As we face a new wave of competitive populism in the State elections, it is useful to understand the initial wave, its ill effects, recent measures that seem to be finally mitigating these, and draw lessons for aborting the current wave.
Intense multi-party competition coincided with the large international oil price shocks of the 1970s and led to competitive populism to attract voters. Prices for many public services were kept constant. Low or no user charges resulted in cross subsidies, distortions, deterioration in quality of public services. Or indirect charges, not obvious to voters, such as higher prices of intermediate goods, made India a high-cost economy. The rich turned to private providers creating further revenue losses. Interfering in prices is one of the worst forms of freebies as it distorts resource allocation and ends up hurting the very people it says it is helping. We see this with electricity subsidies.
The Congress party was the first to use electricity subsidy as a political tool during the 1977 elections in Andhra Pradesh. It offered flat-rate tariffs based on the capacity of the pump rather than on metered consumption to farmers. The idea spread like wildfire through the 1980s. Power subsidies in Punjab are responsible for wasting water, growing inappropriate crops that necessitate burning of residue and smother Delhi in smog in November every year. Cross subsidisation by higher tariffs on industrial and commercial consumers hurt development and future revenues. Lack of investment made power supply unreliable. Free electricity for some meant no electricity for many.
Reversing ill effects
A series of reforms were attempted. Unbundling in the 1990s and the Electricity Act (EA) of 2003 succeeded in improving production and transmission. By 2014 India had a national grid. But distribution remained the weak link that hurt the whole sector.
The EA sought to create an open market for electricity, allowing procurement at cheapest prices and sale anywhere at mutually agreed prices. Competition should have brought down prices. But States sabotaged this in order to preserve their cross subsidies and the monopoly of State Electricity Boards. They used their ability to route power through State Load Dispatch Centres as an instrument to deny open access to large consumers even while continuing to impose a cross-subsidy surcharge (CSS) on them. The EA had allowed CSS, but with the understanding that it would be eliminated. The National Tariff Policy (2016) had articulated the necessity of shifting to direct subsidies to support poorer consumers. But States continued with distorting tariffs. They also misused what was supposed to be an emergency provision (Section 11) in the Electricity Act, to prevent State power producers from supplying outside State borders. Other ‘open access charges’, imposed on flimsy grounds, helped preserve the market for inefficient State distribution companies (discoms).
High transmission and distribution losses, unpaid bills, continuing political interference, no investment to upgrade outdated distribution systems and poor maintenance of equipment meant discom losses mounted reaching trillions of rupees. A number of Central restructuring cum bailout schemes failed to improve matters. In 2015, Uday sought to reduce moral hazard by aligning discom with State finances. Special State bonds were issued to cover 75 per cent of discom debt along with supportive measures to improve operational efficiency. But States remained reluctant to increase tariffs. They were able to arm twist banks to finance them and gencos to suffer large pending dues.
In mid-2022 the Ministry of Power passed Late Payment Surcharge (LPS) Rules, helping discoms with loans to clear their legacy monthly instalments failing which a LPS and disincentives such as progressive withdrawal of open access would be applied. There would be no LPS on past outstanding dues under timely payment of instalments. For example, in August 27 defaulting discoms were barred from buying electricity to meet their short-term requirements from power exchanges. Thereafter, 11 States paid. The plan was to reduce long-term access of defaulters by 10 per cent every month.
Power Finance Corporation, the nodal agency for implementation, used an automated process with online portals to monitor regular payment of bills and identify defaults. A remarkable recovery of outstanding dues followed. By March 23 they had dropped 39 per cent. Finally, decades of damage were being reversed. States that reform their power sector will get more of the green finance flowing in.
Ways to impose discipline
So it seems while State governments can bully parties dependent on them for business, discipline and incentives imposed by independent Central/Constitutional institutions does work. These must be used to abort the current wave of electoral freebies before they create the type of damage seen above. Freebies can be defined as hand-outs that do not build capacity and/or create distortions. Continuous payments required are largely financed by cutting investment, the quality of public services, or shifting problems to future governments. The poor suffer the most and are kept poor since they depend on public services. The rich can afford alternatives. One reason reviving the old pension scheme is a popular election sop is because it will have a large impact on government expenditure but only after 2050, shifting the burden to future taxpayers.
The Election Commission can help voters understand that freebies are never free by asking parties to estimate costs of poll promises and also to clarify what tax will rise or what expenditure will be cut to finance them. Independent analysts are making such estimates helping raise voter awareness. For example, estimates of poll promises by the current Uttarakhand government put them at such a large share of revenues that a cut in capex and the quality of public services is inevitable. This would degrade State facilities and lock those getting subsidies in a cycle of poverty and dependence. Voters must see through short-term gains. It is also a race to the bottom that does help parties get re-elected since other parties are forced to compete in offering such sops if they work in some elections.
Central incentives such as interest-free loans conditional on capex have induced a double-digit rise in States’ capital spending over the last two years. But still 10 out of 21 States spent less than the budgeted amounts on capex. More conditionality must be imposed on State borrowing. The Constitution of India has wisely made provision for this. A package of carrots and sticks the 12th Finance Commission offered was able to reduce State debt.
Markets would also discipline unproductive expenditure if Central backing of State borrowing stops. Debt varies widely across States but borrowing costs are the same unlike in other countries. Indian subnational debt share at 28 per cent is the 4th highest in the world and should come down. The OECD average is 20 per cent. Politicians must be forced to think of development not just the next elections.
The writer is Emeritus professor, IGIDR