CIRCULAR DEBT IN PAKISTAN

2011

IQRA UNIVERSITY

CIRCULAR DEBT IN PAKISTAN

SUBMITTED TO: DR. ABDUL WAHEED DATE OF SUBMISSION: 4 NOV, 2011

SUBMITTED BY: HIRA NOOR ASRA OBAID ASMA UROOJ SAMEER AHAD HAQ

CIRCULAR DEBT IN PAKISTAN

2011

ACKNOWLEDGEMENT

We are deeply indebted to our instructor Dr. Abdul Waheed whose help, stimulating suggestions and encouragement helped us in writing this report.

CIRCULAR DEBT IN PAKISTAN

2011

TABLE OF CONTENTS
INTRODUCTION TO CIRCULAR DEBT ............................................................................. 5 HISTORY OF CIRCULAR DEBT .......................................................................................... 5 ANALYSIS OF CIRCULAR DEBT ........................................................................................ 6 CAUSES OF CIRCULAR DEBT ........................................................................................... 6 1) OUTSTANDING BILLS OR PAYMENTS ....................................................................... 6 2) TARIFFS AND SUBSIDIES ............................................................................................ 6 3) LIQUIDITY TRAP ........................................................................................................... 7 4) IMPORT AND EXPORT (TRADE BALANCE) ............................................................. 7 5) GOVERNMENT POLICY................................................................................................ 7 CURRENT SITUATION OF CIRCULAR DEBT IN PAKISTAN ......................................... 8 MEASURES TAKEN BY THE GOVERNMENT .................................................................. 9 IMPACT OF CIRCULAR DEBT ON PAKISTANS ECONOMY ....................................... 10 1) COMPROMISED BALANCE OF PAYMENT ............................................................... 10 2) DEPRIVED FOREIGN RESERVES .............................................................................. 10 3) EFFECTED GDP ............................................................................................................ 10 4) INCREASED LOAD SHEDDING .................................................................................. 11 5) SHORTFALL OF CASHFLOWS IN ENERGY SECTOR .............................................. 11 6) DECREASED INDUSTRIAL OPERATIONS ................................................................ 11 7) SOCIAL EFFECTS ......................................................................................................... 11 8) INCREASED PRICES .................................................................................................... 11 COMPANIES MOST AFFECTED BY CIRCULAR DEBT ................................................. 12 RECOMMENDATION .......................................................................................................... 12 CONCLUSION ....................................................................................................................... 13
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CIRCULAR DEBT IN PAKISTAN

2011

EXECUTIVE SUMMARY

Circular debt is a persistent and a growing problem of Pakistan. Especially circular debt is striking the companies related to oil and gas. The circular debt of Pakistan has reached up till Rs 258.5 billion i.e. 1.5 times the last year and is increasing monthly at the rate of Rs. 5 to 10 billion. The major reason of the circular debt is that in 2006 PEPCO, a core entity in energy sector was not paid its payments and so it was forced to take loans from bank to meet its expenses. It started delaying its payments to IPPs. As a result IPPs started taking loans from bank in 2007. In 2008 IPPs payable to OMC especially PSO started building up and so the OMCs and refineries started taking loans from bank as OMCs delayed payments to oil refineries. The most affected company is OGDCL as it has least amount of payables but highest amount of receivables i.e. Rs 115.5 billion. It is unable to even survive now.

Though government has taken various steps like in May 2010 the government attempted to reduce the circular debt of more than Rs 150 billion by issuing Rs100 billions UK bonds, and it also issued Treasury Bills but still it this circular debt is building up. The whole economy is affected due to circular debt. The economy is giving less output then it should be giving, load shedding is increasing which makes the conditions more worse.

Objective of this report is to explain the circular debt issue and evaluate various policy options for its resolution. We also develop a basic understanding of circular debt in the energy sector; we also discuss its causes, recent situation of circular debt, implication, industries beaten worst, and then recommendations and conclusion.

CIRCULAR DEBT IN PAKISTAN

2011

INTRODUCTION TO CIRCULAR DEBT

It is occurs basically in a condition in which a string of creditors and debtors exist in a manner such that the net final creditor in the string is indebted to the first creditor.

EXAMPLE: Circular debt could also explain by the example, three persons are indebted, Mr. A owes Rs 100 to Mr. B and Mr. B owes same amount to Mr. C and Mr. C owes Rs 100 to Mr. A. According to the current situation the net balance of all debts in between the three persons is zero.

Further explanations: Something that exists facing the issue in their cash inflows holds back payments to its creditors and suppliers. Therefore, issues in the cash inflow of one entity cascade down to other section of the payment chain. In Pakistan, the energy sector has faced this problem for separate years. HISTORY OF CIRCULAR DEBT: Circular debt is the term was coined approximately two years back when due to managerial inefficiency in the power generation and dues collection system, the oil marketing companies, refineries and the power generation organizations got involved in an inter circular debt mechanism where companies in these sectors very comfortably passed. Pertaining to money matters crunch took heavy on the corporate sector. By August 20, the inter-corporate circular debt crossed over Rs 400 billion. Oil firms expressed their inability to make sure smooth supplies in the days ahead and independent power producers (IPPS) were running at less than their generating capacity because of financial crunch to purchase fuel partially, because of previous government`s dilly-dallying on major economic decisions and mainly because of current government`s pre-occupation with political crisis, it is hard to take even day-to-day decisions in a prudent manner finding by the administration. The IPPs threatened to declare force and call government`s sovereign guarantees. The government has started eliminating subsidies. Receivables of the Pakistan Electric Power Company (Pepco) and its allied power organizations have gone beyond Rs 150 billion in 2008. Karachi Electric supply company has been holding over Rs 56 billion payments to Pepco while arrears payable by Federally Administered Tribal.
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2011

ANALYSIS OF CIRCULAR DEBT

CAUSES OF CIRCULAR DEBT The circular debt is emerged due to the following main reasons:

1) OUTSTANDING BILLS OR PAYMENTS: Our energy sector is the main area in which the circular debt is emerging more day by day. Many entities and various private and public sectors like PIA (Pakistan International Airline), Pakistan Railways, Pakistan Steel mills, the departments of federal and provincial government etc, are defaulted to pay huge electricity bills which are in billions of rupees. For instance, PSO (Pakistan State Oil) is the largest supplier of furnace oil to the power sector to whom many public and private sectors of power producing companies has to be paid more than Rs.100 billion outstanding and in return PSO itself has to pay around Rs.95 billion to its suppliers within the country which are various oil refineries and other foreign suppliers as well. So, the situation is getting more critical because of delaying in payments or we can say that the improper flow of cash is one of the main causes of circular debt in the country.

2) TARIFFS AND SUBSIDIES: Government is unable to pay the power tariffs to electricity companies like PEPCO and KESC which are the main suppliers or power distributing companies in Pakistan. Government is also unable to facilitate them by providing subsidies to these large power distributing companies and because of that, these companies are further unable to supply more electricity and give payments to their own suppliers, which increases the ratio of circular debt in a huge amount.

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2011

3) LIQUIDITY TRAP When people expected rate of return from investments in securities and other assets become low then recession begins and investments go down, people avoid investing in businesses and try to hold the cash continuously, their spending becomes low. By holding money rather to spend on businesses, circular debt increases due to lack of supply of money in the market as the ratio of savings in banks increases.

4) IMPORT AND EXPORT (TRADE BALANCE) : Another big cause of circular debt is import and export. Import and export itself is not the reason behind

circular debt but the rapid increase in the amount of the import rather than export caused the circular debt. As exporters are not facilitating and due to shortage of gas, electricity etc, the exports of the country is decreased. Higher amount of import leads the federal reserves to be getting low which further leads the government to take loan from IMF (International Monetary Fund) and World Bank which caused the country is in huge debt. Moreover, to get loans from IMF and World Bank in a massive amount is one of the main causes of inflation in the country.

5) GOVERNMENT POLICY: As we know that the main problem of circular debt is largely aroused in the energy sector. The wrong government policy and mismanagement is also the apparent cause of circular debt in the
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2011

energy sector. The exporters are also not facilitating properly by the government so that they can be able to increase the amount of exports of the country. There is no sustainable job like making dams to produce more electricity in a country which can further helps a country to export more and reduce its debts. Due to lack of proper management and Self consideration or Party consideration of the government rather than Nation consideration unable the government to think better for the country which leads the country is in circular debt.

CURRENT SITUATION OF CIRCULAR DEBT IN PAKISTAN

The power crisis and circular debt both are interlinked issues that cannot be resolved unless all the consumers, stakeholders, power generation and distribution organizations and the government decide to resolutely resolve them in a comprehensive manner. Total capacity installed Pakistan has roughly 18,500 mega ward (MW). Around two-third 12,500 MW (against a minimum demand of 12,500 MW) is generated. Around 6,500 MW of hydro-electricity can be available provided the hydro-electricity generating units work to their full potential. Due to shortage of water in dams just one-third hydro-electricity generated now. Because of the shortage Oil and gas units cannot generate electric power according to their capability, which is primarily due to circular debt. Because of high cost of raw material the cost of electricity generated from Gas and Oil is also very much high.

Currently the situation of circular debt is very critical in Pakistan and the amount of circular debt is substantially increased by this year in power sector. Recently, on the energy crisis the special parliamentary committee was informed that the circular debt in power sector is reached Rs.664.52 billion.

Following are the receivables and payables of some of the major stakeholders which are currently facing or suffering from circular debt: S. NO. 1. 2. 3. 4. STAKEHOLDERS PEPCO KESC PSO IPPs RECEIVABLES Rs.299 billion 14.3 billion Rs.133.541 billion Rs. 775.2 billion PAYABLES Rs.367 billion Rs.32 billion Rs.139.169 billion Rs.516.7 billion
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2011

 MEASURES TAKEN BY THE GOVERNMENT: Government is trying not to do any more requests for IMF program and has taken the following solid steps or measures to resolve the issue of circular debt on sustainable basis:

i.

By issuing Treasury Bills (TBs) and Pakistan investment bonds (PIBs) through banks in the country, the Federal government has announced to resolve the issue of circular debt. The Pakistan investment bonds and Treasury bills both, worth of Rs.195 billion has been issued by State Bank of Pakistan.

ii.

In May 2010 the government is once again attempting trying to reducing the circular debt of more than Rs 150 billion by issuing Rs100 billions UK bonds with a cut-off yield of nearly 12.7 per cent as is on Pakistan Investment bonds.

iii.

The government has decided that Pakistan would have to pay off $1.2 billion to the IMF in the third and fourth quarter of the ongoing financial year to reduce the amount of debt.

iv.

The government is also thinking to privatize the Pakistan Railways to reduce its expenditures, so that, they can be able to manage debt.

v.

From many of the defaulted private consumers, the PEPCO is being persuaded to recover its dues as soon as possible because PEPCO is one of the major stakeholders in energy sector.

vi.

On electricity bills, a special surcharge from consumers is considering to be imposed by the government but the high court has given the order of stay for now.

CIRCULAR DEBT IN PAKISTAN

2011

IMPACT OF CIRCULAR DEBT ON PAKISTANS ECONOMY

Persistent increase in circular debt has caused a snow ball effect of devastation and destruction in the economy of Pakistan. Its some of the adverse impacts are discussed below:

1) COMPROMISED BALANCE OF PAYMENT: Pakistans oil and energy sectors are under burden of heavy debt and are not receiving its payments as well. Due to this debt which is increasing monthly at the rate of Rs. 5 to 10 billion and up till now has touched Rs. 258.5 billion i.e. 1.5 times the last year, these energy and power sectors are cutting back their production and are not generating to its full capacity. As a result, the economys need for energy like petroleum products is fulfilled by imports. These higher imports are compromising Pakistans balance of payment. Dawn reported that; In May 2010, oil marketing companies imported 1.4 million tons of oil products, which is the highest monthly imports ever witnessed by the country, said Farhan Mahmood, an oil expert and analyst at Topline Securities, adding that it is 34 per cent higher than average monthly import of one million tons so far in this financial year.1

2) DEPRIVED FOREIGN RESERVES: Due to increasing prices of oil, Pakistan had to rush for loans to IMF in 2009. These loans depressed Pakistan foreign reserves. Moreover, loans by IMF dragged the growth of Pakistans economic growth towards retardation.

3) EFFECTED GDP: Circular debt has adverse effects on potential GDP. This is because energy sectors are producing less power o giving less output to maintain its cash flows. This reduced power generation is reducing Pakistans GDP because unavailability of power creates many constraints in the operations and other companies are also unable to produce to its full potential. The growth in

Iqbal, S. (2010), Domino effects of circular debt, The Dawn Pakistan

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2011

GDP was expected to be 2.5% which is less than the actual target of 4.5 %. The major reason of not achieving this target was the circular debt crisis in energy sector and due to devastation of crops caused by flood.

4) INCREASED LOAD SHEDDING: As mentioned above, due to circular debt energy sector is producing less power. This is because it has not received its payments and so is unable to work at its full capacity. When less power is generated and less electricity is generated due to which unnecessary load shedding occurs.

5) SHORTFALL OF CASHFLOWS IN ENERGY SECTOR: Due to circular debt the whole chain of energy sector is affected. They do not have enough cash flows to invest in new projects or to even survive. These companies then borrow from banks to meet their expenditures.

6) DECREASED INDUSTRIAL OPERATIONS: Due to load shedding the industries are unable to perform well and give maximum productivity which in turn reduces the output of the country and their profits too.

7) SOCIAL EFFECTS: Due to unavailability of electricity patients, students and children suffer. Load shedding is a constraint in their path to success even people at homes cannot run their electricity appliances and increased load shedding has made them nearly useless. People are moving again to manual machines so that they can work during load shedding. This means that the standard of living of people in Pakistan is falling.

8) INCREASED PRICES: Circular debt has increased the electricity production cost. When electricity becomes expensive the goods are made at high manufacturing cost and so the prices of commodities are rising day by day making it difficult for a person to buy daily consuming items. This is due to inflation as the reduction in money supply increases the demand of money. The following graph shows the Real rates:
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2011

COMPANIES MOST AFFECTED BY CIRCULAR DEBT

The most effected industry by circular debt is oil, petroleum, power and electricity generating companies. These include Oil and Gas Development Limited (OGDCL), Pakistan Petroleum Limited (PPL), Attock Refinery Limited (ARL), PAK Arab Refinery Limited (Parco), Pakistan State Oil (PSO), Shell, Sui Northern Gas Pipelines (SNGPL), Sui Southern Gas Company (SSGC) as suppliers of primary energy and Karachi Electric Supply Company (KESC), Independent power producers (IPPs) e.g. Hub Power Company and Kot Addu Power Company, captive power producers, rental power producers, Water and Power Development Authority (WAPDA Hydel), and the Pakistan Electric Power Company (PEPCO) as power generator and distribution companies.

According to an economic survey 2010-201, the total receivables of these companies are Rs775.2 billion and payables are Rs516.7 billion. Oil and Gas Development Limited (OGDCL) has the greatest share of 115.5 billion out of 258.5 billion. OGDCL even does not have the finance to invest in its current crucial projects of oil and gas exploration. These projects KunnerPasakhi and Uch-II require $6 million for execution. This company is the major victim of circular debt which has the largest amount of receivables and the least amount payables.

Other effected companies are Pakistan State Oil (PSO) with Rs51 billion receivables, Parco Rs37.5 billion, KESC Rs27.5 billion, PPL Rs22.2 billion, GHPL Rs9.6 billion, SSGCL Rs7.1 billion, and Pepco Rs2.7 billion. While SNGPL and Karachi Water Board have 13.4 and 1.2 billion net payables respectively. RECOMMENDATION: Government must ensure the optimal utilization of resources.  Raising the Tax-to-GDP ratio is a key pillar of the governments economic strategy.  In addition, other measures such as improving tax administration and reinstating tax audits have been taken.

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 Restructure key Public Sector Enterprises (PIA, PEPCO, Railways, TCP, USC, Pakistan Steel Mills, and NHA) to stop leakages caused by annual losses amounting to approximately 1.5% of GDP. The eventual aim is to turnaround these PSEs into profitable, self-sustaining ventures under Public-Private Partnership mode.  Under reform of the power sector, electricity tariffs a full cost-recovery tariff for the power utilities. Under a new Act of parliament, adjustment in tariff for changes in fuel prices for power generation has been made automatic.  Checking inflationthis involves limiting borrowing by the government and the public sector.  Bringing people to the centre stage, by appropriately designed employment and training programs to protect those in strife-affected areas, and new entrants to the labor force.

CONCLUSION: We have found following main causes of circular debt; outstanding bill of payments, Liquidity Trap, Tariffs and subsidies, import and export (trade deficit) and government policies. The current situation of Pakistan is worse and the economy is moving towards depression. Pakistan railways, PIA, Steel mill, WAPDA, OGDCL, PSO, and KESC all are affected by circular debt. Over all our circular debt is more than 664 billion rupees. Circular debt is affecting mostly those industries whose raw material is Oil and Gas.

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REFERENCES

   

http://www.lawsofpakistan.com/what-is-circular-debt-problem-of-circular-debt-in-pakistan/ http://www.thenews.com.pk/TodaysPrintDetail.aspx?ID=8816&Cat=13 http://www.scribd.com/doc/59224479/Published-Circular-Debt-Presentation-Rev2 http://www.aup.edu.pk/sj_pdf/CAUSES%20OF%20UNEMPLOYMENT%20AMONG%20THE%20 EDUCATED%20SEGMENTS.pdf

http://www.brecorder.com/editorials/single/600/0/1250432:a-new-measure-towards-resolvingcircular-debt/?date=2011-11-12

 

http://archives.dawn.com/archives/170777 http://pakistangeonews.net/govt-takes-over-circular-debt/

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