Wednesday, March 10, 2010

The UID solution to free power

I have blogged earlier about the possible incentive distortions and negative externalities generated by the supply of free or concessional power to farmers. Power subsidies today form the largest share among the subsidy burdens of state governments in India. Rising power purchase costs and stagnant tariffs, coupled with rapid growth in (free or heavily subsidized) agriculture consumption have had a devastating impact on the balance sheets of unbundled state power distribution utilities across the country.

Though the Electricity Act, 2003 mandates that state governments pay the subsidy borne by way of lower tariffs (or free power) to specific categories of consumers in advance to the utilities, fiscally strained state governments are in no position to pay up-front. Worse still, many state governments repeatedly postpone the payment of the subsidy amount and even force utilities to borrow on behalf of the state government and finance power purchases. Some states have even defaulted or refused to pay the subsidies despite regulatory directives to do so.

The Planning Commission found that the state governments provided Rs 24,000 Cr of subsidies in 2001-02 to farmers by way of free power, which formed 23% of states' gross fiscal deficit. Agriculture sector accounts for 25-30% of the total electricity consumption in India (though reaching 35-45% in some states) and electricity subsidies to farmers form 10-15% of state fiscal deficits. The largest agricultural states in India - Andhra Pradesh, Haryana, Punjab, Maharashtra, Tamil Nadu, Karnataka - provide free or concessional power to their farmers.

Punjab government subsidized its farmers to an extent of Rs 2150 Cr for 2008-09. Free power to farmers cost Andhra Pradesh Rs 6040 Cr, Karnataka Rs 2,100 crore, and Tamil Nadu Rs 279 Cr in their respective 2009-10 budgets.

One of the most debilitating, though least acknowledged, consequences of free power for farmers has been its considerable contribution towards perpetuating the rural-urban divide. Since state governments provide free agriculture power for a certain number of hours, the utilities supply single phase power to rural areas beyond this requirement so as to eliminate excess-utilization by farmers. Distribution utilities have resorted to various methods to restrict three phase supply by incurring massive expenditures. Some like Gujarat have spend huge amounts to establish alternative feeders for agriculture supply, which can be controlled from the sub-station.

But the unfortunate consequence of this arrangement is that it denies rural areas one of the primary ingredients essential for development of non-farm small and medium-scale industrial and manufacturing activities. This is all the more unfortunate since in view of the scarcity of land in and around urban centers, rural India is already the natural location for setting up of newer industrial activities.

Even forward linkage activities for supporting agriculture like cold storages and processing facilities get disincentivized. Promoters of all these activities have to incur huge up-front expenditures to pay for drawing exclusive lines from the nearby sub-station for accessing three-phase supply necessary to support such activities. In other words, the state governments which supply free power to farmers actually ends up strangling non-farm economic activity in the same villages.

Under the existing free-power regime rural feeders are provided with three phase supply for a fixed number of hours (seven hours in Andhra Pradesh) according to a pre-defined (often rotating) schedule, mostly in two or more spells. Since supply is discontinuous and often during non-working hours, late in the night or early in the morning, and changes periodically (say every week), farmers cannot make optimum use of the electricity supply. They leave open their motors fully operational during the non-working hours, thereby wasting water. Further, the restricted timings also denies power to even those farmers willing to pay the price of accessing additional supply.

In order to eliminate these discrepancies, it is proposed to move over to a mew subsidy administration regime. Here is how the new subsidy regime would work. Electricity supply to farmers in India is mostly unmetered, either free or charged at a flat rate per month. The new subsidy administration will usher in universal metering of agricultural services and therefore control wastage of ground water and check illegal connections. In the absence of any pricing mechanism, farmers use higher capacity pumps and also leave them running for hours thereby rapidly depleting ground water reserves.

Once the UID is rolled out in a district, all the farmers who desire to avail of free-power can be directed to either open a UID-linked bank account or link their existing account to the UID database. The former can be enrolled in a campaign mode, by organizing camps at local banks to enable farmers to open their UID-linked accounts. The existing farmers can be captured into the UID database by capturing their identities when they come to access their bank account.

The government should then announce a specific cut-off date beyond which all free power supply would stop. Farmers can be provided a fixed number of units of power free or at a lower tariff every month during the cropping season. Any consumption beyond this limit will be charged at the regular tariffs. However, the farmers will have to pay the prevailing agriculture tariff and then get the subsidy reimbursed as a direct transfer into their UID-linked bank account on production of their electricity bills at the electricity call center (or some other pre-designated place). In fact, by integrating the electricity utility's consumer database with the UID-linked bank accounts of its consumers, the subsidy reimbursement, to the extent of consumption, can be made automatically into the farmer's UID-linked account once the bill is paid.

This regime will increase the flexibility with governments to structure the subsidy regime to meet the specific situations in states. For example, it becomes possible to provide free power to farmers for the first crop and limit the extent of subsidy for the second crop, or provide varying levels of subsidy based on extent of landownership.

This subsidy administration regime will help eliminate most of these wastages and inefficiencies. For a start, once the eligible farmers are accurately identified, it will help target subsidies to the intended beneficiaries. This arrangement will also improve the collection efficiency of the utility since the electricity bill can be bundled along with the farmers residential and other services and thereby make the subsidy reimbursement every month conditional to the payment of all other bills. By restricting free-power to only the cropping season, it becomes possible to control the widespread practice in many parts of the country of misusing an agricultural connection for various other commercial activities.

In contrast to the existing free power regime which leaves distribution utilities with little incentive to make investments in improving quality or reducing losses in rural feeders, introduction of metering will encourage them to invest in improving quality of supply to rural areas. Similarly farmers too will be incentivized into adopting energy saving motors and more water efficient cropping practices, besides moving into less water intensive crops.

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