Plug power financials - Now!

States committed to reforms should privatise power distribution

"We can talk about computers, information technology, great talent and intellect in India. But unless you get power to drive it, you will miss the next revolution."

Jack Welch, September 2000

The euphoria on the economic front is, undoubtedly, underpinned by a stack of positive data. GDP growth rate is all set to accelerate past 7.5 per cent, foreign exchange reserves are above $ 100 billion, teledensity has crossed seven per hundred, IT and IT-enabled services are flourishing, the manufacturing sector is turning internationally competitive and there is renewed warmth in the relationships with our neighbours. The nation, prima facie, seems to have breached major barriers to growth.

Yet, it cannot afford to ignore two strongly inter-related impediments, viz., burgeoning government (fiscal and quasi-fiscal) deficit and the mess called the power sector. Those familiar with state finances know that the power sector is a major culprit.

For instance, in 2002-03, the aggregate fiscal deficit of states was 4.7 per cent of GDP, and the State Electricity Boards (SEBs) incurred commercial losses of Rs 24,320 crore (about 1 per cent of GDP). SEBs posted a negative rate of return of over 30 per cent and, although the reported Transmission and Distribution (T&D) losses are pegged at 28 per cent, Aggregate Technical and Commercial (AT&C) losses in reality are anywhere between 35 to 45 per cent. The energy and peak shortages have been estimated respectively at 8.8 per cent and 12.2 per cent.

While 40 per cent of households still do not have electricity connections, nearly 22 per cent of our villages are yet to be electrified. The sector's performance looks gloomier if one goes by the ubiquitous metric of Sino-India comparison; India's per capita power consumption is less than half of China's.

To be fair, the sector has recently also witnessed some positive developments. Independent regulatory commissions have been established and the Electricity Act 2003 imparts scope for further market-based liberalisation.

The central government has ushered in the Accelerated Power Development and Reform Programme (APDRP) and, earlier, had introduced a scheme for the securitisation of SEB dues to Central Sector Undertakings (CSUs). Are these efforts adequate to re-establish the financial viability of the sector and ensure its sustainable growth?

To attract further investment the sector has to be able to charge and collect remunerative prices for what it supplies; in other words, become creditworthy.

It is noteworthy that while the financially challenged SEBs are finding it difficult to attract more generation capacity, their creditworthy counterparts from the private sector engaged in electricity distribution have been far more successful in meeting their power requirements, either through their own generation or through suppliers keen to retain their custom.

The principal stakeholders of even the recently privatised distribution companies in Delhi are already evincing keen interest to install or acquire generation capacity and, given their value-maximising orientation, are unlikely to face major difficulty in attracting the requisite finance.

Similarly, private investors and lenders are willing to put their money in projects with low off-take risk "" e.g., small generating capacities meant for captive consumption "" rather than on big-ticket projects which require relatively large and solvent customers (distribution utilities).

In the last four years, almost every major expert group/committee that examined the sector has persuasively argued that early privatisation of the cash-generating end of the sector, specifically, the distribution segment is sine qua non for stemming the rot and achieving a relatively rapid turnaround.

Despite this, even those states that have traversed quite a distance on the path of reform by establishing regulatory commissions and unbundling generation, transmission and distribution, are dithering on taking the crucial step of distribution privatisation.

Anecdotal evidence suggests that the vacillation is attributable to the apparent failure of distribution privatisation in Orissa in turning the sector around. While this may be true, even a cursory examination reveals at least three factors that have adversely affected the prospects for distribution privatisation.

First, mixed zone configuration: Until recently, prompted mainly by the multilateral institutions, several states have sought to configure their distribution segments into composite zones with a mix of urban and rural loads.

In the process, considerable time and effort was expended in arriving at an 'optimal' configuration, i.e., balancing between subsidised and subsidising categories in each zone. The fact is that urban and rural distribution are different businesses and this has been widely recognised.

Supply of electricity to rural areas has been given special dispensation (subsidies for network expansion), and innovative institutional mechanisms are deployed. For instance, while Bangladesh and the USA successfully harnessed cooperatives to extend electricity supply to rural areas, Chile and Argentina engaged the private sector through minimum subsidy bidding.

In any case, a composite zoning arrangement is not particularly attractive to private investors as it enhances uncertainty with regard to the extent of cross-subsidy that will be allowed by the regulator and the direct subsidy that is payable by the government.

Incidentally, such an arrangement is also sub-optimal from the viewpoint of the subsidy provider (state government) as it allows ample scope for camouflaging theft and inefficiencies as unmetered consumption by subsidised categories such as agriculture (a common practice among SEBs).

Admittedly, the alternative approach of segregating urban and rural areas per se does not remove the potential of cross-subsidy; however, it makes such subsidies transparent. If the government wants to continue subsidies, it can do so from general budgetary allocations and, if necessary, supplement them through an explicit (power) tax and subsidy scheme, say, by imposing a transparent surcharge on the subsidising consumers.

Second, regulation: The prevalent practice of annual cost-plus regulation for setting tariffs increases regulatory risk and also compromises incentive for aggressively pursuing efficiency. In other words, under this regime, utilities would be wary that if they perform well in one year the regulator might 'reward' them next year by imposing more stringent standards and/or by clawing back their gains.

Third, financing gap: The sector is saddled with huge unfunded liabilities comprising debt, unpaid bills of suppliers, employee pensions etc., and is facing continued losses in the foreseeable future.

As of February 2002, outstanding dues of SEBs to CSUs amounted to about Rs 34,000 crore and, according to the report of the Ministry of Power's Expert Committee on State-specific Reforms, transition financing for SEBs to cover losses during 2001-07 is projected at Rs 72,000 crore.

While new private investors cannot be expected to carry this burden "" bitter harvest of sins of the past "" the state governments too are not in a position to take over the entire onus of past and future obligations.

Of the aforementioned factors, those state governments that are committed to reform can perhaps address the first two on their own, by initiating distribution privatisation with concentrated urban zones and by requesting state regulators to pronounce multi-year (light-handed) tariff orders.

However, in order to be effective, these steps need to be complemented by a robust Financial Restructuring Plan that credibly addresses the vexed issue of past unfunded liabilities and losses during the transition. It is here that the state governments need most help.

urjitpatel@idfc.com

(The author is with IDFC; views expressed here are personal)