Tuesday, September 25, 2012

India's latest power sector reforms - A recipe for failure?

The Union Government has announced an ambitious plan to restructure the debts of the massively indebted state electricity distribution utilities. As part of the "Financial Restructuring of Discoms" package, worth nearly Rs 2 trillion (~$38 bn), the state governments will immediately take over half the outstanding short-term liabilities upto March 31, 2012 and convert them into state government guaranteed bonds. In the second stage, the the remaining half of the liabilities will be restructured by rescheduling loans and by providing a three year moratorium on the principal repayment.

The electricity utilities will have to enter into a tripartite debt restructuring agreement involving the state and union governments. As part of the deal, they will have to undertake periodic tariff revisions and reduce their aggregate technical and commercial losses. The Union government will reimburse states 25% of the principal they repay if they meet the conditionalities and exceed their loss reduction targets. The plan is voluntary and states will have time till 31st December to embrace the plan.

There are a few immediate concerns. The bonds will not get the statutory liquidity ratio (SLR) status, thereby making them less attractive for banks and other financial institutions. It will also raise the coupon rates for the state governments. Also, state governments will almost certainly breach the Fiscal Responsibility and Budget Management limits and strain an already stretched state fiscal balances. The biggest beneficiaries, apart form the utilities, will be the public sector banks, who face the threat of these loans becoming non performing assets. The RBI data reveals that Indian banks' loans outstanding to the power sector rose to Rs 3.4 trillion as of July 2012, up 17.4% from Rs 2.9 trillion in July 2011.  

On closer analysis, this scheme looks like throwing good money after bad. Such performance based incentives to reimburse loans has been at the center of all the major central government programs in the sector for more than a decade. In fact, in the early part of the last decade, as part of the "big bang" electricity reforms, the debts of the bundled state utilities were similarly restructured. The two rounds of the APDRP reforms have had similar loss reduction and other reform commitments. And even after all these efforts, distribution losses remain at a shockingly high 27% and worse still, it appears to have plateaued.

Further, loss reduction, as I have blogged earlier, is more a political, than technical or enforcement problems. Allowing for the 10% technical losses (itself a high estimate), the remaining are commercial losses, which consists of both theft and fraud, apart from a share of the unaccounted for agriculture consumption. For sure, enforcement will contribute to commercial loss reduction. But it will have to be complemented with political commitment to crack down on those pockets of heavy losses, which are also unfortunately powerful electoral vote banks.

Mandating tariff revisions, based on cost of service, too is not easy to enforce. Currently, most of the larger utilities provide for tariff revisions in their annual tariff filings before the state regulatory commissions. However, even when they are agreed to, the state governments quickly step in to subsidize the incremental tariffs, especially on residential consumers. Further, though the subsidy has to be a budgetary transfer, the state government force the utilities, through creative accounting practices, to raise debt to cover for the higher burden.

In the circumstances, any meaningful attempt to wipe the slate clean and initiate genuine reforms in the finances of state utilities has to go beyond loss reduction and tariff revision mandates. There are atleast two areas which require immediate attention.

One, the most urgent challenge is the problem of free agriculture supply. Agriculture is critical because it not only contributes to the commercial losses, but also a large proportion of the free power subsidy burden gets transferred to the balance sheets of the utilities. In fact, agriculture is one big black hole in energy audits into which all undesirable and unaccounted for supply units are lumped. A more reliable audit could reveal even higher losses in many utilities. Therefore agriculture supply has to be metered and audited. Incentives have to be introduced to optimize and ration consumption and improve feeder level energy audits within utilities. It will also make rural supply sufficiently remunerative for utilities to focus on improving supply quality and reducing losses.

Second, there has to be a mechanism to take the burden of costly power purchases - mostly peak-time and summer spot market purchases - off the utilities books. Whether they are passed through to consumers, atleast certain categories, is a matter of important detail. Borrowings to finance such purchases have come to  form an increasingly large share of the accumulated debts on utilities' balance sheets. Both these measures will not be easy and will risk strong political opposition. But without addressing these two issues, especially the former, it is certain that the state utilities will require another round of debt restructuring in a decade.  

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