Beyond UDAY

More steps to make power reform sustainable

Last week, the government unveiled its Ujwal DISCOM Assurance Yojana (UDAY), with the intent to find a permanent solution to the financial mess that the power distribution is in. Massive accumulated losses have made these state-owned entities not only hugely dependent on banks but also unable to service their huge debts. It is a travesty that India has over 270 gigawatts of power generation capacity, but is currently using only half of it, because distributors refuse to lift power that they are forced to sell at a loss. As a consequence, several parts of the country are still suffer long periods of outages. The solution to the problem is technically obvious, but politically challenging. The first phase of the solution is to buffer the finances of the distribution companies, or discoms, from the subsidies that state governments may want to provide for power. UDAY attempts this by asking states to issue bonds to banks as repayment for discom dues. This will accomplish the significant objective of forcing states to put their money where their mouth is on power subsidies. They will now have to directly bear on their budgets the entire cost of the subsidies. From the discoms' perspective, the shifting of the debt burden to the state government changes their financial picture significantly and, presumably, allow them to buy enough power to meet aggregate demand in their domains. This is all to the good.

But, the next step, that is implied by the policy but not explicitly articulated, is where the challenge lies. Two previous attempts to break the financial logjam in this sector, both of which essentially involved sequestering funds from central transfers to pay off the discoms' dues to various suppliers both ended up unsuccessful precisely because the next step was not taken. Fundamentally, unless discoms are allowed to charge prices that reflect cost of delivery, including a return on capital, they will always be on the financial brink. This could be done in two ways; let the consumer pay the full price, as determined by state regulators, after which the state governments can directly transfer subsidy payments to selected groups. This way, discoms' financial health is protected and the subsidy becomes an explicit contract between the government and the beneficiary. A more practical but also more risky approach is to build the subsidy into the tariffs, but have an annual budgetary provision for subsidies, which is transferred to discoms at periodic intervals. This is risky because it is difficult to enforce. In essence though, whatever approach is taken, UDAY will meet the same fate as its predecessors unless it is followed up by meaningful tariff reform.

The political hesitancy in implementing this is somewhat surprising. Over and over again, consumers have demonstrated their willingness to pay higher prices for services as long as supply and quality are consistent and assured. From education to healthcare to water to energy, quality improvements are essential to meeting mass aspirations. But state governments still shy away from re-writing the contract on power supply and tariffs with their constituents. If the same reluctance persists after UDAY, it will bring the commendable efforts of the central government to solve this problem to nought.