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CPEC for all: Is Pakistan ready for private sector Chinese investment?


8/19/2017

Experts believe that foreign capital is expected to flow across the board with improved economic performance and the government of Pakistan and other corporate sector stakeholders are leaning towards the fish very deep in waters: the power sector. The Ministry of Water and Power announced earlier this year that Chinese companies will invest $35 billion in 19 power projects which will generate 12,134MW of electricity under the China Pakistan Economic Corridor (CPEC) project.

Other than the CPEC related investments, there are number of Chinese investments that are being considered in Pakistan. Abraaj Group signed an agreement with Shanghai Electric, a fortune 500 company based out of China, whereby 66% shares of K-Electric will be sold to Shanghai for $1.77 billion making it the largest such transaction in Pakistan. This deal with Shanghai Electric is tipped to be a turning point for the power infrastructure of Karachi as with its extensive technical expertise it will aid KE in further improving its infrastructure hence benefitting the city tremendously.
 
Karachi, being the industrial hub of the country, has an ever growing demand of electricity. The demand in the city is increasing at the rate of almost 5% every year. 90% of the head offices of banks, financial institutions and multinational companies operate from Karachi. Moreover, the city is the industrial hub of the country and plays a very significant role in catering to the demands of the whole country. A city so diverse and huge needs a very efficient energy plan to cater to both the commercial and residential areas. Karachi needs stable power infrastructure to thrive, which highlights the importance of investment at this stage. Shanghai Electric has shared with Ministry and Nepra, its investment plan of $9 billion in KE over the period of seven years.
 
In addition to receiving approval from Government of Pakistan, a crucial element for this deal to go through was a reasonable multiyear tariff for KE by Nepra. While the government is yet to give its approval, Nepra earlier this year has reduced KE's tariff substantially and put KE back on losses trajectory and the deal in doldrums. KE currently has filed a review petition and the deal now hinges on the outcome of Nepra's decision.
 
Established by Nepra in September 2002, MYT is a performance-based price control. It allows uncontrollable costs to be passed through into tariff, while controllable costs are subject to CPI-X price regulation. The assurance to earn reasonable returns and incentives to make investments are based on the investor's ability to meet efficiency targets, especially those relating to losses, set by Nepra. The term for KE's MYT ended in mid-2016 and therefore KE applied for renewal of MYT till 2026.
 
Despite KE's earning being significantly lower than IPP's, NEPRA cut the tariff from Rs 15.57 hK/W to 12.07h K/W which is bound to lead KE to losses and create a significant cash flow crunch. Generally, any news of tariff reduction is to be considered good news for customers, however, this will be a recipe of disaster for Karachi.
 
First, KE being a regulated entity needs to be allowed a tariff which ensures reasonable return for investment and provides incentive for investment. One would assume that KE's return would be exorbitantly high in 2016, however, a glance at KE's 9m FY-16 shows that its ROE is around 11% (prorated annual around 15%) which is very low as compared to guaranteed USD rate of 17% (which in PKR would be around 23%) offered to other power sector investors. Second, it is empirical to understand that the reduction in MYT tariff is not going to affect the end user in any way, as the consumer-end tariff is uniform across Pakistan as per the subsidy policy of the Ministry of Water and Power. This reduction at best will help lower the burden of subsidy and in no way affect the tariff for end consumers.
 
Lastly, putting KE into losses means putting Karachi a decade back as inability of KE to make the planned investment of power projects would translate into increased load shedding and depleted quality of supply across the city. This will have a negative effect on the economic output of the city and quality of life in Karachi.
 
While KE can plead its case for a higher tariff, it is the sole role of NEPRA to balance the interest of both consumers and the power utility and allow a tariff which ensures sustainability, viability and investor confidence. A rupee-based return of less than 20% is already significantly lower than what Nepra is allowing to other private investors in rest of Pakistan. Any further reduction to KE's tariff will definitely woe away the investors from KE resultantly driving away investment for Karachi.
 
Despite KE's shortcomings, the importance of privatization and investment in KE cannot be denied. Abraaj Group took control of K-Electric in 2009 and has been able to financially and operationally turn around the company which is acknowledged by all. However, the company is yet to turn customer centric and it struggles in times of natural challenges like heat wave and rain. The company has come a long way and has still has a steep journey ahead. KE has already shown its willingness to commit investment of PKR 496 billion for next ten years' subject to a reasonable tariff and now it's up to Nepra to decide the fate. Let's hope for the better future of Karachi and for Pakistan that sanity prevails and Nepra allows a tariff which instead of putting KE into losses offers reasonable return and ensure that committed investments are executed.
 
Chinese are not so naïve as to buy the mangoes that are rotting or are about to rot. Especially if they have other avenues for investment with higher returns available. Pakistan is finally in the emerging market arena, we better make the most of it. For this to happen, the government and its functionaries need to open up to private sector investment in a manner similar to government-to-government deals so that true benefits of CPEC can be reaped across Pakistan.