Sitting in his garden in New Delhi last Wednesday, Sushil Kumar Shinde, India’s outgoing power minister, looked relaxed in an open-necked white shirt, serenely detached from the chaos that had over-run his country in the previous 48 hours.
In the aftermath of a series of rolling blackouts that left more than 600m people without electricity and heaped further doubt on his nation’s faltering image as an aspirant economic superpower, Mr Shinde calmly deflected criticism. “India is an expert in this sector,” he told a television interviewer, adding: “This is technological failure, it has nothing to do with the political system.” When asked how he rated his own six-year tenure, he replied with just one word: “Excellent.”
It is an assessment few in India are likely to accept.
In fact, the rickety power grid represents only part of a deeper crisis brewing in this country of 1.2bn. Indian business leaders fear the troubles of the moribund energy sector could fatally undermine some of the nation’s banks, unless the government takes decisive action.
Anil Ambani, the billionaire head of Reliance Power, has even warned that India could face “our version of the US subprime crisis” unless it addresses the complex problems that have locked the power and banking sectors together in a dangerous embrace.
Energy networks need hundreds of billions of dollars in fresh investment to meet fast-rising demand and fuel India’s economic rise. But the banks are hardly in a position to provide the funding. They are already heavily overexposed to energy companies in frail health, raising the spectre of growing loan defaults.
The investment required ranges far beyond patching up the grid. The wider power sector offers a toxic combination of inadequate fuel supplies, debt-laden power generators and bankrupt state electricity boards. If their weakness does spill over into India’s financial system, it will imperil investment and further dent the country’s weakening growth.
The scale of this malaise was laid out in March, at an acrimonious meeting hosted by India’s Association of Power Producers in New Delhi and presided over by Pranab Mukherjee, the former finance minister.
The gathering was the second of the year. At a previous get-together in January with Manmohan Singh, prime minister, members of the group, which included many of India’s most powerful businessmen, complained bitterly about the parlous state of their industry.
At the March meeting, Mr Ambani delivered his ominous warning to Mr Mukherjee that India could face a financial meltdown similar to America’s subprime mortgage collapse, unless the government took action. “There will be a banking crisis,” he said starkly.
Any such crisis would severely damage not only India’s ability to rescue its power sector, but also to invest more widely.
“India needs [to invest] $400bn to $500bn in the next five years,” says Rajiv Lall, head of Infrastructure Development Finance Company in Mumbai. “Where will that money come from? The problems threaten the debt service capacity of the power producers. If the problems aren’t solved, the banks will not be willing to finance future growth. How will we fund future capacity?”
The practical problems are grave. A rising cost of capital and the heavy burden of India’s high interest rates are aggravating the already critical health of many power producers.
The stakes are particularly high for many of the rich industrialists present at the meeting in March. Mr Ambani, alongside Ratan Tata’s Tata Power, had won contracts to build massive 4,000 megawatt “ultra mega” power plants in the past few years, costing as much as $4bn. Private power companies headed by other prominent tycoons, including billionaire Gautam Adani’s Adani Power, have also spent heavily and piled up large debts.
This investment is bearing fruit. More than 26,000mw of new power capacity will be added in 2012, nearly twice the level added the year before, according to Kotak, a Mumbai-based brokerage. Yet these new operations face major shortages of domestic coal, raising the risk of plants lying idle for lack of fuel. Even if they begin generation, India’s dilapidated grid system is often unable to transmit their power – as last week’s blackouts showed only too clearly.
These problems stem partly from the fact that Coal India, an entity 90 per cent owned by the government, is failing to deliver promised fuel supplies, in part because of its own inefficiency and partly because other parts of India’s government have failed to provide regulatory and environmental clearances. Meanwhile, many of the 28 state-level electricity boards to whom the producers are obliged to sell are effectively bankrupt, raising doubts over whether power generators will be paid and can pay back their loans in turn.
In desperation, Mr Singh, in April ordered the state-backed miner to supply fuel to private producers or face penalties, effectively forcing Coal India to crank up imports. India is now set to increase substantially the $5bn it spent bringing in more expensive foreign coal last year, despite sitting on about 7 per cent of the world’s recoverable coal reserves.
“The structural threat of fuel availability and pricing can potentially impair the viability of one-third of the generation capacity under implementation today,” Crisil, the Indian credit rating agency, noted in a report last year. And all of this is before considering problems with the electricity grid itself, where losses in distribution during 2011 may have been some Rs400bn ($7.2bn), increasing the debt of state power utilities to Rs3tn, Crisil estimates.
“All the private power producers are caught in the middle,” says Jaideep Khanna, managing director of Barclays in India. “The coal supply isn’t being delivered and they are not being paid by the state distribution companies. Sovereign related entities on both sides are not meeting their obligations. Only the government has the wherewithal to resolve the problems. The business model is broken.”
This is where the banks begin to get worried. Between 2008 and 2011, half of all new credit in India went to infrastructure and power, according to Mahrukh Adajania, a director at Standard Chartered bank in Mumbai. Now $500bn in loans to the power sector is at risk. If a solution is not found, as much as 90 per cent of the loans to the sector could default, an amount that “would have a significant impact on the banks,” says Pawan Agrawal, a senior director at Crisil.
These problems could hardly come at a worse time. As new capacity comes online, the banking system’s exposure to power debts will almost double over the next three years, to about $162bn, according to Kotak. At the same time, ongoing fuel shortages mean more power stations will probably operate below capacity, bringing in insufficient revenues and increasing non-performing loans to the banks themselves.
“The situation is worse now ... than in 2008 when they [India’s banks] were perceived as more defensive,” notes an analyst for one major Hong Kong hedge fund, which has recently been buying protection on Indian banks in the credit default swap market, in the belief that price for credit protection will rise – essentially a bet that the banks’ credit quality will worsen, largely because of exposure to power debts.
Trying to find a way round these multiple, intertwined problems will prove difficult. The government’s first task is to prevent a repeat of last week’s catastrophe, a promise India’s new power minister, appointed as part of wider government reshuffle that preceded the start of the blackout by barely a few hours, was quick to make.
Delivering on that pledge will require a range of measures, including stronger enforcement and stiffer penalties for states who take too much electricity from the National Grid, one of the causes of last week’s collapse. State electricity utilities must also accelerate plans to upgrade their transmission facilities, which India’s government says need investments of about Rs3.1tn ($55bn) in the next five years.
Yet these steps alone will hardly be sufficient to head off the sector’s wider problems. Many of the state electricity boards lack the cash to pay producers or to invest in distribution and transmission: only two, in Gujarat and West Bengal, are not loss- making. Raising tariffs for heavily subsidised industrial and domestic consumers, the most obvious long-term solution, is also hugely politically sensitive.
Recently, about a dozen of the boards have managed to increase prices, while the government is also trying to produce a solution by taking over some of the loans to these boards, prompted by fears over non-payment of loans to banks – as Reliance’s Mr Ambani predicted earlier this year.
With any solution some way off, and with few signs that increases in domestic coal supplies will materialise, many power providers are taking matters into their own hands. Mr Ambani, for instance, has suspended construction of one ultra-mega power plant in the central state of Andhra Pradesh, citing problems over fuel. Mr Tata’s group also says its $3bn plant at Mundra in the state of Gujarat is currently not financially viable because of soaring fuel import costs.
To be sure, not all of the present mess is the government’s fault. In many cases the power companies miscalculated. “They thought they could eliminate the competition and then renegotiate the contracts with the government,” says the head of one international bank in Mumbai. “They wanted to bait and switch. But they got caught out.”
Fixing India’s broken power system will take a mixture of time, skilful policy and extensive investment. “India’s economic growth is going to depend on reliable power,” says David Sloan, director for Asia at the Eurasia Group, a risk consultancy. “If India doesn’t take broader action to correct the wider problems in its power sector it will end up settling for a ... rate of growth in the 4-5 per cent range.”
For Mr Singh’s struggling government, facing a national election in 2014, finding a way to prevent a repeat of last week’s fiasco and head off the more profound crisis brewing beneath it is now its most urgent political priority. If it fails, the headline on one of India’s main newspapers the day after the first blackout – “Powerless & Clueless” – could quickly become its epitaph.