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Power sector remains Pakistan’s Achilles heel

The power sector continues to be a major source of concern with circular debt a high of 2.6 trillion rupees at present – a burden on the country’s scarce resources in spite of multilaterals continuing to allow a one-off exemption from adding this debt to the budget deficit.

So what is so intractable about the power sector that has administration after administration unable to make any positive difference other than to pass on the cost to the consumers to attain full cost recovery. The answer lies in the number and terms of the contractual obligations agreed with Independent Power Producers (IPPs) during the tenure of two civilian and one military governments: Pakistan Peoples’ Party approved 18 Independent Power Producers (IPPs), including Hub Power and Kot Addu under 1994 Power Policy with a combined installed capacity of 2930MW (out of a total of 6031 MW); (ii) the Musharraf-led government approved a total of 16 IPPs (with the largest installed capacity of 720MW followed by 404MW Uch-III Power in Balochistan) with a total installed capacity of 3987MW; and (iii) Pakistan Muslim League-Nawaz established 10 power plants with 20,911 MW installed capacity out of which only 4293 MW were not generated under the umbrella of China Pakistan Economic Corridor (CPEC) projects. And a Matiari-Lahore transmission line, under CPEC, has a capacity to evacuate 4000MW.

Three flawed premises are evident in all three power policies – 1994, 2002 and 2015: (i) to attract IPP investment in a country where foreign investment has remained historically abysmally low, below 1.5 billion dollars per annum in spite of obvious cost and location advantages relative to other countries, necessitated agreeing to capacity payments irrespective of known significant differences in demand between the summer and winter months – estimated at 10,000 MW at least – to be payable in dollars. Thus in times of low foreign exchange reserves, Pakistan periodically experiences low reserves as it continues to grapple with cyclical balance of payment issues indicated by the fact that the ongoing Stand By Arrangement is the 24th International Monetary Fund (IMF) programme, meeting contractual obligations to IPPs has become a serious challenge; (ii) supply shortages, read massive load shedding, is entirely due to a significant shortfall in generation partly attributable at present to lack of foreign exchange reserves to pay for fuel imports, and with no account taken of the eroding capacity of the obsolete transmission network to evacuate existing generation capacity leave alone any additions; and (iii) transmission/distribution losses that are not only way above international standards but also above those allowed by the regulator Nepra.

Add some flawed domestic policies and a clearer picture of the reasons behind the accumulating circular debt becomes clear. First, tariff for all distribution companies is the same to ensure equity, which, in turn, has implied that better performing Discos (in rich areas where bill payment is not an issue) are forced to cross-subsidise poorly performing ones. This requires ever rising annual budgeted subsidy for the sector in spite of the government operating under extremely limited fiscal space – in the current year 579 billion rupees has been budgeted for Wapda/Pepco and 315 billion rupees for KESC. This is around 25 percent of all sales tax collections budgeted for the current year – a major source of government revenue that is an indirect tax whose incidence on the poor is greater than on the rich or, in other words, heavy reliance on indirect taxes as a source of revenue coupled with the government’s decision to allocate such a large sum to subsidies has implied giving with one hand to electricity consumers but taking much more through the other.

Two, agreeing to revenue-based load shedding, read switching off feeders where losses/ are high and bill clearance low, or in other words capacity payments are being made on the one hand and supply deliberately cut to stop line losses but which may imply higher capacity charges payable in dollars.

Three, forging ahead with the most popular/fashionable policy while developing a political narrative without due process or, in other words, sans input from neutral sector experts. Power plants approved and installed under CPEC focused on generation and not on a cost-benefit analysis. Thus for example the decision to set up a coal power plant away from the source of coal failed to take account of the obvious transport, environmental and health costs. Today the focus is on renewables and one can only hope that the lacunas in the entire sector are being taken into account and a cost-benefit analysis undertaken before forging ahead.

In 2020 the government renegotiated with IPPs formed under the 1994 and 2002 power policies; however, to reach an agreement required the presence of a premier spy agency as one of the negotiators. The agreement included payment of outstanding receivables (with 601 billion rupees requested by the Power Division and provided by the Finance Ministry prior to 30 June 2023) as well as: (i) reduction of capacity payments and variable operation and maintenance by 11 percent, (ii) the dollar rate and US CPI indexation to be discontinued on 50 percent of the reduced capacity payments agreed and to be fixed at National Bank of Pakistan’s TT/OD selling rate with no currency indexation or inflation adjustments in future; (iii) termination of plants considering their commercial and technical viability; and (iv) the power purchaser to ensure adherence to its contractual obligations and the government and power purchaser pledged to work towards resolution of adjudication for relevant IPPs.

The net effect of this agreement sadly was estimated at less than a rupee per unit on consumer tariffs in the next three decades.

The outstanding issue is that of CPEC projects with China refusing to renegotiate citing the fact that it would then have to do so for projects in other countries, though there is heavy reliance on China for roll-overs and new lending to meet the country’s external resource requirements as a key component of the SBA with the IMF. While multilaterals as well as some bilaterals are reportedly urging the government to try to renegotiate with Chinese IPPs on the same lines as those successfully completed with the IPPs under the 1994 and 2002 power policies yet the only mention in the SBA documents is a pledge by the government that a budgeted subsidy of 976 billion rupees would address urgent liquidity needs in the current fiscal year by covering: (i) outlays for the projected power differentials (for discos and KE 319 billion rupees) as well as one off payments or instalments to provinces, tribal areas and KE (265 billion rupees, and (ii) circular debt stock of 392 billion rupees through PHPL principal settlements (82 billion rupees) and payments to Government Power Producers and CPEC (310 billion rupees). At Chinese continued insistence the government has set up a 50 billion rupee revolving fund, allowing 4 billion-rupee withdrawal per month, that places Chinese IPPs at the front of the queue for repayment.

SBA however does not focus on improving energy sector performance but on strengthening sector’s financial viability by aligning tariffs with costs through promptly notifying regulators Nepra and Ogra’s determinations while circular debt related financial costs are to be in line with current power and emerging gas circular debt management plan to put tariffs on a downward trajectory – a plan that has yet to be finalized.

To conclude, disturbingly while the IMF engaged with all national parties on the SBA it failed to engage with economists/financial and power sector experts or the general consumers for their input in formulating a plan that minimises the onus of passing on the buck to the paying consumers, especially with inflation a high of 28 percent, and focusing on improving sectoral performance.

Anjum Ibrahim, "Power sector remains Pakistan’s Achilles heel," Business recorder. 2023-07-31.
Keywords: Economics , Power sector , Budget deficit , Cost recovery , National bank , Dollar rate , Foreign exchange , Fiscal year , Muslim League-Nawaz , Pakistan , IMF , GDP , CPEC , US , CPI , KESC , TT , MW

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