A new dawn for the power sector?

SURYA P SETHI | Updated on January 22, 2018

Unclear view UDAY raises as many questions as answers B VELANKANNI RAJ


Ujwal Discom Assurance Yojna, though better designed than its predecessors, cannot, by itself, deliver a turnaround

Having correctly predicted the failure of two earlier attempts to turnaround power distribution utilities, I can humbly say that those who do not learn from the mistakes of their predecessors are doomed to repeat them. UDAY, easily the best designed scheme thus far, falls well short of addressing the real malaise. Blaming power distribution companies alone or raising tariffs to eliminate their revenue gaps will simply compound the problem as demonstrated by experience since the first restructuring of 2002-03.

The unaddressed malaise

The average price of bulk power in India is among the highest in the world and India’s average consumer tariff is easily the highest worldwide when corrected for capacity to pay. This is so because: (i) average delivered cost of Indian coal, the cheapest power generation fuel in India, at the burner tip is currently the highest in the world in energy terms; (ii) capital outlays on conventional power and transmission systems are about 35 per cent higher than comparable infrastructure elsewhere; and (iii) everyone engaged in the electricity value-chain, other than the distribution utilities, extracts unjustified amounts of profit despite remaining grossly inefficient by global standards.

UDAY is the first financial restructuring scheme that implicitly recognises this malaise and includes measures to reduce bulk power prices through reductions in the delivered cost of coal and potentially higher capacity factors in generation. However, several regulatory and governance shortcomings behind uncompetitive bulk power prices in India remain unaddressed. Bulk power in India should be at least 30 per cent cheaper. Such a correction can, by itself, wipe out all current distribution losses.

High bulk power prices severely constrain the scope for creating surpluses in power distribution. The distribution segment also lacks concentrated creamy mega projects. The consequent neglect and disproportionately low investment in distribution has and continues to plague the Indian power sector.

Poor performance standards

Individual distribution investments are relatively small and widely dispersed. Ensuring effectiveness of such outlays requires sophisticated control systems. Instead, prevailing practices seek to maximise rents from what little flows to this segment. Poor metering, billing and collection efficiencies that increase commercial losses essentially expand the limited rent-seeking opportunities in distribution. Poor performance standards that typify India’s power sector are hence exposed most in the loss-making distribution segment.

Much like the earlier two attempts, UDAY also sees higher distribution investments and meaningful monitoring as key ingredients of success. Hence, as before, UDAY incentivises performance improvements through higher allocations from the renamed central schemes supporting rural electrification and distribution reform. Unfortunately, the funding requirements for distribution investments greatly exceed what is actually made available through the central and State resource pools.

Like its predecessors, UDAY too relies on assumed performance improvements delivering additional resource flows to distribution companies for funding unmet investment needs. This does not work because distribution performance improvements are predicated upon: (i) providing funds upfront for such investments; and (ii) radically realigning the risk-reward profile of actors engaged across the electricity value-chain to ensure competitiveness of each element that ultimately feeds distribution. The alternative of raising average consumer tariffs is neither desirable nor viable

UDAY promises additional coal at “notified” prices and “low-cost” bulk power resulting from higher capacity factors in generation to compliant distribution companies. This needs rigorous scrutiny as it presumes higher coal availability for power sector at current notified prices despite shortages across several coal consuming sectors. Stranded coal or power surpluses, if any, likely reflect infrastructure constraints and/or subdued demand at prevailing high tariffs. UDAY lacks an investment component for removing infrastructure constraints and a robust 24x7 power system would typically have capacity factors of around 65 per cent and possibly lower with growing share of renewables.

Contrary to the government’s claim, UDAY is a bailout for the financial institutions that have knowingly funded losses of distribution utilities for years. Converting 75 per cent of their outstanding to State government bonds/loans and the balance potentially to State government guaranteed utility bonds/loans with no provisioning requirements is a recipe for continuing profligate lending practices.

Financial bailout

While the two largest lenders to the sector are outside Reserve Bank of India’s regulatory oversight, it would be educative to understand from the independent bank regulator why the proposed book-keeping exercise negates the need for provisioning 25-100 per cent of the commercial bank exposure to these State government owned distribution companies? Does a State government taking over or guaranteeing its de-facto existing obligations as sole owner of a State corporation change the credit risk?

It is also incorrect to say that consumers will not be burdened by the inefficiencies of the sector. State governments do not have a slush fund to pay for such past or future inefficiencies. They manage their budgets through taxes and levies or cuts in proposed spending or services they provide. Either way, consumers will suffer the full consequence beyond the haircut taken by the lenders through reduced interest.

UDAY proposes to restructure an outstanding of ₹4.3 trillion. This off-balance-sheet fiscal hole is a sizeable 15.8 per cent of the estimated combined total liabilities of all States as of end March 2015. These combined total liabilities grew by less than ₹3 trillion in 2014-15. UDAY alone will add ₹3.2 trillion to State government liabilities through new bonds or state development loans (SDLs) and potentially create a contingent liability for the balance ₹1.1 trillion.

The additional interest burden on State governments from UDAY will further pressure State deficits and likely breach the limit on interest payments remaining below 10 per cent of revenue receipts. And finally, there is no market for non-SLR bonds/SDLs. The lenders will simply be asked to accept these bonds in lieu of their outstanding.

The above facts pose daunting questions for State finances. The consequences will be dire for the six most-indebted States. Excluding such fiscal profligacy from State deficits for two years does not change the reality of seriously breached fiscal discipline. For reasons detailed above, two additional years with UDAY would likely make the financial/fiscal challenge even bigger, in keeping with the experience of the previous 13 years.

Rhetoric, repeated constantly, will not deliver a bankable and competitive 24x7 power system for all by 2019. Despite good intentions and a feverish pace, the power ministry’s capacity limitations are showing. Those responsible for the current mess appear to still hold sway. We can again kick the can down the road, or bite the bullet and change course to deliver a radically reformed power sector fully compliant with Electricity Act 2003.

The writer was Principal Adviser, Power & Energy, Government of India

Published on November 23, 2015

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