CURRENTLY, the 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 objectives.

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. S 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.