What is Circular Debt?

Circular debt is a term that refers to the difference in cost of power generation and its transmission, and subsequent revenue collection at the distribution level. It is primarily due to electricity theft abetted by the power distribution companies coupled with lack of recoveries on billed amounts.

It is a complex issue that involves many factors such as inefficiency, corruption, and mismanagement amongst power distributors (DISCOs). Several heads of losses exist such as technical losses, distribution losses and theft.

Definition

What is Circular Debt?

Circular debt is a form of debt that involves a series of individuals who owe each other money. The debtors are all connected to each other by middlemen. However, this doesn’t necessarily mean that the debt will cause a problem. In some cases, the debtors can cancel out each other’s debt or it can lead to frustration and confusion.

In Pakistan, circular debt is a major issue in the energy sector. It has grown exponentially and is becoming a burden on the country’s economy.

Power sector circular debt has accumulated to a staggering Rs2.5 trillion. It has become a major challenge to the government and its various stakeholders.

The main reason behind the rise in circular debt is that Independent Power Producers (IPPs) are unable to pay their fuel suppliers and electricity distribution companies for the electricity they produce. In other words, IPPs have to borrow money from their fuel suppliers to pay for the electricity they produce.

Meanwhile, the electricity distribution companies have to borrow money from their customers in order to cover the cost of providing the electricity that they sell to consumers. This creates a vicious cycle whereby the debtors owe their creditors more money than they can afford to pay back.

This is not the first time that the power sector has experienced this kind of crisis. In fact, it’s a common problem worldwide.

There are a variety of reasons why the problem is occurring, and they can include bad deals between power distributors and IPPs. It can also cause by a mismatch in demand and supply.

In addition, it can be due to inefficiency or corruption in the power distribution sector. Inefficiency is a major factor in power theft, whereby distribution companies fail to collect their revenue for electricity that they deliver to customers.

This can be especially true in developing countries where there is often less money to go around. This can result in lower payments to the generators, who then fail to pay their fuel suppliers. In addition, this can exacerbate the problem of circular debt, which is why the government has to take steps to fix it.

Causes

Circular debt is a cascade of unpaid bills, non-payment of subsidies, and low recoveries; where receivables of one component of the power sector become payable for others. It has a number of causes, which include inefficiencies at the DISCO level and technical losses.

The accumulated circular debt has been a major challenge for the power industry in Pakistan and has resulted in frequent load shedding and outages, and erratic energy prices. The government is trying to fix the problem through its policy of improving the management and operation of DISCOs.

Despite the efforts, there are still inefficiencies and losses at the DISCO level. These inefficiencies and losses are the most important cause of the accumulating circular debt.

Another important cause is the high cost of fuel. The importation of foreign fuel has pushed up the cost of electricity to consumers. This has also led to a surge in the circular debt.

Furthermore, the government is attempting to curb the problem by signing deals with independent power producers (IPPs). The agreements will help reduce capacity charges and bring down the costs of generation.

These agreements will also reduce the amount of fuel imports by GENCOs and IPPs. In addition, the government is negotiating with IPPs to reduce their dues by paying them through dividends.

According to the MoUs signed by the government, these will save about Rs850 billion in 10 years. The changes are meant to reduce the fixed costs and capacity charges that IPPs have to pay under existing PPAs.

The power sector in Pakistan has two main components – the generation and distribution sectors. These sectors have different public-owned or independent power generation companies (GENCOs) and public-owned distribution companies (DISCOs).

Currently, the power industry dominated by imported fuel-based power plants which account for almost 46 percent of the country’s total installed capacity. This dependence on imported fuel has been a major cause of the circular debt.

The government is working to fix the problem by increasing the reliance on indigenous gas and oil supply as well as increasing the share of solar and wind power in the country’s power mix. These steps will reduce the cost of energy and cut down the demand for imported fuels, which in turn will help curtail the accumulating circular debt.

Circular Debt Impact

Circular debt is a term that describes a situation in which a person or company has a long list of creditors and debtors. This is a problem because the net balance of all of the creditors and debtors is zero, even though they all owe money to each other.

In Pakistan, circular debt is a big issue in the electricity industry. It is cause by unpaid government subsidies to Independent Power Producers (IPPs) and other entities in the energy sector.

IPPs operate oil and coal-fired plants that burn fuel to produce power for the public to use. The government provides these IPPs the fuel they need to operate their plants, and the different electricity boards pay them for the electricity they supply.

If the IPPs did not receive these government subsidies, they would be unable to operate their plants and therefore not be able to provide electricity to the people of Pakistan. This would lead to many people in the country being without electricity and could be disastrous for businesses.

The government can fix this problem by reversing the subsidies that given to IPPs. However, this is not an easy solution because it will require the government to pay a lot of money to the IPPs in order to cover their losses.

Another way to solve the circular debt problem is to increase gas prices. This can do by increasing the price of liquefied natural gas in the international market, or by putting a higher price on gas produced in the country.

This will allow the government to recover the cost of importing the gas and the price of the fuel it is use in power generation. This will help to keep the circular debt from becoming a bigger issue in the future.

The circular debt is a serious problem in the gas and electricity sectors and it needs to fix immediately. The government can do this by creating a committee to determine the amount of cash that needs to paid back and to figure out how to clear it. This will be a complicated process, but it will be necessary if the country is going to survive the financial crisis that is currently happening in the economy.

Circular Debt Solution

Circular debt is a form of non-cash payments that made between entities within a supply chain. This occurs because of differences in the time it takes to receive or pay for a product, and it’s a problem that has plagued the energy sector since 2008-09.

Circular debt usually starts as payables from one entity to another. For example, an electricity producer owes money to a power distribution company. When the power distributor doesn’t receive its cash on time, it essentially holds back its payment to its suppliers, which then hold back their payments to the power plant. This causes a cascade of issues that affects the entire supply chain, causing load-shedding and other operational problems.

Ideally, these differences should cancel out, but in practice, they don’t. Instead, they get pass around like a wand, making it difficult to balance out the amounts due from each party.

In the case of the energy sector, circular debt is a serious concern because it has risen to over Rs 2.5 trillion. It’s a huge amount of money that is sitting on the government’s books, waiting to paid.

A solution to the circular debt issue lies in a series of reforms, starting with improving the revenue collection of power distribution companies. This could do by introducing an effective revenue model that makes sure every meter read and the charges collected.

Other possible reforms include changing the way the power distribution companies deal with theft. Electricity theft is a very large contributor to the circular debt, especially in areas where power distribution companies have failed to collect their full charge.

If the power theft properly dealt with, a lot of the accumulated losses can avoid. This would also help clear up the circular debt problem and allow more resources to deployed on other parts of the power sector.

Besides improving revenue collection, other reforms can introduce to reduce the volume of circular debt. These include transforming the power distribution sector to an efficient one, and ensuring that subsidies paid promptly by the federal government.

Recommended readings:

• Business Community and Pakistan’s Power Crisis
• Why You Should Go Solar in Pakistan
• Board Of Investment Pakistan
• Financial Capital – Debt Vs Equity
• What Is Capital?