Power, a reality check

Excellent recent reports by the RBI and PRS Legislative Research provide lucid analyses of the fiscal situation of the states. Intended probably as a wake-up call, the RBI’s report reassured more than it alarmed. To be sure, 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. But failing to fully integrate discom operations in the analysis of state government finances obscures the true picture. When this is done — as we do below — the reality is alarming.

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. But the financial health of the power sector is rapidly deteriorating and flirting with catastrophe.

Figure 1 plots three measures of the estimated losses of the discoms in increasing order of “truth”: Headline losses, losses without subsidies and grants, and losses without subsidies and grants and including the arrears of the discoms.

Our 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 crore.

But even these numbers might underestimate the problem. The loss numbers only exclude grants under the UDAY scheme even though there are several other grants. And 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 per cent of GDP just from this one sector. Moreover, as Figure 1 shows, apart from a brief period when headline losses were stabilised in the mid-2010s, true losses have been steadily increasing for over a decade.

The truth is that 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, not a bug. 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. De facto, some public sector balance sheet back-stops the discoms and ultimately prevents the Ponzi fallout. Accepting this reality has one implication for accounting transparency. Public sector discom operations are traditionally thought to create contingent liabilities. Contingency seems a euphemism because with unfailing regularity they become actual liabilities. Put starkly, discom operations are state government operations.

If that is true, and 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).

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. The contrast between the two is striking. 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 per cent to 5.5 per cent of state GSDP, putting state governments above fiscal responsibility limits. And their “true” aggregate debt increases from 31.0 per cent to 34.5 per cent. 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? Figure 3 provides the surprising answer. 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. Moreover, 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.

In sum, the facts presented above illustrate three new realities: The financial problem of discoms is considerably worse than headline numbers indicate; consequently, state government finances are considerably more precarious than even the recent RBI analysis suggests; and the vulnerabilities stemming from the financing of unsustainable discom operations have extended to a new institution, namely PFC/REC.

What are the consequences and possible solutions? We take these up in our next article.

Anand and Sharma are consultants in the private sector. Subramanian is with Brown University and the Center for Global Development