What is Circular Debt | Causes and Cure

Circular Debt
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What is Circular Debt?

Circular debt, also known as power sector payable, is the cascade of unpaid bills, non-payment of subsidies, and low recoveries where receivables of one component of the power sector become payable for others.

Before studying the causes of rising circular debt, it is pertinent to have a brief overview of the components of the power sector of Pakistan.

Components of the Power Sector

The power sector of Pakistan is mainly divided into two components. The first one is the generation sector with different public-owned or independent power generation companies (GENCOs). The second one is the power distribution sector with public-owned distribution companies (DISCOs).

Transmission and distribution parts of the supply chain of Pakistan’s power sector are exclusively owned, managed, and operated by the public sector whereas the production sector enjoys contributions from both public and private companies.

At the generation level, WAPDA, KESC, Independent Power Producers (IPPs), and Pakistan Atomic Energy Commission are generating electricity from an installed generation capacity of 35,975 MW (Pakistan Economic Survey 2019-20)

Understanding Circular Debt

The problem starts at the level of the power Distribution Companies (DISCOs). The widespread corruption, mismanagement, power theft, and low recoveries result in the accumulation of payables at the level of end consumers. As a result, DISCOs fail to clear their payables to Central Power Purchasing Authority (CPPA) or National Transmission and Despatch Company (NTDC).

Eventually, this vicious cycle of unpaid bills cripples the ability of the government to clear the longstanding dues of the Independent Power Producers (IPPs), public-owned generation companies (GENCOs), and WAPDA.

Resultantly, the power generation sector remains unable to pay for the fuel to their suppliers. Hence, they either reduce the generation of power or shut down their plants completely.

Thus, despite having a surplus installed generation capacity of power/electricity, load shedding and power outages have become a routine. In return, frequent load shedding causes serious disruptions to industrial and commercial activities, thereby hurting the national economy.

Circular Debt Statistics

As per reports, in the fiscal year 2019-20 alone, the circular debt grew at an average rate of PKR 1.5 billion and reached 2.15 trillion at the end of the fiscal year.

A briefing given to the Economic Coordination Committee (ECC) of the cabinet in November 2020 has revealed that the circular debt was accumulated to a whopping level of PKR 2300 billion, out of which the PTI-led coalition government has added PKR 1139 billion in two years.

As of January 2021, according to Dawn Report, the circular debt in Pakistan has reached PKR 2306 trillion.

Causes and Factors Behind Circular Debt

  • Corruption, Mismanagement, and Inefficiency

The first and the biggest reason behind the swelling circular debt and the accumulation of payables is the power theft, inadequate recoveries, and transmission and dispatch losses due to corruption, mismanagement, and inefficiency on the part of almost all government-owned distribution companies.

In the fiscal year 2019-20, power theft and transmission losses stood at 29 percent of total power generation which resulted in an addition of PKR 140 billion in the power sector payables.

Similarly, in 2015, the non-technical line losses, electricity theft, meter tampering, and unpaid bills, caused a loss of $18 billion to the national economy. Almost one-fifth of the electricity generated is lost through poor infrastructure and faulty metering.

In 2017-19, Pakistan suffered a loss to the tune of PKR 53 billion because of corruption and power theft.

Moreover, technical line losses due to poor conductors, weak and dilapidated grid, transmission and distribution infrastructure, low time-to-time maintenance, and resistive losses (losses due to resistance, atmospheric condition, and heat) have reached 20 percent. It has been estimated that if these technical and non-technical losses remain unaddressed and unchecked, Pakistan’s total circular debt may rise to PKR 4 trillion by 2025.

  • The problem at Supply Side

On the supply side i.e. electricity generation, there has been a continuous addition of power plants without consideration to the growth of demand. Under the 2015 Power Policy, which was designed to ensure smooth execution and operation of power projects under CPEC, seven power plants having aggregated power-generation capacity of 8253 MW have already been commissioned. Besides, there are also soon-to-be commissioned plants with an accumulated power capacity of 10,000 MW.

If we suppose that Pakistan’s GDP growth remains 4.5 percent for the next 5 years, Pakistan will have a 3500 MW surplus power supply by the end of 2025. If we predict the demand-supply situation based on IMF or World Bank forecasted GDP growth, Pakistan will continue to have a surplus power supply by 2028. In other words, Pakistan will continue to have an excessive supply for the next 5 to 7 years.

  • The problem at Demand Side

On the demand side too, the situation is worrisome. The major sectors that consume electricity are domestic (46.2 percent), industries (27.7 percent), and agriculture (11.8) percent. Both the domestic and agriculture sectors cannot be expected to show a continuous rise in demand. It is the only industrial sector that must show some capacity enhancement to consuming surplus power. Both owing to expensive and unreliable power, deindustrialization, and growing tendencies on the part of the major industrial units to have power generation units of their own (captive power supply), the power demand has dumped or stagnated.

Thus, increasing supply and decreasing demand have increased the burden on the government to pay for the idle capacity of the IPPs, which is called capacity payment. The capacity payment-linked liabilities of the government have reached the tune of PKR 1 trillion and this is what cripples the power sector of Pakistan.

  • Capacity Payment

It was back in the 1990s when the government was facing financial constraints amidst the growing demand for electricity, the central government decided to bring in private investment in the generation sector of the supply chain.

Resultantly, the government offered generous terms of the power-purchase agreement that included payment to IPPs based on their installed capacity instead of power acquisition and consumption, and payment on the return on equity in dollars rather than in Pak rupees. These agreements, backed by sovereign guarantees, were signed under the Power Policies of 1994, 2002, and 2015.

Thus, bound by these purchase regimes, the current government is finding it increasingly harder to clear the mounting debt of capacity payment charges. The situation has further worsened due to a 30 percent depreciation in Pak rupee value during the last two years, adding PKR186 billion in capacity payment-related charges.

The worsening situation can be gauged from the fact that the government paid PKR900 billion in FY 2019-20 under the head of capacity payment as opposed to 650 billion in the previous financial year.

Thus, the ever-mounting government liabilities have kept the power prices on the higher side despite a notable drop in the fuel cost which has created a serious hurdle in reducing the cost of doing business in Pakistan.

Unless the status quo is broken, it is estimated that capacity charges will be hovering around PKR1.5 trillion in the next two years which, in return, will further deteriorate the crisis of circular debt.

  • High Cost of Production

The high cost of production is another factor responsible for the ballooning circular debt. The most important root cause of the higher cost of electricity is the dependency on imported fuel.

Pakistan’s power generation mix is largely dominated by imported fuel-based power plants that account for almost 46 percent of the total installed capacity. The dependency on imported fuel has created vulnerabilities for Pakistan’s power sector.

Fluctuation in the prices of fossil fuel in the international market and instability in the exchange rate of Pakistan has resulted in the worsening of circular debt issue as both state-owned and independent power producers become unable to timely pay for their longstanding dues to supplying companies, thereby adding further to the circular debt.

Remedial Measures for the Resolution of Circular Debt Issue

  • Improving Management of DISCOs

Improving the management and operation of DISCOs must be the first and foremost pillar of any strategy carved out to curb the circular debt. In this regard, transferring the ownership to the provinces should be contemplated seriously as it will help make the anti-pilferage campaign effective and well-targeted.

Furthermore, the management of these DISCOs should be in the hands of the corporate sector as the privatization of these entities would risk political instability and an exorbitant increase in electricity prices.

Overhauling Transmission and Distribution Infrastructure

Overhauling the dilapidated transmission and distribution infrastructure, synchronization of the frequencies and speed of power plants and transmission and dispatch (T&D) networks, improving the conductivity of the conductors (wires), and institutionalized mechanism for the maintenance of the system can pave the way for minimizing the T&D losses to the acceptable level.

  • Renegotiating Capacity Charges/Payments

Mounting liabilities attributable to capacity charges can be resolved by tackling issues of debt payment and return on equity.

PTI-led government has undertaken the right step in the right direction by renegotiating the terms of agreements with IPPs signed under the Power Policies of 1994 and 2002. As per the details shared by the government, it has succeeded in convincing some IPPs (13 in number) to receive their capacity payment in rupees (albeit at the fixed exchange rate of 148 rupees to dollar indexation) and adhere to a take-and-pay mechanism where the government would pay as per the power acquired and consumed rather the installed capacity of IPPs.

The scope of this negotiation should be enlarged to cover IPPs under the 2015 Power Policy.

  • Shifting from Fossil Fuel to Renewable Resources

Pakistan’s energy mix is unsustainable, both environmentally and financially, as it is dominated by imported fossil fuel-based power generation. This should be rectified as soon as possible.

It is indeed a welcome development that PM Imran Khan has announced while addressing Climate Ambition Summit 2020 that Pakistan has decided not to have thermal power plants anymore. He revealed that Pakistan had already scrapped two thermal power plants having accumulated a capacity of 2600 MW. He further added that 60 percent of Pakistan’s energy would be clean and green by 2030.

A shift to renewable sources of energy would go a long way in ensuring indigenization of power generation and reducing reliance on expensive imported fossil fuels.

Bottom Line

To conclude, the circular debt is a serious stumbling block in the way of sustained growth and development of Pakistan. The above-mentioned reforms can go a long way in overcoming the vicious circle of circular debt.

Note: The information provided in this write-up has been extracted from the JWT Magazine during research on the topic.

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