India's Draft Electricity Policy Chases Financial Viability by Indexing Tariffs, but Leaves Rate-of-Return Capture Intact

The Ministry of Power has moved a draft National Electricity Policy 2026 to India's Union Cabinet for inter-ministerial consultation, Power Secretary Pankaj Agarwal announced on 24 September.^[2][3] The policy proposes index-linked tariff revisions to force cost-reflective pricing where state electricity regulatory commissions (SERCs) fail to act, a mechanism meant to address the chronic financial distress of India's state-owned distribution companies (DISCOMs).^[3] This is the first major rewrite since 2005, and it comes as India confronts a grid challenge the last policy did not: 300 gigawatts of non-fossil generation already online, and demand pressures from data centres and green hydrogen facilities that will stress an aging distribution layer designed for centralized coal and hydropower.

The index-linked tariff proposal addresses a real problem, regulatory forbearance and cross-subsidy that leave DISCOMs insolvent, but it does not touch the economic incentive that made that forbearance inevitable. State-owned distribution companies in India operate under rate-of-return regulation: they are permitted a percentage return (typically 10 to 12 percent) on the capital value of their assets.^[1] This structure predictably creates what economists call the Averch-Johnson effect: a utility earns nothing on what it buys or avoids, but earns its allowed return on what it owns. A DISCOM manager facing the choice between a power purchase agreement with a third party or building company-owned generation, between efficiency investment or wires infrastructure, will rationally choose the path that expands the capital base. More wires, more substations, more owned-and-operated plant means more allowed profit, even when a cheaper alternative exists. The bias is baked into the regulation, not a moral failing.

India's draft policy does not change that incentive. An index-linked tariff adjustment is a financial-viability band-aid: it ensures DISCOMs recover costs faster if SERCs delay rate orders, but it leaves the underlying rate base intact. A DISCOM earning 10 to 12 percent on capital has no reason to welcome rooftop solar (it shrinks sales and rate base), to prioritize demand-side management (same effect), or to procure power competitively from non-utility providers (cheaper but not company-owned). The index mechanism merely makes tariffs rise faster when DISCOMs spend more, which reinforces the capital bias, not corrects it. Predictably, DISCOMs have historically resisted third-party solar and interconnection of distributed resources, even where tariff orders nominally permit it. That behavior is not obstruction; it is the regulation's forecast.

The draft policy also proposes a parallel distribution licensing framework, allowing multiple distribution companies to operate in a given area and giving consumers choice of power supplier.^[9] This is structurally healthier than index-linked tariffs alone because functional competition and customer exit pressure weakens the monopoly's ability to over-invest and ignore alternatives. But parallel licensing without functional separation of wires from retail and procurement leaves the incumbent DISCOM's capital bias intact. If a state DISCOM still operates its own generation fleet and long-term PPAs alongside the wires monopoly, it will use rate design (fixed charges, solar-specific standby fees, demand charges on homes) to make third-party solar uneconomic for the competitor's customer base. The mechanism is not new: utilities in restructured U.S. markets have used the same tools to protect generation and supply revenues against distributed solar, even where the wires business itself is regulated. Parallel licensing without unbundling is competition-theater that leaves the incumbent's incentive to gold-plate capital and reject third parties unaltered.

A structural fix would separate the DISCOM's regulated wires monopoly from its generation ownership, retail supply, and procurement authority, functional unbundling on the model of wholesale market restructuring. The wires operator would become a Distribution System Operator (DSO) or Distribution System Platform that does not own generation or retail supply, cannot favor owned resources over competitive procurement, and earns its return (ideally decoupled from capital) on grid operation and non-wires alternatives: storage, demand response, efficiency, and distributed resources that defer or eliminate the need for wires expansion. Performance-based regulation tied to peak deferral, reliability, and cost-per-MWh served would replace the incentive to spend capital with an incentive to minimize system cost. India's state regulators have the authority to pilot such separation within existing SERC jurisdiction; pilot programs in one or two states would test whether parallel licensing accelerates investment and customer choice, or whether incumbent advantage and rate-base capture defeat it.