As the next electoral cycle approaches, politicians are once again promising voters cheap, if not free, electricity. After taking office as Chief Minister of Punjab, Charanjit Singh Channi burned copies of electricity bills and announced the restoration of power connections that were disconnected for non-payment of bills. And the Aam Admi Party (AAP), which has effectively used the promise of autonomy in Delhi, is making similar promises in states like Punjab and Uttarakhand. While these policies have some advantages, they can be detrimental in the long run. Here’s why.

Who ultimately pays the electricity subsidies?

There really is no such thing as a free lunch. Electricity distribution companies (Discoms) that buy electricity from power producers (Gencos) are obliged to pay for it at commercial rates. When governments offer cheap or free electricity to households or farmers, they must compensate Discoms for the residual amount. This is done in two ways. State governments subsidize or end up taking over the debt of the Discoms. This is what happened in the Ujjwal Discom Assurance Yojna (UDAY) when state governments issued bonds worth ??2.32 lakh crores to repay the accumulated debt of the Discoms. Another way in which governments recover the costs of cheap tariffs is through cross-subsidization, which means that they increase the price of electricity for other consumers. Ultimately, it is the consumer who ends up paying, as commercial users pass these costs on. An Oct. 13 research note from Pranjul Bhandari and others at HSBC Capital Markets and Research gave estimates of this cross-subsidy of electricity prices in India. The note shows that cross-subsidies are not sufficient to recover costs, creating the burden of large unpaid contributions.

See graph 1: cross-subsidies in electricity

Unpaid Discoms contributions are worth more than the annual cost of MGNREGS

The latest data from the Ministry of Electricity Portal (PRAAPTI) shows that the total undisputed payment owed by Discoms in various states to Gencos amounted to ??1.01 lakh crore on October 22. It was ??79,112 crore at the start of the year. This is more than what is spent in a year on Mahatma Gandhi’s rural employment guarantee program. The total late payments fall into two categories: those due for a maximum of 60 days; and those that have been pending for more than 60 days. This classification is important because the Discoms benefit from a 60-day credit by Gencos. Then, the latter levy penal interest on the unpaid contributions in most cases. Data from the electricity portal shows that the share of late payments that are delayed by more than 60 days has increased by 8 percentage points since the start of this year and now represents 80% of total contributions.

See Graph 2A and 2B: Contributions due to Gencos and their breakdown by threshold of 60 days

What causes this delay in payment by Discoms?

According to Sabyasachi Majumdar, Senior Vice President and Group Head – Corporate Ratings, ICRA, late payments to Gencos can be attributed to the low operational and financial efficiency of Discoms. Various factors contribute to this. Electricity tariffs are insufficient in relation to their supply cost because they are set lower. Sometimes this is due to the inadequacy of tariffs relative to their cost of supply due to delays in the approval of tariff orders by regulators. There is also the insufficiency and delays in the payment of grants by state governments, he added. According to a March report by ICRA, government grant payments were estimated at 16% of dcom revenues across India in 2021-2022.

A recent article in the economic and political weekly by Amandeep Kaur and others on the performance of Discoms at the state level shows a deterioration in financial parameters over the years. The document underlines that the gap between the average cost of supply (ACS) per unit of power and the average unit income realized (ARR) by utilities has fallen from ??0.27 in October 2018 at ??0.58 per Kwh unit in January. In addition, the average aggregate technical and commercial losses (AT&C) by Discoms fell from 19.93% of the total energy intake received in May 2017 to 26.15% in January (compared to the target of 15% as part of the UDAY program).

The previously mentioned HSBC memo notes that an upturn in the financial health of Discoms is a must for India’s transition to a low carbon economy. “Transmission grids need to be upgraded with ancillary services and storage to successfully increase the share of renewables over time (this is necessary to handle the sudden change in frequencies and supply associated with energy. renewable). The financial weakness of Discoms also has an impact on other players in the energy sector. Because Discoms don’t want to abandon paying customers such as businesses, they impose restrictions through policy reversals and ad hoc fees to discourage the private sector from sourcing renewable energy directly.

See graph 3: AT&C and ARR-ACS spread for Discoms

Which states are the worst offenders?

Data for October shows that Discoms from Tamil Nadu, Maharashtra and Rajasthan have the highest share of late payments at Gencos. While these three states account for 50% of late payments, it is not those with the highest share of late payments that are delayed by more than 60 days. Discoms owe more than 50% of their arrears to independent power producers (IPP) followed by central public sector companies (CPSE). The largest overdue amount is owed to Adani Power (25,611 crore) which represents approximately 25% of the overall contributions to Gencos.

See graph 4: Share of States in pending payments at Discoms

How do such measures affect state finances? According to Aditi Nayar, chief economist at ICRA Ratings, “the exemption of electricity bills or other forms of subsidies granted by a state government adds to its revenue expenditure, thus widening the budget deficit”. The amount owed by Discoms in 27 states (for which the domestic product and 2019-2020 budget data are available on CMIE) represented 18.4% of the total budget deficit of these states. It is a burden that will eventually show up in the state government’s ability to spend money on other chiefs.