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

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

iii

Dedication

I dedicate this work to Monika and Zev.

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.

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

vi 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.

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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 viii

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 ix

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 x

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

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

xii

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

xiii

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

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Chapter 1 - Introduction and Background

Electricity has consistently ranked first in polls of all-time greatest inventions carried out by Gallup in the United States 1. 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.

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,

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

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

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

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 scale 2. 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.

• 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

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).

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

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

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.

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.

Figure 1.2 - Timeline of Reforms in Bangladesh, India 4, Nepal Sri Lanka and Pakistan

Competitiv e Power Market Privatization Not completed Delhi (2002) in any of Establishment Orissa (1996) the states Unbundling of Independent or countries of Utilities Regulatory Andhra Pradesh Commission (2000), Assam(2004), Bangladesh(2004), Bangladesh(2004) Pakistan(1998), Introduction of Chattisgarh (2009) Sri Lanka (2009) Independent PowerDelhi(2002), All Indian states Gujarat(2005), (1996-2011) Producers Haryana(1998), All Indian States (1991), Himachal (2010) Nepal(1992), Karnataka(1999), Pakistan(1994), BangladeshMP (2005) (1996) Maharashtra(2005), Sri Lanka (1996) Meghalaya (2010) Orissa(1996), Pakistan(1992), Punjab(2010), Rajasthan(2000), Tamil Nadu(2010), UP (2000) Uttaranchal (2004) West Bengal(2007) Pakistan (2001) 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.

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 nationalized 5 (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.

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

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,

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 1948 6 (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.

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

unbundling and corporatization of into fourteen companies (nine distribution, one hydroelectric 7, one transmission, and four thermal generation 8). 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.

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.

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

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-

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 23

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.

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).

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

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).

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 prominence 9. 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.

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

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, 30

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).

Figure 2.1 - Williamson's Four Level of Institutions

Level Frequency of change

Level 1: Embeddedness 100 to 1000 years (Informal institutions, customs)

traditions, norms, religion

Level 2: Institutional Environment (Formal rules of the game such as 10 to 100 years constitutions, laws, property rights, political institutions)

Level 3: Institutional Arrangement (governance 1 to 10 years structures, contracts, transaction costs)

Level 4: Resource Allocation and Continuous

Employment (prices and quantities, incentive

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

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 Implied Regularity of internalized norms Behavior Scenario 1:Rules on Utility, Police, Courts Utility officials, police, Widespread electricity electricity theft court officials all believe theft and corruption it is acceptable to take bribes; belief that paying a bribe is least costly way of advancing ones interest Scenario 2:Rules on Utility, Police, Courts Belief that law Little or no electricity electricity theft enforcement agencies all theft behave according to the law and trying to pay bribes is likely to results in legal action

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 33

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).

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)

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

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 markets 10 . 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)

10 Consideration 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.

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.

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).

11 The 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.

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

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

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 place 12 . 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.

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

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).

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

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).

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 &

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 48

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).

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 conditions 13 (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.

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

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

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.

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.

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.

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.

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.

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 countries 14 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.

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.

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

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

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

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

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.

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 65

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

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

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

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, 69

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

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

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 72

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.

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

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

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.

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.

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.

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

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

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.

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

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.

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

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

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 86

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

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.

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.

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.

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

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

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.

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

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

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

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.

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

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

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 India 15 . 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.

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(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 preconditions 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

Level 1: Embeddedness

(Informal institutions, customs)

traditions, norms, religion Intermediate and

Associated Outcomes Level 2: Institutional Environment • T&D loss (Formal rules of the game such as • Per Capita Generation Electricity Sector • constitutions, laws, property Average Tariff Reform Variables rights, political institutions)

1. PSP in Level 3: Institutional Performance Generation • Electricity Access Arrangement (governance 2. Establishment of • Per Capita Electricity structures, contracts, transaction independent Consumption regulator costs) 3. Unbundling

Level 4: Resource allocation and employment (prices and quantities, incentive

Initial conditions Subsidies/State Revenues Performance (quality, losses)

Controls Per capita income Budget

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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: 105

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 model 16 will be used. The most appropriate specification will then be selected using the Hausman and Breusch and Pagan tests.

16 Fixed 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.

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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.

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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

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

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.

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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.

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• 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 World Development Indicators Nepal Data on Socio-economic control variables Data from Indian Planning Commission for 26 Indian States accessed at Indiastat.com Data on Different Reform Milestones for Website of ministries and utilities all states and countries Data on Different Electricity Sector World Development Indicators, Performance Indicators for all states and International Energy Agency, Website of countries ministries and utilities,

Table 4-2 - Subject States and Countries of this Study Subject Countries and States Madhya Pradesh and Bangladesh Haryana Mizoram Chhattisgarh Pakistan Delhi Tripura Gujarat Nepal Rajasthan Meghalaya Maharashtra Uttar Pradesh and Sri Lanka Assam Andhra Pradesh Uttaranchal 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 Annual production of power plants and per year) 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 distribution 17 . 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

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

Table 5-5 - Timeline of reforms in South Asia Year IPP Entry Unbundling Independent Privatization of

Regulatory Distribution

Commission

1990

1991 All Indian States

1992

1993 Nepal

1994 Pakistan

1995

1996 Bangladesh, Sri Bangladesh, Orissa Orissa

Lanka 1997

1998 Haryana, Pakistan Gujarat, Haryana, MP, Orissa

1999 Andhra Pradesh, AP, Delhi,UP, Karnataka,

2000 Rajasthan,Karnataka, UP Maharashtra,Rajasthan Punjab, Orissa

2001 Assam

2002 Delhi HimachalChhattisgarh Pradesh Delhi

2003 JharkhandKerala Delhi

2004 Assam, Uttarakhand Meghalaya

120 Tripura

2005 Gujarat, MP, Bihar

2006 Maharashtra Manipur

2007 West Bengal

2008 Goa

2009 Chhattisgarh SriNagaland Lanka

2010 HP, Meghalaya, Punjab, JK

Source: Compiled from government sourcesTamil by Nadu the aut hor

Section 2b: Difference in Sample Means 18 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

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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 Vertical Vertical Unbundling Integration Variable (Mean) (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 regulation 19 . 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.

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Figure 5.2 - Performance and Independent Regulation

Late adopters Early adopters of of Independent Independent Regulation Regulation Variable (Mean) (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 Participation 20

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 Below Above Average Average Private Sector Private Sector Participation Participation Variable (Mean) (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

• Governance 21

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 Strong Weak Governance Governance Variable (Mean) (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 reformers 22 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) Strong Reformers Weak Reformers Variable (Mean) (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) Strong Reformers Weak Reformers Variable (Mean) (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

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only a few of the states and countries or have not covered reforms and performance at the state level in India 23 .

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).

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

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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.

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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 Asia 24 . 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).

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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

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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

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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

Access to Per Capital T&D Losses Per Capita Electricity (%) Electricity (%)

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Generation Consumption Average Tariff

Capacity (KwH) (US $ cents) (Kw)

Share of Private NA Sector

Participation in Generation

Unbundling of NA NA NA NA NA Utilities

Independent Regulatory

Commission

Privatization of

Distribution

Section 3: Results

The results of the fixed effects and random effects regression analysis are presented in

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7 and Error! Reference source not found. 8, respectively 25 . 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.

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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 137

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.

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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.

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Table 5-7 - Regression Results (Fixed Effects)

Access Per Capita to Per Capita T&D Generation Electricity Electricity Losses Average VARIABLES Capacity (%) Consumption (%) 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

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Table 5-8 - Regression Results (Random Effects)

Per capita Access Per capita Average Generation to Electricity T&D tariff Capacity Electricity Consumption Losses (US $ VARIABLES (Kw) (%) (Kwh) (%) 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

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Table 5-9 - Fixed and Random Effects Tests Per Capita Access Per Capita T&D Loss Average

Generation Electricity Tariff

Consumption

HAUSMAN TEST FOR FIXED EFFECT

Hausman 24.08*** 2.58 245.72*** 17.2*** 310.98***

Test

PREFERRED SPECIFICATION

Fixed X X X X

Effect

Random X

Effect

BREUSCH AND PAGAN LAGRANGIAN MULTIPLIER TEST

BPLM 2083.66***

PREFERRED SPECIFICATION

Random X

Effect

Pooled

OLS

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Table 5-10 - Summary of statistically significant findings

Access to Per Capital T&D Losses Per Capita Electricity (%) Electricity (%) Generation Consumption Average Tariff Capacity

(Kw) (KwH) (US $ cents)

Share of Private

Sector

Participation in Generation

Unbundling of

Utilities

Independent Regulatory

Commission

Privatization of

Distribution

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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

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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.

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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.

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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

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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.

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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.

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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

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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

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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.

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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).

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Section 2b: Implementation of Reforms

Nepal and Gujarat 27 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 1992 28 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 sector 29 (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 services 30 (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}}.

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power plant structures. Likewise, Maoist threats caused another private station - Bhote

Koshi power plant – to close operations in October 2003 31 (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.

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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 constitution 32 , 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.

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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 100 percent foreign ownership of generating plants generating plants

Returns for IPPs based on negotiations Guaranteed returns of 16 percent on equity with the utility Exemption of income tax for five years Exemption from income tax for a period of fifteen years No Reduction in customs duty on import of Reduced customs duty on import of equipment equipment to attract private investment

33 Overall, the incentives provided for IPP developers by Gujarat are similar to the ones provided by Nepal.

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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 1997 34 (Woodhouse,

2006). This was followed by a number of other private investments, including the

655MW Paguthan power project 35 .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 reforms 36 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.

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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 GETCO MGVCL PGVCL UGVCL DGVCL (Generation) (Transmission) (Distribution) (Distribution) (Distribution) (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)

Pre -reforms Post reforms

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 163

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 Year Initial Year Latest Year Available Available 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 4793 1990 15722 2011 275 1990 721 2010 Capacity (MW)

IPP Generation 0 1990 7178 2011 0 1990 156 2010 Capacity (MW)

Cost Per Unit (US $ 4.8 1991 9.6 2010 5.5 1991 10.2 2010 Cents/kwh)

Average Electricity 3.4 1991 8.9 2010 4.2 1990 7.5 2009 Tariff (US $ Cents/kwh)

Profit/Loss Of Utility ($ 32.7 1993 84.2 2010 -11.4 1991 -95.2 2010 Million)

Per Capita Consumption 469 1990 1615 2010 35 1990 93 2010 Of Electricity

Source: Compiled by the author from various sources

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Figure 6.5 - IPP Installed Capacity, 1990-2011 (MW)

7178

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Gujarat Nepal

Figure 6.6 - IPP Investments, 1990-2011 ($ billion)

9.4

0.2 Gujarat Nepal

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).

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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 systems 37 .

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).

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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).

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Table 6-2 - One Sided Prisoner's Dilemma 38

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).

38 Pay offs are only for purpose s of illustration.

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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 Governance 39

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.

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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

Player 1 x Probability of meeting ~e¯ αx

Gain from trade ~e¯ Ωx

P Player 2

News Probability ~e¯ βy

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 172

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

α/(α -Ω) V(P,P) V (P*, P*) C

V(P,P) -c

Player 1

V(X(P),S

P P*

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

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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 177

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 ADB 41 , 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 184

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 Electricity Act Hydropower Draft Electricity Development 1992 Development Act Policy 1992 Policy 2001 2006 (pending approval) Royalty For all the projects For all the For all the projects As 2001 policy above 1 MW fix projects above 1 above 1 MW fixed capacity and MW fixed capacity and energy capacity and energy payment energy payment payment. Different 1st 15 years Rs 100 1st 15 years Rs rates for different per kW plus 2% of 100 per kW plus bands before and tariff 2% of tariff after 15 years. Thereafter Rs Thereafter Rs Different rates for 1,000 1,000 per kW export and internal per kW plus 10 % plus 10 % of use projects of tariff 1% of royalty to be tariff provided to Village Development Committees PPA PPA to be PPA should be PPA to be signed signed between transparent between buyers buyers and and sellers sellers and reviewed by Regulatory Commission Pricing Mutual Fixed Subject to review Certain percentage understanding percentage of by of between private avoided cost or Electricity Tariff avoided cost or producer and NEA an addition to Fixation certain be fixed on the the generation Commission percentage of basis of fixed cost of fixed average percentage of the percentage of electricity tariff rate avoided cost or average tariff of or cost NEA certain percentage plus or fixed Depreciation rate of return on percentage of over 25 years equity. average selling Consent of price of NEA. Commission Depreciation over required 25 years After establishment of wholesale market the rate fixing 185

procedure as specified by the Commission Income Tax Exemption of 15 years tax Income tax per Exemption of income tax for 15 exemption for prevailing Income income years from date of licensee for Tax Act tax for 10 years commercial generation, No additional or from operations transmission new tax to be commencement of When income tax and distribution levied on existing generation payable rate When income hydropower project When income tax reduced by 10% tax payable rate except those in payable the rate is reduced by 10% place at issuance 15% of If any reduction in project license 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 186

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 187

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 188

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 189

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 190

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 194

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 behavior 42 .

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 203

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

As a result of British As Nepal had remained in influence, greater interaction isolation from the rest of the with other individualist and world and had largely operated rule-based systems, long under a traditional monarchy, experience with democracy, Nepal’s institutional environment and indigenous reform (Level 2 institutions) was weak. movements, Gujarat had a Similarly, at the time of reform, more robust institutional social beliefs and norms (Level environment (Level 2) at the 1) still gave preference to time of reform; Likewise, collectivist and relation based Gujarat’s social customs and social arrangements such as beliefs (Level 1) had evolved family and caste (i.e. they did not to become more encourage people to follow individualistic and formal rules and systems). encouraged people to follow a rule based 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.

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. 204

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 century 43 . 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 18 th 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

India 44 . 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 210

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 214

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 superficial 47 . 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 sector 48 . 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 Rank out of 148 Score 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.

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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

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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 rights 49 - 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 cooperation 50 . 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.

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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 Number of From To Prime Minister Days in Office Party

19-Apr-90 26-May-91 Girija Prasad Koirala (1/5) 402 Nepali Congress Communist Party of Nepal 26-May-91 30-Nov-94 Man Mohan Adhikari (1/1) 1284 (Unified Marxist-Leninist)

30-Nov-94 12-Sep-95 Sher Bahadur Deuba (1/3) 286 Nepali Congress 223

Lokendra Bahadur Chand Rastriya Prajatantra Party 12-Sep-95 12-Mar-97 (3/4) 547 (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 Krishna Prasad Bhattarai 15-Apr-98 31-May-99 (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 Direct rule by King Gyanendra Bir Bikram 26-Jul-01 4-Oct-02 Shah 435 Nepali Congress Lokendra Bahadur Chand 4-Oct-02 11-Oct-02 (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) Direct rule by King Gyanendra Bir Bikram 3-Jun-04 1-Feb-05 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 Unified Communist Party of 18-Aug-08 25-May-09 Prachanda 280 Nepal (Maoist)

Communist Party of Nepal 25-May-09 6-Feb-11 Madhav Kumar Nepal 622 (Unified Marxist-Leninist)

Communist Party of Nepal 6-Feb-11 29-Aug-11 Jhala Nath Khanal 204 (Unified Marxist-Leninist) Unified Communist Party of 29-Aug-11 14-Mar-13 Baburam Bhattarai 563 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 Number of Days in From To Chief Minister Office Party Madhav Singh 10-Dec-89 4-Mar-90 Solanki 85 days Indian National Congress 224

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 Shankersinh 23-Oct-96 27-Oct-97 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-

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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.

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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.

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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.

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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 229

(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

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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 231

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

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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). 233

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.

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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

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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

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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

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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.

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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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Appendix A - Summary of the Key Results of Econometric Studies on Electricity Market Reforms and Sector Performance

Study Hypothesis Dependent Independent Control Variables Notes: # of countries, Variable(s) Variable(s) times period, data source

H0: Privatization leads to -operating efficiency: net -privatization: existence GDP per capita (US$ 95) 51 LDCs from 1985-2000. higher operating electricity generation of (CL) Generation and capacity Zhang et efficiency (MWh) per employee (#) private generation Result: significant at the data: al. and asset utilization. (PI) (dummy) 1% level APERC database and World (2002) -asset utilization: electricity (MS/RM) -urban population as % of Dev. Indicators.

generation (MWh) / average Result: insignificant total Labor: Industrial Statistics capacity (MW) (CL) Yearbook, International (PI) Result: significant at the Labor Organization. 1% level Privatization, regulation, -industrial output as % of and GDP competition: The Yearbook (CL) of Privatization, EIA, WEC, Result: significance varies and APERC. across models -degree of economic Price: OLADE, OECD. freedom (based on 10- point indices in ‘Economic Freedom of the World: 2002 Annual Report’)

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(CL) Result: significant at the 1% level H1: Privatization with -output: net generation -privatization: existence supportive regulation (MWh) per capita of leads (PI) private generation to higher output and -capacity: generation (dummy) capacity. capacity (MW) per capita (MS/RM) (PI) -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 residential prices: user -privatization: existence higher residential and price of lower (PI) private generation industrial prices. -industrial price: user price (dummy) (PI) (MS/RM) Result: insignificant H3: Competition leads to -output: net generation competition: existence larger capacity, higher (MWh) per capita of output, and greater labor (PI) wholesale market productivity. -capacity: generation (dummy)

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capacity (MW) per capita (RM) (PI) Result: significant (the -labor productivity: net levels of electricity generation significance vary across (MWh) per employee (#) different (PI) models and equations – either 5 or 10%) H4: Competition leads to -residential prices: user -competition: existence higher residential and price (US$) of lower (PI) wholesale market industrial prices. -industrial price: user price (dummy) (PI) (RM) Result: this is significant for industrial prices for only one of the specified equations (at 1% level of significance) H5: Independent output: net generation -regulation: existence of regulation (MWh) per capita independent regulatory will improve productive (PI) agency efficiency. -capacity: generation (dummy) capacity (MW) per capita (I) (PI) Result: insignificant H6: Regulation leads to -residential prices: user -regulation: existence of higher residential prices. price (US$) independent regulatory (PI) agency

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(dummy) (I) Result: insignificant H0: Regulation and -industrial end-user price in -time to liberalization -GDP (US$) (CL) Panel data from restructuring leads to PPPs (PI) (years) Result: insignificant International improved utilization rate -ratio of industrial to (RM) -hydro share in generation Energy Agency and other Steiner and reserve margin in residential prices in PPPs Results: significantly (SE) sources covering 19 OECD (2001) electricity generation. (PI) positive for Result: significant for Countries. Number of H1: Regulation and -utilization rate: energy prices prices periods restructuring leads to production/total average -time to privatization -nuclear share in (1986-1996): 11 ⇒ number lower capacity (PI) (years) generation (SE) of observations: 209 industrial electricity -distance of actual from (RM) -state preference against prices optimal reserve margin Results: insignificant nuclear technology (SE) and industrial/residential (PI) for prices -state preference in favor price ratio. -unbundling of of coal technology (SE) generation from -urbanization (CL) 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

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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)

H0: Unbundling of -industrial end-user price in -wholesale pool -GDP (US$ PPP) (CL) Panel dataset of 19 OECD generation from PPPs (PI) (dummy) (RM) Results: statistically countries for the period transmission, third party -ratio of industrial to Results: significantly significantly negative for 1987- Hattori and access, the existence of a residential prices in PPPs positive for prices 1999 (number of Tsutsui wholesale market, and (PI) prices -share of hydro capacity observations: 232). (2003) privatization leads to -third party access (SE) lower (dummy) Results: statistically industrial electricity (RM) insignificant prices Results: significantly -share of nuclear capacity and industrial/residential negative for (SE) price ratios. As the start prices Results: statistically of -private ownership insignificant

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liberalization and (multi-level privatization approaches indicator) (RM) prices decrease. Results: significantly negative for prices -time to privatization (years) (RM) Results: statistically insignificant Hypothesis 1 The Vagliasindi implementation of key Access -vertical and horizontal GDP per capita The data set is based on a unbundling Results: significantly (2011) sectoral reforms, panel of 22 middle income Labor Productivity Results: significantly positive for including vertical and and developing countries for positive for horizontal unbundling, Access, labor a period beginning in 1989 Tariff Access for Group A privatization and productivity,and tariff and extending through 2009. countries but significantly regulation, is expected to The maximum total number Emissions Index negative for Access for be significantly Installed Capacity of maximum observations is Group D Countries; associated with higher Results: significantly 440. Overall, significantly access and better positive for positive for tariff operational and financial Access, labor productivity, Data was compiled from the

and tariff government sources and performance of the power -privatization utilities sector. Results: significantly GDP per capita*Installed . positive for Capacity Hypotheses 2A Key Labor productivity for Results: significantly Group A countries but sectoral reforms, negative for significantly negative for particularly vertical and Access, labor Labor productivity for horizontal unbundling, Group D Countries: productivity,and tariff

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are expected to produce Overall significantly the most significant positive for results in the group of Access, labor countries characterized productivity, tariff by high power system size -regulation and income per capita Results: significantly (Group A). positive for

Access, labor Hypotheses 2B Key productivity, tariff for sectoral reforms, Group A countries but particularly vertical and significantly negative for horizontal unbundling, Access, labor are not expected to be productivity, and tariff effective in the group of for Group D Countries; Overall significantly countries characterized positive for by low power system size Access, labor and income per capita. productivity, tariff

HO:IPPs increase Nagayama generation capacity per -IPPs GDP per capita, T&D Loss The dataset comprise of panel

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(2008) capita and reduce T&D Results: significantly Share of industry in GDP, and data for 85 countries divided loss Generation Capacity per capita positive for generation Degree of political into four regions (developed capacity per capita democracy, countries 25,the H1: Privatization overall; Significantly countries of the former Soviet increase generation negative for Asian Union and eastern Europe 27, Developing Countries for Latin capacity per capita and T&D loss. America 21, and Asian reduce T&D loss developing countries

-Privatization 13)from1985 to 2006 H2: Unbundling increase Results: significantly generation capacity per positive for generation capita and reduce T&D capacity per capita loss overall;

H3: Retail Competition -Unbundling increase generation Results: significantly capacity per capita and positive for T&D loss reduce T&D loss overall;

H4: Independent -Retail Competition Regulator increase Results: significantly generation capacity per positive for generation capacity per capita capita and reduce T&D overall and for developed loss countries;

H5: Power Market -independent regulator increase generation Results; significantly capacity per capita and positive for generation reduce T&D loss capacity per capita and T&D loss overall and for

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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.

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Appendix B - Strategy for Addressing Challenges

Limitation Description Strategy

Measurement There are numerous indicators for Use measures that have Validity measuring electricity sector been previously validated performance and the ones selected for by experts and/or other the study may not accurately or fully studies capture sector performance.

Reliability Government data may be unreliable. Cross check to the extent Government agencies may lack possible with data collected capacity to independently collect data by independent agencies or may have an incentive to mis- such as the World Bank report the collected data to show their agencies in a better light.

Internal validity The changes in sector performance Careful examination of the may not be linked to implementation external context in which of reforms but some other reforms were implemented; development that has taken place such question carefully findings as for instance overall improvements regarding co-variation to in the economy. identify other variables that produce variation in sector performance.

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The findings may not be generalizable Compare results with External Validity beyond the South Asian context. similar studies undertaken in different contexts

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Appendix C - Scatter Plots

(i) Electricity Generation Capacity Vs Per Capita GDP

2500 2000 1500 1000 500 0

0 500 1000 1500 2000 2500 16 data

18 data Fitted values

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(ii) Electricity Access Vs Per Capita GDP 1.5 1 .5 0

0 500 1000 1500 2000 2500

(iii) Per Capita Generation Capacity Vs Per Capita GDP .0004 .0003 .0002 .0001 0

0 500 1000 1500 2000 2500

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(iv) T&D Loss Vs Per Capita GDP .8 .6 .4 .2 0

0 500 1000 1500 2000 2500

(i) Average Tariff Vs Per Capita GDP 15 10 5 0

0 500 1000 1500 2000 2500

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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

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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

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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.

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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

Fixed-effects (within) regression Number of obs = 514 Group variable: state_coun~1 Number of groups = 30

R-sq: within = 0.4797 Obs per group: min = 10 between = 0.4293 avg = 17.1 overall = 0.4422 max = 20

F(8,476) = 54.86 corr(u_i, Xb) = -0.3253 Prob > F = 0.0000

percapitagencap Coef. Std. Err. t P>|t| [95% Conf. Interval]

shpvtingencap .0002193 .0000274 8.00 0.000 .0001654 .0002732 utilunbundling 4.05e-06 6.04e-06 0.67 0.503 -7.82e-06 .0000159 regcomm 5.17e-06 5.21e-06 0.99 0.322 -5.08e-06 .0000154 pvtizationofdist .0000587 .0000143 4.11 0.000 .0000307 .0000868 percapitaGDPreal 1.22e-07 1.11e-08 10.92 0.000 9.97e-08 1.43e-07 urbanizationrate -4.37e-06 3.83e-06 -1.14 0.255 -.0000119 3.16e-06 shofindustry .0001616 .0000433 3.73 0.000 .0000765 .0002466 politicalstability -3.01e-06 4.99e-06 -0.60 0.546 -.0000128 6.79e-06 _cons -.0000323 .0000101 -3.20 0.001 -.0000522 -.0000125

sigma_u .000041 sigma_e .00003707 rho .55021624 (fraction of variance due to u_i)

F test that all u_i=0: F(29, 476) = 15.33 Prob > F = 0.0000

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Electricity Access Fixed-effects (within) regression Number of obs = 495 Group variable: state_coun~1 Number of groups = 30

R-sq: within = 0.6361 Obs per group: min = 10 between = 0.1878 avg = 16.5 overall = 0.2311 max = 20

F(8,457) = 99.85 corr(u_i, Xb) = -0.4907 Prob > F = 0.0000

access2 Coef. Std. Err. t P>|t| [95% Conf. Interval]

shpvtingencap .3546625 .0452736 7.83 0.000 .2656922 .4436327 utilunbundling .0407832 .009604 4.25 0.000 .0219096 .0596567 regcomm .0507725 .0084382 6.02 0.000 .0341899 .067355 pvtizationofdist .030955 .0220327 1.40 0.161 -.0123429 .0742529 percapitaGDPreal -.0000927 .0000209 -4.43 0.000 -.0001338 -.0000516 urbanizationrate 1.334895 .1499321 8.90 0.000 1.040253 1.629537 shofindustry .4035225 .0675425 5.97 0.000 .2707902 .5362549 politicalstability -.0031113 .0078382 -0.40 0.692 -.0185147 .012292 _cons .1895085 .0367351 5.16 0.000 .1173179 .2616992

sigma_u .24208046 sigma_e .05697093 rho .94752209 (fraction of variance due to u_i)

F test that all u_i=0: F(29, 457) = 164.07 Prob > F = 0.0000 Per Capita Electricity Consumption Fixed-effects (within) regression Number of obs = 358 Group variable: state_coun~1 Number of groups = 30

R-sq: within = 0.8409 Obs per group: min = 4 between = 0.5238 avg = 11.9 overall = 0.5935 max = 20

F(8,320) = 211.41 corr(u_i, Xb) = -0.2583 Prob > F = 0.0000

percapitaeleccons Coef. Std. Err. t P>|t| [95% Conf. Interval]

shpvtingencap 921.7015 80.08494 11.51 0.000 764.142 1079.261 utilunbundling 107.0396 20.27073 5.28 0.000 67.15885 146.9203 regcomm -8.236618 18.31655 -0.45 0.653 -44.27269 27.79946 pvtizationofdist 48.80454 47.5175 1.03 0.305 -44.68162 142.2907 percapitaGDPreal .8498689 .0348243 24.40 0.000 .7813554 .9183823 urbanizationrate -10.25415 10.51117 -0.98 0.330 -30.93387 10.42557 shofindustry 655.9128 142.0517 4.62 0.000 376.4396 935.3859 politicalstability 21.81735 16.24534 1.34 0.180 -10.14381 53.77851 _cons -320.9329 33.34901 -9.62 0.000 -386.5439 -255.3219

sigma_u 230.53264 sigma_e 101.27491 rho .83822874 (fraction of variance due to u_i)

F test that all u_i=0: F(29, 320) = 47.18 Prob > F = 0.0000

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T&D Loss

Fixed-effects (within) regression Number of obs = 232 Group variable: state_coun~1 Number of groups = 28

R-sq: within = 0.1945 Obs per group: min = 2 between = 0.0003 avg = 8.3 overall = 0.0240 max = 20

F(8,196) = 5.92 corr(u_i, Xb) = -0.5970 Prob > F = 0.0000

tdloss2 Coef. Std. Err. t P>|t| [95% Conf. Interval]

shpvtingencap -.0571304 .1022449 -0.56 0.577 -.2587718 .144511 utilunbundling -.0778112 .0236451 -3.29 0.001 -.1244427 -.0311797 regcomm .0222769 .0225546 0.99 0.325 -.022204 .0667578 pvtizationofdist -.1501236 .0416631 -3.60 0.000 -.2322892 -.067958 percapitaGDPreal .000135 .0000498 2.71 0.007 .0000367 .0002333 urbanizationrate -.3244713 .3015609 -1.08 0.283 -.9191919 .2702493 shofindustry .1605455 .1468837 1.09 0.276 -.1291298 .4502209 politicalstability .0179006 .0190957 0.94 0.350 -.0197588 .05556 _cons .2859284 .0765336 3.74 0.000 .1349933 .4368634

sigma_u .11556969 sigma_e .08301504 rho .65964307 (fraction of variance due to u_i)

F test that all u_i=0: F(27, 196) = 9.35 Prob > F = 0.0000

Average tariff

Fixed-effects (within) regression Number of obs = 347 Group variable: state_coun~1 Number of groups = 30

R-sq: within = 0.6222 Obs per group: min = 5 between = 0.0901 avg = 11.6 overall = 0.3628 max = 20

F(8,309) = 63.61 corr(u_i, Xb) = -0.4125 Prob > F = 0.0000

electariff Coef. Std. Err. t P>|t| [95% Conf. Interval]

shpvtingencap -.9041033 .962907 -0.94 0.348 -2.798787 .9905809 regcomm .7005637 .1867066 3.75 0.000 .3331865 1.067941 utilunbundling .9830729 .2202014 4.46 0.000 .549789 1.416357 pvtizationofdist -1.336505 .5079215 -2.63 0.009 -2.335927 -.3370826 percapitaGDP .0020765 .0002281 9.10 0.000 .0016276 .0025254 urbanizationrate -.1302851 .1153961 -1.13 0.260 -.3573467 .0967764 shofindustry 10.02922 1.648255 6.08 0.000 6.785995 13.27244 politicalstability -.2175635 .1835664 -1.19 0.237 -.5787618 .1436348 _cons 1.246499 .3890344 3.20 0.001 .4810069 2.01199

sigma_u 1.3013764 sigma_e 1.1045776 rho .58125293 (fraction of variance due to u_i)

F test that all u_i=0: F(29, 309) = 10.45 Prob > F = 0.0000

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Random Effect Model Results

Per Capita Generation Capacity

Random-effects GLS regression Number of obs = 514 Group variable: state_coun~1 Number of groups = 30

R-sq: within = 0.4788 Obs per group: min = 10 between = 0.4413 avg = 17.1 overall = 0.4515 max = 20

Wald chi2(8) = 451.36 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000

percapitagencap Coef. Std. Err. z P>|z| [95% Conf. Interval]

shpvtingencap .0001983 .0000264 7.52 0.000 .0001466 .00025 utilunbundling 3.02e-06 5.93e-06 0.51 0.611 -8.61e-06 .0000146 regcomm 8.14e-06 5.12e-06 1.59 0.112 -1.90e-06 .0000182 pvtizationofdist .0000535 .0000137 3.90 0.000 .0000266 .0000804 percapitaGDPreal 1.15e-07 1.03e-08 11.20 0.000 9.48e-08 1.35e-07 urbanizationrate -4.44e-06 3.84e-06 -1.16 0.247 -.000012 3.08e-06 shofindustry .0001638 .0000406 4.03 0.000 .0000842 .0002434 politicalstability -1.09e-06 4.85e-06 -0.22 0.823 -.0000106 8.42e-06 _cons -.0000281 .0000115 -2.45 0.014 -.0000506 -5.61e-06

sigma_u .00003477 sigma_e .00003707 rho .46810336 (fraction of variance due to u_i)

Electricity Access

Random-effects GLS regression Number of obs = 495 Group variable: state_coun~1 Number of groups = 30

R-sq: within = 0.6345 Obs per group: min = 10 between = 0.1868 avg = 16.5 overall = 0.2368 max = 20

Wald chi2(8) = 770.69 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000

access2 Coef. Std. Err. z P>|z| [95% Conf. Interval]

shpvtingencap .3604157 .0455984 7.90 0.000 .2710445 .449787 utilunbundling .0403773 .009734 4.15 0.000 .021299 .0594556 regcomm .0541713 .0084729 6.39 0.000 .0375648 .0707779 pvtizationofdist .0236916 .0222972 1.06 0.288 -.0200101 .0673932 percapitaGDPreal -.0000735 .0000205 -3.59 0.000 -.0001136 -.0000334 urbanizationrate 1.11861 .1275792 8.77 0.000 .8685596 1.368661 shofindustry .4199935 .0680384 6.17 0.000 .2866407 .5533463 politicalstability -.0033856 .0079471 -0.43 0.670 -.0189615 .0121904 _cons .236079 .047186 5.00 0.000 .1435961 .3285619

sigma_u .18457227 sigma_e .05697093 rho .91301367 (fraction of variance due to u_i)

283

Per Capita Electricity Consumption

Random-effects GLS regression Number of obs = 358 Group variable: state_coun~1 Number of groups = 30

R-sq: within = 0.8403 Obs per group: min = 4 between = 0.5352 avg = 11.9 overall = 0.6036 max = 20

Wald chi2(8) = 1598.42 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000

percapitaeleccons Coef. Std. Err. z P>|z| [95% Conf. Interval]

shpvtingencap 858.5424 82.14882 10.45 0.000 697.5337 1019.551 utilunbundling 106.078 21.02232 5.05 0.000 64.87503 147.281 regcomm 2.727295 18.84425 0.14 0.885 -34.20676 39.66135 pvtizationofdist 60.48803 49.00214 1.23 0.217 -35.5544 156.5305 percapitaGDPreal .8236323 .0346544 23.77 0.000 .7557109 .8915537 urbanizationrate -9.752707 10.98953 -0.89 0.375 -31.29178 11.78637 shofindustry 708.3985 141.9957 4.99 0.000 430.0921 986.7049 politicalstability 22.48182 16.67333 1.35 0.178 -10.19731 55.16096 _cons -276.1808 44.1937 -6.25 0.000 -362.7989 -189.5627

sigma_u 150.88627 sigma_e 101.27491 rho .68941277 (fraction of variance due to u_i)

T&D Loss Random-effects GLS regression Number of obs = 232 Group variable: state_coun~1 Number of groups = 28

R-sq: within = 0.1860 Obs per group: min = 2 between = 0.0005 avg = 8.3 overall = 0.0391 max = 20

Wald chi2(8) = 40.25 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000

tdloss2 Coef. Std. Err. z P>|z| [95% Conf. Interval]

shpvtingencap -.112739 .0923598 -1.22 0.222 -.2937609 .068283 utilunbundling -.0756024 .0231125 -3.27 0.001 -.120902 -.0303028 regcomm .0311515 .0210083 1.48 0.138 -.010024 .0723271 pvtizationofdist -.1368845 .0407013 -3.36 0.001 -.2166576 -.0571114 percapitaGDPreal .0000776 .000041 1.89 0.059 -2.84e-06 .000158 urbanizationrate -.0810308 .1149284 -0.71 0.481 -.3062863 .1442248 shofindustry .0488653 .1303878 0.37 0.708 -.2066901 .3044207 politicalstability .0210785 .0180385 1.17 0.243 -.0142763 .0564333 _cons .2710604 .0446239 6.07 0.000 .1835992 .3585216

sigma_u .09109993 sigma_e .08301504 rho .54633432 (fraction of variance due to u_i)

284

Average tariff Random-effects GLS regression Number of obs = 347 Group variable: state_coun~1 Number of groups = 30

R-sq: within = 0.5304 Obs per group: min = 5 between = 0.1424 avg = 11.6 overall = 0.3225 max = 20

Wald chi2(8) = 296.71 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000

electariff Coef. Std. Err. z P>|z| [95% Conf. Interval]

shpvtingencap 2.214909 .9458282 2.34 0.019 .3611198 4.068698 regcomm 1.048668 .2068813 5.07 0.000 .6431883 1.454148 utilunbundling .9228843 .2414312 3.82 0.000 .4496879 1.396081 pvtizationofdist -.2970777 .5421093 -0.55 0.584 -1.359592 .7654371 percapitaGDPreal .0019585 .0003615 5.42 0.000 .0012501 .002667 urbanizationrate -.1858163 .133732 -1.39 0.165 -.4479263 .0762936 shofindustry 6.800685 1.547797 4.39 0.000 3.767057 9.834312 politicalstability .035034 .1935035 0.18 0.856 -.3442259 .414294 _cons 1.599767 .3886631 4.12 0.000 .838001 2.361532

sigma_u .69553617 sigma_e 1.2103198 rho .24826001 (fraction of variance due to u_i)

Hausman Test

Per Capita Generation Capacity . hausman fixed random

Coefficients (b) (B) (b-B) sqrt(diag(V_b-V_B)) fixed random Difference S.E. shpvtingen~p .0002193 .0001983 .000021 7.49e-06 utilunbund~g 4.05e-06 3.02e-06 1.03e-06 1.14e-06 regcomm 5.17e-06 8.14e-06 -2.97e-06 9.78e-07 pvtization~t .0000587 .0000535 5.22e-06 3.98e-06 percapitaG~l 1.22e-07 1.15e-07 6.64e-09 4.30e-09 urbanizati~e -4.37e-06 -4.44e-06 7.47e-08 . shofindustry .0001616 .0001638 -2.21e-06 .0000149 politicals~y -3.01e-06 -1.09e-06 -1.92e-06 1.14e-06

b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(8) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 24.08 Prob>chi2 = 0.0022 (V_b-V_B is not positive definite) 285

Electricity Access

Coefficients (b) (B) (b-B) sqrt(diag(V_b-V_B)) fixed random Difference S.E. shpvtingen~p .3546625 .3604157 -.0057533 . utilunbund~g .0407832 .0403773 .0004059 . regcomm .0507725 .0541713 -.0033989 . pvtization~t .030955 .0236916 .0072634 . percapitaG~l -.0000927 -.0000735 -.0000192 4.39e-06 urbanizati~e 1.334895 1.11861 .2162849 .0787602 shofindustry .4035225 .4199935 -.0164709 . politicals~y -.0031113 -.0033856 .0002742 .

b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(7) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 2.58 Prob>chi2 = 0.9208 (V_b-V_B is not positive definite)

Per Capita Electricity Consumption . hausman fixed random

Coefficients (b) (B) (b-B) sqrt(diag(V_b-V_B)) fixed random Difference S.E. shpvtingen~p 921.7015 858.5424 63.15908 . utilunbund~g 107.0396 106.078 .9615791 . regcomm -8.236618 2.727295 -10.96391 . pvtization~t 48.80454 60.48803 -11.68349 . percapitaG~l .8498689 .8236323 .0262365 .0034353 urbanizati~e -10.25415 -9.752707 -.5014427 . shofindustry 655.9128 708.3985 -52.48575 3.987534 politicals~y 21.81735 22.48182 -.6644733 .

b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(8) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 245.72 Prob>chi2 = 0.0000 (V_b-V_B is not positive definite)

286

T&D Loss

Coefficients (b) (B) (b-B) sqrt(diag(V_b-V_B)) fixed random Difference S.E.

shpvtingen~p -.0571304 -.112739 .0556086 .0438598 utilunbund~g -.0778112 -.0756024 -.0022088 .0049905 regcomm .0222769 .0311515 -.0088746 .0082074 pvtization~t -.1501236 -.1368845 -.0132391 .0089005 percapitaG~l .000135 .0000776 .0000574 .0000283 urbanizati~e -.3244713 -.0810308 -.2434406 .2788017 shofindustry .1605455 .0488653 .1116802 .0676302 politicals~y .0179006 .0210785 -.0031779 .0062656

b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(7) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 17.20 Prob>chi2 = 0.0162 (V_b-V_B is not positive definite)

Average Tariff . hausman fixed random

Coefficients (b) (B) (b-B) sqrt(diag(V_b-V_B)) fixed random Difference S.E. shpvtingen~p -.9041033 2.214909 -3.119012 .1805519 regcomm .7005637 1.048668 -.3481046 . utilunbund~g .9830729 .9228843 .0601886 . pvtization~t -1.336505 -.2970777 -1.039427 . urbanizati~e -.1302851 -.1858163 .0555312 . shofindustry 10.02922 6.800685 3.228533 .5666273 politicals~y -.2175635 .035034 -.2525975 .

b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(7) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 310.98 Prob>chi2 = 0.0000 (V_b-V_B is not positive definite)

287

BREUSCH AND PAGAN LAGRANGIAN MULTIPLIER Test

Electricity Access

Breusch and Pagan Lagrangian multiplier test for random effects

access2[state_country1,t] = Xb + u[state_country1] + e[state_country1,t]

Estimated results: Var sd = sqrt(Var)

access2 .0585605 .2419927 e .0032457 .0569709 u .0340669 .1845723

Test: Var(u) = 0 chibar2(01) = 2083.66 Prob > chibar2 = 0.0000

288

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

289

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

290

Summary of Statistically Significant Results for Group A

Access to Per Capital T&D Losses Per Capita Electricity (%) Electricity (%) Generation Consumption Average Tariff Capacity

(Kw) (KwH) (US $ Cents)

Share of PSP in Generation

Unbundling of

Utilities

Independent Regulatory

Commission

Privatization of

Distribution

291

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

292

Summary of Statistically Significant Results for Group D

Access to Per Capital T&D Losses Per Capita Electricity (%) Electricity (%) Generation Consumption Average Tariff Capacity

(Kw) (KwH) (US $ Cents)

Share of PSP in Generation

Unbundling of

Utilities

Independent

Regulatory

Commission

Privatization of

Distribution

293

Appendix H - List of Utilities Covered in the Study

Agency - Long Name State Agency - Type of Year of Year of Short Agency Unbun Privatiz Name dling ation

Andhra Pradesh Central Power Andhra APCPDCL Discom 2000 NA Distribution Company Limited Pradesh Andhra Pradesh Eastern Power Andhra APEPDCL Discom 2000 NA Distribution Company Limited Pradesh Andhra Pradesh Northern Andhra APNPDCL Discom 2000 NA Power Distribution Company Pradesh Limited Andhra Pradesh Southern Andhra APSPDCL Discom 2000 NA Power Distribution Company Pradesh Limited Andhra Pradesh Generation Andhra AP Genco Genco 2000 NA Company Limited Pradesh Andhra Pradesh Transmission Andhra AP Transco 2000 NA Company Limited Pradesh Transco Arunachal Pradesh Department Arunachal Arunachal Bundled N/A NA of Power Pradesh PD Assam State Electricity Board Assam ASEB Bundled 2004 NA Central Assam Electricity Assam CAEDCL Discom 2004 NA Distribution Company Limited Lower Assam Electricity Assam LAEDCL Discom 2004 NA Distribution Company Limited Upper Assam Electricity Assam UAEDCL Discom 2004 NA Distribution Company Limited Assam Power Generation Assam APGCL Genco 2004 NA Company Limited Assam Electricity Grid Assam AEGCL Transco 2004 NA Corporation Limited Assam Power Distribution Assam APDCL Discom 2004 NA Corporation Limited Bihar State Electricity Board Bihar BSEB Bundled N/A NA Chhattisgarh State Electricity Chhattisgarh CSEB Bundled 2009 NA Board Chhattisgarh State Power Chhattisgarh CSPDCL Discom 2009 NA Distribution Company Limited Chhattisgarh State Power Chhattisgarh CSPGCL Genco 2009 NA Generation Company Limited Chhattisgarh State Power Chhattisgarh CSPTCL Transco 2009 NA Transmission Company Limited Chhattisgarh State Power Chhattisgarh N/A Holdco 2009 NA Holding Company Limited

294

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 Delhi IPGCL Genco 2002 2002 Company Limited Pragati Power Corporation Delhi PPCL Genco 2002 NA Limited Delhi Transco Limited Delhi DTL Transco 2002 NA Indraprastha Power Generation Delhi N/A Genco 2002 NA Company Limited - Pragati Power Corporation Limited Goa Electricity Department Goa GoaPD Discom + N/A NA Transco GEB Gujarat GSEB Bundled 2005 NA Dakshin Gujarat Vij Company Gujarat DGVCL Discom 2005 NA Limited Madhya Gujarat Vij Company Gujarat MGVCL Discom 2005 NA Limited Paschim Gujarat Vij Company Gujarat PGVCL Discom 2005 NA Limited Uttar Gujarat Vij Company Gujarat UGVCL Discom 2005 NA Limited Gujarat State Electricity Gujarat GSECL Genco 2005 NA Corporation Limited Gujarat Energy Transmission Gujarat GETCO Transco 2005 NA Corporation Limited GUVNL Gujarat N/A Holdco/Tr 2005 NA adeco Dakshin Haryana Bijli Vitran Haryana DHBVNL Discom 1998 NA Nigam Ltd Uttar Haryana Bijli Vitran Nigam Haryana UHBVNL Discom 1998 NA Ltd Haryana Power Generation Haryana HPGCL Genco 1998 NA Corporation Limited Haryana Vidyut Prasaran Nigam Haryana HVPNL Transco 1998 NA Limited Himachal Pradesh State Himachal HPSEB Bundled 2010 NA Electricity Board Pradesh Himachal Pradesh State Himachal HPSEB Genco + 2010 NA Electricity Board Ltd Pradesh LTD Discom Jammu Kashmir Power Jammu & J&K PDD Discom + #N/A NA Development Department Kashmir Transco Jammu & Kashmir State Power Jammu & J&K PDCL Genco #N/A NA Development Corporation Kashmir Limited Jharkhand State Electricity Jharkhand JSEB Bundled N/A NA Board

295

Jamshedpur Utilities and Jharkhand N/A Discom N/A NA Services Company Limited 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 Karnataka BESCOM Discom 1999 NA Company Limited Gulbarga Electricity Supply Karnataka GESCOM Discom 1999 NA Company Limited Hubli Electricity Supply Karnataka HESCOM Discom 1999 NA Company Limited Mangalore electricity Supply Karnataka MESCOM Discom 1999 NA Company Limited Karnataka Power Corporation Karnataka KPCL Genco 1999 NA Company Limited Karnataka Power Transmission Karnataka KPTCL Transco 1999 NA Company Limited Chamundeshwari Electricity Karnataka CESCOM Discom 1999 NA Supply Company Limited Kerala State Electricity Board Kerala KSEB Bundled N/A NA Madhya Pradesh State Madhya MPSEB Bundled 2005 NA Electricity Board Pradesh Madhya Pradesh Power Madhya MPPTCL Transco 2005 NA Transmission Company Limited Pradesh Madhya Pradesh Madhya Madhya MPMKVV Discom 2005 NA Kshetra Vidyut Vitaran Pradesh CL Company Limited Madhya Pradesh Paschim Madhya MPPAKVV Discom 2005 NA Kshetra Vidyut Vitaran Pradesh CL Company Limited Madhya Pradesh Poorva Madhya MPPUKVV Discom 2005 NA Kshetra Vidyut Vitaran Pradesh CL Company Limited Madhya Pradesh Power Madhya MPPGCL Genco 2005 NA Generation Company Limited Pradesh MP Power Management Madhya N/A Holdco/Tr 2005 NA Company Limited Pradesh adeco Maharashtra State Electricity Maharashtra MSEB Bundled 2005 NA Board Maharashtra State Electricity Maharashtra MSEDCL Discom 2005 NA Distribution Company Limited Maharashtra State Power Maharashtra MSPGCL Genco 2005 NA Generation Company Limited Maharashtra State Electricity Maharashtra MSPTCL Transco 2005 NA Transmission Company Limited Brihanmumbai Electric Supply & Maharashtra N/A Discom 2005 NA Transport Undertaking MSEB Holding Company Limited Maharashtra N/A SEB/Holdc 2005 NA

296

o Manipur Electricity Department Manipur Manipur Bundled N/A NA (Manipur) PD Meghalaya State Electricity Meghalaya MeSEB Bundled 2010 NA Board Meghalaya Energy Corporation Meghalaya Me ECL Bundled 2010 NA Limited Mizoram Power and Electricity Mizoram Mizoram Bundled N/A NA Department PD Manipur Electricity Department Mizoram N/A Genco N/A NA (Mizoram) Department of Power Nagaland Nagaland Bundled N/A NA PD Central Electricity Supply Utility Orissa CESCO Discom 1996 1999 - 2001 North Eastern Electricity Supply Orissa NESCO Discom 1996 1999 Company Southern Electricity Supply Orissa SESCO Discom 1996 1999 Company Western Electricity Supply Orissa WESCO Discom 1996 1999 Company Orissa Hydro Power Orissa OHPCL Genco 1996 NA Corporation Orissa Power Generation Orissa OPGCL Genco 1996 NA Corporation Orissa Power Transmission Orissa OPTCL Transco 1996 NA Corporation Limited Grid Corporation of Orissa Orissa GCOL Bundled 1996 NA Limited Punjab State Electricity Board Punjab PSEB Bundled 2010 NA Punjab State Power Punjab PSPCL Genco + 2010 NA Corporation Limited Discom Punjab State Transmission Punjab N/A Transco 2010 NA Corporation Limited Ajmer Vidyut Vitran Nigam Rajasthan AVVNL Discom 2000 NA Limited Jaipur Vidyut Vitran Nigam Rajasthan JVVNL Discom 2000 NA Limited Jodhpur Vidyut Vitran Nigam Rajasthan JDVVNL Discom 2000 NA Limited Rajasthan Rajya Vidyut Utpadan Rajasthan RRVUNL Genco 2000 NA Nigam Limited Rajasthan Rajya Vidyut Rajasthan RRVPNL Transco 2000 NA Prasaran Nigam Limited Sikkim Energy and Power Sikkim Sikkim PD Bundled N/A NA Department Tamil Nadu State Electricity Tamil Nadu TNEB Bundled/ 2010 NA

297

Board Holdco Tamil Nadu Generation and Tamil Nadu TANGEDC Genco + 2010 NA Distribution Corporation O Discom Limited Tamil Nadu Transmission Tamil Nadu TANTRAN Transco 2010 NA Corporation Limited SCO Tripura State Electricity Tripura TSECL Bundled N/A NA Corporation Limited Uttar Pradesh Jal Vidyut Nigam Uttar Pradesh UPJVNL Genco 2000 NA Limited Uttar Pradesh Rajya Vidyut Uttar Pradesh UPRVUNL Genco 2000 NA Utpadan Nigam Limited Dakshinanchal Vidyut Vitran Uttar Pradesh DVVN Discom 2000 NA Nigam Limited Kanpur Electric Supply Uttar Pradesh KESCO Discom 2000 NA Company Madhyanchal Vidyut Vitran Uttar Pradesh MVVN Discom 2000 NA Nigam Limited Paschimanchal Vidyut Vitaran Uttar Pradesh Pash VVN Discom 2000 NA Nigam Limited Purvanchal Vidyut Vitaran Uttar Pradesh Poorv Discom 2000 NA Nigam Limited VVN Uttar Pradesh Power Uttar Pradesh UPPCL Transco 2000 NA Transmission Corporation Limited Uttar Pradesh Power Uttar Pradesh N/A Holdco 2000 NA Corporation Limited Uttarakhand Power Uttarakhand UPCL Discom 2004 NA Corporation Limited Uttarakhand Jal Vidyut Nigam Uttarakhand UJVNL Genco 2004 NA Limited Power Transmission Uttarakhand N/A Transco 2004 NA Corporation of Uttarakhand Limited West Bengal State Electricity West Bengal WBSEB Bundled 2007 NA Board West Bengal Power West Bengal WBPDCL Genco 2007 NA Development Corporation Limited West Bengal State Electricity West Bengal WBSEDCL Genco + 2007 NA Distribution Company Limited Discom West Bengal State Electricity West Bengal WBSETCL Transco 2007 NA Transmission Company Limited WAPDA Pakistan WAPDA Genco 1998 NA Karachi Electric Supply Pakistan KESC Bundled NA 2005 Corporation Pakistan Electricity Company Pakistan PEPCO 1998 NA

298

National Transmission and Pakistan NTDC Transco 1998 NA Dispatch Company (PEPCO) Lahore Electric Supply Pakistan LESCO Discom 1998 NA Company (PEPCO) Gujranwala Electric Power Pakistan GEPCO Discom 1998 NA Company (PEPCO) Faisalabad Electric Supply Pakistan FESCO Discom 1998 NA Company (PEPCO) Islamabad Electric Supply Pakistan IESCO Discom 1998 NA Company (PEPCO) Multan Electric Power Pakistan MEPCO Discom 1998 NA Company (PEPCO) Peshawar Electric Power Pakistan PESCO Discom 1998 NA Company(PEPCO) Hyderabad Electric Supply Pakistan HESCO Discom 1998 NA Company(PEPCO) Quetta Electric Supply Pakistan QESCO Discom 1998 NA Company(PEPCO) Tribal Electric Supply Pakistan TESCO Discom 1998 NA Company(PEPCO) Southern Generation Power Pakistan SGPCL Genco 1998 NA Company Limited(PEPCO) Central Power Generation Pakistan CPGCL Genco 1998 NA Company Limited (PEPCO) Northern Power Generation Pakistan NPGCL Genco 1998 NA Company Limited (PEPCO) Lakhra Power Generation Pakistan LPGCL Genco 1998 NA Company Limited (PEPCO) Ashuganj Power Station Co. Ltd. Bangladesh APCSL Genco 1996 NA (APSCL) Power Grid Company of Bangladesh PGCB Transco 1996 NA Bangladesh Dhaka Electricity Supply Bangladesh DESA Discom NA NA Authority Dhaka Electricity Supply Bangladesh DESCO Discom NA NA Company Dhaka Power Distribution Bangladesh DPDC Discom NA NA Company Limited (DPDC) West Zone Power Distribution Bangladesh WZPDCL Discom 2005 NA Company Electricity Generation Company Bangladesh EGCB Genco 1996 NA of Bangladesh North West Power Generation Bangladesh NWPGCL 2007 NA Company Ltd. BPDB Bangladesh BPDB Genco 1996 NA and Discom

299

Rural Electrification Board Bangladesh REB Discom 1996 NA NEA Nepal NEA Bundled N/A NA CEB Sri Lanka CEA Bundled NA NA

300

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?

301

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.

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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.

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Appendix K - Classification of states and countries into reform and governance categories

Reform States Governance Unbundling Regulator PSP Rank Above Andhra Pradesh Strong Yes Early Average Strong Below Arunachal Pradesh Weak No Late Average Weak Below Assam Weak Yes Late Average Weak Below Delhi Strong Yes Early Average Strong Above Goa Strong No Late Average Weak Above Gujarat Strong Yes Early Average Strong Below Haryana Strong Yes Early Average Strong Above Himachal Pradesh Strong Yes Late Average Strong Below J&K Weak No Late Average Weak Above Jharkhand Weak No Late Average Weak Above Karnataka Strong Yes Early Average Strong Below Kerala Strong No Late Average Weak Above Maharashtra Weak Yes Early Average Strong Below Manipur Weak No Late Average Weak Below Meghalaya Weak Yes Late Average Weak Below Mizoram Weak No Late Average Weak Below Nagaland Weak No Late Average Weak Below Orissa Weak Yes Early Average Strong Below Punjab Weak Yes Early Average Strong Above Rajasthan Strong Yes Early Average Strong Sikkim Weak No Late Below Weak 304

Average Above Tamil Nadu Strong Yes Early Average Strong Below Tripura Weak No Late Average Weak Above West Bengal Weak Yes Early Average Strong Above Pakistan Weak Yes Late Average Strong Above Bangladesh Weak Yes Late Average Strong Above Nepal Weak No Late Average Weak Above Sri Lanka Strong No Late Average Weak Below Bihar (& Jharkhand) Weak No Late Average Weak Above MP (& Chattisgarh) Strong Yes Early Average Strong Below UP (& Uttarakhand) Strong Yes Early Average Strong

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