Posted Date : 12 Sep 2008
This comment follows the Malaysian government's announcement on the scrapping of the windfall profit levy imposed on independent power producers (IPPs) with immediate effect. Instead, the IPPs will make a one-off payment to the government equivalent to a year's windfall levy payment. This move vindicates our belief that sound decision would ultimately prevail with respect to the implementation of the windfall tax, as expressed in MARC's initial comments on the proposed levy, published in July 2008. The government has also suspended renegotiations over power purchase agreements (PPAs) with the IPPs pending a comprehensive study into the restructuring of the electricity supply industry.
This announcement comes a month after 13 affected IPPs have made their first payments of the windfall tax in August 2008. Kapar Energy Ventures Sdn Bhd, whose RM3.4 billion Islamic Debt Notes is rated AA+ID by MARC and currently on MARCWatch Negative, is among the IPPs liable to pay 30% windfall tax, having a return on assets in excess of 9%. The excess was to be computed based on earnings before interest and tax.
MARC believes that the above development will neutralize the downward rating pressure on junior IPP debt which would be precipitated by a weakening of debt service capacities had the windfall profit levy remained in effect for an extended period. The scrapping of the windfall profit levy will also be welcomed by a cross section of the capital markets. The value of IPP bonds are expected to improve from the anticipated yield pickups arising from this positive development. Financial institutions will now have the likely opportunity to reverse the unrealised mark-to-market losses arising from IPP bonds held in their trading portfolio. Apart from the banks and bond funds, equity market investors in IPP-related stocks will possibly see some share price recovery. IPP bonds in the bond pipeline can now see the light of day where issuance is concerned. With this move, we are hopeful that emerging market infrastructure funds will consider putting Malaysia on their radar screen.
The government's willingness to reconsider the adverse long-term effects of windfall tax on the credit quality of IPP debt in the light of the funding structure of IPPs is critical for the long-term viability of infrastructure project financing in the context of its broader implications for regulatory risk. The recent developments establish the importance of creating a proper balance between risk and reward for all parties in the structuring of PPAs. “Unbalanced” concession contracts are inevitably exposed to higher risk of re-negotiation, if not during a period of political uncertainty, maybe at some later date.