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NOW here’s something interesting. For many years the power sector has been hobbled with large amounts of debt, whether circular or otherwise. It is one of the largest users of bank liquidity (after government), and the size of the so-called circular debt, when it was at its peak, was comparable to the peace-time defence budget.
But a few years ago, a string of Chinese investors began acquiring stakes in the power sector, and in the course of doing so, they examined carefully the myriad risks that the country presented. One of the chief risks that caught their eye was the circular debt.
A racket of sorts had developed around the circular debt when it was in its heyday. Even though many IPPs made a noise about the liquidity constraints that were imposed upon them as a result of delayed payments from government, they were compensated through penal interest charges on all outstanding government receivables to the tune of 2 to 4pc spread over KIBOR — the benchmark lending rate for corporate debt in Pakistan.
A racket was born when sponsors of some IPPs deliberately sought to build up a stock of receivables from the government, then use that as an excuse to shut down their plant and live off the penalties and capacity charges. Of course, managing an enterprise under these constraints remained a challenge, when inflows were erratic but payments to creditors and shareholders had to be made on a rigid schedule. But if you were so inclined, you could enjoy returns on your investment under these circumstances even as your plant lay idle.
The racket got its first hit when the new government came into power in 2013. First, the accumulated stock of outstanding receivables was largely wiped out in a colossal one-time payment of almost Rs500bn. Then, through a concerted effort that was aided by a sharply falling price of furnace oil, the government succeeded in halting the accumulation of outstanding receivables somewhere around late 2014. Today, the IPPs are paid largely on time and fresh accumulation has been avoided.
The new investors are asking for protections against a return to a period of delayed payments and legal disputes.
After this the government began to play hardball with the IPPs. It agreed to pay the penal interest charges on whatever stock of outstanding receivables was in place around September 2014, when the accumulation halted, but in return demanded liquidated damages from those IPPs that refused to restart generation. A dispute arose which was taken to London for international arbitration, during which the IPPs obtained a favourable judgement.
It was in the era of fresh accumulation that many of the Chinese investors first scanned the economic landscape of Pakistan to determine whether or not to acquire stakes in the power sector in Pakistan. Interestingly enough, they wanted nothing to do with any “penal interest charges” or any other element of the racket that the power sector had become host to.
In tariff petitions placed before Nepra, the power sector regulator, successive Chinese investors make reference to a “revolving fund” that they expect the government to maintain to cover delayed payments. These concerns may have abated somewhat once the government established a track record of timely payments from September (or thereabouts) 2014 onward, but what if fuel prices in the future should climb back up past the $60 per barrel mark?
The uncertainties that are the hallmark of dealings with government carry a price tag, and even though things may be better on the circular debt front today than they were five years ago, the fact that there is still a single buyer means the problem can resurface in the future.
It is with this in mind that the new investors are asking for protections against a return to a period of delayed payments and legal disputes. A revolving fund is one way to provide that protection, although it only adds to the government’s fiscal burden. But a few months ago, another potential Chinese investor has found a second innovative way.
It is an open secret that K-Electric is about to be sold to a Chinese sponsor. The utility’s head offices are swarming with Chinese personnel, who are busy going through its books and evaluating its finances. Before the new sponsors take over, though, there is a small hurdle: a new multiyear tariff needs to be determined.
Towards this end, the company has placed a petition before Nepra detailing the requirements of the new MYT, which it asks should run for 10 years. The tariff petition identifies “working capital constraints due to circular debt” as one of seven challenges the company faces going forward and proposes the following remedy.
“KE incurs additional costs in holding working capital to cover late payments by government entities and TDC [Tariff Differential Claims] by the Government, due to circular debt,” says the KE in the petition. “This is an uncontrollable and unavoidable cost. Therefore, KE requests that a working capital allowance should be included as a pass through component in the tariff on the basis of a mechanism to be determined by Nepra.”
Translation: if we don’t receive payments from any government entity, we should be allowed to simply recover that money from consumers through their bills. Notice the language does not differentiate between local, provincial or federal government. It simply says “government entities”, so we can ask: might the outstanding amounts owed to KE by the Karachi Water and Sewerage Board, for example, potentially be considered a pass through item for all other paying consumers of KE?
One cannot blame the Chinese investors for demanding such protections. Unlike domestic investors, they don’t see themselves as acquiring stakes in a highly uncertain racket. They are coming in for a simple purpose: to generate electricity, sell it for a profit. It’s fair that they want nothing to do with the problem of delayed payments, with or without penal interest charges. But is it fair that the cost of this risk ought to be pushed onto consumers?
The writer is a member of staff.
Twitter: @khurramhusain
Published in Dawn, August 4th, 2016
