Pakistan is currently on its twenty third International Monetary Fund (IMF) programme and faces the most stringent conditions relating to the power and tax sectors that it has ever faced – conditions agreed by the dismissed Dr Hafeez Sheikh and Dr Reza Baqir, the incumbent Governor State Bank of Pakistan (SBP), in February 2021 and which the incumbent Finance Minister Shaukat Tarin has pledged to renegotiate.
The reason for these harsh conditions: sustained failure (spanning decades) to improve power and tax sectors’ performance – failure that has reached critical levels today nearly three years into the Khan administration.
The power sector has performed particularly poorly 2018-2021 – a charge that is evident as the circular debt today is 2.4 trillion rupees (against 1.2 trillion rupees in August 2018) on the back of low receivables for electricity sold, high transmission and distribution losses, and failure to release the budgeted subsidies. The Prime Minister and his cabinet members have placed the entire onus on the agreements signed with the Independent Power Producers (IPPs) during Benazir Bhutto and Nawaz Sharif’s tenures that envisage: (i) capacity payments (irrespective of demand and the productive capacity given the steady depreciation of machinery), (ii) a fixed dollar rupee rate that has favoured the IPPs and last but not least (iii) an inordinate focus by the PML-N government (2013-18) on generation without taking account of the capacity of the transmission system to vacate the additional generation or the environmental aspects of the fuel (coal) to be used.
The PPP-led government established a Power Holding Private Limited (PHPL) in 2009 under the administrative control of the Ministry of Energy (Power Division) wholly owned by the Government of Pakistan with the objective of reducing power sector liabilities through borrowing from financial institutions. While initially the idea was to clear the loan within a stipulated period however to this day the loan amount continues to rise (through direct borrowing from banks or through issuance of Sukuk/Eurobonds - green or otherwise) with interest payments passed onto the consumers through higher tariffs. About 850 billion rupees are parked in PHPL and in December 2019 in the first quarterly review under the ongoing IMF programme the government agreed to “absorb PHPL into its budget, fully recognising the liabilities in PHPL as debt of the government of Pakistan and taking over the servicing of the loans contained in PHPL.” Previously, the debt was given a one off waiver in the budgets.
So what positive steps with respect to the power sector, if any, has the Khan administration taken during its tenure other than to blame previous administrations? It has made deals with IPPs that envisage savings on capacity payments that would be passed onto the consumers in the next decade or two – a step in the right direction but too little to make any dent in consumer tariffs. However not included are the projects under the China Pakistan Economic Corridor (CPEC) that were given the same incentives as the one’s the government recently renegotiated; and which account for the warnings by the West that: (i) China through CPEC is raising Pakistan’s indebtedness - projects largely backed by Pakistan government guarantees which may have accounted for the amendment to the fiscal responsibility and debt limitation (amendment) bill 2021 introduced in the National Assembly last month which proposed raising the limit on government guarantees from 2 to 10 percent of GDP; (ii) disregard of a project’s feasibility – environmental as well as the possibility of a negative impact on indigenous people. In this context Robert Ichord, nonresident senior fellow at Atlantic Council and former deputy assistant secretary for energy transformation, energy resources bureau wrote that “significant vehicles for Chinese government energy finance include the two so-called policy banks—the China Development Bank and the Chinese Export-Import Bank. A Boston University dashboard that tracks energy financing from these institutions reports US$19.098 billion in Chinese energy loans from these banks to Pakistan during 2014-18, mainly for nuclear, coal, and hydro projects.”
China has emerged as the major player in Pakistan’s ability to meet its debt obligations yet one would hope that the government changes the way the Public Sector Development Programme (PSDP) projects are selected – not on the whim of the country’s chief executive or the cabinet but on the financial, economic and environmental feasibility of a project which may be determined by calculating the economic and internal rate of return of projects and prioritizing those with higher returns.
The tax sector performance has also remained appalling in spite of a raise in total collections as reliance on the low hanging fruit continues which has implied ever-rising reliance on: (i) corporate tax which negatively impacts on output; (ii) indirect taxes in the sales tax mode including petroleum levy that has raised transport costs, a major contributory factor in food inflation which, in turn, places pressure on the kitchen budget of the common man; and (iii) personal income tax-payers continue to consist mainly of the salaried class while the rich landlords sitting in our assemblies remain exempt citing the constitutional provision disabling the centre from taxing farm income; however ignored is the fact that the provinces need to impose a tax on farm income that is commensurate to the income tax payable by the salaried class. Add corruption to this mix and Pakistan has one of the lowest tax-to-GDP ratios in the world. The newly-appointed finance minister has supported widening the tax net through third party audit of sales and income tax which if implemented would go a long way in widening the tax net.
However, irrespective of these disturbing ground realities which Shaukat Tarin would have to deal with in the budget there have been some significant changes in thinking. First off, the government for the first time has acknowledged that the pension system, which is absorbing an ever larger percentage of the total budget, needs urgent reforms; the major issue with our pension system is that employees do not contribute to it, it is budgeted and there is no dedicated pension fund that could become self financing. This needs to change however this cannot be achieved over-night as those who have retired would have to be grandfathered while new entrants into the system should be made to contribute to their pension funds. In addition, the danger of having a pension fund is: (i) an unscrupulous finance minister may well use it to reduce the budget deficit and in this context it may be recalled that Ishaq Dar did use dedicated funds for budget support; and/or (ii) the financial managers of the fund may make an inappropriate investment or the market may go in a downward spiral thus losing billions as has happened in several European countries. If pensions are rationalized and the system reformed it stands to reason that the pressure on the treasury would ease.
And secondly, the thinking that subsidies must be targeted to the poor and vulnerable has gathered momentum in recent years. This has been a long-standing demand of international financial institutions, and the Khan administration recently set up a subsidies cell that concluded that total subsidies are 2 trillion rupees per annum which constitute 4.5 percent of GDP and 58 percent of current budget (excluding interest payments). In the power sector alone there are distortions with the top 25 percent consumers availing 36 percent of the total subsidy and the bottom 20 percent enjoying only 10 percent of the subsidy. Its recommendations are: (i) subsidy on electricity be channeled through the ehsaas programme; (ii) subsidy to industries be targeted through elimination of industrial support package of 3 rupees per kWh from July 1, 2021 and suitably reducing burden on cross-subsidies on industries and settlement of arrears. Calculation of arrears and settlement of claims be finalised up to June 30, 2020 projected to save 75 billion rupees; (iii) for target subsidies and fiscal burden sharing, provinces be requested for 50:50 per cent sharing from July 1, 2021, which will save 45 billion rupees;(v) implementation on electricity pricing agreements (2018) reached with AJ&K through Nepra, which will save 15 billion rupees; (v) recovery ratio to be improved in merged districts of KP (ex-Fata) which will reduce flow of 12 billion rupees; (vi) adoption of national average electricity tariff by consolidating the accounts of Discos, minimizing electricity pricing slabs and subsidy to be distinctly identified on bills which will save 200 billion rupees; (vii) reduction in burden of capacity payments to IPPs through negotiation; (viii) settlement of circular debt and reform in power sector; (ix) elimination of losses and inefficiencies in Discos operations; and (x) align the structure of rates of returns with government debt auctions rates projected to save 91 billion rupees.
To conclude, there appears to be a change in the thinking which if implemented would go a long way towards resolving some of the sectoral issues that have faced successive governments including the present.
Copyright Business Recorder, 2021