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Institutional and Regulatory Economics of Electricity Market Reforms: the Evidence from India, Pakistan, Bangladesh, Nepal, and Sri Lanka
by Bipulendu Singh
A Dissertation submitted to
The Faculty of Columbian College of Arts and Sciences of The George Washington University
in partial fulfillment of the requirements for the degree of Doctor in Philosophy
May 17, 2015
Dissertation directed by
Gerald W. Brock Professor of Telecommunication and of Public Policy and Public Administration
ii
The Columbian College of Arts and Sciences of The George Washington University
certifies that Bipulendu Singh has passed the Final Examination for the degree of Doctor
of Philosophy as of 18 February 2015. This is the final and approved form of the
dissertation.
Institutional and Regulatory Economics of Electricity Market Reforms: the Evidence from India, Pakistan, Bangladesh, Nepal and Sri Lanka
Bipulendu Singh
Dissertation Research Committee:
Gerald Brock, Professor of Telecommunication and of Public Policy and Public Administration, Dissertation Director Christopher Carrigan, Assistant Professor of Public Policy and Public Administration, Committee Member Davida Wood, Project Manager, World Resources Institute, Committee Member
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© Copyright 2015 by Bipulendu Singh All rights reserved
iv
Dedication
I dedicate this work to Monika and Zev.
v
Acknowledgements
I am greatly indebted to many people for helping me in this journey. My
professors at Wabash College, Ms. Joyce Burnette, Ms. Joyce Castro and Mr. William
Placher (Late) were instrumental in inculcating a love of learning and scholarship in me.
My supervisors at the Asian Development Bank, Mr. Sultan Hafeez Rahman and Mr.
Sungsup Ra made me appreciate the links between economics and development and
inspired me to continue my studies in this field.
My dissertation director at The George Washington University Professor Gerald
Brock introduced me to New Institutional Economics and has been a source of constant
support and guidance ever since I was admitted to the program. I am indebted to my
committee members Prof. Christopher Carrigan and Ms. Davida Woods for their
guidance and support through this process. I must also thank Prof. Donna Infeld for her
inputs to my dissertation proposal.
My father Dr. Narsingh Narayan Singh has been a wonderful parent and a source
of inspiration. He has taught me to work hard, be determined and be true to my intellect.
My mother Ms. Viveki Singh (late) was unconditional with her love and generosity and
always encouraged me to put in my best effort.
vi
Abstract
Institutional and Regulatory Economics of Electricity Market Reforms: the Evidence
from India, Pakistan, Bangladesh, Nepal, and Sri Lanka
Five South Asian countries– India, Pakistan, Bangladesh, Nepal and Sri Lanka –
embarked on electricity market reforms in the 1990’s. The dissertation uses the
framework of New Institutional Economics to assess the effects on electricity sector
performance of both observables elements of reform (i.e. privatization, unbundling,
establishment of independent regulatory agencies etc.) as well as the unobservable
elements (informal beliefs, habit, norms and culture of the actors involved in reforms).
The first part of the dissertation – econometric analysis of the relationship between
observable electricity market reform measures and performance indicators – finds that for
the most part electricity market reforms in South Asia are having a positive impact on the
performance of the sector. This is particularly the case for reforms that have increased
private sector participation in generation and distribution and have vertically unbundled
utilities into generation, transmission and distribution entities. Many of the reforms are
positively correlated with higher tariffs, indicating a cost to the consumers from the
reforms. The relationship between independent regulation and performance indicators ,
however, is not established.
The second part of the dissertation - analytical narrative of the reform experiences
of Gujarat and Nepal – examines the informal elements (such as beliefs, norms, culture)
that motivate behavior and explains how and why reform outcomes differed in these two
places. The dissertation finds that the strength of formal institutions rules and the nature
vii
of social norms and customs have a significant influence on the outcome of reforms.
Aided by the strength of its formal institutional framework and more evolved social
norms and customs that encouraged people to follow formal rules, reforms in the Indian
state of Gujarat were a success. The weakness of the formal institutional framework and
the predominance of relation-based norms and customs in Nepal that led to limited
compliance with formal rules, by contrast, limited the success of power sector reforms
there.
Efforts to reform the electricity sector in South Asia undertaken by governments
with the assistance of development agencies such as the World Bank and the Asian
Development Bank have focused to a large extent on getting the content of electricity
market reform measures such as unbundling, privatization, and establishment of a power
market right. The analysis in this dissertation suggests that such measures will be more
successful in places with relatively robust formal rule based systems. Countries that are
planning to carry out significant reforms in the electricity sector will benefit from the
explicit consideration of the informal norms, habits and customs of the actors that will be
affected by the reforms.
viii
Table of Contents
Dedication………………………………………………….……......................................iv
Acknowledgement………………………………………………………………………...v
Abstract ...……………………………………………………………...…………………vi
List of Figures……………………………………………………………………………xii
List of Tables..…………………………………………………………………………..xiii
Table of Abbreviations………………………………………………………………….xiv
Chapter 1 - Introduction and Background…………………………………...……………1
Section 1: Power Sector Reforms ................................................................................... 3
Section 1a: Organization of the Power Sector ............................................................ 3
Section 1b: Deteriorating Performance ....................................................................... 7
Section 1c: Global Developments and Roadmap ........................................................ 7
Section 2: Evolution of Policy and Institutional Reforms ............................................ 12
Section 2a: India ....................................................................................................... 14
Section 2b: Pakistan .................................................................................................. 17
Section 2c: Bangladesh ............................................................................................. 20
Section 2d: Nepal ...................................................................................................... 23
Section 2e: Sri Lanka ................................................................................................ 25
Chapter 2 - Theoretical Perspectives…………………………………………………….28
Section 1: New Institutional Economics ....................................................................... 29
Section 1a: Nature and Role of Institutions .............................................................. 30
Section 1b: Transaction Costs ................................................................................... 35
Section 1c: Alternative Modes of Governance ......................................................... 38
Section 1d: Regulation .............................................................................................. 42
Section 2: Privatization ................................................................................................. 45
Section 2a: Addressing Bureaucratic Inefficiencies ................................................. 45
Section 2b: Incentivizing Efficiency ......................................................................... 48
Section 2c: Competition ............................................................................................ 51
Chapter 3 - Literature Review……………………………………………………………54
ix
Section 1: Econometric Studies .................................................................................... 55
Section 1a: Determinants of Reform ......................................................................... 55
Section 1b: Reforms and Performance ..................................................................... 56
Section 2: Case Studies ................................................................................................. 65
Section 2a: Performance of Reforms ........................................................................ 65
Section 2b: Reform Preconditions ............................................................................ 69
Section 2c: Contracts ................................................................................................ 72
Section 2d: Local Context ......................................................................................... 78
Section 2e: Implementation ...................................................................................... 82
Section 2e: Political Economy .................................................................................. 86
Section 2f: Distribution ............................................................................................. 87
Section 2g: Country Specific Issues ......................................................................... 93
Section 3: Gaps Addressed by this Dissertation ........................................................... 95
Chapter 4 - Research Framework and Methodology…………………………………. 98
Section 1: Research Questions ...................................................................................... 99
Section 2: Analytical Framework ............................................................................... 103
Section 3: Methodology .............................................................................................. 105
Section 3a: Econometric Methods .......................................................................... 105
Section 3b: Analytical Narratives ........................................................................... 107
Section 3c: Data Collection .................................................................................... 109
Section 4: Limitations ................................................................................................. 114
Chapter 5 - Econometric Analysis……………………………………………….……..115
Section 1: Introduction ................................................................................................ 115
Section 2: Data and Model .......................................................................................... 116
Section 2a: Explanation of Data.............................................................................. 116
Section 2b: Difference in Sample Means ................................................................ 121
Section 2c: The Model ............................................................................................ 127
Section 2d: Expected Signs ..................................................................................... 131
Section 3: Results ........................................................................................................ 135
Section 4: Conclusion ................................................................................................. 144
Chapter 6 - Analytical Narrative on the IPP Experiences of Nepal and Gujarat….…. 149
x
Section 1: Introduction ................................................................................................ 149
Section 2: Narrative .................................................................................................... 150
Section 2a: Pre-reform Period ................................................................................. 150
Section 2b: Implementation of Reforms ................................................................. 154
Section 2c: Outcomes of Power Sector Reforms .................................................... 163
Section 3: Theory and Model ...................................................................................... 167
Section 3a: Modeling the Relationship between IPPs and the Utility/Government 168
Section 3b: Model of Relation Based Governance ................................................. 171
Section 3c: Model of Rule Based Governance ....................................................... 173
Section 3d: Summary of Key Insights from the Theoretical Models ..................... 174
Section 3e: Propositions .......................................................................................... 176
Section 4: Back to the Narrative ................................................................................. 177
Section 5: Evolution of Social Beliefs and Culture in Nepal and Gujarat .................. 203
Section 5a: Gujarat and Nepal: A Common Cultural Past ...................................... 203
Section 5b: Development of Separate Cultural Identities ....................................... 205
Section 5c: Interaction between East India Company and Gujarat ......................... 208
Section 5d: British Conquest of India ..................................................................... 210
Section 5e: Evolution of Institutions in Nepal ........................................................ 214
Section 5f: Nepali and Gujarat in the Early 1990’s ................................................ 217
Section 6: Rankings of Gujarat and Nepal in Governance Indices ............................. 218
Section 7: The Role of Political Instability ................................................................. 222
Section 8: Conclusion ................................................................................................. 225
Chapter 7 - Policy Recommendations…………………………………………………..228
Policy Recommendation 1: Consider the Institutional Setting .................................. 229
Policy Recommendation 2: Strengthen Capacity of Regulatory Agencies ................ 231
Policy Recommendation 3: Adopt an Interdisciplinary Approach to Reforms .......... 233
Policy Recommendation 4: Make Efforts to Establish Rule Based Governance ....... 235
Chapter 8 - Contributions to the Literature on Electricity Market Reforms….………. 237
References………………………………………………………………………………239
Appendix A - Summary of the Key Results of Econometric Studies………….……….263
Appendix B - Strategy for Addressing Challenges………………………………..……272
xi
Appendix C - Scatter Plots...............................................................................................274
Appendix D - Fixed and Random Effects Specification…………………..……………277
Appendix E - Detailed Stata Outputs …………………………….………………….…280
Appendix F - Results for Sample with Indian States Only.………………………….... 289
Appendix G - Results for States/Countries by Income and System Size………….…. 290
Appendix H - List of Utilities Covered in the Study…………………………….……. 294
Appendix I - Interview Questions………………………………………………………301
Appendix J - Instrumental Variables………………………………….………………..302
Appendix K - Classification of states and countries……………………….…………...304
xii
List of Figures
Figure 1.1 - Organization of the Power Sector ................................................................... 5
Figure 1.2 - Timeline of Reforms in Bangladesh, India, Nepal Sri Lanka and Pakistan .. 13
Figure 2.1 - Williamson's Four Level of Institutions ........................................................ 32
Figure 4.1 - Analytical Framework for Assessment of Electricity Market Reforms ...... 104
Figure 5.1- Performance and Unbundling ...................................................................... 122
Figure 5.2 - Performance and Independent Regulation .................................................. 123
Figure 5.3 - Performance and Private Sector Participation ............................................. 123
Figure 5.4 - Governance and Performance ..................................................................... 124
Figure 5.5 - Reforms and Performance ........................................................................... 126
Figure 5.6 - Reforms and Performance ........................................................................... 126
Figure 6.1 - Incentives for IPPs in Nepal and Gujarat .................................................... 160
Figure 6.2 - Current Structure of Power Sector in Gujarat ............................................. 162
Figure 6.3 - T&D losses and Aggregate Technical and Commercial losses (%) ........... 163
Figure 6.4 - Average Realization, Cost to Serve & Profit before Tax (Rs. million) ...... 163
Figure 6.5 - IPP Installed Capacity, 1990-2011 (MW) ................................................... 166
Figure 6.6 - IPP Investments, 1990-2011 ($ billion) ...................................................... 166
Figure 6.7 - A Model of Relation Based Governance .................................................... 172
Figure 6.8 - Optimal Enforcement Modes in Different Size Worlds .............................. 174
Figure 6.9 - Comparison of Main Hydropower Policies and Acts ................................. 185
Figure 6.10 – Evolution of Institutions in Gujarat and Nepal......................................... 204
xiii
List of Tables
Table 2-1 - Regularity of Behavior in the Electricity Sector ............................................ 33
Table 2-2 - Attributes of Leading Generic Modes of Governance ................................... 36
Table 4-1 - Data Sources................................................................................................. 113
Table 4-2 - Subject States and Countries of this Study .................................................. 113
Table 5-1 - Selected Power Sector Performance Indicators ........................................... 117
Table 5-2 - List of Explanatory Electricity Market Reform Variables ........................... 118
Table 5-3 - List of Other Explanatory Variables ............................................................ 118
Table 5-4 - Statistical summary of key variables............................................................ 120
Table 5-5 - Timeline of reforms in South Asia ............................................................... 120
Table 5-6 - Summary of expected signs ......................................................................... 134
Table 5-7 - Regression Results (Fixed Effects) .............................................................. 140
Table 5-8 - Regression Results (Random Effects) .......................................................... 141
Table 5-9 - Fixed and Random Effects Tests.................................................................. 142
Table 5-10 - Summary of statistically significant findings ............................................. 143
Table 6-1- Pre and Post Reform Power Sector Performance Indicators ......................... 165
Table 6-2 - One Sided Prisoner's Dilemma .................................................................... 170
Table 6-3 - Scores of Nepal and India on Different Governance Variables ................... 219
Table 6-4 - Risk Premiums for Different Countries ....................................................... 221
Table 6-5 - List of Prime Ministers of Nepal Since 1990 ............................................... 223
Table 6-6 - List of Chief Ministers in Gujarat ................................................................ 224
xiv
Table of Abbreviations
ADB Asian Development Bank
BPDB Bangladesh Power Development Board
CEB Ceylon Electricity Board
ETFC Electricity Tariff Fixation Committee
GDP Gross Domestic Product
GEB Gujarat Electricity Board
IIPA Indian Institute of Public Administration
IPP Independent Power Producer
NEA Nepal Electricity Authority
NIE New Institutional Economics
OECD Organization for Economic Cooperation and Development
PPA Power Purchase Agreement
SEE South East Europe
T&D Transmission and Distribution
TAP Transparency, accountability and public participation
WAPDA Water and Power Development Authority
1
Chapter 1 - Introduction and Background
Electricity has consistently ranked first in polls of all-time greatest inventions
carried out by Gallup in the United States1. Electricity is critical to economic
development and poverty reduction. Electricity access, especially for the poor,
contributed to the achievement of Millennium Development Goals. Without electricity,
economies cannot grow and poverty cannot be reduced. Electricity is an important input
to all sectors of the economy, and aids industry, commerce, agriculture, and important
social services such as education and health.
Yet almost two hundred years after Michael Faraday invented the electric
dynamo, more than 1.3 billion people still lack access to electricity. Many countries face
frequent electricity outages and load shedding, which serves to lower enterprise
productivity, competitiveness, and employment, and is a severe constraint on economic
growth. The South Asia region in particular has fared poorly in ensuring access to
reliable electricity. Of the 1.3 billion people without electricity in the world, two fifths or
about 493 million live in South Asia (International Energy Agency, 2011). Many more
lack access to reliable and regular electricity supply.
Industries have to rely on backup generators for electricity, which are
significantly more expensive ($0.22-0.30) than grid electricity ($0.09-0.16/kWh).For
1Gallup Poll has twice asked Americans -- in 1947 and again in 2005 -- what they think is the greatest invention ever made. In both surveys taken nearly six decades apart, the same response -- electricity, electric light, or electrical appliances -- is named most frequently. Twenty-nine percent of Americans thought this was the greatest invention in 1947*, and 21% think so in 2005.
2
India, a 2012 survey by the Federation of Indian Chambers of Commerce and Industry
found that the lack of affordable and quality power has been a serious detriment to the
health and stability of Indian industry, especially small and medium enterprises. A 2006
World Bank investment climate assessment indicated an almost 7 percent loss in
production value due to power outages or surges from the public grid (Pargal, 2014). The
average per capita annual consumption of electricity in South Asia at 605Kwh is a fifth of
the global average. Moreover, the electricity sectors of South Asian countries are
characterized by high levels of transmission and distribution (T&D) losses (S. C.
Bhattacharyya, 2007c).
United Nations Secretary-General Ban Ki-moon launched the Sustainable Energy
for All initiative in September 2011 to make universal electricity access a reality by 2030.
The initiative plans to pursue greater energy efficiency and penetration of renewable
energy in parallel. The World Bank estimates that achieving universal access to modern
energy services by 2030 will cost $48 billion a year, which will have to be met through a
partnership of governments, private sector, development agencies and civil society
(World Bank, 2013b).
It is now well accepted that institutional and regulatory arrangements play an
important role in determining the outcomes of the electricity sector. According to the
New Institutional Economics (NIE) literature, institutions are defined to include formal
constraints (rules, laws, and constitutions) and informal constraints (norms of behavior,
conventions, and self-imposed codes of conduct) as well as their enforcement
characteristics (North, 1994). Regulations are formal constituents of institutions,
3
developed by governments to focus on specific economic sectors for controlling market
power, monitoring performance and providing incentives (Kumar, 2009). The structure
and design of institutions as well as the manner in which different levels of institutions
interact with each other has a significant influence on sector performance.
Countries have continuously striven to set up appropriate institutional and
regulatory structures to improve electricity sector performance. For several decades after
the Second World War, these efforts were typically led in most countries by a vertically
integrated supply chain in which all the main supply functions—power generation,
transmission, distribution, and customer services—were the responsibility of a state-
owned electricity utility. However, starting in the late 1970’s, reform efforts were
initiated to unbundle the electricity sector and promote private sector participation and
competition in the sector. These reforms had spread to South Asia by the early 1990’s.
Section 1: Power Sector Reforms
Section 1a: Organization of the Power Sector
The electricity sector can be divided into generation, transmission, and
distribution/supply segments (Figure 1.1). Each of the segments has qualities that
differentiate it from the others and determine the nature of reforms that can be
undertaken.
Generation is the creation of electricity using fossil fuel and renewable energy
sources such as oil, natural gas, coal, nuclear power, hydropower (falling water),
renewable fuels, wind turbines, and photovoltaic technologies. Electricity generation
4
costs depend on fuel prices, capital costs, labor costs and maintenance costs as well as the
performance characteristics of the technology, including capacity factor, thermal
efficiency, and operating life.
T&D are the “wires” component of electricity sector. Transmission involves the
high-voltage transportation of electricity between generating sites and a distribution
center. Transmission also involves the management of generators in a grid to maintain
voltage and frequency stability and to prevent the system from breaking down.
Transmission has natural monopoly characteristics since competition means duplication
of the existing network.
Distribution is the low-voltage transport of electricity to household and
businesses. In some instances, the retail and supply functions such as metering, billing
and various demand management services may be separated from distribution (Steiner,
2000).
The characteristics of electricity have important implications for the kind of
reforms that can be introduced in the sector. First, there is significant variation in the
demand for electricity over the course of the day, month and year. Second, electricity
cannot be stored economically by consumers or distributors. As a result, the generation
and consumption of electrical energy needs to be matched at any given time. In
particular, there is need to maintain significant complementarities between the generation
and transmission segments to ensure that “a large number of generating facilities
dispersed over wide geographic areas provide a reliable flow of electricity to dispersed
5
demand nodes while adhering to tight physical requirements to maintain network
frequency, voltage and stability” (P. L. Joskow, 1997).
Figure 1.1 - Organization of the Power Sector
Source: U.S. Department of Energy.
In the pre-reform stage, the power sector of South Asian countries was dominated
by state owned power utilities. This structure consisted of a vertically and horizontally
integrated supply chain in which all the main supply functions—generation, transmission,
distribution, and customer service—were the responsibility of a power utility. The
6
justification for adopting the pre-reform industry and market structure rested on
following grounds:
• Transaction costs. The generation and T&D segments of the electric industry were
seen to be technically interdependent, with design and operation of one segment
requiring coordination with the design and operation of the other segments. It was
understood that vertical integration reduced transaction costs by mitigating the
information asymmetry, lessening uncertainty and risk, and reducing overhead costs
(P. Joskow & Schmalensee, 1983).
• Economies of Scale. Utilities were seen to enjoy increasing returns to scale2. State
financing was seen to be required to undertake the large scale investments in
production and network assets with high fixed costs that were needed to capture
economies of scale, but which had little market value in alternative uses to mitigate
investment risks (Steiner, 2001).
• Natural Monopoly. The T&D segments of the sector in particular were seen to have
strong natural monopoly characteristics given the large investments required and the
necessity to avoid wasteful duplication. State ownership and financing was favored to
keep an industry with substantial degree of natural monopoly under state stewardship
to enhance consumer welfare from these services (P. L. Joskow, 1997).
2 Electricity is a non-storable good which requires demand and supply through wires to be balanced in real time. For this to happen, suppliers must maintain sufficient reserves in the form of “spinning reserve” and “black start capacity” to meet the maximum demand possible at any given time. (Steiner 2000). An increase in the customer base of a utility causes the reserve margin requirement to decrease, as heterogeneous consumers effectively pools risk faced by suppliers. Likewise, it was more cost efficient to produce electricity from large power plants compared to small power plants.
7
• Strategic Considerations. Governments considered the power market to be critical
to national economic security, as well as a means for pursuing economic and social
distributional objectives. Electricity was seen not as an economic good that needed to
be priced on economic terms but as a social good that governments needed to make
available to everyone and state ownership was considered critical for this to happen
(J. E. Besant-Jones, 2006; J. Besant-Jones & Vagliasindi, 2012).
Section 1b: Deteriorating Performance
Under this structure, however, the quality of power supply deteriorated alarmingly
by the late 1980’s and early 1990’s. South Asian countries experienced power shortages
and frequent interruptions. The financial performance of utilities was undermined by
below cost pricing, electricity theft and large T&D losses. A large number of citizens—
especially in rural areas—lacked access to electricity supply, and the power sector was a
drain on the government’s budget (Harris, 2003). Consumers had to cope with shortages
and lack of access by self-provision or buying expensive inferior substitutes to network
access. The inability of public utilities to meet demand created black markets for
connections and the opportunity for employees and government officials to solicit bribes
to move customers to the head of the queue (S. C. Bhattacharyya, 2007c).
Section 1c: Global Developments and Roadmap
The global movement to reform electricity markets started in the late 1970’s and
early 1980s. This movement was influenced by the larger economic liberalization,
deregulation and privatization movement. In 1978, the United States passed legislation
requiring utilities to buy electricity from independent “qualified facilities.” Several years
8
later in 1982, Chile passed legislation enabling large end users to choose their supplier
and freely negotiate prices (IEA, 2001). In the years to follow, this reform movement
quickly spread to other parts of the world, with the phenomenon accelerating during the
1990’s. Reform proponents argued that the natural monopoly and economy of scale
considerations from vertical integration were no longer valid for the electricity sector,
and that the benefits of market reforms such as competition, private investment, and
private sector managerial expertise outweighed the additional transaction costs associated
with unbundled power systems. Technological advances supported the argument of
reformers (Steiner, 2001). In particular, advances in technology in electricity generation
in the form of combined heat and power plants and combined-cycle gas turbine
generation enabled electricity generation to be efficient at a smaller scale than before, and
diminished the importance of economies of scale. Moreover, advances in the computing
systems used to meter and dispatch power, reduced the transaction costs associated with
coordination between generation, transmission and distribution segments of the electricity
sector.
The generation and supply sub-sectors were now seen to be subject to increasing
marginal costs. It was expected that entities under dispersed ownership would facilitate
competition and that privatizing unbundled generators and suppliers would not only
introduce financial resources and management expertise but also lead to lower prices and
improvements in quality of services. As implemented in different countries, electricity
market reforms have included the following stages and elements, with only a few
countries having reached the most advanced stage of reforms (Vagliasindi & Besant-
Jones, 2013).
9
1) Vertical integration with Independent Power Producers (IPP). This stage
involves liberalization of generation to allow private IPPs to sell power to the
vertically integrated utility, usually through a Power Purchase Agreement (PPA).
These arrangements can be either reached through a negotiated memorandum of
understanding or through a competitive bidding approach. Although this kind of a
single buyer arrangement is easier to implement than other market structures, it
carries substantial risks for reform outcomes since the government retains control
over the utility. It can use this influence to (i) manipulate the terms of agreement
with IPPs; (ii) commission excess generating capacity and to choose costly
generation technologies; and (iii) impose tariffs that are not consistent with
financial viability of the utility (J. E. Besant-Jones, 2006).
2) Vertical and horizontal unbundling. This involves unbundling of the state
owned utility along the power supply chain (generation, transmission, and
distribution/retail) and/or into numerous entities (“horizontal” unbundling). In
some countries distribution and retail functions are combined in one entity while
in others they are undertaken by separate entities. Unbundling aims to take away
the state owned utility from the day to day control of the politicians and
bureaucrats in government, and transform it into independent legal business units
through corporatization and commercialization. The new corporate entities are
governed through an independent Board of Directors and expected to raise
financing for expansion of their supply capacity from capital markets without
recourse to government fiscal resources. The economic benefits from unbundling
a vertically integrated power utility rests on whether the gains from greater
10
efficiency can exceed the costs of arm’s length transactions among the separated
segments (Meyer, 2012).
3) Establishment of an independent regulator. This involves the establishment of
an independent regulatory agency to oversee the actions of the different players in
the power market, including issuing tariff orders, preventing anticompetitive
abuses of market power and ensuring appropriate investment in new supply
capacity. Independent regulators are expected to encourage private capital to
invest in capacity in the face of a potential “hold up” problem under conditions of
incomplete contracts and provide reassurance to investors that prices, outputs and
inputs will not be politically manipulated (Mâenard, Claude 2005 320). The role
of the independent regulator varies according to the specifics of the power market.
4) Privatization of the unbundled entities. This involves the privatization of the
unbundled entities to bring in the financial resources and technical and managerial
expertise of the private sector and to facilitate the emergence of competitive
power market. Private investment in power markets depends on the prospective
risks and returns of investments. These risks and returns depend not only on the
investors’ perspective of the specific terms attached to each investment proposal,
but also on the specific political, macroeconomic and regulatory environment of
the country. Electricity generators principally look for transparent pricing
mechanisms in the electricity market, viable purchasers of the output, and the
ability to manage uncertainty in market prices for their outputs. Electricity
distributors look for predictability of regulated electricity tariffs, pass through to
retail tariffs of cost elements beyond the distributor’s control, freedom to
11
disconnect nonpayers, and regulated open access to the transmission network
(Newbery, 2003).
5) Creation of a competitive electricity market. This involves the creation of a
competitive power market where consumers are able to purchase power from
multiple retail entities, which themselves have the option of procuring power from
multiple generation entities through a power market exchange. The transmission
segment is left as a monopoly entity, given its natural monopoly characteristics
but regulated by the independent regulator and required to facilitate the effective
operation of the power market. Bilateral trading and organized power exchanges
are the main market designs that have emerged for competitive trade in wholesale
power. In a gross power pool, generators have to sell all their electrical energy
into an organized exchange. In a net power pool most—typically over 90
percent—of the trade is conducted under bilateral arrangements, under which
generators sell power to power retailers (including distribution companies) that
sell power to end users, power marketers (traders that deal with other traders and
retailers), and large end users of electricity. In a competitive power market, a
combination of regulatory oversight and competition law is needed to provide
consumers with the protection from market power that conventional competition
law provides in markets for other products 3(IEA, 2001).
3 The 2001 electricity crisis of California demonstrates the possibility of abuse of market power by market participants – hence the role of regulatory oversight is very important for successful establishment of power markets.
12
Section 2: Evolution of Policy and Institutional Reforms
Against the backdrop of poor sector performance and the growing global
movement toward electricity market reforms, South Asian countries embarked on the
reform process in the early 1990’s. Their expectations from reforms were similar to those
in other parts of the world: (i) attracting private investment including foreign investment;
(ii) improving the financial and operational performance of the sector; (iii) reducing
dependence on state support; (iv) improving the quality of service and (v) increasing
access to electricity (S. C. Bhattacharyya, 2007c). While all countries and states in South
Asia have made some progress in reforming their power markets, the progress is uneven
and none has moved to the most advanced stages of reform. Figure 1.2 depicts the
timeline of electricity market reforms in the four countries.
13
Figure 1.2 - Timeline of Reforms in Bangladesh, India4, Nepal Sri Lanka and
Pakistan
Source: Compiled from utility and government websites by the author
4 In India, six urban distribution utilities– Tata Power Company (TPC), BSES, Calcutta Electricity Supply Company
(CESC), Surat Electric Company (SEC), Ahmedabad Electric Company (AEC) and NOIDA Power company– have
existed as private utilities since before the initiation of electricity market reforms. Since these utilities cover relatively
small share of India’s population and are not part of an electricity sector reform roadmap, they are not covered in this
study.
Introduction of
Independent Power
ProducersAll Indian States (1991), Nepal(1992), Pakistan(1994), Bangladesh (1996)Sri Lanka (1996)
Unbundling
of Utilities
Andhra Pradesh (2000), Assam(2004), Bangladesh(2004)
Chattisgarh (2009)
Delhi(2002), Gujarat(2005), Haryana(1998),
Himachal (2010) Karnataka(1999),
MP (2005) Maharashtra(2005),
Meghalaya (2010) Orissa(1996), Pakistan(1992), Punjab(2010), Rajasthan(2000), Tamil Nadu(2010),
UP (2000)
Uttaranchal (2004)
West Bengal(2007)
Pakistan (2001)
Establishment
of Independent
Regulatory Commission
Bangladesh(2004),
Pakistan(1998),
Sri Lanka (2009)
All Indian states (1996-2011)
Privatization
Delhi (2002)
Orissa (1996)
Competitive Power Market
Not completed in any of the states or countries
14
Section 2a: India
The 1948 Electricity Act and the 1956 Industrial Policy Resolution guided India’s
electricity sector prior to the 1990’s. They established electricity sector as a “concurrent”
subject, giving both India’s central government and the state governments a role in the
development of the sector. The Central Electricity Authority was established as an
advisory body on national power planning, policy making, and monitoring progress. The
state electricity boards were formed as vertically integrated utilities responsible for power
generation, transmission, and distribution and for setting tariffs in states. Prior to the
1960’s, dozens of private utilities were operating in urban areas all over the country. In
the early 1960’s, with the creation of state electricity boards (SEBs) through Electricity
Supply Act (ESA), 1948, all of these utilities except five were gradually taken over by
the SEBs and nationalized5 (Tongia, 2003).
However, by the late 1980’s, “electricity subsidies had burgeoned, perceptions of
corruption in the sector were rife, and the lack of investment in technology and
management of T&D systems had contributed to rising theft and waste in a destructive
downward spiral” (Kale, 2007a). In 1991, the power sector was incurring annual losses of
$0.85 billion— 0.7 percent of Gross Domestic Product (GDP) at the time—and had a cost
recovery rate of only 79 percent. The sector also had high technical and commercial
5 Five major distribution utilities – Tata Power Company (TPC), BSES, Calcutta Electricity Supply Company (CESC),
Surat Electric Company (SEC), and Ahmedabad Electric Company (AEC) - survived this acquisition and still operate
as private utilities. In 1993, distribution in the NOIDA area (adjacent to New Delhi) in Uttar Pradesh was privatized
and was handed over to the NOIDA Power Corporation.
15
inefficiencies, including T&D losses of 23 percent and a plant load factor of 54 percent.
Peak and energy deficits were 18.8 percent and 7.7 percent, respectively (Pargal, 2014).
The poor performance of the sector together with a balance of payment crisis in
1991 provided the impetus for India’s central government to pass a series of legislation to
support reforms in the electricity sector. In 1991, the legislation governing electricity
sector was amended to allow private sector participation in power generation through
IPPs. The Mega Power Policy followed in 1995 to encourage investment in projects
larger than 1,000 MW. As part of these reforms, the central government offered attractive
terms to investors, including a guaranteed 16% return on equity (after tax) as well as “fast
track” status to ensure rapid clearances and central government repayment guarantees. By
August 1995, Letters of Intent had been signed for 189 projects with 75,000 MW.
However, only small proportion of these projects ever came to fruition, reflecting the
high costs of many of these projects relative to state owned projects as well as opposition
from environmental and social groups (Tongia, 2003). Notable failures included the
Dabhol power plant in Maharashtra developed by Enron, which had to be abandoned
after a newly elected state government refused to honor its contractual commitments,
citing high costs of power and lack of transparency in awarding contracts by the previous
state government (Kale, 2007a).
In 1996, Orissa became the first state in India to vertically restructure and
privatize its electricity sector and create an independent regulatory agency for the
electricity sector. In 1998, the Electricity Regulatory Commissions Act was passed,
which provided a legal basis for regulatory commissions and allowed states that had not
16
already independently created legislation for regulatory authorities to establish their own
electricity regulatory commissions. The Act also created the Central Electricity
Regulatory Commission with jurisdiction over inter-state electricity trade. Subsequently,
a number of states, including Haryana, Karnataka, and Rajasthan unbundled their utilities
and established independent state electricity regulatory commissions. In 2002, Delhi
became the only state other than Orissa to privatize its distribution utilities.
These reforms culminated with the passage of a landmark EA 2003, which
consolidated the various reforms undertaken since 1991 into “a single, progressive,
market-oriented framework” (Pargal, 2014). EA 2003 mandated the creation of State
Electricity Regulatory Commissions, multiple licensing in the distribution sector, strict
measures to control theft, license-free entry to thermal generation, and non-
discriminatory access to the transmission system. It also promoted the gradual
introduction of open access in distribution.
In 2006, in line with the 2003 Electricity Act, the National Tariff Policy provided
guidelines to regulators for fixing tariffs for generation and T&D and made it mandatory
for distribution licensees to procure power from the private sector through competitive
bidding. Several other policy measures such as the National Electricity Policy in 2005,
the Integrated Energy Policy in 2006; and the Hydropower Policy in 2008 were also
adopted to elaborate on the provisions of EA 2003.
The implementation of national policies at the state level falls under the
jurisdiction of states and has been uneven, with some states achieving more progress than
others. As of 2013, IPPs are allowed in all states, and 28 regulatory commissions exist,
17
covering all states. Unbundling has been completed in 19 states, with the remaining ten
states having a single utility operating either as a corporation, power department, or State
Electricity Board.
Despite progress in implementing reforms over the last twenty years, the
distribution segment continues to post significant losses. Power sector after-tax losses,
excluding state government subsidies to the sector, were Rs618 billion ($14 billion) in
2011, equivalent to nearly 17 percent of India’s gross fiscal deficit and around 0.7 percent
of GDP (Pargal, 2014). Moreover, the poor financial condition of state owned
distribution utilities is compromising their ability to purchase power from private sector
generators, which in turn is serving to dampen private sector interest in the power sector.
Section 2b: Pakistan
Two public sector utilities, namely Water and Power Development Authority
(WAPDA) and Karachi Electric Supply Company have traditionally served Pakistan’s
power sector since its independence in 19486 (Figure 1.3). Pakistan experienced
widespread power shortage in the 1970s and 1980s as a result of rising demand and
lagging supply (S. C. Bhattacharyya, 2007c).
In 1992, Pakistan’s government approved a strategic plan for power sector
restructuring and initiated wide ranging reforms to increase investment, improve service,
6 Karachi Electric Supply Company, a vertically integrated utility, supplies power to Karachi, the financial and commercial capital of the country, and adjoining industrial areas of Sindh and Balochistan. WAPDA created through a 1958 act for the development and use of water and power on an integrated and multipurpose basis, was the national, vertically integrated power utility serving the entire country, except Karachi.
18
and strengthen the sector’s financial performance, with particular emphasis on attracting
private investors to help achieve these objectives. As part of these reforms, Pakistan
opened its power sector to IPPs in 1992, offering generous incentives for private
investment, including high tariffs for power, take or pay contracts, government guarantee
for payments and indexation and pass through of costs associated with exchange rate
volatility, inflation and fuel price variation (S. C. Bhattacharyya, 2007c). As a result of
these policies, about a half of Pakistan’s generation capacity is currently privately owned.
Figure 1.3 - Overview of Pakistan's Power Sector
In November 1998, the government initiated the restructuring of the vertically
integrated WAPDA, which supplies electricity to 85% of the country, and completed it
19
unbundling and corporatization of into fourteen companies (nine distribution, one
hydroelectric7, one transmission, and four thermal generation8). However, WAPDA
continued to maintain financial and operational control over the successor companies
through the Pakistan Electric Power Company, an agency established in 1998 and
entrusted with the task of managing WAPDA corporate restructuring. It was only in 2008
that four successor distribution companies were granted full financial autonomy. In
November 2005, 73 % of the shares of Karachi Electric Supply Company were sold to a
strategic investor while the government retained 26% ownership.
An independent regulator, the National Electric Power Regulatory Authority,
initially established in 1995, was operationalized in 2001 to regulate the power sector.
The National Electric Power Regulatory Authority is responsible for sector regulation,
including tariffs, licenses, and related responsibilities. National Electric Power
Regulatory Authority is expected to be autonomous in discharging its duties although its
tariff decisions have to be notified by the government in order to become legally binding
(World Bank, 2008b).
Pakistan’s electricity sector has been facing a large financial deficit, on account of
tariffs that are below cost recovery levels. The country has been experiencing prolonged
7 Five companies are in the province of Punjab: Islamabad Electric Supply Company (IESCO), Lahore Electric Supply Company (LESCO), Gujranwala Electric Power Company (GEPCO), Faisalabad Electric Supply Company (FESCO), and Multan Electric Power Company (MEPCO). The other three—Hyderabad Electric Supply Company (HESCO), Quetta Electric Supply Company (QESCO) and Peshawar Electric Supply Company (PESCO)—are in the provinces of Sindh, Baluchistan and Khyber Pakhtunkhwa respectively. 8 The four thermal power companies are: Jamshoro Power Generation Company Limited at Jamshoro, Central Power Generation Company Limited at Guddu, Northern Power Generation Company Limited with its head office at Muzaffargarh, and Lakhra Power Generation Company Limited at Khanote.
20
hours of load shedding, reflecting the massive shortfalls in meeting peak demand. On the
financial front, the government paid PKR349 billion in subsidies or 1.75 percent of GDP
in 2013. Pakistan power sector is suffering from an overhang of circular debt – a term
used to denote costs that are not being recovered from consumers or the government and
accumulate on the books of the public electricity distribution companies. The distribution
companies in turn fail to pay fully for electricity purchased from IPPs and other
generation companies, thus, spreading the shortfall throughout the supply chain (World
Bank, 2014).
Section 2c: Bangladesh
The Bangladesh Power Development Board (BPDB), which was bifurcated from
Pakistan’s WAPDA with Bangladesh’s independence in 1972, has historically enjoyed
monopoly status in the sector (Figure 1.4). In 1978, the rural areas in Bangladesh were
put under the purview of the Rural Electrification Board with the intention of providing
greater focus to rural electrification efforts (IAEA, 2013).
In response to the poor financial and operational performance of BPDB, the
Dhaka Electricity Supply Authority was formed in the 1980s to service the Dhaka
metropolitan area. Dhaka Electricity Supply Authority was created to bring
improvements in the quality of service, revenue collection as well as lessen the
administrative burden of the BPDB. This was followed by the formation of the Dhaka
Electric Supply Company out of Dhaka Electricity Supply Authority assets in 1998
(World Bank, 2008c). However, the sector continued to face shortfalls in investments
needed to meet the growing electricity demand in the country.
21
In 1992, the Industrial Policy was amended to allow entry of IPPs. Foreign
investment in the sector was allowed with the formulation of The Private Sector Power
Generation Policy in 1996. As a result of these policies, Bangladesh was able to attract
private investment for about 1290 MW of generation capacity or about a third of
Bangladesh’s total capacity (World Bank, 2008c).
Figure 1.4 – Overview of Bangladesh’s Power Sector
BPDB: BPDB DPDC: Dhaka Power Distribution Cooperation
DESCO: Dhaka Electric Supply Company WZPDC: Western Zone Power Distribution Company
REB: Rural Electrification Board PGCB: The Power Grid Company of Bangladesh
APSCL: Ashuganj Power Station Company Ltd EGCB: Electricity Gen. Company of Bangladesh
NWPGCL: North West Power Gen. Co. Ltd. WZPDCL: West Zone Power Distribution Co. Ltd.
To improve efficiency and accountability in the sector, the country’s National
Energy Policy formally adopted the principles of functional unbundling and independent
regulation in 1996. Functional unbundling of the vertically integrated utility, BPDB, was
22
initiated in 1996 but has progressed very slowly and is still ongoing (World Bank,
2008a). As part of reforms, the following companies have been created as subsidiaries of
BPDB:
• The Power Grid Company of Bangladesh (1996)
• Ashuganj Power Station Company Limited (1996)
• Electricity Generation Company of Bangladesh (1996)
• North West Power Generation Company Limited (2007)
• West Zone Power Distribution Company Limited (2005)
The unbundling of the Power Grid Company of Bangladesh from BPDB was
completed in 2003, and it began to oversee the transmission assets of BPDB and Dhaka
Electricity Supply Authority. The Power Grid Company of Bangladesh is a public limited
company, and is 76.25 % owned by BPDB; the remaining 23.75% is owned by the
general public. The West Zone Power Distribution Company Limited was unbundled
from BPDB in 2005 but efforts to unbundle the remaining distribution divisions in the
South, North West and Central zones have been proceeding slowly. The Dhaka Power
Distribution Company Limited was incorporated in 2005 and became operational in
2008..
The enabling legislation for the establishment of an independent regulatory
commission was passed in 2003 but the commission was only operationalized in 2005.
However, the Bangladesh Electricity Regulatory Commission is understaffed and under-
23
resourced, and has not been able to carry out all of its responsibilities (World Bank,
2013a).
Bangladesh is now in the midst of a serious power crisis, and is taking steps to
augment power generation capacity, among other steps. But the sector is financially
weak, access to capital is severely constrained, and prices do not cover costs. Generation
has failed to keep pace with demand; load shedding runs at a level of at least 500 MW
during peak periods of most days, and in heavy demand seasons has hit as high as around
1,000 MW.
Section 2d: Nepal
In the early stages of development of the electricity sector, Nepal’s Electricity
Department was in charge. Once the supply capacity began to grow, the Nepal Electricity
Corporation was established in 1962 under the Nepal Electricity Corporation Act. In
1974, the Eastern Electricity Corporation was established to manage the electricity
system in the Eastern Region of the country. The government found the arrangement of
having multiple bodies involved in operating the Nepal electricity system unsatisfactory
and, as a result, established the Nepal Electricity Authority (NEA) in 1984 as a state
owned vertically integrated utility by combining the Electricity Department, Nepal
Electricity Corporation and the Eastern Electricity Corporation (World Bank, 1984).
In 1991, Nepal elected a new government which inherited a situation in which
current public expenditures (including higher subsidies and large wage increases) had
increased significantly and the finances of many public enterprises, including the NEA
were extremely weak. In response, the government committed to an outward-oriented
24
growth strategy and a lead role for the private sector in a market-directed and competitive
economy (World Bank, 1992a). In the power sector, it committed reforms to move from a
state-centered bureaucratic approach towards commercialization of NEA and increasing
the role of the private sector in electricity generation. A new Hydropower Development
Policy and Electricity Act was adopted in 1992 to enable private sector development
(including 100% foreign capital investment) of hydropower through licensees (S. C.
Bhattacharyya, 2007c).
As part of its efforts to increase transparency in decision making in the electricity
sector, the government also set up the Electricity Tariff Fixation Committee (ETFC) in
1994 to make tariff adjustments based on economic and financial criteria, including
automatic adjustment to reflect changes in fuel costs, and ensure that tariffs were in
accord with financial principles. (World Bank, 1992b). By 1996, licenses had been
granted for 10 private sector projects with total installed capacity of 1300MW (Pradhan,
1996). However, only two of these projects was carried through to completion.
With the intention of attracting more investment from the private sector, further
changes were made to the legal and regulatory regime in early 2000’s. The Hydropower
Policy was revised in 2001 recognizing that an investment friendly, clear simple and
transparent policy is necessary to enhance the development process of hydropower. The
2001 policy also proposed the establishment of a new independent regulatory
commission (Government of Nepal, 2001). In line with this objective, a bill was prepared
to establish the Nepal Electricity Regulatory Commission, but this bill was never enacted.
25
These reforms did nothing to improve the size or number of investments in the
electricity sector, with the Maoist insurgency in the country having a dampening effect.
Between 2002 and 2006, only about 40MW of generation capacity was developed with
private sector investment while there was no major public investment in the electricity
sector by the government (NEA). The Draft Electricity Act 2006 focused on further
strengthening the legal and regulatory arrangement for investments in the electricity
sector. However, the bill has not yet been enacted (World Bank, 2011).
Nepal faces a huge shortfall in electricity supply. Kathmandu, the main
consumption center, has blackouts for 14 to18 hours a day during winter season and load
shedding almost every day year-round. A low tariff has left the NEA in a weak financial
situation. As a result, the utility is unable to carry out new investments in the electricity
sector while private sector investors have been reluctant to invest in Nepal (ADB, 2013).
Section 2e: Sri Lanka
The Sri Lankan government formed the Ceylon Electricity Board (CEB) in 1969
as a state owned vertically integrated utility to take charge of the power sector. Until
then, the responsibility for the electricity sector had been divided among a multiple local
and central government departments and the private sector. The government subsequently
established the Lanka Electricity Company in 1983 to distribute electricity in urban areas
as a joint undertaking of the CEB and the Urban Development Authority (Karunanayake,
2007).
26
With the aim of attracting more investment to the power sector, the government
opened up the sector to IPPs in 1996. Faced with CEB’s weak financial performance,
politicized nontransparent tariff processes, generation supply constraints, a transmission
system overloaded in several areas, and high system losses in the late 1990’s, the
government approved a sector restructuring plan in April 2001. The restructuring plan
required the unbundling of the CEB into a generation company, a transmission company,
and four distribution companies and the establishment of an independent regulatory
commission to improve sector governance, (ADB, 2010). Legislation to encourage these
reforms – the Sri Lanka Electricity Reforms Act in 2002 – was approved by the
parliament in 2002 and but never implemented due to opposition from CEB trade unions.
Subsequently, the Supreme Court found it unconstitutional in 2006.
The government initially planned to establish an independent electricity
regulatory agency but later decided to consolidate the regulatory functions of different
sectors – water, electricity, petroleum, ports – under one Public Utilities Commission of
Sri Lanka. The Public Utilities Commission of Sri Lanka was set up in 2003 but remained
inactive (S. C. Bhattacharyya, 2007c).
Electricity sector reforms received a fresh impetus with the enactment of Sri
Lanka Electricity Act in March 2009 that empowered the Public Utilities Commission of
Sri Lanka to regulate the electricity sector from April 2009. Under the provisions of the
Act, the Public Utilities Commission of Sri Lanka is reviewing CEB requests for tariff
increases, is addressing customer complaints, and has taken initiatives in safety
inspection. CEB has converted its generation, transmission, and distribution operations
27
into six functional business units—one for generation, one for transmission, and four for
distribution, although unbundling is no longer being considered (ADB, 2010).
Since the 1990’s, Sri Lanka electricity generation mix has shifted from relatively
inexpensive hydro to significantly more expensive, thermal power generation sources
such as oil. The latter now comprises 61% of the generation mix, up from 6% in 1995.
The vast majority of these investments have been undertaken by IPPs; private sector
generation now comprises a third of the total generation capacity. The growing reliance
on private oil-fired plants, the increase in oil prices, and the delayed construction of new
hydropower plants have significantly pushed up the cost of generation. There is an urgent
need to build base load generation capacity with low cost fuels, such as imported coal,
and to invest in hydropower and other renewable resources (ADB, 2010).
28
Chapter 2 - Theoretical Perspectives
The theoretical core of this dissertation is based on NIE and Theories of
Privatization. NIE highlights the importance of the institutional and regulatory decisions
in shaping economic outcomes. Theories of Privatization provide the rationale for greater
private sector participation. Theories of privatization were one of the main driving forces
behind the reforms in the electricity sector. NIE can be useful in understanding the
performance of reforms in the electricity sector.
The first section of this chapter provides an overview of the works of the major
figures in NIE such as Ronald Coase, Douglas North, Oliver Williamson, Avner Greif
and Avinash Dixit who have been instrumental in bringing NIE to the forefront of the
study of economic development. For a long time, neo-classical economics held complete
sway in academic and policy circle, and the study of institutions was consigned to the
margins. However, the growing evidence of the decisive role played by institutions in
determining economic outcomes along with increasing theoretical and empirical
development in these areas has resulted in NIE’s increased prominence9. NIE can be
particularly useful in studying the implementation of institutional and regulatory reforms
in the electricity sector since these reforms involve a complex interplay between different
levels of institutions, including transaction costs and contractual relationships. NIE
provides a major theoretical underpinning for this dissertation and is covered in the next
section.
9 Ronald Coase, Douglas North, Oliver Williamson, and Elinor Ostrom have all received the Nobel prize in economics over the last 20 years for their work in NIE.
29
The second section covers the theories of privatization such as property rights
theory, agency theory, public choice theory, contract theory, and the corporate
governance literature. Theories of privatization have arguably been the most influential of
economic theories since the Second World War. Under the influence of these theories,
governments have increasingly relied on the private sector, either partially or fully, to
carry out functions that have been traditionally carried out by the public sector.
Economists such as Milton Friedman and Friedrich A. Hayek were early flag bearers of
this movement (Savas, 2000). The movement was also adopted by the Bretton Woods
Institutions, the World Bank and International Monetary Fund, and spread around the
world as conditionality attached to loans. These ideas crept into the electricity sector in
the late 1970’s and were influential in shaping the reform model in the sector.
As we will see in this dissertation, many concepts from the NIE and privatization
literature are useful in understanding the issues connected to electricity market reforms in
developing countries. Hence it is important to review some of the important concepts
from them before going in depth into an analysis of electricity market reforms in South
Asia.
Section 1: New Institutional Economics
In neo-classical economics, institutions are treated as given and assumed to not
matter for economic performance (Mâenard & Shirley, 2005). In particular, neo-classical
economics is limited by its inability to model the influence of informal norms, habits,
customs, culture, and incentives on institutional outcomes (North, 1994). NIE departs
30
from neo-classical economics in considering that institutions matter for economic
performance.
Ronald Coase was the first major economist to point out that using markets entails
costs and this is the reason why many firms often give preference to hierarchical
mechanisms over markets. According to Coase, it made “little sense for economists to
discuss the process of exchange without specifying the institutional setting within which
the trading takes place, since this affects the incentives to produce and the costs of
transacting.” (Mâenard & Shirley, 2005) Coase’s “fundamental insight” has since been
taken further by other theorists in NIE.
NIE adapts neo-classical theory to make it more amenable to understanding the
development of institutions and their influence on economic outcomes. This is achieved
by dropping the complete rationality assumption of neo-classical theory and replacing it
with the more limited “bounded rationality” assumption. NIE assumes that institutions,
both formal (constitutions, laws, contracts and regulations) and informal (norms of
conduct, beliefs and habits of thought and behavior), are created to reduce risks and
transaction costs. NIE offers four main sets of insights on institutional and regulatory
reforms in the electricity sector.
Section 1a: Nature and Role of Institutions
The first insight is derived from the particular understanding of the nature and
role of institutions in NIE. In NIE, it is not just formal rules, laws and organizations that
form institutions but also informal codes of conduct, norms, habits, customs and beliefs.
In the words of Douglas North: “Institutions are the rules of the game—both formal rules,
31
informal norms and their enforcement characteristics. Together they define the way the
game is played. Organizations are the players. They are made up of groups of individuals
held together by some common objectives” (Mâenard, Claude 2005).
To North, “institutions form the incentive structure of the society” (North, 1994).
North states that the interaction of institutions and organizations shape the institutional
evolution of an economy and changes occur through a learning process. According to
North, informal habits, customs, culture, and incentives have a significant influence on
the way people react to formal rules, laws and regulations and on whether the desired
changes are achieved or not. Likewise, North argues that a unifying belief structure is
passed down inter-generationally and gets transformed into societal and economic
structures by institutions and that institutions as they evolve may not necessarily assume
forms supportive to economic growth.
Williamson sketches four levels of institutions (Figure 4). The first consists of
informal institutions, customs, traditions, norms and religion which are embedded in the
society and only change over the period of several decades. The second consists of the
formal rules of the game such as the constitution of a country, its administrative set up,
and other high laws, which can change over the period of years. The third comprises
governance structures for transactions such as the choice between vertically integrated
structures and markets (i.e. the “plays of the game”). The fourth level relates to the
domain of neo-classical economics or to resource allocation, prices, quantities and
incentive alignment (i.e. “rewards of the game”) (Williamson, 1998).
32
Figure 2.1 - Williamson's Four Level of Institutions
Level Frequency of change
Source: Adapted from O. Williamson (2000)
Greif departs from the “institutions as rules” framework in favor of an
endogenous “institutions as equilibria” approach. Greif sees institutions as a system of
rules, beliefs, norms, and organizations that together generate regularity of behavior.
According to Grief, these “manmade non-physical factors” are exogenous to each
individual whose behavior it influences, and individuals do not normally have the power
to change institutions on their own. Individuals are motivated to follow different
Level 1: Embeddedness
(Informal institutions, customs)
traditions, norms, religion
Level 2: Institutional Environment
(Formal rules of the game such as
constitutions, laws, property
rights, political institutions)
Level 3: Institutional
Arrangement (governance
structures, contracts, transaction
costs)
Level 4: Resource Allocation and
Employment
(prices and quantities, incentive
100 to 1000 years
10 to 100 years
1 to 10 years
Continuous
33
institutional elements because of either internalized beliefs regarding the implied
relationship between actions and outcomes or behavioral beliefs regarding what everyone
else will do. Since people are guided by what others are doing, social rules and norms and
not just rationality provide the cognitive models to individuals for their understanding of
the relationship between actions and outcomes. It is by learning other people’s responses
that people converge to an equilibrium regularity of behavior (Greif, 2006). Table 2-1
provides an illustration of how beliefs and internalized norms interact with formal
institutions to generate regulatory of behavior.
Table 2-1 - Regularity of Behavior in the Electricity Sector
Rules Organizations Beliefs And
internalized norms
Implied Regularity of
Behavior
Scenario 1:Rules on
electricity theft
Utility, Police, Courts Utility officials, police,
court officials all believe
it is acceptable to take
bribes; belief that paying
a bribe is least costly
way of advancing ones
interest
Widespread electricity
theft and corruption
Scenario 2:Rules on
electricity theft
Utility, Police, Courts Belief that law
enforcement agencies all
behave according to the
law and trying to pay
bribes is likely to results
in legal action
Little or no electricity
theft
In NIE, a combination of elements, including formal and informal institutions,
and beliefs about actions and outcomes are responsible for creating institutional
equilibrium. Institutional change occurs very slowly and infrequently and requires the
34
existing institutional equilibrium to be undermined by exogenous or endogenous factors.
But even when institutional change does happen, beliefs norms and organizations
inherited from the past continue to influence subsequent institutions by constituting the
default in new situations (Greif, 2006).
Reviewing electricity market reforms in South Asia from this perspective
suggests that mere changes to formal laws, rules and regulations in the electricity sector
is unlikely to bring desired changes in performance in the sector. Reforms that are similar
at a formal level may result in different outcomes depending on their interaction with
informal beliefs, customs, codes of conducts and traditions in the countries.
Reform efforts that are built on careful consideration of the existing institutional
equilibrium in the country and have assessed how the reforms would interact with them
in the short run and the long run are likely to have a greater probability of success than
reform efforts that simply transpose practices from more advanced countries. Reform
efforts are also likely to have better chance of success if they proactively identify and
implement steps to facilitate the transition to a new institutional equilibrium, including
(1) either compensating those who would lose from the change or overcoming their
resistance in the existing political process; (2) changing information and aligning
incentives; and (3) creating common knowledge of actions to sustain the new
equilibrium. All these steps present difficulties; therefore the process of institutional
reform is often slow, and old institutions may persist as a lock-in phenomenon (A. Dixit,
2009).
35
Section 1b: Transaction Costs
The second insight from NIE for electricity market reforms is from Williamson’s
work on transaction costs. Williamson identifies the critical dimensions for characterizing
transactions, describes the main governance structures of transactions, and indicates how
and why transactions can be matched with institutions using the “discriminating
alignment hypothesis”. Building on Coase’s insight that there are different ways of
organizing transactions and that these different forms of organizations have costs,
Williamson elaborates the sources of these costs. First, transaction costs arise from the
propensity of agents to behave opportunistically, which generates contractual hazards and
the need for costly safeguards. Second, costs arise because transactions develop in
environments plagued with uncertainties.
Williamson’s proposition is that complexity of transactions and hence the
transaction cost is determined by (i) uncertainty (U), (ii) frequency with which
transactions recur (F) and (iii) degree to which durable transaction-specific investments
are incurred (AS) (Williamson, 1979). The relation between transaction cost and these
three attributes of transactions is given by the following equation:
TC = f (AS (+), F (-), U (+))
All transactions are differentiated by the level of representation of these three
attributes, which makes them complex and contracts usually incomplete.
Williamson then outlines the attributes of the three different modes of governance
– markets, hybrids, and hierarchy – based on their: (1) incentive intensity, (2)
36
administrative controls, and (3) contract law regime. Markets are characterized by high-
powered incentives, hands-off control mechanism and decentralization, and legal and
court ordering. By contrast hierarchies are characterized by low-powered incentives,
hands on administrative involvement, and internal procedures. Hybrid forms of
organization lie somewhere in between these two extremes (Table 2.2).
Table 2-2 - Attributes of Leading Generic Modes of Governance
Williamson’s “discrete alignment principle” matches transactions with the
different modes of organizations; it holds that in competitive environment the
organizational form that best fits the transaction will be adopted. In particular,
transactions that are non-specific in nature with limited scope for ex-post contractual
opportunism will be undertaken on the spot market through market governance. But as
the asset specificity and the contractual hazards associated with transaction increases,
more complex governance forms with added security features, greater contractual
safeguards reduced incentive intensity, and added bureaucratic costs will be needed. If
transactions are exceedingly complex and costly, they will be removed from the market
37
and placed under unified ownership to effect coordination and decide disputes by fiat
(Williamson, 1991).
Williamson’s work suggests that electricity markets may not be suitable for
improving sector performance in all countries and circumstances. Countries that consider
the transaction costs of different governance mechanisms, including contract
implementation hazards are likely to fare better with electricity sector reforms than
countries that base their decisions solely on the expected efficiency gains of using
markets10. The introduction of markets is particularly likely to be challenging in cases
with significant investments in specific assets and subject to considerable market and
technological uncertainty. The state of California, for instance, rushed into electricity
deregulation in 1996 without proper consideration of potential investment and contractual
hazards and ended up facing an electricity sector crisis in the early 2000’s characterized
by electricity shortages and escalating electricity prices. Joskow, thus, notes: “Many
policy makers and fellow travelers have been surprised by how difficult it has been to
create wholesale electricity markets. ... Had policy makers viewed the restructuring
challenge using a Transaction Cost Economics framework, these potential problems are
more likely to have been identified and mechanisms adopted ex ante to fix them” (P.
Joskow & Kahn, 2001)
10Consideration of transaction costs in the design of electricity markets is particularly important because electricity is difficult to store in an economically feasible manner. The special characteristics of electricity mean that electricity supply and demand have to matched instantaneously and shortages in electricity generation or peaks in electricity demand results in unparalleled jumps, spikes and volatility in spot electricity prices.
38
Section 1c: Alternative Modes of Governance
The third insight from NIE for electricity market reforms is on the role of private
and informal governance arrangements in protecting property rights, enforcing contracts,
and taking collective action in developing countries.
In NIE, the issue of economic cooperation between two or many parties in a
society is often modeled as a prisoner’s dilemma game. It is recognized that if the
prisoner’s dilemma is to be resolved and market economies are to succeed, they need
strong and robust institutions of economic governance. In developed countries, such
governance is usually provided by government institutions and the legislative machinery
at relatively low cost and driven mainly by concern for social welfare. This includes
criminal law which serves to deter theft and economic fraud. However, in most
developing countries, particularly least developed countries, government institutions and
machinery are very costly, slow, and often corrupt.
NIE holds that in the absence of strong formal mechanisms of governance in
developing countries, developing countries can have alternative institutions to provide the
necessary economic governance and to achieve mutually beneficial outcomes. These
include relation based social norms and punishment for contract enforcement, self-
protection or hired professional protection for property rights, and networks of
information dissemination (A. Dixit, 2009). In fact, even businesses in developed
countries end up relying on such alternate modes of governance since resolution of
disputes using the formal state institutions can be more costly and can yield inferior
outcomes.
39
One of the most common forms of alternative governance seen in developing
countries is that of relation based self-enforcing governance through repeated interaction.
Such arrangements rely on multilateral group governance and are characterized by stable
community with many ongoing interactions, and good information flows about members’
behavior and credible threats about collective punishment (Greif, 2006). Relation based
arrangements are less costly for developing countries than formal rule based
arrangements 11(Shuhe Li 2003; Dixit 2004, chap. 3). The literature finds that efforts to
replace relation based arrangements with formal arrangements in developing countries
may at first lead to a worsening of outcomes.
Another alternative governance option is to obtain services from a private party.
This can include specialized arrangements such as credit rating agencies and arbitration.
Credit rating agencies are able to support economic governance by collecting and
disseminating the history of a person’s actions for a fee. Arbitration forums can specialize
and acquire expertise in very narrow areas of focus and customized procedures and rules
of evidence that suit their specific areas. In the absence of legal recognition, arbitration
can use repeated interactions in the group to ensure compliance with its verdicts;
arbitrators can disseminate information about a violator to other participants and count on
them to punish the violator (A. K. Dixit, 2007Ch. 2).
11The NIE literature holds that as countries develop, successful governance eventually requires a shift toward more formal methods of governance. A rule-based formal legal system requires substantial fixed costs to pass the laws and to establish the courts to adjudicate disputes, and a police force to enforce the court’s verdicts. But once the system is in place, people can deal with strangers in relative confidence, so the marginal costs of expansion are low. A relation based system has little or no fixed costs; one starts by dealing with close friends and neighbors. But as business expands, one must deal with strangers and must first establish relationships with them; therefore the marginal costs of expansion are high and rising. The low fixed cost, rising marginal cost system will have lower overall costs for small-scale transactions, and the high fixed cost, low marginal cost system will be better for larger scales.
40
Finally, economic governance can be provided by organized crime for a profit. A
self-enforcing equilibrium relationship can be achieved based on the fact that even
though participants may not interact with each other repeatedly, they have interactions
with the organized criminal entity who provides the governance. The organized crime
entity can provide both information and enforcement services. However, such governance
can trap participants into an undesirable equilibrium. The organized crime entity may
also engage in activities that create the threat with the intention of creating demand for its
protection services (A. K. Dixit, 2007, ch. 1).
Transposed to the electricity sector, this literature implies that developing
countries with relation based arrangements will often struggle to provide sufficient
confidence to international investors that they will be treated fairly in developing
countries. Investors will look to alternative governance arrangements such as
international tribunals or enter into arrangements with local partners before they operate
in the country. Domestic private players that have well established patronage and relation
based arrangements will benefit most from the economic opportunities offered by
electricity market reforms in developing countries.
Firms that come from economies with well-functioning formal governance are
likely to find it hard to negotiate the institutions and norms in many less-developed
countries and transition economies and are likely to make mistakes. One option for firms
from developed countries looking to invest in the electricity sector in developing
countries is to use local partners with established relation based networks in the country.
To make the arrangement work, the firm would need to build a relationship with a
41
partner, and then share the surplus from the transaction with the partner appropriately to
maintain an honest equilibrium. But this cost would still likely to be less costly than the
risk of losing the investment because the property right or the contract cannot be enforced
in the formal system (A. K. Dixit, 2007, p.20)
International firms also risk getting into situations where the either the domestic
private partner or the government, refuses to live up to pre-agreed contract conditions;
sometimes governments can even threaten a takeover of the assets. To prevent unfair
treatment of international private sector parties and to build trust, another option is to set
up international arbitration arrangements. While courts are required to act on information
that is both observable and verifiable, external arbitration through specialized
international private groups can be based on just observable information and also have
greater expertise than courts on the matter concerned (A. K. Dixit, 2007). They are also
less likely to be biased or come under undue political influence of the government. The
effectiveness of international arbitrations arrangements can be increased through the
backing of an international treaty or convention that would give it more credibility and
legitimacy.
Private investors in the electricity sector can also benefit from the establishment
of a “one stop” licensing agency that is empowered to issue all the licenses the
entrepreneur requires. While there are can be many benefits of this arrangement, one of
the main ones, according to Dixit, is that it can help reduce the uncertainty associated
corruption. Drawing on the works of others such as Andrei Shleifer and Robert Vishny,
Dixit argues that when there are many agencies involved in handing out licenses, each
agency demands bribes that are excessive from the point of view of their collective
42
revenues. It would be better for the government to have one agency, which would lower
the number of bribes and increase both the total bribe intake and the volume of the
private investments and therefore be better for general economic efficiency (A. Dixit,
2009). However, there is risk with this sort of arrangements that the weakness that
characterizes that formal institutional environment in developing countries would also
undermine this arrangement.
Section 1d: Regulation
The final insight from NIE for electricity market reforms relates to regulation.
Regulation generally includes regulatory governance (who does what under which laws,
rules, and procedures) and regulatory incentives (rules governing utility pricing,
subsidies, entry, inter-connections, etc.). Regulatory incentives perform well when
regulatory governance is successfully in place12. NIE is concerned mainly with regulatory
governance and the institutional determinants of regulatory governance.
Regulation is required in the electricity sector because of the features that
characterize electricity utilities: (i) large specific, sunk, investments; (ii) economies of
scale and scope; and (iii) widespread and massive consumption. This makes electricity
pricing political and motivates opportunistic behavior from governments to garner
political support. For instance, once the investments have been undertaken, the
government may not approve regular tariff increases or may make other operational
12 Regulatory governance corresponds to Level 3 of Williamson’s (2000) characterization of institutions while regulatory incentive corresponds to Level 4.
43
impositions. All these are attempts to expropriate the company’s sunk costs by
administrative measures.
NIE holds that the most compelling imperative for regulation, both public and
private, is to limit government opportunism of this kind. It holds that an institutional
environment that is capable of limiting government opportunism is crucial for successful
sector performance. Unless there are credible safeguards against such expropriation by
government the sector performance is likely to suffer and inefficiencies are likely to
emerge on multiple fronts including (i) underinvestment in areas where market returns
are low and payback periods are long; (ii) negligence of maintenance at the cost of
quality; (iii) investments in technologies that have lower degree of specificity even if this
compromises quality; and (iv) upfront high prices to quickly recuperate investment,
which may be politically unsustainable (Mâenard & Shirley, 2005, ch. 20)
Levy and Spiller emphasize that there are multiple regulatory regimes that are
capable of providing such safeguards but that these regimes have to be all “stable,
coherent, consistent across areas, and predictable.” They argue that regulatory credibility
can be developed in unpropitious environments and that without such commitment long
term investment will not take place. Furthermore, achieving such commitment may
require inflexible regulatory regimes and that in some cases public ownership of utilities
is the default mode of organization (Levy & Spiller, 1994).
According to Rodríguez and Jiménez (2005), the main governance elements of
regulation consist of clear roles and objectives, regulatory independence and
accountability, stakeholder participation, and transparency and predictability. These
44
enhance the legitimacy of the regulatory process, and strengthen the credibility and
reputation of the regulatory institution. A well-designed regulatory system ensures that
decisions on licenses and tariff are based on technical factors rather than political
interference and helps lower the cost of private capital.
In the electricity sector, establishment of an independent regulatory mechanism
has been one of the key elements of reform. Regulation by contract where regulatory
rules and procedures are incorporated into concession agreements has also been used as a
transition arrangement in developing countries (Bakovic, Tenenbaum, & Woolf, 2003).
Regulation has been deployed to provide private investors protection from expropriation,
control market power, facilitate competition, determine fair tariffs, ensure enforcement of
service standards, ensure efficient provision of services, and ensure free and fair access to
the transmission system.
The NIE literature suggests that regulatory regimes that are able to provide the
most confidence to private investors and that base decisions on technical factors rather
than political interference will have the greatest probability of success. However, as
discussed earlier, this is unlikely to just be a function of the formal arrangements that
have been put in place to regulate the sector and informal customs, habits and beliefs of
the main actors in the country is also likely to play an important role. It is probably for
this reason that regulatory agencies in many developing countries have found it difficult
to discharge their functions properly. Even in countries where legislation explicitly
provides the appropriate framework, government ministries and their power utilities
exercise undue control over regulatory agencies (J. Besant-Jones & Vagliasindi, 2012).
45
Section 2: Privatization
Since one the main objectives of electricity market reforms is to increase private
sector participation in the electricity sector, it is also instructive to review these reforms
in light of the theoretical arguments for privatization.
Theoretical arguments on privatization have not so far determined the superiority
of private ownership. The most compelling arguments for privatization are from property
rights theory, agency theory, public choice theory, contract theory, and the corporate
governance literature. On the opposing side are arguments that hold that the incentive
effects of private property rights depend on many institutional constraints that are
extremely weak in developing countries and that in fact competition is more important
than ownership in promoting efficiency (Z. Zhang, 2003). Overall, there are three main
sets of insights on electricity markets reforms from these theories.
Section 2a: Addressing Bureaucratic Inefficiencies
The first set of insights on electricity market reforms is derived from public
choice theory. Unlike traditional political science, public choice is a positive political
theory and is concerned with the actual behaviors of government officials. It sees
politicians and bureaucrats as rationally pursuing self-interest rather than the public good.
Wright defines it as a “theory which posits that people are egoistic, rational, utility
maximizers, a characterization which affects the state in that this behavior is exhibited
not only by voters, who seek to maximize their individual utility, but also by legislators
and bureaucrats, who seek the same end (1993)”. Public choice theory claims that it is not
possible to develop a social consensus from individual preferences. It thus holds that
46
public ownership cannot be justified on the grounds that it has been agreed by a society
and that the case privatization remains quite valid.
Niskanen sees bureaucrats as pursuing ever expanding budgets to get more power,
more opportunities for promotion, and higher prestige. All things that enter the
bureaucrats utility functions, “salary, perquisites of the office, public reputation, power,
patronage, output of the bureau, ease of making changes and ease of managing the
bureau…are positive monotonic function of the total budget of the Bureau during the
bureaucrat’s tenure in office” (Niskanen, 1971).
Downs also follows the model of bureaucrats as self-interested utility maximizers
but allows for a greater mix of motives including “power, income, prestige, security,
convenience, loyalty, pride in excellent work and desire to serve the public interest” and
classifies bureaucrats into (i)“climbers” who seek to maximize their power, income and
prestige; (ii) “conservers” who seek to maximize their own security and convenience; (iii)
“zealots” who are loyal to a relatively narrow policies; (iv) “advocates” that are loyal to a
broader set of policies or to a broader organization; and (v) “statesmen” that are loyal to
the nation or society as a whole (Downs & Rand Corporation, 1967).
The efforts of the public to hold bureaucrats accountable are compromised by
limited information and high costs monitoring their actions relative to personal benefit.
At the same time, politicians are more interested in getting bureaucrats to pursue socially
sub-optimal policies such as excessive employment than pursuing efficiency. This is
because “they care about votes of the people whose jobs are in danger” (Boycko,
Shleifer, & Vishny, 1996).
47
These factors make the public sector a fertile ground for rent seeking and often
corruption. Individuals and groups pursue efforts to further their own interests at the cost
of the public good while legislators attempt to get reelected through inefficient
distribution of goods and incomes and by distributing special favors to special interests to
get their financial backing in elections.
Public choice theory holds that privatization works because it limits this kind of
behavior by making self-serving behavior of politicians and bureaucrats more difficult or
costly. Public choice theory has been the most widely used rationale for privatization
attempts and has gained the greatest acceptance at the highest levels of policy
development.
Public choice theory provides a useful framework for viewing the performance of
vertically integrated public utilities in developing countries in their pre-reform stage.
Before reforms were initiated the 1990’s, the electricity sectors in most developing
countries had been under a lengthy period of state ownership and were plagued by
endemic corruption, rampant theft of power, below cost electricity tariffs, political
interference, and an inability by stakeholders to work towards long term solutions.
Governments sought to win political support by providing cheap electricity to consumers,
especially politically powerful groups such as large farmers. At the same time, many
utility employees were hand in glove with large industrial consumers and would under
bill them for electricity consumption in return for bribes. For instance, technical losses,
nonpayment of bills, and electricity tariff subsidies imposed a fiscal cost that averaged
7.5 percent of GDP to European and Central Asian countries in 1990’s (Estache &
48
Gassner, 2004). In this context, electricity market reform advocates used public choice
theory to make the case for greater private sector participation in the electricity sector.
Section 2b: Incentivizing Efficiency
Another set of insights on electricity market reforms is offered by property rights
theory, agency theory, and corporate governance literature, which argue that the profit
motive gives a stronger incentive for efficient use of inputs required to produce a given
output, than any incentives offered by an enterprise controlled and managed by a
bureaucracy.
Property rights theory focuses on the impact of ownership structures in a society
on incentives and economic behaviors. Traditional economics has historically ignored
property rights or taken it for granted. It was Coase who first pointed out that the
importance of property rights in determining economic outcomes in his seminal 1960
paper, “The Problem of Social Cost.” According to the Coase (1960) theorem, the initial
division of property rights does not matter for the allocation of resources when all rights
are freely transferable and the costs of transacting are zero. But in a world of positive
transaction costs, allocation of property rights has important consequences for economic
outcomes (Coase, 1960).
According to Libecap (Libecap, 1986), property rights exist as a continuum,
ranging “from open access conditions under public ownership at one extreme to specific,
exclusive property rights at the other extreme under private ownership”. The
transferability of property rights in private ownership brings about “(i) concentration of
rewards and costs more directly on each person responsible for them and (ii) comparative
49
advantage effects of specialized application of knowledge and risk bearing…..people will
concentrate their ownership in those areas in which they believe they have a comparative
advantage, if they want to increase their wealth” (Alchian, 1965). In this sense, the
competitor is the best supervisor of the use of resources a society can find. Hence private
property rights and competition promote allocative efficiency (Z. Zhang, 2003).
The diffuse ownership structure under public ownership by contrast leads to
inefficient economic outcomes since “individuals under open access conditions exploit
the resource too rapidly relative to interest rate and price projections. User costs are
ignored; short time horizons dominate, and long term investment is neglected…without
exclusive rights, exchange and reallocation of resources to higher-valued uses are
extremely difficult. Indeed, with the uncertain control associated with open access,
productive labor and capital resources must be diverted to predatory or defensive
activities and output falls” (Libecap, 1986).
Agency theory is concerned with agency problems between principals and agents
in both public and private organizations. Due to divergent interests and information
asymmetry between principals and agents, two agency problems arise: (i) adverse
selection and (ii) moral hazard. The former refers to inability of the principal to observe
the characteristics of its agents, and the latter refers to the inability to observe the actions
or the effort levels. An agent is supposed to take decisions on behalf of a principal but has
his own objectives which may lead him to act in his own as opposed to the principal’s
interests (Rees, 1988).
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To solve the agency problem, the principal must design mechanisms to get the
agent to reveal his true characteristics and make an effort to work towards the achieving
the principal’s interests (Grossman & Hart, 1983). Agency theory suggests that under
private ownership, agency problems can be more effectively alleviated through its more
efficient information and incentive structure. This suggestion, however, deemed to be
true only in very restrictive conditions13 (Z. Zhang, 2003).
Corporate governance is concerned with regulating discretionary behavior of
managers – so that they do not negatively impact the performance of the organization.
Corporate governance literature suggests that while there are multiple mechanisms –
capital markets, threat of take over, and bankruptcy – that can help restrain managerial
behavior in public joint-stock companies, the mechanism to control managerial behavior
in state owned enterprises – political control – is severely limited (Fama & Jensen, 1983;
Laffont and Tirole 1991; Shirley and Walsh 2000). The collective action problem in public
ownership produces sub-optimal level of monitoring of managers. Thus, “in the presence
of political interference and poor governance in the public sector, it is probable that SOEs
will perform poorly even in highly competitive markets - or worse, that they will seek to
cripple those markets” (Shirley & Walsh, 2001).
13 Sappington and Stiglitz’s article (1987) describes the ideal setting under which all of public provision can be conducted privately and efficiently – privatization is optimal. The ideal setting is as follows: the government auctions off the right to produce to private sector. Two or more risk-neutral private firms bid for the right and receive compensation from government for his output. The compensation is made exactly equal to the value of the output to the government. Through this ideal procedure, the government’s three objectives: efficiency, equity, and rents can always be met.
51
In the electricity sector, developing countries have used the full range of public
private partnerships arrangements such as management contracts where virtually no
investment risk is borne by the private sector through some investment risk under long
term concessions to accepting all investment risks under transfer of ownership to the
private sector. Complete transfer of ownership to the private sector remains relatively
rare in developing countries due to concerns that private sector would not produce
socially desirable levels of services. The evidence on the effectiveness of private sector
participation in the electricity sector so far has been mixed. Benefits that are attributed to
private sector participation by property rights theory, agency theory, and corporate
governance literature have only been seen when a wider set of reforms regulatory and
institutional reforms have been undertaken (Estache, Gomez-Lobo, & Leipziger, 2001).
Section 2c: Competition
The final insight for electricity market reforms concerns competition. In economic
theory, competition helps achieve both allocative and productive efficiency in the long
run. Competition forces prices to move towards marginal costs, thereby allocating
resources to their highest value. Meanwhile, competition also works as an incentive
system and discovery mechanism in a world of imperfect information by reducing
managerial slack and inefficiency. Hayek “considers competition systematically as a
procedure for discovering facts which, if the procedure did not exist, would remain
unknown or at least would not be used” (Snow, 2002).
It is widely argued that the benefits of privatization are most pronounced when
competition is strong. This is in contrast to public ownership, which may not improve
52
efficiency even when it exists with competition. SOEs in most cases receive government
support. They have stronger incentives to undertake anticompetitive practices such as
setting prices below marginal costs and erecting entry barriers. Since they often exist for
political reasons, they do not face the same pressure to exit as other firms. Their presence
is likely to deter new entrants. Hence, “instead of a competitive market improving SOE
performance, SOE may in fact hamper market performance” (Shirley & Walsh, 2001).
Real competition is likely to be hard to achieve with SOEs. Overall, ownership
characteristics of public enterprises will generally dominate competition (Shleifer &
Vishny, 1994).
However, the benefits of privatization outside a competition environment, for
example, in the area of natural monopoly, are not well established. It is generally seen
that, with a natural monopoly, benefits are likely to ensue with privatization only if steps
are taken to introduce some kind of competition. There are two ways to introduce
competition where a natural monopoly exists (Shirley & Walsh, 2001).
The first is to create competition through bidding for the right to operate as a
monopoly, namely franchising monopoly rights. This solution has the attractive property
of combining the efficiency gains from a single producer with incentives to price and
produce at nearly competitive levels. However, there are risks that the bidding may not be
competitive, either because of collusion, asymmetric information, or incumbent
advantages. The second is to use regulatory mechanisms to promote competition among
regulated firms. Under this approach, “the regulated prices for one firm would depend on
53
cost savings in other firms, thus producing a sort of ‘race to the top’ in terms of internal
efficiency” (Shirley & Walsh, 2001).
In the electricity sector, it is possible to develop competition more easily in the
generation and supply service segments than the network segments (transmission,
distribution, and system control) that are natural monopolies. The competition in the
generation and supply service segments is generally more in the form of a managed or
regulated competition than the ideal atomistic competition without regulation. In
developing countries pursuing electricity sector reforms, the contestable form of
competition is seldom sufficiently strong to force players to pass on their efficiency gains
by reducing their prices to consumers. Under weak competitive pressures, regulators are
responsible for pressuring suppliers to do so through “ incentive-based regulation that
allows investment to be adequately rewarded form unsubsidized revenues while
maintaining quality, and restructuring that permits effective competition for the network
services” (Newbery, 2003). There is hence a possibility that the social costs of private
ownership could exceed the benefits under weak competitive conditions. In the early
stages of reform, many developing countries have prioritized privatization over
competition since their main objective has been to attract private investment. They have
used a single buyer model with little or no restructuring to attract private investment into
power generation, since it removes most market risks for the investors. This suggests that
developing countries may make limited efficiency gains from private sector participation.
54
Chapter 3 - Literature Review
Electricity is a critical development need. Yet many developing countries are not
able to provide even basic electricity access to all households, let alone the electricity
needed by industries for economic growth. In many countries, electricity supply is
unreliable and expensive. Since the early 1990’s, South Asian countries have joined a
large number of developed, transition and developing countries in pursuing electricity
market reforms with the intention of drawing more private investment and improving the
performance of the sector. This has resulted in “a broad paradigm shift from state
ownership and centralized organization…to private ownership, public regulation and
market-oriented structures” (Jamasb, 2005)
A stocktaking of the existing research and literature in this area is helpful in
identifying the gaps and setting the agenda for further research. This chapter is divided
into three main sections (i) econometric studies; (ii) case and qualitative studies; and (iii)
gaps in literature and the contributions made by this dissertation. The literature review
covers research on electricity market reforms with a particular focus on the countries
covered in this dissertation. Selectivity has been maintained by focusing on studies that
are based on data collection and a rigorous analytical framework. The first two sections
are further divided by major issues in electricity market reforms in developing countries.
Appendix A presents the summary of the results of the econometric literature covered in
this chapter.
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Section 1: Econometric Studies
Econometric studies on electricity market reforms are broadly of two types. The
first type of studies focus on the determinants of reform while the second type examines
the effects of reforms on performance indicators. In general, there is significantly more
agreement among the first group of studies than there is among the second group of
studies.
Section 1a: Determinants of Reform
Studies examining the determinants of electricity market reforms indicate that
there is a high degree of correlation between the policy and institutional quality of a
country and the adoption of electricity sector reforms.
Bacon and Besant-Jones (2001) use cross-section data of 115 developing
countries to review privatization and liberalization of the power sector in developing
countries. Their study covers forces driving this movement and steps necessary to
achieve success. They find that the risk indicator - a weighted average of nine indices, of
which political risk and economic performance each account for 25% of the weighting -
is significantly correlated with the level of reform. Countries with lower risk indicators
have higher reform scores and vice versa. Likewise, they find a positive relationship
between the policy and institutional score (measured through a 20 indicator index) and
level of reform. In addition, the paper finds that countries in Latin America and
Caribbean are likely to have more reforms for a given policy and institutional score than
countries in Africa and Middle East.
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Ruffin (2003) uses cross-section Ordinary Least Squares regression analysis to
examine the institutional determinants of electricity reforms in 75 developed and
developing countries in the 1990s.The institutional determinants used are measures of
judicial independence, distributional conflict, and economic ideology. The study finds
that the relationship between judicial independence on the one hand, and competition and
ownership on the other, is ambiguous. The results also suggest that greater distributional
conflict is significantly correlated with a higher degree of monopoly. Finally, the paper
finds that the relationship between economic ideology favoring competition and private
ownership is positive and statistically significant.
Section 1b: Reforms and Performance
Studies undertaken to examine the relationship between reforms and performance
show a wider variation in results. Using a panel dataset of Organization for Economic
Cooperation and Development countries for the period 1986-1997, Steiner (2001)
assesses the impact of regulatory environment, the degree of vertical integration and the
degree of private ownership on efficiency and price in the generation segment of the
electricity sector. The paper finds that unbundling of generation and transmission and
private ownership has positive impact on efficiency – improving both the utilization of
capacity in electricity generation and reserve margins. The unbundling of generation and
transmission and introduction of electricity markets are observed to reduce both industrial
end-user electricity prices and the ratio of industrial to residential prices. However, a high
degree of private ownership is seen to increase industrial end-user prices, suggesting that
private ownership is not necessarily correlated with increased competition.
57
Hattori and Tsutsui (2004) reexamine the impact of the regulatory reforms on
price in the electricity sector, using the same model as Steiner but changing slightly the
definitions of regulatory reform indicators. They find that expanded retail access is likely
to lower the industrial price and increase the price differential between industrial
customers and household customers, as expected. They also find however that the
unbundling of generation and the introduction of a wholesale spot market can result in a
higher price. This finding is not consistent with theoretical expectations and differs from
Steiner (2000) but is plausible in the light of recent experiences in many countries. Citing
the difference in results with Steiner due to slight changes in definition of indicators, the
authors argue that the precise definition of the indicators is critical to this kind of empirical
work.
Zhang, Parker and Kirkpatrick (2005) study the effect of the sequencing of
privatization, competition and regulation reforms in electricity generation using data from
25 developing countries drawn from Latin America and the Caribbean, Africa and Asia
for the period 1985 to 2001. A fixed effects panel data model is used. The study finds that
establishing an independent regulatory authority and introducing competition before
privatization is correlated with higher electricity generation, higher generation capacity
and, in the case of the sequence of competition before privatization, improved capital
utilization. The results of Zhang, Parker and Kirkpatrick suggest that, if ownership
change is to significantly improve performance, privatization should be accompanied by
competition and independent regulation. The study rejects the hypothesis that
privatization per se leads to higher operating efficiency in terms of labor productivity.
58
Nagayama (2010) analyses panel data from 86 countries between 1985 and 2006
to identify the effects of different policy measures on performance indicators (installed
capacity per capita, T&D loss). He finds that reform variables such as the entry of IPPs,
unbundling of generation and transmission, establishment of regulatory agencies, and the
introduction of a wholesale spot market are positively associated with increased
generation capacity, as well as reduced T&D loss. Nagayama also finds that different
electric market reform measures have different impacts on geographically and
economically diverse countries14 and, that coupled with independent regulatory agencies,
reform policy becomes more powerful in realizing sector performances.
Vagliasindindi (2013) uses panel data from 22 developing countries over
1989 – 2009 with fixed and random effect models to examine the effectiveness of
different market structures in improving sector performance. The paper finds that full
vertical unbundling, introduction of an independent regulator, and privatization are
positively associated with enhanced electricity access, higher operational efficiency and
lower tariffs in countries with large system size and high GDP per capita but negatively
associated with these performance indicators in countries with small system size and low
GDP per capita.
Vagliasindi, thus, concludes that unbundling deliver results only when it is used
as an entry point to implement broader reforms, particularly introducing a sound
14 For instance, establishment of regulatory agency is seen to significantly positively relate to generation
capacity per capita in developed countries but significantly negatively related in Asian developing
countries.
59
regulatory framework, reducing the degree of concentration of the generation and
distribution segments of the market by attracting additional number of both public and
private players. She also suggests that there is a credible empirical basis for selecting a
threshold power system size and per capita income level below which unbundling of the
power supply chain is not expected to be worthwhile.
Cubbin and Stern (2006) assess whether a regulatory law and higher quality
regulatory governance are associated with superior outcomes in the electricity sector.
Their analysis using data for 28 developing economies from Latin America, Africa and
Asia over 1980–2001 uses fixed effect estimation methods. Regulatory governance is
measured using a four part index comprising of (i) whether the country has an electricity
or (energy) regulatory law; (ii) whether the country has an autonomous regulator; (iii)
whether the country’s electricity regulator is funded from license fees (or equivalent) or
out of the government budget; and (iv) whether the staff in the electricity regulator can be
paid as appropriate given skill needs and labor markets or whether staff have to be paid
on civil service pay scales.
Controlling for privatization and competition and allowing for country specific
fixed effects, both regulatory law and higher quality regulatory governance are found to
be positively and significantly associated with higher per capita generation capacity. This
positive impact increases for more than 10 years, as experience develops and regulatory
reputation grows. The results are robust to estimating alternative dynamic specifications
(including error correction models), to inclusion of economy governance political risk
indicators.
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Andres et al (2006) analyze the impact of privatization on the performance of 116
distribution electric utilities in 10 Latin American countries using a panel dataset. The
authors apply two different methodologies. The first methodology uses means and
medians from each period and tests the significance of the changes between periods. The
second methodology consists of an econometric model that captures firm fixed effects,
firm-specific time trends, and heteroscedasticity corrections. The results suggest that
changes in ownership generate significant improvements in labor productivity, efficiency,
and product and service quality, and that most of those changes occur in the transition
period. Improvements in the post transition period - beyond two years after the change in
ownership - are much more modest.
Erdogdu (2011) examines the impact of reforms such as introduction of private
sector participation, unbundling, independent regulation and wholesale electricity market
on residential and industrial electricity price-cost margins and their effect on cross
subsidy levels between consumer groups. The paper uses panel data for 63 developed and
developing countries covering the period 1982–2009 and fixed and random effect
models. The research findings suggest that there is no uniform pattern for the impact of
reform process as a whole on price-cost margins and cross subsidy levels. Each
individual reform step has a differential impact on price-cost margins and cross subsidy
levels for each consumer and country group.
Erdogdu thus concludes that transferring the formal and economic structure of a
successful electricity market in a developed country to developing countries is not a
sufficient condition for good economic performance of the electricity sector in
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developing countries. Furthermore, the study suggests that electricity consumption,
income level and country specific features constitute other important determinants of
electricity price-cost margins and cross subsidy levels.
Gao (2011) studies whether the 2002 deregulation and vertical unbundling of the
Chinese electricity sector has boosted productivity in the generation segment of the
sector. Controlling explicitly for sources of price-heterogeneity across firms and for firm
fixed effects, the paper finds deregulation to be associated with a reduction in labor input
and material use of 6 and 4 percent, respectively. This effect only appears two years after
the reforms, is robust to alternative ways of identifying restructured firms, and to the
nonrandom selection of restructured firms using a matching estimator. Input use of new
state owned firms that start operations two years into the reform period does not differ
significantly from input use of private sector entrants.
Du et al. (2009) also estimate the impact of regulatory reforms in the electricity
sector in China, including unbundling, on production efficiency of fossil-fired generation
plants using the plant-level national survey data collected in 1995 and 2004. Applying the
difference-in-differences method, the authors estimate the effects of these reforms on the
demand for inputs of employees, fuel and nonfuel materials. The results show that the net
efficiency improvement in labor input associated with the regulatory reforms is roughly
29% and the gains in nonfuel materials are about 35%, while there is no evidence of
efficiency gains in fuel input associated with the electricity reforms.
Gassner et al. (2007) analyze a panel of 302 utilities with private sector
participation and 928 utilities without private sector participation in 71 developing and
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transition countries in order to evaluate the impact of private sector participation on firm
performance in electricity distribution and water and sanitation services. The paper
compares the change over time in a number of output variables for both groups of utilities
and isolates the effect of private sector participation from time trends and firm-specific
characteristics by using a series of econometric tools.
The paper finds robust evidence in the global sample that private sector
participation has a strong impact on the efficiency of utility operations; at the same time,
the evidence suggests a decrease in employment due to private sector participation.
Private sector participation is associated with output increases, an improvement in bill
collection ratios and improvements in the quality of service in the electricity sector, the
latter expressed as a reduction in distributional losses. The performance improvements
are most evident when assets were divested to the private party. However, there is no
conclusive evidence for a change in prices as a result of private sector participation.
There is also no evidence for an increase in investment following private sector
participation for any contract type except divestures in electricity, suggesting that
infrastructure maintenance and development may suffer as result of private sector
participation.
Kundu et al.(2011) use survey data and a linear regression model to examine the
impact of privatization of distribution utilities in Orissa, which was the first Indian state
to privatize a distribution utility. Based on the analysis of the data of the four distribution
companies in Orissa, the paper finds that the quality and reliability (Kundu & Mishra,
2011) of power has improved since the reforms, and generally, domestic consumers from
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all sectors have benefited. However, agricultural customers have been adversely affected
by higher prices and availability due to the reduction in cross-subsidies by the
government and reluctance of private distribution companies to sell to agricultural
customers.
Chattopadhyay (2004) examines the usefulness of cross-subsidies between
industrial and residential tariffs in the Indian state of Uttar Pradesh over 1997-2000. This
paper uses electricity demand data from a small distribution utility, Noida Power
Company Limited in the Indian state of Uttar Pradesh, to estimate the price elasticity of
demand for several high-voltage large industrial customers over 1997–2003 using linear
Ordinary Least Squares estimations. For a given price/cost ratio, the paper shows that if
the cross-subsidizing class’ electricity demand is sufficiently elastic, increasing the class’
rates fails to recover incremental cross subsidy necessary to support additional revenues
for subsidized classes. Based on the evidence from Noida Power Company Limited, the
paper argues that high cross subsidy charge on industrial tariff is inefficient and needs to
be reduced. The paper argues that it is imperative that electricity prices be reduced in the
industrial sector as soon as possible to allow for a more prudent policy on cross-
subsidizing agricultural and domestic consumers.
Chattopadhyay (2007) carries out follow up analysis on this topic by looking at
longer time frame (1997-2003) and reviewing the impact of reforms to reduce cross-
subsidies between industrial and residential tariffs. The paper also makes use of Box-Cox
estimations in addition to linear Ordinary Least Squares estimations. Using results from
both the methods, the paper finds evidence that the cross subsidy regime was sub-optimal
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prior to October 2001 but finds that tariff reforms implemented by Uttar Pradesh
Electricity Regulatory Commission in 2007 have helped reduce sub-optimal cross-
subsidies.
Jamir (2013) uses data from 1985-2010 to examine the relationship between
electricity shortfalls, tariff rate and electricity theft in the context of the ongoing power
crisis in Pakistan. This study employs the Granger causality test through error correction
model and out-of-sample causality through variance decomposition method to show that
electricity theft greatly influences electricity shortfalls through lower investment and
inefficient use of electricity. The study concludes that electricity crisis in Pakistan cannot
be handled without combating rampant electricity theft in the distribution of electricity.
Thakur et al. (2009) compare the efficiencies of generation, distribution and
transmission utilities in India using Data Envelopment Analysis. This includes utilities
that have been unbundled and restructured as well as utilities that are still vertically
integrated. The results indicate that the performance of state owned utilities is sub-
optimal, with potential for significant cost reductions. The authors derive separate
benchmarks for possible reductions in employees’ number, and the results indicate that
several vertically integrated utilities deploy a much larger number of employees than
required by a best practice utility, and significant savings are possible on this account.
The paper also finds that the bigger utilities display greater inefficiencies and have
distinct scale inefficiencies. The paper argues that restructuring and unbundling of
utilities may help improve efficiency.
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Section 2: Case Studies
Case studies on electricity market reforms help improve understanding of the
complex, multidimensional and often country specific implementation issues that impact
the performance of electricity market reforms in developing countries. The vast majority
of single or multi-country case studies on electricity market reforms assess the reform
steps and processes in individual countries and attempt to link them to the subsequent
performance of the sector.
The key messages emerging from case studies on electricity market reforms
include (i) the outcomes of electricity market reforms are often but not always positive;
(ii) institutional preconditions need to be met for reforms to be successful; (ii) contracts
with the private sector must be structured carefully for reforms to be successful (iii)
reforms have to be adapted to the local context to be successful; (iv) the quality of
implementation is very important; (v) the political economy of electricity market reforms
is very challenging; (vi) the next phase of electricity market reforms must focus on
improvements in distribution; and (vii) country specific bottlenecks need to be addressed.
Section 2a: Performance of Reforms
In general, case studies find that electricity market reforms are contributing to
improvements in performance. Reform experiences vary by country and area of reform.
Some case studies find that the outcomes of reforms have fallen short relative to
expectations and potential.
Newbery and Pollitt (1997) estimate the costs and benefits of restructuring the
state owned Central Electricity Generation Board, the enterprise in charge of electricity
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transmission and generation in England and Wales that was privatized in 1990. The study
uses data for 1990-1996 and compares the post privatization performance of the Central
Electricity Generation Board relative to a counterfactual scenario without restructuring. It
finds that there has been considerable improvement in labor productivity in the post-
restructuring period and that most of the efficiency gains came from nonfuel costs.
Pandey et al. (2009) review various phases of electricity sector reforms in India,
including roles of government authorities in reform, constraints to reform and the role of
regulators. They find that reforms have so far yielded mixed results. On the positive side
(i) technical and operational performance of the sector has improved; (ii) several states
have been able to reduce distribution losses and improve collection efficiency; and (iii)
private sector investments in distribution have been successfully introduced in states such
Delhi. On the negative side, (i) capacity additions in the sector have been inadequate; (ii)
energy shortages including peak level shortages continue; (iii) distribution losses remain
very high; (iv) financial performance of distribution entities remains weak; and (v)
regulators do not have adequate financial and human resources to perform their roles
effectively.
Power Finance Corporation (Power Finance Corporation, 2007) reviews the
financial performance of 90 utilities in India. The report indicates high level of
cumulative losses for the vast majority of the distribution utilities, driven mainly by large
aggregate technical and commercial losses. For instance, cash losses for all utilities
increased from Rs65 billion in 2007 to Rs284 billion in 2009. The average aggregate
technical and commercial losses for utilities decreased from 29.6 percent in the year 2008
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to 28.4 percent in 2008-09 but still remained very high. The average cost of supply (input
energy basis) increased from Rs2.9/kwh in the year 2008 to Rs3.4/kwh in 2009. The
period covered in this report does not allow for a comparison of pre-reform and post
reform performance but it is still possible to see that despite reforms, a consistent
improvement in performance is not being achieved in India.
Shukla et al. (2011) analyze competition and market power in the wholesale
electricity market in India in the context of the adoption of EA 2003 and other reforms to
promote competition. The concentration ratio, Herfindahl– Hirschman Index, Supply
Margin Assessment, and Residual Supply Index are used to measure market power. This
paper also uses the price–cost mark-up to examine if market power led to higher margins.
The analysis finds that market power of firms may be part of the reason for the
increase in electricity prices in the wholesale market. The study recommends various
measures to increase competition in the wholesale electricity market including 1)
divesture of generating facilities, 2) increasing transmission capacity, 3) price ceilings,
and 4) reduction in the demand-supply gap by swiftly adding new generation capacities,
improving efficiency, reducing losses and demand side management.
Shrestha et al. (2004) analyze the impacts of private sector participation in
electricity generation and tariff reforms in Thailand and Bangladesh. The reforms in
Bangladesh and Thailand used a similar approach. However, their achievements were
very different. In Thailand, the rural electrification rate increased from 7% in early 1970s
to 97% of rural households by 2000, while, in Bangladesh only 19% of households were
electrified by 2000. The authors identify three reasons for the poor performance of
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reforms in Bangladesh: (i) inadequate generation capacity; (ii) weak financial situation of
Bangladesh’s power sector institutions, which impacted their ability to undertake
investments; and (iii) relatively weak economic growth, which hampered the purchasing
power of residential as well as industrial customers.
Galal, Jones, Tandon, and Vogelsang (1994) in one of the first and most
comprehensive studies of reform, analyze the welfare implications of privatization of
state owned electricity utilities in Chile. The study is among the first to emphasize that
privatization of natural monopolies, when combined with proper regulatory framework,
can be welfare enhancing. The study finds that privatization of the two Chilean utilities
produced significant new welfare improvements.
Delfino and Casarin (2001) examine the welfare impacts of the privatization of
electricity utilities in Argentina in the Gran Buenos Aires area, using a family
expenditure survey of about 5,000 households. Between the time of privatization in 1993
and the end of 1999, expenditure on electricity in real terms for a representative small
consumer increased by about 20%, while an average large user enjoyed a tariff reduction
of about 23%. The paper shows that nearly all income groups among the existing
customers increased their consumer welfare after privatization, with the exception of the
lowest income group. The results indicate that higher income groups have, in absolute
terms, benefited more than low income groups, although in percentage terms, the benefits
are similar.
Toba (2007) studies the welfare impacts of the introduction of private sector
participation in generation in Philippines’ electricity sector during the electricity crisis of
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1990–1993. This study uses a social cost and benefit analysis. The study finds that the
main benefits came from IPPs, who contributed to resolving the crisis, and promoted
economic and social development. Consumers and investors were net gainers, while the
government lost and there was an air pollution cost. The paper concludes that, overall,
private sector participation in the electricity sector increased social welfare.
Sharma et al (2005) review the performance of Indian power sector over 1991-
2001 by critically assessing performance indicators of different states and make
suggestion for future reforms in the sector. Their analysis shows that reforms have been
unsuccessful in improving technical efficiency, T&D losses, and financial position of the
power sector. The social objectives also have not been achieved. According to the
authors, implementing an integrated approach with redefined methodologies and
objectives can provide positive results. Going forward, they advise the pursuit of reforms
in small incremental steps and question the effectiveness of unbundling and privatization
in all conditions.
Section 2b: Reform Preconditions
When reforms have not gone well or at least not as well as expected, studies have
pointed to the lack of institutional preconditions as one of the main reasons for the lack of
success. Studies identify political leadership, commitment to reforms, strong regulatory
governance, broad public engagement and participation in the design of reforms as the
main preconditions for success.
Indian Institute of Public Administration (2006) carries out a comprehensive
assessment of implementation of reforms in 10 states of India using data analysis,
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interviews and case studies. The report finds that electricity utilities are making
improvements in their financial performance and customer service. The report argues that
restructuring of utilities, including unbundling is a necessary but not a sufficient
condition for turnaround of the electricity sector. The report identifies the following
measures as being necessary for successful reforms: (i) taking employees into confidence
and enlisting their support; (ii) strengthening electricity regulatory agencies; and (iii)
strong and sustained political support.
Bhattacharya (2007a) argues that despite the enactment of a comprehensive legal
framework for the electricity sector, political instability and opportunistic behavior of
political parties in India have reduced the acceptability of reforms. Reforms have not
been successful in rationalizing tariffs or balancing supply and demand and are thus not
likely to produce desired outcomes in India. The study identifies the following
preconditions for successful and sustainable reforms: 1) a climate of political stability and
widespread support; 2) early demonstrable success in creating a strong beneficiary base
and a role model; 3) proper management of risks and expectations; and 4) locally
acceptable solutions as opposed to globally optimal solutions.
In the context of the current ongoing electricity crisis in Pakistan, Kessides (2013)
finds fault with the regulatory environment in Pakistan and suggests that the severe
electricity crisis is the cumulative result of imprudent and reckless energy policies of the
last three decades. These policies have resulted in inefficient fuel choice for electricity
generation, compromising energy and economic security. The full implementation of the
standard reform model – independent regulation, unbundling, and introduction of
71
wholesale market and competition – has several institutional prerequisites that are not
present in Pakistan.
As a result, reforms in Pakistan have stalled with the introduction of IPPs. IPPs
have been an important source of new investment in Pakistan and have helped install
substantial electricity generation capacity. IPPs have generally exhibited superior
technical performance relative to state owned utilities. However, the author argues that
the sector’s performance can be significantly improved if there is stronger political
commitment and effective regulatory governance. According to the authors, Pakistan’s
experience highlights the detrimental consequences of the lack of credible regulatory and
political commitment for the viability of IPP investments.
Nakhooda et al. 2007) argue that while the “standard model” for electricity reform
built around private ownership and competition has left its mark on the electricity sector,
fundamental questions of public interests and sustainable development have not been
adequately addressed. The analysis in the report is based on assessments of electricity
governance in India, Indonesia, Thailand, and the Philippines that were completed in
2005 using World Resource Institute’s Electricity Governance Initiative Indicator Toolkit
as a common research methodology.
The Electricity Governance Initiative indicators address transparency, public
participation, accountability, and the capacity of various actors in policy and regulatory
processes as they relate to electricity, with an emphasis on environmental and social
considerations. The assessments suggest the following major emerging trends in
electricity policy and regulation, and specific areas for consideration, caution, and
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improvement in electricity governance: (i) very little information about the basis for new
policy initiatives is shared with the public; ( ii) opportunities for public participation in
policy processes remain quite limited; (iii) the integrity and capabilities of executive
agencies need to be improved; (iv) planning processes can help mainstream
environmental and social considerations; and (v) public interests such as environmental
sustainability and social equity are seldom included in the mandates of electricity
regulators. In this context, the report argues that the performance of reforms can be
improved through greater attention to the governance of the electricity sector, including
the processes, institutions, and actors that determine how decisions are made.
Tongia (2003) reviews the interplay between legal, political, and institutional factors
that have shaped the electricity market reforms in India. The paper finds that there has been a
large variation in the performance of the states and it is not possible to attribute all of the
variation to reforms. For example, the state of Tamil Nadu implemented few structural
reforms to its State Electricity Board, yet has been successful in bringing down tariffs while
also reducing financial losses. According to the author, the main factor in explaining
outcomes is the ability of the state governments to implement operational improvement plans
and the strength of their institutions. Governments with weak institutions such as the state of
Orissa have performed poorly even when they have had ambitious reform plans.
Governments with strong institutions and sustained commitment to reform (e.g., Andhra
Pradesh and Delhi) on the other hand have fared much better.
Section 2c: Contracts
Studies find that well-structured and balanced contracts are central to the success
of private sector participation in the electricity sector. Early efforts to introduce private
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sector participation in developing countries through IPPs were compromised by the lack
of experience of governments in structuring contracts as well as lack of transparency in
the process used to finalize the contracts. As a result, electricity produced through the
first round of IPP contracts in developing countries was generally more expensive than
the electricity from state owned utilities. While some countries have found it difficult to
restart the momentum after the initial disappointments, others have learned from their
initial experiences to significantly restructure their terms of engagement with IPPs,
including through better distribution of risks and use of competitive bidding to procure
electricity. There is recognition now that for reforms to be successful, contracts must not
only be fair and transparent but also be perceived as being such by stakeholders.
Fraser (2005) reviews Pakistan’s IPP experience in the early 1990’s to find that
the country erred in not focusing sufficient attention on the transparency and fairness of
contracts negotiated with the private sector. Under its 1994 Private Power Policy, 19 IPPs
reached financial closure for an additional 3400 MW of electricity generation capacity,
leading to Pakistan being cited as a model for private sector development in the power
sector in the mid-1990’s. However, by 1998 the new government had issued notices of
intent to terminate 11 IPPs, representing two thirds of private power capacity contracted,
on alleged corruption and/or technical grounds.
In defense of Pakistan’s government, there was a perception that the contracts
with IPPs were unfair and extremely favorable to the private investors. Project sponsors
on the other hand complained of excessive coercion, harassment and heavy-handed legal
and other actions initiated by the government to renegotiate tariffs or cancel contracts.
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This episode contributed to Pakistan’s fall from grace in the eyes of the international
investor community. Fraser notes the following lessons from the review of Pakistan’s
IPP experience: (i) power procured through IPPs should be cost competitive with other
sources of power; (ii) solicitation of IPPs should be on a competitive basis and staggered
over a few years so that changes in international investors’ assessment of country and
contract risks can lead to declining bid prices; (iii) it is important that a transparent
bidding process is followed so that IPPs can be more politically sustainable; and (iv)
parties have to recognize that renegotiation of contracts is reasonable provided it is done
in a mutually acceptable manner.
Eberhard and Gratwick (2005) review the IPP experience in Egypt and find that
while the country’s three IPP projects have had reasonably successful outcomes, both the
government and private sector investors are unwilling to move forward with additional
projects. The Egyptian government used a series of series of competitive, international
bids, which involved four distinct phases, for its IPP projects. The contract stipulated
project financing, rather than balance sheet financing. Fuel cost (i.e. natural gas as the
main fuel and fuel oil as the back-up), based on a formula stated in the PPA, was to be
passed through to the utility. All payments to the IPPs by the utility were to be made in
US dollars and would be backed by an Egyptian Central Bank Guarantee (CBG).
The Egyptian government was able to sign PPAs at extremely competitive rates
but the devaluation of the Egyptian pound by more than 50% in the early 2000’s
significantly increased the financial burden of the IPPs to the government. While power
is still competitively priced by international standards (largely due to cheap state-supplied
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gas), the government has once again charged the state-owned power utility with
developing generation capacity, supported by development finance institutions. While the
original deals have held and the three gas-fired IPP plants continue to provide reliable
and affordable electricity, neither the original sponsors, nor the government, are keen to
develop further IPP projects.
Woodhouse (2005) reviews the IPP experience in the Philippines and finds that
the country has learned from its experience and has gotten better at negotiating contracts
with private sector over the years. Consistent with other many developing country
experiences, the Philippines initially moved to IPPs as a response to a crisis—in this case,
the large power shortages of the late 1980s and 1990s. However, this move became the
foundation for a sustained and energetic push towards a competitive wholesale energy
market. During this time the legal regime and context within which IPPs were negotiated
shifted several times as the leverage and sophistication of the local authorities improved.
Terms for the contracts became more competitive over time, and there was a decreasing
reliance on sovereign guarantees to underwrite projects.
The IPPs have been a lightning rod for criticism of government policy, with
claims of corruption, overpricing, and expensive energy. However, successive
governments continued to honor the basic offtake obligations in the IPP contracts until a
2001 electric industry reform law mandated an inter-agency review of the IPP contracts.
This review process led to a widely publicized renegotiation effort in the IPP sector.
Although this series of renegotiations generated substantial savings for the Philippine
government, the actual modifications to the contracts were minimal – in only a few cases
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did the changes require lender approval. Woodhouse observes that foreign investors in
Philippines seemed relatively more willing to rely on sophisticated contractual safeguards
that depended on ex post enforcement than in other South-East Asian countries such as
Malaysia or Indonesia.
Eberhard and Gratwick (2005) examine Kenya’s experience with private
participation in the electricity sector, focusing on four generation IPPs. They find that the
government’s ability to negotiate with the private sector improved between the first and
the second round of IPPs. Initial IPPs contracted by the government were three times
more expensive than electricity from plants owned by the national utility, KenGen. These
high prices were attributed to the fact that plants were procured during a drought, under
severe time pressures, with a truncated tender process and with extremely short seven
year PPAs. In the second wave of IPPs, projects were tendered under international
competitive bid standards. The result was significantly cheaper power than the first wave,
with wholesale tariffs competitive with KenGen’s.
Rector (2005) reviews the IPP experience of Malaysia. Malaysia IPP program is
unique in the East Asia region for its reliance on domestic investors, financing and fuel,
which provided a high level of stability to the program. These features made Malaysia’s
IPP program less vulnerable to the Asian financial crisis than that of its neighbors.
However, Malaysia was not completely immune to the harmful impacts of the crisis.
Malaysia’s partially privatized but state controlled off-taker, Tenaga, had high levels of
foreign currency debt for which repayment obligations became enormously burdensome
as a result of the currency devaluation that Malaysia experienced during the crisis.
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Additionally, the Asian financial crisis led to a contraction in the Malaysian economy,
which resulted in a slowdown of electricity demand growth and exacerbated an
overcapacity problem that was already causing serious financial strain on the government
off-taker. This put a lot of pressure on the Malaysian government and Tenaga’s ability to
honor its contracts with IPPs. Despite this, the utility and the government did not
unilaterally change the contracts and PPAs with IPPs and instead chose to pursue minor
mutually agreed amendments the contracts. Overall, the Malaysia’s IPP experience was
very positive from the investor’s perspective since they were able to make healthy profits
from their contracts with the utility. The outcome from the government’s side was more
mixed because there was a sense that the government may have overpaid for electricity
procured from the first round of IPPs.
Bayliss and Hall (2000) assess the main categories of problems that have arisen
with IPPs, based on a review of experiences in a number of countries. The authors argue
that IPPs have proven to be (i) inflexible and uncompetitive; (ii) costly and lacking in
transparency; (iii) highly risky for governments; and (iv) prone to corruption. According
to the authors, more and more governments are running into difficulties with IPPs. In the
countries where they have been established for some time, such as Pakistan and
Indonesia, IPPs have been the subject of protracted legal, political and economic battles.
Other countries such as the Philippines and Dominican Republic have seen electricity
utilities crippled by payments to IPPs. Many countries have questioned the generous
terms offered to IPPs by previous governments and have attempted to limit the damage of
such arrangements through renegotiation of PPAs and by voiding the contracts.
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Gratwick and Eberhard (2008) analyze the outcomes of nearly 40 IPP projects in
8 countries. The authors find outcomes have been more balanced in North Africa than
Sub Saharan Africa. The main reasons for this is a better investment climate, a more
robust policy framework, better planning by governments, abundant low-cost fuel and
secure fuel contracts as well as credit enhancements such as sovereign guarantees. With
few exceptions, these elements were absent in Sub Saharan Africa, where the role of
development finance institutions was more important.
To conclude, the authors present three main findings. First, evidence of
contractual failures is widespread among African IPPs. Secondly, contractual failures
have not necessarily signaled the end of project operations. New agreements have been
reached to make the projects sustainable. Third, there is need for efforts to continue to
close the initial knowledge gap between investors and host-country governments.
Section 2d: Local Context
The importance of adapting reforms to the local context, including through greater
engagement with stakeholders is suggested by a number of studies. However, studies are
less clear about how reformers can go about doing this. The case study on reforms in
Bhiwandi region in the state of Maharashtra provides an example of how this has been
pursued in one place but there is need for more work to unlock the puzzle of context
specific design of reforms. Moreover, some studies may be overtly dismissive of the
“standard reform model,” which for all its drawbacks, does provide roadmap for
achieving greater efficiency and transparency and, as indicated in the review of the
econometric literature, has been associated with improvements in sector performance.
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Salgo (1996) argues that for India to achieve its goals of providing electricity to
nearly one billion people, the long term need for fundamental reform- without being
"structurally prescriptive"- is largely at the state level. The paper reviews the reform
plans of the state of Orissa and infers that states level reforms will result in a variety of
prescriptions and models. There is likely to be no set preferred structure, with smaller
states for the most part forgoing unbundling and private sector participation. According
to the author, each state’s reform will likely be relatively unique, as in the case of the US,
due to differences in factors such as population, income levels, mix of loads,
geographical size, and availability of natural resources.
Ali et al. (2007) review the controversies and issues surrounding the 1994 power
policy that was highly successful in attracting foreign direct investment to Pakistan’s
power sector. The policy generated a lot of controversy, as IPPs were accused of using
illegal means to secure lucrative contracts. The paper finds that the IPP policy was
designed with little or no input from relevant stakeholders and this contributed to its
unraveling and reversal at a later stage. The paper suggests that the way forward for
Pakistan lies in strengthening electricity regulation, empowering civil society, and
restructuring WAPDA without necessarily privatizing it.
Singh (2010) provides an overview of competition in various segments of the
electricity sector in India, and whether the changes brought about by the EA 2003 were
effective in encouraging a competitive marketplace. The paper finds that the provisions
of the Act are necessary but not sufficient condition for achieving this objective.
According to Singh, the short term challenges in the Indian power sector relate to
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improvement in technological efficiency and financial performance and that, in the long
run, policy makers and the regulators alike should endeavor towards development of a
competitive power market that provides efficient price discovery and cost-effective
choice to consumers. Singh’s conclusion is that there is no single set of textbook
conditions to enable development of a competitive power markets India; deviations are
necessary to take into account the prevailing market structure including ownership
pattern and supply options, market behavior, subsidy, universal service obligations and
socio-economic compulsions.
Using a narrative assessment supported by data analysis, Dixit et al. (2001) argue
that the main reason for the poor performance of the power sector in India is lack of
transparency, accountability and public participation which has resulted in weak policies
and decision making as well as a failure to execute reforms and regulations. According to
the paper, this situation has directly led to sector inefficiencies such as T&D losses in
excess of 40%, unsustainably high cost of electricity procured from IPPs, and highly
skewed tariff structures. Effective implementation of transparency, accountability and
public participation during the reform process, via legal operational provisions and civil
society, is imperative for the success of reforms.
Tankha et al. (2010) analyze the experience of the Distribution Franchise model
in Bhiwandi, Maharashtra to show that partial reforms whose design and implementation
take into account the local context and different interests of the key stakeholders can
provide valuable and immediate benefits. According to the paper, Bhiwandi, Maharashtra
went from being the worst performing state distribution center to one of its best
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performing ones after the Maharashtra State Electricity Board in 2007 handed a
distribution franchise agreement to a private company, Torrent Power Limited, for 10
years.
Under an environment of high power theft, collusion between users and
Maharashtra State Electricity Board employees and political interference, Torrent Power
Limited used careful stakeholder analysis and strategic coalition building that avoided
rigid positions based on idealized models to achieve sales growth and profits, reduce load
shedding through lower technical and commercial losses, improve collection efficiency
and customer services. However, the author notes that, as these reforms are partial, they
are also fragile and remain vulnerable to public choice action by politicians. The paper
concludes that a favorable institutional framework, while desirable, is not necessary to
make progress towards reforms in general. Private sector participation in particular and,
where institutions are unfavorable, alternate pathways and strategies for improving sector
performance should be pursued; through careful stakeholder analysis and strategic
coalition building, success can be achieved in hostile institutional environments.
Reviewing electricity market reforms in Nepal, Jamasb (2012a) finds that a low
political commitment to reform coupled with weak implementation of necessary
measures due to political instability and the absence of an independent regulator has
adversely affected the electricity sector in Nepal. While the initial reforms followed the
standard template of reform in developing countries, this model has proven unsuccessful
in the Nepalese context.
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The study suggests that a cautious and gradual reform process based on a piece-
meal approach with constant adaptation is appropriate for a country like Nepal. In the
context of Nepal, the authors conclude that separation of accounts of the main functions
of the utility may be a more pragmatic restructuring approach than unbundling given the
present political and market condition. As Nepal’s electricity system grows in size,
unbundling and privatization can be pursued.
Section 2e: Implementation
Implementation of reforms is another area that receives attention in case studies.
Weak reform efforts are inevitably seen to be characterized by poor implementation
while successful reforms are seen to be characterized by meticulous design and robust
implementation. When reforms are implemented poorly, it is almost always because there
is a divergence between letter of the law and actual implementation. The literature on
implementation of reforms highlights the importance of allocating more financial and
human resource for successful reforms. However, the literature does not examine deeply
why certain countries and states are better at implementation than others and what if,
anything, can be done to change the situation. In particular, the literature is silent on the
role played by informal beliefs, habits and customs of actors involved in the reform
process as well as the role of history.
Battacharyya (2005) analyzes the changes brought about by the EA 2003 and
whether it is sufficient to transform the Indian power sector. The paper argues that the
tariff determination has been made flexible and commissions are now empowered to
move to a multi-year tariff regime and decide the tariff principles. The paper concludes
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that the regulatory system in India fulfills the requirements for a credible system.
However, the paper finds that improvements are needed in terms of arrangements for
funding of commissions, and stricter provisions for subsidy.
Malik (2007) examines the regulatory environment in Pakistan’s electricity sector.
National Electric Power Regulatory Authority, Pakistan’s electricity regulatory agency,
was formed in 1997 to protect consumer interests and to ensure an efficient and
competitive environment for electricity generators and distributors, but it has so far had
limited effectiveness. Since its inception, National Electric Power Regulatory Authority
has had limited autonomy, which has adversely affected its ability to carry out its
regulatory functions. In addition, National Electric Power Regulatory Authority has
lacked the professional expertise to supervise sector and establish a rational and equitable
pricing regime. According to the author, the electricity sector has had to pay a price for
National Electric Power Regulatory Authority’s ineffectiveness and is now burdened by
inefficient and non-optimal tariffs, high line losses, and high level of corruption.
Reineberg (Reineberg, 2006) examines India's chances of achieving its goal of
providing “electricity for all”. Reineberg worries that the estimated price tag of updating
and constructing various infrastructure projects may exceed $200 billion, and financing
will be the major challenge. In this regard, the author is particularly concerned by the
failure of the state of Maharashtra to honor its contractual commitments to the Dabhol
power project in 2001 after tariff disputes which resulted in the project being abandoned
after beginning construction. According to the author, this sent a wrong signal to
international private investors and is likely to reduce interest in India.
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Agarwal et al. (2003) review the successful privatization in July 2002 of the
distribution operations of the Delhi Vidyut Board, the state owned utility that served the
14 million people of metropolitan Delhi. The paper tries to uncover how the Delhi
Government was able to sell majority stakes in three distribution utilities covering the
entire metropolitan area even though the total operational and commercial losses were
close to 50%.
The paper finds the following economic and regulatory factors as being
important: (i) a willingness to set a clear subsidy system in place to support a transition
path to full commercial activity; (ii) a willingness to establish companies with a
sustainable level of liabilities even though this required leaving around 85% of the
existing liabilities with a state owned holding company; and (iii) the establishment of key
elements of a multi-year tariff regime. In addition, the decision of the government to have
the bidders bid on the basis of a trajectory of commercial and technical loss
improvements for the first five years was found to be important as this allowed bidders to
reveal the efficiency improvements they felt would be achievable while also providing
consumers with a transparent measure by which the success of the privatization could be
assessed.
Pollitt et al. (2011) revisit a 2002 paper examining the human resources
constraints in the electricity sectors in India, Latin America and Africa. The authors find
strong evidence to indicate that there are significant human resource constraints which
limit the scale and, hence, the scope and potential effectiveness of energy regulatory
agencies in these countries and that there has been little improvement since 2002. In
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India, for instance, the number of professional staff in regulatory agencies, both in
absolute and relative terms, is found to be extremely low.
Ahmad (2011) assesses the role of organizational inefficiency in creating the
electricity crisis in Bangladesh. The paper argues that the organizational inefficiency of
the state owned utility, BPDB and Ministry of Power, Energy, and Mineral Resources
combined with political interference is responsible for creating the electricity crisis in
Bangladesh.
The paper finds that the power sector is highly centralized with all the decisions
taken at the top of the hierarchy. Contrary to the provisions of the 1996 Private Sector
Power Generation Policy, Bangladesh takes a long time to approve IPP projects due to
political interference, corruption and inefficiency. There continues to be widespread
electricity theft due to unauthorized connections, often involving collusion with
employees of the utilities. Utility employees have political affiliations and are able to
thwart any efforts to reform the utilities. The paper argues that the current electricity
crisis can be resolved by increasing the efficiency of government institutions and
stopping political interference in electricity sector institutions.
The Forum of Regulators (2008) analyze the effectiveness of initiatives to
institutionalize and protect consumer interests in India such as Consumer Grievances
Redressal Forum and Ombudsman. Based on interviews with various Non-Government
Organizations, consumer rights protection organizations and consumers, the study
assesses the gap between law and implementation. The study finds that the provisions in
the EA 2003 are interpreted differently in different states, and hence are inconsistently
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followed. To improve the effectiveness of Consumer Grievances Redressal Forum and
Ombudsman, Forum of Regulators recommends 1) ensuring financial and operational
autonomy for such institutions, and 2) establishing a framework for monitoring
performance, implementation and accountability for noncompliance.
Siyambalapitiya (2002) reviews the implementation of Sri Lanka’s energy policy
and finds that “written policy is hardly ever followed by the government: what is
followed is a mix of written and unwritten policies, and a largely ad-hoc series of actions,
that cause confusion, waste of precious human resources and funds in various sector
institutions and to the public.” The paper highlights the need for Sri Lanka to graduate
from the disorderly manner in which energy “policies” are currently implemented,
towards a mature, systematic approach to policy preparation and implementation.
Section 2e: Political Economy
Studies point to the political economy of the electricity sector as being
particularly challenging to reforms. Special interests that stand to lose from reforms (such
as for instance the employee unions, agricultural customers, politicians) are successful in
either stalling reforms completely (such as in the case of Sri Lanka) or watering down the
provisions so much that reforms are severely compromised (such as in the case of India).
This has been responsible to a considerable extent for the slow progress of reforms in
South Asia.
Joseph (2010) examines the relationship between partial reforms, corruption,
private sector growth and the rise of captive power in the Indian electricity sector. The
paper argues that the ongoing problems (corruption, theft, and inefficiency) in the power
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sector are due to "partial reforms" which has resulted in an out flux of industrial
consumers who have established captive power plants to meet their needs. This has
resulted in a dual-track sector, whereby state-run and market-run electricity generation
exist side-by-side. This is encouraged by politicians as it allows them to meet private
sector needs, without jeopardizing the support of key political constituencies at the state
level.
Kale (2007b) reviews the reasons why different Indian states are pursuing
electricity sector reforms at different rates by focusing on (i) ideological predilections of
governing elites, (ii) external pressures like those coming from international financial
institutions, and (iii) state-society interactions. Kale argues that it is the last explanation,
focusing on the degree to which the potential “losers” from reform dominate state politics
that most compellingly accounts for the unevenness in state level reforms. According to
Kale, the primary independent variable that explains the variation in reforms is the
organizational and political strength of societal actors in each state, particularly rural and
industrial constituencies, and middle class interests. For instance, in states with a large
and well organized farm sector, reforms have not proceeded. In the absence of such a
sector, state elites have pushed through with reforms to satisfy industrial and urban
constituents and signal the state’s openness to private capital inflows.
Section 2f: Distribution
According to the literature, the distribution segment of the electricity sector is
emerging as the most critical area of electricity market reforms in South Asia. While
reforms initiated since the 1990’s have been able to successfully transform generation
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through the introduction of IPPs, both the reforms and performance of the distribution
segment has lagged behind. While organizational unbundling has resulted in creation of
new distribution companies, these companies are still a long way from operating on
commercial principles. The vast majority of distribution companies in South Asia
continue to make large financial losses and their operation is hampered by political
interference, corruption and theft. Moreover, the financial weakness of distribution
utilities risks weighing down rest of the sector since it depresses investment by IPPs as
well as efforts to increase electricity access.
Alam et al. (2004) review the implementation of electricity market reforms in
Bangladesh. The paper notes that while recent reforms have focused on the generation
and transmission segments of the sector, the most pressing problem is in the distribution
segment, which is characterized by heavy system loss and poor revenue collection. This
implies that priority in reform must be given to distribution. The authors recommend
following measures to improve the implementation of reforms; (i) substantial
restructuring of the administration to make it efficient and effective; (ii) regular
performance monitoring; and (iii) steps to institute accountability among utility staff to
reduce electricity theft.
Pargal et al. (2014) review the evolution of the Indian power sector with a focus
on distribution as a key to the performance and viability of the sector. The book notes
that government initiated reform efforts have so far focused on the generation and
transmission segments, reflecting the urgent need to add and evacuate capacity while
distribution reforms have lagged.
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Highlighting the importance of distribution reforms for ensuring the financial
sustainability of the sector, the authors analyze the multiple sources of weakness in
distribution and identify the following key areas of action to improve performance in the
short and medium term: i) implement fully the key EA 2003 mandates, especially those
on competition and distribution; (ii)ensure regulatory autonomy, effectiveness, and
accountability; (iii) ensure that high-quality, updated data are publicly available and that
these data are used for monitoring and benchmarking performance; (iv) insulate utilities
from state government to prevent interference; (v) make better use of India’s size and
diversity to experiment with and learn from different models of service provision
operations; and (vi) rationalize domestic tariff structures to improve targeting and reduce
the fiscal burden.
Singh (2006) reviews the implementation of electricity sector reforms in India
since the 1990’s, which culminated with the passage of the EA 2003. The paper finds that
while the main objective of electricity sector reforms in developed countries has been to
enhance competition in the sector, improving the financial situation of utilities and
attracting private investment to the power sector has been the main driving force for
reforms in India. Singh sees EA 2003 as having the potential to further develop the
electricity market in India through license-free thermal generation, non-discriminatory
access to the transmission system and the gradual introduction of open access to the
distribution system. However, the paper sees the possibility of sustained improvements in
performance of the electricity sector only from improvements in the distribution segment,
in particular, through efforts to reduce political interference.
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Singh (2007) provides an overview of the evolving policy and regulatory
framework for private and foreign investment in the Indian power sector. The paper finds
that progress has been achieved in making tariff determination process more transparent
and promoting cost reflective tariffs. Efforts have also been made to reduce the risks
associated with sales to financially weak state utilities by ensuring competition in the
bulk power market and phased direct access to large consumers. Notwithstanding these
promising policy and regulatory developments, more reforms are needed to improve the
performance of distribution utilities. Among other factors, the autonomy to manage
distribution utilities in a commercial manner is a key issue. In the long run, the author
argues that the state’s objectives are best served by nurturing a financially sustainable
sector that can improve access for poor and rural consumers.
Dossani (2004) argues that India's current reform policies are not sufficient to
achieve reliable and efficient power because of the bottlenecks in the distribution
segment electricity sector. The paper finds distribution reforms to be challenging in India
because of the lack of consensus on best practices as well as economic and political
conflicts. The paper analyzes alternative institutional structures for reform in the
distribution sector and finds that that: (i) the objectives of coverage and efficiency may
conflict; (ii) an economically efficient reorganization may be politically unachievable;
and (iii) the small municipally owned distribution company may be the best compromise.
According to the author, the agenda for policymakers is to assess the situation in their
respective states and choose reforms that are the best compromise.
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Bhatia et al. (2004) review the implementation of a campaign to control the theft
of electricity from government owned electricity distribution companies and improve
revenue collection in the Indian state of Andhra Pradesh, India. The initiative helped
reduce losses, boosted revenues, and improved customer service. The paper finds that the
improvements are likely to be sustainable since the utilities have institutionalized new
business processes and made visible changes in their organizational culture.
The paper identifies the following factors as being responsible for the success of
the anti-theft campaign; i) creating a constituency for change through effective
communication with key stakeholders and building confidence in the government’s
assurances by ensuring that the communication is followed by concrete actions; (ii)
modifying the legal framework and enforcement mechanisms to remove legal
impediments and empower enforcement authorities; (iii) ensuring that punitive actions
are seen as judicious and equitable and giving those with illegal connections a chance to
become lawful customers; (iv) institutionalizing new business processes by adopting
modern technology, improving management information systems, and introducing new
management control systems; and (v) changing the incentives of managers and staff by
punishing collusion and poor performance.
Norris (2007) finds that the performance of the distribution segment in
Bangladesh is acting as a barrier to private investment in electricity generation in
Bangladesh. According to the paper, Bangladesh faces a crisis of limited electricity
generation capacity. Only 30% of Bangladeshis have access to electricity, and those who
do, face poor quality service such as frequent blackouts and voltage variations. A lack of
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reliable power impedes economic development of the country. Electricity tariffs are at
below cost recovery levels while the electricity service is poor. Citizens fix illegal hook
ups to existing electricity lines to steal electricity. Bill collectors and utility managers
have long history manipulating figures to inflate electricity lost in the system.
Since the early 1990s, the government has attempted to create market conditions
for the distribution of electricity. However, corruption among political elites dissuades
potential investors. Through analysis based on elite interviews and case studies, the paper
concludes that the government should strengthen the Bangladesh Electricity Regulatory
Board through secured funding and increased staff capacity and facilitate distributed
generation arrangements between industries and neighborhoods.
Sant and Dixit (2003) review the performance of the five distribution companies
in India that weren’t nationalized in the 1960’s and have remained in private sector
control as well as a sixth one that was created in the early 1990’s. They present a
comparative analysis of the performance of these private distribution utilities, Tata Power
Company, BSES, Calcutta Electricity Supply Company, Surat Electric Company,
Ahmedabad Electric Company and NOIDA Power Corporation. As indicative
comparative exercise, data from two public utilities - BEST, Mumbai and Pune Urban
Zone of MSEB - are also presented. The authors find that performance of the two public
utilities is comparable to that of private utilities on many parameters such as distribution
cost and T&D losses. The performance of Pune Urban Zone in reducing T&D losses in
particular compares very favorably with private sector distribution companies. The
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authors conclude by highlighting the need for more detailed performance reviews of
existing private utilities.
Section 2g: Country Specific Issues
Thakur et al. (2005) analyze the likely impacts of the major policy reforms
undertaken by Government of India for revamping the country's electricity sector. The
author expects EA 2003 to bring about revolutionary changes in India’s electricity sector
and serve as a model of policy reform for other developing countries. However, the paper
also highlights unresolved issues such as pricing and transmission, open access,
environmental concerns, market dominance of few generators, mechanism for preventing
sharp increase in trading prices, time frame for implementation of open access, and cross
subsidy elimination. Despite concerns, the paper has a positive outlook on electricity
market reforms in India, but expects there to be slow progress in achieving outcomes.
Ali et al. (2010) examine the circular debt problem in Pakistan’s electricity sector.
After presenting the profile of the electricity sector in Pakistan, the paper explains why
circular debt has emerged in the sector. Two principal reasons are given for the circular
debt problem: first, consumer tariffs are insufficient to recover the rising costs of
electricity generation and the government (due to fiscal constraints) is not compensating
Pakistan Electric Power Company for the resulting losses. Second, Pakistan Electric
Power Company is unable to recover dues from consumers. According to the paper, the
circular debt problem can be resolved through a sharp upward adjustment in power tariffs
and explicit recognition of the costs of electricity subsidies in the Pakistan’s budget.
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A report prepared by the government’s energy sector task force (Friends of
Democratic Pakistan, Energy Sector Task Force, 2010) provides a road map to eliminate
electricity deficits in Pakistan. It includes a detailed set of recommendations and an
action plan to enable the country to achieve full energy security and sustainability. The
report was prepared in the midst of Pakistan's current electricity crisis. This report
recommends five key areas of reforms and investments to sustain Pakistan's electricity
sector and to expand its capacity to meet present and future requirements. They are: (i)
strengthen electricity sector governance and regulation; (ii) rationalize pricing and
electricity subsidies; (iii) mainstream energy efficiency into energy policy; (iv) fast track
investment projects; and (v) develop project finance capability.
Thakur (2002) reviews power sector reforms in Nepal and finds that the
legislative framework for the sound development of the sector is already in place. The
paper argues for the adoption of a strategy for the development of public and private
sectors, large and small projects and for both domestic consumption and exports. The
paper sees reforms in electricity sector as being very complex and painful and requiring
political willingness as well as effective government support. While acknowledging that
radical changes in the way in which the NEA operates is not possible, the paper finds that
some improvement in performance can be achieved with the firm commitment and
determination of political leaders.
Haque and Rahman (2010) review the electricity crisis in Bangladesh and offer
solutions for resolving it. They identify high system losses and corruption as the main
causes of the electricity crisis. They propose the following solutions to addressing the
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crisis: (i) greater use of demand management practices to reduce the power shortage; (ii)
priority efforts to combat corruption in the sector; (iii) better utilization of renewable
energy in the country; (iv) development of manpower necessary for expanding renewable
energy.
Amarawickrama (2004) critically examines the Sri Lankan government’s reform
and restructuring plans for the electricity sector in the context of the 2002 power sector
policy guidelines. The paper finds that the government’s policy guidelines and reforms
are going in the right direction but that there is room for improvement. The paper
recommends that the government’s role in the electricity sector should be reduced
gradually and that a competitive electricity market should be adopted. The paper is
doubtful about the prospects for improvement in the sector’s performance without these
reforms.
Section 3: Gaps Addressed by this Dissertation
The review of the literature indicates there is still considerable uncertainty
regarding the relationship between different electricity market reform measures and
sector performance. Econometric studies on the relationship between reforms and
performance present mixed evidence, with results seen to depend on the size and income
of the country as well as the sequencing of reform measures.
There has been limited cross-testing of most of the hypotheses such that further
analysis in different regional contexts is necessary to increase confidence in the results. In
particular, there has been no effort to test the relationship between reform measures and
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performance indicators in the South Asian region using econometric methods.
Methodologically, given the data limitations in the electricity sector, there is growing
convergence around the use of fixed effects and random effect models for analyzing the
relationship between reform measures and performance indicators.
Similarly, the vast majorities of case studies on electricity market reforms either
describe the implementation of reforms or seek to explain the presumed causal links
between reform interventions and sector performance. There are very few studies that
carry out a detailed review of the institutional context in which reforms occurred and try
to explain how and why certain events may have happened. The analysis is almost
entirely focused on the observable elements of institutions and reforms, with no analysis
whatsoever of the effect of the informal elements (such as beliefs, norms, culture) that
motivate actions and their interactions with the formal elements of institutions and
reforms.
Viewed through the prism of Williamson’s four levels of institutions, the
literature is overtly focused on level 3 and 4 institutions with some coverage of level 2
institutions but a complete absence of level 1 institutions. Methodologically, there are no
case studies that use the analytical narrative methodology to bridge rational choice
modeling with more traditional narrative explanations.
It is these gaps in the literature that this dissertation seeks to address. I carry out
an econometric analysis of electricity market reform measures and performance
indicators for 26 Indian states and Bangladesh, Nepal, Pakistan and Sri Lanka. I then
make use of the analytical narrative methodology to get a better understanding of the
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different factors impacting electricity market reforms in the Indian state of Gujarat and
Nepal.
This dissertation thus expands the existing body of knowledge on electricity
market reforms by plugging these gaps in the literature. The next chapter presents the
research framework and methodology used in the dissertation.
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Chapter 4 - Research Framework and Methodology
As discussed in earlier chapters, the five South Asian countries covered in this
study – India, Pakistan, Bangladesh, Nepal and Sri Lanka – all embarked on electricity
market reforms in the early 1990s. The first step in the reform process - the introduction
private sector participation in generation - was completed by all five countries within a
few years of each other in the early 1990’s. However, there has been substantial variation
among countries and states in the status and timing of adoption of the subsequent reforms
such as the establishment of independent regulatory commission and unbundling of
utilities. None of the countries and states covered in the study has so far advanced to the
stage of a competitive electricity market.
Discussions in the previous sections suggest that the implementation of
institutional and regulatory reforms in the electricity sector is a complex undertaking. The
outcome of electricity market reforms is likely to depend not only on changes in the
formal rules, governance and ownership structures undertaken as part of the reform
process but also on the existing informal rules, norms and customs of the country.
Countries and states that consider the transaction costs associated with different
governance mechanisms in the electricity sector, including contract implementation
hazards are likely to fare better than countries that base their decisions solely on the
supposed efficiency gains of using markets. Likewise, countries and states that take steps
to facilitate competition in the electricity sector are likely to achieve more gains than
countries and states that rely only on private sector participation. Finally, credible and
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politically independent regulatory agencies are likely to be important for improving
outcomes in the electricity sector.
Section 1: Research Questions
(1) What is the relationship between electricity market reforms and sector
performance in South Asia?
As discussed earlier, the theoretical literature is not conclusive on the direction of
the relationship between reforms measures such as introduction of private sector
participation through IPPs, vertical unbundling of utilities and establishment of an
independent regulator and electricity sector performance. Empirical evidence on the
relationship between reform measures and performance indicators is also mixed (see
Appendix A for summary of the results of key econometric studies on electricity market
reforms and electricity sector performance).
Recent empirical studies such as Vagliasindi (2013), Nagayama (Nagayama,
2010) suggest that in general electricity sector reforms are positively correlated with
better sector performance in high and middle income countries with large system size but
negatively associated with these performance indicators in low income countries with
small system size. However, an earlier study covering 26 developing countries in Africa,
Asia and Latin America (Y. Zhang, Parker, & Kirkpatrick, 2008) finds that when
privatization is introduced together with independent regulation and competition, it is
positively correlated with performance indicators such as higher electricity generation. In
general, the relationship between reforms and performance indicators is sensitive to the
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manner in which different reform and performance concepts are operationalized in the
research (Hattori & Tsutsui, 2004).
There is a need to increase confidence in these empirical results through cross-
testing of the hypotheses in different regional contexts (Jamasb, 2005). In particular,
there is a need to gain a better understanding of the relationship between electricity
reforms and performance indicators in the South Asian context. Past efforts to study the
relationship between reforms and performance in South Asia have either been based on
only a few of the states and countries or have not covered reforms and performance at the
state level in India15. Vagliasindi (2013) and Nagayama (2010) for instance cover only 3
out of the more than 30 states and countries in South Asia.
In this context, the research will assess the relationship between electricity market
reforms measures and performance indicators in South Asia. To facilitate comparison of
results with Vagliasindi (2013) and Nagayama (2010), this study uses comparable reform
and performance variables and methodology as these studies.
15 Vagliasindi (2013) has three Indian states – Gujarat, Maharashtra and Andhra Pradesh – in her sample of
22 countries and states while Nagayama (2010) study covers Bangladesh, Pakistan and India. Nagayama presents India as a single unit, which is not an accurate representation since each of the states has its own policies in electricity sector.
101
(2) What are some key institutional factors associated with success of reforms or a
lack thereof?
The success of reforms depends not just on observable elements of institutions
such as formal laws rules and regulations that are adopted as part of the electricity reform
process, but also on the informal elements such as beliefs, habit, norms and culture of the
society in which the reforms takes place. In particular, the theoretical literature suggests
that societies with a strong formal institutional framework and individualistic social
norms and customs are more likely to be successful in their reforms efforts than societies
with a weak formal institutional framework and collectivist social structures.
Case studies of electricity sector reforms in South Asia carried out by
Bhattacharya (2007c) and Nepal and Jamasb (2012b) find that changes in formal rules
and regulation, governance and structure of the electricity sector did not always lead to
expected sector outcomes. However, existing case studies of electricity sector reforms do
not identify the causal factors and mechanisms and lack convincing explanations of why
and how formal and informal institutional set up of the state or country impacts the
performance of the electricity sector.
In this context, the research attempts to derive a more nuanced understanding of
the “deep” institutional factors and causal mechanisms that underlie the successful
outcomes in utility and sector performance. It is anticipated that these insights will be
useful in the design of electricity market reform efforts.
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(3) What are the lessons that can be learned from the implementation of electricity
sector reforms in South Asia over the last two decades?
The state of electricity market reforms in South Asia is very much in a flux. While
all countries and states have embarked on reforms, very few states and countries have
privatized distribution and none has so far established a competitive power market. This
suggests that most countries and states continue to remain ambivalent on the desirability
of such reforms. In particular, countries and states remain either unwilling or unable to
pursue private sector participation in the distribution and retail segment of the electricity
sector.
In this context, the research will try to explicate policy lessons from the
implementation of electricity sector reforms in South Asia since 1990. These lessons will
cover areas such as: (i) the desirability of unbundling; (ii) the effectiveness of private
sector participation; (iii) the importance of regulation; and (iv) institutional pre-
conditions and key enablers necessary for success of reforms.
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Section 2: Analytical Framework
Electricity sector reforms take place in an environment characterized by different
levels of institutions. Figure 4.1 illustrates the analytical framework for electricity sector
reforms that is based on Williamson’s (2000) classification of institutions. The main steps
associated with electricity sector reforms such as introduction private sector participation
in generation, unbundling of utilities, and establishment of independent regulatory
agencies or the independent variables are located at levels 2 and 3 of institutions. These
reforms are however embedded in Level 1 institutions comprising of informal norms,
customs and traditions.
The performance indicators - electricity access, per capita generation capacity,
per capita electricity consumption, T&D losses and average tariff – are the dependent
variables. The success or failure of reforms is likely to depend not just on reform
variables but also the larger institutional environment in which the reforms will be
implemented.
A combination of elements, including formal and informal institutions, and beliefs
about actions and outcomes are responsible for creating an institutional equilibrium.
Institutional change occurs only very slowly and infrequently and requires the existing
institutional equilibrium to be undermined by exogenous or endogenous factors. Reform
efforts thus require a good understanding of the structure and properties of the existing
institutional equilibrium and the manner in which the reforms would interact with them in
the short run and the long run (A. K. Dixit, 2007; A. Dixit, 2009).
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Figure 4.1 - Analytical Framework for Assessment of Electricity Market Reforms
Intermediate and
Associated Outcomes
• T&D loss
• Per Capita Generation
• Average Tariff
Performance
• Electricity Access
• Per Capita Electricity Consumption
Initial conditions
Subsidies/State Revenues
Performance (quality, losses)
Controls
Per capita income
Budget
Level 1: Embeddedness
(Informal institutions, customs)
traditions, norms, religion
Level 2: Institutional Environment
(Formal rules of the game such as
constitutions, laws, property
rights, political institutions)
Level 3: Institutional
Arrangement (governance
structures, contracts, transaction
costs)
Level 4: Resource allocation and
employment
(prices and quantities, incentive
Electricity Sector
Reform Variables
1. PSP in
Generation
2. Establishment of
independent
regulator
3. Unbundling
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Section 3: Methodology
Jamasb et al. (2005) outline three broad the approaches for analyzing the
implementation of electricity market reforms: (i) econometric methods; (ii) efficiency and
productivity analysis methods; and (iii) case studies. Econometric studies are most useful
for testing hypotheses through statistical analysis of reform determinants and
performance. Efficiency and productivity analyses are suitable for measuring the
effectiveness with which inputs are transformed into outputs, relative to best practice.
Finally, single or multi-country case studies are most appropriate when in depth
investigation or qualitative analysis is needed. Since this research is focused on broad
institutional and regulatory reforms rather than systems and processes, it uses the
econometric and case study methods to evaluate the implementation of electricity market
reforms. Case studies are undertaken from a NIE perspective and take the form of
“analytical narratives” to isolate the impact of a theoretical concept in a detailed manner
(Alston, 2008).
Section 3a: Econometric Methods
The econometric approach has been used to draw links between different reform
variables and performance. The econometric model includes market structure (U),
ownership (P), regulation (I), and control variables as independent variables and several
indicators of performance (O) such as electricity access, financial and operational
performance and private sector investment as dependent variables.
(1) Ot = f (Pt, Ut, It, Ct)
where:
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O = Outcome/performance variables (e.g., electricity access, per capita generation
capacity, per capital electricity consumption, average tariff, T&D losses)
P = Private or public ownership (e.g., dummy variable for public vs. private
ownership of distribution, share of private sector electricity generation capacity)
U = Unbundling (e.g., dummy variable for status of unbundling)
I = Independent regulator (e.g., dummy variable on operationalization of
independent regulator)
C = control variables (e.g., GDP per capita, urbanization rate, share of industry in
GDP, political stability etc.)
This methodology represents a new approach for assessing the performance of
electricity market reforms in South Asia. To date, there has been limited empirical work
on South Asia that has included electricity market reform measures in the analysis. As it
is difficult to make assumptions about the explanatory power of the selected independent
variables including various indicators of unbundling and other sector reforms on the
dependent variables, both fixed and random effect model16 will be used. The most
appropriate specification will then be selected using the Hausman and Breusch and Pagan
tests.
16Fixed effects models control for, or partial out, the effects of time-invariant variables with time-invariant
effects. This is true whether the variable is explicitly measured or not. In a random effects model, the
unobserved variables are assumed to be uncorrelated with (or, more strongly, statistically independent of)
all the observed variables.
107
The choice of these models is considered appropriate for two reasons. First, these
models are well suited for analyzing electricity sector panel data from a varied sample of
countries and states, particularly by controlling for unobserved heterogeneity. In his
review of different methodological options, Jamasb (2005) identifies fixed effects or
random effects model as an appropriate option for carrying out the econometric analysis
of electricity market reforms. Second, using fixed and random effects will be helpful for
comparing the results of this study with past studies on electricity market reforms carried
out by Vagliasindi (2013) and Nagayama (2010), both of which make use of fixed effect
and random effect models.
Section 3b: Analytical Narratives
Cross country econometric analysis can be useful for addressing well defined
questions associated with reform and can yield generalizable results. However, such an
analysis cannot yield understanding of the complex, multidimensional and often country
specific institutional issues that impact the performance of electricity market reforms in
developing countries. They are not able to provide insights on the implementation
process or the larger economic, political, social, historical context in which the reforms
are implemented and how these influence sector performance.
For this reason, the econometric method has been supplemented with analytical
narratives on electricity sector reform of the Indian state of Gujarat and Nepal. Gujarat
has been selected as one of the top performing countries/states and while Nepal has been
selected as one of the bottom performing countries/states in the study. Gujarat and Nepal
were selected based on the assessment of their performance as well as data availability.
108
These analytic narratives are “problem driven, not theory driven" (Arias, 2009)
and seek to find a balance between context specific detail and rigorous analytic
techniques. Towards developing the analytical narrative, a detailed review of the context
and the process of electricity sector reforms in Gujarat and Nepal was carried out based
on review of primary data and documentation on reforms and study of existing
evaluations and assessments of electricity sector reform processes. Selected government
and utility officials and electricity sector experts were interviewed to obtain information
about the implementation of reforms in Gujarat and Nepal (see Appendix I for list of
interview questions).
This review isolates the relevant strategic elements in the reform process: the key
actors, their goals, and their behavior. These elements have been formalized in a model,
which specifies the choices, constraints and tradeoffs the actors face in the reform
process. Four propositions predicted by the theoretical analysis are then assessed using a
narrative analysis.
The analytical narratives are undertaken from a NIE perspective and assess the
unobservable elements of institutions on the performance electricity markets reforms in
the selected countries. The effort is to improve the understanding of the institutional
context in which electricity market reforms were implemented and come up with reasons
for the differences in electricity sector performance (Box 4.1 summarizes the analytical
narrative approach to institutional analysis).
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Box 4.1 - Analytical Narratives
Section 3c: Data Collection
A panel data set with the following: (i) reform milestones (date of introduction of
IPPs, date of unbundling of the utility, date of establishment of the independent regulator,
privatization of distribution); (ii) electricity sector performance indicators (electricity
access, per capita generation capacity, per capital electricity consumption, T&D losses,
average tariff); and (iii) socio-economic control variables (GDP per capita, urbanization
rate, share of industry in GDP, political stability) have been collected for India’s 26 states
and Pakistan, Bangladesh, Nepal and Sri Lanka for the 1990-2010 period from different
sources such as the World Bank’s World Development Indicators, annual reports of
utilities, and websites of government ministries and utilities.
The construction of an analytic narrative proceeds, roughly, as follows. First, the scholar acquires in-depth knowledge about the historical phenomenon of interest; that is, a detailed account of the context and the historical process, based on studying the past through primary sources or reading the already existing historical accounts. These elements can then be formalized in a theoretical model. The theory highlights the issues to be explored and the general considerations and evidence that need to be examined, while the knowledge of the historical context is used to develop a conjecture regarding the relevant institution. A successful explanation requires a well confirmed causal claim about why and how a certain outcome obtained - this can be done even if mostly the narrative rather than the model accounts for the explanation. However, the explanation that the model points to should survive competition with other explanations. Source: Arias 2009
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• Data on Reform Milestones
Data on the reform milestones for the 26 Indian states were collected from the
websites of the State Electricity Regulatory Commission of the states. The websites of all
the State Electricity Regulatory Commissions can be accessed from the website of the
India’s Central Electricity Regulatory Commission
(http://www.cercind.gov.in/serc.html). The data on reform milestones for Bangladesh,
Nepal and Pakistan were collected from the websites of Bangladesh Electricity
Regulatory Commission (http://www.berc.org.bd), NEA (www.nea.org.np) and WAPDA
(http://www.wapda.gov.pk/) respectively. To improve reliability, this data was
triangulated with data from independent agencies such as the World Bank and the Asian
Development Bank (ADB). In particular, World Bank’s India Power Sector Review
database and ADB project documents, which contain detailed information on the reform
milestones, were used for this purpose.
• Data on Electricity Sector Performance Indicators
Data on electricity sector performance indicators were collected from the
following sources:
i) Access – The data on electricity access rates for the 26 states of India,
Pakistan, Bangladesh, Nepal and Sri Lanka are from household surveys (see
Table 4.1). The data portal, www. Indiastat.com, compiles data on electricity
access rates from household surveys for each of the 26 states of India. Data on
electricity access rate from Household Surveys of Pakistan, Bangladesh,
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Nepal and Sri Lanka are from the World Bank’s Development Data portal
(data.worldbank.org).
ii) Per Capita Generation Capacity – Data on the electricity generation capacity
for the 26 states in India were collected from the Annual Reports of the
Ministry of Power and data on population were collected from
www.Indiastat.com. Data on electricity generation capacity for Pakistan
Bangladesh, Nepal and Sri Lanka were collected from the website of Energy
Information Agency (www.eia.gov) and data on population from the World
Bank’s Development Data portal (data.worldbank.org).
iii) T&D losses and electricity tariff – Data on T&D losses and average
electricity tariff for the 26 Indian states are from statistical portal
indiastat.com, Annual Reports of the Planning Commission on the State
Power Utilities and Electricity Departments (2002, 2012), and the annual
reports of Central Electricity Regulatory Commission
(http://www.cercind.gov.in/annual_report.html). For Pakistan, Bangladesh,
Nepal and Sri Lanka, data were collected from World Bank’s Development
Data portal (data.worldbank.org) and the annual reports of the utilities in these
countries (http://www.powerdivision.gov.bd/, http://www.nea.org.np/,
http://www.wapda.gov.pk/). To improve reliability, this data was triangulated
with data in the project documents of the World Bank and the ADB.
112
• Data on Socio-economic Control Variables
Data on socio-economic control variables such as GDP per capita, share of
industry in GDP, and the urbanization rate for the 26 Indian states are from the statistical
portal indiastat.com and the website of Indian Planning Commission
(planningcommission.nic.in). For the rest of the countries, the data was collected from
World Bank’s World Development Indicators portal (data.worldbank.org/data-
catalog/world development indicators).
• Data for Analytical Narratives
For Gujarat and Nepal - the two places selected for further exploration through
analytical narratives - the panel dataset was supplemented with (i) original data and
documentation on reforms from government and utility websites; (ii) archival news
reports on the electricity sector; and (iii) existing evaluations/assessments of the
electricity market reforms carried out by the government, agencies such as the World
Bank and others. Selected officials from the government ministries, utilities, and national
and international electricity sector experts were also contacted to obtain information
about the implementation of reforms in Gujarat and Nepal (see Appendix I for list of
interview questions).
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Table 4-1 - Data Sources
Data Source
Data on Socio-economic control variables
for Pakistan, Bangladesh, Sri Lanka and
Nepal
World Development Indicators
Data on Socio-economic control variables
for 26 Indian States
Data from Indian Planning Commission
accessed at Indiastat.com
Data on Different Reform Milestones for
all states and countries Website of ministries and utilities
Data on Different Electricity Sector
Performance Indicators for all states and
countries
World Development Indicators,
International Energy Agency, Website of
ministries and utilities,
Table 4-2 - Subject States and Countries of this Study
Subject Countries and States
Bangladesh Haryana Mizoram Madhya Pradesh and
Chhattisgarh
Pakistan Delhi Tripura Gujarat
Nepal Rajasthan Meghalaya Maharashtra
Sri Lanka Uttar Pradesh and
Uttaranchal Assam Andhra Pradesh
India Bihar and Jharkhand West Bengal Karnataka
Jammu Kashmir Arunachal Orissa Goa
Himachal Nagaland Manipur Kerala
Punjab
Tamil Nadu
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Section 4: Limitations
In conducting the research, I identified key limitations of the study and developed
a strategy to ensure validity and reliability of the study findings. At the outset,
measurement validity, reliability, internal validity and external validity were identified as
the most important challenges faced by the study. Appendix B provides a brief overview
of these challenges and the strategies used to address them.
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Chapter 5 - Econometric Analysis
Section 1: Introduction
As discussed in previous chapters, South Asian countries launched wide ranging
reforms in the electricity sector in the 1990’s in response to the poor performance of state
led vertically integrated electricity systems. These reforms were based on the recognition
that the traditional model of governance under state ownership was not sustainable and
that a private sector led commercial approach was necessary. There was an expectation
that commercially oriented governance by removing the management and development of
electricity supply from political and bureaucratic control would help achieve
improvements in sector performance (J. E. Besant-Jones, 2006). Towards this, the reform
roadmap comprised of greater private sector participation in generation, introduction of
independent regulators, unbundling of utilities, and privatization of distribution
companies and establishment of a wholesale electricity market.
The implementation of reforms and their performance in South Asia has been
slow and uneven. While progress has been achieved in opening the generation segment to
the private sector, unbundling, and establishing independent regulators, only a few states
and countries have introduced private sector participation and competition in distribution.
The distribution segment is making heavy financial losses, undermining the financial
sustainability of the sector.
The variation in timing and extent of reforms provides an opportunity to test the
relationship between reforms and sector performance using econometric methods. From a
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policy perspective, one can examine whether the introduction of private sector
participation in generation and distribution leads to real improvements in electricity
availability, efficiency and cost recovery. Similarly, one can assess the impact of
unbundling on electricity sector performance.
This chapter uses access to electricity, per capita electricity consumption, per
capita generation capacity, T&D losses and average tariff to measure the performance of
electricity market reforms. The analysis in the chapter aims to determine the extent of the
correlation between reform measures and performance indicators.
Section 2: Data and Model
Section 2a: Explanation of Data
The econometric analysis uses panel data for 26 states in India and four countries
– Bangladesh, Nepal, Pakistan and Sri Lanka over 1990-2010. Since the dataset covers 30
states/countries for 20 years, the total number of maximum observations is 600. The
dependent variables used for the econometric analysis are the five indicators of electricity
sector performance listed in Table 5-1 – electricity access, per capita electricity
consumption, per capita electricity generation capacity, T&D losses, and average tariff.
These indicators have been chosen from among the set of core indicators identified by
Jamasb et al (2005) to measure electricity sector performance. The statistical summary of
the key dependent, independent and control variables is provided in Table 5.4.
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Table 5-1 - Selected Power Sector Performance Indicators
Variables Definition Electricity Access (% of population) Number of residential electricity
connections divided by the total population. This indicator provides a measure of the state or country’s performance in connecting a higher share of the population to electricity. In the majority of the cases, this means providing electricity connections to people in rural areas since urban areas generally have universal connections.
Per Capita Electricity Consumption (Kwh per year)
Annual production of power plants and combined heat and power plants less transmission, distribution, and transformation losses and own use by heat and power plants divided by the total population. This indicator provides a measure of the state or country’s performance in increasing electricity consumption, which has been established to be positively associated with social and economic welfare.
Per Capita Generation Capacity (MW) Total installed electricity capacity divided by total population. This indicator provides a measure of a country or states success in building new infrastructure in the electricity sector. This indicator is often but not always closely linked to per capita electricity consumption.
T&D Losses (%) Losses in transmission between sources of supply and points of distribution and in the distribution to consumers, including pilferage. This is a measure of the technical and commercial efficiency of the sector in a state or country. Losses incurred through theft or due to collusion between consumers and utility officials are shown through this indicator.
Average Tariff Rate Total revenue divided by amount of electricity sold. This provides a measure of the price consumers are paying for electricity in a country. A lower average tariff rate is not always a positive indicator, particularly if lower tariffs are leading to
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lower investments and poor service quality in the sector.
The explanatory variables are presented in Table 5-2 and Table 5-3. Table 5-2
lists the electricity sector reform measures - private sector participation in generation,
vertical unbundling of utilities, introduction of an independent regulator, and
privatization of distribution. Table 5-3 lists the control variables including GDP per
capita, share of industry in GDP, urbanization rate, and political stability.
Table 5-2 - List of Explanatory Electricity Market Reform Variables
Variables Definition Vertical Unbundling Indicator which equals 1 from the year in
which a vertically integrated utility is separated into generation, transmission, and distribution companies and 0 otherwise.
Share of Private Sector Participation Private sector installed generation capacity (MW) in a state or country divided by the total generation capacity (MW) in the state or country.
Introduction of an Independent Regulator Indicator which equals 1 from the year of the establishment of independent regulatory agency and 0 otherwise.
Privatization of Distribution Indicator which equals 1 from the year of privatization of the distribution utility and 0 otherwise.
Table 5-3 - List of Other Explanatory Variables
Variables Definition GDP Per Capita GDP of the state or country divided by the
total population. Industry Share of GDP Industrial GDP divided by the total GDP. Urbanization Rate Urban population divided by the total
population. Political Stability Indicator which equals 1 if the head of
government in office lasted the full term and 0 otherwise.
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As mentioned in the previous chapter, the information on the dates of the
introduction of reform measures was extracted from the websites of the government
ministries and/or electricity utilities of each of the states and countries. For Indian states,
the remaining data, including the dependent variables and control variables were
compiled from the statistics portal Indiastat.com. For the four countries, the remaining
data was compiled from the World Bank’s online World Development Indicators
database.
Error! Reference source not found. shows, beginning in 1990, the year of
introduction of each of the electricity reform measures for the 26 states and four
countries. The introduction of IPP for all countries and states occurred in the early to
mid-1990s. However, only about half of the states and countries have unbundled their
power systems and only two thirds of the countries and states have introduced regulatory
agencies. Only two Indian states – Orissa and Delhi – have privatized electricity
distribution17. None of the states or countries has established a competitive electricity
market.
17 Only companies that have divested majority of their shares are considered to have been privatized.
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Table 5-4 - Statistical summary of key variables
Table 5-5 - Timeline of reforms in South Asia
Year IPP Entry Unbundling Independent
Regulatory
Commission
Privatization of
Distribution
1990
1991 All Indian States
1992
1993 Nepal
1994 Pakistan
1995
1996 Bangladesh, Sri
Lanka
Bangladesh, Orissa Orissa
1997
1998 Haryana, Pakistan Gujarat, Haryana, MP,
UP,
Orissa
1999 Andhra Pradesh,
Karnataka,
AP, Delhi, Karnataka,
Maharashtra, Punjab,
Orissa 2000 Rajasthan, UP Rajasthan
2001 Assam
Himachal Pradesh
2002 Delhi Chhattisgarh
Kerala
Delhi
Delhi 2003 Jharkhand
2004 Assam, Uttarakhand Meghalaya
Tripura
Variable Mean Max Min stdev Mean' Max' Min' stdev'
Electricity Access 50% 87% 13% 0.20 82% 99% 25% 0.19
Transmission and Distribution
Loss 23% 48% 12% 0.06 29% 63% 10% 0.11
Per Capital Electricity
Consumption 224 704 37 157.80 781 2264 93 500
Average Tariff 3.5 5.4 1.6 0.81 7.4 11.5 3.5 1.5
Per capita generation capacity 51.2 150.3 5.0 31.9 135.6 325.5 5.7 82.0
Private sector installed
capacity 161 2730 0 537 1892 28009 0 4742
GDP per capita 261 562 324 284.14 764 2,603 321 710
Urbanization 25% 90% 9% 0.15 31% 97% 0.10 0.17
121
2005 Gujarat, MP,
Maharashtra
Bihar
Manipur
2006
2007 West Bengal
2008 Goa
Nagaland
2009 Chhattisgarh Sri Lanka
2010 HP, Meghalaya, Punjab,
Tamil Nadu
JK
Source: Compiled from government sources by the author
Section 2b: Difference in Sample Means18
To get an initial indication of the relationship between reforms and performance
variables, the difference in means of the performance indicators of states/countries that
are strong reformers are compared with countries and states that are weak reformers (see
Appendix K for the classification of states and countries into different reform and
governance categories). The significance of differences between two sample means is
assessed using the t-statistic. A similar comparison is carried out for countries and states
with stronger governance and those with weaker governance. To examine the relationship
between governance and reforms, the difference in means of performance indicators of
strong reformers is compared with those of weak reformers for both strong and weak
governance countries and states.
• Unbundling
18 See Annex B for scatter plots and trend lines of different performance indicators against GDP per capita
122
Vertical unbundling is positively and significantly associated with per capita
electricity consumption and negatively and significantly associated T&D loss. This
suggests that unbundling is associated with improved sector performance on these
measures. The remaining performance indicators (electricity access, per capita electricity
generation and average electricity tariff) are positively associated with unbundling but the
difference in means is not statistically significant.
Figure 5.1- Performance and Unbundling
Variable
Vertical
Unbundling
(Mean)
Vertical
Integration
(Mean) P value
Electricity Access (%) 79% 77% 0.75
Per Capita Generation
(Kw) 0.15 0.13 0.40
Per Capital Electricity
Consumption (Kwh) 911 577 0.07
T&D Loss (%) 25% 35% 0.02
Average Tariff (US$
Cents) 4.96 4.66 0.36
Number 18 12
• Independent Regulation
Early adoption of independent regulation is significantly associated with a
reduction in T&D loss compared to late adoption of independent regulation19. The
difference in means tests of all the other performance indicators of early and late adopters
of regulation are not significant.
19 For the purposes of this analysis, early adopters of regulation are states and countries that established
independent regulatory agencies before 2000 while late adopters of regulations are states and countries that
established independent regulatory agencies after 2000.
123
Figure 5.2 - Performance and Independent Regulation
Variable
Early adopters
of Independent
Regulation
(Mean)
Late adopters
of
Independent
Regulation
(Mean) P Value
Electricity Access (%) 80% 80% 0.99
Per Capita Generation
(Kw) 0.17 0.14 0.44
Per Capital Electricity
Consumption (Kwh) 959 765 0.33
T&D Loss (%) 26% 31% 0.02
Average Tariff (US$
Cents) 5.02 5.01 0.97
Number 13 17
• Private Sector Participation20
An above average level of private sector participation in the electricity sector is
associated with better performance in all the five measures of performance. However,
difference in means between above average private sector participation and below
average private sector participation is only statistically significant for per capita
generation and T&D loss.
Figure 5.3 - Performance and Private Sector Participation
Variable
Above Average
Private Sector
Participation
(Mean)
Below
Average
Private Sector
Participation
(Mean) P Value
20 For the purposes of this analysis, state and countries were divided into two groups - above average and
below average level of private sector participation - based on the share of private sector installed generation
capacity in total generation capacity of that state or country.
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Electricity Access (%) 82.7% 74.5% 0.72
Per Capita Generation
(Kw) 0.19 0.13 0.09
Per Capital Electricity
Consumption (Kwh) 955 626 0.16
T&D Loss (%) 24% 34% 0.02
Average Tariff (US$
Cents) 4.7 5.0 0.65
N 15 15
• Governance21
Stronger rule of law and governance is associated with better performance on four
performance indicators – electricity access, per capita generation, per capita electricity
consumption and T&D loss. This difference in means for average tariff is not statistically
significant.
Figure 5.4 - Governance and Performance
Variable
Strong
Governance
(Mean)
Weak
Governance
(Mean) P Value
Electricity Access (%) 88.0% 75.5% 0.06
21 States and countries are ranked based on scores on from two governance indices (i) Economic Freedom
of the States of India and (ii) World Economic Forum’s Global Competitiveness Opinion Survey. The
former is used to divide Indian states into two equally sized groups – strong governance and weak
governance. Scores from the latter are used to rank Nepal, Pakistan, Bangladesh, and Sri Lanka. Countries
(Nepal, Pakistan, Bangladesh) that score lower than India on World Economic Forum’s Global
Competitiveness Opinion Survey ranking are included in list countries/states with weak governance and
vice versa.
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Per Capita Generation
(Kw) 0.20 0.12 0.05
Per Capital Electricity
Consumption (Kwh) 1082.92 573.1 0.01
T&D Loss (%) 23% 32% 0.02
Average Tariff (US$
Cents) 5.1 4.7 0.23
N 13 17
• Governance and Reforms
To examine the relationship between extent of electricity markets reforms and the
quality of governance, the mean of performance indicators of countries and states that
were strong overall electricity market reformers22 are compared with countries and states
that were weak overall electricity market reformers for countries and states with strong
governance and weak governance.
a) Strong Governance
Among countries and states with strong governance, the mean of four out of five
indicators indicates better performance for strong reformers compared to weak reformer.
However, in the three out of these four cases, the difference in means is modest and the
differences are not statistically significant. A statistically significant difference in
performance is only seen in the case of T&D Loss.
22 Countries and states are divided into strong and weak reformers based on the status of implementation of
reforms. In particular (i) unbundling (ii) early or late adoption of regulation; and (iii) above average or
below average of level of private sector participation in generation. Countries and states have to be in the
above average group in at least two of the three reform areas to be categorized as strong reformers. The rest
are categorized as weak reformers.
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Figure 5.5 - Reforms and Performance (Strong Governance)
Variable
Strong
Reformers
(Mean)
Weak Reformers
(Mean) P Values
Electricity Access (%) 87.5% 89.7% 0.81
Per Capita Generation
(Kw) 0.22 0.17 0.43
Per Capital Electricity
Consumption (Kwh) 1083.99 1079.4 0.99
T&D Loss (%) 23% 32% 0.02
Average Tariff (US$
Cents) 5.1 5.3 0.64
b) Weak Governance
A similar difference in performance is observed among countries and states with
weak governance. The mean of four out of five performance indicators indicates better
performance for strong reformers compared to weak reformer. However, in three out of
four cases, the difference in mean is modest and the differences are not statistically
significant. A statistically significant difference in performance is again only seen in the
case of T&D Loss.
Figure 5.6 - Reforms and Performance (Weak Governance)
Variable
Strong
Reformers
(Mean)
Weak Reformers
(Mean) P Value
Electricity Access (%) 74.3% 76.2% 0.85
Per Capita Generation
(Kw) 785.8 466.7 0.16
Per Capital Electricity
Consumption (Kwh) 0.17 0.10 0.17
T&D Loss (%) 18% 39% 0.00
Average Tariff (US$
Cents) 4.3 4.9 0.51
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Section 2c: The Model
The econometric model consists of market structure (U), ownership (O),
regulation, (I) and control variables as independent variables and five indicators of
performance (P) - electricity access, per capita electricity consumption, per capita
generation capacity, T&D losses and average tariff as dependent variables. Political and
institutional factors are also included as determinants of differences in performance.
Countries with higher degree of political stability can expect to see better performance (S.
C. Bhattacharyya, 2007c). A further independent variable was therefore added to reflect a
country’s political stability. The resulting equation being estimated for each country/state
i and year t is:
Yit= B1X1it + B2X2it+ B3X3it+ B4X4it+ ∑ZXit+eit
where,
Yit = access to electricity, per capita electricity consumption, per capita electricity
generation capacity, T&D losses and average tariff.
X1it = share of private sector participation in generation.
X2it = dummy indicating whether or not vertically integrated utilities have been
unbundled.
X3it = dummy indicating whether or not independent regulatory commission has
been operationalized through issuance of tariff orders.
X4it = dummy for whether or not distribution has been privatized.
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Zit = set of control variables, including er capita GDP, industry as share of GDP,
and urbanization and political stability.
eit = γi +εit denote country fixed effects and error terms, respectively for the fixed
effect model.
eit = θit+ εit denote the random effects and error terms, respectively for the
random effect model.
This methodology represents a new approach for assessing the performance of
electricity market reforms in South Asia. To date, there has been limited econometric
analysis on South Asia that has included electricity market reform measures in the
analysis. Past efforts to study the relationship between reforms and performance in South
Asia have been based on only a few of the states and countries. Vagliasindi (2013) and
Nagayama (2010), for instance, cover only 3 out of the 30 states and countries covered in
this study. Vagliasindi (2013) has three Indian states – Gujarat, Maharashtra and Andhra
Pradesh – in her sample of 22 countries and states. Nagayama (2010) covers Bangladesh,
Pakistan and India. Nagayama presents India as a single unit, which is an inaccurate
representation since each of the Indian states has its own policies and programs in the
electricity sector.
As it is difficult to make assumptions about the explanatory power of the selected
independent variables including unbundling and other sector reforms on the dependent
variables, both fixed and random effect model are used. Past efforts to study the
relationship between reforms and performance in South Asia have either been based on
129
only a few of the states and countries or have not covered reforms and performance at the
state level in India23.
A fixed effects model treats explanatory variables as nonrandom and as fixed
parameters to be estimated. This is in contrast to random effects models in which
explanatory variables are treated as if they arise from random causes. The assumptions of
the random effect model are much stronger, and if they are satisfied, both the fixed and
random effect models are consistent, but the random effect model is more efficient.
Alternatively, when only the assumptions of the fixed effect model are satisfied, the
random effect model is inconsistent.
The most appropriate specification is selected using the Hausman test. If the
Hausman test fails to reject the null hypothesis for the validity of the random effect over
fixed effect, the Breusch-Pagan Lagrange Multiplier test is used to test the random effect
model against a simple pooled Ordinary Least Squares (see Appendix D for more
information on fixed effect and random effect models).
The choice of these models is considered appropriate for two reasons. First, these
models are well suited for analyzing electricity sector panel data from a varied sample of
countries and states, as they can assist in controlling for unobserved heterogeneity. In
their review of different methodological options for carrying out the econometric analysis
23 Vagliasindi (2013) has three Indian states – Gujarat, Maharashtra and Andhra Pradesh – in her sample of
22 countries and states while Nagayama (2010) study covers Bangladesh, Pakistan and India but does not
include Nepal or any of the Indian states
130
of electricity market reforms, Jamasb et al (2005) identify fixed effects and random
effects models as being among the best options. Second, using fixed and random effects
is helpful for comparing the results of this study with past studies on electricity market
reforms carried out by others such as Vagliasindi (2013) and Nagayama (2008), both of
which make use of fixed effect and random effect models.
A possible concern for identification is that reform may be endogenous. In
particular, there may be unobservable state/country level factors that impact performance
in the electricity sector and also drive reform. Reverse causality is also a potential
concern as electricity sector performance may impact timing of reform. For example, the
government may privatize very poorly performing utilities first, since they are keen to
dispose of them, while better performing utilities may be sold off more slowly.
Another potential concern is the inclusion of different units of analysis (i.e. states
and countries) which could be a problem if the relationships between reforms and
outcomes are not similar in states and countries.
This study addresses these problems to some extent by including country and year
fixed effects. The country fixed effects control for country specific propensities to reform
that are time-invariant. For example institutional quality of a state in so far as it is time-
invariant, is controlled for by country fixed effects, and will not bias our results.
Similarly, year fixed effects control for any general trend in the reform of electricity
sector. The potential impact, if any, of having different units of analysis is also lessened
by fixed effects.
131
One strategy for dealing with endogeneity is to use instrumental variables
estimation. Instrumental variable estimation uses as "instruments" variables thought to
have no direct association with the outcome. However, appropriate instrumental variables
that are strongly correlated with electricity market reform variables (but not sector
performance variables) are difficult to find in South Asia24. Since the use of weak
instrumental variables can lead to estimates that are inconsistent and have large standard
errors, instrumental variables were not used to address endogeneity in this study (see
Appendix J for detailed analysis of the issues associated with the selection of
instrumental variables in this study, including list of instrumental variables that were
considered but ruled out in this study).
Section 2d: Expected Signs
The expected direction of signs of the impact of reform policy variables on
performance indicators are as follows:
• Private sector participation in generation
Private sector participation in generation can be expected to raise economic
efficiency by (1) changing the allocation of property rights to ensure better alignment of
incentives; (2) removing dependence on taxpayer support and exposing enterprises to the
disciplines of the private market; and (3) removing political interference and capture by
24 The availability of appropriate instrumental variables for electricity sector reform variable is widely
recognized to be critical constraint in the econometric literature on electricity sector reforms. For more
details, please refer to Jamasb (2005).
132
special interest groups. The increase in share of private sector participation in generation
is expected to increase investments in the power sector and thus have a positive impact
on both per capita generation capacity and electricity consumption. The impact on
electricity access is likely to depend on whether the additional capacity is utilized only
for meeting the growing needs of existing consumers or to electrify places without
electricity. Since a commitment to cost recovery often comes along with private sector
participation in generation, the average tariff for electricity can be expected to go up.
There is unlikely to be a direct relationship between greater private sector participation in
generation and T&D losses.
• Unbundling of vertically integrated utilities
Coase and Williamson among others have shown that the gains from unbundling
the utility by separating the generation, T&D components are worthwhile when they
exceed the costs of transactions among the separated segments. Even when such gains are
not likely, unbundling of accounts, staff, and management among the main functions
helps regulation of the electricity sector by revealing information about the costs of
different segments, increasing the transparency of price setting, and helping benchmark
costs and service standards (J. E. Besant-Jones, 2006). In South Asia, unbundling has
largely only involved organizational unbundling of utilities with no change in ownership
of the unbundled utilities. There has also generally been no change in the level of
competition in the electricity market as a result of the unbundling. In this context, the
benefits from unbundling and corporatization can be expected to be limited.
• Establishment of an independent regulatory commission
133
Electricity generation is characterized by long term sunk investments, which is
why an effective regulatory system is crucial for both investor confidence and consumer
protection. The primary purpose of a well-designed regulatory system is to protect
consumers from monopoly abuse, while providing investors with protection from
expropriation and incentives to promote efficient operation and investment (Y. Zhang et
al., 2005). Operationalization of an independent regulatory commission is likely to reduce
government interference in the functioning of the sector, enabling sector participants to
charge tariffs that are reflective of costs. This is likely to give them an incentive to make
more investments into the sector and hence have a positive impact on the performance
indicators (i.e. increase in access and total generation and reduction in T&D losses). Like
with greater private sector participation in generation, average tariffs can be expected to
go up with the establishment of an independent regulatory agency.
• Privatization of Distribution Companies
Privatization of distribution companies is generally undertaken to attract private
investment and management expertise in the distribution segment of the electricity and as
part of efforts to introduce competition in the electricity. Privatization of distribution also
generally reaffirms the government’s decision to operate the electricity sector according
to commercial principles underpinned by cost-reflective tariffs. South Asian countries
and states have had limited success in increasing private sector participation in
distribution; only Delhi and Orissa in India have completed privatization of distribution
utilities so far. Privatization is expected to yield net welfare benefits to power consumers
in particular and society in general, while private service providers are expected to earn a
134
competitive financial return for their investment risks. In general, privatization of
distribution is can be expected to have a positive impact on performance indicators
except average tariff, which can be expected to increase.
• Political Stability
Political stability in the reforming countries and states is likely to be helpful in
sustaining political commitment to reforms in the face of considerable political risks.
Reforms are likely to have significant short term costs and often uncertain long term
benefits. Countries that have stability of key rule makers are likely to have greater chance
of succeeding at reforms than countries and states with significant turnover of key
decision makers (S. C. Bhattacharyya, 2007c).
Likewise, political stability is more supportive of a co-operative outcome between
governments and private sector players. In absence of strong formal institutions and
mechanisms, the folk theorem suggests that informal and relational arrangements
between the government and investors can help achieve cooperation (A. K. Dixit, 2007).
The insight is based on the idea that when agents interact only once, they have an
incentive to deviate from cooperation. But in a repeated interaction over a sufficiently
long horizon, players can sustain a mutually beneficial outcome. Hence political stability
is likely to be positively associated with performance indicators.
Table 5-6 - Summary of expected signs of relationship between reforms and
performance
Per Capita
Access to
Electricity (%)
Per Capital
Electricity
T&D Losses
(%)
135
Generation
Capacity
(Kw)
Consumption
(KwH)
Average Tariff
(US $ cents)
Share of
Private
Sector
Participation
in Generation
NA
Unbundling of
Utilities
NA NA NA NA NA
Independent
Regulatory
Commission
Privatization
of
Distribution
Section 3: Results
The results of the fixed effects and random effects regression analysis are
presented in
136
7 and Error! Reference source not found.8, respectively25. The results of the
Hausman and Breusch and Pagan Lagrange Multiplier Tests indicate that the fixed effects
model is an appropriate specification for all performance indicators except electricity
access, where the random effect specification is preferable (Table 5.9). The direction of
the statistically significant relationships between reform variables and performance
indicators is given in Table 5.10. Results estimated for Indian states only are very close to
the results of the overall sample, indicating that the relationships between reforms and
outcomes is similar for states and countries (see Appendix F).
• Access to Electricity
There is positive and a statistically significant relationship between electricity
access and private sector participation in generation, unbundling and independent
regulation. Private sector participation in generation, unbundling, and independent
regulatory agency are associated with 3.6%, 4.0% and 5.4% increase electricity access,
respectively, which suggests a highly consequential relationship between reforms and
electricity access. This also means that reform measures are not only translating into
greater investment and supply but also providing the impetus for connecting more people
to electricity. This is consistent with the findings of Vagliasindi (2013) who also finds
access to be positively related with these reform measures.
• Per capita Generation Capacity
25 Detailed results are in Appendix E. Results by the income and system size of states and countries are
given in Appendix G.
137
There is positive and a statistically significant relationship between per capita
generation capacity and private sector participation in generation, privatization of
distribution, and share of industry in GDP. These variables are associated with increases
of 0.21, 0.06, 0.16 KW of per capita generation capacity, respectively for a unit increase
in their values. It is not surprising that private sector participation in generation has
significantly higher impact on per capita generation capacity than privatization of
distribution since greater private sector participation in generation is likely to lead to
higher levels investments in generation capacity in the sector. Pre-reform, countries and
states in South Asia were finding it difficult to make adequate investments in electricity
generation capacity from government resources.
These results show that reforms that allow greater private sector participation in
generation have been successful in increasing investment. Furthermore, the increase in
private investment has more than compensated for the draw back in government
investment in the electricity sector. The positive relationship between per capita
generation capacity and GDP per capita and share of industry in GDP confirms the
hypothesis that countries require more electricity per capita as they industrialize and their
income levels rise.
• Per capita Electricity Consumption
Further confirmation of the effect of reforms on the availability of electricity is
seen in the relationship between reform variables and per capita electricity consumption.
There is positive and a statistically significant relationship between per capita electricity
138
consumption and private sector participation in generation, unbundling, and share of
industry in the GDP. These reform variables increase per capita electricity consumption
by 922, 107, 655 kwh/year, respectively for a unit increase in their values.
These results indicate that reforms are not only associated with a higher
investment in generation capacity but that they are also leading to an increase in per
capita electricity consumption. The link between generation capacity and electricity
consumption may seem obvious but this is not always the case. Increases in installed
generation capacity do not translate into increases in per capita electricity consumption if
the sector is inefficiently run with very low capacity factors or if the utility is unable to
offload electricity from private generators due to financial difficulties.
• T&D Losses
There is negative and a statistically significant relationship between T&D losses
and unbundling and privatization of distribution. These variables are associated with a
7.8% and 15%, decline in T&D losses, respectively. These findings suggest that
privatization of distribution can have a significant impact on technical and commercial
efficiency improvements in the electricity sector.
The results are consistent with the profit motive of private distributors; the more
T&D losses they can reduce, the greater their profit margin. By contrast, under
government ownership, distribution utilities may be driven by personal or political
motives and may not have as much incentive to crack down on electricity theft, which
causes T&D losses to be high.
139
The relationship between T&D losses and independent regulation is not
statistically significant. Independent regulatory agencies are for the most part expected to
push utilities to make improvements in T&D losses. However, the results show that such
a relationship cannot be established.
• Average tariff
Average tariff has positive and a statistically significant relationship with private
sector share of generation capacity, independent regulation, and unbundling and negative
and statistically significant relationship with privatization of distribution. The former
group of variables is associated with a US$ 2.6, 0.9, and 1.2 cent increase in average
tariff, respectively for a unit increase in their values. This represents a significant price
premium for consumers living in reform oriented states. It is likely that the increases in
average tariff in reforming states will be balanced by improvements in availability of
electricity. Privatization of distribution is associated with a US$0.9 cent decline in
average tariff.
Since ensuring cost recovery is often one of the main motives of electricity sector
reforms, it is not surprising to see a positive relationship between reform variables and
average tariff. The negative relationship between average tariff and privatization of
distribution suggests that efficiency improvements can help neutralize the upward
pressure on average tariff as a result of the application of cost recovery principles.
140
Table 5-7 - Regression Results (Fixed Effects)
VARIABLES
Per Capita Generation Capacity
Access to
Electricity (%)
Per Capita Electricity
Consumption
T&D Losses
(%) Average
Tariff
Unbundling 0.004 0.041*** 107.040*** -0.078*** 1.199***
[0.006] [0.010] [20.271] [0.024] [0.239] Share of Private Sector Generation 0.219*** 0.355*** 921.701*** -0.057 2.600***
[0.027] [0.045] [80.085] [0.102] [0.989]
Privatization of Distribution 0.059*** 0.031 48.805 -0.150*** -0.939*
[0.014] [0.022] [47.517] [0.042] [0.554]
Regulatory Commission 0.005 0.051*** -8.237 0.022 0.867***
[0.005] [0.008] [18.317] [0.023] [0.204] Share of Industry in GDP 0.162*** 0.404*** 655.913*** 0.161 12.873***
[0.043] [0.068] [142.052] [0.147] [1.803] Per Capita GDP 0.000*** -0.000*** 0.850*** 0.000*** 0.002***
[0.000] [0.000] [0.035] [0.000] [0.000] Political Stability -0.003 -0.003 21.817 0.018 -0.021
[0.005] [0.008] [16.245] [0.019] [0.199] Urbanization Rate -0.004 1.335*** -10.254 -0.324 -0.162
[0.004] [0.150] [10.511] [0.302] [0.126]
Constant -0.032*** 0.190*** -320.933*** 0.286*** 0.210
[0.010] [0.037] [33.349] [0.077] [0.415]
Observations 514 495 358 232 347
R-squared 0.480 0.636 0.841 0.194 0.546
Number of state_country1 30 30 30 28 30 Standard errors in brackets
*** p<0.01, ** p<0.05, * p<0.1
141
Table 5-8 - Regression Results (Random Effects)
VARIABLES
Per capita Generation Capacity
(Kw)
Access to
Electricity (%)
Per capita Electricity
Consumption (Kwh)
T&D Losses
(%)
Average tariff
(US $ Cents)
Unbundling 0.003 0.040*** 106.078*** -
0.076*** 0.923***
[0.006] [0.010] [21.022] [0.023] [0.241] Private Sector Share of Generation 0.198*** 0.360*** 858.542*** -0.113 2.215**
[0.026] [0.046] [82.149] [0.092] [0.946] Privatization of distribution 0.054*** 0.024 60.488
-0.137*** -0.297
[0.014] [0.022] [49.002] [0.041] [0.542]
Regulatory Commission 0.008 0.054*** 2.727 0.031 1.049***
[0.005] [0.008] [18.844] [0.021] [0.207] Share of Industry in GDP 0.164*** 0.420*** 708.399*** 0.049 6.801***
[0.041] [0.068] [141.996] [0.130] [1.548]
Per capita GDP 0.000*** -0.000*** 0.824*** 0.000* 0.002***
[0.000] [0.000] [0.035] [0.000] [0.000]
Political Stability -0.001 -0.003 22.482 0.021 0.035
[0.005] [0.008] [16.673] [0.018] [0.194]
Urbanization Rate -0.004 1.119*** -9.753 -0.081 -0.186
[0.004] [0.128] [10.990] [0.115] [0.134]
Constant -0.028** 0.236*** -276.181*** 0.271*** 1.600***
[0.011] [0.047] [44.194] [0.045] [0.389]
Observations 514 495 358 232 347
Number of state_country1 30 30 30 28 30 Standard errors in brackets *** p<0.01, ** p<0.05, * p<0.1
142
Table 5-9 - Fixed and Random Effects Tests
Per Capita
Generation
Access Per Capita
Electricity
Consumption
T&D Loss Average
Tariff
HAUSMAN TEST FOR FIXED EFFECT
Hausman
Test
24.08*** 2.58 245.72*** 17.2*** 310.98***
PREFERRED SPECIFICATION
Fixed
Effect
X X X X
Random
Effect
X
BREUSCH AND PAGAN LAGRANGIAN MULTIPLIER TEST
BPLM 2083.66***
PREFERRED SPECIFICATION
Random
Effect
X
Pooled
OLS
143
Table 5-10 - Summary of statistically significant findings
Per Capita
Generation
Capacity
(Kw)
Access to
Electricity (%)
Per Capital
Electricity
Consumption
(KwH)
T&D Losses
(%)
Average Tariff
(US $ cents)
Share of
Private
Sector
Participation
in Generation
Unbundling of
Utilities
Independent
Regulatory
Commission
Privatization
of
Distribution
144
Section 4: Conclusion
This paper uses panel data from 1990 to 2010 to assess the relationship between
electricity sector reforms – private sector share of generation capacity, unbundling of
power utilities, establishment of independent regulatory commissions, and privatization
of distribution – and electricity sector performance in 26 states in India and Pakistan,
Bangladesh, Nepal and Sri Lanka.
The analysis indicates that for the most part reforms are having a positive impact
on the performance of the sector. This is particularly the case for reforms that have
increased private sector participation in generation and distribution and have vertically
unbundled utilities into generation and T&D entities. The analysis carried out in this
chapter suggests that reforms are helping to increase the availability of electricity (as
measured by indicators such as per capita generation capacity, electricity access, and per
capita electricity consumption) and improve the efficiency of the sector (as measured by
reductions in T&D loss).
The improved performance is coming at a cost to consumers. Reform measures
such as private sector participation in generation, independent regulation, and unbundling
are correlated with higher average tariff. This is not surprising since one of the main
objectives of reforms is to improve the commercial orientation of the sector through cost
reflective tariffs. Privatization of distribution is the only reform measure to have a
negative relationship with average tariff, which suggests that efficiency improvements
achieved through privatization, especially with regards to T&D losses, can help ease the
pressure on tariffs. Overall, the analysis provides confirmation of the positive role played
145
by reforms in responding to chronic electricity supply shortages in South Asia and
improving efficiency.
The reform measure to have the weakest relationship with sector performance is
independent regulation. Establishment of an independent regulator does not have a
clearly established relationship with either T&D losses or average tariff. These
ambivalent findings for independent regulation are surprising and most likely reflect the
manner in which it has been implemented in South Asia.
While a large number of governments have established independent regulators in
South Asia, they have not equipped them with adequate resources and capacity to
function effectively. Factors that have inhibited the effective functioning of independent
regulators in South Asia include but are not limited to (i) delays in operationalization; (ii)
inadequate staffing and budget; (iii) political interference; (iv) weak enforcement of
regulatory directives; and (v) inadequate technical skills to carry out regulation (Pargal,
2014).
The results of this study are generally consistent with the findings of studies
carried out in other regions and countries, although there are also some important
differences. For example, Zhang, Parker and Kirkpatrick (2008) find that privatization is
not positively correlated with performance indicators, but here privatization is seen to be
positively correlated with performance indicators. Vagliasindi (2013) and Nagayama
(2010) find that the establishment of an independent regulator is positively correlated
with performance indicators. This is again different from the findings of this study which
show a limited relationship between regulatory independence and sector performance.
146
As countries in South Asia consider the next steps in the reform process, this
analysis provides indication that reforms are largely having a positive impact on sector
performance. However, this analysis has number of limitations. First, this analysis
focuses on five performance indicators - electricity access, per capita generation capacity,
per capita electricity consumption, T&D losses, and average tariff. There are number of
other relevant performance indicators such as labor productivity, service quality and
reliability, fiscal burden of the power sector, environmental sustainability, and poverty
that need to be analyzed to arrive at a full picture of the impact of reforms in South Asia.
Second, there is a need to consider additional institutional, governance and
political economy factors while assessing the impact of electricity sector reforms. The
current model takes into account political stability but there could be other measures that
could be relevant. While the fixed effects model used in this paper factors in time-
invariant differences in countries and states, it does not take into account factors that
would have changed during the review period such as the level of corruption and the
business environment. Future work in this area could include such variables in the model.
Third, this analysis uses dummies to represent many of the reform variables. The
drawback of this approach is that dummy variables cannot entirely capture range of
different implementations of reforms. Such a representation of reforms lump states and
countries that have implemented a reform measure well with others that have initiated
regulations relating to these reforms but are lagging behind significantly in implementing
these regulations.
147
Independent regulation, for instance, is measured using a dummy variable on the
establishment of an independent regulator. However, as has been noted elsewhere in this
dissertation, just because the government announces that a regulatory commission will set
up to be independent, does not mean that the regulatory commission will function
independently. Governments may directly (through directives) or indirectly (by
controlling the budget and appointments) work to undermine the regulatory commission’s
independence. In so much as the dummy variable does not measure the actual
independence of regulatory commission, the results that we get in this study only show
the relationship between the formal establishment of an independent regulatory
commission and performance. Future studies could build make use of variables that
measure the actual independence of the regulatory commission and sector performance.
Fourth, this analysis makes an effort to limit endogeneity by using fixed effects
but is not able to completely rule it out. Reverse causality is a potential concern as
electricity sector performance may impact timing of reforms, something which would not
be solved through effects. Endogeneity can be addressed by using instrumental and
lagged variables and dynamic modeling but this, as noted by Jamasb, is limited in the
electricity sector by the lack of suitable data (Jamasb, 2005). Addressing endogeneity in
studies on electricity market reforms in a dynamic context in which policy decisions can
be influenced by past performance is a relevant research issue that needs to be pursued in
the future.
Fifth, the fixed effect model used in this study does not work well with data for
which within-cluster variation is minimal or for slow changing variables over time. In
148
this study, since fixed effects measures the average "within" effect of the countries/states
in the analysis, the inclusion of countries that don’t have strong rule based governance
systems is likely to dampen the impact of reform measures on performance.
These results indicate that electricity sector reform measures are having a positive
impact on electricity sector performance in South Asia. However, they also indicate the
need to reserve judgment on key pieces of reforms such as independent regulation.
Estimation of the long run effects of the reform on prices will have to wait until a longer
time series becomes available. The regulatory reform in the electricity supply is still an
ongoing process in many countries, which underscores the importance of continuing to
analyze the impact of reforms.
149
Chapter 6 - Analytical Narrative on the IPP Experiences of
Nepal and the Indian State of Gujarat
Section 1: Introduction
The econometric analysis undertaken in the previous section is useful for drawing
robust links between different reform variables and performance. It is useful for
answering well defined questions associated with observable elements of reform and
generating generalizable results. However, econometric analysis is not able to capture
fully the unobservable elements of institutional and regulatory reform in the electricity
sector. As discussed earlier, one of the main insights of NIE is that the same observable
elements can be part of different institutions. Identical rules and organizations can be
components of institutions that differ in their beliefs and norms and hence implications.
Econometric analysis is insufficient for understanding institutional and regulatory
arrangements in the electricity sector because various institutional elements such as
informal norms and beliefs that motivate behavior are not directly observable.
Econometric analysis of institutions is limited by the problems of having to cope with too
many endogenous and unobservable variables whose causal relationships are not
understood and whose implications depend on the context (Greif, 2006).
This section therefore supplements the analysis in the previous section by
carrying out detailed context specific analysis of the implementation of electricity market
reforms. To keep the analysis tractable, the analysis particularly focuses on the
introduction of IPPs in the Indian state of Gujarat and Nepal.
150
Nepal and Gujarat introduced IPPs in the early 1990’s to attract private
investment, increase generation capacity, improve efficiency, and increase electricity
access (S. C. Bhattacharyya, 2007c). Yet after two decades, these reforms have had
markedly different results in the two places. Gujarat is a well-known success whereas
Nepal is facing a severe energy crisis.
There were some differences in the timing and content of formal reforms in
Gujarat and Nepal but these differences are not sufficient to account for the striking
differences in performance of Gujarat and Nepal. This paper reviews the contrasting
reform experiences of Nepal and Gujarat from the perspective of NIE, based on a model
of electricity market reforms under rule based and relation based systems.
This approach follows Avner Greif in interactively using deductive theory,
contextual knowledge of the situation and history and context specific modeling to
develop and evaluate conjectures about electricity market reforms (Greif, 2006).The
analysis demonstrates how the robust formal institutions of Gujarat contributed to the
strong performance of its electricity market reforms whereas the weakness of formal
institutions and the dominance of collectivist beliefs as well as political instability limited
the success of reforms in Nepal.
Section 2: Narrative
Section 2a: Pre-reform Period
In years immediately preceding the reforms, the electricity sectors of both Nepal
and Gujarat were dominated by vertically integrated state owned utilities – the NEA and
151
Gujarat Electricity Board (GEB). Of the two, GEB had a longer history, having been
constituted in 1960, at the time of the formation of the state of Gujarat (Indian Institute of
Planning and Management, 2006). NEA was formed in 1985 out of the merger of the
Department of Electricity and Nepal Electricity Corporation – two institutions that had
until then been responsible for development of the power sector and operation and
maintenance, respectively (World Bank, 1992a).
• Gujarat
Until 1976, the development of electricity infrastructure in Gujarat was the
responsibility of GEB and the state government. The establishment of National Thermal
Power Corporation Limited and National Hydro Power Corporation Limited in 1976
increased the central government’s role in development of electricity infrastructure
(World Bank, 1986)26 but did little to reduce the importance of state agencies.
Under this state led approach, Gujarat was one of the early leaders in rural
electrification in India. With generous subsidies from the state government, it was also
able to keep the increases in electricity tariffs in check. However, by the late 1980’s, this
state led approach to the development of the sector had reached its limits. The GEB was
highly inefficient, making large financial losses and not in a position to meet the
electricity needs of the state. The state and central governments were fiscally constrained
26 These agencies were to construct and operate large power stations and associated transmission facilities and sell bulk power to the State Electricity Boards across India, including GEB
152
and unable to be of much help. World Bank documents from the mid-1980’s offers the
following assessment of the GEB:
The GEBs' management and operational capabilities have not kept pace with the
expansion of supply. In general, GEB…lacks experienced personnel in financial
planning and control. The relatively low status and pay of these personnel
exacerbates the already significant pay differential between the public and private
sectors and makes it difficult to recruit competent staff. Management practices are
generally outmoded. Despite espousing energy prices "which reflect true costs" in
both the Sixth and Seventh Plans, the Government, until now, opposed the
principle of economic pricing of power, for reasons associated with social and
agricultural objectives (World Bank, 1986, p.17).
• Nepal
The state of affairs was even starker in Nepal. Against 83,000MW of hydropower
potential, the government and the utility had only developed 125MW by 1984. Electricity
tariffs were extremely low relative to costs. Documentation of the World Bank’s
interactions with Government of Nepal in the mid-1980 has the following assessment:
There has been reluctance in Nepal to raise tariffs even in the face of increasing
costs. Consequently, the present tariff level, averaging 81 paise/kWh, which was
increased in May 1983 for the first time in three years, is still on the low side and
has been a major factor in Nepal Electricity Corporation’s depressed earnings.
153
This average tariff level compares to the estimated average long run marginal cost
of NRs 2.50 per kWh (World Bank, 1984p.31).
The electricity system was highly inefficient, with T&D losses amounting to
30.5% of total generation. Improper metering and theft of electricity was widespread.
Government departments and major industries were delinquent in settling their accounts
with the utility, without consequences.
There was political interference in the day to day operation of the utility, which
caused its staffing for instance to grow dramatically from 3,200 in 1984 to 9,400 in 1991
without a corresponding increase in sales and installed capacity. By the late 1980’s NEA
was assessed to be seriously overstaffed, while at the same time being deficient in key
personnel in nearly every functional area (World Bank, 1992a). NEA had the lowest
annual sales and generation per employee in Asia. The World Bank noted:
…the scarcity of spare parts and inadequate maintenance of its older plants have
resulted in a progressive decline in generating plant efficiency and availability
which may be seriously aggravated unless action is taken to rehabilitate these
plants. At the same time, delays in the expansion and reinforcement of the T&D
system have led to increased system losses, interruption of supply and
deterioration of service. NEA's financial position has become very weak due to
stagnant tariffs and financial management deficiencies (World Bank, 1992, p.18).
154
Section 2b: Implementation of Reforms
Nepal and Gujarat27 embarked on the electricity sector reform process in the early
1990’s by first focusing on increasing generation capacity through the introduction of
IPPs. The introduction of IPPs represented the adoption of a more commercial
philosophy to develop the sector.
Implicit in this development was the principle of cost recovery to ensure the
financial sustainability of the electricity sector. Since electricity utilities would be
entering into PPAs with IPPs, utilities would have to charge cost reflective tariffs. It was
anticipated that the state owned vertically integrated utilities would be transformed into
more efficient and highly performing units.
• Nepal
In the early 1990’s, Nepal underwent dramatic political changes that greatly aided
the reform push in the electricity sector. These changes culminated in a sharply reduced
role for the monarchy and a democratically elected government in May 1991. The new
government inherited a fiscal crisis created in part by the financial burden imposed by
state owned enterprises such as the NEA. In response, the government committed to a
private sector and market led growth model (World Bank, 1992a).
27 Since electricity is a concurrent in India’s constitution with both the state and central government sharing responsibility, the enabling legislation for IPPs was passed by the Central Government while the implementation of individual projects were undertaken at the state level.
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In the electricity sector, it adopted reforms to move from a state led bureaucratic
approach to commercialization of NEA and private sector participation in hydropower
development. A new Hydropower Development Policy and an Electricity Act were
adopted in 199228 to allow private sector participation in generation, transmission, and
distribution. Fiscal incentives such as income tax exemption, tax rebates, and dollar
denominated PPAs were provided to attract foreign investment (S. C. Bhattacharyya,
2007c).
An ETFC was established in 1994 to provide greater transparency and
predictability to the electricity tariff setting process. While the Committee did not have
the full mandate or responsibilities of an independent regulatory commission, it was
empowered to set tariffs in accordance with financial principles, including automatic
adjustment to reflect changes in fuel costs. The ETFC registered early wins when it was
able to more than doubled electricity tariffs in real terms over a 30-month period.
In parallel, the NEA undertook reforms to improve organizational effectiveness
and efficiency. With the help of a World Bank funded technical assistance, NEA created
a human resources department and created an in depth training program for its staff. The
accounting and financial functions of NEA were also strengthened (ADB, 1996). Canada,
France and Germany provided technical assistance to improve internal management
systems, including operations and maintenance (World Bank, 1992b). A program was
28 In addition, the NEA Act of 1984, which covers the establishment, capital management, functions, duties and powers of NEA, was amended and the Water Resources Act, which provides for the management of water resources and issuing of licenses to corporate bodies for the use of water resources, was adopted.
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implemented to identify and systematically reduce network losses and to reduce
overstaffing.
These developments on the organizational and regulatory front invited a positive
response from a consortium led by Statkraft, a Norwegian electricity utility, which
mobilized resources for the 60 MW Khimti Khola project. The project also received co-
financing from the International Financial Corporation and the ADB. The developers
successfully negotiated a PPA with the NEA (Norway wins BOOT deal for 60MW plant,
1996). The successful initiation of the project spurred additional private sector interest in
Nepal’s electricity sector. By 1996, the government had granted licenses for 10 private
sector projects with total installed capacity of 1300MW (Pradhan, 1996).
However, this interest did not translate into actual private sector investments, and
reforms appeared to stall in the late 1990’s. By the year 2000, Khimti Khola was the only
major private sector project to be completed along with three smaller private projects.
The total installed private sector capacity in the country stood at 113MW – a fraction of
the projects for which NEA had issued licenses earlier in the decade. The only major
hydropower investment in the country – the 144MW Kaligandaki Hydroelectric Project –
was undertaken by the government with a financing from the ADB (ADB, 2012a).
The lack of interest from the private sector spurred a round of legislative and
regulatory changes in the early 2000’s. While the legislative framework of the early
1990’s had put the onus for developing projects squarely on the private investor, the 2001
revision of Hydropower Policy proposed to “minimize the potential risks in hydropower
projects with a joint effort of the government and the private sector, and to make
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provisions for allocating risks to either the government or private sector based on their
capability to bear the lowest cost.” Stated policies included:
• “Implementation of hydropower projects based on the concept of Build, Operate,
Own and Transfer shall be encouraged”; and
• “Appropriate incentive provisions shall be provided and transparent process shall
be pursued to attract national and foreign investment in hydropower
development.”
The 2001 policy proposed the establishment of a new independent regulatory
commission for the electricity sector29 (Government of Nepal, 2001) and the
organizational restructuring of NEA through the creation of five core business groups for
generation, transmission and system operation, distribution, electrification and
engineering services30(World Bank, 2009b).
These reforms barely moved the needle on private sector investments in the
electricity sector. Between 2002 and 2006, private investments accounted for only about
40MWs installed generation capacity (NEA). A major reason for this was the
intensification of the Maoist insurgency in the country, which directly impacted the
electricity sector. The Maoist insurgents for instance attacked the 62.5-MW Khimti
Khola hydro plant, Nepal's largest IPP, in October 2002 causing substantial damage to
29 In line with this objective, a bill was prepared to establish the Nepal Electricity Regulatory Commission but this bill was never enacted. 30 A Draft Electricity Act was prepared to push the reforms in the electricity sector. Important areas of focus of the draft act included (i) time limit for licensing provisions; (ii) land acquisition by the government; and (iii) the introduction of a performance guarantee fee on developers. However, the bill was not enacted 2264 World Bank 2011.
158
power plant structures. Likewise, Maoist threats caused another private station - Bhote
Koshi power plant – to close operations in October 200331 (AFP, 2003).
Maoist threats and actions served to discourage private sector investments in the
electricity sector during this period (T. Bhusal, 2009). In 2002, the Australia-based
Snowy Mountain Engineering Company signed a PPA for the 750 MW West Seti
hydroelectric project with Power Trading Corporation of India and was scheduled to
begin construction from 2004. However, the Company was unable to raise sufficient
financing for the project and abandoned it (International Media Network, 2011).
An additional factor contributing to the poor investment climate was the
reluctance of the ETFC to raise electricity tariffs between 2001 and 2011 because of
political pressure from the government, even as electricity generation costs were
increasing dramatically in this period (World Bank, 2011). This served to undermine the
confidence private investors in the NEA to live up to its PPAs.
There was a flurry of interest in the hydropower sector from foreign investors
after the Maoists joined the political mainstream in 2006. The Power Summit 2006 in
Kathmandu organized by the IPPs' Association of Nepal and Power Trading Corporation
of India drew major international investors from India such as GMR Energy, Tata Power,
Reliance Energy, and Everest Power Private Limited. Subsequently, the Nepal
31 The completion of electricity generation projects being undertaken with public investments such as the Mid-Marshyangdi hydroelectric project were also delayed due to security threats from Maoists.
159
government invited bids for the 600 MW Buri Gandaki, 402 MW Arun III and 300 MW
Upper Karnali projects.
However, for various reasons, none of the projects got off the ground. For
instance, a committee formed to assess the bids adjudged GMR's bids the best for Upper
Karnali and Arun III. However, the bid was blocked by a parliamentary committee after a
French company - Elysee Frontier – claimed to have had its license for the project
terminated illegally by the previous government ((Indo-Asian News Service, 2007).
Thus, the government was unable to attract expected amounts of private
investment in electricity generation. Since the government’s strategy for development of
the sector had relied greatly on private sector investments, this left Nepal with an
electricity crisis from 2006 onwards. Power outages lasting more than 12-14 hours a day
have been a norm in Nepal, an effect which has adversely impacted the country’s
economic growth and development (World Bank, 2011).
• Gujarat
Since electricity is a concurrent subject in the Indian constitution32, the
overarching legal and regulatory framework is set by the central government while
32 The organization of the power sector is determined by India’s federal structure. The Government’s Ministry of
Power provides overall guidance to the sector, mainly through the Central Electricity Authority, and owns the central power sector utilities such as the National Thermal Power Corporation (NTPC), the National Hydroelectric Power Corporation (NHPC), the Nuclear Power Corporation (NPC), and the Powergrid Corporation of India (Powergrid), and Financing institutions such as the Power Finance Corporation (PFC) and the Rural Electrification Corporation. State governments control the rest of the sector through 20 state electricity boards (SEBs) and 12 electricity departments (EDs). These SEBs and EDs provide distribution facilities and set retail tariffs. Power generation and transmission are split between the central power sector agencies and SEBs. The central agencies own and operate 32 percent of the country’s total generation, while SEBs and EDs have 64 percent of the total.
160
implementation is undertaken by state governments. Accordingly, the state of Gujarat
embarked on its power market reform process after the Indian central government
amended the national legislation governing the electricity sector in 1991. The Electricity
Laws Amendment Act of 1991 provided for 100 percent foreign ownership of power
generating plants, a guaranteed return of 16 percent on equity, a five year tax exemption,
and other generous investment incentives (S. C. Bhattacharyya, 2007c)33 (See Table 6.1
for a comparison of incentives provided to IPPs by Nepal and Gujarat).
Figure 6.1 - Incentives for IPPs in Nepal and Gujarat
Nepal Gujarat (India)
100 percent foreign ownership of
generating plants
Returns for IPPs based on negotiations
with the utility
Exemption from income tax for a period of
fifteen years
Reduced customs duty on import of
equipment to attract private investment
100 percent foreign ownership of
generating plants
Guaranteed returns of 16 percent on equity
Exemption of income tax for five years
No Reduction in customs duty on import of
equipment
33 Overall, the incentives provided for IPP developers by Gujarat are similar to the ones provided by Nepal.
161
In 1993, Gujarat became one of the first states in India to reach agreement with an
IPP, Essar, for a 515-MW naphtha and natural gas-fired power plant. The company was
able to sign a PPA with the GEB in 1996 and start generation in 199734 (Woodhouse,
2006). This was followed by a number of other private investments, including the
655MW Paguthan power project35.Overall, Gujarat saw the completion of 2500MW of
generation capacity through three large IPPs agreements in the first decade of reform.
This was the second highest among the 29 states in India (PPIAF, 2014).
Yet there was little improvement in the operational and financial performance of
the GEB. The GEB continued to make large financial losses, which served to limit the
amount of private investments in Gujarat’s electricity sector (Planning Commission,
2002). The recognition of these constraints by the government spurred a second round of
reforms36 in the electricity sector in the late 1990’s and early 2000’s.
An independent regulatory authority, the Gujarat Electricity Regulatory
Commission, was established in Gujarat in 2000 to determine tariffs and regulate the
procurement of electricity from IPPs. To improve operating efficiencies and reform the
34 The plant’s was originally scheduled to start generation from 1995 but delays in raising finance, lack of clarity regarding the Government’s gas provision policy as well as petitions in the country’s Supreme Court challenging the power project as being against public interest led to delays in efforts to start the project. The PPA was renegotiated once, in August 2003, reducing a number of pass-through variable costs, including interest rate reductions through refinancing and fuel cost reductions through the switch to gas. 35 The Paguthan project was developed in Gujarat by the Indian owned Torrent Group (74%) with equity participation of Siemens of Germany (14%) as well as Government of Gujarat (12%). 2266 Woodhouse, Erik J 2006. Comment: What is this? A reference? 36 These included the Electricity Regulatory Commission Act 1998 and Electricity Act 2003 at the central level and the Gujarat Electricity Industry Act at the state level.
162
sector, the GERC issued performance standards for T&D licensees and competitive
bidding guidelines for procurement of power by distribution licensees. The GERC made
regular revisions to the electricity tariff to ensure cost recovery in the electricity sector
(Indian Institute of Planning and Management, 2006).
The GEB was unbundled into a generation company, a transmission company,
and four distribution companies in 2005 (see Figure 6.2). The unbundling of GEB helped
improve the operational efficiency through decentralized decision making, and improved
accountability; and competition (R. Mohan, 2008, p.8).
These reforms led to concrete improvements in the operational and financial
performance of Gujarat’s electricity sector. There was consistent decline in T&D losses
and a corresponding improvement in the profitability of the electricity utilities (R.
Mohan, 2008) (see Figure 6.3 and Figure 6.4). Private investors noticed these
improvements and responded by significantly increasing their investments in Gujarat’s
electricity sector. A significant share of this investment was from international investors
such as Carapo Group (UK), Asian Genco (Singapore), China Power and Light
(Hongkong), and AES Corporation (USA) (PPIAF, 2014).
Figure 6.2 - Current Structure of Power Sector in Gujarat
GUVNL
(Holding Company)
GSECL
(Generation)
GETCO
(Transmission)
MGVCL
(Distribution)
PGVCL
(Distribution)
UGVCL
(Distribution)
DGVCL
(Distribution)
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Figure 6.3 - T&D losses and Aggregate Technical and Commercial losses (%)
Figure 6.4 - Average Realization, Cost to Serve & Profit before Tax (Rs. million)
Source: Data provided by GUVNL
Section 2c: Outcomes of Power Sector Reforms
There is a striking difference in the performance of Gujarat’s and Nepal’s
electricity sectors after two decades of reform. Gujarat added more than 7178 MW of
private sector funded generation capacity between 1990 and 2010 – 46 times the 158MW
added by Nepal (see Table 6-1 and Figures Figure 6.5 and Figure 6.6). By way of
Pre-reforms Post reforms
164
comparison, Gujarat’s population is only twice the size of Nepal’s population and its
GDP is only five times as high as Nepal’s GDP. There is hence a significant difference in
performance even when the relative population and economic strength of the two places
is taken into account.
Gujarat added 2,500 MW in the first ten years of reform compared to 96MW for
Nepal. In the second decade of reform, Gujarat added 4,700MW of private sector
generation capacity compared to 58MW for Nepal. Gujarat became more attractive to
private investors as reforms matured while Nepal slipped in its ability to attract private
investment.
The superior performance of Gujarat in attracting private investment carries over
into other electricity sector performance indicators such as total generation capacity,
electricity access, electricity consumption, T&D losses, financial performance of utilities,
cost per unit of electricity, and power availability. Gujarat was able to get almost 90% of
its population connected to electricity compared to 37% in Nepal. Gujarat’s per capital
electricity consumption in 2010 was almost 20 times higher Nepal’s. People living in
Gujarat face no power outages in 2010 while people living Nepal face more than 12
hours of power outages every day.
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Table 6-1- Pre and Post Reform Power Sector Performance Indicators
Gujarat Nepal
Item Start Year Latest
Available
Year Initial Year Latest
Available
Year
Population (Million) 40 1990 59 2010 18 1990 27 2010
GDP ($ Billion) 12 1990 94 2010 4 1991 19 2010
GDP per Capita ($) 302 1990 1356 2010 200 1990 596 2009
Total Power Generation
Capacity (MW) 4793 1990 15722 2011 275 1990 721 2010
IPP Generation
Capacity (MW) 0 1990 7178 2011 0 1990 156 2010
Cost Per Unit (US $
Cents/kwh) 4.8 1991 9.6 2010 5.5 1991 10.2 2010
Average Electricity
Tariff (US $ Cents/kwh) 3.4 1991 8.9 2010 4.2 1990 7.5 2009
Profit/Loss Of Utility ($
Million) 32.7 1993 84.2 2010 -11.4 1991 -95.2 2010
Per Capita Consumption
Of Electricity 469 1990 1615 2010 35 1990 93 2010
Source: Compiled by the author from various sources
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Figure 6.5 - IPP Installed Capacity, 1990-2011 (MW)
Figure 6.6 - IPP Investments, 1990-2011 ($ billion)
Overall, Gujarat is cited as a model state in attracting private sector investment
(CRISIL, 2006). Nepal, by contrast, has had limited success with private sector
participation in the electricity sector. Nepal has been unable to exploit its large hydro
potential. As a result, new generation capacity has failed to keep pace with rapid growth
in demand, and the country is currently experiencing an energy crisis of unprecedented
severity (World Bank, 2011).
7178
158
Gujarat Nepal
9.4
0.2
Gujarat Nepal
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Section 3: Theory and Model
It is apparent from the previous section that electricity market reforms in both
Gujarat and Nepal responded to similar challenges and endeavored to achieve similar
results. There were some differences in the timing and content of reforms in Gujarat and
Nepal but the differences in the formal rules and regulations are not sufficient to account
for the striking difference in performance of Gujarat and Nepal.
This necessitates a deeper study of norms and beliefs that motivate behavior and
are not directly observable. How did informal beliefs and culture of Nepal and Gujarat
influence the implementation of electricity market reforms? How prevalent are relation
based arrangements? How were foreign investors treated? How strong or weak are formal
institutions such as the judiciary? How easy or difficult is it to enforce contracts? These
are some factors that influence the performance of reforms and need to be examined.
A case study can give rich and detailed description of the facts of each situation.
However, like econometric analysis, it can leave the basic question of cause and effect
unresolved. To correct this deficiency, the analytical narrative approach used in this
section, adapts “off the shelf” models developed by Dixit and Li, to establish a set of
hypotheses about causes and effects and then examines all the logical consequences of
the hypotheses under consideration. It identifies elements common to many situations and
cases and seeks to give a sharper and deeper understanding of the forces and mechanisms
(A. K. Dixit, 2007). While for reasons of tractability this work abstracts rich details of
specific contexts, it seeks to improve understanding of the electricity market reforms by
interpreting them in light of an appropriate model to identify the insights.
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Game theory provides an analytical framework within which it is possible to
restrict the set of admissible rules, beliefs and behavior based on social norms and rules
and study the way in which behavior is endogenously generated (A. K. Dixit, 2007). The
following section describes a game theoretic model, to facilitate analysis of the
differences between rule based and relation based institutional systems37.
Section 3a: Modeling the Relationship between IPPs and the Utility/Government
There is a potential for both IPPs and the government to benefit from a contract in
which IPPs provide electricity to the utility at a pre-agreed rate or formula through a
PPA. The government is able to meet the electricity needs of the country without having
to make a capital investment. It is also able to gain access to private sector technical and
managerial expertise and under competitive bidding may even be able to gain access to
electricity at a rate cheaper than it could produce on its own. The private sector gains
access to an assured revenue stream from the government and can be confident of making
a good return on its investment.
However, since electricity does not involve simultaneous exchange of good and
services and does not have immediately verifiable attributes, each participant in the
process usually has available to him various actions that increase his own gain while
37 Grief and Dixit construct many game theoretic models to undertake institutional analysis. Dixit models the
emergence of alternative institutions that support economic activity when a government is unable to or unwilling to provide adequate protection of property rights and enforcement of contracts (Dixit 2007). Greif examines the cultural factors that led two pre-modern societies - the eleventh century Maghreb traders from the Muslim world and the twelfth century Genoese traders from the European world - to evolve along distinct trajectories of societal organization (Greif 2008).
169
lowering the others gain by a greater amount. For instance, IPPs may not complete the
project on time or not provide the agreed amount of electricity. Likewise, the government
may renege on payment or could expropriate the investor’s assets. Williamson uses the
term “opportunism” to label actions that results in gains for the individuals but hurt the
group as a whole (Williamson, 1979).
Game theory studies many instances of this, most notably the prisoner’s dilemma.
IPPs first make an investment (Invest). The government then takes action to ensure the
benefits of the investment are shared with the IPP by making payment for sale of
electricity at agreed rates (Share). If the government follows through with its payments,
both parties will get a positive outcome or game theoretic pay off. However, the
government can instead take an opportunistic action (Hold Up), which will yield it a
larger payoff but the IPP a negative payoff. If the IPP lacks confidence that the
government will follow through with its payments, it may choose not to make an
investment (Don’t Invest).
In game theory terms, (Don’t Invest, Hold Up) is the only Nash equilibrium; for
any other strategy combination, one of the players wants to deviate to a different strategy.
In this outcome both players get 0, but both would be better off if they could achieve
(Invest, Share). This is also known as a one sided prisoner’s dilemma (see Table 6-2).
170
Table 6-2 - One Sided Prisoner's Dilemma38
Player 2
Share Hold Up
Player 1 Invest 5, 5 -3, 7
Don’t Invest 0, 0 0, 0
There are two broad approaches to ensuring a co-operative outcome. First, an
arrangement can be developed for punishing the second player in case he deviates.
Ordinarily, a strong rule based system with an independent judiciary is able to achieve
this. The IPP and the utility/government agree before the fact that (Invest, Share) is a
better outcome and sign a formal contract (PPA). The court stands ready to enforce this
contract. However, such an arrangement is most effective when the deviations from the
agreement can be proved before the court or are verifiable and the IPP has sufficient
confidence in the courts and law enforcement agencies to act impartially.
Second, if the IPPs and the utility/government expect repeat interactions, and they
both have relatively low discount rates, then the prospect of gains from a long term
relationship can help keep both parties honest. This can induce the government/utility to
choose share and the IPP, recognizing this, can choose to invest. This is also known as
the theory of repeated games (Gibbons, 1992).
38Pay offs are only for purposes of illustration.
171
In practice, transactions may require dealing with different partners at different
times. Therefore it is necessary to consider relationships in group situations. Self-
governance in a group situation can be maintained if the news of cheating can be
communicated to others in the group who could potentially transact with the cheater. A
cheater would invite collective punishment from the group. Any person considering
cheating would weigh the adverse impacts of a collective reaction, which would deter
opportunistic behavior. However, such a system can only be effective if the information
flow is excellent and the threat of collective punishment from the group is credible. These
conditions are fulfilled in cohesive relation based groups or networks (A. K. Dixit, 2007).
Section 3b: Model of Relation Based Governance39
To explore the dynamics associated with relation based governance systems, a
model where different players in the electricity market are a continuum distributed along
a circle is considered (Figure 6.7). The players could be private investors, power utilities,
credit providers, government agencies, or any other entity that needs to get into a
contractual relationship for successful private sector investments in the electricity sector.
Let 2P denote the circumference of the circle; then for any player, the most distant other
player is located diagonally opposite at a distance P away. Each player is randomly
matched with another in two separate time periods – one the present and the other the
future. One is more likely to meet a closer neighbor than a more distant one. Specifically,
39 This model is an adaptation of Avinash Dixit’s (2007) model of relation based and rule based governance.
172
it is assumed that for any one player in each period, the probability of meeting another
player decreases exponentially with distance x and at a rate of decay α.
While one is less likely to meet more distant players, the potential gain from
dealing with them is larger. Specifically, it is assumed that gains from trade increase
exponentially with distance, and Ω is the rate of this increase. Finally, there is
localization of information. If a player cheats his first period match, then the probability
that a third person located at a distance y from the victim of this cheating finds out in
time for action in a possible second period match is exponential with a rate of decay β.
Figure 6.7 - A Model of Relation Based Governance
In each period, when two players are matched, they decide whether to trade in
light of what they know about each other. Each player knows the other’s location; and in
addition each may have heard about any past cheating by the other. The players are
otherwise symmetric and their game is a prisoner’s dilemma with the associated pay off
matrix. If a player cheats his current partner, he gets an immediate gain like in the
Probability of meeting ~e¯αx
Gain from trade ~e¯Ωx
News Probability ~e¯βy
Player 1
Player 2 P
x
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prisoner’s dilemma game. The cost to the player is that his reputation will suffer; future
partners who hear of this may refuse to play with him. The possibility that future partners
may not play with a cheater is what helps sustain the equilibrium, even though the game
is only two period long.
This model can be folded into the formal set up of game theory and the resulting
solutions suggest that equilibrium is characterized by the localization of honesty where
players behave honestly with others within a certain distance of themselves (See A. K.
Dixit, 2007 and A. Dixit, 2003 for a solution to the problem); cheating becomes more
attractive the more distant the partner. Honesty in all exchanges is found to be possible in
a small community but not over a large community (A. K. Dixit, 2007).
Section 3c: Model of Rule Based Governance
Li has modeled an alternative arrangement of formal or official rule based
governance (Li, 2003). As per this model, it is assumed that at a cost c per unit of arc
length along the circle, any cheating can be detected and the information made available
to future players. This can be through any of the arrangements such as a credit history
agency, trade associations or the formal legal system. The costs of the detection system
are recovered from the players by levying a lump sum charge c on each of them. Under
this system, when the semi-circumference of the circle is P, the payoff for each player
will be V(P,P) – c. Figure 6.8 shows the gross and net payoffs from external enforcement;
these are the two parallel curves V(P,P) and V(P,P) – c. It also shows a falling curve for
self-enforcement beyond P*, starting at P*, V (P*, P*).
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When P is less than P*, self-enforcement is globally effective and saves the
detection cost c, so it is obviously superior to external governance. Beyond P*, there is an
interval where the payoff from self-enforcement falls below the gross payoff V(P,P) from
external enforcement but remains above the net payoff V(P,P)-c of that system. Thus
self-enforcement no longer works over the whole circle but external enforcement is not
yet cost-effective. The rising curve for external enforcement and the falling curve for
self-enforcement eventually cross. Beyond that point, external governance is preferable
Figure 6.8 - Optimal Enforcement Modes in Different Size Worlds
Section 3d: Summary of Key Insights from the Theoretical Models
These models suggest relation based governance is likely to work well in small
groups that are connected by extended family relationships, neighborhood structures,
ethno-linguistic ties because such links facilitate repeated interactions and good
communication. In such groups, there is a possibility of a co-operative outcome emerging
V(P,P)
V(P,P)-c
V(X(P),S
α/(α-Ω)
V (P*, P*)
Player 1
P* P
V
C
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automatically as equilibrium of the repeated game. However, relation based governance
loses its relative effectiveness as the scale of economic transaction grows. Once there are
many players over a large area, the benefits that are available from economic
relationships with distant partners can only be realized by instituting more formal
institutions of information dissemination and enforcement at a cost.
In systems that are characterized by relation based governance, economic
decisions and transactions are more likely to be within some identifiable group defined
by links that enable enforcement of implicit contracts based on reputation. In other
words, “crony capitalism” is likely to be widespread. These kind of arrangements will be
slow to react to innovation and will constrain the movement of capital to its most
productive uses. Foreign investors and lenders, especially from rule based systems, will
be reluctant to invest or lend in relation based systems. Likewise, firms in a relation
based system will not feel comfortable going outside their network for credit or
investment. As a result of the closed nature of relation based systems, players in the
system will be not be able to access new technologies and international expertise.
Formal or rule based governance has high fixed costs of setting up the legal and
enforcement system and the information mechanism ,but once these costs have been
incurred, the marginal costs of dealing with additional players are low and may even
decrease. Therefore the total costs of the relation based system will be smaller at small
sizes and those of the rule based system will be smaller at large sizes.
The benefit of rule based systems notwithstanding, there is likely to be a
collective action problem to transitioning to such a system. Since reputations that have
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been built in relation based systems become worthless in a rule based system, people who
stand to lose from transition to a rule based system will resist it by political means. The
public investment required for establishing a rule based system will be hard to mobilize,
especially in face of opposition from players who stand to lose from the move to a rule
based system. Also, the move to a rule based system is likely to entail learning and
adjustment costs on part of individuals in the system (A. K. Dixit, 2007)40.
Section 3e: Propositions
The implementation of electricity market reforms, particularly the introduction of
IPPs, represents a transition to larger, more complex and dynamic sector structure. Under
a vertically integrated sector structure, there are very few players in the sector (in most
cases just the utility and a ministry with latter responsible for the former). The normal
practice is for the government to fund large capital projects in the electricity sector either
from its revenue or through domestic borrowings. The introduction of IPPs opens up the
sector to a large number private sector players, both domestic and foreign. Each of the
IPPs needs to enter into a contractual relationship with the utility while at the same time
borrowing money from domestic and international banks that provide financing for the
project and access international and national capital markets. Depending on the project, a
large number of investors may also have equity in the project. The introduction of IPPs is
also associated with efforts to increase the generation capacity in the country and to bring
in foreign capital investment for large generation projects. The theoretical models in the
40 It is worth noting that rule based and relation base governance systems are not pure dichotomies. Even in countries that have robust rule based systems, we see continued use relation based governance in many areas.
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previous section suggest that the transition to IPPs will be more successful in an
impersonal rule based system than a relation based system. In explaining the strikingly
different performances of Gujarat and Nepal, it can be shown that the existence of a
robust rule based system enabled the successful implementation of reforms in Gujarat
while the prevalence of a relation based system undermined the implementation of
reforms in Nepal. To establish that rule based governance was the differentiating factor in
the performance of Gujarat relative to Nepal, the following propositions are examined.
• Proposition 1. Gujarat undertook investments necessary to support formal rule
based transactions; Nepal did not make these investments or did not make it to the
level required to support rule based governance.
• Proposition 2. In Gujarat, formal law was evenly implemented; in Nepal, there
was significant discrepancy in the letter of the law and actual implementation,
with relation based arrangements gaining priority over the implementation rules
and regulations.
• Proposition 3. Foreign and domestic investors were equally at ease investing in
Gujarat while local investors who are integrated into local relation based
networks found it easier to operate in Nepal than foreign investors.
• Proposition 4. There was opposition to efforts to institute rule based governance
in Nepal by groups who stand to lose out.
Section 4: Back to the Narrative
This section will present evidence for each of these propositions in Gujarat and
Nepal over the last 20 years of reforms. If substantial evidence can be found in favor of
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these propositions, it can be plausibly argued that the strength of formal rule based
systems is the main driving factor behind the disparity in the performance of reforms in
Gujarat and Nepal.
Proposition 1 Gujarat undertook investments necessary to support formal rule based
transactions; Nepal did not make these investments or did not make it to the level
required to support rule based governance.
The first requirement for rule based governance is that a country or state should
have undertaken the necessary investments in institutions, infrastructure and capacity
necessary for rule based governance. The model presented in the previous section
suggests that this implies high fixed costs and is not likely to be spontaneously adopted
by countries with an institutional equilibrium that is based on relation based
arrangements. Evidence from a specific area that has relevance for the performance of
reforms in the electricity – corporate and financial governance – shows that while Gujarat
had undertaken substantial investments to set up a framework for rule based governance,
Nepal had not undertaken these investments and was lacking capacity for rule based
governance.
• Corporate and Financial Governance
The strength of corporate and financial governance is important for electricity
market reforms because it has a bearing on the ability of IPPs to raise financing for
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projects and to operate their companies under a transparent rule based framework.
Corporate and financial governance is particularly important for foreign investors.
• Nepal
Nepal did not have a strong institutional and regulatory framework to support
corporate and financial governance when electricity market reforms were initiated in the
1990’s and despite some effort, was not able to improve it substantially over the reform
period. According to the ADB41, Nepal’s financial sector in the 1990’s was characterized
by dominance of state owned banks, which had limited reach; the vast majority of the
population in the country remained out the reach of the formal banking system. Nepal
had extremely weak accounting and financial reporting systems. ADB’s 2000 assessment
notes:
Nepal lacks sound accounting and reporting standards, which are among the most
fundamental prerequisites for commercial activities…as information available to
lenders is often incomplete or expensive to establish, lending is based primarily
on collateral and personal guarantees instead of a credit analysis relying on
financial statements and business plans. Lending records within the institutions
are usually maintained in manual files and often are missing or incomplete…. the
country’s judicial system has not been fully equipped to implement legislation in
41 The ADB has been engaged with the Nepal government in reforming corporate and financial governance
since the 1990’s and as part of these efforts, it periodically carried out assessments of corporate and
financial governance in Nepal.
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a consistent manner. In the absence of a commercial court or specialized bench to
deal with commercial matters, dispute resolution through the existing court
system is usually a lengthy process. Judgments often are not made public or are
inconsistent…It is widely believed that many companies maintain different books
and accounts for different purposes, such as tax assessment and credit
applications. Such practice has exacerbated the mistrust between tax collector and
payers (ADB, 2000).
Likewise, Nepal’s tax policies, particularly income tax and customs and property-
related taxes, were considered to have many deficiencies. They allowed tax officers to
exercise discretionary powers, resulting in arbitrary tax assessment. Nepal’s legal and
regulatory environment was highly fragmented and inconsistent. Many important areas
required for robust corporate governance – such as bankruptcy, debt recovery, and
secured transactions – were not yet adequately covered in the country’s legislative and
regulatory framework. The country’s stock market was established in 1993 with 110
companies and market capitalization of $650 million, but due to various institutional and
governance weaknesses, the vast majority of shares remained illiquid (ADB, 2000).
The ADB’s 2000 Corporate and Financial Governance Project was a response to
these weaknesses and aimed to (i) improve corporate and financial governance policies,
regulatory and legal framework, and standards; (ii) develop the capacity of key financial
institutions; (iii) strengthen legal enforcement capacity and infrastructure; (iv) deploy
infrastructure for payments and financial service delivery; and (v) develop selected
market participants. The project was completed in June 2009, four years behind schedule.
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The project completion report prepared by ADB found that that the project objectives
were not achieved.
According to the completion report, the government showed limited ownership of
the project, which seriously undermined the project’s efforts to improve corporate and
financial governance in Nepal. A number of components of the project such as
establishment of special commercial benches and secure transaction registry, central
depository system, were not completed. Other components that were either fully or
partially implemented such as establishment of electronic trading scheme, computerized
legal information system were not mainstreamed into the day to day operations of
government institutions. A substantially large amount of ADB’s loan (63% of the loan)
and technical assistance funds remained unutilized (ADB, 2012b). Since the project
completion in 2009, the government has not pursued any major efforts to improve
corporate and financial governance in the country. Despite some minor improvements,
the infrastructure necessary to support rule based corporate and financial transactions
remains very weak in Nepal.
In this regard, excerpts from U.S. State Department’s 2012 Commercial Service
investment climate statement for Nepal are particularly revealing:
Legal, regulatory, and accounting systems are neither fully transparent nor
consistent with international norms. Though auditing is mandatory, professional
accounting standards are low, and many practitioners are either poorly trained or
lack in business ethics. Under these circumstances, published financial reports are
often unreliable, and investors are better advised to rely on general business
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reputations… the most distinguishing features of labor in Nepal are the shortage
of skilled, educated worker (US Department of State, 2012).
• Gujarat
In India, the national institutional and regulatory framework for corporate and
financial governance applies to all states, although implementation is undertaken at the
state level. Gujarat, on account of being one of the states of India, has had a long history
with an institutional and regulatory framework for corporate and financial governance.
At independence in 1947, India inherited one of the world’s poorest economies
but one which, as a legacy of British rule, inherited four functioning stock markets
(predating the Tokyo Stock Exchange) with clearly defined rules governing listing,
trading and settlements; a well-developed equity culture; and a banking system replete
with well-developed lending norms and recovery procedures. This included the
Ahmedabad Stock Exchange in Gujarat that was founded in 1894. The 1956 Companies
Act as well as other laws governing the functioning of joint-stock companies and
protecting the investors’ rights built on this foundation.
The development of the corporate and financial sector in subsequent decades in
India was limited by the government’s inward looking policies and dominant ownership
position in commercial banking, insurance, and development finance (Jaiswal &
Banerjee). However, by the 1990’s, India had developed a deep and well-diversified
financial system with a broad variety of banking and capital market institutions and
instruments. India had a fully functional credit rating agency, the Credit Rating
Information Service of India, which was promoted by financial institutions in the country.
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The country's capital market was deep and sophisticated; with a market capitalization of
US$39 billion in 1991, the Bombay Stock Exchange (the largest of India's nineteen stock
exchanges, accounting for 70 percent of total capitalization and turnover) was the
nineteenth largest in the world. The accounting profession was well established with the
India Institute of Chartered Accountants of India setting the accounting standards that
were in compliance with international standards (Ahluwalia, 1999).
In terms of investor base (i.e., numbers of individual shareholders), the Indian
market was the third largest in the world, behind only those in the United States and
Japan. The equity market witnessed rapid growth in all aspects, including the number of
companies listed, the trading volume, as well as the amount of fresh capital raised.
Furthermore, the country's large and rapidly growing bond market had become an
important source of debt capital to both the public as well as the private corporate sector.
India carried out substantial reforms to it legal and institutional framework for
corporate and financial governance as part of broader economic reforms in the early
1990’s. An important policy initiative in 1993 was the opening of the capital market to
foreign institutional investors and allowing Indian companies to raise capital in foreign
markets by issuing equity in the form of global depository receipts. The National Stock
Exchange was set up in 1994 as an automated electronic exchange. The National Stock
Exchange and Bombay Stock Exchange adopted an online trading system in 2000 and
2002, respectively (Ahluwalia, 1999).
As one of India’s most industrialized states, Gujarat has been a major beneficiary
and contributor to the development of financial and capital markets in India. Gujarat
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contributes 30% to the stock market capitalization in India and businessmen from Gujarat
are among the most active participants on the stock exchange. Private sector companies
making investments in electricity infrastructure in Gujarat have mobilized financing from
the country’s capital markets as well as received financing from foreign institutional
investors.
Proposition 2. In Gujarat, formal law was evenly implemented; in Nepal, there was
significant discrepancy in the letter of the law and actual implementation, with relation
based arrangements gaining priority over the implementation rules and regulations.
In NIE, it is not just formal rules, laws and organizations that form institutions but
also informal codes of conduct, norms, habits, customs and beliefs. The presence of a
robust infrastructure is a necessary but not a sufficient condition for rule based
governance. Rule based governance is also likely to depend on the beliefs and
internalized norms of people following and enforcing the rules. If the institutional
equilibrium in a society is to give preference to relation based arrangements over rules
and laws, the implementation of formal rules and laws is likely to suffer. Evidence from
the electricity sector shows that rules and regulations were more consistently applied in
Gujarat than Nepal.
• Electricity Sector
There is a wide discrepancy between the letter of the law in the electricity sector
and its implementation in Nepal. There are many, often conflicting, laws that apply to the
electricity sector; it is not always clear even to government officials which takes
precedence over the other (see Figure 6.9). For example, there is confusion over whether
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the Hydropower Development Policy of 1992 or the Hydropower Development Policy of
2001 is currently in effect. Tax relief for hydropower developers outlined in electricity
sector legislation is not recognized in the taxation laws (Imran, 2001).
Figure 6.9 - Comparison of Main Hydropower Policies and Acts
Hydropower Development Policy 1992
Electricity Act 1992
Hydropower Development Policy 2001
Draft Electricity Act 2006 (pending approval)
Royalty For all the projects above 1 MW fix capacity and energy payment 1st 15 years Rs 100 per kW plus 2% of tariff Thereafter Rs 1,000 per kW plus 10 % of tariff
For all the projects above 1 MW fixed capacity and energy payment 1st 15 years Rs 100 per kW plus 2% of tariff Thereafter Rs 1,000 per kW plus 10 % of tariff
For all the projects above 1 MW fixed capacity and energy payment. Different rates for different bands before and after 15 years. Different rates for export and internal use projects 1% of royalty to be provided to Village Development Committees
As 2001 policy
PPA PPA to be signed between buyers and sellers
PPA should be transparent
PPA to be signed between buyers and sellers and reviewed by Regulatory Commission
Pricing Mutual understanding between private producer and NEA be fixed on the basis of fixed percentage of the avoided cost or cost plus or fixed percentage of average selling price of NEA. Depreciation over 25 years
Fixed percentage of avoided cost or an addition to the generation cost of fixed percentage of average tariff of NEA Depreciation over 25 years
Subject to review by Electricity Tariff Fixation Commission
Certain percentage of avoided cost or certain percentage of average electricity tariff rate or certain percentage rate of return on equity. Consent of Commission required After establishment of wholesale market the rate fixing
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procedure as specified by the Commission
Income Tax Exemption of income tax for 15 years from date of commercial operations When income tax payable rate reduced by 10%
15 years tax exemption for licensee for generation, transmission and distribution When income tax payable rate reduced by 10%
Income tax per prevailing Income Tax Act No additional or new tax to be levied on existing hydropower project except those in place at issuance of project license
Exemption of income tax for 10 years from commencement of generation When income tax payable the rate is 15% If any reduction in prevailing income tax rates before Act commences tax rate will be reduced by same percentage.
Source: Compiled by author based on review of Government and World Bank documents
The Government of Nepal established a “one stop window” arrangement to
facilitate investments in electricity sector. However, this approach is currently ineffectual
due to the lack of authority of the “one stop window” over the various government
departments. Approval of an application for a hydropower project requires approval from
more than sixteen agencies (World Bank, 2009a).
The lack of clarity in the formal legal and regulatory framework suggests that
formal rules and laws are not the main guiding factor in government decisions. There is
evidence to indicate arbitrary and capricious application of rules and regulations in the
electricity sector in many instances. Investors have reported rent seeking behavior,
corruption in licensing, approval of unfeasible projects, signing of loss making PPAs with
the private sector and politically motivated loss making activities in the electricity sector
(Nepal & Jamasb, 2012a). For instance, an international investor that had been chosen to
develop a power project based on a competitive bidding had its rights arbitrarily
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reassigned to another investor (IANS, 2007). International developers have indicated that
NEA is not able to negotiate freely and is subject to undue political influence.
Project developers get insufficient guidance from the government on project
development. For instance, the developer is responsible for negotiating with communities
in project development sites, agreeing on compensation and relocating the communities.
IPPs have commented that there is no commonality of treatment from one site to another
and that published countrywide guidelines would have been of considerable help (World
Bank, 2009a).
Additional evidence on the behavior and actions of government officials in the
electricity sector can also be found in implementation completion reports of electricity
sector projects funded by international development agencies such as the ADB and the
World Bank. The performance evaluation report of the Kaligandaki Project financed by
the ADB, for instance, indicates the following about the performance of government
agencies in the project:
The executing agency’s performance was less than satisfactory. The project files
indicate that ADB had noted for some time that there were important
shortcomings with respect to the focus of attention on technical, contractual, and
management requirements of project implementation, and, consequently, decision
making in a timely manner (ADB, 2012a).
The intensification of the Maoist insurgency in Nepal after 2001 further weakened
rule based governance in Nepal. There were many instances of electricity project
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property being damaged, sites being padlocked and demands and threats being received
from various groups (AFP, 2003). This was costly in terms of delays to project
development and the requirement to employ increased security measures.
The overall state of affairs with respect to the implementation of formal laws and
rules is summarized in the United States Commercial Service investment climate
statement for 2012 for Nepal:
Foreign investors complain about complex and opaque government procedures
and a working-level attitude that is often more hostile than accommodating…
investors must also deal with inadequate and obscure commercial regulations,
vague and changeable rules governing labor relations, a nontransparent and
capricious tax administration system… foreign investors have identified pervasive
corruption as a major obstacle to making, maintaining and expanding direct
investment in Nepal. There are also frequent allegations of corruption perpetrated
by government officials in the distribution of permits and approvals, in the
procurement of goods and services, and in the award of contracts there is often
variance between the letter of the law and its implementation…. The bureaucracy
is generally reluctant to accept legal precedents. As a consequence, businesses are
often forced to re-litigate issues that had been previously settled (US Department
of State, 2012).
Gujarat by contrast is widely considered to be one of the most well governed
states in India. Gujarat’s bureaucracy is known to follow rules and regulations, which
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serves to increase investor in Gujarat. This perception is widespread across different
sectors and pre-dates the initiation of electricity sector reforms in the early 1990’s. In an
interview to the Business Standard, noted academician and professor of Jawaharlal Nehru
University, Ghanshyam Shah noted:
Project execution in Gujarat has always been fast and hassle-free thanks to the
bureaucracy. Even during the license Raj (i.e. before the 1990 reforms) the
bureaucrats used to get licenses and give it to businessmen for setting up
industries. Traditionally the administration in Gujarat has always been business
friendly and hence the project execution has been smooth (Das, 2013).
Similar views are echoed by businessmen investing in Gujarat. Gourav Swarup,
Managing Director of Paharpur Cooling Towers, statements in an interview with TNN
are specially revealing:
In Gujarat, you can concentrate on business without any other worry…an
industrialist can do what he is supposed to do - that is business…there is no undue
interference by any agency at any level. It is absolutely trouble-free and
everything is in-built into the system, which delivers. This is why we are planning
further expansion in Gujarat (Mukherji, 2013).
The Japanese ambassador to India, Takeshi Yagi, seemed to speak for many
foreign investors when he made the following remarks at an inauguration of Japanese
owned sanitary wear plant in Gujarat:
This new venture will further strengthen the trade ties between Japan and
India. Gujarat has become a hot favorite destination for Japanese firms
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due to good governance and transparent administration. At present, 60
Japanese firms are operational in Gujarat. In the near future, the number
will increase to 100 (PTI 2014).
These perceptions are validated by the Economic Freedom of Indian States
rankings, which includes many variables that are measures of rule based governance such
as the quality of justice mechanism, completion rate of cases by courts and investigations
by the police, and level of corruption. Gujarat ranks number one in the overall ranking
and highly on variables that are measures of formal rule based governance (Aiyar, 2012).
In the electricity sector, Gujarat was the highest ranked among Indian states in
implementing the provisions of the Electricity Authority 2003 (EA 2003) (Pargal, 2014).
Gujarat was one of the first states in India to set up special courts and special inspection
squads for prosecuting electricity theft, as per the provisions of the Act. Gujarat was able
to sharply reduce its losses from theft as a result of this drive, which played an important
role in the financial turnaround of Gujarat’s electricity sector.
Gujarat has a well outlined formal framework and rules to guide land acquisitions
and environmental clearances for projects, including a role for the government in
facilitating land acquisition, infrastructure, fuel linkage, port linkage, and water supply.
Gujarat’s government has been very effective in discharging this role, which has been of
considerable help in attracting private investment to the electricity sector in the state (R.
Mohan, 2008).
Additionally, political interference in projects decisions is minimal in Gujarat. A
review of IPPs in Gujarat undertaken by the Program on Energy and Sustainable
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Development at Stanford University found that political intervention in the electricity
sector was lower in Gujarat than other states such as Andhra Pradesh, Tamil Nadu, and
Maharashtra that were covered in the study (Lamb, 2006). This observation was made by
all of the main players in the Gujarat electricity sector – the GERC, the GEB and the
project companies themselves. Likewise, renegotiations related to project PPA were
reported to have been carried out transparently in Gujarat and with little actual cost to the
returns of the IPPs.
Reports from IPPs and the state off taker in Gujarat in field research interviews
were the most positive among the four states selected for focus in the India study. Not
surprisingly, the costs in Gujarat on a per megawatt basis for electricity projects were
lower than other large states such as Andhra Pradesh, Tamil Nadu, and Maharashtra and
among the most competitive in the country (Lamb, 2006).
Finally, a confirmation of Gujarat strong formal rule based governance is also
seen in ADB’s completion report for the Gujarat Power Sector Development Reform
Program. The program was designed to support the Government of Gujarat to restructure
the power sector. The completion report’s assessment of the performance of the Gujarat
state government was as follows:
The state government demonstrated its full commitment to implementing the
reform measures. Overall, GEB has demonstrated its capacity to formulate,
appraise, and carry out engineering, procurement, and construction of T&D
projects to approved specifications, standards, and to the satisfaction of ADB
(ADB, 2008).
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Proposition 3. Foreign and domestic investors were equally at ease investing in Gujarat
while local investors who are integrated into local relation based networks have found it
easier to operate in Nepal than foreign investors.
It follows from the model in the previous section that people used to dealing in a
relation based system will find it easier to initiate a transaction in a rule based system
than vice versa. People from a relation based system can come into a rule based system
and be assured of operating on the same level playing field as the others in the system. In
a relation based economy, by contrast, activities are mostly carried out by firms that have
long standing relationships with others in the country and who will not deal with others
for fear of spoiling these relationships. Evidence from Gujarat and Nepal confirms that
while in the former both local and international investors have been able to enjoy success,
in the latter, success has been mainly limited to local investors.
• Private Sector Power Projects in Gujarat
Evidence from private sector projects completed in Gujarat indicates that
international investors have had a fair degree of success in Gujarat. The scale and
frequency of their transactions indicate that they have confidence in the government and
other Indian corporate entities.
One of the first private sector electricity generation projects to be completed in
India with international investment was carried out in Gujarat. The development of
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655MW Gujarat Paguthan Power Station was initiated in 1994 as a joint venture between
Torrent Group of India, PowerGen of UK, Siemens of Germany and the state owned
Gujarat Power Corporation Limited. The project achieved financial closure in 1997 and
became operational in 1998.
In July 1999, PowerGen purchased a controlling stake in the Paguthan project
from the Ahmedabad-based Torrent group. In October 2000, PowerGen bought out
Siemens stake in the project, and changed plants name to Gujarat PowerGen Electricity
Corporation. In 2002, the Hongkong based China Light and Power International took
over the entire ownership and management control of Gujarat PowerGen Electricity
Corporation. Since then, China Light and Power has owned 100% of the equity of the
Gujarat PowerGen Electricity Corporation. Gujarat PowerGen Electricity Corporation
sells its entire electrical output to the GEB (and later its successor Gujarat Urja Vikas
Nigam Limited) under a long term PPA whereby the entire capacity of the project is
dedicated to the utility. The outcomes of the project have been largely positive for both
China Light and Power and Gujarat. The Ministry of Power has rated both costs and
operational performance to be better than similar plants in India, including many that
were undertaken by local investors (Woodhouse, 2006).
While several renegotiations of the PPA have taken place between the IPP and the
utility, these have always been successfully resolved. The parties have been able to agree
at a lower PPA than initially agreed because of the plants success in accessing fuel at
cheaper rate than earlier envisioned by tapping the private gas market. The project has
been able to produce a satisfactory return on investment for China Light and Power.
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Overall, China Light and Power has had a positive investment experience in Gujarat,
which is confirmed by the company’s decision to make additional investments in the
electricity sector in Gujarat. China Light and Power successfully commissioned the first
phase of the 101 MW Samana wind farm in Jamnagar district in Gujarat in 2009 and is
currently developing the 50 MW Mahidad wind farm in Gujarat (PPIAF, 2014).
A number of other international investors such as MEMC Dhama Solar Plant
(USA), Caparo Energy Limited (United Kingdom), Surajbari Private Limited
(Singapore), AES Saurashtra Wind Farm (USA) and Genting Jangi Wind Farm
(Malaysia) (PPIAF, 2014) are also successfully operating in Gujarat’s electricity sector.
Gujarat has a robust institutional framework comprising of the GERC as well as
an independent judiciary, which provides confidence to international investors that they
will be treated fairly. There have been number of high profile cases in which the judiciary
has ruled in favor of international investors. For instance, the Gujarat High Court in
February 2014 ruled in favor of Alstom by holding that the provisions of the foreign trade
policy relied upon by India’s Directorate General of Foreign Trade to recover duty
drawback benefits already granted to power producers were unconstitutional (A. Mohan,
2014).
• Private Sector Power Projects in Nepal
Nepal by contrast has seen very little foreign investment in the electricity sector.
Whatever little investment has taken place has been with the involvement of multilateral
development Banks such as ADB and World Bank. No international investor has so far
been able to successfully complete a project without financing from multilateral
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development banks. The national utility NEA has a history of contractual disputes with
foreign contractors. Nepal initially saw very little local private sector investment in the
electricity sector reflecting financing and capacity constraints. But more recently, Nepali
private sector companies have become active in the electricity sector and are more
successful than international investors.
Nepal was an early recipient of foreign investment in the electricity sector. The 60
MW Khimti Khola Hydropower Project, an investment of the Norwegian electricity
company Statkraft and the 36 MW Bhotekoshi project, an investment of the US-Nepal
joint venture Bhotekoshi Power Company Private Limited, reached financial closure in
1994 and 1996, respectively and became operational in 2000 and 2001, respectively
(NEA). However, both of these projects were undertaken with the involvement of
multilateral development banks – the ADB in the case of Khimti Khola and the World
Bank Group’s International Finance Corporation in the case of Bhotekoshi – which
served to minimize the risks face by the private sector developers in interfacing with the
utility and the government. However, after these projects no major hydro power projects
have been undertaken with foreign investment in Nepal. These projects have generated
satisfactory returns to the investors but have turned out to be very expensive for the NEA.
Since the PPA for these projects were in US dollar terms, the depreciation of the Nepali
rupee has had a major financial impact on NEA.
A parliamentary Public Accounts Committee report in 2010 found that the NEA
was incurring an annual loss of NRs2.5 billion ($34 million in 2010) on Bhotekoshi (36
MW) and Khimti (60 MW) PPAs and that cumulative losses for the two projects had
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reached NRs9.5 billion ($128 million) and Rs19.5 billion ($267 million), respectively for
the past decade (Post Reporter, 2010).
The NEA has had a series of contractual disputes with international investors and
contractors, which has served to reduce investor confidence in Nepal. One long running
contractual dispute was with the Bhote Koshi Power Company Private Limited, the US-
Nepal joint venture that developed the Bhotekoshi project. The dispute centered on
NEA’s refusal to fully pay the company’s invoice from 2001. After a bitter five year
dispute that cost Bhotekoshi Power Company Private Limited shareholders about 10% of
their revenues every year, the two American investors, the Panda Global Holdings, a
Dallas-based energy company, and MCN Invest Corp, owned by DTE Energy, exited
from the Bhote Koshi power project by selling their 75% stake in the project to the
private Nepali energy company that owned 10 percent of the shares in the joint venture.
Upon the exit of the American investors, Bhotekoshi Power Company Private
Limited and the NEA reached an agreement to settle the dispute in 2008. Bhote Koshi
Power Company Private Limited agreed to renounce its claims to past payments in return
for NEA making future payments (Xinua News Agency, 2006). This episode caused a lot
bad press for Nepal in the international media. Todd W. Carter, President of Panda
Global Holdings that was forced to exit the project, had the following to say about the
episode:
Tantamount to any lender's ability to loan money for international construction is
the sanctity of the contract in the host country. International lenders will not find
projects in jurisdictions where the contracts upon which a financing is based, are
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not honored. Unfortunately, NEA has not honored the terms and provisions of the
PPA by withholding payments for energy produced and delivered under that
contract. The failure of NEA to fulfill its obligations go far beyond the
Bhotekoshi Power Company and the facility, as the fixture willingness of
international investors and lenders to make significant commitments to Nepal may
be adversely affected. That result is not desirable for NEA, the people of Nepal,
nor Bhotekoshi Power Company (Xinua News Agency, 2006).
Likewise, the NEA faced contractual disputes with a contractor for the Kali
Gandaki Hydroelectric project which was developed by NEA with ADB Financing. The
project construction was completed in 2002. In 2003, Impreglio, a contractor under the
project, demanded $2.5 million citing cost overruns, which was ignored by NEA.
Impreglio filed a case at the International Chamber of Commerce which awarded a
payment of $20 million to Impreglio from NEA but NEA refused to make the payment.
Instead NEA seized Impreglio’s US$ 2 million performance guarantee while at the same
time filing a case against Impreglio in Nepal’s courts. After ten years, NEA and
Impreglio agreed to an out of court settlement in 2012. The terms of settlement were not
made public (R. Bhusal, 2012).An evaluation of the Kali Gandaki project carried out by
the ADB had the following to say about the contractual dispute:
NEA was not able to resolve contractual issues in a timely manner. ADB assisted
in establishing action plans and proposed in March 1999 the establishment of a
dispute review board to assist in resolving matters between the concerned parties.
The proposal was not followed up. When decisions were delayed by NEA, the
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contractor was placed in the position where he had to commit resources without
assurance that he would be adequately compensated (ADB, 2012a).
Finally, electricity sector projects undertaken with local financing and
involvement of domestic players have shown better outcomes than projects undertaken
by foreign investors or with financing from donor agencies such as ADB and World
Bank. In early years of liberalization, there was limited involvement of local players in
the development of electricity generation projects. But this has changed in recent years,
with more local players getting involved.
A notable example of this is the Chilime hydropower company, which was
incorporated in 1995 with 51 percent equity going to the NEA, another 25 percent to
NEA employees and the rest to be offered to the public. Chilime owns and operates 22.1
MW power plant commissioned in August 2003, which was developed without any
international support. It sells bulk electricity to NEA at the long term PPA price. The
project has already paid off all its bank loans which has allowed it to become profitable.
The project was completed in 2003 at a cost of $1,616 per kW of installed capacity and is
one of the cheapest projects built in Nepal. The project is reported to have faced minimal
corruption, which is otherwise a major cost element for projects in Nepal (World Bank,
2009a).
A distinguishing factor in the success of the company has been its ability to
establish good relations with the local community, who were encouraged to participate in
the decision making process. Chilime, through its three subsidiaries, is currently
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developing four hydropower projects with aggregate capacity of 270 MW (Sustainable
Hydropower, 2014).
By contrast, electricity generation projects implemented with foreign financing
have been costlier and have also faced greater resistance from communities impacted by
the project. The cost of the Middle Marsyangdi project in Nepal for instance in excess of
US$6,000 per kW of installed capacity – 3 times as high as a typical project - and was
completed four years behind schedule. The delay was caused by protests and disruption
from local communities against the project (Unknown, 2013).
Proposition 4. There was opposition to efforts to institute rule based governance in Nepal
by groups who stand to lose out.
In the “institutions as equilibria” approach of NIE, institutions are understood as
self-enforcing equilibria or as system of factors that generate regularity of behavior42.
Institutional change occurs only very slowly and infrequently and requires the existing
institutional equilibrium to be undermined by exogenous or endogenous factors. Many
efforts to reform the institutional equilibrium are unsuccessful because they do not
change the underlying institutional equilibrium (Greif, 2006).
In Nepal, the establishment of strong rule based institutional framework would
have required the existing relation based equilibrium to be undermined by reform efforts.
42 For institutions to change, just a change in the formal system is not sufficient, but the entire institutional system (which includes informal beliefs norms and understanding of the relationship between actions and outcomes) has to change and a new institutional equilibria has to be reached.
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However, as suggested by the model in the previous section, such efforts would have
been opposed by people who stand to lose from the change. Unless reform efforts would
successfully facilitate fundamental shifts in the underlying parameters, the society would
revert back to its old equilibrium.
There is evidence to indicate that efforts to improve rule based governance have
had limited success in Nepal and have been opposed by interests with stakes in the
current system. An illustration of this is provided through a review of reform efforts in
NEA and capacity building efforts of donors.
• NEA Reforms
Historically, the administrative set up in NEA as well as the rest of the
government has been characterized by relation based values rather than formal rule based
values. According to Rameshwor (2005), administrative decisions in Nepal are
influenced by informal relationships rather than formal rules, including political
influence, personal connection (Afno Manchhe), and sycophancy (Chakari). Civil
servants commonly use their positions for their personal benefit. Common administrative
norms include slow decision making, excessive secrecy, ritualized official work, and
shifting responsibility to others. The administration is dominated by male Hindus of the
Brahmin, Chhetri and Newar castes (Rameshwor, 2005).
Energy sector assessments have highlighted the need to improve the governance
of the sector. Efforts to institute a merit and rule based culture were undertaken by a
reform oriented energy minister, Gokarna Bista, in 2011. Bista initiated reforms to reduce
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political interference, improve accountability, promote merit and institute rule based
governance. Specific reforms included:
• Recruiting the chief of the NEA based on merit through competition and
establishing market based pay.
Historically, the NEA Managing Director has been selected by the energy
minister based on personal and political connections. The Managing Director is expected
to deliver funds for the minister’s political party in exchange for the appointment. To
shield NEA from political interference and improve its financial and operational
performance, Bista pushed through with reforms to (i) select the NEA Managing Director
through an open and competitive process and based on market pay (The Kathmandu Post,
2011); and (ii) delegated the responsibility of chairing the Board of the NEA to the
Secretary of Energy, the top civil servant responsible for the Ministry of Energy (R.
Bhusal, 2011).
• Crackdown on electricity theft.
The first Managing Director to be selected through competition, Dipendra Nath
Sharma, initiated a crackdown on electricity theft in the country. The NEA carried out
inspections of electricity use in 80 major industries of the country and found that a
quarter of them were engaged in electricity theft. The power utility cut off power lines of
more than 2000 industries that had not cleared dues. The NEA also punished around
20,000 individual offenders for stealing electricity. In some instances, NEA staff were
attacked by locals and injured while disconnecting electricity lines (Post Report, 2011b).
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However, these reforms could not be sustained. There was a change in
government that resulted in minister Bista being replaced by another minister. Managing
Director Sharma developed differences with the new minister and tendered his
resignation soon after (Post Report, 2011a).
The new Managing Director, R. Yadav, was not appointed on a competitive basis.
In fact, soon after the new Managing Director took over, he was accused of being
involved in the involved in unauthorized supply of electricity to more than a dozen
industries, causing losses worth millions of rupees to the government (Poudel, 2013).
Likewise, the new energy minister soon went back to chairing the NEA Board. The
reforms initiated by Bista and Sharma could not be sustained and there was reversion to
the old equilibrium.
• Capacity Building Efforts
Recognizing institutional weaknesses of Nepal’s electricity sector, international
donors such as the ADB and the World Bank have carried out a series of technical
assistance and capacity building activities. The project completion reports of these
interventions indicate these efforts have been unsuccessful in improving governance in
the electricity in sector. Mostly, these technical assistance activities have focused on
improving the infrastructure necessary for rule based governance as well as technical
knowledge. Individual activities have almost inevitably had poor results or results that
have not been sustained upon the completion of the activity. The performance evaluation
report of ADB’s Kali Gandaki project had the following to say about the project’s
technical assistance efforts:
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The project included two technical assistance operations intended to strengthen
NEA’s Environment Division and NEA’s power system master planning capacity,
which were relevant in the context of NEA’s institutional needs. The outcome of
the product extended to the government, however, is not clear. It was evident that
there was no full and lasting transfer of technical knowledge.
Section 5: Evolution of Social Beliefs and Culture in Nepal and Gujarat
This section considers the history of Nepal and Gujarat to investigate the factors
that could be responsible for the differences in their institutions. While Gujarat and Nepal
shared significant social and cultural similarities in the distant past, they have been on
divergent social and cultural paths for about a millennium, a process accelerated by the
British colonization of Gujarat two hundred years ago. As a result of these divergent
paths, including British influence and greater exposure to western ideas and institutions,
institutions in Gujarat evolved to be more consistent with rule based governance. In
Nepal, by contrast, collectivist and relation based governance structures continued to
prevail till the early 1990’s. This difference in the institutional equilibrium contributed to
Gujarat and Nepal having different reform outcomes, with Gujarat being more successful
(Figure 6.10 summarizes the evolution of institutions in Gujarat and Nepal).
Section 5a: Gujarat and Nepal: A Common Cultural Past
Gujarati and Nepali societies both share their origins in ancient Indian/Hindu
culture that took root in South Asia from 1000 BCE to about 1000 CE. Ancient India was
characterized by collectivist and relation based structures. The society was predominantly
Hindu and organized according to Hindu rules and edicts as elaborated in the tenth
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century Manu Smriti. This implied organization of the society in terms of a highly rigid
and hereditary caste system and a subservient role for women. As per this system,
commercial and business activity was the sole privilege of the members belonging to
Vaishya castes. There was a family based system where members of the same caste and
family pooled their resources to maintain the family and invest in business ventures
(Jones, 1796).
Figure 6.10 – Evolution of Institutions in Gujarat and Nepal
Gujarat Nepal
The system ensured younger members were trained and employed in the family
business. Part of the explanation for the system was that the similar background of
members made monitoring of behavior and enforcement of punishments easier.
As a result of British influence, greater interaction with other individualist and rule-based systems, long experience with democracy, and indigenous reform movements, Gujarat had a more robust institutional environment (Level 2) at the time of reform; Likewise, Gujarat’s social customs and beliefs (Level 1) had evolved to become more individualistic and encouraged people to follow a rule based systems.
As Nepal had remained in isolation from the rest of the world and had largely operated under a traditional monarchy, Nepal’s institutional environment (Level 2 institutions) was weak. Similarly, at the time of reform, social beliefs and norms (Level 1) still gave preference to collectivist and relation based social arrangements such as family and caste (i.e. they did not encourage people to follow formal rules and systems).
Reforms were adopted (mainly at Level 3 and 4) in both Nepal and Gujarat in the early 1990’s. However, while Gujarat adapted well to changes to these levels because of the strength of its formal institutions/rules and it’s relatively more individualistic social norms, Nepal had a difficult time adjusting to these reforms. As result, reforms performed poorly in Nepal.
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Coordination was based on informal mechanisms such as custom and oral tradition.
Merchants seldom took initiative to enter into inter-economy arrangements because
collective punishment did not extend to inter-economy transactions (Majumdar, 1920).
What thus prevailed in South Asia was a variation of the relation based and collectivist
system seen among the Maghreb’s in the eleventh century (Greif, 2006). These systems
were dominated by collectivist cultural beliefs with economic self-enforcing collective
punishment and horizontal agency relations.
Section 5b: Development of Separate Cultural Identities
The Islamic invasion of India starting in the 1100 CE caused communities settled
in north India to migrate northwards in search of safe haven to areas in present day
Nepal. This migration started at the end of the twelve century continued till well after the
fourteen century43. The intruding refugees were in such large number that they
encroached upon the fertile land of the indigenous settlers and drove them to the slopes of
the hills. These settlers brought with them the culture and traditions of India (which later
came to be known as Hinduism) and propagated systems and institutions in accordance
with these (Kansakar, 2012). While initially, Nepal existed as collection of numerous
kingdoms and principalities, starting in the middle of the 18th century, Prithvi Narayan
Shah, the monarch of one of these kingdoms whose ancestors had migrated from India,
was able to annex many of these kingdoms and principalities into one large nation. Upon
43 The Mallas seem to have entered the Kathmandu Valley from the eastern Tarai at the end of the twelfth century, while the Shah (the dynasty that ruled Nepal till 2006 and the descendants of the Rajputs of Chitor, India) from the western Tarai in the fourteenth century and established their domain in Gorkha.
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his death, the consolidation of small kingdoms and principalities was continued by his
descendants.
According to Sharma (2002), the religious ideology of the migrants can be
characterized as “defensive Hinduism” in that their migration was motivated by defense
of their faith against the growing tide of Islam. This included the hierarchical caste
system and collectivist and relation based structures. These settlers were very inward
looking and discouraged interaction with people from other cultures and countries.
Contact with the western world and cultures in particular was particularly looked down
on (S. Sharma, 1992).
As coastal region, Gujarat on other hand grew organically as part of ancient
India44. This included interactions with invading Islamic communities as well as exposure
to business communities in other parts of the world. Gujarat’s location on the major
inland trade routes, availability of raw material and skilled labor, easy access to sea ports
helped simulate its trading and manufacturing activities. By the 17th Century, Gujarat
had developed as a robust industrial and commercial center. J. Alberto de Mandelslo, a
German traveler who visited Ahmedabad, the capital of Gujarat, in 1638 wrote: “There is
not in a manner any nation nor any merchandise in all Asia which may not be had at
Ahmedabad” (Commissariat, 1931)
William Finch, an Englishman in 1611 writes: “Amadavade is goodly city
situated on a fair river…the buildings comparable to any city in Asia or Africa…the
44 Gujarati as a language emerged in the 13th century from variation of Sanskrit.
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streets large and well paved, trade great (for almost every ten days go from hence two
hundred coaches richly laden with merchandise for Cambay), the merchants rich, the
artificers excellent for carvings, paintings, inlaid works, embroidery with gold and silver”
(M. Mehta, 1991, p.92)
It had a vibrant business culture that set it apart from the other regions in India. In
divergence from the traditional Hindu system, Gujarat had sizable number of merchants
and entrepreneurs that cut across caste and religious communities. The difference in caste
and community affiliation did not prevent Gujarati businesses from collaborating with
each other. They repeatedly put up a united front on issues such as negotiations with the
European traders, piracy and utilizing business institutions for enlarging the scope of
business. According to Mehta: “The fact that members of the non-Vaishya castes came
forward to assume business roles in spite of their religious traditions and conventions
suggests that Gujarat experienced some “propitious moments” which had weakened if not
shattered the customary occupational barriers” (M. Mehta, 1991p.48).
The capital city of Gujarat, Ahmedabad, had developed a professional guild of
merchants. These merchants cut across the caste and community lines and they controlled
admission of new members to them, safeguarded their member’s rights, kept up
standards, decided upon wages and holidays and deliberated on interests of the city as a
whole. Merchants had also developed a sophisticated hundi network in the country to
facilitate commercial transactions (S. Mehta, 1984).
Gujarati merchants were exposed to business instruments such as forward
contracts to buy and sell goods as a result of their interactions with European traders. For
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instance, on account of growing incidence of piracies, several Gujarati merchants entered
into forward contracts with Europeans. The emergence of forward contracts in India
resulted from the needs of the European companies to sell their goods in a way that could
facilitate multilateral trade (M. Mehta, 1991, p.43).
Section 5c: Interaction between East India Company and Gujarat
The very deep and sustained interactions of Gujarati businessmen with the British
East India Company over a long period of time exposed Gujarat to formal and rule based
governance systems. The British East India Company gained a foothold in India at the
beginning of the seventeenth century as (1612) as a result of commercial treaty between
King James I envoy Sir Thomas Roe and Mughal Emperor Nuruddin Salim Jahangir (r.
1605 – 1627)45 (Lawson, 2014).
Recognizing the commercial importance of Gujarat, the East India Company
chose Surat, a major commercial center in the state, as its headquarters in Western India.
The East India Company was a joint-stock company based in a society that had evolved
to create institutions that were supportive of economic growth such as “an explicit set of
multiple veto points along with primacy of the common law courts over economic
affairs” (North & Weingast, 1989). The company relied on a vertical structure and had
recourse to formal structures such as the court of law and enforcement mechanisms that
45 The company received a Royal Charter from Queen Elizabeth in 1600,[4] making it the oldest among several similarly formed European East India Companies. Wealthy merchants and aristocrats owned the Company's shares.[5] Comment: What are [4] and [5] supposed to designate? The government owned no shares and had only indirect control.
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protected the traders and coordinated their actions46. This reduced the transaction cost of
doing business and enabled the company to undertake operations on a large scale in India
(Keay, 1991).
The joint-stock organization enabled the company to spread a large network of
trading posts and facilitated effective coordination of its personnel and resources. The
organizational structure of the East India Company was headed by a President. Next to
the President in the structural hierarchy was the accountant who maintained general
accounts. He also signed all the bills, though it was treasurer who kept the cash. Last of
all was the Secretary who modeled all consultations, wrote letters and carried them to the
President, to be processed and signed. He also kept the company’s seal which was affixed
to all passes and commissions (M. Mehta, 1991).
Gujarati businessman had extensive interactions with the East India Company.
One of the ways in which Gujarati merchants exercised influence over the East India
Company was by lending large amounts of money to them. Gujarati businessman actively
responded to the growing demand for Indian products by the East India Company. One of
the key relationships of the East India Company in Gujarat in the Seventeenth Century
was with Virji Vora, who was a wholesale trader dealing in wide range of commodities.
Unlike the East India Company, Vohra’s business was a large family business. Vohra
was highly astute trader and earned huge profits in the spice trade (M. Mehta, 1991).
46 The emergence of these systems in British society has been analyzed by North and Weingast (1989). Comment: This should appear in the works cited. Constitutions and commitment; the evolution of institutions governing public choice in seventeenth-century England. The Journal of Economic History (1989), 49: 803-832.
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These interactions exposed Gujarati traders to the effectiveness of rule based
systems of the East India Company. The modes of operation and methods that Gujarati
trader used to achieve their ends were also quite sophisticated. In particular, they
exhibited an excellent business sense and ability to find profits given the surrounding
they operated in. An official of the East India Company had the following to say about
Virji Vora’s pepper trade in the 1643:
I understand that Virgee Vora yearly sends downe his people hither to callibutt
with cotton and opium by which he doth not gain less than double his money to
those people he buyeth his pepper off, and afterwards disposeth of his pepper to
us for double what it cost him; for I find pepper to be worth here but 15.5 and 16
fannams the Maund, which is not halfe the rate hee usually valuawath to our
people in Surat (M. Mehta, 1991, p. 56).
However, the company enjoyed significant advantages from being a large scale
joint-stock organization. For instance, the East India Company, with its vast human and
material resources often received privileges from the emperors. Compared to Gujarati
traders, the Company employees were numerically greater and also took interest in
political events and made efforts to turn the situation to their Company’s advantage.
Section 5d: British Conquest of India
The East India Company enjoyed significant business and military success in
India. By middle of the eighteenth century, the Company had come to rule large areas of
India with its own private armies, exercising military power and assuming administrative
functions. The British replaced Marathas as rulers of Ahmedabad in 1818. This set the
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stage for further interaction between the British and Gujarati society and for the gradual
transformation of the relation based and collectivist governance structures in Gujarat.
Mehta (1991) speaks of the birth of new entrepreneurial climate upon the takeover
by the British. Having gone through their capitalistic processes culminating in the
Industrial Revolution, the British took great care in safeguarding the property rights of
Gujarati businessman. The Gujarati merchant class responded positively to the change in
the ruling class. The businessman who had resented arbitrary interference by the previous
Maratha regime in their business and property matters welcomed the British system that
operated on laws and rules and safeguarded property rights. The Gujarati businessman
even made voluntary contributions for the improvement of roads and markets and the
general sanitation of the city. The British encouraged them to start newspapers and
journals and to establish libraries, schools for boys and girls and hospitals. A journal,
Buddhiprakash, which was started in 1850 with donations from businessmen, become a
harbinger of new ideas, providing useful information on the latest industrial
developments in Western Europe and the United States, including electricity, textile
machines, telegraph and modern sewing.
Several British individuals took particular interest in the social and cultural
evolution of Gujarat. R. Carr Woods for instance was one of the first Englishman to
initiate Gujarati merchants into European methods and machines. He came to Gujarat
around 1845 to study cotton regions. He assured the merchants that they would make
huge profits by setting up a modern industrial enterprise. He was instrumental in Gujarati
businessmen forming a joint-stock company for a paper mill. This was followed by
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efforts to establish a cotton mill. Both the projects ended up not getting off the ground,
but these efforts provide useful evidence of the impact of British rule and western
contacts on people living in Gujarat.
Eventually Ranchodlal, an ex-Gujarati civil servant from the Brahmin caste, was
able to get a modern cotton spinning company, the Ahmedabad Spinning and Weaving
company, off the ground. The company was set up on a joint-stock principle with an
authorized capital of Rs300,000 divided into 60 shares. His first effort to import
equipment from England failed after the ship carrying it sank into the sea. But since the
machinery was insured, Ranchodlal immediately placed fresh orders. Ranchodlal was
eventually able to start production at his new factory in May 1861 (M. Mehta, 1991,ch.
10).
This example demonstrates the changes in the business environment and culture
introduced by the British in Gujarat. Unlike earlier breed of Gujarati businessmen,
Ranchodlal was able to set up a modern industry. It also shows that caste affiliation was
not a major obstacle in participating in business activities in Gujarat, as evidenced by the
success of Ranchodlal who was from the Bramhin priest caste.
Following the Indian Rebellion of 1857 against the East India Company, the
Government of India Act 1858 led the British Crown to assume direct control of India,
which lasted for another century. During this period, the British gradually established a
wide array of governance structures and institutions, including courts, law enforcement
agencies, a new penal code, and codes of civil and criminal procedure to facilitate their
rule in India. Compulsory registration of life events as well as adoptions, property deeds,
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and wills were enforced with the intention of creating a stable, usable public record and
verifiable identities (Singha, 2003). They also gradually introduced various elements of
thinking associated with the enlightenment. For instance, the British outlawed
untouchability, promoted the education of women and reduced caste discrimination.
While many traditional social structures and institutions of India continued to
operate in parallel, the introduction of new thinking set into motion a process that
undermined old institutions and systems. The introduction of new elements can be seen
as bringing about marginal shifts in the value of “quasi-parameters,” rendering existing
institutions no longer self-enforcing (Greif, 2006p.182). This process was facilitated by a
new generation of Indians such as Raja Rammohun Roy, Mohandas Gandhi and
Jawaharlal Nehru who had grown up under the British education system and were
intimately aware of the strengths the system. Roy led a large social movement to rid the
country of the caste system as well as other social and cultural anomalies (Mukherjee,
2014). Gandhi and Nehru were involved in formal organizations such as the Indian
National Congress to lead the political mobilization against the British and were at the
fore front of the efforts to modernize India (Bevir, 2003).
Upon India’s independence in 1947, the country used the legal, administrative and
institutional framework established by the British. Independent India was established as a
secular democratic republic with official separation between the state and the religion.
English was adopted as one of the fourteen national languages. While the changes in
informal rules, norms and culture were often slower than the changes in the formal set up,
there was also noticeable evolution in these (Dalmia & Sadana, 2012). This change was
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particularly notable in more progressive and economically advanced Indian states such as
Gujarat. The influence of caste in the society declined. Business and commercial activity
was now undertaken by members of all castes and traditional relation based and
collectivist systems were no longer dominant.
Section 5e: Evolution of Institutions in Nepal
Nepal on the other hand was both geographically and economically isolated from
the rest of the world. The difficult terrain in much of the country and widespread
prevalence of malaria in the lowland forests of Nepal made it very difficult to foster deep
economic or cultural interactions with the rest of the world.
Even as the area that now falls under the state of Gujarat was successfully
annexed by the British East Indian Company, the Shah dynasty of Nepal, aided greatly by
its army’s knowledge of the terrain and guerilla military tactics, successfully repelled
British attempts to annex the country several times. It eventually signed a treaty with the
British in which it ceded large parts of its territory in exchange for autonomy (Whelpton,
2005).
Nepal was ruled by an absolute monarchy or a party-less and autocratic oligarchy
and exist as a “Shangri-La” in significant isolation from British ruled India for much of
the time until the 1990’s. While the geography of Nepal had much to do with this
isolation, the rulers of Nepal fearful of losing power encouraged this. Emigration of the
Nepalese overseas in these times was conditioned by the existence of “Pani Patia” (caste
purification). Any Hindu who went overseas was automatically out-caste and the
ceremony performed to readmit him in his own caste is known as “Pani Patia.” This
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orthodoxy remained in place for a long time and continued to influence the thinking of
people even after it ceased to be enforced by the government in the early twentieth
century (S. Sharma, 1992, p.272).
According to Sharma (1992), in the early period of unification, when the Nepalese
state came into contact with the East India Company, it resisted its influence by limiting
interactions, including by banning the import of goods from the East India Company and
encouraging local artisan and craft products. At the time when the British were
establishing a transport and industrial infrastructure in India, the Nepalese ruling class did
not allow railway lines inside Nepal.
There was a symbiotic relationship between Hindu religion and the state during
the formative years of Nepal. Since the legitimacy of the monarchy relied on Hindu
beliefs that consider the monarch to be an incarnation of the Hindu god Vishnu, Hindu
religious beliefs and norms received priority. The caste system had official sanctions. In
1954, for instance, a legal code was introduced which reinforced the symbiotic
relationship between Hindu religion and the Nepalese state by formally institutionalizing
caste into state polity (S. Sharma, 1992, p.269).
The religious ideology of Nepal’s ruling class not only insulated them from
foreign Muslim and later Christian influences but also distanced them from Hindu
reformers in India such as Raja Ram Mohun Roy and Mahatma Gandhi. While reformers
in India reinterpreted Hindu Scriptures to advance social justice and make room for
modern institutions, the state sponsored “defensive Hinduism” in Nepal precluded this
possibility. The Nepalese version of Hinduism served as a bulwark against the
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introduction of modern ideas and institutions. Christian missionaries were forbidden from
entering into the country. In keeping with Hindu norms, business and commercial activity
was limited to the members of the Vaishya caste and little effort was put into developing
formal rules and mechanisms for businesses. The Marwari and Newar sub-castes in
particular emerged as the most important merchant class in Nepal (S. Sharma, 1992,
p.272).
There was some opening up to the external world in the 1950’s but these changes
were largely superficial47. Nepal maintained its status as the only official Hindu state in
the world. The country was ruled through large relation based patronage network around
the King. The state apparatus during this period was effectively in the hands of a
hereditary aristocracy. Since it ultimately controlled both the administrative and military
organs of the government, this class did not allow any other self-reliant class outside of
the state to emerge (S. Sharma, 1992p.273).
Nepal did not have a widely dispersed business community, and “crony
capitalism,” where a select few who had privileged access to the ruling class, were
successful in getting business opportunities. Overall, Nepal had a highly “segregated”
social structure with limited interaction between individuals of different social and
cultural groups.
47 This marked the beginning of the formal break with Rana regime and reinstatement of Shah King. There was brief experiment with multiparty democracy, which was outlawed by the King Mahendra Shah. King Mahendra Shah instead introduced the Panchayat rule with the Monarchy assuming absolute powers.
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Section 5f: Nepali and Gujarat in the Early 1990’s
Thus when Nepal and Gujarat both embarked on electricity market reforms in the
early 1990’s, they had different social and cultural norms and institutional and
governance structure. After more than two hundred years under a formal rule based
system established by the British (the last 40 years as an independent nation), Gujarat
was accustomed to a rule based system and had well-functioning institutions for
adjudicating commercial cases and formal contract enforcement. Business and
commercial activity was not limited to selected group of castes or families. The capital
market was relatively efficient. Caste was no longer dominant in the business and
commercial sphere.
Nepal, on the other hand, was a highly traditional society. Nepal’s private sector
was dominated by a group of families from the Vaishya caste. The King and the
government directed credit to favored families and businesses. Nepal relied excessively
on international development agencies for infrastructure investments. The government
was not used to managing complex contractual arrangements with the private sector even
as vested interests opposed the move to a new rule based system.
Nepal transitioned to a democracy in 1990 following a popular revolution. The
newly elected Nepali Congress government pushed through with a number of ambitious
reforms, including in the electricity sector, at the behest of international aid agencies
(World Bank, 1994). However, these rules and regulations were not undertaken through
broad based consultations and did not have buy-in from the population (Nepal & Jamasb,
2012a).
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The different starting point of institutions in Nepal and Gujarat in the 1990’s had
a powerful impact on electricity market reforms in these two places. The starting point of
the institutional set up is important for electricity market reforms because of the nature of
transactions involved in these reforms. Prior to the reforms of the 1990’s, the electricity
sector in both Gujarat and Nepal were under state owned vertically integrated utilities,
which implied limited interactions the private sector48. The adoption of electricity market
reforms changed this situation. The electricity sector was now open to both domestic and
international private sector players. These players needed access to finance and had to
enter into contracts with each other as well as the government. Since external financing
was needed for undertaking large projects, investors needed to have confidence in the
country’s systems. The success of complex and inter-economy transactions required
effective formal rules and institutions to be in place. On all of these fronts, Nepal was less
prepared than Gujarat.
Section 6: Rankings of Gujarat and Nepal in Governance Indices
Support for the assertion regarding the relative strength of formal institutions of
Gujarat and Nepal is also found in International Perception Indexes such as the World
Economic Forum’s Global Competitiveness Opinion Survey and the Organization for
Economic Cooperation and Development’s Country Risk Classification and
Transparency International Corruption Perception Index. In all these rankings, India
48 State-owned utilities had access to financing from the government and international development agencies. While Gujarat contracted with private sector players for construction of power plants, Nepal relied on international donors to help manage procurement and construction.
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scores significantly higher than Nepal. Since Gujarat is one of the top ranked states in
India in governance according to intra-state indices, these rankings provide further
evidence of the strength of formal institutions in Gujarat relative to Nepal.
• The Global Competitiveness Opinion Survey
The Annual Global Competitiveness Reports of the World Economic Forum
examine the many factors enabling national economies to achieve sustained economic
growth and long term prosperity. The Global Competitiveness Index for 2014 ranks 148
countries and provides a useful indication of the each country’s attractiveness to
international investors. Nepal does not score highly in the latest analysis with a ranking
of 117 out of 148 countries. India is ranked 50 (Schwab & Salai Martin, 2013).
The Global Competiveness Report includes a comprehensive set of results from
the World Economic Forum’s Executive Opinion Survey. Survey questions asked for
responses on a scale of 1 to 7 where an answer of one corresponds to the lowest possible
score and an answer of seven corresponds to the highest possible score. Many of the
questions are related to the strength of the formal institutional framework. A selection of
results for Nepal and India is reproduced below. The scores for Nepal are lower than
India for all variables (Table 2-16.3).
Table 6-3 - Scores of Nepal and India on Different Governance Variables
2014
Score
Rank out of 148
countries
Variable Nepal India Nepal India
1.05 Irregular payments and bribes, 1-7 (best) 2.8 3.2 126.0 110.0
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1.10 Efficiency of legal framework in settling disputes,
1-7 (best) 2.9 3.8 123.0 62.0
1.07 Favoritism in decisions of government officials, 1-
7 (best) 2.7 2.8 103.0 94.0
1.12 Transparency of government policymaking, 1-7
(best) 3.7 4.2 110.0 61.0
1.01 Property rights, 1-7 (best) 3.5 4.4 114.0 58.0
1.02 Intellectual property protection, 1-7 (best) 2.9 3.7 117.0 71.0
1.16 Reliability of police services, 1-7 (best) 3.7 4.0 103.0 82.0
1.06 Judicial independence, 1-7 (best) 3.3 4.7 92.0 40.0
1.17 Ethical behavior of firms, 1-7 (best) 3.2 3.7 132.0 86.0
1.21 Strength of investor protection, 0–10 (best) 5.3 6.0 69.0 41.0
• Organization for Economic Cooperation and Development (OECD) Country
Risk Classification
The OECD assesses country credit risk by using its Country Risk Classification
Method which classifies countries into eight country risk categories (0-7). Although the
classifications are intended for a specific purpose, they provide an indication of the
strength of formal institutions in countries. Nepal currently has the lowest rating (7)
available under this classification; India has middling rating of 3 (OECD, 2013).
Table 6-4 shows the minimum risk premium calculated using the formula under
similar conditions for countries in the different risk bands. For example, if a project in
India is financed at 5%, a similar project in Nepal would be financed at 8.5% per annum.
In terms of commercial borrowing this represents a significant additional cost for Nepal
over India.
221
Table 6-4 - Risk Premiums for Different Countries
Country Risk
Classification
Country
Risk Premium
0 USA, Japan 0
1 Slovak Republic 0.6
2 Chile, China 1.0
3 India, Brazil 1.7
4 Philippines 2.4
5 Paraguay 3.3
6 Bangladesh 4.2
7 Nepal, Laos 5.2
• Corruption Perception Index
The Transparency International Corruption Perception Index measures the
perceived levels of public sector corruption in a given country and is a composite index,
drawing on different expert and business surveys. The 2013 Corruption Perception Index
scores 177 countries on a scale from zero (highly corrupt) to 100 (highly clean). Nepal
has a score of 31 and ranking of 116 while India has a score of 36 and ranking of 94
(Transparency International, 2013).
• Ranking of Gujarat among Indian States
The Economic Freedom of the States of India, 2011, estimates economic freedom
in the twenty biggest Indian states, using a methodology adapted from the Fraser
Institute’s Economic Freedom of the World annual reports. The Indian Index ranks 20
states of India for which data is available. The researchers have used published data from
222
official sources or reputed institutions to produce the index. Gujarat ranks number one on
the index out of twenty states (Aiyar, 2012).
The Indian Index is based on the three parameters: size of the government, legal
structure and security of property rights, and regulation of business and labor. The second
parameter – legal structure and security of property rights49 - directly measures the
strength of formal institutions. Gujarat ranks 4 out of twenty on this parameter.
Section 7: The Role of Political Instability
In absence of strong formal institutions and mechanisms, the folk theorem implies
that informal and relational arrangements between the government and investors can be a
more practical way to achieve cooperation50. The insight is based on the idea that when
agents interact only once, they have an incentive to deviate from cooperation. But in a
repeated interaction over a sufficiently long horizon, players have an incentive to sustain
a mutually beneficial outcome (A. K. Dixit, 2007, p. 60).
Dixit modifies this principle to apply it to a kleptocratic and rent seeking
government. He shows that if there is constant turnover of kleptocratic and rent seeking
government (i.e. if the state predators are “roving bandits”) the incentives to produce and
49 The efficiency of the government in protecting human life and property is measured by this category. The quality of
the justice mechanism is measured by the availability of judges, by the completion rate of cases by courts, and by investigations by the police. The level of safety in the region is measured by the recovery rate of stolen property, and by the rate of violent and economic crimes. 50 A formal contract explicitly specifies the penalty and it is enforced by the court. In repeated games, the penalty is indirectly imposed through future interaction. When agents interact only once, they often have an incentive to deviate from cooperation. In a repeated interaction, however, any mutually beneficial outcome can be sustained in an equilibrium.
223
invest can be destroyed completely. However, if the kleptocratic and rent seeking
government is expected to be long lived (i.e. a stationary bandit), the government will
recognize that they stand to gain over the long run by committing themselves not to steal
too much at any one time. Such a kleptocratic government will also recognize the need to
give sufficient incentive to high value investors, as this will increase their net extraction
(A. K. Dixit, 2007, p.130).
In the context of Nepal’s reforms, which was characterized by rent seeking
behavior from the state, stability of political players could have gone a long way towards
ensuring mutually beneficial outcomes with the private sector. However, political
instability has made successive governments remarkably short sighted in their
interactions with the private sector (i.e. has made them behave like roving bandits). Since
1990, Nepal’s has had more than 22 changes in government (Table 6-5). Political energy
and attention has been focused on power struggles, coalition management, and infighting,
with very little effort expended on creating an attractive environment for investors.
Legitimacy of those issuing the rules is central to bringing about reforms in existing rules
and institutions (Greif, 2006, p. 148). However, since Nepal has had many governments
that have lacked the popular mandate, their decisions have lacked legitimacy and have
not been accepted by all stakeholders.
Table 6-5 - List of Prime Ministers of Nepal Since 1990
From To Prime Minister
Number of
Days in Office Party
19-Apr-90 26-May-91 Girija Prasad Koirala (1/5) 402 Nepali Congress
26-May-91 30-Nov-94 Man Mohan Adhikari (1/1) 1284 Communist Party of Nepal (Unified Marxist-Leninist)
30-Nov-94 12-Sep-95 Sher Bahadur Deuba (1/3) 286 Nepali Congress
224
12-Sep-95 12-Mar-97 Lokendra Bahadur Chand (3/4) 547
Rastriya Prajatantra Party (Chand)
12-Mar-97 7-Oct-97 Surya Bahadur Thapa (4/5) 209 Rastriya Prajatantra Party
7-Oct-97 15-Apr-98 Girija Prasad Koirala (2/5) 190 Nepali Congress
15-Apr-98 31-May-99 Krishna Prasad Bhattarai (2/2) 411 Nepali Congress
31-May-99 22-Mar-00 Girija Prasad Koirala (3/5) 296 Nepali Congress
22-Mar-00 26-Jul-01 Sher Bahadur Deuba (2/3) 491 Nepali Congress
26-Jul-01 4-Oct-02
Direct rule by King Gyanendra Bir Bikram Shah 435 Nepali Congress
4-Oct-02 11-Oct-02 Lokendra Bahadur Chand (4/4) 7 Rastriya Prajatantra Party
11-Oct-02 5-Jun-03 Surya Bahadur Thapa (5/5) 237 Rastriya Prajatantra Party
5-Jun-03 3-Jun-04 Sher Bahadur Deuba (3/3) 364 Nepali Congress (Democratic)
3-Jun-04 1-Feb-05
Direct rule by King Gyanendra Bir Bikram Shah 243 —
1-Feb-05 25-Apr-06 Girija Prasad Koirala (4/5) 448 Nepali Congress
25-Apr-06 28-May-08 Girija Prasad Koirala (5/5) 764 Nepali Congress
18-Aug-08 25-May-09 Prachanda 280 Unified Communist Party of Nepal (Maoist)
25-May-09 6-Feb-11 Madhav Kumar Nepal 622 Communist Party of Nepal (Unified Marxist-Leninist)
6-Feb-11 29-Aug-11 Jhala Nath Khanal 204 Communist Party of Nepal (Unified Marxist-Leninist)
29-Aug-11 14-Mar-13 Baburam Bhattarai 563 Unified Communist Party of Nepal (Maoist)
14-Mar-13 11-Feb-14 Khil Raj Regmi 334 Nonpartisan
11-Feb-14 Incumbent Sushil Koirala 131 Nepali Congress
Politically instability is not a factor when a country has strong rule based
governance, which can ensure that commitments of one government are respected by
another. This is borne out by the case of Gujarat. Gujarat had high political instability in
the first decade of reforms (see Table 6-6) but it managed to attract substantially more
private investment in electricity generation than Nepal.
Table 6-6 - List of Chief Ministers in Gujarat
From To Chief Minister
Number of Days in
Office Party
10-Dec-89 4-Mar-90 Madhav Singh Solanki 85 days Indian National Congress
225
4-Mar-90 17-Feb-94 Chimanbhai Patel 1445 days JD(G) + JD + BJP
17-Feb-94 14-Mar-95 Chhabildas Mehta 391 days Indian National Congress
14-Mar-95 21-Oct-95 Keshubhai Patel 221 days Bharatiya Janata Party
21-Oct-95 19-Sep-96 Suresh Mehta 334 days Bharatiya Janata Party
19-Sep-96 23-Oct-96 (President's rule) N/A
23-Oct-96 27-Oct-97 Shankersinh Vaghela 370 days Rashtriya Janata Party
28-Oct-97 4-Mar-98 Dilip Parikh 128 days Rashtriya Janata Party
4-Mar-98 6-Oct-01 Keshubhai Patel 1312 days Bharatiya Janata Party
7-Oct-01 22-May-14 Narendra Modi 4610 days Bharatiya Janata Party
22-May-14 Incumbent Anandiben Patel 31 days Bharatiya Janata Party
Section 8: Conclusion
The power sector reform experiences of Gujarat and Nepal suggest that the
strength of formal institutions rules and the nature of social norms and customs had a
significant influence on the outcome of reforms. Aided by the strength of its formal
institutional framework and more evolved social norms and customs that encouraged
people to follow formal rules, reforms in Gujarat were a success. The weakness of the
formal institutional framework and the predominance of relation based norms and
customs in Nepal that led to limited compliance with formal rules, by contrast, limited the
success of power sector reforms there.
Although Nepal and Gujarat shared a common historical and cultural past, the
Islamic invasion of India and colonization of Gujarat by the British proved to be
important diverging points in the historical evolution of formal and informal institutions
in these two places. Subsequently, Gujarat achieved more progress in establishing a well-
226
functioning formal institutional framework than Nepal. These findings provide further
credence to arguments that favor tailoring economic and sector reforms to specific
institutional conditions of countries.
In analyzing the strength of institutions, the difference in quality of formal
institutions as well as the informal norms and customs between developed and
developing countries is well recognized. Developed countries are known to have strong
formal rules and institutions and individualistic social norms while developing countries
are recognized to have weak formal systems and collectivist belief systems. What is less
recognized is that there may be significant variance in these factors even among
developing countries. The findings of this dissertation suggest a notable difference in the
strength of formal institutions and nature the social norms between Gujarat and Nepal
and highlight the importance of taking this into account while designing reforms in
developing countries.
Efforts to reform the electricity sector in Nepal undertaken by the government as
well as development agencies such as the World Bank and the ADB have focused to a
large extent on getting the content of electricity market reform measures such as
unbundling, privatization, and establishment of a power market right. At the same time,
government and utility officials have been provided technical training on the operations
of utility and electricity market operations. The analysis in this chapter suggests that such
measures will have limited traction unless there is a more fundamental transformation
towards rule based governance.
227
This analysis has several limitations. First this analysis does not explain the
difference in sector performance among Indian states, which shared a similar history after
the arrival of the British. British rule is likely have interacted differently with the culture
and specific situation of each state; some states are likely to have been more successful in
establishing rule based systems than other states. Future work in this area could compare
the reform experience of different states within India.
Second, this analysis points out the importance of promoting social norms, habits
and customs that are supportive of formal rule based governance but does not provide
detailed insights on how a country or a state could go about doing that. Others such as
Dixit have provided some guidance. However, as Dixit acknowledges, this still does not
“constitute an overall framework for understanding institutional change” and more
research is needed in this area.
Third, this analysis subsumes political instability under the overall framework of
rule based and relations based governance. It finds that political instability is not a factor
once a country has established strong rule based governance systems since decisions of
one government are honored by the following government. It sees political instability to
be particularly harmful in the countries with weak rule based governance systems since
agreements and contracts of one regime are not likely to be honored by another regime.
However, it may be possible to build alternate frameworks that analyze the impact of
political stability independent of the rule based vs relation based model. While it is not
clear if such a framework would yield different results, such a framework may provide
additional insights.
228
Fourth, there are limitation associated with analytical narrative methodology used
in this study. The analytical narrative in this study uses a model of rule based and relation
based systems to isolates the relevant strategic elements in the reform process: the key
actors, their goals, and their behavior. The model highlights the issues to be explored and
the general considerations and evidence that need to be examined, while knowledge of
the historical context is used to develop a conjecture regarding the relevant institution.
Evidence is provided to support the causal claim on the role played by rule based
governance in electricity sector performance. While an effort was made in this study to
consider and rule out competing explanations and causal claims, it may be possible to
analyze the performance of reforms using framework and models outside the rule based
and relation based framework such as labor laws, geography, and human capital.
Chapter 7 - Policy Recommendations
As seen in previous chapters, the use of mixed methods to assess the effectiveness
of electricity market reforms in South Asia yields a number of insights on reforms that
have worked and areas for improvement in electricity market reforms in South Asia. The
first part of the dissertation – a standard econometric analysis of reforms using fixed and
random effect models – is useful in analyzing the impact of the observable elements of
institutional reforms namely introduction of private sector participation, establishment of
regulatory agencies, and unbundling of utilities on performance indicators. This analysis
addressed well defined questions associated with reform and produced generalizable
results.
229
The second part of dissertation – an analytical narrative on the reform experiences
of the Indian state of Gujarat contrasted with Nepal – carried out an examination of
“deep” institutional factors that have an impact on reforms. This was achieved through an
analysis of the introduction of IPPs in these two places. This analysis covered the
evolution of informal beliefs and traditions as well as the institutional environment (level
1 and 2 institutions in Williamson’s classification) and their impact on the performance
of electricity market reforms. The dissertation applies the analytical narrative
methodology to the study of electricity market reforms for the first time.
The analysis in the preceding sections points to the following insights and
recommendations that could be considered by governments in the South Asia and other
regions.
Policy Recommendation 1: Commit to electricity market reforms after
taking the institutional setting into account
The econometric analysis carried out in this dissertation finds that for the most
part electricity market reform measures such as the share of private sector in generation,
privatization of distribution and unbundling are positively and significantly associated
performance indicators such as electricity access, per capita generation capacity, per
capital electricity consumption, T&D losses and electricity tariff. Only in rare instances,
do they have an adverse impact on performance indicators and even in these cases, as
discussed later in this section, they may point to drawbacks in the way reforms have been
implemented rather than the reforms themselves. The overall findings of the econometric
analysis are hence consistent with studies undertaken by Vagliasindi (2013), Nagayama
230
(2010), Zhang (Y. Zhang et al., 2008) and others that find a positive relationship between
reforms and performance.
It is difficult to untangle the impact of informal institutions (including culture
belief, and norms) from the econometric analysis since fixed effect analysis effectively
controls for these differences. However, the analytical narratives on electricity market
reforms in Gujarat and Nepal suggest that electricity market reforms are likely to be more
successful in places with robust formal rule based systems. Electricity markets reforms
require the involvement of large number of players as well as highly complex inter-
economy transactions, which can only be pursued efficiently in rule based systems. There
is, for instance, a need to have a relatively well developed banking system and capital
market, an efficient commercial dispute resolution system, an independent judiciary and
transparent regulatory framework for electricity market reforms to be successful. Places
that are able to achieve a co-operative outcome among actors in the economy using an
effective rule based system will be more successful in exploiting the opportunities offered
by electricity reforms than places where the co-operative outcome is achieved through a
relation based system.
Countries with weak governance systems should prioritize economy wide reforms
to improve formal governance over highly complex electricity sector reforms. Reformers
in these countries should be careful not to be get carried away by the purported efficiency
gains of markets and carefully consider the transaction costs associated with different
governance arrangements in the electricity sector. Countries such as Nepal are likely find
it difficult to successfully implement more advanced elements of electricity market
231
reforms such as privatization of distribution companies and establishment of a
competitive electricity market until country’s formal governance systems has been
substantially improved.
Places with stronger formal governance such as Gujarat can afford to commit
more fully to reforms in the electricity sector. Such places should keep an open mind
about more advanced forms of reforms such as the introduction of private sector
participation in distribution. Delhi’s experience suggests that privatization of distribution
can be used to improve performance as long as the terms of the privatization are
structured carefully. While the political economy of such reforms is likely to be
challenging, the analysis in this dissertation suggests that such efforts could deliver
potentially large payoffs. Commitment to reforms along with proper planning and
execution is important because reverting back to pre-reform state of the sector with
government owned utilities at the center of the sector is clearly not a feasible option
anymore for any of the states.
Policy Recommendation 2: Strengthen the capacity of regulatory
agencies
As reported in Chapter 5, the reform measure to have the most unclear
relationship with sector performance is independent regulation. Except for electricity
access, independent regulation does not have a statistically significant positive
relationship with any of the performance indicators. The ambiguous relationship between
regulation and performance indicators is inconsistent with the hypothesis that holds that
independent regulators should have a positive impact on sector performance by creating a
232
more conducive atmosphere for private investments to take place and preventing abuse of
market power.
These findings for independent regulation are surprising but are likely reflective
of the manner in which they have been implemented in South Asia. Regulatory agencies
have faced significant human resource constraints, which has limited their scale and,
hence, their scope and potential effectiveness in the sector. Regulatory agencies have
lacked the technical capacity to design and implement regulations, monitor compliance,
and penalize noncompliance (Pargal, 2014). In India, for instance, the number of
professional staff in regulatory agencies, both in absolute and relative terms, is extremely
low (Pollitt & Stern, 2011). There is hence a need to significantly strengthen the capacity
of regulatory agencies, including adequate numbers of appropriately trained professional
staff, and access to training, research and expertise in key disciplines such as law,
economics, and finance to ensure that they can play their rightful role in electricity sector.
Even with sufficient resources, places with weak formal governance systems may
find it difficult to get an independent regulator to function properly. Like with other
agencies, there could be excessive political interference and cronyism in the selection of
appointees and the regulators may end up taking biased decisions for their own profit or
for the profit of politicians. If the independent regulator is not seen as credible arbitrator
of different interests in the sector, there may be limited gains to be had from establishing
an independent regulator. Like with other reforms measures, thus, the effectiveness of
independent regulation is likely to be determined by the strength of the formal
governance in the country. It would be advisable, hence, to be cautious about the
233
introduction of independent regulation in places with weak governance systems. It will be
particularly important to see the effectiveness of other independent agencies in the
country or state before taking the decision to establish an independent regulator.
Policy Recommendation 3: Adopt an interdisciplinary approach to
reforms
Building on the NIE literature, this study finds confirming evidence for the
proposition that informal elements of institutions such as norms, habits, beliefs, and
customs exercise a significant influence on the outcomes of electricity market reforms. In
Williamson’s terms, they form the “embeddedness” in which formal rules and laws are
implemented. It is seen in Chapter 6 that the historical experiences of Gujarat and Nepal
played an important role in the evolution of institutions in these places and consequently
on the implementation of electricity market reforms. Nepal’s relative isolation from the
outside world for much of its history contributed to its tentativeness in dealings with
international investors while Gujarat’s long history of exposure to the outside world
contributed to the sophistication of its stance with international investors.
Electricity market reform design efforts in South Asia, often led by international
agencies such as the World Bank and Asian Development, have for the most part only
focused on the observable elements of institutional reforms. Academic researchers and
policy analysts have tended to focus on technical fixes rather than ways to alter habits
and social norms. An interdisciplinary approach to policy research and reforms has been
hampered by institutional barriers in academia and government as well as the absence of
social scientists on the staff of energy agencies (Sovacool, 2014).
234
Reforms have been designed with the assumption that there will be no difference
between the letter of the law and actual implementation. However, as this dissertation
demonstrates, this is not likely to be the case in countries with weak formal governance.
There is hence a need to gain a good understanding of the structure and properties
institutional equilibrium of the electricity sector in a particular society before embarking
on major reform effort. This understanding is important even if the aim is to undermine
and replace the institutions (A. Dixit, 2009). For instance, efforts to reform Nepal’s
electricity sector would be well served by an analysis of the interactions and relationships
between politicians, bureaucrats, private industries and the motivations that drive
investment decisions in the electricity sector. Proposed reforms could then explicitly look
for ways to break the nexus between the different interests and move towards providing
formal governance that is driven mainly by concern for social welfare.
While an overall theory and framework that can be applied to design institutional
reforms in the electricity sector is not available, a concrete approach to improve the
design of electricity reforms would be to form a multi-disciplinary team of historians,
sociologists, political scientists, anthropologists, psychologists, lawyers, cognitive
scientists in addition to the economists and engineers who have been typically been
leading such efforts. Such a team would help improve the design of reforms by explicitly
taking into account the role of informal norms, habits and customs as well as the history
of the place. Particular attention would be given to making sure that the proposed reforms
interact well with existing institutions in the short and the long run.
235
Such multi-sector efforts would be in a better position to identify steps necessary
for facilitating the transition to a new institutional equilibrium, including (1)
compensating those who would lose from the change or overcoming their resistance in
the existing political process; (2) changing information and aligning incentives; and (3)
creating common knowledge of actions to sustain the new equilibrium (A. Dixit, 2009).
The adoption of such a proposal will require a change in mindset. Government
ministries are known to function as silos in South Asia and elsewhere and it will be very
difficult to change decades of norms and habits. There will hence likely be significant,
administrative and political challenges to implementing this proposal in governments.
Policy Recommendation 4: Make efforts to establish rule based
governance
Similarly, this study provides confirmation to findings of earlier studies showing
rule based governance to be more compatible with economic growth and development. It
is evident that the Gujarat’s experience with formal rule based system going back to the
British period in its history played an important role in its ability to respond to the
challenges and opportunities presented by electricity market reforms. On the other hand,
the predominance of relation based governance in Nepal limited the gains from reform in
the country.
These findings suggests that South Asian countries should make an effort to
establish strong rule based governance systems in the electricity sector while recognizing
236
that this can be a long drawn out process. So far, efforts to improve rule based
governance in the electricity sector have focused on building the physical infrastructure
and transferring technical knowledge. Going forward, there needs to be as much
emphasis on inculcating norms and behaviors that encourage different actors to follow
rules and regulations.
For a law to be effective in practice, the citizens must expect that the government
will succeed in enforcing the law and that others will also follow the law. This can be
achieved through a policy of carrots and sticks. Behavior that is harmful to the
development of the sector such as power theft, collusion between utility officials and
industries, and corruption needs to be mitigated through strong penalties that are properly
enforced. In parallel, governments should carry out a communication and education
campaign to stigmatize illegal behavior and promote rule based governance. In NIE
terms, the effort should be to move from a sub-optimal institutional equilibrium to a more
optimal institutional equilibrium, while recognizing that any reform will be constrained
by the history of institutions.
A key constraint to the implementation of measures needed for rule based
governance is that such measures will not always yield adequate payoff in the short run.
In fact, as demonstrated by the game theoretic model in in Chapter 6, there might even be
transitional worsening of performance. A transition to a rule based system is also likely to
reduce rent seeking opportunities for the government. Since most governments operate
under relatively short term horizons, they may not see the much value in undertaking
237
such investments. There might, hence, be the need for the involvement of non-
Governmental actors and the civil society in these reform efforts.
Chapter 8 - Contributions to the Literature on Electricity
Market Reforms
This dissertation makes important contributions to the literature on electricity
market reforms in South Asia as well as globally. It presents econometric evidence on the
relationship between different electricity market reform measures and sector performance
in South Asia, finding that for the most part reforms are having a positive impact on the
performance of the sector. This is particularly the case for reforms that have increased
private sector participation in generation and distribution and have vertically unbundled
utilities into generation, T&D entities. The econometric analysis suggests that reforms are
helping to increase the availability of electricity (as measured by indicators such as per
238
capita generation capacity, electricity access, and per capita electricity consumption) and
improve the efficiency of the sector (as measured by reductions in T&D loss). Many of
the reforms are positively correlated with higher tariffs indicating that the improved
performance is coming at a cost to consumers. Of the reform measures, independent
regulation has the most uncertain relationship with sector performance, reflecting the
manner in which it has been implemented in South Asia.
Likewise, the dissertation carries out a detailed investigation of institutional
context in which reforms occurred and explains how and why reforms outcomes differed
in two of the selected places in South Asia – Gujarat and Nepal. In particular, this
dissertation examines the unobservable elements of reforms (such as informal beliefs,
norms, and culture) that motivate actions and their interactions with the formal elements
of institutions and reforms. The dissertation finds that the strength of formal institutional
rules and the nature of social norms and customs jointly have a significant influence on
the outcome of reforms. Aided by the strength of its formal institutional framework and
more evolved social norms and customs that encouraged people to follow formal rules,
reforms in Gujarat were a success. The weakness of the formal institutional framework
and the predominance of relation based norms and customs in Nepal that led to limited
compliance with formal rules, by contrast, limited the success of power sector reforms
there.
Efforts to reform the electricity sector in Nepal undertaken by the government as
well as development agencies such as the World Bank and the ADB have focused to a
large extent on getting the timing and content of electricity market reform measures such
239
as unbundling, privatization, and establishment of a power market right. At the same
time, government and utility officials have been provided technical training on the
operations of utility and electricity market operations. The analysis in this dissertation
suggests that such measures will have limited traction unless there is a more fundamental
transformation towards rule based governance. To get reforms right, Government should
adopt an interdisciplinary approach that takes into account both formal and informal
elements of institutions.
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263
Appendix A - Summary of the Key Results of Econometric Studies on Electricity Market
Reforms and Sector Performance
Study Hypothesis Dependent
Variable(s)
Independent
Variable(s)
Control Variables Notes: # of countries,
times
period, data source
Zhang et
al.
(2002)
H0: Privatization leads to
higher operating
efficiency
and asset utilization.
-operating efficiency: net
electricity generation
(MWh) per employee (#)
(PI)
-asset utilization: electricity
generation (MWh) / average
capacity (MW)
(PI)
-privatization: existence
of
private generation
(dummy)
(MS/RM)
Result: insignificant
GDP per capita (US$ 95)
(CL)
Result: significant at the
1% level
-urban population as % of
total
(CL)
Result: significant at the
1% level
-industrial output as % of
GDP
(CL)
Result: significance varies
across models
-degree of economic
freedom (based on 10-
point indices in ‘Economic
Freedom of the World:
2002 Annual Report’)
51 LDCs from 1985-2000.
Generation and capacity
data:
APERC database and World
Dev. Indicators.
Labor: Industrial Statistics
Yearbook, International
Labor Organization.
Privatization, regulation,
and
competition: The Yearbook
of Privatization, EIA, WEC,
and APERC.
Price: OLADE, OECD.
264
(CL)
Result: significant at the
1% level
H1: Privatization with
supportive regulation
leads
to higher output and
capacity.
-output: net generation
(MWh) per capita
(PI)
-capacity: generation
capacity (MW) per capita
(PI)
-privatization: existence
of
private generation
(dummy)
(MS/RM)
-regulation: existence of
independent regulatory
agency
(dummy)
(I)
Result: taken together,
the
variables are significant
(on generation at 10%
level, on
capacity at 5% level)
H2: Privatization leads to
higher residential and
lower
industrial prices.
residential prices: user
price
(PI)
-industrial price: user price
(PI)
-privatization: existence
of
private generation
(dummy)
(MS/RM)
Result: insignificant
H3: Competition leads to
larger capacity, higher
output, and greater labor
productivity.
-output: net generation
(MWh) per capita
(PI)
-capacity: generation
competition: existence
of
wholesale market
(dummy)
265
capacity (MW) per capita
(PI)
-labor productivity: net
electricity generation
(MWh) per employee (#)
(PI)
(RM)
Result: significant (the
levels of
significance vary across
different
models and equations –
either 5
or 10%)
H4: Competition leads to
higher residential and
lower
industrial prices.
-residential prices: user
price (US$)
(PI)
-industrial price: user price
(PI)
-competition: existence
of
wholesale market
(dummy)
(RM)
Result: this is
significant for
industrial prices for
only one of
the specified equations
(at 1%
level of significance)
H5: Independent
regulation
will improve productive
efficiency.
output: net generation
(MWh) per capita
(PI)
-capacity: generation
capacity (MW) per capita
(PI)
-regulation: existence of
independent regulatory
agency
(dummy)
(I)
Result: insignificant
H6: Regulation leads to
higher residential prices.
-residential prices: user
price (US$)
(PI)
-regulation: existence of
independent regulatory
agency
266
(dummy)
(I)
Result: insignificant
Steiner
(2001)
H0: Regulation and
restructuring leads to
improved utilization rate
and reserve margin in
electricity generation.
H1: Regulation and
restructuring leads to
lower
industrial electricity
prices
and industrial/residential
price ratio.
-industrial end-user price in
PPPs (PI)
-ratio of industrial to
residential prices in PPPs
(PI)
-utilization rate: energy
production/total average
capacity (PI)
-distance of actual from
optimal reserve margin
(PI)
-time to liberalization
(years)
(RM)
Results: significantly
positive for
prices
-time to privatization
(years)
(RM)
Results: insignificant
for prices
-unbundling of
generation from
transmission (multi-
level
indicator) (RM)
Results: insignificant
for prices,
significantly positive for
utilization rate.
-private ownership
(multi-level
indicator) (RM)
Results: significantly
positive for
prices and for
-GDP (US$) (CL)
Result: insignificant
-hydro share in generation
(SE)
Result: significant for
prices
-nuclear share in
generation (SE)
-state preference against
nuclear technology (SE)
-state preference in favor
of coal technology (SE)
-urbanization (CL)
Panel data from
International
Energy Agency and other
sources covering 19 OECD
Countries. Number of
periods
(1986-1996): 11 ⇒ number
of observations: 209
267
utilization rate.
-third party access
(dummy)
(RM)
Results: insignificant
for prices and for
efficiency measures
-wholesale pool
(dummy) (RM)
Results: significantly
negative for
prices
-choice threshold (RM)
-T price regulation (not
used)
(RM)
Hattori and
Tsutsui
(2003)
H0: Unbundling of
generation from
transmission, third party
access, the existence of a
wholesale market, and
privatization leads to
lower
industrial electricity
prices
and industrial/residential
price ratios. As the start
of
-industrial end-user price in
PPPs (PI)
-ratio of industrial to
residential prices in PPPs
(PI)
-wholesale pool
(dummy) (RM)
Results: significantly
positive for
prices
-third party access
(dummy)
(RM)
Results: significantly
negative for
prices
-private ownership
-GDP (US$ PPP) (CL)
Results: statistically
significantly negative for
prices
-share of hydro capacity
(SE)
Results: statistically
insignificant
-share of nuclear capacity
(SE)
Results: statistically
insignificant
Panel dataset of 19 OECD
countries for the period
1987-
1999 (number of
observations: 232).
268
liberalization and
privatization approaches
prices decrease.
(multi-level
indicator) (RM)
Results: significantly
negative for
prices
-time to privatization
(years)
(RM)
Results: statistically
insignificant
Vagliasindi
(2011)
Hypothesis 1 The
implementation of key
sectoral reforms,
including vertical and
horizontal unbundling,
privatization and
regulation, is expected to
be significantly
associated with higher
access and better
operational and financial
performance of the power
sector.
.
Hypotheses 2A Key
sectoral reforms,
particularly vertical and
horizontal unbundling,
Access
Labor Productivity
Tariff
Emissions Index
-vertical and horizontal
unbundling
Results: significantly
positive for
Access for Group A
countries but significantly
negative for Access for
Group D Countries;
Overall, significantly
positive for tariff
-privatization
Results: significantly
positive for
Labor productivity for
Group A countries but
significantly negative for
Labor productivity for
Group D Countries:
GDP per capita
Results: significantly
positive for
Access, labor
productivity,and tariff
Installed Capacity
Results: significantly
positive for
Access, labor productivity,
and tariff
GDP per capita*Installed
Capacity
Results: significantly
negative for
Access, labor
productivity,and tariff
The data set is based on a
panel of 22 middle income
and developing countries for
a period beginning in 1989
and extending through 2009.
The maximum total number
of maximum observations is
440.
Data was compiled from the
government sources and
utilities
269
are expected to produce
the most significant
results in the group of
countries characterized
by high power system size
and income per capita
(Group A).
Hypotheses 2B Key
sectoral reforms,
particularly vertical and
horizontal unbundling,
are not expected to be
effective in the group of
countries characterized
by low power system size
and income per capita.
Overall significantly
positive for
Access, labor
productivity, tariff
-regulation
Results: significantly
positive for
Access, labor
productivity, tariff for
Group A countries but
significantly negative for
Access, labor
productivity, and tariff
for Group D Countries;
Overall significantly
positive for
Access, labor
productivity, tariff
Nagayama
HO:IPPs increase
generation capacity per
T&D Loss
-IPPs
GDP per capita,
The dataset comprise of panel
270
(2008)
capita and reduce T&D
loss
H1: Privatization
increase generation
capacity per capita and
reduce T&D loss
H2: Unbundling increase
generation capacity per
capita and reduce T&D
loss
H3: Retail Competition
increase generation
capacity per capita and
reduce T&D loss
H4: Independent
Regulator increase
generation capacity per
capita and reduce T&D
loss
H5: Power Market
increase generation
capacity per capita and
reduce T&D loss
Generation Capacity per capita Results: significantly
positive for generation
capacity per capita
overall; Significantly
negative for Asian
Developing Countries for
T&D loss.
-Privatization
Results: significantly
positive for generation
capacity per capita
overall;
-Unbundling
Results: significantly
positive for T&D loss
overall;
-Retail Competition
Results: significantly
positive for generation
capacity per capita
overall and for developed
countries;
-independent regulator
Results; significantly
positive for generation
capacity per capita and
T&D loss overall and for
Share of industry in GDP, and
Degree of political
democracy,
data for 85 countries divided
into four regions (developed
countries 25,the
countries of the former Soviet
Union and eastern Europe 27,
Latin
America 21, and Asian
developing countries
13)from1985 to 2006
271
developed countries.
Significantly negative for
Asian developing
countries for generation
capacity per capita
-power market
Results: significantly
negative for generation
capacity per capita
overall and for developed
countries. Significantly
positive for Asian
Developing Countries for
T&D loss.
272
Appendix B - Strategy for Addressing Challenges
Limitation Description Strategy
Measurement
Validity
There are numerous indicators for
measuring electricity sector
performance and the ones selected for
the study may not accurately or fully
capture sector performance.
Use measures that have
been previously validated
by experts and/or other
studies
Reliability
Government data may be unreliable.
Government agencies may lack
capacity to independently collect data
or may have an incentive to mis-
report the collected data to show their
agencies in a better light.
Cross check to the extent
possible with data collected
by independent agencies
such as the World Bank
Internal validity
The changes in sector performance
may not be linked to implementation
of reforms but some other
development that has taken place such
as for instance overall improvements
in the economy.
Careful examination of the
external context in which
reforms were implemented;
question carefully findings
regarding co-variation to
identify other variables that
produce variation in sector
performance.
273
External Validity
The findings may not be generalizable
beyond the South Asian context.
Compare results with
similar studies undertaken
in different contexts
274
Appendix C - Scatter Plots
(i) Electricity Generation Capacity Vs Per Capita GDP
05
00
10
00
15
00
20
00
25
00
0 500 1000 1500 2000 250016 data
18 data Fitted values
275
(ii) Electricity Access Vs Per Capita GDP
(iii) Per Capita Generation Capacity Vs Per Capita GDP
0.5
11
.5
0 500 1000 1500 2000 2500
0.0
001
.00
02
.00
03
.00
04
0 500 1000 1500 2000 2500
276
(iv) T&D Loss Vs Per Capita GDP
(i) Average Tariff Vs Per Capita GDP
0.2
.4.6
.8
0 500 1000 1500 2000 2500
05
10
15
0 500 1000 1500 2000 2500
277
Appendix D - Fixed and Random Effects Specification
In a fixed effects model, the country specific effects are assumed to be the fixed
parameters to be estimated. The fixed effects model is a preferable when the differences
between units are parametric shifts of the regression function. This model is applicable to
the cross-sectional units in the study and its inferences do not apply beyond the study. A
fixed effect model is estimated by Ordinary Least Squares. Fixed Effect explores the
relationship between predictor and outcome variables within an entity. Each entity has its
own individual characteristics that may or may not influence the predictor variables.
When using fixed effects we assume that something within the individual may impact or
bias the predictor or outcome variables and we need to control for this. This is the
rationale behind the assumption of the correlation between entity’s error term and
predictor variables.
Fixed Effect removes the effect of those time-invariant characteristics so we can
assess the net effect of the predictors on the outcome variable. Another important
assumption of the fixed effect model is that those time-invariant characteristics are
unique to the individual and should not be correlated with other individual characteristics.
Each entity is different therefore the entity’s error term and the constant (which captures
individual characteristics) should not be correlated with the others. If the error terms are
correlated, then fixed effect is not suitable since inferences may not be correct.
In a random effect model, the country specific effects are treated as stochastic.
The rationale behind random effects model is that, unlike the fixed effects model, the
278
variation across entities is assumed to be random and uncorrelated with the predictor or
independent variables included in the model. A random effect model is estimated using
generalized least squares when the variance structure is known and feasible generalized
least squares when the variance is unknown.
Random effects allows for time-invariant variables to play a role as explanatory
variables. In random effects you need to specify those individual characteristics that may
or may not influence the predictor variables. The problem with this is that some variables
may not be available therefore leading to omitted variable bias in the model. Random
Effect allows to generalize the inferences beyond the sample used in the model.
The fixed effect model produces consistent estimates, whereas the estimates
obtained from the random effect model is more efficient but the estimates may be
inconsistent. The inefficiency of least squares follows from an inefficient weighting of
the two (within and between) least squares estimators. In particular compared to the
generalized least squares, Ordinary Least Squares places too much weight on the between
unit variation. It includes all in the variation in X, rather than apportioning some of it to
random variation across groups attributable to the variation in u across units. The
inconsistency of the random effect model derives from the fact that there is no
justification for treating the individual effects as uncorrelated with the other regressors so
that it may suffer from the inconsistency due to omitted variables.
The Hausman specification test compares the fixed versus random effects under the null
hypothesis that the individual effects are uncorrelated with the other regressors in the
model. If correlated (namely if the null hypothesis is rejected), a random effect model
279
produces biased estimators, violating one of the Gauss-Markov assumptions; so a fixed
effect model is preferred. Hausman's essential result is that the covariance of an efficient
estimator with its difference from an inefficient estimator is zero.
Breusch and Pagan developed the Lagrange multiplier test; Judge et al. 1988) to
identify the presence of random effects and in order to decide on using either pooled
Ordinary Least Squares or random effects in our analysis. The null hypothesis is that
cross-sectional variance components are zero. The Lagrange multiplier is distributed as
chi-squared with one degree of freedom. If the null is rejected, the random effect model is
more appropriate.
280
Appendix E - Detailed Stata Outputs
This appendix presents the detailed Stata outputs of the fixed effect and random
effect models as well as the results Hausman text and Breusch and Pagan tests.
Fixed Effect Model Results
Per Capita Generation Capacity
F test that all u_i=0: F(29, 476) = 15.33 Prob > F = 0.0000
rho .55021624 (fraction of variance due to u_i)
sigma_e .00003707
sigma_u .000041
_cons -.0000323 .0000101 -3.20 0.001 -.000052 2 -.0000125
politicalstability -3.01e-06 4.99e-06 -0.60 0.546 -.000012 8 6.79e-06
shofindustry .0001616 .0000433 3.73 0.000 .000076 5 .0002466
urbanizationrate -4.37e-06 3.83e-06 -1.14 0.255 -.000011 9 3.16e-06
percapitaGDPreal 1.22e-07 1.11e-08 10.92 0.000 9.97e-0 8 1.43e-07
pvtizationofdist .0000587 .0000143 4.11 0.000 .000030 7 .0000868
regcomm 5.17e-06 5.21e-06 0.99 0.322 -5.08e-0 6 .0000154
utilunbundling 4.05e-06 6.04e-06 0.67 0.503 -7.82e-0 6 .0000159
shpvtingencap .0002193 .0000274 8.00 0.000 .000165 4 .0002732
percapitagencap Coef. Std. Err. t P>|t| [95% Co nf. Interval]
corr(u_i, Xb) = -0.3253 Pro b > F = 0.0000
F(8 ,476) = 54.86
overall = 0.4422 max = 20
between = 0.4293 avg = 17.1
R-sq: within = 0.4797 Obs per group: min = 10
Group variable: state_coun~1 Num ber of groups = 30
Fixed-effects (within) regression Num ber of obs = 514
281
Electricity Access
Per Capita Electricity Consumption
F test that all u_i=0: F(29, 457) = 164.07 Prob > F = 0.0000
rho .94752209 (fraction of variance due to u_i)
sigma_e .05697093
sigma_u .24208046
_cons .1895085 .0367351 5.16 0.000 .117317 9 .2616992
politicalstability -.0031113 .0078382 -0.40 0.692 -.018514 7 .012292
shofindustry .4035225 .0675425 5.97 0.000 .270790 2 .5362549
urbanizationrate 1.334895 .1499321 8.90 0.000 1.04025 3 1.629537
percapitaGDPreal -.0000927 .0000209 -4.43 0.000 -.000133 8 -.0000516
pvtizationofdist .030955 .0220327 1.40 0.161 -.012342 9 .0742529
regcomm .0507725 .0084382 6.02 0.000 .034189 9 .067355
utilunbundling .0407832 .009604 4.25 0.000 .021909 6 .0596567
shpvtingencap .3546625 .0452736 7.83 0.000 .265692 2 .4436327
access2 Coef. Std. Err. t P>|t| [95% Co nf. Interval]
corr(u_i, Xb) = -0.4907 Pro b > F = 0.0000
F(8 ,457) = 99.85
overall = 0.2311 max = 20
between = 0.1878 avg = 16.5
R-sq: within = 0.6361 Obs per group: min = 10
Group variable: state_coun~1 Num ber of groups = 30
Fixed-effects (within) regression Num ber of obs = 495
F test that all u_i=0: F(29, 320) = 47.18 Prob > F = 0.0000
rho .83822874 (fraction of variance due to u_i)
sigma_e 101.27491
sigma_u 230.53264
_cons -320.9329 33.34901 -9.62 0.000 -386.543 9 -255.3219
politicalstability 21.81735 16.24534 1.34 0.180 -10.1438 1 53.77851
shofindustry 655.9128 142.0517 4.62 0.000 376.439 6 935.3859
urbanizationrate -10.25415 10.51117 -0.98 0.330 -30.9338 7 10.42557
percapitaGDPreal .8498689 .0348243 24.40 0.000 .781355 4 .9183823
pvtizationofdist 48.80454 47.5175 1.03 0.305 -44.6816 2 142.2907
regcomm -8.236618 18.31655 -0.45 0.653 -44.2726 9 27.79946
utilunbundling 107.0396 20.27073 5.28 0.000 67.1588 5 146.9203
shpvtingencap 921.7015 80.08494 11.51 0.000 764.14 2 1079.261
percapitaeleccons Coef. Std. Err. t P>|t| [95% Co nf. Interval]
corr(u_i, Xb) = -0.2583 Pro b > F = 0.0000
F(8 ,320) = 211.41
overall = 0.5935 max = 20
between = 0.5238 avg = 11.9
R-sq: within = 0.8409 Obs per group: min = 4
Group variable: state_coun~1 Num ber of groups = 30
Fixed-effects (within) regression Num ber of obs = 358
282
T&D Loss
Average tariff
F test that all u_i=0: F(27, 196) = 9.35 Prob > F = 0.0000
rho .65964307 (fraction of variance due to u_i)
sigma_e .08301504
sigma_u .11556969
_cons .2859284 .0765336 3.74 0.000 .134993 3 .4368634
politicalstability .0179006 .0190957 0.94 0.350 -.019758 8 .05556
shofindustry .1605455 .1468837 1.09 0.276 -.129129 8 .4502209
urbanizationrate -.3244713 .3015609 -1.08 0.283 -.919191 9 .2702493
percapitaGDPreal .000135 .0000498 2.71 0.007 .000036 7 .0002333
pvtizationofdist -.1501236 .0416631 -3.60 0.000 -.232289 2 -.067958
regcomm .0222769 .0225546 0.99 0.325 -.02220 4 .0667578
utilunbundling -.0778112 .0236451 -3.29 0.001 -.124442 7 -.0311797
shpvtingencap -.0571304 .1022449 -0.56 0.577 -.258771 8 .144511
tdloss2 Coef. Std. Err. t P>|t| [95% Co nf. Interval]
corr(u_i, Xb) = -0.5970 Pro b > F = 0.0000
F(8 ,196) = 5.92
overall = 0.0240 max = 20
between = 0.0003 avg = 8.3
R-sq: within = 0.1945 Obs per group: min = 2
Group variable: state_coun~1 Num ber of groups = 28
Fixed-effects (within) regression Num ber of obs = 232
F test that all u_i=0: F(29, 309) = 10.45 Prob > F = 0.0000
rho .58125293 (fraction of variance due to u_i)
sigma_e 1.1045776
sigma_u 1.3013764
_cons 1.246499 .3890344 3.20 0.001 .481006 9 2.01199
politicalstability -.2175635 .1835664 -1.19 0.237 -.578761 8 .1436348
shofindustry 10.02922 1.648255 6.08 0.000 6.78599 5 13.27244
urbanizationrate -.1302851 .1153961 -1.13 0.260 -.357346 7 .0967764
percapitaGDP .0020765 .0002281 9.10 0.000 .001627 6 .0025254
pvtizationofdist -1.336505 .5079215 -2.63 0.009 -2.33592 7 -.3370826
utilunbundling .9830729 .2202014 4.46 0.000 .54978 9 1.416357
regcomm .7005637 .1867066 3.75 0.000 .333186 5 1.067941
shpvtingencap -.9041033 .962907 -0.94 0.348 -2.79878 7 .9905809
electariff Coef. Std. Err. t P>|t| [95% Co nf. Interval]
corr(u_i, Xb) = -0.4125 Pro b > F = 0.0000
F(8 ,309) = 63.61
overall = 0.3628 max = 20
between = 0.0901 avg = 11.6
R-sq: within = 0.6222 Obs per group: min = 5
Group variable: state_coun~1 Num ber of groups = 30
Fixed-effects (within) regression Num ber of obs = 347
283
Random Effect Model Results
Per Capita Generation Capacity
Electricity Access
rho .46810336 (fraction of variance due to u_i)
sigma_e .00003707
sigma_u .00003477
_cons -.0000281 .0000115 -2.45 0.014 -.000050 6 -5.61e-06
politicalstability -1.09e-06 4.85e-06 -0.22 0.823 -.000010 6 8.42e-06
shofindustry .0001638 .0000406 4.03 0.000 .000084 2 .0002434
urbanizationrate -4.44e-06 3.84e-06 -1.16 0.247 -.00001 2 3.08e-06
percapitaGDPreal 1.15e-07 1.03e-08 11.20 0.000 9.48e-0 8 1.35e-07
pvtizationofdist .0000535 .0000137 3.90 0.000 .000026 6 .0000804
regcomm 8.14e-06 5.12e-06 1.59 0.112 -1.90e-0 6 .0000182
utilunbundling 3.02e-06 5.93e-06 0.51 0.611 -8.61e-0 6 .0000146
shpvtingencap .0001983 .0000264 7.52 0.000 .000146 6 .00025
percapitagencap Coef. Std. Err. z P>|z| [95% Co nf. Interval]
corr(u_i, X) = 0 (assumed) Pro b > chi2 = 0.0000
Wal d chi2(8) = 451.36
overall = 0.4515 max = 20
between = 0.4413 avg = 17.1
R-sq: within = 0.4788 Obs per group: min = 10
Group variable: state_coun~1 Num ber of groups = 30
Random-effects GLS regression Num ber of obs = 514
rho .91301367 (fraction of variance due to u_i)
sigma_e .05697093
sigma_u .18457227
_cons .236079 .047186 5.00 0.000 .143596 1 .3285619
politicalstability -.0033856 .0079471 -0.43 0.670 -.018961 5 .0121904
shofindustry .4199935 .0680384 6.17 0.000 .286640 7 .5533463
urbanizationrate 1.11861 .1275792 8.77 0.000 .868559 6 1.368661
percapitaGDPreal -.0000735 .0000205 -3.59 0.000 -.000113 6 -.0000334
pvtizationofdist .0236916 .0222972 1.06 0.288 -.020010 1 .0673932
regcomm .0541713 .0084729 6.39 0.000 .037564 8 .0707779
utilunbundling .0403773 .009734 4.15 0.000 .02129 9 .0594556
shpvtingencap .3604157 .0455984 7.90 0.000 .271044 5 .449787
access2 Coef. Std. Err. z P>|z| [95% Co nf. Interval]
corr(u_i, X) = 0 (assumed) Pro b > chi2 = 0.0000
Wal d chi2(8) = 770.69
overall = 0.2368 max = 20
between = 0.1868 avg = 16.5
R-sq: within = 0.6345 Obs per group: min = 10
Group variable: state_coun~1 Num ber of groups = 30
Random-effects GLS regression Num ber of obs = 495
284
Per Capita Electricity Consumption
T&D Loss
rho .68941277 (fraction of variance due to u_i)
sigma_e 101.27491
sigma_u 150.88627
_cons -276.1808 44.1937 -6.25 0.000 -362.798 9 -189.5627
politicalstability 22.48182 16.67333 1.35 0.178 -10.1973 1 55.16096
shofindustry 708.3985 141.9957 4.99 0.000 430.092 1 986.7049
urbanizationrate -9.752707 10.98953 -0.89 0.375 -31.2917 8 11.78637
percapitaGDPreal .8236323 .0346544 23.77 0.000 .755710 9 .8915537
pvtizationofdist 60.48803 49.00214 1.23 0.217 -35.554 4 156.5305
regcomm 2.727295 18.84425 0.14 0.885 -34.2067 6 39.66135
utilunbundling 106.078 21.02232 5.05 0.000 64.8750 3 147.281
shpvtingencap 858.5424 82.14882 10.45 0.000 697.533 7 1019.551
percapitaeleccons Coef. Std. Err. z P>|z| [95% Co nf. Interval]
corr(u_i, X) = 0 (assumed) Pro b > chi2 = 0.0000
Wal d chi2(8) = 1598.42
overall = 0.6036 max = 20
between = 0.5352 avg = 11.9
R-sq: within = 0.8403 Obs per group: min = 4
Group variable: state_coun~1 Num ber of groups = 30
Random-effects GLS regression Num ber of obs = 358
rho .54633432 (fraction of variance due to u_i)
sigma_e .08301504
sigma_u .09109993
_cons .2710604 .0446239 6.07 0.000 .183599 2 .3585216
politicalstability .0210785 .0180385 1.17 0.243 -.014276 3 .0564333
shofindustry .0488653 .1303878 0.37 0.708 -.206690 1 .3044207
urbanizationrate -.0810308 .1149284 -0.71 0.481 -.306286 3 .1442248
percapitaGDPreal .0000776 .000041 1.89 0.059 -2.84e-0 6 .000158
pvtizationofdist -.1368845 .0407013 -3.36 0.001 -.216657 6 -.0571114
regcomm .0311515 .0210083 1.48 0.138 -.01002 4 .0723271
utilunbundling -.0756024 .0231125 -3.27 0.001 -.12090 2 -.0303028
shpvtingencap -.112739 .0923598 -1.22 0.222 -.293760 9 .068283
tdloss2 Coef. Std. Err. z P>|z| [95% Co nf. Interval]
corr(u_i, X) = 0 (assumed) Pro b > chi2 = 0.0000
Wal d chi2(8) = 40.25
overall = 0.0391 max = 20
between = 0.0005 avg = 8.3
R-sq: within = 0.1860 Obs per group: min = 2
Group variable: state_coun~1 Num ber of groups = 28
Random-effects GLS regression Num ber of obs = 232
285
Average tariff
Hausman Test
Per Capita Generation Capacity
rho .24826001 (fraction of variance due to u_i)
sigma_e 1.2103198
sigma_u .69553617
_cons 1.599767 .3886631 4.12 0.000 .83800 1 2.361532
politicalstability .035034 .1935035 0.18 0.856 -.344225 9 .414294
shofindustry 6.800685 1.547797 4.39 0.000 3.76705 7 9.834312
urbanizationrate -.1858163 .133732 -1.39 0.165 -.447926 3 .0762936
percapitaGDPreal .0019585 .0003615 5.42 0.000 .001250 1 .002667
pvtizationofdist -.2970777 .5421093 -0.55 0.584 -1.35959 2 .7654371
utilunbundling .9228843 .2414312 3.82 0.000 .449687 9 1.396081
regcomm 1.048668 .2068813 5.07 0.000 .643188 3 1.454148
shpvtingencap 2.214909 .9458282 2.34 0.019 .361119 8 4.068698
electariff Coef. Std. Err. z P>|z| [95% Co nf. Interval]
corr(u_i, X) = 0 (assumed) Pro b > chi2 = 0.0000
Wal d chi2(8) = 296.71
overall = 0.3225 max = 20
between = 0.1424 avg = 11.6
R-sq: within = 0.5304 Obs per group: min = 5
Group variable: state_coun~1 Num ber of groups = 30
Random-effects GLS regression Num ber of obs = 347
(V_b-V_B is not positive definite)
Prob>chi2 = 0.0022
= 24.08
chi2(8) = (b-B)'[(V_b-V_B)^(-1)]( b-B)
Test: Ho: difference in coefficients not syst ematic
B = inconsistent under Ha, efficient un der Ho; obtained from xtreg
b = consistent under Ho and Ha; obtained from xtreg
politicals~y -3.01e-06 -1.09e-06 -1.92e-06 1. 14e-06
shofindustry .0001616 .0001638 -2.21e-06 .0 000149
urbanizati~e -4.37e-06 -4.44e-06 7.47e-08 .
percapitaG~l 1.22e-07 1.15e-07 6.64e-09 4. 30e-09
pvtization~t .0000587 .0000535 5.22e-06 3. 98e-06
regcomm 5.17e-06 8.14e-06 -2.97e-06 9. 78e-07
utilunbund~g 4.05e-06 3.02e-06 1.03e-06 1. 14e-06
shpvtingen~p .0002193 .0001983 .000021 7. 49e-06
fixed random Difference S.E.
(b) (B) (b-B) sqrt(di ag(V_b-V_B))
Coefficients
. hausman fixed random
286
Electricity Access
Per Capita Electricity Consumption
(V_b-V_B is not positive definite)
Prob>chi2 = 0.9208
= 2.58
chi2(7) = (b-B)'[(V_b-V_B)^(-1)]( b-B)
Test: Ho: difference in coefficients not syst ematic
B = inconsistent under Ha, efficient un der Ho; obtained from xtreg
b = consistent under Ho and Ha; obtained from xtreg
politicals~y -.0031113 -.0033856 .0002742 .
shofindustry .4035225 .4199935 -.0164709 .
urbanizati~e 1.334895 1.11861 .2162849 .0 787602
percapitaG~l -.0000927 -.0000735 -.0000192 4. 39e-06
pvtization~t .030955 .0236916 .0072634 .
regcomm .0507725 .0541713 -.0033989 .
utilunbund~g .0407832 .0403773 .0004059 .
shpvtingen~p .3546625 .3604157 -.0057533 .
fixed random Difference S.E.
(b) (B) (b-B) sqrt(di ag(V_b-V_B))
Coefficients
(V_b-V_B is not positive definite)
Prob>chi2 = 0.0000
= 245.72
chi2(8) = (b-B)'[(V_b-V_B)^(-1)]( b-B)
Test: Ho: difference in coefficients not syst ematic
B = inconsistent under Ha, efficient un der Ho; obtained from xtreg
b = consistent under Ho and Ha; obtained from xtreg
politicals~y 21.81735 22.48182 -.6644733 .
shofindustry 655.9128 708.3985 -52.48575 3. 987534
urbanizati~e -10.25415 -9.752707 -.5014427 .
percapitaG~l .8498689 .8236323 .0262365 .0 034353
pvtization~t 48.80454 60.48803 -11.68349 .
regcomm -8.236618 2.727295 -10.96391 .
utilunbund~g 107.0396 106.078 .9615791 .
shpvtingen~p 921.7015 858.5424 63.15908 .
fixed random Difference S.E.
(b) (B) (b-B) sqrt(di ag(V_b-V_B))
Coefficients
. hausman fixed random
287
T&D Loss
Average Tariff
(V_b-V_B is not positive definite)
Prob>chi2 = 0.0162
= 17.20
chi2(7) = (b-B)'[(V_b-V_B)^(-1)]( b-B)
Test: Ho: difference in coefficients not syst ematic
B = inconsistent under Ha, efficient un der Ho; obtained from xtreg
b = consistent under Ho and Ha; obtained from xtreg
politicals~y .0179006 .0210785 -.0031779 .0 062656
shofindustry .1605455 .0488653 .1116802 .0 676302
urbanizati~e -.3244713 -.0810308 -.2434406 .2 788017
percapitaG~l .000135 .0000776 .0000574 .0 000283
pvtization~t -.1501236 -.1368845 -.0132391 .0 089005
regcomm .0222769 .0311515 -.0088746 .0 082074
utilunbund~g -.0778112 -.0756024 -.0022088 .0 049905
shpvtingen~p -.0571304 -.112739 .0556086 .0 438598
fixed random Difference S.E.
(b) (B) (b-B) sqrt(di ag(V_b-V_B))
Coefficients
(V_b-V_B is not positive definite)
Prob>chi2 = 0.0000
= 310.98
chi2(7) = (b-B)'[(V_b-V_B)^(-1)]( b-B)
Test: Ho: difference in coefficients not syst ematic
B = inconsistent under Ha, efficient un der Ho; obtained from xtreg
b = consistent under Ho and Ha; obtained from xtreg
politicals~y -.2175635 .035034 -.2525975 .
shofindustry 10.02922 6.800685 3.228533 .5 666273
urbanizati~e -.1302851 -.1858163 .0555312 .
pvtization~t -1.336505 -.2970777 -1.039427 .
utilunbund~g .9830729 .9228843 .0601886 .
regcomm .7005637 1.048668 -.3481046 .
shpvtingen~p -.9041033 2.214909 -3.119012 .1 805519
fixed random Difference S.E.
(b) (B) (b-B) sqrt(di ag(V_b-V_B))
Coefficients
. hausman fixed random
288
BREUSCH AND PAGAN LAGRANGIAN MULTIPLIER Test
Electricity Access
Prob > chibar2 = 0.0000
c hi bar 2( 01) = 2083.66
Test: Var(u) = 0
u .0340669 .1845723
e .0032457 .0569709
access2 .0585605 .2419927
Var sd = sqrt(Var)
Estimated results:
access2[state_country1,t] = Xb + u[state_co untry1] + e[state_country1,t]
Breusch and Pagan Lagrangian multiplier test for ra ndom effects
289
Appendix F - Results for Sample with Indian States Only
States only
(1) (2) (3) (4) (5)
VARIABLES percapitagencap access2 percapitaeleccons tdloss2 electariff
utilunbundling 0.005 0.048*** 117.204*** -0.032 1.136***
[0.007] [0.010] [22.557] [0.026] [0.198]
shpvtingencap 0.306*** 0.161** 983.115*** -0.171 -2.228*
[0.045] [0.063] [132.681] [0.144] [1.191]
pvtizationofdist 0.065*** 0.017 13.443
-
0.168*** -0.956**
[0.015] [0.021] [49.251] [0.041] [0.430]
regcomm -0.003 0.059*** -23.553 0.020 0.803***
[0.006] [0.008] [20.499] [0.023] [0.175]
shofindustry 0.148*** 0.347*** 582.000*** 0.225 10.982***
[0.047] [0.065] [149.809] [0.141] [1.440]
percapitaGDPreal 0.000*** -0.000** 0.953*** 0.000 0.002***
[0.000] [0.000] [0.054] [0.000] [0.000]
politicalstability -0.003 -0.011 19.903 0.055*** -0.418**
[0.006] [0.008] [18.098] [0.020] [0.167]
urbanizationrate 0.349*** 1.304*** -268.869 -0.356 12.477***
[0.105] [0.146] [318.406] [0.314] [2.969]
Constant -0.106*** 0.215*** -191.840** 0.312*** -2.556***
[0.027] [0.037] [77.195] [0.083] [0.737]
Observations 434 433 278 182 281
R-squared 0.519 0.643 0.878 0.181 0.721
Number of
state_country1 26 26 26 24 26
Standard errors in
brackets
*** p<0.01, **
p<0.05, * p<0.1
290
Appendix G - Results for States/Countries by Income and
System Size
Results for States with High Income and Large System Size
(Group A: Delhi, Haryana, Punjab, Karnataka, Andhra Pradesh, Gujarat, Tamil Nadu,
Maharashtra, Pakistan )
Fixed Effect Group A
(1) (2) (3) (4) (5)
VARIABLES percapitagencap access2 percapitaeleccons tdloss2 electariff
utilunbundling 0.009* 0.040*** -8.617 -0.096*** 1.569***
[0.005] [0.008] [23.007] [0.035] [0.251]
shpvtingencap 0.044 0.338*** 217.148* -0.326*** 0.448
[0.029] [0.048] [120.660] [0.113] [1.321]
pvtizationofdist 0.102*** -0.037** 247.242*** -0.167*** -0.502
[0.010] [0.017] [58.929] [0.036] [0.542]
regcomm -0.001 0.024** -19.047 0.021 -0.604**
[0.006] [0.010] [23.897] [0.033] [0.272]
shofindustry 0.031 -0.038 2,431.765*** 0.978*** 3.341
[0.060] [0.102] [274.263] [0.244] [3.070]
percapitaGDPreal 0.000*** -0.000 0.413*** 0.000*** -0.000
[0.000] [0.000] [0.062] [0.000] [0.001]
politicalstability -0.002 -0.008 70.294*** 0.095*** -0.087
[0.005] [0.008] [21.169] [0.024] [0.243]
urbanizationrate 1.027*** 1.723*** 7,250.909*** -0.609 41.724***
[0.163] [0.278] [716.389] [0.696] [7.655]
Constant -0.343*** 0.055 -3,281.957*** 0.297 -12.519***
[0.059] [0.100] [250.740] [0.305] [2.655]
Observations 156 152 108 77 114
R-squared 0.859 0.893 0.962 0.777 0.772
Number of
state_country1 9 9 9 8 9
Standard errors in brackets
*** p<0.01, ** p<0.05, * p<0.1
291
Summary of Statistically Significant Results for Group A
Per Capita
Generation
Capacity
(Kw)
Access to
Electricity (%)
Per Capital
Electricity
Consumption
(KwH)
T&D Losses
(%)
Average Tariff
(US $ Cents)
Share of PSP
in Generation
Unbundling of
Utilities
Independent
Regulatory
Commission
Privatization
of
Distribution
292
Results for States with Low Income and Small System Size
(Group D: Assam, Bihar and Jharkhand, Jammu Kashmir, Manipur, Meghalaya, Nepal, Tripura,
Mizoram)
Fixed Effect
Group D
(1) (2) (3) (4) (5)
VARIABLES percapitagencap access2 percapitaeleccons tdloss2 electariff
utilunbundling -0.003 0.063** -23.787 -0.006 2.446***
[0.009] [0.031] [36.633] [0.108] [0.808]
shpvtingencap -0.030 0.667*** 327.120** 0.620* -7.751*
[0.047] [0.194] [148.653] [0.365] [4.402]
o.pvtizationofdist - - - - -
regcomm -0.007 0.032 150.715*** -0.037 1.548**
[0.006] [0.023] [39.410] [0.075] [0.708]
shofindustry 0.171*** 0.135 299.714 0.990*** 11.174***
[0.039] [0.145] [190.938] [0.340] [3.839]
percapitaGDPreal 0.000 0.000** 0.233* -0.000 -0.002
[0.000] [0.000] [0.130] [0.000] [0.004]
politicalstability 0.008 -0.017 -105.731*** 0.028 -0.424
[0.005] [0.020] [21.327] [0.046] [0.466]
urbanizationrate 0.441*** 1.352** -741.667 -0.036 32.128**
[0.133] [0.554] [471.220] [0.885] [12.220]
Constant -0.089*** 0.127 213.190** 0.312 -2.926
[0.024] [0.099] [98.957] [0.193] [2.203]
Observations 149 140 101 66 93
R-squared 0.452 0.615 0.741 0.268 0.658
Number of
state_country1 9 9 9 9 9
Standard errors in brackets
*** p<0.01, ** p<0.05, * p<0.1
293
Summary of Statistically
Significant Results for Group D
Per Capita
Generation
Capacity
(Kw)
Access to
Electricity (%)
Per Capital
Electricity
Consumption
(KwH)
T&D Losses
(%)
Average Tariff
(US $ Cents)
Share of PSP
in Generation
Unbundling of
Utilities
Independent
Regulatory
Commission
Privatization
of
Distribution
294
Appendix H - List of Utilities Covered in the Study
Agency - Long Name State Agency -
Short
Name
Type of
Agency
Year of
Unbun
dling
Year of
Privatiz
ation
Andhra Pradesh Central Power
Distribution Company Limited
Andhra
Pradesh
APCPDCL Discom 2000 NA
Andhra Pradesh Eastern Power
Distribution Company Limited
Andhra
Pradesh
APEPDCL Discom 2000 NA
Andhra Pradesh Northern
Power Distribution Company
Limited
Andhra
Pradesh
APNPDCL Discom 2000 NA
Andhra Pradesh Southern
Power Distribution Company
Limited
Andhra
Pradesh
APSPDCL Discom 2000 NA
Andhra Pradesh Generation
Company Limited
Andhra
Pradesh
AP Genco Genco 2000 NA
Andhra Pradesh Transmission
Company Limited
Andhra
Pradesh
AP
Transco
Transco 2000 NA
Arunachal Pradesh Department
of Power
Arunachal
Pradesh
Arunachal
PD
Bundled N/A NA
Assam State Electricity Board Assam ASEB Bundled 2004 NA
Central Assam Electricity
Distribution Company Limited
Assam CAEDCL Discom 2004 NA
Lower Assam Electricity
Distribution Company Limited
Assam LAEDCL Discom 2004 NA
Upper Assam Electricity
Distribution Company Limited
Assam UAEDCL Discom 2004 NA
Assam Power Generation
Company Limited
Assam APGCL Genco 2004 NA
Assam Electricity Grid
Corporation Limited
Assam AEGCL Transco 2004 NA
Assam Power Distribution
Corporation Limited
Assam APDCL Discom 2004 NA
Bihar State Electricity Board Bihar BSEB Bundled N/A NA
Chhattisgarh State Electricity
Board
Chhattisgarh CSEB Bundled 2009 NA
Chhattisgarh State Power
Distribution Company Limited
Chhattisgarh CSPDCL Discom 2009 NA
Chhattisgarh State Power
Generation Company Limited
Chhattisgarh CSPGCL Genco 2009 NA
Chhattisgarh State Power
Transmission Company Limited
Chhattisgarh CSPTCL Transco 2009 NA
Chhattisgarh State Power
Holding Company Limited
Chhattisgarh N/A Holdco 2009 NA
295
North Delhi Power Limited Delhi NDPL Discom 2002 NA
BSES Rajdhani Power Limited Delhi BSES RPL Discom 2002 2002
BSES Yamuna Power Limited Delhi BSES YPL Discom 2002 2002
Indraprastha Power Generation
Company Limited
Delhi IPGCL Genco 2002 2002
Pragati Power Corporation
Limited
Delhi PPCL Genco 2002 NA
Delhi Transco Limited Delhi DTL Transco 2002 NA
Indraprastha Power Generation
Company Limited - Pragati
Power Corporation Limited
Delhi N/A Genco 2002 NA
Goa Electricity Department Goa GoaPD Discom +
Transco
N/A NA
GEB Gujarat GSEB Bundled 2005 NA
Dakshin Gujarat Vij Company
Limited
Gujarat DGVCL Discom 2005 NA
Madhya Gujarat Vij Company
Limited
Gujarat MGVCL Discom 2005 NA
Paschim Gujarat Vij Company
Limited
Gujarat PGVCL Discom 2005 NA
Uttar Gujarat Vij Company
Limited
Gujarat UGVCL Discom 2005 NA
Gujarat State Electricity
Corporation Limited
Gujarat GSECL Genco 2005 NA
Gujarat Energy Transmission
Corporation Limited
Gujarat GETCO Transco 2005 NA
GUVNL Gujarat N/A Holdco/Tr
adeco
2005 NA
Dakshin Haryana Bijli Vitran
Nigam Ltd
Haryana DHBVNL Discom 1998 NA
Uttar Haryana Bijli Vitran Nigam
Ltd
Haryana UHBVNL Discom 1998 NA
Haryana Power Generation
Corporation Limited
Haryana HPGCL Genco 1998 NA
Haryana Vidyut Prasaran Nigam
Limited
Haryana HVPNL Transco 1998 NA
Himachal Pradesh State
Electricity Board
Himachal
Pradesh
HPSEB Bundled 2010 NA
Himachal Pradesh State
Electricity Board Ltd
Himachal
Pradesh
HPSEB
LTD
Genco +
Discom
2010 NA
Jammu Kashmir Power
Development Department
Jammu &
Kashmir
J&K PDD Discom +
Transco
#N/A NA
Jammu & Kashmir State Power
Development Corporation
Limited
Jammu &
Kashmir
J&K PDCL Genco #N/A NA
Jharkhand State Electricity
Board
Jharkhand JSEB Bundled N/A NA
296
Jamshedpur Utilities and
Services Company Limited
Jharkhand N/A Discom N/A NA
Tata Power Company Limited Jharkhand N/A Genco N/A NA
Tenughat Vidyut Nigam Limited Jharkhand N/A Genco N/A NA
Bangalore Electricity Supply
Company Limited
Karnataka BESCOM Discom 1999 NA
Gulbarga Electricity Supply
Company Limited
Karnataka GESCOM Discom 1999 NA
Hubli Electricity Supply
Company Limited
Karnataka HESCOM Discom 1999 NA
Mangalore electricity Supply
Company Limited
Karnataka MESCOM Discom 1999 NA
Karnataka Power Corporation
Company Limited
Karnataka KPCL Genco 1999 NA
Karnataka Power Transmission
Company Limited
Karnataka KPTCL Transco 1999 NA
Chamundeshwari Electricity
Supply Company Limited
Karnataka CESCOM Discom 1999 NA
Kerala State Electricity Board Kerala KSEB Bundled N/A NA
Madhya Pradesh State
Electricity Board
Madhya
Pradesh
MPSEB Bundled 2005 NA
Madhya Pradesh Power
Transmission Company Limited
Madhya
Pradesh
MPPTCL Transco 2005 NA
Madhya Pradesh Madhya
Kshetra Vidyut Vitaran
Company Limited
Madhya
Pradesh
MPMKVV
CL
Discom 2005 NA
Madhya Pradesh Paschim
Kshetra Vidyut Vitaran
Company Limited
Madhya
Pradesh
MPPAKVV
CL
Discom 2005 NA
Madhya Pradesh Poorva
Kshetra Vidyut Vitaran
Company Limited
Madhya
Pradesh
MPPUKVV
CL
Discom 2005 NA
Madhya Pradesh Power
Generation Company Limited
Madhya
Pradesh
MPPGCL Genco 2005 NA
MP Power Management
Company Limited
Madhya
Pradesh
N/A Holdco/Tr
adeco
2005 NA
Maharashtra State Electricity
Board
Maharashtra MSEB Bundled 2005 NA
Maharashtra State Electricity
Distribution Company Limited
Maharashtra MSEDCL Discom 2005 NA
Maharashtra State Power
Generation Company Limited
Maharashtra MSPGCL Genco 2005 NA
Maharashtra State Electricity
Transmission Company Limited
Maharashtra MSPTCL Transco 2005 NA
Brihanmumbai Electric Supply &
Transport Undertaking
Maharashtra N/A Discom 2005 NA
MSEB Holding Company Limited Maharashtra N/A SEB/Holdc 2005 NA
297
o
Manipur Electricity Department
(Manipur)
Manipur Manipur
PD
Bundled N/A NA
Meghalaya State Electricity
Board
Meghalaya MeSEB Bundled 2010 NA
Meghalaya Energy Corporation
Limited
Meghalaya Me ECL Bundled 2010 NA
Mizoram Power and Electricity
Department
Mizoram Mizoram
PD
Bundled N/A NA
Manipur Electricity Department
(Mizoram)
Mizoram N/A Genco N/A NA
Department of Power Nagaland Nagaland
PD
Bundled N/A NA
Central Electricity Supply Utility Orissa CESCO Discom 1996 1999-
2001
North Eastern Electricity Supply
Company
Orissa NESCO Discom 1996 1999
Southern Electricity Supply
Company
Orissa SESCO Discom 1996 1999
Western Electricity Supply
Company
Orissa WESCO Discom 1996 1999
Orissa Hydro Power
Corporation
Orissa OHPCL Genco 1996 NA
Orissa Power Generation
Corporation
Orissa OPGCL Genco 1996 NA
Orissa Power Transmission
Corporation Limited
Orissa OPTCL Transco 1996 NA
Grid Corporation of Orissa
Limited
Orissa GCOL Bundled 1996 NA
Punjab State Electricity Board Punjab PSEB Bundled 2010 NA
Punjab State Power
Corporation Limited
Punjab PSPCL Genco +
Discom
2010 NA
Punjab State Transmission
Corporation Limited
Punjab N/A Transco 2010 NA
Ajmer Vidyut Vitran Nigam
Limited
Rajasthan AVVNL Discom 2000 NA
Jaipur Vidyut Vitran Nigam
Limited
Rajasthan JVVNL Discom 2000 NA
Jodhpur Vidyut Vitran Nigam
Limited
Rajasthan JDVVNL Discom 2000 NA
Rajasthan Rajya Vidyut Utpadan
Nigam Limited
Rajasthan RRVUNL Genco 2000 NA
Rajasthan Rajya Vidyut
Prasaran Nigam Limited
Rajasthan RRVPNL Transco 2000 NA
Sikkim Energy and Power
Department
Sikkim Sikkim PD Bundled N/A NA
Tamil Nadu State Electricity Tamil Nadu TNEB Bundled/ 2010 NA
298
Board Holdco
Tamil Nadu Generation and
Distribution Corporation
Limited
Tamil Nadu TANGEDC
O
Genco +
Discom
2010 NA
Tamil Nadu Transmission
Corporation Limited
Tamil Nadu TANTRAN
SCO
Transco 2010 NA
Tripura State Electricity
Corporation Limited
Tripura TSECL Bundled N/A NA
Uttar Pradesh Jal Vidyut Nigam
Limited
Uttar Pradesh UPJVNL Genco 2000 NA
Uttar Pradesh Rajya Vidyut
Utpadan Nigam Limited
Uttar Pradesh UPRVUNL Genco 2000 NA
Dakshinanchal Vidyut Vitran
Nigam Limited
Uttar Pradesh DVVN Discom 2000 NA
Kanpur Electric Supply
Company
Uttar Pradesh KESCO Discom 2000 NA
Madhyanchal Vidyut Vitran
Nigam Limited
Uttar Pradesh MVVN Discom 2000 NA
Paschimanchal Vidyut Vitaran
Nigam Limited
Uttar Pradesh Pash VVN Discom 2000 NA
Purvanchal Vidyut Vitaran
Nigam Limited
Uttar Pradesh Poorv
VVN
Discom 2000 NA
Uttar Pradesh Power
Transmission Corporation
Limited
Uttar Pradesh UPPCL Transco 2000 NA
Uttar Pradesh Power
Corporation Limited
Uttar Pradesh N/A Holdco 2000 NA
Uttarakhand Power
Corporation Limited
Uttarakhand UPCL Discom 2004 NA
Uttarakhand Jal Vidyut Nigam
Limited
Uttarakhand UJVNL Genco 2004 NA
Power Transmission
Corporation of Uttarakhand
Limited
Uttarakhand N/A Transco 2004 NA
West Bengal State Electricity
Board
West Bengal WBSEB Bundled 2007 NA
West Bengal Power
Development Corporation
Limited
West Bengal WBPDCL Genco 2007 NA
West Bengal State Electricity
Distribution Company Limited
West Bengal WBSEDCL Genco +
Discom
2007 NA
West Bengal State Electricity
Transmission Company Limited
West Bengal WBSETCL Transco 2007 NA
WAPDA Pakistan WAPDA Genco 1998 NA
Karachi Electric Supply
Corporation
Pakistan KESC Bundled NA 2005
Pakistan Electricity Company Pakistan PEPCO 1998 NA
299
National Transmission and
Dispatch Company (PEPCO)
Pakistan NTDC Transco 1998 NA
Lahore Electric Supply
Company (PEPCO)
Pakistan LESCO Discom 1998 NA
Gujranwala Electric Power
Company (PEPCO)
Pakistan GEPCO Discom 1998 NA
Faisalabad Electric Supply
Company (PEPCO)
Pakistan FESCO Discom 1998 NA
Islamabad Electric Supply
Company (PEPCO)
Pakistan IESCO Discom 1998 NA
Multan Electric Power
Company (PEPCO)
Pakistan MEPCO Discom 1998 NA
Peshawar Electric Power
Company(PEPCO)
Pakistan PESCO Discom 1998 NA
Hyderabad Electric Supply
Company(PEPCO)
Pakistan HESCO Discom 1998 NA
Quetta Electric Supply
Company(PEPCO)
Pakistan QESCO Discom 1998 NA
Tribal Electric Supply
Company(PEPCO)
Pakistan TESCO Discom 1998 NA
Southern Generation Power
Company Limited(PEPCO)
Pakistan SGPCL Genco 1998 NA
Central Power Generation
Company Limited (PEPCO)
Pakistan CPGCL Genco 1998 NA
Northern Power Generation
Company Limited (PEPCO)
Pakistan NPGCL Genco 1998 NA
Lakhra Power Generation
Company Limited (PEPCO)
Pakistan LPGCL Genco 1998 NA
Ashuganj Power Station Co. Ltd.
(APSCL)
Bangladesh APCSL Genco 1996 NA
Power Grid Company of
Bangladesh
Bangladesh PGCB Transco 1996 NA
Dhaka Electricity Supply
Authority
Bangladesh DESA Discom NA NA
Dhaka Electricity Supply
Company
Bangladesh DESCO Discom NA NA
Dhaka Power Distribution
Company Limited (DPDC)
Bangladesh DPDC Discom NA NA
West Zone Power Distribution
Company
Bangladesh WZPDCL Discom 2005 NA
Electricity Generation Company
of Bangladesh
Bangladesh EGCB Genco 1996 NA
North West Power Generation
Company Ltd.
Bangladesh NWPGCL 2007 NA
BPDB Bangladesh BPDB Genco
and
Discom
1996 NA
300
Rural Electrification Board Bangladesh REB Discom 1996 NA
NEA Nepal NEA Bundled N/A NA
CEB Sri Lanka CEA Bundled NA NA
301
Appendix I - Interview Questions
Selected government official, utility officials, experts were contacted through
email and phone to gather information, documents and publications about the history of
electricity sector reforms in Gujarat and Nepal. The list of questions are as follows:
1) What available documents, articles, and publications document the process of
electricity sector reforms over the last 50 years? What is the best way to find
them?
2) Where can one find the complete list of private sector electricity sector projects as
well as their contractual details?
3) Where can one find publicly available detailed information about electricity sector
projects implemented over the last 50 years?
4) Where can one find public information about the detail of major contractual
disputes in the elctricity sectors?
5) Has any private sector agency carried out an assessment of investment climate in
the electricity sector? If this assessment is publicly available, what is the best way
to get a copy of these assessments?
6) How many times has the government carried out a comprehensive review of
electricity sector performance (including private sector participation)? Are these
reports publicly available? What is the best way to get a copy of these reports?
302
Appendix J - Instrumental Variables
Instrumental variables can be used to address the issue endogeneity. However, it
is very difficult to identify appropriate instrumental variables in the electricity sector and
to find data for instrumental variables. When explanatory variables are endogenous,
ordinary least squares (OLS) gives biased and inconsistent estimates of the causal effect
of an explanatory variable on an outcome. A common strategy for dealing with this
endogeneity is to use instrumental variables (IV) estimation, using as "instruments"
variables thought to have no direct association with the outcome. The exogenous
instruments allow the researcher to partition the variance of the endogenous explanatory
variable into exogenous and endogenous components. The exogenous component is then
used in estimation. More specifically, the IV estimator uses one or more instruments to
predict the value of the potentially endogenous regressor. The predicted values are then
used as a regressor in the original model.
Under the assumptions that the instruments are correlated with the endogenous
explanatory variable but have no direct association with the outcome under study, the IV
estimates of the effect of the endogenous variable are consistent. When searching for
plausible instruments for a potentially endogenous explanatory variable, it is common to
find that the candidates are only weakly correlated with the endogenous variable in
question. Such weakly correlated variables as instruments are likely to produce estimates
with large standard errors. If the instruments are only weakly correlated with the
endogenous explanatory variable, then even a weak correlation between the instruments
and the error in the original equation can lead to a large inconsistency in IV estimates.
303
For this dissertation, the following instrumental variables were considered but rejected
due to weak correlation between these variables and the reform variables.
- Decision of neighboring countries to undertake reforms
- The political strength of the government in a state as an instrumental variable for
the decision to undertake reforms
- Agricultural reforms or reforms in other areas
- Externally imposed requirement to pursue reforms in some countries but not
others.
304
Appendix K - Classification of states and countries into reform
and governance categories
States Governance Unbundling Regulator PSP
Reform
Rank
Andhra Pradesh Strong Yes Early
Above
Average Strong
Arunachal Pradesh Weak No Late
Below
Average Weak
Assam Weak Yes Late
Below
Average Weak
Delhi Strong Yes Early
Below
Average Strong
Goa Strong No Late
Above
Average Weak
Gujarat Strong Yes Early
Above
Average Strong
Haryana Strong Yes Early
Below
Average Strong
Himachal Pradesh Strong Yes Late
Above
Average Strong
J&K Weak No Late
Below
Average Weak
Jharkhand Weak No Late
Above
Average Weak
Karnataka Strong Yes Early
Above
Average Strong
Kerala Strong No Late
Below
Average Weak
Maharashtra Weak Yes Early
Above
Average Strong
Manipur Weak No Late
Below
Average Weak
Meghalaya Weak Yes Late
Below
Average Weak
Mizoram Weak No Late
Below
Average Weak
Nagaland Weak No Late
Below
Average Weak
Orissa Weak Yes Early
Below
Average Strong
Punjab Weak Yes Early
Below
Average Strong
Rajasthan Strong Yes Early
Above
Average Strong
Sikkim Weak No Late Below Weak
305
Average
Tamil Nadu Strong Yes Early
Above
Average Strong
Tripura Weak No Late
Below
Average Weak
West Bengal Weak Yes Early
Above
Average Strong
Pakistan Weak Yes Late
Above
Average Strong
Bangladesh Weak Yes Late
Above
Average Strong
Nepal Weak No Late
Above
Average Weak
Sri Lanka Strong No Late
Above
Average Weak
Bihar (& Jharkhand) Weak No Late
Below
Average Weak
MP (& Chattisgarh) Strong Yes Early
Above
Average Strong
UP (& Uttarakhand) Strong Yes Early
Below
Average Strong
