Circular debt — Myth and reality

We all know that the main reason for the forced increase in base power tariff is the “tsunami” of expensive and excess power capacity contracted by the previous PML government on “take or pay” basis that has hit the sector hard. The previous government also did not pass on any tariff increase in its last years and left that burden to this government. Due to Covid-19, no increase in base tariff was allowed by the PTI government in 2020 to avoid burdening the consumers (which inevitably added to the circular debt build-up). The Rs1.95 tariff increase that is now being passed through is still much less than the actual cost of this faulty planning, by the PML government, as determined by NEPRA.

The total “compulsory” annual Capacity Charges were Rs185 billion (Rs2.1 per unit) in 2013 that increased to Rs468 billion (Rs3.98 per unit) in 2018. Due to the excess and expensive contracts inherited by the PTI government, these charges increased to Rs860 billion in 2020 and projected to be a whopping Rs1,455 billion (Rs10.82 per unit) in 2023. Even assuming a 7+% annual increase in power demand (which is quite optimistic under any base case scenario), we shall have an almost 40pc “over supply” situation in 2023 that the economy will have to pay for regardless of need. Even as our fuel mix has improved in recent years, it is much more than negated by this massive recent increase in fixed Capacity Charges that we are bound to pay for now.

It is an established fact that the power contracts signed by the previous government were, on average, 25-35pc more expensive than comparable regional benchmarks. Imported coal-based plants (including the one in Sahiwal), with guaranteed 30-35pc annual return on equity, are a policy disaster that we are now grappling with. Wind and solar based plants with tariffs now averaging Rs20-25 per unit are crippling the power sector, compared to the Rs6 per unit solar IPP tariffs awarded during the PTI government’s tenure last year.

The PTI government inherited a broken economy in an ICU that depressed the power demand and necessitated Rupee devaluation (kept artificially high by the PML government resulting in an unsustainable current account deficit), alongside increase in interest rates to control inflation. Since 60-80pc of the IPP tariffs are denominated in US$, and almost 45pc of the power generated on imported fuel, the power consumers have had to bear a tariff hike due to this faulty planning of the past.

On the other hand, the PTI government has renegotiated the contracts of almost 50 IPPs resulting in a gross saving of Rs770 billion over the next 20 years, capped the $ indexation for local investors, reduced the return on equity for the foreign investors to 12-13pc, agreed to share the cost savings on fuel efficiency and operations and maintenance costs, etc. In addition, Rs96 billion of “interest on interest” invoices have been waived off, and Rs38 billion saved against various international arbitration awards (against the State) from the previous era. We have also taken a massive (Rs2,000 billion in aggregate) haircut on the returns from the various government-owned power plants (almost 14,000 MW) to provide corresponding tariff relief to consumers in the coming years. Our next aim is to restructure the existing IPP debt (increase in tenor, reduction in margin, etc.) and pass on the savings to the end consumers.

What stopped the previous government(s) from at least attempting to do the same? To increase power demand, the PTI government has taken unprecedented and bold decisions recently including putting a moratorium on gas supply to captive power units along with offering reduced electricity rates to industrial customers and removing the peak/off peak pricing distinction for the same. In order to encourage exports, the PTI government continues to provide subsidized electricity (and gas) to the relevant industries (a key reason as to why our industrial tariff is arguably high is because of the in-built “cross subsidy” to provide corresponding relief to our residential and agricultural consumers – this has been the case for decades and reflects the peculiar socio economic/ political realities of Pakistan that is easier said than rollback). We have also shut down almost 50pc of our old and inefficient government-owned power plants with the remaining scheduled to be taken off the grid within the next 12-18 months. The setting up of a power commodity market, under a multi buyer/ multi seller model, along with a liberalized “wheeling” regime, is in full swing that will not only give the power consumers more choice of supply but also reduce price and improve customer service quality. We have now put professionally qualified and independent people on the Boards of Distribution companies (and NTDC), with the new CEOs under selection from the market in the next few weeks in an open and transparent competitive process. We also intend to hand over management control of the distribution companies to private sector operators (without privatizing the assets or shares of these companies, or jeopardizing the interests of the employees) in the coming months, alongside an enhanced share of the respective provinces in their operations and bottom line.

All of these above steps could and should also have been taken by the previous governments if they wanted to reform the power sector. It is the PTI government that is actually now doing heavy lifting on structural reforms that the previous regimes failed to.

The previous government did not invest in the high voltage transmission network and could not move energy to places where it was required. The PTI government has invested Rs39 billion since 2018-20, resulting in transmitting an additional 4,000 MW. Likewise, the previous government(s) did not invest in the distribution system, which adversely affected the quality of service delivery and efficiency for the end consumers. On the other hand, the PTI government invested Rs74 billion in the distribution system in 2019 which, for the first time, is more than NEPRA’s target. Almost 85pc of the Transmission & Distribution (T&D) losses in the system arise from four Distribution Companies (Hyderabad, Sukkur, Quetta, and Peshawar/Tribal Areas) that have been historically neglected by all of the previous governments. We are now focusing on these companies to improve their performance, with our limited resources and fiscal space. Despite the tariff increases, our overall T&D losses (17.8%) and recoveries (90%) have remained steady, or improved marginally, but there was indeed a dip in performance last year due to Covid-19 (industry shut down, billing relief to consumers, etc.) that everyone, except the opposition, recognizes.

In summary, therefore, circular debt has increased due to two main factors:

(1) excess capacity contracts inherited by our government from the previous regime that were, on average, 25pc more expensive, 40-50pc more than our needs, signed on "take-or-pay" basis (i.e. we pay for them regardless of need), and front-loaded (i.e. much higher tariff in the first 10-years). This "tsunami" of excess and expensive contracts has hit the sector very hard and majorly contributed to the circular debt build-up last two years; and

(2) Covid-19 impact last year due to which the government decided to freeze all tariff increases (including monthly fuel adjustment charges) resulting in an increase in circular debt stock;

All of the structural reforms undertaken by our government have now resulted in arresting the increase in circular debt flow this fiscal year to almost Rs200 billion less than in the previous year. However, for a sustainable turnaround, a comprehensive, data-driven, Circular Debt Management Plan is now in place to be implemented over the next three years.

The writer is Special Assistant to the Prime Minister on Power and Petroleum.