Sukuks to the rescue

The much-awaited Sukuk bond has been finally launched, amid much fanfare. The idea is to help reduce the infamous power sector circular debt. In all fairness, like most such measures in the past, the Sukuk episode is likely to end up being no more than a stopgap measure. And there is good reason to believe for anyone who has followed the power sector affairs of late.

Some perspective will help. The circular debt stockpile had gone out of bounds, having crossed Rs1.6 trillion by the end of January 2019, growing from Rs1.3 trillion just four months ago. The situation demanded action. That is where Sukuk came into play. This definitely gives a breathing space to the entire chain from fuel suppliers to the power producers.

But a breathing space is all what it is. Recall the previous such exercise in the name of clearing the circular debt back in 2013, when nearly Rs500 billion were doled out to clear one-third of the current stock. It took less than 18 months for the circular debt to resurface. Surely, two-fifth of payments for a larger chunk this time around, will not even last as long.

Recall that the government had revised the power tariffs upward last year, in the name of ‘tariff rationalization’. Differential between cost and price of power generated has been one of the core issues. But a closer look at the ‘tariff rationalization’ exercise reveals the subsequent relief in the mini budget to facilitate the industrial and agricultural power usage, is going to cost Rs250 billion more than final tariffs. The allocated amount for power subsidy is close to Rs134 billion only – which does not even account for the domestic sector subsidy.

Pakistan’s fiscal space is very tight and the country is expected to run the highest fiscal deficit in six years. There is no way a billion dollars could be set aside as additional power sector subsidy, at a time when tax revenues have actually fallen in absolute terms.

But some respite will surely come from a much-improved power generation mix, one would say. There is no doubt the power generation fuel mix had improved from being heavily reliant on expensive furnace oil to a more diversified mix. But as the hydel generation drops, furnace oil is back in the mix almost on cue.

To make matters worse, the two relevant ministries of power and petroleum were caught completely off guard in planning fuel imports. The blame game is on, but the casualty in the process, is the fuel cost, which has gone dearer, as more efficient plants high on the merit list, remained idle for two months.

This leads to another tale of inefficiency, that of refineries. Because the refineries in Pakistan have not upgraded themselves, despite decades of protection, they continue to produce furnace oil. And the government, in the end, is left with no option but to procure it, or face a complete shutdown of local oil refineries. The inefficiency here, then leads to the more expensive fuel being used to generate power, at the cost of some of world’s most efficient power units. To top that off, the idle power plants are then paid billions of rupees on a daily basis, irrespective of actual generation, in the name of capacity charges.

Then there is the elephant in the room, the distribution sector, which continues to bleed. Pakistan’s power transmission & distribution (T&D) losses at 18 percent are more than double the global average. Worse still, the losses have actually increased from five years ago. And if this does not sound bad enough, the power regulator has allowed even higher T&D losses for 2019, to be charged in the final tariffs. The T&D losses alone are a drag of almost Rs200 billion every year. The current tariff structure is such that it incentivizes poor performance – and a better performing distribution company ends up sharing the burden.

What is the government doing? Not much. The honeymoon period is well over now, and a concrete energy plan is yet to see the light of the day. The actions so far, indicate a massive lack of coordination between finance, energy and petroleum ministries – which is a recipe for disaster.

Business as usual in the energy sector will not work. All the additional 11,000 MW added in the system in the last four years, could actually become more of a problem than a solution, if the issues are not tackled, soon. Some politically tough decisions may need to be taken, but now is the best time to take them, before it gets too late.

First and foremost, energy pricing needs to reflect the generation cost. The subsidy element needs to go substantially down from where it is today, as fiscal constraints add more pressure on the payment chain in cases of delayed payments from the government. The generation fuel cost must come down – for which the merit order needs to be strictly followed. At the current fuel cost of generation, non payments will rise, and the circular debt will keep mounting.

Thirdly, the distribution sector needs to be privatized. Merely chopping and changing the boards has not worked, and it won’t work, because there is no incentive for the distribution companies to reduce losses. K-Electric is a living example of how privatization changed it from being one of the worst performing to one of the top performing companies in less than ten years. But privatization is not even on the current government’s agenda right now.

Could an IMF programme change things for the better? The IMF does, at times, stress on imposing tough conditions, but does not necessarily push for it. The previous IMF programme is one fine example, where the power sector losses went from bad to worse, the structural issues remained unaddressed, and the best IMF could do was to raise ‘concerns on structural issues in the energy sector’ and the ‘need of deep-rooted reforms’ , without ever making it a precondition for release of funds. In short, the IMF will not clear the mess. The government will have to do it herself. The blueprint is there. It needs political will to be put to work. Or else, Sukuks will keep happening.