June 19, 2012

Powering Gujarat

Power sector reforms are integral to Gujarat’s inclusive growth strategy

A positive relationship between economic growth and energy, especially electricity consumption is empirically well established. While technological progress has reduced energy needed per unit of economic output or GDP, increased energy (including electricity) remains essential for the growth in developing countries.

This article analyses key reform initiatives in the power sector by the state of Gujarat since early 2003. It is argued that these reforms have been integral to Gujarat’s efficient economic management and its high and inclusive economic growth.

Empirically, Human Development Index (HDI) is positively correlated with per capita electricity consumption at least up to 4,000 Kwh (Kilo Watt hour) level. This suggests that India and the state of Gujarat will need to increase electricity consumption if they are to improve their ranking in the HDI.

Gujarat is home to 5 percent of India’s population, demarcates 6 percent of her geographical area and accounted for 7.2 percent of the country’s GDP in 2011-12. Gujarat’s Gross State Domestic Product (GSDP) recorded an annual real growth of 10 percent during 2004-05 to 2011-12 periods. The state has exhibited rapid industrialisation; with 36 percent of GSDP from industry (national average is 28 percent of GDP). In 2011-12, Gujarat was the location for about 10 percent of India’s factories, accounted for about 17 percent of fixed capital investment and contributed about 22 percent of merchandise exports. Almost half of Gujarat’s labour force is employed in industry. A shift of labour force from agricultural to non-agricultural employment is contributing to higher incomes and standard of living in Gujarat.

Gujarat’s per capita GSDP is Rs 84,962 or $1,808 in 2011-12, 30 percent higher than India’s per capita GDP of $1,389. Concurrently, it has the highest urbanisation rate among Indian states, with 43 percent urban population. Within the next two decades, majority of Gujarat’s population will be classified as urban or para-urban. In addition to commercial, industrial and domestic demand the state’s agricultural sector is also a significant energy consumer. Indeed, it is the second largest consumer of electricity after industry.

Among the top 10 electricity-generating states of India, Gujarat had the highest per capita electricity consumption (of 1,512 Kwh in 2010-11), as compared to all India average (of 770 Kwh in 2009-10) and its average per capita consumption is in striking distance of the world average. (of about 2,000 Kwh) As Gujarat aspires to reach upper-middle income status, its per capita electricity consumption (including power) will also increase substantially. There is thus no room for complacency in managing demand and supply of power, and in actively introducing technological and managerial innovations in this sector. In order to achieve inclusive growth, it is imperative for Gujarat to meet power demand from all segments of the economy and society. Meeting power demand from agriculture as well as industry may enable the state to achieve higher productivity, better profitability and become more competitive in export-markets.

For the current level of consumption (total of 58,670 MUs (Million Units) in 2010-11) and the pricing policies employed, the supply situation (gross generation of 71,256 MUs in 2010-11) is relatively comfortable. As of March 2011, Gujarat’s installed power capacity was 15,250 MW (Mega Watt). Data suggests that while the state is mainly dependent on thermal power, it is diversifying its power portfolio as reflected in the moderately high share of renewable sources, particularly solar and wind. Gujarat’s coastal advantage in sourcing fossil fuels and proximity to natural gas resource basins of Middle-East are favourable factors.

Before 2003, Gujarat’s power situation was not comfortable. The State Government’s subsidy to the agricultural sector and cross-subsidy burden on industrial consumers adversely affected Gujarat’s growth and competitiveness. Large transmission and distribution losses damaged viability of its power sector, and distorted efficient allocation of electricity to different uses and sectors. Rural areas were prone to load shedding which was intended to minimise industrial losses from power cut-offs. Substantial fiscal burden from the sector resulted in sub-optimal allocation of state resources. The state’s power sector was therefore in urgent need of a multi-faceted approach for a turnaround.

The state policymakers rightly concluded that comfortable power and efficiency in allocation of power to different uses and sectors were critical to inclusive growth. There appeared to be consensus on this point among political and administrative leadership. Since 2003, the state has undertaken several positions, integrated and synergistic initiatives to reform the power sector. These include:

One, restructuring power generation, transmission and distribution organisations. The state initially focused on restructuring the rather unwieldy and nearly bankrupt Gujarat State Electricity Board (GSEB). GSEB which formerly housed generation, transmission and distribution activities was segregated into seven functional parts- a generation company, a transmission company, four distributional companies and an over-arching company for planning, co-coordinating and ensuring standardised organisational practices across the sector. In addition to elevating operational efficiency, functional segregation was able to sharpen segment-focus, decentralise decision-making and facilitate competition. Each of the seven parts was corporatised for superior accountability and governance through independent boards. Gujarat further liberalised its power sector to augment private sector’s participation in all segments of the industry.

Two, implementing Jyotigram Yojana. Through the Jyotigram Yojana, feeders in rural areas have been segregated into two separate lines – one for supply of electricity for agricultural purposes and the other for supply to rural homes and for other non-agricultural purposes. To achieve this, a substantial initial investment of Rs. 11 billion, was made almost entirely by the state government. As the financing method included loans which need to be rapid, efficient use of borrowed funds became essential. This was recognised by the state government.

Three, reforming pricing policy. The new pricing policy links tariff to recovery of fuel price and variations in the cost of power purchase from other utilities. Thus retail tariffs will progressively reflect the economic cost of supply. As a consequence, average tariffs have increased from Rs. 2.20 per unit in 2001 to Rs. 3.98 per unit by 2011. Instead of infrequent but large discrete changes, small though frequent changes to electricity tariffs are preferable on economic, political and social grounds. This reform reflects Gujarat’s willingness to charge economically efficient and financially sustainable electricity tariffs. Ability and willingness to apply relevant economic reasoning has been an important characteristic of policy making in Gujarat. This characteristic could be usefully adapted by other states to fit their specific contexts.

Four, enhancing policy-thrust and state-investments in RES, particularly solar and wind-generated power. The state has encouraged solar and wind power which is consistent with its advantageous location. Gujarat’s thrust in solar energy is supported by the state’s 250-300 sunny days’ count. Also, its efforts in wind energy are supported by the state’s long coastline. The 450-km long Narmada’s canal-top solar power project of 1 MW generation capacity will have multi-dimensional benefits. Technological innovations in renewable energy may reduce absolute and relative costs of renewable energy sources in future. The state policymakers have argued that the use of solar and other renewable sources could be economically justified under the projected costs and access to coal, natural gas and crude oil. This illustrates Gujarat’s willingness to view energy security from a long term prospective.

Corporate restructuring was able to achieve a more efficient institutional framework. Roughly, 40 percent of the state’s power generation is now in the private sector. Gujarat has thus achieved higher efficiency through competition and curbed monopolistic tendencies that are less consumer-friendly. The new pricing policy has improved the environment for sending efficient and sustainable pricing signals.

Cost reduction came from lower transmission and distribution (T&D) losses; falling from 35 percent in 2001 to 22 percent in 2011. Revenues increased after power purchase agreements were renegotiated on mutually agreeable terms. Modernising transmission and distribution systems achieved significant improvement in quality and quantity of power supply. Collection efficiency has greatly improved due to improved metering, computerised billing and bolstering the collection system. Gujarat must aim to further reduce T and D losses to internationally observed rate of less than 10 percent.

Jyotigram Yojana has enabled entire rural Gujarat to benefit from 24-hours of three-phase power connectivity, improving financial contributions made by rural consumers. An important reason has been that subsidised agricultural rates cannot be incorrectly claimed for any other purpose. Power thefts have also been reduced in the state, though there is room for further progress. Assurance of quality and reliability in power supply has facilitated acceptance by the rural population for paying for electricity, while demonstrating the state’s willingness to charge for power and thereby improve its financial and fiscal position. This in turn increases the state’s capacity to improve quantity and quality of power supply.

Photo: Mystery monotreme

The higher operational efficiency and cost recoveries are expected to more than justify the state’s initial investment in Jyotigram Yojana since the state’s agricultural sector (which consumes about 20 percent of the state’s electricity) has been growing at over 10 percent for the last decade and is expected to continue to grow rapidly.

As a result of higher operational efficiency, lower costs and higher recoveries (including higher recovery from new pricing policy), the electricity companies making substantial losses have become profitable at least in accounting term, since 2006. Gujarat’s subsidy bill has shrunk from Rs 18 bn (total revenue expenditure in 2003) to Rs11 bn (total revenue expenditure in 2006) and has remained at that level since. Implicitly, power subsidy as a percentage of total revenue expenditure has been declining.

Gujarat’s power sector policies have thus incorporated an important insight from growth theory. While free flow of ideas and their adequate utilisation are important cornerstones in the achievement of high economic growth reconfiguration of existing processes in combining factors of production (land, labour and capital) is equally important to sustainable economic growth. Gujarat has provided effective means for communication and non-market based network development, so that adoption and diffusion of good ideas was possible in the power sector.

In projecting future electricity needs, Gujarat must take into account incremental demand from its targeted annual real growth rate of 10 percent and annual nominal growth rate of 16 percent, over the next decade or more, suggesting it has little room for complacency. There still remains urgency for competent planning and implementation in the power sector. Further improvements in Gujarat’s HDI ranking will be dependent on ability to attain higher per capita electricity consumption.

While supply constraints are being addressed, it is important to consider whether there is scope for better management of demand. As Gujarat continues to subsidise electricity supply, its average tariff rates are below those of comparably industrialised and affluent states. This suggests that ‘willingness to pay’ may not be a constraint as yet. At higher tariffs, it may be possible to achieve a new equilibrium, at lower quantity demanded and supply. In the longer term, higher tariffs and lower subsidies, will be economically and fiscally more viable. Also resources may be released for more equity-enhancing use or for augmenting public goods provisioning, which are key functions of any government. Efforts at further reduction in T&D losses to internationally observed rate of less than 10 percent will bring about efficiency and equity gains, while improving capacity of Gujarat’s power sector to expand capacities and improve reliability.

Gujarat has made considerable progress in reforming the power sector, in a way that facilitates the state’s objective of achieving inclusive growth. Now the state aims to become a higher middle-income state within next two decades. Thus it will need even greater competence, innovations and investments in managing supply for power, and improvement in energy efficiency of its economic activities in managing demand for power. Gujarat must remain focused on its long term objectives in the power sector. It has demonstrated its ability to do so, from its recent achievements in tapping RES.

The analysis lends support to the argument that Gujarat’s power sector reforms have contributed to its high and inclusive economic growth. Effective coordination between political and administrative leaderships has been an important contributing factor. There is potential for other states to draw lessons from Gujarat’s power sector reforms, but they will need to adapt them to their specific contexts and needs.

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