A VERY interesting chapter in the recently released first review of the IMF programme casts important light on the matter of the circular debt and its stubborn refusal to go away. The chapter merits close reading, because power sector tariff adjustment (if we include gas here for the moment) presents the most demanding risks to the inflation outlook, and thereby to the possibility of interest rate cuts. Those hoping for a rate cut in March should read this passage carefully, and note the commitment given by the State Bank to the IMF that interest rate easing is only possible once “disinflation is firmly entrenched”.

For now, the inflation outlook, with all power and gas sector price adjustments, is maintained at 11.8 per cent, within the band announced by the State Bank in July (11-12pc), so further rate hikes no longer seem necessary. But average monthly inflation coming in at 11.8pc by the end of the fiscal year means rate cuts are also difficult to envisage. The Fund report notes that administrative and energy tariff adjustments will offset the effect of weakening domestic demand, and one of the key drivers of energy tariffs is what they call “full cost recovery”, to ensure zero accumulation of circular debt.

Much hangs in the balance as the government is tasked by its creditors with eliminating the further accumulation of circular debt. This is of course a good objective, but how it is to be pursued will decide who bears the cost. And at the moment, the pressure is to simply make the consumers bear the cost.

Much hangs in the balance as the government is tasked by its creditors with eliminating the further accumulation of circular debt.

The costs themselves are stupendous. In the last fiscal year alone, the stock of circular debt rose by Rs465 billion, making it equal almost to some of the largest expenditure heads in the federal budget. In 2013, the total stock of the circular debt was Rs450bn. Today, it has more than tripled to rise to Rs1.62 trillion or 4.2pc of the GDP.

Of the total circular debt, Rs812bn is payable directly by the government’s own Central Power Purchasing Authority. The remaining amount is parked with a second company, also government owned, called Power Holding Pvt Ltd, whose only job is to borrow from the banks at Kibor plus 2pc and advance the money to the CPPA. The government pays around Rs80bn per year just in penalty interest charges on the outstanding stock that CPPA owes to producers. Another Rs40bn is paid by the PHPL as debt service costs which is raised through a special surcharge in power bills. That is Rs120bn already, just the cost of carrying the circular debt! By comparison, consider that the total allocation for the Benazir Income Support Programme that aims to provide assistance to almost 5.5 million beneficiaries is Rs180bn.

These figures are stupendous, no doubt. The “large stock of power sector arrears represents a significant quasi-fiscal risk, including combined annual debt servicing costs exceeding PRs 100 billion” the IMF report notes. The report provides four major reasons that contribute to the growth of the circular debt. These are: inefficiency of the power distribution companies, delays in adjusting tariffs, unbudgeted subsidies and financial costs of the sort just discussed here.

In the last fiscal year, for example, of the Rs465bn in fresh accumulation, Rs171bn was due to inefficiency, Rs119bn due to delayed tariff adjustments, Rs93bn due to financial costs and Rs82bn in unbudgeted subsidies.

The plan the government has signed aims to bring the rate of fresh accumulation down from this level to Rs50bn to Rs75bn by 2023. There are multiple ways in which this will be done, but primarily it seems the plan aims to bring about greater flexibility, and more rapid tariff adjustments.

One of the key planks of the plan is to amend the legislation that created the power sector regulator — the National Electric Power Regulatory Authority — and give it the power to adjustment tariffs every quarter, and even more importantly, the power to also notify these tariffs. Currently, the tariff is determined by Nepra but notified into force by the federal government, which is where tariff adjustment delays come in as the government is usually reluctant to follow Nepra’s advice because of the adverse political fallout it brings.

But now, the government has agreed to surrender this power to notify tariffs, and is committed to introducing the legislative amendments in the National Assembly before the end of this month. The process can be delayed for a few more months, but sooner or later, it will have to happen and if successful, it will be a significant step in strengthening regulatory power. We shall see in due course how well the government can live with this decision.

The danger now is if the government fails to control power distribution company inefficiency, which is the leading driver of the circular debt, and succeeds in creating an empowered regulator with sweeping powers to determine and notify tariffs on a quarterly basis. This combination is dangerous because then we will have an endless upward spiral in power tariffs, as the staff of distribution companies also becomes complacent and comfortable in the knowledge that whatever recoveries they do not make will be paid for anyway by those who pay their bills.

There are 10 power distribution companies in Pakistan, and the top underperformers among them are the Peshawar, Hyderabad, Sukkur and Quetta electric supply companies, in that order. These four top the list in terms of high losses and low recoveries. No surprise that these are also the companies operating in places where the government’s writ itself is weakly felt.

Between them, the power distribution companies lose between 20pc to 40pc of the energy they receive from the national grid. Improving the performance of the distribution companies is critical if the circular debt is to be addressed in a way that does not burden those who faithfully pay their bills. But that is the high road to take, the more difficult one.

The writer is a member of staff.

khurram.husain@gmail.com

Twitter: @khurramhusain

Published in Dawn, December 26th, 2019