ISLAMABAD: The federal government has assured the International Monetary Fund (IMF) that it will further increase power base tariff by Rs 1.39 per unit from June 1, 2021 in addition to quarterly and monthly adjustments while acknowledging that adjustments of energy tariffs brought them closer to cost recovery.
This was disclosed in the second to fifth staff reviews under the extended fund facility arrangement and request for re-phasing of access uploaded on the IMF website Thursday.
To strike a balance between achieving cost recovery and softening the social and economic impact of Covid-19, the Cabinet approved a timetable for the outstanding power price adjustments, which includes FY 2021 Annual Rebasing (AR, estimated as a Rs 3.34 kWh hike in the base tariff) and quarterly tariff adjustments (QTAs, estimated at Rs 1.63 per kWh to catch up with past deferrals). The government notified the first-step AR of (i) Rs 1.95 per kWh in January 2021; (ii) completed the Q2–Q3 FY 2020 QTAs of Rs 1.63 per kWh in December 2020 (end-January 2020 Structural Benchmark); and (iii) implemented a first tariff restructuring in March 2021. The adjusted tariff now recovers about 90 percent of the power cost (excluding subsidies).
A second-step AR is due in June (new June 1, 2021 SB) and the Q4 FY 2020 QTA in September (new end-September 2021 SB). The Q1 FY 2021 QTA falls in April 2021 and is expected to be timely implemented under the automaticity of the amended Nepra Act.
The government stated that to mitigate the impact on the consumer and economic recovery in the context of Covid-19, energy subsidy reform steps are being undertaken aimed at reducing the regressive structure of the tariff structure, which include a more expanded definition of the lifeline tariff as a relief for the vulnerable and the determination of the subsidized tariff slab based on households’ maximum usage from the previous 12-month (rather than monthly) consumption. Furthermore, the government launched a public outreach campaign to explain the reform need and strategy to consumers. By end-May 2021, the government has pledged to reduce CPPA-G payables to power producers through a payment of up to Rs 180 billion with no more than one-third in cash and the remainder in debt instruments.
The Fund noted that over the past decade, an unsustainable stock of arrears (circular debt) has emerged, that affects the entire power-gas/petroleum chain and weighs on the financial sector, budget, and real economy. Sectoral viability eroded further during CY 2020 as the authorities delayed price adjustments, deferred payments, and granted temporary subsidies in response to the Covid-19 pandemic, economic slowdown, and concerns about inflation.
The stock of arrears surged to 5.2 percent of GDP at end-FY 2020. This represents a 1.3 percent of GDP increase in the year and largely exceeds the 2019 IFI-supported Circular Debt Management Plan (CDMP), which was part of the reform agenda underpinning the first Extended Finance Facility (EFF) review (December 2019). The Covid-19 shock directly caused a loss of about 0.3 percent of GDP to the distribution companies (Discos), arising from payment deferrals and a change in the consumer mix (from high-tariff industry to low-tariff domestic consumers). Beyond this, other drivers include: (i) delays in updating tariffs; (ii) unpaid subsidies; and (iii) Discos’ usual operational inefficiencies. With the Covid-crisis and some measures lasting into FY 2021 and despite the partial collection of the deferred payments, an additional 0.4 percent of GDP in new arrears was accumulated until end-December 2020.
The stock of arrears grew by 0.1 percent of GDP to 0.5 percent of GDP in FY 2020, steadily fuelled by high unaccounted for gas losses (UFG), often delayed sales price adjustments, uncovered subsidies (especially for export and zero-rated industry), and collection shortfalls. The stock is projected to rise by an additional 0.1 percent of GDP by end-FY 2021, driven by a higher cost-revenue mismatch as more liquefied natural gas (LNG) has recently been diverted from the high-price power sector to low-price domestic users.
Each month of delaying an adjustment of PRe 1 per kWh adds about PRs 8½ billion to the stock of arrears. This includes PRs 23 billion for the time-bound new industrial support package and zero-rated industrial rebate.
The Fund argued that turning the energy sector around requires strong and sustained reforms and while some recent steps (including tariff adjustments and renegotiated IPP contracts) have helped tackle rising arrears, making a dent requires “steadfast implementation of a comprehensive reform strategy”.
According to the Fund, “the authorities remain committed to an ambitious and sustained decline in the accumulation of power sector arrears,” and to this effect, they prepared—in close consultation with the World Bank, Asian Development Bank (ADB), and IMF staff—an updated CDMP, which was approved by the Cabinet in March 2021 as prior action. The CDMP incorporates a detailed action plan, including the short- and medium-term measures. To underpin implementation, the Ministries of Finance and Energy introduced a monthly monitoring scheme. Enacting Nepra Act amendments pledged by Pakistan was adopted by parliament in March 2021 (prior action); the amendments were designed to ensure the automaticity of quarterly tariff adjustments (QTAs) and reintroduced the option to levy surcharges if necessary. The Pakistan authorities recognized that existing subsidies—covering 93 percent of domestic users —represent a heavy budgetary burden and necessitate high tariffs for a narrow group of unsubsidized consumers. Thus, they have embarked on a reform path, supported by World Bank assistance, to improve the fairness and efficiency of the system. As a first step, the authorities started to reduce regressivity and retarget cross-subsidies by restructuring the tariff system in March 2021 (PA subpart) through an adjusted eligibility criterion for the subsidized slabs (based on maximum usage in the previous 12 months) and an expansion of the lifeline tariff for small consumers. They plan to finalize this cross-subsidy reform in June, and ahead of the FY 2022 budget (new end-June 2021 SB). Thereafter, they agreed to shift their efforts to rationalizing subsidies by improving targeting, including to households and the agricultural sector, while protecting the most vulnerable. This includes households up to 300 kWh per month, the agricultural sector and exporters.
“More than 45 private IPPs signed formal agreements on renegotiated PPA terms that will result in cost savings of about 1.8 percent of GDP over the next two decades of remaining life of these IPPs. This group includes IPPs under the pre-1994/1994/2002/and renewable energy 2006 policies.
“In particular, the agreements will reduce capacity payments by lowering—and converting into domestic currency—the guaranteed return on equity and sharing excess returns on operational and maintenance expenses from contractual efficiencies. In return, the government agreed to settle outstanding arrears to these IPPs, of which it scheduled to pay two fifth by end-May 2021 and the remainder for August 2021. In this vein, the stock of CPPA-G payables to power producers will decline through a payment of up to Rs 180 billion by end-May 2021 (new SB for end-May 2021). The authorities are also actively seeking similar renegotiations with other groups of power producers (including the state-owned).
On other medium-term reforms, a range of ongoing reforms seek to gradually (i) reduce commercial and technical losses, power generation costs, and greenhouse gas (GHG) emissions; (ii) improve governance; and (iii) introduce competition. Staff stressed the need for steadfast progress and addressing capacity constraints with international partners’ assistance, especially once the Covid-19 situation allows unhindered field work again.
“Key measures comprise: (i) boosting antitheft and collection efforts; (ii) closing old inefficient generation companies (GENCOs); (iii) expanding cheaper and cleaner energy generation as per the recently approved Alternative and Renewable Energy (ARE) Policy; (iv) updating generation and transmission infrastructure; (v) fostering Discos governance, also to prepare their phased commercialization as per the recent triage; and (vi) making the wholesale power market competitive with multiple buyers and sellers through the establishment of a Competitive Trading Bilateral Contract Market (CTBCM).
The IMF Staff noted that addressing structural deficiencies in the energy sector is key to ensuring its financial viability. “While recent measures go into the right direction, staff reiterated the need to rigorously follow through with the comprehensive IFI-supported Circular Debt Management Plan (CDMP) given the power sector’s soaring circular debt level and the repercussions on the financial sector, budget, and real economy. The CDMP aims at financial viability through management improvements, cost reductions, and adjustments in tariffs; and through improvements in the targeting of subsidies to provide adequate support to the most vulnerable and to attenuate social and sectoral impacts,” according to the IMF.
The IMF further stated that “the stock of publicly guaranteed PHPL arrears reached about 2.2 percent of GDP at end-December 2020. Staff cautioned against the repeated use of guarantees out of concerns about fiscal risks and debt sustainability. The authorities agreed and have devised a ten-year plan for gradually absorbing costly PHPL debt into cheaper central government debt, which would lower debt servicing costs. They, however, agreed with IMF staff that implementation will depend on adequate budget space and implementation progress of the CDMP. For now, they will only assume an amount of up to 0.2 percent of GDP this FY. Moreover, the authorities also confirmed that they will use several proceeds to reduce the circular debt stock, including privatization proceeds from power sector assets and recoveries from the outstanding stock of receivables.
“During talks, Pakistani authorities informed the Staff, that during 2020, they introduced policies aimed at providing relief to power sector consumers from the economic slowdown, rising inflation, and, more importantly, from the impact of the Covid-19 shock. Among these measures, the government (i) paused the adjustments of tariffs for monthly fuel and quarterly capacity payments since January 2020, including the Q2 FY 2020 adjustment (end-January 2020 SB) ; and (ii) introduced payment deferrals beginning in March to provide relief to low-end consumers. These policies, together with a significant decline in consumer demand from the Covid-related containment measures, contributed to a significant accumulation of arrears, erasing the gains achieved in improving sector performance through the implementation of the circular debt reduction plan (CDRP). As a result, Rs 538 billion of arrears were accumulated during FY 2020, significantly higher than projected under the Circular Debt Management Plan (CDMP) and bringing the total stock of arrears to Rs 2.150 trillion at end-June 2020. An additional, Rs 102 billion were accumulated during Q1 FY 2021 and Rs 50 billion during Q2 FY 2021.
“The Cabinet approved an updated CDMP in March 2021 (Prior Action – PA – for completion of the review) that reflects the intense collaboration with the technical experts from the World Bank and Asian Development Bank (ADB) in particular: (i) the impact of the timetable for determined but not yet notified electricity price adjustments adopted by cabinet, implementation of the first-stage AR, notification of the FY 2020 Q4 QTA by September 2021 (new end-September 2021 SB), and amendments to the Nepra Act; (ii) an alignment of the required subsidies in the FY 2021 budget; and (iii) a decision on the budgeted subsidies for FY 2022. The CDMP remains ambitious in the envisaged measures to deliver a sustained decline in the accumulation of power sector arrears. Moreover, the CDMP incorporates savings that are envisaged in the latter part of the plan from measures to reduce transmission and distribution losses and the cost of electricity generation (such as the coming-on-stream of cheaper renewable energy production, impact of renegotiated power purchasing arrangements (PPAs), and improvements in transmission and distribution losses)”.
The authorities assured the Fund that “going forward, they will take additional measures that are crucial for halting the accumulation of arrears. While the enactment of the Nepra Act amendments will ensure the automaticity of QTAs (beyond the already automatic monthly fuel price adjustments, FPAs), the government will ensure that it follows through on time with the remaining AR step-increase by June 1, 2021. The authorities also assured that they will also finalize the cross-subsidy reform, which will underpin a better targeting of energy subsidies in the FY 2022 budget (amongst others through the introduction of more tariff slabs for large consumers) (new end-June 2021 Structural Benchmark – SB). At the same time, the authorities will renew public awareness campaign.
“Preserving the principle embedded in the CDMP of automaticity of tariff adjustments and in line with the plan’s declining path of accumulation of new arrears, Pakistan authorities said that they are streamlining the process of power tariff adjustments to increase its predictability. The new tariff adjustment plan, designed in consultation with international partners, will consolidate tariff adjustments to significantly reduce the number of end consumer tariff adjustments in FY 2022 while delivering the required revenue for the system.
“In particular, the fuel price adjustment, the quarterly adjustment for capacity payments and the annual rebasing of tariffs will continue to take place, but their timing will be adjusted to alleviate consumers from the impact of continued tariff adjustments.
“Crucially, the government will ensure that the consolidation of tariff adjustments will not generate any new accumulation of power sector arrears. The authorities said that they recognize that the existing system of subsidies, covering 93 percent of domestic users, represents a significant budgetary drain and, through cross-subsidies, implies elevated tariffs for the narrow group of unsubsidized users For the FY 2022 budget and based on the first steps to redesign the tariff structure in FY 2021 , the government plans to finalize, with the support of the World Bank, a comprehensive subsidy reform that covers a restructuring of the tariff and measures and improves targeting (including to households and the agricultural sector), while protecting the most vulnerable.
Pakistan authorities have initiated the process of appointing board members and CEOs in all Discos under competitive and transparent procedures. Moreover, the government is exploring options for their phased privatization.
“The stock of power sector arrears held by the Power Holding Private Limited (PHPL) stands at over Rs 1 trillion billion (about 2.2 percent of GDP) as of end-December 2020, representing a significant quasi-fiscal risk. The government continues to work with international partners on the design of a strategy to settle the stock of arrears in PHPL, while limiting the impact on government finances and subject to adequate progress implementing CDMP. In this context, the Economic Coordination Committee (ECC) has issued a notification allowing for the conversion of PHPL debt into public debt over a 10-year period. An initial Rs 25.5 billion was converted in December 2020 and another Rs 47 billion will be cleared until the end of FY 2021—with subsequent transfers continuing to take place under a semi-annual schedule and seeking to transfer the most expensive debt first and subject to satisfactory implementation of the revised CDMP. As part of this strategy, the government also raised Rs 200 billion through a Sukuk in May 2020, issued with government guarantee, to transfer costly Central Power Purchase Agency (CPPA) payables to independent power producers (IPPs) into the PHPL”.