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Tax regime on electricity sector merits a re-look
February, 22nd 2007

The Budget should address four key imperatives: reduction of energy cost, investment in new capacity, improving operational & pricing efficiency, and encouraging competition. In the past year, a number of important initiatives and national policies set the agenda for change in the electricity sector. Some of the national policies that implement the Electricity Act 2003 were also notified, after due process of consultation. These developments give room for optimism; however, considerable backlog in implementation remains.

With the variety of initiatives under way, there is risk of losing the wood for the trees; and it is useful to step back to consider the basic requirements that must be addressed in policy and budgetary support. The four key requirements are to:

  • Reduce cost of energy

  • Invest in new capacity

  • Improve operational and pricing efficiency

  • Encourage competition

    Electricity is a basic input for industry and agriculture, and strongly influences output and prices in the economy: further, lower electricity tariffs help the industry fare better in global competition.

    Lower costs mean lesser subsidy burden for the Government on its rural and lifeline supply obligation. In the emerging competitive regime, this obligation is less easily financed by cross-subsidy, and an overall cost reduction is necessary.

    In this context, the tax regime on electricity sector merits a re-look. There is a case for broad-based exemptions from customs duty for import of: primary fuel, such as LNG and coal, capital goods and spares, construction equipment, and raw materials used for power generation, transmission and distribution. Likewise, reductions of excise duty to say, half the current levels are sought. The benefit of lower cost on all these inputs is recurrent and significant given the large capital investments on the anvil.

    Tax holiday benefits

    The Section 80IA benefit of tax holiday should be extended for at least the next two Plan periods given the forecast capital investments. The benefits of mega projects should be applied to all parts of the energy chain viz. to the captive mining blocks allocated to power producers, and for the large transmission projects at the national and at the state level.

    The second aspect is investment in new capacity: the requirements set by the national economic and social agenda and aspirations are large, and the pace challenging. The next plan envisages 68GW of new power generation capacity against 30GW achieved currently. Transmission interconnection capacity is almost likely to be doubled. In many States, new large industrial growth centres are planned or in progress and these need transmission expressways. This will need targeted funding from budgetary outlays, multilateral lending agencies, but utilities must also be asked to seek new ways, such as through public private partnerships.

    The third aspect is operational efficiency: concerns of how the new investments will be efficiently deployed and operated. The reform efforts are more urgent and essential than ever before: the stakeholders, viz. the State Government, regulators and utilities must work synergistically to improve delivery efficiency and sector's financial viability. This requires structural change (multiple distribution companies with financial and operational autonomy), putting in place new commercial processes, use of IT and targeting tools, and modern management practices.

    Unfortunately, State utilities have invested very little in these areas so far and have been content with marginal improvements whose sustainability is in doubt. They must take bold and comprehensive steps to make the structural, systems and cultural changes necessary to achieve material and lasting improvement.

    Poor pricing is a major value drainer: analysis in a state shows that only 20 per cent of the subsidy intended for residential lifeline consumers (0-50 kWh) is actually used by them; the bulk 80 per cent goes to larger consumers. Tariff re-design is long overdue. In all cases, tariffs under-recover costs by a higher proportion than in 1990s. Analysis in a state shows that basic residential slab (0-100 kWh) covered 108 per cent of cost in 1992, but covers only 39 per cent in 2006. Even a simple index mechanism to cover even a part of the inflation can transform the utility from being a drain on the state exchequer to generating cash flow for its own investments.

    The fourth element is competition: experiences worldwide show that competition provides choice and lower costs. Competitive bidding and supply must be encouraged in much of the value chain as possible. In most States, the path for retail competition is laid out, but corresponding efforts encourage, facilitate and target are missing.

    A recent survey reveals that most large consumers are unaware of retail competition, and the few who have attempted complain of high surcharge or non-tariff barriers such as built in connection charge, overdrawal charge, and exit charges. The regulators must act to simplify the process, ensure non-discrimination in procedure and practice, and require independent system operation. The state utilities must set up systems for regulated settlements as otherwise they lose paying for expensive interchange, as the number of players increase.

    India's electricity sector is the sixth largest in the world and has a strong role in shaping the nation's economic and social development.

    Kameswara Rao
    The author is Leader - Power Practice, PricewaterhouseCoopers.

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