Circular debt - an economic monster

Power sector debt is not an insurmountable quagmire allowed to sap fiscal resources


Mohammad Younus Dagha May 18, 2020
PHOTO: FILE

ISLAMABAD: Any narrative of Pakistan’s economic reforms cannot be complete without mentioning the power sector’s circular debt, which is threatening the fiscal stability.

Most of the economic reforms or stabilisation programmes in the past and present, whether indigenous or donor-prescribed, have tried to address this, with very little success.

Similarly, the International Monetary Fund (IMF) in its first review of the current funding programme noted: “Advancing the strategy for electricity sector reforms, agreed with international partners, is important to put the sector on a sound footing, and remove recurrent arrears and accumulation of debt.” (November 8, 2019)

Sounds like a déjà vu. Similar sentiments were expressed before the beginning of the previous funding facility by the IMF in 2013:

“Energy-related subsidies reached 1¾ per cent of GDP in 2012-13, and payment arrears (circular debt) – estimated at 4 per cent of GDP – continues to accumulate due to below cost recovery tariff rates, and delays in tariff determination and fuel cost adjustments.” (September 2013 – Article IV consultation staff report)

The ensuing fund programme (2013-16) gave specific indicative targets for keeping the circular debt within manageable limits. Before we see whether and how these targets were met, let’s have a look at the problem called circular debt.

Circular debt, the accumulated liabilities of the power sector, is the result of perennial default in payments by some of the power consumers (connected to various distribution companies – DISCOs), which default extends to the suppliers/producers of electricity (independent power producers - IPPs, Wapda, nuclear power plants and generation companies - Gencos) and the fuel suppliers (PSO and gas companies) for those power producers. It also includes theft and operational and technical inefficiencies of the system.

This huge float of arrears and debt, known as circular debt, not only keeps the companies and organisations in a constant state of financial crisis but also keeps the country’s economy in a state of fiscal instability. It now stands at around Rs1,800 billion, which is around 6% of gross domestic product (GDP) or roughly 25% of our annual budget.

Every time we hear different prescriptions to cure this economic ailment. A significant majority of economists believe that a substantial part of the problem lies in the inefficiency of state-owned DISCOs and Gencos; once these are privatised, the budget books would become clean of the power sector losses/subsidies.

Easier said than done: KESC was privatised in 2005 (almost 15 years ago), and the subsidy claimed by it last year (2018-19) was the highest amongst all DISCOs at Rs90 billion. Some of our policies did not allow K-Electric to go off our budget books.

Others blame the private sector IPPs and the capacity charges allowed to them in various power generation policies since 1994, which made the power costlier, posting higher amounts to the circular debt. They suggest a review of these policies and the contracts signed thereunder.

We have seen the power sector entities of both public and private sectors blaming the regulator’s inappropriate and delayed determination of tariffs harming smooth operations and adding to costs, and the National Electric Power Regulatory Authority (Nepra) finding deficiencies in their performances, without any definitive plan to reform the sector as a whole, seeing the back of the perpetual state of financial bankruptcy.

Nepra is the legally empowered regulator responsible to bring improvement in the power sector.

We have seen in the past more than a decade, dozens of programmes initiated by the donors, supported by IMF programme conditions. They start with bringing in a host of foreign and local energy experts/consultants with good-looking plans for the turnaround of the power sector; leaving it in the same or worse condition after the completion of those plans/projects.

Going by the above story, the situation looks complicated and grim with no easy solution. When we create a long list of difficult-to-implement and long gestation reforms, we give an easy alibi to the sector stakeholders to hide behind it.

The history of circular debt shows us that there has been some reasonable amount of success in handling it in the past, which makes the case for tackling the issue now while working out the reforms.

Between the above narrated two similar sounding IMF reports (2013 and 2019), Pakistan’s power sector had such positive reports about its performance as well:

  • “Since the start of the programme, power blackouts declined, distribution losses were reduced, payment collection rates increased and energy subsidies were reduced.”

  • “Improved performance of distribution companies and favourable oil prices have helped contain the accumulation of power sector arrears. The end-March 2016 IT (indicative target) on the accumulation of power sector arrears was met with a large margin.”

  • “The authorities’ enhanced focus on improving the performance of DISCOs…… is welcome.”


(International Monetary Fund, Eleventh Review under the Extended Arrangement, June 10, 2016)

What made the IMF sound so hopeful, was the consistent declining trend in the accumulation of circular debt for three years. And it came as a result of consistent improvement in the performance of DISCOs and Gencos.

During 2014-17, DISCOs’ AT&C losses (which combine both line losses and non-recovery losses) came down by 5%, which meant an annual reduction of Rs100 to Rs150 billion in circular debt accumulation. This created confidence that Pakistan was in a position to overcome a perennial economic problem.

If we prepare a chart for the period 2012-19, it is evident that there was a reasonable control on the accumulation of circular debt during 2014-17, which gives us the hope that while working out structural reforms of the power sector, which might take a few years, we can keep the lid on accumulation of power sector arrears.

The main areas that were focused during those years (2014-17) were regular and professional review of operational as well as financial performance of DISCOs and Gencos, low-cost technological tools (such as mobile meter reading) to reduce billing irregularities and check corrupt practices, vigilance in the field and periodic performance accountability. The results were duly acknowledged by the multilateral partners.

The point is that the power sector circular debt is not an insurmountable quagmire, which we allow to sap our meagre fiscal resources, as a fait accompli. We might pursue the long list of power sector “reforms” but should not let the circular debt become an even larger monster.

The writer has served as federal secretary for finance, water and power, commerce and housing

 

Published in The Express Tribune, May 18th, 2020.

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