Bankability of Renewable Power in India

India has set for itself ambitious targets in the renewable power capacity addition over the next two decades. This is in line with its commitments to strategically reduce its reliance on conventional sources and mitigate carbon emissions. The Ministry of New and Renewable Energy is the nodal agency to regulate and facilitate the growth of renewable power in India. In order to fulfil renewable capacity addition ambitions, the ministry, in close collaboration with its counterpart agencies at the state level, has outlined several policy incentives for both generators and consumers. These incentives include feed in tariffs, capital subsidies, generation linked incentives, renewable power certification etc. The government has also allowed free flow of FDI into renewable power sector.

In spite of incentives and strong stakeholder motivation, many projects in the renewable power sector are proving to be un-bankable. The following are some of the reasons:

1. Transmission and Distribution Issues
2. Availability of Long Term Funds
3. Working Capital Woes
4. Frivolous Motives

Transmission and Distribution Issues

Evacuation, transmission and distribution continue to remain major bottlenecks for renewable power projects. Renewable generation units are characterized by small capacities, variable generation and low PLF. This makes it technically difficult to maintain seamless transmission and distribution. However, the government can identify suitable locations and encourage multimodal renewable clusters and develop dedicated infrastructure for evacuation, transmission and distribution in a clustered fashion. As more and more renewable projects are becoming grid interactive, T&D infrastructure is extremely important to facilitate their growth and sustainability.

Availability of Long Term Funds

Renewable projects are highly capital intensive and require a fairly long payback period. A typical solar/bio-mass project becomes feasible with only when debt funds are available for at least 6-7 years. Availability of long term funds, at a reasonable rate, in the Indian markets is very difficult. Moreover, most banks are facing asset liability mis-match. In this context, a proactive imitative by the government to set up a debt fund which can finance large renewable projects or refinance banks for small projects would prove quite beneficial to the Industry.

Working Capital Issues

Many electricity boards and public utilities across the country are reeling under severe financial pressure. Their ability to honour dues under preferential tariff rates to renewable generators is deteriorating. In this context, renewable developers find PPAs with public utilities unreliable primarily because of the payment woes. Irregular payment of dues would make working capital management of generators quite awry. In this context, introduction of the REC trading facility to delineate cash-flows from environmental attributes (additional tariff for environmental benefits) away from the utilities is an innovative step to improve liquidity in the renewable energy market. However, this measure has failed because of few buyers and sellers in the REC market. Rearranging the renewable obligation, which currently only falls on the distributer, across transmitters, distributers, captive and large consumers would give a shot in the arm to the market, which in turn would enhance the availability of funds in the renewable energy market.

Frivolous Motives

Recently the renewable energy industry has experienced many frivolous investors, equipment suppliers, EPC contractors and operations managers etc whose prime objective is to make a windfall from the beneficial policy environment and incentives. They lack the vision and objective to contribute to a healthy growth in the renewable power industry. Owing to their presence, the due diligence process has become quite tedious even for genuine players. There is an increasing fear that bad players might eventually drive out good players in the market. Hence, it is important for the government to standardize systems, procedures and equipment in this industry. Strong penalties must be imposed on frivolous players and a mechanism to implement the must be put in place by the government.

Financing Independent Power Producers in India 1

In India, banks and financial institutions are conventional sources of infrastructure finance. Until recently, PSUs accounted for almost all of power sector exposures of banks and FIs. However, this trend is changing and with recent reforms paving way for greater private sector participation, banks are witnessing a sudden flurry of long term and working capital lending for Independent Power Producers (IPPs) in the last 3-4 years. Despite substantial revisions of internal exposure limits, by banks and FIs, to infrastructure and power, financing IPPs continues to be significantly constrained by limits both prudential and preferential. Moreover, PSU power companies, infused with fresh equity, are competing in the open market for already scarce financial resources.  In these circumstances, IPPs are facing teething issues in securing both long term and cash credit, from conventional sources.  

Indian Power Sector - Diaries 1

The Indian Power Industry is in an interesting phase of evolution. After the liberalization of the generation space in the Electricity Act 2003, there is a flurry of activity seen especially from Independent Power Producers (IPPs). It is projected that the share of capacity addition from IPPs would exceed that of the public sector (State, Central and Joint Sectors put together) in the next five years.

However, emerging players are confronted by several issues including shortage of long term funds, unproven operations track record, resource and supply logistics uncertainty, transmission and distribution bottlenecks etc. Many new IPPs emerging in the generation space are largely unprepared to face both upstream and downstream shocks widely expected in the industry.  

To mitigate the aforementioned setbacks and develop a strong economic, logistical, operational and managerial foundation, it is important for IPPs to design and implement an effective enterprise information and planning system. 

The ULIP Debate

Regulation is the most coveted item in India’s administrative circles. The ULIPs case has once again reiterated that Indian regulators love to vie for greater regulatory scope and power.  The unit linked insurance plan is a hybrid instrument which originated to circumvent the front loading restrictions in mutual fund industry.  Today ULIPs share a significant chunk of the markets and their architecture is similar to that of a mutual fund unit with underlying securities. The popularity of ULIPs owes to the specific deductions allowed in the Income Tax Act under chapter 6 deductions.

Basically, ULIPs are units of a fund which provide life insurance cover to the subscribers by investing the subscribed sums in market securities (in specific equities). Hence, it acts as a mutual fund under the cover of an insurance fund. This arrangement can be further judged by considering the facts that only a small sum out the periodical premium is diverted to insurance cover while the larger chunk is directly invested in markets. Moreover, IRDA permits a plethora of front end loads for insurance products which makes these ULIPs, all the more interesting to agents and markets brokers.

Now, the question is who should regulate this hybrid instrument? The CBDT, revising its stance on Chapter 6 deductions for ULIPs for the proposed Direct Tax Code, has suggested that it would allow deductions for instruments strictly classified as insurance products by IRDA, hence indicating a regulatory exclusivity on ULIPs to IRDA. However, the genesis of this regulatory debate began when SEBI has slapped, all the companies issuing ULIPs, with a show cause notice alleging that transactions in ULIPs is an unapproved/ illegal business. This provoked the Ulippers to approach IRDA which in-turn counter notified that SEBI’s notification is ultravires of its regulatory powers.  The government has intervened to mellow down this, almost melodramatic, regulatory war, and referred the regulatory issue to the Supreme Court.

However, in a sudden turn of events the Government of India has come out with an ordinance which delivered a clear victory to IRDA in this regulatory turf war. There has been no public discussion and no real assessment of the strengths and weaknesses of these regulators. Moreover, the very nature of the ULIPs instrument has not yet been strictly defined under any sphere. This ad hoc arrangement to protect select interests does not appear as a healthy reform signal from the Government.  

GST and Entry Taxes

One of the state level levies proposed to be subsumed under the Goods and Services Tax umbrella is the Entry Tax not in lieu of Octroi. Entry tax, not in lieu of Octroi, is levied by the State governments on goods entering into their respective territories for final consumption. It is levied under the powers available under Entry 52 of the State List. Entry tax is modeled as a compensatory tax. Compensatory Taxes are proportional to a measurable advantage conferred by the Government. Entry Tax, in its preamble, was stated as a measure for collection of tax to provide facilities to traders and improve infrastructure. Supreme Court has validated that Entry Taxes are in the nature of a Compensatory Tax as it confirms with the yardsticks imposed and has adjudged them to be an exception to Article 301 of the Constitution of India. Article 301, by providing that subject to provisions of Part-XIII, trade, commerce and intercourse throughout the territory of India shall be free, upholds the idea of India being a single economic unit with no restrictions for movement of goods, property and services. Citing this Article, it is often argued that the character of Entry Tax is, effectively, not in congruence with the principle prescribed under article 301 of the Constitution and hence can only be accommodated as an exception.

On one hand, Entry taxes, not in lieu of Octroi,  impose an unnecessary burden on the movement of goods, absorb administrative resources and could defeat the model of GST if not subsumed under it.  Entry Taxes are to be abolished by organizing adequate compensation for revenue losses suffered by states earning significant revenues for this source. On the other hand, Entry Tax, which is in the nature of Octroi, cannot be disturbed. It is imposed by municipalities and urban local bodies to meet their revenue requirements and the proposed Goods and Services Tax regime does not accommodate a compensation system for subsuming taxes levied by local bodies.

The Grasshoppers and the Ants - a Modern Fable

Source: Written by Martin Wolf, Published on the Financial Times: May 25 2010

Everybody in the west knows the fable of the grasshopper and the ant. The grasshopper is lazy and sings away the summer, while the ant piles up stores for the winter. When the cold weather comes, the grasshopper begs the ant for food. The ant refuses and the grasshopper starves. The moral of this story? Idleness brings want.

Yet life is more complex than in Aesop’s fable. Today, the ants are Germans, Chinese and Japanese, while the grasshoppers are American, British, Greek, Irish and Spanish. Ants produce enticing goods grasshoppers want to buy. The latter ask whether the former want something in return. “No,” reply the ants. “You do not have anything we want, except, maybe, a spot by the sea. We will lend you the money. That way, you enjoy our goods and we accumulate stores.”

Ants and grasshoppers are happy. Being frugal and cautious, the ants deposit their surplus earnings in supposedly safe banks, which relend to grasshoppers. The latter, in turn, no longer need to make goods, since ants supply them so cheaply. But ants do not sell them houses, shopping malls or offices. So grasshoppers make these, instead. They even ask ants to come and do the work. Grasshoppers find that with all the money flowing in, the price of land rises. So they borrow more, build more and spend more.

The ants look at the prosperity of grasshopper colonies and tell their bankers: “Lend even more to grasshoppers, since we ants do not want to borrow.” Ants are far better at making real products than at assessing financial ones. So grasshoppers discover clever ways of packaging their grasshopper loans into enticing assets for ant banks.

Now, the German ant nest is very close to some small colonies of grasshoppers. German ants say: “We want to be friends. So why do we not all use the same money? But, first, you must promise to behave like ants forever.” So grasshoppers have to pass a test: behave like ants for a few years. The grasshoppers do so and are then allowed to adopt the European money.

Everyone lives happily, for a while. The German ants look at their loans to grasshoppers and feel rich. Meanwhile, in grasshopper colonies, their governments look at their healthy accounts and say: “Look, we are better at sticking to the fiscal rules than ants.” Ants find this embarrassing. So they say nothing about the fact that wages and prices are rising fast in grasshopper colonies, making their goods more expensive, while lowering the real burden of interest, so encouraging yet more borrowing and building.

Wise German ants insist, gloomily, that “trees do not grow to the sky”. Land prices finally peak in the grasshopper colonies. Ant banks duly become nervous and ask for their money back. So grasshopper debtors are forced to sell. This creates a chain of bankruptcy. It also halts construction in the grasshopper colonies and grasshopper spending on ant goods. Jobs disappear in both grasshopper colonies and ant nests and fiscal deficits soar, especially in grasshopper colonies.

German ants realise that their stores of wealth are not worth much since grasshoppers cannot provide them with anything they want, except for cheap houses in the sun. Ant banks either have to write off bad loans or they must persuade ant governments to give even more ant money to the grasshopper colonies. Ant governments are afraid to admit that they have allowed their banks to lose the ants’ money. So they prefer the latter course, called a “bail-out”. Meanwhile, they order the governments of the grasshoppers to raise taxes and slash spending. Now, they say, you must really behave like ants. So the grasshopper colonies go into a deep recession. But grasshoppers still cannot make anything ants want to buy, because they do not know how to do so. Since grasshoppers can no longer borrow, to buy goods from ants, they starve. The German ants finally write off their loans to grasshoppers. But, having learnt little from this experience, they sell their goods, in return for yet more debt, elsewhere.

As it happens, in the wider world, there are other ant nests. Asia, in particular, is full of them. There is a rich nest, rather like Germany, called Japan. There is also a huge, but poorer, nest called China. These also want to become rich by selling goods to grasshoppers at low prices and building up claims on grasshopper colonies. The Chinese nest even fixes the foreign price of its currency at a level that guarantees the extreme cheapness of its goods. Fortunately, for the Asians, or so it seems, there happens to be a very big and exceptionally industrious grasshopper colony, called America. Indeed, the only way you would know it is a grasshopper colony is that its motto is: “In shopping we trust”. Asian nests develop a relationship with America similar to Germany’s with its neighbours. Asian ants build up piles of grasshopper debt and feel rich.

Yet there is a difference. When the crash comes to America and households stop borrowing and spending and the fiscal deficit explodes, the government does not say to itself: “This is dangerous; we must cut back spending.” Instead, it says: “We must spend even more, to keep the economy humming.” So the fiscal deficit becomes enormous.

This makes the Asians nervous. So the leader of China’s nest tells America: “We, your creditors, insist you stop borrowing, just as European grasshoppers are now doing.” The leader of the American colony laughs: “We did not ask you to lend us this money. In fact, we told you it was a folly. We are going to make sure American grasshoppers have jobs. If you do not want to lend us money, raise the price of your currency. Then we will make what we used to buy and you will no longer have to lend to us.” So America teaches creditors a lesson from a dead sage: “If you owe your bank $100, you have a problem; but if you owe $100m, it does.”

The Chinese leader does not want to admit that his nest’s huge pile of American debt is not going to be worth what it cost. Chinese people also want to go on making cheap goods for foreigners. So China decides to buy yet more American debt, after all. But, decades later, the Chinese finally say to the Americans: “Now we would like you to provide us with goods in return for your debt to us. Thereupon, the American grasshoppers laugh and promptly reduce the debt’s value. The ants lose the value off their savings and some of them then starve to death.

What is the moral of this fable? If you want to accumulate enduring wealth, do not lend to grasshoppers.

GST Diaries - Part 4

Some of the issues to be considered before implementing the new GST regime are:

(i)                   Fate of the existing concessions, exemptions and compounding benefits offered to the industry

            Concessions, Exemptions and Compounding benefits are offered to uphold equity in taxation. The existing indirect taxes regime offers idiosyncratic concessions to different assessees depending upon their turnover, geographical region, range of activity etc. These concessions, benefits and exemptions are obviously different for different levies. These benefits, in many cases, are proving to be distortionary and even regressive. Hence, there is strong case to do away with these multifarious concessions and instead establish a uniform product based exemption (both in SGST and CGST) at all levels of the supply chain. Now an immediate practical problem the committee will face in the implementation of the GST regime, is what will happen to the existing concessions, exemptions and compounding benefits offered by both the central government and the various state governments. The task force recommends allowing the existing assessee specific concessions to stay and henceforth not permit any additional such offers by the state or the centre.  Yet, it is unclear as to what kind of distortions the continuation of these concessions will impose on the new regime. 

(ii)                Should GST on stock transfers be abolished or be levied with credit given?

Stock Transfers are not a sale. Hence, the transferor (or consignor) will not be able to immediately pass the burden of tax on the customer. He needs to pay tax from his working capital. This will put an undue stress on the working capital of businesses. This will be very similar to payment of excise duty (under rules 7, 8 and 10A of the Central Excise (Determination of Value) Rules, 2000) for a transfer from the factory to a depot which is completely unnecessary and not business friendly. Since the additional cost borne for this additional burden on working capital will again be transmitted on to the consumer, this provision might prove to be regressive in its effect. Moreover, assuming the refund of tax is not automated, or in worst case if there is no provision for refund of tax but only a provision for set-off in perpetuity, the businesses will have to incur additional costs which will in turn hike up the price of their products. However, there is a case of tax evasion which may crop up if the transfer of goods, without payment of tax, is allowed. In order to prevent this tight inter-state border screening will be required which can again imply unwanted transaction delays. Hence, it is important to rightly assess and compare the probable economic cost of collecting GST on consignment or stock transfers with the costs implied from transaction delays caused by strict border policing.

(iii)               Degree of administrative standardization.

Administrative standardization means to offer a uniform/standard procedure for all interface related aspects of the Indirect Tax Regime.  Currently, the interface between the assessees and the motley of indirect tax administrations is variegated and in several instances duplicatory of one another.  For example, a common assessee is required to furnish turnover audit reports (where ever necessary) for Cenvat, VAT and Service Tax Assessment independently. This makes compliance burdensome and increases the transaction costs. Also, the number of forms to be filled for each levy (ranges from 7 Forms for Excise and 10 forms for Service Tax to more than 55 Different Forms for VAT) frustrates the businesses and incentivizes tax evasion. The all-in-one form suggested by the Task Force will help to simplify compliance to a reasonable degree.   

(iv)              Abolish all kinds of Declaration forms and Road Permits.

Road permits have been introduced in order to make good for revenue losses made by abolishing octroi. Road permits, also called as way bills, are issued by purchasing dealers to selling dealers to bring the material from one state to another. Example: VAT 65 in Jammu & Kashmir, ST-38 Haryana, ST -31 in Uttar Pradesh, VAT-47 in Rajasthan, FORM -50 in West Bengal, D IX in Bihar etc. One of India’s most troublesome issues which act as sand in wheels to businesses ranging across states is the permit raj. Any reform in this subject has got implications for administration standardization dealt above. This kind of a camouflaged octroi not only distorts prices for the same between states but also breeds in tax/compliance evasive tendencies in assessees.

(v)                The Case of Services

Services are by far the least understood and discusses subject under the GST. Given the fact that Services are India’s largest and most revenue potent industry, it becomes all the more important to understand their probable role and consequent response to the new regime.There are several questions being posed on their treatment in the tax model. Will they charged be at par with Goods? Will their identification be guided by a positive list or a negative list? What infrastructure will be put in place to track or monitor inter-state businesses? If the goods are to be taxed at different rates and services are to be taxed at one of the rates, won’t there be litigations cropping in? (This can potentially be solved by issuing a positive list of services which will be taxed at a stipulated rates and no litigation or bargaining shall be allowed)