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Cover Story | May 2015

SUBSIDY LEAKAGE:SWIPE It Away!

When it comes to the power sector, the buck always stops at State Electricity Boards.Be it wrongful inclusion or exclusion, the existing mechanism of subsidies often encourages utilities to shy away from billing accuracy in certain cases, while they often also have low incentives to enhance collections from highly subsidised customers. POWER TODAY, brings to attention an element that no SEB would have thought of.

The power sector, unlike others, defies easy reform options. The central government can, at best, advise the states on how to reform their ailing electricity supply businesses with sweeteners such as inexpensive power supply or cheap funds to improve the infrastructure, but it cannot force them to act. Meanwhile, subsidies are among the most powerful instruments for manipulation or balancing the growth rate of production and trade in various sectors and regions, and for an equitable distribution of income to protect the weaker sections of society. In this context let us try to understand how the overall subsidy mechanism in the power sector will work, if it is linked with directly with bank accounts of consumers.

Through this story, POWER TODAY tried to establish a mechanism of involving Pradhan Mantri Jan Dhan Yojana (PMJDY), as a base structure to link bank accounts of metered consumers with the State Electricity Boards (SEBs), to receive subsidy via direct benefit transfer (DBT). While many SEBs we spoke to, initially ´hailed´ the concept of DBT in the power sector, they were cautious about its successful implementation.The PMJDY, which aims to provide at least one bank account to all citizens of the country, is an ambitious financial inclusion scheme. Meanwhile, a number of central driven welfare subsidy schemes such as LPG subsidy, student scholarship scheme and National Child Labour Scheme can be administered through these bank accounts paving way for implementation of direct subsidy. To start with, electricity subsidy is driven by states and is the largest welfare scheme which affects almost every household (especially ones below poverty line). At present, most state governments in India provide advance subsidy to state-owned electricity distribution companies. First off, in order to make subsidy administration transparent, a number of challenges in the existing mechanism needs to be overcome and broaden the impact of financial inclusion, the states may leverage PMJDY to adopt direct subsidy mechanism. (Refer Mechanism for direct electricity subsidy on pg no 40).

Can DBT be a success story?
Incidentally, most SEBs were taken aback with the overall concept of providing DBT to consumers, especially in the electricity sector. This is because successful implementation of the concept is largely dependent on one of their largest customer bases-domestic and farmers, who constitute the maximum portion of subsidy beneficiaries and are treated with political ´softness´ due to their status as the largest vote bank.

To this, G Raghuma Reddy, CMD, Central Power Distribution Company of AP Ltd says, ´The concept of providing subsidy to consumers through DBT is a virtually good proposal, but implementing this in reality is accompanied by a lot of impediments. However this could be a huge success, if the subsidy is given by the Central government instead of the state governments.´

Likewise, Dattatraya Wavhal, Director (Finance), Maharashtra State Electricity Distribution Co. Ltd explained that since electricity is a state subject, DBT can be successful only in LPG and not in electricity, as the former works on a pre-paid mechanism (pay before service), while the later works on post-paid mechanism (service before payment).However, for Umesh Agrawal, Associate Director - Energy, Utilities & Mining, PwC and his team -- which is currently working on this concept -- if implemented by SEBs, this will enhance efficiency and provide commercial liberalisation from state governments.

According to Agrawal, the Direct Electricity Subsidy
will bring transparency in the subsidy mechanism and overcome a number of challenges (Refer Key issues with the existing arrangement on pg no 39) in the existing mechanism, thus broadening the impact of financial inclusion.

So going ahead, how will the consumers-household and farmers-benefit from this concept? By implementing this concept, state governments can empower and provide a choice directly to the beneficiaries. This will also add to the consumers delight upon receiving direct subsidy. In addition, SEBs will have power to target non-paying consumers (where subsidies can be stopped). And lastly, the incentive compatible solution will bring about rationalization in electricity usage among customers, as they would now understand the true financial burden. But in a counter argument, some SEBs, with high subsidy liability towards a particular section (farmers), have raised the flag of political ´compulsion´ of providing free electricity. A classic example would be Punjab, where electricity is absolutely free for farmers. The state due to its social obligation and compulsive political ´gentleness´ has extended a whopping Rs 43,600 crore for free power in FY15. According to a senior official from Punjab State Electricity Board, ´This is a sufficient amount to add power generation capacity of around 8,700 MW- adequate to build 20 thermal plants like the one in Bathinda (440 MW) - and enough to service an estimated debt of Rs 40,000 crore on the state´s farmers.´In fact, many senior officials from SEBs on condition of anonymity told us that whenever the state government has given SEBs free hand, their recovery has gone up to 60 per cent.

Senior officials from utilities such as Dakshin Haryana Bijli Vitran Nigam, Gulbarga Electricity Supply Company Ltd, Maharashtra State Electricity Distribution Co. Ltd and Jaipur Vidyut Vitran Nigam Ltd raised a valid point by saying that if the large chunk of consumers get free subsidised electricity, control over consumption patterns of the same will be impossible. M Mahadev, Managing Director, Gulbarga Electricity Supply Company Ltd added, ´Since the recovery from farmers along with consumers who do not pay electricity charges at all is mere 30-40 per cent, they will get the benefit of direct transfer of subsidy in their bank accounts, which is unfair to the consumers who pay electricity charges regularly.´ Countering this argument, PwC suggests that implementation of direct subsidy, will lead to subsidy having no impact on utility´s revenue. This will also enable utility to focus on metering, billing accuracy and improving collections of the subsidised customers. (See box Stakeholder benefit assessment on pg no 43)

Subsidy burden
Now, let´s have a look at some scathing figures of overall subsidy dependence for FY2014-15 by 16 states. On all India basis, subsidy dependence for the state owned distribution utilities for FY 2014-15 is estimated in the range of Rs 72,000 crore, which is estimated to have increased at CAGR rate of 16 per cent since FY 2010. Meanwhile, distribution utilities in the 16 states (based on the allowed subsidy levels in tariff orders) have also shown an increase by 17 per cent over the previous FY, mainly on account of upward pressure on cost of power supply and continued subsidised nature of tariffs for agriculture consumers. Among all the utilities, subsidy dependence for discoms in Maharashtra is estimated to increase sharply by about 55 per cent on year-on-year basis in FY 2015 as a result of tariff subsidy of 20 per cent announced by the state government for a 11-month period (Jan û Nov 2014). For Jammu & Kashmir the subsidy burden is projected to increase by 51 per cent due to continuos support for funding, high transmission and distribution (T&D) losses, while the same for utilities in other states is estimated to increase in the range from 8-20 per cent in FY2015 as compared to FY2014. This implies that the timeliness and adequacy of subsidy support to utilities from their respective state governments remains extremely crucial.And, indeed the timeline remains crucial because, tracking the trend from 2007-2015, there seems to be a huge discrepancy (Refer Increasing Subsidy Burden on pg no 44) in subsidy booked and received by the SEBs. On top of it, utilities face pressure to provide below-cost power to agricultural and rural residential consumers for which they are reimbursed through subsidy payments by state governments. However, 37 per cent of the subsidies booked by state utilities are not paid to them. In fact since 2003, subsidies booked have grown by 12 per cent per year, and subsidies received by 7 per cent per year - the cumulative gap between them was Rs 466 billion for 2003-11. This has had a crippling effect on the already financially struggling of utilities.To this, Arvind Gujral, VP, BSES Rajdhani Power Ltd says, ´The problem for utility finances arises because there is often a gap between the volume of subsidies booked by utilities as compensation and the amount received from the government. This worsens the economics of already struggling utilities, undermining their creditworthiness and preventing them from investing to improve service delivery.´ He further added, ´So if the direct cash payment or subsidy needs to be linked with bank accounts then they (state governments) should release the subsidy amount in advance.´

The leakage
States´ support to the power sector includes explicit fiscal transfers in the form of subsidy payments as well as subsidised loans and contributions of equity to utilities. Fiscal transfers to the power sector account for a significant share of state budgetary spending. State support to the power sector averaged 1.3 per cent of state GDP in 2011 across the 16 Indian states in which distribution utilities received support, and was as high as 6 per cent in Punjab and 5 per cent in Uttarakhand. As a share of the state budget in 2011, state support averaged about 2 per cent, but was 15 per cent in Bihar and 22 per cent in Uttarakhand. Meanwhile, most states also subsidise a substantial portion of domestic consumption. Of all electricity consumed by domestic consumers in India, 87 per cent was subsidised in 2010. As the domestic sector consumes almost a quarter of electricity sold, this is equivalent to 21 per cent of all electricity consumed, with the average subsidy being Rs 1.5 per kWh. While 25 per cent of households lack access to electricity and therefore receive no subsidy, more than half of subsidy payments (52 per cent) India-wide went to the richest 40 per cent of households in 2010, underlining the potential gain to utility revenues from better targeting that would reduce household subsidies.

Despite this generous subsidy regime, most of the domestic tariff subsidies are not reaching the poor. In 2010 some 87 per cent of subsidy payments India-wide were delivered to households above the poverty line (See graph: Subsidies Leaking to Households above the Poverty Line, 2010 on pg no 44). Accounting for cross-subsidy payments improved this figure by less than half a percentage point. In 11 states more than 90 per cent of all subsidy payments were delivered to households above the poverty line. Only one state was successful in targeting subsidies to the poor, with no leakage.

DBT will provide an accurate platform of identifying households below the poverty line and can better target subsidies to the poor. It will also expose the state utility´s financial and operational challenges, as the true collection losses will emerge which will be higher than the currently reported losses, masked by subsidy.

Another source of pressure on utility finances is the mandate to build and ´power up´ the vast network of lines laid across the country under the central government´s flagship access program, RGGVY. Under RGGVY, the Rural Electrification Corporation (REC) provides a 90 per cent subsidy for the capital cost of grid extension. But by January 2013, the amount sanctioned by REC for all RGGVY projects, Rs 342 billion, covered only 58 per cent of the estimated actual cost of Rs 590 billion, and the government had only disbursed 84 per cent of the sanctioned amount. The reasons for this misalignment are inadequate and unrealistic state estimates of the funding required to meet RGGVY goals; the REC´s application of standard cost norms that do not consider geography, cost of living, or other significant factors; a long and unwieldy revisions process, which has deterred states from requesting revisions to approved amounts; and RGGVY´s provision of free connections only to households below the poverty line, which restricts potential aggregate demand to a small group with low consumption levels.

Can DBT heal SEBs?
This was the question which did not fetch an answer when asked to as many as 20 SEBs across India. So, here´s our answer: Yes it will certainly improve the efficiency of a SEB. Importantly, when it comes to the implementation of DBT, one essential aspect raised by SEBs were billing improvement and collection system in rural areas. For instance, a lack of metering means that consumption cannot be accurately measured or billed.

To this, World Bank in its report ´More Power to India´ suggested that prepaid meters could be used to reduce utilities´ commercial risks, while also allowing rural households to have more control over consumption. In fact, the pay-as-you-go system is very familiar to rural users of mobile telephony prepaid cards. Other innovations, widespread in East Africa, allow rural consumers to make various payments through their mobile phones (such as the M-Pesa system in Kenya). India could try this arrangement to reduce transaction costs for all parties. It may be beneficial for interested state utilities to explore management contracts with private operators who can deploy prepaid metering technology.

Ideally, the share of energy realised (as revenue) to energy billed should be 100 per cent. But collection efficiency has generally remained stable, rising only slightly from 89 percent in 2003 to 94 per cent in 2011. The majority of states now report collection efficiency higher than 90 per cent. Meanwhile, according to an annual report of Power Finance Corporation on SEBs, about half the states saw collection performance worsen over 2003û11. The steepest fall was in Uttar Pradesh, which reported no contribution to utility losses from collection inefficiencies (a collection rate of 100 per cent) in 2003, but losses from collection of Rs 32.5 billion in 2011. At the end, Pramod Deo, former Chairman, Central Electricity Commission, cited three examples which will burden exchequers in the future. He tried to understand the disastrous consequences of the recent move of reducing power tariffs in Delhi by Arvind Kejriwal which was followed by the states of Maharashtra and Haryana.

Haryana, in spite of being bailed out by the central government and committing to increase tariffs to fully meet the fund requirement of its discoms, went for tariff reduction on the eve of the general elections.

Technically it could be argued that tariff reduction in all three cases was effected not at the expense of discoms, but by giving subsidy from state budgets. But such subsidy burden on the state exchequer is not sustainable and state electricity regulators would be under tremendous political pressure not to increase prices in future. It is high time that sincere efforts are made at the highest political level to sit down with state chief ministers and arrive at a political consensus on: what should be the quantum of subsidy to agriculture and targeted low-income sections, how to pay this subsidy and provide sufficient funds to state utilities to meet operating expenses, and help strengthen and expand their networks.

Having said that, DBT will improve the efficiency of SEBs, prevent internal leakages in subsidies, as well as prevent wrongful inclusion and exclusion. However, there are certain inheriting challenges while implementing it and the PwC in its report lists out some of them.

Likely implementation challenges
Bank and support infrastructure:

  • Collection and mapping of bank records along with consumer information.
  • Infrastructure strengthening of the banking network to handle the bandwidth of activity.

Customer:

  • Initial challenges in communicating the new subsidy mechanism to the consumers and convincing them that the level of support is unchanged.

Distribution utility:

  • Strengthening the disconnection process (with lower lead times) in case of payment failures to control financial losses to the utility.
  • Digitalisation of records and occasionally questionable integrity of billing data in absence of consumer meters.

POWER TODAY suggestions:

  • Comprehensive reform plan Clear long-term objectives Assess impact of reforms (who wins, looses)
Extensive communication strategy
  • Transparency about size of subsidies
  • Consult stakeholders about benefits of reform

Appropriately phased, sequenced price hikes

  • Allow time to adjust, build safety net

Improve efficiency of state-owned firms

  • Depoliticise, set performance targets, introduce competition if appropriate

  • States with fairly low fiscal costs of subsidies can further limit it by restricting the number of households receive the subsidy, and charging a cross-subsidy to some households

Target mitigating measures to protect the poor

  • Targeted cash transfers are preferred
  • Expand other programs if cash transfers impossible

Depoliticise price (tariff) setting

  • Automatic, rules-based price mechanism
  • May involve price smoothing

Cost recovery and commercial viability

  • Improve operational efficiency

  • State utilities are required to achieve 100 per cent metering within two years, adopt stringent measures to deter electricity theft, and reduce cross-subsidies in a phased manner
    Instead of DCT, SEBs can issue ´Power Stamps´ on the lines of food stamps to the beneficiaries which will arrest unwanted social spending. This can be used against the units consumed by the users.

The diesel subsidy in current crude prices is around Rs 12 ($0.25) per liter. Converted to per kilowatt-hour (kWh) costs of electricity, this means an imputed subsidy of Rs 1.5 ($0.03) per kWh of electricity generated through diesel. At hours of operation varying between two and three a day, the diesel subsidies provided by the central government to back up power users would be between Rs 88 billion ($1.9 billion) and Rs 131 billion ($2.8 billion). These subsidies are effectively being paid out by the central government in cash to diesel backup users.

-Rahul Kamat

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