Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

Reserve Bank of India Governor Raghuram Rajan finally has a chance to put his degree in electrical engineering to good use. Powering up India was supposed to be the government's job, but somehow the mandate to make reasonably priced electricity available to more than a billion people has become his headache.

It's a $48 billion financing challenge, and to find that money, the former International Monetary Fund chief economist has to placate irate bond vigilantes. One misstep, and all investors in the nation -- equity or debt -- could end up paying a heavy price.

To see what's at stake, consider first the government's proposal to take 75 percent of the 4.3 trillion rupees ($63.3 billion) in power distribution companies' debt off their books over two years and convert it into subnational bonds. With the country's most-populous state of Uttar Pradesh signing up for the swap over the weekend, it's clear the plan has taken off.  

The benefits are easy to see. Once the perennially loss-making utilities are no longer servicing bank loans at 14 to 15 percent, they'll be able to break even without needing too many increases in the tariff rate, which are anyway politically very hard to deliver. Throw in the government's promise of cheaper coal, and tighter controls on the country's notoriously high transmission and distribution losses, and there's a good chance India will come to grips with its debilitating power black-outs. Among other things, that's encouraging news for Prime Minister Narendra Modi's ``Make in India'' ambitions.

But who pays the price? A smaller burden falls on Indian banks and state-run Power Finance Corp. and Rural Electrification Corp. Think of these specialist lenders, which have a combined market value of more than $6 billion, as the Freddie Mac and Fannie Mae of India's power financing business. They'll no longer be able to pocket high margins by lending to subprime utilities and instead will have to be satisfied by holding state government bonds that yield 5 to 6 percentage points less:

Farewell to Fat
Bloated net interest margins of India's power lenders might get leaner
Source: Bloomberg
Figures correspond to financial years, e.g., 2014 refers to 12 months ending in March 2015

Small wonder then that ever since the government announced the debt swap in early November, Power Finance and Rural Electrification shares have fallen about 30 percent.

Indian Power Lenders' Shares Fall
Investors turn cautious about profit margins on loans to electricity distributors
Source: Bloomberg

But that's not really a big deal. The lenders could always find other profitable opportunities -- there's enough investment taking place in transmission lines and solar farms to keep bankers busy. The main downside of this financial engineering is going to be felt in the bond market, where the challenge of issuing $48 billion of new state government securities over two years -- an almost a 67 percent jump in the supply of such paper -- is nothing short of daunting. Rajan has to make sure there's demand for these bonds. Otherwise, an already-high cost of capital for Indian companies could shoot through the roof, and that will come as a rude shock for equity investors still hopeful of further monetary easing:

Fund Crunch
Indian companies' cost of capital is the second-highest in emerging Asia
Source: Bloomberg
* Weighted average cost of capital for publicly traded companies with at least $1 billion in market value

Rajan, however, is fighting with his back against the wall. Despite cutting policy rates by 125 basis points in a little more than a year, he's still grappling with government and corporate note yields that refuse to budge from their stubbornly high levels:

Where's All That Easing Gone?
Bond yields remain elevated despite rate cuts
Source: Bloomberg, Reserve Bank of India, FIMMDA

On Tuesday, the central bank refrained from lowering borrowing costs or relaxing liquidity constrains on banks. That's wise, under the circumstances. Monetary easing would do nothing to allay bond vigilantes' concerns about a potential oversupply of subnational notes, but it could extend the rupee's 9 percent decline over the past 12 months, leading to capital outflows. Bet no one warned Rajan, the electrical engineer, about the complexity of the challenge he would one day face lighting up India. Investors will be watching very keenly to see if he can complete the financing circuit, and do so without risking India's investment-grade credit rating.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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Andy Mukherjee in Singapore at

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