Incentive regulation and multi-year price controls: an application to the regulation of power distribution in India

There is a perception among potential investors in electricity distribution projects in India that the price-setting methodologies not conducive to long-term investments. This paper evaluates and shows that this need not be the case.

International Journal of Regulation and Governance
Year : 2005, Volume : 1, Issue : 1
Print ISSN : 0972-4907.

Authors: Alexander Ian, Harris Clive**
Regional Coordinator, East and South Asia, PPIAF (Public–Private Infrastructure Advisory Facility), Singapore

*The work is that of the authors and does not necessarily reflect the views of their respective institutions. This paper draws on work previously published as a mimeo Setting multi-year tariffs in India: an assessment of some options in October 2000 by Alexander and Harris. Alexander's work on this project commenced while employed by the Private Participation in Infrastructure Group within the World Bank.

**Senior Private Sector Development Specialist, Private Sector Advisory Services Department, The World Bank, Washington, DC, USA

There is a perception among potential investors in electricity distribution projects in India that the price-setting methodologies employed by regulatory agencies are not conducive to long-term investments. Although regulators acknowledge the problem that present approaches lead to, they believe that the available information base does not support the development of credible multi-year tariffs. This paper evaluates whether this constraint is a barrier to the implementation of an incentive-based methodology and shows that this need not be the case. An IBRC (incentive-based revenue and cost pass-through) hybrid methodology that rewards companies for improvements in efficiency for cost items under their control is developed. The robustness of this approach is evaluated given the database of information available to regulators in India. These results are more generally applicable across other sectors and in other countries.

This paper has attempted to show that it is possible to construct a multi-year price control formula for the Indian power sector which creates incentives for companies to operate efficiently, limit the benefits enjoyed by companies to controllable cost items, so keeping the return ‘fair’, provide forward-looking price paths that will help provide certainty to investors, and is relatively administratively lighthanded. This can be done within the informational constraints that presently exist in the Indian power sector by focusing on information that is available and can be audited and by incorporating new information on parameters in the control formula as they become available.