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UNIVERSTY OF THE PUNJAB

REPORT ON:

CIRCULAR DEBT OF ENERGY SECTOR IN PAKISTAN

SUBMITTED BY:

MUHAMMAD SHERAZ 1607

ISHAQ AHMAD 1614

MUHAMMAD FAHAD 1619

RANA M. SHAHBAZ 1622

SUBMITTED TO:

SIR FARAZ BABAR

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ACKNOWLEDGEMENT

We are deeply indebted to our instructor Sir Faraz Babar whose help, stimulating

suggestions and encouragement helped us in writing this report.

TABLE OF CONTENTS
 INTRODUCTION TO CIRCULAR DEBT

 HISTORY OF CIRCULAR DEBT

 ANALYSIS OF CIRCULAR DEBT

 CAUSES OF CIRCULARDEBT

1) OUTSTANDING BILLS OR PAYMENTS

2) TARIFFS AND SUBSIDIES

3) LIQUIDITY TRAP

4) IMPORT AND EXPORT (TRADE BALANCE)

5) GOVERNMENT POLICY

 CURRENT SITUATION OF CIRCULAR DEBT IN PAKISTAN

 MEASURES TAKEN BY THE GOVERNMENT

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 IMPACT OF CIRCULAR DEBT ON PAKISTAN`S ECONOMY

1) COMPROMISED BALANCE OF PAYMENT

2) DEPRIVED FOREIGN RESERVES

3) EFFECTED GDP

4) INCREASED LOAD SHEDDING

5) SHORTFALL OF CASHFLOWS IN ENERGY SECTOR

6) DECREASED INDUSTRIAL OPERATIONS

7) SOCIAL EFFECTS

8) INCREASED PRICES

 COMPANIES MOST AFFECTED BY CIRCULAR DEBT

 RECOMMENDATION AND CONCLUSION

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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

Rs258.5 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 badly. In 2013 circular debt increases from Rs105 to 480

billion in July 2013 circular paid by (Pmln) and balance remain Zero In 2017 again increases

with the amount of 439 and Rs 1362 Billion Circular Debt today.

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.

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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. 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 in

efficiency 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

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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.

ANALYSIS AND CAUSES 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 aroundRs.95 billion to its suppliers within the

country which are various oil refineries and other foreign suppliers as well. So, the situation is

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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

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) IMPORTAND EXPORT (TRADEBALANCE)

Another big cause of circular debt is import and export. Import and export itself is not the reason

behind circular debt butte 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.

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5) GOVERNMENTPOLICY:

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

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

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 debits substantially increased by this year in power sector.

Recently, on the energy crisis the special parliamentary committee was informed that the circular

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debt in power sector is reached Rs.664.52 billion. In 2019 Circular debt of Pakistan now 1362.

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 % 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.

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IMPACT OF CIRCULAR DEBTON PAKISTAN`S ECONOMY

Persistent increase in circular debt has caused a snow ball effect of devastation and destruction in

the economy of Pakistan. It’s some of the adverse impacts are discussed below:

1) COMPROMISED BALANCE OF PAYMENT:

Pakistan’s 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 economy’s need for energy like petroleum products is fulfilled by imports. These

higher imports are compromising Pakistanis balance of payment. Dawn reported that; ³In 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 Mahmoud, 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´.

2) DEPR IVED 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 Pakistan’s

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 Pakistan’s 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

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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) INCREASEDLOADSHEDDING:

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) SHORT FALL OF CASH FLOWING 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) DECREASEDINDUSTRIALOPERATIONS:

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

constraint in their path to success even people at homes cannot run their electricity appliances

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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:

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 areRs775.2 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 Kunner-Pasakhi and Uch-II require $6

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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, ParcoRs37.5 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:

1) Government must ensure the optimal utilization of resources.

Raising the Tax-to-GDP ratio is a key pillar of the government’s economic strategy.

2) In addition, other measures such as improving tax administration and reinstating tax audits

have been taken.

3) Restructure key Public Sector Enterprises (PIA, PEPCO, Railways, TCP, USC, Pakistan

Steel Mills, and NHA) to stop leakages caused by annual losses amounting to

approximately1.5% of GDP. The eventual aim is to turnaround these PSEs into profitable, self –

sustaining ventures under Public-Private Partnership mode.

4) 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

5) Checking inflation²this involves limiting borrowing by the government and the public sector.

6) 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.

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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 1362 billion rupees. Circular debt is affecting mostly

those industries whose raw material is Oil and Gas.

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