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26th December 2012 |
Power sector problems are not a systemic riskShiv Puri
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- An article published in August 2012 by a leading financial newspaper in the UK suggested that the power crisis in India was snowballing into a gigantic non-performing loan crisis, as stalled power plant operators could not service debt.
- We analyzed this issue and concluded that in the worst case scenario, even assuming a 100% default rate (a remote possibility), it would mean writing off 1.15% of system wide loans. The Indian banking sector generates an average return on assets of 1.35%. Therefore, in the worst case scenario, the impact to the banking sector would be less than one year of profits. We concluded that this was not a “crisis”.
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On several occasions during the year our conviction was tested in the face of overwhelming negative sentiments on India. Some of concerns raised by investors and the media included a potential banking crisis in India, a power crisis which could snowball into India’s “subprime crisis”, a high inflation rate, an unsustainable fiscal deficit, political inaction, and an agricultural drought due to poor monsoons. While some articles highlighted important shortcomings, many were exaggerated. For example, an article published in August 2012 by a leading financial newspaper in the UK suggested that the power crisis in India was snowballing into a gigantic non-performing loan crisis, as stalled power plant operators could not service debt. It said, not only would the lack of power stall economic growth, but that the resulting banking crisis would require “$400 - $500 billion to fix”. It talked about all the problems plaguing India and gave the feeling that a crisis was just around the corner. It had sensational value but was inaccurate on many fronts.
In reality, the “$400 - $500 billion” number was an estimate by India’s infrastructure planning commission on power capex over the next 5 years under their 13th five year plan. It had nothing to do with the spending required to solve any crisis. We analyzed this issue and concluded that total power sector exposure for the banking sector was Rs 3.3 trillion or $60 billion which was roughly 6.8% of total outstanding credit. The default risk could come from the lending to the private power sector companies which accounted for 33% of the total credit outstanding to the power sector or approximately $20 billion. Further, only loans to plants under construction or those recently started were at real risk of default which represented 50% of the total private power sector loans or $10 billion. Even assuming a 100% default rate (a remote possibility), it would mean writing off 1.15% of system wide loans. The Indian banking sector generates an average return on assets of 1.35%. Therefore, in the worst case scenario, the impact to the banking sector would be less than one year of profits. We concluded that this was not a “crisis”.
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