Pakistan: Energy Sector Reforms and Financial Sustainability Program (Subprogram 2)

Energy / Energy sector development and institutional reform

The programmatic approach and subprogram 1 were approved on 6 December 2019 to address financial, technical, and governance deficits in the energy sector that adversely impact sector sustainability and affordability, and Pakistan's fiscal balance and macroeconomic stability. Subprogram 2 aims to (i) secure financial sustainability by controlling the accumulation of and reducing 'circular debt_; (ii) strengthen governance by implementing a road map for a competitive electricity market, separating the policy and regulatory functions in the hydrocarbon segment, appointing appellate tribunals, implementing multiyear tariffs, and unbundling the gas segment; and (iii) reinforce infrastructure improvements through integrated planning to facilitate public and private sector investment across the energy sector.

Subprogram 2 is embedded in the programmatic approach and is consistent with the Sustainable Development Finance Policy. It complements and mutually reinforces energy reforms with the International Monetary Fund (IMF) under its $6 billion Extended Fund Facility (EFF) and the World Bank's approved $400 million Program for Affordable Clean Energy 1 for sector sustainability enhancement. The second through fifth reviews of the IMF's EFF were approved on 24 March 2021, effecting a disbursement of $500 million. The sixth review was concluded on 18 November 2021, making available for disbursement $1,059 million, bringing total disbursements under the EFF to about $3,027 million. Subprogram 2 (footnote 4) is linked with operational priority (OP) 1 (addressing remaining poverty and reducing inequalities), OP2 (accelerating progress in gender equality), OP3 (tackling climate change, building climate and disaster resilience, and enhancing environmental sustainability), and OP6 (strengthening governance and institutional capacity) of the Asian Development Bank (ADB) Strategy 2030. Subprogram 2 is aligned with meeting Pakistan's Nationally Determined Contribution targets for climate change through the deployment of renewable energy by replacing thermal generation, improving demand-side energy efficiency, and reducing unaccounted for gas losses. Hence, SP2 contributes to Sustainable Development Goal (SDG) 9 (finding lasting innovation and technological solutions for increased energy resources and efficiency), SDG 12 (encouraging sustainable energy production and consumption patterns), and SDG 13 (taking urgent action to climate change and its impacts). It also contributes to the achievement of Sustainable Development Goal 7 (ensure access to affordable, reliable, sustainable, and modern energy for all) through improved energy access across Pakistan.

Macroeconomic management challenges. The coronavirus disease (COVID-19) pandemic hit Pakistan's macroeconomic performance at a critical juncture in its macroeconomic recovery program. The economy was affected by the COVID-19 pandemic in 2020, causing real gross domestic product (GDP) growth to contract to 0.5% in fiscal year (FY) 2020; GDP per capita continued to decrease from $1,321 in FY2019 to $1,250 in FY2020; inflation was exacerbated, averaging 10.7% in FY2020; and total debt climbed to 87.2% of GDP. The government announced a relief package of PRs1,200 billion (2.9% of GDP) in March 2020, of which PRs715 billion (1.7% of GDP) was budgeted for FY2020 and PRs485 billion (1.2% of GDP) was for FY2021. Support to consumers in agriculture, residential, and small and medium-sized enterprises was provided through deferred bill payments and industry support packages with a fixed tariff regime. Due to the government's swift response to the pandemic, GDP growth rebounded strongly to 3.9% in FY2021. Inflation declined from 10.7% in FY2020 to 8.9% in FY2021, but rising food and energy prices kept it above the central bank's 6.5% target for the year. The current account deficit eased slightly from the equivalent of 1.7% of GDP in FY2020 to 0.6% in FY2021, driven by healthy growth in remittances.

In response to the COVID-19 crisis, the government shifted its policy priorities to sustain the economy, save lives and livelihoods, and expand social safety nets to prevent people from plunging into poverty. However, the economy is still struggling. Poverty incidence, measured at $3.2/day, has risen from 35.4% in 2019 to 39.1% in 2020; it is projected to remain around 31.9% even in 2021. The unemployment rate for FY2021, is still being assessed and is expected to increase to 9.56% in FY2021 from 5.79% in FY2018. In FY2020, losses of large state-owned enterprises (SOEs) grew rapidly, constraining the government's fiscal position. Energy SOEs, which comprise about 60% of total SOE assets, were a major driver of these losses. The pandemic has stressed the finances and fragmented the supply chain of the energy sector. This disruption has led to a substantial slowdown in the pace of sector reforms initiated by the government since early 2019. The impact on the country's energy sector circular debt arising from these losses, and exacerbated by the pandemic relief measures, has put unprecedented pressure on sector liquidity and finances. The programmatic approach has been adjusted to continue with the reforms in the current challenging environment.

Circular debt. During the processing of subprogram 1 in JanuaryDecember 2019, in parallel with the approval and first review of the IMF's EFF program in the first half of FY2020, the cabinet approved a 3-year Circular Debt Management Plan (CDMP). The implementation of the plan was on track and circular debt accumulation decreased during FY2019 and in early FY2020 to $215 million per month, from an average buildup of $272 million per month in FY2018. However, with the challenges of the pandemic during the second half of FY2020, circular debt accumulation soared to nearly $300 million per month. The demand for electricity plunged to 52% for industrial users and 66% for commercial users compared with FY2019 volumes, while demand for domestic and agricultural users grew 10%15%. Since agriculture and residential consumer tariffs are cross-subsidized by industrial and commercial tariffs, given the decrease in industrial and commercial energy use and the Ministry of Finance's delayed disbursement of subsidies, the revenues of power distribution companies (DISCOs) decreased significantly. Further, collection rates during FY2020 for domestic customers fell to 34% on average, partially because of the government's COVID-19 relief measures (tariff moratorium and rolling bill installments) during AprilDecember 2020. Total bill collections decreased from around 91% in FY2019 to 86% in FY2020. The result