The state power utilities? (SPUs) losses are not a serious fiscal consolidation concern at the aggregate level. However, they are a serious threat for fiscal consolidation in a few states. The inability to resolve issues such as reducing aggregate technical and commercial (AT&C) costs, cross-subsidisation and tariff hikes may lead to a structural deficit. SPUs? losses could threaten the fiscal consolidation plan for five states, as set out in the Thirteenth Finance Commission (TFC).

In FY10, SPUs in nine out of 30 states were in profit after state government subsidies. However, the deficit in five states alone (Rajasthan, Tamil Nadu, Uttar Pradesh, Madhya Pradesh and Bihar) accounted for 70.6% of the SPUs? total losses. Incremental losses in FY07-FY10 for these five states were 87.2% of the SPUs? aggregate losses.

Overall, the SPUs? finances are fragile, and their net worth declined by 50.1% y-o-y in FY10. In the last decade, state support to power utilities averaged 1% of GDP. In FY10, outstanding state loans and grants were R643.67 billion (1.0% of GDP) and loans from other institutions were R2,665.02 billion (4.1% of GDP). These may eventually fall on the states? balance sheets. The states with better financial management could absorb this, but their fiscal skills would be tested. Due to a limited fiscal space for state governments, aggregate subsidy realisation (subsidy received as a percentage of subsidy booked) declined to 56.1% in FY10 from 94.5% in FY07.

In India, the demand for power outpaces supply, and new capacity is only coming onstream slowly. This leads to higher dependence on short-term power purchases, which cost nearly twice as much as long-term power. The financial weakness is exacerbated by a reluctance to increase tariffs, low subsidies from state governments and high cross-subsidisation. SPUs are currently raising tariffs but at the same time are making huge power purchases in the spot market, offsetting the benefits of the price increases. Also, power tariffs for agriculture are subsidised by higher tariffs from the industrial and commercial sectors. Some states either offer free electricity to agriculture or at a nominal price leading to wasteful use of a productive resource.

State governments provide assistance to SPUs through state budgets. In September 2003, state governments issued

power bonds of R289.84 billion to central public sector undertakings to clear their outstanding dues from SEBs. In the budget estimate of March 2011, power bonds amounting to R158.77 billion were still outstanding on the books of state governments.

Out of the three pillars of the power sector?generation, transmission and distribution?distribution is delicate and incurring huge losses. The state power distribution sector is characterised by high AT&C losses and is unable to recover the cost of power supply through tariffs. Indian power tariffs are among the highest in the world but the losses are due to low tariffs for the domestic and agriculture sector. Poor governance and low investment in the distribution sector leads to power theft and low recovery. As TFC considered the fiscal profile of states in FY09 as an abnormal year, it suggested it could not be used for a roadmap for fiscal consolidation and used states? performance in the previous year (FY08) as the base year. TFC set a fiscal deficit reduction target of 3.0% of GSDP in FY12 for all non-special category states except Kerala, Punjab and West Bengal. For these three states, the target year was extended to FY15. Five special category states (Arunachal Pradesh, Assam, Himachal Pradesh, Meghalaya and Tripura) have to achieve a fiscal deficit reduction of 3.0% of GSDP by FY12. Four special category states (Manipur, Nagaland, Sikkim

and Uttarakhand) have to achieve this target by FY14, and the remaining two (Jammu & Kashmir and Mizoram) have to achieve it by FY15.

The aggregate debt of SPUs increased by a CAGR of 19.3% between FY07 and FY10. It increased at a faster pace in the fiscally stressed years of FY09 and FY10 when it rose by 22.6% and 27.0%, respectively. Debt by utilities from Andhra Pradesh, Goa, Haryana, Karnataka, Madhya Pradesh, Maharashtra, Rajasthan and Tamil Nadu increased at a much faster pace than the overall average. Power utilities from Arunachal Pradesh, Delhi, Kerala, Manipur, Orissa and West Bengal reduced their debt. The power sector deficits of Rajasthan (4.6% of GSDP in FY10), Tamil Nadu (2% of GSDP), Madhya Pradesh (1.9% of GSDP), Uttar Pradesh (1.5% of GSDP) and Bihar (0.8% of GSDP) exert additional pressure on state finances and it would be difficult for these states to achieve the fiscal consolidation targets set by TFC.

SPUs? dependence on the debt market for funds increased during FY09 and FY10. Power utilities from all states have debt from their respective state governments. In difficult financial periods, the state governments converted the debt into equity. This reduced the burden on the utilities and increased their net worth.

The lack of a regular revision of power tariffs is another reason for the fragile finances of SPUs. Although the Electricity Act 2003 focused on the rationalisation of tariffs and reducing cross-subsidisation, it achieved only limited success. Power tariffs are politically sensitive and are not often revised.

According to TFC, tariff increases of as much as 7% a year on average are needed to bridge the gap, even in the better performing states. In some poorly performing states, the tariff increase needed is as much as 19% a year. According to TFC, even in FY10, five states have not revised their tariffs in the last five years. It is only in FY10 and FY11 that state regulators focused on power tariff revisions. There is still high cross-subsidisation such as agriculture and domestic consumers from industrial and commercial users.

The difficulties in SPUs? finances outweigh the positives, leaving them stretched. It is more worrying for SPUs in Rajasthan, Tamil Nadu, Uttar Pradesh, Madhya Pradesh and Bihar. In Rajasthan, power tariffs were revised in September 2011 after a gap of more than eight years and in Tamil Nadu they were revised in August 2010 after a gap of more than seven years. West Bengal?s SPUs generated a surplus in FY08 and FY09 but the new government is reluctant to increase tariffs and this could lead to them going into deficit again.

A combined strategy of regular and sufficient revision in power tariffs coupled with a reduction of AT&C losses is important to improve the financial position of SPUs; increasing power tariffs alone would not help.

The author is director, Fitch Ratings India Private Ltd. Views are personal