ADB CONCERNED OVER ENERGY SECTOR DEVELOPMENTS

UNCLAS SECTION 01 OF 02 ISLAMABAD 000913 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: ECON ETRD EAID EFIN ENGY PK SUBJECT: ADB CONCERNED OVER ENERGY SECTOR DEVELOPMENTS REFS: A. ISLAMABAD 575 B. ISLAMABAD 315 ¶1. (SBU) Summary: On April 21, USAID and ECON officials met with Rune Stroem, Country Director for the Asian Development Bank (ADB), who conveyed the ADB's concerns over the slow pace of energy sector reforms in Pakistan. Stroem identified three problems with the sector: the new Lahore High Court case challenging NEPRA's tariff setting mechanism; the ever increasing amount of circular debt; and the expected spike in power outages over the summer. Post understands ADB's concerns regarding the circular debt but believes that it is very unlikely that NEPRA's tariff setting mechanism will changed anytime soon. End Summary. - - - - - - - ADB CONCERNS - - - - - - - ¶2. (SBU) Rune Stroem, Country Director for the ADB, briefed USAID and ECON officials on the ADB's concerns regarding the energy sector in Pakistan. The meeting, a follow-up to the DCM's earlier conversation with Stroem on the energy problems in Pakistan, was set up to determine how the ADB and USG can cooperate to help the GOP move forward on energy sector reforms. ¶3. (SBU) Stroem highlighted three problems in the energy sector. First, the Lahore High Court recently began reviewing a case which argues that National Electric Power Regulatory Authority's (NEPRA), Pakistan's electricity regulator, tariff setting mechanism for distribution companies is in violation of the NEPRA Act of 1997. The ADB believes the NEPRA tariff setting mechanism depoliticizes tariffs and would be concerned should it be altered. The court case against NEPRA claims that NEPRA's tariffs are determined without any public hearings. Stroem is worried over the end result if the Lahore High Court rules against NEPRA. ¶4. (SBU) Comment: According to our understanding of the Pakistani constitution, however, the Lahore High Court can only review NEPRA's tariff setting mechanism to see if the proposed tariff adjustment conforms with the NEPRA Act. The High Court cannot challenge NEPRA's tariff setting mechanism as the mechanism is defined in the NEPRA Act passed by the National Assembly and only the National Assembly can change it. In January, a similar case was filed in the Lahore High Court and a decision was rendered in favor of NEPRA. End Comment. ¶5. (SBU) The ADB is also concerned by the increasing circular debt problem. Stroem contends that the circular debt in the energy sector is growing by PKR 1.5 billion (USD 18.75 million) per day, putting a heavy burden on Pakistan's financial stability. (Note: Post cannot confirm this figure). He is also worried that the GOP has not issued a verifiable number on the amount of the circular debt. The GOP's Term Financing Certificates (TFC) represent a short term solution to the circular debt problem by shifting the GOP payment obligation from energy companies to the banks. According to ADB figures, the energy sector is still running up rapid debts, borrowing up to PKR 1.5 billion (USD 18.75 million) per day from the banks. This continues to be a problem that re-funding the stock of old debt obviously does not solve. Stroem provided USAID and ECON with summaries of "inter-corporate" debt on three dates that show net debt rising from PKR 146 billion (USD 183 million) on March 20 to PKR 201 billion (USD 251 million) on April 13 (PKR 55 billion or USD 69 million in 24 days) and PKR 206 billion (USD 258 million) on April 17 (PKR 5 billion or USD 6.3 million in 4 days). ¶6. (SBU) Finally, the ADB expects a summer spike in power shortages that will cause the total current electricity deficit to rise from 2,500 MW to 6-7,000 MW. The current 2,500 MW deficit already results in 4-16 hours of power outages a day in major cities. Stroem said he was concerned that this surge in the deficit will lead to more power outages which is sure to cause civil unrest as it has done in the past. - - - - - ISLAMABAD 00000913 002 OF 002 COMMENT - - - - - ¶7. (SBU) The ADB's concerns that the GOP may change or abolish the NEPRA Act are probably overstated. Our understanding is that such a change would prove extremely difficult and would require action by the National Assembly, which could take years. The real difficulty with NEPRA's tariff mechanism is that NEPRA's tariff determinations are not always implemented by the Ministry of Water and Power, which is legally required to announce the tariff adjustment. For political reasons the GOP either does not publish the tariff increases until many months after the recommendation or it announces that it will pay the raise in the form of subsidies. ¶8. (SBU) Post shares Stroem's concerns regarding the circular debt problem in Pakistan. The recent PKR 80 billion (USD 100 million) Term Financing Certificates (TFC) issued to pay part of the PKR 200 billion (USD 2.5 billion) in debt (refs A and B) have not created new liquidity or helped energy companies pay each other's debt. The move has only shifted the GOP's payment obligation from the energy companies to the banks. Post believes that the TFC plan represents a rather ingenious short-term method to allow the IPPs to continue to buy fuel but it is not sustainable. If WAPDA does not address the issues responsible for creating the circular debt such as cutting line losses, improving the recovery system and removing subsidies, the debt will continue and this time the banks may not bail out the government. Regarding ADB's projection of a summer spike of 6-7,000 MW in the electricity deficit, we will confirm these estimates with GOP officials as Post has not seen any forecasts that predict more than a 4,000 MW shortfall. End Comment. FEIERSTEIN