Indian Discoms must now use letters of credit when buying power

The Indian government is trying to reduce delayed payments in the energy industry by making it mandatory for state power distribution companies (Discoms) to use letters of credit when they buy power.

A letter of credit is an assurance from a bank guaranteeing the buyer's payment to a seller will be received on time and for the correct amount. Letters of credit are usually used in international trade when the buyer and seller are not yet on familiar terms.

This reliance on bank guarantees comes as a number of Discoms are not in good financial health due to consumers sometimes not paying their bills and stealing electricity. This has resulted in them delaying payments to power generation companies, leading to stress on the power sector.

The problem of delayed payments in the industry got so bad that the government tried to introduce transparency by setting up the Payment Ratification and Analysis in Power procurement for bringing Transparency (PRAAPTI) last year.

The website reveals the monthly overdue bills to power generation companies from the Discoms. As of May this year, Discoms owed a staggering Rs 38,884 crore (US$5.6 billion) to power generators.

In February, the Ministry of Power created a committee to recommend solutions for payment delays by Discoms.

According to Mercom India, Discoms are paying late because of operational mismanagement and stressed balance sheets. Due to this risk, many investors have completely stayed away from the Indian power sector.

Without a letter of credit, Discoms will not be able to buy power and will be blocked from accessing spot markets as well, possibly forcing affected states to resort to power cuts.

Officials think this move by the central government may end up devastating cash-strapped Discoms, such as those of the state of Uttar Pradesh. The Discoms in the state alone owe almost Rs 20,000 crore (US$2.9 billion) to power generation companies. That is almost half the outstanding bills of all Discoms in India.

The new rule to requiring Discoms to use letters of credit to buy power started on 1 August.