FINAL VERSION
REGULATING STATE OWNED ENTERPRISES
IN INFRASTRUCTURE
by S L Rao
with assistance from Vivek Sharma
of TERI
This paper is based on the experience of regulating the electricity
sector in India. It is about “independent regulation” and not normal
regulation by government. The experience of regulating the electricity
sector is a template for the experience in regulating other
infrastructure areas such as telecommunications, transportationroads, railways, civil aviation and shipping, water, sanitation, and oil,
and gas. The emphasis is on independent regulation, that is, by a
regulator who is by law not subservient to anyone including
government, and whose decisions can only be overruled by a judicial
body after following the appropriate procedures.
Administrative officials and Ministers represent government as
owner in India. The latter are elected and change frequently
depending on the whim of the head of the government, electoral
performance and changes in governments. The former tend to have
relatively longer tenures in the owner Ministry, though at the top,
they also are subject to being shifted because of their equations with
the political powers of the day. The Minister, the Secretary to the
Ministry who is the Head of the Department, the Joint Secretary
specifically in charge who usually sits on the Board of the state owned
enterprise, and other officials are the people through who the will of
government is conveyed to the enterprise. This may be done formally,
through written communications, or informally, through verbal
communications face-to-face or over the telephone. But the will of
government as conveyed through any of its officials, usually has to be
obeyed despite the autonomous nature of some of these state-owned
enterprises, for fear of consequences. These consequences could
range from pinpricks such as not approving overseas tour plans, staff
selections, service extensions, investment programmes, to charge
sheeting and termination. The Chairman-cum-Managing director of
the enterprise, who is the CEO, will usually obey, or might try to
reason it out, knowing that in the end, he has no choice but to obey.
However, electricity is a little more complicated. The Ministry is
staffed by officers and Ministers who are at best, generalists. They
are awed by the apparent technical complexity of electricity, and by
the likely public repercussions of decisions. They can therefore be
quite easily deflected by clever top electricity officials from what they
wish to do, by the threat of complex technical and public reactions.
The management of the state owned enterprise in the electricity
sector has therefore a great deal of influence on any decisions
affecting the sector. This is compounded by the fact that the
enterprise is able to offer favours to the Ministry in picking up
expenses that even when even when legitimate, are not possible
because of restrictive government rules. In addition of course, are the
much larger pay-offs to individuals and political parties that are
possible on large contracts, projects and purchases. The electricity
enterprise also lends its ‘expert’ staff to the Ministry, and is therefore
fully informed about the trend of discussions on decisions affecting
the sector, at every stage, and is able to influence the decisions in
directions that are favourable to the enterprise. There is a strong
vested interest in the government to retain control over enterprises
owned by it This is the chief reason why in India, privatization of state
owned enterprises is preferred over other means of distancing
government from the enterprise.
State ownership also mires the enterprise in subsidies and crosssubsidies, in an attempt to help the ‘poor’ at the cost of the ‘rich’. Very
soon, these build up into huge liabilities that have to be borne by the
enterprise, since government is unable to finance them out of its
budget. In India, the state electricity boards in 2000-01 had deficits
on operations that in total came to over half of the revenue deficits of
the state governments. These deficits preclude the state governments
from doing the things for which it is most responsible, the
improvement of the physical and social infrastructures. State
ownership also leads to higher costs of operations. Overstaffing is
inevitable, as people are employed on compassionate and populist
grounds than on need. Discipline is given the backseat. Inefficiencies
abound and add to the deficits. There is little accountability of top
officers or others for performance. Inevitably generalist
administrators replace professionals as CEO’s. They have short
tenures and little incentive to leave a lasting impression on the
enterprise.
Reforms in India in the infrastructure have meant opening up to
private investment, introducing independent regulation of tariffs and
investment approvals, creating conditions for competition to develop,
giving the consumer choice, reducing and eliminating inefficiencies,
eliminating subsidies and cross-subsidies as charges on the service
providers, and aiming to create conditions in which the market
determines tariffs.
The first state to reform in electricity was Orissa. Orissa government
appropriated to itself the substantial moneys paid by buyers for
buying the distribution circles. The Government earned Rs.1590
million through disinvestment of 51% of its shares by private sector
participation in four distribution circles.
Prior to reforms the Government of Orissa was providing subventions
to OSEB under section 59 of the Supply Act 1948. This practice was
withdrawn immediately in the post-reform period. In the process
GoO saved subsidy payment of about Rs.27.70 billion during the
period 1995-96 to 2000-01.
However the generating company was left to carry the substantial
accumulated liabilities of the past years when the electricity
operations were bundled together. At the same time a transmission
company was created which would buy all the required electricity and
sell it to the private distribution companies. The information given to
the latter on the transmission and distribution losses was of very poor
quality, and the new companies made much larger losses than they
anticipated. Their inability to pay for the electricity they bought from
the transmission company left it unable to pay the generating
companies from which it had bought the electricity. Today, each of
the companies is in financial difficulty, and the customer is unhappy
with the availability and quality of the electricity.
As per the projections made by consultant and intimated to
prospective bidders, it was expected that WESCO & NESCO would
achieve turn around by 1999-00, SOUTHCO by 2000-01 and CESCO
by 2001-02. However, none of the DISTCOs could achieve this and
suffered losses even at the end of the third year
Table 1:
Source: Projected figures given in the IM and actual performance fi
1999-00
2000-01
2001-02*
WESCO
65.6
(581.8) 389.3 (1118.9) 493.1 (408.1)
NESCO
168.6
(542.7) 467.9 (1228.0 778.3 (2080.5
)
)
SOUTHCO (258.5) (873.7) 435.0 (860.5) 222.0 (837.2)
CESCO
(1295.6 (1777.3) (391.5) (1722.9) 1321.2 (2396.8
)
)
gures collected from the OERC. The figures in parenthesis indicate
net loss * unaudited
The Regulator faces many dilemmas. He has poor information from
the companies, according to which he decides on the tariff. But
because of unreliable data there is huge mismatch between the
estimated (proposed) and actual numbers. For example, leaving apart
the approved figure by the Regulator, there is huge difference
between the proposed and actual T&D loss.(Table 2)
Table 2: Extent of unreliable information on T & D Losses
Regulatory Dilemma
Propose Approve Actual
d
d
MSEB
200027.66% 26.87% 39.40%
01
200139.49% 39.49%
02
UPPCL
200034.97% 29.97% 39.47%
01
Orissa
199947.00% 35.00% 45.68%
00
200042.66% 34.00%
01
Haryana
200040.76% 35.76% 47.71%
01
Delhi
Gujarat
200102
200001
46.80% 46.80% 57.00%
21%
30%
25%
From the above table, one can conclude that the regulator has tried to
bring about efficiency through approving reduced T&D losses.
However in Gujarat the Regulator has taken a different view by
increasing the approved loss percentage and reducing the agricultural
consumption. The basis was that the estimates on agricultural
consumption (as not metered) in the state, is actually less than the
proposed number, where as, the losses in the other sector is more
then the proposed number.
Yet the regulator has to determine tariffs based on this unreliable
information. His tariff decisions are invariably based on revenue and
expenditure projections that go wrong. He is unable to determine
tariffs for more than a year at a time because even one year’s
projections are unsound. He is then accused of creating “regulatory
uncertainty” because the distributor and his financiers do not know
what the tariffs are likely to be. The consumers are unhappy because
the availability is so irregular and quality remains poor. The
fundamental weakness is the poor information base, the inefficiency
of the state level generators, the inability of the state to pay up
subsidies to selected customer groups, the past liabilities that have to
be serviced from an inadequate income stream , and the increasing
bellicosity of central government owned outside suppliers demanding
to be paid. This we would discuss in detail in the following section.
In all the states, the load dispatch function is with a state load
dispatch center. This body has to neutrally match loads and
dispatches. But in all states, this function remains with the state
electricity board and where there is unbundling, with the state owned
transmission company. The authority to regulate this function has to
be passed on to the regulator by the state government. Till that
happens, the regulator is regulating tariffs without being able to
ensure that the matching of load and dispatch is balanced at all times.
Without this authority, the Regulator has only partial authority and
the system is not under proper regulation. The principal party in the
transaction, the generator or the owner of the wires is doing the
balancing when he is himself an interested and involved party in the
transaction.
The same contradiction exists at the central level where inter state
transmission is regulated by the Central Electricity Regulatory
Commission, but the regional load dispatch centres that do this
balancing are under the authority of a central government owned
enterprise, who in this case is also the interstate transmission
monopoly enterprise.
Similarly the CERC has to issue licenses to private investors in
interstate transmission but the parties have to be first approved by
the transmission monopoly.
In both instances, the regulatory interventions by the CERC to
provide a fair playing field, to prevent grid collapse, to ensure that all
parties have a fair deal, are frustrated by the fact hat the transmission
company is state owned and is able to get its owners’ approval to stall
actions.
There are therefore two aspects to government ownership that make
independent regulation difficult. They are the inconsistencies, gaps
and ambiguities in government policies; and the fact of government
ownership and a consequent nexus (vested interest) in supporting the
state owned enterprise.
In this context there is also the issue of pre-existing power purchase
agreements and their scrutiny by Regulators. This is seen by some as
violation of the sanctity of contracts, even when the contracts were
entered into by unfair or illegal methods, or the end result is a huge
extra and avoidable burden on the consumer, when cheaper
alternatives are available.
The problems are accentuated by the nature of public governance.
Many Ministries are created to find berths as Ministers for the
maximum number of aspirants. This also helps the bureaucracy since
so many more senior administrative jobs become available to them.
Given the strong sense of turf among these functionaries, there is
little coordination even when the Regulator requires it for his
functioning. To take two examples, the CERC cannot regulate atomic
energy even though all electricity irrespective of source, flows through
the same wires, cannot be identified, and the CERC has to regulate
interstate transmission as well as the tariffs.
Another example is the regulation of the government owned Neiveli
Lignite Coproration, an integrated generator using captive lignite
mines. But coal is with another Ministry and not with CERC for
regulation, so that the company can easily hide extra profits behind
high coal transfer prices.
Government ownership has enabled state electricity boards and
companies to get away with gross violations of all principles of good
governance. Regulators have to face this reality and have difficulties
in working. Thus for example,
 Accounts are not finalized for many years by the state enterprise.
Asset registers are either not kept or are out of date and so it is
impossible to know what to take a s asset base for purposes of
calculating return.
In Uttar Pradesh, restructured distribution companies, KESCO
(Kanpur area) and UPPCL, the Asset registers are not maintained.
Interestingly during the Kanpur privatisation process it was
realised by the consultants that there is no record on the number
of transformers, feeders etc. the board is having. Similar situation
was felt during the DVB privatisation.
In Himachal Pradesh, the Himachal Pradesh State Electricity
Board (HPSEB) has not finalised its accounts and does not
maintain an asset register. The Regulator (HPERC) in its tariff
order for the FY 2001-02 has directed the board to prepare and
maintain fixed asset register. Unfortunately, till now no
improvement has been made on this front.
 Poor estimation of revenues and expenditure, demand and supply.
Examples- DEMAND FORECASTS FOR ELECTRICITY HAVE
BEEN PERRNIALLY OVERESTIMATES; ESTIMATION OF
REVENUES AND EXPENDITURES FOR TARIFF FILINGS THAT
ARE REVISED REPEATEDLY
In Orissa, viability exercise under the power sector reform has
been worked out on the basis of certain assumptions of which
projection of the demand for power was a major one.
Unfortunately, the demand growth that came to be realised was
very different as may be seen from the following
Table 3: Extent of over estimate of demand
Estimated Actuals % Actual to projected
1996-97 9785
9306
95.09%
1997-98 10902
9771
89.63%
1998-99 12726
10128
79.59%
1999-00 13902
10229
73.58%
2000-01 14809
11231
75.84%
The assumption thus turned out to be highly ambitious
compared with actuals. Apart from this, not only in terms of
totals but also in the share between EHT and HT/LT demand.
The latter is even more important for viability purpose because
much of the T&C loss occurs in the HT/LT segment.
Similar situation can be seen in other cost parameters approved
by the Regulator. Let us closely look at the UPERC tariff order
for the year 2000-01 on KESCO (Kanpur area) tariff petition.
Table . UPERC Tariff order on KESCO tariff petition
Propos
ed
28.2%
78%
Approv
ed
25.2%
100%
Difference
(%)
3%
22%
Actual
*
32.3%
79.04
%
7.3%
T&D loss %
Collection
efficiency
Depreciation
7.3%
4.8%
2.5%
rate
Employee cost
37.22
32.24
13%
39
(crores)
Revenue
605
545
10%
544
requested
Source. UPERC Tariff Order for 2000-01,
*Source: Tariff Petition filed by KESCO for 2001-02.
In this particular case, it appears first that private investors do
not find the distribution business viable, as is evident from the
lack of interest by any bidders in the privatization process of
KESCO even after the tariff order. Second, there is a perception
among investors that the price-setting methodology (based on
the ROR concept) employed by regulatory agencies is not
conducive to long-term investments (Alexander and Harris,
2001).
KESCO in the tariff petition for the year 2001-02 has demanded
Multi year tariff framework. But the Commission has not
accepted the framework stating following reasons/issues:
(1) Sufficient data is not available to correctly set the initial level
and benchmark improvements. In that event it is likely that
either excess profits would be made, or company would
make losses and request the Commission to re-open the
issue. Either of theses would damage the credibility of the
regulatory process.
(2) Principles for sharing of risk if demand and/or demandmix changes substantially.
(3) Basis for laying down targets for investments in advance
and method for relating it to target improvements.
(4) Linking of the return on capital base to achievement of
certain performance standards such as improvement in
service quality, extension of coverage to specified group of
consumers’ etc.
Before concluding our discussion let us quickly highlight the
regulatory risk faced by the other utilities where reforms are in
place and tariff order have been passed.
A point that can be stressed here is that the regulators in their
tariff order have tried to minimize tariff shocks to the
consumers through reducing certain inefficiencies, like the
reduction in T&D losses (see Table ).
Table : Tariff Order1 passed by the respective Commission
Distribution
Propose Approve Reductio
Company
d
d
n
HVPNL
24.69% 16.69%
8.00%
Orissa-Discos
39.16% 34.00%
5.16%
CESC
22.40% 16.80%
5.60%
KESCO
28.20% 25.20%
5.50%
1 The source for the data is the first tariff passed by the Commission after unbundling of the business.
From the above table we observe that the targets laid down by
the regulator seem to be on the higher side. The utility faces a
risk of not achieving these targets in one year and hence facing
possible losses in future.
A further risk lies in securing political support to implement
harsh measures for reducing these inefficiencies. To sum up, on
the one hand, the targets laid down by the regulator seem to be
unachievable, and on the other hand they are not able to obtain
that political support to disconnect illegal connections, reduce
thefts and improve collection efficiency.
There are many examples of the unnecessary appeals to Courts
by state owned entities, with either explicit or implicit approval
of the owners, namely the governments. Thus:
 CERC’s orders on operating norms for central government
owned generating companies (that could have been a model
for other Regulators) have been held up in the Courts for two
years.
 Availability based tariffs (ABT) were a novel commercial
method ordered by CERC to enforce grid discipline on all
participants in the power system. The generators, mainly
central government owned, had a vested interest in pushing
as much electricity as possible into the system since their
earnings could be so increased. This affected frequency
adversely. The whole order was held up, with considerable
continuing damage to expensive equipment of users because
of quality variations, because the government undertakings
went in appeal. The private entities in international
experience, are more compliant, because they do not have
the might of the government to give them support.
 The KERC tariff order of 2002 was suspended by
government, quite illegally since the law does not give them
the power to do so, and without justification.
 Subsidy reimbursements are not made by many state
governments despite commitments made at the time of tariff
hearings.
 There are serious data gaps with government controlled
enterprises as well as unwillingness to provide data to
regulators. For example, NTPC withheld data on production
operations parameters from CERC.
Finally, how can these problems be resolved since government
ownership is not likely to go in a hurry, and Regulators will also
remain? One answer is to completely distance the government
enterprises from the controlling Ministry. However, this has not
worked despite attempts in many public enterprises since 1988 to
do so. These include the government and the pse concerned
entering into a MOU about the targets and responsibilities of each
but have ended up as paper exercises to be done by the pse, since
the Ministry concerned is able to commit only for itself, not for the
rest of government.
Another answer is to truncate the size of a Ministry after creation
of a Regulatory Commission, since it will be doing things that were
earlier the responsibility of the Ministry. This means the loss of
power and jobs for many and especially lower level officers,
something which no politician or senior bureaucrat (in service) is
willing to implement.
Another possibility is to put all appeals on fast track. This may
happen with the creation of a special appellate body for electricity.
However, TRAI has such an appellate authority and it has made
no difference to the speed of the appeals process.
The Regulatory process is made a mockery so long as government
is the owner of controller of substantial parts of the regulated
systems. The pse’s are even able to influence appointments of
regulators and staffs through their connections with the
governments concerned. It can work only if the Courts and public
opinion are able to clean up the system. Until that happens, the
process of independent regulation will be severely hobbled. It will
limp along until privatisation, competition, choice for customers,
become common. For that to happen, markets and trading with
adequate regulation to ensure fairness, an independently run
transmission/transportation-(wires in electricity) system is in
place. Governments will act only when compelled by fiscal crisis.
We need to see collapse of the pse.s before their revival through
reform.