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September 2, 2014

What is Circular Debt? Problem of Circular Debt in Pakistan

THE term ‘circular debt’ in the power sector is widely understood in the country as representing an issue whose solution has eluded policymakers for the last three years. This article attempts to explain the genesis of the problem and ways to resolve it. Circular debt arises when one party not having adequate cash flows to discharge its obligations to its suppliers withholds payments. When it does so, the problem affects other entities in the supply chain, each of which withholds its payments, resulting in operational difficulties for all service providers in the sector, none of whom are then able to function at full capacity, causing unnecessary loadshedding. The circular debt numbers that get reported in the press tend to be the sum of the receivables of each organisation which ends up exaggerating the amount, simply because of double counting. After all, one party’s payables are the other party’s receivables, and logically these should cancel out when we subtract one from the other. At worst the net amount should be much smaller.
In our case, however, even this net unadjusted amount on June 30, 2011 was in excess of Rs200bn, which this year is growing by Rs95 crore a day! Let’s refer to this outstanding amount as the issue of ‘stock’. To be able to understand what this stock represents and its daily buildup let’s look at a simplified and abridged version of the supply chain which results in electricity being provided in our homes. Refineries provide oil to oil marketing companies. Most of the crude oil is imported and suppliers abroad have to be paid for them to maintain supplies; in their case there can be no debt beyond the terms agreed for the supply of oil.

Circular Dept of Pakistan
The oil marketing companies sell oil to the IPPs or the Wapda-owned electricity generation plants (called Gencos) which produce electricity and sell it to the government-run distribution companies referred to as DISCOs (for example Lesco, Pesco, etc) which provide power to our homes and factories and bill us for this service.
The tariff (price) at which the Gencos sell to the DISCOs and the tariff at which electricity is supplied to us consumers is determined by Nepra,after receiving government approval.
The first problem which results in the receivables not cancelling out payables is when the tariff is unable to meet the costs of its generation and distribution. For instance, if the price of oil goes up internationally and tariffs are not revised upwards to account for this increase, there is an element of subsidy whose cost the government has to pick up.

So one component of what constitutes circular debt is the lower rate at which electricity is being charged to the consumer than the cost of its generation and distribution. By failing to foot this subsidy bill the government builds up the circular debt. The bulk of the issue arising from the failure to revise tariffs upwards on a timely basis has been resolved; the remaining adjustment required on this account is Rs100bn for this year, which also includes the cost of poor governance.

Next, three components, and the most critical ones, which raise costs, and feed the circular debt, are the following:

— The inefficiencies of governmentowned generation and distribution companies, cosy deals struck with providers of rental power plants, overstaffing, free provision of electricity to Wapda employees (this costs other consumers Rs10 crore a day), poor maintenance of plant equipment, obsolete technologies (resulting in technical losses), corruption, all of which simply add to the cost of electricity that consumers are being constrained to bear with equanimity through tariff increases.

— The massive issue of electricity theft — the cases of DISCOs in Hyderabad, Peshawar, Quetta and Fata are now well known; with literally no one paying in Fata.

— Poor collection of electricity bills. Rs90bn alone is due from provincial governments. Powerful private individuals and companies are also defaulters as are those who in collusion with Wapda employees do not pay without being disconnected — Rs120bn is due from private consumers! To summarise, the issues are failures to revise electricity tariffs on a timely basis; prevent electricity theft; and ensure collection of billings speedily and disconnecting those not paying their bills; disconnections will actually also reduce the extent of outages/loadshedding. In other words, the principle issue is that of governance.

So what is the solution? The liabilities in the shape of the inherited ‘stock’ of Rs200bn can be cleared as a one-time effort — even, dare I say it, ‘through printing of money’ (the latter admittedly at the expense of a slightly higher rate of inflation) provided, and this would be the major caveat, we take firm and clear initiatives that will prevent the build-up of the circular debt again. I highlight this because the prevailing incentive structures enable those operating the sector to live with the comfortable feeling of business as usual (with the same level of incompetence and degree of poor governance), convinced that the government will simply step forward, yet again, a few months down the road to bail out them out.

From these arguments and facts, it should be fairly obvious that the recent decision of the government to privatise the management of the Gencos not just betrays a weak diagnosis of the problem of circular debt but also overlooks the urgency to ensure continued provision of reliable power so that the economy remains a growing concern — the inefficiencies of Gencos is a relatively minor issue. The principle issue is poor governance, reflected in the sheer failure to weaken the control of powerful lobbies who continue to ride this gravy train while the rest of the population wrings its hands helplessly.

It is difficult to fathom how privatising management of generation companies can solve the problem if electricity tariffs are not raised in a timely manner and government-managed DISCOs fail to prevent electricity theft or col lect their bills regularly and disconnect those not paying their bills i.e. take actions that will ensure cash flows to pay Gencos and suppliers of fuel regularly.

Moreover, with existing IPPs already issuing notices to the government that either their dues be paid or they will wind up their operation, it would not be a good advertisement for any entrepreneur seriously contemplating such an investment, unless he is foolhardy or knows something we don’t — the latter could be a situation in which he will get paid a minimum capacity payment without having to run the plant in the express knowledge that fuel, especially gas, would not be supplied.

In other words, we could just end up facilitating a scam, with a government liability being created in the shape of a capacity payment which never had to be discharged while the generation company was owned by Wapda.

So the correct solution is to either immediately privatise the management or ownership of DISCOs (under an appropriate regulatory framework) or hand them over to the provincial governments. The electricity can be supplied at the provincial borders for the provincial governments to purchase it from the Gencos and manage the DISCOs, thereby relieving Islamabad’s overstretched budget from the burden of this seemingly neverending electricity subsidy. ¦ The writer was formerly governor of the State Bank of Pakistan. Source

Comments

  1. Kelash Kumar says:

    The article is really crystal clear to understand the circular debt problem of our country, and also the suggestions are quite practical, but the pity is that our whole system is victim ed of the mis-management and bad governance and most of all there is no accountability from anyone, therefore any initiative taken or imlementation of a plan shows either a very small or no hope of prosperity…. Yet I hope that this recommendation be taken carefully and with positive attitude than we may get rid of this one of the biggest issues of our country.

  2. Mazhar ul yousaf says:

    while watching different talk shows discussing circular debt. i was really worried that what it is. at first i thought that it would be some kind of obligations from IMF or World bank to repay the loan or its interest but now by reading this article i am 100 pcnt clear about the topic. and in last we can just pray to our God that he forgive us and may shower his blessings on our country. we are really in trouble just because of our government so called our rulers.

    • @Mazhar ul Yousuf
      thanks for your comments and appreciation
      keep in touch with us and you will find many informative articles in future

  3. Rizwan Saleem says:

    An article which has elaborated a technical concept in a simple way with workable suggestions for a chronic problem.

  4. The issue is not only at the cases of DISCOs in Hyderabad, Peshawar, Quetta. Even the educated and civilized city of Karachi has areas where the loss is more than 70%. Kaunda’s none payment etc. what’s stopping the recovery from here. The total loss of Karcahi is more the whole cost of maybe FATA. This is conveniently ignored. The people there pay only for the cost of their generation and not equalized to the rest of the country. This option should be given to every place across country.
    De-centralize the whole electricity supply chain. Every province to manage the end to end (gencos to discos) and the consumer should pay for the generation cost of that province and also loss in the supply chain of that province. No more cross subsidies………… end of blame game as well.

    where hydel is generated the consumer should pay for the hydel and also for loss in that areas. For those where the generation is on gas or fuel they should pay for their costs of generations. Same as the case in Karachi.

    Also province should be given the authority to develop the future capacity development plans as their requirement. Rightly said the center should be relieved of this unnecessary burden.

    lets see what the result is then.

  5. I really like this article a lot it has helped me in my coursework of MSc in Pak studies as well. Very good, keep it up!

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