6/18/2020 This is why investing in the power sector is a bad idea - Newspaper - DAWN.

COM

The power sector for the last decade has been marred by an inefficient energy mix, lack of a
competitive bilateral market and an inefficient transmission and distribution system. Additionally,
electricity is being purchased by Central Power Purchasing Agency Guarantee Limited (CPPAG)
from Independent Power Producers (IPP) at higher tariffs. Failure to timely exploit hydro resources
has forced the country to tilt towards expensive power generation through use of expensive fuels like
high speed diesel, imported coal and LNG.
https://www.dawn.com/news/1476105/this-is-why-investing-in-the-power-sector-is-a-bad-idea 2/5
6/18/2020 This is why investing in the power sector is a bad idea - Newspaper - DAWN.COM

A higher interest rate with minimum barriers to flow of capital would be beneficial in the form of
inflow of foreign capital. For an import-based economy like Pakistan, this would have a
strengthening impact on the local currency and reduce input costs. However, given Pakistan’s
growth rate and economic volatility, the marginal propensity of investors to invest is very low. Just
increasing interest rate to induce investors to invest in Pakistan, along with a strengthened fiscal
and monetary policy, may not achieve desired results.

The tariff in power sector has been envisaged under a two part tariff scheme i.e. Energy Purchase
Price (EPP) and Capacity Purchase Price (CPP). EPP, including fuel expense and variable
operational and maintenance cost, is primarily paid to the company for producing and delivering
electricity to the national grid. On the other hand, CPP is a fixed cost (debt servicing, insurance,
fixed operational and maintenance costs, and working capital financing cost) reimbursed to the
company for establishing and maintaining the power plant facility.

A certain percentage of return on equity invested is also incorporated within it. In order words, all
the actual variable and fixed costs incurred by IPPs in producing and delivering electricity are
reimbursed and a certain percentage of return over equity invested is guaranteed.

The ever increasing circular debt due to high

tariffs and an inefficient power distribution
system is creating resentment among
investors

Almost 85 percent of the project cost is the cost of imported machinery, equipment and services of
technical experts. National Electric Power Regulatory Authority (Nepra) determines the project cost
in dollars and converts it into local currency at reference exchange rate, which is the rate at date of
tariff determination. All exchange losses thereafter become part of project cost. Therefore, any
excess cost incurred by investor on account of variation in exchange rate during the construction of
power project becomes part of total project cost.

With increasing project cost, the amount of financing required for the project automatically surges
up. Not only does the investor have to borrow more, the equity investment in the project also
increases due to regulatory restrictions that require total project cost to be financed in the ratio of
20-30pc equity and 70-80pc debt.

The cost of borrowing incurred by the IPPs is reimbursed over the life of the project financing. In
case of local lending, it is indexed to Karachi Inter Bank Offer Rate (Kibor) and in case of foreign
lending it is indexed to London Inter Bank Offer Rate (Libor) and any variation in the exchange rate.

https://www.dawn.com/news/1476105/this-is-why-investing-in-the-power-sector-is-a-bad-idea 3/5
6/18/2020 This is why investing in the power sector is a bad idea - Newspaper - DAWN.COM

Investors are offered guaranteed dollar based returns over equity investment. Paid to investors in
local currency, this investment ranges from 15-20pc. In order to keep the dollar based return intact,
any adverse variation in the exchange rate is reimbursed to IPPs thereby also contributing to an
increase in tariff.

Additionally all local components of the tariff are indexed to local inflation and all foreign
components of tariff are indexed to US inflation and exchange rate. Therefore any increase in
interest rate and exchange rate has a direct impact on tariff.

The circular debt is mounting due to the higher power generation costs because of an expensive fuel
mix, increasing interest rates, weakening of rupee, and lack of timely payments by power
purchasers. The aggravating circular debt issue has compelled IPPs to finance operations by
utilising the maximum limit of working capital facilities available to them, thereby rendering them
unable to access finance from other resources.

This situation, coupled with higher working capital finance cost due to higher borrowing and
increased interest rates, is jeopardizing IPPs that may default under their relevant concession
agreements. Further, if a power purchaser is unable to make payments to IPPs within the due date,
then for each day after the due date the power purchaser is required to pay an outstanding balance
at a specific delay payment rate. The benchmark of which is Kibor plus agreed spread. Hence, any
increase in interest rate would further burden the already cash starved power purchaser in meeting
its payment obligations.

The ever increasing circular debt due to high tariffs and an inefficient power distribution system is
creating resentment among investors. To attract further investment in power sector, particularly in
power transmission sub-sector, additional incentives/securities are required. These measures would
ultimately increase tariffs as well as the government’s contingent liability.

Electricity is one of the major factors of production for any business, particularly for Small and
Medium Enterprises (SMEs) which are assumed to be the backbone of the economy. Any increase in
cost or interrupted supply of electricity has a detrimental impact on their growth. The alternative to
grid power is through the use of generators whose operational costs are very high. All businesses are
impacted due to higher electricity costs and interrupted supply. In the larger context, this hinders
GDP growth and ultimately renders the country’s products uncompetitive in international markets.

The writer is a chartered accountant based in Islamabad

shah.zeb2010@hotmail.com

Published in Dawn, The Business and Finance Weekly, April 15th, 2019

https://www.dawn.com/news/1476105/this-is-why-investing-in-the-power-sector-is-a-bad-idea 4/5