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Forever zero


March 9, 2021

Pakistan’s power sector faces its gravest challenge ever – financial instability of a quantum that threatens the country’s already over-stretched budgetary resources.

The extent of financial haemorrhaging is simply stunning – Rs486 billion in FY19, Rs538 billion in FY20 and Rs155 billion in five months of FY21. In just 29 months it added an unaccounted for quasi-fiscal deficit of 2.6 percent of GDP. Quasi-fiscal deficit is an indirect liability of the state.

The pace of haemorrhaging in the power sector is frightening –Rs40 billion a month. In nominal terms, a nerve-racking Rs1,180 billion or $7.5 billion have become a new quasi-fiscal liability of the state, from July 2018 to November 2020. The accumulative total stock of the power sector payable has risen to an inconceivable Rs2,400 billion. This stock has commonly come to be known as circular debt – though there is hardly anything circular about it. The circular debt or the accumulated stock of the power sector is the liability of the single power sector buyer – the state. The government is considering paying an amount of Rs450 billion to IPPs to settle part of the stock of the circular debt.

The build-up of circular debt is principally the result of flaws in the system covering policy inefficiencies, structural issues, and administrative fault-lines, all over-shadowed by political economy considerations. Let’s make an exceptionally precise and objective attempt to structure steps to permanently stem the leakage accruing in the power sector to near zero.

Policy rectification requires a redesign of three key areas. First, tariff pass-through as determined by the regulator has to be made automatic. The government inordinately delays tariff pass-through after determination by the regulator, adding to circular debt. At the outset, the three tariff notifications (monthly fuel price adjustment; quarterly adjustment; and yearly base tariff adjustment) must be done by the government within a stipulated 15-day time period, with an adequate subsidy amount added to the tariff notification. The permanent solution to rectify the delay in tariff implementation is to allow Nepra to directly notify tariff without government intervention.

The second key policy adjustment is about a larger-than-life subsidy mechanism marred by under budgeting. More than 60 percent of domestic customers (consuming up to 300 units) utilize a major portion of the tariff subsidy. Other subsidized consumers include: Balochistan tube wells (almost 30,000) subsidized with an amount shared between the federal and Balochistan governments on a 40:60 ratio estimated at about Rs60 billion; industrial consumers through a subsidized tariff; and five export sectors provided electricity at a highly subsidized rate 6.5 cents/kwh. These are substantive subsidies.

Budget FY21, like past budgets, partially covers the ambit of promised subsidies. A paltry amount of Rs140 billion budgeted as power-sector subsidy is far short of the estimated need of Rs 430 billion in FY21. The deficit amount, a whopping Rs290 billion, leads to a build-up of circular debt. Adequate budgeting at the start of the fiscal year and adjustments over the course of the year must be adhered to as a new policy. Subsidy verification and payment delays should be avoided. In the medium term, the government must move to a full cost tariff and direct subsidy to the vulnerable.

The third policy issue is to ensure payment of dues from AJK worth Rs38 billion a year. Electricity is being supplied at a concessional rate of Rs5.30 per unit while the regulator notifies a full rate above Rs13.50 per unit. The state continues to partly foot the bill for difference in the tariffs for many years. The historical Mangla agreement determining a concessional rate of electricity supply to AJK has expired. The issue of AJK needs a policy settlement or otherwise adequate budgeting.

At the structural level, the accumulation of circular debt is related to an under-collection of billed amount and higher technical and distribution losses. In FY20 the collection was 88.77 percent of the billed amount and the transmission and distribution losses were 3.5 percent higher than allowed in tariff. Rectification of the two anomalies can stem a bleeding of Rs200 billion a year. These issues have been handled through administrative interventions including crackdowns and policing which have worked only partially.

A more sustainable solution is to rely on technology through a relentless effort to move the entire country to smart meters. Such solutions should apply at the grid level as well. To ease implementation, consumers using a load of 5 kWh and above can be targeted. These cover 75 percent of the country’s billing but constitute only 25 percent of total consumers. The irony is that a multilateral loan is parked with Pakistan to undertake this process for the past three years. Smart metering can help DISCOs move to a near 100 percent recovery of bills. Balochistan tube-wells’ solarisation is a much-delayed project, which needs completion at the earliest. The program of reduction in transmission losses, with targets of 0.75 percent yearly, should be simultaneously implemented. Lastly, a key administrative issue is the non-recovery of GST payable to the FBR. The solution requires a change to fix GST on the recovered rather than billed amount.

The current tariff structure is based on restricting higher use of electricity. This is non-reflective of the removal of the supply constraint from about two years ago. At a structural level, the country needs a new tariff regime. One which incentivizes a higher usage of electricity. This can help reduce the rising tariff as economies of scale will decrease the fixed capacity payment per unit as it gets spread on a larger number of units sold in the country. The added expectation is that a lower tariff at higher consumption levels will also lower the incentive for theft.

The above menu of reforms is likely to make the perturbing financial haemorrhaging for ever zero. The good news is that they are implementable over a course of 12-24 months. Big ideas like divestment, off-grid solutions and greening can continue on the side.

The writer is former advisor,Ministry of Finance, Government of Pakistan.

Email: [email protected]

Twitter: @KhaqanNajeeb