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Paying it off

June 18, 2013

SO we are told that the government plans to retire the circular debt and restore power supplies.

Under the present circumstances, it is hard to imagine a better policy stimulus that will spur supply side growth. One hoped, however, that the money would be raised more prudently, on the fiscal side; either through austerity measures or by collecting taxes owed by those who don’t file returns.

Perhaps because these are difficult policy choices, the government, preferring the path of least resistance, has looked to the monetary side. From here it intends to raise circa Rs500 billion through a treasury bill auction. In layman terms, this is known as printing money.

The last time such a clean slate solution was attempted was in 2009, when most of the Rs200bn debt was moved off Pepco’s (Pakistan Electric Power Company) balance sheet and on to a newly created power holding company.

This company in turn repackaged the debt and sold it as term finance certificates. Back at that time, this financial wizardry was also mooted to be a “one off” affair. This is a crude form of an asset class known in the world of finance as derivatives.

Monetary measures on this scale are not without their macroeconomic effects and inflationary impact. Arguably this money will be incremental to the ‘business as usual’ deficit financing that our governments consider routine.

Unlike fiscal measures which can be targeted, these have an inflationary impact which falls on the poorer segments of society. It would also appear to leave less money on the table for other economic stimuli, such as recapitalising the state-owned enterprises, if the government is planning to turn them around.

Others may argue that the Rs500bn T-bill auction would also reduce liquidity for the private sector, which is clamouring for credit at low interest rates. To put things in perspective, in 2009 the total outstanding credit to the textile sector alone was Rs535bn. As electricity supplies resume, so will the appetite of this industry — which generates over half of our total exports — for working capital expand.

The other important consideration is to ensure that the circular debt does not accumulate all over again. A sharp increase in electricity prices alone is not enough. The previous government also doubled prices during its tenure. Tough reforms across the energy sector are needed.

Which brings us to the essential question; is the government up to taking some tough policy decisions early in its tenure? Or, as with the T-bill, would it choose some easy, circumventing path?

Even after taking all the tough and unpopular policy decisions, the structural anomalies that produce the circular debt will take time to fix. During this time the circular debt will, in all probability, build up again. One more round of retirement may be necessary. The size of that pile will depend on how quickly the government is able to carry through its reform process and bring the power supplies to economically sustainable levels.

In all this there is a silver lining. If a monetary expansion on the one side is accompanied by an increase in aggregate supply on the other, then arguably the two should cancel each other out and the inflationary impact would be neutral.

If this is what the government’s economic planners are hoping to achieve then it is a risky but nevertheless a justifiable executive decision. The risk is that the money is being printed first and after that if output doesn’t expand, then we’re left to deal with the inflationary effects.

But beyond that, let’s look at circular debt more closely. At the bottom of the cascade, it ends up as money payable to four companies, three of which are producers of primary energy in Pakistan, the Oil & Gas Development Company, Pakistan Petroleum Ltd and Mari Petroleum, while the fourth, Pakistan State Oil, is the country’s main importer of primary energy.

All trains terminate here. Excepting Wapda’s hydropower units, the other players in the energy chain, the refineries, the public-sector generation companies, the gas utility companies, the independent power producers, the distribution companies et al are intermediary stations leading up to the top of the cascade where sits the consumer. What may not be so obvious is that the money — the Rs500bn — is also there. It is not lost. It is available in the form of unpaid electricity bills, and most of these pertain to federal, provincial and local government entities.

Others pertain to commercial entities that invariably have disputes with their power utilities over the amount. In addition part of the Rs500bn may well be normal payables and receivables which make up for the working capital of the energy companies. Financial prudence would require the government to retire the Rs500bn T-bill as the revenue from these unpaid bills materialises.

Provision of electricity will fuel aggregate supply. But beyond that there will be other benefits. As the liquidity crunch ends and choke points are removed, the biggest beneficiaries will be the oil and gas sector, in anticipation of which the Karachi Stock Exchange has enjoyed an unprecedented rally in recent weeks.

During its tenure the previous government must have poured over Rs1.5 trillion into the power sector. Each summer Punjab would erupt in violent protests, the prime minister would call for an energy conference. It was, however, unable to follow up with the (politically unpopular) reforms. That is where all eyes will be in the coming weeks.

The writer is a strategist and entrepreneur.