When private investment was invited in the Indian power generation sector in 1991, no one had imagined it would take the government a decade to realise its folly.

Perhaps, Indian bureaucrats lacked foresight. Trying to fight power shortage by increasing generating capacity, it sought to fix a long-term problem (crippled State Electricity Boards) with a short-term solution.

The attempt to attract private investment to power generation has been a non-starter due to many reasons. The excuses can range from bad policy framing to the lackadaisical attitude of the central and state licensing authorities. But the most important factor that has deterred independent power producers (IPPs) is the health of the SEBs.

Today, even officials from the power ministry (who wish to remain anonymous) feel that opening up power generation before restructuring SEBs, was not quite the best idea.

"Private sector investment should have been preceded by restructuring of the SEBs" opines Hemant Joshi, Executive Director, Crisil. "How will any private entrepreneur enter the field without being, to some extent, assured of payments to him?"

The pathetic financial state of the SEBs is quite well known. Just one SEB (Maharashtra, 2.2 per cent) today earns a positive rate of return without a state government subsidy on its capital. Even with subsidies, the estimates for 1998-99 indicate that only Maharashtra and Karnataka are in the black. All the other SEBs have reported a net loss. This inspite of large subsidies doled out by the state governments,

Asks R K Pachori, Director, Teri, "Unless there is an assurance of returns who will risk his money? And that assurance of returns cannot be there firstly because tariffs are totally irrational. Secondly the realisation of dues are totally inadequate. And thirdly the overall health of the SEBs is poor because of overstaffing, inefficiency and poor maintenance.

"Due to this, anybody who is going to invest in power equipment on the assumption that he can sell power to SEB, and get paid for it, is obviously taking on a huge risk", he says.

The crux of the problem is the tariff structure. Agricultural consumption is almost free, while domestic consumption is subsidised to some extent. In order to recover the deficit, industrial and commercial consumers as well as the railway traction are overcharged.

The agriculture sector accounts for nearly one-third of the SEBs' sales volumes. But the revenue realised from this sector has been only 3.5 per cent of the total revenue. The domestic and the agriculture sector taken together account for 50 per cent of the total sales of SEBs. But their share in the total revenue is only 16 per cent.

On the other hand the industrial and commercial sectors account for 80 per cent of the revenue. This when sales to these sectors have been in the range of 34-35 per cent only.

This cross subsidy, however, has a limit. Rising tariffs mean that, after a point, it is cheaper to generate electricity rather than buy from the SEBs. "They (SEBs) could manage in the past because of cross subsidisation. Now the cross-subsidisation opportunity has also been exhausted, because tariffs for the industrial users have reached such levels where they cannot afford new hikes and would rather shift to captive generation", says Joshi.

Increasingly large industrial units are setting up their own power generation plants. The alarming decrease in the contribution of industrial consumers to the total revenue of the SEBs bears enough testimony to the fact (see graphs).

For instance, half a decade back almost all cement plants bought electricity from the SEBs. But, in 1997-98, captive plants powered 28 per cent of the cement produced. The figure rose to over 33 per cent in 1998-99.

Since industrial consumers are in the highest tariff bracket, the SEBs' revenue generation is bound to suffer. The message is clear. Tariff hikes will not hide inefficiencies any longer. It is time to acknowledge the inefficiencies and deal with them.

Falling in place
Take Orissa for instance. It has been the first to unbundle its electricity department. The model is very simple. Strip the SEB into three separate entities, each dealing with generation, transmission and distribution. The distribution company is then split into a number of smaller companies based on the area or circle of electricity distribution. These distribution companies are then privatised.

The model, with minor changes, is now being followed by other states like Andhra Pradesh, Haryana and Gujarat. In Haryana, before work on SEB reforms came to a standstill, the four distribution companies were to be joint ventures with private companies. Gujarat is keen on unbundling and corporatising the distribution entities without privatising them.

Tough task ahead
Whichever model the states evolve, the main worry remains rationalisation of tariffs. In plain language it means increasing inflows from the agricultural consumers. But most states have demurred at taking up SEB reforms for so long mainly because they are wary of alienating this large block of voters.

Whether the states like it or not, "they have very little choice when dealing with independent regulatory bodies. When the external environment is such that the prices are not set by the government, the interface between the government and the SEB will be very different from what it is today, these prices would be set by an independent regulator" opines Pachori.

But that is exactly the reason why the reforms process in Haryana has suffered a setback. With elections round the corner, no political party is willing to commit on any specific scheme for unbundling. No one wants to bell the cat right at the start.

Increasing tariffs or even hinting at the same, at this juncture, would be a difficult proposition for Haryana. Average tariff levels in Haryana are at least 55 paise lower per unit than the average tariff in Orissa. This when the cost of supply of electricity is nearly equal in both states. Hence a higher revision will be required for the Haryana SEB to break even.

Orissa, though it had to deal with fewer complications, took a couple of years to deal with the initial hiccups. What most other states would envy it, is the meagre agricultural consumption in the state. Seeing the tariff hike through was therefore much easier.

In most other states agricultural consumption accounts for a substantial part of the SEBs' supply. Take for instance, Andhra Pradesh, where the share of agricultural consumption is as high as 34 per cent of the state's total consumption. Karnataka is even worse off with 48 per cent of its entire electricity consumption going into agriculture. Any revision in tariffs here will have to be dealt with very carefully.

Also, when reforms are initiated, it would become mandatory for the unbundled entities to meter agricultural consumption. Today, electricity provided to agricultural consumers is not metered, making manipulation easier. Part of the agricultural consumption can be shown as transmission and distribution losses or vice versa. This practice makes it difficult to estimate the actual loss or theft that take place in the system. Also, the subsidy given by the government is on the basis of some imaginary figures. With privatisation not only will agriculture tariffs increase, but consumption will also be metered. Any which way, the electricity bill is sure to explode, at least in the beginning.

The tariff might come down at a later stage courtesy the efficiency of privatisation. Moreover, measures such as time-of-the-day tariffs (alternatively penalty rate for peak-hour usage) through which incentives can be given for off-peak hour usage, could help control the peak hour shortages. Such incentive schemes would also help farmers and domestic consumers minimise their electricity bills.

The bottomline
There are huge benefits to privatisation. But the focus must shift from attracting private players and increasing generation facilities to increasing efficiency. Once privatisation happens, efficiency parameters would be defined and the unbundled entities would be held responsible for attaining those parameters.

Efficiency can be improved on three fronts: