The government has prepared a standby plan for recovery of electricity surcharges from consumers in case of potential negative legal challenges to electricity surcharges slapped in consultation with the lenders. This assurance was given by the Pakistani authorities during the ninth review under the Extended Fund Facility (EFF) arrangement but did not give details of mitigating measures.
According to the IMF review report, ongoing legal challenges to electricity surcharges and the still challenging political and security conditions could affect economic activity and undermine fiscal consolidation efforts. Conversely, fast implementation of China Pakistan Economic Corridor (CPEC) projects and an improvement in the security situation could boost investment and growth, and removal of international trade and financial sanctions against Iran could have a positive impact on energy supply to Pakistan.
IMF Staff noted the progress achieved with reducing untargeted energy subsidies from 2.3 percent of the GDP in FY2011/12 to the planned 0.4 percent of GDP in FY2015/16, along with improved collections and loss reduction. the staff report also welcomed that the end-September indicative ceiling on accumulation of power sector arrears was met, quarterly loss reduction targets have been set for Distribution Companies (Discos ) and progress is under way with setting multi-year tariffs, albeit with some delay owing to late finalisation of Discos' multi-year investment plans (missed end-November 2015) Staff emphasised the importance of implementing other aspects of the energy sector reform including the privatisation of Discos , overcoming legal challenges to electricity surcharges, and completing the gas sector pricing reforms . The authorities reiterated their commitment to the energy sector reforms and were optimistic about eliminating the power deficit in the medium term through significant capacity increases and implementation of the power sector arrears reduction plan.
The Staff observed that power deficit has been a major constraint on growth in the past decade. Utilising less than 70 percent of its installed capacity, Pakistan's cash-strapped power sector has been unable to meet the growing demand for electricity resulting in widespread outages affecting both businesses and households. At the heart of the problem has been the power sector's chronic inability to cover costs. A combination of an unfavourable fuel mix, unsupportive policies, high line losses not fully covered by tariffs, and poor governance produced persistent payment arrears by the Discos. Over the years, these arrears, also known as circular debt, gradually stripped the sector of working capital, constraining investment and capacity utilisation. As a quasi-fiscal liability, circular debt has also increased fiscal risks. Since 2013, the authorities cleared a large part of circular debt from the budget and moved another Rs 335 billion to the books of the specially-created Power Holding Company Ltd (PHCL). This helped relieve pressures in the system, but Discos' continued loss-making led to re-accumulation of arrears which, together with PHCL, amounted to about 2 percent of GDP in 2014/15.
Pakistani authorities assured the Fund that the government is working towards reducing energy subsidies (including amounts for arrears clearance) to 0.4 percent of GDP in FY2015/16, from 0.8 percent in FY2014/15. The authorities further assured that to protect against a potential negative outcome of legal challenges to electricity surcharges, the government will take mitigating measures as necessary.
"We are implementing our time-bound strategy to tackle price distortions, insufficient collections, costly and poorly targeted subsidies, governance and regulatory deficiencies, and low efficiency in energy supply and distribution with the support of our international partners," said the authorities.
IMF mission was also informed that the government is reducing electricity subsidies to 0.3 percent of GDP in FY 2015/16, and allocating an additional 0.1 percent for arrears clearance. The government has also begun addressing both the flow and stock of payable arrears in the power sector including by allocating budgetary resources, levying surcharges, gradual improvement in company performances and recoveries, and initiating the process of privatising power sector companies. In June 2015, the government notified the FY2014/15 tariff, as determined by Nepra and implemented surcharges in line with the program targets.
Authorities assured the IMF Staff Mission that the government is committed to protect the level of revenue in the electricity sector by adjusting prices as needed. The government will undertake all necessary measures to ensure the full recovery of costs from consumers. "We are ensuring that technical loss diagnostic studies for all Discos will be finalised shortly so that better estimates of loss rates can be considered by Nepra in its FY2015/16 tariff determination by end-April 2016. We are committed to gradually phasing out untargeted subsidies, while continuing to protect the most vulnerable consumers," the staff report quoted Pakistani authorities as giving the assurance.
The government informed the Fund staff that it has developed a monitoring mechanism to track the stock and flow of payables at all levels of the energy sector (including Power Sector Holding Company Limited, PHCL). There are two main components of the stock of this circular debt. The payables in the power sector increased by Rs 13 billion in the first quarter of FY 2015/16 and currently stand at Rs 326 billion at end-September 2015. In addition to the current payables, it comprises: (i) a residual from payables clearance of June and July 2013; (ii) a disputed amount with the Independent Power Producers (IPPs); (iii) Discos non- recovery and penalties levied on past non-payment; (iv) transmission and distribution losses that are not recognised by the regulator; (v) the debt that emerged from the court stay order on surcharges; (vi) unpaid amounts of verified subsidy claims of Discos under various heads (vii) PHCL loan servicing, and (viii) payables to cross border trade. The stock of past arrears, including the PHCL, in the Syndicated Term Credit Finance (STCF) facility remained at PRs 335 billion at end-September 2015.
The plan includes steps to improve collections and reduce operating costs, losses, and price distortions in the tariff structure. With this, the accumulation of payables will be reduced from Rs 209 billion in FY 2014/15 (including the PHCL) to under PRs 100 billion in FY 2015/16, with a view towards further halving new arrears accumulation by FY2018/19 . While some elements of the plan have not been fully addressed ie implementation in two regions and GST refunds, yet the government has met the end-September income tax on the flow of power sector arrears, helped by lower international oil prices. Authorities assured that the government will remain on track to meeting upcoming quarterly targets.
According to the Pakistan's economic team, the government will continue to reduce losses and improve collections through capital expenditures and revenue-based load management. Overall losses in at the last 12-months declined from 19.0 to 18.22 percent. Collections in the same period improved from 88.6 to 90.7 percent, primarily due to better load management across consumers in rural and urban areas, and industries. More broadly, to address increased losses in some Discos' the Chief Executives and some members of senior management of poorly performing Discos have been replaced, and the government is working with provincial governments to address their payment problems. The IMF was assured that the government will work on improving the average performance of the sector further in FY2015/16. FY2014/15 determined tariffs utilised the room created by falling oil prices and late payment surcharges, and incorporated better reflection of system losses. This is expected to arrest a portion of the build-up of the circular debt and improve the cash-flow of the system. The continued decline in fuel prices will also mitigate the build-up of arrears due to prior year adjustments. The government has allocated about 0.1 percent of GDP of budgetary resources to clear the part of the stock of arrears that accrued in AJK, FATA and Balochistan tube wells and will continue to work with these governments to prevent further accumulation of arrears. The government is also moving the stock of the PHCL debt into Discos' balance sheets where privatisation will take place. This will help to reduce the stock of PHCL debt and will ease the servicing of this debt. In the meantime, the government will continue to fully service the PHCL obligations.
The authorities further stated that they continue to prioritise the use of gas and coal rather than fuel oil in electricity generation and remain committed to a transition to market-based allocation of natural gas in the medium-term.
By providing adequate liquidity and therefore fuel inventories to generation plants, the government was able to prioritise generation at more efficient plants, while maintaining better recovery from consumers and control over losses. This helped the government to save significant costs (Rs 47 billion) and increase power generation by 3 percent. In addition, the better load management policy helped the government attain zero loadshedding for industrial consumers and ensured predictable and reduced loadshedding for urban and rural consumers. To further improve supply, the government will continue to rehabilitate generation plants, while upgrading electricity transmission and distribution facilities to further reduce technical losses. In addition, the government has signed performance contracts with three state-owned generation companies which are run on furnace oil to reduce their losses. The government is also continuing with the development of hydropower projects, with the start of construction of the Dasu project. The expansions in existing projects include around 1300 MW in 2015 and are expected to add an additional 700 MW in generation capacity in 2016. Beyond this, 8.3 GW generation capacity is envisaged through FDI under the CPEC over 2017-2021, with additional capacity expected to come on stream in the longer term.
The current notified weighted average electricity tariff is Rs 11.45/kWh for all classes of consumers. The FY 2014/15 electricity bill will be notified effective from June 10, 2015, and include the following tariffs and surcharges: (i) weighted average tariff of Rs 9.91/kWh, (ii) a rationalisation surcharge of Rs 1.54 /kWh, (iii) Debt Servicing Surcharge (DSS) of Rs 0.43/kWh, and (iv) Neelum-Jhelum Surcharge of Rs 0.1/kWh. The current notified electricity tariffs for users at 0-50 kWh/month of Rs 2/kWh will be retained.
IMF's Executive Director for Pakistan Jafar Mojarad and Senior Advisor to CE Shahid Mehmood, in their statement said that rationalisation and better targeting are expected to bring down power sector subsidies from 1.4 percent of GDP in FY 2012/13 to 0.3 percent of GDP in FY 2015/16 as planned. To keep the momentum and consolidate gains, the authorities are also following an ambitious but realistic investment plan in the power sector to stay ahead of the demand curve with medium- and long-term needs in focus.