Power sector eats away Rs3.5tr

ISLAMABAD: Pakistan’s cash-bleeding power sector has eaten up Rs3.5 trillion on power subsidies and other liquidity injections in the last 14 years since FY2007.

According to official data available with The News since the beginning of the circular debt problem in FY2007 up to FY2020, the government has cumulatively spent Rs 3.5 trillion on power subsidies and other liquidity injections. The borrowing cost of these subsidies (assuming 8% interest rate) works out to over Rs2 trillion. With public debt at over 87% (Jun-2020), the government has little fiscal room, if any, to dole out generous subsidies in future now. Total circular debt stock reached Rs2.37 trillion at end Mar-21. This comprised Rs1,412 billion on CPPA’s books, Rs962 billion on Power Holding Company known as PHPL’s balance sheet.

The stock of circular debt doubled between June-18 and Mar-21, albeit payment of more than Rs500 billion in electricity subsidies during this period.

The high-profile Economic Advisory Council (EAC) also endorsed and recommended to the government to reduce the burden of taxation on electricity to erase the monster of circular debt while citing the example of the UK. In the UK, where the standard VAT (Value Added Tax) rate is 20%, domestic electricity and gas bills are taxed at 5%.

Reducing sales tax on electricity and increasing base tariff by equivalent amounts in Pak rupee terms can contribute substantially towards reducing the flow of circular debt. Domestic, commercial and agriculture sectors account for more than 70pc of total electricity. Unlike the industrial sector, which can claim input adjustment of sales tax, these sectors are only concerned with total electricity bills including sales tax. Offsetting sales tax reduction with base tariff increase would keep total bills of these consumers unchanged.

In official briefings, the government has been informed that Pakistan’s power sector is facing a critical solvency risk from the mounting burden of circular debt. If not contained immediately, it could potentially tear down the energy supply chain while also having adverse spillover effects on the broader economy.

The outstanding stock of circular debt has more than doubled in 33 months, from Rs1.15 trillion in June-18 to Rs2.37 trillion in Mar-21, despite disbursement of more than Rs500 billion in subsidies. Contrary to the common perception, KE is also entangled in the web of circular debt with Rs250 billion in tariff differential claims and Rs200 billion payable to CPPA outstanding at end Mar-21.

The main underlying causes of the circular debt problem are: i) high cost of electricity generation, ii) billing under collection, iii) excess T&D losses, iv) under-budgeted and delayed subsidies, v) delayed tariff determinations and notifications and vi) under-recovery of financial cost of circular debt.

Even record high consumer electricity prices with an average current tariff of Rs16.5/KWh (US11/KWh) excluding sales tax, are not sufficient to stem the flow of circular debt. High incidence of electricity taxation is putting additional burden on consumers. Solarization is enabling high paying residential consumers to reduce offtake of grid electricity while industries are looking for ways to increase self-generation.

With 13,000 MW of new capacities added to the NTDC system in four years to June-20 and another 7,600 to be added by Jun-23, the tidal wave of capacity payments is drowning the power sector finances. Total capacity payments of CPPA increased form Rs275 billion FY2016 to Rs856 billion in FY2020 and are projected to increase to Rs1.4 trillion in FY2023. However, on the positive side, the new capacities have helped bring down the variable cost of electricity generation, which is projected to slide even lower as more nuclear, hydro and coal plants are added.

A multi-track approach is required to pull the power sector out of economic tailspin and given the urgency of the situation, all tracks need to be pursued concurrently and swiftly. Tenor extension of project debts of power plants can help substantially reduce the near-term cost pressures by flattening out the curve of capacity payments. Debt servicing (interest + repayment) account for ~60% of capacity tariff in the first 10 years for a typical power plant.

Moreover, public sector power plants accounted for 44% of the total capacity payments in FY2020 and their share shall increase as large nuclear, RLNG and coal plants are added. GOP loans (Foreign Re-Lent Loans and Cash Development Loans), which account for a significant part of project debts of large hydro and nuclear power plants, can be re-profiled quickly and on generous terms. Coupled with re-profiling of project debts of private coal fired and renewable energy plants, total capacity payments can be reduced by Rs150-200 billion annually over short to medium term.

Increasing electricity sales by incentivizing captive-to-grid switch by industry and electrification of energy use especially space heating in winter through lower marginal tariffs can help reduce cost of generation by spreading fixed capacity payments over a higher number of units. KE can be made part of the solution by increasing electricity supply to it.

A 2.5 percentage point improvement in billing collection (currently at 90%) could improve annual cash flows by Rs50 billion. Moreover, offering amnesty schemes may help recover a part of the hefty defaulted amount (Rs628 billion in Dec-19).