CASE No. 150 of Coram. Shri. Azeez M. Khan, Member Shri. Deepak Lad, Member. Vidarbha Industries Power Limited ORDER

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1 Before the MAHARASHTRA ELECTRICITY REGULATORY COMMISSION 13 th Floor, Centre No.1, World Trade Centre, Cuffe Parade, Mumbai Tel: /65/69 Fax: Website: / CASE No. 150 of 2014 In the matter of Petition of Vidarbha Industries Power Ltd. regarding treatment of FERV / Hedging Cost on foreign borrowings, post Generating Station COD Coram Shri. Azeez M. Khan, Member Shri. Deepak Lad, Member Vidarbha Industries Power Limited... Petitioner Appearance For the Petitioner: Shri. Manoj Pongde, VIPL Shri. Ramandeep Singh, Consultant Consumer Representative: Shri. Ashok Pendse (TBIA) ORDER Dated: 30 November, 2015 Vidarbha Industries Power Ltd. (VIPL) (Generation Business), has filed a Petition on 28 July, 2014 under Sections 61and 62 of the Electricity Act (EA), 2003, Regulation 100 of the MERC (Multi Year Tariff) Regulations, 2011 (the MYT Regulations ) and Regulation 96 of the MERC (Conduct of Business) Regulations, 2004 for removal of difficulty in the treatment of Foreign Exchange Rate Variation (FERV) and Hedging Cost on foreign borrowings, post the Commercial Operation Date (COD) of its Generating Station 2. VIPL s substantive prayers are as follows: - a) Admit this Petition MERC Order in Case No. 150 of 2014 Page 1 of 9

2 b) Remove the difficulty in treatment of cost for hedging of foreign loans / FERV post COD of the Project. c) Allow FERV / hedging cost post COD of generating station at the time of determination of tariff or during the true-up as deemed appropriate 3. VIPL s Petition states as follows: VIPL has commissioned a 600 MW (2x300 MW) Generating Station at Butibori in Nagpur District for supply of power to Reliance Infrastructure Ltd. (Distribution Business) (R-Infra-D), a Distribution Licensee, under a long-term Power Purchase Agreement (PPA) approved by the Commission vide its Orders dated 19 July and 20 February, 2013 for Unit-1 and Unit-2 respectively. The Commission has approved the provisional Tariff for VIPL vide its Order dated 17 January, 2014 in Case No. 91 of It was submitted in Case No.91 of 2013 that VIPL has taken domestic loans from a consortium of banks and financial institutions, dollar-denominated External Commercial Borrowings (ECBs) and part-funding of foreign equipment supply by buyers credit. VIPL requested the Commission to provide directives regarding the treatment of the cost for hedging foreign loans, and/ or allow the FERV post COD of the Project. Vide Order dated 17 January, 2014 in Case No. 91 of 2013, the Commission directed VIPL to study and submit various options for treatment of FERV at the time of the final Tariff determination process. 3.3 Subsequently, after COD of both Units, VIPL filed a Petition for determination of final Tariff for the Generating Station on 31 May, 2014 in Case No.115 of 2014, in which it presented different scenarios for hedging and impact of FERV on the Tariff. However, at the Technical Validation Session held on 19 June, 2014 in Case No. 115 of 2014, the Commission directed VIPL to file a separate Petition for consideration of the impact of hedging / FERV. Accordingly, VIPL has filed the present Petition. 3.4 Details of funds deployed for development of this Generating Station have been submitted in Case No.115 of These comprise domestic loans from a consortium of banks and financial institutions, dollar-denominated ECBs and partfunding of foreign equipment supply by buyers credit. 3.5 The mechanisms provided under the Tariff Regulations of the Central Electricity Regulatory Commission (CERC) and other State ERCs, etc. for FERV/cost of hedging are as follows: a) As per Regulations 9 and 10 of its Tariff Regulations ( ) and subsequent Regulations, CERC had provided for consideration of FERV as a pass-through in Tariff. MERC Order in Case No. 150 of 2014 Page 2 of 9

3 b) The National Tariff Policy, 2006 introduced cost of hedging to be allowed under Tariff for projects whose Tariff has not been determined through competitive bidding. c) The CERC Tariff Regulations for both FY and FY provide for consideration of FERV and hedging cost in Tariff determination. d) Provisions towards recovery of cost of hedging /FERV have been retained in the new CERC Tariff Regulations e) Similarly, the Bihar ERC Tariff Regulations, 2007 and Gujarat ERC Tariff Regulations, 2005 allow for recovery of FERV on year-to-year basis. f) The Himachal Pradesh ERC MYT Regulations, 2012, Delhi ERC Tariff Regulations, 2011 and Madhya Pradesh Tariff Regulations, 2012 also provide for recovery of hedging cost/ FERV on year-to-year basis. 3.6 Details of the various regulatory provisions are given in the Table below: Regulatory Provisions regarding FERV in MERC Regulations Reference Regulation/clause Analysis MERC (Terms and 30.8 Conditions for determination of Tariff) Regulations, Impacts of FERV on foreign currency loan taken to finance a project are to be treated in accordance with the Statements of Accounting Standard (AS 11). Allows for recovery of gains or losses on account of FERV for rupee liability towards interest payment. MERC MYT Regulations, Capital cost for a project Provides for capitalization of expenses on account of FERV till COD of the project is achieved. However, post COD, Regulations are silent on the impact of FERV on the debt service requirement of the project considering that any variation will impact the debt service requirement for foreign loans in Indian Rupees (INR). Regulatory Provisions regarding FERV in CERC, other SERCs and Tariff Policy Reference Bihar ERC (Terms and Conditions for determination of Tariff) Regulations 2007 CERC (Terms and Conditions of Tariff) Regulations, 2004 CERC (Terms and Conditions of Tariff) Regulations, 2009 Regulation/ Analysis clause 17 Allows for recovery of gains or losses on account of FERV for rupee liability towards interest payment and loan repayment in relevant year. 9 & 10 Allows recovery of rupee cost on account of FERV as a pass-through in tariff. 40 Allows recovery of cost towards hedging corresponding to normative foreign debt on year on year-to-year basis as expense in the period in which it arises. MERC Order in Case No. 150 of 2014 Page 3 of 9

4 Reference Regulation/ clause Analysis hedged, the gains or losses on accounts of FERV will be pass-through CERC (Terms and Conditions of Tariff) Regulations, & 51 Allows recovery of cost towards hedging corresponding to normative foreign debt on year-toyear basis as expense in the period in which it arises. hedged, the gains or losses on accounts of FERV will be pass-through. Delhi ERC (Terms and Conditions for determination of Generation Tariff) Regulations, 2011 Gujarat ERC (Terms and Conditions of Tariff) Regulations, 2005 Haryana ERC (T& C for determination of Tariff for Gen, Tran, Wheeling, Distribution & Retail Supply under MYT Framework) Regulations, 2011 Madhya Pradesh ERC (Terms and Conditions for determination of Generation Tariff) Regulations, Allows recovery of cost towards hedging corresponding to normative foreign debt on year on year basis as expense in the period in which it arises. hedged, the gains or losses on accounts of FERV will be pass-through 8 Allows for recovery of gain or losses on account of FERV for rupee liability towards interest payment and loan repayment in relevant year. 24 Allows recovery of cost towards hedging corresponding to normative foreign debt on year on year basis as expense in the period in which it arises hedged, the gains or losses on accounts of FERV will be pass-through 29 Allows recovery of cost towards hedging, corresponding to normative foreign debt on year on year basis as expense in the period in which it arises hedged, the gains or losses on accounts of FERV will be pass-through Tariff Policy, 2006 Para 5.3 (e) Does not allow the FERV risk to be a pass-through, but directs that appropriate mechanism for mitigating such risk should be devised. Allows the cost of hedging towards foreign currency exposure as pass-through, but only for projects whose Tariff has not been determined on the basis of competitive bidding MERC Order in Case No. 150 of 2014 Page 4 of 9

5 3.7 The CERC provides for both the cost of hedging and/or the cost of FERV to be allowed under the Tariff post-cod, while the MERC Regulations are silent on both these aspects. 3.8 The key features associated with ECB funding are as follows: a) ECB offer a cheap source of funds. b) ECB are exposed to variations in exchange rates. c) Hedging of FERV is dependent on the market outlook. d) Difficulty in accounting for the FERV in Tariff Regulations 3.9 As regards feasible solutions that can be considered for treatment of FERV, VIPL has evaluated various mechanisms available in the market: Option 1 No Hedging of ECB Loan components In this option, VIPL would continue to have no hedging against FERV and will be exposed to the impact of any possible variation in future. Quantum of change in Tariff will depend on the exchange rate movement. Therefore, for assessing the impact on Tariff, VIPL has considered FERV over and above normative interest under three cases, i.e. exchange rate remains at Rs.60 in the base case; exchange rate changes to Rs.55 per US $; and exchange rate changes to Rs.70 per US $. It has been evaluated that exchange rate movement not only results in FERV but also affected the weighted average exchange rate used for computation of normative interest. Option 2 - Entire ECB is converted to Rupee Loan at current Indian Rupee loan terms As per the MYT Regulations, interest on long-term loan is calculated based on the weighted average interest rate of the actual opening loan balance and average of normative loan. If it is assumed that the entire ECB is converted to rupee loan on similar terms as applicable for existing rupee term loan at the end of FY 15, the applicable normative interest rate would be 14% from FY 16. Hence, the weighted average interest rate for computation of normative interest is also considered as 14% from FY 16. Specific approval from the Reserve Bank of India (RBI) towards conversion of ECB loan to Rupee loan would have to be obtained. Considering the existing guidelines, RBI allows conversion of ECB loan into another ECB loan subject to certain terms and conditions, and does not allow prepayment of ECB by availing Rupee Term Loan (RTL). Therefore, the option of conversion of ECB loan to Rupee Loan would be subject to RBI s approval, and seems to be difficult. Option 3 ECB is hedged based on offers received from banks (commercial quotes from banks for cross-currency swaps through forward contracts, for hedging of entire ECB loan.) MERC Order in Case No. 150 of 2014 Page 5 of 9

6 VIPL has approached several banks for hedging foreign exchange exposure. The following quotes for cross-currency swap for hedging the entire foreign exchange and London Inter-Bank Offered Rate (LIBOR) on principal and interest repayment from various banks were received: Axis Bank 14.40%, Standard Chartered Bank (SCB) 13.60% and Development Bank of Singapore (DBS) 13.65%. In case such offers for cross-currency swaps are accepted, VIPL would be fully protected from FERV exposure. VIPL has computed the weighted average interest rate for determining interest on long-term loan by opting for the cheapest quote of 13.60%. Option 4 Hedging of only 50% ECB loan As an additional option for assuming risk towards exchange rate movement, VIPL has also considered hedging of only 50% of the ECB loan. This option would allow passing on the benefits of stable rupee to consumers. At the same time, it would fix 50% risk of rupee volatility. Under this option, FERV on the unhedged portion of ECB would be passed through to consumers. The Table below illustrates the per-unit levelised interest and FERV cost under the various scenarios: Options Per unit interest and FERV cost (Rs/Kwh) No hedging Exchange Rs. 60 per US$ ( base case ) No hedging Exchange Rs. 55 per US$ No hedging Exchange Rs. 70 per US$ Entire ECB is converted to Rupee Loan on similar terms ECB is hedged based on offers received from banks Levelized till tenure of normative loan 0.51 Change with respect to base case^ Hedging of only 50% ECB loan* ^Hedging is not considered in base case, and exchange rate is expected to remain at USD: INR of Rs 60 in base case. *Assuming exchange rate remains at Rs. 60 per US$ 3.10 Further, based on the scenario analysis above, hedging of loans appears to off-set the benefits of lower interest rate. On the contrary, with a stable market outlook, the cost in case loans are not hedged appears to be more beneficial from a Tariff perspective. MERC Order in Case No. 150 of 2014 Page 6 of 9

7 However, the risk in not hedging the loans is that, with an unprecedented increase in exchange rate, the FERV component of Tariff could be high VIPL is currently servicing the loan components of its Butibori Generating Station and has not hedged the loans. It had been awaiting the directives of the Commission on the treatment of FERV impact on the Tariff. Hence, VIPL requests the Commission to remove the difficulty in treatment of cost for hedging of foreign loans/ FERV post-cod of the Project, and to consider the FERV/hedging cost of COD at the time of determination of Tariff or during the true-up, as deemed appropriate. 4. At the hearing on 20 November, 2014, VIPL made a presentation, set out the facts regarding funding of its Project and re-iterated its written submissions. The Commission s Tariff Regulations, 2005 allowed it as interest cost. This was missed out in the MYT Regulations, 2011, perhaps because it was not relevant to other Utilities which were not adding generation capacity. As recorded in its Daily Order, the Commission directed VIPL to submit the following: a. Economic environment under which the hedging option is exercised by other private Power Companies, and its applicability. b. Trend analysis and preference given by private Power Companies pertaining to the ratio of foreign loan to domestic loan in total debt component. 5. In its response dated 28 November, 2014, VIPL submitted that 5.1 ECBs provide funding options which are cheaper by 4 to 5% as compared to domestic loans. However, they are subject to exchange rate variations which are driven by global factors. To protect against adverse exchange rate movement, companies have the option to hedge their ECB exposure. The strategy to hedge depends upon several parameters such as Economic outlook Exchange rate variations Cost of hedging 5.2 After examining these aspects, VIPL s observations are as under: a. The overall exposure to foreign currency loans in the coal-based Generating Stations has been around 20-25% in the past. b. The trend saw a major change with the developers increasing their exposure to such cheap borrowings: Tata Power Company funded its Ultra Mega Power Project (UMPP) with an overall foreign loan component of more than 50%. MERC Order in Case No. 150 of 2014 Page 7 of 9

8 c. Companies prefer foreign loans on account of lower interest rates. However, the cost of such loans, after including the cost of hedging, at present is almost equivalent to the interest rates on domestic loans. Therefore, the actual FERV has been allowed to pass through in Tariff by CERC and various State ERCs d. Therefore, it is difficult to predict the overall trend for availing foreign loans in future as it will depend upon the prevalent economic conditions and hedging costs. However, considering the necessity of import of equipment, it is expected that foreign loans equal to at least the import quantum could be availed by the companies to get the benefit of lower interest rates. 6. The matter was further heard on 27 January, 2015, when VIPL stated that it had complied with the Commission s earlier directions. It was not sure as to the options with regard to which the Commission would allow pass-through. The Commission observed that since this would impact the Tariff payable by consumers, the likely cost involved in hedging would need to be analyzed vis-à-vis the benefits that may accrue to consumers. Accordingly, the Commission directed VIPL to submit a note on different scenarios of impact of tariff on short-term and long-term basis considering hedging of foreign, the benefits of hedging in line with existing Regulations, and the most suitable option in terms of least cost to consumers. 7. In its response dated 18 February, 2015, VIPL submitted that: 7.1 The economic scenario, which witnessed a steep downfall in exchange rates prior to COD of the Project, had stabilized, and stable exchange rates have been observed for a consistent period. VIPL had evaluated the option of hedging for both ECB and buyer s credit, and concluded that the cost of hedging of loans would have been higher as compared to no hedging. In the light of the stable economic outlook, VIPL had, therefore, not resorted to hedging of loans in the short run in the interest of consumers. 7.2 Regarding the long-term scenario, according to one forecast, i.e. the medium currency forecast released by Bloomberg, the Indian Rupee will lie in the range of Rs. 59 to 64 per US $. Considering the stable projections of exchange rates, it is apparent that the cost of hedging would be higher than not hedging in the near future as well. 7.3 The country s economic outlook would be constantly monitored by VIPL, and its strategy for hedging would be decided on a real-time basis, so as to optimize the trade-offs between the associated hedging costs vis-à-vis the impact of FERV. VIPL would share such decisions on an ongoing basis with the Commission as also with RInfra-D. 8. At the hearing on 15 October, 2015, VIPL made a presentation, and highlighted two recent developments relevant to the matter. In its Order dated 26 June, 2015 on the Mid-Term Performance Review of the Maharashtra State Electricity Transmission Co. Ltd. (MSETCL) in Case No. 207 of 2014, the Commission had recently MERC Order in Case No. 150 of 2014 Page 8 of 9

9 approved the variation of exchange rate on foreign currency loan taken by MSETCL as a separate line item of the Aggregate Revenue Requirement (ARR). The same dispensation may be considered for VIPL. Moreover, the draft MERC (MYT) Regulations for the next Control Period pre-published by the Commission for inviting comments and suggestions have provisions relating to the treatment of hedging cost and FERV post-cod. Shri. Ashok Pendse, on behalf of Thane-Belapur Industries Association (TBIA), an Authorized Consumer Representative, submitted that the interest rates on foreign borrowings are generally less than the domestic borrowing interest rates. However, if the hedging cost is significantly higher, hedging may offset the benefits of lower interest rates. Further, there are certain limitations to hedging: not all currencies are hedgeable one-to-one (e.g. the Yen), thus requiring indirect conversion; and hedging may not be possible for very large amounts. If the currency is stable, no hedging is required. Considering these factors, the decision regarding hedging could be taken on a year-on-year basis depending on the scenario of foreign currency variations. VIPL stated it is obtaining informed, expert opinion and then taking such decisions. Commission s Analysis and Ruling 9. The Commission notes that, as pointed out by VIPL, in contrast to the Commission s Tariff Regulations of 2005, its MYT Regulations, 2011 are silent on the treatment of hedging and FERV and consequent gains or losses in determination of the generation Tariff post-cod. 10. VIPL has stated that it would continuously monitor the economic outlook and decide its strategy for hedging, if at all, so as to optimize the trade-offs between the associated hedging costs vis-à-vis the impact of FERV. The Commission expects that VIPL has taken and would take prudent and informed decisions accordingly, and satisfy the Commission that such decisions have been in the best interest of consumers while claiming any consequent expenses in its future truing-up and other Tariff filings. The Commission will also address the treatment of such post-cod expenses in its MYT Regulations for the next Control Period, which are expected to be finalized shortly. The Petition of M/s Vidarbha Industries Power Ltd. in Case No. 150 of 2014 is disposed of accordingly. Sd/- (Deepak Lad) Member Sd/- (Azeez M. Khan) Member MERC Order in Case No. 150 of 2014 Page 9 of 9