The World Bank on Monday released a report titled ‘In the Dark – How much do power sector distortions cost South Asia’. Fan Zhang, Senior Economist, Chief Economist’s Office, South Asia Region — lead author of the report — told Deepak Patel in an interview that institutional distortion, such as expensive coal supply, is having a larger effect on India’s power sector than the distortion by subsidies. Excerpts:
According to your study, distortions in power sector impose a total economic cost of roughly $86.1 billion on India, which is around 4.13 per cent of the GDP. What is the ‘one’ reform that Indian electricity sector needs urgently?
Addressing institutional distortions to rapidly improve the efficiency of fuel supply for power generation, and reducing losses at distribution level.
The greatest source of distortion is the excessive coal-fired power generation, your study states. The government estimates that coal would remain a primary source of energy for at least one or two decades. How do you think the government should deal with coal-based capacity?
I think there are several things that can be done. One is to improve the efficiency of (coal) generation. That would reduce the consumption of coal while generating electricity.
India already has environment cess. Increasing environment cess to fully reflect the social cost will help push towards cleaner fuel mix. According to our analysis, if there is a fuel environment cess that is closer to the social cost, the consumption of coal will reduce by 30 per cent. The government can also use regulations to make sure that the coal that is consumed is cleaner.
Subsidies are often recognised as main distortion in the power sector. Cheap power supply has remained one of the prominent scoring points. Various state governments provide subsidies on electricity. How do you see a solution to this issue?
According to our analysis, the subsidies are not the main cause of distortion. The institutional distortion (such as coal supply at higher price due to an uncompetitive market) has a larger effect than the subsidies distortion. I think it is very important to protect the poor households, making sure that they have access to electricity at an affordable level. But how to deliver this social assistance is another question. It is not a good idea to introduce one distortion to address another distortion. So, in the case of LPG reform, they have removed the price distortion due to subsidies. At the same time, they introduce the real-time cash transfer to protect the poor households. That is a good example on how to give subsidies and protect poor households.
Do you think that direct cash transfer scheme can be emulated in power sector? Could similar methods be devised to provide subsidies effectively?
I think so. The World Bank is already working with some state distribution utilities in deciding new ways in providing direct cash transfer, rather than create a distortion in electricity price, to protect the poor. Right now, under the current structure, they overcharge industry so that they can provide electricity to agricultural households at low price. There are experiments being done on ground on what are the ways to protect the consumers well from such distortions.
Distribution sector in India has not seen much privatisation. However, in few areas or circles, states are experimenting with franchisee models. How do you see the distribution sector? How can there be improvements?
This report talks about introducing incentive-based regulation, where the tariff (that is charged to the consumer) is linked to their performance. If they are not able to meet their benchmark, they will be punished. Other way to deal with it is by removing soft-budget constraints, because right now whenever the distribution companies are in trouble, they are bailed out by the government. Therefore, they have weak incentive to stay afloat. So, budget should be linked to performance.