Invocation of sovereign guarantees

Mismanagement in the power sector cannot be explained better than the decision of four independent power producers (IPPs) on 15th June, 2011 to invoke sovereign guarantees for the recovery of their dues of over Rs 10 billion outstanding against NTDC/Pepco. The government, under its sovereign commitment with the four IPPs, Nishat Chunian, Nishat Power, Liberty Tec and Atlas Power, having a combined capacity of 800 MW, is bound to make payment on behalf of NTDC/Pepco within 10 days of receiving the final notice.
The failure of the government to meet the payment commitment will be deemed as "sovereign default" and affect Pakistan's international ratings. The companies could also stop energy production, adding to the growing electricity shortages in the country. The IPPs had served the first 30-day notice to the government on May 13 to start the process of calling sovereign guarantees for recovering their dues of Rs 16.5 billion. In response to the notice, NTDC/Pepco released Rs 6 billion, but failed to repay the remaining amount due to financial problems. While serving the final notice on the government, a director of one of the IPPs asserted that "we were constrained to invoke sovereign guarantees because NTDC/Pepco did not pay our dues, leading to the exhaustion of our credit lines with banks and leaving us with no cash for purchasing furnace oil to run our plants". Non-payment of dues to the IPPs could result in the disruption of fuel supplies and closure of their plants, which, in turn, could lead to the imposition of heavy "liquidated damages" on them under the contract.
We don't know whether the relevant authorities have taken a serious note of this alarming development but, in our view, the gravity of the situation demands immediate action as well as a firm resolve on the part of the government not to let such a crisis take root and hit the country again. The matter is of course highly critical for a number of reasons. Not only is the credibility of the government and its agencies at stake, the economy of the country will also suffer immensely due to loss of investors' confidence and the resultant flight of capital from the country. It is worth mentioning that foreign investment has already declined by almost 30 percent this year and such untoward incidents would be highly damaging for the future inflows of DFI and country's economic prospects. It also needs to be highlighted that investment in the energy sector is particularly important at this juncture because the supply-demand gap in electricity generation in the country is widening and both businessmen and ordinary consumers have almost lost their patience and are expressing their anger publicly through demonstrations.
The situation could become really chaotic if the four IPPs, who have invoked sovereign guarantees, cease production, adding to the gap by another 800 MW. KESC is already facing acute administrative problems and the residents of Karachi are highly restive at the moment due to their never-ending misery. The government must step in without any further loss of time and control the situation before it comes to the boil. However, the ultimate solution lies in making the energy sector financially viable on its own, or providing enough subsidy from the budget to compensate for the deficit in its accounts. Both these options are, of course, difficult to follow and pose various challenges, but there is no other plausible alternative to improve the conditions in the energy sector.
In the meantime, the government has to cough up Rs 10 billion from the budget somehow to meet its sovereign obligations, failing which it could be declared a defaulter or, in other words, untrustworthy in business dealings. It may, nonetheless, be mentioned that it is the second time in the history of the country that IPPs have invoked sovereign guarantees for recovery of their dues. Hubco, the largest power company, decided to do so in 1998. Luckily, the matter was resolved after the government paid off the money. Recurrence of such incidents is bad for the image of the country as a credible partner, both at home and abroad, and would have highly negative consequences for country's economy.