Indian Infra Devp

INDIA INFRASTRUCTURE REPORT 2004
Editor: SEBASTIAN MORRIS

Project Co-ordinator: ANUPAM B. RASTOGI
Arun K. Agarwal
Pramod Agrawal
Sanjay Agrawal
Hidayathullah Baig
Peeyush Bajpai
Ashok Deo Bardhan
Samir K. Barua
Laveesh Bhandari
Yogesh K. Bichpuriya
Atanu Chakraborty
Manju Ghodke
Dilip Kumar Ghosh
Ashima Goyal
Rekha Jain
Aditi Jagtiani
K. Jayakishan
Ravikant Joshi
Prem K. Kalra
T.C. Kalra
Uddesh Kohli
Bhavin Kothari
Sudha Mahalingam
Rajarshi Majumder
Mukesh P. Mathur
Dileep Mavalankar
Sebastian Morris
Partha Mukhopadhyay
A. Narayanamoorthy
Ajay Pandey
Ashvini Parashar
Swapnil Pawar
Raghu Ramaswamy
G. Raghuram
K.N. Ramganesh
Anupam Rastogi
Joel Ruet
Jagdish Sagar
A.K. Saxena
Manjunath Shankar
Rajiv Shekhar
Daljit Singh
Vipin Prakash Singh
Sidharth Sinha
Cherian Thomas
Akhilesh Tilotia
Chetan Vaidya
Hitesh Vaidya
Jayanth R. Varma
S. Vasudevan
Government of Madhya Pradesh (MPRRDA), Bhopal

Government of Madhya Pradesh (MPRRDA), Bhopal
Infrastructure Development Finance Company, Bangalore
Infrastructure Development Finance Company, Chennai
Indicus Analytics, New Delhi
University of California, Berkeley (Fisher Center for Real Estate and Urban Economics)
Indian Institute of Management, Ahmedabad
Indicus Analytics, New Delhi
Indian Institute of Technology, Kanpur
Government of India, Ministry of Finance, New Delhi
Indian Institute of Capital Markets, Mumbai
State Institute of Panchayats and Rural Development, West Bengal
Indira Gandhi Insititute of Development Research, Mumbai
Infrastructure Development Finance Company, Mumbai
Vadodara Municipal Corporation, Baroda
Independent consultant, Kanpur
Power Finance Corporation of India Ltd, New Delhi
National Institute of Design, Ahmedabad
Institute for Defence Studies and Analyses, New Delhi
University of Burdwan, West Bengal
National Institute of Urban Affairs, New Delhi
Indian Institute of Management, Ahmedabad and
Infrastructure Development Finance Company, New Delhi
Gokhale Institute of Politics and Economics, Pune
Infrastructure Development Finance Company, iDeCK, Bangalore
Infrastructure Development Finance Company, Mumbai
CENTRE de SCIENCES HUMAINES, New Delhi and CERNA, Ecole de Mines, Paris
Government of National Capital Territory of Delhi, New Delhi
Independent consultant, New Delhi
USAID FIRE Project, New Delhi
USAID FIRE Project, New Delhi
Infrastructure Development Corporation of Karnataka, Bangalore
The views expressed in the report are those of the individual authors and not the institutions they are affiliated to.
INDIA INFRASTRUCTURE REPORT 2004

Ensuring Value for Money
3iNetwork
Infrastructure Development Finance Company
PREFACE
The India Infrastructure Report 2004: Ensuring Value for Money takes forward the broad theme of last years report public
expenditure allocation and accountability. We began this series of discussions on how governments spend public money
subsequent to our examining the governance aspect of commercialization of infrastructure. The underlying concept of
governance has thus prevailed in the last three issues of the IIR. This is neither trivial nor accidental. Quality of
governance is a key determinant of the manner in which public funds are allocated and once allocated how they are
infact used. Last years report dwelt in some detail on these issues.
This year we have spent considerable time researching case studies in view of the ultimate aim of any public
expenditure programmeobtaining value for each rupee spent in terms of services to citizen. Hence, this years report
is titled Ensuring Value for Money.
The concept is not new: quantifying it is difficult. Almost all studies of infrastructure development suggest that
involving the private sector in the delivery of services improves economic growth and helps restrain fiscal deficits of
the government. Almost all infrastructure development activities in India have, over the past decades, been taken over
by governments, central, state or local, as the case may be. This was perpetuated by implicit assumption that the
responsibility of providing basic and other services to the common citizen is entirely the states. The result has been
less than desirable. It is no longer possible to tweak the ongoing system in order to improve service delivery. A paradigm
shift is called for to completely overthrow the existing ways of doing things and put in place a more dynamic process
of ensuring solutions rather than attempting them.
I have long maintained that there are only three ways in which this paradigm shift can occur, all depending on the
one crucial decision: the government must let go of infrastructure. Without this, alternative solutions are not possible.
This indeed is the paradigm shift. The rest is mere mechanics. The three options are to
sell assets and depart from the business of service delivery entirely (power distribution, telecom etc);
sweat assets by getting the private sector to reinvest in assets and manage service delivery (ports are the best
example);
where user charges are not possible to make service delivery a commercial proposition, attempt what I call PFPI
(private financing of public infrastructure).
Rural roads, primary education and health care for the poor are examples where ability to pay may not justify a
commercial model of service delivery. In India we are now experimenting with all of these alternatives.
Even in this context the public sector will continue to have a significant role in infrastructure provision. Massive
infrastructure investments in cities, opening up new areas for development (such as Mumbais hinterland or the North
East Region of the country), investing in logistics, railways, and roads will require extensive public sector initiatives.
China has done this with enormous success. Shanghai could not have been transformed in a decade without substantial
government initiative. The role of the government and how it discharges its duties, its fiduciary responsibility of managing
the taxpayers money and the institutional framework within which it executes its business will prove crucial in the
future of infrastructure development.
IIR 2004 is an endeavour at quantifying gains from alternative arrangements. Some cases document best international
practices, others examine the provision of both rural and urban infrastructure services. Value for money has been recorded
vi
Preface
where personal dynamism of individual leaders guaranteed it. Unfortunately systemic failure is by far the larger story
revealed. We have belaboured the value for money argument with different approaches which identify the difficulties
and prerequisites of achieving real gains.
The objective of this series of IIRs is to document what is in fact going on in order to improve and develop new
ways in which we may tackle the single largest problem facing the country at the present time. We would like to eschew
single solutions to complex problems; there is no such magic wand. What is crucial to the debate is not who does
what but how effectively the job gets done. It is more important to set the objective and then work out the mechanics.
What works is best is perhaps a good way to start and many more pilots on the ground are necessary in order to
develop broader and more systemic policy frameworks.
The present report, like its predecessors, is a joint effort of many practitioners, researchers, policy-makers and
teachers. IDFCs role in the 3iNetwork is to foster new thinking on issues related to all aspects of infrastructure
investment and to provide strong inputs on underlying thematic concerns. In matters such as these there are often strong
differences of opinion. We do not necessarily subscribe to every point of view presented in this report but equally strongly
we believe in the merit of diverse opinions and vigorous debate on important issues. The report provides a platform
on which to build the future. Since the inception of the IIR in 1999 a number of journals and magazines have begun
to cover infrastructure issues. We are particularly pleased that the debate continues to grow constantly.
Apart from this report, the 3iNetwork has been working on a number of projects. The Network contributed to
developing software tools for power distribution and transmission; inter-city comparisons of public service quality and
infrastructure required for the promotion of agricultural sector inputs. The reports and software are available on the
network website www.3inetwork.org.
I would like to sincerely thank the Oxford University Press who have continued to support us through these years
and have played a vital role in making these reports available all over the world at an affordable price.
I am sure that IIR 2004 will trigger much debate. IDFC is committed to thinking out of the box to make infrastructure
happen. We are constantly taking ideas and making them work on the ground. The effort will continue till such time
that every Indian citizen has access to the level of infrastructure services he/she deserves.
NASSER MUNJEE
ACKNOWLEDGEMENTS
About three years ago I had to drive between Indore and Mandu en route to Ahmedabad. A certain, perhaps 20 km
stretch of the road, was pressed in with truck tyre impressions so deep that the car could only move on the ridges
left by trucks, at a tilt of over 20 degrees to the horizontal! We learnt that the road had been freshly laid barely five
years ago. Why do even good roads built by the public works departments, get pitted in a monsoon that is a little
more intense than usual? Roads are experience goods and in the typical L1 procurement mode, quality is revealed only
with use, and limitations in governance in PWDs compound the weaknesses inherent in the process. Understanding
the forces behind these and umpteen other instances of state failure, besides market failure is crucial to any effort to
change the system and to improve policy and decision making. In writing the three IIRs, the contributors and editors
have had a wonderful opportunity to explore and understand the state and the markets, their weaknesses and strengths,
in the context of Indias infrastructure development. We are thankful to the IDFC for its support. As authors we also
thank Nasser Munjee for proposing the area of private finance and entrepreneurship for public infrastructure for our
consideration. Here lay the potential of consolidating the strengths of the state and the market to negate the weaknesses
of both and consequently promote infrastructure development in difficult areas.
The understanding built around the need for incentive compatibility in the design of policy and programmes, reveals
the hiatus between policy and its implementation to be a red herring. This understanding is perhaps the key contribution
of the various IIRs to public policy discussions in India. It is now no longer alien among policy-makers and we thank
the support provided by the IDFC to keep the 3iNetworks writing and research going. We are also grateful to the
many readers of the IIRs and especially those who have reverted with comments since feedback is an important element
of the debate on taking infrastructure forward in India. We do hope that they will continue to support the IIRs. The
response from practitioners to the invitation to write for this report was large although only a few could be accommodated.
We are indeed grateful to all those who expressed their interest.
Anupam Rastogi ensured that the communication between the editor, the authors and the publisher was always open
and the authors and I are grateful to him for this. I am also personally grateful to Partha Mukhopadhyay, Ajay Pandey
and Anupam Rastogi for shouldering the editorial tasks when I was unable to attend to them for personal reasons;
and to Anjali and Alice Morris for putting up with my irregular hours over the many months.
The many impromptu corridor discussions snatched between work, on the economy, society and related matters
had an important influence on the final structure and contents of the report. I am personally thankful to Ajay Pandey,
Jayanth Varma, Samir Barua, Partha Mukhopadyay, Biju Varkkey, G. Raghuram, Rekha Jain, and Dileep Mavlankar
in this context.
I am thankful to Anupam Rastogi and Gracinda Rodrigues for their impeccable organization of the Brain Storming
Session and the Writers Workshop, which had preceded the writing of this report. The discussions therein had a
determining impact on the content and the structure of the report. I am thankful to A. Balasubramanian, A.
Narayanamoorthy, A.K. Saxena, A.K.T. Chari, Abhas Kumar Jha, Ajay Narayanan, Ajay Pandey, Ajay Shankar, Ajit
Ranade, Akhil Pathak, Akhilesh Tilotia, Amita Shah, Anand Chiplunkar, Anil Chawla, Anish Nanavaty, Anupam Rastogi,
Anupam Srivastava, Archana Dholakia, Arun Agarwal, Ashima Goyal, Ashok Deo Bardhan, Ashvini Parashar, Atanu
Chakraborty, Athar Shahab, B.H. Jajoo, B.R. Marwah, Bernard DMello, Bhavin Kothari, Biju Varkkey, Bimal Giri,
Binayak Rath, Binoy Acharya, Biswatosh Saha, Cherian Thomas, Chetan Vaidya, D.K. Ghosh, Daljit Singh, Dheeraj
viii
Acknowledgements
Sanghi, Dileep Mavalankar, Dinesh Awasthi, E.A.S. Sarma, Errol DSouza, Farooq Sobhan, G. Raghuram, H.J. Bargstdt,
H.W. Alfen , Harsh Mander, Hidayathullah Baig, Hitesh Vaidya, Indira Hirway, Jagdish Sagar, Jahar Saha, Jayanth
R. Varma, Jayaraman, Jeemol Unni, Jerome Morris, Joel Ruet, K. Jayakishan, K.N. Ramganesh, Karen Priyadarshini,
Kavita Iyengar, Keshab Das, K.K. Gupta, Koshy Abraham, Laveesh Bhandari, M.H. Jowher, M.K. Iyer, M.S. Sriram,
Mahesh Vyas, Manju Ghodke, Manjunath Shankar, Mukesh P. Mathur, N. Venkiteswaran, Narendra Jhaveri, Nirmal
Mohanty, O.K. Balraj, P. Nair, P.S. Brar, Pakki Reddy, Partha Mukhopadhayay, Peeyush Bajpai, Piush Joshi, Pramod
Agrawal, Prem K. Kalra, Puneet Chitkara, R. Kulkarni, R. Mohankumar, R. Nagaraj, R.K. Mishra, R.K. Sharma, R.V.
Anuradha, Rajarshi Majumder, Rajeev Ahuja, Rajiv Shekhar, Rakesh Basant, Ramachandra Guha, Ramesh Gupta,
Ramesh Singhal, Ravikant Joshi, Rekha Jain, S. Parihar, S. Vasudevan, S. Manikutty, S. Suresh, S.C. Lee, S.P. Kashyap,
Sadashiv Rao, Samir K. Barua, Sanjay Agrawal, Sanjay Joshi, Sidharth Sinha, Soumya Kanti Ghosh, Soumen Bagchi,
Sudha Mahalingam, Sudip Chaudhuri, Sunil Sherlekar, Swapnil Pawar, T.C. Kalra, T.L. Sankar, Tapas K. Sen, Uddesh
Kohli, Usha Ramchandran, Vijay Modi, Vinod Kumar, Vipin Prakash Singh, Y.K. Alagh, Y.M. Shivamurthy, Yogesh
K. Bichpuriya, for their participation in the 3iNetwork as mentors, participants in the workshops, contributors, authors,
and as well wishers. My special thanks go to T.C.A. Anant and Subir Gokarn for having participated in the Writers
Workshop to comment on the papers presented therein.
I thank Bakul Dholakia for personally encouraging me and the team from IIMA, and for his concern in the success
of the effort. I also thank B.H. Jajoo, T. Madhavan, Rama Rao, Rita Rama Rao, (late) Ashok Jambhekar, Pranav Kansara,
Pradeep Nair and Syam Prasad for their support especially in ensuring ship-shape facilities here at IIMA upon which
we have been so crucially dependent. IIMAs role in the report is much larger than is reflected in the number of
contributors from there. Our MBA and doctoral students especially from the Infrastructure Development and Financing
course, as also our MDP participants of the course on Infrastructure Development and Financing have sharpened my
own understanding of the problem of infrastructure development through their questions and discussions.
To my secretary, Urmil Anjaria goes a special thanks for entering the many rounds of corrections to the text at odd
hours uncomplainingly. N. Sridhar and Bhavin Kothari helped me with the data. Gracinda Rodrigues worked tirelessly
from the IDFC end tying up so many loose ends.
The editors at Oxford University Press again went far beyond their roles to put the report together. I owe them
my thanks and congratulations for making up for the delays that occurred at my end.
SEBASTIAN MORRIS
CONTENTS
List of Tables
List of Boxes and Figures
List of Abbreviations and Acronyms
1.
xv
xix
xxi
OVERVIEW
Sebastian Morris
The Challenge of Public Services and PFIs 6 Roads, Tolls, Annuities, and Markets 9 Other
PFIs 11 Sanitation and PFIs 13 Challenges for DFIs Today 14 Municipal Finance and
Developments 15 Developments in Electricity 15 Regulation in Electricty 17 Strategy in Oil and
Natural Gas 18 Telecom and ADC 19 Water, PFIs, and Conservation 19 Conclusion 20
References 21
2.
THE INFRASTRUCTURE SECTOR

Anupam Rastogi
IN INDIA,
20023
22
Electricity 23 Oil and Gas 30 Telecom and Information Technology 34 Transport Sector 40 Urban
Infrastructure 46 Rural Infrastructure 47 Conclusion 50
References 52
3.
IN THE NAME OF THE POOR: WHAT ROLE

Partha Mukhopadhyay
FOR
PFI?
53
A Quick Recapitulation 53 There is Enough Money 56 The Core Consumption Basket 57 Two
Rupees a Day is a Lot! 60 Is This Situation Not Tailor-made for PFI? 61 The Way Forward? 61
Availability is Not Access 65 Conclusion 66
References 69
4.
ENTERPRISE PRIVATIZATION
4.1
The Disinvestment Story 71

Samir K. Barua
The Judgement Day and After 71 Pride of a Nation Comes a Cropper 72 The Early Days
72 The First Two Rounds 73 Scepticism Sets In 73 The First Five Years: Missed Opportunity
75 The Next Three Years: Compulsions of Coalition Politics 75 The Latest Four Years: Take
the Bull by the Horn 77 Conclusion 77
4.2
Privatization Today: A Discussion 78

Sebastian Morris
Moral Hazard in Micromanaging Privatization 79 Link With Macro-policies 80 A Complex
71
Contents
and Strategic Task 82 Monopoly and Policy Dimensions 83 Legal Tangles and Pitfalls are Many
85 The Way Forward 85
4.3
The Politics of Disinvestment and Insider Trading 88

Samir K. Barua
4.4
Performance and Market Evaluation of the Public Sector Today 89

Sebastian Morris
Institutional and Structural Basis of Poor Performance 90 Some Empirical Basis 92 Market
Performance 95 Conclusion 97
References 99
5.
PUBLICPRIVATE PARTNERSHIPS TODAY

5.1
101
The Draft Infrastructure Policy of Karnataka for PublicPrivate Partnership 101

S. Vasudevan
Definition and Objectives 101 Fair Regulatory Framework 102 Enabling Institutional
Infrastructure 102 Sustainable Incentives: Fiscal Measures 103
5.2
Real Estate Industry: Creating Value through PublicPrivate Partnerships 103

Ashok Deo Bardhan and Samir K. Barua
Legal Reforms 104 Institutional and Market Reform 106 Mortgage Insurance 110 Information
and Research 112 Affordable Housing Programme 112 Summing Up 112
5.3
A PPP Framework in Education 114

Sanjay Agrawal
Projects in the Education Sector 114 Standards Measuring Level of Educational Performance
115 Payment Mechanisms 115
5.4
PPP Frameworks for Tourism Infrastructure: Using the ROMT Concession 115
Ashvini Parashar and Cherian Thomas
The ROMT Option 116 Development Process 116 Selection of the Private Investor 116
Results 117
References 118
6.
FINANCIAL AND LEGAL PERSPECTIVES

6.1
Development Financial Institutions and the Development of Financial Markets 120

Jayanth R. Varma
DFIs in a Liberalized Financial Sector 120 Alternative Strategies for Existing DFIs 122
Management and Governance of New DFIs 127
6.2
Creating Local Financing Systems for Infrastructure in India 128

Abhas Kumar Jha
Some Initiatives 129 Support and Credit Enhancements 130 The Issues Ahead 131
6.3
Reforming Property Tax in Patna Municipal Corporation: A Critical Analysis 134

Mukesh P. Mathur
Property Tax Reforms in Patna 136 Financial Implications of Property Tax Reforms in Patna
137 Conclusion 138
6.4
Accessing Capital Markets by Urban Local Bodies in India: An Assessment of

Municipal Bonds 139
Manju Ghodke
The Funds Gap and the Capital Market in India 140 Municipal Credit Markets in Developing
120
Contents
xi
Countries 140 History of Municipal Bonds in India 141 Developing the Market for Municipal
Paper 145 Conclusion 149
References 149
7.
REFORMS IN ELECTRICITY
7.1
152
Tariff Policy in the Electricity Sector: A Review 152

Ajay Pandey
Generation Tariffs: Existing Regulations 152 Proposals for Generation 154 Transmission Tariffs:
Existing Regulations 157 Proposals for Transmission 157 Distribution Tariffs: Existing
Regulations 158 Distribution Proposals 158 Conclusion 159
7.2
Financial Closure for Reforms 160

Uddesh Kohli
Conclusion 162
7.3
Why and When Do State Governments Reform: The Case Experiments in Electricity
in Delhi 162
Jagdish Sagar
The DVB 163 Losses Do Not Create Pressure for Change 163 Budgetary Costs of Not
Reforming 166 Non-budgetary Costs of Not Reforming 169 Non-budgetary Costs of Reforming
169 The Reform Package 170 Conclusion 172
7.4
Improving the Performance of the Distribution Sector: An Evaluation of Two

Approaches 174
Daljit Singh and Sidharth Sinha
Andhra Pradesh 174 Delhi BSES Companies 176 DelhiThe North Delhi Power Limited
(NDPL) 177 Progress in Andhra Pradesh 177 Analysis and ConclusionsAndhra Pradesh
181 PerformanceDelhi 182 Analyses and ConclusionsDelhi 183
7.5
The Beginnings of Distribution Reforms in West Madhya Pradesh: A Report 184

Ajay Pandey and Sebastian Morris
Action in Burhanpur City Division 185 Organizational Changes 187 Indore City Circle 189
Lessons 193 Hardening Budgets Should Bite Organizationally 195
References 197
8.
TECHNOLOGY AND REGULATION IN ELECTRICITY

8.1
Approaches to Transmission Pricing: A Discussion 198

P.K. Kalra, A.K. Saxena, T.C. Kalra, Yogesh K. Bichpuriya, Vipin Prakash Singh
Case Study 199 Conclusion 204
8.2
Benchmarking O&M Costs and Operating Parameters of Coal-based Thermal Power

Plants In a Near Cost Plus Regime 204
Rajiv Shekhar and Prem K. Kalra
Operation & Maintenance 205 Station Heat Rate 206 Specific Secondary Fuel Oil Consumption
206 Auxiliary Energy Consumption 207 Some Incentive Issues 207 Conclusion 208
8.3
Management of Power Supply to Agriculture 208

Sidharth Sinha
Impact on State Elecricity Boards 208 Regulating Power Supply to Agriculture 211
Recommendations for Reform of Power Supply to Agriculture 213 Conclusion 214
References 216
198
xii
9.
Contents
OIL
9.1
AND
NATURAL GAS
218
Indias Energy Security: The Strategic Versus Economic Dimensions 218

Sudha Mahalingam
Availability Risks 221 Energy Security Options for India 223 Strategic Petroleum Reserve
225 Conclusion 225
9.2
Backward and Forward Integration for Indian Oil Majors: A Discussion 226
K.N. Ramganesh and Swapnil Pawar
The Indian Petroleum Industry 226 Crude and Oil Product Prices 228 Evaluation of Standalone Refineries 230 The Estimation of Cost of Capital 231 Profitability of Various Segments
of the Oil Value Chain 232 Implications for India 234 Conclusion 235
9.3
The Petroleum Regulatory Bill, 2002: A Review 235

Samir K. Barua
9.4
Tariff Setting in Gas TransmissionA View of Methodologies 236

Atanu Chakraborty
Regulation Today 236 Conclusion 238
References 238
10.
A REVIEW OF TELECOM REGULATORY AUTHORITY OF INDIAS TARIFF AND

INTERCONNECTION REGULATION
Rekha Jain
239
Prior Events 239 The Third Phase of Interconnection Regulation 241 The Issues and an Evaluation
244 Conclusions 247
Annexes 248
References 251
11.
TRANSPORTATION
11.1 Value for Money in Toll Roads: Lessons from Recent Road Projects 252
G. Raghuram
Leveraging the Economic Value of Roads 252 Issues in Project Structuring 254 Risk Assesment
and Mitigation 254 Processes 257 Conclusions 258
11.2 Implementing a Rural Roads Project in Madhya Pradesh 258

Pramod Agrawal and Arun Agrawal
PMGSY in Madhya Pradesh 259 Structure of MPRRDA 259 Project Implementation 259
Execution of Works 260 Need for a New Organization? 262 The Changes 263
Conclusion 265
11.3 Use of Dedicated Road Funds for PPP Projects: The Case of the Kerala Road Fund 265
Hidayathullah Baig and K. Jayakishan
Roads and the Government 266 The Kerala Road Fund 266 Conclusion 268
11.4 Development of Urban Roads Using Annuity PaymentsIssues and Possibilities 268
Annuity Approach 269 Contemporary Practices and Benefits of Annuity 269 Issues 269
11.5 A Faster Road on the Periphery of a City Sprawl Can Have Immense Value 270
Swapnil Pawar and Akhilesh Tilotia
Roads as Commercial Assets 270 The Basic Model 270 Changes Due to the Fast Road from
Periphery 271 Calculation of Value Addition 271 Application to Real Life Case of a City
272 Conclusions 272
252
Contents
xiii
11.6 Traffic Risk ManagementDerivatives in the Transport Sector 273

Akhilesh Tilotia and Swapnil Pawar
The Problem 273 Alternative 1: Intra-private Players Risk 274 Alternative 2: Financial
Intermediary 274 The Derivatives Market 275 Expected Players and the Potential 276
Issues 277
References 278
12.
WATER
279
12.1 Getting Water from PublicPrivate Partnerships 279

Ashima Goyal
Experience with Water Contracts in Other Countries 279 Improving Water Supply 283
Conclusion 289
12.2 Results of an NSSO Survey of Urban Water Access: Implications for Policy 290
Peeyush Bajpai and Laveesh Bhandari
Principal Sources of Water 291 Economic Status and Ability to Pay 292 Policy Implications
294 Views on Contribution 295 Conclusion 295
12.3 More Crop per Drop: Financial Viability of Drip Irrigation 296
A. Narayanamoorthy
Coverage of Drip Irrigation in India 296 A Field View of Drip Irrigation 297 Economic
Viability of Drip Irrigation 300 Policy Implications 302
12.4 Water in Urban India: The Scenario, Energy Linkage, and Private Participation 303
Jol Ruet
The Water Scenario: Limits of the Public, Limits of the Private 303 Water and Pollution
Abatement 306 Water and Energy: Creating Value Through Decentralized Systems and Decentralized
Management 307 Private Management in Water 310 Conclusion 311
References 311
13.
SANITATION AND PANCHAYATS IN INFRASTRUCTURE
314
13.1 Sanitation and Water Supply: The Forgotten Infrastructure 314

Dileep Mavalankar and Manjunath Shankar
Benefits of Sanitation and Water Supply 314 Current Status of Sanitation and Water Supply
in India 316 The Neglect 318 Conclusions 321
13.2 Total Sanitation Campaign: Changing the Face of Rural Burdwan 325
Rajarshi Majumder
The Campaign 325 Impact of the TSC 326
13.3 Rural Infrastructure and the Panchayats: A Report from West Bengal 327
Dilip Kumar Ghosh
Nadia District 327 Conclusion 334
References 335
14.
THE URBAN SITUATION

14.1 Recent Financial Initiatives Among Urban Local Bodies: A Report 336
Chetan Vaidya and Hitesh Vaidya
Financial Initiatives 336 Conclusion 339
14.2 Municipal Governance: Standard Forms for Performance Reporting 339

Ravikant Joshi
336
xiv
Contents
The Canadian Municipal Performance Measurement Programme 339 Urban Services
Environmental Rating System (Users) 339 UIPMP of City Managers AssociationGujarat 341
Remarks 342
14.3 Value for Money and Municipal Accounting Reforms 343

Ravikant Joshi
Municipal Accounting Reforms in India 343 Future Plans 346 The Unfinished Agenda 346
Conclusion 347
References 347
TABLES
2.1
2.2
2.3
2.4
3.1
3.2
4.1.1
4.1.2
4.1.3
4.1.4
4.1.5
4.1.6
4.1.7
4.2.1
4.2.2
4.2.3
4.3.1
4.4.1
4.4.2
4.4.3
4.4.4
4.4.5
4.4.6
4.4.7
5.4.1
6.3.1
6.3.2
6.3.3
6.3.4
6.3.5
6.4.1
6.4.2
6.4.3
7.3.1
7.3.2
7.3.3
APDRP Funds Utilization 20023

Golden Quadrilateral Completion Schedule of On-going Contracts (as on 31 May 2003)
Distribution of BOT, Under Implementation as Part of the Golden Quadrilateral Projects (as on 31 May
2003)
Progress of PMGSY Scheme (August 2003)
Drinking Water Source Says a Lot about Electricity and Latrines
What Would it Cost the Poor to Buy the Core Consumption Basket? (Rs Cr)
Value Assessment by the Two Bidders
Record of Disinvestment: 19912 to 19956
Budgetary Support: 19912 to 19956
Total Investment in Central PSUs at Gross Book Value and the Inflation Adjusted (at 8% Per annum
Average) of the Same
The Matrix of Asymmetric Risks and Costs of Capital in Privatization
Summary of Disinvestment Related Court Cases (as on 31.11.2002)
Top Five Excess Return Days and Associated Information
Performance of State-Owned Enterprise in India in the 1990s: A Schematic Representation
Results of Regression of Market Capitalization of Public Enterprise Firms on Shareholdings by Types of
Shareholders
Results of Regression of Market Capitalization of All Firms on Shareholdings by Types of Shareholders
Results of Regression of Market Capitalization of All Firms on Ownership Dummies
Results of Regression of Market Capitalization on Book Value and Certain Ownership Dummy Variables
Results of Regression of Squared Difference of High and Low Stock Prices Over the Year Ending 21 July
2003 on Certain Ownership Dummies
Results of Regression of Squared Difference of High and Low Market Price over the Year Ending 21 July
2003 on Certain Ownership Related Variables
Summary of Outcomes PortROMT Concessions in Tourism
Property Tax Receipts in Selected Cities, 19992000
New Property Tax Assessment System of Patna Municipal Corporation
Property Tax in the PMC Finances
PT Collection Efficiency in PMC
PT Collection Efficiency in the Selected Cities, 19992000
Structered Products from ULBs
Private Placement of the TNUDF Pooled Financing Bond Issue
Coupon Rates on Municipal Bonds
Commercial Performance of DESU/DVB
Cost to Government of Delhi under Various Alternatives
Power Sector Expenditure and Shares in Delhis Total Plan Expenditure
26
40
41
50
59
60
73
75
75
76
76
77
77
79
82
84
89
92
93
95
95
96
96
97
118
135
136
137
138
138
144
145
148
164
165
167
xvi List of Tables

7.3.4
7.3.5
7.3.6
7.4.1
7.4.2
7.4.3
7.4.4
7.4.5
7.4.6
7.4.7
7.4.8
7.4.9
7.4.10
7.4.11
7.5.1
7.5.2
7.5.3
7.5.4
7.5.5
7.5.6
7.5.7
8.1.1
8.1.2
8.1.3
8.1.4
8.1.5a
8.1.5b
8.3.1
9.1.1
9.2.1
9.2.2
9.2.3
9.2.4
9.2.5
9.2.6
9.2.7
9.2.8
11.1.1
11.1.2
11.2.1
11.2.2
11.2.3
11.2.4
11.4.1
12.2.1
12.2.2
12.2.3
12.2.4
12.2.5
12.2.6
12.2.7
12.2.8
12.2.9
12.2.10
12.2.11
12.2.12
12.3.1
12.3.2
Summary of DVB Accounts (Unaudited) 20001 and 20012

Accumulated Liabilities of DESU/DVB (March 2001)
Payments made by DESU/DVB; Power Purchased and the Payment per cent
Investments Made by AP Distcoms (Rs crore)
Improvements in Metering by AP Distcoms
Metered Sales
Loss Reductions and Revenue Increases by AP Distcoms
Efficiency Improvements by District for APCPDCL
T&D Losses and Sales to Agriculture
33 kV Interruptions in the Service Territories of AP Distcoms
Financial Performance During the Reform Period
Revenue Rs Per Unit Sold
Investments Made by Delhi Distcoms
AT&C Loss Reductions by Delhi Distcoms
Progress of Installation of Electronic Meters in Burhanpur City Division
Line (T&D) Losses in Burhanpur City Division
Increase in Revenue Demand in Burhanpur and Payment by Consumers
Change in Consumers Across Consumption Slab in Burhanpur
Theft and Recovery Efforts by Indore City Circle
T&D Losses in Indore City Circle
Revenue Demand of and Collections by Indore City Circle
Data Specification Required for MW-mile Method
Data Needed from Transmission Company FY: 20012
Data Needed from Disco (NPCL and KESCO) FY: 2002
Asset Value of Lines for Various Voltage Classes (KV)
Results for Postage Stamp Method (FY: 20012)
Results for MW-Mile Method (Year and Month: March 2002)
Summary of Estimates of Agricultural Consumption
ONGCs Improved Oil Recovery (IOR) Projects Worth More than Rs 100 crore
Autocorrelation by Lagging Prices of Crude
Daily Prices of Brent Crude and Primary Distillates of Crude
Will Free Market Approach Reflect Changes in Crude Prices?
Investment Requirement for Indian Refinery
Cash Margin of Refineries
Average Beta of Stand-Alone Refineries in USA
Variation in Profitability of the Four Major Oil Segments
Input/Output Fluctuations in Margins
Comparison of Risk Realization and Impact in Six BOT Road Projects
Overview of NHDP and PMGSY
Inspections by National Quality Monitors (October 2003 to March 2003)
Cost Analysis for the Year 2002
Comparison: PWD and MPRRDA
Summary of Tendering for Phase III
Advantages of the Annuity Approach
Main Sources of Water
Right of Use of Water
Right of Use of Tap Water
Distance from Principal Source of Drinking Water: All Urban Households
Distance from Principal Source of Drinking Water: Households with Taps
Distribution of Households across Right to Use and Distance from Source: Households with Taps (millions)
Distribution of Households across Towns and Requirement for Water Infrastructure Improvement (%)
Step 1Rating Each Household for Each Category
Step 2Final Rating for each Household
Economic Status and Phone Ownership
Urban Households and Water Supply: Economic Capability and Requirement
Willingness to Contribute for Improvements in Sanitation in Neighbourhood
Coverage of Drip Method of Irrigation by States
Cropwise Area under Drip Method of Irrigation in India: 19978
167
168
168
178
178
178
179
179
179
180
180
181
182
183
186
188
188
189
192
193
193
199
203
203
204
204
204
211
224
229
229
230
230
231
232
233
233
255
257
261
263
263
264
270
291
291
291
292
292
292
293
293
293
293
294
295
297
297
List of Tables xvii

12.3.3
12.3.4
12.3.5
12.3.6
12.3.7
12.4.1
12.4.2
12.4.3
12.4.4
12.4.5
12.4.6
12.4.7
12.4.8
12.4.9
12.4.10
13.1.1
13.1.2
13.1.3
13.1.4
13.1.5
13.1.6
13.1.7
13.2.1
13.2.2
13.3.1
13.3.2
13.3.3
13.3.4
13.3.5
13.3.6
13.3.7
13.3.8
13.3.9
13.3.10
13.3.11
14.1.1
14.2.1
Cost of Cultivation for the Adopters and the Non-Adopters of Drip Irrigation (Rs/ha)
Water Use Pattern and Consumption by Drip and Flood Irrigated Crops
Productivity of Drip and non-Drip Irrigated Crops
Input and Output Pattern of Drip and Flood Irrigated Crops
Net Present Worth and Benefit Cost Ratio of Drip Irrigated Crops
Urban Population and Share of the Urban Sector in GDP
Access to Water Supply in Urban Areas (Status as on 1997)
Water Availability in Class I Cities (1988)
Service and Efficiency Indicators for the Major Metropolitan Cities
Value of Water for Different Economic Activities
Revised Estimates for the Expenditures of Chennai Metrowater Board (Rs in crores)
Regional Variations in the Urban Water Markets in Ahmedabad
Costs of Domestic Wastewater Treatment
Break-up of Minimum Domestic Water Supply Standard
Tariffs and Costs in Three Class I Cities
Number of Cases and Deaths Reported and Estimated Due to Select Diseases Caused by Poor Water
Supply and Sanitation (2002)
Time Gains by Improved Access to Water and Sanitation in Sub-regions: African Region (AFR-D)
and Eastern Mediterranean Region (EMR-D) with High Child and High Adult Mortality
Percentage of Population of Select Countries having Access to Improved Water Supply and Sanitation
Percentage Distribution of Households by Principal Source of Drinking Water during 1988, 1993, and
1998 (GOI 1999)
Percentage of Households not having Latrine as per National Sample Survey of 1998
Comparative Data on Sewerage Systems in Major Cities of India (c. 2002)
Annual Budgetary Allocation of Central Government under Various Heads for Select Years
Progress of Total Sanitation Campaign in Burdwan District
Progress of School Sanitation Programme in Burdwan District
Share of the Panchayats in Surfaced and Unsurfaced Roads in Districts
Rural Electrification in West Bengal
Formation of Sanitary Marts and Household Coverage
Rural Households with Latrine Facilities
Shares of Development Expenditure in Total Expenditure of Gram Panchayats
Share of Own Revenue as Percentage of Total Expenditure
Attendance in Gram Sansad Meetings
FemaleMale Ratio (FMR) of Attendance in Gram Sansad Meetings
Receipt and Expenditure in Different Programmes: Karimpur I PS (figures in Rs lakh)
Receipt and Expenditure in Different Programmes: Karimpur II PS (figures in Rs lakh)
Expenditure on Maintenance of Roads and its Share in Total Expenditure (figures in Rs lakhs)
Details of Bonds Issued by ULBs
Performance Indicators in USERS for Water Supply
299
299
300
301
302
303
304
304
304
305
305
306
307
308
310
315
316
316
317
317
318
319
326
326
329
330
330
330
331
331
332
332
333
334
334
337
341
BOXES AND FIGURES
BOXES
1.1
1.2
1.3
1.4
2.1
2.2
3.1
3.2
3.3
3.4
3.5
3.6
4.2.1
4.4.1
5.2.1
5.2.2
6.2.1
6.6.2
6.3.1
6.4.1
7.1.1
7.5.1
7.5.2
8.1.1
8.3.1
9.1.1
9.1.2
9.2.1
10.1
11.1.1
11.2.2
12.1.1
12.1.2
12.1.3
12.1.4
12.1.5
12.1.6
The Ramp Up of the Private Sector Under the Inefficiencies of the Public Sector
GQ, Rainfall, and Exports Drive Growth in India
State Failure in Privatization
Economic Coordination Matrix in Society
Structuring of APDRP, Reform Framework, and Principles of Financial Restructuring of SEBs (First Part
of Deepak Parekh Committee Report)
CDMA Technology
(E)Erie Reflection of the Taj
Contingent Financing and Infrastructure Spending
Networks, Vouchers, and Self-Supply
A Framework for Village Electrification
Increasing Awareness in an Outcome-Oriented Manner
The Road to Reducing Poverty
The Challenge of Privatizing State Road Transport Undertakings (SRTUs)
Public Enterprise and Privatization in History
Value Creation by Housing and Real Estate
Private Land Development in Lucknow
Best Practices with Significant Rating Value for Fitch
Worst Practices with Significant Rating Concern for Fitch
Comparison of New and Old Systems of Property Tax Assessment in Patna
Bank Loans: The Conceptual Basis and Implications
Is Merit Order Being Violated Today?
Why is the Mess in the Electricity Sector Likely to Continue?
MPSEB and MPPKVVC and the Background for Reforms
Transmission Pricing
Background to Flat Rate Unmetered Supply
Indias Energy Choices: A Synoptic View
Dictatorship and Western Oil Interests
The International Oil Industry Briefly
Tariff and Interconnection Regulation (The Earlier Phases)
Roads Today
Salient Features of the NHDP
Contract Theory and Water Supply
Water Supply in Mumbai
Examples of Partial Privatizations
Two-Part Tariffs and Benefits for the Poor
Willingness to Pay and Distribution between Fixed and Volume Charge
Examples of Community Initiatives
2
4
5
8
25
36
55
56
63
64
67
68
87
97
105
107
131
132
137
142
153
190
194
200
209
219
222
227
240
253
255
280
284
285
286
289
289
xx
List of Boxes and Figures
12.4.1
12.4.2
13.1.1
13.1.2
13.1.3
13.3.1
13.3.2
14.2.1
14.2.2
A Benchmark: The Costs of Removing Pollution in Europe

Proposed Institutional Evolutions for Chennai
Gender and Sanitation
Why Isnt Sanitation Happening?
Innovations in Sanitation
Village Infrastructure in West Bengal: An Overview
Programmes in Infrastructure Development
The Performance Measurement Indicators of Canadian MPMP
PMI of CMAGs UIPMP
307
309
315
319
322
328
329
340
342
Subscriber Growth of Wireline and Wireless Telephony and Teledensity

A Framework of Village Electrification
From Market Failure to Market Provision
DVB Financial Restructuring
AT&C Loss ReductionNDPL
Difference Between Crude Oil Price and Final Product Price (US$/barrel)
Operating Income as a Percentage of Net Property, Plant, and Equipment, 198795
Category-wise Road Length (1999)
Transport Myopia
Organization Structure of MPRRDA
The Comparison of Growth with and without Fast Road
Strategy Chart for Various Categories
Moisture Availability for Crops in Different Irrigation Methods
Rate of Improvement of Sanitation in Rural India
36
65
66
171
183
229
231
256
257
260
271
294
300
318
Monthly Rentals for Different Subscriber Categories (TTO 1999) (Rs)

STD Call Charge for Fixed to Fixed Calls (Call duration of 1 minute and pulse charge Rs 1.20 per
metered call)
Monthly Rentals for Rural and Urban Subscribers (Rs)
Profit and Loss Account for the year ended 31 March 2002 (Rs 000s)
Calculations of CAPEX, Depreciation and OPEX Components per DEL based BSNL Cost Data for
Year 20012
Apportionment of CAPEX + Depreciation and OPEX to Different Network Elements Based on Audited
accounts of BSNL for the Year 20012 based on the Mean Capital Employed by BSNL as given in
Schedule 5 of RIO by BSNL
Access Deficit Estimation
Illustrative IUC Charges and Prevailing Tariff for Different Type of Calls
Examples of Problems with the BSNL Annual Report Data
Relevant Excerpts from the USO Consultation Paper
248
FIGURES
2.1
3.1
3.2
7.3.1
7.4.1
9.2.1
9.2.2
11.1.1
11.1.2
11.2.1
11.5.1
12.1.1
12.3.1
13.1.1
ANNEXES
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
248
248
249
249
250
250
250
251
251
ABBREVIATIONS AND ACRONYMS
AAI
ABT
ABTO
ADC
AFC
AG&SY
AGR
AIMTC
ALM
AMC
AMR
APCPDCL
APDRP
APEPDCL
APERC
AP-IDEA
APIIC
APM
APNPDCL
APTRANSCO
AREP
ARPU
ARV
ATC
ATF
BADP
BATF
BMC
BMLPA
BMP
BNDES
BNG
BPCL
BPE
BPL
BRAC
BSNL
Airports Authority of India

Availability Based Tariff
Association of Basic Telecom Operators
Access Deficit Charge
Agricultural Finance Corporation
Accelerated Generation and Supply Programme
adjusted gross revenue
All India Motor Transport Congress
Advanced Locality Management
Ahmedabad Municipal Corporation
automatic meter reading
Andhra Pradesh Central Power Distribution Company Limited
Accelerated Power Development and Reforms Programme
Andhra Pradesh Eastern Power Distribution Company Ltd
Andhra Pradesh Electricity Regulatory Commission
AP Infrastructure Enabling Act, 2001
Andhra Pradesh Industrial Infrastructure Corporation Limited
Administered Price Mechanism
Andhra Pradesh Northern Power Distribution Company Ltd
Andhra Pradesh Transmission Company
Accelerated Rural Electrification Programme
average revenue per unit
annual ratable value
aggregate technical and commercial losses
aviation turbine fuel
Border Area Development Programme
Bangalore Agenda Task Force
Brihanmumbai Municipal Corporation
Mrihan Mumbai Licensed Plumbers Association
Bangalore Mahanagara Palike
Banco Nacional de Desenvolvimento Economico e Social
Bank of Netherlands
Bharat Petroleum Corporation Limited
Bureau of Public Enterprise
below poverty line
Bangladesh Rural Advancement Committee
Bharat Sanchar Nigam Limited
xxii Abbreviations and Acronyms

BSO
BWSA
CA
CAC
CAPEX
CAT
CBO
CCD
CCEA
CCF
CCT
CDMA
CERC
CIDA
CIDCO
CIRIA
CMA-G
CMDA
CMIE
CMWSSB
CNPC
COAI
corDECT
CPBTL
CPC
CPSU
CRF
CUTS
CVIP
DALYs
DCA
DCA
DEL
DERC
DFI
DFIBR
DFID
DINT
DISCOMS
DMI
DMRC
DOE
DOT
DPE
DPSC
DSRF
DTL
DTP
DTS
DWCUA
EA2003
EAS
Basic Service Operator

bulk water sales agreement
Concession Agreement
Carrier Access Code
capital expenditure
Consumer Analysis Tool
community based organisation
Cabinet Committee on Disinvestment
Cabinet Committee on Economic Affairs
City Challenge Fund
Chennai Container Terminal
Code Division Multiple Access
Central Electricity Regulatory Commission
Canadian International Development Agency
City and Industrial Development Corporation of Maharashtra
Construction Industry research Information Association
City Managers Association Gujarat
Calcutta Metropolitan Development Authority
Centre for Monitoring Indian Economy
Chennai Metropolitan Water Supply and Sewerage Board
China National Petroleum Corporation
Cellular Operators Association of India
registered DECT of T-net Corporation, Chennai
cash profits/total liabilities
central power corporation
central public sector undertaking
Central Road Fund
Consumer Unity Trust Society
commercially viable infrastructure projects
Disability Adjusted Life Years
Department of Company Affairs
Development Credit Authority
direct exchange lines
Delhi Electricity Regulatory Commission
development financial institutions
detailed feasibility and investment banking report
Department for International Development
decentralized infrastructure and new technologies
distribution companies
drip method of irrigation
Delhi Metro Rail Corporation
Department of Energy (of the US Government)
Department of Telecommunications
Department of Public Enterprise
delayed payment surcharge component
debt service reserve fund
Delhi Transco Ltd
Draft Tariff Policy (on electricity pricing put out by the MoP)
Department of Telecom Services
Development of Women and Children in Urban Areas
Electricity Act 2003
Employment Assurance Scheme
Abbreviations and Acronyms xxiii

ECC
EDC
EIA
EPC
EPRM
ERC
ERP
ESAR
ESI
ESMAP
EVA
FBI
FERA
FHLMC
FINDETER
FIRE
FMI
FNMA
FOOD
FSI
GAIL
GC
GCC
GD
GDN
GFA
GFI
GMAP
GNCTD
GoAP
GPPL
GPRS
GQ
GSEs
GSM
GTA
GWSSB
HBJ
HFCL
HMRDC
HPCL
HT
HUDCO
HVDS
HVPN
IA
IBJ
IBP
IBT
ICT
IDA
IDC
Engineering Construction Company

external development charges
Energy Information Agency (of the US Government, DOE)
engineering, procurement, construction
Energy Power and Risk Management (Journal)
Electricity Regulatory Commission
European Union Road Federation
Environment and Social Assessment Reprt
Environment Sanitation Institute
Energy Sector Management Assistance Programme
Economic Value Added
farm business income
Foreign Exchange Regulation Act
Federal Home Loan Mortgage Corporation
Financiera de Desarrollo Teritorial, S.A.
Financial Institutions Reform and Expansion
Flood method of irrigation
Federal National Mortgage Association
Foundation of Occupatonal Development
floor space index
Gas Authority of India Limited
Golden Cross
Gulf Cooperation Council
Golden Quadrilateral
global development network
gross fixed assets
General Framework for Interconnection
Gujarat Mundra Adani Port
Government of the National Capital Territory of Delhi
Government of Andhra Pradesh
Gujarat Pipavav Port Ltd
General Packet Radio Service
Golden Quadrilateral
government sponsored enterprises
Group Special Mobile
Gas Transmission Agreement
Gujarat Water Supply and Sewerage Board
Hazira, Bijapur, Jagdishpur (pipeline)
Hindustan Futuristic Communication Ltd
Hassan Mangalore Rail Development Company
Hindustan Petroleum Corporation Limited
high tension (electric voltage and lines)
Housing and Urban Development Corporation Limited
high voltage distribution system
Haryana Vidyut Prasaran Nigam
independent auditor
Industrial Bank of Japan
Indo Burma Petroleum Ltd
increasing block tariff
Information and Communication Technology
international development agency
Inter-Departmental Committee
xxiv
Abbreviations and Acronyms
IDD
iDeCK
IE
IEEJ
IFC
IFCI
IGCC
IL&FS
INCID
IOC
IOR
IPCL
IPO
IPP
IR
IRC
IRDP
ITDC
ITP
IUC
JGSY
JNPT
JRY
KDB
KESCO
KfW
KG
KPTCL
K-Ride
LALF
LDA
LGBs
LGLA
LM
lpcd
LPG
LRMC
LTCB
LTOs
MAHB
MAVs
MBS
MCL
MEA
MERC
MGT
MHRDC
MLD
MMRDA
MMS
MMTS
MNP
Infrastructure Development Department

Infrastructure Development Company (Karnataka) Ltd
independent engineer
Institute of Electrical Engineers Japan
International Finance Corporation
Industrial Finance Corporation of India Ltd
integrated coal gasification and combined cycle
Industrial Leasing and Financial Services
Indian National Committee on Irrigation and Drainage
Indian Oil Corporation Limited
Improved Oil Recovery
Indian Petrochemicals Corporation Limited
Initial Public Offer
Independent Power Producer
Indian Railways
Indian Roads Congress
Integrated Rural Development Programme
India Tourism Development Corporation
Information Technology Parks
Interconnect Usage Charge
Jawahar Gram Samriddhi Yojana
Jawaharlal Nehru Port Trust
Jawahar Rozgar Yojana
Korea Development Bank
Kanpur Electricity Supply Company
Kreditstalt fur Wiederaufbau
Krishna Godavari (basin)
Karnataka Power Transmission Corporation Limited
Karnataka Railway Infrastructure Development Company
Local Authorities Loan Fund
Lucknow Development Authority
local government bodies
Local Government Loan Authority
limited mobility
litres per capita per day
liquified petroleum gas
long run marginal cost
Long Term Credit Bank of Japan
long term options
GMR Malaysia Berhad
multi axle vehicles
mortgage backed securities
Municipal Corporation of Ludhiana
Mumbai water engineers association
Maharastra Electricty Regulatory Commission
Minimum Guaranteed Throughput
Maharashtra Highway Road Development Corporation
million litres per day
Mumbai Metropolitan Regional Development Authority
Multimedia Messaging
multi-modal transport system
Minimum Needs Programme

MoDI
MODVAT
MPLADS
MPMP
MPPKVVC
MPRRDA
MPSEB
MRMP
MSA
MSEB
MSRDC
MTC
MUFIS
MUTP
mva
mvarh
mw
NAV
NDPL
NEEPCO
NEERI
NELP
NESCL
NHDP
NHPC
NIPFP
NLC
NLD
NLEP
NOC
NPA
NPCL
NPT
NRRDA
NRVY
NSICT
NTP
NTPC
NVVNL
O&M
OCC
OECD
OIL
OMS
OMT
OPEC
OPEX
P&O
PAT
PBIT
PBT
PFC
Ministry of Disinvestment
modified value added tax
Member of Parliament Local Area Development Scheme
municipal performance measurement program
Madhya Pradesh Paschim KshetraVidyut Vitran Company Limited
Madhya Pradesh Rural Roads Development Agency
Madhya Pradesh State Electricity Board
municipal performance measurement program
million standard axles
Maharastra State Electricity Board
Maharashtra State Road Development Corporation
mobile termination charge
Municipal Infrastructure Financing Company
Mumbai Urban Transport Project
mega volt ampere
megavolt ampere hour
Megawatt
net asset value
North Delhi Power Ltd
North Eastern Electric Power Corporation
National Environment Engineering Research Institute
New Exploration and Licensing Policy
NTPC Electric Supply Company Ltd
National Highway Development Programme
National Hydro Electric Power Corporation
National Institute of Public Finance and Policy
Neyveli Lignite Corporation
national long distance
New Exploration Licensing Policy
nationalised oil companies
non-performing assets
Noida Power Company Limited
new property tax
National Rural Roads Development Agency
National Rail Vikas Yojana
Nava Sheva International Container Terminal
National Telecom Policy
National Thermal Power Corporation Ltd
NTPC Vidyut Vyapar Nigam Ltd
operation and maintenance
Oil Coordination Committee
Organisation for Economic Cooperation and Development
ONGC Videsh Limited
output per man shift
operations, maintenance and transfer
Organisation of Petroleum Exporting Countries
operating expenditure
Peninsular and Oriental Steam Navigation Company Ltd
profit after tax
profit before interest and taxes
profit before tax
Power Finance Corporation
xxv
xxvi
PFDF
PFDS
PFI
PGCIL
PIL
PIUs
PLF
PMGSY
POTS
PPA
PPPUE
PRI
PROGRESA
PRONASOL
PSA
PSC
PSP
PSTN
PTC
QOS
RCC
RDA
REC
RECOs
REITs
REL
REMICs
RETPL
RFP
RFQ
RIDF
RIO
RKS
ROB
ROMT
RRC
RVNL
SCADA
SCR
SDCA
SENSEX
SERC
SEZ
SICAL
SIPRD
SJSRY
SLOC
SLP
SLPE
SMS
SOCLEEN
Pool Financed Development Fund

Pooled Finance Development Scheme
private finance initiative
Power Grid Corporation of India Ltd
Petronet India Limited
Project Implementation Units
plant load factor
Prime Ministers Gram Sadak Yojana
Plain Old Telephone System
power purchase agreement
Public Private Partnerships for the Urban Environment
Panchayat Raj Institution
Programa de Educacin, Salud y Alimentacin, The Education, Health, and Nutrition Program
of Mexico
Programa Nacional de. Solidaridad, Mexicos National Solidarity Program
Port Authority of Singapore
Production Sharing Contract
private sector participation
Public Switched Telephone Network
Power Trading Corporation
quality of service
reinforced concrete
Regional Development Account
Rural Electrification Corporation
Rural Electricity Supply Companies
Real Estate Investment Trusts
Reliance Energy Ltd
Real Estate Mortgage Investment Conduit
Reliance Power Trading Private Ltd
request for proposal
request for qualification
Rural Infrastructure Development Fund
Reference Interconnect Offer
Rogi Kalyan Samiti
river over-bridge
renovate, operate, maintain and transfer
Revenue Recovery Cell
Rail Vikas Nigam Ltd
Supervisory Control and Data Acquisition
South Central Railways
Short Distance Charging Area
sensitive index of the Mumbai Stock Exchange
State Electricity Regulatory Commission
Special Economic Zone
South India Corporation Agencies Ltd
State Institute of Panchayat and Rural Development
Swarn Jayanti Sahari Rozgar Yojana
Sea lines of communication
single light-point
state level public enterprise
short messaging service
Society for Clean Environment

SPARC
SPIRD
SPV
SRTU
SWD
TAMP
TCM
TCT
TDMA
TDSAT
TEC
TERI
TEU
TMC
tmc
TNEB
TNUDF
TPC
TRAI
TRC
TSC
TSP
TTO
UIPMP
UNCHS
UPERC
UPHDB
UPPCL
UPRVUNL
URIF
USERS
USF
USL
USO
UWSS
VAS
VESCO
VFM
VHSH
VHTRL
VIA
VIWSP
VMA
VMC
VPT
VWSC
WACC
WATSAN
WBM
WDM
YLBC
Society for the Promotion of Area Resource Centres

Special Purpose Vehicle
State Road Transport Undertaking
solid waste disposal
Tariff Authority for Major Ports
Trouble Call Management
Tuticorin Container Terminal
Time Division Multiple Access
Telecom Dispute Settlement Appellate Tribunal
Telecom Engineering Centre
Tata Energy Research Institute
(40) tonne equivalent
Thane Municipal Corporation
trillion cubic meters
Tamilnadu Electricity Board
Tamil Nadu Urban Development Fund
Tata Power Company
Telecom Regulatory Authority of India
Toll review committee
Total Sanitation Campaign
Total Sanitation Programme
Telecommunication Tariff Order
Urban Indicators & Performers Measurement Program
United Nations Centre for Human Settlements
Uttar Pradesh Electricity Regulatory Commission
Uttar Pradesh Housing Development Board
Uttar Pradesh Power Corporation Limited
Uttar Pradesh Rajya Vidyut Utpadhan Nigam Limited
Urban Reforms Incentive Fund
Urban Services Environmental Rationg System
universal service fund
universal service levy
universal service obligation
urban water supply and sanitation
value added services
village electricity supply company
value for money
Vadodara Halol State Highway
Vadodara Halol Toll Road Company Limited
Vidarbha Industries Association
Visakhapatnam Industrial Water Supply Project
village medical attendent
Vadodara Municipal Corporation
Village Public Telephone
village water and sanitation committee
weighted average cost of capital
water and sanitation committees
water board macadam
Wholesale Debt Market
Yeleru Left Bank Canal
xxvii
Overview
OVERVIEW
Sebastian Morris
In India Infrastructure Report 2003, we discussed

government expenditure allocation and accountability and
made many suggestions on how governments could have
better control and accountability, and derive efficiency
gains. We expressed the need for reform in the process
of budgeting, especially at the state level, and highlighted
that the spending of and budgeting for Planning Commission
funds, especially those related to its many programmes,
lead to perversities in state governments. We had argued
for hardening budgets and also for performance budgets.
We also brought out the relationship between policy,
allocation, priorities, and efficiency of expenditure. We
argued that while there is much scope for internal change,
internal instruments need the external environment of
strong pressures for change. These have typically come
when budgets tighten. While the hardening of budgets has
been going on, despite the sideways movements imposed
by off-budget borrowing and spending, we made a strong
case for performance budgets under which the finance
ministries and the central ministers, and allocating agencies
like the Planning Commission can allocate funds based on
performance and actively monitor the use of the money
to ensure better efficacy. But, most important of all, we
argued that the pressures for change, and the earnestness
about efficiency within government, would be incomparably
greater if there were competition and alternative mode for
the spending and when the parastatal organizations of the
government have to compete for the same market space
with private firms.
Major Gains in Privatization

We, therefore, saw the task of bringing in the private
sectorboth as a competitor and as complementary to the
public sectoras a quest for value in government

expenditure. It becomes an issue of value for money more
generally, when the more intimate and specific sectoral
issues are brought into the discussion. That is the focus
of India Infrastructure Report 2004. We go somewhat
beyond the idea of value for money as understood in the
UK with reference to government expenditures in their
privatization and especially private finance initiatives.
Both aspectsthe complementary and the competitive
would be important, in India the latter because it takes
time for the government to exit from sectors and activities
where it does not have the comparative advantage, so that
a phase of competition with state enterprise, before these
are privatized/commercialized is inevitable. While the
arguments in this report cover the entire gamut of the
conceptual, a priori, and empirical, the latter perhaps is
the most important. There is nothing better than the
empirical evidence which shows that where shake up has
taken place much gain has been madeports, roads,
posts, airlines, telecom (Box 1.1). And where the status
quo prevailsrailways, irrigation, and water and sewerage
to name just a fewopportunities are being missed and
there is no improvement. In electricity the effort had been
messed up in the early 1990s and the penalty is being paid
even today. The recently enacted Electricity Act 2003 and
its intended companion, the Draft Tariff Policy, will hopefully
take the sector in the right direction.
In other sectors like manufacturing where the entry of
the private sector was forceful, but the public sector
enterprises could not be divested on any substantial scale,
the question is no longer one of adding value to the
consumer. That has already happened through a phenomenal
expansion of the private corporate sector that includes the
operations of multinationals both old and new. Privatization
2 India Infrastructure Report 2004

Box 1.1
The Ramp Up of the Private Sector Under the Inefficiencies of the Public Sector
Public sector inefficiencies have provided large price umbrellas for the private sector to show its differential performance. And
in some instances even to make very good returns. These are not necessarily bad as long as the surpluses are ploughed back for
expansion to bring about competition, or to lead to a phase where further growth implies price cuts. Price cuts happen when
the private sector firms reach a significant share of the market and their growth is then linked to overall growth of the market.
This ramping up of the private sector especially when the sectors are competitive and/or contestable has provided great consumer
benefit and have probably been one of the biggest and most durable changes in the 1990s in our economy, and society as a
whole. The competition or ensuing market structures may not be ideal and with appropriate policy and regulation could become
better. But there is no gainsaying the enormous value that consumers have derived from the commercialization of the sector. In
some cases the old incumbent SOE has itself been forced to respond in kind to create value for the consumer.
Postal Services
Today the vast array of parcel and courier services have brought down the price of courier (next day) delivery service of letters,
documents, and parcels. The private sector prices are below half that of the Department of Posts (DoP) prices for the same
reliability. There is product differentiation and the emergence of new marketslocal letter couriers at the price of the ordinary
post in most commercially-oriented cities; parcel services which were almost non-existent, mailing services, desk collection, and
letter tracking. The low prices of the private sector have exposed the hollowness of the argument that postal services are necessarily
loss-making. The vast asymmetric price of labour for such mundane jobs as those of postal peons, clerks, etc., besides the slack
control over the labour, are the root causes of high costs in the public sector. The bout of industry consolidation that is most
likely as the quality of service gets better valued, would result in the avoidance of the currently large duplication costs in the
private sectortoo many delivery and collection boys and centresto give even better service as the reputational effects are able
to feed back into pricing. It is a moot point if Speed-post, the DoPs service, could have survived without the monopoly of
government businessa! The public postal delivery services need to change; they could be overhauled with franchise of current
postal office employees. Post offices could compete if the appropriate contracts and share in surpluses can be worked out for
franchisees. Indeed, new offices could go on such privatized models! Similarly, the value derived from the sunk costs in the form
of a vast number of offices can easily be realized if the idea of internal contracting, contracting out, and privatization including
employee privatization of certain offices are not excluded in the design of reform. Far-flung areas may still need some subsidization
but far less than the current losses of the DoP would lead us to believe.
Airlines, Railways, and Buses

The ramp up of the private airlines, especially Jet Airways, under the price umbrella provided by an extremely inefficient Indian
Airlines (IA) has been significant. In less than 10 years starting with a few aircraft, and with much reliance on internal generation
presumablyb, the company is today larger than the IA and is now keen on price competition especially in segments and routes
where it sees much price elasticity of demand. That has suddenly allowed the much exploited Indian consumer to taste the
benefits of low faresc. With a better income distribution the price reductions would have been much more significant. It has
also exposed the hollowness of the Indian Railways passenger transport costs. Most certainly the upper class fares are far above
what actual competitive costs at market prices for inputs (labour) and with standard work norms need be; and, most important
of all, even the second class fares which we think are highly subsidized may not actually be so if passengers did not have to
pay for the vast over-manning, slack work norms and higher than market price of labour. That myth would soon be exposed
as stage carriages and long-distance private buses on a well-developed and speedy highway system can now come about. The
privatization of the state road transport undertakings (SRTUs) could greatly speed up the process. With this ensuing competition
from below and above would the share of the Indian Railways in the passenger market shrink? That would be most unfortunate,
since the comparative advantage of railways (when efficiently and commercially oriented) in long distance passenger and in
commuter movementd to give appropriable values is very high.
Telecom
In telecom, the ramp up of the private sector has been at a stupendous pace as cellular and WLL have resulted in vast increase
in usage. Herein the incumbents has also responded in kind and rightfully hopes to grow out of its ovemanning. Unfortunately
a
There may well be a restrictive trade practice angle here since private courier delivery boys are not allowed to enter government offices in
Delhi!
b Jet Airways is a closely held private company so that its accounts are not available to the public.
c This has happened despite the fact that the airline industry has been kept incontestable; and foreign airline companies are not allowed.
d The appropriability here may be lower than in long distance, but even here there is scope for an integrated (or coordinated operations)
operations of a bus-rail company to enhance values by route segmentation and interlinkage, which can considerably improve appropriability,
especially in the metros like Kolkata, Mumbai, and Chennai where a large network of surface lines exist. Some subsidization may still be required
but this is likely to be much smaller than what is generally believed.
Overview
With the millstone of state ownership they have not been quick enough to respond to such vital new markets as cellular and
value added services especially internet and broadband with their unique capacity to swamp the market. Conservative pricing
has held back their ability to compete against the private sector. Their response egged on by the DoT has been more to attempt
to influence the regulator and stall reform. In any case from the point of view of the consumer, now the developments are not
of great interest since network expansion to all those who can afford, (and some more out of network externality) is assured.
For BSNL /MTNL, the issue is of losing leadership. For the private operators who were not able to ramp up, all they can hope
for is to get a good price to be taken over.
Ports
The quick achievement of global levels of throughput by the private Nava Sheva International Container Terminal (NSICT) and
the attempt by the state-owned Jawaharlal Nehru Port Trust (JNPT) which had hived off some of its berths as the NSICT, to
close the productivity gap between itself and the NSICT, have paid rich dividends. Indeed so large were the gains of reduced
berthing times that ship turnaround times fell dramatically. Mumbais preference as a port of call improved, and Mumbai has
significant and increasing chance of becoming a hub port taking some business away from the Singapore and Jebel Ali ports.
Most gratifying of all the plan projections of the required investments in ports to add capacity had to be scaled down since the
efficiency gain meant a massive release in effective capacity. International trade is no longer constrained at the ports the way it
was in the early 1990s.
Roads
The NHAIs superior contracting for the NHDPe and the annuity-based segments (PFIs) are exemplary in ensuring value and
in lifting road construction and management out of the morass of the public works departments (PWDs), and provide a new
paradigm for imitative developments at the state level. Some states have even gone ahead and created road funds. Simple but
powerful ideas of linking maintenance to construction, independent supervision, providing for access roads, construction only
after all land acquisition is over, annuity-based funding have now become part of the lingo of activist agencies within the
government and industry more generally. The social savings in timely construction and quality are evident for all despite some
expected delays. Again the key to the success has been the marshalling of the private sector rather than departmental construction
and management. The earlier forms of contracting were not incentive compatible and it is interesting what simple correction could
do to set the markets right. A new breed of contractors have come on to the scene displacing the old construction mafia that
hung around PWD offices and cheated on quantity and quality to overcome the problems of winners curse in a badly structured
bid processf. No doubt in the initial contracts signed there was much margin which may have covered the risks in dealing within
a new paradigm and the lack of credibility of the government to be business like (given its prior poor reputation and working).
With some bids having gone through these margins have apparently come down significantly and the business of dealing with
the NHAI on the NHDP has become quite competitiveg. From 20+percentage returns on the early NHDP projects the returns
have apparently become more normal now.
e
Discussed in some detail in Rastogi (2002, 2003), and in this Report, Rastogi, Chapter 2.
See Pandey (2003) for a contextualized conceptual discussion of private procurement.
g Discussions with contractors and financers of several road projects in India.
f
is important to the well being of the state and for right

structuring its portfolio of activities so that the state too
has a chance of delivering its best, in areas where its
comparative advantage is largest. Today privatization is
necessary to allow the public enterprise a chance to invest,
reorganize, and reform in order to catch up with the
private sector, to allow the private sector to keep the
investment rates up in sectors where the barriers to entry
are large, and to bring about even more competition and
overall economy-wide efficiency.
As the growth this year and, in all probability, next year
is going to be high, the opportunity to reform is high
because the pain of reorganization is so much less. The
time is, therefore, right to set in motion the initiatives
required for a new paradigm for government expenditures,
one that combines the efficiency and low costs of the
private sector with the responsibility and commitment of
the state to public services. In earlier issues we had argued

that attempts to cut the fiscal deficit, when a recession is
on can only exacerbate the deficit keeping it much the
same while introducing a downward pressure on demand
to slow the growth of the economy (Box 1.2). We had also
argued that further activist axing of the fiscal deficit (by
expenditure reduction), on structural considerations,
requires the simultaneous pursuit of privatization, so that
private (investment) expenditures compensate for the loss
of public expenditure, thereby keeping the demand pressure
up. The economy has been demand-constrained ever since
the recession of the late 1990s. That understanding continues
to be valid, the high growth rate that will be registered this
year notwithstanding. It would suggest that it is important
to keep infrastructural expenditures up but through the
opening up of the efficient channels that we discuss in this
report.

Box 1.2
GQ, Rainfall, and Exports Drive Growth in India
The high growth this year is due to the spending on the GQ, the PMGSY, and in the electricity sector. This year we have 3
positiveshigher export growth (now slowed down), good monsoon, and continued public spending on GQ and Golden Cross
(GC), which should together keep the industrial growth rates up, the fiscal deficit at the same level or marginally lower, since
taxes have an elasticity greater than one with respect to industrial growth. Next year exports are likely to plateau off, if they have
not already, since the lagged effect of an appreciating rupee would hit exports hard. Unless this is corrected through expansionary
monetary policy (even if foreign exchange reserves rise further), that positive effect would go. But the government spending and
good agricultures delayed effect would continue, unless these are checked by highly restrictive monetary policy. The governments
implicit commitment to buy up agricultural surpluses means that the spending power of rural India enhanced agricultural
production would not (even in part) be nullified by falling prices. There is, therefore, much merit to the argument to use buffer
stocks for infrastructure construction.
Now the RBI and the government again face the challenge of vast portfolio and FDI inflows, that have large speculative and
bandwagon components, which may have been fuelled by large and steady fischer-open in the past. Deciding on the right
portion of these inflows to sterilize is no easy task. An inflexible adherence to the (low) money growth targets would damage
the prospects of high real sector growth, because domestic credit would get affected and that can once more bite domestic industry.
Money supply would have to go up faster than 1012 per cent (month over month of previous year) than they have over the
last several months. The higher growth of M1 over M3 since April has of course created a cushion. The effect of that may wear
off soon. But we would go by the fact that the RBI has indeed tried to keep M1 at 13+percentage, that perhaps the stance
of the RBI has shifted away from monetary conservatism. The dollars fall relative to other currencies and the denomination of
quotation of much of Indian exports in dollars has to some extent mitigated the impact of the rising rupee on the real effective
exchange rate. But that cushion too may not be there anymore, despite the expectations that the dollar would fall further. It
has complicated the conduct of exchange rate policy due to time varying pass-through effects. In the longer run as a transforming
economy with vast idle capacity we simply have to accept that the average US$ 1216 billion dollars of inflow every year on
account of private remittances, as also speculative capital inflows, should not be allowed to determine the exchange rate. This
would mean a far lower value of the rupee, higher exports and even faster rise in the reserves, but very high growth.
If further low rates of interest promote a spurt in private investment so much the better. But lack of regulatory clarity, huge
distortions, inadequate frameworks and models inhibit much private resource flow, especially into sectors like real estate, water,
and urban infrastructure, through mechanisms like PFIs. If EA 2003 and the Draft Tariff Policy can work, commercially-oriented
investments in this sector can begin to have positive demand side effects in about a year and half. The situation would soon
bring back the need for public investments, and it is far better to recast the process for privatization of PSUs, and work towards
mechanisms to take PFIs and more efficient forms of government expenditure in public services further.
The Themes for This Report

Empirically we know that state failure has been endemic and
particularly large in areas where the state had to contend
with human management tasks rather than technical
organizations. In activities like postal services where the task
is labour-intensive, its comparative disadvantage has been
too yawning. More than state failure, the nature of the same
creates a vast opportunity and space for another form of
economic activity that can be considered as an extended
form of procurement where a contract is necessary, and
direct services rather than the means of services are supplied
by the private sector. These forms have come to mean Public
Finance Initiatives (PFIs). Additionally the schism in the
labour market which makes it very expensive for the
government to employ skilled and unskilled labour but
cheaper for the competitive private sector to use labour
efficiently and also buy cheaper, makes the space for such
PFIs very large in India. We explore PFIs and how they
can be used to serve the poor and those waiting for the
service but receiving little or no service because the public
systems have failed.
We also take up two related themes. Privatization of

enterprises and the evolution of development finance
institutions (DFIs). The discussion is focused around the
central public enterprises, because there had been some
action therein but now a killing uncertainty. We complete
the argument begun in earlier IIRs that the government
is not the right body to carry out privatization, certainly
not in the contested democracy that is India. Privatization
needs to be distanced from the state. The failure of public
enterprise arose because governments could not distance
their creations from themselves. Privatization too, for
similar and even more weighty reasons, would fail if not
distanced and made independent of government (Box 1.3).
DFIs are like dinosaurs facing a suddenly changed
environment brought about by the reform of the financial
sector. They need either to adapt give up their traditional
developmental roles, and in many cases pick up new
developmental roles which are of furthering the development
of markets: both for the demand and supply of long-term
bonds and related instruments. This involves much more
than financepolicy advisory, pioneering frameworks for
Overview
Box 1.3
State Failure in Privatization
State failure is perhaps the strongest reason for privatization and the need for the state to step aside to allow a market even with
its inefficiencies and biases to take over. Indeed, the logic of public economics that brings in the state when markets fail, can
be turned around to argue that the time has come for the state to contract much so that it can focus on just those areas where
its comparative advantage is overwhelming. And, hopefully, with that focus its efficacy and efficiency can improve. Right
structuring the states basket of activities began in the early 1990s, but is proceeding very slowly today. There is little doubt
that the overwhelming majority of the central public enterprises (CPSUs) are not in areas where the state has any advantage over
the market. In the manufacturing sectors, where there is no market failure, disinvestment proceeds at a snails pace. When are
these CPSUs going to become free participants in the market without being worried by the state?
Privatization which seemed to have begun in earnestness has come to a virtual standstill after being in a stopstart mode for
nearly 10 years now! The failure to grant public enterprises the operational autonomy that any enterprise requires is itself a state
failure. It makes the enterprises perform poorly, and cut a sorry figure in the marketa. Similarly, the failure to have a credible
and legally enshrined institutional mechanism for privatization is also a state failure. That the government cannot itself carry out
disinvestment was never revealed better than by the Supreme Courts decision asking it to go back to Parliament. And this was
further confirmed by the government coming up with the idea of disembering Indian Oil to sell its distribution business!b The
current dispensation with regard to disinvestment ignores the company and the managements even of professionally managed
enterprises. That is most ill advised since the best values and much success can be had with their involvement. This fiasco ensures
that disinvestment doesnt in any seriousness begin till the current boom is over, and one more business cycle would have been
lost.
Distancing Privatization
Privatization also needs to be die-cast in a process that makes it independent of the pulls and pressures on government and allows
learning to take place, expertise to be built up, and strategy to be exercised to maximize the value to society in disinvestment.
Nothing short of an independent expert commission that has a tenure of at least 5 years deriving its authority, and mandate
and objectives from the law would do. Its the Commissioners independence enshrined in law. There is no other way that the
stock of holdings of around Rs 500,000 crore can be divested over a reasonable time frame of about 8 years or so.
Moral Hazard in the Current Process

The moral hazards in retaining privatization within government are large and are amplified in the Indian context. There are of
course even more weighty reasons which are developed in right constituting the organizational and institutional mechanism for
privatization (Morris, in Chapter 4.4). Barua, in Chapter 4.3 shows that the public sector stocks volatility imposed by
contradictory announcements by officials and politicians could have easily been exploited for gains through insider trading like
opportunity. There is no way for an independent scholar to establish that actually such opportunities were usedonly that the
possibilities were there and have gone uncommented by the regulator and the mediac. The possibility of fraud ought to result
in a mechanism that in its process and design reduces the possibility of perverse behaviour, rather than assuming that moral suasion
on the part of ministers and officials is adequate enough.
The detractors of privatization and commercialization can be well reminded that much of the public enterprise are in areas
where there is no market failure, and even if there was failure earlier there is none today! The key inability of public enterprise
to do well under competitive conditions, and when the required efficient organization is more social than technical stands
exposed. When the operations are also labour-intensive then the failure is almost total. These facts ought to convince all about
the futility of public enterprise, and to explore the possibilities in other modes for state involvement when required on account
of market failure. Being valued too poorly, many public enterprises cannot go to the market, and even when some can, they
are not allowed to. They are trapped and have nowhere to go for their vitally required investments. Now with an absurd dividend
pressure even the few with cash surpluses are being sucked dry without recourse to other options. That market performance has
suffered is not in the least doubt. Morris, in Chapter 4.4 brings out the dimensions of performance of public enterprise, and
shows that the rate of investment is too smallsmall enough to kill any largish enterprise. Barua in Chapter 4.1 reviews the
privatization process from 1991 onwards bringing out the mistakes that were made in the past, before the Ministry of
Disinvestment was set up.
a Until the recent spurt in PSU stocks following expectations of disinvestment, the P/E ratios of Indian PSUs have been very low in comparison
to either private firms or even public enterprises in other LDCs in similar product markets (GOI 2003).
b See Morris, S., Dec. 2001.
c That indeed such possibilities may have been exploited is more than likely. The Bank Stock Scam as it is now being called, wherein certain
officials of the Ministry of Finance are under investigation by the Securities and Exchange Board of India (SEBI) for trading on policy and other
announcements related to these banks is indicative. See Economic Times, Bank Boom: SEBI finds Finmin Broker Nexus by B. Kararsu and Rajeev
Nagpal, 10 October 2003. Source: http://economictimes.indiatimes.com/cms.dll/html/uncomp/articleshow?msid=227229

contracts and public private partnerships (PPPs), new
instruments, credit enhancements, residual risk-taking,
leveraging large funds from the market into long duration
infrastructural projects, etc.
THE CHALLENGE
OF
PUBLIC SERVICES
AND
PFIS
Roads in India, until recently, were a veritable museum

of obstacle courses, railways overcrowded, our children
out of school, or attending schools that had no classrooms
or no teachers! Surely we cannot have the facilities which
rich countries have but, even relative to our income, our
failure in water, roads, sanitation, schooling, and electricity
is woeful. This condemns the state and the current paradigm
of investment and provisioning, and the need to search for
alternatives is beyond doubt.
Efficient governments in areas with vast external effects,
which could also add to demand, are vital today since the
productive efficiency of the manufacturing sector and the
economy has gone up, with a greater role of the private
sector in investments. Sewerage and sanitation, education,
city and village roads, and water supply are important
sectors that await large-scale public and private investments,
and a necessary shift in the paradigm for public expenditure.
There is little merit in merely increasing expenditures,
without the initiatives for efficient spending whether through
PFIs, or reform within government, or privatization.
The New Paradigm of PFIs

Nothing encourages innovation and change within
government more than hardening budgets. Now that avenues
for piling up contingent liabilities (a phase that most state
governments went through) are beginning to close (thanks
to the RBIs and the central governments effort to correctly
measure off-budget borrowings and expenditures) there is
a better understanding of what constitutes reform.
Performance budgets and embedded incentives in the
Accelerated Power Development and Reforms Programme
(ADPDRP) and the PMSGY are far better than in the
Rural Infrastructure Development Fund ((RIDF) or the
umpteen Intergrated Rural Development Programme
(IRDP) type of programmes.
The easier fiscal situation should not be a reason to
reduce the pressure on state governments. The framework
for PFI programmes that defines (a) the quantum and
ceiling for funds that can go the PFI route as a function
of government revenues and other revenue commitments,
and GDP and growth; (b) the borrowings from the central
government and in relation to the contingent liabilities
already incurred; (c) the conditions for guarantee; (d) the
interest rates, is desirable and long overdue.
When PFIs?
When are PFIs more appropriate than other modes of
financing or direct provision by governments? It is first
of all necessary to recognize that there is no fundamental
limitation to the PFI mode, if the right kind of contracts
can be written. And the process of leading to right structuring
and defining the financial limits for PFIs, given state
revenues and the expected growth therein, can itself be a
highly rewarding process. This is so because such an
exercise helps to clarify the dimensions of the outputs and
the service quality in the activities under consideration.
Risks and their sources and the mitigation measures tend
to be identified and understood so that even if after the
exercise the state decides to go ahead with direct provision
there are gains in terms of what to expect and the possible
pitfalls. And there is enough clarity to assign risks and
responsibilities within the various arms of the government.
The danger in PFIs arises out of risk shifting, and the
possibility that PFIs are preferred over privatization due
to vested interests who may still like to have a major say
in the allocative process. Thus, when tourism development
goes PFI and the private sector cannot compete either
because activities are not opened to them or land and site
access or restrictions apply asymmetrically, then the better
option of a competitive private sector may not be taken
up. The best way out is really to first check that, irrespective
of appropriability limitations, the sector is legally open to
the private enterprise with the most minimal regulation to
cover compositional and other negative externalities and
that there are no discriminations against private investment.
In spite of this if the private sector is unwilling to come
forth because of appropriability limitations arising from
the nature of the good or the limitations of endowments,
then PFIs can be actively considered. The argument that
there must be a public sector comparator certainly applies,
especially when the state sector is also successfully
overcoming its limitations. But the argument can be expected
to have less value when state failure is rife. Recall that ex
post the extent of state failure was forcefully revealed by
the entry of the private sector in such areas as ports,
airlines, posts, and telecom (Box 1.1).
PFIs and The Poor

When appropriability is weak because there is endowments
failure, then the problem is basic. This has been perhaps
the most important reason for the failure of public services.
Mukhopadhyay (in Chapter 3) makes a strong case that
even the very poor, that is, those below the poverty line,
have some money to lay out on basic infrastructural services.
And, more importantly, to reach the really poor with basic
services, the amounts required are far smaller than what
Overview
the government currently spends on the sectors in
subsidization and in forgone revenues, etc. This clearly
implies that the inefficiency in targeting/subsidization and
the resulting mess up of the public sector are the real
barriers to sectoral growth and coverage. The poor cannot
be held as an excuse for not having private finance or
publicprivate partnership (PPPs) even in public services.
Indeed, a major change in the paradigm for the poor is
necessary. There are approximately 60 million poor families
in India today. If each of them were able to set aside
Rs 8.6 per day (or Rs 1.70 per person), that would have
enough to provide this purchasing power. This is just
Rs 18,834 crore, say Rs 20,000 crore which is incomparably
smaller than the 1415 per cent of GDP (Rs 336,000
crore) that is the total subsidy burden in country. Even if
an estimates are doubled the really poors infrastructural
needs can be taken care of completely.
Scaling Up Social Innovations

Our country with its enormous variety and with thousands
of initiatives from concerned individuals and organizations
has spawned a vast number of social inventions to better
serve the people. Many of these inventions have arisen to
compensate for state failure, but many others have
indicated a new leverage point for change as, for instance,
the Amul model in milk or the SEWA model of microbanking. There are other successful models in watershed
development such as Samaj Pragati Sahayog, Rogi Kalyan
Samiti, Sulabh that have become household names. Many
of these models have the potential to be scaled up with
or without minor modifications to benefit, incomparably,
more people. PFIs can be designed to carry out this task.
Operation Flood was the success story of the scaling up
of the Amul model. Mukhopadhayay (Chapter 3) and
Mavlankar and Shankar (Chapter 13.1) mention similar
stories of success to highlight the need for social and
organizational innovations in the form of well-structured
PPPs which can be instrumental in scaling up these and
similar innovations.
Economic Coordination Modes Change with Technology

Box 1.4 brings out the relevance for PFIs in the economy
as one of the modes of coordination given supply and
consumption side characteristics. It is important to realize
that the modes of coordination have actually been plural,
and the idealized world of markets and hierarchies (AngloSaxon) is a very incomplete picture even in societies as
the only two modes that have abhorred other forms of
coordination. Interfirm networks (which has become
inevitable in IT industries) today have emerged as inevitable
in IT clusters in the US.
Our task is not merely a first principles-based delineation

of the boundary between the state and markets, relying on
static economic considerations, as is routinely done. Neither
does it start from the ideological position that states always
fail. We usefully bring into the discussion the tasks and
conditions under which the state is prone to failure: (a)
complex tasks involving judgement; (b) making repetitive
investment decisions; (c) holding on to commercial
orientation in enterprises, while keeping a certain defined
space for a non-commercial purpose such as universal
access or subsidization, or under a dysfunctional agenda
for political expediency. But the states comparative advantage
and role in governance and defining the rules of the game
remain. This completely exposes the hollowness of using
the poor to justify the mess in sectors like irrigation, water,
sewerage and electricity.
Similarly, a more dynamic consideration of markets
frontally bringing into the discussion the aspect of growth
and technological changegives far greater scope for
markets than is conventionally understood (Morris 2001;
Varma 2002). The boundary between the state and the
market cannot be seen as being rigid since that boundary,
over some margin, is expected to depend upon the nature
of society, the kind of state and its limitations, the stage
in the developmental process, and technology.
As industrialization proceeds successfully, the role of
markets necessarily increases. And technological and other
developmentsfor example, writing out better contracts
have extended the domain of markets more generally. The
role of semi-market forms such as PFIs have also arisen
as part of this evolving boundary between the state and
markets and as a form in their own right. In Box 1.4 we
present the roles of markets, networks, hierarchies, state
and intermediate forms on the two dimensions of
appropriability, and the structure of efficient production
or task performance as exist today. The schema is valid
only in a contingent sense since both dimensions change
with the developments in technology and the law.
The Space for PFIs1

PFIs, or more correctly, private finance for public
infrastructure involves the use of privately-raised capital to
build facilities and offer services which are procured by
the mediation of the state, with or without the users
paying, necessitating a contract between the private party
and the state. (Varma 2003; George 2003; Barua and
Gujarathi 2003 and Mukhopadhyay, Chapter 3; Agrawal,
1 I have benefited much in my understanding on PFIs through
my discussions with Varma, Mukhopadhyay, Barua, Burman,
Raghuram, and the students/participants of the IDF courses at
IIMA.
Competitive
Box 1.4
Economic Coordination Matrix in Society
Appropriablity problems;
Appropriation can be larger than
social value due to negative
externalities/ natural monopoly
(No large externalities); No large

appropriability problems
Appropriability problems; What is appropriable

is less than the social value created
(IV) Markets with Controls and

Instrumental Regulation of Activity/
Market Creation: Problems include
environmental pollution and related
negative externalities and the
solutions have been in terms of
control orders, liability rules,
tradable rights to pollute and
extract; other monitoring
mechanisms, common property
approaches to check short-term over
appropriation; licenses.
(I) Domain of Markets: In mature

economies no regulation as such
required. Only sound macro
policies and good governance. In
late industrializing economies
with efficient states financial
repression and public enterprise
in leading sectors can help.
Tariffs have been used
universally to spark off industrial
activity.
(V) Partial Market Failure Requiring

Coordination/Imposed Strategy and Subsidies:
Where size does not improve
appropriability. Activities and sectors
include education archtypically, but also
expensive inoculations, sanitation; solid
waste services, museums, public
information. The methods of coordination
have been principally provision by the state
and direct subsidy/support; governmental
oversight of industry associations and
regulation (scope for contracting out and
PFIs are now large with the new
paradigm).
Non-competitive
(III) Domain of Large Hierarchies and

Networks: Where size can improve
appropriability. Example would be of
experience goods, research and development,
product development; (clearer IPR definition;
No particular regulation is called for but
certain orientations in the policy that
recognize the need for large companies/
interfirm linkages and dialogue between
firms can help; no artificial restrictions on
firm size or on mergers and acquisitions/
vehicles for cooperative R&D; allowing and
making feasible networks collaborative efforts
for technology developments; tolerating
kiertsu like structures as long as they
compete in the goods and services market).
(VI) Regulated Industries and Growing
Monopolies: Electricity distribution; gas
and telecom distribution; airline
services; maintaining market places;
irrigation main networks from large
dams; railway especially long distance;
cellular telecom; last-mile loop of
networks; gas distribution networks;
oil/gas transmission networks (light/
incentive regulation; public ownership
only when state failure is out of
question; enhancement of
contestability; better interconnect;
open access; promotion of consumer
groups; recognition of dynamic
aspects mean light regulation that
eschews the creation of barriers against
the un-foldment of technology; light
regulation in high growth situation).
(II) Domain of Markets with

Some Market Intervention
Operations: Problems include low
price elasticity combined with
delayed supply response; quality
quantity trade off with little or
no competition (solutions include
standards, buffer stocking;
allowing reputational effects to
take root; market/trade
interventions).
(VII) Public Service: Sewerage systems; road

networks in a city; dense road networks;
street lighting; drainage systems and storm
sewers; land shaping in cities; watershed
development; some aspects of primary
health care where coordination aspects are
large. (Traditionally were local government
and public-owned or regulated private
entities on the concession mode. Areas with
maximum scope for PFIs, and PPPs more
generally; in situations with little state
failure the public sector comparator could
be useful; distinction between access and
usage and subsidization of the former in
most cases can improve the appropriability/
reduce the subsidy required in many cases).
Overview
Chapter 5.3; Bardhan and Barua, Chapter 5.2; Parashar
and Thomas, Chapter 5.4; Baig and Jaikishan, Chapter
11.5 in this Report, have covered various aspects of PFIs.)
They have potentially large advantages since private
management and enterprise can be brought in to increase
design efficiency (when the contract correctly specificies
the output), besides, of course, operational efficiency.
They can have the additional benefit of market valuation
of risks if risks other than operational are also borne by
the private party, and the party goes to the market for
financing/participation. The latter though may not always
be possible in situations where it is government decision
that creates the demandprisons, for example. In the
Indian context the benefits, as also the risks in large-scale
PFIs, are high.
We had, in the previous IIRs, looked at the experience
of PFIs globally and had highlighted some of the cautions
necessary (Varma 2003; and Barua and Gujarathi 2003).
There is nothing like a few early bad cases to spoil a good
idea. Luckily, in India, the first few visible PFIs, viz., the
road projects on the annuity model, have gone on well,
so that a positive environment for PFIs has opened up not
only in village and city roads but in many other areas
including sanitation and sewerage, education, water supply,
irrigation distribution, minor irrigation, and public health.
Lack of Appropriability and PFIs

When the costs of providing a service are greater than the
revenues that can be generated from the project user fees,
charges, etc., then PFIs/PPPs need to be considered actively.
The inequality may be fundamental as when they arise out
of excludability, additivity, avoided subtractibility but the
benefits are not appropriable. In such situations an imposed
appropriability, as when primary schooling is allowed to
be non-universal, can reduce greatly the positive
externalities, thereby foreclosing the option of appropriation. A PFI then is an important method to bring
in the inefficacies of the private sector when the state
agrees to provide the additional revenue enshrined in a
contract to a private party which invests to provide the
service.
Therefore segment VII (Box 1.4) is the principal arena
for PFIs in the full blown sense of requiring long period
contracts; but that does not exclude PFIs in segments such
as V, where they are much easy and need not involve longterm individual contracts as much as policy and systems
of performance and quality measurement. In this segment
the specificities of the particular project are less important
and standardized ways of dealing with private service
provider at a sectoral level are possible.
Governments could also choose to use PFIs even when
the condition above is not met; with regard to the particular
project but for the sector as such it is. In such conditions

there could be distortions if one project is charged for but
other similar projects are not. An example would be tolling
of roads. If some roads at a certain heirarchy in the
network of roads are tolled but some others at the same
level are not, then there is distortion, to correct which PFI
options could be used. Indeed it is first best to use PFI
with partial tolling (shadow tolling) across all roads or even
to completely privatize with all revenues coming through
annuities but preferably linked in some manner to the
usage. Such choices between first and second best are
lesser issues than the overriding consideration that roads
need to be built and used in the first place, in an economy
that is still transforming. See Morris 2003 for a listing
together of benefits and potential risks and contingencies
in PFI and the interlinkages between PFIs, governance,
and budgets.
ROADS, TOLLS, ANNUITIES,
AND
MARKETS
On the NHDP, more roads need to go on the PFI route

rather than through pure construction contracts. The current
high expected returns in PFIs are falling as the sector
becomes competitive, risks decline, and there is
accumulation of experience on both sidesthe government
laying out the cash flows and the private sector putting up
the investment. The road fund is not as yet completely ringfenced. Rastogi (Chapter 2) argues that ring-fencing has
to take place quickly if the major highways beyond the
Golden Quadrilateral (GQ) have to see improvement.
Similarly, as the government goes beyond the busy GQ
and the Golden Cross (GC) to other national highways it
is important that traffic risk be correctly addressed. It then
becomes important to go shadow tolling since that would
mean that the traffic risk is on the BOT/annuity party.
Even where there is no tolling, and no payment other than
annuity is intended, or where there is no payment at all
it is important that the traffic be measured so that a strong
database emerges for understanding traffic flow and its
composition as growth takes place and as road conditions
improve! Raghuram (Chapter 11.1) makes a case for point
to point sections for private management and maintainence.
OriginDestination Studies
Periodic origindestination (OD) investigations are a must
to commercially orient roads to bring about optimality in
the division of traffic between road and other means, and
for pricing/tolling/toll period decisions, and more generally
to move to a shadow-tolling regime that is least distortionary.
These would also be of great use in the understanding of
regions, the relationships of cities with each other and with
their regions, and in planning of networks and their
10
India Infrastructure Report 2004
upgradation and, most importantly, in the locational choices

made by industry. Such a situation, however, does not exist
at present. Most regional studies are constrained to use
only railway traffic and freight movement data when on
both dimensions the road movement is already dominant.
That need would become urgent action as states realize
(once the tax differences between states go) that they are
competing on the basis of the infrastructure they directly
provide, the natural endowments, and on the city-serving
and city-forming functions of their important cities. That
process has already begun even if states are not acutely
aware of the shift2.
Improvements in Government Decision-Making

State governments need to improve their institutional and
organizational framework for the moneys they plan to
spend. The grants and contributions under the PMSGY are
large and it makes sense to derive all the social and
economic value in the construction of rural roads. The
example of Madhya Pradesh which created the Madhya
Pradesh Rural Roads Development Authority (MPRRDA)
to distance the activity from the traditional process driven
Public Works Department (PWD) is crucial. Major gains
in efficiency and efficacy were possible. Under the old
PWD system it would hardly have been possible to put
out so many contracts in such a short time, leave aside
the fact of the poor quality of the construction that PWD
processes result.
Agarwal and Agrawal (Chapter 11.3) bring out this
interesting story of a change in a small part of the
government being able to bring forth much change and
good roads without having to tussle (with a low probability
of success) with changing the PWD. Political support,
while crucial to the success of the MPRRDA, was not
everything. More appropriate processes for decision-making,
decentralization, empowering the officers of the MPRRDA,
almost entire reliance on outsourcing with adequate
safeguards, better design of bids through appropriate
bundling and allowing choices to the bidders to ensure
their best are some of the innovations that were made. But
the point is that in an organization like the PWD where
processes rule to completely make the primary task
subservient (even to the extent of its non-performance), the
changes and the approach would have been unthinkable3.
2 Thus it is Chennai, Bangalore, Pune, Hyderabad, and Ernakulam
that compete in the southern region.
3 Reform of some organizations may be very difficult. It may be
worthwhile to bypass and neutralize such organizations. An all-ornone approach is sometimes necessary but not with regard to
change within government. We have always argued that any change
that requires all of government to be good and competent all the
time is doomed, that which only requires a part of government to
The MPRRDA remains an island of efficiency and task

orientation but that, while necessary to the process of
change, is difficult to hold on to in the long run, as the
general governmental processes catch up with the
organization. Institutionalization needs to happen. In todays
context that can only mean commercialization and PFIs.
PFIs for Institutionalization

The MPRRDA can go further than efficient procurement
of roads to procurement of road services through PFIs
with smaller maintenance companies locally embedded and
with stakes in the local economy, with village panchayats
and other semi-commercial/cooperative bodies willing to
take on road maintenance on PFI basis. Since road
maintenance is labour-intensive and in a low-income state
like Madhya Pradesh the food/wage goods need of
construction labour are large relative to their incomes,
payment to such road maintenance organizations in the
form of food coupons ought to be made possible. Entities
with natural incentives to monitor maintenancelocal bus
and trucking companies, village panchayats, and local traders
and farmerscould be mobilized to perform the monitoring
mechanism that links the annuities to the road maintenance
entity. That model would, of course, have relevance not
only to roads but also for construction of water storage,
watershed management, rural drainage and sanitation
systems, construction and maintenance of small-scale
irrigation and distributories of major irrigation systems.
Problems with Tolling

Raghuram in Chapter 11.2 raises fundamental issues
regarding tolling. When some roads are tolled and others
are not the distortions are severe and appropriability could
be affected. The impact of the new road may be to
completely overcome congestion in the old road, thereby
greatly improving service quality even with a small shift
in the traffic to the new road. If the old road is not tolled
then there is value loss which could have been anticipated
earlier. The point is if congestion was reducing the capacity
of the old road then the relaxation of that congestion
sometimes by as simple a measure as clearing some key
slow down points, can add much to the capacity.
Feedback Effects in Road Development

In the case of the VadodaraHalol toll road the initial
projections underestimated the role of mutli-axle vehicles.
Interestingly the increased share of multi-axle vehicles is
be good and competent for a while has the best chance of success.
This is the great merit of privatization and such measures as PFIs
that require a necessary distancing (Morris 2002).
Overview
itself the result of improvements in road conditionstypically,
the building of broader roads with smoother surfaces allowing
multi-axles their space. The Halol project lost much revenue
to multi-axles which were underpriced and carried more
than twice the load of a truck but were charged barely 20
per cent more and had a large share in traffic. Similarly,
removal of government sales tax concessions destroyed the
value of locating in Halol which considerably diminished the
traffic on the toll road. These possibilities had not been
envisaged. Currently a Devas bypass road is being built in
Madhya Pradesh which can add considerable value by
removing congestion around the city for northsouth and
eastwest traffic. But again multi-axles are not considered
as a significant load since the surveys did not show much
role for the same. But road conditions are improving in
Madhya Pradesh with the AgraMumbai road, the Burhanpur
Indore road, and others being upgraded. That could make
the AgraMumbai road a feasible alternative to the road via
Ahmedabad, from Mumbai to the north, and bring about
much traffic by multi-axles. A tariff structure from archaic
NHAI rules had not anticipated the possibility in multi-axles.
But a good toll review mechanism in the case of the Vadodara
Halol toll road saved the day for the company.
PFIs for Urban Roads

Baig and Jayakishan in Chapter 11.5 discuss an idea which
can greatly help in improving city roads through PFIs.
PFIs for city road funds can work best if there is also
accompanying privatization of the road, since the issue is
not typically of building new roads but of expanding,
maintaining, and ensuring quality of service. Since flow
on city roads have loop flow characteristics it is important
to demarcate the areas for PFIs correctly. For durable longterm interest, ownership may be important or long period
renovate, operate, maintain and transfer (ROMT). Similarly
service levels and their measurement can be carefully
specified, not just in terms of lane availability but also in
terms of traffic carried and travel times at peak hours so
that there are strong incentives for road companies to
manage traffic, avoid bottleneck situations and prevent
squatting and illegal use of roads and unauthorized and
poor parking. These, together rather than inadequate road
surface actually, congest Indian cities. Suitable shadow
tolling and independence of the measurement of service
levels and carriage, should be the basis of payment. That
would imply that the traffic regulating function is no longer
the exclusive preserve of the police.
11
while having the competence to maintain a road, may not

be particularly good at estimating traffic and taking on
those risks, but that particular section may have been put
up on toll basis subjecting the company to traffic risk. In
contrast, there could be a company that has an annuity
contract but would like to take on traffic risk. Similarly,
much reduction in traffic risk is possible with pooling, the
same way that a portfolio can reduce risk. In other words,
prima facie, there is the possibility of a market which can
trade in traffic risk to give options to road managers and
others. Tilotia and Pawar in Chapter 11.7 discuss this idea
and the tasks ahead for bringing about such a market. This
is an area for new style DFIs to worry about.
Capitalizing on Removing Urban Constraints

The huge values that lie waiting to be unlocked in the
construction of good roads from the pheriphery of a
congested city are estimated by a simple model of a
sprawling city without much investment in quick roads so
that congestion has subtracted from the value of central
places. (Pawar and Tilotia Chapter 11.6) A road about
twice as fast radiating out from the pheriphery of a city
like Pune can attract settlements along it instead of just
outside the pheriphery as a sprawl. The social value that
it creates is of the order of Rs 200 crore per year, and
the extractable value is enough to construct not merely the
road but half way to another city about 100 km away. This
is merely another way of saying that the optimal location
of activity around a large city is in radials with activityrich radials being interspersed with activity-poor radials,
long discovered by Lsch the great location theorist. To
us with congested urban sprawls, rather than organic cities,
it tells us that there are huge values to be unlocked as we
move to more rationally-structured cities with their speedy
highways and railways that increase the amount of land
which has the same time of access to the central place.
When linked to fast metropolitan transport rail/massed
buses the land that such roads use up can be minimized.
OTHER PFIS
Real estate development in the US and China is indicative
of its potential in India if private real estate and land
development can take off. The topic of land, location, and
regional development merits a much deeper examination
since constraints that arise as, for instance, in land
acquisition and use, are major contributors to risk in
infrastructural projects.
A Market for Trading Risk

If some roads are tolled, others are on annuity (fixed
payments), then a market to trade the revenues out of
various contracts would be well received. A company,
Real Estate and Land

Bardhan and Barua in Chapter 5.2 argue that the scope
is large in India and can ultimately constitute as much as
12
a third, if not more, of all infrastructural activities.

Developments herein, especially the entry of large private
players, can do much to the capital market and its depth
since it is in land and real estate development that much
of the savings of ordinary people are expected to be
invested. Securitization and market support to intermediation have much potential. Similarly, the potential of
reverse mortages and such other mechanisms remain to
be exploited. Current constraints emanate from the difficulty
of ensuring clear titles, problems in protecting title, high
transaction costs, and low floor space indices (FSIs) that
promote urban sprawl rather than efficient cities and raise
the cost of real estate, all serving to keep the real estate
markets thin. Despite these problems, the beginnings of
private land development are seen. The sector can have
large spillover and demand multiplier effects.
Kothari (Box 5.3.2 of Chapter 5.3) reports the case of
Lucknow where the fiscal problems of the municipality
allowed a private sector to carry out land development. The
clarification of the tasks for the private sector and the good
values the private players were able to give to buyers of
developed plots through quicker development are important.
These experiences have helped the municipality to learn
and to repose greater confidence in the private sector. Real
estate development has recently been drawing the attention
of bigger players who, since they have reputations to hold
on to, have reduced the risks to the otherwise hapless
house buyer in India. That process should continue with
competition reducing the premium that reputed players
are currently able to extract. The development of the mass
market in most cities, possible with lower FSIs, needs
serious consideration.
State PFIs
There is no doubt that PFIs/PPPs are here to stay and can
become a flood in the ensuing years as the legal, fiscal,
policy, and contractual standardizations come about.
Current efforts must be seen as pioneering and leading to
the development of frameworks. As such they are likely
to be cautious and involve much effort on the legal and
contract-writing side. With time, as these aspects are
understood, the costs and efforts would go down. That
effort can be considerably speeded up and extended to
smaller and more local projects, and mistakes avoided with
institutional mechanisms for training and teaching linked
to research. Such efforts underlay the success of PFI in
the UK.
Besides the PFIs in roads there are efforts to privatize
tourist guest houses and facilities by the state governments
in Kerala and Karnataka with the framework being evolved
by the IDFC/PriceWaterHouseCoopers and iDeCK (an
IDFC and Government of Karnataka initiative). Similarly,
private higher education, private hospitals, state-level

highways and roads, water supply in Vizag for industrial
and related purposes have found the support of financial
institutions.
Vasudevan, Chapter 5.1, reviews the Draft Infrastructure
Policy of the Government of Karnataka which is an
overarching framework for inter alia the development of
PPPs including PFIs. It has the potential to take Karnataka
to the forefront of private infrastructure development if the
requisite and focused training of government officials at
multiple levels can begin with earnestness. The key elements
of the Draft Infrastructure Policy are its explicit mention
of important principles that can actually serve as a guidepost to whet and structure projects. They include: efficient
and equitable contractual structures; transparent process
of procurement which go beyond the typical L1 to allow
a variety of measures depending upon the project and
situation; bidding efficiency; commitment to clearances;
and a fair and transparent regulatory process including the
independence of regulation.
SLPEs, Privatization, and PFIs at the State Level

State governments, as much as the central government, are
likely to benefit much from the higher growth in this fiscal
year, and in all probability the next as well. Rather than go
easy on fiscal reform this is the right time for state
governments to work on the framework for PPP and PFIs,
force through privatization/winding up of state-level public
enterprises and use the increased resources to commit to
local projects in such high positive externalities projects as
sewerage and sanitation in cities, arterial roads, upgradation
of the infrastructure of crucial cities. The temptation to
make budgetary support for sick state-level public enterprises
(SLPEs), and for the status quo in the electricity sector to
continue is large but must be resisted if they have to come
out on top at the end of this cycle of high growth. We see
that effort beginning in some states (Kerala, Karnataka,
Gujarat, Andhra Pradesh, and Madhya Pradesh in a stop
start manner), but nowhere is this strong enough.
Tourism in Kerala
Parashar and Cherian, in Chapter 5.4, discuss the Renovate,
Operate, and Maintain agreement of private players with
the government of Kerala for its tourist infrastructure. That
again has much potential to unlock the value of government
facilities which were underutilized. Measures to include
the private sector by allowing it to access land and sites
in a transparent and fair manner is the key to the
development of private infrastructure in the tourism sector.
Rate regulation may not be necessary but overseeing of the
quality of the services especially in mass facilties may be
called for. As the state goes through a boom in tourism
Overview
with the effects of 9/11 wearing off, a major private level
expansion into tourism is likely. The success in Kerala has
been very encouraging. This has belied the contention of
the detractors that dysfunctional politics is too deep-rooted
in Kerala for anything good to happen4.
SANITATION AND PFIS

Even after half a century of development not too many
homes in India have toilets. Sanitation and sewerage services
have had no private parties involved in provisioning. It
has been almost exclusively a preserve of the state
(Mavlankar and Shankar, Chapter 13.1). Indeed, in all
aspects of health and disease which have a public dimension
our record is pitiable. Our rank in sanitation is lower than
our rank in income. The failure of the state despite its large
comparative advantage virtually, doom the prospect of a
state-led infrastructure development, a priori arguments
notwithstanding. Our very high morbidity rates point to
the masking effect of the powerful technologies of permanent
immunity inoculations, antibiotics, and cheap therapeutics.
Without them the failure of our public aspect would have
been even more starkly revealed, by significantly higher
death and infant mortality rates.
Ghosh, in Chapter 13.3, brings out the dimensions of
the critical public infrastructure in rural West Bengal. The
focus is on Nadia district. Peoples participation is more
formal than real. The role of the panchayats in infrastructure
development is limited although the panchayat samiti has
some role through Employment Assurance Scheme (EAS),
Jawahar Rojgar Yojna (JRY), and Border Area Development
Project (BADP) (for the border blocks). However, in rural
water supply, the panchayats bear complete responsibility
for drinking water, and have ensured good coverage. The
opinion of the local women in the location of water taps
and handpumps continue to be ignored. There is much
avoidable ad hocism in the decision-making by panchayats
and more involvement of the people is possible.
13
to be supported. Majumder in Chapter 13.2 brings out

the dimensions of the campaign, its organization, the role
of NGOs and others, and the level of success achieved thus
far. The programme was simpleinvolving the distribution
at some cost of a slab-toilet seat and encouraging people
to construct their own toilets. The prior role of Operation
Banga in the rise of incomes of the very poor over the
last couple of decades provided a conducive macroeconomic
basis for the campaign to take root among the poor.
Priorities Must Change

Mavlankar and Shankar (Chapter 13.1) make a strong case
for large expenditure and investments in sanitation. They
also argue for newer organizational initiatives including
private participation, stakeholder involvement, as well as
that of NGOs and community organizations.
What are awaited are campaigns, the initial push, the
physical models for toilets and sewerage that are cheap and
hygienic. The linkage of toilets with water, and limitations
in the supply of water and sewerage mains can be a deterrent
to the process. With sufficient resources, it ought to be
possible for the government to attract much private
investment and innovative projects, and the scope for
innovation is large as exemplified by the toilet-seat revolution
in rural West Bengal, and the Sulabh movement in urban
India. The Sulabh movement can be scaled up with public
funds with appropriate PFI models. Similarly, smaller towns
urgently await the developmental and coordination role of
DFIs and governments, including the municipalities, for
PFIs with user contributions.
Lifestyle Economies
Total Sanitation Programme in the Burdwan district of

West Bengal has been eminently successful and within a
couple of years the Burdwan countryside should see a
significant decline in morbidity of the people. As the
coverage reaches a critical level the social attitudes against
the toilets would take a gestalt shift in favour of household
toilets and then that factor would carry through to almost
total coverage, except perhaps the poorest who may have
The moneys currently being wastefully spent on umpteen

poverty-alleviation and other target-oriented schemes5 can
be pooled and leveraged through PFIs that involve revenue
payments (annuities) by governments, and user charges
wherever feasible to create a crash programme in sanitation.
A war footing is justified since the benefits of sanitation
are social and there are critical minimum coverage below
which the benefits are not durable. But above that level they
could cumulate rapidly due to inherent indivisibilities, and
to the additive nature of the consumption of sanitation. The
cultural gestalt shift to a preference to use sanitation services
can suddenly emerge above a certain critical level of usage.
The potential expenditure which people would be willing
to lay out on sanitation could, as a result, increase much
faster than GDP. Then the consumer side scale or lifestyle
4 We are tempted to suggest that very rarely has there been so

dominant a politics which in itself was not an aspect and a result
of the economic, and which was immune from powerful economic
forces of change.
5 Many of the Planning Commission programmes that are

redistributive in nature have been plagued by the malaise of leakage,
little effectiveness or positive spillovers, and dependence on enormous
administrative energies for their management (Morris 2003).
Campaigns
14
economies can come into play as people imitate each other

and not having a household toilet becomes a situation of
shame. This can happen so rapidly that the willingness to
pay can go up suddenly to solve the problem. As per head
incomes rise in both rural and urban areas the basis for
such a transformation to an immeasurably better hygienic
situation exists today.
PFIs have yet to begin in this sector. The framework
and the design of the model contract and legal arrangement
are not ready. Urgent collaboration of the Ministry of Urban
Development with developers, financers, and stakeholders
is necessary to develop the overarching framework for
sanitation. One hopes that these would be ready soon so
that a large investment programme in the sector can be part
of the next new deal to keep the economy from slipping
into recession.
CHALLENGES
FOR
DFIS TODAY
Industrialization itself and, most certainly, late industrialization

has spawned the need for financial intermediaries since
markets, especially financial markets, may be late to develop.
Moreover, in late industrialization there may be a certain
merit to forced savings that is possible through domination
of financial intermediation. The functionality of financial
repression, for a country with an efficient state that is able
to bring forth other economiesof coordination, of scale
and scope, besides dynamic comparative advantagecan be
significant for the speed of industrial transformation.
Thus all successful late-industrialized nations have used
financial intermediaries and repression to raise the rate of
investments. As economies, they face less uncertainity in
the industrial sectors, hence, bankruptcy risk is low which
may be lowered further by kieretsu-like structures or by
state-owned intermediaries with management control of the
enterprises they support. Such economies show high debt/
equity ratio or, more correctly, outside-to-inside funds.
Their ability to keep the growth rates high shields such
risky financing, and in a way they are able to continuously
grow out of possible bad debts. Late industrialization also
generates a much larger share of the rising income in the
hands of workers so that a resource flow from the rest of
the economy to the investing modern private large industry
and the (efficient) state enterprise becomes necessary. People
with low (but growing) incomes are averse to save with the
market, trusting the fixed income of banks and such other
intermediaries with implicit government guarantees. This
lends an added functionality to the intermediary.
DFIs in Developed Market Economies

Even early industrializers like the US have used financial
intermediaries with a developmental orientation in trying
situations, such as during The Great Depression to bring

forth markets for long-term investments and savings.
In countries such as India which were not too successful
in using financial repression to engineer high growth, the
intermediaries played the role of lending out of their own
funds when the markets did not have such long-tenure funds.
The basis of such intervention was government monopoly
over the savings of the people. In late industrialization the
very success meant that increasingly many of their industries
(dram chips or computer pheripherals, for example, in the
case of Korea) would face fundamental uncertainty as they
came out of the catching up phase.
Markets too develop and repression comes at an
increasing cost, since as the growth rate of incomes fall
the value of rate of return to the savings (rather than to
the rise in savings through the rise in incomes per se) rises.
With capital mobility (especially outward) the existence of
financial repression is an invitation to disaster, and this
is exactly what underlay the Korean crisis. In countries like
India where, as the markets develop and financial repression
is removed through financial sector reform, there is little
space for DFIs in their traditional roles. Since the
government has no spare resources, and its own comes at
market cost, the access to cheap6 deposits can come only
with a banking arm.
New Roles for DFIs

Varma in Chapter 6.1 examines the historical role and
need for DFIs. In all cases conscious effort has to be made
by the DFIs to move away from their traditional roles. In
some cases as when the markets are well developed this
may simply mean that they fold into ordinary institutions,
that is, either give up their developmental roles. Or they
keep their developmental role not as a direct fund allocator,
but as an agent that is able to create the conditions and
itself contribute to leveraging large funds to risky and longduration projects which are most difficult to fund. This
new role is discussed at length, which ought to be of
interest to the ex-DFIs especially those that seem unable
to move forward. Specifically they now have the roles of
(a) development of financial markets; (b) assumption of
residual credit risk to facilitate bond issuance; (c) remedying
sectoral financing gaps; (d) being an instrument for improved
governance; and (e) think tank for new policy frameworks.
These are far more difficult to play than being an old style
DFI which meant allocating credit out of resources that
it was allowed to mobilize at favourable terms. It is also
to be noted that even the traditional role was not played
6 These are cheap in the absence of competition, because the
Indian Banks Association acts as a cartel, and the RBI as the owner
of the banks has little incentive to impose competition; and
government policies have kept alive a large spread.
Overview
as well by the Indian DFIs as the Korean ones. The Korean
DFIs roles were well integrated with Korean development
strategy at least till the early 1990s. The newer DFIs have
had good success especially in the think-tank role and
possibly in the assumption of residual credit risks.
MUNICIPAL FINANCE
AND
DEVELOPMENTS
Jha in Chapter 6.2 discusses the problems in obtaining

funds at the municipal level. The situation in the US,
Germany, and elsewhere are cryptically reviewed. The
principal challenges lie in: (a) strengthening the creditworthiness of local bodies; (b) removing the huge distortions
in the inter-governmental fiscal transfer framework;
(c) more than per se accessing of the capital markets. The
need is for a market-based system of access wherein the
monitoring and other risk measurement and management
functions of the market can be brought to bear on the
municipality and its projects. Without the first measure
no amount of credit enhancement or financial engineering
can be a substitute for legal, organizational and structural
reforms of municipalities.
Besides these, strengthening municipal bond issuance,
securitization of future flows, more innovative use of
government and multilateral guarantees, promoting infrastructure financing by banks and housing finance institutions
are ways to overcome the problem of municipal financing.
Ghodke in Chapter 6.4 addresses the same issue and,
specifically, the conditions for bond financing versus credit
financing, and argues that both markets need to develop
with support including tax concessions, pooling, and other
risk-management arrangements which DFIs could bring
about. The scope for credit through banks too is large even
when bond markets are vibrant. Competition between the
two systems can lower costs to the borrowers.
Vaidya and Vaidya in Chapter 14.1 bring out the
experience of local bodies in raising funds from the markets.
Joshi in Chapter 14.2 brings out the need for appropriate
reporting to citizens, users, and upper levels of government,
and the models for the same. The Canadian example is
reviewed, and the blueprint of a model for Indian
municipalities that can be usefully considered by municipalities, is presented, certainly by those who have announced
publicly their charter of commitments to people. In Chapter
14.3 he surveys the experience of all stakeholders in the
accounting reforms that the Chennai and other Tamil
Nadu municipalities went through. The gains made in
terms of information availability, transparency, aid to
managerial decision-making, and critical assessment of the
municipalities functioning are very significant. He decries
the slowness in the process of institutionalization of new
accounting systems.
DEVELOPMENTS
IN
15
ELECTRICITY
With the passage of the Electricity Act 2003 a major step

forward in the electricity sector has been taken. Open
access is almost inevitable. The imposition of the open
access can make even the most recalcitrant entrenched
natural monopoly wake up. It is, however, a moot point
if the diktat to reduce cross-subsidies could not have
worked much better with a non-distortionary mode of
subsidy delivery being incorporated in the Act itself. As
it stands today, while cross-subsidy may go it would be very
difficult to actually get rid of farmer subsidies because
electricity using farmers are discriminated against when
compared to farmers who use canal water for irrigation.
There are other reasons why farmers may have to be
subsidized. But that does not mean distortionary modes
of subsidization that create moral hazard in the distribution
entity. Unfortunately, the direct subsidy now being mooted
and accepted as the best solution in most discussions is
not direct enough. Giving the subsidy through the budget
to the distribution entities does not avoid the root problem
of moral hazard which provided sustenance to perversities
in the sectorinability to account for revenues, unrecorded
sales to the high tariff consumer, leakage, collusion with
theft, incentive not to meter, etc.
Draft Tariff Policy

The recent Draft Tariff Policy (DTP) is a major departure
from the past. Among other things it goes some way to
provide the much-needed regulatory clarity. It lays the
framework for transmission pricing through a 3 part tariff
that could do much to make open access a reality. The
proposals, on the whole are progressive especially a
transmission tariff which lays the basis for nondiscriminatory open access. Further developments to lead
to markets could have come had the DTP not insisted on
long-term contracts but on time of the day pricing and gone
ahead to define the mechanism for spot pricing. This is
eminently feasible for all entities that connect on the grid
with the installation of meters that register the drawl of
power by the instant to compute the Unscheduled Interchange
(UI) charges under the Availability Based Tariff (ABT).
Once the idea of a national grid and national level
optimality is accepted, the requirements of integrated
planning which is optimal not only regionally but also
across the nation would mean that the framework for
tariffs could not vary much across states and regions. What
can vary are the actual tariffs and perhaps the norms. The
state-level regulators thus may have to support stranded
assets, a possibility which is likely to arise in the not-sodistant future when the national market actually comes
about. Caps on taxes and such other measures will be
16
necessary as state governments face the problem of lower

costs of generation outside their states. These major risk
mitigants should have been part of the Draft or even the
Electricity Act 2003.
Why Not Drive Towards Markets?

The drive towards markets can be quicker than what is
envisaged. The proposals do not link up the competition
for supply of power (given existing assets) that is likely
because of open access to the competition to enter the
market. For this to come about a framework for the
construction of the national market for electricity is necessary.
Since the open access envisaged as of now stresses long
term contracts to bring about choice, the right way to move
would be to create a market for differences. These are some
of the tasks that lie ahead in the electricity sector. Only
when the time of the day tariffs allow for peak tariffs to
be high enough would the true value of a competitive, but
integrated market-based-system be revealed.
Performance Budgets
The combination of the EA 2003 and the Draft Tariff
Policy is certainly the first set of steps in the right direction.
For once, after nearly 10 years one is sure that reform
efforts mean what they shouldmoving closer to markets,
to fewer distortions, and to regulatory clarity. The earlier
Independent Power Purchases (IPPs)/Power Purchase
Agreement (PPA) were unmitigated policy disasters.
Although we have not looked critically at the Accelerated
Power Development and Reforms Programme (APDRP),
it seems that through the performance budget7 that it
brings, it has supported change even if it has not been a
harbinger of change. Perhaps that role as expected has been
played by the hardening budgets of state governments. The
process which had started in the early 1990s with the
reform and expenditure reduction policies of the government
was allowed some leeway. States using contingent liabilities,
off-budget borrowings, borrowings from the central
government, and access to new windows such as the Rural
Infrastructure Development Fund (RIDF) were able to
shift their budget constraints for a while. Now that would
be extremely difficult, but that does not mean that the
states would rush for reform.
Pressures for Reform

It was not on fiscal considerations alone that governments
such as Delhis initiated electricity reform. In fact for a
7
We have been arguing for performance in the electricity sector,

and more generally for all of Planning Commission funds to be
based on clearly laid out performance and fiscal criteria (Morris
1996 and 1998).
government with a short time horizon, reform may inform

cash outflow and other fiscal difficulties. This is Sagars
argument in Chapter 7.3. In Delhi the need to make
political capital out of the disenchantment with the power
supply situation was the key. The government wanted to
be seen to be doing something to improve the situation
and that was the reason for the reform; since reform meant
privatization and reigning in the leakages in the popular
perception. It also makes the prospect for reform in other
cities, even if after some time, real, as the Delhi government
is able to cash in on the goodwill that its management of
reform would have created. That should restore our faith
in democracy, despite the detours that populism imposes.
But the fiscal aspect may be stronger than is generally
accepted. It is not a coincidence that among the states
seriously pursuing electricity reform, Andhra Pradesh,
Madhya Pradesh, and Delhi, two clearly had strong
budgetary reasons. Both Delhi and Madhya Pradesh (since
the separation of Chattisgarh) buy a significant part of
their electricity from outside their own state systems and
against whom they could no longer build up payables. In
other words having to pay cash at full-cost prices (including
depreciation) they perforce make larger cash losses, and
that is a situation when governments wake up. In most
other states having recourse to large amounts of electricity,
generating capacity, as long as the leakages and losses are
such as to cover cash costs and there is no cash outflow
from the states budget, or when they are non-rising there
is no fiscal pressure. But when that happy situation changes
as in the case of Madhya Pradesh there is significant
pressure to reform.
The Madhya Pradesh Story

Pandey and Morris in Chapter 7.5 bring out the interesting
and inspiring story of leadership and action in the Madhya
Pradesh Paschim Kendra Vidyut Vitran Ltd (MPPKVVL),
which brought about a dramatic change in the organization.
Now there is major competition within the MPPKVVL
to take the changes to all divisions of the company. All
this was made possible by the organization being shielded
from the enormous pressure of vested interests who stood
to lose heavily in the clamp down on leakages. Officers
are out in the field ensuring that meters are installed,
catching thieves, filing and appearing in court cases,
fighting adverse reports, and persuading illegal colonies
to pay up within the organization they have been fighting
for change, transferring trouble makers, creating
foolproof systems to ensure correct reading of meters
and instituting processes to counter the moral hazard
inherent in varying consumer prices, and in improving
the service levels for consumers. Revenue realizations
have gone up sharply. The change first pioneered by
Overview
Sharma in Burhanpur has become a model for the rest
of Western Madhya Pradesh.
Making it Easy for Reform

How much easier the task would have been if the moral
hazard of consumer price mix arbitrage which the company
struggles against is removed at one stroke through uniform
prices direct subsidization of farmers. This would have
ensured that the vast organizational energies, political
commitment currently spent, could be used to greatly
speed up the process of recovery. Reform can pay, and the
paying consumer has benefited much since now there is
a direct line to a courteous and committed staff with very
quick response to complaints. A groundswell of goodwill
towards the reform is possible as the rates to the paying
consumer can actually fall with better recovery.
Currently the farmers, most certainly the larger farmers,
are in opposition to reform since they stand to lose. The
reform efforts have been completely sustained if these
farmers were given the option of direct subsidization (that
follows an unbundled process of identification). Then their
political support to reform, would be forceful enough to
break any other vested interests. That would also allow the
regulatory task to be much simpler, since now the regulator
and the government would necessarily not have to worry
with the issue of consumer mix arbitrage. Today the regulator
has to virtually duplicate the consumer information base
of the distribution company to be sure that consumer mix
arbitrage is not exploited.
Delhi and Andhra Pradesh

Singh and Sinha in Chapter 7.4 bring out the story of reform
in Delhi and Andhra Pradesh. In both the states, technology
and equipment (metering at all points of the distribution
network, pole mapping, complete measurement, electronic
metering) were used to bypass or, more correctly, go a little
slower on organizational reform to improve recovery and
accountability. Value to the consumer too went up. Support
of the administration and the politician, as also that of the
regulator, were crucial. Looking at the Andhra Pradesh and
Delhi situations they conclude that recovery is an easier
task for a state-owned enterprise (SOE) since the application
of the sovereign functions that the task involvesarrest and
investigation, charge sheeting, etc.implies that governments
or their parastatals have a better chance, though perhaps
lesser motivation in carrying out reform.
Funding Reforms
Kohli, in Chapter 7.2, draws attention to the need for
clearly laying out the sources and requirements of funds
in reform. The requirements can be higher than is typically
17
anticipated since there would be hidden losses or leakages,

urgently required maintenance and renovation expenditures,
and hidden liabilities that are revealed only after due
diligence exercises, subsidies during the phase of tariff
convergence and in the continuing phase of reform when
subsidies are direct, funds to provide for depreciation
which may have been inadequately assessed in the past, or
the need to depreciate at higher rates following privatization
and hike in the transfer price of assets over book value.
There is little point in reform being dashed because of
unanticipated or wrongly anticipated funds requirements.
REGULATION
IN
ELECTRICTY
The movement to deregulation involves light and incentive

regulation where there is pathological market failure
distribution and transmission. Supply, generation, and
auxiliary services could not go to the markets. Even then
the joint optimality of generation and transmission asset
siting and choice has to be ensured by the regulator.
Ensuring Optimal Capacity Addition

Principally, optimal planning would fall on the shoulders
of the regulator. For regulation itself to be light, models
of transmission pricing that give due recognition of its
competition creating effects on generation are important.
This would mean that transmission pricing is such as to
allow much access even if the usage charges are somewhat
higher. Clearly in the context of a national grid the postagestamp approach is out of question. Kalra, Bichpuriya, and
Singh (Chapter 8.1) lay out the framework for an appropriate
transmission pricing that gives due recognition to all
transmission costs. The preference is for the megawattmile method. They illustrate the working with an example
that would be of interest to the regulator and others.
Norms for Better Regulation

Shekhar and Kalra in Chapter 8.2 develop the norms that
can be used to regulate thermal generation in a near costplus regime. Cost-plus regulation is likely to continue for
quite some time and, rather than do the same tasks every
time a tariff application is made with only formal reference
to the details of other plants, a benchmarking process
would be far superior and would result in immediate
benefits since the process is transparent, reliable, and leads
to better understanding of the causal factors that underlie
efficiency and cost build up. And over a period the
accumulated data and analysis can lead to the development
of a relevant price index-based incentive regulatory formula.
Sinha, in Chapter 8.3, reviews the experience of
electricity supply to agriculture, the distortions therein,
18
and the measures suggested for improvements. He argues

that innovations in the organizational form of distribution
companies in rural areasfor example, cooperatives, and
organizations under the supervision of village committees,
physical separation of the village networks8, and comprehensive meteringare necessary before any real gain is
possible in distribution reform in the rural/agricultural
areas.
STRATEGY
IN
OIL
AND
NATURAL GAS
stocks, and this has happened since the profits of oil

companies this year, as prices rose, have been on oil stocks
arbitrage. This is quite unacceptable when there are largish
private players and stocks of oil PSUs already trade in the
market. An exit from APM should mean precisely that,
with the oil companies doing the job without having to
share information with the ministry. Expectedly, follow the
leader or price cuts to increase market share type of
behaviour, common in oligopolistic industries, is likely.
These issues need careful treatment.
The oil and natural gas sectors play a crucial role in any
economy and more so in India where there is both large
import dependence of the sector and also a dangerous
dependence of government revenues on the sector. Both
are undergoing privatization and reformat least in the
sense of a movement away from the administered price
mechanism. But several perversities, not generally
recognized, continue and may have even been introduced
by the reform. This sector bears a huge tax burden which
would have distorted demand immeasurably, and a
movement to rational taxation, even to revenue maximization
taxes, could be accompanied by a huge jump in demand
not anticipated at the moment. The adverse effect on
Indias competitiveness imposed by high taxes in these
sectors is large, and it stands to reason that, at least in
export industries, full MODVAT-type deduction of taxes
paid on fuels and electricity should post-haste be made
available to Indian industry.
Equity Oil Overseas
Huge Distortions Continue
Vertical Integration
The movement to APM does not really mean market

determination of prices. It means that instead of the
market responding to international crude and product
prices, the government with a lag specifies the price changes.
Without a substantial oil pool account this brings no value
to the consumer because there is no inter-temporal
smoothing. Then one can under or over stocking to make
money. These are returns to administrative decisions. It
merely replaces the random price movements with a step
function with the heights approximately predictable but
not the timing. That creates huge perversities to arbitrage
Ramganesh and Pawar, in Chapter 9.2, bring out the

vertical integration economies in oil that make stand-alone
refineries vulnerable especially when integrated refineries
have the ability to hold on to lower variation in the price
of the final product. The control over sources with vastly
varying extraction costs mean that the ability of different
players to bear falling oil prices is different or, in other
words, the ability to control or influence prices depends
not just on total output but on rents. So flexible rents which
large integrated oil companies could use can threaten the
existence of stand-alone and weakly integrated firms, unless
refineries in turn forward integrate into distribution and
into petrochemicals. The options for the Indian major are
explored, and it is unlikely that there are any first best
strategic options beyond backward and forward integration
in a situation where they have to compete with world giants.
The provisions in the EA 2003, would permit this and also

stand-alone companies for rural distribution, and as such Sinhas
suggestions to separate the two networks is consistent and necessary
given the different prices, and is in keeping with the Act. But this
can never be an optimal solution. It also makes necessary other
inferior methods (such as administrative control over hours of
supply, and power quality generally) and does not remove the vast
distortions that price subsidies bring in the agricultural sector. Only
uniform (cost of supply based pricing) can remove the need for such
measures and the distortions.
Mahalingam, in Chapter 9.1, brings out the strategic

aspect of oil, and commercial energy more generally, arguing
that strategy and security demand that the Indian oil
players foray globally to acquire oil fields which can provide
the hedge against arbitrary price rises in the thin spot
markets, and possibly against the large political risk of
having to depend upon the Gulf as our principal source.
China has fast diversified its sources and has been an
important acquirer of oil fields in the 1990s. Actually,
since it is easy to estimate with near certainty the lower
bound of Indias import requirements, there is an excellent
opportunity to take an open position on oil purchases into
the future which would inter alia amount to buying oil
fields, signing long-term contracts, etc. now that the foreign
exchange constraints are beyond us. Indeed it makes sense
to pre-commit a part of foreign exchange earnings to oil
because that can give greater stability and lower oil prices.
Regulation
Barua in Chapter 9.3 reviews the Draft Petroleum Regulatory
Bill and notes that it has several excellent features such as
Overview
open access to oil pipelines with some preference of first
use to the owner, and a transparent tariff mechanism. But
there are dangers too in certain provisions. Two of the
functions specified in the Bill are that the Board would
ensure adequate availability of products and also monitor
prices and take corrective measures to prevent profiteering.
Fulfilment of these objectives would essentially call for
micro-management of the sector, on lines similar to the
manner in which the erstwhile Oil Coordination Committee
(OCC) used to function, and allow the government a
backdoor control over the operative and market decisions
in the sector.
Chakraborty in Chapter 9.4 anticipating the need for
regulation of gas pipelines on open access common carrier
principles lays out the details of the regulatory approach
that has much potential to reduce risks and crowd in
investments and at the same time be fair to the users,
buyers and sellers, and traders of gas. Virtual pipeline and
cluster methods are possible options for pricing of
transmission networks which, while promoting competition
in the market for gas, also create sufficiently strong
incentives for investment in the network.
TELECOM
AND
ADC
The telecom sector after appearing to move so strongly in

the direction of uniform licence conditions for all players,
mobile or fixed line, WLLor mobile, now seems to have
come to a standstill. The force of technology ought not to
be nullified especially when the technology promises to
bring so much for the consumer and the society. To an
outsider the strong resistance of the mobile cellular
companies is difficult to understand. But perhaps there is
a history that is being missed. The access deficit charge
(ADC) which all cellular and other operators have to give
to the basic service (land line) providers in reaching
customers on their network, comes as a bolt from the blue
to other operators.
The arbitrary basis for this argument and what could
instead have been done are brought out by Jain in Chapter
10.1. She argues that the exercise of ADC computation
can be questioned firstly because the assumed extent of
tariff rebalancing is far greater than what is really required.
The segmentation framework assumed is also perhaps
faulty. That the incumbent could have used alternative
tariff packages to considerably enhance revenue9 was entirely
9 Today the BSNL/MTNL have bundled the cost of laying new
lines with that of providing massive redundancy. Everybody knows
that the BSNL/MTNL have laid 5 pair cables to every largish house
and fibre in many cities to buildings. The current usage levels are
only for voice. The potential of these for Internet and virtual private
networks is enormous with the correct pricing and the separation
19
ignored. Was the data supplied by the BSNL free of biases?

USO is a far better mechanism than ADC to fund universal
access which is all that the government should be bothered
about. And there is no logic in defining, as basic and lines
especially since mobile (both GSM and WLL) threaten to
be cheaper and are seen as having superior value for the
consumer. There was not the desired level of disaggregation
and accounts separation in the data supplied. The episode
brings out the large and confidence shattering bias in
favour of the incumbent. The reaction of the GSM operators
to opening full mobile to CDMA and to land line operators
is an unproductive reaction to biases which the government
and the regulator are unable to shed. With full mobility
on WLL, perhaps brought about by equalizing the licensing
conditions, growth can be even faster than what it has
been. So large the consumer side network economies.
WATER, PFIS,
AND
CONSERVATION
Goyal, in Chapter 12.1, takes a comprehensive look at the

water situation in urban India to argue that price reform
is important to enable better access of the poor. Being propoor means smaller access charges than at present, even
if usage charges are high. There are many interlinked
options for improving supply that involve the private sector,
especially small local firms, users associations, besides the
more regular large private participant. With tariff reform
there is much to be gained in moving towards PPPs and
PFIs. Recovery of waste, values gained in the avoidance
of mispricing, and of avoided negative externalities, are
all available and should be able to cover the cost of the
additional investment that the private sector could bring
in. In the maintenance of the system the comparative
advantage of the private sector, when users are brought in
the monitoring and conservation roles, can be very large10.
The global experience and economic theory, given the
characteristics of water as a use good, are additionally
marshalled in support of the suggestions made. As water
contracts and PFIs take root it is important to recognize
the potential as also the limitations of PFIs and, more
importantly, the appropriate forms for the same that lead
to better incentive compatibility.
Conservation
Ruet, in Chapter 12.4, examines the performance of water
organizations in the metros bringing out the organizational
of voice from data packets at the exchange end, which is possible
with most currently available exchanges. The regulator should have
allowed/encouraged the incumbent to factor in such revenues before
considering the access deficit.
10 Being a labour intensive activity the state has great difficulty
in controlling labour and its costs.
20
differences in the same, and how these have affected

pricing and supply. He also makes a case for recyling of
first level waste water which constitutes 40 per cent of the
secondary (toilet flushing) usage which can make the same
water go around far more effectively in a situation of
limited supply. Narayanmoorthy, in Chapter 12.3, brings
out the economics of drip irrigation based on actual field
studies. While drip irrigation (even with the current
distortions emanating from the horse-power-based electricity
pricing that makes the marginal price of water close to zero
for the farmer) is economic especially in water-intensive
crops, it is under-promoted and needs to be brought to
the forefront of government extension. The large initial
costs are a deterrent. All current subsidies to the agricultural
sector could be made available as a general input subsidy
which the farmer can then use to choose drip irrigation
given its strong economics. This would lead to its spread
especially among water using crops and in the drier parts,
to make Indian agriculture not only more efficient but also
far more ecologically sound. This is, of course, urgently
due and one more reason for directly subsidizing the
farmer.
Access and User Charges

Bajpai and Bhandari in Chapter 12.2 use National Sample
Survey Organizations (NSSO) data on water access and
usage at the household level to show that significant rise
in user fees would have to be accompanied by increased
and better (inside home) access to water. Thus the first
stage of water reform that hopes to build on increased and
efficient user charges are well advised to improve the
network access of many as part of the reform. This again
points to the gain (here in improving appropriability) of
spending more on access even if access costs are not fully
recovered to improve overall recovery. Access to a tap is
typically overpriced, since it is linked to a place to stay,
and the poor typically stay in huts, jhopris, and footpaths.
CONCLUSION
The time has come for a paradigm shift in the role of the
state in providing economic and social services. Post-haste
disinvestment of public enterprise needs to be given a
sound legal basis to distance the operation of disinvestment

from government. An independent and expert commission
operating under the framework of an act and policy would
be most appropriate.
Government expenditures on vital social services with
vast positive external effects need to be stepped up, but doing
this the old way would be wasteful and pointless even if they
have some positive demand-side effects. The need of the
hour is to create the policy, the frameworks, and the enabling
legislation and models for PFIs and PPPs that can capitalize
on private enterprise. Among the innumerable experimentation and experiences of non-governmental delivery of
social and public services all over the country, there are many
worthwhile and proven (social) inventions which need to be
scaled up. PFIs inter alia have the potential to address the
problem. Vast gains are possible not only in efficiency. In
the Indian system, the gains arising out of better allocation
including better and efficient supply that can be built into
the frameworks for PFIs and PPPs, can be enormous.
The poor have too long been used as an excuse to create
rents and to result in system and organizational failure.
That stands exposed since denial in the most public and
basic of services is large despite the intentions to the
contrary and the vast sums being lost in rents, inefficiency,
and misdirection. The new paradigm of mobilizing the
private sector and society, in competition and in
collaboration with the state can set in motion the processes
for the state itself to change and improve its efficiency.
The macroeconomic environment for such change is also
conducive today. In some sectors like road building and
management, the change has begun as increased role of
the private sector takes root.
The challenges faced by the DFIs are many as the
financial sector reform progresses. While some, especially
those with a large exposure to the manufacturing sector,
would have to become ordinary financial intermediaries,
others could continue to play a developmental role that is
very different from the sectoral sanction of concessional
finance of the past. Upon them falls the challenge of
leverage funds, credit support, residual risk taking, project
structuring, and framework development for better
regulation and sectoral markets, besides financial markets
development.
Overview
21
REFERENCES
3iNetwork (2003) India Infrastructure Report 2003: Public
Expenditure Allocation and Accountability, Oxford University
Press, New Delhi.
(2002) India Infrastructure Report 2002: Governance
Issues for Commercialization, Oxford University Press, New
Delhi.
(2001) India Infrastructure Report 2001: Issues in Regulation and Market Structure, Oxford University Press, New
Delhi.
Barua, S.K. and Mahendra Gujarathi (2003) Regulatory and
Accounting Considerations for PFI Projects: The UK
Experience, chapter 7.4, in 3iNetwork (2003).
Morris, S. (2003a) Expenditure Accountability in India: The
Interlinkages, in 3iNetwork (2003).
(2003b) Regional Development in India Today: Issues
and Concerns and the Interest of Gujarat in the Region,
mimeo, Paper presented at the National Seminar on New
Developmental Paradigm and Challenges for Western and
Central States of India, March 46, Gujarat Institute of
Development Research, Ahmedabad.
(2003c) Private Finance Initiatives in India: A Consideration
of Issues, mimeo, IIMA, Indian Institute of Management,
c. August.
(2002) Overview, Chapter 1, in 3iNetwork (2002).
(2001a) Growth and Transformation of Small Firms in
India, Oxford University Press, New Delhi.
(2001b) Issues in Infrastructure Today: The Interlinkages,
Chapter 2, in 3iNetwork (2001).
(Dec. 2001) The Challenge of Privatization Paper

presented at seminar on Disinvestment of State Owened
Enterprises organized at IIPM, by IIPM-IIMA and Shastri
Indo-Canadian Institute.
(2000) The Challenge of Privatization, Indian Institute
of Management, mimeo, and presentation at Seminar on
Disinvestment of State Owned Enterprises, The IIMAIndianoil Institute of Petroleum Management, sponsored
by the Shastri Indo-Canadian Institute.
(1998) Accelerating Industrial Development in Gujarat:
Critical Issues in Physical and Social Infrastructures, Paper
presented at the CII Conference on Gujarat: A Development
Strategy for the Next Millennium, 18 March 2003,
Ahmedabad.
Pandey, Ajay (2003) Public Procurement and the Private Sector,
chapter 4.2, in 3iNetwork (2003).
(1996) The Political Economy of Electric Power in India
(Part I and II), Economic and Political Weekly, 18 and 25
May, Vol. 31, Nos 20 and 21.
Rastogi, Anupam (2003) The Infrastructure in India: 20012,
in 3iNetwork (2003).
(2002) A Review of Sectors, Chapter 3.1, in 3iNetwork
(2002).
Varma, Jayanth (2003) Putting Private Finance Back into the
Private Finance Initiative, Chapter 7.1, in 3iNetwork
(2003).
(2002) Private Finance to Private Entrepreneurship,
Chapter 6.1, in 3iNetwork (2002).
22
THE INFRASTRUCTURE SECTOR IN

INDIA, 20023
Anupam Rastogi
A little over 50 years ago, when Edmund Hillary and

Tenzing Norgay became the first people ever to reach the
top of Mt Everest, it took more than 4 days for the news
to reach us. Today, when 137 people from different countries
scaled Mt Everest as part of the golden jubilee celebrations
of that memorable achievement, the world came to know
about it within seconds. In India major changes have
occurred in the telecom and road sectors and the country
is reaping the benefits of these developments. In the power
sector a change for the better has finally started. Competition
in the ports sector, especially in container port terminals,
has led the Tariff Authority for Major Ports (TAMP) to
make a volte face in tariff setting for major ports. For the
first time, the railways reduced passenger fares by 10 per
cent on its Rajdhani networka premium intercity rail
serviceduring the monsoon period. However, there is
little development in the building of better and safer rail
infrastructure. Freight costs across the country have fallen
significantly over the past 2 years. A change for the better
is discernible in all infrastructure sectors now, and there
is a healthy competition among states to provide better
infrastructure services to the public.
However, the Expert Committee1 constituted to look
into any lacunae in the infrastructure was forthright in
pointing out the shortcomings. Probably it underestimated
the institutional lethargy and overestimated private sector
The author would like to thank his colleagues Partha
Mukhopadhyay, Nirmal Mohanty, and Saugata Bhattacharya
for their constructive comments on an earlier draft of this chapter.
However, none of them is responsible for any error which may
have crept in. All views expressed in this chapter are the authors
views and should not be attributed to the organization he
works for.
1 GOI (1996).
appetite to take on the long-term risks inherent in

infrastructure projects but it was absolutely on the dot in
its opinion that, to improve infrastructure services,
competition had to be brought in, in the provisioning of
these services (GOI 1996). The story in this years review
is that wherever competition has entered in service
provisioning and delivery, services have improved, and in
a greenfield area such as mobile telephony they have
exceeded all expectations. If the government is keen on
private investment as a major tool to achieve its policy,
it must take policy decisions that will provide a stable
environment and encourage private investors to commit
funds to long-term projects, and be fair to consumers at
the same time.
Major changes in the energy sector have taken place.
Though it will take a couple of years or more for benefits
to be felt by retail consumers, the stage has been set to
provide power on demand to all categories of consumers.
The time is not far off when bulk consumers will be able
to get power at low prices. New discoveries of oil and gas
reserves in various parts of the country have strengthened
its economic underpinnings. At the macroeconomic level
positive fallouts are apparent. And even at the retail level
real benefits are available to consumers, such as being able
to buy premium, rather than adulterated, fuels. In telecom
and information technology (IT) major changes took place
last year with the introduction of the Code Division
Multiple Access (CDMA). As the problems related to a
level playing field are sorted out, the sector will grow faster
and give value to all its consumers. Competition among
different modes of transportation as well as the emergence
of multi-modal transportation is beginning to change
things for the better. New institutional arrangements are
planned for provisioning of urban infrastructure and new
The Infrastructure Sector in India, 20023

developments in the urban infrastructure including changes
in municipal accounting system. The issues in the power,
telecom, and roads sectors which are related to provisioning
economic infrastructure in a rural setting are particularly
challenging but there has been a headway towards
improvement. Rural infrastructure is implicitly linked to
agriculture and it is well known and accepted that an
inadequate rural infrastructure has been a bottleneck for
the efficient commercialization of agriculture.
ELECTRICITY
If India has to achieve a consistent 7 per cent growth in
gross domestic product (GDP) growth then power
generation and consumption of oil and gas should also
grow in line with the GDP growth. New power plants are
being designed to use natural gas as a primary source of
energy. Last year, both the power and oil and gas sectors
witnessed changes which will favourably affect long-term
prices and availability.
Developments
The Electricity Act 2003 has been accorded presidential
consent. The Act consolidates laws relating to transmission,
distribution, trading, and the use of electricity. It emphasizes
competition, introduction of anti-theft laws, open access
of generation bulk purchase and trade, transmission and
distribution networks, and time-bound restructuring of the
State Electricity Boards (SEBs). The Act seems to be a very
comprehensive one and it consolidates all the previous
legislations in a structured manner. Undoubtedly, the
Electricity Act 2003 is the most important legislative change
for the power sector but there are two equally important
expert committee reportsSettlement of SEB Dues, chaired
by Montek Singh Ahluwalia (GOI 2001), and Structuring
of Accelerated Power Development and Reform Project
(APDRP): Reform Framework and Principles of Financial
Restructuring of SEBs, chaired by Deepak Parekh (GOI
2002a)which will have a huge impact on the SEBs. The
Draft Tariff Policy that looks far in the direction of a lightly
regulated and competitive sector, has just been put out for
discussion. The Act and the Tariff Policy will drive the
sector for many years to come.
One-Time Settlement of SEB Dues: It was in the year 2000
that the central and state governments realized the
debilitating effect of SEBs on power sector development
(GOI 2001). In the previous report we outlined the
constitution of an expert group for the settlement of SEB
dues and the main features of their recommendation
(Rastogi 2003). It took some time to crystallize the
recommendations and the formulation of the scheme. The
23
crux of the scheme is that past dues of the SEBs will cease
to be a financial burden on the SEBs and will have to be
serviced by the respective state governments at concessional
terms. The future revenue generation of SEBs is, therefore,
no longer hostage to past liabilities and the path to reform
is smoother. Additionally, the debt forgiveness that the
one-time settlement of dues entailed (A Memorandum of
Understanding) MoUs which the state governments, signed
committing the useless to reform including tariff
convergence. The credibility of such committment is
obviously not very high. Nevertheless they constitute another
pressure on state governments to reform their electricity
sector. Liquidating the dues to allow central power
corporations (CPCs) to continue functioning was, in any
case, necessary.
As it stood, even if SEBs were to be privatized no buyer
would have been willing to take on the past liabilities of
these entities. Moreover, leakages in the distribution sector
are such that unless they are plugged, there is no hope of
finding a bankable solution to the power sector. Incentives
available to states under the APDRP are dovetailed in the
scheme, and the stick of cutting off the supply of power
and coal from central central public sector undertakings
(CPSUs) is to be wielded if a state refuses to honour its
obligations in time. In reality though the central government
would lack the force to carry out such drastic measures.
Implementation of the One-Time Settlement of SEB Dues: The
scheme progressed further as the Government of India
(GOI), the Reserve Bank of India (RBI), and the state
governments signed tripartite agreements. The RBI notified,
in July 2003, that dues of around Rs 12,000 crore were
to be paid by Andhra Pradesh, Assam, Goa, Gujarat,
Himachal Pradesh, Haryana, Karnataka, Kerala, Meghalaya,
Nagaland, Punjab, Rajasthan, Tamil Nadu, Uttar Pradesh,
Uttranchal, and West Bengal to the National Thermal
Power Corporation (NTPC) and other CPSUs. The states
which did not figure in the RBIs notification were
Maharashtra, Madhya Pradesh, Chhattisgarh, Bihar,
Jharkhand, Orissa, Sikkim, and Jammu and Kashmir.
Since then, the Maharashtra government has signed a
tripartite agreement with the Ministry of Power and the
RBI for one-time settlement of dues of around Rs 600
crore owed by the Maharashtra State Electricity Board
(MSEB) to various CPSUs RBI (2003). These bonds are
fully secure as they are backed by revenue flows from the
centre to the states via the RBI.
In a significant move, the debt burden of SEBs has been
further reduced as the central sector power utilities have
waived a Rs 10,000 crore delayed payment surcharge
component (DPSC) payable by defaulting SEBs, under the
one-time settlement of SEB dues. Accordingly, total SEB
dues to be securitized through the issue of tax-free bonds
24
by the concerned state governments have been reduced to

Rs 31,000 crore from Rs 41,000 crore2.
Further, the central government-owned Power Finance
Corporation (PFC) has restructured the debts of around
Rs 800 crore owed by 18 state-owned utilities. The state
utilities are expected to take advantage of the debt
restructuring because PFC reduced its base lending rate
to 9 per cent in June 2003. The debt restructuring would
reduce the interest burden on the states taking up power
sector reforms. Past loans were given at the rate of 12
15 per cent per annum. Restructuring the debts would,
therefore, mean a substantial savings in expenditure, since
the utilities continue to suffer revenue shortfalls. PFC
could offer this restructuring package to the states as it
took advantage of the soft interest rate regime by effecting
prepayments and exercising early exit options on some of
its high cost borrowings, particularly bonds3.
The Deepak Parekh Committee Report: The Parekh
Committee report outlined a reform framework and
principles of financial restructuring of SEBs that could
form the basis for devising state-specific reform
programmes. The report is aimed at helping the states to
devise strategies that are credibleand, hence, bankable
for raising transition financing support as recommended
by the Ahluwalia Committee (GOI 2001). The Parekh
Committee decided to address its task in 2 stages. In the
first stage the Committee reviewed the Accelerated Power
Development Programme (APDP) and suggested measures
for improvement to be incorporated in the APDRP as part
of a consolidated reform approach; and evolved a reform
framework and broad principles for the financial
restructuring of SEBs, based on a review of reform
experiences in India and abroad.
The reform framework has four critical components:
market structure, distribution zoning, regulatory approach,
and ownership. The report has not suggested any specific
way to reorganize an SEB but has identified the options
that are most appropriate in the Indian context. A reform
template is given in the report which will be the starting
point for devising the state-specific reformsthe second
stage of the Committees work. Hence, the Committee
recommended the linking of support from APDRP to
actual improvements and not to the adoption of any specific
approach (Box 2.1). The first part of the report has been
accepted by the government and the second part of the
report is being finalized4.
All states had been requested in 2002 to draw up their
5-year programme for the power sector. The allocation
2
3
4
Economic Times (29 July 2003).

Business Line (24 July 2003).
http://powermin.nic.in/
under the APDRP depends on the performance of the state

for both components of the programmeincentives and
investment. The status of utilization of APDRP funds
(investment stream) is given in Table 2.1. It is interesting
to note that almost all states have drawn up plans to invest
money in power projects. Though the investment component
of APDRP has achieved its budget target, the states have
not been able to tie up their counterpart funds. Only
4 per cent of the target investment could be utilized (Table
2.1). More funds are being allocated to transmission and
distribution projects as envisaged in the Parekh Committee
report5. The APDRP programme under the Deepak Parekh
Committee focused on power distribution and, hence,
issues such as reliability index of power supply, technical
loss reduction, proper billing, proper metering, improvement
in bill collection, and theft reduction have come into focus.
The performance of the states in the southern and western
regions under the APDRP and their business plans have
been reviewed by the Ministry of Power. A similar review
for the eastern and northern regions is yet to be undertaken.
The state-wise development of the southern states is as
follows:
Tamil Nadu: Tamil Nadu has introduced the concept of
the reliability index for power supply in 6 cities and
townsChennai, Coimbatore, Tiruchi, Madurai, Salem,
and Tirunelveli. Under the APDRP, Tamil Nadu had got
an allocation of Rs 976 crore and the state has assured
the central government that it would be in a position to
use Rs 600 crore within 2003 and the balance by June
2004. By the end of August the Tamil Nadu Electricity
Board (TNEB) would have a call centre in Chennai to
answer consumers complaints.
The TNEBs collection efficiency at 99 per cent and
distribution loss at 18 per cent are the best in the country.
The average distribution loss in the country is 4050 per
cent. The TNEBs business plan includes a reduction of
losses by about Rs 200 crore in 2003, by Rs 100 crore
each in the years 2004 and 2005, and by Rs 200 crore
during 20067, by which time it is expected to turn
around.
Andhra Pradesh: The government subsidy during 20023
reduced from Rs 3000 crore to about Rs 1800 crore. As
per the states business plan, by 20067, the distribution
companies would not need government support at all and
would be able to function on their own. Andhra Pradesh
has also started computing a power supply reliability index
for 20 towns and has put in place an effective anti-theft
legislation. The state has set up call centres in all district
5
Incentive-based funds were released to Gujarat (Rs 236.37

crore), Maharashtra (Rs 137.89 crore) and Haryana (Rs 5.01
crore) (Ministry of Power 12 June 2003).
25
Box 2.1
Structuring of APDRP, Reform Framework, and Principles of Financial Restructuring of SEBs
(First Part of Deepak Parekh Committee Report)
STRUCTURING
OF
APDRP FUND
FOR
SUPPORTING REFORM
The fund was originally recommended to be managed by an independent entity. However, keeping in view the issues put forward
by the Department of Economic Affairs regarding the constitution of such a Fund, the Committee recommended that allocations
for the programme should be clearly spelt out and the responsibility of sanctions, disbursals, and monitoring of funds utilization
under the programme be vested with the existing Accelerated Power Development Programme (APDP) Committee under the
chairmanship of the union minister of power.
Access to assistance under APDRP be made contingent on a state signing off on the SEB Dues Settlement Scheme, comprising
inter alia, the issue of bonds by the state for past dues and graded curtailment of supply on future default and agreeing to an
ex-ante audit of incentive related parameters, namely: energy input, cost of energy, cash collections from energy sales of the present
period, and average revenue realization.
There would be two streams of support from the APDRP Fundone for investment and the other as an incentive-based
one on reduction of the gap between unit cost of supply and revenue realization (calculation based on the number of units
purchased). The funds could also be accessed by private distribution companies.
In order to enable the states to begin to effect improvements, the Committee recommended that 50 per cent of the first years
allocation of APDRP funds, that is, Rs 1750 crore be made available to the states in the fiscal year 20023. For subsequent
years, the Committee suggested that the decision to retain or alter the share of support for investment should be based on
experience. It would be desirable to bring down the share of the support under investment stream and concommittantly increase
the share of the support under incentive stream.
The Committee recommended that assistance under this scheme should be leveraged by obtaining a matching contribution from
the state. In other words, while the Fund should provide 50 per cent of the funds required for a project, the balance 50 per cent
funds of the project requirement should be raised by the state. In order to avoid partial disbursements and the associated problems,
the Committee suggested exploration of alternatives whereby disbursal takes place after the projects are financially closed.
In order to ensure that investments quickly yield quantifiable improvements in performance, the Committee suggested the
following:
Efforts under this segment be directed towards concentrated zones.
Substantive weightage should be given to investments that are aimed at reducing commercial losses.
Sanction of new projects should be withheld if performance targets agreed upon for a project already funded are not
achieved. Further, where applicable, a portion of the funds may be linked to the achievement of performance targets by the utility
in targeted zones.
These funds should be made available to the utilities directly and should also be accessible for private distribution utilities,
subject to adequate safeguards to ensure that public as well as private utilities pass on the benefits arising out of such investments
to the end consumer, as for example, through tariff orders of the respective Regulatory Commission.
The remaining assistance from the Fund, that is, Rs 1750 crore from the first year and the allocations for the remaining years
under incentive stream should be disbursed as a one-for-one matching grant based on reduction of the gap between unit cost
of supply and revenue realization. This reduction must be on an enterprise level, where the enterprise is defined as a corporate
body or an Electricity Board or Department.
In effect, the incentive will be matched rupee for rupee, to the overall reduction in the gap at enterprise level, after adjusting
for the factors that are extraneous to the operational performance. As regards the base year of reference for calculating the
improvements eligible for performance improvement, the year 20001 is taken as the reference year.
The Committee did not recommend any specific market structures but it cautioned the states that they should avoid the Single
Buyer Model. Instead, in order to foster commercial discipline, the Committees template assumes that the distribution companies
would be allowed to procure power from the generators of their choice. Further, the Committees template includes a smooth
transition towards competitive market through sequential introduction of vesting contracts, and introduction of open access to
wires and choice to consumers.
The Committee recommended the formation of concentrated zones in the template, so as to demarcate areas where it is possible
to quickly reap substantive efficiency gains. Furthermore, considering the distinct characteristics of electricity supply to rural areas
and the international experience, the Committees template assumes that the government would ring-fence the subsidy that is
targeted towards the rural zones and deploy it diligently through a combination of innovative solutions such as minimum subsidy
bidding and involving user cooperatives and local franchisees, and fostering institutions to provide quality advice to these
franchisees on financial, technical, and managerial matters.
The Committee recommended multi-year regulatory regimes in order to (a) reduce the regulatory uncertainty and, thereby,
instill confidence among the private investors; and (b) induce the private utilities to aggressively pursue efficiency gains.
26
Accordingly, the Committee suggested that the SERCs consider taking such steps as necessary to make the adoption of multiyear approaches as soon as possible.
The Committees reform template envisaged the privatization of concentrated zones and the introduction of private participation
in the other areas, so as to enable harnessing of the private sectors focus on operational and investment efficiency and viability
of enterprises.
The template outlined by the Committee is a composite framework comprising unbundling and the introduction of
competition, concentrated zones, multi-year regulation, and privatization. In broad terms, these choices are borne out by the
international experiences in power sector reform and were already recommended by several other expert Committees.
The Committee strongly felt that the reforms should be implemented together and in a particular sequence in order to derive
the intended results. For example, the process of privatization needs to be preceded by announcement of the industry structure,
demarcation of concentrated zones, and institutionalization of multi-year regulation.
The Committee addressed the general financial debility of SEBs, by classifying it into two broad types of deficits, namely,
deficits from the past and deficits pertaining to the future. The Committee was convinced that the past liabilities could only
be serviced with the help of surpluses from the sector in the future and additional government (both central and state) support
from the budget. At the same time, the Committee felt that, given the precarious financial condition of the sector, servicing past
liabilities solely from the sectors returns in the future appears well nigh impossible. Hence, while evolving broad principles of
financial restructuring, the Committee espoused a combination of pruning the liabilities and refinancing at concessional terms
in addition to ploughing back a portion of both future profits and the proceeds from further divestments.
Source: GOI (2002a).
Table 2.1
APDRP Funds Utilization 20023
(Fig. in Rs Crore)
State
Project
Cost
Andhra Pradesh
1476.50
Bihar
717.57
Chattisgarh
424.58
Delhi
946.46
Goa
176.34
Gujarat
1035.80
Haryana
450.66
Jharkhand
444.85
Karnataka
1161.19
Kerala
350.35
Madhya Pradesh
598.98
Maharashtra
1107.85
Orissa
592.22
Punjab
667.46
Rajasthan
1255.05
Tamil Nadu
968.17
Uttar Pradesh
718.19
West Bengal
132.71
Assam
365.98
Arunachal Pradesh
67.29
Himachal Pradesh
105.51
Jammu and Kashmir 453.48
Manipur
10.13
Meghalaya
26.29
Mizoram
9.77
Nagaland
47.22
Sikkim
63.48
Tripura
13.27
Uttaranchal
361.51
Total
14,748.86
Contribution
from
APDRP
738.25
358.79
212.29
473.23
88.17
517.90
225.33
222.43
580.60
175.18
299.49
553.93
296.11
333.73
627.53
484.09
359.10
66.36
365.98
67.29
105.51
453.48
10.13
26.29
9.77
47.22
63.48
13.27
361.51
8136.40
APDRP Disbursement in 2002-3

1
(4/4/
2002)
2
(28/1/
2003)
3
(31/3/
2003)
39.07
16.11
10.00
72.75
52.00
50.00
9.00
21.35
18.23
12.00
29.77
17.07
27.83
45.00
14.72
6.52
54.07
19.05
28.40
32.12
30.12
19.02
10.95
13.33
57.69
13.36
23.52
46.74
41.72
62.24
44.45
105.51
6.52
30.00
19.05
57.69
23.52
46.74
39.63
12.26
35.00
35.00
50.00
86.02
19.71
10.00
20.00
2.67
2.67
2.67
2.67
2.67
18.50
425.94
6.57
1.11
10.47
14.53
81.13
661.65
75.00
667.92
Investment
163.82
66.11
10.00
105.51
22.04
105.42
56.33
12.00
145.15
30.43
74.87
138.48
54.35
53.98
125.64
111.57
80.12
19.02
96.97
0.00
43.04
20.00
2.67
6.57
3.78
13.14
17.20
2.67
174.63
1755.51
Source: Ministry of Power (Conference of State Power Ministers, 12 June 2003).
Incentive
236.37
5.01
137.89
379.27
Total
163.82
66.11
10.00
105.51
22.04
341.79
61.34
12.00
145.15
30.43
74.87
276.37
54.35
53.98
125.64
111.57
80.12
19.02
96.97
0.00
43.04
20.00
2.67
6.57
3.78
13.14
17.20
2.67
174.63
2134.78
Counter Utilization
part fund of funds
tied up by
the state
738.25
76.95
10.00
473.23
4.45
291.96
163.38
137.25
580.60
173.18
62.00
345.42
333.73
308.02
484.09
301.77
66.36
69.48
0.48
23.90
25.20
12.53
27.44
35.93
9.32
69.00
17.19
11.96
65.09
71.68
77.14
0.05
4.69
3.78
2.67
2.67
4550.64
56.60
586.80

headquarters to solve consumers complaints. Andhra
Pradesh had a sanctioned an amount of Rs 1460 crore
under the APDRP and in 20034 the state expected to use
up to Rs 650 crore, carrying over the balance to 20045.
Kerala: Kerala has set up its regulatory commission and
the first tariff petition was expected to be filed in July
2003. The state has issued an anti-theft ordinance. Kerala
started with profit centres for generation, transmission,
and distribution, and in a years time proposed to reorganize
them. Though the state had 100 per cent metering, it
needed to replace 8 lakh defective meters. The system loss
was estimated at 30 per cent and collection efficiency at
90 per cent.
According to the business plan, the electricity boards
loss of Rs 1023 crore in 20023 would be gradually
reduced to Rs 500 crore in the next three years. Under
the APDRP, the state had got Rs 350 crore, of which it
would use Rs 190 crore this year and the balance next year.
The electricity board had introduced the reliability index
in Thiruvananthapuram and would extend it to Kochi and
Kozhikode.
Karnataka: The state electricity regulatory commission
issued a discussion paper on the multi-year tariff issue to
seek views of all stakeholders. Under the APDRP, Rs 1200
crore were sanctioned to the state. Karnataka would utilize
Rs 600 crore in the fiscal year 20034 and the balance
next year.
The Electricity Act 2003

The enactment of the Electricity Bill 2001now called the
Electricity Act 2003was eagerly awaited. The Act has
done away with the compulsory licensing required to set
up generation and distribution plans. It has set up a central
power grid, which may act as a market for buyers and
sellers of electricity. But the most significant aspect of the
Act is open access. It encourages the various state
governments to sign up for corporatizing their SEBs which
would facilitate private participation in the distribution of
electricity. The new law will allow generators to sell power
directly to large industrial users for the first time, introducing
price competition that is meant to end the subsidization
for farmers and households through high rates for business.
Meters will be mandatory for all customers and state
utilities will get incentives for diligently collecting payment.
Utilities will be free to buy power from any supplier.
The Act has the potential for transforming the sector
into a commercially viable industry, provided the state
governments restructure the SEBs in the manner prescribed
in the Act. In short, it provides a strong stimulus for
reform and it presents a path forward to lead to a new
paradigm of the electricity sector. It represents the best
27
compromise possible to address the powerful conflicts that

beset the sector, and, as these are overcome, further
legislation and amendments may become necessary.
APDRP was mainly about reforming distribution but
the Act has provided a framework for the reorganization
of SEBs across the country by introducing private sector
participation in generation, transmission, trading and
distribution, and, most importantly, the first steps in the
creation of markets in generation and transmission.
Draft National Tariff Policy6: The draft tariff policy
prepared by the Ministry of Power in consultation with
Crisil is aimed at promoting efficiency and transparency
in the administration of subsidies, introducing competition,
and rationalizing tariffs. To achieve these goals, the policy
has tried to include some financial principles for generation
and distribution companies by which investors can earn
returns while moving on to a more market-determined
regime. A copy of this policy has been sent to all state
governments for feedback. The final tariff policy is to be
finalized by December 2003. The discussion paper aims
at generating a debate on the existing tariff norms and for
soliciting the views of various stakeholders7.
A Paradigm Shift: The draft policy envisages a differential
tariff for peak and off-peak hours for the promotion of
demand-side management, unbundling of tariff for
transmission services to reflect cost of various activities
and establishment of a cross-subsidy reduction road map.
Appropriate commissions are to look at time-of-the-day
tariffs for large consumers and gradually cover other major
consumer classes in a time-bound manner. The appropriate
commission would notify the periods for peak, off-peak,
and normal consumption. The tariffs for peak period
would not be higher than 1.25 times the tariff for normal
consumption, whereas the off-peak tariff would be lower
than 0.75 times the tariff for normal consumption.
The policy offers investors in all power segments a 16
per cent pre-tax rate of return (RoR) on equity. This carries
over from the regime of tariff fixation. If foreign debt is
used to finance projects, the policy allows for the exchange
rate variation to be reflected in the tariff, something that
had evoked criticism in the case of the Dabhol project.
The government seems to have set itself on a collision
course with power regulators by prescribing specific norms
in its draft tariff policy. Its mandate was to just spell out
the broad guidelines for setting tariffs. Central and state
power regulators say the draft intrudes into their jurisdiction
by prescribing specific parameters like depreciation rates
6
For details and critique see Chapter 7.1, Draft Tariff Policy:
A Discussion, by Ajay Pandey in this Report.
7 http://powermin.nic.in/
28
and incentive norms for power stations. They have pointed

out that according to Section 3(1) of the Electricity Act
2003 they should be part of the consultation process, but
they were ignored in the preparation of the draft policy.
Since the Policy Amendment is under discussion much can
change before it becomes policy.
Open Access: One of the key features of the Electricity Act
2003 is the mandatory and non-discriminatory open access.
Open access means non-discriminatory provision for the
use of transmission lines or distribution system or associated
facilities with such lines or system by any licensee or
consumer or a person engaged in generation in accordance
with the regulation specified by an appropriate commission.
This feature of the Act will facilitate power trading to
possibly reduce regional surpluses and deficits. It would
also facilitate the introduction of choice in distribution.
The Central Electricity Regulatory Commission (CERC) is
to finalize the norms for regulating open access by the end
of 2003. On the other hand, since cross subsidies would
be continued to be levied on buyers of power, the first best
option would continue to be captive generation.
Further Developments
Generation: Attempts are being made to improve the
hydelthermal power mix to 40 per cent over the next 15
years. The government is planning to provide equity support
of around Rs 17,000 crore to hydel power projects of over
14,000 mega-watt (mw) to be implemented during the
Tenth Five-Year Plan, through government-owned agencies
like the National Hydro Power Corporation (NHPC) and
the North Eastern Electric Power Corporation (NEEPCO).
The Maharashtra government plans to add a total of 815
mw of hydel generating power capacity during the Tenth
Five-Year Plan. The government will offer 20 small
hydroelectric power projects generating 30 mw of power
to private developers. Further, there are plans to undertake
hydel projects in Kullu, Chamba, and Shimla. The Punjab
State Electricity Board (PSEB) is also going ahead with
plans to establish the 2 x 9 mw Mukerian run-of-the-canal
hydroelectric power plant near Dasuya town in the
Hoshiarpur district of the state.
Hydro power is expected to become a substantial part
of NTPCs generation portfolio as well. The company plans
to increase its power generation capacity nearly three-folds
to 57,000 mw by the year 2017 out of which hydro will
have a component of 11,00012,000 mw. This would
enable NTPC to integrate both in backward and forward
direction. NTPCs first hydro project is coming up with
the 800 mw Koldam project on the river Sutlej in the
Bilaspur district of Himachal Pradesh. The project is
expected to go on-stream by 2007.
Power Trading: Power trading gained momentum in the

year 2002. The CERC is to finalize the guidelines on interstate power trading soon. In the meantime, it has allowed
Power Trading Corporation (PTC)licensed as a power
generation companyto continue with its trading activities
till 31 December 2003. PTC has been purchasing off-peak
power from Delhi Transco Limited (DTL) and selling this
power to Haryana. Delhi, Uttaranchal, and Haryana are
active in trading power. To beef up their energy security,
the northern states are creating buffers by entering into
flexible power purchase contracts with other states and
central utilities. Hitherto, these states negotiated take-orpay power purchase contracts. Under the new arrangement
they sell only the surplus power to other states. This
ensures they are able to take care of their seasonal as well
as peak/off-peak demand variations. They are also able to
meet any sudden demands due to unforeseen outages. Both
Delhi and Haryana are active players in the energy market,
vying for extra power from Himachal Pradeshs hydel
sources. Delhi is an interesting case. Here, peak demand,
both daily and seasonal, tends to be very high and, hence,
the state needs to get into such arrangements to take care
of the variations in demand.
The PTC will soon import 150 mw of power for trading
in India. The PTC has been designated as a nodal agency
for exchange of power between India and Nepal. At present
power exchange has been taking place in the border areas
of Nepal and India with the former being a net importer
of 50 mw. The PTC is also considering introduction of
pool pricing for trading and also looking forward to the
use of more sophisticated instruments like forward trading8.
The Tata Power Company (TPC) and other institutions
have equity stake in PTC.
Reliance Energy Trading Private Ltd (RETPL), a special
purpose vehicle (SPV) set up by Reliance Energy Ltd
(REL), has filed an application with the CERC for an interstate trading licence except in Jammu and Kashmir. RETPLs
move is a serious bid to tap emerging opportunities in
power trading in the wake of the passage of the Electricity
Act 2003.
The NTPC has embarked upon a plan to enter into
power trading. It would carry out its trading business
through its subsidiary, the NTPC Vidyut Vyapar Nigam
Ltd (NVVNL). The NTPC has sought approval from the
CERC. The NVVNL has already traded 20 million units
worth Rs 4 crore to Assam and Meghalaya since November
2002 up to March 2003. The NVVNL is discussing with
SEBs of Maharashtra, Madhya Pradesh, West Bengal,
Jharkhand, and Punjab for a similar trading arrangement.
The NTPC would ultimately like to have a nationwide
exchange for power trading.
8
http://www.ptcindia.com/

Power Exchange: PTC is awaiting a proposal from the
Nordic Power Exchange, Nord Poolthe worlds first
international commodity exchange for electrical power
for sharing experience and expertise in power trading.
Plans are afoot to establish a power exchange with the help
of Nord Pool.
Transmission: The Electricity Act 2003 has ushered in
private sector participation in the transmission sector.
Power Grid Corporation of India Ltd (PGCIL) has entered
into a joint venture with TPC to develop a 1200-kilometre
(km) long transmission line. The link will evacuate power
from the 1200 mw Tala hydroelectric power station in
Bhutan to the eastern region of the country. While TPC
will hold 51 per cent in the joint venture, PGCIL will hold
the remaining 49 per cent, with the latter guaranteeing the
returns from the project. PGCIL will not only obtain all
the clearances to build the project, it will also be responsible
towards collecting the revenues from the purchasing SEBs.
Distribution: Power sector reforms of the kind envisaged
in the Electricity Act 2003 are being implemented on the
ground. The NTPC has set up a new company, the NTPC
Electric Supply Company Ltd. (NESCL), to make an
aggressive entry into electricity distribution. In the first
instance, NESCL is in discussion with the Uttar Pradesh
Power Corporation Ltd. and the government of Uttar
Pradesh regarding the feasibility of taking over/acquiring
majority stake in the loss-making Kanpur Electricity Supply
Company (Kesco) and invest Rs 365 crore in the Kanpur
Power Distribution Circle to improve the power situation
there. As per the plan, NTPC will take over the management
of Kesco, whose power losses are estimated at 526 per
cent, by buying 51 per cent equity after restructuring of
Kescos balance sheet. The past debt burden will be left for
the state to waive. However, on the part of the new
distribution company, it has been agreed upon that they
have to reduce the aggregate technical and commercial
losses to 20.5 per cent by the end of 5 years. The agreement
seems to be in line with the Parekh Committee Report
and the Delhi Vidyut Board privatization. The success of
this venture would lead to the corporation taking over
other circles in the state.
The NTPC is also gearing up to supply directly to
several special economic zones (SEZs), breaking the
hegemony of SEBs over distribution. NTPC is keen to
diversify into new areas including power transmission as
part of its efforts to convert itself into a full-fledged power
utility by 2007. Indraprastha Electricity Supply Company
has applied for a distribution licence to the Delhi Electricity
Regulatory Commission (DERC) to sell power in the
Keshavpuram area of North Delhi. It has taken advantage
of the provisions in the Act whereby more than one
29
distribution licensee can operate in an area. If the licence,

which is being examined by the DERC, is accepted,
consumers in North Delhi will have a choice of sourcing
power from either the Tata-controlled North Delhi Power
Ltd or the new company.
In response to the opening up of the electricity market
for bulk users, the New Delhi Municipal Corporation
(NDMC) has gone to the Delhi High Court to permit it
to buy power from Transco at a lower rate. Earlier, it had
appealed to the DERC, but this resulted in the rates being
lowered by just 1020 paise, a cost saving of around
Rs 30 crore in the NDMCs annual power purchase bill.
The Vidarbha Industries Association (VIA) in Maharashtra
is actively exploring the option of purchasing electricity
from the power surplus Chhattisgarh, paying wheeling
charges to MSEB, because MSEBs tariff to industrial users
are high and it wants to increase it further! Permission
from the Maharashtra Electricity Regulatory Commission
(MERC) can be sought if this alternative is found to be
workable. The VIA claims that the proposed tariff revision
of the MSEB, if approved, will increase the electricity bill
by around 12 per cent for all categories and over 20 per
cent for industrial consumers.
Availability-Based Tariff: The availability-based tariff (ABT)
notified by the CERC with the aim of creating incentives
for improvement in grid discipline, is now being
implemented all over India. The frequency and voltage
profiles have improved remarkably after ABT
implementation. Several states including Delhi, Punjab,
and Haryana are taking advantage of cheaper power and
also the unscheduled interchange (UI) charges as incentive
under the three-part ABT regime wherein if a utility
overdraws power when the grid frequency is above the
prescribed upper limit of 50.5 hertz, it has to pay only
the variable charges for the amount of power drawn. The
fixed charges have to be borne by the state which was
supposed to draw power at that point in time. In addition,
the SEB also avails of UI charge which is an incentive for
overdrawing power at a frequency above 50.5 hertz.
Overdrawing when the grid frequency is below 50 hertz
is heavily penalized. Thus there is a powerful equilibrating
mechanism with ABT in place, and the challenge is to take
ABT beyond state level entities to individual distribution
entities/areas and generating entitities.
New Distribution Zones: The TPC has informally proposed
the setting up of joint venture power distribution companies
with the MSEB in Pune, Navi Mumbai, and Thane. The
ventures will not only improve the distribution networks
but also the overall financial health of the SEB. The TPC
plans to strengthen the distribution network in Pune by
taking advantage of the APDRP.
30
MERC Study: Mumbai has surplus power, off-peak and

two major power distribution companiesTPC and REL,
erstwhile Bombay Suburban Electricity Supply (undertaking)
BSESwith overlapping distribution networks in many
parts of the suburbs, are technically and financially well
equipped to create a competitive situation with immediate
effect. TPC planned to increase its retail customers in
Mumbai to 50,000 from 17,000 in one-and-a-half years.
In the long run, the company expected to cater to one
million retail consumers in Mumbai alone. But its plan has
been still born. MERC has ordered TPC to restrain from
supplying power below 1000 KVA in the distribution area
of REL. MERC on RELs petition filed in July 2002 said
that TPCs action was against the principles of a level
playing field. TPC has moved the Bombay High Court
challenging the order of the MERC, which barred it from
supplying power to retail customers. Supply of power to
retail customers has for long been a bone of contention
between TPC and REL, the retail distributor in Mumbai,
with the latter arguing that under the terms of the licence
issued to TPC, it alone can only supply power to bulk
consumers and not to retail customers.
MERC has brought the two rivalsTPC and REL
together for carrying out a comprehensive study on the
introduction of competition in the electricity distribution
as envisaged in the Electricity Act 2003. MERC has called
upon TPC and REL to file the terms of reference for
engaging a consultancy firm to study the issues relating to
Sections 42 and 14 of the Act, which deal with duties of
distribution licensees and open access and grant of licence.
TPC and REL have been asked to select a consultancy
firm/s (if need be an international level firm) for this
purpose.
Prayas Study: Prayas surveyed 12 Electricity Regulatory
Commissions (ERCs) to study their resources, the extent
of transparency, and public participation in their operations
(Prayas 2003). The Prayas Report clearly brings out the
need to address the issues of independence and autonomy,
empowerment, accountability, transparency, and public
participation, etc. relating to the functioning of the ERCs.
Task Force on Power Sector Investments and Reforms

The government has constituted a task force on power
sector investments and reforms, with the mandate to catalyse
fresh investments into the sector and oversee
implementation of the ongoing reforms measures initiated
by the government as well as the provisions of the Electricity
Act 2003. The 5-member task force is headed by Planning
Commission member N K Singh. The task force will
suggest ways to ensure speedier implementation of central
schemes like the APDRP, the Accelerated Generation and
Supply Programme (AG&SP), and tariff policy, a draft of

which has been circulated9.
The enactment of the Electricity Act 2003 along with
the Deepak Parekh Committee Report and the Ahluwalia
Report has put reforms in the power sector on fast track
and implementation of reforms are gathering pace. The
true beginnings of reforms are visible in all segments of
the industry.
OIL
AND
GAS
Economic development today is hardly feasible without the

use of petroleum products. Natural gas is emerging as the
preferred energy source of the future. As providence would
have it, we have found large gas fields in Indian waters.
Some informed geologists believe that the KrishnaGodavari
finds are part of a gas river which is much larger than
a gas lake. A very high success rate of exploration in that
area provides credibility to this view. Indeed India can
greatly expand its hydrocarbon extraction producing up to
3 per cent of the worlds oil and gas in the coming decades,
and if exclusive export economic zone is extended by
surveys after 2007, Indias oil-bearing sedimentary areas
can become 5.37 per cent of the worlds sedimentary
area10. (BP 2003; Doggett 2003.)
Demand Estimates: The demand for gas would grow at
a faster rate than that for any other energy source on the
basis of the fundamentals of the Indian economy and the
adoption of gas by new power plants and its use in the
urban mass transportation sector11.
The Ministry of Petroleum and Natural Gas (MOP&NG)
is revising its demand and supply projections for natural
gas in the wake of indications that the country can reach
self-sufficiency in fuel over the next 34 years. The ministrys
move can have major implications for the countrys liquefied
natural gas (LNG) import programme. The natural gas
working group for the Tenth Five-Year Plan had indicated
that the countrys domestic production of the gas would
be 85.8 million standard cubic metres per day (mmscmd).
However, the gas discoveries in the KrishnaGodavari
basin and other areas and the prospects of more such finds
have changed the scenario considerably. The working group
had apparently made its assessment before the gas find in
the KrishnaGodavari basin was announced. It is estimated
that the total domestic production of natural gas would go
up from the current 70 mmscmd to 142 mmscmd in
9 Business Standard (22 August 2003).
10 Basin-wise hydrocarbon resources as
(http://www.infraline.com/).
11 Business Standard (22 July 2003).
on 1 April 2003

20067, with the KrishnaGodavari basin contributing a
major part. Compared to this the domestic gas demand
in 20067 could be around 135150 mmscmd. This would
imply that the domestic production of natural gas would
be able to meet much of the domestic demand.
Furthermore, owners of gas fields are upbeat about the
prospect of striking more gas12.
Gas Pricing: It has been reported that Reliance will price
its KrishnaGodavari Basin gas at US$3 per million British
thermal units (mBtu) on a delivered basis. The price of
US$3 per mBtu offered by Reliance is substantially lower
than the price of naphtha and fuel oil (a sizeable proportion
of existing fertilizers and power capacity is based on these)
at about US$77.5 per mBtu and US$5.56.5 per mBtu,
respectively. This means that all users, irrespective of their
location, will get gas at this price. The corresponding price
currently charged by the Gas Authority of India Limited
(GAIL) for supply of domestic gas from the Oil and
Natural Gas Commission (ONGC) and other producers
in the private/joint sectors is US$1.9 per mBtu to plants
at landfall point/receiving point of on-shore gas, and US$2.5
per mBtu to plants along the HaziraBijaipurJagdishpur
(HBJ) pipeline. The local taxes are different in different
states and quite substantially so in some states. For example,
while Madhya Pradesh and Rajasthan charge 4 per cent
sales tax on natural gas or LNG, Maharashtra charges 15.2
per cent, Andhra Pradesh wants 16 per cent, and Gujarat
charges 20 per cent13. For imported LNG, Petronet LNG
12
Business Standard (9 June 2003).

could well change as the Gujarat government proposes
to reduce the sales tax on natural gas from 20 to 12 per cent
and the central draft policy on LNG has indicated that all states
should levy only 4 per cent tax at the landed point. Expectations
are that gas price is likely to hit the downward spiral and settle
at around US$3.5 per mBtu at the factory gate. In case of LNG,
the MOP&NG has asked for infrastructure status for incometax holiday, customs duty exemption on LNG imports, and a
declared goods status to fix sales tax of 4 per cent throughout
all states. However, the Ministry of Finance (MoF) has rejected
MoP&NG request on the ground that the 15-year tax holiday
would erode the countrys tax base with little benefit to the
consumers. The MoF also refused to bring down the customs
duty on LNG imports to zero because the current 5 per cent
was the minimal rate envisaged in the duty structure. On declared
goods status, being a state subject and they stand to lose a
significant part of the revenue if the proposal is implemented
the MoF would like to discuss it with states. Without these
concessions, the delivered price to consumers would be US$4.2
per mBtu compared to US$2.6 per mBtu currently charged for
domestically produced gas. The fiscal relief would have brought
down the price of imported gas to US$3.4 per mBtu, a number
acceptable to fertilizer and power producers (Indian Express 7
August 2003).
13 That
31
has indicated that its price (benchmarked to the Japanese

Cocktail Crude Index) at the Dahej terminal will be US$4
per mBtu14. At the user point, the price will be higher15.
The industries located in the hinterland may end up
paying an amount in excess of US$5 per mBtu. Apart from
Qatar and other Middle East countries Australia and Russia
are ready to supply LNG to India at a competitive price16.
Piped gas from Bangladesh could, perhaps, match the RIL
price. Iran and Burma are also competing to provide
piped-gas to India using transnational gas pipelines17.
The issue of gas pipelines is intrinsically linked to
delivered gas prices. The cornerstone of success of the
New Exploration Licensing Policy (NELP) is that the
companies investing in exploration and development of oil
and gas fields are allowed to sell oil and gas at market price.
The regassified LNG also can be sold at market price but
the price of the gas produced by ONGC and OIL is still
14
This will reduce marginally by US$0.10 per mBtu after

the reduction in import duty from 20 per cent to 5 per cent
announced in the Union Budget 20034.
15 The present price of gas in Gujarat at the delivery point,
as supplied by the Gujarat State Petroleum Corporation is around
US$4 per mBtu.
16 The NTPC tender for supply of 3 million tonnes per
annum of gas to 2 of its power plants in Gujarat, when settled,
will set the benchmark for LNG pricing in the country. It is
reported that RasGas of Qatar has pulled out of the tender
citing tough bid conditions. RasGas was among the 10 global
majors including Royal/Dutch Shell, Total of France, BG Group
of UK, Oman LNG, Unocal, Petronas of Malaysia, Petronet
LNG and Reliance Industries. NTPC had demanded a fixed
price of US$3 per mBtu for gas for 17 years. The gas was for
the expansion of the capacity of the Gandhar and Kawas power
projects from 650 mw each to 2000 mw each (Economic Times
5 August 2003). Reliance Industries gas find on the east coast
will face the first acid test before the end of 2003, when it
competes with public sector ONGC, Indian Oil Corporation,
and GAIL for a gas supply tender for a 1400 mw power plant
in Karnataka. RIL has offered to supply 7 mmscmd of gas from
its Krishna Basin deepwater block D6 to Karnataka Power Corp
Ltds 1400 mw combined cycle power plant at Bidadi, about
30 kms away from Bangalore. The first of the two 700 mw
units is expected to be commissioned in 30 months and the
second in 36 months from zero date.
17 The possibility of finding large reserves of natural gas in
the KrishnaGodavari basin and the deep waters of the
Andamans has cast its shadow on the proposed Indo-Iran gas
pipeline project. While the government maintains that the project
is on and a joint working committee, set up in August 2000,
is looking into its various aspects, knowledgeable sources insist
that the project may eventually be shelved. It will be foolhardy
to make huge investments in laying a pipeline for the gas that
India may not need in the future (Business Standard 2 July
2003).
32
controlled. The MoPNG is in favour of deregulating the

gas prices but the main user industriespower and
fertilizerhave raised serious concerns. In view of the
differing reactions to the gas price revision, the Prime
Minister decided to constitute the Group of Ministers
(GoM) in December 2002, to examine the issue and
submit a report to the Cabinet. The GoM entrusted the
task to a Committee of Secretaries (CoS) and mandated
the Committee to discuss the issues in detail and make
suggestions to arrive at a mutually acceptable price of the
gas. The GoM has recommended Rs 350 per thousand
cubic metres (mcm) increase in domestic natural gas prices
for the general consumer from Rs 2850 to Rs 3200, a rise
of 12.28 per cent. Power and fertilizer consumers will be
hit by this price increase. The GoM, represented by
producer and user ministries, will put forth the proposal
to the Cabinet for approval soon. The Committee also
approved a hike in GAILs transportation tariff for the HBJ
pipeline by Rs 10 to Rs 1160 per mcm per day.
For the power consumers, who account for 42 per cent
of the natural gas consumed in the country, since fuel costs
are a pass-through, the additional bill will be of the order
of Rs 550 crore per annum or a rise in per unit cost of
1011 paise. This would be mainly borne by the northern
states, where around 4500 mw of gas-based power generation
capacity operates. Implication of all these developments is
that gas prices linked to fuel oil prices are not in the longterm interest of Indian consumers. The government should
abandon its existing approach of linking the price of gas
to the imported price of fuel oil18. The pricing of gas
should stand on its own, especially when global trade in
gas is poised to take a quantum jump. Gas prices locked
at the rate of US$3 per mBtu would lead to the supply
of electricity at a competitive rate of Rs 2.30 to Rs 2.70
18
The Organization of Petroleum Exporting Countries

(OPEC) is crumbling now and OPEC producers have realized
that substantially higher prices are not in producers long-term
interests. Major Middle East producers have tried to follow a
strategy of maintaining moderate prices and high market share
that will maximize their returns over time. This strategy has
allowed non-OPEC economies to grow and prosper, whereas
excessive energy prices have led to reduced economic activity
and lower oil consumption. It also discourages a number of
activities that run counter to OPEC interests: oil conservation
and the substitution of alternative energy sources; synthetic fuel
research and LNG developments; tertiary recovery with tax and
fiscal incentives; and exploitation of non-conventional
hydrocarbons (heavy oil, oil shale, deepwater oil in Arctic or near
Arctic regions). A price of US$25 per barrel (1994 prices) is
considered to be optimal and US$20 per barrel discourages oil
conservation and substitution of alternative energy resources.
(Conn and White 1994). Equivalent gas prices are in the range
of US$34 per mmBtu.
per unit and would ensure a competitive position on the

merit order of most SEBs19. Even the fertilizer industry
stands to gain substantially when gas prices are allowed to
be market-determined (ICRA 2003).
Regulatory and Legal Developments

Instead of having separate regulatory authorities for natural
gas and the downstream petroleum sector, the MoPNG,
on recommendations of user ministries, has decided to
have a single authority in the country for the natural gas
and the downstream petroleum sector20. There seems to
be a confusion whether natural gas is a petroleum product
or not. Legally, natural gas is a petroleum product if one
goes by the Petroleum Act 1934 (35, of 1934).
A bill to constitute a downstream petroleum regulatory
board was introduced in Parliament on 8 May 2002 and
has been referred to the Parliamentary Standing Committee
on Petroleum and Chemicals (GOI 2002b). The bill would
be tabled in Parliament as soon as the Standing Committee
approves it. In the interim period, the Union Government
will continue to act as the regulator21. The Cabinet has
cleared a list of priorities for the fiscal year 20034 and
setting up of regulatory authorities for the downstream and
natural gas sectors is one of them.
The Petroleum Regulatory Board Bill 2002

The proposed bill is to provide for the establishment of the
petroleum regulatory board to regulate the refining,
processing, storage, transportation, distribution, marketing,
and sale of petroleum and petroleum products excluding
production of crude oil and natural gas. The purpose of the
bill is to promote competitive markets. salient features of
the bill related to petroleum product pipelines are as follows:
The bill will authorize the central government to
constitute a single authority for the downstream petroleum
sector for the whole country.
The regulator will have authority over new as well
as existing pipelines.
The regulator would regulate gas and oil product
pipelines which have been laid on common carrier principle
19
20
Business Line (30 January 2003) and GoM (2001).

The rationale for having the Gujarat Gas Act according to
the state government has been that the item gas and gas works
figures in the State List of the Constitution. The item gas and
gas works pertains to the synthetic and industrial gas and does
not relate to natural gas. The central government is of the
opinion that natural gas is part of mineral oils, which is under
the Union List. The issue of centrestate jurisdiction would be
settled after the Supreme Court has given its opinion on this
issue to the government.
21 Business Line (22 January 2003).

and captive pipelines and crude oil pipelines would not
come under its purview. New pipeline owners/operators
would have the right of first use.
In practice, pipelines will be laid on modified
contract carriage principle and existing owners and
operators of pipelines would keep the right of first use.
Only that capacity which is not being used would come
under common carrier principle. Even expansion of capacity
will carry the right of first use.
The regulatory body would have powers to declare
a pipeline as a common carrier, and to authorize laying,
building, operating, or expanding a pipeline as a common
carrier, or for establishing an LNG terminal, or for marketing
notified petroleum and petroleum products.
Before declaring a pipeline as a common carrier, the
owner would be given a proper hearing to fix the terms and
conditions subject to which the pipeline is to be declared
as a common carrier. The entity laying, building, operating,
or expanding a pipeline shall have the right of first use.
The authority would permit pipeline-on-pipeline
competition and invite open offers.
The regulator would have the power to regulate any
distribution or marketing company.
Guidelines for Laying Petroleum Product Pipelines

The MoP&NG has notified a new policy for laying
petroleum product pipelines in the country through the
Gazette of India Extraordinary dated 20 November 2002
(GOI 2002c). Salient features of the guidelines are as
follows:
There would be three categories of petroleum product
pipelines, namely: (i) pipelines originating from refineries
up to a distance of around 300 kms, (ii) captive pipelines
originating either from a refinery or from an oil companys
terminal of any length, and (iii) pipelines exceeding 300
kms in length and pipelines originating from ports. Category
(i) and (ii) pipelines would be for the exclusive use of the
proposer company and owned by the company. Any legal
entity can propose and own a category (iii) pipeline. Threefourth of the designed capacity of the category (iii) pipeline
would be reserved for the owner and take or pay contracts
and only one-fourth of the designed capacity would be
made available for use by anyone at government approved
tariff.
Through this notification the government has taken
away the monopoly of Petronet India Limited of laying
product pipelines in the country.
Contract carriage principle has effectively replaced
the common carrier principle for the pipelines22.
22
Gas Transportation and Infrastructure Co. Ltda

subsidiary of Reliance India Ltdhas been given permission to
33
The authority to grant right of use inland, that is,

to give licence to lay a pipeline, will remain with the
ministry.
There is a sunset clause in the guidelines. The
regulatory functions of product pipelines will be passed on
to the regulatory board constituted under the Petroleum
Regulatory Board Bill 2002.
Through the bill and the guidelines the government has
tried to address the issues of investment efficiency, operating
efficiency, and making the pipelines bankable. The
government has recognized that pipeline developments are
long-term investments and reliant on market growth for
their viability. The government recognized the nature of
these risks and their consequences and, thus, came out
with the bill and further liberalized the sector through the
guidelines.
Developments in the Industry

After the recent discovery in the KrishnaGodavari basin
Reliance Industries Limited is planning to bring gas to
household and industrial customers by 2006. For the D6
block Reliance has selected the concept of sub-sea wells
tied back to a gas evacuation pipeline system with provisions
to connect to future discoveries. For this, front-end
engineering and design for such a system has been finalized
and statutory clearances for development of the Krishna
Godavari D6 block are at an advanced stage. Reliance
plans to tap shallower wells in a sub-sea in the first phase
that could yield first gas by 2005, leading to Phase II a
year later that will tap deeper wells with the assistance of
a fixed processing platform installed on the continental
shelf 23. International upstream oil and gas consultant
DeGolyer and MacNaughton has certified that the gas
reserves are 10 trillion cubic feet.
Reliance Industries has also started work on a Rs 1500crore gas pipeline connecting Kakinada in Andhra Pradesh
and coastal Maharashtra. The pipeline will form the spine
of the companys gas distribution network, with links to
Gujarat and Dabhol. The pipeline is expected to be in
place by 2005, by which time the gas is expected to be
ready for marketing. Reliance subsidiary, Gas Transportation
and Infrastructure Company Ltd plans to spend almost
Rs 4500 crore on a 5895-km network of six pipelines being
built under the common carrier principle under which a
acquire land under the Petroleum and Minerals Pipelines
(Acquisition of Right of User Inland) Act 1962 to lay the Goa
HyderabadKakinada gas pipeline and the JamnagarBhopal
oil product pipeline. GoI, MoP & NG, Lok Sabha, starred
question no. 2763, answered on 5 December 2002).
23 Proceedings of the 29 Annual General Body Meeting of
the company.
34
quarter of the capacity is offered to other companies. The

Indian Oil Corporation Limited (IOC) is keen to have a
share in the pipelines as it would save transportation
charges. Reliance plans to link its Jamnagar refinery with
a 2540-km pipeline to Kanpur in northern India and
another 1580-km pipeline to Patiala, also in the north.
Shorter pipelines will be built to take products to interior
areas from the port towns of Goa, Chennai and Kakinada
in the south and Haldia in the east.
The other pipelines include the Rs 460-crore Goa
Hyderabad pipeline, the Rs 110-crore KakinadaVijayawada
pipeline, and the Rs 260-crore HaldiaRanchi pipeline.
These pipelines will originate at a port, to which products
are to be shipped from the Jamnagar refinery. Currently,
around 6 million tonnes of its products are being carried
by IOCs KandlaBhatinda pipeline and sold through IOCs
retail outlets in the northern and western markets. Reliance
is likely to transport petrol and diesel by ship from its
refinery in Gujarat to ports in Goa, Chennai, Kakinada,
and Haldia. From the port cities, 4 pipelines will evacuate
the products for feeding petrol stations in Karnataka, parts
of Maharashtra, Tamil Nadu, Andhra Pradesh, Kerala,
Bihar, and Jharkhand.
Utilization of gas in Andhra Pradesh: To effectively utilize
the huge quantity of gas found in the KrishnaGodavari
basin, the T L Sankar Committee on Utilization of Natural
Gas in Andhra Pradesh has recommended the creation of
a Hydro-carbon Highway for speedy transport of gas
through trunk pipelines across the state. The state
government had appointed the committee in December
2002 under the chairmanship of T L Sankar, Advisor,
Energy Group, ASCI, to study and make recommendations
on the effective utilization of natural gas for promotion of
industries in the state. The committee has suggested that
there is a need for various policy decisions with regard
to transport and pricing of gas and feels that the concept
of a Hydrocarbon Highway would facilitate the economic
growth of the region.
TELECOM
AND INFORMATION
TECHNOLOGY
Technology
The telecom sector is growing at speeds close to 70 per
cent per annum but development in the sector was
overshadowed by the issue of the offer of limited mobility
services by basic services operators (BSOs). The Supreme
Court set aside the Telecom Dispute Settlement and
Appellate Tribunal (TDSAT) order on provision of Wireless
in Local Loop-Limited Mobility (WLL-LM) services by
BSOs and sent the matter back to TDSAT for fresh
adjudication keeping in mind the issue of a level playing
field between cellular and basic services providers24. While

the legality of the services has since been settled by the
TDSAT, crucial issues regarding the full scope of such
services as well as the establishment of a level playing field
between cellular and limited mobility services operators is
to be ensured by the government and the Telecom Regulatory
Authority of India (TRAI). TDSATa quasi-judicial
bodyhas asked TRAI to give its level playing
recommendations by the end of 2003. Among the
suggestions put forward to make the playing field level are
charging additional entry fee from WLL operators, charging
for additional spectrum, and not maintaining the distinction
between the 2 services. WLL technology is being widely
used by the private basic telephony operators in India.
Reliance Infocomm nationwide and Tata Teleservices in
Delhi, Maharashtra, and Andhra Pradesh, are widely using
WLL for last mile connections where the network is
replaced by wireless to greatly reduce cost and deployment
time. WLL can technologically provide roaming, so that
the earlier WLL-LM had to be artificially introduced.
Today such operations could easily provide roaming facility
if allowed by the regulator. The Reliance telecom network
is based on CDMA technology. It is a digital 2.5G network.
It has 144Kbps bandwidth which ensures the high quality
of voice. The global system for mobile communication
(GSM) on the other hand has only 9.6Kbps for voice. One
can use features such as MMS (Multimedia Messaging),
streaming video, Internet, etc. The handsets are Java-ready
for utilizing third party programmes developed in Java. A
third party programme needs to be uploaded to the Reliance
server from which one has to download it and run it on
his mobile phone, thus converting the mobile phone into
a computer.
Todays CDMAGSM clash has its origin in two wrong
policy decisions of the early 1990s. One was that only
GSM would be used for mobile services. The other was
to put basic and mobile services into separate watertight
compartments for licensing purposes. With technology
breaking these barriers, policymakers will have to provide
for a migratory regime for telecom licensees stuck in one
compartment or the other. Appreciation of these historical
developments have led the minister of communication to
suggest that the proposal of unified licence can solve the
issue.
Competition
Competition in the cellular sector increased manifold with
Reliance Infocomm offering limited mobility service at
24
See Jain, Rekha and Dheeraj Sanghi, IIR (2002) for details
and an anticipation of the need for WLL to merge with mobile
service.

attractive tariffs and the launch of cellular services by the
incumbent, Bharat Sanchar Nigam Limited (BSNL), as well
as by the four licensees. The drastic cut in tariffs is witnessed
and many studies have warned an adverse effect of it on
the cash flows of the operators. Consolidation through
acquisition and alliances are continuing in the sector. For
example, Tata Teleservices acquired Hughes Telecom (BSO
in the Maharashtra circle, including Mumbai), some of the
cellular mobile service providers have come together to
form a pan-Indian alliance Mobile First. A proposal to
merge BSNL and the Mahanagar Telephone Nigam Limited
(MTNL) is also under consideration.
Humungous Growth: The Eighth National Telecom Survey25
revealed that the market for telecom services touched
Rs 50,000 crore in 20023. The services covered by the
survey included basic services, cellular services, national
and international long-distance, Internet services, V-SAT
services, and radio trunk services. It also included radio
paging, infrastructure, unified messaging, voice mail, and
audiotex services. The market in India grew 5.1 per cent
to Rs 50,358 crore in 20023 from Rs 47,908 crore in the
previous year. The basic services grew only 9 per cent in
20023, but revenues in the mobile telephony segment grew
50.5 per cent. The mobile segment added 7.75 million
subscribers in both GSM and CDMA lines (Box 2.2:
CDMA). According to the survey, the basic services
contributed 57 per cent to the total worth of the services
industry while the fast growing cellular services segment
contributed only 16 per cent. Other significant contributors
were the national long-distance (12 per cent) and international
long-distance services (11 per cent). The long-distance
segment, in fact, reported a 21 per cent decline in turnover
on account of a significant drop in tariffs. The Internet
services business accounted for 2.5 per cent only.
One of the largest beneficiaries of this growth is going
to be the central government as revenue is likely to grow
hugely. The government raised the service tax from 5 per
cent to 8 per cent in 20034 while the volume is growing
in the region of 10 per cent to 15 per cent.
Wireless to the Fore: The substitution of wireless phones
for wire-line ones is finally becoming a reality26. Basic
25
26
http://www.voicendata.com/
Cell phones in Delhi will outnumber landlines by
15 August 2003. While landline connections stood at about
22.5 lakh in June, cellular subscribers were close behind at
21.08 lakh. More than 1.5 lakh subscribers per month have
been added since May. While MTNL had about 21.72 lakh
subscribers, the Bharti subscriber base stood at 48,284 subscribers
and Tata Teleservices booked 2000 for wireline and about 30,000
for fixed wireless terminals till June (Economic Times 5 August
2003). The development is worldwide and not limited to India
35
telephony operators are providing wireless phones using

WLL-LM to customers. The subscriber base of private
CDMA service providers crossed 44 lakh in July 2003
a growth of 39 per cent over that of June 2003 according
to ABTO figures. Mobile services operators are up in arms
as this has exposed 80 per cent of their market to WLLLM because most customers do not roam beyond their
home city. There are 15 million mobile customers in India,
and this is expected to rise to 50 million within a few years.
The growth in wireline connections has been slowing down
since the last 3 years. In contrast, cellular connections saw
a 63 per cent rise in the fiscal year 2003. This drop in
wirelines has forced the existing fixed service providers
(FSPs) into the wireless segment. Though new connections
dropped until March 2003, the level of penetration has
been steadily rising due to mounting penetration in the
urban and rural areas (Figure 2.1).
GSM cellular subscribers crossed the 10 million mark
in December 2002, growing at 70 per cent per annum.
The growth was powered mainly by a 75 per cent reduction
in tariffs. GSM tariffs in India are competitively priced.
Reliance Infocomms pan-India basic telephony services
CDMA-based WLL-LM service branded as Reliance India
Mobileis arguably the cheapest in the world. The service
became commercially available from May 2003. Its tariff
of 40 paise per minute for outgoing calls and long-distance
calls anywhere in India on the Reliance network at local
call rates has been its main attractions27. Competitors
alone as telecom services using wireless telephony costs 25 per
cent that of wireline telephony (The Wall Street Journal 13
August 2003).
27 Reliance Infocomm hopes to become the largest cellular
player by end-September with a subscriber base of more than
4.8 million users. Reliance has entered into large deals with several
corporates for the use of their office personnel as also for use as
a freebie with another product. For instance, one can now get
Reliance handsets with cars, bikes, washing machines, and so on
as part of promotional offers on these products. Reliance is offering
the handsets free to corporates. In contrast to the early Reliance
Infocomm offers, the Monsoon Hungama offer had a very low
entry barrier requiring an upfront payment of Rs 501 only. The
handset cost is recovered through monthly instalments of Rs 200
payable over a period of 3 years. The Reliance Infocomm has
commissioned its services in 575 cities out of the total 679 cities
where it plans to be present ultimately. In terms of post-paid
subscribers, the company has the largest subscriber base as of date
according to the company announcements. The company is
currently test marketing its pre-paid cards and is expected to
launch a pre-paid product shortly. Reliance Infocomm hopes to
add about 1 million subscribers each in the months of August
and September. However, the companys subscriber additions in
Mumbai could be affected to a certain extent by the launch of
the CDMA-mobile services by Tata Indicom. The Tata service
launched their WLL services in Mumbai on 6 August 2003.
36

Box 2.2
CDMA Technology
CDMA stands for Code Division Multiple Access which was commercialized in 1995 by Qualcomm. CDMA is one of the
standards used worldwide to convert speech into digital information for transmission over a wireless network. CDMA assigns a
unique code to the bits of information to distinguish each call, a process that allows more callers to share the airwaves.
It is a form of spread-spectrum, an advanced digital wireless transmission technique. Instead of using frequencies or time slots,
as do traditional technologies such as Time Division Multiple Access (TDMA) use, CDMA allows the same frequency to be shared
among many users by encrypting each users signal using a different code. Its bandwidth is much wider than that required for
simple point-to-point communications at the same data rate because it uses noise-like carrier waves to spread the information
contained in a signal of interest over a much greater bandwidth. However, because each conversation is distinguished by a digital
code, many users can share the same bandwidth simultaneously.
Multiple users can therefore occupy the same frequency band. This universal frequency reuse is crucial to CDMAs distinguishing
high spectral efficiency. CDMA has gained international acceptance by cellular radio system operators as an upgrade because of
its universal frequency reuse and noise characteristics. CDMA systems provide operators and subscribers with significant
advantages over analog and conventional TDMA-based systems. The advanced methods used in commercial CDMA technology
improve capacity, coverage, and voice quality, leading to a new generation of wireless networks.
CDMA is now the most popular cell phone standard in North America, where it is used by Verizon Wireless (32.5 million
subscribers) and Sprint PCS (17 million subscribers). In South Korea the number of CDMA subscribers was 32 million in 2002.
In China, the Horizon CDMA network run by China Unicom Ltd signed up 7 million users in 2002 and is expected to add
an additional 13 million by the end of 2003 compared to an existing 200 million GSM subscribers. In India, Qualcomm has
invested US$200 million with Reliance Industries Ltd to develop a CDMA-based network covering 95 per cent of the
population. Reliance hopes to sign up 7 million subscribers by the end of 2003, an ambitious goal considering India had a total
of only 12.7 million cellular users in March 2003.
The worldwide GSM subscriber base is at nearly 900 million and is projected to exceed the 1 billion mark by 2004. By
comparison, the worldwide CDMA subscriber base is approximately 156 million. The GSM technology has an extensive network
across 70 countries while CDMA retains its traditional grip across the US, Japanese, and South Korean mobile markets. GSM
is catching up in North America. In 2003, about 28 per cent of new mobile connections sold in the US were GSM, a sharp
rise from 17 per cent in 2002.
120
Wireless
Wireline
Teledensity
100
5
4
60
3
40
20
Teledensity
80
1
0
0
Mar-00
Mar-01
Mar-02
Source: CRIS INFAC.
Mar-03
Mar-03 to
Jul-03
Fig. 2.1 Subscriber Growth of Wireline and Wireless Telephony and Teledensity
cellular as well as other WLL-LM service providershave

matched this tariff in one way or the other. BSNL and
MTNL have also responded with similar cuts as well as
free roaming between their networks.What we see here are
aggresive players pricing to take advantage of consumerside network economies to increase their market share.
Ultimately, few players would survive, and their best
insurance is a large share of the market.
The popularity of mobile services is due to its several

advantages over landline connections. Subscribers are
making vast use of mobile phones for purposes other than
making a call. The usage content provided by some cellular
operators ranged from the latest news to stock prices to
city guide and TV guide. Easy accessibility, free incoming
calls, and free voice mail are some of the additional
advantages.

Declining Average Revenue per User: The studies carried
out by Gartner and Pricewaterhouse Coopers suggest a
continuation of the negative trend on average revenue per
user (ARPU) for cellular service providers in the telecom
industry. The increased commoditization of telecom services
is going to accelerate in the coming years. While price
erosion may continue to impair the cellular industry, volume
growth and increased penetration would continue to create
opportunities for pan-India telecom service providers.
A study conducted by the economic research unit of
the Department of Telecommunications (DoT) for 1999
2001 has pointed out that the telephone is a status symbol
for low-end users and they make calls irrespective of the
charges. This indicates that there is a latent demand for
telecom facility among subscribers in this category,
according to the study. Nevertheless, the future of telecom
services is bright. The study also suggests that increase in
tariff does not affect low-end traffic though there is a
marginal drop in traffic among high-end users. The DoT
is to undertake a new study to monitor the impact of tariff
revision introduced from 1 May 2003.
Cellular service providers, who earlier distinguished
between pre-paid and post-paid subscribers in terms of the
number and type of services offered, are now launching
almost all new services, including international roaming,
GPRS (always on internet) and MMS across both categories
of customers. With over three-fourths of new acquisitions
being in the pre-paid category, service providers cannot
ignore this market due to its sheer size.
Regulatory Developments
TRAI issued consultation papers on tariffs for Cellular
Mobile Telephone Services, tariffs for Basic Services,
interconnection usage charge (IUC), Format for Tariff
Information and Unified Licensing for Basic and Cellular
Mobile Services. Following the quick pace of competition
in a multiple system wireless operating environment
(especially cellular and WLL) with an associated decline
in hardware costs, comments on retail tariff regulation is
no longer required. Most tariff components are set by
service providers but TRAI should continue with the use
of directives to ensure full disclosure of service conditions,
quality of service, prices charged to various segments,
tariff plans offered with connect charges paid, distribution
of calls, etc.
Interconnection Usage Charge: Interconnection is the link
that joins two or more communication units, such as
systems, networks, links, nodes, equipment, circuits, and
devices to enable users of one network to successfully
complete a call to another user or service irrespective of
whose network the originator of the call is using or to
37
whose network the call recipient or service provider is

connected to. This is referred to as the any-to-any principle
of interconnection. To provide the link one network owner
has to pay the other network owner.
The IUC regime has been implemented from 1 May
2003, under which WLL operators are required to pay
termination charges as payable by GSM operators. The
Calling Party Pays (CPP) regulation too has been
implemented. However, in view of the low affordability of
some wireline subscribers, TRAI is reworking the charges
to be paid under the regime and is expected to come up
soon with a revised IUC policy.
TRAI is likely to exempt private basic and cellular
operators from paying port charges to BSNL for
interconnecting with its nationwide network. This is because
BSNL is already being compensated for its investments in
linking up with the other operators by virtue of the IUC
in force since May 2003. Hence, there is no longer any
need for it to levy separate charges. These changes are
going to be announced when the revised IUC is introduced.
Access Deficit Charge: An Access Deficit Charge (ADC)
will raise the cost of cellular and long distance calls, but
will keep fixed line call charges at current levelsthus
ensuring that telephone calls remain affordable to the
Indian masses. If an ADC is not imposed fixed line tariffs
will go up. If it is imposed, depending on the quantum
of the ADC, cellular service tariffs could go up by anywhere
between 10 paise and Rs 2 per minute. Fixed line subscriber
trunk dialling (STD) tariffs could be around Rs 5 per
minute, up from the current Rs 4 per minute28. The
telecom regulator has justified the need for the cess on the
ground that BSNL faces an annual deficit of nearly
Rs 13,000 crore for providing subsidized local calls. TRAI,
however, is considering a sharp cut in its estimates of ADC
in the revised IUC. Interestingly, the ADC estimates going
to be used by TRAI will not be based on estimates provided
by BSNLthe main beneficiary of the ADC. TRAI is
getting these estimates from independent sources.
Calling Party Pays: After the introduction of the CPP
regime in May 2003, there was an immediate impact on
cellular usage. The use of cellular airtime has increased
more than 47 per cent from 270 minutes a month per user
on average to nearly 400 minutes between January and
June 2003. Despite the surge in airtime use, cellular
operators claim the average revenue per user has dropped
1015 per cent in the first half of 2003. With incoming
28
For a detailed discussion on recent regulatory initiatives

including the developments on ADC see Chapter 10.1, A
Review of the TRAIs Interconnection Regulation, by Rekha
Jain in this Report.
38
calls becoming free incoming traffic has increased by more

than 60 per cent from 150 minutes on average to 246
minutes. Outgoing traffic has also gone up by 23 per cent,
owing to the sharp decrease in tariffs.
TRAI has permitted cellular and basic operators to
directly interconnect with each other within a circle without
having to go through the network of BSNL. This will
reduce call tariffs between cellular and basic services by
around 20 paise per minute, the amount paid to BSNL
by operators as transit charge. The move will also reduce
BSNLs revenues by a few hundred crores. BSNL will also
have to bear the upgradation cost for interconnecting its
own cellular network with that of private operators. Until
now, the BSNL had refused to offer direct interconnectivity
between CellOneBSNLs nationwide cellular network
and private cellular operators, forcing them to go through
its fixed-line network.
Format for Tariff Information: The intense competition
among service providers has led to innumerable tariff plans
and many hidden costs. To address these issues TRAI
issued guidelines for the publication of tariffs by service
providers for consumer information to make them better
aware of the overall financial expenditure incurred under
any particular tariff package. The advertisement of tariffs
should include the tariff information in the format given
by TRAI and these guidelines should be implemented
forthwith while in case of advertisement on hoardings, it
may be stated that information regarding financial
implications may be obtained from the following address/
website (giving the address of the website or address).
TRAI has also launched performance indicators for the
telecom sector during 20023 on its website to present a
broad perspective on the industry to the stakeholders,
consumers, and analysts. The performance indicators
launched on www.trai.gov.in, which includes details of
each category of service providers, states that the subscribers
base for basic service had crossed 40 million and the
number of rural direct exchange lines (DELs) including
WLL (fixed) and WLL (mobile) connections had reached
around 11 million as on 31 March 2003.
Unified Licence: The policy measures taken in the recent
past, such as specifying GSM as wireless, or WLL-LM
without roaming, are now, with advancing technological
developments, being considered impractical. It is important
that regulations, under the garb of level playing field, do
not impede the smooth unfoldment of technology that
brings benefits to consumers. The main issues related to
telecom licensing are:
transitioning the existing discrete fragmented licences
for different services into a universal licence,
spectrum charges to be related to actual use of the

spectrum,
administrative rollout obligations to expand rural
telephony, and
restrictive practices by incumbent operators, for
example, poor interconnection.
Keeping some of the issues in mind, TRAI issued a
consultation paper on Unified Licensing for Basic and
Cellular Mobile Services. However, cellular services
providers, as the entrenched oligopolists, are leaving no
stone unturned to convince the telecom regulator not to
pursue the Unified Licensing regime. The scope of the
consultation paper includes entry fee, extent of mobility,
roll out obligations, performance bank guarantee, and
spectrum allocation procedure. Through this paper TRAI
has invited stakeholders opinion pertaining to terms and
conditions for consolidation in the industry and the need
to have a guideline to check the dominance of any party
in the industry. Unified licensingafter all the legal battles
may provide a level playing field between cellular mobile
services and the so-called limited mobility services, but it
will also need to level the uneven surface of past policy29.
Limited mobility was introduced in early 2001 ostensibly
to enable poor mans mobile services restricted by policy
to the local area of the subscriber. Until then, WLL was
permitted in the basic licence, but only for fixed access.
Reliance stayed away from the bidding process for cellular
circles (except for a few small circles) that other players
bought for astronomical amounts and opted instead to pick
up basic licences that were going cheap and without a cap
on the number of players.
If IUC is centred around the questionable ADCs that the
government feels private operators should pay to help subsidize
the operations of the state-owned BSNL, unified licensing
will benefit BSOs including Tata Telecom, Bharti Telecom,
and Reliance Infocom. Not surprisingly, the private basic
operators are wholeheartedly supporting the proposal for a
unified licence regime that has been proposed by TRAI.
They have pointed out that due to the technological
developments and the ability for the infrastructure to be used
for provision of other services, service-specific licences have
lost their significance and relevance. If the infrastructure is
not used to provide all the services, which it is capable of
providing, due to licensing restrictions, it leads to less than
optimum use of the infrastructure and waste of national
resources. This is a major change in orientation that can only
lead to the accelerated development of the sector as a whole.
29
For a rigorously worked out simple but transparent scheme

which provides a level playing field without making a big hole
in the exchequers pocket, see Disunited on United Licensing,
by Urjit R. Patel (Business Standard 29 July 2003).

TRAI has issued an addendum on its consultation paper
on Unified Licensing for Basic and Cellular Services. This
addendum has enhanced the scope of unified licences to
include NLD, ILD, and Internet services. DoT has noted,
The licensor has the power to amend/modify the licence
at any time if it is convinced that it is in the public interest
to do so or it is in the interest of proper conduct of
telegraph. If the regulator is able to ensure that no operator
is treated unfavourably in the process of recommending
the unified licence, the objections of the cellular operator
can be met by it.
DoT has allowed transfer of telecom licences within and
out of a telecom circle by amending with a caveat in
cellular and basic services licenses, that the acquiring
company will have to fulfill conditions applicable for the
grant of a fresh license and roll out obligations, thus paving
the way for further consolidation in the telecom industry.
Acquisition of licenses within the same telecom circle is
allowed. However, it is understood that the acquiring
company will not be given the frequency spectrum of the
acquired company. The government has also withdrawn
the clause related to the prohibition on sale of equity stake
before the expiry of 5 years of the licence.
Own Long Distance Rate: TRAI has allowed cellular and
basic operators to set tariffs for STD calls, instead of
relying on the rates set by long-distance operators. In an
interim order issued on 1 July 2003 the regulator has
shifted the onus of paying the interconnection charges
from long-distance carriers like Bharti and BSNL to the
cellular and BSOs from whose network the call has
originated. TRAI issued guidelines in December 2002,
making it mandatory for telecom operators to adopt a new
accounting system separating their records for each service
offered. The guidelines are aimed at identifying crosssubsidization practices in the telecom sector and were to
be implemented from 1 April 2003.
TRAI has already allowed BSOs to offer SMS on fixedline services and Bharti Teletech Ltd, the manufacturing
arm of the Bharti group, has unveiled the countrys first
SMS-compatible handsets that will enable the landline
customers to send text messages to other cellular, limited
mobility, and fixed-line customers.
New Issues
Spectrum Usage: The Ministry of Communications has
constituted a committee to study whether GSM-based
cellular operators are making optimal use of spectrum. The
report will be significant since allocation of additional
spectrum has been a long standing demand of cellular
operators. The cellular operators have blamed the low level
of spectrum allocation for the poor quality of service and
39
the congestion that mobile users complain of. The spectrum

committee formed by the Ministry of Communications to
study the usage of spectrum by cellular operators is likely
to make additional provision for spectrum allocation beyond
the current uppermost levels of 2 x 10 mega hertz (MHz).
Interestingly, with the upper limits for spectrum allocation
being pushed higher, the government may also need to
rework spectrum charges30. The committee is unlikely to
delve into this issue since this is beyond the purview of
the study.
WiFi to the Fore?: For the last few years spectrum has
continued to remain the battleground for the competing
interests of consumers, the technology industry, the military,
and other government agencies in developed as well as
developing countries. The uncertainty surrounding the
relationship between WiFi or Wireless (local) Lan (standard)
(WiFi) and WLL systems is causing hesitation in both
consumer adoption of the technology and in the setting
of standards for authorization by governments. However,
while the success of WiFi in the private data networking
area does not mean that WLL technologies should be
regarded as obsolete, it nevertheless raises issues that need
to be addressed by regulatory authorities. WiFi, whose
range is limited and whose quality of service is not adequate
at present, could become a competitor to WLL technology
in a few years time31.
30 As per the existing policy, the cellular operators are required

to pay 2 per cent of their adjusted gross revenue (AGR) as
spectrum charges on an annual basis if they are using spectrum
up to 2 x 4.4 MHz. They have to pay an additional 1 per cent
(that is, 3 per cent of their AGR) if they use spectrum beyond
2 x 4.4 MHz and up to 2 x 6.2 MHz. For spectrum allocated
beyond 2 x 6.2 MHz and up to 2 x 10 MHz, the operators
are required to pay 4 per cent of their AGR as spectrum charges.
31 To use WiFi, while on move, one must have a laptop and
there are few people who carry a laptop all the time. Unless WiFi
is added to a mobile phone, most people will not carry a WiFi
enabled device. Nokia already has a mobile phone which is WiFi
enabled. (For a detailed and interesting discussion, seeThe
WiFi Wireless Internet may be just Another Bubble, (The
Economist 28 June 2003). For an opposite view, see WiFi
addicts go to extremes to access web, (AWSJ 13 August 2003).
To understand how the WiFi technology is being absorbed by
Intel, Cisco, Microsoft, and T-Mobile, see Nimble Giants: Titans
Swallow Wi-Fi, Stifling Silicon Valley, (The Wall Street Journal
8 August 2003). It seems that 802.11 technology is optimized
for inside and low user-based services. 802.16 and other WLL
technologies are for outdoor, long range, dedicated user markets.
The success of WiFi market cannot be extrapolated to the public
Hot Spot market. But 802.16 technology can serve as back-haul
technology for Hot Spots and may evolve as complementary to
802.11 technology (Kalmus 2003).
40

Table 2.2
Golden Quadrilateral Completion Schedule of On-going Contracts (as on 31 May 2003)
Completed/Four-laned
Km
Contracts
Cost (Rs bn)
1327
Under Implementation
4383
90
155.36
Number Portability: Number portability is going to be

implemented in 2004 in the United States (US) and once
cellular service providers do it, fixed-line operators will fall
in line sooner or later. In India, it will take some time
for number portability to come. TRAI is going to study
the number portability issue soon32 (GOI 2003a).
Under number portability, a subscriber can retain his/
her number even while switching to a new service provider.
Number portability can be across services, across networks,
across cities, and within a city. Big telecom operators hate
it, new entrants love it, the regulator has no time for it
but the consumer would be the biggest gainer from
introduction of number portability in India. The Telecom
Engineering Centre (TEC) has shot down number portability,
reinforcing itself as the biggest obstacle to real competition
in the sector. TEC claims that the time is not ripe for
number portability as it would increase the cost of a call.
One would hope that DoT would not do something that
makes number portability difficult at a later stage. But by
renumbering all phones in the country (by adding the
service provider code 2 for BSNL/MTNL, 3 for Reliance
Infocomm, and 56 for Tata Telecom), they have taken a
step in the wrong direction because operator specific
numbering is a hurdle to number portability33.
Convergence: Lastly, we touch upon the Convergence Bill.
It has been in limbo since 2002 because of a conflict
between the then ministers for broadcasting and
telecommunications. The bill envisaged a combined
convergent regulation both of the technical infrastructure
and the content of broadcasting. There are many legitimate
differences related to convergence. Just to mention one
example: how can an omnibus regulatory body deal with
both the technical issues of networks as well as the content
of broadcasting. Just as the press and the cinema are
separately regulated, the content of broadcasting must also
be separately regulated. Content has nothing to do with
the infrastructure, that is, the telecommunications network.
In short, the telecom technology is unfolding as a far
more complex tapestry than had been expected, with
dispersed arrangements and disruptive and discontinuous
33 For arguments supporting the early introduction of number
portability, see Sanghi (2001).
Award during Financial Year 2003-4

136
4
9.04
Total
5846
94
164.40
technology. However, the availability of a vast amount of

information in digital form and the ability to communicate
it using airwaves has opened new vistas in communications.
The telecom sector is being affected by these developments
and probably a new way of working and organizing our
lives is on the horizon.
TRANSPORT SECTOR
Roads
Progress of the National Highways Development Programme: As
the two mammoth trunk road projectsthe Golden
Quadrilateral (GQ) (5846 km) and the North-SouthEast
and West corridor (7300 km)move towards completion,
albeit with some delays, private sector interest and
participation in the projects has been unprecedented. Table
2.2 shows the status of the GQ project and Table 2.3 shows
the source of funding for the projects under implementation.
It has been reported that only 45 per cent of the GQ project
will be completed by December 2003. By the end of
December 2003, four-laning and upgradation in 2630 km
is expected to be completed. While the centre has officially
extended the deadline for finishing the project to December
2004, the Ministry of Road Transport and Highways
(MoRTH) has informed the Planning Commission that the
work will not be completed before mid-2005. It has been
reported that the National Highways Development
Programme (NHDP) is one of the 7 schemes that the Prime
Minister will direct to ensure the timely completion of the
GQ project and the northsouth and eastwest road
corridors34. The Cabinet Committee on Economic Reforms
(CCER) has approved the list of schemes to be taken up
on priority basis in 2003435.
34 A study conducted by the Asian Institute of Transport

Development suggests that infrastructure projects such as national
highways help in reducing poverty and improving human wellbeing as much as directly-funded poverty-amelioration
programmes. The study based on data collected from villages on
NH2 found that incidence of poverty is lower than that of
villages situated further away from the highway (Business Standard
28 July 2003).

Table 2.3
Distribution of BOT, Under Implementation as part
of the Golden Quadrilateral projects
(as on 31 May 2003)
Type
Km
BOT
Annuity
SPV
435.10
475.55
197.70
No. of Projects
7
8
6
In line with the 20034 budget announcements, the

MoRTH proposes to take up 4-laning of about 10,000 km
of national highways through private sector participation
on Build, Operate, and Transfer (BOT) basis. MoRTH is
proposing viability gap funding which in essence are cash
flows to be provided by MoRTH during the concession
period to ensure financial viability. MoRTH proposes to
take up about 650 km of road stretches in the fiscal year
20034. The National Highways Authority of India (NHAI)
is also evaluating various options (project recourse debt,
NHAI-guaranteed loans/bonds, etc.) for financing the portconnectivity projects.
Seven high-density road corridors would be multi-laned
this fiscal year under the Rs 48,000 crore BOT road
upgradation scheme. The 7 sections, totalling 622 km,
have been selected from a preliminary list of 23 projects.
The 23 national highways were identified by the Ministry
for Project Implementation. The projects under the road
upgradation scheme have attracted 115 bids from domestic
and international road construction companies. The ministry
would shortlist 40 contractors from this list to form a panel
of entrepreneurs, who would then bid for these projects.
It seems that in a hurry to build roads, the ministry is once
again slipping into one-time contracts rather than providing
good road infrastructure to people permanently.
State Highways: Multilateral agencies are providing funds
to state governments for upgrading the state highways as
roads are being considered an important aspect of
infrastructure which helps to ameliorate poverty. Tamil
Nadu and Madhya Pradesh are the two states which have
received commitments from multilateral agencies.
The World Bank has approved a US$348 million loan
to improve the quality of 750 km of state highways in Tamil
Nadu Road Sector Project. In addition, 14 bypasses will
be upgraded to two lanes with or without paved shoulders
and 2000 km of roads will be taken up for major
maintenance. International consultants have carried out
the road segment designs. The scheme is to be implemented
by the state highways department. The government on its
part will provide US$102 million to the US$450 million
project. The World Bank loan is payable in 20 years and
has a 5 year grace period.
41
The government of Madhya Pradesh has taken up

upgradation of state highways and major district roads
covering a distance of about 1900 kms in two phases. An
investment of US$341.4 million is being entailed and this
will be met by loans from the Asian Development Bank
(ADB). (US$180 million) and with state government funding.
The Phase I scheme involves strengthening and widening
of 6 state highways for a total distance of 353 km at a
cost of Rs 2610 million under 4 packages.
Performance-based Management and Maintenance: The
Kerala government has decided to hand over the
maintenance of certain roads to private parties under the
Performance-based Management and Maintenance system.
This is a part of the Kerala Transport Project funded by
the International Bank for Reconstruction and Development.
To start with, the government has chosen some of the roads
in the district of Thiruvananthapuram, Alappuzha, and
Malappuram. The selected contractor will have to maintain
the road section he is responsible for at the specified
service quality defined in the contract level throughout the
3-year contract period36.
Lacuna in the Central Road Fund: The Union Government
is concerned over the slow pace of utilization of the Central
Road Fund (CRF) corpus by the state governments. Under
the revamped CRF, the Union Government had approved
1796 proposals amounting to Rs 28.95 billion from the
state governments till 31 March 2003 for improvement of
the state highways and major district roads. However, only
Rs 15.82 billion could be released due to slow utilization
by the states.
NHAI failed to make the management of the CRF
visibly strong and accountable, by vesting it with a strong,
independent Road Board with representation from key
road-user groups. The current approach to the management
of the CRF affects the Funds credibility among NHAI
bond investors and financiers of the annuity projects, since
all the key decisions pertaining to the Fundsuch as
investments, raising of funds through securitization, and
allocation of funds across national highways, state roads,
and rural roadsare vested with the government. As a
consequence, the Funds ability to meet its obligations has
become highly contingent upon changes in government
priorities. Already, it appears that the receipts into the
CRF declined from Rs 5962 crore in 20012 (actuals) to
Rs 5791 crore in 20034 (budget), and during the
corresponding period, allocation of funds to the NHAI
from the CRF also declined from Rs 2100 crore (revised)
to Rs 1993 crore (budget). But the government has
announced 48 new road projects covering a total length
36
http://www.infraline.com/ (13 August 2003).
42
of 10,000 km in the Union Budget 20034. In case the

NHAI is required to implement these projects within the
existing framework and allocations, it might end up overcommitting the future cash flows from the CRF, either for
raising resources through securitization or for annuity
payments. Moreover, aggressive securitization of the future
cash flows to raise money for the new projects might leave
the CRF with too little resources to meet its existing
annuity payment obligations. In order to sustain the
confidence of the investors, it is crucial to ensure that
commitments on the CRF are kept in line with the
anticipated inflows into the CRF.
Ports
The container terminal segment witnessed a major spurt
last year. The 4 major portsJawaharlal Nehru Port Trust
(JNPT), Mumbai Port Trust, Cochin Port Trust, and Kandla
Port Trust have drawn plans to add a container terminal
each. The government is following the landlord port model
where private parties will operate terminals and other
services while the ownership of land, waterfront, and
security would remain under government control. Old
rules of port privatization with respect to net worth and
track records are suitably modified to make way for Indian
operators. JM Baxi & Company along with the Dubai
Ports Authority is setting up the Visakha Container Terminal.
P&O Ports, through its Mauritius registered company,
took over the Mundra International Container Terminal,
earlier known as Adani Container (Mundra) Terminals Ltd
and A P Mollier Group (a Danish company which owns
Maersk Sealand) is likely to take over the Pipavav Port.
Major Improvements: There has been an improvement in
port productivity over the years. According to a World
BankCII study, the turnaround time for vessels in Indian
ports has improved from 8.1 days in 19901 to 3.7 in
20012.
Two more private container terminals, besides the Nhava
Sheva International Container Terminal (NSICT), have
come up in Chennai and Tuticorin since the opening of
the port sector in 1996. While the first two are being
operated by the Australia-based P&O since 19992000,
Chennai terminal was taken over by PSA SICAL (A joint
venture of Port of Singapore Authority and South India
Corporation Agencies Ltd) in December 2001. The
performance figures, aggregated by the shipping ministry,
reveal that the private players have managed to achieve
high productivity levels that had been eluding the publicrun terminals for a long time. NSICTs performance brings
out the contrast starkly.
Chennai Container Terminal (CCT) also attained a
steep 97 per cent reduction in average pre-berth waiting
time in just one year of private control, a feat which the

government could not achieve even in five years from
19978 to 20012. In fact, the pre-berth waiting time of
79 hours for the terminal in the year it was privatized was
thrice that in 19978. Even the average turnaround time
fell 74 per cent in the past one year while it fell by half
from 19978 till the time the government handed over the
reins to PSA SICAL. A similar state of affairs can be
discerned for the Tuticorin Container Terminal (TCT).
When PSA (in Tuticorin) took over in 19992000, the
average turnaround time was as high as 2.5 days. But since
then it has dropped by 80 per cent to 12 hours. Even with
respect to average pre-berth waiting time, the terminal
achieved an appreciable reduction from 17 hours to 30
minutes in just three years37.
The Tariff Authority for Major Ports under Pressure: The
government established the Tariff Authority for Major
Ports (TAMP) to set tariff for the 12 major ports in the
country. Since the authority used to set fixed rates for
services rendered by these ports, they could not compete
with the lower rates offered to shipping lines by the private
ports. The new ports are outside the ambit of the TAMP.
TAMP would set only a ceiling and ports would be allowed
to offer their services at lower rates. The regime change
came about as shipping companies are planning to shift
to the P&O-owned Mundra International Container
Terminal in Gujarat38. To attract shipping lines Mundra
port has offered volume discount to its customers, whereas
under TAMP, JNPT had a fixed tariff irrespective of the
volumes. JNPT, which till now had to contend only with
the P&O-operated NSICT, will now have to brace for
tough competition from the Mundra port and other private
ports.
Getting government-run ports to become more
competitive, of course, will require more than just pricing
freedom. Thanks to the stranglehold of labour unions,
productivity is poorberth and crane productivity in the
P&O-run NSICT, for instance, is double that of the
government-run terminal at JNPT. As a result of this, the
turnaround time at the P&O terminal is 0.68 days (or 16
hours), compared to 1.24 (or 30 hours) for the government
one at JNPT, and more than three and a half days for all
the major ports taken together. Not surprisingly, output
at the private terminal is higher than that for the governmentrun one.
Nhava Sheva Third Terminal Port: There are some 10
global and Indian port operators in the race for the Rs 900
38 The Medittaranean Shipping Company, Geneva, the second
largest shipping line in the world, has already started operating

from Mundra port from August 2003.

crore Nhava Sheva Third Terminal Port project, envisaging
conversion of its two bulk terminals into a full-fledged
container terminal to handle about 1.3 million TEU traffic.
The JNPT has decided to drop its proposal to switch over
the terms of payment from the revenue sharing arrangement
to the Minimum Guaranteed Throughput (MGT) formula
for the third container terminal project that is being set
up at the port through private participation on BOT basis.
The ministry has opined that it could jeopardize the
remaining part of the bidding process. The successful
bidder will be awarded the contract by December. The new
terminal is likely to be operational by early 2006.
Airports
Airport Authority of India (Amendment) 2003 Bill: The
Airport Authority of India (AAI) Act was becoming a
major stumbling block in introducing competition in the
running of airports. The Airport Authority of India
(Amendment) Bill, 2003 has been passed by parliament.
The Bill provides a legal framework for operational and
managerial independence to private operators. It also
seeks to ensure a level playing field to private sector
greenfield airports by lifting control of AAI except in
certain respects. The Amendment Bill defines a private
airportone that is owned, developed or managed by any
agency or person other than AAI or a state government,
or managed jointly by AAI, a state government, and a
private player, where the latters share is more than 50 per
centand allows leasing of existing airports to private
operators. It also proposes the levy of a development fee
on passengers to be utilized for the upgradation and
expansion of the airport. This step is expected to clear one
of the hurdles for the proposed projects at Bangalore and
Hyderabad. Further, there are provisions for the
establishment of an airport appellate tribunal to deal with
cases of encroachment at airports. The purpose of this
amendment is to improve the standard of services and
amenities at airports. It seeks to facilitate the restructuring
of airports and the infusion of private sector investment
(GOI 2003b).
Implications: Though there is nothing specific on the
privatization of the Delhi and Mumbai airports, the Bill
allows AAI to lease the premises of existing airports for
better management. Even if an airport is leased, air traffic
control and security will be under the AAIs jurisdiction.
Work on a revised proposal for airport corporatization has
gathered momentum after the amendment to the AAI Act
was cleared by Parliament recently. The crucial issues that
are to be decided now include the term of lease, the
financial terms, and the development plan for the airport
concerned. AAI has already initiated the process of setting
43
up separate companies that would manage the metro

airports.
The amendment has paved the way for the levy of a
development fee on embarking passengers at an existing
airport. The fee can be used for the upgradation of the
airport at which it is levied or used to construct a new
airport. The fee can be invested by the government as
equity in private airports.
The Andhra Pradesh government has allotted a Rs 315
crore interest-free loan and Rs 107 crore advanced
development fees as grant to the international airport
project at Shamshabad near Hyderabad. The GMR
Malaysia Airport Holdings Berhard (MAHB) consortium,
which has projected a total cost for Phase I at Rs 1162
crore, is expected to sign up with the state government
and the AAI to build the new airport at Hyderabad.
The Bangalore International Airport Ltd, on the other
hand, which had hit a roadblock earlier is likely to be
finalized shortly with the Siemens-led consortium. The
consortium has agreed to pay liquidated damages if the
construction work is not completed within the stipulated
period due to reasons that could be attributed to the
consortium. The government, on its part, has softened its
stand on the issue of compensation to be paid to airlines
for the termination of bilateral rights after the closure of
the existing Bangalore airport. The Union finance ministrys
insistence on payment of a turnover-linked concession fee
remains the last hurdle in finalizing the concessional
agreement to pave the way for the Bangalore International
Airport project39.
Railways
Even Railways Respond: Demand for rail services has
grown in tandem with economic expansion, quickly
outstripping the supply capacity of existing assets (GOI
2002d). Pricing anomalies and different priorities assigned
to the Indian Railways (IR) stretched the internal resources
to the extent that regular maintenance of fixed assets was
accorded low priority. As a result, important infrastructure
deficits have appeared. These deficits have created serious
bottlenecks that hamper further growth on certain sections
of IR. The need to increase investment in infrastructure
was recognized in the late 1990s. However, the required
resources are not available from the public purse due to
its own stretched condition. Therefore, in early 2000 a
policy decision was taken to introduce private capital in
the rail infrastructure sector, covering rolling as well as
fixed infrastructure.
The year 20001 was a watershed year for IR when
operating ratio (a ratio of total working expenses to gross
39
Economic Times (13 August 2003).
44
traffic receipts) touched a high of 98.3 and it was 92.5

in the year 20023 (GOI 2002d and IR Budget 20034).
Operational expenses are so high that there is little money
left to increase the capacity of rail network, to provide
better facilities to rail users, to carry out preventive
maintenance and to make safety related investments. The
Railway Safety (Khanna) Committees recommendation to
invest Rs 10,000 crore over the next 5 years to improve
safety of railways is getting inordinately delayed. A large
part of this investment is to be made in track maintenance
and track improvements. The central governments desire
to control fiscal deficit has led to a situation where the
railways are not able to get capital grant from the government
for necessary investments.
National Rail Vikas Yojana: In order to meet competition
from other modes of transportation on the most congested
routes of IR and to make the transport sector competitive,
the Prime Minister announced the National Rail Vikas
Yojana (NRVY) in December 2002. Under this scheme,
IR envisages to increase capacity of the rail golden
quadrilateral, provide better connectivity of the network
to major ports, and build a few critical bridges over the
rivers Ganga, Brahmaputra, and Kosi. An SPVRail Vikas
Nigam Limited (RVNL) has been incorporated to carry
out the specific projects under the NRVY. Funds required
for the NRVY are Rs 15,000 crore. Out of this
approximately Rs 4500 crore has been promised by the
ADB. The funds are to be disbursed over a 10-year period40.
It is estimated that Rs 8000 crore would be required to
enhance the capacity of the rail golden quadrilateral41. IR
is working on a proposal to offer projects under the NRVY
to private operators on BOT basis using annuity payment
scheme on the lines of road projects. These initiatives are
undertaken to increase the freight and passenger-carrying
capacity of the railways. Some of the projects are those
which are being executed by the IR for some time now.
Freight Rationalization? The IRs earnings from freight
during the first quarter of the current fiscal year (April
June 2003) improved by 1.94 per cent compared to the
40
The first tranche of US$313.60 million was approved on

19 December 2002. The objective of the Project is to improve
the performance of the railways sector by supporting (i)
implementation of a programme of institutional and policy reforms
to improve IRs commercial orientation; and (ii) the expansion
of core businesses by financing priority investments to overcome
railway capacity bottlenecks and improve operational efficiency
and safety (Source: http://www.adb.org/Documents/ADBBO/
LOAN/36317013.ASP). Details of institutional and policy
reforms agreed upon by IR are not in public domain yet.
41 Some part of the MLA loan will go to enhance the capacity
of the rail golden quadrilateral.
corresponding period in the last fiscal year. The earnings

are 23.4 per cent of the budgeted target of Rs 27,850 crore
for 20034. This good performance is attributed to the
freight rate rationalization that IR undertook over the past
2 years42. Other factors that contributed to the good
performance were the revival of the steel sector in the
economy and higher generation of thermal power in the
country. Even though the monsoons have been good this
year, reservoirs take time to fill up and till then coal would
continue to be used for generating electricity43. For the
first time, in 2003, the IR reduced the fare on Rajdhani
trains by 10 per cent during off season, thus heralding a
flexible tariff system.
Concessions Signed
In the last couple of years port connectivity projects with
the Gujarat Pipavav Port Limited (GPPL), the Gujarat
Adani Port Limited, and the HasanMangalore Rail
Development Company (HMRDC) have been signed.
Concessions have been signed and new features added.
Although there has been a creeping introduction of
investment from private sector, the IR is still reluctant to
introduce competition in railway services and maintenance
of the infrastructure.
Pipavav Rail Company Limited Concession: The concession
grants the right to own, construct, design, engineer, and
convert metre-gauge link between Surendranagar and
Pipavav by an SPVthe Pipavav Railway Corporation
Limited. The project is concessioned to the SPV for 33
years after which it will revert to the railways. The demand
risk and the project/construction risk are to be borne by
the SPV. Traffic guarantees for 33 years, as already offered
by the GPPL, would now be given to the SPV. The IR will
have an operation and maintenance (O&M) contract with
the SPV to operate this line, in return for a certain
percentage of revenues as charges for operating the line.
They would also recover the operational and maintenance
cost including the hire charges for wagons, locomotives,
and coaches from the SPV. The concession is biased in
favour of the railways and in the event of demand shortfall,
it may become a candidate for renegotiation.
HMRDC Concession: The concession grants the task of
development and construction of the gauge conversion of
42 The movement of goods from Delhi to Agra by train will
now cost 56.3 per cent less than truck charges. As per the new
freight rates by the Northern Railway, a quintal of cargo being
carried by train from Delhi to the Agra Cantonment will cost
Rs 12.1 as compared to Rs 27.7 by truck. (Business Standard
2 July 2003).

existing railway linkage between Hassan and Mangalore
to an SPVthe HMRDC. The government of Karnataka,
along with Infrastructure Development Corporation
(Karnataka) Ltd (iDeCK), Rail Infrastructure Development
Company (Karnataka) Ltd (K-Ride), and IR have joined
hands to invest Rs 100 crore as equity and the former
is looking for some strategic investors such as the New
Mangalore Port Trust, Kudremukh Iron Ore Company
Limited, National Mineral Development Corporation,
mine-owners in Bellary area, etc. to invest in the project.
IR would operate the rail link by providing locomotives,
wagons, and technical staff. O&M of the rail line remains
with IR even though there may be difficulty in separating
out fixed cost and variable cost. Freight rate risk exists
as tariff rate is determined/announced by IR. Freight
traffic will have priority on this route. IR has retained
the right to use the line to run passenger services. However,
it will pay access charge which will be negotiable. In the
event of concessionaire defaulting, the government will
have to pay only 50 per cent of the depreciated value of
the assets.
GMAP Concession: The Gujarat MundraAdani Port
(GMAP) has taken the initiative to improve rail connectivity
between the port and the northern regions. The agreement
is a new model of operation of the railway link, wherein
the Mundra Port owns land, railway track, and other assets
and maintains the same as per the standards laid down by
IR. IR operates the link by providing locomotives, wagons,
and essential technical staff and the revenue derived from
the freight traffic on this link will be shared between IR
and Gujarat Adani Port Limited.
Other Developments
Gauge Conversion: IRs first gauge conversion project
with private sector participation sets a new benchmark in
BOT investment model. The project for gauge conversion
of the ViramgamMahesana section of Western Railways
reached financial closure. The UTI Bank has funded the
entire Rs 62.4-crore debt component of the total project
cost of Rs 89.3 crore. This is the first time that a single
lender has lent the entire debt in an infrastructure
project.
Kandla port is likely to experience a significant increase
in traffic flow from and to New Delhi, with gauge conversion
between Viramgam and Mahesana, that connects the port
with the north-western states. The project is likely to be
completed within 18 months. The project will especially
help the new container terminal that is coming up at
Kandla port through private participation on a BOT basis,
as the Delhi-bound traffic can avoid passing through the
high traffic density Ahmedabad route.
45
Railways as Facilitator44: The Southern Railways is

encouraging private entrepreneurs to set up private goods
terminals at various places in the zone. The goods terminals
will include multi-modal facilities for rail-cum-road link,
warehousing facility, storage facilities, and IT back-up for
logistics services. The zonal railway authority will also enter
into an agreement with the terminal service provider (TSP)
for a period of 20 or 30 years. The Southern Railways has
invited expression of interest (EoI) from interested parties.
While the EoI indicates that the concessionaire should take
care of the land requirement, the Southern Railways may
provide surplus railway land, if available, on terms agreed
upon. The main source of revenue for the TSP will be by
way of add-on services such as warehousing, secondary
transportation, and handling charges. The Southern Railways
will provide necessary facilities like rail link on payment
of siding construction charges.
In these projects, IR has given its right of way for assured
O&M contract from the SPVs and traffic risk is fully
transferred to the SPVs. The last example is an outright
concession. Build, own, operate are all with the concessionaire.
The Southern Railways is merely a facilitator which earns
from the use of its rail network through the link provided
to the terminal. In case, it provides land to a promoter, the
Southern Railways will get rent from the concessionaire.
Monopoly of Concor to Go: The government has decided
to do away with the monopoly of Concor to carry containers
on IR. Concor is one of the companies slated to be
disinvested. Its total container freight market is Rs 4000
crore in India and it has grown at the rate of 22 per cent
a year in the last three years. It is unlikely that Concor
alone will be able to service the large volumes that are
expected. IR would like to deregulate the sector gradually.
Concor has only 10 per cent of the total surface transport
cargo which is containerizable, which demonstrates that
the volume is large and needs multiple players to maximize
the full potential. In fact, even before this, 5 major shipping
lines have shown interest to set up a parallel container
service. Shipping lines and port operators like P&O have
been bargaining with Concor for improved service and
reduced rates for carrying containers from the north to
southern ports45.
Regulatory Authority for Rail Tariff: Despite reservations
from the railway ministry, an independent regulator will
soon be set up to rationalize rail tariffs as suggested by
the Rakesh Mohan Committee (Expert Group on Indian
Railways 2001). In deference to the wishes of the Prime
Minister, the railway ministry has prepared a draft Cabinet
44
45
Business Line (12 September 2002).

46
note on the proposed Rail Tariff Regulatory Authority. The

note has been sent to the law ministry for comments. The
Cabinet took a significant decision in August 2003 by
setting up a regulatory authority for rail tariffs on priority
basis in the fiscal year 2003446.
URBAN INFRASTRUCTURE
City Monitor 2002
3iNetwork and P&M Research Services (P) Ltd released
a report comparing quality of life in seven cities
Ahmedabad, Bangalore, Chandigarh, Indore, Lucknow,
Nagpur, and Suratbased on statistics collected from the
city administrations. The parameters used to compare
quality of life were local economy, infrastructure, civic
services, municipal finances, and living environment.
According to the final score, Bangalore has the best quality
of life followed by Ahmedabad, Surat, Chandigarh, Nagpur,
Indore, and Lucknow. Infrastructure such as roads, public
transport, electricity supply, and telecom and civic services
such as drinking water supply, drainage, solid waste
management etc. were found to be comparable in Bangalore
and Chandigarh (Pangotra 2003).
City Challenge Fund (CCF): has received in-principle
clearance but no allocation has been made. The fund is
to have an initial outlay of Rs 500 crore with demand
driven approach. The fund is for cities with populations
above 10 lakh but now its scope is being extended to state
capitals as well. CCF money is to be disbursed only after
a resolution is passed on reform programmes by the
municipal council with a supporting letter by the state
government.
Pooled Financed Development Fund (PFDF): has also
received in-principle clearance but no allocation has been
made. The fund is to have an initial corpus of Rs 400 crore
for facilitating market access for small and medium cities
through establishment of debt service reserve facility and
grant for reforms. This fund is to be operationalized with
support from the US-FIRE project.
Urban Reform India Fund (URIF): has an outlay of
Rs 500 crore, especially to provide incentives to state
governments to make the land and housing market efficient.
Urban Sanitation Mission: has been allocated Rs 2500
crore by the Planning Commission in the Tenth Five YearPlan. Of this, 7080 per cent will be in the form of grants,
2030 per cent as loans at market rates of interest. One
precondition for disbursement of the loan is the use of
private sector participation.
46
Business Line (7 August 2003).
Municipal Accounting Reforms

The accounting system followed in most of the municipal
bodies is rudimentary. Municipal bodies generally follow
a single entry cash-based accounting system but, in reality,
what exists in municipal bodies is mere bookkeeping,
which is inadequate. In most municipal bodies only dayto-day primary accounting procedures are followed. In the
last 20 years less than 10 Indian municipal bodies have
experimented with accounting reforms with a mixed record
of success.
Municipal accounting reforms in Tamil Nadu, introduced
in the last couple of years, have achieved remarkable
success and the state has introduced accounting reforms
in 107 municipal bodies. The entire process of the municipal
accounting reforms, right from conception and design to
implementation, was characterized by innovation, continuity
follow-up action at every level, and foresight. In 3 years
(19982001) it achieved the path-breaking conversion of
107 municipal bodies from cash-based single entry to
accrual-based double entry accounting system. The most
important aspect of the Tamil Nadu experiment was its
decisive focus to address the issue of uniformity and
comparability of accounting systems and financial statements
of all the municipal bodies of the state. These reforms have
been carried out under USAID guidance and this has
provided a management tool to understand cost of municipal
services and user charges to be levied by the authority.
Standards for Drinking Water

The Cola controversy has woken up the government to the
fact that the country does not have norms for drinking
water47. The central government intends to bring an
ordinance to include water in the definition of food and
prescribe norms for drinking water as well as for ground
water, when the latter is a source of drinking water. All
agenciesincluding local government bodiesresponsible
for supplying drinking water will have to adhere to the
prescribed standards. Whether the standard set would be
at tap level or at the point of orgination is yet to be seen.
Drinking water standards, if implemented, will have
enormous impact on public health, pricing of water, and
provisioning of water. The central government faces an
enormous task in this endeavour as water comes under
State List and rights related to water are jealously guarded
by states.
Rapid Mass Transport System

Delhi: Delhi Metros first section from ShahdaraTis
Hazari was inaugurated on 24 December 2002. Phase I
47

of the project has three lines: ShahdaraTri NagarBarwala
(28 km), Vishwa VidyalayaCentral Secretariat (11 km),
and Barakhamba RoadConnaught PlaceDwarka (23 km).
This phase of the project is expected to be completed by
September 2005. Doubts have been raised about the longterm viability of the Delhi Metro project, costs for which
not discounting for inflationare 60 per cent higher than
Kolkatas and 113 per cent more than Singapores. The
Delhi Metros per-km cost of around Rs 160 crore
(expenditure was Rs 10,571 crore for the 66-km first
phase, including an 11 km underground stretch) was much
higher than the per-km cost of around Rs 100 crore for
the Kolkata Metro and Rs 75 crore for the Singapore
Metro. Delhi Metro Rail Corporation (DMRC) has clarified
that the higher project costs were largely due to the use
of imported technology48, but the matter needs
investigation. To reduce overall project cost, the DMRC
has projected raising around 6 per cent of its total project
cost by way of property development and is aiming to
generate around Rs 600 crore through real-estate projects
by the year 2005.
Hyderabad, Mumbai, Bangalore, and other cities, where
metro projects are already under way, are likely to gain
handsomely from DMRCs experience. With several
domestic firms gaining technical expertise in the Delhi
Metro project, the capital cost of new metro projects
coming up in these cities could be only a fraction of the
Delhi project. For instance, the average project cost of the
metro being envisaged in Hyderabad is only around Rs 80
crore per km, against Rs 160 crore per km for the Delhi
Metro. The detailed project report for the 39.45 km
HyderabadSecunderabad metro project has been estimated
at Rs 3205 crore at April 2003 prices, which translates
into a per-km cost of Rs 81.2 crore.
Hyderabad: The much-awaited Multi-modal Transport
System (MMTS) service was inaugurated on 15 August
2003 along the Hyderabad-Lingampally route, which will
go a long way in easing traffic pressure on the city roads.
The MMTS will have a total of 26 stations, 11 of them
being old ones, to be covered in the first phase. The old
stations are being renovated and rebuilt and 8 rakes are
being procured to start services on schedule. The South
Central Railways has proposed to float an SPV to run the
MMTS. The South Central Railways has appointed L&T
Romball as consultant to prepare a blueprint for the phase
II of the project and to scout for a prospective private
48
The Kolkata Metros 16.46 km section was started with an

initial cost estimate of Rs 440 crore in 1972. The cost escalated
to Rs 1655 crore by the time of the completion of the project
in 1995. The 67-km section of the Singapore Metro, operational
from July 1990, costs about Rs 5000 crore.
47
investor. The second phase will connect Secunderabad to

Falaknuma49.
Mumbai: Mumbai Urban Transport Project (MUTP),
envisaged to bring about improvement in the traffic and
transportation situation in the Mumbai Metropolitan
Region, (MMR) got a fillip with the sanction of a World
Bank loan. Mumbai Metropolitan Regional Development
Authority (MMRDA) is the executing authority for the
project. MUTP envisages investment in suburban railway
projects, local bus transport, new roads, bridges, pedestrian
subways, and traffic management activities. Mumbai Rail
Vikas Corporationa joint venture of IR and the
government of Maharashtrahas been established for
implementation of rail projects under MUTP and other
projects of IR in the MMR. The total estimated cost of
the project is Rs 4526 crore and the World Bank has
sanctioned a loan of Rs 2602 crore, that is, 57 per cent
of the total cost on 18 June 2002.
Mumbai Urban Infrastructure Project: The government
of Maharashtra has planned to spend Rs 2000 crore in
upgrading the urban road network of Mumbai. The project
includes 42 flyovers, 16 elevated roads, 16 rail overbridges,
14 vehicular subways, and 15 pedestrian subways. Funds
would be provided by the state government (Rs 500 crore),
Brihanmumbai Municipal Corporation (Rs 300 crore),
MMRDA (Rs 1000 crore), and GOI (Rs 200 crore). No
extra tolls are envisaged to finance the project. It is hoped
that the improvement in the road infrastructure will firm
up real estate prices which will lead to higher property
taxes which in turn with pay for the development. The
project is being managed by MMRDA.
RURAL INFRASTRUCTURE
Power
The central government has redefined rural electrification.
Currently, a village is considered to be electrified if even
one household has access to power. Under the proposed
definition, 10 or 15 per cent of the village households will
require to be electrified in order to qualify as an electrified
village. Out of the estimated 80,000 villages yet to be
electrified, the Tenth Plan proposes to electrify 62,000
villages through grid supply. The balance 18,000 remote
villages are proposed to be electrified by 20112 through
the use of decentralized non-conventional sources of energy.
In order to facilitate the flow of funds, the rural
electrification programme has been included as a component
of the Pradhan Mantri Gramodaya Yojana (PMGY) and
49
Business Standard (12 August 2003).
48
the states are being encouraged to pool resources from

other schemes under the Minimum Need Programme
(MNP) and Rural Infrastructure Development Fund (RIDF)
to meet the objective of 100 per cent electrification. A new
scheme called Accelerated Rural Electrification Programme
(AREP), with provision for interest subsidy, has been
launched. The participation of decentralized power
producers will be encouraged, especially for electrification
of remote villages. Village-level organizations like panchayat
raj institutions (PRIs), rural cooperatives, and nongovernment organizations (NGOs) will play a crucial role
in the rural electrification programme.
The Cabinet Committee on Economic Affairs (CCEA)
has approved a 4 per cent interest subsidy scheme on loans
availed by the SEBs from financial institutions as a measure
to accelerate rural electrification. The proposal cleared
under AREP intends to ensure 100 per cent electrification
of all villages by the end of the Tenth Plan period. Also,
the interest subsidy would ensure that funds are available
for rural electrification at the same cost as in the PMGY.
The rural electrification programme had an outlay of
Rs 1.64 billion in 20023 and a grant of Rs 5.64 billion
for the Tenth Plan period as an interest subsidy scheme
for the AREP.
The government is planning to seek a World Bank loan
to help finance rural electrification schemes in the villages.
The Ministry of Power is pushing the concept of rural
electricity supply companies (RESCOs) involving the private
sector players by leasing out solar panel-based light systems
to village homes.
The Rural Electrification Policy: The Electricity Act 2003
mandates formulation of a national policy/ies governing
rural electrification and local distribution and rural off-grid
supply including those based on renewable and other nonconventional energy sources. This would make the process
of electrification self-sustaining by making it a commercial
process and enable it to avoid the disturbing feature that
was seen in some villagesvillages which had earlier been
electrified were de-electrified since the producers of
conventional sources of power were not able to provide
reliable, predictable, and good quality power to rural areas.
The way would be paved for the producers of nonconventional sources of power, reinforced by the fact that
the Act allows a person (notified by the state government)
to generate and distribute electricity in rural areas without
getting a licence from the Commission. This would attract
necessary investment in generation as well as distribution
from private players and also help the rural areas grow
economically and socially. The central government is to
formulate a policy for bulk purchase of power and
management of local distribution in rural areas through
panchayat institutions, users associations, cooperative

societies, NGOs, or franchisees.
Telecom
Four of the five private basic operators have failed to
adhere to the deadline set by the DoT for fulfilling their
rural telephony obligations. Except for HFCL Infotel Ltd
in Punjab, the remaining operators, namely, Reliance
Telecom, Tata Teleservices Ltd, Bharti Telenet, and Shyam
Telecom have not been able to cover the stipulated 50 per
cent of the uncovered villages (close to 39,900) in their
service areas by June 2003. The task of connecting the
remaining villages by December 2003 seems to be remote.
So far Reliance has set up close to 4000 village public
telephones (VPTs) in Gujarat and Tata Teleservices has set
up around 3000 VPTs in Andhra Pradesh and around 2000
VPTs in Maharashtra. Bharti and Shyam Telecom too have
provided around 1000 VPTs in Madhya Pradesh.
Nonetheless, the number of villages covered through VPTs
has shown an upward trend with 513,127 villages having
VPTs by March 2003 as compared to 469,010 by March
2002 out of a total of 607,491 villages (GOI 2003c).
Broadband network using WiFi technology, based on 811.11
and 811.16 standards, could be profitably used for spreading
telephony in villages and towns if innovative contracts are
designed to spread IT in the countryside.
Universal Service Obligation: The government had collected
Rs 1760 crore in 20023 by levying Universal Service
Obligation (USO) fee, which was 5 per cent of the total
licence fee given by service providers. Rs 300 crore has
already been allocated to various fixed-line operators to
fund the operational expense of existing village phones.
Earlier, DoT had sought to pass an ordinance to this effect
in order to hasten the process of rolling out telephones in
the rural sector. But the finance ministry had opined that
a fund with an annual corpus of over Rs 1000 crore should
not be passed without a Parliamentary debate.
The Central Cabinet has already approved the amendment
of the Telegraph Act giving statutory status to the USO
Fund. The government will move a bill in this regard in
the winter session of Parliament. The statutory status to
the USO Fund makes it non-lapsable. This will help the
USO administrator to make long-term plans. As per the
USO rules, tenders are invited for maintaining and
implementing VPTs. This is a time-consuming process and
requires long-term planning. In October 2002, GOI invited
tenders for the maintenance and operation of VPTs installed
in the villages enumerated and identified in the USO
document. The implementation of USO in case of household
telephones in net high-cost areas (rural/remote) shall now
be based on Least Quoted Subsidy support. On the adequacy

of resources under the USO Fund, the Ministry of
Telecommunication believes that annual requirement of
funds for rural telephony might be much larger than the
average expected receipts of about Rs 2500 crore.
BSNL has been able to make up for the decline in its
fixed-line business through a rapid growth in its wireless
business in rural areas. Its GSM-based cellularCellOne
has been extremely successful in the rural areas and the
company has gained a 20.8 per cent share of the nationwide
wireless market. BSNL does not expect a dramatic shift
in the voice traffic from wireline to wireless, but BSNL
has rolled out its wireless network to pre-empt rural market.
It is also in the process of providing WLL services in case
tariff differentiation demands it. BSNL hopes that it will
be able to make money if it has the right cost structure
but it is saddled with a huge legacy of fixed costs in the
wireline sector. However, in the wireless sector its spending
has been prudent and in a focused manner comparable to
private sector service providers. The statistics of 20034
which will contain BSNLs full expansion in the countryside
may throw up a few surprises.
The government is keen that every village in the country
be connected with telephone services by December 2004.
There were 1.46 crore basic phones in 1999. Now the
number is more than 4.37 crore. BSNL is using imaginative
promotional schemes to sign up new customers. It waived
registration fee, installation charges, and rental in August
and September 2003 for telephone connection bookings
made in the names of sisters on the Raksha Bandhan Day
to attract new customers in rural as well as urban areas50.
Roads
The National Rural Roads Development Agency (NRRDA)
provides O&M support to the Ministry of Rural
Development in the implementation of the Pradhan Mantri
Gram Sadak Yojana (PMGSY). A review carried out by
NRRDA of the ongoing Rs 600 billion rural road
connectivity project shows that the performance of some
states is not up to the mark. The review notes that since
the launch of the PMGSY in December 2000, till endNovember 2002, a sum of Rs 75.53 billion had been
approved by the centre for road works in all the 28 states
and six union territories. During the year 20023, the
entire sum of Rs 24.69 billion released for Phase II of the
PMGSY has been utilized. The funds could not be released
to Bihar, Jharkhand, Manipur, and Uttaranchal as these
states failed to fulfil the basic eligibility criteria. In terms
of execution of road projects under the scheme up to
August 2003, Madhya Pradesh stands first among all the
states. Madhya Pradesh has executed road works worth
50
Business Line (12 August 2003).
49
Rs 590 crore followed by Uttar Pradesh, which utilized

Rs 547 crore on the scheme. Andhra Pradesh, with road
works of Rs 525 crore, is in third place. Madhya Pradesh
has so far secured sanction of Rs 1370 crore, which is
more than 17 per cent of the total sanction under the
scheme (Table 2.4).
Agriculture
The agriculture sector is gaining importance as this sector
alone can provide gainful employment to millions of people
in the country. The Prime Minister is directly going to
oversee the preparation of a national action plan on
increasing agricultural productivity and doubling foodgrain
production by 2010. Agricultural development was viewed
as a core element of the Tenth Five-Year Plan since growth
in this sector would lead to the widest spread of benefits,
especially to the rural poor. Recognizing the crucial role
played by the agriculture sector in enabling the widest
dispersal of economic benefits, the Tenth Plan emphasized
that agricultural development is central to the economic
development of country.
The report, State of Indian Farmer: a Millennium
Study compiled by the Delhi-based Institute of Economic
Growth, and sponsored by the Ministry of Agriculture,
concludes that the farmer is born in debt, lives in debt
and dies in debt. The study points out that in the case
of small farms inadequate and costly credit can convert a
viable venture into an unviable one. Over the years, the
number of borrowers and the flow of priority sector credit
had risen many times. Moreover, the report reveals that
Indian farmers are, by and large, competitive in terms of
production costs but face grave disadvantages ensue from
poor provision of infrastructure. Some studies have expressed
disquiet over declining public investment in agriculture,
resulting in lack of optimum development of this sector.
The Ministry of Agriculture constituted a Standing
Committee of State Ministers to suggest measures to
accelerate reforms in the agricultural marketing sector. The
Standing Committee will specifically address modernization/
development of existing markets through public-private
partnerships (PPP). It will also look at a model legislation
that will facilitate and promote various liberalized types of
markets and will revisit the existing regulatory structures
and regulations to support different types of liberalized
markets. PPP have been mooted for funding of projects
involving development of fishing harbours and agri-markets.
Interlinking Rivers
The Rs 5,60,000 crore project of interlinking rivers has
become controversial because of its potentially adverse
50

Table 2.4
Progress of PMGSY Scheme
(August 2003)
State
Andhra Pradesh
Arunachal Pradesh
Assam
Bihar
Chhattisgarh
Goa
Gujarat
Himachal Pradesh
Haryana
Jharkhand
Jammu and Kashmir
Karnataka
Kerala
Meghalaya
Maharashtra
Manipur
Madhya Pradesh
Mizoram
Nagaland
Orissa
Value of
Proposals
(Rs crore)
Amount
Released
(Rs crore)
No. of
Road Works
924.7
120.5
423.4
451.6
349.6
22.4
235.7
188.9
130.2
377.4
83.3
435.8
61.4
103.2
699.4
141.2
1370.0
85.4
84.1
716.4
380
70
150
300
174
10
100
120
40
220
40
190
40
70
260
80
426
40
40
350
3815
359
1845
967
434
127
972
372
64
370
112
1692
217
307
2226
572
1756
45
175
1559
No. of Road Works

Completed
(up to August 2003)
1705
147
217
0
89
71
445
196
1
20
0
541
53
208
860
0
244
24
130
663
Road Works
Completed
per cent
44.7
41.0
11.8
0.00
20.5
55.9
45.8
52.7
1.6
5.4
0.0
32.0
24.4
67.8
38.6
0.0
13.9
53.3
74.3
42.5
Source: www.pmgsy.org
social and environmental impacts. Doubts are now being

raised about their viability and, hence, the desirability of
the project. No costbenefit analysis has been done and
hundreds of thousands of people will get displaced and,
given the poor record of PAP rehabilitation, there is a good
chance that communities will get divided. Mixing water
systems, it is feared, can lead to ecological problems. Many
NGOs have asked the government to produce a White
Paper and have a national discussion before finalizing the
project and make project details public by setting up a
transparent and participatory process of assessment.
Moreover, solutions to the far more obvious problem of
water scarcitysuch as more local surface storage, artificial
enhancement of seepage, and diversion of water from
hydro power to irrigation, besides savings in water that
can come through the correct pricingare possible. The
task force is expected to submit its report soon to the
government detailing the modalities of funding and
implementation of the project51.
CONCLUSION
After more than a decade of liberalization, one can witness
some private sector investments in the provisioning of
infrastructure services at various levels. The sectors such as
51
Business Standard (29 August 2003).
telecom, roads and sea ports, oil and gas, etc., which were
opened to private sector earlier, are very competitive and
service providers are going out of their way to get business.
The consumers have shown increased sophistication over
the years. They are price savvy and demanding in other
ways.
The petroleum product market enjoys the fruits of the
economic deregulation (perhaps not fully as yet) set in
motion in 1991. Private sector investment in oil refineries
has resulted in substantial increase in refining capacity in
the last two years and the country is running a surplus of
refined oil products. Post dismantling of APM, transportation
of oil products has acquired an importance which was
overlooked earlier. The failure of Petronet India Limited
to achieve financial closure has led the government to
change its regulatory approach to petroleum product
pipelines. The Guidelines to Lay Petroleum Product Pipelines
has taken away Petronet Indias monopoly over laying new
product pipelines which can now be constructed by anyone
using a modified contract carriage principle rather than
being compelled to adopt common carrier principle. The
Petroleum Regulatory Board Bill 2002 is clear that there will
be a single regulatory authority to regulate the downstream
oil and natural gas sector. As and when the Bill becomes
an Act, the government would establish a regulatory authority
for the downstream petroleum sector under the Act which
has power to regulate petroleum product pipelines.

The natural gas market in India is in transition as it
moves from a fully centralized, government-controlled business
to one that relies increasingly upon reduced government
controls and a more market-responsive pricing climate to
encourage foreign and private investment in upstream
exploration and development of oil and gas. The Petroleum
Regulatory Board Bill 2002 and the Guidelines to Lay
Petroleum Product Pipelines have addressed some of these
issues. The scenario which may become a reality in a couple
of years time is the supply of gas from multiple sources using
different processes having different cost structure. In such
circumstances gas pipelines have been allowed to use contract
carriage principle as well as lay captive pipelines. Captive
gas transmission pipeline companies should not be regulated.
The distribution and supply gas pipelines being laid by
individual gas companies, should be licensed on opencarrier principle right from the beginning.
The Indian telecommunications sector, in the last one
year, has witnessed an unprecedented upheaval which has
affected all stakeholders in different ways. The main concern
remains the interpretation of licensing conditions. The
pace of roll out of telecom network to reach urban and
rural masses is unprecedented. The telecommunications
business in India is emerging as a profitable business for
pan-India service providers. In India, wireless telecom
services are spreading rapidly, partly helped by falling tariff
rates; still there is a vast market which remains untapped.
The fall in average revenue per user has put some doubt
on whether existing service providers would be able to
invest in new technology. Consolidation and strategic
alliances are happening in the sector. Technological
developments in the telecom sector are moving at a rapid
pace. There is little doubt that wireless telephony is
overtaking wireline telephones. Convergence of telephony,
entertainment, and Internet is happening around us.
Even though operational efficiency is improving, IR
needs money to clear the backlog of projects. In the past
few years, IR has been able to garner more resources from
the central government but the government has requested
it to raise resources from the private sector. To meet
competition emanating from pipelines, air-transport, and
road transport, the government has focused on increasing
the capacity of the golden quadrilateral of the rail network
and established the NRVY as an SPV to implement the
project. Funds required for the NRVY are of the order of
Rs 15,000 crore.
51
Roads, ports, and airports are all bracing themselves for

competition and services are improving. The transportation
sector witnessed inter-modal competitionroad, rail, and
air competiting to woo passenger traffic using innovative
pricing. As road network improves, competition for
passenger and freight is going to intensify.
Some path-breaking changes occurred in the power
sector last year: settlement of state dues, incentive-related
payment through APDRP, passing of the Electricity Act
2003, thus paving the way for competition in generation,
transmission, and distribution of power, and trading of
electricity. All these developments do not impact consumers
directly today, but in a couple of years, consumers should
expect quality power at affordable prices. Many important
legal and regulatory issues are being fought at many fronts.
These issues are likely to be resolved soon, in a manner
so that the consumer benefits from the technological
developments but without reducing competition in the
sector. The year 2003 witnessed the Tata group consolidating
its position in the infrastructure sector, especially in telecom
and power, and the Reliance group emerging as a significant
private player in the telecom, power, oil, and gas sectors.
State governments are vying with each other to improve
urban infrastructure of metropolitan cities in order to
attract new investment. But they are still long on their
promises and short on deliveries mainly due to their
precarious financial conditions. Almost all civic amenities
roads, water, disposal of waste water, car parking amenities,
traffic regulation, etc.even when delivery can be by the
private sector, requires large financial commitment from
the local governments. Soft interest rate regime has opened
a window of hope for such entities. Reduction in past debt
burden is being done apart from emphasis on user charges.
Rural infrastructure will also benefit from the reforms,
especially those that expand the network of roads, telecom,
and power. But improvements in infrastructure such as
drinking water and waste disposal have sadly not begun.
There is competition and the market is working and
fighting to woo subscribers. The time is not far when the
fight will be to provide better infrastructure services to
retain customers.
India, despite its impressive IT enabled services, software
firms, and pharmaceutical factories, is viewed as a less
successful economy. With competition being unleashed in
power, telecom, roads, ports, and airports, India can hope
to become a formidable competitor.
52
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Expert Group on Indian Railways (2001) The Indian Railways
Report 2001, NCAER, New Delhi.
GOI (2003c) The Indian Telecommunication Industry Performance
Indicators 20023, Telecom Regulatory Authority of India,
New Delhi.
(2003b) The Airport Authority of India (Amendment)
Bill, (Bill No. 36 of 2003).
(2003a) National Numbering Plan, Department of
Telecommunications, Ministry of Communications and
Information Technology, Government of India, New
Delhi.
(2002d) Status Paper on Indian Railways, Issues and Options,
Ministry of Railways, Government of India, New Delhi.
(2002c) Guidelines for Laying Petroleum Product Pipelines,
Ministry of Petroleum and Natural Gas, Government of
India, New Delhi.
(2002b) The Petroleum Regulatory Board Bill 2002, Bill
No. 38 of 2002, Government of India, New Delhi.
(2002a) Structuring of APDRP, Reform Framework and
Principles of Financial Restructuring of SEBs, Ministry of
Power, New Delhi.
(2001) Settlement of SEB Dues, Ministry of Power, New
Delhi.
(1997) The India Infrastructure Report, Vol. I, II, and III, The
Rakesh Mohan Committee, Government of India, New Delhi.
(1996) The India Infrastructure Report, Vol. I, II, and III,
The Rakesh Mohan Committee Report, NCAER and
Government of India, New Delhi.
ICRA (2003) The Indian Oil and Gas Sector, ICRA Limited,
New Delhi.
Kalmus Philips (2003) WiFi and the Wireless Local Loop: A Brief
Comparison of the Technologies for Authorisation and Licensing
Bodies, NERA, Economic Consulting, London.
Pangotra Prem (2003) City Monitor 2002: Intercity Comparison
of Quality of Life in Seven Cities, Ahmedabad Management
Association, Ahmedabad.
Prayas (2003) A Survey Based Study of Resources, Transparency,
and Public Participation in Electricity Regulatory
Commissions in India, Prayas Group, Pune.
Rastogi, A.B. (2003) The Infrastructure Sector in India 2001
2, in 3iNetwork, India Infrastructure Report 2003, Public
Expenditure Allocation and Accountability, Oxford University
Press, New Delhi.
Reserve Bank of India (2003) Report on Currency and Finance,
Reserve Bank of India, Mumbai.
Sanghi, Dheeraj (2001) Numer Portability: Why do we need
it? 11.1 in 3iNetwork, India Infrastructure Report 2001
Issues in Regulation and Market Structure, Oxford University
Press, New Delhi.
In the Name of the Poor: What Role for PFI? 53
IN THE NAME OF THE POOR

WHAT ROLE FOR PFI?
Partha Mukhopadhyay
Private Finance of Infrastructure (PFI) is often used to

describe a way of delivering infrastructure services in
which the government, instead of acting as a direct supplier,
purchases services from a provider. The relationship between
the service provider and the government is governed through
a contract which specifies what the provider has to do and
what performance standards and benchmarks have to be
maintained. The structure, therefore, is used largely to
deliver services that are currently being provided by the
government and move away from direct provision to a
contractual mode of provision. This is supposed to increase
efficiency by bringing in private sector competitive pressures
and incentive linked employment conditions. In the
framework World Bank (2003b), this is a strengthening of
the compact link between the policy-maker and the
provider.
Let us now take a step back and ask ourselves whether
the focus on this particular type of transition in service
provision is justified given the goals that face India today.
The purpose is to look at the key objectives that face
India today and to try and achieve a better match between
these objectives and the instruments needed to achieve
them.
The primary goal for India today is reduction of poverty,
especially in the rural areas. However, most government
expenditure is directed to this end, in the name of the poor.
Yet, the impact has not been substantial. Is it possible that
PFI can help to attain this goal? The answer is unlikely to
be a simple yes or no. It is unlikely that conventional PFI
is not relevant for India today. To begin with, even while
one accepts the primacy of focus on the reduction of rural
poverty, it is important to remember that growth and
migration remain among the most important instruments
to achieve this goal. Since a significant portion of growth
in economic activity is in urban areas, it would be unwise

to neglect them. Furthermore, no nation has so far developed
in a manner that keeps more than two-thirds of its people
in rural areas. While it is necessary to concentrate on rural
development, in order that its neglect does not create excessive
pressure, pushing people out of rural areas, it would be
utopian to believe that development can be achieved without
being accompanied by a large increase in the share of urban
population. There are a large number of opportunities for
PFI in delivering urban services and building and maintaining
infrastructure in urban areas. The nature of many of these
services will also permit a much more intensively commercial
role for the private sector. Thus, while certain types of PFI
will help to meet a specified set of goals in particular
circumstances, other types of PFI will be appropriate to
meet other goals in the same or different circumstances.
However, in some circumstances or for some goals, it may
not be possible to use conventional PFI techniques. Obviously,
those goals cannot be abandoned. It will be necessary then
to explore methodologies beyond and distinct from
conventional PFI to try and achieve those objectives. This
chapter is part of that exploration.
A QUICK RECAPITULATION
At the outset, it is useful to briefly recapitulate the place
of PFI in the overall scheme of service provision. The core
rationale underlying PFI is that the private sector will be
able to deliver the specific service more efficiently than
the public sector. To the extent that the current
arrangements for service provision are under-funded for
the desired standard of service, it is difficult to make this
comparison, for the private provider will seek a higher
level of funding, either through higher user charges or
54
through higher support from the governmentwhich

would always prompt the counterfactual: What if this
higher support/user charge were available to the public
service provider? PFI is, therefore, easier to justify when
the service standards are improved for a given level of
expenditures or expenditures are reduced for a given level
of service standards, rather than a situation where both
service standards and expenditures move in the same
direction. Second, as a corollary, this implies that the
private provider need not be concerned about there being
insufficient revenue, subject to meeting performance
standards, either from user charges or support or, usually,
both, that is, the risk of non-payment because the
government is bankrupt should be small. Third, the target
users of the service should not be able to afford user
charges that can recover full cost for the service at the
desired level of standardsif they could; there is a strong
case for complete and competitive private provision, based
on cost recovery solely from user charges, for example,
passenger air transport services1. In some instances, even
if there is sufficient commercial demand, it is enough only
for one service provider, which brings forth issues relating
to monopoly licensing and the manner of its allocation,
unless the market is genuinely contestable. Fourth, in
situations where there is limited competition, some
monitoring of performance standards may be needed to
ensure that profits from cost-competitiveness are not
being achieved by scrimping on service standards. Fifth,
there needs to be a process in place that chooses not only
a service provider who is more efficient than the existing
mode of service delivery, but is the best available alternative.
This implies that the choice parameter(s) need to be
defined appropriately and the selection process designed
to compel potential service providers to reveal information
as to their true costs to the maximum possible extent.
Finally, there needs to be an established process for the
resolution of disputes, between the service provider and
the government. Since the agreements are typically over
a long period and the contractual environment is variable,
especially in developing countries, it is unlikely that the
contracts can be complete in the sense of anticipating
every possible situation. At some point, often sooner
rather than later (Guasch et al. 2002) they would need to
be renegotiated. Prospective service providers therefore,
prefer a state of affairs where there is a predictable
process for this eventuality. As we discuss later in the
chapter, these processes for selecting service providers
and resolving disputes are likely to need much more
1 Even for this, there is a concept of universal service, not only
in India where airlines have to fly on certain unremunerative North
Eastern air routes, but also in the US, where airlines are compensated
for flying certain routes from a special fund.
thought as we explore more relevant mechanisms for

service delivery to the poor, especially in rural areas.
Therefore, a successful PFI needs an institutional
environment that is capable of competently executing all the
components of this process, that is, define the contractual
responsibilities, offer credible financing arrangements (which
may simply be the presence of a vibrant capital market and
creditworthy consumers), institute a credible monitoring
mechanism for subsequent adherence to the contract, choose
the service provider through a transparent selection process,
and finally, as is often the case, provide a fair environment
for renegotiation, should it become necessary. Whenever,
any one of the above is missing, successful PFI is difficult
to achieve. In the context of under funding, PFI will
encounter resistance to increased user charges or higher
government support. When the risk of government
bankruptcy is high, the risk premium implicit in the prices
demanded by the private sector will make it unlikely that
value for money would be achieved. If users can afford the
service without government support, there is likely to be
diminished political support for government payments to
service providers. Service providers too may prefer unfettered
competition to the constant interaction with government
bureaucracy2. Finally, if the services cannot be monitored,
the service provider may try to avoid accountability, especially
if they believe that the contract can be renegotiated in their
favour.
Consequently, conventional PFI is successful for services
such as road construction and maintenance, where the
performance requirements, for example, the riding quality
of a road surface, can be defined and monitored relatively
easily, where the selection can be based on easily evaluated
parameters, and there are a large number of potential
service providers. Unfortunately, this makes the use of PFI
controversial in many situations where the private sector
can make a large contribution through new ideas for the
use of existing infrastructure, through cost-saving innovations
in design, and in situations where the benefits of PFI are
based on new information revealed through the market
discovery process3. Such projects inherently have very
broadly specified requirements, which makes monitoring
difficult and because of the innovative features, a limited
number of potential service providers. Indeed, processes
to address unsolicited proposals remain a difficult area for
2
If they dont, they may be of the type who would rather exploit
their access to government instead of competing on the basis of
efficiency. These are not the types that one would prefer as service
providers.
3 The Austrian school of Economics characterized by von Mises
(1949) and Hayek (1962) emphasize precisely this aspect of prices, viz.,
their ability to reflect and coordinate new information (even when the
information itself is not explicitly made public) that is privy only to
some market participants. See, for example, Kirzner (1992).

public policy (for a brief overview see, Hodges (2003)) and
can lead to very contentious outcomes even in countries
with a long and well-accepted tradition of private
participation (Box 3.1). This is of particular concern as

we explore new mechanisms. However, it is possible that
some of this discomfort may be attenuated if the service
Box 3.1
(E)Erie Reflection of the Taja
Aditi Jagtiani
Closed-door government dealings, secret sell-off of state assets, resale at higher pricesthese sound like the much-reviled Taj
shopping complex deal. But, this time the words are being used to describe a deal between the New York State authorities and
a private developer, who, for US$30,000 (which is less than Rs 14 lakh, about the price of a small apartment in an Indian metro),
has bought exclusive access rights to cut private canals into the 524-mile Erie Canal in New York. Should the developer go ahead
with his plan to build houses along the shoreline with their own private waterways, he could make millions.
The Erie Canal, finally completed in 1825, took 8 years to build at a cost of US$8.3 million. For much of the 19th century,
it drove New Yorks economy, making the state a manufacturing and shipping powerhouse. In more recent times, however, other
modes have superseded it and the Erie Canal is left with only recreational and canal boats. The New York State Thruway Authority
and its subsidiary, the Canal Corporation, oversee the canal system, which costs the state US$70 million a year to operate while
it brings in only US$2 million in fees and development rights. In 1996, the then chairman of the Thruway Authority wrote
to 200 prospective investors to submit proposals to redevelop land along the canal. There were 33 responsesproposals from
theme park builders, cruise ship companies, a bank, and real estate developers. Thruway officials, however, found most of these
proposals to be perfunctory, and none of them ever reached fruition.
Then, in 1998, the developer who eventually bought the rights wrote to a canal official, expressing interest in building houses
on small canals that would be cut from private land to the main canal system. Each house would have its own private waterway
system leading to the canal, where home-owners could park their pleasure boats. In the first half of 1999, an advertisement
appeared in a state-run subscription newsletter inviting bids for a proposal similar to the one outlined by the successful developer
who was the only person to send in a written reply. The authorities negotiated a deal with him, agreeing on US$30,000 for
his exclusive right to cut into the canal, with further payments of US$15,000 for every cut made by him. The agreement also
gave the developer right of first refusal on sites identified by other developers. Details of the deal became public over a year later
and the issue became political when it was discovered that the successful developer had been a donor to state Republican (the
Governor of New York State is from the Republican party) funds and a prominent former Republican state senator and ran the
law firm he had hired to seal the deal.
Canal officials insisted that the contract had received a proper review and had been approved by the state comptrollers office
but acknowledged that they could have done a better job of publicizing the sale to attract more bidders. They also admitted
that they did not know whether the 33 other companies that had previously expressed interest in the canal had been contacted,
after they received only one bid in response to the advertisement. Both the chairman and executive director of the Thruway
Authority pointed out that the deal had been struck by their predecessors, and that greater public outreach would be used in
future projects. The deal is now up for a public hearingone scheduled by Democrats who have a majority in the State Assembly.
While critics claim that the developer stands to make millions by developing the land alongside the canal, defendants of the
deal justify the actual price paid as necessary to mitigate the risk undertaken by the first developer to jumpstart canal development.
The problem is that the price payable for an intangible, such as access rights, depends on the value they create for their user,
and could, therefore, vary greatly from user to user. The best possible price for the rights could have been secured by selling
them to the user that valued them the most, a situation that would only have arisen had there been competition amongst many
potential users. Rather than narrowly defining the proposal, canal authorities could have left the end use of the rights
unspecifiedso as to widen the appeal of the sale. The sale could have been put off until they had generated more interest.
By limiting this needed competition, canal officials may not have got the best price for this deal.
The more fundamental question that arises is whether the exclusive access rights to the Erie Canal have been sold off at all.
Should state officials have passed on their licensing authority, for what is essentially a scarce public resource? Already another
developer is planning to build a complex of luxury houses along the canal system. In order to proceed, he would have to buy
access rights to the canal from the private developer who now owns these rights. In fact, such a deal has already been struck
(similar to the resale of the recently divested Centaur Hotel in Mumbai), though the Canal Corporation maintains that under
the contract, the developer did not have the right to make such an arrangement without its approval. Authorities could just as
easily have sold the developer the land he required for his housing plansand access rights on the land that was actually
purchased. All unused land along the canal could have been auctioned off in a similar manner.
Unfortunately, this mess will now probably become an example against private participation, with strong resonance in other
countries where governments remain reluctant to relinquish control.
a
This article is based on Polgren (2003).
56

Box 3.2
Contingent Financing and Infrastructure Spending
Atanu Chakraborty
The past few years have seen some large infrastructure programmes but the private sector has been more of a footnote than the
centrepiece of these programmes, notwithstanding the amount of literature devoted to the formats and processes of Private Sector
Participation (PSP). Over the 9th Plan period, the private sector has built 60 million tonnes of capacity in ports at an investment
of Rs 3480 crore, while the public sector has increased capacity by 92 million tonnes at a cost of Rs 9400 crore. In power,
the private and public sector have built 5000 MW and 14,000 MW, respectively, while they have invested Rs 4300 crore and
Rs 26,000 crore in roads respectively. Telecom stands out as the only sector where the private sector has made a major headway.
Between April to December 2002, the private sector has added 2.4 million lines to the public sectors 2.9 million lines.
This public sector bias has come at the cost of rising contingent liabilities. Projects executed by parastatals and PSUs are also
the largest recipients of the project finances from banks, financial institutions, and even multilateral development banks. Though
no direct data is available, figures on guarantees given by the centre and state governments to help PSUs finance their projects
bear out this trend. State government guarantees have risen from Rs 63,400 crore in 1997 to Rs 124,800 crore in 2000. Of
these, nearly half (46 per cent) are for power, almost a quarter (23 per cent) for irrigation, and another 5 per cent for water
and sanitation. The three together constitute three-fourths of the contingent liabilities of the state. Even the central government
is not immune to this trend of rising contingent liabilities. Of the Rs 168,712 crore outstanding central government guarantees,
Rs 99,474 crore is for multilateral debt, mostly incurred for infrastructure. Of the remaining, 58 per cent is on account of power
(31 per cent), telecom (16 per cent), coal (7 per cent), urban affairs (3 per cent), rail, and road and all this, in a situation where
its total debt service (Rs 277,808 crore) already exceeds its revenue receipts (Rs 236,936 crore).
State governments are, however, in bigger soup. Pursuant to implementation of the Ahluwalia Committee report for the power
sector whereby states have entered into tripartite agreement with central PSUs, even plan transfers to states would be pre-empted
by CPSUs if their bills are not paid. Thus, we have a situation where an excess capacity is set up and contracted by a state
government, which is, thereafter, unable to raise adequate user fee or does not find enough users and has to pay the fixed charges
to the CPSU, thus eroding its financial capability. This load is on account of poor conceptualization, over capacities and underrecoveries. This erodes the capability of governments to make further investments, support operation and maintenance and
ultimately leads to non-provision of infrastructure services itself.
providers have strong links to the community. An interesting

example of such an effect is seen, in a somewhat different
context, in the Vishakapatnam Industrial Water Supply
project (Chiplunkar and Joshi, 2003) where it was possible
to restructure the project relatively quickly since the
financing was being advanced by the major beneficiaries
of the project.
In the subsequent sections, we shall explore the current
situation initiatives for delivery of infrastructure services
to the poor and ask whether the use of PFI can address
some of the identified shortcomings. In this process, we
shall look at the various components necessary for the
successful implementation of PFI and see to what extent
they are applicable in the Indian context and what manner
of innovations are required to meet our objective.
THERE
IS
ENOUGH MONEY
That the public sector does not do an adequate job of

delivering infrastructure services to the poor, is not isolated
to India, but is a widespread phenomenon (World Bank
2003b). Is this lack of service in India due to a lack of funding
or due to lacunae in the public sector delivery structure?
To begin with, we ask the following questions, related
to our earlier discussion on the preconditions for PFI.
First, does the government spend enough? This can only

be answered with reference to what is required. Put
otherwise, can we realistically expect improvement in service
standards given the current level of expenditure? However,
it is important to recognize that when we look at government
expenditure on these services, the direct budgetary
expenditure provides only a partial picture. An increasing
portion of the expenditure is now off-budget, especially at
the level of states, assisted, until recently, by the relatively
liberal risk categorization of state government guaranteed
debt by the Reserve Bank of India (Box 3.2).
Finally, it is important to ask whether the poor can pay
for these services themselves. This is not as preposterous
as it sounds. Indeed, they most probably do pay for a
number of these services, especially the indispensable ones,
since the mechanisms designed to reach these services to
them are not functioning. Survey evidence indicates that
the poor are considerably more burdened than the rich for
items such as water (Water and Sanitation Programme,
South Asia 1999) and health (Mahal et al. 2001).
So we have to find out what it would take the poor4
to purchase a specific consumption basket of infrastructure
4 There is a large and vigorous literature on the identity and
number of the poor, which we shall not enter into at this stage. See,
for instance, the papers at the link: www.worldbank.org/

services at commercial market prices? To answer, we
would first have to define a specific consumption basket.
We do this for the following commodities, viz., power,
telecommunications, water supply, especially the supply of
potable water, sanitation, education, and health.
THE CORE CONSUMPTION BASKET

For electricity, let us define the minimum necessary
consumption as 5 hours of lighting per family, that is, each
family needs to have sufficient purchasing capacity to buy
enough electricity to light a 60-watt lamp for 5 hours in
the day, say, from 6:00 pm to 11:00 pm for each day of
the year. In telecommunication, we take recourse to the
national goal of a teledensity of 4 per 100 in rural areas.
Given a family size of 5, this means 4 telephones for every
20 families or one among 5 families must have access to
a telephone for voice connectivity5. The cost of using the
telephone that is, the cost of that call, is an additional
amount and is not included in the calculation of purchasing
power required for the core consumption basket. For water
and sanitation, the universal provision is assumed to be the
supply of 40 lpcd of water to every household at
commercially-viable rates and the presence of a latrine in
every household. In the case of education, we assume that
every village in the country is provided with 3 teachers who
serve in the local school. The capital cost of building and
maintaining the school is not counted, though it could also
be accounted for without significant difference to our basic
premise. This, we presume, would suffice to provide universal
access to elementary education to every family, assuming
that each family is able to access education if it is present
within the village boundaries and is suitably staffed. In the
case of health, we consider access as being the presence
of one medically trained person, for example, a village
medical attendant (VMA) in every village. The costs of
medicines would be over and above the costs incurred in
stationing this person in the village and is not counted in
this estimate. To summarize, the core consumption basket,
therefore, contains consumption of 5 hours of electricity
per day and 40 lpcd of water and access to voice telephone
service, teaching services and medical consultation.
indiapovertyworkshop. Moreover, there are significant variations across
states and urban and rural areas. This is an important issue, as
discussed later.
5 The goal of an overall teledensity of 7 seems within reach by
the end of this calendar year (see TRAI 2003) given the current
teledensity of 6.3. However, this measure ignores the fact that many
subscribers have multiple connections, especially of cellular and
WLL phones along with fixed-line phones. The number of subscribers
therefore is much smaller. Conversely, the spread of PCOs means
that the level of teleaccess is much higher.
Electricity
In order to estimate the cost of supplying electricity6, let
us assume that there are about 200 million households in
India (obtained by using a 2 per cent annual growth rate
over the level of 192 million households in the 2001
Census). Of these, 31.9 per cent or 46 million of 144
million rural households and 14 million or 24.6 per cent
of the 56 million urban households are assumed to be
below the poverty line (Sundaram and Tendulkar 20017),
which would imply that one would need to supply electricity
to 60 million households. At the rate of 5 hours and 60
watts we have 300 watt hours a day or roughly 9 kilo watt
hours or 9 units a month or about 108 units in a year.
At Rs 5 per unit this approximately comes out to Rs 540
per year. Multiplied by 60 million households, this is about
Rs 3300 crore per year. Pause for a moment to appreciate
what it really means. If we could somehow reach these
Rs 3300 crore to the 60 million families that are currently
below the poverty line, they would be able to afford 5 hours
of lighting per day every day of the year. This is not about
reaching electricity to every village; this is about reaching
electricity to every household that is below the poverty line.
Yet, the government spends much more on this electricity
sector in the name of the poor, without reaching them.
Expenditure on activities such as rural electrification
and the supply of subsidized electricity is not small. The
Rural Electrification Corporation, incorporated in 1969,
to fund the rural electrification programme had a total asset
base in 20023 of about Rs 17,000 crore, while the total
annual commercial loss in the electricity sector that had
to be covered through a government subsidy or what was
left as unpaid bills to various suppliers was of the order
of Rs 30,000 crore, about 9 times the amount just calculated.
Even today, 80,000 odd villages are not electrified8. This
6
It is sobering to recall that the primary form of energy

consumption in rural households is not electricity but cooking fuel,
which accounted for almost 10 per cent of the total expenditure of
the bottom 30 per cent of rural households (Sundaram and Tendulkar
2001). 90 per cent of rural households use firewood (64.1 per cent),
crop residue (13.1 per cent), or cow dung (12.8 per cent). By
comparison, 67.2 per cent of urban households use either LPG (48
per cent) or kerosene, while 22.7 per cent continue to use firewood
(Census of India, Table H-11). As for lighting, 43.5 per cent (87.6
per cent) of rural (urban) households use electricity and 55.6 per
cent (11.6 per cent) use kerosene (Census of India, Table H-9).
7 The number of poor households is the topic of much academic
debate. We return to this in the concluding section.
8 While the country is today struggling to provide connectivity
to these villages, the coverage ratio in the remaining 500,000 odd
villages declared as electrified is often in the single digits, so much
so that the government is considering revising the definition of
electrified villages. However, the regional variance is high. According
to Census 2001, 43.5 per cent of rural households are electrified.
58
makes it quite clear that the expenditure in the electricity

sector is not about providing electricity to the people below
the poverty line, but theft and inefficiency and the cost of
supplying a productive input to agriculture. To the extent
that this is reflected in lower prices for agricultural produce,
especially rice and wheat, it is a subsidy that benefits all
consumers of such products and their derivatives, including
foreign consumers, in case of rice and wheat being exported.
This is acknowledged in academic and policy discussions,
but is not part of the public discourse where electricity
supply to villages, to farmers, and to the poor are often
mixed under one head.
may end up meeting the teledensity goal, but it may not

provide access to the rural poor, who may be better served
by a rural PCO. The current approach, which promotes
fixed-line connectivity as a solution to rural telephone
access is implicitly a huge leap in the quality of universal
service compared to the earlier goal of providing a village
public telephone. It actually moves from providing publicly
accessible voice connectivity, made familiar by the
ubiquitous PCO (public call office) to providing private
connectivity that is capable of high-speed data by focusing
on fixed line residential phones for 4 per cent of the rural
population. In the process the existing approach fails to
recognize the difference between teleaccess and teledensity.
Telecom Services
Let us now consider the case of the telecom services.
Almost a quarter (23 per cent) of urban households now
have a telephone, while only 3.8 per cent of rural households
possess one. By comparison, 18.9 per cent and 64.3 per
cent of rural and urban households own a television set
(Census of India 2001, Table H-13). Today, private
telephone service providers offer access to voice connectivity
at roughly Rs 400 a month9. Based on this figure, the
annual cost is about Rs 4800 to ensure voice connectivity
for each connection. As already mentioned, there are
about 46 million poor rural households. Consequently,
using our earlier rule of thumb, of one connection for
every 5 poor families, we need about 9.2 million connections
at the annual cost of Rs 4800 per connection. This implies
an annual outgo of Rs 4400 crore per year, to ensure that
the goal of a rural teledensity of 4 is reached among the
poor.10 As a comparison, the estimate of universal service
obligations calculated by the TRAI in its consultation paper
(TRAI 2003b) is Rs 12,990 crore, while the 5 per cent
universal service levy on all telecom services itself generates
about Rs 2000 crore11. It is true that this teledensity in
itself may be insufficient in ensuring that the rural poor
have access to a telephone. For example, if telephone
connectivity reaches the richest fifth of the households, it
9 This is based on commercial market cost of ownership for
GSM and CDMA mobile (WLL) connections. The monthly costbased rental for WLL phones calculated by TRAI (2002a) was
Rs 200. The cost of the most efficient provider was lower. This may
be an underestimate since the fixed costs were spread over a dense
urban network.
10 Since the existing teledensity in rural areas is about 1.6, that
is, 12 million connections (based on Census 2001 and TRAI 2003),
there would need to be 19 million additional connections to achieve
the target. This would imply another 10 million connections over
and above these 9 million connections to be provided to the poor.
11 This assumes traffic revenue of Rs 24,000 crore for BSNL,
Rs 6000 crore for MTNL and Rs 10,000 crore for the cellular
companies (assuming an average revenue per user of Rs 500 per
month and 18 million users).
Water Supply and Sanitation

Nearly a fifth of rural households do not have a drinking
water source near their premises (which is true for a little
less than a tenth of urban households). The difference is
more pronounced with respect to sources within and
outside the premises. While nearly two-thirds of urban
households have a drinking water source within their
premises, nearly half of them being served by tap water,
much less than a third of rural households have drinking
water supply inside their premises and less than a tenth
have piped water supply. The consumption of water at
40 lpcd for a family of 5 implies a daily consumption of
200 litres or an annual consumption of approximately 70
kilolitres. At the very conservative price of Rs 10 per
kilolitre12, this implies an annual cost of Rs 4200 crore
for 60 million rural and urban poor families. If one
confines the supply to drinking water alone, the requirement
would be closer to 1015 litres per family per day, or
an annual consumption of 3.5 to 5.5 kilolitres (a cost of
Rs 210 to Rs 330 crore). Here the issue of scale is more
likely to be consequential, as the annual consumption of
a village is only of the order of a 1000 kilolitres. However,
it also points to the feasibility of small-scale solutions for
safe drinking water.
The cost of sanitation is very strongly dependent on the
technology used to provide it. The water closet, familiar
in many urban households, is expensive, dependent on the
presence of a septic tank or sewage system and a very large
supply of water (pour flush latrines are relatively less
wasteful). Pit latrines, appropriately designed to avoid
contaminating underground water sources, are much less
expensive and can be as effective in meeting sanitation
12 Some may quibble with this, arguing that the low consumption
in rural areas would imply a higher per litre cost since the fixed
costs would be spread over a smaller total consumption. However,
village water supply schemes have achieved sustainability at prices
below this level.

Table 3.1
Drinking Water Source Says a Lot about Electricity and Latrines
(% of households)
Electricity
Latrine
Rural
Urban
Rural
Urban
All
Tap
Tube well
Well
Hand Pump
43.5
87.6
21.9
73.7
69.7
93.3
28.2
77.1
41.1
77.9
22.1
67.2
40.4
85.8
21.1
79.5
31.5
71.2
18.1
63.7
Source: Based on Table H-12, Census of India, 2001.
goals. This is also the currently prevalent technology in

rural areas. Of the 22.8 per cent of rural households that
have a latrine (compared to 70.4 per cent of urban
households), almost half (10.3 per cent) have a pit latrine
and only 7.1 per cent have a water closet, a facility that
nearly two-thirds of urban households (49 per cent) have.
One such solution, currently being implemented in
West Bengal as part of the Total Sanitation Campaign (see
chapter 13.3) has a total cost of Rs 400 per household.
To convert this into a monthly cost, let us assume that this
is financed with the help of a 2-year microfinance loan at
2 per cent a month, which yields an instalment of Rs 21
per month. If a latrine were to be installed in all the 46
million poor households13, this would cost Rs 1840 crore.
However, in order to reap the benefits of sanitation it may
take more than installing a latrine, given the number of
existing latrines that are being put to better use as
woodsheds and animal shelters. There is a concomitant
need for associated communication to drive home the
benefits of sanitation, a key part of the West Bengal
initiative14. The availability of water and sanitation facilities
and the consequent improvement in hygiene have a strong
positive impact on health and morbidity and, thereby, the
quality of life, by increasing the available workdays.
Compared to these costs, state government spent Rs 7230
crore in 19992000 on water supply and sanitation (Sen
2002). So far, a capital expenditure of Rs of 34,000 crore
has been made to fully provide 91 per cent of all habitations
with safe drinking water and another 8 per cent is partially
covered (GoI 2003).
It is interesting to note that a number of core
infrastructure facilities seem to come in a package, perhaps
pointing to the importance of community level resources.
Table 3.1 shows the relationship between the availability of
electricity and the presence of a latrine grouped by various
sources of drinking water supply. Rural households are
13
This assumes that none of these households have a latrine,

which is an extreme assumption, but may not be far from the truth
given that 78 per cent of the rural households do not have latrines
and 31.9 per cent of the rural households are poor.
14 See also Jalan and Ravallion (2001).
much more likely to have electricity and a latrine if they

have access to piped water, as opposed to tube wells or wells
(where the difference is not much) or a hand pump. In urban
areas, the same is true, except that more households with
wells have access to electricity and a latrine.
Education
In the case of education, the 86th Constitutional amendment
makes education for children between the ages of 614
a justiciable fundamental right. Is this economically
affordable? Let us calculate the wage bill for 3 schoolteachers
at Rs 3000 per month for every one of the approximately
600,000 inhabited villages. This is approximately Rs 6500
crore per year. To some extent, this strategy of using nonformal teachers is now being practised with some success
under the Sarva Siksha Abhiyan (Education-for-All
Movement), modelled on the Education Guarantee Scheme
of Madhya Pradesh, which provides salary support to
villages that provide for space for school. The teachers are
usually residents of the village who have had a sufficient
level of education15. It is a sobering thought that even if
one provides a school in each one of the 1.4 million
habitations counted in the drinking water survey (GoI
2003), the resources required would still be substantially
less (Rs 15,000 crore as compared to Rs 25,000 crore)
than what the government spends on elementary education.
The Sarva Siksha Abhiyan also provides an interesting
example of externalities at work. The presence of a certain
critical number of educated villagers generated by the
existing spread of education made it possible for this
scheme to spread even further. In addition, it also addresses
the problem of absenteeism for non-resident teachers,
which can be extremely high.
Health
Public subsidies on health hardly reach the rural poor,
though they do manage to help some of the urban poor
(another example of the importance of awareness).
15
The requirement is a school-leaving qualification for men and

8 years of schooling for women.
60

Table 3.2
What Would it Cost the Poor to Buy the Core Consumption Basket? (Rs Cr)
Ball-Park Estimate
Annual Cost
(Rs Cr)
Power
Telecom Services
Water Supply
Sanitation
Education
Health
Total
Current Expenditure
(Rs Cr)
Source for
Current
Expenditure
8339a
24,837b
12,990
7230c
Planning
Commission (2002)
TRAI (2003)
Sen (2002)
24,456
20,580
Tilak (2001)
Mahendra Dev (2002)
Daily Family Cost

(Rs)
3300
1.5
4800
4200
1300
6500
3600
22,400
2.2
2.0
0.7
1.4*
0.8*
8.6
Notes: The cost of installing a latrine is amortized over two years, at a rate of 2 per cent per month.
* The cost of this is shared over the entire rural population rather than just the poor families.
a
Subvention received from State governments.
b
Commercial losses with subsidy.
c
Expenditure by states only.
Nonetheless, we can estimate the cost of making trained

medical care available in every village, as Rs 3600 crore
per year through the presence of a trained VMA who is
paid Rs 5000 per month. Mahal et al. (2001) find that
among various health services, non-hospital outpatient
care (for example, at public health centres (PHCs)) and
immunizations are income neutral and outpatient public
hospital care the most pro-rich. Beds at PHCs are hardly
utilized, and they form less than 5 per cent of inpatient
bed days. The VMA will be able to provide most of the
services currently available as non-hospital outpatient care.
Given the extent of private spending on medical care by
the poor16, who receive only a quarter of the public
subsidy on curative health services (Mahal, et al. 2001)
there is a demonstrated willingness to pay for the cost of
medicines. However, even this could be included in a basic
health services package as the range of medicines to treat
common diseases are not expensive, thanks to Indias
thriving and competitive pharmaceutical industry.
that the core consumption basket consists of privately

consumed goods such as electricity, water, and access to
a telephone as well as shared consumption goods such as
education and health. It means that if each poor family
spent Rs 5.70 per day (about Rs 170 a month), it would
be able to pay for 5 hours of electric lighting with a 60
W bulb, buy 200 litres of water at Rs 10 per kilolitre, and
share in the rental cost of a phone connection with 5 other
families. If they could pay another Rs 2.40 per day (about
Rs 70 a month) as a sort of local poll tax (admittedly
extremely regressive), they would be able to pay the salaries
of 3 schoolteachers17 and a village medical assistant. This
is without any subsidy on part of the government.
Admittedly, even this seemingly small amount is not
affordable for a number of poor households. This is about
3 per cent of the average per capita income in India, but
a much larger percentage of incomes for the poor. If one
inflates the 19992000 per capita poverty line of Rs 335.5
17
TWO RUPEES
DAY
IS A
LOT!
Table 3.2 provides the estimate of the total purchasing

power that would be required for the poor to purchase
the core consumption basket. There are approximately
60 million poor families in India today. If each of them
were able to set aside Rs 8.6 per day (or Rs 1.70 per
person), they would have enough to provide this purchasing
power. It is necessary to dwell a bit on this statement, given
16 Nearly two-thirds (65 per cent) of the cost incurred by the
poor on hospitalization is met through borrowed funds (Mahal
2003). Also, 82 per cent of all visits (not just by the poor) to a
medical service provider are to private providers.
If instead, the salaries of the 3 schoolteachers were to be

recovered from fees paid by every student, then the fee per month
per student would be Rs 23, given that an amount of Rs 9000
would have to be raised from approximately 400 children in each
village (The age distribution of India is roughly 60 per cent below
the age of 15, and 5 per cent above the age of 65 with the rest in
the working age group. This assumes that two-thirds of the children
below 15 are in the age bracket of 614, and there is 100 per cent
enrolment, which is unlikely to be true in practice). Furthermore,
all students would need to attend the village school. If they attend
more than one school, the teachers salaries would be spread over
a smaller number of students and would, therefore, be higher. This
however, compares favourably with the fees charged by private
schools in smaller towns and villages. Similarly, at Rs 10 per
consultation, the village medical assistant would need to see 500
patients a month or roughly 20 patients a day (assuming 25 working
days), from a population of 1000a high morbidity rate.

per month for rural areas18 with the index for agricultural
labourers, one arrives at Rs 349.6 per month in current
prices, or Rs 11.6 per day. The daily cost is thus 15 per
cent of the income at the poverty line. If one compares
the cost to the daily agricultural wage levels of Rs 26 and
Rs 19 for males and females respectively, the per household
cost of Rs 8.60 exceeds 20 per cent of the combined male
and female daily wage. This is unreasonable burden when
food, related items, and fuel constitute 86 per cent of the
expenditure of the bottom 30 per cent of rural households,
leaving 14 per cent, at best, as discretionary income (of
which 2 per cent is spent on clothing and footwear). It
is thus not the contention of this paper that the poor should
be paying the full cost of all these services, though it is
quite possible that they are already spending much more
on these services than what we have just estimated to be
required. 19
IS THIS SITUATION NOT TAILOR-MADE
FOR
PFI?
Certainly, the analysis seems to indicate that the government

is spending much more in trying to deliver these services
to the poor than it would cost the poor to purchase them.
While some costs of delivery are to be expected, they
should not exceed 100 per cent of the ultimate benefit,
which they appear to do today. Unfortunately, this is not
unusual, nor is India unique in this regard. Radhakrishna
and Subbarao (1997) estimated that the public distribution
system (PDS) spent Rs 5.37 per rupee of benefit to the
target group. They also calculated that the total transfer
needed to bring everyone out of poverty in 19867 (which
they called the Aggregate Monetary Shortfall) was Rs 830
crore a month. In todays prices, this would be approximately
Rs 30,000 crore. In Mexico, a targeted poverty alleviation
programme, PRONASOL spent about 1.2 per cent of
GDP for 6 years to reduce poverty by 3 per cent, when
even an untargeted proportional distribution of the
expenditure would have reduced it by 13 per cent (World
Bank 2003a). In Uganda, Reinikka (2001) found that only
2 per cent of the capitation grants meant for schools
actually reached them in 1991. However, in neither instance
was the situation irremediable. After suitable redesign, a
new anti-poverty (conditional cash transfer) programme
in Mexico, PROGRESA (subsequently rechristened
Oportunidades) had overheads of below 8 per cent
18 The estimate for urban areas is Rs 451.2 in 19992000
(Sundaram and Tendulkar 2001).
19 Private spending on health care is estimated to be about
4.2 per cent of income. See Mahendra Dev (2002). The NSS
estimates that households spend about 2.5 per cent of their
expenditure on education and another 1 per cent on institutional
medical services.
(Bourguignon 2003). In Uganda, reform led to a dramatic

increase in the percentage of capitation grants reaching
school, going up to 100 per cent in some cases. Is this
not then a situation tailor-made for PFI? After all, the
money is there, the existing delivery is ineffective, and the
target group is unable to afford the service, satisfying 3
of the basic conditions for the use of PFI.
Unfortunately, there is limited ability to monitor
performance outcomes, in part due to the difficulty in
specifying outcomes especially in the area of health and
education, but, more importantly, due to the lack of
monitoring capacity in a large and dispersed manner would
be required. The presence of publicly-owned service
providers in sectors such as electricity, telecom, and water
supply and sanitation makes it even more difficult, since
even if it were possible to institute a monitoring process,
state-owned utilities are unlikely to respond to incentives
or directions for remedial action.
Is not more private participation the answer to this?
Surely, it could help, but at what pace can we reasonably
expect this to happen in sectors such as electricity and
water supply? There are few private electricity distribution
companies in India and of them only 3 (the private
companies in Orissa) are in any way involved with rural
electrification. The recent data released by the TRAI show
that there are only 12,000 private Village Public Telephones
(VPTs), as compared to 500,000 public VPTs. Neither is
there any organized large-scale private involvement in water
supply. In health and education, the involvement of the
private sector is widespread at all levels of service, be it
the village medical practitioner, the entrepreneur who
runs a one-room English-medium school or the large
super-speciality hospitals and deemed universities for
professional education. Unfortunately, the poor have limited
access to these facilities, and the quality of service when
they do have access remains questionable.
The need is, therefore, to devote some thought, to
develop institutional mechanisms of service delivery, either
through the government, or in partnership with private
providers or through self-provision, but most likely through
a combination of all three, that would ensure that the poor
have access to these services. This is a problem that
concerns many people involved in development.
THE WAY FORWARD?

What could these institutional mechanisms look like? They
will most probably involve moving away from direct public
provision of services, in order to increase accountability.
But, what will it move to? The involvement of private
providers will naturally ring in a commercial environment
for the provision of services. How will the poor be able
62
to access commercially provided services? Will it be through

mandatory universal service requirements? If so, how will
they be monitored? The ineffectiveness of universal service
requirements is eloquently demonstrated by the lack of
progress in rural telephony and the reluctance of private
companies to bid for electricity distribution companies
that have to supply electricity to dispersed rural consumers.
Will they then involve voucher-type mechanisms to ensure
that private companies have sufficient incentives to serve
these consumers. How will voucher mechanisms ensure
efficiency in service delivery? Is that only possible with
private service providers in a competitive environment,
with appropriate regulation? How long will one have to
wait for such a consummation?
The sorry state of infrastructure services has led many
consumers, typically urban and rich and often industrial,
to either self-provide the infrastructure or take measures
that insulate them from the effects of such service.
Consumers generate their own electricity instead of buying
it from the grid, they install their own water extraction and
purification systems, use private schools that are not part
of the government grid, use private hospitals and
practitioners outside the government grid, and even install
their own telecommunication networks. Private road
networks are awaited.
Consequently, urban India is replete with captive
electricity generation, primarily diesel generation, both at
household and industrial plant level20. Once the cost of
the installation is sunk, it is often less expensive to operate
the facility, that is, incur the variable cost of operations,
than to buy electricity from the grid, paying a price that
includes the utilitys fixed cost and an additional crosssubsidy component in the case of industry. Large apartment
complexes have shared captive generation facilities that
rival industrial installations. Even for these apartment
complexes, it is often less expensive to operate these
captive sets than to purchase electricity from the grid.
Some state utilities have been showing negative growth of
industrial consumption. It may not be long before domestic
consumption begins to show similar trends. This flight of
consumers from the grid leaves it more vulnerable with
a lower base on which to spread its overheads.
Households insulate themselves from intermittent water
supply by building underground sumps, overhead tanks,
and water purification systems that allow it to replicate 24hour water supply even when the grid supply is only for
a few hours. In cities where there is severe breakdown in
supply, households tap underground water or purchase
water from tanker-suppliers at rates that are typically 5

10 times the grid supply rates (See Chapter 12.4). The
story is similar for education, where few parents in the
upper deciles send their children to government schools,
and for health, where again, private hospitals are the
institutions of choice for upper-income consumers. If it
were possible to build private telephone systems, consumers
might do so; indeed private data networks are common
and some industrial users have installed private VSAT
systems that permit them to communicate amongst a
closed user group. The explosive growth of private telephone
service, especially cellular services (where today, cellular
connections exceed fixed-line connections in some metros)
is one reflection of the dissatisfaction of consumers with
the previous levels of service.21
This flight from the grid is not solely an upper income
phenomenon. Poor urban consumers buy water from
private providers and pay significantly more unit prices
than richer urban households. Many consumers in informal
settlements (especially commercial establishments) have
taken recourse to captive power generation and are quite
likely to send their children to private English-medium
schools and visit private medical practitioners (though they
may use public hospitals). Should one replicate this
phenomenon in rural areas? Should rural households be
facilitated to leave the grid and self-supply power, water,
health, and education? Is it feasible? Is it desirable?
Feasibility is not a question of private affordability, as
in the case of urban consumption, it is also related to the
relative sustainability of subsidy delivery and the manner
of their delivery in situations of self-supply. The desirability
question has many facets. First, will this approach lead to
better services for more poor people? Next, how will this
affect the sustainability of the grid supply for consumers
who remain? Will the consequent financial pressure on the
grid force it to collapse or reform? Will it lead to higher
social costs, as the benefits of economies of scale are
squandered? This chapter argues that the facilitation of selfsupply or community-supply (mini-grids), in some form,
if not completely, is both feasible and desirable for most
types of infrastructure.
As the economies of scale in the provision of services
reduce, it makes sense to move away from subsidizing
access to network provision, through instruments such as
vouchers and towards facilitating community provision of
services. This would be able to address the incentive,
targeting, and sorting issues arising out of vouchers to
20 Many households have devices called invertors that charge

batteries in order to supply electricity when there is no grid supply.
This changes the daily load curve, increasing demand during periods
of electricity supply, which leads to further incidence of failures.
21 The quality of telephone services had improved substantially

even before the entry of cellular service providers and public service
providers such as MTNL and BSNL have also seen aggressive
business growth.

Box 3.3
Networks, Vouchers, and Self-Supply
Vouchers are often advanced as a relatively simple, if administratively demanding way of providing the poor with purchasing
power. While vouchers have been discussed very intensively as an instrument for promoting school choice, they are used in many
countries for a variety of commoditiesfood stamps in the United States (which have now been upgraded to smart-cards); for
utility bills in Chile, as part of the Mexican Progresa/Oportunidades programme. The list is long and diverse.
The principal benefit is to compensate for a lack of endowments and provide choice to the consumer with respect to a service
provider, but if the services are being provided by a monopoly, as is often the case with network infrastructure, a voucher
programme does not push for efficiency by itself. If such providers are efficient, for example, as a result of effective incentive
regulation, vouchers may be able to ensure that services reach the poor in a cost-efficient manner. This is unlikely to be the case
when the network infrastructure is being provided by a public sector monopoly. In this case, a possible solution is to combine
vouchers with PFI to ensure that the poor can participate in the efficiency benefits of PFI. Even here, the revenue stream from
vouchers may not provide sufficient incentive to the network provider to invest in reaching the poor.
Another problem that bedevils the use of vouchers is their resale, which reduces its ability to target. Of course, this implies
that there is a divergence between the consumption basket chosen by the client and the desired consumption basket. There are
technological solutions that could attenuate this problem, but when the focus is on the financial health of the utility and on
limiting the subsidy bill of the government rather than reaching the poor, targeting is not considered a primary problem. From
this perspective, the counterfeiting of vouchers is often considered a more serious problem. Since common technological solutions
could address both problems, the latter may find a more sympathetic response.
The targeting problem may, however, be more fundamental. It is not easy to decide who should be targeted. Below the
poverty line is an extremely incomplete description of the poor in terms of their material condition. Given the bunching of the
poor near the poverty line (see Deaton and Dreze (2002) for a discussion), even small increases in incomeswith little material
change in conditioncould change the status of the target group. It also induces perverse incentives, since it puts them, as it
were, on a razors edge, facing considerable loss of benefits if they cross the lakshman rekha. Broader and less discreet
characterizations would suffer from measurement problems, while community self-selection may lead to an emphasis on relative
poverty that would result in widespread inconsistency across regions on an absolute income basis. This may be among the more
compelling arguments for choosing instruments other than vouchers in delivering infrastructure services to the poor.
A third problem with vouchers cited in discussions of school choice is sorting, whereby the choice inherent in voucher
programmes leads to an endogenous segregation, with richer, more aware beneficiaries, sorting themselves into particular institutions
that use voucher funds as a supplementary means of finance, leaving the others to make do with less well-endowed voucheronly institutions. This is an issue only when vouchers are seen as an entitlement, for example, when the school budget, instead
of being spent on state schools, is returned to both rich and poor beneficiaries in the form of vouchers to be spent by them
in a manner of their choosing. This will not be an issue in a situation where the vouchers are targeted only to the poor, as an
endowment supplement. However, in circumstances where the richer segments have already abandoned the state systemas, for
example, in educationto a much wider extent in India than in the US, it is quite possible that the politics of the situation
may evolve to a point where the richer taxpayers demand their taxes back, to defray their private costs, which would then increase
the unit costs at the state schools.
some extent (Box 3.3). Unfortunately, while this is happening

in physical infrastructure such as electricity, telecommunications and, to an extent, in water supply,
economies of scale continue to remain in education and
healthwhere, paradoxically, there are a large number of
small-service providers, which limits the extent to which
they can be self-supplied in an efficient manner.
That said, at this stage, however, it would be unwise
to rule out or rule in any particular approach. Diversity
is likely to characterize any ultimate outcome. One of the
factors that will affect the design of technical and institutional
options is likely to be the geographical distribution and
intensity of poverty. The solution is likely to be different
based on whether the poor are many or few, localized or
spread out, urban or rural. A small localized concentration
of the poor located in an otherwise well-functioning urban
service delivery network could well be addressed with the

help of vouchers or community action that helps them link
to the network, while a large, more widespread, group of
rural poor may require a more deep and programmatic
intervention, involving considerable capacity-building in
the community provision of infrastructure and/or welldesigned incentives to encourage nearby service providers
to extend service into the area. Let us examine this
contention for each sector in turn.
Electricity
Extension of electricity distribution grids to rural areas is
often not justified by the costs of extension even when the
rural consumers are willing to pay tariffs comparable to
urban consumers. This is because the load profile of rural
consumptionwith little industrial load and light consumer
64

Box 3.4
A Framework for Village Electrification
What kinds of frameworks could be required for facilitating community provision of services? A possible structure for implementation
is outlined in Figure 3.1. The structure conceptualizes support from the government not in the form of an initial capital grant,
but as a contingent subsidy to a Village Electricity Supply Company (VESCO) in the form of a revenue shortfall guarantee of
a pre-defined amount. This can be structured as a low-interest loan to be repaid in good times, for example, as a share of the
operating surplus of the VESCO. Put otherwise, this support is subordinated to loans from banks or microfinance institutions
and even equity from social venture capital funds such as those funded by donor agencies. The guarantee includes a cash-back
provision that provides a cash reward to the VESCO in the event that the guarantee is not called into use like a no-claim bonus
in an insurance policy. This provision provides an incentive for the VESCO to avoid using the guarantee, and is designed to
mitigate the eventuality that, in the presence of the guarantee, the VESCO may exert insufficient effort to increase its revenue
flows (known as the moral hazard problem).
The framework abstracts from the need for technical and institutional interventions for the formation of a VESCO. While
the technical interventions are significant and necessary, it is also important to stress that these skills are quite transferable to the
local population. Many existing rural electricity supply companies in India and elsewhere are testimony to such transferability.
Institutional support may, however, be more critical. Thus, in the initial phase, it may be prudent to begin this activity in an
area with sufficient social capital, with active presence of institutions that can provide technical support.
loads (owing to the absence of appliances)is unable to

absorb the fixed costs that are spread over a large consumption
base in urban areas. Consequently, self-sufficient rural grids,
as in the USA, where rural electricity cooperatives under
the umbrella of the National Rural Electrification
Cooperatives Association (NRECA) cover three-fourths of
USAs geographical area, often undertake viable electricity
supply to rural areas. Similar cooperatives have been successful
in Bangladesh too22. The reduction in the economies of
scale, or rather the availability of lower cost at ever smaller
capacities in generation make smaller stand-alone electricity
companies viable at the kinds of tariff outlined in the earlier
discussion. This strategy can be complementary to subsidized
grid supply for agricultural purposes (many utilities supply
power to agriculture during night off-peak hours when there
is little domestic demand), that is, it can meet only the
demand for domestic consumption or it can supply power
to agriculture under suitable subsidy transfer arrangements
(Box 3.4; Figure 3.1).
Water and Sanitation

In water, supply through community arrangements rather
than the grid is the conventional option in India23. Village
water supply is currently provided using local groundwater
22 Extension of the grid in Bangladesh is undertaken in a
deliberate manner. Initially a stand-alone system is used to build a
certain level of demand and only subsequently is electricity supplied
through the grid via a rural cooperative. It may be difficult to
replicate this deliberative manner in a more vocal society like India.
23 In countries like the US and France, the water infrastructure
is often designed at the local level though over time groups of such
local water supply companies have come to be managed by large
corporations.
extraction and distribution arrangements (though on

occasion, consumers will express strong preferences for
surface water sources) and this has led to impressive
coverage, with only 1 per cent of 1.4 million habitations
officially left uncovered. The issue here is more of
maintaining the system in a sound operating condition and
paying the electricity bills for pumping watera possible
source of synergy with decentralized electricity gridsand
the institutional mechanism that will facilitate that. This
may require some technological modifications to ease
maintenance and reduce pumping costs and arrangements
that permit more capacity to be built at the village/
habitation level. Sanitation arrangements too are household
(pit latrines) or community-based (septic tanks), with low
maintenance designs becoming increasingly common
(Chapter 13.3 of this report).
Health and Education

Health and education are both sectors where there is
considerable private supply, but little access to the poor.
One approach in areas such as health is to provide locally
resident expertise through a VMA as discussed earlier. The
training and incentive-linked issues connected with delivery
make it a candidate for contracting out on a standard PFI
basis, if local-level monitoring of presence is judged
sufficient for service delivery. It would be advantageous
over public provision if there is an increased ability to
discipline private contractors, as compared to government
employees. This would be effective in dealing with a
number of common treatable diseases that are the cause
of rural morbidity, such as malaria, gastro-intestinal diseases,
etc. Similar approaches could be taken with education,
which could also involve private contracting in the design

Utility
Revenue shortfall
guarantee of a
pre-defined
amount, with the
proviso that a
proportion of the
unused amount
would be paid
out to the
VESCO
Free transfer of
installed capital
like transformers
poles, lines, etc.
Generation set,
arrangement for
supply of biofuel,
operations and
maintenance, etc.
Government
VESCO
Tariff Revenue
Tariff Payment
Promoters (Local
Authority, Users
Association,
Cooperative, etc.)
Electricity
Consumer
Fig. 3.1
A Framework of Village Electrification
and delivery of training for para-teachers that staff village

schools, if monitoring is limited to simple (and also blunt
and occasionally distorting24) measures such as student
test scores. Private contracting may also assist in improving
the career prospects of para-teachers and VMAs, which
would attract better talent.
Moreover, community provision can also work in
conjunction with government delivery to improve service
delivery in institutions such as government hospitals and
primary health centres as demonstrated by the Rogi
Kalyan Samiti25 initiative in Madhya Pradesh (Mohanty,
2000). It is a community-based initiative with clear roles
for government, which continues its earlier budgetary
allocation to the hospital, and the community. The Samiti
is allowed to levy fees for hospital services in government
hospitals. The revenue earned from these fees can be
applied to a defined set of activities as decided by
individual samitis. Among the various uses are purchasing
of consumables such as medicines, reagents, X-Ray plates,
ensuring of regular maintenance, repairs, cleaning,
security, and hospital waste management. The government
budgetary allocation to the hospital, is used to meet the
wage bill. This has led to substantial improvements in
24
Teaching to the test is a common complaint in areas

where it is used as a performance measure. Issues of tampering
with test score may also arise if there are significant financial
benefits based on the score. Addressing these is part of the
institutional capability development required for moving to new
systems of procurement.
25 The Rogi Kalyan Samiti is an association comprising local
politicians, government officials, doctors, donors, and community
leaders.
service delivery, in the sanitation and work environment

of the hospital, and a reduction of cost of health care
to the poor, who were earlier compelled to purchase
consumables from private shops.
Community-based solutions may have another benefit.
As one moves away from conventional PFI to more
innovative structures, the selection mechanisms to be
adopted for service providers and associated dispute
resolution procedures remain unclear. It is obvious that
one cannot use the same metric to choose among CBOs
that one would use to choose between competing private
service providers. Indeed, it is not even clear whether there
should be a bidding process and if so, who or what types
of organizations could be allowed to participate.
Furthermore, any new structure is likely to give rise to
disagreements and disputes in the course of its working.
The existing dispute resolution through the formal court
system may or may not be appropriate. In such a fluid
situation, community-based solutions may be relatively
robust to the controversy that can be expected.
AVAILABILITY
IS
NOT ACCESS
One must recognize that even after infrastructure services

are made available, access is not guaranteed. Access is not
synonymous with availability. In rural India, even today,
though fortunately with decreasing frequency, people of
lower caste who are overwhelmingly poor, are denied
access to common facilities such as wells, prevented from
using appliances, barred from attending schoola form
of social exclusion that can only be remedied when the
persons being discriminated are aware of their rights (a
66
necessary condition) and take action to demand them

which often depends on local dynamics of power.
Gender is often an important basis for differential
access. The gender-bias in education, that is, the lower
enrolment and school completion rates for girls is well
documented. This is also seen in evaluations of ICT
interventions. Less than 13 per cent of the users of
Gyandoot, the ICT project in Dhar in Madhya Pradesh,
were women. These were overwhelmingly (85 per cent)
younger, between the ages of 11 to 30, while less than half
of the men came from this age group. The lack of awareness
prevents the poor from benefiting in many other little
ways. It inhibits them from making use of information and
communication technologies prevents them from taking
advantage of health services such as immunization and
contraception, it reduces the benefits from provision of
safe water supply and sanitation26 since they are not aware
of safe hygiene practices such as hand washing, etc. In an
early evaluation of the Grameenphone project in Bangladesh,
25 per cent of the village phone operators were found to
be male, which is surprising given that the operators were
supposed to be members and the membership of Grameen
is 95 per cent female (Richardson et al. 2000).
While many examples of benefits of awareness come
from the education, health, and water and sanitation sectors,
one can find examples of the need for increased awareness
in all sectors. In one instance, villagers in rural Orissa
became aware about the relationship between individual
consumption and collective quality of supply when voltage
levels improved dramatically after the installation of
individual meters. This removed the need to invest in a
local transformer. Mahal et al. (2001) speculate that the
increased use of public health services by the urban poor
as compared to the rural poor is due to their greater
awareness of the benefits and easier accessibility of facilities.
Increasing awareness of infrastructure services is an
important component of creating sustainable community
level mechanisms for delivering infrastructure services.
As graphically represented in Figure 3.2, increased
efficiency in service provision through better regulation,
more incentive-compatible delivery mechanisms, such as
community provision and increased competition through
a larger number of providers and more contestable markets
where possible, will help to reduce the costs of supply, but
26 Jalan and Ravallion (2001) find that the incidence and duration
of diarrhoea in children below five to be significantly lower in

households with piped water than for similar households without
piped water but these gains were not significant when the mother
was uneducated or the family was poor. Indeed, it was possible that
illiterate households were actually harmed by having access to piped
water. A possible explanation suggested by T.N. Srinivasan is that
piped water provided a false sense of security to illiterate poor
mothers who then did not boil or sterilize their household water.
S0
Increased efficiency in
service provision
S1
D0
Increased endowments and

awareness of the poor
D1
Fig. 3.2 From Market Failure to Market Provision
this may not be enough to make sustainable delivery

possible in the absence of sufficient demand. Increasing
endowments of the poor is one instrument, the other is
increasing awareness. The latter will not only push the poor
to consume these services, it will also encourage them to
demand allocation of public resources towards the provision
of these services through the political process. In the
interim, it is possible to design interventions that increase
awareness; indeed, some of these can be structured as
PFI-type initiatives with outcome-based payment
structures. Box 3.5 provides an example of such an
intervention to increase awareness of oral rehydration
therapy in Bangladesh.
The preceding discussion may make it appear that there
is little place for conventional PFI. This is far from the
truth. Governments, even in India, where over 70 per cent
of the population continues to be rural, spend on much
more than just alleviation of rural poverty. This chapter
has focused on areas where innovative mechanisms may
be needed but there is much that can benefit from
application of conventional PFI approaches. A prime
example is roads, which are a major contributor to poverty
alleviation (Box 3.6). In addition, services in metropolises
can benefit substantially, though in smaller towns there
have been innovative approaches to urban sanitation.
CONCLUSION
We have argued that serving the poor is affordablein the
sense that existing budget allocations, appropriately targeted,
would be adequate; that facilitation of community-based
initiatives closer to the self-supply model need to be explored
more intensively as the primary model of delivery rather
than just focusing on network provision and that PFI-type
techniques may find useful application in sectors like
health and education, apart from continuing to contribute
in areas like road services.
It is critical to appreciate that a uniform solution is
unlikely to be applicable and that the different circumstances
prevailing in each area will generate the need for customized

Box 3.5
Increasing Awareness in an Outcome Oriented Manner
Once one agrees that it is not just access but awareness that is important, the question arises to what the next course of action
should be. One way of addressing the problem is to tackle it directly, through a variant of social marketing, which has been
used to good effect in promoting contraception. Social marketing is the application of commercial marketing techniques and
distribution strategies to increase awareness, and distribute socially useful products at affordable prices. It combines commercial
distribution of socially-beneficial products with the promotion of desired behaviour change through various communications
strategies, whether mass media or interpersonal. Since the talent in creating and delivering such communications strategies often
lies outside the government, this is a non-traditional but appropriate candidate for contracting.
The Bangladesh Rural Advancement Committee (BRAC), an NGO, used an incentive payment scheme for individual health
workers to spread the use of oral rehydration therapy to counteract diarrhoea The payment system linked earnings to results.
Individual health workers were tasked with imparting knowledge about oral rehydration to mothers. A base salary of Taka 250
was supplemented by performance payments based on the mothers knowledge of diarrhoea and ability to prepare the rehydration
solution. A monitor visited 10 per cent of the mothers taught by the health worker over the past month, asked them 10 test
questions and witnessed a demonstration of the preparation of the rehydration fluida. On a 4-point grading scale (A to D), the
health worker received Taka 4 for every A and 0 for a D. Monitoring costs were estimated to be about 4 per cent of project
cost. Supplemented by external monitoring of the quality of fluids prepared by the mothers. Monitors were kept separate from
health workers to prevent collusion.
a
Supplemented by external monitoring of the quality of fluids prepared by the mothers. Monitors were kept separate from
health workers to prevent collusion.
solutions in order to ensure delivery of infrastructure

services to the poor. For this reason, it is fortunate that
most of the services are the responsibility of state or local
governments, which would allow a greater diversity of
approaches, tailored to the needs of the area.
There is large interstate variation in poverty and across
rural and urban areas. There is as much variation in
estimates of poverty across different researchers, for
example Bhalla (2002) calculates rates well below 10 per
cent, while Deaton and Dreze (2002) calculate an allIndia average of 26.3 per cent in rural areas and 12 per
cent in urban areas (compared to 31.9 per cent and 24.6
per cent in Sundaram and Tendulkar (2001). From a
completely different perspective, 49.6 per cent (12.5 per
cent) and 14.8 per cent (3.6 per cent) of households in
rural and urban areas, respectively, live in thatch or mud
houses 27 .
It is important to internalize this variation to avoid a
common problem, which is focusing on the number below
the poverty line when referring to the poor. As Deaton and
Dreze (2002) note, a number of the poor are bunched close
to the poverty line and it does not take much increase in
incomes to push them above the line. This, however,
makes little difference to their material condition. The
number of persons below the poverty line may be an
extremely incomplete characterization of the group of
people that need to be targeted for the purpose of delivering
services. As noted earlier in Box 3.3, this is a problem
that becomes even more critical when considering vouchers
27
Percentage of thatch houses in parenthesis.
as an instrument as compared to community provision of

services.
Community-Based Organizations (CBOs) that currently
work with the rural poor have not yet come forward to
attempt to provide infrastructure services. In part this could
be because a number of these services, especially education,
drinking water, health, and even electricity are seen as the
responsibility of the state and the focus of their efforts is often
to force the government to deliver these services, rather than
explore the extent to which they could provide it themselves
(which would let the government off the hook). This rightsbased approach is useful to the extent that the state is
financially and institutionally capable of delivering these
services, that is, it can afford to pay its teachers and doctors
on time and ensure that they are present in the classroom
and the clinics. When there is a breakdown in these
capabilities, the validity of the approach may need to be
rethought. Just as the microfinance movement has partly
succeeded, in addressing the lack of financial services for the
poor, CBOs may need to explore approaches that enable the
delivery of infrastructure services with only limited involvement
from the government, which may include, as in the example
in Box 3.4, a sustainable level of financial assistance.
There is also the very real possibility that groups involved
in the delivery of services will become involved in the
broader political debate. Not only is this linked to the
effect that such services will have on the existing
relationships of patronage, it is also related to broader
questions of priorities and beneficiaries of public
expenditure. The possibility that services may actually
become available with a modicum of state support may
68

Box 3.6
The Road to Reducing Poverty
According to Fan, Hazell and Thorat (2000), every crore invested in roads lifts 1200 persons out of poverty, compared to 97
for irrigation and 178 for rural development. By that calculation, Rs 25,000 crore invested in roads should see all 300 million
poor lifted out of poverty! Without being facetious, it is widely acknowledged that roads are a powerful force for poverty reduction
through their effect on non-farm employment and agricultural productivitya. Investment in rural roads under the Pradhan Mantri
Gram Sadak Yojana may yet prove to be the most powerful anti-poverty programme. This is especially so if these programmes
are used as a part of an employment guarantee scheme. In 19989, the Jawahar Rozgar Yojana, working directly through
panchayats created man-days equivalent to 4.5 per cent of the labour force, which is significant given that unemployment was
around 7 per cent (Mahendra Dev, 2003). Programmes like the EGS are also very cost-effective. Before it changed the rules and
increased the wages (which were earlier kept below market wages to improve self-targeting), it generated 190 million man-days
at a cost of Rs 272 crore in 19856, at slightly more than Rs 14 per dayb.
Roads, as mentioned earlier, lend themselves well to implementation with the help of PFI. It is conceivable that the
rehabilitation and maintenance of the major road network in each district could be contracted out with performance-based
contracts similar to the annuity contracts used on some stretches of the national highways by the NHAI. Concomitantly, village
roads can be maintained by local organizations, in a manner similar to the community-based approaches mentioned in this paper.
Road maintenance micro enterprises are becoming common in Latin America. In Colombia, for example, over 11,000 km are
maintained using 280 such enterprises at an average of 40 km per enterprise (Zeitlow 2002). Both conventional and novel PFI
approaches can thus be gainfully used in this sector. Another sector where conventional PFI may be effective is rural
telecommunications, as seen, for example, in Chile and Peruc. However, the constantly reducing cost of connectivity may make
rural telephony viable as a purely commercial service.
While roads provide an excellent example of the continuing importance of conventional PFI techniques, new ways of
community participation can also be used to deliver urban services. In Andhra Pradesh groups of women formed under DWCUAd
have been entrusted with provision of sanitation service, that is, sweeping of roads, lifting and transporting garbage to landfill
station and cleaning drainse. Subsequent to a 5 per cent contribution from them, these groups were assisted to purchase a vehicle
for transporting garbage, with the help of a loan from financial institution (45 per cent of the project cost) and grants (50 per
cent of project cost under the national SJSRY programme). The loan is repaid from revenue received from the local body in return
for the sanitation services provided. Since the initiative began in 1998 in Kukatpally, one of the 10 ULBs surrounding
Hyderabad, it has spread to 61 other local bodies, with 165 such groups. In addition to providing a civic service, the programme
also assists the women to stay out of poverty. Such examples attest to our contention that it is difficult to anticipate the nature
of solutions that can be devised.
a See Fan and Hazell (2000), who find that roads increase production returns in low-potential rainfed areas by Rs 136,000 per kilometre
and Fan et al. (2002), who find that for every 10,000 yuan invested on rural roads, 3.2 poor persons are estimated to be lifted out of poverty.
See also Jalan and Ravallion (2002).
b By comparison, casual labour in agriculture received Rs 16 in 1983. See Sundaram and Tendulkar (2001).
c The concession requires the installation of at least one public pay phone in each rural locality listed in the tender, providing access to local
and long-distance voice and narrow-band data communications, and one point of public access to the Internet in each district capital. The operator
may use its facilities to provide additional services to individual subscribers, such as Internet and long-distance telephony. The operator is paid
a subsidy payment over the first five years but he is obliged to provide service over the entire 20-year non-exclusive renewable concession.
d The Development of Women and Children in Urban Areas (DWCUA) is a part of the Swarna Jayanti Shahari Rojgar Yojana (SJSRY) launched
in 1997 with the objective of providing sustainable employment to the urban poor. The DWCUA aims at provision of employment opportunities
to the urban poor women by forming self-help groups of 10 or more women each and devising a project plan.
e This description is based on Rajeswar Rao (2003).
increase the extent of pressure on the government to make

these resources available, where earlier apathy towards
service delivery may have limited the absorption of
budgetary allocations. It is difficult to speculate on how
this involvement may affect the mechanisms and institutions
of service delivery.
Indeed, it is difficult to visualize changes of this
magnitude occurring without a strong demand for these
services being articulated through the political system.
One questions why there has been no such demand so
far, given the extent of deprivation that has taken place.
A partial answer is that the political space is not seen as
an arena for competing economic demands, but rather as

a means to express a particular conception of identity,
unrelated to their economic condition28. However, there
are indications that this is changing, patchily perhaps, but
surely. Occasionally, this discourse focuses on
redistributing benefits, for example, free electricity,
government jobs, from a state that is increasingly incapable
of providing any more. This financial bankruptcy of the
state may need to be more widely appreciated before the
28
This is an explanation suggested by Pratap Bhanu Mehta in

the course of personal communication with him.

focus turns to forging viable and sustainable solutions to
economic deprivation, rather than waiting for the state
to deliver.
The speed of this transformation is uncertain and will
necessarily proceed at different paces at different locations.
However, its inevitability makes it incumbent on us to

build expertise on institutional mechanisms of service
delivery that would ensure that the poor have access to
these services. When the demand for services is articulated,
the supply must not be found wanting.
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Enterprise Privatization
"
71
ENTERPRISE PRIVATIZATION
4.1 THE DISINVESTMENT STORY

Samir K. Barua
THE JUDGEMENT DAY
AND
AFTER
On 16 September 2003, the reforms and the privatization

process of government undertakings received a body blow
when the Supreme Court restrained the central government
from going ahead with privatization of the 2 oil companies
HPCL (Hindustan Petroleum Corporation Limited) and
BPCL (Bharat Petroleum Company Limited). The
judgement was pronounced on the petitions filed by the
Centre for Public Interest Litigation and the Oil Sector
Officers Association, questioning the governments use of
its executive powers to divest its stakes in the two companies.
HPCL was created by acquisition and nationalization
of ESSO Eastern Incorporated through the Esso (Acquisition
of Undertakings in India) Act, 1974. Similarly, acquisition
and nationalization of Burma Shell Oil Distribution
Company India Limited through the Burma Shell
(Acquisition of Undertakings in India) Act, 1976, resulted
in the creation of BPCL. The preamble to the Acts states
that the acquisition was intended to ensure that the
ownership and control of petroleum products, distributed
and marketed in India by the said company are vested in
the state, thereby so distributed as best to subserve the
common good. The Supreme Court is reported to have
interpreted this as an implicit bar on disinvestment of the
governments stakes in the companies without parliamentary
approval. In addition, the judgement also appears to be
based on the argument that since the acquisition of these
companies was made using funds from the consolidated
fund of India that is appropriated by the Parliament,
parliamentary approval is required for disinvestment of
government stakes from these companies.
At the time of writing the minister of disinvestment has

said in a statement to the press that the government has put
on hold further stake sale in all other companies such as
Indo Burma Petroleum, Bharat Aluminium Company Ltd.,
Indian Petrochemicals Ltd., Videsh Sanchar Nigam Ltd.,
and Computer Maintainance Corporation (IBP, BALCO,
IPCL, VSNL, and CMC), where the government stakes had
been sold earlier to strategic investors, since the investments
in these companies had also been funded from the
consolidated fund of India. He has announced that his
ministry would prepare a white paper on the matter and
outline the possible courses of action for the consideration
by the Cabinet Committee on Disinvestment (CCD) that
was scheduled to meet on 3 October. It appears that the
government would examine 2 possible options (other than,
of course, shelving divestment altogether!)a) requesting
the Supreme Court for a review of the decision by a larger
bench, b) promulgating an ordinance to go ahead with
divestment. The first option would require the government
to broaden the scope of review, or else, the review will be
done by the same bench that gave the judgement. The
second option would obviously require parliamentary approval
at a subsequent date.
Elections May Halt Divestment

Most analysts in the financial sector feel that given the
proximity of elections in several states and to the Lok
Sabha, disinvestment would be kept on the back burner for
at least a year. The government thus far has raised just Rs
983 crore through disinvestmentsMaruti IPOfar short
of the budgeted target of Rs 13,200 crore for the financial
72
year 20034. The shortfall in resources generated through

disinvestment along with the typical profligacy of governments
in election years imply that government would have to
borrow much more than the budgeted borrowing in the
current financial year. Despite the liquidity in the market,
this excess supply of government paper in the market is
likely to reverse the downward trend in yields and interest
rates and hurt investments and growth in the economy.
The set back reconfirms the manner in which
disinvestment of government stakes in Public Sector
Undertakings (PSUs) has progressed in Indiaone step
forward and two steps back. This chapter takes stock of
the manner in which the exercise of divestment of control
has proceeded to realize the well-enunciated dreams of
reforms initiated in early 1990s.
PRIDE
OF A
NATION COMES
CROPPER
Change is rarely a continuous process. Major changes

occur in a discontinuous manner as a result of jolts that
happen without a discernible build up. India experienced
such a shock on 6 July 1991, when it had to agree to airlift
47 tonnes of gold from the vaults of the Reserve Bank of
India (RBI) to Londoninto the vaults of Bank of England
to act as collateral for borrowing in the international
financial market. A little earlier, the government had leased
20 tonnes of gold to the State Bank of India (SBI) for sale
in the international bullion market. The funds were urgently
needed to ensure that it did not default on its international
financial commitments and also to ensure that there was
continued supply of petroleum and petroleum products to
keep its economy moving. The acute balance of payments
crisis was accompanied by a high inflation rate 17 per cent.
The pledging of gold to raise money woke up not only
the politicians but also the public at large. It was clear that
the mismanagement of the economy had gone too far and
corrective actions were urgently needed.
Crisis and PSU Reform

The crisis had been temporarily averted but a more lasting
solution had to be found by the new government that had
just assumed office in June 1991. As happens with most
nations in such situations, India turned to the International
Monetary Fund and the World Bank for assistance. The
international agencies were particularly critical of the poor
returns on PSU investments and the budgetary support that
had always been provided to the PSUs. They agreed to
help, provided India was willing to subject itself to strict
economic discipline specified by the agencies. A letter
from the then finance minister to the World Bank promised
the following:
no new PSUs, except in the core sector;
no further nationalization of sick units;

initiation of closure of unviable units;
establishment of a time-table for eliminating budgetary
support to PSUs;
greater autonomy to PSUs to cope with harder
budgetary constraints.
That was the beginning of the structural adjustment
programme in India. Stung and shamed by the crisis, the
speed of reforms with regard to divestment was breathtaking.
The erstwhile government had already taken a decision to
divest up to 20 per cent of government holding in PSUs.
The government that came to power after the next elections
raised the limit to 49 per cent. The DCA (Department
of Company Affairs), whose advise was sought by the
government, suggested that the government should think
of divesting up to 74 per cent of its stakes in PSUs
thereby giving up control on management of companies
while retaining adequate stakes to control certain key
decisions. The DPE (Department of Public Enterprises)
advised the government to divest stakes in profitable
companies also so as to create a favourable climate for
divestment. Rarely has the nation witnessed such perfect
alignment between the views of the politicians and the
bureaucrats. The magnitude of the crisis had completely
silenced those who may have harboured any misgivings on
divestment. Looking back, a wonderful opportunity to
clear all potential hurdles to disinvestment was lost since
the government did not act with foresight and planning.
THE EARLY DAYS

The reforms began with substantial deregulation of the
industrial sector and liberalization of foreign investments
and import of technology. Since 1956, 17 industries had
been reserved for investment by the public sector. In the
new Industrial Policy Statement of 24 July 1991, this
number was reduced to 8. The government also decided
to divest its holding in the PSUs to raise resources and
to bring in wider participation in the ownership of PSUs.
The policy was elaborated upon by the then Prime Minister,
Narasimha Rao, who declared in the Parliament on
20 December 1991, that the country would not resort to
further nationalization of industries. Instead, the government would work towards reducing the budgetary support
for sick PSUs and allow participation of private capital
in the funding of such PSUs to restore them to health or
even close them down should such restoration be unviable.
He also announced the setting up of the National Renewal
Fund to mitigate the hardships that would be faced by
the workforce in the sick PSUs from withdrawal of
budgetary support. The thrust would be to restructure and
modernize the over 1000 PSUs, of which about 30 per
cent were owned by the centre and the rest by the state
governments.
Major Reform Intentions

The clarity of purpose of the major initiative could hardly
have been better stated. The government also acted with
decisiveness in those early days of reforms. In addition to
pruning the list of industries reserved for public sector, the
government announced policy measures to encourage
private investment, both domestic and foreign, in core
sectors such as power and hydrocarbons. Comprehensive
amendments were also proposed in the Foreign Exchange
Regulation Act (FERA) to facilitate flow of funds from
outside. The key to the success of these measures would
be the divestment of government holding in the equity of
PSUs so as to not only allow private ownership of these
companies but also to bring in, over time, private
management of these companies, to improve their efficiency.
THE FIRST TWO ROUNDS

As a precursor to divestment, the government permitted
the PSUs to get listed with the stock exchanges. The stock
exchanges were persuaded by the government to list the
PSU stocks in violation of the listing norms. The PSUs
were exempted from the key norms of wide distribution
of shareholding and from providing the mandatory
information for an IPO (Initial Public Offering). In
retrospect, it would have served the cause of divestment
much better had these relaxations for listing not been asked
for by the government or permitted by the exchanges. The
relaxations resulted in stocks of companies getting listed
and traded in the market even when government held
99 per cent of the paid-up equity. The absence of up-todate information on the performance of the companies
also made the task of valuing these stocks difficult.
Sale to MFs and Institutions

The first 2 rounds of disinvestment of government equity
holding occurred in December 1991 and February 1992.
The shares were offered only to mutual funds, insurance
companies, banks and investment institutions. Since some
of these organizations are government controlled it would
not be incorrect to surmise that some of them were
persuaded to bid for the stocks offered, despite inadequate
information on the performance of the companies. Between
5 and 20 per cent government holding in 31 companies
were offered in these 2 rounds. These were a mix of 8
very good, 12 good, and 11 fair companies. The classification
being determined by the Net Asset Values (NAV) of the
shares offeredvery good being shares with NAV in excess
of Rs 50; good being shares with NAV between Rs 20 and
73
50 and fair being shares with NAV below Rs 20. Instead

of selling the shares of individual companies, bundles of
shares were offered, each bundle comprising shares of 9
PSUs. Each bundle had a reserve price that was the average
of the NAV and the price arrived at by discounting the
profits earned per share at a specified discount rate. The
total shares divested in 19912 through the 2 rounds
represented 8 per cent of government shareholding in the
31 companies and fetched the government a total of
Rs 3038 crore.
The Bundling Fiasco

Valuation, at best, is an imprecise exercise. The same share
is likely to be valued differently by different investors.
Bundling of shares of different hues, therefore, is an
inappropriate process if the objective is (as it should be)
to maximize the realization from the sale of shares. This
flaw is easily illustrated through a situation that consists
of two bidders (A and B) for 2 shares (X and Y). Table
4.1.1 contains the assessment of value of the shares by the
2 bidders.
Table 4.1.1
Value Assessment by the Two Bidders
Bidder
A
B
Assessed Value of X
Assessed Value of Y
Rs 70
Rs 50
Rs 40
Rs 60
If the stocks were to be offered separately, the prices

realized for stocks X and Y would be Rs 70 and 60
respectively, thereby generating a total of Rs 130 from the
sale. If the stocks are bundled and sold, the realization
from the sale would be just Rs 110. By bundling the stocks,
therefore, the government realized less value than what it
could have had the stocks been auctioned separately to the
bidders. It is ironical that bundling was discontinued not
because the government realized the folly but because of
objections raised by potential bidders!
SCEPTICISM SETS IN
The euphoria about divestment lasted very briefly and
started showing signs of flagging by the middle of 1992.
There were 3 factors that were responsible for the cooling
off of commitment to divestment. The international funding
agencies that had bailed the government out of the financial
crisis would not permit the government to adjust the
money raised through divestment against fiscal deficit for
which they had specified stringent targets. This considerably
reduced the incentive for the government to disinvest.
After prolonged deliberations, the funding agencies relented
74
to permit the government to adjust up to Rs 2500 crore

raised from disinvestment towards bridging the deficit.
This placed implicit ceiling on the governments motivation
for raising resources through the disinvestment programme.
The second setback to disinvestment was the securities
scam that hit the Indian financial markets in April 1992.
The government was put on the back foot by vociferous
opposition that found the scam a handy tool to beat the
government with. The third reason for reversal of sentiments
was that the foreign exchange position had improved
significantly by the middle of 1992. The over 20 per cent
devaluation of the rupee the previous year had started
paying dividends in terms of export growth. The abatement
of the crisis led to the return of complacency. The urgency
to divest government stakes had disappeared.
Inertial Disinvestment
The process of disinvestments, however, continued
perhaps due to sheer inertia. The budget for the financial
year 19923, presented before the securities scam and
before the foreign exchange position had recovered
significantly, had set a target of resources to be raised from
divestment at Rs 3500 crore for the year. The divestment
was done in 2 phases, in October 1992 and December
1992. The total realization was about Rs 1865 crore. On
this occasion the method of computing the reserve price
was changed. It was the average price recommended by
three merchant bankers. The stocks were offered to a
larger set of institutions and also individual investors.
Stocks of 2 PSUs were not sold as the bids received were
below the reserve price for these stocks.
Rangarajan Committee
In an attempt to put some distance between itself and
divestment, in November 1992, the government set up
a committee under the chairmanship of C. Rangarajan
to enunciate a policy on disinvestment. The major
recommendations of the committee were as follows:
the percentage of equity to be disinvested should be
49 per cent in the industries reserved for public sector and
74 per cent in other cases;
instead of year-wise targets of disinvestments, a clear
action plan should be evolved.
a number of steps need to be undertaken by the
government, including corporatization of the PSUs,
restructuring the debtequity gearing, as well as setting
up an independent Regulatory Commission for the sector.
the choice of method of valuation of shares of PSUs
should take into account the special circumstances affecting
PSUs operations, such as, the past focus on social
responsibilities rather than pure commercial focus.
a scheme for preferential offer of shares to workers

and employees of the PSUs may be devised.
10 per cent of the proceeds from disinvestments
may be set aside by the government for lending to PSUs
on concessional terms to meet their expansion and
rationalization needs.
a standing committee on disinvestment may be
constituted to oversee the action plan for reform,
restructuring, and disinvestment as well as monitoring and
evaluation of progress made.
the percentage of equity to be divested could be as
high as 49 per cent for industries that were explicitly
reserved for the public sector. In certain cases, the
divestment could take place up to 74 per cent. In all other
cases, the divestment could be 100 per cent. The 6 industries
where the government should maintain 51 per cent holding
were coal and lignite, mineral oils, arms, ammunition and
defence equipment, atomic energy, radioactive mineral,
and railway transport.
The committee submitted its report in April 1993. The
incumbent government, however, did not take any decision
on implementation of the recommendations made by the
committee. On hindsight, it is clear that had the
government implemented the bold recommendations of
the Rangarajan Committee, the story of disinvestment
would have been entirely different from what it turned out
to be. The recommendations came a little too late for
them to receive adequate support in the Parliament. The
government was already on the defensive after it was
forced to set up a JPC (Joint Parliamentary Committee)
to investigate the securities scam of April 1992. The scam
had provided the much-needed ammunition to those
opposed to reforms. They had been silenced initially
because of the deepest ever financial crisis that had been
faced by the nation.
External Pressures Loose Steam

By the time the Rangarajan Committee completed its work
in 1993, the foreign currency reserves had improved even
further and the urgency for reforms had lost its edge.
Despite that, the process of disinvestment would perhaps
have gathered momentum but the World Bank stipulated
that only a limited amount out of the proceeds from
disinvestment could be set off against the budget deficit.
The stipulation dealt a body blow to the political expediency
for disinvestment. If the funds generated could not be used
to dress up the balance sheet of the government, there
was no immediate motivation to accelerate the process.
Disinvestment became a victim of these circumstantial
factors that collectively slowed down the process. As the
voices of those opposed to disinvestment became louder,
the motivation of those who were championing its cause
became weaker.
The Economic Survey, (19923) captures the key elements
of the governments thinking at that point in time on the
strategy for reforms of the public sector:
strengthening managerial autonomy;
promotion of private-sector competition in areas
where social considerations are paramount;
reduction in budgetary support to public enterprises
in view of severe budgetary constraints,
increasing dividend payments to ensure adequate
return on government equity;
partial divestment of equity in selected enterprises
to mobilize non-inflationary resources;
to widen public and private participation in public
sector in order to introduce a greater sense of accountability;
and
restructuring or closure of unviable enterprises and
creation of a safety net to protect the interest of workers.
The above suggestions highlight the fact that the
government thinking was in the right direction. However,
the will to implement them to realize the objectives had
weakened. The Narasimha Rao government was also nearing
the end of its term. The impending elections ensured that
disinvestment was quietly put on the back-burner.
THE FIRST FIVE YEARS: MISSED OPPORTUNITY

The targets set and the achievements in the first 5 years
by the Narsimha Rao government are presented in Table
4.1.2.
Table 4.1.2
Year
Target
Actual
Process Used for Disinvestment
(Rs crore) (Rs crore)
19912
2500
3038
19923
2500
1913
19934
3500
Nil
19945
4000
4843
19956
7000
362
Minority stakes sold through

auction of bundles
Shares sold separately for each
company through auction
Auction the proceeds received
in 19945
Auction + NRIs and others
allowed to participate in the
auction
Auction + Sale at a fixed price
for shares of one of the
companies
The government did manage simultaneously to reduce

the budgetary support to the PSUs. The data pertaining
to this are presented in Table 4.1.3.
75
Table 4.1.3
Year
19912
19923
19934
19945
19956
Support
(Rs crore)
Relative to
Budget
Real Value
(Base 19901)
5985
5241
7271
7966
6452
5.372%
4.274%
5.126%
4.956%
3.834%
5271
4312
5399
5357
4132
The figures confirm the sporadic nature of support that

disinvestment received and the clear decline in support in
the last year of the government due to impending elections.
The government clearly missed the IMF induced golden
opportunity for privatization in 1991. The heartening feature
of the 5 years, however, is the fact that the budgetary
support to PSUs declined. While the absolute amount in
nominal terms did not go down, the level of support as
a percentage of the budget declined from well over 5 per
cent to below 4 per cent. The support provided in real
terms (computed using 19901 as the base year) also
showed a declining trend over the 5 years.
THE NEXT THREE YEARS: COMPULSIONS

COALITION POLITICS
OF
The 3 year period from 19967 to 19989 was a period

of political instability arising from coalition politics at its
worst. In this span of 3 years, the prime ministership
changed from Atal Behari Vajpayee to Deve Gowda, to
Inder Kumar Gujral, and then back to Vajpayee.
On the first occasion, Vajpayee had to demit office in
just over 2 weeks. The new government under the Prime
Ministership of Deve Gowda assumed office in June 1996.
The government was a coalition of political parties of
different hues, including the leftist parties that were
ideologically opposed to the idea of disinvestment. A way,
therefore, had to be found to take the process of
disinvestment forward. Acting on the recommendations of
the Rangarajan Committee that was set up under the
earlier government, the new government set up the
Disinvestment Commission in August 1996 for
recommending the modalities for undertaking disinvestment
of government equity in PSUs. By the time the commission
was set up, the process of disinvestment had slowed down
considerably. The political will to push through
disinvestment had weakened considerably with spectacular
improvement in the countrys foreign exchange reserves.
Besides, disinvestment was already being labelled as being
anti-labour and anti-poor. The political ambivalence was
also fully exploited by the bureaucracy that saw no merit
76
in pushing through an agenda that would hurt their access

to luxuries that could be offered by profitable PSUs. The
commission was set up so that the coalition government
at the center could put some distance between the
government and the decisions made on disinvestment.
Disinvestment Commission
Fifty PSUs were referred to the commission by the
government for advice and recommendation on disinvestment.
However, before the commission completed its work, Gujral
had assumed the mantle of the prime minister. By March
1998, the commission had examined 41 PSUs. The
commission formulated a 3 part recommendation
disinvestment at various levels for 12 PSUs, strategic sale
of equity in 21 enterprises, and no disinvestment in 8
enterprises. The commission recommended greater
operational autonomy for the PSUs and induction of nonofficial, outside directors on the boards. The dismantling
of APM was specified as a pre-condition for disinvestment
of equity in companies in the petroleum sector. The
commission also gave its views on important issues such as
Voluntary Retirement Scheme (VRS) and Employees Pensioncum-Insurance Scheme. Almost simultaneously with the
completion of the work by the commission, the Gujral
ministry fell, and Vajpayee again became the prime
minister.
Fortunately, despite the fact that the commission had
been appointed by the earlier government, the incumbent
government accepted some of the recommendations of the
commission. As recommended by the commission, the
government granted enhanced autonomy to nine selected
PSUsIOC, ONGC, BPCL, HPCL, NTPC, IPCL, SAIL,
VSNL, and BHEL. These companies were referred to as
Navratnas. The boards of these companies were to be
augmented through inclusion of independent directors and
considerable operational autonomy was to be given to
these companies. Two more enterprises, namely, GAIL and
MTNL, were also given a similar status. The objective was
to make these companies board-managed rather than
government-managed enterprises.
Modest Targets
The targets set for resource raising through disinvestment
were modest during this period, and the achievements
were even more modest compared to the earlier period.
The data pertaining to the 3 years are presented in Table
4.1.4.
Table 4.1.4
Year
19967
19978
19989
5000
4800
5000
380
902
5371
GDR (VSNL)
GDR (MTNL)
GDR + Sale in the domestic
market + Cross-holding by 3 oil
sector companies
markets through use of Global Depository Receipts

(GDRs). In the year 19989, during the second stint of
Vajpayee as prime minister, the government found a
novel way of extracting cash from cash-rich PSUs
through cross holding of equity. IOC, the largest PSU
in oil refining and the only Fortune 500 company in
India, was asked by the government to acquire a part of
government stakes in 2 other oil sector PSUs, namely,
ONGC and GAIL. Similarly, ONGC was asked to buy
a part of government stakes in IOC and GAIL. And
GAIL was asked to buy a part of government stakes in
ONGC. The proportions of acquisition were worked out
so as to achieve the target of Rs 5000 crore for the year.
This manner of appropriation of cash from the PSUs to
finance government expenditure was mooted by the then
finance secretary. There was an outpouring of concern
at the diabolical plan as that adversely affected the
investment plans of these companies and forced them to
borrow to finance their operations. In retrospect, however,
all the 3 companies have benefited immensely from
the significant increase in the valuations of their
investments in each other. The governments action would
be vindicated if these companies are permitted to sell
their holdings in the market to convert the paper gains
into cash.
Budgetary Support
As regards budgetary support to PSUs, as is evident from
the figures presented in Table 4.1.5, the trend observed
in the first 5 years continued during this period too. The
budgetary support to PSUs showed a steady decline as a
proportion of the total budget.
Table 4.1.5
Year
Extracting Cash Out of PSUs

Since the domestic markets were comatose during this
period, the government sold its holding in the international
Target
Actual
Process Used for Disinvestment
19967
19978
19989
Support
(Rs crore)
Relative to
Budget
Real Value
(Base 19901)
6854
7137
7230
3.601%
3.299%
2.835%
4107
4061
3925
THE LATEST FOUR YEARS: TAKE

HORN
THE
BULL
Table 4.1.6
BY THE
Immediately after the Kargil war, Vajpayee sought a fresh

mandate from the nation and became prime minister for
the third time. Since then the government under his
leadership has shown the strongest resolve to push the
process of disinvestment. Making a distinct break from
the past, Vajpayee set up a separate ministry and department
of disinvestment on 10 December 1999. Despite facing
considerable opposition, not only from its coalition partners
but even from within the Bharatiya Janata Party (BJP) and
its sister organization, the Sangh Parivar, the government
has made serious attempts to carry the process of
disinvestment to its logical conclusion. The policy on
disinvestment has undergone a major change in the new
regime. Instead of selling its holding in small lots, the
government has been in favour of strategic sale of its
stakes. The reasons given for the change in policy are:
a) higher prices are realized as the management control
is transferred to the buyer, b) more importantly, the transfer
of management to private hands is likely to improve the
efficiency of operations, c) sale of minority stakes gave the
impression that the government was just keen on generating
cash from sale of stakes rather than improving the
performance of the units; sale to strategic investor reflects
the intent of the government better.
The governments attempts have been rewarded in the
form of significant rise in valuations of stocks of PSUs.
As of 27 September 2003, the aggregate market value of
equity of listed PSUs accounted for over one-third of the
total market capitalization of Indian stock market. ONGC,
with market capitalization of about US$17 billion, was by
far the most valuable company in the Indian stock markets,
accounting for about 9 per cent of aggregate market
capitalization of stocks listed on the Bombay Stock Exchange
(BSE). The sea change in the valuation has resulted from
the change in the perception about PSUs. The credit for
this must go to the incumbent government. Despite this,
however, the record of disinvestment is not significantly
different from the earlier periods. The figures for different
years are presented in Table 4.1.6.
The budgetary support, based on the revised estimates
available for two years, 19992000 and 20001 are presented
in Table 4.1.7.
77
Year
Target
Actual
19992000
10,000
1829
20001
10,000
1870
20012
12,000
5632
20023
12,000
4748
20034
13,200
993
Process Used for

Disinvestment
GDR, Sale in domestic
market
Strategic sale, Sale through
nomination of 3 refineries
Strategic sale, Sale of stakes
in public-sector hotels,
payment of hefty dividends
Strategic sale, Sale of
control premium (Maruti)
IPO in domestic market
through book building
(Maruti)
Table 4.1.7
Year
Support
(Rs crore)
Relative to
Budget
Real Value
(Base 19901)
8406
8896
2.82%
2.65%
4391
4405
19992000
20001
different approach to disinvestment of its stake. It decided

to sell its stake through an IPO, whereby it could claim
that the ownership was being returned to the people directly.
The Maruti Udyog IPO was a resounding success. The
major advantage of selling government stakes through IPO
is that possible under-pricing in retrospect does not become
a hugely politically sensitive issue since the benefit from
under-pricing goes to the investorsthe people of India.
The government adopted another strategy for garnering
cash from PSUs. Many PSUs with huge cash reserves, such
as VSNL, were persuaded to declare huge dividends just
before their disinvestment. The proceeds received from
these special dividends as well as those from what the
government has chosen to call control premium paid by
the strategic investor are also accounted for under proceeds
from disinvestment.
The budgetary support to PSUs declined further as a
proportion of the budget. In real terms also the amount
of support stayed almost at the same levels as the earlier
period of political instability.
Strategic Sale to the Fore
CONCLUSION
The primary method of disinvestment that has been adopted

by the incumbent government is sale of stakes to a strategic
partner who would take over management control of the
PSU. However, anticipating possible resistance to bigticket sale in the oil sector, the government adopted a
It is clear that even after long years of experience with

disinvestment, India has not been able to formulate a stable
and sensible strategy for disinvestment, that has the support
of the political parties and that subserves national interests.
It could possibly be because none of the governments over
78
this long time span was willing to think through the entire
process before getting into action. Each government has
simply been reacting to challenges as they arose from
different constituencies. The most encouraging development
has been the fact that in recent times, with continuing
deterioration in the finances of state governments, several
state governments, such as Andhra Pradesh and Punjab,
are actively pursuing the route of disinvestment of state
government stakes in various enterprises. If more states,
particularly those ruled by the Congress Party or those
parties that are opposed to disinvestment at the moment,
join the bandwagon of disinvestment, it may yet be possible
to reach political consensus on the issue. However, going

by the way India is governed, one can never be sure about
how long it would take for a consensus to emerge. One
is reminded of the 4 lines from an anonymous poem on
a perennial seafarer:
Sailor, sailor, where do you come from?
From a distant land, I do not recall;
Sailor, sailor, where are you headed to?
To a distant land, I do not know.
One hopes that the story of disinvestment will not be

narrated in a similar manner decades later!
4.2 PRIVATIZATION TODAY: A DISCUSSION

Sebastian Morris
In the 1990s, starting with 19923, partial disinvestment
and sale of minority shares in public enterprises had taken
place. There was much that was wanting in the process.
The major lacunae in the process until the Ministry of
Disinvestment (MoDI) took charge were as follows1:
Initially the shares of good and not so good
enterprises were bundled together into lots with the hope
that they would be more saleable thereby. But this was
a technical error since the stocks could only have fetched
a price lower than that which was possible without bundling.
It would have only reduced saleability and destroyed value.
Many of the market norms including listing norms,
accounting norms, etc. were bypassed to result in low or
lukewarm response from the market.
In selling some minority stake in companies after
announcing that the government would not go below 51
per cent (merely to pander to anti-privatization political
lobbies), only very low prices could be realized since the
market then could not have incorporated the value of the
expectation that it would be finally fully privatized. With
51 per cent held by the government legally the enterprise
was state and, as such, expectations of future commercial
orientation would be very low.
Minority shares were hardly ever sold with the
explicit and credible statement (commitment) that the
share of the government would be finally brought down
below 50 per cent. Therefore, price increases in anticipation
of the final relinquishment of control could not be realized
by the government.
Contradictory and conflicting statements regarding
privatization as a whole, and regarding individual enterprises
1
For a detailed coverage see Barua, The Disinvestment Story,

Chapter 4.1 in this Report.
would have enhanced the volatility in the price of the

stocks, and this would have, over the longer period,
impacted negatively on the valuation of the stock.
The divestments or sale of stock until recently was
carried out through sales to financial institutions (FIs)
rather than directly into the market. This again would have
introduced value loss to the government since FI
shareholding in stocks of both private and public firms was
known to be negatively related with market capitalization
over book values.
Privatization with Hurdles

Privatization as such is no longer an issue. The issue today
is how best to carry the process forward and the priorities
for privatization. Nearly all political parties have de facto
accepted the need to roll back the state, and with the policy
being clarified that the interests of the employees would
be protected, there is little substantive opposition from
unions either. This is not to deny that employees would
not create hurdles and roadblocks to bargain for the best
deals in any change. With the success of the first few
privatizations, no significant retrenchment, or reduction
in wages, the opposition from labour is not a major hurdle
in the privatization that is gathering momentum.
Just because the opposition from employees is weak
does not mean that there is no opposition to privatization.
The benefits that the bureaucracy and the politicians derive
through preferential access to the services of public
enterprise, the loss of rents in the loss of control and in
the emergence of commercial orientation, their inability
any more to use public enterprise to serve particular
constituencies, the loss of position for bureaucrats and
others, the loss of expense accounts that a management
position in an enterprise provides to the government official,
are all powerful but dysfunctional forces arrayed against
privatization. Therefore, it is a foregone conclusion that
administrative ministries would be opposed to privatization.
Slow by Design
Privatization at the low and variable rate of under
Rs 10,000 crore (most probably around Rs 5000 crore per
year) can happen if the current regime and system continues,
but even this rate is contingent. Exigencies, and political
processes make it virtually certain that the spirited push
today for privatization would not always continue without
a radically different approach to privatization.
What then are the impediments to privatization?
Privatization like public investment and the management
of public enterprise offers much scope for rents for the
party in power. Even if a particular party is serious about
privatization, and does not want to make rents out of the
process and its decisions, few would accept the same as
being credible and no political opponent would let go an
opportunity to claim that corruption prevailed in
privatization. The current mode of privatization makes
every act a major contest, which considerably slows down
the process. Only when it is absolutely clear that the
process is above board for all political contestants, that is
if the process is completely depoliticized, would privatization
make significant headway to create an entirely commercially
oriented and dynamic industrial sector.
79
Mammoth Task Ahead

The gross book value of investments in the PSUs was
Rs 274,000 crore approximately at the end of March 2002.
Since much of the capital formation has taken place in
the past, the inflation adjusted value is of the order of
Rs 700,000 crore (Table 4.2.1). Accounting for depreciation
would reduce this value, but accounting for the appreciation,
especially of land and real estate which has been large,
would perhaps partly counter the depreciation and give a
value not likely to be less than Rs 500,000 crore and closer
to 600,000. This means that at the current rates of
disinvestments, the completion would take an age. This
leaves the enterprises in a prolonged state of anomie. The
need to speed up disinvestments to unlock the value of this
huge capital stock is obvious. And a process that can
virtually complete disinvestments in a decade or less ought
be the objective of the government.
Earlier the MoDI was pursuing strategic sale to the
exclusion of other modes of disinvestments. Today, in
principle, the MoDI has outlined several methods so that
there is no problem with regard to the methodology broadly
considered. But there are problems with regard to the
details and, most importantly, the institutional framework.
MORAL HAZARD
IN
MICROMANAGING PRIVATIZATION
There is much moral hazard to the government itself

directly carrying on privatization, given the contested and
Table 4.2.1
Total Investment in Central PSUs at Gross Book Value and the Inflation Adjusted (at 8% Per annum Average) of the Same
Particulars
At the commencement of the 1st 5-Year Plan (1.4.1951)

At the commencement of the 2nd 5-Year Plan (1.4.1956)
At the commencement of the 3rd 5-Year Plan (1.4.1961)
At the end of the 3rd 5-Year Plan (31.3.1966)
At the commencement of the 4th 5-Year Plan (1.4.1969)
At the end of 5th 5-Year Plan (31.3.1979)
As on 31.3.1998
As on 31.3.1999
As on 31.3.2000
As on 31.3.2001
Value as on end-March 2002 (Estimated)
Total Investment
(Rs crore)
Enterprises
(Numbers)
29
81
948
2410
3897
6237
15,534
18,150
42,673
99,329
1,35,445
2,13,610
2,31,024
2,39,167
2,52,554
2,74,114
5
21
47
73
84
122
169
179
215
244
246
242
240
240
240
242
242
5
29
Source: Columns (1), (2), and (3), from Public Enterprises Survey, 20001 as reported in GOI (2003).
Current Book Value

(Inflation Adjusted)
(Rs crore)
2331
2091
23,727
27,230
21,986
23,547
63,670
14,222
1,05,834
1,66,410
84,209
1,33,961
23,692
10,258
15,615
23,285
7,42,067
2331
80
competitive politics in the country, and the complex nature

of the task.
Not Immune from Politics

The current processes as followed and laid out by the
governmentminor squabbles apartare exemplary but
only with strong motivation within the MoDI and ability
to handle all legal and political issues. It is not immune
from interdepartmental rivalry; there would be political
pressures for and against particular actions and modes in
privatization, since nothing is institutionally shielded from
the usual day-to-day workings of the government.
Privatization is not about economics alone, politics is
always involved. The implicit assumption in the current
process is that a committed prime minister, with a
competent disinvestment minister, can continually
overcome all hurdles. But micromanaging the show even
when one is competent is problematic. For instance, not
only can any valuations, however, competently done be
questioned, there would always be scope for claiming that
valuations were done so as to favour one particular party
or the other. Similarly, it is well known that despite
bidding, the bid-design, the timing of the bid, the
qualifying criteria, the rejection criteria such as
consideration of competitive markets post divestment, or
non-exercise of monopoly, post privatization adjustments,
all can be questioned. The very nature of the process is
such that there are limits to transparency as an option.
In valuation and in the process of arriving at the best
bids, unlike in the case of many other governance
situations, there can only be limited information sharing.
An example of a situation where transparency would be
the key is the budgetary and public expenditure process.
Many things, especially the due diligence findings,
information of parties, have to kept confidential to ensure
proper and competitive bids.
Complex and Dynamic Optimality

The speed of privatization, social optimality, optimality of
the particular privatization, timing, meticulousness with
regard to the process, information basis of the bids, postprivatization commitments, strategy in the privatization
process, besides the choices of methods exercised, the
changes in the policy environment governing the industry
and even the economy are all interrelated. Privatization,
especially when a large set of enterprises which house a
significant part of the capital stock of the country are
involved, is necessarily, a dynamic process. This implies
that there is no one optimality and the optimal in a
particular case can differ when considered alone or as part
of a process. Therefore, questions can always be raised and
in a situation of competitive politics it would be difficult

for any government to come clean even if it has nothing
to hide.
Equally importantly, the political cycle of any party is
short, and the party in power cannot make the assumption
that just because it has laid out the formal processes
privatization would not be contested at every possible
opportunity.
LINK WITH MACRO-POLICIES

There are other moral hazards in governments being
involved in the day-to-day aspect of privatization.
Monetary Policy Linkage

This happens when governments carry out or influence
both macroeconomic policy and privatization. For example,
it is a simple matter for the government to bring markets
down with high interest rate (tight money policies), and
justify a strategic sale at the now low bid prices. As interest
rates become normal again the party could gain much.
More generally there are cyclicalities in macroeconomic
environment and governments could exploit these to favour
the potential bidders/buyers of stock.
Asymmetric Cost of Capital

Perhaps the biggest difficulty is that which arises in the
asymmetric information and systematic capacity difference
between groups of bidders activated by government actions
and policies more generally. Consider the situation as it
existed from 1994 onwards till about the end of the decade
and has again come aboutthe fact that the Indian economy
has been showing a fischer-open, that is, that the ex post
realized depreciation of the currency is smaller than the
ex ante expected depreciation in the sense of the uncovered
interest parity. In such a situation there is asymmetric cost
of capital between the foreign parties on the one hand and
domestic parties without recourse to earnings in foreign
currency on the other. This is especially high when the RBI
in a situation of capital inflows sterilizes the foreign exchange
inflows. When the fischer-open is large and positive, domestic
entrepreneurs face a higher cost of capital than do potential
foreign entrants. PriceWaterhouseCoopers, in 2002 the
international consultants, drew attention to this phenomenon
arrived at but the erroneous conclusion that the asymmetry
could be bridged by allowing domestic firms access to
foreign capital markets. Earlier Rosario (1999) had found
the large fischer-open and the resulting asymmetric cost
of capital, in a multivariate model with other determinants
of foreign direct investments (FDI), to be its most important
driver in the economy since the liberalization of 19912.
It was also the principal determinant in the patterns of
control, including the takeover of many otherwise worthy
Indian businesses.2
Asymmetric Risk Perception

Asymmetric cost of capital in the privatization context
implies that the domestic bidders would not have the
capacity to bid high enough as compared to the foreign
bidder ceterius paribus. Not only does this reduce the
value to the government but it also creates the
dysfunctionality of valueless FDI. That in turn can
potentially hurt the privatization process since no country,
and especially not India with a high degree of consciousness
about its culture, history, and nationality, and with an
independent bourgeoisie, can afford to drive privatization
through foreign investors. But this is only one side of the
story. In India, this asymmetry has meant that the
government was forced to accept the low bids of domestic
parties and the perceived high risk has kept foreign
investors out. Risk is the other half of the story. In
contrast to the cost of capital, the perception of risk runs
the other way. There is much risk perceived in any
privatization and more so when the due diligence tasks
become a challenge due to prior unclear and legally
questionable deals within government and its parastatals,
unclear titles with regard to land, the status of concessions
under non-government ownership, and many other legal
matters.
2
When the fischer-open rather than technological and other

firm-based advantages drive FDI, as was the case in India since
1993, FDI tends to displace domestic investments rather than raise
the investment level significantly. (It is never expected to raise the
investment rate by the gross value of the FDI, since there is always
some substitution.) Under such circumstances growth is smaller
than otherwise, and worse, a process of de-nationalization of the
industry begins. Indeed in Latin America, it is this kind of FDI
that has lead to the deep penetration by foreign capital to the
great detriment of domestic industry. In contrast when FDI is
driven by strong ownership advantages, as has been the case in
East Asia whenever FDI was significant (except in the three years
following the Korean currency crisis in the country), the gains in
terms of spillovers and direct technological upgradation are
potentially large. (Basant and Morris 2002). For a savings surplus
economy such as India (the marginal savings rate is much higher
than the average savings rate) it does not make sense at all to have
FDI whose principal basis is the fischer-open. The often made
statement without qualification that FDI is desirable in
infrastructure, where the advantage of the foreign firm typically
tends to be only financial (power, roads, construction), is
questionable. Not only do such FDI necessarily demand exportoriented policies to generate the foreign exchange surplus required
to service the FDI, but they also could displace domestic
investments.
81
Low Bid Arise

The cacophony about disinvestments itself emanating from
multiple quarters within the government adds to the risk3.
Thus when the administrative ministry strongly resists
disinvestments, insists on large residual share holding for
government, refuses the sectoral policy clarity necessary
for disinvestments, or asks for golden shares, while the
MoDI attempts to forge ahead and announce prodivestment statements, and there are the swings in the
stock price as a result, the perceived risk is very high,
and foreign parties would naturally perceive this
asymmetrically high and acute4. So despite their lower
cost of capital they would bid low, if at all, and the
government would at best only get low bids from both
parties! The Indian party, better in the know of the
working of governments, would not as acutely perceive the
risks but could even take into account other actions not
possible to the foreign party pre-privatisation and even
post privatisation to reduce the risk. But having higher
capital costs it would not as said before bid high. The
matrix below (Table 4.2.2) presents the current situation
(quadrant I) and where the situation ought to have been
ideally (quadrant III). The combination of low risks and
low cost of capital is being ruled out by adverse policy
and design. Indeed only at low bids possible from high
cost of capital and high risks would today a slow and stop
start privatisation be possible. This situation which has
plagued privatisation thus far is likely to become critical
as the oil companies formally come on the block. It goes
without saying that the fischer-open should close so that
domestic parties are able to bid high5 need to go down.
And the risks in divestment through clear policy,
appropriate institutional mechanisms.
It may have added more than risk. The huge volatility in

prices of public enterprise following comments by government
officials and politicians, create situations akin to inside-trading
allowing huge scope for capital gains in the market. One cannot
more be sure that such gains have not been made. See Barua,
Politics of Disinvestment and Insider Trading, Chapter 4.3 in this
Report.
4 These risks can, to a considerable extent, be mitigated by
appropriate overarching legislation, as also by distancing privatization
from government, and empowering an independent disinvestment
commission.
5 The fischer-open should close if sound growth enhancing
macroeconomic policies, that emanate from interest rate and
exchange rate targeting, rather than from monetary targeting, are
put in place. From the viewpoint of the real economy and exports
and competitiveness of the economy this changeover is long overdue.
We have been arguing this point in the three India Infrastructure
Reports (IIRs) and ever since 1997 (Morris 1997, 2001, 2002,
2003).
82

Table 4.2.2
The Matrix of Asymmetric Risks and Costs of Capital in Privatization
LOW RISKS
HIGH RISKS
LARGE AND POSITIVE FISCHER OPEN
(II) Foreign parties have a distinct advantage

since risks are low enough to not result in
asymmetric risk perception. Indian parties lose out
in disinvestments. Economy is widely penetrated
by FDI. Dysfunctional FDI gets linked to
privatization and gets a boost. Creates massive
political opposition to privatization until such time
as foreign capital itself becomes a significant
influence on domestic policies. (India could be
here if the process of privatization is distanced and
put on a firm institutional basis but with
continued adverse macroeconomic policy.
Privatization could initially be faster than in (I)
but could run into massive opposition from the
country. Latin Americas privatizations have been
from this position.)
(I) Foreign parties asymmetrically perceive risks to

be high to bid low or not bid at all. They may
prefer temporary JVs to direct bids, after which
foreign parties could dump Indian parties. Indian
parties having asymmetrically high cost of capital
bid low. Government has few bids largely from
Indian parties and the values realized are very low.
(India is here. Ad hoc behaviour and a process too
close to government and not having legal sanctity
could keep the country in column. Adverse macro
policies in the row.)
NEGLIGIBLE FISCHER OPEN EVEN

IF INTERSPERSED BY SHORT (RARE)
PERIODS OF HIGH FISCHER OPEN
Aggressive exchange rate and interest rate policies that are both expansionary and export oriented
Privatization legally enshrined; distanced from government, through independent commission
(III) Risks being low the degree of asymmetry

in the risk would be low. Both groups have
strong and high bids. Privatization proceeds
with great functionality and much social value.
Dysfunctional FDI is almost entirely avoided.
Privatization is seen as strengthening the basis of
private property and its opponents give up. (India
needs to reach this position quickly enough. An
independent distanced from government mechanism
is the best recipe and pursuit of interest rate and
exchange rate targeting by the RBI. Privatization
takes place by leaps and bounds and the market
too booms to have positive feedback on each
other. East Asian privatizations (crisis period
excluding) have been from this position.
(IV) Foreign parties asymmetrically perceive high

risks and do not bid at all. Indian parties can
bid better but would discount for the high risks.
(Correction of adverse macro policy but with high
risks creates a field day for perverse sell offs, low
values, profiteering, and crony capital relationship
between government and Indian business but
privatization could move much faster than in (I).)
A COMPLEX
AND
STRATEGIC TASK
Small Investor Interest

Strategically, and also from a political angle, the first few
privatizations should have created a positive flavour in the
market and should have tilted in the reckoning of investors,
media, and the general public. This has been a feature
of all successful and deep privatizations especially in
democraciesthe best example of which would be the UK.
Even though prices in dilution or public offer are typically
lower than in strategic sale, such methods have other
benefits and value. Since the small investor benefits the
markets are given a buoyancy that often more than recoups
the loss especially in the later rounds of sale or
disinvestment. More importantly, it creates positive
pressures from disinvestments from an influential group,

viz., the large and numerous small investor class. The well
performing companies, or more correctly where the
management was strong and not in anyway inadequate (and
companies looking forward to high growth prospects),
should also have been taken up with priority for
privatization, via the market sale route.
Employee Shares
Manufacturing businesses, with scale and scope and with
high growth prospects have potentially high valuations but
their realization is contingent on the mode and the timing
of divestment. To obtain very high values, the timing on
a rise to the boom in the economy and, with no
conditionalites about management control, and with the
appropriate marketing of the issue would be the answer.
Similarly, in some companies employee shareholding would
be crucial to successful disinvestments, especially in
improving post divestment performance. Provision for
leveraged buyouts would be necessary.
Sequencing and Policy

But the problem of disinvestment cannot be broken down
into maximization of realization in every act of dilution/
sale. This is because there are dynamic aspects that arise
out of inter temporal dependence of actions including
announcements. Thus, a sale with a marketing blitz that
followed one which was priced slightly below value would
fetch high values. Thus strategy arises in disinvestments,
and only an expert authority and with much independence
and which has the ability to build and design complex
processes including strategy, and who has control over the
process and especially timing and sequencing, and is in
place at least over a couple of business cycles (about 7
years) would be able to carry out optimal and fair
privatization. Moreover, such an institution would not be
able to function if it has to be accountable or explain every
little detail. Also the institution would have to be a learning
one and be able to have many in-house skills and
competencies 6.
MONOPOLY
AND
POLICY DIMENSIONS
Resulting Market Ought to be Competitive/Well

Regulated
It is essential to keep in mind the potential exercise of
monopoly power in the domestic economy by the privatized
entities especially in non-tradables, and in industries with
naturally high barriers to entry. Allowing monopoly especially
when the monopoly is natural and regulation is not
particularly good (electricity would be an example) is a
possibility when there is a singular focus on high values.
This, though may be detrimental to the economy. Mercifully,
markets do not value highly returns that arise in regulation,
so it is important that disinvestment of all entities in
regulated sectors should go on the dilution, sale in market
rather than through strategic sale. The scope for the potential
strategic buyer to insert covenants to defacto continue with
monopoly to take the divested entity out of the regulatory
ambit for a while etc. are large and tempting and ought
to be avoided.
6 Recourse to international and reputed consultants, while
necessary, is not sufficient. The quality of advice, and the value
derived from such consultancy would depend greatly on the skills
within the organization responsible for divestment.
83
Policy Quirks Need to Go

It is important to be acutely aware of policy quirks7 that
add value or subtract from the same. While the fact of the
influence of such policy and control (typically interventionist
control, concessions, policies such as directed credit or
vendor development that limit managerial freedoms or
impose constraints, etc.) is often known as also their
direction, the quantum is well nigh impossible to assess.
As such the best option is, therefore, to remove these
distortions (a good example would be the heavy and nonvattable taxation of oil products), and then to carry out
the privatization. Announcement of a strong commitment
and a time frame over which such quirks would be removed
can only be second best8, because they presume that in
some linear manner the influence of the policy, etc. can
be gauged.
To give an example, currently, the oil sector is subject
to heavy taxation. As a proportion of the value added at
market prices (including the taxes), the sector is subject
to taxation of 64 per cent! There is no modvat set off either
in the use of oil products by industry. The state taxes too
are not vattable and besides being heavy also vary a great
deal. The rate of taxation similarly varies greatly across the
final products that constitute the industry. The market and
demand has moved so far from the non-distorted situation
that there is no way in which even a possible general
equilibrium model9 could have given a reliable assessment
of the impact. Even then the feed back effects can hardly
be modelled without heroic assumptions.
Distortions in the Oil Sector Need to Go

It is possible that the taxes may not even have been revenue
maximizingparticularly on a product like motor spirit.
7 We use the term quirk because we presume that these
distortions are vestiges of the past. It is presumed that serious
reform means that there would have been an active liberalization
process wherein the role of controls, etc. would have gone,
distortionary taxes removed or replaced by modvat type of taxes,
and subsidies targeted more directly and in non-distortionary manner.
8 One of the reasons for the interest of a giant like Hindustan
Lever in Modern Foods was the reservation policy of the government
which froze capacities in the organized sector in bread-making, so
that there were few players with their own capacity in the organized
sectorBritannia and the public sector Modern. It was the access
to this capacity that would allow HLL to run a food business based
largely on outsourcing of supply but with some internal capacity for
R&D product development and possibly for strategic considerations
that made the company cough up high values for assets that were
more junk in other respects. The government was of course aware
of the factor.
9 It could not be an exclusively sectoral model alone since the
impact of such heavy and distortionary taxes on income and growth
is high.
84
Given a large base of personal cars which are currently

used sparingly because of high petrol prices, through a
significant reduction in the tax rate, there could be a major
impact on demand to perhaps even compensate for the fall
in the tax rate. This is most likely since the taxes of the
central and state governments fall on the same base. Private
parties with a commercial orientation and need to expand,
rather than timidly hold on to the status quo as PSU
managers do in the face of a vastly more powerful civil
service which finally decides, would seize such opportunities
to show to the government the irrationality of such rates,
to result in change. This could greatly enhance the values
of enterprises in the sector, which the government would
not be able to capture unless the value destroying distortions
are removed in the first place.
Dereservation
Similarly the reservation of so many products for the small
scale industry when imports are freely allowed, would have
to go. In areas where the large sector has a comparative
advantage such as in biscuits, processed foods vegetable
oil extraction and refining, the operations with the public
sector could improve in their values with reform especially
for a private management that could run such operations
far more efficiently. Where the advantage is with the small
units such operations in the public sector would be almost
entirely useless and divestment as going concerns would
not have any meaning. (Examples would be footwear,
leather, consumer electronics, house construction, etc.)
Problems in Bank Privatization

Similarly credit and banking policies are hardly transparent
and are not without their differential effects and distortions.
Currently banks are constrained to operate with directed
credit targets (to the so called priority sectors), and there
is little tradability that banks can take advantage of with
regard to priority sector targets. As a result banks are not
entirely free to operate at their desired levels of diversity
and specialization in their credit portfolios. Similarly, the
current policy of shoring up the equity base of public
sector banks by allowing them through monetary and
credit policy, and through regulation high spreads rather
than through the more transparent method of doing so
through budgetary infusions create opportunities for the
private sector banking to make supernormal profits (Varma
J.R., 2002, 1998). In other words in protecting the
operational inefficiencies of public sector banks, private
banks with a retail base for deposits enjoy high regulated
returns. Ideally such distortionary policies would have to
go before privatization; and certainly strategic sale is not
advised, since otherwise powerful vested interests would
emerge to allow the current distortions to continue.
LEGAL TANGLES
AND
PITFALLS
ARE
MANY
Many Cases
The process of privatization today is fraught with many
legal issues and tangles because it is a case by case approach.
There is no special court/arbitrator for disinvestment related
cases, which would have been possible, had an act and an
institutional structure driven the process. It was the good
fortune and the good legal counsel of the government that
won it the case against Bharat Aluminium Company Ltd.
(BALCO) disinvestment. The ministry has rightly taken
credit for the same. But a swing in the other way is also
possible, which can stall disinvestment. Courts are not the
experts with regard to disinvestment. They can at best
worry about the legalities and the form rather than the true
substance which ought to be the issue in disinvestment.
Thus the MoDI has taken pride in the large number of
cases which have come up, and have also been disposed
off (Table 4.2.3).
Table 4.2.3
Summary of Disinvestment Related Court Cases
(As on 31.11.2002)
Total no. of cases filed up to 30.11.2002
ITDC related cases
Total number of cases out of 40 dismissed
Number of pending cases
ITDC pending cases transferred to the Supreme Court
(out of pending cases)
40
23
21
19
7
Note: The above does not include cases where the challenge is not
disinvestment but other aspects like pay revision, etc.; ITDC
India Tourism Development Corporation.
Source: GOI (2003), p. 30.
But the fact of the matter is that even one instance of

disinvestment could attract as many as 40 cases, their
dismissal apart. Courts, not excluding the Supreme Court,
have been known to have their biases and decisions do
not necessarily lead to strong precedence, so that a torturous
process of legal clarity by practice (and at high cost to the
economy) would have to be gone through before
disinvestment, if ever, becomes a clear enough business.
Equally importantly, many PSUs have been set up under
separate acts so that there is de facto nullification of such
acts. Overarching counter legislation, to nullify enblock
such legislation, may be desirable10.
10 This was written just before the current Supreme Court ruling
on the case of the oil companies. It was not entirely unexpected,
but has set back disinvestment significantly. Barua, The
Disinvestment Story, Chapter 4.1, covers the issue briefly, in this
Report.
Need for Legal Basis

Gaming of courts to delay rulings has been part and parcel
of standard Indian legal practice especially in civil cases.
Hence, it necessitated the rather special (some would call
harsh) Act relating to securities recently to enable financing
intermediaries some reasonable chance to recover loans and
debts. Similarly, most economic legislations such as the
Electricity Regulatory Commissions Act, 1998, the Electricity
Act, 2003, and the Competition Policy Bill, besides the
TRAI Act, the Petroleum Regulatory Bill, all ensure closure
on the legal front by providing for arbitration and defining
the conditions (in a very specific way) under which the cases
relating to the act/bill could go to the courts.
While the purist could argue that this reduces the role
of the judiciary, there are valid structural and historical
reasons for the same. Law and its practice (owing in no
small measure to the content of the law especially on
account of the adherence related aspects) have generally
ignored the economics of law, being over-ambitious and
pretentious than the economy is capable of supporting.
This is also one of the important reasons for governance
failure in the economy and for non-adherence to law
(Morris 2002). The economics of adherence has also
typically been ignored since fines tend to be small even
when the probability of detection is small, or monitoring
is very expensive. Similarly, the poor drafting of rules of
many economic laws, and the behaviour of the enforcement
agencies which could be perverse as in the case of pollution
control11 would have resulted in systematic deviations
from adherence to the law. Thus a solution that demands
necessarily the reform of the legal system, disposal of
pending cases, speeding up of currently dilatory judicial
processes demands too much. While measures in the
direction ought to begin and have the topmost priority of
the government and influential people, the key economic
frameworks ought not to wait for the reform of the judicial
system. It is this realization that has resulted in the
incorporation of internal arbitration processes in much
recent economic legislation. And the need for the same
with regard to privatization is even more acute.
THE WAY FORWARD

Our contention is that correct valuation, even if it does
not mean the highest gain for the government exchequer,
11
See Curmally, Atiyah (2002) for details in this regard. It is

a remarkable fact that in the worlds largest democracy that is India,
the police and the state are not entirely accountable to the law in
their discharge of the sovereign functions which have been very
liberally interpreted to allow even some criminal acts of the police
to go unpunished.
85
is better for the economy and society and for privatization

to continue, and, hence, to the government in the long run.
They engender consistent expectations and the risks in
disinvestments, therefore, decline.
Credit conditions perhaps would determine in a big way
the ability of domestic parties to bid high. It is well known
that domestic investors are most bullish about the economy
especially in contrast to large foreign direct investors. When
the technology is available to or with domestic investors their
propensity to investment is large enough to reduce the
imitation lag substantially12. Thus in a situation wherein
there is a credit squeeze, that is, when domestic credit is
being curtailed to adhere to money supply targets, as when
unplanned foreign capital inflows take place, there would
be little, if any, bids from domestic parties who have no
recourse to substantial stream of earnings designated in
foreign currency.
More important perhaps are the institutional difficulties
with the current process of disinvestments. Disinvestment
remains a process entirely driven by the government and
so all the pulls and pressures within the government have
to be overcome before a particular company can be placed
on the block. Since the process is hardly under the control
of the MoDI, they would not have control over the timing
of disinvestment. We have already argued why timing is
important for optimal value realization.
The current process of divestment demands continually
political patronage and support, and great management
skills and energy from the bureaucracy. This is perhaps its
greatest weakness. The fact that the MoDI has been able
to rise up to the challenge does not mean that this condition
is always going to be met over the long haul that is required
to carry thorough disinvestment of the sector.
Just as privatization is a permanent solution to get a
dysfunctional and interfering government and bureaucracy
off the back of the enterprise manager, and once carried
out liberates the enterprise from the particular situation
within the administrative ministry and the government
more generally, it is important to distance privatization
itself from the government of the day.
It is natural for governments to resist giving up control,
especially in a process as sensitive as and as full of potential
(to make both political capital and generate rents if so
desired) as privatization is. Similarly, it is irresistible to an
opposition party to oppose privatization even if privately,
or when it was in power, it would itself have been active
with privatization. The stakes are high. But so were the
12
Stobaugh, Robert (1969) was the earliest to describe the

imitation lag and outline the factors underlying the same, and the
relationship of the same to both direct foreign investment and to
domestic investments.
86
stakes in the case of electricity reform and yet a bill could

become law in Parliament. The point is: would statesmanship
on the part of the ruling party be strong enough for it to
allow and develop an institutional mechanism that would
make privatization above board for all political parties and
distance the bureaucracy from the same? Indeed self-interest
in a situation of coalition politics, that makes a second run
of power anything but certain, and where there cannot be
a permanency to commitment to reform of public enterprise,
would demand that parties agree to a process that is above
the government of the day and is truly independent.
Independent Commission Under Law

A law describing the objectives and modes of privatization
and laying out a fresh process that grants the government
at the highest level only a veto, but is otherwise internal
to an independent disinvestment commission, is the way
forward. In any case if the MoDI is keen on a fair and
orderly process and if it itself does not want to generate
rents out of disinvestments, it should have strong incentives
to enshrine the process in a legal and institutional process
that is beyond its own operational control, or in other
words, exercise the statesmanship necessary to take
democracy and the nation forward. After all it is not the
business of the government to micro manage enterprise
or disinvestment (or for that matter programmes) but only
to create the enabling environment to secure permanently
the institutional basis (rules, organizations, relationships,
and laws) that allow the best management of these roles
and functions. The enormous complexity in ensuring
anything like optimal disinvestment, and since the future
of the economy depends on unlocking the large potential
values in public assets, makes this initiative vitally
necessary.
Earlier13 we had argued that any further direct cutting
of the fiscal deficit is not desirable since it would hurt the
economy by reducing demand, unless massive privatization
to reduce the capital stock with the public sector is carried
out. A privatization that leads to enhanced expenditures
on investment by the ex-public enterprise (many of which
have a huge backlog of investments, and the need to
upgrade facilities) would raise the investment rate to ensure
a much higher growth rate, which the economy, especially
in an entrepreneurial sense, is capable of.
these parties then go through the longwinded process of

due diligence, interaction to develop the bid documents
and the key parameters of concern to the parties, and the
government and other stakeholders. Then the bid is put
out, and from among those who have signed the due
diligence agreement, the highest bid is selected. While the
process is fair it is not one that can maximize the bid
interest. Various ways are possible to enhance the bid
interest. The initial document that lays out the expression
on interest can be much clearer and have standard
descriptions on how landed property; contingent liabilities
of various types if and when uncovered would be treated.
Clauses from prior privatizations would have much value
since the practice in as complex a process as divestment
would define the process more than any a priori definition.
It may be possible to consider a swiss-challenge when the
situation is not complex, with a bid handicap and huge
forfeiture amounts for those entering the bids without or
only with cursory due diligence.
Buying Out IPPs

Even in strategic sale in certain cases it may be important
to go through the capital markets. Not only can this
process bring in the risk diversification, it can also bring
in the monitoring function of the market, additionally to
the technical competence and synergy of the strategic
buyer. We have, for instance, been saying that the best way
out of perverse Indian Power Producer (IPP) contracts
would have been to bring to the fore the market valuation
of regulated excess returns which are likely to be low. It
would mean asking all IPPs to divest a part of the stock
in the market so that the market can correctly value
the gilt contracts which have actually taken upon
(inappropriately) huge political risks even as they have
shifted much of the business risks on to the SEB/
government. Then buying off the IPPs at the market value
would not be expensivemost likely at under 20 per cent
above the value of a plant with normal returns and which
faces business risks, such as a merchant generation in a
competitive market. The unit can then be resold as a
merchant generator for instance or to any participant for
its value. Such reorganization can truly unleash the potential
of competition in generation, that is, of markets14.
Strategic Sale
Being Market Friendly
In strategic sale, the bid process is very important. In the

process currently in use, a short list is made of the parties
expressing interest based on qualification criteria, and
Similarly, many PSUs with no shareholding in the stock

market could be wisely corporatized, given company form
13
See Box 2.1.4 The Fiscal Deficit, in chapter 2, Expenditure

Accountability and Society, S. Morris, (ed.) (2003).
14
See Morris, S. (2001) for a detailed discussion on how IPPs

and adverse power purchase agreements can be set right. In the light
of the Electricity Act 2003, these become all the more important
and closer to feasibility.
and some stock offloaded. Strategic buyers could in turn
be asked to ensure that a certain minimal portion of the
stock is widely held by agencies with strong incentives to
monitor performance (and keep a check on policy that
directly impinges on the company). The information set
of the Indian market and a wide diversity of players can
then be brought to bear to improve and, more correctly,
value the stock.
Employee Stocks and Cooperatives

Significant employee stock ownership in companies that
are focused on consultancy, high tech services involving
skills and motivation of employees directly is possible.
87
They can also be used when the operations are labourintensive, cost of supervision is high and the business in
the organized sector may not be viable due to lower labour
costs in the unorganized sector. Thus bus transport at the
state level are a case in point. Bus operations are not viable
in the organized sector without monopoly, or entry barriers
imposed on the unorganized sector. The private sector is
difficult to regulate since there are always options for
unscrupulous private operators to run fewer and more
overcrowded services to result in reduction of consumer
surplus, but with low probability of detection. And a few
such operators going unpunished is sure to wreck the
service from the consumers point of view. (Box 4.2.1).
Box 4.2.1
The Challenge of Privatizing State Road Transport Undertakings (SRTUs)
The real challenge to privatize the vast operations of the SRTUs would be regulatory oversight at not too high a cost, which
also ensures that operating companies adhere strictly to their timetables and do not omit services. Independence of observing
and certifying agencies, while necessary is not adequate since collusion is possible and a public entity could be slack. The only
solution is to raise the punitive measures against service omission and to bring in competitors monitoring of each other. The
monitoring by independent agencies, could usefully have representation on their boards of users and other organizations like large
employers who stand to gain through better and efficient performance of SRTUs especially in the cities. Peak pricing creates
perverse incentives unless the peak is of small duration. Ensuring competition from other modes wherever feasiblerail and
taxiscan have some positive effect.
But the social benefit in the privatization of bus companies can be maximized if they can be sold off as operating units. This
could be financially unsound since the entire burden of workers would then be on the government account, and socially the
costs of unemployment among the ex-public sector employees (or of continued over manning and high salaries) would be on
the government and consumers (especially if there is a concession approach that is used). Hence, other less conventional measures
that are able to bring the economies (and natural high motivation) of owner supervision (small bus companies) or self supervision
of the smaller cost of operators who have access to the unorganized (competitive) labour markets, would be worthwhile.
Thus, sets of three or fewer buses could be sold at values close to a valuers assessment as also garages to cooperatives of exSRTU employees. As both employee and owner they would be value added maximizers rather than pure profit maximizers
allowing them to compete with a private company that has access to low cost labour. The key to such cooperatives would be
a framework that is acceptable to workers. And workers would have to be helped to have the financial means to come together
in groups to buy buses and depots. Credit assistance for such operators with appropriate safeguards may also be required.
Whatever the industry structure, but especially, if these are many small operators, the crucial determinant of sucess would be
a regulatory mechanism that ensures route discipline and service frequencies.
SRTUs vary in their efficiency and in someMaharashtra, Karnatakait may be possible to sell off SRTUs to a few employeeowned largish enterprises. (In Tamil Nadu the SRTUs compete and are oriented commercially, so that they are best left much
as they are with sell off to the incumbent managers and employees through stock options, without disturbing their structure.)
In others where the share of SRTUs in total passenger carriage is small, it may be worthwhile to close operations, sell assets to
finance liabilities, to retire workers, and shift the focus on regulating a private sector service quality in contrast to fares have been
ignored in the regulatory approaches thus far. This is most unfortunate since privatization then has come to mean bus mafias,
poor and overcrowded services, where safety aspects are ignored. Delhis private operations illustrate how best not to privatize.
The potential of private bus transport to cheaply provide quality service is very large.
88
4.3 THE POLITICS OF DISINVESTMENT AND INSIDER TRADING

Samir K. Barua
Liberalization, including privatization, invariably implies
significant changes in polices of the government. The
fluctuations in the prices of shares of companies that are
materially affected by these policy changes, may provide
opportunities to those privy to the information, before it
becomes public knowledge, to make money through trading
in the stock market on the basis of such information. Is
there reason to believe that: a) there are opportunities for
making money based on such information in the Indian
market? and b) that such opportunities are being (mis)used
by unscrupulous individuals who are in the know of such
price sensitive information?
did the rounds of the market. The finance minister was

so miffed at what happened that he asked SEBI to carry
out an investigation into the entire episode to determine
the possible involvement of his ministrys officials. As
happens with most such investigations, it is unlikely that
any foolproof evidence of malpractice would be unearthed.
The episode highlights the danger of destroying the market
integrity due to such insider trading. What happened was
bad enough, but what was even worse is the fact that even
after 4 months had gone by since the episode, the
government was yet to make up its mind on how the equity
to be returned by the banks would be priced. This shows
callousness of a high order on the part of the government.
Public Sector Banks

A recent example of the issue under discussion was the
episode vis--vis the prices of shares of some of the public
sector banks. The government has infused recapitalization
funds of over Rs 21,000 crore into PSU banks since 1992.
Several banks that have come out with IPOs in the last
few years returned the capital to the government at par.
The price at which the government equity was returned
never became an issue since most PSU bank shares were
quoted at little premium over par. However, over the last
2 years, due to significant decline in interest rates, most
banks have made huge profits on treasury operations. That
has sent the stock prices of most public sector banks skyrocketing. The issue of price at which the governments
equity is to be returned, therefore, has assumed importance.
By the beginning of May 2003, several banks, such as
Punjab National Bank, Bank of Baroda, Andhra Bank,
Indian Overseas Bank, announced their intention to return
capital to the government. If this capital were permitted
to be returned at par, then that would imply huge benefits
to the remaining shareholders while, if the capital were to
be returned at market-related prices, there would be little
benefit to the other shareholders. As a result, the
governments, more specifically, the finance ministrys,
view on the issue became a crucial factor for determining
stock prices of these banks.
Towards the end of May 2003, one was witness to an
apparent flip flop that was reportedly done by the finance
ministry officials regarding the issue. Based on information
apparently provided by finance ministry officials the prices
of public sector bank stocks yo-yoedrising sharply on
news that the return of equity would be at par and dropping
sharply on news that the return would be at market prices.
Huge amounts of monies were made and lost as the 2 views
Petroleum Stocks Volatility

Another sector that has seen high volatility in valuations
over the last few years is the petroleum sector, in particular,
the stock prices of HPCL and BPCL. The changes in stock
price of HPCL, in relation to the changes in the index
(SENSEX), were analysed from 1 January 1999 to 30 June
2003, to assess the impact of statements by politicians and
government on disinvestment of government stakes in
HPCL.
The daily closing prices of HPCL shares and the daily
closing level of SENSEX (the index used) were obtained
from the PROWESS database (marketed by CMIE). The
daily returns were then computed for both HPCL stock
and SENSEX. The beta coefficient of HPCL stock was
determined for the 4 years period by regressing the daily
returns for HPCL stock against daily returns for SENSEX.
This coefficient measures the sensitivity of HPCL stock
to changes in SENSEXthe percentage change in the
price of HPCL stock for 1 per cent change in the index.
The daily excess returns were then computed as the
difference between the actual return on HPCL stock and
the mandated return on the stock based on the beta
coefficient of the stock and the return on the market index.
The beta coefficient of HPCL stock for the period was
about 0.80. The excess return would, therefore, be
computed as follows: suppose on a specific day, the return
on HPCL stock is 5.4 per cent while the market return
for the day is 2 per cent; then, the excess return would
be 3.8 per cent [= 5.4% 0.80 2%]. Large excess return
would signify unusual stock price movement. The data was
then sorted in the descending order of excess return. The
dates on which the five highest excess returns were observed
during the period and the information that preceded these
89
Table 4.3.1
Top Five Excess Return Days and Associated Information
Date
HPCL
Return (3)
SENSEX
Return (4)
Excess Return
(3) 0.80 (4)
News/Information
9 Sep. 2002
30.15%
1.66%
28.83%
6 Dec. 2002
19.97%
2.34%
18.09%
12 Jan. 2001
31 May 2000
7 Oct. 2002
14.82%
12.24%
13.46%
0.23%
2.79%
0.76%
14.64%
14.47%
12.85%
Cabinet Committee on Disinvestment (CCD) defers sale

of HPCL
PM, L.K. Advani, George Fernandes, and Arun Shourie
meet and decide to put HPCL on strategic sale
FM says that stakes in HPCL to be reduced to 26%
HPCL Results
PM says privatization is irreversible
price movements are presented in Table 4.3.1.
Price Gyration and Politicians Pronouncements

It is noteworthy that on four out of five highest excess
return days, the stock prices gyrated significantly because
of political developments and pronouncements by key
politicians. On each occasion, the information was such
that there was no uncertainty about the direction of the
impact on the price of HPCL stockonly the magnitude
of price change would have been hard to predict. It would
have been, therefore, possible for someone who got the
information early to take a potentially profitable stance in
the market based on the information. It is a moot point
whether someone indeed benefited from the information

being available to him/her before it became public.
Over the last several years one has witnessed significant
price gyrations arising from such statements and posturing
by key politicians and bureaucrats with regard to
disinvestment of government stakes in a host of other
PSUs. While this has gone on unchecked, SEBI has been
tightening norms to prevent insider trading by a host of
other constituencies. It is high time to bring into force
a code of ethics on these pronouncements by politicians
and bureaucrats. Such pronouncements are destroying the
integrity of the Indian stock market.
4.4 PERFORMANCE AND MARKET EVALUATION OF THE PUBLIC SECTOR TODAY

Sebastian Morris
Few studies on performance of PSUs are correct with
regard to their methodology. But the few that are, bring
out the fact that the performance of PSUsa few exceptions
aparthas been woefully below that of the private sector.
Many studies though have attempted to justify such
performance on the ground that these enterprises have
multiple objectives, non-commercial objectives, or social
objectives, that they were set up to lead or to develop
sectors rather than make profits and so on.
The Mask of Social or Multiple Objectives

While many of these reasonings might/would have had a
grain of truth in the 1960s and the 1970s, and perhaps
even in the 1980s, performance of PSUs in the 1990s
shows quite the reverse. Performance in the competitive
sectorsmanufacturing, trade, and serviceswas weakest
relative to that in other sectors. Here entry is not difficult.
The sectors were almost completely liberalized since the
beginning of reform in 19923. They are open to imports
and to entry by the private sector.
Actually in the non-competitive or partially competitive

sectors, or still protected sectors, or sectors where regulation
in some form is necessary the relative performance of the
public sector (relative to other public enterprises) was
better in the late 1980s and the early 1990s. Entry barriers
arising out of policy or otherwise, or the administered
nature of the prices helped the enterprises. Thus the
performance of the PSUs is not constrained because they
are in sectors of market failure, but quite the reverse, it
is in areas of no-market failure that their performance has
been the worst. In other words, the so-called social objectives
has been a mask for poor performance, emanating out of
constraint on managerial autonomy, in competitive areas.
Regulation and Monopolythe Only Hedge

In sectors where public enterprise has a near monopoly,
or in regulated areas like electricity generation and telecom,
the issues have been of delay in the institution of appropriate
regulatory regime (oil) or, given the setting up of such
institutions, the delay or retardation in competition due
90
to the ability of the incumbent to use state pressure on

regulators.
Inappropriate Areas
Another aspect of the public enterprise is that a whole lot
of it is in areas of developed markets. This portfolio
cannot be justified on the ground of public economics
(that is, the provision of services and goods in areas where
there is pathological market failure). They also cannot be
justified on the grounds of leading the developments in
the sector in the late industrialising context. Thus the large
number of engineering, machinery making, mining and
metallurgical firms, textiles, hotels construction, trading
entities are hardly in the high tech/or leading sectors that
require the state to take the initiative. There are a few
exceptions to this perversityperhaps BHEL and ONGC
in electrical engineering and oil explorationwhich involve
large-scale economies, high risks, and massive entry
barriers, given the domination of international markets by
a few giants.
Double Handicap
Even here public ownership in India has come with the
double handicap of managers being restrained from
entrepreneurial behaviour and interference, and reducing
many to being mere enterprise extensions of the government
itself. Lately, as the state itself is fiscally constrained, these
enterprises are starved of funds for crucial investments.
Additionally, the fiscal constraint has brought on to the
boards of successful companies a pressure for dividends
irrespective of profits or investment needs, which have
been greatly dysfunctional.
States Strategic Incapacity

Today the state has little or no capacity for strategic
calculation and investments today (either because the
strategic aspect is unrecognized in the classical kind of
liberal ideology that rules, or even when it recognizes it
is unable to do much about the same given the financial
stringency or the lack of understanding with regard to the
contents of a possible strategy). This rules out strategic
public enterprises. The public sector in all segments is a
burden on the economy, almost all economic activities it
carries out is possible in the private sector, subject if
necessary to regulation. There are of course areas of
extreme public goods like roads in a city, and to a lesser
extent irrigation and drinking water, where the public role
is essential, though options of publicprivate or cooperative
partnerships and Private Finance Initiatives (PFIs) can do
much to improve the efficacy of service provision, especially
given the limited capacity of the state to manage enterprise.
Privatization to Correct Sectoral Imbalance

Thus, the first major reason for privatization is that the
state has little reason to be in areas where there are no
market failures. The shedding of all such activities can be
justified on most ideological grounds that accept the role
of markets. Performance in such competitive areas has
been extremely poor, so that non-closure or divestment of
this portfolio only increases the cost to society, since the
efficiency difference between the public and private sectors
is not hypothetical but very large and real. In other words,
in these sectors, we can say that with disinvestment there
is a ready and willing private sector that would carry out
the business or, with closure, the current societal costs of
keeping the enterprises going can be avoided.
Regulatory and Institutional Constraints Limit

Privatization
In areas of market failure, privatization is constrained by
the prior need for an institutional mechanism that can
right regulate the sector. This need is satisfied today in
telecom and in power. But in the latter closer examination
would reveal that the complex problem of subsidization,
especially the distortions caused by the mode of
subsidization, which have brought about enterprise failure
and the pursuit of inappropriate privatization and regulation
have been major problems. Telecom alone15 has gone on
the right track. Oil deregulation continues to be constrained
by the lack of appropriate regulatory mechanism (the draft
bill is under discussion), and the avoidance of a suitable
method to right subsidize kerosene and diesel. The large
and onerous taxes too distort the sector.
INSTITUTIONAL
PERFORMANCE
AND
STRUCTURAL BASIS
OF
POOR
Why has the performance of the public enterprise in the

competitive sector been so poor and worsened in the
1990s?
Two-Level Agency Problem

There are the usual reasons that have constrained managerial
performance in public enterprise: the lack of clarity as to
the primary task because of the hiatus between the
intermediate principal (the government) and the true
principal (the people). This is the problem of the political
economy of public enterprise, and has been very strongly
adverse in India ever since the mid-1960s.
15
Besides ports and national highways. See Morris (2003);

Rastogi (2003, 2002).
Today, this takes the form of heightened demands on
public enterprise to declare dividends, or postpone or
avoid vitally needed investments, or even of government
nominees on the board pushing for investment decisions
that would favour particular private competing groups, or
a parasitic bureaucracy or political group. In the past the
failure at this level meant loading the public enterprise with
many taskstaking up non-commercial operations, forcing/
locating plants and enterprises in areas of high cost and
poor connectedness, imposing targets of employment,
forcing the enterprises to serve the interests of particular
segments and regions of society, and cajoling the enterprise
to mask all such directives /influences as being in the
national interest.
91
ability to manage them, let alone turning them around.

Examples would be textiles, engineering, and hand tools.
Such enterprises had to be supported for decades, and
were an important cause in the fiscal crisis. Even when
the policy environment turned better (as, for instance, in
the case of textiles in the mid-1980s, or light engineering
in the first half of the 1990s) the government enterprises
by then were too unwieldy to change and, over the years,
as non-functional entities, had lost the ability to respond
to a more positive environment. Only when the government
could, subsequent to takeover, bring about monopoly in
the market could the enterprises show some improvement
on paper, for example, the coal companies.
State Cannot Manage Labour

DysfunctionalThe Interface
Additionally there was the haitus between the secondary
agent (government) and the public enterprise. Even when
there was little scope for obfuscation of the primary task,
(by the government) as in the case of the enterprises where
markets were well developed, the secondary agent often
chose to interfere at levels below the strategic, at the
managerial and administrative levels. This dysfunctional
interference in a more immediate sense was perhaps the
most important factor underlying the poor performance of
public enterprises. It meant imposition of major constraints
and shackles on managers, the intrusion of bureaucratic
modes of working, and usually a singular lack of
accountability to the primary task. This happened because
when the control by the ministry/government officials was
sought to be exercised at all levels, the control in terms
of the primary task was naturally lost16.
Industrial Policy Failure

Some of the public enterprises in the competitive sectors
have been those taken over from the private sector. They
had in the first place failed due to policy anomalies, or
structural problems. Since such decisions were usually
political and without any economic logic, merely under
pressure of unions and, possibly, the bureaucracy and
creditors, the government could not have had any particular
16
Scholars have generally argued in favour of a balance between

control and autonomy in public enterprise. We have for long
(Morris 1986) been arguing that the choice is between the contract
in terms of the primary task (necessarily meaning autonomy at the
operational and managerial levels), and the dysfunctional control
(that actually results in loss of control in terms of the primary task)
when it is at levels below the strategic. The danger of bureaucratic
intrusion that could destroy management in public enterprise was
pointed out very early in 1969 by the doyen of Indian management,
Vikram Sarabhai.
Many of the competitive areas in which public enterprise

operates are also labour intensive. Examples would be,
textiles, hotels, and services. To retain competitive advantage
in such areas, implies that wages are no higher than market
wages and the control over labour is good enough not to
allow laxity in the working of labour. Both are difficult to
obtain in public enterprise. Firstly the governments de
facto policy under pressure from unions has been to grant
wages in public enterprise that were not only higher than
in private firms but have also risen much faster, through
the 1980s and much of the 1990s. Other kinds of
uniformities in work conditions, salaries, performance
payments that are non-discriminating, and near complete
indexation with inflation17, have been factors in the high
effective cost of labour.
Courts Rule Public Enterprise as State

Control over labour in public enterprise has been much
weaker also because the courts have been ruling these
entities to be state. Such rulings have granted much undue
protection against very lax work behaviour, and even
dysfunctional and militant behaviour. Deep interference at
the operational and managerial levels in enterprises,
nationwide determination of wage rates that do not give
adequate recognition to the nature of the job or the
performance, the difficulties in introducing real (not ritual)
17
The dearness allowance settlement for workers and salaried

employees, especially the latter, on paper has only been partial. But
incomes of PSU workers are far higher than those of the general
urban industrial, or urban non-industrial workers, who constitute
the basket for the two consumer price indices (CPIs). This means
that wage goods like textiles and food, in contrast to durables like
electronics, motor vehicles or rents, have had unduly larger weights.
Since the inflation in the former has been much higher, and very
low in the latter, high paid organized sector workers have had the
benefit of inappropriate basket in indexation.
92

Table 4.4.1
Performance of State-Owned Enterprise in India in the 1990s: A Schematic Representation
Nature of Organization
Nature of market and environment
More technical rather than social, technical

processes drive organizational processes. The
optimality of the technology choice is crucial
Market power; administered

prices; favourable regulation;
protection from imports
Relatively better performance (petroleum

refining, oil extraction, power generation,
telecom)
Little market power, competitive;

unregulated; import competition or
competition from small firms could
be severe
Mixed performance (cement, chemicals,

construction)
performance measurement systems18 and linked to rewards

and punishments, would mean that the contribution to
profits per unit of wage and salary expense (in a one to
one comparison) is much lower in public enterprise.
In Technical-Systems Performance is Better

The performance of the public sector enterprise has been
relatively better where labour and the task of labour
management is a small part of the overall tasks of
management. Thus, for a moment let us suppose that the
2 factors, social and the technical19, determine the
organizational structure and the processes in public
enterprise as much as in any productive organization. The
dimensions are involved in various combinations in any
particular organization or sub-organization. Thus, in oil
refining the technical would dominate; virtually all processes
and operational norms and performance measures would
be defined by the chemistry of the process and the chemical
engineering of the plant. Much of the competitiveness is
(pre) determined at the project stage, as operational costs
(which are under the control of plant managers) are a small
part of the total costs. The bulk of the costs is capital and
input, and arises out of design efficiencynot in the
control of operational managers.
The man-management tasks are simple since they are
derived from the technical and there is little deviation
possible from the requirements of functionality even for
the most minimal performance. Manpower costs being a
small part of overall costs, over-manning or higher than
market wages would have only a small adverse effect upon
profitability. Thus the NTPC, the oil refining companies,
More social rather than technical organizations;

processes and management have the task of
optimizing the use of labour. Control over
labour and price of labour are critical
Mixed performance (Banks, financial
institutions, developmental organizations, steel,
coal, industrial development, preferential
trading)
Generally poor performance with few
exceptions (Financial services, electronics,
equipment manufacture, textiles, hotels,
consultancy, and manufacturing generally)
the fertilizer companies (where the prior technology choice

was not in error) are better performing.
The Matrix of Performance

In areas like textiles, engineering, consultancy, the task of
man-management is crucial, labour and employee costs by
the nature of the process and the technology are a large
part of the value added, and so optimal use of labour and
at wage and salary rates close to the market are critical.
There are almost no-good performers among such industries,
except BHEL, Maruti, IRCON, and a few construction
companies. There are few exceptions to the general rule
that in such industries performance has been generally
poor. We may, therefore, conceptualize the performance
probability of public enterprise in the following model. See
Table 4.4.1.
SOME EMPIRICAL BASIS20

In order to quickly check out the above hypotheses we
looked at the status of enterprises public and private
covered in the PROWESS database of the Centre for
Monitoring the Indian Economy (CMIE). They include
only enterprises whose reports have been collected by the
CMIE and are widely available. All companies registered
with stock exchanges are included. Some entities other
than companies such as the Maharashtra State Electricity
Board were also included. The merit of these over the
Bureau of Public Enterprise (BPE) database is that they
are in electronic form, readily available, and allow ready
comparison with privately-owned firms in the base. Besides
that, unlike BPE data base they include the financial sector
18 The ritualization/formalization of all performance measurement
to reduce the natural variance is a recurring and dominant tendency

of a managerial hierarchy when not subject to performance pressure
and tight budgets, and where task responsibility has been displaced.
19 As first discussed in Katz and Kahn (1966).
20
This section is based on Performance and Market Evaluation

of the Public Sector, mimeo, Morris, S., Sept. 2003, IIMA,
hereinafter (Morris, Sept. 2003).
enterprises including banks, and a very small number of
state level public enterprise, especially those that have
taken the company form and whose annual reports are
available. Thus they include much of the variety that is
there in publicly-owned enterprises, though not in a
representative manner (that is, proportional to the universe).
Thus, the data cannot be used to make overall statements
of the public enterprise sector, but the variations can be
correctly studied.
Management Issues
Since many public enterprises have negative net worth, and
even with positive net worth may be over leveraged
(implicitly the state guaranteeing the same), or may have
varying amounts of loans which are de facto equity, or
explicit unsecured loans from the government, the formal
distinction between equity and borrowings in not entirely
meaningful. Therefore, few performance measures are
possible: return on total liabilities (or assets) that include
current liabilities that is, PBI(all)T on total liabilities. Now
since the depreciation rules of public enterprises vary,
without a clear dependence on the life of the assets or the
duration of liabilities, a more reliable measure would be
cash profits/total liabilities (CPBTL). In an economic way
too it makes sense because the measure gives the overall
surpluses created by the business from which both the
usage of assets21 and the addition of new assets besides
the returns to claimants have to be met. Total liabilities
represent the sacrifice of consumption made by society to
create the business with all its tangible and intangible assets
and the losses made in the past. Since loss-making
enterprises typically use short term borrowings to cover
losses and fixed assets, the usual measure of profitability
of the business, viz, PBT/total capital employed is
problematic and overstates the performance of the enterprise
when there are interest-free short-term loans, or the company
by its monopoly position or implicit backing of the state
is able to create payables to suppliers.
Competitive Manufacturing Performs Poorly

Morris (Sep. 2003), regresses cash profits/total liabilities
on control variables and industry dummies to show that
manufacture of textiles, extraction of limestone and related
minerals, other manufacturing, transport services, engineering,
chemicals, equipment, and machinery all do much worse
than other enterprises in the extraction of oil, coal and iron
ore, telecom services all of which have either a monopoly
21 Actually depreciation provided in company accounts may be
more for obsolescence rather than for usage, since maintenance
expenditures are typically provided for keeping assets in a state of
repair. See Scott, (1991) for arguments in this direction.
93
Table 4.4.2
Results of Regression of Market Capitalization of Public
Enterprise Firms on Share Holdings by Types of Shareholders
Variable
Constant
Book value stock
Government holdings share
Institutional investors share
Private corporate bodies share
R-sq
R-adj-sq
No. of Observations
F-ratio
Coefficient
T-Value
93.236
1.595
0.59
33.489
0.972
0.0983
39.822
0.0552
2.1023
0.0227
0.9535
0.9512
85
409.898
Note: The 85 firms constitute the public enterprise sample in the

PROWESS database for which the stocks were quoted on the
Bombay Stock Exchange. They included, PSUs, SLPEs, and some
financial institutions and banks; The categories are as in the
PROWESS database.
or are firms in regulated industries, show better

performance.
Similarly labour intensity (as indicated by wage and
salary intensity), and also reflective of the social dimension
of the organization as argued earlier has a strong negative
influence on performance, thereby supporting the
understanding that man-management has been the Achilles
heel of public enterprise in India. The intangible asset
intensity as expected is positively related to performance.
The networth/total liabilities, is again the least in the
case of manufacturing, meaning, thereby, that the
performance of manufacturing (competitive and where the
enterprises are more social than technical) has been poor
for a rather long period in the past eroding much of the
networth and expanding the liabilities base as operations
were continued despite losses or any serious efforts to
reverse them. Similarly, the measure of PBIT/total capital
employed and PBIT/total liabilities further confirm the
finding drawn on the basis of cash profits/networth. This
measure looks better for the manufacturing sector but is
problematic since networth excludes both the unsecured
loans and the capitalized losses, and losses written off, all
of which are rampant in public enterprise. The reserves
and surplus/paid up capital, PAT/networth indicate much
the same relative performance (Morris, Sept. 2003).
Monopoly and Administered Sectors Fare Better

Competitive manufacturing-oriented industries have
performed the worst relatively, and those with some
monopoly power, administered pricing or regulation
relatively the best. The chemical, engineering, other
manufacturing, some of the extractive industries show the
lowest performance, whereas paper, petroleum refining,
which have either high effective protection or administered
94
prices, power and telecom (regulated industries) in the

service sector show better performance.
Decline in Investments
The effect of loss-making enterprises has been to erode
networth and the demand on government for funds in the
form of extended borrowings and further equity support.
Similarly, pressures for higher dividends on the public
enterprise with better financial performance and an overall
situation of financial stringency of the government would
result in slowing down of the growth rate in fixed-asset
formation. It is well known that the rate of gross domestic
capital formation in the public sector, which had been
declining since the mid-1980s fell dramatically so that by
the end of the 1990s it was at barely 30 per cent, having
declined from the high level of 50 per cent or more in
the mid-1980s. This fall which was functional (Morris
2002) from the point of view of the efficiency of the
economy, given the higher cost and time overruns of
public sector projects, was one of the important reasons
for the decline/stagnation in the capital output ratio,
since the incremental ration fell as a result (Morris, Sept.
2003).
Suspended State
Ideally the decline should have been accompanied by
privatization of existing public assets and /or their retirement
as by de novo rising private investments, and not by the
slowing down of investments by public enterprises that
remained as such. Such forcible slowing down of
investments would have been harmful to any firm in an
economy. The ill effects of the particular way in which
public investments declined (which kept the rate of overall
investment from rising significantly since other factors
were positive) was to keep growth low through a demand
side recession. Till 1997 or so this ill effect was masked
by a rapid rise in private investment that more than
compensated for the fall in public investment. This rise
happened due to the sudden opening up of many sectors
hitherto reserved for the public sector (manufacturing and
many services), to both private and foreign investments,
following the stabilization and as part of the structural
adjustment. But from 1997 onwards for further rise in
private investment it would have been necessary for private
capital to enter into sectors of infrastructure which, barring
telecom, were all caught in a quagmire of regulatory (Morris
1997) uncertainty and distortions created by the
administration of subsidies, or had large entry barriers.
Sectors such oil exploration, oil pipelines, power, water,
roads, coal, etc. continue to be affected.
Deterioration of Assets Possible

In the manufacturing sectors since private capital was
allowed and from 1992 with no restrictions (abolition of
licensing) at all, it does not make sense to have (public)
enterprises that perform poorly and are unable or prevented
from making investments to keep pace with other competing
firms. The intangible organizational resources also quickly
erode when curbs are placed on managers and they cannot
invest to keep pace with the competition. Those with
potential should have been liberated from the shackles of
government to both compete and to make the necessary
investments. The costs of maintaining these enterprises in
the current state are entirely avoidable and are a large drain
on the exchequer. The costs they impose on society are
even larger.
Poor Capital Formation

The implied growth rate of addition to fixed capital sectorally
is very small barely 3.6 per cent per annum on the whole
and as low as 2.5 per cent for the manufacturing sector
as a whole. For all of manufacturing and for textiles it is
as low as 0.6 per cent, when textile markets have been
growing in excess of 10 per cent if exports are included!
Even for the extractive industries which are better
performing and with much market potential (in excess of
8 per cent per annum growth) it is being in rates of 2.6
to 1.2 per cent (Morris, Sept. 2003).
The Millstone of State Ownership

Thus public ownership or control has been a drag in terms
of the value derived out of the assets controlled. They are
being enhanced at rates that are far too low, and in some
instances (textiles) that would only destroy their values
completely. Given that the economy has been growing at
5 to 6 per cent and with a constant (if nor rising capital
output ratio) the growth rate of investments should have
been of that order at the very best. In other words, the
bigger loss in the continued public ownership of assets
especially of those in competitive sectors is the opportunity
loss for investments that reduces the economy wide growth
rate. This loss has been exacerbated by the high and often
absurd dividend pressure on PSUs. The public finance cost
in terms of the drain on the state exchequer is only a small
part of the overall cost imposed by public ownership of
productive assets. Indeed we may have overestimated the
actual rate of growth of the addition of fixed assets in
public enterprises. The depreciation rates are far too low,
giving implied asset lives of 20 years even in manufacturing.
The point is that the value of assets embodied in a
productive organization decline if additions do not take
place in a growing economy, due to obsolescence and
depreciation, especially the former.
MARKET PERFORMANCE
We took a set of about 85 public enterprises whose stock
price data was available in the PROWESS database for the
latest year and regressed the market capitalization on the
book value along with other determining variables
government shareholding, the share of financial institutions
(FIs), and that of private corporate bodies.
Institutional Shares and Performance of PEs

The higher institutional shares resulted in lower market
capitalization, pointing to the poor strategy of the
government in having gone through FIs then and the same
would be true today. The share of the FIs is more generally
connected with poor performance because the investment
behaviour of the FIs may have been perverse with undue
influence of private and public businesses in its portfolio
decisions. That is FIs may have been used to create buyers
for the stock of poorer performers. This can also happen
when FIs are under pressure to support the market to
support issues and particular stock (Table 4.4.2).
With the state-owned enterprise set, the extent of
government does not have a significant influence on market
capitalization. Many had agreed and anticipated that partial
privatization, in bringing non-government directors on the
board could improve performance. Also could such directors
provide a link with the market which could improve the
market perception of the enterprise. These were of course
a priori expectations. Empirically though we do not see
any such effect in Indias case in the privatizations thus
far. This is because divestment until recently has not been
with a clear mandate, may not have been credible, and the
mode of disinvestment in going through the FIs may have
been faulty. Thus with careful consideration the finding
may not be unexpected. Only as privatization makes
progress and is accepted as inevitable and is correctly
carried out would we expect the share of government to
be a significant negative influence on valuation of public
enterprises that is when they have de facto become
(commercial) enterprises with some government
shareholding. The large negative influence of institutional
investors share is also reflective of the sub-optimal
privatization that has been carried out.
Market capitalization was regressed on book value and
stock shares of different types of owners in the entire list
of quoted companies in the PROWESS database. The
results (Tables 4.4.3 and 4.4.4) clearly bring out the large
and highly significant value destroying effect of public
ownership, the significant positive role of private corporate
95
Table 4.4.3
Results of Regression of Market Capitalization of All
Firms on Share Holdings by Types of Shareholders
Variable
Constant
Book value stock
Government holdings share
Foreign promoters share
Private corporate bodies share
R-sq
R-adj-sq
No. of Observations
F-ratio
Coefficient
T-Value
41.419
1.696
6.342
2.953
2.999
2.671
1.7681
99.726
4.05
2.614
1.778
20,282
0.7462
0.7459
2193.82
3737
Note: The 3737 firms constitute part of the PROWESS database

whose stocks were quoted on the Bombay Stock Exchange, and for
which the data on the other variables too were available. They
included, PSUs, SLPEs, and some financial institutions and banks,
besides private sector firms. The categories are as in the PROWESS
database.
bodies, and of foreign investors and the positive role of

institutional investors. Thus today institutional investors
may not be associated with a bias to pick poorly performing
stocks. The emergence of competition and the entry of
foreign institutional investors ensures this. In holdings of
PSU stocks (by domestic institutional investors) the matter
may have been quite different though.
Rather than using the equity share holding percentage,
if we use the CMIE classification of ownership to estimate
the influence of categories therein on market capitalization,
Table 4.4.4
Results of Regression of Market Capitalization of
All Firms on Ownership Dummies
Variable
Constant
Book value stock
Central Government Financial
Central Government Trading
Foreign Houses
Foreign Private (Independent)
Indian Houses
Indian Private (Independent)
Joint Sector
R-sq
R-adj-sq
No. of Observations
F-ratio
Coefficient
T-Value
376.491
1.714
1879.45
793.019
1757.969
455.872
357.961
387.692
1.714
3.613
116.047
7.258
1.288
9.503
3.696
3.372
3.682
1.463
0.754
0.7537
4779
1828.62
Note: The 4779 firms constitute part of the PROWESS database

whose stocks were quoted on the Bombay Stock Exchange, and for
which the data on the other variables too were available. They
included, PSUs, SLPEs, and some financial institutions and banks,
besides private sector firms. The categories are as in the PROWESS
database. The Financial includes banks.
96
we get similar results. The CMIE categorization of ownership

are Central Government Commercial, Central Government
Financial, Central Government Trading and Services, Foreign
Houses, Foreign Private (individual) Firms, Indian Private
(independent) firms, Joint Sector Firms, State Government
Financial, and State Government Services. We have
reclassified the banks and FIs which were classed as groups
such as ICICI Group, SBI Group into Central Government
Financial. Besides these we have made some obvious
corrections. The Groups (Houses) of the CMIE are not just
the old monopoly houses of the MRTPA, but include such
groups of firms where there is cross shareholding. Similarly,
foreign houses are a set of firms that are held together.
With the reference category as Central Government
Commercial, dummy variables for the other categories
(nine such dummies) representing all the above ownership
types, were used as independent variables along with book
value of the shares. After much experimentation, the
variables reported in Table 4.4.5 were found to have the
best combined fit.
From Table 4.4.5 we see that the government has reduced
value in comparison to private ownership whether group
or independent, or foreign or domestic. The financial
sector with the government shows the highest value erosion
given their book values which are good. The Central
Government Trading and Services sector and the joint
sector are a little better that the Government Commercial
sector. These are powerful results that tell us even in the
year 2003, when there is so much expectations of
privatization and progress on reform of public enterprise,
government ownership has considerably reduced value for
the same book value. The excess of market value over book
value is a function of the growth prospects of the company,
Table 4.4.5
Results of Regression of Market Capitalization on Book
Value and Certain Ownership Dummy Variables
Independent Variable
Constant
Central Government Trading
and Services
Foreign Houses
Indian Houses
Joint Sector
Book Value
R-sq
R-sq (adjusted)
No. of Observations
F-ratio
Coefficient
t-value
376.49
1789.44
793.02
3.61
7.26
1.29
1757.97
455.87
357.96
387.69
379.86
1.71
9.50
3.70
3.37
3.68
1.46
116.05
0.7541
0.7537
4779
1828.62
Note: The data is from the PROWESS database for the year ended
21 July 2003 or the latest year available.
(the intangible assets which the firm possesses and which

can, therefore, keep its profitability high as well as improve
the growth prospects, by allowing it to grow at rates higher
than the competition) and negatively to the risks imposed
by managementsthe mistakes it could make, besides the
risks of the business. The fact that market capitalization
is adversely influenced by government ownership, therefore,
means that the growth and the intangible assets that such
enterprise can expect are lower than when the same business
were under private management.
The variance in stock prices could also be different for
public enterprises if government policy/announcements
affect them in a special way. Thus announcements of
privatization, no privatization, modalities of disinvestment
would affect them more than private firms, but with such
announcements being routine and predictably contradictory
(or alternatively because there are few such announcements),
the market could factor in the same to reveal a variation
in the price of the stock no greater than the average.
Empirical results show that ownership differences did
not significantly affect or explain the squared difference
of high and low stock prices over the year (Table 4.4.6).
Thus public ownership or ownership as such has not been
a significant influence in determining the range over which
stock prices have moved in the year 20023. We have
used, along with ownership, other variables that a priori
are expected to influence this range, viz. the average value
of prices, and the log of market capitalization, which being
a size variable is expected to have an influence. Large firms
show higher range of variation. This is as expected since
Table 4.4.6
Results of Regression of Squared Difference of High and
Low Stock Prices Over the Year Ending 21 July 2003 on
Certain Ownership Dummies
Constant
Central Government Trade and
Services
Foreign Houses
Indian House
Joint Sector
State Government Commercial
State Government Services
Average of High and Low prices
Log (Market Capitalization)
R-sq
R-sq adjusted
No. of Observations
F-ratio
Note: Data from PROWESS database.
Coefficient
t-value
2363.6
1064.2
5550.9
0.4366
0.0908
0.02023
1.5303
5071.7
1185.3
1114.1
3002.8
3610.4
5284.1
200.7
2071.1
1.7971
0.8579
0.2244
0.2069
0.2550
0.3171
0.1927
62.9128
6.3481
0.4619
0.4608
4779
372.137
they are far more actively traded, and more sensitive to
the events that move markets. Only foreign ownership
seems to have a weak negative effect on the range, but this
is barely significant. We next used shareholding by types
of shareholders rather than ownership dummies and the
results show that there is a weak negative effect of private
holding share and a positive effect of institutional investors
share. This again is as expected (Table 4.4.7).
Table 4.4.7
Results of Regression of Squared Difference of High and
Low Market Price over the Year Ending 21 July 2003 on
Certain Ownership Related Variables
Coefficient
Constant
Log of market capitalization
Average of high and low prices
Private holdings share
R-sq
R-sq adjusted
No. of Observations
F-ratio
579.4
25020.0
206.6
53.2
176.2
t-value
0.3716
7.0332
57.2106
1.8221
2.2584
0.4761
0.4755
3737
847.735
Note: The data are from the PROWESS database.
Adverse Effect of Taxes

The share of indirect taxes in value added (that includes
taxes) has been a stupendous 49.8 per cent for manufacturing
and 14 per cent for extractive industries. In financial
services, banking and other services it is much smaller. The
vast difference in the impact of taxation with manufacturing
bearing an onerous burden is reflective of the inability of
the state and the system to move towards a true and neutral
value added tax regime. The tax on manufacturing has been
particularly onerous on registered manufacturing and public
enterprise manufacturing; the latter being additionally not
able to develop functional relationship with the unorganized
sector.
97
It is also reflective of the stupendous dependence of the

state sector exchequer on the oil and natural gas industries
for taxation. Thus it is estimated that over 25 per cent of
the states indirect taxes and 22 per cent of the central arise
out this sector. Given this dependence the government has
not been able to extend MODVAT credit to the use of
oil and energy more generally so that the relative burden
on these industries and on energy-intensive industries has
gone up significantly.22 The distortion caused by such
over-dependence on one commodity raises the cost of
manufacturing and creates a large bias against value added
in the sector. It also artificially restricts the consumption
of oil products in the country. Given that the tax is based
on the same base by two governmentscentral and state
at all the stages in the value chain, it is highly probably
that even accepting the overriding objective of tax resources
from the sector, revenue maximization consideration in
the determination of the tariff may have been bypassed to
lower both demand and tax revenue23.
The indirect taxes on the sector (mfg-petroleum) have
been 64 per cent of the value added. At such a high level
of taxation, which has been on for decades, the price
elasticities may have gone haywire and it is anybodys guess
what they would be like in a non-distortionary situation.
We can definitely say that they would be much larger than
they are today.
CONCLUSION
Public enterprise, performance has been poor particularly
in competitive sectors, and in sectors that are labourintensive. It is only in some sectors with administered
prices, or where barriers to entry have been large that their
performance seems to be possible. Markets, though, have
undervalued their performance considerablypointing to
severe institutional constraints on their growth and
performance.
Box 4.4.1
Public Enterprise and Privatization in History
Late industrialization has always meant increased role of the state. Indeed the later a country industrializes the larger is the role
of the state. This regularity, first conceptualized by Alexander Gerschenkron (1962), has been a fact of every single successful
industrialization. But after industrialization was carried through to a point of irreversibility, the role of the state in directly
productive activities have varied much. Thus in France since the Napoleanic period and especially after 1860, the states role
has remained the same, or has increased as after World War II, and it is only now that privatizations are being pushed through.
In Germany the states direct role in enterprise was small but interventions through the banks for industrialization was the key.
22 It is also one of the most important factors that has adversely
affected international competitiveness of Indian industry. MODVAT,
on energy use for export industries, at least those based on national
input of energy fixed for all items, should have been constituted
long ago.
23
See also Box 9.1.1 of Chapter 9.1 in this Report.
98
In the Bismarckian period the role played by the state to take Germany through the industrial transformation, had contracted
in the 20th century to result in the emergence of large firms often cartelizing the entire market. The coordination that this brought
about in the economy was crucial to Germanys industrial success but there was no large direct role of the state in production.
In the UK and the US in the early years of industrialization the process of industrialization was almost entirely private, with
the state in the US playing a major role in creating through investments in education and especially engineering to create a surfeit
of skills. After the second World War a much weakened UK along with the ideology of the day went socialist by nationalizing
several industries especially those having a public policy character. It had to live with the inefficiencies of public ownership unlike
France. In France where nationalizations were driven by both public policy and strategic considerations, and the desire for
independence from the US military and economy, the public sector was a driving force in the faster growth of France so that
it was able to reach US levels of per capita income, albeit aided by a certain degree of protectionism. The Thatcher era pioneered
the new privatizations and brought privatization as a global phenomenon.
EAST ASIA
Japans industrialization really began with state enterprise in armaments, ship building, mining, and steel, besides machinery
industries (Yoshio 1965). Its other important institutional actors were the Zaibatsus or highly diversified groups which competed
intensely with each other in the goods and services market even as they collaborated with each other to obtain technology from
western firms. In internalizing many functions for which markets did not exist, and in exploiting coordination economies, they
along with the state were the active elements in the late industrialization of the country. But once these private groups achieved
sufficient size, the state privatized nearly all public enterprises. These sold off to the business groups constituted the core of the
heavy industries of each of the principal Zaibatsu groups. This happened over the period from 1905 to 1913 (Yasuzo Horie
1965) before the First World War. The destruction of Japan in the Second World War created a second phase of industrialization,
which was partly aided again by the coordination and internalizing functions of the Kieretsu, which was the new form in which
the old Zaibatsu emerged, and of course by the land reforms which greatly expanded the home market (Dore 1965, 1966).
In Korea too the role of the public enterprise state and business groups (Chaebols) and the interrelationships between them
were similar to that in Japan, though perhaps more pronounced. At one time in the early 1980s both the relative size and
distribution of the public enterprise was no different from that of India (Jones 1982). But since then the role of the public
sector has come down due largely to the faster and more diversified growth of the private sector especially the chaebols, and
a few instances of privatization such as the dilution of the share holding of Pohang Steel. In all areas where market failure was
not pathological (areas of public services), Korean private enterprise took the lead. Korea, unlike India but more like Japan, had
never faced the problem of inefficiency of the public enterprise or state failure, so that using the state and the chaebols under
the tutelage of the state for industrialization was eminently viable and successful. Similar was the case of Taiwan, which too could
use the state to overcome market failure, though the role of the states or of large firms was not as deeply pervasive as in South
Korea.
PUBLIC ENTERPRISE
IN
CHINA
In China, the story was different in detail and ideology but in function and the historical role played by the public sector is
no different from the Korean Communism meant that virtually all enterprise except petty trade was in the state and local
government sectors. Unlike the Soviet Union, China never completely eliminated the bazaar in the society. The strategy of
planning and inward orientation (import substitution) of industrialization was adopted. With massive state intervention,
investments and control over society growth was rapid and by the mid-1970s, China had overcome poverty entirely and showed
high levels of human achievementa. By the late 1970s the Chinese economy had diversified almost entirely due to the public
sector, and growth rates exceeding 6 per cent had been achieved. But it was an inefficient public sector that could ill afford
the high labour inefficiency now, since disguised unemployment had been overcome. In the open-door policy that came in 1978
9, the market was strengthened through the system of private farms and encouragement to state enterprise to sell and buy in
the open market especially for exports. The fact that the phase of communist rule had carried out land reforms meant that there
could not have been a home market constraint in any investment push strategy of development. As part of the reform, starting
from the early 1980s, public enterprise managers were given incentives for performance. This led to the first boom in exports,
to the commercialization of the public enterprise, many of them emerging as the fastest growing enterprises in the world. The
old core of the public enterprise which was inefficient did not change till recently, was therefore sidestepped in the reform as
the new public enterprise grew rapidly within the enterprise (Naughton 1996). The enormous growth of China was fuelled by
an export orientation that was more dramatic than that of its predecessors, large-scale investments by aggressive and commerciallyoriented state-owned enterprises, the prior land reforms which relaxed the home market constraint, and the prior diversification
of the economy and foreign investments (especially from Hong Kong and Taiwan) in areas of deficiency of Chinese enterprise
(Yougsoni 1983; Sung Yun-Wing 1991).
The fortunes both legitimate and illegitimate, made by the party elites, managers of public enterprise and private Chinese
enterprise from China, HK, and Taiwan provides the basis for the emergence of the Chinese bourgeoisie which is pan any
particular country (Zao Dengri, 2000).
CLASS
AND
STRUCTURAL LIMITATIONS
IN
99
LATIN AMERICA
In Latin America political independence from the 1820s onwards did not lead to strong and defined measures to bring about
industrialization (Dos Santos 1970). When Germany and France and later the Nordic countries not to speak of the US and Japan,
through Lisztian policies began to catch up with the UK, the Latin American states remained agrarian and primary products
or extraction oriented, since their governments were dominated by agrarian or latifundia interests. The two world wars were
periods of much diversification of the economies into manufacturing. After the First World War lacking the tariff and other
support, the partial industrialization could not be built upon (Frank 1986). But after the Second World War the industrialization
was taken much further especially in the larger countries of Mexico, Columbia, Argentina, and Brazil. State enterprise played
an active role, but the economies were generally open to capital movements both portfolio and direct. Their economies began
to be deeply penetrated by foreign capital in manufacturing even as public enterprises grew in areas of market failure and in
sectors like oil and steel, where foreign investors were reluctant to enter. Local private enterprise from its position of strength in
the immediate Second World War period lost the profitable high growth and leading sectors to foreign enterprise to be confined
to industries like textiles, food products, bulk chemicals, cement, etc. (Evans 1984). Rapid growth in such economies was typically
followed by decline or even negative growth for extended periods. These were reflected in a cyclical change in the ideology of
the state from far right (during austerity) to left wing (during expansion). The amplitude of the business cycle was enhanced
by the periodic openness of the economy on the capital account (capital flight). The debt crisis of the late 1970s, led to the
collapse of many of these economies. Since then they have witnessed intermittent rise and fall. The crisis cumulated as the debt
crisis. Large debt equity swaps in the 1980s and the early 1990s took place. During this period there was little greenfield FDI,
much of the FDI arising out of debt-equity swaps. The latter as also FDI got a boost due to takeover as these economies opened
their public sector to privatization.
Many utilities in the public sector with a none too good performance record were privatized. The privatizations resulted in
foreign rather than domestic enterprise taking over the large and challenging task of raising and enhancing the investments in
the sectors. This spread FDI into the region and in the 1990s as much as half the FDI if not more took the form of privatization
(Basant and Morris 2002). Some of these privatizations were successful. Others successes were based on enhanced state subsidies
and credit enhancements and on significant rise in fees and charges imposed on consumers. The models used herein are today
widely touted perhaps not always correctly as worthy of emulation in other countries with vastly different conditions and
concerns.
a
In the political sphere and in human rights its record was abysmal and brutal. In events like the Great Leap Forward and the Cultural
Revolution it is estimated that millions had perished or were eliminated by the state.
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1113, December.
PublicPrivate Partnerships Today 101
PUBLICPRIVATE PARTNERSHIPS
TODAY
5.1 THE DRAFT INFRASTRUCTURE POLICY OF KARNATAKA FOR

PUBLICPRIVATE PARTNERSHIP
S. Vasudevan
A policy should be a charter that enunciates the principles
of goal-setting, sets out the framework for achieving
targeted objectives and, thereby, brings about economic
performance. Policy-making in India, since the mid-1970s,
has been a short-sighted exercise, not free of the influences
of the vicissitudes of political expediency. Rarely have
policies been market-friendly.
The mandate to review the Infrastructure Policy of the
Government of Karnataka presented the first opportunity
to iDeCK (Infrastructure Development Corporation of
Karnataka) to create policies and measures that are incentivecompatible and have economic and market logic, and draw
little administrative energies. The policy was first announced
in 1997 with the principal objective of encouraging privatesector participation in infrastructure development. Similar
policy measures in other sectors such as tourism, ports,
roads, IT, and power were also separately announced
around the same period, setting out briefly the governments
agenda in incentivizing private-sector investments in various
planned and envisaged sectoral development initiatives.
What was particularly apparent in infrastructure policy,
was the need to delineate a framework for operationalizing
suitable public-private partnerships (PPP) and the process
that government would largely adopt for leveraging private
finance initiatives.
policy. These were broadly organized under the following

heads:
power, including power generation (captive generation,
non-conventional and renewable energy projects),
transmission, distribution, and power trading services,
integrated transport and logistics, covering roads,
bridges (flyovers), railway systems, ports, airports, oil and
gas pipelines, and warehousing infrastructure;
urban and municipal infrastructure comprising water
supply and sewerage systems, solid waste and garbage
disposal facilities;
industrial infrastructure including industrial parks
(IT, biotech, floriculture, etc.), Special Economic/Free
Trade Zones, Export Promotion Zones, industrial estates,
and industrial townships; and
other infrastructure such as township development
and infrastructure related to tourism and agriculture.
DEFINITION AND OBJECTIVES
Next, the objective of the policy was defined, with a

clear message to potential private investors of the
governments commitment to the reform process and an
unambiguous recognition of the formers role in state
infrastructure development. The need to provide high
service standards while at the same time value for money
(VFM) to users was defined as underlying the objective
of the policy. The private sector was expected to play a
key role in providing VFM by ensuring the following key
benefits:
As a first step, iDeCK sought to define what infrastructure

would essentially be covered under the gamut of the
savings in costs due to innovative designs, timely

project implementation, and higher efficiencies in operations;
102
enhanced quality of services to users due to better

managerial practices;
reduction in and gradual elimination of pricing
constraints;
enabling public funds to be earmarked for sociallyjustifiable projects; and
financial innovation and development of cost-effective
solutions.
Next was the creation of an appropriate institutional
and regulatory framework. Touchstone principles, as outlined
below, were enunciated:
Efficient Use of Existing Assets and Optimal Allocation of
Additional Resources: The intention of the government
would be to first look at the option of better utilization
of existing assets before new investments were proposed.
Further, priority would be accorded to those projects
where development of critical linkages provide significant
network externalities. The government would also develop
objective criteria for rationalization of investments for
expansion, upgradation or development of infrastructure
facilities.
Equitable Contractual Structures: The government would
enter into suitable contractual arrangements with private
developers for development and management of both existing
(O&M contracts, leases, sale or divestment) and new assets
(BOT, BOOT, BOO, etc.). The contractual/ implementation
structures could be evolved based on equitable allocation
of risks between the parties, taking into account the
legitimate concerns of private investors.
Transparent Process of Procurement: To ensure that private
services are procured in a fair and transparent manner, the
government would typically award contracts on the basis
of an open competitive bidding process for which the
criteria would be spelt out upfront. The government would
adopt a single-stage or 2-stage process depending on the
complexity of the project. The selection criteria used
would be one or more of the following:
quantifiable technical criteria (for example, level of
service, quality of assets offered);
lowest present value of financial support from GoK/
subsidy;
highest share (or present value) of revenue;
lowest present value of payments by GoK;
highest upfront payment (or present value of upfront
payments);
highest present value of future payments;
lowest concession period;
lowest present value of user fees; or
highest premium (or present value of ) on equity
shares offered.
Bidding Efficiency: The policy also provides for procurement

through a swiss-challenge approach or an innovative/suomotu proposal, where warranted, based on the proposal
meeting the necessary conditions.
Commitment to Clearances: With a view to achieve better
accountability and hasten the process of project
implementation, the policy also proposes that the
government would endeavour to provide all clearances and
approvals for sanctioned projects within 30 days of a
technically complete application.
FAIR REGULATORY FRAMEWORK

Since many infrastructure facilities and services have
natural monopoly characteristics or have excludability/
appropriability problems, independent regulation would be
desirable to ensure that the interests of both users and
service providers are not compromised. The policy also
underscores the intention of the government to set up
independent regulatory authorities for all the infrastructure
sectors. The independent regulator would ensure that
services provided by the operator are of the highest quality
at the best possible prices and put in place a mechanism
to address consumer grievances with regard to service
quality on the one hand and ensure compliance with
environmental, safety, and other standards on the other.
In addition, the independent regulator would also arbitrate
disputes between the various stakeholders. The scope and
functions of the regulatory authority would be specifically
outlined for each sector.
ENABLING INSTITUTIONAL INFRASTRUCTURE

At present the process of project identification and
development is handled by the various government
departments and agencies and in the case of urban projects
by the respective urban local bodies. For projects over
Rs 100 crore, the Infrastructure Development Department
(IDD, Government of Karnataka) has been set up as the
nodal agency to streamline the process of appraisal and
approval. Subsequent to this policy, IDD would also be
the nodal department for all infrastructure projects to be
implemented through private sector participation.
The policy proposes strengthening of the nodal agency
with appropriate technical staff to enable it to coordinate
and integrate the necessary procedures and processes and
ensure that projects are implemented expeditiously. It is
also proposed that an Inter-Departmental Committee (IDC)
headed by the chief secretary and comprising secretaries
of the various government departments concerned with
infrastructure could constitute the approving authority,

and act as a single window mechanism for evaluation of
proposals for private-sector investment. Where necessary,
the government could also set up independent advisory
group(s) which would serve as think-tanks to assist in the
formulation of sector strategies, selection of implementation
options and overall infrastructure development.
SUSTAINABLE INCENTIVES: FISCAL MEASURES

From a policy perspective, the government has realized
that fiscal incentives are perhaps necessary but not a
sufficient condition for successful private sector
participation. Hence, this appears last in the hierarchy of
touchstone principles. Various incentives and concessions to promote private finance initiatives in infrastructure development are already available under the existing
policy and have been carried forward to the new (draft)
policy. Besides, other incentives and concessions under
extant sectoral policies would also be available to private
investors.
A key priority of government is the progressive
elimination of subsidies and cross-subsidies so that prices
for services are commensurate with the real costs of
provision. A level playing field and market determination
of demand and supply can bring about commercialization.
Subsidies, as long as they continue in the infrastructure
sector, would be based on the need for adequate cost
recovery, social needs, and balanced regional development.
Wherever subsidy is necessitated by social compulsions,
it would be the endeavour of the government to ensure
that payments are direct and transparent and funded out

of a dedicated corpus raised through appropriate fiscal
measures. Such subsidies may also be a bid out for private
service provision in a competitive bidding framework.
These principles form the crux of the draft infrastructure
policy developed by iDeCK for the Government of
Karnataka. The infrastructure policy provides an umbrella
framework for development/restructuring of various sectoral
policies to bring about purposeful reform in issues of
governance that would allow greater private participation
in infrastructure projects. Further, it also provides a basis
on which the government would develop medium and long
term strategies and implementation plans for each of the
infrastructure sectors clearly setting out the role for the
private sector, in both the management of existing assets
and creation of new assets.
GoKs decision to review and restructure the existing
infrastructure policy was primarily 2-fold. First, the policy
was due for a temporal review, as provided in the earlier
document. Second, and more significantly, it was borne
out of the governments genuine intention to institutionalize
private sector participation in infrastructure development.
This policy is predicated on the governments vision to
build strong PPP in order to develop, expand, broaden,
and deepen private investment in infrastructure that would
help achieve the twin objectives of high growth and equity.
The formalization of this policy would be a significant step
towards establishing Karnataka as a role model for
infrastructure development, where governance is based on
best practices.
5.2 REAL ESTATE INDUSTRY: CREATING VALUE THROUGH

PUBLICPRIVATE PARTNERSHIPS
Ashok Deo Bardhan and Samir K. Barua
The real estate industry cluster, broadly defined, consists
of a collection of industrial and services sectors of the
economy, such as construction (housing construction, as
well as construction of commercial offices, retail and
industrial buildings, and infrastructure projects such as
dams, roads, and bridges), brokerage services, real estate
finance services (mortgage banking, real estate investment),
real estate operations, property management, architecture
and design. A number of other sectors of the economy are
also intricately linked to the real estate cluster. These
include the cement manufacturing industry, the power
sector, the furniture and appliances industry, the finance
cluster as well as a range of other downstream and
upstream sectors. The cluster is, therefore, critical for the
health of the nation as its impact is felt throughout the

economy.
Real estate as a whole, and housing in particular, is the
single largest asset class and wealth holding of individuals
and households globally. The development of the housing
sector is an integral part of economic development. In
addition to its size in the economy, its importance also
arises from the positive externalities and spillover effects,
and their impact on the social and political climate. In
most countries, and particularly in developing countries,
housing is a very large proportion of a households
expenditure and takes up a substantial part of lifetime
income. The backward and forward linkages to land
markets, durable goods manufacturing and the contribution
104
to the development of labour markets with depth and

mobility further underscores the significance of this sector,
particularly in the process of economic reform and
transition.
Housing and Real Estate Markets are Large

The total market value of housing in the US, for example,
is approximately US$12 trillion. This is larger than the
market capitalization of the US stock market or the US
GDP. Similarly, in other OECD countries, the total stock
of housing is worth 100 per cent to 150 per cent of GDP.
Even in an era of financial maturity and enthusiasm for
investments in stocks and other financial channels, the
primary residence remains the principal form of wealth
held by a household in the US, and constitutes over 50 per
cent of its net worth1. Moreover, the claims represented
in financial assets, both stocks and bonds, also pertain in
part to the real estate held by firms and the government.
Real Estate in China

The role played by the real estate industry in economic
growth is underscored by the example of China. In
comparison to the well-known contribution to economic
growth of Chinas special economic zones, the impact of
foreign direct investment, and the impetus provided by
town and village enterprises in the hinterland, the story of
the real estate cluster and its impact on the economy is
relatively unknown. Major construction projects in the
office and residential real estate sectors2, industrial
construction and massive infrastructure projects have been
instrumental in providing the necessary conditions for
other sectors to flourish, and have themselves had a
significant direct and indirect impact on the overall growth
rates. Commercial real estate growth has been exceeding
25 per cent per annum in recent years, with the first half
of 2003 alone witnessing completion of approximately
80 million sqm of office space. Chinas overall real estate
investment (including housing) grew by 33.5 per cent yearon-year to 198 billion yuan (US$24.9 billion) during the
first 4 months of this year, according to Chinas National
Bureau of Statistics. There have been major spillover
effects in the economy with sectors such as furniture,
appliances, and other home furnishings growing at rates
in excess of 25 per cent and the State Council Information
Office, which oversees the official government information
portal, estimates that the real estate industry contributes
1.5 to 2 per cent to the overall growth rate of GDP.
1
2
Bureau of Economic Analysis, US Dept. of Commerce.

The development of Shanghai Pudong New Area alone, where
a metropolis with world class urban infrastructure has sprung up in
a matter of a decade, is worth special emphasis.
While the commercial real estate sector may be a

manifestation of derived demand, dependent on how well
the industrial and services sectors are doing or are expected
to do in the future, the housing sector is driven by a
number of extra-economic and demographic factors, in
addition to the economic ones such as income and the
interest rate environment. This attribute of the housing
sector coupled with its size and its multiplier effects on
the economy gives it the role of a leading indicator of the
imminent state of health of the economy at large.
We examine the multifaceted value that the real estate
cluster is capable of delivering to the economy and society.
We look at the spillover effects that it generates, review
some of the theoretical and conceptual issues involved, and
make an assessment of the new institutional and market
innovations required, as well as the reforms that are needed
in India to enhance the role of the industry as an engine
of growth for the economy and as a tool of long-term
wealth creation. Based on the statistics thrown up by the
recently concluded survey by the Census of India, we argue
that the sector offers immense potential for creation of
value through PPP (Box 5.2.1).
LEGAL REFORMS
By a number of criteria India seems poised to jump on
to a higher growth path. It is our contention that the gamut
of industries comprising the real estate cluster can not only
play a critical role in this economic transformation, but
can also serve as an engine of future growth. A number
of reforms, however, need to be carried out and bottlenecks
impeding the natural growth of the industry removed
before the inherent potential can be realized.
Property Rights Deficiencies

The legal structure in India has not kept pace with some
of the far-reaching reforms now taking place in the Indian
economy. This is also true of the laws and regulations
governing real estate development and investment.
Development of a proper transparent process of title
registration, for example, is critical to the growth of the
industry. The need for evidence of a good title, indicating
that the property is free from past residual and future
claims and encumbrances is the bedrock of secure property
transfers and sales. Due to the vagaries of history, convoluted
legislation and a plethora of systems, what we have today
in India is mostly transaction registration rather than title
registration. It is important that potential buyers feel secure
in the sanctity of the title that they acquire, regardless of
the pursuit back into the record books, and do not feel
required to hire lawyers or investigators to dig into title

Box 5.2.1
Value Creation by Housing and Real Estate
SOCIAL IMPACT
The purported benefits of housing, and of home ownership in particular, have been stressed in theoretical and empirical literature
on housing. The social value creation by housing, such as social stability, functional neighbourhoods, development of civil society,
abatement of crime, and general enhancement of welfare, have been well recognized. This is particularly true of provision of
affordable housing for the poor, in addition to the widely acclaimed objectives of equity and social justice. Homeowners
accumulate wealth as the investment in their homes grows, enjoy better living conditions, are often more involved in their
communities, and have children who tend on average to do better in school and are less likely to become involved with crime.
Communities benefit from real estate taxes homeowners pay, and from stable neighborhoods homeowners create (US Department
of Housing and Urban Development 2000). Home ownership creates neighbourhoods with a collective sense of identity through
the development of stakeholding that is linked in terms of its value to the dynamics of the neighbourhood at large. By this we
do not just mean value in the monetary sense, but also in terms of the quality of life in the immediate neighbourhood of the
primary residence. Indeed, some go so far as to raise the question whether home owners make better citizens (DiPasquale and
Glaeser 1999). Although the ownership rate in India is higha (that is, owned homes as a proportion of total dwellings) the quality
of a large segment of dwellings leaves much to be desired and many of the externalities of housing are thus not captured.
SPILLOVERS, MULTIPLIER EFFECTS

Direct new expenditures in the construction industry or in other sectors in the real estate cluster themselves stimulate the economy
and generate jobs. Since a substantial portion of such generated income is plough back into the economy, there is an additional,
multiplier effect. This is true of any industry. However, since the real estate cluster is largely a non-tradable industry (that is,
most of the output and inputs associated with the industry stay, and originate from within the confines of the domestic economy),
there is very little leakage out of the country. The localized and domestic nature of real estate, therefore, leads to a much higher
multiplier effect than would be the case for a more tradable industry. While construction, home maintenance and repairs, power
and transportation directly affect the economy, the extensive nature of downstream and upstream linkages of real estate, from
the finance sector to the furniture/consumer goods sector, from infrastructure (roads, bridges, public works) to superstructure
(commercial space/retail, industrial etc.) further impact the national economy. A given amount of expenditure in the real estate
industry, therefore, tends to support larger number of jobs in the economy.
IMPACT
ON
FINANCIAL MARKETS
Underlying the provision of real estate services in general, and housing services in particular, lies the criticality of a well-functioning
financial system. Indeed, without a properly functioning housing finance system that operates in an allocationally and operationally
efficient manner, the real housing market would be grossly sub-optimal. Moreover, in a manner similar to the housing markets,
the housing finance system has beneficial spillover effects on the entire financial system with far-reaching consequences for economic
development. For example, a mortgage market is very important for the process of capital accumulation in a developing economy.
Since housing is the primary tangible asset of a developing or transitioning economy it can then also be used as collateral to borrow
funds in order to carry out productive capital investment. Mortgage debt ends up accounting for a large proportion of household
debt and, through secondary markets and securitization, supports the efficient functioning of financial markets. Housing finance,
as well as real estate finance more generally are vital elements both in the development of a dynamic housing sector, as well as in
the development and deepening of the financial sector. In addition to creation of more lending channels, more investment channels
are opened up as well for both institutional and individual investors, thus leading to more complete and efficient markets.
ROLE
IN
CREATION
OF A
NATIONALLY INTEGRATED MARKET
A national residential and non-residential/commercial real estate market is essential for the proper development of a nationally
integrated market in general. A national market assumes free flow of capital, labour, and resources within the borders of a nationstate, and neither is possible without a concomitant free flow of housing and other real estate resources. The experience of several
countries shows that regional disparities and distorted development are the norm if real estate markets are regionally segregated
and segmented. Whether firms respond to investment opportunities in various parts of the country or whether people follow
jobs, a rapidly responsive market in commercial construction and support services, in the development of hotels, rental housing,
and homes for sale can lead to a more efficient and mobile labour market.
TOOL
OF
UPWARD MOBILITY
In some countries the first purchase of an entry-level home, usually subsidized in some form or another has served as a stepping
stone for upward social and economic mobility. As pointed out by Bardhan, Datta, Edelstein, and Kim (2003), the Singapore
a
Proxenos (2002).
106
housing market, for example, is characterized by the coexistence of a dominant public sector and a small, growing private sector
with relatively higher quality housing. While accounting for the impact of the former on the latter in an econometric model,
they find that an increase in the rate of change of public housing resale prices has an important and significant positive impact
on the sales of private residential units. The underlying reason here is that occupants of the subsidized public sector flats are
allowed to sell their flats after a certain period, subject to some restrictions, and the sale mitigates their down payment constraints
in the purchase of new, more expensive, private apartments. This interesting tandem of privatepublic activity lends a helping
hand to upwardly-mobile households, and the larger social and economic value created far surpass the resources sunk and foregone
in the public sector housing subsidies.
records going back a long time. Title and title guarantee

companies providing title insurance and escrow services
may then develop together with the market.
Land Acquisition: A Problem

The exercise of the doctrine of eminent domain for land
acquisition by the government has been carried out widely
in other countries. Given the needs of development and
the penchant of the state for quasi-coercive acquisition,
it is vital that some independent body looks into the
criteria for exercising this ultimate power of the state. In
the Indian context, this power should be exercised only
with the transparently stated objective of appropriate,
imminent use in the public interest, with a particular
regard for environmental sustainability and with fair and
just compensation/resettlement3.
and planning the kind of real estate (residential, office,

retail, or mixed use), design norms and neighbourhood
landscaping in addition to the floor space index or floor
area ratios. Unbridled market development can lead to
eyesores and can also distort the market in favour of
powerful players. Intervention in the market process is also
needed in order to choose between alternative strategies
of density versus sprawl in real estate development.
Restrictive and low floor space indices can artificially
ration land-use, drive prices up, lead to speculative
behaviour, and may not be the optimal usage of scarce
land. Cities with inadequate transportation infrastructure
are served better by liberalization of floor area ratios,
which lead to more efficient and intense exploitation of
land, albeit at the cost of achieving higher density.
INSTITUTIONAL
Foreclosure Proceedings
A proper system for foreclosure proceedings in case of
mortgage default that also shortens the time for repossession
of the collateral is important to allay the apprehensions of
mortgage lenders. Also, various kinds of liens, such as the
mechanics lien, which is a claim against property on which
contractors have expended labour can protect the interests
of various real estate related creditors. In the Indian
context, a reform of laws governing landlordtenant
relationships also needs to take into account the issue of
balance between affordability and landlord rights in a way
that market distortions are minimized and the needs of
equity served. This is easier said than done. However, it
should be noted that even the most market-oriented
countries have tenant protection and rent control systems
in place.
Zoning and FSIs

With major real estate development comes the need for
proper zoning and land-use controls for economic and
aesthetic reasons, as well as for larger social objectives.
Zoning in its broadest sense would involve determining
3
Some attempts to use the private sector to bring about land

development have begun. (Box 5.2.2).
AND
MARKET REFORM
Mortgage Markets
For the housing sector to function well over a long period
of time, it is necessary to have a vigorous market-oriented
system for financing the construction and purchases of new
and existing housing. Well-functioning mortgage markets,
in addition to their positive effects on the development of
the real estate market, may also have a critical impact on
the functioning of the banking sector and the financial
industry as a whole. For example, for banks to issue loans
as complicated as mortgage loans, they need to develop
critical capabilities and expertise in product design, credit
analysis, and risk management. In addition, offering
mortgage loans would attract increased savings and
investments from which both financial and non-financial
sectors would benefit. Indeed, mortgage market development
is likely to be a key factor in overall financial market
development. As pointed out by Jaffee and Renaud (1997),
an efficient mortgage market will act as a positive externality
for other capital markets, creating pressure for higher
efficiency in these markets. On the other hand, a poorly
functioning mortgage market is likely to pollute other
financial markets with its inefficiency. A combination of
economic and social factors, such as high domestic savings
rates, particularly after accounting for mattress savings

Box 5.2.2
Private Land Development in Lucknow
Bhavin Kothari
Partnerships for urban development in general and for urban infrastructure and land development in particular have become
increasingly popular, as an alternative arrangement to direct provision by local authorities (Payne 1998). According to the Centre
for Monitoring Indian Economy in 19989 alone 129 partnerships were forged in the various sectors of the Indian economy. Since
1994 UNDP under its Public Private Partnerships for the Urban Environment (PPPUE) programme, has tried to initiate action
by creating new enterprises, owned jointly by public authorities and private companies to deliver reliable, affordable, profitable, ecoefficient urban infrastructure services. Partnership arrangements seem to have become the panacea for all urban issues.
The real estate contributes approx 10 per cent of Indias GDP. If the parallel economy is recognized it should form a much
higher share of the GDP of the country. We have now recognized real estate as an important aspect and means to ensure economic
growth and investment. But systematic overhaul of policy, law, and rules governing real estate, zoning, town planning, building
rules still need to be addressed. The entry of the private sector in a significant and organized way, even with the current constraints,
is worth mentioning. Private parties are, for the first time outside Delhi and Gurgaon, showing an appetite for large projects. The
shortages built up over the last several decades are quite large and despite the liberalization of housing finance over the last 2
decades, these shortages are only now beginning to be addressed. Organizations both in the public and the private sector are
increasingly looking towards converting their real estate assets such as vacant land holdings and other surplus real estate into revenue
earners or profit centres. Research shows that a crore of investment in the real estate sector generate 750 man-years of employment.
Synergy between public and private sector participation is a winwin situation for all. The National Housing and Habitat Policy
1998 envisages a shift in the governments role from a builder to an enabler, with the government committed to removing barriers
like access to land, finance, and technology, and forging strong to accelerate the pace of house construction mainly for the
disadvantaged sections. NRIs are permitted to invest up to 100 per cent in the housing and real estate development projects.
NEED
FOR A
PUBLICPRIVATE PARTNERSHIP MODEL
OF
LAND DEVELOPMENT
The public sector is faced with constraints of lack of expertise, and lack of commitment to quality besides the budgetary
constraints. The private sector faces difficulties in assembling large chunks of contiguous land, inordinate delays and problems
in approvals from the local authority, development control regulations, non-coordination with the local authorities who are
charged with the provision of off-site infrastructure. There has always been a problem in getting institutional finance for the
private sector because housing is not declared as an industry. Hence, PPPs, when correctly structured even with the current policy
and administrative constraints, can help to lead to better results. To cover all cities and town with basic infrastructure, the Rakesh
Mohan Committee set up by the Government of India had estimated that urban India would need at least Rs 793 billion
between 19962001. Partnerships assume strategic dimension since they aim to tackle an important issue, policy or problem,
which extends beyond the capabilities of a single individual and organization.
The PPP models used in Gurgaon in Haryana and Lucknow in Uttar Pradesh for land developments have proved to be
successful. In these PPP models the private sector was principally responsible for all on-site development like provisions of internal
infrastructure, social and public amenities, plots, houses of desired sizes for different income groups, whereas the public sector
was to make suitable provisions for the off-site infrastructure in a prespecified time frame, as well as act as a sanctioning, facilitating,
and controlling authority. In case of Haryana the (undeveloped) land was to be acquired by the private developer, whereas in
the case of Lucknow the land for development was provided by the public sector. Both these PPP models for the land
development were self-sustaining and commercially viable.
PPP
IN
LUCKNOW
Lucknow, the capital city of Uttar Pradesh, is ranked 10th amongst the million plus urban centres in India. The city has
experienced high growth in population. To satisfy the housing demand of the city the public agencies like Lucknow Development
Authority (LDA), Uttar Pradesh Housing Development Board (UPHDB), Uttar Pradesh Avaas Vikaas have been engaged in this
process of housing supply.
In 1985, the High Court ruled that a public agency can acquire the land and start physical development on-site only after
awarding 80 per cent of the decided compensation to the farmers. This was to ensure that such agencies did not delay payments
to farmers and others from whom the land was acquired. Thus there was a sudden change in the process of acquiring land because
this judgement made it compulsory for LDA to financially strengthen their base before starting any new development scheme.
Given the financial weakness of the agencies, bringing in the private sector was, therefore, necessary even to acquire land. First
it happened along the Lucknow-Kanpur Road.
To support the public sector agencies the UP State Housing Policy, enacted by the UP State Government in 1987, as a
government order, No. 379 under Section-5, of this notification, empowered 20 development authorities throughout the state
The author acknowledges the assistance of Dinesh Gajjar and inspirations from Ushaben and Dhvani. The views expressed in this paper are
those of the author and do not represent any other individuals or organization.
108
to provide land on licence basis to the reputed private developers within the country engaged in the field of land development.
Lucknow was the first city to implement this policy of the government.
LDA invited the private developers to come forward and negotiate with the development authority to initiate the land
development in potential urban areas of south lucknow, along the Kanpur and Rai Bareli road. The entire scheme was called
the Kanpur Road Extension Scheme.
LDA has played a major role by developing 6500 acres of land. UPHDB has developed about 2612 acres of land in the
past 30 years. LDA and UPHDB was instrumental in adding housing stock of the city till the 1990s and have added 70,000
and 43,500 dwelling units, respectively. 2056 acres of land was decided to be developed with the help of the private sector,
out of which 811 acres of land was allotted to the private developers like Ansals, Eldeco, and Unitech as part of the Kanpur
Road Extension Scheme. M/s Ansals Housing and Construction Ltd was allotted about 432.25 acres land for development on
Kanpur Road. M/s Eldeco Housing and Construction Ltd was allotted about 155 acres on Rai Bareli Road. M/s Unitech Housing
and Construction Ltd was given 224 acres of land for development on Rai Bareli Road as part of the Sharda Nagar Yojna.
SALIENT FEATURES
OF
PPP MODEL
IN
LUCKNOW
The (undeveloped) land (Khand) is provided to private developers by the development authority and developer has to
pay the cost of this land to LDA in specific time frame.
10 per cent of the cost of land and External Development Charges (EDC) is to be paid within 45 days from the date
of issue of the licence.
15 per cent of the land cost is to be paid in 90 days from the date of issue of licence.
The remaining 75 per cent of the land cost is to be paid in 6 half-yearly equal installments.
The private developer reimburses the cost of external services like trunk infrastructure connection points to the development
authority.
Internal development of physical and social infrastructure is to be done by the developer as per the development control
norms of LDA.
Out of the total area available with the developer 55 per cent will be for residential development and 45 per cent for
the internal infrastructure and social facilities. Out of the total residential area 70 per cent should be as group housing and up
to 30 per cent could be plotted development.
40 per cent of the total number of constructed units should be of economically weaker section (EWS) category, with a
built up area of 30 sq m. Developer is to be reimbursed at the predetermined rate for construction of EWS houses through LDA
and HUDCO.
The developer is free to sell residential area other than those in the EWS category.
The licence granted to the developer is valid for a period of 3 years. Extension may be granted for the genuine case.
Initially the developer maintains the colony for the period decided upon by the LDA but eventually it is to be done by
the respective public departments.
SELECTION CRITERIA
FOR THE
DEVELOPER
AS A
PARTNER
The private developer has to develop a minimum of 100 acres of land allotted by the LDA. This criterion was later reduced
to 50 acres.
The private partner should be a firm registered under the Indian Companies Act as a private company and should provide
documents regarding its financial/technical and administrative capability.
The private land developer should have experience of developing at least 25 acres of land.
The details of the schemes and documents provided by the private developer are scrutinized by the concerned departments
of the development authority and the private developer has to deposit 50 per cent of the bank guarantee of the estimated cost
of internal development within 30 days after the sanctioning of the scheme.
South City
The South City Project was established as part of the Sharda Nagar Yojna of the Kanpur Road Extension Scheme on the
LucknowRai Bareli highway. M/s Unitech Ltd was the developer for this project with 224 acres of land finally allotted by LDA.
Land Use Statement of South City Scheme
Land Use
Residential
Commercial
Community Facilities
Recreational Spaces
Roads
Total
Area in Acres
125.74
6.224
19.035
20.115
52.88
224.00

Details of Plotted Development in South City Scheme
Plot Area in Sq m
No. of Plots
142
188
293
418
Total
99
659
357
317
2686
Details of Group Housing in South City Scheme
Built up area in Sq m
No. of Units
30
5075
75100
100150
>150
Total
1254
100
239
80
131
1804
Pricing of the Scheme

The launching price of the plots in 1998 was between Rs 340 to 370 per sq m. The construction cost at that time was about
Rs 200 per sq ft. In South City majority of the houses have been provided with 142 sq m to 188 sq m plots with the construction
of 5060 per cent of different types. Thus the houses in South City are available from Rs 1 lakh to the maximum of Rs 16
lakhs. The predominant range of houses are between Rs 37 lakhs. The EWS houses were being sold at Rs 65,000 in 1997.
Rs 50 per month maintenance charges are taken as from group housing occupants and Rs 75 per month from the serviced plot
owners in the South City Scheme.
Cost Break Up for the South City Scheme
Component
Land
Internal Development
Construction
Overheads
Total Cost of the Project
Cost in million Rs
87.5
107.5
218.0
87.0
500.0
Marketing Strategy of the Private Developer

Initially the developer sells 25 per cent of the stock at the launching price, which is comparatively less. Then the firm stops
selling the units for a considerable time by which time the prices go high. Then the developer brings the stock in the market
and disposes of it at the high market rate, to generate the surplus.
SWOT Analysis of PPP Models for Land Development with reference to the case study of Lucknow reveals:
Strengths
Efficient supply of serviced land and houses to the different income groups;
Good quality houses with excellent social and public amenities;
Guided development takes place even in the peripheral areas to develop new town culture;
Proper marketing, management, and maintenance of the projects;
These models are self sufficient and commercially-viable;
Risk reduces since the portfolio is diversified;
Partners and the stakeholders are the same;
Quality development takes place because of professional approach and expertise of the private sector; and
Control on land speculation because of public sector involvement.
Weaknesses
much
Project may suffer in case of conflict of interest between partners;

Beneficiaries may suffer in case of delay in delivering the goods in time (In case of Lucknow, off-site infrastructure came
later than the completion of the Sharda Nagar Scheme;
Local authority takes a long time in approving project and plans;
The development costs collected by the authority is too little to support the provision of infrastructure;
110
Coordination with local authority for provision of off-site external infrastructure;

Sector is not recognized as an industry so continue to await institutional and bank finance;
Constraints to development of land are many. The city areas are constrained by archaic zoning, building, and floor space
index (FSI) regulations, so that development takes place mainly in the peripheral areas;
Prices of undeveloped land are highly distorted, with land related policies like rent control act, tenancy law, urban land
ceiling, and regulation act, stamp duty act, being major factors, besides low FSIs; and
Existing land holdings and title clearance is a problem, so is acquiring contiguous land for major projects.
and cash holdings, the high price to income ratios, and

a general cultural and social predisposition towards home
ownership seem to suggest that the essential core of the
problem in the development of a vibrant housing market
lies in the provision of housing finance services that can
allocate untapped resources, mitigate regional distortions,
and assist in consumption smoothening for households
over long periods. The creation of a functioning mortgage
market will release these moribund savings, stimulate pent
up demand, and move the economy to a higher equilibrium.
MORTGAGE INSURANCE
In an environment fraught with the difficulty of risk
assessment, the widespread promotion of mortgage
insurance might be necessary for boosting lending. Mortgage
insurance is a contract that promises to compensate a
creditor (a bank) in the case of an insolvent debtor. The
systematic component of risk is much higher for mortgage
insurance than for other types of insurance contracts.
Indeed, with proper demographic and geographic
diversification it is possible to reduce risk to a minimum
with other types of insurance contracts. However, both the
default and pre-payment risks of mortgage loans greatly
depend on macroeconomic variables, such as the change
of real estate prices, interest rates, average income, and
unemployment rate. The advantage of the introduction of
a mortgage insurance scheme is that it will boost the
number of mortgages and consequently have an indirect
impact on the real housing sector. Urosevic et al. (2003),
study the costs and impact of a government-sponsored
mortgage insurance system in transition and developing
economies in which mortgage markets either fail to
materialize or are underdeveloped. They calculate the
mortgage insurance premium that such an agency would
fairly charge, and its profits and losses. They also assess
the beneficial impact on the economy of developing mortgage
insurance, and, by extension, of mortgage markets. While
in developed economies the mortgage insurance premium
is in the range of 0.3 to 0.5 per cent, of the outstanding
loan, the costs in developing countries would be a multiple
of that, that is, 1 to 2 per cent of the mortgage amount.
However, the estimated impact on employment will be
significant because of the pent-up demand for new housing

as well as for additions, improvements, and repairs.
Secondary Mortgage Markets

For complete housing finance markets with depth, it is also
necessary to create secondary mortgage markets. By
insuring, packaging, and selling the original mortgages in
the form of Mortgage Backed Securities, and in good time
their related derivatives to outside investors (foreign or
domestic), originators can free up their capital and
simultaneously reduce the risk of mortgage origination in
order to offer fresh issuance of mortgages. The creation
and development of mortgage insurance/secondary market
institutions, dominated by state establishments, but with
economic space afforded to private players, particularly in
the commercial real estate mortgage business would play
a key role in generating investor confidence in mortgage
products.
Corporatization is Necessary
Generally speaking, investment in real estate comes in
various forms: sole proprietorships, partnerships of different
kinds, and corporations with limited liability. In many
countries there are also Real Estate Investment Trusts
(REITs). The promotion of REITs, entities that own,
manage, and operate income-producing portfolios of real
estate assets would have multiple benefits. Investing in
REIT stock is akin to investing in a mutual fund. Whereas
in the latter case an investor has a claim on underlying
company stocks, in the case of REITs it is a claim on
underlying properties. Development of REITs would
professionalize and corporatize real estate operations and
management. It would also give an opportunity to individual
and institutional investors to add real estate to their
portfolio, a problematic thing under usual circumstances
because of the lumpiness of the assets and the low liquidity.
In most countries, REITs are not subject to taxation at
the corporate level and 90 per cent of the income is
distributed as a dividend payout. There are various
regulations regarding share of income from real estate
holdings, as well as restrictions on ownership concentration,
and like a mutual fund a REIT can be quoted at a discount

or a premium to the underlying assets, that is, the market
capitalization and the net asset value are different. In the
US, for example, REIT stocks have become a very popular
investment alternative in recent years, particularly in the
wake of the dotcom collapse.
Home Equity Conversion Products

The development of home equity conversion products and
reverse mortgages might also provide benefits to the
economy. India has substantial wealth locked up in illiquid
housing stock. The increasing accumulation of wealth
locked up in illiquid housing stock around the world has
generated interest in new financing instruments that would
enable consumers and investors to tap this source of funds
for more productive usage. Real estate finance has come
up with ingenious instruments that can operationalize this
demand for home equity conversion products. One of
these financial innovations has been the development of
reverse mortgages for those who may have paid off their
regular mortgages and now own the home. In the US and
other developed economies, reverse mortgages enable those
elderly citizens who are house-rich and cash-poor to convert
the equity in their home into either a lump sum amount
or into a regular income stream. Since home equity is
distributed relatively more evenly than financial assets,
tapping this source of funds increases the lifetime
consumption of people who have low incomes, but who
happen to own a house. This tends to ameliorate income
inequality at the expense of wealth. The attractiveness of
these products for large developing countries like India is
great because a large proportion of households are in the
low-income, but home-owning category. From a pure
economic viewpoint, there are welfare and efficiency gains
to be had from loans that tap into home equity and boost
consumption. More complete markets are thus created,
and there is a smoothening of lifetime and inter-generational
consumption through re-injection of locked equity into the
economy.
Reverse Mortgages
In reverse mortgages, once a home owner qualifies, he is
offered a loan either as a stream of regular monthly
instalments, as a lump sum cash amount, or as a line of
credit. Unlike in regular mortgages, where borrowers make
monthly payments, in reverse mortgages it is the lenders
who make monthly payments to the borrowers. All the
monthly instalments and the accumulated interest become
due when the borrower moves, sells his home or dies. The
monthly payouts can be for a fixed term, or, if an insurance
annuity is part of the deal, for as long as the borrower lives.
The monthly payments and the loan amount depend on
the age of the borrower, the market value of the house,

assumptions regarding house appreciation rate in the future,
and the interest rate.
Between 1991 and 2001, the number of households who
own their dwellings rose to 166 million from 130 million.
In the last few years, tax concessions for house building
and significant decline in interest rates have given a fillip
to the housing sector. Increase in life expectancy and the
existence of a large number of households that are wealthy
(through ownership of their homes) but poor in terms of
current income, point to a high potential for home equitybased products in India. The major advantages for borrowers
in a reverse mortgage include: a) no income requirements
for borrowing, b) no payments to the lender as the repayment
of loan is only on maturity, and c) no possibility of owing
more than the value of the home at the time of maturity,
even if the accumulated principal and interest exceed it,
since it is a non-recourse loan.
It is estimated that in most industrialized countries
more than 10 per cent of the total number of households
could take advantage of reverse mortgage loans. However,
the actual market is considerably smaller in comparison
to the size of the potential market. The problems with
reverse mortgages have come from both the demand, as
well as the supply side. On the borrowers side, complications
arise due to: a) the contradiction between the desire to
maximize lifetime consumption and their wish to bequeath
homes to their children, b) uncertainty about future
preferences, costs and benefits, and c) the high level of risk
aversion regarding the primary residence. On the supply
side, the lenders face issues relating to upkeep and
maintenance of the houses, since the borrowers lose equity
in them. Optimal pricing of reverse mortgages is extremely
difficult because they involve a number of uncertainties,
such as future value of houses, life expectancy, and the
usual interest rate risks. The transaction costs, due to the
complex nature of these loans and the institutional and
regulatory complications are also high. These further reduce
the market size. One way of dealing with inter-generational
issues is to develop home equity conversion mortgages for
all households, and not just for the elderly. Inter-generational
contracts and significantly lower loan to value ratios might
mitigate some of the problems.
Equity Participation
Equity financing in housing can help solve a lot of financial
bottlenecks, such as the issue of affordability for younger
households, income enhancement for those who are willing
to forego home equity and diversification of investment
portfolios for lenders. Shared partnerships in housing,
where equity, and, hence, any future appreciation is shared
with the lending institution, reduce the cost of home
112
owning, both in terms of the down-payment, as well as the

monthly instalment, while the borrower/home owner enjoys
the same housing services as he would with a higher equity
in the home. The mistakes made in developed countries
should be taken into account in the contract design and
particular care should be taken to promote an institutional
and regulatory structure that supports a fair pricing
mechanism. In India where a large proportion of housing
wealth sits idle, home equity conversion products would
create a more active housing market.
INFORMATION
AND
RESEARCH
Both serious academic research and informed business

activity will be enhanced by reliable collection of data
relating to housing and commercial real estate. Housing
data, including prices, volumes of existing and new housing
transactions, housing starts, vacancy rates, and household
formation rates, as well as other demographic data,
segmented by metros, states, and at the national level need
to be collected frequently and in a reliable manner by local
and central authorities and disseminated widely. Real estate
commercial data would be more or less the exclusive
domain of the private sector.
Use of IT is Vital
Here India has an opportunity of leapfrogging ahead of
a number of other countries by harnessing its comparative
advantage in information technology. In some of the more
developed countries online databases of different kinds of
real estate (office, retail, and industrial/warehouse) with
data on city-wise vacancy rates, capitalization rates, the
local economic situation, job and household creation help
firms, investors, and businessmen make informed choices.
The Discipline
Links with urban planning and regional economics, on the
one hand, and finance and macroeconomics on the other
would go a long way in a better understanding of the
economy, its monitoring, regulation, management, and
forecasting. It would also promote appraisal and valuation
techniques. In India, provision of housing credit may be
a supply side issue since banks cannot properly evaluate
lending risks in the absence of development of credit and
risk assessment systems, and databases on credit benchmarks
and credit scoring. It is vital to develop these riskmanagement systems on the basis of sound data and
proper, widely available techniques. All these steps will
promote analyses and research that could inform domestic
or foreign investors to evaluate markets and carry out risk
assessment for purposes of property development and
investment. The establishment of the discipline of real

estate economics would help in the dissemination of a
common language of discourse and promote standardized
procedures, both necessary for national market development.
AFFORDABLE HOUSING PROGRAMME

In the Indian context, a countrywide affordable housing
programme is important above all else for reasons of social
justice. However, due to its potential scale, externalities,
and hopefully its entry-level, stepping-stone nature, as
mentioned before in the case of Singapore, the programme
might end up having a sizeable positive impact on the
economy and society. For the urban segment of the
programme, urban planning commensurate with
transportation and labour market needs should be part of
the scheme. In addition to the synergy created by the
interaction of the public and private sectors in the upward
mobility model, other joint publicprivate initiatives,
involving local, state and central governments are required
for proper implementation and promotion of affordable
housing. The joint privatepublicnon-profit organization
initiatives are needed at the local urban level in order to:
promote new zoning ordinances and floor space
indices in such a way that it encourages supply of affordable
housing through an integrated incentive structure for
developers;
encourage a holistic approach that bundles together
new infrastructure projects with affordable housing;
coordinate and to lobby for more funding from state
and central governments, as well as for expansion of tax
credits and subsidies;
link some purely commercial developments with
affordable housing projects by stressing the long-term
benefits to firms; and
modify zoning codes to promote special low cost
affordable high-rises, that can simultaneously tackle issues
of efficient land usage, as well as affordability.
Unlike in the developed countries, where affordable
housing policy deals with both demand and supply side
issues, in the Indian scenario it is primarily a question of
boosting supply, that is, creating new housing. Although
the government needs to play the lead role, the problem,
as everywhere else, has to be attacked by all branches of
local and central governance, and business, and the real
estate community.
SUMMING UP
Real estate markets are fraught with problems of information
asymmetry, moral hazard, liquidity, and heterogeneity.

Market failures are, therefore, common and state
intervention is imperative at many levels to ensure fair
economic outcomes. Our assessment is that the share of
the real estate finance sector, as well as that of the cluster
of real-estate-related industries in Indias GDP is
significantly less than corresponding shares in marketoriented economies. For example, total outstanding
mortgages are on an average about 40 per cent of GDP
for countries of the European Union, the US, and Japan,
whereas it is a relatively new activity in India. The recently
concluded first ever survey of household amenities and
assets by the Census of India has thrown up statistics that
clearly point to the immense potential that the sector
offers for growth. There are only 179 million houses for
192 million families in the country. There is thus a
significant gap of 13 million in availability of dwellings.
The situation is in fact worse since about 10 per cent of
the dwellings are vacant, perhaps because of the archaic
Rent Control Act. Close to 50 per cent of the households
live in non-permanent constructions. About two in every
5 houses are 1-room residences. About one in every 5
houses has a concrete roof and only about a third have
cement floors. About two-thirds of the residences do not
get water at home and just over 50 per cent of houses
have electricity connection (though some of them may not
be receiving any electricity because of the poor state of
the electricity sector!). In short, the assessed gap in
requirement and availability of housing severely
underestimates the real gap if bare minimum standards
for space and amenities are the basis. There is, therefore,
scope and a crying need for action by the government to
improve the situation. Along with appropriate changes in
the laws and the regulatory framework, adequate public
funding for the sector is called for to act as a catalyst for
attracting private capital and management. The value in
exchange for the public resources spent and in terms of
an active PPP would be immense.
In addition to the housing sector, the hotel, retail, and
office real estate sectors are also underdeveloped, relative
to the size of the economy. We, are convinced that the
real estate industry can play the role of a core sector for
decades to come and serve as an engine of growth for the
economy. There are early signs of this already. Housing
activity is witnessing a major boom as a result of low
interest rates and excess liquidity in the economy. The
commercial real estate sector is also booming, partly because
of the expected inflow of business in the software and
business process outsourcing sector, large infrastructure
projects particularly in road and highway construction, and
affordable housing projects such as the Indira Awaas Yojana.
Major new developments are also taking place in mortgage
finance, securitization, and regulations.
Yet, there are a number of critical questions that need

to be answered: a) To what extent are supply of housing
credit and demand for housing constrained by the existing
financial system? b) What are the bottlenecks and rigidities
in the existing institutions, norms, and regulations
surrounding land, construction policy, urban planning, and
infrastructure? c) What are the appropriate and optimal
instruments of mortgage design in the Indian context?
d) How can one unlock the illiquid wealth represented in
Indias stock of owned homes? e) What should be the role
of the public sector in both housing and housing finance
markets? f ) What are the costs and benefits underlying the
implicit guarantee that a government supported mortgage
insurance programme would entail? g) How to provide
individuals and others a way to invest in real estate? and
h) How to go about promoting growth in secondary and
tertiary cities in order to moderate congestion and high
costs in major metros?
Answers from China?

Some answers can be found from scrutiny of practices
elsewhere, learning from mistakes and market failures in
other countries and then designing programmes appropriate
for Indian conditions. Since we have a penchant for
comparisons with China, it is worthwhile to note that
although the real estate industry in that country plays a key
role in the ongoing dynamism displayed by the Chinese
economy, haphazard policies, the lopsided growth-at-anycost approach, and uneven reform in different sectors of
the economy have given rise to serious concerns and
misgivings. Indeed, all the breakneck activity in the real
estate sector, fuelled by rapid, and at times reckless,
expansion of commercial bank lending to the construction
industry is now raising concerns about a real estate bubble,
high vacancy rates and solvency of some banks. Housing
prices have increased by over 5 per cent between the first
and the second quarters of 20034. Together with a number
of other sectors of the Chinese economy, the real estate
industry also faces some structural pitfalls. To begin with,
the financial sector has not kept pace with the overall
economic reform process, and mortgage activity, bank
supervision, credit assessment capabilities, clarification of
property rights, land markets, and privatization in the
housing sector are all in the initial stages of development.
Critical shortcomings of the existing financial system
include underdevelopment of effective financial
institutions, channels, and instruments to support the
housing industry, and the lack of effective operating
mechanisms to guarantee the smooth flow of such financing.
Historically, after the establishment of the Peoples Republic,
4
ISI Emerging Markets Database.
114
housing policy envisaged an all-pervasive role for the

public sector. This sustained a planned system and although
it initially did serve to house large numbers of the urban
population, resulted in restricted housing choices, uneven
quality of construction, and low maintenanceissues that
exist till today. Privatization of housing stock belonging
to the state-owned enterprises and housing bureaus is a
major issue confronting reformers, since it is tied up with
the reform of state enterprises as a whole. As these entities
get restructured they will no longer be primary homebuilders, as well as home providers and landlords, a void
that will have to be filled by the private sector5. In India,
the relatively more organic growth of both the real estate
sector and the financial sector, democratic and participatory

processes of urban planning, and a long history of public
and private activity in and ownership of real estate bode
well for sound future development and a sustained PPP
for value creation.
We have attempted to answer some of the questions
posed above by suggesting development of institutions and
markets for home equity conversion products and real
estate investment trusts among other reforms and measures.
We believe the whole gamut of policies can lead to significant
enhancement of overall welfare, increase geographical
mobility, reduce regional disparities, increase efficiency,
and give a boost to the economy.
5.3 A PPP FRAMEWORK IN EDUCATION

Sanjay Agrawal
The Government of India and several state governments
are increasingly looking to PPPs as the mechanism for
implementation of projects and programmes across various
infrastructure sectors including education. Many more
new/refurbished schools are required urgently throughout
the country, to meet the increase in demand. The objectives
sought to be achieved could be the improvement in quality
of education, improvement in infrastructure or better
value for the money spent by the government. PPP could
play a crucial role in opening up a large pool of sustainable
financial resources and bring in private sector innovation
and efficiencies into design, implementation, and
management of education infrastructure and at the same
time ease fiscal pressures of governments.
PROJECTS
IN THE
EDUCATION SECTOR
The types of projects, which could be taken up for development under a PPP framework, could include the following:
1. Construction of new schools and handing over
of entire school operations/maintenance under a BOT
concession, under which the concessionaire would be free
to recruit its own teaching and non-teaching staff and
implement its own O&M plan for the school. This would
cover the methodology of educational instruction, cocurricular activities, and so on. The curriculum would be
as specified by the government from time to time. However,
the following conditions could be stipulated:
5
Thus, in another example of a positive externality, housing

reform will improve the stability of Chinas ailing banking system by
making state-owned enterprises more profitable.
admissions only from a pre-determined area;

government fee would be charged;
level of Government funding would be as per scale
for other government schools.
2. Handing over entire school operations/maintenance
of newly constructed schools under ROMT/OMT (Renovate
Operate Maintain and Transfer/Operate Maintain and
Transfer) concessions.
3. Upgradation and modernization of existing schools
(either with or without transfer of teaching/non-teaching
staff under OMT Concessions.
4. Upgradation of quality of education under
management contracts.
5. Outsourcing of servicesmidday meal scheme,
IT services, housekeeping services, building/facilities
maintenance, teaching services (general/specialized).
6. Extending standards to learning targets/ education
performance which could be assessed by surveys (for
example; measuring improvement in attitudes to using
technology in learning), attendance levels, educational
attainment, including performance of students at national
level tests for example, Class 10/Class 12 examination. It
could also be done by independent third party evaluation
of a students performance on the basis of surprise tests.
However, education outcomes have the bearing on factors
like quality of teaching, management of the school, and
the nature of the schools intake. Therefore, the
concessionaires risk relating to education outcomes should
be proportionate to the influence he could have on the
above factors.
Producing an effective output specification involves the
art of defining the end without specifying the means. This

remains a fundamental challenge. The option of subsidizing
purely private schools and educational institutions, and
hoping that tests student performance and reputational
effects alone would suffice has proven problematic.
Therefore, a more direct role of the state in education
becomes necessary in most contexts. (Editors Note)
STANDARDS MEASURING LEVEL

PERFORMANCE
OF
EDUCATIONAL
Standards measurement has never been easy, education

being an experience good. Nevertheless, standards
measurement would have to:
reflect the actual requirement of school users;
be clear, concise, and unambiguous;
give the potential bidders sufficient information to
decide and cost the facilities and services they will offer;
take account of the need for compliance with legal
or other statutory requirements and policies;
specify any constraints, which are essential to defining
a deliverable. They should be distinguished between
mandatory and other constraints;
identify those service areas which are critical to the
availability and performance of the school and which,
therefore, will be given most weight in the payment structure
and performance monitoring.
The range of high-level outputs required in a schools PPP
project, would typically cover some or all of the following:
demolition/redevelopment of existing buildings;
provision of new/altered forms of access to the
school (for example, roads, disabled access);
provision of school playing fields, sports halls, car
park, or other external facilities;
maintenance and service standards for building,
installations and related assets, grounds and recreational
facilities, furniture, and equipment;
energy management;
cleaning and waste management service;

care taking/site supervisory services;
security and safety;
catering, including provision of midday meals;
information technology requirements.
Other support activities, which could also be delivered

under these frameworks, could include:
pupil transport;
reception and administration services;
printing, photocopying, and stationery services;
examination administration;
library services; and
other specific technical support services.
PAYMENT MECHANISMS
A variety of payment mechanisms could be used across
different project types in the education sector based on
the following principal parameters:
availability of services;
performance standards; and
usage.
These could be structured as:

fixed periodical payments depending upon the capital
costs incurred for creating school assets and facilities and
cost of subsequent O&M;
payments based upon performance against availability,
usage, and education performance targets;
fixed payments per student depending upon the
targets achieved;
fixed lump sum periodical payment plus fixed
payment per student.
The PPP approach can go a long way in developing
education infrastructure in the country. However, political
commitment would be the key in programme implementation.
5.4 PPP FRAMEWORKS FOR TOURISM INFRASTRUCTURE: USING

THE ROMT CONCESSION
Ashvini Parashar and Cherian Thomas
Most state governments, have made investments for the
development of hospitality infrastructure both for the use
of its officials as well as for the general public. These
include rest houses and inspection bungalows (managed
usually by the Public Works Departments), guesthouses,
Yatri Niwases, and hotels (usually managed by the state level
tourism development corporations, and which are more

up-market properties). Since these facilities have been
created either for use by employees or as low cost alternatives
for tourists, the user fees recovered are inadequate to cover
operating costs let alone service capital investments.
Moreover, their management departmentally leaves much
116
to be desired in terms of the quality of service, so that in

their present status, high charges or rentals
would not
be feasible. Very high costs emanating from inefficiencies
in management are an additional aspect. With increasing
fiscal pressures on state governments over the last few
years, the subsidies required for the sustainable O&M of
these properties have been declining steeply, as a result of
which many of these are in a poor state of maintenance
and need significant repair and upgradation work. These
factors coupled with inadequate managerial skills and
increased competition from private hotel operators have
led to a general decline in the utility of most such facilities.
Interestingly many of these properties are in places
of tourist interest or prime urban locations. Several
governments are, therefore, looking at options to unlock
the commercial value of these properties without changing
the purpose for which these were constructed in the first
place. For larger properties owned/operated by the India
Tourism Development Corporation (ITDC), the Government
of India has proceeded with the divestment option. Some
of the state governments have given out properties on
leases or management contracts. The process, however, has
not been without its share of controversies and scrutiny
by the industry, academia, and media. In case of divestment,
the major controversieshave centred around the valuation
of the properties/underlying business. In particular, the
case of Hotel Centaur in Mumbai where the original buyer
(the successful bidder) paid Rs 83 crore to the government,
but within a period of 4 months sold it to another private
investor for Rs 115 crore, a return on investment of 38.5
per cent attracted considerable media attention. While
leasing is a less complex alternative, for certain reasons,
several state governments find it difficult to offer
mortgageable rights on properties under a lease, without
which debt financing becomes difficult to achieve.
properties and has been successfully used for hotels in

Karnataka and PWD rest houses in Kerala.
THE ROMT OPTION
SELECTION
It is in this context that the ROMT concession structure

was developed by iDeCK for giving out such properties
to private investors, while meeting the objectives of all
stakeholders. For the government it ensures that the property
gets re-developed/renovated to a pre-specified standard, is
sustainably operated and maintained, meets the needs of
users and unlocks commercial value in that concession
payments are made over the period of the concession,
without any transfer of title interest in the property. The
private investor obtains exclusive rights to commercially
exploit the property for a pre-specified period. Lenders
rights are recognized under the concession. Lenders can
also substitute the concessionaire in the event of financial
default. The structure is particularly suitable for smaller
An open, competitive, 2-stage bidding process, comprising

qualification and proposal stages was used to select the
private investor. Quantifiable and objective qualification
criteria relating to experience and financial capability were
used to qualify interested parties. To improve competition,
consortia comprising an experienced hotel operator and
a financially capable investor were also deemed eligible to
participate in the bidding. In order to generate investor
interest, iDeCK embarked on an active process of
marketingthrough letters, e-mails, telephonic discussions
and visits to potential investors in order to encourage them
to participate in the bidding process.
A combination of technical and financial parameters
were used to evaluate the proposals. Objective technical
DEVELOPMENT PROCESS
In developing the project it was ab initio agreed with the
governments that the basic objective in development of
these properties would be to offer better facilities to users
since tourism development was the original purpose for
their creation in the first place. The properties would,
therefore, have to be developed only as hotels. As a natural
corollary, it was considered appropriate to evaluate the
value of the properties and the likely returns to the
government through the process of selection of the private
investor through a competitive bidding process on the
basis of their underlying business potential as hotels. This
approach circumvented a major obstacle encountered earlier
in the valuation of properties which was simply based on
the perceived real estate value of these properties as a
result of which returns expected by the governments were
unrealistic and led to lack of success in bidding them out.
The period of concession offered was arrived at after a
limited market study that was undertaken for this purpose.
iDeCK developed a proxy financial model, taking into
account considerations of a potential investor. This
incorporated assumptions regarding operating parameters,
revenues, and O&M costs, as well as the upfront cost of
renovation and re-development. Based on the targeted
equity return expectations, the possible payments that
could be made to the government out of the projected cash
flows were estimated. This was translated into an upfront
and annual fixed payment to be stipulated in the bidding
documents as mandatory payments by all bidders, with
variable payments to be quoted by each bidder then being
stipulated as the main bid evaluation parameter.
OF THE
PRIVATE INVESTOR

criteria (proposed upgradation level, star category, minimum
concession period quoted, bidder status6, etc.) were used,
with the scoring pattern for these being clearly defined
in the request for proposal (RFP) document. Since the
properties were small and with time the number of those
offered would increase significantly, a simple financial
parameter was developedpayments were offered, rather
than any profit/revenue linked parameter, the monitoring
of which would otherwise, require a high degree of
administrative effort. The payment structure design
incorporates a certain mandatory minimum level of upfront
and fixed payments (set out in the bidding document) over
and above which the bidder has to quote a variable payment.
The present value of payments offered, with the discount
factor set out upfront was used as the financial evaluation
parameter.
Features of the Concession

A draft concession agreement was circulated to bidders as
part of the RFP document. As a result, all issues were
clarified at the pre-bid meetings, with little or no
negotiations after selection of the concessionaire. The key
features of the concession structure are set out below:
The concession (and, therefore, the concession
agreement) would be for a duration of 20 to 30 years,
depending on the minimum selected concession period
thrown up by the bidding process.
The concessionaire would have to implement the project
and make available the facilities undertaken to be provided
in the bid, within a stipulated period from the date of
signing the concession agreement. For this, the investor
would have to submit appropriate performance security.
The concessionaire would be at liberty to add new
facilities and construct additional rooms as deemed fit,
subject to adherence to applicable laws and obtaining
applicable statutory permissions. Where warranted, he
could demolish the old construction, carry out new
construction, and renovate the existing building structures,
subject to obtaining applicable statutory permissions.
However, prior to carrying out any demolition, written
permission of the government would need to be obtained,
which permission would not be unreasonably withheld.
The concession payments that is, the sum of the fixed
payment and variable payment would have to be made in
advance annually, on the anniversary of signing of the
concession agreement7. In the case of the Kerala PWD
6
For the properties in Kerala, proposals from non-resident

Keralites were given a small additional weightage.
7 If the selected concession period is 28 years, then 28 annual
payments would be made by the concessionaire. The first annual
payment would be made at the time of the signing of the concession
agreement and the last concession payment would be made at the
beginning of the 28th year.
properties, the concessionaire would have to provide a

pre-specified number of rooms, redeveloped to specified
standards, for use by persons authorized by PWD, during
the concession period. The concessionaire would not be
entitled to collect room rent/tariffs from such users.
However, the occupants would have to pay for all other
services and facilities used by them at the normal
rates prescribed by the concessionaire. According to the
terms the concession, lenders have the right to substitute
an erring concessionaire in consultation with the
government.
At the end of the concession period the redeveloped
property would be handed back to the government. The
government would have the option of either renewing the
concession on mutually agreed terms or rebidding the
concession. Since there is no transfer of land or structures
to the private investor under the concession, the real estate
value would continue to remain at all times with the
government.
RESULTS
So far 4 rounds of bidding for 31 properties have been
concluded. Valid bids have been received for 18 of these
and concession agreements have already been signed for
7 properties, which are in an advanced stage of renovation.
This includes a partially constructed beach side property
at Malpe in Karnataka, the construction of which was held
up for nearly 2 decades. A summary of the outcomes is
set out in the Table 5.4.1.
Since the properties offered in each round are a mix
of good and bad (from the point of view of location and
commercial attractiveness), bids have not come in for
some of them. Further, in some cases, bidders have found
the level of fixed payments a little high. All in all, though,
the ROMT concession structure appears to have been well
understood and accepted by the market, with increased
responses at each new round of bidding. The entire process
can be completed in a matter of 45 months depending
on the speed of response of the government at various
stages.
For governments, the ROMT concession structure has
opened up a new mechanism for developing tourism
infrastructure while at the same time providing some
financial returns. In Karnataka, the upfront payments are
being set apart in a dedicated fund to be utilized for
funding a voluntary retirement scheme. Around 50 more
properties in Karnataka, Kerala, and Uttaranchal are now
on the anvil and would be on offer soon. Most importantly,
however, this structure would help utlilize and sweat
government assets productively, which otherwise would
only fall into progressive disuse and deterioration.
118

Table 5.4.1
Summary of Outcomes Post-ROMT Concessions in Tourism
Government agency
Properties
No. of
applications
received
No. of
qualifying
applicants
Properties
for which
valid bids
received
Department of Tourism, Karnataka
2 heritage hotels
in Karnataka
12
Public Works Department,

Government of Kerala
9 PWD rest
houses across
the state
20
Karnataka State Tourism

Development Corporation
Karnataka State Tourism
Development Corporation
8 properties at
various locations
12 properties at
various locations
21
14
36
29
Status
Government decided to give

properties to a state-owned
undertaking.
Concession agreements
signed for 3 rest houses.
One bidder for 3 properties
backed out resulting in
forfeiture of bid security.
Concession agreements
signed for 4 hotels.
Process concluded.
Concession agreements to be signed.
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120
FINANCIAL AND LEGAL PERSPECTIVES
6.1 DEVELOPMENT FINANCIAL INSTITUTIONS AND THE DEVELOPMENT

OF FINANCIAL MARKETS
Jayanth R. Varma
During the 25 years after World War II, over 300
development financial institutions (DFIs) were established
worldwide whereas less than a dozen such institutions had
existed at the beginning of this period (Roberts 1971).
These 25 years were also the period of fixed exchange rates
and repressed financial markets in most developing countries.
Since then there has been a wave of financial liberalization
that has brought financial markets to centre stage. In India,
financial markets were liberalized from the mid-1980s
onward.
What does financial liberalization mean for the DFIs?
This paper argues that it means a redefinition of their
mission and nature of operations. During the era of financial
repression, the developmental role of these institutions
consisted in mobilizing large amounts of capital and
deploying them in direct funding of industrial enterprises.
In an era of financial deregulation, the developmental role
is very differentdevelopment of markets and market
institutions, innovation of new products and securities, and
using relatively small amounts of capital to intermediate
and support much larger capital flows through the markets.
Thus there is a role for a DFI in an era of financial
deregulation, but it is a very different role from its past role.
Not all DFIs can cope with these traumatic changes in
mission and emerge as free market DFIs. Some may not
survive at all and some may cease to be DFIs.
The free market DFIs, whether newly created or created
by the transformation of older DFIs, must confront a number
of difficult questions about management and governance.
Old performance measures like loan disbursements, profits
and contribution to priority sectors are meaningless and
irrelevant. New measures are needed that will define the

developmental role that they have played.
DFIS
IN A
LIBERALIZED FINANCIAL SECTOR
Collapse of the Old Model

The regime in which DFIs flourished worldwide was
characterized by financial repression in the words of
McKinnonShaw (McKinnon 1973; Shaw 1973). In this
regime, interest rates are administered and pegged at
unrealistically low levels. With interest rates kept out of the
purview of market forces, financial markets are unable to
perform the important function of allocating resources
efficiently to the most productive sectors of the economy.
Instead this task falls to the state and bodies sponsored by
the state. The state pre-empts resources from the financial
system either to itself or to DFIs and similar entities chosen
by it to perform the resource allocation function. When
interest rates are set too low, it may also be necessary to
implement some form of forced saving to ensure that
aggregate savings in the economy does not collapse.
The theory underlying financial repression is that in the
formative stages, the cost of capital to industrial undertakings
must be subsidized to allow them to establish themselves.
This argument for providing an interest rate subsidy is very
similar to the infant industry argument that is often used
to justify tariff protection.
It is evident that in a regime of financial repression, DFIs
played a pivotal role as they were the principal resource
allocation mechanism in a financial sector which has been
Financial and Legal Perspectives

more or less insulated from market forces. DFIs enjoyed
preferential access to cheap capital from the government,
the central bank, or from the banking system. In India, for
example, the DFIs received cheap funds from the central
bank through its Long Term Operations (LTO) funds and
from the banking system (by issue of government-guaranteed
bonds that were eligible for the Statutory Liquidity Ratio).
In Brazil, the money came from pension funds and worker
support funds. In Korea, it came from the exclusive privilege
of issuing Industrial Finance Bonds. In most countries, the
borrowings of the DFIs were guaranteed by the government.
Economic reforms tend to eliminate financial repression
and restore the resources allocation function to the financial
markets. This threatens to deprive the development financial
institutions of their access to this cheap funding and force
them to raise resources at market rates of interest. In India,
the access to cheap funds has been removed completely. In
some other countries, cheap funds have become a smaller
proportion of the total balance sheet. When this happens,
the DFIs lose their cost advantage and are exposed to
competition from other more efficient intermediaries.
In India, the impact of these forces has been more severe
than in many other countries and many DFIs have been
pushed to the brink of bankruptcy. A similar phenomenon
can be observed in Japan where institutions like the Long
Term Credit Bank of Japan (LTCB) and Industrial Bank of
Japan (IBJ) were financially crippled in the 1990s. Around
the world, we find that financial liberalization removes
many of the privileges that makes DFIs viable. Unless they
can find new business models, they are unlikely to survive.
Those DFIs that are financed by direct government
support or enjoy explicit government guarantees (like KfW
in Germany or BNDES in Brazil) are less affected by these
changes, but for private sector DFIs or quasi-public DFIs
that are expected to be run on commercial lines, financial
liberalization is often like the kiss of death.
Old Roles Become Irrelevant

The traditional DFI performed several critical functions
that have become irrelevant with financial deregulation:
Traditional roles
DFIs were the principal
source of long-term finance
for industry. In an
underdeveloped and
repressed financial sector,
most financial instruments
tend to be short-term.
Indeed, in a repressed
economy, it makes little
sense for investors to lend
Impact of deregulation
With the end of financial
repression, bond markets
become more sophisticated.
At the same time, improved
asset-liability management
and advanced hedging
techniques enable commercial
banks to lend longer term.
Contd.
121
Contd.
Traditional roles
Impact of deregulation
long term. DFIs used their

cheap sources of capital to
fill this gap.
In a skill scarce financial
sector, DFIs constitute an
island of expertise in project
appraisal and credit
assessment.
Skills become more widely

available and DFIs are
typically unable to retain
their own talent. Moreover,
after decades of monopolistic
existence, the DFIs appraisal
methods become ritualized
and increasingly out of tune
with the ground realities of a
liberalized economy.
In an economy where the

price mechanism was not
sufficiently well developed to
signal demand supply gaps
and the need for capacity
creation, DFI lending to an
enterprise signalled to the
rest of the financial sector
that the enterprises business
plans fitted well into the
governments industrial
strategy (Stiglitz and Uy
1996).
With the diminishing role of

the state in planning and
directing economic activity
there is greater reliance on
the price mechanism for
resource allocation. The
signalling role of DFI lending
is almost completely lost.
Moreover, in the decadent
stages of the command
economy, DFI support for a
business enterprise becomes a
manifestation of crony
capitalism rather than of
government industrial policy.
But DFIs Have New Roles to Perform

While many of the old roles of the DFIs have become
irrelevant, that does not mean that DFIs have no role at all
to perform. Financial markets and non-DFI intermediaries
may perform most of the funding roles that DFIs used to
perform, but several developmental tasks remain and DFIs
are uniquely suited to perform them.
Development of financial markets, particularly bond
markets is an important developmental role that DFIs need
to play. Deregulation does not create markets. There is a
need for a variety of institutions and processes to support
the development of the markets. DFIs could play a major
role in this. In India, DFIs have sponsored the creation of
credit rating agencies, venture capital funds, mutual funds,
stock exchanges, and a number of other institutions that are
critical for the functioning of a modern financial sector.
In some cases, the development of new markets is
facilitated by the presence of institutions that assume residual
credit risk to make these products acceptable in the initial
stages. The role of state-sponsored agencies in developing
the mortgage backed securities (MBS) market in the US is
122
a good example. The role of Kreditstalt fur Wiederaufbau

(KfW) in the proposed large securitization of bank loans in
Germany could well turn out to be another example. The
amount of capital allocated by these institutions to the
intermediation and support of these markets could be quite
small in relation to the total amount of capital flow that
is enabled by such support.
The process of deregulation could create financing
gaps for certain kinds of firms in certain sectors (Cieply
2001). There is scope for DFIs to create new financial
products that fill these gaps.
DFIs could use their strategic stakes in many
companies as instruments for improving corporate
governance. Over time, a deregulated financial sector would
lead to the emergence of a large base of institutional investors
who could take over this role, but in the initial period, DFIs
may be the only significant institutional investors. In India,
the DFIs were in this position at the beginning of the
1990s, but for a variety of political and institutional reasons,
they failed to perform this function. DFIs could also use
their financial clout to improve governance practices of
sub-sovereign governments and governmental agencies in
much the same way as supra-national lenders use
conditionalities to influence the policies of sovereign
governments.
The process of deregulation creates the need for new
regulations and policy frameworks. In this regard, the DFI
as a market participant with a developmental role is
uniquely placed to act as a think tank or sounding board
for the government. During the process of liberalization,
the entire policy framework needs to be revamped. While
governments tend to lack the market expertise essential for
sensible policies and regulations, they also quite rightly
regard market participants as interested parties whose
suggestions could be biased. DFIs which combine market
expertise with a developmental objective could provide a
useful source of relatively unbiased advice on policy
formulation to the government. Needless to say, no market
participant (not even a fully government-owned DFI) can
be completely unbiased on all aspects of the financial
sector.
ALTERNATIVE STRATEGIES
FOR
EXISTING DFIS
This section discusses in detail 5 different strategies for

existing DFIs during the process of deregulation:
Folding into the State: Some institutions that started out
as some form of DFIs have ended up becoming arms of the
state as their role was gradually transformed from one of
financing to regulation. Many central banks (including the
Bank of England) started out as ordinary financial
institutions, but were folded into the state.
At one point, it appeared that in India, the Industrial

Development Bank of India (IDBI) was headed in this
direction as the central bank transferred many of its regulatory
functions in the field of financial markets to the IDBI. But
this transformation did not take place and it appears likely
that IDBI would now be converted into an ordinary financial
institution.
Transformation into Ordinary Financial Institutions: Some
institutions may well be turned into regular financial
institutions without any explicit developmental role. (For
public sector institutions, this could be preceded by
privatization.) In India, the transformation of ICICI from
a DFI into a bank is a good example of this process of
turning a DFI into an ordinary financial institution.
Insolvency and/or Liquidation: In some cases, the DFI
may simply be wound up on the ground that it has outlived
its utility. In practice, this rarely happens without the
institution having been first become nearly bankrupt. The
case of IFCI in India is probably illustrative of the dynamics
involved.
Transformation into Free Market DFIs: Finally, a few DFIs
may actually transform themselves into institutions capable
of playing a developmental role even in a deregulated
environment. By redefining their mission and reorienting
their operations, they reinvent themselves as innovators,
market developers, and market facilitators. Globally, a
handful of DFIs are attempting this transformation, but
nowhere is the transformation complete and it is too early
to say to what extent these attempts would be successful.
Several of these examples are discussed in the next
section.
Determinants of Successful Transformation

It is evident that some DFIs have achieved the transformation
better than others. It is possible that state ownership does
make a difference to the speed and thoroughness of the
transformation. It is also possible that a DFI with a wide
scope of operations would be able to make the transformation
better and faster than a DFI with narrowly circumscribed
ambit of operations. To explore these questions, we take a
look at a number of large DFIs from around the world and
analyse how they have coped with the process of financial
deregulation.
Fannie Mae and Freddie Mac (United States): The Federal
National Mortgage Association (FNMA or Fannie Mae) was
established in 1938 as a government corporation under
depression era legislation. Fannie Mae was partly privatized
in 1954 and fully privatized in 1968. The Federal Home
Loan Mortgage Corporation (FHLMC or Freddie Mac) was

charted as private corporation in 1970. Under their respective
charter acts, the purpose of these two enterprises is to
establish a secondary market for residential mortgages
financed by private capital to the maximum extent possible.
The main functions of these Government Sponsored
Enterprises (GSEs) are to provide stability in the secondary
market for residential mortgages; respond appropriately to
the private capital market; increase the liquidity of mortgage
investments and improve the distribution of investment
capital available for financing residential mortgages (Federal
National Mortgage Association Charter Act 12 USC 1716,
Section 301 and Federal Home Loan Mortgage Corporation
Act, 12 USC Note to 1451, Section 301). Fannie Mae and
Freddie Mac are interesting examples of:
the evolution of free-market DFIs in the 1980s and

their degeneration into old style DFIs in the 1990s.
Though neither Fannie Mae nor Freddie Mac invented

the securitization of mortgage loans, Freddie Mac embraced
the concept aggressively in the early 1980s and Fannie Mae
followed soon thereafter. Instead of issuing debt to buy
mortgage loans, the two GSEs repackaged the mortgage
loans as mortgage-backed securities. In the process, they
helped make the US housing finance market one of the
most efficient in the world. By 1991, the 2 GSEs put
together had outstanding mortgage-backed securities
amounting to 435 per cent of their regular debt (Office of
Federal Housing Enterprise Oversight, 2003 Table 24). They
had very popular swap programmes under which a lender
instead of selling the mortgage loan for cash to the 2 agencies
swapped the loans for mortgage backed securities that they
could sell in the market whenever they liked. At this stage,
the two probably represented well-functioning free-market
DFIs. They were performing an important market
development role as opposed to a funding role.
However, Fannie Mae and Freddie Mac succeeded too
well in developing these markets and faced increasing
competition. Private securitization conduits initially
concentrated on jumbo mortgages whose amounts exceeded
what Fannie Mae and Freddie Mac could purchase by law.
But soon they extended their activities to sub-prime
borrowers, home equity loans and to loans with
documentation that did not meet the GSEs standards. All
of these were fast-growing markets while the agencies
operated in a mature slow-growing market. In response to
this competitive situation, the GSEs adopted a strategy that
has slowly transformed them back to old style DFIs. As their
regulator stated in its annual report:
in the early 1990s Fannie Mae and Freddie Mac began
increasing their on-balance sheet assets, primarily by buying
MBS and REMICs. Buying mortgage assets allows the
Enterprises to take full advantage of their low funding
123
costs. This has facilitated increases in their earnings at

double-digit rates despite less rapid growth in non-jumbo
conventional mortgage debt outstanding, and it has added
stability to the mortgage securities market in times of
otherwise weak demand. (Office of Federal Housing
Enterprise Oversight, 2003)
This is a classical old style DFI strategy: make use of

cheap funds provided by government support to build a
large balance sheet and make money off the interest spread.
Though Freddie Mac and Fannie Mae do not enjoy
government guarantees, they do enjoy an implicit support
of the government and their credit rating is based strongly
on this support. For example, one rating agency stated:
Central to Fitchs ratings assessment of Freddie Macs senior
debt and short-term ratings is its U.S. Government charter
and GSE status, exceptionally strong operating platform,
and leading position within the domestic housing finance
system. Fitch expects the U.S Governments commitment
to the residential housing system to remain intact and
within the existing GSE structure. (Fitch Ratings, 2003)
The example of Fannie Mae and Freddie Mac show that

successful free market DFIs need to reinvent themselves
continuously. Markets that needed developmental efforts in
the 1980s had become quite mature by the 1990s and a
mission focused on developing these mature markets became
quite meaningless. They needed to undergo a second
transformation to remain relevant. This they failed to do,
and the pressures of profitability saw them relapse into old
style DFIs. At the end of 2002, the outstanding mortgagebacked securities of the 2 GSEs amounted to only 118 per
cent of their regular debt as compared to 435 per cent in
1991 (Office of Federal Housing Enterprise Oversight, 2003
Table 24).
KDB (Korea): The Korea Development Bank (KDB) was
established in 1953, and its purpose was stated to be to
furnish and administer funds for the financing of major
industrial projects in order to expedite industrial development
and expansion of the national economy (Korea Development
Bank Act, Article 1). It is wholly owned by the government
(Article 4). Unlike some other DFIs, KDB has a very wide
remit including providing working capital to assisted units,
investing in stocks and bonds, engaging in foreign exchange
business and providing economic and technical consultancy
services (Article 18).
The government does not provide a blanket guarantee
of all obligations of KDB and the financial statements show
that only a relatively small percentage of its borrowings have
been guaranteed by the government. However, the
government is legally obligated to offset any deficit that
arises if KDBs reserves are insufficient to cover its annual
net losses (Article 44). Though this kind of legal provision
is often described as a deficiency guarantee, it is not in fact
124
a guarantee and does not provide legal remedies to the

creditor to ensure timely payment. However, globally, KDB
is regarded as a sovereign proxy borrower and is rated at the
same level as the government itself. Apart from bond issues
made during the Asian Crisis, the Republic of Korea itself
has generally not borrowed in international markets.
Taking advantage of its wide legal mandate and the
structural changes in the Korean economy after the Asian
Crisis of 1997, KDB has charted out a course radically
different from that of old style DFIs. Its vision statement
(KDB 2003) is worth quoting in full:
Banking in the 21st Century will be as informationintensive and vital to national competitiveness as any hitech industry.
In this era of global competition, to continue its locomotive
role in national industry development and to lead Korea
financial industry in globalization, we have articulated our
vision to become a world-class investment bank.
Having overcome the most turbulent period in Koreas
recent economic history, we are clear as to the direction
we should take and feel more confident of our ability to
get there on schedule.
Specifically, we envision a world-class investment bank
that
Leads the Korean financial industry in globalization

Practices a universal banking system
Supports the strategic industries of the 21st Century
Plays a leadership role in international finance
Develops and supports North Korea-related investment.
This is not the mission statement of an old style DFI at

all. While the goal of national industry development is
present, the emphasis is strongly free-market-oriented and
also extends far beyond national boundaries.
KDB defines its four core business areas as corporate
finance, emphasizing Relationship Banking, investment
finance, international finance, corporate restructuring and
consulting (KDB 2002). The Governor of the KDB says,
Having laid a solid financial foundation through our recent
restructuring efforts, we intend to consolidate our position
as Koreas leading corporate and investment bank and extend
our reputation beyond domestic borders.
KDB topped the league table for loan arranging and
syndicating international loans in Korea; was the second
largest underwriter of domestic Korean bonds with a 12.7
per cent market share; and was the largest player in the
Korean derivatives market with a 19 per cent market share
(KDB 2002). KDB has progressively shifted its asset
allocation from loans to stocks and bonds which in 2002
accounted for 38 per cent of assets.
Once again, we see a DFI attempting to transform itself
in response to the forces of financial deregulation. It is too
early to say whether this experiment will succeed. At least
some part of KDBs success in recent years is due to the power
of a strong balance sheet (and implicit government guarantee)

during the process of recovery from a financial crisis.
BNDES (Brazil): Banco Nacional de Desenvolvimento
Econmico e Social (BNDES) or the National Bank for the
Economic and Social Development was set up in 1952 as
an independent federal body under a separate statute. In
1971, it was converted into a government-owned company.
Under Brazilian law, as a company wholly owned by the
Federal Government, BNDES is not subject to bankruptcy
and the government is jointly liable for the Banks liabilities
(BNDES 2002). BNDES receives a large fraction of its
funds from the Employee Pension Funds and Worker Support
Funds at concessional rates of interest. It is thus an old style
DFI in every respect.
However, towards the end of 2000, the President of
Brazil set forth Vision 2005a strategic plan for BNDES
for 20005. Under this plan, BNDES had 3 main objectives
(BNDES 2001): (a) the modernization of the Brazilian
economy; (b) the social development of the country; and
(c) the strengthening of the domestic capital market. From
the viewpoint of this paper the last of these is on the role
of DFIs in a deregulated financial sector, most interesting.
What was envisaged under this objective were the
following:
Extend BNDESs collaboration with other institutions,
particularly with multilateral development agencies;
Foster the emergence of new private-sector players in
BNDESs areas of activity; and
Encourage the spread of share ownership and the
recognition of minority shareholder rights.
In this context, it must be mentioned that one of BNDESs
major tasks has been to handle the privatization programme
of the Brazilian government. Initially, BNDES started by
privatizing enterprises owned by itself. In many of these
cases, BNDES had become a shareholder due to nonpayment of loans. Subsequently, because of its experience,
BNDES was appointed the agent of the government for its
privatization programme (BNDES 2002). This was a very
large activity. The cumulative amount of privatizations from
1991 to 2001 was US$103 billion.
Though BNDES remains an old style DFI, the
implementation of Vision 2005 could see BNDES move in
the direction of a free market DFI.
KfW (Germany): The Kreditanstalt fur Wiederaufbau
(KfW) was established in1948 with two principal functions
(Law Concerning the Kreditanstalt fur Wiederaufbau,
Articles 2):
Within Germany, it was mandated to grant loans and
guarantees in so far as other credit institutions are unable

to raise the necessary funds for projects serving the promotion
of the German economy. It was also mandated to provide
export finance and guarantees.
In foreign countries, it was mandated to finance
projects linked with developmental aid as well as other
projects that are of governmental or economic importance
to Germany.
KfW was allowed to undertake other activities like
securities trading only in so far as such business is connected
with its main mission. It is forbidden to undertake
commercial banking activities like deposit-taking and current
accounts. KfWs financing is normally limited to medium
or long-term finance extended through refinancing other
credit institutions, and only in exceptional cases is direct
credit or short-term finance contemplated (Article 3).
KfW is entirely owned by federal and state governments
(Article 1) and its obligations are unconditionally guaranteed
by the German government (Article 1A). This legal
framework makes KfW virtually an arm of the state and
appears to confine it almost completely to the role of an
old style DFI. Yet over the years, KfW has ended up
becoming something completely different. It has developed
a large securitization business: securitization was 14 per
cent of its total investment promotion activity in 2000, it
had risen to 43 per cent in 2002 (KfW 2002). It has also
been actively developing private equity and other equity
market instruments for small and medium enterprises, and
now provides financing for acquisitions, spinoffs, mergers,
and leveraged buyouts. In 2003, KfW joined hands with
several other German banks to securitize the loans portfolios
of these banks (KfW 2003). This is partly designed to
improve the capital adequacy of the banks. Clearly, KfW
is becoming more of a capital markets intermediary than
an old style DFI.
Regulatory initiatives from the European Commission
may complicate this transformation. The European
Commission has taken the stand that the government
guarantees to German public banks and special credit
institutions like KfW is anti-competitive and violates the
state aid rules of the European Community. In 2002,
Germany arrived at an agreement with the European
Commission on this issue. Under this agreement, institutions
like KfW can receive government guarantees only to the
extent they perform well defined public tasks and social
responsibilities that conform to the state aid rules of the
European Community. All commercial activities have to be
discontinued or isolated by forming a separate legal entity
that does not receive government guarantee. (Moser, Pesarasi,
and Soukoup 2002).
The transformation of KfW is clearly a work in progress.
Nevertheless, it indicates that neither public ownership nor
125
rigid legal restrictions need be barriers to a transformation

of DFIs.
IDBI and IFCI (India): The Industrial Finance Corporation
of India (IFCI) was set up as a statutory corporation in 1948
under its own statute for the purpose of making medium
and long-term credits more readily available to industrial
concerns in India, particularly in circumstances where normal
banking accommodation is inappropriate or recourse to
capital issue methods is impracticable (IFCI Act, preamble).
The IDBI was established in 1964 as a statutory corporation
under its own statute for providing credit and other facilities
for the development of industry (IDBI Act, preamble).
Apart from the stipulation that restricted them to industrial
concerns, the two DFIs were permitted by law to undertake
a broad range of businesses including underwriting and
purchase of securities and consultancy services.
The 2 DFIs had access to cheap funds from the banking
system (by issue of government guaranteed bonds) and from
the central bank (Long Term Operations (LTO) funds of
the Reserve Bank of India (RBI). Commercial banks in
India were required to invest a large fraction (well over a
third at the peak) of their deposits in government and
government-guaranteed securities as part of a Statutory
Liquidity Ratio (SLR) requirement. Since the bonds of the
DFIs were eligible SLR securities, the DFIs had access to
the cheap funds pre-empted from the banking system.
Economic reforms deprived the development financial
institutions of their access to cheap funding via the statutory
pre-emptions from the banking system. They were forced
to raise resources at market rates of interest. Concomitantly,
the subsidized rates at which they used to lend to industry
gave way to market-driven rates that reflected the institutions
cost of funds as well as an appropriate credit spread. In the
process, institutions have been exposed to competition from
the banks that are able to mobilize deposits at lower cost
because of their large retail branch network.
In the early 1990s, an attempt was made to convert them
into free-standing financial institutions. The IFCI was
converted into a company and came out with an IPO in
1993. Government and government controlled institutions
continue to hold 56 per cent of IFCI. In 1994, the IDBI
Act was amended to allow the government holding to be
reduced to 51 per cent and an IPO brought the governments
stake down to 74.6 per cent (RBI 1999, Statement 2).
However, this process was not carried through to its logical
culmination of converting them into ordinary financial
institutions. A number of committees examined the issue
and the central bank issued a discussion paper on the subject
in 1999 (RBI 1999). These reports and papers were however
overtaken by the course of events.
The immediate impact of the reforms has been felt on
the asset quality of the financial institutions. They have
126
been the victims of severe adverse selection as these

institutions have tended to become lenders of last resort to
projects that cannot raise finance in the capital markets or
from other sources. Moreover, the historical asset base of
these institutions exposed them to precisely those sectors of
the economy that have been the losers in the reform process
the globally uncompetitive industries that owed their survival
to the high degree of protection in the pre-reform era. As
a result, the financial institutions faced mounting levels of
non-performing assets that have pushed them to the verge
of bankruptcy.
The government is now in the process of restructuring
these 2 DFIs to restore their solvency (RBI 2003, paragraph
10.84). In the case of IFCI, a large portion of the liabilities
were taken over by the government in exchange for quasiequity instruments that will probably have to be written off.
In the case of IDBI, a debt restructuring agreement has been
worked out under which the government subsidizes part of
the interest bill.
The 2 DFIs are also trying to restructure their operations.
IFCI is in the process of turning over its bad loans into an
asset reconstruction company and focusing the residual
good bank on the small and medium corporate sector.
IDBI is in the process of being corporatized and converted
into a bank with significant regulatory and tax exemptions
to ensure its survival.
ICICI (India): The Industrial Credit and Investment
Corporation of India (ICICI) was set up as a company in
the private sector with the primary objective of providing
foreign currency loans to industrial projects and promote
industries in the private sector. ICICI also received assistance
from the World Bank which at that time had a policy of
encouraging private sector DFIs and of not providing
financial support to public sector DFIs (Roberts 1971). In
1969, all large banks were nationalized and since they were
the major shareholders of ICICI, in effect, ICICI also became
a quasi-public organization.
ICICI was treated at par with IDBI and IFCI for most
purposes and enjoyed the same access to cheap funds prior
to liberalization. Over a period of time, the 3 institutions
(IDBI, IFCI, and ICICI) developed the practice of lending
to large projects in a consortium and, therefore, the loan
portfolio of these institutions were also very similar. One
of the sad features of development banking in India was that
despite having 3 different national level DFIs, there was no
competition between them. Several mechanisms were created
to coordinate the activities of the 3 DFIs. Virtually all
important decisions were taken at inter institutional meetings
designed to ensure a common approach to all issues. This,
combined with the consortium approach meant that the
DFIs were completely insulated from competition and lost
their ability to compete.
When financial liberalization took place, in order to

survive, the DFIs needed to create a competitive culture very
quickly. In this respect, ICICI moved more aggressively than
the other two DFIs to adapt to the new environment and
exploit the new opportunities. It created a banking subsidiary
(ICICI Bank) and grew this banking business far more
aggressively than other financial institutions that also set up
similar subsidiaries. It also moved aggressively into securities
trading, insurance, and mutual funds with the stated intention
of becoming a diversified financial services group. At the
same time, an ADR issue and consequent listing in the New
York Stock Exchange diversified its investor base.
In 2001, ICICI decided to merge into ICICI Bank to
convert itself into a bank; the merger became effective in
2002. The drawback of this was that the merged entity had
to meet all the regulatory requirements (regarding priority
sector lending and SLR) on its entire business while ICICI
had been exempt from these requirements since it was not
a bank.
ICICI Bank continues to carry the legacy of nonperforming assets of the old DFI. Moreover, as a universal
bank, it continues to have the ability to provide long-term
capital to its borrowers, if required. Nevertheless, the
transformation from a DFI into a regular bank is more or
less complete.
IDFC (India): In some cases, governments may find it
easier to create new free market DFIs than to transform old
style DFIs. The Infrastructure Development Finance
Company (IDFC), set up in 1997, with the mission to lead
private capital to commercially viable infrastructure projects
in India is one example. The idea of creating a new institution
instead of entrusting this task to one of the existing DFIs
came from the India Infrastructure Report (Mohan 1997).
This report argued that the large funding needs of the
infrastructure sector in India could be met only by attracting
private capital and proposed the creation of an institution
for this purpose.
IDFC was set up with a capital of Rs 10 billion and a
delicate mix of private and public sector investors. The
government (and government-controlled institutions)
contributed 40 per cent, foreign financial institutions 40
per cent, and domestic financial institutions 20 per cent.
The holding of domestic financial institutions was almost
equally divided between public sector institutions and private
sector institutions leading to a shareholding pattern that
was almost exactly 50:50 between the private and public
sectors.
In its first annual report (IDFC 1998), the chairman of
IDFC stated:
The infrastructure environment today is akin to a jigsaw
puzzle ... IDFCs task as I see it is to visualise the complete

picture, identify the gaps, create the missing pieces and
with the assistance of all players in the infrastructure sector ...
help put these pieces in their proper place. ... IDFC will
create policy advisory groups in each of its chosen fields
of activity ... and these groups will be responsible for not
only creating the missing pieces of the jigsaw puzzle but
ensuring that they are placed correctly in the emerging
holistic picture we are attempting to create. ... Conditional
and unconditional take-out financing, risk participation
facilities, stepped-down pricing, maturity enhancement,
liquidity support to bond issues and some amount of term
funding would constitute some of the product armoury of
IDFC. Equity and mezzanine capital support would also,
in time, be considered in specific situational contexts.
This is indeed the kind of role that a free-market DFI

should be performing. The question is how well is IDFC
living up to this role 6 years after its formation. This paper
will not attempt to evaluate the financial performance of
IDFC. (Though IDFC has no non performing assets (NPAs)
as per its last balance sheet, it is still too early to judge the
soundness of IDFCs credit assessment and investment
appraisal since a major part of its disbursements have taken
place only in the last couple of years.)
For everybody, except its shareholders, the more important
question is the extent to which it has succeeded in its core
mission of attracting private capital into infrastructure. This
paper will, therefore, look at each of the roles that a free
market DFI could play and examine how well IDFC has
performed that role:
Development of Financial Markets: The last 3 or 4 years
have witnessed a radical transformation of the debt market
in India. The market has become more liquid and a number
of new instruments have become available. The maturity of
instruments has also increased significantly. The single biggest
reason for this change is the benign global financial
environment and the equally benign easy-money policy of
the central bank since the end of the Asian Crisis (Varma
2002). One contribution that IDFC has made to this market
is the development of take-out financing. This allows banks
with short-term liabilities to provide long-term financing
for infrastructure secure in the knowledge that the take-out
financing provided by IDFC eliminates the maturity
mismatch.
Assumption of Residual Credit Risk to Facilitate Bond
Issuance: An examination of the annual report (IDFC 2002)
does not reveal any major activity in this area. The biggest
guarantees issued by IDFC are performance guarantees issued
in connection with telecom licences. Excluding these, the
rest of the guarantees amount to only about 10 per cent
of the companys funded exposure to infrastructure projects.
Remedying Sectoral Financing Gaps: IDFC itself exists to fill
a financing gap in the infrastructure sector and as such all
its activities belong here.
127
Instrumentality for Improved Governance: There is some

evidence on the ground that IDFC has been able to influence
governance practices of sub-sovereign governments (states
and municipalities) through its lending policies. By its very
nature, however, this contribution is difficult to measure.
Think Tank for New Policy Frameworks: This is the role in
which IDFC has excelled. It has worked hard on influencing
government policy in all key infrastructure sectors. It has
succeeded more in some sectors than in others, and the
sectors in which it has succeeded are the ones where large
private investment in infrastructure has taken place. In
some of these sectors, IDFCs contribution in the policy
sphere has been far larger than its financial contribution to
the sector. For example, the IDFC played a crucial role in
the conceptualization and bid-management for the annuity
projects of the NHAI that brought in private sector
investment in the roads sector during 20012 of Rs 30
billion (IDFC 2002). On the other hand, IDFCs lending
to the entire transportation sector (including roads, ports,
and railways) was only Rs 8 billion.
In its first annual report (IDFC 1998), the chairman of
IDFC stated: We are building an institution the likes of
which does not exist in any part of the globe. Over the last
6 years, IDFC has begun this task on a promising note.
During much of this period, it has concentrated its energies
on improving the policy framework for infrastructure in
India. This is indeed a prerequisite for private sector
infrastructure development that was sorely lacking in India,
and IDFCs preoccupation with this in the initial years was
quite understandable. In the coming years, as it succeeds
in creating this prerequisite, it will have to move on to the
financial issues. Its ability to do this will determine how well
it succeeds in its mission. There is reason to hope that IDFC
will emerge in the next few years as an example of a successful
DFI operating in a free-market environment.
MANAGEMENT
AND
GOVERNANCE
OF
NEW DFIS
The free-market DFIs whether newly created or created by

the transformation of older DFIs must confront a number
of difficult questions about management and governance.
Old performance measures like loan disbursements, profits
and contribution to priority sectors are meaningless and
irrelevant. New measures are needed that measure the
developmental role that they have played.
Performance Measures
The example of Fannie Mae and Freddie Mac discussed
earlier in this paper demonstrate the dangers of using balance
sheet and profitability measure to measure the success of a
free-market DFI. It is evident that the very size of their
128
balance sheets as well as the profitability that it creates is

a problem today for everybody except their shareholders. In
a deregulated environment, financial markets are perfectly
capable of intermediating the flow of capital from savers to
investors. There is little reason for this intermediation to
happen through DFIs with bloated balance sheets. Indeed
a bloated balance sheet is in some sense a danger signal. The
sheer size of the balance sheet makes it easier to hide problems
and the size also engenders a too big to fail mentality
among lenders and investors thereby weakening market
discipline.
In a well-functioning financial sector, most risks can and
should be laid off in the market place. Only a tiny sliver
of residual risks should remain on a DFIs balance sheet (or
on its off balance sheet exposures). An important measure
of a free-market DFIs success is how tiny this sliver is. In
other words, how much of capital flow does it facilitate for
every rupee of risk exposure that it retains (on or off balance
sheet). If a DFI is able to bring a Rs 1 billion project to
financial closure retaining only Rs 10 million of project risk
on its own balance sheet, it is more successful than another
DFI that shows loan sanctions of Rs 500 million but helps
bring only Rs 6 billion of projects to financial closure.
Governance
A critical question facing a free-market DFI is that of
governance. It faces pressure from lenders (if not from
shareholders) to operate on purely commercial
considerations. But if it does so, it would not be a DFI but
a regular financial institution. For example, in Korea, KDB

has played an important role in the governments
privatization and restructuring efforts and has acquired
large stakes in several public sector organizations. A
particularly large transaction was one in which the
government injected capital into KDB in the form of shares
of Kepco (Korea Electric Power Company) in return for
guaranteeing Kepcos debt prior to privatization. Since this
strengthened KDBs capital adequacy on financially attractive
terms, lenders did not complain (Mizuho International
2003), but it is evident that deals like this could easily
antagonize lenders if they are not attractively structured. If
the DFI has private sector shareholders, the pressures are
even more serious. For example, Fannie Mae and Freddie
Mac have been largely shareholder-governed and their
activities appear guided purely by profit considerations.
This in turn invites regulatory intervention.
Strategy
Financial markets are continuously evolving. Markets that
were underdeveloped at one point of time soon become well
developed. For example, KfW has played in important role
in creating the securitization market in Germany, but in
another few years, the market could possibly be mature
enough not to need the DFIs support any more.
The free-market DFI needs to continually reinvent itself
to remain relevant. The old style DFIs had an easier job.
They just had to keep throwing money at projects. The
projects changed, but their job did not.
6.2 CREATING LOCAL FINANCING SYSTEMS FOR INFRASTRUCTURE IN INDIA

Abhas Kumar Jha
The question generally asked is why we should care about
local borrowings to finance infrastructure. Most rural and
urban local bodies are perceived to be inefficient, and
providing public services inadequately. They are known to
be overstaffed and in a financially precarious situation. The
idea that such institutions could be able to access private
capital in a significant way to finance basic infrastructure
provision may seem highly incongruous. However, the
experience of a number of developing countries shows that,
under the right enabling circumstances, and when faced
with the correct institutional incentives, local savings, and
I am grateful to Priya Basu, V. Bhaskar, Robert Buckley, and
Sonia Hammam for detailed comments on an earlier draft. The usual
disclaimer applies. The views expressed here are personal and do not
necessarily reflect the views of the World Bank, its Executive Directors,
or the governments they represent.
the surpluses of local bodies can often be a valuable source

of finance for infrastructure and economic growth. The
huge and growing unmet demands for infrastructure along
with the decentralization imperatives of the 73rd and 74th
Constitutional Amendments imply that local government
access to financing systems will be crucial in the development
of infrastructure in India1.
Developing countries have a broad range of options and
models to choose from when making the decision on how
1 The India Infrastructure Report (1996) estimates that capital
markets will have to increase the amount generated for public investment
in infrastructure from US$7 billion in 1997 to US$20 billion by
2006, the vast majority at the state and local government level. The
Report also estimated total infrastructure investment in India to be
about US$115130 billion from 19962001 and rising to about
US$215 billion from 20012 to 20056. Needless to say the actual
investments in infrastructure have fallen far short of these projections.

to locally finance infrastructure. Peterson (2002) poses the
question of local financing for infrastructure as bonds versus
banks. The West European countries like France and the
Netherlands have well-established and well-regarded
specialized banks for municipal lending2. The gigantic and
sophisticated US municipal bond market (US$1.3 trillion
debt outstanding) is at the other end of the spectrum in
terms of decentralization and unbundling of lending
relationships. A country like India with fairly deep and wide
domestic capital markets and a well-established banking system
with almost universal geographical coverage offers possibilities
on both ends of this spectrum of bonds and banks.
As a third alternative, many developing countries have
set up specialized municipal funds. Peterson (1997) points
out that more than 50 countries have set up specialized
credit intermediaries to lend funds to municipalities but
very few have made the transition to self-sustaining systems
in which private savings are voluntarily channelled through
market intermediaries to local governments for financing of
infrastructure.
Local governments in India are extremely weak financially.
McCarten (2003) estimates local government or third-tier
tax to GDP ratio to be just about 1 per cent. In contrast,
central and state taxes typically constitute 7.5 per cent and
8.5 per cent of GDP, respectively. Of the approximately
3700 ULBs, Whitbread (1999) estimates that only 50 are
creditworthy enough to access domestic capital markets.
The 73rd and 74th Constitutional Amendments, by
providing for the establishment of State Finance
Commissions, offer the promise of putting local government
finance on a sound and sustainable basis.
The recently announced Urban Reforms Incentive Fund
(URIF) and the City Challenge Fund (CCF) both have
positive elements that may promote local government access
to private capital markets. The URIF, which aims at reforms
at the state level, identifies, inter-alia, the introduction of
double-entry system of accounting and the levy of realistic
user charges as two required reforms for access to URIF
funds. Similarly, the CCF has provision for cities to improve
their financial management through better accounting,
reduction of wasteful expenditure, etc. The proposed Pooled
Finance Development Scheme (PFDS) would allow state
entities to raise funds from the market on behalf of ULBs.
The repayment of bonds would be through escrow accounts
in which revenues, state grants, and a debt service reserve
fund (DSRF) would be channelled. The central and state
governments would contribute 7 per cent each to the DSRF.
2 Dexia Credit Local de France and Municipal Bank of Netherlands
(BNG), respectively. Both entities have evolved from monopoly
access to personal savings deposits and government capital
contributions to raising money from competitive capital markets
backed by an AAA rating (Peterson 2002).
129
SOME INITIATIVES
Earlier, in 2001, the Government of India announced the
guidelines for issuance of tax-free municipal bonds by ULBs.
Funds raised from the bonds are to be used only for capital
investment for setting up of new projects and expansion or
augmentation of the existing systems relating to urban
infrastructure services such as water supply, sewerage,
drainage, solid waste management, roads, bridges, flyovers,
urban transport, etc. The guidelines also state that there has
to be compulsory credit rating of the debt instrument and
it would be mandatory for the issuer to obtain an investment
grade rating from an RBI-approved and a reputed grade
rating agency before issuance of tax-free municipal bonds.
The bonds shall have a minimum maturity of 5 years. The
issuer shall also create an escrow account for debt servicing
of bonds proceeds with earmarked revenue. The Ministry
of Urban Development and Poverty Alleviation is the nodal
agency for processing the proposals for tax-free municipal
bonds. The proposals will be placed before a committee
which will have representatives from the Department of
Economic Affairs and the Central Board of Direct Taxes.
The committee will forward its recommendations on the
proposals to the Department of Economic Affairs, which
will notify the specific bonds in the official gazette with the
approval of the Finance Minister3.
In the 5 years since Ahmedabad issued the first such
bond, only 11 other ULBs have come forward to borrow
a total of Rs 750 crore. In addition, with the exception of
Hyderabad and Ahmedabad, none of the 12 other cities in
the country with populations over 1.5 million has issued
a bond. In 2002, interest rates on municipal bonds had
fallen from the 14.5 per cent in the case of the first bond
to 8.5 per cent (Annez 2003). Much of the fall was due to
the fall in the rates of interest generally, and had little to
do with the ratings of the ULBs. The premium above the
risk-free rates remained much the same. As a measure to
boost the transparency of local body financial statements,
the Institute of Chartered Accountants, India, has developed
guidelines for preparation of manuals for switching over to
a new system of accounting and financial reporting based
on double-entry accrual system. The Tamil Nadu Urban
Local Bodies Act 1998 makes it mandatory for ULBs to
switch to a modified accrual accounting system.
The fact that just 12 local bodies have actually raised
money from the capital markets begs the question: why so
few? Clearly key gaps remain in promoting access of local
and sub-national governments to adequate and sustainable
sources of infrastructure finance. Some of the questions for
local governments are how to bring in local private capital
3 See http://urbanindia.nic.in/mud-final-site/urbscene/urban reform.
htm
130
and reduce dependence on national budgets; how to foster

competition among multiple lending sources for financing
business so that margins are lowered and tenors improved;
how to use domestic subsidies and IFI funds to leverage
private domestic capital. A number of models of good
practice exist by which countries have sought to promote
local financing for infrastructure.
SUPPORT
AND
CREDIT ENHANCEMENTS
Two Successful Municipal Development Funds

Financiera de Desarrollo Territorial, S.A. (FINDETER) in
Colombia, for example, is a market-oriented municipal
development fund. It operates as a rediscount facility for
commercial bank lending to the municipal sector.
FINDETER supplements the banks project appraisal
capacity and thus improves the technical quality of their
lending, but the banks take the commercial risk. FINDETER
fulfils its poverty alleviation mandate by paying particular
attention to institutionally-weak small towns and by
favouring investments in essential servicesmainly water
and sanitation. FINDETER is now established as a credible
financing agency with a poverty reduction mandate. The
second-tier financial institution mobilized 10 per cent of
project costs from the formal banking sector via its loanguarantee programme, familiarizing banks with municipal
lending and helping to establish a medium-term financing
market.
In the Czech Republic, the Municipal Infrastructure
Financing Company (MUFIS) provides long-term loans to
commercial banks for on-lending to municipalities. The
banks assume all the credit risk and do the project appraisal.
MUFISs presence in the municipal finance market has led
to 8 commercial banks now being actively engaged in
municipal lending. Real interest rates in the municipal sector
have declined and tenors have increased (Peterson 2000).
US Bond Banks and State Revolving Funds

A bond bank is a financial intermediary that sells its own
securities and on-lends the proceeds to local governments4.
This provides the smaller municipalities, which lack the
requisite creditworthiness and expertise to access the market
on their own, the economies and efficiencies of the municipal
finance market. In 1984, in connection with the Federal
Clean Water Act, the US Federal Government set up state
revolving funds (SRFs) for waste water and water projects
in the US. The federal government makes capital grants to
the state government, matched by a contribution from the
4
See Council of Infrastructure Authorities (1997).
state (currently at 20 per cent). Several states use these

subsidies to create dedicated reserve funds to collateralize
pooled bond flotation to support financing needs of local
governments in the state. The pooled SRF bonds of New
York state are AAA rated even when many participating local
governments have lower ratings or are not rated at all. Bond
banks typically provide a number of credit enhancements
like debt service reserve funds and state transfers payment
intercept provisions to provide additional comfort to lenders
and thereby lowering the cost of borrowing.
Local Financing Using Multilateral Finance Institution

Guarantees
The International Finance Corporation (IFC), the private
financing arm of the World Bank Group has recently financed
an innovative transaction at the sub-sovereign level for the
city of Tlalnepantla, on the suburbs of Mexico City. IFC
has extended a peso-denominated partial credit guarantee
of up to US$3 million equivalent to a water conservation
project. The partial credit guarantee will be to a private
Mexican trust that will issue up to US$8.8 million in bonds
in the local capital market. The proceeds of the bonds will
be used to provide a loan to finance Tlalnepantla Municipal
Water Company and the City of Tlalnepantla for the design
and construction of a waste water treatment plant and the
implementation of a leak-reduction programme for the
existing water supply network.
This is IFCs first direct municipal finance deal, but it
is helping to create a new asset class in a local currency so
that long-term infrastructure projects can be financed by
local institutional investors. The partial credit guarantee
will allow the project to enhance the bond credit rating
from Mx.AA to Mx.AAA without a sovereign guarantee.
This will be the first municipal bond offering in Mexico,
which is dependent on the full faith and credit of the local
municipality; there is no federal guarantee or assignment of
federal transfers. Dexia Credit Local Agency New York, a
subsidiary of Dexia Credit Local, France, will be a coenhancer of the investment with IFC, providing a letter of
credit capped at US$5 million equivalent.
Within India, the Tamil Nadu Urban Development Fund5
(TNUDF) has established itself as one of the best run
municipal funds in the world. The Fund which has lent over
Rs 4.93 billion to ULBs in Tamil Nadu has achieved
repayment rates of over 96 per cent and made a profit of
Rs 848 million in the financial year ending 31 March 2003.
The TNUDF is a trust fund established under the Indian
Trusts Act, 1882, by the Government of Tamil Nadu, ICICI,
5
This section draws largely on a presentation made by K.

Rajivan, Managing Director, TNUDF in the World Bank on 20
May 2003.

HDFC, and IL&FS with a line of credit from the World
Bank. The Tamil Nadu governments equity in the venture
is restricted to 49 per cent, to allow private sector
management in investment decisions. Other shareholders of
TNUIFSL are ICICI (21 per cent), HDFC (15 per cent)
and IL&FS (15 per cent). ICICI, the lead institution, has
taken up management responsibility, putting in place
appraisal systems and key personnel.
TNUDF can lend to ULBs, statutory boards, public
sector undertakings (PSUs), and private corporates for water
supply, sanitation, SWM, roads/bridges, transportation, sites
and services, and integrated area development projects. It
can only fund capital expenditure, civil works, services, and
goods/materials. It cannot fund land acquisition costs, O&M
expenditure/other revenue expenditure such as salaries. For
a ULB to be eligible for funding from the Fund, its total
expenditure should be less than its total revenue and annuity
payments/total revenue should be less than 30 per cent. In
case ULBs fail to meet above criteria, the project specific
returns (IRR) should be greater than 18.5 per cent per
annum. For private sector borrowers, long term debt to net
worth ratio should be less than 1.5, net fixed assets to longterm debt should be greater than 1.5, and average debt
service coverage ratio (DSCR) should be greater than 1.5.
Various credit enhancement measures such as escrow accounts
of property tax and water charges and hypothecation of
movables are put in place. In the case of commercial
complexes, a default option of conversion of up to 40 per
cent of loans outstanding into office space is stipulated.
With regard to lending for infrastructure to local
governments and community organizations by banks and
housing finance institutions, this remains a special activity
and is far from mainstreamed. Mehta (2003) cites 4 examples
of banks or housing finance institutions which have undertaken
community infrastructure finance. Housing Finance
Development Corporation (HDFC) has used donor funds,
particularly the shelter related Kreditanstalt fur Wiederaufbau
131
(KfW) line of credit, for shelter and micro-finance. However,

despite the use of soft funds from KfW line of credit, HDFCs
lending has generally been preceded by rigorous appraisal and
it has maintained a good recovery rate. UTI Bank has provided
performance guarantees on commercial terms towards
mobilization advance to Society for the Promotion of Resource
Centres (SPARC), an NGO, involved in construction of
shelters for resettlement and rehabilitation of slum dwellers
under the Bank-funded Mumbai Urban Transport Project.
IDFC has set up a separate unit for decentralized infrastructure
and new technologies (DINT) to focus on opportunities
involving smaller projects and appropriate technologies. ICICI
Bank has now directly financed over Rs 200 million for
micro-credit for infrastructure.
THE ISSUES AHEAD

Strengthening the Creditworthiness of Local Bodies
Local government bodies (LGBs) access to private capital
depends critically on significant improvement in their creditworthiness. No amount of credit enhancement or financial
engineering can substitute for a sound legal, institutional,
and regulatory framework underpinning and incentivizing
sound local body finances. The two fundamental issues
underpinning the creditworthiness of LGBs in India are the
autonomous authority to set realistic tax-rates and tariffs or
user charges for the basic services they provide and to allow
them flexibility in wage structures and hiringfiring policies
(combined with a hard budget constraint). The central issue
in setting up mechanisms to channel private savings to local
bodies for the financing of infrastructure is the assurance
to lenders that they will be repaid. Box 6.2.1 and 6.2.2
provide Fitch Ratings best and worst practices with rating
value in terms of the financial management of sub-sovereign
bodies. This provides a useful checklist of financial
Box 6.2.1
Best Practices with Significant Rating Value for Fitch
Cash reserve policy/working capital reserves/budgetary cushions

Multi-year financial forecasting
Monthly or quarterly financial reporting and monitoring
Contingency planning policies
Policies regarding non-recurring revenue
Depreciation of fixed assets
Debt affordability reviews and policies
Pay-as-you-go capital funding policies
Debt retirement speed
Five-year capital improvement plan integrating operating costs
Source: Fitch Ratings, International Rating Methodology for Regional and Local Governments, 4 April 2002, http://www.fitchratings.com/corporate/
reports/report.cfm?rpt_id=141098
132

Box 6.6.2
Worst Practices with Significant Rating Concern for Fitch
Cash basis accounting

Qualified audit opinion for material weakness
Deficit financing for two of the last five years
Debt retirement speed
Unfunded accrued pension liability
Short-term borrowing growing significantly faster than annual spending
Debt reprogramming that defers a small share of current debt service
Over reliance on non-recurring revenue
Aggressive investment policy for operating funds
Pension contribution deferral in the current budget year
Budgetary impasse beyond legal completion date
Lack of capital improvement plan
Excess borrowing from related entities, with no capacity to repay in near future
Source: Fitch Ratings, International Rating Methodology for Regional and Local Governments, 4 April 2002, http://www.fitchratings.com/corporate/
reports/report.cfm?rpt_id=141098
management reforms that LGBs can pursue. The yet-to-beissued guidelines for the URIF and CCF offer a good
opportunity to address the problems of LGB creditworthiness
provided the amount of financing promised under these
facilities is commensurate with the pain of reform that is
sought from the LGBs.
Distortions in the Inter-governmental Fiscal Transfer

Framework
Ahluwalia (2000) argues for linking a substantial portion
of centrestate fiscal transfers explicitly to performance.
Increased access to local financing for infrastructure will
require transfers to both from the centre (grants for various
anti-poverty schemes and loans from HUDCO) and the
state governments to LGBs be substantially linked to
improved performance. The resources committed to the
incentive-based URIF and CCF are far too inadequate to
change the perverse incentives of the formula linked gapfilling centre and state government transfers to LGBs.
HUDCOs disbursements in 20023 were 8 times the
provision made for URIF (Annez 2003). This clearly needs
to change.
A market-based system of access to capital markets by
LGBs will also require putting into place an adequate legal
and regulatory framework. This would include, inter alia,
a strict no bailout policy for LGBs in trouble. This is easier
said than done. Inman (2003) points out that in the US,
it took about 70 years of the federation for the principle
of hard-budget constraints for US states and local
governments to be generally accepted. The turning point
was the federal governments refusal to bail out 8 defaulting
states and the Territory of Florida in the 1840s. Mexico and
South Africa have both formulated no bail out systems for
their LGBs in which national government does not guarantee

sub-sovereign debt. In the case of Mexico, the capital risk
weighting of bank loans to LGBs is linked to local credit
ratings. South Africa has established a Municipal Financial
Emergency Authority for technical assistance, resources and
legal remedies to LGBs in distress (Weist 2002). The
possibility that the demand for hard-budget constraints on
local governments would be linked to similar measure on
state governments is remote.
A related legal issue is the need for orderly bankruptcy/
work-out procedures as well as a time-bound procedure for
foreclosure. In 1995, Hungary introduced a US style
Chapter-11 type bankruptcy stand-still procedure to
regulate debt clearance procedures in case of default by
LGBs. Since the law was introduced, 8 small cities went
through the procedure, and are now in stable financial
condition (Noel 2000).
Strengthening Municipal Bond Issuance

The US Bond Bank model (including the use of state
revolving funds) offers good possibilities in the Indian context
for smaller less creditworthy LGBs to access the capital
markets. The success of the TNUDF offers a nationally
replicable model. It must be emphasized that pooling
arrangements will work only when the individual entities
participating in the pool are financially sound but too small
to access the capital markets individually. It makes no sense
to pool financially insolvent local bodies.
Close to 50 per cent of total US municipal bond issues
(75 per cent of BBB, A, or better) are covered by bond
insurance (El Daher 1997). Policy-makers should consider
setting up a bond insurance facility (either in the private
or public sector) to facilitate small issuers, considered less

creditworthy, to access the domestic markets for high
investment grade debt. Noel (2000) lists several measures
to promote the secondary market in sub-sovereign debt.
Among direct measures, countries are exploring ways to
facilitate the listing of bonds on domestic stock exchanges
and to encourage the development of pre-indication posting
or other municipal finance information systems similar to
those used in the US to support placement and sales function
(for example, Blue List and Munifax). Amongst indirect
measures, removing minimum holding requirements by
institutional investors for government securities, including
municipal bonds eliminates the bias toward private placement
inherent in the system and increases the incentive of
institutional investors for trading. This is one of the objectives
pursued by the government of South Africa in abandoning
its prescribed investment regime for institutional investors.
Securitization
Securitization of future flows too offers a means of raising
affordable and sustainable finance for local governments. In
Argentina and Pakistan, asset-backed papers have continued
regular payment even in the face of selective sovereign
default6. Typically, the cost of obtaining corporate ratings
and the high legal costs with structured transactions have
been deterrents to large-scale use of securitization by local
governments. The Master Trust (MT) Arrangement favoured
by state governments in Mexico and Argentina addresses
some of these problems. Under the MT Agreement the
states pledge a certain per cent of federal contributions to
a trust whose specific objective is to isolate the source of
repayment of each borrowing. Many obstacles remain,
however, to the large-scale use of securitization in India.
More Innovative Use of Government and Multilateral

Guarantees
The IFCs Mexico Domestic Partial Credit Guarantee
highlights the scope and possibility of innovative uses of
guarantees in catalysing and crowding in private
infrastructure investment. A word of caution may be in
order. Governments have typically not correctly priced or
accounted for the contingent liabilities arising out of
guarantees for infrastructure projects. The default of a
number of Turkish municipalities in 1996 triggered a national
fiscal crisis. Earlier, Mexicos state banks had to assume
much of the losses arising out of revenue shortfalls from the
private construction of toll roads (Peterson 1997).
Lewis and Mody (1998) argue for the need for
governments to properly account for their contingent
liabilities arising out of infrastructure projects. The World
6
case.
See Ketkar and Ratha (2001) for a discussion on the Pakistan
133
Bank in collaboration with the Government of Colombia,

for the first time, put in place a framework to estimate the
risk exposures for 3 infrastructure projects in the country:
market risk (relating to market volumes and prices),
construction risk (from cost and schedule overruns),
counterparty risk (operations risk and risk of failure of
participating companies), currency risk (relating to exchange
rates and liquidity), force majeure, termination risk (risk of
contract buyout, possibly including penalties), and regulatory
risk (the risk of adverse regulatory changes). The assessment
for the El CortijoEl Vino toll road project showed that the
greatest exposures for the government are from the market
risk associated with traffic volatility and the risk of
construction cost overruns. The total expected loss to the
government under these two guarantees was estimated at
about US$4.2 million. The valuation process allows
governments to critically assess the distribution of risks
under a direct loan, a guarantee, or an insurance programme
and to design contracts that lead to fewer and smaller calls
on guarantees. While the capacity to perform sophisticated
modelling processes like stochastic or Monte Carlo
simulations can be developed at the national or state levels,
local governments should, at the minimum, develop a
capacity to identify and efficiently allocate risks in their
capital investment projects.
Promoting Infrastructure Financing by Banks and

Housing Finance Institutions
Second-tier organizations like FINDETER have the potential
to jumpstart bank and HFC financing for infrastructure
both by refinancing at attractive terms and by offering
guarantees which would potentially lower spreads and lengthen
tenors. Instead of setting up a new institution for this purpose
it would make sense to dovetail this function into one of the
infrastructure related institutions notably IDFC which already
has a cadre of infrastructure professionals who can perform
the required appraisal and monitoring functions. Such an
intermediary could also help smaller LGs in capital planning,
public participation, and bond issuance and supporting
documentation. Micro-bonds issued through the intermediary
could be in a standard format, in standard amounts and
could be consolidated into groups of similar maturities and
sold to institutional investors (Glasser et al. 1998).
Finally, capacity building within municipalities for budget
making, understanding the impact of debt service and of
operating and maintaining capital investments on their
budgets, and the ability to strategically plan capital
investments will be the key to successful local financing
(Glasser et al. 1998). The success of MUFIS and FINDETER
was underpinned by large amounts of technical assistance
for capacity building of local government officials and elected
representatives.
134
6.3 REFORMING PROPERTY TAX IN PATNA MUNICIPAL CORPORATION: A

CRITICAL ANALYSIS
Mukesh P. Mathur
The fiscal domain of municipal governments in India consists
of a large array of tax and non-tax sources of revenue. They
also receive funds from the state government in the form of
grants-in-aid as also share in taxes collected by the state
government. There is little variation among the states in the
matter of taxation powers authorized to the ULBs. However,
significant variations exist across states in their application.
Taxes on the entry of goods (octroi), which was among the
most buoyant and elastic of the local taxes, are currently
levied only in 6 states, namely Gujarat7, Haryana,
Maharashtra8, Manipur, Orissa, and Punjab. The inclusion
or exclusion of this tax has an overwhelmingly large impact
on the revenue base of municipalities9. Many municipalities
in Rajasthan do not levy property taxes. The Punjab
government has recently abolished the levy of property tax
on properties for domestic use. Similarly, there are interstate
differences in respect of taxes on professions, entertainment,
trades, callings, etc. The differences in the tax jurisdiction,
the degree of control exercised by the state government in
terms of the fixation of tax base, rates, exemptions, etc. has
a direct impact on the finances of municipalities.
Property Tax: The Key

Data on municipal finances10 show that own sources of
municipalities, which consist of tax and non-tax revenues,
7 Levied only in municipal corporations.
8 Levied only in municipal corporations.
9 Notwithstanding the importance of octroi for municipal finance,
a large number of committees and commissions have recommended

its abolition. Committees set up by the Governments of Maharashtra
(1987) and Rajasthan (1992) strongly recommended the abolition
of octroi. In their opinion, it is an obnoxious, vexatious, and wasteful
tax and needs to be replaced with a suitable alternative. In 1993,
the All India Motor Transport Congress (AIMTC), had gone on a
countrywide strike against the imposition of octroi and had submitted
a memorandum to the Government of India for its abolition in the
states where it was levied. As a follow-up action, the Government
of India had constituted a committee of chief ministers under the
chairmanship of Jyoti Basu, the then chief minister of West Bengal,
to examine the issues related to octroi. The committee had submitted
its report in 1994, and suggested various measures to streamline the
system of levy, assessment, and collection of octroi. The committee,
however, did not favour the abolition of octroi in the states where
it was being levied (NIUA 1999a).
10 Refer M.P. Mathurs paper on Finances and Functioning of
Urban Local BodiesA Situation Report, published in the India
Infrastructure Report 2001, 3iNetwork, Oxford University Press,
New Delhi.
form an important part of the total revenue income of

municipalities; and within own sources property tax is the
most common and important source of income for majority
of the municipalities, especially after abolition of octroi. It
is assessed on the annual ratable value (ARV) of land and
building and may include service taxes on water supply,
drainage, street lighting, fire, education, etc. Table 6.3.1
illustrates a comparative picture of the receipts from the
property tax in the selected cities. It shows that share of
property tax in the total municipal revenues in non-octroi
states/cities is usually higher compared to those that have
octroi.
Variations in Collections
Though property tax is the most important tax source of
revenue, particularly for the municipal bodies of non-octroi
states, it is not considered to be a buoyant source of revenue
for the municipalities. In principle, the tax should respond
to increasing value of properties. But it is not happening
in practice. In Mumbai, for example, despite a phenomenal
increase in property prices, the income from the property
tax has been virtually stagnant in real terms during the
period from 19801 to 19901. The ARV per property in
this city was only Rs 8644 in 19901 and it increased by
merely 2 per cent per year during 19801 and 19901;
whereas property prices in Mumbai was reported to have
increased by more than 20 per cent during the corresponding
years. In real terms, over the period of 19901 to 1997
8, yield from property taxes has shown an increase of nearly
6 per cent annually, which is much lower than the large
increases that have taken place in the property values (NIPFP
2000). Studies show that on an average, only 3040 per
cent of the potential tax is realized, and taxes on property
continued to be plagued by problems of narrow base,
persistent under valuation, high rates, poor collection
efficiency, and limits imposed on rents of properties under
the rent control acts.
Property tax is levied on the basis of rateable value (RV)
of the property. RV is usually defined as the rental value,
which the property would fetch if it were to be rented out.
In practice, however, the RV is estimated not through market
mechanism but through administrative procedures. Further,
large variations are found in the rates of property tax not
only across states but also within states. It ranges from
nearly 6.5 per cent of ARV in Jaipur (fixed for all categories
of properties) to as high as 83.5 per cent of ARV in Greater
135
Table 6.3.1
Property Tax Receipts in Selected Cities, 19992000
Municipal Corporation
Ahmedabad(O)
Ludhiana (O)
Mumbai (O)
Bangalore
Bhopal
Hyderabad
Patna
Tirunelveli
State
Gujarat
Punjab
Maharashtra
Karnataka
Madhya Pradesh
Andhra Pradesh
Bihar
Tamil Nadu
Total Receipts
(Rs crore)
(PT) Receipts
(Rs crore)
PT receipts as a
proportion to total (%)
Per Capita Tax Revenue

from PT (Rs)
119.45
22.13
711.16
113.44
143.31
83.00
5.13
8.44
21.24
19.04
21.31
53.39
33.97
42.60
14.46
34.94
468.71
130.76
375.18
291.36
NA
238.89
48.36
172.25
566.12
116.24
3338.46
212.51
421.98
194.84
35.46
24.16
Notes: NANot available; OOctroi cities; PTProperty tax.

Source: NIUA (2003, 2002, 2001).
Mumbai for residential properties having metered water

supply and 320.5 per cent of ARV for non-residential
properties with un-metered water supply (NIUA 2002). It
is observed that in many instances these rates have to be
deliberately kept high to maintain the revenue stream from
the tax as the taxable base has not been increasing!
Property tax reforms have been a matter of debate in the
country for a very long time. However, there are differences
of opinion among the tax experts. One school of thought
has suggested an area-based tax assessment whereby rental
values are standardized per unit area of properties for a given
zone, use, type of binding, age, etc. Another has suggested
reforms in the rent control acts, followed by rationalization
of ARV assessment procedures. Both schools generally agreed
that the ARV assessment should be de-linked from standard
rent concepts of rent control acts. In the past, most discussion
of property tax reforms has concentrated on assessment
procedures. But later it was realized that improvement in
tax administration in terms of identification of properties,
assessment, and record management is also necessary.
Reforms Have Begun

In recent years, some states and cities including Andhra
Pradesh, Madhya Pradesh, Tamil Nadu, Gujarat, Uttar
Pradesh, Rajasthan, Bihar, etc., have introduced legal reforms
in property tax assessment. Municipal governments of
Chennai, Hyderabad, Bangalore, Mirzapur, Ahmedabad,
etc. have also initiated management reforms to improve
property tax administration in these cities. These innovations
have helped to increase revenues from property tax
considerably. Both first and second generation Finance
Commissions of many states have suggested reforms in the
existing property tax assessment and valuation systems. For
example, First State Finance Commissions of Uttar Pradesh,
Kerala, Punjab, and Tamil Nadu have suggested that ARV
of a property may be determined by a simple area-based
method, keeping in view location of the property; use of
the property; type of construction and such other indicators.

These commissions have also suggested for tough compliance
of the reassessment cycle besides other administrative and
legal reforms. It is noteworthy that in Kerala the periodicity
of reassessment has been reduced from 5 years to 4 years
by the State Finance Commission (Mathur 1999).
Central Initiative
It is important that the Ministry of Urban Development,
Government of India, has issued guidelines to reform
property tax in 1997. It suggests (i) the substitution of the
existing ARV system of property tax by a mix of capital
value and Area Detail System of property tax by decomposing
it into land tax and building tax; and (ii) the introduction
of the concept of user charges for directly chargeable services
such as water supply and to relate the cost recovery for other
services through a building tax on the basis of area details
of buildings. Other suggestions of the guidelines relate to
the modality for relating building tax to cost of services,
determination of tax liability, tax exemptions, property tax
record management, assessment cycle of property tax, system
of appeals, etc. The building tax was proposed to be levied
by adopting an area-based property tax system in line with
the Patna and Andhra Pradesh models. Whereas the Andhra
Pradesh model uses the values obtained through sample
survey of prevailing market rents for different categories of
properties in terms of location, quality of construction, land
use, age, and physical area; the Patna model uses values
arrived at suo moto. The guidelines suggested a mix of these
two models. The Government of the National Capital
Territory of Delhi is also moving fast to implement the unit
area method of property tax in Delhi. It is likely to be
implemented from April 2004. The President of India has
given his assent on 1 June 2003 and the process is on for
notifying it in the gazette.
The proposed reforms in property tax will not only
improve the yield from this important source of revenue for
136

Table 6.3.2
New Property Tax Assessment System of Patna Municipal Corporation
(Rupee per Square Feet/year)
Type of construction
Holding on principal main road

Purely
residential
Holding on main road
Holding on other roads
Purely
commercial
or industrial
Others
`
Purely
residential
Purely
commercial
or industrial
Others
54
36
12
36
24
18
12
36
24
24
16
12
18
12
12
Pucca building
18
with RCC roof
Pucca building with
12
asbestos or corrugated
roof
Other buildings
6
Purely
residential
Purely
Others
commercial
or industrial
Source: Patna Municipal Corporation.
the municipal bodies, but may also reduce the taxation

disputes due to the simplicity of the suggested procedures
and method of assessment.
PROPERTY TAX REFORMS
IN
PATNA
In 1993, the Patna Municipal Corporation (PMC) came up

with a defined approach of determining the ARV of
properties. Under the new system, the ARV has been defined
as the rent that a holding is capable of fetching over a period
of a year. In order to assess the rent-fetching capability of
a holding, an area-based assessment method was introduced
which provided a definite criterion for assessment of property
tax on the basis of location, use, type, and carpet area of
a holding. The ARV rates vary from Rs 2 to Rs 54 per square
feet, and properties located on the principal roads have
higher rates compared to properties on other roads. Following
are the details of these parameters:
Location of Holding: (a) on principal main roads; (b) on
main roads; and (c) on other roads.
Use of Holding: (a) purely residential; (b) purely commercial
or industrial (self-occupied or otherwise); and (c) any other
which do not fall in these categories.
Type of Construction of the Holding: (a) pucca building
with RCC roof; (b) pucca building with asbestos corrugated
sheet roof; and (c) other buildings which do not fall in the
above two categories.
Carpet Area of Holding: for the purpose of calculating
ARV of a holding, carpet area should include room area,
covered verandah area, 50 per cent area of balcony, corridor,
kitchen, and store and 25 per cent area of garage. Area
covered by latrines, bathrooms, portico, and staircase should
not be included to compute the carpet area to levy the
property tax.
Based on above principles, the PMC through state

government, notification (order no. 2258 dated 12-08-1993),
implemented the new property tax assessments rules in
Patna city (NIUA 2003). Under the new system the tax rate
reduced to 9 per cent from the earlier 43.75 per cent. This
provided a big relief to the honest taxpayers and also
minimized the discretion of those officials concerned with
the property tax collection and its assessment. Table 6.3.2
illustrates the annual per square feet value of holdings as
per the new property tax rules.
Property tax (PT) on individual holding will be worked
out as follows:
PT = ARV R, where
(6.3.1)
ARV refers to carpet area of the holding x value per

square feet per year
R refers to tax rate, which is presently 9 per cent for
all types of properties/holdings. It includes holding tax @
2.5 per cent; water tax @ 2 per cent; latrine or scavenging
tax @ 2 per cent; health cess @ 1.25 per cent; and education
cess @ 1.25 per cent.
Significantly, the PMC has no power to revise the tax
rates on its own or even to reclassify the categories of
different roads, assessment system, etc. They have to take
the prior approval from the state government to do so. This
is contrary to the spirit of the 74th Constitution Amendment
Act of 1992 that stressed the democratic decentralization
of functional and financial powers to local bodies of the
country with a focus on self-reliance at the local level.
Against the cases filed by some of the concerned parties
(vested interests who earlier avoided paying tax) before the
High Court and Supreme Court of India on the new
assessment rules, the Supreme Court, in its ruling upholding
the new system, mentioned that it was designed with good
intentions. The new rules improved the property tax
collections manifold.
137
Box 6.3.1
Comparison of New and Old Systems of Property Tax Assessment in Patna
Before Revision
After Revision
Definition-ARV: the gross annual rent at which the holding

may reasonably be expected to let
Definition-Under the new rules ARV is redefined as the rent

that a holding is capable of fetching over a period of 1 year
Arbitrary and unreasonable assessment by officials
Eliminated or at least minimized the scope of discretion of tax

officials
Scope for corruption and unscrupulousness
Transparent and simple, apparently thus have wider

acceptability. Supreme Court of India upheld the new PT
systems of Patna on the grounds that earlier system gave too
much discretion to the assessors, that a new system with all
good intentions is being tried out
No clear definition of carpet area
Clear definition of carpet area
High tax rate with low compliance (43.75 per cent)
Lower rates for all the categories of properties (9 per cent)
Estimated property tax demandRs 4 crore
Estimated to grow to Rs 40 crore if estimated properly
Series of exemptions to different categories of buildings
No exemption to any type of building
Source: Patna Municipal Corporation and excerpts from S.K. Singhs paper on Property Tax Reformsa Case Study, presented in the MUNINIPALIKA
Conference on Good Governance India, 810 April 2003, New Delhi.
FINANCIAL IMPLICATIONS
REFORMS IN PATNA
OF
PROPERTY TAX
Table 6.3.3 brings out the trends in property taxes. The

CAGR from 19912 to 19934 is 1.28 per cent. Only in
late 1993 were the reforms introduced. The CAGR from
19934 to 19978 has been a stupendous 102.65 per cent.
Since then it has more or less stagnated at 3.48 per cent.
It is important to note that property tax reforms were
initiated in the PMC only in late 1993; and in the first year
of the post-reform period, the corporation could not collect
more than 10.28 per cent of the total demand raised because
the property tax was assessed on the area-based system of

assessment (Table 6.3.4). The new rules of property tax
assessment definitely improved the resource generation
capacity of the PMC as the demanded amount on account
of property tax as gone up substantially from Rs 55.87
million in 19934 to Rs 107.48 million in 19945, registering
an increase of over 90 per cent in a year. But compliance
(or collection efficiency) has remained poor. One of the
factors for the comparatively high success rate in the yield
from property tax in other cities/states where reforms had
been initiated in the recent years was improvement in
collections as a proportion of demand. As against roughly
Table 6.3.3
Property Tax in the PMC Finances
Year*
19901
19912
19923
19934
19945
19956
19978
19989
19992000
20001
CAGR (19901 to 19945)
CAGR (19945 to 19978)
CAGR (19978 to 20001)
Receipts from PT
(Rs million)
7.20
14.10
10.40
15.70
11.04
21.60
45.34
35.11
51.26
50.26
11.28%
102.65%
3.49%
Note: *Data for 19967 is not available.

Source: PMC Budgets.
% to Tax Revenue
26.65
32.75
29.76
28.19
35.25
41.46
38.10
28.89
28.92
28.92
7.24%
3.96%
8.78%
% to Total Revenue
14.09
14.62
11.51
19.36
15.09
16.70
19.58
16.28
14.46
18.96
1.73%
13.91%
1.07%
% to Own Revenue
23.44
30.55
27.12
26.35
30.57
36.11
36.61
27.23
27.99
27.64
6.86%
9.43%
8.94%
138

Table 6.3.4
PT Collection Efficiency in PMC
Year
19901
19912
19923
19934
19945
19956
11967
19978
19989
19992000
20001
% Increase from 19956 to 20001
% Increase from 19934 to 20001
No. of Holdings
(in million)
% Growth in
No. of Holdings
Total Demand
(Rs million)
Total Collection
(Rs million)
% Collection
to Demand
NA
NA
NA
NA
NA
94,158
1,00,097
1,02,442
1,04,856
1,07,025
1,10,132
16.97
100.00
106.31
108.80
111.37
113.67
116.97
31.60
57.10
18.70
55.87
107.48
117.80
151.30
170.70
182.50
188.20
189.00
60.45
238.29
7.20
14.10
10.40
15.70
11.04
21.60
47.70
45.34
35.11
51.26
50.76
135.00
223.32
22.79
24.70
55.62
28.10
10.28
18.34
31.50
26.57
19.24
27.24
26.86
Note: NANot available.

Source: PMC Budgets and NIUA (2003).
27 per cent efficiency recorded by the PMC in property tax

collections during the year 1999 to 2000, Hyderabad has
recorded 69 per cent, Bangalore has recorded 64 per cent,
and Ahmedabad has recorded 78 per cent efficiency. This
has resulted in a high yield from this tax source of municipal
revenue both in proportion as also in per capita terms, which
has helped the municipalities to strengthen their finances to
provide the better services to the citizens (Table 6.3.5).
Key Issues
The PMC introduced a simple user-friendly area-based
system to assess the property tax on land and buildings.
Initially, the new system was introduced only in the wellto-do areas of the city, which accounted for less than 40 per
cent of the total area under the jurisdiction of the corporation.
Considering the growth in the revenues from property tax
(more than 50 per cent during 19934 and 19945), it was
expected that the modified system, when implemented fully,
would enhance the collection of property tax by roughly 4
5 times, and reduce the dependency of the PMC on state
finances to maintain the municipal infrastructure services

at satisfactory level. However, it has not yielded the desired
results due to a variety of reasons, including:
Problem With the Categorization of Holdings on Principal
Main Roads, Main Roads, and Other Roads: The major
problem with the new system was defining the location of
holding on the basis of the above criteria. Holdings, which
are in between the different categories, often file petitions
against such confusion, which delay the process. As per the
rough estimates, more than 40 per cent of the properties
within the PMC jurisdiction either have not been assessed or,
if assessed, payment of tax is pending largely due to disputes.
No Clause on Revision of Tax Rates, Assessment Cycle,
etc.: As new rules are silent on the issues concerning revision
of tax rates, assessment cycle, self-assessment system, etc.,
the PMC is required to take prior approval from the state
authorities to revise the tax rates or even reclassify the
properties on the basis of location of such properties. It has
been estimated that more than 200 city roads which fell
Table 6.3.5
PT Collection Efficiency in the Selected Cities, 19992000
Cities
Bangalore
Hyderabada
Ahmedabad
Patna
% Share of PT in
total revenue
Per capita revenue

from PT (Rs)
53.40
42.60
21.24b
14.46
291.36
238.89
468.71
48.36
Collection efficiency
(% collection to demand)
63.78
68.51
77.80
27.24
Notes: a Data relate to 19989.

Ahmedabad is an octroi city. Thus the yield of PT in proportionate terms is comparatively low in Ahmedabad than it is in Hyderabad
and Bangalore, which are non-octroi cities.
Source: NIUA (2003).

under the category of other roads in 19934 when the last
survey was undertaken at the time of the implementation
of the new rules, are required to be upgraded to the level
of main roads or principal main roads. The PMC is reported
to have submitted a proposal to the Government of Bihar
in this regard. However, no decision has yet been taken on
this important matter which would substantially increase
the yield from property tax.
In-effective Monitoring System and Poor Information
System: The PMC has not developed an efficient monitoring
system to assess the properties as also to realize the dues.
Whereas in the earlier system, the tax officials concerned had
just a single factor to manipulate in the property tax assessment
(in terms of rental values of a property), in the new system,
the number of options for manipulation has increased
significantly. Only with an elaborate information base with
a centralized system of monitoring for valuation of properties
can such tendencies be checked. Barring a few instances of
random checking by the supervisory staff, no system was
developed by the corporation for regular checking and periodic
updating of property tax records. It may be mentioned that
the number of officials engaged in tax collection and
assessment in the PMC is comparatively higher than that in
Indias better-managed municipalities. In Patna, on an average,
every tax official of the corporation deals with the property
tax cases of roughly 727 taxpayers as against the better
managed municipalities level of 1500 taxpayers per tax official.
139
Uncertain Tenure of the Chief Executive Officer

(CEO): The major reason for the not-so-effective implementation of the new property tax rules in Patna was the
frequent change in the leadership at the level of the CEO
in the municipal corporation. During the 19934 and
20023 period, more than 20 CEOs have been transferred
from the corporation. Thus the average tenure of a CEO
worked out to a mere 67 months, which is not sufficient
to push up the reform agenda by any standards. State
control and interference in the working of local bodies
would have to reduce if the objectives of the 74th
Amendment of the Constitution have to be truly
received.
CONCLUSION
The new method attempted by the PMC to measure the
base for property tax was multidimensional and should have
been simple and transparent. The total collections rose
dramatically in a couple of years as people responded to the
low and fair rates. But then it stagnated. Low rates in itself
did not improve matters, since compliance remained low.
Cases filed in courts by vested interests, disputes arising out
of confusion in the determination of the base, interference
of the state government, very short tenures of the CEOs of
the PMC, all worked to deny success to an attempt at
reform.
6.4 ACCESSING CAPITAL MARKETS BY URBAN LOCAL BODIES IN INDIA: AN

ASSESSMENT OF MUNICIPAL BONDS
Manju Ghodke
The need for ULBs to raise funds in the market and
borrow from banks in a sustainable manner is beyond
doubt. Their need for investments to augment and improve
services, the long life of these investments, and investment
lumpiness means that debt of municipalities would be
large relative to their revenue streams from the assets that
provide these services. In India, financial liberalization
offers an opportunity for municipalities to use the route
of markets and bank borrowings. Both phenomena have
begun but remain very small. Crucial institutional,
legislative, design (of investments), and regulatory
initiatives would be necessary before the market can really
take off. This, of course, presumes that ULBs are able to
substantially raise their revenues through efficiency in
taxation, cost-based user fees, and save costs through
operational efficiency. Here we look at the financial side
of the process.
As early as June 1996, at the United Nations Habitat II

Conference in Istanbul, a great deal of attention was paid
to the issue of how best to provide local government with
direct access to international financial markets. The World
Bank saw this as essential to adequately resourcing local
governments in developing countries to deal with the
challenge of financing large-scale and rapid urbanization.
Credit rating agencies and financial intermediaries supported
these proposals, clearly on the basis of the potential for new
areas of business activity. The Conference, among other
things, resolved to:
Facilitate and rationalize, where appropriate, local
authorities access to national, regional and international
capital markets and specialized lending institutions,
including, inter alia, through measures to establish
independent municipal credit rating and credit systems,
bearing in mind the borrowers capacity to repay the debt
in accordance with relevant domestic laws and regulations.
140
THE FUNDS GAP

INDIA
AND THE
CAPITAL MARKET
IN
A number of estimates are available detailing the shortfall

in funds for the urban sector. According to the Rakesh
Mohan Committee report on Indian infrastructure, the per
annum requirement for urban infrastructure during the
period 20016 is Rs 37,836 crore adjusted at fiscal year (FY)
2001 prices. The Plan fund is to the order of Rs 5000 crore
per annum with an additional Rs 400 crore grant to
states by the 11th Finance Commission. With Plan fund
commitments being woefully short of the required resources,
the gap between demand and supply of funds is large.
The Indian capital market in FY 2003 raised capital
totalling Rs 40,740 crore. This included Rs 33,420 crore
through debt and Rs 7320 crore through equity. The peak
was in FY 2000, when the capital markets had raised
Rs 66,300 crore, including Rs 41,290 crore of debt and
Rs 25,010 crore of equity. Additionally, the outstanding
liabilities of the central government in FY 2003 (RE) was
Rs 10,37,163 crore including Rs 6,21,470 crore of market
loans. In FY 2002, market borrowings financed 69.4 per
cent of the gross fiscal deficit of the central government and
15.2 per cent of the state governments (pending data for
FY 2003). In perspective, if the urban sector was to receive
all funds from the capital market, the share of funds required
by urban infrastructure would account for almost 90 per
cent raised in the capital market, or about 50 per cent of
the market loans of the central government.
Currently the actual money raised for urban infrastructure
in the capital markets is not documented separately in the
published data sources, as the amounts involved are negligible.
The predominant segment of the Indian capital market is
debt and the institutional mechanism for trading in both the
primary and secondary segments are of global standards.
As on 30 June 2003 the total market capitalization was
Rs 9,538,94 crore on the wholesale debt markets (WDM)
segment of NSE of which the share of central government
securities was 78 per cent, state loans at 7.53 per cent, public
sector undertaking (PSU) bonds at 4.42 per cent and corporate
bonds at 1.04 per cent. The only ULB paper listed for trading
are the Nashik municipal bonds. This information detailing
the access to markets of different players has to be seen in the
light of the per capita availability of funds to the 3 levels of
government. While at the centre it was Rs 987 on a per capita
basis, at the state level it was Rs 574 and only Rs 205 at the
local level. Research shows that at the urban level, currently
only 2 taxes, octroi and property tax, are of any significance
in terms of volumes and buoyancy. For example, the per
capita revenue availability in 19967 in some cities having
octroi, such as Ahmedabad, was Rs 1187, PuneRs 1575,
SuratRs 1184, and NashikRs 1196. On the other hand,
some cities, which had abolished octroi, had lower levels of

per capita revenue availability, such as Chennai at Rs 513,
Indore at Rs 338, Bangalore at Rs 354, and Kolkata at
Rs 387. In the context of availability of resources at the local
level the move in certain states to abolish octroi without a
replacement by a similar buoyant levy can only lead to a
worsening of deficit. Alternatives must available to the local
bodies to augment their resources to enable them to implement
the functional decentralization in the urban sector.
Some Positive Developments

While there is still a lot to be done in terms of capital market
funding of the urban sector, some positive developments are
clearly evident. Attempts are being made to make the ULBs
develop the required commercial outlook for private funding.
Different models of financing are being tried, such as direct
access of capital market through the issue of municipal
bonds (ULBs of Ahmedabad, Bangalore, Hyderabad, and
Ludhiana), implementation through the setting up of an
SPV (Tirupur water supply and sewerage project), BOOT
and BOT arrangement (Bangalore water supply), state level
urban development funds (TNUDF), and tax intercept
concept for loan servicing of ULBs (in Madhya Pradesh).
MUNICIPAL CREDIT MARKETS

COUNTRIES
IN
DEVELOPING
In developing countries like India, municipal credit markets

have been slow to develop, because the risks of municipal
lending have been difficult to identify, and even more difficult
to limit except through government guarantees. Many
Municipal Development Funds sponsored by multilateral
institutions have experienced unacceptably high loan loss
rates, frightening away potential private-sector lenders. The
credit experience of these arrangements varies widely. The
non performing assets (NPA) rates were as high as 90 per
cent (Calcutta Metropolitan Development Authority), 85
per cent (Kenya Local Government Loan Authority), 57 per
cent (Honduras Banco Municipal Antonomo), 28 per cent
(Indonesia Regional Development Account), and 11 per
cent (South Africa Local Authorities Loan Fund). Within
World Bank programmes alone, default rates on municipal
loan projects have ranged from 0 to more than 90 per cent.
This variation provides a good basis for assessing the factors
that contribute to municipal credit risk and creditworthiness
in terms of market development.
Financial markets have found it difficult to use municipal
budgets and municipal financial reports to gauge underlying
financial condition so as to assess the credit risks involved
in municipal lending. This situation needs a change for two
important reasonsthe immense investment backlogs that
local governments face and the continuing decentralization

of service responsibilities. Some developing countries have
been able to involve the private sector in direct municipal
lending. Other countries have created specialized financial
intermediaries whose job is to raise financial resources from
the private sector and lend them to local authorities.
Municipal borrowings are more market determined and
streamlined in countries that use bond markets to allocate
municipal credit. For instance, in the USA, specialized
institutions like independent credit-rating agencies and bondinsurance firms have developed that are paid by market
participants to perform part of the task of assessing and
reducing credit risk. In these countries, central government
regulators have a critical interest both in ensuring that
individual municipalities take on prudent risks in borrowing,
and in establishing a national framework that will reduce
credit risk for the entire municipal sector.
The conceptual basis on whether to raise resources through
bonds or bank borrowings is discussed in Box 6.4.1. The
general agreement is that without pooled financing, it would
be worthwhile only for large entities to directly access the
markets to avoid the cost of intermediation. More importantly,
there is an interesting insight that with high risks, junk
bonds may be preferred to bank borrowings and, as the risk
falls further, the preference is for investment grade issues.
We make a strong case for the ULBs to access the capital
markets for debt funding, either through loans or bonds.
Both these options are attractive in the current scenario of
declining interest rates. The use of municipal bonds would
be highly beneficial as an initial public offer (IPO) and as
a debt swap exercise to reduce the interest burden. This debt
swap could include swapping high cost debts of ULBs from
banks and financial institutions and even multilateral lending
institutions. Although it may be argued that few ULBs have
taken exposure to banks, most have some form of multilateral
borrowing. The actual cost of multilateral loans works out
higher on account of the cascading effect of the loan being
transferred from the centre to the state and then to the
ULB, thus adding to the cost of intermediation. In an era
of changing interest rates (interest rates declined by more
than 300 basis points in FY 2000 to FY 2002) a bond issue
for a period of, say, 7 years, not in the form of a plain vanilla
product but with structured features would be a viable
capital market access option.
HISTORY
OF
MUNICIPAL BONDS
IN
INDIA
An important beginning towards a fully market-based system

of local government finance was made in 1997, when the
Bangalore Municipal Corporation for the first time issued
municipal bonds of Rs 125 crore with a state guarantee.
This was followed in January 1998, by the Ahmedabad
Municipal Corporation (AMC) which accessed the Indian
141
capital market without a state guarantee. It issued Rs 100

crore in municipal bonds to partially finance a Rs 489 crore
water supply and sewerage project. See Table 6.4.1 for some
details of these issues.
In most cases, the bond proceeds were used to fund water
and sewerage schemes or road projects. Overall, the city
governments have so far raised about Rs 700 crore from the
domestic capital market via municipal bonds. This is an
insignificant proportion of the Indian debt market. The
debt market in India now has trading systems in place
including micro structures such as market makers providing
buy and sell quotes, an anonymous and transparent computer
based order book driven system, a system of margins, demat
and custodians and the latest, listing of government debt
for retail trading on the stock market. It is significant to
note that most issues of municipal paper so far have been
without a government guarantee and not all have opted for
the tax-free status. The status of the Indian municipal market
lays bare the phenomenal potential that is untapped when
one considers the developments in the USA, where municipal
bonds account for almost 80 per cent of the volumes in the
bond market.
Tax Free Bonds

The budget of FY 2000 permitted the ULBs to issue taxfree municipal bonds. Subsequently, interest income from
bonds issued by local authorities was exempted from income
tax. The Government of India issued guidelines for issue of
tax-free municipal bonds in February 2001. In the budget
of FY 2003 the limit of municipal tax-free bonds was
increased from Rs 200 crore in FY 2002 to Rs 500 crore
in FY 2003. The budget also proposed the setting up of a
Pooled Finance Development Fund (PFDF). The objective
of this fund is to support state initiatives to establish pooled
financing structures, provide technical support and credit
enhancements, and leverage urban reforms.
Pooled Financing
Another method of funding being advocated is pooled
financing. While, only financially strong, large municipal
corporations are in a position to directly access capital
markets, most small and medium ULBs are not able to
access capital markets simply on the strength of their balance
sheets. The cost of the transaction is a significant barrier.
In the USA and elsewhere, small local bodies can pool their
resources and jointly access the capital market. The
Government of India decided to create a similar vehicle that
enables capital investments to be pooled under one borrowing
umbrella. The pooled financing works because of the value
addition through portfolio diversification and because
monitoring costs to the retail investments are reduced when
carried out appropriately. The Tamil Nadu Urban
142

Box 6.4.1
Bank Loans: The Conceptual Basis and Implications
The development of municipal credit markets will accelerate the process of capital market funding of ULBs. For this purpose, it
would be useful to consider 2 models on municipal credit markets, namely, the bank lending model used in western Europe, and
the municipal bond model used in North America. Depending on the countrys socio-economic environment useful elements from
each model could be selected. Municipal credit markets may start with either of the 2 models but typically end up with both models
serving different segments of the markets.
THE PRINCIPLES
OF
BANK LENDING
Municipal bank lending is premised on 3 principles. First, bank funding is relationship banking. In other words, banks strive to
establish lasting and stable relationships with their clients. Experience has shown that relationship banking is most useful to small
municipalities and businesses that need to be assisted from project preparation to financing and implementation. Second, banks
perform the function of delegated monitoring. It is possible for individual savers or a group of savers to go directly and lend their
funds to municipalities. However, it may be inefficient for a given saver to try to monitor the financial condition and performance
of this municipality except in the case when the loan is large. Thus, it makes sense to delegate this monitoring and intermediation
function to a bank which has the advantage of knowing the client better through the stable relationship nurtured from the start.
This active monitoring by the bank also enables it to initiate talks on loan restructuring whenever it detects that its clients are
in financial distress. Bank operations are characterized by bundled services and bundled pricing. These banks, which usually enjoy
legal monopolies and interest rate subsidies, offer a host of related services under one price and are not usually priced individually
to reflect the corresponding cost of providing them. Normally, the cost of these goods may be subsumed in the spread between
its cost of funds and the lending rate or through a government subsidy. Credit assessments are used for deciding when a loan should
be made and how big it should be but rarely to assign a risk premium to a specific borrower.
In developing countries where banks have had little or no history of relationship banking with local bodies, the effect of a financial
deregulation has meant lending to ULBs as commercial banks. The experiences of borrowing from the commercial banks for
infrastructure places the banking system at a significant risk due to the use of short-term loans to finance long-term projects.
In western Europe, banks lending to municipal clients have acted as their financial advisers and have helped them in preparation
of their budgets. Moreover, they typically hold the municipalitys deposits and manage their financial accounts. Legal provisions
initially protected this special relationship between bank and municipality. For example, the Municipal Bank of the Netherlands
(BNG) had a legal monopoly for local government lending. In India, bank funding of ULBs has begun on a modest scale and
encouraging results are emerging from certain cities, such as Vadodara and Surat in Gujarat.
THE BOND MODEL

The nature of the municipal bond market model contrasts with the 3 principles of the municipal bank lending model. First, in
place of relationship banking, the municipal bond model is based on competition. Although municipal underwriters strive to maintain
a long-term relationship with their clients, each bond issue is subject to competitive bidding that results in large savings for large
and established municipal issuers. This model, however, is deficient in serving the lending needs of smaller and inexperienced local
governments, as would be the case in India.
Second, the municipal bond model is based on public monitoring as opposed to the delegated monitoring of municipal bank
lending. In municipal bank lending, the creditworthiness of municipalities is assessed by bank loan departments using in-house
methods to analyse proprietary information. In contrast, in a municipal bond market the creditworthiness of municipalitys hinges
on the public disclosure of municipal financial information.
Third, the bundled services that a municipality receives from a municipal bank are typically unbundled in a municipal bond
market. ULBs can decide to receive their financial advisory services and technical assistance from various institutions that are different
from the municipal bank. Each of these unbundled services can be purchased on a competitive bid, which has the likely effect
of lowering project costs.
In conclusion, perhaps one could infer that there is no need to choose a single instrument as the best way to help ULBs access
capital markets. It is desirable to promote simultaneously both models in the short run. In the long run, however, the policy rationale
justifies according the priority to development of bond markets given that the public monitoring and public disclosure required
for efficient bond market operations are consistent with the need for greater corporate governance and transparency of local
government finance. In a competitive market environment, bonds offer more opportunities for tapping institutions and households
long-term savings.
LOANS
AND
BONDS
IN THE INDIAN CONTEXT
Bank loans and bonds have certain common yet vastly differing features. The characteristics can set the necessary background for
the ULBs quest for capital market funds. The first difference is in the size of funds under the two instruments. While bank loans
can be small, bonds have to be substantially large. This requirement may perhaps cater to the larger corporations, as generally it
143
is believed that for other ULBs the fund requirement is not more than Rs 20 crore annually. This makes bonds a viable proposition
aside from the large corporations, only in the case of pooled financing, where smaller municipalities come together thus reaping
economies of scale. So far the individual bond offerings by ULBs in the Indian market have been by large city corporations. Regarding
the size of the issues there has been a variation. The amounts have ranged from a low of Rs 18 crore to Rs 125 crore per issue.
If there is an optimal size of a bond issue given that fixed costs and other things are constant, then the small size of the bond
issues in some cases have been on account of other objectives, such as getting a credit rating, testing market appetite, and introducing
market discipline in functioning. Bonds are for longer tenures that match the requirement of urban finance unlike loans, which
are for shorter tenures and can get bound by limits on industry exposures and prudential norms. Bonds have limited payment patterns
as compared to the flexibility of loans. While there are other differences such as standardized credit rating, no restrictions on use
of proceeds, large number of investors and transferability and liquidity in case of bonds, the most defining reason for investigating
the need for bonds for the ULBs is that on a total cost basis bonds are cheaper compared to loans and, hence, would be the better
option for ULBs. This is in light of the Tenth Plan observation that market borrowings are not yet a viable alternative for ULBs
in India.
In selecting the instrument the crucial issue is the credit risk of the ULB in question. So the first important decision for a
ULB would be to take a conscious decision (helped by its credit rating) of whether to access the capital market via bonds or bank
loans. Empirical studies of the advanced economies have shown that given the different levels of risk it may be more optimal to
either raise bonds or bank loans. The same theory could be applied for the local bodies in India, since a wide variation in credit
risk among the more than 4000 ULBs is anticipated.
It is important for policy makers, lenders, and borrowers to understand the determinants of these instruments. Capital flows
mediated by banks and the bond market pose different systemic risks. Borrowers, which rely on bank loans, are exposed to a higher
liquidity risk because banks can withdraw their money at short notice. Bonds, on the other hand with a longer tenure are harder
to restructure because of the large number of participants and also on account of the absence of a sharing clause as exists in syndicated
loans.
SOME THEORETICAL BASIS
FOR
SELECTION
OF INSTRUMENT
In a statistical model that builds on Diamond (1991) framework, it has been suggested that the choice of a debt instrument among
others is a function of borrower creditworthiness. In particular as credit worthiness improves, borrowers are likely to switch to bank
loans from junk bonds. As creditworthiness improves further, borrowers switch back to the bond market, this time issuing investment
grade bonds, reflecting the now lower level of risk. This result hinges on the fact that a good reputation induces borrowers to choose
safe projects and thus eliminates the risk for monitoring, while a bad reputation makes it impossible to provide incentives to ensure
the choice of the safe project via monitoring.
The model shows that even without differentiated reputation costs, the above result holds as long as there is a fee for bank
intermediation (monitoring cost in Diamonds framework). This model is static as it assumes the exogenous costs of default and
loan cancellation as same for all borrowers and not linked to reputation, but have to be positive to sustain borrowing.
This paper has found support for both moral hazard and adverse selection in capital markets. Rajan (1992) emphasizes a different
trade-off in the choice of debt instruments. Monitoring allows the bank to discontinue the project when the NPV becomes negative.
However, since the bank cannot commit to funding with a positive NPV, the firm in question must pay a premium to the bank
to continue. This amplifies moral hazard, as there is no incentive to increase the project payoff. Bolton and Freixas (2000) add
equity to the choice set and show among other things that if the supply of loans is large, equity will disappear and high-risk firms
will borrow from banks while low risk firms will issue bonds.
THE INTUITIVE MODEL

In a dynamic version of the model, Diamond (1991) endogenizes the cost of reputation and argues that reputation cost is the main
reason for the high-risk and low-risk borrowers to issue bonds and the moderate-risk borrowers to access banks. This holds true
even in a static model with an exogenous and constant cost of default which may be interpreted as a reputation cost.
Banks can limit their risks through monitoring, and can, hence, offer funds at a lower rate. However, monitoring has a cost
aside from the costs that banks have to incur on account of regulation such as the mandatory CRR/SLR. Hence, borrowers face
a trade-off between the lower risk premium and additional costs of bank loans compared to bonds. Different borrowers resolve
this trade-off differently. For the low-risk borrowers, they do not need to be monitored. Hence, the cost of financial intermediation
outweighs its benefits making them opt for the lower cost bonds. For the moderate-risk borrowers, monitoring can reduce the risk
of a loan and thus, the risk premium. This makes a bank loan more attractive to this set. For high-risk borrowers, adverse selection
is important. The bank which is unable to reduce risks even after monitoring will charge a premium for risk. In a situation of
asymmetric information, the rates become high for the low-risk borrowers as well and the market disappears due to adverse selection
(Stiglitz and Weiss 1981). Safe projects get priced out of the loan market for a larger number of cases than they get priced out
of the bond market. As a result high- and low-risk borrowers issue bonds and moderate-risk borrowers rely on banks.
144
Development Fund (TNUDF) has raised a Rs 30.4 crore

bond issue by pooling 14 municipalities proposals for
commercially viable infrastructure projects has made a step
in this direction.
Structured Products by ULBs

The municipal papers issued so far have been in the form
of structured products, as their rating has been based on not
just project recourse basis but on the basis of credit
enhancements through escrowing of additional revenue
sources, normally octroi or property tax. Escrowing strong
financial inflows has enhanced each issue (Table 6.4.1).
If the ratio of escrowed revenue to total revenue is considered
then the financial risk of a ULB becomes evident. In the case
of Bangalore this ratio was as high as 65.3 per cent followed
by Nashik at 59.1 per cent, both issues of Ahmedabad at 51.9
per cent, and Hyderabad at 50.2 per cent. This meant that
almost 50 per cent of their total revenue was being used as
collateral for a single issue. This would impact their flexibility
in financing other projects. Though, not many ULBs have
opted for municipal bonds, the Indian debt markets have
already seen the beginning of municipal bonds incorporating
derivative features such as call/put options.
An example is that of Ahmedabad Municipal Corporation.
In April 2002, the AMC issued secured, non-convertible
redeemable tax-free debentures for a period of 10 years on
a private placement basis. The bond has a call/put option
at the end of the fifth year. The interest rate for the first
5 years is 9 per cent payable semi-annually; and the rate for
the next 5 years is linked to the prevailing bank rate. The
issue size was Rs 50 crore with a right to retain oversubscription up to Rs 50 crore.
Tamil Nadu
A successful example of a structured bond is the bond issued
by the Municipal Corporation of Madurai (CoM). This was
different from the others because it was issued to refinance

an existing project. The corporation built a 27 km, 2-lane
inner ring road between Kanyakumari and Melur. The project
was completed in October 2000 at a total cost of about
Rs 43 crore. The original financing of the project was a
Rs 14 crore grant from the state government (considered
as equity contribution by the CoM) and a Rs 29 crore loan
from the TNUDF. The CoM decided to refinance the
project through a private placement of bonds. The proceeds
would be used to meet part of the balance fund required
for the project and to replace the TNUDF loan. The interest
rate of the TNUDF loan was 15.5 per cent whereas the
bond issue of Rs 30 crore was at 12.25 per cent payable
semi-annually. This debt swap to repay the higher cost
TNUDF loan with the bond market issue would save the
corporation an annual interest payout of about 3 per cent
resulting in an overall saving in excess of Rs 8 crore. Another
landmark issue has been the Rs 30.4 crore raised by TNUDF
on behalf of the 14 municipalities in Tamil Nadu through
the pooled financing mechanism. It is the only issue of its
kind in Asia and internationally it is being cited as a successful
model for a replicable case study. For the purpose an SPV
Water & Sanitation Pooled Fund (WSPF) was set up to
issue the bonds. The issue proceeds would finance small
water and sanitation projects in 14 locales. The bonds have
a face value of Rs 1 lakh each, 9.2 per cent annual interest
rate, 15-year maturity, and redemption in 15 equal annual
instalments, and are puttable/callable at the end of 10 years.
This is the first municipal issue in India with a 15-year
maturity. While the bonds were unsecured, a multilayered
credit enhancement mechanism was set up. The ULBs were
to set apart monthly payments equal to one-ninth of their
annual payment into escrow accounts they hold, and transfer
the same during the tenth month into the WSPFs escrow
account. If the ULB payments were insufficient, the WSPF
may withdraw funds from ULB bank accounts where tax
collections are remitted and/or directly intercept state transfer
Table 6.4.1
Structured Products from ULBs
City
Amount (Rs cr)
Placement
Guarantee
No
14
Octroi (10 collection centres)
45.7
State Govt.
No
No
No
No
No
No
13
13.514
13
14.75
12.25
9
8.5
65.3
6.3
27.6
59.1
25.1
6.2
50.2
Yes
State govt. grants & property taxes

Water & sewerage taxes & charges
Property tax & water charges
Octroi (4 collection centres)
Toll tax collection
Property taxes of 2 zones
Non-residential property tax,
prof. tax, town planning surcharge
& stamp duty surcharge
NA
Ahmedabad (1)
100
Bangalore
Ludhiana
Nagpur
Nashik
Madurai
Ahmedabad (2)
Hyderabad
125
10
50
100
30
100
82.5
Private/
Public
Private
Private
Private
Private
Private
Private
Private
10
Private
Indore
Source: Wilbur Smith Associates.
Interest (%)
NA
Escrow (ER)
ER/Tax
Revenue (%)
NA

payments. The second charge is the creation of a Bond
Service Fund (BSF); a state funded Rs 6.9 crore-reserve
fund (equal to about one and a half times annual debt
service) set up before the bond issue would then be tapped.
This fund would be liquid securities held by WSPF. The
third level of security would be a USAID guarantee of 50
per cent of the bonds principal through Development Credit
Authority (DCA) to replenish the BSF if needed. The issue
was privately placed (Table 6.4.2).
Table 6.4.2
Private Placement of the TNUDF Pooled Financing Bond Issue
Subscriber
Karnataka Bank
ICICI Bank
City Union Bank
Guj. Industries Power Co. Ltd. PF
Metlife Insurance PF
Total
Amount (Rs crore)

20.0
10.0
0.25
0.11
0.05
30.41
Source: Project Note No. 31, May 2003, Indo-US FIRE (D).
Besides the strong escrow mechanism with government

guarantee, a key to its success was that all projects pooled
demonstrated collection of user charges and or fixed fees
from citizens. The majority of the proceeds were disbursed
to ULBs in January 2003, in the range of Rs 16 lakh to
Rs 547 lakh. Most are using these proceeds to refinance
TNUDF loans at lower interest rates.
This issue has been important for a variety of reasons.
It has demonstrated a successful model of pooled financing
in India. It has thrown open the possibility of enabling
smaller municipalities to access capital market funds at
competitive rates. The 14 ULBs forming a pool had an
incentive to come together. For the ULBs in the pool having
a positive net-owned income the incentive was to get funds
at 9.20 per cent as against their earlier borrowing at 12 per
cent. Also their requirement in terms of size was not large
enough to access the markets on their own. The ULBs with
negative net-owned income had an incentive to join the
pool on the strength of their project revenues than their
general revenue account as this was the only mechanism
allowing them access to market funds at competitive rates.
As a beginning this model is a landmark in initiating the
smaller ULBs to capital market funding. However, in the
strict sense of the term this model would not comply with
a market-based mechanism of raising capital market funds.
This is on account of the government guarantee as well as
the USAID contribution in the escrow mechanism that
provided a strong credit enhancement. As an interim measure
this model is appropriate till the ULBs develop market
rigour and discipline and are able to attract market funds
on their inherent strength.
DEVELOPING
THE
MARKET
FOR
145
MUNICIPAL PAPER
Given the different dimensions of the 2 economies, namely,

India and the USA, on almost all parameters the same
model may not be replicable but may require modifications.
The advantages of using municipal bonds to finance urban
infrastructure are increasingly evident to policymakers in
emerging economies, some of whom are undertaking efforts
to accelerate the development of municipal bond markets
in their countries. Many of these efforts use the strengths
of the US municipal market as a guide to suggest the kinds
of market characteristics necessary to attract issuers as well
as investors to the marketplace. Features of the US market
are often difficult to recreate in these countries in the short
run, but policymakers are using a variety of innovative
techniques to approximate essential market characteristics.
Factors of Success
The important features that have led to the success of
municipal issues in the developed countries have been clearly
identified. The strong demand conditions for municipal
paper have been on account of: investor familiarity and
confidence backed by a long history of legal and procedural
protections (there is a separate board for municipal rules in
the US); ability to trade securities on account of an active
secondary market (liquidity); freedom to invest for both
institutional or retail investors on account of absence of
government controls for the most parts; acceptable return
on investment buffeted by tax-exemption; strong credit
quality enhanced by strong tax supported revenue streams
or through creation of separate corporate issuers (SPVs);
extensive disclosures by issuers supported by standardized
systems of legal and financial reporting; and the establishment
of intermediaries such as rating agencies and consultants to
aid the process of information dissemination.
The supply of large volumes of municipal paper has been
aided by the following factors: low costs of borrowing (tax
exemption, competition amongst underwriters/trustees), and
the existence of a master document for underwriters in the
US; long-term debt amortization; assistance to the smaller
local bodies through bond banks and pooled financing; and
responsible self-regulation with focus on disclosure of
information.
The Demand Pull for Bonds

This came with investor familiarity and confidence. In the
USA, the holders of bonds are largely retail and surveys
show that investors voted these bonds as safe investments.
Interestingly the share of households has increased sharply
since the 1980s while that of the institutional investors,
namely banks and insurance companies has declined.
146
Not Yet Retail in India

In India, the debt markets whether government securities
or corporate paper is predominantly institutional. Similarly,
the municipal bond issues that have entered the market
have been placed institutionally and on a private placement
basis. The only issue, which went partly public, was the first
bond issue of the Ahmedabad Corporation, which offered
25 per cent of the total amount, or Rs 25 crore. The public
and, in particular, investor regard for municipal government
is low, making it difficult to convey that a particular
municipality is solid with low credit risk. In fact, local
capacity to recover costs of urban services from user charges
such as water tariffs is very weak in most cases.
In order to attract investors, it becomes necessary for the
borrower to make its credit profile attractive to prospective
investors about the efficiency of investment and safety in
terms of debt servicing. The municipal credit rating process
partly achieves this. In case of India, we have witnessed the
range of rating from a high of LAA+ (SO) (Hyderabad) to
A (SO) (Bangalore) indicating the differences in credit
quality. Whereas the financial situation of some
municipalities is strong enough to make bond issuance
feasible, cities are still hampered by the lack of a strong
financial history and by the overall view in the market that
they are not viable or bankable entities that can attract
investment capital on a competitive basis. Moreover, few
undertake the kind of economic development planning that
is common among their US counterparts, as there are little
direct benefits to gain in an environment in which tax
revenues must be shared with higher levels of government.
As municipal governments improve their services, it is also
possible to instil a higher level of willingness to pay the taxes
and service charges required sustaining these services. On
the other hand, it is more difficult in India, as everywhere
else, to inspire confidence in municipal government and its
demands for greater revenue before the quality of service is
upgraded to the satisfaction of taxpayers. No ULB in India
has entered into any agreement, which would specify the
quality of service or a periodic review of user charges.
Investor demand in the US has also been the result of lower
risk on account of private-bond insurance. Almost half the
bonds issued today are insured by private insurance companies
for timely payment of interest and principal. The borrowing
ULBs need to pay a premium for this cover, which adds to
their cost but creates confidence in investors. In India we
are yet to see this market emerging.
A Phase of Development
The confidence of the US investor has been buoyed by a
long history of legal and procedural protection. The issues
are underwritten and a master agreement has been created
for underwriters. There exists a separate regulator, the

Municipal Securities Rulemaking Board, that defines rules
for the entire sector. However, during the 19th and 20th
centuries, it was very much a developing country market
facing many of the current problems faced by developing
countries in creating capital market funding options for
ULBs. At the turn of the century local government debt
in the US excluding the debt of states was 50 per cent higher
than the federal government. This high growth in local
government debt revealed cracks in the credit system. Periodic
recessions led to bond defaults. In these situations foreign
investors sought protection from both the federal and state
government citing the reason that the local bodies were
within their boundaries. The courts rejected this argument.
The state governments, on the other hand, tried to limit
their exposures, mandated voter approval for general
obligation bonds and established debt ceilings for local
bodies. To further limit risks many states formally amended
their constitutions to prohibit state assumption of municipal
indebtedness. In India there is no separate regulator for the
municipal sector and neither have we established debt
ceilings.
Bankruptcy Laws
Parastatal lenders would benefit from a well-defined legal
framework for loan recovery in case of default. An important
differentiating factor sharply in favour of ULBs is that unlike
other borrowers, municipalities cannot go out of business.
Therefore, it is more likely that some kind of adjustment
or restructuring will be negotiated. A good example is the
handling of the US$100 million default by the New York
local government to Chase Manhattan Bank in February
1975. The crisis was stemmed by the lending banks, state
legislature, and the municipal employees collectively creating
a bail-out package, as they realized that the default by the
ULB would have a higher cost than the actual bail out.
Clarity on State Guarantee

A lender to an issue will find comfort in a well-defined legal
or political process that clarifies what happens in the event
of default. One issue involves the priority of claims as between
lenders, municipal employees, vendors, and other creditors
during default. Another issue involves the role of the state.
Often, it is perceived that municipal debt carries an implicit
guarantee from the state. The process should involve sufficient
enforced fiscal discipline to reduce credit risks throughout
the municipal sector by making clear to municipalities the
importance of responsible credit management. The legal
rules surrounding collateral and guarantees have similar
importance. Clarity with respect to the conditions under
which a lender can claim payment of a loan guarantee or

foreclose on collateral helps reduce municipal credit risk.
The setting up of the asset reconstruction companies in
India is an important step in this direction.
Comprehensive Policy is Lacking

In India, we do not have in place a comprehensive municipal
finance policy, which would address the range of financial
conditions, found within the municipal sector and would
identify ways to provide a basic level of resources to
governments of all means. It also might include multi-year
estimates by sector of the level of demand for finance by
local government, and identify appropriate funding sources
for these demands, including both local and central
government contributions, private finance, and privatization,
taking into account the dual objectives of equity and financial
market development. A good municipal finance policy could
provide direction and transparency and lay out roles and
expectations for the central government, the municipal sector,
and the private sector in the municipal finance field. Few
countries have in place a municipal finance policy as
comprehensive and transparent as that described above
(South Africa is one exception). What is more common is
a patchwork of policy statements and laws that guide
municipal finance, which may be contradictory and out of
date. This is especially true where significant fiscal
decentralization is taking place as in India. The legal
framework for municipal bonds is poorly developed in many
new markets and the legal exposure of local governments
is not well understood. Underdeveloped disclosure
requirements add to the potential for liability, especially
where retail investors are involved.
Role of Liquidity
An instrument can be liquid through structuring, such as
having call and put options. However, the main liquidity
is imparted only when it can be traded actively in the
secondary market. In India, this attribute can be seen in the
case of central government paper and some state debt paper.
This factor is missing in the case of municipal bonds. The
only bond that was listed for secondary market trading was
the Nashik municipal issue. As has been argued in a large
number of platforms, this is perhaps the single most
important issue that can create markets or demand for
municipal paper. The efficiency of financial markets is
partially related to the volume of transactions taking place
within them. Emerging markets have a very small number
of transactions initially, thus making it difficult to develop
investor interest and transactional skills. New strategies,
such as the refinancing of existing public projects, may offer
ways to increase market volume. Given the importance to
activating this market the RBI has issued a series of measures
147
to deepen this market. Apart from strengthening further the

system of PDs, the entire market design has been put in
place for debt paper. This includes trading in demat,
formation of the Clearing Corporation of India Ltd. (CCIL)
for providing counter guarantee and, most important, the
launching of the negotiated dealing system on NSE aimed
at providing an anonymous transparent system of trading
in debt. This is available for all market participants who
have a current and SGL account with RBI. The CCIL
promoted by major banks, financial institutions, and primary
dealers, is going to be a key market infrastructure to
significantly improve market efficiency and integrity. It will
also put in place strong risk management measures since it
will be acting as the central party offering settlement
guarantee in respect of clearing and settlement. To offer the
settlement guarantee CCIL will insist on its members entering
a contractual arrangement through appropriate legal
documentation. With RBI functioning as the settlement
bank the settlement risk will be completely eliminated. The
CCIL and NDS would together introduce transparency,
market efficiency, and nationwide markets and investor
protection. In the first phase, this screen-based facility has
been made available for dealing in call money, notice/term
money, government securities, T-bills, repos, CDs, and CPs.
In the second phase this would cover derivative products
such as interest rate swaps and forward rate agreements. The
listing criteria for securities on the WDM segment of NSE
have been specified as per the issuer. An important issue of
reforms, which could help kick-start the secondary market
activity in non-government debt, is the proposal to expand
the list of securities for repo transactions. Given this spurt
in reforms aimed at developing the debt markets, it would
perhaps be an opportune time to interlink the municipal
securities in this process.
The Incentive Paradox

A financial instrument such as a municipal bond succeeds
in a market not on principle, but because buyers and sellers
(and others involved in its issuance and sale) have an incentive
to keep it availablesellers, because it is a cost-effective way
to raise funds, and buyers, because the risk and return are
at least as good as for other investments in the market of
similar term, and other intermediaries because their
involvement in its issuance and sale is profitable. Just
establishing the array of institutions necessary to issue and
sell bonds does not create a municipal bond market; the
market is the complex set of incentives that allow the process
to take place on a self-supporting basis. For private
institutions to assist in the development of these markets
there must be adequate financial returns. For creditworthy
municipalities to be willing to graduate to market finance
from concessionary finance, there must be incentives as
148
well, in terms of access to a larger pool of funds, lower

interest rates or, perhaps, other forms of encouragement
from the central government. Alternatively, creditworthy
municipalities who could borrow privately will try (and
often succeed at) accessing concessionary financing instead,
and the pace of market development will be slowed. In
India, we need to work on creating incentives at all levels
of the market.
Globally, there is freedom to the investors to invest in
municipal bonds with no restrictive directives from the
government. In India, the selling has been mainly through
the private placement route and the government is attempting
to create a retail market for its issues by mandating 5 per
cent of every government IPO issue to be reserved for the
retail investors. The municipal issues in the developed market
offer acceptable return on investment with tax exemption.
In India, the issues have so far offered rates, which are
market related and higher than sovereign paper as can be
seen from the data available in the Table 6.4.3.
The municipal issues listed above have been for a period
of 7 years except in the case of TNUDF (pooled finance
bond), which is for a period of 15 years. Hence, the yield
on 10 year G-Sec may not be strictly comparable, but can
be used as the average for a long-term risk free loan for
comparison. As can be seen from Table 6.4.3 some ULBs
have raised money at fine prices (Ahmedabad 1) while some
have raised bonds at high costs (Nagpur). What is interesting
is that both the issues were structured products, with similar
rating, except for the differences in the amounts raised.
However, majority of the issues were taxable and it is only
in the budget of 2003 that the tax-exempt amount has been
raised to Rs 500 crore. In the US, the tax-exempt status is
the main driver of retail interest (World Bank). The credit
quality of our issues, which have been in the nature of
structured products, have been strengthened by escrowing
strong and reliable revenue streams from the general budgets
of the ULBs. The bond issues of the Madurai ring road and
the pooled financing of the 14 municipalities in Tamil Nadu
by TNUDF was executed through the formation of an SPV
to ensure credit quality. Regarding disclosures, the private
placement in India has allowed it to be less rigorous. Public
disclosures in the US too improved in the wake of the
financial crisis that hit New York City in the mid-1970s.
Subsequent to the crisis the municipal finance officers
association and the public securities association adopted
voluntary disclosure norms. These guidelines comprehensively
identified the kind of municipal financial information that
should be made available to the public before a bond issue
could be sold, and recommended standardized formats for
presentation. Later the disclosure guidelines became
mandatory and were regulated by the government.
Municipalities are now required to report any change in
their financial or legal condition as long as bonds are
outstanding. In India, we are still to reach this stage of
voluntary disclosures.
Standardization in Financial ReportingThe Need

In the absence of standardized systems of legal and financial
reporting, the process is still maturing. The rating agencies
and the rating process in India are fairly developed and
standardized, with CRISIL, ICRA, and CARE having rated
almost 35 ULBs till date. We also have consultants who act
as intermediaries between the capital market players and the
ULBs.
The Supply Push

The supply of large amounts of municipal paper in the US
has been aided by certain factors. The costs of borrowing
through the municipal bond route have been lower on
account of tax exemptions and competition amongst
underwriters and trustees. The US markets have been exposed
Table 6.4.3
Coupon Rates on Municipal Bonds
Municipality/ULB
Ahmedabad (1)
Bangalore
Ludhiana
Nashik
Bangalore
Kanpur
Madurai
Ludhiana
TNUDF
Nagpur
Ahmedabad (2)
Hyderabad
Source: IL&FS
Year
Amount (Rs cr)
Coupon (%)
Jan 1998
Nov 1998
Sep 1999
May 1999
Aug 2000
Dec 2000
Mar 2001
Jun 2001
Aug 2001
Nov 2001
Mar 2002
Mar 2002
100
125
17.8
100
10
50
30
2
106.1
31.1
100
82.5
14
13
14
14.75
12.9
13.5
12.25
13.5
11.85
13
9
8.5
10 yr. G-Sec yield (%)

13.3
12.2
11.6
11.7
11.4
10.9
10.3
9.3
8.9
7.8
7.4
7.4
Premium over G-Sec (%)

0.7
0.8
1.4
2.3
1.5
2.6
1.95
4.2
2.95
5.2
1.6
1.1

to long-term debt amortization. In India too, the maturity
profile of the debt paper has been growing with the maximum
tenure of 30 years at present. In the case of municipal issues
the maximum tenure of the debt paper has been 15 years
(pooled finance).
In developed countries, institutional investors such as
pension funds, insurance companies, and endowment
companies finance infrastructure either through direct private
placements or through bonds. In India too, this can be
possible if policy measures allow these entities to invest in the
long gestation projects in proportions that are higher than
their current sectoral limits. Comprehensive changes would
be required in the institutional segment of contractual savings
and the debt market. This would be crucial for expanding
the size of the market as also the secondary market for debt.
CONCLUSION
Our urban areas need improvements necessitating huge
investments. For the purpose, the allotted planned funds are
149
negligible leaving the local bodies with no other option but

to access the capital markets. In India, the capital markets
are fairly developed and active particularly in the debt
segment. The important issue is the medium of access,
whether loans or bonds. Partisans of bank lending and
municipal-bond markets have debated which system better
satisfies the financing need at lower cost. There is no reason
to opt a priori for one of these over the other. Bank lending
can operate simultaneously with a vibrant municipal-bond
market. The same municipal financing system and basic
legal structure can support both markets as long as neither
system is subsidized preferentially. The optimum situation
would be competition between the 2 systems, which would
lower the cost of borrowing for the ULBs and increase the
flow of information about credit quality. Given the aim to
reach a higher growth trajectory for the economy, a concerted
approach to encourage and enable capital market
participation in urban infrastructure would be critical and
a vibrant and deep secondary market for debt would help
accelerate the process.
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152
REFORMS IN ELECTRICITY
7.1 TARIFF POLICY IN THE ELECTRICITY SECTOR: A REVIEW

Ajay Pandey
As per Section 3(1) of the Electricity Act 2003 (referred to

as EA2003 or the Act, hereinafter), recently passed by the
Parliament, the central government is required to formulate.
National Electricity Policy and Tariff Policy. While the role
of the central government in formulation of such policies
itself is debatable considering 2 levels (central and state) of
independent regulators in place, the thrust of this section
of the chapter is to review the Preliminary Discussion Paper
on Tariff Policy prepared by the government with the
assistance of CRISIL, a rating and advisory agency. Besides
the desirability of having a tariff policy being specified by
the government, the content of the tariff policy is also an
issue. The Electricity Act uses three distinct terms related
to tariffs. These terms are policy, methodology, and
determination. The tariff policy, as per the act, is to be
notified by the government (Section 3(1) of the EA2003)
and the regulators are supposed to determine tariffs (Sections
61 and 62 of the EA2003). On these two terms, there
are possibly no ambiguities. However, the third term,
methodology, has been used in the act in the context that
the state regulators would follow the methodology followed
by the central regulator (Section 61(a) of the EA2003).
Normally, this would imply that the tariff policy notified
would be broad enough to let the central regulator evolve
appropriate methodology. As we review the preliminary
discussion paper on tariff policy, it becomes clear that the
paper also covers methodology for tariff determination in
substantial details.
Any review of the tariff policy has to keep in mind the
current regulatory framework on tariffs and the fact that
the sector is currently in transition and is perceived to be

unviable due to the extent of transmission and distribution
losses. Currently, the tariff regulations by the central and
state regulators are determined independently. The EA2003
envisages state regulators to follow the methodology of the
central regulator, which in turn is expected to be guided by
the tariff policy notified by the central government. While
this arrangement is suitable for the sector given the integrated
grids, it could raise contentious issue of statecentre
relationship. Given the widespread implications of tariff
policy formulated by the central government in the context
of EA2003, the discussion paper is essentially a precursor
to the tariff policy which is likely to be adopted and, hence,
assumes importance.
The discussion paper covers tariff policy for each of the
three sub-sectorsgeneration, transmission, and distribution
separately. It also suggests different approaches for
determination of tariffs for each of these sub-sectors.
Accordingly, we review the position taken in the discussion
paper for each of the sub-sector separately and in the end
summarize the implications of the proposals in the discussion
paper for the sector as a whole.
GENERATION TARIFFS: EXISTING REGULATIONS

A good starting point to compare generation tariffs outlined
in the discussion paper is the tariff order of the Central
Electricity Regulatory Commission (CERC) passed in
December 2000. This order itself is based on the then
prevailing framework for determination of tariffs for central
Reforms in Electricity
sector generators such as National Thermal Power
Corporation (NTPC), National Hydro Power Corporation
(NHPC), North Eastern Electric Power Corporation
(NEEPCO), etc. It was pointed in the India Infrastructure
Report 2002 that the CERC failed to address certain anomalies
in the prevalent framework despite acknowledging them
while passing its tariff order for the period 20014 (fiscal).
Before reviewing the position taken in the discussion paper
on tariff policy, it would be probably interesting to review
and critique existing tariff regulations (Pandey, Ajay 2002).
Currently, the generation tariffs for central generators are
two part tariffs. One part is essentially to let the generating
entity recover its fixed costs in case it was adequately available
for generation, when required. The other part of the tariff
is (or rather should be) for allowing the generation entity
to recover its variable costs depending upon how much
electricity it produced (but not for simply being available).
Tariffs are structured this way so that the fixed (and sunk)
costs do not determine which generator is asked to generate.
The optimal or merit order dispatch in case of 2-part tariff
is based on the variable part of the tariff and not on the
total tariff. But merit order may well be violated when the
two parts are effectively reduced to a single part (Box 7.1.1).
In case of thermal generation, for example, the fixed part
of the tariff would allow the generator to recover interest
on debt (including interest on normative working capital),
return on equity, depreciation, and fixed operating and
maintenance (O&M) expenses. The variable part of the
tariff in this case would be predominantly based on fuel
consumed for generating availability. In case of hydroelectricity, the variable part would be practically non-existent.
Despite having predominantly fixed costs, the 2-part tariffs
for hydro-generation, in earlier tariff framework (before the
CERC order of 2000), assigned return on equity, interest
on normative working capital and O&M expenses to the
variable part of the tariff, called energy charge. While the
capacity charges for thermal generation are determined by
the sanctioned or approved capital costs, the energy charges
are based on operating norms such as heat rate and secondary
oil consumption. The O&M expenses allowed were earlier
based on the capital cost of the project with provision for
153
escalation of these costs due to inflation. In the tariff order

of 2000, however, CERC allowed O&M expense recovery
through tariffs for thermal and hydro generation on the
basis of the average annual actual O&M expenses incurred
during the previous 5 years (reference years), suitably escalated
to take into account the effect of inflation. By linking the
base of O&M expenses with the actual O&M expenses, it
is probable that imprudent O&M expenses incurred in the
reference years have been accepted as normative O&M
expenses.
Rate-base and Depreciation Anomalies Result in Higher

Tariffs
Within the framework of cost-of-service regulations for
electricity generation, as it exists today, there are anomalies,
which have crept in and have continued despite
acknowledgement of some of these by the CERC in its tariff
order of 2000. The return on equity investment in a
generating station is recovered every year on the initial
equity base despite recovery of depreciation through tariffs.
Ever since the Independent Power Producers (IPP) policy
was formulated in 1992, the tariffs for IPPs and, later,
central sector generating entities are based on return to
equity every year on the basis of initial equity. In reality, if
the debt is not being repaid completely by the amount
recovered as depreciation the generating entity earns return
on the cash so collected. If the entity is in electricity
generation, this amount can be invested in another project/
station where the amount would be counted as equity and
would earn returns as well. Similarly, if the debt for the
project or station is repaid early and exceeds depreciation,
then de facto equity of the entity in the project increases
without any returns on the same. In essence, a generating
entity can increase its effective returns in the existing
framework by using long-term bullet repayment debt, if
feasible.
It is obvious from the discussion above that the effect of
allowing returns on initial equity throughout the life of the
project on increased returns to equity is intimately linked
with the depreciation allowed. The higher the depreciation
Box 7.1.1
Is Merit Order Being Violated Today?
Despite having 2-part tariffs for generation for a long time as suggested by the K.P. Rao Committee, it is not certain that the
dispatches and trading in electricity is based on the underlying principles. As the fixed charge is converted to price per unit, it
is likely that the players consider the total tariffs (fixed part as well as variable part together) while trading amongst themselves.
This is quite likely if the auditors and players do not distinguish the sunk costs related to buying of capacity and the incremental
costs of operating a generation plant. The problem is aggravated if it is possible to avoid paying capacity costs or if there exist
capacities, which have not been committed upfront. For example, if there exists a plant which has low capacity costs and high
operating costs but whose total tariffs are low then such a plant would be preferred by everyone over another plant whose capacity
is not yet completely committed even if it is more efficient. This would be a violation of merit-order.
154
allowed, the more would be the returns for the equity

investor in case he chooses to take long-term debt.
Recognizing this, CERC, in its tariff order of 2000, allowed
depreciation on lower rates, as prevalent before 1992 and
as given in the Electric (Supply) Act of 1948 originally. The
rates prior to 1992 were based on expected life of the assets,
whereas in 1992 and 1994 they were revised upwards. The
accelerated depreciation allowed by the policy changes had
the effect of increasing the effective return to equity investors
of the generating entities. This policy was possibly aimed
at attracting private investors for IPPs but had undesirable
effect of increasing generation tariffs, albeit indirectly. Besides
increasing effective return to the shareholders of generating
entities, allowing accelerated depreciation also raises intergenerational equity issues. In case the generating station is
expected to have a longer useful life than what is implied
by the depreciation rates, the depreciation to be recovered
through tariff would not be there in the later part of plant
life and tariffs would be considerably lower. This begs the
question as to why the current generation of consumers
should pay for the benefit of the future generation of
consumers. Even though CERC lowered the depreciation,
it allowed the affected entities to levy a surcharge to meet
the deficit created in their cashflows due to reduction in
depreciation rates. The surcharge collected was allowed to
be invested as equity but was excluded for computation of
returns on equity.
Different Capital Structure Across Stations Result in

Unfair Tariffs
Another anomaly, which has continued in the tariff
regulations since 1992, is that the computation of equity
for each project or station is based on internal resources
generated by the investing entity. This means that an entity
operating two or more generating station would have different
mix of equity and debt for each of its stations for tariff
determination even though the risks faced by creditors and
shareholders are determined by the risks of all stations put
together. Application of diverse debtequity mix across
projects, results in unfair tariffs for the beneficiaries of those
projects, where the equity so computed is higher in proportion
to debt as compared to the average proportion of equity to
debt. Another fallout of separate treatment of debt and
equity in the existing regulations coupled with recovery of
taxes on actual basis through tariffs is that there is no
incentive for the generating entity to optimize its capital
structure (proportion of debt and equity) and tax payments.
A Mix of Cost-plus and Incentive Regulations

As far as the incentives to improve efficiency are concerned,
current regulations have normative operating norms on
heat rate, secondary oil consumption, etc. An entity,

therefore, can save and earn higher returns if it were to do
better than the norms specified. Other than the operating
norms, there are incentives and disincentives for higher
station plant load factor (PLF). Full recovery of fixed costs
is allowed only after a station has been operating at a certain
minimum availability. Incentives, however, are usually
available to the generating entity for operating its station
at more than a certain PLF or making its station availability
above a certain target. The only other item, which is
incentivized, is the working capital, for which interest is
computed on normative basis creating an incentive to keep
the working capital to a feasible minimum. As is evident
from the discussion so far, while there are incentives and
disincentives built into the existing regulations for operating
norms, availability/PLF, working capital, there are no such
incentives and disincentives on capital costs. The capital
costs are a large part of the total tariffs (in case of hydro
generation, almost all costs other than O&M costs are
capital costs) and current regulations rely on prior approval
of these costs before allowing them to be recovered through
tariffs. While prior approval may limit the extent to which
such costs can be charged through tariffs, it does not create
any incentive for the entity to keep the capital costs to an
efficient minimum. The O&M costs are still incentivized,
as they are based on past costs, though the norms might
have been relaxed by the CERCs order making actual O&M
costs as the benchmark O&M costs. In effect, the current
regulations are a mix of cost-of-service and incentive
regulations with capital costs guided by the former and
other costs being guided by the latter approach.
PROPOSALS
FOR
GENERATION
On a positive note, the discussion paper proposes to

rationalize the fixed costs for hydro-generating stations unlike
the present scheme of regulations (Para. 5.1). Some of the
capital and fixed costs were earlier designated as energy
charges in case of hydro generation. This would result in
lowering of the energy (variable) charges of hydro generation,
which in turn would help in scheduling and dispatch of
electricity in merit order. The disincentives for not making
stations available for generation has been continued (Para.
5.3). The returns on equity, as specified for generation subsector in the discussion paper, are proposed to be lowered
to 16 per cent on pre-tax basis from the current level of
16 per cent on posttax basis (Para. 4.5.1). This proposal
is in line with the fall in interest rates (and, hence, in cost
of capital) since the previous rates were specified. However,
the exact level proposed at 16 per cent (pre-tax) return on
equity is essentially an adhoc number without any rationale
or reference to methodology. Keeping the return on pre-
tax basis would encourage the generation entities to do taxplanning, for which there was no incentive earlier as tax on
income of the entity was recoverable from the tariffs on
actual basis. Another sound proposal in the discussion paper
is rationalization of the depreciation rates. While CERC in
its tariff order had already disallowed accelerated
depreciation, the discussion paper also proposes allowable
depreciation of generation plants at the rates specified in
the Companies Act, 1956 for continuous process plants
(Para 4.5.2). The schedule XIV of the Companies Act
specifies 15.33 per cent depreciation on written-down value
basis and 5.28 per cent depreciation on straight-line basis.
Assuming straight-line depreciation rate, the implicit useful
life of the asset is around 19 years, slightly less than realistic
estimate of 25 years useful life of generation plants and
transmission assets.
Rate-base and Depreciation Anomalies Remain

On the negative side, the tariff proposals in the discussion
paper retain some of the anomalies discussed above. First,
the returns on equity would be computed on initial equity
(Para 4.5.1). With the lowered depreciation rates (as
compared to 1992 and 1994 rates), the impact of this
anomaly would be lower but it is conceptually difficult to
defend this proposal for generation and transmission subsectors particularly when it is proposed in the discussion
paper to allow returns on networth1 in the distribution subsector. Second, the current practice of tariffs based on cost
of actual debt and equity for each station for computing
debt and equity has been retained (Para 5.2). Only positive
feature of the proposals in this regard is in specifying 70:30
as preferred debtequity ratio (Para. 5.2). As pointed out
earlier, for an entity with multiple stations, the debtequity
ratio should ideally be the same for all the stations, otherwise
some stations with higher than average equity would have
higher tariffs even though in reality the proportion of equity
and debt is the same. Further, returns allowed to an entity
should be based on cost of capital without any distinction
of debt and equity so that the entity itself can optimize the
capital structure. The cost of capital so arrived at should
be applied to the total capital employed or to depreciated
asset base to compute capital costs. Alternatively, the returns
should be based on a pre-specified capital structure without
regard to the actual capital structure. The existing as well
1 Networth, per se, would not address the anomaly of doublecounting pointed out above as the utility could get return on networth
through tariffs as well as through any excess asset not deployed in
the core business. For example, a utility may have large amount of
financial assets earning returns. This possibility has been eliminated
following asset side approach in the proposals related to distribution
sub-sector. The networth is proposed to be computed by the regulator
to eliminate the effect of any such assets.
155
as proposed framework leads to unfair tariffs for some

beneficiaries of those stations, which have higher than average
equity, as computed for tariff purposes.
It is interesting to note here that CERC itself recognized
these anomalies while passing its tariff order in 2000, as
pointed out earlier. Recently, CERC has once again opened
up the issues related to rate base (gross fixed assets vs net
fixed assets), rate-of-return (ROR) (cost of capital vs cost
of equity), and depreciation in a consultation paper as a part
of the process initiated to fix tariffs for the period starting
April 2004. While CERC is revisiting these anomalies, the
preliminary discussion paper retains them at this stage.
Competitive Procurement may not Result in Prudent

Capital Costs
The second set of issues in the proposals for generation subsector is related to capital costs of the stations. Currently,
the capital costs of such projects are based on sanctioned
costs or pre-approved costs. In addition, because the Central
Electricity Authority (CEA) was required to give technoeconomic clearance (TEC) to all projects (earlier practically
all projects, but recently only projects above Rs 2000 crore
of investment), the capital costs were examined at various
stages. Since EA2003 does away with TEC for all thermal
generation projects, the regulations need to have in-built
safeguards for not allowing imprudent or inefficient capital
costs to be recovered from the consumers. The proposals in
the discussion paper in this regard require the regulator to
approve initial capital costs after taking into account the
capital structure, cost of debt, and procurement of EPC
services through competitive bidding (Para. 5.2). The
discussion paper is, however, silent on whether scope of the
regulators approval includes examination of the choice of
location, technology, specifications, etc.. The discussion paper
further proposes that the regulator shall accept the project
cost approved by an appropriate authority in case of
government-owned projects (Para. 5.2). It is not clear as to
what is meant by appropriate authority as this term has
been used in the Act for CEA (See definitions in EA2003).
If the reference in the discussion paper is to any other
authority within the government, it begs the question as to
why such an approval should be binding on the regulator
for government-owned projects. What would be the incentives
and capabilities of such an authority to keep capital costs
to an efficient minimum? Having pointed this out, it is
important to state that even at present a similar practice
prevails for government-owned projects. The point here is
that any imprudence or inefficiency on the part of one arm
of the government (project agency) should not be evaluated
by another arm of the government (appropriate authority)
but by the regulator. For non-government projects, the
proposal in the discussion paper rely either on competitive
156
bidding in case turnkey award is given or on benchmarking

if separate packages are given (Para. 5.2). In case of large
projects such as generating plants or stations, the capital
costs are sensitive to choice of location, technology,
specifications, contract clauses, etc. The capital costs of any
generation project would depend upon the location, as the
civil work costs are terrain specific. Similarly, capital cost of
water-related utilities depends upon the water source, the
cost of equipment depends upon specifications (and, therefore,
likely competition) and redundancies/ over-engineering in
design and specifications. In such projects, it is unclear how
competitive bidding or benchmarking can ensure that capital
costs are prudent as well as efficient. Even in case of turnkey
engineering, procurement, construction (EPC) contracts,
capital costs can be known with certainty at the time of
award only and, then too, only if there is no default by the
contractor and if no variation clauses are allowed in the
contract. Both these conditions are difficult to envisage in
case of long gestation turnkey awards. Given these issues, it
is clear that some pre-approval of all the design-elements (in
case capital costs are determined pre-completion) that can
affect capital costs and oversight during execution (in case
capital costs are to be determined post-completion) would
be required to ensure optimum capital costs.
Issues in Competitive Tariff-based Generation Capacity

The discussion paper also enunciates the principle of
determination of tariffs on the basis of competitive bidding
on tariffs (Para. 4.1). While this would ensure incentives for
the bidders to keep all relevant costs low, this provision
needs to be clarified. In case of a base load plant, singlepart competitive and deterministic tariffs, which include
both capital and operating costs, with provision for changes
in only fuel costs (based on operating norms), would not
create problems only if fuel costs do not go out of line.
However, in case of a peaking station, it is difficult to
operationalize this principle as no one would bid for or
invest in a plant without a clear commitment on the
utilization of capacity. Therefore, competitive tariff-based
proposal of the discussion paper can be used to attract
investments only for base-load plants/stations. Even if a
base-load station comes up through competitive bidding on
tariffs, there are a couple of issues requiring closer scrutiny.
First, the investment in any capacity needs to be cleared by
the regulator to ensure that the capacity planned will be for
meeting base load requirement. Ideally, this should be done
at the central level to ensure that a base-load plant having
higher variable cost does not come up when an existing
plant with lower variable cost station elsewhere (outside the
state) can meet base-load requirements. Second, if a thermal
plant for base load using a particular fuel (for example,
naphtha) comes up on a long-term contract with a particular
utility, it is possible that ex-post it might be economical to

backdown the capacity due to increase in the cost of that
particular fuel. In other words, it is difficult to be sure as
to which capacity would be used to meet baseload unless
the prices of all the fuels are highly correlated.
Bidding Too has Problems

This brings to focus the possibility of allowing capacity on
the basis of competitive bidding on tariff in 2 parts, capital
cost part (fixed charge) and variable part (energy charge).
Evaluating bids in such a case poses a problem. In particular,
if a bidder bids for lower fixed charge and higher energy
charge compared to another bidder then a robust mechanism
should be required to evaluate the bids. Ideally, such bids
should be evaluated on the basis of total lifetime (over the
life of the capacity) payment to be made to the bidders for
generating the electricity required or for expected generation.
The problem is that the utilization pattern over the life cycle
is not known with certainty to anyone. It does not make
sense to commit for a minimum level of utilization either.
In such a case, the winning bidder is likely to be the one
who has better (or insider) information on likely utilization
of the capacity or can influence better utilization of capacity.
Such a bidder would quote lower fixed charge and higher
energy charge. An easy alternative, which is free from this
problem, is competitive bidding based on the fixed charge
alone. The energy charges could be paid on the basis of
operating norms. This would ensure that no gaming is
possible while bidding, the bid evaluation process is errorfree, and the merit order is preserved in actual operation.
This process, however, puts the burden of fuel choice on
the regulator. This alternative has not been explored in the
discussion paper.
Delicensed Generation and Optimal Siting of Capacity

The choice of location for delicensed generation is also an
issue in the Act as well as in the discussion paper. Since the
optimality of location in generation depends on the total
costs of generation at alternative locations as well as costs
of transmission for a spatially given demand pattern, optimal
choices for generation should be constrained by the planner
(regulator or a planning agency such as CEA). Alternatively,
a firm or contingent transmission plan for the next few years
should be declared by the regulator based on an optimal
capacity addition plan as is common in other countries with
unbundled delicensed generation. Currently, both the Act
and the discussion paper are silent on this issue.
Incentives on PLF Stays

The proposals on O&M costs of generation for plants
operating for more than 5 years are for a benchmark based
on historical averages but for new plants and related to
capital costs (Para. 5.7) the proposals entail escalating O&M
costs in line with inflation as per the existing regulations.
As far as incentives are concerned, thermal pants are proposed
to get 0.4 per cent additional return on equity for every 1
per cent increase in PLF above 80 per cent and this would
be capped at PLF of 90 per cent (Para. 5.4). These proposals
are similar to existing regulations. In case of hydro generation,
the incentives proposed are above 85 per cent capacity index
(Para. 5.4). The operating norms for generation is proposed
to be uniform for all the plants and stations except for a
transition period of 35 years in cases where such relaxation
has been allowed by the regulator (Para. 4.2). These norms
would be determined by the CERC after obtaining inputs
from the CEA (Para. 5.5). This in itself would not be an
easy exercise given the experience of CERC in formulation
of its last tariff order. The inputs provided by CEA were
vehemently contested by the regulated entities and were left
untouched by the CERC in its last tariff order. The proposals
in the discussion paper on operating norms are welcome
nonetheless because once these are accepted as part of tariff
policy, the resistance from some of the regulated entities is
likely to disappear.
TRANSMISSION TARIFFS: EXISTING REGULATIONS

Currently, transmission tariffs are computed line-wise but
are aggregated to have a uniform regional transmission
tariff. The capital costs of transmission assets and O&M
expenses are the 2 major items in determining transmission
tariff. The capital costs allowed to be recovered consist of
depreciation, interest on loan based on actual debt profile
of the project, 16 per cent post-tax return on equity and
interest on normative working capital. The O&M expenses
allowed were earlier 1.5 per cent of capital costs for plains
and 2 per cent for hilly areas, escalated to reflect impact of
inflation on O&M expenses. In the tariff order of 2000,
CERC allowed O&M expenses based on actual expenses of
5 reference years rather than capital costs. The incentives
in transmission tariffs have been based on availability of the
transmission system. Earlier, 1 per cent extra return on
equity was allowed on every 1 per cent extra availability.
CERC, in its tariff order revised the base availability upward
to 98 per cent, provided for 1 per cent extra returns on every
0.5 per cent availability subject to a cap of 4 per cent extra
return corresponding to 99.75 per cent availability.
Rate-base and Depreciation Anomalies

Some of the issues in the existing regulations on transmission
tariffs are similar to the generation sub-sector. These are
related to allowing return on equity based on initial equity
rather than on net worth at the beginning of the year,
157
computation of actual debt and equity for different projects,

and accelerated depreciation. In case of transmission subsector also, the proposals in the discussion paper do not
address these problems and propose continuation of existing
practice except lowering of allowed return on equity to
16 per cent on pre-tax basis from existing 16 per cent posttax returns. Besides the issues related to computation of rate
base and appropriate ROR, there are other issues in existing
tariff regulations, which are specific to the transmission subsector.
Alternative Transmission Pricing Mechanisms and

Problems with Postage Stamp Tariffs
Current tariff regulations in the transmission sector are
called postage stamp tariffs, wherein the transmission tariff
is paid on per unit energy basis irrespective of how long a
beneficiary transported energy or how much transmission
losses were incurred or whether the energy flows caused any
congestion or not. Other possible approaches towards
transmission pricing are: (a) MW-mile tariffs, which take
into account the distance over which energy is transported
and (b) Nodal tariffs, which takes into account losses
(distance) and congestion causing flows. In the latter, the
capital costs are treated separately from short-run marginal
costs due to losses and congestion. These approaches are
better than the postage stamp tariff approach that is currently
used. Besides the pricing approach, another problem with
the existing regulation is that pooling of tariffs at the
regional level results in high transmission tariffs for regions
where the transmission assets are new and/or have temporary
over-capacity. Even though the assets created have utility
for consumers outside the region, only consumers of the
region are charged for those assets. In addition, conversion
of capacity costs into unit charges could also potentially
deter the use of the system by other beneficiaries in such
regions.
PROPOSALS
FOR
TRANSMISSION
The discussion paper proposes pooling of revenue

requirement of a transmission entity for all the assets owned
by it after computing the same line-wise (Para. 6.1). This
is a positive feature as the transmission system should be
viewed by the buyers and consumers as a network resource
and not simply as a pool of segmented lines for evacuation
of power from generating stations. In addition to evacuation
of power, the transmission system offers reliability and
alternative paths for sourcing power, whenever required. An
integrated transmission system can emerge only if the entire
system is willing to pay for the network rather than parts
of the system.
158
Distance-related Costs Included in Transmission Tariffs

In the discussion paper, the transmission tariffs for the
transmission entity are proposed to be recovered through
the following components (Para. 6.2): (a) Use of Network
Charges; (b) System Operation Charges; and (c) Reactive
Power Charges.
The Use of Network Charges would cover both capital
costs as well as O&M expenses of the transmission entity.
These charges would allow the transmission entity to meet
its revenue requirements. The transmission tariffs for this
component, however, would be structured based on distance
slabs to reflect the distance travelled by the energy transmitted
while charging this component from individual beneficiaries.
The System Operation Charges are proposed to cover the
expenses associated with the load dispatch centres and would
be recovered from the users on the basis of energy transacted.
The third component, Reactive Power Charge, is a variable
charge to incentivize management of reactive power by the
beneficiaries through adequate investments in capacitors. In
addition to these, the discussion paper proposes to allocate
transmission losses on the basis of energy drawals and
distance, using the concept of transmission zones (Para.
6.6). The proposals in the discussion paper are progressive
as far as transmission tariffs are concerned. Both the use
of network and transmission losses is based on distance
over which energy is transmitted and is related to the cost
of transmitting energy for a particular beneficiary. In essence,
the changes proposed incorporate the distance factor in the
transmission tariffs even though they do not move the
transmission pricing framework to MW-mile or nodal
pricing approaches. While nodal pricing approach is the
best available framework, it requires willingness to charge
customers the price of congestion as well. It works best if
the spot market for electricity evolves and the consumer
tariffs reflect the spot market prices. Since the EA2003 itself
does not envisage emergence of spot markets, nodal pricing
for transmission tariff may also not be critical. This, however,
also implies that the overall system behaviour would also
be less than optimal economically.
Rate-base and Depreciation Anomalies Remain

Despite some progressive features, as far as capital costs are
concerned, the proposals in the discussion paper are on the
same lines as that of generation and have similar problems.
In case of the transmission sub-sector also, the return on
equity is proposed on initial equity and is conceptually
indefensible (Para. 6.7). Distortionary effect of computing
actual debt and equity for each project in this case, however,
would not be felt, as the capital costs related part of the
tariff would be common to all beneficiaries because of
pooling. The capital costs for government-owned projects
are proposed to be based on the approval by an appropriate

authority, which system suffers from the problems pointed
out earlier in the case of generation (Para. 6.7). The
availability-based incentives which are proposed, are same
as currently available under CERCs tariff order of 2000
(Para. 6.8 & 6.9).
Open Access and Transmission Surcharge

Another issue explicitly addressed by the discussion paper
in the transmission sub-sector is related to open access
envisaged in the EA2003 (Para 6.3). As proposed in the Act,
the consumers would have to pay a transmission surcharge
to avail of non-discriminatory open access till cross-subsidy
has not been eliminated altogether. The exact determination
of the surcharge has been left to the regulators but the
discussion paper caps the surcharge at 50 per cent of the
difference between the existing average tariff for that
consumer category and the average cost (Para. 6.5) of supply
of the distribution licensee. This, in effect, would entail the
distribution licensee bearing 50 per cent of the cross-subsidy
loss. This proposal, if adopted, would increase the pressure
on distribution licensees to retain well-paying consumers
and towards elimination of cross-subsidies.
DISTRIBUTION TARIFFS: EXISTING REGULATIONS

Near Cost-Plus Regime
Tariff regulations in the distribution sub-sector currently do
not have any uniform approach. Even in the states, where
regulators have been in place, different approaches are
followed. In general, however, the approach followed by the
state regulators for setting end consumer tariffs are based
on revenue requirements of the distribution factoring in the
cost of supply and assessed transmission and distribution
losses. While earlier the state electricity boards (SEBs) tended
to under-report these losses, now they have incentive to
inflate them to press for higher tariffs. The extent of losses
and operating inefficiencies are concerns which remain
hidden in present cost-plus regulations and unreliable baseline
loss data. The extent of cross-subsidization across consumers,
its sustainability, unmetered supply, inadequate availability
of state subsidy, and inadequate investments are some of the
other issues in this sub-sector.
DISTRIBUTION PROPOSALS
Road-map towards Price-cap Regulations Specified
For the distribution sub-sector, the proposals in the discussion
paper are not only restricted to the tariff framework but,
in line with the EA2003, include a road-map to reduce data
uncertainty, regulatory uncertainty, and reduction of crosssubsidy (Para. 7.1). In order to reduce data uncertainty, the
proposals entail: (a) using aggregate technical and distribution
(AT&C) losses, which include collection efficiency; (b)
ensuring 100 per cent metering; and (c) verification of
opening level of system losses, base year O&M expenses,
and capital expenditure plan for network augmentation.
These measures, though difficult and time-consuming, are
required, as most of the distribution systems have made
inadequate investments in the past, have problems of
unmetered supply and, therefore, inaccurate assessment of
losses and collection efficiency. In order to reduce crosssubsidy, the discussion paper proposes that the state regulator
should undertake studies to ascertain consumer categorywise cost of supply. With regard to reduction of regulatory
uncertainty, the proposals envisage moving over to price-cap
regulations in the sub-sector after a pre-specified control
period. During the control period, the state regulators should
lay out long-term/multi-year tariff principles which will be
based on a few critical parameters, such as trajectory of
AT&C losses and collection efficiency improvements and
these would be used to determine the aggregate revenue
requirement of the distribution licensee.
The proposals in the discussion paper, by specifying a
move towards price-cap regulations in the long run (Para.
7.1) and laying out a road-map in the interim are welcome.
High-powered incentives such as built-in price cap regulations
as against cost-of-service regulations (as proposed for part
of the generation tariffs) should result in improving efficiency
in the sub-sector. The tariff proposals also do not have any
anomaly associated with the return on equity based on
initial equity, as is the case in transmission and generation
sub-sectors. During the control period, the return on equity
proposed in the discussion paper for the distribution subsector is based on networth (Para. 7.2.2). The capital
expenditure to be recovered through capital costs as a part
of tariff is also proposed to be examined by the regulators
for their prudence and usefulness (Para. 7.2.1).
Another positive proposal in the discussion paper is related
to time-of-the-day tariffs. The discussion paper proposes
(Para. 4.4) that the regulators would, in a time-bound
manner move towards time-of-the-day tariffs for bulk
consumers of electricity. The time frame specified for
consumers with load greater than 3 MW is 6 months from
the notification of the tariff policy and would include
consumers having more than 500 KW load in 2 years.
While this proposal is welcome as it would result in reducing
the peak demand compared to the base demand and,
therefore, lesser capacity for peak generation, the discussion
paper also specifies that the peak rate would be not more
than 1.25 times normal rate and non-peak rates would not
be less than 0.75 times normal rates. The latter proposal
159
is clearly arbitrary as the difference in peak and non-peak

rates should be driven by the elasticity of demand from such
consumers and should be left to the regulators to assess.
The discussion paper also proposes the concept of
regulatory assets in the distribution sub-sector. In situations
when the cost compensatory tariffs are likely to result in
tariff shock to the consumers, the regulator can capitalize
the deficit in revenue requirement and allow it to be recovered
over a period of time (Para. 7.2.7). The cost of purchasing
power as a part of the consumer tariff is proposed to be
passed through to the consumers (Para. 7.2.6). So is the
proposed treatment of excess expenses incurred by the
distribution entity, which are recognized as expenses beyond
the control of the entity (Para. 7.2.6).
Open Access, Wheeling Charges, and Surcharge

Regarding the distribution sub-sector as well, the discussion
paper deals with the issues arising in the context of open
access. The wheeling charges payable to the distribution
entity are proposed on the basis of the cost of pure wire
business of the distribution entity, that is, the revenue
requirement less cost of purchase of power. The revenue
requirement so computed, divided by the units projected
to be sold, would determine the wheeling charges (Para.
7.2.8). The wheeling charges would also take into account
normative losses, which would be different at different voltage
levels (Para. 7.2.8). In case a consumer or class of consumers
receive electricity from a licensee other than the licensee of
the area, an additional surcharge would be payable by the
consumer(s) to recover fixed costs of the distribution licensee
of the area (Para. 7.2.10). The proposals in the discussion
paper also propose a mechanism for profit sharing during
the control period, in case the distribution entity is able to
earn higher than allowed profits. One-third of such profits
can be retained by the entity, one-third to be returned to
the consumers, and the remaining one-third to be used for
tariff balancing through retention as tariff balancing reserve
(Para. 7.2.12).
CONCLUSION
By and large, the proposals in the discussion paper are quite
progressive as far as the distribution sub-sector is concerned.
Even though price cap regulations are not envisaged
immediately, yet by clearly specifying the road map and
insisting on a finite control period the discussion paper
binds the regulators to move towards such a regime. In case
of transmission tariffs also, the pooling of costs for
determining use of network charges and determination of
tariff and allocation of losses on the basis of distances involved
are welcome and progressive features of the discussion paper.
160
This should make transmission tariffs more cost-reflective

than the current postage stamp tariffs. The proposals, if
adopted, would be just a step behind the framework required
for the emergence of electricity markets over the transmission
network. Similarly, insistence on time-of-the-day tariffs in
a time-bound manner should help in reducing peak load
requirements from the system. The problems in the discussion
paper are limited to the proposed framework for computation
of capital costs in generation and transmission sub-sectors,
as pointed above. These anomalies would increase the tariffs
payable by the consumers and intermediaries for these two
sub-sectors. These problems, if addressed could make the
tariff policy robust and act as a trigger for change through
regulators.
Besides tariff policy, a larger problem, that is reliance on
long-term contracts for dispatches rather than purely based
on merit order or through quasi-spot markets, is an issue
which remains a constraint in the proposed framework for
the sector. This constraint in any case has been imposed by
the EA2003 and has been incorporated in the discussion
paper. Besides the specifics of the proposal, the paper also
raises the issue of role of the regulators in tariff matters.
Given the level of details in the preliminary discussion
paper, one feels that the regulators would be merely
administering the tariff policy! This is a complaint that is
likely to come up in the days to come; but it has less
economic rationale even though electricity as a subject is
in the concurrent list of the constitution. After all, once the

idea of a national grid and national level optimality is
accepted, the requirements of integrated planning which is
not only optimal regionally but also across the nation would
mean that the framework for tariffs could not vary much
across states and regions. What can vary are the actual tariffs
and perhaps the norms. The state-level regulators thus may
have to support stranded assets, a possibility which is likely
to arise in the not so distant future when the national
market actually comes about. Caps on taxes and such other
measures are necessary as state governments face the problem
of lower costs of generation outside their states. This should
have been part of the Draft or even the EA2003.
The drive towards markets can be quicker than what is
envisaged. The proposals do not link up the competition
for supply of power (given existing assets) that is likely
because of open access to the competition to enter the
market. For this to become a reality the construction of the
national market for electricity is necessary. Since the open
access envisaged as of now stresses long-term contracts to
bring about choice, the right way to move forward would
be to create a market for differencesvariations over the
contract by the 15-minute intervals. These are some of the
tasks that lie ahead in the electricity sector. Only then, when
the time-of-the-day tariffs are in place, would the true value
of competitive but an integrated market-based system be
revealed.
7.2 FINANCIAL CLOSURE FOR REFORMS

Uddesh Kohli
The problems of state power utilities are well known.
Most of them have accumulated losses, outstanding loans/
debts/interest and other liabilities which include among
others, provisions for employees pension, provident fund,
gratuity, and other benefits. All this require proper
financial re-structuring after careful analysis, based on
realistic data. The experience of Orissa, the first state
which went in for reforms, has not been very happy and
one key reason for this has been inadequate financial
restructuring due to which the successor companies long
continued to face financial problems. Other states which
have followed Orissa, such as Andhra Pradesh, Rajasthan,
Delhi, UP, etc. may perhaps have learnt from the
experience of Orissa while developing their financial
restructuring plans. If the funding of the liabilities of
these state utilities, and the reform period requirements
of resources are not adequately taken care of, the reforms
will not be successful.
Realistic Assessment of Liabilities

The first step obviously is the correct and realistic estimation
of the outstanding liabilities and the cash requirements
during the reform period. However, lack of data, sometimes
even purposefully misreported data, would be problematic.
Thus there have been inflated billing so as to show less
transmission and distribution (T&D) losses, and corresponding non-realized amount shown as receivables which
obviously are fictious. Even technical and commercial losses
together are generally understated. Second, very little may
be known of the condition of the physical assets. Even
reputed consultants may go wrong. In Orissas case, huge
expenditure was incurred on the consultancies which were
funded by donor agencies such as the Department of
International Development (DFID), UK and the restructuring plans developed turned out to be quite unachievable.
Of course, they were handicapped by non-availability of
realistic data. It goes without saying that consultants have
to analyse thoroughly the data available and look critically
at the assumptions made and the data provided.
Several alternative methods are available for overall
valuation of utilities by the consultants. The data availability
and the situation of the utility has to be kept in view, in
the valuation of assets, and of the utility. Balance sheet
figures of accumulated loses would usually need correction.
Similarly, the estimates of accumulated outstanding
employee benefits including pension, provident fund,
gratuity, etc. have to be closely examined. In some utilities,
the provision for these may not have been made in the
balance sheets and it may be necessary to correct the
figures. The estimates for other outstandings like loans/
interest/creditors/central utilities can be made from the
balance sheet.
The expected cash losses are most difficult to estimate.
It depends upon several factors including the expected
reduction in ATC, mainly theft; assumed levels of efficiency
gain, the demand for power, and the consumer mix. Next
would be the estimate of working capital required.
Rehabilitation Investments
In many cases, the power systems are so run down that
considerable investments in transmission, distribution, and
systems improvement may be needed, in addition to power
generation. The assumptions relating to T&D loss reduction
involve investments on metering and other system improvements. Most of these investments may be required during
the reform period.
Once preliminary estimates of fund requirement during
the reform period are made, these need to be discussed
intensively among all the stakeholders so that the assumptions
are critically examined. The estimates will be more realistic
if these have the acceptance and commitment of all the
stakeholders. Similarly, there must be a clear understanding
on who brings in the required funds.
Owners Financial Responsibilities

The first agency to meet these requirements is the owner
of state utilities, namely state governments. The state funding
could cover:
writing off loans;
taking over fully or in part outstanding liabilities,
including employee benefits, loans, interest, payments to
central utilities;
subsidy to cover cash losses during reform period;
investment requirements possible out of state plan
funds and the money received through privatization;
support for working capital.
The second agency is the central government which has
recently started providing funds to states under the
161
Accelerated Power Development and Reform Programme

(APDRP). Government and APDRP funds are available to
cover: (a) 50 per cent (half grant, half loan) of investment
requirements for approved projects for distribution systems;
(b) incentive grant equal to half of reduction in cash losses
in a year compared to the base year. While (a) can partly
meet investment requirements, (b) can be used for meeting
some of the cash needs during the reform period.
A third agency would be the multilateral/bilateral donor
organizations. World Bank/ADB, etc. have been providing
loans for investment projects, some technical assistance (TA),
grants for studies Asian Development Bank/Department for
International Development, UK/Canadian International
Development Assistance (ADB/DFID/CIDA etc.), and
recently, funds under state restructuring loans to meet some
of the cash requirements.
Fourth, Power Finance Corporation (PFC), Rural
Electrification Corporation (REC), other financial
institutions and banks have been meeting the investment
and working capital requirements to a great extent. Lastly,
some state utilities have also raised funds in the form of
bonds, deposits from consumers and other instruments, as
well as sale of assets.
Both organizations, the PFC and the REC, have been
providing investment and working capital loans. Their loans
also cover the remaining 50 per cent fund needs of APDRP
projects (in addition to 50 per cent funds provided by the
central government). When the state power sector financial
restructuring plans are being developed, there ought to be
intensive discussions with PFC and REC and likely funding
by them should be taken into consideration after relating
these to investment projects and working capital needs.
Their funding should be linked to state power sector reform
milestones which would be a part of an agreed reform
programme.
Huge Resource Commitment

But the fund requirements of state utilities during reform
period are very large. A rough estimate may be over
Rs 100,000 crore for cash needs, and about Rs 150200,000
crore for investment during the next 5 years. This is beyond
the capacity of states. Even in the states taken up by World
Bank/ADB for power sector reforms, shortage of funds
during the reform period has been a major problem. Most
of the funds committed by these agencies have been for
investments. Even here, state utilities have to provide
counterpart funding. The responsibility for meeting cash
requirements is left to the states. In their anxiety to get
multi-lateral funding, often states make commitments beyond
their capacity. Later, when they are not able to provide these
funds, the restructuring plans have to be revised repeatedly
and the reform and restructuring slows down.
162
One should also consider the role of the private sector

promoters who bid for and take over the state power utilities.
If full and realistic information is not provided to them at
the time of bidding, their assumptions will not be correct
and they will run into problems later. As happened in
Orissa, they will be required to provide more funds than
originally anticipated. On the other hand, if central
governments grant funds meant for state utilities would
also go to them, then these need to be identified and factored
in at the time of bidding.
Lastly, one needs to look at the role of the central
government. It is heartening to note that it has started
providing some funds under APDRP. But considering the
large requirement, this alone may not be enough. If reforms
have to be expedited, the central government would need
to provide financial assistance to meet cash requirement
during the reform period, which may be partly as grant and

partly as loan, but it should be determined after critically
examining the total reform period requirement and how
that would be met fully through various sources.
CONCLUSION
For reforms to succeed, it is very important to estimate
realistically the fund requirements during the reform period
and to ensure that these are fully met through various
sources. The financial commitments made by different
agencies would be more like financial closure for reforms
and would provide a solid base for reforms. If such financial
closure is achieved, the reforms will not be hampered or
slowed for want of funds.
7.3 WHY AND WHEN DO STATE GOVERNMENTS REFORM: THE

CASE EXPERIMENTS IN ELECTRICITY IN DELHI
Jagdish Sagar
The losses imposed by non-reform of the electricity sector
are not an adequate force to bring about change and reform.
This is because governments do not respond to financial
losses the way businesses do. Moreover, on a cash basis over
the small time horizon (3 years) or so, according to the
governments consideration, reform would have involved
higher costs. The pressures for reform, therefore, do not
come from tightening budgets but, rather, are political in
nature. When there is a need to do something about a
power situation which has become exasperating for a large
number of people, the political capital that may be made
from correcting a bad situation is the principal driver of
reform.2
The goals of reform in the power sector are commonly
stated in economic termsto make the sector self-sustaining,
incentivizing efficiency improvement, restoring the
effectiveness of price signals, ensuring that any remaining
subsidies are direct and transparent. In practice these goals
will, translate into the simplified objective of finding a
feasible way to distance the government both from regulation
2
At the time of writing, it has been over a year since the DVB
was unbundled and much has happened since then, including
Government of the National Capital Territory of Delhis (GNCTDs)
decision of its own to provide an additional subsidy of about Rs 52
crore (explicitly, and as fixed by the Regulatory Commission) to
maintain the previous years tariff for the majority of Delhis
consumers; this subsequent development is strictly outside the scope
of the present paper but it is consistent with the thesis that financial
considerations were not the driving force of the Delhi reforms.
of the industry and from operational control of it. This is

especially true of the distribution segment which is the
point of interface with consumers and the source of the
whole industrys revenues. The extent of willingness to
relinquish control is, therefore, the best measure of a state
governments intention to reform. In principle, even the
willingness to put suitably qualified persons in charge of the
State Electricity Board (SEB) and allow them to function
with complete independence, under independent regulation,
would be a reforming intention; though of course in practice,
given the realities of our political economy, few would
suggest that reform could be achieved without restructuring
the SEB. In the Indian context, the paradigm case would
be the unbundling of an SEB with the definite prior intention
of privatizing distribution in particular (whether immediately
or as a second stage) plus the transfer of all regulatory
functions to a State Electricity Regulatory Commission
(SERC).
There cannot, of course, be any precise index of such
willingness to reform. A state governments decision-making
is in any case not necessarily a coherent process: the course
of policy may shift and meander with the entry and exit of
different actors3 within the government. It may also be
3 In the case of Delhi, the process from start to finish (1999 to
2002) saw successively 2 ministers, 3 chief secretaries, and 3 secretaries
in charge of the Power Department; however, there was no change
of government (that is, of chief minister) and the same person
continued throughout as chairman of DVB.
influenced variously by such factors as externally imposed
conditionalities for badly-needed financial assistance, or the
prospect of disconnection for non-payment to centrallyowned utilities, and the like. But expressed intentions to
reform in response to such external pressures are likely to
include some element of window-dressing. In Delhi, the
intention to reform was as clear-cut as possible once the
government had (by early 2001) decided to unbundle and
privatize distribution simultaneously, that is, without an
intermediate stage of corporatization. In other cases, where
such an intermediate stage is envisaged beforehand as a
necessary step in the process,4 the intention to actually
distance the government from operational management of
the power industry has to be considered as being contingent
or hesitant, at least until the final step has been taken.
THE DVB
The Delhi Vidyut Board (DVB) came into existence as an
SEB in February 1997, succeeding the Delhi Electric Supply
Undertaking (DESU), which had handled Delhis power
supply since 1958 as a wing of the Municipal Corporation
of Delhi. DESU in turn had succeeded the earlier Delhi
State Electricity Board (DSEB) that had been set up in
1951. Organizationally though, DSEB, DESU, and DVB
alike were afflicted with the hierarchies, procedures, and
work culture of similar government utilities in other states.
These changes in legal status were not accompanied by any
significant changes of personnel. Performance in terms of
the key parameter of (T&D) losses5 deteriorated from the
mid-1970s, and very sharply in the 1990s, apparently
correlating quite remarkably with the establishment of a
Legislative Assembly and the elected Government of the
National Capital Territory of Delhi (GNCTD) in 1993.
The organizations general image for quality of service and
consumer relations also deteriorated, perhaps touching its
nadir by 1998.
Some features of Delhis power supply situation are:
high per capita consumption by Indian standards,
that is, 1382 kWh per annum in 20012;
generally high rate of load and consumption growth;
sharp diurnal and seasonal variation between peak
and off-peak load, attributable to the climate plus the absence
of agricultural and other possible off-peak consumption.
Also, consumption during the peak seasons (mainly May to
August, and January) has been growing more rapidly than
during the off-peak season. Delhis own generation is limited
4
Which is the usual pattern: Delhi is perhaps the only case where
corporatization and privatization were simultaneous.
5 Unaccounted energy being the difference between energy input
and energy billed.
163
and the scope for expanding it locally is constrained by cost

and environmental considerations so far as coal thermal
generation is concerned, and for the time being (though this
is likely to change) by a shortage of gas. There is, therefore,
an endemic peaking shortage that has to be met annually
by costly bilateral arrangements, further increasing the cost
of power;
the presence of a large population in unauthorized
colonies and jhuggie basties (squatter hutments) tends to
offset the advantage of negligible agricultural consumption.
The unplanned character of much of Delhis growth, and
the mismatch between planned and unplanned land use
even in many planned areas, have obvious implications for
power supply as for other services. However, their effects in
respect of the power sector were compounded by certain
provisions of the Delhi Electricity Control Order (DECO)
in force from 1959 (until largely withdrawn in 1999) which
restrained the utility from supplying power to unauthorized
structures or for unauthorized (commercial or industrial)
use. This virtually compelled a very significant proportion
of the population to steal electricity. Thus, in 2001, DVB
estimated that about 14 per cent of Delhis power
consumption was going unmetered and unbilled to
unauthorized colonies and jhuggie basties (mostly to the
former). This factor compounded the utilitys growing
difficulties.
Performance and Reform

DESU and later DVB were notoriously subject to the ills
attributable to political interference and, more broadly, to
political goal setting and the consequent skewed reward
system, that have afflicted most SEBs. The low priority
accorded to commercial performance is also evident from the
fact that even when (down to the early 1990s) DESUs T&D
losses were at relatively acceptable levels, the utilitys retail
tariff was insufficient to cover its costs (Table 7.3.1). But as
this fact itself suggests, it would be wrong to suppose that
DVBs poor financial performance was by itself the primary
driver of the reform process. There is a difference between
mere poor financial performance (as would have been reflected
in the utilitys accounts, if they had been prepared6 or even
as visibly reflected in the mounting dues to central utilities
as well as to the Delhi government itself ) and actual, perceived
inconvenience to the government in power.
LOSSES DO NOT CREATE PRESSURE
FOR
CHANGE
SEBs have actually been able to survive, sliding comfortably

downhill whilst cheerfully accumulating liabilities, for a
6 DESU and DVB accounts were finally brought up to date in
20012, but remain to be audited from 19912 onwards.
164

Table 7.3.1
Commercial Performance of DESU/DVB
Year
19834
19845
19856
19867
19878
19889
198990
19901
19912
19923
19934
19945
19956
19967
19978
19989
1999-2000
20001
20012
T&D
Losses (%)
Collection
Efficiency (%)
Revenue
Realized (Rs Cr)
Net Commercial
Loss (Rs Cr)
Operating
Deficit (Rs Cr)
22.16
21.56
19.00
25.43
30.78
23.49
24.46
22.33
26.50
42.66
41.96
45.27
48.46
48.41
48.61
48.21
47.52
45.64
47.45
82.13
79.62
85.89
87.91
83.05
72.69
72.45
76.73
87.23
89.92
92.42
89.45
87.44
88.10
88.27
88.28
90.8
91.00
90.61
150.36
182.96
288.17
328.23
360.63
456.08
529.09
701.16
865.00
1072.00
1322.78
1555.09
1711.95
1970.19
2699.14
3031.99
90.81
3554.32
4004.73
86.92
100.59
40.74
104.25
226.16
242.20
241.63
208.82
90.96
328.79
245.46
326.55
500.76
709.74
536.31
833.47
3266.75
1104.41
1196.04
63.59
73.92
4.92
52.43
165.81
165.65
199.94
150.98
15.50
216.38
114.14
172.95
354.35
491.81
281.98
502.23
833.93
462.63
248.04
Note: DESU/DVBs annual accounts audited up to 19901; unaudited accounts thereafter.
surprisingly long period. They have not managed to do so

merely on the strength of subsidies. They also have been
surviving by not paying for power purchases (Table 7.3.4)
and not repaying government loans. Not even the extremes
of non-performance and the prospect of severe curtailment
of power supply are necessarily sufficient by themselves to
goad a state government into effective reform. Thus in the
summer of 2003, with electric supply officially available for
a little over 9 hours a day in most of the state, and for only
16 hours a day even in district headquarters,7 Uttar Pradesh
was restricting its own power purchases under financial
compulsion, imposing heavy power cuts and even selling
power to Delhi to improve the short-term liquidity of the
states transmission and distribution utility,8 This was done
presumably because the government perceived the cost and
inconvenience of genuine effective reform as being
incommensurate with the possible benefits, that it could
envisage as accruing to itself from such reform. We must
7 Uttar Pradesh Electricity Regulatory Commission (UPERC)s
Tariff Order of Uttar Pradesh Power Corporation Limited (UPPCL)
for 20034, ch 2. UPERC found that Instead of adopting harsh
measures to improve collection efficiency and T&D losses, the Licensee
appears to have taken the easy route of curtailing power purchase
as a result of which almost all categories of consumers have been
starved for electricity
8 In UP, the SEB was unbundled into a generation company and
a T&D company (UPPCL) in 2000; the next stage of creating
separate distribution companies has, at the time of writing, yet to
materialize.
also make allowance for the fact that a government is very

likely to assess this balance of pain and pleasure with reference
to the limited time span of its own term of office. And for
the nature of motivation and the quality of understanding
and foresight available at the effective decision-making levels
(which may simply be inadequate to the purpose). And
these in turn are likely to be influenced by the prevailing
political culture of the state, within the context of which
those in power will judge the electoral value of reform.
Finally, in practice it is remarkably easy, even in such
circumstances as described, for an SEB to get by for the time
being (which might well be the limit of a governments
concern) with a slight, but more or less promising show of
improvement, which may or may not be more than windowdressing.9
Table 7.3.2 shows the budgetary costs to GNCTD of
continuing with DVB and of adopting the reform package
that was actually adopted. It is in 2 parts, the first showing
all budgetary costs and benefits and the second showing the
cash outflows from the government. A state government is
much more likely to be swayed by the latter than it is by
the former, as it is the latter that actually presents it with
a choice involving an immediately perceptible opportunity
9 This applies equally to an unbundled but still governmentowned distributing utility; since a state government can buy time
by going through the motions of reform, unbundling it into companies
that are subjected to the same malign influences as the SEB is an
alternative.
165
Table 7.3.2
Cost to Government of Delhi under Various Alternatives
Budgetary (A) Cost if DVB without Reform Continued
Years
20001
20012
20023
20034
20045
20056
20067
Plan
Fund
Central Plan
Assistance
Interest Accured
(Re-Loaned)
Special
Loan
Govt. Subsidy
Total
A+B+C+D+E
103.50 **
60.98 **
104.50 **
842.83
693.00
762.30
838.53
922.38
1014.62
1116.08
**
**
**
*
*
*
*
292.59
315.00
326.03
339.07
365.00
392.93
422.99
**
**
**
#
#
#
#
401.04
471.75
523.20
579.80
624.06
692.55
767.88
**
*
*
*
*
*
*
1639.96
1645.23
1611.53
1757.40
1911.44
2100.10
2306.95
Budgetary (B) Cost After Reforms

Years
20001
20012
20023
20034
20045
20056
20067
Cash Flow
(Repayment
of Loan
Interest)
Grant (For
Pension Trust)
Loan (With
4 Years
Moratorium)
Transco/
Genco Plan
Investments
Assistance to
DVB to Liquidate
Outstanding
Dues of DVB
Total
B+C+D+EA
0.00
0.00
0.00
0.00
0.00
0.00
414.00 #
860.00 **
21.00 **
5.58 ^
1364.00
1260.00
690.00
138.00
0.00
**
**
**
**
209.00
200.00
200.00
200.00
200.00
**
**
#
#
#
142.00
120.00
120.00
120.00
120.00
120.00
**
#
#
#
#
#
1002.00
1714.00
1585.58
1010.00
458.00
94.00
Cash Outflow (A) if DVB without Reform Continued

Years
20001
20012
20023
20034
20045
20056
20067
Plan Fund
Central Plan
Assistance
Special Loan
Govt. Subsidy
Total
A+B+C+D
103.50 **
60.98 **
104.50 **
842.83
693.00
762.30
838.53
922.38
1014.62
1116.08
**
**
**
*
*
*
*
292.59
315.00
326.03
339.07
365.00
392.93
422.99
**
**
**
#
#
#
#
1238.92
1173.48
1088.33
1177.60
1287.38
1407.55
1539.07
Cash Outflow (B) after Reforms

Years
20001
20012
20023
20034
20045
20056
20067
Cash Flow
(Repayment
of Loan
Interest)
Grant (For
Pension Trust)
Loan (With
4 Years
Moratorium)
Transco/
Genco Plan
Investments
Assistance to
DVB to Liquidate
Outstanding
Dues of DVB
Total
B+C+D+EA
0.00
0.00
0.00
0.00
0.00
414.00 #
860.00 **
21.00 **
5.58 ^
1364.00
1260.00
690.00
138.00
0.00
209.00
200.00
200.00
200.00
200.00
**
**
#
#
#
142.00
120.00
120.00
120.00
120.00
120.00
**
#
#
#
#
#
2175.48
1714.00
1585.58
1010.00
458.00
94.00
Notes: All figures are in Rs cr. Actually, DVB was unbundled w.e.f. 1 July 2002. These statements ignore the period 1 April 2002 to
1 July 2002.
* As per proposals submitted by DVB to GNCTD in December 2001; ** Actuals; # Estimated; ^ Balance of Rs 886.58 cr., to be paid
by GNCTD; Includes cash outflow to DVB, as it continued to exist in 20012.
166
cost. Costs that do not involve any present cash outflow are,
in practice, likely to be ignored for years together: Howsoever
grave their long-term implications may be, these are painless
costs. Again, those costs that have become a regular annual
feature in the budget10 are unlikely to be scrutinized unless
there are special reasons for doing so, as when the cost
increases suddenly. We may call these costs, which the
government is likely to take for granted, normal costs.
Of course, when there is a very severe overall shortage
of resources all costs may become painful. However in such
a case a State Government will, at least initially, try to meet
the crisis by restricting costs that are neither normal nor
painless. In such a situation, if reform involves an immediate
cash outflow, it will not appear attractive even if it promises
substantial long-term benefitsunless, of course, it is made
a condition for much-needed financial assistance. Reform
that starts with such financial assistance may indeed be
sincerely intended, but should be looked at with some
caution since in practice the lender may find it difficult to
ensure that it really takes place, and the State Government
may be able to buy time with assurances and a show of
improvement.11
BUDGETARY COSTS
OF
Annual Plan Loan

Delhis power system requires quite heavy capital investment
every year just to keep pace with the rapid growth of load
and consumption (that is, even without necessarily improving
the quality of service). The annual plan loan for capital
expenditure accounted for a very significant proportion of
the territorys Annual Plan. Although in principle this was
a loan, it had never been repaid and it was quite well
understood in practice that it never would be. In the event
of unbundling with privatization of distribution, the annual
capital investment in distribution would cease to be the
governments responsibility and, assuming that the reforms
did achieve financial viability, any future plan loans for
the generation and transmission sectors would be repaid.
It would also be possible for the new generation and
transmission entities, assuming them to be as creditworthy
as DVB was not, to raise funds for capital investment from
financial institutions, thus freeing yet more of Delhis annual
plan resources for other purposes. This, again, was in the
category of normal costs. Table 7.3.3 shows Annual Plan
expenditure broken up between generation, transmission,
and distribution, and as a proportion of the total Annual
Plan expenditure.
NOT REFORMING
The costs of DVB to GNCTD included (a) diversion of

Delhis Central Plan Assistance by the central government,
(b) annual plan assistance to DVB, which was in theory a
loan repayable with interest of about 12 per cent; (c) nonplan assistance, also in theory a loan, given on an ad hoc
basis from time to time; (d) the mounting dues from
previous loans, none of which had ever been repaid, the
amount repayable each year being treated as a fresh loan;
(e) mandatory subsidy payments).
Non-Plan Assistance
Fresh non-plan loan assistance to DVB was given only at
particular times to meet with particular situations. However,
notional loan assistance, to cover DVBs repayment obligations to GNCTD, increased annually. The two kinds of
assistance are very distinguishable in practice, the latter
being painless and the former decidedly painful. However,
as the former had been necessary only occasionally, it did
not weigh heavily in this case.
Diversion of Central Plan Assistance
Subsidy
Delhis entire Central Plan Assistance (CPA) was being

diverted for direct payment to the Badarpur Thermal Power
Station (BTPS) owned by the Ministry of Power. This was
a clear loss to GNCTD of potential resources for capital
investment, which might be avoided through effective reform
(that is, assuming that the successor entities to DVB would
have the necessary paying capacity.) However, by the time
the reform process began it was sufficiently long-established
to be treated in practice as a normal annual cost.
Before the reform explicit subsidy assistance had been

provided only once. Since the previously existing tariff (fixed
in 1997) had provided for Fuel Adjustment Charges (FAC)12
to be paid only by industrial and non-domestic (that is,
commercial) consumers the Delhi Electricity Regulatory
Commission (DERC) in its Tariff Rationalisation Order
dated 16 January 2001 required GNCTD to pay the cost
of FAC for domestic and agricultural consumers; this
remained operational until the next tariff order became
effective in June 2001, hence, the government paid DVB
a total of Rs 104.50 crore in April and May 2001. This was,
in short, an atypical occurrence and there was no continuing
10
Including capital investments of the kind for which there is

an annually recurring provision in the State Plan, for example, those
for augmentation of the T&D system (as distinct, for example, from
provision for a new generating station, which is a one-time decision).
11 And the lenders motivation might be sufficiently ambivalent
to live with this situation.
12 These charges actually covered increases both in the cost of

fuel for DVBs own generation and DVBs power-purchase costs.
167
Table 7.3.3
Power Sector Expenditure and Shares in Delhis Total Plan Expenditure
Year
19934
19945
19956
19967
19978
19989
19992000
20001
20012
Generation
Transmission
Distribution
All Electricity
Total for All Sectors
57.39
5.92
57.67
5.02
33.03
2.54
10.27
0.55
1.50
0.08
7.39
0.36
68.70
2.99
292.57
9.35
414.70
10.34
120.62
12.44
121.29
10.56
70.08
5.40
53.56
2.85
63.12
3.19
91.16
4.44
74.35
3.24
79.07
2.53
42.06
1.05
131.02
13.51
131.55
11.45
180.33
13.89
257.99
13.72
198.69
10.04
339.44
16.52
336.36
14.64
349.46
11.17
349.54
8.72
309.03
31.87
31.52
27.02
283.43
21.83
321.81
17.12
263.31
13.31
438.00
21.32
479.41
20.86
721.10
23.04
806.31
20.11
969.58
100.00
1149.00
100.00
1298.25
100.00
1879.88
100.00
1978.31
100.00
2054.56
100.00
2298.20
100.00
3129.11
100.00
4009.50
100.00
Notes: The first row for each year gives the amount of expenditure in Rs crore, and the second row give the per cent to total for all sectors
of expenditure of the Delhi government.
burden of subsidy that the government might hope to shed

by reform.13
the Power Finance Corporation (PFC) for loan assistance

for its capital expenditure. And this was not for want of
creditworthiness, since it was in a better position relative to
The Practical Implications

DVBs financial performance in the last two years of its
existence (20001 and 20012) is summarized in Table
7.3.4. Its accumulated liabilities (as in July 2001) are shown
in Table 7.3.5. Nothing that will be said hereafter should
be read as making light of DVBs mounting losses and of
the apparent impossibility of turning it around.14 But against
these realities, if we wish to consider the actual probability
of their motivating an elected Government to reform, we
must weigh the following considerations:
GNCTD was not facing any such pressing financial
difficulties as to compel it to consider divesting itself of
DVB for purely financial reasons. Nor was it compelled to
seek external assistance under terms that compelled it to
make any commitments to reform the power sector. It is
noteworthy that DESU and DVB had never even approached
13
As we have seen (footnote 2 of this chapter) GNCTD postreform as voluntarily decided to give an explicit subsidy: it can afford
to do so when it considers it necessary.
14 If DVBs T&D losses were miraculously to have been reduced
from about 47 per cent (as they were in the last year of its existence)
to about 11 per cent (being the T&D losses of BSES in Bombay)
the resultant revenue gain at the same tariff would exceed Rs 2500
crore giving it a surplus (or a possible saving to the public) of over
Rs 1300 crore in 20012. However, those without experience of the
distribution business often fail to appreciate the hypothetical nature
of this calculation.
Table 7.3.4
Summary of DVB Accounts (Unaudited) 20001 and 20012
Income
Revenue from Sale of Power
Revenue Subsidies and Grants
Other Income
Total
Expenditure
Purchase of Power
Generation of Power
Repair and Maintenance
Employee Costs
Administration and General Expenses
Depreciation and Related Debits (Net)
Interest and Finance Charges
Sub Total
Less Expenses Capitalized
Interest and Finance Charges Capitalized
Other Expenses Capitalized
Sub Total
Total Net Expenditure
Profit/(Loss) Before Tax
Provision for Income tax
Profit/(Loss) After Tax
Net Prior Period Credits/(Charges)
Surplus/(Deficit)
20001
20012
3194.51
0.28
359.44
3554.22
3549.62
104.50
350.61
4004.73
3085.03
364.80
127.65
436.23
62.75
216.04
425.74
4718.23
3402.77
370.03
111.45
429.61
83.12
240.02
707.99
5344.98
24.70
13.67
126.97
130.71
151.67
144.39
4573.68
5209.52
1019.46 1204.79
0.00
0.00
1019.46 1204.79
84.95
8.74
1104.41 1196.04
168

Table 7.3.5
Accumulated Liabilities of DESU/DVB (March 2001)
DESU Period Liabilities (Up to 25 February 97)

Loans to DESU
Loan from GOI
Loan from CEA
Interest accrued and due on loans
Loan from Delhi Administration Plan and Non-plan
Interest accrued and due on loans
Total
Power purchase dues
Energy dues
Surcharges
Grand Total
12953
DVB Liabilities
Loans from GNCTD to DVB Plan
Non-Plan
Interest accrued and due
Total
Power/fuel purchase dues
Energy dues
Surcharge
Total
Liability to Terminal Benefit Fund
Grand Total
Total Liabilities (DESU+DVB)
2078
2317
445
4840
1710
2747
4457
9297
887
10184
23137
126
13
57
2863
726
816
4601
3506
4846
other SEBs, but merely because the funds for capital

expenditure that were available from the State Plan had
always been more than adequate (at any rate, in terms of
the utilitys ability to utilize them).
In any case, reform offered no immediate benefit.
The financial benefits of reform to the government would
begin to flow only a few years after the decision to reform.
The GNCTD was perfectly justified in disclaiming
responsibility for that large part of the utilitys dues that
pertained to the DESU period. DESU, being a wing of the
Municipal Corporation of Delhi, had been under the
statutory control (under the Delhi Municipal Corporation
Act) of the central government in the Home Ministry, and
not of GNCTD. (The break-up between DVB and DESU
liabilities in Table 7.3.5 may be noted in this connection.)
The existence of this unresolved issue not only reduced the
magnitude of the problem of accumulated liabilities but
also provided a justification for delaying any action to address
the question pending its resolution.
When liabilities have reached such astronomical
proportions, it is natural (and correct) to presume that they
will have to be dealt with by some special debt-restructuring
scheme (as has since happened, with the Ahluwalia
Committee Report), or simply be written off. It is obvious
that no utility or state government will ever actually be able
to pay off liabilities on such a scale, hence it will never be
required to do so. In fact, accumulated dues to central
utilities and the central government from DESU amounting

to Rs 1407 crore (mostly interest) were actually waived in
1989, and Rs 1004.10 crore of principal due converted into
a perpetual loan that was 50 per cent interest-free. Under
the current Ahluwalia Report scheme, too, it is only the
principal and 40 per cent of accumulated interest that is
being securitized; the remaining interest is being waived. In
the circumstances, DVB and GNCTD would have had
little practical incentive to begin to discharge part of the
accumulated liabilities even supposing they had been able
to. The utility in such a situation can actually earn a lot
of goodwill simply by paying most of its current dues, as
indeed DVB was doing in its last few years. DVBs operating
loss was not increasing rapidly, rather it would decrease with
the occasional tariff revisions every few years; the balance
sheet looked worse every year mainly because of the
compounding of debt.
We have already remarked that it may be possible to
get by for the all-important time being with just some
apparent improvement in performance. This was certainly
the case with DVB during its last few years, when it was
able to discharge most current dues as it had not been doing
earlier, and as most SEBs were still unable to do (Table
7.3.6). Thus during FY 20012, when NTPC was able to
realize only 76.7 per cent of its current dues overall, its
realization of over 98 per cent from DVB showed DVB in
a very favourable lightmaking any thought of punishing
DVB for its past defaults unlikely, at least for the time
being.
Table 7.3.6
Payments made by DESU/DVB; Power Purchased
and the Payment Per cent
Year
19934
19945
19956
19967
19978
19989
19992000
20001
20012
Power
Purchase Bill
Rs crore
Payment
Made
Rs crore
Payment
Purchase
%
1017.48
1290.13
1551.20
1838.54
2380.08
2714.04
2893.44
3085.03
3369.32
591.84
911.65
1110.96
1321.53
1853.97
1972.62
2770.11
2871.56
3160.29
58.17
70.66
71.62
71.88
77.90
72.68
95.74
93.08
93.80
Finally GNCTD and DVB could always draw comfort

from the circumstance that, as DVB served the national
capital, there would at all times be a special sensitivity about
restricting its power supply or denying it any kind of help
to continue functioning.
While the case for immediate and drastic reform might
in all financial logic be unanswerable, an elected territorial
government might not necessarily see the matter in the
same light. It might well fail to perceive any overwhelming
necessity to disturb the status quo during the short period
of its own term of office, and when the same situation might
be sustained indefinitely by sporadic just enough
improvements in DVBs performance from time to time. It
might have been said of DVB, as it was said of the AustroHungarian Empire, that the situation was desperate but not
urgent. We must, therefore, move on to consider those costs
of continuing with DVB that were not so readily quantifiable,
and also the real and potential costs, as the government
might perceive them, of going in for reform.
169
anywhere in the country), popular dissatisfaction with the

quality of power supply was widely perceived as having had
a major electoral impact. For the new government that took
office in December of that year, electoral defeat would
therefore have appeared as a distinct possibility penalty for
failure to improve the power situation. If the government
were further to be convinced (as in fact it was) that such
an improvement entailed effective structural reform including
privatization, then it would perceive the cost of failure to
reform, and the corresponding potential reward for successful
reform, as decisive.
Image of the Government
NON-BUDGETARY COSTS
OF
NOT REFORMING
The non-budgetary costs of failure to reform would include

the loss of economic activity on account of inadequate or
poor power supply; difficulties (caused by bureaucratic
rigidity, inefficiency, or corruption) in obtaining access to
power supply; the enhanced cost of power because of the
utilitys commercial inefficiency, which specially affects
productive industrial and commercial activities that are made
to cross-subsidize the more politically important consumer
categories; all these have economic effects, and also
implications for the governments revenues. There was also
an added cost of maintaining law and order, because of
disturbances of the peace as a result of power supply failures
(though under the peculiar constitutional arrangements made
for Delhi this remains the responsibility of the Ministry of
Home Affairs and not of GNCTD). There are costs to the
water supply and sewage systems, the functioning of which
depends a great deal on power supply. And there are
administrative costs, including loss of executive time, that
are attributable to the power situation. However, a state
government is likely to perceive all these costs more directly
in terms of inconvenience and of damage to its image; the
decision-making process in Delhi did not adopt any direct
evaluation of reform in terms of social cost-benefit. Social
cost-benefit may form part of the state governments
calculation indirectly, to the extent (itself a variable related
to the working of the political system) that it is reflected in
the anticipated electoral consequences of a course of action.
Consequences of Unpopularity
It would be difficult to try to capture in these pages the
atmosphere of governance in Delhi during periods of severe
power shortages or breakdowns, especially during the summer
seasondemonstrations, riots, headlines; the constant
monitoring of harassed engineers; tense, repetitive meetings,
press releases, press conferences, widely publicized ministerial
site visits, frantic excuse-making at all levels. Eventually in
1998, probably for the first time in Delhi (and perhaps
Delhi is the headquarters of sundry professional, industrial,

voluntary or research organizations, the venue of a
disproportionately large number of conferences, seminars,
workshops, training courses, and the like. It is, therefore,
home to an opinion-forming population which, though
numerically insufficient to be of any direct electoral
importance, is by no means unimportant for a territorial
government in Delhi. The image a government obtains in
this circuit should have a perceptible multiplier effect, not
the least via the media. At a time when the discourse of
reform was gaining ascendancy, the image of a territorial
government that continued shamelessly to own DVB would
certainly suffer in the eyes of this population. And, more
broadly, voters might, and not wholly without reason, put
the commercial and operational deficiencies of DVB down
to its reputed corruptiona stain that in times of serious
discontent would naturally tend to rub off on the government
as a whole.
NON-BUDGETARY COSTS
OF
REFORMING
Against the above considerations, we may weigh what nonbudgetary costs the government might perceive in its decision
to reform.
Not a Mafia
The prospect of loss of illegitimate personal benefits, by an
indeterminate number of individuals, is without doubt a
factor capable of influencing a governments decisions on
reform. Political interference has become a euphemism for
improper influence with corrupt motives. On the other
hand, it is all too easy to succumb to the intellectual comfort
of conspiracy theory and explain the corruption and poor
performance of SEBs by putting them down to some vaguely
designated mafia functioning under political protection
that is projected as the main obstacle to reform. One has
heard it confidently asserted that such a mafia was
swallowing the entire losses of Rs 1200 crore (Table 7.3.4).
170
This is simplistic. It would be a digression to discuss how

corruption operates in SEBs, but it is by no means the only
or even the principal possible source of rent for those in
charge of a state government and for our purposes here it
is best appreciated simply as an aspect of the self-inflicted
role erosion, the sacrifice of power and patronage, that
effective reform in this case necessarily involves.
Concern about such role erosion would also encompass
a genuine apprehension of being left with responsibility to
a sensitive electorate after having surrendered the power
to intervene, especially perhaps where strict commercial
measures need to be adopted, but also more generally.
Moreover, the very inefficiency of organizations like the
SEBs creates an opportunity of interface with the electorate:
goodwill can be earned by getting wrong bills corrected, and
crisis power-supply situations may be seized upon as an
opportunity for visible, hectic activity to establish ones
personal credentials with the public. The apprehension of
role erosion will be more widely dispersed in the case of
electricity distribution than in generation and transmission
both because the nature of distribution activities tends to
give rise to decentralized rents. It also provides local leadership
with one more area of activity. Its importance as a factor
influencing decisions about reform depends both on the
personal motivation of those involved and on their capacity
to impose their decision-making on legislators who, in this
case, may feel directly affected. It will certainly help if they
can convince legislators that the reforms will be electorally
advantageous.
The Tension of Reform

Then, again, the reform process is likely to involve a certain
amount of mindset discomfort, the pain of giving up settled
notions, and that too at a perceived risk. The upward revision
of tariff, which can hardly be avoided in the early stages of
reform, will not be matched immediately by improvements
in the quality of service. The reforms may not work,
privatization may be attacked as a scam, there may be a
very painful transition period with labour unrest, disruption
of supply and popular criticism, the whole thing may prove
counterproductive. These were all very real apprehensions
at a time when relatively few states had taken up serious
reforms in the power sector and it was necessary to innovate
and improvise a reform package in the absence of an
established success model. In Delhi, it is already too easy
to forget how heavily these factors weighed at the time when
the crucial decisions had to be taken.
Budgetary Costs of the Reform Package

The reform package was designed around the overriding
necessity to attract investor interest in the context of the
experience in Orissa, where the aftermath of unbundling

and privatization was unfolding contemporaneously with
the reform process in Delhi over the period 1999 to 2002,
while at the same time providing assurance that the
distribution business would actually turn round within a
reasonable time frame. The Orissa experience was not
developing as a happy one for the investors there. Moreover,
in 2000 the UP governments attempt to privatize the Kanpur
Electric Supply Company (KESCO) fell through for want
of investor interest. The summary description attempted
below presents much too tidy a picture of the whole process,
but this is not the place to recount all the twists and turns
it actually took.15
THE REFORM PACKAGE

The main concerns that had to be addressed were identified
as follows:
Above all else, it was necessary to achieve results well
within the governments term of office, for the reasons that
have been described.
It was necessary to create confidence in the data
provided to investors, after the experience in Orissa where
the T&D losses had turned out actually to be very much
higher than what the investors had been led to believe.
Something would have to be done to mitigate
regulatory uncertainty, since in Orissa decisions regarding
the extent of T&D losses that would be allowed in the
Annual Revenue Requirements (ARRs) filed by the
distribution companies were left entirely in the hands of the
Orissa Electricity Regulatory Commission, which not only
failed to allow reasonable and achievable targets but also
each year, left uncertain what it would do the following year.
It would be impossible for an investor to prepare a business
plan, as the basis for his bidding, if this kind of uncertainty
were now to be repeated in Delhi.
Closely related to the above was the need to provide
for reasonable and realistic annual efficiency improvement
targets, in view of the experience in Orissa where the effective
target for T&D loss reduction in the first year was as high
as about 15 per cent, condemning the distribution companies
to unavoidably heavy losses.
15
Secretariat decision-making depends upon the movement of

a file through numerous channels both vertically and horizontally,
which can be sent backwards or sideways at any time with queries
and observations, unknown to the originator; or simply sat upon.
It is thus both painless and risk-free, even in the face of political
will, for individuals to block or delay any decision. Of course the
survival of such an inefficient method of consultation is itself
significant Honest, useful brainstorming would threaten turf and
hierarchical authorityand, in any case, would presuppose a certain
community of mindset that does not exist in such matters.
Legend
Assets
Liabilities
DVB
2. All the liabilities of DVB are transferred
to Holding Company, entire Equity of
Holding Company is issued to GNCTD
1. All the assets and liabilities of

DVB are acquired by GNCTD
Holding Co.
GoNCT
4. Equity and Debt in the

successor entities, equal to
the value of serviceable
liabilities is issued in favour
of the Holding Company
3. All the assets are transferred from

GNCTD to successor entities. Assets
will be assigned a value equal to
serviceable liabilities
Genco
171
Transco
Fig. 7.3.1
D1
D2
D3
DVB Financial Restructuring
It would be necessary to value the assets without

having up-to-date asset registers or even annual accounts for
the past several years, and without the possibility of waiting
for these to be prepared. It was equally necessary to ensure
that the valuation of assets reflected their earning capacity
and did not impose an undue burden on the tariff.
The new distribution companies must not be saddled
with any of DVBs liabilities, including its receivables.
The interests of personnel to be transferred to the
new companies, particularly the distribution companies that
were to be privatized, must be protected in order to ensure
a smooth transition. Moreover, it was necessary to give
comfort, both to the employees and to the investors, that
the latter would not be responsible for the retirement benefits
of the former.
Finally, it was vitally important to ensure both that
there should be no tariff shock, and that the investors
would be assured of a reasonable return if they achieved
reasonable efficiency improvements.
The main features of the package that was finally evolved
over the period of the reform process, addressing the above
identified issues, were briefly as follows:
The projected time frame of reform did not permit
the involvement of external agencies like the World Bank.
SBI Capital Markets were engaged on the basis of their work
in Kanpur.
Aggregate technical and economic (AT&C) loss, being
the difference between units of energy input and units for
which payment is actually recovered, was adopted as the
measure of commercial efficiency instead of the conventional
measure of (T&D) loss.16 This makes inflated billing figures,

which artificially reduce the declared T&D loss of most
SEBs, irrelevant. (In Delhi, in point of fact, the declared
T&D losses were reasonably accurate since there was no
unmetered billing, nevertheless AT&C loss was adopted as
the efficiency criterion to remove all possible uncertainty).
A business valuation methodology was adopted, based
on projected revenue yields for each of the 3 distribution
companies assuming certain tariff increases, efficiency
improvements, government assistance, and normal cost
escalation. The unserviceable liabilities of DVB were parked
in a holding company and the new companies provided
with clean balance sheets fixed by statutory rules. The
restructuring is depicted in Figure 7.3.1. The serviceable
liabilities of Rs 3160 crore comprised of the equity and debt
(to the holding company) of the new companies.
It was decided to adopt 5-year tariff setting principles
in advance in respect of the one key parameter of efficiency
improvement. Since it did not prove possible to persuade
the Regulatory Commission to adopt such tariff-setting
principles, the objective was achieved by means of statutory
policy directions. At the same time, the vexed and highly
sensitive issue of target fixation for efficiency improvement
was resolved by making the percentage of efficiency
improvement committed by the bidder for each year over
a period of 5 years, rather than a premium on equity, the
16 T&D loss is the difference between units input and units for
which bills are raised. AT&C loss is the difference between units
input and units for which bills are raised and payment actually
recovered.
172
bidding criterion for potential investors. The targets set

were thus justifiable as the outcome of a competitive bidding
process.
To obviate tariff shock, the government committed
itself to providing the transmission company with loan
assistance that would total about Rs 3450 crore over the
transitional 5-year period, diminishing annually as the gap
between acceptable tariff increases and the distribution
companies actual requirements decreased annually with the
projected efficiency improvements (Table 7.3.2). The loan
would be subsequently recoverable through the transmission
companys charges for its service, when the tariff could bear
this burden because of the reduction of AT&C losses that
would have taken place. An additional advantage of this
arrangement was that it would make it possible to maintain
a uniform (across distribution companies) retail tariff, with
differential bulk tariffs for the distribution companies, during
the transitional period. This obviated one potential source
of difficulty for the government, namely, that otherwise one
of the distribution companies serving proportionately more
of the poorer parts of Delhi, where the AT&C losses were
higher, would have a much higher retail tariff.
The governments success in securing acceptance of
the reforms by the employees as represented through the
majority union and various staff associations did much to
smooth the process. The employees had two assurances:
(a) that those in position would not be retrenched, nor
their service conditions altered adversely; and (b) that the
government would, through a trust it would set up, assume
responsibility for their retirement benefits. The latter was
also an important source of comfort for investors while,
since staff costs are not crucial in the viability of the
distribution business in present conditions in India, the cost
of securing the existing employees against retrenchment
was not burdensome. It involved a commitment by the
government to provide funds to the Trust upfront, to meet
the difference between the amount available in the fund
DVB had been maintaining for the purpose and the
amount needed according to actuarial valuation. This cost
of Rs 886.58 crore is shown in Table 7.3.2; the bulk of it
was paid in the financial year preceding DVBs unbundling.
Another cost imposed by the reforms was that, in
future, government departments and organizations would
be under more effective constraint to pay their electricity
bills. Their non-payments were not as acute a problem in
Delhi as in some other states, but the Delhi Jal Board (DJB)
had been consistently in default to the tune of Rs 7 to 9 crore
a month. During the year 20012, in order to create a
favourable environment for bidding, GNCTD provided
additional assistance to DJB to enable it to pay its bills.
During the negotiations with the successful bidders, it became
necessary to make a commitment that GNCTD would
continue to do so, taking responsibility for DJBs electricity

bills whenever DJB failed to pay them in full. Table 7.3.2
provides for an estimated annual cost of Rs 120 crore to
GNCTD on account of greater need to pay for electricity
bills as a result of the reforms.
The budgetary costs of reform as shown in Table 7.3.2
will, it is hoped, be sufficiently clear from the foregoing
discussion. The reforms presented excellent value in
budgetary terms from the third year onwards, but the benefits
would not begin to flow before the third year and would
be significant only thereafter, well beyond the governments
term of office, while in the initial stage they required
additional budgetary provision that the government had to
agree to as being advantageous to it for non-budgetary
reasons.
CONCLUSION
At the time when GNCTD took the crucial decisions that
led to the unbundling of DVB and the privatization of
distribution, it was under no unavoidable, compelling
pressure to do so. DVB was inefficient and unpopular but
pressures on it arising from its continuing losses and
mounting liabilities could have been finessed by a show
of improvement for the time beingwhich DVB did, in
fact, achieve. Second, there was no immediate budgetary
advantage, in the sense of freeing resources for other purposes,
that could accrue to the government during the remainder
of its term of office from unbundling DVB and privatizing
distribution. Rather, there was a budgetary outgo involving
the sacrifice of other possible expendituresand that too
in the year immediately preceding the next election. There
is never any prospect of a governments gaining widespread
approbation (except among economists) for financial reform
per se. Hence, GNCTDs decision to adopt the reform
package would, unless purely altruistic, have to be driven
by the hope of non-budgetary gains. The government
understood that without a genuine turnaround there was
no prospect of improving the quality of service to the level
the electorate expected, that privatizing distribution was the
best means of achieving it, and that it would be a popular
step. It was reasonable to hope that even if it were to take
time for the fruits of reform to materialize, the very fact
that the government had taken decisive steps to reform the
power sector would weigh in its favour in Delhi.
Can the Same Happen Elsewhere?

What wider conclusions can we draw from the Delhi
experience? It does not follow that state governments will
never take any steps to reform the power sector unless
compelled by an angry electorate. Reforms that are made
under external pressure need to be viewed with caution, as
we have pointed out. Nevertheless the collective impact of
such pressures on state governments generally, both directly
and because they also contribute to generating public
opinion, is surely greater than it was just a few years ago.
The establishment of SERCs in most of the major states
over the past few years has not been wholly without effect.
The Ministry of Power is currently attempting the carrotand-stick of the Accelerated Power Distribution Reform
Programme (APDRP) and the scheme for securitization and
partial write-off of past dues, which also involves a new
compulsion to pay central generating utilities under a threat
of disconnection that is somewhat more credible than in the
past. The EA2003 will force the pace of institutional
restructuring, and it is designed to put pressure on the SEB
or its successor licensees to improve their efficiency by
potentially exposing them to competition.17 The outcome
of all this remains uncertain but, if nothing else, it is not
as easy for state governments to resist change now as it was
in the past. And to that extent the environment has already
changed from what it was in 1999 when GNCTD and
DVB began their 3-year journey to unbundling. Finally,
reform might conceivably take place over a period of time
as the cumulative effect of measures adopted in response to
the various influences discussed above, rather than in
pursuance of the conscious decisions of a particular government, as was the case in Delhi.
Nor can we conclude that reform will take place wherever
it is popular. For example, UPERC reports that 8090 per
cent of respondents in Lucknow, Agra, and Allahabad districts
supported the idea of privatizing the utility,18 yet it would
be nave to expect the state government to hasten
privatization in response merely to such a finding. The
electorate is not an otherwise undifferentiated collection of
persons whose response to polling on such an issue will itself
determine the course of a governments policy. The people
who say they are in favour of privatizing power distribution
are not generally identifiable as a coherent political force.
For opinion to get translated into an effective influence on
government policyas it apparently did in Delhi
something more is required. When searching for the
wellsprings of government decision-making, we may have
to think in terms of a number of interrelated influences,
which might (not necessarily in order of importance) include
the following:
1. What is the relative weightage assigned by local
politics to the delivery of services and quality of governance
17 It remains, of course, to be seen how effective this will prove,
within the given political economy, in making government
distribution utilities efficient.
18 UPERC, ibid. UPERC had commissioned a survey by ORG
MARG.
173
in general, as against issues affecting the allocation of resource

to groups or localities, or to questions of identity or other
less rational considerations? The relative political importance
of issues like the quality of power supply will vary according
to the nature and the basis of support that the leadership
feels it would be advantageous for it to seek.
2. State government leadership, and the advice available
to it.
3. The local importance of power supply, which must
vary with (among other things) the level of development
and consequent dependence on electric power.
4. The prevailing climate of opinion in matters of
economic policy (recalling what we said about mindset
discomfort).
5. The SEBs image and its reputationobjectively of
course no SEBs actual performance has been good enough
to make reform unnecessary, but its image depends both on
its performance and on consumer expectations. For example,
DVBs technical and financial performance was not actually
worse than that of some other SEBs which nevertheless
failed to bring on themselves anything like the same degree
of obloquy, their consumers being apparently more tolerant
than those residing in the nations capital.
6. The experience of other states, which influences the
design of the reform package.
7. The states financial situation, which may also expose
it to external pressure to reform.
8. External pressures to reform, including both those
from lending agencies and from the central government.
9. External compulsion to make structural changes such
as those arising out of, and in the form of; new central
legislation.
We cannot thus draw any simple, unqualified conclusions
from the Delhi experience. We may, however, suggest 2
thumb rules: (a) we are unlikely to bring about reform by
convincing a state government about the arithmetic of it.
A government does not think like a business and the V
in its perception of the value for money (VFM) is unlikely
to be budgetary in this case. (b) whatever other factors may
support it, reform is most likely to take place quickly when
the effective demand for better service matters seriously to
the government. Looking back, at the foregoing list, we may
note that the local situation, in respect of items (1) to (5)
was conducive to reform at the relevant time in Delhi and
that sufficed to bring about reform without any of the
remaining possible influences coming to play. That is most
unlikely to happen everywhere.
174
7.4 IMPROVING THE PERFORMANCE OF THE DISTRIBUTION SECTOR: AN

EVALUATION OF TWO APPROACHES
Daljit Singh and Sidharth Sinha
Today we have 2 cases that differ in their approach to reform
of distribution of electricity which we can compare and
contrast. In the case of Delhi, privatization was immediate
and simultaneous with the decision to reform. Events
followed in quick succession19. In Andhra Pradesh the
decision to reform was followed by attempts which continue
with vigour on the part of the successor companies (still
public) to the SEB. The literature on the benefits of
privatization do point to the large benefits in the phase of
the preparation for privatization. In Delhi the process was
dramatic and government was willing to lay out large sums
to initiate change.
ANDHRA PRADESH20
Before comprehensive power reforms were launched in
Andhra Pradesh, the power sector in the state was plagued
by shortages, high losses, and theft (Bhatia and Prasad
2003). As with many other states in the country, political
interference made commercial operation of the utilities
difficult, and lack of transparency in management and
business processes undermined accountability. The result
was that the state utilities were in poor financial health and
put a heavy fiscal burden on the government. Like other
states, Andhra Pradesh would have liked to combine efficiency
improvements with some tariff increases, but political
agitations after previous tariff hikes forced the Andhra
Pradesh government, APERC, and the distcoms to focus on
improving efficiency in order to ensure the financial health
of Andhra Pradeshs power sector without tariff increases.
Consistent with this focus on efficiency improvements,
APERC issues directives to licensees in its tariff orders on
reducing losses, improved metering and billing, and building
sales databases. The Commission meets periodically with
the licensees to review compliance with these directives.
19 See Why and When Do State Government Reform: The Case
of Electricity in Delhi, by Jagdish Sagar in section 7.3 of this report,
for a discussion of the political and other basis for reform in the
current context.
20 In writing this section, we relied extensively on the presentation
made by T.V.S.N. Prasad, then CEO of APCPDCL at the
Brainstorming Workshop on Power Sector Reforms (Prasad 2003).
We also benefited from our meeting with Rama Mohan Rao, Director,
HRD and P&MM, AP Central Power Distribution Company,
Hyderabad. Where not explicitly stated otherwise, data for this
section is based on information provided in that meeting.
However, each distcom is free to choose the approach to

complying with the directives. This has led to a healthy
competition amongst the companies with each distcom
developing its own innovative techniques for loss reduction
and revenue enhancement. In addition, there is crosspollination of ideas with each company learning from the
others.
Strengthening the Legal Framework to Reduce Theft

The Government of Andhra Pradesh amended Section (39)
of the Indian Electricity Act, 1910 to provide tough penalties
for theft of energy (Chatterjee 2003). The measures in the
Act include: (1) a mandatory imprisonment of 3 months
to five years; (2) a penalty of Rs 5000 to Rs 50,000; and
(3) explicit recognition of collusion by staff of the licensees
as an offence (Bhatia and Prasad 2003). In order to enhance
enforcement, special tribunals have been created in each
district headed by an additional district judge. The tribunals
decisions can be appealed to in a special appellate court at
the state level that also handles high assessment cases directly.
Bhatia and Prasad report that the enforcement is further
strengthened by not allowing a stay of the court order unless
the amount due is deposited. Further, the Act requires
disposal of cases in 6 months.
The utilities deployed 2000 inspection teams throughout
the state to launch the anti-theft drive (Bhatia and Prasad
2003). The success of the anti-theft programme can be
gauged by the fact that during 20012, 36,000 cases were
registered, assessments of Rs 30 crore made, and Rs 13 crore
were collected (Chatterjee 2003). In that year, 860 people
were arrested for theft. For the financial year 20023, until
October, 8377 cases had been registered. The effectiveness
of the Act was enhanced by a clause in the Act that allows
a one-time voluntary disclosure. The state machinery was
mobilized to make people aware of this clause and to get
them to use it. Under this scheme, about 5 lakh domestic
consumers have been regularized.
Tracking the Product Chain Better

The utilities are installing meters at key locations to enable
a comprehensive energy audit. Pre-reform, there was not
much metering at the boundaries of transmission (now
Transco) and distribution (now the distcoms). Now all the
interface points are accurately metered using 0.5 class
accuracy meters (Chatterjee 2003). Furthermore, the
companies plan to install data loggers on all 11 kV feeders
that feed primarily industrial load; about half of such feeders
have already been covered. The data loggers are able to store
data for 35 days and also provide full tamper details (Bhatia
and Prasad 2003).
The distcoms are also putting considerable effort in
revamping meters at the consumer end. Chatterjee (2003)
states that earlier the companies were purchasing 67 lakh
meters every year, while in 20001 alone, they purchased
28 lakh meters. In urban areas, existing meters are being
replaced by high accuracy electronic meters for residential
and commercial customers. For large consumers with more
than 40 kW of load, high accuracy tamper-proof electronic
meters with time of day and remote reading capabilities are
being installed (Bhatia and Prasad 2003). The companies
report that this has led to an increase in recorded
consumption by upto 25 per cent in some cases.
Technology to the Fore

The most significant feature of Andhra Pradeshs approach
to improving the performance of the distcoms is the reliance
on technology, particularly information technology. As we
describe in more detail in this section, technology has been
used to accomplish the following goals: (1) to reduce technical
losses; (2) to allow better management control; (3) to allow
the distcoms to target areas of high commercial loss; and
(4) to reduce the need for human intervention and bypass
the need for difficult organizational change and to bypass
difficult socio-political situations. While the initiatives
we describe below are those that are being carried out by
Andhra Pradesh Central Power Distribution Company Ltd
(APCPDCL), the other 3 distcoms of Andhra Pradesh are
also carrying out many of these initiatives.
High Voltage Distribution System (HVDS): Currently,
APCPDCL is implementing HVDS on selected 11 kV
feeders in the twin cities of Hyderabad and Secunderabad
(APCPDCL 2003). HVDS will be extended to other feeders
in a phased manner. HVDS is being introduced (a) to
reduce technical losses; (b) to reduce commercial losses by
making it more difficult to steal electricity; (c) to improve
the quality of supply by reducing voltage drop along the
length of line; and (d) to reduce outages.
Spot Billing: Spot billing using handheld computers was
introduced in November 2001 in Hyderabad, and now it
has been introduced throughout the state. A meter reader
reads the meter and produces a bill immediately using the
handheld computer. According to APCPDCL, there has
been a remarkable increase in billing demand and in customer
satisfaction. The company has been able to reduce the time
from when the meter is read until the company receives the
payment from the customer by half (from 90 days to 45
175
days). This has resulted in better cash flow for the company
(Prasad 2003). As a result, the bills are not bunched, which
is better monitoring and reduction of billing complaints.
Remote Metering: Meters at some selected locations are
being read remotely from the corporate office of APCPDCL.
These locations fall into one of the following categories
(Prasad 2003):
Interface points between CPDCL and AP Transco
and AP Genco;
Agricultural feeders;
Feeders at selected substations providing power for
major loads;
Some large consumers.
With real time information about power consumption
at various levels in the distribution link thus available to the
company it is able to identify meters, which are (a) tampered
with; (b) wrongly connected; (c) not reading properly. In
addition, consumption in agricultural feeders can be
monitored to ensure that power is available only for the
stipulated time. In this way, interference from local politicians
to extend power beyond the stipulated time is considerably
reduced.
Micro-controllers: In order to regulate power supply to
agriculture and eliminate over-consumption of electricity
by customers under agricultural tariffs, the distcoms segregate
feeders and fix circuit breakers with timer controls on
distribution transformers feeding agricultural loads (Prasad,
2003). Micro logic controllers are used to trip the breaker
as per schedule in 600 substations to ensure that the 9-hour
limit on supply is observed. Data is recorded so that reports
can be generated regarding the actual power supply, which
can, in turn, be used to provide feeder wise reports or other
data for load research.
Customer Analysis Tool (CAT): This is an Oracle-based
software tool that mines data to identify customers whose
consumption or payment pattern is unusual indicating
problems such as stuck meters, zero consumption, bills
unpaid for 12 months, etc. (APCPDCL, 2003). This tool
is particularly useful for consumer categories, which have
a large number of consumers making it difficult to pick out
exceptionals by hand. The distcoms use the data to identify
theft or malpractice and also for customers with genuine
problems.
GIS Mapping: Geographic Information Systems (GIS)
are used for modelling, analysis, and management of
geographically-located resources. They combine database
operations of Andhra Pradesh such querying and statistical
analysis with the visual benefits of maps.The Andhra Pradesh
distcoms plan to use GIS mapping to integrate trouble call
management and transformer-based consumer database to
176
improve the response to trouble calls. APCPDCL claims

that this is currently being done for 2 districts.
Improving Customer Value

Improving Customer Service: The distcoms have established
call centres in all major towns in addition to the district
headquarters (Chatterjee 2003). In addition, APCPDCL
has launched a website to cater to 15 lakh customers in
Hyderabad and Rangareddy.
Trouble Call Management (TCM): APCPDCL has
developed a TCM system that has been implemented in
Hyderabad. Geographical and non-geographical data about
the network and consumers is combined in a comprehensive
database and is used to manage trouble calls more effectively
(APCPDCL 2003). When a trouble call is received, the
database is queried to get the location of the problem. The
Supervisory Control and Data Acquisition (SCADA) system
is then used to determine if there is indeed a technical
problem at that location. Once the complaint is verified,
SCADA is used to assist in repair. If the problem is not
technical but is related to billing, then the calling customer
is informed accordingly.
Common Billing System: The distcoms have developed a
common billing software to replace multiple programmes
that were being used previously by private accounting
agencies (Bhatia and Prasad 2003).
Focusing on High Value Customers: One part of the strategy
adopted by the companies is to get better realization from
high-yield consumers. About 700 feeders that have more
than 50 per cent of their load as industrial load have been
labeled express feeders (Chatterjee 2003). These feeders are
not subject to interruptions of supply. In addition, the HT
tariff has been rationalized, and the company reports that
this has resulted in an increase in consumption of 26 per
cent in the year 20023.
Improving Business Practices

Performance Monitoring: The distcoms have defined roles
and responsibilities of employees in various positions and
accountability has been fixed at each level through
performance targets and grading on achieving those targets
(Chatterjee 2003). The performance of the system is
monitored by top management using the software tools
such as CAT described earlier. On a daily basis the
management monitors critical parameters such as energy
drawls, collections, supply to agricultural consumers, line
breakdowns, and transformer failures (Prasad 2003).
Employees are also given performance targets for billing and
revenue collections and graded on their performance. These
grades received by individuals are posted on the website in
order to create incentives for performance improvement. In

addition, the company states that employees receiving poor
grades are counselled in order to help develop a strategy for
improving performance.
Employee Training: As part of the re-engineering of business
processes, the electric companies of Andhra Pradesh have
provided extensive training to their employees (Bhatia and
Prasad 2003). In addition to a Central Training Institute
at the Transco level, there are training centres at all 4
distcoms21. At these centres, employees are trained not only
in their routine responsibilities, but also in any new systems
such as HVDS that are introduced in the service territories
of the distcoms.
DELHI BSES COMPANIES

Loss Reduction
For loss reduction, and augmenting the system and quality
improvement BSES plans to carryout or is already carrying
out the following:
Installing electronic meters at the incoming 66/33
kV feeders;
Installing electronic meters on all 11 kV feeders;
Installing electronic meters at each interface location;
Consumer indexation, that is, link consumers to
distribution transformers, 11 kV feeders and grid substations;
Collecting details of units billed, amount billed, and
amount collected;
Computing AT&C losses monthly;
Replacing existing defective meters;
Streamlining and improving the billing system;
Streamlining and improving the payment collection
system;
Electrifying and metering jhuggijhopri (JJ) clusters
and unauthorized colonies;
Installing of capacitor banks;
Replacing overloaded or defective cables and upgrading
lines;
Replacing and providing switch gear; and
Introducing an LT less distribution system wherever
feasible.
Improving Quality of Service

Improving quality of service by improving complaint
handling, using fault-locating vans, and using mobile
breakdown vans;
21
The details of the training programmes described here are

based on a conversation with by K. Durga Prasad, Joint Managing
Director, Vigilance.
Giving cell phones, wireless pagers, and mopeds to
their service personnel to reduce the time to respond to a
complaint.
DELHITHE NORTH DELHI POWER

LIMITED (NDPL)22
NDPL has a strategy similar to the BSESs companies to
improve the performance of the company. The strategy of
NDPL is spread over 5 years and includes the following:
The company plans to replace all meters. According
to company personnel, 3 lakh meters have already been
procured. (NDPL has about 8 lakh customers.) NDPL
claims that the billed consumption has increased by about
10 per cent wherever they have replaced meters.
For meter reading and energy audit, there are 3 things
they are implementing: (1) on an experimental basis, the
company is using a digital camera to take a picture of the
meter reading and the meter reading is fed directly into
the system; (2) using a handheld device for data entry; and
(3) automatic meter reading (AMR) for high value customers.
Meters for these customers read the consumption level
periodically and store the data. The data can then be accessed
through a dial-up facility. This has been done for 100
customers.
NDPL is providing power to unauthorized colonies
through a HT (11 kV) network rather than a LT network.
Such an HVDS makes it difficult for customers to hook
the conductor and steal electricity.
Furthermore, because power is provided to customers
through pole mounted transformers with 35 customers per
transformer, there is feeling of ownership of the transformer.
This, in turn, makes it difficult for others to tap into the
line. NDPL estimates that there are 170 unauthorized colonies
with 600 customers each. HVDS is expected to reduce both
technical and commercial losses in these colonies.
177
company claims that cable joint faults have been reduced

from about 1620 cable joint faults per day to about 4
faults per day.
This has increased the capacity of the distribution by
25 MVA.
NDPL plans to use about Rs 300 crore of APDRP
funds over the next half year. The company claims that
Rs 150 crore of equipmentcapacitors and primary side
protection for transformers has already been ordered.
For handling additional load that is likely to materialize
in the future, the company plans to add 46 sub-stations
every year.
Improving Customer Service

NDPL has implemented several measures to improve the
quality of customer service:
Customer care centres now have air-conditioning, a
television, and provide each visiting customer with a number
and a display, which shows the number being serviced.
Now NDPL has district-level billing.
Customer bills are available on the companys website.
NDPL has breakdown vans and has provided mobile
phones to all its field staff, for quicker response to complaints.
The company has established a call centre.
Scheduled and emergency outages are announced 3
times a day on FM radio.
Training Employees
Training of both in-house and external personnel has
been introduced. NDPL also has an exchange programme with Baltimore Gas & Electric (BG&E), USA and
about 5 employees have gone over to BG&E under this
programme.
PROGRESS
IN
ANDHRA PRADESH
Improving Reliability
Level of Investment
It is introducing primary side protection for

transformers. Earlier there was no protection on the primary
side, and the transformer failure rate was about 20 per cent.
Of the total of 3200 transformers in 2300 substations,
NDPL has installed primary side protection in 968
transformers. The company claims that the failure rate is
9 per cent, although it might increase somewhat during the
summer.
The company has hired one company to do all the
cable joints rather than have unmanageably many. The
Table 7.4.1 shows the level of investments made by the

distcoms over the 3-year period from FY2001 to FY2003.
The level of investment by the distribution companies over
this period has not shown any major change.
However, the companies are planning to make capital
expenditures in the near future to enhance their performance.
For example, for improvement of the distribution system
in the twin cities of Hyderabad and Secunderabad, about
Rs 307 crore has been sanctioned under APDRP funds
from the Government of India. From these funds, about
Rs 188 crore is to be used for installation of HVDS and
the remaining Rs 119 crore is for installing high quality
meters and other works (APCPDCL 2003).
22
This section is based on information provided by V.D. Apte,

GM (Technical Services & Corporate Monitoring), NDPL.
178

Table 7.4.1
Investments Made by AP Distcoms (Rs crore)
FY 2001
FY 2002
FY 2003
99
239
71
109
518
119
189
100
114
522
126
137
109
85
457
Eastern
Central
Northern
Southern
Total
Note: (1) Numbers are for capital expenditure in that year including
IDC and capitalized expenses.
(2) FY01 numbers from tariff order for FY03.
(3) In FY 2000, transmission and distribution investments were
not separated.
Source: FY02 and FY03 nuimbers were obtained from the tariff
order for FY04. FY03 figures are projections made by APERC.
Metering
Earlier we discussed the Metering Plan of the Andhra Pradesh
distcoms and the great number of meters ordered in the year
20001. Table 7.4.2 also shows the number of meters that
have been installed in each of the years. As shown in Table
7.4.3, from the most recent tariff order the licensees have
been claiming all non-agricultural sales as metered sales.
This effectively assumes 100 per cent non-agricultural
metering. This is also being reported to the Ministry of
Power.
Table 7.4.2
Improvements in Metering by AP Distcoms
FY 2000
Number of Meters
Replaced
Number of New
MetersNon Ag.
Number of New
MetersAg.
Percentage of Sales
that are Metered
FY 2001 FY 2002 FY 2003
556,530 2,218,630 511,846
463,283
544,760 1,784,508 506,612
476,103
39,128
36.89
38.05
42.66
46.40
Note: Ag.Agricultural
Source: Summary Sheet from APERC
Table 7.4.3
Metered Sales
(All Figures in MU)
Metered Sales
Sales to Agriculture +
Losses
Metered Sales/Total
Purchases
(Sales to Agriculture +
Losses)/Total Purchases
FY 03 and FY 04 data
are based on projections
FY 2001 FY 2002 FY 2003 FY 2004

15,905
25,894
17,353
23,325
20,040
23,148
22,107
22,285
38.10% 42.70% 46.40% 49.80%

61.90% 57.30% 53.60% 50.20%
In its latest tariff order (Tariff Order 24/3/2003, para

249) the APERC has noted that the sale of electricity to
the metered categories of consumers consists of 2 parts:
(a) metered and billed units, and (b) assessed units. The
latter part refers to units billed to the consumer in case the
meter reading is not available to the distcoms on account
of meter defects, door locks, etc. The APERC staff analysed
the sales database filed by the distcoms for LT Category I:
Domestic consumers for all 4 distcoms for varying periods.
The meter readings were verified for consistency by
comparing the metered units and billed units for each
consumer. If these two are not similar, the staff reckoned
that the consumers electricity consumption is assessed by
the distcom and billed accordingly.
The Commission notes with disquiet that out of the bills
issued, bills and units billed on assessment basis constituted
far more than the 23 per cent which the distcoms normally
should reckon in their estimates. In some circles/districts,
the proportion of assessed bills and units is more than
50 per cent. It is generally in the range of 14 to 25 per cent.
Therefore, despite the claim of 100 per cent non-agriculture
metering there is a serious problem of non-functioning
meters. Unfortunately, this problem does not seem to have
been fully addressed so far.
T&D Losses
Table 7.4.4 shows the reductions in losses and improvements
in revenue collection that have been achieved by the distcoms
of Andhra Pradesh. As can be seen there has been a dramatic
reduction in the T&D losses. Over a period of 3 years, the
losses have gone down by about 11 percentage points
from 39 per cent in 19992000 to 28 per cent in 20023.
Because much of agricultural consumption is not metered,
it is difficult to separate agricultural consumption from
T&D loss. Therefore, we also look at the sum of agricultural
consumption and losses. This quantity too has declined by
11.7 per cent over 3 years. Another indicator of improved
revenue collection is the cost coverage, that is, the ratio of
the revenue realized per kWh to the cost incurred per kWh.
Here too there has been a commendable improvement with
the cost coverage increasing from 62.5 per cent in 20001
to 80.2 per cent in 20023. As a consequence of the improved
cost coverage, the requirement for subsidies from the
Government has decreased by 1200 crore over 3 years.
We reviewed the loss data for all the circles for one
distcomAPCPDCL. Table 7.4.5 shows the results. The 2
urban districts showed dramatic reductions in losses and
improved collection per kWh of input. In rural areas the
loss reduction was not uniform across all districts. Two of
the five rural districts (Mahabubnagar and Nalagonda)
showed very significant reductions in losses; for the other
Table 7.4.4
Loss Reductions and Revenue Increases by AP Distcoms
number of interesting features emerge from this table.

Agriculture sales as a proportion of input has varied between
a narrow 2527 per cent band since 19967. During the same
period sales to agriculture as a proportion of total sales increased
from 37 per cent in 19967 to 41 per cent in 20001 (first
year of reforms) and has since declined to 34 per cent in
20023. The loss percentage was almost constant at 3233
per cent during 19967 to 19992000, the pre-reform period.
There was a sudden increase to 35 per cent in 20001, after
FY 2000 FY 2001 FY 2002 FY 2003

T&D Loss
(Sales to Agri + Losses)/
Total Purchases
Cost Coverage
Govt. Subsidy (Rs crore)
38.9%
63.11%
35.5%
61.9%
29.8%
57.3%
27.6%
53.6%
56.9%
3064
62.5%
2759
68.4%
2457
80.2%
1859
179
Note: FY03 and FY04 data are based on projections.
Table 7.4.5
Efficiency Improvements by District for APCPDCL
Losses
Circle
Rural
Ananthapur
Kurnool
Mahabubnagar
Nalagonda
Medak
Urban
Rangareddy
Hyderabad
Total Company
Avg. Revenue Rs/kWh input
FY 2001
FY 2002
FY 2003
FY 2001
FY 2002
FY 2003
24.22%
22.38%
42.22%
34.14%
27.06%
26.92%
25.14%
35.67%
26.15%
21.33%
25.56%
25.67%
25.24%
20.30%
24.86%
0.92
1.28
0.56
0.83
1.32
0.94
1.38
0.62
0.93
1.39
1.16
1.79
0.89
1.39
1.51
29.63%
35.09%
31.58%
21.97%
32.09%
27.04%
16.79%
22.77%
22.49%
2.01
2.59
1.44
2.24
2.91
1.58
2.57
3.32
1.96
Source: Presentation by T.V.S.N. Prasad at IIM Bangalore.

Table 7.4.6
T&D Losses and Sales to Agriculture
Year
19945
19956
19967
19978
19989
19992000
20001
20012
20023
20034
Input
MU
Total Sales
MU
Agri Sales
MU
Agri Sales/
Total Sales
Agri Sales/
Input
Loss of
Power (MU)
Loss/Input
(T&D Loss)
Agri + Loss/
Input
28,629
29,149
31,600
35,818
37,612
40,759
41,799
40,678
43,188
44,392
23,095
23,562
21,068
23,944
25,224
27,523
26,976
28,556
31,277
33,457
10,922
11,399
7835
9336
9866
11,138
11,071
11,203
11,237
11,350
47%
48%
37%
39%
39%
40%
41%
39%
36%
34%
38%
39%
25%
26%
26%
27%
26%
28%
26%
26%
5534
5587
10,532
11,874
12,388
13,236
14,823
12,122
11,911
10,935
19%
19%
33%
33%
33%
32%
35%
30%
28%
25%
57%
58%
58%
59%
59%
60%
62%
57%
54%
50%
Note: FY 2003 and FY 2004 data are based on projections.
3 districts it was not so. However, all 5 rural districts showed

increases in revenue per kWh of input.
T&D loss measurement is inextricably tied up with
estimates of supply to agriculture. T&D losses reduced from
11,399 MU in 19956 to 7835 MU in 19967 following
an intensive energy audit. However, the estimate steadily
increased to the 19956 level by 19992000 and has
stabilized at that level.
Table 7.4.6 shows agricultural consumption and its
relationship to sales and losses from FY1995 to FY2004. A
which it has steadily decreased to 28 per cent in 20023. If

20001 is considered as the first year of reforms, then
compared to 19992000 losses are lower in 20023 by only
about 4 per cent. During the same period the share of
agriculture in total sales has also decreased by 4 per cent
from 40 per cent in 19992000 to 36 per cent in 20034.
It is possible that the pre-reform loss figures, even after
the audit of agriculture in 19967, are manipulated
downwards by inflating the total sales figure through bogus
bills which were never collected. In contrast during the
180

Table 7.4.7
FY 2000
Company
APEPDCL
APSPDCL
APCPDCL
APNPDCL
All Distcoms
FY 2001
FY 2002
FY 2003
Number
Avg
Duration
(Hours)
Number
Avg
Duration
(Hours)
Number
Avg
Duration
(Hours)
15,021
28,722
816
32,881
77,440
1.35
1.07
5.10
1.07
1.17
15,760
26,365
60,396
24,038
126,559
0.95
1.04
1.11
1.33
1.12
12,199
15,788
25,964
19,155
73,106
0.76
1.12
1.02
2.09
1.28
Number
Avg
Duration
(Hours)
7276
NA
NA
NA
NA
1.22
NA
NA
NA
NA

FY 2000
FY 2001
FY 2002
FY 2003
Company
Number
Avg
Duration
(Hours)
Number
Avg
Duration
(Hours)
Number
Avg
Duration
(Hours)
Number
Avg
Duration
(Hours)
APEPDCL
APSPDCL
APCPDCL
APNPDCL
All Distcoms
88,297
291,985
6458
308,174
694,914
2.46
2.24
3.06
1.85
2.10
101,086
255,012
382,281
232,748
971,127
1.79
1.64
2.53
1.80
2.04
101,741
244,262
261,099
208,458
815,560
1.48
1.51
0.83
2.49
1.54
39,980
NA
NA
NA
NA
0.88
NA
NA
NA
NA
reform period the collection performance is almost 100 per

cent. Therefore, the actual loss figures could have been
higher in the pre-reform period than what had been
reported. This would imply an increase in the pre-reform
loss figures and a sharper reduction in losses during the
reform process.
Outages
One important measure of Quality of Service (QOS) is the
duration and frequency of power outages23. We look at the
number and average duration of the interruptions. Table
7.4.7 shows the results for 33 kV and 11 kV interruptions.
On these metrics there is no clear indication of an
improvement of performance. For example, based on the
aggregate data for all four distcoms, for 11 kV interruptions,
while the average duration has decreased from 2.10 hours
to 1.54 hours, the number of interruptions has increased.
Financial Performance
Table 7.4.8 shows the financial performance of the distcoms
over the period FY2001FY2003. The ratio of collection to
expenditure has increased from 62 per cent to about 80 per
cent, with almost 100 per cent collection performance.
23 Ideally, one would like to use indices such as the System
Average Interruption Duration Index (SAIDI) or System Average
Interruption Frequency Index (SAIFI) that account for not only the
duration of an outage but also how many customers are affected by
individual outages. Such data is not available for the AP distcoms.
Table 7.4.8
Financial Performance During the Reform Period
Rs crore
Revenue (billed) (Rs crore)
Collections (Rs crore)
Collections/Billing
Actual Expenditure Incurred
Collection/Expenditure
Financial Profit of licensees
Financial Profit of licensees
reworked by Commission
Subsidy (approved) (Rs crore)
Addl. Govt. Support provided
Total
20001 20012 20023

5592
5592
100%
8951
62%
1073
1024
6199
5968
96%
9061
66%
876
7239
7094
98%
9031
79%
819
254
1626
1133
2759
1561
896
2457
1509
350
1859
Note: Financial profits are after taking into account the approved
subsidy; FY 2003 data are based on projections.
However, the distcoms continue to incur financial losses of

close to Rs 1000 crore a year, after accounting for government
subsidies. The total government subsidy has decreased from
Rs 3064 crore in 19992000 to Rs 1859 crore in 20023.
Cross-subsidy in Tariffs
Because an important objective of the reform process is to
reduce cross-subsidy in tariffs, we also looked at how the
distcoms fared on this measure of performance. As seen
from Table 7.4.9, the cross-subsidy in tariffs continues to
be quite significant. This is true not only for supply to
agriculture but also for domestic consumers.
Table 7.4.9
Revenue Rs Per Unit Sold
Domestic
Commercial
Industrial LT
Agri
Total LT
HT Industry
Railway Traction
Total HT
Total Discom
20023
20012
20001
2.34
5.88
4.13
0.32
1.77
4.55
4.6
3.9
2.31
2.09
5.78
4.16
0.22
1.47
4.72
4.61
3.92
2.03
2.09
5.61
4.11
0.21
1.46
4.83
4.57
3.94
2.05
Note: FY 2003 data are based on projections.
Consumer Perceptions of QOS24

Consumer representatives state that while there is
improvement in supply to the large urban centres, some
villages are getting supply for 34 hours only instead of the
9 hours that they were promised. Similarly, while urban
consumers are getting monthly bills, rural customers are
getting bills once every 2 months. In general, agricultural
consumers are not happy with the progress being made in
the power sector in Andhra Pradesh. They feel that there
is a lack of adequate supply, and in spite of that the tariffs
were increased. Their fear is that the tariff may be raised
further as part of the reform process. However, the consumer
representatives did concede that the voltage and frequency
had stabilized considerably following the introduction of
the grid code and ABT.
ANALYSIS
AND
CONCLUSIONSANDHRA PRADESH
While the performance of the distcoms in Andhra Pradesh

OS for rural consumers and reduction of power outages has
been disappointing, we note that on reduction of T&D
losses and increase in revenues, the performance of the
distcoms is very impressive. This was also the area of greatest
interest to the Government of Andhra Pradesh. What factors
have contributed to this success? We look at the role played
by the government and APERC.
Role of the Government25

The Chief Minister of Andhra Pradesh, Chandrababu Naidu,
has played a pivotal role in the changes that have occurred
in the power sector in the state. The most important
24 This
section is based on information provided during meetings

or phone conversations with Thimma Reddy of Cenvicon, Hyderabad,
Vijayakar and Sivaram Krishna of Loksatta, Hyderabad, and Bhavani
Prasad of AP Farmers Association.
25 This section is based on information provided by G.P. Rao,
Chairman, APERC, and C. Rama Mohan Rao of APCPDCL.
181
ingredient in the significant reductions in losses is the

commitment to reforms shown by the chief minister. The
administrative machinery was mobilized to assist in the
power sector reforms. The most important assistance provided
was that of law and order. Without visible police support,
reductions in theft would not have occurred and the
implementation of the anti-theft legislation would not have
been effective. The government also mobilized the
administrative machinery to promote awareness of the
problem of power theft and of the anti-theft legislation. The
second important role played by the chief minister was in
the selection of reform-minded commissioners for APERC.
He is said to have avoided selecting political appointees to
fill positions at APERC. Similarly, he handpicked people to
head the licensees (distcoms and Transco) based on their
competence and ability to get things done.
Having selected the APERC members and the chairman
for their competence, the GoAP did much to protect and
enhance the legitimacy of the APERC. On occasions where
the government disagreed with the Commission, as in the
case of allowing captive power in the state, it voiced its
concerns and even appealed the decision at Court but
accepted the Courts decision. Another example is the case
when the government wanted the domestic tariff to remain
the same but the industrial tariff to increase. In that case,
the APERC did not follow the governments request, but
the government did not malign the Commission in public
or do anything else to reduce its legitimacy. The government
also supported the reform process by providing subsidies on
time and in full.
Role of the APERC

With every tariff order the APERC issues directives to the
licensees. Many of these directives give targets for efficiency
and QOS. For example, the tariff order for the FY 20023
covered the following areas: metering of new services;
regularization of unauthorized agricultural connections;
identification of multiple connections; energy audit;
completion of census of agricultural pumpsets; collection
of arrears, preparation of databases, reduction in failure of
distribution transformers; appropriations for contingencies
reserve; approvals for new schemes and details of Capital
Works in Progress (CWIP); credit to non-drawl bank
accounts of employee funds and revenue estimation. In the
tariff order for FY 20034, APERCs directives covered
some of the same issues but also included a target of 7 per
cent for the transmission losses incurred by AP Transco.
Having set performance targets through its directives,
the APERC monitors the performance of the distcoms
through periodic review meetings. These meetings help the
regulators and the distcoms to understand each others
perspectives. In addition, the APERC can point out areas
182
of poor performance and push the distcoms to perform

better.
PERFORMANCEDELHI
Level of Investment
Table 7.4.10 shows the investments made by the distcoms
in the 9-month period following privatization. It also shows
the amounts proposed to be spent by the companies in
FY 2004 and the amounts spent by DVB in the year
preceding privatization. The total amount spent by the
distcoms (Rs 181 crore) is considerably lower than the
amount spent by DVB (Rs 493 crore) in the year preceding
privatization. Noting the low level of capital expenditure by
the companies, the Commission opined that because the
companies took over operations from DVB during the
summer when the system was overloaded, their attention
was focused on repair and maintenance (DERC 2003).
Consequently, the level of investment was low. The
Commission has directed the distcoms that the investments
proposed under APDRP for FY 2004 be completed so that
the Companies may avail of the benefits of the APDRP
schemes. The distcoms are proposing a total investment of
Rs 1046 crore as shown in Table 7.4.10.
Table 7.4.10
Investments Made by Delhi Distcoms
Company
BSES Rajdhani
BSES Yamuna
NDPL
Total
FY 2002
(DVB Era)
(Rs crore)
FY 2003
(Rs crore)
FY 2004
(Rs crore)
NA
NA
NA
493
76
56
49
181
423
336
287
1046
Source:
(1) The amount for investments in FY 2002 were obtained from
the DERC Order on DVBs tariff proposal for 20012, Table 3.13.
Information on investments by circle was not available and only
the total for DVB as a whole was available.
(2) The FY 2003 investment levels were based on the amounts
approved by DERC for inclusion in the ARR in its orders on the
ARRs for FY 20023 and 20034, dated 26 June 2003, Table 3.4.
losses are defined as the difference between the units input

and the units realized, that is the units billed and collected.
According to this definition units realized are equal to the
product of units billed and the collection efficiency.
In the privatization package, AT&C loss reduction targets
were made the bidding criterion and thus pre-set for 5 years
based on the bid amounts (Sagar 2003). The initial bids
received were much lower than the levels stipulated by the
government. After negotiations, although the winning
bidders did raise their bids they were still lower than the
levels stipulated by the government. For the purposes of
setting tariffs, the values of AT&C loss reduction are to be
those bid by the purchasers and accepted by the government
(GNCTD 2001 para 2). If the actual AT&C losses for a
distcom are lower and, therefore, better than the levels
stipulated by the government, then the licensee is to be
allowed to retain 50 per cent of the additional revenue
resulting from the better performance. If the AT&C loss
for a distcom is higher and, therefore, worse than the finally
accepted bid level, then the entire shortfall in revenue is to
be borne by the distribution licensee. Lastly, if the actual
AT&C loss is between the accepted bid level and the level
originally stipulated by the government, then the entire
additional revenue from the better performance will be used
to reduce tariffs.
The actual performance of the companies for the nine
month period from July 2002 to March 2003 is shown in
Table 7.4.11. Only one of the distcoms, BSES Rajdhani,
bettered the AT&C loss reduction target; actual AT&C
losses were 47.4 per cent compared to a target of 47.55 per
cent. NDPLs actual AT&C losses were 47.8 per cent and
were slightly higher than the target of 47.6 per cent. In
contrast, BSES Yamunas actual AT&C losses were 61.89
per cent and considerably higher than the target of 56.45
per cent. NDPL claims that the reason that it missed the
target AT&C loss is because the starting level was much
higher than the base level26 set by the Commission (Sardana
2003). NDPL says that the starting level of AT&C loss in
July 2003 was 63.1 per cent which was much higher than
the base level of 48.10 per cent set by the DERC. It contends
that it has reduced AT&C losses dramatically (Figure 7.4.1).
Outages
T&D Losses
The Delhi government decided to use the Aggregate
Technical and Commercial Loss (AT&C loss) as the measure
of efficiency for tariff setting principles. Explaining the
rationale for selecting AT&C losses, the government argued
that losses of any kind, technical, non-technical, or nonrealization of payments, ultimately result in a loss of revenues,
and, therefore, the measure of efficiency gains must include
all these kinds of losses (GNCTD, 2001, para 9). AT&C
The DERCs tariff order dated 26 June 2003 did not address
many of the issues regarding QOS. In their filings, the
distcoms had provided data on outages, transformer failures
26 In the auction for privatizing DVB, Tata Power and BSES bid
to reduce the AT&C losses by at least the bid amount. For example,
Tata Power bid that in the first year it would reduce AT&C losses
by 0.5 per cent from the opening (or base) level. The base level was
determined by the DERC in its order dated 22 February 2002.
Table 7.4.11
AT&C Loss Reductions by Delhi Distcoms
Company
BSES Rajdhani
BSES Yamuna
NDPL
Base Level
Losses
Losses
July 2002
March 2003
(Committed)
Losses
July 2002
March 2003
(Actual)
48.10%
57.20%
48.10%
47.55%
56.45%
47.60%
47.40%
61.89%
47.80%
70
Percentage
60
May 2003 one of the best Mays in recent years (Indian

Express 2003). During the summer consumers reported
that there were fewer outages and with shorter durations.
Both companies also reported reduced load shedding.
NDPL reported a reduction from 30 MU in the summer
of 2002 to 6.9 MU in the summer of 2003 (Sardana 2003).
Load shedding was lower in all 3 months of 2003. However,
it is difficult to attribute these reductions to superior
performance by the distcoms. It may simply be a result of
more power being purchased by the Transco and thus more
being available for the distcoms.
ANALYSES
50
40
30
Target
Actual
20
10
Mar
Feb
Jan
Dec
Nov
Oct
Sep
Aug
Jul
0
Month
Source: Sardana (2003)
Fig. 7.4.1
AT&C Loss ReductionNDPL
and other indicators of QOS. However, because of the

timing of the original filings, data on these QOS indicators
were provided from July to September in the case of NDPL
and July to November in the case of the BSES filings. In
its deliberations on the companies filings, the DERC did
not require them to update their filings on these indicators
to cover the entire nine month period of July 2002 to March
2003 even though it required them to update other data.
Therefore, there are not much data on QOS issues that have
been vetted by the Commission. In our analysis of the
performance of the Delhi distcoms during their first year
as private entities we have been forced to rely on data
provided by the companies but not ratified by the
Commission.
While data is not available for the level of outages due
to faults in the distribution system, the companies have
provided information on the number of transformer failures
before and after privatization. The BSES companies report
that the transformer burnout rate has decreased from 20 per
cent in May 2002 to 7.4 per cent in May 2003. NDPL also
reports a significant reduction in transformer failures.
Consumer Perceptions of QOS

According to some newspaper reports, the availability of
power at the consumers premises has been much higher
during the summer of 2003 compared to other years making
183
AND
CONCLUSIONSDELHI
There has been some improvement in the performance of

the distribution companies. This can be seen from the
reduction in AT&C losses assuming that the starting point
was higher than the base levels established by the DERC,
lower transformer failure rates, and fewer and shorter outages.
While the performance of the distcoms has not been
spectacular post-privatization, it is reasonable given that
only 9 months have passed since the private companies took
over, and that the takeover took place in the summer when
the operational difficulties are the greatest and the system
at its most vulnerable to breakdowns. Based on the experience
in Andhra Pradesh and Delhi, we list some lessons that can
be drawn for improving the performance of the distcoms
in other states.
1. Political will and support is the most important
ingredient for the success of reforms. As we have shown
earlier in this chapter, one of the main reasons for the rapid
improvement in the performance of the AP distcoms is the
role played by the chief minister. He appointed reformminded individuals at the ERC and at top-management
positions in the distcoms. In addition, he directed the state
machinery, particularly the law and order agencies, to give
full support to the distcoms in their efforts to reduce theft.
Even in the case of Delhi, political support has been
important27. The chief minister and other members of the
government take a keen interest in the sector and meet
informally with the companies to review the power situation
and to give feedback on specific actions the companies
propose to take. The companies report several examples of
support provided by the government.
The government issued a circular to its agencies
directing them to budget for, and pay for their electricity
consumption.
The government generally does not interfere in cases
of theft.
27
The statements on the experience in Delhi are based on

information provided by Maheshwari of BSES.
184
The government takes a balanced and unbiased stance

in any disputes between the Transco and the distcoms.
When there were power cuts in Delhi because of
a major breakdown on the DadriRihandMandola
transmission line, the government did not malign or blame
the distcoms for the power cuts. Instead the Transco publicly
acknowledged that the problems were arising because it
(Transco) had not contracted for additional power.
2. Cooperation between the government, the ERC,
and the distcoms greatly facilitates reforms.
Technology can be used to bypass the need for organizational change or to bypass difficult socio-political issues.
Under some circumstances, it maybe easier to improve
performance of a distcom as a State owned enterprise (SOE)
before privatization28.
While the above conditions are not unique, they are
certainly not commonplace in the Indian power sector. But
when these conditions are likely to exist, it may be easier
to first improve the performance of a distcom while it is
still government-owned and then to privatize, rather than
privatizing directly. Some of the reasons are:

It is easier to for an SOE to obtain law and order
support for theft reduction than it is for a privately-owned
company.
An SOE is likely to get the support of other parts
of the administration such as happened when the anti-theft
legislation had to be publicized and the state machinery of
Andhra Pradesh was mobilized for that purpose.
An SOE may be more reverential towards the ERC
and thus less likely to challenge directives.
The problems with asymmetric information are likely
to be less severe with an SOE. A private company is more
likely than a publicly-owned company to use its asymmetric
access to information to its own advantage and thus act in
a way detrimental to the consumers interests.
Improving the performance of a distcom and then
privatizing may allow employees and consumers to get
comfortable with change and they may be more open to
privatization. If privatization is done directly, then vested
interests may play on the fears of employees and subsidized
groups.
7.5 THE BEGINNINGS OF DISTRIBUTION REFORMS IN

WEST MADHYA PRADESH: A REPORT
Ajay Pandey and Sebastian Morris
Despite opening up the sector to private participation
through independent power producers (IPPs), the actual
progress of reforms in electricity has been atrociously slow.
The unbundling of the industry by trifurcating the SEB
and allowing private participation in the distribution subsector, as attempted by Orissa, failed to result in the desired
objectives of improving efficiency or even restoring financial
viability of the sector. The problem was of not frontally
attacking the main and obvious problem, namely, the
interruption of the cash flow through leakage, theft, and
inefficiency. Fragmentation per se without a market design
or working regulatory model to put the sector together was
no solution. It may have even exacerbated the situation by
creating massive restructuring, policy, and regulatory risk,
which all but kept private investments out. We have argued
that the IPP policy with full cost recovery even on the base
load stations at 68.5 per cent, to give a return of 16 per
cent29 was itself part of the problem.
28 In developing this sub-section and the next we benefited from
ideas suggested by Geeta Gouri of APERC, C. Rama Mohan Rao
of APCPDCL; and T.V.S.N. Prasad, then CEO of APCPDCL.
29 The effective return may have been as high as 28 per cent for
possible capacity ultilization close to 90 per cent. Additionally, the
The Problems
The reform efforts, until the ERC Act and Electricity Act
2003 came into operation, were in the perverse direction
(Morris 1996 and 2000).
After the Orissa experiment, and with unbundling and
hardening budget constraints, it soon became apparent that
the true T&D losses were of the order of 4050 per cent
as against 2025 per cent claimed by the SEBs (Sinha, S.
2002).30 The inter-related problems of high T&D losses
and the mode and extent of subsidies for agriculture are also
now recognized as inter-related as unmetered agricultural
supplies in particular, and price differences in general between
consumer groups, could be exploited to hide commercial
losses, mainly, theft. In, last 2 to 3 years, the focus of the
governments has shifted to the reforms in the distribution
sub-sector through initiation of the Accelerated Power
Development and Reforms Programme (APDRP), which
provides fiscal assistance and incentives to the states to
way the rate base was calculated meant that the returns were higher
than this figure too.
30 See Morris (1999) for an earlier discussion on this issue and
the identification of the same as the root cause of the problem.
undertake reforms of the distribution sub-sector. Through
the recently passed Electricity Act 2003, it has also laid out
a road map for gradual elimination of cross-subsidies,
unbundling, open access, 100 per cent metering, private
participation besides strengthening the legal provisions
against theft of power31.
It is in this context of extremely high T&D or line losses,
which are probably due to both weaknessess in enforcement
and active collusion by the employees in allowing theft, that
the initial successes made by a few circles and divisions of
Madhya Pradesh Paschim Kshetra Vidyut Vitran Company
Ltd. (MPPKVVC), a distribution company, are worth
examining. Some of the initiatives by these divisions and
circles were taken when these were part of MPSEB.
MPPKVVC is a state government-owned company and the
reduction of line losses in few areas of its operations help
us to understand better how losses can be reduced and how
distribution reforms can be initiated.
We report and analyse some developments in Burhanpur
division of Khandwa circle and Indore City circle of this
distcom, which have led to considerable reduction in line
losses and increased revenue realization in these areas32. in
its newsletter. A priori, it stands to reason that when theft,
resulting from poor enforcement, is the principal cause of
revenue leakage, then a state-owned entity (if it has the
motivation to recover these leakages) may be able to do
better, since it could deal more easily with the law
enforcement agencies. It could also take on some of the
sovereign related roles as detection and arrests, working
in coordination with the police. A private entity may have
more durable incentives to recover losses from theft, but
perhaps equally strong incentives to under report the same
if the contract defining its tasks is not correctly worded. Far
reaching internal changes have been brought about by the
MPPKVVC in response to the challenge of revenue recovery,
and the need to avoid technical losses.
ACTION
IN
BURHANPUR CITY DIVISION
Burhanpur is a sleepy town not far from the Madhya PradeshMaharashtra border, located on the banks of the river Tapti,
with a population of about 3 lakhs. The town has a hoary
history, being known as the Gateway to the Deccan in
medieval times. At present, much of the densely populated
town is within the fort and a considerable part of the
population are Muslims. Powerloom and related businesses,
185
constitute an important activity. The water intensive banana

plantations are grown in the area around the Tapti.
Burhanpur City Division (BCD) of MPPKVVC is one
of the divisions of Khandwa circle. Khandwa, a slightly
larger town, is the district headquarters and has four divisions.
Burhanpur city division has, since 2001, achieved
considerable progress in metering, theft and loss reduction,
and carrying forth of distribution reforms. The APDRP has
come in handy to take certain aspects of the reform further.
R.K. Sharma, the engineer incharge of the BCD, pioneered
the change which, in many ways, constituted an approach,
if not a model, for other divisions and circles.
100 Per Cent Metering and Installation of Electronic Meters

Electronic meters were brought in place of electro-mechanical
meters as metering was taken up on a war footing. Though
not tamper-proof, the electronic meters are more difficult
to tamper with than the old electro-mechanical ones.
Consumers, who have been paying on the basis of low
sanctioned load without metering or on the basis of flat rate
or had tampered with their existing easy-to-tamper-with
meters, as expected, resisted 100 per cent metering as well
as replacement of their old meters.
Overcoming Ground Level Resistance

Burhanpur division commenced the replacement of electromechanical meters with electronic meters in the month of
March 2001. As soon as the work commenced, consumers
in general, and, specifically, certain powerful sections of the
local community resisted the attempts to replace existing
meters. A forum for struggle (Sangharsh Samiti) was formed
to resist replacement of old meters. Why should the company
replace the old meters when they are in order? was their
rallying slogan.
The Sangharsh Samiti published its intent to resist
installation of new meters and announced the creation of
the forum using a megaphone on a tonga (a horse-drawn
carriage), that went all over the town. The residents of the
town were requested to submit protest letters at the SEB
office, which they did in large numbers. The agency that
held the contract to install the new meters had doors shut
on them and complaints of harassment being lodged against
them. Some influential consumers resisted by abusing the
contractors team and by threatening them. A rumour was
circulated that a petition had been filed against installation
of electronic meters in the court and that the court had
given a stay order on the basis of the petition.
31
For a review of the problems agricultural subsidies, see Sinha,

Management of Power Supply to Agriculture, Chapter 8.4, in this
Report.
32 To some extent, the successes achieved by the Burhanpur
division have already been highlighted by the MPERC.
The Tonga Counter Campaign

In the face of such widespread resistance, progress in the
installation of electronic meters was initially slow (Table
186

Table 7.5.1
Progress of Installation of Electronic Meters in
Burhanpur City Division
Month
March 2001
April 2001
May 2001
June 2001
July 2001
August 2001
Sept. 2001
Oct. 2001
Nov. 2001
Dec. 2001
Jan. 2002
Feb. 2002
March 2002
April 2002
May 2002
June 2002
July 2002
August 2002
Sept. 2002
Oct. 2002
Nov. 2002
Dec. 2002
Jan. 2003
New Connections
Total
Rumours and False Reports
Single Phase
Three Phase
Total
42
822
2024
243
873
1205
304
1574
3228
2738
2811
1960
160
699
993
174
316
279
528
382
819
974
2623
2707
28478
249
195
108
113
34
41
620
176
176
325
275
295
142
145
318
251
184
157
127
157
107
440
165
4800
42
1071
2219
351
986
1239
345
2194
3404
2914
3136
2235
455
841
1138
492
567
463
685
509
976
1081
3063
2872
33278
Source: MPPKVVC Ltd., Indore.
7.5.1). But the city division responded in kind. The police

were called in to stop the Tonga Campaign. The division,
on its part, used a horse-carriage to publicize the advantages
of electronic meters and to counter the previous adverse
publicity. The announcements in various ways explained
that electronic meters facilitated theft detection and, hence,
ought not be a cause of concern for honest and paying
consumers. The flood of protest letters from the public,
engineered by the Sangarsh Samiti were not accepted.
Rationality was emphasized. If electronic weighing scales
are acceptable why not electronic meters? Discussions and
demonstrations to explain and put forward its merits were
organized. An electronic meter was set-up side by side with
the older dectro-mechanical meter which showed the public
that the consumption recorded by both electronic and electromechanical meters was same. A team was constituted to
address complaints of faster movement of electronic meters.
Quick replacements followed in the rare instances when
they were found faulty. Meanwhile, a local lawyer filed a
petition with the State Consumer Forum at Bhopal against
installation of electronic meters by MPSEB. The forum
gave a verdict in favour of the SEB and asked the complainant
to provide assistance to the SEB in the installation of
electronic meters.
A new set of problems arose by June 2001. One of the local

dailies reported that an electronic meter in the Jabalpur
region had exploded. This scared the consumers in Burhanpur
and some of them found a new excuse to resist installation
of electronic meters. A news item also appeared in a daily
published from Indore regarding explosion of an electronic
meter in a grocery store at Burhanpur. On investigation it
was found that the shop mentioned in the news item didnt
have electronic meter and no incident of the type mentioned
in the daily had taken place! R.K. Sharma, Additional
Superintendent Engineer, heading the city division and at the
forefront of these initiatives, wrote to the editor of the daily
pointing this out and requested the newspaper to publish
such news items only after verification on ground. After this
request, no further news items appeared on incidents involving
electronic meters. But the damage had been done. Certain
political elements, using the reported event as an excuse,
joined in to resist installation of electronic meters. Owners
of shops of stationary, cloth, etc. began to argue against the
installation of electronic meters in their establishments, fearing
fire hazards. The result was slow progress in installation of
electronic meters for about three months, starting June 2001.
Example
To speed up installations other measures were adopted .
Electronic meters were installed with much publicity at the
residencies of the officials and staff of the SEB, and at
government offices. Electronic meters were made compulsory
for all new connections, in cases of requests for load
enhancements and in cases of faults at existing connections.
These measures, coupled with quick redressal of complaints
about functioning of electronic meters, helped in allaying
consumer fears. With tact and persuasion, the elders in the
slum areas were convinced. Similarly, influential people
were persuaded into accepting electronic meters. The vested
interests were neutralized by these measures. By January
2003, almost two years after the project was taken up,
Burhanpur city division became the first 100 per cent
electronically metered division in Madhya Pradesh, and
possibly in the entire country.
Metering All Connect Points

Accurate and reliable metering at the consumer end, is just
one of the measures required to reduce T&D losses. Metering
is required at each stage of T&D to be able to separate
technical losses from commercial ones and also for fixing
the responsibility for the losses at each stage. Since prices
are different for different consumers complete metering
down to transformer level would be necessary to reconcile
energy flows with revenue.
Typically, the distribution entity buys power at extra high
voltage (EHV) levels from transmission entity and steps the
voltage down at sub-stations and through distribution
transformers. The losses up to distribution transformer levels
are technical losses as the electricity is, till that stage, not
amenable for direct use by the consumers. Burhanpur city
division has also installed electronic meters, which record
not only energy flows but other information such as
frequency, power factor, etc. and allow this information to
be directly down-loaded for management control, analysis,
and archiving. The metering at input and output levels
helped in identifying the extent of technical losses at the
sub-station level. Corrective actions were taken by replacing
under-sized jumpers (wires) and faulty equipment (cutouts
and breakers) at the sub-stations. As of now, metering is
complete up to 33/11 kV sub-stations and partial at the
distribution transformer level. The efforts to reduce technical
losses, however, through use of proper wires, cables,
equipment, etc., have gone down to the consumer level.
It was vitally necessary to map the distribution network
by indicating each and every consumer on to the pole,
feeder, and distribution transformer. The information so
generated is necessary for any distribution entity in planning
system expansion and strengthening, load balancing, revenue
management, preventive and breakdown maintenance, in
improving consumer servicing and in fixing responsibilities.
The work continues to make rapid and visible progress.
Cross-checking and Verifying Readings

With 100 per cent metering theft becomes difficult but not
impossible. Also, it is still possible to bypass meters or
tamper with meters so that electricity can be used without
payment. One of the ways in which it is done or at least
goes undetected is through active connivance of the linesmen
or other superior officials of the area. Of course, in case of
unmetered connections such as agricultural pumps and
single light-point (SLP) connections, the consumption itself
is wasteful. The reading of meters in Burhanpur as well as
in Indore has been out-sourced with individuals on contract
performing this task. This prevents the possibility of collusion
of the linesmen with the consumers especially since crosscheck readings are taken. The payments for meter reading
are small and are on per meter basis. In order to ensure
accuracy of meter readings, internal processes have been
altered and new processes brought in to detect any possible
mis-reporting. The meter readers diaries are reviewed twice
on specific dates by all staff (including those, for instance,
in accounts, support, seniors, etc.) of the division with a
view to detect anomalies. This is akin to mining the data
and applying filters to test any outlier observation. Besides
these reviews, the staff, on specific days of the month, fans
out in teams to perform checks on meter-readings (around
187
5001000 per month on the total connections of about

33000). This also helps in detecting any physical bypassing
of meters besides a check on the accuracy of meter readers.
It is relatively easy, unlike in the case of the utilitys own
linesman, to fire the contract meter readers in case they are
found to have deliberately mis-reported the readings or to
be hand-in-glove with dishonest consumers. Meter readers
themselves are rotated across areas to prevent such collusion.
Exemplary Handling of Theft

Besides changing the processes, the handling of theft cases
was also an important part of the exercise. When the
consumers of a particular community were caught in the
act of thieving electricity they tried to resist by giving a
communal colour to the event. Sharma contacted the
maulana of the local mosque, who himself was quite liberal
and enlightened, and explained to him the background.
When the group approached the maulana, hoping for his
support, he turned them away. The commitment of the
senior officers of the MPPKVVC, the exemplary support
from politicians, and especially from the chief minister to
push through the difficult changes, and Sharma and his
teams tactful activism helped quell the theft of electricity.
Fighting Meter Tampering

Sharma and his team were also on the lookout for cases
involving meter tampering to put a complete end to theft.
They were informed that a gang operating from Maharashtra,
was helping some consumers to slow down the new meters
for a fee. On 7 June 2002, the gang was at a particular
powerlooms premises. Sharma, along with his staff and the
police, rushed to the site and found that the meter had been
taken out from its seat. The consumer was taken into
custody. On inquiry, the consumer named another person.
The team of SEB officials and the police party raided the
premises of the named person and found the meter. This
person named two more persons. All of them were taken
into policy custody, FIRs were lodged and court cases
initiated. Subsequently, the entire gang, including the gang
leader, was arrested. This incident was widely publicised in
the regional newspapers and had the much needed impact
on the consumers. Some more cases of theft were actively
pursued with the help of local police and the message that
meter tampering would not be tolerated was effectively
communicated.
ORGANIZATIONAL CHANGES
Another major change brought about at the divisional level
was the involvement of all staff into revenue enhancing or
loss reducing activities. The distinction between clerical and
188
field staff gave way in the spirited push for change and
enhancement of revenue. Periodic meetings were organized
with the staff to drill in the importance of loss reduction
and to take up the challenge to make Burhanpur division
into a model division. After creation of MPPKVVC, Sharma
and other divisional heads were allowed to select one staff
member for a small cash award every month. This allowed
the development of an open relationship with the staff
union, and punishment for one or two erring staff members
helped remove the apathy. The successes achieved and the
wider recognition, first within the circle and later in the
state, gave positive motivational feedback that sustained the
momentum of change. The process of meter reading by
contractors, checking and review, independent energy audits
by officials and analysis of consumption, (detailed later),
institutionalized a system of checks and balances reducing
the possibility of undetected slackness or connivance on the
part of individual employees, became an approach for change
elsewhere.
Attention to the Consumer

The consumer was not lost sight of in this drive for revenue
recovery. Complaints over the phone were encouraged, and
Table 7.5.2
Line (T&D) Losses in Burhanpur City Division
Month
June 2001
July 2001
Aug. 2001
Sep. 2001
Oct. 2001
Nov. 2001
Dec. 2001
Jan. 2002
Feb. 2002
March 2002
April 2002
May 2002
June 2002
July 2002
Aug. 2002
Sep. 2002
Oct. 2002
Nov. 2002
Dec. 2002
Jan. 2003
Feb. 2003
March 2003
April 2003
Units^
Purchased
Units^
Sold
Loss (%)
82.59
86.98
86.26
80.6
80.94
75.47
76.05
72.07
67.25
66.34
81.8
84.51
83.43
83.23
85.09
84.87
79.96
68.72
58.28
63.29
56.41
63.27
44.05
57.99
63.7
54.59
62.86
56.53
64.21
57.24
63.24
55.87
59.44
59.88
69.81
59.32
71.34
63.75
68.26
61.47
58.59
45.39
52.6
45.86
46.44
35.39
29.79
26.76
36.71
22.01
30.16
14.92
24.73
12.25
16.92
10.40
26.80
17.39
28.90
14.29
25.08
19.57
23.12
14.74
22.12
16.89
18.70
26.60
19.66
were courteously attended to by the staff who had to

necessarily identify themselves providing details of their
location, and register the complaint. Delaying, not picking
up the phone, usual in government offices, very quickly
became a thing of the past. Attendance to complaints was
also reviewed by senior staff. There was a sea change in the
response to complaints by the division and consumers began
to feel the difference.
Major Gains
The line-losses (calculated as the difference between the
electricity purchased by the division) and electricity sold by
the division, during the period August 2001 to May 2003
is given in Table 7.5.2. Since the billing at Burhanpur is
bi-monthly, it is difficult to interpret the table directly. The
impact in terms of reduction on line losses in 2002 is clearly
discernible. There is, however, a slight uptrend in 2003.
More importantly, the units purchased by the division have
come down over time, even after adjusting for seasonality,
and this is clearly evident.
The revenue demand and collections between August
2001 and August 2002 (Table 7.5.3) show substantial
increase particularly from domestic light and fan consumers.
The revenue collection in the division, which was Rs 130.72
Table 7.5.3
Increase in Revenue Demand in Burhanpur and
Payment by Consumers
Adj*.Loss (%)
Month
30.05
31.43
27.14
26.25
20.01
20.15
16.41
11.44
13.09
27.07
23.27
22.61
21.51
20.62
22.23
18.88
12.65
10.79
22.59
12.73
27.06
7.12
Notes: The adjusted losses are calculated by taking a months sale as

an average of the sale during the month and its previous month.
^ In lakhs
June 2001
July 2001
Aug. 2001
Sep. 2001
Oct. 2001
Nov. 2001
Dec. 2001
Jan. 2002
Feb. 2002
March 2002
April 2002
May 2002
June 2002
July 2002
Aug. 2002
Sep. 2002
Oct. 2002
Nov. 2002
Dec. 2002
Jan. 2003
Feb. 2003
March 2003
April 2003
Units Sold
(in lakhs)
Average
Revenue
Rs/Unit
Collection
(%age of
consumers)
57.99
63.7
54.59
62.86
56.53
64.21
57.24
63.24
55.87
59.44
59.88
69.81
59.32
71.34
63.75
68.26
61.47
58.59
45.39
52.6
45.86
46.44
35.39
2.78
2.63
2.9
2.64
2.98
3.32
3.62
3.28
3.72
3.32
3.57
3.32
3.64
3.11
3.23
2.81
3.33
2.91
3.37
3.69
4.53
3.97
5.32
86.90
92.75
89.86
92.31
89.25
90.35
91.47
92.54
90.73
94.15
89.98
88.48
89.37
89.68
90.98
91.40
93.28
93.47
92.22
92.64
89.28
94.32
lakh in November 2001, increased to Rs 196.72 lakh by
November 2002. Revenue demand increased further and
had become Rs 224 lakh by June 2003. An analysis of
domestic consumers in different consumption slabs in
March 2002 and in October 2002 (Table 7.5.4) shows the
increase in the number of consumers in the higher
consumption slab. This indicates that the metering and
other changes focused on theft reduction have resulted in
correct reporting of consumption. A similar trend can be
noticed in the category of commercial lighting during the
period, reported in Table 7.5.4. Since the tariffs for low
consumption slabs are lower than for higher slabs and
there are major gains at the higher price consumptions
slabs, recovery is true, the control over theft is real and
the reporting is also true.
A special drive was also undertaken in the first quarter
of calendar year 2003 for collection of arrears from
disconnected consumers. Such dues were Rs 22.97 lakh at
the end of March 2003. With the enactment of the reforms
act in Madhya Pradesh, SEB dues are treated as land
revenue in arrears. This allows the SEB and its constituent
corporatized entities to proceed against the defaulting
consumers by following the procedure for attachment of
property of the consumer. The designated officials of the
SEB and its constituents can act as tehsildar for this purpose!
Earlier, two divisions of the Khandwa circle were being
taken care of by one such designated official. Now there
is one such official designated for the Burhanpur city
division alone. After doing the ABC analysis of arrears in
terms of amount, the senior officials (Assistant Engineers/
Junior Engineers) were each given a list of about 65
consumers for making personal efforts whereas the rest of
the staff was given lists of consumers from whom the
189
amounts due were small. Due to concerted efforts and

active involvement, Rs 15.80 lakh were recovered from
such consumers in the three months. Of the balance
Rs 7.17 lakh, one consumer owed Rs 2.18 lakh. He had
declared himself bankrupt and left the town making it
difficult to proceed further. On an ongoing basis, the
collections have been made from about 95 per cent of the
consumers billed, every month.
INDORE CITY CIRCLE

The Indore City circle of MPPKVCC is another area where
major progress is evident. Unlike Burhanpur, which is a
small town, Indore is the largest city in the state of Madhya
Pradesh and obviously the challenges here are more severe
than in Burhanpur.
Critical to Reform
The number of consumers in the circle, at 305 thousand,
is about ten times that of Burhanpur (around 33 thousand).
Geographically, it is a sprawling city whereas Burhanpur is
a congested town within the precincts of a medieval fort.
Since there are many commercial and industrial consumers,
and even among the households there is a significantly
larger proportion of upper tariff slab consumers, and few
agricultural consumers, the potential average revenue per
unit of input could be very high if theft and wastage could
be overcome. It was critical for MPPKVVC to turn the
Indore division into a cash cow. However, at the end of
March 2001, the extent of T&D losses for the circle was
46.12 per cent (an average of the prior 6 months), quite
close to the average T&D losses for the SEB itself. This was
Table 7.5.4
Change in Consumers Across Consumption Slab in Burhanpur
Unit Slab
Number of Consumers
March 2002
Oct. 2002
Domestic Lighting
05
2650
51100
101150
151200
>200
2581
5117
8690
4230
1732
1538
1867
3954
8265
4647
2579
2604
Commercial Lighting
025
2650
51100
101150
151200
>200
1972
934
534
131
54
94
1601
1045
701
180
71
127
Change
Units Consumed
Change
March 2002
Oct. 2002
38%
30%
5%
+10%
+49%
+69%
29674
199145
631854
517720
297713
497989
22218
156135
607197
573141
445139
835861
34%
28%
4%
+11%
+50%
+68%
23%
+12%
+31%
+37%
+32%
+35%
23393
33411
36472
15956
9128
38923
19087
37773
48918
21536
12063
49758
26%
+13%
+34%
+35%
+32%
+28%
190

Box 7.5.1
Why is the Mess in the Electricity Sector Likely to Continue?
We have been suffering the mess now for over ten years. All along we were told that it was only a matter of time before the vast
losses of the electricity sector would lead to a collapse of the SEBs, and so to their reform, however painful it might be, since there
was no other alternative.
The losses of SEBs have been in excess of Rs 20,000 crore over the last several years and have now crossed Rs 30,000 crore.
Even then there is no rush towards reforms. If the total subsidy cost is considered, it is significantly larger than this figure, and
may have become the largest item of subsidy in the country, and perhaps the most dysfunctional. The arguments have been that
as the budgets of state governments tighten they would be more inclined to carry out reforms, that avoid unnecessary and wasteful
expenditure, which is what reforms are all about.
CAPITAL ASSETS WITH GOVERNMENTSA PROBLEM

While this understanding at the general level is true, in particular cases where the government has ownership of much capital assets
with long life, and produces a service or good that is capital intensive it may not be that simple. The electricity sector is one such.
Here, given that assets are the under the control of the government, as long as electricity is priced to cover current cash costs (which
means allowing a certain degree of leakage and theft) there is a stability to the situation which governments can exploit to delay
reform. This happens because government accounting is on cash basis whereas enterprise accounting is on accrual bases. Governments
are worried about losses only when there are cash losses, and possibly, not even thena, if there has been a time over which such
losses have been built up.
But the situation is dynamic with respect to electricity in that capacity needs to be added, and rates do go up (at least for paying
consumers). We develop a simple model that allows the electricity sector to add capacity at the rate of 6 per cent per annum, keep
a rate of tariff to paying consumers rising at 1.5 per cent per annum, and managing leakage to a certain level (40 per cent)
a proportion of electricity generated that is lost. We show that for as long as 15 years the mess can continue with constant cash
outflows, and finally the cash flows actually turn positive. In other words there is no fiscal pressure upon governments to reform
as long as the leakage levels are controlled, and tariffs rise. The conclusion is obvious. Regulators should limit cross-subsidy to deny
governments these routes and not easily grant tariff increases on paying customers to SEBsb. That will bring the whole edifice of
tolerating losses and leakage crashing down. Similarly, tolerating large payables to central power corporations only furthers the mess,
as do budgetary contributions unconditional on reform.
We have considered the following in the computation:
Cap cost Rs
Life of asset
Depreciation period (years)
Depreciation
Fuel cost
Other cash costs
Proportion of loan in fixed cost on base assets
Proportion of loan in fixed cost on new assets
Rate of interest (real) on base assets
Rate of interest (real) on new assets
Current Capacity
Growth rate
Annual Public investment today
T&D loss technical
Commercial losses
Tariff rate of paying customers
Tariff increase for paying customers real rate
PLF achieved at base year
PLF on new capacity
2.8
20
15
0.066667
1.9
0.2
0.6
0.65
0.03
0.04
8000
0.06
200
0.12
0.4
3.5
0.015
0.6
0.75
crore per MW
Yrs
Rate
KWH
per KWH
MW
per annum
Rs crore
fraction of net generation
proportion of net generation not paid for
Rs per KWH
per annum
The cash losses remain around Rs 2700 crore for as long as 12 years before they start falling.
Similarly, trifurcations and bifurcations that have allowed the distribution companies to pile up huge payables to the transmission
companies or to the generating companies have in no way created the right pressures for change.
a
b
See Sagar, Why and When Do State Governments Reform? The Case of Electricity in Delhi, Chapter 7.3, in this Report.
Some of the worst mistakes were made when many early consultancy studies that informed the tariff setting of regulators and governments, took the
commercial losses as given and, hence, ended up raising tariffs of paying customers to far above the costs to serve.
Cash surpluses from operations
and investments
Cash surpluses from operations
Rs crore
10000
5000
0
0
191
12
15
18
21
24
27
5000
Fig. B7.5.1.1 Cash Losses/Profits in a Simulated Exercise
ACCOUNTING DISABILITY
FOR
ENTERPRISE BEHAVIOUR
It is not accidental that those boards that have to buy (that is, pay full costs) a large part of their powerMadhya Pradesh after
the separation of Chattisgarh, and Delhihave been at the forefront of reform.
The point also drives home an accounting disability on the part of governments to price the products of enterprise activities
appropriately. This problem exists even when enterprise form is given to the governments productive and enterprise activities. And
when the enterprise has lost all autonomy a situation of perverse behaviour of governments is laid. Thus, besides electricity, irrigation,
railways, passenger road transport also suffer from the problem.
despite the fact that the Indore city circle did not have any
substantial agricultural load. The reasons for the losses, as
diagnosed by the officials, were similar to other cities-theft,
tampering with meters, and wasteful use by flat rate uses
such as SLP connections charged on the basis of assessed
demand, and high tariff consumption being reported as low
tariff slab consumption.
Illegal Colonies
However, some of the reasons were peculiar to the city.
Indore had grown considerably. A large number of illegal
colonies had come up on lands adjoining the city. These
colonies straddle and are close to legal colonies. The
developers and the residents in these colonies helped
themselves by laying wires from the nearest distribution line
of 440 V pairs of wires go to every household, travelling
considerable distances from the points where they are
hooked on to naked overhead 440 V lines. There are
around 250 such colonies in and around Indore drawing
electricity from the network of the circle.
The drawl of power by these colonies creates its own
problems. The technical losses are expectedly quite high
because of these primitive arrangements, under capacity of
the wires, overloading of distribution transformers, and
sparking at contact points. Since the power is taken without
metering and payment, almost the entire consumption results
in commercial losses as well. To rectify this situation, not
only is metering required at the consumer end but substantial
expansion of the network is also required to take care of
technical losses. For the latter, however, the SEB was
constrained, as the laws did not permit it to lay lines for
such illegal colonies. Even if sporadically some of these
colonies were regularized, the investments made in the
distribution network were constrained by the unwillingness

to pay and by the resource constraints of the SEB itself,
which did not allow a complete upgradation of such
networks.
It is in this backdrop that changes were initiated sometime
in 2001 in Indore City circle. The elements were similar100 per cent metering and energy audits at various levels
to manage technical and commercial losses separately and
to fix responsibilities, reduction of theft and meter tampering,
recovery of dues by defaulting consumers, improving
consumer services and prompt consumer grievance redressal,
and improvements in the network.
Energy Audit, Line Metering, and Jumpers

Accordingly, meters were installed by November 2001 on
all 33 kV (78 in Numbers) and 11 kV (136 in numbers)
feeders. This resulted in identification of 6 high value and
16 high loss feeders in the network. Of the total 3449
distribution transformers (DTR), 40 transformers were
converted into model transformers with metering. Work
on the remaining transformer is in progress. DTR metering
takes the loss reduction efforts further by focusing on lossprone final distribution lines (440 V) rather than only at
the feeders (11 kV level). Energy audit is carried out
independently by a peer of the divisional in-charge
engineers, responsible for each of the four geographical
divisions. All of them report to J.C. Yadav, Addition Chief
Engineer, who heads this circle. Based on the energy audits
and in order to reduce technical losses, new 33/11 kV substations have been installed, 33/11 kV lines reconditioned
and transformers repaired. LT lines were also relaid wherever
found under-sized, and undersized jumpers and connectors
replaced.
192
Looped Connections Also Metered

Metering had made good progress at the consumer end and
the city circle is expecting to have 100 per cent metered
connections by July 2003. There has been no dramatic
resistance in this city to electronic meters, and the
replacement of electronic meters is also progressing well. It
is expected that by September 2003, all the meters in the
city would be electronic meters. By March 2003, around
85 per cent domestic connections had electronic meters.
Even though electronic meters are being installed on every
connection to have proper energy accounting, a large number
of these connections are in illegal colonies and still have
connections taken by hooking onto the distribution lines.
Connection charges are been collected but improving the
network which the circle is expecting to undertake will
require capital expenditure.
Energy audits and metering helped in directing the efforts
towards possible areas for reduction of commercial losses.
Since the repeal of the provisions preventing electricity
connections to illegal colonies, ghost connections in illegal
colonies have been regularized and electronic meters have
been installed. Out of 250 such colonies, work for
regularization has been completed in 43, work is in progress
in 19, and in the remaining it is expected to begin soon.
Further, LT overhead naked lines in theft-prone areas were
replaced with armoured cables to prevent thefts.
Some other measures, similar to those in Burhanpur,
have also been used effectively to reduce commercial losses.
Meter reading has been outsourced and the old meter readers
of the SEB have been either assigned new tasks and/or have
been posted out of the circle. Meter readers are rotated
across areas and are summarily removed if found misreporting
or acting in collusion with the unscrupulous consumer.
Meter diaries are reviewed periodically by officers and staff
to check for anomalies. Teams of staff and officers carry out
physical checks on meters every month on a sample basis
and particular care is taken to monitor connections reporting
low consumption. The pole maps and minor feeder level
metering help to reconcile and establish the veracity of
readings. Similarly, disconnected premises are physically
inspected to check for unauthorized reconnection.
losses, and ensure reliability of the system, and would also

pave the way for finer time of the day pricing and contracts
to result in flattening the load curve.
Congregating to Fight Theft

Although the possibility of collusion has been reduced
considerably with checking by different persons, meter
tampering is always a threat. An anecdote narrated by a
division-in-charge in the circle, where he found the outside
seal of the meter intact but the inside seal tampered with,
is illustrative. The consumer must have cut open the meter
casing and rejoined the same after tampering with the meter.
Though relatively difficult to tamper with, there are
mechanical parts (gears) even in the electronic meters, which
can be tampered with if it can be opened. Similarly, people
have used extremely strong magnets to slow down the meters!
Such consumers are difficult to deal with, as either they are
well connected or are not averse to physically threatening
the officials and staff. Joint action has been found to be the
key in such cases. The circle has provided two-way radio sets
to field officers and staff to improve operational coordination
and connectivity. All officers have mobile telephones. In
difficult situations, it has become easy for the officer on
ground to quickly let others know that errant consumers
are confronting him in the field. This enables his colleagues
to converge to the site when a situation warrants immediate
and strong action. This increases the morale and effectiveness
of the field staff. Mass media and advertisements were also
used to spread awareness and to get information (with a
credible promise of reward and secrecy) about theft of
electricity.
The efforts towards detection of theft and other
irregularities such as using electricity for other purposes,
than those declared, under and-declared load, and the
amounts realized are reported in Table 7.5.5. As many as
47 thousand such cases were detected (amounting to almost
15 per cent of the consumer base!) and over Rs 9 crore
realized from such consumers during the last fiscal year.
Large Recovery of Theft and Dues

The dues of the SEB from customers in Madhya Pradesh
now have the legal status of land revenue arrears. This allows
Online Monitoring of HT Consumers

For high value consumers, physical inspection and
telemetering are the bases of monitoring. These consumers
have been provided with digital meters, from which readings
can also be downloaded remotely. These consumers are
charged higher tariffs during peak evening hours as per the
MPERC rulings, which is possible only with the time-ofthe-day metering. SCADA and telemetering technologies
could allow a distribution entity to have better control over
Table 7.5.5
Theft and Recovery Efforts by Indore City Circle
Year
20001
20012
20023
Theft/Irregularities
Recovery Efforts
Number
Amount
(in lakhs)
Number
of RRCs
Amount
(in lakhs)
39902
20193
47628
647
783
910
19601
1400
4193
161
183
331
the utility to proceed against the defaulting consumer by
initiating the process for attachment of property of the
defaulting consumer. Under this provision, it is required
that the consumer be served a notice (called Revenue Recovery
Call (RRC)) first. Several such cases were initiated against
defaulting consumers. Indeed incentives have been instituted
for meter readers and staff for serving notices or finding the
whereabouts of defaulting consumers. This has met with
reasonable success as can be seen in Table 7.5.5. Last year,
more than Rs 3 crore were recovered from defaulting
consumers through efforts under the dues recovery act.
Improving Customer Services

In a city like Indore, efforts aimed at loss reduction and
revenue maximization alone could have easily boomeranged
had it not been for the considerable and simultaneous efforts
to improve customer service. Several initiatives were taken in
this direction. As in Burhanpur, the personnel attending to
complaints were trained to be more polite and responsive to
the consumers. Zonal offices (19 in number) were created
(November 2001) to facilitate handling of complaints as well
as payment of bills. The zonal offices were renovated with
better layout and waiting facilities, instruction panels, increased
telephone lines, provisioning of pre-printed complaint forms,
cheque collection boxes and assistance counters. Cash
payments were accepted even on Sundays and holidays.
Zonal officers were made responsible for addressing
consumer complaints. In case of continuing problems, zonal
offices have pre-printed post cards, which can be used by
the consumers to lodge their grievances directly to the
CMD. Several camps were organized to increase awareness
among consumers regarding their rights, and the changes
in the working of the company. Complaints regarding line
faults and excessive metering are reviewed and monitored
by senior officers on a daily basis. Similarly, applications for
new connections are reviewed continuously at different levels.
Currently, an online billing system, as part of the Revenue
Management System (RMS) funded by ADB, is under
implementation. A call-centre linked with zonal offices is
also planned. The sea change that these efforts brought are
visible enough.
Major Gains Made but Further to Go

The extent of average T&D losses in Indore City circle since
March 2001 (of previous 6 months) is given in Table 7.5.6.
The trend of reduction in losses is clearly evident even
though the losses at 38.37 per cent in the month of May
2003 are still quite high. The revenue demand and collection
in each of the last three fiscal years are also given in the table.
The collections have been quite high in each of these years.
The effect of reduction in losses can be seen clearly in the
year 20023 when the electricity sold increased by 11.9 per
193
Table 7.5.6
T&D Losses in Indore City Circle
Month Ending
Average Loss during

Previous 6 Months
March 2001
Sept. 2001
March 2002
Sept. 2002
March 2003
May 2003
46.12%
44.47%
42.43%
42.18%
38.39%
38.37%
cent as opposed to 6.9 per cent increase in energy purchased

by the circle.
Despite considerable improvement, there are certain
obvious steps, which remain to be undertaken by the circle.
These require further capital investments in DTR metering,
network improvement, particularly in the illegal colonies,
besides continuation of the drive to reduce commercial
losses further.
LESSONS
Some of the lessons from the successes at Indore and
Burhanpur are self-evident. First, even minor changes in the
practices, such as cross-checking by multiple persons, and
at various levels, reduces the possibility of theft in collusion
with employees. This is true, however, only if the corruption
is not deeply institutionalized in the sense of payoffs being
distributed along the hierarchy. Thus, the outsourcing of
meter readings, physical cross-checking of meter readings,
and review of meter diaries at various levels eliminates the
possibility of collusion.
Second, energy audits and metering at various levels can
help in identifying the nature of losses and facilitates the
appropriate combination of corrective actions. Not only
does it set off competition, but it also increases accountability
when backed by superiors who are willing to act against
erring officials and staff in the interest of the primary task
and the organization. Vested interests are bound to use all
possible arguments to mobilize public support to resistance
in other ways. Sustained efforts are needed to disentangle
the vested interests from the rest of the consumers.
Table 7.5.7
Revenue Demand of and Collections by Indore City Circle
(Rs in crore)
Year
20001
20012
20023
Revenue Demand
Collections
193.12
226.7
277.67
191.14
220.73
269.06
194

Box 7.5.2
MPSEB and MPPKVVC and the Background for Reforms
Like most other SEBs, MPSEB came into being in the early 1950s with the enactment of the Electric (Supply) Act of 1948 entrusting
the electricity sector to state-owned SEBs.
Cash Losses Significant

MPSEB, like other SEBs over the years, has also been incurring cash losses in its operations. In a recent white papera (June 2003),
the Government of Madhya Pradesh has accepted that even though MPSEB was making notional profits after accounting for subsidy
receivable from the government, in reality the subsidies were not received from the state government. After setting up of the state
regulatory commission, viz., MPERC in FY2000, the practice of booking subsidy, not yet received, as income, has been stopped.
According to the white paper, the MPSEB had excess of expenditure over revenue to the order of Rs 8090 crore per month or
about Rs 1000 crore per year on the eve of bifurcation of the state of Madhya Pradesh into Madhya Pradesh and Chattisgarh in
2000.
Free Power to Agriculturists

The Government of Madhya Pradesh, which came into power in 1993, implemented its electoral promise of providing free power
to agriculturists owning a pump of less than 5 HP. In addition, it decided to provide free power to single light connection to people
below the poverty line. The resultant demand and natural growth increased the peak unrestricted demand from 4314 MW in 1993
to 6638 MW in 2000. The generation capacity, however, increased only to 4261 MW from 3484 MW during the period leaving
a wide gap. Even after buying power from outside, the peak demand met on the eve of bifurcation of state was only 5566 MW.
MPSEB After Chattisgarh

After carving out a new state, Chattisgarh, from Madhya Pradesh, the latter was left with only 2900 MW capacity, 68 per cent
of the original capacity despite utilizing 78 per cent of the energy consumption of the undivided state. Since the remaining parts
of Madhya Pradesh dominated in terms of connected agricultural pumps (94 per cent of the total) and population (73.28 per cent
of the total), the revenue collection was only 64 per cent of the total revenue collection. It also retained 78 per cent of the total
employees. As a result of free unmetered power to agriculture and single light connections, the T&D losses were assessed to be
of the order of 32 per cent on the eve of the bifurcation as against reported T&D losses of 22.68 per cent in 1993. Both these
were gross underestimates. Earlier, the agricultural consumption was estimated on a load factor of 21 per cent, equivalent of 16
hours daily supply to the pump sets during Rabi season. Later it was revised by MPERC in 2000 to 12 per cent, equivalent of
9 hours of supply during the rabi season. On the eve of the carving out of Chattisgarh, the T&D losses for the remaining parts
of Madhya Pradesh were assessed to be of the order of 51 per cent.
Purchased Power Goes Up

With the carving out of Chattisgarh, Madhya Pradesh had to rely more on purchased power on one hand and increased (as a
proportion) commercial and technical losses in distribution on the other. Its problems were further compounded by allocation of
78 per cent of the total liabilities of the undivided SEB to the MPSEB by the Government of India. The excess of expenditure
over revenue on the eve of bifurcation was assessed at around Rs 140 crore per month (Rs 16001700 crore per year), almost double
that of the undivided state. Madhya Pradesh government initiated the reforms in the power sector in the state in 2000 by enacting
the reforms act and setting up an independent regulator. The reforms act stipulated that tariff to any class of consumers would
be at least 75 per cent of cost to serve that class of consumer in a timeframe of five years.
ADB Diktat
Later in July 2002, five companies were formed to unbundle and corporatize MPSEB. Of these, one is a generation company
(MPPGCL), one a transmission company (MPPTCL) and remaining three are distribution companies covering three separate
geographical areas. Besides efforts to reform the sector in pursuance with the MoU entered with the central government to obtain
central assistance and allocation of additional power, Madhya Pradesh also obtained loans of $350 million from ADB to augment
the transmission and distribution system in the state. The MoU with the central government entails tariff rationalization and energy
audit through metering among other things whereas the ADB loan is for augmenting the T&D system, both focused on reducing
T&D losses in particular and improving the distribution sub-sector in general.
MPPKVVC
MPPKVVC Ltd. is a distribution company, which came into being as a result of unbundling of MPSEB in 2002. MPPKVVC,
as a distribution company, has been assigned the western part of Madhya Pradesh as its geographical coverage area. Within its coverage
a
See para 5.1 in The Status of Power Sector in Madhya Pradesh, June 2003, Government of Madhya Pradesh (http://www.mp.nic.in/energy/mpseb).
195
area, it has important commercial city of Indore and adjoining industrial areas of Pithampur, Dewas, etc. It also covers the agricultural
belt along the Narmada bordering Maharashtra and the Malwa region, which includes medium to moffusil towns such as Ujjain,
Khandwa, Burhanpur, Mhow, Dhar, etc. and tribal areas of Jhabua. Some of the initiatives in these circles were taken even before
MPSEB was unbundled and MPPKVCC came into being.
Vested Interest Can be Overcome

Once the vested interests are isolated and most of the other
consumers, who are honest, begin to accept the rational and
value enhancing approach of the company, others will quickly,
fall in line. In other words, when consumers begin to perceive
that it pays to be honest, and there are no other choices
(deterrents being strong and effective) bulk of the consumers
will avoid imitating the dishonest consumers. On the other
hand, when dishonest consumers can get away easily, the
others would imitate them to create non-adherence or lawless
behaviour. In changing the balance so that vested interests
are isolated, political will of the state and cooperation from
the enforcement agencies are necessary. Deterrents such as
detention, treating electricity dues as land revenue in arrears,
are effective and worthy of emulation.
Crucial Support from Regulator

Similarly, collective rewards or punishments through
scheduled and unscheduled power cuts (in any case required
due to shortage of power but also serving the purpose of
bringing about adherence and good behaviour) should be
based on the losses and collections from an area. Regulators,
as is being attempted by the MPERC, should refine this,
publicize it, and monitor its implementation by the utility
to create social pressures against those who avoid paying and
indulge in thieving. It creates strong pressures on neighbours
and others to report theft and unauthorized use of electricity.
The utilities can then isolate dishonest consumers from
others even in difficult situations.
Decentralized Working
We found that allowing direct communication across
different levels, use of radio and mobile phones and
empowerment to act independently and quite unlike in
government hierarchies, had great impact on the employees
bringing about much involvement and initiative. This was
evident and palpable when we visited these two places.
HARDENING BUDGETS SHOULD BITE

ORGANIZATIONALLY
Other factors, too, would have contributed in bringing
about change. Due to financial constraints, MPSEB has
not revised its pay scales in the last few years and has in
fact withdrawn some of the entitlements such as overtime,
employment of wards in the even of death of an employee,

LTC, etc. This is consistent with the claim in the recent
white paper by the Government of Madhya Pradesh that
the MPSEB employee costs at an average of Rs 1,23,200
per year per employee, are lower than that in most other
states including Delhi, Gujarat, Uttar Pradesh, Bihar, West
Bengal, Assam, Maharashtra, and Tamil Nadu. The impact
of the curtailment of benefits and freezing of salaries might
have been to make employees appreciate the gravity of the
situation and the harm caused by their unscrupulous
colleagues who either turned the other way when theft took
place, or actively connived. Had the entitlements continued,
that would have meant business-as-usual for employees. In
fact, hardening of the budget constraint as faced by the
state due to its bifurcation and consequent increased reliance
of purchased power seems to have been transmitted down
the line, and most importantly on the salary and benefits
account! This could possibly have worked in the elimination
of apathy of employees towards their corrupt colleagues,
as they are made to bear some of the costs of poor
performance.
Potential of TOD Tariffs

We also found during a demonstration of the telemetering
project, which is a part of the revenue management system
funded by ADB, that certain consumers (such as steel rolling
mills, which could be easily switched on and off and for
whom electricity is a major cost) did respond to time-ofthe day-tariff. On the back of availability-based tariffs already
in place at the grid level, if time-of-the-day pricing is
implemented more extensively all over the country for certain
segments with suitable meters, it might be possible to manage
the demand better. Telemetering also allows the utility to
assess the elasticity of demand better and could even allow
surplus captive generation to come on to the grid during
peak.
Organizing Internal Capability and Motivation

There are issues related to sustainability and replicability of
these experiments. Yadav and his team of divisional engineers
at Indore and Sharma at Burhanpur were hand-picked from
among the officers of the SEB for these experiments. To that
extent, it is difficult to say whether any other team would
have been equally effective. On the other hand, however,
once the processes are changed, the sensitivity of the
performance to the individual initiatives can diminish over
196
a period of time provided the system is not allowed to drift

backwards.
Source of Political Will

That leads to another interesting issue-the presence of political
will, particularly in handling theft and meterization during
these experiments. It is a well known fact that was widely
covered in the media that Madhya Pradesh faced chronic
power shortage in the last two years and had to resort to
extensive power cuts even at night in the summer months.
This led to protests on the street and political mobilization
as well. In such as situation pursuing distribution reforms,
particularly when they are seemingly unpopular, required
political will and conviction on the part of the political
leadership. It also came with the promise of much political
capital if through reforms the situation could visibly improve.
The presence of the political will to carry forward reforms
despite popular backlash and tendency to use political
influence in cases of theft, etc., was corroborated by the
officials of MPPKVVC. It can also, however, be argued that
there were not too many degrees of freedom left with the
political leadership after the bifurcation of state and
consequent hardening of budget constraint.
Institutionalization is Still Awaited

Another issue related to sustainability of reforms is absence
of incentives for employees to change. Even though small
cash awards have been instituted and the red tape associated
with these awards eliminated, currently the incentives are
too meagre for the employees to sustain the efforts. In the
absence of incentives (pecuniary as well as non-pecuniary,
but more importantly pecuniary incentives) for sustained
good performance, the current working environment focused
on doing tasks taken up as challenges rather than as routine
might be difficult to sustain beyond a point. Flexibility
within the utility to provide incentives and rewards tied to
objective measures of performance could possibly make the
changes more sustainable.
Leadership as Shield Against Dysfunctional Politics

MPPKVVC is headed by S.P.S.Parihar, an IAS, since the last
one year. He was brought in specially to set things right and
to take the Burhanpur and Indore experiments further.
Being an IAS officer, he has used his networking with the
enforcement agencies to recover dues. And in dealing with
theft and similar cases, he has allowed and empowered other
senior engineers also to network with these agencies. His
own commitment to the reforms and openness and respect
towards the engineers of the SEB is mentionable. This
means that rather special people with much capacity to
bring about change and, most importantly, shield the change
from political pressures and expediency would be important.
Agriculture Not a Holy Cow

Agricultural tariffs and metering in western Madhya Pradesh
presents an interesting situation. Farmers are being cajoled
and pressured to place meters with the promise of reliable
and abundant supply at Rs 1.50 per KWH, which means
a subsidy of about Re 1.50. The cost to serve this segment
would be about Rs 3 since the supply can be interrupted
any time and their loads are largely off-peak. To farmers
used to free power, this move was not to their liking and
they expectedly resisted. But the resistance of course varied
greatly depending on whether the farmer actually got power
at the low rates implied by the horsepower-based tariffs.
Since there was unwavering political backing to the effort
to shift from flat rate to metered and subsidized tariffs, the
natural contradictions among farmers revealed themselves
which could then be used to push through the change.
Many small farmers actually were not able to take advantage
of the free power since there was hardly any supply.
Contradictions Can be Exploited

So the promise of paid power was attractive, and after some
initial resistance they were willing to allow meters on their
premises. But large farmers, especially the farmers in the
Tapti basin who used electricity to grow a water intensive
crop like banana, strongly resisted. Earlier they could use
their political clout and connections to get supplies of power.
Many had consumption of power that even at the low tariff
of Re 1.50 would have amounted to a few lakhs of rupees
a year! At the prevailing banana prices, there was no way
they could have paid up without a major hit to their income.
In nearby Maharashtra, on the Tapti basin and more generally
in the Khandesh region, tariffs were horsepower-based and
farmers continued to enjoy free power with better availability.
So the banana farmers of Madhya Pradesh had strong reasons
to resist, while most small farmers found the new
dispensations acceptable. This division has helped
MPPKVVC to push metering significantly among farmers,
a process that is of special significance to the Khandwa circle
with much agricultural demand.
Macro Framework Needs to Change

Clearly, the current approach has limitations since the farmers
are in a competitive economy, and Madhya Pradesh alone
cannot push for reform without losing much political support
among its farmers. But there is also opportunity in seeing
agricultural demand not as a homogenous one but as being
differentiated33. Perhaps the banana farmers could be given
33
This is important in Gujarat too where the farmers who truly

and in a large way benefit from the current horsepower based tariffs
are in Mehasana, and those who farm sugarcane and banana in the
additional bundled subsidy, especially capital subsidy to use
drip irrigation34 that can conserve water and reduce the
demand for electricity in a big way, or they could be supported
to change to alternative crops that do not demand heavy
inputs of water. Ultimately, of course, subsidization would
necessarily have to be non-distortionary and capable of
being capped, and preferably bundled and given directly to
the farmer to avoid the massive input use distortions on the
farm, and the severe moral hazard that it creates on the
distribution business (Morris 2001).
Arbitrage Opportunity Should Close

Today much organizational effort goes in reconciling the
H H
energy account with the revenue account, since R = P . S ;
H
where P is the tariff vector across consumer groups and
H
H
S is similarly the sales vector. Getting S and recording it
(and reporting it internally at all levels and externally) truly
is absolutely necessary to the current situation of different
tariffs to different consumers. If this goes, with subsidization
being direct to consumers, then an entire stream of effort
197
H
that ensures that S is correct is unnecessary. It removes
entirely the possibility of consumer mix arbitrage arising
H
out the incorrect reporting of S .
Is advantage of such arbitrage being taken by groups
within the MPPKVVC today? Most certainly not, and,
being state-owned, is one reason why it is not. But could
the current leaders, pushing for change with the company,
be able to ensure that it never happens? With things settling
down and improvement in collections, and with lessening
of the revenue pressure on the company we cannot exclude
that possibility. Can one with confidence say that private
H
companies would not misreport S to hide some gains?35
The need for tariff convergence to the cost to serve and,
therefore, for right subsidization, remains and is made urgent
now that entities like the MPPKVVC have made rapid
strides in meterization and control over the distribution
network and would soon be ready for privatization. And
that makes the case of western Madhya Pradesh and especially
the pioneering Burhanpur and Khandwa and Indore circles
of great interest to distribution reforms all over the country.
REFERENCES
3iNetwork (2002) India Infrastructure Report 2002: Governance
Issues for Commercialization, Oxford University Press, New
Delhi.
APCPDCL (2003) Replies to Questions Raised by IDFC, Andhra
Pradesh Central Power Distribution Company Limited.
Banerjee, Himanshu (2003) Performance vs Expectation,
Presentation at the Confederation of Indian Industry (CII)
Conference on Delhi Power ReformsTaking Stock, 3 July
2003, New Delhi.
Bhatia, Bhavna and K. Durga Prasad (2003) Issues and Challenges
in Controlling Electricity Theft & Revenue Leakagesa
Case Study of Andhra Pradesh, India, Energy Markets
Workshop, Washington, D.C., 26 February.
BSES (2003) BSES Yamuna Power Limited Petition for Aggregate
Revenue Requirement (ARR) to Honble Delhi Electricity
Regulatory Commission for Financial Year 2002-03 (Nine
Months) and Financial Year 2003-04, Capital Expenditure
Plan, 3 March.
Chatterjee, Rachel (2003) Power Sector Reforms in the Indian
Electricity Sector & Status of Reforms in Andhra Pradesh,
Economic and Political Weekly, 2229 March.
DERC (2003) Order on ARR for FY200203 & 200304, Delhi
Electricity Regulatory Commission, 26 June.
south have to take recourse to groundwater. Most others would be
quite willing to accept coupon based subsidy which is nondistortionary and does not hoist agency problems on the distribution
company.
34 See Narayanamoorthy, More Crops Per Drop: Financial
Viability of Drip Irrigation. Chapter 12.3 in this Report.
GNCTD (2001) Notification No. F.11(118)/2001-Power/2889,

Government of National Capital Territory of Delhi
(Department of Power), 22 November.
Indian Express (2003) Where have power cuts gone? Delhi
remembers those dark days, The Indian Express, Express
Newsline, 3 June, New Delhi.
Morris, S. (2000) Regulatory Strategy and Restructuring: Model
for the Gujarat Power Sector, Economic and Political Weekly,
3 June, pp. 191529.
(1996) The Political Economy of Electric Power in India
(Parts I and II), Economic and Political Weekly, 18 and 25
May, Vol. 31, Nos 20, 21.
Pandey, Ajay (2002) Regulatory Objectives, Pressures and
Outcomes: First Power Tariff Norms, Chapter 9.1 in Morris,
S. and Rajiv Shekhar (eds), 2002.
Prasad, TVSN (2003) Improving profitability and customer services
in Electric Distribution, Presented at the Brainstorming Workshop
on Power Sector Reforms, IIM Bangalore, 1112 April.
Sagar, Jagdish (2003) The Unbundling and Privatization of DVB,
Paper Presented at the Brainstorming Workshop on Power
Sector Reforms, IIM Bangalore, 1112 April.
Sardana, A.K. (2003) Delhi Power ScenarioTaking Stock,
Presentation at the Confederation of Indian Industry (CII)
Conference on Delhi Power ReformsTaking Stock, 3 July,
New Delhi.
Sinha, Sidharth (2002) Orissa Power Sector Reforms: Getting
Back on Track in 3iNetwork, 2002.
35
Only, by large scale data mining and detailed monitoring by

the regulator that virtually reproduces the billing process could the
possibility be completely eliminated.
198
&
TECHNOLOGY AND REGULATION IN

ELECTRICITY
8.1 APPROACHES TO TRANSMISSION PRICING: A DISCUSSION

P.K. Kalra, A.K. Saxena, T.C. Kalra, Yogesh K. Bichpuriya, Vipin Prakash Singh
Even in a situation of markets for generation and supply
which the Electricity Act 2003 hopes to lead to, transmission
remains a natural monopoly, not only because of subadditivity of costs but also because of externalities arising
out of the loop flow characteristics of electricity. This means
that there is no alternative to regulation of the sector.
Indeed, the way transmission is priced and managed has
large effects for the realization and conduct of competition
in generation and supply. No theoretical solution exists to
the problem of pricing to ensure both efficient short run
operations of the system, and its expansion. Therefore,
transmission needs regulatory oversight for its expansion,
to ensure that such expansion is system cost (including
of generation) minimizing (CERC 2001). Transmission
ownership and management of operations needs to be kept
independent of generators and distributors, so that perverse
incentives to restrict transmission capacity to prevent
competition in generation and supply do not arise. In what
follows, we outline various ways of transmission pricing
that ought to be of interest to the regulator, since open
access (under the Electricity Act 2003) is going to be a
reality soon.
Objectives
Economic Efficiency: A good pricing system has to give
correct incentives to the market participants. Economic
efficiency has to remain the key target. In the case of
electricity transmission the following is applicable:
encouraging an efficient use of the existing network;
encouraging an efficient location of new generation
units and customers;
encouraging investments in the existing network and

network expansion. In the short run, the existing network
should be used efficiently. This involves lossessubject to
a required level of system reliability. An efficient location
of new customers and deciding which generating station is
part of the task.
Non-discrimination: The prices should be non-discriminatory.
Two important parameters for electricity transmission emerge
from this consideration: transmission prices may be function
of time (for example, off or on peak, summer or winter) or
place (for example, local demand or supply, congestion
avoidance, voltage level as an 'electrical' place).
Transparency: The transparency of pricing is a key in a
good market model. Together with transparency, an
appropriate measuring and metering system has to be
available to ensure correct and transparent pricing for both
transport and services ancillary to transmission.
Cost Coverage: As the transmission of electricity constitutes
a natural monopoly, marginal cost pricing would lead to a
price level that is well below the average cost. Therefore,
nowhere in the world is a pure marginal cost pricing used.
The transmission charges should reflect the cost of the assets
or services provided or acquired by the ISO as well as the
following:
Spinning reservethat is, fast-response capability held
on part-loaded synchronized generators to check any sudden
frequency change due to loss of generating capability. To
ensure that contracted response is available, monitoring and
periodic assessment are required.
Technology and Regulation in Electricity

Reactive power (voltage control)that is, the
requirement of generators to operate at an instructed power
factor within registered capabilities and to have a prescribed
excitation response on change of voltage. The cost of mega
volt ampere hours (mvarh) is negotiated with individual
suppliers; dependent upon type and design of plant. Note
that the independent system operators (ISOs) can provide
their own reactive power by installing compensators at
strategic node in the system.
Active powerfor compensation of actual use of power.
199
flow on lines and the system limitations changes. Box 8.1.1

describes the various approaches to transmission pricing.
Furthermore, in the processes of deregulation and
privatization, it is important for transmission utility and
Distribution companies to know which point of a
transmission network is beneficial for them. This calculation
has been done on this basis of megawatt mile (MW) method.
For this, 1 MW power is increased at the selling group and
buying group of nodes, and finds the usage cost index for
each pair of nodes. Node pair, which has the minimum
usage cost index, is the best solution.
Variants of Transmission Pricing

Postage Stamp Method: Within the postage stamp method,
there are variations possible. The methodology for such
variants is given in Box 8.1.1. In each of these variants, there
are 2 components of transmission charges. These are: (a) a
charge to recover cost of transmission, assets, and operating
costs, and (b) a charge for transmission loss. The variants are:
i. Annual Revenue Required (ARR) Method: In this
method, the total transmission charges are determined as
per unit bases for the transmission entity as a whole.
ii. Energy Division Method: In this method, the
transmission charges are determined for each distribution
entity based on proportion of energy sold to that distribution
entity by the transmission entity.
iii. Peak Load Method: In this method, the transmission
charges are determined for each distribution entity on the
basis of per cent of peak load of that distribution entity as
compared to peak load of transmission entity at various
times.
iv. Approximation Method: This method is relevant
only when transmission entity has distribution business as
well. It is assumed that 20 per cent of expenses related to
transmission and the transmission charges are fixed on the
basis of proportion of peak load.
v. CERC's Guideline: CERC, in its guidelines dated 26
March 2001 has come up with the transmission charges.
These guidelines do not incorporate transmission losses but
are otherwise almost similar to ARR Method.
Megawatt Mile Method: In this approach, first the
distribution entities' system usage index is calculated based
on their use of the system in terms of a usage index. This
index is used to allocate actual amount to be paid by the
distribution company to the transmission company.
Depending upon the contracts 4 types of variations are also
possible in this method in the Indian scenario.
Nodal Pricing Method: Nodal pricing takes into account
the actual system load and the losses that occur given feasible
load flow. At a certain optimal load flow there is a vector
of prices (one for each node) that is changing, as the load
CASE STUDY
Problem: Two distribution companies Kanpur Electric
Supply Company (KESCO), Noida Power Company Ltd.
(NPCL) are buying power from Uttar Pradesh Power
Corporation Ltd. (UPPCL) and they are using UPPCL
Transmission Network, so how much transmission charges
should be charged by UPPCL from these companies?
Having made a programme for calculating Transmission
Tariff for different methodologies as above, a case study has
been done over UPPCL network. The various data
specifications required for MW-mile method are as given
in Table 8.1.1.
Table 8.1.1
Data Specifications Required for MW-mile Method
Largest bus number used
Actual number of buses
Two winding transformers
Three winding transformer
Transmission lines
Series Capacitor
Circuit Breaker
Shunt Reactor
Shunt Impedances
Shunt Capacitor
Generator
Loads
Load Characteristics
Under Frequency Relay
Gen Capability Curves
Filters
Line Schedule
Converter
DC Links
Series Reactors
507
309
159
0
353
0
0
22
0
127
58
133
0
0
0
0
0
2
1
0
Calculation of the Current Assets of the Line Voltages

Classwise: This is the most important step. In this we
have:
F = Assets of the system / (length of the system x capacity
of the system)
The unit of F is Rs/Km/MW.
200

Box 8.1.1
Transmission Pricing
POSTAGE STAMP TARIFF

Of all pricing systems available, the postage stamp system is the simplest one. For transporting a given amount of electrical energy
over the grid, a fixed price per energy unit is charged, independent of the distance or the voltage level. This fixed charge allows
the ISO to recover its costs. In its simplest form, the postage tariff is independent of the place the energy is supplied to or taken
from the grid. It is also not a function of time. Such a tariff system is extremely simple to implement as regards the billing of
charges.
Performance
In order to guarantee a long-term profitable operation of the grid, the costs are divided among all users independent of the actual
costs they impose on the system. In general, the postage stamp pricing system does not give the correct incentives to suppliers
or users of electrical energy for sitting future investments or for an efficient use of the grid in the short term. Furthermore, the
ISO does not get any incentive from such a pricing system, neither to improve the transport efficiency of the present system, nor
for future investments to improve or extend the system. Thus, the simple postage stamp system does not satisfy the basic requirements
of an adequate pricing system.
MEGAWATT MILE
This is another system that looks at the distance between generator and customer. The basic concept is that the power flow kilometre
on the transmission due to transaction is calculated by multiplying the power flow and distance of the line. The total transmission
system use is then the sum of the entire power flow kilometer and this provides a measure of how much each transaction uses
the grid. The price is then proportional to the transmission usage by a transaction.
Performance
Apparently this method seeks to allocate the cost based on actual system use as closely as possible though there have been arguments
that it suffers from defects arising due to lumping of operating and embedded costs.
NODAL PRICING
None of the above systems in their elementary form take the actual cost of transmission into account; either based on momentary
or on typical load flows. Once generation is dispersed across the transmission system, economic dispatch must take the marginal costs
of transmission into account. There are two kinds: the actual costs of system losses and the opportunity cost of transmission constraints.
The approach is to base dispatch upon an explicit system model, including losses and constraints. The ISO receives bids from
the generator that should equal their marginal generation costs, and runs the system model to produce an operating schedule and
spot prices. Generators are paid the spot price at their node including the marginal cost of losses and constraints. The prices paid
by the customers must also be considered. Transmission costs can also be seen as the cost of meeting demand at each point in
the network. If consumers in an area with a high marginal cost do not face a high price for electricity, their demand is likely to
be excessive. Similarly, consumers in an area with low marginal cost could be encouraged to increase their demand with relatively
lower prices.
Performance
The nodal pricing approach manages congestion and sets transmission prices through a centralized energy market based on economic
dispatch.
VARIOUS PRICING PROPOSAL
FOR INDIA
Postage Stamp Method

Five methods of calculation of Transmission Tariff using postage stamp method are being shown. Tariff is calculated monthly in
this method. In each method the ARR components are taken as follows:
1.
2.
3.
4.
5.
6.
7.
8.
Return on capital base

Administrative and general cost
Repair and maintenance cost
Interest and finance cost
Depreciation
Provision for bad and doubtful debts
Other expenses
Less expense capitalized
201
Each method has two components of charge:

i. Transmission charges,
ii. Charges for loss.
ARR Method
The wheeling charges are calculated as follows:
X = (Yearly energy Purchased)/12 Units
Rate of average energy purchased by Transco = Rs R per unit
Total energy loss in the transmission system: Y = (% of energy loss) * X Units
Energy left for selling Z = (X Y) Units
Charges for transmission C = Rs (ARR/12) / Z per unit per month
Charges for energy loss LC = Rs R*(% of energy lost) per unit per month
Total charge T = Rs (C + LC) per unit per month
Energy sold to a Disco (Monthly) = E Units
Total amount charged per month from Disco = Rs (E * T)
Energy Division Method

Total monthly energy purchase (+Wheeled) by Transco
X = (Yearly energy purchased)/12 Units
Total Energy sold per month to a Disco = E Units
Total ARR of transmission company = ARR
% Energy loss = L
Amount Charged for transmission of energy C = Rs (ARR * E)/ (12 * X)
Amount Charged for energy lost from Disco LC = Rs R * (L/(1 - L)) * E
Total amount charged per month from Disco T = Rs (C + LC)
Peak Load Method

Total ARR of transmission company (UPPCL) = Rs ARR
Load of Disco at the time of Transco peak = LDS MW
Peak load of Transco = TPL MW
% Energy loss = L
The expression for transmission charge is as follows:
Charge C = Rs [ARR * LDS/12]/ TPL
Monthly Energy sold to a Disco = E Units
Amount Charged for energy loss from Disco LC = Rs R * (L /(1 - L)) * E
Total monthly charge T = Rs (C + LC)
Depending upon the time of occurrence of peak load on the system (Transco) the above methodology can be divided into:
Monthly
Monthly
Monthly
Monthly
Day Peak of Transco (Occurrence of maximum peak load in a particular month in between 6.00 AM to 6.00 PM)
Night Peak of Transco (Occurrence of maximum peak load in a particular month between 6.00 PM to 6.00 AM)
Peak of Transco (Occurrence of maximum peak load in a particular month within 24 hours)
average Peak load (Average of daily peak during all days of the month)
Approximation Method
In this method it is considered that the company is playing the role of both Disco and Transco and ARR is not split (Transmission
and Distribution).
Total cost of annual Energy purchased by the company = Rs P
Total annual expenses of company = Rs F
Return on Capital Base = Rs B
Annual Revenue Required ARR = (Z + B); where Z = k * (F P), k = running cost taken as 20 per cent of total cost.
Monthly Transmission Charge in Rs C = (ARR * LDS/12)/ TPL
Rate of average energy purchased by Transco = R Rs per unit
Energy sold per month to a Disco = E Units
% Energy loss = L
Amount to be collected from Disco for energy loss LC = Rs R * (L/(1 L)) * E
Total amount to be collected per month from Disco T = Rs (C + LC)
202
CALCULATIONS
AS
PER CERC RECOMMENDATIONS
In this method we have followed all the guidelines of CERC as per their notification dated 26 March 2001. The salient points
of the notification are reproduced as below.
A. Megawatt Mile Method

The general mathematical expression of this is
Pj ; Ti L j F j
RTi =
j Pj ; Ti + Pj ; base
i
(8.1.1)
RTi is the price charge for transaction in Rs (System Usage Index)

Pj ; Ti is the incremental loading of line j due to transaction , in MW (Real power)
L j is the length of line j, in Km
F j is the cost of the line per unit length, (Rupees per km)
Take the following example for a better understanding of the method, Consider an 8-bus system comprising 3 generators at
busses 1, 2, and 3 load busses namely 4, 7, and 8. There are 2 transactions taking place in addition to the native loads, which
a Transmission Company has to satisfy:
A. A Generating company at bus 5 has entered into a contract with a customer at bus 6 for power sell of P1 MW (for example T1).
B. A Generating company at bus 8 has a contract with a customer at bus 4 for power sell of P2 MW (for example T2).
The power will be transported through the network system and the Transco will receive payments for power transactions from
the buying selling nodes/parties.
The problem will be solved as follows by the MW-Mile method:
11
88
22
66
5
77
33
44
First we define constant K (could be more than one for better precision)
F = Asset of the system / (Length of the system capacity), Rs/Km/Mw
Now we follow the steps in this method as they are given below:
Step
Step
Step
Step
Step
Step
Step
Step
Step
Step
Step
A: Find the cost of the line by multiplying the unit cost of the line with the line lengths.
B: Find the base case power flow on all lines.
C: Find the new power flow solution with the transaction T1, and, hence, the power flows on each line.
D: Find the new power flow solution with the transaction T2, and hence the power flows on each line.
E: Calculate the incremental power flow on each line caused by the transaction T1.
F: Calculate the incremental power flow on each line caused by the transaction T2.
G: Calculate each line usage due to transaction T1 and hence find the total transaction system usage by T1.
H: Calculate each line usage due to transaction T2 and hence find the total transaction system usage by T2.
I: Calculate the total transaction system usage by T1 and T2 for proportional allocation of the cost.
J: Calculate the proportional allocation of Transmission ARR to transaction T1.
K: Calculate the proportional allocation of Transmission ARR to transaction T2.
For allocation of the ARR and losses the following 4 methodologies can be used.
203
Let A, B, C be the 3 companies having system usage index A1, B1, C1 by the above-described method. D1 is the usage index
when all the transactions are combined. A is the Transmission Company and B, C are the Distribution Companies,
Method 1 (Division_base_Trans)
Amount paid by the company B = (ARR * B1) / (A1 + B1 + C1)
Amount paid by the company C = (ARR * C1) / (A1 + B1 + C1)
Method 2 (Division_base)
Amount paid by the company B = (ARR * B1) / (A1)
Amount paid by the company C = (ARR * C1) / (A1)
Method 3 (Division_base_Trans_both)
Amount paid by all the Distribution Company (B & C) P1 = (ARR * D1) / (A1 + D1)
Amount paid by the company B = (P1 * B1) / (B1 + C1)
Amount paid by the company C = (P1 * C1) / (B1 + C1)
Method 4 (Division_base_both)
Amount paid by all the Distribution Company (B & C) P2 = (ARR * D1) / (A1)
Amount paid by the company B = (P2 * B1) / (B1 + C1)
Amount paid by the company C = (P2 * C1) / (B1 + C1)
Similar calculation can be done if more distribution companies are there.
The charges calculated for real power would be added with the cost of the losses (only real) for total transmission charge. To
distribute the cost of losses for each transaction, the method used is the same as real power charging (that is, calculating indexes
for company losses also). Total cost of losses has been calculated according to the following formula:
Cost of losses = (Average Power Purchase Cost of Transmission Company) (% of loss) (Total Energy Purchase (+Wheeled)
by Transmission Company)
Table 8.1.2
Data Needed from Transmission Company FY: 20012
Variable/Aspect
Total Expenses of the UPPCL (Yearly)
Capital base amount of the UPPCL
Average power purchase cost of KESCO
(Excluding Transmission & Wheeling
Charges)
Total Annual power purchase cost
amount of UPPCL
Peak load UPPCL & KESCO
Transmission losses
Employee cost
Administrative & general charges
Repair and maintenance charges
Depreciation
Provision for bad & doubtful debts
Other expenses
Less expenses capitalized
Energy purchased by UPPCL
Energy purchased by KESCO
Net capital base
Initial capitalized spare cost
Total income tax
Total equity
Availability
Fixed assets
Interest and finance cost
Value
Rs 8173.67 cr
Rs 2317 cr
1.62 Rs/Unit
Rs 6039.59 cr
Table 8.1.3
Data Needed from Disco (NPCL and KESCO) FY: 2002
Variable/Aspect
Load of KESCO at the time of transmission
company peak (UPPCL) (MW) (March 2002)
Load of NPCL at the time of transmission
company peak (UPPCL) (MW) (March 2002)
Yearly Energy purchase by Disco (MU) (KESCO)
Energy purchase by Disco (MU) Monthly
(KESCO)
Yearly Energy purchase by Disco (MU) (NPCL)
Energy purchase by Disco (MU) Monthly (NPCL)
Value
355 MW
24 MW
2400 MU
200 MU
7200 & 350 MW

3.6% of the energy
Rs 234 cr
Rs 25 cr
Rs 40 cr
Rs 131 cr
Rs 0 cr
Rs 4 cr
Rs (32) cr
39756 MU
2400 MU
Rs 2317 cr
Rs 23.17 cr
Rs 0 cr
Rs 2317 cr
98%
Rs 3599.92 cr
Rs 47 cr
175.93 MU
14.66 MU
In the present system of UPPCL we have considered

seven Fj constants, which has been calculated as follows:
F1: For 800 KV, line
F2: For 400 KV, double circuit line
F3: For 400 KV, single circuit line
The current asset of the line on different voltage class
is calculated as follows:
Source: These data have been collected from the planning section
of UPPCL.
Step 1: First the current costs of the lines are calculated

voltage classwise.
204
(800SC/400DC/400SC/220DC/220SC/132DC/
132SC)
Step 2: The current cost of the substation is calculated
voltage classwise. (400/220/132) (With the help of the substation components transformers, etc.)
Step 3: Divide the current assets of UPPCL into substation and lines in 30:70 ratio.
Step 4: Divide the current assets cost of lines and substation voltage classwise depending on the current ratio
of various classes in the current calculated (step 1 and
step 2).
Step 5: Adding the cost of the substation in line cost after
dividing the cost of the substation into different voltages in
the ratio of the length of the line.
Step 6: Calculate the total cost of the lines voltage
classwise.
Table 8.1.4 shows the typical values of the above calculation.
Table 8.1.4
Asset Value of Lines for Various Voltage Classes (KV)
Voltage class (KV)
800
400
400
220
220
132
132
SC
DC
SC
DC
SC
DC
SC
Assets
Value (crore)
496.1
155.5979
919.59
601.3742
357.4805
480.5463
589.4398
Comments: In the above calculation the 800 KV SC line

is newly built in year 2000. Total cost of it is Rs 523 crore.
The calculation of current cost has been done taking the
CERC India depreciation norms.
Comparative Results: Transmission charges* using postage
stamp method and megawatt mile is calculated for KESCO
and NPCL are shown in the Table 8.1.5a and 8.1.5b.
Comments: The charge using CERC method is less than
other methods. It is because losses are not considered in this
Table 8.1.5a
Results for Postage Stamp Method (FY: 20012)
Method of calculation
ARR Method
Energy Division Method
Peak Load Method (monthly peak)
Approximation Method
CERC Recommendations
NPCL
Transmission
charge
(Paisa/unit)
KESCO
Transmission
charge
(Paisa/unit)
27.438
26.668
21.581
21.161
16.150
27.438
26.668
22.890
22.434
16.150
Table 8.1.5b
Results for MW-Mile Method (Year and Month: March 2002)
Method of calculation
Division_base_transaction
Division_base
Division_base_transaction_both
Division_base_both
NPCL
Transmission
charge
(Paisa/unit)
KESCO
Transmission
charge
(Paisa/unit)
34.16
36.37
32.56
34.64
19.70
20.99
19.16
20.38
Note: See Box 8.1 for explanation of Division Base.

(* at system losses = 3.6%)
method. The charge using megawatt mile method is also
in case of KESCO because it uses little of the UPPCL
transmission network.
CONCLUSION
This case study is a typical example of applicability of
postage stamp and MW-mile method suiting the Indian
scenario and conditions. Since there is no proper data
available for generation plants in India, besides other
problems, nodal pricing does not fit as the best option.
Keeping Indian conditions in mind the best possible methods
are postage stamp and MW-mile method. Out of all the
approaches MW-Mile Method is the most transparent and
efficient method which can be applied in India.
8.2 BENCHMARKING O&M COSTS AND OPERATING PARAMETERS OF

COAL-BASED THERMAL POWER PLANTS IN A NEAR COST PLUS REGIME1
Rajiv Shekhar and Prem K. Kalra
Coal-based thermal power stations are presently the mainstay
of power development and this is likely to be so in the
1
This section of Chapter 8 is based on the Discussion Paper

on Terms & Conditions of Tariff (Tariff Period Commencing
immediate future also, considering the present status of the

projects and various constraints in development of hydro
1.4.2004) circulated by the CERC in June, 2003. Information from
the Tariff Order (20023) of the UPERC has also been used.

and nuclear power. In this section of the chapter we will
first assess the current practice of determining parameters
such as allowed O&M costs, station heat rate, secondary
oil consumption, and auxiliary energy consumption. We
will also examine the incentive scheme based on PLF, and
the implied incentives in the operational norms. The
discussion, while based on the central power stations and
CERCs ruling, has application in the context of the states
as a fragmented system evolves.
OPERATION & MAINTENANCE

Current Practice
The current CERC regulations require that power plants
submit details of year-wise actual O&M cost data for the
previous 5 years. The average O&M based on the actual
O&M expenses for the years 19956 to 19992000 would
correspond to the year 19978. This average O&M expense
was escalated by the CERC at the rate of 10 per cent per
annum to determine O&M expenses for the year 1999
2000. Thereafter the O&M expenses were to be increased
at the rate of 6 per cent per annum. For thermal power
stations that were set up in the last 5 years, the base O&M
expenses were fixed at 2.5 per cent of the capital cost, duly
escalated at the rate of 10 per cent to bring it to 19992000.
Sufficient details of O&M expenses were not provided by
the power companies for the commission to objectively
analyse and assess the O&M expenses. In addition, the
power companies tended to inflate O&M costs by adding
unrelated costs of power consumed by residential colonies,
construction power, etc. The CERC also observed that in
one hydro generating station, the O&M expenses had risen
steeply, from Rs 10.92 crore in 19956 to Rs 25.15 crore
(projected) in 20034. In another hydro station, the O&M
expenses in 19967 were Rs 8.17 crore which had gone up
to Rs 24.10 crore (projected) in 20034. The thermal sector
was comparatively stable, but the tendency towards increase
in actual O&M expenses were noticeable2. The huge
2
UPERC conducted a study to determine the reasons for poor

operating conditions and lack of poor maintenance in UP thermal
power plants. As a part of their study, UPERC statistically analysed
the functioning of 65 power stations and concluded that size and
vintage were not the predominant reasons for underperformance. A
major problem has also been in the proper utilization of O&M funds.
CAGs audit of O&M expenditure of 4 power plants, namely Obra
A & B, Panki and Anpara from 19967 to 19992000 revealed that
(1) of the expenditure on technical O&M, about 73 per cent had
been spent on non-moving serviceable parts, while only a small portion
was spent on the actual repair and maintenance of machines; (2)
employees expenditure had increased gradually to 65 per cent of the
total O&M budget, with a consequent decline on actual maintenance
of plant and machinery. As a result, critical stand-by auxiliaries could
not take full load once the running equipments broke down.
205
demandsupply gap means that power plants are not given

due respite, leading to a disruption in the maintenance
schedule. This problem is particularly galling in stateoperated power plants.
Lack of funds for investment in new power plants means
that old plants that should have been condemned, continue
to operate. The old plants continue to swallow O&M and
other funds without providing commensurate returns in
terms of cost-effective power supply.
Options for Determining O&M Costs

Using actual O&M costs as the basis for determining O&M
expenses have the following shortcomings:
Tendency of power plants to inflate the O&M expenses
with unrelated expenses;
The kaleidoscopic nature of O&M expenses defies a
detailed examination within a reasonable span of time;
Possible lack of definiteness in tariff.
Consequently, there have been suggestions (Pandey 2002)
to move from actual O&M to normative O&M. However,
the normative method based on capital costs has some
inherent shortcomings:
Complexities in the measurement of the capital cost;
Over-capitalization which could unnecessarily inflate
the O&M charges;
In case of old power stations, it may be difficult to
determine O&M charges on the basis of capital cost of the
project;
O&M charges would have to be revised based on the
additional capitalization.
The matter can be improved by using a normative O&M
cost. This can be done by benchmarking.
There are 2 possible methods of benchmarking:
Statistical averaging
Reference utility
Statistical Averaging
This technique has been implemented by UPERC in
determining tariffs for 20023. Here monthly operational
data of 65 power plants across the country for the past 6
years, constituting 5000 sets of observations, were collected.
Data were then used to conduct a regression analysis to relate
operational parameters such as PLF, generation, auxiliary
power consumption, specific oil consumption, station heat
rate with plant capacity, vintage, make, R&M status, and
coal consumption of generating units. Based on the regression
equations, benchmarks were set for individual power plants.
This method can be extended to benchmark O&M costs,
which unfortunately has the following drawbacks:
206
Problem in determining real O&M costs for each

plant;
The wide variation in power plant performance across
the country will produce average benchmarks. An average
benchmark may not provide sufficient incentive to plants
to improve their performance to the desired extent. Moreover,
electricity is a critical infrastructure, the availability of which
will determine whether India can industrialize rapidly.
Consequently, an average benchmark is not good enough.
The problem of average benchmarks may be overcome
by building incentives/disincentives. Incentives/disincentives,
in turn, can be a function of the difference between the
benchmark and the actual value of a performance-reflecting,
accurately measurable operational parameter such as PLF.
Reference Utility
The problem of average benchmarking and real O&M
costs can be addressed by creating/identifying a reference
utility that can serve as a benchmark for determining O&M
costs. The benchmark cost for the reference utility can be
either actual O&M costs or normative cost, in terms of
capital costs or Rs per MW basis. In fact, due to the failure
of Uttar Pradesh Rajya Utpadhan Nigam Ltd. (UPRUNL)
to provide actual O&M costs for the last 5 years, UPERC
chose the reference utility approach. For example, the
O&M expenses of Anpara were fixed on the basis of actual
expenses on a similar station, Singrauli. Several questions
also arise in the reference utility approach.
The normative total O&M expenses can be broken into
2 parts: (a) base O&M and (b) incentives based on actual
power plant performance. Base O&M can be fixed by first
identifying model operating plants, classified on the basis
of scale. The diversity of unit sizes in thermal power stations
in India ranges from 30 MW to 500 MW of capacity. Most
of the capacity addition done in the late 1970s and mid1980s has been in the 110 MW/210 MW unit capacity sizes
which have completed about 50 per cent of their useful life.
The present trend has been to add larger unit sizes of 250
MW/500 MW capacities. Hence, it is expected that, with
the passage of time, thermal power plants can be categorized
in at most 2 to 3 categories. For age indexing, it is imperative
that data from good plants, for example, those operated by
NTPC, should be used. The logic behind this suggestion
is to simply set a superior benchmark. The escalation factor
can then be based on a combination of CPI and WPI, as
is the current practice.
STATION HEAT RATE

Heat rate, defined as the thermal energy contained in the
fuels used, in kilo calories, required to generate 1 kwh of
electricity, is the primary factor that determines fuel cost

and, hence, is tariff sensitive.
Current Practice
The existing norms for coal-based thermal power stations
specify that the heat rate should be 2500 kilo calories/kwh.
During the stabilization period, however, the station heat
rate for coal-based station allowed is 2600 kilo calories/kwh
in the Government of India notification of 30 March 1992.
It should be pointed out that heat rate is intimately related
to the quality of O&M. A high heat rate points to poor
maintenance. An SEB has suggested that the gross station
heat rate should be related to manufacturers guaranteed
heat rate. On the other hand, the regulated entities have
recommended the retention of the existing heat rate norms
without any change. Neyveli Lignite Corporation (NLC)
has, however, added that the gross station heat rate should
further be arrived at after providing a factor for moisture
content.
Recommendation
Linking the station heat rate to the manufacturers guaranteed
heat rate seems to be the only logical option. The
manufacturers guarantee, in turn, is normally based on the
nature of coal used3 in boilers. Consequently, the
manufacturers guaranteed heat rate should be indexed to the
quality of coal used by the plant4. The problem again is
authentication of coal quality, which, in turn, again points
to the use of reference utility in specifying station heat rates.
SPECIFIC SECONDARY FUEL OIL CONSUMPTION

Current Practice
The existing norm for the Secondary Fuel Oil Consumption
is 3.5 ml/kwh. Earlier, the draft norms of Central Electricity
Authority (CEA) specified that it should be 1.0 ml/kwh for
coal and 3.0 ml/kwh for lignite-based power stations. NTPC
has argued that reduction of the norms from the existing
3.5 ml/kwh would result in a situation leading to furnace
pressurization and even endangering the human lives. Also,
the introduction of Availability Based Tariff (ABT) is expected
to lead to higher partial load cycling on the machine. This
would lead to instability in operation. Machines would
3 Indian coals are known to have high ash content, and today
it is beyond the capacity of the plant or the power station to ensure
that coal quality as per contract is dispatched by the coal companies.
4 Doing so is justified from the point of plant level operations
of the plant. But from the point of view of overall operations of the
company this will not be desirable, since the company would have
no incentive to monitor coal quality, or even explore possibilities of
coal washing, better coal, or blending coal (editors note).

require to be shut down considering merit order operation
and restart depending upon the requirement of the grid,
resulting in increased secondary fuel oil consumption.
One SEB has suggested that secondary fuel oil
consumption should be related to actuals, and has indicated
that the actuals in respect of their own thermal stations be
less than 3.5 ml/kwh. Another SEB has suggested that the
norms for secondary fuel oil consumption should be 2.0 ml/
kwh during stabilization and 1.0 ml/kwh for poststabilization period. The central generating utilities have
not suggested any change in the existing norms for secondary
fuel oil consumption.
Recommendations
The difference between the existing norm and the draft
norm of CEA is significant, reasons for which should be
first looked into. In particular, the effect of ABT on
secondary fuel consumption should be investigated. Since
the secondary fuel consumption is linked to O&M, and
also because of the difficulty in authenticating consumption
data, the reference utility approach should be used to fix
the norm.
AUXILIARY ENERGY CONSUMPTION

A power plant consists of several pumps, motors, and other
equipments besides main equipments (boiler, turbine, and
generator). These are collectively known as power plant
auxiliaries. Auxiliaries themselves consume power in the
process of power production. Auxiliary consumption is
expressed as a percentage of the power produced by the
plant. It can vary in a thermal power plant depending on
type of fuel, unit size, efficiency of auxiliaries, plant load
factor (PLF), etc. PLF has a significant impact on the
auxiliary consumption. Low PLF increases percentage
auxiliary consumption as the plant auxiliaries are optimized
for full load operation in most of the power plants5. The
auxiliary consumption has been observed to vary from 5 to
14 per cent in India. In a majority of cases, there is scope
to reduce this to below 10 per cent.
Current Practice
The existing norms for the auxiliary consumption are as
follows:
5 PLF has a significant bearing on a units auxiliary consumption.
Auxiliaries in almost all the plants are optimized for full load operation.
Therefore, at part loads, the auxiliary consumption does not reduce
in proportion to the output, resulting in high auxiliary consumption.
A survey shows that states whose auxiliary consumption is very high
(Bihar and Durgapur Projects Ltd. (DPL), above 12 per cent) the
annual PLF is as low as 30 per cent. For states with higher PLFs,
the auxiliary consumption figures are lower.
Auxiliary Consumption
for Coal-based Stations
With Cooling
Tower
200 MW series
500 MW series
(Steam driven pumps)
Electricity driven pumps
207
Without Cooling
Tower
9.5%
8.0%
9.0%
7.5%
9.5%
9.0%
The suggestions given by the chairman of the expert

group constituted by the CERC was that it should be in
the range of 68 per cent for various stations. NTPC had
argued that the existing norms for auxiliary energy
consumption should not be disturbed. NLC has suggested
that for 200 MW series, auxiliary consumption should be
10.5 per cent without cooling tower as against 9 per cent
as indicated above. NLC had also contended that the norms
and not the actuals should be the basis. On the other hand,
one SEB has suggested that the actual auxiliary energy
consumption should be the basis. It has also been pointed
out that auxiliary energy consumption would be much less
if colony power consumption and power consumed during
construction are excluded. Another SEB has suggested that
it should be 9.0 per cent for 200 MW series with cooling
tower and 8.0 per cent without cooling tower. In respect
of 500 MW series for steam-driven pumps, it should be 7.0
per cent with cooling tower and 6.5 per cent without cooling
tower. For electrical-driven pumps, it should be 7.5 per cent
with cooling tower and 7.0 per cent without cooling tower.
Recommendation
Similar to secondary oil consumption, there is a wide
divergence in the numbers recommended by the expert
group, NTPC, and the SEBs. Again, given the problem in
verifying actual auxiliary consumption and the tendency of
power plants to inflate numbers, among others, by including
colony and construction power consumption, using actuals
as a basis for benchmarking is not a good idea. A better
option would be to link auxiliary energy consumption to
PLF6 through the reference utility approach.
SOME INCENTIVE ISSUES

One problem with the current incentive scheme is that
there are no disincentives for poor performance. Incentives
6
One should, however, note that an overemphasis on thermal

PLF can be a misleading. For example, if a good monsoon provides
more water to generate electricity from hydel plants, it may be
advisable to generate less from thermal plants. Thus, factors like the
thermal unit backing down due to high hydro generation during the
monsoon months, may lead to low thermal PLFs. Therefore, it is
necessary to consider factors like backing down time and energy lost
due to backing down, partial and forced outages, etc. while analysing
the PLF, and associated trends in auxiliary consumption figures. Also,
auxiliary consumption depends on plant vintage, size, and age.
208
are normally provided when the actual PLF is greater than

the benchmark PLF. However, there has been no provision
for penalizing power plants for sustained poor performance.
The current practice of linking incentives with the
benchmark PLF should be continued, primarily because
it is a verifiable parameter. In fact, PLF should also be
linked to availability. PLF and availability are related: PLF
= Capacity Utilization * Availability. Hence, the relationship
between PLF and availability gives an insight into plant
performance. High availability and low PLF means low
capacity utilization, and is a sign of system inefficiency. If
availability and PLF are very close, it implies that the plant
is being run without adequate stoppage for maintenance,
a phenomenon that can have disastrous consequences in
the long run. Established thumb-rule correlations between
PLF and availability in good plants as a function of age
can be used as benchmarks.
It should definitely be ensured that incentive payments
should not lead to a proportional increase in tariffs. Achieving
higher PLFs should lead to economies of scale, and, hence,
lower production costs per MW of power generated. It is
implied that higher PLF should be accompanied with a
reduction in the station heat rate, secondary fuel consumption
and auxiliary energy consumption. In fact, power companies
should be encouraged to carry out innovative techniques to
ensure a smoothly-running plant.
How do we deal with inherently inefficient power plants?
Clearly, these plants have to be given time and money to
shore up the performance of their plant to achieve benchmark
PLFs. For example, extra O&M funds should be provided
only after setting annual PLF (and availability) targets.
These power plants should then be penalized for not achieving

their annual PLF targets by proportionately reducing the
approved O&M expenses.
What should be the formula for determining the quantum
of incentive payments? Should the current practice of linking
incentives to the fixed cost be continued, despite its inherent
limitations? Or an alternative approach that provides
incentives for generation above a target PLF at a flat rate
(paisa/kwh), which is attractive to the generators and fair
to consumers be tried. A major problem with the current
practice is that the incentive is different for different plants
having the same performance level and the same installed
capacity. Moreover, since the fixed cost of old plants is less
than that of new plants, the incentive for older plants is
much lower than for new plants. The problem with the
alternative approach is the basis for determining the flat rate
that is fair both to the producers and consumers. In fact,
both the approaches mentioned above can be implemented
more objectively through (a) the reference utility approach
discussed before and (b) by capping the annual increase in
tariff.
CONCLUSION
The major problem in fixing benchmarks, either normative
or actuals-based, is the lack of authentic information.
Moreover, given the fact that India needs to increase its
electricity supply rather dramatically, the reference utility
route appears to be the most viable method for
benchmarking operational parameters as well as incentives
for power supply7.
8.3 MANAGEMENT OF POWER SUPPLY TO AGRICULTURE

Sidharth Sinha
Flat rate and low tariffs have over a period become the norm
in the agricultural sector. For a discussion of the background
to these tariffs and the many distortionary and other effects
it has see Box 8.3.1: The Background to Agricultural Power
Subsidies.
For the SEBs flat rate unmetered subsidized power supply
to agriculture makes it necessary to ration supply to
agriculture. This is a difficult task and the SEBs have not
been able to manage it successfully resulting in overall poor
quality of supply to agriculture. Secondly, unmetered supply
to agriculture has created an opportunity for camouflaging
T&D losses as supply to agriculture. This may have actually
made it possible for SEB employees to participate in the
theft of power and benefit from it.
IMPACT ON STATE ELECRICITY BOARDS

Rationing of Agriculture Supply
While the change to a flat tariff gave a powerful stimulus
to pump irrigation the SEBs had not planned for the rapid
increase in the electricity consumption per tube well after
the change to the flat tariff. Tariff increases became a political
7
In regimes other than cost plus, such as markets for generation,

based either on pools, or through other clearing mechanisms, or in
high powered incentive regulation, the norms would be merely the
basis for the current price as in an RPI-X regime. In the Indian
context, instead of the retail price index (RPI), a more relevant
constructed price index could be used (Editors note).
209
Box 8.3.1
Background to Flat Rate Unmetered Supply
During the mid-1970s to early 1980s, most SEBs shifted away from metering electricity sales to agricultural consumers and
introduced tariffs based on capacity of the pumps. This shift was apparently a matter of administrative convenience meant to minimize
costs involved in metering, billing, and collection from agriculture consumers scattered in remote areas. Among the states with
high electricity consumption in the agriculture sector, Andhra Pradesh, Uttar Pradesh, Punjab, Tamil Nadu, and Karnataka do not
meter any agricultural connections. Rajasthan is the only state, which has about half of its agriculture connections metered, but
they account for only one-fifth of the total electricity sales to agriculture consumers. Haryana, Maharasthra, and Kerala also have
some metered agriculture connections. Later Punjab and Tamil Nadu adopted a policy of free power to agriculture.
Flat rate tariffs were generally sticky upwards and did not keep up with the increasing consumption and cost of power. A meterbased tariff alternative at 50 paise per unit was introduced in 1993. However, metered consumption constitutes a very small
proportion of total agriculture consumption.a
IMPLICATIONS
OF
FLAT RATE TARIFFS
FOR
AGRICULTURE
There are 2 major implications for the agriculture sector of flat rate subsidized power supply. With poor condition of canal water
irrigation farmers have placed increasing reliance on groundwater. Were it not for the problems in quality of power supply, pumped
groundwater extraction would have been significantly higher. Second, the zero marginal cost of groundwater extraction, implied
by flat rates, has provided a strong impetus to the market for pumped groundwater. This has made it possible for the power subsidy
to reach small and marginal farmers who do not own pump-sets.
INCREASING RELIANCE
ON
GROUNDWATER
Pricing of canal waters is a state responsibility and tends to differ widely across states (Gulati and Narayanan 2000). Although
there are some states, like Punjab, which give free irrigation water from canals, in most states pricing is based on crop area and
the growing season. Volumetric pricing is not considered feasible because of the technical problems of measuring water supplies
on a volumetric basis to a large number of small cultivators. In practice the pricing of canal waters did not cover more than
20 per cent of the O&M expenses in the mid-1990s, even though the actual expenditure on O&M per hectare of irrigated area
is considerably below the accepted norms. Collections also remain extremely poor so that in some states the cost of collection is
more than the sum collected. It is interesting though that till the late 1960s the pricing of irrigation including that of canal water,
covered costs. The divergence between costs and prices since then has widened since then. The Irrigation Prices Enquiry Committee
of 1992 had asked for a rapid convergence to full cost recovery and for decentralization in the management of the distribution
and networks. See Vaidyanathan (2003) for a review of water and electricity subsidies in India.
The pricing policy and management of the irrigation department has lead to a sequence of problems quite similar to what is
observed in the case of power supply to agriculture. Given the fiscal constraints of the irrigation service agency and the state, the
budgetary allocation towards O&M of these systems is curtailed. Inadequate funding leads to physical deterioration of the irrigation
system and affects water delivery and supply. Problems are exacerbated by institutional constraints such as the lack of incentive
and accountability on the part of the monopoly government agency to assure quality supply. In this situation farmers are unwilling
to pay higher charges since they do not expect a corresponding improvement in the quality of the service. Attempts to raise canal
water charges, under the given institutional structure and quality of service, become grounds for dispute between the bureaucracy
and policymakers on the one hand and farmers and their representatives on the other.
The poor condition of canal irrigation and the massive decline in investments in major (canal) irrigation since the mid-1960s,
along with flat rate subsidized power tariffs has lead to increasing reliance on pumped groundwater. Groundwater provides a more
flexible and reliable source of irrigation than surface water, in spite of the poor quality of power supply. The increasing reliance
on groundwater for irrigation is reflected in the fact that during the period 19909 the area under canal irrigation remained virtually
constant at 1718 million hectares. As shown in the table a little later in this section of the chapter, the share of land under canal
irrigation dropped from 37 per cent to 31 per cent while the share irrigated by wells increased from 51 to 58 per cent. More
specifically, the share irrigated by tube wells increased from 30 to 36 per cent.b
In recent years there has been a large-scale effort at institutional reform of canal irrigation initiated by the states. Andhra Pradesh
has taken the lead in passing an Act to transfer the management of irrigation systems to farmers organizations referred to as Water
Users Associations (WUAs). The major task of the WUAs appears to be rehabilitation of the irrigation system and ensuring equity
in water allocation. Water charges continue to be collected by the Revenue Department. According to a World Bank report (World
Bank 1999) on Andhra Pradesh, the transition from the present system of collection of water charges by the Revenue Department
to collection and retention of water charges by the WUAs may take several years to complete.
Given the uncertain progress of irrigation reforms reliance on groundwater is likely to continue into the future.
a
b
For example, in the first tariff order the GERC included 115 MU of metered consumption in the total consumption of 9175 MU.
Separate figures for electric and diesel tubewells are not available.
210
EQUITY
IN
POWER SUBSIDIES
Flat rate tariffs also lead to a significant growth in the market for pumped water. Empirical studies record some form of exchange
of groundwater in Gujarat, Punjab, Uttar Pradesh, Andhra Pradesh, Tamil Nadu, and West Bengal. (Dubash 2000) According to
Shah (1993) flat rate tariffs encouraged maximum water extraction and the incentive to sell water at any positive price given the
zero marginal cost of pumping water. This enabled even those farmers who could not buy a pump to benefit from subsidized power
supply.c
It is important to appreciate that access to power subsidies requires pump ownership. However, non-pump-owning farmers can
also benefit from the power subsidies through the market for pumped water. The actual flow of subsidy would depend upon the
characteristics of the pumped water market (Dubash 2000).
Some information on Farmers Use of Electric Pumpsets is available from a survey of 6 states carried out by ORG for the World
Bank (2002). According to this study, the number of farmers taking advantage of electricity subsidies varies significantly among
farmer classes and states. With greater access to agricultural pumps, Punjab, the wealthiest state in this study, and the large-farmer
class, are able to taking greater advantage of the agricultural pumping subsidies. Although marginal farmers comprise about 43
per cent of the farm population in the 6 states studied, only 5 per cent of the farmers in this category own pump sets. In the
case of Punjab almost 60 per cent of the farmers own electric pump sets as compared to 22 per cent in Maharashtra and 10 per
cent in Andhra Pradesh.
In addition to owning more pumps, large farmers use more electricity. With flat rates this also translates into lower cost per
kilowatt-hour for electricity. Large farmers, who represent 23 per cent of the farmer population in the survey, consume about
50 per cent of the electricity and pay about 50 per cent of the agricultural electricity revenues collected by the state electricity
companies. The distortions due to flat rate tariffs create major ecological problems such as overexploitation of ground water, especially
in dry areas (Morris 2001).
c
Shah (1993) suggests that Gujarat may have moved to flat rate tariffs partly on the basis of this argument.
issue and the increases were far from adequate to cover the
full cost of agricultural power supply. Over time this resulted
in declining quality and reliability of power supply. Within
each state, there were electrically privileged areas where the
rural electricity infrastructure remained relatively better
maintained and the power-supply environment remained in
a reasonably good condition. However, the rest of the state
ended up with a poor power-supply environment.
Currently, SEBs attempt to restrict the number of hours
of supply as well as limit supply to predetermined areas at
any point in time so that their cumulative impact on system
demand is reduced. Usually, half of the geographical area
gets supply only during the night while the other half
receives power supply during the day, excluding evening
peaking periods. The utility has a declared policy of how
much electricity is supplied and at what times. This is
extremely important to farmers who need to know when
and for how long they can irrigate their fields. This rostering
is sought to be achieved through the following arrangement
(World Bank 2001).
Agricultural pumping load is mostly supplied through
three-phase system and the consumers use three phase
induction motors of varying horsepower to suit their
irrigation requirements. This unique technical arrangement
used to restrict power supply hours to the agricultural
consumers involves switching of specially designed load
make/break switches, which, with the help of a single lever
operation, snaps the power supply to one phase from the
source and connects to one of the remaining two phases.
After this arrangement comes in operation, the feeder
has all the three lines charged but two of them are running
in same phase and in parallel. This arrangement hinders
the farmers from running three phase motors, but allows
other single phase supply users like households and shops,
etc. to use electricity. This arrangement puts tremendous
stress on the phase, which supplies power to two lines and
also could be a contributor for high equipment failure rate
in the distribution system. It is learnt that some of the
farmers have found a way out to pump water, when it is
needed most by them, by converting this two phase system
to three-phase system by using phase split capacitors.
The World Bank study points out the poor reliability and
availability of power for the agriculture sector. One important
cause of unreliable power delivery and erratic availability is
transformer failure, burnouts due to overloading and
unbalanced loading, poor maintenance and protection, and
lightning strikes. Long delays in repairing the transformers
compound the problems of the farmers and, by increasing
the utilities operating cost, further aggravate their poor
financial health. Over-loading problems are caused both by
too many pumps being connected to the transformer and
the use of hp pumps that are higher than the hp registered.
Concealing T&D Losses under Agriculture Consumption

With unmetered supply, agriculture consumption can only
be estimated. It must be pointed out that this problem of
measurement extends to other consumer categories as well,
mainly as a result of faulty meters or unauthorized tapping
of power. SEBs have traditionally followed a practice of
fixing a reasonable T&D loss figure, and subtracting the

loss and non-agriculture metered or estimated consumption
from the total power input into the system, to arrive at an
estimate of agriculture consumption. The general impression
has been that the T&D losses are understated, in order to
conceal inefficiency and corruption, and the agriculture
consumption is overstated (Morris 2000).
With initiation of the reform process in many states there
have been sharp reductions in the estimates of agriculture
consumption and simultaneous increase in the T&D loss
percentage. For example, in the case of Andhra Pradesh in
1996, the APSEB carried out an intensive energy audit for
the first time in the country by installing about 10 meters
per mandal in all mandals to estimate the agricultural
consumption. On this basis the agricultural consumption
was estimated as 7835 MU in 19967 against a figure of
11,399 MU in 19956. Energy losses, being the remainder
of the unaccounted energy after fixing agricultural
consumption, were estimated as 34.35 per cent against
previous years reported figure of 20.56 per cent. It is
interesting that by 20012 agriculture consumption had
gone back to the 19956 level.
REGULATING POWER SUPPLY
TO
AGRICULTURE
Regulators have been unsuccessful in dealing with the

problems of power supply to agriculture. Attempts at metering
of pump sets and quantitative restrictions on the overall
supply of power to agriculture have not worked. Farmers
have even ignored attractive metered tariffs and continue
to prefer flat rate supply.
Estimates for Regulation

Most regulators attempt to estimate the extent of agriculture
consumption using sample surveys or information on metered
agriculture consumers. In the case of Karnataka, even though
IP set connections after January 1997 were provided with
meters, no data on these connections could be made available
to the regulator in spite of repeated requests. The
Commission concluded that the utility did not have the
data. It instead relied on the metering of the secondary side
of a sample of distribution transformers feeding
predominantly IP sets. The figures obtained from these
sample meters had to be adjusted for distribution loss and
estimates of non-IP consumption.
In the case of Andhra Pradesh, in 2000, as against a total
of 18 lakh regular connections, there were approximately
3 lakh unauthorized connections waiting for regularization.
In addition there was a large waiting list of about 4 lakh
consumers for new connections. Given these problems, the
State regulator accepted the figures given by the utility as
all other estimates were also guestimates.
211
In the case of Haryana about 20 per cent of the agricultural

connections have meters, not all of them functioning. The
utility estimated unmetered tube-well usage as being about
30 per cent higher than the metered consumption on the
assumption that farmers are likely to be consuming more
power if it is unmetered. The regulator did not accept this
and estimated unmetered tubewell usage on the same basis
as metered tubewells. In addition there is widespread underreporting of pump capacity. According to the World Bank
study, in the case of Haryana, The readings of 78 electronic
meters installed on agriculture pump sets under the metering
study shows that, on average, the actual connected load is
about 74 per cent higher than the official utility record.
One of the key inputs into the estimate of agriculture
consumption is the estimate for power consumption per
KW of connected load adopted by various SERCs. The
table below provides a summary of these estimates.
Table 8.3.1
Summary Estimates of Agricultural Consumption
State
Gujarat
Punjab
Karnataka
Haryana
Andhra Pradesh
Maharashtra
Uttar Pradesh
Units consumption
per kw per annum
2300
1700
1590
1452
1250
1250
1100
Source: Tariff Regulatory Order, FY 20023; at http://pserc.nic.in/

pages/taro2k22k3main.html
Given this wide dispersion of estimates it is also not possible

for regulators to benchmark against estimates of other states.
Metering
Most regulators have asked for a phased programme of 100
per cent metering of agriculture pump sets. Regulators have
also provided metered tariffs, which are attractive relative
to flat-rate tariffs, especially for low users, in order to
encourage use of meters. In the case of Andhra Pradesh the
Commission determined a tariff of 35 paise for metered
connections, on an optional basis. According to the
Commission, At this tariff level the farmers stand to gain
if their operation of pump sets is only about 45 hours
during the two crop seasons as claimed by the farmer
organizations. In the subsequent tariff order, noting the
slow progress of metering, in spite of the 35 paise per unit
metered offer, the Commission decided to reduce this to 20
paise per unit for consumption up to 2500 units and 50
paise per unit for the balance consumption in a year. In the
subsequent tariff determination for 20023 the Commission
noted the continuing poor response to metered tariff and
attributed it to the fact that many farmers are not aware
212
of the metered tariff and APTRANSCO/DISCOMS

discourage the farmers from opting for the metered tariff .
In the case of Haryana, according to the World Bank study
about 69 per cent of the farmers surveyed favoured metered
supply. However, according to Haryana Vidyut Prasaran
Nigam (HVPN), these statements by farmers are not
confirmed by the reality on the ground. In spite of significant
increases in unmetered tariff and attractive metered tariffs,
farmers still prefer to take unmetered connections. HVPN
has initiated a programme to complete meter installation to
all tubewells in 2 years. However, according to them there
are several difficulties encountered in the installation of meters:
it is necessary to house the meter in a safe weatherproof
place, and farmers are not ready to construct the room or
shed for the meters;
farmers apprehend that once the meter is installed
they would be questioned for the extra consumption for
other purposes and their unauthorized load would be
detected;
farmers do not own the responsibility of safe custody
of the meters, as these are not covered under their Power
Supply Contract for unmetered connections;
the utility is unable to recover the cost of the meter
or charge any meter rental or maintenance costs;
the cost for reading the meters would be an extra
financial burden to the utility;
there are reports of the meters having been removed
or damaged by the farmers.
According to the HVPN the metering programme will
be successful only after the unmetered tariff is totally
withdrawn and there is no option for farmers other than
to have a metered connection.
Controlling Supply to Agriculture

Most regulators instruct the utilities to restrict total supply
to agriculture to a predetermined quantity so as to cap the
subsidy. They also require the licensee to supply as per the
announced schedule and ensure adequate voltage of supply.
In its first tariff order the Andhra Pradesh regulator (http://
ercap.org/ (various orders)) instructed the licensee to ensure
that the agricultural consumption is strictly regulated on
the basis of the approved estimate of 9815 MU. If it became
necessary to buy more power for supplying to agriculture,
the licensee was to obtain the prior permission of the
Commission and arrange for the additional funds required
for power purchase. However, in the subsequent order the
regulator conceded that, It is also not always possible to
regulate strictly the hours of supply to agricultural sector,
as the rural feeders are common for agricultural as well as
domestic and other loads. APTRANSCO informed the
regulator that it had plans to separate feeders for agricultural
and non-agricultural loads in order to better regulate the

quantity supplied to agriculture. The Andhra Pradesh tariff
order also confirmed the bypassing of the 3-phase restriction
by the farmers:
Agricultural consumers in several places of the state are
known to be using phase converters to avail 3-phase supply
to run the 3 phase motors when single phasing is done
by the DISCOMS. This renders licensees efforts to regulate
the supplies to agriculture to 9 hours meaningless. The
Commission directs that the DISCOMS shall remove the
phase converters with immediate effect.
In the case of Karnataka, in response to a situation of

power shortage at the end of 2001, the KERC wrote to the
government about the need to ensure that farmers receive
the minimum requirement of power supply. The KERC
pointed out that, Many disagreements arise between
Karnataka Power Transmission Corporation Ltd. (KPTCL)
and the ryots, on this score. Since stations are spread all
over the state and the recording of the power supply hours
is manual, it is not possible for even the divisional engineer
of the division, let alone the top officers of KPTCL at
Bangalore, to monitor the power supply position to Irrigation
pump (IP) sets. The KERC recommended that the feeder
readings should be obtained automatically through suitable
modems fitted to meters.
Targeting of Subsidies
Given that the power subsidy is effectively untargeted, in its
tariff order for 20001 the Karnataka Commission attempted
to identify IP set consumers who need to be brought out
of the category eligible for subsidized tariffs. The Commission
proposed to remove IP set consumers, who satisfy at least
one of the following conditions, from the category eligible
for subsidies and create a separate category:
1. Consumers who have more than one IP set
connection;
2. Any income tax payer;
3. Owner of a tractor;
4. Owner of a 4-wheeled motor vehicle;
5. Any person who has a telephone connection including
mobile telephone.
In respect of IP set consumers falling in any of the above
categories, the Commission specified a rate of Rs 1.35 per
unit, equal to the cost of power purchase, as against the
subsidized rate of 50 paise per unit. This would be increased
to the applicable cost of service over a period of 5 years.
In view of these objections the Commission revised the
conditions to enable the following categories to qualify as
the creamy layer:
1.
2.
Income tax assessee;

Professional taxpayers;

3. Persons drawing salary from state or central
government, or from boards/corporations of state or central
government, or from universities or aided educational
institutions;
4. Consumers with 3 or more IP sets.
According to the Commission the logic behind the criteria
is to identify IP set consumers for whom agriculture does
not represent the sole source of livelihood. If in all these
cases a person undertakes agriculture, such activity must be
considered as being entirely supplemental and not essential
to the subsistence of the consumer. In the Tariff Order for
2000 the KERC fixed the tariff for this category on the basis
of the average cost of purchase and proposed to increase this
to the average cost of supply within a period of 3 years.
RECOMMENDATIONS FOR REFORM

SUPPLY TO AGRICULTURE
OF
POWER
Reform of power supply to agriculture must address the

issues of amount and form of subsidies to the agriculture
sector, and the organization structure for managing the
supply of power to agriculture.
Need for Subsidies

The nature of the rural electrification problem and possible
solutions were recognized as early as 1980 in the
Rajadhyaksha Committee (Report of the Committee on
Power, Ministry of Energy, Department of Power, 1980).
The Committee drew special attention to the high levels
of tariff subsidies extended to farmers as a group. The
Committee expressed its clear disapproval of such general
subsidies. In terms of solutions the Committee was clear
that the system of flat tariff should be given up and metering
of supplies reintroduced.
The Distribution Policy Committee (2002) of the
Ministry of Power also recommends clearly targeted subsidies
according to the following priority:
i. Granting access to rural consumers;
ii. Support for consumers falling below the poverty
line;
iii. Farmers affected by drought, etc.; and
iv. Support to other consumers.
The state governments would need to clearly define a
path for reducing the extent of subsidy to the last group.
The committee noted the problem of removing subsidies
in a situation of poor quality of supply. The committee felt
that if there was a rostered but dependable and steady power
supply for 4 to 6 hours per day to rural consumers for
pumping water, agriculturists would be prepared to pay
more.
213
Organization Structure for Rural Electrification

The Rajadhyaksha Committee considered the question
of the appropriate organization structure for the rural
electrification programme and concluded that, SEBs should
progressively extricate themselves from operating and
servicing the RE (Rural Electrification) system, and consider
other alternatives to the SEB staff undertaking maintenance,
repair, servicing, billing and collection. According to the
committee, operating the RE system solely through
expanding the staff of SEBs, on account of their high costs
and lack of close involvement with the village community,
will make the programme increasingly unviable and retard
its progress. The SEBs instead should stimulate the setting
up of decentralized bodies for servicing the rural consumer,
and assist and oversee and monitor their operations and
provide training inputs. The committee recommended that
the concept of an agent, that is, an entrepreneur who buys
power and sells power at a predetermined commission to
consumers, should be tried out.
Many of these recommendations have appeared in
modified forms in recent reports of the Ministry of Power.
The March 2002 report of the Distribution Policy
Committee recommends, The insulation of the main stream
operations from rural operations and adopting a specific
plan of action for rural operations is an approach, which
has some merit. The rural supply could be dealt with
through decentralized management in the form of rural
cooperatives users association/panchayats/franchisees.
Moreover, where rural communities lack cohesion and are
subject to sharp social and others pressures, a local franchisee
who can manage rural distribution on a commercial basis
with lower overhead costs may be a better option. Even
after separation of the rural supply, A social charge to be
levied upon non-rural consumers for subsidizing the rural
supplies, whether serviced by a private or a state entity is
an option that could be considered along with budgetary
support from the government.
The Expert Committee on State-specific reforms (Ministry
of Power, September 2002) recommends a carving out of
the states into concentrated and other zones. The
concentrated zones are concentrated areas of high load density
and relatively compact distribution network, such as urban
and industrial centres and their immediate periphery. The
remaining areas, characterized by low load density and a
relatively dispersed distribution network would also need to
be aggregated into geographically contiguous areas and
structured as separate zones. The main rationale for
concentrated zoning is to eliminate or at least minimize the
problem of misreporting T&D losses as subsidized agriculture
consumption. It is also expected to make the remaining
distribution business attractive for private investors.
Considering the distinct characteristics of electricity supply
214
to rural areas and the international experience, the committee

recommends that,
the Government would ring-fence the subsidy that is
targeted towards the rural zones and deploy it diligently
through a combination of innovative solutions such as
minimum subsidy bidding and involving user co-operatives
and local franchisees, and fostering of institutions to provide
quality advice to these franchisees on financial, technical
and managerial matters.
Similar recommendations have also been made by several

academics and policymakers.
According to Sankars (2002) Towards a Peoples Plan for
Power Sector Reform, farmers can be persuaded to accept
metering only if offered a substantial material gain on a
permanent basis for getting meters fixed and an irrevocable
assurance that this gain, such as low fixed tariff per unit,
would not be altered for a long time. This can be done by
partitioning the power generating system and linking
different classes of consumers to 3 different sources of
power:
1. The cheapest power-generating stations meet
agricultural and other socially-relevant demands;
2. The demand of existing consumers (poor households
and agriculture) above their entitlement would be met from
the pooled power of utilities;
3. Emerging large demand would be met by new private/
public/captive power stations through mutually arranged
commercial contracts using the transmission/sub-transmission
lines of utilities bearing pre-announced wheeling charges.
In effect, such consumers would pay the marginal cost of
power.
In the case of agricultural pump sets a specified number
of units per year per pump set (the entitlement) could be
charged at the entitlement rate. The government would
provide the subsidy for this entitlement. Above the
entitlement, the charges would be higher. To assure farmers
that this arrangement will not be changed for a long time,
a separate company andcalled Agricultural Power
Generation Corporation100 per cent governmentownedcould be formed. All hydel and the cheapest thermal
assets which meet the entitlement demand for power would
be transferred to this company. This company would sell
power at cost to the Transco or Distcos and the latter would
provide the entitled power at 50 paise per unit, with the
difference being subsidized by the government. Since the
entitlement is capped, the subsidy would also be capped,
subject to generation cost increases. This arrangement
requires metering and Sankar assumes that farmers would
agree to metering given the governments credible
commitment to a permanent entitlement.
According to Gulati and Narayanan (2000), it is crucial
that the operating companies such as SEBs are not made
channels for subsidization of agricultural power consumption

in order to enable them to function on a commercial basis.
Subsidies to agricultural consumers must be given directly
in a transparent manner through a separate rural power
authority that would be billed by the power supplier as
metered at the substation level. An alternative is to subsidize
rural consumers in the form of power stamp programmes
where individual metering is possible. Gulati and Narayanan
also propose the use of electricity cooperatives, especially if
individual metering is unviable.
Morris (2000) recommends that the administration of
subsidy should be separated from the entities (whether stateowned or private) that manage and operate the electricity
business. The subsidy should take the form of an electricity
stamps or coupons scheme, which would be administered
by the agriculture department. This would make it possible
to have cost-based tariffs. Price differences if any would
then be related to cost of supply, time of use and other
aspects such as whether it is interruptible or otherwise. In
a discussion of the proposal (EPW Discussion, 915
September 2000, An Untenable Model, K. Balarama Reddi,
Usha Ramachandra, T.L. Sankar) it is pointed out that the
proposal would require full metering prior to being
implemented.
Political Initiatives
The central government, realizing the political nature of the
problem, and the need for all states to act in concert, has
arranged several meetings of chief ministers. The chief
ministers met on 16 October and 3 December 1996 to
discuss and arrive at a Common Minimum National Action
Plan for Power. The final Plan stated that while crosssubsidization between categories of consumers may be
allowed by SERCs, No sector shall, however, pay less than
50 per cent of the average cost of supply (cost of generation
plus transmission and distribution). Tariffs for agricultural
sector will not be less than fifty paise per Kwh to be brought
to 50 per cent of the average cost in not more than three
years. This was reiterated in the Resolutions of the Chief
Ministers/Power Ministers Conference, 3 March 2001.
That state governments are reluctant to phase out
subsidization is borne out by the fact that several state
governments have decided to subsidize even the nominal
increases in power tariffs for agriculture ordered by the
regulatory commissions.
CONCLUSION
Power supply to agriculture in its current form represents
a major hurdle to power sector reforms, especially
privatization. It is significant that privatization of distribution
has been carried out only in Orissa, which has less than

10 per cent agriculture supply, and in Delhi. Therefore, if
power sector reforms are to progress there is a need to
restructure the system of supplying power to agriculture.
Regulators have been largely unsuccessful in dealing with
the problems of power supply to agriculture. Attempts at
metering of pump-sets and quantitative restrictions on the
overall supply of power to agriculture have not worked.
Farmers have even ignored attractive metered tariffs and
continue to prefer flat rate supply. Hence, there is a need
to work out structural solutions to the problem.
Most academic and policy discussions on supply of power
to agriculture accept the inevitability of subsidies, at least
in the short term. This is in spite of the significant value
addition of groundwater to agriculture productivity and
incomes. The subsidies are a legacy of a period in which
pump-set energization and use was considered critical to
food security. However, continuing extraction of groundwater
has lead to alarming drops in groundwater levels in many
parts of the country forcing policymakers to reassess the
situation.
So far power subsidy has been a general input subsidy,
not targeted at any particular group of farmers. Given the
limitations on pump ownership by small and marginal
farmers a disproportionate amount of the subsidies has gone
to the wealthier farmers. It is important to appreciate that,
unlike other input subsidies, the benefit of power subsidies
requires the ownership of pumps. Farmers, who cannot
afford the capital investment in pumps or do not have access
to credit, cannot directly benefit from the power subsidy.
At best they can benefit through the market for pumped
water.
Current levels of power subsidy are not only unsustainable
given the condition of state government finances but also
undesirable given its impact on groundwater extraction. In
future, subsidies will have to be reduced and targeted.
The second important issue in the supply of power to
agriculture is the feasibility and viability of metering, billing,
and collection. The logistical difficulties and cost of metering,
billing, and collection was the primary justification for the
move to flat rate tariffs and the abandonment of metering.
While the cost of metering, billing, and collection was likely
to be high because of the widely dispersed pump-set
installations, the financial benefits were low given the
subsidized tariffs. However, this adverse cost benefit equation
may not be valid any longer. There has been a significant
increase in the density of pump set installations and
consumption per pump set. Simultaneously, there has been
a significant increase in the cost of power. With tariff increases
and reduction in subsidies, the financial benefit of metering,
billing, and collection would increase. Along with the
reduction in cost this would make metering a viable
proposition.
215
There is likely to be serious resistance by farmers to the

transition to metered tariffs and progressive reduction in
subsidies. Most farmers organizations have justified such
resistance to tariff increases given the poor quality of power
supply. Several studies have concluded that farmers are
willing to pay more for power if the supply is reliable and
of better quality. Of course, there is no guarantee that
farmers will actually pay more once the supply has improved.
Studies have found that farmers are unwilling to pay more
even where the quality of supply is already good.
(Ranganathan and Ramanayya 1998). In any case, it will
be easier for politicians to justify utilities and to implement
installation of meters and increases in tariffs if it is
accompanied by improvements in quality and reliability.
Such improvements will require significant upgradation
of the rural power supply infrastructure and close monitoring
of agriculture power supply. As pointed out, what is crucial
for power supply to agriculture is not the quantity but the
quality and reliability geared to farmers needs. These needs
are likely to vary across states, seasons, cropping patterns,
rainfall, and surface water availability. The pattern of power
requirement for agriculture is likely to be quite different
from domestic and industrial load. Utilities need to
understand these needs and match the supply. This is
especially crucial in situations of constrained supply.
Given the specific characteristics of power supply to
agriculture, it is not surprising that there is broad consensus
on the need for a separate organization for delivering power
to agriculture. This is necessary not only from the perspective
of meeting the agriculture demand more efficiently but also
to separate the problems of rationing and subsidy in the case
of power supply to agriculture, from other parts of the
organization. This will make reforms, including privatization,
of other parts feasible and attractive to private investors.
Several issues will need to be sorted out in creating a
separate organization for supplying power to agriculture:
Organization Form: this is likely to be a government
organization, carved out of the existing SEBs. However, it
would need to use appropriate local organization forms such
as cooperatives, village committees, and franchisees to
perform most of its tasks of routine maintenance and billing
and collection. There is some experience with village
committees in Orissa. It is important to bear in mind that
the village committee and franchisee arrangement in Orissa
is in the post-privatization period. It is not clear if similar
results would be obtained with a government-controlled
organization. In fact the village committee system was
designed to initially bypass the SEB organization inherited
by the private licensee in Orissa.
Scope of the Organization: Supply to agriculture may
have to be combined with supply to rural domestic,
216
commercial, and industrial consumers. The trade-off is

between economies of scale and scope and a clear separation
of agriculture load.
timing of power supply to agriculture. Once again there is

the question of viability and feasibility of separating the
agriculture supply network from other rural supply.
Physical Separation of the Agriculture/Rural Network: 100

per cent metering is likely to be a long drawn-out process
for rural areas in general, and agriculture in particular.
Therefore, the only way to determine the exact amount of
supply to agriculture is to physically separate the network
and measure the input into the system. Separation of the
network is also necessary for controlling the quality and
Delivery of Subsidies: Mechanisms for delivering subsidies

through power stamps or coupons are possible only with
comprehensive metering. Moreover, non-pump-owning
farmers would not be able to directly benefit from the power
subsidy through stamps or coupons. Therefore, without
comprehensive metering the current system of untargeted
subsidies is likely to continue.
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218
'
OIL AND NATURAL GAS
9.1 INDIAS ENERGY SECURITY: THE STRATEGIC VERSUS

ECONOMIC DIMENSIONS
Sudha Mahalingam
Geologists are of the view that the liquid gold vein passing
through West Asia, the Caspian and Siberia tantalizingly
bypasses the Indian sub-continent, although it is possible
that there are significant gas reserves. Currently, natural gas
accounts for 8 per cent of energy consumption. Even if
recent domestic gas finds imply an increasing share for gas
in Indias energy basket, swift transition from oil to gas is
not envisaged. It entails a time-consuming and costly process
of commercial exploitation and transportation, not to
mention adaptation of existing liquid-fuel-based industries
and automobiles to gas-based technologies. The recent gas
find by Reliance is a deepwater source and extraction costs
are expected to be high enough to make imported liquefied
natural gas (LNG) a competitive substitute.
India has ratified the Kyoto Protocol and is, therefore,
committed to reducing polluting fuels in the long-run. This
would mean moving away from coal which currently occupies
a little over half of Indias energy basket1. Economic
liberalization has meant the retreat of the state from the
commercial energy scene which in turn augurs ill for the
commissioning of new power plants based on alternative
technologies. For instance, nowhere in the world have new
nuclear stations been financed within a liberalized electricity
market for the simple reason that nuclear power is capitalintensive and considered uncompetitive2. Similarly, nonconventional energy sources which are expensive alternatives,
but have a definite utility, are unlikely to find sponsors.
1 See the discussion on coal in Box 9.1.1: Indias Energy Choices:
A Synoptic View, by Sebastian Morris.
2 Hagen E. Ronald (2002) pp. 602.
Consequently, the advent of energy markets will tend to

limit energy diversity and reinforce the countrys dependence
on hydrocarbons.
Domestic Production
Domestic crude production has plateaued around 640,000
barrels a day, having peaked at 724,000 barrels a day in
FY1995. Existing reserves are expected to last less than 20
years at current production levels. Domestic oil recovery
rates are low, in the region of 30 per cent, with Bombay
High offshore fields contributing the bulk. The Indian
government has awarded 70 exploration blocks to investors
during the three rounds of bidding under New Exploration
Licensing Policy. (NELP). It is noteworthy that despite the
generous terms offered, foreign investors have kept a low
profile, opting to take only 3 blocks. The government has
offered even more attractive terms for the NELP-IV round
that is currently being awarded, allowing up to 100 per cent
foreign equity participation, yet the response seems to be
lukewarm.
At current consumption levels, India imports over 73 per
cent of its hydrocarbon requirements. Indias import-intensity
is much more acute than that of the US which imports only
half of the 20 million barrels it consumes every day. Even
China imports only a third of its oil consumption. Japan
and South Korea are the only countries that import almost
all their hydrocarbon consumption.
Such heavy import dependence has a deep impact on
Indias trade balance. In FY 2002, India imported crude and
petrol, oil, and lubricants (POL) to the tune of US$17.5
Oil and Natural Gas
219
Box 9.1.1
Indias Energy Choices: A Synoptic View
Sebastian Morris
INEVITABILITY
OF INCREASING
COMMERCIAL ENERGY USE
Developing countries are transforming economies. As their GDP grows faster than the rest of the worlds (as it must if they are
to successfully transform themselves), their commercial energy use intensity from low levels climbs rapidly. During the transformation
phase their elasticities of commercial energy use with respect to GDP are in the range of 1.0 to 1.5 and that declines only after
the manufacturing sector has matured. These elasticities are significantly higher for larger countries that attempt a wide diversification
of the economy, and lower for smaller countries that are lucky enough to specialize in less energy intensive industrial structure.
In that effort, human and animal sources, plant wastes, etc. decline rapidly in their importance, since the use of these sources was
contingent on low incomes and community systems, and common property modes of exchange, the role of which decline in favour
of private property and commercial exchange.
DECLINE
IN
ELASTICITIES
COULD BE A
PERVERSITY
Indeed, if the commercial energy use elasticities prematurely decline then the growth process may well have been exclusive, with
vast income inequalities and many still outside the market and the development process. Much of the development of Latin America
(and perhaps of India today) is of this variety. All largish countries which are unambiguously industrializing (East Asian) showed
high commercial energy use elasticities which declined rapidly as these economies matured. This happens because a high value
adding manufacturing sector emerges as also as a functional services sector (rather than the premature services sector typical of
the first set of countries) which grows rapidly.
CAPITAL
AND
OIL
Equally importantly, since there is capital scarcity, the usual pattern in the initial phase has been to use such fuels as are low in
the capital intensity of their useoil rather than gas or coal, and high energy coals rather than high ash coals. Only after the capital
hunger of the transformation phase is over, does it become socially worthwhile (as the interest rates fall with lower levels of growth)
to use of fuels that require much capitalgas or low calorific value coals. These become relatively cheaper as the discount rate declines.
Many East Asian countries have also been energy-scarce (Taiwan, South Korea, Japan, Singapore), and their export-led growth has,
with enormous success, financed the imports of large amounts of commercial fuel, principally crude oil. Others, given their vast
resources, are either self-sufficient (Malaysia) or their dependence is not to the extreme levels (China) that rest of East Asias is.
DISTORTIONARY TAXES
Indias dependence on commercial energy and imported energy is likely to closely resemble that of Korea or Taiwan. With few
domestic resources, its dependence on imported energy and, more specifically oil, is likely to be very high. Currently the huge
indirect taxes on oil and oil products, being of the order of 64 per cent on value added in the sector, along with the much lower
taxes on gas, and the non-availability of MODVAT credit on oil and energy has distorted the energy market. And despite the
dismantling of the Administered Price Mechanism (APM) severe biases against the consumption of oil and oil products continue.
In turn these have resulted in costly investments in gas infrastructure, which are premature for the economy and would probably
not have taken place (when based on imported gas) had it not been for the distortionary taxation.
INEVITABLE IMPORT DEPENDENCE

It is only extreme poverty and low incomes that have kept its commercial energy use intensity low. The elasticities after being in
the range of about 1.2 for over a couple of decades (the 1960s and 1970s) had begun to decline in the 1980s and today is only
a little below 1.0. But with non-distorting taxes it could rise a little. More importantly, since Indian growth has not been all inclusive,
its lower energy use intensity is to be expected. It is erroneously believed than Indian industry is highly energy-intensive and since
it wastes energy there is much scope to save energy. This may be overstated, and today it is highly unlikely that any slack exists.
Savings are still possible but these may not be economically sensible (and certainly so at the undistorted prices for oil and coal),
since such savings would demand much use of capital. Decomposition of Indian industrys energy use intensity into a structural
component and use efficiency component would reveal that its intensity seems high only because of its industrial structure that
is different from that of smaller countries which have a smaller proportion of high energy use industries. Moreover, when the analysis
is adjusted for the purchasing power parity, which is high in both India and China, the so called higher energy use intensity of
these countries is fictional. Thus for a very long period, with growth, energy and principally-imported oil use is likely to increase
at elasticities that are no less than 0.7 and most probably closer to 1.0. Chinas rapid fall in energy use intensity in the 1990s is
an aspect of its export-led growth and a very large share of the manufacturing sector.
KRISHNAGODAVARI FINDINGS
DO NOT
ALTER
THE
PICTURE
The recent large findings of gas in the KrishnaGodavari basin would no doubt provide some relief but only at high capital cost.
It does not significantly alter the imported energy requirements over a twenty year period. The use of nuclear energy is problematic
220
and with large risks in all but the most well ordered economic systems it is out of question. Even here if the total cost including
the decommissioning costs are taken into account, nuclear power is hardly viable. In India, the actual experience of nuclear power
has been woefulabsorbing vast financial resources, with little public accountability, and with extremely poor capacity utlilization.
Recent developments in gas turbines, resulting from the cooperative and state (US government) sponsored researchthe Advanced
Turbine Projecthas stepped up the efficiency of GTs by about 8 to 10 per cent without recourse to extra capital costs, so that
gas has somewhat narrowed the gap in its suitability to coal even in the transforming economies. But whether these turbines or
their technology would be widely available or would command premium prices to nullify their increased efficiency to the user is
another matter.
COAL CAN REDUCE DEPENDENCE SOMEWHAT

The highest priority ought to have been for the development and use of high ash Indian coals with greater efficiency and reliability,
including at lower capital cost. Unfortunately, 2 kinds of problems have beset the coal sector. One is that the coal sector is controlled
by a mafia and a public sector that shows the worst kind of inefficiency. Output per man shift (OMS) and such other physical
parameters of mining efficiency and productivity have been abysmally low despite the vast investments in the sector. Only a
privatization with the entry of both foreign and domestic players and a taming of the mafia would work. Even the first effort, viz.
the award of large coal mining blocks to private parties for non-captive use, has to begin. The second set of problems relate to R&D
to use high ash content coals more effectively. Bharat Heavy Electricals (BHELs) valiant efforts at developing IGCC (integrated
coal gasification and combined cycle) power plants where coal is gasified to be burnt in combined cycle gas turbines, has resulted
in pilot and small-scale plants. But unfortunately their efforts to seek national commitment and government contributions to raise
the Rs, 600 crore or so required to scale up the technology has not borne fruit. One cannot think of a higher national energy research
priority that requires state support than for the IGCC scale up. But the complete abdication of any strategic intent in policy-making
today has resulted in bypassing many such opportunities. Similarly other possible opportunities in methane, in situ gassification
requiring national level R&D response would be bypassed.
LARGE POLICY RISKS
IN
COAL USAGE
The use of coal is constrained by the lack of a clear policy. Today huge risks, much of them emanating from the lack of a clear
policy, and regulatory risk impede the efficient use of coal. The fact that there is no cap on the interstate taxes in the movement
of coal or electricity generated out of coal, no framework to cap and limit the policy risk with regard to royalties, restricts the scope
of the coal-rich interior and the hydro-rich north to supply energy to the rest of the country. At current real costs (keeping aside
the distortions caused by taxes, their nonvattable status, absurd freight pricing by the railways, and lack of framework to govern
royalty rates) pit head stations with 500 MW or more TG sets linked to transmission lines from coal sources in central and eastern
India are most economical and are almost completely hedged against exchange rate variation risk. This is a major plus in a sector
like power, where assets have long life and the output is almost entirely non-tradable.
This means that there is no foreseeable escape from large amounts of imported energy.
ENVIRONMENTALIST FAILURE
Indian intellectuals, NGOs, and commentators have not been critical enough of the Kyoto Protocol and such other conventions
that try to limit Indias carbon emissions at levels close to its current levels that are based on a commercial energy consumption
that is barely 1/20 of the developed country levels. The idea that in all fairness it ought to be the rich countries who should limit
and reduce carbon emissions with no restriction at all on less developed countries (LDCs), till they reach levels of consumption
that are at least half the current rich country per capita levels should have been put far more forcefully and nothing short of this
thesis should have been acceptable to the Indian government and national NGOsa. In the long run of course we would have to
find solutions in solar energy and in the use of coal to result in solid residues rather than carbon dioxide. But this is very much
into the future and is certainly not Indias burden but that of the technologically powerful nations. This does not mean that India
does not carry out intense research in solar panels and related technologies, only that it is not our responsibility.
While coal could contribute in vastly enhanced ways, oil dependence would continue and imports can only grow. Again the
only viable strategy is to push for manufactured exports and services which can pay for the raw materials particularly oil in which
India is woefully short. The often made statement that India is rich in natural resources is quite misplaced. With less than 2 per
cent of the worlds area and over 17 per cent of the worlds population India is certainly one of most poor natural-resource economies
in the world with only Japan and South Korea being in the same class of import dependence. As mentioned before it is only Indias
extremely low income that keeps its hunger for the worlds natural resources low.
a
It is indeed a shame on Indian environmentalists that they have been unable to expose the simple tabulations of greenhouse contributions
put out by international bodies and NGOs. These show India in a poor light because of its large methane emissions that come from the decomposition
of the dung from a vast cattle population. The simple fact that methane has a short half life in the atmosphere while carbon dioxide has a permanency
even when absorbed by the oceans water should have been incorporated. With this adjustment Indias contribution to greenhouse gases becomes
incomparably smaller than of the advanced countries on a per capita basis.
Oil and Natural Gas

billion (Rs 840 billion), accounting for more than a third
of the countrys total import bill. POL imports pre-empt
40 per cent of export earnings. Compare this with China
whose oil import bill is just 5 per cent of its foreign trade
volume and less than 6 per cent of Chinas export revenues3.
Indias per capita energy consumption is just about 3 per
cent of OECD average4. Such a low energy consumption
base portends quantitative leaps, especially in the
transportation sector. By 2020, India, along with China,
will be among the worlds largest consumer of primary
energy. And the two Asian giants will compete with each
other for supplies from the GCC region5. Indian government
data forecast that in the next 25 years, oil consumption will
triple to more than 7 million barrels a day implying neartotal dependence on imports to fuel the economy.
In this scenario, what is the outlook for India in terms
of security of access to energy supplies? The term security
is used to mean availability, accessibility, affordability, and
physical safety of tankers/pipelines ferrying energy supplies
to India. Import-reliance of the magnitudes outlined above
for a commodity that is critical to economic well-being
spells security implications of a very serious nature, especially
for a developing country with an energy-intensive growth
paradigm. Potential supply disruptions, price volatility, and
security of shipping lanes/pipelines, triggered by political,
military, terrorist, environmental, or economic factors
constitute the energy security conundrum for India.
AVAILABILITY RISKS
History has shown that oil and democracy have a manifest
reluctance to mix with each other. Oil-rich states are often
ruled by either monarchies or thinly disguised dictatorships6.
Even the Caspian statesreckoned the new energy frontier
lean towards dictatorships. Governments in oil-exporting
countrieswhether democratic or otherwisetend to
maintain tight control over their energy resources, especially
because their economies depend heavily on oil revenues.
Perhaps such control is easier to exercise in a dictatorial setup than in a democracy7.
3 Guo (2002) IEEJ, September 2002. Chinas huge manufacturing
exports, following its active pursuit of trade-oriented growth is
another factor. China, of course is much richer than India in oil
through deficit in terms of its overall requirements.
4 Manning (2000) pp. 7388.
5 In 2003, China accounted for virtually all the increase in
world oil demand. See Petroleum Intelligence Weekly, 16 June 2003,
pp. 7.
6 Except Indonesia, Malaysia, Nigeria, and Venezuela which are
democracies, even if troubled, oil-exporting countries are ruled by
authoritarian regimes.
7 Efforts by multilateral agencies to induce oil-exporting states
to open up their oil sector to private investment have not met with
much success so far.
221
9/11
Until recently, the non-democratic nature of regimes in oilexporting countries did not seem to threaten global energy
supplies (Box 9.1.2). However, the terrorist attacks of 11
September 2001 (referred to as 9/11) on New York and
Washington, D.C. seem to have focused attention not only
on the unstable nature of regimes in oil-producing countries,
but also on the religious composition of their populations.
A Cambridge Energy Research Association (CERA) report8
points out that oil-rich countries are predominantly Islamic.
This has compelled the US to rethink its conventional
energy options and embark upon a multi-pronged strategy
which combines demand-side management with supplyside diversification. The latter includes, inter alia, drilling
in Alaska, building energy bridges with Russia and
Kazakhstan and regrouping US military forces in the Caspian.
In pursuit of this objective, the US government has already
stationed over 5000 troops in the Caspian and extended
generous financial assistance to the region even as its
companies have invested several billion dollars in the energy
industry in this part of the world.
Terrorist strikes that would disrupt energy supplies have
graduated from the realm of the probable to the possible.
Scenarios of upheaval in Saudi Arabiadeposition of the
ruling family and capture of oil installations by radicals
are no longer seen as belonging to the realms of fantasy, but
as real threats, especially if the US does pull its forces out
of Saudi Arabia. A large number of prominent Saudi-based
religious charities were identified as possible conduits of
terrorist finance by the US government in the wake of the
events of 9/11. The security of Gulf oil installations as well
as the sea lines of communication (SLOC) can no longer
be taken for granted when the US turns its attention away
from the region. This is particularly worrisome for India
and China whose supplies will have to pass through the
Straits of Hormuz.
No Insurance
Freight insurance premia have increased substantially since
the 9/11 attacks. The attack on a French oil tanker in
Yemeni waters in the first week of October 2002 is seen as
the handiwork of Al Qaieda. Off-shore properties are
perceived to be at greater risk from terrorist attacks and the
premium for cover is commensurately higher. Besides these,
war premium on shipping ruled at a whopping 5 per cent
prior to and during the US attack on Iraq. ONGCs risk
insurance premium rose by 80 per cent in 2002. National
naval budgets of oil-importing countries for ensuring security
of SLOC are envisaged to rise substantially. Heavily importdependent countries are taking a hard look at other energy
8
CERA (2002) pp. 157.
222

Box 9.1.2
Dictatorship and Western Oil Interests
Sebastian Morris
That oil and dictatorships have gone together may have a historical and economic reason, that lie in the desire and actions of western
powers especially the US and the UK to control oil sources. Had the Arab states including Egypt succeeded in uniting to form
an extended United Arab Republic as was envisaged, Egypt with its large population would have consumed oil at far higher levels
leaving much less Arab oil surpluses than what exist today. Similarly the separation of Brunei from Malaysia and Indonesia, and
the attempt at separating Nigerian oil from the Nigerian people during the Biafran civil war, and today the US machinations in
Central Asia are all in that line of keeping access to oil to a minimum number of people.
The same policies expressed through Seven Sisters kept areas outside the industrialized world under-explored, especially after
the OPEC oil embargo of 1979, so that much of the production, if not the discoveries, outside the OPEC and the advanced countries
owe to the state oil companies and the independents. It was vitally important to the oil giants interests and to the US demands
for cheap oil to keep populations away from oil, which resulted in foreign policies that necessarily divided the Arab world. That
this policy has seen much economic successes (from the western point of view) over the long period is quite clear since in the
1990s oil revenues have remained much the same for the Arab world and, most importantly, even the per capita incomes, especially
the populous part of the Arab world, has declined or stagnated through the 1990s and late 1980s.
The exercise of influence and sometimes direct control over the state and its nature in the oil countries was crucial to keeping
oil away from populations. Gaman Abdel Nasser, had to be eliminated to make way for this policy and dictatorships with a thin
support base that was at best obscurantist and religious, and pliable to US tutelage. Such dictatorship, the archetypes of which
are the Kuwaiti and the Saudi, were dependent on the western powers to suppress their populations from pursuing a democratic
and republication agenda. A similar policy was followed by the Shah of Iran (until his attempt to break free of western tutelage),
and the Sultan of Brunei. That these dictatorships should turn fundamental and use religion to derive their legitimacy was a necessity
to keep liberating modernist movements at bay. Similarly, in a world of western dominance the peoples fight for control over oil
has taken an even more obscurantist turn with ethnicity and religion as the basis. This too was inevitable since all modernist channels
were blocked by the rulers and their western allies. This policy has extracted some price from the US as exemplified by the rise
of terrorism.
While such dictatorships ensured oil supplies for the rest of the world, that policy may have finally begun to backfire, as Saudi
Arabia itself, despite official denials, may have ended up spawning and feeding obscurantist terrorist anti-western groups. This is
a case of the lie of religion as a way of ordering modern society and economy finally becoming real. The destructive potential of
this ideology manifests itself not only where the reactionary regime of Saudi Arabia has had influence, and Talibanism is merely
one form of the same approach, but has also resulted in increasing the appeal of imitative movements among other religions, such
as militant Hinduism and Buddhism, that seek to order societies on the basis of dogma. Yet the benefits of that policy to the western
world (and even more so to Europe) and to other oil-consuming economies like East Asia and Japan and now India is evident,
since oil prices have risen much slower than world inflation. Underlying this performance is the de facto US control of more than
60 per cent the production in the world (US, Canada, Saudi Arabia, Kuwait, and now Iraq and part of Central Asian oil).
In this global game other major military powers like the Soviet Union before its break-up and China today have proven singularly
incapable of resisting US interests. That invincibility of the US is based on its capacity for force extension beyond its borders that
are way ahead of any other power. Western Europes gain in the US policing for world oil is immense.
options, including nuclear energy in order to diversify their

sources of supply. Japan, which imports all the hydrocarbons
it needs, is contemplating several nuclear plants that will
minimize its dependence on tanker-borne LNG.
These developments have substantial and, to some extent,
conflicting implications for Indias energy security. Unlike
the US and Europe, India will continue to rely on oil from
the Gulf region to satisfy its burgeoning needs. Considering
the excessive reliance of the Gulf oil producers on oil revenues,
it is unlikely that they would be able to withstand sustained
production cuts to the extent of American and European
withdrawal from their supplies. Therefore, the OPEC,
especially its Gulf members would be looking at other large,
growing, and stable markets like India and China.
Geographical proximity will also ensure that Gulf oil is the
most viable source of supply to India. The changing global

equations will introduce a modicum of interdependence
between the Gulf producers and the Asian consumers.
Nevertheless, reliance on the Persian Gulf for the chunk of
energy imports could expose India to supply disruptions as
well as threaten security of SLOCs. In this context, any
investments made by India in supply diversification measures
would go a long way in mitigating the extent of reliance
on this troubled region.
Dependence on Gulf
Global economic slumps and rebounds are critically related
to oil. Any sudden increase in oil prices or disruptions in
oil supply could seriously impact economic recovery around
the world. The IMF estimates that a US$15 increase in
Oil and Natural Gas
223
global oil prices could reduce world economic growth by

1 per cent. It is certain that for every dollar increase in the
price of crude, Indias import bill goes up US$1.9 million
per day at current levels of consumption. It is estimated that
each dollar increase in the price of a barrel of crude sustained
over a year would lead to an increase of US$693 million
and bring down Indias GDP growth rate by 0.04 per cent.
ENERGY SECURITY OPTIONS
Dependence on Short-Term Contracts
Restructuring and Reform
Market forces were envisaged as a mechanism to provide

stability and security of energy supply in a world of unequal
endowments further vitiated by political, military, ideological,
and economic disparities. What geology sought to keep
asunder, market forces were expected to weave together,
acting as a bulwark against supply disruptions. But, markets
have also come to displace other forms of energy relationships.
Short-term contracts and spot purchases have supplanted
long-term bilateral energy alliances giving rise to
unpredictability in price movements. Despite its efforts to
contract term purchases, a significant proportion of Indias
crude is sourced from spot markets, exacerbating the countrys
vulnerability to price volatility9. The absence of regional
exchange-traded oil futures market in Asia has limited the
potential for minimizing price-related risks.
The instability in the Gulf Corporation Council (GCC)
region that supplies the bulk of Indias imports has exposed
the country to acute price volatility. The history of Gulf oil
has been one of fluctuations caused by political upheavals.
During the last Gulf War, crude prices rose from US$16.3
a barrel in July 1990 to US$34.6 a barrel in October 1990
and for the next 6 months, Indias petroleum import bill
doubled. After having slumped to US$12 a barrel in December
1991, crude price rose to US$2175 in October 1996
consequent on the US military attack on Iraq. In December
1998, oil price slumped to an all-time low of US$10 a barrel
only to soar to US$31 soon after the 9/11 attack on the US.
Prior to the March 2003 US attack on Iraq, spot prices of
OPEC basket crude rose from US$26 to US$32 to a barrel.
After having slumped back to normal soon after the outbreak
of the war, prices again hardened. Besides, OPEC, the
producers cartel manipulates prices by calibrating supplies.
At its meet on 24 September 2003, the OPEC leaders resolved
to cut production to 24.5 million barrels from 1 November
2003 to keep prices up. They claimed that the rise in nonOPEC supplies and the re-entry of Iraq into OPEC warranted
such a step. If OPEC manages to peg prices at US$25 a
barrel by fine-tuning production, as it has claimed it will,
Indias import bill could rise by up to 25 per cent.
For a heavily import-dependent economy, integration with

international markets sends out the right price signals so
that consumption responds to price. But in an energydriven economy like India, demand-side management can
at best be a limited tool10.
Reforms in Indias oil and gas were initiated with an
official document entitled Hydrocarbon Vision 2025. It set
out the medium and long-term vision for achieving energy
security through 2 thrust areas, namely, increased domestic
production and investments in oil equity abroad. The exercise
comprised the following steps: (a) opening up new investments
in exploration, production, refining, pipelines, and marketing
to private and foreign capital; (b) introducing competition
between various players in each segment of the industry; (c)
dismantling the administered price mechanism and integration
of domestic market prices with international markets; and
d) divesting government stake in Nationalized Oil Companies
(NOCs) and the privatization of their management.
In India, as elsewhere, energy industry restructuring has
been somewhat of a paradox. While reforms targeted
unbundling the erstwhile integrated electric supply industry,
in oil and gas, vertical integration has been the global trend.
Vertical integration is considered necessary because the
various segments of the oil industry operate in different
cycles. Besides, size is a critical factor for a country becoming
a global player11. While China created two verticallyintegrated oil companies by cross-assigning assets, in India,
the process is taking an unnatural course. ONGC, the
upstream company has acquired a stake in a joint venture
refinery and plans to get into retail marketing as well. IOC,
the other refiner and marketer has been trying to get into
exploration activity overseas, but for the moment, is being
restrained by the government!
IOC purchased 12.2 million tonnes out of the total 31.4

million tonnes in spot sales in FY 2002. HPCL and BPCL purchase
30 per cent of their crude in spot markets. (Petrowatch, Vol. 7, Issue
5, 21 May 2003). The figures for Reliance refinery are not available.
FOR
INDIA
In the last few years, India has launched a series of measures

diplomatic, political, economic, and commercial with a view
to augmenting its domestic resources as well as diversifying
external energy supplies. In this section, we briefly touch upon
some of the options exercised by India to ensure energy security.
Enhancing Recovery from Existing Oil Wells/Gas Fields

Enhancing recovery from existing oil wells is a prudent
short-term option to increase domestic supply. Public Sector
10 See also Box 9.1.1, which argues that the potential for demand-
side management is overstated, and current consumption is highly

constrained by very heavy taxation.
11 See Ramganesh and Pawar, Backward and Forward Integration
for Oil Mergers: A Discussion, Chapter 9.2 in this Report, for the
economies of vertical integration.
224

Table 9.1.1
ONGCs Improved Oil Recovery (IOR) Projects Worth More than Rs 100 crore
Schemes
Mumbai High North

Mumbai High South
IOR-Neelam
IOR-Gandhar
Heera and South Heera fields
Gandhar Redevelopment
IOR Rudrasagar
IOR Geleki
IOR LakhwaLakhmani
IOR Kalol
Capital expenditure
in Rs crore
(US$million)
2929.40
5255.97
347.69
473.23
309.08
385.99
113.87
390.09
277.20
99.67
(610)
(1100)
(72.3)
(98.54)
(64.38)
(80.21)
(23.54)
(81.25)
(57.71)
(20.61)
Incremental oil Incremental gas

(million tonnes) (billion cubic
metres)
24.8
35.95
2.06
4.34
3.19
4.69
1.38
3.94
4.94
2.65
5.85
9.63
1.23
1.51
0.55
4.65
Nil
Nil
Nil
Nil
Completion
schedule
Profile period
December 2005
July 2007
July 2003
December 2004
January 2004
December 2004
March 2006
20067
Same as above
March 2005
20001 to 202930
Same as above
20001 to 201920
Same as above
20034 to 201920
20001 to 201920
20012 to 201920
Same as above
Same as above
Same as above
Source: Petrowatch, Vol. 6 PW5, 8 May 2002.
Oil Companies have set aside US$1.8 billion to redevelop

and upgrade existing producing oil wells and gas fields.
They expect to boost recovery rates from 26 per cent to
32 per cent. Table 9.1.1 gives some of the major projects
planned by ONGC for the next 3 to 4 years.
concessions in Sudan, Venezuela, Iraq, and Kazhakstan. In

2002, CNPC pumped 430,000 barrels a day from its overseas
fields. China has set itself a target of 30 million tonnes
(about 0.6 mbd) of crude oil by 200513. In fact, Chinese
officials have been quoted saying that almost half of Chinas
oil imports come from its own overseas acreages14.
Overseas Oil Acreages

While drilling for new wells is considered a competitive
option for countries heavily dependent on imported oil,
globally, greenfield exploration costs have been rising. Reserve
additions have not been commensurate with capital
investments. Therefore, countries thirsty for oil are
increasingly opting to acquire equity stakes in overseas oil
exploration and production acreages. According to Deutche
Banks energy team, the cost of adding reserves through
acquisition of proven acreages is 40 per cent lower than the
cost of new exploration12.
China Forges Ahead

China has been quick to grasp the opportunities provided
by the opening up of upstream activities to foreign
investments in energy-rich countries around the world. It
has effectively used diplomacy as a tool in this pursuit. Just
3 years after it became a net oil importer, China National
Petroleum Corporation (CNPC) launched an aggressive
foray into overseas oil acreages as well as share-oil ventures.
It now has committed investments in Argentina, Bangladesh,
Canada, Columbia, Ecuador, Indonesia, Iran, Kazhakstan,
Malaysia, Mexico, Mongolia, Nigeria, Pakistan, Papua New
Guinea, Peru, Russia, Sudan, Thailand, Turkmenistan,
United States, and Venezuela. Production sharing contracts
have been signed with more than 20 countries as of 1997
and more than US$8 billion have been committed for oil
12
Petroleum Economist, June 2003, pp. 30.
Limited Indian Forays

For some years now, Indias premier Exploration and
Production company ONGC has been making forays into
overseas oil acreages in the form of Production Sharing
Contracts (PSC) through its subsidiary ONGC Videsh
Limited (OVL). It has also been acquiring exploration rights
in various parts of the world. Oil India Limited, the other
public sector upstream company and Reliance Industries
Limited, the private sector oil major have also made forays
into overseas exploration acreages. OVL has obtained a
20 per cent stake in Sakhalin-1 in Russia at a cost of US$1.7
billion and the field is expected to commence production
in 2005. In Iraq, OVL is eyeing a stake in the giant Tuba
oilfield in the south of the country. It hopes to develop this
field with Reliance once sanctions are lifted. In Vietnam,
OVL has 45 per cent stake in Nam Con San gas basin which
is being developed by a consortium of BP, Petrovietnam, and
OVL. The venture, which has just commenced production,
will produce 3 billion cubic metres a year for 20 years. OVL
has invested US$165 million in this venture. In Kazakhstan,
OVL has submitted a bid for minority stake in Kurmangazy
oil field which is being shared equally by Russia and
Kazakhstan. If successful, this venture will give India a
toehold in Central Asia. It is one of the largest offshore fields
in the region and has 820 million tonnes of recoverable
13
14
China Economic News, (No. 13), 15 April 2002.

IEA (2000), pp. 59.
Oil and Natural Gas

reserves. OVL is also considering acquiring a 15 per cent
stake in Alibekmola, a discovered field, currently controlled
by the Canadian firm Nelson Resources. OVLs acquired
25 per cent stake in the Greater Nile Petroleum Operating
Company in Sudan from the Canadian firm Talisman Energy
Inc. at a cost of US$720 million. In Libya, OVL has signed
an agreement with the Turkish Petroleum Overseas Company
to acquire 49 per cent stake in 2 onland oil and gas blocks.
In Myanmar it has acquired a 20 per cent stake in offshore
gas exploration block. See Table 9.1.1 for details. OIL has
10 per cent prospecting share in North Hell Hole Bayou
fields in the US and a 20 per cent share in Irans Farsi
alongwith ONGC and OIL, each of which hold 40 per cent
of the equity. ONGC and Reliance have equity stakes in
Yemeni oil fields as well. The exact quantum of funds
committed for these ventures is not available. Altogether,
OVL has committed US$3 billion to date for its overseas
ventures.
Beginning of Equity Oil Abroad

Already, India has received two consignments of oil from
its investment in the Greater Nile project in Sudan at a fixed
price far below the prevailing market price for similar grade
of crude. Between March and July 2003, the company
recovered US$115 million from the sale of this oil. Similarly,
the investment in Vietnam has already started yielding
dividends in the form payments in lieu of gas. India has
already received US$6 million in revenues from its investment
in Vietnam and expects to receive a total of US$30 million
by the year-end. OVL has targeted a supply of 400,000
barrels of oil in 20 years and eventually hopes to source
15 per cent of Indias oil consumption from its overseas
acreages. That, however, would depend upon a number of
factors, including ONGCs ability to raise the finances to
fund the development.
Questions have been raised about the wisdom of investing
enormous sums of money in unexplored/discovered oil fields
overseas in the name of diversification of supply sources.
The Greater Nile project in Sudan came in for considerable
criticism because of the poor human rights record of the
Sudanese government. There are those who argue that it
would make better economic sense to source oil directly
from the markets rather than invest huge sums of money
on hitherto unexplored oilfields especially because of the
existence of well-developed oil markets with a variety of
hedging instruments.
Nevertheless, considering the enormous energy security
concerns faced by India, diversification of supply sources
should be informed by strategic rather than economic
considerations. Almost all import-dependent countries which
include the US, EU, Japan, and China, have encouraged
their companies to acquire overseas oil acreages as one of
225
the means of securing their supplies, the steep costs involved

in such efforts notwithstanding. As long as these investments
are made after carrying out political risk analysis of the
target countries, they should be considered strategically
optimal solutions to the energy problem. India should
therefore, exercise all options in this regard, including
acquisition of overseas oil equity, building pipelines to access
gas from neighbouring regions and the setting up of a
strategic stockpile.
STRATEGIC PETROLEUM RESERVE

All major oil-importing countries with the exception of
China and India maintain a strategic stockpile of crude and
petroproducts. The US has the biggest stockpile of 700
million barrels closely followed by Japan. The EU also
stockpiles 45 days stock of petroleum to cushion its members
against supply disruptions.
Currently India maintains inventories of petro-products
of up to 15 days only. Crude inventories are geared to
refinery requirements. Maintaining a strategic stockpile of
crude as well as petro-products is an expensive proposition.
Petroleum Minister, Ram Naik, has been quoted saying that
a 30-day stockpile of crude would cost US$1 billion. China
is actively considering building a stockpile and there is also
talk of a common Asian/ASEAN stockpile although still in
rudimentary stages.
CONCLUSION
In its current development phase, India has chosen an energyintensive growth paradigm where demand-side management
measures have limited utility. Geographical compulsions and
ratification of the Kyoto Protocol have restricted Indias energy
diversity options. Hydrocarbons dominate Indias energy basket
and imports satisfy almost three quarters of domestic oil
consumption. In a situation where domestic production
prospects seem limited, heavy import reliance is an inescapable
reality. Excessive and growing dependence on imported
hydrocarbons from a single region constitutes the single most
worrisome threat to our energy security. The emergence of
China as an energy-guzzling giant competing for the same
sources of supply exacerbates Indias energy vulnerability.
Threats to energy security come from potential supply
disruptions as well as price volatility. Petroleum and petroproduct imports entail huge outflows of foreign exchange
and adversely affect Indias trade balance. Hence, the country
is acutely sensitive to oil price volatility. The volatility of
energy prices caused by instability in the Gulf region is
being exacerbated by market imperfections. Energy markets,
like markets for other commodities, are far from perfect.
Globally, spot sales and short-term contracts are replacing
226
long-term energy relationships so much so, financing energy

infrastructure in developing countries is considered an
unattractive option.
The political instability of the Persian Gulf region,
especially with the contemplated retreat of the US from
Saudi Arabia is a real and present concern for stability of
energy supplies from the region as well as for the security
of sea lines of communication.
In this context, diversification of energy supplies assumes
paramount importance. Supply diversification efforts in the
form of overseas oil equity investments by National Oil
Companies and the proposal to establish a Strategic Petroleum

Reserve significant costs (possibly to the taxpayers) should
therefore be actively considered. Strategic considerations of
securing oil supplies by diversifying sources and building up
a reserve are necessary from the economic point of view if
risk and uncertainty are brought in as they must be. Similarly
the active pursuit of proven fields and reserves at opportune
moments as when oil prices are below their long term
average is very important. After all the first best use of our
foreign exchange reserves is to secure oil since that import
need is almost entirely certain.
9.2 BACKWARD AND FORWARD INTEGRATION FOR INDIAN OIL MAJORS: A

DISCUSSION
K.N. Ramganesh and Swapnil Pawar
In process industries, there is a fundamental value chain
along which the firms operate as suppliers or customers of
other firms above or below them in the chain. The points
along the chain at which this separation of businesses occurs
can change with major changes in technology and as new
players, especially from the newly industrializing countries
enter. The extent of and rationale for vertical integration
of firms in this value chain then changes. Even then, while
some firms could be vertically integrated, others need not
be. Then the firms constitute different strategic groups with
differing competitive assets.
One such industry is the global petroleum industry where
there are some very large and well integrated firms and there
is a whole host of independent refiners and marketing firms.
What makes the sector particularly interesting is the existence
of large and sustained rents in oil production (drilling)
business and peculiar market imperfections in the global
crude oil markets. This is inter alia due to the geopolitical
complications associated with the highly skewed distribution
of oil reserves across the globe. Two important facts that
cannot let late industrializing governments be completely
aloof of the market structure are the critical importance of
oil to the smooth functioning of modern economy (with
its heavy dependence on oil for transport and several other
major uses) and the geographical concentration of oil reserves
in very few countries (Box 9.2.1).
The independent refiners (also referred to here as
standalone refiners) have often been at the receiving end of
the ill effects of market imperfections. Add to that the low
fraction of overall value added in the entire industry value
chain, the refinery business is found to have been regularly
The authors thank Sebastian Morris for his suggestions and
comments.
underperforming over the past several years. It is true that

most of the standalone refiners have been able to manage
accounting profits. However, whether they attain a return
on the capital employed in tune with what is the expected
return commensurate with the associated risks of the business
is not clear enough, and this is the subject matter of this
part of the chapter.
We show that the refining leg of the value chain is the
least profitable and consistently so.
THE INDIAN PETROLEUM INDUSTRY

The Indian petroleum industry has had hoary beginnings.
Quite against the domination of transnationals the
government set up a parallel petroleum refinery and
exploration industry by taking recourse to East European
and Russian technologies whenever (better) western
technologies were not available. The Gujarat Refinery (IOC)
at Koyali was the culmination of this effort. The foundation
for self-reliant development was laid by the great K.D.
Malviya.
Nationalization
As the global oil majors with refinery operation in India
refused to give up the freedom to transfer price (they supplied
Indian operations with high cost crude from their own
sources rather than low cost Russian crude then available),
the government nationalized the industry.
The Crisis and APM

As the oil crisis emerged and as a result of the Fuel Policy
Inquiry Committee's recommendations, an administered
Oil and Natural Gas
227
Box 9.2.1
The International Oil Industry Briefly
Both the varying reservoir characteristics and the physical characteristics of the crude oil are important components of the cost
of producing oil. These costs can range from as little as US$2 per barrel in the Middle East to more than US$15 per barrel in
some fields in the United States, including capital recovery. It is interesting to note that technological advances in finding and
producing oil have made it possible to bring once-expensive deepwater Gulf of Mexico oil into production for less than US$10
per barrel.
Crude Oil
The physical characteristics of crude oils differ. Crude oil with a similar mix of physical and chemical characteristics, usually produced
from a given reservoir, field or sometimes even a region, constitutes a crude oil 'stream'. More simply, crude oils are classified by
their density and sulfur content. Less dense (or lighter) crudes generally have a higher share of light hydrocarbonshigher value
productsthat can be recovered with simple distillation. The denser (heavier) crude oils produce a greater share of lower-valued
products with simple distillation and require additional processing to produce the desired range of products. Some crude oils also
have a higher sulfur content, an undesirable characteristic with respect to both processing and product quality. For pricing purposes,
crude oils of similar quality are often compared to a single representative crude oil, a benchmark, of the quality class.
Refinery
The quality of the crude oil dictates the level of processing and re-processing necessary to achieve the optimal mix of product output.
Hence, price and price differentials between crude oils also reflect the relative ease of refining. A premium crude oil like West Texas
Intermediate, the US benchmark, has a relatively high natural yield of desirable naphtha and straight-run gasoline. Another premium
crude oil, Nigerias Bonny Light, has a high natural yield of middle distillates.
After simple distillation alone, the output from a crude oil like Arab Light would be about 20 per cent of the lightest, the gasolinelike products, and about 50 per cent of the heaviest, the residuum. After further processing in the most sophisticated refinery, however,
the finished product output is about 60 per cent gasoline, and 5 per cent residuum. The refinery margins are quite sensitive to
the type of crude used. Refiners, therefore, strive to run the optimal mix of crudes through their refineries, depending on the refinery's
equipment, the desired output mix, and the relative price of available crudes.
World Refining Capacity

Broadly speaking, refining developed in consuming areas, because it was cheaper to move crude oil than to move product.
Furthermore, the proximity to consuming markets made it easier to respond to weather-induced spikes in demand or to gauge seasonal
shifts. Thus, while the Middle East is the largest producing region, the bulk of refining takes place in the United States, Europe,
or Asia. The largest concentration of refining capacity is in North America, accounting for about one-quarter of the crude oil
distillation capacity worldwide. Asia and Europe follow as refining centres.
Refinery Profitability and Industry Structure

In general, refining has been significantly less profitable than other industry segments during the 1990s. Gross refinery margins
the difference between the cost of the input and the price of the outputhave been squeezed at the same time that operating
costs and the need for additional investment to meet environmental mandates has grown, thus reducing the net margin even further.
In addition, much of the investment made during the 1980s was designed to take advantage of the differential between the dwindling
supply of higher quality crude oils and the growing supply of heavier and higher sulfur crudes. When that differential narrowed,
however, the return on those investments declined. The following figure shows the cost of crude oil to US refiners over the years.
Usually a single refinery suffices for a large geographical territory's oil needs. The final products, therefore, have to be transported
from the site of the refinery to the retail outlets spread over the entire territory. This is generally done by the marketing company,
which could be a division of an integrated oil company or a separate standalone firm. In case of the latter, the marketing company
buys the final products from the refinery.
OPEC'S FAILURE
TO
CONTROL CRUDE OIL PRICES
OPEC has seldom been effective as a cartel. During the 197980 period of rapidly increasing prices, Saudi Arabia repeatedly warned
other members of OPEC that high prices would lead to a reduction in demand. The rapid price increases caused several reactions
among consumers: better insulation in new homes, increased insulation in many older homes, more energy efficiency in industrial
processes, and automobiles with higher mileage. These factors along with a global recession caused a reduction in demand, which
led to falling crude prices. Unfortunately for OPEC, only the global recession was temporary. Nobody rushed to remove insulation
from their homes or to replace energy efficient plants and equipment. Much of the reaction to the oil price increase of the end
of the decade was permanent and would not respond to lower prices with increased demand for oil.
The current price of crude oil is hovering around US$30/barrel at current prices. This is in reaction to the recent attack by
USA on Iraq and the consequent supply disruption. The bottom-line that emerges from the brief history of oil prices mentioned
228
above is that the market for crude oil is far from perfect and the prices are governed by lot more than market forces. As explained
in the following section, this volatility of price is not passed on to the final products fully. As a result, the refinery margins are
always at the mercy of the crude oil price volatility.
pricing scheme was put in place which brought about the

era of differential prices and cross-subsidies based on the
same. Thus kerosene and diesel were lower priced relative
to petrol and aviation turbine fuel (ATF). The APM also
seemed to smoothen price movements imposed by the crude
price volatility because the oil pool account was set up as
a mechanism to cover the sharp intertemporal variations.
The original idea was to keep using this account only to
manage price volatility but the temptation to not raise
prices during politically sensitive periods, and to over-tax
the sector has all but completely distorted the sector so that
the true demands for oil products in a neutral and low value
added tax regime is difficult to infer15.
Subsidization and Distortions

The fallout of the price-based subsidization has been to
create perverse incentives to adulterate final products
especially petrol and diesel with neptha and solvent, and
kerosene, respectively. Society continues to pay huge costs
as a result. While the oil distribution business may not have
corrupted the oil companies, the distributor are largely
corrupt entities. Over-entry has happened in a major way
because adulteration is possible to completely distort the
distribution business16. The massive dependence of indirect
taxes both at the central and state levels has been another
problem, along with the adherence to price-based subsidies
that make reform and privatization difficult. Thus, today
the centre and the states derive as much as 20 to 25 per
cent of their taxes from this sector! In the early 1990s, the
exploration sectors were opened to transnationals on contract,
and the refinery sector was opened to private investment.
Private Sector Entry

In 2002, the government phased out the APM and announced
the New Exploration and Licensing Policy (NELP) creating
a level field for domestic and foreign players in the Indian
oil industry. This led to a sharp rise in profits of oil companies,
ostensibly due to improved refining margins. Upstream
companies such as ONGC now get international prices for
their crude, improving their topline too.
India is now surplus in refining capacity, with the setting
up of Reliances 27-million tonne refinery at Jamnagar.
15 The true demand with the correct conditions for motor spirit
is most certainly likely to be far in excess of current demands, and
of kerosene much lower than the present demand since a large part
of the kerosene is used to adulterate diesel.
16 See Morris, S. (2002) for a detailed discussion.
There is also now more scope for entry of foreign players

into the country in the following fields:
Exploration of oil and gas received a boost with
significant findings of natural gas off India's East Coast in
2002 by Reliance Industries Limited. Foreign participation
may occur through funding of Reliance in extraction and
distribution of these reserves. Consortia with equity
participation by foreign companies have already obtained
rights to gas reserves in the Krishna basin (Gujarat State
Petroleum Corporation and Canada based Geo-Global
Resources Inc.).
With oil majors such as HPCL and BPCL on the
disinvestment block, foreign giants could possibly acquire
controlling stake in these and gain entry to the Indian
downstream segment. Some of refining and marketing majors
have surplus refining capacity in Asia and could try and later
import refined products directly into the country.
The only barriers to entry for new players are the
distribution chain and the pipeline network. While the
latter can continue to be a barrier17, the former need not
be, since many have the freedom to change their supply
service such being their contracts with the existing players.
With active privatization of HPCL and BPCL, the
entry of transnationals is almost imminent. Would Indian
players, whose value chains lack the depth, be able to survive
the onslaught from large integrated players? This is a vital
question if the industry has to remain in Indian hands18.
CRUDE
AND
OIL PRODUCT PRICES
One of the basic characteristics of an efficient market for

crude is the absence of significant autocorrelation between
lagged prices of crude. We test autocorrelation by lagging
17 If full open access to oil pipelines were to come, then prior
investments in oil pipelines would not protect the existing player
viz., Indian Oil with significant investments in oil pipelines.
18 Strategic oil stocks controlled by governments irrespective of
ownership are an important hedge against oil insecurity in times of
stress. While such strategies would work in times of most crisis; a
war situation with the US/UK on the wrong side would prove
disastrous for India, given these countries capacity and willingness
for force extension far beyond their boundaries. A better hedge then
would be oil fields and production chain in areas where India itself
can extend its force. In this sense, therefore, the investments by
ONGC in far away countries does not make sense but their economics
is favourable. The Sudanese fields of ONGC are known to have a
cost of production of under US$10 a barrel. See also Mahalingam,
Chapter 9.1 in this Report.
40.00
Margins
229
100
90
35.00
80
30.00
70
25.00
60
20.00
50
40
15.00
30
10.00
Brent (US. Dollars Per Barrel)

20
Weighted ave
5.00
6/1/03
3/1/03
12/1/02
9/1/02
6/1/02
3/1/02
12/1/01
9/1/01
6/1/01
3/1/01
12/1/00
9/1/00
6/1/00
3/1/00
12/1/99
9/1/99
0.00
10
6/1/99
Difference between crude oil price and final product price (USD/barrel)
Oil and Natural Gas
Source: International Petroleum Information, US Energy Information Administration (on line) Sept. 2003. (http://www.eia/doc.gov/emeu/
international/petroleum.htm# prices.)
Fig. 9.2.1
Difference Between Crude Oil Price and Final Product Price (US$/barrel)
prices by 1, 5, and 10 days with daily prices taken from

January 1997 to July 2003, with results as shown in the
table below:
Table 9.2.1
Autocorrelation by Lagging Prices of Crude
Lag
1 Day
5 Days
10 Days
Autocorrelation
0.0213
0.0037
0.0040
This absence of autocorrelation indicates at least weakform efficiency in the crude oil market.
To understand refinery margins and their variability, we
carry out an analysis of the volatility of the daily crude oil
and petroleum product prices in deregulated economies.
The spread earned by refineries is the difference in the prices
between crude oil, and the weighted prices of the various
products of the fractional distillation (which are petroleum
products). Thus, we hypothesise that if these volatilities vary
widely and if crude oil price fluctuations are far more than
those of products, the stickiness in refinery output prices19
may lead to squeezing of their margins.
19
The stickiness of retail output prices has several reasons, one

of which is menu costs. But among customers used to price variations,
The daily prices of Brent crude oil, and wholesale prices

of conventional gasoline, heating oil, and diesel have been
used. The last three are the primary distillates of crude and
other constituents have been ignored due to non-availability
of daily data and due to their relative small weight in output
and co-movement with principal output prices. Prices have
been taken from January 1997 to July 2003. For the United
Kingdom the prices are shown in Table 9.2.2.
Table 9.2.2
Daily Prices of Brent Crude and Primary Distillates of Crude
Brent Crude
Mean Price (US$/barrel)

Standard Deviation
(US$/barrel)
Stdev/Mean
25.62
4.21
16.44%
Weighted Average
of Gasoline, Diesel,
and Heating Oil
81.26
5.42
6.67%
Source: International Petroleum Information, US Energy Information

Administration (on line) Sept. 2003. (http://www.eia/doc.gov/emeu/
as long as these are seen as fair, even retail price movements are
possible if all costs are not large and if consumers are not optimizing
their use on the basis of average prices.
230
Thus, there is a stickiness seen in the prices of the final

refined products. These prices do not fluctuate as much as
the crude oil prices do. This indicates a possible basis in the
squeeze on refinery margins, that is, if the refineries are
unable to freely change the output prices to reflect changed
raw material prices, their spreads could get squeezed. This
is further illustrated in the figure below that shows weighted
average prices of final products (weighted by their volume
composition in the fractional distillation process) against
crude prices.
Such a situation is most likely to prevail in India, where,
despite dismantling of the administered pricing, the oil
companies are far from free to move petrol, diesel, and other
prices on a day-to-day basis to reflect changes in crude prices.
However, in a far more free market such as that of the
US, this problem is not seen to a significant degree. The
data for the US is shown in the Table 9.2.3.
Table 9.2.3
Will Free Market Approach Reflect Changes in Crude Prices
Mean (US$/barrel)
Standard Deviation
(US$/barrel)
Stdev/Mean
Brent
Crude
Motor
Gasoline
Diesel
Heating
Oil
23.19
5.81
66.90
17.96
65.31
19.21
64.13
19.67
25.03%
26.84%
29.41%
30.67%
Source: International Petroleum Information, US Energy Information

Administration (on line) Sept. 2003. (http://www.eia/doc.gov/emeu/
Thus, stickiness of output prices alone cannot explain

refinery margins in different countries and an analysis of
refining costs and return on assets and investment is to be
done to ascertain whether refineries are viable.
EVALUATION
OF
STAND-ALONE REFINERIES
The evaluation of the economic viability of a stand-alone

refinery is analysed with reference to the (opportunity) cost
of capital. The hypothesis is that the return on assets in a
stand-alone refinery is less than its weighted average cost of
capital. In other words, it is a firm with negative Economic
Value Added (EVA) or that the stakeholder value is destroyed
in the operations of a stand-alone refinery.
Estimates of the Return on Assets

The required investment is difficult to determine due to the
fact that no new refinery has been set up in the USA since
1974. Hence, we took figures of the investment requirements
based on the data available for recently set up Indian
refineries.
Table 9.2.4
Investment Requirement for Indian Refinery
Refinery
Capacity Investment Per Tonne Per Barrel

(Million (Rs crore) Investment Investment
Tonnes)
(Rs/tonne) (US$/barrel)
Reliance (Jamnagar)
HPCL (Bhatinda)
BPCL (Bina)
15*
9
6
9700
9800
6000
6467
10,889
10,000
18.81
31.67
29.09
Note: *As first planned
A figure of around US$18 per barrel of annual crudeprocessing capacity seems to be the absolute minimum
investment today. The effect of PPP is mitigated to some
extent due to the fact that the refinery equipment is likely
to be imported and the only difference PPP can have is
through other set-up costs. In the absence of clear data on
the fraction of these costs, we decided to go ahead with these
figures. Considering the hypothesis, it is clear that if we prove
the stand-alone refinery operations to be value destroying for
these estimates of investment requirement, they will obviously
hold for higher investment requirement as well. This is because,
given a stream of future cash flows, a higher upfront
investment will always lead to lower returns vis--vis a lower
one. Hence, we will need to fine tune these estimates further
only in case we are unable to prove the hypothesis.
As regard the cash flows, we worked with the cash margins
of the refiners, which are fairly common in the industry and
are hence easy to arrive at. Instead of taking data from the
actual refiners, we concentrated on the result derived for
typical refineries in an earlier study EA (2003). This would
eliminate any aberration due to the need to otherwise adjust
the data. These refineries are fairly representative of the
stand-alone refineries in the USA.
In the above-mentioned study, 3 refinery types are used
to explore the historical cash margin trends for the US
refining industrytwo typical Gulf Coast refineries and
one East Coast refinery. The 2 Gulf Coast refineries have
complex configurations containing fluid catalytic cracking,
coking, and hydro treating. One is designed to process light,
sweet crude oil, and the second has a larger coking unit and
more extensive hydro treating than the first in order to
process high sulphur (sour) crude oils. The East Coast
refinery has a fluid catalytic cracking unit, but no coking
capability, and is designed to process only low sulphur
crude oils.
The cash margin is defined as follows:
Cash margin = (price producti yield producti)
Crude cost consist of: Other feedstock cost;Fuel plus
other variable cost; Operating, maintenance cost.
The East Coast refinery type is represented by a 170,000
barrel per day, single train refinery with reforming, fluid
Oil and Natural Gas
Table 9.2.5
Cash Margin of Refineries
Refinery
Bonny Lt Ec
Brent-Ec
Brent-Gc
Wti-Gc
Arab Lt Gc
Average
Cash
Margin
US$9/
barrel
Return on investment (RoI)

with the investment of
US$18/
barrel
US$25/
barrel
US$30/
barrel
1.670
1.553
2.243
1.534
1.732
9.28%
8.63%
12.46%
8.52%
9.62%
6.68%
6.21%
8.97%
6.13%
6.93%
5.57%
5.18%
7.48%
5.11%
5.77%
As we can see, the average return on investment is found

to be in the regions below 10 per cent for almost all the
cases. As pointed out above, the Gulf Coast refineries are
more complex and would require higher investment, the
appropriate estimate of RoI for them is that with an
investment of US$2530/barrel. However, for the East Coast,
the investment can be assumed to be on the lower side. All
these cases have RoI around 6 per cent to 9 per cent.
Alternative Estimates
The returns on assets of US refiners according to the US
Government is an in Figure 9.2.2 (EIA 2003).
25
20
Percent
catalytic cracking (FCC), alkylation, and hydro treating of

naphtha and middle distillate streams. The Gulf Coast
refineries are similar in size, but also include coking capability.
The Gulf Coast has 2 refinery variations, one allowing
processing of light crude oils with low or moderate sulphur
content, and a second allowing processing of more sour
crude oils by having a larger coking unit and additional
hydro treating capability, including a vacuum gas
configuration, oil hydro-treater for the FCC unit feedstock.
The 2 Gulf Coast refineries are more complex and require
a larger financial investment than the East Coast refineries.
The larger investment is premised on the expectation that
larger cash margins will be obtained to provide funds for
capital recovery and an adequate return for the incremental
investment. The additional investments are aimed at
increasing light product yields and/or running cheaper sour,
heavy crude oils. The extra coking and sulphur removal
capability of the more complex Gulf Coast refiner allows
this facility to convert most of the heavy materials in crude
oil to higher valued gasoline and distillate, thereby improving
margins. Unfortunately, the price discount for these low
quality crude oils relative to light sweet crude oils is not
always sufficient to allow these more complex refineries to
earn competitive returns on the added conversion equipment.
The average cash margin for each of the refineries from
these numbers has been found to be as follows (Table 9.2.5):
231
Independent refining companies
15
10
5
Major petroleum companies U.S. refining,

0 marketing, and transportation activities
1987 1988 1989 1990 1991 1992 1993 1994 1995
Fig. 9.2.2 Operating Income as a Percentage of Net
Property, Plant, and Equipment, 198795
These observations confirm our earlier estimates regarding

the RoI values. For most part of the 1990s, the values for
RoA have stayed below or around 10 per cent for the majors
and around 10 per cent for the stand-alone refiners. When
we consider the RoI figures for the oil majors, we are taking
into consideration only the refinery and marketing operations
in isolation.
THE ESTIMATION
OF
COST
OF
CAPITAL
To estimate the cost of capital for the firm we use what can
be termed the weighted average cost of capital (WACC)
Approach. The WACC is defined as the weighted average
of the cost of long-term debt and cost of equity where the
weights are in the proportion of their respective market
values. Generally the book value of the debt is taken as a
good proxy for its market value while the market value of
equity is available from the share price in case of a listed
company. The cost of debt is simply the rate of interest
adjusted for the interest tax shield20.
The cost of equity is generally arrived at using the measure
of the risk of holding the stock of that company as a part
of a diversified portfolio. This risk is measured by the beta
coefficient, which is an indicator of the correlation of the
returns on the stock of the firm with the market returns
generally taken on a daily basis. The capital asset pricing
model, which is the backbone of this approach to finding
the cost of equity, states that the expected rate of return
from a stock is the risk-free rate plus a risk premium in
proportion to what is called the systemic risk of the stock.
This systemic risk is measured by beta coefficient.
K e = R f + RM R f
(9.2.1)
20 The interest tax shield is the reduction in tax liability of the

firm due to the interest being treated as an expense unlike profit
that is taxed.
232
Where
Ke = Cost of Equity
Rf = Risk free rate
RM = Return on the market
Generally, government treasury bills of an appropriate
maturity are taken as the indicators of the risk-free rate of
return. The market risk premium (RM Rf) is dependent
on the market and for US markets it has been observed to
be between 8 per cent and 11per cent.
The expected rate of return on the stock of various standalone refineries was found from the market data. The values
of the other variables assumed are as follows:
Rf = 6% (This is in tune with the prevailing government
treasury bill rates during the 1990s in the USA. We have
considered the yield on long-term securities)
RM RM = 10%
For estimating beta, we considered the average beta of the
various stand-alone refineries operating in the USA currently.
Table 9.2.6 lists a few of these and the associated betas.
The average beta is found to be 0.7. Substituting in the
above equation,
Table 9.2.6
Average Beta of Stand-Alone Refineries in USA
WACC = 0.5 13 + 0.5 0.6 10

WACC = 9.5%
Hence, the expected returns on the capital employed in
a refinery works out to be around 9.5 per cent.
Comparison of WACC and RoA
Number
Refinery Name
Beta
1
2
3
4
5
Frontier Oil Inc.

Giant Oil Inc.
Sunoco Inc.
Tesero Oil Inc.
Valero Oil Inc.
0.43
0.72
0.66
0.84
0.85
Source: Listed companies, NYSE (online), Sept. 2003 (http://

www.nyse.com/listed/p1020656067970.html?display Page=%2F listed
%2F1020656067970.html)
Ke = 6 + 0.7 10
Ke = 13%
The leverage21 of the firms was found to be close to 0.5
for most of the stand-alone refineries. We consider a leverage
of 0.5 for our case. The weighted average cost of capital
(WACC) is hence defined as,
WACC = (1 L)Ke + L(1 T)KD
Where, L:
Leverage
T:
Marginal tax rate for the firm
KD :
The cost of debt for the firm
This is because the firm raising debt from the market has
to compensate the creditor for the extra risk of default that
is associated with the firm. It is expected that the firms with
widely varying margins are more likely to default on their
debt repayments than those with stable cash flows if their
averages are equal. We have seen the wide variation that
refinery margins experience. This would mean that the cost
of debt for the refiners is likely to be quite large. If we were
to express this fact in the standard debt market terms, we
can say that the investment grade of the refinery will be
close to BB or BBB. This grade is a proxy for the default
risk and, hence, the associated spread over the risk free rate.
Considering the generally prevailing spreads, the cost of
debt for a refiner can be assumed to be close to 10 per cent
which means a spread of around 4 per cent over the riskfree rate for a similar duration of time. The marginal tax
rate for the US firms is assumed to be close to 40 per cent.
The WACC thus found is,
Recall that the RoA of most of the hypothetical refineries

we considered has been in the region of 6 per cent9 per
cent. The best cases have shown return of slightly more than
9 per cent. However the WACC with most of the conservative
estimates has been 9.5 per cent is unlikely to be smaller than
this in any case. This shows that the returns on investment
in the stand-alone refineries have not been in tune with the
expected returns. This is including the benefits of leverage
and diversification. The former reduces WACC by increasing
the debt component of capital and the latter reduces the beta
of the firm, which enables the firm to raise equity capital
at reasonable rates in spite of wide variation in the cash
margins. If we consider the undiversified business risks of
the refining business, the cost of equity will be even higher
since the benefits of the diversification will disappear and the
beta will be higher than 1 pushing the cost of equity to more
than 16 per cent and WACC to more than 11 per cent.
(9.2.2)
Generally, the cost of debt is inferred from the prevailing

risk-free rate and the spread over the same for a given firm.
21 Leverage is the ratio of debt to total capital that comprises the
long-term debt and market value of equity. Its value for firms in a
given industry is generally close though it differs widely across industries.
PROFITABILITY OF VARIOUS SEGMENTS

OIL VALUE CHAIN
OF THE
As explained earlier, the oil sector can be segmented into 4

major segments, namely exploration, production, refining,
and marketing. There is a dramatic variation in the profitability
of each of these segments as noted in Table 9.2.7.
Historically, the rents in the oil production business have
been high. This was owing to the high geographical
Oil and Natural Gas
233
Table 9.2.7
Variation in Profitability of the Four Major Oil Segments
Segment
Characteristic
Capital intensity
Rents
Profitability
Value fraction in the entire chain
Competition
Volatility of margins
Volatility of margins/value fraction in the entire chain
Exploration
Production
Refining
Marketing
Moderate
Average
Moderate
Moderate
ModerateHigh
Low
Low
High
Very High
Very High
High
Low
Average
Low
High
Nil
Low
Very Low
High
High
Extremely High
Moderate
Low
Moderate
Moderate
High
Low
Low
concentration of the oil reserves. Also the initial development

of the oil was undertaken largely by large companies, which
were interested in perpetrating their market power. These
were to become what were termed the seven sisters or the
'majors'. Although now they are fewer in number owing to
mergers, these companies continue to exert a significant
control over oil prices and other activities. The emergence
of the national oil companies in the Middle East mitigated
the powers of the seven sisters to some extent. However,
many times these national companies themselves had
significant holding by the majors.
The majors are vertically integrated oil companies.
Although they do not necessarily offtake their entire crude
production, they certainly do not have to face the crude
price volatility for their downstream operations. This makes
it possible for these companies to maintain stable final
product prices. The independent refiners on the other hand,
have to face the spot market crude oil price volatility together
with the volatility in the final product prices. Often these
two are neither proportional nor synchronous. This erodes
the margins of the stand-alone refiners.
ref_mar = Pfinal_product Pcrude
(9.2.3)
Hence,
2
2
2
srefine
= sfinal_product
+ scrude
2
srefine
=4 +9
(9.2.4)
This would lead to a volatility of around US$3.6/barrel.

In per cent terms, it is more than 70 per cent of the mean
refinery margins. Compare this with the 8 per cent10 per
cent variation in the crude oil price and the final product
price.
One natural question, however, is why the majors let the
profitability of their refining operations suffer. Taken in
isolation their refinery operations are as profitable as those of
the stand-alone refiners. The possible explanations for this are
that the huge rents in the production business enable the
majors to take hit on their refinery operations. The refining
operations form a small part of the overall value chain of the
integrated players. The final product demand optimization
leads to the existing prices of those products and an independent
optimal price for the crude oil exists for the majors who do
not necessarily use all the crude oil they produce.
Volatility Impact on Standalone Refineries
Implications for the Global Oil Industry
As it is value addition in the refining operation is low to

start with. If one superimposes the margin fluctuations due
to the input and output price fluctuations, the per cent
variation in the margins turns out to be quite high. One
such case is detailed in the Table 9.2.8 below:
The volatility of the refinery margins will be sum of the
individual volatilities.
The global oil industry is likely to see no further investments

in refinery capacity other than those by the integrated players.
The sustained under-performance of the independent refiners
will eventually make them takeover targets for the larger
firms. Recent developments in the Gulf region which are
likely to reduce the influence of OPEC to a significant
extent may, however, have serious implications for the standalone refiners. The lack of quantitative restrictions and quotas
in the absence of OPEC may lead to a fall of crude oil prices
which may give some breathing space for the refiners if the
final product prices do not fall as much. However, the
immediate fallouts of the recent Gulf War have been more
damaging than encouraging for the refiners with the crude
oil prices surging up owing to disruption of the oil supply
from Iraq on one hand and the integrated players keeping
the final product prices in check on the other. In the long
Table 9.2.8
Input/Output Fluctuations in Margins
Crude Oil Price (US$/barrel)

Final Product Price
(US$/barrel of crude oil used)
Refinery Margin
Mean
Volatility
Volatility/
Mean
25
30
2
3
8%
10%
234
run, however, the rationale for the existence of stand-alone

refiners having thinned out, these entities are on the path
to extinction. The options open to them are as follows:
merge into suitable fully vertically integrated oil major;
merge with an oil marketing firm or start marketing
operations, or
merge backwards into a stand-alone oil production
firm or invest in recently found oil wells. This can hardly
be done by individual refiners. Hence, this option really calls
for significant horizontal integration as an intermediate step.
IMPLICATIONS
FOR
INDIA
The dismantling of the APM and its impact on the incomes

of oil companies in India has already been pointed out.
Foreign Investors
Likely foreign investors into the Indian oil industry such as
Shell, Mobil, and others are all vertically integrated players.
Thus, they would be able to adjust the volatile refining
margins against rents made on exploration and production
(E&P) elsewhere in the world. Foreign players have not yet
entered in a big way despite the dismantling of APM . This
may be due to the following reasons:
With the recent large findings of natural gas in the
country, there is a threat of increasing substitution of oil
with natural gas. In such a scenario, foreign players would
be well advised to be wary of making huge investments
without waiting to watch developments in this direction.
Till then, the shortfall of products like naphtha can be met
by imports, even if at a cost slightly higher than that of
indigenous refining.
There is a surplus refining capacity not only in India,
but also in South and South-East Asia. Again, this makes
refining investments in India unattractive.
HPCL and BPCL are up for disinvestment. They
enjoy a distribution network that is dense and hard to
replicate. Thus, buying a controlling stake in one of them
could be the strategy that would be employed by a foreign
entrant such as Shell.
The government is yet reluctant to fully relinquish
control of petroleum prices. Kerosene and LPG continue to
be subsidized at the cost of ATF and petrol. There is also
an attempt to keep prices of petroleum products
approximately the same in all parts of the country (in spite
of large transport cost differences). These introduce distortions
that potential investors would be very uncomfortable with.
Domestic Players
Domestic players such as IOC and HPCL should strive to
vertically integrate backwards. They ought to make
investments in oil or gas fields not necessarily in India, but

anywhere in the world. We argue that any purely-refining
units would not be able to compete against vertically
integrated international players, if these make a foray into
the country soon.
For the present, however, IOC, HPCL, and BPCL have
the advantage of a wide marketing network and this leg
of the value chain should provide them sufficient margins
to compete. But this barrier can give way suddenly if
pipelines go open access and retailers are free to chose their
suppliers.
For pure refiners such as Reliance Petroleum, it is
important to quickly integrate backwards and forwards22.
They are already reported to be looking at a share in
marketing and distribution by acquiring controlling stake
in HPCL or BPCL in the disinvestment.
The government should, in order to provide a level playing
field, permit downstream companies to enter upstream
operations and vice versa. This may take place either through
greenfield investments or through mergers. Again, integration
need not be limited to Indian territory alone.
CONCLUSION
International crude oil prices are weak-form efficient
in that there is no significant autocorrelation in crude oil
prices.
In some countries like the UK, petroleum product
prices exhibit less volatility and, hence, more stickiness
compared to crude oil prices and this may lead to squeezing
of refinery margins.
Return of assets earned by stand-alone refineries, based
on historical data, does not justify the investment made
therein. Hence, stand-alone refiners cannot compete
effectively with integrated players in the long run and earn
returns above the WACC.
If refineries are taken as a proprietary investment
rather than as a stock in a portfolio, the situation is even
worse. The only reason returns on refineries come close to
expected levels is their low correlation with market returns
(leading to low beta).
The Indian government should permit, and the oil majors
should quickly strive for vertical integration upwards and
downwards, the latter by going out to foreign oil fields.
Only such investments would help to create the barriers to
entry against the global oil regions.
22 Reliance, of course, has been managing its business and gaining
from an efficient refinery without having to make the investments
in pipelines or distribution assets through its marketing contracts with
a reluctant Indianoil Corporation (IOC). With independent regulation,
Reliances ability to get and enforce such contracts is not guaranteed.
Oil and Natural Gas
235
9.3 THE PETROLEUM REGULATORY BILL, 2002: A REVIEW

Samir K. Barua
The Petroleum Regulatory Bill was necessitated because of
the decision of the government to dismantle the APM for
the petroleum sector from April 2002. The objectives of the
Bill are
to provide for a regulatory mechanism which would
facilitate uninterrupted and adequate supply of petroleum
and petroleum products in all parts of the country including
remote areas at fair price, promote competitive markets
and access to monopolistic infrastructure in the nature of
common carrier on non-discriminatory basis by all entities.
These objectives are intended to be achieved by setting
up of a Petroleum Regulatory Board to regulate the
refining, processing, storage, transportation, distribution,
marketing and sale of petroleum and petroleum products
excluding production of crude oil and natural gas .
Governments Hand
The Bill is another instance of how governments find it
difficult and perhaps even impossible to let go of controls.
While there can be little disagreement on the laudable
objectives stated for the Petroleum Regulatory Board, some
of the functions specified in Section 12 of the Bill raise
serious concerns about extent of freedom that would indeed
be accorded to the sector, particularly to the Public Sector
Undertakings (PSUs). Two of the functions specified in the
Bill are that the Board would ensure adequate availability
of products and also monitor prices and take corrective
measures to prevent profiteering. Fulfillment of these
objectives would essentially call for micro-management of
the sector, on lines similar to the manner in which the
erstwhile Oil Coordination Committee (OCC) used to
function. However, since in the deregulated era, it would
be difficult to coerce the private sector companies, the
functions are likely to lead to the PSUs in the sector being
persuaded into servicing the unremunerative or loss-making
markets and increasing supplies to prevent profiteering. The
freeze on the domestic prices and subsidies for LPG and
kerosene despite increase in the international prices is a clear
pointer to what may happen if such functions are assigned
to the Board.
Pipelines and Common Carrier

As regards pipelines, the Bill requires the Boards approval
for laying a pipeline. The Board also may declare pipelines
as common carrier and regulate access to common carrier
so as to ensure fair trade and competition. The entity
laying the pipeline shall have the right of first use for its
own requirement and the remaining capacity shall be used
amongst entities as the Board may determine having

regard to needs of fair competition in marketing and
availability of products throughout the country. It is clear
that two opposite considerations are implicitly at work in
framing these functions. The government certainly would
like to minimize duplication of investments in the pipeline
infrastructure so as to improve asset utilization. At the same
time the first use principle is being stipulated to encourage
investments in enhancing pipeline capacities. Operationally,
however, the implementation of the norms laid down could
create significant governance difficulties for the Board.
Besides tariff determination for use of pipelines, even the
scheduling of capacity utilization is likely to create intractable
disputes. In addition, creation of any new capacities has
implications for the capacity utilization of the entire network.
Without a well-reasoned policy framework for addressing
these issues, the Board would find it difficult to perform
these functions effectively and equitably and would be open
to adverse criticism. The government should formulate clear
policy on pricing for transportation of petroleum products
through pipelines well before the Bill becomes an Act, so
as to eliminate not only the associated uncertainties, and
thereby remove a major source of possible disputes in the
emerging deregulated era.
Government Hand in Regulation

As in the case of regulatory function in other sectors, even
in the case of the functions specified for the Petroleum
Regulatory Board, the last function specified is the omnibus
requirement that the Board would perform such other
functions as may be entrusted to it by the Central Government
to carry out the provisions of this Act. This, read along with
the provision in Section 34 on Power of Central Government
that the Central Government may issue policy directives
to the Board in writing and such policy directives shall be
binding upon the board The decision of the Central
Government whether a question is one of policy or not shall
be final, ensures that the invisible hand of the government
would guide the decisions of the Board. The possibility of
governmental interference in the functioning of the Board
becomes more evident from the method suggested for
constitution of the Board and the funding of the Boards
activities (including salaries of the Board members).
Independent Funding of Regulator Necessary

As has been the practice in the case of all other regulatory
bodies, the members of the Petroleum Board too are to be
236
appointed by the central government. This quite often

leads to these positions being filled up by retired civil
servants which raises questions about independence of the
Board from the incumbent government. And as can happen
sometimes, the decisions that the regulators are persuaded
to take by the incumbent governments may not be in the
longer-term interests of the sector or the nation. One possible
way of cutting the umbilical cord with the extant
government could be selection or at least approval of
members of such Boards by the Parliament and not by the
government. In this case, the multi-party parliamentary
committee on the petroleum sector could be assigned the
responsibility of selecting the members for the Petroleum
Board. Another significant issue associated with independence is the source of funding for such regulatory agencies.
The Bill proposes to fund the operation of the Board
through grants made out of the consolidated fund of India.
Instead of this mode of funding, it would be better if the
Board is permitted to charge a small fee from all the entities
in the petroleum sector as a percentage of either turnover
or asset or profits. Independent source of funding would
go a long way in ensuring independence of action and
provide true meaning to the petroleum ministers assertion
in the Statement of Objects and Reasons for the Bill that
The Board would operate at an arms length from the
Central Government.
9.4 TARIFF SETTING IN GAS TRANSMISSIONA VIEW OF METHODOLOGIES

Atanu Chakraborty
Gas consumption in any substantial manner in India began
with the formation of GAIL and setting up of the Hazira
BijaipurJagdishpur (HBJ) pipeline. This long line actually
boosted natural gas consumption in the country. Major
consumers of gas in the country happen to be the power
and fertilizer sector consuming about 40 and 34 per cent,
respectively. Domestic and household usage of gas is yet to
develop23.
The discovery of gas in the KrishnaGodavari (KG)Basin
and other places and setting up of LNG terminals on the
west coast of the country has suddenly changed the gas
scenario in the country, and the future is likely to see a
much larger share of gas in the overall energy consumption
pattern. The Tenth Plan projects a demand of about
180 mmscd from the present level of 145 mmscd and a
shortfall of about 100 mmscd and domestic supply of about
80 mmscd. This can change with the exploitation of the KG
gas resource.
Natural gas, unlike other commodities, cannot be
transported by road or rail. There has to be a network of
23
A company catering specifically to domestic gas users has now

been in existence for over 15 years and many others have come up
recently. This company, Gujarat Gas Limited (now a subsidiary of
British Gas), is also in the business of transmission of gas for quite
some time, but largely it is for its own captive use in the distribution
zones. It has hired out transmission capacity to other users only on
certain sections. Thus, apart from GAIL, Gujarat State Petronet
Limited with about 400 km of gas pipeline is the other serious player
in the business and is in fact the only company which goes by the
principle Open Access, Common Carrier. There are other companies
like Mahanagar Gas and Indraprastha Gas Limited, in Mumbai and
Delhi, which are more of gas distribution companies. So far other
gas producers have not entered into gas transmission business seriously.
pipelines for gas transmission and a local distribution zone

where it can be retailed or sold in bulk. A good gas
transportation network is a prerequisite for development of
free market in gas (Chakraborty 2002). As capital costs are
high, construction risks are very high, and because there are
network externalities. the business of gas transportation tends
to be natural monopoly. Unbundling in this sector means
the separation of the pipes business (natural monopoly),
from supply which can be competitive. The pipes business,
therefore, needs to be regulated, and Open Access Common
Carrier principle will have to be enforced on the lines of
what obtains in the electricity sector. In such a scenario,
tariffs become an important feature for selling of natural gas
as a competitive fuel24. Tariff will also determine the
geographic spread of usage of gas.
REGULATION TODAY
Postage Stamp Tariff
GAIL is the major transporter today and it has, since
inception, followed postal stamp tariff. This means that
tariff at any place in the country remains the same irrespective
of distance. This tariff recovers capital costs, variable costs
like gas consumption for pressure boosting and manpower
costs, and a post tax return of 12 per cent on networth.
24
Electricity can compete with natural gas especially for heating

and industrial applications when gas networks overlay high power
electric transmission lines. With efficient small size gas-turbinebased generation now possible, gas pipelines can compete with large
capacity transmission lines, and the market for peaking power becomes
far more competitive.
Oil and Natural Gas

Perhaps this kind of regime was justified because of
shortage of gas with no alternative than the allocation of
gas by the central government. It was perhaps also the
vestigial idea of equalization of cost of transport similar to
freight equalization for coal and steel. With few users there
could not have been a gas market25. The need to correct
the regional imbalances and, therefore, siting of industries
in backward regions became necessary.
This has led to fertilizer factories being set up in Uttar
Pradesh while gas was available on the west coast. However,
in a scenario where gas was being allocated, cost recovery
was not really difficult. Presently this tariff is in the range
of Rs 1150 per thousand SCM. APM for petroleum products
has already been dismantled and it will not be long before
this momentum catches up with gas also. Already, for the
new discoveries the price of the commodity, that is, gas, is
being marked to market. Industrial policy has long been
liberalized and siting of central PSU units is more on the
basis of locational economics. In such a regime, a postage
stamp tariff defies economic logic. Once gas sales are driven
more by market consideration, fixing transmission tariffs on
postage stamp principle would not be possible.
In a deregulated scenario, the tariff system must: (a)
allow for cost recovery so that the system is bankable; (b)
be transparent, stable, and practicable; (c) enable transition
to the market-based system on gas transactions; (d) send
economically appropriate signals to foster greater utilization
of capacity and permit gas to be a competitive fuel. This
would imply the unbundling of the tariff with respect to
the pressure and area that is, the pricing regime would be
different for a local distribution zone and different for a
trunk transmission line. Similarly, pricing would be different
for high and low pressure lines.
As in the case of power, there are essentially two
components in the gas transmission tariff. They are: capacity
charge to recover fixed cost and variable charge to cover the
through put costs. However, a third element of costs which
includes inter alia connection charge and system gas charges,
would, normally, be subsumed in the above 2 categories. In
practice, one has seen in that capacity charge/variable cost
split can be as high as 90/10. But, at this split level, it would
be difficult to sell transmission capacity except for very large
buyers with firm demands for long periods. Therefore, an
appropriate tariff methodology needs to be developed.
Transmission lines have fairly long lives. Once the loan is
fully paid out the tariff structure would change.
Average Accounting Cost

Here, the total cost of setting and operating the system is
allocated over the entire capacity and average unit cost is
237
developed from that. Though it is a transparent and straightforward system, it has disadvantages and it charges customers
for excess capacity. Also, customers who are distant from the
gas facility end up paying disproportionately high tariff.
Long Run Marginal Cost (LRMC)

This approach takes into account incremental capital and
operating cost required to meet sustained increase in
throughput. It provides an economically sound basis for
tariff setting and users do not have to pay for surplus
capacity. But it presumes a good understanding of demand
and it does not always permit the transporter to fully recover
his costs. It also requires an incremental capacity to be
defined over which LRMC would be applied. Therefore, a
pure LRC has better applicability in a mature market, where
demand patterns have stabilized and investment pattern in
pipelines over a period of time is more or less known a
priori. Text book principles in themselves do not yield
workable tariffs. They have to be contextualized to the
particular situation of the product/service, and the country.
When applied to gas pipelines the following methods are
important in leading to the appropriate regulation:
Virtual Pipeline Method: While the transmission company
may like to set up a large system to cater for full demand,
the user may not like to pay the capital charge for the full
capacity. Therefore, one basis for tariff setting is to assume
only the capacity that the user is likely to use. In this
method it is assumed as if a line is actually being set up for
that user and for the capacity that he wants to use within
the main line. Thus the entire line gets divided into a large
number of virtual pipelines. This permits the user to pay
for a limited capacity even if the pipeline size is large. This
also pushes the transmitting company to push for higher
sale of capacity and, thus, promotes usage of gas. There is
a tendency for the transporter to incentivize additional
usage of capacity and thus permit an aggressive pricing
regime26. In a virtual pipeline methodology, since the user
virtually owns part of the line, the capacity charges tend to
be on the higher side, about 85 per cent of the total charges.
Such pipelines are normally set up with high equity
contributions, which is to the tune of 5070 per cent of
the project cost. They are also helpful for the markets where
initial demand is low but the future is bright.
Cluster Approach: This is also popularly known as entry/
exit pricing. In this various demand centres are demarcated.
For each demand centre uniform pricing is done relative to
an entry point. If there are more than one entry points, than
those many different slabs of rates would exist with respect
to entry and exist points. Normally, an attempt is made to
25
Gas markets would not arise automatically but would have to

be created. The market in the US was created by the initiatives of
Enron and other companies.
26
This is because the price of two virtual pipelines is much more

than the cost of the real pipeline to the transmission company.
238
capture all the costs pertaining to one demand centre within

the tariff itself. Thus, costs for each demand centre is
effectively segregated. This policy also helps in reducing
tariffs for distant demand centres.
However, it must be understood that no single tariff
methodology can capture all the requirements of both the
users and the transmission company. Factors like growth in
demand, demand patterns, cost of laying pipelines have
tremendous impact on the choice of tariff methodology.
Gas transmission lines are seen as natural monopolies. It
is difficult for the user to shift from one line to the other.
However, the west coast has seen multiple operators, signalling
a certain amount of contestability at the entry point of the
value chain. The transmission entity which puts in investment
upfront, is always the great risk and its revenue stream is
shaky. This delicate relationship between the user and the
transmission entity is normally maintained through a
contractual framework known as Gas Transmission Agreement
(GTA). The salient features of a normal GTA are:
i. It specifies the capacity that is offered to the user. It
also specifies the uptime for the system. These are backed by
penalties if these requirements are not met. Normally, the
shortfall or the excess use of the capacity is measured on a daily
basis and penalties are determined at the end of the month.
ii. In a common carrier system there is a mix of slightly
different gases, therefore, what the user puts in and gets out
of the system is the energy per and this remains a unit of
transaction. However, the properties of gas on entry are
regulated on such parameters as waxing properties, dew
point, pressure, etc.
iii. Depending upon the type of tariff methodology

used, there are invariably incentives for using larger volumes
of capacity. However, where capacity is a constraint the
pricing methodology may be reversed.
iv. Capacity charges ensure that even non-usage of the
capacity does not impact the revenues of the transmitting
entity. However, in case the user reneges on his promise to
use the capacity, then most of the contracts make a provision
for a lump-sum compensation to the transmitting entity.
CONCLUSION
Gas market in India is still in its infancy. The allocation
based system is changing to markets for gas. That there are
various components of costs in usage of gas when unbundled,
which users will have to consider before ruling out alternative
fuels. The market for gas would develop only when a
transmission system is in place. This assumes a transmission
entity, which does not club sale of commodity along with
transmission and follows common carrier principles with a
tariff regime that is appropriate to the development of
markets. Virtual pipelines and cluster methods are possible
options. One is also witnessing a slow shift from a single
source of gas to multiple entry points. This would also
facilitate short-term and spot contracts in gas apart from
standard long-term contracts. This would mean short-term
pricing of transmission capacity as well. This will provide
additional cash flow streams to the gas transportation entities
and we might soon see a tariff regime for short-term users
and one for long-term users.
REFERENCES
Cambridge Energy Research Associates (CERA) (2002) Global
and Asian Oil and Gas Markets: Opportunities for Russia,
Second Baikal Economic Forum, Irkutsk, Siberia, 1720
September.
Chakraborty, Atanu (2002) The Gujarat Gas Bill and Its Genesis,
Chapter 6.2, in S. Morris, and Rajiv Shekhar (eds), India
Infrastructure Report 2002: Governance Issues for Commercialization, 3iNetwork, New Delhi, Oxford University Press.
EIA (2003) US Refining Cash Marg in Trends: Factors Affecting
the Margin Component of Price, Petroleum 1996, Issues
and Trends, Energy Information Administration, Office of
Oil and Gas, US Dept. of Energy (on line), Sept. 2003
(http://www.eia.doc.gov/pub/oil-gas/petroleum/analysispublications/petroleum-issues-trends-1996/CHAPTERT.pdf).
GOI (2003a), Annual Report 20023: Ministry of Petroleum &
Natural Gas, Government of India.
(2003b) Tenth Plan Document, Vol. II: Planning
Commission, Government of India.
(2003c) Performance Budget 2003-04: Ministry of
Petroleum and Natural Gas, Government of India.
Guo, Sishi (2002) Oil Security, A Crucial Strategic Issue for the
Economic Development of China, IEEJ, September.
Hagen, Ronald E. (2002) The outlook for Nuclear power in
Asia, in World Energy Yearbook 2000, published jointly by
Petroleum Economist of London and Ernst & Young, London,
2000.
International Energy Agency: Chinas Worldwide Quest for Energy
Security 2000, www.iea.org/public/studies/china.htm, pp. 59.
Manning, Robert A. (2000) The Asian Energy Predicament, in
Survival Vol. 42, No. 3.
Morris, S. (2002) The Challenge to Governance in India, in
3iNetwork, India Infrastructure Report 2002: Governance
Issues for Commercialization, New Delhi, Oxford University
Press.
MOP (2002) Petroleum Regulating Board Bill, 2002 (http://
petroleum.nic.in/prbill.htm).
PriceWaterHouseCoopers (2002) Tariff Setting Methodology:
Broad Tariff PrinciplesA Discussion Paper: Commission of
Energy Regulation, N. Ireland, mimeo, PriceWaterHouse
Coopers.
A Review of Telecom Regulatory Authority of Indias Tariff and Interconnection Regulation 239

A REVIEW OF TELECOM REGULATORY

AUTHORITY OF INDIAS TARIFF AND
INTERCONNECTION REGULATION
Rekha Jain
Tariff rebalancing and interconnection regulation plays a

critical role in reforming the telecom sector, characterized
by rapid technological changes and monopoly service
provision by the incumbent. Due to rapid advances in
technology, the prices of long distance communication have
fallen more dramatically and incomparably more than that
of the wire line local access. Further, competition in the
long distance segment has resulted in a sharp decline in
prices, almost bringing them near costs. However, the decline
in long distance prices may not be accompanied by costbased local access rates. They may have been historically
kept low due to political reasons. The below cost rentals and
call charges may not invite private participation. On the
other hand, it may not be possible to have above cost long
distance charges (usually used to subsidize the below cost
rentals and local call charges) in a competitive environment.
Tariff regulation to rebalance these by increasing local call
charges as a means to encourage private entry and
corresponding reduction in long distance charges creates the
appropriate incentives for investment. Tariff rebalancing as
a regulatory tool can ensure adequate incentives to the
incumbents for the transition to a competitive environment
by specifying the road map and protecting its revenues.
interconnection to the new entrant. With the deregulation

of the Indian telecommunications sector and the move from
monopoly to duopoly and finally to oligopoly in the telecom
sector, the choice for the end user has increased. However,
this has also placed demands on the regulator to ensure
implementation of policies for efficient operation of the
sector with interconnection as one of the critical issues in
enhancing competition.
One of the most crucial and debated issues in
interconnection regulation is interconnection charging as it
forms a major part of both the expenses as well as the
revenues for a telecom operator. Interconnection charging
can be a significant factor in the viability of the business
of an interconnection-seeking private telecom operator as
well as for the interconnection-granting incumbent. The
access charges, if passed on to the consumers, also affect the
retail price of services offered. Therefore, the charging regime
has to be efficient, fair and unambiguous to protect the
interests of all the players. TRAI began tariff balancing as
early as in 1999, and the exercise has gone through two
phases (Box 10.1).
Interconnection to the Fore
In May 1999, the TRAI allowed fixed service operators to

provide WLL services using CDMA as it would be strongly
in the interest of the subscribers. Technologically, this was
a cellular service1. However, TRAI had limited the mobility
that could be offered on these networks to the Short Distance
Charging Areas (SDCA). The spectrum for these services
was given on a first come first serve basis and the players
With multiple players in the industry, interconnection has

become a critical issue, especially as the incumbent usually
has a large spread out network. The challenge before
regulators is to provide a framework that addresses not only
the technical, economic, and commercial aspects, but also
provides for technological changes. The regulator must adopt
policies that encourage the emergence of a competitive
market, despite the reluctance of the incumbent to provide
PRIOR EVENTS
For a detailed discussion of this initiation and the likely fall

out see Annexe Table 10.1, Jain and Sanghi (2002).
240

Box 10.1
Tariff and Interconnection Regulation (The Earlier Phases)
THE FIRST PHASE

TRAI began the tariff rebalancing with a second consultation paper in September 1998 and specified the tariffs in the first Telecom
Tariff Order, March 1999 (TTO 99) (http://www.trai.gov.in/order.html).
Tariff Rebalancing
For fixed services, the TTO 99 was the first step in the process of tariff rebalancing. The tariffs were specified in terms of standard
packages that all providers were obliged to offer. However, there was provision for both fixed and cellular service providers to offer
alternative packages in terms of monthly rentals and per minute charges. The TTO 99 envisaged an increase in monthly rentals
and a decrease in NLD and ILD tariffs to bring them near costs in 3 phases over a 3-year period. The phasing would help to
cushion the impact of changes. The TTO 99 categorized the users as rural and urban (based on classification as per census) and
further within each category, the users were divided into low, general, and commercial. The rentals for the different categories varied
and also depended on the exchange capacity to which the subscriber was connected (Annexe 10.1).
The categorization into low and general user was based on the usage in terms of MCUs. For both the urban and rural users,
low users were those who made less than or equal to 500 MCUs per month, while general users were those who belonged to neither
commercial nor low user categories. The definition for commercial user was left to be decided in the future after a due process
of consultation. For the time being, commercial users were those who opted for a rental under the commercial category. For rural
subscribers, if MCUs were less than or equal to 500, then the per call unit charge would be Rs 0.80, additional MCUs would
have a charge of Rs 1.00 per unit, while for urban areas, the corresponding charges were Rs 1.00 and Rs 1.20, respectively. The
per minute charge did not vary within the specific sub-categories (low, general, or commercial). The rural and urban subscribers
got 75 and 60 free MCUs per month.
The paper provided for a change in rentals for every year for the 3-year period for the period 1 April 2000 to 31 March 2002
only for the general category. For the long distance and international calls, the TTO 99 specified a pulse rate and charge on different
distance slabs. These were expected to reduce over the 3-year period. For the rural subscriber the minimum and maximum charges
for a one minute long distance call at pulse charge of Rs 0.80 per minute would be Rs 0.80 (for a call within 50 km) and
Rs 20.00 (for a call distance of greater than 1000 km). These were expected to be Rs 0.80 and Rs 14.40, respectively by 31 March
2002. For the urban subscriber the corresponding rates would be Rs 1.00 and Rs 25.00, expected to go to Rs 1.00 and Rs 18.00,
respectively, over the 3-year period. The above elements were a part of the standard package which all service providers were required
to provide. For cellular services, the TTO specified cost based rentals (Rs 600 per month) and air time tariffs (Rs 6 per minute).
Interconnections
Interconnection regulation had been in terms of interconnection charges (set up charges) and revenue share (usage charges)a . The
basic framework was laid down in TRAIs consultation paper on Telecom Pricing (9 September 1998) and TTO 99. Key aspects
of the framework were: Interconnection prices were based on costs and usage charges were based on a percentage of revenue share.
For interconnections between fixed services providers, the provision for the local calls was on the basis of bill and keep, for NLD
calls the revenue share proportion was 40:60 for the originating and terminating service provider, respectively. For ILD services,
revenue share proportion was 45:55 between the originating and terminating network, in this case, the DoT.
For interconnection between fixed and mobile services, the Receiving Party Pays principle was followed, with no revenue share.
The called party would pay the airtime. For calls between the mobile to fixed services, the originator would pay the airtime as
well as the Public Switched Telephone Network (PSTN) charges (as applicable). The PSTN charges were to be passed on to the
fixed service provider in toto for the long distance and the international component.
TRAI proposed a shift to the CPP regime in September 1998 but shifted the implementation to August 1999, as the implications
of the National Telecom Policy 1999 (NTP 99) that was likely to be announced in March 1999 also needed to be factored in.
The NTP 99 changed the annual licence fee to a 1-time entry fee and an annual revenue share. This had implications on the
cost-based tariffs. TRAI subsequently reviewed the tariffs and reduced the cap on rentals (from Rs 600 to Rs 450) and airtime
(from Rs 6.00 per minute to Rs 4.0 in metros and Rs 4.50 in circles). The revenue share for NLD and ILD continued as before.
For fixed to mobile local calls, TRAI specified a charge of Rs 2.40 for the first minute and Rs 1.20 for each successive minute.
Along with it, the revenue share was mandated as 33:67 per cent between the fixed and mobile operator specified as a mobile
terminating charge. Due to MTNL and others filing a case in the High Court requesting for a stay on the CPP regime on the
grounds that this would lead to (i) increased costs due to network upgradation, bill collection, and bad debts, and (ii)TRAI having
no jurisdiction to issue or to make regulations to regulate arrangements amongst service providers. The courts held that TRAI did
not have powers to alter the terms and conditions of the licence (through specifying the revenue sharing regulation). Subsequently,
the government issued the TRAI Amendment Ordinance 2000 in January 2000. This changed the composition and powers of
TRAI, specifically giving TRAI the power to fix interconnectivity terms, and setting up the Telecom Dispute Settlement Appellate
Tribunal (TDSAT). In addition to the scope of the disputes in the earlier act, the tribunal would also be the appeal mechanism
for the decisions of TRAI. The decisions of the tribunal could be appealed against only in the Supreme Court. (for a detailed analysis,
see Sinha 2001)).
THE SECOND PHASE

The second phase of the rebalancing was to be effective from 1 April 2000 but was postponed to July 2000, as due to the lag
in the availability of data for the required period of operation, the TRAI could not do the necessary review. This was further postponed
by a month to August 2000. During the review process the service providing arm of the erstwhile DoT, called Department of Telecom
Services (DTS), (now BSNL) mentioned that due to tariff rebalancing, (the long distance calls becoming cheaper), it had earned
lower revenues by Rs 20002200 crore during 19992000. The flexibility of the alternative tariff package had been utilized to
the extent of not charging rent for subscribers making 200 MCUs. This had led to a further loss of Rs 10001200 crore.
However, in TRAIs assessment, due to the delays in implementation of the second round of rebalancing, declining cost of telecom
equipment and overall revenue increase due to lower priced STS/ISD calls, the effects of the rebalancing in the first phase had
not been very severe. As it expected the DTS to bring about efficiency changes to further reduce its costs, TRAI decided to go
ahead with the second round of rebalancing which would be applicable until 31 March 2002. The longer time frame would enable
elasticity of demand to manifest itself, and give greater time to the incumbent to make structural adjustments.
The STD rates were expected to decline by nearly 11.5 per cent, while the rentals were not expected to significantly change
during this period. While the original plan had envisaged an increase in rentals for the general subscriber category, the TRAI decided
not to implement it, as it felt that the total loss on this account would be about Rs 200220 crore. This amount, as a percentage
of total revenues of DTS was very small and could be made up by greater number of STD/ISD calls and improved efficiency of
the incumbent. It felt that not increasing the rental would help in the increase of teledensity.
Since TRAI was in the process of working out the cost-based tariffs on the basis of forward looking costs and a different
methodology, both of which were going to be a part of a further consultation process, it deferred an increase in rentals. The revised
tariffs were to be effective from 1 October 2000.
In August 2000, the National Long Distance Competition policy that would allow private operators to offer long-distance services
was announced and it was expected that this would bring down long-distance prices. A revision in the cellular air time to Rs 3
per minute was also affected.
a The
Set up Costs of Interconnection is specified as the initial cost of any engineering work needed to provide the specific interconnection facilities
requested and the Usage Charge is specified as the charge levied by a service provider for carriage of telecommunication traffic on its network.
would have to follow the associated roll out obligations. The

cellular operators had regarded this as a backdoor entry for
fixed service operators to provide cellular services, without
having to pay the high licence fees for spectrum that they
had paid in the auctions. The Cellular Operators Association
of India (COAI) had taken this issue to the Telecom Dispute
Settlement Appellate Tribunal (TDSAT), that had agreed
with TRAIs decision to allow WLL (LM) services. The
COAI had then appealed against the TDSAT decision in
the Supreme Court. The Supreme Court had allowed the
roll out of WLL (LM) services while enjoining the TDSAT
to examine the issues of level playing field raised by the
COAI. Any disadvantage to the cellular operators due to the
regulation was to be neutralized.
The COAI considered WLL (LM) services as unfair
impositions in the market. Therefore, when Tata Teleservices,
a fixed service provider, rolled out its CDMA-based WLL
(LM) network in mid-January 2003, the cellular operators
denied it interconnectivity with their networks. Since there
was no formal interconnect agreement of the fixed service
operators with cellular operators, Tata Teleservices started
routing its calls through the BSNL/MTNL network. But
the cellular operators were able to block such calls too. In
retaliation, BSNL and MTNL cut off access to selected

cellular operators. Subsequently, the then Minister for
Information Technology and Telecommunications, Pramod
Mahajan, after a meeting with cellular operators, announced
that he would be willing to arbitrate in the dispute to
ensure fair and equitable outcomes and all networks should
conform to the need for interconnectivity with others.
THE THIRD PHASE

REGULATION
OF
INTERCONNECTION
Since the March 1999 consultation dealt only with

interconnections of the various service providers with DoT,
TRAI brought out a consultation paper on 14 December
2001 to address the interconnection issues and to develop
a General Framework for Interconnection (GFI) in the
context of private NLD operators entry into the telecom
service market. This provided a methodology for charging
carriage of a long distance call in a multi-operator
environment and to discuss issues relating to equal ease of
access by subscribers to the NLD networks particularly
relating to Carrier Access Code (CAC), pre-selection, and
default carrier (http://www.trai.gov.in/intpap.doc).
242
Subsequently, consultations with the stakeholders as well

as the TRAI consultation paper 2001/5 dated 14 December
2001 led to regulation for interconnection charges and
revenue sharing for WLL (LM). These were as per the fixed
service licences. TRAI felt that given the changed market
conditions (introduction of greater competition in cellular,
introduction of players offering WLL (LM), and competition
in the NLD and ILD segments) in the interim, the tariffs
for other categories needed to be reviewed. By this time the
long-distance tariffs had fallen considerably (and in excess
of those stipulated in the TTO 99), due to the introduction
of competition. Annexe 10.2 gives the existing NLD calls
as well as those specified in the TTO 99.
Events in 2002 and 2003

The third phase of rebalancing consisted of 2 parts. These
were implemented through TTO dated 14 March 2002 and
TTO dated 24 January 2003, respectively. In the TTO
dated 24 March 2002, TRAI decided to club the categories
of general and low user into a single category of noncommercial user subscriber. Since a tariff review was under
way, TRAI decided to implement the tariffs as per the earlier
order and only for the commercial user subscriber. The
service providers were required to identify the commercial
user subscriber and implement the tariff package accordingly.
The free calls were reduced to 30 and 45 for the urban and
rural commercial subscribers (Annexe 10.3).
In July 2002, TRAI came out with a framework for a
Reference Interconnect Offer (RIO). The RIO specified the
framework and the unbundled network elements to be
taken into account while calculating the IUC, that was
applicable in a multi-operator context. The players with
significant market power (players with more than 40 per
cent of the relevant market share) were required to publish
the RIO.
TRAIs consultation paper on Tariffs for Cellular Mobile
Telephone Services dated 8 July 2002 (www.trai.gov.in/
cellular%20cons%20paper-final.htm) related to the changes
in cellular tariffs that had happened because of changes in
the cost structure of the cellular operator due to decreasing
costs and increasing subscriber base. A review of the
competitive trends in basic services was undertaken by TRAI
(http://www.trai.gov.in/consultbasicpaper.htm) in September
2002. This paper laid out the basis of tariff rebalancing and
the possibility of using ADC. It laid out the framework for
estimating cost-based tariff, various means of addressing the
access deficit, and mechanisms to estimate the IUC.
TRAI came up with the TTO 2003 and the accompanying
Telecommunications Interconnections Usage Charges
Regulation. These formed the basis for the third phase of
rebalancing. The regulation covered arrangements amongst
service providers for payment of IUC for telecommunication
services covering basic, including WLL (M), services,

cellular mobile service and long-distance services. The
interconnection charges would continue to be governed by
the Telecommunications Interconnections (Charges and
Revenue Sharing) Regulation 2001, except to the extent
that it was modified by the current regulation.
Access Deficit
Since the first tariff review, while the NLD and ILD tariffs
had been substantially reduced, adequate increments in
rentals and local charges had not taken place. As per TRAI,
this had created an access deficit for the fixed service provider.
This was due to rentals and local call charges continuing
to be below cost.
The tariffs in the TTO 2003 were, as earlier, based on
an affordability criterion and the objective of increasing
teledensity. TRAIs studies (http://trai.gov.in/24thamend
ment.htm) indicated that users would not like rentals and
local call charges to be increased. On this consideration,
TRAI did not increase rentals and local call charges. The
access deficit could only be compensated through NLD
and ILD charges. The ADC was to be recovered through
IUC.
Consideration of acceptable rentals based on Consumer
Price Index increments was rejected because the increase
could have implications with respect to the differential of
rentals between fixed and WLL (M) and cellular services.
As per TRAI, the rentals for fixed services were to be
determined so that changes are not brought about in a
manner which reduces the spread of the basic fixed line
services called Plain Old Telephone Systems (POTS), which
is considered an essential service in a developing country like
ours. (www.trai.gov.in/consultbasicpaper.htm, page 36) The
commercial users were to pay higher rentals, while tariffs
for the non-commercial users was not changed in the interest
of affordability and increasing teledensity. A new rental
category was defined for senior citizens (definition was the
same as for payment of income tax).
The pulse duration for local charge was reduced to 2
minutes from the earlier three minutes. Given the
competition in the NLD, there was forbearance, subject to
a ceiling of Rs 8.40 per minute for peak time. On the ILD
segment, there was total forbearance.
The IUC included the ADC payable to the fixed service
operators which they must get in order to keep the rentals
as well as local calls affordable (http://www.trai.gov.in/
consul25.htm, page 6, point 1). The IUC determination
was based on the detailed data given by the service providers
based on an assessment of the various cost items
attributable to the network elements involved in the
different stages in setting up of a call in a multi-operator
environment.
ADC Computation
For Cellular Mobile and Wireless in Local Loop with limited
mobility (WLL-M), the Access Deficit Charge is not
applicable as the rentals and call charges have been left to
market forces and have not been kept below cost by
regulation, as is the case with fixed local telephone service
(POTS) (www.trai.gov.in/consul25.htm, page 8, point 8).
For fixed services, the ADC was assessed by fixing an
affordable level for rental/ local call charges, such as monthly
rentals, local call charges, special concessionary local call
charges in the rural areas, provision of free calls, and other
below cost tariffs that the regulator specified to make the
fixed services affordable to the common man to promote
both Universal Service and Universal Access as per NTP 99
rather than leave these to the market. In order to reach the
final estimates of IUC this Regulation takes into account
the requirements of Access Deficit Charge arising out of the
Tariff Order being issued (www.trai.gov.in/consul25.htm,
page 8, point 7).
For calculating the IUC, cost data from BSNL and
MTNL, which are the dominant operators providing fixed
and NLD services, was taken. For deriving the capex, TRAI
took the audited figures of BSNL, for the financial year
20012 (Annexe 10.4). The components included data on
depreciation charges during the year, net block, capital
works in progress, current assets, current liability, employees
remuneration and administrative expenses. Information on
the number of DELs at the end of the period was also
provided. CAPEX + Depreciation costs and OPEX costs
had been converted to cost per line against these heads by
dividing the costs with the DELs as on 31 March 2002. The
derived values were adjusted for costs attributable to
telephone service with the assumption that only 95 per cent
of total revenues are derived from these services (Annexe
10.5).
The overall CAPEX and OPEX were allocated to different
portions of the network by allocating these costs in the same
ratio as was done by the BSNL in its RIO Schedule report
cost data submitted to the TRAI. Thus, based on BSNL
inputs, the aggregate amount of CAPEX + OPEX had been
allocated to network elements based on Mean Capital
Employed for each un-bundled network element as shown
in Annexe 10.6. On this basis, the rentals were calculated
as Rs 424 per month. The average recovery of BSNL on
the rentals was Rs 165175 per month. TRAI suggested
that the access deficit on rentals amounting to Rs 249259
needed to be recovered through ADC. In order to calculate
the total amount to be recovered through the ADC, the free
calls and the 300 below cost metered call units (MCUs)
provided in rural areas were factored in (Annexe 10.7).
The ADC-incorporated local charges were estimated as
Re 1 per minute, while those for long distance were Re 1
per minute plus the cost of long distance carriage. But since
the per minute charges had been fixed at Rs 0.80, Rs 1.00
or Rs 1.20 per two minute duration, the portion of the
access deficit not recovered from the local calls was to be
recovered from the long distance charge.
For the rental portion, the capex up to the SDCC, licence
fee (revenue share), and spectrum charge (12 per cent) were
taken. Local charges were taken on the opex for that part
of the segment distributed across the minutes of usage. A
similar principle of relevant costs (based on the work done)
distributed over minutes of usage for computing the long
distance charge was used. In this case licence fee (revenue
share) was taken as 15 per cent. Both origination and
termination charges for fixed line to fixed-line calls were
taken as equal. For the long distance charge, the access deficit
on account of below cost local charge was also added. It was
also decided that the IUC (including the ADC component)
would be uniform (independent of the distance slabs) due
to current technologys inability to implement differential
IUCs. With the ADC loaded to the IUC, the new NLD rates
were higher than the then prevailing NLD prices.
The fixed to cellular calls would be chargeable at Rs 1.20
for 90 seconds in metros and Rs 1.20 for 60 seconds in
circles. For cellular services, a mobile termination charge,
based on costs of termination was specified. With this, the
receiving party was not required to pay for the incoming
calls. In effect, this implemented the CPP. The cellular
operator would get Rs 0.30 as mobile termination charge
(MTC). The balance would be retained by the fixed service
provider. For intra circle calls, the charge was Rs 1.20 per
minute and the cellular operator would get Rs 0.40 per
minute for termination.
For cellular to fixed line, the cellular operator would give
Rs 0.50 in metros and Rs 0.60 in circles, respectively. An
additional Rs 0.20 would be paid to transit Level II tax in
circles. These charges were based on the existing subscriber
base, a quarterly annual growth of 25 per cent for January
to March 2003 and an annual growth rate of 70 per cent
over the period April 2003 to March 2004. The opex was
based on data of 25 metro and circle operators based on the
annual audited figures reckoned to work out opex as on
31 March 2004. The per minute usage figures of 220 minutes
was expected to go up to 250 minutes (Annexe 10.8).
Unlike the earlier CPP introduction, this time TRAI felt
that the additional costs to be borne by the fixed subscriber
(to pay for the MTC) were not high. The MTC had come
down due to fall in prices of the network elements, increasing
subscriber base and additional revenue from value added
services (VAS). On the plus slide, the TRAI felt, it would
enhance the call completion rates as the called party would
not have an incentive to keep the handset off to avoid
unwanted calls.
244
The changes in tariffs were viewed as significant due to

the shorter call duration, reduction in number of free phone
calls (from 75 to 30 for urban), and what was viewed as
differential pricing for BSNL/MTNL subscribers making
calls to cellular/WLL(LM) phones. While earlier, a 3-minute
call from a landline in a metro to cellular subscriber in the
same service area cost Rs 1.20, the same would cost Rs 3.60
and a call to WLL(LM) would cost Rs 2.40.
The Political Fall Out

Due to political pressure and the media coverage of this
issue, the then Minister for Information Technology and
Telecommunications, Arun Shourie, was summoned for a
meeting with the Prime Minister, the Deputy Prime Minister,
the Union finance minister, and the BJP president, M
Venkiah Naidu to discuss the political fallout of the tariff
increase. This led to an announcement of a partial roll back
of the tariff increase. The number of free calls for BSNL
subscribers was raised to 50 and 75 for the urban and rural
categories, respectively. The MTNL subscribers would get
60 free calls instead of the 30 announced earlier. The fixed
to cellular calls anywhere in the country would cost Rs 3.60
for 2 minutes.
TRAI also announced it would review its regulation on
the implementation of the IUC and sought comments and
held open house discussions as there were several concerns
regarding the treatment of ADC, its computation, and its
incorporation into the IUC.
THE ISSUES
AND AN
EVALUATION
We analyse the organizational and policy issues in the context

of this exercise of tariff rebalancing and subsequently focus
on issues relating to the treatment of ADC and IUC.
Independence of TRAI
Despite the TRAI Amendment Ordinance (2000), that gave
it the power to fix interconnectivity terms, TRAI has not
been able to enforce its mandate as is evident from the case
of cellular operators denying interconnections to WLL(LM)
operators or BSNLs blocking of calls. By not enforcing the
interconnections, TRAI created space for intervention by
the minister.
Technology Neutrality
While TRAI professes to be technologically neutral, its
perspective that POTS through wireline is best for a country
like India does not reflect neutrality. In another instance,
exemplifying the same perspective (and contradictory to its
stand on ADC), it did not recommend increasing wireline
rentals as they would then compete with cellular and
WLL(LM) rentals, and, therefore, subscribers could prefer
them over fixed line. Creating price differentials through

regulation could create demand for a particular technology
that would not otherwise exist in the market. Such
interventions would be detrimental to the growth of the
sector. Technology choices should be left to the market.
The Extent of Tariff Rebalancing

While TRAI started out with a mandate for bringing about
full tariff rebalancing, its performance in this area has been
poor. The consultation paper on Tariffs for Basic Services
(23 September 2002, page 24) notes in the context of
rebalancing, the objective would be to make the access deficit
zero by raising the rental/local call charges to their cost-based
levels. In the following sections we identify the major issues
that needed to be resolved for achieving the objective.
The Segmentation Framework

The TTO 99 gave the right perspective by segmenting
subscribers as urban and rural and, within these categories,
as low, general, and commercial, and attempted to fix the
rentals accordingly. However, the basis for categorization
that was used for low users (MCUs) was not carried through
for general and commercial categories. In addition, the
rentals for the different categories did not indicate a clear
distinction between the subscriber categories (Annexe 10.1).
For example, a) the rentals for the low and general user in
the rural and urban categories were kept the same in the
first phase (from 1 April 1999 to 31 March 2000), b) the
rentals for the general and commercial categories both in
the rural and urban segments were kept the same during
the third phase (1 April 2001 to 31 March 2002), c) TRAI
clubbed the low and general categories into one category
non commercial, and d) after the first increase in rentals,
TRAI did not plan to increase them for the low user and
commercial categories during the subsequent periods. Thus,
TRAI was unable to leverage the differences in the
requirements for the 3 categories.
Basis for Increasing Rentals

TRAI could have been more aggressive about increases in
rentals, as in the years during the tariff rebalancing, the
Consumer Price Index had been increasing at 10 per cent
per annum. But it based its decision to a general sense of
affordability. While, despite the increase in consumer prices,
it may have been difficult to raise rentals for the low user,
the potential of commercial users to pay higher rentals was
not fully exploited. This was possibly not done as commercial
consumers may have demanded higher rentals to be linked
to better quality services (for example, flexibility in billing,
payments, etc.) which DoT/BSNL may not have been able
to commit to.
Exploiting Alternative Tariff Packages

Even though TRAI was not very aggressive about the tariff
rebalancing, DoT/BSNL, should have easily foreseen the
emergent competition in NLD and offered alternative tariff
packages to the subscribers much earlier.The consultation
paper on Tariffs for Basic Services (23 September 2002,
page 24) notes that: It is pertinent to mention that while
rebalancing did allow for recalibration of commercial users
rentals, none of the service providers have raised these rentals.
The service providers have thus not rebalanced this element
although they had the opportunity to do so, and have
foregone some much needed resources.....
We estimate the extent of loss in revenues due to not
increasing the rentals. In March 1999, DOT/BSNL had
nearly 16 million DELs in non-metros (about 70 per cent
of them are urban, as per DoT/BSNL annual reports), and
5 million lines in metro cities which went up to a total of
31 million lines and 6.8 million, respectively, by 2002. A
one-time conservative increase in the rentals of Rs 100 per
month in the commercial category would have yielded
additional revenues of Rs 1200 crore in 1999 going up to
Rs 2000 crore in 2002. (This assumes that in the urban
areas, 60 per cent lines are in commercial categories). This
calculation does not take into account the possibility of
higher revenues that could be generated by linking higher
rentals to lower per minute call rates, leading to greater
usage.
While operators had the option of alternative tariff
packages since 1999, they had not exercised this option
until May 2003. If the fixed service providers do not leverage
the flexibility (alternative tariff packages), they cannot claim
that they were not allowed to recover access deficit.
Freedom in Bundling Targeted Subsidies

Lower rentals need to be targeted only for those customers
who cannot afford to pay the true cost of service provision.
TRAI based its calculations of lower rentals on a study
which fixed them according to the level of affordability
for different categories. However, the TRAI consultation
paper does not provide a reference to the study and the
underlying assumptions. In contrast, a number of various
other studies have shown that the rural people spend
significant amounts on telecom services. The trade-off for
them is in terms of cost of alternative means of
communications (Jain and Sastry, 1997, 1999).
Categorization of all subscribers who live in rural areas as
qualifying for lower rentals and higher free calls is against
any economic principles. This leads to poor services in rural
areas (as operators are unable to recover costs), further
exacerbating the problem. The rentals should be based on
MCUs and subsidies should be targeted.
Before identifying the specific set of subscribers who

should receive subsidized access, there could be a process of
self-selection. The targeted subscribers for whom affordability
is an issue, could have a cap on usage charges. The total
bill for such customers can be generated with lower rentals
and lower call charges. The problem in such an approach
is that it could lead to a situation where subscribers opt for
multiple phones at lower rentals. This could be addressed
by requiring a proof of residence and having a searchable
database of addresses. In any case, this is the basic information
that is required for billing purposes and is not a huge
additional cost.
The Incorrectness of Data Values Supplied by BSNL

The values used by TRAI from the balance sheet of BSNL
should only be used for creating some possible scenarios and
not as a basis for decision-making. The balance sheet has
several underlying significant assumptions that are not
explicitly considered in the paper. For example, the basis of
arriving at the BSNL valuation at the time of corporatization
and, hence, the value of Gross Block and depreciation was
historic costs. Since BSNL did not have commercial
accounting practices, there were problems with this valuation.
Various other examples of problem areas are provided in
Annexe 10.9. The data problems are likely to remain unless
BSNL adopts commercial accounting practices. Other
examples of discrepancies are:
The Gross Block numbers used to calculate the capex
also reflects the investments made by BSNL for its cellular
services. As per the annual report a capacity of 4 million
cellular lines have been installed, of which 2.4 million lines
have been made operational. These amounts need to be
deducted for calculating the fixed cost per line.
While BSNLs ROR on capital employed is 9.6 per
cent, in calculating the pre-tax percentage for allocation to
capital, it has been taken as 13.78 per centfor a regulated
industry these are far too high2.
The values of net block have been arrived using the
historical cost. These reflect the inefficiencies of the past,
and do not take into account falling prices, at least in some
segment (exchange) centres, for land lines.
Treatment of Access Deficit

Much, therefore, depends on the flexibilities available
in the existing set of tariffs, that is, those relating to the
NLD and ILD sectors for rebalancing. The current paper
would need to factor in the changed competitive conditions
2
Indeed, for service providers, which are trying to take

advantage of network economies, by rapid growth of its network,
strategic pricing would, at that stage, mean low return.
246
as well as the feasibility and desirability of using IUC as a

means to address the issue of access deficit. After stating
this, the consultation paper does not discuss the alternatives
for managing the access deficit. It assumes that IUC is the
best mechanism to manage it. There must be deliberations
on whether it is indeed so.
USO as a Better Mechanism than IUC to Fund the AD

The IUC mechanism to implement the ADC is not
appropriate. The loading of ADC implies that subscribers
of all networks that interconnect to the BSNL/MTNL
network, in effect, subsidize all the subscribers including the
commercial and urban subscribers of the BSNL/MTNL
network. While the USO mechanism imposes a cap on
subsidy that is based on the revenues, the IUC (loaded with
ADC) is determined on the basis of subsidy that has
already been decided to be provided. The IUC (loaded with
ADC) does not provide any signals regarding the quantum
at which the ADC will be capped.
Inappropriate Unbundling of Costs and Revenues for

Rentals and Free Calls
In calculating the ADC, TRAI unbundled the costs of the
local network and free calls and reviewed them against the
revenue attributable to rentals as opposed to calculating the
total revenue in relation to the total cost.
Economically, there is no reason to presume that an
input that is used to provide a variety of different services
must have its cost recovered from a particular charge. Rather,
if one input is used to facilitate a large variety of retail
products, then any evaluation of the deficit or surplus
associated with that input needs to consider the entire
operations of the relevant firm.
From the subscribers perspective, in acquiring a
connection is the trade-off in the various costs (rentals,
local, long distance, international, Internet, cellular) balanced
against the benefits. From the operators perspective, it is
the collective revenue from all services that indicate the
profitability of the specific customer. If providing access to
a customer is profitable when all revenues and costs associated
with that customer are considered, then there is no
meaningful access deficit for that customer.
But the access deficit has been calculated only with
regard to rentals and free calls ignoring any economic profits
that accrue to the fixed service providers including BSNL
from other telecommunications services. The availability of
other services, such as cellular and Internet over the same
network gives rise to additional calls, the revenue for which
accrues to the access provider as these calls originate at the
subscriber end. For example, the cellular to fixed line and
fixed to cellular calls constitute 70 per cent of the total
cellular calls.
The TRAI consultation paper assesses the ADC by

adjusting the fixed cost per line per year as Rs 5120.46
(Annexe 3.5), which has a pre-tax return of 13.48 per cent
built into it only against the rental of Rs 200 per month
plus the cost of free calls. However, it should also take into
account the revenue per line (Rs 7317 per year) after
adjusting for the opex of Rs 2243.34 per DEL per year. (As
per BSNL Annual Report: Total income from services
Rs 242,998,944 thousand, total DELs 332184198, which
gives an income per DEL per year as Rs 7317.) Since the
actual pre-tax return on capital for BSNL is 9.36 per cent,
the actual revenue generated by BSNL more than adequately
covers the capex and opex.
The Benefits to the Incumbent

Any access deficit calculation of revenue shortfall arising
from regulatory constraints should be significantly discounted
by a value ascribed to the strategic benefits that BSNL
derives from basic access. Being the incumbent and dominant
provider of all telecommunication services, it has certain
advantages that may balance the costs associated with access.
These are: a) as the provider of basic access, BSNL is
necessarily the preferred supplier of all call services. For
example, users must make a deliberate choice for a
competitive service provider, which may involve operational
shortcomings (for example, use of a conditional access code);
b) BSNL is able to include all services on one bill; c) being
the incumbent and the universal service provider brings
BSNL brand recognition; and d) as an incumbent BSNL
has certain cost benefits of network operations (for example,
early acquisition of sites for exchanges, towers), established
land access (for trenches), etc.
Desegregated Data for Different Service Components

And Accounting Separation
The revenue/DEL used by TRAI includes the long distance
and other revenues. The only way to arrive at desegregated
costs and revenues of the various segments is probably
through accounting separation of BSNL/MTNL into BSNL
Cellular, BSNL Long Distance, and BSNL Access. These
units would have to then offer their products and services
at non-discriminatory prices to any external party vis--vis
the various BSNL units. In such a scenario, if indeed BSNL
access has a deficit, then there could be a case for IUC (with
ADC).
Performance-Based ADC
While BSNL has justified its high long-distance charges due
to the social obligations of having to meet rural demand,
the recent (C&AG) report has identified that nearly 45 per
cent of the village phones do not work. Similar results have
been reported in other studies (Jain and Sastry 1997, 1999).
Thus, BSNL has not only foregone revenues from call
origination but also from those phones in other parts of the
network wishing to contact the people in villages if the
phone had been working.
During the monopolistic regime of DoT/BSNL, the
spread of the rural network had been poor. Even today, only
25 per cent of its DELs are in the rural areas. This implies
that without explicit performance criteria, it would be
difficult to ensure adequate rural coverage. The ADC recovery
through IUC does not provide for such a mechanism. The
quantum of deficit is first arrived at and then built into the
IUC. Even if the ADC-based IUC is to be implemented,
the ADC calculations should vary over the implementation
period, and provide for giving incentives to the compensated
firms to bring down the capex and opex values. For example,
TRAI should specify the percentage points by which the
capex and opex values used in estimating ADC would come
down over a specified period. The TTO 2003 and the
accompanying regulation should also specify the time when
the next review would be undertaken.
The USO consultation paper has provided a framework
for assessing the access deficit (Annexe 10.10). Thus, the
only significant issue to be examined is whether the quantum
provided in the USO consultation paper is adequate, and
if not, best to increase it. It could be through an increase
in the percentage revenue of licence fee towards the USO
(say from 5 per cent to 7 per cent). Since the increment
is envisaged to come out of the existing licence fee, no
additional administrative changes need to be worked out to
manage a larger corpus.
Incorporating the Future Trends: Fixed Line and

Wireless Networks
business will constitute only 60 per cent of its business by

2007.
The growing size of cellular networks (both the subscriber
base and minutes of usage) would ensure that revenues
contributed by the cellular subscriber would be very
significant. An increasing number would come from the
non-urban areas. However, the ADC is based on fixed
networks. If using fixed networks becomes more expensive,
(because of the addition of ADC component of IUC), this
would cause a further migration to cellular networks
(especially as, by then, cellular networks would have reached
significant proportions of the total network size).
CONCLUSIONS
This chapter raises issues about the role of TRAI in the
context of facilitating competition through tariff rebalancing
and interconnections. While TRAI began the tariff
rebalancing exercise with the objective of completing the
same within 3 years, the target was ambitious to begin with.
Subsequently, it was not able to maintain the pace. A more
realistic timeframe would have led to a greater certainty and
credibility. TRAI lost significance of its role when it was not
able to enforce interconnections. Its perspective on assessment
of the ADC reflects the DoT/BSNL viewpoint rather than
an unbiased approach. The manner in which TRAIs
consultation papers on tariff regulation have segmented the
customer reflect a lack of technical expertise. TRAI would
need to ensure that its decisions reflect technology neutrality.
Otherwise the sector could see distorted growth due to
regulatory interventions. For this to happen, a change in the
mind-set of those responsible for making such decisions is
critical.
The growth in wireless is expected to be extremely fast,

especially in the next 510 years. For example, during
20027, only 18 per cent of BSNLs future additions are
going to be in the fixed line category. The remaining 82 per
cent would be in the cellular and WLL categories3. The
fixed line that currently constitutes 95 per cent of BSNL
3
As per a news item in Economic Times, New Delhi: The

public sector telecom companies Bharat Sanchar Nigam Ltd and
Mahanagar Telephone Nigam Ltd would add about 3.95 crore
telephones by 2007. In the current 5-year plan (20027), BSNL
would add 81.70 lakh landline phones, 2.18 crore mobile phones
and 68 lakh Wireless in Local Loop (WLL) phones, meaning
thereby that the number of mobile phones added by BSNL would
far exceed fixed phones and WLL phone additions. The financial
outlay for BSNL has been earmarked at Rs 66,412 crore, an
official release said here. Another state-owned corporation MTNL
would add 16 lakh landline and WLL telephones and 11.57 lakh
mobile phones during the plan period. The private sector is

expected to add 2.55 crore Direct Exchange Lines (DELs) during
the period, it added.
248

Annexe 10.1
Monthly Rentals for Different Subscriber Categories (TTO 1999) (Rs)
Urban Subscribers
Exchange
System Capacity
From 1 April 1999 to

31 March 2000
Number of Lines
1000 to 29,999
30,000 to 99,999
1 lakh and above

31 March 2001
Type of User

31 March 2002
Type of User
Type of User
Low
General
Commercial
Low
General
Commercial
Low
General
Commercial
120
180
250
120
180
250
160
220
310
120
180
250
140
200
280
160
220
310
120
180
250
160
220
310
160
220
310
70
120
180
250
70
120
180
250
120
160
220
310
70
120
180
250
95
140
200
280
120
160
220
310
70
120
180
250
120
160
220
310
120
160
220
310
Rural Subscribers
Up to 999
1000 to 29,999
30,000 to 99,999
1 lakh and above
Source: TRAI, The Telecommunication Tariff Order 1999, pages 912.
Annexe 10.2
STD Call Charge for Fixed to Fixed Calls (Call duration of 1 minute and pulse charge Rs 1.20 per metered call)
Distance category
Peak tariff envisaged at

end of tariff rebalancing under
TTO 1999 (1 April 2002)
Prevailing rate at present
Intra Circle
Up to 50 km
51200 km
201500 km
5011000 km
> 1000 km
1.2
4.8
10.8
16.8
21.6
Percentage reduction
Inter Circle
1.2
2.4
2.4
2.4
2.4
Intra Circle
1.2
2.4
4.8
4.8
4.8
Inter Circle
Nil
50
78
86
89
Nil
50
56
72
78
Source: TRAI, Consultation Paper on IUC issues, 15 May 2003, page 39.
Annexe 10.3
Monthly Rentals for Rural and Urban Subscribers (Rs)
Exchange
System Capacity
Number of Lines
Up to 999
1000 to 29,999
30,000 to 99,999
1 lakh and above
Rural
Type of User
Urban
Type of User
Non-Commercial
Commercial
70
120
180
250
120
160
220
310
Source: TRAI, The Telecommunication Tariff Order, 14 March 2002.
Non-Commercial
120
180
250
Commercial
160
220
310
Annexe 10.4
Profit and Loss Account for the year ended 31st March 2002 (Rs 000s)
Year ended 31 March 02
Year ended 31 March 01
242,998,944
26,817,995
269,816,939
115,966,611
1,028,156
116,994,767
38,484,520
34,031,191
39,957,915
4,682,106
87,461,309
204,617,041
65,199,898
3,321,938
68,521,836
5,400,141
63,121,695
20,700,739
15,732,466
28,937,314
2,742,899
38,580,811
106,694,229
10,300,538
10,300,538
2,830,000
7,470,538
Income from Services

Other income
Total
Expenditure
Employees Remuneration and Benefits
Licence fee and spectrum fee (Ref. note 13, 14 on schedule U)
Administrative, Operating and other expenses
Financial expenses
Depreciation
Total
Profit before prior period adjustment and taxation
Prior period adjustments
Profit before taxation
Provision for taxation
Profit after taxation
Appropriation:
Bonds Redemption Reserve
Surplus carried to balance sheet
Earnings per share
Basic/Diluted earnings per share (Rs)
Refer note 20 on Schedule U
5,719,018
57,402,677
63,121,695
12.62
3,717,746
3,752,792
7,470,538
1.49
Source: Annual Report 20012, BSNL.
Annexe 10.5
Calculations of CAPEX, Depreciation and OPEX Components per DEL based BSNL Cost Data for Year 20012
Total Number of DELs as on 31.3.2002 (in crore)
As per BSNL audited figures on 31.3.2002 (Rs in crore)
Depreciation charged during the year
Depreciation per line in Rs
Net Block
Capital Works in progress
Current assets
Current liability
Amount to be considered for multiplication by pre-tax weighted allocation of capital
Pre-tax weighted allocation of capital percentage
CAPEX Component
CAPEX Component per line in Rs
CAPEX + Depreciation per line in Rs
CAPEX + Depreciation per line in Rs attributable to telephone services (95 per cent)
OPEX
Employees Remuneration
Administration
Total OPEX
OPEX per line in Rs
OPEX per line in Rs attributable to telephone services (95 per cent)
Source: TRAI, The Telecommunication IUC, 24 January 2003, page 30.
3.32
8746.13
2632.91
58,922.21
10,826.24
17,083.4
20,369.55
66,462.3
13.78
9158.5
2757.05
5389.96
5120.46
3848.45
3995.79
7844.24
2361
2243.34
250
Annexe 10.6
Apportionment of CAPEX + Depreciation and OPEX to Different Network Elements Based on Audited accounts of BSNL for the
Year 20012 based on the Mean Capital Employed by BSNL as given in Schedule 5 of RIO by BSNL
Network Element (NE)
Annual CAPEX + Depreciation

as apportioned for Network
Element excluding licence and
spectrum fee
Share of Mean Capital

Employed per line
(in per cent)
Access Loop
Local Exchange
SDCC Tandem
Intra-LDCA (Level II Tax)
Inter-LDCC Intra-circle + Inter Circle (Level 1)
LE-SDCC Transmission System
LE-SDCC Transmission Length (Avg. 10 km)
SDCC-LDCC Tax Trans.
SDCC-LDCC Tax Transmission Length (Avg. 40 km)
Inter-TAX Transmission Length (Intra-Circle) [SDH Rings]
Inter-TAX Transmission Length (Inter-Circle)
Inter-TAX Transmission SDH-16 System (Inter-Circle)
Inter-TAX Transmission Length (Inter-circle) [SDH Rings]
Total
54.78
20.38
1.27
1.25
1.25
3.26
7.74
0.66
3.85
0.31
1.64
0.33
3.27
100.00
Annual OPEX as
apportioned for
Network Element
2805
1044
65
64
64
167
397
34
197
16
84
17
167
5120
1229
457
29
28
28
73
174
15
86
7
37
7
73
2243
Source: TRAI, The Telecommunication IUC, 24 January 2003, page 31.
Annexe 10.7
Access Deficit Estimation
No. of fixed subscribers
40
Average cost-based rental
Rs 425
Average rental actually charged
Rs 200
Deficit per fixed phone per month
Rs 225
Annual deficit (per fixed line)
Rs 225 12 = Rs 2700
Annual deficit on account of rentals for 40 million fixed subscribers
Rs 10,800
Average number of free calls 30 per subscribers per month
Rs 1440
Deficit on this account
Deficit on account of below cost calls between 0 to 50 km (706 calls per subscribers per year)
Per call deficit 25 paise per call
Rs 750
Total annual access deficit estimate
Rs 13,000
million
per month
crore
crore
crore
crore
Source: TRAI, Consultation Paper on IUC issues, 15 May 2003, page 40.
Annexe 10.8
Illustrative IUC Charges and Prevailing Tariff for Different Type of Calls
>500 km
F-F
F-W
F-C
W-F
W-W
W-C
C-F
C-W
C-C
200500 km
50200 km
050 km
Inter Circle
Intra Circle
Inter Circle
Intra Circle
Inter Circle
Intra Circle
Inter Circle
Intra Circle
5.1
3.6
3.5
3.6
2.1
2.0
3.5
2.1
1.9
5.1
3.6
1.2
3.5
2.0
1.0
1.2
1.0
0.8
4.75
3.25
3.15
3.25
1.75
1.65
3.15
1.65
1.55
4.75
3.25
1.2
3.15
1.65
1.0
1.2
1.0
0.8
4.45
2.95
2.85
2.95
1.45
1.35
2.85
1.35
1.25
2.45
1.95
1.2
1.85
1.35
1.0
1.2
1.0
0.8
0.5
0.85
0.75
0.85
1.2
1.1
0.75
1.1
1.0
0.7
0.95
1.2
0.85
1.1
1.0
1.2
1
0.8
Notes: F Fixed; W WLL(LM); C Cellular.

Source: TRAI, Consultation Paper on IUC issues, 15 May 2003, pages 434.
Annexe 10.9
Examples of Problems with the BSNL Annual Report Data
As per the auditors report The accounting policies regarding depreciation of fixed assets are not uniformly applied across all the
circles.
The depreciation has been provided on fixed assets taken over from DoT as of 1 October 2000 on written down value method at
rates as per the Companies Act, as if it were its original assets and has not calculated the rates for the remaining useful life of the asset
(page 48, BSNL, Annual Report, 20012). As per the auditors report, there are several places where it is mentioned that appropriate
commercial policies have not been followed in computing the depreciation. This has implications for the value used in calculating the cost
per line based on depreciation for the year (TRAI Consultation Paper 24 January 2003, Table 1, page 30).
The overheads (Establishment Expenses) are allocated as a percentage of capital expenditure at percentages prescribed by DoT and
not on the basis of directly allocable costs (page 50, Annual Report, BSNL 20012).
At several places the auditors have indicated that accounting practices recommended by the Institute of Chartered Accountants is
not being followed and amounts under several heads of account are unascertainable.
The fixed assets have not been revalued during the year.
It is not clear who (DoT, BSNL) will bear the incremental pension liabilities due to the pay increases on 1 October 2000.
Annexe 10.10
Relevant Excerpts from the USO Consultation Paper
In its consultation paper on USO, TRAI had suggested an imposition of a Universal Service levy that included both access, which means
public access through public or community telephone and provision of individual household telephones. Since the levy would support
both these activities, it has been called TRAI Universal Service Levy (USL)..
The Authority has recommended that implementation of USO should be divided in two clearly identifiable streams: First, for provision
of public telecom and information services and, second, for provision of household phones in net high cost rural/remote areas.
The Authority has recommended that support from Universal Service Fund (USF) be provided for Net Cost (that is, Cost minus
Revenue) of providing VPTs/PTICs and DELs in rural/remote SDCAs. Details on the relevant costs are in the main recommendations.
These include, for instance, no capital recovery for VPTs or phones installed before April 2002. For them, only operating expenses should
be taken into account for estimating net cost. However, both capital recovery and operating expenses should be taken into account for
VPTs, PTICs and phones installed after April 2002. Also, in a multi-operator environment, the lowest Net Cost computed by the proxy
model for the least cost operator in an SDCA, should be used as the basis to compute USF support available to all operators.
This figure that is, 5 per cent of the revenue of all the telecom operators, appears to be adequate to support Universal Service programme
in its first phase of VPTs/PTICs as well as DELs in rural/remote areas. The amount of USL that is, 5 per cent of revenues, should come
out of the licence fee itself and should not be an additional levy. Hence, the licence fee realized may be bifurcated into two parts. The
designated portion of the Universal Service Levy may go the Universal Service fund and the balance to be Consolidated Fund of the
Government of India. In subsequent years, the Universal Service Administrator may revise this figure depending upon the requirement.
REFERENCES
Jain, Rekha and Trilochan Sastry (1999) Assessment of Socioeconomic Impact of Rural Telecom Services: Implications for
Policy, Workshop on Telecom Policy Initiatives: The Road
Ahead.
Jain, Rekha and Trilochan Sastry (1997) Rural Telecommunication
Services, Workshop on Telecom Policy Research.
Sinha, Sidharth (2001) Regulation of Tariffs and Interconnection:

Case Studies, India Infrastructure Report 2001, Oxford
University Press, New Delhi, India.
Jain, Rekha and Dheeraj Sanghi (2002) Untangling Wireless in
Local Loops, in 3iNetwork (2002), India Infrastructure Report:
Governance Issues for Commercial, Oxford University Press,
New Delhi.
252

11.1
TRANSPORTATION
VALUE FOR MONEY IN TOLL ROADS: LESSONS FROM

RECENT ROAD PROJECTS
G. Raghuram
Lack of excludability creates problems of appropriability to

the road builder, even when roads create much social value.
Roads also are a natural monopoly. But in sections (on
bridges and at key points on highways), builders can extract
part of the value they create. In order to enhance the role
of the private sector, it is important that roads are built,
tolled, and subsidized through appropriate policy framework
that creates strong incentives on the part of the various
stakeholders to use and maintain the roads properly. For
example, project roads built by commercial entities for their
own use with access to the public as a quid pro quo for using
government land, are better maintained, since there is better
incentive compatibility here.
LEVERAGING
THE
ECONOMIC VALUE
OF
ROADS
Like in any asset, private parties could, with the appropriate

policy that bundles road building with development rights
over the adjoining property, extract much value to make
road construction and maintenance privately feasible. The
private sector is also far more efficient in construction and
maintenance.
Direct Tolling
One of the forms of revenue generation is direct tolling.
While this satisfies the user pay principle, there is a debate
as to whether the cost of collecting toll and the impact on
demand (and consequently on revenue) is worth the likely
We acknowledge the research support by Swati Gupta, Ashwin
Jain, Priyanka Jain, and Deepa Kheskani. We thank the VHTRL
for their input.
revenue, which in itself is not expected to cover the total

costs. Additionally, partial tolling is distortionary. A recent
editorial in Business Line (Business Line 2003) estimates
that the toll system in India currently yields Rs 3 billion
annually and is expected not to rise more than Rs 12 billion
per annum when the NHDP is completed. This can be
compared with the fuel cess, which is expected to raise
Rs 90 billion (of which Rs 30 billion is expected to accrue
to NHDP) during 20034. There is thus a fundamental
issue as to whether there should be direct tolling in roads.
Other problems of toll dependence are wrong estimations
(VadodaraHalol Toll Company Limited [VHTRL]),
difficulty1 in collecting tolls (Coimbatore Bypass [Raghuram
and Kheskani 2002]) and even politically-motivated delays
in issuing toll notifications (East Coast Road: The Tamil
Nadu government delayed the notification in view of elections
and then due to a settling-in period by the newly-elected
government). The inability of governments to mitigate traffic
revenue risks have also affected toll-based projects (VHTRL).
Alternatives to Direct Tolling

Two alternatives in this context are (a) shadow tolling,
where the government compensates the road developer/
operator based on a formula that is dependent on the actual
traffic, and (b) annuity, where the compensation is
independent of traffic and ensures a desirable rate of return.
It must be recognized that these alternatives take away any
relationship of road usage with road pricing and might, in
1 This
chapter refers extensively to G. Raghuram The Case of the

VadodaraHalol Toll Road, mimeo, Indian Institute of Management,
Ahmedabad, Sept. 2003, hereinafter G. Raghuram (2003).
Transportation
253
Box 11.1.1
Roads Today
India has a network of about 3.3 million km (www.morth.nic.in), which carry 52 per cent of freight traffic and 83 per cent of
passenger traffic (Raghuram 2000). While the road network has grown at a CAGR of 2.95 per cent between 1991 and 1999, the
traffic in vehicles during the same period has grown at a CAGR of 9.71 per cent (CMIE 2003). During 19912 to 19989, the
road freight traffic in billion tonne kilometres (btkm) grew from 267 to 585, at a CAGR of 11.9 per cent (Raghuram 2000).
The NH and State Highways (SH), which constituted 187,535 km in 1999 (CMIE 2003), formed 7.42 per cent of the total
road length (Figure 11.1.1). (This data has a discrepancy. As per the MORTH, the NH and SH which constituted 172,000 km
in 2001, formed 5.21 per cent of the total road length.) The NH and SH carried nearly 60 per cent of the road freight traffic
and 87 per cent of the road passenger traffic during 2001 (www.morth.nic.in). The NH alone constituted 49,585 km in 1999,
forming 1.96 per cent of the total road length (CMIE 2003). (As per MORTH, the NH constituted 57,737 km in 2001 forming
1.75 per cent of the total road length.) The NH carried nearly 40 per cent of the road freight traffic (NHAI 2001).
The NH had a CAGR of 5.55 per cent between 1991 and 2001. This growth has been more significant in the later part of
the decade, due to an increased attention on the development of the NH. In the first 6 years, the CAGR was 0.56 per cent, while
in the later 4 years it was 13.45 per cent. The growth in NH is almost entirely due to an upgraded reclassification of SH segments,
attracting central government funds for development and maintenance. The NH have tradionally been maintained by the state
governments with the central funds. However, after the formation of the NHAI in 1988, key segments of the NH have been taken
over by the NHAI.
It is now generally accepted that due to the thrust on road development from the 1950s, the road length and the consequent
connectivity is less of an issue than the road quality. Poor road quality affects capacity (leading to congestion and additional travel
time), wear and tear on vehicles, safety, and pollution. These implications are all the more significant in NH due to the higher
traffic density. In 1996, it was estimated that the economic losses due to the poor quality of main roads was of the order of
Rs 200 to 300 billion per annum, which was about 2 per cent of the GDP (Mohan 1996). In rural areas, sometimes the poor
quality even results in loss of all-weather connectivity, especially to remote locations. Figure 11.1.2 brings out the interlinkages
of policy formulation and resource allocation on the implications of poor road infrastructure.
With the above in view, the government is executing two major projects to improve road quality, namely the NHDP and the
Pradhan Mantri Gram Sadak Yojana (PMGSY). Table 11.1.1 gives an overview of these projects. Apart from these programmes,
there are various road segments taken up by the state governments for quality improvement. Quality roads are possible with better
policy planning and implementation, and larger resource allocations, with a focus on leveraging the economic value of roads.
fact, create situations of over usage of roads. This may also

be distortionary, especially when considered in relation to
other modes like rail. In the case of shadow tolling, the
operator has still an incentive to woo traffic, apart from
ensuring specified service levels, while in the annuity, the
incentive is only to ensure specified service levels.
While structuring a road project other than toll-based,
revenue streams should also be leveraged. Such streams are
concessions for economic activities in which the road user
is the market, property development, and access to right of
way for other infrastructure like telecommunications.
Economic activities focusing on the road user as a market
are petrol pumps, auto repair garages, places of stay,
restaurants, advertisement hoardings, parkingespecially
in urban roads (CG Road of Ahmedabad [Pangotra and
Jaryal 1999]), etc. A classic case of developing a new industry
in order to spur travel demand by a transport infrastructure
provider was the advent of amusement parks by the interurbans (a low-cost rail-based commuter transport system
that grew around many urban nodes at the turn of the 20th
century). This was meant to create reverse traffic by the
urban dweller, as well as increase ridership during the
weekends. The idea of a tie-up with the tourist and pilgrim
centre administrators of Pavagadh which is near Halol is a

distinct possibility for increasing revenues in the context of
the VHTRL (Raghuram, G. 2003).
Government Contribution
Even after all such measures, it should not seem unexpected
that there would still be revenue shortfalls which the
government would have to make good. For example, in
VHTRL, even though the original toll revenue projections
indicated a healthy project surplus, the toll revenues have
been significantly less than expected (one-third) due to a
variety of exogenous factors. With the current financial
structure and expected toll revenue of Rs 90 million, there
would be an operating deficit of Rs 104 million and cash
deficit of Rs 160 million. With reasonably optimistic
estimates on toll collections and financial restructuring, the
operating deficit could become nil and the cash deficit
about Rs 55 million per annum. The Government of Gujarat,
which has contributed Rs 50 million as equity and Rs 100
million as preference shares towards a total project cost of
Rs 1600 million, may have to also worry about the deficit,
along with the promoters.
254
ISSUES
IN
PROJECT STRUCTURING
Typically, toll-based road projects have succeeded in short

stretches like river bridges, bypasses, and road overbridges,
where excludability is high and the value of a large section
may be seen to accrue to the bridge or a now-cleared bottleneck.
Small Stretches could be Problematic

Regular road stretches have generally not yielded commercial
returns on their own standing. One of the problems is that
such road segments do not have the required scale, both to
ensure a larger traffic base and to leverage additional sources
of revenue. For example, the VHTRL could have a larger
traffic base if the HalolShamlaji segment is added to the
current segment, forming an effective alternative route to
the NH-8, between Vadodara and Shamlaji (Raghuram
2003). Similarly, the AhmedabadVadodara Expressway
cannot really leverage additional sources of income through
concessions for activities where the road user is the market,
since the journey time on the road would only be about an
hour and any additional stoppages may not find favour with
the road user. The AhmedabadMumbai stretch may make
a lot more sense for this. Interestingly, amongst the NHDP
project segments with higher returns, there is a correlation
between the length of the project segment and the expected
return.
Bypass project is the inappropriate bundling with a bridge

on a different route. It is also important to take a perspective
of how the benefits of a project accrue so that the same can
be channelized back into the project. A success story is the
example of the Vatrak bridge on the NH-8, where the new
bridge is on a different alignment, but tolls are being levied
on both the existing and the new alignments (ensuring
exemption for local traffic). This recognizes the fact that the
traffic on the existing alignment also benefits in terms of
smoother flow due to the traffic which has switched to the
new alignment. The same principle has not been adopted
in the MumbaiPune Expressway, where only 30 per cent
(significantly lower than what was expected) of the truck
traffic has switched to the expressway.
Linkage to Service Levels

While considering tolling where compliance by the user is
important, it is essential to relate the tolls to the service
levels. For example, if a toll is being levied because a 4-lane
capacity on bridges has been provided (as an enhancement
to the earlier free two-lane bridge), then the toll should not
be levied whenever one of the bridges is closed for any
reason, resulting in the effective availability of only 2-lane
capacity. This would ensure better toll compliance and tolls
would not appear arbitrary to users.
Longer Point to Point
RISK ASSESMENT
If the appetite for long segments is absent at the project

phase for private sector participation, then policy needs to
allow for mergers between adjacent segments, if found viable,
during the operations phase. A similar example is in the case
of road projects initiated by the Madhya Pradesh government,
wherein the initial structuring was ambitious and did not
find any bidders under a scheme of limited capital subsidy
(Rastogi 2002). After a careful reconsideration of the
technical parameters (in the context of expected traffic) like
road width, drainage requirements, etc., the costs were
brought down, without significantly affecting the service
levels, to an extent where bidders took on the projects2.
Project segments can be suitably defined between
appropriate OD pairs so that the promoter can go after a
better-defined road user market. In contrast, project segments
ending on state borders (many of the NHDP segments do
so) reflect more an administrative supply-side mentality
rather than a commercial demand-side perspective.
The government and the promoter have an important

responsibility in identifying the various risk elements in a
project and providing mitigating mechanisms for the same.
An analysis of such risks in Indian road BOT projects is
provided in Thomas (2002). Six projects were analysed. Table
11.1.1 gives a comparison of risk realization and its impact
on the 6 projects. The key risk elements identified by the
author are (i) traffic revenue risk other than demand/market
risk, (ii) delay in land acquisition, (iii) demand/market risk,
(iv) delay in financial closure, (v) project completion risk,
(vi) cost overrun risk, (vii) debt servicing risk, and (viii)
political risk. Through a methodology of talking to a variety
of stakeholders, the author has also provided a criticality
index for the 8 risks, ranging from 0.88 to 0.71.
Appropriate Bundling
Appropriate bundling of project activities is also important.
One of the important causes of the failure of the Coimbatore
2
See Chapter 11.2, Implementing a Rural Roads Project in

Madhya Pradesh, by Agrawal and Agrawal in this Report.
AND
MITIGATION
Traffic Revenue Risks

Not surprisingly, the traffic revenue risk is on the top. The
Coimbatore Bypass project experience, where enforcement
of toll collection has been the problem, is illustrative of
the toll collection risk (Raghuram and Kheskani 2002).
While land acquisition is the next risk in terms of criticality,
the effects of this can be mitigated with the project starting
only after all the required land is procured and handed
over by the government. While this of course reduces the
Transportation
255
Table 11.1.1
Comparison of Risk Realization and Impact in Six BOT Road Projects
Risk Category
Criticality
Index
Traffic revenue risk

0.88
(other than demand/
market risk)
Delay in land acquisition 0.83
Coimbatore
Bypass
VadodaraHalol
Toll Road
30% loss
510% loss
Minor delay Marginal increase

No Impact
in cost
20% reduction 4555%
reduction
6 months
4 months
delay
delay
1 month
YesBut
completed as
per schedule
through
deployment of
additional
resources
Change in
1.6% of the
scope
project cost
Demand/market risk
0.81
Delay in financial
closure
Completion risk
0.77
Cost overrun risk
0.74
Debt servicing risk
0.74
Marginal
impact
Political risk
0.71
Yes
0.77
Yet to be
realized, but
expected
No
Bharatpur
Bypass
25% loss
Second Narmada
Bridge
Marginal
4 months delay Nil

1518%
reduction
4 months
delay
Completed
well ahead
of schedule
25% reduction
8 months
delay
Completed
well ahead
of schedule
No
Marginal
increase
Yes
No
Yes
Not realized
yet
DelhiNoida
Bridge Flyover
Nardhana
ROB
510% loss
1015% loss
1 year delay
in Flyover
5055%
reduction
Marginal
delay
Completed
well ahead
of schedule
additional
resources
deployed
6 months
delay
2025%
reduction
Nil
Completed
before
schedule by
deployment
of additional
resources
YesMarginal About 7%
increase
net increase
in cost
YesYet to
No
be realized
YesMainly
during
developmental
phase
Yes
Marginal
impact
Source: A.V. Thomas 2002.
risk in a financial sense, (since no investments are made

until all the land is acquired), the start of an intended
project could get delayed significantly. The primary reason
for certain segments of the GQ phase of the NHDP
exceeding the current project completion deadline of

December 2004 would be problems due to land acquisition
(and in certain segments, security concerns of the project
staff ).
Box 11.1.2
Salient Features of the NHDP
The Rs 540 billion (Table 11.1.2) is financed through fuel cess (Rs 200 billion), MLA assistance (Rs 200 billion), market
borrowings (Rs 100 billion), and private sector participation (Rs 40 billion). Additional funds for inflationary increases are being
sourced through market borrowings (Rs 20 billion), and private sector participation (Rs 20 billion).
The Re 1 per litre fuel cess raised Rs 340 billion over the 6 years until 20023, first introduced in 19978. The split in
the fuel cess for the revenue of nearly Rs 60 billion per year was Rs 25 billion for PMGSY, Rs 20 billion for NHDP, Rs 10 billion
for SH, and Rs 5 billion of IR.
From 20034, the fuel cess has been raised to Rs 1.50 per litre and is expected to yield Rs 90 billion per year. The additional
revenue that would accrue to NHDP is towards the 2003 Budget-proposed 10,000 km of 4-laning of new corridors.
While private sector contribution has been more than what was originally thought feasible, it provides for only a total of
1358 kms over 30 projects out of the 7595 kms awarded so far over 146 project contracts.
Out of projects awarded so far, 6 projects covering a distance of about 1500 km expect a rate of return of more than 20
per cent. Another 9 projects, covering a distance of about 1800 km expect a rate of return between 1015 per cent.
It has been estimated that the GQ phase alone will save the economy Rs 80 billion per annum as per 1999 prices. (This
can be benchmarked with the estimated losses of Rs 200 to 300 billion per annum on the main roads, as per 1996 prices.)
Source: www.nhai.org, www.pmgsy.org, and NHAI (2002).
256

Total
2526 (100) (57)
Highways
2018 (80) (60)
Urban Roads
238 (9) (76)
PWD
989 (39) (85)
Project Roads
271 (11) (19)
Panchayat Raj Roads

1028 (41) (37)
National
Highway
State Highway
Others
50 (2) (100)
138 (5) (99)
802 (32) (82)
Zilla
Parishad
Road
457 (18) (55)
Village
Panchayat
Road
425 (17) (16)
Community
Development
Road
146 (6) (38)
Notes: 1. The figures above are in the 000s km.

2. The figures in the first brackets are the percentage share with respect to total roads.
3. The figures in the second brackets are the percentage share of the surfaced roads in each category.
Source: CMIE (2003).
Fig. 11.1.1 Category-wise Road Length (1999)
Demand Risk
Demand/market risk is the next in criticality. The
fundamental problems are due to over-estimation by
stakeholders, more as a result of feel good about the project
rather than a hard-nosed look at the traffic and its drivers.
In a sense, this phase may be over since the early entrants
into this industry have built up their experience and
governments are more willing to make financial contributions
towards projects. Sometimes, the demand risk is a direct
consequence of government policy. In many of the recent
projects, this has actually materialized. In the case of VHTRL,
the traffic expectation was based on the industrial potential
of an area given the benefit of sales tax concessions. However,
the sales tax concessions were lifted even as the road project
was underway, reducing the demand significantly. Should
not the government compensate for the changes it brings
about? Two important issues still need to be taken care of.
Promoters need to focus on soft aspects like methodologies
to collect, analyse and interpret data that would help in
appropriate market assessments. Governments need to
facilitate and direct investments in such a manner that tollpaying traffic on such road stretches increase. Since such
pay-offs would happen over a longer time frame, concession
agreements need to recognize this. For example, in the case
of VHTRL, the concession period is a rolling period until
the required return accrues to the promoter. Such a concession

agreement obviously needs to be backed up by strategies for
improving the traffic base (Raghuram, G. 2003).
Other Risks
Delays in financial closure, completion risk, and cost overrun
risk are the next in criticality. These risks call for better preproject and during-project management, which is increasingly
happening due to the experience build up. The penalties on
delayed project completion have helped minimize the
completion delays, which are often being dealt with
deployment of additional resources by construction
companies. In the context of many NHDP segments,
changing project structure, especially due to demands of
increased provisioning of pedestrian subways/overbridges to
connect rural households with their farms has caused delays
and overruns. In subsequent phases, this is being taken care
of by appropriate hearings prior to the project formulation.
In the context of VHTRL, the requirement of a service road
increased the project costs, though not significantly.
Debt servicing risk is the next in criticality. Appropriate
debtequity mix and proactive managerial strategies in
financial restructuring would be the risk mitigants. Lastly,
political risks could impact projects. The delay in toll
notification in the East Coast road and withdrawal of tax
Transportation
Table 11.1.2
Overview of NHDP and PMGSY
Public Consultation
Name of
the Project
Project Component
Length
(km)
Cost
(Rs billion)
NHDP (1999)
GQ
NorthSouth and
EastWest Corridors
Port Connectivity
Additional Segments
Total
New Corridors
5846
7300
235
270
381
653
14,180
10,000
86,000
35
(2003)
PMGSY (2000)
540
125
concessions in VHTRL are examples. It is also possible that

governments could fail in bringing their share of financial
compensation or sanction competing facilities. Mitigants
could be to ensure that the government is a stakeholder in
the project, and have provisions for compensation by the
government when the consequences are clearly attributable
to acts of the government (Raghuram, G. 2003).
PROCESSES
Having good processes in place can do a lot to correctly
structure projects and risk mitigation. Apart from commerciallyoriented management processes by the project promoters,
there are a few distinguishing processes that are essential.
Public consultation in a proactive and meaningful manner

is critical. Promoters often dither on this since the perception
is that there would be a lot of giving away to unreasonable
demands. It is important to recognize that being open to
negotiations does not necessarily mean giving away to
unreasonableness. On the other hand, it is an opportunity
to explain and arrive at sustainable consensus. Many segments
of the NHDP have benefited even in sensitive matters like
relocation of religious structures. In one instance on the
NH-8 in Rajasthan, the entire alignment was switched from
going through an environmentally-sensitive hilly segment
(via Beawar) to a segment with industry potential (via
Bhilwara). The solution, though resulting in a longer
alignment, was welcomed by the residents and representatives
of both the areas.
Tolling being a significant issue, consultation papers (like
those the TRAI puts out in the context of the telecom
sector) on matters of toll structure, schemes, etc. would
help. Consultation papers can also help on other dimensions
of project structuring like the need for service roads and by
bringing in greater sensitivity among the road users by not
abusing such services. Such papers and discussions around
them could lead to more robust concession agreements. In
the context of toll enforcement and on equity considerations,
the idea that government vehicles can be exempted from
paying toll (which often is a part of the concession agreement/
Poor Policy Formulation

and Implementation
Poor Management
Insufficient Resource
Allocation
Uneven Distribution of
Transport Demend
Insufficient Transport
Capacity
Poor Maintenance
Poor Controls
Safety
257
Wear and Tear
Pollution
Source: Raghuram G. (2000).

Fig. 11.1.2
Transport Myopia
Congestion
(Time)
258
toll notification) is unreasonable. Government must take

the lead in paying toll so that it sets an example.
Review Arrangements
Review processes in terms of provisions of the concession
agreement including toll structure would be essential,
especially when contextual factors change beyond what
was expected. A good example is the idea of toll review
committees, as in the case of VHTRL, wherein the toll
structure can be reviewed due to changes in environmental
factors, apart from the automatic revisions provided for due
to the price index variations. To enable such reviews, systems
for appropriate data collection and analysis must be put in
place, and provisions to that effect should be there in the
concession agreement.
CONCLUSIONS
Attributing all possible sources of non-toll based revenues
to road projects should be considered. The promoters and
the government should work together in also ensuring
traffic volumes by creating and servicing the demand. In

this context, the evolving function of corridor management
that NHAI has initiated should be taken advantage of.
Tolls have value. It is important to design tolls
appropriately. The current short stretches for tolling may
not be appropriate.
Toll roads can become effective sources of information
for profiling traffic flows and for policy analysis3. Even at
the national level this kind of information is not being
actively built up. Besides toll data, road usage studies covering
important seasons and with adequate periodicity are
important (Raghuram 2000). Systems should be evolved to
capture data electronically (at each toll booth) regarding the
type of vehicle, number of passengers/nature and quantity
of cargo carried, origin, destination, etc. Aggregation and
analysis of this data would go a long way in addressing this
lacuna.
There are other institutional and contractual matters,
like hearing out public interest litigants, providing service
roads, putting in place appropriate mechanisms for dispute
settlement, and toll reviews that ought to be part of any
good contract.
11.2 IMPLEMENTING A RURAL ROADS PROJECT IN MADHYA PRADESH

Pramod Agrawal and Arun Agrawal
The importance of roads in connecting the vast rural areas
of India to form the national market and economy cannot
be overstated. Connectivity provided by roads is perhaps the
single most important determinant for the well being and
the quality of life of people living in an urban area. The
efficiency of the innumerable government programmes aimed
at rural development, employment generation, and local
industrialization is, to a large extent, determined by the
connectivity provided by roads. There is a considerable body
of evidence that demonstrates the links between rural road
investment, decline in poverty, and improvement in the
quality of life in India. Road investment contributed directly
to the growth of agricultural output, increased use of fertilizer,
and commercial bank expansion.4 Improvements in rural
roads are positively correlated with decline in poverty. The
potential value in improving of rural connectivity especially
3 Tilotia and Pawar, Use of Derivatives in Traffic Risk Management
in the Road Transport Sector, Chapter 5.1 in this Report, also
argues for complete databases in all tolled and annuity-based roads,
as a must for market participation to take on traffic risk.
4 Hans Binswanger, Shahidur Khandker and Mark Rosenzweig,
How Infrastucture and Financial Institutions Affect Agricultural
Output and Investment in India, Journal of Development Economics,
Vol. 41, 1993, pp. 33766.
in the states of MP, Bihar, UP and Orissa is revealed by the

large differences between mandi and farmgate prices.
The existing rural road network has a total length of
about 2.7 million km. About 40 per cent of the 661,000
villages in India are not as yet connected by all-weather
roads. There is a wide disparity in quality and degree in
connectivity among states. Many villages still rely on dirt
tracks that are unsuitable for motorized traffic, and which
are practically impassable during the rainy season, especially
in areas with regur soils. Typically, there is under-provision
of bridges, culverts, and earth works that stabilize the road
layers. A large part of the network is underdeveloped, of
poor quality and standard, structurally weak, poorly
maintained, and in urgent need of repairs. The lack of roads
also means that an estimated 2030 per cent of the
agricultural, horticultural, and forest produce get wasted
because of inability to reach marketing and processing centres.
The current estimated value of the existing rural road
network, based on the value of construction work, is about
Rs 2400 billion. The maintenance of the existing rural road
network requires about Rs 50 billion per annum. But only
about 2030 per cent of this is being spent. Most rural road
investment decisions are at present subject to considerable
political influence, with little or no consideration of the
Transportation
economic priorities. For example, in developing network
master plans in 3 districts in Andhra Pradesh, 15 per cent
of the blacktop roads and 25 per cent of the water bound
macadam (WBM) roads were not identified by local
stakeholders as part of the core road networkan indication
of over-investment in some links.5 Most rural roads
expectedly have very low initial traffic volumes, and the
expected benefits of improvement come primarily through
increased socio-economic opportunities. These increase
traffic, but are difficult to forecast and quantify in monetary
terms. Moreover, rural road investment programmes in India
often cover large areas, where needs include both
improvement of existing all-weather passable roads for the
purpose of traffic efficiency, and the provision of basic access
for poverty reduction. Allocating limited budgets sometimes
means choosing between poverty-focused and efficiencyoriented road works.
Such a state of affairs has come about because of: (i)
inadequate funds: The government typically commits to
provide road access to all the villages but is constrained due
to shortage of funds; (ii) lack of inter-agency coordination;
and (iii) lack of accountability and effective mechanisms for
monitoring and control.
Investments made in such circumstances have considerably
reduced the actual value of the assets, not withstanding the
sums actually spent. Thus, despite the many government
programmes and much funding, the deficiencies continue.
Recently, Government of India launched a national
programme, the PMGSY, aiming at all-weather road access
to all habitations with a population of 1000 and above by
the year 2003, and those with a population above 500 by
the year 2007. Besides providing connectivity to about
160,000 habitations, the programme also aims to upgrade
about 500,000 km of existing rural roads. The major source
of funding of the programme is the Central Road Fund
(CRF), which will allocate about Rs 25 billion annually for
rural roads.
PMGSY
IN
MADHYA PRADESH
Madhya Pradesh is today the second largest state in the

country having an area of 337,871 sq km where the state
of rural road connectivity is rather poor. As on end 1997,
18,600 villages in Madhya Pradesh out of about 65,000
villages in the state were connected by roads (CMIE 2003).
PMGSY has been a great boon to this state. Though the
state government has started levying a 1 per cent extra cess
on food grains and other agricultural products traded in
Mandis; the generation of resources through this means was
5
World Bank project appraisal documents for Andhra Pradesh

Economic Restructuring Project, rural road component, 1998.
259
inadequate to take up projects on a large scale. Out of this

1 per cent, 0.85 per cent was to be spent on roads. This
cess has been generating about Rs 100 crore every year for
the roads.
The total length of State Highways (SH) in the state is
6000 km; whereas the length proposed to be constructed
under PMGSY in the first 3 years is over 9000 km. The
share of Madhya Pradesh in PMGSY is almost 9 per cent
of the total fund. Keeping in mind the connectivity status
and large amount of money being given to Madhya Pradesh,
it was thought essential to establish a dedicated organization
to implement this scheme. The funds generated through the
Mandi cess was also given to Madhya Pradesh Rural Roads
Development Agency (MPRRDA), the organization specially
set up to develop rural roads.
STRUCTURE
OF
MPRRDA
MPRRDA is registered under the Societies Act. A CEO

from the Indian Administrative Service (IAS) cadre heads
the Authority. Twenty-seven Project Implementation Units
(PIUs) for 45 districts have been constituted to coordinate
the works executed by the contractors and supervised by the
consultants. The PIUs are headed by general managers who
are of the rank of superintending/executive engineer. The
Authority has a General Body, which in chaired by the chief
minister. This body lays down the policy guidelines and
monitors the programme (Fig. 11.2.1).
There is an Empowered Committee under the
chairmanship of the chief secretary. It is responsible for
monitoring the progress of the project. It also takes the
financial and administrative decisions. The project proposals
are scrutinized and sanctioned by this committee. It also
accords final sanction to the Master Plan of the state.
PROJECT IMPLEMENTATION
At the district level, the programme is planned, coordinated,
and implemented through the PIUs. All PIUs are manned
by competent technical personnel from amongst the available
staff or from those on deputation and no new posts were
created. This meant that a new organization could be set
up without adding to the number of government employees.
These technical people have been recruited in the
Authority with one promotion. The incremental salary and
the opportunity cost of time for getting a similar promotion
in their parent department acts as an incentive for these
people to work for the Authority. Unsatisfactory performance
is not acceptable to the Authority. There have been instances
where unsatisfactory or under performance have led to the
personnel on deputation being returned to the parent
department, which effectively means doing away with the
260
promotion received while working in the Authority. These

measures have acted to bring about much dynamism in the
working of the Authority.
Master Plans are prepared at the block level, which are
later synchronized at the district level. They indicate the
habitations and the existing status of road connectivity,
including the proposed new construction as well as roads
requiring upgradation. The District Master Plans so prepared
are subject to scrutiny to arrive at the most economical
alignment of the roads. It also indicates the priority of roads
to be taken up for construction/upgradation in a phased
manner The Master Plans are approved by the Governing
Body of the respective Zilla Panchayats, taking into account
the views and suggestions of the local MLAs/MP. Thereafter,
the District Planning Board gives approval to the Master
Plan. For works to be taken up each year on their priority,
project proposals are prepared and forwarded to the
Empowered Committee for approval.
The state level Empowered Committee forwards the
approved proposals to the central government for
administrative sanction and release of funds. On clearance

of the project proposals by the central government, the
relevant projects are executed by the PIUs and completed
within a period of 9 months, from the date of approval. In
exceptional cases, this period may extend up to 12 months.
The well-established procedure for tendering, through
competitive bidding, is followed for all projects. The projects
are tendered in packages of appropriate size (between Rs 1
crore to Rs 5 crore).
EXECUTION
OF
WORKS
Technical Standards
Before the MPRRDAs taking up of rural roads under the
PMGSY, rural road technologies used in Madhya Pradesh
were largely traditional and had not undergone any major
changes. Technologies were generally borrowed from those
developed for highways, without realizing the potential
savings which could be achieved if the technologies are
Executive Council
headed by Rural Development
Minister
General Body
headed by Chief Minister
Empowered Committee
headed by Chief Secretary
Chief Executive Officer
Chief General
Manager II
Chief General
Manager I
Project Implementation Unit

(13 PIUs covering 24 Districts)
Project Implementation Unit

(14 PIUs covering 21 Districts)
(EACH PIU)
General Manager
(Supdt. Engineer)
Asst. Manager
(Technical)
Sub
Engineer
Fig. 11.2.1
Organization Structure of MPRRDA
Transportation
developed according to the specific needs of rural roads.
Rural roads differ widely in terms of traffic, the population
served, and the functions to be served. The design standards,
technologies, and material specifications did not take
adequate account of these parameters. Under PMGSY, it
has been possible to introduce cost-effectiveness through
changes in design and material specifications. The Rural
Roads Manual (an Indian Roads Congress [IRC] special
publication) has now been developed for technical
specifications of rural roads to be followed in PMGSY.
Quality and Supervision

Earlier, the actual quality of rural roads was generally poor,
leading to high maintenance costs and low service life.
Many rural roads had been constructed without any basic
system for quality control, or monitoring. Quality of works
being the essence of this programme, all works are effectively
supervised by reputed consultants. It is the prime
responsibility of the PIUs to make certain that the work
done and all the materials utilized conform to the prescribed
specifications. Periodic inspections of works are carried out
by the MPRRDA. The Empowered Committee of the
Authority oversees that the supervision of works is continuous
and effective. The Ministry of Rural Development and the
Authority has engaged Quality Monitors for inspection of
works under the programme. The PIUs facilitate the
inspection of works by the Monitors, who are given free
access to all recordsadministrative, technical, and financial
(Table 11.2.1).
Putting in place suitable quality assurance systems with
the necessary facilities and institutional set-up has helped
secure value for money that goes into public investment in
rural roads. However, the inspections by the Quality Monitors
need to be planned in such a way that they do not pose an
operational bottlenecks for the ongoing works.
Information Systems and Monitoring

The Authority has made significant improvements in
information systems. Senior managers generally have good
261
understanding and appreciation of the importance of

information technology in ensuring effective monitoring
and supervision. They have personal computers in their
offices and use them very frequently. Resources are devoted
to systems improvements and staff training. In addition to
investment in hardware, software, and staff development,
the Authority has a reliable and comprehensive system for
collecting critical informationsuch as road status, money
transfer, financial progress, technical and personnel
information on the consultants and contractors to feed key
databases and improve future decision-making.
The Authority has its own website (http://www.
mprrda.com) which is primarily designed to help the
prospective bidders to access timely information relating to
procurement and the spread of the works. The facility for
downloading model contract documents for civil works and
their supervision consultancy is also available on the website.
All the bidders can know online the results of the tendering
process. Individual PIUs are also ranked every month, based
on their performance vis--vis the targets set for them. The
Authority is also in the process of fine-tuning a system for
grading the contractors and consultants. As reputation is a
vital factor in the construction industry, making this
information online is expected to act as a deterrent to failing
to satisfactorily accomplish the works assigned to them.
Winning support from senior management for investments
in information systems have created opportunities to enhance
productivity, decision-making, governance, and transparency
in the Authority.
Asset Maintenance
Maintenance is integral to the design of the programme. A
clause was introduced in the contractors agreement to
maintain the roads for 5 years from the date of completing
the road. Contractually it meant that, they would receive
10 per cent of the contract amount only after the
maintenance guarantee period was over. For maintenance
of PMGSY roads beyond the lock-in period of 5 years, the
state government has taken a policy decision to fund the
Table 11.2.1
Inspections by National Quality Monitors (October 2003 to March 2003)
State
Tamil Nadu
Gujarat
Madhya Pradesh
Maharashtra
Rajasthan
Uttar Pradesh
Andhra Pradesh
India
Total No. of
Works Inspected
382
328
449
423
387
639
402
4948
Poor
5
7
0
12
13
24
6
129
Grading
Average
44
47
34
93
40
100
91
836
% of
Good
V. Good
Good/V. Good
302
259
396
316
268
490
301
3713
31
15
19
2
66
25
4
270
87
83
92
75
86
80
76
80
262
maintenance from the Mandi cess, levied on the produce

brought to the agricultural markets. At present, the annual
collection from the cess is Rs 90 crore. Five years from now,
the annual collection of this cess is expected to increase to
approximately Rs 125 crore.
Capacity Building
The technical and managerial skills of the Authority had to
be enhanced. First, a good number of technical workforce
at the middle and junior level did not have adequate exposure
to road-related works. They had an engineering background
but little hands-on experience in designing roads and
supervising projects. Second, the contractors needed to be
fully aware of the design specifications for rural roads under
PMGSY. The designs were not entirely conventional adding
to the need for training. Similarly, in the case of the
consultants, they were supposed to deploy considerable
technical staff in a given PIU. But a majority of their junior
level engineers were fresh diploma holderssound in
knowledge but lacking hands-on experience with civil works.
Unlike in the usual Public Works Department (PWD) style
of working the Authority was committed to a certain schedule
of construction.
Training sessions are regularly organized at the PIU level
where all the personnel of the contractors, consultants, and
the PIU assemble to learn and discuss the issues they faced.
Such sessions are assisted and facilitated by an external
expert who is paid a honorarium. Training sessions at the
PIU level, also serve as a platform for the agencies associated
with the project to agree to a common approach to deal
with problems as they emerge. Thereby, costly disagreements
are avoided on the field, such as those relating to the quantum
of work done. Remote training using satellite communication
was attempted, besides, regular training at the state capital.
Technical personnel cutting across the various levels could
attend relevant workshops/seminars outside the state as well.
NEED
FOR A
NEW ORGANIZATION?
Dysfunctional PWD
Projects in the states are typically carried out by the PWD.
PWDs typically lack focus and are entirely driven by processes
rather than goals. They could also be overladen with many
tasks and cumbersome processes that mean huge manpower
usage in their working. The Government of Madhya Pradesh
had already decided to hand over other district roads (ODRs)
and village roads (VRs) to Panchayati Raj Institutions
(coming under the Panchayati and Rural Development
Department). Second, money from the central government
for PMGSY was channelled through Rural Development
ministry and, hence, it made sense to make the rural
development department of the state as the nodal department

for executing the PMGSY project.
The supply of roads, both in terms of capacity and
quality, had not kept pace with the tremendous growth in
demand for road transport in the state. Other road agencies
in the state had been traditional bureaucratic organizations
that lacked both autonomy, and the external pressures for
optimal performance. They were also outdated and
dysfunctional.
Little Decentralization
They operated without any clear goals; without performance
indicators, or investment plans. Performance evaluation was
merely input-based. Expenditures incurred were considered
as performance and at best were measured against budgets.
The physical condition of the roads was never an aspect of
performance or achievement. There was little autonomy or
decentralization. Large volume contracts went up to the
minister for approval. The staff were subject to exhaustive
and restrictive financial and administrative regulations,
multiple layers of approval, and limited delegation of authority.
These factors stifled personal initiative and slowed decisionmaking, often bringing it to a standstill. The department was
also frequently subject to instability and insecurity in funding.
This hindered any planning or programming of works.
Irregular payments also hurt the private construction industry.
The private industry would have responded to these
perversities by lowering quality and cheating on quantity.
Need to Outsource Labour

In the early days of the Public Works Department (PWD)
much of the work was done by in-house labour, and as
control over labour diminished in the 1970s and 1980s,
labour contracts were common. But excess and idle labour
continued. Similarly in the past, when the Narmada irrigation
project was taken up, indiscriminate recruitment resulted
in large excess manpower, both of engineers and workers.
Construction machinery, acquired then, lay idle and, with
disuse deteriorated. In the present case it was important to
carry out the project without adding to manpower or fixed
cost. Outsourcing of construction work, as also of
supervision, was the key to the completion of the project
without incurring excessive costs.
It is almost 2 years since the Authority was created. Road
construction works of about Rs 425 crore have been
completed in 1 year, which is much more than all the works
executed by PWD. The cost of running the Authority
annually is less than 2 per cent of the works executed in
the same period. The payments for supervision and QC
consultancy are only 2 per cent of the project, which is
much lower than that for the PWD (Table 11.2.2).
Transportation
Table 11.2.2
Cost Analysis for the Year 2002
Expenditure
Item
Amount
(crores)
As % of
Construction
Construction
Supervision Consultancy
DPR Consultancy
Advertisements
Master Plan
Office and Establishment
Total
424.85
8.76
3.61
0.79
0.04
7.00
445.05
2.06 %
0.85 %
0.18 %
0.01%
1.65 %
The most important thing is that no large permanent

liability has been created. The Authoritys staff is on deputation,
and they will return to their parent departments once the
project is over. The consultants have hired engineers whose
contracts would expire once the project is through. Thus, the
Authority can be wound up whenever the project is over.
THE CHANGES
Advantages
Executing the PMGSY project by establishing a separate
Authority had its own advantages:
Note: DPRdetail project report.
MPRRDA has a staff of around 500 and has executed

works of Rs 425 crore in the year 20023. Expenditure
under the head of establishment and consultancy fee is
around to Rs 20 crore. The project implementation
expenditure as a percentage of works executed is
approximately 5 per cent. PWD has a staff of 7289 regular
employees. Budget for road works for the year 20023 was
Rs 373 crore (includes maintenance expenditure of buildings
and roads) and establishment expenditure is approximately
Rs 200 crore (includes payments to gang labour also) which
works out to roughly 53.61 per cent (Table 11.2.3).
Table 11.2.3
Comparison: PWD and MPRRDA
Item
MPRRDA
PWD
Roads (km)
Works Expenditure (crore)
Establishment Expenditure
Consultancy Payment
Staff
5833 *
425 crore
8 crore
12 crore
500
23872 #
373 crore
200 crore
Not applicable
7289
Notes: * New Construction; # Maintenance.
If the 2 agencies are compared on their scale of operations,

it is clear that expenditure on executing the works is
exorbitantly high in PWD relative to MPRRDA. This large
difference can be attributed to the differences in the
operations (including procedures) of the agencies. MPRRDA
operates in a project mode and maintains a lean staff
outsourcing its construction, supervision, and quality control
consultancy activities. On the other hand, PWD employs
a huge staff and carries out most of the work internally. It
has roughly 40,000 gang labourers on its rolls whose annual
payments are close to Rs 120 crore6.
6
263
It is clear that, to improve its operational efficiency, some

reforms have to take place in the PWD. It would need to reorganize
its set-up. The government can ill afford to undertake civil works with
the present structure and processes. They ought to restrict themselves
to managing civil works, much as the MPRRDA has done.
Clear Vision and Stated Objectives: The Authority had its

job cut out from the very beginning. PMGSY was the sole
project for which it was created and it was expected to have
a more proactive work culture from other government
departments. It was not bogged down by myriad rules and
regulations rife in other departments and schemes. For
operational efficiency, the powers of the state cabinet were
entrusted to the Empowered Committee, which could be
convened at a very short notice, and take swift decisions.
Project Mode: The project was executed in a true project
mode. Every effort has been made to avoid time and cost
overruns. Monthly and quarterly targets are set for the
works and the achievements monitored vigorously.
Greater Flexibility: Operational flexibility derived from the
independent set-up of the Authority enabled it to quickly
deal with issues and take decisions, that would have otherwise
followed a set bureaucratic coursehad the project been
executed by a typical government department.
Adoption of New Technical Design: Embankments were
constructed with transported soil. This helped in reducing
the cost and giving more stability to the roads.
Outsourcing Activities: The Authority has the mandate to
outsource activities without having to justify its decisions.
Process of Tendering: Given the increase in civil construction
activity in the state, it was not easy to get enough contractors
to bid for the various packages at reasonable rates.
Comprehensive changes were made in the process of
tendering to overcome this disadvantage. First, tenders for
works were floated at the state level in one go. Centralized
tendering has many advantages. Value of the floated tenders
is huge and thus it attracts that much more attention from
the targeted audience (contractors, consultants, etc.). If the
PIUs floated the same works individually, the impact would
not have been the same. Second, there was much saving in
costs in tendering. Wide publicity was given to the tenders
with far more insertions, and coverage in many more
newspapers. During the submission of tenders, both the
264
technical and financial offers are collected at the same time.

This results in considerable time saving. Financial offers of
only those parties are considered who are prima facie
technically eligible.
Special Committee: A committee is in place for finalizing
the allotment of works. Had the decision been channelled
through the layers of administrative hierarchy, there would
have been much paperwork and file movement. All the
eligible offers received are put before this committee and
works are allotted after due deliberations but without delay.
The entire process of tendering and retendering is managed
in a tight time schedule and an all-out endeavour is made
to adhere to deadlines (Table 11.2.4).
In the usual process, the tenders of different packages
were opened according to the order in which they were
published in the tender notice. This sometimes resulted in
the contractor getting works not of his choice. It also
discouraged contractors from submitting tenders. Small lot
tenders also imposed large tendering costs on potential
contractors. Now the offers received by the Authority for
all the packages are opened together. The contractor is
awarded work depending on his choice. If he is the lowest
bidder in packages worth more than his bid capacity, he is
awarded work up to his bid capacity. Rest of the works are
awarded to the second lowest bidder. This has improved
competition and working conditions for the contractor.
Earlier the norm was that, for each package, the contractor
would submit an individual tender. Now, to fuel more
competition for getting lower rates, the contractors are
given the option to quote for more than one package in a
single tender. Thus, until the tenders are opened, nobody
other than the contractor himself knows about the number
of packages he has bid for. Experience showed that this has
worked to the governments advantage. Terms of tender
were also changed to ensure that potential new entrants
were prima facie not disqualified.
Recruitments: Vacancies were advertised in the newspapers
for government employees working in other departments.
Thus, people who were really interested applied and the
best, with a good track record, were taken on deputation
in the Authority. Thus, the choice was with the Authority.
Gravel Road vs Bituminous Road: Under PMGSY specifications, constructing a gravel road roughly would cost 60
per cent less than a bituminous road. And, hence, it has
been decided that, for villages with small populations, where
traffic density is very low, gravel roads would be more
appropriate. Thus, many more habitations could be covered
with the limited amount of funds available.
Faster Decision-Making: Initially the tender premium for
the works were more than 30 per cent. As a result of speedily
putting up the tenders that followed (25 rounds of tenders
were done in 18 months and projects worth Rs 760 crore
were allotted in a year) the tender premium came down to
7.09 per cent. Decisions, which customarily would have
been taken in a Cabinet meeting, were now taken within
the Authority at the level of chief secretary in the meeting
of Empowered Committee convened at short notice.
Committee System: For other important decision-making
involving financial implications, the powers have been
delegated to an Internal Committee of the Authority headed
by the CEO, MPRRDA. Two hundred packages, for the
PED, would have taken years to finalize.
Reduction in Project Management Cost: The cost of
executing this project comes to roughly around 5 per cent
for the Authority. If we consider the reality that the staff
on deputation would even otherwise have received their
salary from the government, the project management cost
would further go down by a further 40 per cent.
Difficulties Encountered
The project has not been without its problems:
Interdepartmental Rivalry: Roads are built by the PWDs,
the bridge Corporation, the Zilla Panchayat, and and now
by the MPRRDA. As all these bodies come under different
departments and there is a general lack of coordination, the
PWD, anticipating loss of control over a large turf once the
MPRRDA was set up, hastily declared 30,000 km of village
roads and other district roads as major district roads so as
to prevent them from being under the responsibility of the
panchayat and Rural Development Department! The matter
Table 11.2.4
Summary of Tendering for Phase III
Call
No. of Packages
Rate
Amount (Rs crore)
Ist
IInd
IIIrd
Total
110
42
6
158
9.21 % below SoR

9.90 % below SoR
5.69 % below SoR
396
135
17
548
Note: SoRSchedule of Rates.
Tender Cycle (days)

34
30
25
Transportation
had to be taken up with the chief secretary and the action
of PWD was reversed.
Initial Delay: MPRRDA had its share of initial hiccups
when a lot of decisions on policy matters were referred to
the General Body and the Empowered Committee, which
slowed the implementation.
Substantial Increase of Construction Activities: For the
contractors in the state and adjacent places, there was
suddenly a lot of business. The limited capacity, especially
of machinery, in the state meant that the project
implementation was going to be slower than had been
anticipated, at least initially. It was also a new experience
for contractors to work to schedule.
Multiplicity of Executing Hands: There are a number of
agencies/organizations/bodies that come into play in
executing this project. On the field level primarily, there are
4 parties that regularly have to coordinate: the PIU, the
contractor, quality control consultant, the DPR consultant.
Apart from this, the District/Commissioner too is involved
intermittently. Project proposals for each year pass though
a number of hands before being finalized. There are 3 levels
of quality control experts that supervise the works. Besides
these, orders and fresh guidelines/instructions both from
the centre and the state many a times means that old wine
is being asked for, to fill in the new bottle (the same
information in new formats), consuming a lot of effort,
time, and resources. Last, but not the least, public
accountability to representatives (MPs/MLAs) means that
substantial time of the project staff is spent on such activities.
Given the poor connectivity status of roads in Madhya
Pradesh, the level of funding received under PMGSY, though
265
very large is still inadequate to radically improve the rural

road networks. The ADB was approached to co-finance the
project. Luckily, the deliberations bore fruit and they have
agreed to finance the construction of 5000 km each in both
Madhya Pradesh and Chattisgarh. The proposals have been
worked out and in December 2003, the first batch of roads
under ADB Finance will be put up for tender. HUDCO
has recognized and awarded the Authority, for its outstanding
performance in the field of infrastructure development.
CONCLUSION
Madhya Pradesh has shown a new way to implement the
PMGSYa programme to fund village and district road
construction. It is possible to create fresh organizations
within government such as the MPRRDA, which is taskoriented and decentralized in its functioning and shielded
from the bureaucracy with its slow way of functioning. This
was necessary and crucial to the efficient and timely
implementation of the PMSGY. Innovation in design and
specification, the use of IT, contracts that were incentivecompatible with the objective of good and cost-effective
construction, contract bundling to reduce the bidder side
costs, special measures to attract far more bidders than ever
before, all went on to ensure successful implementation.
Since the success was based on innovations in organization
from, and in new procedures that made the space for
decentralized decision-making within the Authority, and
the internalization of decision-making subject to the policy
and programme laid out by the larger body of the
government, the model is replicable by other states hoping
to make the most of the PMSGY.
11.3 USE OF DEDICATED ROAD FUNDS FOR PPP PROJECTS:

THE CASE OF THE KERALA ROAD FUND
Besides budgetary finances, road systems are funded, across
the world by alternate methods such as private finance,
dedicated local and national road funds, and dedicated tolls
and taxes, often in tandem with each other. Bringing in
private finance and enterprise into road design, construction,
and management are crucial to realize the best value for
money, especially in the Indian situation where state failure
is large7.
7
The state PWDs are charged with building state highways and
other construction activities. Over a period many have become slowmoving and process-oriented to a point where their primary task has
suffered. See Chapter 11.2 in this report.
Complete private financing of road stretches with cost

recovery by levy of tolls is possible only under conditions
of high traffic intensity coupled with a high willingness to
pay user charges/tolls. In other cases, since the revenue
potential is limited (either due to low traffic intensity or low
willingness/ability to pay), unsupported private developers
would find projects unattractive without added concession/
support from the government. Apart from policy/tax
concessions made available to developers, a more effective
method of improving commercial attractiveness of projects
would be through direct provision of financial support by
the government either in the form of upfront/staggered
266
capital grants, deferred payments, subordinated debt and

more recently, in India, through annuity payments.
In order to ensure that governments are able to sustainably
provide such forms of financial support for road projects,
it is necessary to put in place a dependable and continued
source of funds, outside of the existing state finances and
budgets, earmarked exclusively for development of roads.
One such mechanisma dedicated Road Fund (either at
national, state, or local level), earmarked for development
of roads would also serve as a single receptacle for user fees
levied by government/local authorities, cesses levied on fuel
or commodities for improving roads, taxes and fines, and
concession payments received.
Road user charges can generate large amounts of revenue
and is especially attractive where the allocative efficiency of
the general revenues is poor, but dedicated users, with
the capacity to pay, existfor example, tourist traffic or
commercial vehicles. In many countries user charges are a
major source of general revenue generation, in some cases
representing as much as 10 per cent of the national tax
revenues. Keeping the dedicated Road Fund outside the
Consolidated Fund of the government helps retain focus on
the basic objectivedevelopment of the roads and insulating
the deployment of funds from the vagaries of the budgeting
process.
Such an approach calls for a new system for efficient and
effective administration and deployment of the Road Fund.
Kerala has been one of the few states in the country which
has incorporated and operationalized such a fund called the
Kerala Road Fund.
to Rs 108 crore in the fiscal year 1999 and to Rs 88 crore

in the fiscal year 2000. These annual allocations are
inadequate9 and have led to delays in completion of most
road construction and maintenance works. PWD levies and
collects tolls from some selected bridges; however, the
amounts collected are inadequate to support a highway
maintenance programme in any sustainable manner.
PWD commissioned studies (with technical assistance
from the World Bank), which have identified the various
components of the highway network in the state requiring
investment. While funds would be available from the World
Bank for some of these projects, the existing financial
resources available to Government of Kerala are limited and
inadequate to meet the investment needs for upgradation,
expansion, and upkeep of the network on a sustainable
basis.
The Government of Kerala, therefore, envisaged a major
role for the private sector in financing the construction
(which would include new construction, reconstruction,
rehabilitation, repair, and O&M) of highways. To achieve
this objective, the state government enacted the Kerala
Road Fund Act, 2001 (Road Fund Act) which, inter alia,
provides for the setting up of the Kerala Road Fund (Road
Fund) with identified and dedicated revenue sources and
sets out the framework for private sector participation in
the development of highways. These significant initiatives
of the state government would elicit the interest of private
investors in the commercialization of transport facility10
projects vested with the PWD.
THE KERALA ROAD FUND

ROADS
AND THE
GOVERNMENT
The highway network in the state of Kerala encompasses

a length of 142,300 km. Of this, the PWD, Government
of Kerala, is responsible for 23,150 km comprising 5 national
highways (1560 km), dozens of state highways (3150 km),
district roads (15,130 km) and village roads (3310 km).
Over the last decade, the population of registered vehicles
has been increasing at an average of 13 per cent per annum;
however, the highway capacity and current level of
maintenance are considered generally inadequate to support
this growth in traffic. PWDs responsibility includes planning,
development, construction, and O&M of the states highway8
network and it has hitherto financed the same largely through
budgetary resources. As in most other states, the level of
funding for the road sector has been inadequate and has,
in fact, declined from Rs 150 crore in the fiscal year 1998
8
Mainly those categorized as state highways, hill highways,

major district roads, or any other category of roads under the Kerala
Highway Protection Act, 1999.
The objective of the Kerala Road Fund is to assist the

commercialization efforts of the state government over the
long term and hasten development of high quality but
affordable road infrastructure in the state through private
sector participation not only in commercially viable projects,
but also in projects which, while not commercially viable on
stand-alone basis, but are strategically important for the state,
through suitable implementation structures, to attract private
investment and to make optimal use of the funds available
with the Road Fund. IDFC, together with iDeCK, has assisted
the Government of Kerala in developing the operating
framework and business plan for the Kerala Road Fund.
9 As per norms of the MoRTH, Government of India, it is

estimated that PWD would require an amount of Rs 220 crore each
year for highway maintenance alone.
10 Transport facility would include a bridge or a tunnel, including
approach and exit roads thereto, or a road, or any section of bridge,
or tunnel, or road, or a specified combination of all or some of them
on the state highways.
Transportation
Sources of Funding
The Kerala Road Fund would have the following revenue
streams as sources of funds:
All moneys received from the Central Road Fund
established under the Central Road Fund Act, 2000;
10 per cent of the tax collected by the state government
in the previous year under the provisions of the Kerala
Motor Vehicles Taxation Act, 1976;
All fees, fines, and other amounts collected by the
state government as per the provisions of the Kerala Highway
Protection Act, 1999;
All payments made by the concessionaire as per the
concession agreements executed under the provisions of the
Road Fund Act;
All amounts standing to the credit of the Bridges
Fund established under Section 12 of the Kerala Tolls Act,
1976;
The user fees11 collected by the government agency12,
or the statutory body under the Road Fund Act;
Grants or loans or advances made by the Government
of India or any institution;
Grants or loans or advances made by the Government
of Kerala; and
Income from treasury operations.
The cumulative funds that could be available for project
funding over the next 10 years is estimated at around
Rs 1300 crore13.
Utilization of the Road Fund

The Road Fund would primarily be used to provide financial
assistance to transport facility projects for implementation
through private sector participation. The financial assistance
could be any of the following:
Payments/guarantees for payments to be made under
the concession agreementannuity payments, shadow toll
payments, capital grant, termination payments, and other
payments under concession agreement such as payment to
an independent engineer, or any other independent
consultant whose appointment is envisaged under the
concession agreement.
11
As defined in the Road Fund Act, for projects, which would

be awarded on the basis of annuity approach, user fee collected would
accrue to the Road Fund.
12 As defined in the Road Fund Act.
13 This estimate is based on the assumption that the revenue
sources into the Road Fund, including the contribution of Motor
Vehicle Tax Collection by Government of Kerala, and allocations
from the Central Road Fund are credited into the Road Fund each
year as envisaged.
267
Project Finance assistancesenior and subordinate

loans, capital subsidies, equity investments, guarantee, and
other non-funded assistance.
The total investments which could be catalysed, under
various scenarios of deployment of the Road Fund, have
been estimated as follows:
Scenario
Possible Investment
(Rs in crore)
All Projects requiring 25% Capital Grant

Annuity Projects of Rs 500 crore and
balance investment in projects requiring
25% Capital Grant
25% Capital Grant
25% Capital Grant; however, without inflow
from Central Road Fund
4760
3470
2170
1770
The possible inflows from tolling of annuity-based projects

and projects financed by other sources (budgetary resources
and borrowings from multilateral agencies and financial
institutions) have not been considered; this would only
enhance the investment levels even further.
Governance Framework
The Kerala Road Fund Board, under the chairmanship of
the chief minister, oversees the operations of the Road Fund.
The composition of the Board is the following:
Ex-officio members: chief minister, minister (Public
Works), minister (Finance), minister (Transport), principal
secretary (Public Works), law secretary, and chief engineer
(Roads and Bridges).
Nominated members: There are three nominated
members on the Boardto be selected from among heads
of financial institutions (currently includes the managing
director, IDFC) and leading technical experts in the sector.
The principal secretary (Public Works) serves as the
member secretary of the Board. Most of the powers of the
Board have been delegated to the Executive Committee,
chaired by the minister (Public Works) and with two other
nominated members on it.
Operating Framework for the Road Fund

The operating framework for the Road Fund has been put
in place comprising the Kerala Road Fund Rules, 2003, the
Kerala Road Fund Regulations, 2002, and an Operations
Manual setting out, inter alia, criteria for allocation of funds
for different types of projects, procedures for approval of
projects/ financial assistance, procedures for disbursements,
268
project development processes, procedures for audit, and a

framework for evaluation of performance of the Road Fund.
A detailed 5-year business plan for the operation of the Road
Fund has also been prepared.
Way Forward
The Government of Kerala has already identified a few
projects for expeditious implementation with support from
the Road Fund. These include the Trivandrum City Roads
Improvement Project (on annuity payment basis), expansion/
improvement of the VadakkancheryPollachi road,
development of a new west coast highway connecting Ponnani
and Kozhikode, and a tourist highway connecting Kottayam
and Cherthala. The first two projects have already crossed

the first stage of bidding (qualification). Depending on the
sustained level of inflows into the Road Fund other road
projects could be taken up with support from the Fund.
CONCLUSION
Road Funds provide a stable source of financing for roads
and could be a useful mechanism to develop and maintain
a good state road network system. In tandem with private
financing, this framework could be the most sustainable one
for state highways. The Kerala Road Fund experience could
be easily replicated in other states as well.
11.4 DEVELOPMENT OF URBAN ROADS USING ANNUITY

PAYMENTSISSUES AND POSSIBILITIES
Although the urban road networks would typically account
for less than 10 per cent of the total road length within a
state, their impact on the quality of life in urban areas is
immense. Besides being directly a city-serving function they
can indirectly contribute to the growth and development
of the city and its hinterland14. With rapid urbanization,
urban infrastructure provision and maintenance has come
under severe strain, and the creation and maintenance of
urban road networks has been no exception.
Typically, development of the urban road network falls
under the purview of the ULB which more often than not
faces severe financial constraints in taking up large-scale
development works. This results in piecemeal development
of the network. After the development of the road network,
it is the maintenance of the road network which becomes
the first casualty in times of financial difficulties. The result
is a pot-hole ridden road network which characterizes most
of the cities and towns in the country.
Interface with Utility Services

In the case of urban roads (unlike inter-city roads), a number
of underground utilities (water, sewerage, telecom ducts,
etc.) criss-cross the road network, the maintenance of which
could pose a significant problem to the concessionaire during
the operations period. Typically, there is no coordination in
the maintenance of these utilities, often resulting in freshly
14
See Swapnil Pawar, A Faster Road on the Periphery of a City

Sprawl Can Have Immense Value, Chapter 11. 5, in this report for
the value creation effects of roads in cities.
laid roads being dug up for carrying out maintenance works

on underground utilities.
Impracticability of Collection of Tolls

Although, prevalent in developed economies, tolling of urban
roads without compromising on the level of service provided
involves installation of expensive, sophisticated tolling
equipments, which appears to be impractical in the Indian
context today (where even direct tolling of rural stretches
are sometimes debated ad-infinitum within the political
arena). Moreover, given the umpteen ever categories of
vehicles, both slow- and fast-moving, using the city road
network, even the most sophisticated tolling systems could
fail15. It would, therefore, be useful to evolve a mechanism
for the development of urban roads which
Does not put an inordinate, immediate strain on the
available financial resources of a ULB;
Provides for a holistic planning approach to the
development of the network, taking into account design
improvements/ innovations to the utility networks, so as to
minimize subsequent disruptions in road availability to the
citizens; and
Ensures continued maintenance of the network over
the medium to long term.
Projects developed under PPP frameworks, with payment
of annuity as the main revenue source (developed by the
15
Essentially, therefore, the excludability problem is severe in the

case of urban roads, and measures other than direct tolling are
necessary for commercialization to be feasible.
Transportation
Infrastructure Development Finance Company (IDFC), and
used on a few select stretches of the GQ forming part of
the NHDP) could largely meet the above requirements.
ANNUITY APPROACH
The annuity approach is a variation of the direct tolling
model of BOT contracts in that the private developer takes
up all project-related risks except the traffic-revenue risk.
The private developer would carry out the following tasks:
Design of the project road;
Mobilization of finances for executing the project;
Procurement of material;
Construction of the project road; and
Maintenance of the project road over the period of
the concession.
For undertaking the above obligations, the developer is
paid a fixed periodic (quarterly/semi-annual) payment, called
the annuity payment, over the concession period. The annuity
payments are essentially performance-based payments for
ensuring quality in construction and maintenance of the
project road to certain set standards and in making the road
available to road users.
Efficient Bidding
To optimize on bid preparation costs and to lend credibility
to the selection process, the implementing government
agency would prepare the detailed project report, which
would inter alia set out the detailed standards and
specifications for construction (including designs and
drawings) as well as the detailed O & M standards, in terms
of well-defined output parameters (permissible roughness
per km, maximum duration of lane closures, drainage
maintenance, etc.) which the concessionaire would have to
adhere to over the concession period.
The process of selection could be a 2-stage competitive
bidding process in which qualifying bidders are invited to
submit annuity payment quotes over the concession period
in return for undertaking the obligation of design,
construction, O&M of the project road over this period16.
The bidder quoting the minimum annuity payment is
selected as the concessionaire for the project.
CONTEMPORARY PRACTICES
ANNUITY
AND
BENEFITS
OF
Typically, a ULB awards construction contracts for the

construction of roads. This usually involves the following
activities:
16 NHAI has awarded projects with concession periods of 15
years (excluding construction period).
269
Preparation of the detailed project report (including

designs and drawings);
Submission of quotations by contractors in terms of
unit rates for material(s) used;
Selection of a contractorthe contractor quoting
the minimum unit rate is selected for implementation of
the project; and
Periodic payment to the contractor on the basis of
quantities of materials used in the particular period and
quoted unit rates for these materials.
This system suffers from a number of disadvantages, that
are effectively addressed through the annuity approach as
set out in Table 11.4.1:
The adoption of the annuity method would promote
innovation, not only in technical and operational matters,
but also in financial and commercial arrangements. By
appropriate contractual arrangements it would maximize
benefits to the ULB, and lead to an efficient service offering
with lower project-life cycle cost to the ULB.
ISSUES
There are two important factors that need to be considered
while using the annuity approach to urban roads. In order
to attract private developers, the government would have
to assure regularity of payments throughout the concession
period. This would require some earmarking of identified
fund streams (escrowing) to be exclusively used for making
the annuity payments. This could include property tax
collections from areas, lease/ rent dues from property owned
by the ULB, or levy of new cess/fees (parking fees,
infrastructure cess, etc.) for this purpose. In the context of
Karnataka, the proposed amendment to the Municipalities
Act empowering ULBs to raise revenues for infrastructure
development would be useful for development of roads
under this approach.
The second issue to be addressed would be the interface
with the various utility service providers since maintenance
work on underground utilities would typically lead to
disruption in road availability. At the initial stage of the
concession itself, the concessionaire, the ULB, and the
respective utility agencies would need to subscribe to a
common maintenance protocol. Besides, a system to monitor
service quality, preferably by independent agencies, is
important.
270

Table 11.4.1
Advantages of the Annuity Approach
Parameter
Construction Contract
Annuity Method
Financing
To be entirely mobilized by ULB
Responsibility for mobilizing finances for

implementation of the project would be
entirely taken up by the private developer
Time and
cost overruns
Plagued by time and cost overruns due to

procedural inefficiencies and financial
constraints, resulting in delays in payment
leading to frequent stoppages in work
Time overruns would result in changes in the
unit-rates quoted, thereby necessitating
protracted negotiations for finalizing revised
rates
Variations in quantities (due to changes in
ground conditions, etc.) to be paid for by the
ULB
The private developer is incentivized to

complete the project execution as early as
possible, since the annuity payments commence
from the date of completion of the project
Additional monetary incentives for early
completion
Scrutiny and negotiation of unitrates not
necessary since entire risk of project execution
(in terms of variations in quantities and price)
is taken by the private developer
Maintenance of
the project road
Since the construction contractor has been paid

the entire amount due, there is no financial
penalty on him for poor quality construction
which becomes apparent only after a period of
1 or 2 years
Construction contractor receives staggered

payments over the concession period, subject to
maintenance of the road to prespecified
standards, thereby, ensuring maintenance of the
project road
11.5 A FASTER ROAD ON THE PERIPHERY OF A CITY SPRAWL

CAN HAVE IMMENSE VALUE
Swapnil Pawar and Akhilesh Tilotia
ROADS
AS
COMMERCIAL ASSETS
Although roads serve a critical need, it is incorrect to

assume that they necessarily have to be provided for by the
state because they cannot always be commercially viable
by themselves. Faster roads add value in more ways than
one. Besides reduction in vehicle wear and tear, and lower
pollution and lower transport costs there is usually much
value addition to the property along the roadside. The key
to commercialization of roads lies in identifying these
values and attempting to internalize these as much as
possible.
We try to identify the quantum of value creation in terms
of real estate price increases due to a fast road in the vicinity
of the periphery of a growing city. The time reduction
achieved due to a faster road would push up the value of
the land near the road to values higher than what it would
have been without the road. This value addition can be used
to generate revenues for the road building which could go
a long way in making the road a commercially-viable asset
in itself. The thrust of the current exercise is to find the
fraction of the total road investment such revenue streams
can support.
THE BASIC MODEL

Consider a circular city of radius R within which all activities
are located. The value of the land is, hence, inversely related
to the time taken from the land to the commercial centre.
Hence the land prices will be roughly inversely proportional
to the radial distance17. We assume a simple relation, as
follows: The price P is given by
P=
rt
(11.5.1)
where K and t are constants.

Evidently, K > 0 and t > 0.
At the outset, it is necessary to clarify that, while the
model assumed appears too simplistic to start with, since
the primary motive is not so much to model the price
variation accurately as it is to find the order of magnitude
of the possible value of land due to time savings, it suffices.
As we will see later, this simple model serves that purpose
quite well.
17 This is only a simplification. Even with more elaborate bell
curves, the results do not change significantly.
Transportation
Let the annual growth rate of the city population be g.
We assume that the per capita area of the city remains
constant. Hence, the area of the city has to grow (in per
cent terms) by g as well. In the absence of a faster road on
any side, the city is likely to grow outwards along its entire
periphery. The new radius of the city will be, say, R + Dr1.
The price of land in this area will be given by the above
equation.
The total value of the land in this grown area is given by,
V =
R +r
= r = R
K
rt
drd
(11.5.2)
Since P is independent of q (as it merely depends on the

radial distance form the centre and not the orientation),
V = 2
R +r1
r =R
K
rt
dr
CHANGES DUE
PERIPHERY
(11.5.3)
TO THE
FAST ROAD
FROM
Now consider that on one side of the city, there is a fast

road which enables vehicles to travel at a speed m times that
as within the city. It is assumed that the road does not go
all the way up to the centre and is only up to the original
radius R of the city. If we assume that the people treat two
places with equal travel time from the commercial centre
as being of equal value irrespective of the distance, we can
derive the following figure for the equi-price contours. The
equal price contours will be skewed in the direction of the
road, as shown in the Figure 11.5.1.
If the area of the city grows by amount A, in presence
of the fast road, it would grow partially along the road as
well. This would reduce the radial expansion in other
Dr1
Dr2
R
Faster
Road
directions. Hence, if it would have grown to a new radius

R + Dr1 in the absence of the road, it would grow by, say,
R + Dr2 in the presence of the road (excluding, for the
moment, the new area along the road) where Dr2 < Dr1.
Evidently, the new area along the road has to be equal to
the difference in the areas of these two rings. Hence, the
new area along the road is given by,
r + r2
A = 2 R + 1
( r1 r2 )
2
(11.5.4)
Value of Dr2 is found by equating the area of the ring

to the new area developed along the road. This latter value
is known from the nature of the skew introduced by the
road in the equi-price contours. The faster the road the
higher the skew and, subsequently, the lower the value of
Dr2. Since the vehicles travel m times faster on the new road
than in the city, the time equivalence along the periphery
of the city would result in equality, as follows:
Distance along road = distance along other directions/m
The prices will adjust to this and the prices of the land
along the road would be given by
Proad =
(11.5.5)
( R + D / m)t
While the prices on the periphery otherwise (in other

directions) are given by
P=
(11.5.6)
( R + D )t
CALCULATION
OF
VALUE ADDITION
There are two modes of calculation to proceed from here

onwards. For one, we can calculate the increase in the value
of the roadside land as such and find the increase in the same
due to the road. This can be used to derive revenues for the
investment required to build the road. Also we can find the
net social benefit due to the road. The latter is somewhat
lesser than the former in the sense that it will find only the
incremental value of the land near the road over the value
of the land in the ring described earlier. The former is the
value increase in the specific land along the road. We start
with the net social benefit.
To simplify calculations, we assume a strip of width w
along the road along which the alternative growth would
happen. Hence, the value of the area along the road is given
by
Vroad = w
Fig. 11.5.1 The Comparison of Growth with and

without Fast Road
271
mr2
(
/ )t
p =0 R + p m
dp
(11.5.7)
The upper limit for integration is taken as mDr2 because

the time equivalent of the distance of Dr2 along other
directions is given by mDr2 in the direction of the road. As
272
we can verify, the price of the outermost point on the

extended area along the road is equal to the price of the land
at a distance of R + Dr2 in other directions.
Social Value Addition

The social value addition is given by the difference as follows:
Vsocial = w
mr2
r1
K
K
dp 2
dp w
t
(
/
)
(
R
p
m
R
p )t
+
+
p=0
p =r
r2
p=0
( R + p )t
(11.5.8)
dp
For t = 1,
1 + r1 / R
r
Vsocial = Kw(m 1)ln 1 + 2 2K ln
(11.5.9)
R
1 + r2 / R
1
w(m 1) 1
t 1
(1 r2 / R )
KR1 t
t 1

1
1
2
(1 + r / R )t 1 (1 + r / R )t 1
2
1
(11.5.10)
The Value Addition to the Roadside Land

The value of the road/side strip of land earlier is given by:
V =w
mr2
p=0
K
( R + p )t
dp
(11.5.11)
The value after the road is given by

V =w
TO
REAL LIFE CASE
OF A
CITY
Consider the city of Pune. The basis for K is the price of

land in Kothrud, around 10 km away from heart of city,
is quoted at Rs 500 per sq ft. From this, following values
were arrived at:
R = 10,000 m
P0 at radius R = Rs 5379 Rs/sq m
Assuming t = 1,
K = 5,37,92,000 Rs/m
We assume
Speed multiple m = 2.0 (since we are considering only
the part of road outside city, this is reasonable)
Width of the strip w = 1000 m
Growth Rate = 10 per cent
Results
For t 1
Vsocial =
APPLICATION
mr2
(
/ )t
p=0 R + p m
dp
(11.5.12)
Hence, the value differential is given by

Vroadside = w
mr2
mr
2
K
K
dp w
dp
t
(
/
)
(
R
p
m
R
+
+ p)t
p=0
p=0
(11.5.13)
Which when simplified becomes,

Vroadside = Kw
mr2
1
1
t
(
/
)
(
R
p
m
R
p )t
+
+
p =0
dp
(11.5.14)
For t = 1
(1 + r2 / R )m
Vroadside = Kw ln
(1 + mr2 / R )
(11.5.15)
For t 1
Vroadside =
KwmR1 t
t 1
1
1
t 1
t 1
(1
/
)
(1
/
)
r
R
m
r
R
+
2
2
(11.5.16)
The area of the strip is found to be around 0.947 sq km.

Social value addition is Rs 249 crore a year. The value
extractable from the land price appreciation is Rs 11 crore
per year. Assuming a discount rate of 10 per cent15 per
cent, this value can sustain an investment of up to around
Rs 110150 crore. Assuming a cost of Rs 34 crore per km
for a six lane road, this would enable building a road around
3040 km long. This, however, is excluding the other end
of the road which again would end in a city and will add
value to land near the periphery of that city as well. Hence,
pairs of cities of the size of Pune with similar price of
property and around 6080 km apart can, between them,
sustain the complete investment in a road connecting them.
If the distance is higher, however, other sources of revenue
have to be sought. Also, in case of more than one fast road
on the periphery of the city, the additional land value will
be lesser than that discussed for the case above.
CONCLUSIONS
The social value addition by way of land price appreciation
due to a faster road is enormous. The part of it that is
amenable to commercial realization via the price appreciation
near the road itself varies, depending upon various
parameters. However, around a tenth of the social value
addition can be extracted through this way. One possible
method is to award the road building firm the right to
award building contracts in the vicinity of the road outside
the city. A market for these rights/permits which can capture
most of the value addition to the land due to the faster road
can develop. Extending the logic further into the future, we
can foresee a close interaction of the urban planning with
road development in so far as faster roads can be extremely
useful in reducing the increasing congestion in cities.
Transportation
The past in-optimal growth of a city manifests itself in
the form of an urban sprawl, with movements possible only
at low speeds. This necessarily raises the value of property
in the centre in an extreme fashion. Low floor spare indices,
contribute to the urban sprawl. In relaxing the constraints
on economic activity that is the urban sprawl, to take cities
to their economically efficient layouts, the values that can
be unlocked by road construction can be very large. In this
case we have conservatively assumed the construction of a
high-speed road that starts from the periphery to go out
radially. But roads can be constructed to reach central places,
and that can only enhance their value further.
273
Thus, in laying out roads from cities and, more generally,

from all mid- and large-size habitats, especially those with
urban sprawls (Pune, Ahmedabad, Hyderabad, Delhi,
Kanpur, Lucknow), there are large social values to be realized,
since such measures would amount to relaxing existing
constraints. The conclusions are in keeping with Loschs
ideas of radial layout of activities in and around large
(naturally arising) metropolitan cities with activity-poor
and activity-rich radial segments. Indeed, the development
of such roads or railways, would be necessary to hasten the
metropolitan development of the second order cities of
India.
11.6 TRAFFIC RISK MANAGEMENTDERIVATIVES IN THE

TRANSPORT SECTOR
Akhilesh Tilotia and Swapnil Pawar
THE PROBLEM
One of the major hurdles faced by the private parties to
enter into a road construction contract is the traffic risk.
While many of the risks faced by the private party can be
countered through mechanisms like guarantees or escrows
(in case of receivables-risk) or sovereign guarantees (in case
of political risks) or currency and inflation coverage (for the
specific risks), there is no mechanism through which the
traffic risk of a private player can be shared/reduced.
A crude manner in which this problem is currently
addressed (and this is being done in India also) is to resort
to an annuity-based payment to the concessionaire. The
idea here is that the government/government agency bears
the traffic risk while the private party is assured of a fixed
inflow every year (half-yearly).
The current method of estimating annuity (in India) is
not very clear. One way in which the annuity payable to
the private contractor can be worked out is to find out the
expected number of vehicles that will roll on the road. The
expectation can be developed either through a sample study
of the road, or through observation at other (similar) roads,
or through a simulated model.
After generating the vehicle-wise expectation, the toll
that should have been levied on them is ascertained. The
toll-pricing can be done in such a manner that it reflects
the benefit accrued to the vehicle that has used the road.
The toll should ideally take into account not only the firstorder benefits that the user derives but should also account
for the second-order effects. For example, while valuing the
benefit to a goods vehicle, not only should the charge be
for the fuel and time saved but should also incorporate the
increase in profits or consume values due to reduction in
cost of the final product.
The toll is then multiplied by the expected number of

vehicles (in each category). This gives the expected gain that
has accrued to the society from the usage of the road in the
first year. In order to generate the pay-off profile to the society
for the period of the concession, various growth projections
(and scenarios) are built. The various growth paths (and
scenarios) have some associated probabilities (observed or
estimated or judgemental) and the expected gain to the
society is calculated for every year that the road is in existence.
Having so arrived at a figure for the utility generated by
the society over the period of the concession, a present value
of that can be calculated using the appropriate discount rate
(accounting for the high variability inherent in the above
estimates). This present value is then spread over the life of
the concession in the form of an annuity, which is nothing
but a fixed payment (semi) annually. As can be clearly seen,
the risk of the traffic has now been passed on totally to the
government (agency). The private contactor now has very
little variability in his cash flows. Though the private player
gives up the up-side potential on the shadow toll system,
he increases the value of the contract to himself by minimizing
the variability in the cash flows (and, hence, risk).
Even if we assume that the tolls can be correctly computed,
so as to be at the socially optimum level, there is huge risk
associated with the traffic flow every year and the growth
projections and scenarios. As already pointed out, currently,
there is no market mechanism through which this risk can
be transferred to a) the best person who can handle the risk,
or b) someone who is willing to take the risk. Neither the
concessionaire, nor the government is always the right entity
to bear this riskthe former, because it may cause wild
fluctuations in his business plan and the latter, because that
is not its job anyway!
274
Why Annuity and Shadow Tolling would Exist?

The Government of India, when it invites bids, specifies
that they will be accepted only under the annuity scheme
(GQ) and North-South East-West corridor. This means
that even if the private concessionaire is upbeat about the
prospects of his road, he will have to settle for a fixed
payment, which may prove to be unremunerative or underremunerative. However, currently, there is no way in which
the private player can break out of the contract and assume
the traffic risk.
There are, however, older roads where the concessionaire
either has direct tolling (MumbaiPune highway) or has
agreed to shadow tolling. In this case, the private party is
now burdened with the traffic risk which he might be
unable or unwilling to take. However, as can be seen, his
revenues depend directly on the number of vehicles travelling
on his road. Currently, there is no way to do away with this
risk.
In order to create a market for the risk to be suitably
offloaded from the private player (under the shadow tolling
scheme) or the government (under the annuity scheme),
two alternatives are suggested.
ALTERNATIVE 1: INTRA-PRIVATE PLAYERS RISK

SHARING
In this context, the private parties could agree to enter into
a contract wherein they could agree to give up and take on
the traffic risk as is appropriate for them. This can be done
where the annuity party agrees to monitor the traffic on
his road and accounts for a notional toll from them. The
difference between the annuity it receives and the payment
it ought to have received under the shadow toll is recorded.
The shadow toll party works out the annuity it ought to
have received (as elaborated above) and the actual shadow
or direct toll it receives. This difference is set aside and
recorded.
The above situation is easily modelled in everyday financial
markets. The closest analogy is a swap between two parties:
one with fixed-dollar liabilities and the other with floatingpound liabilities. As in the case of a cross-currency fixed to
floating swap, one party will have to bear the currency risk.
In this case, Shadow toll party bears the residual risk.
Start off with:

Square off Annuity (A)
Final Pay-off
Annuity Party
Shadow toll Party
Annuity (A)
[Annuity (A)]
Notional (A)
Notional (A)
Notional (B)
Annuity A
[Notional (A)]
Annuity (A) + N(B)
N(A)
Note: The amounts in square brackets [ ] indicate outflow from the

concerned party and amounts without, inflow.
However, note that, Annuity party has successfully

converted his annuity exposure to notional (or shadow toll)
exposure. Also, see that the notional exposure of the shadow
toll party has been converted to a primarily annuity
contract. If we assume that the variability of N(A) and N(B)
cancel each other out, then the shadow toll party has
totally given up traffic risk.
The above will hold only if both the projects are equally
big, that is, the annuity payments under both would have
been the same had both been on the annuity model. For
this to happen, more than one party can combine on both
sides so as to meet (or near) the equality condition. However,
this suffers from the fact that one/both party(ies) will have
to bear the residual risk (which should be very low).
ALTERNATIVE 2: FINANCIAL INTERMEDIARY

The above alternative is dependent on double-coincidence
of wants. However, there can/might be organizations which
might be willing to play market-maker in this field. These
organizations would be willing to take on the risks that
these firms want to avoid, or they can create customized
risks that their clients would want to take.
Continuing with the above example (and including
intermediary):
Annuity Party Intermediary
Start off with:
Square off
Annuity (A)
Square off
Notional (B)
Final Pay-off
Annuity (A)
[Annuity (A)] Annuity A
Notional (A) [Notional (A)]
Notional (B)
[Annuity (B)]
Notional (A) A(A) A(B)
+ N(B) N(A)
Shadow toll
Party
Notional (B)
[Notional (B)]
Annuity (B)
Annuity (B)
Note: The amounts in square brackets [ ] indicate outflow from the

concerned party and amounts without, inflow.
If the intermediary comes into the picture, he can take

up all the residuary risks (of course, for adequate
compensation) such that the annuity payment is transformed
into a shadow (notional) toll and vice-versa.
Why might it be attractive for the intermediary to come
into the business? The reasons inter alia could be:
Expertise in the sector;
Willingness to take a call on which roads will perform
better than the others;
Ability to value the amount correctly and, hence,
make profits (create value) by removing uncertainty;
As part of the facilitation process set up by government
(agency); and
Ability to pass on the risk to other market participants
(secondary market development).
Transportation
Now that the intermediary has taken up the risks in the
contracts, he can do either of the following two things:
Keep the Risk with Himself so as to Profit from it: For this
to happen he should be in a position to extract value from
either or both the parties. This is possible because the
intermediary increases value for both the parties: by bringing
their variability in tune with what they deem desirable,
and, hence, reducing the cost of capital for them. This
increase in value of the firms can be appropriated by the
intermediary.
Develop a Derivatives Market for the Securitized Cash Flows:
The intermediary might not be in a position to keep the
risks to itself or might be interested in offloading the risks
to other parties, who might be interested in taking these
risks, either as speculators, hedgers, or market-makers.
THE DERIVATIVES MARKET

Markets can be created where individual participants can
place a bet on the expected traffic on a particular road. The
derivatives markets serve in that:
They help the intermediary offload his risks to others
who are willing and able to take such risks, either as pure
speculation or because of better information/information
processing abilities.
They help generate market expectations: Prices and
trends from the derivatives market will help generate
investment/market-expectations signals. These signals can
be interpreted to show how the market perceives the road
to behave in the future.
They help to make asset allocation decisions: The
private parties interested in construction of roads will find
market information assisting them in making decision
relating to the choice of the roads that need to be taken up
for construction.
The derivatives market will manifest itself through the
following products: Futures, Options, and esoteric combinations of these products. We will discuss these products in
detail below. The market needs to have an underlying risk
factor on which the derivatives can trade. The underlying
risk factor needs to be rigorously defined, so that its
interpretation and computations there-from is easy and noncontroversial.
In the case of roads, it is not possible to have each and
every road as the underlying basis for a derivatives contract.
This is because of 2 reasons:
i. There will not be enough interest in all the roads and
many roads will have very illiquid derivatives market. This
lack of liquidity will reduce the ability of the market to
generate information.
275
ii. The risk factors affecting the roads will include,

inter-alia, macroeconomic factors which will be common
for the entire country. Hence, if a person wishes to take a
position on the C-D road while derivatives are available only
on A-B road, he can do so by observing the correlation
between the two stretches. Also, the road specific risk can
be diversified away in a derivatives portfolio.
This builds a case for having derivative securities on some
specified roads. The roads chosen should be representative
of the roads in the country. A representative market, in
India, could possibly be on the following lines:
Three road stretches from GQ,
Two road stretches from the NorthSouth EastWest
Corridor.
Five to seven stretches, and
A few arterial/ring roads around the major cities.
The road stretches will be chosen based on geographical
and volume considerations.
Another level of simplification that needs to be done in
order to make the market easy to operate in and to grow
would be to define and measure the vehicle units clearly.
The roads will see a multitude of traffic types travelling on
them. Again, it will be futile to have derivatives on each
road-vehicle type combination. A simpler way out is to
convert all the traffic flowing on the road to one unit
this unit can be defined in terms of the passengers, weight,
standard axle weight, payload, etc. However, the unit chosen
should be such that the measurability is easy to conduct and
to verify.
Now that the underlying is ready, let us look at the
derivatives market products.
Futures
At a very simple level, the market can be of futures: where
one takes a bet today as to how many vehicles (or vehicle
units, as appropriately defined) will travel over a particular
road over the next time period (1 month, 6 months, 1 year,
etc.). For example, some investor might have the view that
the traffic on A-B highway will be x vehicle units over the
next 1 year. He longs a future at that value. If the actual
number of vehicle-units is y, then:
If y > x, then the long party receives a payment of
{(y-x)*notional-toll}
If y < x, then the long party loses a sum of {(xy)*notional-toll}
It is obvious that the pay-offs to the short investor are
symmetrical but opposite in nature. Futures have no upfront
payment and, hence, are zero-cost to set up. Note that the
swaps that have been discussed earlier are nothing but a
series of futures contracts on the same underlying.
276
Options
Options would mean that the investor will have the right
but not the obligation to exercise the contract. Taking the
above example, if the expected traffic on A-B highway is x
but the investor wants to take only the upside potential but
not the downside risk; he will long the call option. He
would, hence, expect a positive payoff if y > x and no
payout if the actual vehicle units is less than x. Similarly,
if some investor is interested in capturing the downside
potential but suffers from an upside (for example, pollutioncontrol agencies), they may long a put at x where they
gain if y < x and have no pay off if y > x.
Although the payoffs for the long and the short are
mirror images of each other, they are not linear with the
changes in the value of the underlying (in this case the vehicle
units). A judicious combination of calls and puts can be used
to create any desired payoff. However, given the flexibility of
the options, they require upfront non-zero investments.
Having these basic derivatives in place, the market
participants can formulate any payoffs from them. The
positions taken in the market will help generate information
which can be suitably analysed to find out the market
expectations about the usage of the road.
EXPECTED PLAYERS
AND THE
POTENTIAL
Any financial market normally witnesses 3 types of players

the hedgers, the speculators, and the market-makers. The
derivative market in roads is not expected to be any different.
Hedgers: Corporates and institutions that have genuine
risk to hedge for will enter the derivatives market as hedgers.
As in the swap example that we have seen, the corporations
actually have an underlying exposure in the traffic risk and
this risk they want to manage through the use of swaps
(which is nothing but a series of forwards). The role of
hedgers is basically to seed the market with the genuine risk
that they want to offload. The counter-party to a hedger
Road Type
Length in Km
(NHAI website)
National Highways
58,112
State Highways
1,37,119
Major District Roads
4,70,000
Village and other Roads
26,50,000
Total Expected Annual Toll (000,000 Rs)
Maharashtra State Road Development Corporation

(MSRDC), L&T, etc. to be the hedgers.
Speculators: The objective of this group of people is to
profit from the risk that they take from the hedgers. Through
their action they provide liquidity to the system. It is generally
believed that 8090 per cent of the derivatives market
transactions are speculative in nature. They are generally
short-term players who are willing to take a call on the
movement of the underlying. In the case of India, if a roadderivative product is launched, it will be the first product
where the speculator will be able to take a call on a realeconomic variable. Hence, speculators from other markets
like equity or foreign exchange could be expected to take
some exposures here.
Market-Makers: Drawing from the experience of the
international weather derivatives market, participation is
also seen from insurers, reinsurers, investment banks, and
hedge funds. These entities can call upon their expertise in
valuation of risk and are also in a position to cross sell the
product as a diversification instrument to their clients,
thereby facilitating risk-transfer. As discussed below, the
pricing of the derivative contracts can be a complex exercise
and, hence, this expertise will be of importance for the
development of the market. In the specific case of India,
this product should appeal to organizations like IDFC,
IL&FS, and banks with significant interest and exposure
in infrastructure financing like ICICI Bank. Insurers may
also find this product attractive for investment/hedging if
the regulations governing their investment options are
relaxed.
Market Potential
A preliminary analysis is considered here to arrive at the
potential size of the market. The analysis here is only
indicative in nature and a more thorough analysis is required
to realize the actual potential size of the market. However,
quick calculations show that:
Direct Toll
(Rs/Km)
Expected annual number

of Vehicles
Expected Annual Direct Toll

(Rs 000,000)
1.50
1.00
0.75
0.10
10000,000
7000,000
5000,000
3000,000
8,71,680
9,59,833
17,62,500
7,95,000
43,89,013
can be another hedger (as in alternative 1) or can be a

speculator/market-maker (as in alternative 2), whose objective
is to take on the risk offloaded by the hedger.
In the specific case of India, one can expect organizations
like NHAI, SH authorities, and road constructors like the
Assuming a growth rate of 6 per cent in vehicular traffic

(roughly equal to the growth rate of the economy) and a
required rate of return of 15 per cent from the infrastructure
project, we can convert the above expected annual cash
flows to find the present value of all the cash flows using
Transportation
277
the well-known formula:

Value = Initial Cash Flow / (Required rate of return
Expected Growth Rate)
= Rs 4389 bn./(0.150.06)
= Rs 48,766 bn.
Assuming that even a modest 0.2 per cent of the above
market is traded on the derivatives market every year, then
the initial year market size is almost Rs 9750 crore (US$
2 bn. a year).
Again drawing from the international experience, the
weather derivatives market has grown exponentially to US$
10bn.18 (notional value) from its inception in less than a
decade.
assumption is that the past always reflects the future on

average. To be more precise, the method assumes that the
distribution of the past payoffs accurately depicts the future
payoff s distribution. It is tempting to argue that one should
use as long a time series as possible to enhance accuracy. But
this is a one-sided argument. Surely, using more data will
cover more variations. However, a derivative securitys payoff
depends on the future economic behaviour, which may be
quite different from history. This is especially so if the
maturity of the derivative security is short. Note that nonexistence of derivatives market earlier is not of much
difference because the realized payoffs from a particular
position can still be calculated.
Pricing of the Derivatives
c. Dynamic Modelling Method: In contrast to previous

methods, a dynamic model directly simulates the future
behaviour of the economic variable. This is achieved by
postulating a stochastic process for the variable, which could
be continuous or discrete. The continuous process usually
takes the following form:
Pricing of derivatives on roads cannot follow the no-arbitrage

pricing principle that is conveniently used in the pricing of
the financial securities. Since the underlying risk is an
economic variable and not a financial security, it neither has
a price nor can it be replicated. This problem is similar to
the problem faced in other derivatives market, the underlying
of which is not a financial security, for example the weather
derivatives market. Cao and Wei (1999)19 have listed the
following methods for the valuation of derivatives contracts
in the weather market: a) Actuarial Method, b) Historical
Method, and c) Dynamic Modelling Method.
a. Actuarial Method: As is well known, this methodology
is widely used by companies specializing in property,
automobile, health and life insurance, to name a few.
Statistical analysis based on historical data is the backbone
of this method. A probabilistic assessment is attached to the
insured event and a fair premium is calculated accordingly.
In the case of road derivatives, this method is less applicable
for most contracts since the underlying variables (for example,
vehicle units) tend to follow a recurrent, predictable pattern.
Nonetheless, if the contract is written on rare events such
as accidents, repair time, etc. then the actuarial method will
be very useful. In fact, one may even argue that this is the
only appropriate method in this case.
b. Historical Method: This method is perhaps the simplest
in terms of implementation, and as a result, is the most
probable to cause large pricing errors. In a nutshell, the
method of historical burn analysis evaluates the contract
against historical data and takes the average of realized
payoffs as the fair value estimate. Thus, this methods key
18
19
http://www.ms-ins.com/english/news/2003/0407.html
Pricing Weather Derivative: An Equilibrium Approach, by
Melanie Cao and Jason Zhanshun Wei. Available at www.ssrn.com
(1999).
dY (t) = e(t)dt + (t)dz(t),
(11.6.1)
where e(t)dt is the mean expected growth rate (popularly

known as drift rate in financial securities pricing), (t) is
the volatility associated with it and z(t) is a Wiener process
which models the randomness of the fluctuations. The
functional forms for e(t) and (t) can be specified based on
careful statistical analyses. Once the process in the above
equation is estimated, one can then value any contingent
claim by taking expectation of the discounted future payoff.
ISSUES
Some significant issues that need to be tackled before the
derivatives market can be fully developed are:
Tolling of all roads;
Transparency in measurement of traffic flow;
Allowing banks and institutions to take part in this
market as derivatives markets are generally considered as
risky.
In any case with private contractors and management of
roads already on in a big way in India today, the first two
initiatives are inevitable, and necessary. With financial
reforms, the last is not only possible but also necessary, if
the idea of greater role for markets has to become a reality.
278
REFERENCES
Business Line (2003) Cess vs Toll, 13 August 2003.
CMIE (2003a) InfrastructureFebruary 2003, Centre for
Monitoring Indian Economy, Mumbai.
CMIE (2003b) Economic Intelligence Statistics (EIS), (Electronic
DataBase), Centre for Monitoring the Indian Economy,
Mumbai.
Cao, Melanie and J.Z. Wei (1999) Pricing Weather Derivatives:
An Equilibrium Approach, Department of Economics,
Queens University, Kingston, Ontario, Working Paper (http://
www.ssrn.com).
Lsch, A. (1940) Die Rumliche Ordnung der Wirtschaft, Jena:
Gustav Fischer Verlag. English translation: The Economics of
Location, New Haven (CN): Yale University Press, 1954.
Mohan, R. (1996) The India Infrastructure Report: Policy
Imperatives for Growth and Welfare, Expert Group on the
Commercialization of Infrastructure Projects, New Delhi.
NHAI (2001) National Highways Development Project:
Connecting People to Opportunities, National Highways
Authority of India.
NHAI (2002) Realising a Dream, National Highways Authority
of India.
Pangotra, P. and S. Jaryal (1999) Public Private Partnership in
Urban Infrastructure: CG Road Redevelopment in
AhmedabadA Case Study in Infrastructure Development

and Financing, by Raghuram, G., Rekha Jain, Sidharth Sinha,
Prem Pangotra and Sebastian Morris, Macmillan India
Limited, Delhi.
Raghuram, G. (2000) The Transport Sector, India Infrastructure
Report 2001, Oxford University Press, New Delhi, pp. 129
45.
Raghuram, G. and D. Kheskani (2002) The Governments Role
in Road Toll Collection: The Coimbatore Bypass Experience,
India Infrastructure Report 2003, Oxford University Press,
New Delhi, pp. 27985.
Rastogi, A.B. (2002) The Infrastructure Sector in India, 2001
2, India Infrastructure Report 2003, Oxford University Press,
New Delhi, pp. 6584.
Thomas, A.V. (2002) Identification, Assessment and Allocation
of Critical Risks in Indian BOT Road Projects: A Thesis
Report, Building Technology and Construction Management
Division, Department of Civil Engineering, Indian Institute
of Technology, Chennai.
Ministry of Road Transport and Highways (www.morth.nic.in).
Pradhan Mantri Gram Sadak Yojana (www.pmgsy.org).
National Highways Authority of India (www.nhai.org).
Water 279
WATER
12.1 GETTING WATER FROM PUBLICPRIVATE PARTNERSHIPS

Ashima Goyal
Dirty water cannot be washed
West African Proverb
What should be the contractual type of PPP in order to get
the maximum value from such partnerships in the Indian
context? Well-designed and chosen contracts improve
governance. Insights from contract theory and international
experience with PPP in water supply can suggest how services
from public utilities, specifically from Mumbais water supply,
can be improved, with cost saving through the reduction
of waste.
As the literature has developed, PPP itself has come to
be defined more broadly, to include not only a contract
between a government and a formal commercial business
firm to deliver a public good or service, but also wider
interactions between the government and informal small
scale providers (SSPs) that can improve the efficiency of
delivery of public services. Civic society also has a major
role to play in making such partnerships work well.
Transaction cost perspective tells us that contracts are
essentially incomplete. Then many social institutions have
to contribute to ensure effective coordination.
An earlier version of this paper was presented at the IIR workshop,
15 June 2003. The participants were knowledgeable and generous,
and I thank them for very useful comments and discussion. It was
also presented at a symposium in honour of Jyoti Parikh at IGIDR,
7 July 2003. Again I am grateful for very encouraging responses,
and a valuable discussion with A Vaidyanathan. I thank Sebastian
Morris for suggestions and encouragement, Anirban Acharya for
helpful research assistance including site visits, and T.S. Ananthi for
drawing the diagram.
Experience with reform had clearly shown market failure

to exist along with government failure, especially in the
provision of public services. PPP could be a way to utilize
the best of both worlds, while overcoming the specific
weaknesses of each. But for this to be feasible contracts and
regulation have to be carefully designed. Theory is helpful
in analysing these weaknesses and suggesting design elements.
They also need to be tailored to the specific context. Menard
and Saussier (2002) empirically establish that PPP contracts
in France have endogenously adapted to suit local conditions.
(Box 12.1.1).
EXPERIENCE
COUNTRIES
WITH
WATER CONTRACTS
IN
OTHER
Experience in different parts of the world has tempered the

enthusiasm of the 1990s for private provision of water,
which itself had been started as a response to severe municipal
failure. For a long time the World Bank was the dominant
international voice pushing for private participation,
especially concessions and divestiture (World Bank 2000).
But new, more nuanced, voices have emerged. A selective
survey of some of the experiences they recount is useful.
It turns out that the contractual forms gave too much
expost bargaining power to private parties. Major concessions
given with fanfare in Manila in 1997 have exposed many
potential problems. The companies made unrealistic bids
just to win the tender and then passed on large price increases
280

Box 12.1.1
Contract Theory and Water Supply
Contract theory recognizes that there is much more to a market transaction than just price and quantitya. A contract is a bilateral
coordination arrangement (Brousseau and Glachant 2002). There are a number of difficulties associated with coordination. Laws,
regulations, incentives, and other mechanisms are required to achieve it among agents who may have asymmetric and incomplete
information.
Contracts tend to be incomplete, but even more so in developing countries, and difficult to enforce using only the courts. A
variety of institutional features that enforce commitments are needed. At the same time, unanticipated shocks are more frequent
in such countries. Therefore some expost flexibility in contracts is also essential. Renegotiations, sanctions, private conflict resolution
mechanisms, organizational forms, and norms, all have a role in providing the required mix of commitment and flexibility. Since
private conflict resolution mechanisms are imperfect, coordinating rules and sanctions are also required. These mechanisms have
been highlighted in the literature on transaction costs theory.
Transaction cost theory views contracts as inherently incomplete because it is not possible to costlessly include unforeseen or
unspecified contingencies in contracts. Therefore, the expost bargaining position is important. Residual rights of control, in
uncontracted for circumstances, determine agents incentives. For example, either residual control rights must be given to the party
who makes a relationship specific investment or that party will underinvest. When such allocation of control is not possible
internalizing the transaction can improve welfare. This is one of the justifications for the existence of a firm.
If complete contracts could be written public or private provision of public services would be equivalent. Public goods and
services are often experience rather than search goods, and their quality is revealed only by consuming. Contracts are incomplete
for such goods because all dimensions of quality of service cannot be fully specified. Under complete contracts agents are induced
to take appropriate discretionary actions and reveal their information. Control rights, however, cannot fully substitute for this
mechanism. If control rights are conferred on a single group it may result in self-serving actions. Therefore, control rights have
to be carefully divided and civic society and other democratic pressures used. Supervisory or coercive mechanisms may be required
to ensure that parties respect their commitments, but these should not restrict the flexibility required to ensure expost optimal
coordination. A wide variety of institutions that impinge on the transaction and have the potential to improve its efficiency should
be considered.
Different transaction structures solve the coordination problem to different degrees. A contractual structure can evolve endogenously
as a way of resolving the problem. Differing contract forms will be more appropriate in differing circumstances and will vary in
their efficiency properties. In considering the conscious design of contracts these aspects have to be kept in mind.
A choice of PPP in a particular public service delivery normally offers a menu of contract choices, ranging from outright
privatization or divestiture, to long-term concessions or management contracts where asset ownership remains in the public sector,
to outsourcing of specific jobs. Control, asset ownership and risk shared by the private sector falls in moving from the first to the
last. The general principle is that risk should stay with the agency most able to bear and best able to alleviate it. Service contracts
normally vary over a period of 6 months to 2 years. Private sector expertise is used or it may be developed and competition increased.
The responsibility for coordination and for investment rests with the public sector. Management contracts transfer responsibility
for operation and maintenence (O&M) also to the private sector. These run typically for 3 to 5 years. They may have a fixed fee
and include a performance target. In a lease contract the private party buys rights to the income stream so it assumes the commercial
risk. Incentives for reducing costs and quality standards can be written in. Concessions last for 25 to 30 years. Responsibility for
O&M as well as investment is transferred while asset ownership remains with the government. The contracts set out performance
targets, standards, investment amounts, mechanisms for adjusting tariffs, and arrangements for arbitrating disputes. Assets are to
be returned in good condition and consumers are to be protected from monopoly pricing. Under divestiture, asset ownership also
passes into private hands and the government is only left with the task of regulation (Suresh 1998). Contract theory suggests a
number of factors to consider in deciding the position taken on this range.
1. The more specific assets are to the particular service, the more ownership and control should stay with the public sector.
The private sector would have an incentive to underinvest, since it is liable to holdup once it has invested in assets, which have
no use elsewhereb.This explains why there is so little private ownership of water sources and distribution networks since the assets
are highly specific. Well-written contracts may be able to ameliorate the problem to some extent but will not resolve it entirely.
2. A financially constrained public sector entity has a greater incentive to outsource, and a larger population or consumer density
will make outsourcing more feasiblec.The private sector may be able to provide funds that highly indebted governments lack. But
the former will be motivated to provide the funds only if it is possible to recover the investments through user charges. Therefore,
a
The discussion in this section largely draws upon Tirole (1994), Hart et al. (1997), Brousseau and Glachant (2002), and papers collected
in the latter.
b This is a basic premise of TCT, developed by Olivier Williamson (Brousseau and Glachant 2002).
c In French water utilities almost the entire range of PPP contracts is to be found. Menard and Saussier (2002) empirically test for the factors
that determine endogenous adoption of a particular contract type, and find size of population to be an important variable.
Water 281
the key reform is one of pricing. Reasonable user charges can make either a public or a private project viable, and a larger customer
base will increase profitability.
3. Public sector provision should dominate, the greater the uncertainty affecting the quality and the more difficult it is to enforce
quality standards. If it is not possible to contract for quality, integration is to be expected, and provision of the good or service
would stay in the public sector. The literature generally expects quality to be higher in the public sector because incentives to reduce
costs and quality are too high for the private sector. With residual control rights or under a price cap from a regulator the private
sector would retain any profits made from a reduction in cost. If quality falls with a reduction in cost such high powered incentives
would reduce quality. Incentives, therefore, have to be low-powered, such as they are in a bureaucracy, or with cost-plus pricing
rules, in order to maintain quality (Tirole 1994).
In the public sector the bureaucrat-manager has poor incentives or control rights since he is transferable, but there may be a
mission, reputation, or career concerns, or political pressure to ensure quality service. Hart et al. (1997) point out that while private
provision will always have lower costs than public, quality in private provision may be lower or higher, if quality decreases with
costs but increases with innovation. The latter is normally higher under private provision and is likely to be more important in
some kinds of services. Private provision would be superior in cases where quality can be contracted for, or is insensitive to cost
reduction, or opportunities for cost reduction are small. Private provision will also dominate if incentives for quality improvement
are poor for public managers.
The poor quality associated with public sector provision of services in developing countries is a paradox in the context of these
arguments. The answer may lie in the use of poor quality as a rationing device in order to target the poor and serve them within
resource constraints. As we argue below, this is particularly relevant in the case of water where demand is highly elastic at low prices
so that quantity rationing becomes necessary at low user charges.
4. If there are multiple, non-measurable aspects of quality, public provision will do better. Incentives have to be low for bureaucrats
partly because they have to satisfy multiple objectives, some of which are not measurable. High-powered incentives or residual control
rights for measurable performance targets lead to a neglect of non-measurable aspects. Among non-incentivized tasks a public good
provider has to satisfy is inclusion of the poor, or geographically dispersed difficult to serve categories, and other universal service
obligations. In the water sector, it is ironic that the instruments used to target the poor, such as public standposts, or rationing
of piped water for limited time-periods, require a steep fall in quality.
5. Public goods provision is compatible with some competition. Many public goods and services are local monopolies. Even
so, a regulator can introduce elements of yardstick competition, where relative performance of one local body is compared to that
of another, which is similarly placed, and thus forced to reduce costs. Another example is allowing local water boards to compete
with each other through bids, for the award of management or concession contracts, in the supply of public services. Unbundling
makes competitive supply possible for parts of the public good or service. If the latter is a search good, where consumers can assess
quality for themselves, and suppliers are perfectly competitive at each level of quality, private supply would face socially-optimal
incentives (Hart et al. 1999). Citizen or user groups are another useful source of information for the regulator, to discipline public
monopolies. Such countervailing pressures make it feasible for incentives to be high powered even in the provision of public goods.
So far we assumed the public servant really serves the public. But there are a number of features contracts must cover to control
self-interested bureaucrats or politicians, or to prevent regulatory capture.
6. Transparent rules that minimize discretion may be necessary even at the cost of some flexibility. Parts of the public sector
may have more information compared to others. If they have discretion they could use the informational advantage to benefit interest
groups they favour. In general interest groups that benefit from withholding of information stand to gain. They have an incentive
to persuade the official not to release information that harms them. If the officials have to follow a rulebook, then interest groups
have less of a stake in the decision and therefore less incentive for regulatory capture. This is one reason officials are made to follow
rules. Thus low-powered cost plus rules are less subject to regulatory capture, since they leave low rents with the firm, and the
regulator has little discretion. If high-powered incentive schemes such as price caps are to be retained then alternative pressure groups
such as user groups are required to guard against regulatory capture by the supplier. Control rights need to be divided among
countervailing groups.
In government auctions there is more discretion in judging quality, and, therefore, more scope for favouritism. Therefore, tangible
variables such as price are given precedence (Tirole 1994). Klein (1996) points out that the large discretion French municipalities
have in the award of contracts for water supply are responsible for allegations of political funding received from firms.
7. Commitment for public service contracts should be short-term and they should be subject to rebidding. In many situations
social welfare is enhanced if a benevolent government can make an intertemporal commitment to a long-term complete contract
this would remove fears of expropriation and encourage utilities to achieve optimal efficiency and investment, as is argued in point
1. But short-term commitments provide a check against decisions taken to favour interest groups. Thus, rebidding water contracts
may not only keep a check on costs but also allow removal of a corrupt or inefficient firm. Elections are another disciplinary device
and a change in the elected government makes it more feasible to force an exit of its corrupt or inefficient cronies (Tirole 1994).
Such considerations explain why governments cannot commit not to hold-up sector specific investment, and, therefore, why private
investment would not be optimal.
282
8. Checks and balances are required to prevent corrupt politicians making money from privatization or using public utilities
for patronage. If the first tendency dominates sale of government assets would not raise social welfare and if the second more
independent private sector management or sale of public utilities would be beneficial. The latter would prevent the non-publicspirited politician from obliging special interest groups such as trade union vote banks (Hart et al. 1997). Control rights for any
particular decision must not devolve on a single group. In a democracy these are divided among the judiciary and executive as
well as the legislature; and the media, the user, and other independent groups must play a major role. Often advocacy by each
group reveals valuable information for a decision-maker (Tirole 1994).
using loopholes and weaknesses in regulation. Bidding low

and hoping to renegotiate is regarded as an acceptable entry
tactic in the water business. Officials complain that once
having won the concession, the companies make their own
rules. There was some increase in coverage of the poor and
of slum areas, but the companies exaggerated it. For example,
they would provide a single water main to a group who
would then have to set up a committee and hire a contractor.
The company would charge the committee but count each
household as a connection. Since the charge was higher for
higher water consumption, these poor households ended up
paying more. But sometimes the companies were unable to
collect user charges. The companies had promised to reduce
leakage and theft, but were unable to do so. Non-revenue
water increased slightly and accounted for between half and
two-thirds of the water supplied. Since the companies installed
meters near the mains and the leakage took place in the
distribution lines they were still able to bill the households
for the water losses (Landingin 2003; Gutierrez 2001).
Cost plus pricing, non-transparent accounting and padding
of bills, results in higher user charges for consumers even in
developed countries like France. Companies tend to distribute
their costs across all municipalities they work for in a nontransparent way. In the Grenoble corruption case it was
shown that this allowed them to give kickbacks to political
parties. The concession was investigated after a series of
letters from Grenoble citizens complaining about the sudden
jump in water prices. The contract even had the regressive
feature of discouraging conservation, since the company
could increase the price if consumption fell below a contracted
amount (Godoy 2003). Often there are systematic incentives
to exploit new water sources rather than conserve water by
reducing both leakage and consumption.
Despite the wave of privatization in the 1990s, water
utilities remain publicly owned and operated in most
countries of the world except the UK and France (Gutierrez
2001). One of the key factors facilitating efficient public
delivery is a reasonable user charge. Bogota, Columbia, is
an example of a public water utility that transformed itself
in the 1990s after it was allowed to revise user charges
(Ronderos 2003).
Competition can come not only from rebidding but also
from encouraging niche domestic informal firms or SSPs.
These are often the ones that reach large sections of the
population left uncovered by large water utilities. In Paraguay

they have proved themselves to be more efficient, competitive,
and cheaper in serving niches. These aguateros lay pipes
from ground/water wells they dig. They pay taxes and the
government regulates them and tests their water quality
periodically. Thus, open entry and competition becomes a
possible model of water supply (Solo 1999).
In the US, in 1850, the majority of water systems were
privately owned, but this was reversed in the early 19th
century because of a concern for quality and public hygiene.
Today 81 per cent of the population is served by public
utilities. Thus quality is a concern in private utilities. In
2003 Atlanta Mayor, Shirley Franklin, cancelled a concession
contract, which had been running for 4 years, on grounds
of non-performance (Hobbs 2003).
In developing countries administrations are less resolute
and water companies were often able to renegotiate contracts
on terms favourable to themselves, because of expost
monopoly power and the high cost of terminating a
concession once given. Moreover, transnationals need not
bring in money themselves, but borrow from local resources,
and then recover the cost through user costs (Gutierrez
2001). Their only contribution is management experience,
but even there they do not have experience of local conditions.
An argument is sometimes made for their starting with
management or service contracts so that they can gain
knowledge of the functioning of the utilities and local
conditions before moving on to concessions (World Bank
2000). But building governance structures that allow public
utilities to run on more commercial lines could be an
alternative solution. This is the strategy of strengthening the
capacity of the public sector.
A thorough review from Gleick et al. (2003) recognizes
that some privatization is required to improve efficiency,
but warns that better regulatory controls are required to
ensure safe, affordable, high quality environmentally
sustainable water supplies. It is necessary to have transparent
contracts with clear dispute resolution mechanisms and all
stakeholders involved in the negotiation. At the same time
it is necessary to strengthen the ability of governments to
meet water needs. An NGO, WaterAid, in their private
sector participation framework document emphasize benefits
for the poor, strengthening of the local community,
government capacity, and the domestic private sector to
Water 283
deliver according to standards (despite support, usually from
only a small and unstable financial sector) and give Value
for Money (VFM) (Gutierrez 2001).
Contextual analysis is also essential to decide on the
specific form of outsourcing, and to yield insights on the
ideal features of the contracts to be entered into. In a
developing country, the main objectives in water supply
provision must be, first, to maintain the quality and quantity
essential to life. The poor must have access to adequate
quantities of affordable water1. Second, to conserve water
or prevent its waste, given the pressures on world water
resources2. The lessons from the problems with both
government and private sector provision of water suggest a
third objectivethe importance of maintaining some
competition in water supply provision to ensure consumers
a better deal. Finally, encouraging entrepreneurship is a
fourth objective, to strengthen the local community.
Contracts should be designed with these objectives in mind.
These features of an ideal water service, together with the
current structure and larger context, will be used to deduce
appropriate contractual forms for PPP.
IMPROVING WATER SUPPLY

Theory, international experience, and the current domestic
context suggest that the Indian water supply system can
benefit from PPP in the form of service and management
contracts, although assets should continue to be in public
hands3. In Indian cities with large populations potential
revenues from water supply are huge with price reform. (See
point 2 of Box 12.1.1.) Water assets will be developed
better, however, and their quality maintained, in public
hands because of disincentives for optimal private investment
(the asset specificity argument made in Box 12.1.1),
incentives to overuse scarce water resources, and the ability
of large foreign firms to renege on contractual commitments
in developing countries. Divestiture would give too much
of residual control rights to one party, namely the private
firm. But strategic PPP in service contracts would strengthen
the public provision of water. Weaknesses in quality of
1
This is a major part of the millennium development goals

recently established by the United Nations.
2 The World Water Development Report, subtitled Water for
People, Water for Life, from UNESCO, released ahead of the Third
World Water Forum in Japan in 2003, calculates that by 2050,
between 2 billion people in 48 countries and up to 7 billion people
in 60 countries will be faced with scarcity of fresh water (sourcepress reports).
3 A. Vaidyanathan made the observation that if rain harvesting
techniques become widespread some water sources would effectively
be in private hands. We need to distinguish such private measures
to augment water supply from development of large water sources.
customer care would be removed (points 3 and 4 of Box

12.1.1) and competition improved (point 5). Examples as
in Box 12.1.3 show the beginnings of such low level service
contracts, suggesting that a wider adoption of such contracts
may be feasible.
The key to these changes is price reform, and the
establishment of independent regulators, who would set
tariffs on the basis of economic principles, free from political
interference. But efficiency prices, with a lower dependence
on non-transparent fixed charges, and higher volume charges
require improved metering and billing. The latter are aspects
of improved quality of service, which will increase willingness
to pay. The waste and slack in the system gives an opportunity
for designing service contracts that will finance themselves
by removing this waste. Institutionalized user groups have
a major role in monitoring contractors, ensuring quality,
encouraging conservation, providing information to
regulators, and preventing the misuse of political power in
patronage or corruption (points 6, 7, and 8 of Box 12.1.1).
Such user groups have leverage in aligning politicians
incentives since they represent potential votes. Tax
concessions, reputation and recognition aspects can provide
incentives for these groups. We examine these aspects in
greater detail below, and show why these interacting changes
are feasible, and why they would achieve the objectives of
a water supply system in the Indian context.
The major reason independent regulators are essential in
the Indian context is to free the pricing of water from
political influences. The Sukthankar (2000) Committee has
recommended a state level independent regulator for
Maharashtra. Since water is a state subject, the regulator
would have to be at the state level, but some general principles
may be laid out to apply across states through a central body
such as the Finance Commission.
Regulation
The general principles for ensuring efficient, independent
regulation, and preventing regulatory capture are well known,
and there is large international experience in the functioning
of regulatory commissions, which can be drawn upon (Klein
1996). In the Indian context experience has to be built up,
but if the regulators have an understanding of basic economic
principles and the ability to withstand political pressures,
technical expertise can be hired. The regulators must not
be from water utilities, retired government insiders, or be
elected. There must be staggered retirement, and the term
must not coincide with that of the elected government.
Elected officials tend to favour consumers too much, and
officers earlier associated with water utilities would favour
the latter.
The pricing rule selected must provide good incentives
for conservation in water use, efficiency in water production,
284

Box 12.1.2
Water Supply in Mumbai
We start with a brief description of the current state. Then some gaps are highlighted, where PPP can contribute. It turns out
that PPP may even be self-financing if it is successful in removing waste. Then it would truly be a partnership, with gains that
are potentially very high.
Since Mumbais population is around 15 million and is expected to grow substantially, its water requirements are huge, and
the water supply system is among the 8th largest in the world. The Brihanmumbai Municipal Corporation (BMC), which runs
the system, is justifiably proud of its assets. In 2002, the total supply was 3000 mld (million litres per day) compared to estimated
demand of 3975 MLD. Taking leakage as 20 per cent or 600 mld, the average consumption was 167 lpcd (litres per capita per
day), with total domestic consumption at 2160 mld, and non-domestic at 240 mld. Although the supply ratio to the two was 90:10,
their respective contribution to revenue was 50:50. The cost of production was Rs 5 per kilolitrea.
Organization Structure: Although in Mumbai the BMC directly runs the water supply system, in many municipalities water
boards run the system on behalf of the urban local bodies (ULBs). The water boards are state level organizations with more power
than municipalities so that the latter are unable to monitor their services. Moreover, their cost-plus administration charges of 18
to 22 per cent (Suresh 1998) give them no incentives to reduce costs.
A standing committee of elected representatives approves the setting and revision of tariffs in municipal corporations. For
municipal councils and ULBs state governments dictate tariffs. Under present governance structures politicians cannot credibly assure
coverage or quality but they can effect prices and tend to use that as a populist tool (Nanavathy 2001).
Pipe Network, Maintenance, and Leakage: The daily average water supply to the city is 2 hours, and to the suburbs 3.5 hours.
Trunk, feeder, and distributory water mains form the water supply network. The trunk and feeder mains carry water continuously.
They are of large diameters and made of mild steel which requires protective coatings. Among other materials used ductile iron,
and galvanized iron require internal mortar lining and external painting or plastic coating. Cast iron distributory mains are of smaller
diameter and carry water only at specific times. Because of intermittent water supply they are subject to alternate wet and dry
conditions which induces corrosion. This is a major cause of contamination and wastage of water. Corrosion is also aggravated from
aggressive soil conditions, vicinity of the sea, and currents induced by the railways direct current traction system. The pipes develop
internal scaling, pitting, tubercular and micro-bacterial growths. Periodic cleaning and scraping is required after internal inspection
through video equipment. GI water connections to customer premises corrode over time. They are the most neglected and a major
source of contamination and leakage. Periodic renewal or use of non-corrosive materials and leakproof joints is required. More recently
poly-ethylene pipelines are laid in particularly hostile conditions (MEA and BMLPA 2003). Domestic companies have started
manufacturing these, and accessories are now available.
Contamination arises from intermittent supply, low water pressure, leaking pipes, and inadequate wastewater collection systems.
In slums because of inadequate sewage disposal the soil around the water pipes is polluted. Moreover, since some pipes run close
to sewage lines there is great danger of contamination. The danger is compounded by slum dwellers who break the pipes, and then
cover the hole with cloth or other rough plugs, which are removed to draw water whenever neededb. During periods when water
supply is stopped the contaminated soil then gets sucked into water pipes (MEA and BMLPA 2003).
The Mumbai Water Engineers Association (MEA) reports that while water leakage in developed countries is between 812 per
cent, in India it is 3060 per cent, and in Mumbai 2025 per cent. Bringing this below 15 per cent is not cost effective. A National
Environment Engineering Research Institute (NEERI) study finds that 17 to 44 per cent of total flow in Indian distribution system
is lost through leakages, and about 82 per cent of this takes place in the housing service connection, and the rest is due to leakage
in pipelines.
The components prone to failure are generally pumping stations, pipelines, and appurtenances. Preventive maintenance is
required. But there is a poor stock of maintenance materials in the municipal store, and low availability of funds. The sanctioning
procedure is cumbersome. Repairs are undertaken during crises only. Maintenance staff report daily for attendance at the ward office,
then require 23 hours to reach the actual work site.The cross-section of pipes for household distribution varies from 0.5 to 2
inches. Metering is efficient at 1.5 to 2 inches pipe width in large housing societies, where water supply is 24 hours.
There have been major investments and improvements in the 1990s, but mainly in the water sources and plants. BMC has
drawn up a Rs 100 crore plan to replace old corroded pipes in a phased manner. Leak detection is possible through sounding and
a The source of these statistics is pamphlets from the Brihanmumbai Municipal Corporation (BMC). We are grateful to deputy municipal
commissioner R.K. Bhatia for a personal interview and for making these documents available. We also visited the Bhandup plant.
b da Cunha (2003a) reports one horrifying but not unusual case. The water supply line to Lokhande Marg in Mumbai passes through several
slums whose residents have punctured the line at 135 points. Suction pressure causes contamination to be sucked in and carried to the tanks of
the housing societies. The Deputy Municipal Commissioner who located the holes got them plugged but they were unplugged in 3 days. He ordered
installation of a new pipe bypassing the slums, but the order was not carried out. The Welfare Association and the housing societies wrote 51
letters of complaint, which were not answered. Two young people died of infection. The area pays Rs 3 lakh in municipal water taxes; for the
slums water is free. This illustrates the problems of maintenance, absence of prompt response to consumers, and intermittent supply. Privatization
and competition could address all of these issues.
Water 285
electronic methods, or bypass meters can be used at the two ends of a water main and variation in flows recorded. A leak detection
cell has been set up since 1973, and there are 615 leak detection zones. Quality monitoring is undertaken with 6500 water samples
collected dailyc. Consumer satisfaction is reported at 73 per cent. But customer orientation is still poor and commercial principles
are not applied fully. Supply is released for various points in the city with almost no knowledge of demand, just rough estimates.
Tariff Structure and Use of Meters: For unmetered water connections water tax and sewerage tax is based on the rateable value
of the property (65 per cent for residential and 130 per cent for non-residential). Metered connections are charged tariffs on a
per kilolitre basis: stand-posts in slums Rs 2.25 per kilolitre, buildings and chawls Rs 3.5 per kilolitre (it is planned to raise this
to Rs 5.8), commercial and industrial establishments Rs 10.5-35 per kilolitre. A sewerage charge of 60 per cent of the rate is added.
In addition all premises are charged water and sewerage benefit tax based on the rateable value of the property (12.5 per cent for
residential and 25 per cent for non-residential). Thus, users pay charges or tax plus benefit tax. The revenue is sufficient to fund
40 per cent capital works in addition to operation and maintenance costs, 40 per cent is spent on the latter. Actual recovery works
out to 82 per cent. There are large outstandings from other government agencies, which often do not pay.
Till May 1997 water charges were only 60 paise per kilolitres (consumption of a family of 5). After that they were revised 3
times. They are expected to increase in future to cover higher capital costs of new assets. Only from 1997 were other households
required to pay higher charges compared to those paid by slums. Mumbai is doing well compared to Delhi where the lowest slab
for domestic connection is only 35 paise per kilolitre and the Delhi Jal Board loses Rs 260 crore annually on the revenue account
alone (Delhi Times, 21 April 2003).
Since April 2001 a decentralized computerized billing system has been introduced, with appropriate software. There are 2,46,000
metered connections, and 75,000 un-metered connections, of which municipal meters are 48,550, and private meters 1,97,450.
But only 20 per cent of domestic meters and 60 per cent of commercial meters work. Water meters are defective, and get clogged.
Problems arise with metering since water supply is intermittent, booster pumps are used, good quality non-magnetic water meters
are not available, and it is difficult to find locations for housing water meters in the old city and slums. Illegal tapping creates
more problems in metering for less-developed areas. Moreover, there is an acute staff problem. It is not possible to send meter
readers, house to house, and the reliability of the task performed is questionable (MEA 2003). Absence of full cost recovery, therefore,
is due not so much to absence of willingness to pay as to absence of infrastructure and personnel to collect dues (Suresh 1998).
Since it is difficult to bill the consumer correctly, disputes arise. A gap is assigned based on average monthly consumption for last
month/year. BMC argues that since domestic demand is almost constant it can be determined by size of the connection, number
of hours of supply, and pressure difference at key points on daily basisor discharge capacity. For high consumption consumers,
meters are used, as demand is seasonal depending on business conditions.
c
A study by Society for Clean Environment (SOCLEEN) and funded by Mumbai Metropolitan Development Authority (MMRDA) reported
in the Times of India, 10 July 2003, Mumbai edition, however, found levels of bacterial contamination hovering at about 20 per cent in many
wards. In some areas, especially those surrounded by slums, the level of fecal coliform (fc) touched 1600 fc per 100 ml of water. The safe norm
(Bureau of Indian Standards) is 10 fc per 100ml. The contamination was higher than that found by BMC perhaps because the tests were undertaken
at the household level. They were also found to be temporary suggesting that the BMC does respond to complaints.
investment, and financing, and efficient allocation of risks

among consumers, utilities, and taxpayers. A price cap that
subtracts productivity improvements, and rises with cost
shocks that are out of the utilities control works best. But
public reviews of proposals, and feedback from user groups
are necessary for the regulator to obtain information to be

able to impose effective yardstick competition, and to limit
regulatory discretion or regulatory capture under price caps
(point 6 of Box 12.1.1). Retired bureaucrats have captured
the first few regulatory commissions set up in India showing
Box 12.1.3
Examples of Partial Privatizations
The Chennai Water Board has privatized water delivery to the poor through tankers. Tanker service is contracted to the private
sector with payment per trip, and annual contracts. The contractor, therefore, has incentives for regular trips and for the provision
of good servicea.
In Mumbai one private maintenance contract has been given in K-East ward. Operation of two pumping stations, one in Raoli
and the other in Sion, which were privatized, is successful. City and Industrial Development Corporation of Maharashtra (CIDCO),
Navi Mumbai, has privatized water pumps, meter reading and billing, maintenance of parks and gardens (Suresh 1998).
In Delhi complaints cells have been privatized in 2003 after complaints about rudeness of the water supply staff. Poor attendance
to water supply complaints is a sore point.
a Subir Gokarn made the point that since tankers are non-specific assets, there tends to be overuse of tankers in private water supply although
this mode of supply is more expensive compared to piped water. The explosion in credit to small road and water transport operators from commercial
banks validates this point. The figure rose from 2979 crores in 19945 to 4973 crores in 20001 (RBI, 2003, Table 54).
286
the necessity of countervailing pressure by user and voter

groups. Comparisons across similar local utilities can give
a regulator the necessary information to separate idiosyncratic
risk from aggregate risk. The utility is then held accountable
only for the former. For example, the monopoly can be
allowed to pass on aggregate cost shocks, which are not in
its control. Thus, utilities should not have to bear the risk
of exogenous shocks.
Presently local bodies revise water tariffs steeply once in
5 years, which meets with consumer resistance. Suresh (1998)
suggests a 10 per cent increase every year. But this is cost
of production pricing which does not pass on productivity
gains to consumers or motivate utilities to lower costs. A
price review could occur every year or two initially, and
then, as learning proceeds could even be every 5 years, so
as to give firms a longer period during which they can retain
profits from cost reductions. The regulator can also monitor
compliance with other service standards, such as quality of
service and of water supplied.
Tariffs
Is a reform in pricing politically feasible? Box 12.1.4 suggests
that even the poor would benefit from such reform. An
independent regulator can free politicians from the status
quo of low user charges they are caught in, partly because
each party is afraid the other will make political capital from
such subsidies. Political pressures have kept user charges low,
with indirect and hidden costs, which are much larger as
a result. These costs include the inefficiencies in water supply
and use, coping costs to compensate for poor quality and
coverage, and rack renting for industry, which just passes
on costs to consumers. Coping costs include time spent
queueing for and purifying water, use of domestic tanks,
pumps, use of private vendors and bottled water, which cost
much more than piped water. There are also social costs such
as water hoarded due to irregular supply and then wasted.
User groups can make such indirect costs clear to voters, so
that the latter demand quality from politicians.
Box 12.1.4
Two-Part Tariffs and Benefits for the Poor
Water is a peculiar good in that it is essential to life. Therefore the utility it contributes at low levels of consumption is very high.
But it has many non-essential uses, and at high levels of consumption the contribution to utility of the marginal unit may be very
low. Demand is inelastic at low levels of consumption but very elastic at high levelsa. This has clear implications for the pricing
of water. Figure B12.1.4.1 develops a simple example with one rich (R) and one poor (P) consumer. The rich consumer has income
level YR and the poor YP. Y can be measured in terms of time available, with the assumption that time can be translated into incomeb.
Indifference curves are drawn for each type, showing the combination of water and consumption of other goods O, which would
keep the consumer at the same level of utility. The indifference UO is the reservation level of utility. It originates on the Y-axis
when other goods consumption O equals income. Initially the indifference curve is steep, the consumer is willing to give up large
amounts of other goods when water consumption is low. The curve also approaches the X-axis asymptotically since water
consumption can be very large at a low price in terms of other goods foregone.
Water is priced through a two-part tariff consisting of a fixed payment (F), which entails some free units of consumption, and
a price per unit of additional consumption or volume charge. Since normally the fixed payment is less than the maximum amount
the consumer would be willing to pay for his consumption of water, he is able to reach a level of utility higher than his reservation
level. Now suppose in period 1 there is no charge for the poor consumer, but he is subject to rationing of water. The implicit
cost of queueing, etc. he is subject to, FP1, drives him to his reservation utility UPO. This FP1 is a net welfare loss since it does
not go to the service provider but is a real coping cost for the poor consumer.
The rich consumer is charged a fixed cost FR1, which covers consumption of some water units along the horizontal section,
and pays a low price p1 per unit of additional water he consumes. The budget line gives the rate at which he can convert other
goods consumption of Y F into extra units of water. The fixed cost is measured on his reservation utility curve and the price
line starts from the point on UOR giving free consumption at the fixed cost charged. His water consumption is at QR1 where his
budget line is tangent to his indifference curve. A fixed cost that does not extract all surplus and his ability to adjust his commodity
consumption at the margin take him above his reservation utility UOR. Since he is on the elastic portion of his demand curve,
he consumes a large amount of water but derives a low utility from the marginal unit.
a Samuelson in his famous textbook had used this paradox to illustrate the difference between total and marginal utility. He pointed out that
diamonds, which are not essential to life, have a very high price, but water whose contribution to total utility is much higher has a very low price.
The reason is that water is supplied to the point where its marginal utility is very low. Like air it is almost a free good. But in modern communities
delivering potable water to every doorstep is quite expensive, and costs have to be recovered. See Morris (2001) for an earlier treatment which
does not, however, analyse two part tariffs.
b T.C. Anant made the point that the poor may not be able to convert time into income. Indeed this belief is the reason that queueing is
used as a means of targeting the consumption of the poor. But the poor cannot afford to be unemployed and often have multi-activity going on
so that there is an income loss in queueing. Since water is essential to life high time costs of collecting it can have very large opportunity costs.
I know of one poor family who, since it took a large amount of time to collect their daily requirement of water, and the mother had a job, withdrew
their daughter from school to perform the task.
Water 287
Other goods
YR
FR2
U 2R
Slope = p2
FR
YP
FP2
Slope = p1
Slope = p2
1
FP
U 1R
U 0R
U 0P
U1P
QP1
QP2
QR2
QR1
Water
Fig. B12.1.4.1 Price Reform and Welfare
Fig. 12.1.1 Price Reform and Welfare
Now consider a price reform in period 2 where both consumers are charged a higher unit volume price p2, but lower fixed
costs than they were paying in period 1. Thus the rich consumer pays FR2 > FP2. The consumption of the poor consumer goes
up QP2, but he remains on the inelastic part of his demand curve, and he reaches a higher level of utility, U1P. Although he is
paying a small fixed cost, lower than his earlier coping costs, his choice of additional units of consumption is voluntary, and takes
him to a higher indifference curve. A French student of BMCs water supply reported that in the current rationing regime
consumption is taken to be 240 lpcd for the rich consumer and 45 lpcd for slumsc. The changes proposed would improve water
equity and the welfare of the poor.
The consumption of the rich consumer falls much more. But since he was on the elastic part of his demand curve, the total
utility loss from the marginal units of consumption is not very high. A high fixed and low volume charge turns all rich consumers
into high volume consumers. If the fixed cost he was paying earlier was high, he may continue to be on the same utility level
U1R. If the fixed cost he was paying earlier was lower at YRA (< FR1) his utility level may fall from U2R to U1R, after the change,
but he would continue to be above his reservation utility.
Moreover, social welfare will rise since the consumption of the rich falls about double the rise in the consumption of the poor.
Assume that there are constraints in expanding the supply of water, and that earlier some poor were uncovered. Now enough water
is released to cover two poor consumers. The move is revenue enhancing, since a higher price is paid per unit of water, and the
fall in fixed costs charged for the rich consumer is more than made up by the smaller fixed costs now actually paid by double
the number of poor consumers. Although in order to simplify the diagram we have kept p2 the same for rich and poor consumers,
the poor could be charged a lower price that varies with the consumption slab. Such differential pricing is common. If the coping
strategies of the poor earlier included puncturing pipes, and stealing water, these changes will reduce such wastage, and further
improve revenues for the water supplier.
c
Presentation at IGIDR by a French engineer from Cerna in 2002.
Piped water supply has one peculiar featurethe easy

availability of quantity rationing. Managers can just turn
off the water supply to whole areas, especially to selected
slums. Since this instrument allows them to cut demand to
fit available supply, it is not surprising that they make so
many excuses about the difficulties in extending metering
more fully. They say household demand tends to be constant,
so they can fix a daily amount and just shut off the valves
after this is dispatched. Lump sum connection charges and

taxes are easy to collect to cover costs. But a study in Uttar
Pradesh found a 50 per cent fall in domestic water
consumption upon full metering (Suresh 1998). An ADB
(1997) study showed 67 per cent metering in Mumbai
compared to 0 per cent in Kolkata, and 94 per cent in
Colombo, Sri Lanka, while in Malaysia, Indonesia, and
China all the major cities had 100 per cent metering.
288
Incentives for Service Contracts and Conservation

The Case of Water Supply in Mumbai (Box 12.1.2) has
made clear the enormous health and wastage costs of this
system of quantity rationing. It has also made clear that
intermittent supply and poor maintenance affects mainly
household distributory mains. About 82 per cent of the
leakage takes place in the household connections and the
rest through deliberate puncturing of the distributory mains,
and household consumption accounts for 90 per cent of the
water supplied. Irregular supplies lead to considerable
additional wastage through water hoarding and disposal. If
service contracts are given at a pipe width of 150 mm4 in
various localities, the contractors could be made responsible
for maintenance of the distributory pipes, attending to
complaints, 24-hour water supply, metering, billing, and
collecting. Uninterrupted water supply would reduce
corrosion, leakage, contamination, and metering would
reduce the demand for water and wastage at the household
level, thus keeping demand below available supply. Slum
households could be given one tap each, and the number
of standposts reduced. Households could be given a choice
of a high fixed cost and low or zero unit charge compared
to a low fixed cost and a water charge that increases with
consumption slabs. It may become worthwhile for peak
consumption households to install meters themselves. Box
12.1.5 shows that even slum households are willing to pay,
and prefer a combination of volume and low connection
charge. A connection charge has some justification for
recovering capital costs, and taking advantage of the
willingness to pay, but non-transparent water taxes should
be avoided. Giving the contractor part of the reduction in
water leakage as incentive payment would motivate him to
put in capital equipment unlike in the case of Manilas
private water companies that could pass on the cost of
leakage to the consumer. Bypass meters could measure the
leakage he saves and give him some percentage of this. His
profits then would come from improvement in quality,
giving him strong incentives. If the volume charge makes
a large part of payment contingent on delivery, delivery
would take place, and the tendency to rationing would be
lowered. The whole package could be self-financing.
Experience is slowly accumulating in designing PPP
contracts. The Andhra Pradesh Infrastructure Act passed
recently gives a useful prototype that may be used elsewhere.
Such service contracts could be tied with new initiatives
in privatizing metering of electricity consumption. Broad
synergy may be possible between service provision by different
4 R.K. Bhatia, Deputy Municipal Commissioner, Mumbai,
suggested in an interview with Anirban Acharya on 9 April 2003
that, if retail privatization were to be considered, the most efficient
pipe width would be 150mm.
utilities. Local high-level storage reservoirs, maintained by the

private contractor, may save the electricity costs of 24-hour
water supply, and allow cheaper local treatment of water5.
Another irony is that the municipality complains of staff
shortage for maintenance and meter reading but its staff per
1000 connections was 33.3, compared to 17.1 in Kolkata,
and 7.3 in Colombo, (ADB 1997). Many low-skill and
low-education workers were recruited but even so there is
a large store of tacit knowledge and information in older
workers. For example, daily 757 valves are operated. The
service contractors may be able to usefully employ some of
these workers.
Another group of potential employers for these workers
could be user groups or water committees. Box 12.1.6 gives
examples of how well these have worked in some cases.
Some such groups may perform monitoring of contracted
quality, conservation, and information functions as byproducts of other club activities, others may usefully perform
meter reading and collection functions as sub-contractors,
or be motivated by tax exemption, or awards for water
conservancy. Pilot groups and institutions aiding the
widespread adoption of efficient structures are required.
Websites are a useful instrument to achieve these ends6.
These user groups would put pressure on politicians to force
the municipality to coordinate service contracts, improve
delivery, adopt transparent bidding and a customer-oriented
service, and develop and guard precious core water resources.
There are many ways in which citizens can reduce water
wastage, and water committees can play a major role in
establishing these practices. With community pressure
households would learn to replace leaking fissures, not throw
away stored water, install 510 litre slim dual flushing
cisterns or control cocks, use flow control taps, avoid overflow
of storage tanks, replace rusted pipes and fittings, and inform
the municipality about leakage and theft. It is possible to
capture run-off from rooftops in special water harvesting
tanks.
On an average, a Mumbaiite uses 40 litres a day for
flushing, and 80 per cent of distributed water is discharged
as wastewater. If a part is reused it would help to cover the
huge projected demand deficiency, and reduce the necessity
of developing new sources.
Mumbai buildings constructed after 2001 have to put
in water recycling procedures to get a no-objection certificate.
Filters allow water used in the kitchen to be reused in the
bathroom.
5
Participants at the IIR writers workshop made the suggestions

mentioned in this paragraph. Joel Ruet suggested breaking up the
water supply according to its uses (only 8 per cent is used for
drinking) with recycling and local treatment of other parts.
6 Chetan Vaidya points out that networking initiatives have
started for utility managers.
Water 289
Box 12.1.5
Willingness to Pay and Distribution between Fixed and Volume Charge
The Vijayawada Municipal Corporation is responsible for household connections. In 1999 it used to charge a connection fee of
Rs 4000 plus a monthly fee of Rs 40. Standposts were dysfunctional and leaking. A cut to Rs 2000 generated a huge response
from slum dwellers, and household connections were laid. (Communication from Arvind Kumar, Municipal Commissioner, VMC,
9 April 1999).
A non-refundable one time deposit or connection charge covered 37 per cent of project cost in Tirupur. Under these own your
own tap schemes, which are becoming common, charges vary from Rs 40007000 per connection in large towns and Rs 2000
Rs 3500 in small towns (Suresh 1998).
In Baroda upper- and middle-income households paid 20 per cent less than the actual cost of the water they consumed. Adding
opportunity costs, the average citywide cost of water was 1.7 per cent of household income. For poor households in income groups
less than Rs 1500 a month, the cost was 2 per cent of their household income. They were willing to pay Rs 275 per annum against
the prevailing Rs 43. Wealthier families in income groups Rs 45006000, were willing to pay Rs 440 against actual charges of
Rs 200 (Vaidya 1998).
Financial Viability, Entry, and Competition

Reform of pricing, and transparent tariffs allowing price
recovery is a precondition to attract private firms to water
supply. Foreign and domestic firms both lack experience in
Indian conditions; service and the occasional management
contracts are the best way to acquire these. Both will also
be looking for domestic capital to finance them. Service
contracts will attract largely the small entrepreneur, wellstructured contracts will make the enterprise viable allowing
financial closure. Thus, domestic enterprise will be developed
and banks will find more safe avenues to deploy their excess
liquidity. Performance clauses, such as connection targets to
be met, and annuities will ensure high standards and local
accountability. Foreign firms are also welcome to bid for the

service contracts, and their management experience will be
valuable, but they must not be allowed special concessions
such as exchange cover. Foreign exchange risk can be hedged
in the market. On a larger scale, efficient water boards and
large private firms should be allowed to bid for management
contracts in other states, thus improving yardstick
competition.
CONCLUSION
While assets should continue to be in public hands, welldesigned service contracts would have to be incentive
Box 12.1.6
Examples of Community Initiatives
CIDCO, Navi Mumbai, has given the collection of service charges to Senior Citizens Clubs, to whom it pays 1 per cent as commission
(Suresh 1998).
SALMA, or senior advanced locality management (ALM) activists, has delivered promising results in solid waste management
in Bandra. Municipal citizen partnership has worked effectively through ALM and its senior wing. The ward office commits to
responding to the needs of a street committee and the households commit to follow segregation and composting. The Marinisha
Award is given monthly to buildings that successfully handle their solid waste (Cunha 2003b).
In Delhi the Bhagidari or participative system of civic governance is working well. District councils have been established where
representatives of residents welfare associations (RWA) and the local government meet, discuss, and resolve problems relating to
water supply, energy, and environmental issues.
From Kolhapur, Maharashtra comes an example of sustainable community management of a multi-village water supply scheme.
Operating for more than 20 years as a self-help group, it has a revenue surplus even though charges are lower than in other
neighbouring water schemes. It operates 1723 household connections and 43 standposts. Transparency, committed leadership, and
importance given to consensus and discussions explain its success (Sukthankar 2000, chapter 2, pp. 22).
The Sukthankar Committee suggests an interacting multi-tiered institutional structure for water supply, with an independent
regulator at the state level, and ULBs and RLBs who would appoint service contractors through local Water and Sanitation
Committees, with open feedback from many groups including NGOs and customer councils. Women are to constitute the majority
in these committees. These autonomous entities would have the basic responsibility for the provision of water services. There would
be centrally sponsored Urban basic services for the poor in slum areas with neighbourhood groups of 20 houses represented by
Women Resident Community Volunteers. Responsibilities of village level water and sanitation committees (WATSAN) would
include formation of rules for use of water supply and sanitation. Thus, an institutional structure would be created for local
distribution of water by community groups.
290
compatible. They would improve consumer orientation and

low level accountability which is missing in public provision,
reduce wastage, encourage competition and entrepreneurship
in SSPs, achieve financial viability, and develop a thick network
of low-risk credit-customers for banks and financial institutions.
They would, however, require support from price
reform, independent regulators, and user groups. Since
contracts cannot be fully specified the latter two have a

vital role in enforcing contracts. Since citizen groups have
voting power, they can motivate politicians to change
focus from direct subsidies and hidden costs to delivery
of quality services. Examples of initiatives from India and
other developing countries suggest that changes are
feasible.
12.2 RESULTS OF AN NSSO SURVEY OF URBAN WATER ACCESS:

IMPLICATIONS FOR POLICY
Peeyush Bajpai and Laveesh Bhandari
Indian cities rate among the lowest quality of life in the world.
The environment, infrastructure, land prices, and general
livabilityall leave much to be desired (UWSS 1997). This
chapter attempts to highlight the need for investment in
water supply and sanitation infrastructure, duly recognizing
the limitations and the potential of the households to support
such investment. In the process it highlights the policy issues,
and the impediments in ensuring access to all.
Urban local governments across India are generally
considered to be in extremely poor financial health (Srivastava
and Sen 1997; Khandwalla 1999; IPFS 19989). Their
revenues are low and, as a result, their investments and
expenditures on urban services have suffered. As a result
urban India has poor infrastructure and even worse services.
Water supply is one such area where local governments have
not been able to keep up with the increase in requirements.
Indeed the quality of water supplied may have deteriorated
due to pollution of water bodies and groundwater.
Pricing policies usually do not distinguish between access
and usage. Subsidies are generally on prices of water, but
access charges tend to be very high as when they are linked
to possession of built up space. As a result the subsidies are
perverse and anti-poor (WSP 2001).
Something that would be considered to be the very basic
of serviceswater on tap for 24 hours a day has been
unheard of for decades in most Indian towns (ADB 1993).
A large part of the households depend on their own private
tube wells and pumps for their daily water needs. As a result
water tables are falling at dramatic rates. In areas of limited
groundwater, or where the heavy metal composition is high,
large costs are imposed on households, even those who can
make their own arrangements for pumping out groundwater.
Drinking water on tap for each household is desirable if
correct pricing of water is to be established. twenty-four-hour
water supply is desirable because there are large negative
externalities on account of health and wastage in intermittent
supply.
Maximizing social benefits would actually mean low or
very small connection charges and high usage charges. But
levying user charges, however, would have to be preceded

by a good understanding of Indian households water
connectivity. The number of sole use connections and shared
connections need to be ascertained for any kind of tariff
plan. Lack of such information can cause reverse effects. For
instance the increasing block tariff (IBT) model is
inapplicable where the water connection is shared among
households, a characteristic that we show is common among
the poor. The tariff rates under IBT are directly and positively
related to the consumption beyond a threshold limit. Then
joint users end up paying a higher average price for water
than the sole users. (Boland and Whittington 2001).
The bulk of the expenditures in augmenting water supply
are front ended. Even if financial resources were available
from external sources, they would typically require some
contribution from the local governmentswhich would
not be easy for most of them. Most households would not
be able to pay for the up front costs. Thus tatkal schemes
would hardly work. We study (a) the kind of demands of
households with regard to the quantum and frequency of
water supply, and (b) the quality of water supply.
The data reveals that consumers do not expect much.
This lack of expectations, we believe, is the strongest
impediment in improving water supply in urban India. Any
water supply improvement programme will only succeed if
society desires it, that is, it is willing to pay for it in the
long run and rewards policymakers for delivering it.
Consequently, a public awareness programme that aims at
increasing expectations would help facilitate access to water7.
7 Systematic denial and long years of poor quality supply make
people get used to the good as it is, so that they are unable to imagine
a significantly better quality good, or its enhanced availability. But
the social benefits of adequate consumption of good quality water
and its joint use goodsewerageare so large that, it is important
to stimulate this consumption. Once critical levels of households in
a particular strata of society consume the product, others will follow.
So the task may not be as difficult as it appears from the snapshot
picture that the survey results reported herein provide.
Water 291
We also highlight the need for an evaluation of water
supply requirements prior to any improvement programme.
Studies have shown that the absence of such assessment has
contributed to the failure of such programmes in other
countries (Hardoy and Schusterman 2000).
The paper is based on a data set from a survey conducted
by the National Sample Survey Organization (NSSO) in
1998 (the 54th round). More than 110,300 rural and urban
households were queried on the following aspects:
Access to drinking water

Access to bathing water
Access to bathroom/toilet
Latrine and drainage
Garbage removal
Additional household level information on lifestyle, habits

such as on commuting, access to media, etc. were elicited
by the NSSO. This allows us to relate the occupation,
religion, and the geography of the availability of urban
services.
For the purposes of this paper, we limited ourselves to
31,323 urban households. We focused on drinking water
because in our opinion it is the most indicative of the issues
related to water in general. Moreover, the type of queries
asked about drinking water had a wider scope.
PRINCIPAL SOURCES
OF
Table 12.2.2
Right of Use of Water
Sole
Shared
Community
Others
Not Available
Total
Table 12.2.1
Main Sources of Water
Number of Households
(millions)
Per cent
33.3
10.2
3.2
0.1
0.0
70.1
21.4
6.7
0.2
0.1
0.1
0.0
0.5
0.1
0.1
47.6
0.2
0.1
1.0
0.2
0.1
100.0
(millions)
Per cent
19.6
12.7
13.6
1.6
0.0
47.6
41.3
26.6
28.6
3.5
0.0
100.0
In other words, only 41 per cent have exclusive access

to their main source of water. Exclusivity in supply is
important, because that is a necessary precondition for
imposing any user charges/taxes on water. Many of the
70 per cent households who have access to taps have to share
water from their main source. Of the 33.4 million households
who have access to tap water about 54 per cent or 18 million
require some sharing (Table 12.2.3).
WATER
The bulk of the households in urban India depend on the

municipal water supply for their daily needsmore than
70 per cent depend on tap water and an insignificant number
on tankers. Access to underground water is the next most
importantwells, tube wells, and hand pumps, together
account for more than 27 per cent of the households main
water supply. As would be expected, other sources that
include tanks, ponds, springs, rivers, canals, etc. are
insignificant in urban areas (Table 12.2.1).
Tap
Tubewells
Wells
Tank/Pond Reserved
Other Tanks/Ponds
for Drinking
River, Canal, Lake
Spring
Tanker
Others
Not Available
Total
About 30 per cent of the urban households do not obtain

water from their municipality/local government. However,
even those households who do have some access to water
from the government, have to share it with their neighbours.
Almost 59 per cent of the households either share water
with their neighbours or the supply is for the community
(Table 12.2.2).
Table 12.2.3
Right of Use of Tap Water
Sole
Shared
Community
Others
Missing
Total
(millions)
Per cent
15.2
8.7
8.4
1.0
0.0
33.3
45.6
26.1
25.2
3.1
0.0
100.0
Sharing is not the only issue. The majority of the

households do not have water within their dwellings
(approximately 61 per cent) and have to transport it from
the main source (Table 12.2.4).
It would only be natural that those who access water
from wells, tanks, tube wells, etc. would not obtain water
within the dwelling. But more importantly, a majority about
54 per cent of those who have access to tap water do not
have it within the dwelling but have to transport it from
the source outside their place of stay (Table 12.2.5).
In sum, not only is the penetration of municipal water
supply low (about 70 per cent of total households), it is also
quite poor in terms of access. Most households that depend
on tap water have to either share it with their neighbours,
or themselves transport it to their dwelling, or both.
292

Table 12.2.4
Distance from Principal Source of Drinking
Water: All Urban Households
(millions)
Per cent
18.4
12.9
15.0
0.8
0.4
0.1
0.0
0.0
47.6
38.6
27.1
31.5
1.7
0.7
0.3
0.1
0.1
100.0
Dwelling
Premises*
<0.2 km
0.20.5
0.51.0
1.01.6
>1.6 km
Not Available
Total
some improvements in access to water. But that is not all.

Another 14.3 million households do not have any access to
municipal water. These also need to be provided adequate
access. Thus, of the total 47.6 million urban households at
least 32 million households require some improvements in
access to water within their dwellings.
Providing access is likely to require major investments in
water supply infrastructure. Consequently, we term the
15.1 million households that have sole access within their
dwellings or premises, as those who have a low requirement
for such infrastructure improvements. The rest 32.5 million
households are termed as high-requirement households, in
that their adequate access requires infrastructure investment.
In sum, the large majority of the households require some
investment in water supply infrastructure to satisfy their
requirements. These households tend to have a lower
economic status as the discussions in the later sections will
reveal.
As is apparent from Table 12.2.7, the requirement of tap
water is a problem that spreads across all types of towns and
cities, irrespective of the size. However, from our perspective
what is more important is the economic status of the
households, since that would have a greater impact on the
ability and the willingness to pay.
Note: *The term premises means outside the dwelling but within
the dwellings compound.
Table 12.2.5
Distance from Principal Source of Drinking Water:
Households with Taps
(millions)
Per cent
15.3
8.4
9.6
0.0
33.3
45.8
25.3
28.8
0.0
100.0
Dwelling
Premises
Others
Not Available
Total
ECONOMIC STATUS
We argue that proper access requires two conditions to

be fulfilled. One, the household should have the right to
sole use. Only in such conditions would it be possible to
levy any user charges on households. Two, the point of water
supply should be ideally within the dwelling. In general, the
closer water can be supplied to the dwelling, the better
would it be. Table 12.2.6 presents the distribution of the
more than 33.4 million urban households who have access
to tap water.
Barely 15.1 million households, that is, 12.9 and 2.2
households, respectively, have sole access within the dwelling,
or premises. These are the households where it is the easiest
to levy user charges. Arguably, all the remaining 18.2 million
odd households with access to tap water require at least
AND
ABILITY
TO
PAY
The data set does not contain any information on aspects

such as per capita monthly expenditures of households
the standard measure of economic status. Neither does it
provide any information on the households expenditure on
any products. However, some household- and individuallevel information is present that allow us to extract the
following information:
1. TV ownershipThe data provide details as to
whether a household has no television, or the type of television
ownedblack and white, or colour.
2. Newspaper subscriptionNumber of newspapers
subscribed to by the household.
3. Mode of regular commutingIndividual level
Table 12.2.6
Distribution of Households across Right to Use and Distance from Source: Households with Taps (millions)
Right / Distance
Dwell
Premises
Others
Missing
Total
Sole
Shared
Community
Others
Missing
Tapped Households
Untapped Households
Total Urban Households
12.9
2.3
0.1
0.0
0.0
15.3
3.1
18.4
2.2
5.1
1.1
0.1
0.0
8.4
4.4
12.9
0.1
1.4
7.2
0.9
0.0
9.6
6.7
16.3
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
15.2
8.7
8.4
1.0
0.0
33.3
14.3
47.6
Water 293
Table 12.2.7
Distribution of Households across Towns and Requirement for Water Infrastructure Improvement (%)
Class of Town
(Population as per
1991 Census)
Less than 50,000
50,0002 lakhs
2 lakhs10 lakhs
More than 10 lakhs
More than 10 lakhs
Total
Total (millions)
Low Requirement
23.3
29.2
37.5
40.5
28.6
31.7
15.1
Based on this information we categorized households on

their economic status. This involved a two- step methodology.
First, each household was given a value rating of 1, 2, or
3, for each of the lifestyle categories. Therefore, each
household now had a rating for each of the categories.
Table 12.2.8
Step 1Rating Each Household for Each Category
TV
No television
Black and white
Colour TV
Mode of Commuting
Foot or bicycle
Public transport, rickshaw, and animal transport
Owned car, two wheelers, taxi, and auto
Newspapers Subscribed to
None
One
Two or more
Total
76.7
70.8
62.5
59.5
71.4
68.1
32.4
information on daily commute for work or education by:

foot, cycle, animal drawn transport, public transport, taxi,
autos, two and four wheelers.
Lifestyle category
High Requirement
Rating
1
2
3
1
2
3
1
2
3
In the second stage a consolidated rating was given to

each urban household by summing these value ratings. For
instance, a household that does not have a television, but
where commuting occurs by a two-wheeler, and subscribes
to a single newspaper obtains a consolidated rating of 5.
These consolidated value ratings were then used to classify
households as high, medium, and low economic status.
The final economic status was, therefore, assigned on the
basis as listed in the Table 12.2.9. For instance, low economic
status households are considered to be those who do not
have a TV, do not subscribe to a newspaper, and commute
on foot or bicycle. Though, to account for certain
idiosyncrasies, we also include in this class the households
who perform better than the minimum in any one of these
Total
(millions)
100.0
100.0
100.0
100.0
100.0
100.0
47.6
13.3
12.0
10.4
11.1
0.7
47.6
characteristics. Similar considerations were made for other

categories.
Table 12.2.9
Step 2Final Rating for each Household
Consolidated
Rating
Number of
Households
(millions)
3
4
5
6
7
8
9
Unavailable
Total
9.0
10.3
6.3
4.3
4.0
2.3
0.4
11.0
47.6
Per cent
of Total
19.0
21.6
13.2
9.0
8.4
4.8
0.9
23.1
100.0
Economic
Status
Low
Medium
High
Cross-checking the ResultsPhone Ownership: As mentioned

earlier, there are no standard measures for assessing the
income/expenditure capability of the households. The
methodology thus ascertains the economic status, which in
a manner reflects the capability of the households (Bhandari
and Dubey 2001). The economic status as obtained after
the aggregated rating was compared with the ownership of
phones. As expected, a majority of those having telephones
fell in the high economic status category. While majority
of those not having a phone connection belonged to the low
and medium economic status. This result indicates that the
variables used in classification do relate with other
independent variables that highlight the economic status.
We have, therefore, been able to stratify 37 of the
47 million urban households on the basis of their economic
Table 12.2.10
Economic Status and Phone Ownership
Economic Status
Low
Medium
High
Missing
Total
No Telephone
46.6
14.1
14.8
24.5
100.0
Telephone
2.8
7.7
75.3
14.3
100.0
Total
40.6
13.2
23.0
23.1
100.0
294
Table 12.2.11
Urban Households and Water Supply: Economic Capability
and Requirement
Infrastructure Requirement
Economic Status
Low
Medium
High
Unavailable
Total
Low
High
Unavailable
3.3
2.3
6.6
3.0
15.1
16.0
4.0
4.4
8.0
32.4
0.1
0.0
0.0
0.0
0.1
Total
19.3
6.3
11.0
11.0
47.6
status. The bulk of the households, as expected, are in the

economic strata who would have a low capability to pay for
any capital investment for improvement of water supply at
their end.
POLICY IMPLICATIONS
This section attempts to develop a policy strategy for ensuring
good water supply to all. In doing that it takes into
consideration various factors.
At one extreme we have a set of households who have
a high need but their economic status does not reflect their
ability to make investment for improvements. Such
households account for almost one-third of the total urban
households. At the other extreme there is a set of high
economic status households that already have adequate
accessthey are unlikely to pay though they have the ability
to pay. Specific strategies have to be drawn up to cover all
these sets of households (Figure 12.2.1).
Low NeedLow Economic Status: These are less than
10 per cent of all the urban households. These households
have their need nearly satisfied at present. They are also not
in a position to pay for improvements. Status quo needs to
be maintained for these households. O&M expenditure
would have to be on the part of the government. However,
if any across the board rate increases are made, these
households are likely to be the most vociferous protestors.
Neighbourhoods that contain a large proportion of such
households would need to be insulated from such increases.
Low NeedMedium Economic Status: About 2.3 million
(5 per cent of the total) urban households belong to this
set. Having medium capability with a low need for

improvement, they can pay nominal user charges. They are
also less likely to support price increases to finance better
supply. Though they may not be as stringent protestors, as
those in group 1 above.
Low NeedHigh Economic Status: These comprise about
6.6 million (14 per cent of the total) urban households.
These have the capability to pay for the provision of the
present service and also for little improvements, such as
availability of tap water within dwelling from premises.
They are not likely to support improvements in access.
However, as is true for higher economic status groups
elsewhere, they have a high inclination to pay premiums for
better quality. In the case of water supply this would include
cleaner water with low levels of dirt, minerals, and biological
matter, as well as 24-hour water supply. These groups would
not support improvements in simple access (though they
may not be vociferous protestors either). However, they are
likely to be strong supporters if better quality is assured.
High NeedLow Economic Status: The major chunk of
the total urban households, about 15.9 million, fall under
this category. Without government subsidy, their low
economic status stands in the way of improvements. For this
set of households, budgetary provisions towards infrastructure
investment are essential. These households, a third of the
total urban households, may have some ability to pay user
charges. However, our data is limited and we cannot make
an unambiguous judgement on that front. For that purpose
a study that analyses their expenditure and income patterns
would be required. This segment of the population has the
most to gain by government support, and would be the
most vociferous supporters of water supply reform. However,
care would have to be taken in designing the fee structure.
Some non-price constraints may have to be considered if
charges are low.
High NeedMedium Economic Status: Slightly more than
4 million households (8 per cent of the total) fall in this
category. Though they have a high need they are limited
by their capability to generate funds. These households
would be less likely to have the ability to pay for
improvements but more likely to be able to pay the user
fees. Charges for infrastructure improvements, if imposed,
Requirement
Economic
Status
Low
Low
Medium
High
Status Quo (3.3)

Nominal Charges (2.3)
Revised Charges (6.6)
High
Support (16.0)
Charges Spread over a period (4.0)
Investment & Charges (4.4)
Note: The figures in bracket indicate the number of households in each category in millions
Fig. 12.2.1
Strategy Chart for Various Categories
Water 295
would need to be spread over a period of time. These
households would be willing supporters for improvements,
provided that the burden on them is not too high.
High NeedHigh Capability: There are about 4.4 million
such households in urban India. These households can make
one time capital investment for the required improvement
and also pay any recurring charges towards maintenance of
the necessary services. These households would also be
supporters of government initiative on water infrastructure
investment, provided credible initiatives are taken.
VIEWS
ON
CONTRIBUTION
The data also contains responses to queries on households

perceptions on improving sanitation in general. This also,
to some extent, reflects their views on water supply in
particular. Note that about 40 per cent of the households
are willing to contribute financially in some way. Another
30 per cent are willing to put in their own labour for the
purpose. Thus, in total about 70 per cent of the households
state that they have some interest in improving their
conditions (Table 12.2.12).
Table 12.2.12
Willingness to Contribute for Improvements in
Sanitation in Neighbourhood
Contribution
(millions)
Money
Labour
Both
Neither
Missing
Total
10.2
14.6
8.6
14.0
0.1
47.6
Per cent
21.34
30.69
18.18
29.5
0.3
100
However queries on the sufficiency of water reveal a

different picturemore than 80 per cent of the households
across different segments, consider that they have sufficient
supply. However, the bulk of these households do not have
even sufficient access as the data reveal. We argue that this
is because the bulk of the population benchmarks
sufficiency at very low levels8. Therefore, it is conceivable
See Footnote 7, earlier.
that improvement programmes do not get much public

support.
The approach paper to the Ninth Plan estimates that
85 per cent of Indias urban population has access to water
supplies. However, adequate details on quality of service
delivered are not generally available. While many schemes
are designed for a 24-hour supply using 150/200 lpcd
demand, consumers experience regular shortages with only
few hours supply each day (UWSS 1997).
Take for example Delhi. Only 20 per cent of the capitals
population receive 24 hours water supply; 60 per cent obtain
it for between 412 hours; and the rest for less than 4 hours.
A small survey indicated that the majority of consumers in
Delhi would be satisfied with a daily supply of 56 hours
per day (ADB 1993)9.
Consequently, any improvement programme would first
have to improve the consumers benchmarking. In other
words, for improving access, consumer support is essential.
For that, urban consumers have to believe that a 24-hour
supply, universal access, and clean water, are not
inconceivable but a likelihood. This we believe should be
the first focus of water infrastructure improvement
initiatives.
CONCLUSION
In almost all cities and towns in India many households do
not have access to water on tap. Of those that do, most have
to share it with others. Of those who do not have to share
it, many have to transport it from outside their dwelling.
It is well known that even those who have water on tap for
their sole consumption within their dwelling, the supply is
erratic and of poor quality.
In relating customers income proxies to current levels
and quality of consumption, the felt need, and willingness
to contribute to improvements, a strategy for enhancing
water supply infrastructure that is realistic and feasible is
drawn out. The current low levels of supply at which
satisfaction occurs, can be a barrier to enhanced supply that
requires significantly enhanced user charges. The size of the
support base, the opposition, and the indifference to water
reforms are estimated.
9 Denial may be large. See S. Morris (2001) and A. Goyal in

this Report (Chapter 12.1). The low prices for water, in a situation
of limited supply, means that the elastic demand of the rich takes
away water from the inelastic demand of the poor creating denial,
even in a city where as much as 200 lpcd is suppliedDelhi.
296
12.3 MORE CROP PER DROP: FINANCIAL VIABILITY OF DRIP IRRIGATION

A. Narayanamoorthy
The agricultural sector (irrigation), which currently consumes
over 80 per cent of the available water in India, continues
to be the major water consuming sector due to the
intensification of agriculture (MOWR 1999; Iyer 2003).
Though India has the largest irrigated area in the world, the
coverage of irrigation is only about 38 per cent of the gross
cropped area as of today. One of the main reasons for the
low coverage of irrigation is poor water-use efficiency under
the flood (conventional) method of irrigation, which is
predominantly practised in Indian agriculture. Available
estimates indicate that water-use efficiency under flood
method of irrigation (FMI) is only about 35 to 40 per cent
(Rosegrant 1997). Considering the water availability for
future use and the increasing demand for water from different
sectors, a number of demand and supply management
strategies have been introduced in India to augment the
supply as well as to control the demand for water. One of
the demand management strategies introduced recently to
control water consumption in Indian agriculture is drip
method of irrigation (DMI). Unlike flood method of
irrigation, drip method supplies water directly to the root
zone of the crop through a network of pipes with the help
of emitters. Since it supplies water directly to the crop
instead of to the land, as followed in the flood method of
irrigation, the water losses occurring through evaporation
and distribution are completely absent (INCID 1994;
Narayanamoorthy 1996 and 1997a; Dhawan 2002). The
on-farm irrigation efficiency of properly designed and
managed drip irrigation system is estimated to be about
90 per cent, while the same is only about 40 per cent for
surface method of irrigation (INCID 1994).
Though this technology is introduced primarily to increase
the water-use efficiency in agriculture, it also delivers many
other economic and social benefits to society. Reduction in
water consumption due to drip method of irrigation varies
from 30 to 70 per cent for different crops (INCID 1994;
Narayanamoorthy 1997; Postel 2001). Productivity gains
due to drip method of irrigation is estimated to be in the
range of 20 to 90 per cent for different crops, as per research
station data (INCID 1994). While increasing the
productivity of crops, it also reduces the cost of cultivation
especially in labour-intensive operations. The reduction in
water consumption in drip method of irrigation also reduces
the energy use (electricity) that is required to lift the water
from irrigation wells (Narayanamoorthy 1995 2001).
Drip irrigation technology requires fixed investment
that varies from Rs 20,000 to Rs 55,000 per hectare
depending upon the nature of crops (wide or narrow

spaced) and the material to be used for the system. As
farmers have been getting water at low cost for many years
from the public irrigation system and also from well
irrigation (because of the introduction of flat-rate electricity
tariff ), there is no incentive for them to adopt this capitalintensive technology unless it is necessary. Moreover, since
it involves fixed investment farmers often ask questions
like what will be the water saving and productivity gains?
Is investment on drip irrigation economically viable? What
will be the pay-back period of the drip investment? But
the matter needs a thorough study with use of field level
rather than research station data. (Verma and Rao 1998;
INCID 1994; Dhawan 2002). Some of the studies have
shown that the results derived from research station data
are substantially different from that of survey data
(Narayanamoorthy 2001).
COVERAGE
OF
DRIP IRRIGATION
IN
INDIA
Drip method of irrigation was initially introduced in the

early 1970s by the agricultural universities and other research
institutions in India with the aim of increasing the wateruse efficiency in crop cultivation (INCID 1994). The
development of drip irrigation was very slow in the initial
years and only from early the 1990s significant development
has been achieved in certain states. In India, the area under
drip method of irrigation has increased from 1500 ha in
1985 to 70,589 ha in 19912 and further to 2,46,000 ha
in 19978 (INCID 1994; AFC 1998). Though India has
enormous potential and prospects, the development of drip
irrigation does not match expectations in most of the states.
Table 12.3.1 presents state-wise area under drip method of
irrigation and its growth rate for 2 time points: 19912 and
19978.
In both time points, Maharashtra state alone accounted
for nearly 50 per cent of Indias total drip irrigated area
followed by Karnataka, Tamil Nadu, and Andhra Pradesh.
Over the last 10 years, significant growth has been achieved
in the area under drip method of irrigation in many states.
However, drip-irrigated area constitutes a very meagre
percentage in relation to gross irrigated area in all the states
of India. For instance, during 19978, the share of dripirrigated area to gross-irrigated area was just 0.34 per cent
and about 0.64 per cent in relation to total groundwater
irrigated area of the country.
Water 297
Table 12.3.1
Coverage of Drip Method of Irrigation by States
State
Maharashtra
Karnataka
Tamil Nadu
Andhra Pradesh
Gujarat
Kerala
Orissa
Haryana
Rajasthan
Uttar Pradesh
Punjab
Other States
Total
Area (ha)
Percent to Total Area
ACGR
19912
19978
19912
19978
(Area)
32,924
11,412
5357
11,585
3560
3035
44
120
304
111
20
2117
70,589
1,22,995a
40,800b
34,100
26,300
7000
4865
2696
1900
1600
1500
1100
1150
2,46,006
44.64
16.17
7.59
16.41
5.05
4.30
0.06
0.17
0.43
0.16
0.03
3.00
100.00
50.00
16.58
13.86
10.70
2.85
1.98
1.10
0.77
0.65
0.61
0.45
0.47
100.00
24.56
23.66
36.14
14.64
11.93
8.18
98.55
58.46
31.89
54.33
95.01
-9.67
23.13
Note: aincludes state subsidy scheme area of 58,498 ha.

bincludes area under central and state schemes for development of oil palm and sugar cane.
ACGRAnnual compound growth rate percent per annum between 19912 and 19978.
Source: AFC (1998).
Although INCID (1994) report mentions that over

80 different crops are suitable for drip method of irrigation,
only a few crops have been dominating in the total area
under drip irrigation so far. As of 19978, crops like coconut,
grapes, banana, citrus, mango, and pomegranate have
together accounted for nearly 67 per cent of total drip
irrigated area (Table 12.3.2). Of this, except for banana,
other crops are not heavy water consuming crops. More
importantly, out of 26,460 ha of the total area for banana,
Maharashtra alone accounted for as much as 93 per cent
at the end of 19978.
The crop composition of Maharashtra, which accounts
for over 50 per cent of Indias total drip irrigated area, is
different from the all-India picture. Of the total area of
1,60,281 ha (as March 2000), crops like banana (22.78
per cent), grapes (18.15 per cent), sugar cane (12.68 per
cent), citrus group of crops (11.59 per cent), and

pomegranate (10.27 per cent) together accounted for about
75 per cent of the total area. Sugar cane is seen as one of
the important crops in Maharashtras total area, which is
not seen at the all-India level. This is because of the fact
that unlike central schemes, Maharashtra has been
providing subsidy for drip irrigation sugar cane, keeping
in view its water for potential saving.
A FIELD VIEW
OF
DRIP IRRIGATION
This study was carried out in Maharashtra, where DMI was

introduced during 1986 itself as a state-sponsored
programme. The effort taken by the state government paid
dividend and the area under DMI increased from
Table 12.3.2
Cropwise Area under Drip Method of Irrigation in India: 19978
Crops Name
Area
Coconut
Grapes
48,360 (19.66)
29,630 (12.04)
Banana
Citrus
Mango
26,460 (10.76)
22,210 (9.03)
21,860 (8.89)
Pomegranate
Total all crops*
15,250 (6.20)
2,46,006 (100.00)
Leading states
Karnataka (24.00), Tamil Nadu (21.20)
Maharashtra (24.10), Andhra Pradesh (2.20),
Karnataka (3.00)
Maharashtra (24.50)
Maharashtra (15.00), Andhra Pradesh (4.80)
Andhra Pradesh (9.22), Maharashtra (5.00),
Karnataka (2.30), Tamil Nadu (4.00), Gujarat (1.20)
Maharashtra (11.40), Karnataka (2.00)
Note: *Total will not tally as all the crops are not included. Figures in brackets are percentage to total area.
Source: AFC (1998).
298
236 ha in 19867 to 2,17,447 ha in 20002, an increase

of about 62 per cent per annum.10
Though more than 26 crops are being cultivated using
DMI in Maharashtra as of March 2000, we have selected
2 important water-intensive crops, namely, sugar cane and
banana, for detailed analysis. Using the data compiled from
Commissionerate of Agriculture, Government of
Maharashtra, Pune, two districts, namely, Pune for sugar
cane and Jalgaon for banana, were selected for detailed field
survey. A sample of 50 farmers consisting of 25 drip adopters
and 25 non-drip adopters have been selected for each crop
from each district. That is, altogether, a total of 100 sample
farmers (50 drip and 50 non-drip adopters) have been
selected for this study. In order to avoid the differential
impact of sources of irrigation on productivity and other
parameters, we have considered only those farmers who
cultivated the 2 selected crops using groundwater under
both drip and flood irrigated condition. While the drip
adopters have been selected by random sampling method
using the list of names obtained from the Agricultural
Department of the respective districts, the farmers cultivating
the same crops under flood method of irrigation nearest to
the field of drip adopters have been selected purposively as
non-drip sample farmers in order to reduce the variation in
agro-economic parameters between the 2 categories of
farmers. The field survey data from the sample farmers has
been collected pertaining to the year 19989 for sugar cane
and 19934 for banana.11 While comparing the drip adopters
with the non-drip adopters in respect of various parameters
underlined earlier, net present worth (NPW) and benefit
cost ratio (BCR) have been computed using the discounted
cash-flow technique to judge whether or not the investment
on DMI is economically viable.
Operation-wise Cost of Cultivation

As mentioned earlier, DMI also helps to reduce the cost
of cultivation in certain operations besides increasing water
use efficiency and productivity of crops. Many studies based
on experimental data have confirmed that DMI reduces the
cost of cultivation, especially in labour-intensive operations
like weeding, irrigation, ploughing, etc. (INCID 1994;
Verma and Rao 1998). When labour cost reduces, total
cost of cultivation also reduces, because labour cost
constitutes a considerable portion in the total cost of
cultivation. In order to understand the impact of drip
irrigation on cost of cultivation of different operations, we
10
For achieving this impressive growth, the government of

Maharashtra has distributed a subsidy of Rs 332 crore to the drip
adopters through various schemes up to the end of March 2002
(GOM 2003).
11 Detailed methodologies followed for this study can be seen
from Narayanamoorthy (1996) and (2001).
have compared the cost of each operation between the

farmers who adopt DMI and flood irrigation method.
Table 12.3.3 shows the operation-wise cost of cultivation
for sugar cane and banana for both the adopters and the
non-adopters. It is clear from the table that drip irrigation
reduces the total cost of cultivation by nearly 12 per cent
in sugar cane and nearly 3 per cent in banana over the
method of flood irrigation. Though total cost saving in
terms of percentage is not very high in the aggregate, it
varies across different operations. Among the different
operations, cost saving is very high in ploughing and
preparatory works, weeding and interculture, fertilizers, as
well as irrigation. The reason for the cost reduction in
fertilizers is that some of the adopters have used liquid
fertilizers and thus, the cost incurred on fertilizers is relatively
less. A few earlier studies have reported that drip irrigation
also reduces the cost of fertilizers enormously as it can be
supplied with water (liquid fertilizers).12 Some of the farmers
have argued that even without using liquid form of fertilizers,
it can be reduced by avoiding wastage under DMI. Cost
saving in irrigation is mainly due to 2 reasons. First, since
water is supplied through pipe network under DMI, it does
not require more labour. But, in the case of surface method
of irrigation, labour input is necessary to control water
supply (changing course of water from one field to other)
and to govern leakage and seepage. Second, in addition to
saving in cost of labour, the cost incurred on electricity for
operating pump-sets is also less as drip requires less amount
of water as compared to flood method of irrigation. Since
DMI does not warrant much ploughing as it supplies water
only at the root zone of the crops, there is a cost saving
in ploughing and preparatory operations as well. As shown
by earlier studies, the cost saving is also very high in weeding
operation especially in banana crop. Since DMI supplies
water only at the root zone of the crop, it does not allow
weeds to come up in the non-crop space.
Water Saving
One of the important advantages of DMI is that it saves
substantial amount of water over the method of flood
irrigation. It is evident from Table 12.3.4 that despite higher
number of irrigation used by farmers with DMI, the time
utilized in hours per irrigation is significantly less for the
drip adopters. This is mainly because it supplies water only
to the crop and not to the land. In the case of surface
method of irrigation, there is a need to spend more for each
turn of irrigation because it supplies water not only to the
12 Application of fertilizers through water is called fertigation.
It substantially reduces consumption of fertilizers and wastage
compared to methods like basal and top dressing. As a result,
efficiency of input increases in DMI.
Water 299
Table 12.3.3
Cost of Cultivation for the Adopters and the Non-Adopters of Drip Irrigation (Rs/ha)
Operations
Sugar cane
DMI
FMI
Ploughing and Preparation 5218

Seed and Seed Sowing
6871
Fertilizers (inorganic)
9587
Farmyard Manure
7817
Pesticides
1241
Weeding and Interculture
4869
Irrigationa
5948
Others
2178
Total Cost of Cultivationb 43729
5790
8502
11,042
8263
1042
4935
6822
3177
49,573
Banana
% change
over FMI
9.88
19.17
13.18
5.39
19.11
1.32
12.81
31.43
11.78
DMI
FMI
2633
5331
16,378
9975
10
1826
5757
2207
51,437
3223
5416
17,494
8316
2123
6379
1895
52,739
% change
over FMI
18.30
1.56
6.38
19.95
14.00
9.75
16.47
5.47
Notes: aIncludes O&M costs of pump set and drip set.

bCosts of harvesting, transport, and marketing are not included in sugar cane as these costs are incurred by the sugar factories in
Maharashtra.
Source: Calculated from field survey data.
crop zone but also to the non-crop zone. Uneven land

surface and water conveying channels also consume
considerable quantity of water in surface method of irrigation.
Evaporation losses are also very high in open water conveying
channels, which increases the requirement of time used for
each turn of irrigation. In spite of higher amount of water
supply for each turn of irrigation under flood method,
moisture stress is common for those crops cultivated under
FMI.
Water consumption is measured in terms of horse power
(HP) hours of irrigation in the present study. HP hours of
water is estimated by multiplying HP of pumpset with
hours of water used in each pumpset. Water consumption
by non-drip irrigated crops is substantially higher than the
same crop cultivated under DMI (Table 12.3.4). Water
saving due to DMI is about 47 per cent for sugar cane and
nearly 30 per cent for banana. In absolute term, water
saving over the method of flood irrigation is estimated to
be 1194 HP hours/hectare for sugar cane and about 3245

HP hours/hectare for banana crop.
Another way of judging the water use efficiency is to
compare the water required to produce one unit (quintal)
of output between the two methods of irrigation. In order
to estimate the per quintal requirement of water under drip
and non-drip irrigated condition, we have divided per hectare
consumption of water with per hectare of yield of the
respective crops. As seen in total water consumption, water
use efficiency in terms of output is substantially higher for
those crops cultivated under DMI as compared to the crops
cultivated under FMI. Estimate shows that sugar cane
cultivated under DMI consumes only 1.23 HP hours to
produce one quintal of sugar cane against the requirement
of 2.51 HP hours under FMI. Similarly, for producing
one quintal of banana, drip irrigated crop consumed only
11.60 HP hours of water, whereas the same is estimated to
be 21.10 HP hours for non-drip irrigated crop.
Table 12.3.4
Water Use Pattern and Consumption by Drip and Flood Irrigated Crops
Particulars
Crops Name
Method of Irrigation
DMI
FMI
No. of irrigation
per hectare
Banana
Sugar cane
139.14
34.04
66.19
25.92
Hours used per irrigation
Banana
Sugar cane
Banana
Sugar cane
Banana
Sugar cane
5.33
15.44
9.82
3.40
7884.70
1740.08
16.44
33.44
10.82
3.56
11,130.30
2934.08
HP of the pumpset used

Water Consumption
(HP/hours/hectares)
Notes: Data on banana and sugar cane are related to the year 19934 and 19989 respectively.
Source: Computed using field survey data.
Benefit over FMI

Per cent
29.20
40.69
Value
3245.60
1194.00
300

Table 12.3.5
Productivity of Drip and non-Drip Irrigated Crops
Particulars
Crops Name
Productivity (quintal/hectare)
Cost of production (Rs/quintal)
Water use efficiency
(HP hours/quintal)
Banana
Sugar cane
Banana
Sugar cane
Banana
Sugar cane
DMI
FMI
679.50
1413.20
75.70
30.94
11.60
1.23
526.35
1168.00
100.20
42.44
21.14
2.51
Benefit over FMI

Percent
Value
29.10
20.99
24.45
27.09
45.13
50.99
153.20
245.20
24.50
24.50
9.54
1.28
Source: Same as in Table 12.3.4.
Productivity Gains
Another important advantage of DMI is increased productivity.
Studies on DMI have confirmed that the problem of moisture
stress is completely reduced by providing water at required
quantity and regular interval, both of which help to increase
the yield of crop to a considerable extent. Our survey results
indicate a significant difference in the productivity of crops
cultivated under drip and non-drip irrigated condition (Table
12.3.5). The productivity difference between drip and nondrip irrigated crops comes to about 245.20 quintals per ha
for sugar cane and about 153.20 quintals per ha for banana.
That is, productivity gain due to DMI is about 21 per cent
in sugar cane and 29 per cent in banana. There are 3 main
reasons for the higher productivity of crops cultivated under
DMI over the method of FMI. First, the moisture stress is
less in drip irrigated crops as water is supplied at a regular
interval and in required quantity (Figure 12.3.1). Second,
weed problem is less in drip irrigated crops as it does not
supply water to non-crop zone. Third, the efficiency of fertilizer
use is very high as losses through leaching and evaporation
are very minimal while using DMI. One may argue that the
productivity difference is possibly due to higher use of yield

increasing inputs by drip adopters. However, this argument
is not validated by our survey data. In both crops, the cost
of cultivation (it is a proxy for level of input use) of drip
adopters is marginally lower than that of the non-drip adopters.
Therefore, one can firmly conclude that the increase in yield
is mainly because of DMI. Besides increasing the productivity
of crops in absolute term the cost efficiency (cost required
to produce one unit of output) is also found to be higher
among the crops cultivated under DMI.
ECONOMIC VIABILITY
OF
DRIP IRRIGATION
Despite the gains, the costs too have to be considered. Drip

irrigation system requires relatively a larger amount of fixed
investment and, therefore, farmers often ask whether it is
economically viable or not. The farm business income (FBI),
which is the difference between gross income and total cost
of cultivation (our cost refers to A2), explains the relative
profit level of DMI and FMI. As expected, the FBI of drip
adopters is significantly higher than non-drip adopters in
Moisture Content
Drip Method
Sprinkler
Method
Surface
Method
Wilting Point (15 atm)
20
15
10
Days
Fig. 12.3.1 Moisture Availability for Crops in Different Irrigation Methods
Water 301
Table 12.3.6
Input and Output Pattern of Drip and Flood Irrigated Crops
Particulars
Crops Name
DMI
Cost of Cultivation (Rs/ha)

Gross Income (Rs/ha)
Farm Business Income (Rs/ha)
Capital Cost of Drip Set (Rs/ha)
(without subsidy)
Capita Cost of Drip Set (Rs/ha)
(with subsidy)
Banana
Sugar cane
Banana
Sugar cane
Banana
Sugar cane
Banana
Sugar cane
Banana
Sugar cane
51,437
43,729
1,34,044
1,14,536
82,607
70,861
33,595
54,470
22,236
35,313
FMI
52,740
49,573
1,02,935
91,871
50,197
42,298
Benefit over FMI

Percent
Value
2.50
11.78
30.22
24.67
64.56
67.53
1303
5844
31,109
22,665
32,410
28,563
Notes: Banana and Sugar cane are related to the year 19934 and 19989, respectively.
Source: Computed using field survey data.
both the crops considered for the analysis. The FBI of drip
adopters is Rs 28,563 per ha higher than that of the nondrip adopters in sugarcane and the same comes to about Rs
32,410 per ha for banana (Table 12.3.6). Since drip method
of irrigation increases the productivity, and that too with
reduced cost of cultivation, the FBI of the drip adopters is
substantially higher that of non-drip adopters.
We have next computed both NPW and in BCR using
discounted cash-flow technique. Since drip irrigation involves
fixed capital, it is necessary to take into account the income
stream for the whole life span of drip investment. But, in
the absence of observed temporal information on benefits
and costs, the following realistic assumptions were used so
as to estimate both the cash inflows and cash outflows:
1. The life period of the drip set is considered as 5 years
for both sugar cane and banana as followed by the INCID
study (1994).
2. The cost of cultivation and income generated using
DMI is assumed constant during the entire life period of
the drip set.
3. Differential rates of discount (interest rates) are
considered to undertake the sensitivity of investment. These
are assumed at 10, 12, and 15 per cent as alternatives
representing the opportunity costs of capital.
4. The crop cultivation technology is assumed constant
for both sugar cane and banana during the entire life period
of the drip set.
The investment on the drip set can be treated as
economically viable if the net present value of benefits is
greater than the net present value of costs. The BCR is also
related to NPW as it is obtained just by dividing the present
worth of the benefit stream with that of the cost stream.
Generally, if the BCR is more than one, then, the investment
on that project can be considered as economically viable
(Gittinger 1984).
Table 12.3.6 presents the details of capital cost, subsidy,

production cost, and gross value of production for sugar
cane for both Pune and Ahmednagar districts. As mentioned
earlier, since DMI is a capital-intensive technology, the state
government provides nearly 50 per cent of the capital cost
as subsidy to encourage the adoption of drip irrigation in
crop cultivation. The average capital subsidy comes to
Rs 19,157 per ha for sugar cane and the same is about Rs
11,359 for banana. As a proportion of the total capital cost
of the drip set, subsidy amount accounts for about 35 per
cent for sugar cane and about 33.82 per cent for banana.
After deducting the subsidy, the fixed capital cost of the drip
set comes down to about Rs 35,313 per ha for sugar cane
and about Rs 22,236 for banana. The estimated NPW and
BCR, with the assumption that there will not be any change
in cost of production and gross income during the entire
life period of the drip set, are presented in Table 12.3.7.
It comes clearly from the estimate that investment in
DMI is economically viable even without subsidy. The NPW
estimated with subsidy is higher than that without subsidy,
indicating the potential role of subsidy in increasing the
viability of drip investment. For sugar cane, at 15 per cent
discount rate, the NPW of drip investment is about
Rs 2,06,692 per ha with subsidy and the same is about
Rs 1,90,025 per ha without subsidy. For banana, the NPW
of drip investment is about Rs 2,57,635 per ha with subsidy
and Rs 2,47,753 without subsidy at 15 per cent discount
rate. As subsidy reduces the density of capital, the NPW of
drip investment increases considerably after excluding the
subsidy amount from the capital cost. Similarly, while
reducing the discount rate from 15 per cent to 10 per cent,
a significant improvement is observed in the NPW of drip
investment under both with and without subsidy condition
in both crops. This implies that farmers will gain more by
adopting DMI if the lending rate goes down, which is
possible in the new economic environment. The benefit
302

Table 12.3.7
Net Present Worth and Benefit Cost Ratio of Drip Irrigated Crops
Particulars
Discount Rate %
Without subsidy
Sugar cane
Present Worth of Gross Income (Rs/ha)
Present Worth of Gross Cost (Rs/ha)
Net Present Worth (Rs/ha)
BenefitCost Ratio
15
12
10
15
12
10
15
12
10
15
12
10
3,84,039
4,12,902
4,34,206
1,94,014
2,06,287
2,15,347
1,90,025
2,06,615
2,18,859
1.98
2.00
2.02
Banana
4,49,449
4,83,228
5,08,026
2,01,696
2,15,431
2,25,484
2,47,753
2,64,797
2,82,542
2.29
2.24
2.25
With subsidy
Sugar cane
3,84,039
4,12,902
4,34,206
1,77,347
1,89,179
1,97,913
2,06,692
2,23,723
2,36,293
2.16
2.18
2.19
Banana
4,49,449
4,83,228
5,08,026
1,91,814
2,05,287
2,15,159
2,57,635
2,77,941
2,92,867
2.34
2.35
2.36
Source: Computed using sample survey data.
cost ratio estimated for sugar cane varies from 2.16 to 2.19
with subsidy and from 1.98 to 2.02 without subsidy, while
the same ranges from 2.34 to 2.36 with subsidy and from
2.23 to 2.25 without subsidy for banana crop. Interestingly,
our estimate of NPW also indicates that the adopters of
drip-irrigation technology from both the crops would be
able to recover the entire capital cost from their income in
the very first year itself.
This analysis has considered only the explicit direct benefits
realized by the farmers in the form of productivity and does
not include the various benefits of drip method of irrigation
that the society ultimately expected to gain. For instance,
by reducing the consumption of water, drip irrigation
technology conserves water, reduces over-exploitation of
groundwater as well as degradation of soil fertility and
consumption of electricity required to lift water from the
wells. If we quantify all these benefits and include them in
the benefitcost analysis, the BCR of drip investment would
increase considerably.
POLICY IMPLICATIONS
Though our study confirms that DMI is economically viable
for farmers even without subsidy in crops like sugar cane
and banana, the subsidy cannot be stopped till the new
irrigation technology covers an area adequate to expand
subsequently through demonstration effect. However,
uniform level of subsidy schemes currently followed for
water-scarce and water-abundant areas need to be changed
and higher subsidy should be provided for those regions
where the scarcity of water is acute.
One of the important reasons for the low spread of this
technology even in the water-scarce area is the availability
of highly subsidised canal water as well as electricity for
irrigation pumpsets13. Appropriate pricing policies on these

two inputs may encourage the farmers to adopt this
technology. Despite the fact that the investment on drip
irrigation technology is economically viable, farmers are
often reluctant to adopt this mainly because of its relatively
capital-intensive nature. In order to increase the adoption of
DMI by the cultivators including the resource-poor farmers
(marginal and small categories), the capital cost required for
drip irrigation system should be brought down. By recognizing
drip industry as an infrastructure industry as well as
announcing tax holiday for specific time periods to all drip
set industries can the competition be increased, which will
ultimately bring down the capital cost of the drip set. For
widespread adoption of any new technology, quality extension
network is essential. The present status of extension network
operated mainly by government agencies does not seem to
be making significant impact on the adoption of this
technology. Therefore, there is a need to revamp the whole
extension network by involving the drip set manufacturers
in order to increase the quality of extension service. Sustainable
agricultural development will not be possible unless the goal
of more crop per drop of water is achieved.
13 If we rework the data to incorporate the difference in true cost
of water reflected in the difference between the two technologies then
per hectare for banana the difference in HP hours is (11,130.30
7884.70)=3245.60 (Table 12.3.4 ), which is roughly 2550 units,
which today at a low estimate of the cost to serve of Rs 2, amounts
to Rs 5100 in favour of drip irrigation. This is more than 10 per cent
of the gross private cost of cultivation. (In the case of sugar cane the
savings is significantly less). This would substantially improve the
private return for the farmer and lead to the adoption of drip irrigation.
When the good water table is deep down, the economics both social
and private would be in favour of drip, and the latter would, even
without any subsidy (or with bundled input subsidies), have led to fast
adoption of drip had there been no flat rate-based subsidies in electricity.
Water 303
12.4 WATER IN URBAN INDIA: THE SCENARIO, ENERGY LINKAGE, AND

PRIVATE PARTICIPATION
Jol Ruet
This section adopts a long-term perspective on costsustainability. Assessing the fuzzy economic characteristic
of water, with tariffs numbering in the hundreds and no
guarantee on quality, it argues for greater scope for product
as well as consumer differentiation, and a rethinking of the
entire technical-cum managerial organization of the sector.
The idea is to reach differentiated targeted costs for specific
uses of water and ways to integrate the management of
pollution and sanitation, with water supply. The implications of technical choices in water are discussed
as well as the role for the civil society and alternative
systems.
THE WATER SCENARIO: LIMITS

LIMITS OF THE PRIVATE
OF THE
PUBLIC,
The Johannesburg Summit estimated the worlds annual

public plus private capacity to invest in water and sanitation
to be in a range from US$30 billion to US$60 billion.
However, the annual requirement has been assessed to be
of the order of US$100 billion (according to the pessimists,
a US$180 billion). Taking a more local perspective, if we
look at the different types of revenues in India, traditional
financing modes for infrastructure may anyway only be
relevant for a happy few for whom they are affordable.
Beyond this group, it is imperative to reduce cost and
quantity, and some use of decentralized systems cannot be
dismissed. In other words, the current estimates in billions
of dollars have to be contested on the field to see whether
it is possible to deliver reasonable services at a lower cost

using alternative approaches.
What is the size of the problem in India? When the
treated wastewater is less than 10 per cent even in urban
areas and 90,000 unprotected sites for industrial solid waste
exist, the task left unfinished is simply humungous. This is
despite the fact that the urban contribution to the national
GDP is more than 50 per cent and urban revenues should
have been used more to solve these issues (Table 12.4.1).
The Public Sector Response

Water is mostly publicly managed in India and this model
is in a critical shape today. As far as water access is concerned,
the average situation is quite poor for some states (Tables
12.4.2 and 12.4.3), even in official figures. For the total
annual demand for water for India, Sharma (2002) gives
the figures of 470 billion cubic metres3 in 1985, and 770
billion cubic metres3 in 2025, that is, an annual growth of
1.65 per cent. Of this, groundwater meets 80 per cent of
the demand in rural and 50 per cent of the demand in urban
areas. However, about 70 per cent of available water is
polluted, about 80 per cent people live with inadequate
sanitation facilities, about 70 per cent of all diseases are
water-borne, which materialize into about 73 million
workdays being lost each year.
In Class I cities, only 32 per cent receive more than
145 lpcd. The situation becomes really worrying in Class
II cities (population of more than 50,000 persons), where
only 20 per cent exceed this level. Further, even when cities
Table 12.4.1
Urban Population and Share of the Urban Sector in GDP
Total population (million)

Urban population (million)
Per cent urban of total
Contribution of urban
Sector to GDP (%)
Level of water demand (BCM1)
domestic sector2
industry and energy
Share of total withdrawals (%)
1951
361
62
17.3
29
1981
683
160
23.3
47
1991
846
217
25.7
2001*
2011*
1012
291
28.8
> 50
1178
377
32.0
25
67
17
2025
52
228
27
Notes: 1. BCM = Billion Cubic Metres.

2. Includes both rural and urban households.
* Estimates or Projections.
Sources: Ministry of Urban Development and Poverty Alleviation, New Delhi; World Bank (1998); Ninth Plan Document (20027); all
quoted by Meinzen-Dick and Appasamy (2002). Updated with Census 2001.
304

Table 12.4.2
Access to Water Supply in Urban Areas (Status as on 1997)
Population provided with

water supply (percentage)
States
High: More than 85 per cent
Medium: Between 75 and 85 per cent

Low: Less than 75 per cent
Andhra Pradesh, Arunachal Pradesh, Delhi, Gujarat, Haryana, Himachal Pradesh,

Jammu and Kashmir, Karnataka, Madhya Pradesh, Maharashtra, Meghalaya, Nagaland,
Rajasthan, Uttar Pradesh, West Bengal
Bihar, Goa, Manipur, Punjab, Tamil Nadu, Tripura
Assam, Kerala, Mizoram, Orissa, Sikkim
Note: Table 12.4.2 shows that nearly half the states only get a medium to low water supply access. Even in Class I cities the quantity of
water is medium or low in a majority of states).
Source: GoI, 1999:136.
Table 12.4.3
Water Availability in Class I Cities (1988)
Per Capita water availability
States
High: Over 160 lpcd

Medium: Between 120160 lpcd
Low: Less than 120 lpcd
Maharashtra, Orissa, Uttar Pradesh, Jammu and Kashmir, Delhi, Chandigarh, Pondicherry,
Andhra Pradesh, Bihar, Gujarat, West Bengal
Haryana, Karnataka, Punjab, Rajasthan, Tamil Nadu, Kerala, Madhya Pradesh, Manipur, Tripura
Source: Compiled by Saravanan (in Ruet, Saravanan, Zrah 2002, from TARU (1999:7) and MIDS (1995:7))
have supply, continuity of the service can be quite low, as

Table 12.4.2 shows, even for the four metropolitan cities.
Table 12.4.4 also shows that the only city that recovers
the cost of its public water service is Mumbai, which helps
it sustain its infrastructure in the long run. The figure for
Chennai relates to the (very limited) part of water that is
charged. Actually, Chennai recovers only a limited part of
its expenses, and this mostly through tax collection. Divided
by the total water production, the de-facto water tariff was
only Rs 0.14 per kl in 2002 (Moench and Janakarajan 2002.
See note to Table 12.4.5), while its total cost was Rs 15.11
per kl. The situation is unsustainable.
A Private Alternative?
In a situation of scarcity, and limits to public sector expansion,
the private sector has been advocated as the solution to the
problems of the sector. Chennai has been advanced as a case

in point (WSP 2001), especially because the Chennai Metro
Water Board has started buying water from farmers and
hiring transporters to deliver it, or even because, in a purely
private transaction, lorry owners themselves buy and sell
water. However, one should not forget the context of the
scarcity scenario of water supply in Chennai that has led
to a necessary complement by the private sector. However,
if one looks at the water supplied by the private sector and
compares the economic cost to its value it is no longer
certain that it is a panacea. Table 12.4.5 shows the various
economic values of the water good. It gives an amazing
range of values, but what do they mean and what is the
economic value of water?
First of all, let us look at water as a raw product, before
treatment. Its extraction cost is difficult to assess, since it
Table 12.4.4
Service and Efficiency Indicators for the Major Metropolitan Cities
Service Indicators
Service Coverage (in %)
Water Availability (in hours per day)
Average Tariff (Rs per cubic metre)
Efficiency Indicators
Unaccounted Water (%)
Unit Production Cost (Rs per cubic metre)
Accounts Receivable (months)
Staff per 1000 connection
Average O&M cost per person (in Rs)
Mumbai
Kolkata
1997
N.A.
5
2.1
100
5
2.7
64
10
1.5
66
10
0.5
69
7
1.4
86
3.5
1.6
48
3
N.A.
18
2.4
19.7
33.3
1358
36
1
2
16.2
84.30
50
1.2
1.5
17.1
25
30
0.6
NA
8.9
98.80
26
1.7
4.5
21.4
355
N.A.
2.9
9.5
38.7
85.9
Note: * The figure for Chennai relates to the charge for industrial consumers.
Source: MIDS (1995:4) and ADB (1997).
1997
1992
Chennai
1991
24
1.1
2.5
61
90.25
1992
Delhi
1997
1991
1997
97
4
11.4*
20
8.5
5.8
25.9
675
Water 305
Table 12.4.5
Value of Water for Different Economic Activities
Table 12.4.6
Revised Estimates for the Expenditures of Chennai Metrowater
Board (Rs in crores)
Rs/m3
Value of rice produced (per cubic metre of water)

6.00
Value of water at rate Chennai Metro Water Authority
0.14*
charges to customers
Cost of supply for Chennai Metro Water Authority
15.11
Rate at which water is sold by farmers to transporters
3.15
Water sale charges (bulk private)
33
Water sale as represented by metro bribes for
67
bulk deliveries, drought periods
Water sale in cans (at Rs 1.25/litre)
1250
Water sale rate in bottles (at Rs 10/litre)
10,000
Note: * This figure is the average figure obtained by dividing the
total revenues by the total distributed water.
Source: Moench and Janakarajan, 2002.
would require a proper valuation of total electricity costs

(Nagaraj 1998). However, the tariff at which farmers sell
it to landowners might be a proxy, even if it includes the
farmers profits. This gives a value of Rs 3.15 per cubic
metre (kilolitre). Is this the value of water? Actually, if one
considers that the cost of treatment does not constitute a
large share of expenses of the Chennai water board (Table
12.4.6), the distinction between raw and treated water does
not matter much if one is to seek for a general economic
value of water for urban use. Then, if one looks at the total
cost for water supply, of Rs 15.11 per kl for the CMWSSB
(Chennai Metro Water Supply & Sanitation Board), it
means that, one way or another, through public expenditure
and subsidies, the economic system is ready to pay this rate.
This implies that the social value of water may be higher,
and the value is much higher than its mere extraction cost.
Compared to this the economic value generated through
water-intensive agriculture like rice, is lower by 60 per cent
(Rs 6.00 per kl).
In other words, and with appropriate caveats for the use
of proxies, at the level of the metropolis, a resource with
a high social value is used for an agricultural purpose worth
60 per cent less. This suggests what more refined studies
confirm: that less water-intensive agricultural practices should
be thought of in densely populated water-scarce areas
(Nagaraj 1998).
Ultimately, and even if the implicit market rationality of
the above reasoning cannot directly apply to a good whose
nature differs, whether it is locally extracted or transported
to the city, the rough evaluations give the scope of a public
regulation of water usage at the metropolitan level. However,
this has to be organized carefully. Indeed, a preliminary
study (Gambiez Lacour 2003) on the so-called tripartite
agreement (between the Tamil Nadu Electricity Board, the
farmers, and the Chennai Metro Water Supply and Sanitation
Board (CMWSSB), to extract rural groundwater to be sold
Description
R.E. 20012
Power
Chemicals
Operation & maintenance
Drought
Water tanker hire charges
Payment & provision to employees
Office & administration expenses
Depreciation
Interest
Provision for bad debts
Contribution to pension fund
Renewal of asset fund
Total
17.39
2.21
10.71
45.00
30.00
52.98
3.99
45.00
116.73
2.00
326.01
Source: http://chennaimetrowater.com/archivemain.htm
to the CMWSSB) shows that water extraction in rural areas

for an urban use may lead to higher social segregation in
concerned villages, as well as endanger the resource,
ultimately bringing a halt to the local rural economy. When
the public sector fails to keep in view these externalities, it
is all the more unlikely that private lorries will be the better
solution.
This discussion gives a more precise clue to the public
failure, but suggests that the solution is rather to be looked
at from the angle of usage segregation and adapting different
qualities than to different uses. But in that context, what
does the private sector do? From buying water at a Rs 3.15
per kl from the farmers, it sells it at Rs 33 per kl in bulk,
after little (if any) treatment. This tariff partly reflects the
huge costs of transportation, which are socially inefficient
(notwithstanding the congestion and pollution costs in the
city), but it is also, taking into account the private profit,
unaffordable to most of the Chennai residents. This way of
using the private model simply cannot be a long-term general
solution. However, it has to be compared with the larger
public sectors failure: the unofficial bribing costs for access
to so-called freely distributed water during scarcity periods,
which Moench and Janakarajan (2002) estimate to be in the
range of Rs. 67 per kl!
We therefore see that for a supposedly homogenous
product, the market price for a cubic metre of water varies
from Rs 0.14 (with no guarantee either on quality or quality)
to Rs 33 and even Rs 67 (with no additional guarantees)
even ignoring the cost of bottled water. Our main line of
argument is that the sector offers scope for product as well
as consumer differentiation, and calls for a rethinking of the
entire technical-cum managerial organization of the sector.
The advantage of considering separately the various uses
of water allows a more refined analysis of the role of the
306

Table 12.4.7
Regional Variations in the Urban Water Markets in Ahmedabad
Attributes
Public Sector
User perceptions of public
supply quality
Cost of supply to government
Tariff charged by government
Per cent tariff recovery
reported by government
Loss to government
Per cent willing to pay more
Private Sector
Per cent of users depending on
private sources due to inadequacy
of government supply
Cost of supply in private sector
Tariff charged by private sector
Profit for private sector
Per cent supporting privatization
of government water services
Hard Rock Region
Central Alluvial
Southern Water Abundant
48% pressure adequate,

quality generally good
Rs 7.81/m3
Rs 1.61/m3
60
58% pressure adequate, quality

generally unsatisfactory
Rs 6.8/m3
Rs 1.23/m3
61
72% pressure and

quality good
Rs 5.7/m3
Rs 1.21/m3
60
Rs 6.84/m3
51
Rs 6.04/m3
36
Rs 4.97/m3
39
25
18
Rs
Rs
Rs
Rs
Rs
25
20/m3
45/m3
34/m3
25/m3
14/m3
summer
non-summer
summer
non-summer
Rs
Rs
Rs
Rs
Rs
25
26/m3
41/m3 summer
33/m3 non-summer
15/m3 summer
7/m3 non-summer
Rs
Rs
Rs
Rs
Rs
22
23/m3
44/m3
34/m3
21/m3
11/m3
summer
non-summer
summer
non-summer
Source: Survey by VIKSAT, 19992000, Ahmedabad, quoted by Moench and Janakarajan (2002)
private sector. For instance, if one looks at the lessons on

the functioning of urban water markets in Ahmedabad
(Table 12.4.7), one can see that there is a section who, in
order to receive better service conditions, are ready to pay
more and go for comprehensive privatization. In some
zones, anyway, people have to de facto depend on private
sources. However, if one looks at the production costs,
which measure the economic cost efficiency, they vary from
Rs 5.7 to Rs 7.8 per kl for the public sector, but from Rs
20 to Rs 26 for the private sector14. It is true that these
higher private costs hide the fact that both the quality and
the service are possibly higher. But such tariffs, if possibly
understandable for potable water, cannot be extended in a
sustainable way to the bulk of the consumers, or to the bulk
of different water usages. This example suggests how,
according to the water usages, the delineation of the public
role and the private role can be assessed. In the present
situation it is very likely that the Indian private sector is
able to take charge of the supply of relatively higher and
purer usages of water, but not so much the bulk supply
for other uses.
Before examining possible solutions based on usage
segregation for some specific Indian cities, let us complete
14 We consider only the costs, and not the tariffs, since the tariff
issues are linked with regulation as well as with a trade-off between
affordability to the consumer and a reasonable profit, which is not
the issue discussed here.
the long-term cost scenario with the pollution and treatment

costs.
WATER
AND
POLLUTION ABATEMENT
Though we will keep the focus on water, pollution must

be discussed. Indeed, it links up with water quality as far
as treatment of raw water to obtain potable water is
concerned. Pollution ultimately leads to an increase in
treatment costs, and, hence, water costs. Also, local pollution
directly impacts groundwater quality, which still meets
50 per cent of urban needs. The question is as follows: at
the current pollution levels, are abatement costs affordable
and sustainable for India? Abatement costs are always difficult
to assess ex ante, and feedback in the Indian context is
lacking. However, an interesting benchmark can be taken
from the European case (Box 12.4.1).
As far as India is concerned, the World Bank (1998) gives
estimated costs of inaction on health, soil degradation,
costs of power subsidy, and industrial production. Health
aspects were estimated to be in the tune of Rs 230 billion
in 19912, (3 per cent of GNP). This gives only an indirect
measure of the costs that should be borne to treat water
effluents; basically, if one assumes these social costs, this
means that a benevolent public state can spend up to that
level in addressing pollution. More direct assessment studies
such as those made by TERI (report Green India 2047)
details that, for water treatment with a full coverage by
Water 307
Box 12.4.1
A Benchmark: The Costs of Removing Pollution in Europe
In Europe, cost of water has risen with higher quality norms, and Dangeard (2001) reports that At the time the Directive on urban
wastewater treatment (91/271) was adopted (1991), the initial cost analysis estimated that additional investments of 40 bn to
60 bn were required. In 1998, the Court of Auditors of the EU found that the costs were to reach 201 bn for nine member
States. An expert report has estimated the average incremental annual treatment costs per capita to be incurred by implementation
before 2005 in 15 member States: in 1995, at 41 increasing to 48 in 2010. He further states that, from the new water Directive
(2000/60), in the UK, for example, costs of implementation up to 2010 would range from 2 billion to 9.3 billion. Tariffs
had to follow and sewerage and wastewater treatment represents a 50 per cent of the water tariffs. Dangeard (2001) indicates that
the charges come to 302 per capita per year for an annual consumption of 120 cubic metres, approximately 1.2 per cent of
the GDP.
Source: Dangeard (2001)
sewage, the annual cost per capita varies between Rs 188

for small (Class II) cities, up to Rs 316 for million plus
cities, for a total of US$99.1 billion over 50 years. Similarly,
IEG (2000) estimates US$2.9 billion a year, as urban and
industrial sector investment requirements between 1995
and 2020, a sum which would be below 1 per cent of GDP.
Ultimately, and even if the costs and land requirement
vary from one technique to another, capital as well as O&M
costs are far from negligible. Table 12.4.8 shows the estimates
from the Ministry of Environment and Forests (MoEF). For
instance, the estimate of O&M costs for an activated sludge
treatment plant is Rs 3 lakh per mld per year. A capacity
of 1 mld used over 365 days represents 3,65,000 kl. That
is, wastewater treatment nearly adds a rupee per kl, only by
taking into account the O&M. If capital costs are to be
amortized over 20 years, this adds another Rs 0.5 per kl.
The Linkage between Pollution, Misuse of Water and

Inefficient Management
In India, treatment is negligible, but the need for it would
be rendered easier by reducing the demand of water. The
latter is feasible if one looks at the useful part of the
produced/used water. In that respect, huge untapped savings
exist, and, if one takes some examples of quantity wasted
(Sharma 2002) from sectoral estimates, they are in the range

of 16 to 25 per cent for domestic use, 20 per cent for
industries and workshops, 25 per cent in construction and
public works, 10 per cent in commercial establishments, 15
to 25 per cent in transportation including road, rail and air
transport, and storage, and 10 to 25 per cent in public
services like government offices, courts, police, etc. In rural
irrigation systems, water losses amount to 15 per cent,
25 per cent for field application losses, and 15 per cent for
farm distribution losses. At the end of the day, there remains
only 45 per cent for effective use by the crop.
Locally, the segment of the population which is the most
affected by pollution, are slum dwellers, and especially those
from slums that are not notified. There, complete dependence
on groundwater resources, in the absence of sanitation,
leads to serious health hazards due to infiltration.
WATER AND ENERGY: CREATING VALUE THROUGH

DECENTRALIZED SYSTEMS AND DECENTRALIZED
MANAGEMENT
Differences in technology including design, and modes of
organization for maintainence and monitoring imply
different categories of stakeholders, with varying patterns of
Table 12.4.8
Costs of Domestic Wastewater Treatment
Technology
Land Required
Hectares/mld
Activated Sludge Treatment Plant (ASTP)

Oxidation Ponds
Aerated Lagoons
Upward Anaerobic Sludge Blanke
Duckweed and fish culture technology
Karnal technology
Trickling filter
Source: Ministry of Environment and Forests, 1998
0.4
1.0
0.6
0.2
0.7 to 1.0
1.0 to 1.5
0.4
Capital Costs
Lakh rupees/mld
35 to 40
12 to 15
15 to 20
23 to 28
10 to 12
0.6 to 0.8
35 to 40
Operation and Maintenance Costs

Lakh rupees/mld/year
3.0
0.5
2.75
1.5
0.5 to 1.0
0.25 to 0.3
3.0
308
consumption, to result in varying in the use of water and

hence economic valuation ultimately, a different willingness
to pay, and different capacities to actually enforce willingness
to pay. This offers scope to specify and reach appropriately
modified levels of purification and treatment according to
the desired quality of water which depends on the type of
use that is expected. Table 12.4.9 shows the break-up of
different domestic uses by supply standards. Flushing and
house cleaning, that is, the use of water that needs the
lowest norms of potability and clarity of water represents
30 per cent of domestic usage15. Given the energy share in
total supply costs, potential savings may be made here.
Indeed, this water could be produced locally, either by using
groundwater sources that otherwise tend to be gradually
eliminated by public organizations, or more likely by local
(area-wise, ward-wise) recycling of the wastewater coming
from the other 70 per cent uses of water. This would, in
turn, save on transportation costs for water. Such a measure
is relevant not only for cities like Chennai (resources
constrained) or Bangalore (where water has to be pumped
from a 150 km distant source and brought to the heights
of the city), but even for a water-rich city like Mumbai,
which, offers 250 lpcd to its people, but takes it from distant
sources (Ruet, Saravanan, and Zrah 2002).
Table 12.4.9 also clearly shows that only a 15 per cent
of water consumption is related to food, drinking, and
dishwashing, that is, only this share of the total consumption
really requires treatment norms up to potable standards.
The problem is that potability norms are lost through
leaking pipes, catchment pollution, and insufficient treatment
or pipe level pollution. This treatment can be done more
locally, (with a differentiated piped system) to actually reach
potability standards.
Simultaneously, this segregation also means that
appropriate wastewater treatment can be very specific to the
Table 12.4.9
Break-up of Minimum Domestic Water Supply Standard
Use/ Activity
Amount (in lpcd)
Drinking
Cooking
Bathing
Cleaning dishes
Cleaning house
Washing clothes
Flushing toilets
Total
5
5
55
10
10
20
30
135
Percentage
4
4
41
7
7
15
22
100
Source: Sanjeev, 1997:15.

15
The part relating to flushing of the toilets may not necessarily

represent in-house toilets: it represents what, one way or another,
is needed to evacuate the excreta: that way, this estimate applies to
all categories.
pollution sources, again focusing on the share of the

wastewater that really needs thorough treatment. These
kinds of measures (whose financial viability needs further
research and is insufficiently documented in India today),
necessitates a managerial change (decentralization of
information and decision making) as well as technical
adaptations.
Pollution Avoidance
India traditionally has a workforce that is linked with
alternative institutional arrangements (for example,
recycling). These can be taken advantage of and developed,
compared to capital and energy-based techniques.
Dangeard mentions one way that has been relatively
unexplored, viz., the (partial) local reuse of water for some
uses, to be segregated from the potable water. They would
include bathing, washing, cleaning, toilet, or many industrial
uses as discussed above. These short circuits are being
attempted in Europe and in the USA but are still
insufficiently considered in India, where no publicized
experiment exists.
Though this is difficult to appreciate in a growth situation
where expansion of cities favours the development of
connections at the expense of pollution abatement, the
latter is, in the long run, much more profitable and, therefore,
sustainable and the policy makers should focus their budgets
on this issue. This should be done in a targeted way, as far
as possible at the source level itself, and in that respect it
is far from obvious that even Common Effluent Treatment
Plants (CETPs) can be a panacea. Indeed, industrial pollution
is more efficiently treated if specific pollutants are directly
reduced from the source, and not from a set of sources, with
mixed pollutions, as non-homogeneous industrial clusters
would lead to.
If one looks at the energy linkage, and especially on the
energy component in the inputs for water supply, the figures
from Chennai are illustrative of two aspects. First of all,
among technical operational costs on the centralized piped
system (power, chemicals, O&M), power amounts to 57 per
cent. Second, this share is actually much higher as far as
long-term energy use is considered, since the insufficiencies
of the centralized piped system have led to a drought
scheme, and hiring of water lorries. In both cases, the
energy part represents the major part of the total burden
of Rs 75 crore! The amounts at stake imply that alternative
technical approaches merit serious consideration.
Institutional Structure in Metros: Different Kinds of

Administrations and Administrative Contexts
Among cities, and independently from the water-resource
situation, the nature of the concerned administration in
Water 309
charge of water can vary from a centralized agency with
principally a single output-oriented objective (water supply),
strongly embedded in the state/municipal sphere, to a rather
autonomous agency, evenly focusing on different issues and
aiming at a managerial delegation, and making attempts for
decentralized techniques. In other words, and using the
main metropolitan cities of India, this ranges from a Kolkatalike situation, surprisingly both politically centralized and
unclear in terms of administrative responsibility, to a Chennailike situation, where institutional and organizational
innovations exist, and are worth being replicated (Box 12.4.2).
Institutional Structure in Class I Cities

Let us sum up the respective characteristics of the water
scenarios in three Class I cities Hisar (Haryana), Vijayawada
(Andhra Pradesh), and Rajkot (Gujarat). The tariffs of these
cities are given in Table 12.4.10.
In Hisar, where water is available, there are no typical
quantity constraints. Interventions to increase the capacity
(expand the system: treatment, distribution), and as well to

optimize the present system are executed by the Public
Health Engineering Department (PHED) of the state, which
is less favoured by the municipality. Public funds channelled
through the various agencies of the Indian public financing
and development system: the PHED as an executing agency,
and HUSA plus HUDCO as the financing agency. This
source of funding, by design, does not include any
conditionality regarding a tariff hike or any kind of tariff
reform and is, therefore, favoured by municipal corporations.
The second aspect, of optimizing and rationalizing the
operation, involves a more unusual set of internal studies,
designing of solutions not off-the-shelf, and a high dose of
social marketing to make the general public aware of the
benefits they can derive from such measures.
In contrast to the Hisar-type municipality, Vijayawada
shows a situation where the entire management of water is
integrated within a single organizationthe Vijayawada
Municipal Corporation (VMC). The financing of the
Box 12.4.2
Proposed Institutional Evolutions for Chennai
Chennai illustrates the levels managerial decentralization can reach within the Indian administrative frame. While it relies on property
tax collection and government support (or government-routed support) for its schemes, the CMWSSB is still mostly structured
around procedures (technical and administrative), and not around services. As a matter of fact, providing full sanitation, in spite
of a tax collected for the purpose, is not looked up as a compulsion. Similarly, as a response to the water scarcity situation, the
Board has de facto given up on satisfying and supplying a part of the population, or rather a segment of the consumption. Whatever
the pragmatic reasons of impossibility to face the demand through a centralized technical system, the Board has had the courage
to promote some more decentralized resources.
CMWSSB treats 60 per cent of its wastewater, of which one-fourth (15 per cent) is sold to industry and power plants. O&M
of water-production wells, water-treatment plants, and sewage pumping stations have been outsourced since 1982 and almost half
of the 118 stations are operated by 24 private contractors. To supplement its piped delivery, it has signed contracts with 500 ownersa
of tankers, who are grouped in an association and has entered into tripartite agreements with TNEB and farmers to purchase water.
Exnora, an NGO with substantial experience in organizing informal solid waste collection, has formed committees among slum
dwellers to organize distribution of water supplied by tankers. CMWSSB has also tried to decentralize management. It has merged
billing and collection at the depot level and made the depot engineer responsible for collection targets. Financial powers have been
delegated down to the assistant engineer level. An information and facilitation cell has been established and monthly meetings
of ward committees are held.
Internally, this did mean that the headquarters have promoted a less centralized model over their technical and engineering
officers. But the Board has also gone beyond that, by promoting an internal delegation of power as well as a better service interface
as far as complaints monitoring is concerned. Whatever the contextual situation in terms of resource and perhaps human resource
at the top of the board, and in spite of the fact that the outsourcing has been mostly decided on a human resource policy basis,
the institutional aspects matter. It can be argued that, compared to the Corporation form, the Board form, with a more clear-cut
budget and allocation from resources to expenditures, allows a better isolation and identification of the tasks, rights, and duties
of the organization. Likewise, the integration of the supply activity and the planning and maintenance, brings some clarity in the
establishment and management of control rights over the assets. And, last but not the least, a sound definition of enforceable and
reasonably sustainable (at least in the short run) tariffs leads to soundness in decision making. Better definition and delineation
of the boundaries of the institution thus allows focusing on the margins of this perimeter, and consideration of suitable policies
in terms of outsourcing. Within that framework, marginal optimizing solutions are envisaged, but keeping this very integration
intact.
a
There are other owners who remain outside the association but contract on a similar basis.
Source: Ruet, Saravanan, and Zrah 2002.
310

Table 12.4.10
Tariffs and Costs in Three Class I Cities
Hisar
Inhabitants (thousands)
Population covered (through piped system; rest is through
hand pumps or tanks)
Supply (lpcd)
Total municipal expenditure (in crores)
Municipal budget for water (operating costs in crores)
Part recovered (in crores)
Vijayawada
Rajkot
257
60 %
845
89 %
850
65 %
135
Not relevant
4.6
1.01
150
155
7.5
5.8
70
79
10.8
Less than energy costs
Note: Water supply (80%) + sewerage (20%).

Source: interviews.
infrastructure remains largely within the funding provided

by the state, and again the kind of operations to be undertaken
has to fit with traditional procedures and practices. However,
the newly-developing areas may be technically isolated,
though they are within the VMC. This zone, the eastern
part of the city, used to be managed through panchayats
before it was incorporated within the VMC. Therefore, this
zone has its own supply through borewells and a stand-alone
distribution network. One option could, therefore, be a
more decentralized option taking into account the existing
system rather than building a new system. For this, and as
per the Vijayawada Municipal Corporation Act, there is no
formal request necessary per se for the sanction from the
state on designing such a decentralized project. Here, the
fact that, compared to Hisar, the PHED does not have to
intervene, is clearly an asset. There is the issue of pollution
as far as the local water cycle is concerned, but here too,
the VMC will be responsible for seeking the state clearance
on the project. Since the city manages the waste disposal
and has shown itself to be reasonably competent, it can be
expected that the implementation of a local clean cycle will
be feasible and positively supported as far as environmental
regulations are concerned.
In Rajkot, the water management is included in the
responsibilities of the municipality. Further, its experience
in PPP17 makes it possible to hope for a good response on
experiments of differentiated use of water. Besides, the
acute scarcity, with service durations of half-an-hour a day,
is the strongest incentive for the general public to welcome
original and decentralized attempts. Further, in the local
context of resource scarcity, the traditional infrastructuredriven and quantity-driven public projects can no longer be
exclusively advocated.
From the example of a few Class I cities, one can again
notice that a clear-cut allocation of responsibilities in favour
of a single administration is an asset in evolving projects;
17 These have to be properly evaluated on field, through an expost analysis of several projects and decision-making processes.
these few examples indicate that a decentralized organization

with powers delegated to the municipal level helps in
promoting more original techniques and managerial schemes.
PRIVATE MANAGEMENT
IN
WATER
Socially equitable, and economically efficient supply options

would be possible only if water is considered as an urban
common property resource (CPR). Such a conceptual shift
necessarily addresses (i) the definition of the property rights
and the CPR relationships at stake, (ii) the governance of
the sector, and (iii) the need for setting up coordinated de
jure rights on the resource through both channels of local
(including civil society) and global actors. In both Chennai
and Kolkata the property rights are exercised by the
municipality (state) and private individuals and enterpreneurs,
but lack of coordination between the two leads to higher cost
than necessary.
The reform of the governance can be based on specific
trade-offs between some amount of reform of the public
sphere (delegation of power within administrations, actual
decentralization from state), and contracting out. The
Chennai example shows relatively better governance and a
technical-cum-managerial solidity of the system that allows
capacity building through delegation, and contracting out
(though the politicization of such deals is not negligible).
With the recourse to local entrepreneurs for pumping
stations, which the experience of Chennai has proved to be
profitable, as it reduces formal costs. The consequence is
that the informal sector gradually increases its part of the
revenue, while the formal sector reduces its deficit for a
given structure by aggregating local entrepreneurs. The
experience of Chennai shows that this is not enough to
cover the structural financial situation, but that there is a
high incremental profitability in such measures. The best
strategy, would be to support and coordinate with the
informal sector, and to start with local entrepreneurs. Then,
after some time, when all the (limited) possibilities given
to the local entrepreneurs and the informal sector have been
Water 311
reached, or close to be fulfilled, one can still consider the
recourse to a global service company.
Given the administrative structure of water agencies in
India, access to information is virtually impossible in the
sense that the information gathered is rarely compiled in an
integrated manner. Since the management of physical
quantities is done independently from the management of
financial sources, which is rather an administrative clearance
process, investors face difficulties in investing in Indian
public agencies or negotiating a contract with them (Ruet
2001 and 2003). Initial recourse to local entrepreneurs de
facto generates information and clarity about legal and
property rights that help analysing the situation of the
agency for the potential investor, that is, the global service
company. In that context, negotiating such a contract after
the involvement of local entrepreneurs is also beneficial to
the service company, and leads to less uncertainty and,
therefore, to a lower premium in financing investments, and
to more targeted investments. That way, the transitory period,
that is, the period that the company needs for the benefits
to cover the costs can be considered as substantially less as
compared directly bringing in a global company.
This strategy is thus to be preferred by the global company,
by the policy makers in the sense that it saves jobs and
provides preliminary (visible) results before privatization,
and for the water agency itself in the sense that the strategy
maximizes its revenue.
CONCLUSION
Water scenarios are city-dependent. If there is an opportunity
to jointly promote decentralized techniques, decentralized
management, and delegation of management, even in limited
respects to the local private entrepreneurs and communities,
one should consider the initial situation, and adopt a more
dynamic approach. Indeed, the Chennai example shows
both governance and a technical-cum-managerial solidity of
the system that allows capacity building through delegation

and technical decentralization.
The traditional question of giving water to the private
sphere as a concession versus leaving it within the public
sphere can be examined in this very framework. There are
no credible projects for a large management contract, or
recourse to the large (international) private water companies.
On the contrary, and despite the doubts and hesitations on
its possible implementation, Mumbai seems to mostly focus
on schemes supported by large international organizations.
Chennai at the moment is in the intermediary position, as
it simultaneously considers local outsourcing for the water
supply and sanitation operation, and large private companies
as far as waste disposal is concerned. However, questions
arise on both the environmental sustainability (without
recycling), and the economic sustainability (compared to
employment generation and recourse to the informal or
NGO sector).
So far, the debate is limited to the adherents of technical
centralization, among them mostly engineers of water boards/
departments, and the others who hold that decentralized
options such as water tankers (but mostly rain water harvesting),
and the use of local water sources through mini water supply
schemes hold the key to service improvement. Applied research
on the actual costs for the society (economic and environmental
costs), and the potential development of such schemes
(identification of actors that can be involved, financing tools
required, quality control and monitoring, etc.) could be the
first step towards engaging in a fruitful debate.
Bringing in local entepreneurs in outsourced tasks and
in smaller supply systems could be useful intermediate stage
before global companies are brought in. The clarity of
information and diligence that this intermediate stage can
bring are vital to reducing risks for both the public entity
and the private company. There is considerable savings in
water usage and in costs that are possible if the variegated
uses of water are recognized to exploit recycling opportunities.
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314
!
SANITATION AND PANCHAYATS IN

INFRASTRUCTURE
13.1 SANITATION AND WATER SUPPLY: THE FORGOTTEN INFRASTRUCTURE

Dileep Mavalankar and Manjunath Shankar
Images of big dams, bridges, roads, power plants, airports,

etc. are evoked by the word infrastructure. But few think
of the toilet bowl or the water tap in the house as
infrastructure. But they remain the most commonly needed
items of basic infrastructure. Recent studies have shown
that investing in infrastructure will improve the health of
the people, which in turn will increase productivity. For
instance, regression studies on data from 74 middle income
countries shows that good infrastructure (access to water,
sanitation, telephones, and roads) is very strongly associated
with low levels of maternal mortality, infant mortality and
under-5 mortality; as well as low levels of poverty and high
levels of enrolment in primary education (Irigoyen 2003).
The most vital sector of infrastructure for achieving the goal
of health is provision of sanitation and drinking water.
Water supply and sanitation, which has the greatest impact
on health, is one of the sectors of infrastructure of our
country, which need the most urgent attention. The need
is felt more, since investments are not necessarily
appropriable, but the social benefits are stupendously large,
warranting, therefore, state intervention. Studies and research
on sanitation and water supply as infrastructure are also
limited. For example, the India Infrastructure Reports
covered over the last three years, a total of 103 articles, of
which only 7 were on sanitation and 10 on water.
We explore the importance of sanitation and water supply
in terms of health and other benefits. We also bring out the
woeful status of sanitation and water in India, and the rate
of progress in the sector. Next we analyse the reasons for
the poor status of sanitation and its slow progress. We also
explore the role of NGOs in promoting water and sanitation,

which we illustrate with case studies. Lastly, we provide
some suggestions on how the situation can be improved.
Although water and sanitation are both important, we have
stressed sanitation since it is even more neglected than
water. Epidemiological evidence suggests that sanitation is
as effective in preventing disease as improved water supply.
BENEFITS
OF
SANITATION
AND
WATER SUPPLY
Access to sanitation and water supply is a fundamental need

and a human right. It is vital for the life, health, and dignity
of the people. According to World Health Organization
(WHO and UNICEF 2000), the improved water supply
and adequate sanitation will result in:
25 to 33 per cent reduction in diarrhoeal diseases in
the developing world, which accounts for 4 billion cases
each year.
Decreased incidence of intestinal worm infestation
(estimated at 10 per cent of the population in developing
countries), which leads to malnutrition, anaemia, and
retarded growth.
Controlling blindness due to trachoma, and
schistosomiasis, which are also water related.
In India poor hygiene and sanitation accounts for 9 per
cent of all deaths and an estimated 27,463,000 years of life
lost each year (Murray 1996). This risk factor (arising from
poor water supply and sanitation) is the second largest
contributor to the burden of disease in India, contributing
Sanitation and Panchayats in Infrastructure
315
Box 13.1.1
Gender and Sanitation
Gender differences play an important role in sanitation. Young girls and boys often do not differ in their personal sanitation habits.
Both may relieve themselves in open spaces as and when required. When they approach puberty, girls often have to meet stricter
cultural requirements than boys: they must
use only more secluded places, which are often farther from home,
go only with a group of other girls and only during the twilight hours, or
defecate only at home and help their mothers to dispose human and solid waste
stop attending school, etc.
The situation for adolescent girls becomes more complicated when they start having their menstrual periods and need more
privacy and sanitary facilities. A sanitation facility in school and at home may reduce these inequalities. Girls become more equal
because they no longer have to walk far and drop out of school for lack of proper sanitation. The improvement may, however,
also create new gender inequalities. The collection of water for flushing, cleaning, and hand washing, for example, may create more
work for women and girls. Often, such new tasks are not shared between allmen and women, boys and girlswho use latrines
and practice hand washing. Most of the times burden of getting water and keeping the toilets clean falls on girls and women.
Source: Sanitation Connection (2003).
to 9.5 per cent of total Disability Adjusted Life Years

(DALYs1) lost. (The first is malnutrition, contributing to
22.4 per cent of total DALYs lost, and which is indirectly
linked with sanitation.) The problem of poor sanitation is
exacerbated in India because of the following factors: i)
tropical climate, ii) dense population, iii) low socio-economic
status of most of the population, and iv) underdevelopment.
Women and the poor bear a disproportionate burden of
the effect of poor sanitation and water supply due to their
socially defined roles. Box 13.1.1 summarizes the relationship
between women and sanitation.
There are many diseases caused by poor water and
sanitation, such as diarrhoea, typhoid, jaundice, intestinal
worms, etc. Table 13.1.1 gives the number of cases and deaths
Table 13.1.1
Number of Cases and Deaths Reported and Estimated
Due to Select Diseases Caused by Poor Water
Supply and Sanitation (2002)
Reported
Disease
Cholera
Acute
diarrhoeal
disease
Enteric fever
Viral hepatitis
Estimated
Cases
Deaths
Cases
Deaths
3829
8,215,296
6
3594
NA
19,29,43,000*
NA
7,11,000*
9,22,000#
3,79,304
1,31,798
382
1322
3,00,000*
NA
NA
17000#
reported and estimated for few selected diseases in India,

which are caused due to poor water supply and sanitation.
The above reported figures are a gross underestimate
since the health management information system or disease
reporting system is poorly developed in India and, hence,
there is considerable underreporting of cases of infectious
diseases. Also, not all the diseases caused by poor sanitation
are shown in the table. It is estimated that 70 per cent of
all diseases are water-borne. The economic burden of ill
health caused by poor sanitation and water supply is also
substantial. People spend a lot of money for treatment of
these highly preventable diseases. Surveys have shown that
on an average people spend Rs 123136 per case of gastroenteric infection (NCAER 1992). The costs of treatment
have gone up substantially since 1992 as medicine costs
especially have gone up. Also, about 73 million workdays
are lost each year due to water-borne diseases. Health benefits
of improved water supply and sanitation, also include an
increased economic well being at the household level, mainly
through saving large amounts of peoples time and energy.
Such saved time and energy can be used in economically
productive or educational activities. Table 13.1.2 gives details
of estimated time saved by improved water supply and
sanitation.
Key Dependencies
Notes: Park (2000); # Murray, Christopher and Alan Lopez (1996);

NA Not available
Source: GOI (2002).
Irigoyen has reviewed a number of studies worldwide and

has listed the following benefits to education and health
arising from better sanitation and water supply (Irigoyen
2003):
1 DALYs is a measure of disease burden which is devised to

combine mortality and morbidity after adjusting disability. It measures
how many years of healthy life is lost due to mortality and morbidity
caused by a particular disease.
Water and sanitation affect school attendance and

test scores. The lack of piped water reduces school attendance
by 217 per cent in Africa.
316
Table 13.1.2
Time Gains by Improved Access to Water and Sanitation
in Sub-regions: African Region (AFR-D) and Eastern
Mediterranean Region (EMR-D) with High Child
and High Adult Mortality
Potential Outcomes achieved by
Time gains by sub-regions

(hours per year per capita)
AFR-D
Halving the population without

access to safe water
Halving the population without access
to water and by improving sanitation
Disinfecting at point of use
Improving sanitation (low cost) +
disinfection
Increasing piped water supply and
sewer connections
EMR-D
5.9
2.0
44.1
19.4
88.2
88.2
38.8
38.8
144.6
96.0
Source: World Health Organization (2002).
Doubling the access of rural families to tap and well

water would increase enrolment by 20 per cent in rural
India.
Adequate water supply and sanitation in schools have
increased attendance of girls by 15 per cent in Bangladesh.
Better water and sanitation facilities is associated with
reduced absenteeism and improved test scores in Tanzania
and Nigeria.
Access to clean water reduces probability of child
mortality by 55 per cent (42 studies).
Presence of sewers in urban Nicaragua reduces the
probability of child mortality by 55 per cent.
Good water supply and sanitation reduces stunting
and wasting in children (Nigeria, Guatemala, Mozambique).
There is, therefore, substantial evidence to show that
adequate water supply and sanitation are important
determinants of health, education, and social well being. It
is a moot point if any of these vast positive externalities are
at all factored in, in the design of plans and priorities of
governments.
CURRENT STATUS
SUPPLY IN INDIA
OF
SANITATION
AND
significantly better on per capita income! Globally, over 2.4

billion people have no access to basic sanitation (WHO
UNICEF 2000). In India, 83 per cent of households in rural
areas have no basic sanitation facility (toilets) while 26 per
cent in urban areas do not have such facility (GOI 1999).
Compared to other similar developing countries India lags
behind in terms of rural sanitation as shown in Table 13.1.3.
WATER
It is common experience that in India sanitation in public

places is poor and water is unsafe for drinking. International
comparisons show that India is much behind many countries
in sanitation and water supply figures. India was ranked a
lowly 133rd among 180 countries in terms of water
availability and 120th among 122 in terms of water quality
as per World Water Development Report, 2003 (Times of
India 10 June 2003). We do not have similar figures for
sanitation. This is entirely shameful since Indias rank is
Table 13.1.3
Percentage of Population of Select Countries having
Access to Improved Water Supply and Sanitation
Country
Saudi Arabia
Philippines
Sri Lanka
China
India
Pakistan
Bangladesh
Malawi
HDI Rank
Access to
sanitation*
68
70
81
87
115
127
132
151
100
83
83
38
31
61
53
77
Access to GDP per

water
capita
supply** (PPP US$)
95
87
83
75
88
88
97
57
10,815
3805
3279
3617
2248
1834
1483
586
Notes:
*Access to sanitation is defined as the percentage of the population
using adequate sanitation facilities, such as a connection to a sewer
or septic tank system, a pour-flush latrine, a simple pit latrine, or
a ventilated improved latrine. An excreta disposal system is
considered adequate if it is private or shared (but not public) and
if it hygienically separates excreta from human contact.
**Access to water is defined as the percentage of the population
with reasonable access to an adequate amount of drinking water
from improved sources. Reasonable access is defined as the
availability of at least 20 litres per person per day from a source
within 1 km of the users dwelling. Improved sources include
household connections, public standpipes, boreholes with handpumps, protected dug wells, protected springs, and rainwater
collection (not included are vendor, tanker trucks, and unprotected
wells and springs).
Source: Human Development Report (2001).
Poor Water Supply

The numbers shown in the above table for water are
somewhat misleading as simple access (88 per cent) does not
necessarily translate into good quality potable water supply
for 24 hours across the year. Most water supply is for a few
hours per day. It can even be just for few minutes every 3
or 4 days in a week in certain urban areas. In many rural
areas some people have to walk long distances to get water.
The situation becomes worse in summer and in years of
drought. When there is shortage of water the chances of
water contamination increases manifold. For example,
intermittent water supply creates negative pressure in the
pipes when there is no water supply and thus dirty water
is sucked in from sites of leakages in the pipe system. When
water supply resumes, this dirty water is supplied first. Even

in well and pond water when the quantity of water is small
chances of contamination increase substantially.
In rural areas water supply through taps is very limited.
National Sample Survey (NSS) shows only 18.7 per cent
of households in rural areas have piped water. The
improvement between 1988 to 1998 in households with
piped water is less than 3 per cent points. In urban areas
the coverage of tap water seems to have declined from 72.1
per cent to 70.1 per cent between 198898, with increase
in use of tube wells and handpumps. This indicates that the
cities are not able to provide tap water to newer settlements.
(Table 13.1.4)
Table 13.1.4
Percentage Distribution of Households by Principal Source of
Drinking Water during 1988, 1993, and 1998 (GOI 1999)
Source of drinking water
Percentage of household in
Rural
Urban
1988 1993 1998 1988 1993 1998

Tap
Tube well, hand pump
Well
Tank, ponds, river canal
Lake spring and others
15.5 18.9 18.7 72.1

39.1 44.5 50.1 17.2
39.1 31.7 25.8 9.2
6.6 5.0 5.3 1.6
70.4 70.1
18.5 21.3
8.6 6.7
2.4 1.7
Source: NSS Report No. 449.
Deplorable Sanitation
The situation for sanitation facilities is even worse. In rural
areas 82.5 per cent of households and in urban areas 25.5
per cent of households do not have a latrine. There is a lot
of statewise variation in these numbers (Table 13.1.5). Only
1 per cent of rural households and 22.5 per cent of urban

households reported having toilets connected to sewerage
systems (GOI 1996b). This is a deplorable situation in a
country whose 5000-year old Indus Valley civilization was
known for its urban planning and sewer systems!
Sanitation facilities in urban areas is better than rural
areas but is far from ideal. Large populations in urban areas
still do not have access to latrines and go for open defecation.
A survey of 7 major cities in India found that only 2 of them
had fully covered underground sewerage systems and high
sewage network densities. The other 5 had inadequate
network coverage. More importantly, of the 7 cities, 3 do
not have any functional sewage treatment plant. The
remaining 4 cities treat only 4859 per cent of waste water
generated. The untreated waste water is disposed into tanks/
lakes or rivers, thus polluting them and creating severe
environmental hazards for the populations downstream
(Table 13.1.6). The government has taken up projects to
clean up only a few major rivers like the Ganga (under
Ganga Action Plan) and the Yamuna and, that too, with
little positive impact. Many rivers like the Sabarmati in
Ahmedabad and the Gomti in Lucknow are dumping
grounds for large amounts of untreated sewage even today.
This is similar to the situation in the Thames river of
London around the 1850s when major cholera epidemics
had occurred there when the Thames became the dump for
the citys sewers.
If the situation of major cities in India is so pitiable
regarding the sewerage system, one can well imagine the
what it is like in the thousands of medium and small towns
in the country.
Are There Improvements?
Table 13.1.5
Percentage of Households not having Latrine as per
National Sample Survey of 1998
States
Rural
Urban
Andhra Pradesh
Assam
Bihar
Gujarat
Haryana
Karnataka
Kerala
Madhya Pradesh
Maharashtra
Orissa
Punjab
Rajasthan
Tamil Nadu
Uttar Pradesh
West Bengal
India
88.5
24.7
89.4
79.9
84.5
88.9
23.1
94.5
85.8
96.1
67.9
87.0
88.5
90.6
76.1
82.5
30.8
2.0
45.3
21.1
32.9
30.0
5.1
45.2
15.8
35.8
14.8
25.5
32.5
28.2
15.2
25.5
Source: Ghosh (2002).
317
Improvement in water and sanitation has been slow in the

past. NSS data shows that between 198898 the households
with no latrine declined from 89 to 82.5 per cent in rural
areas and from 31.8 to 25.5 per cent in urban areas, that
is, a mere 6.5 per cent points improvement in rural areas
and 6.3 per cent points improvement in urban areas in
10 years. (Ghosh 2002) The following graphs made by UN
agencies using various data sources show the very slow
progress of water and sanitation coverage in India.
At the current rate of improvement of sanitation facilities
in rural areas (as shown in the graph) it will take about 75
85 years to reach 100 per cent coverage of sanitation in rural
areas. It is shameful for a country like India to have such
a slow progress in sanitation. This slow progress also shows
lack of societal and national commitment to improving
sanitation. Sanitation is not seen as a national priority.
There has to be a paradigm shift if significant change has
to come.
318

Table 13.1.6
Comparative Data on Sewerage Systems in Major Cities of India (c. 2002)
Unit
Population of the city

Total Municipal Budget (Expenditure)
Wastewater Collection (Through sewers)
Wastewater Collection (Through surface drains)
Sewerage Network (Network density)
Sewerage Network (Ratio to road length)
Treatment (Operational capacity as proportion
of WW generated)
Treatment (Quantity treated as proportion of
WW generated)
Bangalore
Ahmedabad
Surat
35.2
789.3
100
0
6.5
1.0
59
24.3
561.1
75
25
3.3
0.4
81
22.1
137.8
46
54
1.5
0.3
0
20.5
371.8
40
60
2.0
0.3
0
16.0
222.8
41
59
4.7
0.5
0
8.1
135.1
100
0
6.9
1.2
58
59
48
58
lakh
50.0
Rs cr
665.5
%
60
%
40
km/sq km
*
*
%
56
%
56
Lucknow Nagpur Indore Chandigarh
Source: Pangotra (2003).
Budgets for Water Supply and Sanitation

Historically, water and sanitation have received a very small
proportion of the total government budget. Table 13.1.7
gives the budgetary allocation of the central government for
water supply and sanitation during the past 15 years. It
shows that water and sanitation has been getting only 2 per
cent of allocation of the central government budget. While
other sectors with little problem of appropriability, like
telecommunication services, get 17 per cent. It is not
unrealistic or facetious to imagine a future where even the
poor have telephones but no toilets or clean water.
The Government of India has initiated many programmes
and projects since independence to bring about universal
coverage of safe water supply and adequate sanitation. The
Minimum Needs Programme, rural water supply, and
sanitation programme have all tried to address this issue as
also the more recent ones like Rajiv Gandhi National

Drinking Water Mission, and Integrated Rural Water Supply
and Environmental Sanitation Project. Even with these many
schemes water supply and, more so, sanitation have not seen
any significant change. The planned expenditure by the
public sector on water supply and sanitation increased after
the Fourth Five-Year Plan from 1.6 per cent of the total
outlay to 2.9 per cent. Since then it has hovered around 3.5
per cent of the total outlay (GOI 1998).
THE NEGLECT
Although there are many reasons for the failure to achieve
satisfactory sanitation coverage, it is clear that low social and
political priority combined with poor planning and
implementation, rather than the lack of knowledge or tools,
30
% Coverage
20
MIC00
IIMC97
JMP96
NSS89
DHS99
CEN91 DHS93
10
NSS96
WHO88
WHO80
0
1980
WHO83
1982
1984
WHO90
JMP93
1986
1988
1990
1992
1994
1996
Year
Source: Adapted from WHO/UNICEF 2001.
Fig. 13.1.1 Rate of Improvement of Sanitation in Rural India
1998
2000
319
Table 13.1.7
Annual Budgetary Allocation of Central Government under Various Heads for Selected Years
(Rs in crore)
Water supply and sanitation

Telecommunication
Roads and bridges
Telecommunication services
Medical and public health
Family welfare
Total plan outlays
Mar-87
Mar-91
Mar-95
Mar-99
Mar-01
Growth
(19872001)
percentage
Total
(19872001)
329.7
1.7
184.1
0.95
300
1.54
827
4.26
200
1.03
530
2.73
19,422.3
100
470.3
1.39
328.4
0.97
460
1.36
2875
8.49
275
0.81
675
1.99
33,856
100
1006.6
1.6
309.6
0.49
665
1.06
6751
10.72
577.6
0.92
1430
2.27
62,992
100
1826
1.91
394.7
0.41
2230.8
2.33
13,772
14.39
1194.5
1.25
2489.3
2.6
95,685.7
100
2100.8
2.01
518.2
0.5
4827.4
4.63
18,155
17.4
1399
1.34
3520
3.37
1,04,361
100
537.19
5733.4
181.48
1735
1509.13
8483.2
2095.28
42380
599.50
3646.1
564.15
8644.3
437.33
3,16,317.7
Notes: Figures in lower row show percentage of total allocation.

Source: CMIE, 2003.
lies at the heart of the current slow progress in the sanitation

and water supply sector. WSSC working group on promotion
of sanitation has suggested the following list of reasons for
neglect of sanitation (Box 13.1.2).
State Failurethe Key: Politically, sanitation and drinking
water are not a great priority. This may be because people
are used to poor sanitation and water supply. Second, the
benefits of sanitation and water supply are social, shared,
and preventive in nature, while the costs are private and
governmental. It is not common to observe ministers
inaugurating sanitation and water supply projects. Of course
in the years of drought and water scarcity, water becomes
a big political and media priority. In such years many shortterm measures like supply of water by tankers and digging
of ponds are taken up to generate employment. But in the
long run the overall development of water resources has low

political and administrative priority or visibility. Major
irrigation projects are sometimes top political agendafor
example, the Narmada dam in Gujarat. Irrigation water is
also a reason for conflict between states. But sanitation and
drinking water has never received that level of priority.
Sanitation is even further neglected by the society, as that
is not a social priority. Open defecation, waste water flowing
on the roads, and garbage being dumped in public places
has become an acceptable social norm even in the most posh
areas of major cities in India. Fundamentally, the benefits
of good water supply and sanitation are not easily politically
appropriable, nor privately, but only socially, so given state
and institutional failure, there is neglect. Neglect, in turn,
creates mindsets that accept the current situation without
protest and as being normal.
Box 13.1.2
Why Isnt Sanitation Happening?
Lack of political will

Low prestige and recognition of the importance of sanitation
Poor policy framework at all levels
Poor institutional framework
Inadequate and poorly used resources
Inappropriate approaches
Neglect of consumer preferences and low public awareness
Women and children last is the policy followed in many programmes and plans
Lack of public health leadership
Source: Kalbermatten, Middleton (1999).
320
Sidestepping Sanitation: Another important reason is the

lack of public health leadership. In western countries hygiene
and sanitation were emphasized as preventive measures,
because the public awareness about its impact on health
came in the 18th and 19th centuriesbefore the advent of
modern curative medicines such as antibiotics. The European
societies of those times had no alternative but to improve
water supply and sanitation to prevent diseases. But in India
the availability of cheap antibiotics coupled with lack of
vision among the public health and political leadership has
meant that authorities have become complacent to poor
sanitation and water supply. Even the people and civil society
organizations have become insensitive to gross insanitation.
We would call this insanitation-antibiotic syndrome.
Insanitation is tolerated and its effects covered by use of
cheap antibiotics. But this is a dangerous spiral. Antibiotic
resistance is rapidly developing.
Misplaced Concerns: There are no strong peoples groups
advocating the need for better sanitation and water supply.
In India there are strong environmental groups, which
highlight chemical pollution of water, but they have not
done much about environmental pollution caused by open
defecation, garbage dumping, etc2. Similarly, consumer
groups have highlighted the problem of hospital waste
being disposed off in an unsanitary way. Public interest
litigation in this area has lead to strict enforcement of waste
disposal in hospitals. But such legal and environmental
activism is not seen in the area of basic sanitation and water
which are much larger public health problems causing
much more disease and death. The recent controversy
resulting from the Centre for Science and Environments
report on high level of pesticides in Coca-Cola and Pepsi
is a classical example of such misdirected environmental
activism. From a public health perspective lack of access
to adequate water, sanitation, and biological contamination
of municipal water supply which millions of people drink
daily is a much more important problem than the levels
of pesticides being higher than European standards in cola
drinks.
Cost Recovery: Economic sustainability implies that users
pay the full cost of their actions, including environmental
costs, and the full cost of future replacement. Financial
sustainability requires that systems are able to meet their
capital, and operations and maintainance (O&M) costs.
This has important implications for approaches to cost
recovery, financing mechanisms, and the use of subsidies.
As such many recent projects have implemented innovative
approaches for cost recovery by following a demand-driven
2
Neither have they been much concerned about effects of

workplace pollution and its hazards.
approach and involving the community, panchayats, local

NGOs, funding agencies, and other institutions.
Poor Planning and Design: Investments made in sanitation
and water do not yield proportionate results because of poor
planning and implementation as well as poor repair and
maintenance. Economic and financial sustainability of
environmental sanitation is severely hampered due to lack
of funds for O&M. Poor planning is reflected in many ways.
Services are not conceived in an integrated way that takes
into account all their potential impacts. For example,
provision of water supply without planning for the removal
of waste water will create pools of stagnant water and
mosquito breeding sites, thereby causing health hazards and
poor living conditions, which could outweigh the positive
benefits of water supply. Many times services do not take
into account the needs and preferences of people and, hence,
people do not use them. For example, many toilet
construction programmes without demand generation lead
to non-use of constructed toilets.
Misplaced Priorities: Lack of resources is an important
constraint on improving water supply and sanitation. But
resources depend on priorities. For example, we have seen
many cases where local, state, and national governments
have invested public money in far less important activities,
from the point of view of health of the people. Here are
a few examples:
The Ahmedabad Municipal Corporation runs a
medical college and hospitals, sports stadiums, etc.which
are not among its primary (obligatory) duties. These activities
take up a lot of the budget while the municipal corporation
is not able to treat all the sewage the city produces and there
are not enough toilets for all the people. As a result about
20 per cent of the citys population is estimated to be
defecating on the roads and a substantial portion of untreated
sewage is dumped into the river!
Latur city (a district HQ in Maharashtra) with a
population of about 80,000 has built flyovers in the city
to reduce traffic congestion and waiting time at railway
crossings, but the drainage system in the city is still entirely
open and unhygienic.
Lucknow is building a huge public garden at the cost
of Rs 100 crore in honour of Baba Saheb Ambedkar, but
it still does not have a working sewage treatment plant. All
the untreated sewage is dumped in the Gomti river.
After the earthquake in Kutch a luxurious district
hospital worth Rs 100 crore was built in Bhuj with the
Prime Ministers relief fund, while the allocation for sanitation
in the whole of Kutch is very small.
There are never any large and focused allocation on
the basis similar to that of the Golden Quadrilateral (GQ)
or the APDP. For example in the Eighth Five-Year Plan the

allocation for rural sanitation programmes was only Rs 674
crore.
Sanitation and drinking water are grossly under-funded.
The question is not whether roads are important or not, but
whether roads, gardens, and hospitals can take precedence
over water and sanitation for public welfare and public
health.
A paper published in the journal Yojana indicated that
i) a mid-term appraisal of the Ninth Five-Year Plan showed
that against the requirement of Rs 1200 crore for rural
sanitation only Rs 500 crore were allocated, and ii) in 1999
2000, under the Centrally Sponsored Rural Sanitation
Programme only 49 per cent of the allocated funds were
spent (Ghosh 2002).
Institutionalization of Neglect: The neglect of sanitation is
also seen in the condition of toilets in public places like
airports, railway stations, bus-stations, gardens, etc. Most of
the times such toilets are dirty, ill-maintained, and without
water, soap, or towels. Not only at public places but toilets
in hospitals and health department buildings are also in a
very poor condition signifying the total neglect of sanitation
at such vital health installations. This shows that even doctors
and health managers are not bothered by dirty toilets. It is
not an uncommon sight to find people relieving themselves
in the open grounds of hospitals. Such is the total neglect
of sanitation in India.
Some Changes?
The funds allocated to water supply and sanitation sectors
by the government are slowly increasing over time. The
government has been implementing various programmes
for improving sanitation and water supply. As a result, the
water supply in the country has improved, even though
there are lots of problems of the quality and quantity of
water made available, as well as problems of equity in access
to water. The progress in sanitation is still abysmal, especially
in rural areas.
Role of the NGOs

Important changes have begun to take place in the sanitation
and water supply sector over the past few years. These
increase the role of the private sector, and the importance
of the community and women as stakeholders. More
generally, the decentralization process has been furthered.
Due to lack of progress of government-run programmes on
water and sanitation, over the past years, more and more
NGOs and social scientists have been involved in the projects
to generate community participation and demand. NGOs
are also providing training, planning, information
education and communication inputsto water and
321
sanitation projects. There have been a few NGOs who have

sanitation and water as their main activity. Here we present
brief case studies of a few such NGOs and some innovations
in this sector, which have shown positive results. (Box 13.1.3)
Consumption of sanitation has large additivity benefits.
It is of benefit to rich people to pay the poor to access
sanitation or to pay the state to provide universal sanitation.
So large are the additivity benefits arising from lower
morbidity. The appropriability is also low especially at low
levels of income, meaning that the matter cannot be left to
the private sector. Therefore, it ought to have the highest
priority of the state. Unfortunately, state failure in the
design, and, more importantly, in the institutional
mechanisms, coverage, and maintenance of sanitation and
of public health systems and services, has necessitated fresh
approaches and innovation. It creates the space for increased
private and NGO participation, through partnerships and
other forms. Since state failure is largest in maintenance and
in micro-management, there is much scope to improve
services when the private sector and NGOs are brought in
the role of the provider, with subsidies and funds from both
users and the state. Innovative forms of PPPs and PFIs in
sanitation ought to be a top priority.
CONCLUSIONS
Improvements in sanitation and water supply are crucial to
the substantial decrease in disease and deaths. Besides, better
sanitation and water supply has positive synergies in
improving education, decreasing gender disparities, reducing
work burden on the families, and providing many other
social benefits. All these reduce the economic burden of ill
health in the family and improve social well-being. Thus,
sanitation and water supply form an important sector in
infrastructure.
India has made reasonable progress in improving access
to water but the situation of sanitation is highly unsatisfactory,
especially in rural areas. Some of the key reasons for the slow
progress in water supply and sanitation are:
Very low priority to sanitation and water supply among
political circles as well as within the society.
This results in meagre financial allocations to
sanitation and water. Even the allocated amounts are not
fully spent due to administrative and design weaknesses.
Weak programme management has also lead to slow
progress in this sector.
Lack of pressure from public, judiciary or NGOs to
ensure rapid progress in sanitation and water supply.
At the current rate of improvement in sanitation it will
take about 75 to 85 years to reach 100 per cent coverage
in rural areas. Such slow progress should be unacceptable
322

Box 13.1.3
Innovations in Sanitation
SULABH INTERNATIONAL
Started in 1974, by Bindeshwar Pathak, Sulabh International, a non-governmental organization (NGO) has done pioneering work
in the field of sanitation and has shown that human waste can be disposed of affordably an in a socially acceptable way. Sulabhs
approach is based on partnerships with local governments, backed by community participation. Its activities have substantially
improved environmental quality in rural and urban slums. Pathak developed the Sulabh Shauchalaya technology, which is appropriate,
socio-culturally acceptable and economically affordable. It is low cost, requires only two litres (instead of usual ten) of water to
flush, and can function even where enough water is not available. It does not require the service of scavengers nor does it pollute
the air. Toilets are easily cleaned and maintained by house-owners themselves. Two (instead of one) pits re use and they work
alternately. It results in manure as a by-product. It also has high potential for upgradation when sewers are in place because it can
easily be connected to a sewer system.
Public Sulabh complexes have electricity and 24 hours water supply and soap powder is supplied free to users for washing hands.
The complexes have separate enclosures for men and women. The innovation introduced by Sulabh was that all the public toilets
managed by Sulabh are staffed by an attendant around the clock who supplies soap for washing hands, ensures proper cleaning
and hygiene. The users have to pay a small fee (usually one rupee) in order to use the toilet. Children, the disabled and the poor
can use the toilet for free. Sulabh is operating and maintaining more than 5500 community complexes in 1100 towns in 26 states
and 3 Union Territories As a result of Sulabhs efforts more than 10 million people have received improved, low-cost sanitation,
and over 50,000 scavengers have been rehabilitated as they now have jobs in these complexes.
The NGO follows a profit-centric model. Most of its public toilets break-even, but those located near highly congested areas
return massive profits, which in turn cross-subsidse some loss-making toilets. The NGO returns constant margins of 1520 per
cent on an average annual turnover of around Rs 100 crore. It has shown that a mid-sized public toilet breaks even within eight
to nine months of usage.
Sulabh also provides free health education to millions of people through door-to-door campaigns. The organization trains local
people to construct more latrines themselves, and has helped other organizations to set up and maintain user-fee-based community
toilets in slums and other areas. For example National Sanitation Foundation in Gujarat had developed pay and use toilets in many
places in Gujarat. Sulabh with branch officers in many states and union territories has become international now by opening its
complexes in countries such as Bhutan, Nepal and Afghanistan. The key idea that Sulabh demonstrated was the people will pay
to use a clean toilet. It also showed that sanitation makes sound business sense.
Unfortunately Sulabh or its like have not multiplied fast enough to facilitate a more substantive coverage of population.
ENVIRONMENTAL SANITATION INSTITUTE (ESI)

The Environmental Sanitation Institute (ESI), formerly known as Safai Vidyalaya, is one of the few institutes in the country which
has taken up sanitation as its core business. Started by a Gandhian in 1964, its chief aim is capacity building in the field of
sanitationits name Safai Vidyalaya means school for cleaning. It trains health workers, nurses, anganwadi workers, village headmen, teachers, engineers, doctors, etc. in the art and science of sanitationconstructing and maintaining toilets. It also acts as
a nodal agency for implementing various sanitation projects of the GOI, the GWSSB, UNICEF, and others agencies. It promotes
low-cost sanitation in Gujarat and the whole country. Due to the sanitation promotion and training work done by ESI for many
years, it is invited as an important member in various policy-making bodies of the government on matters of sanitation. In 1993
it was made a nodal institute for implementing sanitation programme in nagarpalikas and nagar-panchayats. The highlights of its
activities are given in the table below.
Table B13.1.3.1
Key Achievements of Environment Sanitation Institute, Ahmedabad
Key Achievements of ESI
Training Camps organized
Training programmes for engineers in 15 states
Bawla type latrines constructed
Conversion of dry latrines into water seal latrines
Sanitary model ground financed by UNICEF
Latrines constructed in 3888 villages through 146 NGOs
Latrines constructed in 55 towns under GWSSB, IDA-1280-IN
School Sanitation Project
Awards Received: Jamanlal Bajaj Award of Excellence in Local Self-Government, National
Award for Lok Shikshak, Mahatma Gandhi award, etc.
Numbers of units
2092
102
17,500
1,86,000
21
1,87,798
29,949
4400
323
Unfortunately, in spite of such exemplary work done by ESI, it is the only institution of its kind in India which focuses entirely
on sanitation training . The case of ESI shows that with a small number of committed individuals a training institute can catalyse
a much larger impact on rural sanitation.
SWAJAL PROJECT
The Swajal project assisted by the World Bank seeks to improve sanitation and water supply and was conceived in 1994 in Uttar
Pradesh. The project philosophy is sustainability through demand driven partnership. The project created a new institutional
structure by forging a partnership among three entitiesthe Project Management Unit (an autonomous government society) of
UP Water Board, NGO support organizations, and village water and sanitation committees (VWSC).
The project was divided into four phases covering 1000 villages. NGOs serve as social intermediaries between the project
management unit and the community. It is called a support organization because the NGOs give single-window assistance to a
rural community. To do this, they must have expertise in both software and hardware. The cost of the NGOs involvement was
only for 6 per cent of the project budget. The NGOs role is disseminating the rules to the villagers, helping the community form
a representative organization (VWSC), and facilitating community decision-making about the choice of water facility design option.
The project, for the first time in India, introduced capital cost recovery and full community responsibility for operation and
maintenance. The main rationale for following a demand responsive approach in the Swajal project is to ensure that investments
are sustainable and the best proxy for demand is willingness to share costs.
The experience with this project showed that people are willing to pay for the services if they have choice in selecting the
technology and if they are properly informed of the choice and their obligations. But this process is slow and needs lot of facilitation.
The key lesson from this project is that with NGO involvement cost recovery is possible (even of the capital costs) and thus
projects can be made more sustainable. If such project can be undertaken with cost recovery in Uttar Pradesh which is an
underdeveloped state, it can certainly be carried out in most other states of India.
MARKETING SANITATION
IN
RURAL INDIA
In India the Water and Sanitation ProgrammeSouth Asia is working towards the adoption of significant institutional and financial
reforms, in order to ensure that the poor are explicitly recognized as valid customers and that they have increased access to selfsustained water and sanitation systems across the country. Water-Aid Indias rural sanitation programme was making slow progress
in 19956 which prompted them to change their strategy from supply orientation to demand creation, social marketing, providing
access to credit, and developing a reliable supply of sanitation goods and services.
Demand creation was accomplished by moving from health education to health promotion. Partner NGOs started a school
hygiene education programme to supplement this, proving that a convinced child is a committed advocate. All the principles of
marketing like product, price, place, and promotion were adapted to the rural conditions. Promotion stressed the non-health benefits
of a household latrine like privacy, convenience, safety, status/prestige, cost saving, and income generation. Other promotional
activities included putting up billboards, painting promotional messages on the walls of the houses, and the use of sanitation road
showshealth workers touring local villages in a bullock cart delivering hygiene messages and selling sanitary wares.
This was reinforced by providing access to micro credit and establishing sanitary marts. As a result the number of latrines
constructed had risen from just 460 in 19956 to 5000 in 19978. The key lessons learnt are:
Reduce and redirect subsidy from construction to hygiene promotion and marketing sanitation;
Motivate target communities to install latrines by highlighting the non-health benefits of sanitation;
Provide users with a range of options with low subsidy rather than a single high price model of latrines with high subsidy.
What this project showed was that social marketing approach can help rapid acceptance of the toilets in rural areas in spite
of low subsidy.
SEWA
AND
FINANCING
OF
SANITATION
The biggest constraints facing sanitation is lack of funding and poor management of the sanitation systems. Decentralization, which
shifts responsibility of sanitation to Panchayati Raj Institutions (PRIs) and local self-governments, might exacerbate this problem
since local bodies are already under severe financial constraints and their management capacities are even poorer than state
governments. This may lead to further neglect of this sector. In such a situation a viable option is to let households invest in the
infrastructure. This can be done through micro finance as demonstrated by the four NGOs in certain urban areas. These NGOs
(Baroda Citizens Council, Mahila Milan, SEWA Bank, Sri Padmavathy Mahila Abyudaya Sangam) have been giving micro credit
to their members under their housing/infrastructure category. An action research carried out by the Water and Sanitation programme
and SEWA (UNDP, SEWA) brought out the following points:
Micro-finance is an enabling tool for improved water and sanitation services;

Access to technical advisory support is vital for the success of credit provision for infrastructure;
Social collateral in place of land tenure or traditional collateral would smoothen the process;
324
Community and municipal partnership is the key to sustainability;

Regular savings and effective field workers are vital for financial sustainability.
The study also found that there was a need for national loan bridge fund or loan guarantee fund, for capacity building of
communities, micro-finance institutions, municipalities, and housing finance institutions. In order to scale up both infrastructure
provision and infrastructure to poor communities, there is a need to understand the roles and responsibilities of the stakeholder,
clarify the different roles required and match appropriate actors with these. It resulted in defining joint guidelines with local
authorities containing a clear and simple set of rules vis vis access to and level of subsidies and detailing the norms and requirements
for service connections to slum communities. Communities were also to contribute to scaling up of the coverage.
The above 5 small cases show that NGOs can play a vital and catalytic role in sanitation and water development. But their
resources are much smaller than that of the governments. Hence, partnership between the government and the NGOs is needed
on a much larger scale to rapidly scale up sanitation and water supply programmes in rural areas.
Source: UNDP 2003, Business Today 2003
to any civilized society and more so for our own country

with its ancient cultural heritage, and where rapid progress
is on in other sectors.
Over the last several years some NGOs, through some
innovative externally-funded projects, have attempted to
improve the coverage of sanitation and water supply in rural
areas. Some have shown reasonable success in improving
water and sanitation by generating demand through
community participation and improving supply of services
through training, marketing, and micro-finance. Government
programmes on sanitation and water are largely supplyoriented and could learn important lessons from the
innovative approaches. The government could also usefully
partner with private and community organizations.
There is an urgent need to increase political and social
priority to sanitation and water supply. This can be achieved
through sustained research-based advocacy using popular mass
media. NGOs and activists have to take up this challenge.
The resource allocation to sanitation and water supply has
to go up very substantially given its vital importance to
health, social and economic development, and gender equity.
The pace for improvement of sanitation and water supply
can be increased by involving various stakeholders in the
process of development of this sector. The stakeholders
include NGOs, the community, the private businesses, and
local self-governments including panchayats, development
partners, and financial institutions. Each stakeholders role
has to be well defined and coordinated with other
stakeholders. For example, NGOs can support community
mobilization and demand generation as well as training.
Panchayats and local governments can develop sustainable

mechanism of operation, maintenance, and cost recovery of
expenditures. The development partners and financial
institutes can provide financial support for rapidly scaling
up effective programmes including micro-finance to the
families.
Large-scale investments in sanitation and water supply
can have vast multiplier effects on industries like cement,
hygienic products, soap, and building materials. More
importantly, given its vast externalities waiting to be realized,
worthy corporates could also take the lead in improving
sanitation. Indeed, it would be part of market development
to enhance supply and create the demand for sanitary and
other products, as, with improvements in sanitation, its
position changes from a make do facility to one seen as
necessary to good living.
Reorienting the priorities of local self-governments
including municipalities and panchayats towards basic
infrastructure such as sanitation and water supply is crucial.
The state governments and funding agencies ought to control
non-priority spending of local bodies and help direct the
available resources to ensuring proper sanitation and adequate
water supply. Activist environmental groups need to focus
on pollution and health problems being caused by gross
neglect of sanitation and drinking water supply. The potential
gains are far in excess of the media-catching activism that
we have witnessed thus far for CNG, or against pesticides
in aerated drinks. Judicial activism and public interest
litigation could help improve the situation rapidly and make
the government agencies accountable.
325
13.2 TOTAL SANITATION CAMPAIGN: CHANGING THE FACE OF

RURAL BURDWAN
Rajarshi Majumder
Burdwan district of West Bengal is considered to be both
the granary and the ruhr of Bengal. It has 3 distinct
regions. The eastern and east-central parts are the
agricultural powerhouses, the west is the mining area of
Raniganj, and the central region includes the industries
and educational and other services. But rural Burdwan like
much of Bengal has been poor, despite the large rise in
rural incomes since Operation Barga in 1982. Sanitary
infrastructure has been underprovided in rural Bengal, and
Burdwan is no exception. Only 27 per cent families had
access to sanitary latrines in 2001, and open defecation has
been the predominant practice. This has been causing great
harm to the rural society. Diarrhoea and other water-borne
gastroenteric diseases are frequent leading to substantial
adult deaths, and high infant mortality. Snakebites during
the monsoons also claim many lives as people venture out
into the fields and ponds for defecation. But suddenly
things are changing. Thanks to a novel programme by the
(SIPRD), the construction and usage of toilets has increased
rapidly.
THE CAMPAIGN
SIPRD was quick to understand that the conventional
sanitation programme in existence since 1994 had been a
non-starter with only 35 thousand installations in 7 years,
leaving a gap of 7.5 lakh families in 2001! It was a typical
government programme left to be implemented without
clear cut targets, incentives, and involvement of the people.
SIPRD realized the need for a change in design. The Total
Sanitation Campaign (TSC) started on 11 June 2001. The
District Development Authority or the zilla parishad was
given the task of implementing the TSC through the
institutions of the 3-tier panchayat system in West Bengal,
with financial and logistical support from central and state
governments. Specific targets for each block, panchayat
Acknowledgement is due to my senior colleague Pinaki Chakraborti

and the head of our department, Kausik Gupta, for assisting and
encouraging me for this write-up. Uday Sarkar and Ramkrishna
Bandopadhyay, present and former sabhadhipati of Burdwan ZP
respectively, and Shibashish Banerjee, District Coordinator of TSC,
are the chief architects of the success of TSC as also the mainstay
of our survey. I also thank my students who worked hard for the
field survey.
samiti, and gram panchayat were fixed. Prizes for the best
performer in every month and year were announced, creating
a sense of competition among the administrators of these
local self-governance bodies. The usually slothful public
officials suddenly became enthusiastic.
Another fresh element of the programme was the
technology, which allowed users to themselves install the
toilet in their courtyard. Experts from WHO and SIPRD
designed a water-washed concrete latrine platform with pan
that would not cost more than Rs 350 after allowing normal
profit. It was to be set over a soak-pit that would take
10 years for a family of 6 to fill up. Then all that needs to
be done is to cover up the old pit and shift the platform
to a new pit! NGOs were roped in to produce these latrines
and gram panchayats were asked to dig the pit for Rs 50.
Thus, a family could install a sanitary latrine for Rs 400,
and then fence it with sundry articles like plastic sheets or
bamboo thatches. For families below the poverty line the
state subsidized Rs 150 and asked the family to dig up the
pit themselves, reducing the cost to just Rs 200. The gram
panchayats conducted frequent meetings in the villages where
the villagers submitted their contribution to the panchayat
officials. Typically, within 710 days the latrine platform
was sent to the home of the beneficiary. The gram panchayat
then arranged for digging the pit in a few days, and
installation of the latrine. After that the family was asked
to suitably surround it with materials according to their
choice and affordability.
The NGOs as producers and profit earners had an
interest in more installations and they joined the local
officials in promoting TSC. This was crucial. The villagers
were advised, persuaded, coaxed, and cajoled. Wall writings,
folk songs, street drama, puppet shows, etc. were arranged
for awareness build-up. Role models like teachers and
gram panchayat members were targeted first. Then the
children and women of the neighbours were persuaded to
create a sense of deprivation among them. The effect of
demonstration was dramatic on the population. Once a
threshold level of installaton was achieved the programme
gained momentum to create a demand for such toilets.
UNICEF was roped in to provide sanitary latrines in the
schools. This integrated approach broke the deadlock and
created the necessary big push. The authorities took a
block-by-block approach where the district administrations
focused on one block at a time and supplemented local
initiative with state support so that the block could reach
full coverage.
326

Table 13.2.1
Progress of Total Sanitation Campaign in Burdwan District
Block
No. of Households
in 2001 Census
No. of Latrines
Existing in 2001
Latrines Installed
during 20013
No. of Latrines
in 2003
Coverage % of all
Households
All
Burdwan-I
Burdwan-II
Bhatar
Ausgram-I
Ausgram-II
Galsi-II
Raina-I
Raina-II
Khandaghosh
Memari-I
Memari-II
Jamalpur
Kalna-I
Kalna-II
Monteswar
Purbasthali-I
Purbasthali-II
Katwa-I
Katwa-II
Mongalkote
Ketugram-I
Ketugram-II
Galsi-I
Faridpur
Durgapur
Andal
Kanksa
Pandaveswar
Raniganj
Jamuria
Barabani
Salanpur
Burdwan
IMPACT
BPL
All
BPL
All
BPL
All
BPL
All
BPL
2001
2003
2001
2003
38,933
28,855
53,505
24,164
30,374
29,115
35,169
29,168
34,590
42,139
29,016
51,610
37,731
32,534
48,803
40,944
42,951
32,627
26,942
50,618
30,421
23,426
36,289
22,973
21,178
15,491
30,910
15,839
16,521
19,131
22,618
13,416
19,401
18,920
15,788
26,196
24,566
20,929
21,682
29,063
25,394
16,918
14,012
23,621
19,383
15,229
18,520
10,839
12,708
10,735
10,718
3080
3845
5430
9747
7914
7974
16,561
9226
15,967
14,147
11,170
13,554
14,402
10,897
8585
7483
9037
4597
4218
7498
6347
2280
2814
1552
308
625
862
2661
1052
1250
3028
1510
2143
5081
2641
2281
5793
3034
1611
1092
1136
441
830
586
428
6615
3234
12,094
21,084
10,595
3268
24,455
21,254
13,725
8263
3796
4549
1105
921
7492
12,815
5493
4602
3217
5184
6518
2460
2544
2296
5873
3058
10,926
14,704
8846
3166
19,124
12,316
10,013
6253
3086
2598
1072
863
7064
11,040
5418
3930
2885
4025
3961
2200
2513
1775
19,323
13,969
22,812
24,164
14,440
8698
34,202
29,168
21,699
24,824
13,022
20,516
15,252
12,091
21,046
27,217
16,390
13,187
10,700
14,221
11,115
6678
10,042
8643
8153
5872
12,478
15,012
9471
4028
21,785
13,368
11,263
9281
4596
4741
6153
3504
9345
16,833
8452
5541
3977
5161
4402
3030
3099
2203
32.6
37.2
20.0
12.7
12.7
18.7
27.7
27.1
23.1
39.3
31.8
30.9
37.5
34.3
27.8
35.2
25.4
26.3
27.8
17.9
15.1
18.0
20.7
27.6
49.6
48.4
42.6
100.0
47.5
29.9
97.3
100.0
62.7
58.9
44.9
39.8
40.4
37.2
43.1
66.5
38.2
40.4
39.7
28.1
36.5
28.5
27.7
37.6
10.8
18.2
5.0
1.9
3.8
4.5
11.8
7.8
6.4
16.0
9.6
8.2
20.7
12.6
10.5
19.9
11.9
9.5
7.8
4.8
2.3
5.5
3.2
3.9
38.5
37.9
40.4
94.8
57.3
21.1
96.3
99.6
58.1
49.1
29.1
18.1
25.0
16.7
43.1
57.9
33.3
32.8
28.4
21.8
22.7
19.9
16.7
20.3
35,914
29,954
36,077
20,527
24,527
22,600
19,406
10,41,902
8819
15,437
13,857
4213
9506
7989
3423
5,38,809
17,126
8699
13,851
6727
5722
3894
6721
2,88,580
1450
2672
2533
19,798
3983
1687
4222
3205
12,921
4892
1190
660
650
14,511
1840
271
1805
1388
8532
1659
485
2289
1017
8011
1502
229
1194
279
5088
508
162
333
172
7054
334
50,513 2,00,754 1,55,953 4,89,334 2,06,466
47.7
29.0
38.4
32.8
23.3
17.2
34.6
27.7
55.1
43.1
40.2
41.6
32.7
22.5
36.3
47.0
16.4
10.9
8.6
6.4
5.1
2.9
4.7
9.4
45.2
31.7
13.3
39.4
15.8
6.4
9.8
38.3
OF THE
TSC
The success has been phenomenal. Against a target of 30,000

installations in 20012, 34,000 were installed. And in 2002
3 there was a revolution. Over 1.7 lakh latrines were installed
which was in excess of the ambitious target of 1.5 lakh. More
than 2 lakh families were covered in 2 years of TSC. As a result,
47 per cent households in 2003 had access to toilets as against
only 27 per cent in 2001. More outstanding, however, is the
fact that 3 blocks of the districtRaina-I and II and AusgramIhave been able to provide access to sanitary latrines to
almost all families. These 3 blocks with about 89,000 families
can thus be declared as totally sanitized blocks. And all these
have been achieved at an expense of just Rs 150 million. The
beneficiary families have put up Rs 103.5 million, the central
and state governments together provided Rs 45 million, and
UNICEF provided Rs 1.5 million. Rarely has this kind of

success been achieved in a rural development programme.
Table 13.2.2
Progress of School Sanitation Programme in Burdwan District
No. of Schools
Blocks
Memari-II
Raina-II
Memari-I
Kanksa
Raniganj
Monteswar
Katwa-I
Khandaghosh
Total
116
112
110
109
42
175
98
141
With Latrine
With Drinking Water
2001
2003
2001
2003
28
18
83
13
11
23
14
5
116
112
110
109
42
175
98
141
68
45
93
101
10
127
64
36
116
112
110
109
42
175
98
141

The benefits of using toilets are immense.3 The frequency
of diseases in the families have reduced substantially and
medical expenses have fallen. This is bound to have a positive
effect in reducing poverty. Also, the state subsidy for providing
medicines through Rural Health Centres (RHCs) has come
down, thereby recovering some of the expenditures on TSC.
The key to the success of TSC has obviously been the
novel design and unconventional implementation methods
used, along with the mechanism of incentives for the
implementing units. The conventional top-down approach
of imposed development was abandoned in favour of
involvement of NGOs, local bodies and, most importantly,
327
the people. The promotion was also imaginative and

functional. Not having a sanitary latrine was projected as
something to be ashamed of. The rural society reacted
strongly and adopted the product.
The very success of the programme has revealed certain
inadequacies in the situation. As saturation is nearing,
problems crop up. Several families are willing to install
toilets but do not have a courtyard to place the toilet!. Some
(the very poor) are unwilling to shell out even Rs 200, as
the opportunity cost is felt to be too high. Unless endowments
improve there would be difficulties in carrying the movement
to cover the entire population.
13.3 RURAL INFRASTRUCTURE AND THE PANCHAYATS: A REPORT

FROM WEST BENGAL
Dilip Kumar Ghosh
With the passage of the Constitution (73rd Amendment) Act,
1992, and by insertion of the Article 243G, village panchayats
have formally become institutions of self-government. The
Eleventh Schedule contains 29 subjects where inter alia items
of infrastructure development are also included. The items
are: (a) minor irrigation, water management, and watershed
development; (b) drinking water; (c) roads, culverts, bridges,
ferries and other means of communication; (d) rural
electrification, including distribution of electricity, and (e)
health and sanitation. The panchayats are mainly entrusted
with the implementation of different centrally-sponsored public
works programmes administered by the Ministry of Rural
Development. Their dependence on the government grants
is almost totalin fact, they merely act as agencies of the
government and implement schemes according to government
directives. Thus decentralization of the decision-making process
(so far as infrastructural development is concerned) means
that panchayats are in better position to identify local
preferences and priorities for infrastructure services. It has so
far not resulted in any substantial mobilization of resources
locally. Involvement of local people can enhance accountability
and quality implementation; but local performance depends
on the institutional and political environments in which the
decentralization process works.
We look at Nadia district closely using records at the
village and block levels, covering both expenditures and
physical achievements. In Box 13.3.1, we briefly introduce
the state of rural infrastructure (village roads, water, and
sanitation) in West Bengal.
3 As a large and substantial portion of the population is covered
there are additivity effects that arise, so that the benefits in terms
of both health and well-being would be large.
NADIA DISTRICT
Nadia has average ranking among the districts of the state.
In this study 3 blocks were chosentwo of them being the
furthest from the district headquarters. Locations close to
the headquarters are expected to have better infrastructure,
and one is located very near the district headquarters. From
each block 5 gram panchayats were selected on the basis of
their size. Since West Bengal is trying to decentralize the
planning process gram sansad (village constituency) and
gram sabha are given importance by the state government.
From Karimpur I Block, the gram panchayats selected are:
Karimpur I, Karimpur II, Jamsherpur, Madhugari, and
Pipulberia. The 5 gram panchayats of Karimpur II Block
are Dhoradaha I and II, Murutia, Dighalkandi, and
Nandanpur. Karimpur I and Karimpur II blocks are located
at a distance of approximately 90 km and 75 km, respectively
from the district headquarters at Krishnagar. Krishnagar I
block is very near the district headquarter and is urban
oriented. The gram panchayats selected from Krishnagar I
are Asannagar, Bhanderkhola, Dogachhi, Bhatjangla, and
Bhaluka4.
4 The main data source is the Statutory Annual Audit Report
of the gram panchayats and incomeexpenditure report of the
panchayat samitis. As the data is not maintained adequately and in
the appropriate format, data loss seems to be a serious problem in
local offices. The blocks (where the office of the panchayat samiti
is also located) have computers from the year 19992000, but the
gram panchayats have no computers. As these data are unpublished,
in general, access to them is very difficult. The maintenance and
updating of data in different registers of the gram panchayats and
the block offices is irregular. This generates data-gap which in
normal course remain unattended.
328

Box 13.3.1
Village Infrastructure in West Bengal: An Overview
In West Bengal, the road network in the rural areas is developed and maintained by the Public Works Department (PWD) of the
Government of West Bengal, municipalities, zilla parishad (district-tier panchayat), and panchayat samiti (block-tier panchayat).
The PWD usually does not take up the works related with unsurfaced roads. These roads are normally under the jurisdiction of
zilla parishad or panchayat samitis, who also build all-weather and metalled roads. The gram panchayats (village panchayats) do
not take up construction of surfaced roads and mainly take care of village roads, mostly katcha (unsurfaced) in nature.
Roads
At the GP level repairing and maintenance of village roads connecting different clusters of habitations (parah in the local language)
is limited to keeping them walkable. In Table 13.3.1, the share of panchayats in surfaced and unsurfaced roads in districts is given.
From Table 13.3.1 it can be seen that the panchayat bodies have a large chunk of unsurfaced roads which become inaccessible
during the rainy season. There is considerable variation in road density across districts, in part driven by terrain and population
density. Road density is particularly low in northern districts of the state whereas, in the districts near the state capital, Kolkata,
the road density is quite high (Bureau 2001)a
Electricity
Table 13.3.2 shows the progress of rural electrification in the state. It reflects slow progress. Further, in the electricity sector also,
the north districts of West Bengal have very low per capita consumption of electricity as compared to Kolkatab.
Sanitation
The Rural Sanitation Programme in West Bengal is administered by the Department of Panchayats and Rural Development. Truly
speaking, only in this programme is there a blending of work by NGOs and the government. In each block, efforts are being made
to set up a sanitary mart to produce low cost sanitary latrines and accessories on one hand, and to generate awareness among
households regarding the need to have a sanitary latrine on the other. These sanitary marts are visualized as social marketing outlets
where people can request a latrine according to their choice and capacity. Though expanding, they have yet to reach all the blocks.
The year-wise formation of sanitary marts and the coverage of households under this programme are given in Table 13.3.3 for
the period 19934 (when all the districts of the state are brought under this programme) to 20001. Growth rate in use of toilets
has been stupendous averaging about 7.5 per cent per annum over the decade. But coverage still remains only at a quarter of all
householdsc.
From Table 13.3.3 it can be easily realized that the task is huge because the number of rural households living in West Bengal
is tentatively 1,04,02,647d. As district estimates are not available in the NSSO report, Table 13.3.4 uses the 1991 Census and
the report of the Sanitation Cell of the Department of Panchayats and Rural Development, Government of West Bengal to map
the progress of toilet facilitye.
Water Supply
Panchayat bodies at the block and village level are the key actors in implementing the schemes in this sector. Handpumps are the
principal source of drinking water. They are community-based and installed according to the demands of the inhabitants. A household
has access to safe drinking water when it has access to drinking water supplied through pipes and tap, or a handpump/tube well
situated within the premises or outside the premises. According to District Statistical Handbook (2001) of Bureau, in West Bengal
the coverage of safe drinking water so defined in the rural areas is 77.86 per cent. NFHS 2 Survey points out that taking both
the rural and urban areas, the percentage of households with safe drinking water is 89.3 per cent in West Bengal. The Public Health
Engineering Department of the state government is also working in the rural areas for implementing piped-water supply schemes.
These schemes are identified by the zilla parishad in consultation with the panchayat samitis at block level.
a For example, in 20001, it is 375.16 km in Uttar Dinajpur, 508.34 km in Dakshin Dinajpur, 517.28 km in Malda, 376.43 km in Jalpaiguri.
Only in Darjeeling district it is 1113.05 km while it is 1628.72 km in North 24 Parganas (22 km from Kolkata), 1477.01 km in South 24 Parganas,
3064.78 km in Hooghly (45 km from Kolkata), 1849.35 km in Howrah (14 km from Kolkata), and 1699.24 km in Midnapur (130 km from
Kolkata).
b According to District Statistical Handbook, 2001 of Bureau, Govt. of West Bengal, it is 22 kwh in Uttar Dinajpaur, 26.93 kwh in Dakshin
Dinajpur, 58.74 kwh in Malda, 45.25 kwh in Jalpaiguri, and 31.92 kwh in Coochbehar. By comparison, Kolkata has a per capita electricity
consumption of 1127.81 kwh.
c For more detailed coverage of the campaign see Rajarshi Mazumder, Total Sanitation Campaign, Chapter 13.2, in this report.
d Using an approximate family size of 5.55 and a total population of 5,77,34,690 (2001 Census).
e Figures for 2001 are taken from the intensive survey undertaken under the Total Sanitation Programme (TSP) for ascertaining the coverage of
latrines in rural households. This survey was done under the overall guidance and supervision of zilla parishads. For Purulia, Birbhum, and Darjeeling
districts this survey was not undertaken at this stage. In case of these districts, the coverage is calculated on the basis of sanitary latrines constructed
under Centrally Sponsored Rural Sanitation Programme and with private initiatives. From the survey of TSP it is seen that if one latrine is constructed
under the government-sponsored programme, two additional latrines are constructed by the people themselves on their own initiative.
329
Box 13.3.2
Programmes in Infrastructure Development
Currently, there are 4 programmes under which the panchayat bodies at the village and block level undertake construction and
maintenance of road network in their respective jurisdiction. The programmes are the JRY, renamed as Jawahar Gram Samriddhi
Yojana (JGSY) since 1 April 2001, the Employment Assurance Scheme (EAS), the Member of Parliament Local Area Development
Scheme (MPLADS), and the Border Area Development Programme (BADP). The gram panchayats get funds for JRY only, while
the panchayat samitis implement all the 4 programmes. A brief introduction about the programmes will help to understand their
basic objectives.
The JRY or JGSY was started in April 1989 with the main objective to generate additional gainful employment for the unemployed
and underemployed persons living below the poverty line in the rural areas. The secondary objective of the Yojana is creation of
durable community and social assets for strengthening rural infrastructure. The EAS was introduced with effect from 2 October
1993 in the rural areas of 1778 blocks of 261 districts where a revamped public distribution system was in operation. It was extended
in a phased manner and by 19978, all 5448 rural blocks of the country were brought under the programme. The primary objective
of EAS is to provide gainful employment during lean agricultural season (assurance is to provide 100 days of manual labour in
a year to a maximum of 2 adults per family). The secondary objective is the creation of economic infrastructure and community
assets for sustained employment and development of the area. Both JRY and EAS are centrally-sponsored programmes, where the
centre and the states share costs in a 80:20 ratio.
MPLADS was introduced in December 1993 to enable the Members of Parliament to identify and get implemented small works
of capital nature based on locally felt needs with emphasis on creation of durable assets in their respective constituencies. The scheme
allows each MP an annual appropriation of Rs 2 crore. The Collector is responsible for implementation of the schemes through
government departments, PRIs, or any other reputed and capable NGO. The Border Area Development Programme (BADP) was
started during the Seventh Plan in the western region of the country, and from 19934 it was extended to the eastern region states
having an international border with Bangladesh. BADP is being implemented by Karimpur I and Karimpur II panchayat samiti.
The main objective of the programme is to meet the special needs of people living in the remote, inaccessible areas near the border.
According to the guidelines of this programme, schemes which address problems such as inadequacies relating to provision of essential
needs, strengthening of social infrastructure, filling up of critical gaps in the road network, may be taken up under the programme.
But it is also mentioned therein that it must be ensured that no single sector gets a disproportionately large share of the total allocation
in a year. The involvement of local people in the decision-making process is stressed by BADP guidelines (Planning Commission
2001). Both BADP and MPLADS are centrally-funded programmes.
Table 13.3.1
Share of the Panchayats in Surfaced and Unsurfaced Roads in Districts
District
Burdwan
Birbhum
Bankura
Midnapore
Howrah
Hooghly
24 Parganas North
24 Parganas South
Nadia
Murshidabad
Uttar Dinajpur
Dakshin Dinajpur
Malda
Jalpaiguri
Darjeeling
Coochbehar
Purulia
West Bengal
19967
19978
19989
19992000
20001
13.09
41.67
21.70
34.80
17.87
50.89
3.71
37.07
16.02
22.90
9.53
18.16
38.00
9.79
43.00
7.87
36.54
25.39
71.94
51.29
87.11
69.08
95.16
82.89
10.57
88.33
73.22
79.35
35.61
52.69
68.71
80.68
93.59
70.82
98.31
73.77
10.00
41.66
21.63
33.58
29.37
49.78
3.89
46.08
14.65
22.09
10.91
17.69
39.40
23.68
43.00
12.02
37.75
27.32
67.42
51.29
87.30
69.16
94.99
85.84
15.63
90.56
62.94
75.85
39.67
51.09
67.10
66.38
93.59
69.99
38.05
75.56
12.05
41.81
25.35
32.90
29.93
50.57
3.84
45.42
14.79
22.74
10.54
18.64
38.83
24.12
40.43
12.66
87.91
36.76
63.88
64.26
86.31
69.10
90.73
86.30
14.47
95.05
60.73
73.35
39.67
29.23
53.66
66.04
86.27
68.34
98.38
78.89
11.34
41.81
25.35
64.80
29.93
51.21
4.28
57.26
14.88
23.82
14.60
29.84
39.54
24.46
39.87
12.85
42.42
35.16
69.14
68.12
86.31
92.38
90.73
86.20
13.81
96.18
61.03
72.99
35.61
29.56
52.99
70.83
85.22
68.46
98.44
84.42
11.86
41.99
25.53
60.95
29.93
51.10
4.93
56.20
14.00
22.12
14.51
38.76
39.14
24.90
39.24
12.09
42.79
34.56
68.76
69.99
86.42
94.83
90.73
84.47
12.15
96.24
67.82
75.27
33.18
30.65
54.55
69.67
85.13
71.38
98.51
85.41
Note: S> Surfaced, U> Unsurfaced. All figures in percentage.

Source: District Statistical Handbooks published by the Bureau of Applied Economics and Statistics, Govt. of West Bengal.
330

Table 13.3.2
Rural Electrification in West Bengal
Year
Table 13.3.4
Rural Households with Latrine Facilities
No. of Mouzas electrified
Percentage
29271
29321
29402
29537
30025
30356
76.98
77.11
77.33
77.68
79.20
80.07
199697
199798
199899
19992000
20001
20012
Note: According to 1991 Census total number of mouzas is 37,910.

Source: Economic Review, 20012002 of Govt. of West Bengal.
Table 13.3.3
Formation of Sanitary Marts and Household Coverage
Year
19934
19945
19956
19967
19978
19989
19992000
20001
Total
No. of Sanitary
Marts
Additional
household
coverage during
the year
Percentage
change over
the previous
year
86
42
28
23
17
17
41
12
266
19,565
36,940
74,761
1,17,053
1,47,072
1,96,737
2,31,678
2,72,567
10,96,373
88.80
102.38
56.57
25.64
33.77
17.76
17.65
Note: 2nd col. of the table denotes year-wise opening of Sanitary

Marts.
Source: Annual Administrative Report (20012002) of Department
of Panchayats & Rural Development, Government of West Bengal.
Duties of the Gram Panchayat

According to the West Bengal Panchayat Act, 1973 (along
with its subsequent amendments), the gram panchayats
have 3 types of duties. These are (i) obligatory duties
containing 14 items of activities (Section 19 of WBP Act),
(ii) other duties containing 21 items of works (Section 20),
and (iii) discretionary duties containing 29 items of works
(Section 21) where it is mentioned in the Act that the state
government will direct and make provision for undertaking
such works. The main activities of gram panchayats as seen
from the Audit Reports fall under these discretionary duties,
because for each activity the state government provides
funds through zilla parishad/panchayat samiti. Their own
resources are very meagre in relation to the expenditure they
have to incur. In reality, therefore, the gram panchayat
becomes an extended agency of the block office for
implementing different schemes losing their own characteristic
as self-government at local level. The total grant received
by the gram panchayats from the state government varies
in the range of Rs 3 lakh to Rs 17 lakh, depending on the
size of the gram panchayats. These grants-in-aid also include
District
1991
2001
Rate of change
Burdwan
Birbhum
Bankura
Midnapore
Howrah
Hooghly
24 Parganas North
24 Parganas South
Nadia
Murshidabad
Uttar Dinajpur
Dakshin Dinajpur
Malda
Jalpaiguri
Darjeeling
Coochbehar
Purulia
West Bengal
15.32
6.79
3.94
4.74
13.60
21.34
28.33
13.70
22.71
8.36
6.15
6.15
7.84
15.43
27.23
9.69
3.27
12.26
27.65
9.64
12.86
42.60
47.33
13.30
40.30
26.17
34.78
16.15
10.00
12.84
11.19
24.69
34.43
20.01
11.14
25.97
5.90
3.50
11.83
21.96
12.47
4.73
3.52
6.47
4.26
6.58
4.86
7.36
3.56
4.70
2.35
7.25
12.26
7.50
Note: Rate of change = [{In(2001/1991)}/10]x100

Source: (i) 1991 figures are taken from 1991 Census Report.
(ii) 2001 figures are taken from Sanitation Cell, Department of
Panchayats & Rural Development, Government of West Bengal.
administrative expenditure, as the state government bears

the total burden of the gram panchayats5. Generally, the
share of administrative expenditure varies in the range of
20 to 30 per cent of the total expenditure.
Expenditures at Village Level: In Table 13.3.5, the shares
of development expenditure in gram panchayats are shown.
It is around 65 to 70 per cent and implementation of
schemes under JRY is the major work in gram panchayats.
Under this programme, gram panchayats undertake schemes
like construction and renovation of primary schools,
installation and repairing of hand pumps for drinking water,
repairing of katcha roads connecting different habitations,
construction of all-weather roads on a small scale, plantation
of trees, etc. Of JRY receipts, around 3540 per cent goes
for repairing existing village roads (mostly katcha).
From Table 13.3.5 it can be seen that the share of
development expenditure in total expenditure was at an all
time high in the year 19978 in all the blocks under study.
One plausible explanation is that 19978 is the year prior
to the 5th Panchayat General Election held on 28 May
1998. For retaining the hold over the panchayats, the state
government channellized more funds to the panchayats.
5 The components of administrative expenditure include salaries
and different allowances for employees of the gram panchayats,
honorarium for the pradhan and upa-pradhan (chairman and vicechairman of the village panchayat), allowances for the members,
expenses for office management, etc.
331
Table 13.3.5
Shares of Development Expenditure in Total Expenditure of Gram Panchayats
Block
Karimpur I
Karimpur II
Krishnanagar I
19923
19934
19945
19956
19967
19978
19989
19992000
20001
65.40
64.97
64.89
65.72
65.81
65.67
64.84
65.88
69.28
66.08
60.17
66.44
66.64
69.20
72.14
70.54
77.23
78.12
68.75
59.76
70.22
66.60
62.28
65.63
69.81
65.37
69.06
Note: Sample GPs of each block are added together and then shares are calculated.
Source: Audit Reports of Gram Panchayats, collected from BDO.
Items of Work: Normally gram panchayats do not take up

works requiring technical expertise as there is no support
personnel for these works. There are only 2 ministerial
employees in West Bengal for managing the entire affairs
of gram panchayats. There are no technical persons having
skills equivalent to subordinate engineers at the gram
panchayat level. By contrast, at the block panchayat level
there are 4 to 5 subordinate engineers, who possess diplomas
in engineering. For these reasons, the gram panchayats prefer
to undertake schemes that are less technical in nature.
However, their role in providing drinking water to the
villagers is praiseworthy. Around 20 to 25 per cent of the
money received under JRY was spent for it although
everything is provided free of cost.
Even petty repairing of hand pump/tube well is
undertaken by the gram panchayats. In most of the cases
the repairing cost varies between Rs 50 to Rs 150 (repairing
involves replacement of check valves, filters, handles, etc.).
Imposing of user charges of only Rs 10 (that is, 35 paise
per day) per family per month can free the panchayats from
expenditure on such maintenance works on one hand and
can mobilize resources towards their own non-tax revenue
on the other. In the sanitation sector the village panchayats
practically have no role.
Even though under Section 19, sub-section 2 (a), of WBP
Act, the duties of a gram panchayat shall be to provide
sanitation, conservancy and drainage, and the prevention of

public nuisances within the area under its jurisdiction, the
panchayats, however, do not undertake any work on their
own initiative, because they have very little own resource
base. The share of own revenue as percentage of total
expenditure is calculated for 10 gram panchayats under study
over a period of 6 years. The result is given in Table 13.3.6.
It can be seen that the own revenue base is comparatively
better in case of Karimpur I and Karimpur II GP of Karimpur
I Block and Asannagar of Krishnanagar I Block. But usually
little autonomy exists and everything is directed and funded
from above. To quote from a report published by the
Government of West Bengal in this regard: ... the fact is
that the panchayats are not at all concerned about acquiring
even a modicum of financial self reliancethere is near zero
self reliance, which means near zero autonomy and
correspondingly near zero self-government. (Mukarji and
Bandopadhyay 1993).
Peoples Participation in Planning

Attendance at Gram Sansad: According to Section 16A of
the West Bengal Panchayat Act, every gram panchayat shall
hold one annual meeting in the month of May and one halfyearly meeting in the month of November within the local
limit of each village constituency. As per the provisions laid
down in the WBP Act, a gram sansad shall guide and advice
Table 13.3.6
Share of Own Revenue as Percentage of Total Expenditure
Name of GP
19956
19967
19978
19989
19992000
20001
Average for the period
Murutia
Dhoradaha I
Dhoradaha II
Nandanpur
Karimpur I
Karimpur II
Jamsherpur
Madhugari
Asannagar
Bhanderkhola
6.4
7.8
3.2
10.3
10.4
8.9
6.2
2.5
10.3
7.2
8.1
7.0
3.3
1.6
9.3
9.0
7.1
2.8
9.6
8.1
3.9
3.4
1.4
3.5
9.2
6.9
7.1
1.9
8.3
7.9
5.7
9.2
4.2
7.5
9.4
7.5
6.9
2.3
9.4
7.8
4.4
6.2
2.4
6.8
9.4
8.4
7.5
2.4
9.4
6.7
5.2
7.0
2.8
6.4
9.6
8.5
7.3
2.5
9.1
7.5
5.62
6.77
2.88
6.02
9.55
8.20
7.02
2.40
9.35
7.53
Note: First four GPs are from Karimpur II Block, next four GPs are from Karimpur I Block, and the last two GPs are from Krishnagar
I Block.
Source: As in Table 13.3.5.
332

Table 13.3.7
Attendance in Gram Sansad Meetings
Attendance in
Gram Panchayat
Murutia
Dighalkandi
Dhordaha I
Dhordaha II
Nandanpur
Karimpur I
Karimpur II
Jamsherpur
Pipulberia
Madhugari
Total no. of Sansads

10
19
10
11
22
16
17
20
12
5
Total voter
Male voter
7053
13091
7941
8307
15610
14223
14131
15482
10031
3013
3622
6808
4105
4276
8022
7256
7528
8022
5135
1595
Female voter
3431
6283
3836
4031
7588
6967
6703
7460
4896
1418
May 2002
November 2002
Male
Female
Male
Female
402
818
456
448
636
798
375
688
475
98
78
206
120
52
148
242
102
143
121
22
363
796
436
478
673
874
493
1317
389
118
69
135
69
49
123
176
75
166
113
12
Note: Gram Sansad means village constituency.

Source: Karimpur I and II Block offices.
the gram panchayat in regard to the schemes of economic

development and social justice undertaken or proposed to
be undertaken in its area; shall identify or lay down principles
for identification of the schemes which are required to be
taken on priority basis for economic development of the
village and identify or lay down principles for identification
of the beneficiaries for various poverty alleviation and allied
programmes. But in reality, these gram sansads are not given
adequate importance by the gram panchayats. Even if they
are convened, the meetings are convened in a very casual
manner and the local people feel disinterested to attend
those meetings. Table 13.3.7 presents data in respect of the
sample gram panchayats of Karimpur I and Karimpur II
Blocks for the gram sansad meetings during May 2002 and
November 2002.
The poor attendance in the gram sansad meetings is an
ample proof of the fact that in the process of decentralizing
the planning exercises, peoples involvement is very rare, and
decisions are mostly taken unilaterally by the panchayats
under the diktat of the political party controlling the
panchayats. In the words of World Development Report
1994, without local participation, projects often either
foundered at the implementation stage or were not
maintained and failed to produce sustained benefits.
Absence of Women in Meetings: Another weak area in the
gram sansad meetings is the limited presence of women.
Calculation of femalemale ratio (FMR) depicts this clearly
in Table 13.3.8. FMR of electors is also calculated to show
that though in voting participation of women is quite high,
yet their turnout in gram sansad meetings is quite low.
During informal discussions in the course of undertaking
field visits to the blocks under study, women categorically
told ki habe giye? (What is the utility in going there?).
In fact, there is no ready reply to the query because the

panchayats have so far kept them marginalized in the
decision-making process even after the reservation of at least
one-third seats for women. Incidentally, the savapati
(chairpersons of panchayat samiti) in both the Karimpur I
and Karimpur II blocks are women. Even in site selection
for installation of hand pumps, women, who have to carry
the water, are not asked to give their views.
The Samiti Level

Standing Committees: The panchayat samitis in West Bengal
bear the burden of a large chunk of development works. On
an average in a panchayat samiti, available funds amount
to Rs 80 lakh and above. In this study, the average availability
of funds in Karimpur I PS is Rs 116.58 lakh and Karimpur
II it is Rs 135.38 lakh. The programmes executed by the
panchayat samiti having the scope for infrastructure building
are EAS, BADP, MPLADS, and JRY (Box 13.3.2). The
Table 13.3.8
FemaleMale Ratio (FMR) of Attendance in Gram
Sansad Meetings
Gram Panchayat
Murutia
Dighalkandi
Dhoradaha I
Dhoradaha II
Nandanpur
Karimpur I
Karimpur II
Jamsherpur
Pipulberia
Madhugari
FMR elector
FMR
May 2002
FMR
November 2002
0.947
0.923
0.934
0.943
0.946
0.960
0.890
0.930
0.953
0.889
0.194
0.252
0.263
0.116
0.232
0.303
0.272
0.208
0.254
0.224
0.190
0.169
0.158
0.102
0.183
0.201
0.152
0.126
0.290
0.102
Source: As in Table 13.3.8.
333
Table 13.3.9
Receipt and Expenditure in Different Programmes: Karimpur I PS (figures in Rs lakh)
Year
EAS
BADP
MPLADS
JRY
Available fund Expenditure Available fund Expenditure Available fund Expenditure Available fund Expenditure
19967
19978
19989
19992000
20001
20012
X
25.00
20.01
35.81
48.23
39.46
X
23.14
1.59
13.30
26.72
18.29
X
X
11.25
38.25
70.50
107.55
X
X
Nil
35.25
11.25
63.21
X
X
10.32
13.85
16.76
Nil
X
X
9.30
6.60
16.76
Nil
5.78
14.28
9.08
5.91
X
X
3.86
9.36
7.87
5.91
X
X
Source: Karimpur I Panchayat Samiti Office.
panchayat samiti functions through a set of standing

committees (in Bengali Sthayee Samitis). At present,
according to WBP Act (Section 124) there are 10 standing
committees. These committees cater to all 29 subjects of the
Eleventh Schedule of the Constitution of India. Artha,
Sanstha, Unnayan O Parikalpana Sthayee Samiti (Finance,
Establishment, Development and Planning Standing
Committee) is mainly responsible for the whole range of
activities in a panchayat samiti including plan preparation.
Purta Karya O Paribahan Sthayee Samiti (Public Works and
Transport Standing Committee) undertakes construction
and maintenance of road network, Janasasthya O Paribesh
Sthayee Samiti (Public Health and Environment Standing
Committee) implements programmes for rural water supply
and sanitation, and Khudrashilpa, Bidyut O Achiracharit
Sakti Sthayee Samiti (Small Industries, Electricity, and Nonconventional Energy Standing Committee) is to look after
rural electrification programme along with development of
small and cottage industries and propagation of nonconventional energies. But in rural electrification, the
panchayat samitis under the study have practically no role.
In local infrastructure development, the major role of the
panchayat samiti lies in the road sector.
Data are collected from incomeexpenditure report of
the panchayat samitis. The maintenance of records is better
at this tier in comparison to the gram panchayat tier. The
services of all government employees working in the Block
Development Office and its associate offices are placed at
the disposal of the panchayat samiti. For this reason, funds
allotted to the panchayat samiti are mostly meant for
development funds. On tabulating, it has been seen that the
share of road in total expenditure under the programmes
EAS, BDAP, MPLADS, and JRY varies in the range of 40
to 45 per cent on an average. The detailed receipt and
expenditure under these four programmes during the period
19967 to 20012 are given in Table 13.3.9.
It can be seen that for infrastructure development, BADP
is the major source in blocks such as Karimpur I which has
international borders where around 4045 per cent money
has been spent on development of roads, mostly metalled.
For example, of the Rs 38.25 lakh fund received under

BADP in 19992000, Rs 16.25 lakh (42.48 per cent) were
for road construction. But the records show that no fund
is earmarked for maintenance of road.
In Karimpur II, 4 out of total 10 gram panchayats share
the international border with Bangladesh. Three of them,
Murutia, Dighalkandi, and Nandanpur, are included in this
study. Like Karimpur I Panchayat Samiti, Karimpur II
Panchayat Samiti also has these four programmes for
infrastructure development. Table 13.3.10 gives the annual
available fund vis vis expenditure in these 4 programmes
for the period 19967 to 20012.
It can be seen that in this block too, BADP is the major
source of fund for development of infrastructure. For
example, available funds over 19989 to 20012 in BADP
were Rs 214.58 lakh against Rs 131.35 lakh in EAS.
Maintenance Expenditures: The scheme register of the block
shows that funds allotted for maintenance of the roads that
already exist is very low. According to the guidelines of wage
employment programmes, it is prescribed that up to 15 per
cent of available funds can be spent on maintenance of assets
already in existence. The guidelines place importance on
maintenance because inadequate maintenance shortens the
useful life of the assets. Delay in maintainence only increases
the expenditures later required to make them service-worthy6.
In Table 13.3.9, programme-wise funds spent for
maintenance of road and its share in total expenditure are
given.
From Table 13.3.11 it can be seen that expenditure on
maintenance of roads, taking all 4 programmes together
varies from minimum of 4.82 per cent in BADP to maximum
6 Block officials of Karimpur I Block mentioned 2 roads where
for the last 7 years no maintenance work has been taken up and
as a result when it was taken up in the year 19989 under BADP,
the scheme cost stood at Rs 4.25 lakh in one case and in another
case under the same programme it stood at Rs 5 lakh in 19992000.
According to them if these roads were maintained in time the
scheme cost would have been Rs 1.50 lakh for the first and Rs 2
lakh for the second case.
334

Table 13.3.10
Receipt and Expenditure in Different Programmes: Karimpur II PS (figures in Rs lakh)
Year
EAS
BADP
MPLADS
JRY
Available fund Expenditure Available fund Expenditure Available fund Expenditure

19967
19978
19989
19992000
20001
20012
X
25.00
33.06
32.30
42.87
23.12
X
16.55
12.93
13.94
27.69
21.04
X
X
25.87
54.78
66.16
67.77
X
X
0.09
23.84
21.38
39.14
6.65
0.75
2.72
5.87
5.57
3.56
6.60
0.74
2.68
5.21
3.78
3.01
Available fund Expenditure

8.99
7.87
9.34
19.21
X
X
6.71
3.57
6.12
18.21
X
X
Source: Karimpur II Panchayat Samiti Office.

Table 13.3.11
Expenditure on Maintenance of Roads and its Share in Total Expenditure (figures in Rs lakhs)
Year
Karimpur I PS
EAS
BADP
MPLADS
19967
19978
2.26
(9.76)
X
2.72
(7.71)
0.95
(8.44)
5.23
(8.27)
19989
19992000
20001
20012
0.82
(6.16)
2.76
(10.33)
1.92
(10.50)
X
X
Karimpur II PS
JRY
0.29
(7.51)
0.67
(7.16)
0.75
(9.53)
0.49
(8.29)
EAS
X
1.85
(11.18)
1.35
(10.44)
1.98
(14.20)
1.68
(6.07)
X
BADP
MPLADS
JRY
1.15
(4.82)
1.22
(5.70)
1.55
(3.96)
X
X
0.75
(11.18)
0.40
(11.20)
0.55
(8.98)
1.10
(6.04)
Note: (i) Expenditure figures are in Rs lakhs.

(ii) Shares in total expenditure are in percentage and within brackets.
Source: As Table 13.3.9.
14.20 per cent in EAS in Karimpur II Panchayat Samiti.

In Karimpur I Panchayat Samiti it varies from minimum
6.16 per cent in EAS to maximum 10.50 per cent also in
EAS. In the MPLADS programme, maintenance works
were not normally taken up and the construction of primary
school buildings was a priority. It was realized during
discussions with the panchayat officials that they were more
interested in new constructions rather than allot fund for
maintenance work. This is natural, because new constructions
would increase the periphery of their popular support
benefits to be distributed but not to be supplemented.
CONCLUSION
From the expenditure data of select villages and blocks in
Nadia district we infer that the role of the panchayats in
infrastructure development is limited. In rural areas, the

panchayat samiti has some role through EAS, JRY, and
BADP (for the border blocks). However, in rural water
supply, the panchayats role is worth mentioning since
they bear complete responsibility for drinking water, and
have ensured good coverage. The only weak area is that
in the process of selecting the spots, local womens choices
are mostly ignored. Unfortunately, despite sincere wishes
of the state government to involve the people in all stages
of the functioning of the panchayats, the grass root
experiences tell a different storey. The decisions taken by
the panchayats tend to be adhoc as the participation of the
people in the decision-making process is limited and
infrequent. There may be some exceptions, but they are
few (like the Nandigram II experience in the total sanitation
campaign).
335
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Bureau of Applied Economics and Statistics (2001) District Statistical
Handbook Series, 2001, Government of West Bengal.
Business India (2003) The Convenient Millionaire, B.T. Ngor,
28 September.
CMIE (2003) Economic Intelligence Service, Electric Database.
GOI (1999) Central Bureau of Health Intelligence (2002), Health
Information in India 1999, Ministry of Health and Family
Welfare.
GOI (1999) Drinking Water, Sanitation and Hygiene in India,
NSS, 54th Round Report, No. 449 (JanJune) 1998, National
Sample Survey Organization, Dept. of Statistics, New Delhi.
Ghosh, D.K. (2002) Sanitation: The Unfinished Agenda, Yojana,
Vol. 46 (10), October.
Government of India (1999) Central Bureau of Health Intelligence.
Government of India (1996) Health Information of India 1996,
Ministry of Health and Family Welfare, New Delhi, 1996,
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(2000) Health Information of India, Ministry of Health and
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Government of West Bengal (2002) Annual Administrative
Report, 20012002, Department of Panchayats and Rural
Development.
http://www.sanicon.net/titles/topicintro.php3?topicId=18 (cited 25
June 2003).
Irigoyen, Jose Luis (2003) Millennium Development Goals:
The Infrastructure Contribution, Transport Forum URL:
www.worldbank.org/transport/forum2003/presentations/
irigoyen.ppt.
Kalbermatten, J.M. and R. Middleton (1999) Household Centred
Environmental Sanitation (http://www.Sandec.ch/Environmental
Sanitation/Documents/Paper%20 Description %20HCES%20
July 99.pdf)
Mehta, Meera (2003) Meeting the financing challenge for water
supply and sanitationIncentives to promote reforms,
leverage resources and improve targeting, World Bank and
Water and Sanitation Programme, May.
Mukarji, N. and D. Bandyopadhyay (1993) New Horizons for West
Bengals Panchayats, published by Department of Panchayats,
Government of West Bengal.
Murray, Christopher J.L. and Alan Lopez (1996) The Global

Burden of Disease, Harvard School of Public Health, USA.
National Council for Applied Economic Research (1992)
Household Survey of Medical Care, New Delhi, NCAER.
Pangotra, Prem (2003) City Monitor 2002, Ahmedabad
Management Association, Ahmedabad.
Park K. (2000) Parks Textbook of Preventive and Social Medicine,
Banarsidas Bhanot (16th edition), Jabalpur, India.
Planning Commission (2001) Report of the Working Group on
Border Area Development Programme for formulation of the
Tenth Five Year Plan, Government of India.
RUET, Joel (2003) Water in Urban India: Scenario, the energy
linkage, the limits of the private sector, Draft Paper for India
Infrastructure Report 2004.
The Times of India (2003) Waters Worth (Interview of A.
Vaidyanathan by Parul Chandra), 10 June, Ahmedabad.
UNDP (2003) Human Development Report 2003, Chapter 4,
URL: http://www.undp.org/hdr2003/pdf/hdr03_chapter_4. pdf.
(2001) Human Development Report 2001, Making
Technologies Work for People, Oxford University Press, New
Delhi.
UNDP, SEWA (2000) Meeting the Infrastructure needs of the
informal sector through microfinance in urban India, Credit
Connections Issues Paper.
UNDP (2001) Human Development Report 2001: Making
Technology Work for People, Oxford University Press, New
York.
World Bank (1994) World Development Report.
World Health Organization (2002) The World Health Report 2003:
Reducing Risks, Promoting Healthy Life, WHO, Geneva.
World Health Organization and UNICEF (2000) The Global
Water Supply and Sanitation Assessment Report 2000,
Chapter 1: Available from URL:http: //www.who.int/docstore/
water_sanitation_health/Globassessment/Global1.htm#Top.
World Health Organization and UNICEF (2001) Access to
Improved SanitationIndia, WHO/UNICEF Joint
Monitoring Programme for Water Supply and Sanitation
Coverage Estimates 19802000, September 2001 (http://
www.childinfo.org/cddb/sani/asia/india-sanitation1.pdf).
336
"
THE URBAN SITUATION
14.1 RECENT FINANCIAL INITIATIVES AMONG URBAN LOCAL BODIES:

A REPORT
Chetan Vaidya and Hitesh Vaidya
Municipalities are just beginning to go to markets to raise
funds, and in many ways to respond to the challenge of
efficiency, responsibility, and involvement of citizens in the
provision of services. We list some of the more significant
initiatives in recent years.
FINANCIAL INITIATIVES
The AMC was the first ULB to access the Indian capital
market. In January 1998, it issued Rs 1000 million in
municipal bonds to partially finance a Rs 4393 million
water supply and sewerage project. This was the first
municipal bond issued in India without a state guarantee
and represented the first step towards a fully market-based
system of local government finance1. The AMC had
previously instituted fiscal and management reforms,
including improved collection of property taxes and octroi,
computerization of financial records, a modern accounting
system, strengthened workforce and financial management,
and development of a comprehensive capital improvement
programme. Consequently, from a loss-making municipal
corporation till 19923, with accumulated cash losses of
Rs 350 million, the AMC achieved a closing cash surplus
of Rs 2142 million in March 1999. These reforms laid the
groundwork for the AMCs bond issue and the successful
implementation of the water supply and sewerage project.
The debt market for municipal securities in India has
grown since the issuance of the Ahmedabad bonds. Since
1997, cities that have issued municipal bonds without state

government guarantees are Nashik, Nagpur, Ludhiana,
Indore, and Madurai. In most cases, bond proceeds were
used to fund water and sewerage schemes2.
The bond issue of the Municipal Corporation of Madurai
(CoM) was different from the others because it was to
refinance an existing project. The corporation built a 2-lane
inner ring road that cost about Rs 430 million. The project
was financed by a Rs 140 million grant from the state
government (considered as equity contribution by the CoM)
and a Rs 290 million loan from the Tamil Nadu Urban
Development Fund (TNUDF). The CoM decided to
refinance the project through a private placement of bonds.
This debt swap to repay the higher cost TNUDF loan with
the bond market issue saved the corporation an annual
interest payout of about 3 per cent, saving more than
Rs 80 million.
Tax Free Municipal Bonds

The Government of India decided to provide tax-free status
to municipal bonds to boost the municipal bond market.
During his budget speech of 19992000, the finance minister
announced the Government of Indias intention to permit
ULBs to issue tax-free municipal bonds. Subsequently, the
central government amended the Income Tax Act (1961 vide
the Finance Act 2000) to exempt interest income from bonds
issued by local authorities from income tax and provided
guidelines for issuing tax-free municipal bonds in 2001.
The Bangalore Municipal Corporation was the first municipal

corporation to issue a municipal bond with state guarantee in 1997.
Vaidya, Chetan and Hitesh Vaidya (2002).
The Urban Situation 337

Table 14.1.1
Details of Bonds Issued by ULBs
City
Amount
(Rs million)
Placement
Guarantee
Interest
%
Public &
Private
Private
No
14
State govt.
13
Ahmedabad
1000
Bangalore
1250
Ludhiana
100
Private
No
Nagpur
500
Private
No
13.5 to
14
13
Nashik
1000
Private
No
14.75
Indore
100
Private
Yes
Madurai
300
Ahmedabad (Tax Free) 1000
Private
Private
No
No
12.25
9
Hyderabad (Tax Free)
825
Private
No
8.5
Tamil Nadu
(Pooled Financing)
304
Private
9.20
Escrow
Octroi from 10 octroi
collection points
State government grants
and property tax
Water and sewerage
taxes and charges
Property tax and
water charges
Octroi from 4
octroi collection points
NA
Purpose
Rating
WS&S project
AA- (SO)
City roads/
street drains
WS&S project
A- (SO)
LAA- (SO)
WS project
LAA- (SO)
WS&S project
AA- (SO)
Improvement of A (SO)
city roads
City road project LA+(SO)
WS&S project AA (SO)
Toll tax collection

Property taxes of
2 zones
Non-residential PT,
Road
LAA+(SO)
Advt. Tax, Prof tax, etc. construction
AA+ (SO)
and widening
Monthly payments
WS&S projects LAA (SO)
equal to one-ninth of
in 14 ULBs
their annual payments
Note: * The USAID provided a backup guarantee of 50 per cent of the bonds principal through its Development Credit Authority.
WS = Water Supply; S = Sewerage.
Source: Compiled from Bond Issuance Brochures.
Ahmedabad was the first municipal corporation in India

to issue a tax-free municipal bond, and used it for water and
sewerage projects. In April 2002, the AMC issued secured,
non-convertible redeemable tax-free debentures on a private
placement basis. The bonds term is 10 years with a put/
call option at the end of the fifth year. The interest rate for
the first 5 years is 9 per cent payable semi-annually; and
the rate for the next 5 years is linked to the prevailing bank
rate. The bond issue amount was Rs 500 million with a
right to retain over-subscription up to Rs 500 million.
The Municipal Corporation of Hyderabad issued a taxfree municipal bond in 2002, the second city to do so. The
Rs 825 million raised by the bond will provide urban
infrastructure especially in slums. The tenure of the bond
is 7 years and its interest rate is 8.5 per cent. The income
accruing to the investors will be exempt from income tax.
At the same time, the Government of India increased the
limit of municipal tax-free bonds from Rs 2000 million in
20012 to Rs 5000 million in 20023. Nashik, Nagpur,
and Vizakapatnam municipal corporations are in the process
of issuing tax-free municipal bonds (Table 14.1.1).
Pooled Financing
Only financially strong, large ULBs are in a position to
directly access capital markets. Most small and medium
ULBs are not able to access capital markets on the strength

of their balance sheets alone. The cost of the transaction is
another significant barrier. In the US and elsewhere, small
local bodies can pool their resources and jointly access the
capital market. The central government decided to create
a similar vehicle that would enable capital investments to
be pooled under one borrowing umbrella. The objective was
to provide a cost-effective and efficient approach for smaller
and medium-sized ULBs and to reduce the cost of
borrowing3. In this context, the USAIDs Financial
Institutions Reform and Expansion (FIRE) project is working
with the GOI to set up a state-level pooled finance
mechanism for smaller and medium-sized ULBs to access
the capital market. The Union Budget (20023) proposed
setting up the Pooled Finance Development Facility (PFDF).
The objectives of this fund are to support state initiatives
to establish pooled financing structures, provide technical
support and credit enhancements, and leverage urban
reforms. The FIRE project supported TNUDF in structuring
a pooled financing entity that, in December 2002, issued
a bond and mobilized Rs 32 million from domestic capital
markets to finance water and sanitation projects in 14 smaller
and medium sized towns4.
3
4
Bhattacharjee, N. (2002).
Indo-US FIRE Project (2003).
338
The success of these issues demonstrates that local

governments can access the capital market for resources for
environmental infrastructure. The ability of municipalities
to take advantage of these opportunities, however, depends
on their presenting themselves as viable financial entities.
ULBs must demonstrate creditworthiness and obtain an
investment grade credit rating. This forces them to improve
their revenue base by introducing reforms, including
improved cost recovery and financial management, and
better management of urban services. Another prerequisite
for issuing municipal bonds is the development of
commercially-viable infrastructure projects, that is, projects
that can recover full costs including the cost of debt service.
Borrowing from Commercial Banks/Financial Institutions

Recently, the banking system in India has become highly
liquid and commercial banks are actively pursuing lending
opportunities with local governments. The Vadodara and
Surat Municipal Corporations decided to finance their urban
infrastructure projects by obtaining commercial bank loans.
The Vadodara Municipal Corporations first loan was for a
Rs 40 million project to revamp existing sewerage treatment
plants. The loans interest rate is based on the prime lending
rate, plus 1 per cent. The corporation reserves an exit option
without any extra charges due, that is, there is no pre-payment
penalty. No security was offered except a general lien on the
investments. After the success of the first loan, the Vadodara
Municipal Corporation decided to seek loans from other
commercial banks. Not only has it obtained loans at the
lowest possible interest rates, but it also has not paid any legal
documentation charges or one- time front-end fees. It obtained
medium-term loans of Rs 700 million from commercial
banks with no fees and with any time exit options5. The
Surat Municipal Corporation also obtained several commercial
bank loans in the last 3 years to finance water supply and
sewerage projects. The Thane Municipal Corporation obtained
an ICICI loan of Rs 500 million in 2001. The loan term is
9 years and interest rate is the long-term prime rate plus 0.25
per cent per annum that is payable quarterly. The ICICI
charged the Thane Municipal Corporation a one- time frontend fee of 1.05 per cent (Rs 5.25 million). To secure the loan,
the corporation opened an escrow account into which
designated collections are transferred on a daily basis. These
efforts demonstrate that bank loans can and will play a very
important role in financing urban infrastructure projects.
Private Sector Partnerships

Several cities have established business partnerships in
municipal infrastructure. The private sector functions include
specific tasks pertaining to solid waste management (SWM)
(collection, transportation, and disposal), water supply
5
Joshi, Ravi (2002).
(pumping, tankers), roads (toll, O&M in lieu of advertisement

rights), and streetlights. Contracting solid waste collection
and transportation of the entire city to private firms and
community groups has led to improved effectiveness,
responsiveness, and cost savings for many ULBs. Cities and
secondary towns have arranged for maintenance of streetlights,
parks, and even collection of octroi revenue by private
contractors. Some ULBs have begun to outsource tax and
octroi collections, maintenance of streetlights, issuance of
death and birth certificates, and O&M of tube wells. The
Municipal Corporation of Ludhiana, for example, introduced
a private courier system for bill distribution, saving nearly Rs
2.5 million per year6.
The Tiruppur Exporters Association supported by the
state and local government decided to involve the private
sector in meeting water demand. They formed a public
limited company with private sector participation, the New
Tiruppur Area Development Corporation, to implement
the project. The project is being implemented on a buildown-operate-transfer (BOOT) basis. This is the first PPP
to access commercial funds for the construction of a large
new water project in India. The Tiruppur experiment is a
benchmark for private initiatives in the sector. The
foundation stone for the project was laid on June 2002. The
project will build a strong case for private financing of water
projects in India. Cities are also experimenting with PPP
in financing and construction of waste composting and
power generation cum bio-fertilizer plants on a build-ownoperate (BOO) basis.
Municipal Asset Management

ULBs hold a significant amount of fixed assets in real estate,
but very few local bodies have exploited the commercial
potential of these properties to generate non-tax revenues.
Most ULBs do not have a proper inventory of assets nor
do they update the inventories regularly. When villages on
the periphery are brought into municipal limits as the city
expands, panchayat land then comes under municipal
ownership. This way, the Municipal Corporation of Ludhiana
added to its assets about 800 properties worth an estimated
Rs 1900 million7. An asset inventory of the small town of
Ramanagaram under the Karnataka Urban Development
Project showed that the town owns saleable assets worth
Rs 16 million. Indore also prepared a computer database of
its 1150 properties and, with the assistance of the FIRE
project, is developing a strategy for optimal use of these
assets. The Vijayawada Municipal Corporations (VMC)
annual revenue from leasing municipal properties is Rs 27
million, about 7 per cent of its total revenue8. In 1999
6
7
National Institute of Urban Affairs (1999).

Singh, Ashwajit (2001).
8 Kirloskar Consultants Limited (1998).

2000, the Surat Municipal Corporation generated Rs 182
million by selling a 34,000 sq m site to a private developer.
CONCLUSION
While municipalities have successfully raised funds outside
their usual sources (grants and devolutions from the state
governments and local taxes) through the market and from

banks, these have not amounted to the substantial increase
that was expected as municipalities geared up for enhanced
provision of services since it is difficult for ULBs to develop
commercially-viable projects and strengthen their revenue
base.
14.2 MUNICIPAL GOVERNANCE: STANDARD FORMS FOR

PERFORMANCE REPORTING
Ravikant Joshi
In India there are no formal models or frameworks that are
used to measure the performance of municipalities in the
provision of services. Credit rating agencies9 have rated
municipal bond issues, and to a limited extent have looked
at the finances of municipalities they have rated. The Tata
Energy Research Institute (TERI) and City Managers
Association-Gujarat (CMA-G) proposed models, the former
for the more limited purpose of assessing the environmental
compliance of municipalities in the performance of their
tasks. There is a need to develop a performance-based
evaluation model to measure VFM of municipal services/
sector to aid citizens and others in their task of assessment.
Many governments of advanced countries have laid down
standards and formats for performance reporting by
municipalities, especially for use by citizens.
The Canadian government has developed a municipal
performance measurement programme (MPMP) based on
selected performance indicators largely to aid citizens in
their assessment of the performance of their municipalities.
THE CANADIAN MUNICIPAL PERFORMANCE

MEASUREMENT PROGRAMME
Canadian municipal bodies have the double-entry accrualbased accounting system. But in order to go beyond financial
measures to measures of relevance for citizens and supporting
agencies including the higher levels of government, over and
above the balance sheet and financial statement, the Canadian
Ministry of Municipal Affairs and Housing designed the
municipal performance measurement system under Section
83.1 of the Municipal Act and introduced it with effect
from the month of December 2001. The model is backed
by detailed operational guidelines about how to conduct
performance measurement and the various performance
indicators to be utilized for the same.
9 CRISILIndia developed methodology for rating municipal
bond and municipal bodies. For further information source web site
www.crisil.com
Under the MPMP, municipal bodies by law are required

to provide detailed information10 of its accounts and in
addition the measures on the indicators listed in Box 14.2.1.
The Canadian Model of Municipal Performance Measurement covers 9 core municipal functions or service areas by
using 25 broad-level efficiency and effectiveness performance
measures. The model provides for publication and
dissemination of the municipal performance information
under the 9 core municipal service areas and 25 efficiency
and effectiveness performance measures to the people at
large within 9 months of the end of the fiscal year. This
report is to be published over and above the annual financial
accounts. Many of the performance measures of the Canadian
MPMP are applicable to Indian municipal bodies. Of course
we will need a more elaborate list of performance measures/
indicators to suit the heterogeneity associated with the Indian
municipal system.11 Further, we will have to decide about
addressing the issue of multiplicity of stakeholders. The
Canadian MPMP is inter alia designed keeping in view the
needs of common citizens and higher-level government.
URBAN SERVICES ENVIRONMENTAL RATING

SYSTEM (USERS)
In India, TERI was engaged by the MoEF and the United
Nations Development Programme (UNDP) to develop a
framework called USERS (Urban Services Environmental
Rating System). The aim of this project is to measure the
10
11
To the ministry and to the public.

In India, municipal body or local self-government system is
a state subject by the Constitution. Accordingly, the state governments
have enacted independent legislation for the municipal system in the
state. These legislations are common or similar at certain broader/
macro aspects but differ widely at micro level or actual municipal
governance level. Again, within the state, between various municipal
bodies, there exists diversity in terms of functional sphere, financial
powers, resources, etc. We will, accordingly, need a municipal
performance measurement system which is broad-based and can take
any heterogeneity in its fold.
340

Box 14.2.1
The Performance Measurement Indicators of Canadian MPMP
The Canadian MPMP use the following Performance Measurement Indicators (PMIs) for the purpose of performance measurement
and evaluation:
OVERALL COSTS
Operating costs for general government as a percentage of total municipal operating costs.
Operating costs for fire services per US$1000 of assessment. (Where this is the municipalitys responsibility.)
POLICE
(In India this is not a municipal function)
Operating costs for police services per household.
Total crime rate as defined by Statistics Canada.
PUBLIC TRANSPORT
Operating costs for paved (hard top) roads per lane kilometres.
Operating costs for unpaved (loose top) roads per lane kilometres.
Operating costs for winter control maintenance of roadways per lane kilometres.
Percentage of paved lane kilometres rated as good to very good.
Percentage of winter event responses that met or exceeded municipal road maintenance standards.
Operating costs for conventional transit per regular service passenger trip.
Number of conventional transit passenger trips per person in the service area in a year.
WASTEWATER (SEWAGE)
Operating costs for wastewater per kilometre of sewer line.
Number of sewer-main backups per 100 kilometres of sewer line in the year.
Percentage of wastewater estimated to have by-passed treatment.
WATER
Operating costs for the treatment and distribution of drinking quality water per mega-litre.
Number of breaks in water mains per 100 km of water main pipe in a year.
Weighted number of days when boil water advisory is issued by the Medical Officer of Health, and is applicable to a municipal
water supply.
SOLID WASTE MANAGEMENT (GARBAGE)

Operating costs for solid waste collection, transfer and disposal per tonne or per household.
Operating costs for solid waste diversion per tonne or per household.
Average operating costs for SWM per tonne or per household.
Number of days per year when a Ministry of Environment compliance order for remediation concerning an air or groundwater
standard was in effect for a SWM facility, by site and total number of sites in the municipality.
Number of complaints received in a year concerning the collection of solid waste and recycled materials per 1000 households.
Percentage of residential solid waste diverted.
LAND-USE PLANNING
Percentage of new development with final approval, which is located within settlement areas and the number of new lots, blocks,
and/or units.
Percentage of land designated for agricultural purposes, which was preserved, and number of hectares of land originally designated
for agricultural purposes, which was re-designated for other uses.
performance of a municipal body with respect to its service

delivery in urban areas through a set of performance
indicators that are benchmarked against set targets. The
ULBs of Kanpur and Delhi have been identified as pilot case
studies. The USERS project is aimed at:
1. Addressing the problem of environmental degradation

in urban areas by empowering urban communities with
information, which would foster the emerging trend towards
transparency and accountability;
2. Providing policy-makers/implementation agencies

with an analytical tool, which would enable more informed
planning/decision-making; and
3. Developing and disseminating a rating system for
the environmental aspects associated with the operations of
urban agencies involved in 3 service areaswater supply
and waste (solid waste and sewerage) management.
The TERIs USERS programme is quite limited since it
focuses mainly on the environmental aspect of urban service.
For measuring performance the TERI Model uses a list of
the indicators for the 3 different services, with an integrated
approach under 3 different categories covering management,
technical, and financial indicators The details are listed in
Table 14.2.1 for water supply.
UIPMP OF CITY MANAGERS ASSOCIATION

GUJARAT
The CMAG selected 29 finance indicators and 38
infrastructure indicators for its maiden pilot Urban Indicators
and Performance Measurement Programme (UIPMP),
and applied it to 10 selected cities of Gujarat for the year
20001 data. The salient features of this programme and
the list of the indicators used are elaborated below:
1. The UIPM programme was undertaken by the CMAG to provide the ULBs with an analytical tool for selfassessment, which would also make them more transparent
and accountable.
2. The process involved the formulation of a list of

performance indicators by a Technical Advisory Committee,
which comprised outside expert and practising municipal
officers.
3. Having finalized the list placed below, a hierarchy
of weightages was formed and weightages were assigned to
each performance indicator to facilitate comparison of one
municipal body with another and to facilitate ranking of
the municipal bodies evaluated.
4. The CMA-G team collected data through the
questionnaire, followed by an orientation visit and data
collection and validation visits to the municipal bodies.
5. Being the first experiment, not many municipal bodies
participated in it. The data was not available nor was it reliable,
so, as a result, many indicators could not be worked out.
6. The biggest obstacles turned out to be lack of uniform
and compatible data, and apathy or indifference.
7. This entire exercise of performance measurement
was based on the comparative measurement among the
municipal bodies and did not include comparison against
the standards or benchmarks.
8. CMA-G could not undertake or replicate the UIPM
programme for years subsequent to 2001 and 2002 due to
various reasons, but it still plans to extend the programme
to 30 cities.
9. Though the UIPMP aimed at providing an analytical
tool to municipal bodies for self-assessment, no municipal
body has utilized UIPM for self-assessment in the last 2
years or so.
Table 14.2.1
Performance Indicators in USERS for Water Supply
Management PMIs for water production
Indicator
Average daily intake of surface raw water
Average daily clear water production
Average daily withdrawal by tube wells
Technical PMIs on water quality surveillance
At water treatment plants,
a) Residual chlorine tests
Samples tested
Found not satisfactory
b) Full chemical tests
Samples tested
c) Bacteriological examination
Samples tested
Financial PMIs for revenue collection
Average revenue collected per unit
of water produced
Average revenue collected per unit of water sold
Total revenue collected/total revenue demanded
Unit
Type
Level
Frequency
MLD
MLD
MLD
Output
Output
Output
C
C
C, Z
Weekly
Weekly
Weekly
Trend
Trend
Trend
No
%
Eff.
Weekly
C
Water Quality
Standards
No
%
Eff.
C
C
Weekly
Water Quality
Standards
No
%
Eff.
Weekly
C
Water Quality
Standards
Rs
Eff.
C, Z
Monthly
Comparisons
Rs
-
Eff.
Eff.
C, Z
C, Z
Monthly
Monthly
Comparisons
Trend
Note: C = city; Z = zone; Eff. = efficiency; MLD = million litres per day.
Benchmark
342
The list of the performance indicators utilized as part of

UIPMP of CMA-G are as in Box 14.2.2. As mentioned
earlier the UIPMP of the CMA-G was aimed at providing
a self-assessment tool to the municipal bodies. It included
various types of performance indicators right from the input
output analysis, impact analysis, and cost recovery. Very few
of them dwelt on VFM.
REMARKS
To lead to serious evaluation and ensure transparency of
municipal bodies functioning, public reporting on the lines
of the Canadian system with suitable alterations to account
for the differences in the statutory responsibilities of ULBs
between the 2 countries would be necessary. Only then can
Box 14.2.2
PMI of CMAGs UIPMP
WATER SUPPLY
Road Length Covered per Sweeper
Service Level
Service Cost and Efficiency
Water supplied per capita per day

Average house supply per day
Number of supply days in a week
Treatment plant capacity as percentage of water supply from
surface water resources
Storage Capacity Adequacy
Total Cost per Tonne of Waste Collected

Manpower per Tonne of Waste
Cost Recovery
Service Coverage
% of Roads Surfaced
% Road Length having Storm Water Drains
Ratio of Slum Population to Public Stand Post

Percentages HH Covered by Water Supply Connections
Percentages Pipe Length to Total Road Length
ROADS
AND
STORM WATER DRAINAGE
Service Level
Service Coverage
Road Density
% City Area Covered by Storm Water Drains
Cost of Supply
Establishment Cost Per Capita
Cost Recovery
Amount of Unaccounted for Water
Staff per MLD Supplied
SEWERAGE
Service Level and Coverage
AND
SANITATION
Cost per km of Road Length

Staff per 10 km of Road Length
STREETLIGHTS
Service Level
Street Light Service Coverage
% of Waste Water Treated

Slum Population Per Public Convenience
Ratio of Pay and Use Toilets to Total Public Toilets
Service Coverage
% of Population covered by Underground Drainage and
Individual Septic Tanks System
% HH Covered by Sewerage Connection

Cost per Sewerage Connections
Cost Recover
Staff per 1000 Sewerage Connections
SOLID WASTE MANAGEMENT

Service Level and Coverage
% Waste Collection
% Vehicle to Waste Generated
Spacing of Waste Bins
% Capacity of Bins
Cost per Street Light

Staff per 1000 Streetlights
FINANCIAL INDICATORS
Resource Mobilization
Per Capita Revenue Income
Per Capita Tax Income
Per Capita Non-Tax Revenue
% of Own Resources in Revenue Income
% of Own Resource in Capital Income
% Growth in Per Capita Tax Income
% Growth in Per Capital Non-tax Income
% Growth of Own Resources in Revenue Income
% of Octroi in Revenue Income
% of Total Grants in Total Income
Per Capita Property Tax Income
Property Tax Collection Performance
Number of Properties Assessed per Staff

Property Tax Collection per Staff
Properties Assessed per sq km of City Area
% of Arrears in Total Demand
Expenditure Management
Per
Per
Per
Per
Per
Per
Capita Revenue Expenditure

Capital Expenditure on Water Supply and Sanitation
Capita Expenditure on Public Health
Capita Expenditure on Public Safety
Capita Expenditure on Public Works
Capita Expenditure on General Administration
citizens, funding agencies, markets, and upper levels of

government (as also the municipality itself ) take upon
themselves the task of measuring whether society has got
the value for its money. It goes without saying that
appropriate accounting reforms make this possible, databases
and query modules that make reporting in a variety of ways
and for a variety of purposes, and to serve the interest of
stakeholders, are necessary. Only then can formal VFM
analysis between alternative modes of service delivery such
as PFIs /PPPs, other forms of partial outsourcing, and own
production be evaluated in detail.
In the reporting task the benchmarks need to be developed
that also recognize the particular areas where there is a
tendency to fail. For example, these could inter alia include
as much as the per capita litres per day served by the
municipality, also measures like what percentage of the
people are served with water below a certain lifeline level,
say 40 lpcd. Judicious benchmarking or selecting suitable
performance standards is part of the task of measuring
relative performance. One technique or tool of performance
% of Establishment Expenditure in Total Revenue Expenditure

Operating Ratio
Per Capita Expenditure on Capital Works
% of Expenditure on Discretionary Services
Debt Management
Debt Service Ratio to Income (Loan Repayment/Revenue
Income)
Debt Service Ratio to Expenditure (Loan Repayment/Revenue
Expenditure)
Outstanding Liabilities per Capita
measurement, which can be easily and effectively used for

the VFM of municipal expenditure, is Analysis by Indicators.
This is a practice in the municipalities round the world
wherein measurement programmes have been structured
based on selected performance indicators. With such data
in the public domain, and is wide use, the benchmarking
of municipalities would not only be possible but would lead
to much pressure for performance improvement.
Among all tiers of government, the municipal government
is closest to the people, and they render basic urban services
upon which quality of life depends. So, in the context of
municipal governments, the concept of VFM to assess their
performance becomes more relevant than ever before,
especially since the responsibilities of the municipalities are
now constitutional. It is also in keeping with the protection
of consumers rights since municipal bodies provide various
services to citizens as consumers. It will gain rigorous
ground12, and then municipal governments will be under
its constant surveillance. Already there are NGOs and peoples
movements of all kinds that could take on this task.
14.3 VALUE FOR MONEY AND MUNICIPAL ACCOUNTING REFORMS

Ravikant Joshi
The accounting system in most of the municipal bodies is
highly rudimentary. Municipal bodies are said to have a
single-entry cash-based accounting system but in reality, no
accounting system exists. What exists in municipal bodies
is mere bookkeeping, which is inadequate. In most municipal
bodies only day-to-day primary accounting procedures are
12
Chennai and several other municipalities have announced a

charter of citizens rights and publicly announced their commitment
to provide services and amenities. Bangalore Municipal Corporation
is being watched over by an external but powerful body, the Bangalore
Agenda Task Force. With reform of sales taxes, states in India would
be increasingly competing through their cities and, therefore, both
through the city-serving and city-forming functions.
followed. The secondary and final processes of accounting

are carried out inadequately. Such dilapidated accounting
systems render it impossible to have real figures to calculate
benefits that accrue from municipal expenditures.
MUNICIPAL ACCOUNTING REFORMS
IN
INDIA
During the entire period of 18 years (1981 to 1999) less

than 10 Indian municipal bodies experimented with
accounting reforms with a chequered record of success but
they were neither systematically pursued nor structured13.
13
We carried out an opinion survey to understand the impact

and the value of the reforms as perceived by various stakeholders.
344
Against this background came the Tamil Nadu municipal

accounting reforms14, achieving unimaginable success. The
reforms were introduced enbloc, in 107 municipal bodies,
after the successful experiment with Chennai. The entire
process of Tamil Nadu municipal accounting reforms right
from the conception, design, to implementation was
characterized by innovation, continuity and follow-up action
at every level, and much foresight. The most important
aspect of the Tamil Nadu experiment was its decisive focus
to address the issue of uniformity and comparability of
accounting systems and financial statements of all the
municipal bodies of the state.
We carried out an opinion survey of councillors,
employees, citizens, and NGOs to understand the impact
and the value of reforms as perceived by them. Below we
report the results.
The State Government and State Level Agency

Perspective15 16
The quality of accounting data in municipal bodies
has improved substantially.
Reforms have created a feel good effect among all
the stakeholders, especially among municipal bodies.
Timeliness in preparation and submission of annual
accounts has improved tremendously. Bookkeeping has
become a daily affair from an annual affair. Now annual
accounts of around 90 per cent of municipal bodies are
received by the end of June. Even annual accounts of the
rest of the municipal bodies do not remain pending more
than half a year. Before reforms, annual accounts used to
be pending for 2 to 3 years on an average.
All subsidiary records like tax register, water charge,
Lease revenue records, which were either unwritten or/and
unreconciled for years have been brought to current status
and are being reconciled with the accounts on regular basis.
Deposits and advance registers are updated and
differences removed.
Transparency in repairs and capital works improved
since capital expenditures now get classified and the asset
14
Refer success story of the Tamil Nadu Municipal Accounting

Reforms documented by Joshi (2003).
15 Based on discussions with Vijayraghavan, Secretary, Urban
Development, Government of Tamil Nadu, Devaraj, Project Director,
and Malaichamy, Financial Specialist of TNUDP II, Rajivan, CEO,
and Ravikumar, Assistant Vice President, TNUDF.
16 Tamil Nadu Urban Development Project II is an extension
of the work done by the Commissioner of Municipal Administration.
It specifically deals with technical assistance to municipal bodies for
specific reforms. The technical assistance, coordinating with different
agencies, and the training aspects of the municipal accounting reforms
were looked after by the TNUDP II for the past 4 years.
registers with details of improvement done are recorded

without fail.
Accounts are placed periodically to the council and,
as a result, elected officials as well as the public become
aware of the financial health of ULBs.
It reveals the collateral (liability) or asset position of
each municipal body through the balance sheet. As it has
become easy to know what a municipal body can offer as
a collateral security against the loans, it will be easy to raise
funds from the market.
It has become possible to provide comprehensive and
realistic data to outside agencies about the municipal bodies
for which the TNUDF17 was planning to raise funds from
the market or outside agencies.
The comfort of rating agencies has increased. TNUDF
could easily get a rating from the rating agencies for its
Rs 29 crore bonds for Madurai Municipal Body. Similarly
improved accounting system of the municipal bodies helped
to satisfy and convince investors and Development Credit
Agency of USA to extend guarantee to TNUDFs municipal
bonds of Rs 30.4 crore. These bonds were raised under
Pooled Finance Mechanism for a group of 12 municipal
bodies at the interest rate of 9.25 per cent through private
placement.
The improved accounting system and availability of
annual accounts have made it possible for TNUDF to carry
out the study of working capital needs, and repayment
capacity of the municipal bodies.
Demandcollectionbalance (DCB) statement18
regarding property and other taxes always lacked credibility
and correctness. Now the DCB statement has become part
of accrual accounting system and annual accounts.
Markets and firms which were familiar with DES,
can now look at municipal bodies performance and situation,
and without much effort arrive at the correct picture.
The data provided by the new accounting system
helped TNUDF to modify its financial appraisal system for
judging proposals submitted by the municipal bodies for
17
Tamil Nadu Urban Infrastructure Financial Services Ltd

(TNUIFSL) manages a grant fund owned by the Government of
Tamil Nadu and known popularly as Tamil Nadu Urban Development
Fund (TNUDF). This fund is constituted to provide technical
assistance for project preparation and management. It also takes
municipal projects out from problems of implementation. The
TNUIFSL is a joint stock company whose equity holders are the
Government of Tamil Nadu, IL&FS, and other financial institutions.
18 DCB statement is an MIS derived from the subsidiary registers
taxes and demand revenues such as individual accounts of property
tax, professional tax, water charges, and other miscellaneous demand
items. In the cash accounting system these subsidiary records were
kept independent (that is, they did not form part of the accounts
or accounting system) and, hence, there was no compulsion for
timely updating them.

financial assistance. Earlier TNUDF was using Financial
Operational Plan (FOP) and Debt Service Coverage Ratio
(DSCR) and comparison of total expenditure to total receipt
to evaluate loan proposals of municipal bodies. As it was not
possible to appropriate salary and other revenue expenses to
the projects under progress under capital account, the revenue
expenditure was turning out much higher compared to
revenue income and thus depicting much negative scenario.
The improved accounting system data indicated that almost
10 to 15 per cent revenue expenditure can legitimately be
classified as project overheads and can be charged to capital
account. Using this analysis when appropriate part of revenue
expenditure of Salem municipal body was charged to capital
(project) account its revenue account turned out to be much
better and acceptable while evaluating its Rs 2400 lakh
water supply project loan application.
TNUDF has now decided to allocate appropriate
percentage of revenue expenditure to project account if such
information is available while doing the financial appraisal
of municipal loan proposals.
Municipal Executives Perspective19

It is a much more useful tool for managing a municipal
council.
It provides detailed information about municipal
receipts, progress of their recovery, item-wise expenditure,
current liability towards contractors, suppliers, etc.
As we know fairly well about our net revenue and
how much more money we can spend, we are in a position
to take decisions regarding various expenses without worrying
about liquidity crisis or deficit.
It has lent status and credibility to municipal accounts.
Fixing accountability has become possible. In the
earlier system it was not possible. It is now possible to know
who is spending more or who is now bringing adequate
recovery. New computerized double-entry accounting system
has solved the problem of tallying the accounts on time, and
has provided confidence in the correctness and fairness of
municipal accounts to the concerned officers and, in turn,
to the people associated with them.
It is now easily possible to have head-wise allocation
and receipts and payments figures. With the help of such
classified information municipal officers were able to counter
the misconception of municipal councillors that the former
are not spending on development work or services. They
now know for certain how much they are spending on each
capital work and from which source or stream of revenue.
19 Based on the views shared by Jayaraman, Tyagarajan,
Hemamalini, and other staff of Alandur City Municipal Council,
and Mohankumar, Srinivasam, Manimaran, and other staff of
Tambaram City Municipal Council.
The separation of the single consolidated fund into

3 separate funds, namely, municipal fund, water supply, and
education, is helping them in better fund management.
Funds do not remain idle, and adherence to the budget is
better.
The new computerized accounting system has made
it possible to put information on the website. Since the
format and data under the new accounting system is peoplefriendly and do not require too many changes to put it on
the website.
The accounting reforms should have started much
earlier. That would have helped them to achieve better
development of the city.
State Local Fund Audit Office Perspective20

The improved accrual-based double-entry accounting
is beneficial to the auditors of the Local Fund Audit office
as it is easy to audit double-entry accrual-based accounts
kept as per standard norms and procedures.
As a sequal to accounting reforms the Local Fund
Audit Office has trained its more than 50 auditors to audit
the new accounting system.
It improved their auditing system qualitatively. Earlier
it was not possible to carry out financial audit so their
auditors use to do only propriety audit. Now they do financial
audit of municipal bodies and a separate section has been
introduced about financial audit in their audit report. Using
the information, which has become available due to improved
accounting system, they have made their audit reports more
informative. If things go well they intend to introduce
management and efficiency audit in future.
It has compelled municipal bodies to write DCB
statements regarding property and other taxes and books of
accounts within a time limit. There is overall improvement
in timeliness of maintaining accounts.
It has reduced unintentional accounting errors.
Income accrued is entered in the books of accounts
through journal entry only, and can be reduced or altered
through journal entry only. In this respect, the new system
is theoretically and practically better than the earlier one.
In the earlier system it was possible to manipulate demand
or arrears of tax or even asset data.
NGO or Social Activists Perspective21

The municipal accounting reforms have made
municipal accounts easy to understand and user-friendly.
20 Based on discussions with K. Vishvaksenan, Director of Local
Fund Audit Office, and his team of senior audit officers.
21 Based on a discussion with Loyola Joseph, Secretary, Foundation
of Occupational Development (FOOD), Chennai.
346
This understanding of finances of municipal body helped

us to formulate a meaningful municipal e-governance project
for Tamaram municipal body.
The information (financial statements, balance sheets)
that was generated by the improved accounting system was
further simplified by them (NGO FOOD and Tamaram
Municipal Council) for the understanding of the common
man. It was then placed on the website of Tamaram City
Municipal Council and on the electronic touch screen
information kiosk.
The NGO has been able to work effectively.
E-governance infused a sense of value of their work
among employees.
Having known the real financial position the
councillors of Tamaram municipal council have started
prioritizing their expenditure or budget requests.
Furthermore, they are now supportive of any valid
expenditure control suggestion.
based accounting system. A consultancy has been awarded

to Centre for Development Studies, New Delhi.
A circular has been issued to municipal bodies to
place-monthly trial balance with certain performance
indicators to the council.
They have now taken up introduction of doubleentry accounting system in 611 town panchayats on the
same line they were introduced in the municipal bodies.
THE UNFINISHED AGENDA

Many improvements, some immediate and others that would
take time, are possible and need to be pursued. Indeed, if
the effort to bring the accounting reforms and the use of
the same slackens, even the gains made could be lost. The
following are some of the observations made by various
stakeholders:
State Government and TNUDF

Individual Municipal Councillors
Perspective22
In the opinion of municipal councillors, accounting

reforms is a very good thing that has happened to their
municipality in recent years.
It helped them to understand the real financial
situation of their municipality. It showed us what works
have been undertaken and how much we have spent on it.
Now we are able to make judgements on the expenditures
note. It also showed them which money/funds are remaining
unutilized.
It will be certainly useful for decision-making, as it
has already helped them to prioritize their budget requests.
Their discussions, though beset with party politics, have
now become more informed on the financial front.
FUTURE PLANS
The state government and state-level agencies have taken
the following initiatives to make optimal use of the new
accounting system.
In future TNUDF is planning to utilize comparative
analysis of municipal bodies using improved accounting
data to find out bankable municipal bodies and their projects
before raising funds from the market for them.
As accounting system or Balance Sheet cannot reveal
real performance efficiency of a municipal body, TNUDP
II has taken necessary steps to develop performance indicators
as a sequel to the introduction of double-entry accrual22
Based on a discussion with D.V. Ramamurthy, Councillor,

Ward No. 32 of Tamaram City Municipal Council.
The disclosure notes do not accompany the annual

accounts.
Each municipal body maintains 3 separate accounts
(funds) and prepares 3 balance sheets, namely, municipal
fund, water supply fund, and education fund. But the effort
to combine all these into one balance sheet and accounting
statement that has its own value is not being done.
Capital income and expenditure on an annual basis
are not captured in reporting.
The report on actual status of assets (which could
have accompanied the accounts) is not prepared and made
part of annual accounts.
Non-availability of staff is a serious problem. More
than one-third of the municipal bodies do not have necessary
accounting staff. In order to overcome inadequate manpower,
the CMA office has allowed municipal bodies to hire
computers. This system needs to be formalized.
The reconciliation of the opening balance sheet has
not been completed.
TNUDP II is not using it for the purpose of
comparative and overall analysis of all the municipal bodies.
The outsourcing to complete the pending works needs
to continue.
Municipal Executive
Requisite staff to run the new accounting system is
not available in most of the municipal bodies23. With
shortage of staff the effort to develop the queries for
23 We find that one muncipality had employed 4 data entry
operators informally. As their posts were not sanctioned, they could
not be paid from the municipal funds. The staff managed to pay
them from outside sources or by raising contribution.

management control is not there. Because decision makers
have not been trained to use improved accounting system
for decision making there is no pressure from the managers
for such useful information.
general council, newspaper, publication and circulation of

annual accounts to the people, electronic media, and internet/
web pagehas yet to take place.
Individual Municipal Councillors Perspective
State Local Fund Audit Office

The implementation of double-entry accounting system
has added or opened up new areas of accounting errors. For
example, when advance is given for purchase of material an
entry is passed. On receipt of stock another entry is passed,
but when stock is received adjustment of advances entry is
passed, this results into inflation of balance sheet.
Similarly, tax receivable amount is getting inflated
because proper provisioning for non-recoverable tax revenue
is not done.
Employees handling the new accounting system do
not have proper training so its implementation has problems,
and errors are taking place. There should be a system of
continuous training. Frequent transfers of accountants and
municipal officers result in lack of continuity in the work
of the department.
Appropriate system to clear audit paras given against
the old and current accounting systems needs to be developed,
and to be put into practice.
NGO or Social Activists

The dissemination of the financial results and financial
statements which the new accounting system has made
possible to the people at large through various mediums
compulsory detailed review by the elected councillors in
The new system has benefited elected members in an

equal way. For example, CMA has given directions to put
trial balance to council every month, but various municipal
commissioners are not following this order.
They are not in a position to do anything even if
they start receiving improved accounting information, as
they do not have real executive powers or decision-making
powers.
Training of councillors with regard to accounting and
the new system would be necessary before they can use the
information for oversight and intelligent involvement in the
decision making.
CONCLUSION
With proper double-entry accounting in place the stage is
set in Tamil Nadu for managers of municipalities, and,
equally importantly, the government and funding agencies
and the citizens, and NGOs on their behalf to be able to
use the basic system in very imaginative ways, but concerned
stakeholders, including municipal managers have lagged in
their effort to use the improved accounting system to
advantage. Principally, much more training and example
would be necessary. It is also important to remove those
glitches that still remain.
REFERENCES
Bhattacharjee, N. (2002) Pooled Financing Structures for
Financing Urban Infrastructure Projects of Small and Medium
Urban Local Bodies, Urban Finance, Quarterly Newsletter
of NIUA, Vol. 5, No. 1.
Indo-US FIRE Project (2003) Pooled Finance Model for Water
and Sanitation Projects: The Tamil Nadu Water and Sanitation
Pooled Fund, Project Note No. 31.
Joshi, Ravi (2002), Financing Urban Development through
Commercial Banks: New approach by Vadodara Municipal
Corporation, Vadodara.
Kirloskar Consultants Limited (1998) Municipal Property Value

and Revenue Study in Vijayawada, prepared for Indo-USAID
FIRE project.
National Institute of Urban Affairs (1999) Urban Innovations in
Ludhiana, Urban Finance Newsletter, Vol. 2 No. 4.
Singh, Ashwajit (2001) Urban Reforms and Efficiency Enhancement,
Good Urban Governance Campaign: India Launch.
Vaidya, Chetan and Hitesh Vaidya (2002) Management
Innovations for Municipal Resource Mobilization in India,
Indian Infrastructure, Vol. 4, pp. 5860.

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INDIA INFRASTRUCTURE REPORT 2004

Editor: SEBASTIAN MORRIS

Government of Madhya Pradesh (MPRRDA), Bhopal

INDIA INFRASTRUCTURE REPORT 2004

THE INFRASTRUCTURE SECTOR

IN THE NAME OF THE POOR: WHAT ROLE

The Disinvestment Story 71

Privatization Today: A Discussion 78

The Politics of Disinvestment and Insider Trading 88

Performance and Market Evaluation of the Public Sector Today 89

PUBLICPRIVATE PARTNERSHIPS TODAY

The Draft Infrastructure Policy of Karnataka for PublicPrivate Partnership 101

Real Estate Industry: Creating Value through PublicPrivate Partnerships 103

A PPP Framework in Education 114

FINANCIAL AND LEGAL PERSPECTIVES

Development Financial Institutions and the Development of Financial Markets 120

Creating Local Financing Systems for Infrastructure in India 128

Reforming Property Tax in Patna Municipal Corporation: A Critical Analysis 134

Accessing Capital Markets by Urban Local Bodies in India: An Assessment of

Tariff Policy in the Electricity Sector: A Review 152

Financial Closure for Reforms 160

Improving the Performance of the Distribution Sector: An Evaluation of Two

The Beginnings of Distribution Reforms in West Madhya Pradesh: A Report 184

TECHNOLOGY AND REGULATION IN ELECTRICITY

Approaches to Transmission Pricing: A Discussion 198

Benchmarking O&M Costs and Operating Parameters of Coal-based Thermal Power

Management of Power Supply to Agriculture 208

Indias Energy Security: The Strategic Versus Economic Dimensions 218

The Petroleum Regulatory Bill, 2002: A Review 235

Tariff Setting in Gas TransmissionA View of Methodologies 236

A REVIEW OF TELECOM REGULATORY AUTHORITY OF INDIAS TARIFF AND

11.2 Implementing a Rural Roads Project in Madhya Pradesh 258

11.6 Traffic Risk ManagementDerivatives in the Transport Sector 273

12.1 Getting Water from PublicPrivate Partnerships 279

SANITATION AND PANCHAYATS IN INFRASTRUCTURE

13.1 Sanitation and Water Supply: The Forgotten Infrastructure 314

THE URBAN SITUATION

14.2 Municipal Governance: Standard Forms for Performance Reporting 339

14.3 Value for Money and Municipal Accounting Reforms 343

APDRP Funds Utilization 20023

xvi List of Tables

Summary of DVB Accounts (Unaudited) 20001 and 20012

List of Tables xvii

BOXES AND FIGURES

List of Boxes and Figures

A Benchmark: The Costs of Removing Pollution in Europe

Subscriber Growth of Wireline and Wireless Telephony and Teledensity

Monthly Rentals for Different Subscriber Categories (TTO 1999) (Rs)

ABBREVIATIONS AND ACRONYMS

Airports Authority of India

xxii Abbreviations and Acronyms

Basic Service Operator

Abbreviations and Acronyms xxiii

Engineering Construction Company

Abbreviations and Acronyms

Infrastructure Development Department

Abbreviations and Acronyms

Abbreviations and Acronyms

Pool Financed Development Fund

Abbreviations and Acronyms

Society for the Promotion of Area Resource Centres

In India Infrastructure Report 2003, we discussed

Major Gains in Privatization

public sectoras a quest for value in government