state electricity board finances

hammer1.gif (1140 bytes) People’s Democracy

(Weekly Organ of the Communist Party of
India (Marxist)


No. 34

August 26, 2001

SEB Finances: In
a Nutcracker

Prabir Purkayastha

finances of the State Electricity Boards (SEBs) are in complete shambles. The report of
the Expert Group headed by Montek Singh Ahluwalia, set up to address this issue, has
suggested “a one time settlement” along with “a commitment to initiate the
process of reforms”. The underlying assumption of the report is that reforming the
power sector means privatisation of the SEBs. The electricity bill being introduced in
this session of the Parliament has also the same objectives in mind.


One of the
problems in privatising the electricity sector is deciding which entity takes over the
accumulated losses of the existing SEBs. One of the reasons cited for the failure of
reforms in Orissa was that the state-owned Gridco was burdened with virtually the entire
past losses of the OSEB, after which it never was going to be viable. The state-owned
Gridco carried this burden so that the distribution and generation parts of OSEB could be
made more attractive to private bidders. The distribution companies are collecting revenue
but not paying Gridco, while Gridco has to shell out the full amount to the generators. The
state-owned Gridco is thus getting deeper into the red: a classic case of privatising
profits and nationalising losses.

The Montek Singh
Report therefore seeks to address one of the key problems of privatising the SEBs. For
power, coal, freight, etc, the SEBs owe about Rs 25,000 crore as principal to the Central
Public Sector Undertakings (CPSUs), and another Rs 15,000 crore as interest and
surcharges. Obviously, if this amount can be deleted from the balance sheet of the SEBs,
it would remove “one of the major impediments to reforms” (read privatisation).
The report suggests that the principal amount and half of the accumulated interest be
converted into tax-free bonds worth about Rs 35,000 crore. In other words, the state
governments should take over almost all the past dues of the SEBs. They would get a grace
period of five years before repayments begin.


It is important
to know how the SEBs got into the current financial mess in the first place. Montek Singh
and his experts carefully avoid this question, as that would need the examination of the
impact of the last decade of reforms on the finances of the SEBs. The dominant view today
is that the state governments are giving power away free to agriculture and are also run
very inefficiently. This, however, fails to explain why the SEB losses have ballooned so
dramatically only in the last decade.

The power sector
reforms began in the 1990s when a number of incentives were offered to Independent Power
Producers (IPPs) for investing in the power sector. Though only few states were directly
affected by IPPs, there was a far bigger impact on the SEBs due to the effect of these
incentives on the price of power imported from NTPC and NHPC. For example, one such
incentive — the increase of depreciation rate from the earlier 3.5 per cent to 8.24 per
cent — raised the cost per unit of supply by about 35 paise. If we combine this with the
increased return on equity allowed (16 per cent from the earlier 11 per cent) and the
higher interest charges that NTPC incurred on its commercial borrowings (instead of the
earlier soft loans), the increase in the cost of imported power to the SEBs was of the
order of 75 paise per unit. This means a whopping additional Rs 5,000 crore per annum for
the new generating capacity of more than 10,000 MW that was added by NTPC and NHPC. If we
add to this the exorbitant prices that SEBs are paying to IPPs, the use of the costly
liquid fuel route, the increase in coal prices and freight charges, etc, it is not
surprising that the increase in the cost of generation in the reform years has
significantly outstripped the annual rate of inflation. While the central government took
these decisions, the resulting burden was borne exclusively by the SEBs and the states.

The other part
of the reforms was lifting restrictions on captive power generation. The industry sector
that was subsiding the other two – agriculture and domestic sectors — moved away
from the grid as the cost of grid power increased sharply. Presently, the industrial
demand is growing at a much lower rate than of the other two sectors. Consequently, the
revenue per unit of this new demand – averaged over the three sectors — is below the
current revenue per unit of existing demand. For supply it is just the reverse. All new
electricity supply (even if we take the Dabhol or other IPPs out of the equation) is at a
cost much higher than the average cost of generation. The SEB finances are in this classic
pincer; if the demand increases the SEBs lose due to adverse marginal costs on both the
supply and the generation sides. They get less revenue per unit of new demand while they
have to pay more than their current generating costs for every new unit added.


Privatisation in
no way solves this structural problem of the electricity sector. If subsidies are to be
reduced, they can be reduced with or without privatisation. The CERC and SERCs – the
regulatory bodies at the central and state levels – have been set up for this
purpose. The only area where privatisation can help is presumably in improving
efficiencies and a more effective revenue realisation. The privatisation Orissa State
Electricity Board, as well as the greater Noida private distribution experiment, do not
auger well in this respect. The distribution companies in Orissa, it is understood, owe
the Gridco more than of Rs 1,000 crore, and AES has recently given notice that it wants to
pull out of CESCO, one of the four private distribution companies in Orissa. IFC, the
World Bank’s financial arm for the private sector, as well as other lenders have
turned down proposals from the other three private distribution companies run by BSES, as
they find these projects not viable. The annual losses to the state-owned Gridco are now
higher than the earlier losses of the Orissa SEB. This shows that the drain on the State
exchequer does not stop after privatisation. The important issue here is that even after
taking all the losses of OSEB on the state owned Gridco’s books, making Gridco
responsible for loss making rural electrification, and with only nominal agricultural
consumption of electricity (of the order of 5 per cent), the privatisation experiment in
Orissa has failed and failed miserably. Undoubtedly, the protagonists of privatisation
will find new excuses for this failure. The stark reality is that if Orissa privatisation,
deemed to be the most attractive case for privatisation in view of its low agricultural
consumption, does not succeed, other boards have even less of a chance. The situation is
no different for the Greater Noida distribution privatisation, which now owes huge amounts
to UPSEB, even though it receives electricity at Rs 1.42 from UPSEB, estimated to be only
50 per cent of the current cost of supply.

Even if
realisation does improve, the question remains what will happen to subsidies after
privatisation? Once the assets of SEBs are revalued and privatised, the capital costs that
which have already been paid for by the consumers will have to be paid again. All experts
agree that the average cost of power will first go up by 50 to 75 per cent after
privatisation, before they can come down. It is clear that with the current level of
incomes, it will be impossible for large sections of the people to pay the resulting costs
of Rs 5 or 6 per unit for domestic and Rs 3.00-3.50 per unit for agriculture. A number of
countries have privatised their electricity sector and the governments have had to provide
subsidies for the poorer sections in response to popular protests. Such subsidies, along
with the repayment for the proposed bonds will ensure that the finances of the state
government finances sink completely.


We are not
raising questions here regarding what happens to electrifying rural areas, which was the
raison d’etre for the formation of the SEBs or the impact of privatisation on low-end
consumers. There is little doubt that neither rural electrification nor providing power to
low-end consumers will be an objective of the private distribution companies. They have
already made clear that their business is to make profits for their shareholders and not
fulfil any social objective. Those arguing for reforms are committing a fraud on the
people by not clarifying that the government now does not consider that it has any social
obligations in the sector. The privatisation proposals and the electricity bill being
introduced is thus a complete re-orientation of the sector away from its earlier

In a recent
article, Montek Singh recently has written that market failure does not automatically mean
success of government intervention. He of course has no hesitation in arguing its converse
that government failure automatically means the success of privatisation. That this is not
so is brought out by the Orissa example. It is true that SEBs have problems that require
urgent attention. Mindless privatisation, as is being advocated today, will lead to
a sharp rise in electricity prices without reducing the losses of the state governments.
N Roy, former Chairman, CEA, has already warned of large-scale political instability due
to continuing steep rise of the electricity rates in the country. It is time that we
looked at the power sector reforms afresh without the ideological blinkers that
privatisation is the sole solution to the problems of the sector.

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