Letter of Credit Has not Been Effective as Payment Security for Solar Developers

To tackle the risks related to delays in payments to independent power producers, the Ministry of Power (MoP) recently mandated state-owned distribution companies (DISCOMs) to issue a letter of credit (LCs).

In June 2019, the central government came up with an order that stated that the state DISCOMs need to start opening and maintaining LCs as a payment security mechanism to power generators starting from August 1, 2019.

Further, the electricity generating company would be entitled to encash these LCs in case of non-payment of dues after the grace period, usually 45 to 60 days, as provided in the power purchase agreement (PPA). This announcement was good news for the renewable independent power producers, who have been facing severe challenges in collecting payments for the power supplied by them to the state DISCOMs.

According to the order, the national and regional load despatch centers (NLDC and RLDC) would dispatch power only after being informed by the generating company and DISCOM that an LC for the desired amount of power has been opened. The order also instructed the load dispatch centers to ensure that the DISCOMs do not access the short-term open access market or the power exchanges to procure power during this period.



Challenges related to timely collection of payments for power procured by DISCOMs are more pronounced in states such as Andhra Pradesh, Tamil Nadu, Telangana, and more recently Madhya Pradesh. Continuing operational inefficiencies leading to mounting aggregate and technical (AT&C) losses are prevalent in most state DISCOMs (barring Gujarat DISCOMS), and developers remain at risk across the country. This is where the new payment security mechanism by way of LCs was expected to increase investor confidence and boost renewable power development. But there are still many hurdles with the adoption of this payment security mechanism.

Mercom spoke to several solar power developers to find out how well this payment security mechanism is being implemented. From the feedback received from the industry, it is clear that most state DISCOMs are not providing LCs to developers yet, and there is a lack of clarity concerning these LCs.

Talking on this subject, an executive from a Delhi-based solar generation company, stated, “We have utility-scale projects in central and southern India. Since the MoP directive, we have made many representations to the respective DISCOMs. But no LCs have been opened by the DISCOMs in these states.”

Talking about the states that are opening LCs, another industry source said, “A few DISCOMs in Karnataka have started opening LCs. We have also received some indication from Madhya Pradesh that they may follow the mandate. However, largely, the practice has not been adopted yet. In a state like Gujarat, we feel that there is no need to open LCs because they are paying power generators on time but DISCOMs in Telangana and Andhra Pradesh are not providing these LCs at all.

States like Andhra Pradesh have gained a bad reputation among developers for their delayed payments. According to Central Electricity Authority’s (CEAs) report, the total payment due for 513 renewable projects now amounts to ₹97.356 billion (~$1.356 billion) as of July 31, 2019, showing an increase of nearly ~ ₹15 billion (~$0.21 billion) compared to the previous figure of ₹82.3 billion (~$1.14 billion) for the same period.

The other issue faced by the developers is that in some states, the PPAs don’t provide for an LC mechanism.

A Mercom source stated that “In Maharashtra and Rajasthan, the PPA’s don’t provide for opening the LCs. So, in these cases, the MoP may need to step in and mandate these DISCOMs to make advance payments instead. There was a clarification from the MoP that allows state DISCOMs to avoid opening LCs in case they make an advance payment for the same amount.”

Expressing the fact that the move to open and maintain LCs is positive, a senior executive from a private equity-backed renewable energy developer told Mercom, “We welcome the government’s initiative to mandate DISCOMs to open and maintain LCs as a payment security mechanism. However, as most state DISCOMs are in financial distress and are not in a position to open such LCs (due to the non-availability of limits), they are trying to honor the requirements under the notification by providing one week or one month’s advance payments so that the power requirement will get scheduled as required. This may address the immediate requirements of renewable generators. The issue of renewable generators’ long-pending dues with the state DISCOMs also needs to be proactively resolved to address the immediate and long-term insolvency issues and thereby facilitating the attraction of investment in the sector to achieve long-term goals set by the central government.”

The problem seems deeper than just DISCOMs being unwilling to provide LCs. According to a spokesperson from the National Solar Energy Federation of India (NSEFI), the SLDCs have not yet adopted a process to schedule power based on payment security to developers. So, DISCOMS are oblivious of curtailment or non-scheduling of power in the absence of a payment security mechanism with generators.

Another executive from a renewable IPP told Mercom, “Typically, if an LC is opened, the power cannot be scheduled to a particular state. So, a developer should be allowed to sell power through exchanges or open access. But for that, they need to get a “no objection certificate” from the same state which hasn’t opened the letter of credit. But there is no guideline regarding this. The MNRE and MoP keep tossing it between each other. This is a typical example of lack of inter-ministerial coordination.”

Although there are penalties in place if DISCOMs are unable to open these LCs, in some cases, there is no sign of recourse available to the developers. In October 2019, Andhra Pradesh High Court issued a stay order on the central government’s proceedings against DISCOMs in the state for not providing LCs to power generators in line with the order from the center.

“As usual, policies look good on paper, but the execution is lacking. Payment security is one of the most challenging issues right now, and fixing it with a sense of urgency will help spur much needed growth in the sector,” said Raj Prabhu CEO Mercom Capital Group.

Although power generators across India welcomed the move to open LCs by DISCOMs, there is still much doubt on how the government will implement this measure. The central government is actively working on resolving the issue which currently seems very complicated due to the resistance posed by DISCOMs and state governments. However, it is a little early to say that the measure has failed. If DISCOMs start following the procedure diligently and work on getting their finances in order by taking Gujarat as a model, it will give a major boost to the power sector in India.

Image credit: EDF Renewables