ISLAMABAD: The government has committed to the International Monetary fund (IMF) to revise terms of Power Purchase Agreements (PPAs) of Government Power Plants (GPPs) and Independent Power Plants (IPPs) to settle Rs 263 billion earmarked for them in the budget and put a moratorium on new generation capacity sans new transmission infrastructure and to fully utilise existing capacity at peak times.
According to the IMF staff Report for an Extended Arrangement under the Extended Fund Facility of $7 billion for 37 months, the energy sector has become a major point of macro-fiscal risk as Circular Debt (CD) spiked over 2013–21 for power and 2020–23 for gas.
The authorities began to significantly adjust tariffs in line with costs beginning in 2021 (electricity) and early 2023 (gas). This along with sizeable power subsidies (around 1 percent of GDP in FY24) broadly stabilised nominal CD flow in 2023-24. However, large persistent power subsidies are not a viable ongoing tool to plug the sector’s gaps.
Govt approves termination of existing Power Purchase Agreement with five IPPs
The Fund urged the authorities for broad structural reforms aimed at reducing costs and tackling theft, captive power, and inefficiencies in the sector (especially Discos).
The stock of power payment arrears (circular debt, CD) stood at Rs 2,794 billion (2.6 percent of GDP) at end-March 2024, while the stock of gas payment arrears stood at Rs 2,083 billion (2.0 percent of GDP) at end-January 2024. CD has historically been driven by the failure of tariffs to keep pace with prices (although more regular tariff increases over 2023-24 helped to moderate CD flow); inefficient management of distribution and transmission companies and under-collections, and delayed maintenance coupled with weak transmission and distribution infrastructure.
“We see the need for fundamental energy sector reform to reduce our fiscal risks, ensure the viability of the sector and debt sustainability, and build a business environment conducive to dynamic growth.
Our program will keep energy tariffs in line with costs while we implement fundamental reforms to ease price pressures and shore up viability over the medium term,“ the government maintained.
According to the Fund, for the power sector, this requires an annual rebasing notification in full by the Power Ministry at a rate consistent with cost recovery, which occurred on July 14, 2024, along with timely implementation of quarter tariff adjustments and monthly fuel cost adjustments. This, along with the budgeted FY25 power subsidy of Rs1,229 billion (1.0 percent of GDP), would minimize net CD flow.
“Timely energy tariff adjustments under the previous program have helped stabilise energy sector circular debt. Going forward, deep cost-side reforms are critical to securing the sector’s lasting viability and reducing its costs,” the Fund said adding that efforts to ensure cost-recovery in the energy sector continued to dwindle until early 2023, but subsequent tariff adjustments have broadly conformed with staff recommendations by limiting CD growth. Meanwhile, staff advice to undertake broader cost-side reforms and resolve infrastructure issues, even as some first steps have been taken, remains largely unaddressed.
The Fund argued that an unreliable energy supply and high and unpredictable costs negatively impact economic activity and development. Structural inefficiencies (particularly in Discos), guaranteed US$ returns to power producers, and a long-running reluctance to adjust tariffs in line with costs, have led to large losses, accumulation of arrears, and a network of cross-subsidisation among different consumer groups. In addition, inadequate maintenance, declining service, and under-collection lead to the need for ever-higher tariffs.
For the power sector, this requires an annual rebasing notification in full by the Power Ministry at a rate consistent with cost recovery, which occurred on July 14, 2024, along with timely implementation of quarter tariff adjustments and monthly fuel cost adjustments. This, along with the budgeted FY25 power subsidy of Rs 1,229 billion (1.0 percent of GDP), would minimise net CD flow over the course of the fiscal year.
According to the Fund, key reforms to reduce costs and CD focus on improving distribution efficiencies, most notably by accelerating steps to improve distribution company management via private sector participation (end-January 2025 ) include: (i) institutionalising anti-theft procedures to reduce losses; (ii) improving the policy and regulatory framework of the transmission system which has been a key bottleneck; (iii) privatising inefficient generation companies; (iv) improving power plant efficiencies; (iv) completing the transition to a competitive electricity market; and (v) reducing capacity payments by renegotiating power purchase arrangements (which account for approximately 60 percent of generation costs).
The authorities recognise the urgency of implementing cost-reducing reforms. At the same time, they remained committed to implementing scheduled tariff increases, recognising the need to prevent further CD flow. They highlighted the tension inherent in a tariff structure in which certain non-residential consumer categories cross-subsidise lower-slab households and thus face higher input costs, agreeing with staff that these cross-subsidies should be phased out when they can be shifted to direct cash transfers in the medium term (pending fiscal space). They agreed that progressive tariff structures should be maintained until then.
The FY25 budget includes Rs 1,229 billion (1.0 percent of GDP) in power subsidies to address liquidity needs. This, along with tariff adjustments and cost-side reforms, will broadly stabilise the CD stock.
The subsidy will cover (i) the projected tariff differential (Rs 663 billion); (ii) arrears payments of FATA and KE (Rs 174 billion); (iii) agricultural tube-wells (Rs 10 billion); and (iv) CD stock payments to compensate for the projected CD flow via PHPL principal payments (Rs 24 billion) and arrears payments to power producers (Rs 358 billion). The use of any resources allocated above this in the FY25 budget will be decided upon during the fiscal year, with the potential to retire up to an additional Rs 35 billion in CD stock or return these resources back to the Treasury.
In parallel, with the support of the World Bank, the government will continue efforts to reform tube-well subsidies, which primarily benefit large agricultural users, and have not budgeted tube-well subsidies for three provinces for FY25.
More broadly, over the medium term the government aims to eliminate cross-subsidies to households, and replace it with directly-targeted cash transfers for vulnerable households to be provided via BISP.
Pakistani authorities have assured IMF that they are prioritising plans to either privatise or enter into concession arrangements for the private management of nine Discos to improve their performance, efficiency, and governance, lack whereof has been a key driver of power sector CD accumulation and the need for higher tariffs.
Copyright Business Recorder, 2024
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