The current liquidity crisis in the power sector of several states in India presents a crisis of unprecedented magnitude. With accumulated losses close to Rs.1 trillion and outstanding liabilities in excess of Rs.3 trillion to Indian financial institutions, the anatomy of the current crisis is entirely different from the one that the sector was faced with in 2002-03 (which led to the one-time settlement scheme with central power sector undertakings under the aegis of the Montek Singh Ahluwalia committee). What makes the current crisis alarming is that the affected parties in this case are the Indian financial institutions—public sector banks and power sector non-banking financial companies (NBFCs) in particular.
Up until 2008, governments in several states, buoyed by growing private investment proposals and the ability to sustain higher levels of subventions in the face of strong economic growth, had not only neglected reforms but have been guilty of completely subverting the independence of utilities and regulatory institutions. The central government too has been guilty over the years in structuring several capital expenditure schemes for state utilities without enforcing performance linkages, which were originally conceived to be part of such programmes.
The current crisis has presented an opportunity for the central government to overcome political resistance to necessary reform measures in the power sector. It is probably the last opportunity the country can afford to make this crisis count for the sake of the country.
A proposal to restructure the debt of state electricity boards has been approved by the Cabinet, bringing together the larger states, the Reserve Bank of India and the finance ministry to agree on rescheduling half the loans owed by the state-owned distribution utilities and restructuring the other half in the form of bonds to be issued by the state governments to the lenders. A transitional finance mechanism is also part of the package and will allow cash-starved state utilities to borrow much-needed transitional finance over the next three years.
Given the magnitude of the outstandings, it will require some magic to fit such additional state liabilities within the Fiscal Responsibility and Budget Management (FRBM) targets but that is just a matter of presentation, given that the distribution utilities are mostly state-owned and hence their losses should have reflected in the consolidated holdings of the state government, had it been a corporate entity
What one hopes for, and which the Ahluwalia committee warned of in 2002-03, is that the moral hazard of such a restructuring scheme (i.e., the tendency of the state governments and state-owned utilities to slip back into doing much the same in the hope of a future bailout) is sufficiently addressed through strong contractual quid pro quos from the state government and utilities.
All central government schemes and the current restructuring measures must link back to progress along a simple, objective framework for measuring performance improvements.
In the past, the APDRP (Accelerated Power Development and Reforms Programme) scheme linked incentives to cash losses but did not go far enough to encompass the state government and place the responsibility of tariff revisions at its doorstep. The current proposal, of placing the responsibility for fuel and power cost increases to be passed through by means of automatic tariff adjustments and agreeing to mandatory tariff filings, on the state governments, would be a significant step forward in the right direction.
One also hopes that the central government does not lose this opportunity to push through mandatory private participation in the distribution sector, which is the only means of transforming the cultural orientation of distribution utilities and making efficiency improvements sustainable. At the moment, several states have shown encouraging signs of efficiency improvements in distribution in some years only to lapse back to erring ways with change in leadership or increase in government interventions. Competitive bidding in generation and transmission, which is being interpreted as optional, despite the benefits documented by Central Electricity Regulatory Commission (CERC) and deemed mandatory under the National Tariff Policy, should also be enforced.
The ministry of power must thank the crisis to have vested in it a degree of control over the distribution sector. It should quickly follow up with a transparent, objective performance framework to measure the performance of not only the utilities but also the state government and regulators in the states, given the inter-linkages between these three arms. It is also for the central ministry to keep the Electricity Act and Policies thereunder dynamic and responsive to the times.
Shubhranshu Patnaik is a senior director, consulting, energy and resources, Deloitte Touche Tohmatsu India Pvt. Ltd.