UK: Cautious Optimism? - the Indian Power Sector

Last Updated: 14 March 2006
Article by Sachin Kerur

In the mid-1930s Mahatma Gandhi in his pursuit of freedom for Indian society, established an ashram in a remote village, in the middle of India called Segaon. Segaon had no electricity but India's political elite would make their way there to talk to Gandhi in the dark about policy. Fifty years after gaining independence, India's politicians, faced with a lack of electricity in the countryside as only 30% of rural Indian households have access to sustained electricity supplies, are often accused of remaining in the dark when it comes to implementing policy to remedy matters. However, with India's economy growing at 10% a year, the staggering financial outlay needed for the energy sector across the country to maintain such a growth pattern has prompted significant reforms.

For the potential foreign investor however, the Indian power sector often seems a step too far. Power projects anywhere are typically capital intensive undertakings with significant gestation periods and adverse risk profiles that make the availability of project finance difficult to come by. Added to this, the Indian power sector has for some time been mired in losses caused by inadequate management, populist and investor-unfriendly policies and diminutive investment levels. Hardly an attractive state of affairs for those contemplating sinking time, effort and money in the sector from abroad. However there is now an obvious trend emerging recognising the urgent need to bring new generation capacity on stream as quickly as possible and this is likely to mean more opportunities for private sector participation, particularly from outside India.

It is often forgotten that under British rule, private sector participation was the primary route used to develop the Indian power sector. The Indian Electricity Act 1910 set out the framework for the private sector to participate in the distribution and supply of electricity through a system of licences including those for developing power generation stations. Indeed the private British incorporated company, Bombay Electric Supply & Tramways Company held a licence from the Government of Bombay in the 1920s for the supply of electricity to Bombay. However successive public sector reservation and nationalisation policies following independence reduced the participation of the private sector. With the introduction of a central electricity authority, state electricity boards and regional electricity boards, by the 1960s the Indian energy sector had largely become a state monopoly.

Although by the 1990s India had increased its installed electricity generation capacity over the previous 40 years fifty times, from 1,500 MW to 80,000 MW, serious problems beset the power sector. In particular, the quality and reliability of supply was poor, India suffered widespread power outages, there were significant fluctuations in supply voltage and frequency and grid disturbances. Shortages in power were made worse by high transmission and distribution losses. The problems were caused by many factors. Underinvestment in transmission and distribution networks, poor capacity utilisation, inadequate billing, poor metering, irrational tariff structures, stolen power supply, the poor financial health of the state electricity boards and slow generation project implementation were the primary difficulties. By the 1990s only 55% of total electricity generated was billed and a mere 40% was actually paid for. The retail price of electricity represented less than 75% of the real average generation cost.

A new power policy was introduced in 1991 as part of an overall reform programme to boost foreign and Indian private industry involvement in the sector. Various legislative and fiscal reforms were introduced but foreign investors remained nervous about cumbersome project clearance procedures. In particular the credit worthiness of the state electricity boards, the main consumer for electricity generated, was considered miserable making the structuring and negotiation of suitable payment, escrow and security mechanisms under power purchase agreements with these boards hazardous.

Today it is estimated that around $200 billion is required for India's power sector development over the next 10 years. Whilst half of this would be for generation projects, the other half is needed for transmission and distribution and rural electrification projects. Strong political commitment and sector reforms are needed to attract such levels of investment and many such reforms are being implemented in earnest.

The most significant reform package has been the introduction of the Electricity Act 2003 (the "Act") that has changed the entire legal framework governing the electricity sector and has been designed to remedy many of the problems besetting India's power sector and to attract capital back to large-scale power projects. It is now the only central government law governing the electricity sector and consolidates and replaces a number of older laws. The Act has introduced significant changes in the industry, notably by moving the sector from a single-buyer market to a multi-buyer multi-seller system. The aim is to give the private sector access to the state electricity board transmission grids, allowing private power producers to sell directly to large industrial consumers. Stricter sanctions have also been introduced for power theft.

One of the key changes introduced by the Act is to remove the legal foundation for the continuation of state electricity boards and they must be completely restructured and their assets unbundled into generation, transmission, and distribution companies and the assets eventually privatised. Although restructuring has raised a number of difficult issues such as what structure to adopt and how to convert a statutory government corporation into a number of resultant corporate entities, 13 boards have been unbundled to date. Though the deadline for boards to restructure has recently been extended, the path to turning electricity boards into commercially viable entities is clearly one-way only.

The long-awaited National Electricity Policy ("NEP") was introduced this year to supplement the Act and aims to make electricity available to all households in the next five years and addresses issues relating to generation, transmission, distribution, rural electrification, energy conservation and environmental issues. The Rajiv Gandhi Gramin Vidyutikaran Yojana has also been introduced, an initiative that integrates a number of previous rural electrification schemes with the aim to electrify all villages and to strengthen the transmission and distribution network.

The tariff regulation of any infrastructure project is of course critical when it comes to attracting funding and disappointingly the National Tariff Policy has yet to see the light of day. This policy is expected to provide a basic framework to state regulators for fixing generation and distribution tariffs and is essential in providing potential foreign stakeholders comfort on a number of issues related to tariffs and surcharge. Distorted tariffs in India remain a concern, causing as they do an unsustainably high cross-subsidy which does not cover the cost of service provision. Indeed low tariffs rarely benefit India's poor, most of whom lack access to power, particularly in the rural areas.

Current installed generation capacity in India is 120,000 MW - 80,000 MW thermal, 35,000 MW hydro, 3,000 MW nuclear and 2,000 MW wind. India is looking to add another 50,000 MW by 2008. Electricity generation is increasing annually at 5% and the Plant Load Factor of generating stations has increased to around 75%. Energy and peak shortages are decreasing. However whilst generating capacity is performing relatively well, the transmission sector remains congested and inadequate and T&D losses are as much as 35%. The power transmission system is however going through an extensive national restructuring programme and Power Grid Corporation of India, the national transmission company is at the forefront of the changes.

There have been a number of reforms in the distribution sector led by the Accelerated Power Development and Reform Programme that provides loan and grant facilities to states willing to reform to develop and maintain an effective, co-ordinated and economical distribution system. A number of states have utilised such facilities to help implement measures to stem T&D losses. The sector has seen a number of states instigate energy accounting, energy audits, customer indexing and interface and feeder-level metering to improve accountability.

There are a number of significant problems in the Indian power sector that appear intransigent. For example, agricultural subsidies continue to stifle reforms. There is a pressing need for the Indian government to implement a national policy on farm tariffs. At present political "generosity" such as the free grant of electricity to farmers needs to stop in order to make the sector financially more viable and attractive investment. However questions will be asked as to whether the current coalition government with significant socialist backing will be able to implement reform in this area. A further bottleneck to progress is a lack of adequate fuel and poor port facilities in the country. Although a number of initiatives in the coal sector should assist the supply of fuel for power generation, the quantum and reliability of the gas supply remains an issue.

Overall however, after a number of false-starts, the Indian power sector is in the midst of a positive hue and much of that stems from the recent revolutionary Electricity Act. Foreign investors are however unlikely to make an immediate rush into the sector. However many will see the recent changes as a forerunner to more innovative policies that will bring commercial viability to the sector, further tariff rationalisation and more incentives. This will go a long way in persuading them to come off the sidelines and participate in the development of one of the world's largest infrastructure markets.

Sachin Kerur is based at Masons Galadari, Dubai

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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