India Power Sector Review More Power to India: The Challenge of Distribution Sheoli Pargal and Sudeshna Ghosh Banerjee Copyright © 2014 The International Bank for Reconstruction and Development / The World Bank Group 1818 H Street, NW Washington, DC 20433, USA All rights reserved Cover photo credit: NOAA The findings, interpretations, and conclusions expressed in this report are entirely those of the authors and should not be at- tributed in any manner to the World Bank, or its affiliated organizations, or to members of its board of executive directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement or acceptance of such boundaries. Acknowledgments The India Power Sector Review was carried out at the request of the Department of Economic Affairs in the Ministry of Fi- nance, and the Planning Commission of India. Led by Sheoli Pargal and Sudeshna Ghosh Banerjee, the team comprised Mohua Mukherjee, Kristy Mayer, Mani Khurana, Pranav Vaidya, and Bartley Higgins. Amrita Kundu, Arsh Sharma, and Joeri de Wit provided research, econometric analysis, and presentational assistance. Shaukat Javed, Harriette Peters, and Vinod Ghosh provided able administrative support. The work was supervised by Jyoti Shukla and Salman Zaheer. The team is grateful to Ashish Khanna, Rohit Mittal, Kavita Saraswat, and Kwawu Gaba for discussions and constructive ideas. Crucial analysis, inputs, and insights were provided by consulting teams at Deloitte Touche Tohmatsu India Pvt. Ltd. (Shubhran- shu Patnaik and Anujesh Dwivedi), Mercados Energy Markets India Pvt. Ltd. (Anish De, Puneet Chitkara, Anvesha Paresh, Kumar Sanchit and Debadrita Dhara), and PricewaterhouseCoopers Pvt. Ltd. (Ashok Varma, Debasis Mohapatra and S. Johnny Edward). The team thanks the peer reviewers Vivien Foster, Lucio Monari, Sameer Shukla, and Luis Andres as well as Ashok Lavasa (former Additional Secretary, Ministry of Power) and Sushanta Chatterjee (Deputy Chief [Regulatory Affairs], Central Electricity Regula- tory Commission) for substantive comments. Finally, the team appreciates the advice and suggestions of the Technical Advisory Panel constituted for this task: Ms. Jyoti Arora Joint Secretary, Ministry of Power Mr. J.L. Bajaj Former Chairman, Uttar Pradesh Electricity Regulatory Commission Mr. Shantanu Dixit Coordinator, Prayas Energy Group Mr. Rajat Misra Senior Vice President, SBI Capital Markets Mr. Sunil Mitra Former Power Secretary, Government of West Bengal Dr. M. Govinda Rao Director, National Institute of Public Finance and Policy Mr. Anil Sardana Managing Director, Tata Power The team gratefully acknowledges financial support from the Energy Sector Management Assistance Program (ESMAP), the South Asia Poverty and Social Impact Analysis (PSIA) Trust Fund, the Australian Agency for International Development, and the Asia Sustainable and Alternative Energy Program (ASTAE). Bruce Ross-Larson and his team at Communications Development Incorporated edited this report. i Abbreviations and Acronyms discom distribution company MW Megawatt EA Electricity Act RGGVY Rajiv Gandhi Grameen Vidyutikaran Yojana GDP Gross Domestic Product SEB State Electricity Board kWh kilowatt hour SERC State Electricity Regulatory Commission All amounts are in Indian Rupees unless otherwise indicated. All dollar amounts are in U.S. dollars. Indian Rupees are converted to dollar amounts using the year specific exchange rates taken from the World Development Indicators. ii India Power Sector Review More Power to India: The Challenge of Distribution Introduction and financial shortcomings of distribution have repeatedly led to central bailouts for the whole sector even though power The government of India has emphasized that an efficient, is a “concurrent”1 subject under the Indian constitution and resilient, and financially robust power sector is essential for distribution is almost entirely under the control of state gov- growth and poverty reduction (Ministry of Power 2005). Al- ernments. Ominously, the sharp increase in private invest- most all investment-climate surveys point to poor availability ment and market borrowing in recent years has increased the and quality of power as critical constraints to commercial and potential for power sector difficulties to spill over to lenders manufacturing activity with implications for national compet- and thus affect the broader financial sector. Government ini- itiveness. Further, more than 300 million Indians live without tiated reform efforts initially focused on the generation and electricity, and those with power must cope with unreliable transmission segments, reflecting the urgent need for adding supply, pointing to huge unsatisfied demand and restricted capacity and the complexity of issues to be addressed at the consumer welfare. consumer interface. Consequently, distribution reforms have This report reviews the evolution of the Indian power lagged behind but now need to be the highest priority for sector since the enactment of the landmark Electricity Act sector improvement efforts going forward. This report an- (EA) of 2003 with a focus on distribution as key to perfor- alyzes the multiple sources of weakness in distribution and mance and viability of the sector as a whole. While all three identifies key challenges to improving performance in the segments of the power sector—generation, transmission, and short and medium term. distribution—are important, revenues ultimately originate with the customer at distribution, so subpar performance Evolution of Policies and Institutions there affects the entire value chain. The persistent operational India implemented sweeping economic reforms in 1991 following a debilitating balance-of-payments crisis. The state-dominated power sector was inefficient, hamstrung • 300 million Indians live without electricity, 200 million in by years of under-maintenance and inadequate investment, villages that are connected to the electricity grid. and had large financial losses. With only 70,000  megawatts • Per capita annual electricity consumption at 780 kWh is (MW) installed, it was also extremely short of generation ca- among the lowest levels in the world. pacity. In light of the massive additions to capacity needed • In 2006, 41 percent of Indian firms owned generators, to support growth, private sector participation was seen as supplying almost 10 percent of the electricity they used. a necessary complement to public investment. Beginning in 1991 with amendments to the Electricity Supply Act, the sec- • Power outages or surges led to a 7 percent loss in tor was opened to private participation in generation. As the production or value of merchandise. economy continued to face crippling power shortages, indi- • Getting a power connection requires seven different vidual states started restructuring their vertically integrated procedures and takes more than 67 days. state electricity boards (SEBs) and establishing state electricity 1 2 | INDIA POWER SECTOR REVIEW Figure 1. Timeline of Sector Unbundling and Establishment of Regulatory Commissions 1998 2002 2004 2010 Gujarat 2000 Chhattisgarh Assam HP Haryana AP Delhi Meghalaya 2008 Meghalaya 1996 MP Rajasthan Kerala Uttarakhand Goa Punjab 2012 Orissa UP UP Other Tripura 2006 Nagaland TN Bihar 1997 1999 2001 2003 2005 2007 2009 2011 AP Assam Jharkhand Bihar WB Chhattisgarh Other Delhi HP Gujarat Sikkim Karnataka Uttarakhand MP Maharashtra Maharashtra Punjab Manipur/Mizoram TN WB Unbundling date SERC creation date Both Source: Pargal and Mayer 2013. regulatory commissions (SERCs) under their own state reform state utilities reflected internal and external shortfalls in gov- legislative initiatives to improve performance (figure 1). The ernance, the EA mandated unbundling and corporatizing the Electricity Regulatory Commission Act of 1998 set up the Cen- SEBs and establishing independent regulators at the central tral Electricity Regulatory Commission and brought regulatory and state levels as well as the Appellate Tribunal, all in order to consistency to the states. bring about a more accountable and commercial performance Despite these efforts, the commercial performance of culture.2 Subsidiary policies that followed laid the ground- state utilities continued to deteriorate, with losses mount- work for competitive bulk procurement of power, multiyear ing to Rs 250 billion in fiscal 2002 (US$6 billion or 1.5 percent tariff frameworks, rural electrification, and renewable energy of India’s gross domestic product [GDP]). In 2002, a decade expansion. after the opening of the sector, total SEB debt to central pub- lic power suppliers had risen to Rs 400 billion (US$8.5 billion), Impressive Achievements in threatening their financial solvency and resulting in a central Many Dimensions bailout of the state power utilities. The EA 2003, responding to these developments, was Bolstered by a sound policy framework and a favorable eco- designed as a forward-looking, pro-competitive policy and nomic environment, the sector has taken giant strides on institutional framework for developing the power sector. many fronts. Generation capacity tripled between 1991 and Superseding existing legislation, it de-licensed thermal gener- 2012, bringing installed capacity to 214 gigawatts, boosted by a ation; set timelines for open access to transmission and distri- surge in the share invested by the private sector from 3  to 29 bution, providing choice to power procurers and end-users; percent (figure 2). Renewable energy generation capacity, both introduced power trading as a licensed activity to foster com- on- and off-grid, increased sharply in response to government petition; and encouraged private sector entry into generation incentives such as feed-in tariffs on the generation end and and transmission. Considering that the dismal performance of renewable purchase obligations on the distribution end, as More Power to India: The Challenge of Distribution | 3 Figure 2. Generation Capacity Added Over Time Figure 3. Number of People Gaining Access (2000–10) by Income Quintile 2012 62459 Richest Quintile 47 mn people 14139 Private Poorest Quintile 2006 State 49 mn people Central 2001 11067 2nd Quintile 1992 4th Quintile 2484 59 mn people 61 mn people 0 50,000 100,000 150,000 200,000 250,000 MW Source: Mukherjee 2013. 3rd Quintile 66 mn people well as renewable energy certificates that have promoted trade in renewables. Starting with 18  MW in 1990, grid-con- Source: Banerjee and others 2013. nected capacity rose to 25,856  MW in March 2013—12  per- cent of total capacity. Off-grid renewable energy capacity stands at 825 MW. By recognizing trading as a licensed activity; opening entry population in 2000 to 74 percent in 2010, on the back of an into generation; permitting multiple distribution licensees; in- ambitious central scheme—the Rajiv Gandhi Grameen Vidyu- troducing a “smart” transmission tariff to relieve network con- tikaran Yojana (RGGVY), with the number of new users fairly gestion through point-of-connection pricing; and separating uniformly distributed across income quintiles (figure 3). The transmission from dispatch, trading, and generation along with bulk of new consumers were located in rural areas, where open access, the EA has led to the development of an active electricity access rates jumped 18 percentage points, to 66 power market and power exchanges that have eased the entry percent from 48 percent. of latent (captive) capacity into the market. The move from Promising models to obtain efficiencies from private negotiated memorandums of understanding with guaranteed participation in distribution have been developed but need rates of return to investors to market-driven competitive pro- to be scaled up for impact. Globally, private participation has curement brought forth a huge private response in generation long been considered an effective way of resolving efficiency and very low tariff bids (although recent experience indicates issues in distribution. In India, the “legacy” private distribution that allocating fuel-price risk to bidders may have been unre- utilities in Kolkata, Mumbai, Surat, and Ahmedabad, with their alistic and is now being adjusted). Subsequently, the shift from impressive performance on efficiency and customer service, feed-in tariffs to reverse auctions underpinned the expansion have been recognized as obvious examples of the potential of solar capacity from 17.8 MW in 2010 to 1,440 MW in 2013 gains from private participation. They were the inspiration be- while competitive bidding for projects under the National hind the public–private joint ventures in power distribution Solar Mission drove down prices for grid-connected solar en- ergy to as low as Rs 7.49 (US$0.15) per kilowatt-hour (kWh). A state-of-the-art integrated transmission grid that can balance • Between 2000–10, 283 million Indians gained access to demand and load flows across the country has been realized– electricity. with the recent connection of the southern grid, all of India is now synchronously connected in a single grid. • The electrification rate rose by 2.4 percent annually While successes in distribution have been less wide- between 2000–10. spread than those in generation and transmission, a major • Two-thirds of the population without electricity belongs to achievement in this segment has been the sharp increase the bottom 40 percent of the income distribution. in access to electricity. Access rose from 59 percent of the 4 | INDIA POWER SECTOR REVIEW taken forward first in Orissa, with limited impact, then in Delhi (learning from Orissa’s experience) with greater success. Rec- Delhi, Kerala, and West Bengal were the only states in 2011 that ognizing the limited political space for such “privatization,” were profitable without requiring subsidies. the EA 2003 established the concept of “distribution fran- chises.” Following the success of the Bhiwandi franchise op- goals—deteriorated sharply over 2003–11. Power sector af- eration in Maharashtra, which demonstrated the considerable ter-tax annual losses excluding subsidies came to Rs 618 bil- efficiencies and reduction in losses that could be achieved, lion (US$14 billion) in 2011. These losses, equivalent to nearly private participation through the franchise route is today 17 percent of India’s gross fiscal deficit and around 1 percent being explored in Madhya Pradesh, Maharashtra, and Uttar of GDP, are overwhelmingly concentrated among distribution Pradesh. A push toward rural franchises has also occurred, to companies (discoms) in the unbundled states, and SEBs and help state utilities manage (metering, billing, collection, and power departments in the states that have not unbundled. operation and maintenance) low-income and low-consump- When subsidies3 are included (as revenue), recorded losses fall tion rural distribution networks, which have expanded under by more than 50 percent to Rs 295 billion (US$6.5 billion). Six the RGGVY program. states reported profits in 2011, but only three would have re- ported a profit if subsidies had been excluded: Delhi, Kerala, The Agenda for Addressing Distribution and West Bengal (figure 4). Total subsidies booked by power Finances Must Now Be a Priority sector utilities amounted to Rs 323 billion (US$6.9 billion) in Despite considerable progress in implementing EA man- 2011.4 dates and associated policies over the past decade and Aggregating profits and losses over time, sector-wide ac- lowered physical losses, the distribution segment continues cumulated losses stood at Rs 1,146 billion (US$25 billion) in 2011, to lose money. Utility finances—critical to realizing sector more than twice the value in 2003 (in real terms).5 Accumulated Figure 4. Profit/Loss after Tax and Subsidies Booked, 2011 (Rs billion) Profits Profits without with a a subsidy subsidy Losses without subsidy Losses with subsidy 120 100 80 60 40 20 Rs billion 0 -20 -40 -60 -80 -100 -120 -140 u rn l tti a .B a An jarat Gu ka P. ra a d m kim ga . O r M er m Ke i r ar an Ha tra As a eg am a Pu r Jh njab Tr d ad a Ut P. il N P. M nd Sik h Na al P Ka nga lh u Ra he ha M pur lay W ral ha iss ta Go an ad ar an an ra th ip ra a Ta tar a De M jasth la h s hy sg Bi at t ry Ch O r kh kh h izo ha an dh as e O i ac ar m ah M Hi Ut Profits excluding subsidy Subsidy Profits including subsidy Source: Khurana and Banerjee 2013. More Power to India: The Challenge of Distribution | 5 Figure 5. Accumulated Losses by Segment, 2003–11 In 2011 100 0 • Uttar Pradesh, Madhya Pradesh, Tamil Nadu, and Jharkhand -100 Generation accounted for almost 60 percent of the power sector’s Transmission -200 DIstribution accumulated losses. Rs billion -300 SEB/PD -400 • Uttar Pradesh alone accounted for 40 percent of sector- -500 accumulated losses. -600 -700 • Only Kerala, Gujarat, Andhra Pradesh, Goa, and West -800 Bengal had accumulated profits. 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Khurana and Banerjee 2013. this debt (36 percent in 2011), followed by generation compa- nies, including independent power producers. Of great con- cern is the fact that many discoms have relied on short-term losses grew at a compound annual growth rate of 9 percent loans to meet operating expenses in recent years: long-term in real terms from 2003, though the share of losses relative loans declined from 87 percent of total sector borrowing in to GDP remained stable at about 1.3 percent, largely because 2007 to 77 percent in 2011. the economy also grew strongly over this period. Discoms and Mounting debt and continuing losses have led to a pre- bundled utilities (SEBs and power departments) are once again cipitous decline in overall discom creditworthiness—in the largest contributors to accumulated losses,6 although Uttar Pradesh, Rajasthan, Meghalaya, and Haryana, power their share of the total has fluctuated from 90 percent in 2003 sector debt exceeded 10 percent of state GDP in 2011 (fig- down to 79 percent in 2008, and back up to 86 percent in 2011 ure 6). Facing the prospect of huge and increasing nonper- (figure 5). forming assets and approaching their sector exposure limits, Sector losses have been financed by heavy borrowing by by late 2011 lenders pulled the plug on loss-making utilities. As all segments of the value chain. Total sector debt grew to credit dried up, these discoms were unable to pay for power Rs 3.5 trillion (US$77 billion) in 2011, equivalent to 5 percent of purchases, with a knock-on effect on upstream (generation) India’s GDP. Discoms are responsible for the largest share of investor sentiment. The absence of alternative buyers for Figure 6. Debt Owed by State Utilities, 2011 Debt owed, 2011 Rajasthan (Rs billions) 18% 650 600 Size of bubble = Debt as a share of state GDP, 2011 (%) 550 500 Uttar Pradesh 450 Maharashtra 3% 43% 400 Andhra Pradesh 350 5% Tamil Nadu Haryana 10% 10% 300 Madhya Pradesh Punjab Karnataka 8% 250 8% 5% Delhi Bihar 7% 200 Gujrat 5% Jharkhand Orissa 2% 150 5% West Himachal 7% Chhattisgarh Other Pradesh 5% 100 Kerala Other Bengal 8% 8% Uttarakhand 1% 0.5% 3% 50 1% Goa 0 Assam 0.3% -50 -30 -20 1% -10 Manipur Nagaland 0 Meghalaya 10 20 30 1% 2% 12% Rate of debt growth, 2003–11 (%) Source: Khurana and Banerjee 2013. 6 | INDIA POWER SECTOR REVIEW or more of net worth. At the extreme, the funded exposure In 2011 of some smaller banks exceeds their net worth, leading to • The top 10 indebted states accounted for 78 percent of concerns about contagion to the financial sector and possi- India’s total power sector debt. bly other parts of the economy if poor power sector perfor- mance leads to difficulties for some or all of these financial • In Rajasthan, Meghalaya, and Haryana, power sector debt institutions. as a share of state GDP was more than 10 percent. Thus, two decades after the initiation of reforms, an in- • Power sector debt was a startling 43 percent of state GDP efficient, loss-making distribution segment and inadequate in Uttar Pradesh. and unreliable power supply have become major constraints to India’s aspirations for growth, inclusion, job creation, and middle-income country status.8 The peak electricity supply power has spelled trouble for power generation companies, deficit today stands at 10.5  percent, and the overall deficit which are overly dependent on state discoms as customers. at 7.5 percent. More than 300 million people remain without This, in turn, has meant a simultaneous slowing of investment electricity, and the level of per capita annual consumption, at in generation, also resulting in difficulties in that segment of 780 kWh, is among the lowest in the world (Press Information the sector as significant funds are locked up in generation Bureau 2011). Despite the low tariff bids from competitive pro- projects that have had to be delayed or shelved. Thus, at the curement, the cost of power purchased by utilities has been end of 2011, just 10 years after being bailed out, the sector was increasing. And while the private sector has enthusiastically looking at another rescue from the center, four times larger participated in building power plants, there has been less of than before.7 an interest in inviting private participation into distribution, The 2011 crisis was different from that in 2001 because where its expertise in raising efficiency is most needed. this time players from outside the power sector and govern- ment were involved. Lending by banks and financial institu- tions to all segments of the sector has implicitly relied on the Analyzing Operational and Financial quasi-guarantee of state governments in the face of known Performance of Distribution insolvency of discoms, the offtaker and source of revenues Aggregate technical and commercial losses, which measure for the entire sector. In 2011, about half the sector’s borrow- utility operational and financial performance, have fallen ing came from commercial banks. Additional amounts were from 38 percent to (a still-high) 26 percent over 2003–11 (fig- lent at concessional rates by financial institutions, such as the ure 7). Aggregate technical and commercial losses consist of Power Finance Corporation, the Rural Electrification Corpora- distribution losses,9 which are comprised of physical losses tion, and the Infrastructure Development Finance Company, due to both technical and non-technical factors, and losses to bring the total contribution of commercial banks and fi- from collection inefficiency. Distribution losses have dropped nancial institutions to 86 percent of power-sector borrowing. from 32 percent in 2003 to an average of approximately 21 per- The flow of liquidity limited the pressure on discoms to im- cent in 2011. So despite the encouraging trend, utilities have prove performance and on state governments to permit tariff still not been paid for more than one-fifth of the power they increases. It was not until 2011, when banks were directed to stop lending to insolvent utilities, that states reacted to push through tariff increases (Unnikrishnan and Gadgil 2011). Such In 2011 profligate lending has harmed banks’ capital adequacy and net worth. More than half of 13 major state-owned banks have • The absolute amount lost was highest in Tamil Nadu, funded loans to the power sector amounting to 50 percent followed by Rajasthan and Andhra Pradesh. • Some states, including Mizoram, Nagaland, and Manipur, lost more than 100 percent of distribution revenues More than half of 13 major state-owned banks have funded earned. loans to the power sector amounting to 50 percent or more of • Overall, more than one-fifth of power supplied by utilities net worth. was not paid for. More Power to India: The Challenge of Distribution | 7 Figure 7. Aggregate Technical and Commercial Losses, 2003–11—Best and Worst Performers by State Top 10 average Bottom 10 average 70 All India average 2004-07 2008-11 61% Top 5 Top 5 60 54% 1. APEPDCL (14%) 1. APEPDCL (11%) 2. HPSEB 2. Goa PD 50 3. APSPDCL 3. Chhatt. SEB 4. Goa PD 4. UG VCL 5. APNPDCL 5. DG VCL 40 38% percent Bottom 5 Bottom 5 30 26% 44. Poorv VVN 48. Sikkim PD 45. Jharkhand SEB 49. SESCO 18% 46. Other 50. Other 20 47. Bihar SEB 51. Manipur PD 13% 48. Manipur PD (83%) 52. Other (71%) 10 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 2009–10 2010–11 0 Source: Khurana and Banerjee 2013. purchased and supplied. In 2011, the lowest distribution losses were reported in Kerala, at about 12 percent, similar to inter- Gross mismanagement of cash flows is indicated by the time national best practice. Andhra Pradesh, Goa, and Punjab also taken to collect payments, which averaged 170 days in 2011, recorded distribution losses of less than 15  percent. While with the ten worst performing utilities averaging 489 days. distribution’s contribution to total utility losses has fallen in more than two-thirds of states, performance has deteriorated come down from 213 to approximately 170 days from 2003–11, in nine states, most dramatically in Uttar Pradesh and Orissa. with the ten best performers averaging 21 days in 2011, but the To understand the relative contribution of different fac- ten worst—indicating gross mismanagement of cash flow— tors to performance, distribution-utility revenue losses10 averaging 489 days. can be decomposed as follows (figure 8): losses from under- In 2003, states were, in aggregate, charging an average pricing (average billed tariffs below cost-recovery tariff levels), billed tariff12 well above cost recovery,13 and losses that year from under-collection (not collecting the full amount billed), were overwhelmingly driven by distribution losses—that and from physical losses of energy (losses above international is, above the norm physical losses of energy. By contrast, norms due to technical reasons or due to non-technical fac- in 2011, states were, in aggregate, charging an average billed tors, such as theft). In 2011, the absolute amount lost was high- tariff below cost recovery. Thus, underpricing emerged as est in Tamil Nadu, followed by Rajasthan and Andhra Pradesh; an important contributor to losses, although distribution in- losses in Mizoram, Nagaland, and Manipur, among others, efficiencies, while smaller than in 2003, continued to be the were more than 100 percent of distribution revenues earned. largest contributor to total losses. Collection efficiency11 has generally remained stable, ris- Across all states, the margin of cost recovery declined ing from 89 percent in 2003 to 94 percent in 2011. Most states over 2003–11 because tariff increases failed to keep pace are above 90  percent, although performance declined in with cost increases. While in 2011, the average billed tariff was about half the states during 2003–11. The time taken to collect payments—debtor days— is another operational inefficiency that has contributed, In 2003, tariffs did not meet cost recovery in only 7 states; in through the collection rate, to the poor financial perfor- 2011, this number was 14. mance of distribution utilities. Average debtor days have 8 | INDIA POWER SECTOR REVIEW Figure 8. Decomposition of Losses, 2003 and 2011 Projections for the end of the 12th Plan show that even if (Rs 2011 billion) tariffs rise 6 percent per year to keep up with the cost of 700 +123 supply, annual losses in 2017 will likely amount to Rs 1,253 billion (US$27 billion). 600 +86 =583 537 +151 500 higher than cost recovery in 15 states, technical losses, theft, Rs billion 400 346 and under-collection can (and often do) lead to an absence of 300 revenues from a significant amount of power supplied by utili- 200 ties, resulting in financial losses. The fact that most utilities still =138 have losses despite having tariffs at or above cost recovery 100 -522 levels reinforces how much operational inefficiencies contrib- 0 ute to utility losses. Only Delhi, Kerala, and West Bengal had Distribution Collection Underpricing Total Distribution Collection Underpricing Total tariffs that covered costs in 2011 and made a profit without requiring subsidies (see table 1). The Sector Operating Environment Has Contributed to Discom Financial 2003 2011 Difficulties Source: Khurana and Banerjee 2013. On the cost side, unforeseen shortages of fuel (mainly coal) and poor planning by discoms have led to a steep rise in the procurement planning by discoms, which has led to last-min- price of bulk power. This has led to a growing gap between ute purchases of power for supply to end-consumers. Such discom costs and revenues (figure 9). While average revenues purchases must be procured from the spot market and tend grew at an impressive real compound annual growth rate of to be more expensive than power contracted for longer pe- 6 percent over 2003–11, the average cost of supply rose at a riods. A sharp increase in the use of imported coal, which is real compound annual growth rate of about 7 percent, grow- often two to three times as expensive as domestic coal, and ing by 70 percent in real terms over the period. The share of power producers’ increased use of e-auctions, which are typ- power purchases in total discom costs rose from 56 percent in ically expensive, to purchase coal have further pushed up the 2003 to 74 percent in 2011. Power has become more expensive cost of power generation. Rising interest expenses, driven by because of a decline in domestic fuel availability resulting in discoms’ increased borrowing to meet cash-flow needs (often an acute increase in the price of fuel and because of poor due to inadequate revisions in tariffs), have also contributed Table 1. Tariff Performance and Utility Losses, 2011 Group Description States 1 Tariffs are not set at cost recovery, but states achieve profits with subsidies Andhra Pradesh, Rajasthan 2 Tariffs are not set at cost recovery, and states make losses with subsidies Assam, Bihar, Haryana, Punjab, Tamil Nadu, Tripura 3 Tariffs are not set at cost recovery, and states make losses without Goa, Himachal Pradesh, Manipur, Mizoram, Nagaland subsidies 4 Tariffs are set at cost recovery, but states do not achieve profits even Chhattisgarh, Jharkhand, Karnataka, Madhya Pradesh, with subsidies Maharashtra, Meghalaya, Orissa, Sikkim, Uttar Pradesh, Uttarakhand 5 Tariffs are set at cost recovery, and state achieves profits with subsidies Gujarat 6 Tariffs are set at cost recovery, and states achieve profits without subsidies Delhi, Kerala, West Bengal Source: Khurana and Banerjee 2013. Note: Subsidies refers to those booked by the distribution utilities. More Power to India: The Challenge of Distribution | 9 Figure 9. Average Cost and Average Revenue, 2003–11 4.5 4.0 Gap without subsidies Gap with subsidies 3.5 Average cost Average revenue with subsidy 3.0 Average revenue without subsidy Rs/kWh 2.5 2.0 1.5 1.0 0.5 0.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Khurana and Banerjee 2013. to higher costs. The escalation in cost is not always permitted political decision in many states) has also weakened utility as a pass-through, adding to the pressure on discoms.14 finances. The health of the distribution business is closely Inefficiencies and lack of coordination among the agen- linked to the share of agricultural consumers in the total. Not cies responsible have resulted in coal production and sup- only are these consumers heavily cross-subsidized by indus- ply well below projections.15 Approximately 76  percent of trial and commercial consumers as a conscious policy of the the coal consumed in India is used by the power sector, and government, but utilities usually require an additional ex- 67  percent of electricity generated comes from coal. Coal plicit subsidy contribution from the state to cover the cost India Ltd.’s monopoly on coal production and sales, coupled of serving them. The share of agriculture in total electricity with its inefficiency, has led to consistent shortfalls in coal consumption was 23 percent in 2011, while revenues from agri- availability against official estimates over the past two Plan culture were only 7 percent of the total (figure 10)–thus com- periods (2002–07 and 2007–12). Plan targets for coal produc- pensation from the state budget to cover the cost of supply tion have been overly optimistic considering the volume of to agriculture is critical to utility financial viability. exploration undertaken in earlier years. Poor coordination The problem for utility finances arises because there is among the multiple agencies that need to provide clearances often a gap between the volume of subsidies booked by has added long delays to mine development. Infrastructure utilities as compensation and the amount received from for evacuation of coal produced has not kept up with pro- the government (figure 11). This worsens the economics of duction, either. The gap between coal requirements for plants already-struggling utilities, undermining their creditworthiness that had been awarded coal linkages and that were to be and preventing them from investing to improve service deliv- commissioned during the Plan period and the actual increase ery. The gap was Rs 119 billion (US$2.6 billion) for all states in in coal production, particularly over 2010–12, points to an ur- 2011. Since 2003, subsidies booked have grown by 12 percent gent need for harmonization between the concerned minis- per year, and subsidies received by 7  percent per year; the tries. In fact, a considerable volume of investment in thermal cumulative gap between them was US$10 billion for 2003–11.16 power plants with power purchase agreements based on the projected availability of cheap domestic coal is now likely to remain stranded. The share of agriculture in total electricity consumption was The expense of providing below-cost power to key con- 23 percent in 2011, while revenues from agriculture were only 7 sumer groups, such as agricultural and rural consumers (a percent of the total. 10 | INDIA POWER SECTOR REVIEW Figure 10. Consumer Mix (a) By consumption (b) By revenues 100 100 90 90 80 80 Agriculture 49 53 70 57 70 83 Domestic 60 60 79 74 percent percent Industrial and 50 50 Commerical and 40 25 40 Others 17 24 30 30 20 20 19 26 26 23 11 16 10 10 0 0 4 4 7 1993 2001 2011 1993 2001 2011 Source: Planning Commission 2011. received support, and was as high as six percent in Punjab and The opportunity cost of budget support to the power sector five percent in Uttarakhand (figure 12). As a share of the state is high. About 15,000 hospitals and 123,000 schools could budget in 2011, state support averaged about 2 percent but have been developed in 2011 if the power sector had not was 15 percent in Bihar and 22 percent in Uttarakhand. preempted the funds. A majority of states also subsidize a substantial por- tion of domestic consumption. Eighty-seven percent of all electricity consumed by domestic consumers in India was State support to the power sector includes explicit fiscal subsidized in 2010. As the domestic sector consumes almost transfers in the form of subsidy payments as well as sub- one-quarter of electricity sold, this is equivalent to 21 percent sidized loans and contributions of equity to utilities. Fiscal of all electricity consumed, with the average subsidy being Rs transfers to the power sector account for a significant share 1.5 per kWh. While 25 percent of households lack access to of state budgetary spending. On average, state support to electricity and therefore receive no subsidy, over half of sub- the power sector amounted to 1.3 percent of state GDP in sidy payments (52 percent) India-wide went to the richest 40 2011 across the 16 Indian states in which distribution utilities percent of households in the country in 2010, underlining the potential gain to utility revenues from better targeting that would reduce household subsidies. In 2010 • Eighty-seven percent of all electricity consumed by Figure 11. Subsidies Booked and Received, 2003–11 domestic consumers was subsidized. • In 21 states, the average household consuming less than 30 400,000 Subsidies kWh a month paid more per unit of electricity than the booked average household consuming 30–100 kWh a month. 300,000 Subsidies Rs million received • In 10 of those states, the average household consuming less 200,000 than 30 kWh a month paid more per unit of electricity than even the average household consuming more than 300 kWh 100,000 a month. 0 • Some 87 percent of subsidy payments India-wide were 2003 2004 2005 2006 2007 2008 2009 2010 2011 delivered to households above the poverty line. Source: Khurana and Banerjee 2013. More Power to India: The Challenge of Distribution | 11 Figure 12. State Support to the Power Sector, as a Share of State Budget and State GDP (2011) (a) As percentage of budget (b) As percentage of state GDP Uttarakhand Punjab Bihar Uttarakhand Punjab Jharkhand Andhra Pradesh Bihar Jharkhand Haryana Karnataka Uttar Pradesh Haryana Andhra Pradesh Uttar Pradesh Kerala Kerala Rajasthan Rajasthan Karnataka Meghalaya Meghalaya Madhya Pradesh Assam Maharashtra Madhya Pradesh Assam Maharashtra Gujarat Gujarat Tamil Nadu Tamil Nadu 0 5 10 15 20 25 0 2 4 6 8 percent percent Source: Khurana and Banerjee 2013. Institutional Factors and Governance regulators have notified wheeling and transmission charges Shortcomings Are Other Contributors and the cross-subsidy surcharge, but only one has specified a path for the cross-subsidy reductions necessary for open Key reforms mandated by the EA have still not been imple- access to take effect. Implementing open access and ensuring mented. EA mandates in six key areas—access, quality and adequate available evacuation capacity are also necessary to affordability, cost recovery, accountability and transparency, permit third-party sales to compensate generation companies renewable energy, and competition—have been unevenly if discoms fail to honor their power purchase agreements. carried out. An index that measures the actions taken by state With regard to the states, Delhi has progressed the most actors (that is, governments, regulatory commissions, and util- by far in implementing EA mandates, followed by Gujarat, Ma- ities) to realize the objectives of the EA and its associated pol- harashtra, Madhya Pradesh, and Andhra Pradesh (figure 14). icies indicates that most states have completed only half the reform actions envisaged. Among the reform areas, statewide Sector outcomes are highly correlated with the extent performance was the lowest on promotion of competition by of implementation of EA mandates (figure 15). An index of a wide margin. Service quality and affordability has seen the outcomes on objectives ranging from power availability and most progress, closely followed by access (figure 13). affordability through access and reduction of fiscal burden to In fact, open access, a key enabler of competition under openness and sector financial viability was used to measure the EA, has still not been implemented in a manner such overall sector performance. It shows that sector outcomes, that a robust merchant market could compensate for a de- in line with the implementation of reforms, have been un- cline in sales to state discoms and thus balance demand even across states, with Gujarat and Punjab ranking highest in and supply. Of the five indicators used in this study to assess achievement of outcomes (see figure 15). progress in promoting competition, only notification of open Continued state interference in utility governance weak- access regulations and unbundling have been completed ens incentives for commercial operation. The unbundling by most states.17 In addition to these measures, most state and corporatization of utilities envisaged under the EA was 12 | INDIA POWER SECTOR REVIEW Figure 13. State Performance on Reform Areas 30 1.0 0.75–1 0.5–0.75 25 0.8 0.25–0.5 0–0.25 20 Number of states Mean 0.6 Median 15 0.4 10 0.2 5 0 0 Competition Accountability Cost Access Quality Renewables and Recovery and Transparency Affordability Source: Deloitte 2013. Note: Within each reform area, the index identifies between one and four objectives. For each objective, several implementation parameters (indicators) are used to measure progress toward that objective, with scores across indicators averaged to obtain scores for each objective and scores for the objectives averaged to obtain performance scores in each reform area. intended to limit state involvement in their operations, in- considerably less than it appears—and clearly identifying the crease transparency and accountability, and bring a commer- contributions of individual entities in the service value chain cial orientation to their operations. But while unbundling the and holding them accountable for their performance remains SEBs has progressed quite well on paper, actual separation difficult. and functional independence of the unbundled entities is Figure 14. Progress on Reform Implementation—Top and Bottom Five States by Reform Area Accountability Quality and Renewable Competition and transparency Cost recovery Access affordability energy TOP • Rajasthan • Maharashtra • Delhi • Delhi • Mizoram • Orissa FIVE • Maharashtra • Gujarat • Assam • Goa • Orissa • Punjab • Madhya Pradesh • Rajasthan • Himachal Pradesh • Andhra Pradesh • Delhi • Kerala • Gujarat • Orissa • Maharashtra • Chhattisgarh • Goa • Maharashtra • Punjab • West Bengal • West Bengal • Sikkim • Assam • Madhya Pradesh • Jharkhand • Mizoram • Nagaland • Other • Tripura • Goa • Other • Goa • Tamil Nadu • Punjab • Nagaland • Chhattisgarh • Goa • Nagaland • Meghalaya • Nagaland • Other • West Bengal • Sikkim • Other • Kerala • Other • Other • Sikkim • Other • Sikkim • Rajasthan • Manipur • Sikkim • Other BOTTOM FIVE Bolded states are in the top five overall; italicized states are in the bottom five overall. Source: Deloitte 2013. More Power to India: The Challenge of Distribution | 13 Figure 15. Relationship between Reform Implementation and Outcomes 1.0 Low reforms High reforms 0.9 High performance High performance 0.8 Gujarat Punjab 0.7 Karnataka Uttarakhand Chhattisgarh Tamil Nadu Rajasthan Orissa Outcomes index score 0.6 Goa Andhra P. Delhi Kerala Haryana Himachal P. Uttar P. Maharashtra W. Bengal Madhya P. 0.5 Jharkhand Assam Sikkim Tripura 0.4 Other Manipur Nagaland Mizoram 0.3 Meghalaya R2 = 0.52252 Other Bihar 0.2 0.1 Low reforms High reforms Low performance Low performance 0 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 Reform implementation score Source: Deloitte 2013. Corporatization has been unable to insulate utilities from utility interests. SERCs have been established in all states but state interference because boards remain state dominated, generally perform poorly on an index of regulatory design lack sufficient decision-making authority, and are rarely that measures their autonomy, capacity, and transparency, evaluated on performance. Utility boards tend to have more and that is highly correlated with utility financial performance government and executive directors than recommended (figure 17). True autonomy from state governments is lack- under the good practice guidelines issued by the Department ing, partly because of relationships built into the EA itself. In of Public Enterprises and even fewer independent directors— addition, many SERCs lack the resources to carry out their only 16 percent of 69 utilities studied have the recommended functions fully, especially with regard to adequate numbers share of independent directors, and several lack independent of professional staff and appropriate information technol- directors entirely (figure 16). Further constraining the auton- ogy systems. Although most SERCs are nominally promoting omy of the boards and management’s ability to operate on consumer empowerment and transparency, they need to do a commercial basis is the state government’s involvement in far more to create frameworks for meaningful public input to key recruitment, personnel, procurement, and enforcement the regulatory process, such as promoting consumer engage- decisions. ment and ensuring that high-quality information is publicly The regulatory environment has not sufficiently pushed utilities to improve performance, in part because a lack of accountability, limited autonomy, and constrained technical Only 16 percent of 69 utilities studied have the recommended capacity on the part of SERCs have prevented the creation of share of independent directors, and several entirely lack an independent, transparent, and unbiased governance frame- independent directors. work for the sector that balances consumer and investor or 14 | INDIA POWER SECTOR REVIEW Figure 16. Share of Utilities in Compliance with Key Good Practices in Corporate Governance 100 All sample utilities 80 All sample distribution utilities 60 percent 40 20 0 Executive Audit External Audits Accounts Board Government Independent Directors Committees Auditor Made Public are SIze Directors Directors Published Source: Pargal and Mayer 2013. available. Perhaps most importantly, there is no clear account- them. The regulatory mandates reviewed in this study relate ability mechanism to govern SERCs themselves and to hold to tariffs, protection of consumers, standards of performance, them responsible for implementing their mandates. open access, renewable energy, and notification of regulations SERCs face challenges in carrying out their mandates in selected other areas.19 On average, states score 74 percent largely because the utilities they regulate are almost all state on an index measuring implementation of regulatory man- owned. As a result, most SERCs have notified18 the key regu- dates (figure 18). Andhra Pradesh, Himachal Pradesh, and Kar- lations necessary to enact the mandates of the EA 2003, but nataka are the highest ranking SERCs. many have yet to take concrete steps to actually implement Figure 17. Institutional Design Index Scores Transparency 100 Capacity Autonomy 80 60 Average percent 40 20 0 esh al adu issa sh t lhi tra esh aka a esh ala am and her Tam jab ar a ram ura na han nd arh jara lay Go eng Bih de De rya kha Ker ash Pun Ass Trip tisg nat Ot rad rad rad Or ast il N rkh izo gha Gu Pra st B Ha har ara Kar al P Raj ra P ar P hat dM Jha Me ya We Utt Ma Ch ach dh Utt dh an An Ma Him ur nip Ma Source: Pargal and Mayer 2013. More Power to India: The Challenge of Distribution | 15 Figure 18. Implementation of Mandates Index Scores Regulations Standards of practice Clean energy Consumer protection Open access Tariffs 100 80 Average 60 percent 40 20 0 esh al sh adu issa esh aka tra lhi t and han am ala nd ar esh na jab ya am her a ura arh jara Go eng Bih ala de De rya kha Ker ash zor Pun Ass Trip tisg nat Ot rad rad rad Or ast il N rkh Gu Pra h st B Ha har ara g Mi Kar Raj al P ra P ar P hat Jha Tam Me ya We Utt Ma and Ch ach dh Utt dh An Ma Him ur nip Ma Source: Pargal and Mayer 2013. Examining implementation more closely, for example, while SERCs have struggled to achieve true autonomy from tariffs cover average costs in most states, very few states issue state governments. multiyear tariffs that would enable long-term planning by util- ities and incentivize efficient operations. On average, states increased tariffs at least once every two years from fiscal 2008 three years, the sheer magnitude of current regulatory assets to fiscal 2013. Three states increased tariffs each year while means this would cause a major tariff shock. Therefore, re- Sikkim did not revise tariffs at all in the entire six-year period. covery has been spread over a longer period with no relief to The frequency of tariff increases varied from year to year— utility finances. Exacerbating the problem are delays in “truing for instance, in fiscal 2009, 13 states reported tariff increases, up,”22 regulators assigning lower power purchase costs than while in fiscal 2013 about 26 states issued orders to raise tar- used by discoms in their projected revenue requirements just iffs. Goa, one of the best performers, did not issue a tariff to keep starting tariffs low, and the interest burden on cash- order for the first five years in this period, finally raising tariffs strapped discoms that have to borrow to purchase power. only in fiscal 2013. Steady revisions in tariffs avoid the shock Another source of pressure on utility finances is the to consumers from having to adjust to a sudden large jump in mandate to build and “power up” the vast network of lines the tariff. And they enhance the general acceptability of tariff being laid across the country under the central govern- increases and help prevent receivables such as “regulatory as- ment’s flagship access program, RGGVY. There are structural sets” from building up in utility accounts.20 disincentives to supply power in rural areas: low demand per Mounting regulatory assets have increased the discoms’ consumer and overall; the high cost of service provision; and cash-flow problems, jeopardizing routine operations.21 In low, frequently below-cost, tariffs. In 2011, utilities lost Rs  3 Tamil Nadu, Rajasthan, Punjab, Uttar Pradesh, Haryana, Delhi, (US$0.06)–Rs 4 (US$0.08) per unit of power sold to rural con- and West Bengal, utilities have had to borrow heavily to fund sumers; the aggregate burden of serving rural consumers in the deficit of revenues over costs. Although the Appellate Tri- 2010 was around Rs 200 billion (US$4.4 billion) in the 12 large bunal has ruled that regulatory assets must be recovered over states studied (figure 19). Apart from this, losses related to 16 | INDIA POWER SECTOR REVIEW Figure 19. Financial Burden of Serving Rural Consumers (a) Revenues and costs (2010) (b) Total losses (2010) 10 65% 70 40 36.0 55% 60 8 51% 48% 51% 48% 30 27.1 41% 50 21.1 22.5 Rs per kWh Rs billion 6 35% 40 20 19.4 17.2 4 30 13.8 16% 11.5 11.5 20 10 8.7 25% 26% 6.7 2 19% 10 3.1 0 0 0 issa Tam esh al nd am and t ar esh an esh adu jara esh adu esh esh t am al and issa nd han Tam har eng Bih jara sth kha eng Ass rad rad rad Or il N rkh kha Ass Gu Bi rad rad rad Or ast il N rkh st B Gu a ara st B Raj aP aP ar P Jha ara Raj aP aP ar P Jha We Utt dhr dhy We Utt Utt dhr dhy Utt An Ma An Ma Average revenue billed Cost of rural supply % Cost realization Source: Banerjee and others 2013. RGGVY implementation have placed a heavy weight on the not yet realized its potential. The R-APDRP aims to reduce finances of distribution utilities, and this is not always com- aggregate technical and commercial losses in selected urban pensated by state governments as the cost of rural service areas to 15  percent through support for collecting baseline delivery is very difficult to estimate exactly. Under RGGVY, data; adopting information technology applications for key the Rural Electrification Corporation provides a 90  percent functions; and the provision of grant funding for investments subsidy for the capital cost of grid extension. As of Janu- to renovate, strengthen, and modernize distribution end op- ary 2013, the amount sanctioned by the Rural Electrification erational/technical and service delivery mechanisms.24 But no Corporation for all RGGVY projects, Rs 342 billion (US$8 bil- state has completed even the first part of the scheme, largely lion), covered only 58  percent of the estimated actual cost because it was rolled out without sensitizing utilities to the of Rs 590 billion (US$13 billion), and the government had only extensive “change management” needed for implementation, disbursed 84 percent of the sanctioned amount. The reasons exacerbated by limited resources, a lack of appropriate capac- for this misalignment are inadequate and unrealistic estimates ity, and the absence of a supportive information technology by states of the funding required to meet RGGVY goals; the ecosystem in the broader economy. Rural Electrification Corporation’s application of standardized In sum, multiple institutions with diffuse accountability cost norms that do not consider variations in geography, cost have undermined the sector’s commercial orientation. The of living, or other significant factors; a long and unwieldy re- EA 2003 sought to limit government interference in utility op- visions process, which has deterred states from requesting erations, yet state governments are still a major presence with revisions to approved amounts; and RGGVY’s provision of a generally detrimental impact on utility operations. They free connections only to households below the poverty line, have worsened discoms’ financial difficulties by compelling which restricts potential aggregate demand to a small group them to borrow to cover operational expenses, given the rev- with low consumption levels.23 enue shortfalls caused by the under-recovery of power pur- A potentially transformative two-part central scheme to chase costs and incomplete or late subsidy payments by the increase distribution efficiency, the Restructured-Accelerated state governments; by applying political pressure to keep tar- Power Development and Reform Programme (R-APDRP), has iffs low; and by pressuring discoms to purchase power during More Power to India: The Challenge of Distribution | 17 elections to appease voters. Irregular and inadequate tariff is an option. An overarching issue is enhancing the account- increases over the past decade, despite the ability of state ability of regulators. Given the general lack of involvement regulators to act on their own initiative, have lowered cost of the state legislatures, alternatives include reporting every recovery and increased regulatory assets.25 Banks and financial six months to a standing Parliamentary Committee, possibly institutions continued financing insolvent discoms through through the Forum of Regulators. 2011, ignoring due diligence and prudential norms; indeed, Ensure the availability of high-quality, updated data and lending to unbundled discoms grew 35 percent per year over the use of these data for monitoring and benchmarking 2006-11. This flow of liquidity limited the pressure on discoms performance as well as for planning and decision-making. to improve performance and on state governments to allow Sector monitoring can only be as good as the data it is based tariff increases. on, but there is a lack of consistent reliable data. This ham- pers planning, decision-making, implementation monitoring, The Way Forward: and compliance enforcement, and affects all players as well Priority Areas for Action as both internal accountability (e.g., of utility management to The problem of poor power sector performance has its its board and owners) and external accountability (e.g., the roots in inefficiencies and limited accountability at the utility, government, regulators, and consumers/civil society distribution end of the sector value chain, so fixing these to each other). The regulator can also bring greater transpar- aspects of distribution is key to improving service delivery ency and accountability to sector institutions by routinely and other metrics of sector performance, putting the sector collecting and publishing data on performance targets and on a financially sustainable path, and ensuring that power is achievements. A statutory requirement for utilities to regu- no longer a bottleneck for growth. Priorities for action are as larly collect and publish primary data is advisable, including follows: data on customer satisfaction and compliance of states with Fully implement key EA mandates, especially those re- their subsidy commitments. Third-party monitoring of utility garding competition and distribution (tariffs, open access, performance should be encouraged. and standards of performance). This will incentivize loss re- Insulate utilities from state government to prevent inter- duction, modernize operations, and improve service delivery ference with internal operations. State utilities should comply and cost recovery, thus bringing distribution performance up with corporate governance guidelines from the Department to international benchmarks of quality. of Public Enterprises regarding the inclusion of independent Ensure regulatory autonomy, effectiveness, and ac- directors on boards and limiting the share of executive direc- countability. Widespread concerns about the objectivity of tors on them. Independent directors should be appointed decisions and autonomy of decision-making arise from the by a committee, with members drawn from entities like the revolving door among the regulator, utility, and government Central Electricity Authority or other representatives of the that is the result of a limited pool of qualified staff in the public interest, in order to avoid capture by the state govern- sector. One option would be to establish a common pool of ment. An arm’s length relationship between government and regulatory staff working across states and regulatory com- utilities can be more easily institutionalized if utilities’ articles missions. Financial autonomy could be enhanced by charging of association specify a limited role for the government. Using regulatory expenses to the consolidated fund of the state so compliance with listing requirements (“shadow” listing) as a that the SERC has a dedicated source of funding, indepen- precondition for central or other support can bring greater dent of the state. Most critically, safeguards need to be de- accountability to utility boards while limiting state interfer- veloped against the misuse of section 108 of the EA, which ence. Divesting an ownership share to central public sector permits states to “direct” SERCs. The limited ability of SERCs undertakings such as National Thermal Power Company Ltd. to penalize state-owned utilities and to overcome state polit- or Power Grid Company of India Ltd., which are recognized ical considerations (on tariff increases, for example) highlights for strong results, may also limit state government influence the need to weaken the connection among an individual because as equity owners, they would have the ability to push state government, its utilities, and the state electricity regu- for better performance. The performance of utilities can be lator. Establishing four or five regional regulators that would strengthened through memorandums of understanding with be responsible for regulating the sector in a group of states the state government, following the practice of central public 18 | INDIA POWER SECTOR REVIEW An Eight Point Agenda for Action Central Government to Actively Align Stakeholder Ensure Availability of High-quality, Updated Data and Incentives Dissemination of Good Practices • Use central schemes to incentivize better distribution- • Assign responsibility for data collection and publication, and segment performance. base decisions on data analysis. • Hold state governments accountable for sector performance. • Induce better performance by benchmarking utilities against Make central transfers contingent on payment of subsidies each other. due. • Establish feedback loops: set performance targets, monitor • Use utility performance ratings to inform lending by govern- commitments, and publicize achievements to incentivize regu- ment institutions. Link the Power Finance Corporation/Rural lar updating and vetting of data. Electrification Corporation loan disbursements to performance • Reinvigorate planning, coordination mechanisms, and knowl- and creditworthiness. edge capture. • Promote responsible lending by avoiding bailouts for poor de- • Strengthen system-wide planning, possibly by Central Electric- cisions or inadequate due diligence. ity Authority, and make it the sectoral knowledge repository. • Give lenders step-in rights to bring in new management if there is default/non-compliance with financial covenants States to Explore Different Models to Improve Distribution Center and States to Strengthen Regulatory Governance • Use management contracts to allow learning-by-doing. and Processes • Separate urban and rural areas to tailor service to differences in • Ensure autonomy of regulators through dedicated funding, the load, the ability and willingness to pay, and the need for reliable option of regional regulators, a common pool of technical staff power. for all regulators, and safeguards against misuse of Section 108. • Allow differentiated service above the mandated minimum at • Develop SERC technical capacity to design, implement, moni- an additional charge. tor, and penalize noncompliance with regulations. • Experiment with different approaches to private participation. • Enhance transparency and credibility through open hearings, Delhi, Mumbai, Bhiwandi, and Kolkata are examples. participatory processes, publication of studies, comments, and • Pilot retail choice through separation of carriage and content decisions. to understand the information and regulatory requirements for • Make SERCs accountable, possibly to Parliament with a perfor- success. mance evaluation by Appellate Tribunal. Center and States to Promote Electrification Regulators to Implement Key Regulatory Mandates in a Financially Responsible Manner • Specify, measure, and publicize standards of performance. • Fully compensate discoms for RGGVY line extensions and for • Revise retail tariffs regularly but avoid passing through up- power supplied to rural consumers. stream inefficiencies. • Promote coordination through a single central agency for plan- • Determine charges required for open access and a sustainable ning and monitoring grid and off-grid investments. path for removal of cross-subsidies. • Increase rural commercial load by encouraging productive uses. • Bring households above the poverty line into RGGVY to en- Center and States to Improve Corporate hance social cohesion and sustainability of the access expan- Governance of State Utilities sion achieved. • Use prepaid meters, payment through cell phones, and rural • Require state utility compliance with the corporate governance franchises to improve rural billing and collection systems. guidelines issued by the Department of Public Enterprises. • Complete operational and financial unbundling to improve Regulators to Improve Targeting and Reduce accountability. the Fiscal Burden of Domestic Tariffs • Use memoranda of understanding to strengthen incentives for utility performance, following the practice in Central Public • Move to volume-differentiated tariffs rather than incremen- Sector Undertakings. tal block tariffs, tariff block cut-offs that better match the consumption patterns of households at different income lev- els, and to above cost-recovery tariffs for higher-consuming households. • Define clear eligibility criteria for subsidies and design tariffs to restrict subsidies to eligible households, ultimately transition- ing from consumption subsidies to cash transfers. More Power to India: The Challenge of Distribution | 19 sector undertakings, many with exemplary performance re- specific functions like revenue collection to a rural franchi- cords. States also need to be held responsible for making see) and assigning low-cost public sector generation such timely and complete subsidy payments when they mandate as the National Thermal Power Company Ltd. power pur- below-cost supply of power to certain consumer groups. The chase agreements to them. The private urban operators central government’s budgetary transfer to the states could would be responsible for procuring power for their own be a potential source for making up shortfalls if the state gov- consumers and could transparently contribute to a univer- ernment does not make payments that are due. sal service fund that would cross-subsidize rural supply. Use central programs and other support to incentivize • Establish urban franchises and encourage them to gradu- operational and financial efficiency. The central government ally expand their services to cover rural areas through, for and its agencies can have immense financial leverage. The example, a series of concentric circles, so that learning be- large centrally-sponsored programs such as the RGGVY and comes consolidated. Variants of this basic approach could the R-APDRP can be used to promote responsible behavior by include permitting private entrants to offer greater service utilities and state governments, particularly if their implemen- reliability than the mandated standard upon payment of tation is coordinated and if disbursements are tied to reach- fees in addition to the basic regulated tariff. ing operational and financial performance targets.26 Another • Appoint operation and maintenance contractors to up- promising approach would be a consistent use of ratings re- grade dilapidated distribution networks for discoms, be- cently developed by the Ministry of Power by the Power Fi- ginning with the most lucrative, high-value feeders. This nance Corporation and the Rural Electrification Corporation will improve service and increase collections, and a portion as a core input in lending decisions (Ministry of Power 2013). of the increased collections can be paid to the contractors Because the Power Finance Corporation and the Rural Elec- as incentives. Such loss-reduction practices can gradually trification Corporation are the leading lenders to the sector, spread over the entire network. this would send a clear signal about the need to achieve and Promote electrification in a financially responsible man- maintain strong operational and financial performance. ner and support diverse delivery models. Rural service deliv- Make better use of India’s size and diversity to experi- ery will become viable only if discoms are fully compensated ment with and learn from different models of service pro- for supplying power to rural consumers. Supporting pro- vision, including private sector participation through joint ductive uses of power through capacity building, provision ventures (Delhi), franchising (Bhiwandi), management con- of information, complementary microfinance, and technical tracts, and so on. Key issues faced in attracting outside exper- support is critical for aggregating the rural load and improving tise and investment for improving distribution are a lack of the commercial viability of rural service delivery. Beyond this, reliable information on asset quality; very different demand, funding needs to be allocated in the state budget to make up needs, and ability to pay of rural and urban consumers served the shortfall in discom revenues from supplying power to rural by the same utility provider; long-lived assets that require communities. While increasing rural loads will make it cost-ef- heavy upfront investment; and government sensitivity to po- fective to meter, bill, and collect, innovations in technology tential for “extra” profits being earned by private investors and use of rural collection franchisees can help reduce the as- leading to excessive conditionality (damping interest in the sociated transaction costs. Prepaid meters would lower com- newer franchises offered). mercial risks to utilities and allow rural households to have On these factors, potential approaches include: more control over their consumption.29 It may also be bene- • Make provision for learning by doing, starting with man- ficial for state utilities to explore management contracts with agement contracts or franchises that permit the discovery private operators who can deploy new metering technology. of the true state of assets and that bring basic efficiencies Use of own-state funds to extend free connections to house- to operations before specifying investment requirements holds above the poverty line can increase community support over the longer term.27 and improve sustainability of the access expansion achieved. • Ring-fence urban and rural customers and consider license, A single central agency for planning and monitoring grid franchise, or public–private partnership models28 only and off-grid investments can promote coordination by lead- in urban areas, while letting state discoms maintain their ing the development and regular updating of state rural elec- responsibility for rural supply (or separately contract out trification plans as well as providing a countrywide picture of 20 | INDIA POWER SECTOR REVIEW the rollout of grid and off-grid facilities, critical information • Volume-differentiated tariffs instead of incremental block for private investors in distributed generation. Coordination tariffs. In the former, households are grouped by total would require more reliable information on people without monthly consumption, and each household in a given electricity living in villages which have power (important for group pays the same (constant) tariff for all the power it state utilities)as well as in villages without power (important consumes. for off-grid providers). • Tariff block cut-offs that better match the electricity con- Rationalize domestic tariff structures to improve target- sumption patterns of households at different incomes. ing and reduce fiscal burdens. An accurate system of identi- • Charging above cost-recovery tariffs to higher consum- fying households below the poverty line would allow states ing households. States with low fiscal costs of subsidies to better target subsidies to the poor, using special tariff achieve this by limiting the size of subsidies, restricting schedules or cash transfers. Until such a system is functional, how many households receive subsidies and charging a it would be useful to work toward rationalizing tariff struc- cross-subsidy to some households. tures through: More Power to India: The Challenge of Distribution | 21 Notes 16. Cumulative subsidies booked and received between 2003 and 2011 are Rs 1,496 billion (US$32 billion) and Rs 1,044 billion (US$22 billion), respectively. 1. Both central and state legislatures have a role in developing policy. 17. All but 2 states have notified open access regulations, and 13 states have 2. The structure of the sector has moved away from vertically integrated SEBs: reduced cross-subsidy surcharges over the last five years. Only 10 states have unbundled generation, transmission, and distribution entities now exist in 19 of initiated competitive power procurement, and only 8 have begun implementation India’s 29 states. As of 2013, 28 regulatory commissions have been established. of an availability-based tariff (ABT) beyond notifying ABT regulations. 3. Such subsidies are primarily given to distribution companies to compensate for 18. In the Indian context, “notifying” a regulation means the regulation has been below-cost tariffs charged to agriculture and domestic consumers on equity and published in the necessary channels and is enforceable. political grounds. 19. Specifically, regulations related to the supply code, power trading, metering, 4. This is equivalent to 2.4 percent of total central budgetary spending or 0.4 multiyear tariffs, and intra-state availability based tariffs. percent of GDP in 2011. 20. Regulatory assets are dues to the discoms, typically on account of tariff in- 5. This figure includes subsidies (booked) from state governments as revenue. creases that the regulator accepts as justified but does not allow in the year they are incurred to avoid a sudden jump in tariffs, on the presumption that they will 6. Accumulated losses are highest in Uttar Pradesh, Madhya Pradesh, Tamil Nadu, be recovered through gradual tariff increases in the future. and Jharkhand, which together account for almost 60 percent of the total. By contrast, Kerala, Gujarat, Andhra Pradesh, Goa, and West Bengal had accumulated 21. Borrowing against regulatory assets is becoming less feasible. Because commer- profits in 2003–11. cial banks are unsure how to value regulatory assets that may not be worth their face value, discoms can no longer borrow up to the full amount of the regulatory 7. In October 2012, the government announced the Scheme for Financial Restruc- assets they own. turing of State Distribution Companies, available to all loss-making discoms that wish to participate, which potentially amounts to a bailout of about Rs 1.9 trillion. 22. In other words, adjusting the value (for example, of costs, revenues, and tariffs) approved by the regulator in advance (when passing a tariff order) against what 8. The Integrated Energy Policy of 2006 forecasts that generation capacity will was actually achieved. In this instance, actual costs are used to update the cost need to increase to about 800 gigawatts by 2031 to meet predicted demand and estimates provided by utilities in their tariff petitions. sustain growth of 8 percent a year—four times current generation capacity. 23. Increasing both the consumer base and per consumer consumption levels will 9. That is, the difference between input energy (which is paid for by the utility) address low load, and for this it will be critical to improve the quality of supply and energy sold (which generates revenues for the utility). so that there is greater consumer interest in connecting (“hooking up”) to the grid 10. That is, the difference between total revenues accrued and total costs = profit and thus generating effective demand. before tax. 24. The program requires participating utilities to demonstrate performance im- 11. Collection efficiency is the proportion of energy realized (as revenue) to energy provements (sustained loss reductions) to obtain financial assistance. Thus utilities billed; anything less than 100 percent is inefficient. need to collect accurate baseline data and measure performance. To ensure data 12. Average billed tariff is revenues billed/energy sold. integrity, reliable and “no manual touch” systems need to be established for data 13. While cost recovery basically requires the tariff to equal or exceed average collection, while adopting information technology for energy accounting. Under cost, a more stringent requirement is used in this review. Cost recovery is defined the program, there is support is for both aspects, recognizing that they are pre- as the tariff level that covers (equals) average cost plus a premium to account for conditions for successful distribution-strengthening projects. “normal” distribution losses, which are set at 10 percent for India for this analysis. 25. Nationwide it is estimated that regulatory assets are more than Rs 700 billion Thus an efficiently operating utility (with normal distribution losses and 100 per- (US$15 billion) and that the interest cost alone adds up to around Rs 95 billion cent collection) that has a tariff equal to cost recovery, as defined above, would (US$2 billion) a year. break even. 26. Payment release could be conditional on concurrence with the performance 14. There are also significant inefficiencies in fuel use by generation that feed report by lenders’ representatives sitting on utility boards. into end-user tariffs. While an important area for immediate action by regulators 27. “Try before you buy.” The process of operating the system will give the incum- to capture possible savings, over the medium term, as existing power purchase bent franchisee an information advantage when bidding for concessions or privat- agreements wind down and all new power is procured through competitive bid- izing the utility (if that is envisaged in the next stage). Appropriate mechanisms for ding, this source of inefficiency can be expected to decline. capturing this knowledge and handling the information advantage will need to be 15. While beyond the scope of this review, a considerable body of work has ana- developed that provide incentives for franchisee performance but also allow for lyzed the options for moving India to a lower carbon growth path and increasing an open competitive procurement process. the share of renewable energy in India’s generation mix. See, for example, World 28. Delhi utilities are technically public-private partnerships as they are joint ven- Bank studies on “Unleashing the Potential of Renewable Energy in India” (Sargsyan tures between the government of Delhi and the different licensees. and others 2011); “Energy Intensive Sectors of the Indian Economy: Path to Low 29. Because many rural dwellers in India already use prepaid cards for mo- Carbon Development” (Gaba, Cormier, and Rogers 2011); and “Development of bile-phone airtime, mobile phones could be trialed to pay electricity bills, similar Local Supply Chain: A Critical Link for Concentrated Solar Power in India” (Kuli- to M-Pesa in Kenya. chenko and Khanna 2013). 22 | INDIA POWER SECTOR REVIEW References Other Papers Deloitte. 2013. Review of Reforms Implementation in the Indian Power Sector. Report prepared for the World Bank. Background Papers Gaba, Kwawu M., Charles J. Cormier, and John A. Rogers. 2011. Energy Intensive Background paper 1: Banerjee, Sudeshna G., Doug Barnes, Bipul Singh, Kristy Mayer, Sectors of the Indian Economy: Path to Low Carbon Development. Washington, and Hussain Samad. 2013. Power for All: Electricity Access Challenge in India. DC: World Bank. Washington, DC: World Bank. Kulichenko, Nataliya, and Ashish Khanna. 2013. Development of local supply chain: Background paper 2: Mayer, Kristy, Sudeshna G. Banerjee, and Chris Trimble. 2013. A critical link for concentrated solar power in India. New Delhi: World Bank. Elite Capture: Domestic Tariff Subsidies in India. Washington, DC: World Bank. Ministry of Power. 2005. National Electricity Policy. New Delhi: Government of Background paper 3: Mukherjee, Mohua. 2013. Private Sector Participation in the India. Indian Power Sector: Lessons from Two Decades of Experience. World Bank, ———. 2013. State Distribution Utilities First Annual Integrated Rating. New Washington DC. Delhi. Background paper 4: Pargal, Sheoli, and Kristy Mayer. 2013. Governance of Indian Power Finance Corporation. 2004–05 to 2011–12. The Performance of State Power Power Sector Utilities: An Ongoing Journey. World Bank, Washington DC. Utilities. New Delhi. Background paper 5: Khurana, Mani, and Sudeshna G. Banerjee. 2013. Beyond Crisis: Planning Commission. 2011. Annual Report 2011–12 on the Working of State Power Financial and Operational Performance of India’s Power Sector. Washington, DC: Utilities and Electricity Departments. New Delhi: Government of India. World Bank. Press Information Bureau. 2011. Per Capita Power Consumption. New Delhi: Gov- ernment of India. Sargsyan, Gevorg, Mikul Bhatia, Sudeshna G. Banerjee, Krishnan Raghunathan, and Ruchi Soni. 2011. Unleashing the Potential of Renewable Energy in India. Washing- ton, DC: World Bank. Unnikrishnan, Dinesh, and Makarand Gadgil. 2011. “State-Run Banks Stop Fresh Loans to Loss-Making Power Utilities.” Live Mint, October 24, 2011. Retrieved No- vember 20, 2013, from http://www.livemint.com/Companies/Le7TRnX7unqQ9DL- CByz0qM/Staterun-banks-stop-fresh-loans-to-lossmaking-power-utilit.html.