The Ticking Time Bomb of Circular Debt

The loan programme of the International Monetary Fund (IMF) suspended in January remains in limbo as Pakistan’s public debt went past 87 per cent of GDP at the end of 2019-20, up from about 72pc of GDP at the end of 2017-18.

Pakistan direly needs the IMF support to maintain healthy foreign inflows from bilateral and multilateral lenders to keep servicing over $78 billion foreign public debt.

While the circular debt is emerging as one of the key risks to Pakistan’s financial and economic stability, a road map for its resolution through substantial tariff increases and governance improvement has become the biggest challenge to the revival of the $6bn IMF programme stalled since February.

The government now really needs a digital counter installed outside the Pakistan Secretariat to keep an automatic track of the circular debt growing 24/7. The circular debt, commonly known as power sector payables, grew at an average rate of about Rs1.5bn per day (Rs45bn per month) in 2019-20 to reach Rs2.15 trillion.

It increased by Rs87bn in July and August of the current fiscal year to reach almost Rs2.24tr. It would thus be safe to presume the total payables of the power sector at around Rs2.28tr at the end of the first quarter (July-September) of the current fiscal year.

The government wants the revival of the IMF programme before the end of December. For that, it will be taking key decisions and starting their implementation over the next couple of weeks. How political events unfold over the next few days will be the key determinant of the outcome.

In recent weeks, the government has been taking steps to bridge financial gaps in gas and power sectors. Last week, the Economic Coordination Committee (ECC) of the cabinet took decisions for about Rs180bn revenue generation in gas and power sectors. However, the federal cabinet has not endorsed their implementation.

On Sept 29, Special Assistant to Prime Minister (SAPM) Shahzad Qasim briefed the cabinet about the circular debt reduction plan based on the latest data that put the power sector payables at Rs2.24tr at the end of August, up from Rs1.16tr in June 2019 and Rs1.18tr in June 2018. The payables of Rs2.24tr included a little over Rs1tr parked in Power Holding Company and about Rs1.23tr liabilities against power companies. Of this, the biggest chunk of Rs830bn is payable to Independent Power Producers (IPPs) followed by Rs220bn to Wapda, Rs163bn to oil and gas companies and about Rs20bn to National Transmission and Despatch Company (NTDC). In 2019-20, total payables or the circular debt increased by Rs538bn.

On the other hand, the power sector’s receivables also reached about Rs1.44tr by the end of August. Ironically, the biggest portion of about Rs690bn is recoverable from private consumers. It is alarming given the fact that power supply to small consumers is disconnected on non-payment of bills after 45 days. As much as Rs180bn is outstanding against K-Electric while the remaining Rs567bn is payable by the public sector. In 2019-20, these receivables increased by Rs480bn.

Mr Qasim presented a series of book adjustments and recoveries over the next two years until 2022-23 — the terminal year of the current government — but just Rs25-30bn improvement through loss reduction. On top of that, the Power Division had proposed about Rs6 per unit increase in the consumer tariff and about Rs170bn recovery from K-Electric besides incentives for the industry and commerce to encourage higher consumption.

On Sept 30, the ECC approved an increase of about 17pc in the electricity tariff and 14pc in the gas tariff to generate about Rs180bn for power and gas companies. This will include about Rs130bn additional revenue to power companies, about Rs22bn to gas companies and about Rs27bn additional sales tax to the Federal Board of Revenue. Mr Qasim was removed from the position of SAPM the very next day i.e. Oct 1.

The cabinet, which met again on Oct 6, deferred the implementation of new power rates cleared by the ECC. On the other hand, the IMF team is insisting on the implementation of ECC decisions on energy prices as a starting point. After setting aside the subsidy element, the required increase in the power tariff is around 32 paisa per unit for residential consumers with monthly consumption of up to 200 units.

Other consumers will not feel the pinch of the increase given the fact that an earlier time-bound increase in the tariff came to an end on Sept 30 and will be replaced by the new charge.

The build-up of political activities by a multi-party opposition over rising inflation, deteriorating economic conditions and an allegedly biased accountability process may stop the government from taking tough decisions. It is already under pressure for its inability to introduce longstanding structural reforms in taxation and governance improvements in state-owned entities and the energy sector in almost half of its five-year constitutional term.

The IMF had linked the revival of its programme to progress in reforms on the tax system leading to an increase in tax collection, a clear-cut electricity and gas price adjustment mechanism along with price adjustments, a road map to targeted subsidies and the restructuring of public-sector entities.

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