Pakistan Faces Setback as World Bank Cancels $500 Million Loan: A Closer Look
In a major financial blow to Pakistan, the World Bank has canceled a $500 to $600 million budget support loan under the Affordable and Clean Energy (PACE-II) program. This decision underscores the challenges Pakistan faces in implementing critical reforms in its power sector, especially renegotiating agreements under the China-Pakistan Economic Corridor (CPEC). The repercussions of this decision will ripple through Pakistan’s already strained financial framework, potentially exacerbating its economic challenges and causing further instability.
The Background of PACE-II
The PACE program was designed to support Pakistan’s power sector reforms, focusing on affordability and clean energy. The World Bank had initially approved PACE-I in June 2021, releasing $400 million as the first tranche. PACE-II was meant to follow, with conditions tied to renegotiating energy purchase agreements, addressing power distribution inefficiencies, and reducing the flow of circular debt.
However, slower-than-expected progress in achieving these conditions led the World Bank to change its strategy. A spokesperson from the World Bank highlighted the lack of substantial reforms as a key factor in the decision to withdraw further budget support. This decision reflects broader frustrations over the pace of Pakistan’s economic and governance reforms, particularly in the critical energy sector.
Key Challenges in Power Sector Reforms
Stalled Renegotiations with IPPs
One of the major sticking points has been Pakistan’s inability to renegotiate power purchase agreements with Independent Power Producers (IPPs), particularly those established under CPEC. Despite efforts to revise deals and reduce electricity prices, China has repeatedly refused to reopen agreements. These power plants, set up under the 2015 energy policy, represent a significant portion of Pakistan’s energy infrastructure, but the lack of renegotiation has stalled progress.
This stalemate has also contributed to rising costs for electricity production. Pakistan’s reliance on costly power agreements, without addressing underlying inefficiencies, continues to strain its fiscal position and overburden consumers.
Circular Debt and Distribution Inefficiencies
The power sector’s inefficiencies have resulted in massive losses. According to the National Electric Power Regulatory Authority (NEPRA), inefficiencies in power distribution companies caused losses of Rs660 billion in the last fiscal year. Additionally, circular debt has ballooned to Rs2.393 trillion, far exceeding targets set by the International Monetary Fund (IMF) and the World Bank.
The government’s failure to reduce circular debt and plug distribution inefficiencies has been a significant impediment to securing further loans. The lack of progress in implementing a roadmap for private sector participation in power distribution has also raised red flags.
Implications of the World Bank’s Decision
Impact on Fiscal Planning
Pakistan’s budget for the current fiscal year assumed $2 billion in fresh loans from the World Bank. With the cancellation of PACE-II and no new budget support loans in the pipeline, this assumption is now in jeopardy. The government’s ability to bridge the $2.5 billion external financing gap identified by the IMF becomes even more challenging.
This shortfall could compel the government to seek alternative financing sources, such as domestic borrowing or reliance on bilateral loans, both of which carry significant risks. Domestic borrowing could crowd out private investment, while bilateral loans may come with stringent conditions.
Electricity Prices and Public Burden
Electricity prices remain a contentious issue, with per-unit costs hovering around Rs65 to Rs70, including taxes and surcharges. Efforts to renegotiate energy deals have yielded limited savings, while cross-subsidies—charged to higher consumption users to subsidize low-income consumers—continue to inflate costs for many. Eliminating these subsidies could ease the burden on residential and commercial consumers, but such a move requires political will and public support.
Meanwhile, public dissatisfaction with high electricity tariffs could lead to political instability, further complicating reform efforts. Striking a balance between affordability and fiscal sustainability will be crucial.
Economic and Political Instability
The World Bank’s decision not to provide new loans introduces significant uncertainty into Pakistan’s economic and political landscape. The loss of anticipated funding exacerbates fiscal challenges, potentially leading to higher inflation, reduced development spending, and slower economic growth.
Politically, rising electricity costs and stalled reforms could amplify public grievances, resulting in social unrest or heightened opposition to government policies. With a CCC-Plus credit rating, Pakistan’s access to international capital markets is limited, making it difficult to issue sovereign bonds or secure Eurobonds. Finance Minister Muhammad Aurangzeb’s optimism about borrowing on favorable terms will be tested in the coming months, as economic pressures mount.
World Bank’s Continued Support
Despite the cancellation of PACE-II, the World Bank remains engaged in Pakistan’s energy sector through other initiatives. It has committed $1 billion in additional financing for the Dasu Hydropower Project and is actively supporting the Electricity Distribution Efficiency Improvement Project. These projects aim to enhance efficiency and promote clean energy, aligning with Pakistan’s long-term energy goals.
Additionally, the World Bank continues to provide technical assistance for reforms in power distribution companies (DISCOs). This support is crucial for addressing inefficiencies and promoting private sector participation, which could pave the way for sustainable improvements in the sector.
Conclusion
The cancellation of the PACE-II loan by the World Bank serves as a wake-up call for Pakistan’s government to accelerate its power sector reforms. Addressing inefficiencies, renegotiating energy agreements, and reducing circular debt are critical steps to restore investor confidence and secure financial support. While the challenges are immense, a strategic and transparent approach could pave the way for a more sustainable energy future and financial stability for the nation.
However, the broader implications of this decision point to a deeper instability within Pakistan’s economic and governance systems. The government must act decisively to address public dissatisfaction with electricity costs and foster stability. Prioritizing reforms, fostering public-private partnerships, and ensuring transparency in governance will be essential to navigating these turbulent times and achieving long-term progress.
The road ahead is fraught with challenges, but with decisive action and inclusive reforms, Pakistan can navigate its way toward economic resilience and regain the trust of international lenders.