Power investors bullish on India's new sovereign fund

Power cuts are a part of life in India, even in developed cities like Mumbai. In June, the state of Maharashtra, where Mumbai is located, announced it did not expect any power cuts for the next 12 months – shortly after that announcement, the collapse of a Tata Power transmission tower left the suburbs of Mumbai in the dark for five days.

There is no doubt that more power capacity is being installed, including both renewables and conventional power. However, without efficient transmission and distribution networks, the country still has a long way to go to reach its 2019 ‘24/7 Power for All’ target.

In July, India’s largest private power transmission company, Adani Transmission, acquired stakes in two transmission projects from GMR Infrastructure for 1 billion rupees ($15 million; €13.4 million), with the company foreseeing significant growth in the transmission sector. The deal reflectes a growing interest from long-term investors in the sector.

MK Sinha, managing director and chief executive of Indian fund manager IDFC Alternatives, argues that India’s transmission sector has become “fundamentally attractive” thanks to recent reforms and supportive policies.

IDFC is bullish on the sector and has plans to launch a transmission unit, following in the footsteps of its other investment platforms for renewable energy and road assets. Sinha adds that India’s power generation capacity has doubled over the last few years, reflecting demand for expanding and upgrading the country’s transmission networks.

“In the past, transmission companies could not rely on bankrupt state electricity boards. However, over the last few years there have been a lot of positive changes, including [the introduction] of a new payment scheme, thereby improving industry dynamics,” Sinha explains.

The current interstate transmission payment mechanism is based on a pooled system, whereby distribution companies make payments into a central pool, and the aggregation of these payments is then distributed to the transmission licensees. Power Grid Corporation of India acts as the transmission utility maintaining the central pool.

Before, transmission companies had to collect payment directly from their respective state distributors, but the consequent payment delays could put the transmission companies and power generation asset owners in trouble with working capital cycles.

THE WEAKEST LINK

The new mechanism was launched in 2011 to mitigate the direct exposure of transmission companies to fragile state-owned distribution companies, which have historically struggled with high levels of debt and technical power losses.

According to a Moody’s report, an accumulated loss of about $58 billion was recorded for state-owned distribution utilities as of March 2015. The losses were driven in part by inadequate tariffs relative to the cost of supply as well as high levels of power leakage for utilities in many states.

“The poor financial health of these distribution companies has led to lower utilisation rates for generation companies over the last few years, as distribution companies procured less power to reduce their losses,” explains Abhishek Tyagi, a vice-president and senior analyst at Moody’s.

Aware of the situation, the Indian government has launched a few initiatives over the past 10 years, including its latest, the so-called UDAY Scheme, to financially rehabilitate state-owned distribution companies.

Under the proposed UDAY Scheme state governments will take over 75 percent of state distribution companies’ debt over the two years starting on 30 September 2015. Half of the debt had been taken over by March, with the remaining quarter to be taken over by March 2017. The rest of the debt is set to be converted into loans or bonds by banks and financial institutions.

Local reports say 17 states, accounting for up to 77 percent of India’s power demand and 79 percent of outstanding distribution company debt, have agreed to sign up for the UDAY Scheme. Should the scheme see more participation and achieve success in improving offtaker risk, the distribution and transmission sectors would see performance improvements.

Those improvements are important in and of themselves, but will not necessarily lead to a rush of privatisations, considering the dominance of state-owned entities in the market – Power Grid Corporation of India controls half of the transmission networks in India, while most distribution companies are government-owned.

Since there is less likelihood of privatisation in the distribution sector and the transmission sector has been traditionally underinvested in, the two sectors offer limited opportunities, Tyagi points out. But the power generation sector would benefit from these improvements and thus provide better investment opportunities, he adds.

THE BIGGER PICTURE

Still, Anuj Ranjan, Brookfield’s India head, argues that while the country’s power sector is attractive, it requires investors to be extra careful while evaluating investment opportunities, given the complexity of payment schemes and the varying financial health of different states.

Having completed its first major infrastructure investment earlier this year with the acquisition of a roads and power portfolio from Gammon Infrastructure, the Canadian firm ended up dropping the power projects that were originally included as part of the deal. However, Ranjan states the firm is still actively looking at the renewables sector.

“India will continue to rely on coal for power generation but renewable energy sources will have a significant place in the mix,” agrees Sachin Kerur, a partner at Pinsent Masons. Kerur believes the government’s power sector reforms are part of a wider package to attract infrastructure investment to India and he expects renewables to form a big part of those investments, since “India has the right components to make renewables successful”.

The country famously aims to build 175GW of renewable energy capacity by 2022 – 100GW of which will be sourced from solar, 60GW from wind, 10GW from biomass and 5GW from small hydro power.

Apart from government reforms, India has also launched a $6 billion sovereign investment vehicle, dubbed the National Investment and Infrastructure Fund. The latter, expected to support commercially viable greenfield and brownfield projects across the country, has secured support from other sovereign wealth funds, including Russia’s Rusnano, the Abu Dhabi Investment Authority and the Qatar Investment Authority.

It has identified a first batch of projects – including the Konkan Railways project, a national power transmission project and a few roads – before Sujoy Bose, currently global co-head of infrastructure and natural resources at the International Finance Corporation, takes the helm as the fund’s chief executive.

Investors argue it is too early to say whether the fund will be a game-changer, but agree it is a positive initiative to encourage investments in the infrastructure sector. “It’s not easy to attract institutional capital to invest in sectors that have not been [traditionally] attractive,” says Kerur, adding that the fund will need strong leadership to achieve its goal.

According to the World Economic Forum, India ranks 81 out of 140 economies in terms of infrastructure in its latest Global Competitiveness Index. Meanwhile, China ranks 39 and Indonesia sits at 62.

“This is an interesting time to invest in India,” sums up Ranjan. “The macro outlook for the country is no doubt very positive, with great demand, a supportive government and ongoing reforms. However, the micro conditions, specifically with regard to operations, are still very challenging for investors.”