The curious case of coal cess
It is not quite one of the best-kept secrets that India is a power-starved country. With annual per capita consumption of about 1,100Kwh, India trails most of its developing world peer group. In countries such as Iran and South Africa, this exceeds 2,500 and 4,000, respectively. The global average stands at around 2,500.
On the other hand, the average PLF (plant load factor) for coal-based power plants, which constitute about 60% of India’s total power generation capacity, continues to languish below 60%. Such low-capacity utilization is causing extreme financial strain on the entire power value chain—right from the lenders to the power distribution companies, to the power users. There is sizeable power capacity in the country, yet there are large pockets of unmet power demand. Systemic and regulatory shortcomings, largely legacy issues, have been responsible for this irony.
India’s power generation can grow comfortably at a compounded annual growth rate (CAGR) of more than 12% over the next five years—subject to demand. Improved utilization of existing power capacities and a healthy pipeline of new capacities clearly suggest that there will be enough power generation capacity in the medium term.
Poor availability at the consumer end, and low affordability are the key demand-side issues. Discoms’ (distribution companies, which are in most cases owned by state governments) poor financial health has been the biggest deterrent for power availability at end-consumers’ premises. They have been displaying a strange unwillingness—rather, inability—to increase power purchases, even though real demand by end consumers has been rising perceptibly. Starved of cash and with continuing losses, they are not signing fresh PPAs (power purchase agreements), citing high cost of power. Thus, end consumers continue to get suboptimal quantities of power.
Bolstering discoms’ power affordability can be a powerful way to enhance power consumption. This, in turn, can drive improvements in the standard of life for a large proportion of Indians, mitigate the distress of the power and banking sectors, and aid small and medium enterprises.
A close look at taxes levied on coal provides the answer here. It may sound implausible that total taxes on thermal coal work out to more than 65%, on an average, over Coal India’s basic price. Essentially, out of discoms’ cost of power of about Rs5.2/Kwh, more than Rs0.45/Kwh goes to the Central and state governments as taxes, cess, royalty and payment for DMF (district minerals foundation, aimed at the welfare of local communities)—just from coal. In particular, the GST compensatory cess (that has replaced the clean environment cess that existed before the GST roll-out) is a staggering Rs400 per tonne, i.e. about 40% of the average coal price. Other tax elements like royalty and DMF (together, about 17-18% of the coal price) and GST (goods and services tax, at 5% now) seem fair and logical, though.
Taxes on this part of power’s value chain need urgent rationalization. Total tax on the common grades of coal is more than 80%, which is higher than taxes on even alcohol, cigarette or luxury cars. Although optically these taxes and cess are applicable on coal miners and, hence, on power generators, ultimately, they are borne by end consumers across socio-economic segments, despite power being a basic necessity.
Removing the GST compensatory cess on coal can curb the cost of power by Rs 0.30/unit, which is almost half the gap between discoms’ cost of purchase, and price of power as per FY15 data. The tax revenue—about Rs 22,000 crore—that the Central government would forgo if this were to happen would effectively be transferred, in the shape of lower power cost, to discoms and thus to the state governments. So, the country’s total fiscal deficit math wouldn’t change much. This could slash discoms’ losses (that stood at about Rs40,000 crore in FY17) by 55% and set them on course to restart buying incremental power to satiate consumer needs. Of course, this cannot be a substitute for power pricing reforms.
The GST compensatory cess has been put in place after the implementation of GST to compensate state governments for the potential revenue shortfall from GST. This cess may seem like a good way to smoothen the teething issues in GST implementation. However, burdening an important sector like coal and power that is already saddled with a multitude of debilitating issues with such a steep tax for this purpose, seems unjustifiable.
Even earlier, when a similar amount was being charged as environmental cess, such a high rate was unfair, futile and self-defeating, given that coal usage cannot be stopped for the 195 gigawatts (GW) coal-based power capacity (plus the 50 GW in the pipeline) in India. Instead, the thrust on shutting down older, inefficient and highly polluting power plants should be intensified and permission should be refused to new coal-based power projects. Also, the government’s renewable energy push is showing results, more due to the latter’s commercial attractiveness, with fast-declining capital costs for renewable energy equipment. Not surprisingly, of the about Rs54,000 crore collected as clean environment cess since the latter was imposed in 2010, only about 30% has been spent on promotion of renewable energy sources.
Redressal of this flaw in our taxation system can be a game changer not just for the power sector, but for the entire economy, through the multiplier effect that it can unleash.
Vipul Prasad is founder and CEO of Magadh Capital, a long-only Indian equity fund based in Mumbai.
Comments are welcome at firstname.lastname@example.org