Resolving circular debt: The bond market likes Asim Hussain’s plan
Issuing govt debt to pay liabilities seems the obvious solution, except in Islamabad.
KARACHI:
These are not normal times in the global bond market, and Karachi appears to be no different from its larger and more complex counterparts around the world.
The news that the government might flood the market with about Rs300 billion worth of treasury bonds – far from causing prices to drop, as one would normally expect – caused a rally in the prices of government bonds. The reason: the government plans on using that money to resolve that single bugbear of the entire Pakistani economy that has come to be known as circular debt.
“The news reports that the government will soon sort out the conversion of investments and advances (PKR300bn plus) related to power sector circular debt has ignited a rally in PIB [government bond] yields,” said Nurali Barkati, a research analyst at BMA Capital, an investment bank.
The plan being referred to is Petroleum Minister Asim Hussain’s proposal to the cabinet that the government issue bonds that would circulate through the energy sector and ultimately clear out the outstanding liabilities that have thus far financially crippled the energy sector.
The plan is not originally Hussain’s. It was first thought up by then Finance Minister Shaukat Tareen, who issued about Rs90 billion worth of government bonds that were then paid out to power companies, which in turn paid the oil marketing companies who in turn paid the refineries who then paid back what they owed the oil marketing companies. Hussain plans on doing something similar this time around.
There is a simple reason why the bond market likes this idea. Currently, both the energy companies as well as the financial system have hundreds of billions in outstanding loans, many of which are not even actively paying interest.
If the government replaces that debt with treasury bonds, both sides win. The banks get AAA-rated debt that pays interest on time and helps strengthen their balance sheets. The energy companies in turn get rid of their liabilities, which in turn would allow the power companies and the refineries to produce at full capacity.
The economy as a whole would also see some positive effects. Economists estimate that the gross domestic product (the total size of the economy) would grow by 3% faster every year.
That leaves only one question: why should the government do it? Quite simply, because it is their fault. Take the total stock of circular debt: about Rs155 of the Rs300 billion is due to unpaid bills to the power sector by the provincial and federal governments. Another significant chunk of it is due to the unpaid subsidies to the power sector that the government promises but then fails to pay.
The subsidies problem is likely to be significantly reduced or even eliminated this year. The government has been consistently raising prices and trying to improve the efficiency of the electricity grid in order to reduce the amount it needs to pay in subsidies.
In the meantime, the petroleum minister has been forced to take interim measures. For instance, when global oil prices went down last month, rather than passing on the difference to consumers, the Oil and Gas Regulatory Authority decided to let the oil marketing companies increase their margins, with at least part of the difference also going to the government in terms of higher petroleum taxes.
When he was appointed, Asim Hussain was criticised for being unqualified for the job. Yet in recent months, the capital markets have come to respect what appears to be a strong commitment to help solve the energy sector’s most critical problems. A physician by training, he certainly seems to have diagnosed the sector’s problems accurately. Here’s hoping he can deliver the cure.
Published in The Express Tribune, November 14th, 2011.
These are not normal times in the global bond market, and Karachi appears to be no different from its larger and more complex counterparts around the world.
The news that the government might flood the market with about Rs300 billion worth of treasury bonds – far from causing prices to drop, as one would normally expect – caused a rally in the prices of government bonds. The reason: the government plans on using that money to resolve that single bugbear of the entire Pakistani economy that has come to be known as circular debt.
“The news reports that the government will soon sort out the conversion of investments and advances (PKR300bn plus) related to power sector circular debt has ignited a rally in PIB [government bond] yields,” said Nurali Barkati, a research analyst at BMA Capital, an investment bank.
The plan being referred to is Petroleum Minister Asim Hussain’s proposal to the cabinet that the government issue bonds that would circulate through the energy sector and ultimately clear out the outstanding liabilities that have thus far financially crippled the energy sector.
The plan is not originally Hussain’s. It was first thought up by then Finance Minister Shaukat Tareen, who issued about Rs90 billion worth of government bonds that were then paid out to power companies, which in turn paid the oil marketing companies who in turn paid the refineries who then paid back what they owed the oil marketing companies. Hussain plans on doing something similar this time around.
There is a simple reason why the bond market likes this idea. Currently, both the energy companies as well as the financial system have hundreds of billions in outstanding loans, many of which are not even actively paying interest.
If the government replaces that debt with treasury bonds, both sides win. The banks get AAA-rated debt that pays interest on time and helps strengthen their balance sheets. The energy companies in turn get rid of their liabilities, which in turn would allow the power companies and the refineries to produce at full capacity.
The economy as a whole would also see some positive effects. Economists estimate that the gross domestic product (the total size of the economy) would grow by 3% faster every year.
That leaves only one question: why should the government do it? Quite simply, because it is their fault. Take the total stock of circular debt: about Rs155 of the Rs300 billion is due to unpaid bills to the power sector by the provincial and federal governments. Another significant chunk of it is due to the unpaid subsidies to the power sector that the government promises but then fails to pay.
The subsidies problem is likely to be significantly reduced or even eliminated this year. The government has been consistently raising prices and trying to improve the efficiency of the electricity grid in order to reduce the amount it needs to pay in subsidies.
In the meantime, the petroleum minister has been forced to take interim measures. For instance, when global oil prices went down last month, rather than passing on the difference to consumers, the Oil and Gas Regulatory Authority decided to let the oil marketing companies increase their margins, with at least part of the difference also going to the government in terms of higher petroleum taxes.
When he was appointed, Asim Hussain was criticised for being unqualified for the job. Yet in recent months, the capital markets have come to respect what appears to be a strong commitment to help solve the energy sector’s most critical problems. A physician by training, he certainly seems to have diagnosed the sector’s problems accurately. Here’s hoping he can deliver the cure.
Published in The Express Tribune, November 14th, 2011.