Structural Reforms to Improve Regulation of Indian Electricity Distribution Companies

Abstract

This paper examines the regulatory framework of the Indian power sector, often criticised for contributing to the financial strain of electricity distribution companies. This criticism arises primarily because tariffs are frequently set too low, preventing these companies from fully recovering their costs.

While other scholars have proposed reforms centred on the selection process for regulators, oversight mechanisms, and regulator training, this paper takes a different approach. It delves into the structural reasons behind the issues in the current regulatory framework, addressing questions such as: Does the ownership structure of the distribution company influence the effectiveness of regulation? Are incentives aligned within the institutional and organisational structure to encourage good financial performance by distribution companies? What changes could enhance the organisational structure or governance of distribution companies to enable more effective regulation?

Regulation becomes necessary when there is a need to balance competing interests, typically those of the utility versus the consumers’ or the public interest. Given that government ownership of distribution companies is expected to sufficiently protect the public interest, regulation is mostly associated with privately-owned utilities. However, in India, as in other developing countries, state-owned companies are also subject to regulation.

Regulation is generally more effective with private distribution companies due to their strict budgets, creating an inherent incentive for better financial performance. This claim is supported by experience in India and other developing countries, where private utilities tend to perform better, and regulation is more effective.

While effective regulation may be best achieved with privately-owned distribution companies, there is often political resistance to privatisation, as seen in India. In cases of strong resistance, drawing on the Canadian experience of successfully regulating publicly-owned utilities, the governance of state-owned distribution companies can be modified so that they emulate the behaviour of privately-owned companies. This can be achieved by professionalising government ownership; developing more effective, stronger, and independent boards; and enhancing the commercial orientation of the distribution companies. However, these changes will be challenging for the government to implement, and therefore, privatisation should be given priority, and improving governance of stateowned distribution companies should be pursued only when absolutely necessary.

Reforming the regulatory framework is crucial for improving the Indian power sector. Nevertheless, expectations from regulation must be realistic, and challenges to reform must be recognised. The paper highlights that in many cases, regulation is transformed by the governance culture and processes in a country, rather than the other way around. The paper concludes by noting the complexities of regulating politically sensitive sectors like power.