Pakistan’s Power Sector Circular Debt – definitions, realities,

impacts, and solutions

Amna Riaz

The circular debt is not circular but rather telescopic: GOP’s definition of circular
debt does not reflect the complete picture. Circular debt was officially defined by
the Economic Coordination Committee (ECC) of the Cabinet in 2014, in the
following words. “The circular debt is the amount of cash shortfall within the
Central Power Purchasing Agency (CPPA), which it cannot pay to power supply
companies.

The overdue amount is a result of the:

a) difference between the actual cost of power supply for a distribution company
(DISCO) which the National Electric Power Regulatory Authority (NEPRA)
announces as the Determined Tariff for that DISCO, and the revenue which the
Government allows that DISCO to generate through a Notified Tariff.

b) While the Government commits to paying the difference between Determined

Tariffs and Notified Tariffs to each DISCO, there is often a delay in payment, or
non-payment, of such subsidies by government

c) Delayed determination and notification of tariffs.

The ECC definition limits circular debt to the cash shortfall within CPPA only,
which portrays an incomplete picture of the overall circular debt of the power
sector.

There are no circular financial flows, if anything, the debt is telescopic in nature
The figure below explains the power sector supply chain where the flow of the
inputs (fuel which is later converted into electricity—the product) takes place
from oil and gas exploration companies and fuel import companies (mainly PSO),
through refineries, generators, all the way to DISCOs, which then sell the
electricity to the end consumer.
When it comes to the recovery of the value of the product, the DISCOs recover it
from consumers based on a monthly cycle. This is the “genesis” of the power
sector debt because total receipts of the DISCOs do not cover their obligations; as
(a) they cannot charge the consumers the actual cost, (b) they incur more than
the regulator assessed line-losses, and (c) they are unable to recover fully from
their consumers. Therefore, DISCOs are only able to pay-back a part of the cost of
electricity purchased by them, the rest becomes arrears to NTDC/CPPA.

Since CPPA handles the DISCOs payments to power generators, a shortfall in

payments by the DISCOs means NTDC/CPPA does not get the resources it
requires, in order to pay all its obligations towards generators, thus, it builds
arrears with generators. Similarly, generators cannot pay all their fuel suppliers,
and fuel suppliers cannot pay the upstream (exploration) companies. The arrears
at the DISCOs level are the largest, which get smaller at each level up the power
sector supply chain.

This nature of the debt is telescopic (or reverse telescopic to be more specific)
rather than circular because although the debt primarily arises due to late
payment of subsidies by the government, the oil and gas exploration companies
usually don’t owe anything to the government, hence there is no circular flow of
monies. However, it does have everybody going around in circles.
The debt has primarily arisen and stays due to the issues surrounding tariffs,
recoveries, and the poor management of the “stock and flow” aspects of its
financial management.

The buildup of arrears has a stock and flow dimension which can be explained
with a simple example. DISCOs run on a monthly revenue cycle, whereby they
generate revenue at the end of a month. When the underlying causes leading to
loss of revenue for DISCOs are not addressed, then those DISCOs cannot cover
their costs and build arrears each month. Those arrears mount up over time e.g.
from (an assumed figure of) PKR 30 billion per month to PKR 360 billion after a
year. PKR 360 billion therefore is the stock of the power sector debt at the end of
a year. But it is being added to by PKR 30 billion per month. So even if the
government paid PKR 360 billion at the end of any year to wipe out the power
sector debt in full, the arrears would still grow by PKR 30 billion in the very next
month, and be back at PKR 360 billion after another 12 months. So the problem
requires actions to address both the stock of the power sector debt i.e. the PKR
360 billion, and to halt or reduce the flow i.e. to reduce the monthly addition of
PKR 30 billion. One is addressed by outright payments and the other by reforms
to abet the flow.

In addition to the stock and flow nature of the debt, the aggregate debt itself is a
build up from one primary amount of arrears of DISCOs. Down the power sector
supply chain, the subsequent entities keep adding their accrued arrears as a result
of non-payment from DISCOs, and therefore, the aggregate debt amount keeps
on ballooning. The large aggregate amount of PKR 500 or 600 billion or more
creates an illusion of misallocation of resources, however, if the primary amount
to DISCOs is cleared up, all the subsequent parts of the chain will or can
automatically be cleared up.

The flow of the debt and thereby the accumulation starts with the DISCOs due to
the Federal government’s tariff interventions and NEPRA’s losses assumptions for
tariff calculations.

The resources needed to cover the cost of supply for the DISCOs are to be
collected from the consumers who can only be charged up to the extent of tariff
determined by NEPRA.

NEPRA, appointed as the sole regulator in the power sector, ensures a

competitive and commercially oriented power market in Pakistan, determines
eleven different tariffs for consumers of eleven DISCOs, depending on the
conditions in each one of them. That ‘Determined Tariff’ for each DISCO covers its
cost of supply provided that the:

a) Recovery is hundred percent; and

b) line losses stay within the national limit prescribed by NEPRA i.e. 15.3
percent.

Both these assumptions are not based on the ground realities in the country. The
target of 100 percent recovery is not achievable due to poor governance level of
the DISCOs – the recovery performance of DISCOs varies and so do their line
losses. DISCOs improved their performance on an average in 2015 and 2016 with
unprecedented high recoveries of more than 93 percent and line losses at all-time
low of 17.9 percent. Despite this improved performance, this still accounts for a
9.6 percent difference between revenue due to NEPRAs losses assumptions and
actual losses (recovery and line losses).

Moreover, the bigger reason for lack of resources is that in pursuance of its socio-
economic objectives, the federal government changes the determined tariff
structure of DISCOs by notifying a uniform national tariff to be charged by all
DISCOs across the country. From 2005 onwards, each DISCO’s tariff has been set
below what NEPRA determined for it. Since that ‘Notified Tariff’ is below the cost
of supply for the DISCOs, therefore, the government undertakes to pay the
difference to DISCOs as subsidy, also known as tariff differential subsidy (TDS).
The aim of the government is to subsidize the poor, and occasionally, to support
the industry. However, it is a short-sighted policy which is the very basis for the
‘flow of arrears’ as mentioned earlier. As can be seen in the figure below, the
actual subsidy has far been exceeding the budgeted amount, with a difference of
almost PKR 317 billion in FY12. This shows the ballooning effect of stock and flow
of the power sector debt on public finances if the root causes of tariff differential
and DISCOs’ performance are not addressed.
Power sector debt cripples government finances at the macro level and impacts
the financial performance of the sector

Power sector telescopic debt is a problem because:

1) It leads to public sector spending squeeze and creates a misperception about

misallocation of resources by the Government.
The amounts involved are large. PKR 300 billion per annum, or PKR 500-600
billion in aggregate, is a substantial sum. It was more than 10 percent of total
budgetary expenditures during 2008-12. Even now, the amounts are
equivalent to 8-10 percent of total budgetary spending. It is not realistic to
expect that the Government will be able to generate or allocate this quantum
of resources merely to cover the overrun under only one budgetary heading.
This build-up of arrears every year adds a lot of uncertainty to the budget
formulation process. The figure above shows that the actual amount of
budgetary subsidies (which were essentially required for covering the DISCOs
financial losses and paying off the arrears) provided to the power sector has
often been twice or thrice of what was budgeted.
2) Power off-take guarantees add a visibility dimension to debt and makes for
even worse press.
Some of the arrears are on contracts (or for entities – e.g. IPPs) which include
provisions for penal interest on overdue amounts, and involve Sovereign
Guarantees by the Government. NEPRA normally does not accept penal
interest, or interest payments on arrears, as a valid or prudently incurred cost
by the DISCOs or NTDC – therefore, those entities are not able to recover such
interest payments through their tariffs. The Government’s Sovereign
Guarantees, or even a notice by the IPPs that they will invoke the provisions of
such guarantees, adds a visibility dimension to the debt – foreign
governments, donors, and foreign lenders all take significant notice of such
events.
3) Forex drawdown leads to oil import complications.
The Debt also includes the arrears of generation companies to PSO and/or
other oil marketing companies. Since PSO has to import crude oil or products
(generally furnace oil) to meet its contractual obligations to the generators, it
 requires foreign exchange to establish Letters of Credit for the import of these
products. Once its receivables exceed a certain level, commercial banks
become reluctant to provide the required letters of credit. At such times, the
debt problem is translated into one of Pakistan being able to “fulfill its
international obligations and make payments for essential imports.” Again, the
issue acquires a visibility that is larger than the amounts involved or a ‘delay in
payments.’

What is required:

1) Adequate budgeting for subsidies – We cannot argue for no subsidies, there is

a poverty dimension, and even the IMF agreed that subsidies amounting to
0.3% of GDP for the power sector was acceptable as long as appropriately
targeted to the poorer segment of the society. However, the actual subsidy
amount should not exceed the budgeted amount, as has been the case in the
past.
2) Prompt payment of subsidies – The process consists of the DISCOs submitting
the claims, the Ministry of Water and Power scrutinizing them, and then
Ministry of Finance releasing the amount. But the one month which this
process should take actually becomes many months, and even Accountant
General Pakistan Revenues, who does a scrutiny/verification, says it has a
‘Fiduciary responsibility.’
3) One time audit and re-setting of NEPRA standards for losses, collections, etc.
for DISCOs – Some DISCOs don’t meet NEPRA’s allowed limits for these
performance indicators and never will. Perhaps NEPRA should consider
scenarios based on reality. It did, for example, prepare heat rates for GENCOs
but as not a single GENCO was meeting them it allowed a one-time audit, and
then reestablished heat rates for each GENCO based on this ‘reality.’ But this is
a potential time bomb. NEPRA can argue that it allowed DISCOs enough time
to get their act together and question why it should continue to succumb to
the DISCOs’ weak performance.
4) Privatization of DISCOs – One of the main problems plaguing the DISCOs is
poor governance which results in high electricity theft and recovery losses.
This mismanagement leaves DISCOs unable to make investments in the
 dilapidated infrastructure to cover the technical losses. Hence the financial
woes of DISCOs get compounded. The privatization of DISCOs is expected to
keep in check the financial bleeding and will improve efficiencies and
competitiveness in the sector through better customer services.

REFERENCES

[1] National Power Tariff and Subsidy Policy Guidelines 2014.

http://www.mowp.gov.pk/mowp/userfiles1/file/final%20%20policy%20Final%20
20140401.pdf

[2] Ministry of Finance – Budget in Briefs -

http://www.finance.gov.pk/fb_2017_18.html

[3] Pakistan Energy Yearbook 2015

[4] NEPRA Tariff Determination Documents for DISCOs -

http://www.nepra.org.pk/

[5] World Bank Data Repository

[6] IMF Country Report No. 16/94 for Pakistan -

https://www.imf.org/external/pubs/ft/scr/2016/cr1694.pdf

[7] Intercorporate Debt Report – Ministry of Finance

[8] Pakistan Oil Report 2014-2015