Dabhol: Poor appraisal behind FIs' predicament

WHILE THE Enron imbroglio is getting murkier by the day, the role of financial institutions in appraising, sanctioning and disbursing of loans to the project is now coming into sharp focus.

From the beginning, it was clear that there were factors other than merits or demerits of the project that influenced IDBI, the prime lender, to lend such a huge amount. What is even worse is that the FIs went in for guaranteeing of the loans given by foreign institutions to Enron. The other domestic lenders include ICICI, State Bank of India and Canara Bank.

Dabhol Power Company (DPC) is a private unlimited liability company incorporated in India as an independent power producer (IPP) to establish a combined cycle gas/naphtha/distillate power plant of 2184 mw capacity in two phases. Its major shareholder is Enron Corp. of the U.S. (Enron). Other shareholders are Bechtel Enterprises Inc. (Bechtel), General Electric Company (GE) of the U.S. and the Maharashtra State Electricity Board (MSEB). Bechtel and GE hold only 10 per cent stake. While Bechtel is the engineering, procurement and construction contractor, GE is the equipment supplier.

The first phase of the power plant with 740 MW was commissioned in May 1999. The second phase is now under construction and most of the work is complete. However, it has been reported that these two companies have notified DPC that they are terminating the work contracts.

Single largest rupee loan

The Godbole Committee, appointed by the State Government to review the viability of DPC and whose members included the Chairman of Housing Development Financial Corporation (HDFC), is on record that there was complete lack of ``due diligence'' and ``poor judgment'' when the financial institutions agreed to disburse funds for Phase II of the project.

The first and second phases together involve direct exposure of over Rs. 8,000 crores, the single largest loan to a private sector power plant. Phase I itself is of around Rs 3,029 crores.

The public perception is that the project has involved the largest foreign direct investment made in the country. But the fact is it is not a large foreign investment but a very large Indian investment.

According to Mr. Abhay Mehta, author of the book Power Play, Enron appears not to have put even a single paise in the project because of cost overruns. The financial institutions' role was to see that the cost of the project is reasonable, but they not only turned a blind eye to this critical aspect but went on to disburse sums larger than those requested by Enron.

The Godbole Committee has stated, ``The decision of the financial institutions to fund this project seems to have been based primarily on escrow account given by MSEB, guarantee by the State Government and the counter guarantee by the Central Government (for Phase 1) rather than on an independent and meticulous appraisal of the project.''

The failure of the appraisal process and the total disregard for any prudential norms of due diligence is illustrated by the minutes of IDBI itself when it agreed to fund the Phase I of the project. It has failed in the very basic nature of duties required of any banker.

At the first meeting on May 10, 1994, IDBI is on record that the project could not be financed since there were a number of substantive issues that its appraisal had raised. There were many significant observations whose repercussions are being felt today. Some of these are:

1. Because of the unlimited liability on DPC as an unlimited company, there would be no recourse for IDBI to touch the assets of the parent company in the event of a default.

2. Several expenses included in the project were far too high and there was a scope for considerable reduction in those including fuel supply, management fees of $2.5 million, and insurance expenses of Rs. 73 crores. The cost of the project itself was too high, in fact twice that of a similar project implemented by NTPC. There was also no justification for a development fee of Rs. 86 crores or payment of interest on pre-equity loan of Rs. 64 crores. Besides, preliminary and pre-operational cost at Rs. 71 crores and Rs. 613 crores were too high. The institutions could have reduced their exposure by not guaranteeing other loans. Further, there was no techno-economic clearance for the project.

However, at the next meeting on June 19, 1994 IDBI simply turned a blind eye to all of these issues and said that ``all aspects are well thought of'' and quite clearly erred when it noted that the project had a techno-economic clearance. It went on to say that it was the single largest foreign investment in the country and that the project was generally `support-worthy'.

Enron has gone on record saying that it has spent over Rs. 64 crores - not including any project expenses - on ``educating Indian banking officials'' in how to give a loan and conduct project appraisals! It has not withdrawn this statement to date.

This is one issue that should have raised eyebrows a long time ago. But IDBI chose to look the other way and went ahead and sanctioned loans which were not viable by their own analysis and far in excess of amounts that a project of this nature would require. One has to bear in mind that all these funds are collected from the public through issuance of bonds or deposits.

Crisil's miscalculation

Another (rating) institution, Crisil, was the financial consultant to MSEB. Crisil's abject role and its complete failure to perform a plausible calculation is surprising when it compares DPC tariffs with the Government Notification Tariff. DPC's tariff were calculated at Rs. 32 a dollar and the Government of India's at Rs. 42 a dollar (the tariff is in U.S. dollars). By multiplying the same tariff in cents by an average rate of Rs. 35 a dollar in DPC's case and the same tariff by Rs 42 per dollar in arriving at the Government tariff, Crisil has gone on to say that DPC tariff is lower than the Government tariff. At the same time, for the same calculation Crisil used a radically different exchange rate which justified the DPC project. This calculation was made in early January 1999 when the exchange rate was Rs. 42.50 a dollar.

The various exchange rates used in the analysis were: Rs. 32 a dollar for calculating the rupee loan debt service, Rs. 34.70 a dollar as reference rate for Phase I, Rs. 38.35 as reference rate for Phase II, ``and very curiously indeed'' Rs. 42 for calculation of Government of India tariff.

The Godbole committee has stated, ``It has been asserted at various stages, once for Phase I and then for Phase II, that the DPC tariff is lower than the comparable GoI notification tariff on a year on year basis...... The demonstration that the DPC tariff was lower than the GoI tariff was at best another example of systemic failure and at worst something much more worrisome. No reasonable person can accept the assumptions used for the comparison.''

The committee has also noted that the tariff is dollar denominated to a substantially larger percentage than in other projects and therefore the depreciation of the rupee has a more adverse impact on this tariff as compared to others. Had it occurred that the DPC came up in 1991, following the new power policy announced by the Government of India at that point of time - when the rupee's exchange rate was 18.25 and right now the rupee is hovering around 47 to a dollar - even if the price of power remained static the rate fixed in dollar terms would have gone up by 150 per cent because of rupee's devaluation.

In a letter forwarding the results of the analysis to MSEB, Crisil mentioned: ``the scope of the exercise does not include validation of the assumptions used''. Further it notes that ``the modelling assumptions used for tariff computation are those agreed between MSEB and DPC''. Again, ``capital cost and the financing assumptions for Phase I and Phase II have been assumed based on the terms presented by DPC and MSEB''. Enough of excuses, but it shows the non-application of mind by Crisil in its duties as it was aware that this decision would affect the country and its pivotal institutions. Further, Crisil made a presentation to the Godbole Committee which substantiated the extreme sensitivity of the GoI tariff to the assumption. With the new assumption, the scenario undergoes a complete change and the GoI tariff is clearly lower than the DPC tariff.

DPC-friendly tariff

The Godbole committee has further stated, ``The assumptions of a much higher exchange rate for Government of India notification as compared to the DPC is inexplicable.

The lower exchange rate on DPC favours the DPC tariff. Further there is no scenario analysis conducted for depreciation in the exchange rate which would go against the DPC tariff, as it is more heavily dollar weighted. The DPC tariff does not lose this linkage, even after the loans are paid off, as would be in the case of GoI tariff.''

Tariff is the major issue that is haunting all the parties in this issue. The committee has stated, ``In each and every instance, both for Phase I and Phase II, the assumptions are not only untenable, they are also favourable to DPC. Even without any exchange rate depreciation, if the appropriate assumptions were used, DPC tariff ceases to be lower than GoI tariff.''

The committee considers this combination of circumstances to be beyond the realm of coincidence and thereby is constrained to conclude that these assumptions were deliberately chosen to show that the DPC tariff was lower than the GoI tariff.

It has concluded, ``The entire demonstration of public interest owing to the lower DPC tariff is on extremely shaky ground and in the opinion of the committee utterly unsustainable.''

If only the financial institutions which have been using public money for this whole exercise had been listening!

Oommen A. Ninan

in Mumbai

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