Tariff policy reforms – a cautious silver lining for power sector, consumers in the COVID era

Economic Times, June 15, 2020

By Simran Grover and Udai S Mehta

The fragility of fiscal health of distribution utilities has been exposed by the pandemic as it caused an unprecedented slump in demand for electricity and skewed consumer mix towards low paying categories.

State Governments, and consequently electricity regulatory commissions, have consistently betted on future power sector performance, energy demand growth and State’s revenue to artificially regulate electricity tariffs to maintain their political capital. Abuse of regulatory assets, cross-subsidy and subsidies across consumer categories have been detrimental to fiscal health of distribution utilities. The fragility of fiscal health of distribution utilities has been exposed by the pandemic as it caused an unprecedented slump in demand for electricity and skewed consumer mix towards low paying categories (domestic, agriculture).

As of March 2020, dues of distribution utilities towards generators stood at an astounding INR 90,000 Crores, which is likely to have grown significantly during the period of lockdown. The impact of COVID, along with few other factors may have forced the Central Government to push for some aggressive reforms, pending since many years, such as the Draft Electricity (Amendment) Bill and Tariff Policy, both of which were initially introduced in the year 2018. While the Central Government enjoys the political capital to push for aggressive reforms, the subject of electricity reform demands critical analysis of social and economic implications, with prudence along technical and financial dimensions. At the same time, as electricity consumers, it is also our duty to understand such implications and support (or oppose) reforms in a prudent manner.

The Tariff policy largely deals with frameworks for determination of tariff for electricity utilities across generation, transmission and distribution vertical, and lays out mechanisms for same with an aim to support competition, efficiency and fairness. Some of the bold measures introduced by the proposed Tariff Policy (to be notified as Tariff Policy 2020) mandate for reduction of cross-subsidy across consumer categories to 20% of cost of supply, simplification of consumer categories to 5 basic categories based on ‘purpose of use’ and severe limitations on the use of the instrument of ‘regulatory assets’ to curtail tariff hikes.

The proposed measures have a direct bearing on electricity bill of every consumer, and hence it is essential that the implications of these reforms are debated in public domain. On the outset, the above-mentioned reforms are definitively pro industry and other high paying consumer categories. The measures shall imply immediate reduction of tariff (and hence, input costs) for commercial and industrial categories, improvement of their competitiveness in domestic and global market, and hopefully lead to much desired creation of jobs in the Indian market.

At the same, the proposed measures may seem to be anti-poor as the burden of electricity tariffs is intended to be more equitable. While the question of equity is difficult to address, impact on interest of consumers and marginal sections of society must be analyzed. Foremost, the new tariff policy ensures that inefficiencies of distribution utilities cannot be transferred to consumer as it limits the AT&C losses to be accounted in tariff determination to maximum of 15%. Further, provisions for cost reflective tariffs, practical elimination of regulatory assets and direct benefit transfers (DBT) shall improve cash flow of distribution utilities, avoid delayed payment charges for power procurement, reducing requirement for working capital and hence associated interest costs. These benefits shall directly reduce annual revenue requirements (ARR), and hence lower the tariffs across all consumer categories. In Rajasthan for example, the carrying costs amount to INR 1.11 Per unit of electricity sold versus INR 0.18 in Gujrat, for financial year 2018-19. After the implementation of measures in new tariff policy, this shall ideally reduce to nil.

Still, there is the big question of ensuring affordable and quality supply of electricity for the economically poor in our country. About a fifth of our populations is still below the power line and given that affordable and reliable supply to electricity is an instrument for social equity and inclusive growth, addressing the issue of access to electricity for marginalized members of our society is of paramount importance. The new tariff policy suitably deals with the concern by allowing for up to 20% cross-subsidy and further allowing an effective subsidy of at least 50% for households consuming less than 60 units per month. While the 60 units per month might be a debatable figure, the framework for targeted subsidies shall ensure that subsidies are provided only to the deserving households and ensure better adoption of energy conservation and energy efficiency across all consumer segment to curtail their power bills.

Targeted subsidy for household consumption is definitely more efficient use of public funds, but it should be noted that access to electricity can power their growth when used for livelihoods and other income generation activities. Hence, provisions to allow targeted subsidies for income generation and livelihood activities in rural areas needs to be considered. At the same time, subsidies to agriculture sector need to be rationalized to promote efficient use of energy and water.

This brings us to the elephant in the room – ‘Direct Benefit Transfers’, popularly known as DBT. Vouched as an efficient and transparent mechanism for transferring subsidies to the economically poor, there are number of concerns around its practicality and readiness of State infrastructure to implement the same. The primary concern is of course the fiscal health of States and their ability to transfer subsidies in a timely manner to prevent any impact on the beneficiary. Further, there are practical concerns around readiness of the infrastructure across States to implement DBT and the issues pertaining to differentiation between owner of an electricity connection and user of electricity. Lastly, there are major concerns regarding ability of the distribution utilities to recoup their dues, especially in rural areas, given their historical performance of extremely low collection efficiencies.

Gaps and deficiencies in implementation of DBT can create adverse effects for distribution utilities and target beneficiaries. However, the proposed tariff policy does provide the foundation to address these concerns. The mandate of 100% metering for every connection shall also bring in better transparency in accounting of subsidies. Historically, claims of subsidy against un-metered supply for agriculture and other categories has been an issue of ambiguity. Couple with this, rationalization of tariffs and targeted subsidies to the deserving consumers is likely to reduce the subsidy burden on State budgets. Lastly, with a universal shift to pre-paid metering (proposed in tariff policy), DBT may be implemented through Aadhaar linked discount vouchers instead of cash transfers.

The reforms proposed in tariff policy are well intended, but careful implementation is going to dictate the success of proposed measures. Instituting feedback mechanisms, regulatory impact assessment and governance measures are critical to ensure that power sector, especially distribution companies, are able to shed their legacy and transition into a new era.

[This piece was authored by Simran Grover, CEO, Bask Research Foundation and Udai S Mehta, Deputy Executive Director, CUTS International]

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