Pakistan’s power privatization programme was once the jewel in the crown of a country whose private sector was generally underdeveloped and poorly performing.
Now power is a source of great anxiety as the government struggles to pay for electricity at tariffs it complains are too high. There is even talk of default.
But critics say the real problem is not the electricity tariffs but government inefficiency in selling on the power and collecting revenue.
World Bank president James Wolfensohn has personally urged Pakistan to fix things by privatizing further rather than placing the blame on what has already been privatized.
However, this has not stopped the government seeking to renegotiate terms with the sponsors of the power projects to reduce the tariffs.
It is also in discussions with the World Bank to agree an emergency loan enabling it to soften the blow of the agreements with the power sponsors.
These were entered into by previous administrations and are now crippling the current government.
The issue is stark, says World Bank consultant Shahid Sattar. The government really cannot get out of the agreement with the independent power project (IPP) sponsors, other than by defaulting; and that would be in nobody’s interest.
If the country defaults, the IPPs will collapse. But so far the threat of impending execution has not galvanized the IPPs into action. They are sticking to the terms of the original deal.
The terms of the deal between the Water and Power Development Authority (Wapda) and the sponsors of the IPPs require Wapda to make first-year payments of around $1.9 billion, of which $1.4 billion must be in foreign currency.
If Wapda, whose liabilities range between $1 billion and $2 billion cannot make the payment, then the government will step in.
But given Pakistani foreign exchange reserves of some $1.3 billion, this looks likely to send the country into default.
The fear of a failure by Pakistan is of particular concern to the World Bank which encouraged the country to embark on building a massive private sector power industry in the 1980s.
Says Paul Mitchell of the international affairs department of the World Bank: “We are working with the government to prevent a default. We don’t see any danger of a default. Governments like to push things to the brink before they do something.”
Secretary to the Pakistan ministry of finance, Mueen Afzal, sees a Wapda default sending shockwaves through the economy and internationally.
“If Wapda goes under, it is not just a problem for us [government], but for the investors too,” he says. “So we have a mutual interest in keeping Wapda going. But before you approach the investors (including the World Bank), you need a viable programme to present to them.
“Then they will be willing to talk. So, the public decision is to go ahead and honour the agreements, set Wapda back on track, and then make mutually agreed adjustments.”
The Wapda black hole was one of the earliest problems confronting the government of Nawaz Sharif when it took power in February.
At first the government wanted to force the IPPs to reduce the terms of their contracts. But in the past two months it has leaned more towards a free market solution, preferring to turn up the heat on inefficient state organizations.
Says Afzal: “When the government came in it became aware that the IPPs were unpopular and [the government] seemed to want to respond to that. Now that policy is changing.”
But it is changing only slowly. Originally the pressures to renegotiate the contract terms were considerable especially after a report delivered by a government committee set up to assess the risks posed by the Wapda black hole.
The public interest has been severely and progressively eroded in favour of the IPPs, reported the committee in a confidential document (obtained by Euromoney) in June.
It went on to conclude that the project developers for the World Bank-backed UCH project “have continuously been getting concessions from the government of Pakistan to the detriment of the public interest.
“The contracts as they now stand appear unbalanced,” said the committee’s report.
Shahid Sattar, the committee’s former secretary, argues: “We recommended that we renegotiate the tariff in such a way that frontloading was deferred to later years. We are not trying to decrease the rate of return for any of the projects.”
Those wanting to tighten the terms granted to the IPPs argue that the private sector suppliers received excessive benefits in their original contracts.
They claim that the tariff rate paid to the IPPs of 11 cents per kilowatt hour (a figure that quickly falls to 6 cents over the term of the contract) compare unfavourably with agreements in other emerging markets whose power sectors are undergoing privatization such as the Philippines and Malaysia.
Sources in the World Bank argue that the premium is due to Pakistan’s lower sovereign rating. Says the World Bank’s Farida Mazhar: “Because of the difference in credit rating between Pakistan and many other Asian countries, the bank’s appetite to lend to Pakistan was relatively limited so there had to be credit enhancements, from multinationals, and export credit to mobilize funds from the markets.”
The government also had some bad luck in its negotiations; the cost of building power stations dropped by more than half in the years following the signing of some of the IPP contracts.
This enabled the sponsors to enjoy some very high internal rates of return on the projects. According to ANZ’s head of global project finance in the US, Vijay Sethu, these range from 15% to as high as 25%.
The sweeteners offered by the government and multilaterals were so beneficial that investors were, in the words of one government official, queueing up to take part, and the issue quickly became notorious when some made attempts to bribe their way up the queue. The World Bank itself launched a wide-ranging inquiry into the matter which led to one employee leaving.
“The World Bank treated this as a matter of the utmost seriousness and investigated it very thoroughly,” says one banker who participated in the inquiry.
Jehangir Masud, a senior executive with project finance boutique PMD International, argues that the country is now reaping the consequences of the financial recklessness of the former prime minister Benazir Bhutto.
Says Masud: “The World Bank has been saying to the new government, ‘you cannot renegotiate, otherwise you will harm your credibility, and this will harm future investment’. But one way or another, these agreements will have to be renegotiated.
“It would be sensible to renegotiate now rather than later, after Pakistan is pushed into default which now looks inevitable.”
While Pakistan’s power programme looked good for investors, banks also saw the massive risks and drew up some extremely tight contracts.
Said one banker: “The lenders could not actually see where the money was coming from to meet the power payments so they insisted on creditworthy people standing behind the government, including the World Bank, and export credit agencies.”
The World Bank, which set up its Private Sector Energy Development Fund to launch the power programme, and has commitments totalling $275 million in the Hub Power and UCH Power projects has been very vocally opposed to any renegotiation.
“We support the sanctity of contracts,” says Mitchell. “The contracts were arranged in a more or less open and transparent manner.
“The arrangements looked reasonable at the time. The government of Pakistan thinks that the tariffs paid to the IPPs were too high but at the time they were thought to be sound.”
“The way to go about solving the problems is not to pressure the IPPs to renegotiate the contracts. That will only lead to instability on the part of international finance.”
World Bank president Wolfensohn took this message to prime minister Nawaz Sharif on a recent visit to Pakistan and advised him to deal with the problems in his own back yard, in the state power vehicle Wapda, rather than in the IPPs.
Wolfensohn wanted Wapda broken up and privatized, he wanted tariffs raised to make it economically viable, property sold off and efficiencies imposed.
The message went down well with some members of the administration and may account for the change in thinking.
Says Afzal: “Wapda has all the aspects of being a public-sector state entity. It is too large, unwieldy and inefficient. Wapda also has great overstaffing. Probably 40,000 out of its total workforce of 140,000 is surplus.
“We need quick attention and surgery, to increase efficiency, and reduce the burden on the fiscal deficit. I believe the cabinet wants to make Wapda financially viable over the next few months by reducing losses and removing the cross-subsidies.”
Fraud and failure to deliver power were also proving costly to Wapda and the government.
The shortfall on Wapda’s monthly sales and revenues tops $80 million with estimates of power losses ranging from 25% to 40%.
Collecting revenue has become such a problem that the government is considering contracting out revenue collection to a Korean operator.
Wolfensohn’s proposal to break-up Wapda is welcomed by ANZ’s Vijay Sethu. “Wapda have always been very anti-private sector. They have created an illusion that they are going to go bankrupt, and that they are being screwed. In fact, most people in Pakistan want the power and are prepared to pay for it. Wapda’s costs are the problems.” But the tough approach to Wapda rings hollow in some more jaundiced banking circles.
Says Citibank’s regional executive Saadia Khairi: “A large consulting team hired by the Asian Development Bank is sitting in Islamabad, telling the government to split up Wapda, privatize bits and pieces, raise tariffs rapidly in next 12 months. I find the prospect [of this happening] difficult to believe.”
Such cynicism may be sensible, but talking about breaking up Wapda is good news for a government which needs all the help it can get from investors and multilaterals.
By taking the focus off the private sector, IPP sponsors and their supporting banks will be encouraged to do deals with the government, and renegotiate tariffs voluntarily in return for future concessions.
Says Sethu: “We are seeing how the sponsors can reduce the tariffs. The government has to give us something. The sponsors are scratching the government’s back in the hope of further projects down the line.”
The World Bank is now friendlier to Pakistan than it has been for some time, as it sees the prospect of a private sector solution to Wapda’s financing problems materializing.
Says the World Bank’s Mitchell: “There is potential for providing some short-term emergency support to help restructure the sector but we need to see some concrete action first. The financial plan that may be on offer includes a bond issue or a partial loan guarantee. But first we really would like to see Wapda restructured. Any other suggestions are mere speculation.”
World Bank demands for tariff increases appear to be insistent, but they may not be so easy to satisfy.
Says Mitchell: “Tariff increases [by Wapda] would be part of the requirement. Putting the tariffs up so that they are not losing money on producing power is essential. That will pose political danger for a government which has shown a less than steady hand in its first 10 months in office. The tariff increase will also test the government’s much vaunted commitment to the private sector.”
But there are those who believe that raising tariffs to the public will have as severe consequences as defaulting.
The implications could be social unrest, and even a threat to the countrys frail democracy, warns Sattar.
If the west wants to shore up democracy in Pakistan it needs to come up with a package to solve the power issue.
It’s that serious. There is a real risk of a popular backlash against foreign investment, he says. Nick Kochan
