It is well known that the power sector is a serious drag on India's competitive cost advantage, with the potential to short-circuit the economic growth story. Industrial power tariffs in India are probably the highest amongst major emerging markets; around 57 per cent of rural households and 12 per cent of urban households still do not have access to electricity; even as most of the downstream distribution continues to be the monopoly of State Electricity Boards, with mounting losses and poor services. Cold comfort for a country said to be on the threshold of an economic miracle.

So the need for urgent corrective action and a holistic development of the power market are assuming increased importance. The overhaul of the current regulatory environment and making investments viable in a sector is crucial. While interventions at resurrecting the sector have mostly followed the top-down approach, plugging the leak right at the bottom holds the key to a sustainable and efficient electricity market.

Two key issues

The recent paper titled “ Does the Exuberance in the Indian Power Sector Have Legs?” by Mr Saugata Bhattacharya, Vice-President and Chief Economist, Axis Bank and Mr Urjit R. Patel, President (Business Development) at Reliance Industries, looks at two key issues — what the fiscal implications are of the changing financials in the distribution segment and how conditions are evolving regarding the commercial orientation of the sector as a whole. Both the issues are capable of impacting how fast, and in which way, the power sector will develop.

While concern regarding fiscal implications is obvious, the changing commercial orientation of the sector is based on several changes on the ground. For instance, there is increasing participation of private developers in electricity generation, rapid growth in exposure of domestic and foreign debt financiers in the projects and a critical role being played by distribution utilities in generating cash flows for successful enabling of power purchase agreement-tied debt servicing for borrowers. The authors, in order to take a look at the crucial commercial aspects of the sector, have updated a summary measure — the Index of Revenue Orientation — which they had earlier conceptualised and formulated.

The paper points out that there has not been much transformation in the performance of the power sector. The yawning differences between public utilities in different States continue. But even worse is the speed of deterioration in the sector's overall financials, especially the state-level utilities, with losses doubling to Rs. 52,600 crore in 2008-09 in a matter of just a couple of years. After a period of relative stability, as a percentage of GDP, financial losses are back to the 2002-03 levels.

Debt servicing

According to the authors, if the sector continues to perform the way it is currently, the implications for servicing the debt required for funding additional capacities would be of considerable concern. They argue that the increasing gap between the average cost of supply and average revenue realisation of electricity, specifically pertaining to the industrial segment, is probably the most important reason for the losses becoming worse. The gap is attributed to the high increase in procured power costs outpacing the moderate rise in revenues. Concerted efforts at reducing aggregate technical and commercial losses have been losing traction in the last few years. The paper also points out that not only is the power sector less homogenous now than it was about a decade ago, but it has also become more heterogeneous in 2008-09. Unfortunately, the promise shown in 2005-06, with some state utilities managing a financial turnaround and sustaining cash profits for some years, could not be sustained.

Is it possible that these increasing losses can be reversed in the short term? The authors see it as an extremely difficult proposition. What is of increasing concern is that the deterioration has come about in the state utilities traditionally considered to be better in operational terms. The losses reported in 2009-10 and projected for 2010-11 can only suggest that the deterioration has spread to other States as well, the paper notes.

Investor sentiment

The big danger is that the upswing in investor sentiment, which translated into a sharp surge in the financial sector exposure to the sector in recent years, could be in for a crash-landing. The prospect does not augur well for the sector, especially in the wake of the experience of the irrational exuberance that characterised the IPP-led boom of the early nineties. The slide that followed was a rude jolt. This time around too, there is the possibility of a wider challenge if the health of the cash-generating segment has been misread by private investors and lenders. The authors rightly note that given the recent global experience of coping with the aftermath of miscalculated risk and leverage, it may not be as unlikely as one would prima facie think.

Can the much-needed course-correction happen before the entire deck comes crashing down is the key question. It might not be long before we find out.

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