Why trying to legislate lower LPS rates retrospectively is bad for the power sector

The Ministry has proposed Draft rules seeking to regulate the policy around late payment surcharge (LPS) for delayed payments from Discoms to generators and transmission companies.

Delayed payments are a highly charged issue today with Discoms and anything that impinges on LPS , is likely to come under micro scrutiny. The proposed Rules seek to achieve the following:

a) Harmonize and establish MCLR rate of SBI as the basis for all LPS calculations

b) Cap the LPS to SBI’s MCLR + 500 basis points or the LPS rate mentioned in the PPA, whichever is lower

c) LPS to escalate @ 50 basis points for every month of delay, but is capped again at the PPA’s LPS rate

d) A waterfall mechanism is created whereby payments are appropriated first towards LPS first and followed by the longest overdue bill and so on

All these are well-intentioned changes and tend bring some uniformity to the LPS charges in Power PPAs. But as T.S.Eliot once said, “The road to hell is paved with good intentions”.

Let us unpack this. The draft unabashedly claims that the main purpose of the draft rules is to reduce to the high LPS charges which were fixed way back in old PPAs and bring some relief to the discoms. Now that the interest rates have come down, the MoP is trying to remedy the situation with these amendments.

It is not entirely clear whether these changes will apply prospectively to PPAs signed after the issue of these draft rules. All notifications are by tradition prospective , but it is going to be a Catch-22 situation if we apply that logic here. If the idea is to bring down the LPS charges in Older PPAs , then these rules HAVE to apply to older PPAs that have already been signed. Otherwise the entire purpose and objectives are defeated. Newer PPAs already link LPS to a floating rate much in the same manner as proposed in the draft rules and therefore do not need to be remedied. So in essence the draft rules will apply retrospectively to all PPAs that have already been signed in the past. And this is precisely the Achilles heel of the proposed legislation. PPAs are contracts and are inviolate. They cannot be changed unilaterally even with good intention. Any attempt to amend PPAs unilaterally would reduce investor interest and sully the already battered image of contract enforcement in the power sector.

There is another subtle nuance to this . This could end up being a wrong policy nudge. By reducing the penalty for late payment, Discoms now will find it that the cost of delaying payment is cheaper. LPS charges should be seen as deterrent to payment delay and not in the light of cost of doing business. Penalties have to be high for them to act as effective deterrents. The draft rules in proposing to reduce high LPS charges, actually incentivizes late payments by Discoms and is likely to further exacerbate the already worsening situation of payment arrears to generators.

It is another matter that ground realities are vastly different. It is not uncommon for Discoms to arm-twist generators to submit LPS “waiver” letters and avoid LPS liabilities entirely. Most of the time generators comply with such strong-arm method as they have little choice with monopoly buyers. In rare cases, when the generators refuse to buckle, they end up in the courts. There are also many instances where discoms settle the rates at lower than the LPS prescribed in the PPAs on a mutually acceptable basis with regulatory approval.

Our policy makers love tinkering and this is one more example of trying to legislate and correct mistakes of the past. We don’t seem to have learnt our lessons from the Vodafone imbroglio of the consequences of retrospective legislations. When will we realise that PPAs are long term contracts that cannot be tampered with? Good or bad, contracts need to be followed. All talk about sanctity of contracts, creating the ECEA will come to nought if we continue on our well-trodden path of changing the rules of the game after the games have started.

The move to make changes to the LPS are retrograde, violate the rule of law and entirely investor unfriendly. It also creates a perverse incentive to delay payments by reducing the cost of such delayed payments. It would be good if the MoP can withdraw these rules.

The draft of the rules is available at https://bit.ly/33Nb23E