This post, which is divided into three parts, will look at the implications of reforms such as UDAY and GST on state budgets. In this second part, we will take a closer look at the proposed UDAY scheme. In the first part, we examined why it is important to look at this data as well as give an overview of the current trends in state budgets. Part 3 will take a closer look at the GST and its effect on state budgets.
For this post, we refer to the latest RBI report on state finances.
The UDAY scheme is an initiative by the current central government to reform the power sector to achieve its goals of 100% rural electrification and uninterrupted power supply across India. Reforms in the power sector are critical for the government to deliver on its “Make in India” and “Digital India” platforms.
State Electricity Boards (SEBs) are the dominant players in the power sector, being responsible for generation, transmission and distribution. Historically, power distribution companies (discoms) have struggled financially because of a fundamental problem of underpricing; they sell electricity at a much cheaper price than their cost of procurement.
State governments have been very quick to dole out subsidies in the electricity rates, with prices being determined by the ruling party’s political agenda. But at the same time, the states have delayed or denied payment of these promised subsidies to discoms. As a result, discoms have taken on a lot of debt to bridge the shortfall. Outstanding debt of Discoms has increased from about Rs. 2.4 lakh crore in 2011-12 to about 4.3 lakh crore in 2014-15, with interest rates in the range of 14-15 per cent. As a result of their financial fragility, the discoms have low demands for energy, which then affects the entire supply chain.
The UDAY scheme is intended to improve the financial viability and operational efficiency of discoms. It proposes that states take over 75 percent of discom debt over two years with the balance debt being restructured by banks at the base rate plus 0.1 per cent. In addition, states that deliver on operational milestones will be given additional incentives and grants through power schemes.
In effect this is a financial restructuring plan, and is intended to reduce the discom losses by 50 percent by 2017-2018. A large part of this is due to a reduction in interest costs.
This is not the first time that the power sector has had to undergo financial restructuring. The Electricity Act, 2003 mandated unbundling of the State Electricity Boards into separate and independent generation, transmission and distribution companies. Reforms were extended in 2003 and extended in 2008. In 2012, the central government also introduced a financial restructuring plan because of heavy losses and debt that the discoms had accumulated. Unfortunately, the participating governments were unable to implement tariff hikes and so the scheme was unsuccessful.
In the previous schemes, the financial restructuring plan gave states a moratorium on interest payments so that losses could be reduced during the moratorium period. There were no deterrents to the state governments for non-compliance in terms of reducing losses. The UDAY scheme is different in that it actually reduces the interest burden, bringing it down from the range of 14-15% to 8-9%, and it makes states formally accountable because of the transfer of debt. What remains to be seen is if states will take the politically difficult decision of raising tariffs. If they don’t, the scheme will just end up being a constraint the fiscal capacity and, as a result, on the growth of states.
Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.