PowerShock: There are no free lunches—how the politics of free power is killing discoms

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While one may keep deliberating over the pros and cons of giving away electricity for free, one thing that sector experts are unanimous on is that this growing trend can be the last nail in the coffin for power distribution companies or discoms that are already in financial distress. If this continues, we will be left to “the Grace of God!”

“It is bad economics and bad politics,” said Debasish Mishra, partner and leader (energy), Deloitte India. He hopes that people realise the problem with this school of politics and don’t vote only on this basis.

In this article we cover a few nuances that help explain tariff setting and the implications of free power supply to the Indian economy and taxpayers. This is a part of Moneycontrol's special series on the sector titled the Power Shock, which presents in-depth analyses of the different issues in the power sector, its various stakeholders and possible solutions to the recurring power crisis in the country.

Tariff setting principles and politics

Electricity tariff design is often considered an art. If you have ever paid attention to the several subtypes of charges in your electricity bill, you may already have a fair idea of the complexity of tariff setting.

There is no right or wrong way of how retail consumers should be charged, although the sum total of all collections must be sufficient enough to cover for all costs incurred by the discom and provide for a regulated profit margin.

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State electricity regulatory commissions are entrusted with the responsibility of guiding discoms with tariff design and approve retail tariffs such that no consumer category is disproportionately burdened.

On the basis of this, discoms decide on various metrics, including what percentage of costs are to be recovered via fixed monthly charges versus variable usage-based charges, and how much cross-subsidy should be recovered from identified groups of consumers to pay for lower recoveries from the balance consumers. Typically, industrial and commercial consumers pay higher tariffs than residential and agricultural consumers.

Discoms also often rely on grants and loans on favorable terms provided by the central and state governments that help them to bring the overall costs down. On top of it, state governments can offer to cover part of the costs by way of tariff subsidy targeting economically weaker sections of the society such as below-poverty-line residential consumers, agricultural consumption, etc. Thus, discoms rely on both national and state taxpayers for funding.

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In cases where the state government has offered to cover the costs of a section of consumers via tariff subsidy, the discom can lower what it charges to these consumers. At the extreme end, this charge can be zero, which means that the state government is fully sponsoring costs incurred by the discom in supplying power to such consumers.

Theoretically, this does not seem difficult or concerning. But in reality, things are different.

For starters, state governments go overboard in promising tariff subsidy. Later on, they fail to compensate the discoms with monies promised, leaving the companies with holes in their books. According to the ministry of power, the shortfall in tariff subsidy billed and received by discoms pan-India in FY20 was Rs 6,400 crore.

A shift to directly transfer subsidy benefits to beneficiaries has been proposed to take care of this mismatch but is yet to be implemented. “Subsidies should be distributed via direct benefit transfer to those who truly need them. Free power promise, irrespective of actual need, is a self-created problem.” said Mishra of Deloitte India.

Ratepayers versus taxpayers

Another issue is the lack of transparency on how central and state finances get affected as a result of tariff subsidy. Between the twin goals of maintaining economic competitiveness and managing developmental objectives, deciding how much cost burden is borne by the discom ratepayers versus the state and national taxpayers requires striking a fine balance.

According to the Power Finance Corporation, on a national average basis, ratepayers are contributing Rs 5.14 per unit whereas the taxpayers are contributing Rs 1.79 a unit. There is nil reporting by governments on whether they conducted any societal cost-benefit studies to decide on the level of tariff subsidies. Or if the said taxpayer contribution could have been put to use for alternative programmes such as health, education, pollution management, etc.

The Delhi government recently revised its free power policy and made it an opt-in scheme where a consumer can willingly give away her benefit of receiving tariff subsidy, though no justification was reportedly provided on why such a change in policy was necessitated.

It is no rocket science that at the extreme level of tariff subsidy support, which is under the promise of free electricity, government budgets get unnecessarily stretched. Raj Pratap Singh, chairman of the Uttar Pradesh Electricity Regulatory Commission, said, “Ultimately, it is the consumer who decides what value electricity brings to his or her life. That said, setting up expectations of power supply for free is a wrong precedent and should be discouraged by all political parties.”

Lack of accountability

State government-owned discoms are time and again derided for their poor operational and financial performance. But it could be that the growing trend of giving away power for free discourages them from investing in performance improvement.

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Why would they be bothered with accurate metering and billing, and especially with meeting standard of service such as restoration time required in case of supply failures if they are given the short end of the stick? There is already a huge difference between power supply outage hours in urban versus rural areas. Free power policies may further reduce discoms’ motivation to supply 24x7 power to rural consumers.

Consumers themselves can be confused with talk of free electricity and may get frustrated if in future there is any change in terms of number of free units or a complete removal of such benefits. Time-of-day tariff, which is a popular demand-side management tool to optimise system costs, goes for a complete toss in cases where the consumer usage is anyways billed at zero.

Welfare economics and sustainable growth

The political economy is deep-rooted in the workings of the power sector in India. Since electricity is a concurrent subject, both the Union and state governments exercise control over the way policies are set, including how much financial support can be offered to discoms by way of subsidies.

According to Vinayak Chatterjee, founder and managing trustee, The Infravision Foundation, “The management of India’s last-mile electricity delivery and associated commercials has been the weakest of the four links in the power chain: fuels, generation, transmission and distribution. Unfortunately, it is this fourth link that is the tail that wags the power sector dog. Distribution reforms urgently require a federal consensus-type ‘surgical strike’ much like what was achieved in the GST (goods and services tax) Council.” Chatterjee is also the chairman of the Confederation of Indian Industry’s (CII) National Task Force on Infrastructure Projects.

The need for more state and central government coordination and political consensus for better targeting of subsidies is highlighted by other experts too.

“There is a need for a national electricity council on the lines of the GST Council so that the central and state governments work together on various strategic and timely issues, including better targeting of electricity subsidies.” said R Srikanth, professor and dean, National Institute of Advanced Studies, Bengaluru.

Energy poverty is indeed a sad truth. But the same can be tackled via targeted benefits transfer instead of a populist move like free power to all. Free power is not in the interests of consumers or discoms in the long term.

Making sure that the consumer understands the costs incurred in getting power supply and how much of it is contributed by taxpayers is a starting point for promoting efficiency—in consumption as well as operations. Perhaps then the consumer will refuse the promise of free electricity as a political tool and the focus will shift to welfare and sustainability.

(Rasika Athawale is the founder of India Energy Insights)