Budget 2012: External borrowing without internal reform compounds and generalises risks

The Budget's new scheme for external commercial borrowings (ECB) for policy-challenged sectors like power and civil aviation runs the risk of translating the failure of individual companies into an economy wide problem that affects others. Continued lack of reform in the sectors means throwing good money after bad, with real risks of external non-payment and attendant adverse implications including dearer cost of borrowings, reduced credit rating et al.

Note that the ECB norms to finance rupee debt of ongoing power projects appear to be bereft of prudent limits. Yet, the ground reality is that the main sectoral suppliers, the state power utilities, remain very much in the red thanks to perverse politically mandated giveaways, runaway revenue leakage and sheer non-reform of power distribution.

Meanwhile, due to infrastructure status and Section 80-I tax benefits, independent power producers (IPPs) appear to have attractive bottom lines. These companies could get foreign funds, only to find their fortunes sinking along with the health of the sector as a whole.

The seeming balance sheet strength may well camouflage huge sectoral credit risks of non-payment for power purchase by bankrupt state electricity boards. Similarly, in aviation, given that private carriers have piled up losses of over Rs 7,000 crore, with finances of at least one airline, Kingfisher, particularly over-extended, a new ECB window to fund working capital seems highly questionable.

Thankfully, the stated position is to limit such working capital borrowings to $1 billion, and only for one year.

But given that money is fungible, and there are parallel proposals for increased external funding of domestic aviation, the unintended consequences of the new ECB norms could well needlessly add to the risks of external default.

Yet, the Budget speech does glibly mention that the high operating cost of the sector is largely attributable to the cost of aviation turbine fuel. The point is that without purposeful reform, and a functional market for corporate control, mere palliatives like increased ECBs would be gravely suboptimal policy solutions.