Research February 2020

Bretton Woods, their Programs and its effects on Power Sector

The history of IPPs and International Financial Institutions (IFIs) goes back to the inception of the first IPP in 1990’s with the incorporation of HUBCO Pvt Ltd. Since then, IFI mandated reform has affected economic decision making for all sectors of the economy. Currently the country is in the middle of two major IFI based programs i.e. $6 billion IMF program under the Extended Fund Facility and $1 billion ADB Energy Sector Reforms under Financial Sustainability Program Distribution. Both these programs are expected to affect the country’s power sector in major ways. Due to the interlinked nature of these programs the following discussion would analyze their combined impact on the energy sector. However, before delineating these effects, it is important to outline the relevant salient features of these programs that would ultimately change fortunes in this tumultuous sector.

ADB and IMF programs

ADB’s SPBL has three broad objectives for power sector that include: improving financial sustainability, strengthening governance and bolstering sector infrastructure. Under this plan, financial sustainability would be ensured through advanced notification of tariffs and introduction of take and pay contracts. Governance improvement initiatives would oversee appointment of appellate tribunals at NEPRA, separation of policy and regulatory functions in hydrocarbons, rationalization of competitive market road map, implementation of multiyear tariffs as well as unbundling of the gas sector. Lastly, the program would make sure that investments in energy and power infrastructure are made under guidance from the Integrated Energy Plan.

In comparison, the IMF program has a much broader scope and comprises of: rationalizing Market Exchange Rate, enforcement of AML/CTF[1] regulations, Curtailment of Power Sector Circular Debt and Initiation of SOE Reform. These broad goals will be achieved through delineating policy goals for the program and making the tranches of the 39-month long program conditional on Performance Criteria, Structural Benchmarks and Indicative Targets. The following Table lists down these conditionalities.

Performance Criteria
Target Limit Type
International Reserve Target Floor
Net Domestic Assets Ceiling
SBP Stock of Net Currency Swaps Ceiling
Net Government Borrowing from SBP Ceiling
Government Primary Budget Deficit Ceiling
Government Guarantees Ceiling
No flow of SBP credit to general government Ban
Indicative Targets
Target Limit Type
Cash Transfer Spending Floor
Net Accumulation of Tax Refund Ceiling
Spending on Health and Education Floor
Tax Refund Arrears Ceiling
Power Sector Arrears Ceiling
Structural Benchmarks
Target Limit Type
Track and Trace system for Excise on Cigarettes  Structure
BISP Banking Contracts  Structure
Financial Inclusion Strategy for Women  Structure
Circular Debt Reduction Strategy  Structure
Ban on Tax Amnesties  Ban
AML/CFT Framework  Structure

Source: First Review Under the Extended Arrangement Under the Extended Fund Facility and Request for Modification of Performance Criteria— Press Release; Staff Report; and Statement by The Executive Director for Pakistan

The Circular Debt Reduction Strategy[2] aims to bring down the annual flow of circular debt to Rs 50-75 Billion per annum by FY 2023 in comparison to the current flow of 465 Billion for FY 19. Elements of this strategy include: Reintroducing Surcharges[3], Streamlining Tariff Petitions, Improving Collection, Right sizing of Subsidies[4], Addressing Tax Refund concerns and Reassessing of Regulatory Measures[5].

In the same vein, the program has also envisioned a number of Policy Objectives for Fiscal, Monetary, Poverty-Reduction, Structural and Energy-Sector. In addition to reinforcing the conditionalities of tranches, these policy guidelines also provide a number of complementary suggestions.

Public Finance Management Bill, promoted as part of Fiscal Policy, will see tighter obedience to budgetary targets.

The Monetary Policy envisions a high interest rate that aims to keep inflation in check.

Energy Policy aims to reduce the debt servicing cost of Circular Debt by converting system debt into PHPL debt and then converting PHPL debt into Public Debt[6]. It is also expected that the proceeds from privatization would be used to reduce the stock of debt.

Structural Policy will see State Owned Enterprise Reform via Privatization, Audits and Triage of SOEs. Other components of the policy include Public Finance Management Act which will decree bi-annual review of budget. Moreover, the policy also recommends giving the government power to levy charges on top of the notified electricity tariffs.

This program would affect the Power Sector through a number of direct and indirect channels.

Effects on the Sector

Once the effects of this plan take place, the Power Sector has a number of reasons to look to a bright future. For starters, Power Producers can be expected to experience a better cash flow due to implementation of the Circular Debt Reduction Strategy. The conditions of this strategy mandates reduction in technical losses[7] and improvement in collection rate. Abiding with these conditions would increase the financial sustainability of the sector as a whole.

Similarly, SOE reform would open many doors towards private investment in distribution sector. Moreover, Renewables will find themselves at an advantage considering their competitive tariffs under the new Alternate and Renewable Energy Policy[8].  Renewable Energy Projects are mandated to access preferential financing under State Bank of Pakistan Financing Scheme for Renewable Energy.  Such low interest rates[9] will inevitably translate into lower levelized tariffs after accommodating for other modalities.

However, like any good change, this program also has a flipside. For starters, the government will be less generous when it comes to subsides. This is because of conditionalities of the IMF program give low margin for Primary Budget Deficit, limit conversion of SBP profits to the government and impose a ban on tax amnesties while mandating midyear budget reviews that make it hard to overshoot budget allocations.

Similarly, financiers are expected to miss their historical alacrity towards financing the power sector. This change in attitude comes under the specter of a monetary policy that prioritizes low inflation over low interest rates. Apart from high interest rates, the domestic banks will also see dwindling funds due to a bogged process of formalization of economy on account of AML/CFT regulations. These regulations increase the cost of transactions which inevitably promote cash transactions at the cost of availability of loanable funds in the banking sector.

Conclusion

Pakistan is in the middle of two IFI sponsored programs. These programs place targets and policy directions for the country. Targets include Structural Benchmarks, Indicative Targets and Performance Criteria. Policy implications include Circular Debt Reduction Plan. These Programs bring some sigh of hope for the Power Sector in the form of better cash flows and added boost to renewables. However, these perks come that cost of short-term hitches in securing subsidies and accepting high cost of finance.

 

[1] Anti-Money Laundering and Counter-Terrorism Finance

[2] The Strategy uses Economic Coordination Committee’s definition of Circular Debt that defines Circular Debt as all financial obligations that arise from (I) Delay in notification of Tariffs, (ii) Unbudgeted Subsidies and (iii) Technical & Distribution Losses.

[3] Giving government the power to make them part of the tariffs.

[4] Eliminating Unbudgeted Subsidies

[5] Allow tariffs to incorporate lower DISCO recovery ratios.

[6] PHPL debt carries a lower interest premium as compared to system vide debt while Public Debt carries the least amount of debt.

[7] 1% per annum

[8] Take and pay provision, after expiry of debt, will place them higher in the merit order.

[9] 6% for renewable VS (double-digit-KIBOR + spread).