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Paper on India Power Reform



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Hi, 

A friend of mine has recently written an article on the reforms in the power
sector in India.  I feel it will be a valuable read for us on this forum,
and he would love your feedback too...  It gives the development over the
decades, the problems India faces now, why reforms are crucial, and why they
are difficult.  This is an excellent paper, though it is a little long.  It
is appended to this email.

Thanx
Abhijeet

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An Analysis of Reforms in the Indian Power Sector – Problems, Policies and
Politics

						- Amit Pathare


A. Introduction

In 1990, the Government  of India initiated power sector reform to mobilize
the required resources to enhance the supply and increase the efficiency of
the sector through competition.  Since then, it has opened up its power
sector for new private sector investment, started unbundling its vertically
integrated state-owned utilities, privatizing state owned enterprises,
setting up Electricity Regulatory Commissions and amending existing acts. 
These structural and functional changes in such a key infrastructure sector
have huge implications for social stability, and have thus brought about a
concomitant set of problems in their implementation.

The aim of this study is therefore to first evaluate the forms, and then to
suggest ways to overcome barriers to their effective implementation.  We
shall first familiarize ourselves with the background of the reform process
and the key players involved.  We can then carry out this evaluation in
three stages – 
 We will start with a rational view of the constituents involved,
and the policies framed
 We then move to getting an understanding of the internal operating
procedures of these various constituencies
 Finally we will supplement this with an analysis of the impact of
politics between different constituencies
The goal is to examine how the thrust of the solution strategy is modified
with each added layer of complexity in each stage.

 B. Background
History
Post-independence, government policy has evolved in three major phases.  The
first phase, from 1948 to 1975 can be categorized as the growth of state
level investments in the power sector and the decline of private investments
and management.  The second phase from 1975 to 1990 marks the ascension of
central government utilities in generation and transmission.  The last phase
from 1990 onwards marks a turning point where government policy has evolved
to a more market friendly approach.

The legal provisions for the regulation of tariffs of power utilities can be
traced to the Indian Electricity Act, 1910, which provided that tariffs must
be non-discriminatory and allow a reasonable return to the licensee.  The
1948 Electricity Supply Act then established a cost plus methodology for
setting tariffs where the rate of return on the capital invested is
regulated, and a cap is imposed on the clear profit of the licensee.  This
was altered significantly in the 1980s by the recommendations of the K.P.Rao
Committee which included
 The concept of “deemed generation” which compensates generators for
being available, even if not in actual operation
 The concept of “two-part tariff”, comprising fixed and variable
charges
 Efficiency enhancing charges that limited both the incentive and
disincentive for recovery of fixed costs
 Operational norms that laid the basis for performance based
ratemaking
Thus, by the end of the 1980s, the Indian power sector was composed of
vertically integrated State Electricity Boards (SEBs) at the state level,
separate generation, transmission and financing entities at the central
level, and a few small licensed private firms.  Let us examine a few key
stakeholders in this industry on the supply and demand sides.

Key stakeholders
The main institutional stakeholders were the State and Central governments
themselves with the socialistic belief that the government was required to
fuel investment and operation of the power sector.  The Ministry of Power
(MOP) has overall responsibility for power sector development.  Its
activities include formulating policies and plans, processing power projects
for investment decisions, R&D, formulating legislation, and providing
linkages between other ministries and departments, state governments and the
Planning Commission.  The operations of the central & state owned companies
were managed by civil servants belonging to the elite Indian Administrative
Service.  However management was subject to an inordinate amount of
political interference.  Politicians saw power plants (and indeed, all
infrastructure sectors) not as market governed entities, but mainly as
avenues for employment generation.  Employees would often unionize, and
unions would usually have political proclivities.  This internal power base
that politicians enjoyed would further facilitate interference in management
policy.
On the demand side, the main constituencies were the agricultural, domestic
and industrial customers.  The agricultural sector has always been heavily
subsidized.  The domestic customers have also been subsidized, but not as
much.  While this has been at the expense of the industrial sector, which
has had to pay very high prices.  Not only this, but the rate of tariff
increases for this sector are also higher than the average.  Tariff
revisions were generally carried out on an ad-hoc basis, the sole criterion
being the absorbing capacity of the customers.  Apart from this, you have
the NGOs who usually advocate distributional equity of benefits and
environmental consciousness.

Inefficiencies in the system
Lack of resources and project implementation delays led to insufficient
generating-capacity growth, resulting in capacity falling short of rising
energy requirements.  In the last three decades, maximum growth in
consumption was registered under the subsidized domestic and agricultural
consumer segments, straining the SEB balance sheet in the long run.  This
has been pushing the SEBs to the brink of financial insolvency,
necessitating cash injections by the central government achieved by deficit
spending.  Low PLF and high transmission and distribution losses add to the
supply deficit resulting from insufficient generating capacity and rising
demand. India’s PLF is 64.7% against an international average of over 70%,
owing to old, inefficient plants and wide disparity in peak and non-peak
demand causing voltage and frequency fluctuations.  Also the T&D losses are
over 22%, far higher than the international standard of 7-10% because of low
voltage distribution network, theft and pilferage.

Restructuring in the 1990s
States started undertaking SEB reforms in order to save them from financial
bankruptcy, improve operational parameters, fund fresh capacity addition and
provide better service to consumers.  Reforms encompassed:
 Setting up of an independent SERC in each state which will be the
ultimate deciding authority in tariff fixation, eliminating political
interference in tariff fixation. 
 Unbundling of the SEB into generation, transmission and
distribution entities
 Corporatization and privatization of each of these entities
 Making these entities leaner and more efficient, pruning down
workforce, training of personnel to make them more consumer oriented. 
 Rationalisation of tariffs, which includes raising agricultural
tariffs to reasonable levels. 
 Metering of all connections, and toning up the collection mechanism
to ensure that all bills are collected
 Investments in good quality T&D equipment, R&M and Life Extension
of power plant equipment so as to improve operational efficiencies
 Improvement of metering technology to include time-of-day metering,
remote meter reading, theft proof meters etc 
At the central level, the CERC, which is the tariff fixing authority for
central utilities, has been formed.  The Central government has also
incorporated the Power Trading Corporation Limited (PTC) in 1999 with the
aim of reducing the cost of bulk power, increasing the availability of power
in the bulk power market, and thereby establishing a national market for
power.
With this new phase, policy determination has evolved into an exercise in
creating the enabling environment within which these specially empowered
institutions have to function creatively to translate objectives into
achievements.  Many of these functions are new, and precedents are
unavailable to assist the institutions charged with executing these
functions.  Policy support may therefore be required to make these
institutions more effective.  The final stage of evolution envisages greater
reliance on markets to allocate resources and to induce improvements in
efficiency.

The current situation
So how successful have the reforms actually been in unleashing the power and
logic of the markets?
The reforms have definitely made the markets more open to competition, but
have been successful in commissioning only a fraction of the capacity that
is required.  Investment proposals get mired in red-tape and often require
the “right” political patronage for approval and implementation.  And a lack
of assured power also damages India’s credibility in attracting other
investment proposals.  According to the latest estimates of Central
Electricity Authority (CEA), India needs an additional 1,00,000MW at an
estimated investment of nearly US$100bn to meet its power requirements in
the next 15 years.  India still relies mainly on coal and hydro-electric
power, with outdated technologies and huge impacts on the environment. 
Large hydro-electric projects involving huge dams, because of their highly
disruptive nature, invite popular opposition, stalling the projects and
affecting their financial viability.  Transmission and distribution losses
are embarrassingly high at 23% (and of the order of 40-45% in some areas),
as against 7% in China and 10% in Thailand.  Voltage and frequency
fluctuations and power blackouts cripple the system routinely in several
areas.  Price subsidies still exist and are proving hard to eliminate.  The
SEBs hence continue to teeter on the brink of bankruptcy, endangering their
capacity to pay for the power they buy from IPPs.  These, along with a host
of other operational problems, contrive to restrict the performance of
India’s power sector.

 C. A Rational View of Reform Components & Policies

Was this state of affairs inevitable, or could the Government of India (GOI)
have done a better job of increasing the efficiency of the power sector?  It
must be appreciated that with problems springing from so many different
avenues, it becomes difficult to decide from where to start.  Ideally,
action is required simultaneously on all fronts, but with limited resources,
this is clearly impossible.

The overriding aim of the government can be presumed to be the reliable and
sustained supply of adequate power of assured quality in India at a
reasonable cost.  What does this entail?  It requires the following actions
on the part of the government – 
 Firstly, providing adequate power, which requires
o Installing the required capacity to meet average and peak demand
 Creating financial incentives to attract investment
 Ensuring a sound judicial and regulatory structure to ensure
sustained viability of the investment and address disputes
 Creating an environment that ensures speedy implementation
o Maintaining incentives for operation of installed capacity as and when
required by the economics of supply and demand
o Improving the efficiency of existing installed capacity
 Ensuring a reliable and sustained supply
o Long-term planning in conjunction with demand growth and the life-cycles
of installed capacity
o Investment in transmission networks to ensure adequate transmission
capacity
o Creating incentives for maintenance and upgradation of the system
o Ensuring that investors have a fair chance of getting good rates of return
o Internalizing environmental and social costs of power supply
 Maintaining an assured level of quality
o Preventing system constraints that lead to voltage, frequency fluctuations
o Effective monitoring to minimize the incidence of power thefts
 And providing power at a reasonable cost
o Ensuring an efficient market system that reduces deadweight losses and
power prices that fairly reflect the cost of providing that power
 Gradually eliminating subsidies
o Encouraging efficient manufacturing processes and reduction of
procurement/transportation costs
 Labour cost management
 Power generation either close to fuel supply or to the customer
base to save on transport either of the fuel, or of the power itself

The GOI has however focused mainly on the first point, i.e. bridging the
supply gap, without adequately tackling the other questions posed by the
conundrum.  It created fast-track procedures for speedy approval of large
projects, and provided guaranteed off-take of power and for payments of dues
to assist early investors in covering their risk and thus making proposals
more attractive.  However, the political instability in India in the 90s
with the frequent change of governments, and the fact that none of these
governments had a majority in parliament always created questions of
commitment to reforms and their sustainability.  This led to increased
wariness on the part of the investor community.  That was further
exacerbated by cases of alleged corruption where each successive government
was said to demand special “favours” in return for assisting in bestowal of
a preferred status to the potential investor.  Another example of
instability in policy making can be seen in the wind power sector.  In the
early 90s, the government subsidized investors in wind energy.  But over the
years when the early promise of wind energy remained unfulfilled, the
subsidies were withdrawn, leaving the investors with stranded costs on their
investments.

There were also some technical faults in pricing policies.  Capacity owners
were to be compensated for making their capacity “available” even if system
constraints precluded it from being used.  This generated perverse
incentives for plant owners to create situations where their plants would be
available (so that fixed costs would be recovered) but not in operation. 
And providing guarantees of 68.5% or more PLF (Plant Load Factor – actual
plant generation as a percentage of its rated capacity to produce) to IPPs
(Independent Power Producers) who typically build power plants designed for
peaking purposes forces the SEBs to cut down usage of cheaper base-load
plants and operate these expensive plants, putting further financial burden
on them as they have to pay high rates to the IPPs.  Performance based
rate-making that is sought to be introduced too might work as a solution for
long-run markets, but the key to systemic stability is to be able to manage
the short-run markets and achieve a continuous steady balance of supply and
demand because of the special nature of electricity (it cannot be stored).
This can only be done by dispatching your generating assets based on the
short-run marginal costs of generating electricity.  This will always ensure
that the lowest cost plants are in operation, and will automatically
incentivise plant owners to lower costs and place lower bids in order to be
dispatched.  This further necessitates creating a “day-ahead” market managed
by an Independent Transmission Organization (ISO) that invites bids from
generators and plans the dispatch, and a “balancing” market that acts as a
settling market once the actual flows over the period are determined.  India
however is not in a position to develop this market now, as it does not have
sufficient installed capacity to unleash market forces, and is just
beginning to develop a regulatory structure that can then move in the
direction of creating ISOs or equivalent Regional Transmission Authorities
(RTOs) on the lines of advanced markets.  It is thus truly a case of the
chicken and egg conundrum.
And any measure that deviates even slightly from the logic of the short-run
electricity markets will end up creating further inefficiencies that invite
more government intervention.

Thus, we have all these problems in an area that the GOI purports to have
focused on!  Apart from this, there are several other areas where the
government so far has not done much at all.  For instance, there is no
effective monitoring to reduce power thefts from low voltage distribution
lines, even though it has been stated as a major concern.  This is a major
component of line losses.  Transmission links in the country are also
inadequate, creating regions of surplus in the east, and chronic deficit in
the south.  This leads to significant variations in system frequency
(roughly between 48 & 53Hz, as opposed to a maximum allowable range of
49.9-50.1Hz in the US).

Also, in an era when we are slowly moving away from large scale
hydroelectric projects, or nuclear energy, mainly due to environmental and
social disruption concerns, the GOI still continues to plan and execute such
projects.  This has led, in the case of the Narmada Project, to massive
popular resistance that has not only stalled progress on the dam and
rendered it financially unviable, but has also by its continuation, affected
the lives of hundreds of thousands of tribals.  And these have been the
unspoken costs of India’s many large scale hydroelectric projects since
independence.

Finally, India has not been able to keep its power costs low.  India’s power
costs (average of Rs. 4/kwh) are higher than several developed countries,
and consequently its prices are also very high.  And while for instance, in
the US, bulk rates offered to industrial customers are lower than those for
the domestic segment, in India, it is just the opposite.  India has also not
invested in other components of its infrastructure such as roads or
railways, which are crucial for transportation of fuel such as coal.  And an
increasing reliance on coal (which is the only fuel that India possesses in
relative abundance) will require massive investments in the railway
infrastructure, or require more power plants to be co-located at the
pitheads (which the GOI is, I concede, promoting).

Thus we see that a significant component of India’s energy problems can be
explained by a rational analysis of the situation.  And the simple answer is
that the beast is just too big to handle.  There are however, other factors
that aggravate the situation and make problem solving much more difficult by
creating significant inertia.  These enablers, if you may, need to be
analyzed by other means.  We shall now proceed to do so.

 D. The Procedures of Reform - Beneath the Skin of Indian Institutions

Our analysis of India’s power sector reforms can be aided by an
understanding of the internal working of India’s institutions.  Let us cover
the main ones over here.

The main entity propelling the direction of the reforms is the Government of
India.  In the early 90s when reforms were instituted, India was in a
financial crisis.  At this time, the nature of India’s politics was also
undergoing a drastic change.  Till the 80s, Indian elections would reveal a
clear winner (usually the Congress Party) which would enjoy a majority in
the elected Lok Sabha (or Lower House of Parliament).  However since the
late 80s, elections did not return any single party to power with an
absolute majority.  It was the beginning of coalition governments, formed
with a bunch of loose alliances, mostly formed on an opportunistic basis
after the election, than on the basis of a common ideology.  As a result, a
ruling government could have extreme right-leaning as well as extremely
left-leaning parties.  It was only the incidence of India’s dire financial
straits that left it with no alternative and built a cross-party consensus
for reform.  As the 90s went by, this belief in the need for the reform
process got inbuilt into the psyche of most political parties.  Thus
successive coalition governments comprising different sets of parties all
espoused the cause.  And at the beginning of their terms, they rode on the
good will of the electorate to advocate and implement wide-ranging reforms. 
In the early years of a 5-year mandate to rule the country, bearing the
short-term pain of the structural changes inherent in the reform process was
politically feasible.  But the sustained commitment to implementation would
be severely tested later in the term when either benefits from reform would
not be easily forthcoming, or when an election would be imminent.  Here
alliances would be tested and haggling would begin.  This would set into
motion the phenomenon of “roll-back” – i.e. reversing the most painful
(which might well be the most essential) components of the reform process. 
Thus, employment levels at SEBs would be preserved, subsidy elimination
would temporarily be “put under review”, and so forth.  An effective way of
doing this would be to appoint “committees”.  The procedure that thus seems
to be inbuilt into the life cycle of a political coalition government
without a majority in Parliament is as follows:
 Come into power with an agenda for change, and use the goodwill
enjoyed and current bonhomie amongst coalition partners to push through the
most difficult reform decisions
 Invite foreign investment proposals by showcasing reform plans and
potential
 Test public response to reform, as well as success/failure of
reform measures
 Roll back initiatives as a fallback plan before elections if
there’s no other means of stepping up approval ratings
This eventually leads to half-baked measures that instead of solving the
problems, end up exacerbating them.

Other examples of procedures slowing down the pace of reform are those
encountered in the various channels through which proposal documents must
pass, the further discussions that are required when there is a change of
governments and the uncertainty therein, procedures to resolve court
arbitrations and legal procedures, and so on.  There has traditionally been
no dearth of red-tape in Indian institutions.

One of the suggested solutions has been to depoliticize the implementation
of the reform process to avoid being held hostage to election cycles.  The
establishment of the CERC/SERCs with a promise of no governmental
intervention in their policy making addresses this need.  The government has
also reduced significantly the number of clearances that proposals need to
get before being approved, and has segmented projects by virtue of their
size, scope, fuel requirements, ownership structure, and locations to push
preferred ones faster.

Insufficient knowledge of the labyrinths of the Indian institutions limits
the number of examples provided in this study.  However, it is also my
belief that the key stumbling block to successful implementation of reforms
is not procedural, but political.

 E. The Politics of Reform – Interplay of Institutions

Critics of the GOI’s performance in reform implementation must first
appreciate the diversity of India’s social and political system that is
reflected in the various institutions involved in the reform process – their
raison d’ętre, agendas and incompatibilities.

Let us start with an institution that is vital to the implementation of the
reform process – the Indian Administrative Service (IAS).  This is an elite
group of professionals who have been trained to manage public sector firms
and design policies.  They form an integral part of the bureaucracy, and act
as advisors to political appointees.  Till the 90s, IAS officers were in
charge of managing the power infrastructure.  It was a very high profile
job.  However, with the advent of reforms, the monoliths that they were
commanding are slowly being unbundled and sold off.  Thus the role of these
officers is now being reduced to that of transition managers, or managers of
severely truncated operations under a completely new regulatory regime and
market laws.  Their job is now to prepare their power plant or distribution
network for divestment so as to yield maximum revenue for the government, or
in other words, they are being asked to wield the axe for their own
execution.  This changed job profile requires people with a different
mindset and training, or needs the incumbents to adapt fast.  It is no
wonder that these bureaucrats themselves have emerged as some of the more
subtle opponents of reform in their interactions with other players involved
in the reform effort.  One of the ways in which the process gets delayed is
to ask the GOI for more time to improve the operations of the SEBs prior to
their divestment so that a better price may be realized.

A second key constituency is the agricultural lobby.  They have been used to
free/heavily subsidized power.  And it is political suicide to suggest that
their subsidies be reduced or removed.  Farmers, though less educated, are
actively involved in the democratic process, and their votes are essential
to swing elections.  They form a significant lobby that cannot be ignored by
the politicians.  The ruling government always dreads the wrath of the
farmer.  And usually in crunch times before an election, planned
agricultural subsidy reductions are amongst the first to go.
In spite of this, there is however one possible way out, and that is to
expose the fallacy of free power.  The power that is supplied by the state
is never reliable, and one either finds frequent load shedding in rural
areas, or voltage drops that render the supplied power useless for usage,
e.g. to run water pumps on farms.  Farmers therefore have to invest in and
resort to using diesel generators on a regular basis.  Analyses show that
the effective cost of power farmers pay as a result is higher than what they
would have ended up paying had they been charged the market price in a
condition of reliable power supply of assured quality.  This point however
gets drowned out in political debates when farmers are mobilized by the
parties in opposition to rally against the reforms.

A third constituency is that of the worker unions in the public sector that
enjoy power and political patronage.  Those belonging to unions affiliated
with ruling parties exert significant pressure on the government to
compensate them adequately for supporting the reform process.  Those
belonging to opposition party affiliated unions exert themselves adequately
to present a very visible opposition to the reforms, indulging in strikes
and forcing shutdowns.

And on the side of the votaries for reform lie the investors themselves –
both domestic and foreign.  An important development in recent times has
been the emergence of the Non Resident Indian (NRI) entrepreneur and the
rise of Indians to the Heads of several Fortune 500 firms.  These
individuals, together with their counterparts in the largest Indian firms
have been drafted by the GOI into advisory groups for the reform process as
a whole, and are also being courted for investing in India.  It is these
coalitions of individuals that are putting pressure on the GOI to
significantly improve infrastructure in India as a pre-condition for
investment.

The reforms are thus being propelled forward, as well as jerked backwards by
the various constituencies or stakeholders involved.  The key question is –
Can a consensus be reached in a democracy as diverse as India?
 F. Summing Up…

A rational analysis of the reform process by itself is insufficient in
determining the factors that enable their success or failure.  This analysis
has to be supplemented by an understanding of the processes and inherent
“laws” that govern the functioning of the institutions involved, and the
opportunities created/destroyed by the interplay of these institutions with
similar/diverging interests.

This brief study can but lay a tiny finger on the Colossus of power sector
reform that needs to be reined in.  But I hope that it can sensitize the
reader to the magnitude of the task before the implementers of reform.

In the final analysis, implementing reforms successfully is a matter of
education and mobilization of all the beneficiaries.  Because more often
than not in India, there exists a huge information asymmetry as regards the
reform process.  And the asymmetry lies in the fact that the while the
losers can see the consequences immediately, the winners know not who they
are.


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