Power sector challenges

by Sakib Sherani

Published in Dawn, February 12th, 2021

PAKISTAN has been gripped by a crippling power crisis since the 1990s. It has intensified since 2007, imposing punishing costs on the country. According to a report released this week by Macro Economic Insights, the power crisis has cost $82 billion in lost GDP between 2007 and 2020. In per capita terms, the power crisis has cost each Rs43,504 during this period, with rupee per capita GDP lower by 23 per cent as a result.

The lower GDP growth cost approximately 0.9 to 1.6 million jobs a year, on average, between 2007 and 2018. At the lower-bound, this amounts to a cumulative 10.9m jobs that could have been saved and/or created during the 12-year period. Fiscal costs to the budget have amounted to a further 1.2pc of GDP each year, on average, between FY2007 to FY2019. Total budgetary support to the power sector has amounted to Rs3,202bn ($31.4bn at the average exchange rate). The combined welfare costs of the power crisis are likely to be significantly higher.

The nature of the crisis has evolved over the years from one of chronic power supply deficits to one where there is excess installed capacity but not enough cash flow in the system to run it. The latter gives rise to the ‘circular debt’ issue. Specifically, the ‘circular debt’ in Pakistan’s energy supply chain refers to the cash flow shortfall incurred in the power sector from the non-payment of obligations by consumers, distribution companies, and the government. It has continued to grow in size over the years, rising from 1.6pc of GDP (Rs161bn) in 2008, to 5.2pc of GDP (Rs2,150bn) as of end-June 2020. It has risen since to an estimated Rs2,400bn as of end December.

Pakistan’s energy sector woes have cost dearly and have undermined economic stability.

Given its linkages with the rest of the economy and large negative externalities, in conjunction with its magnitude and trend, the accumulation of electricity circular debt can rightly be termed as one of Pakistan’s foremost macroeconomic challenges. The build-up of circular debt has undermined the viability of the country’s energy sector, hurt industry and exports, and impacted new investment and job creation. It has also destabilised Pakistan’s fiscal management and imposed prohibitive opportunity costs in terms of pre-empting government spending on infrastructure and social expenditure, as well as credit in the banking system.

The underlying structural causes for the circular debt include the high cost of electricity generation; tariff anomalies, including a significant difference between cost-recovery and notified tariffs; stubbornly high transmission and distribution losses coupled with low recoveries; unaddressed governance issues in the sector; and delays in tariff notification as well as release of tariff subsidy/cash infusion by the government. A circular debt issue has built up menacingly in the gas sector too. Combined, the twin problem is an existential challenge for the economy.

At the heart of the problem is how ultra-generous incentives, tax breaks and sovereign guarantees have been provided by various governments not just to attract investment in the power sector, but in various other sectors of the economy at different times since the 1990s — polyester fibre, fertiliser, autos, sugar etc. to name a few. The result of these incentives and sovereign guarantees, especially under the umbrella of ‘take-or-pay’ contracts, has been to provide a safety net to private investors by transferring virtually the entire risk to the government (and taxpayers) while setting up a perpetual stream of guaranteed, US dollar-indexed profits to a small group of business people. This business ‘model’ has had serious unintended consequences for new investment, public finances, as well as the economy more broadly.

The drive to seek private investment in the power sector as well as introduce reforms, was spearheaded by the World Bank in the 1990s. The ironclad sovereign guarantees and take-or-pay contracts was the handiwork of the Bank. While the intention was justified, the means used were not. To compound the problem for Pakistan, overly optimistic economic growth projections were used to justify the larger-than-needed generation capacity — and politicians happily made hay from the 1994 as well as the 2015 power policies in ways that are well documented in economic and corruption literature.

The medium-term outlook for the resolution of the electricity circular debt issue is not very promising, unfortunately. The circular debt stock in the electricity sector has increased 3.5 times (250pc) since 2016, from Rs689bn to an estimated Rs2,400bn as of end December 2020. At the end of FY2020, it stood at 5.2pc of GDP.

While the government’s landmark agreements with a significant number of IPPs to renegotiate the terms of power purchase will help reduce the flow at the margin, unaddressed governance issues and a continuing high level of inefficiency in the sector, combined with the addition of a further 12,478 MW of installed capacity by 2028 that is in the pipeline, will ensure that the circular debt stock continues to increase.

Mitigation measures will need to include inter alia: the deferment of the planned new power generation capacity, increased utilisation of existing installed capacity, retirement of older Gencos, and improved overall governance of the sector. In the medium term, increasing the share of renewable energy in the generation mix, and privatising the Discos should be the objectives. In the longer run, the only sustainable resolution will come from moving from the current state-led, single-buyer model (monopsony) to a competitive, multiplayer market with the private sector in the lead.

While tariff increases are inevitable, a singular focus on this one element of circular debt mitigation will be self-defeating. Efficiency improvements are likely to lead to more sustainable progress in reducing circular debt in the power sector.

Given its linkages with the rest of the economy and large negative externalities, in conjunction with its magnitude and trend, fixing the energy sector can rightly be termed as one of Pakistan’s foremost macroeconomic challenges.

The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.

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