The China-Pakistan Economic Corridor (CPEC) is bringing large generation capacity (14 projects worth over $18 billion and with 11.1 GW capacity at various stages of development), but none of these have been awarded through international competitive bids or auctions. This has been stated by the World Bank (WB) in a research paper, “Learning from Power Sector Reform, The Case of Pakistan”.
All projects have been awarded through direct negotiations between the government of Pakistan and the Chinese government and project company. Thus, while the country allows for good practices in procurement these are hardly followed in practice.
The paper states that Pakistan’s economic policy has been significantly influenced by regional politics. The country’s economic trajectory has been buffeted simultaneously by the security implications of being a strategic regional actor and the resulting financial and political aid that has poured into the country. A deteriorating security situation has resulted in dampened growth. Simultaneously, politically-linked bilateral development aid and policy and reform-based lending from multi-lateral agencies have not only buoyed the economy but also influenced the economic reform process.
Pakistan’s experience illustrates how, even when a substantial package of structural reform measures is implemented, it may not be enough to positively impact sector performance, if it isn’t accompanied by a commitment to the principle of cost recovery and an associated hardening of the budget constraint faced by actors in the sector. This lack of financial discipline not only harms the public finances, but also damages the real economy by allowing serious power shortages to persist due to lack of investment incentives.
The country has continuously suffered from inadequate capacity and other constraints, leading to large and frequent blackouts. Some of the government-owned DISCOs have struggled with bill collection, often falling far short of the 100 percent target set by the government.
Transmission and distribution (T&D) losses have continued at high levels with little improvement and have generally exceeded the “target” rate used in determining the subsidy that is paid to DISCOs. This has led to continuing losses and the creation of circular debt (where companies fail to pay their suppliers because they have no cash or prefer to retain cash to cover their own losses).
The government has paid off some or all the cumulated circular debt on a few occasions, and this has created further problems. The utilities have seen that there is no long-term consequence to operating in an inefficient fashion; potential new entrants for urgently needed capacity may have been discouraged by the history of late payment to suppliers by the DISCOs; and the total cost to the government of subsidizing consumers has been larger than planned.
A recent development in the sector has been the agreement of a multi-billion dollar investment package financed in part by the government of China, that is expected to support a large and rapid expansion in generation capacity and shortly lead to a surplus of capacity. International financial institutions have played an important role in supporting the power sector, particularly at times of crisis linked to the use of subsidies and the weak financial performance of the state power sector.
Pakistan had made little progress until recently on the security of supply due to an absolute shortage of generation capacity, made worse by the failure to maintain and operate the nationally-owned generation, transmission and distribution capacity in an optimal fashion.
Although IPPs have played an important role in adding new generation plants, their efforts have fallen short, since the government has not yet been able to make the sector sufficiently attractive to investors.
Further, the government has no integrated energy plan that would identify the best energy mix.
Renewable, although apparently encouraged by the regulatory system, have in practice found it difficult to enter the sector because of planning delays, and the recent unexpected fall in renewable energy prices has acted as a further brake on entry.
On access, the picture is clouded by uncertainty arising from contradictions between alternative data sources. There has been no obvious electrification plan designed to increase access during this period, nor were the distribution utilities in a strong enough position to undertake this on a large scale without government support.
The evidence appears to support the view that little was done to improve access and a current value of 70 percent grid access based on company connections data and a recent census is more plausible than the 98 percent rate based on household surveys.
Affordability is strongly influenced by the subsidies provided to the distribution utilities to bridge the gap in revenue they incur by charging subsidized tariffs. There has been a clear trend of setting the rate of increase of tariffs for the lowest consumption bands well below that on the higher use bands, thus providing a relatively larger support to the poorest users.
On efficiency and financial viability, the performance of many of the distribution utilities with high T&D losses and low collection rates has been weak and shows no signs of improvement, despite the use of efficiency targets set by the regulator. Notably, one private sector company (Karachi Electric) was able to improve on its extremely poor performance pre-privatization, but at present performs no better than the average of the publicly owned utilities.
The financial viability of these companies has been supported by the government policy of eventually paying off debts created by operating at such low levels of efficiency. Tariffs and cost recovery have been impacted by the operation of the semi-independent regulator in a roundabout fashion.
The revenue requirement determined by the regulator includes efficiency targets specific to each distribution utility that can be altered over time. The difference between the “nominated” tariff determined by the Ministry and the revenue requirement is the Tariff Differential Subsidy for that utility.
The regulator has also determined the tariffs for generation and transmission. However, the regulator does not determine the “nominated” tariffs and these are what consumers are charged and carry fiscal implications as well as welfare impacts on households.
Power Sector Reforms
While Pakistan’s regulatory framework embodies many good practice elements on paper, a significant number of these fail to be fully applied in practice. In particular, enforcement of service quality is weak and unnecessary delays in market entry regulation have been discouraging entry for renewable projects.
Implementing a full power sector reform can take much longer than anticipated. The long drawn out nature of the reform process in Pakistan is understandable in view of the frequent changes of government and a general lack of political consensus around the reform agenda and illustrates the difficulties of reforming in such a challenging context.
Structural reforms may be of no avail if they are not accompanied by a commitment to make progress towards cost recovery. Pakistan took major steps towards the unbundling, privatization and regulation of the power sector, as well as allowing entry into the generation sector. However, these reforms are premised on the principle of cost recovery that allows the different actors in the sector to establish a reliable payment process that supports trade along the power supply chain.
The creation of a competent regulatory body will have limited impact if the government is not willing to cede it some authority on key decisions or to dispense with large consumer subsidies to the sector. In Pakistan, the regulator, NEPRA, only has tariff-setting authority over generation and transmission tariffs, and even this is in the process of being removed. Distribution tariffs are set by the ministry, albeit with some reference to revenue requirements determined by the regulator, but without any strong commitment to the notion of reducing consumer subsidies.
Neither does NEPRA have any authority over the process by which utilities procure power from IPPs.
Incentive-based regulation is of limited effectiveness when regulating public utilities and an overall sector that is not run on commercial principles. A central issue in Pakistan has been the weak operational efficiency of the distribution utilities.
Privatization of distribution utilities does not always deliver the anticipated benefits. The privatization of Karachi Electric proved to be highly controversial and is still being contested in the courts more than a decade later. The fact that the transaction was conducted under emergency procedures contributed to public discontent and illustrates the importance of due process in transactions of this kind.