That India's power sector has been in a state of disrepair for years is nothing new. Nor are suggestions on how to reform it. The process has been painfully slow, and scandals such as at Dabhol and Orissa have left private investor ? and lender ? confidence deeply shaken. But encouraging prospects for fundamental reform still exist in the long awaited Electricity Bill, currently before parliament, which may yet inject some inspiration into this otherwise demoralized sector. And flickers of life are also apparent in several IPPs now firmly back on the agenda.

In theory the country has a total installed capacity of 100,000MW. But most of that figure comprises aged and decrepit facilities operating well below full capacity. The government has targeted an extra capacity of 111,500MW by 2007, to meet burgeoning demand. But to do that, it will also require around $250 billion to build new and more efficient plants, and to combat frequent blackouts, unreliable supply and deteriorating power generators. And the bulk of that figure will need to come from private capital.

The issues plaguing the sector, however, have made the challenge of fixing it one of the most complex of any such reforms in the world. On any analysis, power sector reform is the cornerstone of the country's overall structural reform program. According to the World Bank, the country's future growth and welfare of its people ?will continue to be hampered as long as the country's power supply constrains industrial development and the financial losses of the power sector remain a burden on public sectors services.?

The crux of the problem facing the sector is management and financing at the state government level ? electricity supply is the shared responsibility of both the Central Government and the states. In fact, says the World Bank, ?poor operational efficiency? of the State Electricity Boards (SEBs) is the root of the state power sector's ailments.

SEBs, in continual and severe financial distress, have amassed billions of dollars in debt over the years because of what many argue has been mismanagement ? subsidized tariffs to residential and agricultural consumers, low investment in transmission and distribution systems, inadequate maintenance, and high levels of distribution losses, theft and uncollected bills.

The Boards are simply unable to recoup the marginal costs of production. The heavy losses sustained by the country's unreformed and bankrupt boards exceed 1% of the country's gross domestic product. These losses continue to rise.

This in turn drains the limited state budgets, diverting valuable and insufficient resources from vital sectors such as healthcare and education. The World Bank, in its longstanding attempt to spearhead reforms to the sector, has been loudly emphasizing a point now well recognized throughout the industry and the central government ? reforms must begin with the SEBs.

Successive reform agendas have been drawn up over the years, with, as yet, no constructive result. According to S&P, the country has failed to undertake the reforms in a timely manner, and India's ?inability to reignite reform momentum? has constrained the country's rating outlook, with S&P having recently affirmed its negative outlook for the country, and with Fitch following suit, downgrading its sovereign foreign and local currency ratings to BB and BB+ respectively from BB+ and BBB-.

As the SEBs are the main purchasers of power from independent power producers (IPPs), a speedy resolution to their financial woes is critical if India is to attract the capital needed to ensure uninterrupted power supply ? and, ultimately, sustained industrial output.

The new electricity framework

But the Power Minister Suresh Prabhu is no stranger to these issues. In fact, he has been feverishly crafting a new framework for the power industry, which has recently surfaced ? yet again ? in the form of the Electricity Bill 2001, currently before Parliament. Its aim is, in part, to shift the focus from generating capacity to improving transmission and distribution systems to prevent further losses, before redoubling generation efforts.

Referring earlier this month to his strategy, Prabhu explained that unless weaknesses in T&D were addressed first, further generating capacity would only mean greater loss. In effect, his new program amounts to a ?blueprint for power sector development.?

The Bill, which has already seen numerous drafts, also liberalizes generation and allows captive generation without any restrictions. Any generation license can undertake distribution and vice versa. Also, although the government is to retain control of transmission, it will allow private licensed transmission.

It is more comprehensive than its precursors, and focuses on the main issues of transmission and distribution. But, as always, criticisms still persist.

For instance, according to some industry observers, references to ?promotion of competition? have been conspicuously omitted. The Bill does not provide for a multiple-buyer market for power that, in turn, will help lower tariffs. It does away with the need for private power producers to obtain licenses for power generation, allowing them independence from the Central Electricity Authority.

What is of greater concern, however, is that the bill is unclear on whether generating companies will have the freedom to sell power to consumers other than the frequently bankrupt SEBs.

Prospective sponsors are concerned because of the problems created in Orissa, the first state to reform its power sector under the World Bank prescription. Orissa unbundled its power sector into generation, distribution and transmission and allowed private participation in generation and distribution.

The World Bank lent $350 million to the state to ease its power overhaul. But non-payment problems ensued, and the gencos are now owed Rs1,500 crore from the sole buyer, GridCo, the state-owned transmission company formed from the carcass of the unbundled SEB.

In Orissa, the pioneer reforms, lauded by the World Bank and power industry observers worldwide, have largely failed, lending credence to the critics who argue that states have no clear incentive to reform. The major criticism is the massive increase in tariffs, in some cases up to 78%, while the privatization of the various networks became mired in local politics.

But a major incentive is still additional funding from multilaterals, such as the World Bank and Asian Development Bank, albeit with sometimes politically unpalatable conditionalities.

If the Orissa reforms fail completely, its inevitable effect will be to stymie the fervor for reform throughout the country. To prevent this, more focus should be directed at improving state-owned power agencies, before the privatization of assets. And this, in principle, is precisely what the new Bill hopes to achieve.

Security

?Reform of SEBs into financially viable bodies is crucial to the ultimate goal of harnessing private investment in power generation. It will be fundamental to getting deals done,? admits an Indian banker.

But one major impediment to financing power projects has been the absence of any acceptable security payment mechanism to offset sharp offtaker risks. The central government, at the insistence of the World Bank, maintains it will extend no more counterguarantees to projects, as a longer term ?fix?, the restructuring of the SEBs.

Not surprising, considering that outstanding government guarantees now amount to over 10% of GDP, and are contingent liabilities that could easily end up on the government's balance sheet ? as, indeed, they have with the infamous Enron saga.

The unbundling of the SEB's into separate entities for generation, transmission and distribution has added to the complication of some IPPs. For states in the process of restructuring, the IPP contracts and security arrangements, including escrow, have had to be amended to cater for the restructured entities.

Lenders have, however, sought escrow arrangements as a practical form of security, regardless of the availability of a counter guarantee or SEB restructuring, but this has caused delay for several reasons. For instance, the level of escrow that each state can sustain is, in almost every case, insufficient for the number of proposed IPP projects.

But now even escrow accounts provided by the government are mostly unreliable, since the state governments are no longer in a position to bear the burden of the SEBs.

These delays in clinching a suitable security mechanism have forced many major international power sponsors, among them CMS Energy, International Power, EdF, Cogentrix and Enron, to exit the Indian power scene. Indeed, it is the local major players, sponsors and lenders, backed by heavy multilateral support, who are most likely to inform the success of the next phase in India's troubled power sector development.

Dabholical

The problems which have forced the closure of Enron's controversial $2.9 billion Dabhol power project in the northern state of Maharashtra have underlined, among other things, the poor financial condition of SEBs. Dabhol was also the first project to obtain counter guarantees from both the state and central governments.

The minutiae of the dispute are by now well documented ? the Maharashtra SEB having refused to pay Dabol Power Company's (DPC ? 65% owned by Enron) tariffs, landing it in international arbitration.

But it nonetheless raises issues crucial to future power sector lending. 40 international and domestic lenders participated in the financing, implicitly placing faith in the government's guarantees. As a result of the impasse, international sentiment has ebbed considerably, and consternation at the central government's seeming indifference have lead many international bankers to question its commitment.

But domestic lenders, such as IDBI, ICICI, IFCI ,SBI and Canara bank, have carried the greatest risk on the deal, as they went in unprotected, with $1.4 billion in debt. Encouragingly, domestic banks recently agreed in principle to counterguarantee IFCI's guarantee obligations, totaling some Rs4.54billion, to JBIC's DPC commitment. It is understood that other Indian banks have also stepped up to counterguarantee against obligations by any member of the consortium in the event that their capital adequacy ratio falls dangerously low.

Both Tata Power company and BSES, in which Reliance Industries, India's largest private sector company, has a substantial stake, are currently eyeing DPC for potential acquisition after Enron's pull-out earlier this year. An IDBI-led team is coordinating the sale of the plant, and potential bidders are being asked to finalize due diligence by January next year.

The bidders are likely to capitalize on Enron's collapse by submitting sharply reduced offers. Bankers say that DPC may go for a radically slashed ticket. Although the scandal may have dented international confidence in the sector, under new ownership, DPC's future relationship with the state could provide a new benchmark for assessing the depth of reforms. After all, the original Enron deal was, according to some analysts, shrouded in murkiness to begin with ? a fact which casts doubt on the full culpability of MSEB.

And, according to one Indian banker, ?if the contract of this company [Enron] had been allowed to run its course, it would have not only reduced Maharashtra State Electricity Board to a non-entity, but also made Maharashtra bankrupt.?

New investors prepare to step up

Aside from the Electricity Bill, and the slow, but nevertheless extant, pace of reform, there is still a more positive glint to the sector's development. In Uttar Pradesh, Birla Group and PowerGen's 567MW Rosa independent power project is understood to be back on the agenda, with lead arranger IDBI coming on board to put together a Rs1,800 crore debt package.

The bank has received commitments from major domestic lenders, such as ICICI, SBI and Power Finance Corporation. The perennial issue of SEB creditworthiness was initially also evident in this case. Although an escrow agreement had been signed last year, lenders were concerned about SEB's ability to maintain that account. But the state government has since stepped in with a guarantee, while reforms to the Uttar Pradesh SEB are undertaken. Financial close on the domestically financed deal is expected within months.

Other hopeful developments include the Central Government's recent launch of the $1 billion India Power Fund, heralded as a prime catalyst for the development of power generation in the country. The fund is expected to invest private equity, venture capital and debt, in state power projects.

At present, fund investors are likely to include Power Finance Corporation together with other financial institutions such as General Insurance Corp, Life Insurance Corp, and mutlilaterals, such as the World Bank and ADB.

But for IPP development, the most encouraging development of late has been the Andhra Pradesh State government's moves to resolve payment security mechanism issues in the state. The signing of a new security mechanism agreement, linked to certain performance targets for the state (such as reducing transmission losses, improving revenue collection), marks a new turning point in the country's power sector reform. It paves the way the financing of six IPPs, previously impeded by the lack of security.

They include BPL/Marubeni/EPDCJ's 520MW Ramagundan project, Nippon Denro Ispat/Overseas Investment Mauritius' 370MW Vemagiri project, GVK/CMS's 220MW Jegurupadu project, BSES AP's 220MW Samalkot project, Gautami Poer/Satyan/IJM/Unocal Bharat's 464MW Peddapuram project, and Oakwell Power's 445MW project.

With the new power bill yet to be implemented, the success or failure of reforms in the power sector is difficult to predict. And, given the reforms' sheer scope, the final results are unlikely to be in any time soon.