Relevance: GS-3: Infrastructure: Energy, Ports, Roads, Airports, Railways, etc.

Key Phrases: Revamped Distribution Sector Scheme (RDSS), power sector discoms, headline numbers, financial health, subsidies, grants, Ponzi scheme, UDAY scheme, Power Finance Corporation (PFC), Rural Electrification Corporation (REC).

Why in News?

• The Revamped Distribution Sector Scheme (RDSS), along with planned changes to the law, is the latest in a series of attempts by the central government to tackle the challenges of the power sector.
• Power sector reforms are overdue not just for their own sake but also because they are critical to rescuing state government finances.

What do the reports say?

• Recent reports by the RBI and PRS Legislative Research provide lucid analyses of the fiscal situation of the states.
• A few states such as Punjab and Rajasthan had deficits and debt that exceeded the indicative targets set by the Fifteenth Finance Commission (FFC). But overall, most states either met both or one of these targets.
• These reports highlight the challenges faced by states, owing to the dysfunctionality of the power sector discoms. Failing to fully integrate discom operations in the analysis of state government finances obscures the true picture.

Financial issues are more serious than figures suggest:

• India has made impressive strides in increasing access to the quantity and quality of electricity and in expanding renewable capacity, for which the government deserves credit.
• The financial health of the power sector is rapidly deteriorating and flirting with catastrophe.
• The estimates suggest that for the fiscal year 2020-21, combined losses of the discoms are Rs. 2.1 lakh crore without subsidies and grants which mount to Rs. 3.0 lakh crore when arrears are included. These exceed by a factor of 2.7-3.8, respectively, the headline loss of 78,000 crores.
• Even these numbers might underestimate the problem. The loss numbers only exclude grants under the UDAY scheme even though there are several other grants.
• The numbers only include discom arrears to the power generating companies (GENCOs) but not to others, resulting in overall payables of about Rs. 2.4 lakh crore.
• The true arrears situation will therefore depend on the magnitude, certainty, and timing of the discoms getting paid for their receivables, much of which is owed by government actors. The true loss estimate could therefore be greater.

• State governments could be staring at losses of 1.5 percent of GDP just from this one sector.
• As Figure 1 shows, apart from a brief period when headline losses were stabilized in the mid-2010s, true losses have been steadily increasing for over a decade.

Giant Ponzi scheme backed by governments:

• The whole discom operation — with very few exceptions, notably in Gujarat and in a few urban metropolises — is a giant Ponzi scheme, both perpetrated and back-stopped by state governments.
• For over 50 years, costs have never really been covered by revenues, and losses in perpetuity have become a feature.
• Few state government leaders, if any, have even pretended to achieve full cost recovery.
• The imitative populism that has gripped the states recently makes chronic under-recovery a reality going forward too. But this Ponzi scheme never sees — is never allowed to see — its disastrous denouement.
• Some government actor — typically state governments but also public sector banks or the central government — has always come to the rescue, averting a full-blown crisis.
• Some public sector balance sheet back-stops the discoms and ultimately prevents the Ponzi fallout.

Discom operations are state government operations:

• In the spirit of what the UDAY scheme attempted, discom losses (including arrears) operations must be included in state government finances both on the flow and stock side.
• Discom losses must be added to state government deficits, with logic and arithmetic consistency demanding that discom debt be included in state government debt (of course, this principle should apply to other “contingent” liabilities of state governments).

More precarious state finances:

• For fiscal 2020-21, Figure 2 depicts state government finances to exclude (Panel A) and include (Panel B) discom losses (and arrears) for both flows and stocks.
• Ignoring discom losses suggests that six states ran afoul of both fiscal targets set by the FFC and another six were consistent with both.
• When the accounting is done properly, 11 states run afoul of the fiscal targets set by the FFC. There is a general shift to the right (higher deficits) and upwards (higher debt).
• In FY21, “true” deficits, incorporating discom losses, increase state government deficits as a whole from 4.7 percent to 5.5 percent of state GSDP, putting state governments above fiscal responsibility limits.
• And their “true” aggregate debt increases from 31.0 percent to 34.5 percent. And there are some truly alarming cases: Not just Punjab and Rajasthan but also Himachal Pradesh, Uttar Pradesh, Bihar, and to a lesser extent Tamil Nadu and Kerala.
• It is almost certainly the case that with true deficits and debts being greater, state governments’ fiscal sustainability will look much more precarious.

Who then is financing or enabling this Ponzi scheme?

• Increasingly, the power sector is being financed not by the PSBs but by the two non-bank financial companies, Power Finance Corporation (PFC) and Rural Electrification Corporation (REC), which have recently been merged.

• From 2014 onwards, PFC/REC have lent more to the power sector than PSBs.
• As of 2021-22, the latter have lent about Rs. 6 lakh crore (stagnant since 2014), whereas PFC/REC have lent Rs. 7.6 lakh crore, more than doubling within four years from 2017.
• More than one-third of PFC/REC lending is to the discoms. In other words, the next vulnerability in the financial system related to the power sector is PFC/REC.

Conclusion:

• One key lesson from the history of the power sector in India is that the country is too large and diverse for a one-size-fits-all approach.
• A flexible and home-grown approach to reform, which is supported by state and central political will, and which allows for ‘learning by doing, will be instrumental in determining the success of reforms.
• Growing discom losses will likely compel states to prioritize reform over considerations of political economy, equally matched with central support.
• Concerted efforts are required to steer the power sector into a new era of financial sustainability and operational efficiency.

Source: The Indian Express

Mains Question:

Q. “Power sector reforms are overdue not just for their own sake but also because they are critical to rescuing state government finances.” In the light of the statement discuss the challenges in the power sector and suggest some measures to improve the situation.