Why power subsidies are a bad idea

Pakistan’s power sector continues to be heavily reliant on government subsidies, a mechanism intended to keep electricity affordable for consumers.

However, the State of Industry Report 2024 by Nepra paints a troubling picture of the long-term consequences of these subsidies. The power sector’s circular debt has ballooned to Rs2,393.37 billion as of June 30, 2024, reflecting an increase of Rs83.37 billion over the previous year. This increasing financial strain is largely attributed to subsidies, inefficient bill recovery, and high transmission and distribution (T&D) losses.

One of the biggest contributors to the power sector’s financial instability is the high T&D losses, which rose to 18.31 per cent in FY2023-24 from 16.84 per cent in FY2022-23. This is significantly above the Nepra-approved threshold of 11.77 per cent, and the excess losses alone added Rs276 billion to the circular debt in FY2023-24. Despite the government approving an investment of Rs163.1 billion to improve DISCOs’ networks, inefficiencies persist, with many DISCOs failing to modernise infrastructure and reduce losses.

In addition to losses, poor bill recovery has severely exacerbated financial challenges. The combined recovery rate for all DISCOs stood at just 92.44 per cent in FY2023-24, leading to a further addition of Rs314.506 billion to circular debt. Notably, K-Electric’s recovery rate has steadily declined, dropping from 96.69 per cent in FY2021-22 to 91.54 per cent in FY2023-24. This declining trend signals an urgent need for policy interventions to strengthen recovery mechanisms and improve revenue collection.

Another major concern is the cross-subsidisation model implemented under the Uniform Tariff Policy, which disproportionately affects more efficient DISCOs. Under this system, revenue from better-performing DISCOs like LESCO, FESCO, and GEPCO is used to cover the financial shortfalls of loss-making DISCOs such as PESCO, SEPCO, and QESCO.

The Tariff Rationalisation Surcharge (TRS) has been used as a mechanism to balance these disparities, resulting in Rs125.78 billion being allocated for cross-subsidisation in FY2024-25. This policy discourages efficiency, as underperforming DISCOs have little incentive to improve governance and operational performance.

It is evident that high-cost DISCOs, such as HESCO, SEPCO, and QESCO, are receiving significant government subsidies to offset their higher operational costs. For example, HESCO (Hyderabad Electric Supply Company) is determined to require Rs209.62 billion in revenue but, under the uniform tariff system, only generates Rs151.48 billion, leaving a shortfall of Rs58.14 billion, which is covered by government subsidies. Similarly, TESCO (Tribal Areas Electric Supply Company) has a revenue requirement of Rs71.32 billion but only collects Rs48.99 billion, necessitating Rs22.33 billion in government support.

On the other hand, low-cost and more efficient DISCOs, such as IESCO (Islamabad Electric Supply Company), LESCO (Lahore Electric Supply Company), and GEPCO (Gujranwala Electric Power Company), generate more revenue than required under cost-based calculations. However, instead of being allowed to charge lower tariffs and pass the savings to their consumers, these DISCOs are levied with surcharges.

For instance, IESCO is expected to require Rs345.69 billion but collects Rs411.57 billion at the uniform tariff, resulting in a negative adjustment (surcharge) of Rs65.88 billion, which is redistributed to cover the losses of other DISCOs. Similarly, LESCO pays a surcharge of Rs39.53 billion, and GEPCO will contribute Rs14.17 billion to the cross-subsidy pool.

The total TRS for FY2024-25 amounts to Rs125.78 billion, which is the net amount redistributed among DISCOs to ensure uniform pricing for consumers across Pakistan. This approach, while intended to protect consumers from regional pricing disparities, creates significant inefficiencies. Efficient DISCOs, which should have lower tariffs due to better operational performance, are forced to subsidise loss-making DISCOs, reducing their incentive to further improve their efficiency.

This model also incentivises poor performance among high-cost DISCOs, as they do not face financial consequences for high transmission losses, poor bill recovery, and operational inefficiencies. Instead, their deficits are covered through government interventions and cross-subsidisation from better-performing DISCOs. In addition, the uniform tariff model discourages industrial competitiveness, as businesses in more efficient areas end up paying higher-than-necessary tariffs, increasing their production costs.

The cross-subsidisation should be gradually phased out by allowing cost-reflective tariffs, where each DISCO charges consumers based on its actual operational costs. This transition would encourage better governance and efficiency in loss-making DISCOs and reduce the overall financial burden on the government and taxpayers. A shift towards performance-based subsidy allocation – where DISCOs only receive government support if they meet efficiency targets – could also create incentives for improvement while maintaining affordability for low-income consumers.

The government also continues to provide direct subsidies to various consumer categories, particularly lifeline consumers and agricultural users. In the agricultural sector, tube-well consumers received large subsidies, yet only 68.79 per cent of the total billed amount was recovered. This low recovery rate adds further financial strain on the government, as the subsidy burden increases while revenue collection remains weak.

One of the most overlooked but significant financial drains on the power sector is the provision of free electricity, pensions, and medical benefits for retired employees of GENCOs, NTDC, and DISCOs. These costs are currently included in consumer electricity tariffs, further inflating power bills. In FY2022-23, PESCO alone spent Rs8.88 billion on post-retirement benefits, medical expenses, and free electricity for its employees. Experts argue that these expenses should be funded through a dedicated pension fund rather than passed on to consumers, as they significantly distort electricity pricing.

Subsidies and inefficiencies have also deterred private-sector investment in the power industry. With tariffs being politically controlled and revenues highly uncertain due to delayed subsidy payments, investors are reluctant to enter the sector. This has particularly affected renewable energy projects, which struggle to secure financing due to regulatory uncertainty and market distortions caused by subsidies. The Competitive Trading Bilateral Contract Market (CTBCM), a proposed framework to introduce competition in power trading, has also faced implementation delays due to financial instability and the persistent need for government subsidies.

Given the scale of the financial burden imposed by power sector subsidies, it is clear that Pakistan must gradually phase out its reliance on subsidies while ensuring affordability for the most vulnerable consumers. One promising approach is targeted direct subsidies, which would replace the current blanket subsidy model. Instead of subsidising all consumers within a category, the government could use cash transfers to support only low-income households, thereby reducing the overall subsidy burden.

The solarisation of households is also a key policy recommendation that argues that low-income households should be incentivised to shift to solar energy. This would not only reduce dependency on expensive grid electricity but also lower the government’s subsidy expenditure over time.

Improving DISCOs’ financial discipline and governance is also crucial. Reducing T&D losses, enhancing bill recovery mechanisms, and curbing electricity theft are essential steps to stabilise the power sector. It is recommended that Nepra and the government implement stricter performance-based regulations, ensuring that DISCOs failing to meet recovery targets and efficiency benchmarks face penalties.

The unsustainable nature of Pakistan’s power sector subsidies is now a pressing economic challenge. While intended to provide relief to consumers, these subsidies have led to inefficiencies, excessive circular debt, and a discouraged private sector.

A structured reform process focusing on targeted financial support, solarisation and enhanced recovery mechanisms is the only viable path forward. Without immediate reforms, the power sector’s increasing reliance on government support will continue to drain public resources, leading to higher electricity tariffs, more fiscal deficits and a worsening economic crisis.

The writer has a doctorate in energy economics and serves as a research fellow in the Sustainable Development Policy Institute (SDPI).

Twitter/X: @Khalidwaleed_

Email: khalidwaleed@sdpi.org