The monster of circular debt keeps growing in the power sector.

Bad governance is the overwhelming source of the circular debt build-up that is officially projected to cross the Rs2.8 trillion mark by June 30. This is almost half of the country’s about Rs5.5tr total tax revenue this year.

This means an addition of Rs500 billion during the current fiscal year at an average rate of almost Rs42bn per month, according to a report submitted by the Power Division to the Cabinet Committee on Energy (CCOE) last week.

The report is based on actual verified data of the circular debt as of Nov 30, 2020 and projected over the remaining period of 2020-21. It contains the breakdown of the circular debt in terms of operational/non-operational, comparison of last and current year’s build-up, and paid/unpaid and budgeted/unbudgeted subsidy payments.

Strikingly, the combination of lopsided decision-making, inaccurate projections, poor management and inefficient operations, non-payment by the public sector and a handicapped regulatory mechanism emerge as the root cause of the debt build-up. Simply put, the government is responsible for the mess.

The circular debt will increase by Rs152bn in 2020-21 due to distribution losses (Rs35bn) and under-recoveries (Rs117bn)

The outcome, however, is the multiplying costs to the honest and paying consumers in the shape of repeated tariff increases in various shapes and heads – another hike of about Rs3.34 per unit is on the cards. The government legally empowers power companies through the regulatory process to charge the cost of a little over 15pc losses in tariff besides the cost of bad governance and non-payments in the shape of the financing cost surcharge, quarterly and monthly adjustments and taxes.

The last fiscal year ended with a circular debt of Rs2.15tr, with an annual increase of Rs538bn or a monthly increase of Rs44.8bn. As of Nov 30, 2020, the total circular debt increased to Rs2.3tr, showing an increase of Rs156bn in the first five months or Rs31.2bn per month. During the same five months last fiscal year, the circular debt had increased by Rs179bn at the rate of Rs35.8bn per month.

Of the stock of Rs2.3tr on Nov 30, 2020, Rs1.2tr is payable to independent power producers (IPPs), Rs996bn parked in Power Holding Private Ltd (PHPL) of the Power Division and Rs97bn payable by generation companies to fuel suppliers. The payables to IPPs are estimated to surge beyond Rs1.7tr by the end of the current fiscal year while two other components will remain almost unchanged, making the total circular debt equal to Rs2.8tr.

This means the Power Division projects an increase of Rs500bn in the circular debt from December to June (seven months) at the rate of Rs71.4bn per month. The overall increase in the full fiscal year will be around Rs655bn at an average of almost Rs55bn per month. This addition will be despite the recovery of Rs225bn on account of prior-year adjustments. Otherwise, the debt addition would have been about Rs880bn.

Based on a template provided by the CCOE, the Power Division has projected that the circular debt will increase by Rs152bn in the current fiscal year due to distribution losses (Rs35bn) and under-recoveries (Rs117bn). A total of Rs317bn subsidy was required on the basis of existing tariffs. But the Ministry of Finance had budgeted only Rs144bn, leaving an unbudgeted subsidy gap of Rs177bn. The interest charges on delayed payments to IPPs and PHPL mark-up are projected to add Rs143bn, including Rs80bn additional mark-up to IPPs in 2020-21.

On top of that, the addition of Rs97bn will be on account of non-payments by K-Electric and Rs313bn due to the pending generation cost on account of quarterly tariff adjustments and fuel cost adjustments.

The report also explains contributory factors to the existing Rs2.3tr circular debt. These include Rs212bn of non-payment by K-Electric (about 11pc), Rs144bn of outstanding amounts of Azad Jammu and Kashmir (7pc), Rs306bn of non-payment by Quetta Electric Supply Company’s agriculture tube-wells (15pc), Rs270bn limitations and delays in regulatory approvals (14pc), Rs66bn payment of interest on the power-sector debt held by PHPL (3.3pc), Rs260bn non-payment of subsidies (14pc) and Rs752bn of operational inefficiencies (37.4pc).

The report noted that the circular debt should have gone up by Rs848bn during the last fiscal year, but it was contained through Rs309bn worth of tariff increases on account of prior-year adjustments, resulting in the debt build-up of Rs538bn. Similar prior-year adjustments in tariff already being charged to consumers will generate Rs225bn in additional revenue and help restrict the debt build-up to about Rs500bn during the current fiscal year.

Some of the biggest challenges to address the build-up of the circular debt remain the controversies around the settlement of outstanding dues with K-Electric along with the untouchable China-Pakistan Economic Corridor (CPEC)–related power projects, which could have been absorbed by a growing economy but have become a headache owing to economic depression.

The outcome of renegotiated agreements with IPPs, reduction in the rate of return on equity of government-owned power plants and closure of inefficient Gencos are expected to provide some respite going forward, but the actual impact will be felt in the next fiscal year. Here again, the greater part of breather will accrue only on account of the parking of some losses in other accounts like replacement of ROE on hydropower plants from Wapda to the federal budget.

The outstanding amounts of Azad Jammu and Kashmir (AJK) are being addressed through the removal of the AJK tariff differential for which a summary has already been moved. But this too will require that the financial gap will have to be picked up in the budget. A similar arrangement will have to be put in place in the matter of Quetta Electric. To what extent the provincial government can foot the bill is yet to be seen and hence a large part will fall back on the federal government.

The easiest way out to a limited scale is the tariff increase for consumers that the government already decided to an extent of Rs2 per unit of about Rs200bn per annum. A similar low-hanging fruit appearing on the government radar is the tariff rebasing by the regulator to reduce the impact of delay in tariff determinations and their delayed notifications. An amendment to the Nepra Act to allow the financing of PHPL debt through consumer tariff is already pending approval in parliament.

But despite all these additional burdens on consumers, the authorities concerned still appear resisting technological interventions to reduce system losses and improve recoveries. The Ministry of Information Technology has put on the record that a meter-less smart metering system successfully tested and proved on the ground was being resisted by the power sector authorities since November 2018.

Published in Dawn, The Business and Finance Weekly, January 18th, 2021