Addition of over Rs500bn to power circular debt: WB holds previous govt, Nepra responsible

muhammadhafeezmalik · May 6, 2022

Addition of over Rs500bn to power circular debt: WB holds previous govt, Nepra responsible

According to World Bank, power sector has long been a drag on the economy, providing unreliable service and contributing to large fiscal deficits

The World Bank has held the previous government and National Electric Power Regulatory Authority (Nepra) responsible for addition of more than Rs 500 billion to the Circular Debt (CD) in FY 2021-22 as many prior actions were not taken on time.

“There have been delays in annual tariff rebasing and Quarterly Adjustments (QTA) which were included in five Priority Actions (PA5), resulting in increased CD. Half of the increased CD compared to earlier projections (which were close to CDMP target) is attributable to exogenous factors (ie, inflation and Rupee depreciation), rest is because of delayed tariffs.

Further delays in tariff adjustments and Karachi Electric (KE) settlement risk CD flow for FY22 to reach PKR 350 billion. Pending the end March 2022 CD projections by Power Division, we expect the projected CD flow to be actually much larger by end FY22, possibly more than Rs 500 billion,” said Najy Benhassine, Country Director World Bank in a letter to the top government authorities including newly appointed Minister for Power, Engineer Khurram Dastgir Khan.

The World Bank Group has been supporting Pakistan’s energy sector for a long time and is committed to continue to support the development of the sector through a portfolio of investments in Renewable Energy, including in Pakistan’s major hydropower plants, Tarbela and Dasu, as well as projects to improve transmission and distribution efficiency.

PM calls for urgent power sector reforms

The ambitious sector reforms are supported by a series of development policy operations, the Program for Affordable and Clean Energy (PACE), the first of which was approved by the World Bank Board of Directors last fiscal year. The second, PACE II, is currently under preparation, and includes key policy actions to put the sector on a sustainable path and reduce its circular debt.

According to the Bank, power sector has long been a drag on the economy, providing unreliable service and contributing to large fiscal deficits. The power sector fiscal deficit that is not covered by subsidies is accumulated as Circular Debt (CD), adding to the government’s liabilities and having a detrimental effect on the country’s macro stability.

The power sector reforms adopted by the Government are designed to target the sector’s fiscal deficit in a comprehensive way by tackling issues such as cost of generation, better targeting of subsidies, adjustment of consumer tariffs and efficiency improvement in the distribution sector through private sector participation.

Commenting on where do reforms and the circular debt stand, the World Bank said that good progress was made in these areas last year (FY21) which resulted in a decline in the CD flow (reversing the FY17-20 trend for the first time) to Rs 297 billion from Rs 538 billion a year before (FY20). However, progress has stalled, which is expected to result in a significantly higher CD flow for FY22.

“There is now the need for urgent action to contain the accumulation of CD flow and bring the energy sector reform program back on track,” the Bank added.

Talking about priority policy actions and decisions, the World Bank maintained that notification by the Government of phase two of the subsidy rationalization, should be undertaken as soon as possible and the relief package launched in February should be ended or quickly phased out.

The purpose of the rationalization is to allow for the subsidies to domestic consumers to be better targeted, ensuring that they only benefit the most vulnerable consumers. In FY20, 97% of domestic consumers benefitted from subsidies, which included non-poor and those with vested interests-this lack of targeting creates unnecessary additional financial burden for the Government.

“The current relief package has further distorted this scheme, making subsidies even more regressive, and undermining the efforts made so far,” the Bank observed.

Sharing views on annual tariff determination, the Bank stated that the FY22 annual tariff determination, which is awaiting updated investment plans from Discos, should be completed by NEPRA as soon as possible. This step was expected to take place in February 2022 and should now be taken as soon as possible as any further delay will have direct negative impact on the CD flow. Timely tariff adjustments to compensate for changes in generation, transmission and distribution costs are fundamental to avoiding circular debt build-up.

The Bank has proposed that the Government should engage with the group of Independent Power Producers (IPPs) where cost reductions have not yet been negotiated, namely those with international DFL financing and Government-to-Government financing, and seek to negotiate lower power generation costs. High generation cost is one of the core factors contributing to circular debt.

Capacity charges (CC) account for 60% of the cost of power. Government plants account for 50% of power cost, with the remaining from IPPs. Last year, the Government undertook measures to reduce CC for the government plants, and it concluded negotiations with 32 IPPs (primarily domestic).

The Bank maintained that reducing CC for the remaining IPPs is thus important to further reduce power cost and reach equal burden-sharing.

The World Bank has recommended that the Privatization Commission should finalize the ongoing discussions with IFC and USAID on the financial advisory services that will facilitate introduction of private sector participation in the Discos as per the Government’s approved roadmap last year. This is a critical step towards improvement in distribution sector efficiency, and reducing CD flow. Disco losses currently stand at 17% of power generated, compared to the Nepra benchmark of 13.5 %.

The World Bank further stated that Cabinet approval to allow for the establishment of market operator and system operator as per the Competitive Trading Bilateral Contract Market (CTBCMI) design should be completed as soon as possible. This will allow a competitive wholesale market to be launched.

The introduction of private sector participation in Discos, and the opening of the wholesale market for bulk consumers, will incentivize Discos to improve performance and reduce technical and commercial fosses. This will directly reduce circular debt and reduce electricity costs for consumers.

The World Bank also recommended that Neeca board should approve the Energy Efficiency Policy as soon as possible. It can then be approved by Cabinet and then the CCI. The National Electricity Plan, should also be approved by Cabinet as soon as possible.

The EE Policy is important as it will revive the focus on Energy Efficiency. Energy efficiency is critical in managing the cost to Government of electricity supply. More efficient appliances, building codes and materials, as well as fuel efficiencies will lower peak demand (and thus the use of expensive fossil fuel) and will further reduce electricity costs for consumers.

The National Electricity Plan will improve upon the current practice of direct contracting and cost-plus tariffs, which historically led to high power costs, and through competition will decrease power costs over time.

The Bank also observed that the PM’s relief package will reverse the path in the subsidy reform by making the subsidies even more regressive compared to pre-reform level. As a result, the subsidies to the non-protected domestic consumer will increase by 58 percent in FY22, compared to the reform path (or 26 percent increase compared to FY21 level).