IMF agrees to Pakistan’s circular debt makeover

May 18, 2025 (MLN): The International Monetary Fund (IMF) has agreed to the government's detailed plan to address the long-standing issue of circular debt in the power sector.

The government intends to convert the existing circular debt stock of Rs2.4 trillion, equivalent to 2.1% of GDP, into Central Power Purchasing Agency (CPPA) debt, with a clear roadmap to eliminate it by FY31, according to the Country Report issued by the IMF yesterday. 

Under the plan, the government will clear Rs348 billion worth of circular debt by the end of FY25 through renegotiations of arrears with Independent Power Producers (IPPs).

Of this amount, Rs127bn will be cleared using already-budgeted subsidies, while Rs221bn will be paid through CPPA’s cash flow. An additional Rs387bn will be resolved through the waiver of interest fees, and Rs254bn will be settled via further already-budgeted subsidies.

Another Rs224bn of non-interest-bearing liabilities will remain unpaid and are not scheduled for clearance under the current plan.

The remaining Rs1.25tr will be borrowed from commercial banks to fully repay all loans held by Power Holding Limited (PHL), which amount to Rs683bn, and to settle Rs569bn of remaining interest-bearing arrears to power producers.

The government has assured that the borrowing will be secured on more favourable terms than the current servicing costs of the circular debt stock, which have been a primary driver of its continued accumulation.

These loans will be repaid over six years through revenues generated by a debt service surcharge (DSS), set at 10% of NEPRA’s determined revenue requirement.

To ensure adequate recovery, legislation to remove the existing 10% cap on the DSS will be adopted by end-June 2025.

The authorities have further clarified that there will be no fiscalization of any revenue shortfall, as adjustments to the DSS will be made annually to ensure full cost recovery.

Alongside this structural shift, the government has also committed to rationalising power subsidies in the upcoming fiscal year.

With energy sector reforms already showing initial results in reducing electricity costs, the FY26 federal budget will include lower subsidies than FY25.

However, to provide temporary relief and front-load the benefits of reforms, the government will introduce a time-bound electricity subsidy effective March 17, 2025.

This will be financed by a Rs10 per liter increase in the Petroleum Development Levy (PDL), generating Rs182bn annually.

The funds will be used to reduce tariffs for non-lifeline consumers byRs1.7/kWh.

Furthermore, the government has started receiving revenues from the captive power plant (CPP) transition levy, which is expected to contribute an additional Rs0.90/kWh tariff reduction at the initial stage, with more savings anticipated as the levy increases in future.

The total size of the subsidy will be strictly capped at 0.8% of GDP and will also cover outstanding liabilities of K-Electric and the former FATA region, agricultural tubewell support, and circular debt stock-related payments where required.

With the IMF’s nod to this comprehensive circular debt stock conversion strategy, Pakistan has taken a decisive step toward long-term power sector viability and macroeconomic stability.

The removal of interest charges on delayed IPP payments, historically a major source of circular debt build-up, will sharply lower the flow of new debt, enabling a gradual but firm decline in circular debt stock to zero by FY31.

The Fund is of the view that the circular debt flow of Rs154bn strongly outperformed the March indicative target ceiling of Rs554bn, driven by continued strong distribution company recoveries, timely monthly and quarterly tariff adjustments, and lower than expected interest charges to power producers.
 

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