Power shortage could lead to higher inflation

The lives of over 620 million people residing across 22 states in northern, eastern and north eastern part of India came to a standstill on a Monday as they did not have access to electricity.

The outage caused "chaos" for Monday morning rush hour, as passenger trains were shut down and traffic signals were non-operational.

The day was July 30th 2012. The reason was a grid collapse. What is worse is that repairs to fix the outages that arose were not effective leading to another collapse the following day.  This is a classic example to illustrate that power is an essential commodity, the absence of which can make a growing economy come to a standstill.

A closer look at the situation also indicates a phenomenon that has not been subject to much scrutiny in public discussions about inflation. Shortage in power is definitely a contributing factor. Power is consumed by industries right from manufacturing units to even sophisticated looking offices. Interruptions in power, causes disruptions in production, which leads to wastages and delays.

Backup power, in the form of generators, is expensive and given the rise in price of diesel, it is bound to get dearer in future. Diesel power costs roughly between Rs 15 to Rs 19 per unit as against electric power that costs about Rs.5 per unit. Frequent power cuts to meet shortages are bound to increase cost of commodities produced as backup power might have to be used more frequently.

Shortages in power in some states even reduced water supply to farms following failure of monsoon last year. This reduced the rate at which shelf space got filled up with commodities on account of delays in production. What is worse is the cost of coal (the key ingredient in power generation) is going up. In other words, cost of generating electricity is spiralling. Other forms of power generation are not easy to come due to their own disadvantages.

Given that power is an essential commodity, it cannot be ignored that the power sector in India has to deal with shortages and is crying for reform. State owned utilities across states are making losses. State governments are entitled to provide subsidised power so that the consumer does not have to bear the burden of paying market price. As per the Section 65 of the Electricity Act of 2003, the state government is supposed to make subsidy payments in advance to the state utilities. However, states actually make the payment later. The actual subsidy payment to the utilities is termed “subsidy released” and is often lower than the amount of subsidy booked.

According to a report by the Power Finance Corporation  (2010) , 89 major utilities in the country earned revenues equalling Rs 1,90,948 crore (excluding subsidies) in 2009–2010, while their total expenditure was higher, at Rs 2,52,125 crore . This essentially implies a 75.74 per cent cost recovery for these companies. Subsidies released are not sufficient to cover the deficiency. As a result the state owned utilities are making losses. Recently it was proposed to bail out loss-making units by converting their short term debt into three year long-term bonds.

The increase in the cost of power would be transferred to the final consumer. The burden would increase on two fronts. Consumers would have to a) pay higher tariff for power b) pay higher prices for commodities as production costs shoot up.

World Bank studies indicate that by making sure that all consumers pay for power ensures that they adjust their consumption accordingly. As a result the reduction in illegal consumption of power could come down by 50 per cent.

Thereby, there are savings even in terms of power generation and the benefit of subsidised power could be made available to many more people. Also reduction in non-technical losses could reduce the burden of tariff on the taxpayers and at the same time achieve an average tariff level that would be cost effective and ensure sustainable performance. It is a win-win situation for both.

Loss-making state utilities are not unique to India. Most of the Latin American countries in the 1990s, were entrapped in a scenario characterised by State Owned Enterprises (SOEs) making losses, poor service and low access rates. However the scenario was reversed soon afterward, by a comprehensive reform. The sector was opened up for private sector participation. Private companies were successful in reducing technical and non-technical losses, bringing about operational and financial efficiency, improving service and reaching out to masses. 

In the Indian context, privatisation in the power sector exists and there are a few successes to account for, which could pave the way ahead for a comprehensive reform in the power sector. The New Delhi Vidyut Board was privatized in 2002. It was taken over by Reliance and Tata. At the time of takeover it had more than four million customers and losses exceeding 50 per cent.  For those who dislike private sector participation, the success story of the Andhra Electricity Board might be comforting.

The board resorted to an unbundling reform, as part of which entities were corporatised. One transmission and four distribution companies were created, but the state utility retained ownership. The strategy worked; T&D losses came down from about 38 per cent in 1999 to less than 20 per cent in 2008—largely through theft control, with utilities regularising 2.25 million unauthorised connections.

Such instances of success in power reforms indicate that there could be some light at the end of the dark tunnel. The experience of  Latin American countries shows that a comprehensive reform would eventually bring more operational and financial efficiency.

However, if the situation deteriorates, it would reduce purchasing power, hampering demand as workers would demand more wages. On the supply side, industries would have to incur wastages due to unplanned power cuts and increase in cost of backup power.

Rising production costs and decline in demand would further dampen incentive to produce, leaving little incentive for new investments and slow down production. Economic growth would get stunted leading to spiralling inflation.

(The author is a freelance writer.)