others are catalyzing the development of big hydropower by decreasing the initial financial barriers to investment and decreasing the financial risks so that the project is attractive to the private sector.  For IFC Infraventures, the IFC then gets an equity stake in return. It is not unreasonable to claim that such approaches are criticized by Civil Society Actors34 citing serious implications for transparency, accountability and governance.

With the mushrooming of new development banks like BRICS Bank, Asia Infrastructure Investment Bank, consideration for financing of hydropower projects has got a fillip in complementing the agenda of the already existing development banks like the World Bank and the Asian development Bank. But, the main funding spigot in the sector has changed course in India. Even though the multilateral development banks and a host of bilateral financing arrangements, be they wrought by EXIMs or bilaterally negotiated, have the necessary influence to bring to realization projects of scales varying from big hydro to run-of-the-river schemes, their actual influx by way of funds has been reduced to a mere chunk compromised by national financial institutions, either banking or non-banking.

The majority of the funds are pumped in by these national institutions, even if their drive is monitored through equity investments by international financial institutions. Critics of the arrangement often point out to such a huge share as leading to stresses on the banking system eventually paving the way for NPAs. Experience has shown that the impacts of hydropower can be devastating, resulting in physical and economic displacement, the disenfranchisement of indigenous people’s rights, and the destruction of fragile ecosystems. Despite the historically significant impacts of hydropower, the information provided to affected communities and to the general public appears to be woefully inadequate.35 As the authors36 seem to vociferously declare that the all too common adverse consequences of hydro projects do not seem sufficient to prompt a modification on development banks’ investment priorities. The narrative that paints hydropower as source of clean and cheap energy continues to drive banks’ priorities while sweeping under the rug the unacceptable price paid by marginalized members of society.

1) Government of India, Ministry of Power, Central Electricity Authority. Power Sector 2017 <http://www.cea.nic.in/reports/monthly/executivesummary/2017/exe_summary-04.pdf>

2) Government of India, Ministry of Power, Central Electricity Authority. Hydro Planning and Investigation Reports. Page last updated: Mon Feb 13 2017 <http://www.cea.nic.in/monthlyhpi.html>

3) Government of India, Ministry of Power. Hydro Power Policy 2008 <http://www.ielrc.org/con- tent/e0820.pdf>

4) Bosshard, P. Power Finance: Financial Institutions In India’s Hydropower Sector. pp 36-38. January 2002. <http://www.sandrp.in/hydropower/Power_Finance.pdf&gt;

5) Bosshard, P. Power Finance: Financial Institutions In India’s Hydropower Sector. pp 43-48. January 2002. <http://www.sandrp.in/hydropower/Power_Finance.pdf&gt;

6) A concession is a selling group’s compensation in a stock or bond underwriting agreement. The amount of compensation is based on the underwriting spread, or the difference between what the public pays for the securities and what the issuing company receives from the sale.

7) Bosshard, P. Power Finance: Financial Institutions In India’s Hydropower Sector. p 66. January 2002. <http://www.sandrp.in/hydropower/Power_Finance.pdf&gt;

8) Return on Equity is a measure of profitability that calculates how many dollars of profit a company generates with each dollar of shareholders’ equity. Also referred to as return on net worth, it is formulaically ROE = (Net Income)/(Shareholders’ Equity).

9) Ministry of Law and Justice, Legislative Department. The Electricity Act, 2003. 2 Jun 2003. <http://www.cercind.gov.in/Act-with-amendment.pdf&gt;

10) Ullah, A. Public Private Partnership in Hydro-Power Development of India: Prospects and Challenges. In Journal of Business Management & Social Sciences Research (JBM&SSR). volume 4, No. 2, February 2015.

11) Investopedia. What role do SPVs / SPEs play in public-private partnerships? Mar 09 2015 <http://www.investopedia.com/ask/answers/030915/what-role-do-spvs-spes-play-publicprivate-partnerships.asp>

12) Government of India, Ministry of Corporate Affairs. The Companies Act, 2013. <http://ebook.mca.gov.in/default.aspx>

13) Government of India, Ministry of Housing and Urban Affairs. Smart Cities Mission. 18 Jul 2017. <http://smartcities.gov.in/content/innerpage/spvs.php>

14) PricewaterhouseCoopers & ASSOCHAM India. Hydropower @ Crossroads. pp 7 and 14. 2016 <https://www.pwc.in/assets/pdfs/publications/2016/hydropower-at-crossroads-pwc-assocham-report.pdf>

15) Indian Renewable Energy Development Agency Ltd. IREDA-NCEF Refinance Scheme for Scheduled Commercial Banks/FIs for Refinancing of their outstanding loans against Biomass Power & SHP Projects. 31 JUL 2017 <http://www.ireda.gov.in/writereaddata/Revised%20-%20IREDA%20NCEF%20Refinance%20Scheme.pdf>

16) Renewable Purchase Obligation refers to the obligation imposed by law on some entities to either buy electricity generated by specified ‘green’ sources, or buy, in lieu of that, ‘renewable energy certificates (RECs)’ from the market. The ‘obligated entities’ are mostly electricity distribution companies and large consumers of power. RECs are issued to companies that produce green power, who opt not to sell it at a preferable tariff to distribution companies.

17) Jai, S. Uncharted waters for hydropower’s renewable energy status. Business Standard. 24 Mar 2017 <http://www.business-standard.com/article/companies/uncharted-waters-for-hydropower-s-re-status-117032301145_1.html>

18) Small hydro currently enjoys a slew of concessions such as tax benefits and easier environment and water clearance. To promote it as a RE source, the Centre also offers subsidy support of Rs 5 crore per MW and/or Rs 20 crore per project. To replicate these subsidies for a large project would be very heavy on government finances. Also, this move to make large hydro as renewable only benefits the country, not the sector. The sector would have to wait for the new GST (goods and services tax) regime to kick in, to know what concessions are in store for them. The earlier 10-year tax holiday for power projects has ceased to exist. Excise, Customs and like duties would be decided after the GST is notified for the sector. The Government could be looking at removing the whole subsidy mechanism for the sector, like it did in solar and wind power. So, the first target (of its proposed move) is obviously to meet the INDC and the other could be to reform the sector by linking it to market forces. The subsidy in hydro is for loan repayment and that can only happen when a project is operational. Hydro faces operational issues, regulatory hurdles and local issues. These need to be addressed. A speedy approval mechanism would entail growth of the sector.

19) Mohanty, A. & Chaturvedi, D. Relationship between Electricity Energy Consumption and GDP: Evidence from India. In International Journal of Economics and Finance; Vol. 7, No. 2; 2015. pp 186-202.

20) PWC & FICCI. Hydropower in India: Key enablers for a better tomorrow. 2014 <http://www.pwc.in/assets/pdfs/publications/2014/hydropower-in-india-key-enablers-for-better-tomorrow.pdf>

21) A Non-Performing Asset (NPA) is defined as a a credit facility in respect of which the interest and/or installment of Bond finance principal has remained ‘past due’ for a specified period of time. NPA is used by financial institutions that refer to loans that are in jeopardy of default. In the Indian context: You may note that for a bank, the loans given by the bank is considered as its assets. So if the principle or the interest or both the components of a loan is not being serviced to the lender (bank), then it would be considered as a Non-Performing Asset (NPA). Any asset which stops giving returns to its investors for a specified period of time is known as Non-Performing Asset (NPA). Generally, that specified period of time is 90 days in most of the countries and across the various lending institutions. However, it is not a thumb rule and it may vary with the terms and conditions agreed upon by the financial institution and the borrower. Has the hydropower sector been impacted? In March 2017, India Ratings Downgraded Indira Priyadarshini Hydro Power’s Loans to ‘IND D’. The downgrade reflects the instances of delays of up to 90 days in servicing of debt obligations by IPHPPL during the three months ended February 2017, due to tight liquidity position. IPHPPL is sponsored by the Ind Barath group of companies, which is mainly engaged in the power development business. The company is setting up a 4.8MW run-of-the-river hydel power plant on Manuni khad (tributary of Beas) in Kangra District, Himachal Pradesh. The power plant is yet to be commissioned. Bank facilities have low complexity levels which reflect that the relationship between the inherent risk factors and intrinsic return characteristics is straightforward.

22) The transition to private participation in infrastructure has not yet settled; consequently, the financing environment for developing-country infrastructure is not clearly defined. In many developing countries, the agenda of market liberalization, regulatory reform, and the restructuring of state-owned monopoly utilities remains unfinished. Furthermore, given the characteristics of certain infrastructure industries, including the huge sunk costs involved, elements of natural mono- poly, and their political saliency, there remains a strong rationale for state intervention, even in cases where privatization has been completed. Also, investors must factor in ongoing transformations of the global infrastructure industry, such as how to accurately price and gauge demand for new products resulting from rapid technological change. Together with a series of recent financial crises, these developments have taken their toll, presenting a hierarchy of risks at the industry, country, and project levels. Those risks raise the cost of capital and make investors and creditors averse to long-term investments in developing- country infrastructure.

23) According to New Hydropower Policy 2017, which is in the pipeline, there would be provisions with viability gap funding for projects, compulsory hydropower purchase obligations for distribution companies and a set of good practices that states would have to follow. The policy being prepared by the power ministry will have provisions for viability gap funding, which will help in meeting the shortfall in project costs and reducing hydroelectricity tariffs for consumers. Hydropower is expensive and in some cases more than double the cost of power from coal-based thermal plants. Compulsory hydropower purchase from large projects will either be made part of the existing renewable power purchase obligation of distribution companies or a separate requirement, so that its inclusion does not affect the market for other renewable sources of energy like wind, solar or biomass. In February 2015, India’s first proposed hydro-electricity project to be built on a viability gap funding (VGF) basis and PPP mode appears to have fallen flat as the Mizoram government signs an MoU with the North-East Electric Power Corporation (NEEPCO) to take up the planned project in northern Mizoram. The project 210 MW Tuivai HEP was cleared in 2013 to become the country’s first VGF-based HEP in 2013, meaning the Centre was willing to foot up to Rs 750 crores of the total Rs 1,750 crores the project is estimated to cost. The project was envisaged such that it fell under the state sector, meaning Mizoram would have the rights to use as much of power generated for its needs and sell the remaining as it deems fit. But even then, plans fell through towards the end of last year as banks and private developers shied away from going ahead with the project, leaving the state government to look for other alternatives. The Indian Express. India’s first VGF hydro-power project falls through, Mizoram hands it over to NEEPCO. 11 Feb 2015 <http://indianexpress.com/article/india/india-others/indias-first-vgf-hydro-powerproject-falls-through-mizoram-hands-it-over-to-neepco/>

24) Securities and Exchange Board of India. Memorandum to the Board: Disclosure Requirements for Issuance and Listing Green Bonds. <http://www.sebi.gov.in/sebi_data/meetingfiles/1453349548574-a.pdf>

25) International Hydropower Association Communications Team. What will the Paris Agreement mean for hydropower development? Jan 21 2016. <https://www.hydropower.org/blog/what-will-the-paris-agreement-mean-for-hydropower-development>

26) International Hydropower Association. Hydropower Status Report 2017. <https://www.hydropower.org/2017-hydropower-status-report>

27) The World Bank. Rampur Hydropower Project. <http://projects.worldbank.org/P095114/rampur-hydropower-project?lang=en>

28) External Commercial Borrowing (ECB) Policy – Take-out Finance. Jul 22 2010 <http://allindiantaxes.com/rbicir10-11-4.php>

29) Door to Door tenor/maturity is a term that is mostly used in finance sector. It is generally used to indicate the total period within which the total debt borrowed is to be paid, this total period also includes the period of moratorium (that is the period for which payment has been postponed).

30) Reserve Bank of India. RBI/2011-12/ 9, Master Circular on External Commercial Borrowings and Trade Credits. Jul 01 2011 <https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=6501>

31) Strategic investors, venture capital, private equity are the principal providers of equity funding to RE projects. Private equity funds have dominated the equity investment scene. Majority of the investments are in INR and the funds stay invested in the companies for a period of 5 to 7 years. Typically, the hurdle rates for direct equity investments range between 16 and 20 %, and are dependent on factors, such as the size of the project, the background of sponsor, the technology risk, the stage of maturity, and geographic and policy risks. On a related note, there have been talks of Mezzannine financing. So, what exactly is meant by this, and has India had an instance of such financing? Mezzanine Finance is a form of quasi debt/equity instrument, wherein sector-specific investors or short-term investors park their funds assuring higher returns (typically 15 % more than the debt instruments). This facilitates availability of low cost equity to project promoters. The investment is secured by charging on assets after assigning first charge to the term-loan lenders. Mezzanine Finance is typically associated with debentures offered to the investor with an option to convert them to equity at a later stage. This form of finance offers flexibility to meet both the investor’s and the company’s requirements, and also provides medium term capital without significant ownership dilution. Mezzanine finance is less risky than equity for investors, as it provides fixed interest along with principal repayment and minimum guaranteed returns to investors. It is normally used in situations where the company is generating adequate cash flows to service coupon payments and the promoters are unwilling to dilute their equity stake in the company. The Indian RE market has seen very few mezzanine finance transactions. Few of the noteworthy transactions are – Mytrah Energy raised USD 78.5 million from IDFC Project Equity and USD 19 million from PTC Financial Services. Solar IPP Azure Power raised USD 13.6 million from Germany’s DEG.

32) Government of India, Income Tax Department. Income Tax Act 1961. <http://www.incometaxindia.gov.in/pages/acts/income-tax-act.aspx>

33) Capital Adequacy Ratio is a measure of bank’s capital, and expressed as a percentage of a bank’s risk weighted credit exposures. Also known as capital-to-risk weighted assets ratio (CRAR), it is used to protect depositors and promote the stability and efficiency of financial systems.

34) Romero, M. J. Where is the public in PPPs? Analysing the World Bank’s support for public-private partnerships. BrettonWoods Project. Sep 29 2014 <http://www.brettonwoodsproject.org/2014/09/public-ppps-analysing-world-banks-support-public-private-partnerships/>

35) Medallo, J. & Sampaio, A. Ongoing Trends in Hydropower. Coalition for Human Rights in Development. <http://rightsindevelopment.org/project/trends-the-rise-of-hydropower/>

36) ibid.

Conjuncted: Bank Recapitalization – Some Scattered Thoughts on Efficacies.

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In response to this article by Joe.

Some scattered thoughts could be found here.

With demonetization, banks got a surplus liquidity to the tune of Rs. 4 trillion which was largely responsible for call rates becoming tepid. However, there was no commensurate demand for credit as most corporates with a good credit rating managed to raise funds in the bond market at much lower yields. The result was that banks ended up investing most of this liquidity in government securities resulting in the Statutory Liquidity Ratio (SLR) bond holdings of banks exceeding the minimum requirement by up to 700 basis points. This combination of a surfeit of liquidity and weak credit demand can be used to design a recapitalization bond to address the capital problem. Since the banks are anyways sitting on surplus liquidity and investing in G-Secs, recapitalization bonds can be used to convert the bank liquidity to actually recapitalize the banks. Firstly, the government of India, through the RBI, will issue Recapitalization Bonds. Banks, who are sitting on surplus liquidity, will use their resources to invest in these recapitalization bonds. With the funds raised by the government through the issue of recapitalization bonds, the government will infuse capital into the stressed banks. This way, the surplus liquidity of the banks will be used more effectively and in the process the banks will also be better capitalized and now become capable of expanding their asset books as well as negotiating with stressed clients for haircuts. Recapitalization bonds are nothing new and have been used by the RBI in the past. In fact, the former RBI governor, Dr. Y V Reddy, continues to be one of the major proponents of recapitalization bonds in the current juncture. More so, considering that the capital adequacy ratio of Indian banks could dip as low as 11% by March 2018 if the macroeconomic conditions worsen, the motivation for going in for recap bonds has no logical counters. As I have often said this in many a fora, when banks talk numbers, transparency and accountability the way it is perceived isn’t how it is perceived by them, and moreover this argument gets diluted a bit in the wake of demonetization, which has still been haunted by lack of credit demand. As far as the NPAs are concerned, these were lying dormant and thanks to RBI’s AQR, these would not even have surfaced if let be made decisions about by the banks’ free hands. So, RBI’s intervention was a must to recognize NPAs rather than the political will of merely considering them as stressed assets. The real problem with recap bonds lie in the fact that the earlier such exercise in the 90s has still resulted in bonds maturing, and unless, these bonds are made tradable, these would be confined to further immaturities.

Demonetization – One Year Of A Rudderless Cacophony (A Booklet of Compilation of Blog Posts)

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On the midnight of 8/11/16, in a single pronouncement, the Prime Minister of India made higher denominations of Rs. 500 and Rs. 1000 illegal tender under the pretense of curbing black money, arresting tax evasion, stopping funding of terrorist activities and counterfeiting of currency. Those who had these notes were given a time frame of less than 2 months to deposit them and withdraw new denominations in different slabs of limits set by the RBI. The Indian economy, which is predominantly cash based and the Indian people, a great section of who are financially excluded, existing solely on hard currency, would somehow have to manage through this ‘temporary crisis’ for the greater good of the nation. This was the call of the Prime Minister to undergo ‘temporary hardships’ to root out the ills of the Indian Economy.

And so what happened? The country panicked and people rushed to banks to deposit their cash savings, exchange high denominations and lines formed. Long lines, winding unending lines full of people waiting to deposit and get new notes. People died in those lines, many patients could not get timely medical help, many social functions – marriages and burials got drowned in questions of “why cant you suffer a little for the country, when soldiers are giving their blood in the borders to protect you”. But what about people who never had a bank account? Or those too far away from a branch or ATM to withdraw or exchange? Or those whose earnings were so marginal that they could not spare losing a day’s work waiting in lines? Or women who had painstakingly collected money for emergency over many years? What about those crores of rupees that was saved through co-operative banking system, still far away from the mainstream banking operations – but was safeguarding the money of crores of people in many states? Modi’s solution for those suffering was clearly evident on the morning of the 9th, plastered on almost every major newspaper “abhi ATM nahin, Paytm Karo.”…..

Demonetization – One Year Of A Rudderless Cacophony

 

Why Should Modinomics Be Bestowed With An Ignoble Prize In Economics? Demonetization’s Spectacular Failure.

This lesson from history is quite well known:

Muhammad bin Tughlaq thought that may be if he could find an alternative currency, he could save some money. So he replaced the Gold and Silver coins with copper currency. Local goldsmiths started manufacturing these coins and which led to a loss of a huge sum of money to the court. He had to take his orders back and reissue Gold/Silver coins against those copper coins. This counter decision was far more devastating as people exchanged all their fake currency and emptied royal treasure.

And nothing seems to have changed ideatically even after close to 800 years since, when another bold and bald move or rather a balderdash move by the Prime Minister of India Narendra Modi launched his version of the lunacy. Throw in Demonetization and flush out black money. Well, that was the reason promulgated along with a host of other nationalistic-sounding derivatives like curbing terror funding, expanding the tax net, open to embracing digital economy and making the banking system more foolproof by introducing banking accounts for the millions hitherto devoid of any. But, financial analysts and economists of the left of the political spectrum saw this as brazen porto-fascistic move, when they almost unanimously faulted the government for not really understanding the essence of black money. These voices of sanity were chased off the net, and chided in person and at fora by paid trolls of the ruling dispensation, who incidentally were as clueless about it as about their existence. Though, some other motives of demonetization were smuggled in in feeble voices but weren’t really paid any heed to for they would have sounded the economic disaster even back then. And these are the contraband that could give some credibility to the whole exercise even though it has turned the world’s fastest-growing emerging economy (God knows how it even reached that pinnacle, but, so be it!) into a laughing stock of a democratically-elected dictatorial regime. What is the credibility talked about here? It was all about smashing the informal economy (which until the announcement of November 8 contributed to 40% of the GDP and had a workforce bordering on 90% of the entire economy) to smithereens and sucking it into the formal channel through getting banking accounts formalized. Yes, this is a positive in the most negative sense, and even today the government and whatever voices emanate from Delhi refuse to consider it as a numero uno aim.

Fast forward by 3 (period of trauma) + 8 (periods of post-trauma) months and the cat is out of the bag slapping the government for its hubris. But a spectacular failure it has turned out to be. The government has refused to reveal the details of how much money in banned notes was deposited back with the RBI although 8 months have passed since the window of exchange closed in January this year. Despite repeated questioning in Parliament, Supreme Court and through RTIs, the govt. and RBI has doggedly maintained that old banned notes were still being counted. In June this year, finance minister Arun Jaitley claimed that each note was being checked whether it was counterfeit and that the process would take “a long time”. The whole country had seen through these lies because how can it take 8 months to count the notes. Obviously there was some hanky panky going on. Despite statutory responsibility to release data related to currency in circulation and its accounts, the RBI too was not doing so for this period. They were under instructions to fiddle around and not reveal the truth. Consider the statistics next:

As on November 8, 2016, there were 1716.5 crore piece of Rs. 500 and 685.8 crore pieces of Rs. 1000 circulating the economy totaling Rs. 15.44 lakh crore. The Reserve Bank of India (RESERVE BANK OF INDIA ANNUAL REPORT 2016-17), which for a time as long as Urjit Patel runs the show has been criticized for surrendering the autonomy of the Central Bank to the whims and fancies of PM-run circus finally revealed that 99% of the junked notes (500 + 1000) have returned to the banking system. This revelation has begun to ricochet the corridors of power with severe criticisms of the government’s move to flush out black money and arrest corruption. When the RBI finally gave the figures through its annual report for 2016-17, it disclosed that Rs. 15.28 lakh crore of junked currency had formally entered the banking system through deposits, thus leaving out a difference of a mere (yes, a ‘mere’ in this case) Rs. 16,050 crore unaccounted for money. Following through with more statistics, post-demonetization, the RBI spent Rs. 7,965 crore in 2016-17 on printing new Rs. 500 and Rs. 2000 notes in addition to other denominations, which is more than double the Rs. 3,421 crore spent on printing new notes in the previous year. Demonetization, that was hailed as a step has proved to be complete damp squib as the RBI said that just 7.1 pieces of Rs. 500 per million in circulation and 19.1 pieces of Rs. 1000 per million in circulation were discovered to be fake further implying that if demonetization was also to flush pout counterfeit currency from the system, this hypothesis too failed miserably.

Opposition was quick to seize on the data with the former Finance minister P Chidambaram tweeting:

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He further lamented that with 99% of the currency exchanged, was demonetization a scheme designed to convert black money to white? Naresh Agarwal of Samajwadi Party said his party would move privilege motion against Urjit Patel for misleading a Parliamentary Panel on the issue.

But, what of the immense collateral damage that the exercise caused? And why is the government still so shameless in protecting a lunacy? Finance Minister Arun Jaitley on asserted that any attempt to measure the success of the government’s demonetization exercise on the basis of the amount of money that stayed out of the system was flawed since the confiscation of money had not been the objective. He maintained that the government had met its principal objectives of reducing the reliance on cash in the economy, expanding the tax base and pushing digitisation. Holy Shit! And he along with his comrades is selling and marketing this crap and sadly the majority would even buy into this. Let us hear him out on the official position:

Denying that demonetisation failed to achieve its objectives, Finance Minister Arun Jaitley said the measure had succeeded in reducing cash in the economy, increasing digitisation, expanding the tax base, checking black money and in moving towards integrating the informal economy with the formal one. “The objective of demonetisation was that India is a high-cash economy and that scenario needs to be altered,” Jaitley told following the release of the Reserve Bank of India’s (RBI) annual report for the last fiscal giving the figures, for the first time, of demonetised notes returned to the system. The RBI said that of the Rs 15.44 lakh crore of notes taken out of circulation by the demonetisation of Rs 500 and Rs 1,000 notes last November, Rs 15.28 lakh crore, or almost 99 per cent, had returned to the system by way of deposits by the public.”The other objectives of demonetisation were to combat black money and expand the tax base. Post demonetisation, tariff tax base has increased substantially. Personal IT returns have increased by 25 per cent,” the Finance Minister said. “Those dealing in cash currency have now been forced to deposit these in banks, the money has got identified with a particular owner,” he said. “Expanding of the indirect tax base is evident from the results of the GST collections, which shows more and more transactions taking place within the system,” he added. Jaitley said the government has collected Rs 92,283 crore as Goods and Services Tax (GST) revenue for the first month of its roll-out, exceeding the target, while 21.19 lakh taxpayers are yet to file returns. Thus, the July collections target have been met with only 64 per cent of compliance. “The next object of demonetisation is that digitisation must expand, which climaxed during demonetisation and we are trying to sustain that momentum even after remonetisation is completed. Our aim was that the quantum of cash must come down,” Jaitley said. He noted in this regard that RBI reports that the volume of cash transactions had reduced by 17 per cent post-demonetisation. A Finance Ministry reaction to the RBI report said a significant portion of the scrapped notes deposited “could possibly be representing unexplained/black money”. “Accordingly, ‘Operation Clean Money’ was launched on 31st January 2017. Scrutiny of about 18 lakh accounts, prima facie, did not appear to be in line with their tax profile. These were identified and have been approached through email/sms. “Jaitley slammed his predecessor P. Chidambaram for his criticism of the note ban, saying those who had not taken a single step against black money were trying to confuse the objectives of the exercise with the amount of currency that came back into the system. The Finance Ministry said transactions of more than three lakh registered companies are being scrutinised, while one lakh companies have been “struck off the list”. “The government has already identified more than 37,000 shell companies which were engaged in hiding black money and hawala transactions. The Income-tax Directorates of Investigation have identified more than 400 benami transactions up to May 23, 2017, and the market value of properties under attachment is more than Rs 600 crore,” it said. “The integration of the informal with the formal economy was one of the principle objectives of demonetisation,” Jaitley said. He also said that demonetisation had dealt a body blow to terrorist and Maoist financing that was evident from the situation on the ground in Chhattisgarh and Jammu and Kashmir. One thing is for sure: more and more of gobbledygook is to follow.

One of the major offshoots of the demonetisation drive was a push towards a cashless, digital economy. Looking at the chart below, where there is presented the quantum of cashless transactions in some of the major economies of the world…one could only see India’s dismal position. Just about 2% of the volume of economic transactions in India are cashless.

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Less cash would mean less black money…less corruption…and more transparency. Is it? Assuming it is, how far the drive would go on driving? But was India really ready to go digital? There were 5.3 bank branches per one lakh Indians in rural India 15 years ago. On the eve of demonetization, the figure stood at 7.8 bank branches per one lakh Indians. This shows that a majority of rural India has very little access to banks and the organized financial sector. They rely heavily on cash and the informal credit system. Then, we have just 2.2 lakh ATMs in the country. For a population of over 1.2 billion people, that’s a very small number. And guess what? A majority of ATMs are concentrated in metros and cities. For instance, Delhi has more ATMs than the entire state of Rajasthan. Given the poor penetration of banks and formal sector financial services in rural India, Modi’s cashless economy ambitions were always a distant dream. Then there are issues of related to security. Were the banks and other financial institutions technologically competent to tackle the security issues associated with the swift shift towards a digital economy? Can the common man fully trust that his hard earned money in the financial system will be safe from hackers and fraudsters? And the answer does not seem be a comforting one!

“Those dealing in cash currency have now been forced to deposit these in banks, the money has got identified with a particular owner” So surveillance was the reason. Makes sense why they are so desperate to link aadhaar to bank accounts. Some researchers have considered couple of factors which have actually caused demonetization in India. First one includes the refinancing of public sector banks in India. 80% of banks in India are run by government, during the last two decades these banks have been used to lend out loans to corporations which stink of cronyism. These politically-affiliated businesses did not pay back their money which has resulted into the accumulation of huge amount of non-performing assets (NPAs) within these banks. From last three years warning signals were continuously coming about their collapse. Through demonetization millions of poor people have deposited their meagre sums within these banks which have resulted into their refinancing, so that they can now lend the money to the same guys who earlier do not paid back their loans. sounds pretty simplistic, right? Sad, but true, it is this simple. The second factor is the influence of technological and communications companies on the government, as these companies are among the fastest growing ones during the last two decades. Making payments through digital gate ways will be very beneficial for their growth. They can expand their influence over the whole human race. The statements from technological giants like Apple, Microsoft, MasterCard, Facebook, Google etc. clearly shows their intentions behind cashless society. Tim Cook the chief executive of Apple said that “next generation of children will not know what money is” as he promotes “apple pay” as an alternative. MasterCard executives consider apple pay as another step towards cashless society. MasterCard is mining Facebook users data to get consumer behaviour information which it can sell to banks. Bill gates said India will shift to digital payments, as the digital world lets you track things quickly. The acquisition of artificial intelligence companies by Google, Facebook and Microsoft is also on its peak. Over 200 private companies using AI algorithms across different verticals have been acquired since 2012, with over 30 acquisitions taking place in Q1 of 2017 alone. Apple acquired voice recognition firm “Vocal IQ and real face Google has acquired deep learning and neural network, Facebook acquired Masquerade Technologies and Zurich Eye. So what is actually going on, as private corporations and governments are desperate to introduce cashless economy through biometric payment system.

No black money was unearthed by Modi’s historic folly. Terrorism has also not gone down after demonetization and neither has circulation of counterfeit currency. So, it was a failure on all counts, a point that has been predicted by economists worldwide. What the note ban did was cause untold suffering and misery to common people, destroy livelihoods of millions of wage workers, caused bankruptcy to farmers because prices of their produce crashed and disrupted the economic life of the whole country. The only people who benefited from the note bandi were companies that own digital payment systems (like PayTM, MobiKwik etc.) and credit card companies. It also seems now that ultimately, the black money owners have benefited because they managed to convert all their black wealth in to white using proxies.

A Monetary Drain due to Excess Liquidity. Why is the RBI Playing Along

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And so we thought demonetization was not a success. Let me begin with the Socratic irony to assume that it was indeed a success, albeit not in arresting black money for sure. Yes, the tax net has widened and the cruelty of smashing down the informal sector to smithereens to be replaceable with a formal economy, more in the manner of sucking the former into the latter has been achieved. As far as terror funding is concerned, it is anybody’s guess and so let them be with their imaginations. What none can deny is the surge in deposits and liquidity in the wake of demonetization. But, what one has been consciously, or through an ideological-driven standpoint denying is the fact that demonetization clubbed with the governmental red carpet for foreign direct investment has been an utter failure to attract money into the country. And the reason attributed for the same has been a dip in the economy as a result of the idiosyncratic decision of November 8 added with the conjuring acts of mathematics and statistics in tweaking base years to let go off the reality behind a depleting GDP and project the country as the fastest growing emerging economy in the world. The irony I started off with is defeated here, for none of the claims that the government propaganda machine churns out on the assembly line are in fact anywhere near the truth. But, thats what a propaganda is supposed to doing, else why even call it that, or even call for a successful governance and so on and on (sorry for the Žižekian interjections here).

Assuming the irony still has traces and isn’t vanquished, it is time to move on and look into the effects of what calls for a financial reality-check. Abruptly going vertically through the tiers here, it is recently been talked about in the corridors of financial power that the Reserve Bank of India (RBI) is all set to drain close to 1.5 lakh crore in excess liquidity from the financial system as surging foreign investments forces the central bank to absorb the dollar inflows and sell rupees to cap gains in the local currency. This is really interesting, for the narrative or the discourse is again symptomatic of what the government wants us to believe, and so believe we shall, or shall we? After this brief stopover, chugging off again…Foreign investments into debt and shares have reached a net $31 billion this year, compared with $2.7 billion in sales last year, due to factors including India’s low inflation and improving economic growth. This is not merely a leap, but a leap of faith, in this case numerically. Yes, India is suffering from low inflation, but it ain’t deflation, but rather disinflation. There is a method to this maddening reason, if one needs to counter what gets prime time economic news in the media or passes on as Chinese Whispers amongst activists hell-bent on proving the futility of the governmental narrative. There is nothing wrong in the procedure as long as this hell-bent-ness is cooked in proper proportions of reason. But, why call it disinflation and not deflation? A sharp drop in inflation below the Reserve Bank of India’s (RBI’s) 4% target has been driven by only two items – pulses and vegetables. the consumer price index (CPI), excluding pulses and vegetables, rose at the rate of 3.8% in July, much higher than the official headline figure of 2.4% inflation for the month. The re-calculated CPI is based on adjusted weights after excluding pulses and vegetables from the basket of goods and services. The two farm items – pulses and vegetables – have a combined weight of only 8.4% in the consumer price index (CPI) basket. However, they have wielded disproportionate influence over the headline inflation number for more than a year now owing to the sharp volatility in their prices. So, how does it all add up? Prices of pulses and vegetables have fallen significantly this year owing to increased supply amid a normal monsoon last year, as noted by the Economic Survey. The high prices of pulses in the year before and the government’s promises of more effective procurement may have encouraged farmers to produce more last year, resulting in a glut. Demonetisation may have added to farmers’ woes by turning farm markets into buyers’ markets. Thus, there does not seem to be any imminent threat of deflation in India. A more apt characterization of the recent trends in prices may be ‘disinflation’ (a fall in the inflation rate) rather than deflation (falling prices) given that overall inflation, excluding pulses and vegetables, is close to the RBI target of 4%. On the topicality of improving economic growth in the country, this is the bone of contention either weakening or otherwise depending on how the marrow is key up.

Moving on…The strong inflows have sent the rupee up nearly 7 per cent against the dollar and forced the RBI to buy more than $10 billion in spot market and $10 billion in forwards this year – which has meant an equivalent infusion in rupees. Those rupee sales have added liquidity into a financial system already flush with cash after a ban on higher-denomination currency in November sparked a surge in bank deposits. Average daily liquidity has risen to around Rs 3 lakh crore, well above the RBI’s goal of around Rs 1 lakh crore, according to traders. That will force the RBI to step up debt sales to remove liquidity and avoid any inflationary impact. Traders estimate the RBI will need to drain Rs 1 lakh crore to Rs 1.4 lakh crore ($15.7 billion to $22 billion) after taking into account factors such as festival-related consumer spending that naturally reduce cash in the system. How the RBI drains the cash will thus become an impact factor for bond traders, who have benefitted from a rally in debt markets. The RBI has already drained about Rs 1 lakh crore via one-year bills under a special market stabilisation scheme (MSS), as well as Rs 30,000 crore in longer debt through open market sales. MSS (Market Stabilisation Scheme) securities are issued with the objective of providing the RBI with a stock of securities with which it can intervene in the market for managing liquidity. These securities are issued not to meet the government’s expenditure. The MSS scheme was launched in April 2004 to strengthen the RBI’s ability to conduct exchange rate and monetary management. The bills/bonds issued under MSS have all the attributes of the existing treasury bills and dated securities. These securities will be issued by way of auctions to be conducted by the RBI. The timing of issuance, amount and tenure of such securities will be decided by the RBI. The securities issued under the MSS scheme are matched by an equivalent cash balance held by the government with the RBI. As a result, their issuance will have a negligible impact on the fiscal deficit of the government. It is hoped that the procedure would continue, noting staggered sales in bills, combined with daily reverse repo operations and some long-end sales, would be easily absorbable in markets. The most disruptive fashion would be stepping up open market sales, which tend to focus on longer-ended debt. That may send yields higher and blunt the impact of the central bank’s 25 basis point rate cut in August. The RBI does not provide a timetable of its special debt sales for the year. and if the RBI drains the cash largely through MSS bonds then markets wont get too much impacted. This brings us to close in proving the success story of demonetization as a false beacon, in that with a surge in liquidity, the impact on the market would be negligible if MSS are resorted to culminating in establishing the fact that demonetization clubbed with red-carpeted FDI has had absolutely no nexus in the influx of dollars and thus any propaganda of this resulting as a success story of demonetization is to be seen as purely rhetoric. QED.

Fiscal Responsibility and Budget Management (FRBM) Act

The Government appointed a five-member Committee in May 2016, to review the Fiscal Responsibility and Budget Management (FRBM) Act and to examine a changed format including flexible FRBM targets. The Committee formation was announced during the 2016-17 budget by FM Arun Jaitely. The Panel was headed by the former MP and former Revenue and Expenditure Secretary NK Singh and included four other members, CEA Arvind Subramanian, former Finance Secretary Sumit Bose, the then Deputy Governor and present governor of the RBI Urjit Patel and Nathin Roy. There was a difference of opinion about the need for adopting a fixed FRBM target like fiscal deficit, and the divisive opinion lay precisely in not following through such a fixity in times when the government had to spend high to fight recession and support economic growth. The other side of the camp argued it being necessary to inculcate a feeling of fiscal discipline. During Budget speech in 2016, Mr Jaitley expressed this debate:

There is now a school of thought which believes that instead of fixed numbers as fiscal deficit targets, it may be better to have a fiscal deficit range as the target, which would give necessary policy space to the government to deal with dynamic situations. There is also a suggestion that fiscal expansion or contraction should be aligned with credit contraction or expansion, respectively, in the economy.

The need for a flexible FRBM target that allowed higher fiscal deficit during difficult/recessionary years and low targets during comfortable years, gives the government a breathing space to borrow more during tight years. In it report submitted in late January this year, the committee did advocate for a range rather than a fixed fiscal deficit target. Especially, fiscal management becomes all the more important post-demonetisation and the resultant slump in consumption expenditure. The view is that the government could be tempted to increase public spending to boost consumption. but, here is the catch: while ratings agencies do look at the fiscal discipline of a country when considering them for a ratings upgrade, they also look at the context and the growth rate of the economy, so the decision will not be a myopic one based only on the fiscal and revenue deficits.

Fiscal responsibility is an economic concept that has various definitions, depending on the economic theory held by the person or organization offering the definition. Some say being fiscally responsible is just a matter of cutting debt, while others say it’s about completely eliminating debt. Still others might argue that it’s a matter of controlling the level of debt without completely reducing it. Perhaps the most basic definition of fiscal responsibility is the act of creating, optimizing and maintaining a balanced budget.

“Fiscal” refers to money and can include personal finances, though it most often is used in reference to public money or government spending. This can involve income from taxes, revenue, investments or treasuries. In a governmental context, a pledge of fiscal responsibility is a government’s assurance that it will judiciously spend, earn and generate funds without placing undue hardship on its citizens. Fiscal responsibility includes a moral contract to maintain a financially sound government for future generations, because a First World society is difficult to maintain without a financially secure government.

But, what exactly is fiscal responsibility, fiscal management and FRBM. So, here is an attempt to demystify these.

Fiscal responsibility often starts with a balanced budget, which is one with no deficits and no surpluses. The expectations of what might be spent and what is actually spent are equal. Many forms of government have different views and expectations for maintaining a balanced budget, with some preferring to have a budget deficit during certain economic times and a budget surplus during others. Other types of government view a budget deficit as being fiscally irresponsible at any time. Fiscal irresponsibility refers to a lack of effective financial planning by a person, business or government. This can include decreasing taxes in one crucial area while drastically increasing spending in another. This type of situation can cause a budget deficit in which the outgoing expenditures exceed the cash coming in. A government is a business in its own right, and no business — or private citizen — can thrive eternally while operating with a deficit.

When a government is fiscally irresponsible, its ability to function effectively is severely limited. Emergent situations arise unexpectedly, and a government needs to have quick access to reserve funds. A fiscally irresponsible government isn’t able to sustain programs designed to provide fast relief to its citizens.

A government, business or person can take steps to become more fiscally responsible. One useful method for government is to provide some financial transparency, which can reduce waste, expose fraud and highlight areas of financial inefficiency. Not all aspects of government budgets and spending can be brought into full public view because of various risks to security, but offering an inside look at government spending can offer a nation’s citizens a sense of well-being and keep leaders honest. Similarly, a private citizen who is honest with himself about where he is spending his money is better able to determine where he might be able to make cuts that would allow him to live within his means.

Fiscal Responsibility and Budget Management (FRBM) became an Act in 2003. The objective of the Act is to ensure inter-generational equity in fiscal management, long run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in fiscal operation of the Government.

The Government notified FRBM rules in July 2004 to specify the annual reduction targets for fiscal indicators. The FRBM rule specifies reduction of fiscal deficit to 3% of the GDP by 2008-09 with annual reduction target of 0.3% of GDP per year by the Central government. Similarly, revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination to be achieved by 2008-09. It is the responsibility of the government to adhere to these targets. The Finance Minister has to explain the reasons and suggest corrective actions to be taken, in case of breach.

FRBM Act provides a legal institutional framework for fiscal consolidation. It is now mandatory for the Central government to take measures to reduce fiscal deficit, to eliminate revenue deficit and to generate revenue surplus in the subsequent years. The Act binds not only the present government but also the future Government to adhere to the path of fiscal consolidation. The Government can move away from the path of fiscal consolidation only in case of natural calamity, national security and other exceptional grounds which Central Government may specify.

Further, the Act prohibits borrowing by the government from the Reserve Bank of India, thereby, making monetary policy independent of fiscal policy. The Act bans the purchase of primary issues of the Central Government securities by the RBI after 2006, preventing monetization of government deficit. The Act also requires the government to lay before the parliament three policy statements in each financial year namely Medium Term Fiscal Policy Statement; Fiscal Policy Strategy Statement and Macroeconomic Framework Policy Statement.

To impart fiscal discipline at the state level, the Twelfth Finance Commission gave incentives to states through conditional debt restructuring and interest rate relief for introducing Fiscal Responsibility Legislations (FRLs). All the states have implemented their own FRLs.

Indian economy faced with the problem of large fiscal deficit and its monetization spilled over to external sector in the late 1980s and early 1990s. The large borrowings of the government led to such a precarious situation that government was unable to pay even for two weeks of imports resulting in economic crisis of 1991. Consequently, Economic reforms were introduced in 1991 and fiscal consolidation emerged as one of the key areas of reforms. After a good start in the early nineties, the fiscal consolidation faltered after 1997-98. The fiscal deficit started rising after 1997-98. The Government introduced FRBM Act, 2003 to check the deteriorating fiscal situation.

The implementation of FRBM Act/FRLs improved the fiscal performance of both centre and states.

The States have achieved the targets much ahead the prescribed timeline. Government of India was on the path of achieving this objective right in time. However, due to the global financial crisis, this was suspended and the fiscal consolidation as mandated in the FRBM Act was put on hold in 2007- 08.The crisis period called for increase in expenditure by the government to boost demand in the economy. As a result of fiscal stimulus, the government has moved away from the path of fiscal consolidation. However, it should be noted that strict adherence to the path of fiscal consolidation during pre crisis period created enough fiscal space for pursuing counter cyclical fiscal policy.the main provisions of the Act are:

  1. The government has to take appropriate measures to reduce the fiscal deficit and revenue deficit so as to eliminate revenue deficit by 2008-09 and thereafter, sizable revenue surplus has to be created.
  2. Setting annual targets for reduction of fiscal deficit and revenue deficit, contingent liabilities and total liabilities.
  3. The government shall end its borrowing from the RBI except for temporary advances.
  4. The RBI not to subscribe to the primary issues of the central government securities after 2006.
  5. The revenue deficit and fiscal deficit may exceed the targets specified in the rules only on grounds of national security, calamity etc.

Though the Act aims to achieve deficit reductions prima facie, an important objective is to achieve inter-generational equity in fiscal management. This is because when there are high borrowings today, it should be repaid by the future generation. But the benefit from high expenditure and debt today goes to the present generation. Achieving FRBM targets thus ensures inter-generation equity by reducing the debt burden of the future generation. Other objectives include: long run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in fiscal operation of the Government.

The Act had said that the fiscal deficit should be brought down to 3% of the gross domestic product (GDP) and revenue deficit should drop down to nil, both by March 2009. Fiscal deficit is the excess of government’s total expenditure over its total income. The government incurs revenue and capital expenses and receives income on the revenue and capital account. Further, the excess of revenue expenses over revenue income leads to a revenue deficit. The FRBM Act wants the revenue deficit to be nil as the revenue expenditure is day-to-day expenses and does not create a capital asset. Usually, the liabilities should not be carried forward, else the government ends up borrowing to repay its current liabilities.

However, these targets were not achieved because the global credit crisis hit the markets in 2008. The government had to roll out a fiscal stimulus to revive the economy and this increased the deficits.

In the 2011 budget, the finance minister said that the FRBM Act would be modified and new targets would be fixed and flexibility will be built in to have a cushion for unforeseen circumstances. According to the 13th Finance Commission, fiscal deficit will be brought down to 3.5% in 2013-14. Likewise, revenue deficit is expected to be cut to 2.1% in 2013-14.

In the 2012 Budget speech, the finance minister announced an amendment to the FRBM Act. He also announced that instead of the FRBM targeting the revenue deficit, the government will now target the effective revenue deficit. His budget speech defines effective revenue deficit as the difference between revenue deficit and grants for creation of capital assets. In other words, capital expenditure will now be removed from the revenue deficit and whatever remains (effective revenue deficit) will now be the new goalpost of the fiscal consolidation. Here’s what effective revenue deficit means.

Every year the government incurs expenditure and simultaneously earns income. Some expenses are planned (that it includes in its five-year plans) and other are non-planned. However, both planned and non-planned expenditure consists of capital and revenue expenditure. For instance, if the government sets up a power plant as part of its non-planned expenditure, then costs incurred towards maintaining it will now not be called revenue deficit because it is towards maintaining a “capital asset”. Experts say that revenue deficit could become a little distorted because by reclassifying revenue deficit, it is simplifying its target.

 

access to reserve funds. A fiscally irresponsible government isn’t able to sustain programs designed to provide fast relief to its citizens.

India’s Banking Crisis is Made Worse by the Poor Performance of its Debt Recovery Tribunals, and What to Say About the Bankruptcy Code?

Debt recovery tribunals were set up under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 with the aim of streamlining the mechanism to recover bad debts. This process was earlier handled by civil courts before being shifted to 38 debt recovery tribunals and five debt recovery appellate tribunals across the country. Since their conception, these tribunals have been dogged by concerns about their judicial independence because the Ministry of Finance, which controls public-sector banks, has had significant influence on them.

Almost as soon as its parent statute was passed by Parliament in 1993, the Delhi High Court Bar Association challenged the constitutionality of the debt recovery tribunal on the grounds that its parent statute lacked the judicial independence that is expected of judicial bodies. In 1995, the Delhi High Court struck down the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 ruling that it was “unconstitutional as it erodes the independence of the judiciary and is irrational, discriminatory, unreasonable, arbitrary and is hit by Article 14 of the Constitution”. (Article 14 deals with equality before the law). Subsequently, the Gauhati and Karnataka High Courts also struck down the same legislation for being unconstitutional. On appeal, however, the Supreme Court in 2002 over-ruled all of the High Courts and upheld the constitutionality of the legislation.

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DRTs were created to help financial institutions recover dues speedily without being subjected to lengthy procedures of civil courts have fallen into the same trap precisely. In the words of Shaswat Sharma, partner, KPMG, India, “The functioning of DRTs needs to improve to ensure banks are able to recover their existing loans and offer fresh advances at cheaper rates…In the current scheme of things there is no mechanism in place to ensure that the tribunal disposes the case in a timely manner. There is a strong case to bring in more accountability for the DRT.” If dealing with the subject matter at hand with speed is the biggest challenge facing DRTs, any number of additional DRTs and Appellate Tribunals should address this problem convincingly as was outlined by the Finance Minister during his Budget Speech 16-17. The under performance is even keeping the RBI worried. In the words of Raghuram Rajan, Governor, RBI, “If bankers cannot get their money back, they are not going to give ou loans at cheap priceSo, making sure DRTs work better, making sure that you don’t have excess number of stays, excess number of appeals, is what needs to be focused on.”
Bankruptcy Code: Now with all the possible means exercised to constrain the rising debts, bad assets of financial institutions, the situation still seems far from under control, and its here that the proposed Bill on Bankruptcy with the vision to consolidate scattered laws relating to insolvency of companies makes a strong point. Recently, Finance Minister reiterated the commitment to introduce the Bill in the upcoming session of the Parliament. As with other mechanisms, the efficacy is still in hypothetical stage, but the Bill at least promises to accelerate the winding-up process of defaulting companies and opening up a quicker exit route for lenders. The draft of the code draws on may parallels to the US Bankruptcy Code, especially allowing companies to carry out businesses while simultaneously going through bankruptcy proceedings, while differing on management control, where, unlike in the US, the management control in India passes over to “insolvency resolution processes”. But, the question remains as to how would this Bill address the issue of NPAs? The impact felt is likely to be in,
a. The time frame of 180-day limit (an extension of a further 90 days in exceptional cases) would help lenders decide on the viability of the business, whereafter a liquidation process sets in.
b. Economic and financial viability of the debtor company is to be discussed in negotiations with the creditors facilitated by “insolvency experts” rather than courts lending the process more credibility.
c. Bill would have ample scope for early recognition of financial distress helping the process of easing out businesses under stress.
The success of the Bill would depend on how well it is implemented and whether setting up of an “insolvency regulator” would have the requisite powers to see its successful implementation. For the RBI, “an early clearance of the proposed insolvency and bankruptcy bill will play an important role in the face of mounting potential losses.”
Despite having a handful of measures to address the issues of NPAs and NPLs, few seem to be working positively, but are heavily relied upon and banked on for lack of a better alternative. What is really the need of the hour is to arm these mechanism to the teeth for results to flow out, and unless such is undertaken, the likelihood of policy paralysis would ensue.

Bad loan crisis continues: 56.4 per cent rise in NPAs of banks

Gross non-performing assets (NPAs), or bad loans, of state owned banks surged 56.4 per cent to Rs 614,872 crore during the 12-month period ended December 2016, and appear set to rise further in the next two quarters with many units, especially in the small and medium sectors, struggling to repay after being hit by the government’s decision to withdraw currency notes of Rs 500 and Rs 1,000 denomination………The RBI discontinued fresh corporate debt restructuring (CDR) with effect from April 1, 2016. Here, promoters’ equity was financed by the borrowed amount, that added the burden of debt servicing on banks. The CDR cell faced problems on account of delay in the sale of unproductive assets due to various legalities that were involved.

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And despite the discontinuation, some strands of CDR are retained to say the least. Whats wrong and what must have gone wrong or perceived as such for the Central Bank to have withdrawn support to CDR. A small take follows.

15 per cent is still talking about minimalist valuations. The most important part of the whole report lies in CDR failing, and that too when promoters’ equity is getting funded on borrowed money, resulting in an intensification of burdens on banks’-directed debt financing. This directly cross-purposes with Sebi regulations regarding companies/corporations pledging their shares and then discovering that when such valuations compared with market capitalization slump down, this is really a fix, as companies where promoters have pledged a large share of their holdings are viewed with caution in that if a promoter defaults on this debt, the lender transfers the shares into their own hands on one hand, and when they need funds they dump this stock on the market on the other, leading to sharp movements in share prices. These fluctuations really nosedive when economy is on the downturn, forcing promoters to borrow against their shares (not that they do not do that otherwise) and all the more prompting them to go out and borrow to meet volatility checks denting the balance sheet health.