Metro Power’s 50MW wind farm project is inching towards financial close after being delayed because local commercial lenders would not lend until the project had a Government of Pakistan (GoP) guarantee. This is now expected – along with close- within the next two weeks.

The reason the lenders attached such importance to the GoP guarantee is because running a power plant in Pakistan comes with an occupational hazard: not being paid.

The issue, known as circular debt, boils down to the fact that Pakistani off-taker National Transmission and Despatch Company (NTDC) does not always pay its obligations under its PPAs in full. This situation arises because the local electricity companies are not paid in full by their customers as consumers tend to steal their electricity, and so they cannot pay the NTDC. So everyone owes someone monies, hence the term circular debt.

The Government of Pakistan (GoP) guarantee is designed to assuage these concerns, as it promises that any monies owed will be paid. This gives some comfort to sponsors and lenders. And usually it is the state that makes up any shortfall under the terms of the guarantee. For independent power producers (IPPs), the NTDC reportedly owes around Rs 210 billion ($2.1 billion) in circular debt at present.

But Pakistan’s finance minster Ishaq Dar seems ready to change that paradigm. He recently stated that the NTDC’s reported current total dues of Rs 500 billion ($5 billion) should be collected from consumers, and that it would not be prudent for the finance ministry to clear the debt.

Whether Dar keeps this aggressive stance is anyone’s guess. But history suggest that he won’t. One prospective Pakistan IPP consortium told IJGlobal that if circular debt affects them it is not seen as a pressing issue as it is well known the state will pay it off eventually.

But while risks posed by circular debt have been accepted in the past and by present IPPs, this may not be so in the future.

A need for investment

Pakistan has a power crisis. Power shortages in Pakistan are estimated to have slowed GDP growth by 2% a year.

Subsidies remain high at $3.8 billion, or 1.8% of GDP. This is despite a 160% increase in power tariffs’ since 2008. Pakistan’s Prime Minister Nawaz Sharif wants the country’s electricity problem dealt with in three years.

In March, the Asian Development Bank (ADB) approved a $400 million loan to support the Government of Pakistan's National Power Policy (NPP), which aims to solve the country’s energy crisis. The legislation aims to increase the country's electricity generation to 26,800 MW, encourage public and private investment, and import electricity from India, Iran and Central Asian states.

But circular debt is starting to cause concerns amongst outside investors.

The Chinese, both as developers and financiers, are active in Pakistani infrastructure, contributing heavily towards roads, airports and indeed IPPs.

Chinese sponsors are also being touted for many IPPs in Pakistan, including six coal fired projects in the Punjab. The SK Hydro project is also expecting China Gezhouba to inject $80 million in equity once the project reaches financial close later this year.

But IJGlobal understands that Chinese sponsors are seeking assurances from the highest levels of government that their prospective IPPs will not be afflicted by circular debt issues.

They have good reason to be concerned. Circular debt may be an accepted risk, but it can hamstring and even kill projects.

Closures and openings

Last year, circular debt closed the 225MW Narowal oil-fired Power Plant. The plant ended up defaulting on PKR3.2 billion ($33 million) owed to Saudi oil firm Bakri Oil Trading Company.

A still operational IPP, Saif Power is owed roughly $48 million in agreed tariffs. The NTDC has failed to pay Saif agreed tariifs off and on for the last four years. Not receiving the agreed tarrif rates has meant that on at least four occasions, Saif’s backers have had to raise additional monies to pay off project loans.

The problems faced by Saif and Narowal do not make comfortable reading for Chinese and other international investors and sponsors. However, the Chinese are likely to receive the assurances they want due to their presence and significant investment into Pakistani infrastructure across the board.

But Pakistan significantly harms its chances of attracting other international sponsors and developers on a large enough scale to end its power problems if it continues to blindly accept its circular debt issue.

Pakistan needs to rid itself of circular debt. But while Dar and the finance ministry are vocal about not paying this time, no one is really asking how to end it.