UDAY needs four transformational steps

State electricity distribution companies, or discoms, may be up against a wall given the steep loss-reduction target set under the Ujwal Discom Assurance Yojana (UDAY), which aims to improve their financial health.

 

While the central scheme takes over 75 per cent of a discom’s debt (the state has to raise the balance 25 per cent by issuing bonds), and rightly focuses on cost recovery to bring down the interest burden quickly, it also harps on reducing aggregate technical and commercial (AT&C) losses to 14 per cent by 2020 and hiking tariffs as required over this period.

 

A year and a half since the scheme was launched, cost recovery, or the gap between average cost and revenue, has improved in several states. Some discoms have shown a reduction in AT&C losses, too, but many are trailing. Telangana, Andhra Pradesh, Punjab, Meghalaya, Mizoram and Jammu and Kashmir have actually seen their losses mount after implementation of UDAY.

 

Such slippages upend cost recovery efforts at discoms. A back-of-the-envelope calculation suggests that an average deviation of one per cent by states that signed up for UDAY will lead to Rs 24,000 crore of cash losses unless offset by bigger tariff hikes and cost reduction measures.

 

States with higher AT&C losses and steeper loss reduction targets such as Uttar Pradesh, Bihar, Jharkhand, Rajasthan, Chhattisgarh, and Jammu and Kashmir will have greater incentive to remain cash neutral.

 

Indeed, adequate and timely increase in tariff is a crucial parameter for the success of UDAY. On this, too, many states are well behind requirements. One aspect that’s not highlighted is that average tariff hikes of 4.7 per cent is required annually in states along with reduction in AT&C losses. In some states, the tariff hike needed is north of 10 per cent. Here again, a back-of-the-envelope calculation shows that even a 50 per cent deviation can lead to a cash loss of Rs 48,000 crore.

 

Regulations require tariff revision for any financial year to be made before April. However, as of June 2017, 12 states haven’t done their tariff revisions for fiscal 2018. Of those that have, the revision falls short of the estimates made under UDAY.

 

There could be many reasons for this, including a delay in filing of the petition. Besides, it appears that the regulators were not aligned with the overall UDAY package, which has an in-built requirement of tariff increase and freedom to meet AT&C losses during the three-year window. Further, tariffs remain a politically sensitive issue. Rajasthan had to roll back tariff increase for agricultural consumers by almost 25 paise leading to an additional burden of Rs 500 crore on the state.

 

All the same, with so many states missing the target in just the second year, there is a question mark over whether discoms can tap the opportunity provided by the central government through this package. Also, what if these targets are not met, especially considering discoms cannot raise working capital loans?

 

Clearly, four transformational steps would be necessary.

 

First, discoms should seek active support of private players through distribution franchise or other public-private partnership options, especially in the notoriously high AT&C loss areas.

 

Second, they should take the help of central government entities for bringing in best management and operational practices. The draft energy policy issued recently by the NITI Aayog, too, mentions this.

 

Third, tariffs should be increased automatically for at least three years based on inflation or the percentage specified in the UDAY agreement, with no scope for regulatory or political interference. This will be subject to regulatory scrutiny at the end of the three-year “control period” for tariff.

 

Fourth, to plug leakage, states should explore direct benefit transfer in this sector along with retail and supply segregation to infuse competition for the benefit of consumers.

 

With barely a year and a half to go for catching up on the AT&C loss target, such out-of-the-box ideas have become imperative to improve the operations and management capability of discoms.
The author is senior director, CRISIL Infrastructure Advisory

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