Government bailouts are not the answer to India’s energy sector woes

Across several states, the fiscal situation is becoming increasingly challenging. Yet, the common thread that runs through these deficits — state ownership and control — remains unaddressed.

State ownership: structural cause of India’s deficit

Coal India’s inability to raise production to meet growing demand contributed to the recent power crisis.

The state-owned power distribution companies have failed to bring down losses despite many schemes and packages.

The state control of these critical aspects of India’s power chain is central to a higher current account deficit and growing fiscal risks at the state level.

Coal output fails to meet the demand

From 2013-14, the Indian economy has grown by around 50 per cent (in real terms).

But Coal India, which accounts for around 80 per cent of India’s total coal production, was able to raise its output by just 34 per cent over the same period.

Increased reliance on imported coal: India’s coal imports (thermal and cooking) rose to a staggering 230.3 million tonnes in 2020-21, up 37 per cent from 168.5 million tonnes in 2013-14.

Coal imports for thermal power alone have more than doubled in the first quarter, compared to the same period last year.

To put this in perspective — the value of coal imports in just the first three months of this year is likely to be around half of what was imported in all of last year.

Increase in current account deficit: This growing reliance on coal imports (along with crude and gold) is at the root of the country’s widening current account deficit.

An inability to ramp up production, to forecast demand accurately, as every episode of coal shortage over the years has exposed, is the hallmark of the coal sector that is still largely the preserve of a public sector monopoly.

Problem of DISCOMS

No improvement in financial and operational issues: Despite repeated attempts to turn around their financial and operational positions, on key metrics, the divide between the public and private sector discoms is deepening.

In 2019-20, public sector discoms lost Rs 0.72 per unit of power sold, while private discoms made Rs 0.20 per unit.

High AT&C losses: Similarly, in 2019-20, the AT&C losses (due to operational inefficiencies) for state discoms were pegged at 21.7 per cent, while for the private sector, losses were at 8 per cent.

With deteriorating finances, the net worth of all public sector discoms put together stands at a negative Rs 61,757 crore, while for the private sector, it is a positive Rs 24,965 crore.

There have been several attempts to rescue state discoms.

In the early 2000s, the scheme for repayment of SEB dues amounted to Rs 41,473 crore.

In 2012, the financial restructuring plan added up to Rs 1.19 lakh crore.

In 2015, UDAY involved a transfer of Rs 2.01 lakh crore to state government balance sheets.

Notwithstanding various schemes to turn around their finances, the total debt of all discoms put together stood at Rs 5.14 lakh crore at the end of 2019-20.

Of this, Rs 4.87 lakh crore is owed by state discoms.

Impact on entire power chain: A deterioration in the financial position of discoms means that their dues to power generating companies start mounting, which in turn delay payments to coal miners, affecting the financial stability of the entire power chain.

Declining cross-subsidisation

As tariffs charged by discoms are much higher than the cost of alternatives, a sizeable part of non-agricultural sales of discoms (industrial and commercial consumers) have already shifted towards captive and solar.

 And with the ministry of power recently reducing the threshold for green energy open access, more and more consumers will increasingly opt out.

This would mean that discom losses will rise as cross subsidisation from commercial and industrial consumers will decline, increasing their dependence on state subsidies.

In 2019-20, the total state subsidy claimed and released was around Rs 1.1 lakh crore or 17 per cent of total discom revenue.

This will only increase down the line, making future bailouts even more fiscally challenging.

RBI and the rupee: To break a free fall or not to

The Indian rupee has been in free fall. Some commentators have pointed out that it has fallen less against the US dollar than a lot of other currencies.

Significance of foreign exchange reserves

Decline by 10 per cent: A large part of the current relative strength of the rupee vis-à-vis other currencies is due to the sale of dollars by the RBI — it has lost more than 10 per cent of its foreign reserves in the space of about nine months.

Why country needs foreign exchange: A developing economy needs foreign exchange to finance its international transactions for both the current account (goods and services) and capital account (assets) transactions.

Cost involved: The benefits of this stock are obvious, but there are also costs associated with the holding of these.

 The larger the stock, the more its reassuring value.

Typically, because of their “liquid” nature, the returns on these are low.

How RBI manages the foreign exchange reserves?

How country accumulates foreign exchange reserves? A country can accumulate reserves by running current account surpluses that is, keeping its total expenditure below its gross national product, and/or by interventions in the foreign exchange markets.

India (usually) runs a current account deficit.

Its reserves are then accumulated solely through “sterilised” interventions.

When foreign entities want to invest in Indian assets (stocks and debt), the RBI gives them rupees in exchange for foreign exchange.

Mindful of the fact that this may cause a surge in inflation, the RBI then sells government bonds, sucking out the additional rupees.

The foreign exchange reserves rise, and are matched by an increase in government bonds outstanding.

How outflow of foreign financial capital affects foreign exchange reserves?

When capital inflows were taking place, the RBI accumulated foreign exchange and allowed some currency appreciation.

As long as capital flows were strong, foreign reserves kept piling up and the currency (in real terms) was strong.

Depreciation of rupee: In recent months, we have witnessed an outflow of foreign financial capital, with reserves falling and the rupee depreciating.

International capital flows tend to be pro-cyclical, that is, they move with the world economic activity.

Unlikely to increase export: A depreciation of our currency is unlikely to see our exports rise very much because the world income levels are down.

Inflation: What this depreciation will cause is imported inflation and bankruptcies.

Analysing the RBI’s role

Allowed outward remittances: The RBI threw caution to the winds and allowed outward remittances in foreign currency by Indian residents, with almost no questions asked (up to $2,50,000 annually).

The RBI could have had a much larger supply of foreign exchange had they not generously handed out foreign currency to be frittered away.

While they have not restricted outward remittances, they are trying to shore up reserves by making FCNR (B) and FRE deposits more attractive.

It is not in any individual’s interest to bail out the RBI.

The RBI has also committed to using reserves to ensure an orderly depreciation.

Futility of RBI’s intervention: If the world financial markets want a depreciated rupee, the RBI’s intervention would not be able to prevent it.

But in spite of this, the RBI, with its commitment to inflation targeting, would try to prevent a depreciation (because it causes the price of imported goods to rise).

Possible impact on the poor: Having too open a capital account policy was always fraught with risks.

When countries are confronted with a crisis, the IMF is asked to provide assistance.

But assistance from IMF would involve a “structural adjustment”, including cutting back on subsidies for the poor and vulnerable.

India’s first Global Bullion Exchange unveiled

Prime Minister has launched India’s first International Bullion Exchange (IIBX) at the Gujarat International Finance Tec-City (GIFT City) near Gandhinagar.

What is Bullion?

Bullion refers to physical gold and silver of high purity that is often kept in the form of bars, ingots, or coins.

It can sometimes be considered legal tender and is often held as reserves by central banks or held by institutional investors.

When was the IIBX announced?

During her 2020 budget speech, Finance Minister announced the setting up of India International Bullion Exchange (IIBX) at International Financial Services Center (IFSC) at GIFT City in Gandhinagar.

The International Financial Services Centres Authority (Bullion Exchange) Regulations, 2020, was notified in December 2020 for trading of precious metals, including gold and silver.

These regulations also cover bullion exchange, clearing corporation, depository and vaults.

What is the IIBX?

India for the first time had liberalised gold imports through nominated banks and agencies in the 1990s.

Now, the eligible qualified jewellers in India have been allowed to directly import gold through IIBX.

For this, jewellers will have to become a trading partner or a client of an existing trading member.

In addition, the exchange has set up necessary infrastructure to store physical gold and silver.

The exchange will sell physical gold and silver and aims to be set up on the lines of the Shanghai Gold Exchange and Borsa Istanbul in order to make India a key regional hub for bullion flows.

How will it work?

The thought process behind setting this up is to enable the trading of commodities on an exchange.

Since this is international exchange, trading can take place in US dollars as well.

India has positioned itself as one of the biggest trading hubs in Asia.

Because of the competitive pricing on IIBX, international players will be happy to use our vaulting services.

Moreover, with this being a free trade zone, no duty will be paid.

What is the advantage of an exchange?

Through the dis-intermediation by facilitating transactions through an anonymously traded exchange platform, bullion is made available across special economic zones (SEZs) at International Financial Services Centres Authority (IFSCA)-approved vaults.

This means the growth of IIBX is not just limited to GIFT City but across jewellery manufacturing hubs nationwide.

The qualified jeweller allowed to import gold through IIBX, or a jeweller who is a client of an IIBX member, can view the available stock and place the order.

This shall nudge jewellers towards just-in-time inventory management.

It will also result in greater transparency in pricing, and order sequencing, thereby removing any room for unfair preference by supplier, importing or logistics agency.

Which jewellers have come on board?

So far, 64 big jewellers have come onboard and more applications are in the pipelines.

Some of the big names include Malabar Gold Pvt Ltd, Titan Company Ltd, Bangalore Refinery Pvt Ltd, RBZ Jewellers Pvt Ltd, Zaveri and Company Pvt Ltd.

What are the new RBI guidelines for importing gold?

Banks may now allow qualified Jewellers to remit advance payments for 11 days for import of gold through IIBX in compliance to the extant Foreign Trade Policy and regulations issued under IFSC Act.

According to the RBI, all payments by qualified jewellers for imports of gold through IIBX shall be made through the exchange mechanism as approved by IFSCA.

Who can enrol on the exchange?

Non-Resident Individual / Proprietorship Firm

Registered Partnership Firm

Private Limited Company

Public Limited Company

Qualified Jewellers

Branches of IBU at GIFT City

Foreign Bullion Suppliers who follow OECD guideline

In order to become a qualified jeweller, entities require a minimum net worth of Rs 25 crore.

And 90 per cent of the average annual turnover in the last three financial years through deals in goods categorised as precious metals.

NRIs and institutes will also be eligible to participate in the exchange after registering with the International Financial Services Centre Association (IFSCA).

Jewellers will be able to transact on IIBX only as trading members or as clients of a trading member.

If one wants to become a trader, a qualified jeweller will have to establish a branch or a subsidiary in IFSC (international financial services centre) and apply to the IFSCA.

Significance of IIBX

The IIBX shall be the “Gateway for Bullion Imports into India”, wherein all the bullion imports for domestic consumption shall be channelized through the exchange.

The exchange ecosystem is expected to bring all the market participants to a common transparent platform for bullion trading.

It would provide efficient price discovery, assurance in the quality of gold, and enable greater integration with other segments of financial markets.