More self-goals by the PFC

In July this year, a Comptroller and Auditor General (CAG) report signed by A Basu, the Deputy CAG was tabled in Parliament. The CAG had criticised the Power Finance Corporation (PFC) on a remarkable "lapse" that resulted in a loss of Rs.13.48 crores.

First, the Power Finance Corporation (PFC) was criticized in 2004 by the CAG for having disbursed loans to Shree Maheshwar Hydropower Corporation Ltd. without ensuring the fulfillment of pre-disbursement conditions, for the year ending 31 March 2003. A similar violation was witnessed Sept 2003 in its decision to disburse loan to Jai Prakash Hydropower Ltd. – which had gone unnoticed by CAG.

And now again after almost three years of loan disbursal to the Jindal Thermal Power Company Ltd. (Jindal) for the 260 MegaWatt Tornagallu power project in Karnataka, PFC has drawn flak from CAG for having extended undue benefits to Jindal causing a loss of Rs.13.48 crores to itself. Will this instance too pass over as yet another technical lapse arising out of the lack of foresight or will PFC put its house in order?

The Power Finance Corporation was established in July 1986 as a development Financial Institution dedicated to the power sector. It is a Public Sector Undertaking (PSU), wholly owned by the Government of India. Its mission is "to excel as a pivotal developmental financial institution in the power sector committed to the integrated development of the power and associated sectors by channeling the resources and providing financial, technological and managerial services for ensuring the development of economic, reliable and efficient systems and institutions."

Two years ago, on one fine morning of April, Business Line reported that this major power sector lender had slipped up over a loan to Jindal due to Yen - Dollar fluctuation and this would result in a loss of around Rs.4 crores to PFC. (See: the report)

It all started in February 2003, when PFC received several proposals from Jindal requesting it to refinance a foreign currency loan of USD 44.50 million and a rupee term loan of Rs.65 crores. PFC was the original lender as well. In response, PFC was quick to sign an agreement with Jindal in February 2003 to refinance both the USD and rupee loans at interest rates of LIBOR [London Inter Bank Offering Rate] plus 2.4 percent and 12.25 percent respectively. The agreement was bearing a specific condition that the disbursement of the foreign currency loan would be from proceeds of external commercial borrowing (ECB) of PFC. Accordingly, in March 2003, PFC had disbursed foreign currency loan amounting to USD 41.72 million (i.e. Rs.198.77 crore) from its ECB of 12 Billion Japanese Yen. Note, this is where the Yen-Dollar currency risk came in. PFC also disbursed a rupee term loan of Rs.63.07 crore.

With dollar weakening against the Yen, the adverse exchange rate variation hit PFC. In November that year, it issued a demand of 0.86 million USD, roughly Rs.3.92 crores, to Jindal asking them to make good the difference. Jindal reportedly declined to submit to the demand citing that the refinancing loan agreement did not envisage Jindal to bear cross currency hedging cost.

Although this much was known when the Business Line story appeared in April 2004, the issue was still hanging fire with both PFC and Jindal amidst intense negotiations. The Business Line quoted A A Khan, the then chairman and Managing Director of PFC saying that PFC had set up a committee to examine the issue and that a report was likely to submitted by that end of that month. Krishna Desika, Jindal's Director of Finance of Jindal, was quoted as saying, "we are currently in talks with PFC and I would not like to go into details of the negotiations."

In November 2004, PFC agreed to withdraw its demand totaling Rs.9.63 crore towards cross currency hedging cost for the past period from March 2003 to October 2004. Taking note of this in its audit report of 2005, the CAG pinned responsibility on the PFC and points out that PFC had to forego this amount due to not incorporating an enabling clause in the loan agreement.

Non inclusion of such a cause – which CAG refers to as a "lapse" later – was rather a shocking revelation. The PFC's own policy (an internal circular dated 11 December 2002) unambiguously suggested that in case its lending was in a currency other than the currency of ECB raised, the spread (2.4 per cent over LIBOR in the case of the Jindal loan) should be increased appropriately to reflect the hedging cost arising from adverse exchange rate variation. In other words, PFC's own rules already had it that for refinancing Jindal's USD loan from its Yen borrowings, it should not have offered LIBOR plus 2.4 per cent, but higher.

It is now known – thanks to the CAG report that entered Parliament in July 2006 – that PFC revised the interest rate on Jindal's USD loan to LIBOR plus 3.50 percent – being the difference of margin of 1.10 percent [3.50 minus 2.40 percent] in hedging costs, for the period from October 2004 to April 2008. The upward revision in interest rates was done following the recommendation of an internal committee in October 2004, states the CAG report. In March 2005, Jindal agreed to pay a lump-sump amount of Rs.3.58 crore, by accepting this offer.

Coming back to the PFC's lapse in covering currency risk, the question that arises is: is it correct to term failure to implement its own policy merely as a "lapse"?

In fact, the CAG found during audit scrutiny that in May 2004, another internal PFC committee opined that the hedging cost was not recoverable in terms of sanction letter – no matter what was underlined in internal circulars! This committee also proposed to revise the margin to include the additional cost to be recovered from the borrower, but the borrower had not agreed to this proposal.

There's more. Simultaneously, following the settlement in hedging cost, in April 2005, PFC restructured the interest on the rupee loan from 12.25 per cent to nine per cent retrospectively from July 2004. Again, the CAG observed that the restructuring of interest on the rupee loan, was not in accordance with PFC's own policy prevalent on the date of sanction of the loan, as the rupee loan agreement did not contain any specific clause in this regard.

However, PFC revised its policy in July 2004 and allowed benefit of restructuring to the borrower on the plea that the settlement on hedging cost was reached. Even the revised policy was relaxed to give Jindal a benefit from back date.

CAG also states in its report that this decision was taken without taking a consent of the "lead financial institution" for the interest restructuring, which was required in terms of the revised policy! But the CAG has not gone ahead to name the institution, This resulted in undue benefit of Rs.3.85 crore to the borrower.

On this being pointed out during audit scrutiny, PFC management stated (August 2005) that since settlement on the cross currency hedging cost was reached, it permitted restructuring of interest on Rupee Term Loan, which was earlier denied to the borrower because of default in service of Foreign Currency Loan. They added that these were two different issues going on simultaneously and no undue benefit was given to the borrower.

CAG concluded stating, "the reply is not tenable as the Company failed to incorporate the clause for recovery of hedging cost in the agreement in deviation of its internal circular of December 2002, nor did it fix any responsibility for this lapse. As regards restructuring of interest rate on Rupee Term Loan, this was neither in accordance with the loan agreement, nor with the prevailing interest restructuring policy of PFC." This is as close as it can get to the auditor saying that the PFC had breached all governance norms.

In actual terms, the CAG probe into the PFC-Jindal financing violations raises more questions. First, is it a matter involving merely a lapse, arising from lack of foresight, when it involves a serious violation of the spirit of an internal circular? Second, what explains that two internal committees failed to address such a malady and kept their attention on merely solving the immediate stalemate? Third, the CAG's assertion that the reply of PFC management was not "not tenable" and that "nor did it (the PFC) fix any responsibility for this lapse" fails to have had any impact on the Ministry of Power.

The last line of the CAG report, which has become a typical, reads: "The matter was reported to the Ministry in June 2005; its reply was awaited (November 2005)." The CAG's scrutiny might be satisfying auditing standards, but ensuring accountability of the Ministry of Power in a Right To Information-era still appears a far cry away, given repeated instances of violations by PFC.

In the meantime, the CAG's report entered Parliament in July this year, and it has joined the long list of similar such reports that await real action.