Trapped in a Maze of Cross-Subsidies

The Economic Coordination Committee (ECC) of the cabinet decided in a recent meeting to begin the process for the rationalisation of subsidies — a long-time demand of global lending agencies led by the International Monetary Fund (IMF).

The decision was based on a presentation made by Dr Waqar Masood Khan, who headed a Subsidy Cell in the Ministry of Finance before being elevated as special assistant to the prime minister on revenue. Dr Khan is reported to have estimated that the action plan proposed for the first phase of subsidy rationalisation plan covering energy, national food security and national savings could provide a benefit of Rs488 billion per annum.

The ECC led by Finance Minister Dr Abdul Hafeez Shaikh appreciated the plan and asked that ministries concerned should come up with proper summaries as required under the 1973 rules of business for approval and implementation of policy actions.

The biggest step in terms of financial impact pertains to the “adoption of national average electricity tariff by consolidating the accounts of distribution companies (Discos), minimising electricity pricing slabs and subsidy to be distinctly identified on bills, which will save Rs200bn”.

For this, the Central Power Purchasing Agency (CPPA) or defunct Pakistan Electric Power Company (Pepco) would be directed to file a single tariff application to the National Electric Power Regulatory Authority (Nepra) based on consolidated accounts of all Discos. At present, all Discos file their separate tariff petitions and their separate tariffs are determined by Nepra. But then a uniform rate is applied to all Discos, including privatised K-Electric.

This would be done through the enforcement of Section 31(4) of Nepra Amendment Act 2017 that allows a uniform tariff for companies owned by a single owner – the federal government in this case. The government would then use surcharges as the weapon of choice.

This is practically anti-climax to the power sector reforms currently in progress. It is not only unfair to honest consumers but also counter-productive. The federal government and Nepra are already in the process of implementing Competitive Trading Bilateral Contract Market (CTBCM) that has to ultimately generate competition among market players to the benefit of consumers in terms of both the quality of service and pricing.

But if the accounts of poorly managed and efficient Discos are treated as one and the tariff has to continue being uniform across the country, then there is no point in spending time and energy on CTBCM. The proposal is also counter-productive in the sense that it leaves no attraction for efficient Discos to further improve or remain efficient and offers no incentive for the poor and loss-making Discos to reduce losses and become efficient.

The uniform tariff is the main source of all inefficiencies the power system has been facing since good companies and honest consumers cross-subsidise bad companies and electricity thieves. Unless the actual cost of power supply reaches every consumer, the power sector cannot improve.

In fact, the repeated build-up of equalisation surcharges or financing cost surcharges to ensure uniform rates has compelled honest consumers to switch to alternate sources — good industrial consumers have set up their own captive plants and residential consumers are shifting to their individual solar systems. This in turn is sparing up existing power capacity that is already surplus and attracting high capacity charges. As a way out, the government will have to stop gas supply for power generation by industries in the near future.

What the government has failed so far to realise is the fact that every tariff increase expands the black-hole in the power system and all efforts to reduce aggregate transmission and commercial losses at 18-19 per cent have failed so far and actually resulted in a higher financial gap.

For example, the system loss of 1pc used to be around Rs6bn a decade ago. It has gone beyond Rs17bn by now. This simply means that a 20pc loss now costs the system about Rs350bn instead of Rs120bn. On top of that, the affordability factor also compels average consumers to try to find short-cuts, including theft.

Moreover, the government has also committed subsidised power rates to the export industry in the short term and then charge a marginal cost for next two years. This will mean the burden of elimination of subsidies to certain slabs will shift to fewer consumers mostly in the middle class already struggling with high inflation and low growth challenges.

The presentation on subsidies showed the cost of all existing, coming due and hidden subsidies and contingent liabilities and transfers at about Rs5.2 trillion (stock) and estimated annual subsidies of about Rs2tr (flow) – almost 4.5pc of GDP and 58pc of the current year’s budget, excluding interest payments. It was explained that large amounts of past investments, loans, guarantees and uncovered borrowings also posed an actual and potential loss to the government in the absence of adequate returns. As such, the total stock of such liabilities and subsidies by the end of 2019-20 was put at Rs.5.2tr, almost one-fourth of the domestic debt.

The first phase of the action plan envisages targeting electricity bill payments to Ehsaas beneficiaries only to be estimated after a survey, starting with a pilot project in Islamabad Electric Supply Company and ultimately expanding to all Discos including K-Electric. The Industrial Support Package of Rs3 per unit at present and involving a Rs75bn impact would be eliminated with effect from July 1, 2021.

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