Time to go back to basics

Privatisation with structured reforms in the power sector is the way forward

There is increasing recognition that ushering in the private sector in power distribution is the only credible alternative to turn the sector around. However, in order to achieve this goal, state governments should first credibly address inter alia the vexed issue of huge unfunded liabilities from the past (debt, unpaid bills of suppliers, employee pensions etc.) and the continuing losses during the transition.

According to the report of the Ministry of Power's Expert Committee on State-specific Reforms, transition financing for State Electricity Boards (SEBs) to cover losses during 2001-07 is projected at Rs 72,000 crore.

Clearly, the financially challenged state governments could do with some assistance in this regard. Against this backdrop, this article evaluates recent 'reform' initiatives that have been proffered to state governments, and highlights apposite measures that could catalyse self-sustained growth for the sector.

First, the Accelerated Power Development and Reform Programme (APDRP): The two distinct streams of support under this significant window of assistance (Rs 3,500 crore/annum) are directed towards facilitating investments and providing ex-post incentives for better financial performance.

However, this Programme does little to enhance a state's capability to undertake comprehensive financial restructuring by paring down unfunded past liabilities (legacy cost).

It is only fair to mention that APDRP seems to have had some success in catalysing states to improve the power sector financials; seven states have reported reduced cash losses in 2002-03, and eleven states increased average revenue realisation. However, it is unclear whether and how such gains would be sustained in the future, especially after the cessation of incentives.

Second, multilateral agencies "" yet another source of cheap finance "" are willing to extend financing only to 'investment' projects and not to financial workouts which entails refinancing of past unfunded liabilities.

Third, the central government is reportedly pursuing various avenues for attracting private generation in the interim period, i.e., until the State Electricity Boards become creditworthy.

In this context, in consultation with some financial institutions a payment security mechanism has been established wherein states agree to a milestone based reform package comprising restructuring of SEBs, establishing regulatory commissions, 100 per cent metering, energy audit, etc.

While these measures are unexceptionable, they are unlikely to change the underlying incentive structure of either the SEBs or their owners, the state governments.

Accordingly, it remains to be seen whether finance is actually going to be forthcoming on the strength of this security mechanism and, if at all, how such decisions would pass the test of (unencumbered) commercial due diligence.

Furthermore, a proposal has been mooted whereby National Thermal Power Corporation (NTPC) and National Hydel Power Corporation (NHPC) would buy power generated by large private power plants so as to alleviate the latter's worry regarding payment defaults (by SEBs).

This arrangement should carry a strong warning for the central government. If states revert to their old ways of defaulting on payments to Central Power Sector Undertakings (CPSUs), the financial deficit would shift from states to the Centre (the problem is 'socialised' at the national level).

Even if the Union government manages to impose payment discipline by dipping into its devolutions to the defaulting state, the price for the power sector's profligacy would ultimately be 'paid' by curtailing other sectors in that state.

Fourth, the Electricity Act 2003 includes an impressive array of pro-reform features comprising liberalisation of captive generation, introduction of open access in transmission and subsequently in distribution, and the provision for issuing multiple distribution licences in a given area.

These features are welcome as, inter alia, they increase choice to consumers and producers. The question, however, is when will the sector be ready to implement and sustain these measures. Presently, the sector does not seem to be prepared for introduction of open access at the retail level.

For starters, a major portion of consumption is not metered and the balance is measured mostly in terms of total energy flows and not by time-of-use; buyers and sellers would be hard put to even reconcile electricity supply and consumption flows.

Also, it is not clear how those opting for open access would be compensated in case their supply is interrupted on account of distribution utilities' decisions such as, for example, administered load shedding in a given area.

This becomes even more problematic in cases involving government distribution utilities since, going by their track record, they are unlikely to either conform to market discipline or fully comply with regulatory directives. Regulatory determination of the level and pace of reduction of cross-subsidies is yet another source of uncertainty.

There is genuine apprehension, not entirely unjustified, that haphazard pursuit of some of these initiatives will work at cross-purposes. For instance, competitive supply of power envisaged in the Electricity Act is undermined by mega IPPs selling power to CPSUs for onward sale to states.

In a similar vein, encouraging investment through artificial props such as untested 'alternate payment security mechanisms' is not only likely to exacerbate moral hazard but also vitiate remnants of a hard budget constraint and consequently dilute the resolve of state governments to undertake the more arduous but necessary elements of reform.

Faced with the prospect of a higher subsidy burden on account of losing remunerative customers, state governments may take a myopic view and thwart the liberalisation of captive generation and open access arrangements.

They could impose additional levies on such transactions or exert pressure on the regulators whose remit includes determining wheeling and cross-subsidy charges (payable to government-owned utilities).

In light of the above, it is imperative that reforms should be structured in a manner that is incentive compatible, especially for the state governments.

Towards this end, the central government could consider providing additional support to states that offer urban and industrial areas with concentrated loads for expeditious privatisation (it is estimated that 83 urban areas account for 87 per cent of power consumption).

In this regard, measures by the Centre (for reforming states) that merit consideration include: (a) an ex-ante grant to set off a portion of the past liabilities; (b) further write-downs in the dues to CPSUs; (c) concessional pricing of power from the CPSUs; and (d) higher assistance under APDRP.

Complementary to these efforts, some haircuts could be coaxed out of existing creditors, and multilaterals could widen the scope of their assistance to include financial workouts.

Concomitantly, the regulatory commissions have to institutionalise a multi-year regulatory framework and announce a timeframe for introduction of open access (choice) at the retail level.

Concerted implementation of these measures would enable state governments to train their efforts on critical aspects, viz., financial restructuring, distribution privatisation and establishment of wholesale electricity market, including associated institutions such as power exchanges.

Lastly, a word of caution for state governments. An effective turnaround strategy should encompass appropriate reform steps (distribution privatisation and multi-year regulation) and a credible financial restructuring plan (FRP).

Reform without a credible FRP to deal with past deficits is akin to attempting a marathon with a millstone around one's neck. At the same time, an FRP that is not complemented by an appropriate reform framework is like running on quicksand!

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

urjitpatel@idfc.com