New govt to consult IMF over power sector issues

ISLAMABAD: The new government will re-engage the IMF over the caretaker regime’s plans of tariff rationalisation and circular debt (CD) stock management, which the Fund had earlier rejected. The authorities in Islamabad reckon that without the approval of the said two plans, the country’s economy cannot grow, a senior official of the Energy Ministry told The News.

“We have communicated to the Fund that the functionaries in the Power Division are ready to respond to the objections on the plans to settle down Rs1.27 trillion of energy sector circular debt and tariff rationalisation plan under which tariff of the industrial sector will be brought to 9 cents per unit from the existing 14 cents to stimulate the economy by doing away with Rs222 billion cross-subsidy the industry is giving to domestic sector.”

“The government will try to find a middle way out to overcome the said two issues that have taken the economy hostage. The government has decided to re-engage with the IMF on tariff rationalisation and circular debt stock management.”

The Fund earlier on February 12, 2024 refused to support the tariff rationalisation plan arguing the bulk of the proposal is substantively similar to the proposed winter package of November 2023, which it did not support and IMF does not see it as the appropriate response to energy sector’s problems.

It said the proposal is regressive, as it would pay for reduced industrial tariffs by substantially increasing tariffs on residential consumers, with the lowest-income residential consumers facing significantly higher tariffs. It is also far from unclear that the proposal would be the Circular Debt (CD) neutral.

Ultimately, the only way to deal with the high electricity tariffs Pakistan faces is to dramatically and fundamentally reduce the costs of electricity sector. This should be the authorities’ main focus and would make the energy sector viable and allow lower tariffs for all. The fixed-variable adjustment of the pricing (rather than the redistribution) could possibly be considered some time down the line once these other structural cost-side reforms are visibly reducing the cost structure in the sector and allowing lower tariffs for all.

The IMF in its response said that the CD-neutrality of the proposal is questionable saying: “We welcome the proposal’s recognition that any CD slippage would need to be met with price adjustments, although this would likely only increase the regressive impact of the proposal and decrease the tariff recovery rate.”

Moreover, the Fund had disagreed that any “anticipated increase in recoveries” should be counted as a way to make the scheme “CD neutral”. Improved recoveries must be entirely used to decrease overall CD relative to the baseline rather than offset losses created by new schemes.

The Fund in its earlier response has said: “It also does not see electricity prices currently threatening Pakistani industries or broader macroeconomic stability and growth in Pakistan. While electricity sales to industry declined in FY24H1, industrial activity and exports appear to have been stable during this period, as was broader economic activity (with a GDP recovery in FY24Q1). This is consistent with available historical data, which does not show strong evidence of a link between electricity sales and industrial production and exports. The negative indicators cited in the proposal are centered on FY23, an exceptional year during which Pakistani industry (and macroeconomic stability) were deeply impacted by highly destructive import controls and the 2022 floods. Moreover, broader business confidence has recovered strongly in recent months.”

Even if there were a general economic slowdown, stronger macroeconomic policies would likely be a more appropriate policy response than fiddling with the tariff structure.

IMF had wondered whether the lowest-hanging cross subsidies to immediately eliminate would be through ending free/subsidized electricity currently received by employees of energy sector and other public sector entities (including Discos and the government), and for them to pay the regularly applicable tariff from now on. Even without any other change in the tariff structure, this change would presumably allow a reduction in tariffs for many existing domestic and business customers. Why has this not been done?

The cross-subsidy from non-residential to residential consumers reflects how Pakistan currently manages the impact of electricity tariffs on vulnerable households. Until an alternative is carefully developed (funded), the reduction of this cross-subsidy effectively reduces support to the most vulnerable (just as a reduction in the BISP stipend would).

“As we would not support a reduction in the BISP stipend, we cannot support any such change in this case. Moreover, we would expect the significant additional burden on domestic consumers to heavily impact recovery rates, ultimately necessitating larger tariff adjustments,” the IMF said.

In summary, Pakistan’s high electricity tariffs reflect the high cost of its electricity sector. Reducing these costs (which are higher than competitors) through renegotiated IPPs, ending captive power, addressing theft and line losses, and privatizing Discos should be a key priority, and is the only sustainable means towards lower tariffs.

The IMF had not supported the proposed CD reduction plan saying: “Although, if the finance minister agrees, we can go along with the TSG (technical supplementary grant) given that these funds were appropriated for this purpose.” Beyond that, the plan does not fundamentally help to restore energy sector viability, essentially only dealing with legacy claims that not all entities even seem to record (or anticipate collecting). Equally, even after its implementation, a very large stock of the CD would remain.

The Fund had said: “We do not support the use of any supplemental grant and would see such a grant as a significant breach of programme commitments.”