Circular debt – solution lies in removing cost-tariff deficit

T&D losses, receivables should be controlled in an organised manner

ISLAMABAD: The circular debt has reached Rs1,160 billion and is expected to grow further if nothing is done to control it.

The debt has caused extreme liquidity crisis, forcing several IPPs to shut down their plants. In today’s difficult economic circumstances, the government’s capacity to inject cash into the sector is quite limited.

The consumer’s ability to afford increase in electricity prices will also be limited due to the impending cycle of inflation and slow economic activity. The supply chain of the power sector has the following sequence - fuel producer and/or supplier like PSO and gas companies who sell fuel to the IPPs and Gencos who produce and sell electricity to distribution companies which sell it to consumers.

The government acts both as a financier and the consumer also. If consumers do not pay or steal electricity or if Nepra does not calculate the full-cost tariff or delays its determination, etc, the distribution companies suffer a loss and have cash flow problems.

As a result, they cannot pay their own bills to the electricity suppliers and the IPPs, in turn, have cash flow shortages and do not pay to fuel suppliers or pay partly. Fuel suppliers being government companies keep supplying until their own suppliers refuse to sell to them or LCs are not honoured.

The buck stops here and the government comes in which is the ultimate buyer and manager of the system.

The government itself is a defaulter also in many ways. It has to pay accumulated subsidies of Rs244 billion. It lowers tariff for certain users and promises to pay on their behalf in the form of subsidies, but never pays or pays only partly, which creates cash flow problems and debt.

It is often convenient for the government to funnel subsidies to other sectors such as agriculture through cheap gas or electricity, which otherwise would be impossible to give directly to farmers. Cheaper fertiliser is passed on through cheaper gas provided to fertiliser plants. These debts or shortages do not get resolved in a year or two but keep adding up over the years.

Thus, there is an accumulated debt of Rs1,196 billion, call it circular debt or serial. This amount will grow at a pace of Rs180 billion or more per year if not controlled.

Senate report

The Senate has released a very informative and useful report on the circular debt in the name of the author - Senator Shibli Faraz, who is the convener of the Senate Standing Committee on Circular Debt. This article is largely based on the data provided by the report.

According to the report, the CPPA-G/ distribution companies’ receivables stand at Rs824 billion, of which Rs500 billion is owed by defaulters. About 5.3 million consumers are running defaulters meaning they continue to consume electricity despite default and no payment and power connections of only 1.3 million defaulters have been cut off.

The government has to pay Rs244 billion in outstanding subsidies to the AJK, for tariff differential, agricultural tube wells, etc. Against the estimated circular debt of Rs1,196 billion, the defaulters have to pay Rs500 billion, the bulk of which belongs to three companies - Qesco, Pesco and Sepco.

The second major cause of circular debt is unpaid subsidies. Under this head, Rs44.4 billion has to be paid to agricultural pumps. In fact, a major issue causing financial problems is agricultural consumers running tube wells.

They have defaulted on payments amounting to Rs188.5 billion. Agricultural consumers operating tube wells require a major intervention. The report has made a major recommendation.

Transmission and distribution losses of Rs187 billion appear to be much lesser than the receivables of Rs500 billion from the defaulters. It appears that authorities may have to either write off more than three-year-old receivables or launch a major drive to recover the amount.

It may be possible that leakages have been hidden under the receivables. A more dangerous indicator is that such receivables are on the rise. For example, for Sepco, the receivables have increased from Rs39.8 billion in 2013 to Rs84.6 billion in 2017, more than double in five years.

One would be sceptic about the correctness of these numbers. A rigorous audit may be conducted.

Regulations

Regulatory issues also contribute to the accumulation of circular debt. In order to control costs, Nepra pulls a tight rope which, however, results in lower recoveries. The regulatory time lag is there due to a time-consuming cost-plus cycle. Also, it takes very long to notify the tariff.

We may have to examine an alternative performance-based tariff system for the distribution companies ala K-Electric in order to eliminate the need of frequent rate-setting which is time-consuming.

The Senate report says the power sector lacks 3C - consensus, cohesiveness and continuity - for which the report recommends creation of an institution. Utopia of so-called independent and effective boards has been relied upon, which has not happened. Instead executive power has practically been exercised by the ministry.

The ministry, now Power Division, could not organise itself according to the challenge and vacuum created by the erstwhile Pepco. On the other hand, its counterpart the Petroleum Division managed to create a modicum of organisational infrastructure in the form of directorate generals.

One would like to support the recommendation of the report of creating an institution. To give it a concrete picture, let us call it reviving Pepco in an improved form with a progressive organisational structure and design.



The report proposes the introduction of hydro royalty/net hydel profit ala Khyber-Pakhtunkhwa and doing away with the reduced tariff for the AJK. Most probably, the AJK would benefit in a number of ways. There is another recommendation of handling the receivables of tube well consumers, particularly in Balochistan. The proposal is to develop a solar PV scheme in this respect.

Bridging cost-revenue gap

The real solution lies in reducing the gap between the cost of supplies and the electricity revenue. Following means may help achieve this - tariff reforms in the form of reducing excessive rate of return and other parameters, introducing competition, changing the fuel mix in favour of cheaper ones in the form of cheaper solar, wind and Thar coal; reduction of T&D losses and theft along with collection of bills regularly; improving law and order situation in major default areas of Pesco, Sepco and Qesco, in cooperation with provinces.

On a lighter note, there is another point of view that debt is not that bad so long as you can service it and that financing business through retaining payables is a common business practice. However, excess of everything is bad.



One should not be too scared of Rs1,160 billion in circular debt, but should be mindful of financing the payables to fuel suppliers like PSO and to the IPPs which stand around Rs523 billion.

The government has to pay Rs248 billion in subsidies, thus a net of Rs275.9 billion may be passed on to consumers in installments so as not to have an impact of more than Rs0.5 per unit.

Years of accumulated problem cannot be wiped out in one go. A gradual approach will be required which, in turn, will require external financing. A concessionary loan from Chinese banks or the ADB of Rs300 billion may be obtained, if feasible. At 2% interest rate, the servicing cost will be Rs6 billion.

The interest cost may be passed on to the consumer tariff, which would result in Rs0.6 per unit addition to the latter.

Concluding, the ultimate solution lies in removing the deficit between the cost of supplies and the consumer tariff. Recent projects have been installed at a tariff 40% higher than normal rates.

Introduction of renewable energy which is the cheapest today can help. Reforms in the tariff system and a competitive regime can bring down the cost of local resource-based electricity such as Thar coal. Control on transmission and distribution losses as well as on receivables are to be undertaken with seriousness and in an organised manner.

The writer is former member energy of the Planning Commission

Published in The Express Tribune, October 29^th, 2018.

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