Invoking sovereign guarantees

A desperate financial position of the Independent Power Producers (IPPs) seem to have finally forced them to take the ultimate step of invoking government guarantees to recover their receivables from the government and avert closures. In a bid to overcome their financial crunch, as many as nine IPPs having a combined capacity of about 1900 megawatts have joined hands to serve notices on the state-owned Central Purchasing Power Agency (CPPA) over the authorities' failure to clear dues amounting to Rs 31 billion.
The authorities now have 30 days to pay the dues, otherwise the guarantees would be encashed. Painting a bleak scenario of the conditions prevailing in the power sector, former Federal Secretary Abdullah Yousuf, who now heads an advisory council for 29 IPPs, says that even if the government paid Rs 31 billion within the mandatory 30-day notice period to avoid the embarrassment of seeing the guarantees being invoked, at least four of the IPPs with power generation capacity of 900 MW will stop their operations on August 28 and could even terminate their contracts. Banks are also no longer prepared to extend working capital facility to the IPPs because the recovery of only Rs 28 billion against the billing of Rs 56 billion to Pepco has badly affected the IPPs' financial position and the government has "already defaulted" on about Rs 40 billion in payment to the banking sector on account of interest payment on the liabilities of Rs 301 billion assumed from the Wapda companies two years ago. Total outstanding amount of IPPs against Pepco at present is Rs 211 billion, out of which Rs 130 billion is owed to Hubco and Kapco while Rs 81 billion is payable to the other IPPs. The PSO, which has been supplying oil to Hubco and Kapco on credit was also facing financial hardships and its LCs could be cancelled because of non-payment to banks on the maturity dates.
Tracing the history of the problem, Abdullah Yousuf explains that in the beginning the fuel mix for the power sector was 70 percent hydel and 30 percent thermal but over the years, the equation has reversed and now the fuel mix is exactly the opposite. Despite successive increases in the price of electricity over the years, there is still a cost differential of almost Rs 2/KWh, which the government is supposed to pay as subsidy. This translated into a total subsidy of Rs 190 billion as against the allocation of Rs 81 billion for the purpose in the budget. The saddest part is that the government has invested more than one trillion rupees in the last three years in the power sector, not for asset expansion but for non-productive financing of cash deficits. A visibly frustrated Abdullah Yousuf discloses that the IPPs have also not heard anything about the Rs 25 billion that the Prime Minister has reportedly ordered to be released. Invoking sovereign guarantees has international implications and the stakeholders are getting anxious to find out the worth of the government paper. The IPPs have highlighted the issue at every level - from the Finance Ministry to various committees. They have also raised the issue with the Prime Minister - but there is nobody to take charge of the situation. "If you have in-house problems, resolve them. Why are you piling things up? The government does not have a policy and we don't see things coming through," according to an embittered Yousuf.
We believe that nobody in the government can claim that the above perennial problem has emerged suddenly or the authorities lack the ability to foresee the inevitability of this ugly development which has sullied the credibility of the government of Pakistan among investors. In fact, the authorities had been warned a number of times to desist from the practice of providing sovereign guarantees to attract investors into financially risky sectors and accumulating contingent liabilities beyond their capacity to pay by the IMF and other institutions but no serious attention was paid to such a sane advice. There is no doubt that the energy sector had to be given all sorts of incentives because of its critical importance in the economy but the cost of these incentives should have then either been accounted for in the budget or the energy sector should have been managed in a way so as to avoid the possibility of resorting to the extreme action of invoking the guarantees by the IPPs.
The most disturbing aspect is that even if the government now finds a way to clear the past liabilities, it has no plans to avoid the problem in future by providing enough fiscal space in the budget or removing the cost differential of about Rs 2/KWh between production and distribution of electricity, with the result that liabilities would continue to pile up, forcing the IPPs again and again to resort to this unsavoury measure. Obviously, such a madness would ruin the credibility of the government further and scare away investors who usually don't have the time and inclination to indulge in such unproductive disputes.
The banks' reluctance to pump in more money to run the perpetually unprofitable IPPs is also understandable. Obviously, banks have to make provisions for bad loans as prescribed by the State Bank which affects their profitability and the capacity to expand their credit activities further. We are worried that the government guarantees provided in other sectors have also a good chance of meeting the same fate unless some bold measures are not taken to avoid such a distressing situation. However, the record of the government in this particular area also does not inspire the confidence that it is aware of the gravity of the situation and prepared to take the necessary steps.
The experience of IPPs in this respect is undoubtedly despairing and full of gloom. They had to knock at every door and go from pillar to post to urge upon the authorities to realise the seriousness of the matter, but no one was prepared to take charge and resolve the issue that could have very serious implications for the economy of the country. It is not only an indication of the financial mismanagement but also a signal that nobody at the top is even prepared to assume the responsibility of setting the house in order. We can only pray and hope that good sense prevails in the coming weeks and months and the issue is given the importance that it deserves to pull the country out of this unsustainable situation. In the meantime, the minimum the government should do is to stop the provision of sovereign guarantees from now onwards, except in profoundly exceptional circumstances and let the investors plan their future undertakings purely on commercial considerations in order to reduce the level of quasi-fiscal commitments.