Managing

Circular Debt

APRIL 2015

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Introduction

Introduction
This working paper addresses the CD issue in the Pakistan power sector and describes a
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mechanism to: (i) maintain a cap of Rs. 280 billion on the CD (ii) reduce circular debt and (iii)
reduce PHCL debt by FY2018. CD is the amount of payables within the Central Power
Purchasing Agency (CPPA) that it cannot pay to power generation companies (Independent
Power Producer (IPP), government owned thermal generation companies (GENCOs), the
hydropower producer (WAPDA Hydel) and National Transmission & Despatch Company
(NTDC).

Major Contributors to Circular Debt

The major sources and contributors of buildup of CD are as follows.

Sector inefficiencies

The sectors inefficiencies stem from DISCOs having higher levels of losses and lower levels of
collections than those allowed by the regulator. Some DISCOs are at or close to the NEPRAdetermined levels of losses and collections. Less well performing DISCOs experience levels of
losses that are up to 5-10% worse than those allowed, and of collections that are up to 20-30%
lower than the 100% recovery assumed by the regulator, as owner of these entities. In FY
2014, sector inefficiencies added Rs. 88 billion to CD and accounted for Rs. 60 billion for FY
2015 up to March 2015.

Discrepancies in tariff regime

Beside sector inefficiencies noted above, tariffs do not capture the full cost of supply of
electricity. Factors include delay in determinations, late payment surcharge and cost of debt
servicing.

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Introduction

Fiscal requirements and government performance

Some costs are imposed on the DISCOs by virtue of government policy like subsidies for
domestic consumers, users of tube wells etc. To compensate, the government provides
subsidies to DISCOs. However, these subsidies are sometimes under budgeted or provided
late which increases the CD.

Government Objectives and Strategy for Tackling CD

The objective of the GOP is to have a financially self-sustaining power sector to support
economic growth which implies the elimination of the CD. To that end, GOP will pursue the
following strategies:
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Improved Efficiencies. The strategy for improving efficiency is based on a gradual

decrease in the losses and increase in the collections from consumers. Working on the
same strategy, collections have seen an improvement in FY 2015 in the range of 8991% as opposed to the previous rate of recoveries in FY 2014 of 87%. Losses reduced
by 0.5% in the same period. The plan for management of CD until the end of FY 2018
is based on the same strategy and principles. Incorporation of subsides properly in the
budget to reflect the bulk.

Surcharges: Surcharges are levied under Section 31(5) of the Regulation of Electricity
Generation, Transmission and Distribution Act 1997 (the NEPRA Act). Surcharges will
be set at the level that will rationalize subsidies and allow recovery of full cost of supply
such that the flow of CD is eliminated by FY 2018.

Privatization Receipts: With the majority of DISCOs in the privatization plan of the
GOP, will help elimination of contribution of privatized entities towards circular debt will
help reducing it.

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Dealing with Sector Inefficiencies

Dealing with Sector Inefficiencies

Technical and Non-technical Losses
Table 1 shows a comparison of losses that the regulator has allowed in the determination for
each company.

Table 1: Comparison of Losses in FY2014 and FY2015

LESCO

GEPCO

FESCO

IESCO

MEPCO

HESCO

QESCO

PESCO/
TESCO

SEPCO

Total

11.75%

9.98%

9.50%

9.44%

15.00%

20.50%

17.50%

26.00%

27.50%

15.13%

Actual Losses
(% ) FY 2015

10.8%

11.2%

9.1%

9.8%

15.7%

27.9%

23.5%

37.4%

36.5%

18.5%

Losses (%)
FY 2014

9.01%

9.98%

9.50%

9.45%

15.00%

15.00%

18.00%

20.00%

17.00%

13.05%

Description
Allowed Losses
(%) FY 2015

Action Plan: NEPRA issued the tariff determinations for FY 2014 for most of the DISCOs in
last quarter of 2014-15. In the short term there is little that can be done about the flow because
the tariffs have been determined. NEPRA as a condition of its determinations requires DISCOs
to conduct a study on technical losses to justify the need for increase and to set out future loss
reduction initiatives, to be conducted by independent consultants. For the purposes of CD
management plan, a loss reduction of 0.5% per year is assumed starting from FY 2016. A
0.5% reduction in losses will reduce the flow of CD from Rs. 31 billion per year in FY2016, to
Rs. 13 billion in FY2018 based on assumptions of increased supply of electricity.
The privatization program will also be likely to reduce excess line losses, to the extent of the
companies that will be privatized.

Low Collections by DISCOs from Consumers

Collections from private sector in most of the DISCOs have been an issue which contributed to
the buildup of CD. Actual recovery fluctuates between 89-91% for the current financial year.
The plan is divided into three parts. For all distribution companies, recoveries will be managed
through supply based on AT&C.

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Dealing with Sector Inefficiencies

The second part of the plan is to outsource to the private sector collections of bills in areas
where recoveries are weakest, based on the same categorization mentioned in the preceding
paragraph.
The third part will address collection of Federal and Provincial government bills. For all Federal
accounts, MOWP will notify DISCOs that non-payment beyond the billing cycle of 45 days
should result in disconnection, per commercial procedures.

Tube-Wells
For ensuring receivables from agriculture tube wells consumers in the country, a summary has
been approved to the ECC defining payments by subsidized consumers and share of provincial
and Federal governments.

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Discrepancies in Tariff Regime

Discrepancies in Tariff Regime

Policy Induced Debt
Leading up to 2008, DISCOs borrowed for operational costs which NEPRA did not allow to be
recovered through the tariff. This debt is now in the process of being transferred to DISCO
balance sheets. The loans have tenors ranging from 5 to 7 years with reschedule and rollover
options and interest payment rebates if payments are made promptly.
To arrest the flow of circular debt arising from servicing of the debt, the collection will be made
through tariff.

Late Payment Surcharge

Another cost not considered by the regulator while determining the cost of service is the late
payment interest (Kibor + 4%) imposed by the IPPs as per their power purchase agreements. It
becomes due if payments for capacity or energy components are below invoiced amounts.
Since the sector recoveries are to the tune of 89-91% from consumers, IPPs have often
received short payments. For FY2015 the regulator has allowed the cost of late payment
surcharges to be recovered from the consumer tariff which is estimated to off-set the amount of
buildup on account of late payments to generators.

Delays in Tariff Determination

Delays in the annual tariff determination for DISCOs stem from late submission of tariff
petitions by DISCOs and the time it takes for NEPRA to conduct the determinations.
The privatization program is expected to reduce the problem because the cost of delays will be
managed by DISCOs by DISCOS who have shifted to the MYT procedure, with the first three
to five Discos expected to move in the first year. The MYT procedure reduces the workload in
NEPRA in the longer run, thus allowing faster determinations, and in intermediate years
adjustments to tariffs are formula-based and thus do not require lengthy determination periods.
For its part, GOP will increase its supervision of those DISCOs it continues to own to ensure
that they are prompt in submitting tariff determinations and are responsive to any further
requirements of NEPRA.

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Fiscal Requirements

Fiscal Requirements
Tariff Differential Subsidy
Late payment of subsidies impacts buildup of CD. Subsidies which are under budgeted or
where the budget amounts are breached due to external factors like court cases, add to the
buildup of CD. It is government policy to focus tariff differential subsidy (TDS) on residential
connections consuming up to 300 kWh/month which now account for about 76% of the TDS
and for which GOP intends to budget fully. The GoP will ensure that budgeting of subsides is
sufficient such that it does not contribute to the flow or build of CD.
The balance of the TDS has historically been used to maintain uniform tariff for all DISCOs and
the NEPRA determined average tariff cannot be reached unless surcharges are allowed. Thus
under uniform tariff, only the minimum determined tariff can be charged.
The government intends to shift the cost of the uniform tariff from the TDS budget. For all tariff
categories where subsidies are zero, an equalization surcharge has been levied the proceeds
of which are used to fund the uniform tariff policy.
Flow: There will thus be no incremental flow to the CD from this source.

Azad Jammu and Kashmir (AJ&K) Supplies

AJ&K receives power in bulk from three distribution companies: IESCO, PESCO and GEPCO.
Currently AJ&K pays concessional tariff under Magla Raising Agreement against the GOP
notified tariff. To stop increase in the flow of CD on account of AJ&K supplies, following two
options are being explored:
Option A: The difference between AJ&K tariff and determined tariff will be taken up under tariff
petition of WAPDA to NEPRA.
Option B: To review the revise applicable concessionary tariff.
The outstanding stock will be picked up by GOP in Federal Budget over a period of three years
starting from FY2016.

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Fiscal Requirements

FATA Supplies
GOP has split out Tribal Electricity Supply Company Limited (TESCO) from the original
company PESCO to determine its billing and subsidy requirements. TESCO is now an
autonomous DISCO and manages its operations independently in that area. GOP policy is that
the cost of supply to residential consumers of FATA will be picked up.
The subsidy sharing arrangement will be presented in the ECC after which Federal
government subsidy on account of TESCO will be budgeted by the government for next tariff
determination cycle. In a scenario where recoveries remain lower than the expected 25%, GOP
will review and revise the subsidy sharing mechanism in the next year (FY2017) and pick up
any additional liability to zero out FATA receivables and its accumulation on CD by moving a
revised summary in ECC.
Considering the current social economic situation in the area, this paper assumes that GOP
may pick up the entire billing on account of FATA.