A better bailout plan, yet not a permanent fix

The Indian electricity market beggars belief. Falling prices in spot trading markets suggest that there is a surplus of electricity waiting to be sold. The power cuts in many parts of the country tell us citizens are not getting electricity.

The problem is well known. Power generation companies reach most final consumers through state electricity boards (SEBs). These are bankrupt. So power generation companies are not keen to sell electricity to the power distribution companies because they are unlikely to get money in return. They have surplus power while there are blackouts in many areas. This is a very Indian variant of the missing markets problem that economists write about in their textbooks.

The new bailout of state power distribution companies announced last week has some good features. The most important is that the state governments are expected to foot most of the bill by taking over three-fourths of their SEB debts as well as taking ownership of future losses. It should hopefully deal with the problem of moral hazard that is embedded in every government bailout.

The decision to offer free power is always taken by state governments. It is only fair that they should now face the consequences. There are good reasons to worry about the financial implications for the budgets of states such as Uttar Pradesh, Bihar or Rajasthan, even though the deal has an accounting trick that allows state governments to not include the new debt in their fiscal deficit next year.

Eventually, cooperative federalism should work both ways. States should get more freedom to decide on how to spend money while they should also be held responsible for their choices.

Does such as bailout amount to throwing good money after bad? A lot depends on which direction the financials of the distribution companies are moving. A recent report by Credit Suisse analysts Lokesh Garg and Vaibhav Jain is based on the latest financial data from SEBs, which, published after an inexplicable lag of two years, shows that the combined cash loss of these utilities at the operating level has come down sharply in fiscal 2014.

The aggregate story hides a lot of regional variation, but the general improvement in SEB finances should hopefully mean that the new money will help them turn the corner.

Of course, a bailout can never be anything but a temporary solution. The biggest challenge will be for state governments to fix their political economy. Consumers will eventually have to pay for the power they consume. Theft will have to be minimized. These structural changes alone can bolster cash flows in the long run. These are not easy decisions in a country where free power is a standard feature in many election manifestos. But some recent decisions to hike electricity prices do not seem to have generated the expected electoral backlash.

State governments that want to provide cheap power to vulnerable parts of their population should seek new ways to get the desired result. Cash transfers are one clear option. Nandan Nilekani and Viral Shah have argued in their new book—Rebooting India—that power subsidies can be transferred directly to the bank accounts of beneficiaries. As with subsidies on cooking gas, the big advantage of this move will be that the subsidy burden will sit in government books rather than wreck SEB finances. Another advantage will be that there will be incentives for people to get registered meters in their homes.

Indian power reforms have been very messy. There has been relatively more success on the electricity generation front, despite recent problems with coal linkages. The problem on the distribution side has been almost intractable. The new bailout package is structured sensibly because it expects states to bear most of the financial burden. But at best, it provides breathing space before the next SEB crisis strikes. Remember that the current bailout comes just three years after a similar lifeline was thrown by the previous government.

The only way to break this vicious circle is through structural reforms in the way power is distributed. Cash transfers should be one element in these reforms.

Are cash transfers a viable solution to fix the SEB problem? Tell us at views@livemint.com