India is facing an electricity crisis. This year, five states have declared power holidays and another eight say they intend to ration power at peak times. Nationwide, there is a peak shortage of around 12%.
This isn’t exactly a new problem for India since it’s faced such shortages in the past few decades, but this time there is a difference. Voters earlier may have countenanced blackouts, but the increasing living standards of the past decade have now made them unwilling to do so. Some state governments are summoning the will for change, and one in particular has even developed solutions that open the door for more policy innovation and reform.
For decades, the political wisdom was to provide electricity at very low cost to consumers, and often at no cost to farmers. So while one set of users paid little or nothing, another set usually comprising primarily of the commercial and industrial users, often paid three to four times higher. These so-called cross subsidies couldn’t keep up with politicians’ promises though. The result was a big financial hole for the power generator or distributor—these days the latter—which eventually left it unable to supply power.
Voter agitation about these shortages, as well as recent state election victories for parties that talk about reforming public services, have gotten politicians to rethink their tack. The southern state of Tamil Nadu, in the face of rolling blackouts for 2-6 hours every day, agreed to hike tariffs for the first time in a decade this year. The enormity of the situation can perhaps be best appreciated from the fact that the two major parties in the state haven’t opposed the construction of the Kundakulam nuclear power plant, despite NGO protests over it since last year’s Fukushima meltdown in Japan.
Next, consider Gujarat, which has summoned the political will for a new creative idea. In the past decade, it has built a parallel distribution grid, particularly in rural areas, and offered consumers a unique choice. If farmers opt for the new grid, separating domestic and agricultural connections, they are assured electricity for 8 hours a day, but at higher tariffs (they can still access the old grid). Or they could remain on just the old supply network, without any assurance of supply of electricity, but at the lower price. To the surprise of many observers, farmers have opted for the former. At the same time there has been an aggressive steps to curb theft of electricity.
Tamil Nadu and Gujarat’s examples clearly show that people prefer stable supply of power over its price. The ideal next step is complete deregulation of distribution, but let’s be realistic: Few politicians will abandon control so quickly; nor will they be brave enough to immediately take this radical solution to voters. Meantime, though, state governments can take their innovations to the next level.
Gujarat’s case demonstrates that farmers could do with the irregular supply for some needs such as running household appliances, but for larger requirements like tending to their fields, they specifically want a premium supply. Yet, right now, this comes in the form of a second distribution network, which is expensive to build and maintain. Increasingly, however, rural households too are beginning to realise the benefit of assured electric supply, and many are opting for the new three phase supply, at a higher rates, which allows them to start small household businesses too. Despite all these changes, those who want to retain their old connections based on size of their electric motors, at fixed but low tariff, without assured supply, are allowed to do so too. This option has been a very important element in diffusing the political opposition to increase in tariff.
Vernon Smith, the Nobel laureate economist had suggested differential pricing as an economic strategy to overcome political opposition to increase in tariff using the same grid. One way forward is for consumers to pay a below-market price for ‘x’ units of electricity—or, for the poorest households, even make consumption of these ‘x’ units free. But above ‘x’, electricity should be priced competitively. The 'x' could be calculated in a variety of ways. For instance, on the basis of monthly average household electricity consumption in the past three or five years. Or it could be politically agreed upon to make a certain minimum amount of electricity as a “right” available to all households at a nominal or no cost. And all new connections would, of course, pay at the market rate.
Today, per capita consumption of electricity in India is one-twentieth of that in the United States. As India’s economy grows, more people will begin to enjoy the benefits of many modern appliances, and consume more electricity, this big marginal increase in consumption would be paid at market prices. After some years, most of electricity consumption will be at competitive prices.
Such a transition will change the landscape of the power industry and make it more economically viable. It will reduce the incentive for political interference in pricing, since consumers would be willingly hiking their electricity consumption and enjoy assured supply, without expecting to be subsidized. Meanwhile, politicians can still claim to be pro-poor. Losses incurred by state-owned distribution companies, which currently runs to over 1 trillion rupees ($ 20 billion) all over India, would dramatically come down.
As a result, this system would stop skewing price signals. Today’s distribution network involves below-market prices nearly across the board, which means that few producers have incentives to set up power plants. Even in Gujarat, the incentive isn’t fully in place since one distribution grid still operates on subsidies.
This plan for a single-grid premium system still involves some distortions, but that distortion itself dwindles once most electricity consumption takes place above ‘x’. And this is, anyway, an intermediate solution to convince voters of the idea of paying competitive prices for quality supply from utilities they took for granted a decade ago. A grid that is financially viable will also allow large consumers and generators to directly negotiate the price of electricity, and this increased capacity to trade in electricity which will dramatically improve the financial health of the generators and assure quality supply to consumers.
Clearly, innovations like these will not occur overnight, and not across all states at the same time. But voters are realising that the price of being powerless without electricity, which may be free yet not available at all, can be quite high. And politicians too are becoming aware of the high political price for promising electric power and then failing to meet the growing demand. So the political trend in favor of competition is clear, and in a federal setup such as India, the onus will fall on the states to explore and experiment with such ideas. When political leaders feel confident that voters are behind them, these governments will surely begin to take the small steps leading to bigger reforms in the electricity sector.
Note: A shorter version of this article has been published in the Asian Wall Street Journal on 26 July 2012, under the title “Power to India's People”.