The Time To Privatise India’s Electricity Sector Is Now

Prime Minister Narendra Modi has made big commitments in Glasgow on behalf of India. Linking these commitments to the provision of climate finance and calling for a change in lifestyles was a smart move and will appeal to concerns for climate equity. India will nevertheless need to imagine the path for its own decarbonisation in greater detail. Ground-zero for this is the electricity sector, which is badly broken and needs major surgery. The solution is deep privatisation.

Only time will tell if and how India will fulfill the five major commitments the Prime Minister made at Glasgow. At present, commentators are still trying to make sense of what exactly these commitments mean. Apart from the increase of the renewables target from 450 gigawatts to 500 GW, the path to achieving the other promises India made at Glasgow is unclear. The announcements were made without public consultation or debate, and we do not yet have an understanding of how these objectives will be achieved.

The current policy environment might be sufficient to allow well-entrenched Indian firms to make some multibillion-dollar bets in energy transition businesses. But the state of the Indian energy sector, particularly electricity, does not currently lend itself to receiving much of the $1 trillion that the Prime Minister is demanding of the developed world.

Most of this money is unlikely to come from governments. It will come from private sources, and only if the electricity sector becomes more investible.

It is useful to remember that the Paris Agreement envisages two sources of funding, public and private. Government-to-government funding might flow irrespective of major power sector reform, but significant private cash will come only if the sector is more attractive for investment. Of the $303.5 billion of energy transition investment made worldwide in 2020, India received only $6.2 billion, while China got $83.6 billion.

We wrote recently that the best way for India to decarbonise was to ditch central planning and allow the price system – markets – plus a carbon tax to do the work. This strategy will work best in the context of fundamental reform of the power sector.

Outdated Framework

The architecture of the power sector dates from a time when India was a smaller and simpler economy. The electricity system was built around public sector ownership of generation, transmission, and distribution and the problems of this public sector system remained internal to it. Risk assessment and mitigation were not required. Delayed payments, unbalanced contracts, or poor fiscal performance had implications only for the owner of this public system, the government.

The reforms brought about by the Electricity Act, 2003 essentially took this public system and grafted independent power production onto it.

Various other reforms have been brought in over the past 20 years, involving sometimes creative but ultimately always incremental thinking, remaining trapped in the context of a government-owned, centrally-planned power sector. These reforms did not prevent the need for a series of financial bailouts that the Electricity Act 2003 was originally brought in to prevent.

More incremental reform will not prevent the need for further bailouts in the future. Strategic thinking and deep change are required for the sector to not make demands on the taxpayer as it has done for the past two decades. The first step is fixing the distribution sector.

Discom Dysfunction

India’s discoms impede the path to the large-scale investments needed to fuel India’s energy transition. There are problems with them beyond the fact that most of them are broke and do not present as financially credible contractual counterparties. Discoms are ultimately controlled by politicians and used as tools for redistribution and political patronage.

Discoms, and the state more generally, have low capacity in contracting, as a result of which power purchase agreements are unbalanced and allocate risk inadequately. These unbalanced PPAs are not negotiable, and no producer wishes to antagonise a state discom that it has to live with through a 20-year contract.

Government ownership of discoms also makes them subject to vigilance processes. This leads to them feeling the need to fight legitimate requests for contractual relief for events such as force majeure and change in law out of fear of being investigated.

Discoms, and their government shareholders, regularly renege on PPAs, attempting to drive down legally-binding tariffs. As the union government did in the Vodafone case, state governments try and change the law to get out of contractual commitments. On top of this regulators, especially in the states, regularly favour state discoms over private power producers.

State-Specific Privatisation Design

The only sustainable way to avoid these problems is large-scale discom privatisation. This will enable us to build an electricity sector organised around the price system, as opposed to the current centrally planned, government-owned sector, with a few private vendors brought in as service providers.

The brunt of the political fallout of privatisation will be felt by the states and not by the union government.

The route to effective privatisation is therefore to address the issue state-by-state.

This will require us to develop a deep understanding of the political economy of the power sector in each state, which will identify the potential losers from the privatisation. Then, detailed state-specific bargains can be designed through which these losers can be compensated. Here, key constituencies are those groups who do not currently pay the true cost of power. Schemes such as the solarisation of water pumps and direct benefit transfers from the government (instead of subsidies paid for by the discoms) are being launched, these and similar measures must be broadened. At the same time, those who steal electricity will also have to be compensated, for example by giving them formal electricity connections and vouchers for a certain amount of free power. This is not dissimilar to the way that slum dwellers in Mumbai were compensated by rehousing them as part of the slum redevelopment.

The climate of opinion on privatisation more generally has shifted. Air India has been sold, talk of privatising banks is no longer taboo, there is a National Asset Monetisation Pipeline and the union government has started work on privatising union territory discoms. If close and sensitive attention can be paid to the political economy, there is now a good opportunity to free the electricity sector from the shackles of government ownership and enable a more effective energy transition.

Akshay Jaitly is President, 262 Advisors; and co-founder of Trilegal. Ajay Shah is Senior Fellow at Pune International Centre; and Research Professor of Business at Jindal Global University. This article draws from a paper by Akshay Jaitly and Ajay Shah on India’s climate transition through electricity sector reform, available here.

The views expressed here are those of the authors, and do not necessarily represent the views of BloombergQuint or its editorial team.