MARC expects the outcome of the Windfall Profit Levy (Electricity) Order 2008 would be, reduced project returns and lowered debt servicing ability on the part of affected independent power producers (IPPs), if implemented. The impact will be uneven across different classes of IPP project debts. Holders of subordinated debt will be affected to a greater extent given the reduced after-tax residual cashflows available for servicing junior debt.
The government's move to impose windfall taxes may have far grave potential implications, in the longer term, on infrastructure debt financings, and for both lenders and borrowers. A key question which arises is whether recent developments signal increased regulatory risk going forward. The willingness of the government to support original arrangements on which project financings rest, from power purchase agreements (PPA) to its tax regime, has always been an important underpinning for the high investment grade ratings assigned to IPPs and their senior bonds.
The introduction of windfall tax now challenges the historical assumption of low regulatory risk for IPP financings and introduces an added element of uncertainty, i.e. the potential erosion of project cashflows due to interim regulatory changes. This risk could equally apply to all other infrastructure concessions. Proposed changes to the tax regime should be considered in the light of its effects on existing project financiers including bondholders and future investor behaviour. MARC views the windfall tax regime as punitive in nature as it would have the effect of penalizing efficient IPPs. Of greater concern from a rating perspective is the transfer of the financial effects of the punitive elements to bondholders, and consequently, the potential downward re-rating of existing bonds.
MARC believes that implementation of the windfall tax will detract from the original objective of power sector privatization, i.e. to promote and reward efficiency. MARC foresees that IPP may start engaging tax optimization strategies rather than striving for operational efficiency to avoid exceeding the 9% benchmark of return on asset, defined as PBIT (profit before interest & tax) over fixed assets, to avoid the costly 30% windfall levy. MARC believes the IPPs may be motivated to circumvent the windfall levy by revaluing their power plant assets on a replacement cost method, especially now that current material, engineering and contract prices are much higher.
In the overall scheme of things, while we acknowledge the government’s need to address its fiscal deficit under the current scenario of moderating economic growth, the windfall tax may not be the most appropriate fiscal tool. Nonetheless, MARC believes sound decision will ultimately prevail with respect to the proposed implementation of the windfall tax.