One sector that analysts predict will be a significant source of bad loans is India’s power sector.
Observing a huge need in this electricity-starved nation, several new players have entered the market in recent years to build power plants.
However, many of these companies set up new projects without lining up the fuel supply – coal or gas – needed to generate electricity. As a result, there are several plants across the country that are either running below capacity or are lying unused, or their construction has been put on hold.
Problems also persist in power distribution as most such companies are state-owned and sell power to customers at a subsidised rate, and have been racking up losses in the process for years.
“Myopic policies and bad lending practices may result in a significant portion of new generation projects being unable to service their debt obligations,” says Kotak Institutional Equities Research in a research note.
“Banks may camouflage NPLs [non performing loans] … However, the challenges to the banking system will remain.”
Kotak cites the case of the GMR Group, which builds airports and power plants. Last year its net debt was 16 times its earnings. The new plants that the company is constructing, predicts Kotak, will suffer from an insufficient fuel supply, leading to further losses. Nearly 80 per cent of the cost of the new power plants was funded with debt and the low cash flow from new power projects may not be sufficient to service the corresponding debt of these plants, says Kotak.
These problems are not limited to the power sector and instead are pervasive across several sectors and companies.
“Indian banks have been very lenient about lending to certain companies and groups without taking cognizance of their weak financials and the operating challenges in various sectors,” Kotak wrote in a research note. “In many cases we do not see a turnaround in operating conditions that can prevent some of the loans from turning into [non performing loans].”
Take the case of Reliance Communications, owned by the Indian billionaire Anil Ambani. The company’s net debt increased 81 per cent over a two-year period to US$6.45 billion in 2012 while earnings before interest and taxes declined 10 per cent. As a result, the company has barely enough net earnings to pay interest on its debt for 1.3 times, at most, says Kotak.
In another case, the infrastructure company GVK, which builds airports and power plants, is an example of how large loans to fund acquisitions and regularity uncertainty can hurt the finances of a company in this capital expenditure heavy sector.
GVK took large loans to buy stakes in airports in Mumbai and Bangalore. Regulatory uncertainty on tariffs and airport charges are adversely affecting its operations. Its power plants are not receiving adequate supply of gas they need to run at an optimum level and are therefore operating at a loss.
The result is that GVK’s net debt in 2012 was 17.8 times its earnings and it had enough net earnings to pay the interest on its debt just about for one time. With its finances strained, the company’s financial position is unlikely to improve materially in the next couple of years, says Kotak.
There is no one-size-fits-all solution to these problems. Companies can try to chip away at some of their debt – by selling non-core assets for a start. The rest requires a long-term clean-up of the system.
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