Fuel subsidies

The Federal Minister for Water and Power, Syed Naveed Qamar, while on a visit to Kuwait, was reported to have said that the government of Pakistan would be unable to afford fuel subsidies this summer.
The upshot of this statement is the expectation of a steady rise in tariffs and, disturbingly for the productive sector as well as domestic consumers of electricity if the precedence established during the last three years is anything to go by, a rise in price would not necessarily lead to a decline in the hours of load shedding. In short the higher cost of electricity would still leave many a productive unit not operating at optimum capacity that would have repercussions on employment opportunities as well as on the rate of inflation.
Be that as it may, there is ample economic justification for a government to raise tariffs if the objective is to meet the over arching objective of full cost recovery, considered critical for the financial viability of state-operated utility companies. However, most economists are in agreement that four major policy decisions need to be implemented to ensure full cost recovery. One, empowering the management of the utility to ensure it is allowed to take decisions on their financial merit.
In other words the utility must be allowed to cut connections of not only those engaged in theft but also of those government ministries/departments who fail to clear their bills promptly as this involves implicit subsidy. Additionally, the utility's management must be allowed to take personnel decisions in accordance with its financial constraints. Two, reduce transmission losses to international standards. In the case of Pakistan our transmission losses are high and unfortunately, to date, there have been no significant gains in this area.
Three, tariffs based on the full cost recovery principle must include research as well as expansion plans of the utility company thereby ensuring its ability to engage in strengthening its infrastructure through investing in projects that would enhance supply to meet an expected demand surge in a timely fashion. In this country the levies that should be used to further develop the sector are being used to balance the budget. Proof of this is evident from the government's decision to quickly rename the Petroleum Development Levy (PDL) as Petroleum Levy (PL) as the revenue collected under this head was to be targeted not to develop this sadly deficient sector that is the root cause of a decline in our manufacturing potential but to balance the budget.
And lastly what is specific to Pakistan is the inter-circular debt that is attributable to the government's failure to ensure that each sub-sector operating within the energy sector pays off its bills promptly. The result is inability of the generating units to operate at optimum capacity with the major oil importer of this country, Pakistan State Oil, periodically left with no cash to pay for oil imports necessitating the cash-strapped Ministry of Finance to engage in fire-fighting by releasing the minimum possible funds that would enable PSO to pay for oil imports.
Thus Qamar's statement in Kuwait that the government would be unable to continue fuel subsidies in one sense can be qualified as disinformation. The price of oil and products in Pakistan are set by a formula that includes not only petroleum levy but also general sales tax. PL according to the budget for 2010-11 was expected to generate 110 billion rupees - only 16.6 billion rupees less than total subsidies earmarked in the budget, inclusive of 10.8 billion rupees to refineries and 87.3 billion rupees to Wapda and KESC. It is not known how much revenue the government collects from the imposition of sales tax on oil and products.
In its defence the government would argue that a revenue shortfall due to lower collections under the PL (in an attempt not to pass on the entire oil price rise in the international market to domestic consumers) is a form of subsidy which may be defined as not a direct injection into the sector but as a reduction in revenue. Redefining subsidy as a reduction in tax collections is not going to find too many takers.
The government may also maintain that the price of energy is much lower in Pakistan than in neighbouring India as justification for raising rates. However, it is relevant to note an important fact. India is not at the same stage of economic development as Pakistan and comparisons in this regard are no longer appropriate.
Thus India may charge more for energy but what must be borne in mind is that load shedding in India is not for as many hours as in Pakistan accounting for over 6 percent GDP growth rate even during the ongoing global recession. In addition, India is firmly focused on using its indigenous coal reserves as well as development of alternate energy sources like solar as well as wind energy. True that India too has issues with demand-supply gap, cross subsidy, transmission losses and theft/non-payment of bills but it has a vibrant productive sector and its rich pay taxes domestically.