In Gordium, the capital of Phrygia (ancient Greece), legend had it that whoever could untie an oxcart tied by a complex knot would rule all Asia. Famously, in 333 BCE, Alexander the Great untied the knot, not by untangling it, but by cutting through it.
This article advocates cutting the Gordian Knot of our purchasing power agreements (PPAs) with Independent Power Producers (IPPs), by nationalising the IPPs. This would lower electricity tariffs, which now threaten civil order, and solve the problem of circular debt, once and for all, albeit at an upfront cost.
The mechanics are straightforward. A ‘Power Sector Nationalisation Ordinance, 2023’ can be drafted and promulgated in less than eight weeks of decision. The Ordinance would specify its coverage and provide for owners to be compensated by suitably structured federal government bonds (or sukuk), but only on the basis of a comprehensive, reliable audit, preferably forensic, of their accounts.
No other compensation should be allowed. It would provide for orderly transfer of their boards and management, under a newly defined mandate, and include an Orderly Nationalisation Framework, drawing on the 1998 Orderly Framework for IPP Negotiations.
Other provisions to facilitate implementation and remove difficulties should be provided. The aim should be to unlink all indexing to dollars, shift all commercial risks from government to investors, strictly restrict sovereign guarantees to political risks only, and align the target return on equity to global norms.
Based on careful study of all contracts, the Ordinance should cover all IPPs whose PPAs contravene these aims: around 40 IPPs (of the 247 currently licensed), of which only 10 comprise 60-70pc of the sector.
No doubt, the IPPs cartel would resist this. But let us first look at what would be accomplished if such an Ordinance could be passed. Reportedly, (ET, 29 August), the government is committed to pay Rs 1,300 billion (roughly $4.3 billion) in capacity payments to idle IPP plants in the current fiscal year.
If promulgated by say end December, over half this amount (roughly 9pc of the budgeted federal deficit this year) would be saved and the average consumer’s monthly electricity bill would be reduced by perhaps 25-35pc.
More significantly, the Ordinance would lay to rest the problem of so-called Circular Debt that has bedeviled public finances and the national economy since 2006. This unfortunate term, sanctified by the Economic Committee of the Cabinet in 2014, misleadingly suggests that these debts arise from a shortage of liquidity to settle offsetting obligations.
In fact, they are structural debts that arise from the incentive (“security”) package offered by governments to IPPs in the early 1990s. These agreements tie successive generations of the people of Pakistan, for 25-30 years, to providing inputs (fuel oil, natural gas, and coal) to IPPs effectively at rupee-indexed prices, while paying for their installed capacity and electricity generated in dollar-indexed prices.
This deceptive, fraudulent asymmetry in the structure of PPAs, along with numerous other unjust provisions, ensures that governments will go on accumulating rising debts to the IPPs, as prices, interest rates, and foreign currency exchange rates rise.
They must then recover these from citizens through increases in tariffs and taxes that now threaten to outstrip their incomes, as well as through improvements in technical and commercial efficiency. These contracts are unconscionably unfair and inequitable.
This structural debt, created by failing to fulfill obligations under these PPAs, is reportedly (PT Profit, 16 August), around Rs 2,310 billion (roughly $7.7 billion) today. This should be offset against a final settlement with the IPPs.
What would be the upfront cost of this nationalisation? There are well-established ways of valuing an acquisition, which yield a range of values for each unit, within which a price can be negotiated. While easy for the government to estimate more precisely, as a rough-and-ready estimate by an outsider, it seems reasonable to budget for up to Rs 5,400 billion (roughly $18 billion) in compensation, payable over 20-30 years. Profits realised so far, especially by the older IPPs, have been astronomically high.
Under accepted legal standards of “fair, just, and equitable” compensation, these IPPs may well have to pay rather than receive compensation. The final figure, therefore, may be much lower. (A delay in settlement, due to delay in provision of accounts and their audit, would provide unintended liquidity to a government in financial difficulties.)
The Nationalisation Framework, under the Ordinance, should provide for the issue of Notices of Intent to Nationalise, declaring a moratorium on interest payments and preventing companies and lenders from untoward legal steps to protect their rights under the agreements, as was done in 1998. Most IPPs are now owned by citizens (even if dual citizens), so all disputes should be subject to domestic courts.
As precedent, local courts successfully restrained Hub Power Company from recourse to international arbitration in 1998. In the unlikely event that a legal jeopardy exists in some contracts, we have recourse under international and foreign municipal laws to several pre-emptive measures, best left unspecified for now.
This concludes the case for nationalisation, but concurrent efforts would also be needed to reimagine the future design and functioning of the electricity sector, after nationalisation. This would call, above all, for a change in the mindset of policymakers, who have been indoctrinated over the last thirty years in the theoretical, unquestionable virtues of deregulation and privatisation. But in reality, the textbook paradigm of reforms has failed in Pakistan mainly because the regulatory and antitrust systems needed to break up monopolistic cartels and promote competition, essential for its success, do not exist.
Consequently, none of the expected gains of increased efficiency, improved service quality, and reduced costs and consumer tariffs, have materialised. It is high time, therefore, that we move from ideology-based to results-oriented reforms. The World Bank admits as much (Rethinking Power Sector Reform, 2020):
“During the 1990s, a new paradigm for power sector organization emerged from the wider ‘Washington Consensus,’ a term coined in 1989. Multilateral institutions spearheaded the new paradigm across the world, and it rapidly took hold... Marked by 10 neoliberal policy recommendations, the era featured two policies that were particularly relevant to the power sector—namely, the privatization of state-owned enterprises (SOEs) and the abolition of regulations restricting competition… the World Bank and the International Monetary Fund, played prominent roles in diffusing market ideas throughout the developing world… [But the] prescriptions of the 1990s reform model were primarily derived from economic theory and principles. By the early 2000s, it had become clear that the model was not universally applicable in practice.”
The design of a practical, reality-based, results-oriented middle path between the old WAPDA/KESC system and the current state of disorder is a complex technical task which should be entrusted to a committee of experts.
They should draft a roadmap of common-sense reforms, which should constantly be reviewed and revised in the light of experience. The proposed Ordinance should be the first step toward the new system. But to succeed, not just in the power sector but in overall economic reforms, governments must abandon the blind pursuit of theoretical paradigms, unmindful of consequences, and make policy by rational trial-and-error. “Cross the river by feeling the stones,” as the Chinese say.
Copyright Business Recorder, 2023
The writer has served as Senior Economist with the World Bank in the 1970s and as the Chief Economist of the Government of Pakistan in the 1980s. This article draws on a larger paper, Social Origins of Debt Crises, available at: https://tinyurl.com/tv4ebjjz