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Settling circular debt

June 17, 2013

FINANCE Minister Ishaq Dar, a chartered accountant by profession, decided to pitch the fiscal deficit at 8.8 per cent of GDP for the outgoing fiscal year — perhaps highest in the country’s history — against 7.3 per cent projected by the caretaker prime minister’s adviser on finance, Dr Shahid Amjad Chaudhry, only a fortnight ago.

Dar considers the cash accounting system as unfair, because it adds the financial burden of the current year to the subsequent year — which used to be done in the past by adjusting the previous loan accrual as a ‘one-time fiscal deficit’.

His view on the matter carries weight, particularly in respect of the circular debt of over Rs500 billion, which is holding the entire energy chain hostage. The circular debt has already accrued, and it only needs to be settled.

By doing so, the finance minister has made allocations for the current circular debt within the current year’s deficit, to pass the buck where it belonged — the previous PPP government.

The circular debt will be settled under the head of net lending. Net lending is the balance resource transfer left after deducting loan repayments to the federal government. Budget estimates for net lending during fiscal year 2012-13 stood at Rs50 billion. Mr Dar has increased it to Rs326 billion, to settle the circular debt and Pepco’s dues under the government’s initiative to resolve the chronic problem immediately before the current year ends on June 30.

Within days, Rs200 billon will be used to make cash settlements, mostly to independent power producers (IPPs) and Pakistan State Oil, which borrowed from banks and are now facing credit line choking of the worst order. Another Rs126 billion will be settled through the issuance of a bond to organisations like OGDCL and Pakistan Petroleum Limited, because they do not have bank borrowings on their books.

The remaining Rs177 billion of circular debt, relating to public sector corporations like Wapda, Government Holdings Private Limited, Mari Gas and Pakistan Atomic Energy Commission, which have counter liabilities with the government, will be settled next year through set-off or book adjustment. Hence, net lending for the next year has been estimated again at Rs50 billion.

And to stop the recurrence of the circular debt, there is a need for system improvement, loss reduction and an upfront Rs2.50 per unit increase in average sale rate from Rs8.81 per unit to Rs11.30, while still leaving a gap of Rs3.40 per unit to reach Nepra’s determined tariff of Rs14.70, which will be taken care off through a Rs200 billion subsidy allocated in the budget for the next year.

Meanwhile, starting off with a fractured economy, the PML-N, through the 2013-14 budget, has embarked upon an ambitious but tough path, which comprises structural reforms, and stabilization/ consolidation measures that include some unpopular painful actions.

With a 10-point budget strategy, the PML-N government aims to reduce the fiscal deficit to 6.3 per cent of GDP, enhance the tax effort, solve the energy crisis, end the circular debt, gradually reduce untargeted subsidies, create room for private sector credit, stabilise reserves and the exchange rate, reform public sector enterprises, create jobs, enhance the national income support programme and promote austerity.

However, fingers remain crossed as to how space would be created for private sector credit in the short-term, when the government itself has projected to borrow over Rs975 billion from commercial banks to finance the fiscal deficit, against the current year’s bank borrowing of Rs1.576 trillion from the budgeted estimate of just Rs484 billion.

The first and immediate result of the budget announcement came in the shape of an increase in the prices of petroleum products, CNG, electricity, natural gas and other consumer items — all having an inflationary impact — as a result of a widely unwelcome decision to increase the standard rate of general sales tax from 16 to 17 per cent.

More will follow as the government moves early next month to increase base electricity rates by almost 30 per cent or Rs2.50 per unit on average to offset the Rs130 billion tariff differential subsidy, from Rs350 billion this year to Rs220 billion next year. This will be supported by dealing with the circular debt issue, which has hurt components of the entire energy chain, from producers to suppliers and from fuel importers to energy consumers, in the form of cash flow constraints and over 16 hours of power outages.

In response, the government has decided to make a symbolic move to convince international lenders and investors that it is serious in setting right the economic and fiscal direction of the country by containing current expenditure of ministries and divisions by 30 per cent, and those of the prime minister’s office by 45 per cent — excluding salary and pensions, defence, and interest payments.

As part of the government’s strategy to create job opportunities and spur economic growth, there has been a substantial jump in development allocations for next year at Rs712 billion, including over Rs115 billion in block allocations for ‘new development initiatives,’ in which provinces will not have any share.

Of this, Rs540 billion is earmarked for the federal public sector development programme, with a 50 per cent increase over the current year’s allocation of Rs360 billion (which was later increased to Rs388 billion due to excessive spending on discretionary development schemes of the PPP government). Coupled with provincial annual development plans, the total development outlay has been put at Rs1.155 trillion, which gives top priority to energy and water sector projects, including over 2500MW of nuclear power projects of Rs52 billion.

This is followed by infrastructure development, linking of rail and road networks with neighbouring countries like China and Afghanistan, and from Gwadar to rest of the country. This is expected to have a salutary impact on the construction and its associated industries.

The PML-N government is, however, faced with a tough challenge, which requires it to ensure intergenerational equity, an adequate social safety net, and provision of public services. The federal cabinet was warned ahead of budget presentation that this would bring up a critical trade-off between short-term excessive subsidies of an inflationary nature, and long-term economic growth.