Column : Been there, done what

Written by Ashwini Chitnis | Ann Josey | Updated: Jan 26 2013, 05:15am hrs
Since 1996, there have been four bailout schemes for the state electricity distribution companies (discoms) and the recent Financial Restructuring Plan (FRP) keeps with this tradition. The last massive bailout was in 2001 based on the Ahluwalia Committees recommendations, which emphasised on operating discoms on commercial terms and improving their efficiency by reducing aggregate technical and commercial (AT&C) losses. Following this bailout, the Electricity Act 2003 came into force and laid down a framework for operationalising competition by way of open access, unbundling of discoms, de-licensing generation, and improving efficiency of the sector. It strengthened regulatory powers by spelling out clear provisions for tariff determination, reduction of cross-subsidy, advance payment of subsidy by state governments, thereby converting the conditions of the 2001 bailout into a binding law.

Unfortunately, despite a decade of reform, discoms are once again in financial distress on account of comparable reasons, and a bailout with similar terms (which are now legally binding) is being proposed. This article argues that the current crisis is a result of the failure of discoms, state electricity regulatory commissions (SERC), central and state governments and, importantly, banks also to ensure implementation of existing legal provisions. While the current bailout may be unavoidable, it does not address the issue of institutional accountability, which is at the root of this crisis. Let us first quickly understand how we (once again) landed in the current situation.

Why discoms are in a soup

The examination of accumulated losses and short-term liabilities shows that a high level of AT&C losses, a high proportion of short-term high-cost power purchases, and delays in payment of subsidies by state governments are three major reasons for discoms financial woes. Most debt-affected states have significantly high levels of losses, which act as a big drain on their finances. Power purchase accounts for around 70% of the discoms total expenditure and hence failure in procuring low-cost power results in power cuts on the one hand and purchase of high-cost short-term power on the other. The figure shows that the seven defaulting states have a significantly large share of high-cost short-term power in their overall power purchase cost.

State governments failure to disburse subsidies on time further worsens discom finances. Planning Commission estimates suggest that uncovered subsidies account for around 34% of accumulated liabilities. The revenue loss is further exacerbated by a lack of timely and adequate tariff revisions. States like Tamil Nadu, Uttar Pradesh and Rajasthan had not increased tariffs for several years, leading to the crisis. In the absence of an increase in revenue from tariff, discoms borrowed heavily from commercial banks to finance their high-cost power purchases as well as daily operations. The banks did not exercise restraint in lending to discoms, even in the face of an inevitable default. The Ahluwalia Committee report presciently identified the risk of moral hazard on part of discoms and banks not exercising financial prudence in anticipation of another bailout. A decade later, this risk has not only become real and apparent but worse is that it may persist as the bailout does not acknowledge this issue. In fact, banks which enabled discoms to accumulate huge losses are the primary beneficiaries of the bailout.

Interestingly, there are clear provisions in the Act and SERC regulations to tackle these situations. Almost all SERCs have empowered themselves to undertake suo motu tariff revision in case the discom does not file a tariff revision petition. Section 65 of the Electricity Act empowers SERCs to demand advance payment of subsidies from state governments, but no SERC has made use of this provision. Under multi-year tariff regulations, almost all SERCs have provisions for formulating and reviewing power procurement plans, making it possible to avoid high-cost short-term power purchases. Thus, failure on part of institutions responsible for ensuring implementation of legal provisions is mainly responsible for the current crisis. However, the proposed bailout package does not address this issue.

Dressing up debt

The FRP requires state governments to take over 50% of the outstanding liabilities of discoms by converting this debt into bonds and discoms are to service the remaining part. If a discom defaults, the state government ensures debt servicing. Banks pay for their folly by simply foregoing penal interest and principal payment for three years, and have to contend with a restructured loan. Discoms cannot borrow from banks to finance present short-term losses and an alternate arrangement is proposed where three-year support on a diminishing scale will be given on a case-by-case basis. This alternate arrangement is, in fact, a bailout within a bailout. The scheme is subject to certain mandatory conditions such as upfront subsidy payment using feeder level data, streamlining metering and billing processes, annual revision of tariff to reduce cost-revenue gap. It seeks a commitment to reduce short-term power purchase and liquidate regulatory assets. Recommendatory conditions include a time-bound plan for power procurement, cross-subsidy reduction, operationalising open access and cleaning up accounts. However, most of the proposed conditions are mandatory legal provisions and the reason that we ended up in a crisis was that these were not implemented as envisaged under the Act. The scheme, however, does not analyse this aspect at all, nor does it provide any solution that will lead to better compliance.

Treat symptoms, not disease

Focusing merely on regular tariff increases without addressing fundamental institutional issues, coupled with the risk of moral hazard, may lead us to yet another bigger bailout in future. The Centre is not taking any steps to ensure that SERCs who are responsible for ensuring accountability of discoms and state governments function in an autonomous and effective manner. As the table shows, even the basic requirement of appointing members for SERCs is not being fulfilled in most states and the Centre has seldom raised this issue. There has been hardly any thought or investment in improving the capacity of civil society to participate in regulatory processes, which can act as an effective means of ensuring accountability. While the current crisis is bad enough, it is worse to not use it as an opportunity to avert future ones. It is very unfortunate that we may have to wait for yet another crisis to ensure the proper functioning of the very institutions that govern the sector.

The authors are with Prayas Energy Group, Pune