Circular debt: A mounting pressure
The country’s circular debt has ballooned to over Rs2.3 trillion, owing to the mismanagement of the Power Division and other factors, BOL News has learnt.
Unfortunately, there is no end to the vicious cycle of the circular debt in Pakistan that has been plagued by a severe electricity crisis since the 90s. It is estimated to have cost the economy at least 2 per cent of GDP annually in terms of lost output, and a further 1.2 per cent of GDP each year, on an average, in terms of fiscal costs to the budget between FY2007 to FY2019 and it is continuously on the rise giving an impression as if the government is completely clueless how to overcome it.
Sakib Sherani, a renowned economist and former member of the Prime Minister Imran Khan’s Economic Advisory Council (EAC) told BOL News 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 the chronic power supply deficits to excess installed capacity but not enough cash flow in the system to run it.
The latter gives rise to the circular debt issue, he said. 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.
For Sherani, it has continued to grow in size over the years, rising from 1.6 per cent of GDP (Rs161 billion) in 2008, to 5.2 per cent of GDP (Rs2.150 trillion) as of end of June 2020, which now reached Rs2.3 trillion.
Given its linkages with the rest of the economy and large negative externalities, in conjunction with its magnitude and trend, it can rightly be termed as one of Pakistan’s foremost macroeconomic challenges.
“The build-up of [the] 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 preempting government spending on infrastructure and social expenditure,” Sherani said.
Finally, the issue of the circular debt has potentially negative consequences for the banking system, as well, given its high exposure to the energy sector, he said, adding that the underlying structural causes for the circular debt included 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 the tariff notification, as well as the release of tariff subsidy/cash infusion by the government.
Sherani said that the issue of the circular debt has built up menacingly in the gas sector too. Combined, the twin problems are an existential challenge for the economy. The medium-term outlook for the resolution of the circular debt issue is not very promising, unfortunately.
“While the government’s landmark agreements with a significant number of independent power producers (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 12,478MW of installed capacity by 2028 that is in the pipeline, will ensure that the circular debt stock continues to increase,” he said.
The economist said the 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 generation companies, and improved overall governance of the sector.
In the medium-term, increasing the share of renewable energy in the generation mix and privatising the distribution companies should be the objectives.
In the slightly longer run, the only sustainable resolution will come from moving from the current state-led, single-buyer model (monopsony) to a competitive, multi-player market with the private sector in the lead.
“While tariff increases are inevitable, a singular focus on this one element of [the] circular debt mitigation will be self-defeating. Efficiency improvements are likely to lead to more sustainable progress in reducing [the] circular debt in the power sector,” the economist said.
Talking to BOL News, former managing director of the Pakistan Electric Power Company (Pepco) Tahir Basharat Cheema said that several measures are needed to overcome the vicious cycle of the circular debt.
“We need to have a professional management, which means that the Power Division will have to leave the operations and restrict itself to policy control, change the existing board of directors with the power sector professionals and experts who are available, the Power Division just support and assist the loss making distribution companies with over reach to the provincial governments and the Power Division should assist and not take over the operations.
Cheema said that only in-house experts should be posted as chief executive officers, externalities affecting the distribution companies operations should be taken care of by the Power Division and also ban on unions for three years, while creating a firewall to political influence if the government seriously wants to overcome the circular debt.
“By taking these measures, the government could control [the] circular debt in two to three years, otherwise the pace of the circular debt growth would increase,” Cheema predicted.
Another acclaimed economist and Pakistan Institute of Development Economics vice chancellor Nadeemul Haque, agreeing with Cheema told BOL News, that the systemic reform to decentralise the system into autonomous units with the professional management could help overcome the growth in the circular debt.
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