Stopping short of privatisation

Consultants suggest 'distribution margins' approach for the power sector

A recent realisation has been that starting electricity reforms with generation has been a non-starter. In fact, two senior World Bank officers compared it to "trying to build a house by starting with the roof".

Given that it's the World Bank's prescriptions that lead independent power producers to sell power to bankrupt state electricity boards (SEBs) by negotiating shady power-purchase agreements, they must be complimented for learning quickly from past mistakes.

The government turned to privatisation of electricity distribution "" first in Orissa, then Delhi and some time soon, Karnataka. In Orissa, it paid about Rs 305 crore to consultants for guidance on privatisation and capacity-building "" that is, to teach the still public sector but corporatised entities how to act commercially.

Then in no time it realised that capacity-building was a waste of time and money, and did away with it in Delhi's privatisation process.

As competition from Indian consultants emerged, the Delhi transaction was awarded to SBI Caps for a mere Rs 3.5 crore. But somehow Karnataka did not learn this lesson and paid about Rs 54 lakh to the Administrative Staff College "" whose members, under a government committee, had done a similar study for Andhra Pradesh for free.

The study, rather predictably, suggested unbundling and corporatisation of the Karnataka Electricity Board into Karnataka Power Transmission Corporation Limited and four to five distribution companies (discoms), but stopped short of privatisation.

The strategy here was to show the World Bank some semblance of progress so that the government becomes eligible for loan instalments under the adjustable lending programme, while at the same time maintaining status quo vis-à-vis the issue of privatisation.

However, inevitably the privatisation issue had to be addressed and the government engaged two multinational consultants "" one for privatisation and the other for capacity-building "" spending about Rs 14 crore on each.

In doing so, the government ignored the lessons from Delhi's case that capacity-building in public sector discoms is a waste of money. In Delhi, the trick was that electricity was never corporatised "" the government opted for privatisation straight away. The added advantage of this is that you need not write down the liabilities twice.

The privatisation consultant found that investor appetite was poor and suggested a new concept called the "distribution margins" approach. In this scheme, the revenue from customers will be first taken by the discom, corresponding to its cost of distribution with a relatively low but guaranteed return on its investment, all distribution costs being covered "" unlike for public sector discoms "" at the current transmission and distribution loss level.

If any additional revenue is collected consequent to its efforts to reduce losses, the discom can keep 50 per cent of this and also cover the costs incurred for loss reduction, with due regulatory approval.

The residual from the revenue, after meeting these charges for the discom, will go to the power generators and transmitters, with any difference being met as a subsidy from the government.

The main idea behind this scheme is that instead of the government subsidising the SEB year after year, it now needs to subsidise the private discom only for a certain number of transition years by which time it will have become viable.

It now appears that even this scheme is not friendly enough for investors, for they fear that the regulator by having a say on the allowable costs and insisting on regulating on a year-to-year basis, will prove to be a fly in the ointment.

The current thinking "" evolved by the consultant and getting authoritative support from a recent discussion paper from the World Bank on evaluating Delhi electricity discom privatisation "" urges the state governments to embed a multi-year tariff (MYT) for the first tariff period into the government's privatisation agreement (or licence) with the investor.

It also suggests giving directives to the regulator for a smooth transition in the second tariff period so that "the investor is not pushed over the regulatory precipice" at the end of the first tariff period.

The arguments of the authors are:

• It is the government that has to deliver finally on the reform and not the regulator, which anyway has lacked teeth in enforcing orders on public sector SEBs.
• State governments have now realised to their embarrassment that "the existing tariff policies of their state regulatory commission are an impediment to privatisation."
• "The state government will be in ongoing discussion with the investor and, therefore, is in a better position than the regulator to know the elements of the tariff regime that are necessary for a successful privatisation."

Privatisation along these lines has been successfully implemented in Latin American countries. The authors also suggest embedding the MYT system and treatment of costs and all other rules as part of the licence to the discom before privatisation so that investors are rid of the regulatory uncertainty. To effect this, they see two options:

• To incorporate it under the Electricity Act 2003, through the provision left for National Tariff Policy. They suggest that the power ministry can come out with a non-bonding "model discom licence" that gives an enabling provision for the state governments.
• For the state governments to create some or all the elements of the regulatory system through a policy directive. This runs the risk that the next government may reverse these policy directives, and so is less preferred.

The authors realise that the suggestion to short circuit the regulator may come as a shock to many since the commissions were set up in the first place to disconnect the government from populist tariff making.

But they say this one-time disengagement of the regulator is the only thing that will satisfy potential investors unless, of course, the regulators voluntarily switch to the MYT scheme and follow the same practices as the government would suggest. They cite some early adopters like the Andhra Pradesh and Orissa regulators, which considered the MYT scheme on their own initiative.

The Karnataka Electricity Regulatory Commission has opined that this is equivalent to giving the regulator a 10-year garden leave. It has also, like many other regulators, expressed opposition to the MYT scheme, citing lack of information.

The most provocative recommendation is their assertion that "it is probably neither feasible nor desirable to have public consultations on the terms and conditions of the privatisation deal during the period of bidding and negotiations".

The above suggestion implies that in spite of doing all this to generate investor interest, the authors do not expect large number of investors and aggressive bidding. So they envisage secret parleys of negotiations with a single investor whose interest the government has to engage.

There is an undercurrent in the article that India is like any other banana republic where deals can be made outside the public purview. Unfortunately, it is not being proved wrong.

(The writer is RBI chair professor and professor of economics and energy, Indian Institute of Management, Bangalore)