The politics of circular debt

Circular debt is more of a political challenge than a management problem. The stock of circular debt has grown five times over the last eight years. From Rs450 billion in FY2013, it is expected to reach Rs2.3 trillion by June 2021. The flow of circular debt touched Rs538 billion last year, exceeding the federal PSDP of Rs533 billion, though very recently this flow has slightly slowed down due to increase in tariffs.

In simple terms, circular debt is the cash shortfall across the power sector, which builds up either as payables to Central Power Purchasing Agency Guarantee Limited (CPPA-G), spilling over to power generators and fuel importers, or liabilities parked in the books of Power Holding Private Limited (PHPL). Yearly increase in circular debt, also termed as ‘flow’, adds to its mounting stock.

Looking through a political economy lens, there are four problems at the root of circular debt challenge: the hangover of past contracts, artificial sweeteners to appease political constituencies, white elephants at the tail end of electricity network, and pigeonholing to avoid difficult decisions.

The hangover problem includes high returns on equity for power producers, dollar indexation and capacity payments, all stemming from past contracts translating into high power generation costs. These contracts were signed by various governments during the last 25 years, since 1994. The government’s recent attempt to address this problem through renegotiating the contracts with independent power producers (under 1994-2006 policies); reducing rate of return on government’s own power plants; and shutting old inefficient plants address only a fraction of the problem. The rest of IPPs under the 2015 policy, including CPEC investments, will be adding the bulk of capacity payment in the next few years. But any renegotiation there hinges on underlying diplomatic relations.

The artificial sweeteners are delays in tariff adjustments and excessive subsidies without the requisite budgetary resources. Political compulsions sometimes prevent governments from passing on tariff increase to consumers, such as during Covid. But without check, it can also create a perverse incentive to pass on the hot potato to the next government. From 2013-18, for instance, about 65% of the circular debt flow was attributed to such delayed notifications. Any changes in tariff adjustment mechanism (through proposed NEPRA Act amendments) or withdrawal of subsidies, however, can be politically contentious, especially in a charged political environment.

Thirdly, the white elephants refer to power distribution companies (DISCOs) with excessive technical and commercial losses, on the back of poor infrastructure, thefts and non-recoveries from private and government consumers. Almost half of the circular debt build-up is because of transmission and distribution losses over and above NEPRA’s allowed limit, and non-recoveries. The DISCOs, however, operate with impunity without penalty for poor performance and are marred with powerful labour unions and vested interests. The perks, privileges and retirement benefits of staff cost billions, yet even the slightest change is met with stiff resistance, protests and strikes, as has been recently witnessed on issues of proposed outsourcing and appointment of CEOs from private sector.

Lastly, the pigeonholing problem is about previous governments’ continued avoidance to find a solution for circular debt, which results in huge interest cost accrued on debt parked at PHPL and late payment charges by CPPA-G to power producers, further adding to the mounting burden. Almost 30% of circular debt stock has been caused by such financing charges and any further pigeonholing will further contribute to it.

Any management solution without addressing these intricate political dimensions is not going to work. Approval of circular debt management plan is an IMF condition, but its effective implementation would depend upon political will for taking tough decisions on these deep-rooted problems.

Published in The Express Tribune, March 16^th, 2021.

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