India’s electricity distribution companies are facing a financial crisis.

According to many analysts, this is primarily because retail electricity tariffs are artificially low and therefore are insufficient to recover costs. Government policies have repeatedly used this logic to compel distribution companies (also known as discoms) to push for tariff hikes. A recent article notes that the logic of reducing losses by increasing tariffs is a central aspect of the government’s UDAY scheme to revive debt-ridden discoms. This is also why the Niti Aayog has proposed that the government should take the next step in power reforms by privatising all discoms.

But will such steps help? Are tariff hikes and privatisation really the way forward?

There are several reasons to doubt this contention. While tariff hikes would have a big impact on a large part of India’s population, they may not address the actual problems ailing the country’s discoms.

Pricing problems

To begin with, let’s look at how tariffs are actually fixed. Under the 2003 Electricity Act, discoms approach State Electricity Regulatory Commissions with a projection of the annual revenue required for their functioning. The commission sets the tariff after examining these claims through a legal process. Assuming that the tariff is suggested based on what the discoms quote, the contention that the present electricity rates are inadequate would ostensibly mean that discoms are understating how much revenue they require before the commissions. Had that been the case, one would either expect commissions to approve these requests without difficulty – as they are artificially low – or to question discoms for undercharging.

But precisely the opposite is happening. Regulatory commissions are almost uniformly reducing discoms’ projections of the revenue they will require. In 2016, for instance, Uttarakhand’s discom said there was a revenue deficit of about Rs 1,220 crores (requiring a tariff hike of 26%) and was allowed only Rs 249 crores, amounting to a hike of only 5%.

In Himachal Pradesh, the regulator reduced the discom’s claim by Rs 1,500 crores. In Karnataka, the discom got only about a third of what it asked for, while in Gujarat, the Electricity Regulatory Commission refused to give any hike at all this year. In Maharashtra, in late 2016, the discom requested Rs 56,000 crores in additional revenue, but the Commission approved only Rs 9,000-odd crores. In Kerala, the discom had not even filed a tariff revision petition for three years since 2014, since it was fighting the Electricity Regulatory Commission in court over previous denials.

Why would this be happening? Some would argue that the commissions themselves are under political pressure. But this glib claim is belied by the fact that the regulators often had very good reasons for rejecting the discoms’ applications. Take the Uttarakhand Electricity Regulatory Commission, whose 2016 retail tariff order we studied in detail.

The Uttarakhand Electricity Commission found several inconsistencies in the claim of the of the Uttarakhand Power Corporation Ltd. The discom had recorded very low rates for some connections – well below the minimum charge. (For instance, in Gopeshwar, it was found that average money recovered was Rs 2.60 per unit, when the minimum energy charge was Rs 3.80 per unit for this category). Also, data on public water works and streetlights in some areas implied that these services are available for more than 24 hours a day, which, the Commission termed as a “mockery” and “obnoxious”.

More importantly, the discom tried to double the cost of “banked power” – power purchased on the basis of a promise to return the same amount to the supplier later. The Commission pointed out that Uttarakhand Power Corporation Ltd was listing the purchase cost of banked power both in the year when it had obtained it from the supplier and for the year in which it would return it. The Commission’s rejection of this non-existent cost accounted for the biggest chunk of the cut imposed on Uttarakhand Power Corporation Ltd Annual Revenue Required estimate in 2016.

Uttarakhand does not appear to be alone in this regard. For instance, in April, The Karnataka Electricity Regulatory Commission granted the state distributor a tariff hike of just 8% as opposed to the discom’s request of a 25% hike, as it found that the claim was unnecessary.

Excesses prevail

There are also cases where regulators are not reducing the discoms’ estimates by nearly enough. For instance, in an analysis published in the Economic and Political Weekly in 2014, researcher Kannan Kasturi found that discoms in Delhi were systematically purchasing merchant power (power purchased on a day to day basis) at high costs instead of setting up enough long-term power purchase agreements. Private generation companies benefited from this mismanagement. Almost all the approved tariff hikes between 2008 and 2013 were a result of these unnecessary costs.

This problem becomes worse as one goes down the electricity supply chain. For instance, when generation companies inflate their costs, this results in higher costs for discoms and therefore higher losses – when such costs may not be justified at all. Take the alleged over-invoicing for coal imports by power generation companies – where companies allegedly lied about the price of the coal they were importing from their own subsidiaries, to the tune of tens of thousands of crores.

Similarly, after Indonesia changed its rules to bar coal miners from selling to their parent companies at preferential prices, Tata and Adanis attempted another variation on this scam, demanding higher “compensatory tariffs” for “higher coal costs” – even though the profits from those higher costs would go to their own subsidiaries. Nevertheless, both the Central Electricity Regulatory Commission and the Appellate Tribunal for Electricity permitted these companies to seek compensatory tariffs, until the Supreme Court overruled them in April.

It is possible that, despite all these problems, there might still be a logic to implement major hikes in retail tariffs. However, experience shows that simply relying on discoms’ statements of their own costs requires a leap of faith. Such a leap of faith is bad public policy as drastic hikes would have a terrible impact on a huge proportion of the population.

In a field survey we conducted among daily wage workers, farm workers and small farmers in four sites in Tamil Nadu, Delhi and Uttarakhand, we found that for these impoverished groups, electricity costs already accounted for between 4% to 6% of monthly income. If tariff hikes of the oft-suggested 50% are imposed, this would rise to 6% to 9% of monthly income. This would be a giant blow. Electricity is an essential good, and to suddenly hike its price by 50% would have as devastating an impact as would a 50% hike in the price of food.

Tariff hikes should therefore be the last resort and not the first solution for those seeking to fix an electricity sector that is both opaque and unjust.