The hole keeps getting deeper no matter what.

The circular debt — or the power-sector arrears described as the cash shortfall within the Central Power Purchasing Agency (CPPA) that it cannot pay to power supply companies — was Rs100 billion heftier at the end of the first half of 2019-20 from six months ago.

Multiple upward adjustments in electricity prices over the last one year notwithstanding, the government’s significantly large off-the-budget liability keeps growing. The addition to the stock in the last six months took the total unpaid bills of the power sector to Rs1.7 trillion. This amount includes Rs812 billion parked in a government holding company. The debt is described by the International Monetary Fund (IMF) as the result of the difference between the actual electricity distribution cost and its price charged from consumers; the delayed payment or non-payment of subsidies by government; and the delayed determination and notification of tariffs.

Indeed, the pace of growth in the size of the circular debt has significantly slowed down in recent months because of increased electricity tariffs. After adjusting the power subsidies, a recent newspaper report quoted unnamed sources in the federal energy and finance ministries, the average monthly increase in the circular debt between July and December was Rs17bn — higher than the government’s claim of Rs10bn but much less than the monthly flow of Rs38bn during the last fiscal year.

The issue of power-sector arrears cannot be resolved through periodic hikes in electricity prices

Without subsidies, the gross monthly increase in the circular debt was Rs29bn. The government paid roughly Rs73bn in power subsidies in the first half of the current fiscal year, the report said.

With more upward tariff adjustments, the pace of accumulation of arrears is expected to further decelerate in the second half of the fiscal year.

The government is believed to have approved a plan to enhance existing benchmarks of the so-called line losses of distribution firms with a view to gradually recover the full cost of each unit of electricity produced — including stolen or lost in transmission/distribution units — from consumers. Eventually, consumers will be made to pay for any expense, including capacity payments of generation companies, the government is accruing to keep the circular debt at bay.

Since January last year, the government has increased electricity prices by a cumulative Rs3.95 per unit. After the upcoming increase, the total tariff hike will jump to Rs4.25 a unit.

The government has reportedly put an additional burden of Rs405bn on consumers in last one year to slow down the increase in the circular debt accumulation. Almost half of that amount, Rs195bn, was recovered from consumers in the first half of the fiscal year, according to published reports.

But is that a solution at all?

The strategy being pursued by the government to recover the full cost of electricity from consumers is reducing off-take and increasing theft. “The government has brought the average monthly run rate of the accumulation in the circular debt substantially down in the last six months, but it is done by bringing additional financial burden on honest consumers instead of improving system efficiencies, reducing losses and theft estimated to be in the range of 20-40pc of the energy received, getting full recovery of bills and addressing other core issues of the power sector,” a senior executive of an independent power producer (IPP) said.

According to the IMF, the Imran Khan administration has committed itself to reducing the pace of increase in the circular debt, which represents a significant quasi-fiscal risk.

The plan calls for the liquidation of the existing stock, privatisation of distribution firms, recovery of uncollected bills, rightsizing power subsidies and so on. Essentially, the plan to reduce and eliminate the future accumulation of the circular debt in the short to medium term remains dependent on continuous upward adjustments in tariffs.

Many believe that the circular debt issue cannot be dealt with through periodic hikes in electricity prices. The CEO of a private power producer suggested that the government must abolish the tariff announcement strategy for new projects as a first step to reform the power sector. “Even if the government is the sole buyer, reverse or competitive bidding should take place to ensure that the market determines the tariff.”

The government also needs to sell all distribution and generation companies to create a merchant market, he said. One major reason for expensive electricity is that the tariff is for 25 years but the loan repayments are spread over the first 10 years and debt financing is 80pc. So the majority of the cost is incurred in the projects’ earlier life. “You do not have a 25-year bond market. If there was one, the debt schedule would have been spread over 25 years and the cost would have automatically come down. So we need to find some way out to reduce the tariffs of existing power producers.”

Published in Dawn, The Business and Finance Weekly, January 20th, 2020