BREAKINGVIEWS - Indian power sector bailout is a good first step

By Andy Mukherjee

SINGAPORE (Reuters Breakingviews) - India's electricity distributors have become zombies. The industry's $35 billion debt overhang, equivalent to 2 percent of the country's GDP, means it has few resources to invest in transmission and distribution. The result is massive underinvestment that chokes off economic growth - 11 percent of power demand is unmet - and causes crippling grid failures like the ones that plunged most of the country into darkness in July.

That is why the government's bailout of the sector is a good first step. Half the debt, most of which is owed to state-owned banks, will be shifted to state governments. That's as it should be: officials have long curried favour with voters by directing distributors to supply power at uneconomic prices.

Banks will also have to restructure the remaining loans, triggering bad-debt charges that will hit their earnings this year. But bank shareholders can't complain. The deal is the best they could have expected, especially as distributors are prohibited from raising tariffs to recoup past shortfalls.

Beyond the onetime cleanup, India needs a strategy to ensure that distributors don't accumulate new bad debts. It will be hard to make state politicians improve their behaviour: they are powerful figures in a fragmented political landscape. One possibility, however, is to tie their hands by linking distributors' pricing to benchmarks based on the cost of producing, transmitting and generating energy.

If states want to subsidise electricity prices, these should be explicitly a part of annual budgets. A 2003 fiscal management law, currently in tatters, should be revived to place a limit on the states' - as well as the government's - spending.

Sticks alone won't do, carrots are also needed. The biggest obstacle to making India's power sector economically viable is the addiction of farmers in some states to free power for pumping water. State governments that limit power subsidies should be rewarded with New Delhi-funded investments in canals and other forms of irrigation. Distribution companies could also be given grants to modernize their infrastructure and reduce transmission losses. It will take more than a bailout to make India's blackouts go away.

CONTEXT NEWS

- India approved a plan on September 24 to bail out cash-strapped power distributors saddled with more than $35 billion in debt, but which analysts said offered little to reform a sector whose dysfunction has exacerbated a growth-sapping energy crisis. (Click here to read full story)

- Under the rescue plan, provincial governments will take on half of power distributors' short-term debt over the next two to five years and convert it into long-term bonds.

- Lenders, which are mostly government-run banks, will recast the rest into long-term loans and offer a moratorium on repayment of principal.

(Editing by Peter Thal Larsen and Katrina Hamlin)