Role of Policy Environment and Regulatory Reforms in Private Investment in the Power Sector

Creation of regulatory institutions along with legislated private sector participation in the sector aimed at mitigating risks associated with long-term investment in the sector. With the replacement of public monopolies by private monopolies, the role of independent regulation was envisioned to provide justifiable rates of return to investors while protecting consumers' interest.

Investors in the power sector attach priority to the legal framework defining investors' rights and contractual obligations (Woodhouse, 2005; Stern & Cubbin, 2005; Lamech & Saeed, 2003; Pargal, 2003). Foreign investment in the infrastructure sector in developing countries responds positively to the presence of an effective regulatory framework, thus providing regulatory credibility to the private investors (Kirkpatrick et al., 2004). Shortcomings on these aspects are often addressed through incentives for investment and sovereign guarantees. Many developing electricity markets provide some sort of guarantee to private investors. Sovereign guarantees are not substitutes for effective policy and regulatory environment. Transparent and predictable government policies can obviate the need for sovereign guarantees (Klein, 1997).

Using regional data from a study by Estache & Goicoechea (2005), Figure 3 [ PDF 30.3KB | 1 pages ] & Figure 4 [ PDF 29.6KB | 1 pages ] depict the complementarity ¹ between regulatory institutions and private participation, in generation and distribution segments, respectively. A country with independent regulatory institutions is more likely to have private investment in generation and more specifically in the distribution segment.

Further analysis using country-specific data further strengthens the argument for the above mentioned complementarity (Table 2 [ PDF 9.9KB | 1 pages ]). The relationship is more pronounced in the case of the distribution segment.

In 2004, 51% of the countries in a sample of 136 countries had independent regulators. This proportion was 79% in the case of the sample of 29 developed countries (Estache & Goicoechea, 2005). Regulation matters in aligning the cost of capital and rate of return, and hence influences profitability of investment (Sirtaine et al., 2005). There is a clear trend towards more effective regulatory governance in the electricity sector in India. However, it is difficult to ascertain convergence of regulatory regime to the best practice, which itself is difficult to define (NERA, 1998).

The efficacy of a transparent policy environment and independent regulatory framework in attracting private investment in developing countries can not be undermined. The transition path and sustainability of reforms provide a long-term policy stability thereby reducing investor risk. The reform program in developing countries is aimed at inducing private and foreign investment. However, the design of the reforms program, its pace and scope vary across countries, as discussed in the following section.

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