Opinion Coming out of the dark

There have been chronic electricity shortages and outages in the sector,as well as a lack of investment sufficient to meet growing demand. The electricity market lacks a fully implemented market design,is overseen by a regulatory regime that is jurisdictionally fragmented,has inefficient pricing,relies on subsidies for subsistence and has been unable to attract the type of investment required to keep up with demand.

To understand the current situation,a bit of historical perspective is in order. The Indian power sector,since Independence,has been both successful and seriously flawed at the same time. The success has come from the expansion of service to millions of Indians,who the British colonial authorities failed to reach. The extension of service was accomplished by significant investment as well as strong policy oversight by the state at both the national and state levels.

While many millions of Indians remain un- or under-served,India is far closer to universal service than it was before Independence. That success was achieved at a cost. Little private investment was sought or obtained in the sector. The market was,with a few exceptions,fragmented into vertically integrated,largely insular companies owned by state governments (generally known as state electricity boards,or SEBs). As a result,the sector evolved more as an extension of the state than as a commercially viable part of the economy. It also existed in a protected environment removed from normal market pressures such as competition or sensitivity to consumer needs.

Over time,not surprisingly,the social objectives that drove the sector gave way to less lofty political objectives,such as keeping rates low to serve political ends,without due regard to the fact that the sector was being deprived of much-needed capital,or that funds were being diverted from the public treasury to make up for rates that were substantially less than compensatory.

Once the precedent for public subsidies was established,the sector functioned in large part to serve purposes that appeared to be more political than economic or even social. A prime example is that subsidies initially designed to provide service to poor rural Indians and to enable greater use of irrigation to increase agricultural production became broad subsidies to rural residents and agricultural producers without regard to need. Over time it became politically difficult,if not toxic,to undertake changing them. Those subsidies had the dual effect of starving the sector of capital while at the same time sending signals to customers to consume more.

The evolution of the sector was not without its critics,but those critics who argued that the sector needed to be run on a more commercial basis were,for many years,ignored until the demands for subsidies reached levels that strained the treasury and the unreliability of service became intolerable.

Over the years there have been several efforts at reform,including the creation of a national grid company to interconnect India’s heretofore isolated SEBs and to enable a nationally integrated electricity market,the creation of independent regulatory agencies at both the state and national levels and allowing the entrance of private capital into the marketplace. Some states have recently taken politically difficult steps to raise tariffs to levels that cover the cost of providing service. While opinions vary as to how successful these efforts have been,the shortages and unreliability of service make it clear that,regardless of their success or lack of same,the reforms have been insufficient to meet the needs of the country’s ever growing appetite for electricity.

While it is presumptuous for a foreigner to prescribe specific measures for India to take,there is considerable international experience from which lessons can be learned. Indeed,as one looks at power sectors in various nations,the sophistication of the sector tends to track the sophistication and evolution of the economy as a whole. India,however,appears to be an exception to that. While the economy has made enormous strides,the nation’s power sector,despite reforms,seems not to have kept pace. What steps might India take to modernise its electricity industry?

A useful first step would be the adoption of a pricing regime that accomplishes two things. The first is to set tariffs at levels that make the sector financially viable so that no general,untargeted subsidies from the public treasury will be required and new investment capital can be attracted. That capital can be used to do better maintenance,instal state of the art technology and to expand in order to better accommodate growth. If there are to be subsidies or non-economic social objectives,they need to be explicitly articulated and then efficiently targeted to serve that purpose and that purpose alone.

Second,the prices must communicate to customers the actual cost of energy at the time of consumption. By so doing,customers will find it in their interest to consume when demand is low and reduce consumption when demand is high. In that way,the overall system is rendered more efficient.

On a related note,once revenue levels are sufficient,utility managers must be held strictly accountable for maintaining satisfactory levels of service. Whether that requires privatisation or whether state-owned enterprises can be made to function on a fully commercial basis is an open question,but either way,management must be held to account for the performance. Once revenues are adequate,poor quality of service is simply intolerable,but absent adequate revenue,acceptable levels of service are not obtainable.

In a nation as technologically savvy as India,it is important to note the relatively recent availability of the “smart grid” technology that enables customers to receive real-time price signals and to instal chips in their appliances to respond automatically to those price signals without human intervention. It also enables utilities to monitor conditions on their system in real time in order to anticipate and prevent service interruptions or,when they do occur,to respond more quickly and efficiently to them. Proper pricing would permit such investments and would signal customers to react in economically sophisticated ways. Proper pricing would also establish real incentives for more efficient use of energy and for overall conservation.

The issue of appropriate pricing,to be fair,is not entirely one of the depoliticisation of the sector. It is also one of organising the market in such a way as to allow it to function over large footprints in order to diversify supply. Such energy markets exist in many countries but their evolution in India has been stunted by regulatory and policy fragmentation between the national and state governments,severe limitations placed on the role of traders who would otherwise add considerable flexibility,liquidity and efficiency to the market,the absence of entrepreneurs from the market,and the weak financial condition of so many of the distribution companies on whose revenue stream the system rests. Each of these problems should be addressed as part of a comprehensive reform of the sector.

While we do not yet know the precise cause of the recent blackouts,we do know that the power sector as currently constituted is not one that can be relied on to support the country’s economic growth. India can do better and,indeed,it deserves better. The outages should be taken as a wake-up call that it is time for comprehensive and fundamental reform.

Ashley C. Brown is director,Harvard Electricity Policy Group,Kennedy School of Government,Harvard University and was advisor to several countries,including India,on energy markets and infrastructure regulation