Salman Khalid and Kamal Munir
WE live in a world where profits are privatised and losses are socialised. Nowhere is this truer than in Pakistan’s power sector.
However, despite extensive debate in the national press, this reality still does not seem to be obvious to many. A few weeks ago, we wrote an article calling for a fundamental shift in the energy policy. The response was overwhelmingly positive except for one small issue which seems to confuse many: circular debt.
It is widely believed that circular debt has built up because of subsidies that the state has been providing to the people. It is argued that this debt has choked the pipeline and as part of the solution, the true cost of electricity production must be passed on to consumers (even if it means half the country will go without electricity).
It surprises us how many eminent policymakers, economists, and politicians continue to believe in and peddle this myth.
It is important that we understand who is subsidising who here. In the early ’90s, the energy mix in Pakistan was 70:30 with hydel dwarfing thermal. Energy generation, planning and transmission were done by the giant state-owned organisation Wapda, which had developed the country’s entire generation and transmission capacity since 1959. The country had plentiful and cheap resources available for hydel and coal-based thermal generation (contrary to what some believe, Pakistan’s coal is perfectly suited to
economically generate power).
It beggars belief that in a country with extensive hydel and coal resources — and with no oil and little gas — the government of the time chose to add more than 90 per cent of new capacity through oil and gas-fired power plants. These were to run on imported fuel and cost approximately two to six times more than the alternatives on a per-kilowatt-hour (kWh) basis depending on which hydel or coal project one compares against. Utilising the most expensive options (which were to become several times more expensive with escalating costs of oil) meant prices went several times higher too.
While third-world governments often sign such policies under pressure from multi-lateral agencies and to line their own pockets, they cannot alienate people completely by passing the entire cost on to them. In order to cover their incompetence and corruption, they find themselves covering some of the difference, passing which on is likely to bring people out on the streets.
Thus, when the government runs out of money, production stops and ‘circular debt’ builds up. Can this be attributed to a ‘subsidy’ to the people? If you let producers raise the price of sugar 100 per cent tomorrow, and then provide a 20 per cent subsidy, are you really subsidising the people? If anyone is being subsidised, it is the producer. This is exactly the case in Pakistan’s power sector. By choosing to buy power at exorbitant rates from IPPs and now RPPs, the government is burdening the people — not subsidising them.
Unfortunately, the story gets worse. Each time the government runs out of money to pay the so-called ‘subsidy’, it prints billions of rupees and taxes the people through inflation rather than trying to raise taxes from the rich (most of whom don’t pay their power bills anyway).
Let us now come to an even more fundamental way in which the ordinary taxpayer subsidises the power producers. Prior to the 1994 policy, the production of power was essentially a state-sector activity. The current policy delivered it to the private sector with the government claiming considerable credit for inviting foreign investment into the country. Now, while we are all for the private sector (indeed many of the world’s most inspiring and innovative companies are private) it still merits some scrutiny how this particular privatisation has fared.
Let us compare a typical 100MW thermal (oil-fired) power plant in the public and private sectors respectively. To keep things simple, let us assume it will cost $100m to set up a thermal IPP. Under the 1994 and 2002 power policies, 20-25 per cent equity has to be provided by the investor while the rest is financed through the banks against the backdrop of sovereign guarantees.
Interestingly, the government commits to pay for this 80-75 per cent bank-financing through the monthly tariff paid to the IPPs. Here is how: since banks typically charge the IPPs two to three per cent spread on top of government lending rates, a private power-producer will end up paying 15 per cent interest (in rupee terms) as opposed to 12 per cent that a state-owned one (e.g., a Wapda one) would have to pay. Assuming a 10-year equal repayment and no exchange rate variation, cumulative interest payments for the IPP will be approximately $56m while it will be approximately $45m in the public sector (a difference of $11m). Either way, the government will be financing both loans through its own coffers.
On top of that, the government pays an equity return of 15 per cent per annum for the entire 25-year life of the plant which comes to approximately $4m per annum and cumulatively $97m. So essentially, for the sake of the 25 per cent equity ($25m) which the IPP investors bring in, the government ends up spending approximately $83m (97 plus 11 minus 25) more through the life of a 100MW thermal IPP.
It is important to realise that the same equity return of $4m per annum that is paid to the IPP is enough to set up a 16MW power-plant every year in the public sector. However,
since the motivation was always rent-seeking rather than public welfare, expanding capacity in the much cheaper public sector was never really on the agenda.
Who, then, is subsidising who? Contrary to what highly eminent economists, policymakers and politicians have been propagating, it is in fact the people of Pakistan who have been subsidising the IPPs. If any subsidies are to be cut, it should be theirs’. Let us understand circular debt for what it really is and do away with the myths that are obscuring reality. And as for the government, it should be hiding its face rather than claiming credit for this elaborate plan to defraud the hapless people of this country.
Salman Khalid has managed investments in power generation in Pakistan, Turkey, Bangladesh and Saudi Arabia while Kamal Munir teaches strategy and policy at the University of Cambridge.