PPP Perspectives from a Financial Institution in India

November 26, 2014: Dr. Sambit Basu is the Policy Group Director at the Infrastructure Development Finance Company (IDFC) Limited, a position which he has held since 2010. The IDFC, founded in 1997, is a group of specialists that provides advisory or financial intermediation in infrastructure development projects in India.

“First and most important, is that one has to believe in the India story. One has to believe that, yes, there is an immense opportunity. One has to look closely, not just from the narrow interest of immediate returns. One has to understand the psyche of the Indian culture, especially if one is foreign. I am sure all of the businessmen that are succeeding have done exactly this.”

Have you noticed an increase in power sector investments in India over the last ten years? What are your projections for the years to come?

Sambit Basu: We have definitely seen significant investment additions, but mostly in the generation segment. Following the Electricity Act in 2003, the interest has only increased because the sector has been de-licensed, so it is easier to enter that sector. In terms of investment, the expectation is that the investment will double what it was initially, particularly from the private sector. This is evidenced from the fact that roughly 30-35% of installed capacity in generation is from the private sector. The only other large entities are the state and the central government. They are almost at par with each other.


There are a lot of other projects that are in the pipeline at this moment. Generation projects are right now at two different stages. There are those projects that are already under development but somewhat delayed or stalled due mainly to lack of fuel resources or because of land or environmental issues. And then there are new projects. The extent to which these new projects will come into being will be determined by how many of the existing pent-up projects will be completed. That is why it is difficult to make projections. But the expectation is that, if the proportion of the overall infrastructure doubles, a lot will be in the power sector.

But there are fundamental problems in the power sector which need to be resolved. We have reached a level where there is a sort of euphoria when there is a change in the government –there is a lot of optimism that things are going to be different now every time the government changes. But unless one can actually see things moving, the risk perception of the private sector will continue to be the same. To that extent, the private sector investments are still treading a cautious path.

What particularities would you highlight from the Indian power sector when comparing it with other infrastructure sectors in the country?

Sambit Basu: The broad infrastructure markets where the private sector has been active have been power, telecommunications, ports, roads and civil aviation. If we look at the similarities, telecommunications and power come closest to each other because they both have multiple functionalities which are very similar: both have a generation segment, a wire business, a retail business, a service business, etc. With regards to ports, this also might apply, but not so much for the road sector.


Power and telecommunications have also seen significant reforms at a regulatory level. Nevertheless, there is a principal difference between them: in telecommunications, there is only one regulator, which is at the central government level, driving and running all the initiatives. In the power sector, both the central government and the state have a role to play. The central government defines central regulations but the states can still come up with their own policies. The states will be guided by the central government but they are not obliged to adopt the regulations from the central level.  That is why there are so many differences in the different steps of the power supply chain. Transmission and distribution are still licensed, generation is not. Given that the state can have its own generation policy, the private sector will come and place their power plants in one of the states which are most progressive. In brief, I think this is the first particularity of power sector.

The second particularity comes from the fact that electricity is a secondary form of energy, and being a secondary form, it depends on its primary form: oil, gas and other sources. So if the reforms occur along the entire value chain, then the progress occurs similarly across. But if the reforms get stuck at the primary energy level, then you don’t get to see the positive impacts of the reforms at the secondary level. That’s one of the reasons why we don’t see large generation at this point in time, even though there is a large generation capacity. India is stuck with non-availability of primary sources of energy. On the other hand, there is also interplay between the central and the state governments, so the situation is much more complex in the power sector. The results in terms of the outcomes are not so easily observed, and that is why it is taking so much time for the system to change, despite having started the reforms 20 years ago. Other infrastructure sectors have advanced much more.

Markets always present risks and opportunities. The key is to find the right balance. Could you explain to us what risks (market, credit, operational) private investors expose themselves to when doing business in the Indian power sector?

Sambit Basu: From a private investor’s point of view, I am exposed to all the risks. We cannot segregate any particular risk as the most important one. Credit in my mind, is linked to everything. If I am an investor or a developer and I go to the finance company asking for a loan, the finance company will not only want to see my business plan, but also the technology I have, whether I am able to generate to the extent I have committed too, who I am selling the energy to, whether I am selling it to a utility or a private consumer directly, which state I am selling to, which state I am putting up my plant, etc. So this is linked to the second question I answered: I am governed by the rules of the particular state I choose.


Secondly, the product that I am churning out (e.g. energy that I am generating) will be governed by the risks of the state that I am selling to, and also the risks in terms of the regulatory framework through which I am selling. The biggest risk is not being able to generate to the extent I want to due to fuel problems or other issues. The other risk is whether I am able to recover my revenues. If I am selling the energy to direct consumers by open access, I am able to identify my credible consumers. If I am selling it to a state electricity distribution company, I am exposing myself to multiple risks, because my consumers are mixed: some of them pay, others don’t. At the same time, the utilities’ ability to pay me back depends on how well they are able to recover their revenues. The creditworthiness is determined by all these things.

In the case of conventional and non-conventional energies, the technology risk can be important. In the case of non-conventional energies, if the technology is well-established, the technology risk may be low. In the case of non-conventional energies, the risk will depend on the maturity of the technology.

When an investor is investing in India, they are exposing themselves to all of these risks. On top of that we have a very important factor, which is the regulatory risk. Regulators are sometimes under pressure to act contrarily to what they think is best. If one takes the case of Delhi distribution companies, they were recently given a tariff order. A couple of weeks ago, the regulators clawed back the new tariff order with the pretext that there was not really enough information to put the new tariff order into practice. When a regulator comes up with a tariff order, a detailed auditing of the generator is carried out. After this, you also need to go through a public stakeholder hearing where everyone is invited to make comments – the public, the utilities, the generator – anybody can review the petition and give comments on it. The regulators hear all of the views on the petition and after this the regulator sits with all of this information and comes up with the tariff order. So, having gone through this entire process, can a regulatory body go back and say the tariff order is cancelled because of lack of information? This type of uncertainty sends very wrong signals to all investors.  After having reformed the legislation, these risks still persist and this is just one of them. All of these risks are intertwined with each other. That is why it is hard to separate them into different categories.

How can those risks be efficiently mitigated? What are the most adequate tools?

Sambit Basu: Because of the connection between all of the risks, if one starts solving one risk, one automatically advances in the solution of the others. But the sad thing is India has been working on reform for the last 20 years. The 2003 Electricity Act repealed three legislations that we had and the deficiencies in them were addressed. It was thought that this new Act would truly reform the sector since it took us almost 11 years to come up with it. Nevertheless, the fundamental issues that were there in 1999 are still there, because the problem is not in the legislation but in the implementation. If the regulator gives a directive to a company, then the regulator should also make sure it is implemented.


There are also some important gaps in the Act. A simple example:  if the regulated entities (the licensed companies in the transmission and distribution) are given a directive by the regulator but do not comply with it, according to the Act, they must be sent to prison. What is the problem with this? No regulator will penalize the noncompliance in this way because this criminal punishment is not adequate for a commercial activity. So what happens? The regulated entities ignore the regulation. Having such a regulation in the legislation is immaterial because one is not acting on it.

In the case of renewables, the Electricity Act has set the use of renewable power purchases obligations (RPO), which means that a percentage of the power purchases have to be from renewable sources. In order to comply with this, the different states have usually set a very small percentage for RPO, which eventually doesn’t make any difference. This is another demonstration of a flaw in the regulation which fails to be effective and realistic. Secondly, the regulators are not making sure that the regulated entities are respecting the RPOs. As a consequence, none of these entities feel like they need to comply. I can keep on listing activities like these that are not successful, mainly on the regulatory front.

Another common situation regarding third-party sales: the generator sometimes assures you can go ahead and have a third-party sale provided that the generator is not honouring the contract, i.e., they are not paying. You can actually stop supplying the generator and sell the energy to another person. But even though one can go and look for another buyer, one still does not get money from the generator and on top of that, the generator is still the buyer and is the one who draws the lines. The state government is hand in glove so it uses some loophole legislation to come up with an order saying that now you can’t sell, using different pretexts. This really blurs the lines. To correct this situation, what is most important is to ensure that no matter which regulations are in force, they must be acted on and implemented. If you do this, most of the other problems will also be corrected. We need to stop churning out more papers and start acting on them.

In terms of priority, the least reformed area of the entire power supply chain is distribution. If any mitigation or reforms need to be done, this is the activity to address first. Historically, the entire focus has been on generation but not in distribution.  Nowadays we have a loss in state distribution activities of around 3,000 billion rupees. With that kind of loss, there is no hope that any investor will come in and do business.

What advice would you give to all the large or medium private sector developers in India that are trying to take part in the increasing number of opportunities in the power sector infrastructure business?

Sambit Basu: First and most important, is that one has to believe in the India story. One has to believe that, yes, there is an immense opportunity. One has to look closely, not just from the narrow interest of immediate returns. One has to understand the psyche of the Indian culture, especially if one is foreign. I used to work at Rio Tinto, one of the largest international mining companies in the world. When I joined, they had already been in India for 15 years, and they had been there all that time studying and observing the country very keenly. They could afford to do this because they are gigantic and therefore have deep pockets, but also because they believed in the India story. They were ensuring that their good governance issues didn’t get compromised: no bribing, no insinuations, and no lobbying; they didn’t believe in these paths. They were just studying the developments and, as part of industry associations, they were trying to influence the policies in the largest interest of the sector. This is one way of looking at India.


India is a different animal altogether. Here things only happen, like regulations being reformed, when the changes are urgently needed. For example, nobody before this particular year believed an election could be won on the basis of the development agenda. People always thought that one could win an election on the basis of giving gifts or other similar actions; nobody thought that the development agenda was important. Secondly, even if you are an infrastructure investor in a particular sector, one has to understand what is happening in the other sectors as well. We keep talking about the young population we have, about demographic dividends, about the explosion of the demand. All these things will get unleashed suddenly because it is inevitable.

Apart from this, the reality is that telecommunications have brought people together, so even though there are rural and urban areas, people are much closer to each other. The rural population, which makes up 70% of the population, have aspirations, they want to grow big. They also want to get the same things the urban people have. But how many commodities companies, whether it is in retail or infrastructure, have studied the importance of health and education? One has an educated sector, but is it healthy? Who are the ones that yield the demographic dividends? It is the young and healthy population; a sick young population is no good to the country. So when it comes to social priorities, one cannot shy away from all these other aspects any more.

If you look at developed countries, historically, they have achieved a certain level of economic development hand in hand with social development, so the “social aspect” has been developed from an early stage. This is not the case in India: we have achieved economic growth for a long time, but the social evolution has not advanced at the same speed. We have an emerging country, one of the fastest growing emerging economies, but in human development indexes (health, education) we are ranked between 140-180th in the world. Can one achieve a high level of development without addressing these issues first? Who will do this? If you ask the private sector to do it, they will not, it’s not their task. Who should do it then? The government? The government is already in a complete mess. Social spending and borrowing are only going to increase. The interest rates will not come down easily. So how does a lender give cheap funds to a borrower? It’s not possible. Because of this, one has to believe India’s entire story and then project the business plan in a manner that is realistic so that no disappointment comes in. So, a question that one must ask oneself: “I believe in the Indian story, but do I believe in its totality?” One has to know which sector to go in and at which level.

Once you believe in the India story, the second step is to see the extent of reforms that have been carried out in the particular sector one is interested in and select the adequate timing and extent to go in the business. Will one be having a contract that is transparent? Will one be having a contract where someone is held accountable? What happens if the availability of primary resources varies? All these are linked. One also has to take into account that even if the government in power at a certain moment is inviting and wants to help you exploit resources in their country, the next government that comes in might not believe in this agenda. One has to be very realistic in the planning and be righteous to one’s own beliefs. One must have good governance, even if it compromises the immediate returns, for in the long run it will be much more beneficial. One will get respect for doing this.

Moreover, India is a very diverse country. Depending on which state you go into, you will find diverse cultures, religion, mind sets, distinctive characters. There is a regional disparity in everything. Because of this, most of the examples we have discussed here today, whether it is energy efficiency, renewable energy, innovative models in health, education, are happening in the southern part of India. In the other regions of India, education is still not valued as in the south. I insist therefore once more, one has to study the country. I am sure all of the businessmen that are succeeding have done exactly this.