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The fundamental premise upon which the foundations of modern-day economics stand is that resources are finite and therefore must be allocated to their most productive use.

However, our policymakers’ erroneous pursuit of political mileage over economic growth has guided resources towards low productivity uses. Electricity is one such resource.

As in most of the world, electricity tariffs in Pakistan are based on their end-use with separate tariff-categories for residential, commercial, industrial and agricultural consumers. Our prices, however, are not set to achieve the optimal allocation of resources.

Industrial users—whose productivity is highest in terms of value added per KWh consumed—have historically been charged substantially higher tariffs compared to relatively less productive residential and agricultural users.

In advanced economies and developing regional competitors like India and Bangladesh, industrial sectors are provided with competitive rates for electricity.

Energy is where structural reform must begin.

Pakistan’s total external debt stands at approximately $127 billion, and annual debt servicing costs are upwards of $18 billion. In FY23, we imported around $60 billion worth of goods and services, down from $80 billion in FY22 due to import restrictions. To pay for this, we exported only $35 billion worth of goods and services and received about $30 billion in remittances. The difference was borrowed.

The only way out of this chronic cycle of external balance crises is to build a strong and sustainable export base. But standard models of international trade tell us that this is practically impossible without providing industry with competitive energy tariffs.

A firm’s decision to export is based on a cost function which comprises costs of fixed capital, raw material, wages, and factory overheads, including electricity to power production equipment. It decides to export only if its total cost of production is less than the international price of the goods it produces.

If the cost of an input increases beyond a certain threshold that pushes the total cost above international prices, it is unable to compete in the international market andexits the export sector. When multiple firms face the same dynamics, the export sector is crowded out, with a subsequent reduction in exports and further implications for the aggregate economy.

Figure 1 illustrates how Pakistan’s textile sector is being similarly crowded out.

In 2020, the government provided export firms with a regionally competitive energy tariff (RCET) of 9 cents/KWh under which exports increased from $27.9 billion in 2020 to $39.4 billion in 2022. In October 2022, RCET was converted to a rupee-based fixed rate of Rs 19.9/KWh and subsequently withdrawn in March 2023. With electricity costs accounting for 30-40% of conversion costs, this caused over 30% of Punjab’s textile industry to cease production and another 25% is expected to shut down by August if business as usual continues, increasing the number of laid-off textile workers from 4.3 million to over 7.8 million—approximately 10% of Pakistan’s total workforce.

If we are to take the economy out of this vicious cycle of crisis after crisis, a sizable and sustainable increase in exports is immediately needed. This requires a continuous commitment to support exporters through all possible means.

The prevalent argument against government support is that exporters should no longer benefit from government subsidies, and that such subsidies are not compliant with the current IMF Stand-by Agreement (SBA).

This is simply not true. First, the provision of competitive energy tariffs is not a subsidy because it involves no transfer or discount from the government to the industry on the actual cost of service, which includes power generation, transmission and other applicable costs. What the cost-of-service tariff does exclude is economic inefficiencies like stranded costs, cross-subsidies to lifeline consumers and distribution losses—all of which are penalties on the government and power-sector’s own inefficiencies, both past and present, that consumers are now having to pay for.

Second, even if this were an actual subsidy, the IMF programme only prohibits untargeted and unbudgeted subsidies. Since cost-of-service tariffs would only be provided to exporters, they are indeed targeted.

To make them fully compliant, the government must spread the resulting revenue differential of Rs 100 billion over other consumer categories. This represents an upper bound increase of Rs 2/KWh that should be loaded towards high-end residential, commercial and non-exporting industrial users.

Compared to the Rs 7.5/KWh increase already recommended by Nepra, the short-term costs of an additional Rs 2 hike are heavily outweighed by medium- and long-term benefits. First, it will enable the resumption and expansion of export industries.

This will bring in much-needed foreign exchange and secure the economy’s external position, build resilience against exchange rate shocks and pass-through inflation, provide productive employment, and attract investment. It will also serve as an incentive to divert investment away from less productive non-export sectors towards export-oriented sectors—further reinforcing the first-order effects discussed above.

Rationalization of power tariffs with an export-oriented outlook is one of those “difficult decisions” that the government has repeatedly asserted it is willing to take for the betterment of the economy. It is now time to walk the walk.

Copyright Business Recorder, 2023

Author Image

Shahid Sattar

PUBLIC SECTOR EXPERIENCE: He has served as Member Energy of the Planning Commission of Pakistan & has also been an advisor at: Ministry of Finance Ministry of Petroleum Ministry of Water & Power

PRIVATE SECTOR EXPERIENCE: He has held senior management positions with various energy sector entities and has worked with the World Bank, USAID and DFID since 1988. Mr. Shahid Sattar joined All Pakistan Textile Mills Association in 2017 and holds the office of Executive Director and Secretary General of APTMA.

He has many international publications and has been regularly writing articles in Pakistani newspapers on the industry and economic issues which can be viewed in Articles & Blogs Section of this website.

Comments

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Azeem Hakro Jul 27, 2023 09:56am
Providing exporters with direct subsidies, such as tax breaks or grants. This would be a more targeted approach than providing competitive energy tariffs, and it would ensure that the benefits of govt support are actually reaching the intended recipients. Reducing transmission and distribution losses would make possible to provide competitive energy tariffs to all consumers, including exporters. Govt should seek a small number of export destinations, and it would make it easier for exporters to compete in the international market. Modernizing the power grid would improve the efficiency of the power sector and make it easier to deliver electricity to consumers.
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Tariq Qurashi Jul 27, 2023 10:27am
Given the central importance of textiles in our export earnings, anything that kills our textile industry is likely to sink our economy. In many countries industrial electricity rates are half those of domestic consumers; here it is the reverse. We cannot have our export industries subsidizing electricity theft, circular debt, and line losses. In addition many of our export industries are struggling to import raw materials, machinery and spare parts. Some immediate steps that need to be taken are that industrial zones must be exempt from electricity and gas load shedding. The electricity rates for export industries need to be rationalized; as mentioned above, the IMF should have no objections. In addition the import of raw materials, spare parts and machinery for our export industry need to be given high priority. Reducing your balance of payments deficit by restriction the import of raw materials for our export industries is just short sighted and rather incompetent.
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Power Master Jul 27, 2023 05:10pm
Cost of electricity so high due to theft by elites. Not possible to control this. Future is doomed
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Investot Jul 28, 2023 09:02pm
Some of the figures you wrote seem wrong. Like exports in 2022 were not $39 billion.
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Qasim Jul 28, 2023 11:36pm
@Azeem Hakro, sorry, but tax benefits from the Pakistan government do not work. They have implemented a zero sales tax system where the exporter pays the sales tax which is supposed to be refunded but it isn't, or at least it is not done on a timely basis. Pakistan's industry is the largest tax paying sector, and the government does everything it can to screw over the productive people on society. Are energery rates are so high because the government gives itself free electricity which the general public along with industry has to subsidize. If the government is serious about ending subsidies, then it should start with itself first!
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