Comparative Policy Analysis with Argentina, Brazil, PRC, Mexico and Thailand

In spite of being an early bird, Indian power sector did not succeed much in attracting private investment as compared to some Latin American countries, like Argentina and Brazil. A comparative policy analysis further investigates the role of policy and the regulatory environment in this context. This highlights the relative strengths and weaknesses of the power sector reform and investment climate for private investors in India. The sample includes Argentina, Brazil, PRC, Thailand and Mexico. The first two countries have attracted significant private investment in the power sector. PRC is included on account of its overall attractiveness for foreign investment. Thailand and Mexico have been considered as these are at an initial phase of reforms. From the initial phase of reforms, the two countries have also been described as "best practices" for the IPP model (Woodhouse, 2005). Figure 5 [ PDF 13.3KB | 1 pages ]

Power sector reforms and policies to encourage private investment have progressed at different paces and sequencing across the sample of countries under examination (Table 3 [ PDF 40.2KB | 3 pages ]). In the context of regulatory and policy environment, such differences arise from:

• Policy Environment for Private Participation
• Independence of Regulatory Institutions
• Approach to Power Sector Reform and Regulation

Policy Environment for Private Participation

India liberalized private investment in 1991, a year before such an initiative was launched in Argentina and Brazil. While unbundling of the sector and privatization of distribution companies commenced almost simultaneously in the case of both Argentina and Brazil, the lag in the Indian case was 8 years. Similarly, power market reform leading to development of a wholesale power market materialized almost 12 years after the reform process was initiated in India. Argentina's initial reform process included setting up the wholesale power market, whereas Brazil undertook such initiatives with a lag of a few years. Divestiture of majority holding of a generating company followed the year after the sector was opened for private investment in Thailand. In the absence of restructuring / unbundling / privatization and independent regulatory institutions, PRC's attractiveness followed from a “Can't Afford not to be there� syndrome (Crow, 2001). However, foreign investors had to face repeated tariff reductions and unenforceable contracts. It has been termed an example of an obsolescing bargain, signifying shifting negotiating leverage between the host country and the investors during the project life cycle (Woodhouse, 2005). The newly setup State Electricity Regulatory Commission in PRC has introduced annually renewable PPAs for IPPs. The fate of earlier negotiated PPAs remains doubtful in the emerging scenario (Woo, 2005a). Such an uncertain environment would reduce investors' interest in committing long-term investments like those in the power sector.

A roadmap to regulatory and market reforms provides policy clarity and comfort to investors. This helped successful accomplishment of the privatization process in Argentina without any government guarantees. Transition from initiation of sectoral reforms to the point when rules of the game for private investors are clear, is a fundamental constraint to private investment in the power sector (Rosenzweig et al., 2001). Policy reforms in the Indian power sector kept alive the uncertainty about the reform path for a long time, and this seem to have influenced private investment in the sector. At the current stage of reform, Mexico and Thailand need to address policy uncertainty to reap the full potential of investor response.

Subsidies remain an integral part of electricity pricing in most developing countries. In India, industrial and commercial consumers continue to cross-subsidize domestic and agricultural consumers. Argentina prohibits cross-subsidies by law, whereas in the case of Brazil and Thailand industrial tariffs are subsidized by residential customers. The presence of significant cross-subsidies at the beginning of the reforms program in India has made the job of regulators more challenging and distasteful for politically sensitive consumers.

Independence of Regulatory Institutions

The efficacy of regulatory institutions in reforming electricity sectors with greater private participation is influenced by independence of such institutions. Effective regulation—supported by law; financial autonomy and decision autonomy—should be a key priority to protect both consumers as well as investors interests (Sirtaine et al., 2005). Regulatory independence is derived from financial independence, administrative / operational independence and reduced government influence on regulatory appointments. Regulatory institutions developed in India continue to live under political influence due to influence over appointment of regulators and financial dependence on government. This problem is more serious in the case of state level regulatory institutions. Both Argentina and Brazil provide some semblance of independence due to required approval of regulators' appointments by the legislature and greater financial autonomy. Regulation matters in aligning cost of capital and rate of return, and hence influences profitability of investment. At the same time it also protects consumers from overexploitation, giving credibility to the reform process and its sustainability. National Electricity Policy issued in 2005 by the government of India also recognizes efficacy of independence of regulatory institutions. It notes that lack of transparency in selection procedure, delayed, inconsistent and deficient orders, and lack of accountability on part of regulators is hampering its ability to meet the intended objectives of regulatory reforms.

Approach to Power Sector Reform and Regulation

The success of power sector reform, measured in terms of improvement in performance of utilities and reduction in consumer tariffs can not be expected if public monopolies are replaced by private monopolies. Policy measures and regulatory institutions need to provide appropriate incentives for performance improvement and encourage sharing of such benefits through enhanced competition in the market. Failure to bring competition in the wholesale market and, later, unavailability of retail choice would leave the process of reform incomplete and subject to criticism. Argentina and Brazil introduced competition at an early stage, thereby providing investors with a choice to sell power without long-term contracts to a certain extent. Timing and sequencing of privatization is critical to the success of privatization itself and the reform program (Rosenzweig & Voll, 1997). The reform strategy followed by the Latin American countries realized the benefit of distribution reforms coupled with privatization. The strategy seems to have paid well for attracting private investment in the sector.

Investors in the power sector expect to earn returns over a long investment horizon, which may last up to 20-30 years for greenfield generation investment. Uncertainties on account of lack of a roadmap to reform are disliked by investors and more so by lenders, who perceive policy risk to be significant unless covered by government guarantees. Argentina and Brazil are almost textbook examples of reforming the power sector. The uncertainties associated with the emerging policy and regulatory environment in the sector were minimal in both cases as critical reform steps were undertaken almost simultaneously. India, PRC, Mexico and Thailand continue to be riddled with reform hiccups. PRC reforms have been the most unpredictable for investors and have often resulted in adverse outcomes for investors, prompting their exit from the market.

Regulatory institutions also bring with them a new kind of risk called 'regulatory risk' that arises due to unpredictable regulator, behavior, especially in setting rate of return and performance standards. Such fears were reduced in Argentina and Brazil through adoption of price cap regulation with a five-year period of regulatory review. Mexico proposes to adopt a similar approach. In contrast to this, the Indian power sector chose to adopt cost of service regulation. This was the appropriate choice at the time due to lack of reliable data and the sector's lack of preparedness for incentive regulation. CERC, the federal regulator, has adopted a four-year tariff framework under rate of return regulation with performance standards. The Electricity Act 2003 stipulates adoption of multi-year tariff principles by regulators. As per the National Electricity Policy, choice of regulatory principles remains with the regulatory institutions, which are free to adopt incentive regulation as deemed fit.

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