PM AND FINANCE MINISTER ON PAKISTAN'S TROUBLED

UNCLAS SECTION 01 OF 03 ISLAMABAD 002140

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: PGOV EFIN ECON EAID ENRG PK
SUBJECT: PM AND FINANCE MINISTER ON PAKISTAN'S TROUBLED
ENERGY SECTOR

REF: ISLAMABAD 1983


1. (SBU) Summary: In meetings with Prime Minister Gilani
and Finance Minister Tarin, NSC Senior Director for
International Economics David Lipton said Pakistan needed to
take a number of steps in the coming months to put its energy
sector on firmer footing: resolve the remaining $3.7 billion
"circular" overhang of energy sector inter-corporate and bank
debt; ensure that energy tariff's are adjusted to cover
energy generation and distribution costs, as agreed to with
the ADB and World Bank and blessed by the IMF; and create an
energy sector task force to prioritize and implement
short-term projects to limit blackouts and unscheduled load
shedding through improved generation and distribution. Tarin
said the circular debt would be resolved by August 31,
through the placement of $2.6 billion of old debt into a
holding company and a $1.1 billion capital injection for
current arrears. Gilani said the GOP would stick to its
commitment to raise tariff rates and said a ministerial-level
task force was meeting daily to address the energy sector.
Gilani welcomed the proposed October 21-22 strategic energy
dialogue.


2. (SBU) Lipton warned Gilani and Tarin that banks,
overloaded with GOP and energy sector debt, planned to cut
credit lines to the power sector, squeezing power producers'
ability to secure fuel stocks and perform essential
maintenance and repair. Tarin said he would work with State
Bank of Pakistan (SBP) Governor Raza to persuade banks to
keep credit lines open. Lipton noted that public opinion
could turn against tariff increases because of the GOP's
approval of 14 expensive rental power projects, some of which
may questionable merits. Tarin agreed with Lipton,s
suggestion that independent auditors should review the rental
power agreements to dispel public criticism. End Summary.

Resolving Pakistan's Circular Debt
--------------


3. (SBU) In an August 28 meeting, Tarin said that $2.6
billion of energy sector circular debt had been placed in the
Government Power Holding Company, a newly-created GOP debt
holding company. As further detailed reftel, circular debt
is inter-corporate and bank debt that accrued from
non-payment between various energy companies as a result of
insufficient tariff collection and non-payment of government
subsidies. Tarin hoped to repackage the holding company debt
as bonds for sale to domestic and overseas markets. (Note:
Currently, there is no secondary bond market in Pakistan,
though the State Bank of Pakistan(SBP) and Karachi Stock
Exchange (KSE) are working to develop one. End note). Tarin
said the GOP injected an additional $850 million in the
sector on August 28 to erase more recent arrears and planned
to inject another $240 million on August 31. The injections
were financed through five-year term finance certificates
(TFCs) with a sovereign guarantee placed in domestic banks.
(Note: The Asian Development Bank (ADB),which closely
follows the circular debt issue, could not confirm these
figures. Post will report on the amount of arrears actually
removed from the sector septel).


4. (SBU) Lipton reported that a number of banks, overloaded
with government and energy sector debt, planned to cut lines
of credit to the power sector, further squeezing power
producers' ability to secure fuel stocks and finance
necessary repairs and maintenance. He asked that the
Ministry of Finance and SBP work with the banks to keep
credit flowing so that power producers had the financial
wherewithal to bring additional power on the grid before the
October 1 tariff increase. Tarin said that power producers
would not need large credit lines, as the financial injection
would erase their arrears, but agreed to ensure the banks
extended appropriate credit lines to the sector.


ISLAMABAD 00002140 002 OF 003


Tariff Increases
--------------


5. (SBU) In an August 28 meeting, Prime Minister Gilani
reiterated his long-standing assertion that the political
opposition and the public would accept tariff increases if
they saw new power coming on the grid. (Note: The GOP
agreed to a World Bank/ADB plan to raise tariffs 6 percent on
October 1, 12 percent on January 1, 2010, and 6 percent on
April 1, 2010. End Note). Gilani said his government was
put in the unenviable position of correcting energy policy
mistakes of previous administrations. Minister of Water and
Power Raja Ashraf added that the GOP had tried to push
through a 17.5 percent tariff increase in June but reversed
itself in response to public outcry. Gilani said, however,
that a consensus had been built on energy and that opposition
PML-N leader Nawaz Sharif supported his policies. He said
additional generation would be on the grid by December,
reducing blackouts and public opposition to the tariff hikes.

Rental Power Projects
--------------


6. (SBU) Tarin said he had opposed the August 24 GOP
decision to approve 14 rental power projects with a total
installed capacity of 2250 MW. (Note: Rental power was
conceived as a stop gap measure to increase power generation.
Rental power producers (RPPs) agreed to quickly install
refurbished equipment to deliver power for three to five
years. Though the official cost per kw/h for RPP power is
only 1-2 cents higher than that of long-term independent
power producers (IPPs),the structure of the RPP contracts
pushes the actual kw/h costs higher. There have been
accusations of corruption in the awarding of RPP contracts.
End note.) Lipton said that public opinion could turn
against tariff increases if RPP contracts were not perceived
as transparent and fair. Tarin said he acquiesced to the 14
rental projects only after Gilani promised him that the GOP
would raise tariffs as scheduled and allow a third-party
auditor to review the RPP agreements. (Note: The ADB
confirmed that the Ministry of Finance requested it arrange
the audits. The ADB has yet to decide whether to do the
audit itself or contract with an outside firm. End note.)
Tarin also said he would not direct banks to finance the
RPPs, noting loans should be based on each project's
financial merits.

Energy Sector Planning
--------------


7. (SBU) Lipton urged Gilani to put a working-level energy
task force in place that could prioritize and implement
short-term repair and maintenance projects to improve
existing power generation and distribution. Gilani said he
had already instituted a daily ministerial-level task force.
Minister for Water and Power Ashraf added that the GOP had a
short-term and medium-term energy plan. (Note: None of our
other energy interlocutors had heard of such a plan. End
note.) Tarin said a working-level task force that reported
to a ministerial committee biweekly would be an effective
means to improve the sector's performance. Gilani welcomed a
U.S.-Pakistan strategic energy dialogue on October 21-22.


8. (SBU) Comment: The clearing of the circular debt is an
important first step in getting Pakistan's energy sector on
firm footing, opening the financial space for short and
long-term investments in generation and distribution. Much
now depends on the GOP's commitment to raise tariffs, as well
as paying out necessary subsidies to the energy sector until
the payment gap is closed. Adherence to the October 1 tariff
increase would signal to the banking community that the GOP
is serious about energy sector financial reform and could
help loosen up credit lines. However, continued load
shedding and rising public suspicions about rental power

ISLAMABAD 00002140 003 OF 003


could well combine and derail tariff reform. End Comment.


9. (U) This cable was cleared by NSC Senior Director for
International Economics David Lipton.
PATTERSON