Circular Debt: The Vicious Cycle

The unprecedented tale of Pakistan’s power sector has been a tale of institutional weaknesses, weak governance and a lack of financial sustainability. The result has been decades of power outages and expensive electricity thanks to the incompetent corporate governance and implausible financial management in country’s power companies. This has led to a chronic shortfall between inflows and outflows, which are commonly known as circular debt.

The developing economies are facing issues due to non-natural energy crises. It is the evidence of the fact that there are flaws and inconsistencies on the part of public value agents in keeping pace with the demand-supply requirements of power services. This inability to manage the public’s needs, a shortage of power generation from the back-end, and technical as well as political problems give rise to a vicious cycle of circular debt. The debt is being accumulated at the cost of the state’s social and economic stability. This implies that circular debt is a wider problem of public value creation, which must be addressed through a concerted and joint effort of public value agents.

As of January 2021, the total circular debt of Pakistan is ₨2,306 billion. As per Federal government, the power sector’s circular debt went past Rs2.306 trillion as of Nov 30, 2020, up by Rs156 billion over the first five months of the last fiscal year, at a rate of Rs31.2bn per month. The bulk share of the increase in circular debt is the poor governance in the public sector itself. The Rs156bn increase in circular debt included the non-payment of budgeted and unbudgeted subsidy, delayed payments on account of interest to independent power producers (IPPs), other mark-ups, pending price adjustment on account of quarterly and monthly adjustments and non-payments by K-Electric.

The causes of the circular debt can be attributed to a failure of public value co-creation: the cumulative effect of administrative, political, social and economic failures to bridge the gap between demand and supply gap. Specific elements that comprise the problem includes are:

  1. Transmission & Distribution losses
  2. Discrepancies in the tariff rates
  3. Inefficient regulatory framework
  4. Federal-Provincial frictions
  5. Overly paid incentives for Independent Power Producers

This incapacity at the part of national stakeholders not only affects the efficiency level of the whole supply chain but also disrupts household-level consumption and market productivity. It is essential to address the public value destruction of circular debt as a priority if we are to keep pace on national development projects and on international obligations. Remedying the public value problem of circular debt will offer a chance to utilize operational resources in the best interest of the nation, and this requires putting our house in order by addressing the domestic issues, building institutional capacity and addressing the public grievances.

The amount of cash shortfall within the Central Power Purchasing Agency (CPPA), which it cannot pay to power supply companies. The overdue amount is the result of:

  • Difference between the actual cost and the tariff determined by NEPRA which is the distribution company’s loss over and collections under that allowed by NEPRA.
  • Delayed or non-payment of subsidies by government.
  • 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 Circular Debt.

It is ironic to understand the primary causes for the accumulation of circular debt and to hold accountable the primary defaulters behind its public value destruction. OGDL, Pakistan Petroleum Limited and Pakistan Oil Fields Limited (POL) are the major suppliers of crude oil to the refineries, power generators and power distributors. Similarly, generation companies, Karachi Electric Supply Cooperation and Independent Power Producers are three of the main power generators operating in Pakistan. The power from the power generators is transferred to the national power grid.

End consumers pay tariffs that are often subsidized by the government in the form of power and fuel subsidies. These tariffs are utilized to make payments at different phases of the energy supply. Any impediment in the supply chain would affect the efficiency of the whole system. Contextualizing circular debt in power sector thus requires examining debt amassed by various government departments, DISCOs, IPP’s and the GENCO’s under the control of PEPCO and KESC. By that account, the components of the energy supply chain (as influenced by circular debt) include:

  • payables to IPP’S
  • the gap between electricity being purchased/invoiced by CPPA and the recoveries being made by the DISCOs
  • non-payment of subsidies by the federal government,
  • an archaic transmission and distribution system ridden with power theft and wastages,
  • delay in determination of and imposition of tariff determinations for the power sector that rates of return on investor equities are not only high but are also governed by the principle like rupee-dollar indexation and compounding of interest on delayed payments.

This revenue shortfall cascades through the entire energy supply chain, from electricity generators to fuel suppliers, refiners and producers resulting in the shortage of fuel supply to the public sector thermal generating companies, a reduction in power generated by Independent power producers resulting into the break of power shortages

The power system of Pakistan operates in the form of a chain, and inefficiency in one link of the chain will affect the efficiency level of the whole supply chain. The ultimate outcome of the break in supply chain would be in form of blackouts to which Pakistan has been a victim for more than a decade now. This implies that circular debt is a form of national crisis which calls for a collective responsibility and implementation of a comprehensive national plan of action. The good side of the picture is that timely diagnosis to the disease, its symptoms and scale is available. Having this clear picture in mind, all stakeholders’ needs to take both remedial and precautionary measures to address the shortcomings at their level of operation.

Another incentive available for the policy and power sector is that a framework already exists in the form of 2013 Energy Policy that contains set of reforms addressing each cause of circular debt under a separate set of reforms. All it requires from the government is sincere efforts to implement the framework in its true spirit. On the other hand there is a need of strong integration and coherence between the state’s administration, its institutions and as well as energy and policy sector stakeholders to maximize the efficiency output both for its consumers and market to set on the path of economic stability by keeping pace with the ongoing development projects in the country. Lastly, whatever the framed approach, it should be flexible enough to accommodate the best energy alternates available that too in the best interest of the nation.

In brief, for Pakistan to achieve the goal of sustainable economic growth and poverty reduction, the national stakeholders must focus on tools and means to provide a reliable, efficient, and affordable electricity prices to its consumers. For this purpose the whole value chain of electricity system should be well integrated, receptive and efficient in such a way that system logic arises among different components of the value chain, and public value is thus created. It is difficult to fathom how privatizing management of generation companies can solve the problem if electricity tariffs are not raised in a timely manner and government-managed DISCOs fail to prevent electricity theft or collect their bills regularly and disconnect those not paying their bills i.e. take actions that will ensure cash flows to pay Gencos and suppliers of fuel regularly.

Moreover, with existing IPPs already issuing notices to the government that either their dues be paid or they will wind up their operation, it would not be a good advertisement for any entrepreneur seriously contemplating such an investment, unless he is foolhardy or knows something we don’t — the latter could be a situation in which he will get paid a minimum capacity payment without having to run the plant in the express knowledge that fuel, especially gas, would not be supplied. In other words, we could just end up facilitating a scam, with a government liability being created in the shape of a capacity payment which never had to be discharged while the generation company was owned by Wapda.

So the correct solution is to either immediately privatize the management or ownership of DISCOs (under an appropriate regulatory framework) or hand them over to the provincial governments. The electricity can be supplied at the provincial borders for the provincial governments to purchase it from the Gencos and manage the DISCOs, thereby relieving Islamabad’s overstretched budget from the burden of this seemingly never-ending electricity subsidy.

The author, Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. Mr. Nazir Shaikh can be reached at [email protected]

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