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IPPs and circular debt: concerns and solutions

Circular debt is one of the biggest challenges Pakistan’s energy sector is facing since 2008-09, which has just crossed the PKR 2.2 trillion mark. As a matter of fact, circular debt is quite a natural phenomenon in the energy sector, which ideally occurs due to timing difference between receipts and payments of various companies within the ecosystem. Since long, circular debt is being associated with high cost of generation and that too with the highreturn on equity (ROE) of investors thus entire focus is on the reduction in profits of the investors that is actually just one component of the circular debt while some of other components are high cost of fuel, transmission and gas pipeline losses, short or no recovery at all from the end consumers and inefficient DISCOs.

Recently, Government of Pakistan (GoP) has signed a number of MOUs with almost all the Independent Power Producers (IPPs) except with public sector IPPs and IPPs under CPEC (China Pakistan Economic Corridor), those will be signed in coming months, as per market news. IPPs are one of the contributors in mounting circular debt therefore, it is important to understand the role of IPPs in this whole vicious cycle.

Third Power Policy was issued in 2002 but IPP sector couldn’t get the required traction from the private sector; hence the Economic Coordination Committee (ECC) of GoP in 2007 decided to offer a huge concession to the local investors by allowing dollar indexation on their local currency equity. This one decision changed the entire dynamics of the power sector for the next 13 years. Interestingly, under 1994 power policy; all the investors were foreigners, no one showed interest in 1998 power policy while all except one were local investors in 2002 power policy and then we saw Chinese, the Middle Eastern and public sector companies invested under 2015 power policy mainly in thermal and hydropower sector. Prime reason for lack of interest by the foreign investors in 1998 and 2002 policies was the investigations of the Accountability Bureau in 1998-2000.

ROE and IRR are two different concepts but these are conveniently being interchanged these days. The question remains how to determine the actual IRR of an IPP as CPPA-G delaysin making the payments consequently IPPs,in some instances, have to repay debt from their available cash or shareholders have to pay under sponsors support agreements to the lenders. Moreover, lenders do not allow them to declare dividends, in case the ratios are not being met. In fact there are the companies that are in operations for 3/4 years now yet unable to declare first dividend and in such a case, IRR of an IPP would be in a single digit let alone 20 plus.

In 2004, Orient Power requested a CAPM based ROE of 14.92 percent, which means it would keep on changing on the basis of variations in the parameters of CAPM. Instead, NEPRA gave a fixed ROE of 15 percent in 2005. Ironically, now the ROE in rupee and US Dollar is being fixed at 17 and 12 percent respectively. Rupee based equity holders will no longer get the dollar indexed returns while ROE of an operating IPP will be frozen at PKR 148. Interestingly, average base dollar rate is PKR 80, which means rupee equity holders will get approx 31 percent return (i.e. 148/80 x 17). While a US Dollar equity holder will only get flat 12 percent, which will obviously be indexed with US Dollar so as to make it 12 percent return. Sector experts are of the view that there should be a level playing field and both local and foreign investor should get the same rate of return while dollar indexation should not be allowed to local investors. In order to avoid controversies and discontent; it is better to calculate ROE by using CAPM rather than using a fixedarbitrary number.

A lot many analysts and retired government officials question the rationale for making capacity payments to the IPPs even when electricity is not being procured from them and countit as a source of circular debt. The reason is very simple; an IPP signs a long term PPA with CPPA-G, a state owned entity whereas it is not allowed to sell power to any other party even if plant is shut down on the request of NPCC, another state owned entity. If revenue stream is not clear then which bank willfund such a multimillion dollar infrastructure project? An IPP is not like a steel mill or a car manufacturing unit or an oil refinery where it would be free to sell its output in the open market. Allowing an IPP to sell to anyone in the market can only help remove the fixed capacity payments. Take-and-pay arrangements with CPPA-G as an off-taker and without the must-run option is a non-starter because of uncertain cash flows. No investor can invest, no bank can finance and no infrastructure project can sustain on these terms.

In Budget 2019-20; the federal government has increased the withholding tax on dividend of an IPP from 7.5 to 15 percent, which is a direct hit on the returns of the investors but surely will increase the government’s tax collection.Since early 2000, sales tax @ 17 percent was imposed on the sale of electricity. It is a pass-through item under the terms of PPA. There is a 17 percent input tax i.e. on fuel procurement and then there is a 17 percent output tax i.e. on the sale of electricity. Power companies can off-set input and output taxes but due to timing difference it is hardly adjusted in full. Similarly, in the good old days, IPPs were asked to pay WPPO and WWF, which are taxes and are pass through items under PPA. In order to meet the tax collection targets; these taxes were imposed without considering that it would increase the cost of the electricity. Government takes into account every single rupee it spends in the calculation of cost of electricity and the same is later claimed by the DISCOs under consumer-end tariff to NEPRA. Therefore, it is a trade-off between presenting higher (indirect) tax collections or reducing the cost of electricity. Moreover, the Government is giving subsidies on electricity, which are basically paid from the tax collections where most of the time, subsidies are misused and deserving couldn’t get the benefits. If higher cost of generation is the cause of circular debt and other economic issues then it is better to remove these taxes at least, resultantly price of electricity will automatically be dropped by a considerable percentage.Over a period, there are various IPPs that have invested heavily in software and equipment for the improvements in efficiency of their power plants, which also increased their profitability. While there are companies that are poorly operated and have higher administrative spending thus have lower profits, which is now a blessing in disguise for them. Moreover, unlike commercial banks which have depositors’ money for lending; multilaterals usually issue Notes for raising funds.These Note holders are usually private equity firms and investment houses where pricing and risk assessments are done differently therefore, trying to bring down the spread (i.e. 4 to 4.5 percent) on the disbursed debt would be difficult and in fact, it can potentially shake the confidence of multilaterals and international investors. Therefore, it can safely be concluded that savings in; ROE by 5 percent, 1 to 2 percent in debt spread and taking upside from O&M improvement would not have a significant monetary impact ona yearly basis but will surely have a psychological effect.


While looking at the circular debt numbers; it is evident that it is mainly driven by the big holes in the system of DISCOs. A DISCO applies for tariff to NEPRA under “Guidelines for determination of consumer end tariff (methodology and process)”, 2015 issued by NEPRA in Jan 2015.A DISCO’s tariff includes “Distribution Margin” which means the component of revenue requirement comprising operations & maintenance cost, return on rate base, depreciation, taxes, other regulatory cost including other income determined or approved by NEPRA for running the distribution business. In typical accounting terms, depreciation is a non-cash item but here it refers to repair and maintenance of the fixed assets. Where, depreciation is calculated by taking percentage of total gross amount of the fixed assetsand fixed assets include a 20 plus years old asset as well. This depreciation cost would probably be one third of the allowed cost, if standards used for assessing the O&M cost of an IPP areapplied here as well. Therefore, it is important to discontinue using straight line depreciation as an alternate to the O&M cost.

For some unknown reasons, DISCOs have taken loans on fixed interest rates and in some cases it is even 15 and 17 percent (source: GEPCO 2018 petition) and interestingly the same is allowed as well. Such financial arrangements cannot be imagined in the IPP sector.

It is important to review the detailed breakdown of circular debt but a large chunk is coming from the state owned enterprises (SOEs). Receivables of one state owned enterprise is payable of another state owned enterprise and that too within the energy sector thus on a consolidated basis, it should be zero at a certain level. Ultimately, the government has to borrow funds to support its enterprises and after rotating money from one enterprise to another, cost always increases, which becomes a part of the circular debt. Therefore, it is better to just write offthe receivables/payables of state owned enterprises on a cut-off date and thereafter make a system where it must not be accumulated.

Following the provisions of Grid Code of June 2005; NTDC has submitted its first ever generation plan to NEPRA for approval in Apr 2020. It is important to note that Grid Code was issued when there was no 2006 RE Policy, even there was no concept of CPPA-G and NPCC was also a part of NTDC hence the entire sector was virtually under NTDC. When CPPA-G was separated from NTDC then ideally grid code should have been amended accordingly. Conceptually under present day roles and responsibilities, it should not be the responsibility of a transmission company to prepare a generation plan instead NTDC should only prepare a transmission plan on the basis of the provided generation planwhere it should provide its input on the evacuation of power thus generation plan be revised accordingly, if required.

Various plans are currently under consideration, e.g. IGCEP, CTBCM, and DISCOs long stop date; but it seems that all are not synchronized. It is evident from the below;

First there would be a competitive regime under CTBCM from Nov 2021 onward with multiple sellers and multiple buyers.

Second already prepared IGCEP will be effective as soon as it is approved by NEPRA and thereafter new projects will only be injected as per the plan where the plan will also determine the technology (wind, solar hydro, coal etc).

Third exclusivity of DISCOs will end in 2022 (20 years from the date of issuance of license) and thereafter, the private sector could also enter into the distribution sector after getting a distribution license.

Above three are self-contradictory. IF anyone can sell power to anyone in the market, then what is the purpose of CTBCM. Ifthere are multiple buyers from Nov 2021 then what is the purpose of IGCEP and If IGCEP is still relevant then how this will fit in when DISCOs will not have the exclusivity. Simply, these are not fully insync.

Restructuring of DISCOs is probably the best solution to ever increasing circular debt. Let exclusivity of DISCOs be expired; split the DISCOs,break the NTDC on district wise basis, allow wheeling arrangements and lastly privatize NTDC. If a strategic asset like PTCL, which was extensively used by the security agencies can be privatized with proper controls then why not NTDC. The IPP sector is thoroughly scrutinized and now it’s time to evaluate other components of the circular debt as well.

(Views expressed here are personal views of Arooj Asghar – Islamabad based consultant)

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