Managing Circular Debt

APRIL 2015

Pg. 01

Introduction

Introduction This working paper addresses the CD issue in the Pakistan power sector and describes a

mechanism to: (i) maintain a cap of Rs. 280 billion1 on the CD (ii) reduce circular debt and (iii)

reduce PHCL debt by FY2018. CD is the amount of payables within the Central Power

Purchasing Agency (CPPA) that it cannot pay to power generation companies (Independent

Power Producer (IPP), government owned thermal generation companies (GENCOs), the

hydropower producer (WAPDA Hydel) and National Transmission & Despatch Company

(NTDC).

Major Contributors to Circular Debt

The major sources and contributors of buildup of CD are as follows.

• Sector inefficiencies

The sector’s inefficiencies stem from DISCOs having higher levels of losses and lower levels of

collections than those allowed by the regulator. Some DISCOs are at or close to the NEPRA-

determined levels of losses and collections. Less well performing DISCOs experience levels of

losses that are up to 5-10% worse than those allowed, and of collections that are up to 20-30%

lower than the 100% recovery assumed by the regulator, as owner of these entities. In FY

2014, sector inefficiencies added Rs. 88 billion to CD and accounted for Rs. 60 billion for FY

2015 up to March 2015.

• Discrepancies in tariff regime

Beside sector inefficiencies noted above, tariffs do not capture the full cost of supply of

electricity. Factors include delay in determinations, late payment surcharge and cost of debt

servicing.

Pg. 02

Introduction

• Fiscal requirements and government performance

Some costs are imposed on the DISCOs by virtue of government policy like subsidies for

domestic consumers, users of tube wells etc. To compensate, the government provides

subsidies to DISCOs. However, these subsidies are sometimes under budgeted or provided

late which increases the CD.

Government Objectives and Strategy for Tackling CD

The objective of the GOP is to have a financially self-sustaining power sector to support

economic growth which implies the elimination of the CD. To that end, GOP will pursue the

following strategies:

- Improved Efficiencies. The strategy for improving efficiency is based on a gradual

decrease in the losses and increase in the collections from consumers. Working on the

same strategy, collections have seen an improvement in FY 2015 in the range of 89-

91% as opposed to the previous rate of recoveries in FY 2014 of 87%. Losses reduced

by 0.5% in the same period. The plan for management of CD until the end of FY 2018

is based on the same strategy and principles. Incorporation of subsides properly in the

budget to reflect the bulk.

- Surcharges: Surcharges are levied under Section 31(5) of the Regulation of Electricity

Generation, Transmission and Distribution Act 1997 (the NEPRA Act). Surcharges will

be set at the level that will rationalize subsidies and allow recovery of full cost of supply

such that the flow of CD is eliminated by FY 2018.

- Privatization Receipts: With the majority of DISCOs in the privatization plan of the

GOP, will help elimination of contribution of privatized entities towards circular debt will

help reducing it.

Pg. 03

Dealing with Sector Inefficiencies

Dealing with Sector Inefficiencies

Technical and Non-technical Losses

Table 1 shows a comparison of losses that the regulator has allowed in the determination for

each company.

Table 1: Comparison of Losses in FY2014 and FY2015

Description LESCO GEPCO FESCO IESCO MEPCO HESCO QESCO PESCO/ TESCO

SEPCO Total

Allowed Losses (%) FY 2015

11.75% 9.98% 9.50% 9.44% 15.00% 20.50% 17.50% 26.00% 27.50% 15.13%

Actual Losses (% ) FY 2015

10.8% 11.2% 9.1% 9.8% 15.7% 27.9% 23.5% 37.4% 36.5% 18.5%

Losses (%) FY 2014

9.01% 9.98% 9.50% 9.45% 15.00% 15.00% 18.00% 20.00% 17.00% 13.05%

Action Plan: NEPRA issued the tariff determinations for FY 2014 for most of the DISCOs in

last quarter of 2014-15. In the short term there is little that can be done about the flow because

the tariffs have been determined. NEPRA as a condition of its determinations requires DISCOs

to conduct a study on technical losses to justify the need for increase and to set out future loss

reduction initiatives, to be conducted by independent consultants. For the purposes of CD

management plan, a loss reduction of 0.5% per year is assumed starting from FY 2016. A

0.5% reduction in losses will reduce the flow of CD from Rs. 31 billion per year in FY2016, to

Rs. 13 billion in FY2018 based on assumptions of increased supply of electricity.

The privatization program will also be likely to reduce excess line losses, to the extent of the

companies that will be privatized.

Low Collections by DISCOs from Consumers

Collections from private sector in most of the DISCOs have been an issue which contributed to

the buildup of CD. Actual recovery fluctuates between 89-91% for the current financial year.

The plan is divided into three parts. For all distribution companies, recoveries will be managed

through supply based on AT&C.

Pg. 04

Dealing with Sector Inefficiencies

The second part of the plan is to outsource to the private sector collections of bills in areas

where recoveries are weakest, based on the same categorization mentioned in the preceding

paragraph.

The third part will address collection of Federal and Provincial government bills. For all Federal

accounts, MOWP will notify DISCOs that non-payment beyond the billing cycle of 45 days

should result in disconnection, per commercial procedures.

Tube-Wells

For ensuring receivables from agriculture tube wells consumers in the country, a summary has

been approved to the ECC defining payments by subsidized consumers and share of provincial

and Federal governments.

Pg. 05

Discrepancies in Tariff Regime

Discrepancies in Tariff Regime

Policy Induced Debt

Leading up to 2008, DISCOs borrowed for operational costs which NEPRA did not allow to be

recovered through the tariff. This debt is now in the process of being transferred to DISCO

balance sheets. The loans have tenors ranging from 5 to 7 years with reschedule and rollover

options and interest payment rebates if payments are made promptly.

To arrest the flow of circular debt arising from servicing of the debt, the collection will be made

through tariff.

Late Payment Surcharge

Another cost not considered by the regulator while determining the cost of service is the late

payment interest (Kibor + 4%) imposed by the IPPs as per their power purchase agreements. It

becomes due if payments for capacity or energy components are below invoiced amounts.

Since the sector recoveries are to the tune of 89-91% from consumers, IPPs have often

received short payments. For FY2015 the regulator has allowed the cost of late payment

surcharges to be recovered from the consumer tariff which is estimated to off-set the amount of

buildup on account of late payments to generators.

Delays in Tariff Determination

Delays in the annual tariff determination for DISCOs stem from late submission of tariff

petitions by DISCOs and the time it takes for NEPRA to conduct the determinations.

The privatization program is expected to reduce the problem because the cost of delays will be

managed by DISCOs by DISCOS who have shifted to the MYT procedure, with the first three

to five Discos expected to move in the first year. The MYT procedure reduces the workload in

NEPRA in the longer run, thus allowing faster determinations, and in intermediate years

adjustments to tariffs are formula-based and thus do not require lengthy determination periods.

For its part, GOP will increase its supervision of those DISCOs it continues to own to ensure

that they are prompt in submitting tariff determinations and are responsive to any further

requirements of NEPRA.

Pg. 06

Fiscal Requirements

Fiscal Requirements

Tariff Differential Subsidy

Late payment of subsidies impacts buildup of CD. Subsidies which are under budgeted or

where the budget amounts are breached due to external factors like court cases, add to the

buildup of CD. It is government policy to focus tariff differential subsidy (TDS) on residential

connections consuming up to 300 kWh/month which now account for about 76% of the TDS

and for which GOP intends to budget fully. The GoP will ensure that budgeting of subsides is

sufficient such that it does not contribute to the flow or build of CD.

The balance of the TDS has historically been used to maintain uniform tariff for all DISCOs and

the NEPRA determined average tariff cannot be reached unless surcharges are allowed. Thus

under uniform tariff, only the minimum determined tariff can be charged.

The government intends to shift the cost of the uniform tariff from the TDS budget. For all tariff

categories where subsidies are zero, an equalization surcharge has been levied the proceeds

of which are used to fund the uniform tariff policy.

Flow: There will thus be no incremental flow to the CD from this source.

Azad Jammu and Kashmir (AJ&K) Supplies

AJ&K receives power in bulk from three distribution companies: IESCO, PESCO and GEPCO.

Currently AJ&K pays concessional tariff under Magla Raising Agreement against the GOP

notified tariff. To stop increase in the flow of CD on account of AJ&K supplies, following two

options are being explored:

Option A: The difference between AJ&K tariff and determined tariff will be taken up under tariff

petition of WAPDA to NEPRA.

Option B: To review the revise applicable concessionary tariff.

The outstanding stock will be picked up by GOP in Federal Budget over a period of three years

starting from FY2016.

Pg. 07

Fiscal Requirements

FATA Supplies

GOP has split out Tribal Electricity Supply Company Limited (TESCO) from the original

company PESCO to determine its billing and subsidy requirements. TESCO is now an

autonomous DISCO and manages its operations independently in that area. GOP policy is that

the cost of supply to residential consumers of FATA will be picked up.

The subsidy sharing arrangement will be presented in the ECC after which Federal

government subsidy on account of TESCO will be budgeted by the government for next tariff

determination cycle. In a scenario where recoveries remain lower than the expected 25%, GOP

will review and revise the subsidy sharing mechanism in the next year (FY2017) and pick up

any additional liability to zero out FATA receivables and its accumulation on CD by moving a

revised summary in ECC.

Considering the current social economic situation in the area, this paper assumes that GOP

may pick up the entire billing on account of FATA.