International Monetary Fund (IMF) has called for swiftly addressing the resumption in the accumulation of arrears to ensure a financially viable and growth-supporting power sector.
The IMF staff level report on the article IV consultation with Pakistan released on Thursday stated that accumulation of power sector arrears resumed in the first half of fiscal year 2016-17 (Rs 53 billion), with the stock increasing to Rs 374 billion (about 1.2 percent of GDP).
This reflected a widening of the system’s operational deficit due to delays in passing through to end-consumers higher generation tariffs and weaker bill collection by distribution companies (DISCOs), only in part compensated by the positive impact of a reduction in DISCOS’ distribution losses and still low oil prices.
Staff stressed the need to strengthen DISCOs’ performance and adjust end-consumer tariffs to reflect higher input costs, also in view of upcoming increases in generation capacity.
While most DISCOs met their end-December 2016 targets in terms of collection, about half met their targets in terms of distribution losses. Furthermore, moving ahead with the planned IPOs of DISCOs is key to strengthen corporate governance and mobilize proceeds to start reducing the stock of outstanding arrears.
Staff stressed that ensuring transparency and managing risks associated with new power generation projects will be key. The authorities agreed with staff’s assessment, re-iterated their commitment to contain the accumulation of new arrears, and noted that the recent arrears build-up was due to a one-off delay in passing through higher generation tariffs.
Ensuring the power sector’s operational and financial soundness and supporting investor confidence require maintenance of a strong regulatory framework. Staff underscored that preserving NEPRA’s independence and maintaining an appropriate tariff-setting process will be important in the context of planned amendments of the NEPRA Act. In parallel, swiftly resolving the ongoing litigation with the regulator on DISCOs’ benchmark distribution losses and recoveries is necessary to resume regular tariff setting. In addition, moving forward with establishing a multi-year tariff framework is key to strengthen the regulatory framework, attract private sector investors, and support the planned IPOs of DISCOs.
Staff stressed that restructuring PSEs and attracting private sector participation are needed to improve efficiency, reduce financial losses and contain fiscal costs.
Despite some improvements, PSEs’ annual financial losses remain high at about 0.3 percent of GDP, with accumulated losses at 3.8 percent of GDP.
In the near-term, it would important to finalize the transaction structure for PIA’s minority sale and for attracting private sector participation in PSM move ahead with the IPO for GEPCO and set a timeline for other DISCOs’ IPOs, finalize KAPCO’s divestment, advance with the Pakistan Railways restructuring plan, and finalize ongoing capital market transactions.
Over the medium term, a new comprehensive strategy to eliminate PSEs’ losses and ensure private sector participation will be needed. The authorities indicated their continued intention to pursue restructuring and attract private sector participation to contain PSEs’ financial losses.
Pakistan has embarked on a massive investment program in energy and infrastructure sectors to mitigate chronic energy shortages, diversify the country’s fuel mix and improve trade connectivity. Part of this investment is implemented in the context of the China Pakistan Economic Corridor (CPEC)—a large package of investment projects, potentially totaling about $55 billion (19 percent of fiscal year 2015-16 GDP) over the next decade.
CPEC projects in the energy sector involve foreign direct investment and commercial borrowing from Chinese financial institutions, either by majority foreign-owned joint ventures or Chinese investors. Financing of non-CPEC energy projects ranges from private domestic financing to private commercial as well as government concessional borrowing from international financial institutions.
If implemented on schedule, these investments could help close Pakistan’s power deficit, significantly improve its fuel mix, and boost GDP. The planned expansion of energy sector capacity could eliminate Pakistan’s 6GW generation capacity gap in 2016 as early as end- 2018. In the process, Pakistan’s excessive reliance on furnace oil would be significantly reduced.
Impact on GDP will likely come in three stages: construction, power generation, and—over time— second-round effects on broader economic activity due to increased productivity, lower costs, and improved trade connectivity.
The first two stages (direct contribution) could add about $13 billion to Pakistan’s GDP in the next seven years (4.7 percent of fiscal year 2015-16 GDP). Second-round effects will likely accrue gradually and could lead to a significant contribution in the long run, depending on various other supportive factors.
It is not difficult to reform the power sector. DISCOs may be privatized by giving a share to every electricity connection in the jurisdiction of every DISCO. Not outside investors. The head of DISCO must get a vote of confidence from consumer-shareholders every year. Secondly, every DISCO should buy power directly from producers through competitive tenders. The central government should not be a middleman in purchase of power, nor should it determine power rates. The line losses will come down, tariff will drop and corruption will be dealt with effectively. The consumers will benefit as a result of all reforms.