Power sector needs sweeping reforms

The recent release of the World Bank group’s study, “More Power to India: The Challenge of Electricity Distribution”, is very well timed. It comes just after the new government led by Prime Minister Narendra Modi which asserts its belief in ‘co-operative federalism’ assumed office. The study also directly addresses the issues raised by Kejriwal’s movement on high electricity prices in India. By highlighting the bottlenecks in the power sector that impede the country’s economic growth aspirations, it sets an agenda for both the centre and state governments.

The report is a review of the power sector’s performance over the past two decades. On the positive side, three-quarters[1] of India’s population now has an electricity connection. Generation capacity has tripled, with the private sector playing a substantial role. Today the share of the private sector is almost 40% in the total installed generation capacity of 245 GW, and is likely to reach 52% by 2017[2]. The government’s efforts to promote clean energy have resulted in a rising share of renewables in the energy mix – it now accounts for 12% of the total power[3] generated in the country. Moreover, with the recent linking of the southern part of country, a single state-of-the-art transmission grid now connects India’s vast and diverse landscape and adds to energy security.

This report reviews the evolution of the Indian power sector since the landmark Electricity Act of 2003, and focuses on distribution as key to its performance and viability. While all three segments of the sector—generation, transmission, and distribution—are important, revenues originate with the customer at distribution and poor performance there hurts the entire value chain. Persistent operational and financial shortcomings in distribution have repeatedly led to central bailouts for the whole sector. It is well to remember that even though power is a “concurrent” subject under the Indian constitution, distribution is almost entirely under state control.

According to the report, the financial health of the sector is very fragile, limiting its ability to invest in delivering better services. Total accumulated losses in the sector stood at Rs 1.14 trillion ($25 billion) in 2011[4]. These losses are overwhelmingly concentrated among distribution companies, or discoms, who supply power to millions of consumers. Sector losses have led to heavy borrowing – power sector debt reached Rs 3.5 trillion ($77 billion) in 2011, as much as 5% of the GDP[5].  The problem is concentrated in a handful of states. Over 60% of the accumulated losses in 2011 came from the states of Uttar Pradesh, Madhya Pradesh, Tamil Nadu, and Jharkhand, with UP alone accounting for 40%[6].

In fact, the sector has had to be bailed out twice, costing the exchequer Rs 350 billion in 2001, and more than four times that—Rs 1.9 trillion[7]—a decade later.  The bailout equaled 1% of the GDP. However, the 2011 crisis was different from that in 2001 because this time players from outside the power sector and the government were involved.

Lending by banks and financial institutions to all sector segments has relied on the ‘quasi-guarantee’ of state governments in the face of the known insolvency of discoms, the off-taker and source of revenues for the entire sector. In 2011 about half the sector’s borrowing came from commercial banks[8]. Additional amounts were lent at concessional rates by financial institutions such as the Power Finance Corporation (PFC), Rural Electrification Corporation (REC), and Infrastructure Development Finance Company (IDFC), to bring the total contribution of commercial banks and financial institutions to 86% of power sector borrowing. The flow of liquidity limited the pressure on utilities to improve performance and on state governments to permit tariff increases. It was only in 2011 when banks were directed to stop lending to insolvent utilities that states pushed through tariff increases. Such profligate lending has harmed banks’ capital adequacy and net worth. More than half of 13 major state-owned banks have funded loans to the power sector of 50% or more of net worth. At the extreme, the funded exposure of some smaller banks exceeds their net worth, raising concerns over how poor power sector performance and difficulties for some or all of these financial institutions could spread to the financial sector and, possibly, other parts of the economy. Thus, two decades after the initiation of power sector reforms, an inefficient, loss-making distribution segment and inadequate and unreliable supply have become major constraints to India’s growth, inclusion, job creation, and aspirations for middle-income country status.

Utilities face pressure to provide below-cost power to agricultural and rural residential consumers for which they are reimbursed through subsidy payments by state governments. However, currently, 37% of the subsidies booked by state utilities are not paid to them. Since 2003, in fact, subsidies booked have grown by 12% per year, and subsidies received by 7% per year – the cumulative gap between them was Rs 466 billion ($10 billion) for 2003–11[9]. This has had a crippling effect on the already struggling financials of the utilities.

In short, multiple institutions with diffuse accountability have undermined the sector’s commercial orientation. The Electricity Act 2003 sought to limit government interference in utility operations, yet state governments are still a major presence with a generally detrimental impact on operations. They have exacerbated the discoms’ financial difficulties by compelling them to borrow to cover operational expenses (given the revenue shortfalls due to under-recovery of power purchase costs and incomplete or late subsidy payments by state governments), by applying political pressure to keep tariffs low, and by pressuring discoms to purchase power during elections to keep voters happy. Irregular and inadequate tariff increases over the past decade, despite state regulators’ ability to act on their own initiative, have lowered cost recovery and increased regulatory assets.

To summarise, the report makes following key recommendations:

*Utilities must be freed from government interference and their management professionalised. Despite corporatisation, utility boards remain state-dominated and are rarely evaluated on performance.

*Banks/lenders should hold utilities accountable for efficient operation and not lend to those that are not credit-worthy.

*Regulators should transparently revise tariffs in line with efficient costs, hold utilities to service standards, and create a predictable environment for decision-making.

*Consumers need to pay for the power they use, and hold regulators and state governments accountable for the quality of power they supply.

*The central government should pledge no future bailouts, give regulators autonomy and adequate resources, and hold them accountable for their performance. It should also allow competition to create pressure for efficient operation, and promote rural access to electricity in a financially responsible manner.

All these recommendations made by the Bank in this study are unexceptionable. No one will disagree that below par power sector performance has its roots in distribution inefficiencies and limited accountability, so fixing them will help improve service delivery and other metrics of sector performance, put the sector on a financially sustainable path, and ensure that power is no longer a bottleneck for growth. But the report proposes approaches which are far removed from ground reality. This lacuna is understandable. The World Bank being a multilateral development agency cannot venture into the domestic politics of a member country. Hence, the suggested way forward in the report completely ignores the federal nature of Indian polity. An example of it is: “Establishing four or five regional regulators responsible for regulating the sector in a group of states is an option. An overarching issue is enhancing the accountability of regulators. Given the general lack of involvement of the state legislatures, alternatives include reporting every six months, possibly through the Forum of Regulators, to a standing Parliamentary Committee.”

The power sector, unlike other sectors, defies easy reform options. The central government can, at best, advise the states on how to reform their ailing electricity supply businesses with sweeteners such as inexpensive power supply or cheap funds to improve the infrastructure. But it cannot force them to act. The “incentive-based” efforts have fared poorly over the last decade.

In this context, let us try to understand the disastrous consequences of the recent move of reducing power tariffs in Delhi by Arvind Kejriwal which was followed by the states of Maharashtra and Haryana. Haryana, in spite of being bailed out by the central government and committing to increase tariffs to fully meet the fund requirement of its discoms, went for tariff reduction on the eve of the general elections. Technically it could be argued that tariff reduction in all three cases was effected not at the expense of discoms, but by giving subsidy from state budgets. But such subsidy burden on the state exchequer is not sustainable and state electricity regulators would be under tremendous political pressure not to increase prices in future. Statutorily all state regulators should have come out with annual tariff orders by end of the financial year, but they chose to refer the issue to the Election Commission which suited the political executive in all states. The Report’s projection for the 12th Plan period is that even if tariffs rise by 6% a year to keep pace with rising supply costs, the annual losses in 2017 could reach Rs 1,253 billion ($27 billion)[10]. This assumes serious proportion for country’s economy.

It is high time that sincere efforts are made at the highest political level to sit down with state chief ministers and arrive at a political consensus on: what should be the quantum of subsidy to agriculture and targeted low-income sections, how to pay this subsidy and provide sufficient funds to state utilities to meet operating expenses, and help strengthen and expand their networks. The reluctance of chief ministers to privatise state utilities is understandable because it means losing control over a large part of their domain. But if there is no improvement in the performance of public utilities, states need to be persuaded to try out different models of management starting from contracting out certain functions to outside agencies, franchising selected areas to private bidders, joint sector management and finally outright privatisation.  Since we are dealing with the political economy of electricity, the central government needs to demonstrate how reforms have improved the power situation in states controlled by the ruling party, and earned them rich political dividends. In the above discussed case of Delhi, Maharashtra and Haryana, bringing down tariffs by giving government subsidies did not translate into more votes for those political parties. Therefore, implementation of co-operative federalism can alone transform the electricity scenario.

Pramod Deo is the former chairperson of the Central Electricity Regulatory Commission. He has co-authored three books on energy planning, energy management and regulatory practice.

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