Column: Power tariff cuts unsustainable

Written by Prasad Koparkar | Updated: Feb 27 2014, 08:34am hrs
The recent decisions by some states to slash power tariffs, poses a threat of reversal of the considerable progress towards cost-reflective tariffs made over the past few years, further erode the financials of power distribution companies (discoms) and reduce much-needed infrastructure investments in the sector.

Given the stretched finances of most state governments, these tariff cuts are not only unsustainable over the long run, they will also increase the risk of delays in subsidy payments to discoms and pressurise their debt-servicing ability. There could also be a negative, ripple effect on the finances of generation and transmission companies due to lower power off-take and delays in payment of dues.

In the broader context, low tariffs on a sustained basis will hurt investments in the power sector, which is already battling several other issues including lack of fuel availability and timely project clearance.

In January, some states approved power tariff cuts to reduce the power bills of consumers. While states such as Maharashtra and Delhi lowered tariffs for certain categories of consumers by 20% and 50%, respectively, Haryana rolled back tariff hikes implemented for 2013-14.

These tariff cuts are a setback to power-sector reforms of the last three years, particularly the move towards cost-reflective tariffs. Despite regular tariff hikes across states over this period, the deficit between average revenue realised (ARR) and average cost of supply (ACS) was R0.70 per unit in 2011-12 on a subsidy-booked basis. The burden of these tariff cuts will be largely borne by the respective state governments. In Maharashtra, for example, the state government will bear about 85% of the total subsidy amounting to R60.6 billion while the balance R10 billion will be borne by the state generation and transmission utilities.

An analysis by CRISIL Research to evaluate the ability of state governments to take up these liabilities

revealed that many of these states are already financially stretched, so they would find it challenging to bear the burden of additional subsidy, considering the Fiscal Responsibility and Budget Management (FRBM) limits. States such as Bihar, Tamil Nadu, Uttar Pradesh and Karnataka already have a high gross fiscal deficit (GFD)-to-gross domestic product (GDP) ratio. In fact, most states will breach their FRBM limits if they undertake significant power tariff cuts. Maharashtra and Delhi are relatively more comfortable on the FRBM front right now, but given the subdued economic outlook over the near term, the cuts in these states are also, clearly, not sustainable.

It is not just the finances of state governments that will come under strain. The finances of many state discoms will also become perilous as the risk of delays in subsidy payments will increase in view of the shaky financial situation in many states.

Any delay in subsidy payments will increase the working capital requirements of discoms, further stretch their debt-servicing ability, and also lead to delay in payments to generation and transmission companies.

More importantly, restricting tariff hikes will hamper the ability of discoms to invest in infrastructure to reduce the aggregate and technical (AT&C) losses that is necessary to lower their operational losses.

In some states such as Andhra Pradesh, Punjab and Haryana, subsidy contribution by state governments is already high (at 35-45% of total discom revenues), while it is significantly higher for Bihar, at 68%.

If the subsidy burden is shared with state generation and transmission companies, it will significantly erode their profitability since the financial position of most of these utilities is not very strong and requirement of funds for investment is high.

For instance, the Maharashtra governments proposal to make MahaGenco and MahaTransco to shareR10 billion of the total subsidy burden of R70.6 billion will entirely erode their combined profitability of R10 billion in FY12. This will severely impair the ability of these companies to undertake capital investments in the future, which are critical to meet the growing power demand and control transmission losses.

Despite significant tariff hikes by most state discoms over the last 3 years, the gap between ACS and ARR has remained. This, in turn, has impacted the ability of discoms to off-take power and also led to delayed payments to generation companies. As of December 2013, the total outstanding dues of discoms towards central generation and transmission utilities (such as NTPC, PGCIL, DVC and others) were R162.6 billion as compared to R69 billion as of December 2011.

Although a restructuring plan is being implemented in financially stressed states, we believe that only cost-reflective tariff hikes will eventually lead to sustainable improvement in the financial health of the power sector.

Because tariff cuts are unsustainable, and the FRBM Act limits their maneuverability, we believe that state governments will have to carry out course correction on power tariffs sooner rather than later. Consequently, we expect power tariffs to increase at a CAGR of about 6% over the next 5 years and the ARR and ACS gap to be bridged in 2017-18.

The author is senior director, CRISIL Research