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LESSONS:

Energy Sector Restructuring Program

sector: Energy | country: Pakistan

1. The program could have included a mechanism of formal review after about 18 months to consider revising the content and timing of loan covenants. The objective would be to make the covenants more relevant to prevailing conditions, strengthen or bring forward some conditions, and waive or defer others.

2. The program derived its strengths from the following: (i) the Ministry of Finance was well placed to see the link between Pakistan’s macroeconomic crisis and the need for reforms in the energy sector; (ii) a well-thought out structure for monitoring and implementing the program was established; (iii) close coordination of the ADB loans with those of the International Monetary Fund and the World Bank.

3. Where possible, ADB should link its loan conditions to program aspects where it has strongly positioned itself in the policy dialogue and relationship leadership.

4. Difficult lending conditions like the requirement to privatize the Karachi Electric Supply Corporation are achievable, but both ADB and the executing agency must persevere over a long period, extensive support must be provided through technical assistance and policy dialogue, and a long-term perspective must be taken.

Lessons from Validation

Pakistan: Energy Sector Restructuring Program

This Validation agrees with the Lessons to be learned that are identified by the project completion report (PCR) and paraphrased as follows:

1. The early processing of the loan and the success with respect to meeting the loan covenants demonstrate the importance of investing time in loan processing and setting tough conditions for loan approval.

2. The Program could have included a mechanism of formal review after about 18 months in order to consider revising the content and timing of loan covenants. The objective would be to make the covenants more relevant to prevailing conditions, strengthen or bring forward some conditions, and waive or defer others.

3. A well-thought-out structure for implementing the Energy Sector Restructuring Program (ESRP) monitoring was established. The loans for the ESRP were closely coordinated with those of the International Monetary Fund (IMF) and other development partners, particularly the World Bank. This close coordination was a key strength in successful implementation of the ESRP.

4. If ADB attaches great importance to similar analysis, it should consider ensuring that commitment to undertake the analysis is irrevocable, for example, by making the work a loan condition and carrying out preliminary work before loan approval.

5. Where possible, ADB should link its loan conditions to aspects of the Program where it has strongly positioned itself in the policy dialogue and should take a leadership role in the financing partnership.

6. Difficult lending conditions like the requirement to privatize Karachi Electric Supply Corporation (KESC) are achievable, but ADB (and the executing agency or EA) must be prepared to persevere over a long period and extensive support must be provided through technical assistance and policy guidance.

Lessons from Project Evaluation

Pakistan: Energy Sector Restructuring Program

Unbundling and privatization. Water and Power Development Authority (WAPDA) was unbundled because the organization had degenerated into an unwieldy, overcentralized, and multilayered bureaucracy, dominated by political expediency and experiencing declining efficiency and quality of service. Even though the unbundling was carried out, operational and financial performance of the unbundled entities did not improve significantly. The unbundled distribution and generation companies do not have full autonomy, and there is little incentive for these companies to strengthen management and technical capabilities, reduce overstaffing and upgrade staffing skills, foster accountability, and root out corruption.

The privatization of Karachi Electric Supply Corporation demonstrates that private sector ownership in the energy sector has benefits in terms of efficiency gains. System losses are declining significantly, and Karachi Electric Supply Corporation’s financial performance has improved substantially since privatization, such that it is now self-financing since first turning a profit in 2012. This accomplishment is remarkable considering the environment in which it operates includes a constrained availability of fuel for its thermal power plants and an unfavorable security and law and order situation. Nevertheless, the lesson is that unbundling alone is not sufficient and that subsequent privatization is needed so that improvements in the operational efficiency of the power sector can be realized.

Electricity subsidies and regulation. Subsidization of electricity is a drain on budgetary resources and not sustainable in the longer term when an economy is growing and tax revenues are stagnant. Under the Energy Sector Restructuring Program, electricity subsidies were expected to be eliminated with the establishment of National Electric Power Regulatory Authority, and the tariff was expected to reflect and recover the full cost of production. However, the government continues to subsidize electricity, primarily to domestic and agricultural customers. The process by which subsidies are determined in Pakistan also undermines the credibility of National Electric Power Regulatory Authority and its efforts to create a competitive environment in the energy sector. Electricity subsidization is a politically sensitive issue that will not be easily resolved without strong measures by ADB. In retrospect, the Energy Sector Restructuring Program should have included the elimination of subsidies or, at least, reduction and careful targeting of them in the policy matrix as a condition for tranche release.

Staying engaged. The Energy Sector Restructuring Program comprised three loans. The largest (Loan 1807) was for $300 million and was designed as a three tranche plus incentive tranche program loan. The other two loans were a $50 million Asian Development Fund loan (Loan 1808) and a $5 million TA loan (Loan 1809). The government availed of the first and incentive tranches of Loan 1807 for $150 million as well as the $50 million Asian Development Fund loan when it complied with the first tranche loan conditions. The second and third tranches of Loan 1807 and Loan 1809, totaling $155 million, were declined by the government in 2003, when overall economic conditions improved. The cancellation of the balance of Loan 1807 meant that ADB no longer had leverage to ensure compliance with second and third tranche conditions, particularly the requirement that the unbundled WAPDA entities be privatized. The lesson here is that ADB should stay engaged with the government to enable follow-up of unfulfilled commitments and covenants as a condition for subsequent assistance in the energy sector. ADB also has a long history of being a major development partner in the energy sector in Pakistan and will continue to be so. Coordination among development partners and the government, particularly in the energy sector, is also strong, as evidenced by the joint preparation of an integrated energy sector recovery plan in 2010. ADB therefore has the opportunity to engage the government in policy dialogue with respect to several critical issues and to formulate an updated plan of action with other development partners on how to best help resolve the current crisis in the energy sector.

Cross-indebtedness. Cross-indebtedness has been an energy sector issue since the 1980s. Although the Energy Sector Restructuring Program provided the government the means to eliminate cross-indebtedness by financing the arrears out of the budget, the respite provided by the Energy Sector Restructuring Program was temporary, and cross-indebtedness became a major issue again shortly thereafter, reaching unprecedented levels of about PRs503 billion by mid-2013. The lesson is that paying down arrears of others creates a moral hazard and encourages some energy consumers to not pay their bills because of the knowledge that the government will eventually pay when the situation became untenable. The payment of arrears needs to be accompanied by a campaign of disconnecting delinquent customers and prosecuting those who steal electricity. The establishment of the Anti-Electricity, Gas and Oil Theft Unit in July 2013 under the Federal Investigation Agency of the Ministry of Interior is a first step in addressing electricity theft and cross-indebtedness. The government, however, also needs to consider providing security to those enforcing the rules.

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