Volume 22 Issue 3, March 2018


The sorry tale of circular debt is a legacy of vested interests circumventing the chain of oil purchases, power generation and power distribution and, as a result, burdening taxpayers and consumers with inefficiencies of managing the problem.

In 2014, circular debt was officially defined by the Economic Coordination Committee (ECC) of the Cabinet as follows:
“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:

(a) the difference between the actual cost and the tariff determined by National Electric Power Regulatory Authority (NEPRA) which is the distribution company’s loss over and collections under that allowed by NEPRA

(b) The delayed payments or non-payments of subsidies by government

(c) Delayed determination and notification of tariffs. It is the government’s policy to reduce, limit to a certain amount which would be reduced over time, and eliminate the causes of the circular Debt.” (National Power Tariff and Subsidy Policy guidelines 2014).

Circular debt is effectively the non-payment by the purchasers of power to the power distributors. Consequently the power distributors do not make sufficient payment to the power generators. This non-payment feeds down the line. The power generators in turn do not pay the oil companies (fuel suppliers), who in turn are unable to pay for the import of fuel unless the government issues support for the credit.

Why does circular debt exist?
The non-payment is predicated on the inefficiency and corruption prevalent not only in distribution companies but throughout the chain. These are categorized as technical losses (inclusive of distribution losses) and theft.
NEPRA regulates the losses to a certain limit. However, the political government does not pass on the full cost of the generated tariff. This (growing) gap is covered by government subsidies. More often than not, these subsidies are not performance-based and this tends to exacerbate the circular debt problem.

When the distribution companies do not make full payment to the power generators, the shortfall in payments creates a problem for the fuel suppliers, as a result of which the fuel suppliers are also caught in the vicious cycle of circular debt.

The problem and the consequences
The quantum of circular debt is now estimated to exceed PKR900 billion and is continuing to grow. This is at a time when the price of oil in the international markets is at a relatively low.

The power sector has been burdened under the impact of circular debt for over 10 years. Unfortunately, the lack of political will to resolve the issue has resulted in an institutional failure on all fronts.

Circular debt has continued to grow over the last decade. This has proven to be one of the biggest impediments and threats to the power sector and will continue to be so till resolved.

The ad hoc approach relating to circular debt has been clouded by a lack of transparency. Financial and technical audits undertaken with regard to these payments (made and not made) have been flawed.

In the process, institutional policy guidelines are being breached as the inter-company payables and receivables are recorded but limits have not been assigned. There is an implicit assumption that these are underpinned by the government. This is a dangerous assumption in the absence of a legal and contractual relationship.

Other shortcomings include the lack of analysis, both comparative and probabilistic, of data for power generation, power distribution and transmission and final consumer demand, supply and payments. As such the institutional checks and balances that should be in place are not there.

As such, some generators get paid for electricity that they do not generate but are entitled to a minimum capacity payment. On the other hand, other generators do not get paid for the electricity that they have produced.

As the lack of transparency is pervasive, agencies responsible for purchasing power, the Private Power and Infrastructure Board (PPIB) and Alternative Energy Development Board (AEDB), also resort to purchasing power without competitive bidding. Consequently, prices contracted are not competitively determined, nor are they necessarily optimal.
The problem is further exacerbated since the power purchase agreements are long-term, generally spanning 20-30 years and the contracts are entered into without having a long-term vision.

The affected parties
The amount owed to the IPPs (Independent Power Producers) is collectively around PKR250 billion.
PSO (Pakistan State Oil) is currently owed around PKR350 billion, mainly by the government. PSO is considerably constrained on liquidity on account of this massive outstanding balance.

PHPL (Power Holding Company Limited) was created to take over the loan and liabilities of the government relating to the power sector. (The loans and liabilities of over Rs400 billion of the power sector have been parked in PHPL. If the circular debt is also included then the amount is in excess of Rs900 billion).

Issue highlighted by the IMF

Given the severity of the problem, the International Monetary Fund (IMF) in its report released a few months ago highlighted the problem.

The observations in the report stated: “Some renewed accumulation of arrears in the power sector has been observed,” which was brought to nearly zero by 2015-16 with the help of favourable oil prices and sustained reform efforts.
In the report, the IMF has asked the Pakistan government to swiftly address “the issue of a resumption in the accumulation of arrears to ensure a financially viable and growth-supporting power sector” and has noted Rs53bn accumulation of power-sector arrears in the first half of 2016-17, with the stock increasing to Rs374bn.
The IMF report has further stated that the issue was indicative of a widening of the system’s operational deficit due to delays in passing through to consumers higher generation tariffs and weaker bill collection by distribution companies, only in part compensated by the positive impact of a reduction in distribution losses and still low oil prices.

Reduction of circular debt
The successful reduction of circular debt in the past, before it built up again in recent months, was on account of the following factors:

a) Recoveries: There was an improved performance by the state-owned discos (power distribution companies) in 2015 and 2016. The recoveries were at an all-time high. In 2015 and 2016, the recoveries were in excess of 93%. Line losses were correspondingly much lower.

b) International oil prices: Oil prices were significantly lower and a major portion of this cost was passed on to the final consumer in the form of monthly fuel price adjustments.

c) Payment by the governments: The federal and provincial governments allocated and made payments to reduce the arrears.

Future reduction and eventual elimination of circular debt will require political will, better performance by the discos and market-based pricing of energy that is closer to the economic reality.

The writer is a senior banker and CEO Pak Takaful.
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