Security Analysis: Briefly

hi all

 

find two files attached. just  basic security things for you.

 

Regards

 

Sumit/Aatish

Short selling by FII

Institutional Investors : Enter Short Selling

Sebi's decision to allow short selling by institutional investors is expected to not only help reduce market volatility but also facilitate better price discovery for investors.

This (move) will enable FIIs and domestic institutions to hedge their risks. It will also help contain volatility and create a deeper market.

- Andrew Holland,
Managing Director,
DSP Merrill Lynch.

Soon, short selling (the strategy of selling a stock without actu- ally owning it) will become a reality for institutional players like Foreign Institutional Investors (FIIs) and mutual funds as they have long since craved for a level playing field (with retail investors) and a mechanism to hedge their risk in the spot market; institutional investors, at the moment, can hedge their risk only in the derivatives market. "Allowing MFs to short sell will have a threefold impact. It will deepen the market, will provide better options to find houses to execute their views and strategy and, most importantly, it will offer investors a wider range of products," said Pankaj Razdan, Managing Director, ICICI Prudential AMC. To begin with, the institutional investors would be allowed to go short only on a universe of the same 159 stocks in which derivatives trading is allowed. Another rider is that these large investors also have to pay margin money like retail investors do; institutional investors are exempted from paying margin money in the spot market, so far.

The news has been received well by large investors including hedge funds, the largest users of the short-selling approach, as well. Sebi's intention to move towards introducing a system that allows short selling is good because it will create more liquidity and deepen the market.

While India has emerged as the favorite destination for FIIs, they will get that extra fizz with Sebi opening the doors for short selling. Apart from them, even the domestic retail investors are likely to get the benefit of carrying forward the short position, which was hitherto not offered to them. As of now, they have to square up the trade (by buying the equivalent amount of share sold on the same day). While it sounds great, there are nonetheless some concerns as skeptics feel that institutional short selling will worsen the situation instead of minimizing volatility.

Taming volatility

The Indian markets have undergone many changes since the ban of short selling in 2001. The contribution from domestic and foreign investors has dramatically increased, resulting in a big take-off by the derivatives market. Further, the indices have consistently moved upwards since mid-2003 and to touch 14,500 in early 2007. However, the rise has also been characterized by much volatility. The sharp run-up in the market has created big worries in the minds of the investors. Increased volatility has, however, forced the regulators to allow institutions. Therefore, Sebi finally approves institutional investors to indulge in short selling in March 2007. It will act as a balancing factor to maintain the market equilibrium as the initiative would improve the economic performance by injecting liquidity, thus helping to reduce volatility and checking undue price rises in the market. Sandesh Kirkire, CEO, Kotak Mahindra Asset Management Ltd., said, "It will enable institutions to take advantage of both sides of the market—rising and falling. Earlier, investors could only use the derivative route to hedge their portfolio when markets fell. This move will allow institutions to participate in a falling market." As well, Jayanth R Varma, Professor, IIM-Ahmedabad, said, "Allowing institutional investors to sell short will act as a kind of resistance when the market moves in one direction. In the short run, it may cause some volatility, but in the longer run, it will definitely help in curbing volatility and improve price discovery."

Some glitches yet

According to Sebi, initially short selling would be restricted to only 159 liquid stocks for which derivative trading is allowed. However, it is a negligible number for the Indian bourses. Justifying its move, Sebi's Chairman, M Damodaran, reasoned, "When you do something new like this, it is important to make sure that the system stabilizes first. To begin with, the 159 derivatives stocks are a good starting point. Once the system stabilizes, the facility can be extended to more stocks."

In another first, unlike in the past when institutions did not have to pay a margin while trading at the stock market, but now those opting for short selling have to pay margin money at the same rate that the investors pay. However, in another initiative, Sebi has also brought the benefit of freeing institutions from Securities Transaction Tax (STT) if they are going to be lenders, attracting more number of sellers of security into the market. "Introduction of short selling settled by delivery and securities lending and borrowing to facilitate delivery by institutions will help enhance the depth of the capital market and the flexibility for the participants and provide total mechanism for the market price discovery," said Nimesh Kampani, Chairman, JM Financial Group.

Sebi is likely to widen the scope of the lending and borrowing scheme for the institutional investors. For this, the market regulator is going to approve more entities by identifying the potential lenders in the market. Big institutions like LIC, GIC and PSB need to get the board's approval if they want to lend their shares. It is a big opportunity for institutions because the lender can lend the stock rather than keep it idle. Moreover, there is no possibility of short-term uncertainties while it can be avoided through short selling by investors. In the case of foreign investors, Sebi shall put an obligation of borrowing shares through Securities Lending and Borrowing (SLB) mechanism.

India can take a leaf out of other countries' books regarding the same. Commenting on Sebi's approval to create the opportunity for institutional investors, Alan Burr, Principal Consultant, Etheios, said to HedgeWeek, an online news publication, "The ability to short sell, however, will enable hedge funds to gain the market access they desire, but first the market will need to provide certain infrastructure measures to accommodate this. This will require banks, prime brokers and custody providers to set up an effective stock lending and borrowing facility." These kinds of concerns would definitely pop up, since the markets abroad are much mature and the investors in these markets are big in size unlike the Indian investors trading in individual stock futures. "It is a good measure, but details of stock lending and how it is going to work are going to be very important," said Falguni Nayar, Managing Director of Kotak Investment Banking. "It is a big deal for us to be able to put them in place too. We have to study it right, and Sebi has to implement something that works easily, especially for investors," she added. Therefore, with a detailed study of markets, effective procedural and technical guidelines can be prepared, which are easy to implement.

Road ahead

The proposal by Sebi allowing institutional investors to short sell equities is likely to change the market dynamics by helping the investors to hedge their market risks more effectively. Ajay Bagga, CEO of Lotus India Mutual Fund said, "Overall, this is a good move to improve market efficiency. Short selling is a part of all developed markets in the world. It will lead to greater market depth. However, guidelines from Sebi are awaited for trading." Experts say that an ideal plan will help to develop an effective lending and borrowing mechanism with the much needed length and breadth in the Indian capital market. "The bottom line is that short-selling is a good thing for Indian investment. It gives investors a proven mechanism for hedging risk and over time should attract more capital to India and ultimately reduce volatility in that market," said Michael Purves, Partner and CFO, Hudson Fairfax Group. However, for now, it is welcome back short selling. How far the market depth will improve can only be identified once the guidelines are announced.

- Amit Singh Sisodiya and Kavitha Putta

SEZ

SEZs : Or, Industrial Dharavis in the Making?

"Wealth, like knowledge, grows in spots and spreads out," so postulated William James, the philosopher. And Deng Xiaoping—the Chinese statesman for whom "It does not matter what color is the cat, so long as it catches the mouse" —proved William James right by establishing SEZs at Shenzhen, Xiamen, Zhuhai, and Shantou that have today become economic powerhouses, besides acquiring a place among the largest manufacturing bases in the world and turning China into a global economic power next only to the US and Japan.

Enthused by the success of the Chinese experiment with SEZs, we deliberated upon them, debated on their pros and cons for a couple of years, and finally decided to put in place an appropriate law for establishing SEZs 15 years after we started the liberalization process—which is, of course, in stark contrast with China, which started its liberalization with the establishment of SEZs. And, thus began all our woes. As a race, being highly possessive of the `sovereignty of reason', we—`pregnant' with `thoughts' that are `disjoint and out of prime'—took to the fancy of `reasoning out' the good and bad of SEZs—whose capability to develop agglomeration economies, to make socio-political control of foreign involvement easier, and create better infrastructure and links with the external world, has been proved beyond doubt in China and elsewhere —and have become perplexed by the problems it has created. The net result is pandemonium across the country.

Reacting to the violence and police firings, the empowered group of ministers has come up with revised policy guidelines: one, the size of multi-product SEZs is caped at 5,000 hectares; two, state governments will not acquire land for SEZs; three, at least, half the area of the SEZ should be earmarked for processing unit; and four, SEZs cannot merely be net foreign exchange earners but their exports must equal their purchases from the domestic tariff areas.

Now, what does all this mean? It means: on the one hand, the government wants to create industrial cities of world-class standard with their own ports, airports, power stations, offshore banking, water supply, and other essential social infrastructure, so that they could become `global centers' of growth; and on the other hand, it wants them to confine to a miniscule size of 5,000 hectares. India cannot have SEZs of the size anywhere nearer to that of Shenzhen which is spread over an area of 20,000 hectares with all the supporting infrastructure of world-class, and hence, it is feared that they would not be able to generate the `driving force' that is required to really transform the economy as envisioned. Some have, therefore, dubbed it as an act of government's continued lack of a long-term vision.

Secondly, it is palpable that the government has resorted to such capping of SEZs across the board only to placate the political forces that are opposing the acquisition of agricultural land for establishing SEZs. But what is enigmatic here is why the government should prescribe the size for SEZs when acquisition of land is no longer by the state governments but only by the respective promoters of SEZs. The revised policy prescription of land acquisition through `voluntarism' between the acquirer and the seller raises a question: why should government cap it? Such half-hearted attempts at promoting SEZs would only result in the mushroom growth of small-sized SEZs which, instead of creating world-class infrastructure, are sure to become a drag on the existing infrastructure in and around them. Further, as the laws permit establishment of sector-specific SEZs with as low as 10 hectares, many such may sprout all around cities causing further strain on the already fragile urban infrastructure, and gain exorbitant tax benefits for breaking down the existing infrastructure. Unfair, isn't it?

That is not the end of the story, for it raises another important question: How would the withdrawal of state governments from land acquisition help farmers? Whether land is acquired by the government or by the SEZ promoter, the sufferings of the farmer will not change. In either case, he needs to rehabilitate himself. That being the reality, withdrawal of the government from the scenario with a modification of policy guidelines is nothing short of abdication of its responsibility towards the welfare of citizens. That aside, what would happen, if, say, a small group of `no-saying' farmers hold the rest to ransom? Such predicaments will only hasten the process of small SEZs mushrooming around cities. In that context, wouldn't they do more harm than good to the nation?

Amidst these unanswered questions, there emerges a ray of hope: Commerce Minister has announced that the government is open to lift the land ceiling on SEZs. "In future, should a proposal come that looks at an area that may be larger, we are willing to look at it", said Kamal Nath. That must have cheered many, but this dilly-dallying is what is ailing the country for decades, which could, perhaps be more due to our "tendency to give ourselves the fullest benefit of every possible doubt…"

"To be or not to be": but how long?

- grk

ESOP's Future

ESOPs : Is the Party Over?

The move to bring ESOPs into the FBT net may not only act as a spoilsport to retain the best talent but may also signal the end of the ESOPs era.

The inclusion of ESOPs under FBT will add to the challenges being faced by employers in knowledge-intensive industries in attracting and retaining world-class talent.

- Ashank Desai,
Non-Executive Chairman,
Mastek Ltd.

In this new millennium, knowledge plays a vital role in the progress of the organizations. Hence, it becomes imperative for corporations to recruit and retain a pool of knowledgeable employees. Nonetheless, this poses a great challenge to the organizations given the backdrop of the increasing rate of attrition. Factors such as shortage of skilled manpower and increasingly competitive business landscape have compelled organizations to look out for innovative ways to retain competent employees. Against this backdrop, Employee Stock Option Plan (ESOP) has emerged as an effective tool, in recent years, to motivate and retain talented employees.

Nevertheless, the concept of ESOP, which has become the corporate mantra for employee retention, may soon lose its charm once the proposal for the imposition of Fringe Benefit Tax (FBT) on ESOPs becomes a reality. In the Union Budget 2007-08, the Finance Minister of India, P Chidambaram, has announced that ESOPs will come under the tax ambit as he intends to further stretch the FBT net to ESOPs. Hence, the ultimate victims of this proposal, the employers, who are destined to bear the brunt, are likely to disapprove the issuing of ESOPs. In other words, the move may signal the end of the golden era of the ESOPs as analysts predict that the corporate world may embark on more viable motivational tools to retain their best talent.

The `two' options

ESOPs are typically tax qualified, contribution defined, employee benefit plans intended to provide employees with an ownership stake in the company that they work for. ESOPs, governed by the Employee Retirement Income Security Act (ERISA), were given a specific legislative framework in 1974. As per the framework, they can avail themselves of the tax benefits, provided they abide by certain rules. Among many other requirements, ERISA mandates that ESOP assets should be held in trust, and also imposes fiduciary norms on those who manage and administer the assets. To abide by these norms, the company has to set up a trust which holds the stock to be purchased by the company. Later, it appoints an individual or an institution as a trustee.

The company, however, can proceed with one of the two forms of ESOPs, such as leveraged and non-leveraged. Nevertheless, the most popular form is leveraged ESOP, which facilitates borrowing of money from the bank or any other commercial lender. Either the company or the trust can borrow the money and loan the proceeds to the ESOP. If the trust borrows the funds directly, it entails for the guarantee from the company. To facilitate the repayment of the loan amount, the company makes periodic cash contributions to the trust which enables regular loan repayments which due to the lenders. These payments are usually tax deductible in the hands of the company and should be within the prescribed limits.

The introduction of FBT on ESOPs in the hands of employers will make it more expensive for employers to retain skilled employees. The Union Budget 2007-08 has come up with the proposal that ESOP will be placed in the hands of the employers as it is considered a fringe benefit. What difference does this make to the employer as well as the employee vis-à-vis the earlier procedure? Akil Hirani: Currently, if shares under an ESOP scheme are offered to employees in conformity with the Income Tax rules, and the ESOP scheme is filed with the income tax authorities, the difference between the fair market value of the shares on the date of allotment/exercise and the exercise price of the shares will not be treated as a perquisite in the hands of the employee, and will not be taxable as income under the head of 'Salary'. However, if the ESOP scheme is not filed with the income tax authorities, the foregoing benefit is not available and the ESOPs are taxed in the hands of the employee at the time of exercise. The proposal to consider an ESOP as a fringe benefit will per se change the tax incidence vis-à-vis an ESOP. With effect from April 1, 2008, it is proposed to amend Section 115WB of the Income Tax Act, 1961 and bring the issuing company (the 'employer') under the Fringe Benefit Tax (FBT) net in respect of ESOPs at the time they are exercised. Further, the method to calculate the FBT has not as yet been prescribed. Introducing this provision will increase the tax liability of the employer, and in a way helps the government do away with the current tax exemption, i.e., an ESOP not being regarded as a perquisite in respect of a scheme that is filed with the tax authorities. Additionally, this will result in double taxation: the FBT, and in the form of capital gains tax on the sale of the shares by the employee. In my opinion, most employers will pass on the FBT burden to their employees. Deepak Ghaisas: A typical ESOP passes through three stages: In stage one, an employer grants an option that is exercisable at a predetermined price before its expiry by the employee. The second stage is the employee, exercising the option by paying in money and becoming a shareholder. The third stage is employee selling the share and paying capital gains tax depending on the holding period. As against this provision, the finance bill 2007-08 taxes ESOPs. When the employee exercises his option at the stage two under FBT through the employer. In other words, even if the employee holds the share for over 12 months, his ESOP gets subjected to an element of tax at the corporate rate, which of course, the employer can pass on to the employee. Secondly, what if the employee is no longer working with the firm at the time of exercising the option the current provision becomes complex. What are the implications of the move in general? Akil Hirani: ESOP is a very effective retention tool, and in an economy that is currently facing talent crunch, ESOPs are very essential. The introduction of FBT on ESOPs in the hands of employers will make it more expensive for employers to retain skilled employees. Further, unlisted companies will have to attribute a notional market price to calculate FBT, and this may be inconsistent with their overall valuation. Deepak Ghaisas: FBT on ESOPs may breed unfair practices. Unlisted companies may issue options at jacked up valuations to minimize the difference on which tax will be levied. Some companies are not yet clear who will bear the brunt of FBT on ESOPs: the employer or the employee? Either way, FBT is going to hurt the industry. Which sectors would be hard hit by this move? Akil Hirani: The sectors that will be worst hit by this move will be the BPO, IT, pharmaceutical, and financial services sectors. The attrition rates in these sectors have always been high requiring employers to use ESOPs as a retention tool. Deepak Ghaisas: Small and Medium Enterprise IT companies, new media companies, and generally new knowledge-based industry would be worst hit. They already are reeling under staff crunch and thwarting employee-defection to established players. FBT on ESOPs is also going to hit mid-cap and small-cap IT companies. Thanks to a severe shortage of skilled personnel, several sectors ranging from aviation to yarn makers have chosen the ESOP route to empower their employees. But now, it will not work. Insurance sector will also be affected. There is a serious contention from the industry people that a tax on ESOPs would affect their ability to retain talent. Does the imposition of FBT on ESOPs blur the future of ESOPs as a critical retention tool? Akil Hirani: Due to the imposition of FBT, employers will have second thoughts about offering ESOPs to employees. In some cases, they may try to pass on the burden to employees. Either way, it will impact the competitiveness of employers in marketplace, and employers may be forced to create alternative products in lieu of ESOPs. Deepak Ghaisas: ESOPs have been used as an HR tool to attract and retain top talent in a company and has been quite successful. Mid-cap and small-cap IT companies cannot pay as much as MNC giants do. They cannot offer brand value, as well. The only way they can attract talented employees is by giving a share in the company and showing them a dream of becoming a millionaire in two years once the company goes in for listing. But FBT may take that away, as well. The current scenario ignores the fact that many companies in their early stages often give stock options to hire and retain talent because they do not have the ability to pay large cash wages. Now, they have to pay the tax on something they could not afford to pay before. The tax outgo will flow out of net profits and impact the cash flow of the company and reduce the profits. We have to see if we can counter this by passing on the costs to employees, which again will be an unpopular move and affect retention of the staff. With the recent move, companies and HR personnel are worried that ESOPs can no longer be used as a way of negotiating with prospective candidates. Employees and prospective candidates will now obviously ask for a 50% hike in salaries than go for ESOPs. Any other comments? Deepak Ghaisas: Thinking up new ways of taxing people and corporations, while claiming that you have not increased the tax rate, may sound convincing to those who voice it but does not fool anyone anymore. - Akil Hirani Managing Partner, Majmudar & Co., International Lawyers, India - Deepak Ghaisas CEO- India Operations and CFO of i-flex solutions ltd., India

Akin to the way that regular pension fund contributions are made by the company, the non-leveraged ESOPs also make periodic contributions to the trust on behalf of the employees. The company may choose to contribute either shares which do not require initial outlay or cash which would, in turn, be utilized to purchase shares. Whichever is the form of issuing ESOPs, soon after the purchase of shares from the existing shareholders, they are allocated among individual accounts maintained by the trust for each participating employee.

ESOPs are distinct from other qualified benefit plans in several respects. Unlike most defined contribution retirement plans, which are required to be invested in a diversified portfolio, ESOPs are intended to be invested primarily in company stock. In addition, ESOPs can borrow money to purchase a large block of company stock and pay for it over time through tax-deductible corporate contributions. ESOPs also enjoy substantial tax advantages, including corporate tax deductions for principal and interest payments on ESOP loans, a deferral or total avoidance of capital gains for stock sold to an ESOP by owners of privately-held companies, and tax deductions for dividends paid on ESOP stock.

India's pick

The concept of ESOP was pioneered in India by the leading IT major, Infosys Technologies, in 1994. However, the broad guidelines to issue stock options were laid down only in 1999 by the stock market regulator. The then Union Budget has contended that ESOPs would be taxed as a perquisite at the time of exercise of the option and subsequently as capital gains at the time of the sale of security. Interestingly, after a while, two senior officials at Zee Telefilms filed a suit contending that ESOPs, being a perquisite, cannot be taxed at the time of exercise. Hence, for five years, only capital gains tax has been levied on the employee at the point of sale of the ESOPs.

During these years, ESOPs have gained huge popularity and emerged as a critical retention tool for many organizations. ESOPs typically work on the philosophy of sharing wealth with the employees by fostering a sense of ownership among them. It has been instrumental in motivating employees to perform better and to retain the talent during times when employee turnover is a norm rather than an exception. In India, its popularity has not only been widespread in IT sector but also in non-IT sectors like media, communications, etc. Unlike other countries where companies primarily use ESOPs to their advantage, in India, they are perceived more as a part of employee expectations, particularly in knowledge-intensive industries.

Spoilsport

Nevertheless, the proposal made in the Union Budget 2007-08 by Chidambaram to levy FBT on ESOPs can act as a dampener to withholding the best talent of the organizations. The new levy is proposed to come into effect from the accounting year April 1, 2007 to the assessment year 2008-09. The issue of taxing ESOPs has always generated problems. All along, it was debated that ESOPs should be taxed in the hands of the employee only as he is the principal beneficiary.

Though the employer did not fall into the tax ambit of ESOPs in the last 5-6 years, all that is set to change now if the recent proposal is accepted. When the proposal comes into effect, it is expected that the difference between the prevailing fair market value of the shares at the time of exercise and the amount actually paid by the employee (exercise price of the option) will be considered as a fringe benefit. Subsequently, the calculated fringe benefit is taxed in the hands of the employee at the proposed rate of 33.99% which is inclusive of corporate tax, surcharge, and the cess. "The tax outgo will flow out of net profits and impact the cash flow of the company and reduce the profits. We have to see if we can counter this by passing on the costs to employees, which again will be an unpopular move," avers Anil Bakht, CMD of ESS.

Losing sheen

Bringing ESOPs under the purview of FBT has been criticized in many ways. As the employers have to bear the brunt of FBT, it will obviously dampen their net profits. The fact that FBT payable would not tax deductible expenses further aggravates the effective cost of 45.54% post-tax to the employer. Hence, they may be reluctant to issue more number of ESOPs, which may badly impinge on talent retention.

Besides, the implied higher tax outflows for employers, the proposal has also been criticized on the grounds of double taxation. Cross-border taxation issues, especially in the case of globally-mobile staff, may arise. Though the employer pays the FBT in India, the employee working overseas may be entitled to personal taxation subject to the concerned jurisdiction norms. This will certainly lead to economic double taxation.

Moreover, industry experts see that small and medium-sized companies will be most hurt as they can offer neither competitive packages nor brand value. The only way out for them to lure skilled employees is by way of giving a share in their company through ESOPs. "Mid-cap and small-cap IT companies cannot pay as much as MNC giants. They cannot offer brand value, as well. The only way they can attract talented employees is by giving a share in the company and showing them a dream of becoming a millionaire in two years once the company goes in for listing. But FBT may take that away as well," says SL Ananthanarayan, CFO, Birlasoft.

Due to the net increase in cost due to imposition of FBT, even start-up companies with great ideas cannot afford to issue ESOPs to their employees any longer. This will, in turn, hamper the company's innovation and entrepreneurship. Nikhil Bhatia, Partner of BSR & Co., worries, "Until the Budget 2007, ESOPs had great appeal, and the Finance Minister has probably hit where it hurts the most as far as ESOPs are concerned. Software companies, which generally face a shortage of talent, have been effectively using ESOPs for retention and reward. But that sheen may be a thing of the past."

In fact, the early success of ESOPs in the western countries can be greatly attributed to the dual benefits that the structure offers. In the US, ESOPs are both tax deductible in the hands of employer and are also tax-free for employees. As many analysts in India fear, the move to bring ESOPs in the FBT net can have a sabotage impact on ESOPs, and the corporate world is raising concerns on this issue. Rahul Mulay, General Manager, Operations and HR Head at Harbinger says, "ESOPs have so far performed well as a motivation tool in the IT industry. This move is not a very good idea. It might be detrimental as companies would mull looking at other alternatives." Thus, it is most likely that the move may prove to be detrimental to the future of the hitherto effective motivational tool.n

- Y Bala Bharathi

Indian-Air India

Indian-Air India : Merger of Promise

The proposed merger of Air India and Indian marks the beginning of the consolidation era in the Indian aviation space.

In line with the global trend of consolidation, the stage is all set for the Indian aviation industry to create a single mega national carrier which is also poised to become South Asia's largest airline. Touted as the mother of Indian aviation mergers, the merger of Air India and Indian is expected to form India's largest airline with a clout to take on the domestic and international competition.

The formal approval given for the merger by the Union Cabinet on March 1, 2007 paved the way for the birth of the Rs. 15,500 cr airline which is almost thrice the size of its closest domestic rival, Jet Airways. Catapulting its position to be among the top 30 league of airlines in the world, the new jumbo entity has the potential to regain the dominant market share that the two state-owned airlines once enjoyed, provided proper restructuring efforts are put into practice. Though the cost of integration of the merger is estimated to be around Rs. 200 cr, it is also expected to reap a net benefit of Rs. 600 cr by the end of the next three years.

Merger motives

The merger move, first mooted around 20 years ago, seems to be inevitable now for both the public sector airlines which are burdened with ageing aircraft and are desperately in need to overhaul their fleets. The merger is expected to help the two ailing giants to revive from the brink of collapse.

Air India, founded in 1932 by Tata group as Tata Airlines, mostly operates on international routes and serves more than 40 destinations across the globe. Though the government initially bought 49% of the airline's shares in 1946, making it a public company and renaming it as Air India, it subsequently bought the remaining stakes also and made it fully government-owned. However, Air India, once considered among the most preferred airlines for international travel in the 1970s and 1980s, lost its sheen because of government apathy. As time passed by, Air India lost its market share to other international airlines which were not only aggressive in marketing and services but also were successful in replacing their old fleet of aircraft.

On the other hand, Indian, set up in 1953 as Indian Airlines, mostly serves the domestic arena besides a few neighboring countries. The airline has also been suffering from huge losses due to bureaucratic management process. Added to this, the private players which were allowed to operate are now capturing its market share with better customer service, attractive deals and lesser delays. Though at the beginning , India had just two domestic carriers—Indian, Air India—the number has increased substantially in the past couple of years. Now, many players like Kingfisher, Air Saraha, Jet Airways, Go Air, Air Deccan, SpiceJet, Paramount, Indigo and Indus have entered the air space .

Besides these, many others like Trans India, Easy Air, and Air Dravida have been awaiting the government's approval to take advantage of the air travel boom which has been primarily driven by the increased income levels of the average Indian. Jet airways and Kingfisher, closest rivals of the two public sector airlines, have around 44 and 23 fleets respectively and are gearing up to induct about 20 and 109 aircrafts respectively, by 2009. All these factors are posing stiff challenges for the government-owned airlines which have been witnessing declining market shares.

In an attempt to increase their market shares, both Indian and Air India have started eating into each other's market share. The Indian Government, the owner of these two airlines, has finally decided to merge these two ailing giants to protect the economic interests of both entities as well as to realize the synergies.

Leveraging synergies

The merger of the duo is the latest buzz in the Indian aviation sector. The deal would be executed in a phased manner over the next two years to create a mega airline and thus reap a net benefit of Rs. 600 cr by the end of the next three years. One of the best-loved mascots, Air India's Maharaja, might be retained as the mascot of the newly formed airline as well.

The merger formalities are expected to be completed by 2010, forming a new entity with over 33,000 employees and a fleet size of 112 new-generation aircrafts. The government has already placed orders for 68 and 43 planes from Boeing and Airbus respectively. The merged entity can compete effectively with airlines like UAE carrier Emirates which has a fleet size of 93 new aircraft, Singapore Airlines with 118 and Malaysian Airlines with 110 aircrafts respectively.

The merged entity can effectively leverage the strong domestic network of Indian to room in international flights through the class hub-and-spoke-operations in a similar way that many global major airlines do. On the other hand, the merged entity can reap the benefits of the international network—easily access the American and European aerospace—which Air India brings with it.

The merged entity can also leverage the tax benefits to offset its losses. Since the Finance Ministry has given its approval to extend Section 72A tax benefits of the Income Tax Act to the merged entity, it will enable the new jumbo to offset the accumulated losses and the unabsorbed depreciation against the future years' profits. Indian can set off Rs. 1,150 cr against the profits for the years to come.

The integration plan envisages that the low-cost subsidiaries of both the airlines be clubbed into one which would act as a subsidiary to the merged entity. This subsidiary would offer low-cost travel services to a selected few domestic and international arenas. Besides this, the new entity is expected to work on a business model which would create separate Strategic Business Units (SBUs) to look after different areas of service like Maintenance-Repair-Overhaul (MRO), cargo, engineering, Low-Cost Carriers (LCCs), jet shop and ground handling.

Post-merger, there are more chances for the new entity to witness significant increase in valuations as it will emerge as a much bigger and stronger player than the individual entities. Hence, the concerned authorities have decided to carry out the IPO after the merger, though it was earlier planned before the merger. Thus, the merged entity is also poised to enjoy the benefit of increased valuations.

Integration challenges

Besides benefits, the merger is also likely to pose some serious integration challenges due to completely divergent operations and different fleet composition as well as diverse organizational cultures. The fact that the size of the workforce is large makes it all the more difficult to carry out integration efforts simultaneously across all centers of the world. Divergent operations and fleet sizes of the duo bring out issues like managing spares, pilot training, etc.

Different workforce with different pay structures and different cultures may also raise few human resource concerns. For instance, issues like which pilots should fly overseas may also turn out to be a matter of debate. As pilots flying overseas receive huge amounts of international allowances, crew of both companies will be interested to work in the international arena. Rationalization of staff could be the only solution to such issues. However, such rationalization of staff is also prone to create turbulence within the system. On the other hand, without rationalization, the merged entity cannot reap economies of scale. At this critical juncture, the airlines should also see to it that they do not lose out their priced staff and pilots to other competitors. Against this challenging backdrop, the aviation authorities have a daunting task ahead to carry out the merger integration process smoothly and successfully.

Players on the prowl

Though the merged entity can enjoy the privilege of increased market share, which is one of the objectives of the merger, it could just be a temporary benefit than a permanent one. To be successful in the long haul, it should rather address the underlying factors which led to the declining glory of these two airlines. Perhaps, after the merger is through, the government might offload some of its share to the public and perhaps a strategic partner would be brought in. All this would probably bring in more transparency and accountability which is very much the need of the hour.

The merger of the two airlines can be envisaged as the beginning of the consolidation efforts in the Indian aviation space which is the fastest growing in the world. Air traffic to India has been growing at a rapid pace of 40% compared to 15-20% growth at the global level. Private players are on a prowl to cash in on the growing demand. Jet Airways had felt the necessity much before, thus seeking to acquire Air Sahara in 2006. Though the deal had collapsed then, Jet Airways has recently clinched a fresh deal to takeover Air Sahara which is valued at $337.8 mn. Besides this, analysts opine that other arch rivals like Kingfisher and SpiceJet are also gearing up to consolidate themselves. All these speculations signify that the merger of Air India and Indian will set the ball rolling to further consolidation frenzy in the Indian aviation space.

- D Satish and Y Bala Bharathi

Power Crisis: Let There Be Light!

Fixing India's Power Woes : Let There Be Light!

Time is running out, and unless we are able to arrest the growing shortages, the effect on our economy may well prove disastrous.

- Manmohan Singh
Prime Minister, India,
on the worsening power situation in the country.

As India prepares to grow into the double digit, after consistently growing at 8-9% during the last couple of years, one sector that threatens to act as a major deterrent is the power sector. It is no secret that the power situation in the country remains grave even after more than five decades of independence, and more importantly, even after over a decade-and-a-half when we ushered into the era of reforms in 1991-92. The ground reality is: SEBs continue to accumulate losses thanks to unabated power theft and transmission and distribution losses; demand continues to outpace supply (peak demand vs. peak met situation is even worse) as new capacity additions are far and a few. The result is: power cuts are a routine and have become severe during summer as utilities resort to long-duration power cuts making the common man sweat more during sweltering summer every year, and forcing hundreds of tiny and mid-sized firms to shut factories that cannot afford their own captive power plants. This is no good news for the country that aims to grow at 10%.

However, there may be light at the end of the tunnel. Realizing the seriousness of the issue, the government has not only got into an overdrive to augment power supply in the country but has also set itself an ambitious goal of `Power for All,' by 2012. In essence, the govern-ment's latest move with regard to the setting up of Ultra Power Projects across the country, power merchant plants, open access, and continued reforms, including restructuring of SEBs and transmission and distribution, augurs well for the power sector in the country. But, curbing the rampant electricity theft, attracting long-term investment for setting up new power plants, and removing other bottlenecks would pose significant challenges

Delhi is certainly not the place to be in during summer. Soaring temperatures, with the mercury zipping past 44-degree celsius and frequent power cuts in areas such as Munirka, Rajender Nagar and Malviya Nagar—where the ordeal lasts as long as 12-15 hours a day during the peak summer months of May and June, thanks to Delhi distribution companies' (discoms) erratic ways—make days in India's capital a nightmarish experience for the 10 million denizens who have continued to suffer every summer for decades.

Unfortunately, no other Indian city fares better: without counting the hundreds of thousands of villages, which do not even have electric poles, an estimated 20% rural households do not have access to electricity (of the estimated 593,732 villages about 115,067 villages in the country do not have access to power).

In Kolkata, another major metropolis in the country, 2 million consumers are forced to endure power cuts lasting eight hours a day, which is worse than the two to three hours of cuts they had to cope with until last year. In Mumbai, the commercial capital of the country and an aspiring international financial hub, though the situation does not appear to be as grave, sensing the urgency, Tata Power, which supplies electricity to the city, urged Mumbaikars to reduce the use of air-conditioners, use energy-efficient bulbs and put computers on sleep mode to save energy.

On the whole, nationwide, how bad the situation is can be understood from the fact that during peak hours supply shortfall could be as high as 25% in some parts of the country. The national average is, however, lower at 9%, though the figure touched 14% during peak hours last year—the largest shortfall in the last 10 years. Needless to say, the frequent power cuts have led to many shutdowns. It is not surprising then that frequent surveys on businesses have cited power shortages as one of the main reasons for industrial sickness, far ahead of labor strike or mismanagement. And now, with the power deficit reaching an alarming level, it is even threatening to derail the country's recent dramatic growth.

Cancerous crisis

India's power woes began three decades ago, in 1977, when politicians came up with the idea of subsidized electricity for farmers as a populist measure to woo voters. Subsequently, over the years, it has taken the more dangerous form of free power (for agriculture), as India's political masters dangled the carrot of free power supply in front of farmers to ride to power, never minding the fact that it would push the state-run electricity boards into financial bankruptcy; though states of Madhya Pradesh, Punjab and Tamil Nadu have abandoned the practice. Besides, another severe damage that is crippling the power sector is that of power theft. According to Reliance Energy's own submission, every third of its customer in Mumbai lives in a shantytown where pilferage ranges from 15-70%. In other places like Amritsar, pilferers have found the new electronic meters to be a shot in the arm for them to indulge in power theft. Pilferers are able to jam these modern meters even from a distance of more than 25 feet without tampering the meters or the wiring, much to the frustration of the Punjab State Electricity Board.

According to the Central Electricity Authority (CEA), demand for power exceeded by 7.3% (estimated) in FY 2005 and 7.1% in FY 2004. In terms of total requirement and in terms of peak demand there was a shortfall of 11.7% and 11.2% during FY 2005 and FY 2004 respectively. Overall, the total deficit during the fiscal 2006-07 was to the tune of 13.8% or 13,897 MW(peak demand of 100,715 MW vs. 86,818 MW of peak met). The country currently has a total installed capacity of 132,110 MW. Added to this, transmission and distribution losses were to the extent of 33%. Further, load shedding has become quite common in nearly all the states.

During the 10^th plan, the Accelerated Power Development and Reform Program (APDRP) was launched with an objective to reduce Aggregate Technical and Commercial (AT&C) losses and reduc outages and interruptions to 10%. However, it has failed to achieve this objective as AT&C losses continue to average over 35%, ranging from 18-62% across states. The loss was mainly due to theft and inefficiencies at various levels. As a result, SEBs suffered heavy losses and the rate of returns fell further to a negative 27.4% in 2006-07 from a negative 24.8% in 2005-06. This has acted as a major deterrent against investment in new projects by SEBs.

Commensurate capacity addition in transmission and distribution will be necessary to absorb the additional power generation. How realistic is the government's plan of `power for all'? Anish: I think it's a big challenge, I don't think anybody should expect that it will happen at the current space of accuracy, particularly because of long gestation periods. It's not easy to construct power plants within a short time frame. There will be slippages and we will not be able to meet the `power for all' target by 11 th plan. That's the reality. Rakesh Nath: In the 10th plan, 21,180 MW was commissioned against the target of 41,110 MW. The main reasons were delay in equipment supplies and erection by suppliers/contractors, delay in technological tie-up for super critical technology by the indigenous manufacturers, non-availability of gas resulting in dropping and non-commissioning of some projects, and dropping of some projects in private sector due to non-achievement of financial closure and delays in clearances and investment decisions. We have analyzed the reasons for the slippages and have taken corrective action. Compared to the 10th plan, the preparedness for the targeted 11th plan capacity addition of 78,500 MW has been much better. Projects totaling about 50,000 MW are currently under execution as against about 20,000 MW at the beginning of 11th plan. Efforts are being made to complete the ordering process of remaining projects during the year 2007-08. In view of the boom in construction of power projects and other infrastructure sector, we are facing problem of equipment supplies, shortage of contractors, particularly civil contractors, and shortage of skilled manpower. We are addressing these issues. Some major equipment suppliers have taken steps to augment their capacity. We have also organized an International Conclave of equipment suppliers, contractors, industry associations and training institutions on 4 th and 5th July, 2007 calling upon them to augment their capacities. Presently, there is no shortage of finances but considering the huge investment required for transmission and distribution sub-sectors to transmit and deliver the additional electrical energy to the ultimate consumer, financing may pose a constraint. The Government of India has decided to constitute a high level committee headed by the Union Finance Minister to look at the financial issues. The committee is likely to complete its work in three months. What are the major factors that you attribute to the acute power shortage situation in the country? Anish: The major factors are several including the fact that the private sector has not come up to the extent that we expect it to and a combination of poor policies which are there, and also the poor paying capacity of the electricity board. Secondly, State Electricity Boards (SEBs) are also not included; deficiencies are as much necessary which become segmented as a problem. From demand side, we could have had some relief, which has not happened. The third is deficit of faulty planning and policy, I think the wake up call should have come long time back; unfortunately people in power did not react. So, if we are heading towards this level of energy demand now, we should have planned 3 or 4 years back to get this kind of capacity. Fourth is on the fuel side: the big problem is the coal mine allocation and resource availability for shedding of power problem or linkages. The coal production grew at less than 4%. As coal being the mainstay, you cannot have 8% or 9% growth is intra capacity when the principal yield is growing at less than 4%. All these factors together have contributed to this kind of problem which is going to grow bigger as you go along. Rakesh Nath: The major factors contributing to the acute power shortage situation in the country are meagre or no capacity addition from many states during last 10 years, high AT&C losses, inadequate availability of gas, and inefficient end-use of electricity. The agriculture sector, which consumes 23% of total energy, has an abysmally low efficiency usage of pumps. Study estimates indicate electrical energy saving potential of 23% on account of energy conservation alone. In the 11th plan, there is a major thrust on capacity addition, reduction of AT&C losses, and energy conservation. Since there is also high potential for alternative sources (like non-conventional sources of electricity generation), what initiatives from the government are needed to tide over the power deficit? Anish: On the non-conventional energy front (wind, hydro and solar), all of them are pretty much potential sources, some of them seem more expensive but others are not. Wind is now pretty much cost-competitive, even solar is becoming cost-competitive. If these work out, then there is potential for meeting the deficit. These alone would not be enough, I think we need everything; we need thermal, hydro, gas, renewable, nuclear. All of them have to come and contribute in meeting the shortages. I think the Ultra Mega Power Project is a very good initiative from the government. It has been progressing well though there are some controversies regarding the project. It is progressing pretty well and the model is good as it takes away the risks from developers, helps them to keep their focus on project development, and gives customers good tariffs. You cannot have just one flagship scheme and then try to achieve everything from it. UMPP alone will not achieve everything for you; you have to do much more than UMPP. We need more generation, renewable and capital power. There are lots of options to meet the demand; the only thing required is to have large capital power. Rakesh Nath: Renewable energy sources constitute about 6.8% of total installed generation capacity of the country. It has inherent advantages of low gestation period and participation of small entrepreneurs on account of low investment requirement in capacity building. The main development so far has been in wind, small hydro, and bagasse co-generation which have been found commercially viable. In view of the present demand and supply imbalance and anticipated growth in demand, energy generation has to grow at 9% which is possible only by conventional energy sources, as renewable sources have a low plant load factor. However, all encouragement needs to be given for exploitation of our huge renewable resources. In the 11 th plan, a capacity addition target of 13,500 MW has been proposed for renewable sources. Some State Electricity Regulatory Commissions (SERCs) have specified a minimum percentage of energy consumption to distribution companies for sourcing from the renewable energy to encourage development of renewables. Utilities and SERCs have allowed banking arrangements and open access to captive plants based on renewables to encourage development of captive plants with renewable sources. This needs to be emulated in other states. Private players hold a meager share of 12.9%. What reforms are needed? Anish: A few things are holding private investments back. One is the bit process which is slower and not mature enough. You are not allowing the policies to evolve. For instance, the national electricity policy has been designed in a manner where other forms of generation—whether it is by the utilities themselves, or MOU-based project, or PPP-based projects—had to face bumpy regulatory approvals, and I don't think that was a wise measure. We should make avenues for private sector investment. The bit process should expedite and permit projects to come from outside the bit processes also. You need to allocate fuel resources better. Coal mines need to be allocated and then finally I think you need standard transparent contractual framework with typical work set. The private sector is not compelled to come only through the competitor bid route. Now it is not necessary. I don't think we should have any kind of restrictions and that is how businesses are done worldwide. Secondly, the contractual framework does not have the real allocation to the extent necessary; so, a lot of foreign players are not coming in, because they are not happy with the contractual framework which is their specialty. Thirdly, the merchant power policy: where there was some talk of the policy and then it died down. Nobody was clear as to what is happening with the merchant power plant: will they be given any coal mines? Will they be allowed to have long-term contracts? There was a lack of clarity and there were some conflicting signals. Rakesh Nath: Capacity addition in the private sector is very crucial to meet our targets. The weakest link in the whole power supply chain is distribution which suffers from high Aggregate Technical & Commercial (AT&C) losses. The average AT&C losses are to the order of 34%. In some of the distribution companies, AT&C losses are above 40%. Due to high Transmission & Distribution losses (30%) and financial losses (Rs. 221 bn in 2004-05 without subsidy) of State Power Utilities, the desired investment in the private sector has not taken place in the past. Reforms in the distribution sector covering technological and governance issues with a view to reduce AT&C losses to 15% should be the top priority of the State. A healthy distribution sector will attract more private investment. The enactment of the Electricity Act, 2003 has created enthusiasm in the private sector to add to the capacity. Provision of non-discriminatory open access addresses some of the concerns of the power sector. In the tariff-based competitive bidding of the two Ultra Mega Power Projects (UMPPs) of 4,000 MW each, we have seen good participation by the private sector. Execution of one UMPP has already started. The private sector has also taken interest in the development of hydro power. Though in the 11 th plan, 10,760 MW capacity addition in the private sector has been programmed, a number of additional projects in the private sector are on the anvil and are likely to be commissioned during the 11th plan. Your Comments on Andhra Pradesh Power Distribution? Anish: Andhra Pradesh on the distribution end has taken an initiative and it has worked well. It is a question of whether there is a will to do it without worrying about private or public sector participation. But we must remember that Andhra Pradesh took several commercial measures which we normally don't expect from any public sector. They dropped the tariffs and the books were better balanced. They got lot more revenues and incentives in edge which is very good and all of this together has worked. Loss reduction is one dimension of this and it is more commercial in Andhra Pradesh. They can do much better. What is your outlook for the power sector in India? Anish: On the whole, the challenge is about meeting the demand. I think in the next 7-8 years, we will have a surplus of demand over supply. Now, if we manage to free up the captive power sector and the merchant power sector and things like that it would be helpful. However, much depends on how the policy shapes up in the next 1-2 years. I think we need more practical government policies and an overall oversight framework to ensure that capacity addition is much faster and much easier. So hopefully right from the top echelons of power to other levels, there should be a lot more practical initiatives to take the process forward. They need to make the necessary investments in technology, data processes, people capacity, and also better vigilance. All things put together can help. Rakesh Nath: I am optimistic about the future of the power sector in India. The Electricity Act, 2003 has provided the framework for the accelerated development of the power sector. We expect huge capacity addition in the next 10 years. The capacity addition is expected to be predominantly coal-based thermal power projects in 11 th and 12th plans. However, in the 12th plan, we can expect increase in share of hydro power as preparatory works on 30,000 MW identified hydro capacity will be completed during the 11 th plan. Commensurate capacity addition in transmission and distribution will be necessary to absorb the additional power generation. Reduction of AT&C losses will be a thrust area as sustained capacity addition will depend heavily on the financial health of the distribution companies. We expect increased capacity addition in renewables and reduction in energy intensity by improved energy efficiency in the industry, commercial establishment and domestic sectors as people become more conscious about global warming. We are also going to see very soon the establishment of Power Exchange and increased activities in power market by power traded without long-term PPAs and consumers having wider choice to select their suppliers. There has been a marked improvement in grid frequency and voltage profile with the implementation of Availability Based Tariff (ABT). Our regional grids are more secure and reliable and grid disturbances and blackouts are things of past. In 2006, the Northern Grid was synchronized with the integrated Western, Eastern and North-Eastern regional grids thereby creating the large Central Grid having total installed capacity of about 94,000 MW operating synchronously. The All India Plant Load Factor of thermal machines was at an all-time high of 76.8% during 2006-07. The inter-regional transfer capacity has resulted in optimum utilization of surplus power available in some regions. The National Grid is expected to be further strengthened during the 11 th plan with the inter-regional transfer capacity planned to be increased to about 37,000 MW. Any other comments? Anish: The general message is that we need to work at two levels: at the demand side, we need to do much more work on the utilities to build the capacities. Control losses: become more efficient in operations; have better price signaling; all these have to come on the demand side. And on the supply side, we need to free up all avenues. We had a very good legal framework for 2006, but unfortunately, it was not well-implemented because there were some policy bottlenecks. It is necessary to work on those bottlenecks and have a proper framework. - Anish De Associate Director Transaction Advisory Services Ernst & Young, India - Rakesh Nath Chairperson, Central Electricity Authority (CEA) Government of India

Besides, another concern is related to India's higher power cost when compared with other countries. According to estimates, power costs are higher by 74% in India than in Malaysia and 39% more than in China. This has a major impact on businesses, particularly small and medium industries, which have suffered on account of the massive power costs as well as frequent power cuts. According to estimates, Indian firms are losing output by 9% because of load shedding, which is much higher than that of Malaysia and China with just 2%, which just reflects the worsening power scenario in the country.

Power Deficit: Status Quo Remains
Year	Energy Requirement (MW)	Energy availability (MW)	Energy shortage(MW)	Energy shortage (%)
2000-01	507216	467400	39816	7.8
2001-02	522537	483350	39187	7.5
2002-03	545983	497890	48093	8.8
2003-04	559264	519398	39866	7.1
2004-05	591373	548115	43258	7.3
2005-06	631554	578819	52938	8.4
2005-07	690587	624496	66091	9.6
Source: Ministry of Power & CEA, India

Power for all: a mere rhetoric?

To tide over the crisis, which threatens to derail India's nascent fast-paced economic growth, the central government has launched an ambitious drive which aims at achieving a whopping target of 78,577 MW of electricity generation during the 11 ^th five-year plan 2007-2012, which is almost four times higher than the capacity achieved during 2002-2007. It raises doubts given the government's past track record. For instance, during the 10^th plan (2002-07), against the target of 41,110 MW of electricity, the government could manage only 23,000 MW or 56% of the planned capacity additions. Prior to this, i.e., during the 9^th plan, only 47.5% of the planned capacity addition of 40,245 MW could be achieved.

Nonetheless, the government is going ahead with its ambitious plan. A project of around 47,000 MW, which will include a mix of 14,000 MW of hydro power, 30,000 MW of thermal power and 3,380 MW of nuclear power, is currently underway and is expected to be ready in the next two years. In addition, about 9,000 MW that could not be achieved in the 10 ^th plan would also be added during 2007-08, so as to reach the assured mark of 56,000 MW in the 11^th plan. The total of 78,000 MW target is planned as: 16,785 MW in 2007-08 (i.e., its first year of the plan); another 7,272 MW in 2008-09; 15,198 MW in 2009-10; 16,970 MW in 2010-2011; and, finally 22,372 in 2011-12. And if everything goes according to the plan, by the end of the 11 ^th plan, the country can boast of an energy surplus of 5.6% and a peak time surplus of 0.6%.

Electricity Act 2003 was a milestone and in a significant move to better reforms and tide over the demand and supply gaps, government has amended it and has introduced Electricity Act 2007 that comes into effect from June 15, 2007. This amendment will now bridge the shortage gaps. According to the Act, no approval or license is required to set up captive power plants by individuals, groups and cooperatives. But there is a major hitch while supply of electricity generated from captive power plants to any distribution licensee has been delicensed, industry experts says that supply from captive power plants is only possible if SEBs adopt a strong distribution franchisee model.

Further, achieving such an ambitious target (of power for all) calls for huge investments. According to a Citibank report, "Electricity Sector in India - Status and Outlook", to achieve the planned capacity, the power sector needs an investment of $200 bn over the next five years. Of this, investment about $90 bn is required for generation, an additional $90 bn for Transmission and Distribution (T&D), of which $15 bn is needed for the power grid. Of this, the private sector is expected to invest $25 bn ($19 bn for generation and $6 bn for the national power grid). The balance investment is expected from the state and the central sectors. The report adds that given the market opportunity and competitive positioning, India is an attractive destination for foreign companies. The action plan to revitalize the sector also includes setting up a power project management which is professionally managed, probably headed by the Union Power Secretary.

Apt policies: need of the hour

To deal with the massive power losses, the government has identified the introduction of competition through `open access' to be a major help in the power sector. "We have to look closely at all regulations to ensure that there is `open access' in transmission and distribution. State policy has to proactively encourage utilization of the transmission and distribution corridors to ensure the free flow of power to any consumer who may be willing to contract for the power," the Prime Minister said recently. On the issue of encouraging private sector participation, the Prime Minister said, "The key to attracting investment, particularly from the private sector, lies in ensuring open access to consumers. It will encourage investment. It will also put competitive pressure on the incumbent utility."

The country also needs reforms in the area of electricity distribution. This is due to the fact that about 75% of the technical losses and almost all of the commercial losses occur at the distribution stage. "The quality of the power distribution network, for example, is poor with approximately 40-50% of power lost to the network due to power theft and transmission and distribution loss, resulting in inadequate capacity and frequent power outages," says Manish Agarwal, National Industry Director, KPMG. According to a KPMG report, distribution losses are shown at $6 bn per annum only due to power theft. The Prime Minister said, "Theft is the cancer of the power sector. We need to come down on it heavily as it is seriously affecting the financial viability of the sector as a whole." The KPMG report suggests introduction of tariff and distribution reforms to bring efficiency into the sector.

The government is planning to provide a boost to the distribution sector and proposes a new distribution mechanism that involves delinking the distribution wires business from the last mile business. Further, the T&D of wires would be handled by a new company area-wise, and distribution firms would be allowed to access the network and deliver it from the grid to the end- users. Regional power grid will be allowed to sell power to private distribution firms and bill accordingly under the proposed mechanism. At present, the state-run power companies are the sole controllers of the grid and distribution network. Manish Agarwal, Director, Infrastructure Advisory, KPMG, India, opines, "The Open Access regime has the potential to significantly relieve the capacity addition burden (either through capital or through contract) on the public sector, by transferring the generation investment risk entirely into the private sector."

While this mechanism sounds great, there are certain conditions to be considered such as private players paying the wheeling charges to the wiring company and maintenance charges of distribution to the government. Hence, whether the government's effort through the power distribution mechanism would yield results is not a certainty if the past experience is any indication. For instance, privatizing of distribution was initially launched in Delhi and Orissa, but it yielded mixed results. Besides, no major global power is showing interest in India's T&D area.

Attracting private investment

The government's initiative in 1991 of encouraging the private players in generation, transmission and distribution yielded no results. Because of the regulatory bottlenecks only few private players have invested in building new power plants. "I think this is a serious issue that needs to be considered. Why are we unable to attract private investment? Are there systematic or structural issues that need to be addressed in order to make the sector viable and capable of providing decent returns to investors?" asked the Prime Minister in a recent conference on the Indian power sector. Experts say that in order to attract private investors, there is need for a clear policy framework in areas such as pricing, market structure, foreign investments and exchange of energy products.

Then there are concerns such as deteriorating financial health of utilities with recurrent losses, regulatory uncertainty, high open access charges, pricing of surplus power grid support charges, renewable reliability issues, grid connectivity, fuel availability and price risks. Under these circumstances, the investor needs to be provided with mitigation by government. In response to these concerns, the government is taking up proper steps such as trying to bring in greater transparency in regulatory proceedings and multi-year tariffs, introduction of policy measures like National Electricity Policy, de-blocking of coal reserves held by the public sector, private participation through coal linkage/captive mines, enhanced coal production targets and advanced technologies. However, the government needs to look further into aspects such as risk allocation between stakeholders, price volatility, capacity assessment of utilities, involvement of private parties for energy distribution and assessing the discoms' efficiency. Reforms in the distribution sectors have been taken with the introduction of the open access system. "Reforms in distribution sector covering technological and governance issues with a view to reduce AT&C losses to 15% should be the top priority of the state," says Rakesh Nath, Chairman, CEA, India. However, Agarwal notes, "Open access is largely seen as a threat, and not an opportunity. While many of the regulations have been put in place, there are significant implementation gaps—addressing these will require `champions of competition' in the electricity supply system."

Beyond thermal power

To meet its ambitious target of electricity for all by 2012, the government has plans to set up 46,520 MW of Thermal, Hydel (17,997 MW), Nuclear (3,160 MW) and Ultra Mega Power Projects (36,000 MW). A look at the power generation fuel-wise shows that coal has a major share of 55% followed by Hydro (26%), Gas (11%), Renewable (5%), Nuclear (2%) and Oil (1%).

Mission 2012: Power for All

• Sufficient power to achieve the GDP growth rate of 8% • Reliability of power • Quality power • Optimum power cost • Commercial viability of power industry • Power for all Strategies to achieve the objectives: Power Generation Strategy with focus on low-cost generation, optimization of capacity utilization, controlling the input cost, optimization of fuel mix, technology upgradation and utilization of non-conventional energy sources. Transmission Strategy with focus on development of the National Grid including interstate connections, technology upgradation and optimization of transmission cost. Distribution Strategy to achieve distribution reforms with focus on system upgradation, loss reduction, theft control, consumer service orientation, quality power supply commercialization, decentralized distributed generation and supply for rural areas. Regulation Strategy aimed at protecting consumer interests and making the sector commercially viable. Financing Strategy to generate resources for the required growth of the power sector. Conservation Strategy to optimize the utilization of electricity with focus on demand side management, load management and technology upgradation to provide energy-efficient equipment/gadgets.

Source: Ministry of Power, India

The second major fuel for power generation, hydroelectric power stands at 5th position in the world in terms of exploitable hydro potential. Thus far, only 17% of the potential has been exploited and another 5% is under expansion, leaving a huge potential to be tapped. While the government is determined to fully harness the hydro potential, legal and pollution control boards are becoming bottlenecks for these projects. For instance, the hydropower policy has not looked into issues such as submergence of large areas involving forest, ramifications of submergence, safety of dams, drinking water schemes, irrigation and infrastructure. These concerns have held back private sector investment.

In the 11^th plan, the government is pinning hopes on Ultra Mega Power Projects (UMPP) as an answer to India's energy shortages. Experts concur that UMPP could yield better results. "In the tariff-based competitive bidding of the two UMPPs (Mudra and Sasan) of 4,000 MW each, we have seen good participation by private sectors. Execution of one UMPP has already started," says Nath. After a competitive bidding, the Sasan project was handed over to Lanco-Globeleq located in Madhya Pradesh and Mudra Project in Gujarat to Tata Power Company. Unfortunately, Sasan project has to be delayed due to Globeleq's with drawal from the project as it failed to meet qualifying norms.

Nuclear energy is another area that the government is looking at to boost supply. Nuclear power offers another option to increase India's power generation capacity quickly. A lot, however, would depend on the outcome of the country's ongoing negotiations with the US. If the fallout is positive, it could see the lifting of the global sanctions on India's nuclear energy program and open up significant commercial opportunities for foreign power sector players. However, a section of experts say that nuclear energy, which today accounts for a mere 3% of the total electricity produced in the country, cannot be the solution to India's power woes, and that even a sustained focus cannot see its contribution going beyond 8-10% even by 2020. Thus, the country needs to focus on resources which could help it meet the power needs in the short-term.

Apart from these, the government has also identified wind and small hydro as very much commercially viable energy sources. Renewable energy is another area where the government is keen to tap the potential. "It has inherent advantages of low gestation period and participation of small entrepreneurs on account of low investment requirement in capacity building," says Rakesh Nath. He also adds, "All encouragement needs to be given for the exploitation of our huge renewable resources."

Another concept that is being explored now to end India's power woes is `power trading'. Currently, around 15 GWh of electricity is traded every year and there are four or five large trading players. Further, the government is planning to set up over a dozen merchant power plants to generate 500 MW-1,000 MW of power, open access and the plan to set up a power exchange will all give a further leg-up to power trading.

Distribution end efficiency improvement remains the most important requirement for the financial viability of the entire sector. There have been improvements to different extents in different states. The franchisee model is an interesting initiative being pursued by a number of utilities to bring in private sector participation in this area. Tariff reform is the other critical area to ensure that the cash flows into the sector meet the economic cost of supply. The competitive pressure on industrial tariffs to reduce (in real terms) is being felt by most states. However, increasing the tariffs of subsidized categories remains politically difficult. States need to assess the implications and readiness needs to achieve the cross subsidy reduction target set in the Tariff Policy. The RGGVY scheme will increase the proportion of subsidized consumption—further underlining the need for rapid tariff reform (and a sustainable subsidy policy). A significant increase in "quality of supply and service" orientation of utilities is essential for both—loss reduction and tariff reform—initiatives to be successful. The 'Open Access' regime has the potential to significantly relieve the capacity addition burden (either through capital or through contract) on the public sector, by transferring the generation investment risk entirely into the private sector. However, open access is largely seen as a threat, and not an opportunity. While many of the regulations have been put in place, there are significant implementation gaps—addressing these will require 'champions of competition' in the electricity supply system. Each state needs to have a clearer, and committed road map for reform, including its targets for ensuring competition in generation/bulk supply, and clarity on how the de-link between fuel prices and electricity prices will be reduced over time. Investor interest in the power sector is very high, and a number of smaller capacity projects are likely to be added in the private sector. Large capacity private projects continue to require a winning competitive bidding process. In the immediate future, public sector investments and contracted private sector capacity will remain the path for large scale capacity addition. - Manish Agarwal Director, Infrastructure Advisory KPMG India

These plants fill different niches in the market: some provide steady sup plies to a power grid, while others fire up only when the demand is highest. The advantage of merchant plants for equity investors is that they can offer returns in excess of 20%, whereas long-term power purchase agreements limit returns to 14-16%. "We are also going to see, very soon, the establishment of Power Exchange and increased activities in the power market by power traded without long-term PPAs and consumers having wider choice to select their suppliers," says Nath.

Grand goal - hope lights up

While there is a major focus on privatization of power distribution, this may not be the panacea for all problems. In fact, one can draw a lesson or two from the state-owned Andhra Pradesh Transco (AP Transco)'s success. At the time, when the Central Government was trying to overhaul the SEBs' losses of more than Rs. 22,000 cr, AP Transco met with significant success. For this state-owned entity, the hitch was AT&C losses and the inefficiencies in the system. To bring down losses, it made its employees accountable; something none of the SEBs would have dared to do. It also improved the efficiencies of the delivery system and service quality by carrying out monthly performance reviews at different levels of supply. "Month to month, we have been doing this without fail for five years," said Rachel Chatterjee, Managing Director, AP Transco. The outcome of the state's turnaround clearly reflects in the sharp reduction in losses from 37% in 1999-00 to 15.8% in 2005-06 and rise in its collections by 100%. The most noticeable and admirable part is that this accomplishment has been achieved with no tariff increase, despite the fact that the state provides free power to farmers.

Apart from such constraints, the state stood as the fourth largest electricity consumer in the country and was rated as the top utility by CRISIL and ICRA agencies for the past three years. Serving almost 18.5 million consumers, AP Transco has turned out to be a healthy and profitable SEB. AP Transco's example clearly underlines the fact that it is not the ownership that matters, rather good governance and apt policy reforms hold the key to success. Perhaps, this also holds the key to India's grand goal of achieving access to power for all.

- Amit Singh Sisodiya and Kavita Putta