The woes of power: A moderate approach to the discom sector might be the answer

Source: The post is based on an article “The woes of power: A moderate approach to the discom sector might be the answer” published in the Indian Express on 17^th August 2022.

Syllabus: GS 3 Infrastructure; Energy

Relevance: Power Sector Reforms

News: The Government has launched the latest Revamped Distribution Sector scheme (RDSS),

About the scheme

The government has allowed the states to access some central government resources based on certain conditions like adhering to regular revision in tariffs, smart metering, and committing to a reduction in the AT&C losses.

Some findings about the state of affairs of the power sector.

(1) The problem of discoms is considerably worse than recognized because true losses of Rs 3 lakh crore exceed substantially the headline number of Rs 78,000 crore.

(2) The state government finances (due to power woes) have deteriorated, i.e., true state government deficits are about 5.5% of GSDP, not 4.7%, and the true debt is 34.5% of GSDP, not 31.0%.

(3) unsustainable discom operations are increasingly financed not by public sector banks, but by the Power Finance Corporation/Rural Electrification Corporation (PFC/REC).

What are the political economy implications or issues in the power sector reforms?

(1) On the one hand, the Ministry of Finance is concerned about the financial situation of the discoms. Therefore, it is trying to induce state governments to make reforms through incentives. On the other hand, the Ministry of Power (MOP) has the mandate to pursue objectives that are politically popular (access and quality) and increase renewable capacity, important for international acknowledgment. For example, the MOP has given higher priority to infrastructure building over financial sustainability, which has become a major concern for the MOF.

(2) Discoms owe increasing amounts of money to PFC/REC. Further, any default by discoms will jeopardize the functioning of the PFC/REC.

(3) There are issues in the regulation of the Power Finance Corporation (PFC)/ Rural Electrification Corporation (REC). On the one hand, these are regulated by the RBI as non-bank financial companies (NBFC). But such regulatory oversight is lighter compared to that involving the PSBs. On the other hand, these have been used to pursue the government’s quantity targets on access, quality, and renewable capacity. Therefore, the MOP will be reluctant to impose hard budget constraints on the discoms, which creates moral hazard and disincentives for discoms reforms.

(4) The state governments are involved in greater freebie-ism like offering free electricity, in the power sector. Therefore, lending to discoms has become a Ponzi dynamic which leads to under-recovery by the discoms.

What should be done to resolve the above issues?

(1) There should be a comprehensive attempt at institutional changes and financial performance. The latest RDSS scheme along with proposed changes to the electricity law steps in this direction.

Unlike the UDAY scheme, the RDSS desires frontload of the actions that discoms and state governments need to take. Further, the proposed legal provisions under the Electricity Bill may help make the RDSS provisions more effective.

(2) There should be greater transparency. For this, the next finance commission should recommend that the state government should ensure that discoms losses and debts are reflected in their state government balance sheet.

(3) There should be simplicity in power tariffs in India. For example, most states have more than a hundred tariff rates, which leads to large costs and zero benefits. The central government and the central regulator should nudge/persuade their respective state government counterparts to have tariff schedules with no more than say 5-6 rates. For example, one for agriculture, one for industry and commerce, and say 3-4 for households.

(4) There should be a target for smart metering of the entire system, including agriculture. This has the potential to improve financial performance and reduce inefficiency and corruption.

(5) The principle of no cross-subsidization must be accepted. The state government must eliminate rampant cross-subsidization. For example, Industrial and commercial consumers should pay tariffs close to the costs of procuring power by the discoms and not the costs that make up for losses elsewhere in the system, like below-cost pricing for agricultural consumers and households consumer in a state.