Circular debt leaves Pakistan in the dark

The difference between high power generation cost and low electricity bills is at a new high, and this will slow down economic growth.
Pakistan’s energy subsidies have worsened the power crisis, which in turn has led to the decline in industrial output. Reuters
Pakistan’s energy subsidies have worsened the power crisis, which in turn has led to the decline in industrial output. Reuters

Syed Fazl-e-Haider

There are no quick fixes to Pakistan’s chronic circular debt problem, a major reason for the severe power shortages in the country.

What is circular debt?

It is the term for a phenomenon that appears particular to Pakistan. Circular debt reflects the difference between high power generation cost and low electricity bills.

The Pakistani power sector’s circular debt denotes liabilities to the entire energy chain. The problem emerges due to difference between production cost of electricity and the tariff charged from consumers, which forces the government to provide subsidy.

The power tariffs are not revised upwards domestically when the oil prices go up internationally. The government gives subsidy to account for this increase and the consumers continue to pay lower rates for the expensive electricity.

The circular debt accumulates as the government’s subsidy bill balloons. Last year, the government settled a 480 billion-rupee (Dh17.5bn) circular debt after clearing dues to the Independent Power Producers (IPPs) to avoid sovereign default. But now the circular debt has reached a historic high of 580bn rupees, pushing the government back to the situation it was facing a year ago.

“Circular debt, if continued unabated, will increasingly constrain the availability of electricity and slow down economic growth,” says a report on circular debt issued last year by Planning Commission of Pakistan.

The circular debt issue emerged in 2006 during the presidency of Pervez Musharraf, when oil prices in the international markets rose to new highs. The Musharraf government decided to freeze the tariff because passing fuel price hike on to consumers in the form of high electricity prices would have been a politically sensitive decision. In 2006, the circular debt for the first time reached 111bn rupees, while it reached its historic peak of 480bn rupees in June last year when the government led by the prime minister, Nawaz Sharif, came to power.

The Sharif government is struggling to arrange funds to retire the 580bn-rupee circular debt that has resurfaced after 18 months. It has increased despite huge increases in the power tariff in the last year. The government has assured the IPPs of clearing at least 50bn rupees by the end of this month.

The assurance has temporarily stopped the IPPS from initiating the legal and financial process to call sovereign guarantees of the government on its inability to make payment against the electricity it purchased.

A glance at the structure of the country’s power sector shows an energy supply chain comprising generation and distribution companies. The generation companies (GENCOs) include IPPs and WAPDA (water and power development authorities), while the government-run distribution companies are referred to as DISCOs. The oil marketing companies sell oil to GENCOs, which produce electricity.

The GENCOs sell electricity to the DISCOs, which supply electricity to the consumers. The bills charged by DISCOs do not match the actual cost of electricity at which GENCOs sell it to the DISCOs. That affects the ability to pay of DISCOs, or the government, and hence payments to GENCOs are blocked. The cash-strapped GENCOs stop payments to the oil marketing companies, which stop supplying oil to GENCOs. This causes accumulation of circular debt.

Consumers and households now pay a price of 11.21 rupees per kilowatt-hour and 8.66 rupees per kWh, respectively, for electricity generated at an average cost of 14.95 rupees per kWh. The country spent on average 304bn rupees annually to subsidise power consumption during the last five years.

The circular debt has been a perpetual drain on the country’s fragile economy. It worsens power crises, which have already led to a decline in industrial output, the closure of many industries, unemployment, economic slowdown and an increased fiscal deficit. A liquidity crunch in the energy sector has hit the country’s growth and stalled fresh investment in power generation.

The government of the former prime minister, Yousuf Raza Gilani, tried to counter the circular debt through electricity load shedding, but that hit industryby pushing up production costs by more than 30 per cent.

The resent government manages power shortages by cutting supply for hours to industrial and domestic users.

What is needed is to increase power generation and improve transmission and distribution system. Like the previous governments, the Sharif administration is mainly focusing on generation side without touching the key issues related to the transmission and distribution of power. In its annual report released this month, the State Bank of Pakistan points out that the more binding bottleneck in the energy sector is distribution, not generation, and without upgrading the existing distribution network, any addition to generation capacity and even the settlement of the circular debt could not ease load management on a sustainable basis.

The central bank’s report regrets that policymakers continue to emphasise adding more generation capacity instead of addressing core issues such as price distortion, high generation cost and inefficiency of the distribution system.

The circular debt problem cannot be resolved without restructuring and overhauling the power sector. Electricity supply shortages stem from distorted pricing, rampant power theft, incompetent management and poor governance. It is the lack of political will and administrative inabilities on the part of the government that pushed the country into the acute energy crisis.

The government will have to show political will by making hard and unpopular decisions. Such decisions may include elimination of subsidies, cutting free supply of electricity to WAPDA employees and raising power tariff and gas prices to create additional revenue.

The management of government-run DISCOs should either be privatised or placed under control of provincial governments.

Syed Fazl-e-Haider is a development analyst in Pakistan. His books include The Economic Development of Balochistan

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Published: December 27, 2014 04:00 AM


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