India Ratings and Research (India Ratings) assigned U.P. Power Corporation (UPPCL) proposed Rs 100 billion bonds a Provisional 'AA(SO)' rating with a stable outlook. This is India’s first state government revenue supported bond.

India Ratings notes that while state/central government supported bonds, in the form of an unconditional and irrevocable guarantee are common, what makes this particular bond issue different from the bonds issued in the past is that in this case the entire state revenue is available for bond servicing. As the quarterly debt servicing of the proposed bond is only a fraction of the Uttar Pradesh state government revenue, India Ratings believes this structure will provide confidence to investors and timely servicing of the debt.

Another first for this transaction, is the structured debt servicing mechanism that is backed by the Reserve Bank of India (RBI). Under this mechanism, in case the specially created bond servicing account falls short of the amount required to service the debt and later if the state government is unable to fund it by a specified date then RBI will debit the requisite amount from the government of UP’s account with the RBI and credit it to the UPPCL bond servicing account one day prior to the due date of bond servicing.

This structure is similar to the power bonds issued by the state governments in 2003. As part of the one-time settlement of the dues owed by state electricity boards to public sector undertakings namely, NTPC ('AAA'/Stable), NHPC ('AAA'/Stable), Power Grid Corporation of India and coal public sector units. An agreement was thus reached between 27 state governments, Union Ministry of Power and RBI in 2003, to release these bonds for the state-owned firms.

The UPPCL bond also has other regular security features such as state guarantee and debt-service reserve account. India Ratings believes the innovative structure put in place to service the bonds has the potential to open a new and alternative funding line for state governments in India, besides also imposing fiscal discipline on the state governments.

Based on bond market yields and banks' lending rates, India Ratings expects UPPCL to save interest cost of  around Rs 2-2.5 billion annually. Similar to UPPCL many other state power distribution companies under financial strain could rely on such structures for funding.